Corporate Scandals and Macroeconomic Impact

Corporate ScandalsCorporate Scandalsand theirand their

Macroeconomic ImpactMacroeconomic Impact

Jeff MillerJeff Miller4/27/20054/27/2005

Corporate Scandals and Their Corporate Scandals and Their Macroeconomic ImpactMacroeconomic Impact

History of Corporate ScandalsHistory of Corporate Scandals

Reaction: Citizens, Investors, Reaction: Citizens, Investors, GovernmentGovernment

Macroeconomic EffectMacroeconomic Effect

Corporate scandals are not Corporate scandals are not newnew

Early 1900’s:Early 1900’s: Charles PonziCharles Ponzi

Ivar KruegerIvar Krueger 1920’s: Samuel Insull1920’s: Samuel Insull 1940’s:1940’s: Richard WhitneyRichard Whitney 1960’s:1960’s: GE, WestinghouseGE, Westinghouse 1970’s:1970’s: Investors Overseas Investors Overseas

ServicesServices

Robert VescoRobert Vesco

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tory

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Corporate scandals are not Corporate scandals are not newnew

1980’s1980’s

Ivan BoeskyIvan BoeskyInsider TradingInsider Trading

$100 million – 3 years$100 million – 3 years

Michael MilkenMichael Milken Securities FraudSecurities Fraud

10 years10 years

Charles KeatingCharles Keating Savings & LoansSavings & LoansInvestors lost $200 millionInvestors lost $200 millionH

isto

ryH

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Source: A Century of Greed, Scams, Scandals and Swindles - A Look at the Seamy Side of 20 th Century Wealth cnn.com

EnronEnron

February 2000February 2000

Fortune magazine chooses EnronFortune magazine chooses Enron

as it’s “Best Managed andas it’s “Best Managed and

Most InnovativeMost Innovative company” company”

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Most Innovative for five years in a row

EnronEnron

February 2000: Fortune February 2000: Fortune MagazineMagazine

#1 – Quality of Management#1 – Quality of Management

#2 – Employee Talent#2 – Employee Talent

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Source: Enron Corporation Press Release

EnronEnron

August 2000: Stock at $73 billionAugust 2000: Stock at $73 billion March 2001: FY2000 revenues atMarch 2001: FY2000 revenues at

$100 billion$100 billion Sep 16, 2001: “Buy more shares”Sep 16, 2001: “Buy more shares” October 2001: Enron pays itsOctober 2001: Enron pays its

regular dividendregular dividendRece

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EnronEnron

October 16, 2001October 16, 2001

$618 million 3$618 million 3rdrd Qtr Loss Qtr Loss

$1.2 billion reduction in$1.2 billion reduction in

shareholder equityshareholder equity October 31, 2001October 31, 2001

SEC upgrades inquiry into aSEC upgrades inquiry into a

formal investigationformal investigation

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EnronEnron

December 2, 2001December 2, 2001

Enron files for bankruptcyEnron files for bankruptcy

4,000 employees fired4,000 employees fired

20,000 workers lose their jobs20,000 workers lose their jobs

$73 billion in stock value - gone$73 billion in stock value - gone

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Enron – What Happened?Enron – What Happened?

$3 billion from pipelines$3 billion from pipelines

Energy producerEnergy producer

to an energy traderto an energy trader

to an energy “bank”to an energy “bank”

Maze of partnershipsMaze of partnerships

DerivativesDerivatives

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Enron – What Happened?Enron – What Happened?

““Enron apparently, with the Enron apparently, with the approval or advice of its approval or advice of its accountants, auditors and accountants, auditors and lawyers, used thousands of off-lawyers, used thousands of off-the-book entities to overstate the-book entities to overstate corporate profits, understate corporate profits, understate corporate debts, and inflate corporate debts, and inflate Enron’s stock price.”Enron’s stock price.”

