Leonard Dennis Kozlowski (born November 16, 1946) is a former CEO of Tyco International, convicted in 2005 of crimes related to his receipt of $81 million in purportedly unauthorized bonuses, the purchase of art for $14.725 million and the payment by Tyco of a $20 million investment banking fee to Frank Walsh, a former Tyco director. He is currently serving 8.33 to 25 years at the Mid-State Correctional Facility in Marcy, New York. His earliest release date is January 17, 2014, when he becomes eligible for parole
In 2005, he was convicted of fraud and conspiracy as a result of WorldCom's false financial reporting, and subsequent loss of US$100-billion to investors. The WorldCom scandal was, until the Madoff schemes came to light in 2008, the largest accounting scandal in United States history. He is currently serving a 25-year prison term at Oakdale Federal Correctional Complex in Louisiana.
Houston energy company failed in 2001. Symbol of corporate greed and corruption .Bogus accounting. Created fake blackouts and shortages so company could raise electricity prices and book huge profits. Enron ruined Arthur Andersen, one of the nation’s top accounting firms.
In March 2009, Madoff pleaded guilty to 11 federal felonies and admitted to turning his wealth management business into a massive Ponzi scheme that defrauded thousands of investors of billions of dollars.
How to Spot Financial Trouble at Companies
How companies play games with numbers
By Mark Tatge
Aggressive accounting is rewarded.
Higher numbers = higher stock price.
Bigger piece of CEOs compensation tied to stock.
Accountants hired and paid by the company.
• Firm provides the numbers.
• Most companies are honest.
• But fraud has been on the rise.
Why fraud occurs
• If a company is going to
deliberately falsify a financial
statement – it will be very
difficult to find.
• Deal with what is publicly
disclosed – not what we can’t
• Are the statements you are viewing audited?
• Are the statements prepared in accordance
with Generally Accepted Accounting Principles
• Are they based on cash or accrual?
• Are you viewing more than one period’s data?
Concept: Basic rules
• Companies are supposed to match
each revenue item with its
Concept: Matching Principle
• Recording fake or bogus revenue
• Boosting income on one-time gains
• Recording revenue too soon, or
revenue of questionable quality.
• Release of excess reserves – to cover
Watch for revenue games
• Companies also play games with
expenses – but if there is going to
be a problem it will most likely be
on the revenue side of the
• Companies are supposed to match income
with the corresponding expense.
• The period where the revenue is
recorded, the expense used to create that
revenue should be expensed.
• But some companies will defer expenses
until a later period of time.
Tip 1: Deferring expenses
• AOL in 1994 decided to exclude current marketing
costs in its profit.
• Instead of immediately expensing these costs –
AOL shifted them to the balance sheet as an asset
and charged them off in future periods.
• This decision had the impact of inflating AOL’s
profits since it did not expense market costs.
• These costs were amortized over time.
Lesson: marketing costs
• Companies that plan to merge or divest often
will come up with “pro-forma” earnings.
• Pro-forma is supposed to be an estimate of
what the firm will be after the merger.
• Often based on inaccurate assumptions.
• Management will include or remove net
income that it feels is not “material” to the
remaining operations of the company.
Tip 2: Pro-forma earnings
• Has the company
• The change may
have occurred due
to a disagreement
Tip 3: Firing auditors
• Companies often bury important documents and
then reference them in reports.
• Finding the detail means looking through several
levels of reports dating back quarters, or in some
• 8Ks are a catchall – may be changes in CEO
compensation agreement, changes in accounting
policies, even changes in auditors.
Tip 4: Burying Exhibits
• How a company
accounts for the value
of its inventory can
have a big impact on
Tip 5 – Fudging Inventory
• Inventory are goods that are
finished and available for sale.
May also be “raw materials” used
in finished goods.
• The company must actually sell
these goods to produce cash.
• The value of a
inventory is found
on the balance
as an asset.
• Executives faked inventory to borrow
• Told the lenders the money was for
• Pharmor needed the cash to pay suppliers.
• Pharmor was forced to file bankruptcy.
• Founder and CFO sent to prison.
Lesson: Pharmor (1992)
• Companies are expected to use a single standard in
measuring the value of inventories.
FIFO – First in- First Out
LIFO – Last in – First Out.
LIFO - charges the latest (or last inventory) costs first
FIFO – charges the earliest (or oldest) costs
Companies are required to pick one method and are
not allowed to keep switching back and forth
• In times of rising costs, the differences can be
substantial. If a company switched to FIFO –
this would produce much higher profits.
• Beware of stock buybacks.
• Flashes sign company is confident in its
• Should the company be doing something
different with its cash?
• Buyback artificially improves earnings per
Tip 6: Stock buybacks
EPS = Net earnings / Outstanding shares.
$10 million / 5 million shares = $2.00 EPS
After 3 million share buyback
$10 million / 2 million shares = $5.00 EPS
Concept: Boosting EPS
• Companies are forced to set aside
funds to cover defaults, decreases
in asset values, inventory
• The asset reserve or pot of money
set aside is expensed and reduces
Tip 7: Shell games
• As assets are written down, the amount of the
written down is charged against the reserves.
• If a company has set aside too much – it can
• Failing to reserve enough to cover potential losses
boosts profits – firm’s expenses are less.
• Recapturing extra funds set aside in reserves – can
also artificially boost profits for a given quarter.
Shell games to watch
Cash flow – is often more important to earnings.
How much cash flow is the company generating?
How much cash is the company burning?
Does the company have enough cash to cover its
Tip 8: Pay attention to cash
• Subtract current liabilities from current assets. The
calculation tells us how much in liquid assets the
company has on had to pay its debts during the next
Lesson: Cash Flow
• As you can see using the figures from Dell's
abbreviated balance sheet, we have approximately
$1.48 of current assets to cover every dollar of
liabilities. This is OK, but nothing superior. A better
margin of comfort would be a 2-to-1 ratio.
Lesson: Cash flow
• Companies understate liabilities. This inflates
• Best example of this is pension and retiree health care
• Has the company signed contracts or agreed to
contingencies that could cost it dearly?
• Merger breakup fees
• Legal obligations / pending lawsuits
• Contractual arrangements with vendors.
Tip 9: Understating Liabilities
• GM and many
cities and states
Lesson: GM Pension Mess
• Watch filing deadlines.
• If a company misses or delays filing a 10Q or 10K –
it usually means something is wrong. Company may
be faced with:
Bankruptcy or liquidation.
Face a large charge against earnings.
Re-valuation of assets or the business.
Restatement of past financial results.
Tip 10: Blowing deadlines
• No one item on this list is a silver bullet.
• Uncovering problems often involves being a careful
reader of financial statements and drawing
• If you don’t understand then ask. (e.g. Enron)
• If the company can’t explain it – you probably have
• It if looks too good to be true – it probably is.
A few parting thoughts…