Infectious Greed (35 page)

Prosecutors persuaded several former Cendant employees to plead guilty to securities fraud, and—in exchange for leniency—they agreed to testify that, between 1995 and 1997, their supervisors had instructed them to manipulate accounting figures to increase profits.
¹³
With this testimony in hand, prosecutors indicted Walter Forbes on February 28, 2001, and he ultimately was convicted, not of securities fraud, but for conspiracy and making false statements to regulators. The Supreme Court rejected his final appeal in 2008.

The Cendant case was a wake-up call for government officials, who finally recognized that they would need to bring more criminal prosecutions in the financial area, to make up for the increase in fraud following the regulatory changes of 1994-95. As former SEC director of enforcement Richard H. Walker put it, “There is a growing awareness that committing a fraud by cooking the books results in the same, if not greater, harm than pulling up to a bank and putting a gun in a teller's face. But civil remedies and injunctions simply were not sufficient to achieve the kind of deterrence to stop people.”
¹⁴
For Cendant's investors, even a $3 billion settlement was too little, too late.

 

 

L
ike Walter Forbes, Dean Buntrock was not well-known. (Neither man had ever been mentioned in
People
magazine or
The New Yorker,
for example.) In 1955, Dean Buntrock was selling insurance in Colorado, when his father-in-law, Peter Huizenga, died. Buntrock had little business experience, but he was needed to help run his in-laws' family business, a garbage collection company called Ace Scavenger Service, which operated fifteen dump trucks.
¹⁵

Meanwhile, one of Buntrock's wife Elizabeth's cousins, Wayne Huizenga, had dropped out of Calvin College in Michigan and wandered down to Fort Lauderdale, Florida, where he purchased a garbage truck and began working a $500-a-month route. Within a few years, Wayne Huizenga had twenty trucks of his own, and he and Buntrock—cousins by marriage—decided to merge.
¹⁶
They named their new venture Waste Management.

The men borrowed a “tremendous amount of money” from banks and sold stock to the public in 1971.
¹⁷
During the next decade, they bought more than a hundred local dumping companies and landfills, and made generous political contributions. They won a city cleaning contract for Riyadh, Saudi Arabia, in 1976, and followed that with over a billion dollars' worth of contracts with major foreign cities. Over time, as hundreds of U.S. landfills closed due to environmental concerns, Waste Management's remained open. As state and local governments bowed out of the distasteful business of garbage collection, they effectively gave Waste Management a monopoly. As one company official, Phillip Rooney, put it, “Regulation has been very, very good for the business.”
¹⁸

Wayne Huizenga stepped down from Waste Management in 1984,
when he began a string of successful business ventures (the video rental company Blockbuster, which he sold to Viacom; AutoNation, the largest U.S. auto dealer; Boca Resorts, a luxury-resort chain; and a somewhat less successful stint as owner of several Florida professional sports teams).
¹⁹
Buntrock became chairman and CEO of Waste Management.

Under Buntrock's leadership, Waste Management's executives had been accused of every crime or infraction imaginable, from bribing local officials to denying competitors access to dumps to violating numerous environmental regulations.
²⁰
The company had been a defendant in seven antitrust cases, and had paid tens of millions of dollars in fines related to its illegal storage and improper handling of carcinogenic polychlorinated biphenyls (PCBs).
²¹
The phrase “No job is too dirty for Waste Management” stuck to the firm, yet criminal charges did not. Unlike some of its employees, the company—and Dean Buntrock—had never been convicted of a crime.

Given its aggressive approach to the law, it is not surprising that Waste Management—like CUC—began managing its earnings during the 1990s. The garbage business was becoming less profitable—in part due to a glut of dump capacity—and Waste Management sought to inflate its earnings and push expenses into the future.

