May 2004 Newsletter
Issue Five, Volume Five

THE MOTHER OF ALL FINANCIAL SCANDALS

By Mike Gasior

The past few years have presented us with a literal parade of financial scandals involving an amazing variety of stories and a cast of characters even Hollywood would have difficulty dreaming up. Let me quickly refresh your memory with just a few names:

• Enron
• WorldCom
• Rite Aid
• ImClone
• Adelphia Communications
• Tyco
• Waste Management
• Cendant

The dollar amount of fraud committed by the companies listed above total something just under $20 billion. I would need to add the entire Wall Street research scandal, the current mutual fund scandal and probably Martha Stewart's 40 grand to get us to the $20 billion level.

Now, what if I could tell you of a scandal that was at least 10 times the size of all of those already mentioned COMBINED, and even included a bunch of dirty politicians and diplomats? Would you agree that it might qualify as the mother of all financial scandals?? Well then, read on my friend, and ask yourself why you haven't heard anything about a story of this magnitude from the mainstream media.

Because of some horrific travel problems for me recently (more on that later), the video commentary will be uploaded to the website this weekend. Visit the homepage on Monday, June 7th to view it. The topic I chose was very interesting and I think you'll agree. The homepage is:

http://www.afs-seminars.com

Now let's move on to the topics for this month.

THE BIGGEST FINANCIAL SCANDAL IN HISTORY

I took some flack last month from a handful of people who felt I was picking on the French again with my telling of the Executive Life story. It is unclear to me where I had been unfair, given that the French government had been the one who entered a guilty plea to criminal fraud in a U.S. courtroom. What I feel compelled to warn you about is that if you felt the French were made to look bad last month, then you should skip the remainder of this story. It will make them and a cast of others look considerably worse.

Let me begin by saying that the mess in Iraq is beginning to wear on me somewhat, and knowing that 802 American service men and women have died in the conflict so far makes this a very somber Memorial Day for me and many others. While Iraq will be the central figure in the scandal I am about to outline for you, I want it clear that the story isn't a commentary on the current situation, but a story of graft and corruption at the highest levels of world politics.

After the Gulf War in 1991, it is common knowledge that the United Nations passed a resolution aimed at aiding the rebuilding of Iraq that came to be known as the Oil-for-Food program. Since Iraq was under sanction after the Gulf War, this humanitarian resolution was aimed at keeping the people of Iraq from suffering starvation in the aftermath. The United Nations appointed itself as overseer of the operation, as well as the chief bookkeeper.

As one might suspect, our friend Saddam Hussein tried as much as humanly possible to circumvent monies from going toward the public good, and instead fill his own pockets with secret cash. This ended up being easier than he could have imagined since he found there was quite a line of people more than happy to do the same exact thing. Just recently the Iraqi Governing Counsel released a list of 275 power brokers who had made deals with Saddam to either buy oil at prices far below market prices, or sell food and other supplies to the Iraqi government. All this money was required to flow through the U.N., who was supposed to be "in charge" of making sure that everything was above board and that Saddam was not using any of the money for things not included in the Oil-for-Food program.

It does not take much imagination to think that Saddam might have cut kickback schemes with these power brokers for him to receive secret payments for selling the oil to them below market, or for buying goods from their companies. The General Accounting Office (GAO) just released a report that Saddam's take from the Oil-for-Food program totaled about $10.1 billion, of which, only a small portion has been recovered. There are some who suspect that this money may be helping to support the current level of opposition by the radical factions within Iraq.

More troubling are some of the people whose names appeared on the list of 275 released by the Iraqi Governing Counsel. Let me give you a very short list of those who received some of the cheap oil that Saddam sold and most likely kicked money back to Saddam in secret:

--In total French oil traders received 165 million barrels of crude oil at below market prices.

--The CEO of the French company SOCO International personally got vouchers for 36 million barrels of oil. You might find it interesting that this man is very close to French president, Jacques Chirac, and is a large political contributor to his campaigns.

--The former French Ambassador to the United Nations, Jean-Bernard Merimee got an allocation of 11 million barrels.

