Discuss/analysis/comment on the following:

a.Was the "secret payroll account" within the engagement letter from the auditing firm?

b.When/what should have alerted the auditors to problems?

PTL Club-The Harbinger of Things to Come?

The PTL scandal is a picture-perfect, suitable-for-framing example of how auditors with a modicum of skepticisrn and alertness could have been heroes instead of goats. PTL was an accident waiting to happen even before Tammy got the notion that heading to the mall was the perfect cure for her blues. Auditors who were concerned with doing more than the absolute bare minimum required by GAAS and GAAP could have exposed this fraud much earlier, saving innocent and gullible viewers tens of millions of dollars.

Robert A. Prehike, "Anatomy of a Fraud: Inside the Finances of the PTL Ministries," American Business Law Journal, November 1. 1993

In January 1974. Jim and Tammy Faye Bakker launched the PTL Club, which for more than a decade was one of the most successful television ministries. At its peak, the PTL Club broadcast from nearly 200 television stations to a national audience estimated at 12 million viewers. PTL stood for both "Praise the Lord" and "People That Love." The Bakkers' combined a traditional talk show format with religious entertainment, emotional personal testimonies, and frequent campaigns for financial support. The Bakkers' established a Christian theme park, Heritage USA, which attracted fundamentalist Christians for prayer and fun. They had the country's third most popular amusement park with biblically themed rides and attractions and a large shopping mall selling Christian tapes, records, books, and religious action figures. At its height in 1986, more than 5 million people visited Heritage USA annually, and the PTL Club was raising $10 million a month.

The Bakker's ministry was so popular that, in the final days of the 1980 presidential campaign, Jimmy Carter summoned Jim Bakker to pray with him aboard Air Force One. Ronald Reagan invited him and Tammy to his first inaugural and three years later Reagan told the National Association of Religious Broadcasters' convention that "The PTL TV network is carrying out a master plan for people that love."

While millions of people tuned into the PTL Club for its entertainment and religious inspiration, it had many detractors. Many concluded that "PTL" stood for "Pass the Loot." a reference to the Bakkers' frequent, passionate fund raising appeals and to Jim and Tammy's lavish lifestyle. The Bakkers' perceived excesses (remember to think in 1980s dollars) included

A vacation retreat in the Great Smoky Mountains.

A $449,000 Palm Springs home with a spectacular view of the Santa Rosa Mountains from the heated pool and hot tub.

Vacations in $350 a night hotel suites in Hawaii.

A 1981 Christmas bash for PTL executives at Caf Eugene in Charlotte that included $9,000 worth of truffles flown in from Brussels.

An oceanfront condominium near Palm Beach, which PTL bought for the Bakkers' and spent more than $200,000 to furnish. (The Bakker's had recently made a vow to be "good stewards of God's money")

A $340,000 five level lakeside home with another $73,000 in renovations and of course, a 43 foot houseboat tied to the dock.

A heated and air conditioned dog house for Tammy's dog.

Tammy's minks and Gucci handbags.

A new Mercedes, a 1953 Rolls Royce, a Corvette, and several Cadillac limousines.

A basement health spa and indoor pool in their home in Heritage USA. In his dressing room, Bakker installed gold plated bathroom fixtures and an $11,000 sauna and Jacuzzi.

The crown jewel in the Bakkers' opulent lifestyle was the 4,000 square foot suite at the PTL ministry's Heritage USA theme park and retreat. The "presidential suite" in the Heritage Grand Hotel was designed for use by the Bakkers', although they often preferred their nearby lakeside home. The site included gold plated swan bathroom fixtures, antique beds, and mirrored walls in the bedroom. The suite also included Tammy's 10 by 60 foot closet. Other celebrities also used the presidential suite, but they had to be cleared through Bakker's office. One prosecutor noted the hypocritical conduct in the suite. "People sent their money in for an attractive place where there was no smoking, no alcohol - no alcohol except for Mr. Bakker in the Presidential Suite," referring to Bakker's secret taste for wine and vodka screwdrivers that former staffers detailed in interviews with The Washington Post.

Bakker's frequent explanation for his expenditures was that "God wants his people to go first class." At the same time, this lifestyle inspired Ray Stevens' country song, "Would Jesus Wear a Rolex on His Television Show?"

