English Case Studies

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, \ 8 4 sEcTroN oNE ConapRuHnNsrvr Clsss

easily adapted to the Internet, which pror an online company that would offer Inter

pted him and his wife to create NextCard, et users the opportunity to obtain a credit

card in a matter of moments. Because of his tenure at Providian. Le t realized that a key metric in the credit

card industry is the acquisition cost of a could use the Internet to undercut the a

ew customer. Lent was convinced that he rage acquisition cost of a new customer

incurred by brick-and-mortar credit c companies, such as Providian. Likewise, Lent believed that his company would ha significantly lower bad debt losses than conventional credit card issuers. Marketi g research had found that Internet users were generally more affluent and, thus, from the generalpopulation of consume

etter credit risks, than individuals drawn

O n e o f L e n t ' s f i r s t m a j o r s t r a t e g i c i n i iatives was hiring dozens of marketing

keting team developed Internet-baseddvertis;ing campaigns targeting Internet users who made frecuent use of. and intained large balances on, their credit

researchers to analyze a large database "surfing" habits of Internet users. After

cards. NextCard's online ads encoura card with NextBank. a virtual bank that to transfer their existing credit card bal ment used by Lent to convince potential card was a lower interest rate than that ers. Lent also promised those potential

of the top 50 financial websites by Mon "hits" or visits than any other website in t tantly, for several consecutive years, N

t h a t y e a r , N e x t C a r d e x t e n d e d m o r e t h T'hose impressive operating statistics di

"clickstream data" that documented the alyzing these data, the company's mar-

d suctr individuals to apply for a credit as Nex.tCard's largest operating unit, and nces to this new card. The key induce- ustomrers to apply for a NextBank credit

hargedl by conventional credit card issu- ustomers that a decision regarding their made rrithin 30 seconds of their submit-

n $ 1 b i l l i o n o f c r e d i t t o i t s c u s t o m e r s . not translate into immediate profits for

online credit card application would be ting that application.

Initially, Lent's business model for Ne tCard appeared to be a huge success as t h e c o m p a n y q u i c k l y b e c a m e r e c o g n i d as one of the leaders of the Internet

the hottest buzzword among Wall Street pany'siwebsite was regularly named one magalzine and by 2000 had more daily

Revolution that made the term e-comme analysts and individual investors. The co

financial services industry. More impor- tCard issued more credit cards online

than any other credit card issuer, includ as American Express, Bank of America,

rg sucJir large and well-established firms tibank, and MBNA. Lent used NextCard's

prominent position in the Internet indu ry to create a network of 60,000 online "affiliates" that referred potential credit ard customers to NextCard. Several of these affiliates, including Amazon.com, in NextCard.

urchased significant ownership interests

B y e a r l y 2 0 0 0 , N e x t C a r d w a s w e l l o mary goals for the company: obtaining

its way to achieving one of Lent's pri- e million credit card customers. During

NextCard, a fact that Lent and other com ny executives frequently downplayed or simply ignored in press releases and oth r public disclosures. In February 2000, a NextCard executive commented on the ength of his company's business model:

ield-all major drivers of profitability-"Our acquisition cost, credit quality, and continue to be strong and stable, leadi to continued stronq revenue results."3 T'his statement conveniently overlooked t e fact that NextCard's New Age business

3. Basrness ffire (online), "NextCard Announces Si 22 February 2000.

ificant Growth Milestones Ahead of Plan.

