Michael Woodford has plenty to say about corporate governance. The former CEO and president of Japanese electronics giant Olympus has spent the past year fighting to get to the bottom of a $1.7bn fraud that he was alerted to in July 2011.
When he first wrote to his fellow board directors to flag up a series of massive payments to companies that appeared to offer no value to Olympus, and which were highlighted to Japanese publication Facta by a whistleblower, he was stonewalled.
He then wrote additional letters to directors, copying them to the senior heads of Olympus’s auditor, Ernst & Young.
As he pursued the issue with senior directors, Olympus chairman Tsuyoshi Kikukawa ceded the role of CEO to Woodford. But after Woodford commissioned a PwC report that found potential offences of “false accounting, false assistance and breaches of directors’ duties”, he was sacked in October last year.
He then vigorously campaigned for the truth, helping the FBI in the US and the Serious Fraud Office in the UK with their investigations. He also travelled the world to update the global media as revelation after revelation spilled out of the company.
An independent report in Japan found that the senior management team at Olympus was “rotten to the core”.
During this time the company’s share price collapsed amid stories that the fraud may have been connected to organised crime.
Senior members of the board resigned soon after, including chairman Kikukawa. Following arrests in February this year, three former Olympus executives (including Kikukawa) pleaded guilty in a Japanese court to filing false financial reports in September.
Based on his experience, Woodford is keen to see improved corporate governance and better protection for whistleblowers in a bid to prevent a similar fraud taking place elsewhere.
A 30-year veteran of Olympus, Woodford had been hired as president shortly before the fraud broke in an attempt to turn round the company’s fortunes after operating income had fallen from $1bn in 2008 to around $400m in 2011.
His determination to pursue the truth reflects his difficult position at the moment the fraud was revealed.
“As president of the company, I had to sign off the company’s accounts. I was the person who had to sign a letter of representation with auditors, saying that what we were disclosing was a fair and accurate reflection of the company’s position.”
Considering whether it could happen elsewhere, Woodford suggests that once the accusations of fraud had been aired it would have been responded to quite differently in the UK and US.
“If that was a British company the non-execs would have said, ‘What is this?’ The police would be called in if you’re alleging massive fraud. You couldn’t have people standing up and defending the indefensible, you and your colleagues.”
Woodford says that part of the problem is cultural, whereby various elements of the financial and business establishment, including Olympus’s largest Japanese shareholders, avoided confrontation with Olympus’s directors over the issue.
“There’s something terribly wrong with corporate Japan, why it throws up the leaders it does. I think the reasons go back a long, long time.”
But why wouldn’t the institutional Japanese shareholders criticise the incumbent board?
“I think some of the debates we’ve been having on directors’ remuneration and compulsory voting on earnings has resulted in shareholder activism becoming the single most important element of good corporate governance,” says Woodford.
Woodford refers to the Fukushima nuclear plant catastrophe in Japan in 2011 that followed the earthquake and tsunami.
“When it [operating company Tepco] was investigated by a Japanese university professor he reported to the Japanese parliament a hierarchical system of directors blindly following orders, lacking questioning and a total deference to authority.”
But how did the fraud go unnoticed in the first place? Woodford suggests that a more robust auditing process could have reduced the chances of such a fraud taking place.
“When I first started running companies the audit was much more basic. They’d count the widgets on different trays of the factory. They would check an expense form. I think the forensic side of auditing could be enhanced, the statutory audit – the forensic side. Sampling transactions could be improved.
“External auditing has to be done in a very rigorous way. The big accountancy firms all have forensic branches so you could introduce an element of that. It would not be difficult for external audit firms to have an element of the forensic fraud prevention element to the audits they carry out, but that would involve going down to a micro level where they would check expenses and customer transactions in a much more complex and detailed way than happens now, where everything is high level. We may have to pay more money for it, but I think it would be well worth it.”
Woodford is positive about the impact that a cadre of skilled management accountants can have in an organisation. “They can do a lot of good, auditing subsidiaries such as in jurisdictions where corruption is endemic.”
