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Audit   1 - Duke Energy Employee Advocate

Duke Power Audit - Page 7

Rate Case Gives Duke New Headache – by Melissa Davis - September 10, 2003

(9/8/03) – Duke is hoping that a new accounting trick can solve a familiar problem.

The company is seeking permission for a novel change -- accelerating years' worth of interest payments -- in an effort to dodge a rate cut in its second-largest market. But the company is at the mercy of the same utility regulators who have been burned by Duke's books before.

The Public Service Commission of South Carolina, which last year determined that Duke had been understating its regulated profits for years, is set to decide Tuesday whether it will grant the accounting change and keep Duke's current rates intact. The hearing comes two months after the commission demanded an explanation for soaring profits earned from regulated assets that apparently helped the company at the expense of its customers.

In a response last week to the commission, Duke acknowledged that it had earned profits that were "significantly in excess" of what the state permits. It attributed the fat returns -- which came in at 14.25%, well above the allowed 12.5% -- to a cold snap that boosted demand for its cheap electricity in the wholesale power market. And it asked to book $50 million worth of long-term interest costs in a single quarter to bring its reported profits back under the cap.

Gary Walsh, who serves as executive director of the South Carolina commission, said the agency has granted accounting orders for utilities in the past. But he pointed to Duke's strategy -- which would revise profits that have already been posted -- as a bit unusual.

"The principle [of accounting orders] is not foreign to us," Walsh said. "But I do not believe, in my 32 years here, we've ever granted an accelerated write-off of debt costs."

Walsh declined to predict whether the seven-member commission will break that pattern this week.

"We'll just have to see where four votes fall on Tuesday," he said.

Duke shares slipped 20 cents Friday to close at $17.40.

High Stakes

Duke clearly needs a victory.

Duke Power, which ranks as the company's biggest profit center, relies on South Carolina customers for roughly 25% of its income. Even without a rate cut, Duke expects to hit just the low end of its full-year earnings guidance of $1.35 to $1.60 a share. So an unfavorable decision, if implemented soon, almost guarantees an earnings miss.

It also threatens the lavish dividend that helps keep Duke's stock propped up. Already, Duke has shied away from promising the $1.10 dividend much longer.

"We do not anticipate eliminating the dividend in 2004," said Duke spokesman Terry Francisco. "But it's up to the board to set it."

Francisco expects the board to evaluate the dividend some time in the fourth quarter. In the meantime, the rating agencies -- which could push for a cut before then -- are reportedly focused on the case in South Carolina.

"Gary Walsh gets a phone call once a week from Moody's about the issues going on down there," said one company insider. "They're interested in any change in Duke's outlook from a cash-flow perspective."

Duke itself has indicated that a rate cut would hurt. Indeed, the company has taken extraordinary steps to dodge possible rate cuts before.

Fuzzy Math

Last time around, Duke simply took matters into its own hands.

In late 1998, after the South Carolina commission slashed another utility's rates, Duke took a closer look at its own returns. And it was clearly worried by what it saw.

"A number of Duke mid- to senior-level managers met and developed a plan to identify expense and revenue items which could serve as a basis for accounting adjustments which could be made to 'avoid reporting over-earnings to regulators,'" a 2002 audit, carried out by Grant Thornton on behalf of Carolina regulators, determined.

Particularly damaging was evidence tied to Duke's former manager of rates and regulatory affairs. Throughout the audit, Don Stratton is seen pushing for accounting changes that would have reduced Duke's reported earnings.

"Stratton prepared a three-page spreadsheet entitled 'Analysis of EBIT,' which calculated that Duke needed '$70 million [in] additional expense items ... to avoid over-earnings to regulators," the audit states, citing internal interviews and documents. "In [a] meeting, at which the two accountants reported to Stratton that they had identified only $48 million in adjustments, Stratton said 'he would have liked $100 million.'"

In the end, the audit found, Duke used a mix of accounting tricks -- some with little or no justification under generally accepted accounting practices -- to shave $64 million from its regulated profits. The company continued to underreport utility profits for the next two years until internal accountant F. Barron Stone finally blew the whistle in 2001. Duke ultimately paid a modest sum to settle the affair. But federal investigators have since taken over with a criminal probe that could turn up indictments.

In the meantime, some company leaders have already made themselves scarce. Stratton, for instance, was last seen by some fellow employees weeks ago. Although Francisco confirmed Friday that Stratton is still with the company, Stratton's voice mail offers only a vague message saying, "I'll be out of the office until further notice."

Even Duke's top executive, CEO Richard Priory, has been far less visible than usual. He was absent from a recent earnings call that, many observers believe, was badly bungled by his subordinates. He also missed out on follow-up meetings with analysts in Boston and New York, as well as a big utility conference hosted by Lehman Brothers last week.

Francisco downplayed the matter by saying Priory has been tied up with other commitments.

For now, the company itself is focused on the South Carolina hearing. Duke is hoping to convince the Carolina regulators that it has the best interests of its customers -- and not just its shareholders -- in mind.

"South Carolina retail customers will realize long-term benefits because these costs [associated with the proposed accounting change] will no longer be included in the company's rate base and expenses after they are written off," wrote Duke Power President Ruth Shaw.

But Stone, for one, has his doubts.

