- The WORLDCOM Scandal (2002)
Among the largest financial frauds in history is that produced by WORLDCOM, one of the largest telecommunications companies in the world.
WorldCom developed rapidly in the 1990s through strategic acquisitions of telecommunications companies, and later turned its attention to Internet communications, so that, by 2001, it handled half of all Internet and email traffic in the United States of America. For its development strategy to work, the price of WorldCom shares had to remain high in the margins provided by analysts and investors.
Since 1999, however, the company’s revenues have begun to decline and, with them, the share price. Concerned that the decline will not look well in the analysis of Wall Street financiers, the company’s top management have begun to change their financial reporting to camouflage poor performance and continue to make WorldCom perceived as a financially strong company and a safe investment.
To hide its declining profitability, WorldCom recorded expenses as investments and decreased the company’s reserves, with the money being recorded as revenue. In total, the company reported higher profits of $ 3.8 billion in 2001 and $ 797 million in the first quarter of 2002, reporting a profit of $ 1.4 billion, instead of a net loss.
The economic and financial fraud of WorldCom was discovered starting with the notification of a whistle-blower. Since his employment in 1996, analyst Kim Emigh has noted that there was a fraudulent environment within the telecommunications company. Because he reported several suspicious practices to his superiors, the employee was threatened with dismissal and eventually requested the transfer. Over the next 4 years, Emigh was promoted several times, reaching a management position. At the end of 2000, Kim Emigh was fired after notifying the Chief Operating Officer that he had been asked to change the tax records, that is, to commit fraud.
Cynthia Cooper, Director of Internal Audit at WorldCom, learned of Emigh’s reports and decided to launch an anti-fraud investigation. She discovered that, in addition to the financial fraud scheme reported by Kim Emigh, the company’s investors and employees were being deceived by another fraud method. WorldCom’s management had invented the “prepaid capacity” term, which concealed another practice of financial fraud: operating costs were recorded as capital expenditures. Capital expenditures are allocated to assets and may be spread over several years, while operating expenses must be reported in full at the time of their occurrence. As in previous practice, the financial statements illustrated a healthy and profitable company. But the reality was completely different.
When WorldCom’s top management broke the news that the audit team led by Cynthia Cooper had discovered billions of dollars fraudulently declared, she was suggested to give up the anti-fraud investigation she was conducting. Not only did Cooper not give up conducting the financial investigation, but she also informed the chairman of the audit committee of the WorldCom board of directors about the corporate fraud committed in the company’s accounting.
Following Cynthia Cooper’s complaint, the Securities and Exchange Commission (SEC) conducted its own anti-fraud investigation and found that WorldCom had overvalued its assets by more than $ 11 billion. The WorldCom scandal was the biggest corporate fraud of an economic and financial nature in the United States until then and, along with the bankruptcy of Enron, which you can read about here led to the adoption of new regulations and legislative measures to combat corporate fraud.
One month after its auditor, Arthur Andersen, was convicted of destroying documents from Enron’s audit, the telecommunications company filed for bankruptcy on July 21, 2002.
- The MISSISSIPPI Scheme (1719)
France’s financial situation was not at all bright in 1715. The reign and wars of Louis XIV had almost bankrupted the country, the value of gold and silver coins was declining, and France was unable to keep up with the payment of its foreign debt.
The solution to the crisis seemed to be John Law, a Scotsman in exile whose financial theories convinced members of the French government. According to him, the supply of gold and silver was unpredictable, unlike a paper currency, which could be put into circulation much faster and thus speed up trade.
Supported by the Duke of Orleans, the regent of Louis XV, John Law founded Banque Générale in 1716, which received currency deposits but offered banknote loans and withdrawals. The bank built its reserves through a share issue and made a profit by managing the financial needs of the French government.
A year later, the Scotsman founded the Compagnie d’Occident and acquired the exclusive rights to develop the vast French territories of the Mississippi River Valley in North America. By 1719, the Scotsman had monopolized France’s trade in tobacco and African slaves, collected French taxes, issued banknotes, and controlled France’s foreign trade through a company renamed the Compagnie des Indes. Law was even awarded the title of Duke of Arkansas.
