Nextcard, Inc. Case Study

Siega, Mara Shaira A.    BSA - 4     Acctg 121 C 8:00 - 9:00    January 5, 2016

Case 5.3 NextCard, Inc.

      In the late 1990s, internet-based companies started to bloom in USA and made new millionnaires everyday. Among these millionnaire are the couple, Jeremy and Molly Lent who founded NextCard, Inc. In 1997. NextCard, Inc. is an online company that would offer internet users the opportunity to obtain a credit card in a matter of moments. Below are the key facts in NextCard's endeavor towards becoming one of the growing internet-based companies until its downfall in 2001.

* NextCard created online ads to attract customers to apply for a credit card in NextBank, the company's main operating unit, for a lower rate and fast application process.

* NextCard's business model appeared to be a success and was considered to be one of the frontliners in the "internet revolution".

* NextCard's success was in appearance only because in reality, the company's business model produced a large loss for the company in 1999.

* Despite the losses faced by the company, Jeremy Lent had taken NextCard, Inc. in the public market. The company received overwhelming response from the public.

* In 2000, the internet "bubble" in the stock market burst causing the stock prices to spiral downward, this included NextCard, Inc.

* Jeremy Lent had been mistaken about his initial assumptions on the average acquisition cost and the credit risk involved for his company. NextCard spent large amounts of to acquire “bad” credit card customers.

* The executives of NextCard chose to conceal the company's financial problems. They refused to provide sufficient allowances for each bad debt to understate the major credit losses.

* In the late 2001, a lawsuit was filed against NextCard which prompted investigations from federal regulatory authorities including SEC.

        On the other hand, the following events occurred in Ernst & Young, the audit firm of NextCard, Inc.:

* Robert Trauger had served as the audit engagement partner for NextCard and had authorized the unqualified opinion issued on NextCard's 2000 financial statements. With his position, he is at risk due to the issues surrounding NextCard, Inc.

* Oliver Flanagan was assigned as the senior audit manager for the NextCard engagement.

* Michael Mullen was considered one of the audit managers for the NextCard engagement.

* In November 2001, Trauger contacted both Flanagan and Mullen, telling them respectively to gather all the workpapers for the 2000 NextCard audit, and to determine if it was possible to manipulate the system of Ernst & Young so that some electronic working papers could be altered.

* Trauger and Flanagan made numerous alterations to the workpaper files of the company being audited.

* The SEC issued multiple enforcement releases that documented the improper professional conduct of Trauger, Flanagan and Mullen.

* During the time when the workpapers were asked for, Trauger discovered that Mullen kept a diskette which shows the original workpapers of NextCard, Inc. Flanagan was asked to obtain the diskette and destroy it, which he did but did not destroy it.

        After all the events that occurred, the verdict concluded by the court are all follows:

* The hidden diskette was the triger for Trauger's arrest when it was submitted by Flanagan to the authorities.

* Under the criminal provisions of Sarbanes-Oxlet Act of 2002, Robert Trauger was arrested for destroying audit-related documents.

* In August 2003, Oliver Flanagan pled guilty to one count of criminal obstruction of justice.

* In October 2004, Michael Mullen pled guilty to lying to an FBI agent investigating the NextCard case.

* In December 2005, a settlement out of court occurred wherein  E & Y and Lent contributed $23.5 million and $635,000 respectively.

* The executives of NextCard were oblligated to pay $1.4 million of fines and other monetary damages to settle fraud charges.

        When he became a member of the NextCard audit engagement team, Oliver Flanagan hoped that Robert Trauger would serve as his mentor. What responsibilty, if any, do senior audit personnel have to serve as mentors for their subordinates?

        Let us first describe what is a mentor. In layman's term, a mentor is said to be an experienced and trusted adviser. Therefore, to be a good mentor, you need to have the credibility that you are well aware of the responsibilities and tasks that entails your position. A good mentor is someone whom you trust to give you advise, to teach you, and to supervise you with your work. Robert Trauger, as the audit engagement partner, had a lot of responsibilities. As an audit partner, you are mainly responsible for the whole audit engagement. According to Internal Standards on Auditing 220, the engagement partner shall take responsibility for the overall quality on each audit engagement to which that partner is assigned. The engagement partner shall take responsibility for the direction, supervision and performance of the audit engagement in compliance with professional standards and applicable legal and regulatory requirements; and the auditor’s report being appropriate in the circumstances. The engagement partner shall take responsibility for reviews being performed in accordance with the firm’s review policies and procedures. On or before the date of the auditor’s report, the engagement partner shall, through a review of the audit documentation and discussion with the engagement team, be satisfied that sufficient appropriate audit evidence has been obtained to support the conclusions reached and for the auditor’s report to be issued. In the end, Trauger failed to fulfill his role as a good mentor to his subordinates. With him, altering the workpapers showed signs of his dishonesty and uncredibility. Knowing that he was responsibility for the engagement, he made a move that would only safeguard himself and would go against the standards.

        Assume the role of Oliver Flanagan in this case. What would you have done when Robert Trauger asked you to help him alter the 2000 NextCard audit workpapers? In answering this question, identify the alternative courses of action available to you. Also identify the individuals who may be affected by your decision and briefly describe how they may be affected.

        If I were Oliver Flanagan, it would be really hard to decide on what I should do. It would lower down to the principles that I believe in and the values that I uphold. There a a lot of alternatives for this situation. First, If I were Flanagan, I would follow the instructions of Trauger. He is my mentor and I look up to him. I believe, if you trust someone, you would not likely question the decision that they're making. Also, I would like to go up to the higher positions right away therefore, I should not do anything to disobey my superior. This way of thinking may be absurd but it is happening in society. When one only thinks of his personal growth in position, he would not care about the consequences of the actions that his taking. Another alternative course is to ask questions. Yes, you ought to follow your superior but ask the whys and hows of  such actions. If I would not care whatever the reason given is, I would continue to follow his instructions. If I care about my values and principles, and I know that what my superior is asking me to do is wrong, that is the time when I would make definite actions myself. In doing something against the will of your superior, one's challenge is on how they can do it without affecting too many people. One option would be to investigate the situation my superior is in. He would not be asking me to do something against company policy if he is not hiding anything. If I obtained enough evidence to prove my superior guilt, I would call the attention of the higher management. I would let them decide on what action should be taken against the wrong doings of my superior. If worse comes to worst, I would file my resignation to the company to protect myself against my superior. If no action is done by the management, I might be forced to call the attention of the authorities. With the situation being publicized, it will be possible that it will tarnish the name of the firm. Lastly, the easiest way is to avoid the situation entirely. I would resign from the very beginning of my superior asked for my help. I would be able to avoid direct confrontations and controversy, but I believe that my conscience would kill me as well knowing that I know something yet I've kept my mouth closed. I would have avoided lesser damage if I said and did something. In the end, it all depends on the person's beliefs on what course of action he would take.