--Also interesting is that the French bank, BNP Paribas, was chosen by the U.N. to be the bank that would handle all the money for the Oil-for-Food program. At the time of this decision, Francois Mitterrand was the president of France and he had close, long standing ties to BNP Paribas.

--Altogether, 42 French companies and individuals got pieces of this lucrative relationship with Iraq.

--Not to be left out, assorted Russians received allocations of over 2.5 BILLION barrels of oil, with the Russian government getting 1.4 billion of them.

Now for the MOST troubling part, which is the level of possible corruption going on within the United Nations. The old saying is that a fish will rot from the head down, so let me begin with U.N. Secretary General Kofi Annan.

--When a decision had to made regarding what company to hire to monitor the food and medicine being shipped into Iraq, the contract went to a Swiss company named Cotecna. What is of issue here, is that an employee of Cotecna between 1995 and 1998 was a gentleman by the name of Kojo Annan, who happens to be the son of Kofi Annan. Although he left Cotecna in 1998, he returned as a "consultant" a couple of months later during the period that Cotecna would have been preparing the bid for the United Nations. He disappeared from the scene right before the contract was ultimately awarded. Oddly, none of this was disclosed by the U.N.

--The United Nations has received a total of $2 billion dollars for performing the administration of the Oil-for-Food program and they may actually deserve that money. What is upsetting, is that the senior United Nations official who supervised the program, Benon Sevan, got 11.5 million barrels of the cheap oil himself from Iraq.

--If Iraq wanted to use ANY of the money from this program for things other than food or medicine, they needed the Secretary General himself to approve the allocation. I can't help but wonder the humanitarian reason for approving $20 million for Uday Hussein to build a sports complex, or $50 million for Saddam to buy television and radio equipment, yet Mr. Annan signed off on both expenditures. It is little surprise that Kofi Annan stated in 1998, that Saddam Hussein was someone "I can do business with."

There is much, much more to this story, but I will spare you the endless details. The United States has spent months trying to view the bank statements regarding this program looking for some sort of trail that might lead to the $10.1 billion that Saddam has stashed away somewhere in the world. So far the United Nations has completely stonewalled the request, and has reported that some of the documents and bank statements might be missing.

Many are now calling for a complete and thorough investigation, and even Kofi Annan has admitted that he supports such an inquiry. Even the former Chairman of the Federal Reserve, Paul Volker, has volunteered to head the panel to look into what happened. The unfortunate thing is that Mr. Volker has agreed with the stipulation that the U.N. Security Council must authorize the investigation since they have ultimate control over the documentation containing the evidence. Since two members of the Security Council are France and Russia one can assume that there will be no such authorization coming any time soon.

Luckily, the U.S. Congress will conducting its own hearings into these matters, and the Iraqi Governing Counsel has hired KPMG International to perform a complete audit based on Saddam's meticulous record keeping. The KPMG report is due in a couple of months.

As best it can be estimated, this brewing scandal totals around $200 billion and involves plenty of foreign intrigue. Sadly, I'm willing to wager that not only will no one be charged with anything criminal, not very much will actually result at all. What I wonder is how much longer the United States is going to be willing to provide 22% of the funding for this increasingly useless and probably corrupt organization.

STICKING UP FOR FRIENDS

Let me start by telling you that I tend toward being the best kind of friend you can have, since I'll never let you down when you need me. Should we be in a bar together and you find yourself getting into trouble, you never have to worry where Mike is. Mike will be the one hitting somebody with a barstool sometime very shortly and expediting your departure from the scene. I also tend toward this sort of behavior when I see someone attacked unfairly or picked on by a bully. This is the framework and context for the following story.

