Accounting fraud

Accounting scandals are political and/or business scandals which arise with the disclosure of financial misdeeds by trusted executives of corporations or governments. Such misdeeds typically involve complex methods for misusing or misdirecting funds, overstating revenues, understating expenses, overstating the value of corporate assets or underreporting the existence of liabilities, sometimes with the cooperation of officials in other corporations or affiliates.

In public companies, this type of "creative accounting" can amount to fraud, and investigations are typically launched by government oversight agencies, such as the Securities and Exchange Commission (SEC) in the United States.

Causes

It is fairly easy for a top executive to reduce the price of his/her company's stock – due to information asymmetry. The executive can accelerate accounting of expected expenses, delay accounting of expected revenue, engage in off balance sheet transactions to make the company's profitability appear temporarily poorer, or simply promote and report severely conservative (e.g. pessimistic) estimates of future earnings. Such seemingly adverse earnings news will be likely to (at least temporarily) reduce share price. (This is again due to information asymmetries since it is more common for top executives to do everything they can to window dress their company's earnings forecasts). There are typically very few legal risks to being 'too conservative' in one's accounting and earnings estimates.

A reduced share price makes a company an easier takeover target. When the company gets bought out (or taken private) – at a dramatically lower price – the takeover artist gains a windfall from the former top executive's actions to surreptitiously reduce share price. This can represent tens of billions of dollars (questionably) transferred from previous shareholders to the takeover artist. The former top executive is then rewarded with a golden handshake for presiding over the firesale that can sometimes be in the hundreds of millions of dollars for one or two years of work. (This is nevertheless an excellent bargain for the takeover artist, who will tend to benefit from developing a reputation of being very generous to parting top executives.)

Similar issues occur when a publicly held asset or non-profit organization undergoes privatization. Top executives often reap tremendous monetary benefits when a government-owned or non-profit entity is sold to private hands. Just as in the example above, they can facilitate this process by making the entity appear to be in financial crisis – this reduces the sale price (to the profit of the purchaser), and makes non-profits and governments more likely to sell. It can also contribute to a public perception that private entities are more efficiently run, thereby reinforcing the political will to sell off public assets. Again, due to asymmetric information, policy makers and the general public see a government-owned firm that was a financial 'disaster' – miraculously turned around by the private sector (and typically resold) within a few years.

All accounting scandals are not caused by top executives. Often managers and employees are pressured or willingly alter financial statements for the personal benefit of the individuals over the company. Managerial opportunism plays a large role in these scandals. For example, managers who would be compensated more for short-term results would report inaccurate information, since short-term benefits outweigh the long-term ones such as pension obligations.[1]

Most employees see the scandals as affecting the economy, and some say investor demands are weakening the corporate focus on meeting customer needs. The feelings with respect to the economy are very strong: More than nine out of ten employees (91%) agree that the scandals are a serious or very serious problem for the nation's economy, and nearly two out of three (62%) rank the scandals a "very serious" problem for the economy. Feelings about customer focus are almost as strong: Nearly three-fourths (72%) agree that recent pressure to satisfy shareholder expectations has led publicly held companies to focus more on meeting the demands of investors than customers. A significant minority (41%) say they have observed this trend in their own company.

