1. Corporate Scandals and their Macroeconomic Impact Jeff Miller 4/27/2005

2. Corporate Scandals and Their Macroeconomic Impact History of Corporate Scandals History of Corporate Scandals Reaction: Citizens, Investors, Government Reaction: Citizens, Investors, Government Macroeconomic Effect Macroeconomic Effect

3. Corporate scandals are not new Early 1900’s:Charles Ponzi Early 1900’s:Charles Ponzi Ivar Krueger 1920’s: Samuel Insull 1920’s: Samuel Insull 1940’s:Richard Whitney 1940’s:Richard Whitney 1960’s:GE, Westinghouse 1960’s:GE, Westinghouse 1970’s: Investors Overseas Services 1970’s: Investors Overseas Services Robert Vesco

4. Corporate scandals are not new 1980’s Ivan BoeskyInsider Trading $100 million – 3 years Michael MilkenSecurities Fraud 10 years Charles KeatingSavings & Loans Investors lost $200 million Source: A Century of Greed, Scams, Scandals and Swindles - A Look at the Seamy Side of 20 th Century Wealth cnn.com

5. Enron February 2000 Fortune magazine chooses Enron as it’s “Best Managed and Most Innovative company” Most Innovative for five years in a row

6. Enron February 2000: Fortune Magazine #1 – Quality of Management #2 – Employee Talent Source: Enron Corporation Press Release

7. Enron August 2000: Stock at $73 billion August 2000: Stock at $73 billion March 2001: FY2000 revenues at March 2001: FY2000 revenues at $100 billion Sep 16, 2001: “Buy more shares” Sep 16, 2001: “Buy more shares” October 2001: Enron pays its October 2001: Enron pays its regular dividend regular dividend

8. Enron October 16, 2001 October 16, 2001 $618 million 3 rd Qtr Loss $1.2 billion reduction in shareholder equity October 31, 2001 October 31, 2001 SEC upgrades inquiry into a formal investigation

9. Enron December 2, 2001 December 2, 2001 Enron files for bankruptcy 4,000 employees fired 20,000 workers lose their jobs 20,000 workers lose their jobs $73 billion in stock value - gone $73 billion in stock value - gone

10. Enron – What Happened? $3 billion from pipelines $3 billion from pipelines Energy producer Energy producer to an energy trader to an energy “bank” Maze of partnerships Maze of partnerships Derivatives Derivatives

11. Enron – What Happened? “Enron apparently, with the approval or advice of its accountants, auditors and lawyers, used thousands of off-the-book entities to overstate corporate profits, understate corporate debts, and inflate Enron’s stock price.” Source: Corporate and Criminal Fraud and Accountability Act of 2002

12. Enron – What Happened? Most Innovative

13. Enron Enron Corporation CorporateSocialResponsibilityReport

14. WorldCom $3.9 billion in expenses hidden $3.9 billion in expenses hidden $3.3 billion in accounting $3.3 billion in accounting irregularities irregularities 17,000 jobs lost 17,000 jobs lost Company applied for bankruptcy Company applied for bankruptcy Market value of $100 billion Market value of $100 billion

15. Tyco Tax evasion Tax evasion Evidence tampering Evidence tampering 1500 jobs lost 1500 jobs lost Additional 4,500 laid off Additional 4,500 laid off Down $86 billion in one year Down $86 billion in one year from peak share price from peak share price

16. Global Crossing Ghost transactions Ghost transactions 2000 jobs lost 2000 jobs lost Down $40 billion in a few months Down $40 billion in a few months

17. Adelphia Questionable loans Questionable loans Loss of $6.5 billion in market value Loss of $6.5 billion in market value in one year Company in bankruptcy Company in bankruptcy

18. Wall Street Analysts Investment Banking Firms Biased research Biased research 10 firms fined $1.4 billion by SEC 10 firms fined $1.4 billion by SEC Citigroup Salomon Smith Barney Credit Suisse Group’s CSFB Merrill Lynch & Co. Goldman Sachs Group Morgan Stanley Source: Regulators Finalize $1.4 Billion Settlement Against Wall St. Firms - PBS Newshour

