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

2. Misappropriation of Assets
The Sting

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

4. 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.

5. 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.

6. 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)

7. 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

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

9. 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

10. 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%

11. 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

12. 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

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

14. 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

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

16. 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

17. 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

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

19. 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

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

21. 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

22. 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)

23. 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

24. 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.

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

26. 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

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

28. 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”)

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

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

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

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

33. 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

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

35. 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

36. 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

37. 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

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

39. 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

40. 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

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

42. 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

43. Freddie Mac (2003)
Discovery of the Fraud
SEC Investigation

44. 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

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

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

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

48. American Insurance Group (2005)
Culprits
CEO Hank Greenberg

49. 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

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

51. 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

52. 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)

53. 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

54. 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

55. 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

56. 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

57. 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%)

58. Any Questions?

59. Thank You