8 f s

s i # t f t l

i q \ i

C A S E 1 . 6 rxtCa.Rn,lNc.

model hacl prpduced a large loss during the company's iust ompl:ted 1999 fiscal

reporting Period' Lent rd's stock was traded,

are to more than $40,

ultimilllionaires. A few "lock-uP" Period man-

owing an initial Public

vear, 577.2 miflion to be exact' J _ l

Despite the lact that NextCard was posti"g t"F:^lit^:::,:3:

# ;'k;; lr'lf.o*pany public in 1999. on the first dav Next

;'r* ,1f,.1.i, ;;i." ,ose fiom an initiat selling price of $20 per

;il;n le,nt {nd several other Nextcard executives instant

;;;,h: tut.t,l,rt. stock surged past $50 per share' when th

ffiil;,r,u'$-..urities and Exchange commission (sEC) fo

;ff;;"g .,*fo[0, Lent and his colleagues sold iarge chunks

ests in the: colnPanY. When l,lextCard reported an unexpectedly

large loss of

ZOOO, .onrpapY ut*.utiu"s could no longer sidestep the re

lV p"rritt"r,t [Vun Street analysts, namely' "ry1:,1,Y3iii)-?

aly;;;fi,tt; N"*tcard's management team insisred rhat t

the corner,, a]nd pledged that Nlxtcard would report its fir

if,. fourttr-qrJarter of iiscal 2001. At the same time, compan'

Nextcard would report a net income of $150 million by fisca

S.ild:'o;;;ifi iollowing 18 months, the Internet "bubble" i

;;;tiil trte $toct priceJ of most Internet companies:,11t1'

;;;;;",a. il,r""v tf th*t* New Age companies survived'

il";;;..onlt, .euy, Monster.com, and Yahoo!. NextCard w'

i;"M;;h ioob, the NASDAQ srock index cresred at an al ime high of more than

their ownershiP inter-

$81.9 rnillion for fiscal rring question Posed

Card earn its first quar-

company had "turned

ver qruarterlY Profit bY officials Predicted that

2003.

the stock market burst, ing NelxtCard, to sPiral ncluding such firms as

ld not be among those

survivors.

Loose {}rgdit = Bod Debts , . rr_ ̂ !^ ̂r- _. , l - ". n,^-., The burs;ting of the Internet bubble in the stock

market cutl?fi.Ier:tCard's access to

the debt ang equiiy *urt.ts. without the ability to raise uldditioo,ul debt or equity

capitar, i,{expcarJ slooenty faced the need to raise capitarlthe "ol,J-fashioned w&y,"

namely, 'via profitable opeiations' .. - r rr^--!i,1^-.-. | ,r

Despite thrp promises and predictions of Nextcard's execlltives' the company never

reported a frofit, principally b".uure two of the key premisles on

which JereT*.?:',

had pr,edic{ted Nextcaid's business model were invarid. Ffirst, the average acqutsl-

tion cost. Ne[tCard incurred to obtain new customers pl"::fl::

PT"ch higher than

the figur:e Lpnt had originally proiected. NextCarO :P"ll.hi'q",uo:ounts on Internet

advertrsrng campaigns to recruit customers onry to find. th{t Internet users routinely

ignored, if rlot treerted with cont;; ;;sf 9t{oris 111?Y:h*::i:f::::"3:i'i'jll;X:',t"ff jii';ililffi ff l#'.i,;:'*-#'lJffi Jffi '*;;;;;'F:"1*,ioveredatarrac' tion of 1 pepcent, considerably lower than the

responr" .u{u to direct or "junk" mail

advertisempnts used by conventional credit card issuet:

- ̂ 1.-. ^,,^ ..,-\ Lent':; otper maf or miscalculation had even

more.t"ll""t::onsequences for

N e xt c a rd l',9, '' "j u, ",3, "'':'l iL".'',.' |ry":::T ;,:il[: ::ffi'?-y HJi '*Xi

il;i::ill'##,'- credit card, proved to be much hish{er -'i":li: risks than Lent

had expec[ed. n iurg" proportion of the Internet ut*tl tho

tcok advantage of

Nextcard,s liberar .rJdit'policies were individuals who .oJrtq not obtain credit from

any other fource. For these desperate and shallow-pockei:.0.t:t:umers'

