Topics: Audit, Auditing, Internal control Pages: 7 (2175 words) Published: October 11, 2013

CASE 1.3



This case focuses on David Sokol, an executive who has made a “name” for himself in recent years within the energy industries. After becoming recognized as a successful “turnaround” agent for troubled companies, Sokol was hired in 1992 to serve as the chief operating officer of JWP, Inc., a large, New York-based conglomerate. At the time, JWP had an impressive history of sustained profits and revenue growth that was being threatened by the company’s far-flung operations and unwieldy organizational structure. Unknown to Sokol, JWP’s impressive operating results over the prior few years had been embellished by the company’s CFO and several of his top subordinates. Because of Sokol’s reputation for being a “hands-on” executive who insisted on personally obtaining a thorough understanding of his employer’s financial affairs, the CFO attempted to conceal misrepresentations in JWP’s accounting records from Sokol. Despite the efforts of the CFO, Sokol quickly uncovered suspicious items in JWP’s accounting records after he assumed responsibility for the company’s day-to-day operations. The diligent and persistent Sokol eventually met with JWP’s CEO and informed him of the problems he had uncovered. Sokol insisted that an accounting firm other than JWP’s audit firm be retained to perform a forensic investigation. Sokol questioned whether JWP’s audit firm could objectively perform that investigation since there were close relationships between key members of the audit engagement team and JWP’s top accountants, including its CFO. In fact, the CFO and three of his key subordinates had formerly worked for JWP’s audit firm. Before the second accounting firm could complete its investigation, Sokol discovered additional distortions in JWP’s accounting records. Sokol rejected a $1 million “stay” bonus offered to him by JWP’s CEO and resigned as the company’s COO after turning over the evidence he had collected to the board of directors. The SEC issued a series of accounting and auditing enforcement releases focusing on the JWP accounting fraud. JWP’s CFO and the three subordinates who had helped him carry out the fraud were sanctioned by the SEC. JWP’s audit firm, Ernst & Young, reportedly paid $23 million to settle lawsuits filed by JWP’s stockholders. Ernst & Young was eventually successful in defeating a large lawsuit filed by JWP’s former lenders. However, in the latter lawsuit the federal judge who presided over the case severely chastised Ernst & Young for its “willingness to accommodate” JWP’s former CFO and for its “spinelessness” in performing JWP’s annual audits.

Jamaica Water Properties--Key Facts

1.In 1992, David Sokol accepted an offer to become the COO of JWP, Inc., a large, New York-based conglomerate whose impressive earnings and revenue trends were being threatened.

2.Unknown to Sokol, JWP’s operating results had been embellished by an accounting fraud directed by the company’s CFO, Ernest Grendi, and three of his subordinates.

3.Grendi relied on the far-reaching authority granted to him by Andrew Dwyer, JWP’s CEO, and on his “intransigent and intimidating” personality to gain complete control over JWP’s accounting function.

4.Because Sokol had a reputation as an effective and hands-on executive, Grendi attempted to conceal misrepresentations in JWP’s accounting records from Sokol.

5.Sokol discovered suspicious items in JWP’s accounting records shortly after joining the company, which prompted him to insist that an accounting firm be brought in to perform a forensic investigation of those records.

6.Sokol wanted a firm other than JWP’s audit firm, Ernst & Young, to perform the investigation because of close, personal relationships that existed between members of the Ernst & Young audit team and JWP’s key accounting officials, including Ernest Grendi.

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