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Running head: MAGNACHIP CASE STUDY

MAGNACHIP CASE STUDY

ELISABETH J PAGE

SOUTHERN NEW HAMPSHIRE UNIVERSITY


MAGNACHIP CASE STUDY 2

CASE SUMMARY

MagnaChip SemiConductor Corporation is a, “designer and manufacturer of analog and

mixed-signal semiconductor platform solutions” (Corporate profile). After going public in 2011,

MagnaChip began to place enormous pressure on its employees to reach unrealistic revenue and

other operational targets. While lower level employees engaged in schemes to reach these

otherwise unattainable benchmarks, Margaret Hye-Ryoung Sakai, MagnaChip’s Chief Financial

Officer at that time, was allegedly aware of the financial shenanigans taking place. According to

the Accounting and Auditing Enforcement Release (AAER), “although these improper practices

were well-known through MagnaChip’s Korea-based management… Sakai directed or approved

several of the practices, failed to remediate other practices, and understood how the practices

would impact MagnaChip’s reported financial results” (ACCOUNTING AND AUDITING

ENFORCEMENT release no. 3869). MagnaChip’s audit committee launched an investigation to

address mounting concerns over the company’s accounts receivables balances; the findings led to

multiple restatements and ultimately the unmasking of the fraud.

ACCOUNTANT’S ROLE & DISCOVERY

According to the AAER, “both MagnaChip’s outside auditors and members of its Board

and Audit Committee independently raised concerns about the Company’s rising accounts

receivable balances” (ACCOUNTING AND AUDITING ENFORCEMENT release no. 3869).

The investigation identified a number of improper revenue recognition practices and triggered

the restatement of various Forms 10-Q and 10-K between the years of 2011 and 2014. The

domino effect continued and, in 2014, “MagnaChip announced that the scope of the Audit

Committee’s investigation had expanded to include errors and adjustments to costs of goods

sold, inventory, and reserves and related business practices” (ACCOUNTING AND AUDITING
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ENFORCEMENT release no. 3869). As the audit committee unraveled the financial statement

fraud that had been taking place, Sakai finally became implicated as a perpetrator. The

Accounting and Auditing Enforcement Release alleges over and over that Sakai was negligent in

violating multiple sections of the Exchange Act. The scope of the fraud and the blatantly

improper recognition of revenue should have been detected long before the audit committee

launched its investigation. Had there been anti-fraud measures, like a whistle-blower hotline, at

MagnaChip, this fraud and the consequences may have been detected and mitigated much earlier

on.

ANALYIS & FRAUD TRIANGLE

PRESSURE. After its initial public offering, MagnaChip applied intense pressure to its

employees to achieve revenue targets. Management did not want the company’s operating results

to fall short of its previously announced performance goals and, as evidenced by the AAER, “in

several instances when employees objected to the targets, management refused to lower them”

(ACCOUNTING AND AUDITING ENFORCEMENT release no. 3869). The unrealistic

revenue targets were taken seriously and management strictly monitored the progress of these

initiatives. Senior managers would allegedly hold, “weekly sales meetings with the Company’s

sales and manufacturing personnel to track their progress, often berating them when they fell

short.” (ACCOUNTING AND AUDITING ENFORCEMENT release no. 3869). With all of the

downward pressure coming from management, it is no wonder that personnel began to entertain

fraudulent revenue recognition schemes.

OPPORTUNITY. The massive MagnaChip fraud remained undetected due to a weak control

environment. The absence of internal controls gave manufacturing employees sufficient

opportunity to manipulate the company’s earnings while employees were simultaneously


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rewarded for reaching predetermined revenue targets. To illustrate, in 2011, MagnaChip

accelerated the recognition of $1.8 billion improperly. MagnaChip’s then CFO, Sakai, “approved

the recording of revenue in 2011, even though she either knew or was reckless in not knowing

that the customer had always insisted on title and risk of loss transferring in 2012”

(ACCOUNTING AND AUDITING ENFORCEMENT release no. 3869). With no barriers to

fraud and no tone-at-the-top emphasizing integrity, there was virtually nothing standing in the

way of employees circumventing accounting controls with intent to doctor MagnaChip’s

operating results.

RATIONALIZATION. Fraud occurs when all three prongs of the fraud triangle are present;

while MagnaChip employees were undoubtedly subject to pressure and had ample opportunity to

improperly recognize revenue, they needed a way to legitimize their behavior. Management at

MagnaChip set revenue targets that were so unattainable it is likely that employees began to feel

that by committing fraud they were only doing what was necessary to keep their jobs. According

to the AAER, “in 2011, some MagnaChip Korean sales employees met with some manufacturing

employees to express concern about their ability to meet the sales targets set by senior

management because manufacturing could not keep up” (ACCOUNTING AND AUDITING

ENFORCEMENT release no. 3869). Soon after this meeting, manufacturing employees began to

fraudulently record revenue on unfinished products.

CONCLUSION AND INTERNAL CONTROLS

The MagnaChip fraud could have been prevented altogether or at least detected and dealt

with long before it was discovered by the audit committee’s investigation. An utter lack of

internal controls perpetuated a collaborative effort at MagnaChip to manipulate financial results

and the material weaknesses in internal controls were not relayed to MagnaChip’s audit
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committee and therefore were never remediated. A strong control environment goes a long way

in fraud prevention; management should have established a strong tone-at-the-top as well as

instituted a whistleblower incentive system. While tone-at-the-top is an effective preventative

control, a whistle-blower incentive program serves as a powerful detective control. According to

findings from the 2014 ACFE survey, “organizations with hotlines were much more likely to

catch fraud by a tip. These organizations also experienced frauds that were 41 percent less costly,

and they detected frauds 50 percent more quickly” (Mintz 2017). Strong evidence supports the

institution of whistle-blower hotlines, a relatively inexpensive measure.

In the AAER, the SEC lists the absence of, “prevention or detection of undisclosed

business practices involving the circumvention of internal controls” (ACCOUNTING AND

AUDITING ENFORCEMENT release no. 3869) as a contributing factor to the fraud. Sales and

manufacturing employees colluded at MagnaChip to falsify revenue on unfinished products.

Separation of duties may have been an effective deterrent to the revenue recognition scheme

taking place; however, in this case, it appears that both employees and management were aware

the fraud was happening. Because employees and management were colluding together, this

fraud would have been difficult to prevent even with separation of duties. In the end,

MagnaChip’s only saving grace was its audit committee. Had the audit committee not remained

vigilant about the company’s accounts receivable balances and launched an investigation, this

fraud may have been allowed to continue through several more reporting periods.
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REFERENCES

ACCOUNTING AND AUDITING ENFORCEMENT release no. 3869. (2017). Retrieved

December 31, 2017, from https://www.sec.gov/litigation/admin/2017/33-10352.pdf

Corporate profile. Retrieved Dec 31, 2017, from http://investors.magnachip.com/corporate-

profile

Mintz, S.M., & Morris, R.E. (2017). Ethical obligations and decision making in accounting (4th

ed.). New York, NY: McGraw-Hill.