Review the attached case study and also use information from attached presentation on Chapter 18 (Corporate Governance for MBAA605)
Answer all parts o this multi-pronged Assignment:
Question: Identify and Critically evaluate the case study issue(s) from the perspective of Business, Government, Society, Infividually; Critically evaluate and discuss how the issues are inter-related.
Chapter 18
Corporate
Governance
McGraw-Hill/Irwin
Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
What is Corporate Governance?
o Corporate governance: The exercise of authority
over the members of a corporate community based on
formal structures, rules, and processes
o The authority is based on a body of rules defining the
rights and duties of shareholders, boards of directors,
and managers
18-2
Figure 18.2 – The Power Triangle
18-3
The Corporate Charter
o Corporate charter: A document issued by a state
government to create a corporation
o Corporate charters specify the purpose of the
corporation and basic rights and duties of
stockholders, directors, and officers
o Fiduciary responsibility: The legal duty of a
representative to manage property in the interest of
the owner
18-4
The Corporate Charter
o Charters include provisions about numbers of shares
and classes of stock authorized, dividends, annual
shareholder meetings, the size of boards, and
procedures for removing directors
o Bylaws: Rules of corporate governance adopted by
corporations
18-5
The Corporate Charter
o States compete to attract the incorporation fees and
tax revenues of corporations
o For more than a century tiny Delaware has been the
victor in this competition
18-6
Figure 18.3 – Flow of Authority in
Corporate Governance
18-7
Federal Regulation of Governance
o Corporate governance laws have been primarily the
province of states, however, the Supreme Court has
said that the Constitution empowers Congress to
regulate corporations if it chooses
o Federal intervention generally comes in reaction to
conspicuous failures of governance and imposes
mandatory rules and restrictions
18-8
Enron Corp. Example
o Enron enjoyed admiration and respect among
investors, managers of other companies, and the
public
o Government regulators uncovered multiple instances
of :
o Juggling accounting records to inflate sales and profits
o Hiding debt, concealing excessive CEO perks and
compensation in vague footnotes
18-9
Enron Corp. Example
o Ignoring standard accounting and financial practices
o Shredding documents to destroy incriminating records
18-10
Enron Corp. Example
o The board’s Special Investigative Committee did not
place sole blame for Enron’s failure on its directors,
but it accused the board of failing to exercise it
oversight responsibility
o A fundamental cause of the catastrophe was the
culture of the company
o In 2006 a federal jury found Chairman of the Board
Lay and CEO Skilling guilty of conspiracy and fraud
18-11
The Sarbanes-Oxley Act
o It holds management responsible for accurate
financial reports and strengthens the power and
responsibility of board audit committees
o A few of the act’s provisions are:
o Creates a five-member oversight board that has
authority over practices of accounting firms
o Prescribes rules to improve auditing
18-12
The Sarbanes-Oxley Act
o Requires the CEO and CFO to sign and certify the
accuracy of annual and quarterly financial statements
o Establishes heavy criminal penalties for violating its
provisions
18-13
Lehman Brothers Example
o Lehman Brothers Holdings began in 1850 as a cotton
broker and grew into the nation’s fourth-largest
investment bank
o Since 1994 it had been run by a CEO named Richard
S. Fuld, Jr. Intense, intimidating, and impatient
o In 2006, Fuld decided that the way to keep share
prices rising was to make Lehman grow faster
18-14
Lehman Brothers Example
o To fund its operations, Lehman depended on
borrowing tens of billions of dollars each day in
financial markets
o Lehman’s bankruptcy caused panic in the markets
o During the year preceding bankruptcy the board met
eight times and its members earned between
$325,038 and $397,538
o Lehman’s management made serious errors of
judgment
18-15
The Dodd-Frank Act
o A statute to reform financial regulation and prevent a
recurrence of the 2007–2008 financial crisis
o Portions repealed in 2018 – what is the effect on
financial organizations?
o Any unintended consequences?
