CRIME-Magazine_Annual-Edition

CRIME WHITE COLLAR CRIME

CRIME MAGAZINE

A LETTER FROM THE EDITOR I am growing up in an era where questioning our justice system has become a prevalent part of our society. Everywhere I hear stories of how victims are abused by the justice system for crimes they either did not commit or crimes that don't deserve the punishment they are serving. But, in contrary, there are still many stories of people that commit numerous crimes and never get caught. Or, if they do get caught, they often have the money or connections to receive less time or punishment than they deserve.

Through CRIME magazine, my goal is to bring to light all sides of crime. The good, the bad, and the gray area. No matter how much people may think they know about crime, unless they study it, there is a lot to learn from looking back at cases that often make headlines. If you disassociate morality while reading CRIME, what

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also becomes a point of interest is how elaborate crimes often are, often requiring a lot of meticulous planning. With this issue of CRIME, I decided to discuss some of the biggest white collar crimes in history. From one to ten, ten being the least, I organized each article in order of what I thought was a crime with the biggest loss for everyone involved. I hope through this issue of CRIME that people gain intrigue and a better understanding of the crime that has been going on for years.

Shanjida Kibria Editor

EDITOR’S LETTER

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01 02 03 04 05

QWEST

ADELPHIA MARTHA STEWART INSTOCK TRADING

LIBOR HURRICANE KATRINA FRAUD

06 07 08 09 10

BERNIE MADOFF PONZI SCHEME

TABLE OF CONTENTS

CONTENTS

WORLDCOM

VOLKSWAGEN

ENRON 2008 FINANCIAL CRISIS

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BY SHAWN YOUNG, DEBOR AH SOLOMON AND DENNIS K. BERMAN OCT. 22, 2004 | WSJ

Qwest Communications International Inc. engaged in pervasive fraud led by top management that extended to almost every part of its business, according to a complaint by the Securities and Exchange Commission.

The complaint, filed in federal court yesterday as Qwest agreed to pay a $250 million penalty, said the telecommunications company was riddled with accounting fraud between 1999 and 2002. The fraud included generating phony revenue through sham transactions, booking inflated results for its phone-directory business and even the way Qwest accounted for employee vacation time, according to the complaint. The SEC said Qwest fraudulently recognized more than $3.8 billion in revenue and excluded $231 million in expenses as part of a multifaceted accounting scheme. (Read the full text of the complaint.)

The 56-page document depicts Qwest as a company so desperate to satisfy Wall Street that it used any means necessary to meet "outrageously optimistic revenue projections." As its financial condition deteriorated, the SEC says Qwest began to rely on one-time sales contracts that one employee described as a kind of fiscal "heroin" that filled revenue gaps but were increasingly difficult to maintain.

"This was definitely orchestrated from the top down," said Mary Brady, assistant regional

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director for the SEC's Denver office. The SEC said the fraud was "directed by Qwest's senior management" and implemented by "numerous" other managers and employees.

Though the SEC didn't name specific Qwest executives, the agency continues to investigate former top officials, including Joseph P. Nacchio, the tough-talking executive who led Qwest until 2002. Mr. Nacchio recently received a so-called Wells notice from the SEC, indicating it soon may file civil charges against him, people familiar with the matter have said.

A spokesman for Mr. Nacchio said in a statement that "Mr. Nacchio never did anything improper or illegal -- nor instructed anyone else to do anything improper or illegal — during his tenure as CEO of Qwest."

A few other former top executives also have received Wells notices, according to people familiar with the matter. In addition, a dozen former Qwest executives have faced either civil or criminal charges or have settled allegations.

The $250 million penalty, which Qwest agreed to without admitting or denying wrongdoing, is the second-largest resulting from a SEC action, following only the mammoth $750 million levied against the former WorldCom Inc., now MCI Inc., after that company's $11 billion accounting fraud, the largest in U.S. history.

Qwest, the local-phone company in 14 Western states, has struggled in recent years with massive debt and huge losses. In recognition of its financial difficulties, Qwest will be allowed to pay the SEC penalty in two equal yearly installments. Qwest Chairman and Chief Executive Richard Notebaert said in a statement the Denver company is glad to resolve the matter.

