Monday, October 3, 2011

Accounting scandals

Accounting scandals, or corporate accounting scandals, are political and business scandals which arise with the disclosure of misdeeds by trusted executives of large public corporations. 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 ofliabilities, 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.
Scandals are often only the 'tip of the iceberg'. They represent the visible catastrophic failures. Note that much abuse can be completely legal or quasi legal.
For example, in the domain of privatization and takeovers :
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 (eg. 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 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.

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 theSupreme Court of the United States, the firm ceased performing audits and is currently unwinding its business operations.
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 ofimaginary 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 Dunn, Beatty, Gollogly, Pahapill and Hamilton. These proceedings have been postponed pending criminal proceedings in Canada.
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.[43] CEO Maurice R. "Hank" Greenberg was forced to step down and is still fighting civil charges being pursued by New York state.

Notable accounting scandals

Company
Year
Audit Firm
Country
Notes
1980[1]
Australia
1986[2]
United States
Barlow Clowes
1988[3]
United Kingdom
Gilts management service. £110 million missing
1989[4]
United States
1990[5]
United Kingdom
1991[6]
United Kingdom
1992[7]
United States
1996[8]
United States
United States
1998[14]
United States
1999[15]
United States
Financial mistatements
2000[16]
United States
2000[17]
United States
2000[18]
United States
2000
Belgium
Fictitious transactions in Korea and improper accounting methodologies elsewhere
2000[19]
United States
Falsifying financial results
2001[20]
Australia
2001[21]
United States
2002[22]
United States
2002[19]
United States
Inflated sales
United States
Inflated revenues
United States
Round trip trades
2002[19]
United States
Round trip trades
2002[19]
United States
Round trip trades
2002[19]
United States
Round trip trades
2002[25]
United States
Understated earnings
2002[19]
Bermuda
Network capacity swaps to inflate revenues
2002[19]
United States
Improper booking of cost overruns
United States
Improper booking of sales
2002[27]
United States
United States
Misleading accounting practices
2002[19]
United States
Recorded co-payments that were not collected
2002[29]
United States
Conflict of interest
2002[19]
United States
Overstated assets and liabilities
2002[19]
United States
Overstated assets, understated liabilities
2002[19]
United States
Overstated sales
2002[19]
United States
Inflated revenues
2002[19]
United States
Round trip trades
2002[30]
United States
2002[19]
Bermuda
Improper accounting, Dennis Kozlowski
2002[19]
United States
Overstated cash flows, Bernard Ebbers
2003[31]
Netherlands
Inflating promotional allowances
Italy
Falsified accounting documents, Calisto Tanzi
2003[34]
United States
2003[35]
Distributed ill advised corporate bonuses to top 43 managers
2004[36]
United States
Illegal payments
2004[37]
United States
Accounting of structured financial deals
2008[38]
Massive Ponzi scheme.[39]
2008[40]
Ireland
2009[41]
India
Falsified accounts
2010[42]
United States
Failure to disclose Repo 105 transactions to investors


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