Property Crime - Corporate America Rechecks Its Books

According to a study by Financial Executives International, a total of 464 companies issued restatements of their earnings in the 1998 to 2000 period. This figure is higher than in the previous ten years combined. The study argues that there was heightened pressure on corporate executives to have their companies perform (that is, to meet investor's expectations) during the bull market of the 1990s. The main reason for the restatements came from revenue errors (which accounted for 20% of the restatements, according to one study). Other reasons were improperly accounting for accounts receivable, reserves, accruals and other forms of liability.

As the graphic shows, a number of companies file restatements of their earnings every year; an average of 46 firms did so from 1987 to 1997. What touched off the push for accurate accounting in 1998? In that year, Waste Management Inc., Sunbeam Corp., and Cendant Corp. all filed large restatements of their earnings. In his speech, "The Numbers Game," Securities and Exchange Commission Chairman Arthur Levitt lamented that too many corporate managers and auditors let the desire to meet earnings expectations override their sense of good business practices. His fear was that "Managing might give way to manipulation; integrity may be losing out to illusion" (Magrath, Weld).

It is important to note that there are forms of earnings management that all companies can and should practice — reducing production schedules with excessive inventory, for example. Some, as Magrath and Weld note, are more subtle, such as pressuring sales and marketing staff to "meet the numbers" that the company has set for itself. This is acceptable, but what about hazier situations — say, the sale is recorded before deliveries are completed? Carol Loomis cites the example of a corporate chief, under pressure to meet numbers, making an off-price deal at the end of a quarter that simply steals from full-priced business down the road. Something which she notes is "dumb but legal." Too often an executive may be tempted to sidestep the rules publicly owned companies are required to abide by, Generally Accepted Accounting Principles (also known by the eyebrow raising acronym GAAP).

The SEC seemed to mobilize after Levitt's speech. Financial fraud and managed earnings were noted by the commission as a top enforcement priority. The SEC even christened 1999 as "The Year of the Accountant." One must wonder how this announcement played in the hallways of Arthur Andersen and energy giant Enron Corp. In August 2000, Jeffrey Skilling quit as Chief Executive of Enron, an event generally regarded as a sign all was not well within the company. Vice Chairman Clifford Baxter resigned over the firm's "inappropriate partnerships" in May 2001. On October 16, 2001, the company was forced to admit a $1.2 billion decrease in its value from its fraudulent bookkeeping methods. Less than two months later it filed for bankruptcy. Investors in the firm lost more than $60 billion. Arthur Andersen, the firm's accountant, was convicted of obstruction of justice in destroying documents related to the Enron case while on notice of a federal investigation. It received five years of probation and a $500,000 fine. The future of the firm, which is but a shadow of its former self, remains uncertain.

A few months later came the collapse of WorldCom. In March 2002, just months after the fall of Enron, the SEC filed a request with the company for information relating to its accounting procedures. On June 26, 2002, the company admitted to inflating earnings by $3.8 billion. A handful of months later, the firm filed for bankruptcy after it admitted the total misstated earnings were in excess of $7 billion. As of August 2002, it is the largest U.S. bankruptcy on record.

There have been several other well publicized cases of fraud after the WorldCom case, most notably the arrest of executives of cable system Adelphia on fraud charges. The SEC recently informed the chief executives of 947 of the largest corporations to submit certified, accurate statements by August 14, 2002. Nearly 700 companies turned in their paperwork, eager to comply with the SEC and, presumably, to certify their numbers and to give a boost to nervous investors on the jittery stock market. A number of other companies were given later due dates because they do not report on a calendar basis.

Source: "Market Shrugs Off Certification Day." And "Restatements Rise on SEC Initiative." Retrieved from http://www.cfo.com/ print articles; Hill, Patrice. "Stock Hopes Rise on SEC Order." Washington Times, July 29, 2002; Magrath, Lorraine and Leonard G. Weld. "Managed Earnings or Fraud: Where Do We Draw the Line." Retrieved from http://www.spectrum.troyst.edu/~symposium/2002_papers/Magrath%2020%.weld.doc; "Why so many earnings restatements?" Retrieved from http://www.j-bradford-delong.net; "Managed Earnings" and "The Year of the Accountant." Retrieved from http://www.sec.gov; Cathy Booth. "Called to Account." Time, June 18, 2002. "Andersen Guilty." Retrieved from http://www.cnnmoney.com. Carol Loomis. "Lies, damned lies and managed earnings" from http://www.fortune.com; Jeanne Lang Jones. "Washington Ranks Relatively High in Financial Restatements. Puget Sound Business Journal, August 12, 2002, p. 4; Brian Morrisey. "WorldCom's Day of Reckoning." Retrieved from http://www.intenetnews.com/ispnews/article.php/1430361.