Corporate Scandals

and their
Macroeconomic Impact

Jeff Miller
4/27/2005
 Corporate Scandals and Their
Macroeconomic Impact

 History of Corporate Scandals

 Reaction: Citizens, Investors, Government

 Macroeconomic Effect
Corporate scandals are not new
 Early 1900’s: Charles Ponzi
Ivar Krueger
 1920’s: Samuel Insull
or
st

y
 1940’s: Richard Whitney
 1960’s: GE, Westinghouse
 1970’s: Investors Overseas Services
Robert Vesco
 Corporate scandals are not new
1980’s
Ivan Boesky Insider Trading
$100 million – 3 years
or
Michael Milken Securities Fraud
st

y
10 years
Charles Keating Savings & Loans
Investors lost $200 million

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

Scan
February 2000
dals
nt

Fortune magazine chooses Enron

as it’s “Best Managed and
Most Innovative company”

Most Innovative for five years in a row

 Enron
Rece

Scan
February 2000: Fortune
dals
nt

Magazine
#1 – Quality of Management
#2 – Employee Talent

Source: Enron Corporation Press Release

 Enron
Rece

ScanAugust 2000: Stock at $73 billion

dals

nt

 March 2001: FY2000 revenues at

$100 billion
 Sep 16, 2001: “Buy more shares”
 October 2001: Enron pays its
regular dividend
 Enron
Rece

ScanOctober 16, 2001

dals

nt

$618 million 3rd Qtr Loss

$1.2 billion reduction in
shareholder equity
 October 31, 2001
SEC upgrades inquiry into a
formal investigation
 Enron
Rece

Scan December 2, 2001

dals

nt

Enron files for bankruptcy

4,000 employees fired

 20,000 workers lose their jobs

 $73 billion in stock value - gone

 Enron – What Happened?
Rece

Scan $3 billion from pipelines

dals

nt

 Energy producer
to an energy trader
to an energy “bank”
 Maze of partnerships
 Derivatives
 Enron – What Happened?
Rece

Scan
“Enron apparently, with the approval
dals
nt

or advice of its accountants,

auditors and lawyers, used
thousands of off-the-book entities
to overstate corporate profits,
understate corporate debts, and
inflate Enron’s stock price.”
Source: Corporate and Criminal Fraud and Accountability Act of 2002
 Enron – What Happened?
Rece

Scan
dals
nt
Most Innovative
 Enron
Rece

Scan
Enron Corporation
dals
nt

Corporate
Social
Responsibility
Report
 WorldCom
Rece

Scan
dals
 $3.9 billion in expenses hidden
nt

 $3.3 billion in accounting

irregularities
 17,000 jobs lost
 Company applied for bankruptcy
 Market value of $100 billion
 Tyco
Rece

Scan
dals
 Tax evasion
nt

 Evidence tampering
 1500 jobs lost
 Additional 4,500 laid off
 Down $86 billion in one year
from peak share price
 Global Crossing
Rece

Scan
dals
Ghost transactions
nt


 2000 jobs lost

 Down $40 billion in a few months

 Adelphia
Rece

Scan
dals
nt
 Questionable loans
 Loss of $6.5 billion in market value
in one year

 Company in bankruptcy
 Wall Street Analysts
Rece

Scan
Investment Banking Firms
dals
nt

 Biased research
 10 firms fined $1.4 billion by SEC
Citigroup 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 Funds
Rece

Scan
Market Timing
dals
nt

Buying or selling of mutual fund

shares in order to exploit
inefficiencies in mutual fund pricing
practices
 Insurance Companies
March & McLennan
Rece

Scan


dals
nt
Largest Insurance broker
Soliciting rigged bids for insurance
contracts
Will pay $850 million
 AON Corporation
Second largest Insurance broker
Fraud and anti-competitive practices
Will pay $190 million
Source: “Classic Financial and Corporate Scandals” website
 Fannie Mae - Mortgages
Rece

Scan Improper accounting methods

dals

nt

 KMPG would not stipulate that

reporting was accurate

 Reported a $9 billion loss

 NYSE
Rece

Scan Pay scandal involving former exec

dals

nt

Richard Grasso - $188 million

 Traders executing their own trades
in advance of customer orders
 Investors deprived of at least
$32 million
Source: Washington Post – Fifteen NYSE Traders Indicted – 4/13/2005
 KMPG
$22.5 million settlement with SEC
Rece

Scan


dals
nt
 Avoids trial next year on charges that
KMPG willfully ignored warning signs
related to Xerox’s accounting maneuvers
 Largest accounting firm settlement in
history
 "This is a fairly egregious fraud on the
part of Xerox, and KPMG didn't live up to
its role as gatekeeper," said Paul Berger,
associate director of enforcement at the
SEC.
Source: USA Today – KPMG to pay $22.5M to settle Xerox questions – 4/19/2005
 Widespread Moral Deficit
Rece

