How Did We Get Here?

Scott Sullivan in handcuffs. Jokes about how "CFO" stands for Chief Fraud Officer. How did we get here?

The fact is, we've been here before, and not all that long ago. It just feels worse this time because the recent boom lasted so long and the CFOs are doing the "perp walk" instead of the bankers. But in the hope of avoiding an eternal looping repetition of the same scenario, like Bill Murray's character in the movie Groundhog Day, it might help to remember that we learned in the 1980s what we are learning again now.

The most recent bull market really began in 1982, when sales of personal computers first began to take off, spawning a slew of fast-growing new businesses. Most soon disappeared, but some became household names, such as Apple, Microsoft, and Dell. Telecom soared when AT&T was split up in 1984, creating a free-for-all among the Baby Bells and enabling others to compete for long-distance coverage.

Twenty years ago, widespread use of high-yield junk bonds fueled the boom. Then as now, the big players--mostly banks and so-called corporate raiders--invoked the mantra of shareholder value to justify enormous merger-and-acquisition transactions. In a 1985 interview with CFO magazine, David Batchelder, CFO to notorious raider T. Boone Pickens, argued that by forcing target companies to pile on debt to avoid a takeover, Pickens was helping them perform better. "They take on more leverage, and as a result of increased leverage, [managers] are generally more careful how they spend money," said Batchelder.

The use of massive debt for acquisitions had legitimate uses. We can thank Michael Milken and Drexel Burnham Lambert for MCI and Turner Networks. But, ultimately, deal frenzy overtook the leveraged buyout market, resulting in preposterous overpayments, solid companies broken and sold for parts, and a plethora of companies overburdened with debt. The flurry of ever-bigger deals eventually collapsed into a series of scandals involving insider trading and misuse of derivatives instruments. Sound familiar?

By 1990, Ivan Boesky and Milken had been convicted of insider trading and Charles Keating, boss of the Lincoln Savings & Loan, had been accused of fraud. Moreover, the LBO fallout, along with the stock market plunges of 1987 and 1989, led to a huge economic hangover.

That hangover, however, created a huge opportunity for CFOs to assume a higher profile in their organizations. Companies were preoccupied with cost-cutting and restructuring. And CFOs, who had remained on the sidelines for most of the past decade's deal-making, could now demonstrate their ability to move the stock price of their companies by undoing the damage wrought by the LBO binge. Everyone at least claimed to be reengineering, and in most cases CFOs directed these initiatives.

Meanwhile, market observers argued over who or what deserved the most blame for the excesses of the 1980s. In a June 1989 interview, no less an authority than current Securities and Exchange Commission chairman Harvey Pitt, who at the time was the lawyer defending Boesky, put the blame squarely on greed: "Our marketplaces...have created more opportunities for certain people to take advantage of informational superiority."

Others pointed to aggressive tactics by investment bankers. At Kidder, Peabody, former managing director Martin Siegel's collusion with Boesky exposed serious deficiencies in financial controls at the firm, as well as the dark side of its freewheeling, overpaid culture. When Charles Sheehan was installed as CFO to restore order after Siegel was ousted, he observed: "The creative, revenue-producing types had gotten far ahead of the firm's ability to support or control them."

Auditor Angst
Public outrage may have been targeted at the bankers, but as early as 1986 people were also asking, "Where were the auditors?" Then­-Rep. Ronald Wyden (D-­Ore.) introduced legislation that would have required auditors to tell the federal government whenever they detected fraud in financial statements. To no one's surprise, the auditing industry vehemently opposed the bill. But the accounting profession did help launch the Treadway Commission, which in 1987 issued its landmark report on fraud. (Later, it set standards for internal controls.)

Less than four years later, the profession began the process that would culminate in the destruction of its most respected partnership. The Big Eight shrunk to the Big Six. All six jumped into consulting services. In July 1991, author Mark Stevens warned about these developments in an interview with CFO. He explained that while accountants used to consider themselves "professionals who happened to be in business," now the reverse was true. "Historically, if you became a Big Eight accountant," he said, "you'd make a nice living, you'd never get fired, and you wouldn't have to sell. That was the deal. Now you've got to sell, and you've got to promote."

Stevens predicted that the liabilities inherent in the auditing business would make it harder to attract good auditors, thus diminishing the quality of audits.

The Enemy Within
By 1994, the stock market had returned to life, swept up by demand for another hot new technology--the Internet--and by further deregulation of energy and telecommunications markets. This time equity fed the deal flow instead of debt.

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