Did You Know?Arthur Anderson LLP, one of the 'Big Five Audit Firms' collapsed after the infamous Enron and WorldCom accounting scandals. The scandals revealed the firm's failure to discharge its duties as auditors of the companies. These scandals also gave birth to the 'Sarbanes-Oxley Act of 2002'.
The basic purpose of preparing financial statements of any organization is to represent or portray its financial position and health. Accounting transactions are recorded as per the accepted accounting standards of that particular nation.
The financial statements should reflect the accounting position of the company. Also, it is the auditor's duty to ensure that the books are maintained in a fair manner―the company does not intend to mislead its stakeholders.
A carefully planned accounting fraud looks out for loopholes in laws, or simply uses accounting gimmicks to present financial statements that are completely misleading. Fake and fabricated accounts, fake expenses, assets, or income to show that the company is in good financial condition is simply done to maintain the company's brand name in the financial market, and increase its stock prices. It is saddening to know that big giants with good reputation have been involved in such frauds.
While greed is a human tendency, an accounting fraud at such a high level can ruin the stakeholders of the company―with employees losing their jobs and investors losing their hard-earned money. Top management has been involved in such frauds for myriad of reasons: to give an optimistic outlook to the company, or the use the funds of the company for personal use, or simply to earn more revenue.
Of course, sometimes, a fraud can be so effectively laid out that even the auditors fail to detect it. In some cases, even the auditors have been deemed guilty, though unfortunately, some of them willingly were a part of the ploy, while some were negligent in discharging their duties. Let's go through some of the top accounting frauds that shook the world. The scandals in this list are mentioned according to the potential harm they caused to the investors, and the repercussions that followed.
Examples of Corporate Accounting Scandals
Enron Corporation (2001)
✦ Enron was born out of the merger of Houston Natural Gas and Omaha-based InterNorth. It was a major player in the energy market.
✦ This can be considered as the smartest accounting fraud in corporate history. In December 2001, the company came crashing down and filed for bankruptcy, which revealed that the energy and service providing giant was falsifying its account books to the tune of around USD 74 billion.
✦ The company used 'special purpose entities (SPE)' for the purpose of hedging risk. However, they also used SPEs to hide their losses from the company's account books, and compensated the SPE by issuing stocks of Enron. This would paint a healthy picture of Enron's accounts.
✦ Many employees were rendered jobless, and also lost their retirement savings. This fraud also led to the fall of the giant auditor firm Arthur Anderson LLP, one of the 'Big Five' Accounting firms of the world.
✦ It was the sudden resignation of Jeff Skilling, in August 2001, which sparked rumors that there may have been a possibility of fraudulent activity. Also, it closed down one of its SPE, which added to the suspicion held by the Securities and Exchange Commission (SEC).
✦ The Enron case accelerated the government's actions to make stringent regulations for corporate governance.
Lehman Brothers Holdings Inc. (2008)
✦ A classic example of how law can be twisted, and loopholes can be used to your own advantage, this is known as one of the biggest accounting scams in U.S. history. They filed for bankruptcy in 2008.
✦ Lehman Brothers, the bank that rose to the greatest heights at Wall Street, was hiding a dirty secret. They manipulated accounts to make the company's financial position appear healthy.
✦ They used "REPO 105", which is an accounting gimmick planned at converting the short-term loan into 'sales'. They managed to conceal a USD 50 billion loan, by simply classifying it as sales, which made the company's financial position appear good enough.
✦ Lawyers in U.S. are not legally allowed to make a true sale opinion. Hence, they approached a U.K firm to mark these transactions as sales, and carefully carried out this activity through their U.S. subsidiary.
✦ Due to Lehman Brothers filing for bankruptcy, many investors lost their money, considering their poor asset positioning to dispose off the liabilities.
Satyam Computer Services Ltd. (2009)
✦ 'Satya', which means truth, was what this Indian IT company was not about. A winner of many awards, in January 2009, B. Ramalingan Raju, its CEO, admitted that the company was running on fraudulent accounts for the past 7 years. To date, this is considered to be India's biggest accounting scam.
