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PART I www.cambridge.org Accounting in Crisis – a in Crisis – Accounting With be Reckoned Farce to © Cambridge University Press More information Excerpt Frank Clarke, Graeme Dean and Kyle Oliver Graeme Dean Frank Clarke, Second Edition 978-0-521-82684-6 - Corporate Collapse: Accounting, Regulatory and Ethical Failure, Ethical and Regulatory Accounting, Collapse: - Corporate 978-0-521-82684-6 Cambridge University Press University Cambridge Cambridge University Press 978-0-521-82684-6 - Corporate Collapse: Accounting, Regulatory and Ethical Failure, Second Edition Frank Clarke, Graeme Dean and Kyle Oliver Excerpt More information CHAPTER 1

Chaos in the Counting-house

Corporate accounting does not do violence to the truth occasionally and trivally, but comprehensively, systematically, and universally, annually and perennially. R.J. Chambers, 1991, p. 19.

When Bond Corp first announced its loss of almost $1 billion in October 1989 it surprised most of those who felt that they had their finger on the pulse of Australian corporate life.1 Perhaps it shouldn’t have been such a surprise, for it had all happened before, many times, over many decades, all around the world. Different charac- ters, different settings, different companies in different industries – but in similar circumstances – a common pervading regulatory philosophy – procedural input processing rules within a capitalisation-of-expenditure model coupled to sanctions for non-compliance, even when non-compliance made more sense in reporting an entity’s financial state of affairs. And it would happen again. Happen again, indeed! In mid-2001 it hit with added force as the media grappled with Australia’s contribution to the tech-wreck – the dot.com collapses of telcos such as One.Tel. But it was not only the new economy companies that were falling over. HIH, one of Australia’s old economy companies and largest insurers, had collapsed unexpectedly in circumstances rivalling the collapse of Bond Corp. HIH’s collapse was claimed to be Australia’s largest corporate collapse. Typically it embroiled the affairs of many of the big names in commerce and the accounting profession. It would produce Australia’s first accounting-related negligence litigation against the federal government and its prudential regulator, APRA. Several months later in the United States the ‘reported’ superstar Enron would become its largest bankruptcy up to that time, with asset book values in excess of US$60 billion and an estimated deficiency in shareholder value of over US$63 billion. No sooner was Enron’s enormity grasped than it was eclipsed by WorldCom’s US$103 billion bankruptcy,2 the demise of several technology companies, including Adelphia Communi- cations, Global Crossing, and by the alleged massive ‘accounting irregularities’ at several large US companies in 2002, such as Disney, WorldCom, Xerox, Merck and Qwest Communications, forcing ‘earnings restatements’. Again, the stellar performers at the sharp end of town were in disgrace.

© Cambridge University Press www.cambridge.org Cambridge University Press 978-0-521-82684-6 - Corporate Collapse: Accounting, Regulatory and Ethical Failure, Second Edition Frank Clarke, Graeme Dean and Kyle Oliver Excerpt More information

4 ACCOUNTING IN CRISIS

Back in 1989 it had been the turn of Alan Bond, one-time Australian ‘Businessman of the Year’, then ‘Father of the Year’, and local folk hero for bankrolling the 1983 America’s Cup challenge that had seen the famed cup unscrewed from its Rhode Island mantelpiece and sent to Australia. Bond Cor- poration’s assets (it seemed) were not as gold-plated as they had been rep- resented to be. Indeed, it was being said that they were mostly water. One top-value asset, the accounting-created Future Income Tax Benefits had a massive $453.4 million written off it. Unbelievable! Well, at least it was to those who had an inadequate understanding of the annals of corporate history. And that included, it seemed, almost everyone. In 2001–02 some of the contemporary corporate high-fliers were under a similar cloud: in Australia, Williams, the doyen of the insurance industry; Rich, the entrepreneur extraordinaire; and other ‘big’ names such as Keeling and Cooper. Household names such as Murdoch and Packer were hitting the headlines by virtue of their association with One.Tel. In the United States ‘Chainsaw’ Dunlap of Sunbeam, Lay, Fastow and Skilling from Enron, Ebbers from WorldCom, Tyco’s Kozlowski, the Rigas family from Adelphia, were all making the news; President Bush’s time with Harken and Vice-President Cheney’s stint at Halliburton also enjoyed considerable print space. It had become a familiar story. In its time, the 1990s aftermath of Bond Corp’s announced ‘record reported loss’ had a lot in common with its antecedents too. Media commentators would zoom in on the personalities, intrude into their private lives, pick up and highlight the gossip regarding their peccadillos. A regulatory theatre provided old refrains of indignation and outrage, promises of retribution to offenders, justice to the aggrieved. The cult of the individual would be revived. Connell, Yuill, Goldberg, Bond, Skase, Goward and other major players in the 1980s failures would be labelled ‘corporate cowboys’ and their life in the saddle exposed. Huge sums would be spent attempting to bring the high-fliers to ground, extract them from their hideaways. Skase was chased to Majorca, where he even- tually died in 2001. Following his death the attention continued – witness the ‘Spurned Skase heirs dob in Pixie’ headline.3 A decade after his time as leader of the Liberal Party, John Elliott was being questioned over his role as non- executive director of the insolvent Water Wheel Ltd.4 Of course, the search for scapegoats has been time-consuming. But again, attention has been on individuals – individual auditors, individual accountants, or the firms of which they were partners; individual directors, or the Boards of which they were members; individual bankers and financial intermediaries, or the financial institutions which they headed. Their business morality, their ethics, would be raked over and called into question. Ethics would be equated with corporate governance. It is an exemplar of what Neil Postman described as Amusing Ourselves to Death – entertainment! But it is entertainment that

