ETHICS Curtis C. Verschoor, CMA, Editor

Olympus Scandal Shows Need for U.S.

The misdeeds by Japanese manu- facturer Standards demonstrate the immense dangers of lax compliance with and challenging—devil’s advocate, lished, Olympus’s share price the weaker global standards of whatever you want to call it—leads plunged 18%, followed by a 24% ethics, governance, accounting, to better decision making.” decline on the next trading day. and auditing that seem to be Whether or not Woodford knew Woodford’s side of the story acceptable in an advanced indus- the details at the time, Olympus’s came out in an October 15 FT trial country like Japan. stifling ethical culture—where story. Since July, he had been employees were afraid to speak strongly questioning members of up—appears to be the single most the board about large payments to lympus Corporation, with important cause of events that “financial advisors” relating to the Osales of $10.6 billion for the almost took the company down. 2008 purchase of Gyrus Group, a fiscal year ended March 31, 2011, is In Olympus’s fiscal 2011 annual U.K. medical device manufacturer, a leading manufacturer of endo- report, Woodford outlined his and about details of the acquisi- scopic medical devices as well as plans to maintain innovation while tion of three other Japanese com- cameras and other imaging devices, cutting costs through changes to a panies, some in totally unrelated microscopes, and information and more centralized organizational businesses. communications equipment. structure. Under the slogan of In an October 11 letter to Olympus is listed on the Tokyo “Advancing to the Next Stage of Olympus’s chairman, Woodford Stock Exchange, and American Globalization,” the annual report described “a catalogue of calami- Depository Receipts are traded in also related specific goals in the tous errors and exceptionally poor the U.S. over-the-counter market strategic plan for the company. judgment which...has resulted in and listed on the “Pink Sheets.” Woodford saw his mandate as: “Do the destruction of shareholder value Thomson even named what you did in Europe, and do of $1.3 billion.” Payments of $687 Olympus Optical one of the world’s that around the world.” million, about a third of the Gyrus 100 most innovative companies. Woodford became CEO of acquisition cost, and estimated to In April 2011, Olympus named Olympus on October 1, 2011, but be the largest M&A fee ever paid, Michael Woodford its first non- was summarily dismissed from the were made to a Cayman Islands Japanese president. A U.K. citizen, company on October 14. The cor- special purpose investment vehicle Woodford had worked for the porate termination announcement that disappeared from view shortly company for more than 30 years, stated the reason for his firing was after receiving the final payment. including as head of European that he had “largely diverted from This information was based on an operations. In a July 5 article in the the rest of the management team investigation by Pricewaterhouse- (FT), Woodford in regard to the management Coopers, which had been hired by noted that part of his mission was direction and method, and it is Woodford. The recipients of the to change Olympus’s culture, say- now causing problems for decision payments were said to be a U.S. ing, “Harmony and consensus have making by the management team.” brokerage house and its subsidiary. their place and time but scrutiny On the day the news was pub- The Olympus audit board in

