UNITED STATES SECURITIES AND EXCHANGE COMMISSION
LITIGATION RELEASE NO. 17435 / March 26, 2002
ACCOUNTING AND AUDITING ENFORCEMENT
RELEASE NO. 1532 / March 26, 2002
Waste Management, Inc. Founder and Five Other Former Top Officers Sued for Massive Earnings Management Fraud
Securities and Exchange Commission v. Dean L. Buntrock, Phillip B. Rooney, James E. Koenig, Thomas C. Hau, Herbert A. Getz, and Bruce D. Tobecksen, Civil Action No. 02C 2180 (Judge Manning) (N.D. Ill. March 26, 2002)
The Securities and Exchange Commission ("Commission") today filed a Complaint charging the founder and five other former top officers of Waste Management, Inc. ("Waste Management" or "Company") with perpetrating a massive financial fraud lasting more than five years. The Commission alleged that, beginning in 1992 and continuing into 1997, defendants engaged in a systematic scheme to falsify and misrepresent Waste Management's financial results and thereby enrich themselves and keep their jobs. The scheme was orchestrated and implemented by Waste Management's most senior officers:
The Commission brought its action in the United States District Court for the Northern District of Illinois. The Complaint alleges that the defendants violated, and aided and abetted violations of, antifraud, reporting, and record-keeping provisions of the federal securities laws. As relief, the Commission seeks final judgments permanently enjoining defendants from further violations of these provisions, ordering disgorgement of defendants' ill-gotten gains plus prejudgment thereon, imposing civil money penalties, and prohibiting defendants from serving as officers or directors of public companies.
In its Complaint, the Commission alleges the following:
Defendants fraudulently manipulated the Company's financial results to meet predetermined earnings targets. The Company's revenues and profits were not growing fast enough to meet these targets, so defendants instead resorted to improperly eliminating and deferring current period expenses to inflate earnings. They employed a multitude of improper accounting practices to achieve this objective. Among other things, defendants
Defendants' improper accounting practices were centralized at corporate headquarters. Each year, Buntrock, Rooney, and others prepared an annual budget in which they set earnings targets for the upcoming year. During the year, they monitored the Company's actual operating results and compared them to the quarterly targets set in the budget. To reduce expenses and inflate earnings artificially, defendants then primarily used "top-level adjustments" 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, however, created what Hau referred to as a "one-off" problem. To sustain the scheme, earnings fraudulently achieved in one period had to be replaced in the next.
Defendants concealed their scheme in a variety of ways. They made false and misleading statements about the Company's accounting practices, financial condition, and future prospects in filings with the Commission, reports to shareholders, and press releases. They also used accounting manipulations known as "netting" and "geography" to make reported results appear better than they actually were and avoid scrutiny. Defendants used netting to eliminate approximately $490 million in current period operating expenses and accumulated prior period accounting misstatements by offsetting them against unrelated one-time gains on the sale or exchange of assets. They used geography entries to move tens of millions of dollars between various line items on the Company's income statement to, in Koenig's words, "make the financials look the way we want to show them."
Defendants were aided in their fraud by the Company's long-time auditor Arthur Andersen LLP ("Andersen"), which repeatedly issued unqualified audit reports on the Company's materially false and misleading annual financial statements. At the outset of the fraud, management capped Andersen's audit fees and advised the Andersen engagement partner that the firm could earn additional fees through "special work." Andersen nevertheless identified the Company's improper accounting practices and quantified much of the impact of those practices on the Company's financial statements. Andersen annually presented Company management with what it called Proposed Adjusting Journal Entries ("PAJEs") to correct errors that understated expenses and overstated earnings in the Company's financial statements.
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. That signed, four-page agreement, known as the Summary of Action Steps (attached to the Commission's complaint), identified improper accounting practices that went to the core of the company's operations and prescribed thirty-two "must do" steps for the company to follow to change those practices. The Action Steps thus constituted an agreement between the company and its outside auditor to cover up past frauds by committing additional frauds in the future.
Defendants could not even comply with the Action Steps agreement. 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 profited handsomely from their fraud. All of the defendants received performance-based bonuses 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. Buntrock, Rooney, and Koenig also avoided losses by cashing in their Waste Management stock while the fraud was ongoing. For example, just ten days before certain of the accounting irregularities first became public, Buntrock enriched himself with a tax benefit by donating inflated Company stock to his college alma mater to fund a building in his name.
Defendants' scheme eventually unraveled. In mid-July 1997, a new CEO ordered a review of the Company's accounting practices. That review ultimately led to the restatement of the Company's financial statements for 1992 through the third quarter of 1997. 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.
As news of the Company's overstatement of earnings became public, Waste Management's shareholders (other than the defendants who sold Company stock and thus avoided losses) lost over $6 billion in the market value of their investments when the stock price plummeted by more than 33%.
The Complaint details the roles that each of the individuals played in the scheme. Buntrock was the driving force behind the fraud. He set earnings targets, fostered a culture of aggressive accounting, personally directed certain of the accounting changes to make the targeted earnings, and was the spokesperson who announced the Company's phony numbers. Rooney was in charge of building the profitability of the Company's core solid waste operations and at all times exercised overall control over the Company's largest subsidiary. He ensured that required write-offs were not recorded and, in some instances, overruled accounting decisions that would have a negative impact on operations. Koenig had primary responsibility 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. Hau was the accounting expert who, among other things, devised many "one-off" accounting manipulations to deliver the targeted earnings and carefully crafted the deceptive disclosures. Tobecksen, another accounting expert, was enlisted in 1994 to handle Hau's overflow. Getz, the general counsel, blessed the Company's fraudulent disclosures.
As a result of defendants' conduct, the Commission alleges that Buntrock, Rooney, and Getz violated, or aided and abetted violations of, section 17(a) of the Securities Act of 1933 ("Securities Act"), sections 10(b) and 13(a) of the Securities Exchange Act of 1934 ("Exchange Act"), and Exchange Act rules 10b-5, 12b-20, 13a-1, and 13a-13. The Commission further alleges that Koenig and Hau violated, or aided and abetted violations of, section 17(a) of the Securities Act, sections 10(b), 13(a), 13(b)(2)(A) of the Exchange Act, and Exchange Act rules 10b-5, 12b-20, 13a-1, 13a-13, 13b2-1, and 13b2-2. The Commission alleges that Tobecksen violated, or aided and abetted violations of, section 17(a) of the Securities Act, sections 10(b), 13(a), 13(b)(2)(A) of the Exchange Act, and Exchange Act rules 10b-5, 12b-20, 13a-1, 13a-13, and 13b2-1.
Previously, the Commission instituted and simultaneously settled the following proceedings against Andersen and four of its partners:
SEC v. Arthur Andersen LLP, et al., No. 1:01CV01348 (JR) (D.D.C.) [Release No. LR-17039] (June 19, 2001)