Those dethroned execs now doing the perp walk employed a slew of scams to siphon big money out of companies and investors, including self-dealing transactions, off-the-book partnerships, and company loans that they never intended to repay.
The reasons they were able to defraud companies and investors were surprisingly few, however. Boards were overly cozy with management. The fast-and-loose corporate culture of the 1990s boom lacked sufficient controls. And do-or-die pressures to meet unrealistic financial goals made it easy for some execs to rationalize putting ethics aside.
And then there was greed. "The opportunity to take money to meet your simplest needs or to meet your most extravagant needs is always present," says Carl Pergola, national director of the litigation and fraud investigation practices for accounting firm BDO Seidman in New York.
Pergola, a certified public accountant, has probed claims involving management fraud, employee embezzlement, and investment swindles at scores of companies. As the fraud investigator for the National Basketball Players Assn. -- the players' union -- Pergola also represents clients who may be victims of crooked sports agents and unprincipled investment advisers.
Sometimes, it's hard to spot the line between doing something wrong and simply being really aggressive. In fact, BDO Seidman's tax practice -- which is separate from Pergola's fraud unit -- has been named by the IRS as one of several accounting firms that may have helped wealthy clients set up what the IRS calls "potentially abusive tax shelters." (A BDO Seidman spokesman says the only issue is a disagreement with the IRS over the interpretation of tax law.)
Pergola's world has fewer shades of gray -- and plenty of things that companies can do to make it less likely that they'll turn into the next Enron or WorldCom. Recently, BusinessWeek Online's Eric Wahlgren chatted with Pergola about how companies can build a fraud-proof culture and how to keep potential fraudsters from getting in the door. Following are edited excerpts of their conversation:
Q: We've seen a lot of examples of fraud in Corporate America in the last year or so. Does any case strike you as most egregious?
A: For someone like myself, the only thing that's truly unique about what's happening now is that it's more on the public's radar screen. And that's because of the magnitude of certain cases. Certainly Enron and the effect it has had on shareholders and lenders really put fraud out there for the public. So probably Enron is the most significant. Not surprising to me, but significant.
Q: It seems like a lot of the individuals accused of fraud were celebrated not long ago as innovators or visionaries. What are the character traits of people who might be more prone to stepping over the line?
A: You often find that individuals who commit fraud have larger-than-life personalities. And they're very charismatic. They're often good leaders and can get people to move in a direction that they want them to move in. Certainly, the ability to be innovative helps when you're attempting to commit a fraud.
I think what we're seeing now is a much more sophisticated type of fraud. You have individuals who have access to an enormous amount of wealth, and by virtue of that, they have access to the best legal resources. They really can operate on the fringes of legality.
Q: Does a looser corporate culture, which became fashionable during the tech boom of the late 1990s, make it easier for fraud to thrive than when there's a more rigid corporate structure?
A: Humans can be weak. There's no question that in an environment that's more loosey goosey, there's a greater probability of fraud. When you see boards that maybe aren't entirely independent of management, or when you see management that has absolute power and a lack of transparency, you're more likely to see fraud.
Q: If you're a corporate director or a recruiter, how do you keep a potential fraudster from joining your company?
A: It's different for different levels of individuals. Assuming that top management is honest, then you're talking about having the normal controls in place. You perform background investigations. You communicate the importance of an ethical environment. You have a code of ethics and all the things -- proper internal controls, for instance -- that create an environment where fraud isn't tolerated.
But when you're dealing with top management, you have to do a very thorough background investigation. This is not your traditional database search that you would do on entry-level employees or middle management. I'm talking about hiring private investigators to look into the backgrounds and to interview former employers, former spouses, or former business associates.
There's a responsibility on the board's part to do a thorough investigation when hiring someone at that level because the risks are tremendous. No one should be given the position of CEO of a major public company without everyone knowing clearly what this person is about.
