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Ah for 'creative accounting' !

From the Detroit Free Press:

A LOOK AT THE BOOKS: How GM juggled millions GM's road may get rougher

June 4, 2006



One morning in March last year, General Motors executives conducted a conference call with Wall Street analysts to lay out some gloomy news: Shareholders could expect first-quarter losses and lower-than-expected earnings to follow.

When it was his turn, Prudential analyst Michael Bruynesteyn raised a delicate question. He asked if GM had the same sort of accounting problems that were haunting Delphi Corp.

GM's former parts unit had improperly recorded cash payments, known as rebates, from suppliers.

"Our policy is no rebates from suppliers," shot back John Devine, GM's chief financial officer. He added that the automaker "had been very clear with our suppliers that we don't do business that way.

"We think our accounting is very acceptable."

But in fact, GM had improperly recorded rebates. It later admitted that its accounting practices led GM to inflate its 2001 income by 42% -- and by lesser amounts in 2000, 2002 and 2004, errors GM attributes to honest mistakes.

GM's books are now under investigation by federal regulators and under fire from some GM investors, who claim in lawsuits that they were misled. The investigations come at a sensitive time for GM as it seeks to bolster shareholder confidence and turn a profit in North America.

'A great deal of suspicion'

Federal securities records and court filings reviewed by the Free Press show a string of accounting errors that consistently favored the company and offered investors a rosier outlook than actually existed. While GM is not accused of any crimes, experts warn that if GM is found to have intentionally misled investors, it might face legal problems and costly sanctions that could devastate the automaker.

Some industry experts said they are disturbed by what they already know. Most troubling, they say, is that nearly every error GM has acknowledged helped to improve its financial picture.

"The evidence is there was a string of errors, all going in one direction, giving a more positive light to GM's results," said Charles Mulford, an accounting professor at the Georgia Institute of Technology who has studied accounting at GM and other large companies. "Simple, honest errors go both ways. Investors were misled, in my view."

GM said the errors were nothing more than a series of mistakes and must be viewed in the context of a company that had $193 billion in revenue last year.

Peter Henning, a Wayne State University law professor who specializes in white-collar crime, sees reason for concern. When errors fall uniformly in the company's favor, he said, "that starts to look like a plan; that's not a series of accidents. That would generate a great deal of suspicion on the part of the government."

Jerry Dubrowski, a GM spokesman, did not directly address why the errors tended to favor GM.

"There's no question that the accounting errors were embarrassing to GM, that they hurt our reputation or damaged our reputation with investors," he said. "We are working very hard to restore that reputation.

"Our decision to correct these mistakes was not at all guided by whether they were in GM's favor or not," he said. "It was to get the correct accounting."

GM's defense was supported by David Cole, chairman of the Center for Automotive Research, a nonprofit in Ann Arbor that studies the auto industry.

The bigger, more troubling picture

Van Conway, a corporate-turnaround specialist based in Birmingham, said whatever accounting problems existed, they pale compared with GM's larger problem: survival.

"If the company doesn't solve its declining market share, how they account for a rebate really isn't going to matter," he said.

Dubrowski said GM has tightened accounting controls and changed how it records supplier credits. The company also has brought in AlixPartners, a firm known for advising troubled companies such as Kmart, WorldCom and Dana Corp., to help GM with a range of accounting matters.

Last month Peter Bible, GM's chief accounting officer, abruptly resigned and controller Paul W. Schmidt said he was retiring.

Since October 2004, GM's accounting has come under scrutiny by two federal grand juries and the Securities and Exchange Commission, which has issued six subpoenas seeking records -- including records on rebates and price adjustments GM received from suppliers and its dealings with Delphi.

Sued by investors

GM is accused of fraud by lawyers representing investors from Mississippi to Germany. In the suits, which were consolidated in a New York federal court, investors point to Devine's assurances to Wall Street, among other things, as evidence of a massive scheme to deceive stockholders.

Devine declined to comment.

DekaBank, one of Germany's largest financial institutions, said GM's deceptions cost two of its subsidiaries $23 million.

"They lied about the finances. My client lost lots and lots of money for its clients, and they want some of their money back," said Marvin Frank, a Manhattan attorney with Murray, Frank & Sailer who represents DekaBank.

Where the trouble began

The story of how venerable General Motors became entangled in federal investigations began with the spinoff of Delphi in 1999.

It was supposed to be a good deal for both companies. GM could save money by buying parts from other, less-expensive suppliers. Delphi could market itself to GM competitors and negotiate contracts directly with its unions.

J.T. Battenberg III, a longtime GM executive, took over as Delphi's president, chief executive and chairman. He assembled a cabinet of top lieutenants, including several GM veterans.

Deloitte & Touche, GM's independent auditor since 1918, added Delphi to its client list. BBK, an advisory firm used by GM, became Delphi's turnaround firm.

Delphi had to quickly show investors it was a viable and expanding business. But it was saddled with obsolete, worthless inventory like scrap metal and outdated electronics -- and needed cash almost immediately, according to an investor lawsuit filed against Delphi.

Delphi turned to Setech, a Murfreesboro, Tenn., firm that helps reduce unwanted inventory.

Setech agreed to temporarily buy $145 million of Delphi's excess inventory, then sell the material back to Delphi later, according to the suit. That allowed Delphi to show on its books that it was shedding inventory and bringing in revenue. In reality, the lawsuit alleges, the tactics were a sham designed to mislead investors.

