Midnight Journal Entry

The Midnight Journal Entry Anne T. Lawrence, San Jose State University On an altogether all overcast afternoon in Portland, Oregon, on Friday, inch 28, 2003, Richard Okumoto intently studied a set of hard-copy chronicle documents called adjusting journal entries spread out on his desk. He had been appointed foreman financial rancidicer (chief financial officer) 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 familiaritys books for the third quarter of monetary form 2003, which displaceed February 28.An experienced executive who had served as chief financial officer for some(prenominal) other technology trustworthys, Okumoto was familiar with the task, which ordinarily would be routine. But this time, he felt that something was seriously amiss. When reviewing the lodges recent results, he had detect a sharp dip in accrued liabilities between the two quarters en ding whitethorn 31 (the last quarter of the 2002 fiscal year) and August 31 (the number one quarter of the current fiscal year).Now, looking at the detailed journal entries his staff had contributed, he noticed that several signifi understructuret accounting entries had been made around midnight on kinfolk 12, 2002. The entries made that September evening had significantly changed the keep companys results for the quarter ending August 31, 2002, a few days before they were crudespapered to the Securities and Exchange Commission. He after recalled The fact that the time stamps on the journal entries were midnight through one oclock in the break of the day made me rely they were having difficulties closing the quarter.Not just because of accounting difficulties, however because they were having difficulties finding the right answers. My initial chemical reaction was, even apt(p) a difficult quarterly close, if the group was realizeing that late at night, that wasnt typical . From the pass codes required by the accounting software, Okumoto could slang who had made the entries. They include James Dooley, then the companys acting chief operating officer and now the chief executive officer, the corporate controller, and several senior members of the stipend team. One midnight journal entry in particular drew the new CFOs 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 net income, had the cumulative effect of permitting the company to report earnings of $0. 01 per treat 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? Whats going on? He was sur e something was not right. RICHARD OKUMOTO innate(p) in 1952, Richard Okumoto was raised with his four siblings in a Nipponese-American family in a low-income, African-American neighborhood that surround 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. dadaism 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 director redact 9066 under which persons of Japanese ancestry on the West Coast were displace to relocation camps during World War II. They met and married in a relocation camp. During their incarceration, their families could not make their behavements. Dad and his relatives lost their land, and Moms parents lost their chicken ranch. afterwards those experiences, my father was committed to having no debt . He built our family radix in 1955, with the idea of paying off the loan in eight years.In 1962, Okumotos father, who hold outed 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, Okumotos mother took a job cleaning homes to serve well support her five children. Okumoto described his family relationship with his mother She and I had an especially close bond. Shortly before my dads accident, both her parents had died. I was the one who supported her through a very difficult year.As a result, she forever treated me other than from the other kidsalmost like an adult. The Okumoto familys financial situation after the accident was difficult. Okumoto had vivid memories of how they coped capital was very short. We had to account for every penny. Every week, my mother wrote discomfit in a le ather-bound journal everything she take in 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 mortg while.In that situation, budgeting became extremely important. Her comment to me was, You cant complain to the highest degree what you dont have unless you understand whats happening. Those were her ground rules. He added this comment or so his mothers values The ethics of doing the right thing become very important, because thats rightfully 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 Jose State University, where he comp allowed an undergraduate degree in accounting in 1974 and attended the MBA program from1975 to 1978. He soon embarked on a highly in( predicate) career in pay. Over the next two-and-a-half decades, he held increasingly responsible roles at a add up of high-technology companies in the Silicon Valley, including Fairchild Semiconductor, Novellus Systems, Measurex, Credence Systems, and Photon Dynamics. Okumoto admired a number of managers he had worked for, who had set high superior 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 political 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 practiced ethical grounding. They would always tell me to ask myselfwhat are your obligations to others? ELECTRO SCIENTIFIC INDUSTRIES, INC. Electro Scientific Industries, Inc. ESI), the company that Okumoto joined as CFO in early 2003, was the second-largest technology company in Oregon, trailing only Tektronix in size. base in Portland, the company was founded in 1944 as Brown Engineering to make test and measurement equipment. As technology evolved, so did the companys products. In the 1960s, the firmby then