When the higher-ups at large corporations or even in government intentionally manipulate financial statements for their own personal gain, the ramifications can be huge. When discovered, these financial accounting scandals have a huge effect on the entire company, including its employees and customers. Over the past few decades, we’ve seen some of the largest accounting fraud scandals ever, and we’re going to break each one down in this article.
Accounting fraud can happen in any number of ways, such as misdirecting funds or underreporting liabilities. When financial scandals are uncovered, the majority of shareholders and employees are in the dark and suffer the negative effects. When huge corporate accounting scandals are revealed, an investigation is generally launched by an appropriate authority. In the United States, the Securities and Exchange Commission (S.E.C.) holds these inquiries. Unfortunately, even our authorities can’t be trusted to steer clear of fraud, as recent news about US government bonds has shown.
There are two main types of fraud that financial accounting scandals usually fall under. The first, misappropriation of assets, occurs when an employee steals from the company. This can be at any level, including cash, company data, and intellectual property. Company assets such as inventory and office supplies also fall under this category of fraud.
Fraudulent financial reporting, or earnings management fraud, is the other form of financial scandal we see reported. In these cases, corporation management lies in statements and reports to make the company’s finances seem more attractive than they really are. This can occur in both public and private corporations and can lead to serious consequences as drastic as an entire collapse. Fraudulent reporting is sometimes called “creative accounting”, a friendly name for a dangerous practice.
The biggest accounting fraud and financial scandals in history have caused thousands of lost jobs and led to billions of dollars paid in fees and reparations. These cases of greed in a handful of high-up executives destroyed the lives and livelihoods of many, bringing down companies that were established for generations. The actions of a few can have gargantuan effects when powerful people start to play around with the numbers. By learning about the accounting scandals that have brought down financial giants in the past, you can gain a better understanding of the world we live in.
1. Enron Scandal
The Enron Scandal of 2001 is one of the largest financial scandals in US history. The scandal led to the bankruptcy and collapse of the Enron Corporation, destroying thousands of jobs as well as seriously shaking the Wall Street market. As well as Enron, the uncovering of this accounting fraud led to the dissolution of Arthur Andersen, which was one of the largest financial auditing companies globally at the time.
Enron was an energy, commodity, and services company based in Houston, Texas. All seemed well until it was uncovered that the company had been using loopholes to hide billions in debt while inflating the company's earnings. Shareholders in Enron suffered a loss of more than $74 billion as prices dropped from $90 per share to less than 1. The SEC’s investigation into Enron found that the Chief Executive Officer Jeff Skillings and former CEO Ken Lay had purposefully hidden debt from the company's balance sheet.
Jeff Skillings and Ken Lay had also pressured their auditing company (Arthus Andersen) to ignore the issue, rather than report it to the relevant financial authorities. During the prosecution of the case, the entire accounting firm of Artur Andersen was held responsible, putting the company straight out of business. As a result, over 20,000 employees lost their jobs and one of the largest financial auditing corporations in the world collapsed.
The convictions of the CEO and former CEO of Enron, as well as the unfortunate consequences dolled out to Arthur Andersen, were largely the result of a single testimony. Sherron Watkins was the Vice President of Corporate Development at Enron, and her actions as whistleblower led to the corporation's demise. It was Sherron Watkins who reported and testified about irregularities in the company's financial statements, for which she was nominated for Time’s Person of the Year award in 2002.
Because the ripple effect from the Enron scandal was so huge across the financial community, it can be defined as the sole trigger for the release of the Sarbanes-Oxley Act. This act implemented new standards for audit reports and more limits on the power of executives. The Sarbanes-Oxley Act was implemented in 2002 in the hopes of preventing such a devastating incident as the Enron Scandal from happening again.
2. WorldCom
In the summer of 2002, when US investors were still recovering from the Enron scandal, another case of major accounting fraud was revealed. WorldCom was the USA’s second-largest long-distance telephone company, worth a massive $180 billion dollars at the peak of its success. However, an internal audit revealed $3.8 billion in fraudulent balance sheet entries, leading to further discoveries of a total of $11 billion in overstated assets.
The bankruptcy which followed WorldCom’s collapse was the biggest in history at the time, dwarfing the previous Enron Scandal. Bernie Ebbers (the founder and CEO of WorldCom) was sentenced to 25 years in prison for his deception, which caused the loss of more than 30 thousand jobs. Ebbers was accompanied by a handful of top executives, who worked between them to inflate the company’s earnings and maintain WorldCom’s stock price.
