What Went Wrong?: Accounting Fraud and Lessons from the Recent Scandals

Gary Giroux What Went Wrong? Accounting Fraud and Lessons from the Recent Scandals In the public eye, Enron’s mission was nothing more than the cover stoiy for a massive fraud. —Bethany McLean and Peter Elkind CORPORATE FRAUD, BANKRUPTCIES, AND VARIOUS ILLEGAL ACTS HAVE always been part of the business environment. Every time fiascos erupt there is a shock, but business history records dozens of major failures, frauds, and other measures of massive corruption each decade. The big ones often hit during recessions or periods of other economic problems, as expected. The high-risk firms are the most vulnerable to economic shocks. The recent scandals are no exceptions. The most important scandals are the focus of this paper and are summarized in table 1. Although the problems that exist are diverse, a few common characteristics stand out. The first is the obvious backdrop of corporate greed. Presumably, senior executives expect to get away with it. They also fit the financial-corporate culture described above. And earnings manipulation is part of (and usually central to) most of the scandals. Some of them used brazen and unsophisticated approaches (such as WorldCom), while others used new, sophisticated devices to defraud (like Enron). Determining the existence of criminal acts takes years. social research Vol 75 : No 4 : Winter 2008 1205 Table 1. Twenty-First-Century Scandals Company Year Description Enron 2001 Declared bankruptcy on December 2, 2001 after restating earnings in the 3rd-quarter 10-Q, indicating major problems with spe­ cial-purpose entities. Investigations by the SEC, Justice Department, and others; execu­ tives indicted and class-action lawsuits filed. Global Crossing 2002 Overstated revenue and earnings over net­ work capacity swaps and then declared bankruptcy; investigated by SEC and FBI. WorldCom 2002 Recorded improper expenses of $3.8 bil­ lion and then declared bankruptcy; under investigation for accounting fraud and other violations; the amount of improper expenses uncovered approached $10 billion. Tyco 2002 Conglomerate with questionable practices on accounting for acquisitions and other issues. Restated 1999-2001 financials based on merger-related restructurings plus other problems with reserves. CEO and CFO indicted. Qwest 2002 Subject to criminal investigation by Justice Department and accounting practice probe by the SEC, associated with “hollow swaps.” Adelphia 2002 Cable TV operation charged with over­ stating earnings; former CEO John Rigas charged with looting the company, which went bankrupt. Imclone 2002 Insider trading charges against former CEO for selling stock after FDA rejected a new drug; alleged to have tipped off Martha Stewart and other friends and relatives. Merrill Lynch, Salomon, Smith Barney, Credit Suisse, Goldman Sachs, J. P . Morgan, and others 2002 Major investment banks settled with the New York attorney general, SEC, and other regulators on deceptive stock analysis and other brokerage-related practices, similar to Merrill Lynch earlier. The total fine was a combined $2 billion approximately, plus other sanctions and agreement to correct deceptive practices. 1206 social research Table 1, continued HealthSouth 2003 Accused of accounting fraud involving $1.4 billion in earnings and $800 million in over­ stated assets. Former CFO and others plead­ ed guilty to fraud charges. The Mutual Funds Scandal 2003 The mutual funds have only limited SEC reg­ ulation requirements and often poor corpo­ rate governance, yet have been considered highly ethical. That changed when New York Attorney General Eliot Spitzer sued them on several counts. Some pundits consider the mutual fund scandal as egregious as Enron. Fannie Mae 2004 Fraudulent accounting practices totaling $16 billion and extensive payouts to ousted executives; earnings restated and executives fired. AIG 2005 Internal control weaknesses and poor corpo­ rate governance; CEO fired. Stock Option Backdating 2006 Backdating options grant date to lower stock price; dozens of companies investi­ gated by SEC. Subprime Loans 2007 Massive number of mortgage loans to sub­ prime borrowers, often without documen­ tation. Mortgages then repackaged through SPEs and sold as bonds. Huge losses taken at major financial institutions and many executives fired. An FBI investigation is ongoing. Two industries were particularly prominent in the scandals: the energy companies and telecommunications. Deregulation allowed the stodgy energy companies that carried out such basic operations as trans­ mitting natural gas to become high-tech energy traders using sophis­ ticated derivatives...