The Sunbeams Dark Days

Published Date: 02 Nov 2017

By:

Lauretta Lovejoy

Kyle Downey

Jonathan Wooddy

Stuart Johnson

History of Sunbeam

Sunbeam was originally founded in 1897 as the Chicago Flexible Shaft Company, CFSC, to produce sheep shearing and horse trimming machinery. In 1910, CFSC started producing electrical home appliances and in 1946 branded the name, Sunbeam. Today, Sunbeam is a subsidiary of the parent company, Jarden Corporation, and is a surprising stable and profitable company. But if people remember hearing about Sunbeam in the news a decade ago, they would find it very hard to believe that Sunbeam is both stable and profitable. Only ten years ago Sunbeam was facing accusations of grossly misrepresenting themselves on their financials, deceiving investors and shareholders.

Throughout the twentieth century, Sunbeam grew into a major American producer of kitchen appliances, bedding, and other home appliances. Some people might recognize some common home appliances such as the Sunbeam CG Waffle Iron and the fully automatic T20 Toaster, others may remember the famous Coffeemaster. Sunbeam products became a staple in most American homes. The success was not easy, however, coming from numerous purchases and acquisitions, new product lines, and handfuls of CEO’s. Sunbeam experienced a rollercoaster of growth, in 1987 the company filed for chapter 11 bankruptcy but by 1991 sales had increased enough for them to make the Fortune 500 list.

In 1996, Sunbeam’s profits had declined 83% since 1994 and stock was down 52%; the company was on the path to bankruptcy. After many failed attempts to sell the company, Michael Price and Michael Steinhardt decided to hire Albert J. Dunlap as the new CEO and Chairman. Nicknamed "Chainsaw Al", Mr. Dunlap was an "A list" executive in the business world. Notoriously known for his ruthless leadership decisions, he proved to be extremely successful at restructuring failing companies and increasing their profits by firing employees and consolidating facilities. Michael Price and Michael Steinhardt had high hopes of Mr. Dunlap making Sunbeam successful again.

Sunbeam Resurrection Backfires

The day after Dunlap was named CEO and Chairman, Sunbeam’s stock jumped nearly 50% from around $12.50 to $18.63. As mentioned previously, Dunlap believed in dramatically downsizing costs for companies in various ways, in particularly with expansive layoffs. He believed that every business’s primary goal should be to increase shareholder value, and that is just what he planned to do with Sunbeam.

Dunlap’s restructuring plan can be organized into four simple steps: 1. Get the right management team, 2. Cut Costs, 3. Focus on the Core business, and 4. Develop a real strategy. As soon as Dunlap took the position as CEO he began to change Sunbeam’s management team. He only retained one senior executive from the previous management team, and replaced the rest with people who had previously worked under him, namely Russ Kersh - a close colleague, as his new CFO. He called his new team the "Dream team for Sunbeam". After appointing his own top officials, Dunlap and his "dream team" began the process of cutting costs. True to his reputation, Dunlap "eliminated about half of Sunbeam’s 12,000 jobs, sold poor-performing units, and closed facilities. Overall, annual expenses fell $225, or $2.62 a share, a company spokesman says" (Hagerty). Around the time of these events Sunbeam’s stock jumped again to the mid $20 range. After the massive layoffs, decreased facilities, and reduced product differentiation, Dunlap was ready to focus on Sunbeam’s Core business. He divested any product line that did not directly relate to the Sunbeam name. Finally, Dunlap and his team defined Sunbeam’s strategy as,

"driving the growth of the company through core business expansions by further differentiating Sunbeam’s products from competitors’, moving into new global markets, and introducing new products that were linked directly to emerging customer trends as lifestyles evolved around the world" (Drever)

After only seven months, Dunlap had completed his reorganization of the company. Sunbeam reported record sales and earnings for 1997 and with stock selling at more than 48$/share, Dunlap was ready to sell. Unfortunately with the exponential growth of Sunbeam’s stock price, it’s market capitalization was over $4 billion, and no investors were willing to pay that price for a company with only $1.2 billion revenue on their books. After the failed attempt to sell, Dunlap decided to purchase controlling interest in three companies – Cole-man, Signature Brands, and First Alert. Within only two short days Sunbeam’s stock rose to an all time high of $52. With this peak, Dunlap was offered a new contract more than doubling his annual base salary to $2 million.

