Mann et al 2008 and GAAP Accounting

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.

GAAP Accounting
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.

35 Comments

  1. stan palmer
    Posted Oct 1, 2008 at 9:14 AM | Permalink

    The article quotes from teh AR4 with my emphasis

    At this time there is no consensus on these issues (for further references see NRC, 2006) and the possibility of investigating them further is restricted by the lack of recent tree ring data at most of the sites from which tree ring data discussed in this chapter were acquired.

    There is an enormous amout of money being dedicated to climate change policy. If research is being hampered by lack of recent data, then the obvious solution would be to commission work to gather such data.

    Perhaps this shows the limitations of the IPCC process. A passive review agency that is dependent on hte work that is initated by a small group of academic researchers is not adequate to the importance of this izsuse.
    This is true for this and other reasons. I cannot believe that a issue of this importance is hanpered by IPR claims by professors. Eminent domain was invneted to handle such claims.

    • Dave Dardinger
      Posted Oct 1, 2008 at 11:19 AM | Permalink

      Re: stan palmer (#1),

      While your reply is readable and correct, I would suggest you re-read your messages before posting. I count at least 8 typos / grammatical errors. Steve M has an excuse since he has hundreds of messages to read a day and many to respond to, but responders here should try to show we’re willing to do due diligence. I also find in re-reading that I often find additional things I should add (or subtract) to make the message better.

  2. Steve McIntyre
    Posted Oct 1, 2008 at 9:20 AM | Permalink

    #1. This has obviously been a long-standing theme at CA. See our 2005 Op Ed “Bring the Proxies Up to Date.” It also motivated our testing of th Starbucks Hypothesis at Almagre bristlecones.

    However, take a look at my Erice presentation where I take a different slant on this – arguing that this particular statement by IPCC is not correct as it stands and that key sites – Sheep Mt, Tornetrask and Polar Urals have been updated. However these results have been ignored (Ababneh, Grudd, Polar Urals Update.)

    But let’s not get into that issue here; it’s been discussed on many other occasions. See other threads. I’ve now shortened the quote so that this issue doesn’t monopolize.

  3. W F Lenihan
    Posted Oct 1, 2008 at 9:31 AM | Permalink

    Wonderful post. You have given new meaning to “cook the books”.

  4. Jeff Alberts
    Posted Oct 1, 2008 at 9:51 AM | Permalink

    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.

    Forget about proven, nothing was even suggested, was it? To me, that’s known as “making s*** up.”

    • Craig Loehle
      Posted Oct 1, 2008 at 1:17 PM | Permalink

      Re: Jeff Alberts (#4), When writing a paper, there is always a little devil who temps one to “make sh** up” but it is best to think twice about such temptings, because it is going to end up in print. At least I think twice about it.

      • Luis Dias
        Posted Oct 2, 2008 at 4:22 AM | Permalink

        Re: Craig Loehle (#13),

        Re: Jeff Alberts (#4), When writing a paper, there is always a little devil who temps one to “make sh** up” but it is best to think twice about such temptings, because it is going to end up in print. At least I think twice about it.

        And the conclusion of your thoughts is exactly what?

  5. Steve McIntyre
    Posted Oct 1, 2008 at 9:57 AM | Permalink

    Briffa suggested an impact from ozone. Such an impact has been “suggested”, but I’ve previously opined that such suggestions do not rise above cargo cult. I’ve noted the discontent of some younger dendros with Briffa’s cargo cult.

  6. Sam Urbinto
    Posted Oct 1, 2008 at 9:58 AM | Permalink

    Marking to market, or assigning something a value according to current open market prices for accounting purposes.

    An edited version of a paragraph from Wikipedia on the subject.

    Since the 1980s when the practice of mark-to-market moved to corporations and banks, some seem to have discovered it could be a way to commit accounting fraud. Market prices can not be objectively determined in cases where no real day-to-day market is available. Assets in these cases can be ‘marked to model’ using estimated valuations derived from financial modeling, and sometimes marked to spurious valuations.

    Hmmmm.

