Scoping out scandal
KAREN GIBBS: Many of the men (and this is an all male club) accused of being the masterminds behind the financial frauds and scandals of the past decade are getting their day in court. WorldCom boss Bernie Ebbers has already been convicted and juries are meeting behind closed doors to decide the fate of Tyco chief Dennis Kozlowski and HealthSouth CEO Richard Scrushy.
Despite these high profile prosecutions, the reform pendulum may now be swinging in the other direction. Securities and Exchange Commission chairman William Donaldson announced his resignation this week amidst criticism he's been too tough on big business.
PBS Frontline correspondent Hedrick Smith has gone inside corporate America for a peek at how things really work. His Emmy Award-winning program "The Wall Street Fix" re-airs next Tuesday, and he joins us now in the studio.
President Bush wasted no time replacing Donaldson with Christopher Cox, a congressman who among other things pushed legislation making it harder for investors to sue brokerage firms.
What's the message being sent here?
HEDRICK SMITH: Well, I don't think there's any question that big business is going to be happy with the appointment of Christopher Cox. Business has not been happy with Bill Donaldson, who after all came from Wall Street, found and helped found a Wall Street firm, and I think they thought he was going to be a friendly Republican chairman of the SEC. He wound up by voting with the Democratic members many times on enforcement actions. He was certainly much more vigorous than his predecessor, Harvey Pitt, who got in a lot of trouble.
I think Chris Cox represents a swing back in the other direction. I think you're going to see the balance in the SEC change. As you said, he was an author of legislation to make it harder to file investor lawsuits. Business has been putting the heat on the White House and on the SEC, Chamber of Commerce, Business Roundtable, other groups, saying Donaldson and the SEC have been too tough. So I think there's a desire at the White House. I would have a question whether or not there wasn't a desire and maybe even a push from the White House to have Donaldson get out and get somebody who was friendlier to corporate America in charge of the SEC.
GIBBS: Where does the individual investor then come out in all of this? Are we still on the short end of the stick?
SMITH: Well, I think you do at least see, as you pointed out in your lead in, that some of the big CEOs at some of these companies -- Bernie Ebbers, Kozlowski, Scrushy, and the latest from Eliot Spitzer, the attorney general in New York, is Hank Greenberg, the CEO, now out, of AIG, the big insurance company -- he's looked into mutual funds -- I think it's watchdogs like that that are the protector of the individual investor. I mean Spitzer has been, he's found one industry after another, not just one company after another, but one area after another; finance, accounting, mutual funds, and now the insurance industry, which suggests that the problems are really very widespread. That's the protection for the individual investor, somebody who is an active watchdog. And that's why we need to see what Cox does as the new chairman of the SEC, whether or not he continues in that kind of Spitzer vein or sort of pulls back and takes it easy. But he's a deregulator by reputation and experience.
GIBBS: The position of CEO, it had been elevated to almost iconic status. It's getting a little tarnished now. Have you seen a change in the corner office?
SMITH: I don't think so. I think that you continue to see CEOs getting enormous pay, enormous bonuses. There's still controversy over whether or not pay is actually calibrated to performance. You see companies that are in trouble, not doing well, but nonetheless the pay bonuses and the stock options that they're getting are still very, very high.
I think the Sarbanes-Oxley bill, which was passed actually in part because of the WorldCom explosion, $11 billion fraud, inflated picture of the financial, of WorldCom being presented to investors. That helped trigger that legislation. I think now the CEOs have to sign documents saying, yeah, this accounting is correct. I think more important is going to be whether or not any of the CEOs in the trials that are either underway or coming up, if any of those people are convicted and are sent to jail, that will send a message that goes way beyond regulations, that you are not just taking a risk of a fine, you're taking a risk if you cheat on your books and you get caught and people in your company know about it. You can go to jail. People don't want to go to jail.
GIBBS: How likely is it that these CEOs are going to go to jail?
SMITH: I think there's a pretty high likelihood that Bernie Ebbers will.
I mean after all he's been convicted on multiple counts of fraud. So he's just facing sentencing. Who knows?
The claim is going to be in Scrushy's case at HealthSouth, and certainly the claim in public at least on the part of the two Enron CEOs was they didn't know about it, their underlings did it, and they really didn't understand all the technicalities of accounting. A little hard to believe. These guys are all known as very vigorous, hands-on, take-command, I'm the boss kind of CEOs. It's a little hard to imagine that something as important as the corporate books they weren't watching, because the corporate books determine their salaries, and they care a lot about their salaries.
So I think that's going to be tough for them to maintain, but it's also going to be tough for the prosecution to prove that they knew and they understood that they were violating the law. I mean the intent is a very important part of it. So the conviction of Ebbers is a very important breakthrough.