18-16
Boards of Directors
o Directors in large corporations are chosen after being
nominated by the board and approved by a majority
vote of shareholders
o Directors who are employees of the company are
called inside directors; those who are not employed
by the company are outside directors
o Boards are divided into committees
18-17
Duties of Directors
o Laws impose two lofty duties on directors:
o Represent the interests of stockholders
o Exercise due diligence in supervising management
o Directors do not make day-to-day decisions
o Boards exercise a very broad oversight
o Compensation varies substantially among industries
18-18
Duties of Directors
o Some specific board functions:
o Approve the issuance of securities and the voting
rights of their holders
o Review and approve the corporation’s goals and
strategies
o Select the CEO, evaluate his or her performance, and
remove that person if necessary
o Give advice and counsel to management
18-19
Duties of Directors
o Create governance policies for the firm, including
compensation policies
o Evaluate the performance of individual directors,
board committees, and the board as a whole
o Nominate candidates for election as directors
o Exercise oversight of ethics and compliance programs
18-20
Board Composition
o The average board has 11 members and this has not
changed for many years
o Most state incorporation laws require a minimum of
three, but companies typically have between 7 and 15
o Directors are elected by shareholders, usually for
terms of one year
o Inside directors
o Outside directors
o Independent directors
18-21
Board Dynamics
o The average board meets eight times a year, although
many meet monthly
o Agendas include committee reports, mandatory
governance matters, and presentations by company
executives
o The chairman of the board presides over meetings
18-22
Board Dynamics
o Advocates of greater board independence believe that
a better solution for strengthening the board is to split
the roles of chairman and CEO
o Management opposes separation
o One fear is compromising clarity in the chain of
command
18-23
Executive Compensation
o A compensation committee of the board of directors
sets the pay and benefits of top executives
o Elements of compensation include a combination of
the following
o Base salary
o Annual cash incentives
18-24
Executive Compensation
o Long-term stock-based incentives
o Stock options
o Performance shares
o Restricted stock
o Retirement plans
o Perquisites
18-25
Problems with CEO Compensation
o The size of extraordinary payouts
o The compensation packages given to some newly
hired CEOs
o The golden handshakes received by some CEOs
when they leave under fire
o An alleged bias in favor of boosting CEO
compensation due to the composition of the
compensation committees
18-26
Problems with CEO Compensation
o Nonconformance with the interests of shareholders
o The number and misuse of stock option grants
o The spread between executive pay and that of the
average worker
18-27
Concluding Observations
o Despite well-defined legal bonds between share
owners, boards of directors, and management, there
are many tensions between them
o Scandals revealed lax oversight of financial strategies
and reporting by many boards
18-28
Concluding Observations
o Many shareholders believe that boards have allowed
management compensation to exceed reason
o The outlook is for more pressures and regulations that
tighten board oversight
18-29
Mercy MBAA 605 – SUMMER 2019
Business, Government, and Society
BUSINESS CASE PAPERS:
It is expected students thoroughly read the case study, textbook chapters, and supplement materials to
understand the topic and identify the issues so as to qualitatively and substantively critically evaluate
how the issues affect and are affected by the inter-relationship of business, government and society.
As you are Master’s students, write accordingly paying attention to grammar, spelling, syntax, and tone.
Thoroughly proofreading your paper prior to submission is strongly encouraged.
Business Case Papers WILL:
Be a critical evaluation of the issues and NOT personal opinion.
Include citations and references of at least 3 trusted sources other than the case study to support
assertions being made as part of the critical evaluation process.
Answer the multi-pronged Assignment Question specified in the syllabus.
Comport with all current APA formatting guidelines including, but not limited to references; in-text
citations; cover page; pagination; double-spacing; 1-inch margins; Times New Roman 12-point font.
Be independently authored and submitted as a Word document via Blackboard.
Be a Minimum of 3 full pages, Maximum of 4 pages of content.
*this does NOT include the cover page, an abstract if written, or the reference section
**Failure to submit 3 FULL pages of content will adversely impact your grade as follows:
(1 page=33%, 2 pages=66%, 3 pages=100% of content).
Grading Rubric for Business Case Papers
Concise Introduction
Summary of Case
Critical Evaluation of issues from the perspective of Business
Critical Evaluation of issues from the perspective of Government
Critical Evaluation of issues from the perspective of Society
Critical Evaluation of how issues relate with each other
Concise Conclusion
Grammar, Spelling, Syntax, Tone and Writing Style
APA Referencing and Citations
Total points per Business Case Paper
POINTS
10
20
10
10
10
10
10
10
10
100
Business Case Papers will comprise a maximum of 30% of the final grade.
Cases can be purchased at Harvard Business Publishing accessed by clicking this link:
https://hbsp.harvard.edu/import/629182
9
For the exclusive use of S. Campbell, 2019.