    Steve: Please don’t be overly literal in this metaphor. My principal objective is to illustrate the role of consistency in GAAP using a topical term. So let’s stay with issues of inconsistency rather than trying to extend the metaphor.

  7. Soronel Haetir
    Posted Oct 1, 2008 at 11:11 AM | Permalink

    Wow, Steve can be humorous. A total outlier amongst all the statistics folks I’ve ever met.

  8. per
    Posted Oct 1, 2008 at 11:36 AM | Permalink

    is it known who the reviewers of the recent MBH paper were ? Like properly ?

    peer-review is normally anonymous, and in the absence of rather clear evidence that anonymity has been waived, i would be intrigued if people owned up to being peer-reviewers.
    cheers
    per

  9. Mark T.
    Posted Oct 1, 2008 at 11:48 AM | Permalink

    Wegman drew a pretty good dartboard. You could probably toss a few at it and be reasonably close to correct.

    Mark

  10. PhilH
    Posted Oct 1, 2008 at 12:19 PM | Permalink

    This was damn well done. BTW, I beieve the SEC changed the rules on M to M yesterday.

  11. Steve McIntyre
    Posted Oct 1, 2008 at 12:24 PM | Permalink

    Someone commented previously that PNAS review was cursory for sponsored papers. The acknowledgments do not mention peer reviewers. It states:

    ACKNOWLEDGMENTS. We are indebted to G. North and G. Hegerl for their valuable insight, suggestions, and comments and to L. Thompson for presiding over the review process for this paper. M.E.M. and Z.Z. gratefully acknowledge support from the Atmospheric Sciences program of the National Science Foundation (Grant ATM-0542356). R.S.B. acknowledges support from the Office of Science (Biological and Environmental Research), U.S. Department of Energy, Grant No. DE-FG02-98ER62604. M.K.H. and F.N. were supported by National Oceanic and Atmospheric Administration Grant NA16GP2914 from Climate Change Data and Detection.

    That’s why I mentioned North and Hegerl.

  12. Clark
    Posted Oct 1, 2008 at 2:25 PM | Permalink

    RE#12:

    Yes, PNAS has an odd system where a National Academy member can submit or sponsor a paper to the journal. The rigor of the peer review is then at the discretion of the Academy member. If you have a good relationship with the Academy member, you have a chance of steering the choice of reviewers and of getting the benefit of the doubt in any conflict with reviewers.

    Of course, the extent to which this privilege is abused is going to depend on the particular Academy member, and presumably most would treat papers from friends the same as any other papers. However, the existence of this process leaves that an open question for any particular paper. (You can also submit papers to PNAS directly to an editor like at other journals.)

    Peer review in general is an ugly system. The sample size is very small for reviewers (n=1, 2 or 3) and strongly influenced by the persons involved. A paper can get glowing reviews from one set of reviewers, and trashed by another. The problem ultimately arises from the fact that reviewing is an entirely voluntary service that scientists provide. Which means that some people won’t review at all, other spend hours carefully going over a paper, and others seem to skim the paper 5 minutes before submitting their 1 paragraph review.

    And the editors at many journals are not there because they are the brightest in their field and have been promoted to that position. For example, the editors at Nature are usually not experts for most of the research topics they cover. First, because each individual editor covers a large number of different topics. Second, because they are no longer (and often were only briefly) active scientists. It’s not that they are dumb, or not committed to publishing quality science, it’s that their training is often not sufficient or current enough to accurately judge the work in question.

  13. Craig Loehle
    Posted Oct 1, 2008 at 3:12 PM | Permalink

    Another practice of Team Capital Management is to value the assets they hold in a unique way. Many of their assets only have data for performance up to the 1980s. To obtain their current value they use projected earnings to 2006 by mirror reflecting earnings trends for the prior 20 years. They then treat these projected earnings as real dollars.

    • Earle Williams
      Posted Oct 1, 2008 at 3:21 PM | Permalink

      Re: Craig Loehle (#15),

      Craig, that is a zinger. Thank goodness I wasn’t drinking anything when I read that.

      Thanks, although I suspect you may still hear about a couple of drenched keyboards.

