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The Midnight Journal Entry
Anne T. Lawrence, San Jos State University
O
n an overcast afternoon in Portland, Oregon, on Friday, March 28, 2003,
Richard Okumoto intently studied a set of hard-copy accounting documents
called adjusting journal entries spread out on his desk. He had been ap-
pointed chief financial officer (CFO) of Electro Scientific Industries, Inc. (ESI), a
multi-million-dollar equipment manufacturer, just a few weeks earlier. Okumoto was
in the midst of closing the companys books for the third quarter of fiscal year 2003,
which ended February 28. An experienced executive who had served as CFO for sev-
eral other technology firms, Okumoto was familiar with the task, which normally
would be routine. But this time, he felt that something was seriously amiss. When
reviewing the companys recent results, he had noticed a sharp dip in accrued liabilities
between the two quarters ending May 31 (the last quarter of the 2002 fiscal year) and
August 31 (the first quarter of the current fiscal year). Now, looking at the detailed
journal entries his staff had provided, he noticed that several significant accounting
entries had been made around midnight on September 12, 2002. The entries made
that September evening had significantly changed the companys results for the quarter
ending August 31, 2002, a few days before they were reported to the Securities and
Exchange Commission. He later recalled:
The fact that the time stamps [on the journal entries] were midnight through one
oclock in the morning made me believe they were having difficulties closing the quar-
ter. Not just because of accounting difficulties, but because they were having difficulties
finding the right answers. My initial reaction was, even given a difficult quarterly close,
if the team was working that late at night, that wasnt typical.
From the pass codes required by the accounting software, Okumoto could see who had
made the entries. They included James Dooley, then the companys acting chief operat-
ing officer and now the CEO, the corporate controller, and several senior members of
the finance team.
One midnight journal entry in particular drew the new CFOs attention. The
late-night team had wiped out an accrued liability of $977,000 associated with the
anticipated cost of retirement and severance benefits to company employees in Japan,
Korea, and Taiwan. That entry, and several smaller ones, all of which were favorable to
Copyright 2012 by the Case Research Journal and Anne T. Lawrence. The author developed this case to
provide a basis for class discussion rather than to illustrate either the effective or ineffective handling of
a managerial situation. An earlier version of this case was presented at NACRAs annual meeting in San
Antonio, Texas, October 2011. The author gratefully acknowledges the assistance of Richard Okumoto
and the thoughtful comments of the editor, Deborah Ettington, and three anonymous reviewers.
The Midnight Journal Entry 137
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net income, had the cumulative effect of permitting the company to report earnings
of $0.01 per share for the quarter ending August 31, 2002, rather than a loss. When
he realized that, Okumoto recalled, he felt a sinking feeling in my gut. He asked
himself, What happened here? At that time of night? All of the changes in a single
direction? Whats going on? He was sure something was not right.
Richard Okumoto
Born in 1952, Richard Okumoto was raised with his four siblings in a Japanese-
American family in a low-income, African-American neighborhood that bordered the
Pepper Street Projects of Pasadena, California. He explained how his parents experi-
ences had shaped their outlook:
My parents grew up during the depression years. Dad farmed with relatives, and Mom
grew up tending 3,000 chickens on a three-acre ranch in Gardena, California. Shortly
after the Pearl Harbor attack by the Japanese, my parents were relocated under Execu-
tive Order 9066 [under which persons of Japanese ancestry on the West Coast were
sent to relocation camps during World War II]. They met and married in a relocation
camp. During their incarceration, their families could not make their payments. Dad
and his relatives lost their land, and Moms parents lost their chicken ranch. After those
experiences, my father was committed to having no debt. He built our family home in
1955, with the idea of paying off the loan in eight years.
In 1962, Okumotos father, who worked as a gardener, landscaper, and salesman of
Japanese mutual funds, was disabled in a serious auto accident. Fortunately, by then,
he had almost paid off the loan on their home, so the family was able to survive finan-
cially. After the accident, Okumotos mother took a job cleaning homes to help sup-
port her five children. Okumoto described his relationship with his mother:
She and I had an especially close bond. Shortly before my dads accident, both her par-
ents had died. I was the one who supported her through a very difficult year. As a result,
she always treated me differently from the other kidsalmost like an adult.
