A Timeline on Accounting Fraud Scandals, What Have We Learnt from the Past and Should Expect for the Future.
1. WIRECARD – ANOTHER STAIN IN OUR TIMELINE
Once again, accounting fraud is on the news. WIRECARD’s case surely made Germany’s financial base tremble, but not after several warnings directed by FINANCIAL TIMES (“FT”) as well as several investigators, accountants, and industry-related experts. All of which were unattended.
The fall of such a shady company, secretive as it was, only depended on time. Those who knew that the business was not going through the right path, that the truth behind WIRECARD’s success was frightening, found that its drop was happening sooner than later.
We, compliance officers, risk managers, accountants, lawyers and readers from all of the finance and banking ecosystem, gather around thinking in the same direction “A scandal of such proportions will change the way of doing business, regulations will strengthen, we will learn from what has happened” but history tells us that quite the opposite is what really happens. Sure, we learn in some way to another from past mistakes, but we keep stumbling over the same stone over and over again, like if it was an elliptical circle.
All of us, look with suspicion when a different form of Ponzi Scheme arises; a new company comes out of the blue, promising fabulous returns, showing unprecedented growth and solid grounding (okay, sometimes this is absolutely absent, raising red-flags everywhere). Then, the catastrophe arrives, taking on everyone’s savings, taking away dreams, while masterminds behind the schemes are laying on Seychelle’s beaches, bearded and moustachioed to continue their days completely in disguise. These Houdini’s of businesses are not the only ones to blame, there is some guilt to be placed on the investors, who are willing to become rich from day to night, but the governments, who also carry out this lack of memory from past experiences.
Same as with Ponzi Schemes, our history is rich in accounting frauds, investors desperately want to become rich, underestimating human nature, and the perfect environment for this to happen (the fraud to materialize, not the wealth to arrive).
Below you will find some of the most interesting Accounting Scandals of the past.
2. THE SCANDALS
“If it is too good to be true….it is probably a fraud.” – Ron Weber –
Human nature is inclined to committing crimes. Sometimes for the simple pleasure of making its own way, most of them for the pleasure produced by breaking the rules, all of them, because of the power money brings, money itself and the freedom of money.
Below, you will find some of the most creative accounting frauds of the last decades if not of history. Creative accounting, cooking books (falsifying financial statements, manipulating data to show non-existing earnings), and several fancy and fashion terms to state exactly the same terms, fraud in accounting to disguise the companies real balances, its revenues, and its real value. The outcome is pretty known.
1998 – PRE – ENRON, WASTE MANAGEMENT SCANDAL
“Cooking books and records”, as the common denominator in all the accounting frauds we will shortly cover… In 1998, Maurice Meyers (the new company’s CEO) as well as the rest of the team, learnt that the company reported inexistent fake earnings of $1.7 billion.
After a long investigation was undertaken by the SEC, Dean L Buntrock (Waste Management former CEO) was prosecuted and found guilty of accounting fraud, as well as several other executives at WM, and of course, ARTHUR ANDERSEN, WM’s external auditor (fined over $7 million).
The story ended with WM paying $457 to shareholders in a class-action suit.
2001 – ENRON, BREAKING THE MOULD
This speed wagon, the Houston based rocketing US energy, commodities and services provider company, was the most controversial accounting scandals authored before the WIRECARD scandal changed became known.
Everyone wanted to invest in ENRON’S promises, Billions of dollars of bad debt had been hidden by 2001, nonexistent in the accounting records, exhibiting fabulous revenues for the company, whilst inflating ENRON’S earnings was an everyday practice.
When the fraud was discovered the company’s shares plummeted from $90 to $1 in the course of that year, generating a loss for the shareholders of over $74 billion.
According to the SEC’s investigation, Jeff Skilling and Ken Lay, ENRON’S former CEO’s kept billions of dollars of debts off the company’s balance sheet. The BIG issue behind this, was -again-, ARTHUR ANDERSEN, the company’s external auditor. Can you spot a pattern here?
This scandal, known to be the largest in accounting history, led to the bankruptcy of the company and the dissolution of ARTHUR ANDERSEN.
The interesting fact of the scandal was that the public prosecutor indicted not only flesh and bone people, but brought ARTHUR ANDERSEN to trial.
With ARTHUR ANDERSEN’s dissolution, 20,000 employees lost their job.
2002 – THE INTERNET BUBBLE, WORLDCOM SCANDAL
The year was 2002, the end of a millennium and the start of a new one brought many advances, opportunities, and again, the scandal was not far behind.