"I believe GAAP says these financing costs follow the debt instruments," he said. "You don't have to be an accountant to figure that out. ... I'd be very surprised if the commission approves an accounting order for Duke."

Previous article:

Rate Case Means New Headaches for Duke

Duke's Psychoanalytical Accounting

Employee Advocate – - July 28, 2003

On Saturday, The Charlotte Observer ran a story on various accounting investigations taking place. The federal investigation of Duke Power’s books was mentioned. Duke will not like that at all. The last time The Observer mentioned the FBI and federal grand jury investigation, Duke executives had a “dying duck fit”! The executives said that it was “old news.” Evidently they feel that the media can report on an event only one time. But the media can update the FBI investigation of Duke Power’s books story every day if desired.

The investigators are deciding if they will press criminal charges against Duke. The Observer delves deeper into the investigation each time a story is published. That may be Duke’s real beef. Executives may fear a deep examination of the matter.

Duke tried the “We didn’t do it” defense, with about zero success. It would seem that if Duke is as clean as claimed, that the executives would welcome all the investigations they could get.

Duke joined other nuclear utilities in starting their own nuclear insurance fund. The fund grew due to the bull stock market of the 1990’s. The annual return of fund investments was growing larger that the premiums! This is beginning to sound like the cash balance pension fund. Employees’ benefits were reduced so much that the pension fund was “self funding.” This did not come about by accident, Duke did not want to contribute any more to the retirement fund. The stock market crash left the executives with egg on their faces.

Duke decided to put the insurance money being made into a different account. The money would go into a shareholder account, rather than a ratepayer account.

In 2002, the independent auditor concluded that the switcheroo was “completely without accounting justification under any accepted accounting standards.” This, and other problems, left Duke $124 million short on reports made to the state regulators.

The FBI intends to discover what Duke actually meant to do by using “psychoanalytical accounting.” If this procedure involves electrodes, high voltage, and sodium pentothal, they might get the truth out of the parties involved!

S. C. to Duke: Explain Profits

The Charlotte Observer – by Stan Choe - July 21, 2003

(7/16/03) - Duke Power has a month to explain to S.C. regulators why it has made so much money recently. As a regulated utility, Duke is supposed to stay under a certain profit rate, but it was $41 million over the target for the 12 months leading to March 31, regulators say.

The S.C. Public Service Commission's executive director, Gary Walsh, faxed and mailed a letter to Duke Tuesday, giving the utility 30 days to explain why it was so far over its target. Walsh also asked for specific details, such as a month-by-month breakdown of Duke's profits.

During the 12 months, Duke earned a 14.25 percent return on what it has invested in power plants and equipment. Its target rate is 12.25 percent.

Duke will look over and respond to the questions, company spokesman Tom Williams said.

Utilities routinely come in above and below their target rates, and Duke recently has been coming in under more often than over.

But the 2 percentage point difference is the largest Walsh can remember for an electric utility.

Both he and Duke say the higher profits came from the colder winter's pushing up heating bills and Duke's increased electricity sales to other utilities. With natural-gas prices skyrocketing recently, other utilities have been buying more power from Duke, which can generate energy cheaper from dams, coal and nuclear plants.

Regulators could cut Duke's rates for customers because it went over its target, but it's too early to say if that will happen.

Duke's 600,000 S.C. customers already pay lower rates than its N.C. customers, by about 8 percent to 10 percent, because the states use different accounting methods.

Duke, the Carolinas largest utility, also already charges lower rates in South Carolina than other utilities, such as S.C. Electric & Gas and Progress Energy.

"They're by far the lowest in the state," Walsh said. "They produce electricity better and cheaper than anybody else in the country."

The last time S.C. regulators forcibly cut a utility's rates for earning too much was in 1998, Walsh said. The commission then cut rates for S.C. Electric & Gas customers by about 1.5 percent, after that utility came in $23 million over its target following a warm summer that pushed up air-conditioner use.

Duke earned $41 million more than its target.

The Federal Bureau of Investigation is looking into allegations that the forcible rate cut prompted Duke Power to change its accounting between 1998 and 2000 to stay below its target profit rate.

An independent auditor hired by Carolinas regulators accused Duke of inappropriately and intentionally altering its accounting methods to avoid what happened to S.C. Electric & Gas.

Duke denies the accusations, and it settled with Carolinas regulators last year.

Rate Case Means New Headaches for Duke – by Melissa Davis - July 18, 2003

(7/15/03) - Duke Energy's strongest division may be in for another jolt.

Duke Power, already under the cloud of a criminal investigation, faces a possible rate cut in its second-largest market. Due to sizzling first-quarter profits, Duke's South Carolina utility has officially stormed past its so-called allowed rate of return.

The power division, which ranks as Duke's biggest profit center, has been accused in the past of using accounting tricks to downplay utility profits and dodge rate cuts. But a state-ordered probe, recently expanded into a sweeping federal investigation, has blown the company's books wide open.

Under intense scrutiny from the authorities, Duke recently became the first South Carolina utility in five years to report excessive profits. Gary Walsh, executive director of the Public Service Commission of South Carolina, confirmed Monday that Duke had gone "well over" its allowed rate of return during the latest reporting period. "I've done some analysis myself," Walsh said. "But I'm going to give [Duke] 30 days to respond to the commission as to what caused the excess earnings."

