Q: What are some of the parallels with
Enron and the S&Ls?
A: One of the things that [Kenneth] Lay did was go to his chief regulator, the chairman of the Federal Energy Regulatory
Commission (FERC) that regulates pipe lines, and said, "if you want to be reappointed, I could be helpful to you. If you
modify your position." The second thing that Lay did was give a list of proposed regulators to Bush. The people currently
serving are from that list.
Arthur Andersen is a direct parallel. In fact Arthur Andersen, in the case of Lincoln [Savings and Loan] did worse things
than it did in Enron. What AA is getting in tremendous trouble for [now] is a cover-up after the fact, not from shareholders,
but from trying to escape liability itself.
In the Lincoln case, Keating's entire purchase of the S&L was
funded by Michael Milken of Drexel Burnham. And Michael did
what he commonly did, which was to overfund dramatically.
Keating needed $51 million to buy Lincoln Savings. Instead
Milken issued well over $100 million in Keating's parent company
bonds. Now this is a really, really heavily leveraged company.
Which is to say that Milken had Keating by the short hairs.
So Lincoln is soon buying more than a billion dollars in junk
bonds, overwhelmingly from Milken. But now they have a
problem, because a junk bond, as Milken used to be fond of
emphasizing, is really a corporate loan. So we have these little
things called rules which say that if you are going to make a loan
to somebody, you have to underwrite it first. You have to make
sure you are going to get paid back. But Keating has zero control
or input on this billion-dollar junk bond portfolio. He finds out at
the end of the day in a telex what he now owns. Milken just does
all the trades. You can see how useful this is to Milken in
manipulating junk bond prices, creating his record low default
rates that he always bragged about. So they have done no
underwriting, and they know that our examiners, the first thing
we look at is underwriting. So they go, "oh shit, we have a
problem."
Again like Enron, they hire Arthur Andersen in their consulting
role, then simultaneously as their auditor. They have a team of
folks in a big conference room who spend weeks creating phony
documents. It's more clever than backdating. Undated. This is in
some cases two years after they bought the junk bonds. When
they do the undated stuff, they make sure that they only have information in there up to the date the investment was
actually made. So the intent is obviously to make it look like they were contemporaneous underwriting documents, but
without ever dating them, and creating an express falsehood. They did that to at least hundreds of files.
Then you have the special partnerships. Keating used the special partnerships as a way to get money to his family from the
S&L. Keating even had an [Andrew] Fastow like character.
...
Q: Where is the line between creative
accounting and fraud?
A: What we seem unwilling in our business culture to admit is that it became fraud a long time ago in a broad range of
businesses. Let me give you an example. I live near Silicon valley. It is very common in the high-tech companies to sell
merchandise on December 31 and have it returned two days later. Typically it's software. You sell it to someone who
understands the game, and they have a complete right to return it. You book the gain in the current fiscal year, do your
financial reports with that gain, and it makes your statement look really good. And that is known as "window dressing."
Window dressing is fairly pervasive. Managing earnings is incredibly pervasive. They teach it in business school. You
want to smooth earnings, so you manage them. Let's book this gain, but not book that gain until the next month. Then it will
be more steady and investors will like that and such. All of those things are actually fraudulent practices. You are not
following appropriate rules. You are doing so to mislead the investor. But we don't treat it as if it is illegal.
The rules actually say it is securities fraud to deliberately not follow generally accepted accounting principles (GAAP). If
they deliberately don't follow GAAP, under SEC rules, that's fraud. But nobody believes the SEC is going to bring that
action unless you have also done other bad things, in which case they may add in a charge. And so those practices become
not universal, but pervasive. And in my criminology ethics hat, that is a very bad thing, because that's an erosion. And if we
can justify that, then it's not that much greater a step to lay on this phony partnership and this phony deal because we
really think there is value down the line in the investment. You can see this whole rationalization practice. People do that,
and it gets easier, I think, because the SEC allows it.
I don't know if you ever heard of Stanley Sporkin. Sporkin was the SEC enforcement head back maybe 30 years ago. He
was the guy who was just hell on wheels about evil conduct. When I was a lawyer at my big law firm, Sporkin was really
useful with clients because you could say, "It's wrong to do it. If you do it, you know what Stanley Sporkin is like. You may
end up on the front page of the Washington Post." We haven't had a Stanley Sporkin for a long time.
Q: How prevalent do you think fraud
truly is in American business?
A: I don't think control fraud is frequent in the Fortune 500. But I think we now know that it was not remotely an unheard
of thing. Some of the biggest companies in America were at root financial frauds. Enron's strategic plan was to engage in
fraud, which is basically what the Powers' report shows. As soon as you make it clear that it is fine to scam the
numbers-not only fine, but the central business strategy-what kind of message are you sending? We now have several
other major firms and charities where that has also proven true. And we have seen all of those folks get clean opinions
from big five audit firms, which is really scary.
More generally, people are starting to figure out that having something like the high-tech bubble is really bad for the
American economy. When you allow values to get way out of whack with the fundamentals, it's not just money moving
around, you can screw up your economy big time. I have some hope that the collapse of our tech bubble, which was one of
the largest bubbles in the history of the world, has also scared some folks into thinking that maybe this isn't such a clever
way of doing it. Unfortunately, the attitude was "The rules are silly" and "Aren't we so clever." And that combination
produces a lot of the worst disasters.
...
Q: How do the scandals of today measure up to the S&L scandal?
A: You want my pessimistic way of approaching it? If Keating and Milken didn't have the small problem of both having
confessed to felonies, they would have made Enron look trivial. The key problem that Keating and Milken had was that
they found it very difficult to raise equity. Think of what Keating could have done during the greatest stock boom in the
history of the world, where you could have no product at all, and it could be worth billions the next day in an IPO. If Milken
had still been at the helm during this incredible boom, think what he would have done in leveraged buyouts. It's staggering.
Lay actually got started in part through Milken back in the old days. If the master had been available during this time
period, we might be in recession now.
...
Q: Is there a possibility that fraudulent accounting practices could catch up with more companies?
A: Oh yeah. The recession and the collapse of the high-tech bubble act like a stress test. There is no doubt that there are
pretty broad-scale games in accounting, and there are a lot of products that didn't make a whole lot of sense or never came
through. The only way typically to hide it is to grow a whole lot more-and with the current economy, the money isn't even
remotely coming in the same way. It will catch up to them because when you lie, you eventually do end up getting caught
once it collapses.
