Summary of Olympus financial fraud – based on independent report – part 1

The investigative report on the Olympus fraud has been released. The fact pattern, causes, and recommendations are scathing.

This and my followup post are a thumbnail description.  These are the result of just an hour or two of research.  If you wish to expand the summary, point out errors, or clarify, feel free to do so.  My guess is that readers of this blog won’t want as many details as I am providing, but do want to know more than just what shows up in the general news reports.

You can see one news article here: Olympus faces Tokyo delisting after management hid $1.7 billion of losses.

The Wall Street Journal has a good report, but it is behind a pay wall. WSJ also has a copy of the report, but I caution you on getting their copy.  I was able to access the report once, but when I went back to it, accessing the report crashed my computer. Twice.

Update: Olympus has made the report available here.

The report’s conclusion compares management to a cancer:

Olympus had originally been a sound company, with diligent employees and high technical strength. Not all part (sic) of the company was involved in this misconduct. Olympus should remove its malignant tumor and literally renew itself. (Page 30)

What is the amount of the fraud and time frame?

According to the report, the company started incurring losses on financial investments in the early 90s.  The report indicates that from 1995 about 1990 (update 2) through 1998 very large losses were incurred but the investments were never written down.  In 1999 and 2000, approximately ¥96B ($US1.2B) of unrealized investment losses were moved off the books. Again in 2003, approximately ¥118B ($US1.5B) of unrealized losses were moved off the books. The scheme blew up in 2011.  Losses are reported at ¥137B ($US1.7B). (Update: changed amounts from “Yen” to “¥”.)

Yes, that means there was $2.7B moved off the books but the current loss is $1.7B.  I don’t know how to bring those two numbers together, whether it is due to changes in the exchange rate, or recoveries of losses, or the money moved off the books actually had some value in it.  Update 2:  Historical cost of the investments moved off the books was $2.7B.  Loss is about $1.7B. Difference is the fair market value of the assets moved off the books, plus some additional losses while off-books.

For perspective, the March 31, 2011 audited financial statements report total assets are $US13.3B, equity is $US2.08B, net sales are $US10.59B, net income is $US92M.

So obviously $1.7B of hidden losses is exquisitely material , since it is 13% of total assets, 81% of net worth, 60%  16%(update 3) of total revenue, and 18 times net income.  Especially so since it was hidden from 2011 back to at least 1995. (update 2 – at least it’s my opinion that 1/7th of assets and 3/5th of revenue is material.)

Update: The losses were apparently all written of off by March 31, 2010, so the above calculations are after the $1.7B had all been written off.  See part 2a.

Also since those losses are were primarily hidden in goodwill, that loss constitutes 78% of goodwill.  Umm, I think several audit firms are going to be on the receiving end of some tough questions. 

On the other hand, the report also mentions the fraud was hidden quite well, including possible collusion with a European-based bank.   (Update: there were three European banks involved, at least one of whom, if not all, (update 2) all of whom, according to the committee’s report and NYT article, agreed not to tell auditors all the information that would normally be provided on an audit confirmation.)

Full disclosure:  deletions from first edition identified by strikethrough. (Update 1 noted with bold intro) (update 2 on 12-19-11 noted with italic comments) (update 3 on 1-3-12 to correct my math error)

Next post, the debits & credits.  Part 3, the causes identified by the investigating committee and some of their recommendations.