Lessons from Olympus

Within days of the Enron debacle’s 10th anniversary and three years from the Madoff Ponzi scheme, a new scandal emerged at the Japanese electronics giant Olympus. This fraud — complete with fresh allegations of financial manipulation, management abuse, special purpose entities, conflicts of interest and complicit auditors — shares many of the issues of Enron. Olympus may show just how little we have progressed since Enron — a bellwether in business ethics and corporate conduct.

Unethical behavior of insiders at Enron and Olympus manifested in overstating operational value. Both companies gained operational advantages by exploiting laws and common business or accounting practices, sometimes with their auditors’ concurrence. Therefore, management of both companies deceived their shareholders and most of their employees. Of course, Enron tanked, and, as of press time, we don’t yet know the future of Olympus.

OLYMPUS' ETHICS 

The U.S. Sarbanes-Oxley Act (SOX) of 2001 — the reaction to Enron, WorldCom and other frauds in the early part of the century — has influenced governments and companies around the world. The act doesn’t require U.S. public companies to have a code of ethics, but it directed the Securities and Exchange Commission (SEC) to issue rules to require these companies to disclose if they haven’t adopted a code and the reasons why. Although Olympus isn’t bound by SOX, it appeared to have had ethics policies incorporated into its compliance programs. However, as we’ve all seen, unenforced ethics policies are a colossal waste of time.

Let’s take a look at the ethical issues at Olympus. The company, a well-known Japanese manufacturer of optical equipment whose stock traded on the Tokyo Stock Exchange, boasted worldwide revenues in excess of $10 billion per year. Olympus has been in business since 1919 and has more than 40,000 employees globally.

We won’t go into great detail about the Olympus scandals because Fraud Magazine has thoroughly covered the Olympus frauds. But we’ll condense the main points.

In the final months of 2011, allegations of financial manipulation, management misconduct and illegal activities began to surface. Investigations continue, but Olympus has admitted to utilizing “loss-hiding arrangements” (in Japanese, “Tobashi”) to cover decades of investment losses.

These loss-hiding schemes primarily involved Olympus selling poorly performing investments to related parties for inflated prices. Cooperative investment banks provided the financing, which allowed Olympus to hide the losses from poor investments.

Michael Woodford, the recently appointed Olympus COO and CEO, blew the whistle on his own corporation after reading about the irregularities in a small Japanese business publication, FACTA. Woodford, an Olympus employee for more than 30 years and a British citizen, had worked his way up the executive ranks. The Olympus board fired him after he began questioning the loss-hiding arrangements.

ETHICAL ISSUES

After the Olympus board summarily fired Woodford, he took his story of the massive $1.7 billion accounting cover-up to the Financial Times; the U.K. Serious Fraud Office; the U.S. Department of Justice; the Japan Securities, Exchange and Surveillance Commission, and several other agencies. He became the highest-ranking corporate whistleblower in history. (The ACFE presented Woodford with its Cliff Robertson Sentinel Award in 2012.)

Upper-level management

Apparently, top management was fully aware of the loss-hiding schemes and actively tried to hide it from Woodford. Management went so far as to say, “If this secret information had not been leaked, there would have been no change in our corporate value.” Woodford’s replacement, Shuichi Takayama, initially denied the allegations and blamed Woodford for Olympus’ decreased shareholder value. As the investigations expanded, Olympus finally admitted the scheme was used to hide losses, and Kikugawa, Muri and a board member resigned. (See “Olympus Scandal: Bye, Old Guard, Hello … Old Guard?” by Cesar Bacani, CFOinnovationASIA, Oct. 31, 2011.)

Board of directors

Olympus’ board didn’t act as an independent group. Twelve of 15 members had been Olympus employees. The board approved of the acquisitions, which either implicated them in the scheme, or they didn’t have the financial acumen to understand the inflated acquisition valuations. Toshio Oguchi, representative director of Governance for Owners in Tokyo, argued that the affair pointed to a dysfunctional board. “Even if they didn’t know about the Tobashi,” Oguchi said, “the fact that the board approved the payment cannot have been a correct decision.” (See “Focus turns on Japan’s corporate culture,” by Michiyo Nakamoto, FT.com, Nov. 8, 2011.)

External auditors

KPMG audited Olympus from 2002 to 2009 and then Ernst & Young from 2009 to 2011. Although both auditors claimed that they raised issues about the acquisitions, both gave clean opinions (unqualified) on Olympus’ financial statements in those time periods.

In late November 2011, Michael Andrew, KPMG International global chairman, said his firm had complied with its legal obligations to pass on information related to Olympus’ 2008 acquisition of Gyrus, and Olympus removed KPMG for doing so. “It’s pretty evident to me,” Andrew said, “there was very, very significant fraud and that a number of parties had been complicit.” (See “Olympus: Where were the auditors?” by Jonathan Weill, BusinessReport, Nov. 14, 2011, and “Olympus’s $687 Million Scam Lay Hidden in Cardiff Filing System,” by Katie Linsell and Mariko Yasu, Nov. 20, 2011.)

What lessons can we learn from the Olympus scandal that may improve internal compliance and ethical issues in our corporations?