The unraveling of Dunlap’s success, and the onset of an SEC investigation into Sunbeam’s accounting practices cannot be attributed to just one event, but rather a multitude of events. In the end, "there was no smoking gun, but taken as a whole, it was not a sustainable situation" (Byrne). The large purchase of the three companies in the beginning of 1998 perked many people’s interest and rumors began to spread that the purchases were an attempt to cover previous losses. One particular analyst, Andrew Shore, had been closely following Sunbeam since Dunlap’s takeover. At first, Shore began to recognize unusual accumulating levels of inventory and accounts receivable, which he noted as odd. His suspicions were confirmed when insiders said that Sunbeam had been giving lucrative deals to dealers who would ship their items aggressively. Shore continued to scrutinize Sunbeam’s financials, but didn’t have his clients pull out just yet. Red flags continued with reports of Sunbeam selling unusual volumes of certain products in their off seasons – electric blankets in the summer, grills in the winter. By the beginning of 1998, the internal workings of Sunbeam were starting to fall apart. Management began to clash over how aggressively Sunbeam should be pursuing revenues, and pivotal executives either resigned or were terminated by Dunlap. And on April 3, 1998 after Sunbeam divulged it would be reporting a loss for the first quarter, stock immediately fell 25% and soon after shareholders began filing lawsuits on grounds that Sunbeam had deceived them.

In addition, the loss in the first quarter of 1998 brought concern to Sunbeam’s Board of Directors. They called Dunlap in to discuss the loss as well as the next quarter’s predictions. The Board was not pleased with Dunlap’s predicted numbers for the second quarter, but nonetheless trusted Dunlap. But when the Board caught wind of the shady accounting practices that were going on coupled with Dunlap’s plans to quit, they began to look into the company’s financials. Langerman, the only board member who did not have close ties to Dunlap, decided to dig deeper and began calling and questioning Sunbeam insiders, including top executives. Answers came in the form of Sunbeam’s Executive Vice President, David Fannin. Fannin, who had been brought in by Dunlap, had become disillusioned to Dunlap’s unscrupulous and immoral ways of operating. Fannin told Langerman that Sunbeam’s numbers weren’t only "soft", but Sunbeam had a crisis on their hands. Fannin quoted Gluck, the company’s controller, as saying, "Look, as much as possible we tried to do things in accordance with GAAP, but everything has been pushed to the limit" (Byrne). An emergency meeting was called and all the outside board members decided it was time for Dunlap to go. But, word got out to the public too fast, and in June of 1998 Barron’s published an article stating that Sunbeam had been participating in questionable accounting practices. The internal investigation that Langerman had begun, continued with the SEC coming in and revealing exactly how deep a crisis Sunbeam was in.

SEC Investigation

As previously noted, there were multiple reasons as to how the Sunbeam fraud came to light and what initially launched the investigation. As a result of multiple internal suspicion’s the Securities and Exchange Commission officially became involved in the situation and "in May 2001, SEC file[d] a complaint against 5 of Sunbeam Corporation’s former officers, alleging that senior management of Sunbeam engaged in fraudulent scheme to create an illusion of successful restructure of the company" (http://www.analyzr.org/tag/bill-and-hold-sales/). It was discovered that through the use of "bill and hold" schemes, "channel stuffing", "cookie jar reserves", and multiple other improper accounting means Dunlap and management were able to fraudulently inflate Sunbeam’s bottom line. Dunlap had orchestrated a massive accounting scandal. The SEC scrutinized the financial statements of Sunbeam and ultimately discovered that the sudden increase in demand of barbeque grills and electric blankets did not hold up under evidence. After this was discovered the rest of the missing information was soon filled in.