NextCard

effectively served as the "lender of last resort." tl-_t:f!*:g:t: eventually pro-

duced rhe large balances that Lent had expected Inte:tH'-:T:s to carry on their

;;.di, ,;;.d; hr"r; they often allowed those balances to go

lun'aidL' resulting in large

credit lossgs for NextCard' - , _ ^..,-^+:-. I

In sum, iinstead of incurring minimal marke,t"q :y,.^i3:t:Ti.': acquire "good"

credit car$ customers, NextCird spent large u*ounti to

lacOuire

"bad" credit card

I

customers. Making matters worse, ,nunVl of Ne'rtCard's competitors' including

American Expressl "went to school" on ltf extCard's mistakes' These

:"T,?"tll?i,: Iearned from those mistakes and develofed more cost-effective-and

ultimately

profitable-lnternet marketing strategief to expand their market shares in the

intensely competitive credit card industry' I Early in NextCard's historv, the to-Runvlp exlcufie: "p?,1lt?ly:"3t::1j}:lf]:'^,- *^-- -^-t,i.o.l

"ori..',,,

- -r hat realization, those executivesb u s i n e s s m o d e l c o n t a i n e d s e r i o u s f l a w s . l " | e s p t t e

continued to pursue Jeremy Lent's dream of creating one of the dominant companies

inL the credit card industry. To shore up thF company's stock pti:t and to maintain

credibility on wall street and among priuui. inve.s;tors, Nextcard's executives chose

to conceal the extent and source of lne .orftRunv's; financial problems. The principal

rrreans used to accomplish this goar was un{erstating Nextcard's massive credit losses

by refusing to provide sufficient allowanc.esle3grr period fI::f:':il:i*:::^{

+}.^ Because NextBank was subject to federfal banJ<ing regulations,

the office of the

Comptroler of the Curren.y (OCC) regulfrly review:d tl::"Xp:t_v-t,,T::igli

records and operating poliiies und pto.ldur.t During 2001' OCC auditors forced

NtexrCard to significantly increase its alloufance for bad debtt; Wl"T

,T:i'.?T9^?ll_ ricry reportedlhe occs decision, .orppny riloLrr&g€rTlent

denied that the larger

a*owance for bad debts was due to ,nprp".tedly high credit losses. Instead,

Nextcard officials insisted that the incrlase in the allowance for bad debts was

necessary because the company had suffpred large losses as ? r::ull:l'flt**:T

schemes perpetrated by hackers and othler Internet outlaws. In November 2001, a

skeptical Wall Street analyst questioneO frlw such a massive problem::Y11".p,T.:g'

so unexpectedly and without any previou{warnirng from company officials'a In fact'

subsequent investigations rrouid revear lrtut N.xtcard.officials had routinely and

materiilly understated the company's allojvance lor credit losses'

In late 2001, angry NextCard investorsltit.o a large class-action lawzuit against

the compuny und iis executives. Amon{ other charges, that lawsuit alleged that

NextCard's management team had inteniionally'concealeg t1""" extent ulq,nlt:1:

of the company's financial problems. Inl addition, the plaintiffs charged that the

Nextcard executives had engaged in in$ider tr'ding by selling off large portions

of their ownership interests in trte compfny before Nextcard's true financial con-

dition became aiparent. This large classl-action lawsujt and.widespread t::t:tn:

regarding the integrity of Nextcari's publ{cly reported financial data caused federal

,elututory authoriliei, including the SnC,lto laun,ch investigations of the company's

sEcTtoN oNE ConlpnEHnNslvu C'q'sns

iinancial affairs,

iSuspicious Audit Trqils Discovering that your largest client is the

for tampering with its accounting records

for NextCard. In March 2001, Trauger ha

rbject of a series of federal investigations nd issuing materially misleading financial

.statements is, no doubt, among the life ts feaLred most by audit partners of malor

accounting firms. Thirty-six-year-old Th

turbing scenario in the fall of 2001. Trau as Trauger found himself facing that dis-

r, a paLrtner in the San Francisco office of

Ernst & Young (E&Y), had served for sev ral yeaLrs as the audit engagement partner

authorized the unqualified opinion issued

on NextCard's 2000 financial statements' After considering his options, includi

outcome of the federal investigations of g doinrg nothing and simply awaiting the

xtCard, Trauger decided to take matters

4. J. Graham, "What's the Next Move for Troubled

2001, 6.

