By Yehudah Barlev
The 21st century has started with a wave of massive accounting frauds, estimated in billions of US dollars, it continued with “cooked books” which were revealed due to the Subprime mortgage crisis – and even at these very days, such “cooked books (reports)” are being discovered.
“Many fake accounts are printed, prepared in an artistic way with the intention to mislead and deceive”1
In the beginning of the current century, a wave of fraud, mostly fake financial reports oriented has occurred. Here are few examples, shortly;
Waste Management – Company’s top management have established certain profit goals, though, once the profit growth wasn’t satisfying enough in their eyes, they have taken “accounting measures” to “improve” the company’s scores. These actions included: Prevention of registration of depreciation on garbage trucks owned by the company; Determining a residual value for the Company’s assets, while in fact these assets had no residual value at all; Non-recording of expenses for the elimination of costs of garbage removal and burial projects (which incurred losses); Capitalization of various expenses and thereby turning them into assets in the Company’s balance sheets.
Enron – In the years 1996-2001 Fortune magazine has granted Enron corporation (company specialized in the energy field) the desirable title of “The Most Innovative American Company”. The Company’s executives, acted systematically to conceal the company’s most significant debts by using special purpose companies, these companies were used as well for: Acquisitions of Enron assets for billions of dollars, while making profits for the company, when in fact these were loans; Acquisitions of Enron shares in order to raise their market price; Capitalized profits of future transactions, including long-term transactions. While the SCE (US Securities and Exchange Commission) has approved this accounting policy for future gas contracts, the Company has taken this approval for future transactions in other areas in order to meet the profit goals expected for its shares.
WorldCom – The company’s share price has decreased as a result of a halt in its growth strategy, including the prevention of merger with Sprint by the US authorities. The banks pressured the company’s CEO to cover the gaps in his personal securities created by loans for which the securities for them were based on the CEO’s shares in the company. The CEO convinced the company’s board of directors to grant him $ 1 million in loans and guarantees in order to prevent the sale of substantial amounts of his shares in the company, as this would lead to a further decline in the share price. The CEO convinced the company’s board of directors to grant him loans and guarantees exceeding the value $ 400 million, in order to prevent the sale of significant amount of his shares in the company, as this would lead to a further decline in the share price. That strategy has been failed, and in order to conceal the reduction of profits and to maintain the share price of the company, the company’s managers have adopted “creative” accounting methods, which included recording the costs of communication lines as assets rather than expenses. They have inflated the profits using unrecorded income records (which have not occurred).
Tyco International – The company’s CEO, the economic consultant and the legal advisor were convicted of false records in the company’s books to conceal withdrawals, loans and private expenses taken from the company in various ways, including: Payments for private purposes – purchases of apartments and luxury homes, jewelry and even a birthday party for CEO’s wife in Italy at estimated cost of millions of dollars; loans to the legal adviser without proper permits; bribery of directors and certain employees of the company – to keep the false records confidential; Purchasing works of Art by the company, that were put in the CEO’s house; Unallowed salaries and bonuses for managers. The defense claims of the CEO were that nothing was done secretly, and everything is recorded in the company’s books, so there’s no case of criminal acts with malicious intent.
HealthSouth Corporation – The company’s “cooked books” were revealed after the company’s CEO has sold his shares of the company for approximately 75 million US dollars. This was done several days before the company has reported about massive losses. The sale has led to an investigation of the company’s accounting records and exposed a criminal behavior of its executives, which included: CEO’s instructions for the executives to forge the company’s revenue reports in order to meet investor expectations and control the prices of the company’s shares. The executives have found creative ways to record non-existing revenues; The false reports were continuing for seven years till their reveal; At some point, corporate taxes, based on false profits, were higher than real profits; The records of income against assets and an increase of over 10 % in the value of the assets in the financial statements.
Freddie Mac – Was a mortgage brokerage company specializing in trading of mortgage securitization in the US. The company’s reports were manipulated to meet profit expectations, including reporting billions of dollars of non-existing profits -as part of the company’s policy to increase reported profits at any cost; Profit reserves for future hedging transactions ; Manipulation of reports on reserves for profits; Records of profits on future hedging transactions and transfer of profits between different periods, in order to indicate an increase or stability in the Company’s performance.
The Subprime Wave
The wave of 2008 and the wave that followed it also revealed the weaknesses of Sarbanes-Oxley legislation enacted in the United States in 2002 and spread to binding standards for public companies in many countries around the world, including in Israel3, as well as IFRS (International Financial Reporting Standard) standardization, which also deserved a place of honor in presenting the financial statements of public companies around the world.