Q: Can incredible pressure or unrealistic goals push normally ethical employees to do the wrong thing? And if that's the case, what can companies do to reduce the temptation to commit fraud?
A: Unrealistic goals and overt pressures to achieve those goals often lead otherwise conscientious and ethical employees to do unethical things. If there's a demand that you meet budget, but the budget was set in an unrealistic way, people will become innovative. Sometimes they think they're doing...the right thing.
The way to avoid that is to have competent managers who set realistic goals. They need to communicate those goals, and they need to listen to their employees and understand what the challenges are. Managers need to help employees overcome those challenges as opposed to simply developing unachievable goals and putting undue pressure on them.
An environment where management's view is "do it, or you're out of here" can lead to fraud. And it's possible to manage a very effective and profitable business by setting realistic goals and giving the people the tools to achieve those goals.
Q: Can ethics be taught?
A: I absolutely think ethics can be taught. It needs to be taught. And I think it needs to be talked about more often. For instance, when you count your change, you need to notify the cashier not only if she underpays you, but if she overpays you. That's something my father taught me. Some people may think it's stupid, but I think it builds moral character. Some says it's found money. Well, it doesn't really differ that much from someone at a senior level in an organization figuring out a way to take money out of your pocket.
If you hold yourself to those high ethical standards, then you should hold other people to them. If we all start to deteriorate as a society by justifying virtually any means to acquire money as being appropriate, then we're in trouble.
Q: Despite all of these recent examples of fraud on a huge scale, a lot of corporate fraud probably occurs at a lower level -- people cheating on expense forms, stealing property, etc.
A: There's a vast amount of fraud that never hits the radar screen. Sometimes you have an environment where employees observe their superiors being fraudulent. For instance, the boss may abuse his expense account. If he goes out to lunch and his wife is there, he puts that through too. And the junior people observe what the supervisors are doing. It can permeate the entire organization. It becomes tacit approval for employees to commit a fraud.
For instance, you could rationalize that you weren't paid overtime when you thought you should have gotten it. So now that's your opportunity to say, "I'm going to take this laptop home. They're not going to miss it, and they owe me that because they didn't give me that overtime."
Q: What are other things companies can do to build a fraud-free culture?
A: In new-employee orientation programs there should be a component on fraud. Management should go over what the organization considers to be fraudulent behavior and what the implications are if you're caught. It might be cheating on your expense report or taking gifts from vendors.
Depending on the crime, the company might tell employees "not only will you lose your job but we will prosecute you." You very rarely see companies spelling out what's right and wrong, and what are the risks of breaking the law. It's very important that companies treat employees with fairness and equity. Whenever you take advantage of employees, you are handing them the sword of rationalization. And that's when employees are going to say, "O.K., now it's time for me to cut out my piece of the pie."
And the other point is that you should operate in a very professional way. The culture shouldn't be loosey goosey. You have employees. The employees have families. There are investors, lenders, outside professionals, and a whole host of constituents who have something at risk. It's a tremendous amount of responsibility. If you're in management, you must ensure that you have an environment that minimizes the opportunity for fraud to occur.
Q: What role do co-workers play in stopping fraud?
A: If the organization makes it clear that it will not tolerate fraud and provides a code of conduct that gives employees an outlet for reporting fraudulent behavior, then you're empowering your employees to bring fraudulent activity to the forefront.
The entity that it's being reported to should be independent of management. Because again, if ultimately reporting fraud gets back to the CEO or the CFO and the CEO and the CFO are colluding, you really are just going around in a circle.
Q: We've seen a lot of cracking down on fraud lately with a number of CEOs and other execs having been charged. Some of these guys may actually end up going to jail. Is this enough to keep others who might be in a position to commit fraud from doing it?
A: Frauds will always occur. It may be that frauds take a different form and shape, they may be of a different nature. But I can assure you, 10 years from now, we will find that thousands of investors have lost money in other schemes or frauds. [That] hasn't changed for decades.
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