Corporate scandals exposed vulnerabilities of market

Monday, December 16, 2002

Executives were led away in handcuffs and business leaders took the Fifth Amendment, images of a tumultuous year in which the fabric of corporate America was tearing apart.

In time, though, they might better serve as reminders of the system's weaknesses and the need to patch them, lest the whole thing come unraveled again.

"Hopefully, what will come out of all this will be some wariness, skepticism and vigilance," said Nancy Koehn, a financial historian at Harvard Business School.

As details emerged about Enron, WorldCom and executives who got rich at the expense of employees and shareholders, investors on Wall Street and Main Street were devastated.

Whatever satisfaction the public felt as executives were indicted was certainly tempered by the economic damage wrought by accounting shenanigans. Stocks plunged, jobs were lost and retirement savings were wiped out.

While the financial pain lingers, the more enduring legacy of this scandalous era could be beneficial to the American financial system.

Executives, auditors and corporate boards are likely to face greater scrutiny as a result of new laws and industry standards. Equally important, experts said, is that individual investors are paying greater attention to the conflicts of interest and the culture of self-interest that dominate corporate America.

But this renewed attentiveness should not be taken for granted, said James Schrager, a professor of strategic management at the University of Chicago's Graduate School of Business.

"It will only last until the next giant, silly expansion based on air," Schrager said. "There will be other great frauds."

They are likely, though, to be measured against the corporate excess and duplicity exposed in 2002:

Enron's former chairman and chief executive, Kenneth Lay, received $152.7 million in payments and stock in the year leading up to the company's collapse amid revelations that it hid debt and inflated profit for years. Lay's take in 2001 was more than 11,000 times the maximum amount of severance paid to laid-off workers.

Former WorldCom CEO Bernard Ebbers borrowed $408 million from the telecommunications company that had improperly accounted for $9 billion and was forced into bankruptcy. Ebbers had pledged company shares as collateral, but with those shares, once valued at $286 million, worthless, he was said to be considering forgoing his $1.5 million annual pension to help settle the debt.

Adelphia Communications' founder and former CEO, John J. Rigas, allegedly conspired with four other executives to loot the company, leading prosecutors to seek the forfeiture of more than $2.5 billion.

Of the 15 people indicted in the scandals at Enron, WorldCom and Adelphia, six have pleaded guilty to securities fraud and other crimes. Only one CEO from these companies, John J. Rigas, has been indicted. None has been convicted.

In addition, a dozen insiders from Arthur Andersen, Enron, ImClone Systems, Merrill Lynch and WorldCom exercised their constitutional right against self-incrimation during congressional hearings.

Massive earnings restatements at Adelphia, Enron and WorldCom drew attention, but a government report found it was just part of a growing trend among public companies.

The General Accounting Office, Congress' investigative arm, reported that earnings restatements due to accounting irregularities rose 145 percent between 1997 and June 2002. By the end of 2002, the GAO predicted 3 percent of all companies will have restated earnings, compared with less than 0.9 percent in 1997.

$6,000 shower curtain

The public glare went beyond the executive suite.

Former Tyco International CEO Dennis Kozlowski was said to spend millions of dollars of company money on art and furniture -- even a $6,000 shower curtain, by one report -- and Adelphia executives allegedly used corporate jets for personal business.

Lawrence White, a former economist at the Justice Department who is now a professor at New York University's Stern School of Business, said the type of behavior exposed in 2002 only happens when there is "a breakdown of institutions."

"Despite the lip service, executives weren't really managing their companies in the long-term interest of the shareholders," White said.

"That was combined with accountants not doing their job, shareholders being lulled by those back-to-back years of double-digit gains, figuring they didn't have to pay attention, and the analysts essentially getting co-opted by the companies they're supposed to cover."

The underlying problem of the era, said Barry Barbash, a former lawyer for the Securities and Exchange Commission who now works at Shearman & Sterling, was "superficiality."

Investors didn't ask

The overwhelming majority of individual investors weren't asking enough questions either, experts said.

As their 401(k) retirement plans grew at staggering rates, workers developed a blind faith in the market, said Ken Janke, chairman of the National Association of Investors Corp., a nonprofit investor education group.

And while individual investors should not have been expected to anticipate the kinds of accounting mischief that went on at Enron, Janke said they should have known that research published by analysts who work for investment banks was suspect.

"That's not something new," he said.

To be sure, the scandals of the past year and the subsequent decline in value of 401(k)s demystified plenty about the way Wall Street works.

"Nothing focuses the mind like a hanging," quipped the AFL-CIO's Patterson.

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