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Source: Corporate and Criminal Fraud and Accountability Act of 2002

Enron – What Happened?Enron – What Happened?R

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EnronEnron

Enron Enron CorporationCorporation

Corporate Corporate

Social Social

ResponsibilityResponsibility

ReportReportRece

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WorldComWorldCom

$3.9 billion in expenses hidden$3.9 billion in expenses hidden $3.3 billion in accounting $3.3 billion in accounting

irregularitiesirregularities 17,000 jobs lost17,000 jobs lost Company applied for Company applied for

bankruptcybankruptcy Market value of $100 billionMarket value of $100 billion

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TycoTyco

Tax evasionTax evasion Evidence tamperingEvidence tampering 1500 jobs lost1500 jobs lost Additional 4,500 laid offAdditional 4,500 laid off Down $86 billion in one yearDown $86 billion in one year

from peak share pricefrom peak share price

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Global CrossingGlobal Crossing

Ghost transactionsGhost transactions

2000 jobs lost2000 jobs lost

Down $40 billion in a few Down $40 billion in a few monthsmonthsR

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AdelphiaAdelphia

Questionable loansQuestionable loans

Loss of $6.5 billion in market Loss of $6.5 billion in market valuevalue

in one yearin one year

Company in bankruptcyCompany in bankruptcy

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Wall Street AnalystsWall Street Analysts

Investment Banking FirmsInvestment Banking Firms Biased researchBiased research 10 firms fined $1.4 billion by SEC10 firms fined $1.4 billion by SEC

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Citigroup Salomon Smith BarneyCitigroup Salomon Smith Barney

Credit Suisse Group’s CSFB

Merrill Lynch & Co.

Goldman Sachs Group

Morgan Stanley

Source: Regulators Finalize $1.4 Billion Settlement Against Wall St. Firms

- PBS Newshour

Mutual FundsMutual Funds

Market TimingMarket Timing

Buying or selling of mutual fund Buying or selling of mutual fund shares in order to exploit shares in order to exploit inefficiencies in mutual fund inefficiencies in mutual fund pricing practicespricing practicesR

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Insurance CompaniesInsurance Companies March & McLennanMarch & McLennan

Largest Insurance brokerLargest Insurance brokerSoliciting rigged bids for insurance Soliciting rigged bids for insurance contractscontractsWill pay $850 millionWill pay $850 million

AON CorporationAON CorporationSecond largest Insurance brokerSecond largest Insurance brokerFraud and anti-competitive practicesFraud and anti-competitive practicesWill pay $190 millionWill pay $190 million

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Source: “Classic Financial and Corporate Scandals” website

Fannie Mae - MortgagesFannie Mae - Mortgages

Improper accounting methodsImproper accounting methods

KMPG would not stipulate that KMPG would not stipulate that reporting was accuratereporting was accurate

Reported a $9 billion lossReported a $9 billion lossRece

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NYSENYSE

Pay scandal involving former exec Pay scandal involving former exec Richard Grasso - $188 millionRichard Grasso - $188 million

Traders executing their own trades Traders executing their own trades in advance of customer ordersin advance of customer orders

Investors deprived of at least Investors deprived of at least $32 million$32 million

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Source: Washington Post – Fifteen NYSE Traders Indicted – 4/13/2005

KMPGKMPG $22.5 million settlement with SEC$22.5 million settlement with SEC Avoids trial next year on charges that Avoids trial next year on charges that

KMPG willfully ignored warning signs KMPG willfully ignored warning signs related to Xerox’s accounting related to Xerox’s accounting maneuversmaneuvers

Largest accounting firm settlement in Largest accounting firm settlement in historyhistory

"This is a fairly egregious fraud on "This is a fairly egregious fraud on the part of Xerox, and KPMG didn't the part of Xerox, and KPMG didn't live up to its role as gatekeeper," live up to its role as gatekeeper," said Paul Berger, associate director said Paul Berger, associate director of enforcement at the SEC. of enforcement at the SEC.

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Source: USA Today – KPMG to pay $22.5M to settle Xerox questions– 4/19/2005

Widespread Moral DeficitWidespread Moral Deficit

““Accountants held no one to Accountants held no one to account, governments abandoned account, governments abandoned their regulatory functions, the their regulatory functions, the media turned cheaters into stars, media turned cheaters into stars, and a culture of self-righteous and a culture of self-righteous mendacity was allowed to flourish mendacity was allowed to flourish as long as the stock prices were as long as the stock prices were high.”high.”

