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(Solved) Miniscribe 1. "COOKING THE BOOKS: HOW PRESSURE TO RAISE SALES LED MINISCRIBE TO FALSIFY NUMBERS" (Wall Street Journal, September 11, 1989)...


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Miniscribe
1. “COOKING THE BOOKS: HOW PRESSURE TO RAISE SALES LED MINISCRIBE
TO FALSIFY NUMBERS”
(Wall Street Journal, September 11, 1989)
2. “MINISCRIBE’S INVESTIGATORS DETERMINE THAT ‘MASSIVE FRAUD’ WAS
PERPETRATED”
(Wall Street Journal, September 12, 1989)
3. “MINISCRIBE SEEKS CHAPTER 11 PROTENCTION, POSTS $116 MILLION LOSS
FOR NINE MONTHS”
(Wall Street Journal, January 3, 1990)
4. “COOPERS & LYBRAND AGREES TO PAYMENT OF $95 MILLION IN THE
MINISCRIBE CASE”
(Wall Street Journal, October 30, 1991)
5. IBM’s Management Report and Independent Auditor’s Report Read the attached articles and answer the following questions:
1. List accounting practices that were used to fabricate the numbers in the financial
statements.
2. Comment on the internal accounting control of Miniscribe, specifically the reasons for its
ineffectiveness in preventing fraudulent financial reports.
3. To what extent are each of these parties responsible for the fraudulent reports (i) the CEO,
(ii) the independent accountants and (iii) the board of directors? How does your answer
compare with the actual penalty imposed on them? (Before answering this question refer
to IBM’s management and auditor reports to understand their responsibilities. Note that
Miniscribe also included similar reports along with its financial statements).
4. Based on the stock price behavior before and after the disclosure of fraud, comment on
the importance of accurate financial statements in valuing a firm. Cooking the Books: How Pressure to Raise Sales Led MiniScribe
To Falsify Numbers --- Q.T. Wiles, the Former Chief Of DiskDrive Company, Abrasively Drove His Staff --- Fake Cargo on
Phantom Ship
By Andy Zipser. Wall Street Journal. (Eastern edition). New York, N.Y.: Sep 11, 1989. pg. 1
Abstract (Document Summary) LONGMONT, Colo. -- Last October, as other computer-disk-drive companies were laying off hundreds
of employees, MiniScribe Corp. announced its 13th consecutive record-breaking quarter. This time,
however, the surge in sales sent a shiver of apprehension through MiniScribe's board.
The news shocked Wall Street, whose rosy financial forecasts helped quintuple MiniScribe's stock
price in just two years. After all, this was a company that, by all appearances, had risen from the dead
under the direction of Q.T. Wiles, then the chairman of Hambrecht & Quist, a highly respected venturecapital firm that in 1985 had injected $20 million into MiniScribe. Mr. Wiles's proven ability to resurrect
ailing companies was already so renowned that he was known as "Dr. Fix-It."
Instead, what was supposed to be the crowning achievement of a storied career has become an
epitaph. Mr. Wiles has resigned from MiniScribe and from half a dozen other companies, including
Hambrecht & Quist, and lives in near-seclusion. He repeatedly declined to be interviewed for this
article; his lawyers, instead, supplied a 40-page summary of a seven-hour interview in which Mr. Wiles
responded to questions from investigators hired by the company's outside directors.
Full Text (2482 words) Copyright Dow Jones & Company Inc Sep 11, 1989
LONGMONT, Colo. -- Last October, as other computer-disk-drive companies were laying off hundreds
of employees, MiniScribe Corp. announced its 13th consecutive record-breaking quarter. This time,
however, the surge in sales sent a shiver of apprehension through MiniScribe's board.
"The balance sheet was scary," says William Hambrecht, one of the directors.
What worried Mr. Hambrecht was a sudden, three-month run-up in receivables to $173 million from
$109 million, a 59% increase. Inventories were similarly bloated, swelling to $141 million from $93
million -- a dangerous development because disk drives can become obsolete from one quarter to the
next.
Seven months later, the portents that had worried Mr. Hambrecht generated grim headlines:
MiniScribe's spectacular sales gain had been fabricated. In fact, the company acknowledged, it didn't
know whether it could produce accurate financial statements for the prior three years.
