Bernie Madoff died in prison in 2021, while serving a 150-year sentence for orchestrating the largest financial fraud in history. The disgraced financier's legacy, however, appears to live on through the accounting-fraud scheme at Southern Company, currently being exposed via online journalism. An examination of the firm's most recent Form 10-K annual report reveals that Southern Company's underhanded activities mirror those of Madoff in a number of respects. Longtime Alabama attorney and entrepreneur Donald Watkins conducted the review and publishes his findings today in an article at DonaldWatkins.com. The post, under the title "Southern Company’s Financial Statements Are Built on "Smoke and Mirrors," is Part 2 of a three-part investigative series that asks this question: Does the Southern Company fraud essentially represent the resurrection of Bernie Madoff? Watkins finds enough similarities to suggest the answer is yes:
Madoff’s fraud scheme was successful for so long because he created a front of respectability that attracted investors and he seduced state and federal regulators. It was all smoke and mirrors.
A review of the Southern Company’s 10-K for 2022 (and for prior years) suggests that the "dry bones" of Bernie Madoff's fraud scheme have been resurrected in the Southern Company’s cooked financial books and records. Yes, Madoff’s financial fraud has apparently risen from the dead, albeit in a slightly different form at the Southern Company.
Like Madoff, Southern Company presents an image of respectability--and profitability. But a review of key financial documents shows it is a mirage, unsupported by real numbers. Bernie Madoff pulled off such a magic trick for almost two decades before federal investigators finally started closing in. Writes Watkins:
Bernie Madoff was a New York financier who executed the largest financial fraud crime in history, via a sophisticated Ponzi scheme. Madoff defrauded thousands of investors out of at least $64.8 billion over the course of 17 years.
Bernie Madoff was polished and highly respected by the Wall Street crowd. At one time, Madoff was chairman of the NASDAQ stock exchange.
On December 10, 2008, Madoff's sons, Mark and Andrew, told federal authorities that their father had confessed to them that the asset-management unit of his wealth-management firm was a massive Ponzi scheme. The following day, agents from the Federal Bureau of Investigation (FBI) arrested Madoff and charged him with one count of securities fraud
The U.S. Securities and Exchange Commission (SEC) had previously conducted multiple investigations into Madoff's business practices, but had not uncovered the massive fraud. In 2000, financial analyst Harry Markopolos filed a “whistleblower” complaint with the SEC that was ignored. It wasn’t until five years later, in 2005, that Markopolos was able to convince the SEC of Madoff’s financial crimes.
Madoff’s accounting firm, Friehling & Horowitz, failed to detect the decades-long fraud scheme, and so did Ernst & Young.
On March 12, 2009, Bernie Madoff pleaded guilty to 11 federal felonies and admitted to turning his wealth-management business into a massive Ponzi scheme. Madoff was sentenced to 150 years in prison and required to forfeit $170 billion. He passed away in prison on April 14, 2021.
Is history repeating itself? As happened in the Madoff case, Southern Company's accounting firm (Deloitte & Touche) failed to detect signs of fraud. How does such financial chicanery happen? Watkins explains:
There are three primary reasons why senior-management executives at public companies cook the books. First, in many cases, the compensation of corporate executives is directly tied to the financial performance of the company. As a result, they have a direct incentive to paint a rosy picture of the company's financial condition in order to meet established performance expectations and bolster their personal compensation.
Second, it is a relatively easy thing to do. The Financial Accounting Standards Board (FASB), which sets the GAAP standards, provides a significant amount of latitude and interpretation in accounting provisions and methods. For better or worse, these GAAP standards afford a significant amount of flexibility, making it feasible for corporate management to paint a particular picture of the financial condition of the company.
Third, it is unlikely that cooking the company's financial books and records will be detected by investors due to the relationship between the independent auditor and the corporate client. In the U.S., the Big Four accounting firms and a host of smaller regional accounting firms dominate the corporate auditing environment. While these entities are touted as independent auditors, the firms have a direct conflict of interest because they are compensated, often quite significantly, by the very companies that they audit. As a result, the auditors may be tempted to bend the accounting rules to portray the financial condition of the company in a manner that will keep the client happy -- and keep its business.
