[SOLVED] In 2005, Tony Menendez, a former Ernst &

In 2005, Tony Menendez, a former Ernst & Young LLP auditor and Director of Technical Accounting and Research Training for Halliburton, blew the whistle on Halliburton’s accounting practices. The fight cost him nine years of his life. Just a few months later in 2005, Menendez received an email from Mark McCollum, Halliburton’s chief accounting officer, and a top-ranking executive at Halliburton, that also went to much of the accounting department. “The SEC has opened an inquiry into the allegations of Mr. Menendez,” it read. Everyone was to retain their documents until further notice.”
What happened next changed the life of Menendez and brought into question how such a large and influential company could have such a failed corporate governance system. Further, the role of the auditors, KPMG, with respect to its handling of accounting and auditing matters seemed off, and independence was an issue. Exhibit 1 summarizes some of the relevant accounting and auditing issues in the case.
Nature of Halliburton’s Revenue Transactions in Question
During the months following the “leaked” email, Menendez waited and watched to see if Halliburton would act on his claims that the company was cooking the books. The issue was revenue recognition as discussed below.
Halliburton enters into long-term contracts with energy giants like Royal Dutch Shell or BP to find and exploit huge oil and gas fields. It sells services – the expertise of its geologists and engineers. Halliburton also builds massive and expensive machinery that its professionals use to provide those services. Then, the company charges its customers for that equipment, which has particularly high profit margins. The company’s accountants had been allowing the company to count the full value of the equipment right away as revenue, sometimes even before it had assembled the equipment. But the customers could walk away in the middle of the contracts. Menendez realized that if the equipment were damaged, Halliburton, not the customer, was on the hook.
Menendez accused Halliburton of using so-called bill-and-hold techniques that distort the timing of billions of dollars in revenue and allowed Halliburton to book product sales before they occurred.
Menendez explained Halliburton’s accounting this way.
“For example, the company recognizes revenue when the goods are parked in company warehouses, rather than delivered to the customer. Typically, these goods are not even assembled and ready for the customer. Furthermore, it is unknown as to when the goods will be ultimately assembled, tested, delivered to the customer and, finally, used by the company to perform the required oilfield services for the customer.'”
Based on Menendez's claims, Halliburton's accounting procedures violated generally accepted accounting principles. For companies to recognize revenue before delivery, “the risks of ownership must have passed to the buyer,'” the SEC's staff wrote in a 2003 accounting bulletin. There also “must be a fixed schedule for delivery of the goods," and the product “must be complete and ready for shipment," among other things.
Shortly after joining Halliburton in March 2005, Menendez said he discovered a “terribly flawed'' flow chart on the company's in-house Web site, called the Bill and Hold Decision Tree. The flow chart, a copy of which Menendez included in his complaint, walks through what to do in a situation where a “customer has been billed for completed inventory which is being stored at a Halliburton facility.”
First, it asks: Based on the contract terms, “has title passed to customer?'' If the answer is no -- and here's where it gets strange -- the employee is asked: “Does the transaction meet all of the ‘bill and hold’ criteria for revenue recognition?'' If the answer to that question is yes, the decision tree says to do this: “Recognize revenue.” The decision tree didn't specify what the other criteria were.
In other words, Halliburton told employees to recognize revenue even though the company still owned the product. Ironically, the accelerated revenue for financial statement purposes led to higher income taxes paid to the IRS.
“The policy in the chart is clearly at odds with generally accepted accounting principles,” said Charles Mulford, a Georgia Institute of Technology accounting professor, who reviewed the court records. “It's very clear cut. It's not gray.”
According to the accounting rules, it is possible to use bill-and-hold and comply with the rules. But it's hard. The customer, not the seller, must request such treatment. The customer also must have a compelling reason for doing so. Customers rarely do.
Top Halliburton accounting executives had agreed with Menendez’s analysis, including McCollum, the company’s chief accounting officer. But according to Menendez, they dragged their feet on implementing a change that was certain to slow revenue growth. In an email response to detailed questions, a Halliburton spokeswoman wrote, “The accounting allegations were made by Mr. Menendez almost nine years ago and were promptly reviewed by the company and the Securities and Exchange Commission. The company’s accounting was appropriate and the SEC closed its investigation.” This seems curious when we examine the SEC’s own rules for recognition.
