Written Assignment 3
Accounting scandals are business scandals that arise from intentional manipulation of financial statements. Such acts typically involve complex methods for misusing or misdirecting funds, overstating revenues, understating expenses, overstating the value of corporate assets1, or underreporting the existence of liabilities.
Select one security fraud case out of the list of ten cases provided in Finance Cases of Fraud and Security Lapses. Write a research paper that describes the scandal and investigates this question: What motivates the individuals involved in such schemes to participate? Why do they do it?
Reference at least two scholarly journal articles, one of which is peer-reviewed, and ensure the paper and references are formatted in APA style.
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1 Overstating asset values or understating liabilities will give the impression that the company is better off than it is because both methods increase equity and net worth.
Monsanto Financial Scandal
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Monsanto Financial Scandal
Monsanto is a multinational agricultural company that is focused on producing agricultural inputs, such as herbicides, and seeds, particularly genetically modified organisms (GMOs) (SEC, 2016). The company is headquartered in the St. Louis area while operating in other international markets and across the United States. Monsanto is a controversial company that has had to jump from one scandal to the next, some of which have attracted several high-profile lawsuits over financial, health, and environmental issues related to its products (Saha, 2021). Some cases are still on trial while others have been settled. One case that was judged in 2016 was the one in which Monsanto was accused of misstating company earnings and violating generally accepted accounting principles (GAAP) relating to Roundup, an herbicide widely used by both farmers and homeowners to keep weeds from growing (SEC, 2016). Monsanto was found guilty for this case and change an $80 million penalty to be paid to the Securities & Exchange Commission (SEC) (Whitehouse, 2016). This research paper will discuss this scandal, specifically the motives behind this financial fraud and the reasons for doing it.
Roundup, which is the brand name of a systemic, broad-spectrum glyphosate-based herbicide, is a product of Monsanto (Saha, 2021). The herbicidal activity of glyphosate was discovered in 1970 by Monsanto chemist, Dr. John Franz, who then formulated roundup as an end-use product from the chemical. Benbrook (2016) reports Glyphosate as the most widely used herbicide in the United States. Since its debut in 1974, more than 19 million pounds of roundup have been sprayed by farmers, gardeners, and landscapers across the world. According to Saha (2021), about 20% of the roundup is utilized in the US.
However, the Glyphosate market has faced countless challenges over the years. The glyphosate use to manufacture the roundup as its acidic formula has been reported by empirical studies to be carcinogenic (causing cancer), especially when mixed with other herbicide ingredients though non-toxic to humans (Benbrook, 2016). Studies show that glyphosate and lymphoma increase the risks of lymphoma in people and animals. Other associated health risks include erratic honeybee behavior, male infertility, and degradation of biodiversity in marine habitats (Benbrook, 2016). The entry of these findings shook the glyphosate market, particularly for Monsanto, which was a major manufacturer in the 2000s. Monsanto also faced stiff completion from competitors, particularly in the global market. The company faced competition from Chinese companies that produced other glyphosate-based herbicides. However, in the years leading up to the beginning of the financial fraud (2009), roundup sales contributed about 10% of the total Monsanto revenue (Saha, 2021).
According to the investigation by the SEC, Monsanto was facing some insufficiency in accounting control that prompted it to resort to some fraudulent acts. The company could not account for millions of dollars in rebates offered to retailers and distributors of Roundup (SEC, 2016). The program was developed to counter the dwindling company market share and substantial losses brought about by the growing competition and scandal and controversies surrounding the product. From the program, there was an accumulation of a substantial amount of revenue from sales incentivized by the rebate programs (Orpurt, 2016). Monsanto did not recognize the entire costs related to the program as well. As a result, it misstated the consolidated earnings in the corporate filings for three years as a cover-up for this mistake. SEC Chair Mary Jo White stated that “This type of conduct, which fails to recognize expenses associated with rebates for a flagship product in the period in which they occurred, is the latest page from a well-worn playbook of accounting misstatements” (Whitehouse, 2016).
The onset of the rebate program can be traced to 2009. At that time Monsanto’s sales force began telling US retailers to maximize their roundup purchases in the fourth quarter in order to secure a chance to participate in a new rebate program in 2010 (Orpurt, 2016). The approval to do this was given to Monsanto sales personnel from two Monsanto accounting executives (both CPAs). Hartke (Monsanto accounting executives) then developed talking points that were then approved by Brunnquell (Monsanto accounting executives) before handing it over to the sales force to use when convincing retailers to take advantage of the program and purchase high quantities of Roundup in the stipulated period (SEC, 2016). Additionally, distributors were also given the opportunity to earn rebates they failed to qualify for in 2009 during 2010. The two largest distributors of the company were also promised a guaranteed payment of rebates ($44.5 million) regardless of their target performance (Young, 2016). Other distributors were given a target to meet before they could be given the rebate – later, Monsanto would reverse about $57.3 million of the rebate cost with claims that some distributors did not meet their target (SEC, 2016). Subsequently, it modified the rebate program to allow distributors who failed to attain their targets in 2009 to earn it back.
