coming up next stay with us. welcome to the kaiser report. is or you know recently the prime minister here in the u.k. david cameron claimed the profits were not a dirty word i have news for you dave profit is an even a word and i with any objective meaning anyway thanks to accounting fraud it's whatever some shot of the bean counter wants to be and so so you do have all these units of accounting fraud let's call them profits then what stacey exactly max because we hear all the time profits are up profits are down profits are up profits are down and nothing ever seems to change in the real economy this first headline near the profits profit profits have been booming in america reaching the highest proportion of g.d.p. since the second world war given such boyens conditions you might imagine that

businesses are investing like crazy to take advantage of all those great opportunities correct no they're not max because instead businesses are handing cash back to shareholders a tactic once reserved for executives who had run out of ideas in two thousand and eleven the value of america's share buybacks was equal to two point seven percent of g.d.p. in britain the figure was three point one percent. well you bring up a couple points there the the important point here is that when the corporations report on their profits that is a number that is delivered to them by one of the big four accounting agencies to report as their profit but what we've discovered is that these big four accounting agencies like the banks on wall street like the hedge funds like the rating agencies are also committing massive fraud and they simply cook the books on the mandate of the c.e.o. who wants to report numbers that they feel are the best in terms of how to

affect stock price except for jack welch of general electric very famously was a bookkeeper every single quarter they reported this earnings number that was cooked by whoever their accounting was at the time and of course you'll have big four of big four left of the accounting agencies or used to be the big seven the big eight except her but they've all been systematically closed down for accounting fraud now i've got four left they're all involved in accounting fraud and i'm sure that pretty soon to be only three left well the article on the economist is looking at a new book and it's called the road to recovery how and why economic policy must change is by andrew smithers an economist and he knows that in the early one nine hundred seventy s. american companies invested fifteen times as much cash as they distributed to shareholders in recent years the ratio has dropped back to below two look at this chart cash out the ratio of cash spent on investment versus cast to ship it to

shareholders and that's declined and yes he points out that there are two major reasons one of them is that executives are paid in bonuses now by and large rather than in salaries so their incentive is to use the cash on the books of the company to invest in their own christmas bonus rather than in the future of the nation the economy or the population they're not reinvesting in the company itself they're extracting the equity along with all the shareholders right well used to be that corporations would boost their stock price by increasing what they. due for the business of the corporation they would make more cars or they would deliver some kind of enhanced services or drill more mind more but since the invention of derivatives modern derivatives market starting really in one nine hundred eighty s. and then all the deregulation went on the same time corporations now mostly make money by financialization and by training and by arbitrage and by currency manipulation and market manipulation and accounting manipulations other words most

of the corporations profits are derived from accounting manipulation and financialization an arbitrage and other related kind of paper profits but the actual underlying activity of the corporation is no longer would drive the growth of that corporation the profits all come from rigging the system and that's exactly what that statistic shows is that cash is being paid back to shareholders on top of the cash that they are gaming from the says gaming the system but they're not actually engaging in expending money on their businesses to improve their work get more work create more jobs do more productivity etc that's the headline of this book points out it's about economic policies that david cameron should be worried not so much about profits he shouldn't care about that that's not his role his role is economic policy in governing that and whereas here buybacks tend to boost earnings per share investment decreases earnings per share so he should find a way for them to invest in the economy because he shouldn't care how much they're

bringing home for christmas bonus he should care about the future of the nation the economy of the nation and the world well in the case of let's amazon the retailer they are investing in their own company jeff bezos very smart guy their stock prices it's not down it occasionally because he has invested in the infrastructure of his company invest in the company really more than what he i'm just trying to piece the was. however at the same time he is not paying anywhere near the taxes that he should be paying in the u.k. so he's gaming the system on the financial as well but david cameron in other words is wrong on both scores number one he's wrong not to force amazon to pay taxes and number two he's wrong to equate profits. divorced of any analysis of why those profits come from as a university being good you have to you know he just speaks in sound bites that

especially he's economically illiterate essentially is what we're talking about and so he the nation as a whole then becomes economically illiterate when the prime minister is a complete jackass when it comes to describing how corporations report their earnings and profits so you brought up remuneration how the payment for the c.e.o.'s in the senior executives are tied to the share price in particular they also talk to share options and i know you're a big options trader so this will be your sort of special topic here many executives are rewarded in the form of share options for meeting targets options are more valuable when they are linked to a volatile asset the more the asset price moves the more likely it is the option will be exercised since share prices are affected by trends and profits executives have an incentive to pursue strategies that make profits more mala tile and indeed until two thousand profits in the national accounts data had very similar volatility to the reported profits of s. and p. five hundred companies since then the latter have been four times as volatile more

