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ELS session

    Natalie T Churyk
    Detecting Fraud in Financial Statements
    ELS session posted July 23, 2010 by Natalie T Churyk, last edited March 7, 2012 
    2691 Views, 16 Comments
    Detecting Fraud in Financial Statements
    names(s), affiliation(s):
    Natalie T. Churyk, B. Douglas Clinton, Chih-Chen Lee; all at Northern Illinois University
    July 26, 2010 at 01:00am


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        • Robert E Jensen

          "Dell Is the Latest to Go the SEC’s Woodshed; Settlement of $100 million for Fraudulent Accounting, Disclosure Violations," by Caleb Newquist, Going Concern, July 22, 2010 ---

          Also see;jsessionid=5YIC355EBYCZNQE1GHPSKHWATMY32JVN

          Bob Jensen's threads on Deloitte are at

        • Robert E Jensen

          "There Are More Than a Few Texans Who Aren’t Impressed with Ernst & Young’s Auditing Abilities," by Caleb Newquist, Going Concern, August 26, 2010 ---

          Attorneys from Houston’s Ahmad, Zavitsanos & Anaipakos are representing a group of investors in a lawsuit filed against hedge fund auditors Ernst & Young after the group lost more than $17 million following the collapse of a Plano, Texas-based hedge fund that promised low-risk investments.

          The lawsuit focuses on two funds sold by Plano’s Parkcentral Global and was filed on behalf of Houston financial consultant Gus H. Comiskey and four Tucson, Ariz.-based entities, including the Thomas R. Brown Family Private Foundation. The now-defunct Parkcentral Global was operated by affiliates of billionaire and former presidential candidate H. Ross Perot before closing its doors after losing a total of more than $2.6 billion.

          “Our clients were told that an investment in Parkcentral was designed to preserve capital. Instead, they lost every penny in record time. E&Y was supposed to be auditing Parkcentral, but the audited financial statements never once warned Parkcentral’s investors of their impending doom,” says attorney Demetrios Anaipakos, who will try the case with Amir H. Alavi.

          Continued on article

          Bob Jensen's threads on Ernst & Young are at


        • Robert E Jensen

          "SEC Whistleblower Fund Totals $450 Million," Huffington Post, October 29, 2010 ---

          The Securities and Exchange Commission says it has set aside about $450 million for payments to outside whistleblowers whose information results in successful cases and penalties collected from companies or individuals.

          The SEC set up the program in accordance with the financial overhaul law enacted in July. It follows intense public criticism of the agency for the breakdown that allowed Bernard Madoff's multibillion-dollar fraud to go undetected for 16 years, despite numerous red flags raised by whistleblowers.

          A report issued Friday by the SEC shows it has put $451.9 million into a new fund to pay whistleblowers, which must have a minimum $300 million.

          Bob Jensen's threads on whistle blowing ---

        • Robert E Jensen

          "Heads Up Play With David Einhorn," by Bess Levin, DealBreaker, December 21, 2010 --- Click Here

          If you’re going to commit financial fraud, you probably don’t want to find yourself sitting at a table across from David Einhorn, who will know what you’re up to and share it with the world. Similarly, if you’ve never played poker and have only ever had a 15 minute tutorial on the game, you probably should avoid playing with the Greenlight Capital founder, whose vastly superior skills will demonstrate just how much you suck. As I like to live on the edge, yesterday in an undisclosed location, I choose not to heed the wisdom of the latter. Over several hands, Einhorn and I discussed the new edition of his 2008 book, “Fooling Some Of The People, All Of The Time.”

          The latest version includes an epilogue, and concludes the story of Allied and Einhorn’s years of trying to get other people to listen when he said something was up. As we now know, Allied’s shares collapsed, Greenlight collected $35 million, and the hedge fund made another big (and correct) call on a bank called Lehman Brothers, whose failure was, according to Einhorn, “the Allied story all over again,” just on a bigger scale, with more resounding consequences. Even after the last crisis, which should have been a wake-up call, Einhorn doesn’t think we’ve changed much and if anything, the reforms passed only “encourage poor behavior and will likely foster an even bigger crisis.” He and I chatted about that exciting event, Quantitative Easing, Steve Eisman’s illicit pleasure of choice and more, plus poker tips for people who really, really need them.