The Okumoto familys financial situation after the accident was difficult. Okumoto
had vivid memories of how they coped:
Money was very short. We had to account for every penny. Every week, my mother
wrote down in a leather-bound journal everything she earned and everything we spent
in the household, down to the penny. Every week, from the time I was ten years old,
she went through that with me. We lived on a cash basis. There was no credit card, no
second mortgage. In that situation, budgeting became extremely important. Her com-
ment to me was, You cant complain [about what you dont have] unless you under-
stand whats happening. Those were her ground rules.
He added this comment about his mothers values:
The ethics of doing the right thing become very important, because thats really all you
have. [My mother] instilled in me at an early age, regardless of what else you do, always take
the high road, always do the right thing. That has influenced me throughout my career.
After high school, Okumoto attended San Jos State University, where he com-
pleted an undergraduate degree in accounting in 1974 and attended the MBA program
from 1975 to 1978. He soon embarked on a highly successful career in finance. Over
the next two-and-a-half decades, he held increasingly responsible roles at a number of
high-technology companies in the Silicon Valley, including Fairchild Semiconductor,
138 Case Research Journal Volume 32 Issue 2 Spring 2012
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For exclusive use at Indian Institute of Technology - Madras, 2015
Net income (loss) per share 0.89 0.29 1.55 3.71 (0.58)
*Data refer to fiscal years ending May 31. All data are given in thousands of dollars, except per share
data.
Source: ESI 2002 Annual Report.
The Midnight Journal Entry 139
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James T. Jim Dooley Acting Chief Operating Officer (COO), early 2002December 2002
Chief Executive Officer (CEO), December 2002
140 Case Research Journal Volume 32 Issue 2 Spring 2012
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For exclusive use at Indian Institute of Technology - Madras, 2015
His first task was to prepare for the FY 2003 third quarter close. In reviewing the com-
panys books for the past several quarters, he soon noticed a sharp downward spike in
the balance of accrued liabilities. He noted that fact for further investigation.
In addition to closing the quarter, several other items required Okumotos atten-
tion. Just one week into his new job, on February 24, he got an email from John
(Jack) Isselmann, Jr., the general counsel, asking him to forward to the manager of
the Japanese office, Mike Tetsui, a set of revised work rules (terms of employment) for
ESIs Japanese employees. As a newcomer, Okumoto knew little of the background or
why he had been asked to do this, but complied with the general counsels request,
sending on to the Japanese office manager the revised work rules.
Okumoto received the following reply from Tetsui on March 2:
I have read the proposed work rule and found no section of [sic] retirement fund. I do
not know what is the intention of removing that section, but it is a huge impact on
each employee we haveI do not think I can get concents [sic] from [ESIs Japanese]
employees without reasonable change in retirement benefit. Please let me know how
you would like me to proceed.
Okumoto recalled:
My first response was, uh-oh. There was a big disconnect between what I had been
told and Mikes reply. I had assumed that the Japanese had already been informed of
the cancellation of their retirement benefits and agreed to the changes. It was clear they
had not.
In a prior job at Novellus Systems, Okumoto had set up that companys Japanese
operations, and he was aware that Japanese work rules were normally filed with the
government. Regulators were very strict about altering any documented benefits. Ac-
cordingly, Okumoto believed that ESI was obligated to pay benefits that had been
promised to employees, and he told Isselmann this. Okumoto also expressed the opin-
ion that employees, if dissatisfied with the revised rules, could take the matter before
the Japanese labor board, and that this would be a quantifiable event that would have
to be recorded on the books as a liability. Isselmann responded that he was unfamiliar
with Japanese law.
On March 4, Okumoto spoke with CEO James Dooley about his concerns that
the reversal of benefits for Japanese, Korean, and Taiwanese employees might expose
ESI to litigation, and this could affect the accounting treatment of the event. Dooley
strongly disagreed. Okumoto recalled:
He told me that everything had been cleared with everyone. He said there was full
information. There was full disclosure. He emphasized that KPMG [ESIs external
auditor], the companys own legal staff, and the board had all signed off on it. He said
I should just get past it.
