Accounting scandals

Accounting scandals are business scandals which arise from intentional manipulation of financial statements 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[1] the value of corporate assets, or underreporting the existence of liabilities (these can be detected either manually, or by the means of deep learning[2]). It involves an employee, account, or corporation itself and is misleading to investors and shareholders.[3]

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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. Employees who commit accounting fraud at the request of their employers are subject to personal criminal prosecution.[4]

Two types of fraud

Misappropriation of assets

Misappropriation of assets – often called defalcation or employee fraud – occurs when an employee steals a company's asset, whether those assets are of monetary or physical nature. Typically, assets stolen are cash, or cash equivalents, and company data or intellectual property.[5] However, misappropriation of assets also includes taking inventory out of a facility or using company assets for personal purpose without authorization. Company assets include everything from office supplies and inventory to intellectual property.

Fraudulent financial reporting

Fraudulent financial reporting is also known as earnings management fraud. In this context, management intentionally manipulates accounting policies or accounting estimates to improve financial statements. Public and private corporations commit fraudulent financial reporting to secure investor interest or obtain bank approvals for financing, as justifications for bonuses or increased salaries or to meet the expectations of shareholders.[6] The U.S. Securities and Exchange Commission has brought enforcement actions against corporations for many types of fraudulent financial reporting, including improper revenue recognition, period-end stuffing, fraudulent post-closing entries, improper asset valuations, and misleading non-GAAP financial measures.[7]

The fraud triangle

The fraud triangle is a model for explaining the factors that cause someone to commit fraudulent behaviors in accounting. It consists of three components, which together, lead to fraudulent behavior:

  • Incentives/ Pressure: Management or other employees have incentives or pressures to commit fraud.
  • Opportunities: Circumstances provide opportunities for management or employees to commit fraud.
  • Attitudes/rationalization: An attitude, character, or set of ethical values exists that allows management or employees to commit a dishonest act, or they are in an environment that imposes sufficient pressure that causes them to rationalize committing a dishonest act.[8]

Incentives/pressures: A common incentive for companies to manipulate financial statement is a decline in the company's financial prospects. Companies may also manipulate earnings to meet analysts' forecasts or benchmarks such as prior-year earnings, to meet debt covenant restrictions, achieve a bonus target based on earnings, or artificially inflate stock prices. As for misappropriation of assets, financial pressures are a common incentive for employees. Employees with excessive financial obligations, or those with substance abuse or gambling problems may steal to meet their personal needs.[9]

Opportunities: Although the financial statements of all companies are potentially subject to manipulation, the risk is greater for companies in industries where significant judgments and accounting estimates are involved. Turnover in accounting personnel or other deficiencies in accounting and information processes can create an opportunity for misstatement. As for misappropriation of assets, opportunities are greater in companies with accessible cash or with inventory or other valuable assets, especially if the assets are small or easily removed. A lack of controls over payments to vendors or payroll systems can allow employees to create fictitious vendors or employees and bill the company for services or time.[10]

Attitudes/rationalization: The attitude of top management toward financial reporting is a critical risk factor in assessing the likelihood of fraudulent financial statements. If the CEO or other top managers display a significant disregard for the financial reporting process, such as consistently issuing overly optimistic forecasts, or they are overly concerned about the meeting analysts' earnings forecast, fraudulent financial reporting is more likely. Similarly, for misappropriation of assets, if management cheats customers through overcharging for goods or engaging in high-pressure sales tactics, employees may feel that it is acceptable for them to behave in the same fashion.[11]

Causes

Fraud is done by people. There are three ways to unlawfully take another person’s money: force, trickery, and stealth.[12]Frauds such as embezzlement are easy to hide when company records are opaque to begin with. Poor accounting, such as the absence of monthly reconciliations or an independent audit function, also indicate vulnerability to fraud.[13]

Executive and managerial motivations for fraud

An executive can easily reduce the price of his company's stock due to information asymmetry. He can: accelerate accounting of expenses, delay accounting of revenue, engage in off balance sheet transactions to make the company seem less profitable, or simply report very low estimates of future earnings. Executives may do this to make a company a more attractive takeover target. When the company is bought for less, the acquirer profits from the executive's actions to surreptitiously reduce share price. This can represent tens of billions of dollars (questionably) transferred from former shareholders to the acquirer. The 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.[14] Managerial opportunism plays a large role in these scandals.

