Ethics and Accounting Fraud: A Case Study of Waste Management

Characterization of the ethical leadership at Waste Management

In six to eight pages, supported by evidence from your text and from other research (at least two resources are required), answer the following questions:

• Characterize the ethical leadership at Waste Management and how it influenced organizational ethics.

• The SEC charged Andersen with failing to quantify and estimate all known and likely misstatements due to non-GAAP practices. Describe the failings of the firm with respect to professional judgment and ethical expectations under AICPA Code.

• Classify each of the accounting techniques described in the case that contributed to the fraud into one of Schilit’s accounting shenanigans. Include a discussion of how each technique violated GAAP.

• Do you believe auditors should be expected to discover fraud when a client goes to great lengths, as did Waste management, to withhold evidence from the auditors and mask the true financial effects of transactions? Explain.

Major Case 6 Waste Management Case Overview This case focuses on improper accounting and management decision making at Waste Management, Inc., during the period of its accounting fraud from 1992 to 1997, and the role and responsibilities of Arthur Andersen LLP (Andersen), the Waste Management auditors, with respect to its audit of the company’s financial statements. The case illustrates the kinds of financial statement frauds that were common during the late 1990s and early 2000s. The key accounting issue was the existence of a series of Proposed Adjusting Journal Entries (PAJEs) recommended by Andersen to correct errors that understated expenses and overstated earnings in the company’s financial statements.

These were not recorded even though the company had promised to do so. Andersen developed a “Summary of Action Steps” that was designed to change accounting in the future in order to comply with GAAP but did not require retroactive adjustments to correct past errors. In essence, it was an agreement to do something in the future that should have been done already, with no controls or insistence by Andersen that the proposed changes would in fact occur. According to SEC Litigation Release 17435: Management consistently refused to make the adjustments called for by the PAJEs. Instead, defendants secretly entered into an agreement with Andersen fraudulently to write off the accumulated errors over periods of up to ten years and to change the underlying accounting practices, but to do so only in future periods. The action steps were not followed by Waste Management.

Failings of the auditor Andersen with respect to professional judgment and ethical expectations under AICPA Code

The company promised to look at its cost deferral, capitalization, and reserve policies and make needed adjustments. It never followed through, however, and the audit committee was either inattentive to the financial reporting implications or chose to look the other way. According to Litigation Release 17435, writing off the errors and changing the underlying accounting practices as prescribed in the agreement would have prevented the company from meeting earnings targets and defendants from enriching themselves. Defendants got performance-based Page 580bonuses based on the company’s inflated earnings, retained their high-paying jobs, and received stock options. Some also received enhanced retirement benefits based on the improper bonuses, and some received lucrative employment contracts. Dean Buntrock, the CEO and chair of the board; Philip Rooney, director, president, and chief operating officer (COO); and James Koenig, executive vice president and CFO, also avoided losses by cashing in their Waste Management stock while the fraud was ongoing. Just prior to the public disclosure of the accounting irregularities, Buntrock enriched himself by obtaining a tax benefit by donating inflated company stock to his college alma mater to fund a building in his name. Waste Management today is a leading international provider of waste management services, with 45,000 employees serving over 20 million residential, industrial, municipal, and commercial customers, and it earned about $15 billion of revenues in 2012. It was ranked number 203 in the 2012 Fortune 500 listing of the largest companies in the United States. Here is a brief description of how and why the company committed fraud. Dean Buntrock founded Waste Management in 1968 and took the company public in 1971. During the 1970s and 1980s, Buntrock built a vast waste disposal empire by acquiring and consolidating local waste hauling companies and landfill operators. At one point, the company was performing close to 200 acquisitions a year. It experienced tremendous growth in its first 20 years. From the IPO in 1971 until the end of 1991, Waste Management enjoyed 36 percent average annual growth in revenue and 36 percent annual growth in net income. The company grew from $16 million in revenue in 1971 to become the largest waste removal business in the world, with revenue of more than $7.5 billion in 1991. Despite being a leader in the industry, Waste Management was under increasing pressure from competitors and from changes in the environmental industry.

