Shades of Gray

The fine line between honesty and criminality in corporate America

Greg Farrell

• Reporter USA TODAY– Enron– Arthur Andersen– WorldCom– HealthSouth– Cendant

Character references

• Ken Lay

• Jeff Skilling

• Bernie Ebbers

• Richard Scrushy

• Walter Forbes

• Martha Stewart

Corporate Crooks

• Destruction of $200 billion

• Congress helped it happen– Penalized salaries over $1 million– Underfunded the SEC– Made it more difficult for investors to sue– Allowed auditors to act as consultants

Corporate Crooks II

• What is a crook?• Bad guys lie• Bad guys steal• Easy to recognize

Good guys?

• Successful• Innovative• Charismatic• Media stars• White House• Davos

What unites these men?

• Jeff Skilling, fraud at Enron

• Walter Forbes, fraud at Cendant

• Paul Bilzerian, securities fraud

• Alan Bond, investment fraud

Harvard Business School

White-collar crime

• It’s not “black or white”

• The world is gray

Statistical Ethics

• Normal distribution• Pure evil?• Unadulterated good?• Most in middle

Case studies

• Middle manager at WorldCom

• Senior manager at Enron

WorldCom

• Born during the breakup of AT&T

• Incremental growth (1984-1996)

• Stunning growth (1997-1999)

• Acquisition of MCI, $5 billion income

• Correlation with Internet bubble

Trouble in 2000

• CEO Bernie Ebbers’ stock

• Sinks from $1 billion to $500 million

• CFO Scott Sullivan’s millions

• Ebbers tells Sullivan to fix numbers.

Cooking WorldCom’s books

• Impossible for one• Sullivan recruits four• Conspiracy is born

Betty Vinson

• Careful bookkeeper• Married, one daughter• Family breadwinner• 1996 salary: $50,000• 2000 salary: $80,000

Sullivan’s scheme

• Reverse accrual accounts

• Appalled, but colleague convinces her

• Threatens to resign a few days later

• Conversation in Sullivan’s office

Sullivan’s scheme II

• Vinson comes around

• Sullivan’s stellar reputation

• Vinson’s salary tough to replace

• Finding a new job difficult, arduous

WorldCom’s slide gets worse

• $544 million shortfall• No more accruals

accounts to raid• Desperate tactics• Capitalize line costs

Vinson’s dilemma

• Knows that capitalization of line costs is wrong

• Resolves to put her resume together and seek new job

• Participates in conspiracy

• Does it for 3 more quarters

Meet the New Betty

• By 2002, an innocent no more

• She’s part of the conspiracy

• What happened to “resume,” “new job”?

• Rationalized each step

• Focused on loss of $80,000 job

• Never saw bigger threat ahead

Planet Enron

• Most elaborate fraud in US history

• Pervasive greed• Criminal company?

Brief history

• Natural gas pipeline (1985)

• At the mercy of gas prices

• 1990: creation of the “gas bank”

• Creation of new market

• Enron becomes leading innovator

Enron in the 1990s

• Total focus on stock price

• Attempts to duplicate “gas bank” strategy:– Deregulation of electricity markets– Enron Energy Services– Enron Broadband

Enron: 1998

• Trouble maintaining 15% growth rate

• Need to buy/sell assets at quarter’s end

• Problem finding third parties

Fastow to the rescue

• CFO forms partnership• No pesky “3rd party”• Buys lousy assets• No questions asked• Never loses money• Stole $30 million

Other tricks

• Disguised bank loans as “sales”

• Hid California profits in “cookie jar”

• Assigned bogus values to assets– $80,000 lemonade stand

Fraud at Enron

• Systemic

• Not just 3 or 4 people

• 16 guilty pleas

• 5 convictions

• 100 unindicted co-conspirators

Criminal trial of Lay, Skilling

• Government alleges massive conspiracy

• Lay, Skilling accused of lying to investors

• Parade of cooperating witnesses

Defense argument

• Enron was actually making money

• Implausibility of conspiracy

• Logic: someone would have objected

David Delainey

• Rising star• Named head of EES• EES losses worsen• Skilling’s solution• March 2001 meeting• EES losses hidden

Conspiracy

• No guns required

• Tacit support

• Difficult to resist

Whistleblowers

• Sherron Watkins• Special personality• Ostracized• Demeaned by defense• Lonely role

Conclusions

• Nobody intends to break the law

• Compliance techniques vary

• Rationalizations

• Are you willing to walk?