CEO Crime & Punishment
[This is a guest post from my business partner, and co-founder and CEO of Opsware Inc., Ben Horowitz. Ben has been CEO of a US public company since March 2001.]
As CEO of a public company who grew up in the People's Republic of Berkeley, one question I get from a lot of my old buddies is, 'Why are there so many criminals in corporate America?'
Given the high-profile scandals that led to massive securities law reforms such as Sarbanes-Oxley, and the more recent stock option accounting imbroglio, this is a good question indeed.
Warren Buffet once said that 'marrying for the money probably isn't a good idea in any case, but if you are already rich, it makes no sense at all.' The variation that applies to CEOs is 'robbing investors probably isn't a good idea in any case, but if you are already rich, it makes no sense at all.'
So, why all the fraud? Are CEOs just natural crime bosses who have found a better hustle?
To find the answer, we'll first take a look at regular old run-of-the-mill corporate crime; you know, the Enron, WorldCom, Qwest variety. Then, we'll delve into the very special case of stock option accounting.
What were Bernard 'Bernie' Ebbers, Kenneth 'Kenny Boy' Lay, and Joe 'this guy doesn't even need a nickname to sound like a crime boss' Nacchio thinking? What motivated such legitimately rich and powerful men to risk and ultimately lose everything?
To find that out, we have to examine what motivates CEOs in general. Is it pure greed -- the burning desire to have more money than Bill Gates?
Surprisingly (at least for anyone who watches TV or movies made in Hollywood), the answer is: not necessarily.What motivates most CEOs is some combination of winning and, as a result, building something great. Building a great institution, a great place to work, a great place to do business with, and a great investment. This is what's most motivating and what's most gratifying. And what they'll fight to hold on to most dearly. And this is where the crime comes in.
So if winning and building motivate CEOs, how does this lead to crime?
Let's use as an example the case of Bernard 'Bernie' Ebbers and his motivation to build a huge company. In case you aren't familiar with Bernie's crime, accounting fraud at WorldCom during Bernie's tenure led to the largest bankruptcy ever. And Bernie got sentenced to 5 nickels hard time.
But the really curious thing about Bernie was that he didn't sell any of his WorldCom stock while he was committing this fraud. In fact, he got himself into massive personal financial crisis by borrowing $366M against his WorldCom stock to avoid selling it. If Bernie committed this crime out of personal greed, how do you explain that?
This is simple. Any low class ponzi scheme operator knows that he has to cut and run at some point. But the skillful criminal realizes that he needs a better closing. Bernie realized that if he borrowed $100,000 and couldn't repay it, then he had a problem; but that if he borrowed $400,000,000 and couldn't repay it, then the banks had a problem. It isn't curious that Bernie didn't sell his stock, it would have been curious if he hadn't taken advantage of this asset at all.This is a silly social history. Crime is not accidental. Fraud is planned, and executed with the intent to deceive. It is not something you cross the line into. You cheat because you want to cheat and break the rules.Bernie was the classic American success story. He came from humble beginnings. He dropped out of college twice prior to graduating from Mississippi College. He began his career as a high school physical education teacher. He worked as a milkman by day and a bouncer by night. He built himself up from nothing to arguably the most important and powerful man in the multi-trillion dollar telecom industry.
As WorldCom grew at a rapid pace, Bernie set expectations high. This led investors to give him advance credit, thus boosting his stock, which was the currency he used to build his company. When Bernie saw that WorldCom wasn't going to meet those high expectations, and that thousands of shareholders to whom he had promised great performance would lose their money, and thousands of employees who he had hired would lose their jobs, he was willing to do anything to make things right. Even if it meant doing things that were wrong.
Like a killer committing his second murder, the decisions to commit fraud must have come easier as Bernie gained experience. In addition, the stakes continued to get higher. He continued to commit fraud, because if he hadn't, there was a 100% chance that he would let everyone down who mattered to him and he would no longer be the person that he had worked so hard to become. He wouldn't be Bernie Ebbers #11 in Time Magazine's Cyber Elite; he'd be Bernie Ebbers, former milkman, bouncer, and disgraced CEO.
By committing the crime, he was taking a chance that something much worse would happen (i.e. jail), but he was willing to take that risk. He very likely talked himself into thinking that he wasn't taking much of a risk at all. Bernie's conversation with himself probably went something like this: 'The accounting is complex and I can argue the accounting treatment either way. I am a good person. I have donated enormous amounts of money to charity and done outstanding work with my church. I care more about others than I do myself. Since a good person would not commit accounting fraud and I think that this is a reasonable approach, I am not committing accounting fraud.'
Much like blue collar crime, there is no flashing sign that tells you when you enter into the world of white collar crime. When somebody has five drinks and then walks to their car to drive home, it's likely that nobody tells them they are drunk and about to commit a crime. When Bernie agreed to financial treatment that made the numbers but wasn't quite right, his team might not have pointed out that he was crossing the line.
