Corporate Transgressions   and  Financial Gimmickry Jim   Davidson ,  CFE, CPA, CFS Certified Corporate Director
DEVASTATING Millions  & Billions Lost <ul><li>Deceptive practices, executive fraud, shaken confidence </li></ul><ul><li>Fi...
Financial, Business & Ethical <ul><li>Scandals and high profile cases </li></ul><ul><li>Manipulations, tricks & red flags ...
Scandals and Transgressions <ul><li>Abhold </li></ul><ul><li>ADELPHIA </li></ul><ul><li>ANDERSEN </li></ul><ul><li>AOL </l...
  Scandals and Transgressions  (Cont’d)   <ul><li>Credit Suisse First Boston </li></ul><ul><li>Duke Energy </li></ul><ul><...
Scandals and Transgressions  (Cont’d)   <ul><li>HEALTHSOUTH </li></ul><ul><li>Homestore </li></ul><ul><li>Interpublic </li...
Scandals and Transgressions  (Cont’d) <ul><li>Mirand </li></ul><ul><li>Nicor Energy </li></ul><ul><li>Nine West </li></ul>...
Scandals and Transgressions  (Cont’d) <ul><li>Squibb </li></ul><ul><li>Sybase </li></ul><ul><li>Symbol </li></ul><ul><li>3...
Why the Scandals? <ul><li>Blamed high tech boom </li></ul><ul><li>Meeting quarterly earnings  </li></ul><ul><li>Stock opti...
Why the Scandals?  (Cont’d) <ul><li>“ Accounting fraud does tend to come in waves, and is discovered most often after a ma...
Why the Scandals?  (Cont’d) <ul><li>“ Just a few”- rotten apple theory   </li></ul><ul><li>Specific incentives – bonuses, ...
Why the Scandals?  (Cont’d) <ul><li>Incentives : Greed, power, ego </li></ul><ul><li>Opportunity: </li></ul><ul><li>– Weak...
Why the Scandals?   (Cont’d) <ul><li>Rationalization:   </li></ul><ul><ul><li>– “ Everyone’s doing it.”  </li></ul></ul><u...
Lessons of History <ul><li>It’s the incentives -  GREED ! </li></ul><ul><li>Irrational exuberance  -  booms & bubbles </li...
TRUST BETRAYED <ul><li>All fraud by those we trust! </li></ul><ul><li>CEO and/or CFO 80% of cases </li></ul><ul><li>Anonym...
Recent Scandals <ul><li>Greed — more widespread than previous? </li></ul><ul><li>Prominent industries  - energy, high tech...
EARNINGS MANAGEMENT What is it? How is it accomplished? How is detected?
Earnings  Management Defined <ul><li>“ Active manipulation of earnings toward predetermined target”  {Mulford & Comisky} <...
Gimmicks and Illusions: What? How? When? <ul><li>“ Big Bath”  charges  –w rite-offs, over reserves,  “cushions” ensure hig...
  Earnings Management  Tricks and Gimmicks   <ul><li>“ Materiality &quot;– Intentionally recording errors within  ceiling ...
  <ul><li>Earnings management - manipulation and outright fraud </li></ul><ul><li>Discretionary   policies & estimates– ca...
Other Tricks & Gimmicks <ul><li>Related party loan guarantees, obligations, synthetic leases </li></ul><ul><li>Extreme tax...
Self-Dealing – Questionable and Unauthorized <ul><li>Disguised executive compensation </li></ul><ul><li>“ Evergreen” stock...
  Earnings Management Environment <ul><li>Overbearing CEO with substantial ego </li></ul><ul><li>Few independent directors...
DECEPTION– LIABILITIES <ul><li>Special purpose entities </li></ul><ul><li>Off-books complex schemes and webs - nonconsolid...
Aggressive  Tax Shelters <ul><li>Off-shore tax havens, shelter deals, questionable legal/tax accounting interpretations </...
Questionable, Unauthorized Funds <ul><li>Disguised executive compensation </li></ul><ul><li>“ Evergreen” stock options </l...
Earnings Restatements <ul><li>Previously rare, increasingly common </li></ul><ul><li>Highly suspect manipulation  & decept...