CHAOS IN THE COUNTING-HOUSE 5

is reduced to the point where the seriousness of the affairs is lost from sight in the short term and completely forgotten in the longer term. Whilst resources were increased in the early 1990s to assist regulatory bodies, virtually nowhere would there be concerted attention paid to rectifying the system that permitted it all to occur, even facilitated it – the generic imper- fections in the mechanisms supposedly regulating corporate activities, their financial reporting, permissive corporate structures under Australian law, or the pervading ideas on corporate governance. A decade on and the refrain continues. The major collapses of HIH, One.Tel, Ansett, Harris Scarfe, Centaur and the financial difficulties at Pas- minco in Australia, and similar headline grabbers – Enron, WorldCom, Xerox, Adelphia and Qwest Communications (especially) in the United States – have rekindled interest in the arcane world of accounting and auditing. Size is obviously a drawcard. Just prior to their collapses or financial dilemmas, HIH was one of Australia’s largest insurance companies; Enron was the world’s largest buyer and seller of natural gas and the seventh-largest listed US company; WorldCom was once the sixth-biggest corporate borrower in the United States and Xerox was synonymous with business copiers. Déjà vu is pervasive. Consistent with our descriptions of the ‘cult of the individual’ during earlier periods, the media inquiries quickly honed in on the lives of HIH’s Ray Williams, Rodney Adler and Brad Cooper; One.Tel’s ‘Rich Kids’ – Jodee Rich and Brad Keeling – and heirs to the business dynasties, James Packer and Lachlan Murdoch. A scapegoat had to be found for HIH, One.Tel and other collapses through the HIH Royal Commission’s deliberations, Liquidators’ hearings and regulatory court actions. Initial cries of ‘Where were the auditors?’, ‘How could such entities collapse so suddenly?’, ‘Accounting in crisis’, ‘How crooked is Wall Street?’, ‘Who can you trust?’ ‘Accounting in chaos’, emerged right on cue. Calls for changes to auditing practices thundered – quarantine audit and non-audit services, compulsorily rotate auditors and impose a mandatory audit committee regime! A new Audit Independence Supervisory Board was proposed. Other regulatory layers have been proposed, including: ‘independence boards’ within audit firms to monitor potential conflicts of interest, criminal sanctions for company employees and officers who provide misleading information to auditors and to the public respectively. All of this in the guise of seeking to make auditors more independent, and presumably, to avoid future unexpected corporate collapses. And while the profession has pursued the limitations of auditors’ liabilities individual audit firms like PricewaterhouseCoopers have changed the wording of their audit opinion to achieve that result.5 In the United States the SEC and Congress have head-hunted too. Few have been spared. The Enron fallout blanketed the corporate vista from CEO Kenneth Lay, President Skilling and CFO Fastow to the US President’s mother.

