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Much of what happened in the 1990s also happened in the 1980s. Here's hoping we don't do it again.
Julia Homer, CFO Magazine
October 1, 2002
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."
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.
Once again, the bankers worked both sides of the aisle. But this time CFOs got caught right in the middle. They were full-blown strategic partners now, and as often as not the architects of ever-more- complex deals. Although many privately expressed skepticism about "New Economy" business plans and valuations, by and large they went along for the ride.
The bruising battles over accounting rules, culminating in the fight over stock-option accounting, helped foster a climate in which accounting became a game of outwitting the rules without violating them. Auditors were urged to empathize with their clients, and clients and auditors together strove to make the financial statements satisfy GAAP rather than reflect the financial health of the company.
Then came the deluge: "dot-bombs," the telecom crash, Enron, WorldCom, and the sudden death of Arthur Andersen.
For insight into what has happened, one could do worse than listen to investment banker Warren Hellman's explanation, in August 1991, of the then-current downturn: "Everybody suspended belief in basic principles. First, people confused financial projections with facts.... Second, CEOs, CFOs, and investors started to believe that debt wasn't due when it matured.... [And third], people forgot that there isn't always a greater fool."
There is, however, always someone to blame. This time it's the CFO. Thanks to Enron and WorldCom, a growing chorus wants to know: Whatever happened to ethics in a discipline known for integrity?
Our August 1992 issue dealt with these very questions as they affected one CFO confronting corporate loyalty and fear of reprisal on the one hand and his conscience on the other. Several commentators had observations on his dilemma that are as true today as they were then. One noted that "the CFO's willingness to accommodate gray areas and to mislead auditors sends a message to the CEO that this kind of practice must be acceptable.
"A CFO who acceded to the CEO's demands to commit accounting fraud has abrogated his right to play a strategic role in the corporation. He has become simply an executor of management's whims, not a builder of the business," he added. And finally, one person said simply, "Your reputation and the company's image are the most basic attributes you have in business."
To the extent that we fail to grasp this now, we can expect to repeat this cycle again, and with just as much dislocation and recrimination.
Julia Homer is editor-in-chief of CFO.
Steps on the Path
A look back at events that led Corporate America into a strange new world of finance.
1984: Arthur Andersen's consulting business rakes in more profits than its auditing business for the first time.
July 1985: The National Commission on Fraudulent Financial Reporting--later referred to as the Treadway Commission--is formed. The commission's report is issued in 1987, and includes recommendations for management, boards of directors, the public accounting profession, the SEC, and other regulatory bodies about how to prevent fraud.
May 1986: At a commencement ceremony at the University of California, Ivan Boesky utters the infamous words: "Greed is all right, by the way. I think greed is healthy. You can be greedy and still feel good about yourself."
September 1987: Carpet-cleaning firm turned Ponzi scheme ZZZZ Best declares bankruptcy. At subsequent congressional hearings, Rep. John D. Dingell asks, "Where were the independent auditors and the others that are paid to alert the public to fraud and deceit?"
September 1990: The accounting profession backs legislation requiring auditors to notify regulators of possible corporate illegal acts.
May 1991: The SEC modifies the "short-swing rule" on stock options.
November 1991: The U.S. Sentencing Commission adopts guidelines for use in assessing criminal penalties for white-collar crimes.
January 1992: The SEC wants companies to use a uniform method of valuing stock options.
August 1992: Phar-Mor Inc. seeks bankruptcy protection after it is revealed that founder Mickey Monus had ordered accountants to cook the books to the tune of $500 million. CFO Patrick Finn is sentenced to 33 months in prison; Monus is sentenced to nearly 20 years.
September 1992: The Committee of Sponsoring Organizations of the Treadway Commission releases a standard definition of internal controls.
November 1992: Ernst & Young agrees to pay $400 million to settle charges that it inadequately audited four S&Ls.
