Hodak Value

Well, my material on the Enron scandal is up on SSRN for review and critique. Warning: This is not the Enron story presented as morality tale. This is intended to provide graduate students practical information for evaluating business and regulatory policy.

Michael Jensen has been trying to open up SSRN to these kinds of materials, and encouraged me to submit this. This fully sourced material on Enron is for my "History of Scandal" class starting next Fall at NYU. I will be preparing other cases for this class in a similar format throughout the summer, including Credit Mobilier, the Erie scandal, Kreuger & Toll, etc.

This is the next evolution from a seminar I taught over the last couple of years on corporate meltdowns, taking it to the next level. I'd love to hear what people think.

Whenever I get down to Maryland, I'm re-exposed to the WaPo, often to my dismay at how a scandal sheet looks dressed up as a respectable paper. This morning, I was pleasantly surprised when I saw this story. Key paragraphs:

Congress passed a law, triggering a little-noticed worldwide war on human trafficking that began at the end of the Clinton administration and is now a top Bush administration priority. As part of the fight, President Bush has blanketed the nation with 42 Justice Department task forces and spent more than $150 million -- all to find and help the estimated hundreds of thousands of victims of forced prostitution or labor in the United States.

But the government couldn't find them. Not in this country.

Tony Fratto, deputy White House press secretary, said that the issue is "not about the numbers. It's really about the crime and how horrific it is...

"We have an obligation to set an example for the rest of the world, so if we have this global initiative to stop human trafficking and slavery, how can we tolerate even a minimal number within our own borders?"

It may sound kinda cheap to argue that so much tax money shouldn't be wasted on virtually non-existent problems if they exist at all. But I'm constantly mindful that those taxes were coerced away from us. We worked for it, and it went to someone else. By threat of violence. $150 million. How much forced labor does that represent?

The cases covered in my History of Scandal class are designed to highlight forces behind the evolution of our markets. But many of the questions I raise about the coverage of scandals apply just as well to non-business stories. Take the death of Kanye West's mother after plastic surgery in light of new findings that her semi-famous surgeon had DUI and malpractice judgments against him. Since the facts are presented without much context, this story provides the illusion of objectivity. But these facts are editorially selected to create a set of predictable inferences by the reader:

a) This guy was a bad doctor
b) Mr. West should perhaps have checked into his background before entrusting his mother to his care

The mainstream media is too careful to make those accusations explicit. They are, instead, taking advantage of their readers' hindsight bias to connect the dots. Of course, what the reader doesn't have in this connect-the-dots exercise are all the facts that either weren't selected, or were deemphasized according to the inverted pyramid model or reporting. Here are some facts I would have liked alongside the ones that were presented:

1) Was Ms. West's death related to the surgery?
2) If it was related to the surgery, was it related to actions or decisions made by this doctor?
3) If it was related to the doctor's decisions or actions, was he drunk or otherwise impaired at the time of the operation?
4) Is the number of malpractice judgments against a doctor (at least in the number this doctor has had) a reliable indicator of a doctor's competence?

The first question, which one might think is pretty important before a person's reputation is trashed, was sort of answered in 12th paragraph out of 15 in this story--there is no conclusive evidence that this doctor had anything to do with Ms. West's death. A negative answer to this question would, of course, make the rest of these questions moot, meaning that the "facts" selected for this story would be meaningless.

Let's say your boss walked into your office and asks you to backdate a letter so that a decision looks like it was made earlier than it really was. You don't feel perfectly comfortable with this, but you say, "OK." If you had stopped in your busy day to think about this particular act, and realized that neither you nor your boss would be personally enriched by it, and that the company and its shareholders may very well benefit from it, you'd probably wouldn't think it's such a big deal. You wouldn't think that you'd end up with a criminal conviction leading to up to 20 years in jail. But that's what basically happened to Stephanie Jensen.

Here is the prosecutorial logic. When someone says "OK" to her boss's improper request, that's conspiracy. 10 years. When one signs a letter that is ultimately used to misstate accounting results, even if you have no control over the accounting or understanding of the intricate rules involved, that's fraud. 10 years. Normally, criminal fraud requires that someone personally benefit from their deceit, but in securities law, any impact on disclosed financial results can be presumed to lead investors astray to their detriment.

