Corporate Scandals and their Macroeconomic Impact Jeff Miller

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

Corporate Scandals and Their Macroeconomic Impact n History of Corporate Scandals n Reaction: Citizens, Investors, Government n Macroeconomic Effect

History Corporate scandals are not new n Early 1900’s: Charles Ponzi Ivar Krueger n 1920’s: Samuel Insull n 1940’s: Richard Whitney n 1960’s: GE, Westinghouse n 1970’s: Investors Overseas Services Robert Vesco

Corporate scandals are not new History 1980’s Ivan Boesky Insider Trading $100 million – 3 years Michael Milken Securities Fraud 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

Recent Scandals Enron February 2000 Fortune magazine chooses Enron as it’s “Best Managed and Most Innovative company” Most Innovative for five years in a row

Recent Scandals Enron February 2000: Fortune Magazine #1 – Quality of Management #2 – Employee Talent Source: Enron Corporation Press Release

Recent Scandals Enron n August 2000: Stock at $73 billion n March 2001: FY 2000 revenues at $100 billion n Sep 16, 2001: “Buy more shares” n October 2001: Enron pays its regular dividend

Recent Scandals Enron n October 16, 2001 $618 million 3 rd Qtr Loss $1. 2 billion reduction in shareholder equity n October 31, 2001 SEC upgrades inquiry into a formal investigation

Recent Scandals Enron n December 2, 2001 Enron files for bankruptcy 4, 000 employees fired n 20, 000 n $73 workers lose their jobs billion in stock value - gone

Recent Scandals Enron – What Happened? n $3 billion from pipelines n Energy producer to an energy trader to an energy “bank” n Maze of partnerships n Derivatives

Recent Scandals Enron – What Happened? “Enron apparently, with the approval 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

Recent Scandals Enron – What Happened? Most Innovative

Recent Scandals Enron Corporation Corporate Social Responsibility Report

Recent Scandals World. Com n $3. 9 billion in expenses hidden n $3. 3 billion in accounting irregularities n 17, 000 jobs lost n Company applied for bankruptcy n Market value of $100 billion

Recent Scandals Tyco n Tax evasion n Evidence tampering n 1500 jobs lost n Additional 4, 500 laid off n Down $86 billion in one year from peak share price

Recent Scandals Global Crossing n Ghost n 2000 transactions jobs lost n Down $40 billion in a few months

Recent Scandals Adelphia n Questionable loans n Loss of $6. 5 billion in market value in one year n Company in bankruptcy

Recent Scandals Wall Street Analysts Investment Banking Firms n Biased research n 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

Recent Scandals Mutual Funds Market Timing Buying or selling of mutual fund shares in order to exploit inefficiencies in mutual fund pricing practices

Recent Scandals Insurance Companies n March & Mc. Lennan Largest Insurance broker Soliciting rigged bids for insurance contracts Will pay $850 million n AON Corporation Second largest Insurance broker Fraud anti-competitive practices Will pay $190 million Source: “Classic Financial and Corporate Scandals” website

Recent Scandals Fannie Mae - Mortgages n Improper accounting methods n KMPG would not stipulate that reporting was accurate n Reported a $9 billion loss

Recent Scandals NYSE n Pay scandal involving former exec Richard Grasso - $188 million n Traders executing their own trades in advance of customer orders n Investors deprived of at least $32 million Source: Washington Post – Fifteen NYSE Traders Indicted – 4/13/2005

Recent Scandals KMPG $22. 5 million settlement with SEC Avoids trial next year on charges that KMPG willfully ignored warning signs related to Xerox’s accounting maneuvers n Largest accounting firm settlement in history n "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. n n Source: USA Today – KPMG to pay $22. 5 M to settle Xerox questions – 4/19/2005

Recent Scandals Widespread Moral Deficit “Accountants held no one to account, 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 Reaction n Enron Corporation n Arthur Andersen n Enron’s Law firm n Investment bankers n Countries with Enron operations Argentina, Mozambique, India, Poland n Companies in other countries Shell, BP, Mobil, Total Source: Ethics in Organizations – Learning From Enron

Reaction Enron Wasn’t Just Enron “Among other states’ pensions affected by 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

Reaction Loss of Confidence n Companies n Auditors n Boards of Directors n Credit-raters n FERC – Federal Energy Regulatory Commission n Wall Street Analysts and Underwriters

Reaction The Stock Market Speaks Source: Smart. Money. com DJIA 1/1/2002 – 12/31/2002 modified by jam

Reaction Indictments n Kenneth Lay, Jeffrey Skilling, Andrew Fastow – Enron n Bernard Ebbers – World. Com n Dennis Koslowski – Tyco n Samuel Waksal – Imclone n John Rigas – Adelphia n Martha Stewart

Reaction Creation of New laws Sarbanes-Oxley Act n CEO’s CFO’s certify accuracy n Fines up to $1 million/10 years n No personal loans to executives n Auditing procedures, incl. rotation n Whisteblower protection n 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: § Dot. Com bubble § September 11 § Economic Cycle § President Bush’s Tax Cut § Other Policies

Macroeconomic Impact Estimates of the Costs n New York economy lost $2. 9 billion n New York State revenues decreased by $1 billion in FY 2002 -2003 n Losses n $260 for local governments million loss to New York City Source: Impact of the Corporate Scandals on New York State - Office of the New York State Comptroller

Macroeconomic Impact Estimates of the Costs n National economy reduced by $35 billion in first year n GDP: . 34 percent reduction n Unemployment Source: Cooking the Books: The Cost to the Economy - The Brookings Institution

Macroeconomic Impact Estimates of the Costs n Consumer Spending n Investment n Interest rates Source: Cooking the Books: The Cost to the Economy - The Brookings Institution

Macroeconomic Impact Stock Market Dow Jones: 27% drop Standard & Poor 500: 28% drop Chart: Yahoo Finance

Macroeconomic Impact Stock Market n 50% of households own stock today as compared to 37% in 1992 n 21% of retirement funds are invested in mutual funds today as compared to 5% in 1990 n 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

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

Macroeconomic Impact The Dollar Let’s have more scandal!!!!

Macroeconomic Impact Foreign Investors/Companies n Less inclined to hold stock n Could cause a decline in value of $ n 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

Macroeconomic Impact Cost of Compliance Estimates that spending on Sarbanes-Oxley will reach $5. 8 billion in 2005 Source: AMR Research

Macroeconomic Impact Does the Economy Shift? Real Goods to Financial Assets: n Yes, in the short run n These financial assets have disappeared

Review A Warning “I see in the near future a crisis approaching that unnerves me and causes me to tremble for the safety of my 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

Review A Considerable Effect n Stock Market n Public Confidence n Cost of Compliance n Foreign Investors/Companies Until such time as we effectively address these problems, our economy will continue to be vulnerable

Review A Proposal The Death Penalty For Corporations

Review 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 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