Ken Teegardin

The “act”

In a complex environment where profit is king, accounting scandals – of gigantic proportions – gradually “benefit” from lower and lower attention, until they fade away. Financial statement fraud – which many times takes the form of “earnings management”-, is a serious crime which involves purposely manipulating the numbers in order to alter the status quo and portray an organization in conformity with the expectations of the involved stakeholders. Financial statements are one of the most precise indicators of a company’s health, and numerous bodies and systems are greatly dependent on their accuracy. Whether we talk about assets misappropriation, manipulating revenues, expenses, liabilities and assets or different schemes such as the “cookie jar” or the Ponzi scheme, these types of fraud seem to be somewhat above the law. Hence, the opportunities for exploitation are unlimited. Reasons may vary, however the real question behind these events is not why, but why are they sometimes left unpunished accordingly? Why are they not in the public attention anymore? Were there any lessons to take away? – it does not seem so.

Most of the (known) cases of accounting fraud have been related to the upper-level management, for obvious reasons: the higher in the hierarchy, the more power and more access to information and people. Executives are entrusted with the company as a whole which, by default, has its own ethical strings attached. Before jumping to conclusions, let us have a look at the recent history.

The examples in history

Accounting-degree.org offers us an insightful chronological list of the biggest and most important fraud cases from the past 20 years. “If there is one theme to rival terrorism for defining the last decade-and-a-half, it would have to be corporate greed and malfeasance.” (Accounting-degree.org). Here are some of them:

Waste Management Scandal (1998)

  • Publicly traded waste management company based in Houston, TX
  • Reported $1.7 billion in fake earnings
  • The company allegedly falsely increased the depreciation time length for their property, plant and equipment on the balance sheets
  • Shareholder class-action suit for $457 million; the audit company, Arthur Andersen was fined $7 million
  • Top management is involved

Enron Scandal (2001)

  • Commodities, energy and service corporation
  • Top management kept huge debts off balance sheets which in turn resulted in a $74 billion loss for shareholders, thousands of people losing their retirement funds and many more losing their jobs
  • That-time CEO received a 24 years in prison penalty, while his accomplice deceased before serving his part

WorldCom Scandal (2002)

  • Telecom company, now known as MCI
  • Assets were inflated by $11 billion; CEO as the main character
  • 30,000 jobs lost and $180 million losses for investors
  • CFO fired, CEO sentenced to 25 years for fraud, conspiracy and filling false documents with regulators

American International Group – AIG (2005)

  • Multinational insurance company
  • Massive accounting fraud to the tune of $3.9 billion was alleged, along with bid-rigging and stock price manipulation; CEO as the main character
  • Damages of over $2 billion paid; CEO was fired, but did not face any criminal charges

Lehman Brothers Scandal (2008)

  • Global financial services firm
  • Hid over $50 billion in loans disguised as sales
  • Perpetrators were the executives and the assigned audit firm, Ernst & Young
  • The company went bankrupt, in what it is supposed to be the largest bankruptcy in the history of the U.S.
  • The Securities and Exchange Commission (SEC) could not prosecute anyone due to the lack of evidence

For the rest of the top, please visit accounting-degree.org.

 

TOSHIBA – Toshiba enters the exclusive club of fraudulent companies

In an attempt to strengthen corporate governance practices in Japan in order to attract more outside investors, Prime Minister Shinzo Abe has been working for a while now on a new governance code. Companies in Japan have long been criticized for their internal weak financial controls and resistance to outside oversight. Meant to create transparency and to revive the Japanese economy, one of the first implemented rules requires publicly traded companies in Japan to have at least two outside independent directors on their boards.

