Waste Management Scandal, 1998

As the title suggests, this article deals with the scam committed by Waste Management Inc. The Court found six officials of the company to be perpetrating this scandal. The reason behind this scam was said to be the stagnancy in the profit. Arthur Andersen, the auditor for the company, was also found guilty for their collusion in the fraud. The aftermath of this scam is unique which is lucidly explained by the author
Estimated Reading Time: 13 minutes

Introduction

Waste Management Inc. is a waste company founded in the year 1968 by Larry Beck in the USA. Various frauds were discovered in the company in the year 1998 which were happening since 1992. The various Board members and officers of the company were found to be manipulating the company’s accounting books. To avoid the depreciation expenses, inflated salvage value was assigned to the garbage trucks used by the company. The law mandates filing of depreciation value of the assets of the company in the financial statements of the company as the value of the assets do not remain the same with its usage. The expense related to landfills was also stated to be lesser than it actually was, to help the company decrease its total expenses in the year which would proportionately add to the profit of the company. They even added salvage value to assets which didn’t have any, in the first place. All these fraudulent changes in the account books allowed the company to eliminate at least $500 million as operating expenses. The company had gained false profits into retail earnings, false assets yet no increase in the liability as per the financial statement. There can be no reason for a corporate scandal, so to say, but this one can be seen as an attempt to meet the targets set for oneself. When the revenues did not increase as per the expectations, the officers recognised this and started to manipulate the account books to show what they wanted the world to see from its account books, thereby committed the frauds.

Waste Management Inc.

Waste Management, Inc. is American waste management, comprehensive waste and environmental services company in North America. The company was officially founded in the year 1968 and its headquarters was then located in Chicago. The US Congress passed a law making strict regulations for the disposal of waste in the year 1965. This paved a path for private service for garbage collection and waste management wherefore many companies ventured into this field, ‘Waste Management’ being one of them. The company is divided into four geographic groups- the Midwest, the Western, the Eastern and the Southern. The company’s main services are related to management and reduction of waste, collection, transfer, recycling and disposal services, recovering resources and creation of clean and renewable energy and removal of Methane gas from landfilled facilities used in electrical generation. However, the first establishment of the company can be traced back to the year 1893 when a Dutch immigrant named Harm Huizenga started collecting garbage for $1.25 per wagon. With the rise in population, the business grew but there was no formal organisation at the place. Therefore, in the year 1968, Wayne Huizenga, Dean Buntrock and Larry Beck founded the company and named it Waste Management, Inc. The company aggressively took over various small companies involved in the business of garbage collection throughout the States. The company was shown and promoted to be the original company of Harm Huizenga. As it became a leading company in its business, it soon went public in the year 1971. As per the records of the company, it made 133 acquisitions in one year with revenue of $82 million. It held 600,000 residential customers and approximately 60,000 companies and industries as their service takers. It was spread over 19 states of America, being one of the leaders of the business. The annual revenue of the company was $5 million in the year 1971 which rose to $17 million in just one year.  By 1980s, the annual revenue of the company was ranging up to $800 million. It owned almost 5,000 vehicles for collection of garbage and was employing 12,000 workers across the globe. In the year 1993, major changes were made in the organisation including the change in its name to WMX Technologies, with an annual revenue crossing $10 billion. In the year 1998, WMX was acquired by USA Waste Services Inc., Texas for approximately $19 billion and renamed the company as Waste Management Inc. and its headquarters were then moved to Houston, Texas.

The Scandal

Accounting frauds or corporate accounting scandals are business and political scandals in large public corporations when the misdeeds of the top officials of the company are disclosed. It includes a complex process, sometimes with the assistance of other companies or even government departments. If any fraud is found out or apprehended in a public company, it becomes the responsibility of the government to investigate and punish the perpetrators. The current massive fraud lasted for a period of five years. Six officials of the company were found to be perpetrating this scandal. The reason behind this scam was said to be the stagnancy in the profit. The company was not able to meet the targets set by it for a said period in advance, so the officials namely Dean L. Buntrock, Philip B. Rooney, James E. Koenig and Thomas C. Hau decided to falsify the accounts and financial statements of the company to cover up for the stagnancy to make profits out of these manipulated numbers. The company did the following things in the perusal of their fraud-