GIBBS: Now your documentary explores the role Sandy Weill's Citigroup and WorldCom CEO Bernie Ebbers played in defrauding investors of hundreds of billions of dollars. We pulled a clip where the WorldCom story and the stock begins to unravel.
(video package begins)
SMITH: Long distance prices were plummeting. Telecom hype had produced a glut of overcapacity. Some analysts warned investors to get out.
SUSAN KALLA: We came out with a call that said that the revenues are shrinking and that these companies are not going to be able to cover the cost of servicing their debt.
SMITH: And so you said underperform?
KALLA: We said underperform, which was sell.
SMITH: With WorldCom's stock tumbling, Bernie Ebbers was in trouble. The company was desperate for cash. Weill's super bank came to the rescue. Despite the telecom capacity glut, despite plummeting phone prices, despite Rubin's personal warnings, Citigroup led bank syndicates that sold investors $17 billion of WorldCom bonds.
COFFEY: In effect, you have the investing public giving money to WorldCom, which it then turned around and gave some, at least some of it to the banks, so that the banks' exposure from loans to WorldCom was either reduced or eliminated.
SMITH: When they're floating the WorldCom debt offerings in 2000, 2001, Citigroup and these other big banks have a financial self-interest.
COFFEY: Well, in addition to the investment banking fees, yes, some of the banks were looking to eliminate some of the exposure they had from their loans to WorldCom.
SMITH: And while Citigroup was limiting its own risk, its star analyst told investors WorldCom's plunging stock was now an incredible bargain.
MICKELIS: At this point, as the stocks are starting to really get hammered, I'm talking to my broker two and three times a day to see what kind of damage control we can do here. When WorldCom got down below $10, it was like, this is a big company. Our analysts are still feeling good about these companies. They still have strong buy recommendations.
SMITH: Then the bombshell. June 2002: Charges of massive corporate fraud from inside WorldCom.
COFFEY: We're not talking about a few pencils missing from the stockroom. We're talking about $9 billion of earnings that were suddenly wiped out. And the investment bankers have an obligation to look for the signs.
SMITH: The question remains: Just what did Citigroup know about WorldCom's bogus bookkeeping?
(video package ends)
GIBBS: Well, what did Citigroup know about WorldCom and did they pay enough of a price for their role in the scandal?
SMITH: I don't think there's any question that Citigroup knew WorldCom was in trouble. One of the reasons they were going back and financing, trying to find more money for debt financing for WorldCom was that they knew the company was in trouble. The stock was falling, but more importantly than that was all the mergers that Bernie Ebbers had been doing at WorldCom. He needed money to finance all of that. The bank certainly has indirectly admitted that it knew a lot; not only that bank, but JP Morgan Stanley and a bunch of other banks.
All together they've kicked up more than $6 billion to try to settle class action suits brought on behalf of the New York State Pension Fund and private investors and pension funds all over the country, California, Wisconsin, Florida. But these are peoples' retirement. They lost $2 trillion in the telecom bubble burst, several hundred billion on WorldCom. These are peoples' retirement that's going down the drain, and these pension funds have sued the banks and said, "Hey, you should have known and you did know and you floated the money to us. We bought your bonds on your say so because we trusted you as a bank, and our members' retirement is down the tubes."
And I think we get back to this question of whether or not fines to institutions work if the individuals running those institutions don't run a personal risk. If high-ranking people know that if they're defrauding the public, in effect stealing people's money in order to help Wall Street get richer or to get themselves out of a jam because they've taken the debt and they want to pass it on to somebody else, that the real deterrent here is jail. And I think the question there is, Sandy Weill has retired and most of those other people at Citibank have gone on to other positions.
There are a few mid-level people who have been prosecuted for specific things. Jack Grubman, who was the analyst at Salomon Smith Barney, was barred from ever doing anymore work on Wall Street as a stockbroker analyst, but he's back in the business advising, running his own consulting firm. He was levied a $50 million fine. It sounds like a lot of money. Grubman is probably worth $50-$60-$70 million. But Citibank in effect paid the fine because Grubman owed them $50 million, and when he got fined they wrote off the loan. So in effect they underwrote it.
So the point here is the place is awash with money, and it's very hard to impose tough enough financial penalties so people won't do this again.
GIBBS: Hedrick Smith, thanks for joining us.
SMITH: Thank you.
Importance of design
GEOFF COLVIN: This is my notebook computer. It's been a big success for Apple, and everyone seems to agree that a big reason is its design - it just looks cool. That's important - more important than it used to be. From computers by Apple to can openers at Target, superior design increasingly means big money for companies and for investors who understand the trend.
I spoke earlier with Marco Iansiti, a professor at the Harvard business school who teaches product development and the importance of design. He joined us from New York. Virginia Postrel is a New York Times economics columnist who wrote The Substance of Style: How the Rise of Aesthetic Value is Remaking Commerce, Culture, and Consciousness.
