Joint Accounting Conference Presentation to: Joint Accounting Conference May 17, 2018 Presented by: Daniel Kaufmann

Misappropriation of Assets The Sting

Top U.S. Corporate Accounting Scandals Waste Management Enron Tyco WorldCom HealthSouth Freddie Mac American Insurance Group

Waste Management (1998) Company Background Comprehensive Waste Management Company founded in 1894 Based in Houston, Texas Publicly Traded Company offered environmental services to almost 20 million customers in America, Canada, and Puerto Rico By the 1980s it was the largest waste management and environmental services company in the U.S.

Waste Management (1998) Summary of the Fraud Financial fraud occurred between 1992 and 1997 Reported $1.7 billion in fake earnings In 1998, the Company restated its 1992 – 1997 earnings by $1.7 billion Largest restatement in history at that time Scandal was an attempt to meet predetermined earnings targets by expanding profits and pushing down expenses.

Waste Management (1998) Culprits Founder/CEO/Chairman Dean Buntrock Former President Philip Rooney Chief Accounting Officer Thomas Hau Chief Financial Officer James Koenig General Counsel Herbert Getz V.P. of Finance Bruce Tobecksen Arthur Andersen (Auditors)

Waste Management (1998) Mechanisms of the Fraud Avoided depreciation expenses by assigning and inflating salvage values and extending the useful lives of garbage trucks Refrained from recording expenses for any decreases in the value of the landfills as they were filled with waste Refused to record necessary expenses to write off the costs of unsuccessful and discarded landfill development projects Assigned salvage values to assets that previously had no salvage value Increased environmental reserves to avoid irrelevant operating expenses Improperly capitalized certain expenses

Waste Management (1998) Discovery of the Fraud The new CEO and management team combed through the financial records of the Company.

Waste Management (1998) Settlements and Penalties Waste Managements settled a shareholder class action lawsuit for $457 million Arthur Andersen was fined $7 million by SEC

Waste Management (1998) Interesting Facts The new CEO created an anonymous company hotline for employees to report dishonest or improper behavior The shareholders lost more than $5 billion of investments when stock price plunged by 35%

Enron (2001) Company Background Based in Houston, Texas Publicly Traded Formed in 1985 as a merger of Houston Natural Gas and Internorth Commodities, Energy, and Service Corporation

Enron (2001) Summary of the Fraud Enron issued a restatement in 2001 for the 1997 through 2000 financial statements Earnings for this period were reduced by $613 million Liabilities were increased by $628 million Equity was reduced by $1.2 billion Enron files the nation’s largest bankruptcy Enron’s shareholders lose over $74 billion

Enron (2001) Culprits CEO Jeff Skilling Former CEO Ken Lay CFO Andrew Fastow Arthur Andersen

Enron (2001) Mechanisms of the Fraud Created off balance sheet Special Purpose Entities (SPE) to hide debt and bad assets Enron would park its troubled assets with the SPE to get them off the balance sheet Enron created thousands of SPEs Enron also disguised bank loans as energy derivative trades to conceal the extent of its indebtedness

Enron (2001) Discovery of the Fraud Sherron Watkins blew the whistle High stock prices fueled suspicions

Enron (2001) Settlements and Penalties Ken Lay was convicted of six counts of fraud and conspiracy Jeff Skilling was sentenced to 24 years in prison Enron filed for bankruptcy Andrew Fastow pled guilty to two counts of wire fraud and securities fraud Arthur Andersen was found guilty of obstruction of justice

Enron (2001) Interesting Facts Fortune Magazine named Enron “America’s Most Innovative Company” for six years in a row prior to the accounting scandal Enron’s stock peaked at $90.75 per share; the shares were trading at $0.26 when it declared bankruptcy The Enron Scandal helped usher in the Sarbanes-Oxley Act

Tyco (2002) Company Background New Jersey Based Company Swiss Security System Company Publicly Traded

Tyco (2002) Summary of the Fraud CEO, CFO, and General Counsel stole $170 million from the Company CEO and CFO inflated the Company’s income by $150 million

Tyco (2002) Culprits CEO Dennis Kozlowski CFO Mark Swartz General Counsel Mark Belnick

Tyco (2002) Mechanisms of the Fraud CEO and CFO spent millions of dollars of Company money on personal expenses Stole money through unapproved loans and executive stock sales Money was misappropriated from the Company through improper executive bonuses and benefits Tyco did have an employee loan program. However, the fraudsters took unapproved loans and kept them off the Company’s books. Fraudsters limited internal audits access to documents and bypassed the legal department when making securities filings

Tyco (2002) Discovery of the Fraud SEC started investigating when the Company restated its 1999 earnings SEC and Manhattan District Attorney investigations uncovered improper loans to CEO Kozlowski that had been forgiven ($19 million loan)

Tyco (2002) Settlements and Penalties CEO was sentenced to 25 years and fined $70 million CFO were sentenced to 8 years and fined $35 million Tyco had to pay $2.92 billion to investors

Tyco (2002) Interesting Fact CEO hosted a $2 million birthday party for his wife on an island (Sardinia) complete with a performance by Jimmy Buffett.

