The 3 Most Infamous Tales of Accounting Fraud

Accounting can sometimes go very wrong, either through willful intent or failure to understand proper procedure and protocol. Some of the biggest accounting frauds in history have been caused by failure to adhere to basic accounting principles. The most infamous and well-known — the kind taught in all online accounting courses — are the big three: Enron, WorldCom and the Madoff Ponzi Scheme.

Enron

This massive accounting fraud was revealed in October 2001 and resulted in the bankruptcy of the Enron Corporation, which was an oil and natural gas energy company based in Houston, Texas. It also resulted in the eventual dissolution of accounting firm Arthur Andersen which, at its peak, was one of the five largest audit and accountancy partnerships in the world. In addition to being the greatest bankruptcy reorganization in American history at that time, Enron was attributed as the greatest audit failure.

So what happened? The company’s chief financial officer, Andrew Fastow, and other members of the executive team purposefully misled Enron’s board of directors and audit committee on extremely high-risk accounting practices. They also forced their firm, Arthur Andersen, to ignore the issues.

Enron went to great lengths to conceal losses and maximize profits — real or imagined. They brought on teams of Certified Public Accountants (CPAs) as well as accountants who had been involved in the construction of new accounting procedures with the Financial Accounting Standards Board (FASB). The accountants were inventive in their search for ways to save the company money, including but not limited to capitalizing on the loopholes in the wording of Generally Accepted Accounting Principles (GAAP), the accounting industry’s standards, and reporting costs of cancelled projects as assets with the unscrupulous reasoning that there were no official documents stating the project was cancelled. This technique came to be known as “the snowball”, and although it began with an initial limit of less than $90 million, the projects it was later used to report had increased to $200 million.

Enron shareholders finally filed a forty billion dollar lawsuit after the company’s stock price, which went for $90.75 per share at its peak in mid-2000 and crashed to just sixty cents by the end of November 2001. The U.S. Securities and Exchange Commission (SEC) launched an investigation, and Enron’s main rival, Dynegy, offered to purchase the company at a very low price. The deal collapsed, and in December that year, Enron filed for bankruptcy. Enron’s sixty-three billion in holdings made it the most massive bankruptcy in world history until WorldCom followed just the next year.

WorldCom

When WorldCom (currently known as Verizon Business under Verizon Telecommunications), the enormous telecommunications company, failed and went into bankruptcy, one of the largest accounting frauds in history was discovered. Former CEO, Bernie Ebbers, was found to have committed an eleven billion dollar fraud in order to protect himself and company executives from losses.

WorldCom violated a number of important accounting principles for the purposes of hiding the increasingly unstable and unprofitable financial condition of its operations. According to financial analysts, the accounting misreporting and deception was quite simple, and in fact not as complex and well-orchestrated as Enron’s. The WorldCom accountants and financial managers simply made false or unsupported accounting entries in WorldCom’s financial systems for the purpose of manufacturing the image of a healthy, sustainable and profitable company. These false entries amounted to a staggering eleven billion dollars at the time of WorldCom’s collapse, making it the largest bankruptcy in the history of the United States until the financial crash of 2008.

Bernie Madoff

When the Madoff investment scandal was discovered in December 2008, Bernard Madoff admitted that the enormous wealth management arm of his business was an elaborate Ponzi scheme. Madoff created the Wall Street firm Bernard L. Madoff Investment Securities LLC in 1960. It grew into one of the largest investment firms in the world, with billions of dollars in investments. It was purported to have unnaturally high growth — growth that other financial analysts and investors were unable to replicate.

Madoff never filed disclosures of its holdings with the SEC, which is not against accounting procedure, but is not recommended. Madoff did not allow any external auditing “for reasons of secrecy”, telling investors and analysts that it was solely the responsibility of his brother, Peter, the company’s chief compliance officer. This too, is against accounting protocol because external audits are the primary method of ensuring compliance with the law and other regulations.

Most glaringly, Madoff’s auditor of record was Friehling & Horowitz, a small two-person accounting firm based in a small town that had only one active accountant, David G. Friehling. David Friehling happened to be a close Madoff family friend and, in a clear conflict of interest, an investor in Madoff’s fund. In 2007, some companies began to suggest that their clients not invest with Madoff because of the implausibility that one accountant could actually service such a massive billion dollar investment organization. This obvious and blatant flouting of basic accounting principles finally led to Madoff’s arrest in 2008, when he was convicted for a sixty billion dollar scheme.