WORLDCOM was a promising telecommunications company based in the USA, who inflated its assets by $11 billion, by underreporting costs (in line with what supposedly happened in WIRECARD’S case, capitalizing instead of expensing the costs). On the other hand, they also inflated revenues.
Internal Audit department of WORLDCOM discovered $3.8 billion of revenues derived from fraudulent accounting.
The result, 300,000 job losses and $180 billion in investor losses.
2002 – TYCO SCANDAL
The blue-chip American security systems company, where scandal burst in 2002 when the SEC discovered that the company inflated revenues by $500 million, whilst the CEO and CFO took $150 millions from the company. The scheme involved unapproved loans and stock sales.
2003 – HEALTHSOUTH SCANDAL
This time it was a healthcare company who inflated earnings, by $1.8 billion. The burst came when the CEO sold over $75 million in stocks a day before the company’s filed a huge loss on the balance sheet. This triggered an investigation directed by the SEC.
2003 – FREDDIE MAC SCANDAL
In 2003, it was discovered that the Federal Home Loan Mortgage Corporation -AKA Freddie Mac- backed by US government, “misstated” over $5 billion in earnings.
The SEC found that the COO, CEO, CFO and other executives overstated earnings in the books and records of Freddie Mac.
2005 – AIG SCANDAL
2005 was the turn of the US multinational insurance company American International Group when the CEO was found guilty for stock price manipulation after SEC’s investigation revealed a $4 billion fraud, based on forging books and records. After the investigation, it was found that the company took loans as revenue in books (an old practice).
2008 – THE SUBPRIME CRISIS, LEHMAN BROTHERS SCANDAL
During the 2008 financial crash, an investigation revealed that LEHMAN BROTHERS had hidden over $50 billions in loans, disguised as sales using accounting loopholes.
SEC’s investigation demonstrated that LEHMAN BROTHERS sold toxic assets to banks in Cayman Island, understanding that they would buy them back. This scheme gave the impression that LEHMAN BROTHERS had $50 billion in cash and the same amount -less- in toxic assets.
The ending is pretty known, as Lehman Brothers went bankrupt after the scandal.
2008 – BACK TO PONZI’S SCHEMES, BERNIE MADOFF SCANDAL
Bernie Madoff who ran BERNARD L. MADOFF INVESTMENT SECURITIES LLC – An American stockbroker who claimed he was getting incredible results from the stock market. He was delivering gorgeous profits to his victims through a Ponzi scheme while keeping the capital of the investment. The investors were enjoying the above-market profits without wondering how he achieved the “dividends”.
Well, the subprime crisis brought all the skeletons out of the closet, and amongst them was Bernie. His company delivered the biggest Ponzi Scheme in history, as well as one of the largest accounting scandals dated.
The outcome, Maddoff’s investors/victims lost over $64.8 billion. MADOFF went down, as well as his creative accountant, DAVID FRIEHLING, and right-hand FRAN DIPASCALLI. All of them were sentenced to Jail.
2009 – SATYAM SCANDAL
Inflating revenue by $1.5 billion, SATYAM COMPUTER SERVICES, an Indian IT service and a back-office accounting firm, was responsible for one of the largest accounting scandals in India.
India’s Bureau of Investigation revealed that the CEO, RAMALINGA RAJU forged revenues, and balance statements.
At last, the CEO admitted the fraud to the Board of Directors (“BoD”).
3. THE DUELISTS – ENRON AND WIRECARD
It is becoming more and more common to listen to people refer to WIRECARD as the “new ENRON”. However, there are a few things to consider before jumping to such conclusions. You will find next, our analysis on the major differences between these two companies and their scandals.
INDUSTRY – While WIRECARD was a payment services company within the financial services industry that was thriving. People who wanted to process their payments in a more efficient way would turn to WIRECARD because they found their service valuable and convenient. ENRON, on the other hand, was an international energy company, started as a natural-pipeline in the USA which later ventured into the oil industry, building power plants and later into the electric industry. This means that, for better or worst, ENRON was responsible for providing power to US citizens life. People became seriously dependent on ENRON. The same did not happen in WIRECARD’S case, as a society can survive without WIRECARD, services.
VENTURES – As much as WIRECARD could have diversified its business to provide payment services and credit placements to companies all over the world – notoriously in Southeast Asia. WIRECARD ventures stayed within the financial sector with sight on global expansion. On the other hand, ENRON, like many other companies, diverted from its original business line to offering financial products & services.
