case 5.6 waste management;

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157

5.6Waste Management:Valuation of Fixed Assets

SynopsisIn February 1998 Waste Management announced that it was restating itsfinancial statements for 1993 through 1996. In its restatement, Waste Manage-ment said that it had materially overstated its reported pretax earnings by$1.43 billion. After the announcement, the company’s stock dropped bymore than 33 percent, and shareholders lost over $6 billion.

The SEC brought charges against the company’s founder, Dean Buntrock,and other former top officers. The charges alleged that management hadmade repeated changes to depreciation-related estimates to reduce expensesand had employed several improper accounting practices related to capital-ization policies, also designed to reduce expenses.1 In its final judgment, theSEC permanently barred Buntrock and three other executives from acting asofficers or directors of public companies and required payment from them of$30.8 million in penalties.2

Upper Management Turnover

In the summer of 1996 Dean Buntrock, who founded Waste Management in1968, retired as CEO, but he continued to serve as chairman of the board ofdirectors. Buntrock was initially replaced as CEO by Phillip Rooney, who hadstarted working at Waste Management in 1969. By early 1997 Rooney resignedas director and CEO because of mounting shareholder discontent.

After a new five-month search, Waste Management chose Ronald LeMay,the president and COO of Sprint, to assume its post of chairman and CEO.Surprisingly, just three months into his new role, LeMay quit to return to hisformer job at Sprint.

Case

1 SEC, Accounting and Auditing Enforcement Release No. 1532, March 26, 2002.2 SEC, Accounting and Auditing Enforcement Release No. 2298, August 29, 2005.

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158 Section Five Internal Control Systems: Control Activity Cases

In addition, several other key executives who, unlike LeMay, had worked forWaste Management for several years—including CFO James Koenig, CorporateController Thomas Hau, and Vice President of Finance Bruce Tobecksen—alsoresigned by the end of 1997.

Alleged Fraudulent Activities

In February 1998 Waste Management announced that it was restating its finan-cial statements for 1993 through 1996. Although shareholders lost billions ofdollars, management had already collected salaries and bonuses based on theinflated earnings and the resulting stock options. The SEC brought chargesagainst founder Buntrock and five other former top officers on charges of fraud.The SEC alleged that top management had made several top-side adjustmentsin the process of consolidating the results reported by each of their operatinggroups and intentionally hid these adjustments from the operating groupsthemselves. These entries were routinely posted at the corporate offices and fre-quently lacked adequate supporting documentation.

In addition, the SEC charged that upper management had employed severalother improper accounting practices designed to reduce expenses and artificiallyinflate earnings.3 Specifically, to help conceal the intentional understatement ofexpenses, top management allegedly used a practice known as netting, wherebyone-time gains realized on the sale or exchange of assets were used to eliminateunrelated current period operating expenses, as well as accounting misstatementsthat had accumulated from prior periods. It was also alleged that managementmade use of geography entries, which involved moving millions of dollars to differ-ent line items on the income statement. Essentially, these entries made it harder forauditors to compare operating results over time, a key audit procedure used byArthur Andersen. Finally, top management allegedly made or authorized severalfalse and misleading disclosures in financial statements.4 The company’s auditorhad proposed a series of action steps in early 1994 to help adjust the improperaccounting. However, rather than following these steps, top management at WasteManagement allegedly continued to manipulate results in 1994, 1995, and 1996.

Senior Executives Charged with Fraudulent Activity

A complete profile of the senior executives accused of fraud by the SEC is providedin Table 5.6.1. Top management profited from the fraudulent accounting in at leasttwo ways. First, bonuses were based on the fraudulently inflated net incomeamounts. And stock options increased in value as the share price increased basedon the news of inflated net income amounts. In total, the SEC brought charges offraud against six former top executives and calculated their ill-gotten gains, basedon their bonuses, retirement benefits, trading, and charitable giving alone.

3 SEC v. Dean L. Buntrock, Phillip B. Rooney, James E. Koenig, Thomas C. Hau, Herbert A. Getz, andBruce D. Tobecksen, Complaint No. 02C 2180 (Judge Manning).4 Ibid.

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159

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160

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TAB

LE 5

.6.1

(Con

tinu

ed)


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Case 5.6 Waste Management: Valuation of Fixed Assets 161

Case Questions1. Based on your understanding of fraud risk assessment, what three condi-

tions are likely to be present when a fraud occurs (i.e., the fraud triangle)?Based on the information provided in the case, which of these three condi-tions was most prevalent at Waste Management, and why?

2. Consult Paragraphs 26–27 of PCAOB Auditing Standard No. 5. Do youbelieve that the period-end financial reporting process deserves specialattention from auditors? Why or why not?

3. Consult Paragraph 69 of PCAOB Auditing Standard No. 5 and Sections 204 and301 of SARBOX. What is the role of the audit committee in the financial report-ing process? Do you believe that an audit committee can be effective in provid-ing oversight of the management team at Waste Management?

4. Consult Sections 302 and 305 and Title IX of SARBOX. Do you believe thatthese new provisions will help to deter fraudulent financial reporting by a topmanagement group such as that of Waste Management? Why or why not?


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case 5.6 waste management;

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