Duke defends its rates and says it plans to work with the commission. But with the company's earnings under pressure and its credit rating a source of constant anxiety to investors, Wall Street will be eager indeed to hear Duke's response to the commission. Duke shares fell 11 cents Monday to $18.62.

The Price of Excess

In its latest quarterly report, Duke pointed to cold weather and strong wholesale power sales for an 18% surge in electric utility profits. The company generates most of its electricity with coal or nuclear energy instead of expensive natural gas. This year, with gas prices soaring, Duke has managed to rake in extra profits by selling excess capacity into the open market. But that success could prove bittersweet.

State regulators may now step in and say that excess profits, generated by consumer-funded assets, belong to utility customers instead of shareholders.

"That would be very significant," said Blaylock analyst Lasan Johong. "Duke needs every penny it can get right now."

Stung by a meltdown in the merchant energy business -- which seemed highly profitable before Enron's collapse -- Duke now depends on its regulated divisions for almost all of its earnings. Duke Power, dominated by electric utilities in North and South Carolina, currently generates about half of the company's total profits. So any hit to this division, described by Standard & Poor's as Duke's "largest and most stable generator of cash flow," could hurt.

S&P was fretting over regulatory risks in Duke's utility division even before South Carolina raised questions about Duke's high rate of return. And it has hinted that Duke could face another downgrade -- taking its BBB+ credit at least one notch closer to junk -- if conditions don't improve.

"The company [has] little ability to absorb any further weakening in operating cash flows," S&P wrote last month. But "we believe Duke Energy's operating performance may have not reached its lowest point yet."

Moody's is a bit more optimistic. The competing ratings agency surprised Wall Street this summer by adopting a stable outlook for Duke's investment-grade rating.

To be sure, Duke Power relies on its larger utility in North Carolina -- where it's currently protected by a rate freeze -- for most of its earnings. But it still looks to South Carolina for roughly 25% of its power profits each quarter. There, Duke recently posted a 14.25% rate of return that clearly exceeds its 12.25% limit. But Duke spokesman Terry Francisco described the 12.25% cap as little more than a "target rate." He pointed out that Duke has reported much lower returns -- under 10% through most of 2000 -- without seeking rate hikes from the South Carolina commission. And he seemed to expect similar cooperation from state regulators now that Duke has scored "unusual" profits from excess power sales.

"We have some of the lowest rates in the country -- and I think the commission is aware of that," Francisco said. But "obviously, we're going to work with them."

For now, Francisco isn't fretting over what a rate cut would do to the company's bottom line.

"I can't speculate into the future," he said simply.

Strained Relations

In its home state of North Carolina, Duke is regarded as a prominent investor-owned utility that satisfies the power needs of some 2 million customers across the Carolinas. But Duke's friendly relationship with state regulators has soured a bit in recent years.

Tipped off in 2001 by a Duke whistleblower, state regulators commissioned an independent investigation that -- in the end -- read like a scathing indictment of the company's reporting practices. The investigation, carried out by independent auditor Grant Thornton, concluded that Duke had intentionally overcharged Carolina utility customers by more than $125 million between 1998 and 2000.

Duke settled the charges for $25 million without admitting any wrongdoing. But the company, now under the watchful eyes of criminal investigators, has come forward to report excess utility profits for the first full quarter since Grant Thornton issued its report.

On average, Thornton estimated that Duke had overcharged Carolina customers by more than $40 million annually during the three-year period in question. Now, Walsh is saying that Duke earned $41 million more than allowed -- in South Carolina alone -- for the year ending March 31.

"It's amazing, when the eyes are on you, what your earnings really look like," said F. Barron Stone, the internal accountant who blew the whistle on Duke two years ago. "If the [utility] earnings were reported right before, our rates would have probably been cut already."

Francisco claims otherwise. He says that, even after adopting the Thornton recommendations, Duke would have fallen under its profit limits in South Carolina. But he does admit the accounting changes would have pushed Duke's larger utility in North Carolina over target limits more than once before that state froze Duke's rates last year.

Taking the Fall

Back in 1998, South Carolina Electric & Gas (or SCANA) -- another Carolina utility -- pushed past profit caps itself. And it weathered the only South Carolina rate cut in recent history as a result.

Duke immediately took notice.

In its report to state regulators, Grant Thornton said at least one Duke executive was "shocked" by the "devastating" rate cut at neighboring SCANA. Thornton went on to report that Duke employees viewed a similar rate cut as a "risk to the company" where they worked.

Within days of the SCANA rate cut, Thornton found, Duke began taking deliberate steps to address its own "allowed return problem."

"A number of Duke mid- to senior-level managers met and developed a plan ... for accounting adjustments which could be made to 'avoid reporting overearnings to regulators,'" Thornton said, quoting company documents. Thornton ultimately viewed most of the accounting adjustments as improper -- and some "which were completely without accounting justification under any accepted accounting standards."

Duke, backed up by its own expert accountant, views Thornton's stance as a simple difference of professional opinion. But Duke must now prove its innocence to federal investigators who could slap the company -- and even individual employees -- with criminal indictments. The company must also defend itself against a multimillion-dollar retaliation lawsuit filed by Stone under the new Sarbanes-Oxley Act.

