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Not Another World Con
The past several months have witnessed the sensational spectacle of the implosion of World- Com, which is by far the largest accounting fraud in history and appears destined to be the biggest ever corporate bankruptcy.
The flotsam and jetsam of inveterate corporate fraud is now bobbing to the surface in rapid succession, revealing its not-so- lovely face: Enron, WorldCom, Global Crossing, Qwest, Adel- phia, Xerox, and General Electric. Hot off the press we have Merck caught with a quivering hand still in the cookie jar and Bristol-Myers Squibb is being investigated. Who next?
WorldCom is the second largest telecommunications corporation in the U.S. (after AT&T) and the worlds biggest carrier of Internet traffic, providing Internet access for more than 100 countries, with a client base of 20 million and 80,000 employees. At the crest of the telecoms wave in 1999 it was valued at $180 billion (Enron was worth $80 billion at its peak) and shares at $64. In the aftermath of the initial scandalous revelations, the share price plummeted to 9 cents.
This mind-boggling accounting swindle (6 times the size of Enrons) consisted of $3.8 billion of operating expenses being incorrectly reflected as capital expenditure, which hugely inflated profits to deceive investors and the markets. These expenses were deliberately distributed across a host of accounts for capital expenses to escape detection in a concerted effort at profit manipulation. The Securities and Exchange Commission (SEC) has filed civil fraud charges and subpoenas have been served by Congress and the House Financial Services committee. Investor and market confidence has evaporated.
Armed with fortuitously detailed information from the ongoing investigation into the Enron debacle, one is struck by the astonishing similarities between it and the WorldCom saga. When one factors in the data from the fraudulent activities at Global Crossing to Xerox, there is overwhelming and irrefutable empirical evidence of a consistent pattern of corporate fraud and government collusion.
In the interest of brevity, let us then investigate the parallels between Enron and WorldCom: Both corporations fraudulently inflated profits, Enron by shifting billions of dollars of debt off its balance sheets and into a plethora of offshore financial partnerships (one third in the Cayman Islands) to hide its astronomical losses, duping starry-eyed credit-rating agencies, bankers, regulators and politicians, while WorldCom systematically sprinkled [billions of dollars] across a series of accounts for capital expenditures (New York Times, June 27).
The rationale for the profit manipulation is identical: Like Enron, WorldComs decision to inflate its figures comes down to Wall Street expecting each quarter to be better than the last (The Observer, June 30).
The concealment of debt and inflation of profits was facilitated as both corporations embarked on phenomenal acquisition sprees. In the case of WorldCom, Ebbers [founder and CEO] raced the business through 70 deals in four years, buying up competitors and expanding his reach and In addition, the parent presided over an Enron-like structure of hundreds of smaller subsidiaries based in places as diverse as Bermuda, the British Virgin Islands, Peru, and the Cayman Islands (The Observer, June 30). However, with Enrons acquisitions the corporation diversified into a huge range of products from pulp to petrochemicals and services from transportation to electronic commerce, with astonishing global reach.
As a result of the frenetic pace of acquisitions it was difficult to achieve cohesion, standardization, and centralized executive control in the myriad subsidiaries. The highly fragmented structure of these organizations made them easy targets for the accounting malpractices (like off-balance-sheet transactions and derivatives for concealing the rapidly escalating losses) that were largely responsible for their demise. This mania for acquisitions may be a premeditated technique of ensuring that these scams succeed.
The Bank for International Settlements attributed the collapse of Enron to a catastrophic failure of corporate governance . The companys board of directors, the external auditor, stock analysts, credit rating agencies, creditors and investors jointly failed to critically assess how Enrons management achieved ostensibly superior earnings growth. With reference to WorldCom, Sir David Tweedie, chair of the International Accounting Standards Board, agrees: People are saying this couldnt happen in Britain. Oh yes it could. Its corporate governance failures.
Another common denominator is the identity of the accountant. Full marks if you shout hysterically: Arthur Andersen. This accounting firm is popping up with monotonous regularity in the domain of corporate sleaze. No one appears surprised to learn that Andersen was also Mercks accountant. But the more the shit hits the fan, the more crooked accounting firms are being exposed to the harsh halogen spotlight of public derision.
These similarities between the two corporations do not address the far more serious issue of money-for-political-influence, which is increasingly becoming the Administrations albatross. The Center for Responsive Politics has found that WorldCom had lavished $7.5 million in campaign finance over the past 12 years. Only a few days before the WorldCom drama hit the headlines, the corporation donated $100,000 to the Republicans at a gala attended by Bush. Julian Borger alleges that: WorldComs gala contribution was a routine part of its $3m a year lobbying effort in Washington, aimed at influencing tax policy and the planned deregulation of the long-distance telephone marketlegislation to which WorldCom is opposed. It comes as no surprise that even the judiciary is implicated: John Ashcroft, the attorney general, received $10,000 campaign funding from the company when he ran for senator. He is about to head the investigation of the WorldCom fraud. In addition to the above, there is a long list of high-profile government officials who have financial links with WorldCom, Enron, and the like.
