Accounting Questions

PROTESTERS:

Hey, hey! Ho, ho! Corporate greed has got to go!

MARGARET WARNER:

Demonstrators greeted Vice President Dick Cheney at a Pennsylvania fundraiser last week, protesting his role in a controversy involving the Halliburton Corporation. The Dallas-based Halliburton is one of the world's largest oil services, construction, and engineering firms, and Cheney was its CEO from 1995 to 2000. He left the company to become George W. Bush's running mate in August of 2000, and that month, he sold all of his Halliburton stock at $52 a share for a profit of $18.5 million. Now questions are being raised about Halliburton's revenue figures for some of the years Cheney was CEO, and whether they artificially inflated the company's profits and stock price.

In 1998, Halliburton changed accounting methods on disputed claims against customers. Instead of waiting until the claims were settled, Halliburton booked the anticipated revenues in advance. Those claims revenues amounted to $89 million in 1998, making the company look more profitable than it would have seemed under the old method.

Halliburton didn't publicly disclose the new accounting practice until more than a year later. With the approval of its accountant, Arthur Andersen, Halliburton continued using the new accounting method in subsequent years. In May, after news reports about the matter, the Securities and Exchange Commission opened an investigation into Halliburton's accounting practices. SEC Chairman Harvey Pitt has said the Vice President will not receive any special treatment.

HARVEY PITT:

Halliburton has said it is being investigated, and I will tell you as I have said before: No one in this country gets a pass. I don't care what their status is, I don't care what their prestige is; anyone who violates the law has to be held accountable.

MARGARET WARNER:

On July 10, a legal watchdog group, Judicial Watch, sued Cheney and Halliburton on behalf of investors, alleging fraudulent accounting practices had inflated the company's revenues by $445 million from 1999 to 2001.

LARRY KLAYMAN:

This company, Halliburton, engaged in what we alleged in a complaint filed this morning to be fraudulent securities practices — fraudulent securities practices not exactly identical, but similar to the practices of Enron and Global Crossing, and that because of these accounting practices, profits were overstated.

MARGARET WARNER:

The White House and Halliburton have both called the lawsuit without merit. The Vice President has declined to comment about the suit or the SEC probe. Democrats in Congress have pressed Cheney to address the issue, saying his refusal is fueling the loss of investor confidence.

SEN. JOSEPH LIEBERMAN:

The vice president's disclosures regarding Halliburton have been nonexistent, and I just think that the longer this goes on, the worse it's going to be for the administration. But more to the point, the worse it's going to be for our economy.

MARGARET WARNER:

At a press conference with the Polish president last week, President Bush said he believed Cheney would be exonerated.

PRESIDENT GEORGE W. BUSH:

I've got great confidence in the vice president. He's doing a heck of a good job. When I picked him, I knew he was a fine business leader and a fine, experienced man. And he's doing a great job. That matter will run its course, the Halliburton investigation, and the facts will come out at some point in time.

MARGARET WARNER:

In the two years since Cheney left the company, Halliburton's stock has plummeted more than 75 percent to under $12 a share.

MARGARET WARNER:

For more we're joined by Robert Bryce, an Austin-based journalist who covers the energy industry. He's currently writing a book on Enron; Vincent Love, a certified public accountant and fraud examiner; and Donald Langevoort, a former special counsel at the Securities and Exchange Commission — he is now professor of law at Georgetown University. Welcome to you all and professor, beginning with you. Oh, no, excuse me. Let me first go to Robert Bryce.

Robert Bryce, first lay out for us the kind of business Halliburton is in and what these disputed claims were about. How does that fit into their business?

ROBERT BRYCE:

Sure. Halliburton is an oil field services and construction company. They do everything from seismic analysis in the oil field to building big construction projects. They built Enron Field in Houston, for instance, the baseball stadium that's now known as Minute Maid Park.

The issue with their accounting involves some cost overruns or discrepancies or disagreements rather between Halliburton and some of its clients. And rather than waiting until the discrepancies or the disagreements over those costs were resolved, Halliburton went ahead and booked those revenues as though…as receivables. In other words they counted those revenues on their financial statements immediately. That's very similar to the type of accounting that Enron used. It's called mark-to-market accounting.

What's interesting about it is that Halliburton up until 98 had been using accrual accounting, which is the standard cost accounting method, but in this one segment of their business they used mark-to-market and that's what raised all the red flags.

MARGARET WARNER:

Now, the statements show and Halliburton has said that in '98 these extra revenues amounted to something like $89 million, and they had sales that year of $17 billion. What else was going on at Halliburton at the time in '98 that might have made even this modest an increase interesting or important to investors?

