Blowing the lid on a cover-up

Former Olympus CEO Michael Woodford is emerging from a lengthy battle to highlight a billion-dollar fraud within the company. He tells FM that management accountants hold the key to legitimate and robust corporate governance.

Michael Woodford has plenty to say about corporate governance. The former CEO and president of Japanese electronics giant Olympus has spent the past year fighting to get to the bottom of a $1.7bn fraud that he was alerted to in July 2011.

When he first wrote to his fellow board directors to flag up a series of massive payments to companies that appeared to offer no value to Olympus, and which were highlighted to Japanese publication Facta by a whistleblower, he was stonewalled.

He then wrote additional letters to directors, copying them to the senior heads of Olympus’s auditor, Ernst & Young.

As he pursued the issue with senior directors, Olympus chairman Tsuyoshi Kikukawa ceded the role of CEO to Woodford. But after Woodford commissioned a PwC report that found potential offences of “false accounting, false assistance and breaches of directors’ duties”, he was sacked in October last year.

He then vigorously campaigned for the truth, helping the FBI in the US and the Serious Fraud Office in the UK with their investigations. He also travelled the world to update the global media as revelation after revelation spilled out of the company.

An independent report in Japan found that the senior management team at Olympus was “rotten to the core”.

During this time the company’s share price collapsed amid stories that the fraud may have been connected to organised crime.

Senior members of the board resigned soon after, including chairman Kikukawa. Following arrests in February this year, three former Olympus executives (including Kikukawa) pleaded guilty in a Japanese court to filing false financial reports in September.

Based on his experience, Woodford is keen to see improved corporate governance and better protection for whistleblowers in a bid to prevent a similar fraud taking place elsewhere.

A 30-year veteran of Olympus, Woodford had been hired as president shortly before the fraud broke in an attempt to turn round the company’s fortunes after operating income had fallen from $1bn in 2008 to around $400m in 2011.

His determination to pursue the truth reflects his difficult position at the moment the fraud was revealed.

“As president of the company, I had to sign off the company’s accounts. I was the person who had to sign a letter of representation with auditors, saying that what we were disclosing was a fair and accurate reflection of the company’s position.”

Considering whether it could happen elsewhere, Woodford suggests that once the accusations of fraud had been aired it would have been responded to quite differently in the UK and US.

“If that was a British company the non-execs would have said, ‘What is this?’ The police would be called in if you’re alleging massive fraud. You couldn’t have people standing up and defending the indefensible, you and your colleagues.”

Woodford says that part of the problem is cultural, whereby various elements of the financial and business establishment, including Olympus’s largest Japanese shareholders, avoided confrontation with Olympus’s directors over the issue.

“There’s something terribly wrong with corporate Japan, why it throws up the leaders it does. I think the reasons go back a long, long time.”

But why wouldn’t the institutional Japanese shareholders criticise the incumbent board?

“I think some of the debates we’ve been having on directors’ remuneration and compulsory voting on earnings has resulted in shareholder activism becoming the single most important element of good corporate governance,” says Woodford.

Woodford refers to the Fukushima nuclear plant catastrophe in Japan in 2011 that followed the earthquake and tsunami.

“When it [operating company Tepco] was investigated by a Japanese university professor he reported to the Japanese parliament a hierarchical system of directors blindly following orders, lacking questioning and a total deference to authority.”

But how did the fraud go unnoticed in the first place? Woodford suggests that a more robust auditing process could have reduced the chances of such a fraud taking place.

“When I first started running companies the audit was much more basic. They’d count the widgets on different trays of the factory. They would check an expense form. I think the forensic side of auditing could be enhanced, the statutory audit — the forensic side. Sampling transactions could be improved.

“External auditing has to be done in a very rigorous way. The big accountancy firms all have forensic branches so you could introduce an element of that. It would not be difficult for external audit firms to have an element of the forensic fraud prevention element to the audits they carry out, but that would involve going down to a micro level where they would check expenses and customer transactions in a much more complex and detailed way than happens now, where everything is high level. We may have to pay more money for it, but I think it would be well worth it.”

Woodford is positive about the impact that a cadre of skilled management accountants can have in an organisation. “They can do a lot of good, auditing subsidiaries such as in jurisdictions where corruption is endemic.”

But it is in the area of preparing data that he believes management accountants may have the most impact.

“For capitalism to work, for capital markets to work, you really do want to believe a company’s accounts are what you say they are.”

