45
THE $17,000
46 Crash Profits: Make Money When Stocks SinkandSoar
shareholders’ meeting, waiting anxiously for him to give his speech.
Or he could see her facing him over dinner while her husband eyed him critically.
So he’d stay up late, watching CNN and other news channels.
One night his next set of horrors began. One by one, right there on the headline news, his former friends or rivals were being marched off in handcuffs. He scurried to scan the headlines on New York Times Online:
WORLDCOM SAYS IT HID EXPENSES, INFLATING CASH FLOW $3.8 BILLION(Andrew Ross Sorkin, New York Times,June 26, 2002). WorldCom, the nation’s second-largest long-distance carrier, said last night that it had overstated its cash flow by more than $3.8 billion during the last five quarters in what appears to be one of the largest cases of false corporate bookkeeping yet. WorldCom, which had a peak value of $115.3 billion in June 1999 when its shares reached a high of $62, is now worth less than $1 billion. Its stock, which had already been down more than 94 percent for the year before last night’s disclosure, plunged as low as 26 cents in after-hours trading last night. The S.E.C. said in a statement released early today that the disclosures confirmed “accounting improprieties of un- precedented magnitude.”
Johnston shuddered again a few days later as he read a story by Barnaby J. Feder and David Leonhardt, also of the Times. The names of WorldCom’s executives and board members were dis- played in a prominent table. There they were in black and white, with all the data on the fortunes they had made selling the com- pany’s shares. Even while the stock was tumbling, they allegedly engineered the largest corporate fraud in the history of the world while continually urging the public to buy its sinking shares.
There was Bert C. Roberts, chairman of the board, who sold his shares for $22.8 million . . . Scott D. Sullivan, chief financial officer, who got $44.2 million . . . James Quell Crowe, a former chairman, who walked off with $24.7 million . . . and Gerald H. Taylor, former CEO of MCI, who took $21.8 million. CEO John W. Sidgmore did even better, cashing out with $87.3 million, and Lawrence C.
The $17,000 Toilet Kit 47
Tucker, a board member, trumped them all, waltzing away with
$110.8 million!
Soon, investors would also realize how WorldCom insiders got filthy rich while they suffered crushing losses. So they demanded to see the bums thrown into jail. They wanted blood.
2 EX-OFFICIALS AT WORLDCOM ARE CHARGED IN HUGE FRAUD(Kurt Eichenwald, New York Times,August 2, 2002). Two former executives of the telecommunications giant WorldCom were charged yesterday with carrying out a multi- billion-dollar accounting fraud that disguised mounting losses and ultimately helped drive it into bankruptcy.
The executives—Scott D. Sullivan, WorldCom’s former chief financial officer, and David F. Myers, its former controller—sur- rendered at 7 A.M. yesterday at the F.B.I.’s field office in Lower Manhattan. They were later publicly escorted in handcuffs to the Federal District Court for a brief hearing. . . .
Night after night, after all his personal staff had gone home, Johnston would collapse into the leather sofa behind his office, grab his TV remote control, and flip the cable news channels nervously—
CNN, Fox, MSNBC, and others. One after another, the images of still more acquaintances would appear on the screen—being hauled off by cops, firing angry epithets to reporters, dragged through the mud, doomed to a hellish life of shame.
There was David B. Duncan, the lead auditor of Enron at Arthur Andersen, charged with obstruction of justice, pleading guilty, the entire firm convicted . . . Scott D. Sullivan, former chief financial officer, and David F. Myers, former controller of WorldCom, both charged with securities fraud and conspiracy . . . and Samuel D.
Waksal, former chief executive of ImClone Systems, charged with insider trading.
The reporters’ words rang in Johnston’s ears: “John J. Rigas, 78, the founder and former chief executive of Adelphia, and two of his sons were taken into custody by federal agents at 6A.M. yesterday at their Manhattan apartment on the Upper East Side. . . .” [See Table 5.1.]
“Prosecutors contend they improperly used company money
Table 5.1 Senior Executives Investigated in 2001/2002
Executive Allegations
Adelphia Communications Corporation
John J. Rigas, Founder Acctg. irregularities, fraudulent partnerships Timothy Rigas, former CFO Acctg. irregularities, fraudulent partnerships Michael Rigas, former executive VP Acctg. irregularities, fraudulent partnerships James Brown, former VP Acctg. irregularities, fraudulent partnerships Michael Mulcahey, former VP, treasurer Acctg. irregularities, fraudulent partnerships
Arthur Andersen LLP
Joseph Berardino, former CEO Obstruction of justice David Duncan, Partner Obstruction of justice Nancy Temple, Counsel Obstruction of justice
Dynegy Corp.
