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Introduction: Raw Greed and Red Flags > How Many Bad Apples? A Handful, a Barre...

How Many Bad Apples? A Handful, a Barrel, or an Orchard?

When I started work on this book in the spring of 2002, it looked like the various investigations into the Enron collapse by Congress, the Securities and Exchange Commission, and the Department of Justice were going to destroy the energy trader’s auditors Andersen, probably lead to some prosecutions of Enron management, and prompt some modest tightening of various regulations. However, there was little sign of meaningful reform. The big accounting firms, in particular, appeared to have enough support in Congress to prevent tough new rules from being brought in to govern their behavior.

Well, Andersen was convicted and did disintegrate. Then, throughout the summer, there was revelation after revelation about alleged wrongdoing at a series of large companies, including the disclosure of the alleged massive WorldCom fraud. At the same time, there were continued investigations into corruption on Wall Street, including the use of tainted research, the allocation of shares in initial public offers to get investment banking business, and the role the major banks and brokerages may have played in Enron’s manipulation of its balance sheet.

Media and home products entrepreneur Martha Stewart, known to some as the doyenne of domesticity, perhaps illustrated the zeitgeist best. She was under congressional and then Department of Justice investigation amid allegations of insider trading in the stock of biotechnology company ImClone Systems, which had been run by her friend Samuel Waksal. Stewart declined to talk about the issue, and shares in her company, Martha Stewart Living Omnimedia, at one stage lost almost three-quarters of their value.

Every day brought a new scandal, another chief executive sitting stone-faced—but never, it seemed, shamefaced—in front of congressional inquisitors, or another accountant who couldn’t say why he or she hadn’t been able to detect billions of dollars transferred to one account from another—who apparently took so little interest in the task that he or she never compared his client company with rivals in the industry and asked about glaring discrepancies. Then, the events known in the United States as “perp walks” (when arrested, alleged perpetrators are marched in front of the cameras) began, with executives from Enron, Tyco, Adelphia, WorldCom, and ImClone all providing the photo opportunities. Most of the alleged perpetrators were handcuffed to improve the images. In one memorable moment, Stewart was quizzed about her problems while chopping cabbage during a regular spot on CBS’ The Early Show. “I want to focus on my salad,” she said. Stewart, who also said she expected to be “exonerated of any ridiculousness,” stopped the appearances soon after that.

But more important than such examples of the spirit of the times were a sliding stock market and sinking investor confidence. Altogether, $8 trillion of market value was wiped out in the two-anda-half years following the market’s March 2000 peaks, and both the Dow Jones industrial average and the S&P 500 index reached their lowest levels for five years in October 2002. Attempts to rally in the following few months failed dismally. It was no longer a question of a few bad apples but fears that half the barrel was rotten. President Bush was forced to go to Wall Street to promise a crackdown on corporate crooks in the summer of 2002, but the measures he proposed weren’t enough once news of the WorldCom scandal broke.

Congress rushed through a tougher law, the Sarbanes-Oxley Act. It created a new accounting regulator, banned auditors from providing many consulting services to a company whose books they examined, forbade most loans to company executives and directors, speeded up disclosure of some information, introduced longer prison terms for securities fraud, and forced top management to certify to the fairness and accuracy of their company’s financial statements. The New York Stock Exchange weighed in with new corporate governance guidelines demanding companies appoint more independent directors, requiring directors to meet without executives present, and providing shareholders with voting power over equity-based compensation. Still, there were a number of signs at the end of 2002 and in the first few months of 2003 that reforms could be stymied. This delay in the pace of reform was partly due to a Republican success in mid-term elections, which gave the party control of the Senate (to add to the House and the White House) and suggested that voters were more interested in Bush’s tackling of post-September 11 issues and Iraq than in the economy and corporate crime.

And queries about corporate behavior weren’t just being levied at discredited telecom, Internet, and energy trading companies.

The veracity of earnings figures produced by some of America’s biggest and best-respected corporations, such as GE and IBM, and particularly their ability to meet or beat Wall Street expectations, was increasingly questioned. Critics suggested they massaged the figures from one quarter to the next through the use of accounting sleight of hand, charges that both companies denied. When combined with the uncertainty surrounding war with Iraq and the likelihood of further attacks on the United States and other Western targets, it was enough to undermine an already sputtering economic recovery.