  14. Steve McIntyre
    Posted Oct 1, 2008 at 3:24 PM | Permalink

    #15. Nice :)

    BTW Team Capital Management Inc. reported “unprecedented” profits in their most recent financial statements.

  15. TJ Overton
    Posted Oct 1, 2008 at 7:38 PM | Permalink

    The dendro proxies are leveraged at something like 60:1. A very small amount of capital assets used to back such an enormous amount of speculation.

    Fortunately I bought into credit default swaps that trigger when Mann et. al go bust.

  16. Dave Dardinger
    Posted Oct 1, 2008 at 7:39 PM | Permalink

    Interesting set of Google adds in the sidebar when I logged in. The first one was:

    3 Stocks Set to Explode

    Don’t know if the link will work (nor do I care). Anyway, it seems Google has more “intelligence” than most investors.

  17. Dave Dardinger
    Posted Oct 1, 2008 at 7:41 PM | Permalink

    Make that Google Ads. I should take my own advice and reread before posting!

  18. SteveSadlov
    Posted Oct 1, 2008 at 8:18 PM | Permalink

    Utterly brilliant! Stripbark derivatives. What an excellent analogy.

  19. MartinGAtkins
    Posted Oct 1, 2008 at 9:03 PM | Permalink

    Accounting for Subprime Mortgages on Bristlecone Estates.

    Apply a large amount of smoothing and a dash of algorithm next chuck out the bits you don’t like and serve to the mug punters.

  20. Barbara
    Posted Oct 1, 2008 at 9:28 PM | Permalink

    Dear Steve,

    Forgive me for interrupting this conversation, but I couldn’t find another way to contact you.

    I’ve been copying you posts (and some other peoples) to my Kindle, so I can increase the type size and read it clearly.

    I suddenly realized you might not want you writings used this way, so I am asking for permission.

    I always erase the files as soon as I “understand” them (it may take a while) and I never send them on or pass them along in any way.

    Hope this is OK with you

    • Dave Dardinger
      Posted Oct 1, 2008 at 9:39 PM | Permalink

      Re: Barbara (#23),

      You do know you can increase the size of fonts on a web page simply using the control key and your mouse ball, don’t you? Forward increases and backward decreases.

      However, in any case, what you do with material on the web is your business. Just make sure to attribute quotes and for larger amounts of material use a link instead of cutting and pasting.

  21. pete m
    Posted Oct 1, 2008 at 9:41 PM | Permalink

    Barbara – try VIEW, TEXTSIZE, INCREASE via your toolbar options. (firefox)

    VIEW, TEXTSIZE, LARGEST for IE.

  22. Posted Oct 1, 2008 at 9:48 PM | Permalink

    Only Arthur Anderson would have signed off accounts which so much ad hoc manipulation of key financial data. Only Bernie Ebbers would have signed them off.

    The only pity is that there is no SEC in climate science.

  23. James Lane
    Posted Oct 2, 2008 at 4:04 AM | Permalink

    The Briffa truncation seems to me to be one of the most outrageous episodes in paleoclimate science. If I recall correctly, when Steve (as reviewer) queried the truncation in AR4, he was told that the extension would be “inappropriate” (with no further explanation).

    Forget PCA or RegEM, this is an embarrassment that even a child could understand.

    • bender
      Posted Oct 2, 2008 at 4:44 PM | Permalink

      Re: James Lane (#27),
      The justification was very simple: this was an inexplicable anomaly, not part of a broader, systematic pattern. It is only relatively recently (~2007) that the young dendro rebels have figured out that the “divergence problem” is in fact part of a systematic global pattern.

  24. stan
    Posted Oct 2, 2008 at 8:37 AM | Permalink

    Steve,

    When all the latest Mannian shenanigans have been reviewed and compiled, I hope you will prepare a summary highlighting the most egregious departures from acceptable standards with a short explanation of why each matters.