In 1989, the company started financing oil and gas producers, then in 1990, started trading futures on the New York Stock Exchange (“NYSE”) and subsequently acting as an investment firm by making profits on the products it trades. On the other hand, you would have never seen WIRECARD trying to build power plants to provide people with day-to-day services as Enron did.
FRAUD SCHEME – One of the things that worry us most – as general audience -, is how both companies showed great profits, rising share prices, rising market share value, and overall become so important for us as regular people.
ENRON claimed millions of dollars in assets that were fictional, the company actually managed to increase its share value while over-estimating the reported profits by $600,000,000. ENRON presented its accounting practices as “complex” – by overstating its earnings and then editing its balance sheet to show a positive balance at the end of the fiscal year. Afterwards, they get the company’s stock to be rated by its market value, which was the highest as it was America’s most important company.
ENRON’S executives inflated the stock as much as they wished, and subsequently hid what they owed by using exaggerated financial vehicles that relied on their trading practices which were speculative instead of their energy-related activities which were the real purpose of the company.
To be precise, ENRON registered fake (inflated) earnings in their balance sheets since 1997. Then classified the loans and credits as earnings, and the debt was hidden amongst the subsidiaries, which, to make things worst would register those debts as earnings. This was all possible thanks to ARTHUR ANDERSEN’S brains.
In a nutshell, ENRON’S auditor managed to hide the company’s real situation for the golden years…
WIRECARD, on the other hand, opted to raise its capital from obtaining “payments” from shady companies (dummy corporations/shell companies). According to the Financial Times (“FT”), the company raised $500,000,000 Euros from shareholders and spent it on obscure payment companies.
Series of transactions built a fraud scheme that would fuel up their Asian business by engaging in services that never existed – or at least were never proved – so, it’s even more intriguing as the source of the money is unknown.
The money might have never existed, as $2 billion vanished into Philippine banks which later claimed to have never seen the money. Another coincidence we see here is the abuse of subsidiaries to do some “house-keeping” on the company’s books.
MARKET CONSEQUENCES – Both companies suffered a large plunge on their stock prices. ENRON fell from $90 a share in summer 2000 to less than $1 in late 2001. A 99% decrease before crashing.
WIRECARD went from a $104.50 price in summer 2019 to $2.43 in spring 2020 after the $2 billion hole was disclosed.
THE OUTCOMES – ENRON received a lawsuit from its shareholders for over $40 billion and the Securities and Exchange Commission (“SEC”) the American watchdog, started an investigation. This resulted in a purchase offer by SYNERGY, ENRON’S biggest competitor and subsequently a Chapter 11 filing for bankruptcy.
WIRECARD, received multiple lawsuits as well, from investors claiming violations of the 1934 Securities Exchange Act. Not only that the company is under siege, but also BaFin, as well as the former external auditor. Unsurprisingly, they were accused of turning a blind eye on WIRECARD’S accounting balances.
Unsurprisingly, WIRECARD has also filed for insolvency. On the other side, WIRECARD were called in to sell off several divisions of the entity, for example, foreign divisions. RAILSBANK, its biggest British competitor, acquired the company’s’ assets, clients and employees, in a new twist for our favorite story of the year.
THE AUDITORS – The missing piece in the puzzle, would you agree? How could these scandals occur? Sure, several answers were given – remember ARTHUR ANDERSEN was taken to trial in the case of ENRON – probably the same would happen in WIRECARD’s case in the future. Heads rolled before and will probably in the time to come. Looking at the cases of ENRON and WIRECARD, we reached our preliminary conclusions on what is to happen in this matter.
4. “CLAIRVOYANCE” PREDICTIONS FOR THE FUTURE
CALIFORNIA, 2000 – The economy was roaring, ENRON was the go-to company for cultural organizational trends and FORTUNE’S most innovative companies for the fifth year in a row. ARTHUR ANDERSEN was the most trusted accounting firm in the world and millions of businesses and everyday people would use it to check new business opportunities and upcoming companies that were arising with the new millennium.
Envision being a young entrepreneur in San Francisco – what a year to be alive! However, imagine that a few days into the summer, you may be getting home from work in the middle of a gigantic black-out and started suffering from major rolling blackouts, and not being able to turn the AC on with a temperature of over 90 degrees outside. Now, suppose that after that uncomfortable situation, your power bills increased (and additionally find out there was an 800% increase in wholesale prices), just to discover that the dream company of the last century was the one to be blamed for that.
