Hindsight is 20/20.
Because the causal conjunctions that determine events are contingent, we are more often in a position to explain something that has happened than in a position to predict (in its entirety) what would or will happen. ImClone is a case in point. What happened is worse than anyone predicted. But you know what? I predict the ImClone story will be even more damnable. Perhaps the rest of the ImClone story will be even more damnable than the rest of the Enron story, which has recently revealed that Enron admits frauds.
We now know from the 217-page report from the Enron Corporation’s board that executives intentionally manipulated the company’s profits, inflated them by almost $1 billion in the year before Enron’s collapse. They did this through byzantine dealings with a byzantine group of partnerships. As oversight broke down, the Enron report says, a culture emerged of self-dealing and self-enrichment at the expense of the energy company’s 64,000 shareholders. The report harshly criticizes Enron’s accountants at Arthur Andersen and the company’s lawyers, saying they signed off on flawed and improper decisions every step of the way.
An Arthur Andersen executive testified before Congress about shredp. 115ding accounting documents at Enron. He said, “This policy toward document disposal reflects sound audit practice.”[6] On questioning the official, Congress learned that by “sound audit practice” the witness meant “financially healthy.” Obviously, Arthur Andersen has twisted the definition of financially healthy and uses the term sound audit practice in an idiosyncratic way. Arthur Andersen’s broadcast definition is obviously wrong. That fact exposes fraud on our language and raises serious questions about Arthur Andersen’s accounting integrity.
Subsequently, Arthur Andersen was convicted of obstruction of justice, and its license to do public accounting has been rescinded. Reality crashed down on Andersen’s head. Hard. The company is defunct.
Prescience is impossible, but intelligent analysis is not impossible.
It was impossible for the public to know the details of all these things before Enron collapsed. But it was possible to suspect something by analysis of content and actions. In 1999, when someone asked me if I would invest in Enron, my reply was that Warren Buffet, Peter Lynch, and I all say, “Never invest in what you don’t understand.” Since I didn’t understand Enron’s business, I wouldn’t invest in it. If you had had a chance to practice intelligent analysis on what Ken Lay (Enron’s CEO), Mendelsohn, and the likes of CFO Andrew Fastow said and did, you wouldn’t have invested in Enron either. You especially would not have invested in Enron if you knew about their conflicts of interest and their duplicitous behavior.
Conflicts of interest are unethical because it is almost impossible to prevent our love of power, wealth, and possessions from interfering with our judgment. Judges have to retire from the bench (recuse themselves) if a case comes before them in which their friends, business associates, or relations are involved, and countless precautions are taken in civil and criminal trials to eradicate personal prejudice.
There is a story about a Texan explaining to a man from Louisiana about communism: “If your neighbor has two houses, he has to give one to you.” The proposal met with immediate acceptance. “If he has two cars, he has to give you one.” Again happy agreement. “If he has two boats, he has to give—” That brought a stern interruption. “No way, José. You know I have two boats.”
Knowledge of a conflict of interest can help you uncover a hidden meaning and therefore lead you to a better understanding of the truth. The tip off that you are witnessing a conflict of interest comes from analysis of duplicitous behavior.
p. 116 Most cases of duplicity occur in situations of conflict of interest. Usually the person who has a fiduciary responsibility says one thing but does the opposite. For instance, at the time that Dr. Mendelsohn was talking about ImClone’s positive outlook for the future, according to the New York Times, he exercised options on 90,226 ImClone shares, sold those shares, and received $6.3 million. Subsequently, the Food and Drug Administration refused to consider licensing C-225 and ImClone’s stock went south. Bristol-Myers Squibb, the company that bought those shares from Dr. Mendelsohn, paid him $70 per share. ImClone shares were selling for $16.49 on Friday, January 26, 2002, when I checked them. On June 28, 2002, the shares traded at $8.02, and the headline for the stock said that Congress was investigating conflict of interest in ImClone directors, including Dr. Mendelsohn.
