Within days of the Enron scandal’s 10th Anniversary and three years from the Madoff Ponzi scheme, word of a new scandal emerged. Complete with fresh allegations of financial manipulation, management abuse, special purpose entities, conflicts of interest, and complicit auditors, this new scandal involved the Japanese electronics giant Olympus. It shares many of the issues that we came to associate with Enron. (we were supposed to have been “laser focused.”) Olympus is not only a scandal, but may show just how little we have progressed since Enron, a bell weather in terms of business ethics and corporate conduct.
Unethical behavior at both Enron and Olympus were fraud conspiracies that overstated the actual operational results of both businesses. By the unethical nature of their corporate behavior, insiders had information that caused the inherent value of their companies to be overstated. Both companies gained operational advantages by failure to follow existing laws and commonly followed business or accounting practices, sometimes with the concurrence of their auditors. As a result, both shareholders and most of their employees were deceived.
When these conspiracies were revealed, both companies and the perpetrators paid dramatically. Sarbanes Oxley was the government’s response to discourage such corporate behavior.
Olympus, although they are not necessarily bound by Sarbanes Oxley, the company appeared to have had ethics policies incorporated into their compliance programs. Let’s take a closer look at the ethical issues at Olympus. Olympus is a well-known Japanese manufacturer of optical equipment whose stock traded on the Tokyo Stock Exchange and boasted worldwide revenues in excess of $10 billion per year. Olympus has been in business since 1919 and has over 40,000 employees globally.
Olympus Loss Hiding Schemes
In the final months of 2011, allegations of financial manipulation, management misconduct, and illegal activities began to surface. Investigations continue, but Olympus already admitted to utilizing “loss hiding arrangements” (in Japanese “Tobashi” arrangements) to cover decades of investment losses.
These loss hiding schemes primarily involved Olympus selling poorly performing investments to related parties, with the help of cooperative investment banks to provide the financing, for inflated prices. This allowed Olympus to hide the losses from poor investments. The most prominent scheme disclosed to date involves the Olympus acquisition of Gyrus Group, a European medical equipment maker. Olympus purchased Gyrus for US $2.2 billion and then paid $687 million as a “success” fee – almost one-third of the purchase price – to middle-man advisors, AXAM Investments Ltd., a Cayman Islands company and US-based Axes America LLC. It appears this fee was really intended as a payment to release Olympus from a pledge on a previous deal. The intent was to capitalize the payment as part of the purchase price of Gyrus (goodwill) and to write it off over time.
The schemes were surfaced by Michael Woodford, the recently appointed (April 1st, 2011 COO, October 1, 2011 CEO) Olympus COO and CEO. Mr. Woodford was an outsider among the long-time entrenched management at Olympus and his appointment was something of a surprise. It has been reported that as Mr. Woodford was an outsider, and in fact did not even speak Japanese, he would be easy to control. If this was the case, it was mistaken as Mr. Woodford soon began questioning certain company financial transactions. He was fired shortly after questioning the loss-hiding arrangements.(i) (ii)
Ethical Issues From Several Perspectives
Acting CEO – Whistleblower
The Whistleblower, Michael Woodford, as he was quickly promoted, discovered he was being used as the former Chairman’s puppet. When Woodford discovered the fraud he began pursuing the ethical course by sending several letters with his concerns on the transactions and threatened to resign if actions were not taken. The letters were sent to the compliance officer, Hisashi Mori and Tsuyoshi Kikukawa (Kikukawa), former President of Olympus, and the auditors Ernst & Young (including global chairman). He then hired PWC to investigate the transactions and reported their findings without informing the Olympus board.