microsoft a great example of someone who's gaming the options market to boost their bonus payments and to massage errors on their balance sheet and income statement as well but basically what they're saying here is that we are familiar with the idea that executives are paid stock options instead of cash and those stock options go up in value if the stock price goes up in value and the stock price can go up in value if one of the big four reporting accounting agencies. phony earnings for the quarter that boost the stock price thus the option price and then the executive cashes in those options what you're saying here is a new twist to the game which is that volatility in the options market affects our options are priced and if you can get your accounting firm to come in with lower earnings than you're actually reporting in one quarter and then crash the stock but then get your options priced at that level and then have the following quarter have your accounting firm massage the books to report earnings beyond the one you're

actually making and you can boost the options price when you cash them out so you've got the accounting firms the options trader and the c.e.o. and the executives all colluding to game the system to extract wealth we saw by the way apple computer after nine eleven when their stock crashed they then jumped into the market to price options based on the post nine eleven crash lo those executives and cashed out based on the nine eleven tragedy so they monetize the nine eleven tragedy the apple executives and we see that across the board the fortune five hundred companies gaming the system exploiting tragedy when they can and certainly what everyone else thinks is almighty god nine eleven what a tragedy there's apple like the talk left let's make the money on this tragedy is to scrape will also they point to the fact that all these changes came about because driven by mark to market accounting firms mark up a value of their assets during good times and then write them down in the bad there

is no equivalent to this in the national accounts in mr smithers view that means american profits are overstated particularly at the moment indeed according to the national accounts american companies have been paying out in cash more than one hundred percent of their domestic profits to shareholders there's a two fold problem here so number one is that these companies in america have not actually deal leveraged the hype the mainstream media tells you that all this deal leveraging has been done the economy is on its way to recovery the other thing is because if there actually are not so d. leverage we could be on the verge of another crisis an economic and financial crisis well. the prices on the books these corporations and in particular the banks by the way are which they use both as collateral to finance more lending more loans more capital for themselves as well as in gauging emergent acquisitions or

the buying other companies is overstated substantially and so if you have any kind of mark to market if you have any kind of rationalization where they say particular in the case of banks that the bonds on their balance sheets are not worth one hundred cents on the dollar they're worth actually ten cents on the dollar then you have a repeat of what we saw in two thousand and eight or the massive undertow of deflation which is being masked by accounting fraud and money printing is revealed to show that the economy in the corporate nations that make up the economy are vastly overstating their network than income and so you have a huge crash so speaking of accounting firms many of the accounting firms are now morphing into consulting firms and this isn't our final quick headline here mass i t project is latest black eye for delight this is a massachusetts and an internet technology project in this brochure do lloyd consulting proclaims a record of smooth implementations of complex technology projects but in courts

school systems and government agencies in several states the rollout of computer systems built by the global consulting firm has proved to be anything but smooth so they said from california to florida to pennsylvania to massachusetts time after time all of their programs are coming in way over budget or actually not even delivering anything that's actually even usable right while the counting from displaying themselves into two so instead of having a full service accounting firm like arthur andersen involved in the enron scandal where they had to go after and say well your accounting business of what you do is committing fraud so we're going to have to shut you down they say they outsource their fraud to a consulting firm which they have an intimate relationship with and then they have the consulting firm commit all the fraud but this the effect is the same for diluting. p.m.g. and arthur andersen and the whole group of them commit this massive fraud as part of a conspiracy colluding with the rating agencies in the banks so they go into one in particular case for deloitte and this is in florida's miami dade county school

officials fired deloitte in two thousand and nine part way through an eighty four million dollar contract to overhaul the district's computer system after paying to light thirty million and having virtually nothing usable they could rescue superintendent albert viro fired them he said after much review the best thing to do was terminate deloitte and we did with a vengeance we cut out the middleman this is the thing is that this is the tollbooth economy these middlemen who are the sort that practice these profits that david cameron seeks whether is to lawyer or apple or i just basically they profit from terrorism money laundering and all kinds of social. mishaps all right stacey newman thanks much bring on the guys report thank you max stay tuned for the second half a lot more. i'm talking about obviously about edward snowden and you know that some americans

believe he's a hero i'll just believe he's a criminal what he's done i believe he's a hero of my belief he's directly from his heart that he feels some goodness that he wants to be truthful to the american people that he believes in and loves his country america so strongly and i wish that somebody in the same situation i hope that i have the courage to do the same thing. right the same. first trip. and i would think that your. on army orders later.