Hocus Pocus Accounting- Bill-and-Hold Schemes
The proper accounting for Halliburton’s bill-and-hold transactions was not lost on its external auditors, KPMG. In fact, in early 2005, KPMG published an article entitled: Bill and Hold Transactions in the Oilfield Services Industry, which made it clear that oilfield services companies had to comply with all four of SEC Staff Accounting Bulletin (SAB 101) to recognize revenue early. These include:
• Persuasive evidence of an arrangement exists
• Delivery has occurred or services have been rendered
• The seller's price to the buyer is fixed or determinable, and
• Collectibility is reasonably assured.
KPMG went on to recognize that it would be rare for an oilfield service company to actually meet the necessary criteria. The impact to Halliburton was highlighted by KPMG’s recognition that bill and hold transactions for oilfield service companies were “common” and “involve very large and complex products and equipment that carry significant amounts of economic value.” KPMG went on to state that “perhaps no area of revenue recognition has received as much scrutiny as bill-and-hold.”
Menendez’s Complaint to the DOL
Menendez’s allegations are part of a 54-page complaint he filed against Halliburton with a Department of Labor (DOL) administrative-law judge in Covington, Louisiana, who released the records to Menendez in response to a Freedom of Information Act request. Menendez claimed Halliburton retaliated against him in violation of the Sarbanes-Oxley Act's whistleblower provisions after he reported his concerns to the SEC and the company's audit committee.
According to a company spokesperson, Halliburton's audit committee “directed an independent investigation” and “concluded that the allegations were without merit.” She declined to comment on bill-and-hold issues, and Halliburton's court filings in the case don't provide any details about its accounting practices.
Menendez filed his complaint shortly after a DOL investigator in Dallas rejected his retaliation claim. His initial claim was rejected by the court and subsequently appealed after many years, and the decision was ultimately overturned but not until after he and his family had endured a nine-year ordeal during which time he was an outcast at Halliburton.
The Final Verdict is in: Accountant takes on Halliburton and Wins!
The appeals process went on for three years. In September 2011, the administrative law appeals panel ruled. It overturned the original trial judge. After five years, Menendez had his first victory.
But it wasn’t over. Halliburton appealed to the Fifth Circuit Court of Appeals. There were more legal filings, more hours of work, more money spent.
Finally, in November of 2014, almost nine years after Menendez received “The Email,” he prevailed. The appeals panel ruled that he indeed had been retaliated against for blowing the whistle, just as he had argued all along.
Because he had wanted only to be proven right, he’d asked for a token sum. The administrative law panel, noting the importance of punishing retaliations against whistleblowers, pushed for an increase and Menendez was awarded $30,000.
To say that the outcome stunned experts is something of an understatement. “Accountant beats Halliburton!’’ said Thomas, the attorney and expert on whistleblower law. “The government tries to beat Halliburton and loses.”
Post-Decision Interview about Whistleblowing
In an interview with a reporter, Menendez offered that Halliburton had a whistleblower policy prior to this incident as required under Sarbanes-Oxley. It was required to be confidential and Halliburton's policy promised confidentiality while at the same time discouraging anonymous complaints on the basis that if you didn't provide your identity they may not be able to properly investigate your concern. Menendez added that it was absolutely central to my case and I relied on this policy but it was Halliburton that blatantly ignored its own policy and betrayed my trust.
He was asked how the whistleblowing policy of the SEC might be improved. He said that all too often it is almost impossible for a whistleblower to prevail and that there needs to be more protections and a more balanced playing field. “It shouldn't take nine years and hundreds of thousands of dollars to even have a remote chance of prevailing.”
Exhibit 1
Issues related to the Sarbanes-Oxley Act, SEC, and KPMG
Menendez contacted the audit committee because he believed it was in the best interest of the employees and shareholders if he made himself available to the committee in their efforts to investigate the questionable accounting and auditing practices and properly respond to the SEC. It was discovered that Halliburton did not have in place, as required by Section 301 of SOX, a process for “(1) the receipt and treatment of complaints received by the issuer regarding accounting, internal controls, or auditing matters; and (2) the confidential, anonymous submission of employees of the issuer of concerns regarding questionable accounting or auditing matters.”