Stone, who lost a similar case against Duke through the Labor Department, predicts the company's luck may be waning. He expects South Carolina to cut Duke's utility rates -- just as it did with SCANA -- and Duke to suffer as a result.

"If the commission doesn't take some action, they're going to have another company [SCANA] that's very unhappy," Stone said. "So there's some exposure here. There's an opportunity to lose earnings, to further pressure Duke's ability to hold its credit rating -- just the whole nine yards."

Previous article:

Duke Finds More Doubters

Blowing The Sarbanes-Oxley Whistle – by Ashlea Ebeling - June 19, 2003

(6/18/03) - It's been almost a year since Congress passed the Sarbanes-Oxley Act, and public companies have been focusing their compliance efforts on the general corporate-governance reforms the new law mandates. Meanwhile, many have paid too little attention to Sarbanes-Oxley's whistle-blower provisions. But they ignore these rules at their peril. There are now stiff criminal as well as civil penalties for violating a whistle-blower's rights.

"Employers are in for a big surprise," warns Laurence Stuart, a labor and employment lawyer with Baker & MacKenzie in Houston. A taste of what's in store came on May 28, when the U.S. Department of Labor's Occupational Safety and Health Administration (OSHA) put out interim rules implementing Sarbanes-Oxley's civil whistle-blower provisions. (Interested parties have until July 28 to comment on them.)

"It's a different framework than what companies are used to under other whistle-blower laws,'' says Stuart."Employers have to be ready to defend their actions almost immediately if there's a claim.''

Some background: The Sarbanes-Oxley Act included a groundbreaking provision protecting employees who blow the whistle on corporate fraud, à la Sherron Watkins of Enron or Cynthia Cooper of WorldCom. These whistle-blower provisions provide broader remedies for employees than do other whistle-blower protection laws, such as those protecting employees who face retaliation for reporting environmental or health and safety offenses.

Sarbanes-Oxley actually has two enforcement regimes--one civil, one criminal--to protect people who report on corporate fraud. The civil provision creates a right to reinstatement, back pay and damages for whistle-blowers. The criminal provision makes it a felony to retaliate against a protected whistle-blower.

Not just corporations are at risk. Individual managers--for example, a human relations executive or a whistle-blower's supervisor--can be charged with unlawful retaliation and face up to ten years in prison and a $250,000 fine.

The rules just issued by OSHA, which implement the new civil protections, set a fast time frame for filing and responding to complaints. This could be a shock for companies used to a more drawn-out process. The employee has 90 days after facing retaliation to file a claim with OSHA, which then gives the employer only 20 days to present evidence in its favor. OSHA has to issue an initial determination within 60 days after receiving the complaint.

If OSHA finds reasonable cause to believe that the employer has violated the Sarbanes-Oxley Act, the employer may have only ten days to file additional information before OSHA issues its final decision. Following OSHA's determination, either party can appeal to an administrative law judge.

If OSHA doesn't issue a final ruling within 180 days, the employee can head straight to federal court and file a civil lawsuit claiming a violation of Sarbanes-Oxley. (Significantly, if OSHA does act within the time limits, the employee must go through the administrative law judge and can't take his or her claim directly to court.)

The reinstatement provision will also be of concern to employers. Under the interim rules, the Department of Labor can order an employee reinstated while the proceedings go forward. "To have to reinstate someone pending resolution of their case is virtually unheard of," says Stuart. "It's not going to sit well with U.S. businesses."

Preventative Medicine

What companies must now do to stay out of whistle-blower trouble.

*Write a corporate code of conduct that encourages employees to report potential financial, ethical, legal or other misconduct.
*Include a "no-retaliation" policy and identify employees who are to receive complaints of whistle-blower retaliation.
*Establish a corporate compliance telephone hotline and/or name a corporate compliance or ethics officer.
*Keep well-documented personnel files, disciplinary records and termination records.

Employers also have to be careful how they respond to OSHA investigations. Traditionally, employment lawyers have handled whistle-blower complaints. But with Sarbanes-Oxley cases, companies will have to pay corporate and securities lawyers too. That's because under the rules, the Securities and Exchange Commission is automatically notified of any complaint filed with OSHA; the SEC can even participate as a party if the case goes to an administrative law judge.

Also, the OSHA proceedings are all available to the public under the Freedom of Information Act. So any employer response could be used by plaintiffs' lawyers or other regulatory agencies to bring civil cases over the same conduct the whistle-blower has alleged.

The first whistle-blower cases under the Sarbanes-Oxley Act have already started trickling in to the Department of Labor. But OSHA has found that many of the more than 50 cases filed so far involved conduct that took place before Sarbanes-Oxley. Employers can at least be relieved that the law isn't retroactive.

Two big companies have already been hit with high-profile claims for behavior that allegedly took place after the law was passed. Duke Energy is defending a lawsuit filed by Barron Stone, a company accountant, in May in U.S. District Court in Charlotte, N.C., charging that the utility retaliated against him after he told regulators about the company's improper accounting practices. Stone filed an initial complaint with the Department of Labor, which ruled that Duke didn't violate Sarbanes-Oxley. He appealed, but then got the Department of Labor to stop the proceedings, allowing him to file the federal lawsuit after the 180-day clock was up.

