The recent report of COSO “Fraudulent Financial Reporting 1998-2007- An Analysis of U.S. Public Companies” states that CEOs are involved in 72% of the 347 alleged cases of fraudulent financial reporting listed with SEC during 1998-2007 period. The report shows that the average period of fraud was 31.4 months. The data clearly indicates that in most major cases of fraudulent financial reporting the CEO’s of the organization are the main instigators and it is a planned initiative.
The research paper titled “Why Do CFOs Become Involved in Material Accounting Manipulations?” shows that 46.15% of CEOs involved in fraudulent activity benefitted financially from accounting manipulations. The COSO report states that motivations of fraud as specified by SEC are to meet the financial expectations, hide worsening business situation, increase executive compensation and/or improve chances of gaining debt and equity funding. Since CEO performance and benefits are measured by financial numbers submitted to the stock market, they rationalize the need to report fraudulent financial numbers to protect their positions.
However, not all CEO’s feel pressured to resort to fraud to maintain positions. Most CEO’s do not rationalize fraud and do submit accurate financial statements. Hence, the psyche of these CEOs is generally different as they have little regard for ethical standards and legal requirements. For example, Jeff Skilling had a poster boy status prior to the debacle of Enron. He was known as a charismatic leader and was highly influential. Some state that he had a narcissistic personality. However, at that time he was held in high regard as he gave financial profits which no other energy company was showing. As Stewart Hamilton and Alicia Micklethwait authors of the book Greed and Corporate Failure describe -
“Skilling’s desire to accelerate revenue, and thus, earnings, by using mark-to-market accounting, inevitably led to a ‘treadmill’ effect. If you took all the profit from a deal in one quarter, you were going to have to find another and larger deal in the next. This inevitably put pressure on employees to do deals – often with little regard as to how they were to be managed – and to ‘make the quarter’ by whatever means necessary. There was also self-interest in this as an individual’s remuneration was based on deals done and profits recorded in the previous quarter. The focus on earnings rather than cash led to some crazy deals being done”
In India, in Satyam fraud the founder CEO Ramalinga Raju confessed to fraudulent financial reporting to Rs 7000 crore (USD 1542 million). Now investigators are stating the fraudulent activities were commenced in 2002-2003 and the amount is nearly Rs 14000 crore (USD 3085 million) . He stated in this confession letter:
“The gap between in the Balance Sheet has arisen purely on account of inflated profits over last several years (limited to Satyam standalone the book of subsidiaries reflect true performance). What started as a marginal gap between actual operating profit and the one reflected in the books of accounts continued to grow over the years. It has attained unmanageable proportions as the size of company operations grew significantly (annualized revenue run rate of Rs 11,276 crore (USD 2484 million) in the September quarter of 2008 and official reserves of Rs 8,392 crore (USD 1849)). As the promoters held a small percentage of equity, the concern was that poor performance would result in a takeover, thereby exposing the gap. The aborted Maytas acquisition deal was the last attempt to fill the fictitious assets with real ones. It was like riding a tiger, not knowing how to get off without being eaten”.
The capability to deceive can be assessed by the awards Ramalinga Raju received on behalf of Satyam. He was awarded Ernst & Young Entrepreneur of the Year Services Award 1999 & 2007 (which was withdrawn later), Dataquest IT Man of the Year Award 2000, CNBC’s Asian Business Leader – Corporate Citizen of the Year award in 2002 and Golden Peacock Award for Corporate Governance 2008 (withdrawn later).
It is not that people are completely taken in by the charisma. However, the political power of the man was such, that no one raised questions. As reported in the media, the board of directors, SEBI, ICAI and Income Tax department all had information of some irregularities being done by Satyam. A senior officer in Income Tax department was the only person to conduct an investigation about illegal transfers in 2002. Subsequently, the senior officer was transferred and investigation report suppressed. No other regulator initiated any other investigation. The message was clear no one in Hyderabad (corporate office of Satyam is located in Hyderabad) could raise questions on Satyam.
In my view the reason CEO’s are able to continue fraudulent and illegal activities is that there is no one checking and questioning their decisions and behavior. Hence, the recommendations to curtail CEO’s perpetuated frauds are:
- Regulators should maintain independence and initiate investigations on early warning signs.
- Board of directors should question the spirit of the contract, and not just the technical aspects. For example, why was Satyam a software company considering a deal with a construction company Maytas?
- Audit committees should play a stronger role in protecting Chief Audit Executive and Chief Financial Officers. This will enable audit committee members to understand the real situation within the organization.
- CEO pay should not be linked to quarterly results alone. Longer-term performance measures may lower pressure to give quarterly financial numbers.
- Lastly, board members and audit committee members should be vigilant on news about misdemeanors of CEOs and the company. They should conduct specific investigations of the transgressions and start action to reduce risks.
The CEO is the leader of the organization. If he/she chooses an unethical or illegal path, eventually the organization will suffer severe damages. The responsibility rests with the board and regulators to safeguard the organization. Playing a blame game after the damage is done, doesn’t help the economy or the country. Do not let a CEO’s insatiable hunger get out of control.
- Why Do CFOs Become Involved in Material Accounting Manipulations? (Authors Mei Feng & Weili Ge)
- COSO Fraudulent Financial Reporting 1998-2007- An Analysis of U.S. Public Companies (Authored by Mark S. Beasley, Joseph V. Carcello, Dana R. Harmanson & Terry L. Neal)
- Satyam Fraud Case- Confession letter of Ramalinga Raju
- Satyam Scam Tip of Corporate Fraud Iceberg ( Article in IPS News written by Praful Bidwai)
- Greed and Corporate Failure – The Lessons from Recent Disasters ( Authors Stewart Hamilton and Alicia Micklethwait)
To read the complete list of fraud symptoms, click here.