Its 1996 financial statements showed that, even though its consolidated revenue for the period from December 1994 to 1996 increased 8.3 percent, its net income declined during that period by 75.5 percent. The truth was that the income numbers had been manipulated to minimize the declines over time. The term ill-gotten gains refers to amounts received either dishonestly or illegally. Litigation Release 17345 identifies the following “ill-gotten gains” at Waste Management: Name Positions Amount Buntrock CEO and chair of the board $16,917,761 Rooney Director, president, and COO $ 9,286,124 Koenig Executive vice president and CFO $    951,005 Thomas Hau Vice president, controller, and CAO $    640,100 Herbert Getz Senior vice president, general counsel, and secretary $    472,500 Bruce Tobecksen Vice president of finance $    640,100 These ill-gotten gains were included in a lawsuit filed by the SEC on March 26, 2002, against the six former top officers of Waste Management, Inc., charging them with perpetrating a massive financial fraud lasting more than five years. The complaint, filed in U.S. District Court in Chicago, charged that defendants engaged in a systematic scheme to falsify and misrepresent Waste Management’s financial results between 1992 and 1997. According to the complaint, the defendants violated, and aided and abetted violations of, anti-fraud, reporting, and record-keeping provisions of the federal securities laws. The SEC successfully sought injunctions prohibiting future violations, disgorgement of defendants’ ill-gotten gains, civil money penalties, and officer and director bars against all defendants. The complaint first identified the roles played by top management. Buntrock set earnings targets, fostered a culture of fraudulent accounting, personally directed certain of the accounting changes to Page 581make the targeted earnings, and was the spokesperson who announced the company’s phony numbers. Rooney ensured that required write-offs were not recorded and, in some instances, overruled accounting decisions that would have a negative impact on operations. He reaped more than $9.2 million in ill-gotten gains from, among other things, performance-based bonuses, retirement benefits, and sales of company stock while the fraud was ongoing. Koenig was primarily responsible for executing the scheme. He also ordered the destruction of damaging evidence, misled the company’s audit committee and internal accountants, and withheld information from the outside auditors. He profited by more than $900,000 from his fraudulent acts. Hau was the principal technician for the fraudulent accounting. Among other things, he devised many one-off accounting manipulations to deliver the targeted earnings and carefully crafted the deceptive disclosures. The explanation of these manipulations is that to reduce expenses and inflate earnings artificially, management primarily used adjusting entries to conform the company’s actual results to the predetermined earnings targets. The inflated earnings of prior periods then became the floor for future manipulations. The consequences created what Hau referred to as the one-off problem. To sustain the scheme, earnings fraudulently achieved in one period had to be replaced in the next. Hau profited by more than $600,000 from his fraudulent acts. Tobecksen was enlisted in 1994 to handle Hau’s overflow. He profited by more than $400,000 from his fraudulent acts. Getz was the company’s general counsel. He blessed the company’s fraudulent disclosures and profited by more than $450,000 from his fraudulent acts. The defendants fraudulently manipulated the company’s revenues, because they were not growing enough to meet predetermined earnings targets, by manipulating current and future asset values, failing to write off asset impairments, using reserve accounting to mask operating expenses, implementing improper capitalization policies, and failing to establish reserves (liabilities) to pay for income taxes and other expenses. Overview of Accounting and Financial Reporting Fraud Improper Accounting Practices The accounting fraud involved a variety of practices, including improperly eliminating or deferring current-period expenses in order to inflate earnings. For example, the company avoided depreciation expenses by extending the estimated useful lives of its garbage trucks while at the same time making unsupported increases to the trucks’ salvage values. In other words, the more the trucks were used and the older they became, the more the defendants said they were worth. Other improper accounting practices included: Making unsupported changes in depreciation estimates. Failing to record expenses for decreases in the value of landfills as they were filled with waste.

Classification of accounting techniques described in the case that contributed to the fraud

Failing to record expenses necessary to write off the costs of impaired and abandoned landfill development projects. Improper capitalization of interest on landfill development. Establishing inflated environmental reserves (liabilities) in connection with acquisitions so that the excess reserves could be used to avoid recording unrelated environmental and other expenses. Netting one-time gains against operating expenses. Manipulating reserve account balances to inflate earnings. In February 1998, Waste Management announced that it was restating its financial statements for the five-year period 1992–1996 and the first three quarters of 1997.1 The company admitted that through.