called ESImoved 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, ESIs core commerce was providing precision intersection 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 companys customers included many leading electronics firm s, including AMD, Ericsson, IBM, Samsung, Hitachi, Flextronics, Honeywell, and Lucent. Seventy percent of ESIs 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 slew and reported sales revenue of $167 million (down from $472 million the prior year). Like many firms in the electronics industry, ESI was seriously battered by the economic down worm that began in 2001. After achieving record sales and income in the fiscal year ending May 31, 2001, the companys financial results declined precipitously in FY 2002, as shown in render A.Sales and profits had continued to decline in the beginning(a) 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 inco me (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 company noted in its 2002 annual reportIn fiscal year 2002, ESI wea in that locationd the worst downturn in the electronics industry in over 30 yearsWe 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 in like manner informally explored a merger with another firm in southern California. In early 2002, Don VanLu vanee, the companys long-time CEO, suffered a stroke and was no longer able to serve. The dialog box 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 imperishable replacement. At that time, the board also elevated James Dooley, who had been serving as the firms chief financial officer, to the role of acting chief operating officer to run the companys 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 should appear almost(predicate) here it is at the end of the file. 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 employeesall had a long archives 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. His first task was to prepare for the FY 2003 third quarter close. In reviewing the companys books for the past several quarters, he soon noticed a sharp downward spike in the balance of accrued liabilities. He noted that fact for gain ground investigation. In addition to closing the quarter, several other items required Okumotos attention.Just one week into his new job, on February 24, he got an email from John ( bastard) Isselmann, Jr. , the widely distri simplyed counsel, asking him to forward to the manager of the Japanese office, Mike Tetsui, a set of revised work rules (terms of vocation) for ESIs Japanese employees. As a newcomer, Okumoto knew little of the background or why he had been asked to do this, besid es complied with the global counsels 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 haveI do not hold I can get concents sic from ESIs 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 Mikes reply. I had assumed that the Japanese had already been informed of the scrape uplation of their retirement benefits and agreed to the changes. It was square away they had not.In a prior job at Novellus Systems, Okumoto had set up that companys Japanese operations, and he was aware that Japanese work rules were normally filed with the government. R egulators were very strict about altering any attested benefits. Accordingly, Okumoto believed that ESI was stimulate to pay benefits that had been promised to employees, and he told Isselmann this. Okumoto also expressed the doctrine that employees, if dissatisfied with the revised rules, could take the topic before the Japanese labor board, and that this would be a quantifiable event that would have to be record 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 permutation of benefits for Japanese, Korean, and Taiwanese employees might expose ESI to litigation, and this could affect the accounting treatment of the event. Dooley powerfully 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 ESIs external size uped accountor, the companys own l egal 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 Okumotos upcoming foundation to the audit citizens 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 CEOall six feet-six inches and 280 pounds of himturned an angry red and told me again to just get past this. Thats 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, I f Ive got to reverse this entry, Ill quit. THE MOFO MEMORANDUM On March 13, Okumoto attended a skirmish 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 companys 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 Okumotos suggestion that an independent accounting firm be brought in, but it did direct Barry Harmon (formerly ESIs 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 CFOs office. Okumoto recalled He closed the door and just broke down. He told me that afte r 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 pillar over Jack, who was only 5 feet-6.I watched Jim almost sensually overtake him. Jack was a young guy, graceful 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 notify 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 Isselmanns request. The MoFo memo, now in Okumotos 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 obligate to pay them in accordance with the Rules and cannot remove them at the companys 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 permittedIt 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 employe rs 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.Under the rules of employment established for ESIs employees in Japan, any employee (except executives) who chose to retire after stretchiness the voluntary retirement age of 60 would be entitled to a retirement allowance of one months pay per year of servicein 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 companys 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.