TROUBLE IN PARADISE

The world of PTL and Heritage USA began to collapse in 1987. Jim Bakker had a tryst with church secretary, Jessica Hahn. The PTL Club paid her $256,000 to drop her $12 million lawsuit (later to be characterized as a bribe or "hush money" in court). The Internal Revenue Service questioned $1.3 million of PTL expenditures for the Bakkers' threatening the PTL's tax exempt status (which eventually was revoked and the organization eventually had to pay back taxes and penalties. The Pentecostal Assemblies of God, which had ordained Bakker, defrocked him.

A confidential payroll account was kept without the board's knowledge. When Laventhol & Horwath (L&H) became PTL's auditor in May 1985, William Spears a senior L&H partner, "kept the books" for this secret account. After writing checks for each other, friends, or themselves, the Bakkers' or other top executives would call Spears with the information so the check register would be accurate and additional funds could be transferred if the account balance dwindled. Prosecutors categorized this fund as "unrecorded payroll"; creditors who lost millions and defrauded donors called it a "slush fund."

The funds for all these activities were primarily generated from partnership interests sold in four different resort hotels built or planned at Heritage USA. These resort properties were to be financed solely by selling "lifetime partnerships" to persons "donating" $1,000. Similar to a timeshare, the donors received four days and three nights for their immediate family in one of the resort hotels, annually, for the rest of their lives. To induce donors to provide money, Bakker supposedly limited the number of partnerships in each project and often exaggerated the number of lifetime partnerships that had been sold. Although money from selling partnership interest was to be used only for construction of the buildings, more than $100 million was diverted from just two of the projects to fund PTL day to day operations.

Eventually, many more than the limited number of lifetime memberships were sold, making it physically impossible for every member to exercise their hotel rights. Bakker sold more than 66.000 partnerships in his Heritage Grand Hotel, although he promised followers only 25,000 would be sold, and 74,000 partnerships in the never finished Towers Hotel, even though he had said only 30,000 would be sold. The followers contributed $158 million between 1984 and 1987 for the partnerships. In addition, a lifetime partnership could be worth over a million dollars if a family of five came to PTL each year and used all facilities and other perks associated with their membership. In the criminal case against Bakker, the government characterized the financing of building operations through lifetime partnerships as a giant Ponzi scheme.

WHERE WAS THE OVERSITE?

Following PTL's bankruptcy, evidence surfaced indicating that the PTL's board of directors had functioned improperly. When Jim Bakker needed money, he simply told other key PTL officials to tell a board member to introduce a resolution recommending a bonus. The board met 23 times between July 5, 1983 and February 16, 1987, when it approved bonuses ranging from $10,000 to $390,000 for Jim Baker 13 times. In 21 of those meetings, the board also approved bonuses of $2,000 to $170,000 for Tammy Bakker. From June 1986 to March 1987, Jim and Tammy Bakker received more than $1 million and $335,000 in bonuses, respectively. These bonuses were over and above salary and expenses the Bakkers' used to maintain their lavish lifestyles. From 1984 to 1987, they received more than $4.8 million in salary, bonuses, and other payments. Each of two other PTL executives, David Taggart and Richard Dortch, received bonuses of almost half a million dollars. Despite receiving this exorbitant amount of money, Jim Bakker announced on TV that he was too poor to buy his $1,000 lifetime membership this month but would put it on his credit card (as viewers were urged to do) and pay for it the following month.

WHAT DID THE AUDITORS KNOW?

The mid 1980's had six very large international accountings firms (called the "Big Six") including Deloitte, Haskins & Sells (now a part of Deloitte and Touche), PTL's auditor until May 1985. Laventhol & Horwath (L&H) was then the seventh largest accounting firm. Jim Bakker used both of these highly regarded firms to reassure his viewers of the PTL Club's financial integrity. He often appeared on television to present audited financial statements as indicators of his personal honesty and the PTL Club's financial integrity. After all, PTL paid large fees to nationally reputable accounting firms to inspect its books. Would someone hiding financial misconduct do that? For example, on April 1986, in the midst of allegations against Jim Bakker, he told his television audience.

We don't mind letting you now that we print audits of this ministry. We have done it for, what, ten years now, and we go through an audit almost a hundred percent of the time. An outside auditing firm, one of the big audit firms of America, is in here at all times auditing this ministry at our own expense, thousands of dollars, tens of thousands of dollars, to be responsible, and we are going to go forward, but it's time God's people say enough is enough.