NA0180
The Midnight Journal Entry
Anne T. Lawrence, San José State University
O
n an overcast afternoon in Portland, Oregon, on Friday, March 28, 2003,
Richard Okumoto intently studied a set of hard-copy accounting documents
called “adjusting journal entries” spread out on his desk. He had been appointed chief financial officer (CFO) of Electro Scientific Industries, Inc. (ESI), a
multi-million-dollar equipment manufacturer, just a few weeks earlier. Okumoto was
in the midst of closing the company’s books for the third quarter of fiscal year 2003,
which ended February 28. An experienced executive who had served as CFO for several other technology firms, Okumoto was familiar with the task, which normally
would be routine. But this time, he felt that something was seriously amiss. When
reviewing the company’s recent results, he had noticed a sharp dip in accrued liabilities
between the two quarters ending May 31 (the last quarter of the 2002 fiscal year) and
August 31 (the first quarter of the current fiscal year). Now, looking at the detailed
journal entries his staff had provided, he noticed that several significant accounting
entries had been made around midnight on September 12, 2002. The entries made
that September evening had significantly changed the company’s results for the quarter
ending August 31, 2002, a few days before they were reported to the Securities and
Exchange Commission. He later recalled:
The fact that the time stamps [on the journal entries] were midnight through one
o’clock in the morning made me believe they were having difficulties closing the quarter. Not just because of accounting difficulties, but because they were having difficulties
finding the right answers. My initial reaction was, even given a difficult quarterly close,
if the team was working that late at night, that wasn’t typical.
From the pass codes required by the accounting software, Okumoto could see who had
made the entries. They included James Dooley, then the company’s acting chief operating officer and now the CEO, the corporate controller, and several senior members of
the finance team.
One midnight journal entry in particular drew the new CFO’s attention. The
late-night team had wiped out an accrued liability of $977,000 associated with the
anticipated cost of retirement and severance benefits to company employees in Japan,
Korea, and Taiwan. That entry, and several smaller ones, all of which were favorable to
Copyright © 2012 by the Case Research Journal and Anne T. Lawrence. The author developed this case to
provide a basis for class discussion rather than to illustrate either the effective or ineffective handling of
a managerial situation. An earlier version of this case was presented at NACRA’s annual meeting in San
Antonio, Texas, October 2011. The author gratefully acknowledges the assistance of Richard Okumoto
and the thoughtful comments of the editor, Deborah Ettington, and three anonymous reviewers.
The Midnight Journal Entry
137
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net income, had the cumulative effect of permitting the company to report earnings
of $0.01 per share for the quarter ending August 31, 2002, rather than a loss. When
he realized that, Okumoto recalled, he felt “a sinking feeling in my gut.” He asked
himself, “What happened here? At that time of night? All of the changes in a single
direction? What’s going on?” He was sure something was not right.
Richard Okumoto
Born in 1952, Richard Okumoto was raised with his four siblings in a JapaneseAmerican family in a low-income, African-American neighborhood that bordered the
Pepper Street Projects of Pasadena, California. He explained how his parents’ experiences had shaped their outlook:
My parents grew up during the depression years. Dad farmed with relatives, and Mom
grew up tending 3,000 chickens on a three-acre ranch in Gardena, California. Shortly
after the Pearl Harbor attack by the Japanese, my parents were relocated under Executive Order 9066 [under which persons of Japanese ancestry on the West Coast were
sent to relocation camps during World War II]. They met and married in a relocation
camp. During their incarceration, their families could not make their payments. Dad
and his relatives lost their land, and Mom’s parents lost their chicken ranch. After those
experiences, my father was committed to having no debt. He built our family home in
1955, with the idea of paying off the loan in eight years.
In 1962, Okumoto’s father, who worked as a gardener, landscaper, and salesman of
Japanese mutual funds, was disabled in a serious auto accident. Fortunately, by then,
he had almost paid off the loan on their home, so the family was able to survive financially. After the accident, Okumoto’s mother took a job cleaning homes to help support her five children. Okumoto described his relationship with his mother:
She and I had an especially close bond. Shortly before my dad’s accident, both her parents had died. I was the one who supported her through a very difficult year. As a result,
she always treated me differently from the other kids—almost like an adult.