Also, Watkins reports, dubious financial tactics can become entrenched, even at a seemingly reputable company:
Even financial analysts, however, can be slow to catch on:As noted in Part 1, "How the Southern Company Cooked its Books in a Massive $27-Billion Accounting-Fraud Scheme," the two main drivers of the Southern Company’s accounting-fraud schemes were: (a) the desire to pump up and maintain the company’s stock prices within the range of Wall Street forecasts and expectations, and (b) the need to meet or exceed the earnings per share expectations of Wall Street analysts for the company’s utilities and power industry sector.
Like Bernie Madoff's scheme, the Southern Company engaged in creative accounting, a/k/a accounting fraud or "cooking the books," for many years. The company created a financial mirage to prop up its stock prices and pay consistent, regular earnings per share. This mirage was essential to lure new investors (i.e., common and preferred shareholders) and retain existing common-stock shareholders.
The company needed creative accounting to pull off the fraud scheme because: (a) dividends were consistently and regularly paid from new investments and debt obligations, as opposed to retained earnings, and (b) the company's dividend-funding technique is not expected to change until sometime after 2025.
Led by CEO Tom Fanning, CFO Daniel S. Tucker, and former General Counsel/Chief Compliance Officer/Chief of Staff to the CEO/Executive Vice President James Y. "Jim" Kerr, II, as well as the CEOs and CFOs of its affiliates, the Southern Company created an attractive financial mirage for 2022.
The mirage conned the investing public, Wall Street, the SEC, and Deloitte & Touche into believing that a business enterprise with consolidated revenues of $59 billion in 2022 that is saddled with $55.2 billion in long-term debt and $7.6 billion in credit lines was profitable enough to pay its 1,090,000,000 shareholders of record a reported earnings per share of $3.28 for 2022 on outstanding common shares held by 99,521 shareholders, when it was not. See, K-10, at pp. II-1 and 7.
This kind of Bernie Madoff mirage has been successfully embedded in 10-Qs and 10-Ks filed by the Southern Company, year-after-year since 2017.
In truth, the Southern Company, which is a monopolistic business with captive customers, is leveraged to the hilt and more broke than the “Ten Commandments.” For this reason, the 10-K for 2022 and accompanying investor documents allocate as much focus on discussing “Potential Future Earnings” as they do in fairly and accurately presenting actual revenues and expenses for 2022. This is another characteristic of a Bernie Madoff-type fraud scheme.
Yet, no one on the Southern Company’s board of directors, or at Deloitte & Touche, or at the SEC cared enough about protecting the investing public to take a deep dive into how a publicly traded company that is awash in debt can maintain its high stock price and pay consistent dividends within the range forecast by Wall Street analysts, absent an accounting-fraud scheme.
For 2022, 13 Wall Street analysts offered 12-month price forecasts for the Southern Company that established a median target of $72.00, with a high estimate of $79.00 and a low estimate of $57.00. The median estimate represented a +5.28% increase from the 2021 price of $68.39. Not surprisingly, the Southern Company hit the forecasted target with a price per of $71.41 at the end of 2022. See, 10-K, at p. II-54.The reported book value was $27.93 per share, representing an overly inflated market-to-book value ratio of 256%. Cooking the books is a fairly common occurrence for a financially stressed company that must inflate the market value of its stock in order to constantly borrow money to stay afloat.
The market capitalization (or "market cap") for the Southern Company at the end of 2022, based upon $71.41 per share and the company's sophisticated accounting-fraud scheme, was $76.81 billion. Institutional lenders consider market cap, among other factors evidencing creditworthiness, in determining how much debt to extend to a publicly traded company.
The current consensus among 17 polled investment analysts was to “Hold” stock in Southern Company, as of December 31, 2022. This rating had held steady since March of 2022, when it was unchanged from a “Hold” rating. Of the analysts polled, seven had a “Buy” recommendation, none had an “Outperform” rating, six had a “Hold” rating, one had an “Underperform” rating, and four had a “Sell” rating.
Consider the earnings forecast for 2022:
The analyst forecast for the 1st Quarter of 2022 earnings per share ranged from $0.87 to $0.95, with a consensus estimate of $0.91. Reported earnings were $0.97 and exceeded analyst expectations by +6.59%.
