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Can Trust Be Rebuilt?


Are we fools? Have we jeopardized our futures by buying into Corporate America's idea of a market-driven society only to be deceived by corrupt and unethical behavior on an unimaginable scale? As July 4 approaches, millions of Americans, already jittery about possible terrorist attacks, are now worrying about their financial security. With stocks sinking and the dollar swooning, they're wondering what they should do to protect themselves. They want to be safe. What they do in the months ahead will determine not only the course of the economy but also the political direction of the country.

Even President Bush, who has been reluctant to speak on the subject--and only then to blame individual "bad apples"--has broken his silence on corporate corruption. "I am deeply concerned about some of the accounting practices that take place in America," he said at an international meeting in Canada. Bush called revelations about WorldCom's (WCOM) bookkeeping "outrageous" and vowed to "fully investigate and hold people accountable....There is a need for a renewed corporate responsibility in America."

Well, yes. The simple truth is that people are walking around in a state of shock this summer. Talk to them on the beach or on the road, and they are anxious, angry, and not sure what to do. It has never occurred to them to question the basic truthfulness of companies or their corporate leaders. That trust is now coming undone. It was one thing to see the blowup in dot-coms as an anomaly. Even Enron Corp. could be perceived as a rogue. But the daily drip of scandal is spreading to all parts of the corporate scene. At Tyco International Ltd. (TYC), there are major accounting problems and its CEO is charged with cheating on sales taxes--even tampering with evidence. There's Merrill Lynch & Co. (MER) paying $100 million in fines for misleading investors. People scratch their heads at mainstream companies such as Stanley Works (SWK) trying to evade taxes by setting up sham headquarters in Bermuda. (Ordinary taxpayers know they must make up the shortfall to pay for homeland defense and education.) They see trusted companies such as Merck & Co. (MRK) booking questionable revenues. Finally there's Martha Stewart, the doyenne of domesticity, tarnished by allegations of insider trading and obstruction of justice. Martha Stewart!

The latest financial bomb--and potentially the most damaging to investor confidence--is WorldCom Inc. It may turn out to be the biggest fraud in American economic history--and the biggest bankruptcy. WorldCom appears to have sullied the one credible, true measure of company health left, cash flow, throwing doubts on practically all financial statements. Few companies ever used the esoteric strategems that got Enron into trouble. But all corporations use cash flow and earnings before interest, taxes, depreciation, and amortization (EBITDA) as a measure of well-being. If WorldCom could fake nearly $4 billion in operating cash flow (its auditor was none other than now-convicted Arthur Andersen LLC), then how can people be sure of any company? Where are the rest of the cockroaches?

So people everywhere are asking: Who and in what can you trust? Public confidence in Big Business is at its lowest since 1981, according to the latest Gallup Poll. Indeed, people are so alarmed they are poised to flee the markets entirely. The danger is that if investors and consumers run, they will take down the economy and the dollar with them. A growing buyers' strike in the stock market, the flight of money into housing, and the rising price of gold all indicate that the early stages of a panic may be building.

The timing couldn't be worse. The U.S. economy is showing signs of recovery. Momentum is building. Even corporate profits seem to be making a decent comeback. But the cloud over the credibility of all financial numbers is undermining investors' confidence in proclaimed earnings. Are they real or fake? By the fall, the economic upturn could be in full swing. But if the corporate crime wave leads people to pull back from the stock market, the economy could sink into a double-dip recession.

What worries Americans most is that they might find themselves stuck in a long period of stagnation, like the U.S. in the 1970s or Japan in the '90s: Growth would slow, jobs would become scarce, unemployment would rise, stocks would stay flat, families would suffer deep stress. For baby boomers facing retirement, this is a frightening prospect. Most have bet just about everything on a rising stock market to finance their old age. With their 401(k)s flat for the past two years and going nowhere fast today, fiftysomethings are scared.

Perhaps too scared. The U.S. is not Japan. Pessimism is so rife now that people are blinded to how much economic reform is under way. Japan was paralyzed for nearly 10 years, unable to cope with its problems. In America, an enormous cleansing has already started. Boards of directors are firing CEOs left and right. The turnover for chief executives has never been higher. The market is recalibrating, sending capital to companies with transparent, easy-to-understand financial statements while causing the rest to tank. Taking the hint, nearly 1,000 companies have restated their previous earnings, establishing more credible financial base lines. Pushing them along, the Justice Dept. has just given a death sentence to Arthur Andersen and is likely to teach Enron a severe lesson, sending a crystal-clear message about the consequences of corporate malfeasance.

More reform is on the way. On June 26, Securities & Exchange Commission Chairman Harvey L. Pitt, once the reluctant reformer, filed civil fraud charges against WorldCom. More important, he ordered the CEOs and CFOs of the 1,000 largest U.S. companies to attest personally to the accuracy of financial statements, starting with their most recent annual report. The New York Stock Exchange has also proposed new rules on corporate governance, requiring that a majority of corporate board members be independent and that shareholders get the right to vote on executive compensation (they are the owners, after all). The nonprofit Conference Board may soon propose an "oath" for CEOs to take, requiring them to sign off on a range of issues, from truthful auditing to clean accounting for stock options. The Senate Banking Committee just passed a tough accounting oversight bill that goes a good deal of the way toward reforming the accounting profession--and widespread outrage over the WorldCom fraud makes it much more likely that strong legislation will emerge from Congress. Even a few CEOs, such as Henry Paulson of Goldman Sachs (GS), are beginning to speak out, acknowledging Corporate America's credibility problem and demanding reform.

But will it be enough? The American people appear to be longing for a new Age of Reform, such as the one Teddy Roosevelt advanced at the turn of the century following a similar decline in public trust and confidence in the economic system. People want dramatic action before it is too late. They are shocked by the contrast between the values exhibited by working-class firefighters, police, and soldiers on September 11 and those on parade today by much of the Corporate Elite. They feel that many of the most wealthy, educated, and privileged managers and professionals in society have betrayed their fiduciary trust to the nation.

To most Americans, this goes well beyond being an ethical issue. The high-growth '90s, which generated so many jobs, was based on financial innovation and deregulation. Millions accepted, for the first time in their lives, the conservative argument that they could control their own destinies and prosper by tying their lives to the markets. They were convinced that they could manage the risks through better information and thus garner more of the profits as well.

It worked. From 1995 to 2000, a New Economy delivered enormous prosperity to millions of people. Huge productivity gains were made, pushing up real wages and creating opportunities for mobility. Now, people are discovering that, in the bubble years, starting around 1999 or 2000, some CEOs began to fake this information and corrupt the markets. Checks and balances failed, and professional accountants, lawyers, and analysts became greedy. The truth is that markets can work only if information is honest, rules of the game are clear, and people follow them. Realizing that this isn't the case today has left many Americans doubting their own futures and jeopardizing the future of the economy.

So are we fools? For the sake of the America's future, we had better not be. By Bruce Nussbaum


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