[SOLVED] On June 20, 2005, “John Rigas, the

On June 20, 2005, “John Rigas, the 80-year old founder of Adelphia Communications Corp., was … sentenced to 15 years in prison and his son Timothy, the ex-finance chief, got 20 years for looting the com- pany and lying about its finances.”1 These were the largest sentences handed out to CEOs and CFOs after SOX and before the sentencing of Bernard J. Ebbers, CEO of WorldCom, and Dennis Kozlowski, CEO of Tyco, and before the trial of Richard Scrushy, CEO of HealthSouth.
John and Timothy Rigas had faced a maximum sentence of up to 215 years each, but John’s age, bladder cancer, and heart condition were taken into account. His lawyer argued as well that John had been very generous with Coudersport, his hometown, but Judge Sand responded, stating that what Rigas had done, “he had done with assets and by means that were not appropriately his.… To be a great philanthropist with other people’s money is really not very persuasive.”2
Adelphia was founded by John Rigas in 1952 in Coudersport, Pennsylvania, and incorporated in 1972. The company started as a cinema business that transformed into a cable television provider. By 1988, Adelphia had more than 2 million customers in the cable television service. The company also expanded rapidly into a new line of tele- communications products and services (e.g., high-definition television, video on demand, high-speed Internet, and home security). By 1989, Adelphia more than doubled its reach through acquisitions, extending into forty-one states and serving more than 5 million customers. At its peak, Adelphia employed 14,000 people in the United States. Members of the Rigas family held four seats on the firm’s seven-member board. John Rigas (chairman and CEO), his son Timothy Rigas (CFO), and Michael Rigas (vice president of operations) had control of the firm and access to its resources beyond the oversight mechanisms of its Board of Directors. In essence, they used Adelphia as their own family piggy bank, withdrawing funds when they needed for their own pur- poses, such as golf club construction, property purchases, and stock dealings, as noted in following sections.
Unfortunately, these cash withdrawals and other improper use of company resources, as well as rapid expansion, poor management, and improper use of company’s resources to pay management’s personal expenses, led Adelphia into a tight financial position. Faced with the needs for meeting earnings and cash targets and to keep the company’s debt levels within market averages, the Rigas family members began to commit fraud, and those frauds finally came to light.
On March 27, 2002, the company announced $2.3 billion in off-balance-sheet debt previously undisclosed in the company’s financial statements. Adelphia guaranteed as coborrower $2.3 billion loans given to the Rigas family and entities controlled by them. On April 1, the company delayed filing Form 10-K, required under the SEC rules for public companies in the U.S. mar- kets. The delay was followed by a formal inquiry by the SEC. On April 15, the company announced that continuing review of its financial statements would not result in material changes to historical filings.
However, on May 2, Adelphia changed its position, announcing a possible restatement. Two weeks later, John Rigas and his son Timothy resigned, and the company’s auditors, Deloitte & Touche, suspended the 2001 financial statements audit. The trade of the company’s shares in NASDAQ was suspended after the stock price went from
$20.39 on March 26 to $0.79 on June 3.
On May 23, other members of the Rigas family resigned their positions in manage- ment and the Board of Directors. The Rigas family also agreed to transfer $1 billion in assets back to the company. Nevertheless, Adelphia filed for bankruptcy in June 2002 and operated subsequently under bankruptcy protection.
The SEC charged Adelphia and the Rigas family with massive financial fraud on July 24, 2002. Its complaint alleged
(1) understatement of debt,
(2) over- statement of financial performance, and
(3) extensive self-dealing, which are sum- marized from the SEC press release3 and complaint4 documents as follows:
1. Between 1999 and the end of 2001, the Rigas family (John, Timothy, Michael, and James), with other executives, caused Adelphia to fraudulently exclude over $2 billion in its bank debt by systematically recording liabilities on the books of unconsolidated affiliates. Some of those operations where backed by the company’s management with fictitious documents. False documents showed that Adelphia repaid debts while those debts were just transferred to related companies.
2. From 1999, the company relied heavily on commercial credit issuance of notes and access to equity markets. As of June 1, 2002 Adelphia and its consolidated subsidiaries owed $6.8 billion in credit facilities, $6.9 billion in senior or convertible notes, and $1.6 billion in convertible preferred stock. Certain Adelphia subsidiaries also issued separately notes of which $2.6 billion was outstanding on June 1, 2002. The company’s true liabilities increased from $4.4 billion in the second quarter of 1999 to $20.4 billion in the third quarter of 2001.
3. Funds obtained from borrowing and from a series of public offerings since 1999 were deposited and disbursed from a cash management subsidiary Adelphia CMS. This third company was used to set up schemes to transfer and hide debt in related companies (i.e., special purpose entities).
4. In the same period, the Rigas family with other executives caused Adelphia to regularly misstate press releases, including earnings reports. The company reported inflated figures for the number of cable subscribers, the extent of its cable plant, and earnings before interest, taxes, depreciation, and amortization (EBITDA).
5. Specifically, the company overstated its number of customers by 142,000 by including in basic cable subscribers 43,000 customers from unconsolidated subsidiaries, 39,000 Internet service customers, and 60,000 home security customers. Adelphia also included in these statistics subscribers from the months after the quarter end and false counts of new subscribers for affiliated companies.
