Swindlers R us: big business has tarnished its image in a very big way, from gold diggers to creative accountants. Chief executives and accountants have become less trusted even than politicians and journalists. (Corporate Scandals).

Confidence in the Canadian mining industry was hit hard in March 1997. That's when it was revealed that Bre-X Minerals Ltd. might have been making up stories about its vast gold discoveries. At the time, Bre-X founder David Walsh assured reporters that: "All work that we've done technically has been done appropriately, and ... we'll be exonerated and the property will stand as we've indicated ..." The company vice-chairman, John Felderhof, said he was "110% confident the gold is there."

Several market analysts were equally convinced that unimaginable amounts of gold filled the company's Busang deposit in Borneo, Indonesia. Surely, they said, there could be nothing to the rumours that the discovery was all a hoax. After all, they had been peddling the stock for a year and a half on the news that the deposit had anywhere from 30 million to 200 million ounces of gold (worth about $70 billion in 1997). The finest of engineering consultants had confirmed the find, which was described as the mother of all mother lodes.

And then, on 27 March 1997, the company sent out word that there was "a strong possibility" that estimates about the amount of gold discovered at the site "have been overstated." Shocked investors couldn't unload their stock fast enough and the price of shares plummeted. Together, in a matter of minutes, they lost about $3 billion when the company went bust. All that gold didn't just disappear. It was never there in the first place. The "find" had been based on false samples, and what would have been the biggest gold find of all time became the biggest gold scam in the history of mining anywhere in the world--a three-year, $6 billion fraud.

Just days before the company's fall, some analysts continued to advise their clients to buy more shares. As a Globe and Mail editorial put it, "... That the irregularities weren't enough to really shake (investor) enthusiasm speaks to the power of fairy tales ..."

The combination of gold and greed may not be too surprising, but who would ever have thought that so many executives and accountants could be so dishonest? Enter Enron Corp., the company where executives enriched themselves by tens of millions of dollars through questionable partnerships. In December 2001, it became the largest bankruptcy in U.S. history. The company stunned investors with the news that it had secretly kept more than $1 billion (U.S.) in debts off its books, hiding its crumbling financial condition. They were horrified to discover that, like Bre-X's gold, the company's financial statements were a piece of fiction. It was quite an achievement: the Houston-based company, which had controlled about one-quarter of the world's energy trading, wiped out the $60 billion (U.S.) that investors held in the firm. Once America's seventh-biggest company, Enron has the distinction of being the first blue-chip corporation of its size to be struck down by accounting fraud.

But, cooking the books isn't a new idea. Toronto Star writer David Olive says the current era of fuzzy accounting goes back to the 1980s when General Electric started "to master the art of 'managing' the income statement to meet Wall Street's demands for predictable results--a tactic that distorts actual performance." And, he adds, hundreds of large North American companies continue to reach their financial targets "through the artful use of timely acquisitions or divestitures (buying and selling of companies) and abrupt reductions or hikes in research and development and marketing budgets--devices for manipulating earnings per share that win CEOs a reputation for (brilliance)."

It's a trick that Mr. Olive says gives a huge boost to the stock market, and it "set the stage for the outrageous excesses of Enron."

It also set the stage for the demise of Arthur Andersen LLP, one of the world's largest accounting firms. To give investors confidence, all public companies are audited by outside accountants with reputations for honesty and integrity. These accountants examine a company's records and accounts at the end of each year. If the books look squeaky clean, the accountants sign off on them, saying they are a true picture of the company's financial activities.

Arthur Andersen LLP was one of the world's most prestigious accounting firms yet it brushed aside Enron's abuse of accounting standards. Employees at the accountant's Houston office later busied themselves destroying documents related to its Enron audit in the fall of 2001. It was reported that Andersen helped Enron create about 4,000 subsidiaries, affiliates, and partnerships, enabling the company to inflate its profits artificially, hide debt by keeping it off its own balance sheet, and avoid paying taxes for several years. In June 2002, after a five-week trial and 10 days of deliberation, a jury convicted Andersen of obstruction of justice, and two months later the company was no more.

The same month, telecommunications giant WorldCom Inc. was charged with fraud after revealing it had fiddled its books to the rune of $3.8 billion with magical accounting that turned losses into profits. The company's sales staff was also fudging the numbers resulting in millions of dollars of overpaid commissions.

Global Crossing, another telecom company, also went belly up after falsely boosting its revenues. The auditor for both these companies had been none other than Arthur Andersen. Together with Enron, they form the three biggest bankruptcies in recent corporate history in the U.S.

But, these firms have plenty of company. The massive and public swindling prompted regulators to start looking more closely at other businesses. About 250 American public companies suddenly decided to restate their accounts in 2002. This compares with only 92 in 1997, and three in 1981. (Between 1998 and 2002, more than 700 American companies were forced to restate their accounts.) The former chief accountant at the U.S. Securities and Exchange Commission (which is responsible for making public companies obey the rules) estimated in 2002 that in the previous six years U.S. investors lost $200 billion (U.S.) from profit restatements and audit failures (accounting irregularities). And, it's been calculated that the loss of confidence following the collapse of Enron and WorldCom will cost the U.S. economy $37 billion to $42 billion in reduced Gross Domestic Product.