Scan
“Accountants held no one to account,
dals
nt

governments abandoned their

regulatory functions, the media
turned cheaters into stars, and a
culture of self-righteous mendacity
was allowed to flourish as long as
the stock prices were high.”
Source: Those You Love to Hate – A Look at the Mighty Laid Low – NYT 4/22/2005
Reaction to the Scandals

Edvard Munch, The Scream, 1893

 Enron Wasn’t Just Enron
 Enron Corporation
on
ac

 Arthur Andersen
ti
 Enron’s Law firm
 Investment bankers
 Countries with Enron operations
Argentina, Mozambique, India, Poland
 Companies in other countries
Shell, BP, Mobil, Total
Source: Ethics in Organizations – Learning From Enron
 Enron Wasn’t Just Enron
“Among other states’ pensions affected by
on
ac
ti
Enron’s bankruptcy were California’s
Public Employees’ Retirement System,
which lost $195 million, and the Ohio
Public Employees Retirement System and
State Teachers Retirement System, which
lost about $127 million.”
Source: Texas Retirement System – Slight Loss From Enron Investments
 Loss of Confidence
 Companies
on
ac
ti
 Auditors
 Boards of Directors
 Credit-raters
 FERC – Federal Energy Regulatory
Commission
 Wall Street Analysts and
Underwriters
 The Stock Market Speaks

on
ac
ti

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

 Indictments
 Kenneth Lay, Jeffrey Skilling,
on
ac
ti
Andrew Fastow – Enron
 Bernard Ebbers – WorldCom
 Dennis Koslowski – Tyco
 Samuel Waksal – Imclone
 John Rigas – Adelphia
 Martha Stewart
 Creation of New laws
Sarbanes-Oxley Act
on
ac
ti
 CEO’s CFO’s certify accuracy
 Fines up to $1 million/10 years
 No personal loans to executives
 Auditing procedures, incl. rotation
 Whisteblower protection
 Attorneys must report violations
Source: “Sarbanes-Oxley Explained” website
American Institute of Certified Public Accountants
 Macroeconomic Impact
Estimates of the Cost of the Scandals
Recognizing:
 DotCom bubble
 September 11
 Economic Cycle
 President Bush’s Tax Cut
 Other Policies
 Estimates of the Costs
 New York economy lost $2.9 billion
Imp
mic
eco

act
no

 New York State revenues decreased

by $1 billion in FY 2002-2003
 Losses for local governments
 $260 million loss to New York City
Source: Impact of the Corporate Scandals on New York State - Office of the New York State Comptroller
 Estimates of the Costs


Imp National economy reduced
mic
eco

act
no

by $35 billion in first year

 GDP: .34 percent reduction

 Unemployment
Source: Cooking the Books: The Cost to the Economy - The Brookings Institution
 Estimates of the Costs


Imp Consumer Spending
mic
eco

act
no

 Investment

 Interest rates

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

Imp
mic
eco

act
no

Dow Jones: 27% drop

Standard & Poor 500: 28% drop
Chart: Yahoo Finance
 Stock Market
 50% of households own stock today
Impas compared to 37% in 1992
mic
eco

act
no

 21% of retirement funds are

invested in mutual funds today as
compared to 5% in 1990
 44% of 401(k) funds are invested in
mutual funds today as compared to
9% in 1990
Source: Cooking the Books: The Cost to the Economy - The Brookings Institution
 The Dollar

“The dollar fell below parity with the

Imp
mic
eco

act
no

Euro, for the first time since the

currency was issued, amidst
increasing skepticism among foreign
investors about U.S. markets.”
 The Dollar

Imp
Let’s have more scandal!!!!
mic
eco

act
no
 Foreign Investors/Companies

Imp Less inclined to hold stock

mic
eco

act
no

 Could cause a decline in value of $

 Foreign markets also declined by
28% in April – July 2002 period
Source: As Wall Street Goes, So Go World Markets – Christian Science Monitor – 7/24/2002
 Cost of Compliance

Estimates that spending on

Imp
mic
eco

act
Sarbanes-Oxley will reach
no

$5.8 billion in 2005

Source: AMR Research

 Does the Economy Shift?
Real Goods to Financial Assets:
Imp
mic
eco

act
no

 Yes, in the short run

 These financial assets have
disappeared
 A Warning
“I see in the near future a crisis approaching that unnerves
me and causes me to tremble for the safety of my
vi
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e
e
country. As a result of the war, corporations have been
enthroned, and an era of corruption in high places will
follow, and the money power of the country will endeavor
to prolong its reign by working on the prejudices of the
people until all wealth is aggregated in a few hands, and
the Republic is destroyed. I feel at this moment more
anxiety for the safety of my country than ever before,
even in the midst of war.”
--- Abraham Lincoln, 1864

Source: Lincoln, Abraham. The Lincoln Encyclopedia - The Spoken and Written Words of A. Lincoln
 A Considerable Effect
 Stock Market
 Public Confidence
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 Cost of Compliance
 Foreign Investors/Companies

Until such time as we effectively

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

Jeff Miller
4/27/2005

© 2005 Jeffrey A. Miller