This document discusses numerous corporate scandals and instances of financial misconduct. It lists over 50 companies that have been involved in scandals related to deceptive financial practices, executive fraud, and earnings manipulation. These scandals have led to billions of dollars in losses and economic damage. The document examines common factors like aggressive accounting, weak corporate governance, inflated executive compensation, and permissive cultures that allowed misconduct to occur. Major scandals like Enron, WorldCom, Tyco, and Adelphia are discussed in depth to show how deception and self-dealing led to their falls. Lessons are discussed around improving governance, accounting practices, and prioritizing ethics to prevent future scandals.

1. 1Corporate Transgressions and Financial GimmickryJimDavidson, CFE, CPA, CFSCertified Corporate Director

2. 2DEVASTATINGMillions & Billions LostDeceptive practices, executive fraud, shaken confidenceFinancial markets - billions evaporatedRecession – bankruptcies, savings, pensions, jobs lost, financial ruin Reputations, careers destroyed, imprisonment

3. 3Financial, Business & EthicalScandals and high profile casesManipulations, tricks & red flagsRepercussions–legal, financial, reputationLessons learnedCorporate culture -- “Tone at the Top”Management integrity

4. 4Scandals and TransgressionsAbholdADELPHIAANDERSENAOLBaker HughesBallyBausch & LombBristol-MyersCENDANTCitibankCMS Energy ($5.2 billion)COMPUTER ASSOCIATES

5. 5 Scandals and Transgressions (Cont’d)Credit Suisse First BostonDuke EnergyDynegyFleming CompaniesEDSEl PasoENRON ($85 billion)GATEWAYGaylord EntertainmentGLOBAL CROSSING ($9 billion)HaliburtonJ

6. 6Scandals and Transgressions (Cont’d)HEALTHSOUTHHomestoreInterpublicJDS UniphaseJP Morgan ChaseKimberly ClarkKmartLUCENTMartha StewartMerckMerrill LynchMicrostrategy

7. 7Scandals and Transgressions (Cont’d)MirandNicor EnergyNine WestNortelNorth Face/VF CorpParmalatPeregrine SystemsQUESTReliant Energy ($6 billion)Rite-AidRoyal Dutch/ShellSolomon Smith BarneySUNBEAM

8. 8Scandals and Transgressions (Cont’d)SquibbSybaseSymbol3ComTYCOVail ResortsVeritasWaste Management ($6 billion)WORLDCOM ($11 billion)XEROX ($6.5 billion)

9. 9Why the Scandals?Blamed high tech boomMeeting quarterly earnings Stock options, greed and short-term price manipulationHistorically, same result - speculative bubbles followed by crashesFiascos, corruption, business failures follow economic booms

10. 10Why the Scandals? (Cont’d)“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.”Final Accounting: Ambition, Greed, and the Fall of Arthur Andersen (Toffler)

11. 11Why the Scandals? (Cont’d)“Just a few”- rotten apple theorySpecific incentives – bonuses, excessive optionsInstitutional environment turns blind eye to unethical or illegal actsCulture allows egregious acts“It pays to do it, it’s easy to do, and it’s unlikely that you’ll be caught.” [Schilit]

12. 12Why the Scandals? (Cont’d)Incentives: Greed, power, egoOpportunity: –Weak governance – Corporate culture – Ineffective auditing – Lax regulation – Haphazard enforcement

13. 13Why the Scandals?(Cont’d)Rationalization:– “Everyone’s doing it.” “Wall Street expects it.”“Investment bankers engineered it.” “Our attorneys blessed it.” “Our auditors accepted it.”

14. 14Lessons of HistoryIt’s the incentives - GREED!Irrational exuberance - booms & bubblesRegulations not fool-proofCorporate cultureEthics, particularly at the top is key

15. 15TRUST BETRAYEDAll fraud by those we trust!CEO and/or CFO 80% of casesAnonymous survey of CFO’s:Two-thirds asked to participateOne-third admitted to doing so

16. 16Recent ScandalsGreed — more widespread than previous?Prominent industries - energy, high tech,telecommunicationsGiant firms – largest bankruptcies in historyEarnings manipulation central

17. EARNINGS MANAGEMENTWhat is it? How is it accomplished?How is detected?

18. 18Earnings Management Defined“Active manipulation of earnings toward predetermined target” {Mulford & Comisky}“Purposeful intervention in external financial reporting process with intent of obtaining private gain” {Shipper} “Intentional, deliberate misstatement or omission of material facts, or accounting data, which is misleading” {ACFE}

19. 19Gimmicks and Illusions:What? How? When?“Big Bath” charges –write-offs, over reserves, “cushions” ensure higher future earnings“Merger Magic”– write-offs, misclassifications & disguised costs so no future “drag”“Cookie-Jar Reserves” – income smoothing– “good time” over accruals and reserves used in “bad times”

20. 20 Earnings Management Tricks and Gimmicks“Materiality"– Intentionally recording errors within ceiling – “too small to matter”Revenue recognition – Accelerated, premature before delivery and with contingenciesConsignmentChannel stuffingRound-trips, swaps & barters to gross up salesBill and holdRelated party

21. 21 Other Tricks & GimmicksEarnings management - manipulation and outright fraudDiscretionarypolicies & estimates– capitalization, amortization, deferred expenses, inventory, judgments - bad debts, contingenciesLiability deception – Off-books complex schemes & webs, special purpose entities

22. 22Other Tricks & GimmicksRelated party loan guarantees, obligations, synthetic leasesExtreme tax avoidance (evasion ?), off-shore havens, questionable legal/tax interpretationsBlatant misstatements–disguised transactions and misclassifications- capitalized repair and maintenance