Principle: When there is a conflict between what a person says and what he does, what he does is more likely to point to the truth. In other words, actions speak louder than words. The evidence of action is more powerful than the evidence of words. For this reason, the Latin motto of the Royal Society of London, one of the world’s great scientific institutions, is Nullius in Verba (Take no one’s word for it).
From which follows:
Lesson: When people in authority say one thing and do another , watch out. Uncover the hidden meaning of their contradictory action. By analysis of duplicity, predict what trouble’s coming. And as always, act accordingly. Furthermore, consider the possibility that duplicitous behavior is evidence of bad character.
From which follows:
Lesson: Listen to what people say, but also check what they do. If what they say and what they do don’t match up, consider what they do as stronger evidence of the truth. Any duplicitous behavior is evidence for fraud, hypocrisy, insincerity , or stupidity—one, all, or any comp. 117bination of those four things. Try to profit by using evidence of duplicity to evaluate character. Once that character analysis is done, act accordingly by predicting future trouble.
Duplicitous character usually runs true to form. That’s reasonable and probable. Always bet on the reasonable and probable because they are what usually happens.
If you discover, after you get home, that the one pound of chuck chop that you bought from the corner butcher actually weighs 0.8 pounds, you can bet that the same butcher will have his same thumb on the same scale again next time you attempt to buy the same thing from him.
If Dr. Mendelsohn was on the inside of ImClone when the public and the employees were getting screwed, would it have been possible (from that fact) to predict his behavior as a director of Enron?
Make predictions based on character analysis.
Knowing what you do about Dr. Mendelsohn’s public statements and the evidence derived therefrom of his character, can you predict how he functioned as a director of Enron?
Go on. Take a guess. Pause now to formulate clearly your guess about Dr. Mendelsohn’s behavior as an Enron director.
Answer: As a member of the Enron board of directors, Dr. Mendelsohn was active in many of the board’s most controversial decisions—the approval in June and October 1999 of the partnerships with the company’s chief financial officer at the time, Andrew S. Fastow. Dr. Mendelsohn also figured in the Enron board’s decision to suspend Enron’s own code of ethics so Mr. Fastow could serve as the general partner of the partnerships that led to Enron’s implosion. Dr. Mendelsohn was also a member of the Enron audit committee that dealt with Arthur Anderson’s highly questionable audits of Enron.
See how a short analysis of this man’s statement suggested that ImClone and Enron might be headed for the shoals? See how knowledge of hidden meanings might have helped you not invest in Enron?
Not convinced? Need further examples?
Ken Lay, former Enron CEO, touted Enron stock to his employees and to the general public at the same time that he was selling his Enron shares. In fact, employees were led on to the very end while executives were selling like crazy. Was that duplicitous? You bet.
p. 118 Aristotelian logic: Two contradictory things cannot be simultaneously true. Therefore, one or the other must be false. Either Enron stock was good, the way Ken Lay said, in which case buying the stock would be good. Or the stock was bad, in which case selling the stock would have been the thing to do. The truth, we now know, was that if you knew what Ken Lay knew about Enron,
you would have been selling your stock too, just the way he did.
Yes, Ken Lay spoke with forked tongue. Ken Lay advised one thing while he was doing the opposite, which led to his own personal profit and helped him. But it also led to losses and harmed the public.
Although this was a breach of fiduciary duty, Ken Lay’s behavior was, on a psychological level, understandable. He was on the take. So were the accountants, on the take. So were the other Enron officers, the Enron board, the attorneys who advised the corporation, the politicians who supported legislation favorable to the company, on the take. They were all, in one way or another, on the take. Their loyalty to the company was bought.
Their actions were understandable—but not excusable. In fact, their actions were forms of self-preservation. Human nature dictates that we take care of ourselves. It’s normal human nature that Ken Lay didn’t have the same concern for his employees or Enron shareholders that he had for himself. Given his character, as shown by his actions, to expect him to do otherwise is to expect the impossible. (From someone else, Mother Teresa, for example, we might expect more, but from Ken Lay, no.)