The news shocked Wall Street, whose rosy financial forecasts helped quintuple MiniScribe's stock
price in just two years. After all, this was a company that, by all appearances, had risen from the dead
under the direction of Q.T. Wiles, then the chairman of Hambrecht & Quist, a highly respected venturecapital firm that in 1985 had injected $20 million into MiniScribe. Mr. Wiles's proven ability to resurrect
ailing companies was already so renowned that he was known as "Dr. Fix-It."
"It looked for two or three years like Q.T. was a miracle worker -- at least from the outside," says Jim
Porter, president of Disk/Trend Inc., a California-based market-research firm.
Instead, what was supposed to be the crowning achievement of a storied career has become an
epitaph. Mr. Wiles has resigned from MiniScribe and from half a dozen other companies, including Hambrecht & Quist, and lives in near-seclusion. He repeatedly declined to be interviewed for this
article; his lawyers, instead, supplied a 40-page summary of a seven-hour interview in which Mr. Wiles
responded to questions from investigators hired by the company's outside directors.
Virtually all of MiniScribe's top management has been dismissed, and layoffs have shrunk world-wide
employment to 5,700 from a peak of 8,350 a year ago. MiniScribe might have to write off as much as
$200 million in bad inventory and uncollectable receivables. And an audit team composed of outside
directors, under the scrutiny of the Securities and Exchange Commission, is investigating MiniScribe's
failure to provide reliable financial statements to public investors.
The audit report, expected to be released this week, is unlikely to disclose more than a summary of the
team's findings. Yet interviews with current and former executives, employees, competitors, suppliers
and industry analysts depict a corporation run amok. Mr. Wiles's unrealistic sales targets and abusive
management style created a pressure cooker that drove managers to cook the books or perish. And
cook they did -- booking shipments as sales, manipulating reserves and simply fabricating figures -- to
maintain the illusion of unbounded growth even after the industry was hit by a severe slump.
MiniScribe isn't the only high-tech company to indulge in questionable practices. Datapoint Corp.
almost went out of business seven years ago when its practice of booking shipments as sales got out
of hand, and the computer-networking concern is still struggling to return to profitability.
More recently, a highflying California company, Ashton-Tate Corp., has been sued in a federal court in
Los Angeles by shareholders accusing it of similar bookkeeping games; the company has denied any
wrongdoing. And DSC Communications Corp., of Dallas, signed a consent agreement with the SEC
this year in which it agreed to restate 1984 and 1985 results that allegedly recognized sales
prematurely.
But the temptation to fudge numbers is greatest when times are hardest, and when Quentin Thomas
Wiles arrived at MiniScribe in mid-1985, times were rock-hard. The disk-drive maker had just lost its
biggest customer, International Business Machines Corp., which decided to make its own drives. And
with the personal-computer industry then slumping, MiniScribe was drowning in red ink.
Dr. Fix-It's prescription was to slice off a fifth of the work force and overhaul the company from top to
bottom, chopping it into separate divisions grouped around different products or research efforts. Each
division had its own staff and each division manager set his own budget, sales quotas, incentives and
work rules.
The idea, Mr. Wiles has said, was to create accountability. In practice, MiniScribe became a chaotic
Babel of 20 or more minicompanies under one corporate umbrella. "There was constant change,
constant reorganization," says an employee who held 20 different positions at MiniScribe in 6 1/2
years.
Mr. Wiles also turned up the heat under his lieutenants. Four times a year, he would summon as many
as a hundred MiniScribe employees to Palm Springs for several days of intense "dash meetings," at
which participants were force-fed his idiosyncratic management philosophy. At one of the first such
meetings he attended, says a former division manager, Mr. Wiles demanded that two controllers stand,
"and then he fired them on the spot, saying to everyone, 'That's just to show everyone I'm in control of
the company.'"
At each dash meeting, division managers had to present and defend their "dash books," Mr. Wiles's
term for business plans that had to conform to a set formula. Invariably, say former participants, Mr.
Wiles would find such plans deficient and would berate their authors in front of their peers. A former
controller says Mr. Wiles would throw, kick and rip dash books that displeased him, showering his
intimidated audience with paper while yelling, "Why don't you understand this? Why can't you understand how to do this?"
Mr. Wiles, according to his attorneys, is "fairly autocratic and very demanding of the people who work
for him." Even that understates the case. In fact, Mr. Wiles's behavior drove away some of his most
senior engineers and cast a pall over those who remained. John Squires, a MiniScribe founder, says
he quit after his first dash meeting because he couldn't abide Mr. Wiles's "SWAT team" management
style.
