A Financial History of Modern US Corporate Scandals From Enron to Reform

758 Pages·2006·5.988 MB·English

by  Jerry W.Markham

A
FINANCIAL
HISTORY
of
MODERN U.S.
CORPORATE
SCANDALS
From
Enron to Reform
A
FINANCIAL
HISTORY
of
MODERN U.S.
CORPORATE
SCANDALS
From
Enron to Reform
JERRY W. MARKHAM
ME.Sharpe
.
Armonk, New York
London, England
Copyright © 2006 by M.E. Sharpe, Inc.
All rights reserved. No part of this book may be reproduced in any form
without written permission from the publisher, M.E. Sharpe, Inc.,
80 Business Park Drive, Armonk, New York 10504.
Library of Congress Cataloging-in-Publication Data
Markham, Jerry W.
A financial history of modern U.S. corporate scandals : from Enron to reform / Jerry W.
Markham.
p. cm.
Includes bibliographical references and index.
ISBN 0-7656-1583-5 (hardcover : alk. paper)
1. Corporations—Corrupt practices—United States. 2. Corporations—Accounting—
United States. 3. Enron Corp.—Corrupt practices. 4. Stock Market Bubble, 1995–2000.
5. Commercial crimes—United States. I. Title: Financial history of modern United States
corporate scandals. II. Title.
HV6769.M37 2005
364.16’8’0973—dc22
2005005562
Printed in the United States of America
The paper used in this publication meets the minimum requirements of
American National Standard for Information Sciences
Permanence of Paper for Printed Library Materials,
ANSI Z 39.48-1984.
~
BM (c) 10 9 8 7 6 5 4 3 2 1
Contents
Preface xi
Acknowledgments xiii
Introduction xv
Photographs follow page 302
I. The Stock Market Bubble and Enron
1. The Stock Market Bubble 3
Financial Markets 3 • The Market Boom 3 • Raising All Boats 4 •
Run-Up in IPO Prices 5 • Structured Finance 7 • Collateralized Debt
Obligations 8 • New Instruments 9 • Commodities Futures
Modernization 11 • Traditional Markets 13 • Electronic
Communications Networks 15 • Broker-Dealers 17 • Merger
Activity 20
Fraud and Abuses 21 • Fraud Schemes 21 • Ponzi Schemes 23 •
Electronic Fraud 25 • Pump and Dump Schemes 27 • Other Problems
29 • Executive Compensation 30 • Expensing Options 33
Attacks on the Markets 34 • The First Attack 34 • The Market Reacts
35 • The Fed Reverses Course 37 • Economic Decline 37 • The
Damage Is Done 39 • Deficits and International Problems 40 • Prelude
to September 11 42 • The 9/11 Attack 42 • Restarting Wall Street 44 •
Coping With Terror 46
2. The Enron Corp. 49
A Company Is Born 49 • Creating a Name 49 • Enron’s Management
50 • Jeffrey Skilling 51 • Andrew Fastow 52 • Enron Values 53 •
Pipeline Operations 54 • Deregulation 54 • Trading Operations 55 •
Mark-to-Market 57 • Wind Farms 59 • Foreign Operations 59 • Foreign
Problems 60
Enron Growth 61 • Enron Online 61 • Electricity Market 62 •
Broadband 63 • Merchant Investments 65 • Financial Results 65 •
Fancy Finance 66 • Halcyon Days 67 • An Icon 68 • Special Purpose
Entities 70 • Securitizing the Balance Sheet 70 • Cactus and JEDI 72 •
Beneath the Mask 75
Enron Fails 75 • The Death Spiral 75 • Sherron Watkins 76 •
Accounting Disclosures 78 • LJM 79 • New Power Company 80 •
Implosion 82 • Chewco 83 • Whitewing 84 • Influence Fails 85 • Death
Throes 87 • Bankruptcy 87 • The Powers Report 88 • Media Circus 91 •
Congressional Hearings • 93
3. The Enron Scandal 95
Enron Finance 95 • The SPEs 95 • Debt and Equity 96 • Nikita,
Backbone, and Others 98 • Blockbuster 99 • Business Model and
Disclosure 99 • Executive Bonuses and Stock Sales 101 • Employee
Losses 102 • Lockdown 104 • Other 401(k) Problems 106
Prosecution of Enron Executives 108 • Other Abuses 108 • Andrew
Fastow 109 • Extorting a Guilty Plea 112 • Lea Fastow 112 • Other
Defendants 114 • Kenneth Lay 115 • Jeffrey Skilling 118
Bank Involvement 119 • Prepaid Forward Transactions 119 • The
Prepays 120 • The Sureties 122 • Citigroup 123 • Liability of Financial
Institutions 125 • Merrill Lynch 126 • Other Institutions 127
California Trading Scandals 129 • California Deregulates 129 •
Flawed System 131 • Enron Games the Market 133 • Crimes and
