Analyzing Toshiba's Accounting Scandal: What is Crisis Management to Prevent Brand Image Damage?

“The damage to Toshiba’s brand image, arguably the greatest in its 140-year history, cannot be recovered overnight.”

This is a quote from a press conference held by Hisao Tanaka, the then-president of Toshiba, who resigned on July 21, 2015 (Gregorian calendar), taking responsibility for the accounting fraud scandal.

The systematic accounting fraud, carried out under the involvement of top management to hide deteriorating performance, inflicted significant damage on the brand image, leading to a drop in stock prices and alienation of investors.

When a company’s financial situation worsens, the risk of accounting fraud increases for various reasons, such as obtaining loans from banks or protecting the management team, especially in companies where internal controls are not functioning properly.

Once accounting fraud is exposed, not only legal measures such as criminal penalties and liability for damages are imposed, but also the intangible corporate value, such as the social credibility and brand image built up over many years, may plummet, causing severe damage that is difficult to recover.

However, there is a possibility to mitigate the damage by swiftly implementing appropriate measures after discovering accounting fraud.

Therefore, in this article, we will explain in detail how to handle the damage to the brand image when accounting fraud is exposed, using the example of Toshiba’s accounting fraud scandal.

What is Toshiba’s Accounting Scandal?

Three Categories of Accounting Issues

There are three types of issues in corporate accounting: ‘Inappropriate Accounting’, ‘Fraudulent Accounting’, and ‘Window Dressing’.

Inappropriate Accounting

Inappropriate accounting refers to incorrect accounting processes, regardless of whether they are intentional or due to carelessness, such as not using correct information or misuse.

Although ‘Fraudulent Accounting’ and ‘Window Dressing’, which are violations of laws, are also included in inappropriate accounting, many media use it to distinguish from ‘Fraudulent Accounting’ when the illegality is not clear.

Fraudulent Accounting

Fraudulent accounting refers to intentionally making false statements in financial statements or not recording numbers that should be recorded, thereby making revenues look better than they actually are. In a broader sense, it also includes ‘Window Dressing’.

Window Dressing

Window dressing refers to manipulating financial documents such as ‘Profit and Loss Statements’ and ‘Balance Sheets’ for the benefit or protection of management, making the company’s financial and management situation look better than it actually is.

Overview of Fraudulent Accounting at Toshiba

The Toshiba accounting scandal refers to an incident where profit manipulation exceeding 150 billion yen was carried out over a long period from the fiscal year 2008 to the fiscal year 2014 (April to December).

Toshiba fell into its largest ever deficit due to the financial crisis caused by the Lehman Shock in 2008. Furthermore, one of its main businesses at the time, the nuclear power plant business, ran aground due to the Great East Japan Earthquake in March 2011.

As a result, the management top, calling it a ‘challenge’, demanded the achievement of difficult profit targets from the field, leading to the recording of apparent profits through fraudulent accounting.

However, an internal report submitted to the Securities and Exchange Surveillance Commission in February 2015 triggered the discovery of Toshiba’s fraudulent accounting.

In the investigation report of the third-party committee composed of 98 lawyers and certified public accountants, it was concluded that there was an organized fraudulent accounting heavily involved by the management top.

What Happens When Fraudulent Accounting is Conducted?

Various legal measures are established against fraudulent accounting under laws such as the “Japanese Financial Instruments and Exchange Act,” “Japanese Companies Act,” “Japanese Penal Code,” and “Japanese Civil Code.”

About Criminal Penalties

False Statement in Securities Report

If a false statement is made on a significant matter in the securities report and submitted, not only the perpetrator but also the company will be punished.

For the perpetrator, imprisonment for up to 10 years or a fine of up to 10 million yen, or both (Article 197, Paragraph 1, Item 1 of the Japanese Financial Instruments and Exchange Act)

For the company, a fine of up to 700 million yen (Article 207 of the Japanese Financial Instruments and Exchange Act)

Special Breach of Trust

If a director or similar person conducts fraudulent accounting for their own or a third party’s benefit and causes damage to the company, they may be sentenced to imprisonment for up to 10 years or a fine of up to 10 million yen, or both. (Article 960 of the Japanese Companies Act)

Furthermore, if the surplus funds generated by fraudulent accounting are distributed to shareholders, the director or similar person may be sentenced to imprisonment for up to 5 years or a fine of up to 5 million yen, or both. (Article 963 of the Japanese Companies Act)

Fraud

If you receive financing from financial institutions etc. by making your performance and financial situation look better than they actually are through fraudulent accounting, you may be sentenced to imprisonment for up to 10 years for fraud. (Article 246 of the Japanese Penal Code)

About Civil Liability

Directors’ Liability for Damages

If a director or similar person makes a false statement in financial documents etc. with malice or gross negligence and causes damage to a third party, they will be liable for damages to the third party. (Article 429 of the Japanese Companies Act)

Also, in the case of false statements in securities registration statements, or omission of important facts, the company’s directors etc. will be liable for damages to those who acquired or disposed of the securities without knowing about the false statements etc. (Articles 21, 22, and 24-4 of the Japanese Financial Instruments and Exchange Act)

Company’s Liability for Damages

In the case of false statements on important matters in securities registration statements, or omission of important facts, the company will be liable for damages equivalent to the difference in market price to those who acquired the securities in response to the solicitation or sale. (Articles 18 and 19 of the Japanese Financial Instruments and Exchange Act)

In addition, there is also a possibility of being held liable for damages under Article 709 of the Japanese Civil Code (Tort).