January 1993: Charles Keating is sentenced to 12 years in prison for bilking investors in his Lincoln Savings & Loan. His conviction is later overturned, although he pleads guilty on three fraud counts.
July 1993: Arthur Levitt is confirmed as chairman of the SEC. He will serve until February 9, 2001, and will wage war on managed earnings.
March/April 1994: Derivative losses at Gibson Greetings and Procter & Gamble lead to outcries against financial engineering.
October 1994: Woolworth's fires CEO (and former CFO) William Lavin in the wake of an accounting scandal.
December 1994: FASB drops its plan to force companies to deduct stock options.
December 22, 1995: The Private Securities Litigation Act becomes law after Congress overturns President Clinton's veto.
December 15, 1997: A new standard for reporting and detecting fraud developed by the AICPA kicks in. Auditors are mandated to aggressively seek out and report fraud using a detailed set of guidelines.
December 1997: Michael Eisner, CEO of The Walt Disney Co., receives compensation of more than $575 million. On top of his $750,000 salary, Eisner makes $565 million from stock options. Out-of-control CEO pay starts to be roundly lambasted.
April 1998: CUC International CFO Cosmo Corigliano is ousted after it is revealed that the division of Cendant Corp. is responsible for accounting irregularities that will force it to restate its 1997 earnings by as much as $100 million to $115 million.
September 1998: In a speech to the New York University Center for Law and Business, Arthur Levitt cracks down on "managed earnings," criticizing "accounting hocus-pocus."
July 1999: The board of directors at Waste Management Inc. launches an investigation into charges of insider trading. The SEC will later sue five executives, including CFO James E. Koenig, for a scheme to falsify and misrepresent Waste Management's financial results between 1992 and 1997.
October 18, 1999: The SEC's Levitt cites collusion between investment bankers and analysts as part of the "web of dysfunctional relationships" that undermines the quality of U.S. financial markets.
November 1999: The Glass-Steagall Act of 1933 is repealed.
November 2000: For much of the year, the Big Five accounting firms are at odds with the SEC over its plans to severely limit the consulting work an accounting firm can do for audit clients. On November 21, both sides agree to more lenient terms.
August 2001: Former Wall Street lawyer Harvey Pitt is appointed SEC chairman. In October, in his first public speech after being sworn in, he pledges a "kinder and gentler" treatment for accountants.
October 24, 2001: Enron Corp. ousts finance chief Andrew Fastow eight days after reporting a $618 million third-quarter loss, partly due to partnerships run by the CFO.
January 10, 2002: Arthur Andersen admits that it shredded Enron-related documents.
January 15, 2002: "Chainsaw Al" Dunlap is forced to pay $15 million out of his own pocket for accounting fraud at Sunbeam Corp. Former CFO Russell Kersh is ordered to pay $250,000.
January 2002: Paul Polishan, former CFO of apparel-maker Leslie Fay Co., is sentenced to nine years in prison for manipulating company earnings between 1989 and 1993.
February 2002: Fastow and former Enron CEO Kenneth Lay appear before Congress and invoke their Fifth Amendment rights.
June 26, 2002: WorldCom Inc. announces that it has incorrectly accounted for $3.8 billion in expenses as capital expeditures. It will file for bankruptcy on July 22--the largest in history.
July 30, 2002: The Sarbanes-Oxley bill is signed into law.
August 1, 2002: Scott Sullivan and David Myer, the former CFO and controller, respectively, of WorldCom, are led away in handcuffs into a Manhattan federal courthouse.
August 14, 2002: The first deadline for CEOs and CFOs of the 947 companies with revenues of more than $1.2 billion in 2001 to take personal legal responsibility for the accuracy of their financial statements.
August 31, 2002: Arthur Andersen ceases to exist.
September 12, 2002: Mark Swartz and Dennis Kozlowski, the former CFO and CEO, respectively, of Tyco International Ltd., are indicted on charges of corruption, conspiracy, grand larceny, and falsifying records.