The next wave, after revealing the accounting frauds of the beginning of the 21st century, was revealed in the Subprime crisis in 2008. While the previous wave brought the economic crisis of 2002, for the 2008 wave – the chain of events was opposite – the subprime crisis led to the exposure of illegal accounting practices, as Warren Buffett put it: “only when the tide goes out do you discover who has been swimming naked”2. The wave of 2008 and the wave that followed it also revealed the weaknesses of Sarbanes-Oxley legislation enacted in the United States in 2002 and spread to binding standards for public companies in many countries around the world, including in Israel3, as well as IFRS (International Financial Reporting Standard) standardization, which also deserved a place of honor in presenting the financial statements of public companies around the world. Based on personal experience and many investigative projects of false reports, I believe that the legislation and regulations introduced since 2002, based on Sarbanes Oxley and IFRS, are now making it easier to carry out management frauds of “book cooking (adjusting)”.
In the background of the following events, which we experience every year, are present stricter and sometimes even more stringent, it is time to bring once again Lenin’s statement: None of the rules of control, the publication of balance-sheets, the drawing up of balance sheets according to a definite form, the public auditing of accounts, etc., the things about which well-intentioned professors and officials—that is, those imbued with the good intention of defending and prettifying capitalism—discourse to the public, are of any avail; for private property is sacred, and no one can be prohibited from buying, selling, exchanging or hypothecating shares, etc.” If we look at accounting reporting scandals in years in 2017-2014, it appears that the world goes as usual, in practice, even if only in the margins of business activity, is also practiced by large and strong business entities. These events are repeated in different societies, in different circumstances and in different geographical regions – are filling up many books and articles, as well as gaining titles in the economic journals and magazines. We shall try to explain briefly some of the events that occurred 2014-2017, according to the year of their exposure or the verdict of the cases regarding them.
Year of 2014
Tesco – A source in the company disclosed reports of inflated profits as a result of suppliers’ payments to the company for the sales promotion of their products. The company, Britain’s largest retail chain, was also subjected to inquiries related to the following accounting manipulations: pre-registration of suppliers’ revenues (derived from receipts) based on online sales. As a result, profit from suppliers’ receipts was recognized, while in fact, during the year, such profits were not incurred; Creation of pressure on the suppliers to increase their payments resulted in their leaving and a decrease in revenues that had been already recognized in advance – which had to be erased; The race for establishment of additional stores and expansion of the sales areas created additional operating costs that were recorded as assets and reduced real operating expenses. The initiation of investigations, internal and external, led to a 50% drop in the company’s market value.
Olympus – The company has been handing false reports for over 13 years, aiming to conceal losses incurred from wrong investment in the 80’s and onward; Transfer of funds to cover losses of the Company’s failed investments; Seized payments, apparently to criminal organizations in Japan. This event was defined as the most prolonged fraud committed in a Japanese corporation and raised many questions about corporate governance in Japan in general.
Penn West Petroleum – The company has recorded and reported about operating expenses estimated at hundreds of millions of US dollars as capital expenditures that were charged to property, plant and equipment intended to be amortized over years.
Etihad Etisalat – One of the biggest telecommunication services companies in Saudi Arabia – operating under the Mobily brand name. The company was forced to re-register its revenues for more than two years back, after a false recognition of prepaid lines; Recognition in advance of revenues from sales promotions of mobile SIM cards sold through third parties. With the publication of the inflated profits, the shares value was declined by 30% and $ 9 billion of the company’s market value were written off.
Vatican Bank (Institute for the Works of Religion) – The Bank has been exposed to repeated scandals over the last 20 years, including serving as a pipeline for transferring funds to unknown entities. His actions were carried out under a thick smokescreen, with no transparency, except for a very small group. Although these actions were subject to accounting audits, following Pope’s order – outside parties were brought, in order to remove the “dirty laundry” and expose fraudulent acts carried out under the auspices of the Bank.
Year of 2015
Toshiba – The company admitted it had been inflating its profits by approximately $ 2 billion over seven years. According to the investigation report, Toshiba had a corporate culture that could not be disputed and forced employees to perform improper accounting by rejecting loss reports or transferring certain expenses to later years. The report also revealed that the company’s managers pressed their business divisions to meet difficult and impossible goals and knew that the reports of the business divisions on meeting these objectives were based on reports of false profits and the postponement of losses.