A witness in the suit, an unidentified former senior manager at Delphi, told lawyers: "This was a backroom deal. I told Setech, 'You buy this stuff, get it off my books, and I will buy it back from you.' "

A woman who answered the phone at Setech declined to comment.

Disgruntled investors also cite other Delphi deals -- including an $89-million inventory-shifting arrangement with BBK, the turnaround firm, and a $200-million deal with Bank One.

BBK founder B.N. Bahadur told the Free Press: "We have cooperated with the SEC when they contacted us; we have cooperated with everyone who has contacted us."

Brian Marchiony, spokesman for JP Morgan Chase & Co., the company that bought Bank One in 2004, declined to comment.

The FBI confirmed early last year that it, the Justice Department and postal inspectors were investigating accounting irregularities at Delphi, which already was under scrutiny by the SEC. The company has stated it is not a target of the Justice investigation.

Meanwhile, six Delphi executives lost their jobs, and Battenberg announced his retirement before the magnitude of Delphi's accounting troubles became public.

Claudia Piccinin, a Delphi spokeswoman, said the company's board of directors completed an investigation of its accounting irregularities June 30 and took action to correct the mistakes.

A beating on Wall Street

It was in March of last year, around the time that Delphi said it improperly recorded supplier credits, that Rick Wagoner, GM's chairman and chief executive, and Devine were left to explain GM's gloomier first-quarter forecasts to analysts.

Dubrowski, the GM spokesman, gave the Free Press a statement from GM seeking to clarify Devine's remarks to Wall Street. It said the company, beginning in 2002, instructed its buyers not to accept lump sum payments from suppliers in exchange for future business. The statement also said GM crafted a written policy in early 2005, before Devine's remarks, "prohibiting supplier credits linked to guarantees of future business."

Aside from reporting the disappointing earnings, GM faced up to another problem that day. It acknowledged it was changing the way it accounted for the money flowing between its automotive and financing operations.

Mulford, the Georgia Tech professor, had written a paper suggesting GM was masking the true financial health of its automotive business by treating money it had not yet received from car dealers as current operating cash.

After the SEC questioned the practice, GM reduced cash from operations by $9 billion in 2002 and 2003.

That same day, on March 16, 2005, GM's stock plunged to close at $29.01 per share, down $4.71, or 14% from the day before. It was the company's largest day-to-day decline in almost six years.

Larry Gardner, a retired plant foreman from Florence, Ky., felt the effects of GM's admissions.

The GM bonds he'd bought for $15,000 in January tumbled, and he sold them for a $6,000 loss. Gardner, 82, said he keeps a close eye on the stock market and considers himself a conservative and informed investor. He said he feels deceived by GM and is among the investors suing the automaker.

"I don't think they were perfectly honest in time about revealing the fact that they were going to have these huge losses." Gardner said. "I didn't know that was coming."

Gardner hasn't invested in GM since.

Things get worse

The next month, in April 2005, the SEC subpoenaed GM for records on rebates and other payments it had received from Delphi.

On Oct. 8, Delphi declared Chapter 11 bankruptcy.

That day, GM said that, because of the bankruptcy, it could be on the hook for as much as $11 billion in pension and other retirement costs for Delphi workers.

Later that month, GM disclosed for the first time that it had received SEC subpoenas concerning Delphi and supplier credits.

GM revealed in November that because improper accounting for supplier credits it had overstated its 2001 income. It was GM's first acknowledgement of its own accounting errors. The company said it was investigating its accounting for supplier credits from 2000-2005.

In March, GM disclosed more errors -- and more subpoenas. This time, a federal grand jury had asked for records related to supplier credits and the SEC wanted documents on deals involving precious metals.

The accounting mistakes wiped away $387 million in profits from 2000 through 2004 and required GM to restate its annual reports for each of those years, as well as the first three quarters of 2005.

And all but the smallest misstatements went in GM's favor.

Explaining the mess

Dubrowski said that some of the $387 million that was wiped off the books in those years will be recognized in future years.

"It's fair to say we made mistakes in our accounting and we have acknowledged those mistakes," he said. "No accounting system is 100% foolproof 100% of the time."

In an April 4 interview with the Free Press, Wagoner, GM's chief executive, called the errors honest mistakes.

"By and large people were doing what they thought was right but either didn't refer to the specific accounting rules or thought they knew the rules and didn't know them," Wagoner said.

Edward Ketz, an associate professor of accounting at Pennsylvania State University who has written extensively on corporate accounting scandals, was skeptical.

"Wagoner may be correct in that statement, but given the number of errors and their magnitude, it stretches one's credulity to believe the assertion," he said. "It's fairly clear in the past five years, they've taken a very aggressive position on this. They thought they needed it to look good to creditors and investors."

As a result, he said, "you don't have quite the same trust in what they're saying in the financial reports."

John Lauve, a GM white-collar retiree and shareholder from Holly, said he has lost faith in his former employer.

"It's just a great tragedy of mismanagement by General Motors," said Lauve, who retired in 1999 after 30 years with GM. He plans to run for a seat on the board.

"These transgressions -- they're not mistakes -- were to put off the day of reckoning," Lauve said. "And here it is."
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