" Inuestor's Business Daily, T November

cAsE 1.6 NExrC.q.Rn,lNc'

i. Selurities and Exchange Commisslon'

25 SePtember 2003'

6. Ibtd.

n t o h i s c l w n h a n d s ' H i s f i r s t d e c i s i o n w a s t o c o n t a c t n l s L U y | J u U v I - ^ . . r.*iCut,f audit, Oliver

Flanagan'

Like nros, u..#i,r,Jproi.rrionars, oriver Flanagan en![yed

ctrallenging assign-

ments. lr naltive "] ir"iirio, FlanagJr*accepred.y

J,,t'y-re'f'ei qotiilon on the audit'

ing starf of the ,"ri"*^r.rgrano,'Jtti.. "r iav i" ;;il;]i*r' tFlanagan

left E&Y

in rate leeQ ro ";.A u poiiti* i" ;;; uanr<ing

iffiili"' to,31 discovered that

he missed jn orria ", un ind"r#;; uuJitor-

s", 'ur,.{an asked E&y 'or his iob

back. In thp rutu i6g.r, the rnrer""iu"uule ha.d-c1"""a "lrrugu"gl*und

for the ser-

vices or puplic u..ouniing firms, ftil";;;seo Eay

to ue fnore ll'l', happy to rehire

Flanagiin. 4mong tr': l?:;l'":::t'uuing '!" g:"o-{n*"a f{r auditors

at the time was

rh:!:it:tff ::T,"*',,ffiH:ff -;*ff:*il*'"',"ffi 'li*Tfr:h+Hffi

into his own hands. His first decision was

to contact his topl*o"tl*ate on the 2000

il;a;l4i:Hii,?i?3t1X1;.nars, oriver Franagan "liFl,"1:-lralrenging assign-

" t'* ll ":l,T::, rrer an d, F ian a gan accl{e"{' t :"1{*h1rg :f Ji:l$:Tffitl

ilanagiin. fq9:g toe ruuour"^': "*;;;

SariFrancisco. Givpn hts tnre

ffi ffi ;fl ::l;;*tffi ;::;:l ffi i "? !i ""'11"" il; {s a n qtrickrv

acc ep te d th e ing induslTy .und isco and U".o*.'J;"+';o

o-t 'ft* illextCard audit

^nnortunity to move to San Franctsco &II(l

ucu'urr" I

:T:ilfff l*fiil" rr t r"* rT: :: 1;11::,ff :"" n'u I R u"u-'ii,Lff:Tf T*:l

serve as tiire senior *d'l maffi :: *: ::l?ili#-Ji:l*: t'1"1 t'i'. ':i Y,"i:,.;;;irire senior audit manager on tne l\u^tt'sr*_s;

tr""rizeii that Trauger was a

he woutd reporr air"Jrv to Thomas Trauger' Flanagai,t#::4t * ;";ge of the

;ffi :[#lTH:lilJiil:ffi ;m:l'mf ;:l;;",il";';*3rw'uid

"r#+!truff ["$f';'U*Xr'*l*ff l'*liiii+HH,T:$ ;?;ifi",,,{j,}+"#,?:"';# ?gu;G

su,u'duv T:Ti"s lFranagan wrls pr u u clv L r L' " -

surprisep by the request rin." wJ"X"nO wbrk

*u"io]tfti?'g "'tittal with a malor

accountinef i,pprus.l*::T:$?J*:*inhi'$:".t';lJ&lijil#in:a C C O U I l t l I I S r r r n r ! ' il. J N ;i.td 1ro * u'','" u*i " s ::Tl' i1",1 ;l ;1?i11iff" fi ffi ; '*;; t"

n co ntacted ZbOi

""git tha't SaturdaY mornrng'

Trauger prior ro ir,f,Jileeting, tr,"-uuait partner '"i;{i* t" €1"'TI"1l'?Tff;;-,i:

o3:,]'if i',i ", o'lo"',{, #i *0. # " "