After waiting for the company to take action to no avail, Menendez felt there was no alternative to blowing the whistle and on November 4, 2005, he contacted the SEC and PCAOB stating in part:
“As a C.P.A. and the Director of Technical Accounting Research and Training for Halliburton, I feel it is my duty and obligation to report information that I believe constitutes both a potential failure by a registered public accounting firm, KPMG, to properly perform an audit and the potential filing of materially misleading financial information with the SEC by Halliburton.”
Two weeks later, at the agencies' request, he met with SEC enforcement staff at their Fort Worth office. On November 30, 2005, he· approached members of top management of Halliburton. On February 4, 2006, Menendez provided what he believed would be a confidential report to Halliburton's audit committee, giving the company yet another opportunity for self-examination. However, on the morning of February 6, 2006, Menendez's identity was disclosed to McCollum and less than an hour after finding out that Menendez had reported the questionable accounting and auditing practices to the SEC, McCollum distributed information about Menendez's investigation and identity.
The disclosure was followed by a series of retaliatory actions. Halliburton management stripped Menendez of teaching and researching responsibilities, ordered subordinates to monitor and report on his activity, excluded him from meetings and accounting decisions, and ordered financial and accounting personnel to pre-clear any conversations about accounting issues before discussing them with Menendez.
In May 2005, Menendez filed a civil whistleblower complaint under SOX. In July 2006, Halliburton told the Department of Labor handing the case that KPMG had insisted that Menendez be excluded from a meeting concerning accounting for a potential joint venture arrangement called “RTA.” Halliburton indicated it acceded to KPMG's demand and excluded Menendez from the meeting. SOX prohibits an employer from discriminating against an employee, contractor, or agent and prohibiting such party from engaging in activity protected under the Act, and the SEC stated that the assertion by the company that KPMG's presence was mandatory was misleading. In fact, the SEC opined that KPMG’s presence was not even advisable since KPMG was supposed to be an independent auditor in both appearance and in fact.
The RTA meeting was scheduled to determine whether or not Halliburton would be required to consolidate the proposed joint venture. Senior management explicitly stated that the division management would not receive approval to proceed unless Halliburton could both avoid consolidation and maintain control over the joint venture activities. Earlier in the development of the accounting position regarding this joint venture, KPMG told management that they would allow the company to avoid consolidation and FIN 46R's Anti-Abuse criteria on the basis that the determination required professional judgment, and indicated that they would be willing to support a conclusion that Halliburton was not significantly involved in the joint venture activities, when clearly the facts and circumstances did not support such a conclusion. Menendez had vehemently objected to KPMG and management's proposed conclusion on the basis that such a position was absurd.
According to the SEC, given KPMG's previous guidance to the company regarding RTA, and their willingness to accommodate unsupportable conclusions, continued input by KPMG on RTA was inappropriate and, once again, put KPMG in the position of auditing its own recommendations and advice. In the end, the concerted failures of management and the external auditor underscored the lack of independence between company and KPMG which is a root cause of the accounting violations Menendez fought to correct and, at last, had to report.
Questions.
1. Describe the inadequacies in the corporate governance system at Halliburton.
2. Consider the role of KPMG in the case with respect to the accounting and auditing issues. How did the firm’s actions relate to the ethical and professional expectations for CPAs by the accounting profession?
3. The Halliburton case took place before the Dodd-Frank Financial Reform Act was adopted by Congress. Assume Dodd-Frank had been in effect and Menendez decided to inform the SEC under Dodd-Frank rather than SOX because it had been more than 180 days since the accounting violation had occurred. Given the facts of the case would Menendez have qualified for whistleblower protection? Explain.
4. Menendez objected to Halliburton’s accounting for revenue on bill and hold transactions. He claims that Halliburton had violated accounting rules. What was Halliburton’s motivation in recording bill and hold transactions? Did it violate accounting rules?

Question: In 2005, Tony Menendez, a former Ernst &