ABSTRACT

This case examines the two decade long tobashi scheme by Olympus Imaging Executives to hide $1.7 billion in losses. In the 1980s, a soaring yen and falling dollar caused bottom line income problems for many Japanese companies. Some companies sought to offset the declining revenue with zaiteku, a form of speculative investment. While early activities generated profits in 1987, by 1991 Olympus recorded 2.1 billion losses in yen. Rumors circulated that by the late 1990s, losses had grown larger. Rather than come clean and admit the losses, management continued to double down with riskier investments. Olympus created a tobashi scheme to shift losses off the Olympus balance sheet.

Olympus created a tobashi scheme to shift losses off the Olympus balance sheet. Companies located in the Cayman Islands were purchased via exorbitant Management and Acquisition Fees. When the first Western President, Michael Woodford, questioned these practices, he was fired after two weeks on the job. Woodford became perhaps the first CEO ever to blow the whistle on his own firm. The subsequent scandal brought arrests of the executive team, an 80% decline in share price, the threat of de-listing on the Tokyo Exchange, and an international look at Japanese Corporate Governance. A detailed list of questions along with extensive teaching notes, bibliography, and references are provided. The case should be of interest in an accounting audit, ethics, governance, or international accounting class.

Keywords: Corporate Governance; Whistleblower; Fraud; Tobashi; Zaiteku; Derivatives; Confucian

INTRODUCTION

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Japanese company that produces cameras and medical imaging equipment. This case is unique since the lympus hid the imaging scandal for nearly twenty years, dating back to the 1980s. Olympus is a

whistle blower was Olympus own president and CEO, Michael C. Woodford, hired in September of 2007. (Mintz, 2012) Now the former Board Chairman and 18 other past and present company officials are facing lawsuits and even charges from both British and Japanese officials. (Kubota, 2012)

FACTS AND TIMELINE OF THE OLYMPUS SCANDAL

In 1980, Toshiro Shimoyama was the president and CEO of Olympus Corporation. Olympus operating income fell significantly because of the sharp appreciation of the yen. The CEO decided to develop an aggressive financial assets management unit within the Accounting Department headed by Hideo Yamada. This unit was to make speculative investments known as zaiteku. From these aggressive asset management activities, handsome profits were produced. In 1987, with Yamada in charge of the speculative investments deal, a man named Hisashi Mori became his subordinate in the investment dealings. In time, Yamada and Moris dealings propelled them into upper management. Mori became an executive vice president and board director while Yamada became a standing corporate auditor. Ten years passed before the speculative investment activities resulted in substantial losses. Yamada and Moris investment group doubled and tripled down by investing in high-risk, high-return products, and risky financial products that offered interest advancement as well as the riskier, complex structured bonds. (McKenna, 2012)

By the late 1990s, investment losses at Olympus had reached nearly $100B yen. Yet Yamada and Mori continued to bet money in risky investments in a desperate bid to recover losses. These losses were masked through a Japanese accounting standard that allowed financial assets to be accounted for at historical cost basis versus writing them down to a lower market value. In 1997, the accounting laws were modified which forced Japan to adopt the fair value accounting system, or market-to-market accounting, as part of its implementation of International Financial Reporting Standards. (Mintz, 2012) As accountants, Yamada and Mori knew they would soon be forced to reveal the fair value of the impaired assets they were holding.

In 1998, with President Shimoyamas knowledge and approval, Yamada and Mori came up with a loss separation scheme to work their way around the new market-to-market accounting laws. It would transfer the nearly worthless financial assets Olympus had acquired to entities whose accounts would not be consolidated back into Olympus financial statements. These entities are referred to as shell companies, which are off balance sheet companies. This scheme involved selling the assets to parties that would accept them at book value. It would be necessary to create dummy entities that Yamada and Mori could influence in order to continue to hide the losses. Olympus asked the President of Axes Japan Securities and the President of Axes America to set up these dummy entities.

The president of Axes Japan Securities and President of Axes America were asked by Olympus to set up these dummy entities. In 1998, the first receiver fund, or dummy entity, called Central Forest and registered in the Cayman Islands, was set up to hide the losses. Yamada and Mori obtained financing from a bank in Liechtenstein. As collateral to obtain a loan to finance this dummy entity, Yamada and Mori deposited Olympus-owned Japanese government bonds valued at about 21 billion yen with the bank in return for 30 billion yen from them. Olympus Asset Management also invested 35 billion yen in a class fund managed by this bank, which found its way into this dummy entity as well. Aside from borrowing from the bank in Liechtenstein, Yamada and Mori used a bank in Singapore to get another 45 billion yen into the dummy entity. After Central Forest was set up, Yamada and Mori began setting up the second dummy entity called Easterside Investments. Yamada and Mori invested another 60 billion yen into a different fund whose bond portfolio was lent to this dummy entity. (Bacani, 2011)

Up until 1998, Yamada and Mori succeeded in hiding these assets with a combined book value of 64 billion yen in Central Forest. Adding one last dummy entity, Yamada and Mori set up Quick Progress, having a book value of 32 billion yen. Yamada and Mori knew they needed to find a way to make the losses disappear, so they began to set up a loss disposition scheme. This involved the purchase of start-ups and entrepreneurial ventures at vastly inflated prices and payment of huge advisory fees for merger and acquisitions (M&A) deals.

They used part of the money that flowed out of Olympus for these inflated purchases to retire the loan from the banks. Those banks financed the dummy enterprises and other obligations, and then would bring back the money that went into the investment funds.