19. Mutual Funds Market Timing Buying or selling of mutual fund shares in order to exploit inefficiencies in mutual fund pricing practices

20. Insurance Companies March & McLennan March & McLennan Largest Insurance broker Soliciting rigged bids for insurance contracts Will pay $850 million AON Corporation AON Corporation Second largest Insurance broker Fraud and anti-competitive practices Will pay $190 million Source: “Classic Financial and Corporate Scandals” website

21. Fannie Mae - Mortgages Improper accounting methods Improper accounting methods KMPG would not stipulate that reporting was accurate KMPG would not stipulate that reporting was accurate Reported a $9 billion loss Reported a $9 billion loss

22. NYSE Pay scandal involving former exec Richard Grasso - $188 million Pay scandal involving former exec Richard Grasso - $188 million Traders executing their own trades in advance of customer orders Traders executing their own trades in advance of customer orders Investors deprived of at least $32 million Investors deprived of at least $32 million Source: Washington Post – Fifteen NYSE Traders Indicted – 4/13/2005

23. KMPG $22.5 million settlement with SEC $22.5 million settlement with SEC Avoids trial next year on charges that KMPG willfully ignored warning signs related to Xerox’s accounting maneuvers Avoids trial next year on charges that KMPG willfully ignored warning signs related to Xerox’s accounting maneuvers Largest accounting firm settlement in history Largest accounting firm settlement in history "This is a fairly egregious fraud on the part of Xerox, and KPMG didn't live up to its role as gatekeeper," said Paul Berger, associate director of enforcement at the SEC. "This is a fairly egregious fraud on the part of Xerox, and KPMG didn't live up to its role as gatekeeper," said Paul Berger, associate director of enforcement at the SEC. Source: USA Today – KPMG to pay $22.5M to settle Xerox questions– 4/19/2005

24. Widespread Moral Deficit “Accountants held no one to account, governments abandoned their regulatory functions, the media turned cheaters into stars, and a culture of self-righteous mendacity was allowed to flourish as long as the stock prices were high.” Source: Those You Love to Hate – A Look at the Mighty Laid Low – NYT 4/22/2005

25. Reaction to the Scandals Edvard Munch, The Scream, 1893

26. Enron Wasn’t Just Enron Enron Corporation Enron Corporation Arthur Andersen Arthur Andersen Enron’s Law firm Enron’s Law firm Investment bankers Investment bankers Countries with Enron operations Countries with Enron operations Argentina, Mozambique, India, Poland Companies in other countries Companies in other countries Shell, BP, Mobil, Total Source: Ethics in Organizations – Learning From Enron

27. Enron Wasn’t Just Enron “Among other states’ pensions affected by Enron’s bankruptcy were California’s Public Employees’ Retirement System, which lost $195 million, and the Ohio Public Employees Retirement System and State Teachers Retirement System, which lost about $127 million.” Source: Texas Retirement System – Slight Loss From Enron Investments

28. Loss of Confidence Companies Companies Auditors Auditors Boards of Directors Boards of Directors Credit-raters Credit-raters FERC – Federal Energy Regulatory Commission FERC – Federal Energy Regulatory Commission Wall Street Analysts and Underwriters Wall Street Analysts and Underwriters

29. The Stock Market Speaks Source: SmartMoney.com DJIA 1/1/2002 – 12/31/2002 modified by jam

30. Indictments Kenneth Lay, Jeffrey Skilling, Andrew Fastow – Enron Kenneth Lay, Jeffrey Skilling, Andrew Fastow – Enron Bernard Ebbers – WorldCom Bernard Ebbers – WorldCom Dennis Koslowski – Tyco Dennis Koslowski – Tyco Samuel Waksal – Imclone Samuel Waksal – Imclone John Rigas – Adelphia John Rigas – Adelphia Martha Stewart Martha Stewart

31. Creation of New laws Sarbanes-Oxley Act CEO’s CFO’s certify accuracy CEO’s CFO’s certify accuracy Fines up to $1 million/10 years Fines up to $1 million/10 years No personal loans to executives No personal loans to executives Auditing procedures, incl. rotation Auditing procedures, incl. rotation Whisteblower protection Whisteblower protection Attorneys must report violations Attorneys must report violations Source: “Sarbanes-Oxley Explained” website American Institute of Certified Public Accountants

