Major Corporate Scandals

Why This Matters

Corporate scandals aren't just sensational headlines—they're windows into the structural weaknesses of American capitalism and the regulatory frameworks designed to contain them. When you study these cases, you're really studying corporate governance failures, regulatory capture, market psychology, and the evolution of business ethics. Each scandal triggered specific reforms, from the Sarbanes-Oxley Act to Dodd-Frank, and understanding which scandal prompted which response is essential for connecting cause and effect on exams.

Don't just memorize company names and dollar amounts. Know what type of fraud each scandal represents and what systemic vulnerability it exposed. Ask yourself: Was this an accounting manipulation? Executive theft? Regulatory failure? Consumer deception? The categories matter more than the chronology, because FRQs will ask you to compare scandals by mechanism or explain how one scandal's reforms failed to prevent another.

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Accounting Manipulation and Financial Statement Fraud

These scandals involve companies deliberately misrepresenting their financial health to investors and regulators. The core mechanism is the same: executives manipulate numbers to hide losses, inflate assets, or create the illusion of profitability.

Enron Scandal (2001)

• Mark-to-market accounting abuse—Enron booked projected future profits as current revenue, creating phantom earnings that masked massive debt
• Special purpose entities (SPEs) hid billions in liabilities off the balance sheet, deceiving investors about the company's true financial position
• Arthur Andersen's collapse demonstrated how auditor conflicts of interest enable fraud—the firm earned more from consulting than auditing

WorldCom Accounting Fraud (2002)

• $$11 billion in inflated assets—executives capitalized routine operating expenses, turning costs into "investments" to boost reported profits
• Largest bankruptcy in U.S. history at the time, wiping out employee retirement accounts and investor savings
• Direct catalyst for Sarbanes-Oxley Act, which mandated CEO/CFO certification of financial statements and created the PCAOB

Wirecard Accounting Scandal (2020)

• €1.9 billion in fabricated cash—the German fintech company reported funds that simply didn't exist in Philippine bank accounts
• Regulatory failure across borders exposed gaps in European financial oversight, as German regulators initially defended the company against short-sellers
• Auditor Ernst & Young faced scrutiny for failing to verify basic bank confirmations for years

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Executive Theft and Self-Dealing

These cases involve corporate leaders treating company assets as personal piggy banks. Unlike accounting fraud, which deceives external parties, self-dealing involves direct misappropriation of funds by insiders.

Tyco International Scandal (2002)

• **$600 million in unauthorized compensation**—CEO Dennis Kozlowski and CFO Mark Swartz used company funds for personal luxuries, including a$6,000 shower curtain
• Loan forgiveness schemes allowed executives to take interest-free loans that were quietly written off as bonuses
• Governance failure highlighted weak board oversight—directors rubber-stamped executive compensation without scrutiny

Bernie Madoff Ponzi Scheme (2008)

• $$65 billion fraud—the largest Ponzi scheme in history paid "returns" to early investors using capital from new investors, with no actual trading occurring
• SEC regulatory failure was catastrophic—whistleblower Harry Markopolos warned the agency for nearly a decade before Madoff's arrest
• 150-year prison sentence became symbolic of post-crisis accountability, though most victim funds were never recovered

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Systemic Risk and Financial Crisis Triggers

These scandals didn't just harm individual companies—they threatened the entire financial system. Excessive leverage, interconnected risk, and "too big to fail" institutions created cascading failures.

Lehman Brothers Collapse (2008)

• $$600 billion bankruptcy—the largest in U.S. history, triggering a global credit freeze and the Great Recession
• Repo 105 transactions temporarily moved assets off the balance sheet before quarterly reports, masking the firm's true leverage ratio
• No bailout decision by Treasury Secretary Paulson remains controversial—some argue it worsened the crisis, others that moral hazard required consequences

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Consumer Deception and Product Fraud

These scandals involve companies lying to customers about what they're actually buying. The fraud occurs at the product level rather than the financial statement level, often involving safety or performance claims.

Volkswagen Emissions Scandal (2015)

• "Defeat device" software detected when cars were being tested and temporarily reduced emissions, while normal driving produced up to 40x legal pollution limits
• 11 million vehicles affected globally, resulting in over $$30 billion in fines, settlements, and vehicle buybacks
• Criminal charges against executives demonstrated that environmental fraud carries serious consequences—several VW managers faced prison time

Theranos Fraud (2015-2018)

• Fake blood-testing technology—founder Elizabeth Holmes claimed a finger-prick test could run hundreds of diagnostics, but the technology never worked
• $$700 million raised from investors including major venture capital firms and retail magnate Betsy DeVos, exposing due diligence failures
• Holmes convicted on fraud charges in 2022, becoming a cautionary tale about Silicon Valley hype culture and "fake it till you make it" mentality

Boeing 737 MAX Crisis (2018-2019)

• 346 deaths in two crashes (Lion Air and Ethiopian Airlines) caused by faulty MCAS software that pilots weren't adequately trained to override
• FAA "regulatory capture"—the agency had delegated safety certification to Boeing itself, creating obvious conflicts of interest
• $$20 billion in losses and a two-year grounding exposed how cost-cutting and schedule pressure compromised safety culture

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Toxic Corporate Culture and Incentive Failures

These scandals reveal how internal pressure and misaligned incentives push employees toward unethical behavior. The fraud is systemic rather than the work of a few bad actors.

Wells Fargo Account Fraud Scandal (2016)

• 3.5 million fake accounts—employees opened unauthorized checking, savings, and credit card accounts to meet aggressive "cross-selling" quotas
• "Eight is great" sales culture pressured branch employees to sell eight products per customer, with termination threats for underperformers
• $$3 billion in fines and CEO John Stumpf's resignation demonstrated how toxic incentive structures create fraud at scale

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Quick Reference Table

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Self-Check Questions

1. Both Enron and WorldCom triggered the Sarbanes-Oxley Act—what specific type of accounting manipulation did each use, and how did SOX address these problems?

2. Compare the regulatory failures in the Madoff Ponzi scheme and the Boeing 737 MAX crisis. What different forms did "regulatory capture" or incompetence take in each case?

3. If an FRQ asked you to explain how corporate culture contributes to fraud, which two scandals would you compare, and what would you emphasize about their incentive structures?

4. Distinguish between scandals that harmed investors primarily (through financial statement fraud) versus those that harmed consumers primarily (through product deception). Give two examples of each.

5. The Theranos and Enron scandals both involved charismatic leaders who convinced sophisticated investors to ignore warning signs. What does this pattern reveal about the limits of market discipline in preventing fraud?