The new century's top 10 money messes

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The new century's top 10 money messes

When it comes to scandals, the current uproar over options backdating can't compete against crimes like those of Enron and WorldCom. Here are the rogue all-stars of the 2000s -- so far.

By Tim Middleton

For connoisseurs of scandal, the current flap over options backdating is weak tea. Greg Reyes, a former chief executive of Brocade Communications Systems (BRCD, news, msgs), isn't even accused of enriching himself. Rather than stealing from shareholders, Steve Jobs has boosted the value of Apple (AAPL, news, msgs) stock 1,000% in six years.

No, this stuff is grade school for scandal. Where are the Dennis Kozlowskis and John Rigases, the Enrons and WorldComs? These are the MBAs of swindling in the 21st century. They cost investors hundreds of billions of dollars.

And they teach a more meaningful lesson than backdating, which isn't even illegal. Swindles by their nature are secret, but swindlers often give themselves away very publicly. Two of the great financial scams of this new century -- late trading at mutual funds and bogus research from stockbrokers -- were so obvious they were exposed by a local politician.

The folks who should sniff out these scams, the money managers with billions of dollars at stake -- much of it yours and mine -- have consistently missed even the most obvious of clues. Though it's easy to blame the scammers, the so-called professional investors deserve a healthy dose of scorn, too.

Here's a look back at the top 10 money mistakes of the new century and the folks who made them.

No. 1: The big crooked E

That was Enron's logo, and it was a fitting symbol of a Texas-size swindle that took in everybody, including the president of the United States. George W. Bush's nickname for the power company's chairman, Kenneth Lay, was Kenny Boy.

Enron was the favorite utility of environmentalists because its real business wasn't distributing natural gas but rather conducting exotic (but nonpolluting) financial manipulations. But the greens weren't alone: The five largest shareholders of Enron were Fidelity Management, Alliance Capital, Janus Capital Group (JNS, news, msgs), Putnam Investment Management and Barclays (BCS, news, msgs).

In reality, what Enron did was something of a mystery; the company's own Web site called it "difficult to define." What it really did was fraud: private partnership deals that favored insiders over the company. The deals were disclosed in varying degrees in the fine print of regulatory filings.

When Enron collapsed, it erased $63 billion in shareholder equity, including the life savings of many of its employees. The financial mastermind, Jeffrey Skilling, is serving a 24-year prison sentence. Lay would be in prison, too, if he hadn't died.

No. 2: A not-so-independent auditor

In its final year, Enron paid accounting fees of $25 million to the Arthur Andersen company, but it paid even more, $27 million, in consulting fees. CPAs are supposed to be independent, but Andersen clearly was not.

Only a handful of Andersen employees were implicated in illegal activity, but prosecutors went after the company itself, especially when it emerged that Andersen was also auditing what would become the biggest accounting fraud in history, an $11 billion swindle at WorldCom. Tens of thousands of innocent Arthur Andersen employees lost their jobs when the company collapsed.

No. 3: Pumping up the revenue

The largest bankruptcy filing in U.S. history, at WorldCom, followed the largest accounting fraud, for which a court ultimately held founder Bernard Ebbers responsible, sentencing him to a 25-year prison term.

WorldCom had set public financial goals for itself during the 1990s technology boom that became impossible to meet. Failing to meet them, however, would have weakened the price of the company's stock. So Ebbers and other executives manipulated the books to inflate revenue. So did others, and the entire telecom industry was subsequently gutted.

Among the collateral damage: Citigroup (C, news, msgs). "There is no doubt that Bernard J. Ebbers, the founder and former chairman of WorldCom, was a top client for Citigroup and that his care and feeding were Job One at the firm," The New York Times wrote in late 2002. "Between heaping his plate with almost one million shares of hot stock offerings and raising billions of dollars from investors to fund his business, Citigroup worked to keep Mr. Ebbers happy."

New York's comptroller, in 2002, said Citigroup had a $679 million interest in helping WorldCom's stock price, although Citigroup disputed the accusation, according to Reuters.

No. 4: Shower power

Another emblem of the 2002 corporate scandals was a $6,000 shower curtain purchased, with company money, by Dennis Kozlowski. It was part of perhaps $400 million the former chief executive of Tyco International (TYC, news, msgs) was convicted of stealing from the company. According to news-media accounts, he is allowed three showers a week at the New York prison where he's spending a sentence of eight to 25 years.

Kozlowski's excesses included a multimillion-dollar birthday party for his second wife on the Mediterranean island of Sardinia. He was also accused of manipulating Tyco's financials to prop up the stock price, but his lifestyle wasn't hidden under a basket.

Tyco's shareholders in late 2002 included the Northern California Pipe Trades Pension Trust Fund and the IBEW Pension Benefit Fund, a national pension plan for the International Brotherhood of Electrical Workers.