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 take down the MoFo memo, thinking that Dooleys 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 heTetsuiwould 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 conv ersation 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 companys calculations of its overhead costs, so the financial statements distributed to the board were incorrect. ESIs 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 duck earnings. That was a definite red flag. Okumoto walked out of Dooleys office stunned. He called his staff together and asked them to forgather any documentation they had on accounting entries on or ar ound 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. Thats one reason why no one stepped forward. That tone at the top created an environment where people really couldnt speak out. Its important to look at the people. Its similar to qualitative research. We all do that intuitively.When I looked at the body language of a lot of the people involvedthe cost accountants, the financial analystsit became apparent to me that they were scared. They knew something was revile, and they wanted to say something, but something held them back. They reminded me of trounce animals. Growing up in the neighborhood I did, I knew what fear looked like. As part of his further investigation, Okumoto i ndependently 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 didnt have chummy 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 entriesand who had made them. WEIGHING THE RISKS Over the weekend, Okumoto considered his next moves. none of the ndividuals and groups from whom he had sought supportthe CEO, the general counsel, or the auditorsseemed to share his concern about the seriousness of the issue. The audit committee had shown some in terest, 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 whatif anyadditional steps he should take. He had tried to warn the key players. From all, he had received the same message We dont see this as a serious problem. Let it go.Okumoto realized the risks of escalating the issue further. He was earning a base wages 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 within 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 exuberant to make good decisions?Because if you arent, I can count on the fact that you will make bad decisions when times of harm hit. We all talk about the value of making good decisions, but as we all know, spirit 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 full to get the deal done. Hire your finance people so they are not hungr y enough to do the wrong thing. He added Fortunately, I was financially in a position where I could give in to leave if t came to that. I was single, so I figured the only person I had to comfort 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 considerably 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 overcome 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 dont 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. ) Exhibit C should appear about here it is at the end of the file. Dooley was the only insider on the board.There were some old timers on the boardlike Barry Harmon, who had earlier been CFO at ESI. But there w ere 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 employ 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 tarradiddle I had been in a situation before where I hadnt 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 didnt have enough reason to support my reservations. I had only been with the company three months. Within four months, we had a major revenue shortfall. At that ti me, 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. He also thought about his mothers admonition always to do the right thing, and the advice of his mentors, who had counseled him always to ask the questionwhat are your obligations to others? Exhibit B Executives and Directors of Electro Scientific Industries, Inc. Named in the Case and Their Positions (Listed in Order of Mention)Richard Okumoto headway Financial policeman (CFO) James T. Jim DooleyActing Chief Operating Officer (COO), early 2002 December 2002 Chief Executive Officer (CEO), December 2002 Don VanLuvaneeFormer CEO David F. BolenderActing CEO, early 2002 December 2002 Chairman of the Board, December 2002 John Jack Isselmann, Jr. General Counsel Mike T etsuiManager, Japanese Office Barry L. Harmon Former Chief Financial Officer (CFO) Director and Member of the Audit Committee Gerald F. Jerry TaylorDirector and Member of the Audit Committee Jon D. TompkinsDirectorExhibit 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. chairwoman of Pacific Power and elucidation Co. (retired) 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 of ESI Keith L. Thomson Vice President (retired), Intel Corp. Chair of the Board of Trustees, University of Oregon fanny Jon D. TompkinsCEO and Chairman of the Board (retired), KLA-Tencor Corp. President and CEO of Spectra-Physics (retired) Vernon B. Ryles, Jr. President and CEO (retired), Poppers Supply Co. Gerald F. Taylor (member of the Audit Com mittee) 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. 2 . 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 ineffectual handling of a managerial situation. An earlier version of this case was presented at NACRAs 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. 3 . In 2002, norm annual salaries for ESI employees were $68,000 in Japan, $27,000 in Korea, and $38,000 in Taiwan (in U. S. dollars).