Corporate Financial Scandals - Research Paper Example

? Shakeel Waqas Shakeel McAuley Business: 701 5 November Corporate Financial Scandals The pages of history tell the story of numerous scandals including those of money laundering, Ponzi schemes, investment, accounting and many other scandals. All of these scandals are tied to corporate scandals. We live in a world where money means everything and certain individuals would do anything to be wealthy. It’s a world where man’s ego beats his moral and ethical responsibilities, and where people are willing to put thousands at risk just so they can obtain millions in return. The first reported scandal on Wall Street was in 1826, when 18 of the 67 companies listed on the New York stock exchange suddenly failed. And since then many companies have been involved in corporate scandals. Companies like Aol Time Warner, K-mart, Merck, Tyco, WorldCom, Global Crossing, Adelphia Communications, Arthur Anderson and the biggest of all Enron but the list goes on. Everything about Enron seemed larger than life. From its glittering Houston head quarter reaching to the sky to its spectacular downfall. But Enron’s collapse was more than just a shattering of one American success story. Enron was the climax of an avalanche of American companies that cost investors as much as 200 billion dollars by issuing deceptive financial reports. The company was formed in 1985 by Kenneth Lay, after the merger of Houston natural gas and inter-north. It was a natural gas, energy trading, and electrical utilities company which was based in Houston Texas. Before its bankruptcy, Enron employed roughly 21,000 people. At a point Enron was one of the seventh largest corporations in The United States. Enron was a shining star on Wall Street, and from 1996 to the early 2000’s it was named America’s “Best Managed and Most Innovative Company” by Fortune Magazine. The scandal was revealed in October 2001 and lead to the bankruptcy of Enron Corporation; which sent a huge wave of shock in the business world from its investors, to employees. Enron's collapse affected the lives of thousands of employees, many pension funds and shook Wall Street to its very core (Seabury). It also lead to the break up Arthur Anderson which was the 5th largest audit and accounting partnership in the world at that time. Many people have wondered how companies as big and successful as Enron can fail. It was the biggest audit failure and also the largest bankruptcy in American history of its time. By the late 2000 Enron had begun to crumble and fall apart. Jeffrey Skilling who was the CEO of Enron at that time was found scandalous in terms of hiding financial losses of the trading market and other aspects of the company by mark to market accounting. Mark to market is trading of securities when an individual determines what the actual value of the security is at that current moment. This can be harmful for other business but can work well for the securities. Mr. Skilling made a team of executives that which through the use of accounting loopholes and poor financial reporting was able to hide billions of losses from failed deals and projects. Enron’s board of directors and audit committee were misled by CFO, Andrew Fartow and other executives on high risk accounting practices. Moreover, the external auditor Arthur Anderson was also pressured to ignore such issues. Enron share price which had hit a high of $90 per share in mid 2000 fell to less than $1 a share by the end of November 2001 and share holders lost nearly $11 billion dollars. The US Security and Exchange Commission began an investigation and at the same time Dynegy, Enron’s Houston based competitor offered to buy Enron at a garage sale price. However, the deal fell through and on December 2001 Enron filed for bankruptcy. At that time, with assets of $63.4 billion, it was the largest corporate bankruptcy is US history. Many Enron executives were indicted for a variety of charges and sentenced to jail. A US court also found Arthur Anderson guilty but the ruling was later over turned by the US Supreme Court. However, by that time the firm had lost many of its clients and gone out of business. Despite losing billions in pensions and stock prices, employees and share holders received limited returns in settlements. Enron’s collapse brought about some revolutionary changes in corporate America. The Sarbanes-Oxley act was passed as a result of the scandal, expanding the repercussion for destroying, altering or falsifying records in government investigations of attempting to defraud shareholders. The act also called for auditing firms to become more accountable, unbiased and independent of clients. Board of Directors became more independent monitoring the audits and actively overseeing the managers’ practices and the Financial Accounting Standards Board (FASB) subsequently raised their ethical standards (Seabury). Another scandal is Tyco; a manufacturer of wide variety of products ranging from electronics to healthcare products. Just like Enron or any other successful company, Tyco’s success figures were quite impressive too. Mid 2001 Tyco announced to purchase the CIT Group, a commercial finance company and by the end of year Tyco’s stock closed at $59.76 on the New York stock exchange (USA TODAY). Business Week magazine listed Tyco CEO L. Dennis Kozlowski as one of the top 25 corporate managers of 2001. Formal charges made by the Security and Exchange Commission in September 2002. Executives of a company that operates in more than 100 countries employing approximately 240,000 people were charged for a $600 million fraud. As the investigation unfolded, SEC discovered that Mr. Dennis Kozlowski along with Tyco’s former CFO and chief legal officer, Mr Mark Swartz and Mark Belnick issued a loan of 170 million from the company’s account with little or no interest and subsequently wrote it off under their compensation plan. This was done without informing the compensation committee or the board. And it was also found that they sold 7.5 million shares for $430 million without bring it to the knowledge of the shareholders Kozlowski and Swartz