Jensen is only lucky that she's not facing the full fury of post-Enron sentencing madness. The political appetite to punish what most sane people would consider marginal behavior became completely unhinged during the Enron/WorldCom scandal. Here is a taste of the unchecked attitude toward the sketchiest business behavior by Senator Leahy, Chairman of the Senate Judiciary Committee in 2002:

Today’s report includes a tough new crime of securities fraud, which will cover any scheme or artifice to defraud investors. Working with Chairman Sensenbrenner, we were able to retain the provision as I wrote it with a higher 25 year maximum jail term. That will cause scam artists to think twice. (Their emphasis)

One could only wish that congresspersons were held to anywhere near the same criminal standards. Unfortunately, the media promotes the political vanity that lawmaking is a noble exercise in power free from conspiracies, while business is a messy financial affair where conspiracies abound.

Larry Ribstein makes another excellent case for the fact that Jensen merely lost the criminal backdating lottery.

Isn't that what everybody wants?

No.

First of all "The Whole Story" is more boring than the story based on selected facts and biased interpretations. Any time a reader has a choice between a "whole story" and a "good story," guess which one they'll buy and which goes into the stack of unread manuscripts?

Second, "The Whole Story" is uneconomical to produce. Most stories are outlined based on facts that have already captured people's interest ("good story" facts) before they are written up. Once the story is outlined, the story-writers job is to get the interviews and documentary support before a deadline. The worst thing that could happen under deadline pressure is uncovering information that undermines the impact of the story by providing nuance or inconsistent evidence. So, given their limited time and energy under a deadline, how much time will a writer spend chasing down the "other side" of the story, even if contrary evidence is left in their inbox? Especially if that evidence will be met with skepticism by the reader, anyway?

Third, "The Whole Story" is impossible to obtain. Even if a journalist had plenty of resources and time, and they were able to amass all the information into a plausible time line with all of the player's motives candidly volunteered in a blizzard of interviews, it would not be the whole story. Every historical event or figure has an almost unlimited amount that can be written about them. A historian tracking a recent event, where all the players are still alive, will invariably miss witnesses who have no incentive to volunteer their version, which may offer a valuable perspective. A historian tracking a distant event or figure will invariably miss a welter of material that might have provided key insights. Every time we discover a cache of letters by the relative of some major historical figure, we end up with a new take on the past.

Of course, most people producing words and images for mass consumption aren't even trying.

I believe that most scandals have perverse incentives at their root. In the case of Health Net canceling the policies of ill patients, the incentives had an intended effect, but they couldn't survive the sunshine rule:

During arbitration, Bates' attorneys produced internal company documents that showed that Health Net was rewarding employees with bonuses based on the number of cancellations they got.

Employees were asked to meet cancellation quotas and were also rewarded based on the amount of money they saved the company. Bates' lawyers argued that Health Net had saved more than $35 million by rescinding policyholders between 2002 and 2006.

Mrs. Kroes has emerged as arguably the world's most-feared antitrust enforcer.

Mrs. Kroes announces big fines -- €329 million on a cartel of zipper makers, for example -- with relish at news conferences and denounces with bombast corporations she believes are trampling consumers.

While U.S. regulators are more likely to wait and see what happens after a company becomes dominant, Mrs. Kroes is predisposed to pre-emptive action. If a company is "just blocking competition, then at the end of the day, there will be a type of monopoly," she says.

So, Eliot Spitzer has had to publicly apologize for having sex with someone who wasn't his wife. For money, that is. The pandemonium has begun, because everyone knows that sex-money-politics is the very best headline-grabbing mix.

Like most places, johns are rarely prosecuted in New York, according to Michael Bachner, a former prosecutor in the Manhattan District Attorney's Office:

To the extent Mr. Spitzer is charged it would likely be under the Mann Act, which prohibits transportation of people across state lines with the intent to commit prostitution.

But "the Mann Act really was designed more towards those who get someone to travel against their will," Mr. Bachner said. "If Spitzer gets indicted, it would seem to me he would be indicted based on who he is rather than what he's done.