ENRON <ul><li>Largest bankruptcy 2001  </li></ul><ul><li>7th largest corporation - $1.2 billion equity reduction in quarte...
Enron <ul><li>Extreme use SPEs for blatant manipulation </li></ul><ul><li>Initial use to grow company, managing risk </li>...
Enron  (Cont’d) <ul><li>Gas trading to electricity, risk management, telecom,  and expanding internationally </li></ul><ul...
Enron  (Cont’d) <ul><li>Energy trading: spot market purchases volatility drove demand for risk management and related deri...
Enron  (Cont’d) <ul><li>Focused on meeting quarterly earnings </li></ul><ul><li>Initially cost savings, but increasingly m...
Enron   (Cont’d) <ul><li>CFO manipulated for own enrichment - independence problem </li></ul><ul><li>Questionable SPEs app...
Enron   (Cont’d) <ul><li>Some operations major blunders </li></ul><ul><li>Dramatic increased risk but unwillingness to dis...
WorldCom <ul><li>Growth through mergers & acquisitions  </li></ul><ul><li>$100+ billion assets (with half intangibles) </l...
WorldCom   (Cont’d) <ul><li>WorldCom restated earnings </li></ul><ul><li>Andersen fired </li></ul><ul><li>CFO and CEO fire...
Tyco <ul><li>Conglomerate through acquisitions </li></ul><ul><li>“ Deal a Day Dennis” Kozlowski acquired 750 companies </l...
Tyco   (Cont’d) <ul><li>CIT $9.4 billion loss for 2002 </li></ul><ul><li>Kozlowski indicted for evading taxes & “raiding” ...
Adelphia <ul><li>Fifth cable & communications </li></ul><ul><li>Restatements -  billions off-balance-sheet “co-borrowing a...
What do Enron, WorldCom, Tyco, Adelphia have in common? <ul><li>Massive deception, manipulation, self-dealing </li></ul><u...
What Happened at Andersen? <ul><li>Long-time reputation for integrity and professionalism </li></ul><ul><li>“ Aggressive a...
Governance Red Flags <ul><li>CEO also board chairman </li></ul><ul><li>Executive ego and dominance  </li></ul><ul><li>Perm...
Corporate Governance <ul><li>Majority independent board members – fraud less likely </li></ul><ul><li>Board  and executive...
Corporate Governance <ul><li>Board oversight and “tone at the top” </li></ul><ul><li>Independent directors fact and appear...
Legislative Reaction: SOX <ul><li>Strengthened governance -- independent directors, mandatory committees  </li></ul><ul><l...
Legislative Reaction: SOX  (Cont’d) <ul><li>Established PCAOB </li></ul><ul><li>A new regulatory structure for  accounting...
Corporate Transgressions   and  Financial Gimmickry Jim Davidson, CFE, CPA, CFS Certified Corporate Director
<ul><ul><li>QUESTIONS? </li></ul></ul>
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Corporate Transgression & Financial Gimmickry for National Fraud Conference

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Misleading and/or Fraudulent Financial Reporting

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  • Steeply Declining Prices<number>
  • Let these scandal-plagued companies serve as billboards as to not what to do.<number>
  • Majority Acquisition failuresAOL Time Warner $54 billion write-offFraud potential, earnings managementCendent acquisition- CUC massive fraudAcquisition costs & in-process R&D write-offsValuations and impairment write-downs<number>
  • Global Crossing: revenue recognition on exchanges of fiber optics capacity<number>
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  • Costs and ExpensesSunbeam: Expenses not accrued - sales returns, product liability, warrantyRite Aid: COGS/Inventory adjustments, capitalized R&M, understated compensationWaste Management: Pervasive fraud – depreciation, capitalizing interest<number>
  • Xerox: immediate recognition from leased contracts – Aggressive RecognitionWaste Management Recorded $1.4 Billion in fraudulent income over a 5 year period. Shareholders lost more than $6 BillionEliminated & deferred expenses with “top-level adjustments” to meet pre-determined earnings targetsFailed to record expenses Improperly capitalized expensesSet up inadequate reserves for taxes & other expensesAvoided depreciation expenses<number>