were charged with Corruption, Conspiracy, Grand larceny and Falsifying records while Belnik was charged with deceptive financial reporting and failing to disclose loans made to investors and compensation committee. The investigation of book keepings by SEC started off in January with the immediate downfall of 19 percent in the stock value. Later in June of 2002 Kozlowski was accused of tax evasion. The trial took a serious turn when the Prosecutor showed the jury a video of a 2 million birthday party of Kozlowski’s wife along with a 6000 shower curtain of lavish Kozlowski owned apartment in Manhattan. The second trial took place in January 2005 and finally and in the mid of 2005, Swartz and Kozlowski were sentenced to up to 25 years in prison for stealing an estimated amount of 600 million dollars. Despite the scandal Tyco survived with Edward Breen replacing Kozlowski, who removed nine members of Tyco's original board as a precautionary act. “Tyco is not Enron,” Thomas Curran, a former New York City prosecutor said. “Tyco is a real company with a real business plan that still employs thousands of people. There are no retirees eating cat food because of Dennis Kozlowski.” (Ex-Tyco executives get up to 25 years in prison ) WorldCom, America’s second largest telecommunications company is next on the list. The company went through an accounting scandal of $7 billion in 2002. The company’s internal audit discovered that profits were improperly reported from 1999 to the 1st quarter of 2002. This however, was on top of the $3.8 billion the company had improperly reported as capital investments which was the first fraud the company discovered in June 2002. WorldCom said that most of the 3.3 billion misreporting was due to manipulation of the reserves which inflated company’s revenues (Tran). John Sidgmore, Chief executive of WorldCom, accused the CFO, Scott Sullivan and former controller, David Myers for the scandal. The two had reported regular expenses of 3.8 billion as capital investments by the Company. Company’s accounts were handled by Arthur Anderson, the same company that handled the accounts of Enron and Tyco. Arthur Anderson blamed Mr Sullivan for keeping information from them. Soon after that Security and Exchange Commission launched an inquiry, and by the end of 2003 it was discovered that company’s assets were inflated by $11 billion. (WorldCom Scandal: A Look Back at One of the Biggest Corporate Scandals in U.S. History). The company filed for chapter 11 bankruptcy protection in mid 2002 and eventually emerged out of it with a debt of $5.7 billion. Moreover, in 2005 Bernard Ebbers, company’s ousted CEO was found guilty of all charges and was sentenced to 25 years in prison. WorldCom was the industry benchmark; the demise of the company not only affected the company and its employees but the whole industry and the reputation of the American corporations. Later when the company’s records were audited, it was found that the total fraud amounted up to $79 billion. (Romar and Calkins) Next on the list is Adelphia Communications Corporation, which was a fifth largest cable Television Company headquartered in Coudersport, Pennsylvania. Due to misstatement of financial figure or internal corruption the company filed for bankruptcy in 2002. This raised a question as to how could the 6th largest cable operator having 6 million subscribers collapse within just a few months? In July of 2002, SEC filed charges against the corporation and its founder, John J. Rigas. The Same charges were also filed against his 3 sons and two senior executives who were suspected to be involved in the scandal. The investigations also showed that the firm was responsible for $2 to $3 billion of borrowing by Rigases. Moreover, Rigases misreported the financial statements and created sham transactions including overstating the number of cable subscribers. Finally on 8th july 2004, The Rigases and Mulcahey were charged with hiding $2.3 billion in debt at the cable company. This is one of the most interesting scandals to date, Global Crossing Limited,a voice and data carrier serviceprovider that delivers services to more than 700 cities in more than 60 countries worldwide. The company filed the 4th largest bankruptcies in the history of United States. Surprisingly, the scandal did not receive the same media coverage as Enron; which remained the largest and most devastating scandal of the time. Even though Global Crossing scandal ruined far more lives than Enron. Like Enron the company was involved in misreporting their accounts which were also handled by Arthur Anderson. The reason for no media attention was thought to be the $18 million earned by the Head of the democratic National committee, by selling his stocks just before it collapsed. Terry McAuliffe, Bill Clinton’s hand-picked Chairman of the Democratic National Committee invested 100,000 in company’s stock. He sold the stock in less than 2 years, just before the company’s collapse for 18 million, making a profit of 18000%. It was discovered that the company gave far more money to the Democrats than Enron. More surprisingly the failure was estimated to cost the tax payer billions of dollars as the company was federally insured. Gary Winnick, Founder of the company had donated 1 million to Clinton Presidential Library, which helped the company get a $400 million Pentagon contract. The scandal despite being bigger than Enron was deliberately kept behind the scene (Barrett). Howard Kurtz, media critic for the Washington Post, said that media bias was not the reason for lack of coverage; rather the reporters were too wrapped up in Enron leading the Global Crossing crisis to take a back seat. (Hall) Interestingly, although this scandal has been projected as to be caused by finanacial mis-statements the underlying reasons are extremely political in nature. Lastly, a current ongoing potential corporate scandal is the case of Olympus, a Japanese company that specializes in cameras and gastrointestinal endoscopes for which it has 70% of the global market. Olympus was founded as a pioneering Japanese manufacturer of micro scope and it branched into