A fascination for scoundrels existed long before Allan Pinkerton first compiled his rogue’s gallery in 1855. But today’s master criminals are not highwaymen, they are captains of industry.
No need for pistols these days, just a working knowledge of accounting; enough to turn costs into assets, unwanted inventory into sales, and losses into goodwill.
It’s all fun and games until somebody gets hurt and every year people do get hurt. Accounting scandals cost thousands of jobs and millions in lost pensions.
Investors and creditors lose billions, meaning that ordinary families lose hard-earned savings. Knock-on effects in supply chains further multiply the losses. It is crime on an epic scale and rightfully excites public outrage. Below, you will find our rogue’s list of the most scurrilous accounting scandals of our time.
Table of contents
Types of accounting scandals
Accounting scandals come in four main guises: misstatement of earnings, misstatement of solvency, fraud schemes; and embezzlement.
- Misstatement of earnings occurs when a company manipulates its revenue and/or expenses to make profits appear better than they really are. With enough determination any company can transform its income statement to give the appearance of booming growth and exceptional profitability. The main goal usually being to boost the share price, enriching the controlling owners or senior management.
- Solvency misstatement occurs when a company manipulates its assets and/or debts to give the impression of a healthy balance sheet. This type of accounting fraud is popular with companies that are insolvent, or nearly so, and prefer to hide this inconvenient truth. It is prevalent among companies with large balance sheets in relation to earnings, such as financial corporations and natural resource companies.
- Fraud schemes involve attempts to receive illegal payments through false representation, failing to disclose information or abuse of position. For the most part, these schemes parlay into stock manipulation, money laundering and bribery. Stock manipulation normally coincides with misstatement of earnings and/or solvency. Stock manipulation is commonly associated with maturing options and insider trading.
- Embezzlement is any theft that occurs when a company’s assets are unlawfully transferred. A Ponzi scheme is simply a specific type of embezzlement.
Misstatement of earnings and solvency are the most common types of accounting scandal involving large-scale losses, followed by embezzlement. This is not to say that fraud schemes are less common, simply to say that they typically entail smaller losses. That said, bribery scandals tend to dissuade a lot of potential customers.
The key to all types of accounting fraud is that either a company’s financial statements are either wilfully misstated or there is a deliberate failure to disclose information. The intent, in either case, is to defraud or illicitly obtain money or advantages.
If criminal charges are laid, the prosecution must prove intent. If not, accounting scandals will be dismissed in most jurisdictions. Some scandals do not lead to a formal judgment of guilt by a court, especially of a company avoids bankruptcy, because prosecution is complex.
But even if criminal action is avoided, scandals cause significant economic and social losses. In a recent example, it remains to be seen whether any of the arrests among former employees of Evergrande will be charged with accounting fraud.
The problem of accounting fraud
Figure 1 shows the worst examples of each of the four types of accounting scandal, both convicted and alleged, since 1970.
All of these fraud examples involved losses of more than half a billion US dollars or more. In many cases, a company will engage in several kinds of accounting fraud. Both Enron and WorldCom, for example, misstated earnings, hid debt and engaged in fraud schemes.
Figure 1: Major accounting scandals, convicted and alleged, since 1970
Source: Transparently.AI
We have categorized companies according to whatever action we felt was most egregious in each particular case. In the case of Wirecard, for example, prosecutors appear more concerned about the €1.9 billion “missing” from two Philippine bank accounts than the allegations of money laundering, overstatement of earnings and improper capitalization of expenses.
The list in Figure 1 is long and emphasizes the prevalence of accounting fraud.
We calculate that the absolute worst accounting scandals are those in red: Lehman Brothers, WorldCom, Enron, Daewoo, Adelphia Communications, Valeant Pharma, Madoff and Rite Aid.
We came to this list by examining the debt and equity valuations of each entity just prior to bankruptcy. These give a rough guide to the losses associated with each scandal. These estimates are approximate only because we have not assessed the recovery rate on the debt of each incident. In any case, how does one assess the recovery rate on Lehman’s debt when trillions of emergency liquidity was injected into global financial markets?