Details of the political favors exacted will be provided in the following thrilling episodes:
(1) In 1986 Bushs company was in deep financial trouble. But he was rescued from failure when Harken Energy bought his company at an astonishingly high price. There is no question that Harken was basically paying for Bushs connections . Despite these connections, Harken did badly. For a time it concealed its failure, sustaining its stock price, as it turned out, just long enough for Bush to sell most of his stake at a large profitwith an accounting trick identical to one of the main ploys used by Enron a decade later (Paul Krugman, New York Times).
He allegedly sold shares to the value of $850,000 just 2 months before the price dropped, but failed to immediately report the sale as an insider (he informed the SEC only 34 weeks later). Who was the accountant involved? Yes, youve guessed it. The White House admitted, grudgingly, that Bush profited only from low interest loans (5 percent) from the company to buy Harken shares. George W. is now addressing Wall Street in a desperate bid to affect damage control and demand a new era of integrity from U.S. Corporations.
(2) Every nuance of Dick Cheneys expression is explored by the telephoto lens. Our vice-president squirms subliminally as searching questions are fired at him: Is it true that you were chair and CEO of Halliburton, the oil services corporation, between 1995 and 2000; that the companys revenues were fraudulently overstated by $445 million during that period with the express purpose of boosting the share price; that Andersen was the accounting firm yet again; that you took part in a promotional video for Andersen; is it true that...?
(3) The roving camera picks out Harvey Pitt in the crowd. Hes the current chair of the SEC and is promising rather unconvincingly, If anybody violates the law, we go after them. Alexander Cock- burn enlightens us, In an earlier incarnation Pitt was one of the guys who successfully lobbied the SEC to make it easier for Arthur Andersen and the other big accounting firms to cook the books on behalf of Enron, MCI/World- Com, and others. Bush, flush with campaign contributions from Enron, MCI/WorldCom ($100,000 last summer), duly signaled his gratitude by putting Pitt in charge of the SEC, where he put the agency in snooze mode amid a ripening cloud of scandal involving the biggest names in corporate America.
One of the free market fundamentalist mantras has always been: deregulation good; regulation bad. This has been exploited by droves of unscrupulous corporate executives as gristle for their greed and corruption. The era has been marked by chief executive autonomy, widening income inequality, and a challenge to the role of government so strong that many were cowed from asserting the public interest over markets in even the most modest way. Polly Toynbee sees this as a disease of insufficiently regulated markets and only strong government, strong regulators, heavy penalties, long prison sentences and lashings of red tape would adequately address these iniquities. Who could quibble with the assertion that: if government is entitled to impose appropriate regulations on schools and hospitals in pursuit of the public good, it is entitled to do the same on business.
A great proportion of the blame for corporate fraud goes to the share option schemes that have become almost obligatory and are rarely questioned. Company executives are allowednay, encouragedto award themselves phenomenally generous share options. So these executives will obviously do everything in their power to inflate short-term share prices to earn the greatest financial rewards for themselves. A fail-safe method is to vastly overstate profits by massaging the figures. This is the reason for the routine occurrence of accounting scams, even in the supposedly most ethical companies. Yet investors will continue to wring their hands in righteous disbelief when company after company crashes in the aftermath of accounting chicanery. They cannot see that their own greed and lack of integrity is actually the main cause of the disasters.
Another serious loophole is that there is no mandatory requirement that stock options be reflected on balance sheets. Profits would be reduced by 8 percent if that were the case. Balance sheets would give a truer indication of the corporations performance and would tend to discourage the practice.
A corollary to this is, the relationship between auditors and companies has become too cozy. The problem is that most accounting firms have consulting divisions and they are concerned about substantial loss of income if they act too ethically. The conflict of interest between the auditing and consultancy functions is then swept under the carpet where it festers and eventually erupts. But the U.S. government is equally culpable in the problem of incentives. Stiglitzs analysis is, the U.S. treasury had an incentive to urge the continuation of the bad accounting practices: it responds to the interests of Wall Street, and the financial community benefited as much as did the corporate executives from the artificial boom and bubble to which it contributed.
There are solutions to this problem if the political will is there: The first is to legislate that auditors must rotate every couple of years; the second is to prohibit corporate executives from appointing auditors. The fact that these interventions have never been implemented testifies to the effective lobbying by powerful vested interests and connivance from government and the judiciary.
Besides the ethical and legal issues raised by WorldCom is the profound impact it is having on the lives of ordinary citizens and workers. Many state pension funds are heavily invested in World- ComNew York State lost $300 million, Michigan lost $116 million, and Florida $85-90 million. Thousands of employees have lost their jobs. The viability of many insurance companies has been threatened. The resultant market chaos will decimate further the current meager social services in the U.S. The knock-on effect on world markets could spell disaster for many Third World countries, which are already in dire straits.
Unfortunately the market turmoil in the wake of the corporate accounting scandals does not herald the death knell of capitalism or neo-liberal globalization. It will probably continue to lurch from crisis to crisis, wreaking havoc in every corner of the globe. For the moment the best that can be hoped for is to ameliorate some of its most destructive excesses. The best time for social justice movements to mount an offensive is when the monster is temporarily belly-up, such as at the present moment. So why are we so subdued? Z