Qwest, a fiber-optic company founded by billionaire Philip Anschutz, became one of the biggest stock-market stars in the late 1990s. Its collapse cost investors billions of dollars and resulted in thousands of employees losing their jobs.

Qwest's stock, after reaching a peak of $55 a share in mid-2000, traded yesterday at $3.44, up 12 cents, at 4 p.m. in New York Stock Exchange composite trading.

value at the height of the Internet boom. But billions of dollars of this revenue, the SEC said, wasn't a part of continuing service contracts with big corporations and governments.

Rather, they were "one-hit wonders" that often were sham deals with other telecommunications companies.

At times, Qwest managers backdated contracts to make sure revenue fit into the quarter, the SEC alleged. Qwest employees withheld information from the company's outside auditors to receive favorable accounting treatments.

They also "swapped" telecommunications capacity with other providers, even when they didn't need the assets they were buying.

The complaint is the strongest depiction yet of the desperation that pervaded the overall telecommunications industry in late 2000 and into 2001. In one instance, the complaint alleges that Qwest and Global Crossing Ltd. initially traded facsimile copies of multimillion-dollar checks to "paper over" requirements that actual cash changed hands as part of a business deal.

Qwest also "manipulated" revenue in its directory business, known as Qwest Dex, artificially inflating results by $60 million in 2000 and 2001, according to the complaint and also improperly recognized $112 million from its wireless subsidiary between 2000 and 2002.

In addition, Qwest understated expenses to meet growth targets, improperly changed the accounting policy of expensing sales commissions and made "improper" adjustments to an accrual set up to pay for employee absences.

Regulators also slammed Qwest for forcing its vendors to allow Qwest and some of its executives to invest in their start-up companies at a time when such investments could yield fabulous returns virtually overnight. One vendor was told by a senior Qwest engineer "you have to pay to play," the SEC said. In exchange, Qwest often committed to buy equipment it didn't need.

QWEST

Investors now assign little or no value to the long-distance network that once was Qwest's crown jewel, and the company derives its value from its local-phone operations, which it purchased with what the SEC charges was inflated stock.

At the heart of the SEC's complaint are allegations that Qwest used a simple accounting fraud to mislead investors about what kind of revenue it was bringing in during and just after the boom. The SEC said the fraud got started when Qwest needed to keep its stock price above $22 in order to complete its takeover of US West, which had a so-called collar provision allowing US West to walk away if Qwest's share price fell below the limit.

As the company's stock flirted with the collar limit, "Qwest senior management exerted extreme pressure upon other officers and managers and demanded that, through the use of one-time sales or other means, they meet earnings projections in order to prevent any further drop in the price of Qwest's stock," according to the complaint. By June 2000, Qwest's stock was at $50 and it was able to acquire US West with stock "that turned out to be significantly inflated," the SEC said.

Among the transactions Qwest executives used were some known internally as "Sluts," an acronym for "simultaneous, legally unrelated transactions." These were swaps of telecommunications capacity with other companies whose purpose was to give the appearance of bumping up revenue through numerous -- often sham -transactions, the SEC said. Qwest often didn't need the assets involved in these complex deals, which often were arranged by sales teams that didn't even pretend to consult with officials who knew what network capacity the company actually needed, the SEC said.

To the public, the SEC said, Qwest was trumpeting consistent revenue growth in data and Internet traffic, essential to burnish its

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BY JERRY MARKON AND ROBERT FR ANK ULY 25, 2002 | WSJ

Three members of the Rigas family that founded Adelphia Communications Corp., and two other company executives, were arrested early Wednesday morning and charged with looting the nation's sixth-largest cable-television company "on a massive scale."

In a related move, Adelphia itself was accused of fraud in a similar complaint filed by the Securities and Exchange Commission.

The charges marked the latest effort by the federal government to crack down on corporate malfeasance as public confidence and the financial markets have been battered by seemingly relentless disclosures of financial shenanigans.

"This government will investigate, will arrest and will prosecute corporate executives who break the law, and the Justice Department took action today," President Bush told reporters.

"Today was a day of action and of accomplishment."

Prosecutors are looking "very closely" at whether to file criminal charges against Adelphia itself, but are weighing the possible impact that would have on consumers, according to a person familiar with the matter. The investigation, led by U.S. Attorney James

Right: CEO John Rigas

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Comey in Manhattan, is continuing and other Rigas family members and company executives could face charges, this person said.

