Then and Now: What Lerach Told Us

Plaintiffs' attorney William Lerach, long the scourge of Corporate America, was sentenced today to two years in prison for paying off witnesses. Years ago, here's what he told CFO magazine about his view of corruption in corporate finance.

Obviously, it was a confluence of events that got us to this point. But if you had to name the top three, what would they be?

Stock options, stock options, and stock options! They completely poisoned the system. Misaligning incentives and interests caused corporate managers to become completely focused on short-term results and do whatever was necessary to meet expectations because they were going to exercise stock once the window opened.

Who do you blame for that?

A terrible misjudgment was made in 1991 by the Securities and Exchange Commission. Under pressure from the corporate community, they changed the rule under section 16B of the 1934 act–the short-swing profit rule–which says that if a corporate insider buys and sells stock in six months, it is presumed to be on insider information, and the profit belongs to the company. It was a bedrock insider-trading preventative.

The SEC adopted a regulation that says for 16B purposes, a [stock option] purchase occurs when the option is granted, not when it is exercised–even though when the option is granted it is not vested, the executive does not have the ability to exercise the option, and the executive has no capital at risk. The practical impact of this is that options are granted, six months runs, options begin to vest, executives exercise the options at 8:01, they sell the stock at 8:01:30, they put the profit in their pocket. When people have the opportunity to pocket millions and millions of dollars–in some cases, hundreds of millions–without risk, what do you think they are going to do?

How personally liable do you hold the CEOs–and especially the CFOs–for the fraudulent activity that we’ve seen?

It can’t happen without the CFO. But what I find hysterical is the idea that the CEO didn’t know. The notion that Bernie Ebbers [CEO of WorldCom] didn’t know what [CFO Scott] Sullivan was doing is laughable. What strikes me as unfair, though, is that CFOs get so little out of it compared with CEOs. They are paid less, their options are less lucrative, and, frankly, they don’t sell [stock] the way that a CEO sells. In fact, when I investigate a situation, if I find significant sales by a CFO, that is a tremendous red flag.

How widespread do you think these scandals will get?

It really can’t get worse than this, can it? I love financial history, and often talk about 1929. And while I don’t want to predict anything like that, the rot then went on for years and years, and ultimately resulted in a buyer’s strike in terms of equities.

Do you believe the scandals and restatements will continue to be sector-based?

We just happen to be highly focused on energy and telecom at the moment. Watch next for the bad loans at the banks. Consumers and some companies are not going to be able to pay their debts. So we’ll see a cycle where the banks’ financial statements fall apart. What about pension accounting? How many companies are doing their pension accounting based on 8 or 9 percent annual returns? The chickens are going to come home to roost on that one someday, and companies will have to put tons of money into those plans, meaning they will have overstated their earnings for many years before that. Dishonest accounting cuts across all business sectors in time.

Discuss

Your email address will not be published. Required fields are marked *