Virginia, who are the champion companies at using good design to really pay off?
VIRGINIA POSTREL: Well, I actually think the touchstone is one that we won't have any objects to talk about, which is Starbucks. Starbucks is not just selling coffee, not even expensive coffee. They're selling a multi-sensory, esthetic experience. You go into this place, you would like to be in this environment, and then the customers have created a social space because they like to be there, and then that extends the corporate strategy.
COLVIN: So it's that whole creation of the color, the design of the furniture, the placement, the whole experience.
POSTREL: Every bit of it. Everything the customer sees, hears, smells, tastes is supposed to say this is quality, and also it has a very specific sort of corporate identity, which some people don't like, and then people start competing coffee houses with a different esthetic, because esthetics is about meaning as well as other things.
COLVIN: Well, and it seems to have worked awfully well for them. Marco, you teach the world's highest powered business students about the role of design in product development, and I can imagine that some of them might be skeptical. Are they?
MARCO IANSITI: They're actually pretty excited about it. I think we've been at it for awhile. I think 10 years ago we had to work really hard and lift great weights to get people to pay attention, but I think right now we have a lot of evidence that design is just great business and it really helps companies differentiate themselves in all kinds of different ways, and the students are actually quite excited about it.
COLVIN: How do you get the students to appreciate the importance of it?
IANSITI: Well, there's nothing like talking about great products or putting a great product in front of them, or even better putting a really poorly designed product in front of them and showing off all the different frustrations. It becomes clear very quickly that these things are really important to customer satisfaction, which we teach them is pretty important in itself.
COLVIN: We have some products here, because FORTUNE recently published an article on the best designed products of 2004, and good design can mean different things to different people, and it really does. Now here is a product that was one of the champion products. These are bamboo plates. They're intended to be used only once. They're intended to be disposable. They're made from organic bamboo. They are more expensive than paper. They're about a dollar apiece. On the other hand, you can get plastic plates that cost even less than these. Virginia, why are these good designs?
POSTREL: Well, I think there are two reasons. First of all, to designers within the design community there's a big emphasis on sustainability and environmental values today, and so design students even are often evaluated in part on whether they include that in their projects. But what I really think makes this work is that it's beautiful. It's more esthetically pleasing than a plastic plate or a paper plate, so you're willing to pay more, even if you couldn't care less about the environment. And so it's a coming together of two things. First of all, the appreciation of beauty for its own sake, as opposed to just the function of being able to throw it away, and the other thing that I think designers are realizing is that the way to sell sustainability is not to sell it as a hair shirt but rather to sell it as something that's cool and sensorially pleasurable.
COLVIN: Marco, you were on the judging panel for these best products of 2004, and I gather that you particularly like these sunglasses with the MP3 player. Now, what makes them good design?
IANSITI: I think for once they're very innovative. People have been talking about wearable computing for a long time, and it makes it sound like Star Trek, and people have been trying to visualize computers on people as part of their clothing in various ways. I think what these people managed to do through their design is really to make it very natural and find something innovative and exciting that's comfortable to wear, that works well, that doesn't look like it's just a separate computer on something, but it's really integrated with the functionality of the sunglasses. It's an interesting concept, it's a new idea, and it's well executed, and they're cool, as you said before.
COLVIN: Well, coolness seems to enter into this quite a lot, but functionality too, as you mentioned. Now here's another product completely that was another winner on the list of best designed products. It's a glass that is insulated. I don't know if this comes through. I don't know if you can see it, but in fact this is a glass within a glass. It's a single piece of blown glass, but it's two layers, the inner glass and the outer glass. And as a result, even though it has hot coffee in it, the outer part is only mildly warm. It will keep the coffee hot for a long, long time. You can set it down on things, and since the bottom isn't hot, it doesn't condense and it won't leave rings and stuff like this. Highly functional, yet it doesn't have a single moving part. Marco, what makes this really good?
IANSITI: Well, again it's a wonderful idea. It's got great simplicity and performs a very useful function, and it's beautiful. And when you put all those things together, that makes it a great design.
COLVIN: Virginia, here's something that I don't know if you'd call beautiful, and yet it has something to be said for it. This is a new line from Tupperware that is sort of interesting. What's cool is if you take the top off, when you want to use it, you use it like this, but when you don't want to use it, when you want to store it or you don't have to fill it up, it collapses. It collapses like an old top hat, so that it's almost flat.