The Okumoto family’s financial situation after the accident was difficult. Okumoto
had vivid memories of how they coped:
Money was very short. We had to account for every penny. Every week, my mother
wrote down in a leather-bound journal everything she earned and everything we spent
in the household, down to the penny. Every week, from the time I was ten years old,
she went through that with me. We lived on a cash basis. There was no credit card, no
second mortgage. In that situation, budgeting became extremely important. Her comment to me was, “You can’t complain [about what you don’t have] unless you understand what’s happening.” Those were her ground rules.
He added this comment about his mother’s values:
The ethics of doing the right thing become very important, because that’s really all you
have. [My mother] instilled in me at an early age, regardless of what else you do, always take
the high road, always do the right thing. That has influenced me throughout my career.
After high school, Okumoto attended San José State University, where he completed an undergraduate degree in accounting in 1974 and attended the MBA program
from 1975 to 1978. He soon embarked on a highly successful career in finance. Over
the next two-and-a-half decades, he held increasingly responsible roles at a number of
high-technology companies in the Silicon Valley, including Fairchild Semiconductor,
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For the exclusive use of S. Campbell, 2019.
Novellus Systems, Measurex, Credence Systems, and Photon Dynamics. Okumoto
admired a number of managers he had worked for, who had set high professional
and ethical standards for him and his co-workers. He felt fortunate to have had three
exceptional mentors: Woody Spedden, the CEO of Credence Systems; Jim Hefferman, his boss at Fairchild and later at Measurex; and Don Waite, the CFO at Measurex who later took over that position at Seagate Technologies. “All three individuals
upheld the highest integrity,” Okumoto recalled. “Aside from the technical training I
received from them, I got a strong ethical grounding. They would always tell me to ask
myself—what are your obligations to others?”
Electro Scientific Industries, Inc.
Electro Scientific Industries, Inc., the company that Okumoto joined as CFO in early
2003, was the second-largest technology company in Oregon, trailing only Tektronix
in size. Based in Portland, the company was founded in 1944 as Brown Engineering to
make test and measurement equipment. As technology evolved, so did the company’s
products. In the 1960s, the firm—by then called ESI—moved into lasers, and later
developed applications of laser technology for the emerging semiconductor industry.
ESI went public on the NASDAQ exchange in 1983.
In 2003, ESI’s core business was providing precision production equipment to
electronics firms. The company manufactured equipment that was used in the production of a wide range of electronics products, such as computers, cellular phones, home
entertainment systems, automotive electronics, electronic games, and personal digital
devices. Its products included advanced laser systems, test equipment, and packaging
systems, among others. The company’s customers included many leading electronics
firms, including AMD, Ericsson, IBM, Samsung, Hitachi, Flextronics, Honeywell,
and Lucent. Seventy percent of ESI’s sales were outside the United States, mainly
in Asia and Europe. The company owned and operated manufacturing facilities in
Portland and Klamath Falls, Oregon, and in Escondido, California, and operated sales
offices in many countries. In 2002, it employed 875 people and reported sales revenue
of $167 million (down from $472 million the prior year).
Like many firms in the electronics industry, ESI was badly battered by the economic downturn that began in 2001. After achieving record sales and income in the
fiscal year ending May 31, 2001, the company’s financial results declined precipitously
in FY 2002, as shown in Exhibit A. Sales and profits had continued to decline in the
first half of FY 2003.
Exhibit A: Electro Scientific Industries,
Selected Sales and Income Data*, 1998–2002
1998
1999
2000
2001
2002
Net sales
252,134
197,118
299,419
471,853
166,545
Net income (loss)
22,347
7,528
40,860
99,933
(15,961)
Net income (loss) per share
0.89
0.29
1.55
3.71
(0.58)
*Data refer to fiscal years ending May 31. All data are given in thousands of dollars, except per share
data.
Source: ESI 2002 Annual Report.
The Midnight Journal Entry
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The company noted in its 2002 annual report:
In fiscal year 2002, ESI weathered the worst downturn in the electronics industry in
over 30 years . . . We are conducting a thorough review of our overall market strategy
as well as product line strategies to assure that they will generate significant shareholder
returns over the inevitable cycles in our industry.
To cut costs, the company initiated a shutdown of its Escondido facility, consolidating
its operations in Portland. It divested several underperforming lines of business and
sought to invest in areas it saw as promising through partnerships and, potentially, acquisitions. It also informally explored a merger with another firm in southern California.