Federal prosecutors chose to arrest and handcuff 78-year-old John J. Rigas, Adelphia's founder and former chairman and chief executive, and two of his sons at a company-owned apartment on New York's Upper East Side, rather than seek indictments that would allow them a more dignified surrender. Their doorman announced the arrival of federal postal inspectors, and the Rigas family members came downstairs wearing sport coats, their palms upraised in front of them. The same dramatic flourish was used in the insider-trading arrest last month of Samuel Waksal, former CEO of ImClone Systems Inc. Mr. Rigas’s lawyer, Peter Fleming, criticized the tactic, saying the Rigas family members had volunteered to surrender. “I think it’s pretty tough to arrest a 78-year-old man at 6 a.m.,” Mr. Fleming said. As for the charges themselves, Mr. Fleming said only, “a jury is going to decide who is right and who is wrong.”

Each of the Rigas family members was released on a $10 million personal recognizance bond.

Adelphia said in a statement that it supports the arrests and “believes that these actions will help Adelphia recover the assets improperly taken from the company by the Rigas family.”

But the company said it was “disappointed” that the federal government is also seeking damages from Adelph;ia itself. “This action will only have the effect of further penalizing the company’s stakeholders who were the victims of the Rigas’ improper conduct.”

Adelphia also filed suit Wednesday seeking more than $1 billion against the entire Rigas family, including John’s wife, Doris, and his daughter Ellen and son-in-law, Peter Venetis. The suit accuses the family of a violation of the Racketeer Influenced and Corrupt

ADELPHIA

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Would-be headquarters in Coudersport, completed just as bankruptcy hit, never occupied as planned.

Organizations Act, breaching its fiduciary duties, wasting corporate assets, abusing control, breaching its contracts and other violations. The suit alleges that the Rigases “regularly conducted their business activities with the sole purpose of benefiting themselves at the expense of Adelphia” and borrowed company funds that “either directly or indirectly, unjustly enriched the Rigas family directors and other Rigas family members.”

The criminal complaint, filed in federal court in New York, offers the clearest view yet of one of the biggest cases of alleged insider dealing ever. Long one of the cable world’s most-fabled families, the Rigases engaged in a

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mass coverup that included fictitious receipts, falsified financial reports and lavish personal spending at the expense of shareholders, according to the 68-page complaint that charges them with securities fraud, wire fraud and bank fraud.

In addition to Mr. Rigas, the complaint names his sons, Timothy J. Rigas, the former chief financial officer, and Michael J. Rigas, the firm’s former operations vice president. They had all resigned from the company in May. A lawyer for Timothy Rigas, Jeremy H. Temkin, said, “We intend to defend the charges vigorously.” A lawyer for Michael Rigas didn’t return calls seeking comment.

ADELPHIA

Son of John Rigas, Timothy Rigas

Also charged in the complaint were James R. Brown, former vice president of finance; and Michael C. Mulcahey, director of internal reporting, who has been suspended.

Messrs. Brown and Mulcahey were arrested in Pennsylvania. Steven M. Cohen, an attorney for Mr. Mulcahey, called it “absurd” that his client would be lumped with the Rigases in the government’s complaint. He noted that Mr. Mulcahey wasn’t a board member and only recently had become an Adelphia officer. Mr. Mulcahey didn’t “benefit one dime” from the alleged fraud, he said.

The Rigases used company jets for private jaunts -- including an African safari -- borrowed

billions of dollars for their closely held companies and used $252 million of company funds to meet margin calls on their private stock, the complaint alleged. After John J. Rigas racked up a personal debt of more than $66 million by early 2001, he was withdrawing so much money from the company for personal use that his son Timothy had to limit him to $1 million a month -- which he duly withdrew for 12 months, even as public filings listed his annual compensation at less than $1.9 million, the complaint said.

The Rigases also spent $12.8 million of company funds to start construction of a golf course.

“The thing that makes this case stand out is the scope and magnitude of the looting of the

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company on the part of the Rigas family,” said Wayne Carlin, regional director of the SEC’s northeast regional office in New York. “In terms of the brazenness and the sheer amount of dollars yanked out of this public company and yanked out of the pockets of investors, it’s really quite stunning. It’s even stunning to someone like me who is in the business of unraveling these kinds of schemes.”