Mr. Wiles was so intimidating, adds a former manager, that he and the executives he brought with him
became known as "the VC," derived from "venture capitalists" but alluding to the Viet Cong. Moreover,
Mr. Wiles made no bones about his plans for the company. "He used to say that the faster he could
sell MiniScribe, the better," recalls the former manager.
Then, something changed. In late 1986, the manager says, Mr. Wiles started singing a different song
at the dash meetings: "All of a sudden he was saying, 'I no longer want to be remembered as a
turnaround artist. I want to be remembered as the man who made MiniScribe a billion-dollar
company.'" Sales objectives became the company's driving force, a point Mr. Wiles underscored in the
interview with investigators, when he acknowledged that financial results became "the sole
determinant" of whether bonuses were awarded.
"Basically," a former MiniScribe accountant says, "Q.T. was saying, 'This is the number we want to hit
first quarter, second quarter, third quarter and so on,' and it was amazing to see how close they could
get to the number they wanted to hit."
Hitting the number became a companywide obsession. Although many high-tech manufacturers
accelerate shipments at the end of a quarter to boost sales -- a practice known as "stuffing the
channel" -- MiniScribe went several steps beyond that. On one occasion, an analyst relates, it shipped
more than twice as many disk drives to a computer manufacturer as had been ordered; a former
MiniScribe sales manager says the excess shipment was worth about $9 million. MiniScribe later said
it had shipped the excess drives by mistake. The extras were returned -- but by then MiniScribe had
posted a sale at the higher number. In his interview with investigators, Mr. Wiles said he wasn't aware
of any such incidents.
Other accounting maneuvers, starting as far back as 1986, involved shipments of disk drives from
MiniScribe's factory in Singapore. Most shipments went by air freight, but a squeeze on air-cargo
space toward the end of each quarter would force some shipments onto cargo ships -- which required
up to two weeks for transit. On several occasions, says a former division manager, MiniScribe
executives looking to raise sales changed purchase orders to show that a customer took title to a
shipment in Singapore, when, in fact, title wouldn't change until the drives were delivered in the U.S.
In a more dramatic version of this ruse, according to a former accountant, MiniScribe executives tried
to persuade an audit team that 1986 year-end results should book as sales the cargo on a freighter
that they contended had set sail in late December. The audit team declined to do so. Eventually, the
cargo and the freighter, which didn't exist, were simply forgotten.
MiniScribe executives also found other ways to inflate sales figures. One was to manipulate reserves,
the accounting entries designed to offset unrecognized losses, such as returns of defective
merchandise or bad debts. Mr. Wiles acknowledged to investigators that creating adequate reserves
"never did sufficiently take root in the MiniScribe organization." Despite this awareness, Mr. Wiles
failed to take corrective action and said that the last time he looked closely at the issue was in late
1986.
The problem of inadequate reserves grew so great that private analysts began noticing it in 1988.
Despite $177 million in receivables, one says, MiniScribe was booking less than 1% in reserves; the rest of the industry, meanwhile, had reserves ranging from 4% to 10%.
To avoid booking losses on returns in excess of its skimpy reserves, defective drives would be tossed
onto a "dog pile" and booked as inventory, according to Greg Fortune, a disk-drive failure-analysis
technician. Eventually, the dog-pile drives would be shipped out again to new customers, continuing
the cycle. Returns of defective merchandise ran as high as 15% in some divisions, Mr. Fortune
estimates.
At a time of strong market demand, such ploys enabled MiniScribe to seem to grow almost
exponentially, posting sales of $185 million in 1986 and $362 million in 1987. In early 1988, Mr. Wiles
was confidently forecasting a $660 million year, and he held fast to his rosy forecast even as disk-drive
sales started slipping industrywide in late spring and nosedived in the autumn. Meanwhile, Mr. Wiles
increased the pressure on his managers.
"Everyone wanted to do good by Q.T.," says a customer representative, describing how division
reports would be doctored as they rose from one bureaucratic level to the next.