Upper Level Management
It appears that all the top level management was fully aware of loss-hiding schemes and actively tried to hide it from Woodford. When Woodford did discover the scheme they fired him and even threatened to sue him for making Olympus confidential information public. Management went as far as to say "If this secret information had not been leaked, there would have been no change in our corporate value." Woodford’s replacement, Shuichi Takayama, denied initially the allegations blaming Woodford for Olympus decreased shareholder value. As the investigations expanded, Olympus finally admitted the scheme was used to hide losses, and Kikukawa, Muri and a board member resigned.(iii)
Board of Directors
The Board of Directors did not act as an independent group. 12 of 15 members were prior Olympus employees. The Board approved of acquisitions which either included them in the scheme or they did not have proper financial acumen to understand the inflated acquisition valuations. Toshio Oguchi, representative director of Governance for Owners in Tokyo, argued that the affair pointed to a dysfunctional board: "Even if they didn’t know about the Tobashi, the fact that the board approved the payment cannot have been a correct decision.”(iv)
From 2002 – 2009 KPMG audited Olympus and then E&Y audited Olympus from 2009-2011. Although both auditors claimed that they raised issues about the acquisitions in question, both gave clean opinions (unqualified) on Olympus’ financial statements in that time period. In late November 2011 Michael Andrew, KPMG International global chairman, said his firm had complied with its legal obligations to pass on information related to Olympus’ 2008 acquisition of Gyrus, and were removed as auditors for so doing. Andrew said: “It’s pretty evident to me there was very, very significant fraud and that a number of parties had been complicit.”(v)
Below is a table describing several of the negative impacts that the scandal produced that most likely will hurt Olympus in the short and/or long term.
Click here to view table.
What lessons can be learned from the Olympus scandal that may improve internal compliance and ethical issues in our corporations?
Corporate Practices Associated with Ethics
Let’s examine what the typical public companies are required to do to comply to the higher ethical standards imposed by the Sarbanes Oxley Act of 2002.
The majority of larger and 100% of publicly traded companies should have in place:
- Official company-wide code of conduct policy
- A Whistleblower Ethics / Fraud hotline
- An official compliance program
- A company employee that is tasked with specific compliance duties including monitoring the compliance program
- Written management assessment of its internal control structure for financial reporting
Despite having the aforementioned programs in place, corporations must continue to identify and assess ethical risks that are associated with the structure and nature of the company’s business environment.
Ethical Best Practices
Utilizing the lessons learned from the Olympus scandal, what actions should a corporation take to ensure ethical behavior not only by employees but the leadership at the highest levels of the company?
Below are several steps that can be taken to bolster existing ethical compliance programs:
Planning and Evaluation
- Evaluate and redesign the business plan. Overly aggressive financial initiatives should be replaced with achievable goals and provide transparent results
- Review corporate ethical culture – periodically utilize employee surveys to better understand what training is needed, what employees believe to be the overall ethical barometer, and employees’ view of the “tone at the top”.
- Employees including upper level management should have their performance based on and in line with core values and long term strategy
- Employees at all levels should become involved in the reporting process of unethical behavior.
- Upper level management must encourage employees to come forward when they observe unethical behavior.
- The General Counsel’s office should hire an outside party to periodically review hotline procedures and processes to ensure that calls are being properly documented and then routed to the proper departments. Quick actions should be taken to investigate improper behavior or fraud allegations.
Policies and Training
- Employees should be periodically retrained on the corporate code of ethics, what is considered to be unethical behavior, and what they should do if they observe unethical behavior.
- The company should demonstrate to employees that the code of ethics will be enforced equally and sufficiently to everyone.
- Upper level management must not only promote ethical behavior but adhere to it.
- The General Counsel and or Compliance Officer should ensure there are detailed written policies and procedures that reflect the code of ethics.
Background Checks and Due Diligence
- Corporations should conduct thorough background checks and due diligence for all new hire employees
- Corporations should conduct thorough background checks and due diligence for existing and new Board of Directors to ensure independence and adequate financial and business acumen.
- The corporation and its executives should treat all stakeholders ethically.
Studies have shown that ethical behavior in companies enhance corporate value (See Fraud Magazine’s July/August 2008 article titled, “Ethics Programs: Ethics Pays in So Many Ways”.)(vi) The reverse is also true, “unethical behavior can destroy a company’s innate value.” Olympus’ unethical behavior has already diminished stakeholder confidence, reduced stock price and investor ownership interests, resulted in potential delisting from stock markets and instigated investigations by local and foreign concerns. The story is not over and the repercussions are likely to continue for some time. What is clear is that for those looking to the post-Enron paradigm of ethics and corporate conduct as evidence of improvement, certainly the Olympus situation must be an unwelcome wake-up call.
By Christopher B. Meadors J.D., CPA, CFF and Mark W. Jenkins, CFE of Fidelity Forensics Group LLC