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  • Internal Control Limitations: Internal controls break down Senior executives can circumvent controls Financial statement fraud is often perpetrated by desperate people with extremely large egos They often think rules don’t apply to them<number>
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  • LEGITIMATE PURPOSESGeneral Motors to redevelop closed factories with environmental problems Airlines to hold airplane leases Mortgage companies to consolidate and sell mortgages to investors AOL and Microsoft for synthetic leases GE to resell credit card receivablesFinancing –SPE with higher rating & lower rates than parentSecuritize mortgages, credit cards & other receivablesSynthetic leases—sale-leaseback & tax benefitsR&D risk & liability transferTransfer, contain, wall off, or mitigate risk. Insurance, joint ventures to share risk. Oil, exploration projects, costly R & D with possible litigation Dow’s silicon breast implants and so many product liability exposures.Leases are good examples of off-balance sheet financing transactions. Certain other long term commitments, legitimately unaccrued contingencies that are possible of loss but not probable. <number>
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  • Financing –SPE with higher rating & lower rates than parentSecuritize mortgages, credit cards & other receivablesSynthetic leases—sale-leaseback & tax benefitsR&D risk & liability transfer<number>
  • Fit to business strategy—MD&ATransparency and disclosuresSpecial Purpose Entity (SPE)--Contain risk --leasing or project developmentStructured financing—Contract to achieve specific purpose, including joint ventures <number>
  • Derivatives named because their pricing is derived from some other underlying security or commodity, index, interest rate, or exchange rate. Includes forwards, futures, options, swaps, etc. Bank of International Settlements has annual trading volumes exceeding $400 to $500 trillion annually. Commodity—changing prices – Energy/petroleum company would lock in a future price of fuel at a certain minimum amount/floor to avoid declining fuel prices which would adversely affect profits. On the other hand, an airline would lock in a ceiling of prices to mitigate increasing prices. The purchase of a derivative achieves this for both companies.Price of oil could be hedged. Currencies could be hedged. Interest rate—fluctuationsForeign exchange—currency fluctuationsEvent—uncertaintiesCredit—default, bankruptcyDerivatives should be used to hedge risk as a safety net, not a profit center.<number>
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  • Many feel:They don’t have a problem in their organizationThe cost of implementing a compliance program exceeds the benefits derivedAvoid Criminal Penalties: Failing to comply with Sarbanes-Oxley Cost: $5MM 10 years in prison<number>
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  • So, let’s note and heed the lessons learned from the financial scandals of the recent few years. Think about the underlying ingredients that went into the recipe for these scandals. The main ingredient was greed. Add to that a large dose of conflicts, a large helping of complacency, and a dash of complicity, sift out the transparency, and the end result was disastrous.So as you – the fraud detection and deterrence community – interpret these “lessons learned” for your firms, companies, and clients encourage to avoid making the same mistakes. The last thing investors, employees, and our economy and society needs is another breach of investors’ trust. On this point and given this audience, I know I’m preaching to the choir. In light of the changed environment, it is in all of our best interests to promote ethics, honesty, and transparency in financial reporting. Practices that take place out of the bright sunlight of transparency are usually practices that require scrutiny.