In the case of Rite Aid, there was no immediate bankruptcy. It has taken 25 long years for the company to finally file for Chapter 11. Our calculation assumed that all of the debt at the time of scandal was repaid. Nevertheless, the equity losses associated with Rite Aid were significant.
Figure 2: Losses associated with the greatest scandals (US$ billions)
Source: Transparently.AI estimates
Figure 2 shows our approximation of the losses associated with the world’s worst accounting scandals. Let’s go through the list.
The world's worst accounting scandals
8. Rite Aid
Martin Grass began working for his father’s pharmacy chain, Rite Aid, shortly after graduation in 1984. Established in 1962, Rite Aid was already a well-established company when he started.
Listed on the New York exchange in 1970, Rite Aid sales surpassed US$1 billion in 1983. In 1987, with the acquisition of Gray Drug, Rite Aid became the largest drugstore chain in the US with more than 2,000 stores. That year Dun’s ranked Rite Aid 25th among all publicly traded companies for consistent dividend growth.
When Martin Grass replaced his father as CEO/Chairman of Rite Aid in 1995, there were 3,000 Rite Aid stores on the US east coast and the company’s market capitalization was US$2.5 billion.
Upon his takeover, Martin pursued a strategy of building bigger, more expensive free-standing stores while completing a series of corporate acquisitions to grow Rite Aid and push it into new regions of the country.
By 1996, Rite Aid doubled in size to 4,000 stores after several acquisitions, including Read’s Drug Store, Lane Drug, Hook's Drug, Harco, K&B, Perry Drug Stores, and Thrifty PayLess.
At the time, the strategy appeared warranted due to mounting pressure from Wal-Mart and the debt-free Walgreen drugstore chain. Acquisitions continued through 1997 and 1998 and the share price soared thanks to a perception of growth. From January 1995 until January 1999, Rite Aid’s share price rose some 320%. The market believed in the strategy of growth by acquisition.
Unfortunately, as the acquisitions grew, so did the cost of the debt. Meanwhile, integration of the acquisitions was proving difficult amid intense competitive pressure from Walmart and Walgreen.
Behind the veneer of growth, Rite Aid was foundering and the stock price began to slide from early 1999 onwards. On 7 September 1999, Alex Grass, Rite Aid’s founder and Martin’s father, travelled to New York to warn two members of the company's board that its debt was out of control and Rite Aid was "bleeding cash."
Subsequent internal investigations revealed that the situation was worse than feared. When the company began restating earnings, the SEC began an investigation.
The SEC complaint found that Rite Aid overstated its income in every quarter from May 1997 to May 1999, by massive amounts. When the wrongdoing was ultimately discovered, Rite Aid was forced to restate its pre-tax income by $2.3 billion and net income by $1.6 billion, the largest restatement ever recorded.
The complaint also charges that Grass caused Rite Aid to fail to disclose several related-party transactions, in which Grass sought to enrich himself at the expense of Rite Aid's shareholders. Finally, the Commission alleges that Grass fabricated Finance Committee minutes for a meeting that never occurred, in connection with a corporate loan transaction.
Six former Rite Aid senior executives were convicted of conspiracy in 2003 regarding a wide range of accounting fraud and false filings with the SEC. Grass was sentenced to eight years in prison, the harshest punishment ever given in connection to an accounting-related crime at the time.
The SEC charges included a long list of methods used to inflate earnings including using fake contracts, booking income prematurely, using incorrect depreciation rates and incorrectly recording payments for medicine.
The Rite Aid scandal effectively wiped-out shareholders, causing losses of about US$40 billion. The debt was repaid but the company has recently filed for Chapter 11 and we note that the current debt level is not much lower than it was two decades ago.
Although the losses at Rite Aid were soon overshadowed by those at Enron and WorldCom, it remains one of the worst accounting scandals in history in terms of the losses caused to stakeholders.