* " ^"***,

ffi :,'""#; ;u d it wo ikp a'

pers oqce tr,"y tiuar""n ur.r,iv"a. Almost."rtuinly,-fiextcara's

wet-documented

iinancipip,??l:T:::'- jT#*Tl':#il-::"'':#Ffi il:ll,x:H:iT;"#

."il;;;+d, Thcmas Trauger left a messasc "'-';l;;:lFt*ugutt was Prob"oy:::

him in t$e E&Y o'tti'" tr'9 i:lYy^1s^?i:Tf:'illJu, nopr,ing unu'ual ;'ll l.Tl?:

ffiA;Jed Fianagan to wonder wnat typeb

ur ruv r*l'^-

ffi,["ffi*iCota *otkpup" - 'rvqrr^ar nontact€o ,tf. otherr audit mana.ger,ii :l:

;il" |ffi"i,o".r Jhard copy" workpapers' tnrs *""t+;;ii."*ort pip"tt meant that

renoe. But accompiitni"g'titat same q:*j:li:"":' cln those files' ., -Ienge. But accomplishtng rlldt >ar'r- ?il;;l"mps'

{n thostr fll11.-.;tx;il**;ll:ffi

"["f]:{:i:;'*+::ft "-lf 'rut[:T'iiifi'.

E*tffi r"v""tr'"ittY::ff :':?'""t"""]1'J?i#'H''$ffi ;,oon'r'o'"workpapers' :f,lti',],l5'jirj;;",,u"0 therebv

change the dme stanlps p\J*uu

L _-i-flisqion.AccountingandAuditifgEnforc,ementReIeaseNo']871,

"ii'd#:fi #**nqlrn,.ifgh:"ft *I1t##[HtifNe.rtCard engag€ 2000 \enCard uuoi'

iintu hg Luq oniv been u:t'sn;;+;il;;Ho"inru to "manip-

i;$f*$}j*i***1*trT}$i3;#tri"?""16';.'r*::"1ilr::il1* w c l r k i f r g p a p e r s

w l l r r u u r . v " - " - 1 ^ ^ , , t n r r A . v e v i d e n c e f h a t m e ' y

I I d ( r u s s r r l - - 1 , ^ - * ^ " - r -,,,,,tq*,iworrnaler;w[f;i1*il:?3:T,n:X*i".l:llli;li-i*jj,,**n;

sEcnoN oNE CorupRnHsNstvu Casns

Mullen sent this information to both Tr{uger and Flanagan. During their weekend meeting, Trauger and Flanagan revi the 2000 NextCard audit workpapers and

made numerous additions and deletiohs to throse workpaper files. The principal items changed were the "summary Revi{w Menrorandum" and the receivables work- papers. In a subsequent enforcement release that focused on the conduct of Oliver Flanagan, the SEC described the P used by Trauger and Flanagan to alter the

NexiCard workpapers. (Note: In this enf{rcement release, the SEC referred to Trauger as simply the "audit partner.")

The audit partner marked up printed rsions of the documents and gaue them to Flanagan for Flanagan to input using nagan':t laptop computer. In order to ensure that the reuised documents appeored t haue tJeen created as port of the original working papers, the audit partner inst Flanagan to reset the dote on his com- puter so that arry documents bearing earlv 20a1. Some documents went th

er-generated dates would reflect a date in h more than one edit, os Flanagan input the

audtt partner's chonges and then printed further reqieu)."7

t the reuised uerston for the audit partner's

NextCard's deteriorating f inancial ition inr late 2001 and the increasing scrutiny horities prompted Trauger to ask Flanaganof the company by federal regulatory a

to meet with him once more to make ditionLal alterations to the 2000 NextCard

workpapers. Trauger also asked Michael took place in late November 2001. The S transpired during this second meeting.

ullen to attend this second meeting, which C prorrided the following overview of what

