The past tumultuous week has witnessed the sensational spectacle of the implosion of WorldCom, which is by far the largest accounting fraud in history and appears destined to be the biggest ever corporate bankruptcy. It has also exposed the invasive cancer of avarice and corruption that is probably an indelible feature of the US corporate world and government (and most likely the majority of leading Western economies), and metastasising inexorably into many sectors of society.
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, Adelphia, and more recently Xerox and General Electric. Hot of the press we have Merck caught with a quivering hand still in the cookie jar and Bristol-Myers Squibb is being investigated. Who next? The world waits with bated breath to discover how the denouement of this epic tale will unravel.
But already world markets are doing the domino-thing as investor and consumer confidence is shattered: The Dow Jones fell to the 5-year low of the 1997 Asian financial crisis, followed hard upon by the FTSE. How far and deeply will the contagion spread?
WorldCom is the second largest telecommunications corporation in the US (after AT&T) and the world’s 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 only $80 billion at its peak) and shares at $64. In the aftermath of the initial scandalous revelations the share price plummeted precipitously to 9 cents. Thank goodness for the floor!
This mind-boggling accounting swindle (six times the size of Enron’s) 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), the US financial regulator, has filed civil fraud charges, and subpoenas have been served by Congress and the House financial services committee. Investor and market confidence has evaporated. With a crushing $30 billion debt burden, the plunging share price will make it difficult to pay its creditors, and the probability of bankruptcy is now looming large on the horizon.
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 merely 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, WorldCom’s decision to inflate its figures . . . comes down to Wall Street expecting each quarter to be better than the last.” (The Observer, June 30). There are enormous pressures on corporate executives to achieve this miracle.
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 Enron’s 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, standardisation and centralised executive control in the myriad subsidiaries. The highly fragmented structure of these organisations made them easy targets for the accounting malpractices (like off-balance-sheet transactions and derivatives for concealing the rapidly escalating losses) which were largely responsible for their demise. This mania for acquisitions is probably more than simple greed; it 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 company’s board of directors, the external auditor, stock analysts, credit rating agencies, creditors and investors jointly failed to critically assess how Enron’s management achieved ostensibly superior earnings growth.” With reference to WorldCom, Sir David Tweedie, chairman of the International Accounting Standards Board, agrees: “People are saying this couldn’t happen in Britain. Oh yes it could. It’s corporate governance failures.”
Another common denominator is the identity of the accountant. Full marks if you shout out hysterically: “ARTHUR ANDERSEN!” This accounting firm is popping up with monotonous regularity in the domain of corporate sleaze. And no one appears surprised to learn that Andersen was also Merck’s accountants. But the more the shit hits the fan, the more crooked accounting firms are being exposed to the harsh halogen spotlight of public derision. Now KPMG is implicated in the Xerox scam. The stench is all-pervasive.
These similarities between the two corporations do not address the far more serious issue of money-for-political-influence which is increasingly becoming the Administration’s albatross. The Centre for Responsive Politics has found that WorldCom had lavished $7.5m in campaign finance over the past 12 years. And 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: “WorldCom’s 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 market — legislation 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. And 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 favours exacted will be provided in the next thrilling episode.
Bush is suddenly back-peddling up against the ropes as the new contender lets rip with a stinging left (uh, that’s right) hook. Harken! The name jangles his nerves. How jolly unsporting to drag that mummified story from the archives. In 1986 Bush’s 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 Mr Bush’s connections . . . Despite these connections, Harken did badly. But for a time it concealed its failure – sustaining its stock price, as it turned out, just long enough for Mr Bush to sell most of his stake at a large profit – with an accounting trick identical to one of the main ploys used by Enron a decade later” (Paul Krugman, New York Times columnist). 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). And who was the accountant involved? Yes, you’ve guessed it! Now the White House admits grudgingly that Bush profited only from low interest loans (5%) from the company to buy Harken shares. With the appropriate can-opener the wriggling knot of worms will be unleashed.
George W. addresses Wall Street in a desperate bid to effect damage control and demands a “new era of integrity” from US corporations. He’ll probably blame that left hook for his atrocious lapse of memory and integrity.
Every nuance of Dick Cheney’s expression is explored remorselessly by the omnipresent telephoto lens. Our psychometrically prepared vice-president squirms subliminally as searching questions are fired at him: Is it true that you were chairman and CEO of Halliburton, the oil services corporation, between 1995 and 2000; that the company’s 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 —-
The roving camera picks out Harvey Pitt in the crowd. He’s the current chairman of the SEC and is promising rather unconvincingly that “If anybody violates the law, we go after them.” In his inimitably humorous way Alexander Cockburn enlightens us that: “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/WorldCom 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.” When the chickens come home to roost, will Bush’s goose be cooked? And is there a chef in the House?
Will Hutton argues compellingly that: “Confidence has been shattered by an orgy of unprecedented corporate fraud, plunder and malfeasance . . . American business ethics are abysmally low and require the toughest of policing . . . Everything must be pro-market, pro-business and pro-shareholder, a policy platform lubricated by colossal infusions of corporate cash into America’s money-dominated political system . . . The truth is that American business has bought the American executive and legislature alike.” Such powerful indictments are increasing exponentially, even in the mainstream media, and rising to a thrilling crescendo. Similar tectonic convulsions precipitated the breakup of Gondwanaland and the ensuing continental drift!
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 which have become almost obligatory and is rarely questioned. Company executives are allowed nay, encouraged to 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. And 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 simply cannot see that their own greed and lack of integrity is actually the main cause of the disasters.
Joseph Stiglitz, the eminent Nobel Laureate in Economics, explains that: “By this means [i.e. stock options], corporate officers could ensure that they were extremely well paid, without at the same time taking out anything from the corporation’s bottom line. It was almost too good to be true: while executives were receiving millions, no one seemed to be bearing the cost. It was a mirage: shareholder value was being diluted . . . Incentives matter: but inappropriate incentives do not lead to wealth creation . . . [It is] a drive for the creation of the appearance of wealth, not for the creation of actual wealth.”
Another serious loophole is that there is no mandatory requirement that stock options be reflected on balance sheets. Profits would be reduced by 8% if that were the case. Balance sheets would then give a truer indication of the corporation’s performance and would tend to discourage the practice.
A corollary to this is that “the relationship between auditors and companies has become too cosy.” 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 US government is equally culpable in the problem of incentives. Stiglitz’s analysis is that: “the US 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 simple solutions to this problem if the political will is there: The first is to legislate that auditors must rotate every couple of years; and 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 WorldCom New York State lost $300m, Michigan lost $116m and Florida $85-90m. 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 meagre social services in the US. And 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 globalisation. 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. And the best time for the social justice movements to mount the offensive is when the monster is temporarily belly-up, such as at the present moment.
So why are we so subdued?