The same instinct that protected Ken Lay encourages a tigress at bay to fight until she drops. Ken Lay’s was a basic instinct to attempt to keep his own fortune intact. Self-preservation, the law of the jungle, is so basic an urge that it exerts a profound influence on behavior. It can even cause unprofessional conduct, breach of fiduciary duty, and criminal acts. Whenever there are conflicting interests where a party has a personal stake in outcomes, watch out.
The indicated action to prevent future Enrons is institutional controls to prevent conflicts of interest, fraud, double dealing, and so on. Here we are more concerned with what we as individuals should do or should have done to prevent personal investment losses. What investment action would have been reasonable if stockholders knew at the time of Ken Lay’s duplicitous behavior?
Confidence in an investment rests on the belief that directors and managers will be truthful. When you catch the CEO in a lie, watch out. If you own stock, and you catch an officer of your company in duplicip. 119tous behavior, you have to wonder about his integrity. If you know a manager is dishonest, sell the stock. If you don’t know whether a manager is honest, you should act as if he were not. That means you have to discount the price that you will pay for the stock to adjust for the increased risk and uncertainty.
Pause now and exercise your power of analysis on the following statement made in October 2001 by John J. Legere, CEO of Global Crossing, Inc.: “Bankruptcy is not a possibility at all.”
Tell why the statement is likely to be wrong. Tell what action should be taken when such statements are heard. Even if your answer may differ from mine, consider your answer correct if you got the gist.
The gist, the essence of the statement, is a denial of the possible. Since most things are possible, to say that they are not possible is an uphill fight and would require proof of the assertion. Furthermore, the addition of the “at all” at the end of the statement means that the possibility of bankruptcy is completely denied. By the addition of the “at all,” the man doth protest too much—he shows us that his statement has to be false because bankruptcy can hardly ever be completely impossible. And for Global Crossing at that time when revenues were falling , bankruptcy could not be completely impossible. Bankruptcy had to be possible, even if only a little possible.
If John J. Legere’s statement is false, then the contrary must be true: It must have been possible that Global Crossing could go bankrupt. Since the Legere statement is false and the opposite true, the statement must alert vigilant, ready-to-act investors, those who are thinking, to the possibility of bankruptcy. Those alert and thinking people sold Global Crossing stock that day. Those alert and sophisticated investors sold their stock right after Mr. Legere’s statement.
Why? Why should they sell when the obvious, overt meaning of Legere’s statement is that bankruptcy is not possible at all?
Simple. Intelligent investors ignored the overt message and read the deeper covert message. The covert message said that the man was denying the possible and therefore lying. A man who lies cannot be trusted. Furthermore, if everything is so peachy, then why is he cheerleading? Wall Street traditionally regards such cheerleading with distrust, reasoning darkly that if top officials, especially the CEO, give the market advice and reassurance, things are worse, much worse than they appear.
Subsequently the stock price of Global Crossing went into a steep decline from two dollars a share to one cent a share.
p. 120 Global Crossing filed for bankruptcy protection under chapter 11 on January 28, 2002. Yes, Global Crossing crossed over to the dark side and went bankrupt just four months after the CEO (Legere) said that it was not possible that Global Crossing could go bankrupt.
History, the unimaginative jade, repeated herself. Another major American corporation like Enron went bankrupt after its CEO said that bankruptcy was not possible, not possible at all.
I guess Legere didn’t know what he was talking about. But you—you could have known by analysis that bankruptcy was possible three months before bankruptcy actually occurred. You could have had time to investigate. You could have had time to sell the stock before it headed south.
