This case considers unauthorized financial transactions at Koss Corporation, a small publicly-traded speaker headset manufacturer headquartered in Milwaukee, Wisconsin.
In late December 2009, a federal complaint charged Koss’s CFO with embezzling as much as $4.5 million from Koss, which had 2009 revenues of only $38.2 million. Two days later Koss issued a press release stating that the embezzlement might be as high as $20 million. On January 4, 2010, Koss issued a press release stating that the embezzlement may have exceeded $31 million for the fiscal years ending June 30, 2005 through 2009. Later reports disclosed that the embezzlement ranged from $2,195,477 in fiscal year 2005 to $8,485,967 in fiscal year 2009, and were approximately $5 million per quarter for the two quarters ended September 30, 2009, and December 31, 2010.
The embezzlement was detected when American Express notified Koss’ CEO that the firm was making very large wire transfers of cash to pay off a personal American Express card.
The case takes the perspective of a hedge fund manager who is analyzing Koss’ financial statements in an attempt to value Koss with no more information than previous financial statements and the knowledge that the CFO may have embezzled $35-$40 million during the previous ten years. A quick review of Koss’s annual financial statements from 2005-2009 reveals Koss had virtually no liabilities and that its assets could not have been overstated by the amount of the embezzlement; total assets as of December 31, 2009, were only $28.5 million.
Although accounts receivable and inventories might be overstated by as much as $5 million each, it seems highly unlikely that auditors would miss that much of an overstatement of receivables. Even if receivables and inventory were overstated by a total of $10 million, the remaining $25-30 million embezzled must have been recorded by debiting an expense account and crediting cash. Koss must have been highly profitable before the embezzlement and only moderately profitable after the embezzlement.
Assuming the embezzlement was primarily recorded as an expense, then Koss’ balance sheet is reasonably accurate, so Koss may need only a minor write-off of inventory and receivables. In the future, the major change to Koss’ operations will be that it is far more profitable because no one is embezzling. Koss’ market value should increase as a result of the discovered embezzlement, not decrease, which would have been the initial reaction to a major embezzlement.
Prior to the embezzlement, Koss was trading at about $5.50 per share. After the embezzlement disclosure, Koss’s share price declined to $3.90 per share, but has subsequently risen to $5.65 per share. During that same period the DJIA and SA&P 500 each declined by about 5%. Koss expects to release the results of its investigation in June 2010, so the teaching note will include information that is not now available.