A week ago I was supposed to be returning from Chicago and found my flight, and many others, delayed due to severe thunderstorms and possible tornados. Ultimately my flight was cancelled as well as the following one that I was "standing by" for. At this point it was almost midnight and with the thousands of people stranded there was not a hotel room available with 15 miles of the airport. Since I was fortunate to be booked on the first flight out in the morning, I elected to spend the night in the airport and make the best of it. Although American Airlines was kind enough to set up hundreds of cots with blankets and pillows near a Wolfgang Puck restaurant, it reminded me too much of a homeless shelter and I grabbed a couple of blankets and pillows and headed off to find a place with more privacy. In case it should ever matter to you, a lovely place to spend a Friday night's sleep is behind the gate counter at Gate K4 at O'Hare. The thin carpeting does little to buffer you from the concrete underneath, but welcome to the glamorous world of international business travel.

Before settling in for my miserable night of almost sleeping, I figured I'd grab something new to read; and as I scanned the racks at the WH Smith my eyes suddenly became glued to the front page of that week's Barron's. The headline read:

"The Dirt on Fannie Mae - How accounting ploys at the mortgage giant, while legal, inflated profits and executive pay. Inside, our full report."

My attention was locked to these words because Fannie Mae has been a client of mine for over a decade and I couldn't find a place to sit down and read this article fast enough. Was this the beginning of another huge accounting scandal I wondered? Was Fannie Mae about to be dragged into the abyss that had ruined so many other companies? I needed to get to the facts as fast as possible before my imagination got the better of me.

Just so you know, just because you are a client of mine, doesn't mean I'm going to defend you if you're in the wrong, although I may keep my mouth shut. But being a client of mine does mean that nobody is going to say anything untrue about you without me hitting them with a barstool.

I will quickly sum up my opinion of the Barron's article in a single word: crap.

Seldom have I ever read an article that was more inflammatory, misleading and filled with hyperbole than this one. Quite frankly the article made me furious and want to vomit at the same time. When looking at some of the passages I couldn't tell whether I was actually reading a staid financial newspaper, or The National Enquirer. Let me give you some of my favorite lines directly from the article:

"Indeed, a Barron's analysis of Fannie's accounting methods finds that, while legal, they obfuscate rather than illuminate Fannie's true financial condition, allowing billions of derivative-related losses not to be reflected on its income statement."

"Also, Fannie seems to play a number of different accounting games to keep up appearances. A quirk in GAPP accounting has allowed Fannie to defer literally billions of dollars of derivative losses and thus keep the red ink from having a material impact on Fannie's "core" earnings. And as a result, Fannie's reported capital supporting its investment portfolio is significantly overstated."

"For Fannie, though, hedging has become more than a means of protection. A loophole in hedge accounting rules has also permitted Fannie in recent years to continue to show steady, strong earnings growth despite suffering billions of dollars in derivative hedging losses from interest rate bets gone awry."

"Of course, Fannie has no monopoly on slick accounting and clever disclosure, though few companies are as adept as Fannie in what it says, doesn't say and implies in its pronouncements. But clearly Fannie, as a quasi-government adjunct, has found a winning formula to both boost its profits and enrich its management."

Now I don't even know where to start, although one can't help but pee their pants laughing about the idea of Barron's analyzing ANYONE'S accounting methods, much less a corporation the magnitude of a Fannie Mae. I would be blown away in amazement if this crack, analytic team over at Barron's contained a single Certified Public Accountant, but I digress.

Many thousands of you reading this newsletter have attended my programs over the past five years, and no doubt were lectured to by me about the new accounting rule that was going into effect for U.S GAAP accounting for derivative instruments. The rule was FAS 133, and it went into effect for most U.S. companies at the beginning of 2001. FASB (the Financial Accounting Standards Board) who enacts all the rulemaking for how GAAP accounting is supposed to be done had begun looking at changing how derivatives needed to be accounted for dating back until 1991. The impact that FAS 133 was going to have on companies was thought to be so onerous and expensive that the Federal Reserve, SEC, House & Senate Banking Committees and many others openly and actively lobbied FASB to temper their decision about its implementation of FAS 133. Not bending at all to the intense lobbying effort, FASB choose to err on the side of being more conservative and issued the new ruling to the dismay of many in the financial community. Hundreds of my client companies were affected by the new treatment.