tonight welcome back to the kaiser report imax guys are signed out to go to chicago and speak with francine mckenna of the auditor's dot com ran saying welcome back to the kaiser report allowed thanks for having me all right francine mccann to big for audit firms are morphing into the big four consulting firms tell us about why this is happening and if it matters. well it's happening in spite of the fact that sarbanes oxley was supposed to stop all that if you remember when sarbanes oxley was put in at force in two thousand and two after the enron failure and arthur andersen's involvement in and run failure they said never again will you have an audit firm that was conflicted that was doing to manage work for their clients such

that they lost sight of their responsibility for out it but in the tank plus years that we've had since then nobody's enforcing those rules nobody isn't forcing those restrictions and so the firms have gone all right back to where they started and actually probably even better delight never stops the other three firms had to rebuild after selling or consulting firms and waiting for their known competes to to expire yeah we mentioned this in the first half of the show citing the example of enron and arthur andersen so here you had an accounting firm that was wrapped up in massive fraud there was some kind of action and sarbanes oxley and then you've got the lawyers just ignoring this completely they are separating their businesses to avoid complying with any kind of reasonable standard of accounting and also this should be noted that the traders that were involved in market manipulation for enron simply went to other trading firms including j.p. morgan and started doing the exact same false trading of energy contracts as well

so absolutely nothing was done to stop that enormous massive fraud in the american economy but in the case of these consulting firms i said in the first half i want to get your thoughts on this basically the idea is just to outsource the fraud to the consulting firm because a consulting firm doesn't fall into the same regulatory framework correct they're really in sort of a limbo i've talked to the as c.c. i've talked to the p.c. o.b. the new audit regulator and said who really looks at whether or not a consulting firm is conflicted or has independence restrictions in particular if there were. being on something that relates to their prior art at work for example the lawyer was the reviewer at j.p. morgan for the foreclosure of yos lo and behold the work that they were really looking at related to bear stearns and washington mutual their former audit clients so they're sitting there reviewing these mortgages reviewing these transactions to see if any of the customers

a been defrauded and yet they're being sued by the shareholders of their sterns and washington mutual for their failure to audit those transactions while they were at bear stearns or washington mutual it really was a farce and nobody seemed to think that it was their responsibility to look at delight's role as a consultant really the only one who has standing to sue is the client itself and j.p. morgan was not going to be suing them i was sort of i heartened by this situation in the u.k. with angie rover where delight did get slammed and find a pretty significantly such that they're even appealing as they were the auditor of energy rover before they failed and before they failed they started helping the executives take as much money out as possible loot the company through various compensation schemes and those executives were slammed but more importantly delay was slammed for the conflict of interest or not me energy their public duty where

you ended up with others paying for those mistakes are us talk about delaying to the largest of the big four the lloyds banana dozens of huge id contracts for state and local governments. so how are these contracts go thuram well delight was the only firm of the big four that didn't sell or consulting are after sarbanes oxley was an act it the other three firms saw this coming in said maybe we won't be able to do consulting work in particular to our to clients let's get out of this let's focus on audit and they. did there for a little while the too late never never sold or consulting and they kept going and their primary focus is that or a service a state local government can check so they do that all over the world they do a lot of work for the u.s. defense department and other sovereign governments but here in the united states they do a lot of work for state local governments they're still one of the firms of build custom applications for things like retirement systems and pension systems and

unemployment systems and they're getting in trouble all over the united states a fact the boston globe has had a series of stories about two contracts one with the light was fired and one where they love to fire than because they sunk millions and millions and millions of taxpayer dollars in with a system that failed and it's happened in other places like marin county like los angeles school district and now some cases in florida where they're worried that these systems are just money holes and the lawyer doesn't really take the same responsibility as they should as an audit for people are basically confused who is a lawyer is an audit firm a consulting firm they're consulting firm with a little bit audit audit firm with a little bit of consulting frankly consulting is growing in all of the firms much much faster double digits compared to single digits or not even growing at all in the in the rest of the firms right now the line to show is just sort of three

lawsuits over its audit taylor bean and whitaker mortgage corporation a lender has two thousand and nine collapse help spark one of the biggest bank failures during the financial crisis tell us more about this case well this case is thing going and since and this is an interesting case because it's wrapped up with another failure colonial bank which p.c. is being sued for by the f.d.a. i see so you had the fire case taylor being whitaker which was perpetrated a fraud certain executives have already gone to jail so executives went to jail a colonial bank was enabling a fraud a tailor. you know when a car and the auditors have been sued peter b.c. is still. fighting that lawsuit they might hopefully go to trial i really thought that deloitte was going to go to trial on this one it was due to go to trial in a couple of weeks in miami and it got settled confidentially maybe for a lot of money but certainly not at the level that it would take to take delight

