Top Global Accounting Scandals Impacted Reputation of Big Accounting Firms

Around the world, cases of financial fraud have not only hurt investor trust but also damaged the reputations of well-known accounting firms. These scandals, ranging from fake records to deliberate cover-ups, reveal serious flaws in the corporate and auditing systems. The impact is often devastating, affecting businesses, investors, and economies alike.

This article looks at some of the most well-known accounting scandals that have damaged the reputation of major firms like Arthur Andersen, PricewaterhouseCoopers, Ernst & Young, Deloitte, and KPMG.

The Future of Tax and Finance: Upskill with Us

By discussing cases such as Enron, Satyam, and Wirecard, it points how these incidents changed the accounting industry, led to stricter regulations, and raised concerns about the reliability of audits.

Enron Scandal and Arthur Andersen

The Enron scandal is the biggest accounting fraud in history which led to the introduction of the Sarbanes-Oxley Act in 2002 and the dismantling of the then Big five accounting firm Arthur Andersen.

Enron, once a highly respected energy company, used complex accounting techniques like mark-to-market accounting and special purpose entities (SPEs) to hide its financial losses and inflate profits.

Founded by Kenneth Lay in 1985 through the merger of Houston Natural Gas and InterNorth, Enron was initially a respected energy company. However, it employed fraudulent accounting techniques such as mark-to-market accounting and the creation of special purpose entities ( SPEs ) to inflate profits and hide losses. By 2001, these practices culminated in the largest Chapter 11 bankruptcy filing in U.S. history at the time, resulting in $11 billion in shareholder losses. Enron's stock plummeted from $90 in mid-2000 to mere pennies by late 2001.

Arthur Andersen, Enron's auditor, faced scrutiny for its role in facilitating the fraud. The firm shredded critical audit documents during investigations, leading to its 2002 conviction for obstruction of justice. Although the Supreme Court overturned the conviction in 2005, the damage to Andersen's reputation was irreversible. The SEC’s prohibition on audits from convicted felons forced Andersen to surrender its CPA licenses, effectively ending its operations.

The scandal not only dismantled Enron and Arthur Andersen but also eroded trust in corporate governance and financial reporting. It spurred the enactment of the Sarbanes-Oxley Act of 2002, introducing stringent regulations to prevent similar misconduct.

The Future of Tax and Finance: Upskill with Us

Before its collapse, Andersen had over 28,000 employees and audited other companies implicated in fraud, such as Waste Management and WorldCom. The fallout from these scandals and the loss of business led to Andersen's dissolution. While some parts of Andersen, like its consulting arm, evolved into entities such as Accenture, the firm itself never regained its stature.

In 2014, Andersen Tax ( formerly WTAS ) was established by former Andersen partners, reviving the Andersen name in a limited capacity. Despite this, the firm remains a cautionary tale of corporate malpractice and regulatory oversight.

WorldCom Scandal and Arthur Andersen

The WorldCom accounting scandal, one of the largest corporate frauds in American history, unfolded in 2002. WorldCom, then the second-largest long-distance telecommunications company in the U.S., was found to have engaged in fraudulent accounting practices, overstating its assets by more than $11 billion.

The fraud was uncovered by Cynthia Cooper, Vice President of Internal Audit, whose investigation revealed over $3.8 billion in improper balance sheet entries, later expanded to include 49 fraudulent transactions from 2001 to early 2002.

At the time, it was the largest accounting fraud in American history. About a year later, the company went bankrupt. The auditors of the worldcom were the same Enron, Arthur Andersen. However, KPMG had inherited the WorldCom account when it bought Arthur Andersen's Jackson practice.

The scheme involved capitalizing operating expenses, specifically "prepaid capacity," to inflate profits and meet Wall Street expectations. Cooper and her team’s investigation faced resistance from senior management, including Corporate Finance Director Sanjeev Sethi, Corporate Controller David Myers, and CFO Scott Sullivan.

When confronted, Sullivan justified the entries under the "matching principle," claiming they aligned costs with anticipated future revenues. However, external auditor KPMG and the Audit Committee rejected this rationale, concluding the sole purpose of these entries was to manipulate earnings.

The fraudulent activities were not limited to top executives; lower-level accountants were also implicated. Many made entries under management directives without fully understanding their implications. Some entries were marked with "SS entry," directly linking them to Sullivan. These actions violated Generally Accepted Accounting Principles ( GAAP ), prompting KPMG and the Audit Committee to demand Sullivan and Myers’ resignations.

