The Worst Accounting Scandals At U.S. Companies
Accounting scandals are the consequence of the intentional manipulation of financial statements with the disclosure of financial misdeeds by trusted executives that typically involve complex methods for misusing or misdirecting funds, overstating revenues, understating expenses, overstating the value of corporate assets, or underreporting the existence of liabilities.
There are essentially two types of fraud. Fraudulent financial reporting sees management at public and private corporations intentionally manipulate accounting policies or accounting estimates to improve financial statements. Management can commit fraudulent financial reporting to secure investor interest or obtain lender approvals for financing, or as justifications for bonuses or increased salaries or to meet investor expectations Meanwhile, misappropriation of assets happens when an employee steals a company's asset, such as cash (or cash equivalents), or company data or intellectual property.
Let’s take a look at some of the biggest accounting scandals at U.S. companies – all of which happened in the first decade of the 21st century.
Enron
The Enron scandal in 2001 is seen as one of the biggest audit failures of all time. Top executives at the Houston-based energy trading company use accounting loopholes within the GAAP (General Accepted Accounting Principles), poor financial reporting, and special purpose entities to hide billions of dollars in debt from failed deals. The classification of the huge debt by designating it as an off balance sheet item was partly exposed by internal whistleblower Sherron Watkins. Senior executives misled the board and audit committee about their high-risk accounting practices and put pressure on Arthur Andersen, the firm’s auditor, to ignore issues. $74bn worth of investors’ money was lost as well as thousands of investors and employees who lost their retirement funds. Enron CEO Jeff Skilling was found guilty of fraud and conspiracy in 2006 and sentenced to 24 years in prison. He is now out of jail and is reportedly seeking backers for a venture that the Houston Chronicle says “would combine the hallmarks of his former company: energy, technology and trading.” Arthur Andersen went to the wall as a result of its involvement in the scandal.
WorldCom
In July 2002, WorldCom filed for bankruptcy protection after underreporting expenses by capitalizing them while at the same time inflating revenues by using fake entries. It was at the time considered to be the largest corporate insolvency ever. The Clinton, MS., headquartered long-distance telephone company's internal auditors identified more $3.8bn in illicit accounting entries that were designed to mask worsening earnings. WorldCom eventually admitted to inflating its assets by $11bn. Meanwhile, 30,000 people lost their jobs. WorldCom, by then renamed MCI, was acquired by Verizon Communications in January 2006. WorldCom CEO Bernie Ebbers was sentenced to 25 years in prison for charges of fraud and conspiracy. He died at his home in Brookhaven, MS., on February 2nd, 2020 at the age of 78, just over a month after being released from prison due to health issues.
Tyco International
In 2002, Tyco International former chief executive Dennis Kozlowski and former chief financial officer Mark Swartz were accused of the theft of as much as $600m from the firm. Tyco, which was nominally based in Bermuda for tax purposes but operated out of Exeter, N.H., and Boca Raton, owned dozens of companies that manufactured products ranging from surgical instruments to security systems. In their March 2004 trial, the pair were accused of embezzling around $150m and inflating the company’s income by $500m. The trial ended in mistrial and a retrial took place the next year. At this 2005 trial, they were both declared guilty of more than 30 individual corporate violations. Both Kozlowski and Swartz went to prison and the company had to pay $2.92bn to investors. Kozlowski later admitted his culpability at a parole hearing. “It was greed, pure and simple,” he told a New York State parole panel. “I feel horrible ... I can't say how sorry I am and how deeply I regret my actions.” He now lives between New York City, Florida and Nantucket and runs several businesses with his wife. Swartz was released from prison in January 2014 for demonstrating good behavior after serving the mandatory sentence of the minimum eight years in prison. He maintains his innocence with regard to the fraud convictions.
Lehman Brothers
During the global financial crisis that wracked money markets and the wider world in 2008, a probe by the Securities and Exchange Commission found that New York headquartered investment banking giant Lehman Brothers had artificially reduced its balance sheet to the tune of $50bn using an accounting manoeuver called Repo 105. Using the “creative accounting” opportunities provided by Repo 105, Lehman was able to classify short-term loans as sales to remove the appearance of toxic assets and then use the cash proceeds from these ‘sales’ to reduce liabilities ahead of the company’s year-end financial report. After the reports were published, Lehman then borrowed cash and repurchased its original assets. The company went bankrupt in the aftermath. The events of the weekend leading up to Lehman's bankruptcy were dramatized in The Last Days of Lehman Brothers, a 2009 UK-made television movie. A 2011 HBO movie, Too Big to Fail, recounted the days before Lehman Brothers declared bankruptcy and the fallout afterwards.
These scandals are just four of the many that have made the last two decades a particularly fraught time for the reputation of the corporate world. The scandals led to the loss of billions of dollars and decimated entire organizations, and negatively impacted the lives of tens of thousands of people. Some of the episodes have been the consequence of the actions of a group of people while others are the result of the deeds of a few. Either way, the Italians have a proverb for it: “Big mouthfuls often choke.”