The practices and policies of the business and financial gods of the previous decade were being questioned. Among them was GE’s now former CEO Jack Welch, who faced not only criticism of his record of smooth growth in earnings but also disclosures about munificent post-retirement perks during the start of divorce proceedings by his wife. Following days of negative publicity, Welch announced that he was giving up most of the company benefits.

Even the respected Federal Reserve Chairman Alan Greenspan had his reputation undermined. Stung by suggestions that he should have done more to prevent a stock market bubble by raising interest rates sooner, Greenspan said there was little the Fed could do to identify and fight such problems. Yet, on the day Greenspan was knighted by Britain’s Queen Elizabeth, one commentator suggested that the “Order of the Bubble” might be more appropriate.

Certainly, we should never forget that the greed, fraud, and corruption of the past few years were fed by the easy, cheap money available in the late 1990s. Half-brained ideas for Internet start-ups received funding from venture capitalists, banks, and ordinary investors. Banks and debt markets threw good money after bad in funding dozens of new telecommunications ventures—even as some observers were warning of a glut in capacity. No one cared about when a company might be able to make a profit—it was all a race to gain control of Internet real estate or future telecommunications traffic, whatever the cost. Business plans and cost controls were an inconvenience. Performance was measured in eyeballs and miles of cable, not cash.

Many believe the excesses were greater than anything seen in the insider trading scandals of the 1980s junk bond-financed takeover craze. They were comparable to the 1920s speculative conflagration that led to the 1929 stock market crash, and to some of the bubbles of previous centuries, including the Dutch tulip mania of the late 1630s that saw the prices of tulip bulbs climbing into the stratosphere, or the South Sea stock bubble that burst in Britain in 1720. “I don’t think we have ever seen anything, even the tulip craze, like the end of the last bull market,” said John Gutfreund, former head of Salomon Brothers. As for the Internet revolution, terrific things happened in terms of technology, but mispricing and valuations were just crazy. The wider level of stock ownership in the United States in the past 20 years, particularly through pension plans and mutual funds, means that this bust has hurt a wide cross-section of the population. The greed was also deeper than in some of the other scandals of the past 50 years. It involved more than just CEOs and Wall Street, with accountants, lawyers, venture capitalists, fund managers, and consultants all wanting a bigger piece of the pie.

The extent of the partying during the boom means that the hangover may last beyond a couple of years. “I would be astonished if things were over in a year because of the appreciating excesses,” said James Grant, the publisher of the newsletter Grant’s Interest Rate Observer and one of the lone figures who said the good times could not last through much of the 1990s. “I think the recrimination will be somewhat proportionate to the loss and to the betrayal preceding it. My guess is that the recovery from this particular great bubble is going to be protracted and painful and there will be periods of ferocious bear market rallies followed by more disenchantment, more broken hearts, more loss.”

Many of the veteran investors and former regulators I spoke with for this book voiced a deep disenchantment with the level of greed and the loss of values exposed in corporate America by the boom and bust. “You have a definite feeling in the past few years that ethical standards did deteriorate in many aspects of life, including the financial markets,” said former Fed Chairman Volcker. “There was not that feeling of caution that keeps people in line, whether it is good ethics or good morality or just fright—the fright component diminished and the greed component increased,” Volcker added.

The contrast between the images of greedy executives treating public companies as their own playthings and the rescue workers who died when the World Trade Center collapsed after the September 11 attacks clearly hit home with many people. There were pictures of selfishness, avarice, and cowardice on the one hand, and selflessness, generosity, and heroism on the other. Some commentators even suggested that Osama bin Laden hadn’t done as much as Enron Chairman Kenneth Lay to damage the American economic system.

One of the problems with being able to spread the blame for the scandals across so many industries, professions, regulators, and individuals is that it has given an excuse for many of the culpable to point at others and say it was everybody’s fault. It was, as Vanguard’s former head John Bogle likes to put it, “the happy conspiracy.” Money magazine even apportioned the blame for the disaster in its October 1, 2002, issue, awarding corporate executives 17 percent, stock options grants 16 percent, Wall Street 14 percent, individual investors 14 percent, accountants 12 percent, politicians 10 percent, the mutual fund industry 8 percent, the media 7 percent, and Osama bin Laden 2 percent. Certainly, smaller investors who were suckered in by dreams of overnight riches can’t be excused completely. According to Bill Fleckenstein, a short seller who is head of Seattle-based Fleckenstein Capital, during the mania, the attitude of the public was as follows: “We don’t care if you lie to us, in fact we love it, just don’t get caught.”

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