Those who frequent prostitutes are very, very rarely the subjects of a federal prosecution when clearly it's commercial and consensual."

As for possible state charges, he said "customers are rarely prosecuted in the state" and charges that are brought are typically disposed of with a plea to disorderly conduct, "which is akin to a traffic ticket,"

Here is what I'd like to see instead.

"I hope the arrest can ease the minds of some in the community," District Attorney Jim Woodall said.

I'm reminded by one hilarious, braided commenter: "If this is how the DA treated three white Duke lacrosse players, I don't even know what he woulda done to my black ass."

Update: One of the suspects in Eve Carson's murder has now also been charged with the January murder of Duke student Abhijit Mahato. He's the second person who has been charged with that murder. Two people charged with the same murder, you say? Yea. That's what I'm wondering.

What began as a story about an abusive Mormon sect is quickly turning into a one about abusive Texas authorities. So far, 416 children have been shorn from their mothers on the rationale, or perhaps pretense, of protecting them. The state says the children were abused; the adults and the children say they weren't. The judge, in a court proceeding that unflatteringly evoked the Wild West, ordered the children be placed into foster care.

Here is what a psychiatrist testifying on behalf of the state had to say:

He also conceded that the children, taught from birth to believe that contact with the outside world will lead to eternal damnation, would suffer if placed in traditional foster care.

"If these children are kept in the custody of the state, there would have to be exceptional and innovative programmatic elements for these children and their families," he said. "The traditional foster care system would be destructive for these children."

CPS (Child Protective Services) spokeswoman Marleigh Meisner said the department was pleased with the judge's ruling and believes that the children will now be safe.

BTW, as soon as the story broke, I was skeptical about "Sarah," the 16 year-old girl who made the call from the ranch triggering the Texas raid. The size and scope of the raid seemed disproportionate to the nature of the call, even as bad as that was. Once the raid was completed and they claimed not to have found "Sarah," it began to smell like the WMD justification for Iraq. At this point, it's becoming ever clearer that "Sarah" was a hoax. My bias against conspiracy theories tells me it's unlikely that the hoax was perpetrated by the state, but I wouldn't be surprised if, like the WMD justification, neglect combined with an itchy trigger finger such that proper skepticism--or any sense of restraint--failed the authorities.

Finally, I tend to give more credence to reports about the action from people close to the action:

Local opinion on this is kind of mixed. By and large, people are in support of breaking up a group that was engaged in the systematic sexual abuse of teenage girls. People also have some real qualms that the state went too far in taking all the kids.

I can't imagine why the state took all the boys. I haven't heard anything indicating any boys were abused, but the state argues that they were being raised to be abusers. I'm not sold that this meets the legal standard for "harm or imminent risk of harm."

I don't know why the state separated the kids from their mothers. I haven't heard anything indicating the mothers were abusing anyone.

Its rather odd that we now have the purported victims suffering and/or in custody (mothers and kids) while the perpertators (the men) are still walking around free.

There are almost certainly severe due process problems going on in the hearing on all this. The kids aren't getting individualized hearings and the hearing itself are a total clusterfuck.

The gossip is that the judge is pretty much taking the state's side in all this.

This from a recent BBC report

Mr Fritzl reportedly criticised media-coverage of his case as "totally one-sided", and added that he was "not a monster".

"Without me [she] would not be alive anymore... I was the one who made sure that she was taken to a hospital," Mr Fritzl said.

"I could have killed all of them - then nothing would have happened. No-one would have ever known about it," he added.

Fritzl's attempt at defending his humanity strongly reminded me of the following quote attributed to another man captured just a few miles from Fritzl's home:

My name is Franz Ziereis, born 1903 in Munich, where my mother and brothers and sisters are still living. I, myself, am not a wicked man...

The inmates had to haul stones until they collapsed, then they were shot and their record was annotated "Trying to escape". On 30 April 33, inmates of the camp office were ordered to assemble the court yard. There they were shot like wild animals by SS Oberscharfuehrer Niedermeyer and the Gestapoagent Polaska. Altogether, as far as I know, 65,000 inmates were murdered in Mauthausen. In most cases, I myself took part in the executions.

