Notes

Chapter 1

1. Hermanson et al. (1993), p. 3.

2. According to Giroux (2013, pp. 234–235), fraud involves four characteristics: a false statement or representation, knowledge that it is false, reliance by the person receiving the statement, and financial damages caused by the false statement. The Federal Bureau of Investigation’s (FBI) list of common fraud schemes includes telemarketing, identity theft, healthcare fraud, Ponzi schemes, pyramid schemes, non-delivery of merchandise, and counterfeiting (currency, drugs, etc.).

3. Gordon (2004), p. 207.

4. The most corruption-free cultures are Denmark, Finland, and New Zealand. See the Transparency International webpage (www.transparency.org) for the complete list and considerable information about corruption around the world. According to Google, the term “culture of corruption” first appeared in the 1950s and its use exploded in the last 30 years.

5. Freeland (2012), pp. 223–225.

6. Giroux (2004), pp. 2–4.

7. Frank (2012), p. 39.

8. Schilit (2002), p. 28.

9. Regulatory capture is an economic theory that the responsible agency works to benefit the regulated industry rather than the public interest—the reason they were created. That seemed to develop in the railroad industry, regulated by the Interstate Commerce Commission from 1887. Most recently, the Treasury Department and Federal Reserve seemed more interested in protecting banks than bank customers burned in the subprime meltdown. A more recent explanation from psychology is cognitive capture, in this case regulators having the same perceptions as the executives of the regulated industry. Hank Paulson was CEO of Goldman Sachs before becoming Treasury Secretary (with many senior regulatory executives with similar backgrounds). His reactions to crisis protected banks, but it is less clear if the public benefitted.

10. It is difficult to put Greenspan at the top of the villains’ list, given the arguably incompetent CEOs collecting hundreds of millions of dollars in compensation based on short-sighted greed that destroyed their companies and almost brought down world finances. Richard Fuld of Lehman Brothers and Jimmy Cayne of Bear Stearns come to mind (numbers one and three, respectively, on Portfolio’s list of worst CEOs ever).

11. Johnston (2012), pp. 77–89.

12. Johnston (2012), p. 82.

13. Giroux (2004).

14. Friedman (1970).

15. Friedman (1970), p. 3.

16. Rosenberg (2012), p. 81.

17. Strine (2012).

18. Strine (2012), p. 2.

19. Strine (2012), p. 2.

20. Strine (2012), p. 3.

21. Strine (2012), p. 3.

22. Strine (2012), p. 1.

Chapter 2

1. Smuggler Nation by Peter Andreas (2013) looks at the long history of smuggling in the United States, which started early, was pervasive and much more widespread than generally believed and continued in various forms throughout America’s entire history. Several founding fathers, including John Hancock, were major smugglers.

2. Chandler’s The Visible Hand: The Managerial Revolution in American Business (1977), winner of the Pulitzer Prize, brilliantly examines the rise of business beginning about 1790 in considerable detail. Although the book focuses on professional management including the importance of accounting, little emphasis is placed on corruption or fraud. Despite that, this book is the best historical overview of the importance of professional management.

3. Chandler (1977), p. 109.

4. Josephson (1934), p. 133.

5. Ambrose (2000), p. 320.

6. Livesay (2000), p. 29.

7. Chandler (1977), p. 109.

8. Chandler (1977), p. 179.

9. Brunnermeier and Oehmke (2012).

10. Gladwell (2005), p. 76 described the Warren Harding error thus: “Many people who looked at Warren Harding saw how extraordinarily handsome and distinguished-looking he was and jumped to the immediate—and entirely unwarranted—conclusion that he was a man of courage and intelligence and integrity. … The Warren Harding error is the dark side of rapid cognition. It is at the root of a good deal of prejudice and discrimination. It’s why picking the right candidate for a job is so difficult and why, on more occasions than we may care to admit, utter mediocrities sometimes end up in positions of enormous responsibility.”

Chapter 3

1.Chernow (1990), p. 351.

2.Chernow (1990), p. 355.

3.MacLeish (1933).

4.MacLeish (1933).

5.Investment Trusts (1929).

6.Seligman (2003), p. 66.

7.Hawkins (1986), p. 380.

8.Giroux (1996), p. 28.

9.A similar case occurred in the previous decade. Touche Niven (now Deloitte and Touche, a Big Four auditor) gave Fred Stern and Company an unqualified opinion in 1924. Like McKesson, Stern also falsified inventory and receivables, which were not audited by Touche. Stern’s lender, Ultramares Corp., sued Touche to recover the loan amount after Stern failed. The court found Touche negligent but not fraudulent (and therefore not liable), a victory for Touche but not for appropriate auditing procedures.

Chapter 4

1.Geisst (2000), p. 224.

2.Gladwell (2008), pp. 124–127.

