138 Case Research Journal • Volume 32 • Issue 2 • Spring 2012
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? What’s going on?” He was sure something was not
right.
R ICHARD 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]. Tey 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 Mom’s 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, Okumoto’s 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, Okumoto’s 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 dad’s
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 kids—almost like an adult.
Te Okumoto family’s 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. Tere was
no credit card, no second mortgage. In that situation, budgeting
became extremely important. Her com- ment to me was, “You can’t
complain [about what you don’t have] unless you under- stand what’s
happening.” Tose were her ground rules.
He added this comment about his mother’s values:
Te ethics of doing the right thing become very important, because
that’s 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. Tat has influenced me throughout my
career.
.
Te Midnight Journal Entry 139
Novellus Systems, Measurex, Credence Systems, and Photon Dynamics.
Okumoto admired a number of managers he had worked for, who had set
high professional and ethical standards for him and his co-workers.
He felt fortunate to have had three exceptional mentors: Woody
Spedden, the CEO of Credence Systems; Jim Heffer- man, his boss at
Fairchild and later at Measurex; and Don Waite, the CFO at Meas-
urex who later took over that position at Seagate echnologies. “All
three individuals upheld the highest integrity,” Okumoto recalled.
“Aside from the technical training I received from them, I got a
strong ethical grounding. Tey would always tell me to ask
myself—what are your obligations to others?”
ELECTRO SCIENTIFIC INDUSTRIES, INC.
Electro Scientific Industries, Inc., the company that Okumoto
joined as CFO in early 2003, was the second-largest technology
company in Oregon, trailing only ektronix in size. Based in
Portland, the company was founded in 1944 as Brown Engineering to
make test and measurement equipment. As technology evolved, so did
the company’s products. In the 1960s, the firm—by then called
ESI—moved into lasers, and later developed applications of laser
technology for the emerging semiconductor industry. ESI went public
on the NASDAQ exchange in 1983.
In 2003, ESI’s core business was providing precision production
equipment to electronics firms. Te company manufactured equipment
that was used in the produc- tion of a wide range of electronics
products, such as computers, cellular phones, home entertainment
systems, automotive electronics, electronic games, and personal
digital devices. Its products included advanced laser systems, test
equipment, and packaging systems, among others. Te company’s
customers included many leading electronics firms, including AMD,
Ericsson, IBM, Samsung, Hitachi, Flextronics, Honeywell, and
Lucent. Seventy percent of ESI’s sales were outside the United
States, mainly in Asia and Europe. Te company owned and operated
manufacturing facilities in Portland and Klamath Falls, Oregon, and
in Escondido, California, and operated sales offices in many
countries. In 2002, it employed 875 people and reported sales
revenue of $167 million (down from $472 million the prior
year).
Like many firms in the electronics industry, ESI was badly battered
by the eco- nomic downturn that began in 2001. After achieving
record sales and income in the fiscal year ending May 31, 2001, the
company’s financial results declined precipitously in FY 2002, as
shown in Exhibit A . Sales and profits had continued to
decline in the first half of FY 2003.
Exhibit A: Electro Scientic Industries,
Selected Sales and Income Data*, 1998–2002
1998 1999 2000 2001 2002
Net sales 252,134 197,118 299,419 471,853 166,545
Net income (loss) 22,347 7,528 40,860 99,933 (15,961)
Net income (loss) per share 0.89 0.29 1.55 3.71 (0.58)
*Data refer to scal years ending May 31. All data are given in
thousands of dollars, except per share data.
Source: ESI 2002 Annual Report.
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140 Case Research Journal • Volume 32 • Issue 2 • Spring 2012
Te company noted in its 2002 annual report:
In fiscal year 2002, ESI weathered the worst downturn in the
electronics industry in over 30 years . . . We are conducting a
thorough review of our overall market strategy as well as product
line strategies to assure that they will generate significant
shareholder returns over the inevitable cycles in our
industry.
o cut costs, the company initiated a shutdown of its Escondido
facility, consolidating its operations in Portland. It divested
several underperforming lines of business and sought to invest in
areas it saw as promising through partnerships and, potentially,
ac- quisitions. It also informally explored a merger with another
firm in southern California.
In early 2002, Don VanLuvanee, the company’s long-time CEO,
suffered a stroke and was no longer able to serve. Te board
appointed David Bolender, the former CEO of Protocol Systems and a
director since 1988, to step in as acting CEO until it could find a
permanent replacement. At that time, the board also elevated James
Dooley, who had been serving as the firm’s chief financial officer,
to the role of acting chief operating officer to run the company’s
day-to-day affairs. In December 2002, the board promoted Dooley to
the position of chief executive officer, and Bolender became
chairman of the board. (Executives and directors of ESI named in
the case, and their positions, are summarized in Exhibit B.)