"The only pressure on these companies is speed," says Stone's lawyer, Gerard Bos, of Charlotte, N.C. "It's a good thing to move these cases along rapidly. The whistle-blowers need resolution." Duke hasn't filed an answer in the federal case yet, but it disputed the charges at the administrative level.

Matthew Whitley, a former employee of Coca-Cola, this month filed a Sarbanes-Oxley claim with OSHA asserting he was fired after disclosing accounting irregularities, according to his Marietta, Ga., attorney, Marc Garber. If OSHA doesn't resolve the claim within 180 days, Garber says, he will amend a civil rights employment lawsuit he's already filed in federal court on behalf of Whitley, to add the Sarbanes-Oxley claim.

Coca-Cola declined to comment about Whitley's whistle-blower case but said in a written statement yesterday that outside auditors had found no evidence so far to support his allegations of accounting fraud and employee discrimination. Nevertheless, the company at the same time announced a $9 million writedown in the Fountain division, where Whitley worked. The company is continuing to investigate additional allegations by Whitley.

Duke and Tyco Whistleblowers – by Melissa Davis – May 30, 2003

Enron Aside, Whistle-Blowers Still Withering

(5/29/03) - Most corporate whistle-blowers will never score a book tour.

Yes, Time magazine helped make a few famous by declaring them heroes in a big cover story last year. And one of those people, Enron's Sherron Watkins, has actually gone on to sell a stack of autographed copies of her tell-all, Power Failure: The Inside Story of the Collapse of Enron.

But workers who expose corporate misdeeds don't normally end up with a listing on Instead, many find that straying from the company line ends up derailing their once-promising careers. In an age of rising worries about ethical business practices, some observers call it troubling that dissent is still being suppressed -- and caution that investors could again wind up paying the price.

"Retaliation is a serious problem," says Stephen Meagher, a San Francisco attorney who represents whistle-blowers in health care. "People try to do the right thing, and they get squelched. It happens all the time."

Meagher should know. For years, his clients have been protected by laws that specifically shield, and even reward, people who report abuses of Medicare and other government programs through the False Claims Act.

Spurred on by calamities such as those at Enron and WorldCom, the new Sarbanes-Oxley Act extends similar protection -- though without the financial incentives -- to corporate whistle-blowers outside the health care world. Under the new law, publicly traded companies face harsh penalties for retaliating against employees who expose corporate shenanigans.

Some experts believe managers will now respond with sweeping policy changes like those last seen when sexual harassment took center stage a decade ago. But Meagher has watched similar laws fail to protect his clients already. And noted academic C. Fred Alford remains skeptical that any law can weaken powerful corporations bent on keeping secrets.

"The goal of any organization is to eliminate the disruptive effect of the ethical individual," says Alford, a University of Maryland political science professor who wrote the book Whistleblower: Broken Lives and Organizational Power. "Organizations are basically amoral."

Men in White

In general, fate has not been kind to workers who stick their necks out calling attention to questionable conduct. Whistle-blowers typically spend at least five years -- and sometimes twice that -- fighting expensive battles that they rarely win. In the end, studies show, fewer than half of all whiste-blowers (sic) manage to hold on to their jobs after reporting corporate abuses.

"It's not just the law that hinders whiste-blowers," (sic) Alford says. "It's what it takes to use the law. It's very, very hard for people to use the law against organizations that have a lot of money, a lot of time and a lot of lawyers on their side."

Whistle-blowers who take that risk often lose their old identities in the process. They are no longer accountants or engineers or sales managers. They are, Alford says, people who disrupted company business by "committing the truth."

Take two men in Charlotte, N.C. The first, a finance specialist at Duke Energy, kissed his fast-track career goodbye when he exposed accounting issues now being probed by government agencies. The second, a former standout in one of Tyco's most troubled divisions, lost his career altogether after accusing his superiors of ignoring widespread abuses in regional ADT security offices.

The two Carolina men wouldn't know each other if they wound up on the same elevator. But each would instantly recognize the other's story -- and in many ways could even claim it as his own.

Truth and Consequences

For years, F. Barron Stone kept the troubling truth about Duke mostly to himself.

He complained internally, of course. He saw no legitimate reason for Duke to suddenly change accounting policies that were probably as old as the company itself. He even dragged out federal manuals that indicated the changes -- which protected Duke from utility rate cuts -- were forbidden. And he scored some early praise for his persistence.

"Barron does a good job of keeping management informed of potential problems," Rick Ealey, Duke's assistant controller, wrote in Stone's 1999 performance review. "He has demonstrated managerial courage and is not afraid to stand alone."

But inside, Stone was shaking. After fretting over the accounting changes for months, he finally called the state and national accounting boards to ask whether he was ethically required to report Duke. When they couldn't decide, he went a step further and called the Securities and Exchange Commission and the state utility board. Both expressed immediate interest in the case. Still, Stone was not yet prepared to expose himself -- or even his company -- to the spotlight. He put his head down, went back to work on his promising career and waited for outsiders to detect Duke's problems.

Years passed without event. Stone finally spoke up.