The audit portner marked up printed of the memoranda he was reuising and then the other audit manager [MullenJ tion, the other audit manager deleted

the chonges. At the audit pqrtner's direc- s, pctrtions of tables, ond discussion sec-

tions that tndicated problems with Nex 'ard's

charge-off numbers and trends. The audit partner also added information an altered the tone of certoin sections. One of

rDo.s o memorandum entitled'Analysis forthe documents altered during this meeti Loan losses. " Flonagan remained in in tlte process by proofreading the other audit manager's work to ensure that all the audtt partner's changes uere made.6

The SEC issued multiple enforcement fessional conduct of Thomas Trauger, O

leases that documented the improper pro- ver Flanagan, and Michael Mullen. In those

enforcement releases, the SEC noted o several occasions that Trauger's intent in pers \ ras to "make it appear that there wasrevising the 2000 NextCard audit work

a more satisfactory basis" for the key Y conclusions reached during that engage-

ment. The lVeru York Times reported t wanted to

'beef up' the workpapers to at "Mr'. Trauger told Mr. Flanagan that he ake it appear as if the auditing team had

been 'right on the mark' all along."9 Duri the course of the federal investigations of

NextCard. the FBI retrieved e-mails that iauger had sent to his subordinates. One of those e-mails provided a more pointed NextCard workpapers. According to an

ment of Trauger's intent in modifying the BI affidavit, in one of those e-mails Trauger

stated that he did not want "some smart law'ye1"to second-guessing the decisions auciit.that he had made during the 2000 Next

7. Ibid.

8. Ibid.

9. K. Eichenwald, "U.S. Charges Ernst & Young 26 September 2003, 1.

10. J. Hoppin, "Snared by SOX," Corporate Coun

-Partner in Audit Case," New York Times,

, Decemrber 2003,24.

FollowingthptwomeetingsinwhichtheE&Yauditorshadt

n"n.l.',r';i,eqllTl:::::-d_*T.s"5t:^',:?Hl:lfr :1,*;;;papers,'lraruggr tnstructeo r lalld5d e-mails inconEistent with the altered versions

of the workinl

Flanaganrottqwedhismentor'sinstructions.Approximately, ,"."#a a subipoena from the OCC that

instructed the firm to

.Lr,uin NextC{rd workpapers. At that time, Trauger discovered

kept a computpr disketie containing some of the original Nextc

ffi;altered l[ November 2001. Trauger ordered F]anagan to

destroy it. Flarpagan obtained the diskette and told Trauger th:

fact, FLnagun k"pt the diskette and subsequently gave it to

CASE 1.6 I\nxrCa.no, INc.

the NextCard work' delet.e documents or

papers;."11 Once more,

r€e lTlrcllths later, E&Y

ive thet federai agency

hat Michael Mullen had

workpaPers that had

btain that diskette and

he had destroYed it. In

al authorities.

The computer cliskiette that Oliver Flanagan

iurned ou.t to fedgral authorities investigat-

ing flu*tCard ultinfrately resulted in the FBI

ariesting Thomas lltrauger in September 2003'

The U.S. Department of Justice filed criminal

.iturg., against Trauger for obstr.ucting the fed-

eral lnvestigations of NextCard' Trauger was

thre first partner of a major accounting firm

to be prosecuted for destroying audit-related

d,ocuments undr:r thte criminal provisions of the

Siarbanes-Oxley Aqt of 2AA2' Those provisions

w'ere included in the Sarbanes-Oxley Act as

a direct consequence of the wideiy publicized

s,:andal involving Fnron Corporation' During

an SEC investiSlaiiqn of linron, Andersen' the

company't uuiiit firm, had shredded certain

E , n r o n w o r k p a p e : n s ' T h e s u b s e q u e n t f e l o n y

c o n v i c t i o n h a n d e d d o w r r a g a i n s t A n d e r s e n b y a. federal courl- effectively put the prominent

aLccouilting firrn out of lbusiness'I2 lronically' 'liauger uni hi,t subordinates were altering the

l,trext"Card workpapers in November 2001' the

sarne time frarne during which Andersen per-

s;onnel were shredding ttre Enron workpapers.