Cheating is not winning. Cheating is a parody of winning - the foam without the essence of the beer, so to speak. There is no burning desire to win, there is only the burning desire to deceive -it is a thrill in itself. That is what make a con criminals a criminal: the overwhelming desire to deceive and manipulate. Winning has nothing to do with it.Of course, accounting fraud and bankruptcy in the telecom sector did not begin and end with Bernie. Bernie just got the ball rolling. There were also accounting and/or bankruptcy issues -- the two tend to go together even if not publicly -- at Qwest, Exodus, and Williams Communications to name three (there were many more).
This is where the 'winning' part comes in. The burning desire to win is why corporate crime becomes contagious. This will be important when we get into stock option accounting.
Once WorldCom started committing accounting fraud to prop up their numbers, all of the other telecoms had to either (a) commit accounting fraud to keep pace with WorldCom's blistering growth rate, or (b) be viewed as losers with severe consequences.
How severe were the consequences for not breaking the law? Well, like a baseball player who refuses to take steroids, CEO Mike Armstrong of AT&T did not keep pace with the cheaters. As a reward for his honesty and integrity, he was widely ridiculed in the press prior to being fired and AT&T, perhaps America's most valuable brand, was acquired for cheap. Now you see why Barry Bonds needed something to help him keep pace with Mark McGwire.
CEOs who commit accounting fraud don't need a checklist about how to avoid fraud. Afterall, they are intentionally committing it. (I have no views about whether this list would prevent negligence.) It is pointless to pretend that con criminals wearing suits somehow inadvertantly crossed the line into fraud. They started their dubious trade skills as young people, learned that they were not caught, and started doubling down on their fraud.So how do CEOs avoid committing accounting fraud? There are a few important keys:
- Be clear with yourself –- As CEO you must realize that every incentive for every employee in the company drives them to make the numbers. The only counterbalance to all those incentives is the law. But the law is not always crystal clear, so the company looks to the CEO to make the final call.
- Be clear with others –- It's important to let the people who account for the business know that they are not responsible for making the numbers; they are responsible for reporting them accurately. I always say to my finance people: 'we may whiff a quarter, but we are not going to jail.' It may seem silly to have to say that, but it's critically important for everyone in the company to know that the CEO is not asking them to push the legal limits.
- Stay away from the gray –- It's very tempting to be 'aggressive' when making an accounting judgment, but it's also very dangerous.
- Organize to stop fraud –- One of the most important things that your friendly blogger
pmarcainsisted upon when we started our company was to make sure that the General Counsel reported directly to the CEO and not to some other executive. When things go bad in the company, it's important that the organizational structure enables you to find the badness rather than hiding it.- Heed advice of JaMarcus Russell's mom -- she says: 'trouble is easy to get into, but hard to get out of.'
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Comments
Great post! I have seen fraud by a CEO happen up close. From my vantage point, it was a combination of entitlement, self-deception and playing in the gray. It started before I arrived but I was quickly asked to join in by charging certain personal expenses as business expenses ("we're working 24/7, ALL our personale expenses are business expenses.") I didn't say "then why don't you accurately report them" because I didn't want to lose the job I'd just landed. I just said, "I'd rather not." These expenses got bigger and bigger -- foreign travel, for instance, for one's family, suites at the Ritz in Paris, flying one's family and friends to Rome for a 40th birthday party, etc. These are the things I saw. When the inevitable arrived, the fraud went much deeper, into actual embezzlement. Everyone took a fall but no one was prosecuted or imprisoned. It was all very cheerful until it suddenly wasn't. I watched "The Smartest Guys in the Room" about Enron a few weeks ago & it was chillingly accurate. There was also the attitude that the rules were for patsies. And the division of the world into "us" and "them" so that "they" didn't seem like people at all. Alcohol also fueled this "burn your own success to the ground" high-wire act. I do think there was still a fair amount of adolescent rebellion alive in the main players for whom much had been expected by very strict, very successful parents. To help those at the tippy-top where the lack of oxygen can make ethical thinking very slow, I suggest working in a soup kitchen or reading to the blind. It's remarkable how being of service to "them" can make these high level economic crimes quite personal. Service also helps keep one's feet on the ground and one's heart filled with gratitude. And, oh yes, because we experience the love we may feel we're missing by LOVING, service also tends to fill the hole that all the baubles and trinkets in the world will never begin to touch.
Posted by: Vickie Pynchon | June 30, 2007 12:01 PM
Vickie;
Thank-you for your post. Very intriguing. Especially the part of about us versus them.
I am convinced that a) the number of psychopaths running public companies is seriously underestimated, b) most people when confronted with the behavoir fail to recognize it, and c) there is a great deal of bullying going on, instilling fear in those who sense something is not quite right.
Posted by: michael webster
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July 2, 2007 5:00 PM