They used part of the money that flowed out of Olympus for these inflated purchases to retire the loan from banks that financed the dummy enterprises and other obligations, and bring back the money that went into the investment funds. The high purchase prices of companies were accounted for as goodwill on Olympus balance sheet. Yamada and Mori believed they were golden because the goodwill would be amortized over time down to zero. Then the money that Yamada and Mori lost on bad assets was transferred to the receiver funds, which could be properly accounted for without anyones knowledge. (McKenna, 2012)

Years later, Olympus external auditor, KPMG, did not agree with the vastly overvalued goodwill ascribed to the purchases. Olympus was forced to take an impairment charge of 55.7 billion yen in March of 2009 and another 1.3 billion yen in March of 2010. The company took a financial hit, but from Yamada and Moris point of view, the impairment still allowed them to finally dispose of part of the investment losses they had hidden away in the receiver funds.

Yamada and Mori then embarked on a scheme to acquire a company named Gyrus. The purpose of this transaction was to make another attempt to disguise the 62 billion yen represented by the money invested in the fund lent to Easterside as goodwill.

The purpose of this transaction was to make another attempt to disguise 62 billion yen represented by the money invested in the fund lent to Easterside as goodwill. With this transaction, Yamada and Mori believed they would finally be able to retire the last of their investment losses. Yamada and Mori had to somehow inflate the purchase price, to account for the purchase of Gyrus; so, the two men overpriced the advisory fees for this purchase. Acting as M&A advisors, the presidents of Axes America and Japan negotiated a cash payment of US $12 million of the grant of Gyrus warrants and preference shares that Olympus later bought back for US $670 million. Most of this money freed up the lent-out bond holdings of Easterside fund, thus allowing Yamada and Mori to redeem 3.2 billion yen.

This represented the last of the investment losses they had hidden away. The final step was to book goodwill from the Gyrus deal and to amortize that goodwill over ten to twenty years. Again, KPMG questioned the excessive M&A advisory fees paid out. (Bacani, 2011) Yamada and Mori waited until KPMG was replaced in 2009 by Ernst & Young before buying back the preference shares. Ernst & Young, in turn, allowed US $177 million to be booked as goodwill on the Gyrus acquisition.

In 2007, Olympus appointed British CEO, Michael C. Woodford. He immediately began questioning these transactions specifically, the exorbitant M&A advisory fees. Woodford was fired by Olympus two weeks later after talking to management in an attempt to rectify the discrepancies with the books. Woodford then went forward to British authorities as a whistleblower.

In 2011, after years of investigation, Olympus was forced to create an independent committee; whose findings were made public on December 6, 2011. A six-man committee, headed by a former Supreme Court judge, was appointed to investigate the Olympus scandal. Olympus survived the prospect of being delisted from the Tokyo Stock Exchange (TSE). The TSE removed the company from its watch list for automatic ejection from the world's secondlargest bourse. It filed five years' worth of corrected statements, plus overdue first-half results, just hours before a deadline set by the TSE. (Japan Times, 2012)

Shuichi Takayama assumed office as President and CEO of Olympus after Shimoyama stepped down in November of 2011. In total, Takayama created three committees to look into the panels findings: a management reform committee, a committee formed of attorneys that would investigate the liability of the board directors, and another committee made up of external lawyers that would study the liability of the non-directors and the corporate auditors. Olympus set January 8, 2012 as the due date for filing lawsuits against directors, and January 17, 2012 for other persons, including audit firms.

As of 2012, Olympus is suing its current president and 18 other past and present company officials over the scandal, seeking up to 3.6 billion yen in compensation for the accounting scam. Olympus said that all board members subject to the lawsuit would quit at an emergency shareholders meeting to be held in March/April of 2012. On January 20, 2012, the Tokyo Stock Exchange decided to let Olympus stay listed after paying a small fine of 10 million yen or US $130,000. (Japan Times, 2012)

In February 2012, Japanese prosecutors arrested and formally charged Olympus former chairman, Tsuyoshi Kikukawa, two other former executives, Hisashi Mori and Hideo Yamada, and three men from consulting companies who allegedly collaborated in the scandal, with criminal charges. Prosecutors started a fresh investigation over alleged falsification from 2008 to 2010. These six men faced up to 10 years jail time or US $125,000 fine. The Nikkei Newspaper also reported that Olympus was fined $1.2 million for false accounting. (Gallagher, 2012)

Japanese, U.S. and British officials are still investigating the case.

The stock price fell from a high of 2,769 yen on July 22, 2011 to a low of 460 yen by November 11, 2011. As of July 6, 2011, Olympus shares traded at 1,291 yen. (Tokyo Stock Exchange, 2012) As of this writing March 3, 2014, the stock had recovered to 3,425 yen. (Tokyo Stock Exchange, 2012)

Discussion Questions

1. Identify all stakeholders involved in the fraud and determine the issue at hand.

2. What message did Olympus Board transmit in firing their chosen CEO who became a whistleblower?

3. Does the lack of uniform accounting standards encourage bad behavior? The United States had still not adopted International Financial Reporting Standards IFRS. Does the existence of IFRS for some and PCAOB GAAP for others simply make the regulatory environment more confusing allowing ducking and dodging of rules?

4. Olympus committed a crime, but in punishment they were permitted to stay enlisted on the Tokyo Stock Exchange while only receiving a small fine. How does this punishment for a white-collar crime look to the public? Does this diminish respect for ethical accounting standards? State your opinion.

Read the case study and answer the discussion questions in your own words. The overall maximum word count is 800 and 500 word count as minimum.