Who's Running the Company? - International Center for Journalists

qualifications of executives and board members, and
whether banks and other financial institutions have policies
and systems to protect against unauthorized trades.
Though many of the corporate scandals of recent years
were engineered by top executives, some shady dealings
were the work of rogue employees who managed to hide
their activities from their superiors until it was too late.
At U.K.’s Barings Bank plc, futures trader Nick Leeson
was a star in the early 1990s, responsible in one early
high-flying year for 10 percent of the bank’s entire annual
profits. But then the Asian financial crisis began to unfold,
and losses piled up. Leeson managed to hide more than
£800 million in losses in an obscure account.
His bosses began to uncover the dealings with a spot audit
in 1995, but by that time, all of the bank’s assets and
its very future were on the line. Eventually, heads rolled,
Leeson went to prison and Barings was sold.
Despite investigations and lessons learned from the
Leeson case, another rogue trader caused similar problems
for French banking giant Societe Generale many
years later, in 2008. The tab for Jerome Keviel’s rogue
trades was £7 billion.
That same year, Kweku Adoboli, a trader for Switzerland’s
UBS AG’s investment bank, was starting to hide his trading
losses, which ultimately caused a $2 billion loss for
UBS, discovered in 2011.
Adoboli was charged with fraud and false accounting,
and governance experts immediately began questioning
the banks’ risk management and oversight. USB chief
executive Oswald Gruebel at first said that USB had “one
of the best” risk-management units in the industry. But he
soon resigned, saying he was shocked that a trader was
able to inflict multibillion-dollar losses through unauthorized
trades.
5. Tips for spotting “shenanigans”
Detecting accounting gimmicks is not a job for amateurs,
but accounting professor Howard M. Schlilit has tried
to make it easier to recognize devious tricks. His book,
“Financial Shenanigans” was first published in 1993 and
most recently updated in 2010 (see Sources at the end of
this chapter).
The following charts, used with permission, show where
to look for gimmicks and fraud in financial reports. n
Both charts from “Financial Shenanigans: How to Detect Accounting
Gimmicks and Fraud in Financial Reports,” Howard
Schilit and Jeremy Perler, third edition, McGraw-Hill, 2010.
Financial Shenanigans
Earnings Manipulation
n Recording revenue too soon
n Recording bogus revenue
n Boosting income using one-time or
unsustainable activities
n Shifting current expenses to a later period
n Employing other techniques to hide expenses
n Shifting current income to a later period
n Shifting future expenses to an earlier period
Cash Flow Shenanigans
n Shifting financing cash inflows to the operating
section
n Shifting normal operating cash outflows to the
investing section
n Inflating operating cash flow using acquisitions
or disposals
n Boosting operating cash flow using unsustainable
activities
Key Metrics Shenanigans
n Showcasing misleading metrics that overstate
performance
n Distorting balance sheet metrics to avoid showing
deterioration
Warning Signs:
Breeding Ground for Shenanigans
n Absence of checks and balances among senior
management
n An extended streak of meeting or beating
Wall Street expectations
n A single family dominating management,
ownership or the board of directors
n Presence of related party transactions
n An inappropriate compensation structure that
encourages aggressive financial reporting
n Inappropriate members placed on the board of
directors
n Inappropriate business relationships between
the company and board members
n An unqualified auditing firm
n An auditor lacking objectivity and the appearance
of independence
n Attempts by management to avoid regulatory or
legal scrutiny
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