The irregularities centre on Penguin Books in America where a rogue individual in the accounts department had been secretly giving unauthorised discounts to retailers in return for early payment. Stretching back to 1991 the irregularities involved what Pearson described as "an accounting web of breathtaking complexity." It is thought that the irregularities covered a significant proportion of Penguin USA's book sales
Following heavy losses at Mindscape, the US software house acquired by Pearson in 1994, the Penguin problems cast fresh doubts on Pearson's ability to run businesses in America. Analysts said the scandal would also make Pearson more vulnerable to a break-up bid as predators seek to unlock the value of its disparate interests which range from Lazards, the merchant bank, to Madame Tussauds.
"The more they [Pearson] disappoint, the more people expect someone to bid for them," said Anthony de Larrinaga, media analyst at Panmure Gordon.
After sharp falls following the announcement, Pearson shares recovered to close 14p lower at 749.5p supported by takeover speculation.
The scandal is a huge blow to Marjorie Scardino, who only joined Pearson as chief executive last month. Yesterday, she stressed that the scandal did not affect the underlying profitability of Pearson and that the prompt action by new management showed that Pearson was getting to grips with the problems.
"This is still a strong company and I have been very impressed with the quality of the management in most of the divisions," she said.
The accounting scandal arose at Penguin USA's accounting functions in Bergenfield, New Jersey. Pearson claims one person involved in the accounts receivable division started offering discounts to retailers in 1991 in return for early payment. The discounts averaged 5-7 per cent
The employee was not at senior level nor paid a high salary. Though bonuses were payable Pearson claim there was no financial motive for the employee's action. It says the individual thought their job was to ensure prompt payment from customers and that success in this area would be welcomed by bosses.
Rumours had been circulating in the book trade that Penguin's US profits may have been overstated. "In recent years it has surprised many in the industry the way Penguin in the US has been able to fulfil very demanding financial targets from Pearson," said a senior figure in the book trade who has dealt with the publisher.
Pearson said that the complex environment of a publishing house, where huge numbers of invoices were circulated, made it relatively easy for a determined individual to deceive management and the auditors.
"This person was very sophisticated at moving sums of money around the system," Pearson said. One industry expert said Penguin's problem was not likely to affect the UK division, where operations were tighter.
The scandal was uncovered by Michael Lynton, who took over as chairman and chief executive in January having replaced Peter Mayer who retired. He discovered the irregularities when varying terms of trade with retailers emerged following the merger of Penguin USA with Putnam Berkley in 1995.
Pearson says the accounting practices were stopped immediately on discovery and have not been taking place at any other Penguin businesses outside the US or at Putnam.
"Those found responsible have been and will be appropriately dealt with," Pearson said yesterday. The individual responsible for the scandal was fired earlier this month. The company did not say if it would press for fraud charges.
Legal action against the former auditors Arthur Andersen is possible, though the company would not comment yesterday. Pearson has launched a full investigation led by its lawyers and its recently appointed auditors, Price Waterhouse.
It is possible that Penguin may be forced to make payments to retailers who were not given discounts.