However, as Jim Bakker repeatedly used the auditors' good reputation to assure his audiences of the PTL Club's honestly and integrity, the accounting firms should have known that Jim Bakker was misleading PTL members.

Deloitte admitted that it had known of the advertised limit on the sale of memberships but argued that no oversales occurred until shortly after May 31, 1984, the end of the fiscal year for which it had prepared its last PTL financial statements. However, it took considerable criticism for not knowing or reporting on the oversale occurring shortly after May 31, 1984, because its report was dual dated August 31, 1984 and October 24, 1984. (While auditing standards specify the auditors' responsibilities for subsequent events when the reports is dual dated, the judicial system and the court of public opinion may not always see these responsibilities similarly). Conversely, L&H admitted that it had known that more than 25,000 Grand Hotel lifetime partnerships had been sold but denied that it had any knowledge that a limit was placed on the number of partnerships even though this limit was widely publicized.

Both Deloitte and L&H wrote checks from the PTL secret account to the Bakkers' and other key employees (but did not sign them to avoid an obvious conflict of interest with their audit roles). Both firms prepared the Bakkers' tax returns. Tax law prohibits tax-exempt organizations from providing excessive private enumeration. Both accounting firms claimed to have been unaware that the IRS was seriously considering revoking PTL's tax-exempt status due to the compensation being paid to the Bakkers'. Furthermore, after one outside law firm resigned because of concerns over excessive compensation, PTL's new law firm argued that the compensation was not excessive because the auditors reviewed the amounts paid.

Many red flags should have been evident to both audit firms. Although legal issues were raised regarding the lifetime partner concept, neither audit firm had indicated that this concept presented audit issues. Deloitte had addressed its concerns about the excessive compensation; the dramatically increasing personal expenses of senior executives; and the selling of merchandise at astronomical markups (PTL purchased statues of David and Goliath for $10 and represented them on television as being worth $1,000). But these issues did not lead to a modified audit report opinion or other disclosures.

Financial documentation was often designed to hide items from the auditors. For example, bonuses were not recorded in the minutes of the board of directors meetings but in "addendums" to the minutes that were added at a later date. A year's worth of records regarding travel and other expenses were "lost" and were never provided to L&H. Auditors could not find documentation for other expenditures, including $27 million of $80 million spent on construction projects. In a 23page memo, Deloitte spent 22pages listing inadequacies in PTL's internal controls. Both accounting firms knew that PTL had an unreasonably high number of separate bank accounts and a tremendous problem with bounced checks. A draft of Deloitte's 1984 audit report expressed a concern over "whether PTL would be able to continue as 'a going concern' based on current assets of only $8.6 million against $28.5 million in current liabilities". A going-concern issue was not included, however, in the issued audit report.

AFTER THE FALL

Jim Bakker relinquished his ministry after admitting to the extramarital tryst, and he and his wife, Tammy Faye, exiled themselves to Palm Springs, California. In March 1987, to help avoid bankruptcy and restore its reputation, the PTL Club's new boards appointed the Rev. Jerry Falwell, then a well-respected and well-known television minister, to take over the organization. He was to defend the PTL Club against legal threats from creditors, disgruntled contributors, and the IRS.

The IRS Examination Report contended that tax-exempt rules had been violated because of excessive payments to Bakker, his family, and other PTL officers. Revenue examiners asserted that Bakker's compensation of $968,000 in a three year period was "unreasonable" and that his total compensation should not have exceeded $331,000. PTL Club lawyers argued that Bakker's compensation was reasonable "because he is the guiding light of the ministry and is the key to PTL's success in fund raising".

The PTL Club hired Arthur Andersen to extensively audit PTL activities in an effort to gain a true picture of its financial position. Besides those problems already outlined, the new auditors found the following:

$92 million in funds that could not be accounted for (later reduced to $12 million as PTL executives found documents).

$71 million debt.

Missing records documenting $27 million in construction expenditures. (Building contractors insisted that they submitted the records to PTL as they performed the work).

Operating losses of $27 million sustained by the organization in the nine months preceding Bakker's resignation.

Based on the new information, PTL officials were convinced that Bakker knew that the ministry's financial situation was out of control long before the scandal over the sexual encounter forced him to step down.

