There is an Italian proverb: “Big mouthfuls often choke”. The sentiment is particularly appropriate when it comes to the temptations for those in charge of vast sums of money in the financial accounting of large companies. Accounting scandals occur in business when there is intentional manipulation or misrepresentation of financial statements. These offences often involve complex practices for misusing or mismanaging funds, overstating revenues or the value of assets, or underreporting outgoings or the value of liabilities. Here, we look at three examples of corporate accounting scandals that genuinely shook the world.
Waste Management, Inc. Fraud Scandal, 1998
A waste management scandal sounds like a plotline from The Sopranos. Established in 1894, Waste Management, Inc. went on to provide environmental services to almost 20 million customers across North America, generating about $82 million in revenue by the 1970s. However, in 1998, the many murky accounting practices of those at the very top of the Waste Management were eventually exposed. The list of financial frauds they committed between 1992 and 1997 is almost endless and in doing so appeared to eliminate $490 million from the company’s operating expenses, in an attempt to meet predetermined targets for earnings. Examples of these ploys include not counting depreciation expenses on company assets such as garbage trucks, and not recording the expenses of unsuccessful landfill development projects.
As a publicly traded company, Waste Management were required to have their accounting books audited. For this they enlisted a large independent auditing firm, Arthur Andersen, who had a rather cosy relationship with their board of directors. Sure enough, by effectively bribing Arthur Andersen, any fraudulent activities were overlooked.
Once the revelations did surface, Waste Management's shareholders lost more than $6 billion in the market value of their investments as the stock value tumbled by more than 33%. In the end, the company paid $457 million to settle a shareholder class-action suit in 2003, and Arthur Andersen was fined $7 million for its role.
Enron Scandal, 2001
Arguably the most infamous accounting scandal of them all, the 2001 bankruptcy of Enron had global repercussions. Once regularly considered America’s most innovative company, Enron was a U.S. energy trading firm that grew to dominate the U.S. electricity industry, eventually building power stations and electricity grids, providing broadband, and trading in many other areas.
However, by exploiting loopholes in the accounting rules of the time - specifically the ‘mark-to-market’ system of valuing assets by the most recent market price - Enron’s CFO and other executives booked assets as profit without any actual value. One example that explains this method is when Enron and Blockbuster Video signed a 20-year deal to introduce an on-demand entertainment service by the end of the year. Following several pilot projects, Enron recognised in their books estimated profits of more than $110 million from the deal, despite the explicit misgivings of analysts about the viability of the service. The service didn’t work and Blockbuster pulled out of the deal, but Enron continued to recognise the future profits from the deal, even though it had actually resulted in a loss.
To maintain the deception, a big auditing firm – you guessed it – Arthur Andersen were brought in and encouraged to turn a blind eye, perhaps due to their significant audit and consultancy fees, and even shred documents related to its audit of Enron. Once these debts were revealed, the company collapsed, removing $74 billion of shareholder funds, costing the pensions and jobs of thousands of employees. Also, this was the final straw for the auditing firm Arthur Andersen, which folded following this and many other high-profile illegalities.
The Collapse of Lehman Brothers, 2008
The Enron scandal might be the most infamous, but not many in recent times have had the impact that the collapse of Lehman Brothers had. It’s still the largest bankruptcy in U.S. history, with Lehman holding over $600 billion in assets. One of the many contributing factors to its demise was their use of a specific accounting manoeuver, which they called Repo 105.
Through this process of ‘creative accounting’, Lehman were able to classify short-term loans as sales and then use the cash proceeds from these ‘sales’ to reduce its liabilities in time for the year-end financial report. After the reports were published, Lehman then borrowed cash and repurchased its original assets. Using Repo 105, Lehman was able to artificially reduce its balance sheet by $50 billion.
In June 2008, Lehman announced a second-quarter loss of $2.8 billion and, following a failed takeover from state-run Korean Development Bank, investor confidence plummeted as Lehman’s stock lost around half of its value over concerns about the security of the bank.
Things moved quickly and on 10 September 2008 Lehman announced a loss of $3.9 billion. The following day, with the company searching for a buyer, its stock price dropped another 40%. Less than a week later, with shares tumbling 90%, they filed for bankruptcy. Global markets plummeted and it is generally held that Lehman’s collapsed played a major role in the subsequent global financial crisis, the effects of which are still being felt almost 10 years on.