1.1. Part 1 Background

Dale Perez had a successful career (as a securities broker). His life-long friend, Jeffrey Jones also had a successful career (as a salesman) who could sell anything to anyone. Jeffrey convinced Dale to start a new business venture with him in Cambridge. Together, they created Cambridge Investment Group (a.k.a., CIG), a financial services company that offered both financial consulting and investment banking services. In particular, CIG provided clients with advice tailored to match their financial needs while offering an array of innovative financial products covering capital preservation, income generation, and long-term capital growth. Recently, Dale and Jeffrey identified additional client service offerings to expand their business. Jeffrey and Dale decided to contact their longtime friend, Gary Smith, to see if he would work with them. Jeffrey and Dale thought Gary would be the perfect partner because he had a strong accounting background (as a professional accountant1) and was well-connected in the business community.

Early in his career, Gary worked at Global Ventures, an international real estate development firm that provided project management, commercial and residential real estate investment opportunities, and educational resources to investors throughout the world. Garys responsibility was to help Global Ventures clients secure and process loans to facilitate their real estate investments. Most of his clients loans were processed through Commerce Bank - where Gary had developed many strong business relationships over the years.

Jeffrey and Dale also knew that Gary had recently left Global Ventures to start his own professional accounting practice after the real estate industry started cooling down. While self-employment had flexible hours and unlimited potential opportunity, he started his business from scratch with no client base. Unfortunately, his business grew at a much slower rate than expected. Because he did not know how to develop a marketing plan, Gary was cold calling individuals and businesses to increase his client list. Large, profitable clients were unwilling to engage an unknown accounting firm, so Gary was only able to attract smaller and riskier clients. In addition, his firm was starting to incur debts for computers, software, and other necessary business resources faster than he could generate revenues. He was in danger of having to close the business due to lack of funds. Gary felt his dream of owning his own successful accounting firm slipping away.

Knowing that Garys business was struggling, Jeffrey and Dale approached Gary about possible opportunities. They made a financially tempting offer (twice what Gary was earning). And, to further entice Gary, they pitched their offer also as a way of not only saving his accounting firm, but helping the community.

After discussing opportunities, the three created a separate company, WWM Inc., with the mission to help financially-distressed firms receive special financing. WWM offered Gary a hiring bonus of $75,000 for his services at a time when his firm needed cash. The extra $75,000 would help Gary keep his firm open for another year and hopefully attract more clients to avoid bankruptcy. Moreover, Gary also liked the idea of helping financially-stressed firms (like his) receive needed financing to continue operating. His primary role was to assist WWM clients in preparing the financial information that would be sent to Commerce Bank in connection with their respective loan applications.

WWM helped firms that had difficulty obtaining bank loans typically due to cash-flow, collateral, or credit problems via a program called the Leveraged Asset Plan (LAP), which provided property for WWMs clients to use as collateral for loans. The LAP worked as follows WWM directed clients to purchase treasury bonds (or other low-risk financial instruments) on margin to be held in a securities dealers brokerage account (at CIG). Because of the interlocking nature of CIG (which was controlled by WWM), it appeared the full market value of the securities was available to the bank as collateral for the loan.

As part of the LAP program, WWM required its clients to sign a separate agreement whereby they borrowed funds from WWM for the full value of the financial instruments plus a small 10% service fee and a 10% hold back (money that is held by WWM to cover repayment of the loan in case the client defaults). However, funds were never extended by WWM because the loan was made directly to the client from the bank. WWMs revenue stream was based solely on the 10% service fee. Commerce Bank was unaware of these agreements.

To illustrate WWMs loan process, assume that Gopher Enterprises needs $80,000 in cash to finance its purchase orders. Gopher does not have the required credit or collateral to obtain a business loan through normal banking procedures. The following steps detail the process that Gopher (and other WWM clients) must follow.

Step 1. WWM advises Gopher to obtain $100,000 of 10% margined treasury bonds through CIGs brokerage services (so the cost to Gopher would be $10,000). CIG will then hold these margined bonds in a Securities Dealers Brokerage Account and all margin risks are borne exclusively by Gopher.

Step 2. WWM then creates false documents showing Gopher as the sole (and complete) owner of the $100,000 bonds, when in fact the bonds were held on margin. WWM sends these documents on behalf of CIG and uses Garys bank relationships to help Gopher obtain a $100,000 loan from Commerce Bank.

Step 3. The bank loan proceeds are distributed as follows. $80,000 is distributed to Gopher, $10,000 is held by WWM in an interest escrow account (a common practice for legitimate loans), and $10,000 is paid to WWM as a loan processing fee. Of the $10,000 loan processing fee, Gary Smith receives a commission of 25 percent ($2,500) while Dale and Jeffrey share equally the remaining 75 percent ($7,500).

Things seemed to be going well for WWM. During its first year of operations, WWM processed five loans. The loan amounts range from $100,000 to $2.5 million, including a $140,000 loan for Gary to keep his business going.

Task 1.1.1

Evaluate the loan processes from the perspectives of WWM, CIG, and Commerce Bank. Were any of these practices fraudulent? That is, do you think the parties knew they were engaging in a fraud? Is it possible to perpetrate a fraud without realizing it?

Task 1.1.2

Evaluate Garys actions from the perspective of different ethical frameworks. Appendix A provides a summary of selected ethical frameworks for your consideration as you address the following questions.

1. Why are Garys actions not unethical?
2. Why are Garys actions unethical?

1.2. Part 2 One year later

Because of the financial (and mental) stress of Garys struggle to develop a successful accounting firm and his rationalization that he was helping the community, Gary Smith was blinded to the fact that the WWM financing scheme was fraudulent. He felt he was just serving the greater good as well as providing for his family. Unfortunately, by the end of the first year of operations, three of the five loans (including Garys loan) that were processed by WWM had defaulted. During the ensuing review, Commerce Bank discovered WWMs fraudulent scheme and decided to press criminal charges against all three partners.

Gary Smith, Jeffrey Jones, and Dale Perez were all charged in a 4-count indictment and faced up to 25 years in prison. The indictment first charged them with conspiracy^[1]to commit bank fraud. The individuals were also charged with 2 counts of bank fraud alleging that the three defendants knowingly and willfully devised and intended to defraud Commerce Bank by providing false and fraudulent financial information to Commerce Bank in connection with the applications for loans by clients of WWM, in order to induce Commerce Bank to grant loans to the individual clients. Finally, the individuals were charged with aiding and abetting bank fraud.^[2]

Task 1.2

Evaluate Garys actions from the perspective of an Accounting Regulatory Board. Participation in illegal acts can lead to disciplinary sanctions against the professional accountant. In many countries, a professional accountant may be required to appear before a disciplinary committee to defend his/her actions. Boards typically have the discretion to either wait for the final court resolution of the matter, which may take several years, or start a disciplinary hearing to prevent the accountant from practicing even before the final legal resolution.

1. You have been hired to provide a brief (i.e., memo) to the Accounting Regulatory Board on why Garys actions and conduct do not violate the jurisdictions professional code. As part of your brief, make sure you describe how he might explain his actions and conduct to the Board (i.e., use Task 1.1.2 logic to justify his actions).
2. You have been hired to provide a brief to the Board on why Garys actions and conduct do violate the jurisdictions professional code. What are the implications of allowing Gary to continue practicing as a professional accountant while awaiting the outcome of the trial?

To help you with the task, Appendix B presents two different codes for the accounting profession, the American Institute of Certified Public Accountants (AICPA) Code of Professional Conduct and the International Ethics Standards Board for Accountants (IESBA) Code of Ethics for Professional Accountants. 1.3.