“The key thing is that data needs to be legitimate and accurate because only then can an external audit be robust. For capitalism to work, for capital markets to work, you really do want to believe a company’s accounts are what you say they are.”

A rotation of external auditors is also on his wish list.

“I believe that every ten years or so they should rotate the external auditors because after the fall of Arthur Andersen and Enron, there are only four big accountancy firms. I’ve been a director of a company. I recognise that human beings start to bond and if these relationships have some degree of commerciality, which they do, then the partners are paid on the income they generate and they cross-sell their consultancy services. There are lots of things in accounting that are open to interpretation, such as goodwill impairment and valuation of inventories. If you’re the senior partner auditing a company and you know that in two more years one of your counterparts would come in, you would think differently.”

Woodford concedes that the fraud at Olympus would probably never have been detected without a whistleblower from the company contacting Facta.

“Nothing would have happened without that person’s actions. Fraud, by its nature, and if it’s done in the right way, won’t be discovered.”

The answer is a catch-all whistleblower system that people feel confident in, says Woodford.

“If you’re working for an organisation where you know you can call a confidential number and actually meet people and your identity will be protected, I think that would give a lot of confidence to people. Olympus in Japan had a whistleblower line, but it was internal. I don’t believe in internal whistleblower lines. If they’re going to report to somebody, at some point you’re going to get to the board.”

Whistleblower lines should be compulsory, but they should be well funded and managed independently, says Woodford.

“If they are managed by a firm of lawyers, then the firm can’t have any other trading relationship with the company. I say this because when I was suing Olympus (he eventually settled out of court for £10m), I found that many firms were conflicted. You want people to feel they have enough confidence to say who they are and what they are, and know that their identities will be protected.”

But Woodford believes that the large cash incentives offered to whistleblowers in the US do not represent the way forward.

“The person who reported a fraud at UBS recently received more than $100m: I don’t think that’s right. I think you can offer people some degree of protection, including financial, but it could be on a graduated scale of 10 or 15 per cent of the fines placed on a company. The money should go back to the exchequer of the sovereign state where the fine was issued.

“They may never work again so a payment of $2m or $4m might be reasonable, so I agree with the principle,” says Woodford.

“But they need to refine it. The money needs to be sensible in relation to offering the person some financial protection, not making them a member of the mega rich. You actually damage the issue of transparency and honesty if you are seen to gain hugely from it.”

12 months later

Freed speech

A year after his first interview with FM, Michael Woodford, Olympus president-turned-whistle-blower, tells Lawrie Holmes of his new battle to secure greater protection for those who speak out against corporate malfeasance

Michael Woodford still has plenty to say about a global corporate culture that he believes is failing to address wrongdoing. His thoughts, coming as the Serious Fraud Office starts proceedings against Olympus and its UK subsidiary Gyrus, are timely.

Woodford’s revelation in 2011 of a £1.1bn fraud at the Japanese camera and optical instruments company led to his dismissal as its CEO and president, followed by a campaign to discredit him. Since then, three Olympus directors have been charged and the US Department of Justice has launched an investigation, reflecting the increasingly global nature of the scandal.

As a campaigning member of the Whistleblowing Commission — a new body set up by Public Concern at Work to develop a systematic approach for organisations to implement a hotline or similar mechanism — Woodford is fighting to give whistle-blowers greater protection.

He says that they can be heartened by the fact that the environment they work in is likely to be more conducive to speaking out than it has been in the past. Woodford dismisses the idea that many won’t put their heads above the parapet because of a “climate of fear”.

“If you’re working in a corporation, do you feel less fearful than you would have been 20 years ago because of the legislative framework and the employment tribunals that now exist? I don’t think the situation is as bad compared with when I started working,” he says.

One encouraging development is that non-executive directors are more empowered than ever before, Woodford argues. “I think the scandals of recent years have changed the whole context and the oversight of the executive,” he says. “The quality of non-executive directors is better than it was. But, more crucially, there is a sense that those individuals will be exposed if they don’t do their jobs properly. Imagine a non-executive group where that is the forum where whistle-blowing allegations end up.”

