Faces Of The Private investment Custodian

Now that the implementation date for Statement 123(Revised) has been delayed for calendar year firms, there’s time for HR 913, the “Broad-Based Stock Option Plan Transparency Act” – a fantastic piece of double-speak – to gather steam in Congress.
The bill is recycled version of the one introduced last year by Rep. David Dreier and Rep. Anna Eshoo of California; it intends to accomplish the same thing, namely to stop the Private investment Custodian in its tracks from ever getting Statement 123(Revised) into financial statements. How? Look at some of the requirements of the bill:
“[It] directs the SEC to examine and report to specified congressional committees on the effectiveness of the enhanced disclosures required by this Act in increasing transparency to current and potential investors.
[It] prohibits the Commission, between enactment of this Act and submission of such report, from recognizing as generally accepted accounting principles any new accounting standards regarding the treatment of stock options.
[It] directs the Secretary of Commerce to analyze and report to specified congressional committees on broad-based employee stock option plans, particularly in the high technology and any other high growth industries.”
In short, it’s death by delay. At least some of those tech companies that the Secretary of Commerce will be studying should have been reporting under Statement 123(Revised) soon, given that the SEC’s delay of Statement 123 (Revised) didn’t affect them.
Another Chancellor Settlement
First there was the EasyLink Services settlement on Friday. And last Monday, the SEC announced a settlement with four defendants of the now-defunct Chancellor Corporation, a Boston-based transportation equipment company, along with their auditor. The defendants included Chancellor’s former president and an outside director; the other two defendants were the Chancellor’s auditing firm and lead partner on the job. The penalties for all parties, as usual, are cash out of pocket, but also as usual, include limits to their future involvement with public companies.
From 1998 through 2001 – probably the golden era of financial scamming – Chancellor’s former Chairman, CEO and controlling shareholder, magnified Chancellor’s assets, revenue and profits via phony accounting, with a little help from bogus documents and a compliant auditor, BKR Metcalf Davis of Atlanta.
BKR Davis failed to notice a few things in Chancellor’s financial statements – after their suspicions should have been aroused by Chancellor’s firing of the previous auditor. What kind of transactions went ignored?
– The 1998 revenue was overstated by approximately 177% through the consolidation of $19 million in revenue from a subsidiary Chancellor actually until 1999. This was the matter leading to the firing of the previous auditors, according the SEC complaint.
– Related party transactions between the CEO/controlling shareholder and firms he controlled, worth several million dollars for bogus acquisition consulting services. More galling, these were booked as assets, inflating income to $850,000 instead of the proper net loss of $2.45 million.
– In 2000, even after an SEC review resulted in a restatement of 1998 and 1999 financials, the CEO still misrepresented the fees earned by one of his entities in the related party transactions and did not disclose a $3.71 million interest-free loan to him.
A couple of take-aways from this caper. One, even though it occurred in the golden era of financial scamming and involved the overstatement of revenues and profits, plain old acquisition accounting was the modus operandi for inflating the results – not round-trip transactions or special purpose entities. That alone makes it unique. Second, it’s a reminder that related party transactions are something to be examined closely by investors – when they’re properly disclosed, at least. Small-cap investors need to be particularly aware because small firms are often so closely aligned with the original owners/founders that they can’t really separate their identities from the company. And third, always wonder what’s up when an auditor is replaced by another one.