Chuck Watson, former CEO Acctg. irregularities with energy transactions Enron Corp.
Kenneth Lay, former CEO Acctg. irregularities, fraudulent partnerships Jeffrey Skilling, former CEO Acctg. irregularities, fraudulent partnerships Andrew Fastow, former CFO Acctg. irregularities, money laundering Michael J. Kopper, former MD Money laundering, conspiracy to
commit wire fraud ImClone Systems Inc.
Dr. Samuel Waksal, former CEO Insider trading Martha Stewart Living Omnimedia
Martha Stewart, Founder Insider trading, obstruction of justice Qwest Communications International, Inc.
Joseph P. Nacchio, former CEO Acctg. irregularities Tyco International Ltd.
L. Dennis Kozlowski, former CEO Tax evasion, corporate theft, record falsifications Mark Swartz, former CFO Corporate theft, record falsifications
Mark Belnick, former Counsel Records falsification WorldCom, Inc.
Bernard Ebbers, former CEO Acctg. irregularities, securities fraud Scott D. Sullivan, former CFO Acctg. irregularities, securities fraud David Myers, former controller Acctg. irregularities, securities fraud Buford Yates, former Acctg. director Securities fraud
Betty Vinson, executive Securities fraud Troy Norman, executive Securities fraud
In response to rampant corporate crime, authorities charged or investigated these CEOs of major American corporations. However, these represent only a small fraction of those who stole from the American public by using accounting gimmicks that were defined as “perfectly legal.”
48
The $17,000 Toilet Kit 49
for everything from personal loans to buy stock, to building a
$13 million golf course, to shuttling family members back and forth from a safari vacation in Africa and . . .”
“The sight of top executives facing criminal charges, once rare, has become almost common in recent months. . . .”
“Samuel D. Waksal, former chief executive of the biotechnol- ogy company ImClone Systems, was arrested at his Manhattan home and charged with insider stock trading today. . . .”
“Spitzer sues five telecom executives for ill-gotten personal gains—former WorldCom CEO Bernard J. Ebbers, former McLeod- USA CEO Clark E. McLeod, former Qwest chairman Philip F.
Anschutz, former Qwest CEO Joseph P. N. Nacchio, plus the founder and chairman of Metromedia Fiber Networks, Stephen A.
Garofalo. . . .”
“L. Dennis Kozlowski, former chairman and chief executive of the conglomerate Tyco International, has been indicted . . .”
Johnston suffered another blow when, at 4 A.M. on September 18, 2002, he went to New York Times Onlineand read the following story:
TYCO DETAILS LAVISH LIVES OF EXECUTIVES.
Tyco International, whose former top executives had been indicted on charges of looting the company, said yesterday that it had uncovered a web of deception and personal enrichment that had spread throughout its management ranks.
The Tyco report showed that its former CEO, L. Dennis Kozlowski, had systematically created a corporate culture of greed and excess, secretly authorizing the forgiveness of tens of millions of dollars in loans to dozens of executives. Kozlowski had bypassed his board of directors and, without their approval, gave 51 Tyco managers $56 million in bonuses plus$39 million more to pay the taxes on the bonuses. This money, in turn, was clearly destined to wipe out the loans that the company had made to them.
Tyco’s dirty laundry seemed to pour out onto Johnston’s lap.
Right there in the New York Times—and paraded before millions of Americans on TV—was a long list of personal items that the CEO bought with the money that investors had entrusted to the com- pany:
50 Crash Profits: Make Money When Stocks SinkandSoar
■ Fee to Germán Frers, a yacht maker—$72,000
■ Traveling toilet kit—$17,000
■ Dog umbrella stand—$15,000
■ Sewing basket—$6,300
■ Shower curtain—$6,000
■ Two sets of sheets—$5,960
■ Gilt metal wastebasket—$1,650
A $1,650 wastebasket! A $17,000 toilet kit! All bought with shareholder funds! He could not bear one more headline or flash news report. He was sick to his stomach.
His stomachache was caused, in part, by fear. He could vividly see his own company—already slammed by the stock market—get- ting blasted in the headlines, and he could visualize his own face displayed on CNN like a mug shot. At the same time, however, his nausea was driven by a sense of pride. He never did take most of the lavish executive compensation package that had been pro- posed by the consultants and approved by the board of directors.