“The quality of non-executive directors is better than it was. But, more crucially, there is a sense that those individuals will be exposed if they don’t do their jobs properly”

How does this relate to Woodford’s experience? “In Olympus’s case, the three non-executives on the board, including the president of a Nikkei television company, all acted in this incredibly blind, unquestioning loyalty to the chairman,” he says. “But you have to separate Japan and its cultural behaviour — which is something very different — from the rest of the capitalist world. The way they moved away from me and ran with the pack told me something, aside from the specifics, that most people there care only about themselves and their nuclear families. Many were on protected contracts and had earned high salaries for a number of years. Yet they distanced themselves from me. That’s where you get into how honest people are, how decent people are and how caring people are.”

Woodford says that behaviour in the workplace is most likely to be shaped by the fear of being caught doing something wrong. “That’s why racial discrimination, sexual harassment — all those things that have gone on in the workplace — are probably a lot less common now because of the legislation in place. So you have to set anything including whistle-blowing in the context of what societies are like. I’m very cynical and jaundiced in that sense. I think it’s realistic to say that in the US and Europe there is a better chance that something will be exposed, be it Libor fixing or corruption in procurement.”

On the issue of wilful ignorance at the top of organisations, Woodford is equally forthright: “If you’re a senior officer of an institution in the public or private sector, a different set of rules apply.

You’ve got fiduciary duties to manage in a way that’s protective of stakeholders’ interests. I think that moving from issuing big fines to making officers liable to custodial sentences would be a good thing. There is this feeling that lots of senior people are still turning a blind eye.”

Won’t western companies adopting anti-bribery legislation influence companies in other countries? “The UK Bribery Act and the US Foreign Corrupt Practices Act do reduce the likelihood that western companies will do wrong in developing states where corruption is endemic. These will make management teams think: ‘I am not going to expose the corporation or myself to the risk of an investigation by the Department of Justice.’”

But perhaps the strongest deterrent to potential wrongdoers in recent times is the recognition that the vast amount of corporate and personal data that’s recorded could be retrieved as evidence.

“You’re going to leave a trail of evidence that will condemn you,” Woodford says. “But it’s not only that it’s all traceable; it’s also sortable. Where once you had to go into huge archives, now you can simply put in a search word and it will pull out the whole thing. And, of course, that makes people think carefully about their conduct.”

He adds: “Legislation, electronic data capture, cultural change, the increasing power of non-executives and improved protection for whistle-blowers are starting to bed down and could be enhanced if there were independent reporting lines. This would lead to a better culture. When people ask about changing culture, I say start at the top in the boardroom.”

Woodford says another crucial ingredient in limiting corporate wrongdoing would be the compulsory rotation of external auditors every 10 years. “You should let people know that there’s going to be another audit partner coming in, which would lead to more conservatism in organisations.”

The Financial Reporting Council has ruled out bringing in compulsory rotation because of the likely problems of ensuring that another big-four firm could be found to undertake the work. Its views were supported in a recent report by the Competition Commission.

“I don’t agree with that opinion,” Woodford says. “Four is better than one. If you allow an auditing relationship to go on year after year, common sense tells you that this cannot be ideal.”

How we got where we are

The Olympus scandal first came to global attention on 14 October 2011 , when Michael Woodford was ousted as chief executive of the Japanese group. Although he had been at the company, which sells photographic and medical equipment, for 30 years, he had been chief executive for just two weeks.

Woodford’s fellow directors, including chairman Tsuyoshi Kikukawa, may have hoped he would go quietly, but he did not. Woodford launched his fightback, alleging that he had been sacked because he had been asking difficult questions about multi-billion dollar deals carried out by Olympus before he became chief executive. In particular, he had become alarmed by the $2.2bn takeover by Olympus of British medical equipment company Gyrus Group in 2008.

What had concerned him was that a $687m fee was paid to a middleman for his help in arranging the deal, equivalent to 35 per cent of the deal, compared to a market rate of 1 per cent. He was also concerned about three other acquisitions in 2008, for industrial waste company Altis, mail-order cosmetics firm Humalobo and microwavable dish manufacturer News Chef, which all saw massive write-downs the following year.

They were eventually found to have been used to cover up disastrous speculative investments by the company. At first, Kikukawa and other executives denied anything was amiss, but 12 days later he resigned as chairman.

Then, in early November 2011, as the scale of the offences became impossible to deny any longer, Olympus admitted that the payment was “inappropriate” and was designed to cover up losses made on investments dating back years, but kept secret from investors.

More resignations followed, topped off by the arrest of seven people — three executives and four financial advisers — in February 2012. In September this year three former Olympus executives, including Kikukawa, pleaded guilty in a Japanese court to filing false financial reports. The legal cases are ongoing.

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