Last weekend EnduranceJay, GBates and I decided to absorb a little culture and attend a reception at SFMOMA (which included a fascinating Chuck Close exhibit). On the ensuing cab ride, our driver started talking about corporate governance/chicanery and, specifically, Enron. "Who could have seen that one coming," he asked?

Sammy W, that's who. Back in 2001 Sammy Dub implored me to buy puts on Enron ("It's a big hedge fund that doesn't make any money and is valued at a huge multiple of book") and I didn't listen because I couldn't make head or tail of the balance sheet.

I bring this up today because Ken Lay and Jeffrey Skilling are finally going on trial and will in all probability get their comeuppance.

Ironically, this is happening while Worldcom scumbag Bernie Ebbers is moving forward with appealing his 25 year sentence. Last year, I covered the issue of business ethics at length under the pseudonym "Jack Vincennes" for a sadly defunct website called "whatbubble.com", the brainchild of my buddy Jiggy Donuts. Whatbubble was an iconoclastic investment site which combined a mixture of analysis and bravado. I have included the full text of that article below, which manages to quote "Scarface".

TAKEN AT THE FLOOD

By Jack Vincennes

There is a tide in the affairs of men,
Which, taken at the flood, leads on to fortune

- Shakespeare

All I have in this world is my balls and my word and I don't break them for no one.

- Tony Montana

Before I get to this week’s column, let me first state how excited I am to be affiliated with this most excellent site. We have gathered here a first-class roster of talent commanding deep, battle-tested experience in virtually all facets of markets, asset classes and financial instruments. I am honored to join this stable of investment experts in what will, in time, be regarded as the very best independent financial website on the ‘net.

But as The Wolf from Pulp Fiction wisely intones, “Let’s not start sucking each other’s [members] just yet.” Enough self-congratulation, onto this week’s column:

This is a great country. Seriously, this country is set up so that with minimal effort you can do very, very well. What’s more, if you are privileged enough to earn your keep in the finance industry, all you need to do is work maybe 9-10 hours a day, exhibit some bare minimum competency, and keep your head out of your ass. That’s all it takes. After doing this for a few years, if you follow the above formula, you will soon find yourself eating the finest meats and cheeses, living in a nice crib, driving a sweet ride and dating hot chicks.

But guess what, slick?

This can all be taken away from you.

They can take away your bank account. Your AmEx platinum. Your Audi, your Park Avenue apartment. And if they take those away, the hot chicks will be gone faster than crack at Courtney Love’s place. If you don’t believe me, ask MC Hammer.

But here’s the thing: they cannot take away your honor. They cannot take away your balls, or your word, as Tony Montana so eloquently noted. That’s all you have in this world, ultimately. You have your reputation and your honor that you trade upon every single day in order to do deals, in order to command your partners’ trust, in order to make the mad Benjamins so coveted by the strippers at the Olympic Garden in Las Vegas.

As such, my word and my reputation mean more to me than my entire net worth – not because of some high-minded principle but because of the simple calculus that my word and my reputation represent the sum total of my future earning capacity as a finance professional.

And you should take the same attitude. Jealously guard your scruples and your reputation and do not ever compromise your ethics or your word. Strict adherence to this policy will pay dividends greater than any investment you will ever make in your lifetime. The ethics of the people who do business are truly the underpinnings which support the generous harvest of capitalism. Without ethical norms, the system would fall apart and we’d all be living like citizens of a third-rate socialist country.

Which brings me to Bernie Ebbers. Bernie, you miscreant, you worm, you little pubic louse. Bernie, you toadie, you coward.

Bernie Ebbers, for those of you returning from the deepest Congo, is the former CEO of Worldcom, a glorified pyramid scheme. As the Wall St. Journal noted in a prescient article in the late nineties, Bernie was practicing what Brealey and Myers describe as “the Bootstrap Game”.

(Richard A. Brealey and Stewart C. Myers’ “Principles of Corporate Finance” is the pre-eminent corporate finance textbook used at the finest business schools in the world. If you haven’t already: purchase it, embrace it, digest it. Know it cold, because the guy sitting across from you almost certainly does.)

Where was I? Ah, the Bootstrap Game. This neat little scheme involves a highly valued company which acquires smaller, slower growing companies which are not as highly valued. In terms of p/e ratios, a predator which trades at a high p/e (presumably due to high growth prospects) can issue stock to acquire a target with a low p/e and immediately accrete its (the acquirer’s) earnings per share, without having added any value at all from the acquisition. This can be repeated ad nauseum, resulting in accelerated earnings growth which (using circular logic) is used to justify the high p/e of the acquirer.

“But Hollywood Jack,” the alert reader will ask, “isn’t the target company a low p/e company due to its own low growth prospects, and won’t the integration with the acquiring company inevitably lower the long-term organic growth prospects of the overall business?”

Bingo. The Bootstrap Game only works for a time. Furthermore, it only works if you can keep up the pace of acquisitions. Ultimately, however, no matter how many times you slap lipstick on a low-growth dog, eventually the market will see the underlying growth for what it is.

Worldcom played this beautifully, although it was obvious to even the slow-witted mouth breathers at the Wall St. Journal that Bernie was playing the Bootstrap Game, and that this could not go on forever.

Fast forward to Q3 2000. The market for all stocks is tanking as the Fed’s Y2K-liquidity pop has diminished and the capital expenditure bust is beginning to work its way through the telecom industry. Bernie is facing margin calls on the debt he has unwisely placed against his stockholdings in Worldcom. Bernie needs that stock price to stay up, so he can keep banging hot chicks and eating caviar. So Bernie instructs Worldcom CFO Scott Sullivan to engage in accounting shenanigans (the substance of which is immaterial for this discussion – the very act of compromising the shareholders’, creditors', customers’ and employees’ trust is the issue) in order to prop the stock up for another quarter or two.

Well, you know what happened: the whole house of cards fell apart, with Worldcom declaring bankruptcy, stiffing bondholders and stockholders alike. (The fact that those same bondholders and stockholders should have seen it coming had they been diligent and alert is an issue for another day.)

Shady CFO Sullivan turned State’s evidence à la Sammy “the Bull” Gravano and Bernie Ebbers was convicted of 9 counts of conspiracy and securities fraud in the largest accounting scandal in U.S. history. During the trial, Bernie had the sheer gall to take the stand and claim that he didn’t understand the particulars of finance and accounting. The CEO of a company that, at its peak, was valued at over $180 billion and had made hundreds of acquisitions claimed that he didn’t understand basic finance or accounting that the average college sophomore business student has mastered!

“By my beard, Your Honor,” I would have loudly declaimed, “this halfwit isn’t competent enough to manage the bar at a tri-Delt mixer, let alone a NYSE-listed company! The prosecution moves to have the defendant doused in cat urine.” (Had I been a trial attorney I would likely have been disbarred, I imagine.)

Bernie abused the trust of his shareholders. He screwed ‘em. He screwed many people on the way up, selling them on the lies of the Bootstrap Game, and he screwed ‘em as it was falling apart, dumping stock to save his own ass. And if our justice system truly reflected what Plato referred to as the Form, or ideal, of “Justice”, Bernie would be hoisted up by the little pits he amusingly calls testicles and left to wilt in the hot desert sun.

But he will likely just go to country club prison, where he can serve out his term at his leisure. However, we now know, definitively, what his reputation, his word, his honor mean:

Nothing.

Bernie, you’re nothing.


“Hollywood” Jack Vincennes is a man of his word. His column, “Taken At The Flood”, will appear on a regular basis at whatbubble.com.