Now I remind you of the choice of language used by our friends at Barron's:

• "accounting games"
• "slick accounting"
• "clever disclosure"
• "a quirk in GAAP accounting"
• " a Barron's analysis of Fannie's accounting methods finds that, while legal, they obfuscate rather than illuminate"

A quirk?? Clever disclosure?? Is Barron's kidding me with using these sorts of ridiculous comments to paint some sort of picture of distortion?? I find it difficult to contain the anger here. The media and I have never really gotten along, but it is at moments like this that I am staggered by either the level of stupidity or the advancement of some hidden agenda that must be at work here.

I will tell you the only important fact that you need to understand about this story:
Fannie Mae was required to comply with FAS 133 and report their holdings precisely how they did, or their independent auditors would not have signed off on their financials and Fannie Mae would now be in extremely serious trouble. To put it more simply, Fannie Mae was simply complying with the law. This is the dirt on Fannie Mae that Barron's sought to share with readers.

Since it was the simple compliance with FAS 133 that Fannie Mae was guilty of, you would have figured that Barron's might have found the space to actually refer to the FASB ruling even once in the verbose six pages they dedicated to presenting the story. But sadly, instead of mentioning the accounting rule by its actual name, they decided to reference it as an "accounting game" or as "slick accounting". At this point, I am struck at the only party being slick and using clever disclosures is Barron's.

I'm just plain sick of stories like these, which are not only non-stories but also nonsense. I would have to imagine there might have actually been serious news that could have been reported rather than a witch-hunt type of story that only seeks to incriminate people who have done nothing wrong.

So there you have the story on Fannie Mae. The accounting rules were changed and Fannie Mae was guilty of complying with them.

More interesting is that a Mike Gasior analysis of Barron's reporting methods, while legal, showed that they seem to have their heads up their a**es much of the time. But I digress again.

ONE QUICK MUSICAL RECOMMENDATION

I saw a story in the news yesterday that prompted me to think about an artist I haven't mentioned to you previously. Even though this artist died in 1938, he has been a huge influence to many people and bands during the almost 70 years since his death. Now you may not think you're a fan of the Blues, but listening to Robert Johnson play the Blues is something difficult to describe. The first time I ever listened to one of his albums I sat transfixed, trying and wanting to hear every note and understand every verse. Back in 1990, Sony Records released a box set of Robert Johnson's music that they figured would sell a few copies to hard-core Blues fans. In a massive surprise, the box set sold over 500,000 copies (gold status) and won a Grammy. Not too bad for a guy dead for over 50 years and who many of you readers have never heard of. Everything about Robert Johnson is legendary too, even how he died. Supposedly, a jealous husband poisoned him in a bar in Greenwood, Mississippi and Johnson was so poor and unloved that they just threw his body into the grave without even a coffin. To this very day, the rumor in the Mississippi Delta is that he had sold his soul to the devil in return for the musical abilities he possessed. There was no other way to explain his haunting voice that sounded like no one else, or write the music that he wrote.

Anyway, if you should feel adventurous, try tracking down a Robert Johnson album somewhere and give it a try. I think you might enjoy it, or at least widen your appreciation of the Blues.

If you'd like to read the touching news story that prompted me to make this suggestion, you can view it at the following link:

http://story.news.yahoo.com/news?tmpl=story&u=/latimests/20040602/ts_latimes/bluesmanssongetshisdue

YOUR MONTHLY BRAIN TEASER

I'm still trying to avoid mathematical questions for a least this month and have another musical quiz for you. It seems people enjoyed last month a little, and this one has a somewhat different bent to it.

Two lines from a very well known song have been put into some extremely fancy language below. Can you put the words back into their original form?

"For at least 12 hours and possibly more, I myself have been engaged in arduous travail on the equipment that carries a wheeled, powered conveyance."

To view the answer after some earnest effort on your part just visit:

http://www.afs-seminars.com/brainteaser_May2004.html

And the answer to LAST month's brainteaser is:

Rod Stewart

http://www.afs-seminars.com

Copyright 2004, Michael Gasior. All Rights Reserved.

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