Valeant Pharmaceuticals International – A leading pharmaceutical company. In its annual reports, the company accused its top management of causing its shares to fall and put the company at risk of Insolvency (default). The report states: “The company decided that the style of the company leaders in a performance-based environment where challenging goals were set and achieving the goals was the key to expectations may have led to an improper recognition of the company’s revenues.” The Company added that the internal control over reporting, the disclosure and the accounting procedures were not effective due to presence of weaknesses. The company has been strongly criticized for its aggressive policy of taking control of pharmaceutical companies and medical products. The company integrated the drugs and medicines into its sales and supply chain, and then has increased the prices of these medical products along with its own products. All the company’s takeover rounds created pressure to achieve positive financial results as well as meeting these ambitious and impossible goals.
Year of 2016
Wells Fargo & Company (banking) – The Bank has built an incentive program for its employees for creating new accounts and recruiting new customers. As a result, the bank had over 1.5 million bank and saving and over 500,000 credit cards that the bank’s customers have never approved. That scandal has led to a dismissal of almost 5300 employees and allocation of provisions to refund the customers for fees charged for opening the “unordered” operations. Due the scandal, the fees for credit cards and the opening of the bank accounts have been dramatically reduced. Some of the states and the cities in the US have terminated their business relationships with the bank. In the report published by Wells Fargo’s board of directors, charges were raised, mainly against the chairman and the CEO of the bank, who did not respond in time to complaints about improper operations in the Consumer Services Division and did not address the complaints of the managers regarding the impossible sales goals that were set. The report also states that the head of the Community Banking Services Division was responsible for the establishment of false accounts policy, for deliberately setting up impossible goals and for ignoring the reactions of subordinates who understood that these objectives could not be met.
Hampton Creek (currently- Just, Inc.) – An American food manufacturer. In publications regarding the company’s policy, it was reported that Hampton Creek has approached contractors in order to visit sites of local retailers and buy HC’s mayonnaise product. E-mail correspondence sent by the company’s vice president was presented in which he instructed the contractors to visit the retail stores to buy the product. It was also claimed that the company has asked these contractors to call the retailers to ask about its mayonnaise product – pretending to show interest in the product. In its response, the company claimed that the plan to purchase its products was for quality control purposes.
Year of 2017
Barclays – In this case, we are talking about the formation of several large banks (on a global scale), at least since 1991, which was exposed in 2012. They were acting to set the LIBOR5 rates. Each base point (0.01%) of a change in Libor led to profits of millions of dollars for the involved banks. As a result of the “LIBOR scandal”, the banks were fined billions of US dollars. The fines were imposed by the European Commission and other regulators around the world for manipulating the rates of Libor and EURIBOR6. E-mail between two bank “executors”:
- A: “As always, any help will be appreciated. What do you think you can offer for 3 million?”
- B:” I’ll take 90 even though 91 is what I need to place.”
- A: I completely understand and agree with you. Remember, once I retire and write a book about the business – your name will be written in gold letters … and you will have a free invitation to my bar in the Greek islands.
Ex. B: “I prefer it would not to be written in any book.”
Caterpillar Inc. – Is the world’s largest construction equipment manufacturer. An investigation was initiated against the company due to suspicions that have raised during an analysis of the financial statements of the company- regarding the transfer of billions of dollars in profits earned by subsidiaries registered outside of the United States to the parent company – and avoidance of paying tax on these profits through recording such transfers as loans. The investigation focuses, apparently, on Caterpillar’s subsidiary registered in Switzerland- where the tax rates paid on profits are 4% -6%, compared to tax rate of 35% in the US. According to the report of an accounting expert who analyzed the transactions from the financial statements and additional documents, the Company did not act in accordance with the accounting principles – aiming to maintain a high share price; The transferring of funds action has no any business-wise reason, and is only intended for tax evasion (in the US) purposes. Caterpillar is not alone! It is estimated that companies such as Apple, Google and Pfizer have accumulated more than $ 2.3 trillion, in their subsidiaries who are registered in various tax havens. Transferring these funds to the US will require tax payment in their origin countries.
All these brings us back to the question that worries every novice student of accounting: Is accounting the most boring profession in the world?
- “The Adventures of Peregrine Pickle” written in 1751 by Tobias Smollett -a Scottish poet and author. The source of “Cooked Books” term.
- “Only when the tide goes out do you discover who has been swimming naked”, Warren Buffett.
- Circular 06-2175 by the Banking Supervision, December 2005. Circular 3-9-20 by The Commissioner (supervisor) of Insurance and the Capital Market. Securities Regulations (periodic & immediate reports), 2009.
- Taken from selected writings of Vladimir Ilyich Lenin, 1916: Imperialism, the Highest Stage of Capitalism
- LIBOR- London Inter Bank Offered Rate. The average interest rate is set by grouping (and compiling) the interest rates of the major banks around the world.
- EURIBOR- Euro Interbank Offered Rate- The European interbank rate, determined by a cluster (grouping) of about 40 banks on the continent.