16 Financial Shenanigans That Got Companies In Craploads Of Trouble


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Accounting scandals have leveled off since early 2000, when it seemed a corporate behemoth would get whacked nearly every month thanks to shoddy “best practices” (think WorldCom, Enron, Xerox, Krispy Kreme).But that doesn’t mean they don’t exist today — the scandal that continues to engulf Olympus has marred the Japanese giant and JP Morgan remains under pressure for a massive unexpected loss on a single trade.

Business Insider decided to dig through the most notable instances of when companies employed questionable accounting tricks, financial engineering, complicated risk metrics, and outright fraud in an effort to hide losses are inflate profits.

Special Purpose Vehicle (SPV)

Definition: An SPV is a legal entity typically used to serve as a counterparty with the main corporation. In finance it often used for securitization, but it has also been used to hide risky corporate behaviour/transactions and conceal corporate relationships.

Case: The most notorious case of special purpose entities being used to distort a company's obligations is Enron, which filed for bankruptcy in 2001. Enron used SPVs to lower the appearance of its debt load and overstate earnings and equity.

Mark to Market (MTM)

Definition: MTM is an accounting measure that values accounts to the current environment. Firms use mark-to-market accounting when the value of an asset or liability moves over time.

Case: Bear Stearns, the now defunct investment bank purchased by JP Morgan, reported in June and July of 2007 that its two main hedge funds (the Bear Stearns High-Grade Structured Credit Fund and High-Grade Structured Credit Enhanced Leveraged Fund) had to mark down nearly all their value, sparking concerns of contagion in the financial crisis. Banks across Wall Street suffered huge paper losses thanks to MTM.

Repo 105

Definition: Repo 105 is an accounting trick that defines a short-term loan as a sale. A company will then use that cash to lower liabilities, before paying back the loan with interest. Generally in the repo market, companies will not exchange collateral because the timing is so short.

Case: Lehman Brothers masked extensive liabilities right before quarter-end by using this Repo 105 tactic. The company ultimately filed for bankruptcy and was sold off to different institutions (with most U.S. operations going to Barclays).

Expense Recognition

Definition: Under generally accepted accounting principals, expenses should be recognised when incurred -- not necessarily when the payment is made.

Case: Diamond Foods allegedly shifted payments to walnut growers to later periods to offset costs during its fiscal 2011 year, inflating earnings as it entered negotiations with Proctor & Gamble. The stock transaction depended heavily on Diamond's share price.

Revenue Recognition

Definition: Under generally accepted accounting principals, revenue should be recognised when the company delivers or performs the task it will be paid for -- not necessarily when the payment is received. However, exceptions do apply.

Case: Xerox settled with the SEC in 2002 for accelerating revenue recognition of equipment sales by more than $3 billion, which increased pre-tax earnings by $1.5 billion. The company, which was supposed to record revenues both upfront and over a period of time (for servicing equipment over its usable life), moved those service revenues to the time of purchase.

Misrepresented Cash Flows

Definition: The statement of cash flows is the third major financial statement, which tallies cash generated and spent by a company during a fiscal period. This portion of the financial statement of an earnings release is one of the best ways to gauge a company's solvency and actual performance.

Case: WorldCom used its cash flows statement to hide expenses by marking operating costs, which should have been booked as expenses, as capital investments. Under that plan, WorldCom inflated cash flow by $3.8 billion and posted quarters of positive performance when it really lost money.

Channel Stuffing

Definition: Channel stuffing is a practice where a distributor ships retailers excess goods that were not ordered to increase the accounts receivable portion of their balance sheet. Generally, the retailers then ship back the goods and the company must mark them as returns.

Case: Krispy Kreme allegedly sent franchises double their usual shipments at the end of financial quarters so the company could meet Wall Street forecasts. In 2005 the company said it would restate past financial statements.

Hiding Losses in Acquisitions

Definition: Companies can pay high prices for financial advice during a merger, and some have used that guise as a method to cover prior losses.

Case: Japanese technology giant Olympus announced it had been hiding losses on securities investments for years by using the cover of acquisitions. And when new CEO Michael Woodford called attention to strange payments made in 2008, he was fired.

Round Trip Trading

Definition: This is practice where a firm trades an asset and then buys it back many times to inflate transaction volume. However, the market-manipulation has no impact on profit (although it will bolster top line results).

Case: Dynegy was forced to pay the SEC $3 million after it was found conducting round trip trades with special purpose entities. According to the SEC, Dynegy's 'overstatement of its energy-trading activity resulting from 'round-trip' or 'wash' trades -- simultaneous, pre-arranged buy-sell trades of energy with the same counter-party, at the same price and volume, and over the same term, resulting in neither profit nor loss to either transacting party.'

Smoothing Earnings

Definition: This is practice where a firm smooths net income by using GAAP techniques to level off fluctuations between periods.

Case: Freddie Mac understated earnings by more than $5 billion over three years to keep earnings consistent and investors happy. According to The New York Times, Freddie Mac lost $111 million during a period it announced net income of nearly $1 billion. It was able to achieve that by banking half of what it reported it earned during the third quarter of the year (Freddie earned more than $2 billion during that fiscal period, but said it only earned about $1 billion).


Definition: A practice by brokerage houses where they excessively trade securities to generate commission -- even when the trades do not benefit the account holder. Similarly, the practice has been conducted by insurance companies by moving clients from one policy to another.

Case: MetLife, just one of a number of insurance companies found guilty of the practice, settled with state regulators and set aside billions for claims that it moved clients from one policy to another, to generate high premiums.


Definition: A transaction where two companies (or people) agree to trade goods or services with each other without the use of currency.

Case: AOL was investigated by the SEC and Justice Department for inflating revenue on deals that it had bartered online advertising for goods and services it required in the period leading up to the merger with Time Warner.

Tax Evasion

Definition: Pretty simple: an illegal practice where a person or company does not pay the correct tax liabilities owed to the government.

Case: Crazy Eddie, a discount electronics retailer, evaded taxes for years before going public by 'skimming and under-reporting income.' This was just one of the practices the company used to bolster results.

Back Dating Employee Stock Options

Definition: The process where a company offers options to an employee at a date before the actual date the option was made. Companies have done this so they can set better exercise prices to the employee (generally pushing the option into the money).

Case: Apple came under scrutiny for back dating options to employees and forced then-CEO Steve Jobs and other Apple executives to pay $14 million, plus attorney fees.

Goodwill Impairments

Definition: Although not illegal, companies have come under pressure from investors for overstating goodwill -- which bolsters the balance sheet. Goodwill represents a company's intangible assets (its brand, customer relations, etc.) and often arises during a merger or acquisition.

Case: Green Mountain came under fire for its accounting of goodwill during its acquisition of Van Houtte and how the its jump in assets was mainly attributable to that line item on the balance sheet.

Value at Risk (VAR)

Definition: A tool used by financial institutions that estimates probable losses based on historic trends, prices and volatility. Firms generally report VAR data at quarter-end, with confidence intervals, and for periods stretching from one day to two weeks.

Case: JP Morgan is under intense scrutiny after reporting a $2 billion loss after publishing a VAR of just $76 million a quarter earlier for its entire credit portfolio. At that pace, the entire JP Morgan unit could have lost as much as $76 million in value in any given day (to a 95 per cent confidence interval).

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