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2009 commissioned an investiga- editors noted that the scandal had Enron strategy of burying losses in tion about the advisor payments, wiped $3.2 billion off Olympus’s special purpose entities that but its report found no illegality in share value, and “its reputation for weren’t consolidated. The fact that the transaction. The October 15 FT ethics went down the same tube.” tobashi was declared illegal soon story said that Olympus had Reacting to pressures from institu- after the company employed the declined to comment further about tional investors in the United tactic didn’t stop the Olympus the Woodford accusations, stating, States and Japan, Olympus senior executives. “We have disclosed everything we announced on November 1, 2011, The 2011 special committee are required to disclose.”An Olym- that it had appointed a third-party report described the implementa- pus press release dated October 19 special committee to conduct an tion of the cover-up strategy, relat- notes, “By unanimous resolution of independent inquiry. Consisting of ing that Olympus placed money or the board of corporate auditors, five attorneys and one CPA, the guaranteed borrowings into a their conclusion is that ‘No dishon- group employed Deloitte Touche secret nonconsolidated Receiver esty or illegality is found in the Tomatsu LLC, among others, to Fund corporation and then used transaction itself, nor any breach of assist. Within a week, Olympus those funds to buy overpriced obligation to good management or admitted that it “had been companies at book value, thus any systematic errors by the direc- engaged in deferring the posting recovering the original cash. tors recognized.’” of losses on investment securities Another method was to overpay Olympus’s governance structure since around the 1990s” and that for an acquisition or service fees, regarding auditing is based on the fees paid to financial advisors resulting in huge amounts of good- Japanese law. According to the “had been used in part to resolve will, but release the excess funds 2011 annual report, a Board of unrealized losses.” back to Olympus. In other words, Auditors reports to the General With amazing speed, the special none of the financial advisor’s huge Meeting of Shareholders for committee report was made public fee paid in connection with the appointment/dismissal and also on December 6. It described the Gyrus purchase described earlier provides audits to the president cause of the massive losses as the actually stayed with the “advisor.” and board of directors. Under result of “zaiteku,” or highly spec- E&Y became the external audi- Japanese law, having such a board ulative investments. This strategy tor of Olympus for fiscal 2010, eliminates the need for outsiders was undertaken to offset reduc- relying on the unqualified report on the board of directors. An tions in operating income because of its predecessor, KPMG AZSA, Office of the Auditor reports to the of the rise in the Japanese yen LLC (KPMG) for 2009 and 2008. Board of Auditors. Also reporting after 1985. As investment losses As questions about the involve- to the General Meeting for were ballooning in the late 1990s, ment of auditors began to arise, appointment/dismissal is the inde- unrealized investment losses the company’s former president pendent auditor, Ernst & Young became recognizable under fair was quoted in a December 12 arti- ShinNihon (E&Y). The firm is value accounting. To avoid having cle saying that, in 2009, he person- shown reporting to the Board of to reveal these losses in the Olym- ally went “to the KPMG firm’s Auditors and providing accounting pus financial statements, manage- offices to say it would not be audits to the Board and Represen- ment created a Loss Disposition rehired by Olympus, accusing it of tative Director. An Internal Audit Scheme, deciding to adopt a strat- ‘interfering in management deci- Department reports to the Repre- egy that was apparently so well sions.’” Nevertheless, KPMG didn’t sentative Director and provides known in Japan that it had a insist on disclosing their concerns audits of the various business name, “tobashi,” or making some- and gave a clean opinion on 2009, units. In 2010, E&Y was described thing bad fly away. Loss-making possibly relying on the audit as Accounting Auditor and report- assets were sold to dummy corpo- board’s report noted above. The ed to the president, as did the rations that didn’t have to be firm noted that both the account- Internal Audit Department. included in the consolidated ing principles and audit standards An October 28 letter to the FT results. This is reminiscent of the followed were acceptable in Japan.

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In mid-December, the company corporate behavior that would insufficient (less rigorous restated its results for fiscal years never be countenanced in the U.S. accounting principles). ended March 2007 through 2011. and must be corrected in all 8. HR rotation of the company The corrections resulted in accu- Japanese companies that want to didn’t function (same people mulated retained earnings that be considered to have world-class did same jobs for years). were more than $15 billion less management: 9. The sense of compliance than at the beginning of 2007, trig- 1. It was handled and concealed was lacking (inadequate gering a capital shortfall. E&Y pro- by the top management. governance). vided an unqualified opinion on 2. There was a problem in the 10. There were outside collabora- 2010 and 2011, but KPMG’s opin- corporate culture and mind tors (banks who handled the ion on the earlier period restate- (ethics). money flows). ment was qualified because, 3. The method used to conceal according to KPMG, “information was tactical (no evidentiary Admitting guilt and facing pos- on the investment funds that were matter was kept). sible criminal charges, Tsuyoshi used to conceal losses has not been 4. Each corporate body didn’t Kikukawa, the chairman and for- properly kept…Therefore, we function as required under the mer CEO; Hisashi Mori, director could not obtain evidence to sup- Companies Act. and executive vice president; and port the value of assets held by 5. The auditing firm didn’t func- Hideo Yamada, standing corporate those funds.” tion sufficiently. auditor, have all resigned. Michael The 2011 special committee 6. The committee composed of Woodford hopes to return to lead report presented 10 causes or con- outside experts didn’t func- the corporation with an entirely ditions that allowed the fraud to tion sufficiently. new board of directors. The com- take place. These are violations of 7. Disclosure of information was continued on page 61

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Ethics continued from page 15 pany is looking for a “white knight” to invest in it. Dozens of lawsuits are being filed in the U.S. It may be years before the entire story about the enormous Olym- pus fraud will become public. What is already very obvious is that the U.S. should continue to lead the way toward developing, main- taining, and enforcing the highest, strongest, and most effective stan- dards of business ethics, , accounting principles, and auditing standards. There should be praise for and pride in virtually all of the contents of the Sarbanes-Oxley Act. Implementa- tion of its provisions in Japan almost certainly would have pre- vented the sad Olympus events from occurring or remaining unde- tected for so many years. SF

Curtis C. Verschoor is the Emeritus Ledger & Quill Research Professor, School of Accountancy and MIS, and an honorary Senior Wicklander Re- search Fellow in the Institute for Busi- ness and Professional Ethics, both at DePaul University, Chicago. He was selected by Trust Across America as one of North America’s Top Thought Leaders in Trustworthy Business Behavior–2012. His e-mail address is [email protected].

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