down so some estimates have been made what would it take for another big four for to go under like anderson dead enders and went under because it was a criminal indictment by the u.s. justice department that will never happen again they know that mistake they decided not to make that mistake when katie energy was accused of terror shelter fraud and they did not indict k.p.n. g. criminally for that chris katie and she survived and thrived so that will never happen but what might happen is a big giant lawsuit from a private party or from some country outside the u.s. that doesn't want to follow the u.s. rules taylor being with her was that lawsuit was a seven million dollar claim they had overcome on motions to dismiss it was set to go to trial and it's settled i'm very sad about that because the only way we're going to know what really goes on and the where the public is going to see what a fire started has become is for one of these cases to go to trial and the firms

and their partners to open their big mouth and say something stupid that's what happens when they go to trial there was a case in australia centro where the peter b. c. went to trial the auditors are a partner went to trial and the case settled in the middle of the trial because the firm and a partner started saying stuff that was really stupid like blaming the low level staff and the firm claim department said because he signed the audit it was his fault not the firms so that's why i don't go to trial in the us they know that they're going to say something stupid they know that we're going to see how the sausage is made and they settle. fortunately for delight they surprise probably less than a billion dollar settlement right way mention the collusion of j.p. morgan in accounting fraud and in the case of the lawyer of course they can simply pay a small fine and then lobby congress and lawmakers to change the laws so that they can commit the same fraud over and over and over again but not get caught this is a pattern we've seen a wall street for decades people don't understand this is also the same pattern

with the big four accounting firms are caught breaking the law committing fraud they passed all fine and then they lobbied to have the laws changed to allow them to commit these frauds without being fined or penalized now the c.e.o. of taylor bean was sentenced to thirty years in prison for covering up funding shortfall by pledging ownership and thousands of the same mortgage loans to multiple investors now francine in the u.k. that's completely legal it's called re i popped the question right so why pick on this guy taylor being when this is really the defacto business model for the entire city of london. well you always end up with something to deal with when the firm fails so in that case taylor bean whitaker went bankrupt colonial bank failed was taken over by the f.b.i. see and one of the nice things is that when there's a failure there's a bankruptcy examiner report and we've seen over and over the other case was new century which was a k. p. and g. od occurring in early in the early in the crisis in two thousand and seven when

those firms fail lehman is a good another good example there's a baker's exam report that lays out very very clearly what happened they get investigative powers that are much more difficult if you're trying to do it through court and even with those breadcrumb so that they're very simple trail that points to culpability like the lehman bankruptcy examiner report pointed to culpability of the executives even of ernst and young audit for prosecutors the as the see the department of justice they're reluctant to take the firms down because they're so imbedded in the operation of the government deloitte who we've been talking about also audits the fed also audits blackrock and blackstone you know girl parts of what the federal government the u.s. had to do to try to recover buying assets for from. the director the crisis in the tarp program and other programs to try to recover from the crisis so

they need these audit firms because they're working for the government while they're working for private companies and they're working all over the world and they're part of this network and they play switzerland and they're protected by the government from prosecution reisa just to reiterate here that what they've got the c.e.o. tell are being on replacing the same securities is done by a just b.c. barclays lloyds and r.b.s. every single day in the city of london they call prosecution but it's just fraud now finally francine what's the latest on all the dodgy accounting at j.p. morgan's london the well and now its eleven billion dollar mortgage backed securities fraud charges. that settlement with the f.c.c. talk about a farce they wanted so much to patrol that as a sarbanes oxley when and they didn't use any sarbanes oxley legislation in order to go after either the executives individually the audit firm or anybody else that was involved again j.p. morgan paid a fine like they'll do in

a settlement that they're talking about now it may seem like a big number to us but it's just a cost of doing business and i'll keep going on. it seems to me that of all the frauds that the rating agency is the banks the fund managers the hedge funds the glue that keeps them all together are these big four accounting firms they're really at the nexus of this global fraud wave your thoughts. really they're supposed to be the guardians of the shareholders and capital markets and instead they're played playing both sides and the one that's losing is the shareholders taxpayers now have to pay for the bailouts when these firms bail and the firms are giving us no warning that they're even out nearing insolvency or illiquidity it's terrible and unfortunately they're they're the ones that are sitting in the middle of the whole thing playing switzerland and playing both sides of the fence and collecting billions and billions of dollars and as they're doing it in france

a macand i will have to leave it there thanks so much for being on the kaiser report thank you and that's going to do it for this edition of the kaiser report with me max kaiser and stacy herbert i'd like to thank our guest francine mckenna of the auditor's dot com if you like to get touched please tweet us the kinds of reports much fun. this is a media leader so we leave the. motions to the. party there's a good. news that no one is as you would to guess that you deserve answers from. politicking. on our. i think. we're going to go digital the price is the only industry specifically mentioned in the constitution and. that's because

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