No. 5: A loan, again

Adelphia Communications founder John Rigas was sentenced to 15 years for his part in his family's looting of the cable-TV company, which included taking more than $2 billion in unreported loans. Rigas was 81 when he was sentenced in June 2005, and the federal judge who presided at his trial said his punishment would have been far worse except for his advanced age and poor health.

Amid the barrage of scandals in 2002, Bush personally announced the arrest of Rigas, saying, "This government will investigate, will arrest and will prosecute corporate executives who break the law, and the Justice Department took action today."

A prominent victim: Weitz Value Fund (WVALX), which had the worst three months in its 20-year history from May to July 2002 because of investments in Adelphia and other telecoms.

No. 6: Wall Street, Chapter 1

Amid the numerous scandals of 2002, then-New York Attorney General Eliot Spitzer's victory over 10 Wall Street brokerage firms looked small. They agreed to fines of just $1.4 billion, but they also agreed to separate investment research from investment banking. It was Spitzer who released e-mails showing that Wall Street analysts were publicly touting stocks they privately regarded as trash.

Everybody knew so-called sell-side research is tainted, but Spitzer actually did something about it. His victory lead to the creation of independent research firms and made it possible for brokers' customers to get research beyond that provided by the brokerage houses themselves.

It was only the first punch from an ambitious politician who has since become New York's governor.

No. 7: Wall Street, chapter 2

One year later, Spitzer dropped a bomb on the mutual fund industry, uncovering instances of late trading and market timing at nearly a dozen fund companies that were designed to enrich the companies and their favored customers, including hedge funds. The fund companies agreed to nearly $3 billion in settlements, about half of that pledged to compensate injured shareholders.

Some of the fund companies were wounded fatally: Strong was taken over by Wells Fargo (WFC, news, msgs), and Pilgrim & Baxter disappeared into an insurance company. Putnam Investments hemorrhaged assets. MFS Investment Management and Janus undertook bold reforms and began to spring back fairly quickly.

But ripples from the scandals continue to spread. Directors of the Clipper Fund (CFIMX) declined to rubber-stamp a change in management and instead went out and hired new managers. High fees exposed in the scandals have been under relentless pressure ever since. The net effect was a healthy cleansing of the industry.

No. 8: The other mortgage mess

Before subprime lenders got into trouble, Freddie Mac did. The government-sponsored mortgage agency disclosed in 2003 it had misstated earnings by $5 billion, forcing the ouster of top management and a $125 million fine.

The other government-sponsored mortgage agency, Fannie Mae (FNM, news, msgs), reacted to the accounting scandal at Freddie Mac (FRE, news, msgs) by saying, in the words of Chief Executive Franklin Raines, "we didn't do any of these things."

Within months, however, Fannie Mae admitted serious accounting problems. By the time the dust settled late last year, Fannie restated earnings for 2001 through 2004 to show it earned $6.3 billion less than it had originally claimed. Its top executives, including Raines, were booted, and Fannie paid a $400 million fine.

Fannie is a perennial favorite of bond investors, as all mortgage bond issuers are, but it was stock investors who got whacked in the scandal. In October 2003, Morningstar called problems at Fannie "much ado about nothing" and reiterated its opinion the stock was worth $92 a share. It closed yesterday at $61.68.

No. 9: Sour milk

Italy's Parmalat got tripped up by U.S. regulators when it tried to float new securities in 2003. Auditors quickly discovered the milk company's books were all wet, showing a $4.8 billion bank account that did not exist and $15 billion of unreported debt that did.

Unfortunately, the discoveries came after the securities were sold. According to Moody's, U.S. insurers bought $1.6 billion in public and private Parmalat debt, including Pacific Life, Ohio National and John Hancock. The Boston Globe pegged Hancock's exposure at $117.2 million and added, "If Hancock posts a loss for the Parmalat bonds, it would be the third consecutive year in which the insurer, which is being acquired by Manulife (MFC, news, msgs) in Canada, took a hit from heavy investments in companies that filed for bankruptcy."

The other two deals involved Enron and UAL (UAUA, news, msgs), the parent of United Airlines.

No. 10: Martha's mess

No discussion of iconic financial messes can ignore domestic diva Martha Stewart.

The founder of Martha Stewart Living Omnimedia (MSO, news, msgs) famously sold 3,928 shares of a biotech stock, ImClone Systems (IMCL, news, msgs), one day before it crashed on bad news. Stewart was a pal of ImClone founder Samuel Waksal, and her broker also had Waksal's daughter as a client.

The brouhaha attracted so much attention because the sum involved, about $240,000, was what the media labeled "chump change" to Stewart, whose fortune was estimated at the time at $300 million.

She was convicted -- not of insider trading but of lying about the transaction. She spent five months in a West Virginia prison and six under house arrest. Then she went back on television.

She went back, that is, to displaying the decisiveness she displayed when she made the ImClone trade and then talked about it, including to Congress. Her critics would call it hubris. But the point is, it is an attribute of her character that is not and never was secret. Scandal needn't take you by surprise.