He never once went beyond the legal parameters that were out- lined to him by expert advisors.
Nevertheless, he felt guilty and vulnerable. He regretted having jury-rigged the pension fund numbers. He wished he had never pressured the auditors to overlook their concerns. If he could just go back in time by a few years, he would strike out on an independent path, even if that meant near-term corporate and personal sacrifices and even if it resulted in less capital raised, lower prices for the com- pany’s shares, disappointed employees, and reduced gains for share- holders. The long-term benefits of sanity, control, and self-respect would have made all of those issues look petty by comparison.
The final blow came when he found out, through his wife, that his daughter Linda and her husband had fallen on hard times.
They had invested $80,000 in UCBS stock and already lost 75 per- cent of their money, even before any more bad news came out.
They had invested another $80,000 in a supposedly “diversified”
portfolio of telecom stocks, including Global Crossing, Qwest, and WorldCom, with even more severe losses.
“Except for the house, Linda and Gabriel are virtually broke,”
his wife said, with a sour overtone that Johnston interpreted as a subtle accusation of complicity. “As usual,” she added, “they’re
The $17,000 Toilet Kit 51
refusing financial help. Maybe they’ll take the bare minimum for a college fund for the children. But not a penny more.”
Johnston broke down.
In the days and weeks that followed, the CEO of UCBS suf- fered through each and every one of the phases of a reforming alcoholic: A long struggle with denial, an even longer struggle to admit his own fault in ruining the financial lives of thousands of investors, and, finally, the most difficult step of all—gaining the peace of mind and courage to convert those emotions into mean- ingful action.
With a shaky hand at first, then with growing resolve, he sketched out a timeline to start the process of exorcising the demons that haunted him. He would make changes—drastic changes, not just cosmetic changes which the PR flacks could paste into press releases or plaster onto Business Wire. They’d be fundamental—in corporate structure, in strategies, and in culture.
He observed executives like Warren E. Buffett, who had long ago eliminated options from executive compensation packages. In New York City, he attended a meeting of the Commission on Public Trust and Private Enterprise. He sat in the back row as Buffett, former Fed Chairman Paul Volcker, and others proposed sweeping reforms for corporate America—proper disclosure of executive stock sales, uni- form treatment of stock options as expenses, shareholder approval before stock options are repriced, longer mandatory hold periods before executives can sell their own shares, and more.
He wanted desperately to join these business leaders, to be iden- tified by the media and the public as a leader in corporate reform.
Even more desperately, he wanted to avoid seeing his name in those damning headlines. As it turned out, it was nottoo late for Johnston to save his reputation. It wastoo late, however, to save UCBS.
Debts and Deflation
UCBS problems were not limited strictly to accounting issues.
Otherwise, the company would have made the adjustments, the shareholders would have driven the stock down by another 30 or 40 percent, and the crisis would have passed. But accounting issues were just the tip of the iceberg.
52 Crash Profits: Make Money When Stocks SinkandSoar
The primary problem was that UCBS was caught in a vise betweendebts coming dueanddeflation—falling prices for their primary products.
Had it been just the debts, maybe the company could have sur- vived anyhow. It would have paid off the debts with the cash flow from revenues. Plus, the company would have borrowed from Peter to pay Paul.
Had it been just the deflation—the falling sales and falling prices—UCBS might have been able to get by as well. It would have eliminated tens of thousands of jobs, sold off hundreds of sub- sidiaries and joint ventures, and even shrunk back to the small, one-plant manufacturing company where it all began.
But no. The two forces—debts and deflation—collided in one time and place. UCBS had close to $1 billion in accounts payable and commercial paper (short-term corporate IOUs) coming due before year-end. At the same time, the revenues it hoped to use to cover those debts had disappeared.
Indeed, the three primary industries that impacted UCBS’s largest divisions—PCs, telecom, and wireless—were all sinking like a rock.
Regarding the PC industry, Johnston read an Associated Press story on the Web about a Goldman Sachs survey. Goldman had surveyed 100 IT executives of Fortune 1000 companies, finding that more than half expected to underspendtheir already-slashed IT budgets. Only 8 percent were going to upgrade their companies’
computers, and 44 percent were postponing computer upgrades until the following year. Johnston sent the article in an e-mail to his VP of sales and asked for his feedback.