List of major accounting scandals

Company Year Audit Firm Country Notes
Lockheed Corporation 1976 United States
Nugan Hand Bank 1980[2] Australia
ZZZZ Best 1986[3] United States Ponzi scheme run by Barry Minkow
Barlow Clowes 1988[4] United Kingdom Gilts management service. £110 million missing
MiniScribe 1989[5] United States
Polly Peck 1990[6] United Kingdom
Bank of Credit and Commerce International 1991[7] United Kingdom
Phar-Mor 1992[8] Coopers & Lybrand United States mail fraud, wire fraud, bank fraud, and transportation of funds obtained by theft or fraud
Informix Corporation 1996[9] Ernst & Young[10] United States
Sybase 1997[11][12][13] Ernst & Young[14] United States
Cendant 1998[15] Ernst & Young United States
Waste Management, Inc. 1999[16] Arthur Andersen United States Financial mistatements
MicroStrategy 2000[17] PricewaterhouseCoopers United States Michael Saylor
Unify Corporation 2000[18] Deloitte & Touche United States
Computer Associates 2000[19] KPMG United States Sanjay Kumar
Lernout & Hauspie 2000 KPMG Belgium Fictitious transactions in Korea and improper accounting methodologies elsewhere
Xerox 2000[20] KPMG United States Falsifying financial results
One.Tel 2001[21] Ernst & Young Australia
Enron 2001[22] Arthur Andersen United States Jeffrey Skilling, Kenneth Lay, Andrew Fastow
Swissair 2001 McKinsey & Company Switzerland
Adelphia 2002[23] Deloitte & Touche United States John Rigas
AOL 2002[20] Ernst & Young United States Inflated sales
Bristol-Myers Squibb 2002[20][24] PricewaterhouseCoopers United States Inflated revenues
CMS Energy 2002[20][25] Arthur Andersen United States Round trip trades
Duke Energy 2002[20] Deloitte & Touche United States Round trip trades
Dynegy 2002[20] Arthur Andersen United States Round trip trades
El Paso Corporation 2002[20] Deloitte & Touche United States Round trip trades
Freddie Mac 2002[26] PricewaterhouseCoopers United States Understated earnings
Global Crossing 2002[20] Arthur Andersen Bermuda Network capacity swaps to inflate revenues
Halliburton 2002[20] Arthur Andersen United States Improper booking of cost overruns
Homestore.com 2002[20][27] PricewaterhouseCoopers United States Improper booking of sales
ImClone Systems 2002[28] KPMG United States Samuel D. Waksal
Kmart 2002[20][29] PricewaterhouseCoopers United States Misleading accounting practices
Merck & Co. 2002[20] Pricewaterhouse Coopers United States Recorded co-payments that were not collected
Merrill Lynch 2002[30] Deloitte & Touche United States Conflict of interest
Mirant 2002[20] KPMG United States Overstated assets and liabilities
Nicor 2002[20] Arthur Andersen United States Overstated assets, understated liabilities
Peregrine Systems 2002[20] KPMG United States Overstated sales
Qwest Communications 2002[20] 1999, 2000, 2001 Arthur Andersen 2002 October KPMG United States Inflated revenues
Reliant Energy 2002[20] Deloitte & Touche United States Round trip trades
Sunbeam 2002[31] Arthur Andersen United States
Tyco International 2002[20] PricewaterhouseCoopers Bermuda Improper accounting, Dennis Kozlowski
WorldCom 2002[20] Arthur Andersen United States Overstated cash flows, Bernard Ebbers
Royal Ahold 2003[32] Deloitte & Touche United States Inflating promotional allowances
Parmalat 2003[33][34] Grant Thornton SpA Italy Falsified accounting documents, Calisto Tanzi
HealthSouth Corporation 2003[35] Ernst & Young United States Richard M. Scrushy
Nortel 2003[36] Deloitte & Touche Canada Distributed ill advised corporate bonuses to top 43 managers
Chiquita Brands International 2004[37] Ernst & Young United States Illegal payments
AIG 2004[38] PricewaterhouseCoopers United States Accounting of structured financial deals
Bernard L. Madoff Investment Securities LLC 2008[39] Friehling & Horowitz United States Massive Ponzi scheme.[40]
Anglo Irish Bank 2008[41] Ernst & Young Ireland Anglo Irish Bank hidden loans controversy
Satyam Computer Services 2009[42] PricewaterhouseCoopers India Falsified accounts
Lehman Brothers 2010[43] Ernst & Young United States Failure to disclose Repo 105 transactions to investors
Sino-Forest Corporation 2011[44] Ernst & Young Canada-China
Olympus Corporation 2011[45] Ernst & Young Japan tobashi using acquisitions
Autonomy Corporation 2012[46] Deloitte & Touche United States Subsidiary of HP.