But it is in the area of preparing data that he believes management accountants may have the most impact.
“The key thing is that data needs to be legitimate and accurate because only then can an external audit be robust. For capitalism to work, for capital markets to work, you really do want to believe a company’s accounts are what you say they are.”
A rotation of external auditors is also on his wish list.
“I believe that every ten years or so they should rotate the external auditors because after the fall of Arthur Andersen and Enron, there are only four big accountancy firms. I’ve been a director of a company. I recognise that human beings start to bond and if these relationships have some degree of commerciality, which they do, then the partners are paid on the income they generate and they cross-sell their consultancy services. There are lots of things in accounting that are open to interpretation, such as goodwill impairment and valuation of inventories. If you’re the senior partner auditing a company and you know that in two more years one of your counterparts would come in, you would think differently.”
Woodford concedes that the fraud at Olympus would probably never have been detected without a whistleblower from the company contacting Facta.
“Nothing would have happened without that person’s actions. Fraud, by its nature, and if it’s done in the right way, won’t be discovered.”
The answer is a catch-all whistleblower system that people feel confident in, says Woodford.
“If you’re working for an organisation where you know you can call a confidential number and actually meet people and your identity will be protected, I think that would give a lot of confidence to people. Olympus in Japan had a whistleblower line, but it was internal. I don’t believe in internal whistleblower lines. If they’re going to report to somebody, at some point you’re going to get to the board.”
Whistleblower lines should be compulsory, but they should be well funded and managed independently, says Woodford.
“If they are managed by a firm of lawyers, then the firm can’t have any other trading relationship with the company. I say this because when I was suing Olympus (he eventually settled out of court for £10m), I found that many firms were conflicted. You want people to feel they have enough confidence to say who they are and what they are, and know that their identities will be protected.”
But Woodford believes that the large cash incentives offered to whistleblowers in the US do not represent the way forward.
“The person who reported a fraud at UBS recently received more than $100m: I don’t think that’s right. I think you can offer people some degree of protection, including financial, but it could be on a graduated scale of 10 or 15 per cent of the fines placed on a company. The money should go back to the exchequer of the sovereign state where the fine was issued.
“They may never work again so a payment of $2m or $4m might be reasonable, so I agree with the principle,” says Woodford.
“But they need to refine it. The money needs to be sensible in relation to offering the person some financial protection, not making them a member of the mega rich. You actually damage the issue of transparency and honesty if you are seen to gain hugely from it.”
Photo: Getty Images
Blowing the lid on a cover-up
The story so far
The Olympus scandal first came to global attention on 14 October 2011 , when Michael Woodford was ousted as chief executive of the Japanese group.
Although he had been at the company, which sells photographic and medical equipment, for 30 years, he had been chief executive for just two weeks.
Woodford’s fellow directors, including chairman Tsuyoshi Kikukawa, may have hoped he would go quietly, but he did not. Woodford launched his fightback, alleging that he had been sacked because he had been asking difficult questions about multi-billion dollar deals carried out by Olympus before he became chief executive.
In particular, he had become alarmed by the $2.2bn takeover by Olympus of British medical equipment company Gyrus Group in 2008. What had concerned him was that a $687m fee was paid to a middleman for his help in arranging the deal, equivalent to 35 per cent of the deal, compared to a market rate of 1 per cent.
He was also concerned about three other acquisitions in 2008, for industrial waste company Altis, mail-order cosmetics firm Humalobo and microwavable dish manufacturer News Chef, which all saw massive write-downs the following year.
They were eventually found to have been used to cover up disastrous speculative investments by the company. At first, Kikukawa and other executives denied anything was amiss, but 12 days later he resigned as chairman.
Then, in early November 2011, as the scale of the offences became impossible to deny any longer, Olympus admitted that the payment was “inappropriate” and was designed to cover up losses made on investments dating back years, but kept secret from investors.
More resignations followed, topped off by the arrest of seven people – three executives and four financial advisers – in February 2012. In September this year three former Olympus executives, including Kikukawa, pleaded guilty in a Japanese court to filing false financial reports. The legal cases are ongoing.
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