POSTREL: This is great for storing in kitchen cabinets. I sort of like this idea because my little plastic containers are always falling down on my head. But the other thing that's true of both the glass and the Tupperware container is that they're great examples of a trend that we've seen even in high-end appliances, like the Duet washer/dryer from Whirlpool, which is real technological or technical innovations, functional innovations, an insulated glass, a collapsible container, a washer/dryer that saves energy, saves water, but combined with the coolness factor. You want to play with the Tupperware thing, you know? If it doesn't work as a container, you can give it to your kids and they can use it as a toy. You want to look at the glass. It's beautiful. And similarly people will buy these washers and dryers who wouldn't buy them just to save energy or to save electricity, because they're cool.
COLVIN: Marco, what has changed in the business world that has made design strategically important to companies in a way that it didn't use to be?
IANSITI: Well, two things. I mean first of all you've had tons of failure due to poor design, poorly executed products. People have experienced pain as a result of bad design choices and under investment in this space. And the second thing is obviously the success stories. You know, everybody knows about Apple and what they've managed to do with design and IBM and other companies. Again it's the argument that it's good business, that actually when you solve design problems in an elegant way, when you do what Virginia said, which is follow trends in a way that's still exciting to consumers and it's differentiating for the company, it makes for a great business model, and the evidence speaks for itself.
COLVIN: Virginia, does this have something to do with a response to the commoditization of so many different things? I mean functionally a lot of products are virtually identical.
POSTREL: That's right. And they're really, this is a strategy that's an alternative to doing the low-cost strategy. The low-cost strategy is still out there, it's still going to be out there. There will always be people who just care about functional performance for the lowest dollar. But a lot of companies don't want to be in that space. They don't want to be selling commodities. So if you are Target and you have to fight Wal-Mart, you're not going to be able to do it on price. Give me a break. So what do they do? They differentiate in part on design.
COLVIN: And their can opener works the same as Wal-Mart's can opener, we presume, but it's cooler.
POSTREL: Right. Well, their can opener is probably an OXO can opener actually, which is another great company that started working on functional design, designing things with fat handles to help people with arthritis. And then it turned out that these were really esthetically appealing to people. So people who have no problem with can openers just like it because it's neat looking. But I talk in my book about GE Plastics, which is selling into, not to the consumer, but to the people who make the things for the consumer. And what they see is if you don't want to be a commodity producer, how much plastic can we sell you for how little, they need to innovate, so they innovate special effects plastics, colors, textures. They innovate color choice, they have all kinds of color management services that they offer. And all this allows them to make more money and allows their customers to make more money by differentiation.
COLVIN: Marco, one sign of the growing importance of design in corporate America is this fact that surprised me, which is universities now have more candidates for the MFA degree, Master of Fine Arts, than for the MBA degree, Master of Business Administration, the students you teach. Is this a good thing?
IANSITI: Thank God. I think it's a very good thing. I mean I think it's good to have an abundance of people that specialize in skills that really add values for design, and it's great to have more of them than the people managing. It's a wonderful thing. I mean it's good that there are more engineers than MBAs. I think that there are different roles for the different communities. And design is such a critical differentiator. It's really a pleasure kind of to see the design community and the design profession growing.
COLVIN: Virginia, what happens when esthetics become such a large and important part of what businesses do? This is unexplored territory. We really haven't been here before. What's going to happen next?
POSTREL: Well, there's some very interesting cultural clashes that you see within organizations. For example, I was at Procter & Gamble probably a year or so ago, where the CEO and some of the higher level people are very, they're emphasizing the importance of design and the importance of esthetics, not just design and function, but let's have a good package here that appeals to people. And yet this is a company that traditionally is based on research and marketing to find very traditionally mass advertising. So there is some culture clash there, and yet it's very compatible because all of this that we're talking about assumes product quality. All of this, we're not talking about putting a bad product in a pretty package. We're talking about high quality products in the traditional sense, but additional qualities being added to them, qualities of meaning and of pleasure.
COLVIN: It's a good point, because some of us have observed for a long time that the quality revolution of the past 15 years has raised the standard in so many product categories that most products are pretty good and pretty similar.
POSTREL: Absolutely. I mean the place where you can really see that is in automobiles, because we've had a couple of cycles where we've gone, you know, if you think about back to the 1950s, at that point people thought that the automobile had reached its quality peak and it was all about, you know, all about esthetics, tail fins. Then lo and behold, suddenly reliability and gas mileage became important, and we had this whole quality revolution, and suddenly everybody had to compete on that. And now even, I was just in a rented Kia for a few days, and it was a great car. I mean if you took that car back to 1970, people would think, wow, this is high quality, and that's probably one of the lowest quality cars on the market today.
COLVIN: It really has been a revolution, and it will be interesting to see where we go from here, but quite possibly at least a much better looking world ahead, yes?
POSTREL: I hope so.
COLVIN: Virginia Postrel and Marco Iansiti, thanks so much.
NEXT WEEK: Bull market godfather
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