Exhibit B: Executives and Directors of Electro Scientic Industries,
Inc.
(Listed in Order of Mention)
Richard Okumoto Chief Financial Ofcer (CFO)
James T. “Jim” Dooley Acting Chief Operating Ofcer (COO), early
2002–December 2002
Chief Executive Ofcer (CEO), December 2002–
Don VanLuvanee Former CEO
Chairman of the Board, December 2002–
John “Jack” Isselmann, Jr. General Counsel
Mike Tetsui Manager, Japanese Ofce
Barry L. Harmon Former Chief Financial Ofcer (CFO)
Director and Member of the Audit Committee
Gerald F. “Jerry” Taylor Director and Member of the Audit
Committee
Jon D. Tompkins Director
CLOSING THE Q UARTER
Shortly after Dooley became CEO, Okumoto was recruited as chief
financial officer. He started work on February 17, 2003.
.
Te Midnight Journal Entry 141
His first task was to prepare for the FY 2003 third quarter close.
In reviewing the com- pany’s 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
Okumoto’s 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 etsui, a set of revised work rules (terms of
employment) for ESI’s 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 counsel’s request, sending on
to the Japanese office manager the revised work rules.
Okumoto received the following reply from etsui 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 have…I do
not think I can get concents [sic] from [ESI’s 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.” Tere was a big disconnect between
what I had been told and Mike’s 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
company’s 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 aiwanese
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. Tere was full disclosure. He emphasized
that KPMG [ESI’s external auditor], the company’s 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.
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142 Case Research Journal • Volume 32 • Issue 2 • Spring 2012
Te CEO—all six feet-six inches and 280 pounds of him—turned an
angry red and told me again to just get past this. Tat’s when I
knew that this was going to be swept under the rug. It was clear I
was not part of the club. Ten Jim said, “If I’ve got to
reverse this entry, I’ll quit.”
THE “MOFO” MEMORANDUM
On March 13, Okumoto attended a meeting of the board of directors’
audit com- mittee. Also present at that meeting, in addition to the
audit committee members, were Dooley, Isselmann, and several
senior managers. At the meeting, Okumoto rec- ommended that the
company’s financial statements for the previous two quarters be
restated, and that it hire an independent accounting firm to
conduct an audit of the Asian benefits issue. Dooley
countered that everyone had been fully informed of the reversal and
had “bought off” on it. Te audit committee declined Okumoto’s sug-
gestion that an independent accounting firm be brought in, but it
did direct Barry Harmon (formerly ESI’s CFO and a member of the
audit committee), Okumoto, and Isselmann to lead an internal
investigation into the matter. After the audit committee
meeting, Isselmann came into the CFO’s office. Oku-
moto recalled:
He closed the door and just broke down. He told me that after the
benefits reversal in September he had asked MoFo [Morrison
Foerster, an outside law firm on retainer to ESI] to review its
legality. MoFo had advised it was illegal to cancel the retirement
benefits without employee consent. He said he had immediately shown
the memo to Dooley, who had brow-beat him, intimidated him, and
essentially boxed him into a corner. I believed this, because in
one meeting I actually saw Jim stand up and tower over Jack, who
was only 5 feet 6. I watched Jim almost physically overtake him.
Jack was a young guy, pretty inexperienced, and his job at
ESI was his first in the industry.
On his way out, Isselmann handed Okumoto some documents. From the
documents, Okumoto learned that on October 3, 2002, Isselmann
had
written MoFo, asking for an opinion on whether or not it
would be legal for the com- pany to terminate the Asian employees’
retirement benefits unilaterally. In his letter, Isselmann had
pointed out that the rules had been distributed to employees but
had not been submitted to the relevant government agency. On
October 7, oshihiro So, a Japanese labor and employment
attorney affiliated with Morrison Foerster, responded to
Isselmann’s request. Te MoFo memo, now in Okumoto’s hands, read in
part:
Retirement allowances are not a legal requirement [in Japan].
However, once the com- pany agrees to pay retirement allowances in
Rules of Employment (even though they have not been submitted to
the relevant government agency), the company is obliged to pay them
in accordance with the Rules and cannot remove them at the
company’s discretion. According to Japanese case laws, as a general
rule, …the deprivation of previously acquired rights by newly drawn
up or changed work rules are [sic] not per- mitted…[It] is required
that before changing the work rules, the company should hear and
consider the opinion of the related employees.