✦ The CEO admitted that he was solely responsible for the window dressing of the accounts to a much high level. He admitted to have falsified accounts and created hypothetical assets and pumped revenue up to the tune to USD 1.5 billion.
✦ There was a direct impact on the stock prices of the company, and also posed further questions on the credibility of Indian IT firms in the financial market.
✦ The company was acquired by Tech Mahindra, and is now known as 'Mahindra Satyam'. A legal case was filed against the CEO, and he is currently serving a jail sentence along with other member directors of the board.
✦ The shocking confession by the CEO, also raised doubts on the internal and statutory auditors of the company.
✦ One of the biggest telecommunications company fell immediately after the fall of Enron, in 2002. The company tried to conceal the losses that it was incurring. Instead of expensing out the 'line costs', they were capitalized in the account books, and revenues were also inflated.
✦ The internal auditor had detected an accounting entry of USD 500 million for computer expenses, without any supporting document.
✦ The hypothetical assets measured up to USD 11 billion, and this led to the loss of around USD 180 billion for the company, and many employees subsequently lost their jobs.
✦ Also, the SEC was suspicious of the good position, and whistle blowers confirmed their suspicion.
✦ CEO Bernie Ebbers was sentenced to 25 years in prison. This was again, one of the major reasons for the fall of the Arthur Anderson audit firm.
Bernard L. Madoff Investment Securities LLC. (2008)
✦ This is one of the most curious cases of financial fraud that will be remembered for ages. Bernard Madoff was one the founders of Bernard L. Madoff Investment Securities LLC. He also had served as NASDAQ's chairman.
✦ A ponzi scheme is a scheme in which the investors are usually paid a high amount of returns on their investments, from the money acquired from new investors.
✦ In 2008, Bernard confessed to his sons that he was running an illegitimate business, a USD 65 billion ponzi scheme. He was exposed by his sons, who reported his misdoings to the SEC.
✦ Sadly, both his sons died, one succumbing to cancer, and the other committed suicide. The accused Bernard Madoff is currently serving a 150-year jail sentence.
HealthSouth Corporation (2003)
✦ In 2003, it was revealed that the company, belonging to the health-care industry, was not in the best of financial health. It was a huge sale of stock by the CEO just a day before the company reported a loss, that invited the attention of the SEC, who smelled something fishy.
✦ Apparently, the company's employees were asked to fake transactions that inflated the income of the company, depicting a good financial position.
✦ CEO Richard Scrushy still claims innocence, and pleads not guilty of the accusations of the bribery made against him. He was allegedly involved in overstating the earnings of the company by USD 1.4 billions, since 1999, and a corresponding increase in the assets of the company.
✦ Scrushy was ordered to pay nearly USD 2.9 billion to shareholders for defrauding them.
Tyco International (2002)
✦ In 2002, CEO Dennis Kozlowski and CFO Mark Swartz were accused of using company funds to support their own extravagant lifestyles.
✦ A grand birthday bash which Dennis threw for his wife, his lavish furnishings in the Tyco-owned apartment, all were indicators that he had been embezzling funds from the company.
✦ Kozlowski had resigned citing personal reasons. However, loans were issued to them, illegally, without the knowledge of the Board, under the 'Key Employee Loan' program of the company. He was also under the legal scanner for tax evasion. Also, there was an attempt to illegally sell the stocks of the company.
✦ The jury held that they two were guilty of looting the company to the tune of more than USD 150 billion in the form of unearned bonuses and loans.
✦ They were pronounced guilty and sentenced to 25 years in jail.
Waste Management, Inc. (2002)
The company had increased its fake earnings to the tune of USD 1.7 billion by:
- increasing the depreciation time length for their assets, property, and plant and equipment
- capitalizing expenses
- assigning arbitrary salvage values to assets
- not recording the requisite liabilities.
The company's top management was accused of financial fraud, by the SEC, in 2002. The fraudulent accounting took place between 1992 and 1997. The names involved were: Dean L. Buntrock, Phillip B. Rooney, James E. Koenig, Thomas C. Hau, Herbert Getz, and Bruce D. Tobecksen.