ENRON created a power crisis by speculating with a demand-supply gap and created artificial shortages by taking power plants offline for maintenance just to increase the prices. We would always claim that, and most regulators would agree with us, that after a big crisis, big regulatory changes happen.
ENRON was one of the key actors that inspired the creation of the Sarbanes-Oxley Act (SOX). After the company’s executives aided and abetted by accountants and auditors, misled the company’s shareholders (and the ones with millions of savings invested in the company), SOX was created in an attempt to protect investors against these practices.
We would have to find out if Germany’s watchdog BaFin will adopt a similar standpoint…
For that matter, we should take a peek at ARTHUR ANDERSEN destiny. An auditing company that got to receive over $9 billion in 2001, one of the “Big Five” finally surrendered its licenses in 2002, found guilty of accounting malpractices. The scandal led to it filing for bankruptcy later that year.
On the other hand, we have WIRECARD’S former external auditor, one of world’s largest accounting services provider, reporting over $36 billion dollars in profits in 2019, with over 260,000 headcounts around the globe has followed the same path into the rabbit hole.
Could we be facing a potential “Big Three” in the future?
After the stock plummeted and the investigations/lawsuits began, ENRON was suspended from the NYSE. As of now, WIRECARD is still listed on the Frankfurt Stock Exchange although its values are still historically low. However, as seen before, ENRON’S fraud reached many other aspects of our daily lives that lied beyond the scope of a financial services company such as WIRECARD, however, do we really know how far this has gone?
After the ENRON scandal, the term “Enronomics” was implemented in popular culture to describe when a company cooks its books, by hiding its debt through subsidiaries. This sad trend keeps on happening as of today, and we can expect to receive more regulatory responses after the WIRECARD case finishes its unwinding.
Accounting is not the mere facts or business that a company provides but the technical registration of them. Accountants and auditors are trusted with company’s reputations to show people that have invested their life savings hoping to gain some profit in them if their company of choice is still (or not) a desirable option. Accounting comes with trust. And trust is what shareholders and other investors value the most when venturing into a new business opportunity. Auditors do not get to be creative, as being creative in accounting is a crime.
As everyday citizens, we need to trust accountants and auditors to keep the economy afloat as much as we need lawyers and health professionals. To keep it simple, “we need to know who we’re in bed with”. A truthful balance sheet is what we need to understand if we want to be on that bed or not; but what happens when we base our decision on misleading information? To sum up, we need to uphold honesty and trust in our business world by analyzing these cases, so they will not happen again.
MUNICH, 2019 – The story repeats all over again… The economy is roaring and Germany is leading the Eurozone, again. After saving the whole continent from going to another crisis, living in Bavaria is the dream of every entrepreneur. Imagine being an entrepreneur living there by then. Everything works like a swiss clock, life is simple and steady, you have all the opportunities in a financial market that is worldwide recognized as trustworthy and profitable at the same time. Germany has managed to save the Eurozone and create one of the world’s most innovative payment services companies at the same time. Can anything go wrong?
Gustavo Fideney – Former senior government official (13 years court clerk, leading Corporate Criminal Investigations/ AML/ Corruption cases). For the past three years, he conducted investigations at Baker McKenzie, particularly on the Criminal and Regulatory Compliance Department (Financial – Banking oriented), and is currently providing Financial Crime Compliance consultancy services across the USA – EMEA after moving to Europe for his second masters. JD in Criminal Law and Compliance, an LL.M. in Criminal Taxation (Criminal Corporate Liability – Transfer Pricing Fraud) LL.M. in Criminal Law and Compliance (European – Corporate), ExMBA Candidate 2020-2021, he possesses several postgraduates courses/certifications on AML and Compliance. LinkedIn Profile
Alvaro Ruiz Ostos – Compliance officer with experience in several broker-dealers and financial institutions in the US and Latin America, JD in Law, LLM in Banking and Financial Law (Boston University) and postgraduate of Corporate Law. Alvaro currently implements AML/CFT efforts on the first line of defense for International Wealth Management and Private Banking clients, focusing on the onboarding process of high-risk jurisdictions. LinkedIn Profile
Disclaimer: The opinions expressed in this publication are those of the authors. They do not purport to reflect the opinions or views of the companies where they work or the ones where they provided services for. The information provided is based on the experience gathered while working in governmental agencies, banks and law firms.