In early 2002, Don VanLuvanee, the company’s long-time CEO, suffered a stroke
and was no longer able to serve. The board appointed David Bolender, the former
CEO of Protocol Systems and a director since 1988, to step in as acting CEO until
it could find a permanent replacement. At that time, the board also elevated James
Dooley, who had been serving as the firm’s chief financial officer, to the role of acting
chief operating officer to run the company’s day-to-day affairs. In December 2002,
the board promoted Dooley to the position of chief executive officer, and Bolender
became chairman of the board. (Executives and directors of ESI named in the case,
and their positions, are summarized in Exhibit B.)
Exhibit B: Executives and Directors of Electro Scientific Industries, Inc.
(Listed in Order of Mention)
Richard Okumoto
Chief Financial Officer (CFO)
James T. “Jim” Dooley
Acting Chief Operating Officer (COO), early 2002–December 2002
Don VanLuvanee
Former CEO
David F. Bolender
Acting CEO, early 2002–December 2002
John “Jack” Isselmann, Jr.
General Counsel
Mike Tetsui
Manager, Japanese Office
Barry L. Harmon
Former Chief Financial Officer (CFO)
Gerald F. “Jerry” Taylor
Director and Member of the Audit Committee
Jon D. Tompkins
Director
Chief Executive Officer (CEO), December 2002–
Chairman of the Board, December 2002–
Director and Member of the Audit Committee
Closing the Quarter
Shortly after Dooley became CEO, Okumoto was recruited as chief financial officer.
He started work on February 17, 2003.
I was excited about the job. I thought it might be my last one in the industry. The
company, management, and employees—all had a long history of stability. To me,
it was another walk down the path of hard work, a fresh chance to apply my skills
in strategic planning and execution as well as to implement the new Sarbanes-Oxley
compliance rules.
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For the exclusive use of S. Campbell, 2019.
His first task was to prepare for the FY 2003 third quarter close. In reviewing the company’s books for the past several quarters, he soon noticed a sharp downward spike in
the balance of accrued liabilities. He noted that fact for further investigation.
In addition to closing the quarter, several other items required Okumoto’s attention. Just one week into his new job, on February 24, he got an email from John
(“Jack”) Isselmann, Jr., the general counsel, asking him to forward to the manager of
the Japanese office, Mike Tetsui, a set of revised work rules (terms of employment) for
ESI’s Japanese employees. As a newcomer, Okumoto knew little of the background or
why he had been asked to do this, but complied with the general counsel’s request,
sending on to the Japanese office manager the revised work rules.
Okumoto received the following reply from Tetsui on March 2:
I have read the proposed work rule and found no section of [sic] retirement fund. I do
not know what is the intention of removing that section, but it is a huge impact on
each employee we have…I do not think I can get concents [sic] from [ESI’s Japanese]
employees without reasonable change in retirement benefit. Please let me know how
you would like me to proceed.
Okumoto recalled:
My first response was, “uh-oh.” There was a big disconnect between what I had been
told and Mike’s reply. I had assumed that the Japanese had already been informed of
the cancellation of their retirement benefits and agreed to the changes. It was clear they
had not.
In a prior job at Novellus Systems, Okumoto had set up that company’s Japanese
operations, and he was aware that Japanese work rules were normally filed with the
government. Regulators were very strict about altering any documented benefits. Accordingly, Okumoto believed that ESI was obligated to pay benefits that had been
promised to employees, and he told Isselmann this. Okumoto also expressed the opinion that employees, if dissatisfied with the revised rules, could take the matter before
the Japanese labor board, and that this would be a “quantifiable event” that would have
to be recorded on the books as a liability. Isselmann responded that he was unfamiliar
with Japanese law.
On March 4, Okumoto spoke with CEO James Dooley about his concerns that
the reversal of benefits for Japanese, Korean, and Taiwanese employees might expose
ESI to litigation, and this could affect the accounting treatment of the event. Dooley
strongly disagreed. Okumoto recalled:
He told me that everything had been cleared with everyone. He said there was full
information. There was full disclosure. He emphasized that KPMG [ESI’s external
auditor], the company’s own legal staff, and the board had all signed off on it. He said
I should “just get past it.”
Okumoto was concerned about this conversation, particularly because the CEO
seemed so defensive.
