Let’s say that you were a partner of the firm North, Hegerl and Cicerone and charged with issuing an opinion on the financial statements of Team Capital Management Inc.(TCM) And let’s say that you were doing so in heady pre-crash days when markets were going up and mark-to-market accounting was something that the companies wanted to do.
The footnotes to the TCM statements said that mark-to-market accounting had not been used for non-arms-length investments in securities issued by Briffa MXD Inc. which had shown a lack of “sensitivity” to rising world stock market prices, while mark-to-market accounting had been used for a high-flying Finnish penny stock (Kortajarvi Lake Gold). And while TCM statements did not mention their holdings in controversial Bristlecone Estates, a project that was much in the news, it turned out that mark-to-market accounting had been used on this speculation as well.
In the MD&A (Management Discussion and Analysis), the company said that they were profitable even without their investments in U.S. mortgages. Elsewhere in the footnotes, they said that TCM was profitable even without mark-to-market accounting in the Finnish penny gold stock. However, the combined effect wasn’t discussed.
Can the partners in North, Hegerl and Cicerone certify that these statements meet GAAP? Of course they can’t.
If you’re using mark-to-market accounting on the penny gold stock that went up, then you have to use mark-to-market accounting on the shares in Briffa MXD Inc that went down. While disclosure is important, you can’t disclose your away around this sort of inconsistent non-GAAP accounting. You can’t use mark-to-market accounting on stocks that went up and not do so for stocks that went down.
In case this parable seems too harsh, here are the exact statements from Mann et al 2008. Obviously the precise issue of “mark-to-market” accounting doesn’t arise: I use this as a parable for inconsistent accounting for data that goes up as opposed to data that goes down,
Accounting for MXD
Mann et al say of their handling of the Briffa MXD series (which “diverge” from rising world markets):
Because of the evidence for loss of temperature sensitivity after ~1960, MXD data were eliminated for the post-1960 interval.
In 1998, Briffa postulated an unknown anthropogenic cause for the post-1960 downturn, but nothing has turned up 10 years later. An open alternative is that there is a non-linear upside-down U-shaped temperature response, an alternative referred to even in IPCC AR4 as follows:
Others, however, argue for a breakdown in the assumed linear tree growth response to continued warming, invoking a possible threshold exceedance beyond which moisture stress now limits further growth (D’Arrigo et al., 2004). If true, this would imply a similar limit on the potential to reconstruct possible warm periods in earlier times at such sites. At this time there is no consensus on these issues (for further references see NRC, 2006)
An opinion that you’d think that the auditing firm of North, Hegerl and Cicerone would be aware of.
In respect to the accounting of Mann et al, they truncated this data merely because of a potential non-climate anthropogenic impact on the data, an impact which is postulated, but not proven.
Accounting for Finnish Speculative Stocks
The Mann et al 2008 footnotes say of the speculative Finnish sediments:
These records include the four Tijander et al. (12) series used (see Fig. S9) for which the original authors note that human effects over the past few centuries unrelated to climate might impact records (the original paper states ‘‘Natural variability in the sediment record was disrupted by increased human impact in the catchment area at A.D. 1720.’ and later, ‘‘In the case of Lake Korttajarvi it is a demanding task to calibrate the physical varve data we have collected against meteorological data, because human impacts have distorted the natural signal to varying extents’)…
We therefore … compaired [sic] the reconstructions both with and without the above seven potentially problematic series, as shown in Fig. S8.
Unlike their handling of Briffa MXD data which was truncated merely because of a potential non-climate anthropogenic impact (without reporting on the impact of this truncation), Mann et al included the Finnish sediment (which went up), purporting to justify this by arguing that they were still profitable without the data. A policy which, regardless of its individual merit or lack of merit, is inconsistent with the handling of the Briffa MXD data which went down.
It’s actually worse here, because the original authors do not merely say that human effects unrelated to climate “might” impact the record. They categorically say that they were so caused. No “might” about it. For example:
This recent increase in thickness is due to the clay-rich varves caused by intensive cultivation in the late 20th century. …
There are two exceptionally thick clay-silt layers caused by man. The thick layer of AD 1930 resulted from peat ditching and forest clearance (information from a local farmer in 1999) and the thick layer of AD 1967 originated due to the rebuilding of the bridge in the vicinity of the lake’s southern corner (information from the Finnish Road Administration).
There is another shoe to drop in the handling of the Finnish sediments, which I will discuss in my next post. It appears to me that Mann et al actually have a short position on the Finnish speculative stocks, which they have inadvertently accounted for as a long position. But more on this in another post.
Accounting for Subprime Mortgages on Bristlecone Estates
A consulting report by North and associates, also sponsored by Cicerone, said that subprime mortgages on Bristlecone Estates, in particular, “strip bark” derivatives, should be “avoided”. However, Mann et al 2008 nowhere mention that strip bark derivatives remain on their books.
It’s one thing to object individually to (1) the truncation of post-1960 Briffa MXD data due to a potential anthropogenic disturbance (which may actually be a non-linear response); (2) the use of the 20th century Graybill bristlecone chronologies despite (a) potential non-climate anthropogenic fertilization or (b) recommendations by the NAS panel not to use strip bark derivatives; (3) the use of 20th century Finnish sediment data despite an established non-climate anthropogenic disturbance.
However, the combination of the three is much worse than any one of these individually. The inconsistency of (1) and (3) is particularly opportunistic.
I make no imputation as to intent on the part of the authors, as intent is irrelevant (and, as is blog policy, I ask readers not to speculate on intent either). All that matters is what is presented. Auditors confronted with opportunistic accounting policies of this type cannot certify that the statements comply with GAAP. If North, Hegerl and Cicerone were chartered accountants and certified that such inconsistent and opportunistic practices complied with GAAP, they would be treated very severely by any supervisor of accounting practices.