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Source: Those You Love to Hate – A Look at the Mighty Laid Low – NYT 4/22/2005

Reaction to the ScandalsReaction to the Scandals

Edvard Munch, The Scream, 1893

EnronEnron Wasn’t Just Enron Wasn’t Just Enron Enron CorporationEnron Corporation Arthur AndersenArthur Andersen Enron’s Law firmEnron’s Law firm Investment bankersInvestment bankers Countries with Enron operationsCountries with Enron operations

Argentina, Mozambique, India, PolandArgentina, Mozambique, India, Poland

Companies in other countriesCompanies in other countriesShell, BP, Mobil, TotalShell, BP, Mobil, Total

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Source: Ethics in Organizations – Learning From Enron

EnronEnron Wasn’t Just Enron Wasn’t Just Enron

““Among other states’ pensions affected Among other states’ pensions affected by Enron’s bankruptcy were by Enron’s bankruptcy were California’s Public Employees’ California’s Public Employees’ Retirement System, which lost $195 Retirement System, which lost $195 million, and the Ohio Public million, and the Ohio Public Employees Retirement System and Employees Retirement System and State Teachers Retirement System, State Teachers Retirement System, which lost about $127 million.”which lost about $127 million.”

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Source: Texas Retirement System – Slight Loss From Enron Investments

Loss of ConfidenceLoss of Confidence

CompaniesCompanies AuditorsAuditors Boards of DirectorsBoards of Directors Credit-ratersCredit-raters FERC – Federal Energy FERC – Federal Energy

Regulatory CommissionRegulatory Commission Wall Street Analysts and Wall Street Analysts and

UnderwritersUnderwriters

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The Stock Market SpeaksThe Stock Market SpeaksR

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Source: SmartMoney.com DJIA 1/1/2002 – 12/31/2002 modified by jam

IndictmentsIndictments

Kenneth Lay, Jeffrey Skilling, Kenneth Lay, Jeffrey Skilling, Andrew Fastow – EnronAndrew Fastow – Enron

Bernard Ebbers – WorldComBernard Ebbers – WorldCom Dennis Koslowski – TycoDennis Koslowski – Tyco Samuel Waksal – ImcloneSamuel Waksal – Imclone John Rigas – AdelphiaJohn Rigas – Adelphia Martha StewartMartha Stewart

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Creation of New lawsCreation of New laws

Sarbanes-Oxley ActSarbanes-Oxley Act CEO’s CFO’s certify accuracyCEO’s CFO’s certify accuracy Fines up to $1 million/10 yearsFines up to $1 million/10 years No personal loans to executivesNo personal loans to executives Auditing procedures, incl. rotationAuditing procedures, incl. rotation Whisteblower protectionWhisteblower protection Attorneys must report violationsAttorneys must report violations

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Source: “Sarbanes-Oxley Explained” website

American Institute of Certified Public Accountants


Estimates of the Cost of the Estimates of the Cost of the ScandalsScandals

Recognizing:Recognizing: DotCom bubbleDotCom bubble September 11September 11 Economic CycleEconomic Cycle President Bush’s Tax CutPresident Bush’s Tax Cut Other PoliciesOther Policies

Estimates of the CostsEstimates of the Costs

New York economy lost $2.9 billionNew York economy lost $2.9 billion

New York State revenues decreased New York State revenues decreased by $1 billion in FY 2002-2003by $1 billion in FY 2002-2003

Losses for local governmentsLosses for local governments

$260 million loss to New York City$260 million loss to New York City

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Source: Impact of the Corporate Scandals on New York State - Office of the New York State Comptroller


National economy reduced National economy reduced

by $35 billion in first yearby $35 billion in first year

GDP: .34 percent reductionGDP: .34 percent reduction

UnemploymentUnemployment

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Source: Cooking the Books: The Cost to the Economy - The Brookings Institution


Consumer SpendingConsumer Spending

InvestmentInvestment

Interest ratesInterest rates

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Stock MarketStock Market

Dow Jones: 27% dropDow Jones: 27% dropStandard & Poor 500: 28% dropStandard & Poor 500: 28% dropChart: Yahoo FinanceChart: Yahoo FinanceM

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Stock MarketStock Market 50% of households own stock 50% of households own stock

today as compared to 37% in today as compared to 37% in 19921992

21% of retirement funds are 21% of retirement funds are invested in mutual funds today as invested in mutual funds today as compared to 5% in 1990compared to 5% in 1990

44% of 401(k) funds are invested 44% of 401(k) funds are invested in mutual funds today as in mutual funds today as compared to 9% in 1990compared to 9% in 1990M

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The DollarThe Dollar

““The dollar fell below parity with The dollar fell below parity with the Euro, for the first time since the Euro, for the first time since the currency was issued, the currency was issued, amidst increasing skepticism amidst increasing skepticism among foreign investors about among foreign investors about U.S. markets.”U.S. markets.”

