What's causing all these business scandals?

What's causing all these business scandals?

What's causing all these business scandals?

Moneybox
Commentary about business and finance.
March 25 2002 12:36 PM

The Rise of Business Scandals

Just two years ago, a typical business story told you that two companies you'd dimly heard of were merging and were now worth billions. Today, the same story is likely to tell you that a company you've dimly heard of has been accused of a financial rip-off. The business press these days is so laden with scandal and crime stories that a casual reader might think she's reading the tabloids. The stock market boom may be over, but the business scandal boom is on.

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For the first time in American history, an accounting firm (Arthur Andersen LLP) has been criminally indicted. Telecom companies like Global Crossing and Qwest have been subpoenaed for legerdemain of the ledger. Nor is the current reign of scandal limited to New Agey companies like Enron and high-tech firms. Last week the Federal Trade Commission ordered a California-based mortgage company to pay as much as $60 million back to homeowners, by far the largest settlement against a company involved in "predatory lending" practices. Today's Wall Street Journal contains yet another story about fiscal errors committed by the pump-making company Hanover Compressor, which has been forced to revise its earnings for seven quarters.

My favorite of the current scandals led the Securities and Exchange Commission last week to suspend trading of a stock on the New York Stock Exchange for the first time in more than a quarter century. Acting on concerns raised by TheStreet.com's Herb Greenberg and others, the SEC halted trading on a company called ACLN, described in a news story as "a Belgium-based, Cyprus-incorporated company that sells European used cars in Africa." (Raising the question: What the hell was the stock of this dodgy-sounding firm doing at $50 a share on the Big Board just a few months ago?) Among other irregularities, the company failed to disclose an outstanding Tunisian arrest warrant for its managing director, who was also reportedly doing business under an assumed name.

Have authorities suddenly begun cracking down on financial malpractice? Or is the press, shamed at failing to detect the Enron debacle, now giving more play to scandal stories?

There's little doubt that media attention has increased, and for good reason. Many financial journalists get their juiciest stories about corporate malfeasance from short-sellers, investors who've bet that the price of a given stock will go down, and who thus have an interest in circulating scandalous tales. In the exploding stock climate of the mid- to late '90s, short-sellers were a lonely breed, driven to bitterness by the markets' apparent indifference to fiscal fudging. But the drooping markets of the last two years have created more short-sellers and endowed them with greater power.

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A related factor is the politics of business scandal. Because corporations wield so much political power in America, it's inevitable that business scandals will overflow into the political arena. This is especially the case when government policy has boosted the scandalized company, as true of Enron as it was during the Teapot Dome scandal during the Harding administration. If there's political gain to be made from tarring an incumbent with a business scandal, you can bet the opposition party will become a scandal-monger.

This explains the intriguing story in Sunday's New York Times about Exelon, the nation's largest producer of nuclear power, which managed to get one of its dubious-sounding technologies plugged in the Bush administration's energy policy paper—a development of course unrelated to its meetings with Dick Cheney, et al., and the hundreds of thousands of dollars it donated to the GOP. Not to take anything away from the Times, but this story shares fundamental assumptions with a report issued last week by the office of Rep. Henry Waxman, charging that no fewer than 65 specific suggestions of the White House energy plan will benefit Republican donors (you can download the report  here). So long as Enron potentially enrages voters, the Democrats are our national short-sellers.

There's a broader argument that the reign of scandal is a natural, final phase of the business cycle, a predictable late-life crisis in an economy driven by a boom sector. Whether the sector is aerospace in the '60s, health care in the '80s, or the Internet in the '90s, the same milestones exist. In the beginning, the technology or service is largely in the hands of government. Then, as the market opens up to private business, huge amounts of money are invested, creating a boom. This is followed by a period of consolidation and then a crash. The last stage is scandal.

The fact is that the line between ordinary business practice and potentially scandalous behavior is not as clear as an ethicist might wish. One saw this especially among the dot-com startups: Nearly every entrepreneur boasted of an investment that hadn't quite cleared the bank yet, or promised that a technology is totally reliable, despite a lack of testing. The pressure to produce a return for impatient investors is simply too great for some, and being giddily optimistic about one's company can easily spill over into being not entirely truthful with numbers.

And as the Global Crossing and Qwest scandals have shown, the tangled rules of accounting sometimes encourage companies to make decisions—like the swapping of fiber-network capacity—designed more to massage numbers than to advance any business purpose. In boom times, nearly everyone from bankers to accountants and even journalists has an incentive to look the other way or conceal. Assuming the market keeps rewarding a company, a little bit of chicanery can be reduced to a footnote (literally, in the case of Enron).

But at the end of the business cycle, the same act can become fraud. When investment capital becomes scarce, the possibilities for a sale or merger disappear dramatically, and thus dirty laundry becomes harder to wash.

Will scandal values stay with us during a recovery (which may now already be in progress)? It'd be nice to think that Enron will bring about a much-needed reform of accounting rules. But I suspect that celebration of American business is just as central to the economy's rise as scandal is to its fall.