Waste Management was assisted in its effort to manipulate earnings by its accounting firm, Arthur Andersen—the firm that Cendant's audit committee had hired to investigate CUC's books. Andersen had audited Waste Management for two decades, and it regarded the company as a “crown-jewel” client. During the 1990s, Andersen billed Waste Management $7.5 million for audit work, and another $18 million in other fees, including fees from Andersen's consulting business. During this time, Andersen and Waste Management built a close relationship. Every chief financial officer and chief accounting officer at Waste Management had previously worked at Andersen. Fourteen former Andersen employees worked at Waste Management during the 1990s.
²²

Beginning in 1994, Andersen auditors identified numerous adjustments they thought were necessary to correct misstatements in Waste Management's books. The firm had been pushing expenses into the future, much as CUC had done. Waste Management refused to correct the misstatements and, after some debate, Andersen's partners apparently decided that the problem was temporary. They signed off on Waste Management's 1994 annual report, but wrote a memorandum specifying the minimum
steps Waste Management “must do” to correct the problems. Andersen also identified Waste Management as a “high risk client.”

Notwithstanding this warning, nothing changed. As Andersen's auditors reviewed Waste Management's financial statements in 1995, they worried that Waste Management had not “taken the pill” yet. Waste Management had continued to roll forward its expenses. Moreover, in December 1995, it recorded a gain of $160 million by exchanging shares it owned in a limited partnership called ServiceMaster for shares of ServiceMaster's parent. It was merely a paper transaction—Waste Management retained the same economic interest in ServiceMaster after the deal—but company officials wanted to use this “gain” to offset accumulating expenses.

Accounting rules clearly prohibited the offset. One-time gains from deals such as the ServiceMaster transaction had to be separated from operating expenses, so that investors could get an accurate picture of the company and understand that it was losing money, generally, but had booked a substantial gain on one financial transaction.

However, Andersen concluded that even though the offset was improper, it was not “material” and, therefore, did not need to be disclosed. This interpretation was dubious at best. The legal test for whether information was material was whether an investor would consider it important in the total mix of information about the company. The $160 million offset was obviously important; its disclosure would have caused Waste Management's stock to plummet. Andersen officials wrote another memorandum, this time noting that they had “communicated strongly to WMX [Waste Management] management that this is an area of SEC exposure.” But Andersen nevertheless signed off on the firm's 1995 financial statements.

In 1996, Waste Management was even more aggressive. It continued to push expenses into the future and it netted other one-time gains against various expenses. It even conducted a “sweep” of its field offices, in which it asked controllers to try to find some extra reserves the company could claim as income. At the last minute, one day before releasing its earnings, Waste Management came up with an additional $29 million of such income—an extra four cents a share, which greatly pleased investors and analysts. Again, Andersen signed a statement that Waste Management's annual report presented an accurate financial view of the company.

As with Cendant, this sort of accounting at Waste Management didn't remain hidden forever. Rumors spread about the aggressive practices,
and Dean Buntrock stepped down in 1996. The next year, former SEC chairman Roderick Hills joined Waste Management's board and audit committee, and ordered a thorough audit, which revealed that the company had overstated its earnings by $1.43 billion, twice as much as Cendant had.
²³
In February 1998, Waste Management announced this finding to the public—the company had lost almost as much money as Orange County had lost a few years earlier. At the time, it was the largest corporate financial restatement in history.

Andersen again issued its unqualified approval of the firm's financial statements, which—this time, at least—were accurate. The SEC wasn't impressed, and fined Andersen $7 million for approving Waste Management's earlier, inaccurate financial statements.
²⁴

Like Cendant, Waste Management was sued for securities fraud, but Dean Buntrock wasn't indicted or found personally liable. His reputation suffered, but he did just fine financially. He had earned a salary of about a million dollars for several years, and had received huge grants of stock options (one grant in 1995 was for options on 205,505 shares). As one sign of Buntrock's wealth, he was able to donate $26 million to his alma mater, St. Olaf College, where the student center was now called Buntrock Commons. A St. Olaf philosophy professor said he planned to use the fraud at Waste Management as an example in class: “I'm not saying Buntrock did anything. But this issue would be a good one.”
²⁵

The Waste Management saga ended like a bad horror film, with the perpetrator rising from the dead to commit another wicked act. The plotline was similar: after a smaller garbage company, USA Waste Services, bought Waste Management in July 1998,
²⁶
the new executives failed to tell investors about yet another round of accounting problems. The company—still called Waste Management after the merger—failed to meet its earnings estimates, and the stock plunged from $54 to $34 in one day. The board of directors immediately ousted the new management and began yet another investigation, which revealed an additional $1.2 billion of charges. Was anyone really that surprised? The various cases and appeals were still winding through the courts in 2009, when shareholders were awaiting Waste Management III.