ABC News answers the question: How divergent can a headline be from the content of a story? When it comes to CEOs, the headline and story apparently don't have to have anything more than the flimsiest connection. Here's a recent headline and lede (and accompanying 'fat-cat' photo):

Hard-Charging CEO Rakes in Millions
Blankenship Earned More Than $23 Million in 2007

The CEO of the country's fourth largest coal company raked in more than $23 million in 2007.

And here is the last paragraph:

Blankenship receives the lavish perks that many CEOs are accustomed to, such as the use of the Massey corporate jet, which cost the company and its shareholders more than $180,000 in 2007.

So, this story is clearly about how much money a CEO made, right?

Well, the entire rest of the story, completely sandwiched between the first and last paragraphs, was about this CEO funding a lavish trip and election campaign for a state supreme court justice. The actual lede, buried two-thirds of the way into this story is this:

Fellow justice Larry Starcher told ABCNews.com he believes Blankenship has effectively bought himself a seat on the Supreme Court of West Virginia.

It's becoming increasingly clear that this was the approach taken by Texas CPS in the FLDS raid that took over 460 children away from their mothers. What reason was there for this?

Joseph and Lori Jessop...said they didn't know where the state had sent their 4-year-old daughter and 2 1/2 -year-old son, but as a nursing mother Lori Jessop has been allowed to care for her infant son, who is in a foster care facility in San Antonio, during the day.

Joseph Jessop is 27, and Lori Jessop is 25, according to court documents. They're not in a plural marriage and lived in a single-family unit at the Yearning For Zion Ranch.

Update: A Texas court of appeals has spanked CPS, and restored a sense of semblance to this travesty.

The headline pops, and I'm trying to evaluate this statement well below the lede:

"None of the parties who entered into the settlement agreement has acknowledged any liability or wrongdoing and each made their contribution solely to facilitate a settlement," Cablevision senior vice president Charles Schueler told Reuters.

On the other hand, few if any backdating cases resulted in shareholder harm. And the law firm prosecuting this case is as known as Milberg Weiss for going after high-profile corporate cases, often after the same defendants, where the distinction between legitimate and nuisance lawsuits is very fuzzy.

Would a company pay out $34 million to make a high-profile lawsuit go away and eliminate the risk of a jury trial? Could happen. The point is, we don't know, but most of the readers of this headline would profess to have a certain knowledge.

Quiz: What's the difference between

versus

Answer: In Medieval times, the person first had to have been convicted of something before suffering gratuitous humiliation

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I'm preparing for my next semester of "History of Scandal," and considering Rudy Giuliani's unique contribution to this history--the "perp walk." Today, a couple of other Wall Street desperadoes were handcuffed, and marched to the courthouse to face arraignment because, you know, they wouldn't have just driven there with their lawyers by appointment.

The WSJ Law Blog also raises the issue, and gets some very interesting comments. My favorite:

I thought the perp walk was low and thuggish when I was a prosecutor, and I think so now that I’m a defense attorney. In almost every one of these cases the defense lawyers know that the indictment may be coming and have offered to surrender their clients at a time and place of the prosecution’s request. Prosecutors who think that unnecessary arrest is a legitimate tool will ignore this. (In fact on a couple of occasions I’ve been able to learn of the issuance of the warrant and sneak my client in to the U.S. Marshal’s office in the courthouse to spoil the prosecutor’s little show.)

You’d be surprised at how low prosecutors and police will sink. My partner had a client who was to be arrested (naturally, on a Friday morning so they could keep him for the weekend.) The police and DA Investigator showed up at his house. They had tipped off the press, but the reporter and photographer were late, so they had already put the client in the police car. So they took the client out of the car, walked him back into his house, then turned around and walked him back into the car so the press could take pictures. Of course, the press never reported that — because a pathetic abuse of power by police is not newsworthy compared to juicy pictures.

At first, I thought their headline "Mugabe's remarkable comeback" was an Onion story. In fact, it was a BBC story that somehow managed to write about Mugabe's brutal suppression of democracy with a sense of awe.

It has been done with great brutality, but Robert Mugabe has achieved an extraordinary turnaround here.

I'm sure I could come up with numerous other parallels, but it wouldn't be long before I Godwin the post.