3.Private equity firms (PEFs) are investment firms investing in companies using a variety of strategies (friendly or hostile takeovers, LBOs, venture—or vulture—capital). Like hedge funds, PEFs have a limited number of investors to avoid SEC regulations. Starting in the late 1940s, PEFs first boomed in the 1980s using LBOs and junk bond financing.

4.Stewart (1991), p. 219.

5.Small (immaterial) frauds at big companies (such as stealing inventory or cash or even embezzlement) are typically ignored in corporate reports. Thousands of such cases probably occur annually.

6.Noah (2001).

7.Government Accountability Office (2002).

8.Schilit (2002).

9.Zeff (2003a), pp. 189–205.

10.Cassell and Giroux (2011), pp. 177–183.

11.Cassell and Giroux (2011), pp. 180–182.

Chapter 5

1.King (2006), p. 162.

2.My personal favorite book on Enron is Kurt Eichenwald’s Conspiracy of Fools. It is longer than the rest and came out only in 2005; consequently, it has additional content as new information was made available. Other interesting books include Mimi Swartz and Sherron Watkins’s Power Failure: The Insider Story of the Collapse of Enron. Watkins, a vice president at Enron, was the insider. Also of interest is Bethany McLean and Peter Elkind’s The Smartest Guys in the Room. McLean and Elkind were journalists following the story for Fortune.

3.Profits on long-term contracts using historical cost are recorded over the life of the contract, roughly matching cash flows. All the expected gain can be recognized immediately using fair value. However, the long-term contract must be revalued every period, with the potential for either gains or losses as fair value changes. The unanswered question is which method provides the best measure of performance.

4.Rich Kinder started a new stogy pipeline company with William Morgan, becoming CEO. Kinder Morgan had a market value in 2013 of $36 billion and Kinder is a multi-billionaire. Apparently, a case can be made for slow, conservative growth free of complex manipulation.

5.McLean and Elkind (2002), p. 155.

6.When using the equity method, based on ownership of about 20–50% of a subsidiary, only the net amount (share of assets less liabilities) is reported as a long-term investment. Thus, it eliminates consolidating the liabilities (and assets) of the subsidiary. Joint ventures are usually 50–50 partnerships by two owners, each recording their share using the equity method.

7.Toffler (2003), pp. 62–63.

8.Missing the 60-day deadline is considered a significant event and usually requires a separate 8-K report and a Notification of Late filing on Form 12b-25 to the SEC, stating the reason(s) for the delay. This can be considered a red flag by financial analysts.

9.Cassell et al. (2012).

10.Giroux (2006).

11.Murphy (2012), pp. 92–93.

12.High-frequency traders now use robot trading to front-run large investors buying and selling on the NYSE and other exchanges, a new high-tech illicit practice increasing the cost of basic market transactions. See Scott Patterson’s Dark Pools (2012) for a more detailed analysis.

Chapter 6

1.McLean and Nocera (2010), p. 111.

2.After losing billions of dollars, both Fannie and Freddie became profitable beginning in 2012, in part based on tax-loss carry-forwards (which will continue for years). See Shawn Tully’s article in Fortune (2013).

3.Wessel (2009), p. 17.

4.A CDS pays off if the underlying debt instrument defaults. Designed to allow a creditor to hedge against default by paying a premium to the third party (an insurance company, for example), it remained an unregulated market. Naked CDSs were allowed, meaning buyers (basically speculators) did not have to own the underlying debt. The majority of the market (estimated at 80%) became naked CDSs. In addition, sellers often did not hold reserves against potential payouts.

5.Wessell (2009), pp. 173–174.

6.Barofsky (2012), p.162.

7.Barofsky (2012).

8.A common stalling tactic is to establish a task force or commission to spend months on a difficult issue (with as many pro-lobby group members as possible) and then fail to agree on a solution. Often the regulatory topic no longer seems urgent.

9.Murphy (2012), p. 111.

10.The Basel Committee on Banking Supervision (made up primarily of central bankers from major countries) in Switzerland created the Basel Accords, which focused on capital requirements. Banks are required to hold equity equal to 8% of their risk-weighted assets. Credit risk is divided into five classes, with Tier 1 capital presumed riskless (investments in Treasury securities and other sovereign debt, for example). The greater the risk, the more equity has to be held.

Chapter 7

1. It can be argued that smuggling within the colonies created a relatively free market within a highly regulated mercantilist system. The ethics of smuggling can be debated, but America had plenty of big-time smugglers.

2. Christensen et al. (2013), p. 3.

3. Anyone willing to slog through the notes of the Citi 2006 10-K would discover the previously noted securitization through special purpose entities (called special purpose vehicles) of $2.2 trillion laid out in an informative table by category. In addition, Citi also included a table on derivatives, totaling $29.3 trillion with almost $2 trillion in “credit derivatives” (mainly CDSs). In other words, the astronomical amounts that later shocked the regulators (and just amount everyone else) were in plain sight.