The analyst forecast for the 2nd Quarter of 2022 earnings per share ranged from $0.80 to $0.88, with a consensus estimate of $0.84. Reported earnings were $1.07 and exceeded analyst expectations by +27.38%.
The analyst forecast for the 3rd Quarter of 2022 earnings per share ranged from $1.25 to $1.35, with a consensus estimate of $1.33. Reported earnings were $1.31, which was lower than analyst expectations by -1.5%.
The analyst forecasts for the 4th Quarter of 2022 earnings per share ranged from $0.23 to $0.26, with a consensus estimate of $0.24. Reported earnings (on February 16, 2023) were $0.26, which exceeded analyst expectations by 8.33%.
Did Southern Company try to clear up matters by pitching the truth? No, says Watkins, it responded with more smoke and mirrors:
Instead of highlighting the truth about the Southern Company’s dire financial condition, the 10-K and February 16, 2023, Fourth Quarter 2022 PowerPoint Presentation focused on creating an illusion of profitability. The company repeatedly highlighted its “[r]egular, predictable and sustainable EPS and dividend growth*,” in the PowerPoint document. Of course, the asterisk leads the investor to this fine print disclaimer: “* Future dividends are subject to approval of the Southern Company Board of Directors and depend on earnings, financial condition and other factors.”
Because the Southern Company does NOT generate enough annual operating cash flow to cover its annual operating expenses (absent new investments and heavy borrowing), and because the company will NOT be profitable for years to come, the company also pitched these three additional dividend statements (on the PowerPoints “Value Proposition” page) to unsuspecting shareholders and new investors:
(a) For 75 years, the company has paid a dividend equal to or greater than the previous year. This self-serving promotional claim is repeated in the 10-K, at p. II-1;
(b) Dividends are supported by premier state-regulated utilities and energy infrastructure under long-term contracts; and
(c) The company has had 21 consecutive annual dividend increases since 2002.
The 10-K fails to explicitly state that dividends are Not paid from retained earnings or corporate profits, as the company has not been profitable in years. They are financed by debt.
What is more, the Southern Company packaged its consolidated financial numbers in a way that projected a financial picture for 2022 that is rosy enough to support the illusion of profitability.
One almost expects to learn, at some point, that David Copperfield has been operating behind a curtain. A more down-to-earth tactic actually is in play. It's called "Cover Your Ass (CYA) language, writes Watkins:
The 10-K quickly disclaims that while the “Financial Condition and Results of Operations is a combined presentation" to project this illusion of profitability, the "information contained [in the 10-K] relating to any individual Registrant is filed by such Registrant on its own behalf and each Registrant makes no representation as to information related to the other Registrants.” See, 10-K, at p. II-2.
In other words, none of the six companies listed in the 10-K, including the Southern Company, vouches for the integrity of the financial statements of the other companies in this joint SEC filing. This disclaimer speaks volumes.
Functionally, this disclaimer obfuscates the Southern Company's well-known and fungible financial practice of robbing Peter (its affiliates) to pay Paul (their parent company). It also attempts to isolate and contain potential criminal liability to the signatory parties in those business units where specific acts of fraud occurred, even though CEO Tom Fanning and General Counsel Jim Kerr micro-managed all of the company's affiliates with an iron fist.
An investor must dig real deep into the 10-K to ascertain just how financially strapped the Southern Company was in 2022 and will be for 2023 through 2025.
Here is the Southern Company’s "Cover-Your-Ass" (CYA) language in the 10-K on this point:
“Operating cash flows only provide a substantial portion of the Registrants' cash needs.….. For the three-year period from 2023 through 2025, projected stock dividends, capital expenditures, and debt maturities are expected to exceed operating cash flows for each of Southern Company, the traditional electric operating companies, and Southern Company Gas. Southern Company plans to finance future cash needs in excess of its operating cash flows through one or more of the following: accessing borrowings from financial institutions, issuing debt and hybrid securities in the capital markets, and/or through its stock plans. Each Subsidiary Registrant plans to finance its future cash needs in excess of its operating cash flows primarily through external securities issuances, borrowings from financial institutions, and equity contributions from Southern Company.” See, 10-K, at p. II-53-54.
