Adelphia

Introduction

Accounting misreporting is one of the easiest means to avoid taxation by showing a smaller amount of earnings that the actual one. Yet, most of the scandals that shook the world of accounting were caused by public companies inflating their earnings such as to obtain an advantage on the financial market. However, as the following case shows, this might also eventually lead to devastating effects for the companies that resort to such schemes and for the stakeholders behind the curtains.

The following case study concerns one of the most extensive financial frauds ever to take place at a public company. From at least 1998 through March 2002, Adelphia, the USA sixth largest cable-television company, systematically and fraudulently excluded billions of dollars in liabilities from its consolidated financial statements by hiding them on the books of off-balance sheet affiliates. It also inflated earnings to meet Wall Street's expectations, falsified operations statistics, and concealed blatant self-dealing by the family that founded and controlled Adelphia, the Rigas Family.

In general, the purpose in the company’s misreporting was showing investors a misleading, much brighter than in reality, picture of the company’s financial performance such as to attract investment. Another reason behind their misreporting practices was to allow the Rigas Family an abnormal and unjust control over the company’s financial resources in order to satisfy their extravagant needs. From a technical point of view the fraudulent nature of Adelphia’s reporting falls into several major cathegories:

The Omission of Liabilities from Adelphia's Financial Statements through Co-Borrowings

Between May 1999 and September 28, 2001, Adelphia entered three Credit Facilities, in which certain Adelphia subsidiaries and various Rigas Entities that own or operate cable television systems became co-borrowers. Under the terms of the agreements governing these Co-Borrowing Credit Facilities, each co-borrower may borrow up to the entire amount of the available credit under the applicable Co-Borrowing Credit Facility. In addition, each co-borrower is jointly and severally liable for the entire amount of the indebtedness under the applicable Co-Borrowing Credit Facility regardless of whether that co-borrower actually borrowed that amount. As of December 31, 2001, the maximum aggregate amount available to the co-borrowers under the Co-Borrowing Credit Facilities was $5,630,000,000. Even though the terms of the Co-Borrowing Credit Facilities made Adelphia jointly liable for all amounts outstanding, Adelphia began quarterly, beginning with the second quarter of 1999, to exclude significant portions of Co-Borrowing Credit Facility Debt from Adelphia's quarterly and annual earnings reports and financial statements and record that debt only on the books of certain Rigas Entities.

Adelphia has described aspects of Adelphia's Co-Borrowing Credit Facilities with the Rigas Entities in footnotes to its publicly filed financials, but those footnotes, however, deceptively suggested that Adelphia actually was including its liability for Rigas Entity co-borrowings in Adelphia's reported debts, when-in fact-as a result of those borrowings, Adelphia had significant liability in excess of the company's reported debts.

For example, on the December 31, 2000 balance sheet, Adelphia listed "Total subsidiary debt" of $9.179 billion and stated in the accompanying footnote that:

‘Certain subsidiaries of Adelphia are co-borrowers with [Rigas controlled] Entities under credit facilities for borrowings of up to $3,751,250. Each of the co-borrowers is liable for all borrowings under the credit agreements, and may borrow up to the entire amount of the available credit under the facility. The lenders have no recourse against Adelphia other than against Adelphia's interest in such subsidiaries.’

The footnote failed to explain that the $9.179 billion in "Total subsidiary debt" listed on Adelphia's balance sheet did not reflect Adelphia's liability for additional draw-downs under the Co-Borrowing Credit Facilities that had been placed on the books of the unconsolidated Rigas Entities. In fact, by the close of 2000, over $1.2 billion in co-borrowing liabilities had been omitted from Adelphia's balance sheet and placed on the books of Rigas Entities.

Adelphia specifically refused to alert investors to the fact that it was omitting a significant portion of its co-borrowing liabilities from its financial statements. Indeed, Adelphia management rejected Deloitte's, its financial auditor, recommendation that the footnote disclosure explaining the co-borrowings be enhanced. Beginning in at least the year 2000 audit, Deloitte recommended that Adelphia include in the footnote the total amount of credit available under the co-borrowings, as well as the total amount which had been borrowed by the Rigas Entities. Adelphia management insisted to Deloitte that the disclosure was adequate and Deloitte finally accepted.