A customer checks a camera of Japanese optical giant Olympus at a Tokyo camera shop on October 27, 2011.

Story highlights

NEW: Seven men arrested in connection with $1.7 billion Olympus Corp fraud

Ex-Chairman Tsuyoshi Kikukawa and two other former executives detained

Company executives hid $1.7 billion in losses in bad investments from the 1990s

Ex-CEO Michael Woodford was fired in October when he questioned shady transactions

CNN —  

The drama surrounding Olympus and cover-up of $1.7 billion in losses resulted in the first arrests Thursday.

Three former executives – ex-Chairman Tsuyoshi Kikukawa, former Executive Vice President Hisashi Mori, and Hideo Yamada, a former auditor – were arrested for filing fraudulent information on the company accounts in 2007 and 2008. Four other outside financial advisers were also arrested for assisting with the fraud.

The furor that followed the firing of former Olympus CEO Michael Woodford in October and his subsequent turn as whistleblower on the decades-long cover-up, saw the stock value of the Japanese camera and medical instruments maker drop more than 75% at the height of the crisis. Besides the charges in Japan, officials in the U.S. and the UK are investigating possible criminal wrongdoing.

The company appointed an independent commission, led by a former Japanese supreme court judge, who released a report in December saying, “the management was rotten to the core, and infected those around it.”

Who is Michael Woodford?

A foreign “salariman” for Olympus, the Briton worked for 30 years at the company, starting as a sales assistant in its medical sales division and rising up the ranks to become executive managing director of its European operations in 2008. In April, he was tapped by outgoing President and CEO Kikukawa to become the Japanese company’s first foreign president, a rarity among Japanese listed companies. Only Howard Stringer, Chairman of Sony, Carlos Ghosn, the head of Nissan, and Craig Naylor of Nippon Sheet Glass currently lead Japanese listed companies.

According to Woodford, things began to go awry internally when a Japanese magazine, FACTA, published an expose in July questioning exorbitant fees Olympus paid consultants for a 2008 acquisition deal, and extravagant purchase prices of three small companies.

Woodford said that when he began asking Kikukawa and Mori about the deal, he was stonewalled. Tensions escalated until October 14 when at a board meeting Woodford was fired by a unanimous vote.

What was the cover-up?

According to a December 6 report issued by the third party set up by the company to investigate Woodford’s claims, the company had inflated fees for the 2008 purchase of Gyrus, a UK medical instruments firm. The fees paid to advisers totaled $687 million, nearly one-third of the company’s purchase price.

The panel also found the $773 million paid for three small Japanese companies – a face cream maker, a plastic container maker and a recycling business, each with fewer than 50 employees – were exorbitantly priced to cover-up the company’s loses.

The problems at Olympus date back to Japan’s booming 1980s, according to the report. After the 1985 Plaza Accord on currency, Japan’s yen steeply appreciate in value. To offset the losses Japanese corporations saw on the back of a rising yen, companies like Olympus began dealing highly speculative securities, such as derivatives trading, the report said. By 1990, the losses had mounted and a series of chief executives, ending with Kikukawa, kept the losses secret.

The losses were hidden through an intricate scheme that diverted cash through a Cayman Islands account. Police in several countries are still investigating the transaction – so far, no one has been arrested in the scheme.

Was the Japanese mafia involved?

There have been some published reports that the Japanese mafia may have been involved in helping to hide the assets. While criminal investigators may still examine that possibility, the independent committee report said it did not find any involvement of “antisocial forces” in its investigations.

What’s next?

After his ouster, Woodford talked to investigators in three continents, Japanese legislators about improving corporate governance in the company, and campaigned to retake the helm of the company. Woodford sought the resignation of the entire Olympus board and new management for the company. The Olympus board said it plans to step down, but not until after a special shareholder meeting expected in April to chart the new management direction of the company.

In January, citing lack of support from Japanese institutional investors, Woodford abandoned his drive to return to the company, but said he plans to file suit for wrongful termination.