The scandal came to light in March, when the Rigases disclosed that Adelphia was responsible for more than $2 billion in loans to family-owned entities. Outside board members took control in May and formed a special committee to investigate. The SEC launched a formal probe three and a half months ago and two grand juries -- one in New York and one in Pennsylvania -- also began investigating. The Coudersport, Pa., company filed for bankruptcy-court protection in June.

The scandal stemmed from Adelphia’s mountains of debt. Anxious to keep up with increasingly large competitors such as Comcast Corp. and AT&T Corp., Adelphia went on an acquisition binge after 1999 that doubled its size to more than five million subscribers and increased its debt load to $12.6 billion from $3.5 billion.

As investors and ratings agencies demanded the company reduce its debt, the Rigases

Adelphia Logo

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embarked on a series of escalating financial frauds to conceal the borrowings and inflate earnings -- even as the family withdrew increasingly vast sums for personal use, according to the complaint. Between 1999 and the end of 2001, the amount of debt that was omitted from Adelphia’s public statements ballooned to $1.8 billion from $250 million, the complaint said.

In 2001 and 2002, the Rigases told public shareholders they were buying company stock to help ease the debt pressures. What they didn’t disclose, the complaint said, was that the money -- more than $400 million -- was borrowed from Adelphia. To give the appearance that the family used private funds for the stock, Timothy Rigas and Mr. Mulcahey directed Adelphia employees to create false receipts showing payment by the family for the stock, according to the complaint.

The company also falsified its financial results, authorities said in the complaint. In October 2000, Timothy Rigas discovered that Adelphia’s earnings before interest, taxes depreciation and amortization were below their public forecasts and instructed Adelphia employees to create fictitious transactions to boost Adelphia’s revenue, according to the complaint.

The complaint goes on to allege that the Rigases “would determine a target number for

When the company’s stock started to plunge in April after Adelphia disclosed more than $2 billion in loans to family entities, the Rigases received margin calls on their Adelphia stock. In public statements, the Rigas family said they had had adequate funds to pay the margin calls to their three lenders -- Bank of America Corp., Deutsche Bank AG, Goldman Sachs Group Inc. and Citigroup Inc.’s Salomon Smith Barney unit.

Yet according to the complaint, the Rigases wired $252 million from the company’s cash-management system to satisfy the margin calls. A margin call is a demand from lenders for cash or collateral.

Officials described the investigation as a joint effort by the Postal Inspection Service, the SEC and the U.S. attorney in New York.

The separate SEC case names each of the defendants in the criminal case, as well as a third brother, James P. Rigas. His attorney did not return calls seeking comment. The SEC case also names the company itself in an alleged securities fraud to exclude billions of dollars in liabilities from its financial statements by hiding them in off-balance-sheet affiliates; falsify earnings to meet Wall Street’s expectations; and conceal “rampant self-dealing by the Rigas family, including the undisclosed use of corporate funds” for stock purchases and to buy luxury New York condominiums.

The SEC is seeking disgorgement of potentially hundreds of millions of dollars, including “all ill-gotten gains including -- as to the individuals -- all compensation received during the fraud, all property unlawfully taken from Adelphia through undisclosed related-party transactions, and any severance payments related to their resignations.” It also seeks civil penalties and permanent injunctions barring defendants from ever again acting as officers or directors of a public company.

ADELPHIA

Adelphia’s publicly disclosed Ebitda and would attempt to justify that number by creating backdated sham transactions” between Adelphia and family-owned companies. In one case, Adelphia orchestrated a deal with two suppliers of digital set-top boxes -- Scientific-Atlanta Inc. and Motorola Inc. -- to inflate Adelphia’s Ebidta, the complaint said. The deal allowed Adelphia to pay $7 million more than the contract terms for the set-top boxes in exchange for an equal amount in “marketing support” paid by the two set-top box makers, according to the complaint.

Scientific-Atlanta declined to comment but had stated in a June 10 release that “We believe that our dealings with Adelphia over the years have been legal in all respects and were properly accounted for by us in the financial statements of Scientific Atlanta.” A Motorola spokesman said the company is cooperating with officials on the investigation and that the transactions were all “properly recorded in Motorola’s books in accordance with GAAP.” The Rigases also created a special accounting system to mask their personal transactions, the complaint alleged using the company’s centralized cash-management system, which pooled cash from Adelphia and Rigas private businesses, for their personal use.