  • Corporate Transgression & Financial Gimmickry for National Fraud Conference

    1. 1. Corporate Transgressions and Financial Gimmickry Jim Davidson , CFE, CPA, CFS Certified Corporate Director
    2. 2. DEVASTATING Millions & Billions Lost <ul><li>Deceptive practices, executive fraud, shaken confidence </li></ul><ul><li>Financial markets - billions evaporated </li></ul><ul><li>Recession – bankruptcies, savings, pensions, jobs lost, financial ruin </li></ul><ul><li>Reputations, careers destroyed, imprisonment </li></ul>
    3. 3. Financial, Business & Ethical <ul><li>Scandals and high profile cases </li></ul><ul><li>Manipulations, tricks & red flags </li></ul><ul><li>Repercussions–legal, financial, reputation </li></ul><ul><li>Lessons learned </li></ul><ul><li>Corporate culture -- “Tone at the Top” </li></ul><ul><li>Management integrity </li></ul>
    4. 4. Scandals and Transgressions <ul><li>Abhold </li></ul><ul><li>ADELPHIA </li></ul><ul><li>ANDERSEN </li></ul><ul><li>AOL </li></ul><ul><li>Baker Hughes </li></ul><ul><li>Bally </li></ul><ul><li>Bausch & Lomb </li></ul><ul><li>Bristol-Myers </li></ul><ul><li>CENDANT </li></ul><ul><li>Citibank </li></ul><ul><li>CMS Energy ($5.2 billion) </li></ul><ul><li>COMPUTER ASSOCIATES </li></ul>
    5. 5. Scandals and Transgressions (Cont’d) <ul><li>Credit Suisse First Boston </li></ul><ul><li>Duke Energy </li></ul><ul><li>Dynegy </li></ul><ul><li>Fleming Companies </li></ul><ul><li>EDS </li></ul><ul><li>El Paso </li></ul><ul><li>ENRON ($85 billion) </li></ul><ul><li>GATEWAY </li></ul><ul><li>Gaylord Entertainment </li></ul><ul><li>GLOBAL CROSSING ($9 billion) </li></ul><ul><li>Haliburton </li></ul><ul><li>J </li></ul>
    6. 6. Scandals and Transgressions (Cont’d) <ul><li>HEALTHSOUTH </li></ul><ul><li>Homestore </li></ul><ul><li>Interpublic </li></ul><ul><li>JDS Uniphase </li></ul><ul><li>JP Morgan Chase </li></ul><ul><li>Kimberly Clark </li></ul><ul><li>Kmart </li></ul><ul><li>LUCENT </li></ul><ul><li>Martha Stewart </li></ul><ul><li>Merck </li></ul><ul><li>Merrill Lynch </li></ul><ul><li>Microstrategy </li></ul>
    7. 7. Scandals and Transgressions (Cont’d) <ul><li>Mirand </li></ul><ul><li>Nicor Energy </li></ul><ul><li>Nine West </li></ul><ul><li>Nortel </li></ul><ul><li>North Face/VF Corp </li></ul><ul><li>Parmalat </li></ul><ul><li>Peregrine Systems </li></ul><ul><li>QUEST </li></ul><ul><li>Reliant Energy ($6 billion) </li></ul><ul><li>Rite-Aid </li></ul><ul><li>Royal Dutch/Shell </li></ul><ul><li>Solomon Smith Barney </li></ul><ul><li>SUNBEAM </li></ul>
    8. 8. Scandals and Transgressions (Cont’d) <ul><li>Squibb </li></ul><ul><li>Sybase </li></ul><ul><li>Symbol </li></ul><ul><li>3Com </li></ul><ul><li>TYCO </li></ul><ul><li>Vail Resorts </li></ul><ul><li>Veritas </li></ul><ul><li>Waste Management ($6 billion) </li></ul><ul><li>WORLDCOM ($11 billion) </li></ul><ul><li>XEROX ($6.5 billion) </li></ul>
    9. 9. Why the Scandals? <ul><li>Blamed high tech boom </li></ul><ul><li>Meeting quarterly earnings </li></ul><ul><li>Stock options, greed and short-term price manipulation </li></ul><ul><li>Historically, same result - speculative bubbles followed by crashes </li></ul><ul><li>Fiascos, corruption, business failures follow economic booms </li></ul>
    10. 10. Why the Scandals? (Cont’d) <ul><li>“ Accounting fraud does tend to come in waves, and is discovered most often after a market collapse, since no one is interested in investigating much when stock prices are high and everyone’s making big money.” </li></ul><ul><li>Final Accounting: Ambition, Greed, and the Fall of Arthur Andersen (Toffler) </li></ul>
    11. 11. Why the Scandals? (Cont’d) <ul><li>“ Just a few”- rotten apple theory </li></ul><ul><li>Specific incentives – bonuses, excessive options </li></ul><ul><li>Institutional environment turns blind eye to unethical or illegal acts </li></ul><ul><li>Culture allows egregious acts </li></ul><ul><li>“ It pays to do it, it’s easy to do, and it’s unlikely that you’ll be caught.” [ Schilit ] </li></ul>