          Continued in article

          An older tidbit from

          Selling New Equity to Pay Dividends:  Reminds Me About the South Sea Bubble of 1720 ---

          "Fooling Some People All the Time"

          "Melting into Air:  Before the financial system went bust, it went postmodern," by John Lanchester, The New Yorker, November 10, 2008 ---

          This is also why the financial masters of the universe tend not to write books. If you have been proved—proved—right, why bother? If you need to tell it, you can’t truly know it. The story of David Einhorn and Allied Capital is an example of a moneyman who believed, with absolute certainty, that he was in the right, who said so, and who then watched the world fail to react to his irrefutable demonstration of his own rightness. This drove him so crazy that he did what was, for a hedge-fund manager, a bizarre thing: he wrote a book about it.

          The story began on May 15, 2002, when Einhorn, who runs a hedge fund called Greenlight Capital, made a speech for a children’s-cancer charity in Hackensack, New Jersey. The charity holds an annual fund-raiser at which investment luminaries give advice on specific shares. Einhorn was one of eleven speakers that day, but his speech had a twist: he recommended shorting—betting against—a firm called Allied Capital. Allied is a “business development company,” which invests in companies in their early stages. Einhorn found things not to like in Allied’s accounting practices—in particular, its way of assessing the value of its investments. The mark-to-market accounting that Einhorn favored is based on the price an asset would fetch if it were sold today, but many of Allied’s investments were in small startups that had, in effect, no market to which they could be marked. In Einhorn’s view, Allied’s way of pricing its holdings amounted to “the you-have-got-to-be-kidding-me method of accounting.” At the same time, Allied was issuing new equity, and, according to Einhorn, the revenue from this could be used to fund the dividend payments that were keeping Allied’s investors happy. To Einhorn, this looked like a potential Ponzi scheme.

          The next day, Allied’s stock dipped more than twenty per cent, and a storm of controversy and counter-accusations began to rage. “Those engaging in the current misinformation campaign against Allied Capital are cynically trying to take advantage of the current post-Enron environment by tarring a great and honest company like Allied Capital with the broad brush of a Big Lie,” Allied’s C.E.O. said. Einhorn would be the first to admit that he wanted Allied’s stock to drop, which might make his motives seem impure to the general reader, but not to him. The function of hedge funds is, by his account, to expose faulty companies and make money in the process. Joseph Schumpeter described capitalism as “creative destruction”: hedge funds are destructive agents, predators targeting the weak and infirm. As Einhorn might see it, people like him are especially necessary because so many others have been asleep at the wheel. His book about his five-year battle with Allied, “Fooling Some of the People All of the Time” (Wiley; $29.95), depicts analysts, financial journalists, and the S.E.C. as being culpably complacent. The S.E.C. spent three years investigating Allied. It found that Allied violated accounting guidelines, but noted that the company had since made improvements. There were no penalties. Einhorn calls the S.E.C. judgment “the lightest of taps on the wrist with the softest of feathers.” He deeply minds this, not least because the complacency of the watchdogs prevents him from being proved right on a reasonable schedule: if they had seen things his way, Allied’s stock price would have promptly collapsed and his short selling would be hugely profitable. As it was, Greenlight shorted Allied at $26.25, only to spend the next years watching the stock drift sideways and upward; eventually, in January of 2007, it hit thirty-three dollars.

          All this has a great deal of resonance now, because, on May 21st of this year, at the same charity event, Einhorn announced that Greenlight had shorted another stock, on the ground of the company’s exposure to financial derivatives based on dangerous subprime loans. The company was Lehman Brothers. There was little delay in Einhorn’s being proved right about that one: the toppling company shook the entire financial system. A global cascade of bank implosions ensued—Wachovia, Washington Mutual, and the Icelandic banking system being merely some of the highlights to date—and a global bailout of the entire system had to be put in train. The short sellers were proved right, and also came to be seen as culprits; so was mark-to-market accounting, since it caused sudden, cataclysmic drops in the book value of companies whose holdings had become illiquid. It is therefore the perfect moment for a short-selling advocate of marking to market to publish his account. One can only speculate whether Einhorn would have written his book if he had known what was going to happen next. (One of the things that have happened is that, on September 30th, Ciena Capital, an Allied portfolio company to whose fraudulent lending Einhorn dedicates many pages, went into bankruptcy; this coincided with a collapse in the value of Allied stock—finally!—to a price of around six dollars a share.) Given the esteem with which Einhorn’s profession is regarded these days, it’s a little as if the assassin of Archduke Franz Ferdinand had taken the outbreak of the First World War as the timely moment to publish a book advocating bomb-throwing—and the book had turned out to be unexpectedly persuasive.