While during the time Dunlap was CEO of Sunbeam, investors saw stock prices more than double; this was entirely artificial. Dunlap began by creating "cookie jar reserves" of over $35 million at the end of 1996. Cookie jar reserves, in simple terms, inflate provisions for expenses and then later reverses them to adjust quarterly earnings; it is a very common technique of fraudulent accounting for restructuring reserves and restructuring charges. Management is able to pad these reserve accounts, ultimately creating "cookie jar reserves". Sunbeam was able to pad the restructuring charges with excessive write-downs, prematurely recognized expenses, and other miscellaneous charges and accruals; ultimately distorting financial statements for 1996. In addition, Sunbeam created a litigation reserve fund of $12 million dollars (overstated by $6 million), which was in direct violation of FAS 5, which directly tells companies when to create a litigation fund and how to estimate its losses. As all these reserves were released to income in 1997, quarterly reports became grossly inflated.

Dunlap and top executives continued to inflate earnings with the use of "channel stuffing" and "bill and hold" schemes as means to execute and conceal fraud. Channel stuffing is an unethical means of inflating revenues by way of forcing more products through a distribution channel than the channel is capable of selling. Dunlap did this by offering incentives, such as large discounts and lenient return policies, to Sunbeam’s many retailers to buy products that would have otherwise not been sold until a later period. In early 1997, Sunbeam recognized $400 million in income on sales of grills to a wholesaler. This wholesaler was allowed, with no costs, to return any grills that did not sell, and did end up returning 100% of the grills.

Bill and hold schemes, though very similar to channel stuffing, vary in that bill and hold transactions are sales of products, typically at the end of an accounting period, where revenue is recognized but the actual goods are not shipped. Bill and hold accounting practices, though not illegal in and of themselves, must have a substantial business purpose in the eyes of the SEC and comply with stringent criteria. Using bill and hold techniques allows companies to bill customers and recognize revenue before physically delivering goods or services to these customers, making it a very controversial practice due to the ease of inflating current period revenue meant for subsequent accounting periods. The following are the criteria for a legal bill and hold transaction: 1. The buyer, not the seller, must request the sale be on a bill and hold basis, the buyer must have a substantial business purpose for requesting a bill and hold sale, and all risks of ownership must be passed to the buyer. Sunbeam violated each and every one of these criteria. Sunbeam offered steep discounts and favorable rates and return policies to customers to ensure purchase orders at the end of a quarter, and all costs of shipping, storing, and insuring the inventory was covered by Sunbeam. In one instance a distributer agreed to hold a large order for a retailer if Sunbeam gave them a portion of the profit.

Sunbeam’s management used other miscellaneous means of boosting sales for the company. Sunbeam prematurely recognized income from rebates related to purchases in later periods. And the SEC confirmed suspicions that Sunbeam’s acquisition of the well-known brands Coleman, First Alert and Signature were attained to conceal Sunbeams growing difficulties.

Arthur Anderson, the public accounting firm that was responsible for auditing Sunbeam’s financial statements, ended up with multiple lawsuits against them as well. Arthur Anderson is partly responsible for the fraud committed by Sunbeam because as auditors they are responsible for certifying the financial statements that were misstated. The following excerpt from the SEC investigation of Sunbeam and Arthur Anderson illustrates Arthur Anderson’s role in the affair;

"Harlow, a former partner at Arthur Andersen, LLP ("Andersen"), Sunbeam Corporation's ("Sunbeam" or "the Company") out-side auditing firm, failed to comply with Generally Accepted Auditing Standards ("GAAS") in auditing Sunbeam's 1996 and 1997 financial statements. Harlow proposed certain adjustments that management rejected, and Harlow passed on the adjustments after quantitative materiality analysis. This resulted in Andersen's audit reports on those financial statements being inac-curate in that the reports stated incorrectly that Sunbeam's financial statements conformed to GAAP and that the Andersen audits were conducted in accordance with GAAS." (http://www.sec.gov/litigation/admin/34-47261.htm)

Ultimately it was discovered that due to Dunlap’s fraudulent accounting practices, Sunbeam’s 1997 earnings were inflated by more than sixty million dollars (see income statement in appendix). As a result of this Sunbeam was required to restate the financial statements for years 1996,1997 and 1998. Dunlap deceptively created massive losses in the year 1996 only to make it look like a dramatic turnaround had happened in the years 1997 and 1998. Following the outbreak of the fraud Dunlap was fired from his position at Sunbeam and forced to pay fifteen million in settlement allegations. Due to the monumental crash in the company’s value following the results of the investigation, Sunbeam filed chapter 11 bankruptcy. Arthur Anderson, being the auditor of Sunbeam, was forced to over one hundred million dollars in a lawsuit with the SEC as a result of the Sunbeam fraud. The SEC sued Dunlap, several other officers at Sunbeam and Phillip Harlow, who was Sunbeam’s accountant at Arthur Anderson, and Dunlap is never again allowed to serve as a director or officer of any publicly registered company every again. 

