A Summary of the Major Business Scandals in American History

19th Century (and before) Scandals Company/ Scandal Present at the Revolut ion The birth of Tamma ny Hall as a political machine Early banking The stock market Period 1780s Description Smuggling and bribery were standard business practices; paper currency and note speculation common; the first American banks, land speculation (note that Robert Morris, the first Superintendent of Finance, landed in debtors prison for land speculation). William Mooney was the first Grand Sachem. Aaron Burr turned Tammany into a political machine for the 1800 election (he was elected vice president). Tammany would later emerge as the New York City political machine for the Democratic Party, relying on ward bosses to bring in the vote, especially from the influx of immigrants, and provide patronage. Banks printed paper money. Daniel Drew, Jay Gould and Jim Fisk could be considered the original Robber Barons. They manipulated stocks, caused bear runs to collapse stock prices and cornered markets. They could get control of companies, pilfer them internally, and then sell out at inflated prices. They spent no time in jail, partly from bribing judges and politicians, but mainly because there were few laws dealing with corporations and markets that could be broken.

Started in 1789

Early 19th century Mid19th century

Munitions Manuf acturer s Tax cheating

1861

1860s and beyond 1860s & beyond

John D. Rocke feller and the rise of big busine ss

Credit Mobilier

186272

Raiding the Erie

1868

Cornering Gold

1869

Northern munitions manufacturers sold vast quantities of munitions to the Confederacy before war was declared. In addition to lack of patriotism, this was shortsighted since the Confederate military or companies paid on creditwhich was uncollected. They would fleece the Union military after that. A multitude of tax evasion schemes sprang up as new taxes were instituted to pay for the Civil War, from income tax (relatively easy to avoid), to stamp taxes (counterfeit stamps were issued), to various excise taxes (there were schemes large and small to evade liquor and tobacco taxes). Rockefeller obtained secret rebates from the competing railroads to transport his refined oil to markets from Cleveland. With the lowest production & transportation costs, Rockefeller forced all competitors to combine with his (for cash or stock) at his rates or face ruin through cutthroat competition. Standard Oil became a trust and eventually had a virtual monopoly on the oil industry. Other industries followed Rockefellers lead. He is viewed today either as one of the great entrepreneurs in American or as a ruthless Robber Baron (or both). In any case, he became the richest man in America. There were many successful entrepreneurs both before and after Rockefeller including Cornelius Vanderbilt and Andrew Carnegie. The Central Pacific and the Union Pacific were awarded lucrative contracts to build a railroad line that connected all the way to California. Credit Mobilier was contracted to build the line for the Union Pacific. It was actually a front for the Union Pacific promoters & they enormously overcharged the railroad for construction costs. Congressional investigations in 1872 demonstrated that huge payments in cash & stock to politicians led to federal legislation generous in land grants and government loans (at $16,000-$48,000 per mile of track). Commodore Vanderbilt, after an illustrious career in shipping, decided late in life to go into railroading & acquired the New York Central. He went after the Erie Railroad, a close competitor in the state then controlled by Daniel Drew (plus fellow conspirators Jay Gould & Jim Fisk). Vanderbilt wanted monopoly power. When Vanderbilt tried to corner the market in Erie stock, Drew issued massive amounts of new securities (possibly illegally). Vanderbilt ultimately surrendered and reached an accommodation with Drew. They would loot the railroad, which collapsed in 1873. Jay Gould and Jim Fisk attempted to corner the gold market; Treasury Secretary George Boutwell released gold from the federal stock, foiling their plans. After that, Gould bribed judges to void contracts he broke. 2

Tammany Hall

PostCivil War

Northern Pacific

1890s

Great Corporate Merger Movement

18971903

William (Boss)Tweed headed Tammany Hall, the corrupt Democratic machine that ran much of New York City. Corruption and bribery existed on such a vast scale that Tweed was eventually tried and convicted of bribery and was one of the few corrupt politicians that actually died in jail. He was made particularly infamous thanks to the Thomas Nast cartoons. The two most powerful financial groups in the nation fought for the Northern Pacific Railroad (and thus domination of transportation in mid-America): J.P. Morgan & James Hill versus Edward Harriman and Standard Oil money. It ended in a draw and they colluded to dominate railroad rates across the nation. By 1900 virtually all railroads were organized into six trust systems controlled by Morgan and other New York bankers. Teddy Roosevelt established his trust-busting credentials by breaking up the Northern Pacific Trust, which was held up by the Supreme Courta small victory for the government regulation of monopolies. Promoted by J.P. Morgan and others, giant corporations were created by acquisitions of major competitors in dozens of industries. U.S. Steel was established with the acquisition of Carnegie Steel and most competitors as the first billion dollar corporation in 1902. Considered a scandal at the time for creating monopolies and stock watering (where the stock was valued at greater than par value); presumably, the promoters (and the acquired companies) were pocketing the difference.