Order to Pay Surcharge

If a company submits a securities registration statement etc. with false statements on important matters or omission of important facts, it will be ordered to pay a specified surcharge to the national treasury. (Article 172-4 of the Japanese Financial Instruments and Exchange Act)

Measures to Minimize Damage to Brand Image

To minimize damage to your brand image, it is necessary to ① respond appropriately in accordance with laws and regulations and ② disclose information quickly and accurately.

Investigation by a Third-Party Committee, Not an Internal Organization

When financial misconduct is uncovered, it is important to conduct an objective investigation. Typically, a “third-party committee” composed of impartial experts is established to investigate the facts, identify the cause, and consider measures to prevent recurrence.

In the case of Toshiba, initially, a “special investigation committee” was established, consisting of four out of six members who were current executives of Toshiba, with the then Muromachi chairman as the chairman. The following month, a “third-party committee” was established.

Not only in this case, but also when a company’s scandal is uncovered, establishing a “third-party committee” composed of neutral and fair experts and promptly disclosing the investigation report can minimize damage to social credibility and brand image.

It is unclear why Toshiba did not conduct an investigation by the “third-party committee” from the beginning, but if they had requested an investigation by the “third-party committee” when the financial misconduct was uncovered, the facts would have been known much earlier.

In fact, the amount of profit manipulation revealed by the internal organization’s “special investigation committee” was 4.4 billion yen, and an additional 151.8 billion yen of profit manipulation was found in the investigation by the “third-party committee” established a month later.

Trust in a Company Can Vary Greatly Depending on How It Handles the Media

Whether for individuals or corporations, the best media response when misconduct is uncovered is to quickly and honestly disclose the facts. Concealing or distorting the facts will only worsen the situation.

Toshiba’s initial media response to this issue was as follows:

• April 2015: Announced the establishment of a “special investigation committee” in a press release, stating that matters requiring investigation were found in relation to accounting treatment for some infrastructure-related construction progress standards.
• May 2015: Announced in a press release the establishment of a “third-party committee” for the purpose of requesting investigation, cause identification, and prevention measures, as “improper accounting treatment” related to infrastructure-related cases was found in the investigation by the special investigation committee.
• June 2015: Reported that there was “improper accounting treatment” in the self-check by the “special investigation committee”.

As can be seen from this flow, Toshiba consistently did not admit to the fact of “financial misconduct” and continued to announce “improper accounting treatment”. Therefore, when the third-party committee’s investigation revealed systematic violations of laws and regulations, social credibility and brand image were further significantly damaged.

Prompt Disclosure of Information to Investors

Listed companies have an obligation to provide investors with important company information (timely disclosure system), and the “Securities Listing Regulations” of the Tokyo Stock Exchange, where Toshiba is listed, stipulates as follows:

If a fact that has a significant impact on investors’ investment decisions occurs in relation to the operation, business or property of the listed company or the listed securities, etc., the content must be disclosed immediately in accordance with the enforcement rules. (Article 402, Paragraph 1, Item (2) x)

The loss caused to investors by false statements in securities reports cannot be erased, but it is possible to prevent subsequent losses by prompt disclosure of information.

In the case of Toshiba, the Japan Custody Bank and the Japan Master Trust Bank filed a lawsuit for damages due to a drop in stock prices, and a compensation order of about 160 million yen was issued. In addition, the total amount of claims from lawsuits filed by investors in Japan and abroad is said to be as high as about 178 billion yen.

If information had been disclosed immediately when the financial misconduct was uncovered, the amount might not have been so large, and it might have been possible to avoid losing the trust of investors.

Early Reporting of Violations to the Securities and Exchange Surveillance Commission

Under the Financial Instruments and Exchange Act, a system has been established to reduce the fine by 50% if the violator reports the fact of the violation before the authorities take action for violations such as false statements in securities reports. (Article 185-7, Paragraph 14)

If Toshiba’s management had reported the violation before the inspection or report collection by the Securities and Exchange Surveillance Commission and the Financial Services Agency, etc. started, the fine of 7,373.5 million yen that was ordered to be paid could have been reduced by 50%.

This is not directly related to a company’s social credibility or brand image, but continuing to hide financial misconduct that would be revealed if experts investigated it for many years only widens the wound.

Summary

If mishandled, the revelation of fraudulent accounting can significantly damage the social credibility and brand image that a company has built over many years.

Furthermore, there are numerous related laws and regulations, and appropriate responses are required not only for stakeholders but also for relevant authorities such as the Public Prosecutor’s Office, the Fair Trade Commission, the Financial Services Agency, listed stock exchanges, and the media.

Therefore, when fraudulent accounting is uncovered, we recommend consulting with a lawyer who has extensive knowledge and experience, rather than making independent judgments about how to proceed.

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