Corporate Scandals

By Kerby Anderson

Scandals in corporate America have rocked financial markets and are proving to be fairly difficult to shake off. Within weeks of the September 11 attack on America, investors and consumers were well on their way to shrugging off most of the fallout. However, these current scandals already are having a longer term impact.

Enron. WorldCom. Tyco. Rite Aid. ImClone Systems. These are just a few of the names associated with a string of scandals that have led to faltering financial markets and depleted consumer confidence. Also affected have been the reputations of accounting firms like Arthur Andersen and wealthy investors like Martha Stewart.

The political fallout could be significant. Since President Bush took the oath of office, the Dow Jones has fallen over 30 percent and the Nasdaq 75 percent. The Wilshire 5000 tracks every publicly traded U.S. company. The Wilshire hit its ceiling on March 24, 2000. Since then, the market has lost more than $7 trillion in values and shed more than 1000 companies. When 41 percent of the value of all publicly traded stock has disappeared in 28 months, you can be sure the economy will be a major issue in the 2002 election year.

Given the accounting scandals at Enron and WorldCom, its understandable that members of Congress have been calling for new laws and regulations to reign in business. Unfortunately politicians in heat during an election year may end up passing laws that are ineffective. Enron, for example, used esoteric and highly creative accounting tricks to cook its books. New laws may not be of much help with that level of deception. On the other hand, WorldCom used a scheme that an accounting student could have devised. WorldCom spent more than $3.8 billion on everyday expenses, but treated them as money spent to buy assets (such as real estate or equipment).

Some wonder whether over-zealous politicians might end up doing more harm than good. One provision put forward would require every executive in America who has borrowed money from his firm to repay it immediately or face criminal charges. Imagine the impact of panicked selling by these executives as they unload their entire portfolio to repay a multi-year, multimillion dollar loan in 24 hours to avoid going to jail.

Senator John McCain suggested in a New York Times column that legislation should be enacted that would require executives to retain the net gain from any option they exercise in company stock that could not be sold until 90 days after the executive left the company. Yet it doesn't really make sense to charge options as operating expenses. An "option" gives the executive the option of buying stock at a set price. If the stock price goes up, the executive can exercise the option. It the stock price goes down, the option is worthless. Since we cannot predict whether the stock price will rise or fall, how do we assign a "cost" to the transaction before it takes place?

Congress has already passed, and the president has signed, a bill largely written by Senator Paul Sarbanes (D-MD). Maximum jail time for executives has been quadrupled to 20 years. The bill also established a new crime of securities fraud with a maximum sentence of 25 years while increasing funding for the Securities and Exchange Commission.

Some commentators have pointed out that the biggest accounting scandal has yet to hit the newspapers. This organization sets up off-the-books mechanisms to conceal debt and to inflate its revenues. It also shifts employee pay periods while raiding the employee pension fund. This organization is known as the United States Congress. "No corporation on earth comes close to the accounting fraud practiced year after year by the federal government," says Representative Ron Paul (R-TX).

For example, in order to pay for the census (which is required of the federal government every 10 years), Congress voted to classify the expense as an "emergency." That was $4.5 billion that Congress shifted from the government's operating budget and allowed it to meet its mandated budget caps.

Even worse are the so-called trust funds for Medicare and Social Security. Just as Enron set up off-the-books partnerships to conceal debt, so Congress has set up trust funds with nothing but IOUs. Congress borrows money from these trust funds to spend on current operating costs. But no liability to these funds exists. If a corporation treated pension funds in this way, it would be front page news as a major corporate scandal.

Fundamental to these corporate scandals is a lack of ethics and character. President Bush said, "All investment is an act of faith, and faith is earned by integrity. In the long run, there's no capitalism without conscience; there is no wealth without character." Adam Smith, the father of modern capitalism, certainly would have agreed. He argued that free-markets require ethical behavior at their core. Ethics is crucial yet we no longer teach ethics in school and no longer promote character in our popular culture.

A recent Zogby International poll of college seniors found that 97 percent of them said their college studies had prepared them to behave ethically in their future work lives. But 73 percent of the students said that when their professors taught about ethical issues, the usual message is that uniform standards of right and wrong do not exist. Today students are taught to behave ethically, but they are also taught that there are no absolute standards by which to judge ethical behavior.

Many academic departments report that they have abandoned teaching ethics because the faculty cannot agree on objective standards for ethics. Business schools assume that student will have learned ethics before they arrive, but this is doubtful in a culture of relativism.

The crisis of character in our nation today can be seen not only in the scandals in politics and business. Every sector of our society demonstrates what happens when ethics are seen as personal, relative, and situational. What an opportunity for those of us who believe in biblical absolutes to show that our society must be based upon moral standards of ethics and character.