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The DollarThe Dollar

Let’s have more scandal!!!!Let’s have more scandal!!!!

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Foreign Foreign Investors/CompaniesInvestors/Companies Less inclined to hold stockLess inclined to hold stock

Could cause a decline in value of $Could cause a decline in value of $

Foreign markets also declined by Foreign markets also declined by 28% in April – July 2002 period28% in April – July 2002 period

Source: Source: As Wall Street Goes, So Go World MarketsAs Wall Street Goes, So Go World Markets – Christian Science Monitor – 7/24/2002 – Christian Science Monitor – 7/24/2002

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Cost of ComplianceCost of Compliance

Estimates that spending on Estimates that spending on Sarbanes-Oxley will reach Sarbanes-Oxley will reach

$5.8 billion in 2005 $5.8 billion in 2005

Source: AMR ResearchSource: AMR Research

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Does the Economy Shift?Does the Economy Shift?

Real Goods to Financial Assets:Real Goods to Financial Assets:

Yes, in the short runYes, in the short run

These financial assets have These financial assets have disappeareddisappeared

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A WarningA Warning

““I see in the near future a crisis approaching that I see in the near future a crisis approaching that unnerves me and causes me to tremble for the safety unnerves me and causes me to tremble for the safety of my country. As a result of the war, corporations of my country. As a result of the war, corporations have been enthroned, and an era of corruption in high have been enthroned, and an era of corruption in high places will follow, and the money power of the country places will follow, and the money power of the country will endeavor to prolong its reign by working on the will endeavor to prolong its reign by working on the prejudices of the people until all wealth is aggregated prejudices of the people until all wealth is aggregated in a few hands, and the Republic is destroyed. I feel at in a few hands, and the Republic is destroyed. I feel at this moment more anxiety for the safety of my country this moment more anxiety for the safety of my country than ever before, even in the midst of war.” than ever before, even in the midst of war.”

--- Abraham Lincoln, 1864--- Abraham Lincoln, 1864

Source: Lincoln, Abraham. The Lincoln Encyclopedia - The Spoken and Written Words of A. Source: Lincoln, Abraham. The Lincoln Encyclopedia - The Spoken and Written Words of A. LincolnLincoln

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A Considerable EffectA Considerable Effect Stock MarketStock Market Public ConfidencePublic Confidence Cost of ComplianceCost of Compliance Foreign Investors/CompaniesForeign Investors/Companies

Until such time as we effectively Until such time as we effectively address these problems, our address these problems, our economy will continue to be economy will continue to be vulnerablevulnerable

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A ProposalA Proposal

The Death PenaltyThe Death Penalty

For CorporationsFor Corporations

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A ProposalA Proposal

If we are going to consider the corporation to be a If we are going to consider the corporation to be a person and afford it the same kinds of rights and person and afford it the same kinds of rights and freedoms that are extended to the individual, freedoms that are extended to the individual, perhaps it is time to revise the methods by which we perhaps it is time to revise the methods by which we hold the corporate "person" accountable. We should hold the corporate "person" accountable. We should impose the same kind of punishments that we have impose the same kind of punishments that we have established for individuals. If a corporation is established for individuals. If a corporation is convicted in the courts for a violation of law, we convicted in the courts for a violation of law, we should curtail its freedom to conduct business for a should curtail its freedom to conduct business for a period of time. In the event of repeat offenses, the period of time. In the event of repeat offenses, the penalties should be increased. In those instances penalties should be increased. In those instances where a corporation severely violates the public where a corporation severely violates the public trust, it should cease to exist. The corporate charter trust, it should cease to exist. The corporate charter should be revoked, the assets seized and the should be revoked, the assets seized and the corporation dissolved.corporation dissolved.

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Learn More…Learn More…R

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Shameless Plug Ahead

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© 2005 Jeffrey A. Miller© 2005 Jeffrey A. Miller

Corporate ScandalsCorporate Scandalsand theirand their


Jeff MillerJeff Miller4/27/20054/27/2005

Corporate Scandals and Macroeconomic Impact

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