In 2000, the Chief Executive Officer (CEO) of Qwest, Joseph Nacchio, was charged civil and criminal liabilities after it has been found that he violated the provisions of GAAP against fraud and insider trading. He was sentenced to six years in prison in 2007 and was slapped with a $19 Million fine and a forfeiture order for proven illegal stock sales transactions worth $52 Million. In this memo, the author discusses the different aspects of Qwest’s case, emphasizing the role of GAAP and the PCAOB.
The Generally Accepted Accounting Principles (GAAP) refers to a standard framework of policies and procedures that not only an accounting firm that provides auditing services but also the actual clients that they sell their services to should follow. The full disclosure principle requires all reporting entities, be it a company or an accounting firm, to fully disclose and appropriately record all material information and transactions that may have an impact on the company and its stakeholders.
The reality is that there are numerous issues and accounting gray areas that are yet to be addressed by the most recent version of the GAAP documents. However, the fact remains clear that the GAAP is composed of guidelines that are meant to standardize the conventions, rules, and practices that accountants should follow. This often includes the manner of putting data on and preparing financial statements and annual reports of both private and publicly listed enterprises .
What makes the full disclosure principle important is that it is meant to protect the integrity of the information contained in the financial statements that businesses and accounting firms that provide auditing services prepare and submit to the regulatory agencies. These are done through the inclusion of provisions that penalize and even criminalize any act that may be considered fraudulent.
Qwest’s Violation of the Full Disclosure Principle
Qwest and its CEO had the motivation to push up its stock prices—because otherwise, they would lose the merger deals they have established with their business partners, which would stymie the CEO’s aggressive expansion plans. In order to do this, it can be alleged that the company’s executives intentionally misrepresented the sources of their income. Specifically, they included their non-recurring in the pool designated for recurring income.
Between the two, recurring incomes are the ones that often get factored in in the valuation methods used in the capital markets and investment industry because they represent the company’s income generated as a result of its core operations. From an investor’s point of view, a company with a high level of recurring income is a profitable company.
This would, in theory, push up the company’s stock prices. This is what actually happened in Qwest’s stock prices. Combining the fact that the company failed to disclose the true nature of their income in their financial statements and that it had every reason and motivation to do so builds up a strong case for an actual violation of the full disclosure principle.
PCAOB Auditing Standard No. 12 Paragraph 67
The Public Company Accounting Oversight Board Auditing Standard Number 12 Paragraph 67 states that companies and accounting firms may be considered violators of the said standard if they presented an incomplete or inaccurate piece of disclosure information either by commission or omission . In Qwest’s CEO’s case, it omitted the process of categorizing its non-recurring income properly, among other forms of misrepresentation and non-inclusion of revenue streams.
Therefore, it can be objectively stated, based on PCAOB’s Auditing Standard 12 Paragraph 67 that it indeed committed a violation. Based on these findings, it would be safe to suggest that Qwest did not have an effective internal control system over financial reporting; because it would not have been sentenced with fines and charges if it is otherwise.
PCAOB Auditing Standard Number 5
Ethical Issues in relation to Company Earnings Announcements
The CEO of a publicly listed firm should take into account the interest of not only the company but also the public when releasing material information, especially ones that may have a significant impact on the investors’ expectations about the company’s future earnings and stock prices. It is unethical for a CEO to publish company earnings expectation reports that are reasonably unattainable in an effort to drive up the stock prices of the company—which has to be maintained at a certain level in order not to dissolve its existing partnerships with other businesses.
Unrealistic target earnings announcements may motivate the employees to work harder but in the end, what counts is whether the goals that were set have been achieved or not; and if they were achieved, whether they were achieved in a legal and justifiable way or not. Evidently, in Qwest’s case, the only reason why the company achieved its earnings expectations and targets is because of the fact that they cheated. That is, they resorted to fraudulent acts, specifically the violation of the full disclosure principle of the GAAP, just to be able to say that they met their targets.
The Generally Accepted Accounting Principles (GAAP) is a set of international guidelines that professionals in the accounting industry follow to standardize their practice. In addition to the already strict guidelines set by the GAAP, numerous legislations have also been passed to protect the rights of the public for transparency, particularly the access to correct accounting information. The importance of this feature becomes highlighted when the business in question is a publicly listed firm. This is because a publicly listed firm has to answer to a wide variety of stakeholders aside from its customers. The investors have a stake in the company because they have put their money and trust that the company would deliver a certain level of performance in good faith—and they can only monitor these things through the businesses’ (i.e. the one where they are invested in) financial statements.
It is therefore important that such documents are kept unblemished by any signs of material misrepresentation, most especially fraud. Qwest’s case is but one of the many accounting scandals that involve fraud by means of financial report data omission and misrepresentation. The expectation is that over the years, the GAAP will be more updated and more policies will be put in place in order to deter potential perpetrators of fraud and violators of the GAAP.
Financial Accounting Foundation. "The Importance of Generally Accepted Accounting Principles." FAF (2016): Web. 1. http://www.accountingfoundation.org/cs/ContentServer?c=Page&pagename=Foundation%2FPage%2FFAFBridgePage&cid=1176164538898. Jan 2017.
PCAOB. "Auditing Standard No. 5." Public Company Accounting Oversight Board (2016): Web. 1. https://pcaobus.org/Standards/Auditing/Pages/Auditing_Standard_5_Appendix_A.aspx. Jan 2017.
PCAOB. "PCAOB Auditing Standard No. 12 Paragraph 67." Public Company Accounting Oversight Board (2016): Web. 1. https://pcaobus.org/Standards/Auditing/Pages/Auditing_Standard_12.aspx. Jan 2017.