Relentless monetary tightening imposed a greater financial strain in 2023 than a casual reading of economic and market data might suggest.
This is because rising interest rates disproportionately impacted private capital markets where problems are less visible than in public capital markets.
The upshot is that the largest business failures linked to accounting fraud in 2023 occurred in private rather than public companies. This is not to say that public companies were free from scandal.
The SEC, the world’s leading financial regulator, was exceptionally busy in fiscal 2023, filing a record 784 enforcement actions and obtaining orders for US$4.9 billion in financial remedies.
This article will go through the biggest accounting scandals of 2023 and the ensuing fallout.
Table of contents
FTX: The biggest scandal of 2023
Cryptocurrency scandals dominated the financial headlines for much of 2023, culminating with the conviction in early November of Sam Bankman-Fried, the once-lauded founder of FTX.
FTX rates among the greatest financial frauds of all time. Currently, around US$30 billion to US$35 billion worth of crypto is locked up in cryptocurrency bankruptcies, with around 15 million people affected. Some US$16 billion was entrusted to FTX when it collapsed.
In its complaint against FTX, the SEC claimed that Bankman-Fried had orchestrated a years-long fraud to conceal from FTX’s investors:
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The undisclosed diversion of FTX customers’ funds to Alameda Research, his privately-held crypto hedge fund
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Undisclosed special treatment afforded to Alameda on the FTX platform, including providing Alameda with a virtually unlimited “line of credit” funded by the platform’s customers and exempting Alameda from certain key FTX risk mitigation measures
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Undisclosed risk stemming from FTX’s exposure to Alameda’s significant holdings of overvalued, illiquid assets such as FTX-affiliated tokens.
The complaint further alleges that Bankman-Fried used commingled FTX customers’ funds at Alameda to make undisclosed venture investments, lavish real estate purchases, and large political donations.
Suffice to say, the morass that constituted FTX’s accounting spreadsheets made for interesting analysis.
Cryptocurrency scandals
FTX was not the only cryptocurrency platform charged with fraud in 2023. Celsius Networks is another prominent example. Celsius presented itself as a bank-like platform where customers could deposit crypto assets and earn interest.
However, US prosecutors maintain that Celsius operated as a risky investment fund. The former CEO and CRO face multiple criminal charges and civil lawsuits. The Federal Trade Commission reached a civil settlement with Celsius and its affiliates for US$4.7 billion, suspending payment to allow Celsius to return funds to customers.
Numerous crypto platforms also faced regulatory charges for compliance violations in 2023. The SEC filed 13 charges against Binance, the world’s largest crypto asset trading platform, and its founder, Changpeng Zhao. The SEC subsequently fined Binance and Zhao US$2.7 billion and US$150 million, respectively. Coinbase faced similar charges of operating illegal exchanges and failing to comply with money laundering regulations.
Problems in the world of cryptocurrency should not be seen as isolated events but rather are indicative of a broader problem in private markets.
Specifically, the explosion in startups and unicorn valuations in recent years have imposed funding strains on the venture capital and private equity industries, in turn leading to greater private-market leverage. That leverage comes under considerable stress and pressure from collapses among highly valued startups.
The upshot is that financial stress in the PE industry is significantly greater today than it was in 2019. This is a swift summary that we intend to come back to in a more lengthy exposition, but it explains, at least in part, why accounting scandals have shifted from public to private companies.
Fallout: US bank failures
FTX, Celsius, Binance, and Coinbase were a part of this bigger unfolding picture. They had a cascading effect leading to the exposure of other scandals and subsequent failures in the crypto and tech start-up space.
These failures, combined with the relentless sell-off in bonds, caused SVB's unexpected demise and kicked off a record year of US bank failures.
Thus, although the fall-out from higher rates mostly affected startups and investment companies, the follow-on impact on the broader economy has been significant. US bank failures in 2023 had combined assets of US$548.7 billion, the largest total ever in a single year, outpacing even the financial crisis of 2008.
US accounting scandals in 2023: SEC action
The SEC took action against some prominent companies for their poor financial disclosures in 2023. Among others, it charged several electric vehicle companies for making materially misleading statements regarding revenue projections, sales, or products.
Fluor Corp.
Fluor is a major construction company headquartered in Irving, Texas. The company was charged with improper accounting relating to two large-scale, fixed-price construction projects. The company’s bid for these projects relied on overly optimistic cost and timing estimates.
The company hid subsequent cost overruns that escalated over time. In particular, Fluor didn’t include all anticipated costs in the project forecasts, leading to delayed loss recognition, and revenue from unapproved change orders was improperly incorporated into one project’s forecasts.