20th Century Scandals, to 1990 Company The Stock Market Food and Drugs Description State law attempts to regulate the New York Stock Exchange and other markets were not particularly effective and market manipulation, lack of disclosure, and general corruption continued to be rampant. 1906 The filth and labor conditions were intolerable (as described in Upton Sinclairs The Jungle. Congress passed the Meat Inspection Act in 1906. Drugs also were unregulated and often contained opium and related products. Congress also passed the Pure Food and Drug Act in the same year. 1907 [possibly include the panics that seemed to occur about every 20 years]. J.P. Morgan bailout plus later Congressional hearings and reform legislation. 1911 Rockefellers Standard Oil became one of the first giant industrial firms & held a monopoly position; sued for antitrust violations & convicted by the Supreme Courtbroken up into separate oil companies primarily geographically, most of which were highly successful & are still around. 1920s Oilman Jake Hamon essentially bought the nomination of Warren G. Harding for the presidency with a million dollars. The payoff was supposed to be Secretary of the Interior where he would lease oil properties at Teapot Dome and similar sites in California for large bribes. He was killed by his mistress before Harding took office, but the plan went forward, involving additional corrupt oilmen and politicians. The fall guy proved to be Albert Fall as Secretary of the Interior, who actually carried out the leases (and accepted bribes). Oilman Harry Sinclair and others involved generally were acquitted. Befor Insider trading was common and not illegal. "Preferred list" e 1930 sales of new securities at discount prices before the public issues were the norm. Stock pools existed, syndicates established by investment bankers and brokers to manipulate stock price. Before the Great Depression, prices of at least 100 stocks were openly rigged. Information was considered a private matter, which allowed companies to manipulate, misrepresent and conceal information. 1929 By the summer of 1929 the economy was in recession, with industrial production peaking in June. Stock prices continued to new highs and the Great Bull Market continued into September. The first panic occurred on October 24, Black Thursday. Prices continued down: from a peak of 386 the Dow tumbled to 41 in 1933. The market had no credibility 4 Year 1900

Panic of 1907 Standard Oil

Teapot Dome

NYSE

The Crash

Krueger & Toll

1920s & 30s

Samuel Insull

1920s

McKesson & Robbins

1937

Penn Central

1970

LTV

1970s

Equity Funding

1972

ZZZZ Best

1980s

with the public. From 1929 to 1932 11,000 banks failed, gross national product (GNP) declined ten percent annually, steel production fell to 12% of capacity, and unemployment hit 25%. Ivar Krueger refused to disclose financial information. It was discovered that this was a bankrupt company. Interest and dividend payments were paid regularly from the cash receipts of new securities issues. Krueger's suicide followed the financial collapse of his empire in the early 1930s. Utility pyramid. Insulls holding company acquired utilities with limited equity, only enough to acquire control. It was a pyramid, since there were several layers of acquisition, again acquiring just enough equity to maintain control. Ultimately, only a small amount of equity held the empire together. The debt was paid by the continued dividends from the utilities up to the holding company. When the economy collapsed in 1929, the pyramid collapsed. Insulls was the most infamous utility pyramid and there was a similar scheme in railroads by the Van Sweringen brothers. Massive fraud by the president (Philip Musica), including bogus receivables and inventory; these were missed by the auditor, Price Waterhouse since these were not confirmed. Audit procedures changed as a result of this case and audit regulation considered essential. 1968 merger of New York Central (part of Cornelius Vanderbilts empire in the mid-19th century) and Pennsylvania Railroad (the training ground of Andrew Carnegie)--two of the oldest railroads, with long histories, but failing. After the merger, dividends continued and the board was well paid, but rising debt and declining cash lead to bankruptcy. The bankruptcy was long & difficult, but service continuedeventually by the federal government through Amtrak One of the original conglomerates from the 1950s, which seemed successful because of accounting gimmicks associated with acquisitions & divestitures. The firm appeared very profitable, but the magic profits came from the accounting tricks associated with business combination accounting. Ultimately, new acquisitions became impossible & the company was forced into bankruptcy. Massive computer fraud of insurance company. Financial statements for 1964 were fraudulent, followed by cover up using false insurance policies & inserting bogus data into computer system. Finally shut down by SEC in 1972, based on whistle-blower information. ZZZZ Best went from virtually nothing to a giant in the 5

