Fighting Corporate Recidivism

Thursday, October 30, 2003

Samuel Waksal, the founder and former chief executive of ImClone Systems, is rightfully going to jail for more than seven years for fraud, perjury, and other crimes tied to his central role in a high-profile insider trading scandal. But an important question still remains: Why wasn’t Waksal called on the carpet and stripped of his powers years ago when the company’s board of directors knew of his apparent disdain for the law and his outlandish spending habits?

The sad truth is, Waksal was allowed to remain at his post even after the board learned of two separate incidents in which the CEO reportedly forged the signatures of company executives to financial documents, one case stretching back to 1986. Nor was he fired or disciplined for abusing his corporate credit card. Instead, board members met with him privately in the early 1990s to review his spending and subsequently declared off-limits such prior extravagances as five-star European hotels and bottles of wine in excess of $100 with dinner.

But Samuel Waksal is hardly alone. When it comes to unabashed arrogance and deceit, he stands shoulder to shoulder with former Enron CEO Kenneth Lay and a phalanx of other corporate scoundrels, such as former chief executives John Rigas of Adelphia, Dennis Kozlowski of Tyco International, and Richard Scrushy of HealthSouth Corporation. Whatever their motivation, they have perpetrated a double standard of behavior that has pushed the public’s anger and cynicism to towering new heights.

What can be done to restore order and sanity to the executive suite? One way is to invoke a radical new process: require companies to make a full disclosure to the Securities and Exchange Commission (SEC) of all background information compiled in the course of hiring or promoting a senior executive, not unlike the way they are now obliged to report to the SEC the risks associated with their securities offerings. This disclosure would be required of all top-level executives—newly named as well as those with any length of tenure. And if it’s discovered that a corporate leader at any point lied about, distorted, or withheld material information, the SEC and the company itself would have solid grounds for forceful and swift punitive action.

It’s not difficult to see how uncovering deception and fraud early on could have helped short-circuit the careers of a clutch of unprincipled chief executives long before they had the chance to wreak havoc on the companies they controlled. Consider the following:

• Fifteen years before the lid blew off Enron, Kenneth Lay was involved in a scam that manipulated the energy company’s earnings through its oil trading unit.

• Richard Scrushy of HealthSouth was at the center of a longtime scheme to use Medicare as a way to enrich himself and those close to him, according to government investigators. Just recently, he was fingered by the SEC and the U.S. Justice Department as the ringleader of a scam that had inflated profits at the hospital chain by at least $1.4 billion since 1999.

• In an episode that now seems more prophetic than prosaic, Dennis Kozlowski of Tyco claimed to have earned an MBA from Rivier College in a questionnaire submitted for the 1988–1989 edition of Who’s Who in America. In fact, Mr. Kozlowski completed only three classes at the school.

How concerned should we be about misdeeds in someone’s past? Given the growing number of CEOs caught in the headlights of high-visibility scandals, plenty. You don’t have to be a behavioral scientist to know that once someone has lied, covered up, or deceived, there’s a good chance they’re going to push the envelope again, with the stakes perhaps many times higher. You do it once, it works, and you do it again, said Phyllis Anzalone, former director of Enron Energy Services, of her company’s now famous off-balance-sheet financing. It doesn’t take long for the lines to blur between what’s legal and what’s not.

To be sure, companies can no longer afford to be smug or half-hearted when it comes to their diligence. They must check with universities, past employers, business associates, and other references in much the same way the FBI conducts extensive background investigations on individuals being considered for senior positions within the federal government. Just as important, they must be prepared to act decisively by working closely with the SEC under the terms of a well-defined full disclosure program, as previously suggested, to discipline or fire any senior manager who is found operating outside the boundaries of professional business conduct or the law.

The Veritas Software board of directors proved its integrity when it sacked Chief Financial Officer Kenneth Lonchar after discovering that he had never graduated from Stanford University’s business school, as he had claimed. But the board of Bausch & Lomb fell flat on its face when, after learning that Chief Executive Ronald Zarrella had falsely claimed on his résumé that he had earned an MBA from New York University (and then tried to explain it away as a proofreading error), it issued a statement expressing support for its sorely compromised leader.

Admittedly, calling an errant executive on the carpet may not be the easiest of exercises for a company. But it’s increasingly clear that someone in the organization must be prepared to make that tough judgment—or face the even more unpleasant prospect of history repeating itself.