According to the SEC, these errors caused Fluor to overstate net earnings by as much as 37% from fiscal year 2016 through the first quarter of fiscal year 2019. The SEC settlement was US$14.5 million.
Newell Brands Inc.
Newell Brands is a Georgia-based maker of writing instruments with a product portfolio including Sharpie markers, pens, highlighters and pencils, and Paper Mate pens. In 2023, the SEC charged Newell Brands and its former CEO Michael Polk with misleading investors about Newell’s sales growth
In 2016 and 2017, Newell allegedly artificially inflated a non-GAAP financial measure called core sales growth. It inflated this number by pulling sales forward into earlier quarters without adequate disclosure.
As a consequence, Newell masked disappointing sales and announced strong results. As part of the settlement, Newell agreed to pay a civil penalty of US$12.5 million, and Polk agreed to pay US$110,000.
XL Fleet Corp.
XL Fleet provides hybrid electric vehicle (EV) systems for commercial fleet vehicles. The startup went public in 2020 through a merger with a special purpose acquisition company (SPAC).
Upon listing, the company claimed to have a 12-month sales pipeline of more than US$220 million, which supposedly backed near-term revenue projections of up to $75 million and longer-term projections of up to US$1.4 billion.
However, the SEC argued that the sales pipeline consisted almost entirely of speculative opportunities, including sales to potential customers with whom XL Fleet had little or no contact, customers to whom they could not legally sell their products, and stale sales opportunities that had not been updated within the company’s systems.
Without admitting or denying the SEC findings, XL Fleet, now called Spruce Power, consented to a cease-and-desist order and a civil penalty of US$11 million.
Canoo
Canoo is a Los Angeles-based EV maker that the SEC charged with inaccurate revenue projections and undisclosed executive compensation. Canoo listed via a SPAC in March 2021, garnering attention due to its unique approach of offering vehicles only through subscriptions.
In the lead-up to its SPAC acquisition, Canoo projected revenue of $120 million for 2021 and $250 million for 2022, based on the provision of engineering services to other companies.
However, the SEC alleged that these projections were mostly based on two projects that were no longer active or feasible. In addition, the SEC alleged that Canoo failed to fully disclose payments to the CEO from September 2020 until April 2021.
Without admitting or denying the SEC’s allegations, Canoo agreed to charges of US1.5 million while the the CEO Ulrich Kranz and another senior executive consented to the entry of judgments against them. Ulrich Kranz consented to a three-year officer and director bar and payment of a US$125,000 civil penalty.
Kandi Technologies Group
Kandi Technogies is a China-based EV maker that the SEC charged with: 1) falsely claiming that its EVs met US safety standards; 2) issuing a press release and filing a Form 10-Q filing that claimed it had entered into a contract to sell 2,000 EVs worth approximately US$32 million; and 3) making materially misleading statements about its planned sales in the US of “street-legal” and “highway-legal” EVs.
Without admitting or denying the findings, Kandi consented to a cease-and-desist order and payment of a US$710,000 civil penalty.
Hyzon Motors
Hyzon Motors is a New York company specializing in hydrogen fuel cell EVs (FCEV). The SEC charged it with misleading investors about its business relationships and vehicle sales both before and after its July 2021 merger with a SPAC.
According to the SEC, Hyzon falsely claimed that it had delivered its first FCEV in July 2021, even posting a misleading video of the vehicle purportedly running on hydrogen, when the vehicle was not equipped for hydrogen power.
The SEC also said Hyzon falsely reported selling 87 FCEVs in 2021, when it had not sold any vehicles that year. Hyzon agreed to pay a $25 million civil penalty. Two senior executives also agreed to penalties and were prohibited from serving as officers or directors of a publicly traded company for specific periods.
Sector to watch: China’s property developers
The Chinese financial system faces complex challenges following the downturn of the country’s real estate market.
Signs of trouble at big names like China Evergrande and Country Garden have put the government on high alert as it moves to support and scrutinize the country’s developers. Dozens of Chinese property companies have experienced official scrutiny for fraud in 2023.
As with the murky world of private equity, financial scandals in China tend to offer little visibility to the outside observer. It’s rare to see high-profile failures in China, where regulators are less transparent than US counterparts and the resolution of troubled loans can take years rather than months.
All the same, China has a history of making an example of recalcitrant corporate chiefs. Chinese company officials suspected of fraud, such as the founder of Evergrande, tend to be detained on investigations related to opaquely monikered “illegal crimes.”
Investors typically hear little of the subsequent investigations, accounts get restated if necessary, and life moves on. Nevertheless, this sector is one to watch for potential scandal.
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