6 ACCOUNTING IN CRISIS

US president George W. Bush and Vice-President Cheney have had to weather alleged questionable conduct of their involvement as executives in Harken and Halliburton respectively. Champion CEO ‘Chainsaw’ Al Dunlap has been cut down for his shenanigans at Sunbeam. Enron’s CEO Kenneth Lay and President Jeffrey Skilling, WorldCom’s Bernard Ebbers and Tyco’s Dennis Kozlowski have each incurred a hefty ‘going over’. But most of the reactions have been off-target. Scalps have been collected by the regulators, but virtually nothing done that is likely to rectify the corporate financial system. Rather than more serviceable accounting practices, accounting rules regulating the expensing of share options have been proposed. Inadequate attention is being given to rethinking the nature of the accountability checks in the financial reporting system. This, notwithstanding that many commentators are lamenting the poor quality of the existing information system generally.6 As the securities market grapples with the current spate of collapses, corporate mayhem continues across the board. Huge write-downs by AOL Time- Warner (US$100 billion), News Corp (US$7.4 billion) and NAB ($4 billion) have substantially reduced shareholders’ value, and the AMP is poised at the end of 2002 to delete $1.2 billion from its net assets. The Andersen accounting firm, which was found guilty of obstructing the course of justice in the United States by allegedly shredding Enron documents, provided an immediate scapegoat, even though the remaining Big Four accounting firms are also under inquiry by the SEC (see Table 19.1). These include Deloitte & Touche on account of its alleged failure to tell its client Adelphia Communications that the company’s founding family had used Adelphia credit lines to purchase stock in the company; Ernst & Young for its alleged involvement in agreements to sell software with its client Peoplesoft; KPMG for alleged failure to detect revenue-inflating capers by its Xerox client. While PricewaterhouseCoopers has settled (without prejudice) the SEC charge of revenue overstatement by MicroStrategy, there remains unfinished business. Further, there is a shadow over its self-examination of its involvement with the Russian energy company Gaz Prom; and the accounting practices at Global Crossing, Lucent Tech- nologies, Qwest Communications, Adelphia Communications and WorldCom are under the scrutiny of the SEC and numerous prosecutors. There are further allegations that Lucent boosted revenue by US$679 million by booking further sales before they had actually occurred; Waste Management officers inflated profits by US$1.7 billion by extending the depreciable life of its truck fleet; K-mart under-reported losses in 2001 to the tune of US$1.8 billion; Adelphia Communications inadequately reported US$5.6 billion of loan guarantees. WorldCom’s goodwill and US$408 million of loans treatment have the SEC upset. Alleged conflicts of interest between Merrill Lynch’s investment advisors and its merchant banking arms resulted

CHAOS IN THE COUNTING-HOUSE 7

in a reported US$100 million settlement, as allegedly did CSFB for a similar amount of allocation of IPOs to customers for excessive commissions. Some analysts have been held to have had conflicts of interest. Regulators too are under siege. SEC Chief Harvey Pitt resigned under a cloud for his alleged ‘soft action’ on the accounting profession for which he once had been counsel. Those alleged conflicts of interest have led to calls for major reforms on the ‘street’. Regarding financial reporting, a recent US survey suggested that more than 150 of the 450 SEC-registered companies had to restate their financial filings after queries from the SEC.7 And the CEOs of nearly 1000 of the largest US corporates had to review financial statements in their latest SEC filings, and by the middle of August 2002 swear that there were no ‘untrue’ figures disclosed. Interestingly, truth was invoked as the benchmark. A similar request was made by Australia’s regulator, the Australian Securities and Investments Commission (ASIC), for listed companies filing their 2002 annual financial statements.8 By mid-2002 not only did the corporate failures bear witness to the crisis in corporate regulation, but the cloud over the major accounting firms, accountants, company officers, securities advisors, auditors and regulators gave weight to the inevitable conclusion of ‘accounting, regulatory and ethical failure’ – that the system was fractured.

A window on corporate failure

A necessity for regulatory and quasi-regulatory reform of accounting and auditing practices has been prominent for several decades in Australia and overseas. Unanswered calls for reform have been the norm. Yet, despite ﬂurries of action there has been little progress. If the initial responses to collapses like HIH and Enron are any guide, little is likely to change. Bankruptcies and liquidations in the early years of the 1990s evoked the familiar rhetoric, but little effective action to prevent unexpected failures. Financial and social fallout from the larger unexpected Australian company failures in the latter part of the 1980s – the failures of Ariadne, Hooker, Qintex, Westmex, Parry Corporation, Judge Corporation, Adsteam, Budget Corpor- ation, Tricontinental, Pyramid Building Society, Rothwells, National Safety Council of Australia, the State Bank of Victoria and the State Bank of South Australia, Spedley Securities, the Battery, Duke, Girvan and Linter Groups, Estate Mortgage and Aust-Wide Trusts, the liquidation of Southern Equities Corporation (formerly Bond Corporation), and the dilemmas at Harlin/Fosters Brewing, Westpac and Coles Myer – were well documented in the ﬁnancial press. However, that focus runs contrary to the frequent commentaries on how to achieve business admiration and invites the question: ‘Why undertake inquiry into failure, rather than success?’