WorldCom was one of the biggest accounting scandals in the world at the time; their schemes to hoodwink and scam investors were highly shocking to Wall Street workers. Over a number of years, the company failed to report costs and expenses to shareholders, hiding them instead amongst so-called property accounts. This would allow WorldCom to show expenses over a number of years, instead of revealing the true price to their investors.
3. Lehman Brothers Scandal
Lehman Brothers Holdings Inc was a global financial services firm and the fourth largest investment bank in the US behind big names such as Goldman Sachs. Lehman Brothers dealt in investment banking, trading, investment management, and private banking. The company was established for 158 years before its collapse, which is part of the reason this financial scandal had such a huge effect.
If the world was rocked by the WorldCom and Enron Scandals, it was completely devastated by the events at Lehman Brothers. The first discovery made was a sum of $50 billion hidden in loans, disguised using accounting loopholes. The subsequent SEC investigation showed that Lehman had sold toxic assets to banks in the Cayman Islands, which they would supposedly buy back. Of course, this isn’t how it panned out, and this $50 billion was the first in a string of fraudulent accounting discoveries. This accounting scandal is thought to have a role in triggering the 2008 global financial crisis, so its impact cannot be understated. Lehman Brothers Holdings was one of Wall Street’s “Too big to fail” corporations, but when they filed for bankruptcy the entire global market plummeted.
The Lehman Brothers bankruptcy filing was the single biggest in US history and has yet to be surpassed by a larger disaster. The causes of this financial scandal include cosmetic accounting gimmicks (or creative accounting) on quarterly balance sheets which made the company’s finances seem much more stable than they truly were. Lehman also faced a huge loss during the mortgage crisis, as well as continuing to lie about accounts as suspicion mounted.
All in all, Lehman Brothers cited a bank debt in excess of $600 billion upon filing for bankruptcy, with additional bond debts and assets. The entire bank was liquidated, right down to the company headquarters being emptied out over a period of just two days. Countless economic consequences were suffered as a result of the Lehman Brothers Scandal, and a financial bailout of $700 billion was eventually issued. To date, Lehman has paid more than $100 billion back to creditors, but still has many reparations to make.
Lehman Brothers scammed the U.S. economy out of 600 billion dollars.
4. Bernie Madoff Scandal
Bernie Madoff is one of the most famous names in financial investing and the most infamous when it comes to accounting fraud. As it transpires, Madoff was at the head of the most elaborate and largest Ponzi scheme in US history and was in fact cheating investors out of billions of dollars. Bernard L. Madoff Investment Securities LLC offered a “wealth management” service to its clients, which turned out to be a multi-million-dollar Ponzi scheme which was likely running for decades.
A “Ponzi scheme” is an investment opportunity that guarantees unusually high returns, but the entire system is a scam. New investors give their money to the company, which is then used to pay back older investors. This makes the scheme seem profitable for a time, meanwhile, the showrunner pockets all the extra cash. Ponzi schemes center on investors believing that they are making a profit without actually withdrawing any cash, so the operator continues to make money.
The Madoff Scandal was ignited when investors wanted a return on their reported profits of $7 billion. Unfortunately, the investment firm had only two to three hundred million to give, so collapse and bankruptcy was imminent. Bernie Madoff, the CEO and Founder of Madoff Investment Securities, was convicted to 150 years in federal prison. He was also ordered to pay $170 billion, even though the total stolen from investors only equaled $65 billion. Bernie Madoff’s accountant, David Friehling, and Frank DiPascali (who ran the Ponzi scheme alongside Madoff) were also convicted of accounting fraud.
5. Tyco Scandal
The CEO and CFO of Tyco International were solely responsible for stealing as much as 600 million dollars from the company. This financial fraud was discovered in 2002 and turned into a long trial with drawn-out legal proceedings. Eventually, after a mistrial and retrial, Dennis Kozlowski (CEO) and Mark Swartz (CFO) were both convicted of more than 30 individual counts of corporate fraud.