The complaint also alleges that the Rigases used the company’s three corporate jets for personal use that was neither approved by the company’s board nor paid for by the family. In one case listed in the complaint, in August of 2000, Timothy Rigas and his friends used an Adelphia jet to fly to Africa for a safari. Timothy Rigas prevented Adelphia employees from keeping records of family’s air travel and the company’s board never approved family used of the planes, the complaint said. The company also paid for two apartments in Manhattan -- one used rentfree by John’s daughter and son-in-law, according to the complaint. (The son-in-law was a member of the board at the time).

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MARTHA INSTOCK

STEWART TRADING

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BY K AR A SCANNELL AND MATTHEW ROSE MARCH 7, 2004 | WSJ

A federal jury found Martha Stewart guilty of all four counts related to her obstruction of a government investigation into her sale of ImClone Systems Inc. stock in late 2001, giving the government a big win in its pursuit of white-collar crime.

The jury of eight women and four men took less than three days to find that Ms. Stewart, 62 years old, guilty of obstructing the investigation and making false statements.

Ms. Stewart faces about one to two years in prison, under federal sentencing guidelines, but the judge could order that she spend some of that time in a halfway house or in home detention.

Ms. Stewart's former Merrill Lynch & Co. broker, Peter Bacanovic, who was her co-defendant, was found guilty of four of the five counts against him. He was found guilty of conspiracy, making false statements, perjury and obstruction of agency proceedings. He was found not guilty of the charge of making false documents.

Ms. Stewart said she would appeal.

"I am obviously distressed by the jury's verdict but I continue to take comfort in knowing that I have the confidence and enduring support of my family and friends," Ms. Stewart said in a statement on her Web site. An earlier version of the statement, which was posted shortly after the verdict was announced, and then revised later in the afternoon, began: "I

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am obviously distressed by the jury's verdict but I continue to take comfort in knowing that I have done nothing wrong."

Ms. Stewart's statement continued: "I will appeal the verdict and continue to fight to clear my name. I believe in the fairness of the judicial system and remain confident that I will ultimately prevail.

"I can't tell you how much I appreciate all the words of encouragement I have received from thousands of supporters. It is your continued support that will keep me going until I am completely exonerated."

Each one of the counts against Ms. Stewart carries a maximum prison sentence of five years.

"Maybe it's a victory for the little guys who lose money in the market because of these kinds of transactions," said juror Chappell Hartridge.

Ms. Stewart grimaced upon hearing the verdict, and her eyes widened slightly. Her daughter, Alexis Stewart, was in tears. Ms. Stewart left the courtroom with a somber expression. She and Mr. Bacanovic were ushered by their lawyers and bodyguards into a side room. She didn't speak to anyone at the defense table before going to the holding room away from the media. She and Mr. Bacanovic must report to a probation office within a week for processing.

Leaving the courtroom, Mr. Bacanovic's mother said, "he lost his career and his job and he had no motive."

The conviction is a big win for the government, which had been accused by defense lawyers of overreaching in its attempt to prosecute a celebrity. Ms. Stewart's attorneys have long complained that Ms. Stewart was charged because of who she is, not what she did. They pointed out that Ms. Stewart wasn't charged criminally with an underlying crime, such as criminal insider trading. Instead, she was charged with lying about the reasons for her sale.

Prosecutors also brought a novel charge of securities fraud against Ms. Stewart, accusing her of trying to prop up the stock of her own

company, Martha Stewart Living Omnimedia Inc., by making false public statements about the reason for her ImClone sale. The judge threw out that charge, the most serious one Ms. Stewart faced, before the jury started deliberating.

The future of Martha Stewart Living, the domestic products and publishing company Ms. Stewart founded and controls, is uncertain.

In the hour the stock continued to trade after the verdict was rumored, shares were up $2.31, or 16%, to $16.34 on the New York Stock Exchange. The climb began in the space of just a few minutes, starting at 2 p.m., when TV reports first ran. The stock had been languishing around $14 most of the day after closing Thursday at $14.03.