7. Bernard L.Madoff Investment Securities
Bernard Lawrence "Bernie" Madoff was an American financier who served as the Chairman of Nasdaq in the early 1990s. He was as ‘establishment’ as establishment gets. He was universally respected and trusted by investors, regulators and government. He abused this trust to execute the largest Ponzi scheme in history, defrauding thousands of investors out of US$64.8 bn over the course of at least 17 years, possibly longer.
Madoff built his reputation as a pioneer of electronic trading. The trading platforms developed by he and his brother attracted massive order flow by the late 1980s. He and four other Wall Street firms processed about half of the New York Stock Exchange's order flow. At that time, he was making about US$100 million a year and many believed that his market-making business gave him unique insights into market activity.
In the early 1990s, or possibly much earlier, Madoff began to exploit this perception of trading insight and began to switch from market making to taking money from investors.
His scheme was remarkably simple. Guided by his pedigree and claims of high returns, investors gave Madoff funds to invest in his trading strategies whereupon he deposited their funds in an account at the Chase Manhattan Bank. He made no attempt to trade and merely let the cash sit.
When clients wished to redeem their investments, Madoff funded the payouts with capital attracted from new clients. Clients came easily due to reputation and Madoff’s image of exclusivity. He often initially turned clients away. Roughly half of Madoff's investors cashed out at a profit. When the scheme was exposed, these investors were required to pay into a victims' fund to compensate defrauded investors who lost money.
Some suspected foul play. The SEC investigated Madoff and his securities firm on and off from 1992 onwards. Moreover, there were sporadic claims that his returns were not attainable from the options trading methods he claimed to be using.
In 2005, shortly after Madoff nearly went under due to redemptions, the SEC asked Madoff for documentation on his trading accounts. He invented a six-page list but there was no follow up and no attempt to confirm with his counter-parties.
Madoff was less fortunate during the global financial crisis of 2008. In November 2008, Bernard L. Madoff Investment Securities reported year-to-date returns of 5.6% while the S&P 500 had fallen 39%. Notwithstanding this excellent performance, many clients were forced sellers and Madoff was unable to meet redemptions. Bernie Madoff was arrested on December 11, 2008. He was sentenced to 150 years in prison, where he died on April 14, 2021.
Thousands of investors lost money, many lost their life savings, and some committed suicide from the seventh-worst accounting scandal of all time.
6. Adelphia Communications
Adelphia Communications is a straightforward case of embezzlement.
In 1952, John Rigas and his brother bought the local cable television station in Coudersport, Pennsylvania for the grand sum of US$300. They called the new company Adelphia Communications Corporation. Borrowing aggressively, Adelphia grew by acquisition. Rigas eventually took Adelphia public 34 years later, in 1986.
By 1998 Adelphia was a household name and had become one of the largest providers of cable television, long distance phone calls and then broadband internet in the US.
When Adelphia went public, Rigas retained separate ownership of his own private family ventures.
The cable business is very capital intensive. With the relentless growth of cable and then broadband, banks grew accustomed to lending to both Adelphia and the Rigas family. In 1996, when Adelphia acquired an interest in a cable business in Florida, the Rigases arranged for the first co-borrowing loan -- one that either they or Adelphia could tap.
It was only $200 million, and it arguably benefited Adelphia more than the Rigas family because the assets were held in Adelphia. Nevertheless, the enabling agreement stated openly that the family would use some of the money to purchase stock.
In 1999, three large acquisitions in a single month, representing cable operations in 30 states, vaulted Adelphia to sixth place among cable operators, pushing its subscriber base to more than five million. Adelphia was in the big time. Meanwhile, Adelphia's debt rose up from US$3.7 billion to US$9.7 billion. Adelphia’s debt-to-cash flow was almost 9x versus 5x for an average cable operator. Nevertheless, Adelphia’s stock kept rallying.