The auditors Arthur Andersen, were charged with a penalty of about USD 7 million.
Cendant Corporation (1997-98)
✦ The company was formed in 1997 following a merger of two companies: Hospitality Franchise Systems, Inc. (HFS) and CUC International Inc.
✦ Barely three months after the merger, there were reports of accounting anomalies. It was observed that around USD 640 billions in profits recorded over the last three years were nothing but fictional profits.
✦ The company had apparently been involved in inflating the stock of CUC International up to almost USD 500 million.
✦ Walter Forbes, the former chairman of Cendant was charged in 2007, to pay USD 3.275 billion, and sentenced to 12 years and 7 months in prison.
MF Global Holdings, Ltd. (2011)
✦ MF Global, a major commodities brokerage firm filed for bankruptcy in October 2011, much to the shock of its customers. The company was led by Jon Corzine, the former New Jersey governor and senator.
✦ However, following some bad investments, the company decided to use consumer money to repay its liabilities. There have been reports that the firm had heavily invested in the European sovereign debts. Almost USD 1.6 billion of consumer assets were reported missing.
✦ The curious case surfaced as to where the money had evaporated from the account books. Those hit were farmers, small investors, etc.
✦ The customers had to wait for almost two-and-a-half years until the final payout was made in April 2014.
Qwest Communications International Inc. (2004)
✦ The company's top management allegedly fabricated the accounts of the company by overstating their income through fraudulent transactions recorded in the account books: increasing the revenue from its phone directory business, and also understating the expenses of the company.
✦ It was also alleged that the company failed to disclose information about buying equipment, which proved costly.
✦ The rosy picture painted was simply to float the notion that the company was in good financial condition. In 2004, the SEC filed a complaint against the company.
✦ Qwest agreed to pay a penalty of almost USD 250 millions, following an action take by the Securities and Exchange Commission (SEC).
American International Group, Inc. (2005)
✦ In 2005, the insurance company was caught in an accounting fraud that estimated around USD 3.9 billion, along with bid-rigging and stock manipulation.
✦ Following this, the company had to pay heavily in the form of penalties to the SEC. The CEO Hank Greenburg was one of the major players in the fraud that made the financial statements appear optimistic, thus misleading investors.
✦ He had booked loans as revenue, and also conspired to induce traders to inflate the prices of the stocks.
✦ Note: Bid-rigging is when the bidders decide beforehand to eliminate competition among them, and the process is carried out only for namesake.
Parmalat S.p.A. (2004)
✦ This is one of the biggest controversies surrounding the Italian big player: Parmalat, which was started by the Tanzi family. Parmalat was a global name for milk and dairy products.
✦ In 2004, a default in payment by the company prompted investigations which revealed that the company had created non-existent assets, to conceal its liabilities.
✦ The founder family, which owned 51% stake in the company, was held on account of falsification of accounts, embezzlement of funds, etc.
✦ The Bank of America had denied the existence of any account of the company with them, stating that the company had forged documents to show a fictitious account. Further investigations revealed that the funds were diverted to family-owned firms.
✦ Their debts amounted to almost €14 billion. This is one of the biggest frauds in Italian corporate history that involved banks, auditors, and other players. However, they all pleaded guilty or were unaware of the fraudulent activities.
Recent Accounting Scandal
Tesco PLC. (2014)
Britain's grocery and retail store came under the scanner recently (2014), when reports revealed that the company has been allegedly overstating its profits by over 25%. (£250 million).
While fraudulent accounting practices are still a part of the corporate world, more stringent laws and monitoring might ensure that there are fewer instances. While corporate social responsibility might be on the rise, as long as 'money make the mare go', it is difficult that the corporate world will be devoid of such unethical practices. Other than stringent laws, whistle-blowers might help improve the situation. However, even employees should hold themselves accountable and report to appropriate authorities if they come across falsification of accounts. Needless to say, again, the internal and statutory auditors both play a pivotal role in detection of such frauds.