Lincoln Savings

1980s

Drexel & Milken

1980s

EMS 1986 Governmental Securities BCCI 1988 Scandal

Barings Bank

1995

Waste Management

1997

Long-term Capital Management

1998

Sunbeam

1998

insurance restoration business; records showed tremendous growth. However, most of the actual restoration projects did not exist. It turned out, like McKesson-Robbins, many executives were crooks. This suggested the importance of background checks on new audit clients as well as confirmation of construction projects. Part of the savings & loan scandal of the 1980s; deregulation of this industry and on-going interest rate problems led to massive fraud & other problems, requiring a federal bailout. Charles Keating was one of many S&L executives convicted & sent to jail. Michael Milken discovered that non-investment grade debt (junk bonds) was not that risky & potentially quite profitable. He created a massive junk bond market that fueled leveraged buyouts and acquisitions. Over-speculation and shady practices forced Drexel into bankruptcy & Milken to jail. A CPA audit partner was convicted of accepting bribes to falsify financial statements of EMS Governmental Securities, which defrauded Home State Bank in Ohio. Criminal corporate structure centered in Abu Dhabi, beginning in the 1970s. Acquired US banks and used American politicians as front men. Criminal behavior included global drug money laundering, bribery, arms trafficking, and tax evasion, not to mention a multitude of financial crimes. Layered corporate structure including shell corporations. US indictments started in 1988 & the firm collapsed in 1991. Baring Brothers was one of the early British private banking companies and the oldest existing bank in the world. A single rogue trader, Nick Leeson, who speculated on the Japanese Nikkei 225 stock market and lost $2.2 billion, brought down the company. Too bad no one in charge had a clue what he was doing. In 1997 Waste Management had the largest earnings restatement up to that time, $1.4 billion, for the 1992-7 period, associated with understated expenses included inflated useful lives and salvage value of fixed assets. Arthur Andersen was the auditor. Arbitrage kings of the 1990s, but competition forced them to take increasing risks. They failed when their trading strategies went awry and could have taken down the financial markets without the intervention of the Federal Reserve. It was the collapse of the Russian debt and ruble that caught them on the wrong side of their derivative speculation. Al Dunlap was hired in 1996 to turn the company around. Sunbeam was profitable by 1997, due to premature revenue 6

Cendant

1998

New York Stock Exchange Rite Aid

19981999 19992000

recognition, channel stuffing, bill & hold, ignoring returned merchandise, and other problems. After an internal investigation, Dunlap was fired and Sunbeam wrote-off $1.2 billion in earnings. Arthur Andersen was the auditor. Conglomerate that gobbled up many well-known firms, including Ramada, Coldwell Banker, and Avis. HFS acquired CUC International to form Cendant, but after the acquisition, fraud was discovered in sales and receivables. Cendant lost billions in market value and eventually settled a shareholder suit for $2.8 billion. Floor brokers convicted of trading for their own profit. SEC enforcement action against NYSE for failure to supervise floor brokers. Retail drugstore chain with a multitude of accounting issues, many related to acquisitions; Auditor KPMG resigned in 1999; misstatements related to maintenance costs capitalized; leases recorded as sales; compensation costs capitalized; charges for store closures not expensed; improper inventory & cost of goods sold; SEC investigation & class-action lawsuits filed.

21st Century Scandals Company Enron Year 2001 Description Declared bankruptcy on December 2, 2001 after restating earnings in the 3rd Quarter 10-Q, indicating major problems with special purpose entities. Ongoing investigations by the SEC, Justice Department & others; executives indicted & class action lawsuits filed. Overstated revenue & earnings over network capacity swaps & then declared bankruptcy; investigated by SEC & FBI. Recorded improper expenses of $3.8 billion & then declared bankruptcy; under investigation for accounting fraud & other violations; the amount of improper expenses uncovered approached $10 billion. Conglomerate with questionable practices on accounting for acquisitions and other issues. Restated 1999-2001 financials based on merger-related restructurings plus other problems with reserves. CEO & CFO indicted. Subject to criminal investigation by Justice Dept. & accounting practice probe by the SEC, associated with hollow swaps. Cable TV operation charged with overstating earnings; former CEO John Rigas charged with looting the company, which went bankrupt. Insider trading charges against former CEO for selling stock after FDA rejected a new drug; alleged to have tipped off Martha Stewart & other friends & relatives. Major investment banks settled with the New York Attorney General, SEC and other regulators on deceptive stock analysis and other brokerage-related practices, similar to Merrill Lynch earlier. The total fine was a combined $2 billion or so, plus other sanctions and agreement to correct deceptive practices. Accused of accounting fraud involving $1.4 billion in earnings & $800 million in overstated assets. Former CFO & others pleaded guilty to fraud charges. The mutual funds have only limited SEC regulation requirements & often poor corporate governance; yet have been considered highly ethical. That changed when New York Attorney General Eliot Spitzer sued them on several counts. Some pundits consider the mutual fund scandal as egregious as Enron. $16 billion in fraudulent accounting practices and 8

Global Crossing WorldCom

2002 2002

Tyco

2002

Qwest Adelphia Imclone Merrill Lynch, Salomon, Smith Barney, Credit Suisse, Goldman Sachs, J.P. Morgan, & others HealthSouth The Mutual Funds Scandal

2002 2002 2002 2002

2003 2003

Fannie Mae

2004

AIG Stock Option Backdating Sub-Prime Loans

2005 2006

2007

Bank Rescues

2008

extensive payouts to ousted executives; earnings restated & executives fired. Internal control weaknesses and poor corporate governance; CEO fired. Backdating options grant date to lower stock price; dozens of companies investigated by SEC; plus related investigations on spring-loading, speed vesting, and exercise backdating. Massive number of mortgage loans to sub-prime borrowers, often without documentation. Mortgages then repackaged through SPEs and sold as bonds. Huge losses taken at major financial institutions and many executives fired. An FBI investigation is ongoing. Bear Stearns rescued by J.P. Morgan; Indy Mac failed; massive problems at Fannie Mae and Freddie Mac.