Top Forensic Algorithms Check Whistleblower's $6B Claims Against Disney

Summary

• A former Walt Disney Co. accountant filed a series of whistleblower tips with the Securities and Exchange Commission alleging Disney overstated revenue for years.
• In this article, I examined the scores from four top forensic algorithms that check for earnings manipulation, financial irregularities, and bankruptcy risks.
• Only one period in 2012 produce any adverse scoring by a forensic model, and the period does not correspond to the 2008/2009 assertions.
• The forensic tables of Altman, Beneish, Ohlson, and Montier are displayed below along with value/growth algorithms of Levermann and Piotroski.
• This idea was discussed in more depth with members of my private investing community, Value & Momentum Breakouts. Get started today »

Do Forensic Algorithms Detect Any Disney Financial Fraud?

In an ongoing look at some major whistleblower accusations recently, I took a look to see if the claims against Disney (NYSE:DIS) showed any irregularities in the top forensic algorithms commonly used by certified fraud examiners. As part of my regular stock analysis and selections, I routinely publish screens of the most positive and negative forensic stocks in the market:

Forensic Stock Analysis For August: Do You Own These Stocks?

Most recently, I took a look at Harry Markopolos' accusations that "General Electric (GE) has engaged in fraud larger than Enron or Worldcom" in my article:

Running Top Forensic Algorithms On 2012-2019 GE Financials

In another series of articles, I look at certain combinations of these forensic and value scores to predict stock price performance like Tesla's (TSLA) recent 40% decline:

The 3 Largest Stocks Now Scoring Worse Than Tesla Before Its 40% Decline

These models are designed to flag certain elements where examiners could look deeper to assess conditions of a company.

The Walt Disney Co. Stock Chart from 2006 to 2013

Former Disney Financial Analyst's Fraud Claims

Sandra Kuba, formerly a senior financial analyst in Disney's revenue-operations department who worked for the company for 18 years, alleges that employees working in the parks-and-resorts business segment systematically overstated revenue by billions of dollars by exploiting weaknesses in the company's accounting software. (Source)

While these overstatements are claimed to have occurred in many reporting periods up to 2013, the most specific accusation filed with the SEC says that,

In just one financial year, 2008-09, Disney's annual revenue could have been overstated by as much as $6 billion, Kuba's whistleblower filing alleges. (Source)

Naturally, we would expect some irregularities to show up in the time periods where over $6 billion in revenue statement is alleged to have occurred and some additional irregularities over time period up to 2013 during Kuba's 18-year tenure.

Forensic Algorithms on Disney from 2006 to 2013

Analyzing these Disney accusations over the time period from 2006 to 2013 using the Altman Z-score, Beneish M-score, Ohlson O-score probability and the Montier C-score reveal the following:

(UncleStock.com)

From 2006 to 2013, there was no strong confirmation of irregularities validated across all the forensic models in any single year. The Beneish and Montier scores are intended to detect financial statement irregularities, whereas the Altman and Ohlson scores examine bankruptcy risk and financial distress. The Levermann score is a growth forecast algorithm that showed an adverse score in 2009 because of an EPS change. The Piotroski F-score is a value score that shows strong company value half the years examined. In 2012, the Beneish M-score that is used to detect financial statement irregularities did have an adverse score of -1.76. Taking a deeper look at the more significant Beneish M-scores to address the claims filed with the SEC, we can see the different ratio components that comprise the Beneish model below:

Beneish M-scores:

(UncleStock.com)

The only component of the Beneish M-score that is adverse from 2006 to 2013 is the GMI value. This value is the Gross Margin Index defined as a ratio comparison between gross margin in t-1 and in year t. A value larger than 1 reflects a deterioration in gross margin. So that, if revenue were inflated and gross profit remained the same, the algorithm would detect a deterioration in gross margin from one year to the next.

Only this period in 2012 highlights any possible irregularity, and it is not possible to know the true underlying causes without further analysis. Many different combinations of contributing factors could affect the change in GMI score for 2012.

The Disney spokesperson said: "The claims presented to us by this former employee - who was terminated for cause in 2017 - have been thoroughly reviewed by the company and found to be utterly without merit; in fact, in 2018 she withdrew the claim she had filed challenging her termination. We're not going to dignify her unsubstantiated assertions with further comment." (Source)

Conclusion

According to all the forensic models applied, there is no indication of the alleged rampant financial irregularities or of a $6 billion in revenue overstatement in the 2008/2009 period in the Disney financials. The single period of adverse scoring in 2012 on the Beneish M-score is not sufficient to validate all the claims of years of revenue overstatements as alleged by Sandra Kuba. There are no other periods of any adverse scoring on the Beneish M-score in the Disney financials through today.

These models are certainly not foolproof and were designed by academic researchers to improve the chance of detection of irregularities leading to bankruptcy, earnings manipulation, or flag the presence of financial distress.

At the same time, these models are among the best peer-reviewed forensic models in the financial literature and have some significant documented value.

The Beneish model for example has "correctly identified, in advance of public disclosure, a large majority (71%) of the most famous accounting fraud cases that surfaced after the model's estimation period." (Beneish, Lee, & Nichols, 2013, p. 57).

I trust the insight from these different forensic and value algorithms will give you added value to your investment goals and objectives in the days ahead.

JD Henning, PhD, MBA, CFE, CAMS

References

Altman, E. I. (1968). The Prediction of Corporate Bankruptcy: A Discriminant Analysis. The Journal of Finance, 23(1), 193-194. doi:10.1111/j.1540-6261.1968.tb03007.x.

Beneish, M. D. (1999). The Detection of Earnings Manipulation. Financial Analysts Journal, 55(5), 24-36. doi:10.2469/faj.v55.n5.2296.

Beneish, M. D., Lee, C. M. C., and Nichols, D. C. (2013). Earnings Manipulation and Expected Returns. Financial Analysts Journal, 69.2, 57-82.

Ohlson, J. A. (1980). Financial Ratios and the Probabilistic Prediction of Bankruptcy. Journal of Accounting Research, 18(1), 109. doi:10.2307/2490395.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.