“No wonder our PC sales are falling apart!” the VP said later that day over lunch. “Here, look at these global sales figure we’re tracking! Look at this chart—down nonstop for five quarters in a row! Damn. Every time we think the PC market is about to hit bottom, it sinks again. No one wants to upgrade anymore. I can’t blame ’em. My own computer is already at least 10 times faster than I need it to be. What am I going to do with a computer that’s anotherten times faster than that? I need it like a hole in the head.”
Johnston, again playing dumb, sought to strike an upbeat note.
“You’re too negative. Look at the positive side. Look at . . .”
The VP of sales shrugged and laughed nervously. “Hah! You
TE AM FL Y
Team-Fly®
The $17,000 Toilet Kit 53
thinkI’mnegative. I’m going to quote Brian Gammage—the guy’s an analyst for Gartner Dataquest. Here’s what he says: ‘This is the worsening of a worsening result, the worst since the third quarter of last year, which was the nadir of a bad year.’ Tell me: Doesn’t that sound like he’s sitting right here in our PC division, talking about our business?”
“Let’s talk about our telecom division.”
“Oh no. Please don’t make me talk about the telecom division.
Must I? OK, if you insist. The fact is, the telecom sales folks would gladly change places with the PC sales people. Sure, the PC busi- ness may be falling into a valley, but the telecom business is getting sucked into a giant black hole of debt, overexpansion, and even fraud. You already know about the megabankruptcies at Global Crossing, WorldCom, and soon, possibly, Qwest. But did you know that at least 82 telecom firms filed for bankruptcy between 2000 and 2002? Did you realize that so much of the telecom indus- try is on the verge of financial collapse that it could paralyze key segments of the U.S. economy?”
“That bad?”
“Worse!”
“What about our cellular equipment subsidiary?” queried the CEO still playing dumb.
“The cellular industry is on a collision course with a five-car pileup on the freeway. The people running our cell division thought they were smart, spending billions on rights to the so- called Third Generation airwaves. The rights may be worth some- thing in a sci-fi movie or some future techno-era. But today, they’re one of the greatest white elephants in the history of mankind. Our wireless subsidiary spent a fortune—almost a quarter billion just for a small piece of the pie. You want to hear how much other compa- nies around the world spent on 3G rights? Yes? OK, here it goes:
Telecoms in Europe alone—$260 billion; in the U.S.—$1 trillion.
Total profits from these investments: zero. A big, fat, round zero.”
The CEO had heard these figures before from various other sources. “That’s why I encouraged them to focus back on ordinary low-speed cell phone business,” he said.
“Good move! But sales are drying up there too. There are just too many manufacturers pouring out too many different models at cutthroat prices. There are too many service providers, too many
54 Crash Profits: Make Money When Stocks SinkandSoar
overlapping networks, too many deals and bargains. It’s a classic case of a massive, worldwide glut! That’s why six of America’s nationwide service providers cut capital spending by more than 20 percent in the first quarter of 2002! That’s why Nokia and Ericsson are floundering. That’s why I’ve been telling you to dump that sub- sidiary before it’s too late.”
Johnston stared, stone-faced, at the VP for a few long seconds.
He wasn’t sure whether he should confess his innermost fears about the company, as he might with a shrink, or try to put up a solid defense, as he might when talking to Wall Street analysts. He decided to try a mix of the two. “Look, I admit we’ve made serious mistakes in the high-tech areas. I admit we didn’t stop and ask even the most basic questions: Does this company make money? Does this company have real, tangible assets? But that was part of the euphoria. Did we get caught up in it too? Yes, of course. Fortu- nately, however, we’re a broadly diversified company and . . .”
The VP interrupted, shaking his head. “I have just one ques- tion,” he said.
“Go ahead,” replied Johnston.
“They say the recession last year was short and mild, right?”
“Yes.”
“They say we’re in a recovery now, right?”
“Right.”
“Well, if we’re running into so much trouble—if almost everyone in our industry is running into so much trouble all over the world, even during a recovery—then can you tell me what is going to hap- pen to us if we fall back into just an average recession? Can you tell me what is going to befall us if, God forbid, we get a severe or long recession?”
The meeting ended, and Johnston was not sure what to do next.
He felt like an alcoholic trying to find the right moment to go to an AA meeting. But he finally took the first step.
He called the auditors, apologizing—to no one in particular—for any disdain he had expressed or implied in the previous meeting for the auditing process. Plus, he did something that he had never done before: He called in consultants and auditors to the same meeting at the same time. With everyone assembled, he requested a sweeping internal study of every possible accounting gray area: