Term Paper

Waste Management Scandal, 1998

Submitted by:

GROUP -G

• Md. Abu Bakar Siddik– 2021321008

• Abdullah Al Mamun – 2021321016
• Al Mamun Juwel – 2021321022
MBA in AIS Department of Business Administration in Accounting & Information Systems
Bangladesh University of Professionals

Submitted to:
Md. Mahedi Hasan,

FCA Adjunct Faculty Department of Business Administration in Accounting & Information

Systems Bangladesh University of Professionals
 Waste Management Scandal, 1998

Background :

Between the years 1992-1998, Waste Management were found to have undergone one of the
most remarkable accounting fraud situations of all time. The U.S SEC (2002) explains how the
founder, Buntrock, and five other senior members of the company manipulated the financial
position of the company in order to meet the predetermined targets they had been set at the
beginning of the financial year. The senior officers began to perpetrate the fraud using improper
accounting practices, not acceptable to the Generally Acceptable Accounting Principles (GAAP).
‘Defendants cooked the books, enriched themselves, preserved their jobs, and duped
unsuspecting shareholders’ (U.S SEC, 2002) in order to meet their own financial earnings
targets.

The fraud case was intensified when the company’s long term auditors, Arthur Andersen, along
with three other partners, began to audit the year end statements. Upon inspection, ‘Andersen
fully understood the extent of the accounting misrepresentations and repeatedly tried to press
Waste Management executives to change their practices or correct errors, with little success’
(Eichenwald, 2002). Andersen attempted to use Proposed Adjusting Journal Entries (PAJE’s),
which Waste Management were expected to use to correct their errors, however, management
refused (U.S SEC, 2002). Instead, Andersen became further involved with the fraudulent case
when the two companies came to an agreement, which involved the write off of a build-up of
errors over a 10-year period.

The fraud case unravelled in 1997 when Waste Management appointed a new CEO, who initially
began to review Waste Management’s financial statements and ordered a restatement of the past
5 year’s financial statements ‘When the company filed its restated financial statements in
February 1998, the company acknowledged that it had misstated its pre-tax earnings by
approximately $1.7 billion. At the time, the restatement was the largest in corporate history’ (U.S
SEC, 2002).

As a result of the fraud, Waste Management ‘agreed to pay $26.8 million to settle a lawsuit
brought by the Securities and Exchange Commission against (the) four former top executives’
(Schneirder, 2005), while they also lost massive amounts on their market value. As for Arthur
Andersen, they were made to pay shareholders $220 million as well as $7 million to the U.S
SEC.
Accounting Misstatement

The accounting team at Waste Management Inc. used five key methods to manipulate their
financial records in order to disclose inflated profits. These are explored below:

1) Extension of Asset Useful Life & Overstating Asset Salvage Values:

This practice began in 1992 whereby a policy change was implemented. Front-end loading trucks
were due to be depreciated over eight years whilst rear-end loading trucks over ten.
Salvage/residual values assigned to these were $7,500 and $15,000 respectively. In 1992, the
useful life of the trucks was extended to ten and twelve years for front-end loaders and rear-end
loaders and the residual values doubled leading to savings on the depreciation charge year on
year. Provided that the reasoning behind the extension of useful life and increase in residual
value was sufficient, Waste Management would have complied with GAAP. However, “Koenig
instructed a purchasing agent to create a memorandum stating that the new salvage value was
justified” (Nevin, Rao and Martin Jr., 2014) and there was no substantial evidence to support the
claim. Koenig also applied the effects of the change in depreciation policy in the same
accounting year, which was not permitted under GAAP as it reduced the operating expenses for
the year by a material amount (Nevin, Rao and Martin Jr., 2014).

Following these events, Koenig and his team continued to extend asset useful lives and increase
the salvage values of assets, such as dumpsters, to further reduce the depreciation charges for the
year. They did this, without sufficient evidence to justify the changes and posted manual journal
adjustments at year-end resulting in understated expenses and inflated profits (Nevin, Rao, and
Martin Jr., 2014).
2) Incorrect Capitalization of Periodic Expenditure:

An expense is rightly capitalized when it is expected to bring about future economic benefits, by
either a) improving an existing asset or b) is a new asset. Capitalization allows the expense to be
spread across the useful economic life of an asset, thereby realising the expense in which it truly
relates to, in accordance with the accruals concept, instead of the period of occurrence (Smith,
2010).

