Accounting Scandals and Their Brilliantly Twisted Frauds
Ever wonder how big firms manage to get away with absurd accounting scandals that reports in billions? I did too — until I started researching them. As fraudulent as their actions are, they are brilliantly orchestrated. They’re twisted geniuses who let money take over their conscientiousness and greed take over their humanity. Today, we will be exploring some scandals that were particularly interesting to me.
The Enron Accounting Scandal
The classic. The horrendous. The nearly impossible. Ask any accountant and they could go on rants for forever about the Enron scandal. Enron, once one of the largest commodity trading and energy extraction companies, became bankrupt almost overnight. There is so much that went wrong with Enron operations that I really went “what did they do right?” to myself. But this article isn’t about unethical business practices (despite how much I can tell you about this), it’s about fraudulent accounting.
One of Enron’s earliest scandals was the Valhalla oil scandal. Company executives essentially betted on oil prices, which reaped large amounts of profits — until it didn’t. Since profits were redirected to personal accounts of the execs, the company did not have enough funds to cover their losses. You’d think they’d just write this as a loss right? Well, they should’ve. Instead, the company ruined financial documents regarding the loss and fabricated that they were continuing to earn profits to keep stock prices inflated. Often referred to as a house of cards, this was the first card Enron had put down.
Enron didn’t stop their fraud there. In their cooperation with Blockbuster to deliver movies on demand, the technology had failed and was unable to be sold. Reasonably speaking, this is a clear lost. But that would be too simple for the twisted geniuses. Instead they used mark-to-market accounting, a method that would mark an asset’s worth to the market value. This essentially would write the asset’s worth in company books as the price at what it’s sold at on the market. For example, if I bought a book for $5 but the market price is $10, I may want to bump the worth of my book up. This is supposed to be done very cautiously and conservatively — with assets. Enron definitely were not moderate, and neither did they use the method on assets. The company used the method on their profit! They arbitrarily determined how much profit the would theoretically earn if the technology succeeded (which, again, it didn’t) and wrote down $53 M in earnings. Crazy for a project that never launched!
You think that’s bad? It gets worse. Towards the end of its operations when the mark-to-market accounting could no longer sustain the large scale fraud, the company started making a complex system of shell companies. Admittedly, the fraud was genius and executed to near perfection. Essentially, these shell companies — extensions of Enron — would “buy” the company’s debt for the fiscal period. This wiped the debt off Enron’s financial statements when they publish it to investors, making the company look more financially healthy than what it actually was. Once they start their new fiscal period, Enron would “buy” back the debt. They essentially stored their debt off their balance sheet. It’s like playing monkey-in-the-middle but with the tax agency. Genius — I know. Evil — I also know.
Noble Ltd Accounting Scandal
As someone born and raised in Southeast Asia, it’s quite rare we come across publicly announced accounting scandals. Yet Noble Ltd manage to make the list, in fact, it’s one of Asia’s worst accounting scandals. It gave the regulators of Singapore, a country renowned for its discipline, a horrible global reputation for a long while. For a service based economy focusing on financial services, this didn’t look to great for Singapore. But how did Noble Ltd get there?
Worth at around $6 B, Noble was doing great before the scandal nearly wiped it out. Like Enron, the company used mark-to-market accounting to inflate its profit. While most commodity trading companies also use this method to track its long contracts, Noble inflated it’s income so much that it was worth 90% of shareholders equity. This number lies around 3–5% as per industry standard. So Noble was propping itself up on cardboard boxes — eventually, the fell. Since the company made no real profit, there was no way to pay off its debt.
A trend with the frauds in this article — as observed by yours truly — is that they violate multiple accounting principles and good practices. So, by default, mark-to-market wasn’t Noble’s only problem. The company recorded contracts as financial instruments. Now don’t get me wrong, contracts and procurement make money — lots of it even! Wondering why this is wrong? Well, when you think about the literally worth of a contract, it’s really just the paper and ink used to write it. All the potential financial benefits they bring are implications and expectations. SO while the contract will be of value, the piece of paper itself isn’t worth much. Think about it this way, if I made you a promise and followed through with it, that would be a benefit. But you can’t exactly record my promise on a balance sheet can you? People say it isn’t a crime until you get caught, and well, Noble took that a little too seriously.
Nortel Accounting Scandal
If you’re Canadian, you’ve probably heard of Nortel and may even know former employees. If you’re not Canadian, well, chances are you’ve still heard of Nortel. As one of Canada’s oldest technology companies, Nortel expended during the dot-com boom (1997–2001) and once made up 30% of the Toronto Stock Exchange (TSE) worth. How did a company so big go so…wrong?
Nortel had overshot their growth projections too much at the height of operations that revenue streams could no longer keep up. Company executives became worried and used a manipulation method called the “cookie jar”. They would set up false reserves, something meant to be used to record bad debts as such, that would then be tapped into during financial difficulty. This gave the impression that the company continued to earn stellar amounts and inflated projected growth. When even this couldn’t keep up with projections, executives started inventing their own methods of accounting. They essentially wiped expenses and amortization off their books, increasing the profit they earned. It was as if the revenue appeared from thin air! While all this is happening, Nortel executives were paid bonuses and made large sums off their share of the company.
Alas, house of cards don’t hold forever. Nortel started to see its stock stumble and lawsuits build up. With a long line of creditors they are unable to pay, Nortel tried a last leg of its scheme. The company tried to play off the profitability modelled by false numbers, and encouraged employees to buy stocks options as a part of their payroll. Eventually, the company declared bankruptcy and many saw hope for prosperity shatter.
Where Do We Go?
All these scandals were admittedly executed nearly perfectly. These companies had brilliant accountants and strategists with such in depth understanding of accounting and incredible innovative abilities that they managed to make their balance sheet come off as completely true. They bypassed auditors, government agencies, and the unassuming public in order to orchestrate large scale frauds that shook the accounting industry to its core. While we criticize and criminalize individuals involved in the scandal, we must also acknowledge their incredible intelligence to succeed in such illegalities.
As a society, we need these people in positions where their intelligence and genius minds are put to the good, not the bad. While I’d like to think people would do this out of goodwill, the reality is that there must be incentives. Governments need to invest into talent acquirement in this field of work to match that of the private sector in order to effectively regulate companies and businesses. After all, we can’t continue to put sheeps into a cage full of wolves and hope for it to end up on top!