6. Adelphia added to reported EBITDA management fees paid by the Rigas family entities that owned cable operations. But since Adelphia did not provide any services to earn those payments, the only purpose for recording them on Adelphia’s books was to inflate the company’s earnings.
7. Adelphia entered into agreements with suppliers of digital converter boxes, asking the suppliers for a $26 per box advance to market a new digital service. The money would be repaid later when the boxes were sold to customers. Adelphia recorded those payments (totaling $91 million) as income. The suppliers lost the advanced payments when the company filed for bankruptcy.
8. Adelphia also shifted expenses improperly to unconsolidated related entities to decrease the company’s operating expenses.
9. From at least 1998, Adelphia used fraudulent misrepresentations and omissions of material facts to conceal self-dealing by the Rigas family.
10 The Rigas Family used company funds to finance open stock purchases, pur- chase timber rights to land in Penn- sylvania, construct a golf club for
$12.8 million on a family property, pay off personal margin loans and other debts, and purchase luxury condominiums in Colorado, Mexico, and New York City.
11. The fraud continued even after Adelphia acknowledged, on March 27, that the $2.3 billion excluded liabilities from its balance sheet. In the following months, the Rigas family diverted $174 million to pay personal margin loans.
Not only were the Rigas among the first to face post-SOX justice for their financial frauds, but John, who was seventy-seven years old when arrested, and his sons were among the first to endure the famous “perp walk”—to be handcuffed and marched to a waiting car in front of reporters who were only too glad to spread the embarrassing photos over the media immediately. The perp walk came to be dreaded by executives who faced charges for perpetrating financial crimes.
The SEC charges were not the only ones leveled against the Rigas family. In August 2004, Adelphia, their own company, sued them in a civil action for the return of $3.2 billion that the family misappropriated. In the earlier SEC-sponsored criminal trial, the family had argued that “any debt or funds used from the company were ‘borrowed’ not stolen, ‘and they intended to full repay the amounts.’”5 Adelphia had not received the funds, nor had the Rigases assumed the debt involved, so Adelphia sued the Rigas to force them to keep their word.
This action was not surprising since Adelphia had shored up its governance processes after the Rigases left. For example, new executives were appointed to remove members of the Rigas family and related parties, and six of the seven members of the new Board of Directors were independent of Adelphia and Rigas family interests. The company developed a new code of ethics and changed its mission to the following:
We will leverage our historical strengths of customer focus, com- munity involvement, and employee dedication; address issues that limit profitability and growth; and act with a sense of urgency, accountability and teamwork to emerge from bank- ruptcy and to succeed as a broadband industry leader. We will develop a reputation as a company with out- standing corporate governance.
In November 2002, Adelphia sued its former auditor, Deloitte & Touche (D&T), accusing D&T of professional negligence, breach of contract, fraud, and other wrong- ful conduct “for failing to spot the prob- lems that brought the company down. … For its part, Deloitte said it was the victim of deception just as much as Adelphia’s shareholders and that it would be able to answer any accusations more fully once it had examined the lawsuit. It also said that it would seek damages from whichever members of Adelphia’s management proved to be complicit in any wrongdoing. At the moment, [Adelphia’s] bankruptcy protects it from such action, however.”6
Adelphia’s bondholders also launched a U.S.$5 billion lawsuit in July 2003 against 450 banks and other financial institutions that had “fuelled the massive fraud by lending billions of dollars to the company’s founders.”7 The lawsuit stated, “This action seeks to redress defendant’s knowing participation, substantial assistance and complicity in one of the most serious cases of systematic corporate looting and breach of fiduciary duty in American history.… Aware of the obvious red flags, many of the co- borrowing lenders merely rubber-stamped the co-borrowing facilities so that their affiliated investment banks could earn hundreds of millions of dollars in fees.”8 While the Rigas family was busy using Adelphia as their own piggy bank, it appears they were not alone.
Questions
1. What breaches of fiduciary duty does the Adelphia case raise?
2. Why do you think the Rigas family thought they could get away with using Adelphia as their own piggy bank?
3. What allowed the Rigas family to get away with their fraudulent behavior for so long?
4. What concerns should have been raised in the following areas of risk assessment in Adelphia’s control environment: integrity and ethics, commitment, Audit Committee participation, management philosophy, structure, and authority?
5. What concerns should have been raised in the following areas of risk assessment in Adelphia’s strategy: changes in operating environment, new people and systems, growth, technology, new business, restructurings, and foreign operations?
6. What is your opinion on the importance of independence in corporate governance? What are the most recent rules on corporate governance for public firms?
7. Discuss which changes could be done to the Adelphia’s control system and corporate governance structure to mitigate the risk of accounting fraud in future years.
8. What is the auditor’s responsibility in case of fraud?
9. What is the proper audit procedure to ensure the following?
a. Completeness of liabilities in the financial statements
b. That all the related parties have been included or disclosed in the consolidated financial statements
10. Do you think analytical procedures would aid the detection of fraud? What is the responsibility of the auditor applying analytical procedures?
11. What should the 450 lending institutions have done to protect themselves from subsequent lawsuit?

Question: On June 20, 2005, “John Rigas, the