Corporate Fraud

On October 16, 2001, Enron, the seventh largest corporation in the U.S., announced a $638 million loss in third-quarter earnings. On November 8, 2001, the company publicly admitted to having overstated earnings for four years by $586 million and to having created limited partnerships to hide $3 billion in debt. As investors lost confidence in the company, Enron stock, which had been worth as much as $90 per share in 2000, plummeted to less than $1 per share. Thousands of Enron employees lost their jobs and retirement savings, which had been invested in corporate stock through a 401(k) retirement plan. Banks and lenders lost millions of dollars in loans made to Enron based on the fraudulent earnings reports.

Enron Corporation started as a pipeline company in Houston, Texas, that delivered gas at market price. Over the next 15 years, Enron expanded into an energy power broker that traded electricity and other commodities, such as water and broadband INTERNET services. Enron became one of the nation's most successful companies, employing 21,000 people in more than 40 countries. The senior executives at Enron attributed their success to their corporate strategy, which was to be light in assets but heavy in innovation.

The innovative business practices of overstating profits and concealing debt increased the company's stock value, thus allowing the company to borrow more money and to expand. It also led to some top executives selling their stock and making over one billion dollars. Those former executives were later indicted for FRAUD, MONEY LAUNDERING, and conspiracy, and they also face dozens of civil lawsuits filed by PENSION funds and former employees. The company's accounting firm, Arthur Andersen, admitted to having shredded Enron documents after it had learned that the SECURITIES AND EXCHANGE COMMISSION (SEC) was conducting an investigation of the corporation. The accounting firm was convicted of OBSTRUCTION OF JUSTICE, lost hundreds of clients and employees, and went out of business.

After the Enron scandal became public knowledge, many wondered how such an overstatement could have escaped notice. What the public soon would learn was that Enron was only one among many such stories.

In March 2002, the world learned that WorldCom, the second largest long-distance phone company in the U.S., had overstated profits by listing $3.8 billion in normal operating expenses (which were basically routine maintenance costs) as capital expenses. This move allowed them to spread the expenses out over several years, thereby making profits look much larger and artificially inflating the company's value in order to meet Wall Street's expected earnings. WorldCom stock, which was valued as high as $60 per share in 1999, dropped to 20 cents per share in response to the news. Seventeen thousand WorldCom employees lost their jobs. The JUSTICE DEPARTMENT has secured indictments against the former Chief Financial Officer, Richard Breeden, for bank fraud, SECURITIES fraud, conspiracy and false statements in SEC filings. Four other former WorldCom executives have pled guilty to securities fraud and agreed to cooperate with the prosecution. The SEC has filed a civil suit against the company. As of 2003, the SEC has uncovered over $9 billion in bogus accounting. In July 2002, WorldCom filed the world's largest BANKRUPTCY.

After Enron's and WorldCom's fraudulent accounting practices became public knowledge, news of more corporate accounting scandals came flooding in. In February 2002, Global Crossing was caught inflating revenue and shredding documents that contained accounting information. In April 2002, Adelphia Communications made headlines amidst the discovery that $3.1 billion worth of secret loans had been made to the company's founding family—some of whom were later arrested—and earnings were overstated. In May 2002, Tyco International, Ltd. accused three former senior executives of having fraudulently taken out loans from the company without permission and without paying them back. The men also allegedly issued bonuses to themselves and other employees without approval from the company's board of directors. The SEC has since charged the three for fraud and theft and is investigating whether the company had knowledge of this conduct. In July 2002, it was revealed that AOL Time Warner had inflated sales figures. Amid further investigations, the company admitted to having possibly overstated revenue by $49 million. Other companies in the spotlight for corporate accounting scandal allegations include Bristol-Myers Squibb, Kmart, Qwest Communications International, and Xerox. In addition to corporate scandal, television personality and home decorating maven Martha Stewart was indicted for allegedly selling 3,928 shares of stock in ImClone Systems, thus making about $227,824, based on an insider trading tip that she had received from the company's founder, Samuel Waksal.

Many fraudulent accounting practices came about over the past decade when energy, telecommunication, and other industries were expanding rapidly, and competition was especially fierce. The STOCK MARKET indices were reaching all-time records, and investors were looking for short-term earnings targets. Many corporate executives did whatever was necessary to meet the quarterly expectations of the analysts on Wall Street, thereby increasing the price of their stock. This often allowed their companies to borrow more money to grow and compete. Since most top executives also enjoyed stock options that rose in value with their companies' stock prices, they had the added incentive of making significant profits by selling their stocks at the higher prices. This resulted in a considerable transfer of money from individual shareholders to corporate managers. However, the individual investors were still making profits and therefore not paying attention to conflicts of interest and fraudulent practices, thus allowing the executives to go almost unchecked in their actions.

Since the collapse of Enron and WorldCom, some corrective actions have been taken. The New York Stock Exchange has made improvements in its accounting, auditing, and corporate governance rules for corporations that want to list their stock on the exchange. Congress approved the SARBANES-OXLEY ACT, Pub.L.No. 107-204, 116 Stat. 745, which created the Public Accounting Oversight Board to monitor public accountants, made changes in auditing rules, and authorized an increase in criminal penalties for more WHITE-COLLAR CRIMES. The declining economy and bear market has also changed the attitude of corporate managers who had to downsize and apply more caution in making new investments and deciding executive salaries and bonuses. Most importantly, corporate employees and individual investors are paying more attention to the actions of the executives who control their investments.