Yesterday, the Department of Justice announced a round-up 21 children who were being prostituted in the United States. Few things evoke more horror than the idea of children in sexual bondage, and few things worth celebrating more than their release from that horror. It seems rather petty after such a success to ask "at what cost?" But the question is not just about cost in dollars (answer: about a quarter million dollars per child saved), but a question of cost in credibility of our government.

In 2001, the State Department estimated that about 45,000 to 50,000 people were trafficked in the U.S., defined as the use of force or coercion—violent or psychological—to exploit a person for commercial sex or the recruitment, transportation, or provision of a person for any form of involuntary servitude, debt bondage, or slavery. This is horrific stuff, especially in the "land of the free." This report came out in the midst of one of those "white slavery" panics that has periodically gripped western nations.

By 2003, the State Department estimates had dropped to 18,000 to 20,000, later to be further revised to 14,000 to 17,500. The attorney general later grudgingly admitted that even those estimates were likely too high.

These continual downward revisions, where the government ends up with a new high that was below the prior low, is not because the government has ferreted out tens of thousands of cases. The total number of sexual slavery cases identified by the government since 2000 through the end of last year has been 1,362.

Given the increased incentives since 2000 for government agents, and for the sex workers themselves, to characterize individuals as "sex slaves," even this 1,362 number is cast into doubt.

Lesson #1: It's OK to take money that your boss gives you, but you better be willing to fight for it if the AG doesn't like it.

Spitzer was basically suing Grasso for accepting what he was awarded. Grasso was given several opportunities to settle the case. He was, in fact, willing leave about $48 million behind to the NYSE, but Spitzer said it wasn't enough. So Grasso fought for it all under the quaint notion that his bosses, the board, awarded him his pay, and so he was entitled to it. Five years and millions of dollars later, Grasso gets to keep his money.

Lesson #2: If you want to avoid being sued, be a good friend of the DA

Spitzer's real complaint in this case would have been with the board of the NYSE by alleging that they weren't acting as good fiduciaries. But that would have meant suing the heads of Wall Street's major banks for not knowing what they were doing. Spitzer in his heyday would have no qualms about that, but it would have been tough to argue that people like Henry Paulson, then head of Goldman and now Treasury Secretary, Larry Fink, head of BlackRock, and Richard Fuld, head of Lehman, got all confused about the numbers. So Spitzer narrowed his focus to the compensation committee of the board. There, he had one committee member saying he knew exactly what he was doing, and another saying he had no idea what he was doing. Spitzer was able to thread that needle by going after the first guy, Home Depot founder Ken Langone, and gaving a total pass to the second one, fellow pol Carl McCall.

Lesson #3: The state will cause $12 worth of expense to recover $11.

Spitzer was trying to get back $110 million from Grasso. Langone said the total cost of litigating this thing for the defendants, the exchange, and former directors who were deposed approached $70 million. It's very likely that the state (i.e., New York's taxpayers) spent almost that much in prosecuting this thing.

I hear that Spitzer is now looking to start a private equity fund. I hope he gets better returns than this.

Ivin's suicide has been viewed from two distinct perspectives. The government stenographers posing as a free press, dutifully typing up the selected FBI leaks provided by their sources would have us all breathing a sigh of relief; the FBI cracked this case, and saved us from the domestic terrorist. The inquisitive, skeptical press would have us reserve judgment, which is what civilized people do, even if the government hadn't given us every possible reason to be skeptical of their claims.

The FBI says they will release the evidence shortly. I'll believe it when I see it. Or not.

Update: WaPo is finally allowing some expression of skepticism. Touch a hot stove enough times, you start to get the idea, I guess.

ABC News has finally noticed that the political conventions in Denver and Minneapolis will attract a large amount of prostitution.

Typical for the MSM, they get story all wrong. ABC appears to be implying that politicos draw sex workers in unusual numbers, but that was belied way down in the article itself--all conventions draw sex workers in proportion to the number of attendees.

What ABC missed, of course, is the irony that sex workers, who are offering an honest exchange of companionship for money, have to pretend to hide what they do (well, sort of). In contrast, politicians who are offering a corrupt exchange of favors for money get to pretend that they're doing something completely different.