          Heavy Insider Trading ---

          Allied's independent auditor is KPMG
          KPMG has a lot of problems with litigation ---

          Bob Jensen's threads on the collapse of the Banking System are at

          Bob Jensen's threads on fraud are at
          Also see Fraud Rotten at

          Bob Jensen's threads on accounting theory are at
          Also see the theory of fair value accounting at

          History of Fraud in America ---

          Bob Jensen's Fraud Updates ---


        • Robert E Jensen

          "Man with a ‘Passion’ for Charter Buses Managed to Dupe Moss Adams, Deloitte in Washington’s Largest Ponzi Scheme," by Caleb Newquist, Going Concern,  January 20, 2011 --- Click Here

          Cringe] Oops. To be fair, auditors can’t be expected to be hand-writing experts…can they? Mr. Calvert seems to think so and told the Seattle Times that he plans on suing Moss Adams and Deloitte for their roles. Oh, right! How do they fit in?

          Continued in article

          Bob Jensen's Fraud Updates are at

          Bob Jensen's threads on Deloitte are at

        • Robert E Jensen

          Book --- Click Here

          Financial Shenanigans: How to Detect Accounting Gimmicks & Fraud in Financial Reports, Third Edition [Hardcover]
          Howard Schilit (Author), Jeremy Perler (Author)
          Also available as an eBook

          Bob Jensen's threads on creative accounting ---

        • Robert E Jensen

          "Camouflaged Earnings Management," by Itay Kama and Nahum D. Melumad, SSRN, December 31, 2011 ---

          In recent years, there has been increased scrutiny of financial reporting and greater analysts and investors attention to indicators of potential earnings management, in particular, to cash and accruals relative to earnings and revenues. We assert that, in response, firms have increased their focus on cash management aimed at aligning these variables, which has resulted in camouflaged earnings management. Analytically, we develop indicators of camouflaged earnings management and use them empirically to test whether the alignment of cash and earnings has intensified following the legislation of the Sarbanes-Oxley Act. The empirical results are all in line with, and reinforce, our assertion. This suggests that any comprehensive investigation of earnings management should also consider the option of camouflaging.

          Bob Jensen's threads on earnings management ---

        • Robert E Jensen

          "Navistar Sues Its Former Auditor Deloitte & Touche (for audit fraud)," by Andrew Harris, Bloomberg News, April 27, 2011 ---

          Navistar International Corp. (NAV), a maker of medium- and heavy-duty trucks, accused its former auditor Deloitte & Touche LLP of professional malpractice in a lawsuit seeking $500 million in damages.

          Navistar claimed shoddy work by Deloitte & Touche accountants from 2002 to 2005 forced the company to revise its financial statements, according to a 134-page complaint filed today in Illinois state court in Chicago.

          “Deloitte lied to Navistar and, on information and belief, to Deloitte’s other audit clients, as to the competency of its audit and accounting services,” the Warrenville, Illinois-based truck maker alleged in its complaint.

          Deloitte & Touche, based in New York, functioned as an auditor, accountant and adviser to Navistar for almost a century, a relationship that ended in April 2006, according to the complaint.

          Navistar said in April 2006 that its restatements for 2002 through the third quarter of 2005 were related to warranties and product-development programs at suppliers. It also said it was replacing Deloitte with KPMG LLP. The restatements were made in 2007.

          In its complaint today, the truck maker accused its former auditor of fraud, fraudulent concealment, breach of contract and malpractice relating to the advice and auditing services Deloitte gave Navistar.

          Continued in article

          Jensen Comment
          What makes me think that Francine will be dancing on those stiletto heels tonight. She loves to play gotcha with Deloitte.