Similar issues occur when a publicly held asset or non-profit organization undergoes privatization. Executives often profit greatly. Again, they can help by making the organization appear to be in financial crisis. This lowers the sale price, 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. Under the Special Plea in Fraud statute, "the government must 'establish by clear and convincing evidence that the contractor knew that its submitted claims were false, and that it intended to defraud the government by submitting those claims.'" Mere negligence, inconsistency, or discrepancies are not actionable under the Special Plea in Fraud statute.[15]

Employee motivations for fraud

Not all accounting scandals are caused by those at the top. In fact, in 2015, 33% of all business bankruptcies were caused by employee theft.[16] Often middle managers and employees are pressured to or willingly alter financial statements due to their debts or the possibility of personal benefit over that of the company, respectively. For example, officers who would be compensated more in the short-term (for example, cash in pocket) might be more likely to report inaccurate information on a tab or invoice (enriching the company and maybe eventually getting a raise).[17]

List of biggest accounting scandals
Company Year Audit firm Country Notes
Fred Stern & Company 1925 Touche, Niven & Co.  United States Trial: Ultramares Corp. v. Touche
Hatry Group 1929  United Kingdom
Royal Mail Steam Packet Company 1931 Harold John Morland  United Kingdom Misrepresented drawdowns from reserves as trading profits. Trial: Royal Mail Case (R v Kylsant & Otrs)
Interstate Hosiery Mills 1937 Homes and Davis  United States
McKesson & Robbins, Inc. 1938 Price, Waterhouse & Co.  United States
Yale Express System 1965[18] Peat, Marwick, Mitchell & Co.  United States Overstated net worth and failed to indicate net operating loss
Atlantic Acceptance Corporation 1965[19] Wagman, Fruitman & Lando  Canada CPA conflicts of interest
Continental Vending Machine Corp. 1969[20] Lybrand, Ross Brothers, & Montgomery  United States CPA partners convicted and fined
National Student Marketing Corporation 1970[21] Peat, Marwick, Mitchell & Co.  United States Overstatement of earnings
Four Seasons Nursing Centers of America 1970[22] Arthur Andersen  United States Overstatement of earnings; CPA partners indicted
Equity Funding 1973[23] Wolfson Weiner; Ratoff & Lapin  United States Created fictitious insurance policies
Fund of Funds – Investors Overseas Services 1973[24] Arthur Andersen  Canada Mutual fund that inflated value of assets
Lockheed Corporation 1976[25]  United States
Nugan Hand Bank 1980[26]  Australia
O.P.M. Leasing Services 1981[27] Fox & Company  United States Created fictitious leases
ZZZZ Best 1986[28]  United States Ponzi scheme run by Barry Minkow
Northguard Acceptance Ltd. 1980 to 1982[29] Ernst & Young  Canada
ESM Government Securities 1986[30] Alexander Grant & Company  United States Bribery of CPA partner.
Bankers Trust 1988[31] Arthur Young & Co  United States Hid an $80 million mis-pricing of derivatives contributing to profits by cutting bonuses.
Barlow Clowes 1988[32]  United Kingdom Gilts management service. £110 million missing
Crazy Eddie 1989[33]  United States
MiniScribe 1989[34]  United States
Livent 1989 to 1998 Deloitte & Touche[35][36]  Canada Fraud and forgery
Polly Peck 1990[37]  United Kingdom
Bank of Credit and Commerce International 1991[38]  United Kingdom
Phar-Mor 1992[39] Coopers & Lybrand  United States Mail fraud, wire fraud, bank fraud, and transportation of funds obtained by theft or fraud
1992 Indian stock market scam
Harshad Mehta		 1992[40][41][42][43]  India Fraud, market manipulation, money laundering
Informix Corporation 1996[44] Ernst & Young[45]  United States
Sybase 1997[46][47][48] Ernst & Young[49]  United States
Cendant 1998[50] Ernst & Young  United States
Cinar 1998[51] Ernst & Young  Canada Misuse of corporate funds
Waste Management, Inc. 1999[52] Arthur Andersen  United States Financial misstatements
MicroStrategy 2000[53] PWC  United States Michael Saylor
Unify Corporation 2000[54] Deloitte & Touche  United States
Computer Associates 2000[55] KPMG  United States Sanjay Kumar, Stephen Richards
Lernout & Hauspie 2000 KPMG  Belgium Fictitious transactions in Korea and improper accounting methodologies elsewhere
Xerox 2000[56] KPMG  United States Falsifying financial results
One.Tel 2001[57] Ernst & Young  Australia
Enron 2001[58] Arthur Andersen  United States Jeffrey Skilling, Kenneth Lay, Andrew Fastow
Swissair 2001 PricewaterhouseCoopers   Switzerland
Adelphia 2002[59] Deloitte & Touche  United States John Rigas
AOL 2002[56] Ernst & Young  United States Inflated sales
Bristol-Myers Squibb 2002[56][60] PricewaterhouseCoopers  United States Inflated revenues
CMS Energy 2002[56][61] Arthur Andersen  United States Round trip trades
Duke Energy 2002[56] Deloitte & Touche  United States Round trip trades
Vivendi Universal 2002[56] Arthur Andersen  France Financial reshuffling
Dynegy 2002[56] Arthur Andersen  United States Round trip trades
El Paso Corporation 2002[56] Deloitte & Touche  United States Round trip trades
Freddie Mac 2002[62] PricewaterhouseCoopers  United States Understated earnings
Global Crossing 2002[56] Arthur Andersen  Bermuda Network capacity swaps to inflate revenues
Halliburton 2002[56] Arthur Andersen  United States Improper booking of cost overruns
Homestore.com 2002[56][63] PricewaterhouseCoopers  United States Improper booking of sales
ImClone Systems 2002[64] KPMG  United States Samuel D. Waksal
Kmart 2002[56][65] PricewaterhouseCoopers  United States Misleading accounting practices
Merck & Co. 2002[56] PricewaterhouseCoopers  United States Recorded co-payments that were not collected
Merrill Lynch 2002[66] Deloitte & Touche  United States Conflict of interest
Mirant 2002[56] KPMG  United States Overstated assets and liabilities
Nicor 2002[56] Arthur Andersen  United States Overstated assets, understated liabilities
Peregrine Systems 2002[56] Arthur Andersen  United States Overstated sales
Qwest Communications 2002[56] Arthur Andersen (1999, 2000, 2001)

