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.
It involves an employee, account or
corporation itself and is misleading to
investor and shareholders.[2]

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.[3]

Two types of fraud

Misappropriation of assets
Misappropriation of assets, often called
defalcation or employee fraud, occurs
when an employee steals 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.[4] 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, inventory to intellectual
property.
Fraudulent financial reporting

Fraudulent financial reporting, 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 expectations of
shareholders.[5] The 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.

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.[6]

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, to achieve a bonus target
based on earnings, or to 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 drug abuse or gambling problems
may steal to meet their personal needs.[7]

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.[8]
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.[9]

Causes
A weak internal control is an opportunity
for a fraudster. Fraud is not an accounting
problem; it is a social phenomenon. If you
strip economic crime of its multitudinous
variations, there are but three ways a
victim can be unlawfully separated from
money: by force, stealth or trickery.[10]
Lack of transparency in financial
transactions is an ideal method to hide a
fraud. Poor management information
where a company's management system
does not produce results that are timely,
accurate, sufficiently detailed and relevant.
In such case, the warning signal of fraud
such as ongoing theft from bank account
can be obscured. Lack of an independent
audit department within the company is
also a sign of weak internal control. Poor
accounting practice is also part of a weak
internal control. An example of poor
accounting practice is failure to make
monthly reconciliation of bank account.[11]

A top executive can reduce the price of

his/her company's stock easily 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.
Top managers tend to share price to make
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.[12]
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. 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.[13]
Not all accounting scandals are caused by
top executives. The proceedings can take
so long to come to trial that one executive
saw the charges against him
dismissed.[14] 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.[15]
List of reported accounting
scandals
 Company Year Audit Firm Country Notes

Fred Stern & United

1925 Touche, Niven & Co.
Company States

United
Hatry Group 1929
Kingdom

Royal Mail Steam United

1931
Packet Company Kingdom

Interstate United
1937 Homes and Davis
Hosiery Mills States

McKesson & United

1938 Price, Waterhouse & Co.
Robbins, Inc. States

Overstated net worth

Yale Express Peat, Marwick, Mitchell & United
1965[16] and failed to indicate
System Co. States
net operating loss

Atlantic
Wagman, Fruitman & CPA conflicts of
Acceptance 1965[17] Canada
Lando interest
Corporation

Continental
Lybrand, Ross Brothers, & United CPA partners
Vending Machine 1969[18]
Montgomery States convicted and fined
Corp.

National Student
Peat, Marwick, Mitchell & United Overstatement of
Marketing 1970[19]
Co. States earnings
Corporation

Four Seasons Overstatement of

United
Nursing Centers 1970[20] Arthur Andersen earnings; CPA partners
States
of America indicted

Wolfson Weiner; Ratoff & United Created fictitious

Equity Funding 1973[21]
Lapin States insurance policies

Fund of Funds –
Investors Mutual fund that
1973[22] Arthur Andersen Canada
Overseas inflated value of assets
Services

Lockheed 1976[23] United

Corporation States

Nugan Hand
1980[24] Australia
Bank

O.P.M. Leasing United Created fictitious

1981[25] Fox & Company
Services States leases

United Ponzi scheme run by

ZZZZ Best 1986[26]
States Barry Minkow

Northguard 1980 to 1982

[27]
Ernst & Young Canada
Acceptance Ltd.

ESM Government Alexander Grant & United

1986[28] Bribery of CPA partner.
Securities Company States

Hid a $80 million mis-

United pricing of derivatives
Bankers Trust 1988[29] Arthur Young & Co
States contributing to profits
by cutting bonuses.

Gilts management
United
Barlow Clowes 1988[30] service. £110 million
Kingdom
missing

United
Crazy Eddie 1989[31]
States

United
MiniScribe 1989[32]
States

Livent 1989 to 1998 Deloitte & Touche [33][34] Canada Fraud and forgery

United
Polly Peck 1990[35]
Kingdom

Bank of Credit
United
and Commerce 1991[36]
Kingdom
International

Mail fraud, wire fraud,

bank fraud, and
United
Phar-Mor 1992[37] Coopers & Lybrand transportation of funds
States
obtained by theft or
fraud
Informix 1996[38] Ernst & Young[39] United
Corporation States

United
Sybase 1997[40][41][42] Ernst & Young[43]
States

United
Cendant 1998[44] Ernst & Young
States

Misuse of corporate
Cinar 1998 [45] Ernst & Young Canada
funds

Waste
United Financial
Management, 1999[46] Arthur Andersen
States misstatements
Inc.

United
MicroStrategy 2000[47] PWC Michael Saylor
States

Unify United
2000[48] Deloitte & Touche
Corporation States

Computer United Sanjay Kumar, Stephen

2000[49] KPMG
Associates States Richards

Fictitious transactions
in Korea and improper
Lernout &
2000 KPMG Belgium accounting
Hauspie
methodologies
elsewhere

United Falsifying financial

Xerox 2000[50] KPMG
States results

One.Tel 2001[51] Ernst & Young Australia

Jeffrey Skilling,
United
Enron 2001[52] Arthur Andersen Kenneth Lay, Andrew
States
Fastow

Swissair 2001 PricewaterhouseCoopers Switzerland

United
Adelphia 2002[53] Deloitte & Touche John Rigas
States

AOL 2002[50] Ernst & Young United Inflated sales

States
Bristol-Myers United
2002[50][54] PricewaterhouseCoopers Inflated revenues
Squibb States

