In 2015, Toshiba was hit by a systematic financial fraud scandal that had lasted for seven years.
Three consecutive presidents were involved, with the total amount involved reaching over 150 billion Japanese yen.
The firm responsible for auditing Toshiba was none other than Ernst & Young ShinNihon.
For seven years, they issued unqualified audit reports every single year.
A fraud of this magnitude could not have been achieved by a few executives on a whim; it required close coordination across finance, sales, and production departments, and even more so, the "tacit understanding" of external audit institutions.
Sega's operations are expanding rapidly.
With major markets in North America, Europe, and China all advancing in parallel.
Hardware production lines are running at full capacity, and software development budgets are often in the millions of dollars.
Tens of billions of yen are flowing through the accounts.
As long as someone manipulates the supply chain or sales channels even slightly, it is not difficult to inflate profits, hide losses, and produce a beautiful financial statement.
Entrusting the company's lifeline entirely to the professional ethics of these local audit firms is too high a risk.
Takuya Nakayama closed the book, reached for the telephone receiver on his desk, and dialed Director Hoshino's extension.
"Managing Director," Hoshino answered.
"Hoshino-san, please come to my office. And bring along Sega's external audit contracts from the past three years."
A few minutes later, Hoshino pushed the door open, carrying a document folder.
He sat down in the chair opposite the desk and handed the folder over.
"Here are the contracts you requested. We've always used ChuoAoyama Audit Corporation," Director Hoshino reported.
Nakayama pulled out the contracts and quickly scanned the terms. "The audit fees go up every year, yet the audit reports have become increasingly templated." He tossed the contract onto the desk. "Hoshino-san, which firm did the Investment Department use when conducting due diligence in North America?"
"The team from the PricewaterhouseCoopers New York office," Director Hoshino replied. "Wall Street has extremely rigorous requirements for financial data; we had to use a top-tier team to provide credibility."
"What are the differences in the way the two teams work?"
Hoshino reflected for a moment. "The team in New York is more rigid. They don't listen to explanations of business logic; they only look at the original vouchers and cash flow. If they find any anomalies, they bypass management and send inquiry letters directly to the Board of Directors. Here in Japan—" He paused, choosing his words carefully, "it's more about interpersonal relationships. When they encounter flaws in the accounts, they first communicate with the head of the Finance Department. As long as you can provide a plausible reason, they usually make 'technical adjustments' in the working papers."
This was precisely what Takuya Nakayama was worried about.
"Technical adjustments." Takuya Nakayama repeated the phrase. "One technical adjustment is a flaw; ten technical adjustments is planting a landmine."
Director Hoshino sat up straight. "Are you implying there's a problem with ChuoAoyama?"
"Whether there's a problem or not, you can't tell just by looking at the reports. But I cannot build Sega's financial security on other people's 'interpersonal relationships'."
Takuya Nakayama tapped his fingers on the table. "The Japanese audit market is a society of acquaintances. Many of those auditors and our finance department staff are university alumni, or even former colleagues who worked at the same company. This kind of network easily forms a community of shared interests."
Director Hoshino nodded in agreement.
People in finance have an innate sensitivity to risk.
"I intend to introduce a new auditing mechanism," Takuya Nakayama said, unveiling his plan. "I'll consult with top-tier Western consulting firms, like McKinsey or Boston Consulting Group. I want to reform Sega's internal audit regulations."
"How exactly?"
"A dual-track system," Takuya Nakayama said, holding up two fingers. "The local auditors will continue their routine audits to meet the compliance requirements of the Financial Services Agency. We will bring in an independent team from a Western accounting firm. This team will not report to the Japanese management, nor even to the Finance Department."
Director Hoshino gasped.
This was tantamount to establishing an internal "secret police" that reported directly to the top.
"They will report directly to the Board of Directors, or a newly formed Group Audit Committee," Takuya Nakayama continued. "Any complete audit working papers produced by the Japanese team, and any suspicious findings, must be copied verbatim to this independent team for review. Any attempt to cover up issues will be exposed through cross-referencing between the two systems."
This plan was undeniably ruthless.
It directly severed the paths for subordinates to collude and cheat.
"Pushing this mechanism through will meet with significant resistance from the Finance Department," Director Hoshino cautioned. "No one likes having a pair of eyes watching them all the time. After you called Yoshimura in for questioning today, the Sales Department is already on edge. If we start wielding the knife in Finance too, I'm afraid it will trigger a backlash."
"Backlash is inevitable sooner or later," Takuya Nakayama said, leaning back into his chair. "Right now, Sega is in a growth phase with lucrative profits; everyone has meat to eat, so certain management loopholes are being covered up. The day the market environment changes, or if market performance during a hardware transition period is underwhelming, these loopholes will become fatal bleeding points."
"Please go and contact the North American partners at PwC and McKinsey. Do not go through the Japan branch; contact their US headquarters directly. I want an audit framework that meets the highest international standards while simultaneously circumventing any personal interference from within Japan."
Director Hoshino jotted down the key points in his notebook. "How should the budget be approved?"
"We'll put it to a vote at the board meeting. I'll initiate the motion. Given our current flourishing momentum, I believe the board members won't have an issue with chipping in a little extra for security. They should be happy to see a system that ensures everyone follows the rules. As for the consulting fees, let's pull those from my discretionary budget for managing directors first." Takuya Nakayama paused for a moment, then continued, "You handle this personally. Do not make it public at the board meeting until the dual-track audit plan is finalized."
Director Hoshino closed his notebook and stood up as well. "Understood. I'll call New York tonight."
Takuya Nakayama glanced at the wall clock: 5:25.
He picked up his suit jacket and briefcase, then walked out of the office with Director Hoshino.
In the hallway, several employees preparing to leave for the day stopped and bowed as they saw Takuya Nakayama.
Takuya Nakayama nodded in acknowledgment without slowing his pace.
Establishing a system is far more difficult than firing a few people.
In the hallway, several employees preparing to leave for the day stopped and bowed as Nakayama Takuya approached.
Nakayama Takuya nodded in acknowledgement, not pausing his stride.
Establishing a system is far more difficult than firing a few people.
Firing people solves the immediate problem; establishing a system solves future hidden dangers.
The old man handed over power to him because he valued his ability to lead Sega in conquering the market.
But he knew in his heart that fortresses are often breached from within.
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