KPMG (2002 October)

  United States Inflated revenues
Reliant Energy 2002[56] Deloitte & Touche  United States Round trip trades
Sunbeam 2002[67] Arthur Andersen  United States Overstated sales and revenues
Symbol Technologies 2002[68][69]  United States
Steinhoff International 2002  United States Overstated sales and revenues
Tyco International 2002[56] PricewaterhouseCoopers  Bermuda Improper accounting, Dennis Kozlowski
WorldCom 2002[56][70] Arthur Andersen  United States Fraudulent expense capitalization, Bernard Ebbers
Royal Ahold 2003[71] Deloitte & Touche  United States Inflating promotional allowances
Parmalat 2003[72][73] Grant Thornton SpA  Italy Falsified accounting documents, Calisto Tanzi
HealthSouth Corporation 2003[74] Ernst & Young  United States Richard M. Scrushy
Nortel 2003[75] Deloitte & Touche  Canada Distributed ill-advised corporate bonuses to top 43 managers
Chiquita Brands International 2004[76] Ernst & Young  United States Illegal payments
AIG 2004[77] PricewaterhouseCoopers  United States Accounting of structured financial deals
Bernard L. Madoff Investment Securities LLC 2008[78] Friehling & Horowitz  United States Biggest Ponzi scheme in history[79]
Anglo Irish Bank 2008[80] Ernst & Young  Ireland Anglo Irish Bank hidden loans controversy
Satyam Computer Services 2009[81] PricewaterhouseCoopers  India Falsified accounts
Biovail 2009[82]  Canada False statements
Taylor, Bean & Whitaker 2009[83] PricewaterhouseCoopers  United States Fraudulent spending
Monsanto 2009 to 2011[84] Deloitte  United States Improper accounting for incentive rebates
Kinross Gold 2010[85] KPMG  Canada Overstated asset values
Lehman Brothers 2010[86] Ernst & Young  United States Failure to disclose Repo 105 misclassified transactions to investors
National Stock Exchange of India
NSE co-location scam		 2010[87][88][89]  India Fraud and Market manipulation
Amir-Mansour Aria 2011 IAO (audit organization) and other audit firms  Iran Business loans without putting any collateral and financial system
Bank Saderat Iran 2011 IAO (audit organization) and other audit firms  Iran Financial transactions among banks and getting a lot of business loans without putting any collateral
Sino-Forest Corporation 2011[90] Ernst & Young CanadaChina Canada-China Ponzi scheme, falsifying assets
Olympus Corporation 2011[91] Ernst & Young  Japan Tobashi using acquisitions
Autonomy Corporation 2012[92] Deloitte & Touche  United States Subsidiary of HP
Penn West Exploration 2012 to 2014[93] KPMG  Canada Overstated profits
Pescanova 2013 BDO Spain  Spain Understated debt, fraudulent invoices, falsified accounts
Petrobras 2014[94] PricewaterhouseCoopers  Brazil Government bribes, misappropriation, money laundering
Tesco 2014[95] PricewaterhouseCoopers  United Kingdom Revenue recognition
Toshiba 2015[96] Ernst & Young  Japan Overstated profits
Valeant Pharmaceuticals 2015[97] PricewaterhouseCoopers  Canada Overstated revenues
Alberta Motor Association 2016[98][99]  Canada Fraudulent invoices
Odebrecht 2016[100]  Brazil Government bribes
Wells Fargo 2017[101] KPMG  United States False accounting
1Malaysia Development Berhad 2018 Ernst & Young, Deloitte, KPMG[102]  Malaysia Fraud, money laundering, abuse of political power, government bribes
Wirecard 2020[103] Ernst & Young  Germany Allegations of fraud
Luckin Coffee 2020 Ernst & Young  China Inflated its 2019 sales revenue by up to US$310 million
Adani Group 2023[104][105][106] Shah Dhandharia  India Allegations of accounting fraud, stock manipulation, money laundering
Americanas 2023 KPMG and PWC  Brazil Accounting inconsistencies related to forfait" in the order of R$ 20 billion

