Waste Management Inc accounting fraud analysis
By James Wood (4583887)
This report will explore the accounting fraud committed by the Directors of Waste Management Inc and Arthur Andersen LLC between 1992 and 1997 which totalled $1.7 billion dollars. I will touch on who, why and how the guilty parties committed the fraud as well as applying key theories and accounting standards. Finally I will provide recommendations on how corporate governance procedures could have been improved to avoid the fraud.
Waste Management Inc is an American publically traded Standard and Poor 500 company which provides waste and environmental services on a national scale. With control over 293 landfill sites, 146 recycling plants and 26,000 collection vehicles (Waste Management 2017).
The Fraudulent Activity
The fraud was committed by the following key players at the company at the time with their personal gain shown (SEC 2002):
• Dean Buntrock ($16.9 million) – Founder and CEO,
• Thomas Hau ($600,000) – CAO
• James Keonig ($900,000) – CFO
• Bruce Tobecksen ($400,000) – VP of Finance
• Philip Rooney ($9.2 million) – Former President
• Herbert Getz ($450,000) – General Counsel
• Arthur Andersen LLP – Audit firm
All held high positions at the company whose roles included reviewing/producing the company’s financial accounts and reporting them. The key to defining fraud within accounting cases is distinguishing the difference between management and manipulation. Changing methods allowed by accounting standards is simply management whereas manipulation involves “intentionally misstating their financial information to favourably represent the entity’s financial performance.” (J Trussel 2003)
The fraudulent activity involved the following breaches to International Accounting Standards:
1. Avoiding the complete depreciation on assets: Useful lives of garbage trucks were extended therefore decreasing the depreciation expense on them. Breaking International Accounting Standard 16.61 originally issued in 1993 which states “The depreciation method should be reviewed at least annually and, if the pattern of consumption of benefits has changed, the depreciation method should be changed prospectively as a change in estimate under IAS 8” (IAS 2014).
2. Increase and misrepresentation of salvage values of assets: Also listed under IAS16 asset salvage values were increased, specifically the value of land fill sites. It stand to reason that as a site fills up the site would become less valuable. The necessary adjustments were not made.
3. Improper disclosure: Costs of unsuccessful projects not recorded through netting with one off receipts breaks International Accounting Scandal 1 as all material items must be disclosed of which these unsuccessful projects were not (IAS 2018).
4. Improper capitalisation: Capitalisation is defined as the “recordation of a cost as an asset, rather than an expense” (Accountingtools.com 2017). The directors would allocate expenses as assets to be depreciated over time increasing the net profit in the financial statements. This also breaches ISA16.
Note – Accounting standards referenced are the most updated version available through the links referenced, standards in 1998 followed similar guidelines with slightly differing terminology and definitions. The core ideas were still in place for all breaches.
The fraud was revealed after a new CEO hired in 1997 reviewed the accounting practices.
The reasons behind these actions was due to targets set that were too high to reach which put pressure on the board (ENSSCPA 2017). Pressure is the first component of the fraud triangle a theory which picks out 3 key elements as to why fraud occurs the other 2 being opportunity and rationalization (R U Abdullahi/N Mansor/M S Nuhu 2015). The directors remuneration was directly linked to the target they set for themselves therefore the pressure to reach these target were heightened even more. The board had the ability to by-pass standard accounting practice through internal gaps in corporate governance. These included no way of reporting acts that a staff member may have perceived to be fraudulent, poor segregation of duties and lack of independent checks. An example of the lack of segregation of duty is that the board also agreed remuneration methods that were affected by their work with no separation of duty. These gaps confirm the opportunity portion of the fraud triangle. Lastly rationalization can only been seen as the trade-off between potential loss and gain from the actions. The directors would have been fairly paid anyway and would not have required the extra funds in normal circumstances. Arthur Andersen LLC saw the potential loss of a key client more important that the fines or loss of reputation. Developed from the fraud triangle was the fraud diamond. The fraud diamond was introduced by Wolf and Hermanson (2004) and went that little step further adding a fourth and crucial element being capability. A paper written by the international journal of academic research described the fourth element as “the potential perpetrator must have the skills and ability to commit fraud” (R U Abdullahi/N Mansor/M S Nuhu 2015). This is key to this case as all the participants have more than the capability to commit fraud within the company either owned or worked in. This theory does make an important point but is negated by the fact the all CEO’s should have the skills to act fraudulently. All CEO’s and the team around him/her have many skills and abilities in the way of account management that can be used to act fraudulantly. From this justification of actions needs to in line with accounting standards and audited correctly.
Buntrock was both the owner and CEO at the time of the scandal and was an instigator of the actions taken. The rotten apple theory (Cloninger 2000) also applies as Buntrock seemed to initiate the activity. The theory states that the behaviour of everyone at the company is set from the top down. With Buntrock rationalising the fraud for himself this then fell onto the rest of the board members. Once the ‘rotten’ behaviour reaches the board company management will do very little to challenge them in fear of losing their own jobs. This theory however does not take in the whole picture of the fraud as it does not apply to the audit company. The audit company’s choice to act improperly was not as a result of one bad apple but a combination of many within their own organisation.
