Famous Accounting Scandals in the Financial Hall of Shame
The world of business – like entertainment – has its own list of disgraced public figures. However, when it comes to accounting scandals, fraud undermines the confidence in the capital markets and harms innocent individuals, countries, and societies.
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Bank of Cocaine and Criminals International
How it All Began
This international financial scandal rocked entire nations and reverberated across the globe. The scandal’s roots began in 1972, when Pakistani businessman Agha Hasan Abedi founded Bank of Credit and Commerce International (BCCI) in Luxembourg. It chiefly served developing nations, and it operated 350 branches worldwide and was tied to about 70 countries at its apex.
The Last Chapter
BCCI boosted its American presence through control of the National Bank of Georgia, Independence Bank of Encino, and First American of Washington. However, Price Waterhouse uncovered BCCI’s wrongdoing and sent a report to the Bank of England. This led to banking regulators from numerous countries to seize BCCI in July 1991.
Financial institutions were frequently dumbfounded by BCCI’s “ability to offer exceptionally high rates of interest for deposits while undercutting the competition on loans.” Yet BCCI got busted for three reasons. First, they structured themselves in a manner that prevented control by any regulatory agency. They also never recorded accepted deposits, which helped cover losses and bad loans. Finally, deposits from leaders of developing nations were used to mask money-laundering activities for drug dealers.
Counting the Losses
Investigators have estimated losses as high as $15 billion, threatening the central banks of several Third World nations. Asian small-business owners and the central banks of Peru and Nigeria were among the scandal’s hardest-hit victims. Abu Dhabi sued BCCI’s executives in 1993; one year later, 11 of 12 former BCCI executives received jail sentences and orders to pay compensation, per the BBC. The scandal ultimately revealed serious banking regulation flaws in the U.S. and abroad.
Dodgy Bookkeeping with a Capital “B”
Executives at Japanese-based Toshiba Corporation invented their own numbers and were caught red-handed.
Tearing Through the Financial Cushion
From 2008 to the end of 2014, executives cushioned Toshiba’s operating profit by roughly $1.25 billion. The investigation led to the resignation of company president Hisao Tanaka in 2015, as well as multiple executives stepping down.
The Influencing Factors
Prior to the scandal, the company was looked upon as an example of corporate governance. However, it was determined that the company was excessively focused on meeting goals and producing expected profits, Investigations revealed “culture existed at Toshiba in which superiors’ wishes could not be defied.”
According to the Japanese Times report, there’s a strong focus in organization-based conformity in Japanese culture, and lifetime employment is prized. Experts have said corporate managers “need to create a work environment for diverse people, encourage them to express candid opinions and build a consensus rather than avoiding conflicts of opinions.” Ultimately, the scandal revealed the need for stricter corporate governance and diverse outside directors.
Wall Street Damsel in Distress
Perhaps the most infamous accounting scandal of them all is Enron.
Houston Natural Gas Co. and InterNorth Inc. merged to form Enron in 1985. Enron’s shares were worth $90.75 at the company’s height; when it declared bankruptcy, shares were worth $0.26.
Enron’s 2000 reported revenue compared to similarly-sized companies seemed to fall into the “too good to be true” category. Revenue for that year was alleged to be slightly over $100 billion. Texaco and Chevron, by way of comparison, reported revenues of roughly half of Enron’s. The roots of this claim trace to 1990, when Jeffrey Skilling was hired to head Enron Financial Corp. In 1992, Enron switched to a mark-to-market (MTM) accounting method, which allowed them to start recording estimated profits as actual profits. Meanwhile, Fortune named Enron “America’s Most Innovative Company” every year from 1996 to 2001.
In 2000, Enron started a project building high-speed broadband telecom networks but received almost no profit. To hide its losses, the company started building an asset and immediately recorded the projected profits, even if the project hadn’t yet produced profits.
If the asset’s revenue didn’t reach expectations, Enron would transfer the asset to a hidden corporation and write off unsuccessful activities without affecting its bottom line. In 1998, CFO Andrew Fastow hid Enron’s mountain losses by creating off-balance-sheet special purpose vehicles (SPVs) or special purpose entities (SPEs).
In this process, shares of Enron stocks transferred to SPVs in exchange for cash or notes. These stocks were used by the SPVs to hedge assets on Enron’s balance sheet. The company guaranteed the SPV’s value, reducing counterparty risk.
Because SPVs were capitalized with Enron stock, their ability to hedge Enron stock was compromised if the company’s share prices fell. Enron didn’t disclose conflicts of interest, although it did acknowledge SPVs’ existence to investors.
The Beginning of the End
Enron reports a $137 million loss on August 14, 2001, and their share price drops to $39.95. It would drop to $0.26 on December 2. On October 12, 2001, Arthur Andersen legal counsel directs Enron auditors to destroy all but the legal documents. However, less than a month later, Enron admits to inflating income by $586 million since 1997.
In January 2002, the Justice Departments launches a criminal investigation and Enron gets suspended from the NYSE. In June, Arthur Andersen is convicted of obstructing justice. Fast forward to May 2006, and Skilling gets convicted of fraud, insider trading, and conspiracy. He’s required to pay $42 million to Enron fraud victims. Additionally, former Enron chairman and CEO Kenneth Lay is convicted to commit securities and wire fraud. From 2004 to 2011, Enron pays out more than $21.7 billion to its creditors.
Regardless of how skillful accountants or executives may be with numbers, in the end, those numbers leave a trail that can be examined and analyzed. Following these astronomical financial scandals, regulating bodies have enacted more stringent laws and regulations to prevent any more “winners” from claiming their spot in the financial hall of shame.
Learn more about Ohio University’s online Master of Accountancy.