          Bob Jensen's threads on Deloitte's woes are at

        • Robert E Jensen

          PCAOB Snags KPMG Yet Another Time (this time for a client named Motorola with dubious revenue recognition to meet an earnings target)

          The oversight board said a significant portion of the company’s earnings for the 2006 third quarter came from two licensing agreements that were recorded during the last three days of the quarter. One was the Qualcomm deal that wasn’t signed until the fourth quarter. The board also cited other deficiencies in KPMG’s review of Motorola’s accounting for the transactions.
          "Dirty Secrets Fester in 50-Year Relationships," byJonathan Weil, Bloomberg News, June 9, 2011 ---

          Another financial scandal. Another cover-up by regulators. Four years ago, inspectors for the auditing industry's chief watchdog discovered that KPMG LLP had let Motorola Inc. record revenue during the third quarter of 2006 from a transaction with Qualcomm Inc. (QCOM), even though the final contract wasn’t signed until the early hours of the fourth quarter. That’s no small technicality. Without the deal, Motorola would have missed its third-quarter earnings target.

          The regulator, the Public Company Accounting Oversight Board, later criticized KPMG for letting Motorola book the revenue when it did. Although KPMG had discussed the transaction’s timing with both Motorola and Qualcomm, the board said the firm “failed to obtain persuasive evidence of an arrangement for revenue-recognition purposes in the third quarter.” In other words, KPMG had no good reason to believe the deal shouldn’t have been recorded in the fourth quarter.

          The oversight board didn’t tell the public that this happened at Motorola, though. The maker of wireless- communications equipment, now known as Motorola Solutions Inc., didn’t restate its earnings for the period in question. And there’s no sign the Securities and Exchange Commission ever followed up with an investigation of Motorola’s accounting, even though it oversees the board and had access to its findings.

          All of this is business as usual for America’s numbers cops. Since the board’s creation by the Sarbanes-Oxley Act in 2002, its inspectors have found audit failures by large accounting firms at hundreds of U.S.-listed companies. Yet its policy is to keep the identities of those clients secret.

          ‘Issuer C’

          Likewise, in August 2008 when the board released its annual inspection report on KPMG, it referred to Motorola as “Issuer C” in the section on the auditor’s work for the company. For what it’s worth, Motorola paid the firm $244.2 million from 2000 to 2010.

          This is the third column I’ve written revealing the name of a client whose accounting practices were a subject of a major auditing firm’s inspection report. Motorola is the biggest yet. I hope a whistleblower comes forward someday to leak many more. This is information investors need to know.

          The Sarbanes-Oxley Act authorizes the oversight board to disclose “such confidential and proprietary information as the board may determine to be appropriate” in the public portions of its inspection reports. So it’s the board’s call whether to disclose clients’ names, although the SEC could overrule it. The board never does, bowing to the wishes of the accounting firms.

          Identity Revealed

          Motorola’s identity was disclosed in public records last month as part of a class-action shareholder lawsuit against the company in a federal district court in Chicago. The plaintiffs in the case, led by the Macomb County Employees’ Retirement System in Michigan, filed a transcript of a September 2010 deposition of a KPMG auditor, David Pratt, who testified that Issuer C was Motorola. KPMG isn’t a defendant in the lawsuit.

          Pratt also identified the Motorola customers cited in the board’s inspection report. It’s his deposition that allows me to describe the report’s findings using real names.

          The oversight board said a significant portion of the company’s earnings for the 2006 third quarter came from two licensing agreements that were recorded during the last three days of the quarter. One was the Qualcomm deal that wasn’t signed until the fourth quarter. The board also cited other deficiencies in KPMG’s review of Motorola’s accounting for the transactions.

          Making the Numbers

          Motorola booked $275 million of earnings during the 2006 third quarter as a result of the Qualcomm deal, according to estimates by the plaintiffs in the shareholder suit. The plaintiffs allege that all of it was recorded in violation of generally accepted accounting principles. That’s 28 percent of the net income Motorola reported for the quarter.

          A Motorola spokesman, Nicholas Sweers, said the company’s accounting complied with GAAP, and that the financial statements for the periods covered in the inspection report have never been the subject of an SEC investigation. He declined to discuss details of Motorola’s accounting, citing the litigation. A KPMG spokesman, George Ledwith, declined to comment. So did an oversight board spokeswoman, Colleen Brennan, and an SEC spokesman, John Nester.