    12. 12. Why the Scandals? (Cont’d) <ul><li>Incentives : Greed, power, ego </li></ul><ul><li>Opportunity: </li></ul><ul><li>– Weak governance </li></ul><ul><li>– Corporate culture </li></ul><ul><li>– Ineffective auditing </li></ul><ul><li>– Lax regulation </li></ul><ul><li>– Haphazard enforcement </li></ul>
    13. 13. Why the Scandals? (Cont’d) <ul><li>Rationalization: </li></ul><ul><ul><li>– “ Everyone’s doing it.” </li></ul></ul><ul><ul><li>“ Wall Street expects it.” </li></ul></ul><ul><ul><li>“ Investment bankers engineered it.” </li></ul></ul><ul><ul><li>“ Our attorneys blessed it.” </li></ul></ul><ul><ul><li>“ Our auditors accepted it.” </li></ul></ul>
    14. 14. Lessons of History <ul><li>It’s the incentives - GREED ! </li></ul><ul><li>Irrational exuberance - booms & bubbles </li></ul><ul><li>Regulations not fool-proof </li></ul><ul><li>Corporate culture </li></ul><ul><li>Ethics, particularly at the top is key </li></ul>
    15. 15. TRUST BETRAYED <ul><li>All fraud by those we trust! </li></ul><ul><li>CEO and/or CFO 80% of cases </li></ul><ul><li>Anonymous survey of CFO’s : </li></ul><ul><ul><li>Two-thirds asked to participate </li></ul></ul><ul><ul><li>One-third admitted to doing so </li></ul></ul>
    16. 16. Recent Scandals <ul><li>Greed — more widespread than previous? </li></ul><ul><li>Prominent industries - energy, high tech, telecommunications </li></ul><ul><li>Giant firms – largest bankruptcies in history </li></ul><ul><li>Earnings manipulation central </li></ul>
    17. 17. EARNINGS MANAGEMENT What is it? How is it accomplished? How is detected?
    18. 18. Earnings Management Defined <ul><li>“ Active manipulation of earnings toward predetermined target” {Mulford & Comisky} </li></ul><ul><li>“ Purposeful intervention in external financial reporting process with intent of obtaining private gain” {Shipper} </li></ul><ul><li>“ Intentional, deliberate misstatement or omission of material facts, or accounting data, which is misleading” {ACFE} </li></ul>
    19. 19. Gimmicks and Illusions: What? How? When? <ul><li>“ Big Bath” charges –w rite-offs, over reserves, “cushions” ensure higher future earnings </li></ul><ul><li>“ Merger Magic ”– write-offs, misclassifications & disguised costs so no future “drag” </li></ul><ul><li>“ Cookie-Jar Reserves” – i ncome smoothing– “good time” over accruals and reserves used in “bad times” </li></ul>
    20. 20. Earnings Management Tricks and Gimmicks <ul><li>“ Materiality &quot;– Intentionally recording errors within ceiling – “too small to matter” </li></ul><ul><li>Revenue recognition – Accelerated, premature before delivery and with contingencies </li></ul><ul><ul><li>Consignment </li></ul></ul><ul><ul><li>Channel stuffing </li></ul></ul><ul><ul><li>Round-trips, swaps & barters to gross up sales </li></ul></ul><ul><ul><li>Bill and hold </li></ul></ul><ul><ul><li>Related party </li></ul></ul>
    21. 21. <ul><li>Earnings management - manipulation and outright fraud </li></ul><ul><li>Discretionary policies & estimates– capitalization, amortization, deferred expenses, inventory, judgments - bad debts, contingencies </li></ul><ul><li>Liability deception – Off-books complex schemes & webs, special purpose entities </li></ul>Other Tricks & Gimmicks
    22. 22. Other Tricks & Gimmicks <ul><li>Related party loan guarantees, obligations, synthetic leases </li></ul><ul><li>Extreme tax avoidance (evasion ?), off-shore havens, questionable legal/tax interpretations </li></ul><ul><li>Blatant misstatements–disguised transactions and misclassifications- capitalized repair and maintenance </li></ul>
    23. 23. Self-Dealing – Questionable and Unauthorized <ul><li>Disguised executive compensation </li></ul><ul><li>“ Evergreen” stock options </li></ul><ul><li>Excessive perks & misused funds </li></ul><ul><li>Undisclosed related party transactions and self-dealing – personal “piggy-bank” </li></ul>