CORPORATE PRACTICES ASSOCIATED WITH ETHICS

Let’s examine what U.S. public companies need to do to comply with SOX’s high ethical standards.

As stated before, SOX doesn’t require U.S. public companies to have a code of ethics, but it directed the SEC to issue rules to require these companies to disclose if they haven’t adopted a code and the reasons why, effectively compelling these companies to have a code.

The majority of larger and 100 percent of publicly traded companies should have in place:

• A whistleblower ethics/fraud hotline.
• An official compliance program.
• A company employee who’s tasked with specific compliance duties including monitoring the compliance program.
• Written management assessment of its internal control structure for financial reporting.

Despite having these programs in place, corporations must continue to identify and assess ethical risks that are associated with the structure and nature of the company’s business environment.

EVALUATING ETHICAL RISKS

Although a corporation such as Olympus might have an ethics compliance program and a code of conduct in place, it has to evaluate several ethical risks.

Financial policies: Upper-level management and overall corporate strategy can trump ethical compliance programs. For example, a corporation’s financial policy that emphasizes short-term growth and decisions that focus only on financial objectives can cause unethical behavior. Unrealistic financial goals create pressure on executives and subordinates to manipulate or falsify earnings or losses. Olympus utilized loss-hiding schemes to cover up past failed investment growth strategies as short-term fixes.

Public relations tools: If a corporation uses its code of conduct solely as a public relations tool, it won’t periodically review or modify the code as the corporation grows. Olympus wouldn’t admit to its loss-hiding schemes until there were no other options. The executives ignored their own ethical code of conduct to hide its losses and then attempted to cover up the scandal by terminating the whistleblower.

Communicating a code: Companies often don’t communicate code principles. A conflict of interest occurred at Olympus because its compliance officer and other top-level executives, who were responsible for communicating the code to their employees, apparently were involved in the loss-hiding scheme.

Policy and procedures manual: A company might have a corporate code of conduct but not have a policy and procedure manual to support it.

Tone at the top: “Nobody up there cares about the truth.” The Olympus CEO wrote letters to board members, auditors and compliance officers about the loss-hiding schemes and hired outside investigators to look into the matter and was terminated for his actions. If the C-suite execs don’t respect truth, why should the employees? Olympus, and so many other companies, should seek to modify its ethical attitudes. (See “Flunking the Ethics Test: Aspects Fostering Unethical Behavior in Corporate Culture,” by Marcela Halmagean, CFE, The White Paper and ACFE.com.)

ETHICAL BEST PRACTICES

Using the lessons learned from the Olympus scandal, what actions should a corporation take to ensure ethical behavior not only by employees but its highest leadership?

Here are several steps that organizations can take to bolster existing ethical compliance programs:

Planning and evaluation

• Evaluate whether the ethics compliance program is consistent with the organization’s business plan, and redesign if necessary.
• Replace overly aggressive financial initiatives with achievable goals and then provide transparent results.
• Review corporate ethical culture: Periodically use employee surveys (possibly anonymous) to better understand needed training as well as employees’ views about overall ethical barometers and the ethics of top management.
• Base and measure the performance of all employees, including upper-level management, on core values (such as service excellence, communication, training, integrity, etc.) and long-term strategy.

Reporting process

• Organizational training and communications should educate and reinforce the idea that employees at all levels should have roles and responsibilities to report unethical behavior.
• Upper-level management must encourage employees to come forward when they observe unethical behavior.
• The general counsel’s office should hire an outside party to periodically review hotline procedures and processes to ensure that the company is properly documenting and routing calls to the proper departments. Take quick actions to investigate improper behavior or fraud allegations.

Policies and training

• Employees should be periodically retrained on the corporate code of ethics, what is considered to be unethical behavior and what they should do if they observe unethical behavior.
• The company should demonstrate to employees that the code of ethics will be enforced equally and sufficiently to everyone.
• Upper level management should support ethical behavior, promote employee communication and innovative thinking.
• Upper level management must not only promote ethical behavior but adhere to it.
• The general counsel and/or compliance officer should ensure there are detailed written policies and procedures that reflect the code of ethics.

Background checks and due diligence

• Corporations should conduct thorough background checks and due diligence for all new employees.
• Corporations should conduct thorough background checks and due diligence for existing and new Board of Directors to ensure independence and adequate financial and business acumen. 
• The corporation and its executives should treat all stakeholders ethically.

UNWELCOME WAKE-UP CALL

Studies have shown that ethical behavior in companies enhance corporate value. The reverse is also true, “Unethical behavior can destroy a company’s innate value.”

Olympus’ unethical behavior has already diminished stakeholder confidence, reduced stock price and investor ownership interests, resulted in potential delisting from stock markets and instigated investigations by local and foreign concerns. The story isn’t over, and the repercussions are likely to continue for some time. It’s clear that for those looking to the post-Enron paradigm of ethics and corporate conduct as evidence of improvement, certainly the Olympus situation must be an unwelcome wake-up call.

Mark Jenkins, CFE, is a partner with Fidelity Forensics Group LLC in Dallas, Texas. 

Christopher Meadors, J.D., CPA, is a partner with Fidelity Forensics Group LLC in Dallas, Texas, and an assistant professor of accounting at Texas A&M – Commerce.  

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