 

 

W
hen Sunbeam Corporation announced it had hired Al Dunlap in July 1996, the company's shareholders, directors, and securities analysts were
thrilled. Sunbeam's shares went up 50 percent on the day of the announcement. As far as investors knew, Dunlap was a master cost-cutter, with the credentials and credibility to turn the failing company around.

For Sunbeam, the key fact about Al Dunlap was that he had become CEO of Scott Paper, where he had earned the nickname “Chainsaw Al” by firing 11,200 people—one in three of the firm's employees. Scott Paper's stock was up, and shareholders loved Dunlap, even if employees didn't.

In 1996, Sunbeam was in the same predicament Scott Paper had been in a few years earlier. It was bloated and inefficient, and needed similarly radical reforms. To Sunbeam's board, Dunlap seemed like the perfect person to come in and start cutting.

They couldn't have been more wrong. Within two years, the board would fire Dunlap, the SEC would begin an investigation into massive accounting fraud at Sunbeam, and the company would be headed for bankruptcy. There would be numerous parallels to Cendant and Waste Management.

In fact, if Sunbeam's board had asked more questions about Dunlap's past, they might not have hired him at all. Dunlap's résumé had not listed the fact that Max Phillips & Son had fired him in 1974, or that Nitec Paper Corporation had fired him in 1978, allegedly for overstating profits.
²⁷
(In 1982, Nitec Paper filed for bankruptcy after some executives accused Dunlap of a massive accounting fraud.)
²⁸
Nor did Sunbeam's directors hear from executives who had worked with Dunlap when he ran an Australian firm called Consolidated Press Holdings; they alleged similar improprieties.
²⁹
If the board members had known how many times Al Dunlap had been fired, they might have found his eagerness to fire others suspicious.

In any event, Dunlap didn't disappoint the shareholders' expectations: he fired half of Sunbeam's 12,000 employees right away, and shut down numerous plants. These actions had substantial one-time costs, but the hope was that, with lower future expenses, Sunbeam finally would look attractive to investors and analysts.

At the end of 1996, Sunbeam took a huge one-time restructuring charge of $338 million. Executives padded this charge by $35 million, in the same way Cendant and Waste Management had padded their reserves. In accounting parlance, Sunbeam created a “cookie-jar” reserve. By overstating one-time expenses, it created a $35 million stash from which it could take a cookie when necessary.

In addition, executives front-loaded as many expenses as they could into 1996, in an effort to guarantee that 1997 would be a good year. For example, at the end of 1996, Sunbeam understated the value of inventory it was planning to sell in 1997, thereby guaranteeing that it would make more money when the inventory was later sold. It also recognized expenditures made for 1997 advertising as a 1996 expense.

In 1997, Sunbeam engaged in a variety of accounting games to inflate its income, including
channel stuffing
—stuffing its distribution channels with so many advance sales that there would be little revenue left in future periods. For example, just before the end of the first quarter, Sunbeam booked $1.5 million from sales of barbecue grills, even though it had promised the purchaser it could return any grills it did not sell (in fact, six months later, all of the grills were returned unsold).
³⁰
Sunbeam also began rewarding customers for agreeing to buy products before they needed them, so that Sunbeam could book the revenue earlier (again, purchasers had the right to return unsold products). Throughout 1997, even with these adjustments, Sunbeam just barely beat analysts' earnings estimates, by a penny or two per share. By the end of 1997, it appeared that even with all of the accounting games, Sunbeam's earnings nevertheless would “miss” analysts' estimates. Like Cendant, it was running out of schemes.