Notable outcomes

The Enron scandal turned in the indictment and criminal conviction of one of the Big Five auditor Arthur Andersen on June 15, 2002. Although the conviction was overturned on May 31, 2005, by the Supreme Court of the United States, the firm ceased performing audits and is currently unwinding its business operations. The Enron scandal was defined as being one of the biggest audit failures. The scandal included utilizing loopholes that were found within the GAAP (General Accepted Accounting Principles). For auditing a big sized company such as Enron, the auditors were criticized for having brief meetings a few times a year that covered large amounts of material. By January 17, 2002, Enron decided to discontinue its business with Arthur Andersen claiming they had failed in accounting advice and related documents. Arthur Andersen was judged guilty of obstruction of justice for getting rid of many emails and documents that were related to auditing Enron. From this incident little less than 100,000 employees lost their jobs. Although later the ruling was overturned by the U.S. Supreme Court, the image of the auditing firm have been damaged beyond repair, and was never able to come back to its full operation capacity.

On July 9, 2002 George W. Bush gave a speech about recent accounting scandals that had been uncovered. In spite of its stern tone, the speech did not focus on establishing new policy, but instead focused on actually enforcing current laws, which include holding CEOs and directors personally responsible for accountancy fraud.

In July, 2002, WorldCom filed for bankruptcy protection, in what was considered the largest corporate insolvency ever at the time.

These scandals reignited the debate over the relative merits of US GAAP, which takes a "rules-based" approach to accounting, versus International Accounting Standards and UK GAAP, which takes a "principles-based" approach. The Financial Accounting Standards Board announced that it intends to introduce more principles-based standards. More radical means of accounting reform have been proposed, but so far have very little support. The debate itself, however, overlooks the difficulties of classifying any system of knowledge, including accounting, as rules-based or principles-based.This also led to the establishment of Sarbanes-Oxley.

On a lighter note, the 2002 Ig Nobel Prize in Economics went to the CEOs of those companies involved in the corporate accounting scandals of that year for "adapting the mathematical concept of imaginary numbers for use in the business world".

In 2003, Nortel made a big contribution to this list of scandals by incorrectly reporting a one cent per share earnings directly after their massive layoff period. They used this money to pay the top 43 managers of the company. The SEC and the Ontario securities commission eventually settled civil action with Nortel. However, a separate civil action will be taken up against top Nortel executives including former CEO Frank A. Dunn, Douglas C. Beatty, Michael J. Gollogly and MaryAnne E. Pahapill and Hamilton. These proceedings have been postponed pending criminal proceedings in Canada, which opened in Toronto on January 12, 2012.[47] Crown lawyers at this fraud trial of three former Nortel Networks executives say the men defrauded the shareholders of Nortel of more than $5 million. According to the prosecutor this was accomplished by engineering a financial loss in 2002, and a profit in 2003 thereby triggering Return to Profit bonuses of $70 million for top executives.[48][49][50][51][52]

In 2005, after a scandal on insurance and mutual funds the year before, AIG was investigated for accounting fraud. The company already lost over 45 billion US dollars worth of market capitalisation because of the scandal. Investigations also discovered over a billion US dollars worth of errors in accounting transactions. The New York Attorney General's investigation led to a $1.6 billion fine for AIG and criminal charges for some of its executives.[53] CEO Maurice R. "Hank" Greenberg was forced to step down and is still fighting civil charges being pursued by New York state.[54][55]

See also

References

Further reading

  • John R. Emshwiller and Rebecca Smith, 24 Days: How Two Wall Street Journal Reporters Uncovered the Lies that Destroyed Faith in Corporate America or Infectious Greed, HarperInformation, 2003, ISBN 0-06-052073-6
  • Lawrence A. Cunningham, The Sarbanes-Oxley Yawn: Heavy Rhetoric, Light Reform (And It Might Just Work)
  • Zabihollah Rezaee, Financial Statement Fraud: Prevention and Detection, Wiley 2002.

External links

  • U.S. Securities and Exchange Commission website
  • U.S. President Bush's speech, 2002-07-09 NPR report (audio recording)
  • "Why didn't our auditors find the fraud?", Wisconsin Law Journal, January 25, 2006
  • Accounting Today, November 27, 2012
  • Business Insider,

June 18, 2013

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