Fraud at Waste Management

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Fraud at Waste Management
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(No Transcript)
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Who Was Involved?

• Dean L. Buntrock - Waste Management's founder,
  chairman of the Board of Directors, and chief
  executive officer during most of the relevant
  period
• Phillip B. Rooney - president and chief operating
  officer, director, and CEO for a portion of the
  relevant period
  
• James E. Koenig - executive vice president and
  chief financial officer
  
• Thomas C. Hau - vice president, corporate
  controller, and chief accounting officer
  
• Herbert Getz - senior vice president, general
  counsel, and secretary and
  
• Bruce D. Tobecksen - vice president of finance.

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When

• 1992 to 1997 the former executives cooked the
  company's books to meet predetermined earnings
  targets.

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How was the Fraud perpetrated?

• Refused to record expenses necessary to write off
  the costs of unsuccessful and abandoned landfill
  development projects  
  
• Established inflated environmental reserves
  (liabilities) in connection with acquisitions so
  that the excess reserves could be used to avoid
  recording unrelated operating expenses 
• Improperly capitalized a variety of expenses  
• Failed to establish sufficient reserves
  (liabilities) to pay for income taxes and other
  expenses
  

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How was the Fraud perpetrated? (contd)

• The Company's revenues and profits were not
  growing fast enough to meet targets, so
  management inflated earnings by improperly
  eliminating and deferring current period
  expenses. Employing a multitude of improper
  accounting practices to achieve this objective,
  management
• Avoided depreciation expenses on their garbage
  trucks by both assigning unsupported and inflated
  salvage values and extending their useful lives
  
• Assigned arbitrary salvage values to other assets
  that previously had no salvage value 
  
• Failed to record expenses for decreases in the
  value of landfills as they were filled with
  waste 

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How was the Fraud perpetrated? (contd)

• Waste Management used netting to eliminate
  approximately 490 million in current period
  operating expenses and accumulated prior period
  accounting misstatements by offsetting them
  against unrelated one-time gains on the sale or
  exchange of assets.
• They used geography entries to move tens of
  millions of dollars between various line items on
  the Company's income statement to, in Koenig's
  words, "make the financials look the way we want
  to show them."

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How was the fraud uncovered?

• The scheme unraveled in mid-1997, after a new CEO
  ordered a review of the company's accounting
  practices.
  
• In 1998, Waste Management restated its 1992-1997
  earnings by 1.7 billion, the largest restatement
  in corporate history (as of March 2002).

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Where were the auditors?

• The trash hauler had been one of Andersen's
  biggest clients and had stuck with the firm as
  Waste Management's own accounting scandal emerged
  several years ago.
• Andersen was fined 7 million by the SEC in
  connection with the Waste Management audits, in
  what regulators said was the largest fine ever
  paid by a Big Five firm in an enforcement action
  brought by the SEC. Three audit partners were
  fined individually.

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Cozy Relationships

• "I think for all the relevant periods, the chief
  accounting officers at Waste Management came from
  Arthur Andersen," said one SEC regulator. "The
  relationship is too cozy. (CNN.com europe
  1/11/2002)
• Andersen helped perpetrate the scheme,
  identifying 32 "must-do" steps to cover it up

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Andersens Involvement

• Management capped Andersen's audit fees and
  advised Andersen that the firm could earn
  additional fees through "special work. Andersen
  identified Waste Management's improper accounting
  practices and quantified much of the impact of
  those practices on the company's financial
  statements.
• Andersen annually presented Company management
  with what it called Proposed Adjusting Journal
  Entries ("PAJEs") to correct errors that
  understated expenses and overstated earnings in
  the Company's financial statements.

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Andersens Involvement (contd)

• Management consistently refused to make the
  adjustments called for by the PAJEs.
  
• Instead, Waste Management secretly entered into
  an agreement with Andersen fraudulently to write
  off the accumulated errors over periods of up to
  ten years.
• WM agreed to change the underlying accounting
  practices, but would only do so in future
  periods.

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Why Was This Fraud So Important?

• Some believe that Andersen would have survived
  Enron if not for the blatant acts at Waste
  Management.
  
• The WSJ stated in an article that the Waste
  Management scandal stood out among the numerous
  accounting scandals breaking in the news.

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The Fraudsters scheme

• To reduce expenses and inflate earnings
  artificially, management primarily used
  "top-level adjustments" to conform the company's
  actual results to the predetermined earnings
  targets.
• The inflated earnings of prior periods then
  became the floor for future manipulations. The
  consequences created what Hau referred to as a
  "one-off" problem. To sustain the scheme,
  earnings fraudulently achieved in one period had
  to be replaced in the next.

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How did Management fare?

• Management profited handsomely from their fraud,
  receiving performance-based bonuses based on the
  Company's inflated earnings, retaining their
  high-paying jobs, and receiving stock options.
  Some also received enhanced retirement benefits
  based on the improper bonuses and/or lucrative
  employment contracts.

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Cashing In

• Buntrock, Rooney, and Koenig avoided losses by
  cashing in their Waste Management stock while the
  fraud was ongoing.
  
• For example, just ten days before certain of the
  accounting irregularities first became public,
  Buntrock enriched himself with a tax benefit by
  donating inflated Company stock to his college
  alma mater to fund a building in his name.

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Who Was Hurt?

• Waste Management's shareholders (other than the
  defendants who sold Company stock and thus
  avoided losses) lost over 6 billion in the
  market value of their investments when the stock
  price plummeted by more than 33.

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How Much Was Taken?
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How Compensation Compares

• Execs had less incentive to secure the future
• Why the shift?
• Avoid corporate looting
• Conform to the status quo

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SEC Reaction

• "Our complaint describes one of the most
  egregious accounting frauds we have seen," said
  Thomas C. Newkirk, associate director of the
  SEC's Division of Enforcement. "For years, these
  defendants cooked the books, enriched themselves,
  preserved their jobs, and duped unsuspecting
  shareholders."

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The Web of Deceit - Buntrock

• Buntrock was the driving force behind the fraud.
  
  
• He set earnings targets, fostered a culture of
  aggressive accounting, personally directed
  certain of the accounting changes to make the
  targeted earnings, and was the spokesperson who
  announced the Company's phony numbers.

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The Web of Deceit - Rooney

• Rooney was in charge of building the
  profitability of the Company's core solid waste
  operations and at all times exercised overall
  control over the Company's largest subsidiary.
• He ensured that required write-offs were not
  recorded and, in some instances, overruled
  accounting decisions that would have a negative
  impact on operations.

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The Web of Deceit - Koenig

• Koenig had primary responsibility for executing
  the scheme.
  
• He also ordered the destruction of damaging
  evidence, misled the Company's audit committee
  and internal accountants, and withheld
  information from the outside auditors.

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The Web of Deceit - Hau

• Hau was the accounting expert who, among other
  things, devised many "one-off" accounting
  manipulations to deliver the targeted earnings
  and carefully crafted the deceptive disclosures.
  
• He profited by more than 600,000 from his
  fraudulent acts

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The Web of Deceit

• Tobecksen, another accounting expert, was
  enlisted in 1994 to handle Hau's overflow.
  
• Getz, the general counsel, blessed the Company's
  fraudulent disclosures.