On March 11, Okumoto met again with Dooley, this time to discuss Okumoto’s
upcoming presentation to the audit committee. The new CFO recommended that
the company delay announcing its third quarter earnings and restate its first and second quarter earnings to report correctly the $977,000 in liabilities associated with the
anticipated cost of retirement benefits for its Asian employees. Okumoto explained his
view that not reporting these liabilities had violated Generally Accepted Accounting
Principles. At that point, Okumoto recalled, Dooley became visibly upset.
The Midnight Journal Entry
141
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The CEO—all six feet-six inches and 280 pounds of him—turned an angry red and
told me again to just get past this. That’s when I knew that this was going to be swept
under the rug. It was clear I was not part of the club. Then Jim said, “If I’ve got to
reverse this entry, I’ll quit.”
The “MoFo” Memorandum
On March 13, Okumoto attended a meeting of the board of directors’ audit committee. Also present at that meeting, in addition to the audit committee members,
were Dooley, Isselmann, and several senior managers. At the meeting, Okumoto recommended that the company’s financial statements for the previous two quarters be
restated, and that it hire an independent accounting firm to conduct an audit of the
Asian benefits issue. Dooley countered that everyone had been fully informed of the
reversal and had “bought off” on it. The audit committee declined Okumoto’s suggestion that an independent accounting firm be brought in, but it did direct Barry
Harmon (formerly ESI’s CFO and a member of the audit committee), Okumoto, and
Isselmann to lead an internal investigation into the matter.
After the audit committee meeting, Isselmann came into the CFO’s office. Okumoto recalled:
He closed the door and just broke down. He told me that after the benefits reversal
in September he had asked MoFo [Morrison Foerster, an outside law firm on retainer
to ESI] to review its legality. MoFo had advised it was illegal to cancel the retirement
benefits without employee consent. He said he had immediately shown the memo to
Dooley, who had brow-beat him, intimidated him, and essentially boxed him into a
corner. I believed this, because in one meeting I actually saw Jim stand up and tower
over Jack, who was only 5 feet 6. I watched Jim almost physically overtake him. Jack
was a young guy, pretty inexperienced, and his job at ESI was his first in the industry.
On his way out, Isselmann handed Okumoto some documents.
From the documents, Okumoto learned that on October 3, 2002, Isselmann had
written MoFo, asking for an opinion on whether or not it would be legal for the company to terminate the Asian employees’ retirement benefits unilaterally. In his letter,
Isselmann had pointed out that the rules had been distributed to employees but had
not been submitted to the relevant government agency. On October 7, Toshihiro So, a
Japanese labor and employment attorney affiliated with Morrison Foerster, responded
to Isselmann’s request. The MoFo memo, now in Okumoto’s hands, read in part:
Retirement allowances are not a legal requirement [in Japan]. However, once the company agrees to pay retirement allowances in Rules of Employment (even though they
have not been submitted to the relevant government agency), the company is obliged
to pay them in accordance with the Rules and cannot remove them at the company’s
discretion. According to Japanese case laws, as a general rule, …the deprivation of
previously acquired rights by newly drawn up or changed work rules are [sic] not permitted…[It] is required that before changing the work rules, the company should hear
and consider the opinion of the related employees.
Okumoto was shocked. “This is the smoking gun,” he thought.
Investigating further, Okumoto learned that although private employers in Japan
were not obligated to pay retirement benefits, doing so was considered a good industry practice, and since 1981 ESI had offered such a benefit to its employees there.
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For the exclusive use of S. Campbell, 2019.
Under the rules of employment established for ESI’s employees in Japan, any employee
(except executives) who chose to retire after reaching the voluntary retirement age
of 60 would be entitled to a “retirement allowance” of one month’s pay per year of
service—in effect, a one-time severance payment. Workers who were involuntarily
terminated and the estates of any workers who died before reaching the age of 60 were
also entitled to this benefit. Similar rules were in effect for the company’s workers in
Korea and Taiwan. At the time, ESI had 18 employees in Japan, 13 in Korea, and 23
in Taiwan, mostly in sales and customer support roles.1
On March 14, Okumoto called an “all hands” meeting to disclose his initial findings and discuss a path forward. Present at the meeting were Dooley, Isselmann, Harmon, and several other senior managers. The CFO asked directly if there had been full
disclosure and review of all material facts with respect to the accrual reversal. Dooley
confirmed that everything had been disclosed. Okumoto did not mention the MoFo
memo, thinking that Dooley’s response indicated that he must have already disclosed
it to KPMG and the audit committee.