This case focuses on improper accounting and management decision making at Waste Management, Inc., during the period of its accounting fraud from 1992 to 1997, and the role and responsibilities of Arthur Andersen LLP (Andersen), the Waste Management auditors, with respect to its audit of the company’s financial statements. The case illustrates the kinds of financial statement frauds that were common during the late 1990s and early 2000s. The key accounting issue was the existence of a series of Proposed Adjusting Journal Entries (PAJEs) recommended by Andersen to correct errors that understated expenses and overstated earnings in the company’s financial statements. These were not recorded even though the company had promised to do so. Andersen developed a “Summary of Action Steps” that was designed to change accounting in the future in order to comply with GAAP but did not require retroactive adjustments to correct past errors. In essence, it was an agreement to do something in the future that should have been done already, with no controls or insistence by Andersen that the proposed changes would in fact occur. According to SEC Litigation Release 17435: Management consistently refused to make the adjustments called for by the PAJEs. Instead, defendants secretly entered into an agreement with Andersen fraudulently to write off the accumulated errors over periods of up to ten years and to change the underlying accounting practices, but to do so only in future periods. The action steps were not followed by Waste Management. 

The company promised to look at its cost deferral, capitalization, and reserve policies and make needed adjustments. It never followed through, however, and the audit committee was either inattentive to the financial reporting implications or chose to look the other way. According to Litigation Release 17435, writing off the errors and changing the underlying accounting practices as prescribed in the agreement would have prevented the company from meeting earnings targets and defendants from enriching themselves. Defendants got performance-based Page 580bonuses based on the company’s inflated earnings, retained their high-paying jobs, and received stock options. Some also received enhanced retirement benefits based on the improper bonuses, and some received lucrative employment contracts. Dean Buntrock, the CEO and chair of the board; Philip Rooney, director, president, and chief operating officer (COO); and James Koenig, executive vice president and CFO, also avoided losses by cashing in their Waste Management stock while the fraud was ongoing. Just prior to the public disclosure of the accounting irregularities, Buntrock enriched himself by obtaining a tax benefit by donating inflated company stock to his college alma mater to fund a building in his name. 

Auditors' role in discovering fraud

Waste Management today is a leading international provider of waste management services, with 45,000 employees serving over 20 million residential, industrial, municipal, and commercial customers, and it earned about $15 billion of revenues in 2012. It was ranked number 203 in the 2012 Fortune 500 listing of the largest companies in the United States. Here is a brief description of how and why the company committed fraud. Dean Buntrock founded Waste Management in 1968 and took the company public in 1971. During the 1970s and 1980s, Buntrock built a vast waste disposal empire by acquiring and consolidating local waste hauling companies and landfill operators. At one point, the company was performing close to 200 acquisitions a year. It experienced tremendous growth in its first 20 years. From the IPO in 1971 until the end of 1991, Waste Management enjoyed 36 percent average annual growth in revenue and 36 percent annual growth in net income. The company grew from $16 million in revenue in 1971 to become the largest waste removal business in the world, with revenue of more than $7.5 billion in 1991. Despite being a leader in the industry, Waste Management was under increasing pressure from competitors and from changes in the environmental industry. 

Its 1996 financial statements showed that, even though its consolidated revenue for the period from December 1994 to 1996 increased 8.3 percent, its net income declined during that period by 75.5 percent. The truth was that the income numbers had been manipulated to minimize the declines over time. The term ill-gotten gains refers to amounts received either dishonestly or illegally. Litigation Release 17345 identifies the following “ill-gotten gains” at Waste Management: Name Positions Amount Buntrock CEO and chair of the board $16,917,761 Rooney Director, president, and COO $ 9,286,124 Koenig Executive vice president and CFO $    951,005 Thomas Hau Vice president, controller, and CAO $    640,100 Herbert Getz Senior vice president, general counsel, and secretary $    472,500 

Bruce Tobecksen Vice president of finance $    640,100 These ill-gotten gains were included in a lawsuit filed by the SEC on March 26, 2002, against the six former top officers of Waste Management, Inc., charging them with perpetrating a massive financial fraud lasting more than five years. The complaint, filed in U.S. District Court in Chicago, charged that defendants engaged in a systematic scheme to falsify and misrepresent Waste Management’s financial results between 1992 and 1997. According to the complaint, the defendants violated, and aided and abetted violations of, anti-fraud, reporting, and record-keeping provisions of the federal securities laws. The SEC successfully sought injunctions prohibiting future violations, disgorgement of defendants’ ill-gotten gains, civil money penalties, and officer and director bars against all defendants. The complaint first identified the roles played by top management. 