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‘Success’ is pursued in countless ‘how to get rich’ books. Few seem to heed the message of the one-time adulation and the interest in Dunlap’s genius compared with the disgrace he now endures.9 Enron’s way of doing business was applauded – a Fortune magazine survey rated Enron as the ‘most innovative’ American company five years running; HIH’s insurance dominance was once lauded! Indeed, virtually all of the prominent companies which failed over the past few decades (and their leaders) could earlier have been written up as paragons of how to be successful, like Bob Ansett in Australia and Donald Trump and Tyco’s Dennis Kozlowski (one of BusinessWeek’s ‘top 25 managers in 2001’) in the United States. Alan Bond was ‘Businessman of the Year’ in 1978; Asil Nadir rode high when Polly Peck was in its prime in the United Kingdom. Everyone wanted to be Michael Milken’s mate when junk bonds were the flavour of the month in the 1980s. Many courted Robert Maxwell’s friendship. Few shied away from involvement with Qintex, Equiticorp, or the Hooker Corporation during their good times. More often than not, those who failed had been heralded and lauded earlier as a major success. Adsteam was a model for many before it ran aground. So, in a sense, examining the process of failure is merely the other end of examining success, though for a number of reasons – primarily related to access to more objective data – failure is likely to be more capable of objective dissection and evaluation.10 The increase in corporate failures in Australia (many unexpected) during the late 1980s, 1990s and in the early 2000s is evident in Table 1.1. In 1991 the AMP Society estimated that ‘the collapse of our corporate high-fliers has cost shareholders more than $8 billion’.11 Others have claimed the figure to be closer to $20 billion.12 One collapse alone in 2001, HIH, is expected to result in over $5.3 billion of losses! In the United States, five large companies – including

Table 1.1 Corporate insolvencies, selected years, 1976–2001 Year end 30/6 Number Year end 30/6 Number 1976 1,178 1993 8,859 – – 1994 7,772 1981 1,565 1995 7,240 1987 5,816 1996 8,964 1988 4,836 1997 8,666 1989 6,189 1998 7,920 1990 7,394 1999 7,617 1991 8,366 2000 8,650 1992 10,361 2001 10,015 Source: 1976 and 1981 Corporate Affairs Commission Annual Reports; 1987–98 data compiled from NCSC and ASC releases; 1998–2002 ASIC releases.

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Enron, WorldCom and Tyco – account for a loss of over US$450 billion in shareholder value. What’s a billion or two between corporate friends? The 1980s high priests of corporate finance, now the disgraced entrepreneurs, certainly had no qualms in lending hundreds of millions of dollars to each other. Revelations in the HIH Royal Commission indicate that little may have changed over the subsequent two decades – they refer to alleged corporate largesse with ‘other people’s money’, in the form of a ‘river of money’ flowing from HIH just prior to its liquidation. It was reported in the press that Counsel for the HIH Royal Commission alleged that CEO Ray Williams dished out millions of dollars on executive rewards, bonuses and funding to associates and charities prior to HIH’s collapse.13 Some specific results of Australia’s largest companies, revealed in Table 1.2, further highlight the extent of the battering Australia’s corporate profile took during the early 1990s. Little wonder that the corporate cowboys tag was ascribed to the investment and financing behaviour of some of the more publicised entrepreneurs of the 1980s. As our story unfolds here, it will reveal that the corporate cowboys were able to do their thing only because they had the open ranges on which to run wild. We show that those commercial ranges have been, in many respects, untouched for decades. The tag seems equally apposite today. And the ranges remain open. While Table 1.1 reveals that Australian corporate failures in the 1980s increased relative to the Australian company population, the number of failures remains small. For the years 1962–81, annual liquidations of companies in New South Wales, for example, averaged 77.1 companies per 10,000 companies registered. The highest rate of failure in a single year was 104 liquidations per 10,000 companies in 1977.14 Figures from the late 1880s through to 1960 reveal a similar incidence of failure.15 In the depression following the October 1987 stock market crash, Australian Securities Commission (ASC) annual reports disclosed national business failure rates at levels of 0.77 per cent (1989), 0.88 per cent (1990), 0.95 per cent (1991), 1 per cent in 1992, just over 1 per cent in 1993 and declining to less than 1 per cent in the mid-1990s. This relatively low failure rate is in line with US data over the last 60 years produced by Dun and Bradstreet Corporation’s Business Failure Record.16 It continued until the end of the millennium, then rose slightly with the tech-wreck and GST impacts in early 2000.17 Despite the inevitable hysteria, Australian experience with corporate failures is far from unique. Similar corporate crises also occurred in the United Kingdom and the United States in the 1980s and 1990s, and during previous decades. Moreover, official responses to the latest Australian corporate failures fit the pattern elsewhere.