          The story doesn’t end there. Last week the board’s new chairman, James Doty, gave a speech in which he said the board should consider setting mandatory term limits for auditors at public companies. To prove his point, he cited two instances that were “galling in their simplicity” where auditors “have failed to exercise the required skepticism and have accepted evidence that is less than persuasive.”

          Making a Match

          One of his examples matched the fact pattern of KPMG’s 2006 review at Motorola exactly. “PCAOB inspectors found at one large firm that an engagement team was aware that a significant contract was not signed until the early hours of the fourth quarter,” Doty said. “Nevertheless, the audit partner allowed the company to book the transaction in the third quarter, which allowed the company to meet its earnings target.”

          Continued in article

          Jensen Comment
          Recall that KPMG was fired from the big Fannie Mae audit because of alleged cooperation in helping Fannie's top executives creatively meet earnings targets for their personal bonuses ---

          Bob Jensen's threads on revenue recognition and Hypothetical Future Value are at

          Bob Jensen's threads about the two faces of KPMG are at


        • Robert E Jensen

          Teaching Case
           "Who Wants to Comb Over the New Jersey Nets’ Financial Statements?" by Caleb Newquist, Going Concern, June 30, 2011 ---

        • Robert E Jensen

          Beginning to look like financial reporting intentional fraud
          "GREEN MOUNTAIN COFFEE: A BAD CUP OF JAVA," by Anthony H. Catanach, Jr. and J.Edward Ketz, Grumpy Old Accountants, July 25, 2011 ---

          From the now infamous 8-K ---

          The audit committee and management have discussed the matters disclosed in this current report on Form 8-K with PricewaterhouseCoopers LLP, the Company’s independent registered public accounting firm. The Company is working diligently to complete the restatement of its financial statements. The Company expects to file its annual report on Form 10-K, including the restated financial statements, by no later than December 9, 2010, the expiration date of the extension period provided by Rule 12b-25 of the Securities Exchange Act of 1934, as amended. However, there can be no assurance that the filing will be made within this period.

          Bob Jensen's threads on PwC are at


          Bob Jensen's threads on this "watered down" cup of coffee ---

        • Robert E Jensen

          How can you tell that the market does not trust the audited accounting numbers in financial statements of listed corporations?
          What happens when the market thinks the reported assets are overstated and/or liabilities are understated?

          From The Wall Street Journal Accounting Weekly Review on August 12, 2011

          BofA Pays the Price for Equity Stance
          by: David Reilly
          Aug 09, 2011
          Click here to view the full article on

          TOPICS: Banking, Contingent Liabilities, Financial Analysis, Financial Statement Analysis, Ratios

          SUMMARY: "There is a difference between the amount of equity a bank needs to run its business and the amount it needs to maintain market confidence." This is the statement the author uses introduces issues stemming from a confluence of factors impacting BofA: first, lawsuits related to the $8.5 billion settlement that it reached in June regarding mortgage bonds based on mortgages originated by Countrywide Financial; second, the fact that BofA did not raise equity capital before markets fell around the time of S&P's downgrade of U.S. sovereign debt. "BofA is in a particularly precarious position. The stock is now trading at just 32% of book value and about 51% of tangible book. In other words, markets seem to believe BofA's assets are significantly overstated or liabilities understated."

          CLASSROOM APPLICATION: The article is useful to introduce the importance of bank balance sheet amounts and to cover current events in U.S. markets.

          1. (Introductory) Identify the three major components of any company's balance sheet. List items common for a bank in each of these three categories.

          2. (Advanced) What does stockholders' equity represent?

          3. (Advanced) Why do bank regulations require a certain amount of "equity capital" calculated on the basis of percentages of risky assets held by banks?

          4. (Advanced) What do you think the author means when he writes, "There is a difference between the amount of equity a bank needs to run its business and the amount it needs to maintain market confidence" ? In your answer, define the term "run on the bank."

          5. (Advanced) BofA's stock price values the overall company at just 32% of book value and 51% of tangible book. Define each of these two ratio measures.

          6. (Advanced) Why does the author state that the values of the above two ratios indicate that either assets are overstated or liabilities are understated? Based on the discussion in the article, what assets do you think are possibly overstated? What liabilities are possibly understated?

          7. (Introductory) BofA "points out the bank has created $18 billion in reserves to deal with repurchase claims" by AIG and others for BofA to repurchase mortgage-backed securities it or Countrywide financial sold prior to the financial crisis. What are these "reserves"? What is another preferred accounting term for these items?