Koenig and his senior finance team, took advantage of ‘capitalization’ as a method of spreading
any cost across a number of years and therefore were incorrectly capitalizing interest costs and
other periodic expenses that should have been realised in the accounting period in which they
were incurred (Nevin, Rao and Martin Jr., 2014).

The senior position Koenig was in, as the CFO, placed him in a unique position to override any
controls over the capitalization of expenses. It is likely that in the case of Waste Management
Inc. that a CAPEX form would have been filled in and approved prior to allowing an expense to
be capitalized, however this can be completed by relatively junior members of the team, but the
authorisation would be from senior management. Hence Koenig was capable of approving
periodic expenses for capitalization without detection by the control process in place.

3) Reversal of Reserves into Revenue:

In the years of 1994 and 1995, Waste Management Inc. reversed out funds from their reserves
and re-classed this as income, an example of the ‘creative’ accounting used to inflate revenues.

In 1994, as a result of a win in a litigation settlement where Waste Management Inc. received
$50mil (Nevin, Rao and Martin Jr., 2014), intentionally treated incorrectly. The correct
procedure would be as follows:

DR Bank $50mil, CR Litigation Settlement Reserve $50mil

The accountants did the following in order to inflate revenues, and reduce operating expenses:

DR Bank $25mil ,CR Income $25mil

The remaining $25mil was netted, and this process is explained in the ‘Netting and Geography’
section.

In 1995, Koenig also orchestrated the direct reversal of the reserves to income to the sum of
$17mil (Nevin, Rao and Martin Jr., 2014)

4) Write Off of Impaired Assets:

As the waste land used by the company was filled, the value of the asset was reduced and would
have to be written off as an expense (U.S SEC, 2002). This was completely ignored by the
finance team and this expense never realised.

In addition to this, in 1995, a landfill expansion proposal was rejected and as a result meant that
the landfill would have to be impaired. Knowing this would reduce the asset value and increase
the expense incurred for the year, management ignored the write-off and disclosure entirely
(Nevin, Rao and Martin Jr., 2014).

5) Netting and Geography:

Management within the company also have been accused of using the method of ‘netting’ to
reduce the operating expenses figure (Sec.gov, 2002). This is done by offsetting expenses
relating to the current period against one-off transactions, as above in the case of $25mil in the
litigation settlement.

The U.S SEC charged Waste Management Inc. with using ‘geography entries’ which results in
the movement of balances between different line items within the income statement in particular
(U.S SEC, 2002) to deliberately mislead users of the financial statements.
Who Was Involved?

Essentially, there were two groups involved in the fraudulent reporting of Waste Management:

Auditors Role:

According to the U.S Securities and Exchange Commission, ‘Defendants (Waste Management)
were allegedly aided in their fraud by the company’s long-time auditor, Arthur Andersen LLP’
(U.S SEC, 2002). As an auditor, it was Arthur Andersen’s responsibility to produce reliable audit
reports based on the financial statements provided by Waste Management. It is said that ‘six
Andersen partners were involved, at various times during the relevant period, in the issuance of
unqualified audit reports on Waste Management's annual financial statements’ (U.S SEC, 2001).

Andersen was listed in the case as knowingly assisting fraudulent behaviour and producing
unqualified auditing reports which led to misleading financial statements. This resulted in a lot of
investors and potential investors being misled.

Professional scepticism within the audit field would have meant Arthur Anderson identified that
the audit risks involved the overstatement of assets and revenue, whilst the understatement of
expenses and liabilities. Upon completing the 1992 audit, did propose adjusting journal entries
which management did not accept. An agreement with management was reached that these
corrections would be made over a period of 10 years, hence Arthur Anderson signed the first
year unqualified audit opinion. In 1993, the auditors once again identified that management
continued their malpractice and had not embarked on correcting the prior year journals. Despite
this, Arthur Anderson provided an unqualified audit opinion and began their involvement in the
fraud (Nevin, Rao and Martin Jr., 2014).