23. 23Self-Dealing – Questionable and UnauthorizedDisguised executive compensation“Evergreen” stock optionsExcessive perks & misused fundsUndisclosed related party transactions and self-dealing – personal “piggy-bank”

24. 24Earnings Management EnvironmentOverbearing CEO with substantial egoFew independent directorsInadequate board committee structureExcess executive compensation and perksPoor control structure and culture – “tone at the top”

25. 25DECEPTION– LIABILITIESSpecial purpose entitiesOff-books complex schemes and webs - nonconsolidated debtRelated party loan guarantees, contractual obligations, synthetic leases

26. 26Aggressive Tax SheltersOff-shore tax havens, shelter deals, questionable legal/tax accounting interpretationsComplex series of loans, extreme tax avoidance and possible evasion

27. 27Questionable, Unauthorized FundsDisguised executive compensation“Evergreen” stock optionsUndisclosed related party transactions/self-dealingInadequate, ineffective corporate governance

28. 28Earnings RestatementsPreviously rare, increasingly commonHighly suspect manipulation & deceptionOver 900 restatements 1999-mid-2003 (GAO)Nearly 1,000 recent restatements Predominantly revenue recognition20% of 2001 SEC enforcements accounting related, increasing in 2002 - 2004Market reaction: Significant stock price declines

29. 29ENRONLargest bankruptcy 2001 7th largest corporation - $1.2 billion equity reduction in quarterManipulation and deception -- special purpose entitiesCongressional hearings, revolutionary changes -- regulatory, governance, scrutiny

30. 30EnronExtreme use SPEs for blatant manipulationInitial use to grow company, managing riskMore complex SPEs to record future services as current income using “mark-to-market”Extensive conflicts of interest & related-party transactions

31. 31Enron (Cont’d)Gas trading to electricity, risk management, telecom, and expanding internationallyBased on economic-based assessments, many ventures were failuresBased on manipulations and deception, all were successful

32. 32Enron (Cont’d)Energy trading: spot market purchases volatility drove demand for risk management and related derivativesMassive debt and potential junk bond ratingsUsed special purpose entities to reduce perception of too much debt

33. 33Enron (Cont’d)Focused on meeting quarterly earningsInitially cost savings, but increasingly more gimmicksScheme 1: Revalue physical assets using “fair value” models (SFAS 125, designed for financial assets)—front-loading profitsScheme 2: Complex and mishandled SPEs to record earnings

34. 34Enron(Cont’d)CFO manipulated for own enrichment - independence problemQuestionable SPEs approved by attorneys, auditor/Andersen and boardAccommodated by investment banks and no apparent SEC oversight

35. 35Enron(Cont’d)Some operations major blundersDramatic increased risk but unwillingness to disclose lossesStock price dropped, executives bailed out of stock, ratings to junkRestatements in 2001and subsequent bankruptcy Largest ever bankruptcy until …

36. 36WorldComGrowth through mergers & acquisitions $100+ billion assets (with half intangibles)Debt to equity of 79.3%$11 billion + capitalized operating expenses

37. 37WorldCom(Cont’d)WorldCom restated earningsAndersen firedCFO and CEO firedWorldCom bankruptcy 2002Replaced Enron as largest bankruptcy in US history,

38. 38TycoConglomerate through acquisitions “Deal a Day Dennis” Kozlowski acquired 750 companiesMerger magic CIT acquisition fiasco showed Tyco’s shenanigans

39. 39Tyco(Cont’d)CIT $9.4 billion loss for 2002Kozlowski indicted for evading taxes & “raiding” TycoObvious manipulation & deception Not clear criminal acts

40. 40AdelphiaFifth cable & communicationsRestatements - billions off-balance-sheet “co-borrowing agreements”Rigas family fraud and significant self-dealingBankruptcy 2002

41. 41What do Enron, WorldCom, Tyco, Adelphia have in common?Massive deception, manipulation, self-dealingGrowth through acquisitionsAcquisition accounting abuseTargeted earnings focused Enrichment of senior executivesAccommodating auditors & boards of directors Restated financials

42. 42What Happened at Andersen?Long-time reputation for integrity and professionalism“Aggressive auditing” beginning in ‘80sClients too valuable to defy (Toffler)Major client scandals: Sunbeam, Global Crossing, Waste Management, Enron, WorldCom & Guilty of obstruction of justice

43. 43Governance Red FlagsCEO also board chairmanExecutive ego and dominance Permissive governance structure - manipulation more likelyLax board committees - audit, compensation, nominating and governance

44. 44Corporate GovernanceMajority independent board members – fraud less likelyBoard and executive compensation —performance based Conservative accounting Transparent reporting – full and understandable

45. 45Corporate GovernanceBoard oversight and “tone at the top”Independent directors fact and appearanceCompetent & vigilant – not asleep at wheelAudit committee focus – audit, expertise, SEC investigations & past restatementsCompensation committee oversight, executive compensation, insider tradingInvestment banking relationships

46. 46Legislative Reaction: SOXStrengthened governance -- independent directors, mandatory committees Independent audit committee members and “financial expert”Internal control attestationCEO and CFO certificationsTougher penalties

47. 47Legislative Reaction: SOX (Cont’d)Established PCAOBA new regulatory structure for accounting firmsTighter corporate controlsNew disclosure requirementsNew record retention requirements

48. 48Corporate Transgressions and Financial GimmickryJim Davidson, CFE, CPA, CFSCertified Corporate Director

49. 49QUESTIONS?