In 2005, former WorldCom CEO Bernard Ebbers was convicted of fraud, conspiracy, and filing false documents, receiving a 25-year prison sentence. Released in 2019 due to health issues, he passed away in 2020. The SEC also charged WorldCom's senior management with civil fraud for manipulating earnings to sustain the stock price. Rebranded as MCI, the company was acquired by Verizon Communications in 2006.

The Future of Tax and Finance: Upskill with Us

KPMG played their role with all diligence and professionalism during the WorldCom scandal, effectively fulfilling its auditing responsibilities. However, Arthur Andersen's reputation suffered irreparable damage, having already been embroiled in the Enron scandal prior to WorldCom.

The SEC criticised Arthur Andersen for its grossly inadequate auditing practices, pointing out significant flaws in its approach. Andersen failed to conduct essential tests that are fundamental to the responsibilities of a professional auditor.

Wirecard Scandal and Ernst & Young (Germany)

Wirecard, a successfully run Germany tech company, listed on the prestigious DAX 30 index, and valued at over €24 billion at its peak. However, in June 2020, the company admitted that €1.9 billion (approx $2.1 billion) supposedly held in trustee accounts in the Philippines did not exist. This revelation followed years of allegations about fraudulent practices, suspicious accounting, and corporate misconduct.

The role of the accounting firm Ernst & Young (EY) was that it was the Wirecard’s auditors for decades, signing off on its accounts as accurate, including the nonexistent €1.9 billion. The big 4 accounting firms faced a lot of criticisms, lawsuits..etc for failing to detect the fraud.

EY relied on the documents submitted by the company rather than doing independent checks by verifying the bank accounts. The auditing firm ignored the whistleblowers which raised the concerns about the irregularities on the money of the company.

Later, Wirecard declared insolvency in June 2020, becoming the first DAX-listed company to collapse. Investors lost billions, and regulatory oversight in Germany was criticized. And EY lost its reputation and faced lawsuits from shareholders, creditors, and regulators for its role in the scandal. The German regulator put a ban on EY audits.

Satyam Scandal and PricewaterhouseCoopers (India)

Satyam Scandal can be called as ‘India’s Enron’. It was a massive corporate fraud that happened in 2009. Satyam Computer Services, once one of India’s largest IT outsourcing companies, manipulated its financial statements for years, inflating profits and assets to deceive investors and stakeholders. the founder and then-chairman, Ramalinga Raju, admitted to manipulating the company's financial records

Additionally, Raju falsely claimed that Satyam had cash reserves of over ₹5,000 crore ($1 billion), which did not exist. To further deceive stakeholders, the company reported non-existent assets to project a stronger financial position than reality. These fraudulent practices ultimately led to the collapse of Satyam and significant repercussions for India's corporate governance landscape.

PricewaterhouseCoopers ( PwC ), one of the world’s leading auditing firms, audited Satyam's books for several years and faced intense scrutiny for its failure to detect the fraud. It faced severe backlash for its role in the scandal, as it failed to independently verify the company’s bank balances and cash reserves, instead relying on forged documents provided by Satyam’s management.

The auditors evidenced a lack of professional skepticism by not questioning unusually high profit margins or investigating discrepancies in financial data, which should have raised red flags. Furthermore, allegations of potential collusion between PwC partners and Satyam’s management emerged during investigations, severely tarnishing the firm’s credibility.

The Future of Tax and Finance: Upskill with Us

The scandal resulted in the collapse of Satyam and damaged PwC’s standing in India. PwC faced legal actions, with two of its partners arrested for their alleged involvement in the fraud and it was banned by SEBI from auditing listed companies in India for two years (2018–2020) and it lost many clients.

PwC faced legal consequences, including the arrest of two of its partners for their alleged involvement in the fraud. In addition, the SEBI imposed a two-year ban (2018–2020) on PwC from auditing listed companies in the country. This impacted the firm's operations, resulting in the loss of several key clients and tarnishing its credibility in India.

With regards to the masterminds, then chairman Raju, along with other executives, was sentenced to seven years in prison in 2015. He was fined and barred from serving as a director in any company.

Carillion and KPMG (United Kingdom)

Carillion, a leading UK construction and facilities management company, collapsed in 2018 under the weight of £7 billion in debt. It is one of the largest accounting scandals in the UK.