On March 20, Okumoto spoke by telephone with Mike Tetsui. The Japanese manager told the CFO that the employees had not yet been told that their retirement benefits had been terminated, and he—Tetsui—would resign before he would tell them
that news, which he expected would be devastating. “As head of the group,” Tetsui told
Okumoto, “I will fall on my sword.”
On March 21, Okumoto met again with Dooley to press him on how the reversal
had happened. Dooley was initially “combative.” As the conversation went on, however, he “let his guard down” and began talking about what had happened on the night
of September 12. As Okumoto recalled the conversation:
Jim told me that he had sent a financial packet to the board of directors prior to their
meeting on September 13. After he had distributed the packet, but before the meeting,
he was contacted by KPMG, who told him there had been an error in the company’s
calculations of its overhead costs, so the financial statements distributed to the board
were incorrect. ESI’s reportable earnings were suddenly much less than they thought,
by as much as a million dollars. Jim said this was particularly important because the
company was in informal merger discussions with a company in southern California.
Then he said, “No one was helping me, so I had to help myself.” When Jim made that
comment, my first thought was, he was looking for revenue. He was hunting for credits. He was looking to manipulate earnings. That was a definite red flag.
Okumoto walked out of Dooley’s office stunned. He called his staff together and
asked them to assemble any documentation they had on accounting entries on or
around September 12. He also began talking with the members of the finance team
who had participated in the late-night meeting with Dooley and learned that a number
of people on the finance staff had questioned the benefits reversal, but had not brought
it forward.
This was consistent with a negative tone at the top. I would almost characterize it as
bullying. That’s one reason why no one stepped forward. That tone at the top created
an environment where people really couldn’t speak out. It’s important to look at the
people. It’s similar to qualitative research. We all do that intuitively. When I looked at
the body language of a lot of the people involved—the cost accountants, the financial analysts—it became apparent to me that they were scared. They knew something
was wrong, and they wanted to say something, but something held them back. They
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reminded me of beaten animals. Growing up in the neighborhood I did, I knew what
fear looked like.
As part of his further investigation, Okumoto independently approached the audit
team from KPMG. They told him Dooley had informed them that the company had
received a legal opinion that the reversal was appropriate, and they had deemed that
information sufficient. Okumoto observed:
KPMG was new on the account, which they picked up after the collapse of Arthur
Andersen. They didn’t have deep familiarity with it. They did not have all the information. Some of the partners were new.
On March 28, a week after he had requested the relevant accounting entries for
September 12, his staff finally produced the complete documentation for that date.
Now, drilling down into the details, he saw the full scope of the midnight journal
entries—and who had made them.
Weighing the Risks
Over the weekend, Okumoto considered his next moves. None of the individuals and
groups from whom he had sought support—the CEO, the general counsel, or the auditors—seemed to share his concern about the seriousness of the issue. The audit committee had shown some interest, but had turned down his recommendation to bring
in independent auditors and seemed to believe the matter could be handled internally.
Okumoto was losing sleep, worrying constantly about what—if any—additional steps
he should take. He had tried to warn the key players. From all, he had received the
same message: We don’t see this as a serious problem. Let it go.
Okumoto realized the risks of escalating the issue further. He was earning a base salary of $250,000, with the possibility of a 100 percent performance bonus. He reflected:
I certainly realized the risks. I knew that if I brought this forward, there was a strong
likelihood that I would either lose my job, or I would be in an environment where it
would be difficult to operate, so I would have to leave.
The idea also occurred to him that “I can leverage this for more money and stock if I
look the other way. Plus, I can become invaluable to the company with this dirt. I can
immediately become part of the established inside club.” He had also recently signed a
contract to purchase a home in the nearby community of Lake Oswego, and wondered
how he would make good on that commitment if he lost his job.
However, he felt reasonably secure financially. Following the example of his parents,
Okumoto had worked hard to avoid debt and to save for adverse times. He reflected:
One of the first things I ask friends who are or would like to be CFOs or general managers, where risks such as this can jeopardize their careers, is: Are you financially secure
enough to make good decisions? Because if you aren’t, I can count on the fact that you
will make bad decisions when times of adversity hit. We all talk about the value of
making good decisions, but as we all know, life creeps in. There are economic commitments, family commitments, and people are sometimes moved to do the wrong thing.
