Fraud in Corporate America

Research Case 1: Fraud in Corporate America

        Financial fraud occurs when an individual or individuals knowingly and willfully deceive their company with false accounting entries and financial statements. Many do this to benefit financially or to elevate their position, as the financials are a “reflection” of a job well done. For the executives at Waste Management, meeting predetermined earnings targets was the driving force for cooking the company’s books. By using inflated earnings, management was able to receive performance-based bonuses, keep their high-paying jobs, and receive stock options, all of which lined their pockets on the investors’ dime (Fraud at WM). CEO Dean Buntrock personally benefited from this fraudulent behavior by receiving a tax benefit after “donating” inflated company stock to his college alma mater; the school would later name a building after him for his thoughtful donation (Fraud at WM). Meeting aggressive earnings targets was also an issue at Enron, where the work culture was so cut-throat, that employees were scared to use the bathroom for fear a coworker would pry into their computer. High dollar incentives for short-term results propelled the senior executives at Enron, including former CEOs Jeff Skilling and Ken Lay, to encourage deceptive reporting of financial statements, which in turn, boosted the stock price of the company (Albrecht). The stock price was directly correlated to these executives’ earnings and, as a base six figure salary was no longer cutting it, greed became a strong motivator for engaging in fraudulent behavior. Greed seemed to be the only motivator for WorldCom’s CEO Bernie Ebbers and CFO Scott Sullivan. Ebbers managed to convince the board to loan him $366 million to cover losses on stock, which was never repaid, and also secured loans from WorldCom to fund personal investments nearing $800 million (WorldCom Fraud). Ebbers also succeeded in netting $140 million from stock sales, which was just a little over three times the take-home income of Sullivan. In order to net $140 million, Sullivan did not convince the board to square away losses, but rather, he directed his staff to make false accounting entries to support the ongoing fraud (WorldCom Fraud). Between unconstrained greed and meeting the high standards of the investors, board, and stock market; CEOs, CFOs and other senior executives at these companies only needed any and one reason to commit to fraudulent behavior.

        As an individual not directly impacted by any of the three scandals, I knew very little other than that the name Enron is synonymous with corporate fraud and greed. After researching the three scandals caused by a select few, truly understanding the devastation left to many Americans is hard to digest. All three scandals occurred around the same time, dealing a hard blow to the credibility of financial statements and to Arthur Andersen, the firm that approved them. Andersen’s CPA license was consequently suspended due to all the auditing failures, costing many honest people their jobs. Despite the ruling being reversed and, subsequently, Andersen’s license being reinstated, investors and the public lost any faith they may have had in the reliability and transparency of financial statements. Legislation was passed in order to assure investors that fraud could be combatted, but the damage of loss in jobs, retirement accounts, and investments. The Enron, WorldCom, and Waste Management scandals could have been avoided if proper auditing rules and ethical propriety were exercised (Sherman). The select few that created and perpetuated this deceit to line their pockets had no regard for anyone but themselves (Prentice). Though some restitution was paid, it was not enough for the many that lost pension funds, retirement and savings accounts, and secure jobs with which to provide for their families in the aftermath of the scandals.  

        These frauds were made possible by manipulation of the financial statements, with each specific scandal having an expert that knew how to lie or work around accounting principles. For Waste Management, Anderson Accounting firm was the mastermind behind cooking the books, which ultimately led to a restatement of $1.7 billion in 1998 (Fraud At WM). The fraud occurred by manipulating the depreciation schedule for plant, process, and equipment (i.e. extending the useful lives and inflated salvage values of garbage trucks), refusing to expense write-offs associated with unsuccessful and abandoned landfill development projects and instead allocating inflated book values to the defunct projects. Waste Management also inflated the liabilities so that a reserve “cookie jar” account could be later used to avoid recording operational expenses, and failed to establish enough reserves in liabilities to pay for future income taxes and other forward-looking expenses (Fraud At WM). All of this happened over a period of ten years where Waste Management executives capitalized various expenses to cover the fraud and ensure the financials met profit targets, through inflated and underreported figures. For Enron, deceptive use and exploitation of financial statements helped line the pockets of the executives behind the fraud. Enron employed Special Purpose Entities to hide and manipulate reported earnings and revenues by hiding debts off balance sheet, which in turn, resulted in twenty consecutive quarters of increasing income (Albrecht). Enron also used a “mark-to-model” accounting approach that allowed them to realize large revenues from contracts, though many of the contracts were never recognized (Thomas). As Wall Street saw a positive trend for earnings, they did not question the validity and obscurity of Enron’s financials, and would later realize that there were no true cash flows associated with the revenues booked. It should be noted that Anderson was firmly behind these malpractices of accounting, and even went as far as obstructing when an investigation was under way. They also certified the fraudulent financial statements reported at WorldCom, which resulted in assets inflated by as much as $11 billion. This fraud was made possible by underreporting line costs that should have been expensed, but instead were recognized and capitalized as long-term investments, and inflated the revenue with fake accounting entries (WorldCom Fraud). For two years, WorldCom reduced reserve accounts meant to cover liabilities, but instead, allocated the reduced amount of $2.8 billion to revenue. When reducing the reserves was not enough, CFO Scott Sullivan directed his staff to remove computer expenses from the income statement and change it to an asset on the balance sheet which increased both retained earnings and net income. With Andersen’s sign of approval, all three companies were able to defraud many investors, employees, and the stock market, which ultimately led to misfortune for most of those affected.