United
CMS Energy 2002[50][55] Arthur Andersen Round trip trades
States

United
Duke Energy 2002[50] Deloitte & Touche Round trip trades
States

Vivendi Universal 2002[50] Arthur Andersen France Financial reshuffling

United
Dynegy 2002[50] Arthur Andersen Round trip trades
States

El Paso United
2002[50] Deloitte & Touche Round trip trades
Corporation States

United
Freddie Mac 2002[56] PricewaterhouseCoopers Understated earnings
States

Network capacity
Global Crossing 2002[50] Arthur Andersen Bermuda swaps to inflate
revenues

United Improper booking of

Halliburton 2002[50] Arthur Andersen
States cost overruns

United Improper booking of

Homestore.com 2002[50][57] PricewaterhouseCoopers
States sales

ImClone United
2002[58] KPMG Samuel D. Waksal
Systems States

United Misleading accounting

Kmart 2002[50][59] PricewaterhouseCoopers
States practices

Pricewaterhouse United Recorded co-payments

Merck & Co. 2002[50]
Coopers States that were not collected

United
Merrill Lynch 2002[60] Deloitte & Touche Conflict of interest
States

United Overstated assets and

Mirant 2002[50] KPMG
States liabilities

United Overstated assets,

Nicor 2002[50] Arthur Andersen
States understated liabilities
Peregrine 2002[50] KPMG United Overstated sales
Systems States

1999, 2000, 2001 Arthur

Qwest United
2002[50] Andersen 2002 October Inflated revenues
Communications States
KPMG

United
Reliant Energy 2002[50] Deloitte & Touche Round trip trades
States

United Overstated sales and

Sunbeam 2002[61] Arthur Andersen
States revenues

Symbol United Overstated sales and

2002[62][63]
Technologies States revenues

Tyco Improper accounting,

2002[50] PricewaterhouseCoopers Bermuda
International Dennis Kozlowski

United Overstated cash flows,

WorldCom 2002[50][64] Arthur Andersen
States Bernard Ebbers

United Inflating promotional

Royal Ahold 2003[65] Deloitte & Touche
States allowances

Falsified accounting
Parmalat 2003[66][67] Grant Thornton SpA Italy documents, Calisto
Tanzi

HealthSouth United
2003[68] Ernst & Young Richard M. Scrushy
Corporation States

Distributed ill-advised
Nortel 2003[69] Deloitte & Touche Canada corporate bonuses to
top 43 managers

Chiquita Brands United

2004[70] Ernst & Young Illegal payments
International States

Accounting of
United
AIG 2004[71] PricewaterhouseCoopers structured financial
States
deals

Bernard L. 2008[72] Friehling & Horowitz United Massive Ponzi

Madoff States scheme.[73]
Investment
Securities LLC

Anglo Irish Bank

Anglo Irish Bank 2008[74] Ernst & Young Ireland hidden loans
controversy

Satyam
Computer 2009[75] PricewaterhouseCoopers India Falsified accounts
Services

Biovail 2009 [76] Canada False Statements

Taylor, Bean & United

2009 [77] PricewaterhouseCoopers Fraudulent spending
Whitaker States

2009 to 2011 United Improper accounting

Monsanto [78]
Deloitte
States for incentive rebates

Overstated asset
Kinross Gold 2010 [79] KPMG Canada
values

Failure to disclose
United
Lehman Brothers 2010[80] Ernst & Young Repo 105 transactions
States
to investors

Business loans without

Amir-Mansour IAO (Audit organization)
2011 Iran putting any collateral
Aria and other Audit firms
and financial system

Financial transactions
among banks and
Bank Saderat IAO (Audit organization)
2011 Iran getting a lot of
Iran and other Audit firms
business loans without
putting any collateral

Sino-Forest Canada- Ponzi scheme,

2011[81] Ernst & Young
Corporation China falsifying assets

Olympus Tobashi using

2011[82] Ernst & Young Japan
Corporation acquisitions

Autonomy United
2012[83] Deloitte & Touche Subsidiary of HP.
Corporation States

Penn West 2012 to 2014 KPMG Canada Overstated profits

Exploration [84]

Understated debt,
Pescanova 2013 BDO Spain Spain Fraudulent invoices,
Falsified accounts

Toshiba 2015[85] Ernst & Young Japan Overstated profits

Valeant
2015 [86] PwC Canada Overstated revenues
Pharmaceuticals

Alberta Motor
2016 [87][88] Canada Fraudulent invoices
Association

Odebrecht 2016 [89] Brazil Government bribes

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. 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 later the ruling was 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.

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.[90] 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.[91][92][93][94][95]

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.[96] CEO Maurice R. "Hank"
Greenberg was forced to step down and is
still fighting civil charges being pursued by
New York state.[97][98]

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 multimillion-dollar
operation, especially since it had only one
active accountant, David G. Friehling.[99]
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.[100]
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
aren't 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 the largest accounting fraud in
world history.[101]

See also
Accounting ethics
Dot-com bubble
Financial crisis of 2007–2008
Forensic accounting
List of corporate collapses and scandals
 Microcap stock fraud
Philosophy of accounting
Sarbanes–Oxley Act
Savings and loan crisis
Securities fraud
Tobashi scheme
Vivien v. WorldCom
White-collar crime

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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)
"GMI Warns of Accounting Risks at 40
Companies" , Accounting Today,
November 27, 2012
"The Impact of Fraud on Shareholder
Value" , Business Insider, June 18, 2013
Retrieved from
"https://en.wikipedia.org/w/index.php?
title=Accounting_scandals&oldid=855552142"

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