The Importance of Being Truthful
June 27, 2002

By Henry J. Stern

 
    My work has been in city government rather than the private sector, but the recent series of scandals in business raise issues that are too important to ignore, especially since they have adversely affected the deferred compensation that I trustingly left in the care of the New York City Office of Labor Relations, to be placed in what I thought was a prudent investment, the Vanguard S&P 500 index fund.  Unfortunately, even neutral investors have been hurt by the lack of public confidence in business caused by companies imploding because of false or misleading financial data, or self-dealing by their officers.

    A major effect of this corporate misconduct is that investors are deceived in making judgments on whether to buy or sell stocks, because the financial information they receive is fictitious, contrived, mendacious.  This goes to the very heart of the public stock market:  How can people invest wisely if the basic datum on which they make decisions, how much a company earns, is an unmitigated lie?  The loss of confidence that has resulted from this situation has cost shareholders more than all that was stolen in Enron, Tyco, Adelphia, Global Crossing and WorldCom.

    One scenario that seems to recur in recent disclosures is the CEO borrowing hundreds of millions of dollars from his (the masculine is so far appropriate here) company, usually for the purpose of making other investments.   Why should any business take that risk?   I naively ask what would be wrong in forbidding companies to lend money, except possibly relatively small amounts, to their top officers, or to any individuals for that matter.   If you want to borrow money, go to a bank or a friend. Don’t stick your hand in your company’s till.

    Another pattern is the capitalization of expense items to inflate earnings.  We know something about this, because New York City used to do it in the grand manner.  That led, in part, to Fiscal Crisis 1 (1974-75).  In the 2003 budget, when the city borrows $1.5 billion to meet current costs, we say so, and promise it will be the last time.

    In these cases, the Watergate question arises:  What did you know, and when did you know it.  Did the auditors know what WorldCom was doing?   Apparently, the company dumped Arthur Andersen when that firm got into trouble, and hired KPMG, effective May 15.   But the $3.7 billion in improper allocations are supposed to have been discovered by the company’s internal auditors, just the other day. Who knows how true that is, or if this is, again citing the rich lode of Watergate language, a modified, limited hang-out.

    I want to make it perfectly clear that, at this point in time, we need more effective regulation of business practices.  For American companies to place corporate headquarters in Bermuda or the Cayman Islands appears to be an obvious outrage.  It is currently allowed, but should be forbidden.  When Enron insiders set up off-the-books partnerships, they not only reaped ill-gotten gains for themselves and their cronies, but they diminished Enron’s resources, deceived its shareholders, and betrayed their fiduciary duties.  They should go to jail, and the directors who approved these arrangements should be barred from serving on the boards of public corporations, in the way the SEC banishes stock market crooks from the securities industry.

    For confidence to be restored, strong action is needed.  This is an area where President Bush could provide remarkable leadership. The tragedy of 9-11 changed his view of world affairs.  The erosion of business integrity presents another challenge which he could rise to meet. Business leaders should also offer constructive initiatives in this area, and a few have done so. But whatever the rules, there will always be thieves.  The least we can do is make it much harder for them to operate, and punish them severely when they are caught.  One suggestion is to wipe out the multi-million dollar homestead exemptions for bankruptcies in Florida and Texas (home of the Lays).

    This is a great country, under God, and most businesspeople are honest and decent.  But since human nature is imperfect, as we have seen in government, in commerce and in the clergy, we must find the wisdom, the strength and the moral courage to delete these viruses before they infect all our systems.
 
 

Henry J. Stern is the director of NYCivic.