Trading was halted at 3 p.m. just before the verdict was announced. Almost immediately, indications were that the stock would plummet when it resumed trading. When it did shortly after 3:30 p.m., it fell almost $6, putting it down $3.17, or 23%, to $10.86.

Trading volume for the day was 16.7 million shares, more than 30 times greater than the average daily volume of about 474,000 shares over the past three months.

MARTHA STEWART INSIDER TRADING

Steve Benson - Martha Stewart insider trading scandal

Advertisers are already skittish, hurting Ms. Stewart’s publications, and the company’s flagship, Martha Stewart Living magazine, recently slashed its guaranteed circulation to 1.8 million from 2.3 million because of declining consumer interest.

Still pending are civil charges of insider trading filed by the Securities and Exchange Commission. The SEC could seek to bar Ms. Stewart from holding office or being a director of a public company.

Ms. Stewart’s conviction will likely set off a wave of second-guessing about her legal strategy. Led by renowned defense attorney Robert Morvillo, Ms. Stewart’s team put on a minimal defense, calling only one brief witness. Ms. Stewart didn’t testify. In his summation, Mr. Morvillo concentrated heavily on pointing out the lack of evidence and asserted that the government hadn’t proved its case.

The defendants were charged with conspiring to obstruct an SEC investigation into trading of ImClone Systems stock. Ms. Stewart says she sold her 3,928 ImClone shares on Dec. 27, 2001, because she had a pre-existing agreement with Mr. Bacanovic to sell when the stock fell

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Mr. Faneuil said Mr. Bacanovic at first told him the reason for the trade was tax-loss selling, then told him there was an agreement to sell the stock when it dropped below $60. Mr. Faneuil also said Mr. Bacanovic pressured him to stick to the $60 account. Mr. Faneuil recounted one telephone conversation in which his boss said, “The reason for Martha’s trade is, we came up with a stop-loss order if the stock hits 60.” Mr. Faneuil said he was silent.

“OK? OK?” Mr. Faneuil said his boss asked, in a loud voice.

“OK,” Mr. Faneuil said he replied, dropping his tone to a near whisper.

Mr. Faneuil also described a January 2002 meeting with Mr. Bacanovic at a coffee shop near the office, in which he told Mr. Bacanovic that he knew what really happened. “With all due respect, no, you don’t,” Mr. Faneuil recalled Mr. Bacanovic saying. “Don’t worry, I’ve got everything under control.”

Mr. Faneuil, who was 26 years old at the time of the investigation, testified that he was afraid of losing his job and felt “physically” scared of Mr. Bacanovic. Mr. Faneuil pleaded guilty to a misdemeanor and is cooperating with the government.

Other witnesses included Mariana Pasternak, a close friend of Ms. Stewart, who testified that Ms. Stewart told her three days after her ImClone sale that she knew Dr. Waksal was trying to sell his stock. Ann Armstrong, Ms. Stewart’s personal assistant, testified that her boss altered a phone message in January 2002 left by Mr. Bacanovic on the day of her stock sale, but immediately ordered it changed back. The government used the incident to suggest Ms. Stewart was worried the message didn’t back up her account of the trade.

MARTHA STEWART INSIDER TRADING

below $60 a share. The government argued that agreement was fabricated afterward to conceal that Ms. Stewart had been tipped by Mr. Bacanovic’s assistant about attempted selling by the then-chief executive of ImClone, Samuel Waksal. Dr. Waksal pleaded guilty last year to insider trading and other charges and is serving a seven-year prison sentence.

Ms. Stewart’s conviction follows a setback for the government in the case of former star technology banker Frank Quattrone, who was also charged with obstruction of justice but not an underlying crime. In October, a federal judge granted a mistrial in the case after the jury was unable to reach a verdict. The former Credit Suisse First Boston investment banker is scheduled to be retried next month.

Several senior executives implicated in the big wave of corporate scandals are also on trial, including members of the family that founded Adelphia Communications Corp. and L. Dennis Kozlowski and Mark Swartz of Tyco International Ltd. This week, a federal grand jury indicted Bernard J. Ebbers, WorldCom’s former chief executive, on securities fraud for his role in the telecom company’s $11 billion accounting fraud.