"We were cheating electricity customers," Stone explained. "We were hurting the people we'd been doing business with since the beginning."

Duke's "luck" was about to run out. On a blistering Friday the 13th in 2001, Stone called the company's internal hot line and warned that he planned to expose the accounting changes to utility regulators in South Carolina. Nobody tried to stop him.

Less than two months later, though, Stone's career began to fall apart. He weathered a "hostile" five-hour interrogation by company attorneys gathering information for a report to the Carolina utility regulators. They would go on to order their own investigation -- conducted by independent auditing firm Grant Thornton -- which blasted Duke in the alleged use of accounting tricks to downplay utility profits and lock in higher power rates.

Duke ultimately settled both utility cases. But federal investigators have picked up where state authorities left off. The company has responded by hiring some of the biggest defense attorneys around to represent executives now swept up in a growing criminal probe.

Meanwhile, Stone continues to fight an uphill battle mostly on his own. He lost his first round when the Labor Department recently sided with Duke. But last week he slapped the company with a retaliation lawsuit, filed under the Sarbanes-Oxley Act in federal court.

Duke expects to prevail again. The company pointed out that the Labor Department found no proof of retaliation, and that Stone's new case relies on the same evidence that failed to support his arguments the first time around.

But Stone insists that he has paid an unfair price for his honesty. "As a result of his demotion and harassment by Duke, Stone's career has been shattered," the lawsuit states.

Still, Stone is luckier than most whistle-blowers. He has a job -- for now.

Alford estimates that the average whistle-blower lasts two years, usually weathering an inappropriate job transfer first, before finally getting fired. Stone sounded the alarm at Duke 22 months ago.

Security Breach

Former ADT sales manager Charlie Jones managed to last three years -- all of them miserable, he said -- before he finally lost his job.

In 1999, Jones set out to expose abuses that now seem almost innocent in comparison with the corporate-level looting that since has been alleged at Tyco. Jones sent an anonymous fax to his superiors warning that other ADT managers were taking kickbacks from vendors. He claims that ADT supervisors initially chose to ignore the abuses and punish him for exposing them instead.

In the end, ADT did ultimately fire the managers for continued misconduct. But Jones lost his career too -- after he continued to report abuses. By the time he left ADT in misery last year, Jones had documented transgressions ranging from forgery to fraud to theft. He finally got fired from his next job, working for an ADT authorized dealer, just days after reporting ADT's troubles to new Tyco CEO Ed Breen.

"At this point, my gripe isn't even about the salespeople who committed the theft and fraud," Jones said. "I think the bigger problem is the message the behavior of management sends to the customers and shareholders of this company.

"By refusing to take action, management legitimizes and encourages ongoing unethical behavior."

Tyco insists that it has responded properly.

"We have taken steps to investigate the problem areas that Mr. Jones identified," Tyco spokesman Gary Holmes said Friday. "We take all allegations of wrongdoing seriously."

Indeed, Breen has publicly vowed to crack down on Tyco employees who break rules and has, in fact, already fired some big names in the problematic ADT division. But Jones is still watching for clear signs that ADT's old culture -- which fostered troublemakers in the past -- has truly changed.

In the meantime, the award-winning sales manager is hunting for a job. But his record as a whistle-blower isn't helping.

"I can't even get an interview with a security company despite my record and abilities," Jones said.

And even after everything he's been through, Jones misses his old job at ADT.

"There was never a day in 10 years that I didn't believe that ADT was providing superior service -- and doing it better than anyone else -- for our customers," Jones said. "I was always proud to spread that word."

Unsung Heroes

But obviously, speaking out can hurt.

In the end, people like Stone and Jones often walk away with the label of "disgruntled ex-employee." They don't generally wind up on magazine covers. But they can, and do, make a difference.

"You can't stop them," says Donald Soeken, a clinical social worker who blew the whistle both early and late in his career and now runs a retreat, known as the Whistle Stop, which provides a welcome escape to those who dare to speak the truth. "They will be blowing the whistle from now until the end of time.

"And they'll be paying the price for it, too."

Whistleblower Sues Duke Power

The Charlotte Observer – by Stan Choe – May 23, 2003

Accountant claims retaliation, takes case to federal court

(5/22/03) - A Duke Power whistleblower is suing his employer for more than $2.5 million, saying it retaliated against him for tipping off regulators to allegedly improper accounting changes.

Barron Stone, a Duke accountant, is asking for a jury trial in the lawsuit filed Wednesday in U.S. District Court in Charlotte, claiming the company demoted and harassed him and broke an agreement with him.

He believes a jury would be more sympathetic than the U.S. Department of Labor, which rejected his charges in March. A federal investigator said then that there was either insufficient evidence of retaliation or that Duke's actions preceded federal whistleblower protections that went into effect last summer.

Duke says it feels the Labor Department reached a logical conclusion.

Stone appealed the ruling by going to federal court.

"(Duke has) tried to make it tough for me," said Stone, who still works at the utility's Charlotte-based parent, Duke Energy Corp. "I have to extend a strong will, and I'm going to be here. We're not going away."

In 2001, Stone called S.C. regulators and his company's ethics hot line, saying Duke made improper accounting changes to avoid a possible rate decrease.