  25. Ian Sims
    Posted Oct 2, 2008 at 12:56 PM | Permalink

    You may have underestimated Dr Mann on this occasion. Given that a key element of the big Wall Street bailout is the suspension of mark-to-market rules for loss-making securities, this appears to be a case of Mann et al 2008 being ahead of the game.

    Of course, the mark-to-market suspension has come under fierce attacks from skeptics. One, Octavio Marenzi, was quoted in Business Week as saying “Financial statements would essentially lose all meaning…”. True, Business Week is not a peer-reviewed journal, but so far as I know Mr Marenzi’s not Canadian.

    Steve rightly exhorts us not to speculate on motives and it’s possible I am being over-generous in ascribing vision to Dr Mann’s. Perhaps the bailout plan was inspired by experience in the climatological sciences, with the thinking going along the lines of: “…if a bunch of academics can get away with it, surely we Masters of the Universe can do the same….”

    I knew that the climate science community’s influence on geopolitical affairs has grown in recent years but I didn’t realise they had become that powerful.

  26. Tony
    Posted Oct 3, 2008 at 2:09 AM | Permalink

    Can the partners in North, Hegerl and Cicerone certify that these statements meet GAAP? Of course they can’t

    You have too much faith in the financial world (I know, it is your background). The question is not if they can, but if they should. Of course they could if they wanted to, but they shouldn’t. Remember Enron? Remember Arthur Andersen? The problem both in the financial world and the science world is not that there is no accounting, but that the accounting has it weak points and fails (or can be made to fail). This is amplified by the lack of knowledge and interest by a larger public. And the total lack of consequences until a (local as in Enron or large as in world economy) crash.

    Steve: Please read the blog before making statements like this. I’ve discussed the Enron failure on a number of occasions and (Bre-X). Such failures of disclosure and due diligence interest me. I’ve always been very clear that even audited statements are not foolproof protection against misconduct. But they are a form of protection. In my opinion, without such protection, such misconduct would be more frequent. Please don’t confuse that position with the trivial position that you attribute to me.

  27. Posted Oct 3, 2008 at 4:12 AM | Permalink

    The companies that choose accounting methods more familiar to investors reduce information asymmetry and increase credibility of their financial statements to those investors, thereby attracting higher levels of foreign investment. This study examines the variation in accounting policies associated with institutional investment in Australian equity. The results suggest that large US institutional holdings in Australian companies are associated with American Depositary Receipt listing and, incrementally, choice of accounting methods that conform to US
    Generally Accepted Accounting Principles (GAAP).

    ———————
    kimrennin

    viral marketing

  28. Tony
    Posted Oct 3, 2008 at 4:51 PM | Permalink

    Sorry, it seemed to me (after reading only this posting) that you strongly believed that financial accounting is flawless. You have a way of writing (please don’t change it!) that sometimes makes it hard to decode irony. My bad if I read too much into this single posting :-)

    My point I was trying to make is not that we should get away with accounting, but it being “the only line of defence” seems to be not enough. We need more people who audit the auditors (as you do!).

  29. Geoff Sherrington
    Posted Oct 5, 2008 at 12:10 AM | Permalink

    The following association of names appeared by coincidence. I make no claims other than accidential coincidence of names, and impute no motives to anyone of the same name.

    http://www.dnjournal.com/cover/2007/september.htm

    Man on a Mission: He Made a Fortune When He Sold BuyDomains – Now Michael Mann Wants to Change the World With WashingtonVC

    Michael Mann is driven. He wants to make money – lots of money. Of course, that doesn’t exactly make him unique. The thing that’s different about Mann, who has already made tens of millions of dollars, is that his primary reason for chasing greenbacks is to give them away. He’s been doing it for years through the well-known Grassroots.org foundation he started and he will step up his efforts with Make Change! Trust through its new website that just launched.

    The energetic entrepreneur/philanthropist has been able to support those efforts because he is an extremely tough competitor in the business world. He co-founded BuyDomains.com and quickly built the aftermarket sales venue into an industry powerhouse. That did not sit well with everyone in the business. In fact in a DN Journal Cover Story that was published four years ago this month, our headline asked Superhero or Arch Villain? The Secret Identity of Super Mann.

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