Similar to other perpetrated frauds, the Sunbeam fraud can be visualized and broken down using the fraud triangle. Fraud is not a random occurrence and can happen whenever and wherever conditions are right. All factors of the fraud triangle - rationalization, opportunity, and motivation- are present in this scandal.  Dunlap's mentality that only shareholder value matters coupled with the fact that executives and employees were afraid of losing their jobs represents the pressure aspect of the fraud triangle. Opportunity arose when Dunlap was able to bring in his own management team when taking over as CEO of Sunbeam, thereby giving him more power and authority than normal. Finally, Dunlap most likely rationalized his actions with his own ego. Dunlap was a hotshot, he knew what was best for the company and he didn't feel like he had to play by the rules. Fraud deterrence is an ongoing and proactive process that forces companies to identify and remove these casual factors of the fraud triangle. If Sunbeam would have recognized these signs earlier they could have attacked this fraud at its roots and potentially stopped it before it even began.

Implications

In the end Sunbeam, many of the key executives of Sunbeam, and Arthur Anderson dealt with consequences of the fraud. "Chainsaw Al" was fired on June 13, 1998 after the Board became aware of the fraudulent accounting practices. Shortly after his firing, he filed an arbitration claim against Sunbeam to recover $5.5 million in unpaid salary. And in June of 1999 a judge ruled in favor of Mr. Dunlap. In the beginning of 2002, Mr. Dunlap and other former executives agreed to pay $15 million to settle a stockholder lawsuit for inflating stock prices. In addition, Mr. Dunlap agreed to pay a $500,000 fine on September 2, 2002. Russell Kersh, the former CFO of Sunbeam and a top management official at Scott Paper along side Mr. Dunlap, agreed to pay fines to the SEC of $200,000 and $250,000 in a previous shareholder suit. Both Mr. Dunlap and Mr. Kersh were banned from working as top management officials at public companies, thereafter. After these settlements, Mr. Dunlap still neither admitted to nor denied any wrongdoing. In fact, he said the fraud charges were "totally false." This type of mentality is definitely a rationalization for committing fraud. Even though he violated GAAP accounting principles and practices, he didn’t think he was doing anything wrong, and probably thought his actions were in the best interests of the company. Rationalizing fraud is common among top managements officials that are guilty of fraudulent financial reporting. Mr. Dunlap did not have best intentions for the employees and company as a whole, but rather was trying to sell the company for personal gain by using falsely inflated stock prices.

Phillip E. Harlow, the Arthur Anderson Partner in charge of the Sunbeam Audit, had fraud charges dropped by the SEC. Mr. Harlow was allowed to settle the charges of "improper professional conduct" without admitting or denying guilt. Arthur Anderson stood behind Mr. Harlow, saying that the Sunbeam case was not about fraud but rather about "professional disagreements on the application of sophisticated accounting standards." Mr. Harlow was barred from accounting with consideration for reinstatement three years later. Arthur Anderson agreed to pay $110 million to settle a Sunbeam’s shareholder suit. However, soon after the Sunbeam settlement, Arthur Anderson would basically cease to exist after being involved with another accounting scandal with their client, Enron.

Shortly after firing Mr. Dunlap, Sunbeam hired Jerry W. Levin as their new CEO. With very little time to turn the company around, Mr. Levin led the company into bankruptcy. However, bankruptcy was short-lived. Sunbeam emerged from bankruptcy in 2002 as American Household, Inc. and in 2004 was purchased by Jarden Corporation.