ROBERT BRYCE:

Well, it's important because in '98 the world oil industry was in a world of hurt. They were…oil prices were depressed. Drilling activity was very low. And Halliburton had also just completed a merger with Dresser Industries. So the company was eager to show any revenue that it could and by using mark to market on this one small segment of their business, they were able to add $90 million or $89 million in '98. And then in '99, it was $98 million. And then in 2000 it was $113 million. So again that's a relatively small figure compared to the tens of billions or over $10 billion that they were counting in revenue but it still counted significantly in terms of their profit statement.

MARGARET WARNER:

What has the company said about why they changed accounting methods and then why they didn't disclose this change until actually the year 2000 when they were filing their annual report on the '99 revenue?

ROBERT BRYCE:

Right. The company has said that the change was fairly small. The numbers were small and therefore were not really important. But it is interesting to note that why didn't they disclose it in '99 given that they…

MARGARET WARNER:

You mean why did they?

ROBERT BRYCE:

Well, no, they made the change in '98 but the disclosure didn't come out until March of 2000. So I think the SEC wants to know why wasn't that change…why weren't investors notified rather in the 1999 annual report about this change.

MARGARET WARNER:

And what are they saying about why they made the change at all?

ROBERT BRYCE:

They're saying that it's defensible, that this complies with generally accepted accounting practices and that it is defensible.

MARGARET WARNER:

And then finally, what, if anything, has the company said about Dick Cheney's involvement when he was CEO in this decision, whether he approved it or knew about it?

ROBERT BRYCE:

Right. Their statements thus far have been that apparently Mr. Cheney was not involved. But I think that that clearly won't be known until he's questioned by the SEC.

MARGARET WARNER:

All right. Now, Professor Langevoort, your turn. What is it that the SEC will really be looking for here?

DONALD LANGEVOORT:

Well, first of all, we'll start with the accounting change. Was it fully disclosed? I think in the back of the mind, in the front of the mind of the examiner is going to be, was the company applying a heavy dose of cosmetics here in order to let investors think this was a more profitable company than it really was? If you can get to that motive, we want to keep our stock price high, you're coming close to securities fraud. That's what they're going to be looking for. Or is it innocent?

MARGARET WARNER:

And Vincent Love, as an accountant, first of all is this method of accounting that they changed to, is it a legitimate accounting method?

VINCENT LOVE:

Yes, it is an acceptable method of accounting for these long-term contracts for these claims. I think I just want to go back to the beginning. In 1997, in the notes to the financial statements, they disclosed that these claims and disputed change orders were not recorded in revenue until the settlement was final. In 1998, they dropped out that line, and they didn't disclose that.

In 1999 in their annual report, they then disclosed that they accounted for these claims and on an accrual basis and they looked at the probability of collection. And if it was probable that they would collect based upon their past experience that they were going to record the revenue in that year. That was what was wrong here. They did not disclose what had happened in 1998. And the amount was material when you looked at the bottom line in '98 and what else was going on.

MARGARET WARNER:

I gather there is also an issue about — at least with the SEC about whether you can change accounting methods. Is that right — that there's certain tests for whether it's permissible to do so or not?

VINCENT LOVE:

Well there's a preferability test. Is it a preferable method? And generally, it would be if you can get a reasonable estimate of the collectible amount. They had a past history, and their claim is based on their past history and analysis of the claims that they could accurately estimate what they would receive on those claims. Now they had already expensed the money that they spend on the cost overrun….

MARGARET WARNER:

Let me interrupt you right there. I think maybe we're getting a little technical here.

VINCENT LOVE:

Sure.

MARGARET WARNER:

Let me just ask the professor here. All right, if you're at the SEC and you're looking now at this whole set of transactions and the accounting and you said they're going to want to get to intent — was the intent to defraud or was it simply a legitimate change? What are they going to have to actually do to get to that?

DONALD LANGEVOORT:

Well, they're going to, first of all, assess whether there really was a history with respect to collection on these cost overruns.

MARGARET WARNER:

In other words, had they been successful in the past collecting them?

DONALD LANGEVOORT:

And the clearer that is, the more likely it is there's no fraud. On the other hand, you also want to see whether there was pressure coming from above — and we all know who "above" was in Halliburton — to come up with numbers even if they're artificial. Those questions you only get by deposition. You have to call witnesses and ask about those kinds of conversations in the company. There may be innocent explanations but you're going to have to ask.