Schroeder (2001) explains how Arthur Andersen saw Waste Management as a ‘crown jewel’ to
their business and had audited them for an extensive number of years. This begins to explain the
possible reasons as to why they were so willing to fraudulently bend the rules for Waste
Management. To add to this explanation, ‘until 1997, every chief financial officer and chief
accounting officer in the public company’s history had been employed at Arthur Andersen'
(Schroeder, 2001), again, adding to the reasons behind the assistance of such extensive
fraudulent activity. Furthermore, the U.S SEC (2002) reported that in the initial stages of the
fraud, Waste Management capped the fees they would pay to the auditors.

The restrictions on audit firms providing non-audit services were limited over this time period,
and the incentive to generate additional revenue, Arthur Anderson engaged in ‘special work’ for
Waste Management, causing a self-review and self-interest threat. Due to these reasons, the
closeness of employees and hire regard of Waste Management to Arthur Andersen, it can be said
that the audit firm were no longer independent.

The Management:

Senior management within the firm were involved in the fraudulent activity. This included:

Dean Buntrock – Chairman of the Board, Chief Executive Officer and Founder

James Koenig – Executive Vice President and Chief Financial Officer

Thomas Hau – Vice President, Corporate Controller and Chief Accounting Officer

The ethics of each of these individuals can be questioned, and the working culture of the firm can
be criticised for promoting fraudulent activity from the very top. Ethical standards were ignored,
in order for seniors to benefit from their ‘ill-gotten gains’ (SEC, 2002).

Management acted in their own personal interests instead of aiming to increase shareholder
wealth, a fundamental issue in business explained by agency theory. The directors of the firm
failed in completing their fiduciary duty of reporting true and fair financial results. An
accountant is placed in a unique position, to be able to intentionally not follow accounting
standards should it mean that by doing so, a companies’ financial position is not reflected truly
and fairly. The finance team at Waste Management Inc. intentionally did not act in accordance
with the accounting standards to manipulate the position portrayed through their financial
statements, an unethical and fraudulent act with very simple accounting malpractices.

The Fraud Triangle is a 'psychological model developed to explain why people commit fraud'
(Dellaportas, 2013). The model was initially developed by Donald Cressey in 1971, who argued
that problems and pressures motivate fraud. The model was later developed further to
incorporate opportunity and rationalisation as further motivators of fraud.
Governance Failure

Situational Pressures:

The management team were required to meet high earnings targets set for the firm. This would
provide increasingly challenging in the market conditions and U.S SEC staff claimed the
fraudulent behaviour of Waste Management Inc. was caused by the top officers’ increasing greed
and pressure to retain their lost corporate positions and status in the business and public. This
motivated the fraudulent activity in the first year, however the pressure of covering up this fraud
led to further questionable practices continuing in subsequent years (U.S SEC, 2002).

Available opportunities:

The involvement of senior individuals in this case of fraud allowed the overriding of controls
that would be in place to ensure junior management complied with company policy. An example
of this was mentioned above, whereby Koenig, the Chief Financial Officer, was able to override
the controls in place for the capitalization of expenses process.

A regulatory requirement for the company was the completion of an external audit. This was a
form of external control to ensure the financial statements were not materially misstated. As
explained in the ‘Who Was Involved?’ section, the auditors were willing to provide an
unqualified audit opinion despite misstatements as it benefited their own interests. Therefore this
external control was no longer an issue and the fraudulent financial statements were able to be
published (Nevin, Rao and Martin Jr., 2014).