The Sunbeam fraud scandal came just before the emergence of the larger accounting fraud scandals such as Enron and WorldCom. These major accounting scandals paved the way for congress to pass the Sarbanes Oxley Act of 2002, which established the Public Company Accounting Oversight Board (PCAOB) and established standards for external auditor independence. The PCAOB is essentially auditors of the auditors, which now exists to provide further regulations to assure the integrity of public company financial statements.

What Could Have Been Done Differently?

Fraud is not easy to prevent, detect or correct. Management override of controls and collusion are two major techniques companies can use to disguise fraud. Many reasons exist as to how to prevent the Sunbeam fraud from occurring. For Sunbeam, fraud could have been best prevented by proper segregation of duties and strong internal controls. Even though it was top management officials committing fraud, segregation of duties would have allowed for firmer monitoring by the Board of Directors. In addition, it seems as though there was very little internal control assessment done. Furthermore, Arthur Anderson could have acted with more professional skepticism. For example, Mr. Harlow knew Sunbeam had departures from GAAP in recording profit, however, he signed off on the Audit because he deemed the misstatement amount immaterial. These misstatements should have opened the doors to more thorough investigations of accounts and tests of internal controls.

Three fraud risk factors that should be assessed to detect fraud during the audits are pressures/incentives, opportunity, and rationalization. In the investigation and audit, Anderson should have assessed the three factors that make up the Fraud Triangle. They would have seen that each was prevalent in Sunbeam’s control environment. Numerous pressures and incentives existed at Sunbeam. Top management was under extreme pressures from Mr. Dunlap to do whatever needed to be done to increase profits and earnings so that Sunbeam could make financial analysts estimations. They feared getting fired by Mr. Dunlap after hearing about his ruthless reputation as a CEO. In regards to pressure, Mr. Gluck revealed to the Board that the company had tried to do things in accordance with GAAP, but allegedly stated that everything was "pushed to the limit." Mr. Dunlap himself had personal incentives to manipulate the financial statements. Also, he had his own pressures to not only live up to his reputation in turning companies around, but he also felt obligated to perform the way the Board expected him to. He was also expecting to be rewarded huge profits from the rise of the inflated stock prices and his stock options. Opportunity for fraud existed because of top management’s ability to override controls and work collusively. First and foremost, Mr. Dunlap chose his own top management team, which is a high risk for collusion. Also, perhaps top management officials knew of irregular accounting practices, but did not whistle blow because of collusion. In addition, Mr. Dunlap had the opportunity because the Board provided poor monitoring controls. In detecting fraud, it is the Board’s responsibility to oversee the integrity, quality, transparency, and reliability of the financial reporting process. In addition, the Board is responsible to oversee the effectiveness of internal controls. They did not have the slightest bit of skepticism as to how Mr. Dunlap was so successful at turning companies around. This raises the question that the Board itself gave into fears of going bankrupt as to the reason behind them turning a blind eye while overseeing the financial reporting process. Unfortunately, in the end the company went bankrupt anyways. After hiring him, they did not monitor him, thus giving him a greater opportunity to manipulate the financial statements. Lastly, Mr. Dunlap rationalized his wrongdoings. He has never admitted to any wrongdoing and states that his practices were not fraudulent. In addition, Arthur Anderson rationalized the wrongdoing by saying that the amount was immaterial. However, they still should have acted by investigating deeper into irregular accounting practices.

Investigating deeper into red flagged accounts involving bill and hold transactions and channel stuffing would have detected the fraud. Performing substantive tests on revenue accounts and inventory would have shown that Sunbeam was billing customers more inventory than they had ordered. Sunbeam was recording revenue as the amount in both Sales and Inventory On Hand. Channel stuffing could have been caught if investigators had confirmed with certain customers the amount they ordered on their invoices. If investigators found out that Sunbeam was sending them more than they ordered, and recording it as additional revenue, then many eyebrows would have been raised.

However, channel stuffing is very hard to detect without whistleblowers. One way to investigate channel stuffing would be to compare the number of inventory shipped to the customer in 1996 and 1997 and then see what inventory the customer actually recorded and sold. In addition, returns should be analyzed for appropriateness. Channel stuffing may have brought Sunbeam short term increases in revenue, however, it eventually caught up with them. Using ratio analysis on Inventory accounts, it was pretty obvious to investigators that they were inflating revenues with unusual inventory sales: i.e. increase in grill sales in the winter.

