Schilit - Financial Shenanigans

Second Edition

Howard Schilit

Copyright 2002 by Howard Schilit. All rights reserved. Except as permitted under the United States Copyright Act of 1976, no part of this publication may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system, without the prior written permission of the publisher.

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To my wonderful parents,
Ethel and Irving Schilit,
who taught me right from wrong
and to speak out when I saw wrong.

Teachers and mentors have played a vital role in my intellectual nurturing. The following will always have a special place in my heart: Louis Geller (Queens College, N.Y.), who taught me my first accounting class; Philip Piaker (Binghamton University, N.Y.), who inspired me to become a professor; and Abraham Briloff (Baruch College, N.Y.), whose impassioned writings about accounting chicanery inspired me to pursue my calling.

Family has been my foundation from the earliest days. My siblings, Audrey, W. Keith, and Rob, have provided love, support, and guidance throughout the many years. My wife, Diane, has not only been superlative in her role as a mom and a wife, but also has worked at my side in building an exciting research center. My children, Jonathan, Suzanne, and Amy, have inspired me and kept me feeling young as I approach my fiftieth birthday.

Extended family at CFRA has worked closely with me to help thousands of investors avoid losses on companies using funky accounting. Our senior analysts (Christopher Teeters, Craig Sheets, Sirine Hafez, Brad Rexroad, Jay Huck, and Mark Hamel) have been the unsung stars of our research center. Our summer interns, Sarah Rubin, Jonathan Engelhart, Arieh Kestler, and Jonathan Schilit, provided invaluable research assistance and editing on this book.

It is simply a matter of creative accounting, says Matthew Broderick, playing accountant Leopold Bloom in Broadways new blockbuster musical, The Producers. Under the right circumstances, a producer could make more money with a flop than he could with a hit. Max Bialystock, Blooms client, sees the potential for solving his own money woes. He raises as much as he can from rich widows to finance a new Broadway musical, Springtime for Hitler. He pockets the money and ensures that the show will bomb; in that way, nobody will ask awkward questions about where the money really went. (BusinessWeek, May 14, 2001)

Whether in producer Mel Brookss fictional world played out on a Broadway stage or in the real world played out on Wall Street, creative accounting has often been used to hurt investors. And, in the last decade, it has gotten much worse.

In May 1991, while flying over the Pacific Ocean after a visit to Japan, I began writing the first draft of Financial Shenanigans. Exactly ten years later, May 2001, while flying home over the Atlantic Ocean, the current edition of the book was born.

The decade began with President George H. Bush in the White House and the economy in a recession. Curiously, ten years later, his son George W. Bush occupies the Oval Office and the economy again is sputtering. During the intervening years, however, Americans enjoyed an unprecedented period of prosperity on both Main Street and Wall Street. Unemployment reached the lowest level in generations and stock market indices seemed to set new records virtually every day. The Dow Jones Industrial Average grew by over 20 percent annually for an unprecedented five straight years1995 through 1999. That was nothing compared to the technology-heavy NASDAQ index. It jumped 94 percent in 1999 alone.

But beneath the surface and radar of most investors, ominous signs appearedsigns of financial sleight-of-hand and fraud. The decade began with revelations of a massive bank fraud at the Bank of Commerce and Credit International (BCCI). Then reports of fraud at the Phar Mor drug chain, retailer Leslie Fay, and trash hauler Waste Management Inc. The procession kept growing longer and more painful for investors with debacles at the large health maintenance organization Oxford Health, drug chain Rite Aid and the high-flying software firm Microstrategy. Creative accounting of New Economy companies made things even worse. Investor losses reached unimaginable levels. In the Cendant fraud alone, the financial settlement reached over $3 billion.