LAVENTHOL & HORWATH

Founded in 1915 in New York, Horwath & Horwath merged in 1967 with Laventhol Krekstein Griffith & Co. of Philadelphia. L&H experienced massive growth exemplified by a nearly quadrupling of revenues during the 1980's, fueled through acquisitions by developing expertise in unique areas of practice and by accepting risky clients. From 1984 to 1990, L&H acquired 64 small practices increasing its revenues to $345 million. At its peak, the firm had more than 50 offices and 460 partners. Merging so many practices and commensurate different cultures created a patchwork of ethics and values and a sense that increasing the revenue stream was the firm's paramount objective. The drive for growth led the firm to accept clients without appropriately screening them and to accept clients known to be risky.

L&H often sought expertise that pushed the envelope. One of its most notable and lucrative revenue streams was finding tax write-offs for investors in hotels. This practice warned when the IRS reformed the tax code. L&H also developed a specialty in services to the commercial real estate industry, an industry which in the late 1980's, was pushing a bogus tax shelter involving genetically engineered cows, resulting in L&H's being the first accounting firm to lose a jury trial under federal racketeering law. L&H often found itself in court fighting allegations of sloppy audit work. Following the filings of suits associated with their PTL work, the firm had 115 legal actions against it, seeking a total of $362 million.

L&H tried to survive despite the legal and fiscal pressures. Before its collapse, employees had accepted a 10 percent pay cut, and the payments to retired partners were significantly cut. Still the firm found itself so short of cash that appeals from employees to borrow money occurred daily. Finally, the firm gathered its partners in Houston for a special meeting to address the critical situation. The vote was unanimous to dissolve Laventhol, resulting in what was the largest collapse of an accounting firm. On November 21, 1990, Laventhol & Horwath declared bankruptcy and 3,273 employees were out of work.

GOING TO COURT

In a 28page indictment, Jim Bakker was charged with 24 counts of fraud and conspiracy. The jury convicted Bakker, who was sentenced to 45 years in prison (the sentence was reduced on appeal and Bakker was in prison only from 1989 to 1994). In a civil case brought by disgruntled lifetime partners, Bakker was found liable for common law fraud and almost $130 million in damages (although no money was ever collected). The same jury exonerated Deloitte and Touche (successor to Deloitte, Haskins & Sells) from fraud because the intention (scienter) to aid in the fraud had not been proved.

Richard Dortch, PTL's former second in command, and Bakker aides David and James Taggart were also charged. Dortch, who was to have stood trial with Bakker, agreed to plead guilty to four counts of conspiracy and fraud and was sentenced to eight years (later reduced to two years) in prison and a $200,000 fine. His light sentence was in part due to his agreement to testify against Bakker. Taggart, former PTL executive vice president, received the maximum sentence of 18 years and 5 months on a conviction for income tax evasion. His brother James Taggart, PTL's decorator, was sentenced to 17 years and 9 months.

L&H declared bankruptcy to shield itself from lawsuits, debt repayment (much of which was incurred to finance its acquisitions), and other liabilities. Once L&H declared bankruptcy, all lawsuits, including the PTL lawsuits, were suspended, and in 1992, the bankruptcy court combined the PTL claims and other lawsuits into the bankruptcy proceedings. PTL creditors and members joined a long list of creditors in bankruptcy court with total claims of nearly $2 billion. A federal bankruptcy court approved a plan to collect $47 million from 629 partners and other professional-level firm members, although L&H was not "conceding any allegations in the complaint". The assessments, which were to be paid over 10 years, averaged between $75,000 and $400,000 per employee. Although PTL creditors received only a few cents on the dollar, members received nothing.

CONCLUSION

The AICPA has stated that the accounting profession must learn from past cases to prevent the reoccurrences of similar detrimental activities. Although the PTL engagement by itself did not destroy L&H, it contributed greatly at a time when the firm was already awash in debt and legal proceedings. PTL became the proverbial "straw that broke the camel's back". Furthermore, the PTL engagement is viewed as emblematic of the types of clients and quality of audit work that characterized Laventhol in the mid-1980s.

The L&H case changed the face of the accounting profession. Historically, the accounting profession had demanded that accountants practice as partnerships on the theory that professionals should stand by their work and not be shielded from the cost of their mistakes. It also made financial sense to adopt that structure because profits in a partnership are divided and taxed to the individual. Corporations, on the other hand are taxed twice; once as a company and then as individuals on their corporate dividends. After Lacenthol, the accounting profession moved to organizing under limited liability partnerships, (LLPs) and companies (LLCs). These structures provide legal protection to the partners and top executives in the firm.