With Enron, Tyco, WorldCom and a host of other accounting scandals in the headlines, it’s easy to forget that some companies still go bankrupt the old-fashioned way.

Gleason & Associates has analyzed numerous cases where businesses have failed and people are looking for someone to blame. These cases have involved accusations of fraud, negligence and mismanagement directed toward companies and their officers, directors or advisors. In many, however, the company’s downfall resulted from poor business decisions, high risk strategies, uncontrollable market forces, inadequate marketing or insufficient capital, not financial misstatements, fraud or negligence.

“Our role is to determine why a company went bad and when,” says Tom Pratt, director of Gleason & Associates. “Don’t always assume fraud or negligence. Sometimes people make investments that just don’t pan out.”

‘Bad’ Examples
Consider the case involving a public company in the wholesale distribution business whose accounting firm and law firm were both accused of aiding in fraudulent acts and misstating the company’s financials. In an attempt to grow and diversify, the company had made several risky acquisitions, including multiple acquisitions in an unrelated industry. That’s when the company came undone.

“Our analysis showed that the company overpaid for many of its acquisitions and that the synergies they expected from merging the organizations never materialized,” explains Pratt. “The financial information provided to the lenders when the company embarked on the strategy showed the risks, but the creditors didn’t want to admit that they had made a bad deal.”

Another victim of a high risk acquisition strategy was a privately held supermarket chain with hundreds of stores in several southern states. When the failed acquisition of a competing retailer forced the company into bankruptcy, its lenders and creditors sued, claiming financial mismanagement and fraud. Gleason’s review of the transaction documents revealed, however, that the company appropriately disclosed the risks involved in the acquisition to the interested parties.

Worst of Both Worlds
Sometimes companies manipulate their numbers to hide the bad business decisions that actually caused the financial decline. According to Long, when bad deals and fraudulent deals are linked, it’s important to distinguish between them.

Financial fraud occurs when a company intentionally misstates its financials, creating a fictitious financial picture that generates undeserving investments. To win damages from a financial fraud claim, plaintiffs must prove that they were harmed by the ruse. Often, though, investors were simply taken in by a bad business deal.

“Recently we analyzed a case for a defendant that was accused of manipulating its numbers and defrauding creditors. The motive was to preserve jobs and buy some time until management’s strategy for improving the company’s financial situation began to work. Although management may have lied about the financials, the company had initially been jeopardized by poor operating, marketing and strategic decisions, not the financial statement fraud in itself,” says Long.

Long doesn’t dismiss the importance of accurate financial information, however, which is key for management, investors and creditors. “While some creditors were indeed harmed by the misstated financial statements, at the core of this case were some bad business deals and poor strategic decisions that just didn’t work out as planned.”

Excerpted from Briefly Speaking, a complimentary newsletter published by Gleason & Associates. Subscribe