The call triggered a joint investigation by Carolinas utilities commissions, which accused Duke of intentionally underreporting $124 million in regulated profits from 1998-2000. The FBI is now investigating the matter.

Duke says it made unintentional, one-time mistakes and denies intentional wrongdoing.

After he blew the whistle, Stone had to endure a harassing five-and-a-half hour "interrogation" by Duke attorneys without a break, he said in the suit.

Duke also transferred him to a job against his will, forcing him out of the forecasting department, which dealt with classified information, according to the suit. Stone lost his office and moved to a cubicle in the transfer.

He also accused Duke of backing out of an agreed $2.5 million settlement, which the suit says the two brokered in late 2002. Under the settlement, Stone claims, he would have promised to stop talking to the media and Duke would pay him in cash.

He claims Duke backed out of the agreement in November, when it demanded to go before an arbitrator before any settlement. Stone refused.

Duke says there was no formal offer of $2.5 million.

"There was nothing to pull out of," Duke spokesman Tom Williams said Wednesday. "Nothing existed."

Williams also said Stone's transfer was a lateral move, part of a restructuring that moved 13 people.

The executive overseeing the move didn't know Stone was the whistleblower, Williams said. He also pointed out that Stone's pay increased and that he now has his own office.

The five-hour "interrogation" was part of Duke's in-house compliance review of the accounting allegations, Williams said, and the company treated Stone the same as other employees.

Feds Deepen Duke Probe

The Charlotte Observer – by Stan Choe, Gary L. Wright – May 11, 2003

Audit said company altered accounting to adjust profits

Federal investigators will review thousands of additional documents in a deeper probe of Duke Power's accounting than the one Carolinas regulators conducted last year, sources close to the investigation say.

Federal prosecutors and FBI agents will scour more than 40,000 documents, including a controversial spreadsheet unearthed during the states' investigation, as they evaluate whether Duke intentionally and inappropriately altered its accounting and committed any crimes, according to sources.

After a 10-month investigation last year, independent auditing firm Grant Thornton LLP said Duke underreported $124 million in regulated profits over three years. Duke changed its accounting methods to fall under the profit margin mandated by regulators, the firm said.

When Duke goes over its allowed limit, utility commissioners can lower the power bills for Duke's 2.1 million Carolinas customers.

Duke says it made unintentional, one-time errors but committed no crime. Duke Power, the Carolinas' largest utility, is a subsidiary of Charlotte-based Duke Energy Corp., which is No. 118 on the Fortune 500 with $15.2 billion in revenue last year.

Federal investigators began their probe after The Observer published stories in October about Grant Thornton's allegations of Duke wrongdoing. In February, Duke announced it had received a grand jury subpoena requesting documents related to the Grant Thornton audit.

Days before receiving the subpoena, Duke hired former U.S. Attorney Mark Calloway to represent the corporation. The company also helped assemble A-list criminal defense lawyers for more than a dozen employees. Companies and their employees typically hire lawyers when they learn they're under investigation.

The lawyers include some of North Carolina's most prominent: Jim Cooney, James Wyatt, Ed Hinson, David Keesler and Chris Fialko of Charlotte; David Rudolf, with offices in Chapel Hill and Charlotte; and Wade Smith of Raleigh. Five of those lawyers -- Cooney, Wyatt, Hinson, Rudolf and Smith -- are listed in the publication "The Best Lawyers in America" for either criminal defense, business litigation or personal injury litigation.

The defense lawyers say their clients have done nothing wrong.

"It's not that there's a dead body on the floor or $1 million is missing," one of the Duke employees' lawyers said of the federal investigation. "These were real revenues, and these were real expenses. This isn't like Enron or WorldCom, where people were making things up."

Many sources close to the investigation spoke only on the condition of anonymity.

Different viewpoints

Grant Thornton contends that an internal spreadsheet is "critical evidence of the existence of a coordinated plan" to underreport regulated profits. Duke used "unjustifiable" accounting techniques to fall under its allowed profit margin and avoid a possible rate decrease, according to Grant Thornton.

In Duke's written response to the audit, it acknowledged unintentional, one-time mistakes, which did not affect the reported earnings of Duke Energy Corp.

The spreadsheet, stamped "Confidential" in its lower right-hand corner, is a road map that shows methods to report less profits to Carolinas regulators, the audit says.

In its response, Duke said the spreadsheet is a routine part of business and doesn't show any illegal behavior.

Duke would be shirking its duties to regulators and its shareholders if it didn't keep track of its finances, the company says

No Duke employees have been asked to appear before a grand jury or notified they are targets of the investigation, sources said.

FBI agents have asked to interview some Duke employees and are expected to conduct those interviews soon, sources said. The employees will be accompanied by their lawyers, one source said.

The FBI has interviewed four commissioners and their staffers at the N.C. Utilities Commission; Gary Walsh, the executive director of the S.C. Public Service Commission; and Barron Stone, the Duke Power accountant who tipped off regulators in 2001 to the accounting changes.

FBI agents and prosecutors will study the same documents submitted last year to Grant Thornton before questioning the Duke employees, sources said.

"The government wants to get on top of the paperwork before they interview anyone," one source said. "They're trying to figure out whether or not there was a crime committed, before they start focusing in on other things."

