The disclosure of Japan's biggest corporate scandal follows the incriminating revelation of a huge accounting scam at Toshiba, the effect of which could lead to the restatement of earnings plus a board overhaul and potentially hefty fines by Japan's regulatory bodies. Toshiba enjoys an excellent reputation as one of the world's top computers-to-nuclear conglomerate and recently reported that its boss has resigned over a staggering £780 million accounting scandal. The news of the improper accounting, stretching back to 2008, apparently was intentional and in the opinion of experts would have been difficult for auditors to detect.
It may come as surprise to many that Toshiba has not been able to close its books for the year, and as a result was forced to cancel its annual dividend. A shocking report drawn up by the Tokyo Stock Exchange reveals how Toshiba president and chief executive Hisao Tanaka and his predecessor, vice chairman Norio Sasaki, were aware of the overstatement of profits and associated move to delay reporting losses in a perverse corporate culture. Observers comment that the discovery of an overstatement in profits was roughly three times Toshiba's own initial estimate. It does not rain, it pours when fraud is concerned as the discovery of the scandal show how both Tanaka and Sasaki had set operating superlative profit targets that the heads of divisions were required to meet, applying pressure by hinting at withdrawing from areas that underperformed.
As can be expected in a company where a dominant boss cannot be questioned, the surprise revelation about cooked books of accounts came not a moment too soon. The revelations have shaken confidence in one of the stalwarts of Japanese industry, as Toshiba is Japan's 10th-biggest company by assets and market value. Its stock price cascaded by 26 per cent since the scandal surfaced in early April.
Such massive scandals do sound sensational in foreign media but our own business community is immune from such heavy scandals. In other words, it does not happen in our backyard. Perhaps this is true because of our size and the modest complexities of our business sector does lead to closer surveillance by the financial regulator. Be that as it may, we are not immune to financial peccadilloes lurking under the surface. For example, the incidence of financial fraud has was revealed in an article in MaltaToday which alleged that kickbacks were paid since 2004 in the oil procurement division of Enemalta - the national energy utility. A well-known businessman resigned as ex-president of the Malta Chamber of Commerce, after he was called in for questioning by police regarding his previous role as chairman of Enemalta, while seven other individuals are currently under investigation on alleged kickbacks on oil and their assets frozen pending the outcome of their indictment.
Another person in the spotlight is the former chief executive of Enemalta's bunkering arm and a prominent member of Enemalta's fuel procurement committee when the international oil broker Trafigura was awarded a contract for low sulphur fuel oil. The story of alleged sleaze continued during the investigation by the Public Accounts Committee on an NAO report on Enemalta focusing on the years 2008 to 2011. The ex-chairman is facing charges of corruption over kickbacks Trafigura paid to its local agent starting in 2004 on oil supplies, when the latter was employed as a consultant to the Chairman of Enemalta. Furthermore, a Times of Malta journalist observed that Island Oil Bunkers Ltd, a local company providing oil storage facilities which had reported massive losses between 2003 and 2011 in spite of its staggering turnover of US$1,300 million, yet all audit reports are clean and unqualified. The company enjoyed good relations with local banks and was granted loans and overdrafts in the region of US$46 million. MaltaStar.com revealed that its bankers sought no tangible security, posted no special hypothecs, no pledges, no ship's mortgage, requested no personal guarantees from shareholders, whether those by registered or shadow directors. It is curious to note a weak balance sheet showing a negative equity due to substantial losses yet the bank only requested a general hypothec on the company's assets. Ironically, notwithstanding partisan politics, the public wants to know more about past practices that are hidden in the proverbial cupboard of skeletons and this has certainly whetted the appetite for more inquisitive financial journalism.
On the global scene, the string of accounting scandals exploded with a bang, starting with Enron and the revelations following the dot-com collapse in 2002/3 which dwarfed the gravity of scandals of late connected with the sub-prime banking crisis, the Madoff Ponzi scheme and the unaccounted high sovereign debt latently discovered by the Mandarins in Brussels in cooked public accounts submitted over the years by Greece (now asking for a third bailout of €86 billion and some debt relief). So at this point, it is opportune to discuss how and why fraud persists, why it happens and how it manifests itself in various scenarios.
By definition fraud can be better described as deception or misrepresentation that an individual or entity makes knowing that such misrepresentation could result in some unauthorized benefit to the individual or to the entity or some other third party. This definition therefore excludes errors or misconceptions on accounting estimates. Corruption is a cousin to fraud but takes a broader perspective and includes conflict of interest, bribery, kickbacks, trading in influence and bid-rigging. At this stage, one can cite the famous fraud triangle depicted by the late Donald R. Cressey, a criminologist who specialised in fraud deduction. Dr Cressey said three factors are typically present when a fraud occurs: rationalization, opportunity and pressure. Rationalisation is the intention to cover one's abusive attitudes by wilful justification. Secondly we have "pressure", a symptom closely tied to today's deep recessionary environment which can easily influence management. Then there is "opportunity" which, simply explained, can be attributed to such situations where fraud can be perpetrated due to lack of organizational controls and security.
In business this is usually associated with a domineering manager who over-rides internal controls and manipulates inventory balances at year-end simply by allowing lax control over those responsible in conducting physical counts. Rationalisation means that a common attitude persists that no one will miss the embezzled funds particularly in larger retail environments. Fraud is contagious and the implications for managers/political masters to detect and eradicate it are paramount.
Every organisation is potentially vulnerable to fraud, and those responsible for corporate / state management must know how to detect it or at least when to suspect it. It is not surprising that both political and business leaders have to be vigilant as fraud, sleaze, nepotism and corruption are a threat to the entity's own existence. On the global scene, regulators and policy makers must continue to review corporate governance requirements to ensure they remain relevant, adequate and effective. At the same time, greater awareness and transparency of mandatory, principle-based and supporting guidelines and their interaction is critical in improving accounting standards and raising the financial integrity of directors and top officials.
The fight against fraud continues... it is a journey that never ends just ask Caravaggio the Renaissance artist who painted the famous picture of three poker players, one of whom has hidden ace cards ready to cheat his peers.
The writer is a partner in PKF an audit and business advisory firm
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