Management Fraudsters (graded)
Lets read Chapter 13, Case Study 1, on pages 485487. Do you wonder why management executives commit fraud? Do they think they will not get caught? Why did the Waste Management executives commit the fraud?
Case Study 1
On March 26, 2002, the SEC charged six Waste Management executive officers for the perpetration of a five-year financial fraud. The following is an article summarizing the SECs complaint against these officers:
The complaint names Waste Managements former most senior officers: Dean L. Buntrock, Waste Managements founder, chairman of the board of directors, and chief executive officer during most of the relevant period; Phillip B. Rooney, president and chief operating officer, director, and CEO for a portion of the relevant period; James E. Koenig, executive vice president and chief financial officer; Thomas C. Hau, vice president, corporate controller, and chief accounting officer; Herbert Getz, senior vice president, general counsel, and secretary; and Bruce D. Tobecksen, vice president of finance.
According to the complaint, the defendants violated, and aided and abetted violations of, anti-fraud, reporting, and record-keeping provisions of the federal securities laws. The Commission is seeking injunctions prohibiting future violations, disgorgement of defendants ill-gotten gains, civil money penalties, and officer and director bars against all defendants.
The complaint alleges that defendants fraudulently manipulated the companys financial results to meet predetermined earnings targets. The companys revenues were not growing fast enough to meet these targets, so defendants instead resorted to improperly eliminating and deferring current period expenses to inflate earnings. They employed a multitude of improper accounting practices to achieve this objective. Among other things, the complaint charges that defendants:
Avoided depreciation expenses on their garbage trucks by both assigning unsupported and inflated salvage values and extending their useful lives,
Assigned arbitrary salvage values to other assets that previously had no salvage value,
Failed to record expenses for decreases in the value of landfills as they were filled with waste,
Refused to record expenses necessary to write off the costs of unsuccessful and abandoned landfill development projects,
Established inflated environmental reserves (liabilities) in connection with acquisitions so that the excess reserves could be used to avoid recording unrelated operating expenses,
Improperly capitalized a variety of expenses, and
Failed to establish sufficient reserves (liabilities) to pay for income taxes and other expenses.
Defendants improper accounting practices were centralized at corporate headquarters, according to the complaint. Each year, Buntrock, Rooney, and others prepared an annual budget in which they set earnings targets for the upcoming year. During the year, they monitored the companys actual operating results and compared them to the quarterly targets set in the budget, the complaint says. To reduce expenses and inflate earnings artificially, defendants then primarily used top-level adjustments to conform the companys actual results to the predetermined earnings targets, according to the complaint. The inflated earnings of prior periods then became the floor for future manipulations. The consequences, however, created what Hau referred to as a one-off problem. To sustain the scheme, earnings fraudulently achieved in one period had to be replaced in the next.
Defendants allegedly concealed their scheme in a variety of ways. They are charged with making false and misleading statements about the companys accounting practices, financial condition, and future prospects in filings with the Commission, reports to shareholders, and press releases. They are also are charged with using accounting manipulations known as netting and geography to make reported results appear better than they actually were and avoid public scrutiny. Defendants allegedly used netting to eliminate approximately $490 million in current period operating expenses and accumulated prior period accounting misstatements by offsetting them against unrelated one-time gains on the sale or exchange of assets. They are charged with using geography entries to move tens of millions of dollars between various line items on the companys income statement to, in Koenigs words, make the financials look the way we want to show them.
Defendants were allegedly aided in their fraud by the companys long-time auditor, Arthur Andersen LLP, which repeatedly issued unqualified audit reports on the companys materially false and misleading annual financial statements. At the outset of the fraud, management capped Andersens audit fees and advised the Andersen engagement partner that the firm could earn additional fees through special work. Andersen nevertheless identified the companys improper accounting practices and quantified much of the impact of those practices on the companys financial statements. Andersen annually presented company management with what it called Proposed Adjusting Journal Entries (PAJEs) to correct errors that understated expenses and overstated earnings in the companys financial statements.
1. The SEC is often called the watchdog of corporate America. How does it assist in preventing fraud?
2. According to the summary, why did the Waste Management executives commit the fraud?
3. You are an ambitious manager in the sales department of a company and have just received the upcoming years targeted earnings report. You are concerned that top management has set revenue targets for your division that are practically unreachable. However, anticipating a promotion to vice president of sales if your division maintains good performance, you are determined to reach managements goal. What actions would you take to satisfy managements expectations and still maintain your integrity?
1. What happened to the Waste Management executives who committed the fraud?
What other management frauds has the SEC been involved with? What happened in these frauds? How were they uncovered? Prosecuted?