Federal investigators may have to move fast. Sources say the complex probe may have to be completed by the end of the year. The statute of limitations for many federal crimes -- such as mail fraud and wire fraud -- is five years. The Duke investigation is focusing on activity in late 1998 and early 1999. That means the statute of limitations could run out early next year.

Mail fraud and wire fraud are possible crimes investigators are looking into, sources said. The mailing or faxing of fraudulent documents could be mail or wire fraud.

Accuracy at issue

The public audit Grant Thornton conducted for Carolinas regulators reads like an indictment, one source said.

The audit says that "a number of Duke mid to senior level managers met and developed a plan to identify expense and revenue items which could serve as a basis for accounting adjustments which could be made to `avoid reporting over-earnings to regulators.' "

Duke said most of its errors occurred in 1998, the first full year after Duke Power Co.'s merger with PanEnergy Corp. to create Duke Energy Corp.

Combining the two accounting systems was complicated, and many accountants were doing tasks for the first time. That might have contributed to the errors, Duke said.

After the Grant Thornton audit, Duke settled with Carolinas regulators, agreeing to pay $25 million in fuel-cost increases, which customers typically pay.

When it responded to the audit, Duke complained to Carolinas regulators that Grant Thornton's report was "prosecutorial in tone" and not balanced.

Determining the accuracy of Grant Thornton's audit is one of the FBI's biggest challenges.

Sources say the FBI must determine whether:

  • Duke's accounting errors were unintentional or deliberate.

  • Several disputed accounting methods were legal or illegal.

Grant Thornton believes Duke engaged in two "unjustifiable" actions, while an accounting expert hired by Duke attorneys said they were legal.

Grant Thornton said the spreadsheet shows how more than a dozen accounting changes would alter employee and management bonuses, as well as the profits Duke Power would declare to Carolinas regulators and Duke Energy would declare to the Securities and Exchange Commission.

Grant Thornton and state regulators have known about the spreadsheet since early last year. Authorship of the spreadsheet hasn't been attributed to any employee. The spreadsheet was the only document for which Grant Thornton couldn't find an author.

S.C. Public Service Commission Executive Director Walsh said that spreadsheet, along with internal Duke e-mails that discuss Duke's profit margin, or "allowed return problem," convinced him that there was an orchestrated effort to underreport profits.

Determining that Duke intentionally changed its accounting is "not rocket science," Walsh said.

Duke countered that it regularly analyzes its performance against its allowed profit margin.

Adjusting its accounting to fall under a certain profit margin is legal, as long as the company uses appropriate methods, the company says. And Duke has experts testifying in its response that it acted properly.

"If the accountants can't agree," one source said, "then how can you say somebody committed a crime?"

Walsh said accounting experts can disagree on almost every issue. It's up to the government to decide who is right, he said.

More information sought

Company documents obtained by The Observer show Duke's attorneys directed employees to save a much wider range of documents for the federal grand jury subpoena issued in February than they did for the states' regulatory investigation.

After receiving the subpoena, Duke sent a three-page memo to employees that listed 11 categories of documents to retain, such as all documents related to Grant Thornton's audit, any documents regarding allowable profit margins or any documents related to resignations or terminations.

The most high-profile departures from Duke recently have been former Duke Power President Bill Coley, who retired in February, and former Duke Energy controller Jeffrey Boyer. Neither Duke's nor Boyer's attorney will say why Boyer left.

That three-page memo is much longer than two sent to employees in the past two years, during Grant Thornton's and Carolinas regulators' investigations.

Both were a paragraph long, asking for documents that included the phrase "allowed return" or that were related specifically to the 14 accounting items regulators were investigating.

Duke spokesman Tom Williams declined to comment specifically on the federal investigation.

"The document request shows we are fully cooperating," he said.

U.S. Attorney Bob Conrad and Chris Swecker, who heads the FBI in North Carolina, would not comment on the investigation.

Whistleblower Stone said he thinks, based on his conversation with FBI agents, that the federal investigators are casting a wider net than state regulators did.

Stone said two Duke employees told him they didn't turn over pertinent documents for the state investigation in 2001 because they weren't asked for them.

Those documents, Stone said, are much like the spreadsheet. He said they show forecasting studies for how close Duke would be to its allowed profit margin.

Duke employees who might be the focus of the probe are concerned, said one defense lawyer. "Anybody would be worried to be involved in a grand jury investigation."

Another defense lawyer said the employees are eager to get the matter behind them.

"It's been a tough experience," he said. "It's like being caught up in a tornado."

A third defense lawyer said his clients are not worried. "They're very confident they have done nothing wrong."

If the federal investigation leads to indictments and convictions, it could mean prison time for employees or millions of dollars in fines for the company. . In the states' regulatory investigation that culminated last year, only North Carolina had the legal authority to fine the company.

One of the defense lawyers' tasks, depending on how the investigation progresses, may be to provide convincing evidence to federal prosecutors that no crime was committed.

"Because there's a grand jury investigation doesn't mean there's going to be a prosecution," one defense lawyer said. "Grand jury investigations often lead the government to conclude no crime was committed."

Another defense lawyer said: "They made mistakes. But mistakes are not crimes. These are honorable, hard-working people. They didn't have any financial incentives to do anything criminal."

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