And last month, prosecutors filed a wide-ranging indictment against Jeffrey Skilling, the former chief executive of Enron Corp.

In the Martha Stewart case, prosecutors relied heavily on the testimony of Douglas Faneuil, Mr. Bacanovic’s former assistant. He told the court that Mr. Bacanovic had yelled, “Oh my God, get Martha on the phone,” when he informed his boss about the Waksals selling on Dec. 27, 2001, one day before negative news sent ImClone stock plunging. Mr. Faneuil then testified that his boss instructed him to tip Ms. Stewart about that fact, that he did and that she then sold.

Left: Martha Stewart

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BY JAMES MCBRIDE OCTOBER 12, 2016 | CFR INTRODUCTION Beginning in 2012, an international investigation into the London Interbank Offered Rate, or Libor, revealed a widespread plot by multiple banks—notably Deutsche Bank, Barclays, UBS, Rabobank, and the Royal Bank of Scotland— to manipulate these interest rates for profit starting as far back as 2003. Investigations continue to implicate major institutions, exposing them to lawsuits and shaking trust in the global financial system.

Regulators in the United States, the UK, and the European Union have fined banks more than $9 billion for rigging Libor, which underpins over $300 trillion worth of loans worldwide. Since 2015, authorities in both the UK and the United States have brought criminal charges against individual traders and brokers for their role in manipulating rates, though the success of these prosecutions has been mixed.

The scandal has sparked calls for deeper reform of the entire Libor rate-setting system, as well as harsher penalties for offending individuals and institutions, but so far change remains piecemeal.

WHAT IS LIBOR? Libor is a benchmark interest rate based on the rates at which banks lend unsecured funds to each other on the London interbank market.

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Published daily, the rate was previously administered by the British Bankers’ Association (BBA). But in the aftermath of the scandal, Britain’s primary financial regulator, the Financial Conduct Authority (FCA), shifted supervision of Libor to a new entity, the ICE Benchmark Administration (IBA), an independent UK subsidiary of the private U.S.-based exchange operator Intercontinental Exchange, or ICE. To calculate the Libor rate, a representative panel of global banks submit an estimate of their borrowing costs to the Thomson Reuters data collection service each morning at 11:00 a.m. The calculation agent throws out the highest and lowest 25 percent of submissions and then averages the remaining rates to determine Libor. Calculated for five different currencies— the U.S. dollar, the euro, the British pound sterling, the Japanese yen, and the Swiss franc—at seven different maturity lengths from overnight to one year, Libor is the most relied upon global benchmark for short-term interest rates.

The rate for each currency is set by panels of between eleven and eighteen banks.

HOW DOES LIBOR AFFECT GLOBAL BORROWING? Many banks worldwide use Libor as a base rate for setting interest rates on consumer and corporate loans. Indeed, hundreds of trillions of dollars in securities and loans are linked to Libor, including government and corporate debt, as well as auto, student, and home loans, including over half of the United States’ flexible-rate mortgages. When Libor rises, rates and payments on loans often increase; likewise, they fall when Libor goes down. Libor is also used to “provide private-sector economists and central bankers with insights into market expectations of economic performance and interest rate developments,” explains the IBA, the new Libor administrator.

LIBOR

Chappato - LIBOR Scandal Remains The Largest Financial Crime in History - EconMatters

WHY AND HOW DID TRADERS MANIPULATE LIBOR? Barclays and fifteen other global financial institutions came under investigation by a handful of regulatory authorities—including those of the United States, Canada, Japan, Switzerland, and the UK—for colluding to manipulate the Libor rate beginning in 2003. Barclays reportedly first manipulated Libor during the global economic upswing of 2005–2007 so that its traders could make profits on derivatives pegged to the base rate, explains CFR’s Sebastian Mallaby.

During that period, “swaps traders often asked the Barclays employees who submitted the rates to provide figures that would benefit the traders, instead of submitting the rates the bank would actually pay to borrow money,” the New York Times reported. Moreover, “certain traders at Barclays coordinated with other banks to alter their rates as well.” During this period, Libor was maneuvered both upward and downward based “entirely on a trader's position,”

explains the London School of Economics’ Ronald Anderson.

