W.R. Graces Cookie Jar

1
W.R. Graces Cookie Jar

• Erin Kelly
• Courtney Guziewicz
• Christian Jamerson
• Tammy Tavernaro

2
W.R. Grace A Brief History

• Global specialty chemical and materials company
• Based in Boca Raton, FL
• History of fraud-related litigation

3
Health Care Group National Medical Care

• Subsidiary of W.R. Grace
• Primary Component of Graces Health Care Group
• Manufacturer of medical products
• Provider of kidney dialysis and home-health
  services

4
A Fraud Develops.

• Excess reserves of 10-20 million
• Later release of reserves to smooth income and
  meet growth forecasts
• Reserves set up for unexpected contingencies
• Questions raised by auditors

5
External Auditors PriceWaterhouseCoopers

• W.R. Graces auditors since 1906
• Questioned validity of reserves beginning in
  early 1990s
• Repeatedly warned client about inappropriate
  accounting practices
• Issued unqualified report despite reservations

6
What Allowed This Fraud to Happen?

• Culture of companies in the early 1990s
• Interpretation of accounting principles
• Breakdown of controls

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Culture of Companies in the 1990s

• Phony accounting practices were common
• Pressure from Wall Street

8
Interpretation of Accounting Principles

• Revenue recognition
• Accounting rules clearly state companies can
  only set aside profits in reserve for liabilities
  that can be foreseen and quantified they cant
  use reserves as rainy-day funds

9
Interpretation of Accounting Principles

• Materiality principle
• Material an accounting standard often defined
  as anything that affects earnings by more than
  5-10
• Purpose of principle is to help management avoid
  needless costs

10
Breakdown of Controls

• PriceWaterhouse becomes suspicious
• Concerns from senior partners dismissed in light
  of materiality principle

11
Breakdown of Controls

• In-house audit chief becomes suspicious
• Concerns dismissed by audit committee

12
Breakdown of Controls

• Repeated warnings from both external and internal
  auditors
• Unqualified report issued regardless
• SEC criticism of auditors for not taking stronger
  steps to prevent wrongdoing

13
How Was This Fraud Detected?

• Though widely believed common, it is usually
  invisible

14
How Was This Fraud Detected?

• External auditors
• Legal action
• SEC
• Filed suit against Grace
• Used Grace to redefine materiality and disclosure
  standard
• Internal Audit Chief
• Whistleblower suit

15
How Could This Fraud Have Been Prevented?

• External auditors should have taken more
  aggressive role
• Audit committee should have had more active role
• SEC should have clarified both materiality and
  disclosure standard

16
Outcome

• SEC issues cease and desist order
• Grace agrees to create 1 million education fund
• Partners of PWC agree to
• orders barring them
• from future securities
• law violations

17
Bibliography

• Davis, Ann. SEC Claims Profit Management by
  Grace. Wall Street Journal. April 7, 1999.
• Davis, Ann. SEC and W.R. Grace Are Near
  Accord Over Alleged Earnings Manipulation.
  Wall Street Journal. June 25, 1999.
• Field, David. Earnings Reports Prompt Charges
  SEC W.R. Grace Doctored Books to Gain
  Investors Trust. USA Today. December 23,
  1998
• Ketz, Edward J. and Miller, Paul B.W. W.R.
  Graces Disgraceful Abuse of Materiality.
  Accounting Today. May 24, 1999.
• Mulligan, Thomas S. Special Report Can You
  Trust The Numbers? Los Angeles Times. May 23,
  1999.

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Bibliography

• Schroeder, Michael. SEC Accuses Grace of Fraud
  in Accounting. Wall Street Journal. December
  23, 1998
• Unknown author. Grace Settles Charges That It
  Manipulated Earnings Statements. Wall Street
  Journal. July 1, 1999.
• US Securities and Exchange Commission. SEC
  Sues W.R. Grace and Co. For Financial Fraud
  Involving Earnings Manipulation. Litigation
  Release 16008. Accounting and Auditing
  Enforcement Release 1091. December 22, 1998