The Telegraph
Since 1st March, 1999
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- Alertness about investments can beat corporate fraud

The author is professor, Jawaharlal Nehru university, New Delhi

They have not come up yet with designer handcuffs that go with business suits. After the indictment of very senior executives of Enron, Worldcom, Arthur Andersen, and so on, it might be a good idea to market handcuffs as accessories for the rich and infamous. In days to come corporate kings would not like to be captured by television cameras in ill fitting and non-coordinated handcuffs.

But is all this excitement another example of American exceptionalism with little impact on the corporate world elsewhere' Or are there lessons here that we would do well to heed in India' It is true that George Bush was stung to the quick by what happened with Enron and Arthur Andersen and he passed the tough Sarbanes-Oxley Act. From now on a CEO would be held responsible if the company fudged accounts, cooked its ledger books, or in short, misled shareholders and the public. The sentence for such an offence is a punitive 20 years in prison. If punishment is based on the theory of deterrence then this should probably work in combating such starched white-collar crimes.

Can the American public and shareholders now relax' The deterrence theory of jurisprudence has some serious critics who argue that there will always be criminal minds at work thinking of the latest way of breaking the law. How then can ordinary people — the tax payers, the small shareholders — get any protection if the law can always be bent and broken by a new generation of corporate fraudsters. This is an important question in America as almost 25 per cent of Americans today hold shares in different companies. No wonder the public there is so concerned and incensed at how the corporate sector has credited itself.

The lesson from the latest big time corporate frauds is that rather than trust anybody you should use your own judgment. If a reputed auditing company like Arthur Andersen can be implicated in the Enron scandal (and a few others besides) then who can the ordinary shareholder turn to for authentic information' It is also common knowledge now that annual reports of even reputed companies can be very misleading. The bottomline can be made to look good or bad, depending on what the senior executives want it to be. Profits are hyped up if companies want to boost their market shares and thereby enhance their credit ratings. Profits can be lowered in the books if the enterprise wants to duck paying taxes. Ordinary shareholders and members of the tax paying public are very often left holding the can even after they had very assiduously perused the annual reports and balance sheets of companies.

The scandals in Enron, Worldcom and Xerox have hurt India as well, though not as hard. But as more and more Indians get drawn into the shares game, they had better watch out. By and large Indian shareholders are very forgiving. They continue to hold on to stocks even though they under-perform dreadfully year after year. There are indications, however, that this might soon change. Companies are aggressively advertising themselves against projected profits in the hope of winning over prospective investors. There have been some signal disaster stories in this respect, but even so there are many who get carried away by these promises. After all, most of us do not have the technical knowledge to understand what is being said in financial statements.

Even when we have some expertise in this regard we are not sure to what extent the credit ratings are to be trusted. Enron has stated in its defence that it did indeed disclose information about related-party transactions, but as all that was made in very cryptic footnotes nobody really got a hang of what was being said. So on the face of it, Enron abided by the letter of the law set by the financial accounting standards board, even while it successfully violated every bit of it in spirit.

Very often employees of these companies are in the know of what is going on but they are so seduced by employee stock option plans that they become willing partners in corporate frauds. There is a general acquiescence from top down to dupe the ordinary shareholder. Margaret Ceconi who was once the director of sales in Enron Energy Services sent emails all the way up in her company pointing out that something was very seriously wrong in the way profits were being posted. Profits were booked even before services were delivered and calculated on the basis of aggressive estimates of what energy prices were going to be in the future. According to Ceconi she smelt a rat soon after she joined the organization and it was not as if she was alone. It was common knowledge among her colleagues, and a bit of a joke as well, that the books were being cooked on a massive scale and that all of this was in their interests because they held stocks in their own company.

So no matter how closely we read financial statements of companies it is impossible to know exactly what is going on. After all, Enron was the darling of Wall Street’s many financial analysts and wizards.

Nor can we always depend on the laws to protect us from corporate frauds. When there is big money involved there are always interested political parties that are in the act as well and can act as good protective shields for buccaneer enterpreneurs. Don’t forget that the American president, George W. Bush, affectionately called Kenneth Lay, the now errant chief of Enron,“Kenny boy” in the pre-bust up days. An Enron consultant was a White House economic adviser, an Enron vice-president became secretary of the army, and Harvey Pitt, the lawyer who argued for Arthur Andersen, was appointed by Bush to head the securities and exchange commission.

The only way citizens everywhere can protect themselves is to be able to read red flags when they pop up, regardless of what financial analysts and credit rating agencies may say. The first thing to watch out for is when share prices shoot up phenomenally. It could be an index of genuine growth as with some information technology stocks, but in some cases it may be a spurious spurt. So it is worth checking out. Enron shares jumped to as high as $90 before the crash.

The second red flag is when the annual report is couched in plenty of jargon and is largely incomprehensible. Unreadable statements of this kind usually conceal something quite dark and sinister. This is one of the oldest subterfuges in the world. The third red flag is when the big guns in the company are very cosy with the powers that be. In such cases the temptation to break the law and depend on political patronage is very strong. Sooner or later paytime will come and it will be the poor stockholder and employees of the organization who will lose out the most.

Finally, be a little careful of organizations where the employee stock option is factored as part of salary remuneration. In this case it is very tempting for everyone in the organization to keep share prices up in the stock exchange even when real business is going down the tube.

Some of us may get some malicious pleasure in seeing handcuffs and business suits. But for so many it is really tragic as life’s savings are lost because of corporate greed. This is why it is necessary for the ordinary person to start taking control directly over how and where his money is being invested. We can no longer trust balance sheets, stock prices, and financial analysts. What we need to do is to watch out for warning signals and take corrective action. This will force companies to behave, and the crooked ones to fold up. This is how democracy can be made to work in the corporate sector.

Alarm bells are already ringing in India. The non-performing assets in the banking sector in this country stood at Rs 80,574 crore in March 2001. This has recently begun to draw some attention and scrutiny. We now also know that the biggest defaulters in paying up loans to the banks are major figures in the Indian corporate sector. The list of such people reads like the “who’s who” of the Indian business elite. One business house alone accounts for roughly 10 per cent of the NPAs of the banking sector. It is argued that if these companies are getting away with it they must have enormous political influence. But sooner or later somebody will have to pay. Must it always be the common person'

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