Rationalization and Personal Characteristics

The management and auditors, together, did not comply with ethical guidance. The primary
motivation of the individuals was greed. Their quest for individual financial gain resulted in
them willing to commit fraudulent activity. Across the five years of financial manipulation, the
six members of management cumulatively earned themselves in the region of US$28mil. In
addition to this, Buntrock and Rooney, the CEO and COO respectively, were also able to benefit
through the share options they received. The increase in profit, year on year, whilst the fraud was
committed drove the share price of the company up and allowed senior management to benefit
from this (U.S SEC, 2002).
This white collar crime committed by Waste Management, with assistance from Arthur
Anderson led to the largest re-statement of financials in history. Management and the auditors
should be criticized for their lack of a moral compass and for not fulfilling their responsibility as
accountants due to their greed. Managements’ attitude was disgraceful and due to their
selfishness they lost shareholders US$6bn (U.S SEC, 2002).
The Effect of the Fraud

The fraud at Waste Management was intended to cause rising stock prices.  The stock rose from
$17.11 at the beginning of 1992 to a peak of over $55 in August, 1998.  The stock then waivered
for about a year before collapsing in July, 1999.  Table 1 depicts the rapid rise and collapse of
the stock from 1992 through 1999

Table 1

Waste Management Stock Prices – 1992 through 1999

While these executives profited from the stock price increase, investors lost $6 billion.The rapid
increase in the stock price created great wealth for the corporate executives, who owned
substantial amounts of stock and stock options.  The SEC determined that Buntrock was the
mastermind behind the fraud and reaped the most in ill-gotten gains.  He was assisted by a
number of Waste Management executives who benefited significantly from the fraud but to a
lesser degree compared to Buntrock.  Table 2 shows the estimated profits that each of the
perpetrators gained from the fraud in descending order of magnitude.
 Table 2 – Fraudulent Executive Profits

Executive Estimated Gains from the Fraud

Dean L. Buntrock Over $16.9 million

Phillip B. Rooney Over $9.2 million

James E. Koenig Over $900,000

Thomas C. Hau Over $600,000

Herbert Getz Over $450,000

Bruce D. Tobecksen Over $400,000

The Securities and Exchange Commission files suit against Waste Management on March 26,
2002.  They alleged that the company inflated profits by 1.7 billion dollars while making
millions of dollars for the top executives and defrauding investors out of 6 billion dollars.

Thomas C. Newkirk, associate director of the SEC’s Division of Enforcement, stated in the SEC
press release that the Waste Management fraud was “one of the most egregious accounting
frauds we have ever seen.  For years, these defendants cooked the books, enriched themselves,
preserved their jobs, and duped unsuspecting shareholders.  The defendants’ fraudulent conduct
was driven by greed and a desire to retain their corporate positions and status in the business and
social communities.  Our goal is to take the profit out of securities fraud and to prevent fraudsters
from serving as officers or directors of public companies.
Recommendation
The Waste Management Incorporated scandal was one of largest of fraud scandals of its time.
Looking back at the crimes that occurred it certainly raises the question regarding what
precautions can be taken to stop corporate fraud from occurring in the future. Some may make
the argument that fraud cannot be avoided but rather be minimalised at best. “Others argue that
outside directors and audit committees, are largely perfunctory and have little or no effect on
corporate governance” (Gerety and Lehn, 1997. p.595). The notion that fraud is not completely
avoidable can be explained by the human condition. Management are responsible for a
company’s profitability and can often be subject to large amounts of pressure as they are
expected to meet shareholder’s expectations. This idea at its most basic level can be used to
explain why corporate fraud will always exist to some extent.

On the contrary, fraud in many cases is prevented through employees tipping off regulatory
bodies. Perhaps Waste Management Incorporated’s employees who may have known that the
fraud was occurring, in hindsight, should have felt more confident about coming forward and
reporting it to the appropriate authorities. The crimes could have been halted in its early years,
thus capping the damage inflicted by the fraud. The ACFE’s 2010 Report to the Nations “found
that occupational frauds are more likely to be detected through an employee tip than through
internal audits or internal control” (Biegelman and Bartlow, 2006. p.26). These findings suggest
that firms should invest more resources and attention to confidential reporting mechanisms. The
Sarbanes-Oxley requirement enforces corporate firms to have these in place for this very reason.
Providing a better system for employees to report corporate fraud could potentially save the
government large amounts of money as it would be cheaper than focusing efforts in searching
firms, somewhat aimlessly, for fraud that may or may not be taking place. This was implemented
when the new management took over at Waste Management Inc.

