Enron Corp. didn’t invent creative accounting, it just brought the phenomenon into the limelight.
The use of unconventional corporate-bookkeeping methods became more common during the bull market of the 1990s, as big businesses strove to meet the ambitious expectations of analysts and investors.
The number of complaints about financial-disclosure irregularities that the federal Securities and Exchange Commission files in civil court has risen steadily in the last four years, from 75 in fiscal 1998 to 103 last year, or roughly one-quarter of all SEC case filings in 2001.
Most of the cases have been settled, an agency spokesman said. He could not, however, provide information on the outcomes.
But complaints are mushrooming from investors and company employees to the SEC about possible violations of securities laws, which includes accounting irregularities. Last month, for example, the SEC’s Enforcement Complaint Center received an average of 525 e-mails per day, up 45 percent from a year earlier.
Just last week, the former president of Critical Path Inc. pleaded guilty to participating in a criminal plot to exaggerate the e-mail provider’s revenue for 2000.
Bank of America Corp., in the meantime, said it would pay $490 million to settle lawsuits that accused it of hiding losses from loans to a hedge fund before combining with NationsBank in 1998. Investors in the banking giant accused it of concealing a write-off of $372 million stemming from a loan to the hedge fund.
Companies that cook their books are usually motivated to meet “overly aggressive” financial targets, according to Michael R. Young, a New York lawyer who represents companies sued by their shareholders and who is an editor of a book on financial fraud in corporate America.
“These problems typically don’t start with dishonesty. They stem from the incredible pressures these companies face on Wall Street,” Mr. Young said.
During the record, 10-year economic expansion of the 1990s, shareholders seemingly expected every company to make big money, he said. Businesses that reported losses were often punished by shareholders who abandoned the stock and lowered its price, he said.
Companies resorted to gimmicks to give investors what they wanted, said Dan Green, economist for Economy.com Inc., a West Chester, Pa., research group.
“It was relatively easy in that environment to get away with these kinds of things. Being greedy was in a sense more important than being right,” he said.
The rise in creative accounting was largely ignored by regulators, although Securities and Exchange Commission Chairman Harvey L. Pitt has called recently for corporate-bookkeeping reforms. Mr. Pitt’s predecessor, Arthur Levitt, has criticized the proposals, saying they don’t go far enough.
Enron, once the nation’s top electricity and natural-gas trader, is accused of creating partnerships that allowed its executives to shift debt off its books.
The partnerships allowed the company to keep millions of dollars in debt off the record while earning profits for some executives. The company had to restate earnings since 1997, eliminating more than $580 million in reported income in that time span.
At issue is whether the partnerships deliberately manipulated the books to mislead investors, many of whom were Enron employees with their retirement savings invested in the stock.
Enron has become a poster child for bookkeeping trickery, but the SEC is investigating accounting irregularities at other corporate giants:
High-speed telecommunications company Global Crossing Ltd., which filed for bankruptcy protection last month, has acknowledged that it is under federal investigation for possible accounting irregularities. The FBI is also investigating.
The SEC told Xerox Corp. last month that some of its accounting methods do not follow standard practice. The commission has been investigating how Xerox accounts for revenue from selling and leasing its equipment.
The commission has investigated Rite Aid Corp.’s accounting practices. In 1999, the drugstore chain revealed that its earnings for 1997, 1998 and 1999 would have to be restated, resulting in a $500 million reduction. The investigation has focused on whether the company boosted profit by improperly claiming credits from suppliers to remove supposedly damaged or outdated goods. Last year, a federal judge approved a $200 million class-action settlement between Rite Aid and shareholders who suffered losses stemming from the earnings.
In December 2000, Michael J. Saylor, chairman and chief executive of MicroStrategy Inc., and two other executives agreed to pay $11 million to settle federal regulators’ accusations of accounting fraud. Earlier that year, the McLean software vendor had been forced to issue a restatement of its earnings, which essentially turned two years of profits into two years of losses. The restatement was required because the company had reported revenues that were expected, but had yet to occur.
Most creative accounting comes down to “revenue recognition tricks,” said Joseph V. Carcello, a University of Tennessee accounting professor who specializes in financial fraud.
For example, a company may bill a customer for goods but never ship them, Mr. Carcello said. Or the company may sell products, but not report the sale until months later.
In some cases, a company will sell a product, but have a verbal agreement with a customer to buy the products back if the customer doesn’t sell them, Mr. Carcello said.
In Xerox’s case, federal regulators said last month that the company was not following the bookkeeping methodology required by the Financial Accounting Standards Board. The private board sets accounting standards for U.S. companies.