WorldCom (2002) Company Background Telecommunications Company Long-distance telephone and data service provider Publicly Traded

WorldCom (2002) Summary of the Fraud Company inflated assets by $30 billion Fraud cost investors $180 billion in losses Stock dropped from a high of $64 per share to a low of $0.10 per share

WorldCom (2002) Culprits CEO Bernie Ebbers CFO Scott Sullivan Controller David Myers

WorldCom (2002) Mechanisms of the Fraud Improperly capitalized expenses Company took fees associated with third-party networks and service agreements (“Line Costs”) and booked them as capital expenditures ($3.8 billion in fraud) The fraud led to artificial inflation of net income and EBITDA Inflated revenues with fake accounting entries Company also announced that it manipulated its reserve accounts to the tune of $3.8 billion (“Cookie Jar Reserves”)

WorldCom (2002) Discovery of the Fraud The Company’s internal auditors uncovered $3.8 billion of the fraud

WorldCom (2002) Settlements and Penalties CEO was sentenced to 25 years in prison for fraud, conspiracy, and filing false documents with regulators

WorldCom (2002) Interesting Fact WorldCom scandal was a driving factor for Congress’ passing of the Sarbanes-Oxley Act

HealthSouth (2003) Company Background Birmingham Based Company Publicly Traded Health Care Company

HealthSouth (2003) Summary of the Fraud Earnings were overstated every quarter between 1996 and 2002 to meet Company’s Wall Street expectations Fraudsters overstated earnings by $2.6 billion

HealthSouth (2003) Culprits CEO Richard Scrushy CFO Aaron Beam CFO William Owens CFO Weston Smith CFO Michael Martin Controller Ken Livesay

HealthSouth (2003) Mechanisms of the Fraud The “family” would get together after the books had closed and review the “gap” between real earnings and Wall Street estimates. The fraudsters would then create millions of accounting entries under $5,000 to avoid audit scrutiny Fraudsters improperly capitalized expenses, overestimated insurance reimbursements, overvalued fixed assets, and used faulty reserve accounting Company denied requests from Ernst & Young to have unfettered electronic access to the general ledger

HealthSouth (2003) Discovery of the Fraud Richard Scrushy sold $75 million of Company stock one day before the Company posted a huge loss Stock sale brought on an SEC investigation Two of the CFOs agreed to cooperate with the FBI

HealthSouth (2003) Settlements and Penalties Richard Scrushy was acquitted of all 36 counts of financial fraud However, Scrushy would later being convicted of bribing the Governor for a seat on CON Board Scrushy would be sentenced to 7 years in prison

HealthSouth (2003) Interesting Fact Richard Scrushy is now a motivational speaker Former CFOs Aaron Beam and Weston Smith give lectures on ethics in accounting

Freddie Mac (2003) Company Background Federally supported mortgage financing company Chartered by federal government in 1970 to stabilize the nation’s mortgage markets It is a Government Sponsored Enterprise (GSE) Publicly Traded Company One of the biggest buyers of home mortgages

Freddie Mac (2003) Summary of the Fraud Company committed financial fraud to meet Wall Street expectations for earnings Company misstated $5 billion in earnings Restated net income for 2001 alone was reduced by $1 billion

Freddie Mac (2003) Culprits President/COO David Glenn CEO Leland Brendsel CFO Vaughn Clark

Freddie Mac (2003) Mechanisms of the Fraud The Company “smoothed out” current earnings through questionable interpretations of GAAP The Company hid more than $1 billion in profits in order to show “steady earnings” Classification of Securities – the Company improperly classified bonds as “Held to Maturity” instead of “Available for Sale” Accounting for Derivatives – the Company should have accounted for its derivatives as “speculative positions” instead of as accounting hedges

Freddie Mac (2003) Discovery of the Fraud SEC Investigation

Freddie Mac (2003) Settlements and Penalties Company fined $125 million Officers of Company terminated The Company paid $410 million to settle class action brought by pension funds and investors

Freddie Mac (2003) Interesting Fact The next year Fannie Mae was caught in an equally stunning mortgage financing scandal

American Insurance Group (2005) Company Background Multinational Insurance Giant World’s Largest Insurance and Financial Services Company 93,000 Employees Business in 130 Countries

American Insurance Group (2005) Summary of the Fraud Massive accounting fraud to the tune of $3.9 billion

American Insurance Group (2005) Culprits CEO Hank Greenberg

American Insurance Group (2005) Mechanisms of the Fraud AIG booked $500 million in loans as revenue AIG instructed traders to inflate stock price AIG directed clients to insurers AIG had paid off

American Insurance Group (2005) Discovery of the Fraud SEC regulator investigations (possibly after a tip from a whistleblower)

American Insurance Group (2005) Settlements and Penalties The Company settled with the SEC for $10 million in 2003 and $1.64 billion in 2006 The Company settled with a Louisiana pension fund for $110 million The Company settled with three Ohio pension funds for $725 million

American Insurance Group (2005) Interesting Fact AIG executives awarded themselves with $165 million in bonuses after recording the largest quarterly loss in history ($61.7 billion)

Lessons Learned Types of Fraud Misappropriation of Assets Most Common Caused median loss around $125,000 Corruption Rare (bribery, extortion, conflict of interest) Caused median loss around $200,000 Financial Statement Fraud Less than 10% of cases in recent study Caused median loss of $975,000

Lessons Learned Cost of Fraud A typical organization loses 5% of revenue to fraud. U.S. for profit businesses reported a median loss of $180,000 A recent study revealed that 58% of the victimized organizations had not recovered any of the loss

Lessons Learned Profile of a Fraudster Typically a high ranking officer of the company Generally an officer who has been with the company many years

Lessons Learned Red Flags Associated with a Fraudster Individual living beyond his means Suffered a financial difficulty Excessively controlling or unwilling to share duties Possess a “wheeler-dealer” attitude involving shrewd or unscrupulous behavior Recently divorced or other significant family problem

Lessons Learned COSO Study Studied financial statement frauds in U.S. public companies between 1998 – 2007 Types of Financial Fraud Cases: Revenue Recognition (61%) Overstated Assets (51%) Understated liabilities/expenses (31%) Misappropriation of Assets (13%)

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