Article in the Wall Street Journal on 12-7-11 gives more background on the methodology of the Olympus fraud: Panel Calls Olympus ‘Rotten’ at Core. (article behind paywall)
I made a few updates on my part 2 post. Have a few more comments in this post – things that are interesting to me.
Hiding losses was legal and normal
Apparently, moving underwater investments off the books was so common in Japan that it had a nickname, tobashi. (Update 2) From the WSJ article, Senior leaders:
…devised a plan to transfer the bad assets off Olympus’s books to firms that weren’t officially connected with the company and so wouldn’t appear in Olympus’s accounts, the report said. The intention was to unwind those transactions gradually, allowing Olympus to take the losses secretly, over time. This type of operation had been employed by so many Japanese companies in the 1990s that it was widely known in Japanese as tobashi, meaning, to send something flying away.
KPMG did tumble to one of the tobashi schemes carried out through one of the three different routes that had been set up. I’m not sure if this is the only scheme through that particular bank or not.
Not everything was going smoothly. The report said that in 1999, Olympus’s then-auditor, KPMG AZSA LLC, came across information that indicated the company was engaged in tobashi, which recently had become illegal in Japan. Messrs. Mori and Yamada initially denied KPMG’s assertion, but the auditor pushed them that same year to admit to the presence of one fund and unwind it, booking a loss of ¥16.8 billion. The executives assured KPMG that was the only such deal, the report said.
Notice that tobashi was finally made illegal sometime before the 1999 audit? That means it was an acceptable approach previously.
Warning, rhetorical questions and opinion alert… Hmm. How do you audit in an economy where intentionally hiding losses is legal? How do you function in a business environment where that is acceptable and normative? Does that mean it wasn’t a real fraud prior to 1999?
Notice how the auditor did find one part of the scheme and management denied it existed? Then after agreeing to write it off, senior management lied and said it was the only one?
Update 2 – On the other hand, the scheme grew for another 6 years, through the 2005 fiscal year, and wasn’t completely unwound until the end of fiscal 2010. The growth and continuance of the scheme went undetected until it blew up late in 2011. (End editorial.)
When did the scheme finally get unwound?
The last part of the bad investments were finally written off in March 2010, according to the WSJ article. That month, by the way, would have been the last month of the fiscal year audited by a new firm:
Messrs. Mori and Yamada decided to unwind and write off the whole thing, using three small Japanese companies: …. Olympus bought the trio in 2008 for the highly inflated price of ¥73.2 billion and wrote the bulk of that amount off the next year, an arrangement that allowed it to repay the loans it had borrowed from LGT and close down the European route in 2008, the report said.
Note: LGT is one of the three banks used to hide the money flow. See part 2.
That left only the funds in the Singapore route still operating, the report said. Olympus internal documents said Messrs. Mori and Yamada wrote off those losses using $687 million in fees attached to Olympus’s acquisition of U.K. medical-technology firm Gyrus Group PLC as cover. The last bit of that deal was completed in March 2010. Those fees were paid to the company run by Mr. Sagawa, one of the brokers who first proposed the loss-covering operation to Olympus 12 years earlier.
Note: there were three different ‘routes’ set up to get the bad investments off the books.
When did this mess get started?
A bit more detail. The WSJ article points out the fiasco started back in about 1985 with management pushing aggressive investments that didn’t work out too well. Exchange rates started generating losses on those investments in the late 80s. Thus the fraud was running from about 1985 through 2010, when it was all written off. Fraud blew up this year, October 2011.
That is why you will see comments that this fraud was running for 20 years. That is also why today’s WSJ article leads with:
The secret held for a quarter-century, quietly passed among senior executives.
deletions from first edition identified by strikethrough. (Update 1 noted with bold intro) (update 2 on 12-19-11 noted with italic comments)