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Table 1.2 Selected corporate losses 1990–92* (Consolidated operating and extraordinary figures, after tax, attributable to members of the holding (parent) company for the 1990, ’91 and ’92 financial years.) Institution 1990 $bn 1991 $bn 1992 $bn Bond Corporation 2.250 1.066 0.310 State Bank of South Australia – 2.180 – State Bank of Victoria 1.978 – – Westpac Banking Corporation – – 1.670 Adelaide Steamship – 1.358 0.049 David Jones – 1.381 0.061 Fosters Brewing Group 1.264 0.043 0.949 Tooth and Co. – 0.720 0.038 Bell Resources (Aust. Cons. Invest.) 0.829 0.108 0.034 National Consolidated – 0.390 0.044 Industrial Equity – 0.341 – Petersville Sleigh – 0.309 – News Corp – 0.296 – TNT – 0.275 0.024 Barrack Mines 0.169 0.130 – FAI Insurances Group – 0.144 0.049 Ariadne Australia 0.067 0.019 0.103 Note: * A ‘–’ in a loss column indicates the company reported a profit for that period. Source: Annual Reports of companies for the 1990, 1991 and 1992 financial years.

The relatively low frequency of corporate failure is likely to mask its historical significance and commercial impact. Real resource allocation has social consequences. One large failure, or a large number of small failures, are events of historic, rather than merely historical, dimensions, causing considerable hardship and outrage amongst shareholders, creditors and the general public.18 Damage done before and after the excesses of the 1980s and the new millennium has also had far reaching direct consequences; undermining confidence in Australia’s securities markets, inciting public outrage and creating a perception by some that Australia’s self-regulatory Accounting Standards-setting process is deficient, much more so than in the United Kingdom or the United States.19 Thus, following Lonrho’s well-publicised 1972 liquidity crisis and allegations of corrupt business practices, UK Prime Minister Edward Heath labelled Tiny Rowland’s actions at Lohnro ‘the unpleasant and unacceptable face of capitalism’. Apt too are the comments of a group of British Labour Party members, that those actions were ‘the inevitable logic of capitalism’.20 Note their symmetry with the comment made nearly 50 years earlier in the United Kingdom in the wake of the Royal Mail failure, that it was ‘an offence

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[by Lord Kylsant, Chairman of the Royal Mail Steam Packet Co.], which however innocently committed, struck deep at the roots of investment confidence and menaced the whole stability of commercial financial practice’.21 Similar Australian sentiments were evident in the aftermath of 1960s corporate collapses, for example, this editorial comment following the H.G. Palmer failure: ‘the questions raised … are so serious and affect so seriously the confidence felt in the conduct of our business affairs that only the most thorough inquiry can now satisfy the public’,22 and following the 1970s Minsec collapse: ‘[It] was the biggest borrower on the Australian unofficial money markets. Its fall sparked one of the biggest money panics in Australian history … white- anting the whole Australian money market.’23 Today there are similar events, similar refrains. Table 1.3 confirms the extent of reported corporate ‘losses’. It is easy to find near identical comments to those in the 1960s and 1970s following the belatedly revealed 1980s excesses of Australia’s failed entrepreneurs:

… thanks to Spedley … the security blanket of audited accounts is an illusion …24 The failure of the accounting profession to establish and adhere to decent standards has ... proved that many of their ﬁgures cannot be trusted … Billions of dollars of investors’ funds vanished … Accounts … in many cases cannot be trusted.25 … arguably the September 1991 accounts [of Westpac] are now shown to have been grossly misleading … something like two billion dollars of assets claimed in those accounts did not exist … Westpac … reported assets and proﬁts that

Table 1.3 Selected reported deficiencies and investment writedowns for specified years Institution 2000 $bn 2001 $bn 2002 $bn HIH 5.3 – – Ansett – 1.50 – One.Tel – 0.07 1.5 Pasminco – 2.48 – NAB – – 4.0 News Corp – 0.75 12.8 Note: A ‘–’ in a column indicates the company failed to report a deficiency or writedown for that period. Source: Annual reports of companies for the 2000–02 financial years; as well as liquidators’ or administrators’ reports.