Essentially, this statement is an adaptation of the CYA language Bernie Madoff used in his investment documents. Is this "fig leaf" CYA statement enough to save the Southern Company's signatory officials from exposure for Sarbanes-Oxley accounting fraud? In my humble opinion, probably not -- unless the criminal case is "fixed."
Does Southern Company say anything about mismanagement on costly projects? Not one word:
While the fact of the construction costs and amount of cost overruns at the Kemper coal-gasification plant are disclosed in the 10-K, neither the 10-K, nor any related document, disclosed the fact that Tom Fanning, Daniel Tucker, James Kerr, and the Southern Company board of directors actually mismanaged the Kemper project, which is being demolished after the company spent more than $7 billion building it. This internal mismanagement assessment of a $7 billion project is a "material" fact and it was documented in the "Homewood Notes" by reference to "Money going to [Southern Company Services] to prop up bad decisions by SO."
Likewise, while the fact of the construction costs and amount of cost overruns at the Vogtle Units 3 and 4 are disclosed in the 10-K, neither the 10-K, nor any related document, disclosed the fact that Tom Fanning, Daniel Tucker, James Kerr, and Southern Company board of directors actually mismanaged the costs associated with the construction of Vogtle project, which has now exceeded the projected construction budget by $21 billion. Again, this internal mismanagement assessment of a $21-billion cost overrun is a “material” fact and it was documented in the "Homewood Notes" by reference to "Money going to [Southern Company Services] to prop up bad decisions by SO."
Whether maintained on-site or off-site, the "Homewood Notes" were made by agents of the company and they were germane to the annual audit for each year, from 2017 to 2022. This is particularly true in light of the fact that: (a) the "Homewood Notes" specifically reference the Southern Company's board-level Audit Committee and Committee member Johnny Johns, and (b) criticized the Audit Committee's performance with respect to the Kemper and Vogtle construction projects.
The "Homewood Notes" are part of thousands of Southern Company emails and other documents that are highly relevant to an accounting-fraud inquiry and associated criminal activities. This reservoir of corporate documents is probative of the Southern Company's intent to defraud.
Was the Southern Company's treasure trove of internal documents assessing executive mismanagement in the amount of $27 billion deliberately withheld from Deloitte & Touche during the auditing process for 2022? Apparently so. Deloitte does NOT mention these internal corporate documents anywhere in any 10-K filed between 2017 and 2022.
Would the disclosure of a documented internal assessment of $27 billion in executive mismanagement with respect to two major construction projects, together with "insider" criticism of the board's Audit Committee, influence the decisions of end-users of the financial statements? Of course, it would. This is why the company's documented assessment of mismanagement was parked off-site and suppressed indefinitely.
Did Southern Company senior-management executives in the Atlanta headquarters know that fellow senior-management executives and two longtime key vendors (one of whom still works for the company) prepared and maintained a cache of internal documents regarding: (a) Tom Fanning's, Daniel Tucker's, Jim Kerr's, and the board of directors' mismanagement of Kemper and Vogtle projects, (b) strong criticism of the board's Audit Committee and Committee member Johnny Johns, and (c) a plan to alert the "PSC" (Public Service Commission) and two other government officials about the Southern Company's mismanagement of $27 billion in corporate funds, via an anonymous complaint? Yes.
When individuals get into financial trouble, it often is viewed through a "micro" lens as "failure to live within their means." But something similar can happen with corporations, as Watkins describes:
Like Bernie Madoff in his day, the Southern Company did not live within its financial means (or cash flows) in 2022. At this moment, senior management executives at the company are looking for new money to plug the "Hole" in their financial-fraud scheme.
In their own words, these executives say that they must: (a) access their $7.6 billion in credit lines, (b) issue new debt and hybrid securities in the capital markets, and/or (c) increase the Southern Company’s outstanding shares of stock to keep the company afloat during 2023, 2024, and 2025.