  1. It avoided the depreciated expenses on the garbage trucks by inflating the salvage value by which they logically extended the useful lives of those trucks, thereby making profits out of this technical snag.
  2. Salvage values were assigned to such assets also which did not have any resale value. Salvage value is the worth of an asset after its depreciation. Doing this allowed the company to show falsified addition in the asset count of the company.
  3. While putting the annual expenses in the financial statement of the company, expenses incurred by decrease in value of landfills and the cost of unsuccessful landfill development projects was not added, thereby reducing the overall annual expenditure of the company proportionately adding to the annual profits.
  4. The reserves were manipulated in a manner so as to allow avoiding of unrelated operating expenditure.
  5. Multiple assets of the company were improperly capitalised to add to the profits of the company.
  6. It failed to establish enough reserves or liabilities which suffice for income tax and other expenses.
  7. The company even established more environmental reserves in its documents than it actually held in order to avoid recording unrelated operating expenses.

Therefore, the company and its top officials were sharp in their actions to not let any regulatory authority find out about it while swiftly manipulating the records of the company on multiple levels. This exceptional connivance is what allowed the company to continue this for years at a stretch. 

Role of Auditors

In America, all public companies need to register themselves with the U.S. Securities and Exchange Commission (hereinafter referred as “SEC”) and must give an annual report of the company’s finances. The companies whose securities and shares are traded in stock markets in the US are compelled to get annual audits done by an independent firm designated for this purpose. The auditor of Waste Management Inc. at that time was Arthur Andersen LLP, majorly, and Robert Kutsenda, the regional audit director. Arthur Andersen was one of the biggest accounting firms of its time and had a big name. Generally, the firm auditing the company has not snapped a liability in case a fraud is ruled out in the company. However, this case stood as an exception and set a precedent as well. The SEC Enforcement Chief Richard Walker called out the important role played by the auditors as gatekeepers of the capital market thereby it becomes imperative that they must be levied with the responsibility when a company succeeds in defrauding the market. As a punitive measure, the auditors were barred from doing any accounting work for public companies for five years. The SEC alleged that the auditors were involved in professional misconduct during the time of the misconduct. The firm was given an option of settlement, without going for proceedings. Arthur Anderson was asked to pay $220 million as the penalty for their questionable accounting of Waste Management for years. As evidence, SEC presented the documents showing how Arthur Andersen and Waste Management Inc. have been close aides which maligns the necessary condition that the auditor shall be independent and free from any interest in the company. Arthur Andersen provided non-auditing services to Waste Management Inc. as well, such as consultancy service. The yearly financial report of Waste Management Inc. shows that it paid additional fees to Arthur Andersen for ‘special work’ which were split into two heads, firstly, the amount of $7.5 million for their accounting services and another $17.8 million for non-audit consultancy fee. Arthur Anderson also prepared Proposed Adjusting Journal Entries ( hereinafter referred as “PAJEs”) for the apparent misstatements, to correct the improper accounting practices. It was alleged that Arthur Andersen found about the malpractices of Waste Management and even asked it to mend its ways. However, it did approve the financial statements of Waste Management Inc. thereby joining hands in the fraud. In this matter, the auditor was also questioned and liability was slapped on them as well. When this same auditing firm was later found to be involved in the Enron scam as well, it was severely reprimanded and its license to audit public companies were permanently seized. 

