We have learned that two of Sprint's managers set up tax shelters on the profits they accrued under their stock option plans. I have trouble understanding how somebody can make hundreds of millions of dollars in what seems excessive compensation to me, and yet be unwilling to contribute anything to pay down the federal deficit. I guess they are trying to speed up Bush's tax cut plan with or without the approval of Congress. (In the background we hear Sam playing "Baby Face.")

 

In particular, Sprint gave former CEO William Esrey and President Ronald LeMay a ton of options that enriched them to the tune of $1.9 billion, while Sprint obtained income-tax benefits of around $700 million. Simultaneously, the firm and the managers employed the services of Ernst & Young to create tax shelters that helped both the firm and the executives. Unfortunately, the IRS stuck its nose in the mess and sneezed on the tax shelters. To avoid paying back taxes, interest, and penalties if the IRS pierced the tax shelters, Esrey and LeMay pleaded for the firm to unwind the transactions by purchasing the shares issued upon the exercise of some of their options. The firm, however, would have to recognize these items as compensation expense and lose their IRS tax deductions. In the end, Sprint said no to any unwinding and fired Esrey and LeMay.

 

This episode is delicious for many reasons. First, it provides further evidence that stock options really do not align the interests of managers and shareholders. We have so often been fed the line that stock options join the interests of managers and the firm's shareholders just as Ilsa Lund is married to Victor Laszlo. The problem is that managers do not possess the ideals of Laszlo; rather, they display some of the scruples of Ugarte, who killed German couriers to obtain exit visas. He wanted to leave Casablanca for Lisbon a very rich man. In the same way, the top managers of Sprint cared little for the owners of the firm as seen in their taking their fair share of a couple of billion dollars. That would give anybody enough money to enjoy whatever metaphorical Lisbon they lusted after!

 

Second, Ernst & Young put itself into conflicts of interests I am sure they never imagined. What started out as a service for Sprint and for its top managers became a nightmare when their interests diverged. Ernst & Young must have felt as conflicted as Ilsa! We can forgive Ilsa who thought her husband dead, but how many times will we forgive the sins of large accounting firms, which continue to place themselves into conflicts of interest? Of course, E&Y is shocked -- shocked -- to find out what was going on at Sprint.

 

Third, sellers of tax shelters continue to push the envelope in at least dubious and perhaps illegal ways. Tax shelters similar to Sprint's were created for the executives of Enron and Tyco as well. It is reminiscent of Ferrari, who was said to control the black market of Casablanca. Other executives have stated that E&Y made similar sales pitches to them only after they signed contracts specifying that they would not tell a soul about the tax strategy. Because the IRS has moved to shut down this strategy, these executives are suing E&Y. It would take a miracle for E&Y to come out of this mess unscathed, but like the Germans, the IRS has outlawed miracles.

 

Fourth, the SEC looks pretty silly. Just a few weeks ago, Pitt and the SEC retreated from an earlier position and announced its approval for the Big Four to provide tax consulting to its audit clients. Pitt thought that such a service would provide many advantages to all concerned with few or no liabilities. He reminds me of Captain Louis Renault, the prefect of police, who made up the rules to help himself and his buddies. Of course, his solution is just to round up the usual suspects.

 

Fifth, accounting firms still seem confused about the divergence in the interests of managers and shareholders. They continue to assist managers in various activities with little thought about the consequences. Public auditors owe their allegiance to shareholders, not to managers. When I hear Third Reich Germans chanting "Wacht am Rhein," I want to join the voices of those who sing "Marseillaise." We must know whose side we are really on.

 

Sixth, the accounting profession continues to reel from one accounting scandal to another. It's as if the leadership of the AICPA and the accounting profession are repeating the lines of Ilsa, "I don't know what's right any longer." I suggest the members of the AICPA evict their current leaders and find new ones who do understand the difference between right and wrong.

 

Accounting professionals should take that challenge and, like Rick, figure out a way to move forward. We need to think rightly and have the courage of our convictions. Even now, we can begin a beautiful relationship with investors and creditors.
 

J. EDWARD KETZ is the MBA Faculty Director at the Smeal College of Business at The Pennsylvania State University. Dr. Ketz's teaching and research interests focus on financial accounting, accounting information systems, and accounting ethics. He is the author of the forthcoming Hidden Financial Risk, which explores the causes of recent accounting scandals.