Feeding Frenzy

On Jan. 23, a week after investigators from the Tokyo District Court Public Prosecutor's Office raided the headquarters of Livedoor, the Internet company founded a decade ago, Takafumi Horie and three other executives were arrested on suspicion of securities fraud. The 33-year-old tycoon has since resigned as CEO, leaving his company in disarray, its stock down 80% since the raid. The question now: Will the rough-and-tumble style of capitalism that Horie pioneered be another, more far-reaching casualty of this debacle?

In Japan, the homeland of Sony, Toyota and Toshiba, manufacturing is still widely regarded as the only honorable industry. Organic growth is esteemed above all, and many large companies still disdain the idea of mergers and acquisitions. To this day, there has never been a successful hostile takeover in Japan. Horie looked to smash these conventions. Rather than expanding slowly over many years, he discovered he could generate outsized growth by rapidly acquiring smaller, financially weaker prey, typically using Livedoor stock as the currency.

He cobbled together an empire by purchasing no less than 50 firms, often with the help of so-called special-purpose entities, stock swaps, and other sophisticated financing techniques that are fairly routine in most mature economies, but are still regarded as alchemical in Japan. With the growth his acquisitions provided, Livedoor's stock took off, enabling Horie to buy more and bigger companies. Investment banks, always hungry for lucrative advisory work, helped out.

Horie's ability to turn his tiny company into a behemoth with a market value as high as $8 billion helped spark a broader M&A boom. Rivals in Japan's go-go internet industry learned that they too could grow by gobbling up corporate minnows. Terrie Lloyd, an M&A consultant, says he encounters more and more Japanese investors who are interested in buying a motley batch of companies, pasting them together into mini-conglomerates with dubious business merit, and flipping them via an IPO.

But as Livedoor's woes show, a get-rich-quick, growth-by-acquisition strategy can be rife with risk. Unable to achieve fast enough growth through normal business operations, it allegedly misled the public in order to goose its stock, sell some of its shares, then pocket the proceeds as profits.

The Livedoor fiasco has highlighted inadequacies in Japan's accounting rules, which are not equipped to handle this brave new world of special-purpose entities, stock swaps and other financing arcane. But Tokyo is moving quickly to correct these deficiencies and restore confidence in its regulatory stringency.

Time

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Tough Questions for aig's Auditors Regulators are probing if PwC let the financial shenanigans slip through

Where were the auditors? Now that American International Group Inc. has admitted to a clutch of accounting improprieties and its mulling whether to restate its past results, an all-too-familiar question is emerging: Why didn't the auditor catch what was going on?

Were misdoings hidden from AIG's longtime auditing firm, PricewaterhouseCoopers, or did the firm turn a blind eye to problems it should have seen? Indeed, some of the searing heat that has so far felled AIG Chief Executive and several other execs could soon scorch the $175 billion accounting giant. "I'm sure they will be under suspicion," says Edward Ketz, associate professor of accounting at Pennsylvania State University. Because of its role as a dominant force in auditing and accounting for insurance companies, PricewaterhouseCoopers's work for the outfit is bound to get an especially close going-over from regulators and shareholders alike. Certainly, the outfits were close.

More important, PwC was AIG's auditor through its long years of questionable dealings. AIG said that deals with Barbados-based insurance company, for instance, may have been incorrectly accounted for over the past 14 years, because an AIG-affiliated company may have been secretly covering that insurer's losses. If AIG has to unwind its dealings with the Barbados company, it may be forced to take a big earnings hit.

More recently, PwC appears to have dropped the ball on the now-notorious reinsurance deals between AIG and Berkshire Hathaway Inc.'s General Re Corp.

In its statement, AIG has admitted that some of its paperwork associated with the deals was improper - but it's not clear whether the deals were illegal or how much PwC was told about them. AIG says much of the information only recently came to light. And PwC could have been duped or denied information.

But given PwC's long-standing relationship with AIG, the thoroughness of its auditing over many years will surely come under question. ''These seem like things you'd expect an auditor to look at," says New York attorney Gerald Silk, a plaintiffs’ lawyer whose firm has brought cases against Arthur Andersen and other big auditing firms. "There are sufficient red flags". PwC declined comment, citing client confidentiality requirements, although the firm is said to be cooperating with investigators.

How vulnerable could PwC be? Already, institutional shareholders, who sued AIG last fall when its stock began a 21 % plunge amid the investigations, are considering roping the auditing firm into class action.

PwC's level of culpability could take years to sort out. Just what the firm knew, or should have known, is bound to be a much-contested issue. Already, though, it is looking at a hefty blemish on its role as a leader in insurance accounting. The growing tumult born of AIG's questionable accounting is just beginning.

Business Week

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