The Case

The SEC took the charge of the investigation in the alleged scam. The SEC filed a suit against the six top officials of the company for their involvement and active contribution to the financial manipulations amounting to fraud in their company Waste Management Inc. The complaint was filed against Dean L Buntrock, Founder, Chairman of Board of Directors and CEO, Phillip B Rooney, President, Director and COO of the company, James E Koeing, Executive Vice President and CFO, Thomas C Hau, Vice President, Corporate Controller and CAO, Herbert Getz,Senior Vice President, General Counsel and Secretary and Bruce D Tobecksen, Vice President of Finance. The complaint was filed in the District Court of Chicago for the involvement of the said persons in the fraud by falsifying and misrepresenting the financial statements of Waste Management Inc. for a period of five years from 1992 to 1997.  The SEC alleged that the defendants manipulated the accounts, made profits out of it, and secured their positions in the company all at the cost of the poor shareholders who never suspected their intentions. The SEC prayed to the court that there have been violations of antifraud, reporting and record-keeping provisions of the Federal law. Further, an injunction should be granted to prevent any further violation. The officials should be disgorged of their undue profits and penalty should be issued against them. Additionally, the SEC prayed that they are barred from holding any office in any company as a punishment for their misconduct. The complaint even stated that the defendants took active steps to conceal their wrongdoings thereby amounting to obstruction of justice.

When a fraud of this enormity is ruled out, it is apparent that the auditor of the company had colluded with the company for it is impossible to not find out about such irregularities when the duration of the fraud is as long as half a decade, like in the present case. Arthur Anderson LLP, the auditor issued the audit report of Waste Management Inc. year after year and could never rule out any irregularity. The SEC alleged that Arthur Anderson had knowledge of the fraud and entered into an agreement to provide help in clearing the documents. It provided the company with PAJEs to rectify overstated profits and understated losses in the annual statements. This scheme was eventually eliminated in the year 1997 when the new CEO of the company found out about the irregularities and ordered a review of the company’s accounts. After the company’s restatement, it was acknowledged by Waste Management that the company had misstated its statements for the period of 1992 to 1997 the cost of which amounted up to $1.7 billion. In all this, the shareholders approximately lost $6 billion as the stock price of the company fell by 1/3rd when the news of this fraud became public.

The judgment of U.S. District Court for Northern District of Illinois pronounced on August 29, 2005, was the final judgment in this case. Here, the court permanently barred the said six defendants from serving as an officer or director in any company and penalised them to jointly pay $30,869,054, out of which $16.4 million was levied in the interest of disgorgement, $10.4 million for prejudgment interest and $4 million in civil penalty. The judgment also enjoined them from violating, or aiding and abetting violations of any federal law, mainly the Securities Exchange Act, 1934.

Also Read, HealthSouth Scam : Reason, Investigation and aftermath

Aftermath

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.

Conclusion

A corporate scam of this level, that too in a country like America, which is known for its very stringent laws is a shame on our morals and a never undying greed for money. Even with all the laws coming up in this regard, we will not be able to curb these incidents because of the lack of activism in the judicial mechanism, the omnipresent loopholes and the power of money. Nonetheless, this case is an example of how the wrong will not prevail at the end irrespective of how foolproof it was. The fate company’s collapse not only affected thousands of its employees but also shook the Wall Street to its core. For the handful of people who lost their hard-earned money in this fraud, the implications were serious and heinous, so to say. What is noteworthy is that this institutional failure has more far-reaching ethical implications than we understand. In a set up like a company, it is not very difficult to defraud innocent investors who don’t have much knowledge of the conniving means that the experts may use to manipulate the situation. Every corporate fraud is a disregard of moral values against wealth and greed for earning it. Not that it is the right thing to do, but, had this been a one-time event, the actions of the executives of the company would probably have been justified, but knowing and continuing to participate in this clearly shows the lack of ethics in one and all. What happens in a corporate fraud is exactly the opposite of utilitarianism. Utilitarianism means and states that a decision should be taken on such considerations as it does maximum benefits and minimum harms to the society. The perpetrators of a scam put their interests on such a prioritised position that the rights of and the harm being caused to the shareholders does not bother them.

The legal and moral liability falls on the auditing agency as well. Even though it’s found in an inquiry that it had not been involved in the scam and that a company was exceptionally conniving in planning the fraud that the auditor could not find it for years, yet it needs to be categorically stated that there was a failure on the part of the auditing company in doing its job efficiently as the implication of their negligence is faced by the public with no fault of theirs as we have seen multiple times with all the frauds that come up in India and across the globe.

Also Read, Enron Scam

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