MARGARET WARNER:

And, Vincent Love, if you were doing a fraud investigation here, what would you be looking at? What would you add to that?

VINCENT LOVE:

Well, I'd like to try and find contemporaneously prepared documents to show what the intent was. Was this really a preferable method? What caused them to make the change, and what did they do to support their estimate of what was going to be collectible on those claims.

MARGARET WARNER:

All right. And then, professor, if you were also trying to determine whether the failure to disclose was kind of an innocent mistake… first of all, how firm is this law about having to disclose a change in accounting method?

DONALD LANGEVOORT:

In the last year, the SEC has made a big point of wanting companies to be more forthcoming when they change estimates, change assumptions. It's not that firm. I doubt you could sustain a serious fraud claim simply on non-disclosure of this change. That would be a lower-level violation.

MARGARET WARNER:

And how would the SEC go about trying to figure out – again, as I asked earlier – whether it was innocent or not?

DONALD LANGEVOORT:

Again by reference to were these records there that justify it? Is there a reasonable basis or does that just seem to be caving into some kind of pressure from the market or from your executives?

MARGARET WARNER:

And, Vincent Love, what is your view of the question of the disclosure?

VINCENT LOVE:

Well, there certainly was a failure to disclose in 1998. And I think it was a material failure to disclose, but it's going to be up… the SEC is going to complete their investigation. They've got competent attorneys and lawyers. They'll get to the bottom of this if we give them the time to do it.

MARGARET WARNER:

Now, how are they going to then look into… he wasn't Vice President then, but Dick Cheney's role?

VINCENT LOVE:

Well, they would have to look at what Mr. Cheney, Vice President Cheney, knew at the time. And you have to look at the records to see if he as chairman of the board was aware of the change that was being made, reviewed the financial statements, and focused on the fact that they did not disclose the change in accounting.

ROBERT BRYCE:

If I can jump in here for just one point

MARGARET WARNER:

Yes.

ROBERT BRYCE:

and that is regarding the disclosure, and I think it would — particularly if we're talking about small investors and now they're the ones who have really been hit hard by a lot of these nondisclosure issues — is when the change was finally disclosed in the 1999 annual report that was published in March of 2000, that report was over 40,000 words long and this change, this — the disclosure of the accounting method change only amounted to about 80 words. So you had to be a very sharp-eyed investor to even notice the change because it is also — it's not in plain English or not in plain English for me, perhaps for the accounting professors, but certainly not for me.

MARGARET WARNER:

But that, professor, wouldn't be considered the fault of Dick Cheney or Halliburton, would it?

DONALD LANGEVOORT:

Not likely.

MARGARET WARNER:

Under SEC investigations or standards or whatever?

DONALD LANGEVOORT:

No. You would have to show some unusual set of facts that showed from above there was a direction to get me some good numbers.

MARGARET WARNER:

Now, finally– and I'll ask all three of you– do you expect the question of his sale of his own stock to come into play? What would it take to have that come into play?

DONALD LANGEVOORT:

It's going to come into play. The SEC is very clear that if they can show a stock price drop preceded by senior executive sales, they're looking into it. The question is how material was this? Would there be a stock price drop based on this information alone or are we really talking about stock price drop that came later because of facts that arose well after the sales occurred?

MARGARET WARNER:

But Robert Bryce, there's been no confirmation here even suggesting that they're doing an insider trading investigation on his stock sale, is there?

ROBERT BRYCE:

No, there has not. The only observation that I think that I could make in that regard is that when Mr. Cheney sold in August and garnered $52 or so per share, it was interesting in the weeks prior to his being named as the vice presidential nominee Halliburton stock was in the $40s. When he was named, the stock price surged very quickly. So the company clearly been benefited from at least the perception that their former CEO might be in the White House.

MARGARET WARNER:

All right. And, Mr. Love?

VINCENT LOVE:

I would just like to say one thing. There was no disclosure in 1999 of the change. All they simply stated was what the new policy was. They didn't say "and this is a change from 1997." And they didn't disclose the impact on the financial statements. And it's true that you had to read those financial statements very carefully to see that one line. In the… and where management discussed the changes from one year to the other, they never mentioned in 1998, SEC's filing that part of the increase in revenue was related to this change.

MARGARET WARNER:

And last quick question to you, professor: Would the SEC to do a complete investigation do you think have to interview the vice president?

DONALD LANGEVOORT:

Yes.

MARGARET WARNER:

All right. We'll leave it there. Thank you all three very much for helping us try to figure this out.