In addition to these non-cash-flow-generating measures for pumping desperately needed cash into the company, the Southern Company has linked its ability to keep the company's head above water to potential future earnings that are mostly derived from bringing Vogtle 3 in-service by May or June 2023 and Vogtle 4 in-service by late 4th Quarter of 2023 to the end of the 1st quarter of 2024.
The company's recent secret plan to spinoff Alabama Power to NextEra Energy was shelved after our publication of "Southern Company Reportedly Seeks a Spinoff of Alabama Power." The spinoff was intended to (a) provide the Southern Company with much needed liquidity and (b) afford it an opportunity to off-load a significant portion of the multi-year accounting fraud.
Additionally, the Nuclear Regulatory Commission (NRC) issued the Southern Company (D/B/A Georgia Power Company and Southern Nuclear Operating Company) a combined “Owner/Operator” license 11 years ago. Yet, Vogtle Units 3 and 4 are NOT in-service today. Furthermore, formal complaints were filed on February 3, 2023, that challenged the Southern Company’s "fitness" to hold this combined license, in light of the company's documented racketeering history. An unfavorable outcome for the Southern Company on this complaint would be devastating to the company and its affiliate, Georgia Power.
Like Bernie Madoff, the Southern Company is now resorting to old-fashioned "street hustling" for new investors and additional liquidity, via creative debt financing.
Simply put, the Southern Company cannot live within its financial means (or operating cash flows) for the next three years, or so. It is within this financially suffocating paradigm that the company touts its earnings per share and dividend payment history, just like Bernie Madoff did.
As a matter of policy and practice, SEC-registered public companies do not pay consistent, regular shareholder dividends from borrowed money. Such a practice misleads investors and fosters an illusion that a company in this circumstance is profitable enough to pay dividends from retained earnings.
Where was Deloitte & Touche when all of this was going on? It apparently was gorging on massive fees for its "professional services. Writes Watkins:
Rather than fulfilling its independent accounting role on behalf of shareholders, potential investors, regulators, lenders, and other stakeholders to look for evidence of accounting fraud in a public company that cannot live within its means, Deloitte & Touche abdicated this proactive role in exchange for $17 million by simply looking the other way.
Buying into the Southern Company’s goal to become profitable sometime after 2025, Deloitte & Touche devoted half of its four-page “REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM” to explaining why the auditing firm was comfortable with the cost overruns debacle at Vogtle. See, II-72-75.
Lastly, the only discussion of “Credit Risk” in the 10-K centers on the Southern Company’s and affiliates’ exposure for concentrations of credit risk with counterparties to energy-related and interest rate derivative contracts. See, 10-K, at p. II-69.
However, there is no discussion in the 10-K about whether the Southern Company and its affiliates will have the capacity to service their debts when due in a scenario where: (a) annual operating revenues continue to fall way short of the amount needed to cover operating expenses and (b) borrowing is impaired due to the detection by third-parties and government regulators of a multi-year accounting fraud scheme.
Deloitte was not alone in failing at its oversight function:
As was the case with Bernie Madoff’s fraud scheme, the SEC has been asleep at the wheel in the Southern Company's accounting-fraud case. The commission has been seduced into complacency and inaction by the Southern Company’s ranking and status in the utilities and power industry and its thin veneer of respectability.
The SEC has ignored General Counsel/Chief Compliance Officer/Chief of Staff/Executive Vice President Jim Kerr's demonstrated insensitivity to the environmental protection needs and life-threatening living situation of the Southern Company's captive black customers in Birmingham, Alabama, as recorded on an audiotape in 2018 and first made public in 2020.
Senior-management personnel from the SEC’s Atlanta Regional Office have reportedly busied themselves by enjoying the perks that the Southern Company and its affiliates routinely make available to public officials (e.g., tickets to sporting events and concerts in venues around the nation, wining and dining in restaurants and bars, free out-of-town luxury getaways, and other unreported snuggling with mega-Registrants)
It does not appear that the SEC gives the Southern Company’s 10-Qs and 10-Ks more than a cursory glance. If it does, the SEC has ignored the company's accounting fraud for years, just like the Commission did in Bernie Madoff’s case.
Stay tuned for Part 3, Why the FBI Must Raid the Executive Offices of the Southern Company!
