When upper-level executives go bad

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Tracy L. Coenen

It’s easy to assume that upper-level executives in companies with fraud scandals were always bad people. By assuming that they were inherently bad people, we don’t have to confront the issues related to trusting people who seemed trustworthy. We don’t have to explore the idea that people can turn bad or choose a bad path or give in to greed.

Yet the fact remains that many executives who committed fraud were at one time considered rising stars with good values. If it was recognized that their ethics were a little lower than preferred, some were still promoted because those in charge believed the results were more important than the methods.

Many may look at executives like Kenneth Lay and Jeffrey Skilling of Enron infamy, and believe that they were bad people long before Enron. The role of the villain is sometimes easy to fill when you have someone like Tyco’s Dennis Kozlowski, who was busy buying unusually lavish items with company funds. Certain people just make good villains in our minds.

Who knows for sure where the dishonesty comes from? We can’t really get into the psyche of executives who commit fraud and find out if they were born to be dishonest or if something triggered their deeds. However, an understanding of the motivations and actions of top managers who defraud shareholders, investors, and banks may help companies prevent fraud.

Motivation

Probably the most common reasons upper managers commit fraud are greed, either on a personal or corporate level, and financial need, whether real or perceived. As an employee moves up through the ranks of a company, the monetary rewards increase. By the time they reach executive ranks, they may be earning more money than they ever imagined. Adding in the stock options, bonuses, and fringe benefits, an executive can make previously unimaginable sums of money.

It’s not a stretch to believe that receiving these monetary rewards can create an attitude of greed or entitlement. During good financial times, an executive’s pay may rise rapidly, and the thought of that ending is painful. An executive with a big payday also may create a lifestyle that must be maintained. This type of financial need may not be a “need” in the literal sense of the world, but it can become a personal need.

When a company is doing well by meeting the expectations of banks and investors, greed and need on the part of an executive may not matter much. Things are going well and the person’s pay and benefits match that. But what happens when the company hits a bump in the road and the executive faces lower personal earnings that may not maintain the lifestyle that has been created?

Inflating sales or other financial statement items may be an answer to these problems. There are certainly many motivations and many factors that go into the decision to commit a fraud, and I can appreciate that the above addresses only two pieces of the puzzle. Nonetheless, greed and need can be primary motivators for upper-level executives to commit fraud within corporations.

Upper management fraudsters tend to distinguish themselves from lower-level employees with the depth of the greed and arrogance. They tend to take these to a whole new level. Think of some high-profile executives who were caught in the act. When you read the newspapers and watch the news, you sometimes see that these executives can’t help but display their greed and arrogance quite openly.

An Executive Disaster

Al Dunlap offers us a look at how a fraud disaster can easily occur at the hands of an executive. “Chainsaw Al” had apparently rescued many companies from the brink of disaster, so when he started at Sunbeam the same was expected.

Everyone knew of Dunlap’s reputation for slashing payroll and closing plants, but this action was welcomed by companies that needed a major turnaround. However, the cuts at Sunbeam went so deep that the company had difficulty even functioning at a core level. Many of the company’s costs were even increased as a result of Dunlap’s cuts, and the outlook was grim.

Yet the company’s stock was soaring, in large part based upon Dunlap’s reputation for turnaround success. Yet the downside to a rising stock price is that Wall Street has certain expectations that go along with it. Add to that the impossibility of meeting Dunlap’s outrageous financial projections, and Sunbeam was a company on the brink of collapse.

While Dunlap was busy pushing employees into doing the impossible, the company was unraveling. To cover this, internal games were played with the numbers, and employees were expected to participate in the fraud without questions. Departments were “tasked” with hitting assigned numbers, regardless of what their actual figures for a period were. The company wasn’t paying its bills, it was extending unusual credit terms to retailers, and customers were being overloaded with product.

The beginning of Chainsaw Al’s end may have begun when the company booked $62 million of future sales in the present. Executives also dipped into reserves to make the expected numbers. Such schemes catch up with a company eventually, and soon Sunbeam couldn’t meet the numbers Dunlap promised Wall Street. The entire scheme eventually unraveled.

Executive Characteristics

Executives who steal from companies are generally a bit different from the lower-level employees who commit fraud. The polite term for them is “top management defrauders,” but that’s just a nice way of saying “executives who are crooks.” Often the frauds committed by upper management aren’t tangible to the average employee. While executives are manipulating the financial statements, regular employees may not even understand what financial statement fraud is or how it harms people.

The frauds committed by executives are much larger than those committed by employees or managers. This is based upon power, access, and control. An executive often has rather free access to data, employees, and assets in a company. Couple that with control exercised over employees who may be (knowingly or unknowingly) made part of a fraud scheme, and the dollars at risk grow exponentially.

Top management defrauders often exhibit highly materialistic values. That materialism is shown with excessive spending and flaunting of wealth. They delight in discussing their purchases, the places they’ve been, and their important acquaintances. Success to them is often defined in financial terms, rather than professional recognition. They can be very self-centered, and often treat people as objects.

From a management standpoint, the top management defrauder doesn’t appear to fare well either. Many upper level executives play by their own set of rules. They don’t usually feel that they should be held accountable for following the rules that apply to everyone else within the company.

There is often significant turnover with subordinates, but this may initially be seen as a necessary step toward improving a compan
y. Subordinates are often played against one another, and many times a game of favorites is played. Yet none of it means anything, because the subordinates who remain will be the ones who produce the right numbers or results for the executive.

It is often quite easy for company executives to commit fraud and cause the fraud to be covered up, either through overt acts of the executive or by getting subordinates to assist. What accounting clerk is going to protest making journal entries to the accounting system when directed by a supervisor or executive to do so?

The warning signs at Sunbeam were all there. Chainsaw Al ruled with an iron fist, demanded absolute loyalty while mistreating employees, and the management team knew that anything was acceptable as long as the numbers were met.

So do executives really go from good to bad? Or are they always partly bad, and the rising power and money amplify it? Either way, it is clear to those who attempt to prevent and investigate fraud, that the costs of fraud by upper-level management are huge. Because of these costs, it is imperative that boards of directors, legal counsel, shareholders, and investment analysts pay attention to the warning signs.

Tracy L. Coenen, CPA, MBA, CFE, is the president of Sequence Inc., a forensic accounting firm with offices in Milwaukee and Chicago. Coenen can be reached at [email protected] or 414-727-2361.