Accounting Frauds
Accounting Frauds
Accounting Frauds
ENRON
Enron is the premier scandal, a "new economy" energy-trading company
that seemed to succeed at ever3^hing it attempted. At its height, which
occurred on August 23, 2000, Enron had a stock price over $90, which
gave it a market value of almost $70 billion. Revenues for 2000 were
over $100 billion, making it the seventh-largest American corporation
(based on revenues); stated assets were $65.5 billion; earnings were $1.3
billion (if a $287 million vmte-off is ignored). Stock returns for Enron
were large, 89 percent just for the year 2000 and 700 percent for the
decade. This performance resulted in huge compensation payments to
GAS TRADING
Until the 1980s, natural gas was highly regulated and gas prices
controlled. Gas contracts were mainly long term and relatively little
risk was present for buyers and sellers. Pipeline profits were fairly low
but dependable. That all changed with deregulation. With volatile gas
prices subject to market conditions and the potential for lower prices,
gas users moved fi;om long-term contracts to the spot market (initially
30-day supply contracts). In this now unstable market, prices initially
fell, supply dropped, and prices rose again.
This was not a profitable environment for a pipeline company.
Lay's business strategy shifted to the unregulated gas sales market,
which lent to Enron's gas-trading business. Enron bought and sold stan-
dard amounts of gas and became a market maker, initially from the
standard spot market contracts. As their expertise increased, Enron
traders moved to offering longer-term contracts, for which they could
POLITICAL PRESSURE
As an S&P 500 company willing to bully anyone, Enron applied pressure
to the auditors, investment bankers and analysts, and pohticians at the
federal and state levels. In most cases, the main reason for influence
was cash—the funds Enron was v^àlling to spend on investment banking
deals, consulting contracts to the auditors, pohtical contributions, and
so on. In fact, Enron really did not have that much real political clout
WorldCom
By the middle of 2002, the financial and political worlds stopped h3^er-
ventilating about Enron and business as usual was returning. Then
came the announced bankruptcy of WorldCom on July 22, 2002 after
the discovery of almost $4 billion in accounting irregularities in June
(later to rise to $11 billion), replacing Enron as the largest failure in
American history. WorldCom listed assets of $107 billion (and a market
value that peaked at $115 billion in 1999), compared v«th Enron's $63
billion. Business as usual was no longer possible. Serious reform resur-
faced, including Sarbanes-Oxley in a slightly watered-down version of
the original bill. Former WorldCom chief financial officer (CFO) Scott
Sullivan was charged in the multibillion dollar accounting fraud;
Tyco
Tyco started as a research lab in 1960, only to be transformed into a
conglomerate through acquisitions. Dennis Kozlowski became presi-
dent and chief operating officer (COO) in 1989, then CEO in 1992. He
earned his "Deal-a-Day Dennis" nickname with 750 acquisitions, with
up to 200 in some years. Earnings magic based on business combina-
tion accounting gave the impression of substantial growth and rising
earnings. Revenues rose almost 50 percent a year from 1997 to 2001.
With the $6 billion acquisition of ADT Security Services, the acquisi-
tion was structured as a reverse takeover so that Tyco could use ADT's
Bermuda registration to shelter foreign earnings. The SEC started an
Adelphia
John Rigas turned a local cable franchise into a communications
empire, including high-speed Internet, cable, and long-distance phone
service. In May 2002, Adelphia announced the earnings restatement for
2000 and 2001, including billions of dollars in off-balance-sheet liabili-
ties associated vwth "co-borrowing agreements." The company filed for
bankruptcy in June 2002, following an SEC suit charging Adelphia and
several executives with extensive financial fraud: "Adelphia, at the direc-
tion of the individual defendants: (1) fraudulently excluded billions of
dollars of liabihties from its consohdated financial statements by hiding
them in off-balance-sheet affihates; (2) falsified operation statistics and
inflated Adelphia's earnings to meet Wall Street expectations; and (3)
concealed rampant self-dealing by the Rigas family" (GAO, 2002:122).
Aldelphia also created sham transactions and false documents
indicating that debts were repaid, rather than shifted to afnUates. Self-
dealing by the Rigas family included using Adelphia funds to purchase
stock for the Rigas family, timber rights, construct a golf club, pay off
margin loans of various family members, and purchase several condo-
miniums.
The financial statements of Adelphia indicated a company with
problems. The last 10-K filed (for the fiscal year ended December 31,
2000) showed a net loss of $548 million, vdth losses also in 1998 and
1999. The last 10-Q. (for the September 2001 quarter) also showed
continuing losses. Of $21.5 billion in total assets, $14.1 billion were
intangibles (primarily goodwill). Liabilities totaled $16.3, while equity
was only $4.2 bilhon. And that is after they cooked the books!
Adelphia indicates the importance of corporate governance.
Included on Adelphia's nine-member board of directors were five Rigas
CONCLUSIONS
This paper described the major twenty-first-centuiy business scandals,
with particular focus on Enron. Enron was a case of sophisticated fraud
over an extended period, specifically to manipulate, quarterly earn-
ings to maintain the vast compensation of key executives. WorldCom
was a big company with a case of simple fraud (capitahzing operating
expenses), with the same result: bankruptcy. Combined with other
corporate scandals, the result was the Sarbanes-Oxley Act of 2002 to
improve regulation and oversight, a quick and broad-based federal
response to these problems.
The early twenty-first century has proved that the business cycle
still exists and corporate scandals are not a thing of the past. Greed
and hubris are recurring themes in these as in earlier scandals. There
are obvious differences. Considerable oversight and regulations exist—
they just were not effective when not adequately enforced. Somewhat
unusual were the scandals at really big companies and the fraudulent
schemes coming from the executive offices. Most frauds are at smaller
companies and at lower levels in big companies.
The incentives were somewhat different. Two interrelated prob-
lems are relatively new: executive compensation and meeting analysts'
forecasts. It has always been the money, but the compensation levels
beginning in the 1990s became huge and driven especially by stock
options. To make that work, quarterly earnings targets had to be met.
The result was higher stock prices. As stock prices peaked in the 1990s,
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