Much of the corporate world is in disgrace. It all led U.S. Federal Reserve Board chairman Alan Greenspan to conclude in July 2002 that "an infectious greed seemed to grip much of our business community" in the late 1990s. "It's not that humans have become any more greedy than in generations past," he said. "It is that the avenues to express greed have grown so enormously."

As American companies fell, so did many in Canada. In 1998, accounting irregularities brought the Livent Inc. entertainment company down and left its two founders, Garth Drabinsky and Myron Gottlieb, charged with fraud. YBM Magnex International Inc., a magnet and bicycle maker, went into receivership over alleged ties with Russian organized crime and money laundering.

And, Europe has had its share of scandals too: Marconi, Vivendi, and ABB all have been mentioned in the same breath as accounting irregularities. According to a survey by PricewaterhouseCoopers, serious fraud affects 43% of major European companies, with more than 3.6 billion euro dollars lost between 1999 and 2001. The survey, conducted during the last four months of 2000, involved more than 3,400 interviews at 536 of the leading companies in 15 European countries.

Given all the scams, the results of a June 2002 poll conducted by GPC International aren't too surprising: Canada's largest public affairs and communications company, GPC found that a quarter of Canadians put little or no trust in the financial statements of public companies, and they don't trust chief executives or the financial media.

SUGGESTED ACTIVITIES:

1. Research the tulip bulb craze in Holland in the 17th century that left people bankrupt.

2. According to an article in The Economist in November 2002, Europeans have a very different attitude to bosses than Americans who "appoint a man to the top job and let him get on with it. Europeans are more cynical, believing that those chief executives who are not power-crazed when appointed will soon become so. Left too much to their own devices, such people are, they fear, as likely to run off with the business as to get on with it." Debate the idea that human nature is such that power ultimately will always lead to corruption, if there is no watchdog to stop it. Explore the conditions necessary for corruption, what makes some people greedier than others, and why the watchdogs work at enforcing appropriate behaviour rather than joining the crooks.

DEFINITION

Legerdemain (from the French: light of hand): sleight of hand, juggling; sophistry, or the use of false arguments meant to deceive.

FACT FILE

According to the February 2002 issue of Fortune magazine, five of the 10 largest bankruptcies in U.S. history occurred in 2001: Enron, more than $63 billion; Global Crossing, $25.5 billion; Pacific Gas & Electric, $21.5 billion; Kmart, $17 billion; and Finova Group, $14 billion, for a grand total of $141.4 billion; the previous five took five years to happen and added up to $120 billion.

At Enron, 29 top officers cashed out of the firm's stock at or near its peak price of $90.75 between 1999 and mid-2000, but the 4,000 Enron employees who lost their jobs with the company's bankruptcy filing in December 2001 also lost about $1 billion in their company pension plan.

"Off balance-sheet transactions and partnerships" are financial practices that hide the true nature of a company's financial results.

In April 2002, Xerox paid a $10 million fine to settle a case brought against it by the Securities and Exchange Commission: it was the largest fine ever paid by a public company for financial fraud. The company admitted to overstating its profits by $1.5 billion between 1997 and 2001.

Websites

Bre-X Story Archive--http://acmi.canoe.ca/MoneyBreXSaga/home.html

Canadian Coalition for Good

Governance--http://www.ccgg.ca/web/website.nsf/web/ccgghome

Corporate Ethics Management

Council--http://www.conferenceboard.ca/GCSR/networks/cem.asp

International Corporate Governance 

Network--http://www.icgn.org/

Investopedia--http://www.investopedia.com/default.asp

RELATED ARTICLE: Mr. Andersen would not be pleased.

In June 2002, Harper's Magazine, ran an excerpt from a eulogy at the January 1947 Evanston, Illinois, funeral of Arthur Andersen, founder of the now defunct Arthur Andersen & Co. It was said that, "Wherever the name Arthur Andersen & Co. is known, it is equivalent to integrity, honesty, and service." Mr. Andersen was described as a highly principled man who "could not be bought with money ... power, influence, prestige, or social position. And few, if any, were the people who could mislead him. He had the insight to see through subterfuge ... He believed in honesty ... not mere financial honesty, for that he took for granted.

"He believed in honesty of purpose and motive ... in truth ... in being straightforward ..."

And, to those who were left behind, the Reverend who delivered the eulogy said, "... Those principles upon which his business was built and with which it is synonymous must be preserved. His name must never be associated with any program or action that is not the highest and the best. I am sure he would rather the doors be closed than that it should continue to exist on principles other than those that he established ..."

RELATED ARTICLE: What's happening to the top brass?

According to one report, chief financial officers used to be qualified accountants, but now they tend to have Masters degrees in business administration, and that is a major shift: the idea is that accountancy training encourages respect for numbers, while an MBA breeds creativity.

So, in the 1990s, CFO's moved away from financial reporting to become strategic planners, overseeing mergers. They became involved in information technology, devising complex financial instruments, and managing relations with investors.