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Olympus Scandal

Published on December 8, 2011 by   ·   No Comments

Blame it on James A. Baker III. The “Plaza Accord” that halted the appreciation of the United States dollar in 1985 was largely his doing, as Ronald Reagan’s Treasury secretary. It set in motion a series of events that led to a huge fraud at the Olympus Corporation, the Japanese maker of cameras and medical imaging equipment, that lasted more than two decades.

It turns out that it was an effort to make the company’s books accurate — at least in terms of its balance sheet — that led to the suspicious transactions noticed by Michael C. Woodford, at the time the newly appointed president and chief executive. He thought they showed theft from the company by its chairman, and he confronted him.

It now appears the chairman reacted with righteous indignation. He had not stolen; he had only tried to clean up a mess without damaging the reputation of generations of Olympus executives.

From his point of view, I infer from a new report by an investigating committee, there had been no need to tell Mr. Woodford about what had happened because the fraud was finally behind the company when Mr. Woodford took the job.

The report, released by Olympus this week, shows that two changes in accounting rules, one caused by the Enron scandal, eventually led to the collapse of the scheme.

It shows that KPMG AZSA, the Japanese affiliate of the international accounting group, failed to notice what was going on for years but balked at the somewhat clumsy transactions intended to finally, if misleadingly, put the losses on Olympus’s books. Ernst & Young Sjin Nihon, a Japanese affiliate of that network, was brought in and did sign off.

The scandal also highlights the need for mark-to-market accounting. Until accounting rule makers finally started to require it for some financial instruments in 1997 — seven years after the fraud began — covering up the losses was easy. A decade later, efforts to force companies to stop hiding things in off-balance-sheet entities led to the transactions that ended up exposing the fraud. The collapse of Lehman Brothers in 2008 also played a role.

To understand this scandal fully, remember what life was like for a Japanese company before the Plaza Accord. The dollar had been rising at a good clip and by the end of 1984 was worth more than 250 yen. That was heavenly for Japanese exporters, who could reap large profits exporting to the United States, and it led to a gaping Japanese trade surplus with the United States.

The Plaza Accord was reached by what was then the Group of Five — Japan, the United States, West Germany, France and Britain — at the Plaza Hotel in New York. They agreed on concerted action to bring down the value of the dollar, and to the surprise of many it worked. By the end of the year, the rate was down to 200 yen, and by the end of 1987 it was only 121 yen. It was no longer as much fun to be a Japanese exporter.

But the Japanese bubble was still expanding. In the final four years of the decade, stock prices tripled. In 1985, Olympus — not alone among Japanese companies — introduced zaiteku, or speculative investment, as a major business strategy.

The strategy worked until the Japanese bubble burst in 1990. That year, the company chose to hide losses of nearly 100 billion yen, or about $730 million at the exchange rate at the time. The report does not detail exactly how those losses came, only saying that they involved financial instruments.

How could such a loss be hidden? At the time, accounting rules in Japan, as well as in other countries, allowed investments to be carried at cost. Theoretically, there should eventually have been a write-down, but there never was.

There seems to have been some hope that with additional risky investments, the losses could somehow be made up. They were not. Over time, the company tried securities speculation and private equity, investing in what it thought were promising start-up companies. None of it worked. Eventually, the losses evidently grew to more than $1 billion.

Olympus seems to have been content to sit on the losses until 1997, when accounting rules changed and some investments had to be marked to market. To do so would reveal the entire sordid tale.

So a plan was developed to “sell” the losing investments, at original cost, to shell companies set up by Olympus for that purpose. The sales were financed with loans from banks, which received cash from Olympus to secure the loans. Under lenient accounting rules, those shell companies would not have to be consolidated with Olympus, so the losses could remain hidden.

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