Before long, the accounting gimmickry became increasingly brazen. Division managers were told to
"force the numbers," says a former marketing manager; he tells of one division controller who quit
when ordered by a vice president to lie about financial results. In this tense atmosphere, wild rumors
abounded. Workers whispered that bricks were being shipped just so a division could claim to have
met its quota. Others joked that unwanted disk drives were being shipped and returned so often that
they had to be repackaged because the boxes wore out.
Employees also joked about shipments to "account BW," an acronym for "big warehouse." But that
wasn't just a joke. MiniScribe established several warehouses around the country and in Canada as
"just-in-time" suppliers for distributors. The largest and most abused was in Los Angeles, where it
served as a supply point for Cal-Abco Inc., a major electronics-parts distributor.
Yair Barzilay, a Cal-Abco partner, says his company wasn't invoiced until it received a shipment from
the warehouse. MiniScribe, however, was booking shipments to the warehouse as sales. And because
the "just-in-time" operation wasn't under Cal-Abco's control, the number of disk drives shipped was at
MiniScribe's discretion. MiniScribe won't say how many unordered disk drives went to the warehouse,
but a former employee puts their value at $80 million to $100 million.
By last fall, MiniScribe's suppliers began to sense that something was terribly amiss. Domain
Technology, a supplier of the coated aluminum disks on which disk drives store information, says
MiniScribe started falling behind in its payments; then, its orders dropped. Eventually, says Domain's
president, David Pearce, MiniScribe was returning virtually all Domain shipments, saying they were
defective -- a contention that he vigorously denies. "We took a $7 million hit on that," he says -- a jolt
that helped push Domain into bankruptcy proceedings in June.
Wall Street, which had so eagerly embraced Mr. Wiles's previous forecasts, also began to smell
trouble. "The company was talking a really bullish game," says John Rossi, an analyst at Alex. Brown
& Sons Inc. "But I really couldn't find any significant customers other than Compaq." In fact, several
major anticipated orders on which Mr. Wiles had been pinning his hopes -- principally from Apple
Computer and Digital Equipment Corp. -- fell through in the fall.
So, by the time MiniScribe announced its 1988 results in mid-February, they simply confirmed the
growing suspicions. The company reported a fourth-quarter loss of $14.6 million and a drop in net
income for the year to $25.8 million from $31.1 million despite a 66% increase in sales to $362.5
million -- on paper, that is.
Scarcely a week later, Mr. Wiles abruptly resigned, telling board members that the company's
problems were far more pervasive than he had realized. Friends say he was devastated by what his exhaustive, three-week examination of the company revealed. "He reacted like he'd been blindsided,"
Mr. Hambrecht says. Adds a former marketing manager: "It was almost like a fraternity party, with
everybody huddling together to figure out how to keep the house dad from knowing what was going
on."
The house dad may not have wanted to know. After investigators showed him several memos that had
been distributed at a meeting he attended, Mr. Wiles acknowledged that they "indicated the opposite of
what he had previously been told." He denied having seen them and noted that if he had seen one
particular memo, "he would have certainly read it as saying 'somebody's cheating.'"
Investors say they, too, have been cheated, having seen the value of their stockholdings tumble from a
high of $15 a share to less than $3. A dozen shareholder lawsuits have been filed in federal court in
Denver in recent months, charging, in the words of the first of them, that MiniScribe "engineered phony
'sales'" to artificially inflate its stock to benefit insiders. In 1988, MiniScribe officers and directors sold
350,000 shares of company stock. The suits also charge, among other things, that Coopers &
Lybrand, the company's auditor, "participated in the conspiracy" by "falsely" certifying the company's
financial statements. Hambrecht & Quist also was named as a defendant. Both Hambrecht & Quist
and Coopers & Lybrand deny any wrongdoing.
Robert Sparacino, the chairman of the audit committee of outside directors that has been delving into
the allegations of wrongdoing, declines to say what the panel has found. All he does say is that "the
incidents that occurred were not trivial."
Credit: Staff Reporter of The Wall Street Journal MiniScribe's Investigators Determine That 'Massive Fraud' Was
Perpetrated
By Andy Zipser. Wall Street Journal. (Eastern edition). New York, N.Y.: Sep 12, 1989. pg. 1
Abstract (Document Summary) After spending six months and $2 million, an internal investigation of MiniScribe Corp. has concluded
that senior management apparently "perpetrated a massive fraud on the company, its directors, its
outside auditors and the investing public."