Okumoto was concerned about this conversation, particularly because the CEO
seemed so defensive.
On March 11, Okumoto met again with Dooley, this time to discuss Okumotos
upcoming presentation to the audit committee. The new CFO recommended that
the company delay announcing its third quarter earnings and restate its first and sec-
ond quarter earnings to report correctly the $977,000 in liabilities associated with the
anticipated cost of retirement benefits for its Asian employees. Okumoto explained his
view that not reporting these liabilities had violated Generally Accepted Accounting
Principles. At that point, Okumoto recalled, Dooley became visibly upset.
The Midnight Journal Entry 141
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For exclusive use at Indian Institute of Technology - Madras, 2015
The CEOall six feet-six inches and 280 pounds of himturned an angry red and
told me again to just get past this. Thats when I knew that this was going to be swept
under the rug. It was clear I was not part of the club. Then Jim said, If Ive got to
reverse this entry, Ill quit.
142 Case Research Journal Volume 32 Issue 2 Spring 2012
This document is authorized for use only in Management - 10082015 by Prof. Arun Kumar G, Indian Institute of Technology - Madras from October 2015 to April 2016.
For exclusive use at Indian Institute of Technology - Madras, 2015
Under the rules of employment established for ESIs employees in Japan, any employee
(except executives) who chose to retire after reaching the voluntary retirement age
of 60 would be entitled to a retirement allowance of one months pay per year of
servicein effect, a one-time severance payment. Workers who were involuntarily
terminated and the estates of any workers who died before reaching the age of 60 were
also entitled to this benefit. Similar rules were in effect for the companys workers in
Korea and Taiwan. At the time, ESI had 18 employees in Japan, 13 in Korea, and 23
in Taiwan, mostly in sales and customer support roles.1
On March 14, Okumoto called an all hands meeting to disclose his initial find-
ings and discuss a path forward. Present at the meeting were Dooley, Isselmann, Har-
mon, and several other senior managers. The CFO asked directly if there had been full
disclosure and review of all material facts with respect to the accrual reversal. Dooley
confirmed that everything had been disclosed. Okumoto did not mention the MoFo
memo, thinking that Dooleys response indicated that he must have already disclosed
it to KPMG and the audit committee.
On March 20, Okumoto spoke by telephone with Mike Tetsui. The Japanese man-
ager told the CFO that the employees had not yet been told that their retirement ben-
efits had been terminated, and heTetsuiwould resign before he would tell them
that news, which he expected would be devastating. As head of the group, Tetsui told
Okumoto, I will fall on my sword.
On March 21, Okumoto met again with Dooley to press him on how the reversal
had happened. Dooley was initially combative. As the conversation went on, how-
ever, he let his guard down and began talking about what had happened on the night
of September 12. As Okumoto recalled the conversation:
Jim told me that he had sent a financial packet to the board of directors prior to their
meeting on September 13. After he had distributed the packet, but before the meeting,
he was contacted by KPMG, who told him there had been an error in the companys
calculations of its overhead costs, so the financial statements distributed to the board
were incorrect. ESIs reportable earnings were suddenly much less than they thought,
by as much as a million dollars. Jim said this was particularly important because the
company was in informal merger discussions with a company in southern California.
Then he said, No one was helping me, so I had to help myself. When Jim made that
comment, my first thought was, he was looking for revenue. He was hunting for cred-
its. He was looking to manipulate earnings. That was a definite red flag.
Okumoto walked out of Dooleys office stunned. He called his staff together and
asked them to assemble any documentation they had on accounting entries on or
around September 12. He also began talking with the members of the finance team
who had participated in the late-night meeting with Dooley and learned that a number
of people on the finance staff had questioned the benefits reversal, but had not brought
it forward.
This was consistent with a negative tone at the top. I would almost characterize it as
bullying. Thats one reason why no one stepped forward. That tone at the top created
an environment where people really couldnt speak out. Its important to look at the
people. Its similar to qualitative research. We all do that intuitively. When I looked at
the body language of a lot of the people involvedthe cost accountants, the finan-
cial analystsit became apparent to me that they were scared. They knew something
was wrong, and they wanted to say something, but something held them back. They
The Midnight Journal Entry 143
This document is authorized for use only in Management - 10082015 by Prof. Arun Kumar G, Indian Institute of Technology - Madras from October 2015 to April 2016.