Shortly afterr being arrested in September

i1003, Thbmas tt'raqger insisted that he was inno-

cent of the chargps filed against him' When 'iruug", was releJied after posting a $1 million

bail, his attorney issued the following public

f f i f f i $ t # 4 # 8 l ' f f i

$500.000, On 2

Ernst & You the actions ot a press relea

out that the

were in clear v standards and son also not nature of the i

cooperated fu

authorities. N o t s u r P r i s

elated with th

commenting

statement defe d i n g h i s c l i e n t : " H e ' s a g o o d

man, a well- ted accountant, and I'm con-

fident he will b a s s e r t i o n s , a l i

exonerated."l3 DesPite those

tle more than one Year later

on 28 October 4, Thomas Trauger Pleaded guilty to one co nt of irnPeding a federal inves-

tigation. As a It of that plea, Trauger faced a

prison sentenc of up l:o 25 Years and a fine of

January 2005, a federal judge

ger to one Year in Prison a.ndsentenced Tra two years of "

also ordered Tr ipervir;ed release." The iudge uger tc, PaY a $5,000 fine- In his

Tiaugerr admitted he had failed

I authorities that he and his sub-

g disavowed resPonsibilitY for

iug"t, Flanagan, and Mullen' In

plea agreemen to inform fed ordinates alte certain of the NextCard audit

workpaPers naed by those authorities.

un gAY sPokesPerson Pointed ions rif the three individuals

lation of the firm's Professional ernal policies. That sPokesPer-

that when E&Y discovered the

dividuals' conduct, firm officials with federal law enforcement

ngly, f ederal authorities were

orrt.ottt" of the Trauger case' ln

n the case, a sPokesPerson for

,rr*_*ila *.hange commissio n,Accounttng and Audtting En

1 2 . T h e U . S ' ; $ u p r e m e C o u r t o v e r t u r n e d A n d e r s e n , s f e l o n y c o n v i c t i o n i n time, the firm was in the process of being disbanded'

13. E. Iwaia, lAccountant Arrested under Sarbanes-Oxley"' USA Today'

l?elease No. 1871.

2001j;however, bY that

6 Septernber 2003, 28'

tfr{ U.S. Department of Justice observed that

thd oroper functioning of the nation's capital

;{;#Jepends, in laige paf' on the integritv

of ar.rditors and oir,"t piofessionals involved in

thb financial rePorting Process:

This is one of the first cases in the country

i""riirn'oi oianor has been accused of

" a" " o;;1: * i n"t d o c um e n': i ",,:: ̂ :l:1'::-

obstruct in inuestigation' Our finoncial mar-

nlri i"p*d on thi tntegrity of auditors' Iaus'

vers and other professionals to do their iobs ;;;ity ina ritrtv. where thev rail

to do so

becaus'e of negligence, markets are compro-

";t;i. wneri tiey fait to do so.because

of

,ri*not intent, ali of us ore at risk' The U'S'

Aiilriy't office witl brtng those p.rofession''"itiilltrice who ioin in criminal acts they

ii ripposed' to ui'o'n' and exPose'l4

W *3

Stephen Cutler' the SEC's Director of Enforcement'

dchoed these sentiments and stressed the impor-

,L"*,t "rditors'

maintaining the integrity of the

sEcrloN oNE CotrlpRnHni'lstvr Cesrs

14. Securities and Exchange Commission' "Fo

if,urg", and Criminal Violations of the Sarban

$t00 fine. As a result of his guilty plea' Mullens

rtt* l i pru.ti.e before the SEC was suspended'

ffiG";t 2003, Oliver Flanagan pleaded guilty

i; on; count of criminal obstruction of iustice' a,tt", cooperating with federal authorities

in the

prose,:ution of Thomas Trauger' Fianagan was

alloweld to return to his native lreland' Flanagan's

uitrn"y noted that "Oliver has made peace

*itft ,our [U'S'l government'"l7 The attorney

t h e n a d d * . d t h u t F l u n u g u n ' s o n l y w i s h w a s t h a t Thomas Tiauger had been a "better mentor'"lt]