The financial potential of the Compagnie des Indes did not go unnoticed by the market, therefor the price of a share rose from 500 to more than 18,000 pounds, a value well above the company’s earning potential. John Law issued more than 625,000 shares and later merged Banque Générale with Compagnie des Indes.
Banque Générale, Compagnie d’Occident and Compagnie des Indes were known as the Compagnie des Mississippi.
Laws intention was to pay off the huge public debt, which he had taken over following an agreement with Banque Royale, by selling the shares to the Compagnie des Indes in exchange for government securities issued by the state, whose value rose sharply as a result.
In the speculative bubble that followed and affected the whole Europe, the government printed a lot of banknotes, which were used by state creditors to buy even more shares in the Compagnie des Indes. Excessive banknote issuance has led to rampant inflation, the value of government securities has declined, and the expected profits of shareholders have been delayed. The whole scheme collapsed in 1720, when the value of the shares fell and caused a general stock market disaster in France and other countries.
John Law was held responsible, being forced to flee France in December of 1720. The company’s and its bank’s enormous debts were soon consolidated and taken over by the state, which increased the taxes in order to pay them off.
- The WIRECARD Scandal (2020)
An economic and financial fraud that has recently shaken Europe was the WireCard scandal, also called “Germany’s Enron”. This corporate fraud has all the ingredients of a movie script: whistleblowers, journalistic investigations, passive regulators, repeated but ignored disclosures, cosmetic accounting documents, famous auditors, fugitive managers and billions of dollars missing.
The company was founded in 1999, headquartered in Munich and was valued at no less than $ 28 billion. As an electronic payment processor, WireCard also offered risk management services, issuing and processing physical and virtual bank cards, and, through its WireCard Bank AG subsidiary, held a banking license and contracts with several international financial services companies.
Over the years, there have been several suspicions and reports about the payment processor’s accounting practices that did not comply with applicable law, all virulently denied by the company. BaFin, the Federal Financial Supervisory Authority and Germany’s main supervisory body, reacted rather to those who reported the irregularities, in solidarity with the company, attacking its critics. A possible failure also seems to belong to the Ernst & Young auditor, who has not noticed anything wrong over the years with the company’s accounting documents.
In 2019, the Financial Times published several financial investigation materials, accompanied by testimonies and documents of a whistle-blower, showing how WireCard falsified its income and profit. The reaction of the German company was extremely aggressive, suing the publication.
In the same year, an external audit was requested from KPMG, which revealed that most of the company’s profits for the 2016-2018 period and the existence of cash deposits that appeared in WireCard’s bank statements could not be confirmed. According to a Reuters source, WireCard falsified two-thirds of sales and owes creditors around 3.5 billion euros, of which 1.75 billion euros come from 15 banks plus 500 million euros issued in bonds.
The WireCard scandal has caused significant public outrage and there have been numerous calls for regulatory reforms as well as for the corporate governance rules’ update. While President BaFin called the WireCard scandal a “total disaster” and the European Commission called for an investigation into whether the German authority had breached the EU financial reporting rules, EY defended its position stating that “There are clear indications that this was an elaborate and sophisticated fraud, which involved several parts in various institutions of the world, with a deliberate intent to defraud. (…) Fraud designed to deceive investors and the public often involves extensive efforts to create a false document. Professional standards recognize that even the strongest and most thorough audit procedures may not reveal economic and financial fraud. “
In June 2020, WireCard said that 1.9 billion euros had disappeared, which caused its share price to fall (-98%). One week later, on June 25th, 2020, the company declared insolvency, with a debt of 3.5 billion euros. CEO Markus Braun was arrested shortly after he resigned, and Jan Marsalek, WireCard’s Chief Operating Officer, disappeared as soon as he was suspended. It was later discovered that Marsalek fled to Belarus and he’s currently on Europol’s list of the most wanted fugitives in Europe.
In May 2021, Pavandeep Gill, Singapore-based WireCard’s Chief Legal Counsellor and the one who managed all legal aspects of WireCard’s business and operations in the Asia-Pacific region, stated that he was the whistle-blower who provided the documents used in the investigation conducted by the Financial Times, to reveal the large-scale economic-financial fraud carried out at WireCard.