At this point, the Rigas family had 60% of the voting rights in the company but controlled only 20% of the stock. Younger family members were selling shares and the heavy debt load made an equity raising necessary.
In order to keep control as the company issued shares, between 1999 to 2001 three banking syndicates allowed the Rigases/Adelphia to borrow a total of US$5.6 billion, a staggering sum at the time. Scores of other banks participated. More than US$3 billion was lent on condition that the loans were jointly backed by Adelphia, a public company with public shareholders, as well as the family's own assets.
The money was used, in large part, to buy Adelphia securities, which subsequently lost most of their value, to make payments on stock the family had bought on margin, and to provide a slush fund for family extravagances - US$150 million was lent to a money-losing hockey team, US$3 million was blown on a movie produced by Rigas's daughter, US$13 million went into an unfinished golf course, millions more were spent on the corporate jet, which was used as a family taxi, and the list goes on.
It was not until early 2002 that Adelphia finally disclosed that it was potentially liable for US$2.3 billion in extra loans. When analysts demanded disclosure of the destination of these funds, the stock plunged, prompting the auditor to refuse to sign off on the accounts, which caused the stock to fall even more.
The SEC opened an investigation, prompting John Rigas and his son Tim to resign. Meanwhile, creditors called the loans, pushing Adelphia into bankruptcy.
The SEC filed a civil complaint parallel to a criminal case, calling it ''one of the most extensive financial frauds ever to take place at a public company.'' In 2004, John Rigas and his son were convicted of fraud and sentenced to jail.
It is estimated that the Rigas family embezzled at least US$1 billion from Adelphia. Stockholders were wiped out and, following the tech crash, the loan recovery rate for banks and bond holders was less than US 30 cents in the dollar. At the time, it ranked as the 12th-largest bankruptcy in US corporate history and the largest caused by fraud.
5. Valeant Pharmaceuticals
Valeant Pharmaceuticals International Inc. is a story of two remarkable individuals. The first, Milan Panić, a famous WWII resistance fighter, led the company from 1959 until 2002, briefly serving as Prime Minister of Yugoslavia during this time.
Under his guidance, Valeant became an early player in antiviral drugs and developed a global distribution franchise. However, poor governance saw the company rocked by a series of scandals, law suits and regulatory setbacks. Pressured by investors and hunted by the SEC, Panić stepped down in 2002.
Valeant’s share price languished until 2008 when the board appointed Michael Pearson, the second remarkable individual in the Valeant story, as the new CEO. Pearson believed acquisition was the only way to deliver shareholder value in a pharma business.
He turned Valeant into a corporate raider, buying pharma companies, stripping them of unnecessary costs including R&D, and running their drug catalogue as cash cows until the patents expired.
For a time, the strategy worked and the stock soared. By 2014, Valeant was among the world’s top 15 drugmakers. The stock doubled in the first half of 2015 on record profits as Pearson inked deal after deal, making Valeant Canada’s most valuable company and a top 5 global player.
But there was a flaw. Since the catalogue of a pharma company typically has a life span of about 5 years, Pearson’s strategy required exponential growth in debt to sustain earnings growth unless Valeant could find a way to offset price decay in drugs coming off patent or, more simply, unless it lied about its earnings.
Valeant did both. It engaged in price gouging in its monopoly drugs and it misstated earnings.
From mid-2015 onwards, public discontent with the company’s drug pricing became increasingly vocal. In early October, the company admitted it had been subpoenaed by US prosecutors investigating its drug pricing.
Shortly thereafter, the short seller Citron called the company toxic and highlighted a number of accounting concerns including the relationship between Valeant and a mail-order pharmacy called Philidor, which it controlled and was driving much of its reported sales growth. The Philidor news led to fears of channel stuffing among investors.
In February 2016, amid news of an SEC probe, the company admitted accounting issues and “improper conduct” by top finance executives. Pearson was replaced as CEO and the company changed its name to Bausch Health Companies Inc.