32. Macroeconomic Impact Estimates of the Cost of the Scandals Recognizing:  DotCom bubble  September 11  Economic Cycle  President Bush’s Tax Cut  Other Policies

33. Estimates of the Costs New York economy lost $2.9 billion New York economy lost $2.9 billion New York State revenues decreased by $1 billion in FY 2002-2003 New York State revenues decreased by $1 billion in FY 2002-2003 Losses for local governments Losses for local governments $260 million loss to New York City $260 million loss to New York City Source: Impact of the Corporate Scandals on New York State - Office of the New York State Comptroller

34. Estimates of the Costs National economy reduced National economy reduced by $35 billion in first year by $35 billion in first year GDP:.34 percent reduction GDP:.34 percent reduction Unemployment Unemployment Source: Cooking the Books: The Cost to the Economy - The Brookings Institution

35. Estimates of the Costs Consumer Spending Consumer Spending Investment Investment Interest rates Interest rates Source: Cooking the Books: The Cost to the Economy - The Brookings Institution

36. Stock Market Dow Jones: 27% drop Standard & Poor 500: 28% drop Chart: Yahoo Finance

37. Stock Market 50% of households own stock today as compared to 37% in 1992 50% of households own stock today as compared to 37% in 1992 21% of retirement funds are invested in mutual funds today as compared to 5% in 1990 21% of retirement funds are invested in mutual funds today as compared to 5% in 1990 44% of 401(k) funds are invested in mutual funds today as compared to 9% in 1990 44% of 401(k) funds are invested in mutual funds today as compared to 9% in 1990 Source: Cooking the Books: The Cost to the Economy - The Brookings Institution

38. The Dollar “The dollar fell below parity with the Euro, for the first time since the currency was issued, amidst increasing skepticism among foreign investors about U.S. markets.”

39. The Dollar Let’s have more scandal!!!!

40. Foreign Investors/Companies Less inclined to hold stock Less inclined to hold stock Could cause a decline in value of $ Could cause a decline in value of $ Foreign markets also declined by 28% in April – July 2002 period Foreign markets also declined by 28% in April – July 2002 period Source: As Wall Street Goes, So Go World Markets – Christian Science Monitor – 7/24/2002

41. Cost of Compliance Estimates that spending on Sarbanes-Oxley will reach $5.8 billion in 2005 Source: AMR Research

42. Does the Economy Shift? Real Goods to Financial Assets: Yes, in the short run Yes, in the short run These financial assets have disappeared These financial assets have disappeared

43. A Warning “I see in the near future a crisis approaching that unnerves me and causes me to tremble for the safety of my country. As a result of the war, corporations have been enthroned, and an era of corruption in high places will follow, and the money power of the country will endeavor to prolong its reign by working on the prejudices of the people until all wealth is aggregated in a few hands, and the Republic is destroyed. I feel at this moment more anxiety for the safety of my country than ever before, even in the midst of war.” --- Abraham Lincoln, 1864 Source: Lincoln, Abraham. The Lincoln Encyclopedia - The Spoken and Written Words of A. Lincoln

44. A Considerable Effect Stock Market Stock Market Public Confidence Public Confidence Cost of Compliance Cost of Compliance Foreign Investors/Companies Foreign Investors/Companies Until such time as we effectively address these problems, our economy will continue to be vulnerable

45. A Proposal The Death Penalty For Corporations

46. A Proposal If we are going to consider the corporation to be a person and afford it the same kinds of rights and freedoms that are extended to the individual, perhaps it is time to revise the methods by which we hold the corporate "person" accountable. We should impose the same kind of punishments that we have established for individuals. If a corporation is convicted in the courts for a violation of law, we should curtail its freedom to conduct business for a period of time. In the event of repeat offenses, the penalties should be increased. In those instances where a corporation severely violates the public trust, it should cease to exist. The corporate charter should be revoked, the assets seized and the corporation dissolved.

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49. © 2005 Jeffrey A. Miller Corporate Scandals and their Macroeconomic Impact Jeff Miller 4/27/2005