San Diego The government's Enron prosecutors exulted last month that the guilty verdicts prove "no matter how rich and powerful you are, you have to play by the rules." Some TV talking heads are rejoicing that corporate frauds are on the wane. From now on, chief executives will be Mr. Clean, we're told.
Don't believe such nonsense. Actually, the business establishment is trying to fix the regulatory and court systems to make insider profiteering easier to pull off and more difficult to detect and prosecute. Next week, former board members of Peregrine Systems -- a San Diego fraud that rivaled Enron in brazenness -- are expected to file papers asking the U.S. Supreme Court to overthrow California's tough laws restricting insiders' ability to dump stock when they possess information the public doesn't have. The California Chamber of Commerce and other business groups earlier filed briefs supporting the former Peregrine insiders, who massively jettisoned their shares before the accounting hoax came to the surface.
Peregrine is just one example. State and federal officials are looking into more than 20 companies for possible backdating of stock options, or changing the date the option is granted so that it's at the lowest possible price. Executives and directors can thus maximize their profits when the shares are sold. In some cases, this odious practice may not be illegal, but it is certainly unethical. Most backdating occurred before 2002, when Congress enacted the Sarbanes-Oxley law to force companies to be more honest -- or less dishonest -- in reporting their results to the government and shareholders.
But now lobbying groups such as -- you guessed it -- the U.S. Chamber of Commerce, along with politicians who wallow in corporate largesse, are conspiring to get Sarbanes-Oxley emasculated or eviscerated.
Meanwhile, President Bush has quietly decreed that his national security advisor can exempt certain defense contractors from filing financial records required of other companies. Duke Cunningham must be grinning.
In truth, corporate fraud is growing, and pro-business pressure groups are trying to neuter those who would combat it. If these lobbying groups truly believed in free enterprise, they would welcome efforts to rein in white-collar crime because it interferes with the smooth functioning of free markets. But these groups don't honor Adam Smith, the father of capitalism; they honor Gordon Gekko, the crook in the 1987 movie Wall Street.
Like Enron, Peregrine was a hot stock because of phony accounting. Between 1999 and 2001, the software company falsely inflated its revenue by 40 percent, according to government investigators. Like Enron, it was trying to meet or beat Wall Street expectations each quarter. It used many tricks, such as keeping the books open long after the quarter ended and granting secret kickbacks to customers. In 1999 it began an accounting policy that was wholly misleading: it would record a sale when the product was passed to a distributor -- not when it was actually sold to an end user. But it was an inside secret; the public didn't know it.
The chief executive officer warned the board that to make quarterly numbers, sales had been borrowed from the future. The board was told that the company's accounting firm was unhappy, that it was harder to get away with such monkey business in the new regulatory climate, and that the company was doing poorly and was chronically short of cash. But the public had no idea that Peregrine, like Enron, was rotting underneath. News releases and official financial reports -- many approved by chairman John Moores -- kept telling the world that Peregrine was doing wonderfully.
While this was happening, board members were disposing of their stock. During the period of the fraud, Moores sold Peregrine stock worth $487 million. All told, he sold $650 million before the scam came to light -- almost all he controlled. In early 2000, the company's lawyers told the board members not to sell any of their stock because Peregrine was going to make an acquisition that would likely send its stock down. Despite this warning from the legal side, during three days of February 2000, the insiders jettisoned $194 million of stock, $177 million of that by Moores. Later, the stock was whacked when the acquisition was announced, just as key officials had expected.
Peregrine stock, which had hit $80, lost almost all its value when the ugly news hit. The company plunged into bankruptcy. Several officers were charged with criminal fraud; some have confessed. The bankruptcy court appointed a litigation trustee, San Francisco attorney Robert Friese, who sued the former board members. They had dumped by far the most stock before the collapse.
California law enacted in 1968 and strengthened in 1988 is clear on such matters. An officer or director who jettisons stock while possessing material information that the public doesn't have is vulnerable to a civil lawsuit and may have to cough up three times his or her profits. Friese had access to company records; there was no question insiders had sold off shares while having negative information the public knew nothing about.
So the directors' lawyers cooked up a novel defense: the case should be tried in flimflam-friendly Delaware, where Peregrine was incorporated. Almost 60 percent of Fortune 500 companies are incorporated in Delaware because of its coziness with cozeners. By contrast, last year there were 52 California companies in the Fortune 500, but only 7 were incorporated in their home state. In Delaware, aggrieved investors must prove that directors sold their stock because of their possession of material, nonpublic information. In California, plaintiffs have to show only that insiders dumped stock while having the material, nonpublic information. With Peregrine, that's easy.
San Diego's superior court, just like its city government, has given Padres majority owner Moores just about whatever he wants. This case was no exception. In March of last year, Judge Joan M. Lewis ruled that the case had to be heard in Delaware. Friese protested to the Fourth District Appellate Court. The state attorney general, noting that California laws are essential to prevent fraud in the state, sided with the litigation trustee.