Transparency can be a very effective tool in preventing corporate fraud. Directors have the
responsibility to monitor and oversee the actions of managers, including the managers’
production of accounting results. “Boards of directors are classified (sometimes referred to as
staggered) if in any year only a subset of directors’ stand for election or re-election. Usually with
classified boards, one third of directors stand for election or re-election to a three-year term every
year. Consequently, classified boards improve quick transfers of control, and are frequently
viewed as anti-takeover devices” (Getery and Lehn, 1997. p.595). A classified board may have
been a useful device in deterring the individuals from committing the fraudulent crimes.
Buntrock, who is the founder as well as the chairman of the boards of directors at the time of the
crime, may have not have had the ability to carry out the fraud if the board of directors was
classified. Years of unquestioned authority and power within the firm meant he could carry out
the scheme. The dynamic change of control provided through a classified board would have
dissolved his control to a lesser extent, thus stopping him from being able to alter the accounting
figures unprovoked.
The Present Scenario of Waste Management
When we discuss a past event, the most important part of it is of the relevance, the
present scenario and how the context is related to the present status. Therefore, it is
imperative to discuss the effect of this massive fraud. When the scam became public
and the news of the restatement broke out in the year 1998, there was a huge fall in
the price of shares of the company. The overstatement by the company was to the
tunes of $1.7 billion, the largest in the history till its time. The shareholders lost
approximately $6 billion due to the reduction in the worth of the shares held by them
to the tune of 33 per cent at that time. Waste Management was soon acquired by USA
Waste Services Inc. in 1998 itself. The shareholders filed a class action against the
company and its top officers for their loss which succeeded. The company was made
liable to pay $457 million to them collectively. The auditing firm Arthur Anderson
was fined to the tune of $7 million for their collusion or grave negligence. The firm
paid the fine but never accepted the charges made against it. It neither contested them.
Therefore, the exact role of Arthur Andersen still stays in suspicion. Apart from the
company, a separate suit was filed against the six top officials of the company who
were involved in all the defrauding and ensured the manipulations all the while. A
civil case was made out against them in the year 2005. While they were fined with $31
million, they were additionally barred from serving any public company as an officer
or director. These were the major impacts of the massive fraud which shook the walls
of the American economy.

On being found guilty, the company was seriously reprimanded and the officers in
charge of the fraud were suspended, but the company was allowed to continue
functioning. It is not easy to regain the trust of market and customers after such a
massive blot, but Waste Management has been lucky to recover as it continues its
business activities of collection, disposal and recycling of wastes. The huge financial
penalties snapped by the court and the fallen price of the shares of the company made
it difficult for the company to re-establish itself but today, the company is again the
largest solid waste provider in North America, the largest recycler of the state and
provides the largest integrated environment solutions in the country. It owns more
assets than ever before, employs more than 50,000 people and has a customer base of
more than 20 million currently. This shows how past failures cannot hamper one’s
future if there is enough zeal to achieve one’s goals as in the case of Waste
Management Inc. It did not allow itself to submerge because of the wrongdoings of
certain officials; rather, it stood up from ashes and made a destiny for itself.
References

 The Case Of Fraud – Accounting Scandal Of Waste Management Inc

 https://sites.google.com/site/contgov5/company-overview
 Waste Management Founder, Five Other Former Top Officers Sued For Massive Fraud
 https://www.sec.gov/news/headlines/wastemgmt6.htm
 The Waste Management, Inc. 1998 Fraud Scandal
 https://enscpa.com/waste-management-inc-1998-fraud-scandal/
 The Accounting Scandal Of Waste Management Inc
 https://prezi.com/jv950jedowqf/the-accounting-scandal-of-waste-management-inc/
 Waste Management Scandal
 Ava Prosser – https://prezi.com/kxxafw2pw–/waste-management-scandal/
 Accounting Scandal- Waste Management Inc
 https://www.slideshare.net/SaurabhMaloo3/accounting-scandal-waste-management-inc