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Single call led to unraveling of Toshiba accounting fraud

TOKYO -- When Toshiba received a phone call from the Securities and Exchange Surveillance Commission, Japan's securities watchdog, in late January about an accounting issue, neither party knew where it would lead.

     That call marked the beginning of a scandal that has seriously damaged Toshiba's reputation and cast a pall over the manufacturer's future     

     The accounting scandal cost Toshiba President and CEO Hisao Tanaka his job and forced the company to promise sweeping management reforms. Tanaka's immediate predecessor as president, Vice Chairman Norio Sasaki, also stepped down, along with Atsutoshi Nishida, an adviser who was president prior to Sasaki.

     At 5:00 p.m. on July 21, Tanaka faced a media phalanx. "Our brand image has suffered the most serious damage in our 140-year history," Tanaka said as he announced his resignation.

Initial suspicions

It all started with the January call from an official at the SESC's disclosure statements inspection division. "We have some questions about your accounting practices concerning the infrastructure business," said the official. "Prepare the relevant materials."

     The watchdog's probe into Toshiba's books was launched in response to whistleblowing, although details remain unknown.

     Two weeks later, on Feb. 12, SESC inspectors visited Toshiba's headquarters in Hamamatsucho, Tokyo. During the meeting in a reception room, the inspectors spent several hours asking questions about the way Toshiba applied the "percentage-of-completion" method in its accounting of long-term infrastructure contracts. The method involves booking the revenues and expenses of long-term contracts for every year as a percentage of the work completed during that year.

     After officials pointed to possible irregularities in the company's bookkeeping practices, the Toshiba executive in charge promised an immediate in-house investigation. The SESC already suspected that there might be similar problems at other in-house Toshiba companies as well.

     But it was unclear whether or not these were errors or deliberate misstatements; nor was the scope of the problem known.

     The securities regulators were not aware that they were uncovering one of the biggest accounting scandals in Japanese corporate history. Some officials believed a company as large and reputable as Toshiba should be able to deal with the problems on its own.

Widening scope

As the probe brought multiple questionable accounting practices to light in the weeks that followed, Toshiba set up a special investigation committee on April 3. The panel was led by Chairman Masashi Muromachi and composed of outside accountants and lawyers.

     Even then, the prevailing thought was that the problems were merely errors in accounting for infrastructure operations. The document announcing the establishment of the special committee showed no signs of serious concern about the problems at Toshiba. It described the matter as "an accounting issue about the reasonableness of estimates concerning certain company projects (on an unconsolidated basis), based on the percentage-of-completion method."

     Around that time, Toshiba executives visited creditor banks and others to reassure them, claiming that the irregularities were simply mistakes, and that the issue would be resolved quickly.

     Some board members took the situation more seriously, however, and proposed setting up a crisis management committee and hiring of outside experts to deal with the affair. But their advice fell on deaf ears. One outside director now says that, in retrospect, the company's response to the problems was too slow from the start.

Spiraling into scandal

Things got uglier in May, delivering a severe shock to Toshiba, which initially tried to downplay the issue.

     Muromachi was caught off guard when he received a report from members of the investigation committee that a slew of unseemly emails had been discovered. Those emails contained messages suggesting the use of deceptive accounting practices to postpone booking losses and expenses. That made it difficult for the company to claim the irregularities were simple errors. Now they looked more like intentional manipulations.

     If other business units had similar problems, Muromachi thought, the committee would have a tough time uncovering the facts.

     Muromachi decided to shift the probe to a new and better-equipped independent committee comprising outside lawyers and accountants. On May 8, Toshiba announced it was setting up the independent committee and pulling its earnings forecasts for the year to March 2015. It also said it would delay its announcement of the financial results for the year.

     Senior executives at Ernst & Young ShinNihon, Toshiba's auditor, were stunned when they were informed of these steps immediately before the announcement.

     Toshiba has more than 300,000 shareholders, including foreign investors who account for some 30% of the total. On May 11, the first trading day after the announcement, Toshiba's stock went limit-down due to growing uncertainty about the company's future.    

     At 11:45 p.m. on May 13, Toshiba dropped another bombshell, saying it might cut its operating profit from fiscal 2011 through fiscal 2013 by over 50 billion yen ($400 million) because of improper accounting practices related to its infrastructure business. Up to that point, Toshiba had been disclosing information based on the findings of its own probe. Later, however, the independent panel found the company had padded profits by a total of 156.2 billion yen from fiscal 2008 through December 2014.

     On May 14, Tanaka was summoned to the Tokyo Stock Exchange and told to "respond appropriately to the media circus that will now come." Exchange officials acknowledged that Toshiba had no choice but to delay the announcement of its earnings and the submission of financial statements to the Financial Services Agency. At the same time, the officials urged the company to undertake an exhaustive investigation into the matter.

     The ensuing probe by the independent committee revealed the involvement of top executives in the accounting fraud, embroiling Toshiba in a scandal of massive proportions.



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