    24. 24. Earnings Management Environment <ul><li>Overbearing CEO with substantial ego </li></ul><ul><li>Few independent directors </li></ul><ul><li>Inadequate board committee structure </li></ul><ul><li>Excess executive compensation and perks </li></ul><ul><li>Poor control structure and culture – “tone at the top” </li></ul>
    25. 25. DECEPTION– LIABILITIES <ul><li>Special purpose entities </li></ul><ul><li>Off-books complex schemes and webs - nonconsolidated debt </li></ul><ul><li>Related party loan guarantees, contractual obligations, synthetic leases </li></ul>
    26. 26. Aggressive Tax Shelters <ul><li>Off-shore tax havens, shelter deals, questionable legal/tax accounting interpretations </li></ul><ul><li>Complex series of loans, extreme tax avoidance and possible evasion </li></ul>
    27. 27. Questionable, Unauthorized Funds <ul><li>Disguised executive compensation </li></ul><ul><li>“ Evergreen” stock options </li></ul><ul><li>Undisclosed related party transactions/self-dealing </li></ul><ul><li>Inadequate, ineffective corporate governance </li></ul>
    28. 28. Earnings Restatements <ul><li>Previously rare, increasingly common </li></ul><ul><li>Highly suspect manipulation & deception </li></ul><ul><li>Over 900 restatements 1999-mid-2003 (GAO) </li></ul><ul><li>Nearly 1,000 recent restatements </li></ul><ul><li>Predominantly revenue recognition </li></ul><ul><li>20% of 2001 SEC enforcements accounting related, increasing in 2002 - 2004 </li></ul><ul><li>Market reaction: Significant stock price declines </li></ul>
    29. 29. ENRON <ul><li>Largest bankruptcy 2001 </li></ul><ul><li>7th largest corporation - $1.2 billion equity reduction in quarter </li></ul><ul><li>Manipulation and deception -- special purpose entities </li></ul><ul><li>Congressional hearings, revolutionary changes -- regulatory, governance, scrutiny </li></ul>
    30. 30. Enron <ul><li>Extreme use SPEs for blatant manipulation </li></ul><ul><li>Initial use to grow company, managing risk </li></ul><ul><li>More complex SPEs to record future services as current income using “mark-to-market” </li></ul><ul><li>Extensive conflicts of interest & related-party transactions </li></ul>
    31. 31. Enron (Cont’d) <ul><li>Gas trading to electricity, risk management, telecom, and expanding internationally </li></ul><ul><li>Based on economic-based assessments, many ventures were failures </li></ul><ul><li>Based on manipulations and deception, all were successful </li></ul>
    32. 32. Enron (Cont’d) <ul><li>Energy trading: spot market purchases volatility drove demand for risk management and related derivatives </li></ul><ul><li>Massive debt and potential junk bond ratings </li></ul><ul><li>Used special purpose entities to reduce perception of too much debt </li></ul>
    33. 33. Enron (Cont’d) <ul><li>Focused on meeting quarterly earnings </li></ul><ul><li>Initially cost savings, but increasingly more gimmicks </li></ul><ul><li>Scheme 1: Revalue physical assets using “fair value” models (SFAS 125, designed for financial assets)—front-loading profits </li></ul><ul><li>Scheme 2: Complex and mishandled SPEs to record earnings </li></ul>
    34. 34. Enron (Cont’d) <ul><li>CFO manipulated for own enrichment - independence problem </li></ul><ul><li>Questionable SPEs approved by attorneys, auditor/Andersen and board </li></ul><ul><li>Accommodated by investment banks and no apparent SEC oversight </li></ul>
    35. 35. Enron (Cont’d) <ul><li>Some operations major blunders </li></ul><ul><li>Dramatic increased risk but unwillingness to disclose losses </li></ul><ul><li>Stock price dropped, executives bailed out of stock, ratings to junk </li></ul><ul><li>Restatements in 2001and subsequent bankruptcy </li></ul><ul><li>Largest ever bankruptcy until … </li></ul>
