Accounting Scandals

Enron Scandal

Image source

The Enron scandal was a financial racket uncovered in late 2001 involving Enron Corporation and its accounting firm Arthur Andersen. During the 1990s, Enron took advantage of the newly deregulated electricity markets by entering into numerous contracts with special purpose entities or limited partnerships. These “off-books” deals presented Enron the perfect opportunity to do some creative accounting in order to avoid reporting its mounting debts and losses on its financial statements, thereby giving it the appearance of earnings growth for almost 5 years. By mid-November 2001, following the exposé of these irregular accounting practices, Enron found itself with very little cash for its normal daily operations, let alone to fulfill its financial obligations. A last ditch effort to survive through merger with another energy company, Dynegy, was met with failure. Enron eventually filed for Chapter 11 bankruptcy protection on December 2, 2001, the largest in US history at the time but since surpassed by Worldcom in July 2002 and Lehman Brothers in September 2008.

The scandal did much to unsettle investor confidence in American business since internal and external controls failed to discover financial losses concealed as profits for many years. As a result, Enron shares dropped from over $90 to less than a dollar. The collapse of one of the biggest and supposedly best-managed companies brought about severe government and media attention. Investigations revealed that many Enron’s executives, including CEOs Jeffrey Skilling and Kenneth Lay, whose illegal activities caused the company’s downfall, escaped with millions of dollars as they retired their company shares before its price tumbled. Thousands of Enron employees were not so lucky; aside from losing their jobs, they saw their savings and retirement funds, a major portion of which were linked up in Enron stock, pretty much decimated. In total, investors lost more than $60 billion.

In the highly publicized trial in 2004, Skilling, Lay and a number of executives were found guilty for a wide range of financial offenses including bank and wire fraud, misleading the public with false statements, money laundering, and insider trading. Arthur Andersen, the external auditing firm that failed to act the part, came to its demise in 2002 when it was convicted of obstruction of justice for the destruction of key documents relating to its audit of Enron.

This scandal, along with other major accounting scandals of the time involving premier companies as Peregrine Systems, Waste Management, Sunbeam and WorldCom, resulted in the enactment of the much needed “Public Company Accounting Reform and Investor Protection Act of 2002,” also called “Sarbanes-Oxley,” which granted greater authority to the Security and Exchange Commission (SEC) to investigate accounting fraud, and established stricter standards of responsibilities for all US publicly traded companies and public accounting firms.

Parmalat Scandal

Image source

In December 2003, the Italian food and dairy multinational Parmalat filed for bankruptcy in what would become the biggest-ever corporate failure in Europe. The scandal, also called “Europe’s Enron,” broke out when Bank of America announced that a document reflecting nearly €4 billion deposit in Parmalat’s Cayman Islands subsidiary, Bonlat Financing Corp., to be a counterfeit. Since the 1990s, Parmalat entered into the financial markets in a grand way, expanding its presence into 30 countries from 6 by financing major acquisitions with debt. It was discovered that Parmalat was using its assets to conceal its liabilities through a network of offshore and foreign companies, but the trouble was that these assets were merely imaginary. The fraud was so widespread that the company profit history may almost entirely be fabricated, having claimed that its subsidiary Bonlat had sold sufficient milk powder to generate 55 gallons of milk per capita in the small island nation of Cuba in one particular year.

The scandal created quite a shockwave throughout Italy and around the world affecting a mass of victims: Parmalat’s 36,000 employees in 30 countries lost their jobs; dairy farmers from as far as Brazil and Australia were not paid for milk delivered; and 70,000 to 90,000 investors unexpectedly found their holdings of the company’s stocks and bonds practically worthless (Parmalat had a stock market value of €1.8 billion before the scandal became public). Some major companies were also entangled by the scandal including accounting firms Grant Thornton and Deloitte and Touche, and banks–Bank of America and Citicorp. Bank of America had aided Parmalat acquire $170 million credit in Venezuela; while Citicorp found its uncollectibles abruptly increase by $1.5 billion.

Included among the 11 convicted in connection with the scandal were Calisto Tanzi, Parmalat’s founder and chief executive, who was sentenced to 10 years imprisonment for market rigging and accounting fraud in December 2008; and Fausto Tonna, his chief financial officer, was given 2 ½ year sentence in 2005 for committing forgery and conceiving a web of offshore companies to hide the firm’s true liabilities.

AIG Accounting Scandal

Image source

In 2005, Maurice “Hank” Greenberg was forced to resign from his position as CEO of American International Group amidst accusations of improper accounting practices. The crisis has its origin from a transaction made in 2000 between AIG and General Re, a unit of Warren Buffett’s Berkshire Hathaway, at a time when AIG’s reserves were considered too low according to investigations conducted by then New York Attorney General Eliot Spitzer and SEC.

General Re, a reinsurance company, is supposed to sell insurance plans to insurance companies that are trying to relieve themselves of some of the risk they have assumed from individuals and corporations. However, AIG and General Re exchanged roles in the 2000 deal wherein General Re agreed to pay AIG a premium of $500 million. The transaction was not unlawful per se, but the policies General Re surrendered over to AIG involved insignificant or no risk at all. In addition, AIG was obligated to pay back over time the entire amount, which was in essence a loan. The internal probe initiated by AIG revealed that the $500 million loan was disguised on its books as premium revenues to boost reserves, and that many other accounting manipulations were also committed to strengthen financial performance. AIG subsequent recalculation of its financial statements resulted in the decrease of its shareholder equity by $2.7 billion, a 3.3 % reduction in net worth.

In 2006, a former AIG executive and 4 former General Re executives were found guilty for their participation in the deception. And in settlement of the civil suit filed by Spitzer and the SEC, AIG paid a fine of $1.64 billion to resolve allegations that it resorted to fraudulent accounting to mislead regulators and investors. These scandals show the great degree of dishonesty capable of being perpetrated by the highest levels of the corporate and financial elite at the expense of public interest.

More Scandals

• Scandals in the Corporate World
• Notable Military Scandals in History
• Political Sex Scandals in History
• Scandals: Five Misbehaving Scientists
• Notable Medical Scandals