Notable outcomes

The Enron scandal turned into the indictment and criminal conviction of 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 split into multiple entities. The Enron scandal was defined as being one of the biggest audit failures of all time. The scandal included utilizing loopholes that were found within the GAAP (General Accepted Accounting Principles). For auditing a large-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 disposing of many emails and documents that were related to auditing Enron. Since the SEC is not allowed to accept audits from convicted felons, the firm was forced to give up its CPA licenses later in 2002, costing over 113,000 employees their jobs. Although the ruling was later overturned by the U.S. Supreme Court, the once-proud firm's image was tarnished beyond repair, and it has not returned as a viable business even on a limited scale.

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.[107]

In July 2002, WorldCom filed for bankruptcy protection in what was considered at the time as the largest corporate insolvency ever.[108] A month earlier, the company's internal auditors discovered over $3.8 billion in illicit accounting entries intended to mask WorldCom's dwindling earnings, which was by itself more than the accounting fraud uncovered at Enron less than a year earlier.[109] Ultimately, WorldCom admitted to inflating its assets by $11 billion.[110]

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.[111][112] 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 the Sarbanes-Oxley Act.

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.[113] 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.[114][115][116][117][118] In 2007, Dunn, Beatty, Gollogly, Pahapill, Hamilton, Craig A. Johnson, James B. Kinney, and Kenneth R.W. Taylor were charged with engaging in accounting fraud by "manipulating reserves to manage Nortel's earnings."[119]

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 worth of market capitalization because of the scandal. Investigations also discovered over a $1 billion 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.[120] CEO Maurice R. "Hank" Greenberg was forced to step down and fought fraud charges until 2017, when the 91-year-old reached a $9.9 million settlement.[121][122] Howard Smith, AIG's chief financial officer, also reached a settlement.

Well before Bernard Madoff's massive Ponzi scheme came to light, observers doubted whether his listed accounting firm – an unknown two-person firm in a rural area north of New York City – was competent to service a multibillion-dollar operation, especially since it had only one active accountant, David G. Friehling.[123] Indeed, Friehling's practice was so small that for years, he operated out of his house; he only moved into an office when Madoff customers wanted to know more about who was auditing his accounts.[124] Ultimately, Friehling admitted to simply rubber-stamping at least 18 years' worth of Madoff's filings with the SEC. He also revealed that he continued to audit Madoff even though he had invested a substantial amount of money with him (Accountants are not allowed to audit broker-dealers with whom they're investing). He agreed to forfeit $3.18 million in accounting fees and withdrawals from his account with Madoff. His involvement makes the Madoff scheme not only the largest Ponzi scheme ever uncovered, but the largest accounting fraud in world history.[125] The $64.8 billion claimed to be in Madoff accounts dwarfed the $11 billion fraud at WorldCom.

See also

References
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