Nextcard Inc case study

Nextcard, Inc was a model for successful people who were looking to the internet in the 1990’s as an enterprise. Nextcard credit card was founded in 1996 in California as the first credit card company to issue cards online. Since the internet was still being introduced to households throughout the United States internet companies were still developing effective methods to reach potential customers.

One of the driving factors behind Nextcard Inc believing that it could succeed in the credit card industry was it believed that it could cut cost that tradition ‘brick and mortar’ credit card companies could not. During the 1990’s it was believed that the people who were using the internet were generally more affluent than your average consumer. Third Party Problems

Nextcard was unable to meet its own expectations and the philosophy behind the corporate ideas were beginning to fail. As it turned out, people were using Next card as a last resort for credit and had less than idea credit scores. In addition to this, the cost of obtaining a new customer was much higher than anticipated. All of this led to a culmination of a virtually dead IPO that was launched in 1999 during the tech bubble bursting, virtually shutting off all options to this struggling company (General Information, FDIC). This lead to floating the company until 2001 and it was reported that the company was severally undercapitalized, causing the FDIC to launch a full scale investigation. However, instead of owning up to the problem at hand, Nextcard fraudulently claimed that its losses were due to fraud and not credit losses; its allowance for bad debt was never appropriately assessed. Fraud Risk Factors

The truth is that fraud can happen in just about any company given the right circumstances, in the audit world, we usually refer to this as the fraud triangle. But at Nextcard it was more than just a few people given the opportunity to collude with intent to steal. Overall management at Nextcard Inc failed to be honest to themselves and the public about their accounting. And it wasn’t just the reports that they published, they also failed to set up an internal audit review. And on top of that the management continued to reassure investors of profit and growth during the next quarter. This lie was necessary given that the industry was dominated by a few giants who truthfully control the market they were trying to break into. But the biggest control that was broken? The use of a third party attestation firm. Fraud likely would not have occurred if it was not for Ernst & Young enabling the actions. By giving a clean opinion when not considering their position in the industry was truly damming. Ernst & Young clearly not only violated their own standards, but those of their industry. Work Paper Manipulation

Given this information one of the grade requirements is to discuss whether we believe that public accounting firms can successfully manipulate audit work papers. I do not think this answer has changed since paper work papers to the early form of electronic work papers of the late 1990’s/ early 2000’s to today. Any time that you have the ability to run your reports in a share point site like most of the larger firms use, it gives you a back door into the system to control what the interface displays (Associate Press, 2004). The real issue here is integrity and the reliability of third parties who benefit/have a liability to a service performed there is no other check that could be done without a central repository made to another agency/firm. I think the AICPA is clear in its code of conduct how events like these should be handled, but when someone goes rogue it often gets magnified and over shadow’s all of the positive compliance.

Ernst & Young Problems
Ernst & Young were named to a class action lawsuit once it was discovered that Nextcard was being deceitful in their reports. One of the biggest reasons that a lawsuit was brought forth to Ernst & Young was that it had given Nextcard Inc a clean audit opinion the year before. But Ernst & Young were not ready to accept that they were in fact negligent in their opinion, so they were found to have doctored the work papers and the time stamps on to try and hide any form of liability by one of their own auditors, Oliver Flanagan (Michael Liedtke, 2002). It’s likely that Ernst & Young may have gotten away with this if it had not been for one of their own auditors who saved the edits and turned them over to the authorities. However, I would like to point out that Oliver may not have truly been a hero, but someone just doing some CYA without trying to ruffle anyone’s feathers. You see, when he was asked to alter the work papers, he didn’t immediately notify his work hotline or outright deny this request. Instead, Oliver did what he was told and saved a copy just in case it would be needed later on. It became apparent that he did not offer this information until the investigation was already underway and there would have been a chance that he would have been caught. Oliver should have refused to adhere to this request and then ran the action up the flag pole. And if Oliver did not have the internal fortitude to do the right thing face to face, he at the very least should have notified the work abuse hotline, the AICPA hotline or even the regulatory agency. This would have allowed to him to keep the information as confidential as possible. Financial Fallout

Once all of this had been brought to light, investor confidence in Nextcard had plummeted, causing the stock price to fall from an all time high of $53.12 to $0.14. Furthermore, in early 2002 the FDIC had to take over Nextcard as they tried to negotiate a buyer for what was left of the company. A year later in 2003 Nextcard Inc was completely liquidated for $20 million in assets and with over $470 million in liabilities (General Information, FDIC). Conclusion

During 2003 several charges were brought forth against Nextcard executives for insider trading and fraud. These charges were finally settled in 2006 while the SEC had dropped the fraud charges against the founder in 2005. The firm itself was found to be in viloation of the Professional Code of Conduct by the AICPA. And while the punishment was within the standard opperating cases, it is hard to tell what the real impact to the firm overall was. Ernst & Young as still a hugely successful firm and enjoy a reputation for quality work. Depending on the geographic location and industry they are often the leader. In the end it was Nextcard Inc who suffered the worst of the charges and punishment while Ernst & Young were hardly cited a culprit. Once the case had ended so did the talk about their involvement. I do not think that the punishment was enough but I do not think that the AICPA could have done any worse. Its up to the markets to determine trust and punishment.

References
Associated Press (September 29, 2004). Retrieved October 26, 2013 from http://articles.latimes.com/2004/sep/29/business/fi-next29

General Information (n.d.). Retrieved October 26, 2013 from http://www.fdic.gov/bank/individual/failed/nextbank.html

General Information (n.d.). Retrieved October 26, 2013 from http://securities.stanford.edu/1024/NXCD01-02/

Michael Liedtke (September 7, 2002). Retrieved October 26, 2013 from http://articles.latimes.com/2002/sep/07/business/fi-nextcard7