KPMG, its auditor for 19 years, faced criticism for failing to identify the financial irregularities that contributed to the collapse. The auditing firm came under intense scrutiny for its role in failing to detect the scale of the company’s financial mismanagement. Investigations revealed that KPMG had signed off on Carillion’s financial statements, even though they failed to account for the mounting losses, poor cash flow, and increasing debt.

Parliamentary committees in the UK described KPMG’s audits as “complacent” and “negligent.” The scandal sparked debates about the role of auditors in preventing corporate failures and led to calls for a breakup of the “Big Four” accounting firms to increase competition and accountability.

The Future of Tax and Finance: Upskill with Us

Tesco and Deloitte (United Kingdom)

In 2014, Tesco, the UK’s largest retailer, admitted to overstating its profits by £250 million. Deloitte, Tesco’s auditor, faced scrutiny for failing to identify the accounting irregularities during its audits.

The scandal led to a sharp decline in Tesco’s market value and damaged Deloitte’s reputation. It highlighted the challenges auditors face in navigating complex financial reporting practices and underscored the need for greater diligence.

Olympus and KPMG + EY (Japan)

Olympus, a Japanese camera and medical equipment company, was embroiled in a $1.7 billion accounting scandal in 2011. The company had been concealing losses for years through fraudulent accounting practices.

Michael Christopher Woodford, a British executive with a 30-year career at Olympus, rose through the ranks to become President and COO in April 2011, and later CEO in October. His appointment marked a historic moment as the first non-Japanese to lead the company.

However, suspicions surrounding past acquisitions, notably the 2008 purchase of Gyrus Group, tainted his tenure. Reports revealed Olympus had paid $687 million in questionable advisory fees, prompting Woodford to challenge the company’s governance practices.

The scandal deepened as Olympus admitted to impaired valuations on acquisitions and questionable financial practices, with executives defending decisions amid declining stock prices. While Woodford resigned from the board to push for untainted leadership, investigations in Japan, the UK, and the USA were underway, revealing the scale of Olympus’s governance failures and underscoring the risks of corporate opacity.

The Future of Tax and Finance: Upskill with Us

Olympus's auditors transitioned from Arthur Andersen in the 1990s to KPMG Azsa in 2002, and later to Ernst & Young ShinNihon ( EY ) in 2009. Despite these changes, no major issues were flagged in the audit reports, which consistently received clean opinions.

KPMG reportedly raised concerns about Olympus's accounting for the Gyrus acquisition but still signed off on the 2009 accounts before being replaced by EY. EY similarly approved the 2010 and 2011 accounts despite reservations over the lack of transparency regarding Axam, a related party in the Gyrus deal.

Gyrus's auditors had previously resigned due to concerns about the company’s accounting practices, including the valuation of securities and preference shares, with KPMG explicitly citing unresolved issues in its resignation letter. Both KPMG and EY noted delayed filings of Gyrus's annual reports, raising further questions about governance.

Michael Andrew, KPMG International’s global chairman, later stated that his firm had fulfilled its legal obligations in reporting irregularities but was dismissed by Olympus for doing so. Despite its scrutiny, KPMG signed off on financial statements containing dubious figures that conflicted with warnings from other network members. Meanwhile, EY’s internal review questioned the Olympus inquiry's accuracy but concluded that its own handover from KPMG adhered to guidelines, albeit with limited investigative powers.

The Japanese Institute of Certified Accountants initiated a probe into the auditors' role, while Olympus faced criticism for how these concerns were handled, particularly during the transition between KPMG and EY. Both firms highlighted the systemic failures that allowed significant fraud to remain concealed for years.

The Future of Tax and Finance: Upskill with Us

Bernie Madoff and Friehling & Horowitz (USA)

Bernie Madoff orchestrated one of the largest Ponzi schemes in history, defrauding investors of $65 billion. Friehling & Horowitz, a small accounting firm that audited Madoff’s financials, failed to detect the fraud despite glaring red flags.

The scandal, which unraveled in 2008, exposed flaws in the auditing process and raised questions about the adequacy of oversight for smaller accounting firms. It prompted regulatory agencies to tighten their scrutiny of auditors and investment firms.

Support our journalism by subscribing to Taxscan premium. Follow us on Telegram for quick updates