Okumoto was shocked. “Tis is the smoking gun,” he thought.
Investigating further, Okumoto learned that although private
employers in Japan
.
Te Midnight Journal Entry 143
Under the rules of employment established for ESI’s 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 month’s pay per year of service—in
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 company’s workers in Korea and
aiwan. At the time, ESI had 18 employees in Japan, 13 in Korea, and
23 in aiwan, 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. Te 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 Dooley’s
response indicated that he must have already disclosed it to KPMG
and the audit committee.
On March 20, Okumoto spoke by telephone with Mike etsui. Te
Japanese man- ager told the CFO that the employees had not yet been
told that their retirement ben- efits had been terminated, and
he—etsui—would resign before he would tell them that news, which he
expected would be devastating. “As head of the group,” etsui 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 company’s
calculations of its overhead costs, so the financial statements
distributed to the board were incorrect. ESI’s 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. Ten 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. Tat was a definite red flag.
Okumoto walked out of Dooley’s 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.
.
144 Case Research Journal • Volume 32 • Issue 2 • Spring 2012
reminded me of beaten animals. Growing up in the neighborhood I
did, I knew what fear looked like.
As part of his further investigation, Okumoto independently
approached the audit team from KPMG. Tey told him Dooley had
informed them that the company had received a legal opinion that
the reversal was appropriate, and they had deemed that information
sufficient. Okumoto observed:
KPMG was new on the account, which they picked up after the
collapse of Arthur Andersen. Tey didn’t have deep familiarity
with it. Tey did not have all the informa- tion. Some of the
partners were new.
On March 28, a week after he had requested the relevant accounting
entries for September 12, his staff finally produced the complete
documentation for that date. Now, drilling down into the details,
he saw the full scope of the midnight journal entries—and who had
made them.
W EIGHING THE R ISKS
Over the weekend, Okumoto considered his next moves. None of the
individuals and groups from whom he had sought support—the CEO, the
general counsel, or the au- ditors—seemed to share his concern
about the seriousness of the issue. Te audit com- mittee had shown
some interest, but had turned down his recommendation to bring in
independent auditors and seemed to believe the matter could be
handled internally. Okumoto was losing sleep, worrying constantly
about what—if any—additional steps he should take. He had tried to
warn the key players. From all, he had received the same message:
We don’t see this as a serious problem. Let it go.
Okumoto realized the risks of escalating the issue further. He was
earning a base sal- ary of $250,000, with the possibility of a 100
percent performance bonus. He reflected:
I certainly realized the risks. I knew that if I brought this
forward, there was a strong likelihood that I would either lose my
job, or I would be in an environment where it would be
difficult to operate, so I would have to leave.
Te idea also occurred to him that “I can leverage this for more
money and stock if I look the other way. Plus, I can become
invaluable to the company with this dirt. I can immediately become
part of the established inside club.” He had also recently signed a
contract to purchase a home in the nearby community of Lake Oswego,
and wondered how he would make good on that commitment if he lost
his job.
However, he felt reasonably secure financially. Following the
example of his parents, Okumoto had worked hard to avoid debt and
to save for adverse times. He reflected:
.
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 don’t 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. Tere 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 aylor, 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 ompkins, the former CEO of KLA-encor,
was also on the board. I had known Jon from encor 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:
.
146 Case Research Journal • Volume 32 • Issue 2 • Spring 2012
He also thought about his mother’s admonition always to do the
right thing, and the advice of his mentors, who had counseled him
always to ask the question—what are your obligations to
others?
Exhibit C: Members of the Board of Directors, ESI Inc., March
2003
David F. Bolender, Chairman of the Board
Chairman of the Board and CEO (retired), Protocol Systems,
Inc.
President (retired), Pacic Power and Light Co.
James T. Dooley, Chief Executive Ofcer
Barry L. Harmon, member of the Audit Committee
Senior Vice President (retired), Avocet Corp.
Formerly, Senior Vice President and Chief Financial Ofcer,
ESI
Keith L. Thomson
Chair of the Board of Trustees, University of Oregon
Foundation
Jon D. Tompkins
President and CEO (retired), Spectra-Physics
Vernon B. Ryles, Jr.
Gerald F. Taylor, member of the Audit Committee
Chief Financial Ofcer (retired), Applied Materials
W. Arthur Porter, Chairman of the Audit Committee
Dean of the College of Engineering, University of Oklahoma
Larry L. Hansen
NOTE
.