For exclusive use at Indian Institute of Technology - Madras, 2015
144 Case Research Journal Volume 32 Issue 2 Spring 2012
This document is authorized for use only in Management - 10082015 by Prof. Arun Kumar G, Indian Institute of Technology - Madras from October 2015 to April 2016.
For exclusive use at Indian Institute of Technology - Madras, 2015
He added:
Fortunately, I was financially in a position where I could afford to leave if it came to
that. I was single, so I figured the only person I had to protect was myself.
He also had a network of friends in the area he felt he could turn to for support.
I had a number of friends in the Portland area, having worked there earlier. My prior
company had a division of about 1000 employees in the area. Of these, 500 had worked
directly for me. It might have been a false sense of security, but I felt I had a pretty good
infrastructure of people that I knew.
By this time, Okumoto was also becoming concerned about his personal safety.
Several times, he received anonymous messages on his home answering machine. At the
time, he was living temporarily in corporate housing while he shopped for a home, and
he felt he was particularly visible there. But, he added that he was not easily intimidated.
I felt that I could take care of myself. I had faced a lot worse threats than this one. As
a teenager, I was robbed at gunpoint. I was stabbed in the back and left for dead. I
was beaten so badly that my eyes were swollen shut. I grew up around a lot of physical
violence.
Although Okumoto saw risks in taking action, he also saw risks in inaction. He
commented:
I was concerned about my own legal liability if I did not take action. From the point of
view of the DOJ [Department of Justice] and SEC [Securities and Exchange Commis-
sion], if you dont fix the problem, you become the problem. I had potential legal risk.
As Okumoto pondered the risks of both action and inaction, he reflected on the
board of directors and what kind of response he might expect if he approached them
directly. (See Exhibit C for a list of members of the board.)
Dooley was the only insider on the board. There were some old timers on the board
like Barry Harmon, who had earlier been CFO at ESI. But there were also a fair number
of independents. Even though I was new at the company, I had a prior relationship
with two of the directors. Jerry Taylor, the former CFO at Applied Materials, was a
member of the audit committee. Jerry and I had worked together 25 years earlier at
Fairchild. So, I had a long-standing relationship with him. Jon Tompkins, the former
CEO of KLA-Tencor, was also on the board. I had known Jon from Tencor days, where
he had interviewed me for the CFO position.
As he contemplated his next move, Okumoto thought back to an experience earlier
in his career. As he told the story:
I had been in a situation before where I hadnt spoken up. I had been a CFO for
another public company. I was in a situation in which I had questions on some of the
accounting. But it was close enough, and I was concerned that I didnt have enough
evidence to support my reservations. I had only been with the company three months.
Within four months, we had a major revenue shortfall. At that time, I made the deci-
sion not to try to cover up the revenue shortfall. But, because we had not called it to
the attention of analysts earlier, we lost the confidence of the Street. At that point, the
CEO and I both resigned. I made a decision then that if I ever again saw something
that was close, I would act much faster.
The Midnight Journal Entry 145
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He also thought about his mothers admonition always to do the right thing, and the
advice of his mentors, who had counseled him always to ask the questionwhat are
your obligations to others?
Exhibit C: Members of the Board of Directors, ESI Inc., March 2003
Keith L. Thomson
Vice President (retired), Intel Corp.
Chair of the Board of Trustees, University of Oregon Foundation
Jon D. Tompkins
Chairman of the Board and CEO (retired), KLA-Tencor Corp.
President and CEO (retired), Spectra-Physics
Larry L. Hansen
Executive Vice President (retired), Tylan General, Inc.
Note
1. In 2002, average annual salaries for ESI employees were $68,000 in Japan, $27,000
in Korea, and $38,000 in Taiwan (in U.S. dollars).
146 Case Research Journal Volume 32 Issue 2 Spring 2012
This document is authorized for use only in Management - 10082015 by Prof. Arun Kumar G, Indian Institute of Technology - Madras from October 2015 to April 2016.