In any fraud case it is key to look at the external auditors. External audit is present to provide assurance to the figures being reported by the board therefore once you have passed this barrier then detecting the fraud will only be realised if work is reviewed multiple times. The audit company assigned to Waste Management was Arthur Andersen LLC one of the big five firms in North America at the time. After the review, as any audit company will do, advice was given to fix any misleading information or manipulation, this was ignored by the board. Their reaction to this was to bribe Arthur Andersen with additional payment not mentioned in the original agreement. Following this the accounting errors were written off. Delving into the relationship between internal and external these two areas should be completely independent, unsurprisingly this relationship was not. Thomas Hau and James Koeing were trained by Arthur Andersen and played key roles in being the bridge between the two firms relationship (ENSSCPA 2017). Bruce Tobecksen was both VP of finance and the audit manager of Waste Management and other companies audited by Andersen. Being a very big client and the warmth of the relationship between the two companies the probability for misstatement was very high. As with most criminal acts they catch up with you eventually with a $7 million fine being handed out to Arthur Andersen who were at the centre of not just this fraud scandal but many others (Norris 2001).
Ethical issue: Who did it effect?
Trust is placed on the board to act in an ethical manner and to act in the shareholders best interests. The overall effect on the shareholder of the company was the more than 33% decrease (SEC 2002) in stock price reaching a low of $13.69 during the investigation period of the fraud.
Agency theory states that the board are working as an agent for a principal being the shareholders (L Donaldson/J H Davis). The low share price was as a result of their actions therefore they do no uphold the position given to them by the shareholders. A progression of the Agency theory is the Stakeholder theory which takes into account a wider audience including “shareholders, employees, customers, suppliers, communities and other groups in a way that ensures the long-term success of the firm” (R E Freeman/J McVea). The Waste Management stakeholders would be shareholders, employees, local communities relying on the waste disposal, environmental agencies and government. All of these groups of people relied on Waste Management to work in their best interests not for their own personal ones. Employees rely on job stability, jobs would have been lost by the massive decline in company value. Shareholders rely on market value as explained above. Local communities relied on the quality and reliability of services that would have been reduced after recovering from the scandal.
The fraud which occurred could have easily been prevented with the two main figure heads from the internal perspective, Buntrock, and the external perspective, Arthur Andersen LLC, being too close. I will make recommendations for both internal and external parts of this fraud case.
Externally the relationship between an Audit firm and company should be completely independent with no feeling that one cannot cope without the other. Arthur Andersen saw Waste Management as a key client and saw it as too much of a risk to lose their business. This should never be the case as the assurance being provided should come from a trusted source. The bridge between the two companies needed to be managed by an independent source. I would propose that too increase the corporate governance of any company that there should be no previous employment connections as there were between Hau and Koeing. The rapid growth in the revenues of Waste Management over the 5 year period should have been looked at more closely. Even though strong company performance should be praised it needs to be confirmed. I believe that if a company performs exceptionally under the same audit company for a certain number of years then it should be required to hire a new one to provide more assurance on the results.
Internally the board’s activities should have been monitored by independent executives as well as their own judgment. It seems that at the time the key players were not being monitored what so ever. Following the fraud the new CEO Maurice Meyers set up an anonymous company hotline to report any dishonest or improper behaviour (AccountingDegree.org). This is a prime example of taking a dynamic approach to fraud, giving employees a chance to admit or report smaller errors to enforce a company culture that is against improper actions. The global economic crime and fraud survey 2018 reported that with the fraud triangle opportunity accounts to 59% of why fraud occurs (PWC 2018). Wiping this out through a strong company culture could eliminate fraud all together. Secondly an independent board member should be put in place to sign off decisions on remuneration of board members to remove the pressure/incentive portion. Finally rationalisation is difficult to fix as it is mainly to do with personal character. I feel that removing the pressure/incentive portion also eliminates the need for the rationalisation.
In 2018 Waste Management has recovered from the scandal currently profiting under CEO James Fish. The Arthur Andersen name was severely rubbed in the dirt after multiple scandals were unearthed including the very well-known Enron fraud case. The firm had since collapsed in 2002 but recently resurfaced when former partners bought the Andersen naming rights forming a new firm called Andersen Tax in 2014 (Titcomb 2014). It was made clear in a company statement that they would not be providing any audit services within their new endeavours.
The key points to take from this report is that widening the personal gap between external assurance providers is of primary importance, board of directors control must be spread across all aspects of the business with independent reviews occurring internally and that fraud needs to be controlled from the top of any company down. Answering my initial question on whether the scandal would have occurred without Buntrock I believe it would have. This would have been due to the weak external controls through the audit company and the relations between the present board members that also took personal gain from the scandal. Buntrock may have been the ‘rotten apple’ that started the issues but I believe the other members on the board had the ability to commit ‘rotten’ acts themselves.
Waste Management Inc accounting fraud analysis