Next lesson. What does the false statement say about Legere? Any reflection on his character? From your analysis of his character, can you predict the truth or falsity of his next statement? “I am taking a 30 percent cut in pay as part of my wider effort to conserve capital at Global Crossing.”[7]
Sounds pretty good. Doesn’t it? The man is willing to make a great personal sacrifice to help conserve and preserve shareholder value. That’s nice. Isn’t it? It tends to indicate that Legere feels the pain that the stockholders have. He wants to do his bit to help. That’s great. Or is it?
Would it interest you to know (according to the New York Times, April 8, 2002, p. C5) that Legere told Global Crossing stockholders that he was taking a 30 percent pay cut from his $1.1 million at Global Crossing as part of his wider effort to conserve capital at the same time that he accepted a $3.5 million signing bonus from Global Crossing and the forgiveness of a $10 million loan from Global Crossing?
The salary reduction was not the whole story. Legere didn’t tell the whole truth, just part of the truth that he wanted us to hear. He told only the part that made him look good. He excluded the part that made him look bad. Partial selection of the evidence is an error in thinking because it can lead to a false conclusion. By looking at only one bit of evidence, the salary reduction, we might have concluded Legere was a nice guy. But looking at the full evidence tells us that he wasn’t.
The omission was a deliberate deception. In fact, Legere received a $3.5 million signing bonus and was forgiven a $10 million loan from Asia Global Crossing (another company owed mainly by Global). Asia Global Crossing also paid the taxes that Legere would have owed the United States Treasury from the transaction. Thus, Legere saved the shareholders $1.1 million times 30 percent, or $330,000, by taking a p. 121 cut in salary. But he cost the shareholders $13.5 million plus $3.6 million in taxes paid for him. The net cost, therefore, to the company and to the owners of the company, the shareholders, was $16.77 million. The ratio of bad to good, as far as shareholders are concerned, is fifty-one to one, for that was the ratio of the amount of money Legere saved the company versus the amount of money he took. The ratio of good to bad as far as Legere’s personal stake was concerned was the same, fifty-one to one. Which end of the stick would you prefer to be holding? The shareholders’ or his?
Selling stock on the basis of information not available to the general public, as Ken Lay did, is insider trading, which can be unethical because it may take unfair advantage of others. Under certain circumstances, insider trading is illegal. It is definitely illegal (except for sales of the stock back to the company that issued it) if it has not been reported to the Security Exchange Commission within ten days after the month in which the sal
e took place.
Wouldn’t it be nice to know inside information without having to look it up in the SEC report? That report tells what insider did what. Public information like that is good. Sunshine is a great disinfectant. But the key information is lacking. Sure, we want to know who did what and when. But we also want to know why. Why did the insiders sell? How can we get that kind of inside information—information that is not reported?
Answer: Content analysis. Content analysis gets you insights about the inside information. Without much work you can deduce the why. Here’s how.
Inside information can sometimes be deduced by the analysis of the content of a series of statements. CIA and other government agencies do this to try to deduce the hidden or inside meaning of what has been publicly stated in communiqués from other governments. The technique, called content analysis, reveals hidden meanings by looking at the frequency and use of words and expressions.
“Joan went to the dance last night with me. She is so cool and so cute. She has a nice car too, a Jag XJ. And her father said he will take us to the Titans game next week.”
If your son is always talking about girls, you can bet girls are on his mind. If he is always talking about one girl, Joan, you can bet she’s the one, his heartthrob.
When Nikita Khrushchev said (while pounding on the lectern with p. 122 his shoe), “We will bury you,” you can bet that his intentions were not peaceful. You can also surmise that he had doubts that Russia could win a war with the United States, else why would he talk that way—so belligerently? If he knew he could win easily, why would he try to scare and intimidate us? So you can bet that he had grave doubts that Russia would win a war against the United States. He was bluffing just as so many people who talk that way are bluffing. Later on, many years later, we learned Khrushchev really was bluffing. The great mighty Russian military machine was falling apart under communism, just like the rest of the USSR was falling apart.
Truth, Knowledge, or Just Plain Bull: How to tell the difference Page 14