Investigations 136 • Round-Trip Trades 137
II. Full Disclosure and the Accountants
4. Full Disclosure 143
Full Disclosure Background 143 • Disclosure History 143 • The Panic
of 1907 146 • Federal Actions 146 • Blue-Sky Laws 147 • The Stock
Market Crash of 1929 148 • Franklin D. Roosevelt 149 • Laying the
Groundwork for Full Disclosure 151 • The Securities Act of 1933 153 •
The Securities Exchange Act of 1934 156
The Accountants as Gatekeepers 158 • Disclosure Requirements 158
• FASB 160 • Certification 161 • Early Accounting History 161 •
Accounting in Great Britain 163 • British Accountants Move to
America 165 • Homegrown Accounting 166 • Licensing Accountants
168 • Accountants’ Liability 169 • Accounting Shortcomings 170 •
Accounting Problems Spread 173 • Flaws in Full Disclosure 174
Accounting Reform Efforts 175 • The Metcalf Report 175 • The
Cohen Committee 177 • The Treadway Commission 178 • Financial
Scandals Embroil the Accountants 180 • S&L Crisis 182 • Other Audit
Failures 185 • Liabilities Mount 186 • The Independence Controversy
189 • Other Consulting Issues 192 • Accountants as Policemen 194 •
The LLPs 195
5. Arthur Andersen and Other Scandals 197
Arthur Andersen & Co. 197 • Background 197 • Early Years 197 •
Andersen Audit Problems 199 • Andersen’s Problems Mount 201•
Accenture 204 • Enron Erupts 205 • The Indictment of Arthur
Andersen 206 • The Trial of Arthur Andersen 207 • Conviction 210
Full Disclosure Fails 212 • SEC Role 212 • Accrual Versus Cash
Accounting 213 • Secret Reserves 216 • Cookie Jar Reserves 217 •
Channel Stuffing 218 • Statement of Cash Flows 220 • Pro Forma
Results 221 • Rite Aid 221 • Computer Associates 222 • Xerox 223 •
Critical Path and Others 224 • Still More Problems 229 • Round Trips
231 • Kmart 234
The Tyco Scandal 235 • The Growing of Tyco 235 • Tyco Business
235 • Tyco’s Problems Emerge 236 • Tyco’s Problems Grow 237 •
The Scandal Begins 238 • The Scandal Broadens 239 • Kozlowski’s
Indictment 240 • Restructuring 241 • The Trial 242 • Belnick’s Trial
244
6. Fiduciary Duties and Corporate Governance Principles 246
Corporate Governance 246 • Joint Stock Companies 246 • Early
Corporate Governance Concerns 248 • Charter Wars 249 • General
Incorporation Laws 251 • Modern Corporate Law 253 • Delaware and
the Model Business Act 254 • The Board of Directors 256 • Outside
Directors 257 • More Board Reforms 262 • Corporate Officers 264 •
Shareholder Responsibilities 265 • Shareholder Rights 266 •
Shareholder Voting 267 • Proxy Votes 270 • Proxy Fights 271 • SEC
Proxy Regulation 273
Fiduciary Duties 277 • Trustees 277 • The Business Judgment Rule
278 • Fiduciary Duty of Care 280 • Delaware Duty of Care 281 • The
Fiduciary Duty of Loyalty 285 • Executive Compensation 288 • Close
Corporations 289 • New Business Structures 292
More Fiduciary Duties 293 • Fiduciary Duties of Controlling
Shareholders 293 • Derivative Suits 294 • Fiduciary Duties Redux 296 •
Back to Delaware 299 • Delaware Excesses 301 • For Whom Does
Management Manage? 302 • Social Responsibility 305 • The
Contractarians 306
III. Full Disclosure Fails
7. Telecoms and WorldCom 311
Telecommunications 311 • Meltdown 311 • Nortel 312 • Lucent 314 •
Qwest 316 • Other Telecom Troubles 319 • Global Crossing 320 •
Accounting Manipulations 321 • Bankruptcy 323 • Accounting Failures
324 • Reorganization 324 • Adelphia 325 • Internal Investigation 327 •
Criminal Charges 328
WorldCom 330 • The Company 330 • MCI 332 • WorldCom
Accounting 333• Bernard Ebbers 334 • Scott Sullivan 335 • Free
Fall 335 • Internal Investigations 338 • Corporate Monitor 341 •
Breeden’s World 341 • Like Enron 344 • Litigation 348 • Criminal
and Other Charges 348 • Ebbers’s Indictment 351 • More
Problems 354
Accounting Problems in the Entertainment Industry and Elsewhere
354 • AOL Time Warner 354 • Goodwill 355 • Cooking the Books
356 • Accounting Problems Expand 357 • Vivendi 358 • Vivendi
Problems 359 • HealthSouth 360 • Freddie Mac and Fannie Mae 364 •