The accounting probe was evidently complex. It took the SEC almost five years of investigation before it finally lay charges in July 2020 of improper revenue recognition and misleading disclosures in filings and earnings presentations. The wording of the order did not reveal the extent of the revenue misstatement, suggesting that investigators were unable to accurately determine the full extent of the fraud.
The company's share price plunged 96% from the peak in July 2015 to when the SEC charge was announced, representing a loss of approximately US$80 billion. That makes it the fifth-worst accounting scam in history, by our estimation.
In addition, the company had US$30 billion in debt including US$18 billion in bonds, which also crashed. Asset sales prevented a debt default, but most of the debt pile accumulated by Pearson remains.
4. Daewoo Group
In 1998, Korea’s Daewoo Group was a lonely beacon of hope amid the carnage of the withering Asian financial crisis.
Daewoo appeared not only to have survived the crisis but to have thrived. The company ranked 18th on Fortune magazine’s Global 500 List of the world’s largest corporations, equivalent to today’s Microsoft ranking, and was Korea’s largest chaebol -- a vast conglomerate with 320,000 employees, US$44 billion in assets and interests stretching across the globe from shipbuilding to textiles in more than a hundred subsidiary companies.
As the 1997 crisis bit, Daewoo’s Chairman, Woo Choong Kim, pursued a strategy of aggressive growth, particularly in the auto industry. Kim saw the crisis as a chance for Daewoo to cooperate with the government, borrow to acquire failed companies, and drive expansion.
In January 1998, the nadir of the crisis, Daewoo Motor acquired Ssangyong Motor, assuming US$2.43 billion additional debt. In 1998 alone, the group spent US$7.14 billion on sales promotions.
A strategy of growth during crisis had always underpinned Daewoo’s success and in 1998 the strategy appeared to be working again. Sales of Daewoo Group increased by 25% while sales at Daewoo Corp. rose an incredible 54%. This, while Korea was digesting an IMF bail-out and sales at most Korean firms were declining.
All of this growth, however, was either fabricated or funded by debt. The company raised a staggering US$20.6 billion of additional debt via commercial paper bond issuance in 1998 to fund growth and cover its maturing debt.
Eventually, the collapsing yen and rise in Korean interest rates upended the balancing act. Daewoo declared bankruptcy on 1 November 1999 with debts estimated at between US$50 and US$75 billion. We say estimated because it remains unclear exactly how much of Daewoo’s debt was hidden.
Until the downfall of Enron in 2001, it was the world’s biggest bankruptcy and certainly surpassed Enron if we exclude equity losses.
The true extent of accounting fraud at Daewoo will never be known. Most of the manipulation occurred in the company’s offshore operations, subsidiaries and investments. As is usual, most of the evidence was shredded. Korean prosecutors claimed that Daewoo’s companies inflated assets by US$19.1 trillion, which would make it the largest manipulation by a non-financial corporation.
Daewoo Corp., Daewoo Motor and Daewoo Electronics accounted for about 90% of the conglomerate’s impaired capital. Much of the fraud occurred at Daewoo Corp, which used its London operations to fabricate US$12.2 billion in fraudulent assets.
Most of the accounting fraud in Daewoo’s domestic operations involved hiding debt, fabricating export receipts and utilizing affiliates to hide losses and debts. Prosecutors claimed roughly US$12.5 billion in debt was hidden in off-balance sheet schemes. Related-party transactions were also used for asset swaps among Daewoo subsidiaries at exaggerated values. Stronger affiliates would prop up weaker companies by purchasing assets well above market prices.
Chairman Kim was eventually charged with masterminding accounting fraud of US$43.4 billion, illegally borrowing US$10.3 billion, smuggling US$3.2 billion out of the country and roughly US$1 billion of bribery and corruption. Kim was sentenced to 10 years in prison but was granted amnesty by President Roh Moo-hyun in 2007.
3. Enron
Enron Corp. was a Texas energy-trading firm that grew to dominate the US electricity industry, eventually building power stations and electricity grids, providing broadband, and trading in many commodities besides energy. Investors applauded the company’s innovation, especially with respect to risk management.