NextCard'if inancial problems steadily wors-

ened following the announcement in late 2001

that federal law enforcement authorities \^rere

investigating the company's financial affair's' ln

f"ntuity 200Z,the OCC ruled that NextBank

** up"iuting in an "unsafe and unsound" n'Ian-

""t "tO ptaceO the bank under the control of

if,* tt"O"ral Deposit Insurance Corporation

ifnf C).At the time, NextCard's stock was trad-

irg t"i $0.t+ per share, down from its all-time

rriErt "r

$53'1i.ln the summer of 2003' a fecleral

banlcruptcy court liquidated the company' By

if,i, ,point, NextCard had total assets of only $20

rnittion and liabilities of nearly $470 million'

I n N o v e m b e r 2 0 0 6 , t h e S E C a n n o u n c e d

that it had reached an agreement to settle

fraud charges filed in 2004 against five former

N e x ' t C a r d e x e c u t i v e s , i n c l u d i n g J e r e m y L e n t . In total, the SEC required the executives

to pay

$1.4 million of fines and other monetary dam-

ages. Approximately $900'000 of that arnount

*"us puid by Lent' The SEC allowed the five

executives to consent to the settlement "with-

out admitting or denying" the charges that had

been filed againsi them'le One year earlier' in

De,:emb"r 2b05, the class-action lawsuilt filed

ag",inst NextCard and its former executivels had

b!,:n settled out of court' Ernst & Young con-

iributed $23.5 million to the settlement pool'

duditprccess:

Complete and' accurate workpapers are criti-

;;i6;h" rniegrttv of the audit process and

,;;;i";ri or"ouit'uesttgatiue work' we witt

o:ggr"rriirly pursue auditors who alter or

T"iiioy *orkpopT s or otherwise undermine

the fiiancial reporting process'.and wiII work

closely with criminal authorities to ensure

that tiose who engage in such conduct are

t5. Ibtd.

16. Ibid.

17. V. Colliver, "FBI Arrests Suspect in Fraud"'

18. Ibid.

*f,if" Jeremy Lent contributed $635'000'

rr Ernst i! Young Audit Partner Arrested for Obstruction

b"i"y l"U' Reiease No' 2003'123' 25 September 2003'

Franci:;co Chronicle,26 September 2003' 81'

19. Securities and Exchange Commission' Ltti Rektase No- 19903, November

2006'

I e I l

Ouestions 1. Shoulcl aupitors evaluate the soundness of a client's

busi

your answier.

e Trlentifv anrfl hrieflv describe the specific fraud risk facto

subordinates?

2. Identify arld briefly describe the specific fraud rlsk tactol

2000 lriextCard audit. How should these factors have affe

execul[ion of that engagement?

3 . W h a t a r e t h e p r i m a r y o b j e c t i v e s a n a u d i t t e a m h o p e s t o3 . W h a t a r e f h e p r i m a r y o b j e c t i v e s a n a u d t t t e a m n o p e s l O . preparring a proper set of audit workpapers?

4. Identiliv thle key auditing principles violated by the E&Y a

Brieflvexbtuin how each principle was violated'Brtelly explaln now eacll IJIllrurPrc vvqr vr\-'rcrLUU

5 ' W h e n h e p e c a m e a m e m b e r o f t h e N e x t C a r d a u d i t e n g a { Flanagan hopecl that Thomas Trauger would serve as his

respornsilility, if any, do senior audit personnel have to st

ss mo,iel? Defend

present during the the planning and

comptish bY

ditors in this case'

ent lteam, Oliver

entor. What as rnentors for their

uld you have done 0 NextCard audit

native courses oI

may be affected bY

ted.

6. Assur:ne t[e role of Oliver Flanagan in this case- What w<

when Thqmas Trauger asked you to help him alter the 2[

workpapfrs? In answering this question, iidentify the alte

actioir available to you. Also identify the :individuals whc

vour declsion and briefly describe how they may be a{fe