    36. 36. WorldCom <ul><li>Growth through mergers & acquisitions </li></ul><ul><li>$100+ billion assets (with half intangibles) </li></ul><ul><li>Debt to equity of 79.3% </li></ul><ul><li>$11 billion + capitalized operating expenses </li></ul>
    37. 37. WorldCom (Cont’d) <ul><li>WorldCom restated earnings </li></ul><ul><li>Andersen fired </li></ul><ul><li>CFO and CEO fired </li></ul><ul><li>WorldCom bankruptcy 2002 </li></ul><ul><li>Replaced Enron as largest bankruptcy in US history, </li></ul>
    38. 38. Tyco <ul><li>Conglomerate through acquisitions </li></ul><ul><li>“ Deal a Day Dennis” Kozlowski acquired 750 companies </li></ul><ul><li>Merger magic </li></ul><ul><li>CIT acquisition fiasco showed Tyco’s shenanigans </li></ul>
    39. 39. Tyco (Cont’d) <ul><li>CIT $9.4 billion loss for 2002 </li></ul><ul><li>Kozlowski indicted for evading taxes & “raiding” Tyco </li></ul><ul><li>Obvious manipulation & deception </li></ul><ul><li>Not clear criminal acts </li></ul>
    40. 40. Adelphia <ul><li>Fifth cable & communications </li></ul><ul><li>Restatements - billions off-balance-sheet “co-borrowing agreements” </li></ul><ul><li>Rigas family fraud and significant self-dealing </li></ul><ul><li>Bankruptcy 2002 </li></ul>
    41. 41. What do Enron, WorldCom, Tyco, Adelphia have in common? <ul><li>Massive deception, manipulation, self-dealing </li></ul><ul><li>Growth through acquisitions </li></ul><ul><li>Acquisition accounting abuse </li></ul><ul><li>Targeted earnings focused </li></ul><ul><li>Enrichment of senior executives </li></ul><ul><li>Accommodating auditors & boards of directors </li></ul><ul><li>Restated financials </li></ul>
    42. 42. What Happened at Andersen? <ul><li>Long-time reputation for integrity and professionalism </li></ul><ul><li>“ Aggressive auditing” beginning in ‘80s </li></ul><ul><li>Clients too valuable to defy (Toffler) </li></ul><ul><li>Major client scandals: Sunbeam, Global Crossing, Waste Management, Enron, WorldCom & Guilty of obstruction of justice </li></ul>
    43. 43. Governance Red Flags <ul><li>CEO also board chairman </li></ul><ul><li>Executive ego and dominance </li></ul><ul><li>Permissive governance structure - manipulation more likely </li></ul><ul><li>Lax board committees - audit, compensation, nominating and governance </li></ul>
    44. 44. Corporate Governance <ul><li>Majority independent board members – fraud less likely </li></ul><ul><li>Board and executive compensation —performance based </li></ul><ul><li>Conservative accounting </li></ul><ul><li>Transparent reporting – full and understandable </li></ul>
    45. 45. Corporate Governance <ul><li>Board oversight and “tone at the top” </li></ul><ul><li>Independent directors fact and appearance </li></ul><ul><li>Competent & vigilant – not asleep at wheel </li></ul><ul><li>Audit committee focus – audit, expertise, SEC investigations & past restatements </li></ul><ul><li>Compensation committee oversight, executive compensation, insider trading </li></ul><ul><li>Investment banking relationships </li></ul>
    46. 46. Legislative Reaction: SOX <ul><li>Strengthened governance -- independent directors, mandatory committees </li></ul><ul><li>Independent audit committee members and “financial expert” </li></ul><ul><li>Internal control attestation </li></ul><ul><li>CEO and CFO certifications </li></ul><ul><li>Tougher penalties </li></ul>
    47. 47. Legislative Reaction: SOX (Cont’d) <ul><li>Established PCAOB </li></ul><ul><li>A new regulatory structure for accounting firms </li></ul><ul><li>Tighter corporate controls </li></ul><ul><li>New disclosure requirements </li></ul><ul><li>New record retention requirements </li></ul>
    48. 48. Corporate Transgressions and Financial Gimmickry Jim Davidson, CFE, CPA, CFS Certified Corporate Director
    49. 49. <ul><ul><li>QUESTIONS? </li></ul></ul>

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