The program yield both expected and unexpected outcomes. The rebate program managed to boost sales at a time when demand was lagging due to increased competition (Gaetano, 2016). Unfortunately, the company failed to account for the cost of this program and kept delaying and accumulating the cost to the year that followed. The accumulated amount was $44.5 million and $48 million in 2009 and 2010 respectively (Gaetano, 2016). This is was a wrong move by Monsanto because Generally Accepted Accounting Principles (GAAP) require a portion of the costs related to the rebate program in the 2009 report since the program was meant to incentivize sales in 2009 (SEC, 2016). Yet the company improperly delayed the cost until 2010 and then repeated the same mistake for the 2010 costs of the rebate program.
The situation is further complicated by the failure to uphold some aspects of the agreement when some distributors failed to meet their targets of the agreed-upon volume. As result, the company reversed approximately $57.3 million of rebate costs that accrued from the unmet target (SEC, 2016). Subsequently, Monsanto improperly accounted for more than $56 million in rebates in 2010 and 2011 in France, Canada, and Germany. Instead of booking these sales as a rebate, the company booked them as selling, general, and administrative (SG&A) expenses (Young, 2016). As a result, those countries reported a profit boost from Roundup.
Such acts are considered financial frauds by the SEC and can be prosecuted. Andrew J. Ceresney, Director of the SEC’s Division of Enforcement, added, “Improper revenue and expense recognition practices that obscure a company’s true financial results have long been a focus of the Commission. We are committed to vigorously pursuing and punishing corporate executives and other individuals whose actions contribute to the filing of inaccurate financial statements and other securities law violations” (SEC, 2016). After the SEC investigations, the company decided to restate its earnings for 2009 and 2010 to reflect the exact timelines of the rebate cost. However, that was not enough because it would make the company’s stock drop by a few pennies. Monsanto was further forced to pay a penalty of $80 million for violating generally accepted accounting principles (GAAP) (SEC, 2016).
Monsanto was found in violation of Sections 17(a)(2) and 17(a)(3) of the Securities Act of 1933, the reporting provisions of Section 13(a) of the Securities Exchange Act of 1934, and underlying rules 12b-20, 13a-1, 13a-11, and 13a-13; the books-and-records provisions of Exchange Act Section 13(b)(2)(A); and the internal accounting control provisions of Exchange Act Section 13(b)(2)(B) (SEC, 2016). However, it has not admitted or denied these findings of the investigation. Brunnquell, Hartke, and Nienas were found in violation of Rule 13b2-1 and the Exchange Act Section 13(b)(5) and were charged penalties of $55,000, $50,000, and $30,000 respectively (Whitehouse, 2016). They consented to the charges but did not admit or deny the findings. The whistleblower was also awarded $22 million by the SEC (Baum Hedlund Aristei & Goldman PC., 2016).
All these findings point to the fact that Monsanto indeed violated the generally accepted accounting principles (GAAP) deliberately. Additionally, the case proves that it is easy to commit these accounting frauds and how common they are. This calls for rejuvenated vigilance to guard against violations of accounting frauds by both companies and individuals. People should also be motivated to report such kinds of fraud to help in stopping them and prevent unbearable escalation. Monsanto needs to work on repairing its damaged reputation by upholding transparency and honesty henceforth.
References
Baum Hedlund Aristei & Goldman PC. (2016). Monsanto Whistleblower Receives $22 Million Rewar. Baum Hedlund. https://www.baumhedlundlaw.com/blog/2016/september/monsanto-whistleblower-receives-22-million-rewar/
Gaetano, C. (2016). Monsanto’s $80 Million SEC Settlement Carries Penalties for Execs as Well. New York State Society of Certified Public Accountants. https://www.nysscpa.org/news/publications/the-trusted-professional/article/monsanto’s-80-million-sec-settlement-carries-penalties-for-execs-as-well-021016
Orpurt, S. (2016). Monsanto’s SEC Penalty for Improper Rebate Accounting. businessjournalism.org. https://businessjournalism.org/2016/03/monsantos-sec-penalty-improper-rebate-accounting/
Saha, P. (2021). Roundup is finally going to be made without glyphosate in the US. Popular Science. https://www.popsci.com/health/bayer-lawsuit-phase-out-roundup/
US Security and Exchange Commission (SEC). (2016). Press Release – Monsanto Paying $80 Million Penalty for Accounting Violations. https://www.sec.gov/news/pressrelease/2016-25.html#:~:text=An%20SEC%20investigation%20found%20that,market%20share%20for%20the%20company.
Whitehouse, T. (2016). Monsanto settles $80 million accounting charges with SEC. Compliance Week. https://www.complianceweek.com/monsanto-settles-80-million-accounting-charges-with-sec/11157.article
Young, L. E. (2016). Monsanto Pays $80 Million to SEC for Accounting Issues after Whistleblower Tip. mceldrewyoung.com. https://www.mceldrewyoung.com/monsanto-accounting-sec/