Bill-and-hold techniques should have been investigated in the years of Mr. Dunlap’s tenure. Investigating for premature revenue recognition, the likelihood of catching Sunbeam using bill-and-hold practices would have increased. Sunbeam would agree to ship the goods at a later date, and then would record revenue as the amount equal to Inventory On Hand and Sales. This practice inflates revenue and would have been detected by investigating Inventory amounts and Sales Invoices.

Using Investigating techniques to detect fraud can be very beneficial. Anderson and investigators should have performed additional procedures on red flagged accounts, which consist of main fraud alert accounts, such as Inventory and Revenue. Manual journal entry testing on large and unique transactions, such as the unusual sale of grills in the winter, probably would have detected false accounting practices.

Investigations also involve communicating and discussing fraud with top officials. Conducting behavior analysis through interviews with top officials will give the investigators more assessment information to base their judgments off of. Auditors should be able to detect deception while interviewing top management for fraud. Sunbeams top management would have given off numerous deceptive signals, resulting in a more thorough investigation.

Key Lessons Learned

What can be learned from the Sunbeam fraud scandal? Many important points come to mind, in evaluating the case in regards to society as a whole and us as a team.

Chainsaw Al’s methods were too good to be true. It is important for society to recognize that usually, but not always, when someone is able to perform a magnificent turn around of profits in very little time, it may because of lying and cheating. Take Bernie Madoff for example, he was able to guarantee around an 18% return on investment. This type of return was unheard of in the investment-banking world. An investigation would have realized his high returns were false. In Sunbeam’s case, it should be noted that further investigation should have occurred before hiring Mr. Dunlap. It is a valuable lesson that anyone can cut costs, whether by firing the majority of employees, or from lying on financial statements about the amount of revenues. In Sunbeam’s case, Mr. Dunlap did both. This also ties into the Control Environment, or tone at the top. If top management culture is collusive and corrupt, then society should recognize that fraud is almost a guarantee. Nowadays, auditors cannot accept a new client without evaluating and getting proof of a client’s management’s integrity as well as their sound policies and procedures.

Collusion also leads into another key lesson learned. New and Old employees both matter in a company that is trying to succeed. Sunbeam should have had a good balance of new and old employees at the top management level to avoid the risk of collusion. Because Mr. Dunlap fired the majority of the old top management executives, he was able to bring in his own team and work collusively. It is important for companies to avoid collusive relationships in top management positions and alternatively try to have a balance of old and new employees to better chance of whistleblowing on fraudulent activities if detected.

Another key lesson learned for society and us as a team involved the relationship for Sunbeam had with customers. Customers need to be aware that Channel Stuffing is an illegal accounting practice and bill-and-holding is only allowed to be authorized by the buyer.

An important lesson learned for society and us as a team is to still have important values such as respect in the business world. Yes, Mr. Dunlap was perceived as a very successful, popular businessman. However, when he was accused of fraud, even his own son laughed at him. Many people disliked Mr. Dunlap for his ruthless ways and did not value him as a person. It is important to act with integrity in the business world. In other words, Mr. Dunlap did not treat many other employees with respect. Most employees feared that he was going to fire him. In order to run a company more successfully, and without falsely cooking the books, business leaders need to show employees the respect they deserve. In the long run more will get accomplished. It is important to maintain a good reputation as a business leader.

Reliable numbers still matter. It is important for society and us as a team to realize that companies financial statement results should be presented fairly and accurately. So many people relied on Sunbeam’s financial statements: shareholders, employees, the Board, investors, etc. Making sure all the correct numbers are accounted proves that company has integrity and their financial statements can be relied on for the greater good.

Strong internal controls and strong segregation of duties will almost certainly decrease the risk of fraud in a company. Management override of the controls can be monitored with proper segregation of duties in place. Auditors perform fraud risk assessments and need to act with professional skepticism. It is important for auditors to avoid management’s books and perform enough tests to be satisfied themselves. Although it was concluded that Arthur Anderson did not break any laws, they did not act with the best intentions for society.

Appendix

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