As the old adage goes, hire your sales people so they are hungry enough to get the deal
done. Hire your finance people so they are not hungry enough to do the wrong thing.
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For the exclusive use of S. Campbell, 2019.
He added:
Fortunately, I was financially in a position where I could afford to leave if it came to
that. I was single, so I figured the only person I had to protect was myself.
He also had a network of friends in the area he felt he could turn to for support.
I had a number of friends in the Portland area, having worked there earlier. My prior
company had a division of about 1000 employees in the area. Of these, 500 had worked
directly for me. It might have been a false sense of security, but I felt I had a pretty good
infrastructure of people that I knew.
By this time, Okumoto was also becoming concerned about his personal safety.
Several times, he received anonymous messages on his home answering machine. At the
time, he was living temporarily in corporate housing while he shopped for a home, and
he felt he was particularly visible there. But, he added that he was not easily intimidated.
I felt that I could take care of myself. I had faced a lot worse threats than this one. As
a teenager, I was robbed at gunpoint. I was stabbed in the back and left for dead. I
was beaten so badly that my eyes were swollen shut. I grew up around a lot of physical
violence.
Although Okumoto saw risks in taking action, he also saw risks in inaction. He
commented:
I was concerned about my own legal liability if I did not take action. From the point of
view of the DOJ [Department of Justice] and SEC [Securities and Exchange Commission], if you don’t fix the problem, you become the problem. I had potential legal risk.
As Okumoto pondered the risks of both action and inaction, he reflected on the
board of directors and what kind of response he might expect if he approached them
directly. (See Exhibit C for a list of members of the board.)
Dooley was the only insider on the board. There were some old timers on the board—
like Barry Harmon, who had earlier been CFO at ESI. But there were also a fair number
of independents. Even though I was new at the company, I had a prior relationship
with two of the directors. Jerry Taylor, the former CFO at Applied Materials, was a
member of the audit committee. Jerry and I had worked together 25 years earlier at
Fairchild. So, I had a long-standing relationship with him. Jon Tompkins, the former
CEO of KLA-Tencor, was also on the board. I had known Jon from Tencor days, where
he had interviewed me for the CFO position.
As he contemplated his next move, Okumoto thought back to an experience earlier
in his career. As he told the story:
I had been in a situation before where I hadn’t spoken up. I had been a CFO for
another public company. I was in a situation in which I had questions on some of the
accounting. But it was close enough, and I was concerned that I didn’t have enough
evidence to support my reservations. I had only been with the company three months.
Within four months, we had a major revenue shortfall. At that time, I made the decision not to try to cover up the revenue shortfall. But, because we had not called it to
the attention of analysts earlier, we lost the confidence of the Street. At that point, the
CEO and I both resigned. I made a decision then that if I ever again saw something
that was close, I would act much faster.
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He also thought about his mother’s admonition always to do the right thing, and the
advice of his mentors, who had counseled him always to ask the question—what are
your obligations to others?
Exhibit C: Members of the Board of Directors, ESI Inc., March 2003
David F. Bolender, Chairman of the Board
Chairman of the Board and CEO (retired), Protocol Systems, Inc.
President (retired), Pacific Power and Light Co.
James T. Dooley, Chief Executive Officer
Barry L. Harmon, member of the Audit Committee
Senior Vice President (retired), Avocet Corp.
Formerly, Senior Vice President and Chief Financial Officer, ESI
Keith L. Thomson
Vice President (retired), Intel Corp.
Chair of the Board of Trustees, University of Oregon Foundation
Jon D. Tompkins
Chairman of the Board and CEO (retired), KLA-Tencor Corp.
President and CEO (retired), Spectra-Physics
Vernon B. Ryles, Jr.
President and CEO (retired), Poppers Supply Co.
Gerald F. Taylor, member of the Audit Committee
Chief Financial Officer (retired), Applied Materials
W. Arthur Porter, Chairman of the Audit Committee
Dean of the College of Engineering, University of Oklahoma
Larry L. Hansen
Executive Vice President (retired), Tylan General, Inc.
Note
1. In 2002, average annual salaries for ESI employees were $68,000 in Japan, $27,000
in Korea, and $38,000 in Taiwan (in U.S. dollars).
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