Case overview for Waste Management

Buntrock set earnings targets, fostered a culture of fraudulent accounting, personally directed certain of the accounting changes to Page 581make the targeted earnings, and was the spokesperson who announced the company’s phony numbers. Rooney ensured that required write-offs were not recorded and, in some instances, overruled accounting decisions that would have a negative impact on operations. He reaped more than $9.2 million in ill-gotten gains from, among other things, performance-based bonuses, retirement benefits, and sales of company stock while the fraud was ongoing. Koenig was primarily responsible for executing the scheme. He also ordered the destruction of damaging evidence, misled the company’s audit committee and internal accountants, and withheld information from the outside auditors. He profited by more than $900,000 from his fraudulent acts. Hau was the principal technician for the fraudulent accounting. Among other things, he devised many one-off accounting manipulations to deliver the targeted earnings and carefully crafted the deceptive disclosures. The explanation of these manipulations is that to reduce expenses and inflate earnings artificially, management primarily used adjusting entries to conform the company’s actual results to the predetermined earnings targets. The inflated earnings of prior periods then became the floor for future manipulations. The consequences created what Hau referred to as the one-off problem. 

To sustain the scheme, earnings fraudulently achieved in one period had to be replaced in the next. Hau profited by more than $600,000 from his fraudulent acts. Tobecksen was enlisted in 1994 to handle Hau’s overflow. He profited by more than $400,000 from his fraudulent acts. Getz was the company’s general counsel. He blessed the company’s fraudulent disclosures and profited by more than $450,000 from his fraudulent acts. The defendants fraudulently manipulated the company’s revenues, because they were not growing enough to meet predetermined earnings targets, by manipulating current and future asset values, failing to write off asset impairments, using reserve accounting to mask operating expenses, implementing improper capitalization policies, and failing to establish reserves (liabilities) to pay for income taxes and other expenses. 

Accounting and Financial Reporting Fraud Improper Accounting Practices The accounting fraud involved a variety of practices, including improperly eliminating or deferring current-period expenses in order to inflate earnings. For example, the company avoided depreciation expenses by extending the estimated useful lives of its garbage trucks while at the same time making unsupported increases to the trucks’ salvage values. In other words, the more the trucks were used and the older they became, the more the defendants said they were worth. 

Other improper accounting practices included: Making unsupported changes in depreciation estimates. Failing to record expenses for decreases in the value of landfills as they were filled with waste. Failing to record expenses necessary to write off the costs of impaired and abandoned landfill development projects. Improper capitalization of interest on landfill development. Establishing inflated environmental reserves (liabilities) in connection with acquisitions so that the excess reserves could be used to avoid recording unrelated environmental and other expenses. Netting one-time gains against operating expenses. 

Manipulating reserve account balances to inflate earnings. In February 1998, Waste Management announced that it was restating its financial statements for the five-year period 1992–1996 and the first three quarters of 1997.1 The company admitted that through 1996 it had materially overstated its reported pretax earnings by $1.43 billion and that it had understated certain elements of its tax expense by $178 million, as reported in Accounting and Auditing Enforcement Release (AAER) 1405: Vehicle, equipment, and container depreciation expense $ 509 Capitalized interest 192 Environmental and closure/postclosure liabilities 173 Purchase accounting related to remediation reserves 128 Asset impairment losses 214 Software impairment reversal (85) 

Other 301 Pretax total $1,432 Income tax expense restatement $ 178 Andersen audited and issued an unqualified (i.e., unmodified) report on each of Waste Management’s original financial statements and on the financial statements in the restatement. In so doing, Andersen acknowledged that the company’s original financial statements for the periods 1992 through 1996 were materially misstated and that its prior unqualified reports on those financial statements should not be relied upon.