MiniScribe, a disk-drive manufacturer and onetime stock-market highflier based in Longmont, Colo.,
announced earlier this year that sales results for prior years had been overstated and that it couldn't
produce reliable financial results for those years. The company's chairman, Q.T. Wiles, abruptly
resigned and several top officers were dismissed.
In an executive summary of their findings, an investigative committee of outside directors said they
found fraudulent activities as far back as 1985, when Mr. Wiles, a noted turnaround specialist and then
chairman of the investment firm of Hambrecht & Quist, took over as chief executive officer. The
investigators' summary does not specifically fault Mr. Wiles, adding, however, that the fraud "required
the active participation of many company personnel" and was common knowledge within the company.
Full Text (839 words) Copyright Dow Jones & Company Inc Sep 12, 1989
After spending six months and $2 million, an internal investigation of MiniScribe Corp. has concluded
that senior management apparently "perpetrated a massive fraud on the company, its directors, its
outside auditors and the investing public."
MiniScribe, a disk-drive manufacturer and onetime stock-market highflier based in Longmont, Colo.,
announced earlier this year that sales results for prior years had been overstated and that it couldn't
produce reliable financial results for those years. The company's chairman, Q.T. Wiles, abruptly
resigned and several top officers were dismissed.
In an executive summary of their findings, an investigative committee of outside directors said they
found fraudulent activities as far back as 1985, when Mr. Wiles, a noted turnaround specialist and then
chairman of the investment firm of Hambrecht & Quist, took over as chief executive officer. The
investigators' summary does not specifically fault Mr. Wiles, adding, however, that the fraud "required
the active participation of many company personnel" and was common knowledge within the company.
Indeed, company officials went to extraordinary lengths to create the illusion of unbounded growth. In
their report, investigators said, for instance, that senior company officials:
-- "apparently broke into locked trunks containing the auditors' workpapers" during the year-end 1986
audit and changed inventory figures, inflating inventory values by approximately $1 million.
(MiniScribe's auditor is Coopers & Lybrand.)
-- packaged bricks and shipped them to distributors as disk drives in 1987, recording $4.3 million in
sales. When the shipments were returned, MiniScribe inflated its inventory by the purported cost of the
bricks.
-- "accumulated scrap that had been written off" in 1988 and included it as inventory. Obsolete parts
and scrap from the 1987 inventory were also carried on the 1988 books and valued at approximately $3.5 million.
-- packaged approximately 6,100 disk drives that had been contaminated, in order to inflate inventory
during last year's fourth quarter.
Also during 1988, the summary notes, the company "dramatically" increased shipments to three
warehouses, booking $56.4 million in sales and gross profit of $5.4 million. According to the
investigators, "none of these sales should have been recorded in 1988."
A copy of the committee's full report has been forwarded to the Securities and Exchange Commission,
according to company officials, and is said to consist of more than 1,500 pages. Copies of the report
also are being delivered to plaintiffs' attorneys in 13 shareholder and bondholder lawsuits that have
been filed in federal court in Denver. Although the investigators' summary makes scant mention of the
suits, it adds its weight to charges that MiniScribe officials defrauded shareholders, manipulated stock
prices and benefited from insider trading.
The summary says, for example, that MiniScribe's public filings "were continually and materially
incomplete and inaccurate" and offers the committee's opinion that "public investors were misled." The
summary also notes that "some MiniScribe officers sold significant amounts of company stock" while
they were aware of "material undisclosed deficiencies" in the company's financial statements.
MiniScribe deceived public investors, for example, by announcing its 1986 earnings before Coopers &
Lybrand made adjustments that reduced income, according to the summary. Rather than report the
lower earnings, MiniScribe "originated additional adjustments" to offset the auditors' findings.
But the committee also castigated the auditing firm, which is also named in the lawsuits, stating that
MiniScribe's adjustments were "countenanced by its auditors." Acknowledging that MiniScribe
"perpetrated a series of frauds directly on the auditors," the investigators nevertheless concluded that
Coopers & Lybrand "failed the company at a time when their services were most needed." The failure,
the summary says, "was one of judgment, one of failing to detect 'red flags,' one of allowing
themselves to be pushed too hard and too far."
Jack Grace, managing partner of Coopers & Lybrand's Denver office, declined to respond directly to
the committee's conclusions. In a prepared statement, however, he said the investigative report made
it clear that "Coopers & Lybrand,...

 


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