          Reviewed By: Judy Beckman, University of Rhode Island

          "BofA Pays Price for Taking Equity Hard Line," by David Reilly, The Wall Stree Journal, August 9, 2011 ---

          Brian Moynihan is relearning a painful lesson: There is a difference between the amount of equity a bank needs to run its business and the amount it needs to maintain market confidence.

          That's something Mr. Moynihan, chief executive of Bank of America, and every other bank chief should have remembered from the financial crisis. Yet, despite jitters over burgeoning legal threats associated with mortgage-repurchase demands at BofA, Mr. Moynihan has repeatedly said the bank doesn't need more equity.

          Having failed to raise equity before the recent stock drop, he may have squandered an opportunity to bulk up the balance sheet. Now, BofA's shareholders are paying the price.

          That could put Mr. Moynihan's job in jeopardy.‬

          Stock in BofA fell as much as 22% at one point Monday, after dropping a total of 15% on Thursday and Friday last week. Meanwhile, the cost to insure BofA bonds against default leapt by 50%. That is a particularly scary tumble given BofA is the country's largest bank by assets.

          To be sure, BofA is being hammered by a confluence of events. Besides its own legal issues, the bank was caught up in the broader market selloff on the back of the U.S. rating downgrade, a flight from financial stocks given debt concerns on both sides of the Atlantic and growing worries the U.S. economy could double dip.Citigroup, for example, also saw its shares fall 20% at one point Monday, even though it doesn't face the same kind of mortgage woe.

          Still, BofA is in a particularly precarious position. The stock is now trading at just 32% of book value and about 51% of tangible book. In other words, markets seem to believe BofA's assets are significantly overstated or liabilities understated.

          Much of the concern is because investors continue having difficulty gauging the ultimate cost of demands that BofA repurchase shoddy mortgages originated by Countrywide Financial, which it acquired in 2008. One big worry is whether an $8.5 billion settlement the bank reached in June regarding mortgage bonds is coming undone.

          That deal was challenged last Thursday by New York State Attorney General Eric Schneiderman. American International Group also joined the fray Monday, filing to oppose the deal and, in a separate action, suing BofA over mortgage bonds it had bought.

          BofA has rejected AIG's allegations and defended the settlement with the other mortgage-bond investors. It also points out the bank has created $18 billion in reserves to deal with repurchase claims.

          Still, there appears to be little Mr. Moynihan can do to quickly clarify uncertainties about BofA's ultimate losses. Moreover, raising equity with the stock in free fall would prove tough, if not impossible. But the bank shouldn't rule out the possibility.

          Continued in article

          Why does the market in particular not trust the financial statements of banks?

          Frank Partnoy and Lynn Turner contend that bank accounting is an exercise in writing fiction:
           Watch the video! (a bit slow loading)
           Lynn Turner is Partnoy's co-author of the white paper "Make Markets Be Markets"
           "Bring Transparency to Off-Balance Sheet Accounting," by Frank Partnoy, Roosevelt Institute, March 2010 ---
           Watch the great video!



        • Robert E Jensen

          Altman Z-Score ---

          "RITE AID: IS MANAGEMENT SELLING DRUGS OR USING THEM?" by Anthony H. Catanach Jr. and J. Edward Ketz, Grumpy Old Accountants Blog, August 22, 2011 ---

          Jensen Comment
          Those of you teaching Altman's Z-Score may find this article a good illustration for students.

        • Robert E Jensen

          "How CEO Pay Became a Massive Bubble," An interview with Mihir Desai Harvard Business School, Harvard Business Review Blog, February 23, 2012 ---
          Click Here

          Bob Jensen's threads on outrageous executive compensation and golden parachutes ---

        • Robert E Jensen

          Summary of Major Accounting Scandals ---

          Bob Jensen's threads on such scandals:

          Bob Jensen's threads on audit firm litigation and negligence ---

          Current and past editions of my newsletter called Fraud Updates ---

          Enron ---

          Rotten to the Core ---

          American History of Fraud ---

          Bob Jensen's fraud conclusions ---

          Bob Jensen's threads on auditor professionalism and independence are at

          Bob Jensen's threads on corporate governance are at