CURRENT ISSUE :: COVER STORY

	Every decade has its corporate villains. But the scope and scale of the corporate transgressions of the late 1990s, now coming to light, exceed anything the U.S. has witnessed since before the Great Depression.
By DAVID WESSEL Staff Reporter of The Wall Street Journal

Enron's top executives reaped hundreds of millions of dollars as the company collapsed. Arthur Andersen, Enron's auditor, was convicted this summer of obstructing justice. Tyco International's once highly respected CEO is charged with tax evasion and accused of secret pay deals with underlings. Cable giant Adelphia Communications has admitted inflating its financial numbers. Xerox paid a $10 million fine for overstating revenues. Dynegy and CMS Energy simultaneously bought and sold electricity in transactions with no point other than pumping up trading volumes. Merrill Lynch paid $100 million to settle New York state charges that its analysts misled investors, and other Wall Street firms are now under scrutiny. And telecommunications giant WorldCom disclosed an accounting trick that inflated its reported profits by billions of dollars, then filed for the biggest bankruptcy in American history.

"I've never seen anything of this magnitude with companies this large," says Henry McKinnell, 59, CEO of the drug company Pfizer.

Investors Lose

Why is so much corporate corruption surfacing now? Is there more of it, or is more attention being paid? Did a few executives lose their ethics in the heady days of the 1990s? Or did a few notorious offenders break rules that many others merely bent? Is the entire system of corporate governance and regulation flawed? Or was the system abused by a few unscrupulous players?

The answer, put simply: A stock-market bubble magnified changes in accepted business practices and brought trends that had been building for years to a climax. The victims: the very shareholders the executives were supposed to serve.

When Federal Reserve Chairman Alan Greenspan talks informally with business and other groups, he says the greediness of human beings didn't increase in the 1990s. What increased, he says, was the number of opportunities to satisfy that greed. The run-up in stock prices meant there was more to grab.

One culprit was stock options, which gave executives huge incentives to boost short-term stock prices regardless of the long-term consequences. These incentives helped turn the widely practiced art of earnings management -- making sure profits meet or barely exceed Wall Street expectations -- into a gross distortion of reality at some companies.

And the institutions that were created to check such abuses failed. The remnants of a professional code of conduct in accounting, law and securities analysis gave way to getting the maximum revenue per partner. The auditor's signature on a corporate report didn't mean that the report was an accurate snapshot, says Treasury Secretary Paul O'Neill, but rather "that a company had cooked the books to generally accepted standards."

The current sordid chapter in the history of American business opened on Aug. 14 last year when Jeffrey Skilling quit as CEO of Enron, an unmistakable sign that all was not well inside one of the country's most-admired corporations.

Enron is "the private sector's Watergate," says John Coffee, a Columbia University securities-law professor. Although not all politicians were crooks, Watergate bred cynicism about government among the public, the press and even some politicians. Enron and all that followed threaten to do the same to American business. "I have had a lot of e-mail from shareholders who … think all corporate executives are crooks and all accountants are sheep, just as some think all Catholic priests are pedophiles," says mutual-fund manager James Gipson. "None of those statements are true."

Bad Apples or Sick Tree?

Measuring the volume of corporate mischief precisely is difficult. More than 150 companies restated their earnings in each of the past three years, an acknowledgment that they had misinformed investors. That's more than triple the levels of the early 1990s, but represents only 1% of publicly traded companies. One view, put forth by chief executives and government officials, emphasizes that only a small fraction of companies and executives stand accused of wrongdoing. It's that "few bad apples" analysis. Pfizer's Mr. McKinnell cautions against generalizing from "eight or 10 companies who allegedly behaved in ways that are incomprehensible … and deserve what they're getting."

For this camp, the smart response is to punish the wrongdoers severely and tinker with the parts of the system that are broken, taking care to avoid hasty changes with unintended consequences. "Things aren't as broken as they appear to be," says Mr. McKinnell.

But there's another view: that the headline-making cases are symptoms of a broader disease and a regulatory system that isn't up to the challenge. "A few bad apples? Looks like we've got the whole peck here," says Stanley Sporkin, a former SEC enforcement chief.

"Everybody did this," says Peter Temin, an economic historian at MIT. "The people who got in trouble are those who are most at the edge. Enron didn't get caught. Enron got so far out on the edge that it fell off."

To this camp, the solution is broader legislation and tougher regulation on the scale of the 1930s laws that created the SEC and the modern regulatory system. (See related article on Page 10.)

Roller Coaster Ride

Stock options were supposed to solve a problem of the past: entrenched corporate management that wasn't serving the interests of shareholders. The solution, widely embraced in American business, was to use stock options to link executives' and shareholders' interests. It sounded reasonable: Executives would benefit if they managed companies in a way that lifted share prices.

It didn't work as intended. A soaring stock market rewarded executives not for good strategic management, but for riding the roller coaster. The incentives to do almost anything to increase the stock price were huge. And the incentives weren't to increase profits and share prices over a decade or two, but rather to increase profits just long enough for executives to cash in their options.

Stock options, Mr. Pitt says, were "a device that was supposed to align shareholder and manager interests -- and actually 'disaligned' them."

Of course, corporate executives aren't supposed to be monarchs. All sorts of checks and balances have been established during the past century: accountants, lawyers, securities analysts, investment bankers, audit committees, regulators, even the press.

Whether the rules were adequate is still being debated. But there is little debate about the failure of the professionals who are supposed to see that rules are obeyed and executives are honest. The shortcomings of accounting firms are now well exposed. The duplicity of some highly paid Wall Street analysts is documented in internal e-mails that are now public. The acquiescence of the lawyers inside Enron, Tyco and other companies is readily apparent.

This disturbing pattern is the biggest reason why the abuses of the 1990s can't easily be dismissed as the fault of a few flawed human beings. "The professional gatekeepers were greatly compromised by finding they could make tremendous profits by deferring to management," says Columbia's Prof. Coffee.

But not one of the instances of egregious abuse of shareholder interest would have occurred if the CEO had simply said, "No!"

Mr. Gipson, the mutual-fund manager, divides offenders into two classes: the "confirmed crooks" who deliberately and willfully ripped off shareholders, and the "morally marginal who went right up to the line of acceptable behavior" and then "when the line was moved found themselves on the other side."

Treasury Secretary O'Neill makes a similar point: "A little lie leads to ever bigger ones in lots of cases without a recognition on the part of the perpetrator that they ever told a lie, even when it gets grotesque. They say, 'If only I had another 12 months… .'"