camera production in the 1930s. Two decades later it entered the gastro-camera market which has become its main scale profit earner. The scandal first hit the global headlines on October 14th, when the Michael C. Woodford, its ousted president raised questions about a series of irregular acquisition payouts amounting up to $1.3 billion. He told the board that the usual payments merited investigation, soon after which he was sacked on the grounds of his inability to grasp Japanese culture. Olympus’s new president, Shuichi Takayama said “no money flowed out” and the corporations value remained unchanged. (The Olympus scandal Big trouble in Tokyo). Shareholders remained unconvinced and its shares fell 29% in November and were 80% lower than they had been before Mr. Woodford was sacked. It is currently facing a deadline to issue its corporate results in order to avert a de listing from the Tokyo stock exchange as it has been placed on the watch-list for delisting. South eastern asset management which is the largest foreign shareholder in Olympus has called for an extraordinary meeting of share holders to sweep out all remaining directors and internal auditors after the company admitted to cover up of losses securities dating back to 1990s. The company is currently being investigated by authorities in Japan, UK and USA with the Tokyo police asking for internal accounting documents and seeking to question executives to see if financial laws have been breached. Recent development on the case revealed that Mr. Woodford, after the refusal of his demand for the entire management and board to step down so a fresh team can restore company’s reputation has resigned as the director. Sources suggest that this frees him from any limitations he might have faced being a director of the company and taking the investigation further. If Olympus is delisted, there will be a major loss of confidence in Japan’s capital markets and potential buyers would steer clear of Olympus as they would not be able to absorb its debt load and it would have a vast negative impact on foreign investment in Japan as now the scandal’s impact has spilled over the Japanese Corporate world and has harmed its reputation. (The Olympus scandal:Bowing out and barging in ) July 2002 marked the bankruptcy of several large public companies like Enron, WorldCom and Adelphia These scandals gave rise to emphasis on the role of ethics on business conduct.. American financial markets were shaken American Corporations’ reputation was at it low. It was believed that the capitalist system was in danger. Government’s reaction to these incidents was criticized to be too heavy handed, costly and even unnecessary but its positive impacts were far reaching. The democrats and the Republicans, both should be credited for stepping up by authorizing and supporting very strong enforcement response to the scandals. The Sarbanes-Oxley legislation as helped achieve transparency, checks and balances and greater accuracy of financial information like never before (Gray, Frieder and Clark). The government went far beyond this and said that it must punish those who have shattered the confidence of the American investors and employees. For this matter, President Bush established a Corporate Fraud Task Force in July 2002 which was responsible to root out corruption from the system. The task force has been very successful ever since its establishment. The reason for taking these steps was that increased regulation cannot completely remove all forms of abuse therefore vigorous criminal enforcements will send a strong warning to anyone attempting such scandalous behavior. Mr. Thompson also pointed out in his speech that the primary reason for such scandals was due to the corporate culture which has the power to encourage such practices that grow more and more problematic over time and result in such scandals. (Thompson) Corporate Scandals demonstrate what a company and its leadership is capable of, when they try to make profits at any cost. Moreover, modern corporation structures of public limited companies result in a divorce between an ownership and control. The decision makers are seldom the owners and as such can take decisions that serve their own narrow self interest and not the long term interest of share holders. The inherent conflict that is created by this dichotomy of interest has resulted in a number of famous and not so famous corporate scandals. The lesson learnt from the above mentioned cases is that if left unfettered, man’s natural instinct is to serve himself and benefit even at the expense of others. By no means are all corporate executives so self-serving, nor do all firms neglect their responsibility to their stake holders. However, a tougher legislation and regulation of corporate finances, independent audits and governmental oversight is required to ensure that corporations do not exploit in their quest for profits. Works Cited Barrett, Tom. The Real Scandal Is Global Crossing - Not Enron . 10th March 2002. Dec 1st 2011 . Ex-Tyco executives get up to 25 years in prison . 20 August 2005. 1st December 2011 . Gray, Kenneth R., Larry A. Frieder and George W. Clark. Corporate scandals: the many faces of greed : the great heist, financial bubbles and the absence of virtue. St. Paul, MN: Paragon House, 2005. Hall, Christine. Media Avoid Global Crossing's Scandal. 13 Feb 2002. 1 Dec 2011 . Romar, Edward J. and Martin Calkins. "WorldCom Case Study Update 2006." 2006. 1st Dec 2011 . Seabury, Chris. Enron's Collapse: The Fall Of A Wall Street Darling. 1st May 2009. 1st Dec 2011 . "The Olympus scandal Big Trouble in Tokyo." The Economist 12 Nov. 2011: 112. Print. "The Olympus scandal: Bowing Out and Barging In ." The Economist 1 Dec. 2011: 128. Print. Thompson, Larry D. "The Corporate Scandals, Why They Happened And Why They May Not Happen Again." 13 July 2004. Brookings. 1st Dec 2011 . Tran, Mark. WorldCom accounting scandal. 9 August 2002. 1st December 2011 . USA TODAY. 17 June 2005. 1st December 2011 . WorldCom Scandal: A Look Back at One of the Biggest Corporate Scandals in U.S. History. 8 March 2007. 1st December 2011 . Read More