Lord Black 368 • Grocery Store Accounting 372
8. Analysts and Insider Trading Scandals 377
The Martha Stewart Case 377 • History of Insider Trading 377 •
SEC Creates a Crime 378 • The Supreme Court Responds 380 •
Tippers and Tippees 381 • Insider Trading Scandals 382 • Insider
Trading Legislation 385 • More Insider Trading Issues 386 • Insider
Trading Continues 387 • ImClone 389 • Martha Stewart 391 •
Martha Stewart’s Crime 393 • The Stewart Circus Begins 394 • The
Government’s Case 395 • Aftermath 398
Analysts’ Scandals 400 • The Role of the Analyst 400 • Supervising
the Analyst 401 • Market Solution 402 • Regulation FD 403 • Stock
Touts 405 • Conflicts Grow 406 • Citigroup 407 • IPO Abuses 410 •
Frank Quattrone 412 • Analysts’ Settlement 416 • Congressional
Hearings 420
Mutual Fund Scandals 421 • Some History 421 • Investment Company
Act of 1940 422 • Mutual Funds 423 • Scandals and Abuses 423 • Mutual
Fund Investment 424 • Market Timing 425 • Competition 426 • Spitzer’s
Charges 427 • The Problem Spreads 430 • More Disclosures 432 • Other
Mutual Fund Issues 434 • Variable Annuities 437 • One More Media
Event 438 • Hedge Funds 439
9. More Scandals and Reform 443
Sarbanes-Oxley 443 • Arthur Levitt 443 • A New Chairman Arrives
444 • Election Issues 447 • Sarbanes-Oxley Is Enacted 449 • PCAOB
451 • More Regulation 455 • Attack of the Law Professors 457 •
Disciplinary Proceedings 458 • ABA Response 459 • S&L Problems
460 • Legislation 461 • Role of the Rating Agency 462 • Some
History 463 • Expansion of the Rating Agency’s Role 464
Sarbanes-Oxley Is No Panacea 467 • More Costs 467 • Executive
Compensation 469 • Options Again 470 • The List Grows 472 •
More Audit Failures 477 • Travel and Taxes 479 • Executive
Issues 482
More Fraud 484 • Pump and Dump Schemes 484 • Ponzi Schemes
487 • Other Scandals 490 • Fraud Abroad 494
Scandal at the New York Stock Exchange 498 • Richard Grasso 498 •
NYSE Problems 501 • Spitzer Again 506
IV. Recovery and Reform
10. Market Recovery 521
The Economy 521 • Demographic Changes and Finance 521 •
Economic Conditions 523 • Raising Capital 525 • Infectious Greed 527 •
Mixed Signals 528 • Japanese Operations 529 • Banking and
Insurance 529 • Reparations for Slavery 532 • Stock Market Reaction
533
The New Year—2003 536 • Taxes 536 • Trading Places 538 • More on
the Market 542 • Retirement Concerns 543 • Social Security 544 •
Housing Market and Millionaires 546 • Financial Services 547 •
Financing Resumes 549
Banking 551 • Credit Cards 551 • Banking Consolidation 552 •
Banking Problems 556 • Money 557
The Year 2004 558 • The Recovery Strengthens 558 • Market
Activities 560 • Politics and the Economy 561 • Wealth 562 • Big
Business 563 • Quarterly Results 564 • More Growth 565 • More Fraud
573 • Full Disclosure Continues to Fail 575 • Another Enron? 577 •
Market Development 582 • Enron Continues 586 • More Problems
590
11. Reforming the Reforms 596
The Myths of Full Disclosure 596 • Reforms and Power 596 • Full
Disclosure 597 • Myth Revealed 598 • Accountants as Bloodhounds
600 • Auditor Liability 602 • Accountants Work for Management 603 •
The Perfect Storm 604 • Pre–Full Disclosure Finance 606 • Another
Myth 606 • Still Another Myth 609 • Attacks on Business 610
The SEC Fails 612 • Fraud Before the SEC 612 • The American Ice
Company 613 • Other Pre-SEC Scandals 616 • On the SEC’s Watch
617 • Accounting Scandals New and Old 621 • Prosecutions 623 •
Attorney General Wolf Packs 629 • Private Securities Litigation 633 •
PSLRA 636 • Pension Funds as Managers 638 • Calpers Governance
644
Repealing the Federal Securities Laws 647 • The Securities Laws 647
• Manipulation 651 • Mulheren’s Prosecution 652 • CFTC 653 • Market
Discipline 654 • Disclosure in a Free Market 655 • Commodity Model
658 • Insider Trading 658 • Labeling versus Full Disclosure 659
Conclusion 661
Notes 665
Selected Bibliography 677
Name Index 693
Subject Index 733
About the Author 743