Train Wreck

Eliot Spitzer, Governor of N.Y.

(Credit: N.Y. State)

Five years ago, then N.Y. Attorney General Eliot Spitzer was involved in an investigation into conflicts of interest between research and investment banking at ten of the nation's top investment firms during the Internet bubble.

The landmark $1.4 billion settlement helped put Mr. Spitzer on a fast track to the governor's mansion, but that's not the whole story. ... Read more

Before I began writing this post, I googled "the ends justify the means" and got 204,000 results. The volume of philosophical discourse that's gone into analyzing the implications of the phrase is staggering.

Frankly, I think it's all a bunch of pseudo-academic crap. It's never acceptable to breach moral, ethical, or legal boundaries to achieve some perceived greater good. But I didn't always think that way. ... Read more

Just when you think you've seen it all and covered this stuff to death, another (alleged) greedy sociopath comes along with even more creative ways of defrauding investors.

David Brooks, former CEO of body-armor manufacturer DHB Industries, has been indicted by the feds on a laundry list of charges that include conspiracy, securities fraud, insider trading, tax evasion, and obstruction of justice.

The company's former COO, Sandra Hatfield, and CFO, Dawn Schlegel, were also indicted on similar charges.

Brooks and his cronies allegedly (it's always allegedly) used false accounting entries to inflate profit margins, filed misleading SEC reports, pumped up the company's stock ten-fold, and cashed out to the tune of $200 million.

The scandal also includes millions in unreported bonus payments and Brooks' use of company funds for all the usual personal excesses: luxury cars, vacations, jewelry, lavish parties, and to fund other family-owned businesses. But there are excesses I've never seen before: cosmetic surgery and the purchase of an armored vehicle for the family's use.

I've got to ask, what exactly does a family need an armored vehicle for? ... Read more

This blog's supposed to be about corporate dysfunctionality, but somehow we've gotten sidetracked. We've never really looked at the big picture. The big picture is this: a reasonably significant percentage of executives and their boards are dysfunctional.

What do I mean by that? I mean they shouldn't be doing some of the things they're doing, and those things can get them in big trouble with a variety of law enforcement agencies. Why do they do it? Who knows.

As for you good folks--investors and employees--well, I don't want to be an alarmist, but if you knew what really goes on out there, the countless ways you can get screwed, well, let's just say you'd need a good dose of Ambien to get any sleep.

The good news is you can protect yourself; we'll get to that in a minute.

Until then, here are the most common ways that dysfunctional executives and directors can mess up. I've included a few well-known examples, but the scary part is that, for every big-name scandal, hundreds fly under the radar screen.

The seven deadly sins of corporate dysfunctionality

Creative accounting
Most of the biggest scandals of our time have included some form of creative accounting: shell companies, offshore accounts, creative expensing, or just your run of the mill accounting fraud. That's what did in Enron, WorldCom, Adelphia and a host of others.

Conflicts of interest
One of the biggest scams in history was the conflict of interest between investment banks and their research analysts leading up to the dot.com bust. The top ten investment banks coughed up $1.4 billion to get the SEC, the N.Y. attorney general and a host of others off their back. A few analysts were banned, but amazingly, nobody went to jail.

Insider trading
If you really think this is just the domain of Martha Stewart and ImClone ex-CEO Sam Waksal, then I've got some nice used cars from New Orleans to sell you. I'd be willing to bet that at least half the executives who say they've never traded on inside information would be lying. The other half have so much money they don't need to.

Dysfunctional families
I don't care if it's IBM in the old days, Motorola all too recently, Adelphia, Wang Laboratories, or Atmel. If you're considering a company with any family relations on the executive management team or the board, forget it. And if a family actually controls the stock's voting rights, as was the case with Adelphia, soon enough you'll read about it in the newspaper.

Rubber-stamping boards
Behind every dysfunctional executive and company is a board that fits nicely into the CEO's back pocket and rubber-stamps everything put in front of them. Tyco was a great example, but there are probably hundreds, if not thousands of boards that are blindly loyal to their company's CEO.

Generic SEC filings
10Ks have to be the biggest waste of paper since An Inconvenient Truth was published. The risk factors are generic and watered down while the business sections do more to hide than highlight competitive challenges. The lawyers and Sarbanes-Oxley consultants are in charge. That's really scary.

Ludicrous compensation
How many CEOs and other officers have been sacked as a result of stock option backdating scandals? Must be 30 or more in the technology space alone. Besides the sometimes ludicrous equity and monetary compensation, CEOs can sometimes make even more money by quitting or getting fired. Sure, some deserve their pay, but many don't, and there's everything in between.

Well, that's the seven, and I'm not even talking about the rare psychopath that can take down an entire sector. Take Bernie Ebbers of WorldCom. How smart do you have to be to ask a simple question: in what universe does it make sense for a guy who was a motel owner, a milkman, and a gym teacher to somehow be competent at running one of the world's largest telecom companies? Just thinking about it makes me feel delusional.

With all these ways to get hosed, what's an investor to do? Simple, diversify. If you have more than five or ten percent of your net worth in any one stock, you're asking for trouble. As for employees, you need to manage your own career. Don't expect anybody or any company to do it for you. Trust and protect yourself and you'll do fine.

The only person you can be sure isn't dysfunctional is yourself. If you're not sure if you're dysfunctional, take this quiz and find out.