Some of the new regulations, however, have become effective with the price of shocking discoveries. Toshiba Corp., the 140-year-old electronics conglomerate, has seen one of Japan’s biggest accounting scandal in history, starting last May. Toshiba’s operating profits have been overstated with more than $1.2 billion (152 billion yen) over a period of 7 years, primarily regarding long-term projects, according to Japanese officials. The blame has been taken by two former CEOs who served between 2005-2009 (Atsutoshi Nishida, later an adviser), respectively between 2009-2013 (Norio Sasaki, later vice chairman of the board) and the latter CEO, Hisao Tanaka. Toshiba announced a reorganization of its corporate leadership that already brought the resignation of the three, along with more than half of the board members in July 2015. Norio Sasaki, the former CEO and later vice chairman of the board, has also resigned from his position as an advisor for Shinzo Abe in a panel meant to advise the PM on economic policy.

The investigation done by an independent panel revealed that the three most recent executives of Toshiba have been putting pressure on the employees in all sub-divisions of the company, for these to achieve unrealistic profits. The management has encouraged division leaders to cook the books, according to the report. In the outcome, we can read “The improper accounting procedures were continuously carried out as a de facto policy of the management. And it was impossible for anyone to go against the intention amid Toshiba’s corporate culture.” This fits the exact same pattern as most other accounting scandals – the lessons are never learned.

 

The effects

Financial statement fraud can ultimately have an impact on any person or entity that has the smallest interest in a company’s financial well-being. Whether we talk about banks offering credits, about employees, about investors or about the end-users of a company’s products, they can all be affected by these decisions to purposely alter the numbers.

However, this is not entirely true. More than two months later after the massive resignation and restructuring, this case is not in the public attention anymore. One reform, a couple men, a new chapter – some see these scandals as a mean for a faster transition to a safer, more trustworthy economy. “Japan is changing and I think the Toshiba scandal will accelerate that, because it shows a public desire for better governance. What is important is that Japan needs to develop a system that is best for it, and that requires a good, rigorous public discussion. And these scandals help.” – Bob Eberhart, a Stanford Technology Ventures Program Fellow at Stanford University and an adviser to the non-profit Board Director Training Institute of Japan, in Tokyo.

But is it really the case? In 2011, Olympus Corp. has been in the spotlight for a similar scandal, when the camera-maker covered up $1.7 billion in investment losses. Olympus’ former executives only received suspended prison sentences, while the case has gone to the archives of the business world and stayed there ever since. This certainly puts to doubt Mr. Eberhart’s allegations.

Japan’s finance minister, Taro Aso, has expressed his concerns about the damage the Toshiba scandal could have done to the Japanese market’s trust. “I’m totally disappointed because it could damage investor confidence in the Japanese market”, said the deputy PM. After seeing a sudden decline of 17% in the stock price in May, immediately after the announcements of the accounting probe, Toshiba’s stocks continued going down until today. “This leaves foreign investors with a vague feeling of uncertainty toward Japanese corporate earnings. It impacts all Japanese companies going forward, and we may see a lack of buying”, said Naoki Fujiwara, chief fund manager at Shinkin Asset Management Co. in Tokyo.

Toshiba’s management argued it is considering selling assets, including securities and real estate, to raise money. The main lenders, Mizuho Bank Ltd. and Sumitomo Mitsui Banking Corp. (2 of the largest Japanese banks), confirmed their continuing to support Toshiba, in spite of the scandal.

In terms of penalties, aside from the reformation of the corporate governance at Toshiba, there have not been any other measures taken yet. However, according to an unknown source cited back in July, the Securities and Exchange Surveillance Commission will likely seek a penalty on Toshiba in the upcoming months, over its fraudulent activity.

In a shaking world economy, disruptive events like these should teach corporations and individuals alike a lesson about morals and prevent recurrence. In this light, regulations may be effective in some cases, they may curb some of this fraud, but the real issues are definitely coupled with greed and the unnecessary desire to make more and more money. Regardless of who sets them, unrealistic goals combined with a (corporate) culture that does not tolerate failure, creates a vicious circle. When will this finally stop? When will the focus be on other issues society is dealing with? When will profits not be king anymore? Until then, another scandal of great proportions perishes from the public attention and is slowly written off.