Enron stock peaked on 23 August, 2000 at US$90.75. That made what was essentially a glorified utility an earnings multiple of over 70x, a market cap of about US$70 billion and making it the seventh-largest publicly traded company in the US.
Thereafter, the wheels began to totter. Investors began to scrutinize Enron’s use of ‘mark-to-market’ accounting to inflate earnings by revaluing investments, even if the investments were loss-making or redundant and should have been written down.
In the summer of 2001, Enron Vice President Sherron Watkins wrote a letter to Chairman Kenneth Lay, advising of the problem and warning that the company was using special-purpose entities to hide bad debt from the balance sheet.
An SEC investigation followed and Enron’s share price collapsed. In recognition of her whistleblowing, Watkins and two colleagues were named Time Persons of the Year in 2002.
The scandal led to the bankruptcy of Enron, the dissolution of Arthur Andersen, and the Sarbanes-Oxley Act (2002), which imposed harsh penalties for destroying, altering, or fabricating financial records. Investors and creditors lost more than US$150 billion.
The company’s CEO Jeff Skillings was sentenced to 24 years in prison. Prosecutor Andrew Weissman indicted not just individuals, but the entire accounting firm of Arthur Andersen, effectively putting the company out of business.
2. Worldcom
WorldCom was an American telecommunications company, which was, at its peak, the country's second-largest long-distance provider.
Like all telcos, Worldcom became embroiled in the hype of the dot.com boom, which pressured management to deliver strong earnings growth, mostly via debt-funded acquisitions and creative accounting, to sustain unrealistic valuations.
When the dot.com bubble burst, spending on telecom services fell and WorldCom resorted to increasingly aggressive accounting to maintain the appearance of growth and profitability. The main device was the capitalization of expenses in which the cost of leasing other companies’ phone lines – primarily for last-mile access to homes and businesses – was not expensed but reported as additions to property, plant and equipment.
Those assets, overstated by US$11 billion by the time WorldCom filed for Chapter 11, were then depreciated. In the short term, this device raised earnings, margins and growth. In the longer term, mounting depreciation costs depressed earnings. Meanwhile, the company used false entries to fake revenue, used overstated business combination reserves to boost income in 2001, and revalued acquisitions at overstated prices to bolster earnings.
The scandal came to light in June 2002 when WorldCom's internal audit department discovered the misstatement. WorldCom quickly collapsed, costing over 30,000 people their jobs, and debt and equity investors more than $300 billion. Guilty of fraud, conspiracy and filing false documents, WorldCom's CEO Bernie Ebbers was sentenced to 25 years in prison.
1. Lehman Brothers
Enron might be the best-known accounting scandals of all time, but the collapse of Lehman Brothers dwarfs the losses at Enron. It remains the largest bankruptcy in history, an unmitigated disaster.
Among the creative accounting devices Lehman used to hot up its accounts was an artifice known as Repo 105. Under Repo 105, Lehman classified short-term loans as permanent sales and used the cash from these fake sales to reduce its liabilities for year- and quarter-end financial reporting.
After the reporting, Lehman unwound the transactions. Repo 105 allowed Lehman to artificially reduce its liabilities by US$50 billion and shrank its leverage ratio from 13.9 to 12.1.
Losses can be hidden, but only for so long. On 7 June 2008, Lehman announced a second-quarter loss of US$2.8 billion. The loss widened to US$3.9 billion in the 10 September announcement. Less than a week later, Lehman filed for bankruptcy as the fat lady was belting out the chorus. The world is still dealing with the consequences of the Lehman collapse. It was, without question the worst accounting scandal of all time.
The Great Recession fuelled by the collapse of Lehman cost 10s of millions of jobs globally. No criminal charges were laid. The New York Attorney General sued Ernst & Young LLP, the company’s external accounting firm, for enabling Lehman Brothers to deceive investors. Ernst & Young paid a $10 million settlement.