The two men tried to argue that the Tyco board of directors had authorized their theft of more than $150 million, however, this was overturned. Both received a minimum eight-year prison sentence. A shareholder class-action lawsuit was also carried out, forcing Tyco to repay 2.92 billion dollars back to investors. The Tyco Scandal is one of the most shocking financial fraud cases because it was largely carried out by two sole operators. Kozlowski and Swartz benefited hugely from their scam right up until their convictions. Purchases made with embezzled money included a $2 million island holiday and an $18 million Manhattan apartment.
6. Waste Management Scandal
Before their dissolution following the 2001 Enron Scandal, Arthur Andersen was involved in another financial scam. Waste Management was founded in 1968, and slowly became the largest waste management and environmental services company in the country, managing millions of tons of materials in multiple facilities. Trouble started in 1998 when the new CEO noticed some discrepancies in the company’s accounting books.
The Securities and Exchange Commission found that Waste Management has reported more than 1.7 billion dollars in fake earnings. They did this by inflating the crap value of certain assets (such as garbage trucks) and even assigning scrap value to materials that had none. This accounting fraud meant the company could report decreased annual expenses and add to the total profit. It’s estimated that at least $500 million of operating expenses were erased in this way.
As the true revenues didn’t reflect the books, the new management team at Waste Management looked into the accounts and discovered the fraud that had been committed. Several top executives along with the owner and former CEO were found guilty of financial fraud. The auditors Arthur Andersen were fined $7 million for ignoring the issue, while a shareholder call-action lawsuit was brought before Waste Management. Investors sued the company for a total of 457 million dollars as a result of their fraudulent accounting practices.
Bernard Madoff allegedly confessed to employees of his company that the asset management portion of his firm is actually a large Ponzi scheme.
7. HealthSouth Scandal
HealthSouth Corporation, now called Encompass Health, is one of the USA’s largest publicly traded healthcare companies. The corporation provides many services including post-acute facility-based and home-based services. The founder of HealthSouth is Richard M. Scrushy, a man who has been investigated several different times for embezzlement and corporate fraud.
The SEC had been investigating Scrushy before the HealthSouth Scandal, for selling $75 million in stock the day before the company reported a huge loss. This insider trading was only the first thing to attract attention; in 2003 Scrushy was accused of instructing his employees to falsely report company earnings to meet the expectations of stockholders. Upon investigation, it was discovered that HealthSouth had inflated their earnings by more than 1.8 billion.
Scrushy managed to escape his convictions and was acquitted of all 36 counts of accounting fraud brought against him. The founder of HealthSouth was later found guilty of bribing an Alabama Governor and was sentenced to 7 years behind bars, but he has never faced the consequences of his financial fraud. Scrushy continues to deny all involvement, claiming that other top executives hid the accountancy from him.
8. Satyam Scandal
The Satyam Scandal is one of the few massive cases of accounting fraud to happen outside of the USA. India-based company Satyam Computer Services faced a huge corporate scandal in 2009 when chairman Ramalinga Raju admitted to falsifying the company’s accounts. Unlike the other global accounting scandals on this list, there was no big discovery that led to the uncovering of fraud. Instead, Satyam’s chairman confessed voluntarily, taking all responsibility; until this point, the fraudulent cash holding of over a billion had gone unnoticed.
Satyam’s share prices, which had a previous high of 544 rupees, decreased to just 11.5 rupees apiece. On the New York Stock Exchange prices fell from around $29 to just $1.80. There were many counts of fraud uncovered following Ramalinga Raju’s confession, including a misreporting of employees. One case of Satyam’s deception is the report of 53 thousand employees, where the real figure was closer to 40,000. This means an additional $3 million USD was paid to non-existent employees each month, which is just one example of how this corporation stole money from investors. In total, Satyam inflated their revenue by $1.5 billion, making one of the largest accounting scandals in world history.
Conclusion:
Fraudulent financial accounting scandals are more common than most investors like to think. Even in the largest and most trusted conglomerates, all it takes is one dishonest executive to bring the entire company tumbling down. Cases of corporate fraud have huge ripple effects, resulting at best in thousands of lost jobs and revenue. At worst, accounting fraud can be a trigger for a global financial crisis, as with the Lehman Brothers Scandal.
These financial scandals also reveal deeper issues in our system, as we see the same auditing company (Arthur Andersen) having an impact in multiple areas. Top executives and CEOs have a lot of power, and the temptation to abuse it can be too much for some to resist. Authorities like the S.E.C. are at the forefront against this continued fight against corruption, to help protect innocent investors from financial accounting fraud.