IPOs (initial public offerings) are a huge event in a company's life and definitely worthy of celebration. That said, they're not the be all and end all that many expect them to be. Just ask the folks at Vonage what they think of their post-IPO fortunes.

Just as many things can go wrong after an IPO as before. And public companies have increased legal and financial scrutiny, plus the Sarbanes-Oxley tax to boot.

Sure, IPOs are a liquidity event, but that doesn't mean you'll necessarily cash out before things fall apart. The following ten companies, which I followed for some reason or other, fizzled after their IPOs: ... Read more

As reported, Dell recently concluded a year-long internal investigation into its accounting practices. As a result, the company will restate its financials for four fiscal years (2003 through 2006) plus the first quarter of fiscal 2007. The good news is that the cumulative decrease in net income will be between $50 and $150 million - peanuts compared with Dell's reported profit of $12 billion during the restatement period.

The bad news, however, is contained in a rather heavily wordsmithed paragraph of Dell's press release:

"The investigation identified evidence that certain adjustments appear to have been motivated by the objective of attaining financial targets. According to the investigation, these activities typically occurred at the close of a quarter. The investigation found evidence that, in that timeframe, account balances were reviewed, sometimes at the request or with the knowledge of senior executives, with the goal of seeking adjustments so that quarterly performance objectives could be met."

It appears that certain senior executives had a chronic case of end of quarter madness, a relatively common disease among executives of publicly traded companies.

Confirming what was evident from Dell's announcement, CFO Don Carty said in a conference call with investors, "We did find evidence of fraud." But neither Carty nor Michael Dell - who reclaimed the CEO role in January - would divulge the identities of the senior executives referenced in the company's release. ... Read more

Rambus needs more controversy and scandal like the Internet needs more bloggers and porn. As mired in legal trouble as this company is, you've really got to do something egregious to get noticed.

According to a story by The Recorder, a California legal paper, the wife of Rambus CEO Harold Hughes did just that. Nancy Hughes anonymously posted 170 messages on a popular investor message board over a 10-month period. In her posts, clarissamehitable--alias Nancy Hughes--vigorously defended her embattled husband, and criticized current and former members of the company's management team.

Nancy's posts were so obviously those of a Rambus insider that they aroused not only the suspicion of other posters on the board, but company officials, as well. Rambus brought in outside legal counsel to head up an investigation, which ultimately turned up none other than Hughes' wife.

According to a company spokeswoman, Rambus' board of directors concluded that there was no wrongdoing on the part of either Hughes.

What's troubling is that Nancy was pegged as an insider for good reason. If some of her posts were not inside information, they certainly appear to come razor close to crossing the line. And there's evidence that someone may have removed some of her posts from the message board.

Full disclosure:
I was an executive officer of Rambus from 2002 to 2003 and I am a shareholder. I have never posted on an investor message board and neither has my wife...as far as I know. ... Read more

What do Bernie Ebbers, Walter Forbes, Martin Grass, Dennis Kozlowski, Sanjay Kumar, Ken Lay, Joe Nacchio, John Rigas, Jeff Skilling, and Sam Waksal all have in common?

They were all CEOs of prominent public companies, convicted of big-time corporate fraud and sentenced to lengthy prison terms. They were all also fabulously wealthy (we're talking hundreds of millions of dollars and up) when they committed their crimes.

Who among us hasn't asked themselves, what would I do with $100 million? You get all kinds of whimsical answers to that question, but one thing you never hear is, "I'm going to risk the money, my family's well-being, and my freedom to be a high-powered CEO and defraud thousands of shareholders."

That's because nobody thinks that way and these ten CEOs were no exception. Nevertheless, they risked their careers, families, reputation, wealth, power, everything. And for what? What motivates rich, high-powered CEOs to unnecessarily risk it all against all logic and ethical principals?

Maybe it isn't even about motivation. Perhaps there's something deeper going on here, something in their circuitry that's hard-wired for exceptional success followed by devastating disaster. Or is it just probability? Maybe x% of highly successful, super-wealthy CEOs of prominent public companies will turn out to be dysfunctional crooks. ... Read more

In researching this post, I came across a number of recent reports on Henry Nicholas III, the once high-flying CEO and cofounder of Broadcom. The allegations of illicit sex, drugs, and rock and roll reminded me of the 60s ... or was it the 70s? Funny, I can't remember.

While the story was enthralling, I didn't understand what any of it had to do with a federal investigation into stock option backdating. Sure, Broadcom had to take a $2.2 billion charge to fix the accounting mess left by the company's former executives. But how does that relate to hiring prostitutes and drugging customers without their knowledge?

Said another way, do the feds really need to dig that deep to find enough rope to hang executives with? After all, stock option backdating is all the rage these days. You'd think they'd be up to their eyeballs in rope.

I count no fewer than 38 top executives at 19 high-tech companies that have bit the dust over this stuff. We're talking top executives at big-name companies like Apple, Altera, Broadcom, Brocade, Cirrus Logic, Comverse, KLA-Tencor, Maxim, McAfee, Rambus, Sanmina-SCI, Take Two, Trident, Verisign, and Vitesse. And we're just getting started.

That's serious fallout considering that options backdating is legit as long as the company reports it and accounts for it accurately. You see, if you backdate stock options to a date when the price of the stock was lower, then the options are "in-the-money" when granted. That means the company incurs an expense equal to the difference in the share price between the two dates. ... Read more