Following the onset of the global financial crisis of 2007–2008, Mallaby says, Barclays manipulated Libor downward by telling Libor calculators that it could borrow money at relatively inexpensive rates to make the bank appear less risky and insulate itself. The artificially low rates submitted by Barclays came during an “unprecedented period of disruption,” says Anderson. It provided the bank with a “degree of stability in an unstable time,” he says. In 2012, as part of a settlement with U.S. and UK authorities, Barclays admitted to “misconduct” in the manipulation of rates.

The investigation into the Swiss bank UBS focused on the UK trader Thomas Hayes, who was the first person convicted for rigging Libor.

Prosecutors argued that this allowed him to post profits in the hundreds of millions for the bank over his three-year stint, after which he moved to the U.S.-based Citigroup. After Hayes

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6 Ex-Brokers Cleared in London Trial - New York Times

was arrested in December 2012, UK politicians criticized UBS executives for “negligence” after the bank’s leadership denied knowledge of the traders’ schemes due to the complexity of the bank’s operations. At the same time, most of the fraudulent collusion occurred between Hayes and traders at Royal Bank of Scotland (RBS), which is majority owned by UK taxpayers, to affect submissions across multiple institutions.

WHAT EFFECT HAS THE LIBOR SCANDAL HAD ON GLOBAL FINANCIAL MARKETS? Many experts say that the Libor scandal has eroded public trust in the marketplace. Indeed, securities broker and investment bank Keefe, Bruyette & Woods estimated that the banks

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being investigated for Libor manipulation could end up paying $35 billion in private legal settlements—separate from any fines to regulators. These sums could pose new challenges for financial institutions that are increasingly required to maintain higher reserves to guard against another systemic crisis. “It will be another blow to the banks’ ability to hold enough capital to satisfy higher regulatory requirements in the wake of the financial crisis,” writes the Huffington Post’s Mark Gongloff.

WHAT HAVE BEEN THE PENALTIES FOR FINANCIAL INSTITUTIONS? A wave of Libor-related prosecutions, led by U.S. and European regulatory bodies, has led to multiple major settlements. All told, global banks have paid over $9 billion in fines.

LIBOR

Barclays Building

The UK’s Barclays settled a case with U.S. and UK authorities for $435 million in July 2012, and in 2016 agreed to pay an additional $100 million to forty-four U.S. states for its role in manipulating the dollar-denominated Libor rate. In December 2012, Swiss banking giant UBS was slapped with the biggest Libor-related fine up to that point, paying global regulators a combined $1.5 billion in penalties. The complaint, led by the U.S. Commodity Futures Trading Commission (CFTC), cited over two thousand instances of wrongdoing committed by dozens of UBS employees.

In early 2013, U.S. and UK authorities fined RBS $612 million for rate rigging. Then, in December 2013, EU regulatory authorities settled their investigation into Barclays, Deutsche Bank, RBS, and Société Générale, fining the

latter three banks a combined total of 1.7 billion euros, or over $2 billion. They were all found guilty of colluding to manipulate market rates between 2005 and 2008. In exchange for revealing the cartel to regulators, Barclay’s was not fined by the EU. JP Morgan Chase and Citigroup also became the first U.S. institutions fined, albeit with much smaller penalties. (In 2016, a separate investigation by U.S. authorities fined Citigroup $425 million after finding that senior managers at the bank knew about Libor trader Tom Hayes’ illicit manipulation of the rate.) Also in 2013, Dutch Rabobank settled charges against it for over $1 billion.

In April 2015, Germany’s Deutsche Bank agreed to the largest single settlement in the Libor case, paying $2.5 billion to U.S. and European regulators and entering a guilty plea

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for its London-based branch. It brings the total amount of fines paid by Deutsche Bank to $3.5 billion, more than twice that of any other institution.

Many of these same banks have also come under scrutiny for similar concerns that they colluded to manipulate global currency markets. In May 2015, five banks—Citigroup, JP Morgan Chase, Barclays, Royal Bank of Scotland, and UBS—pleaded guilty to criminal charges of manipulating foreign exchange markets, agreeing to pay over $5 billion to the U.S. Justice Department and other regulators. As part of that settlement, UBS pleaded guilty to additional Libor-related fraud, paying $203 million in penalties. However, the Justice Department did not indict any individuals at that time.

HOW HAVE INDIVIDUALS INVOLVED BEEN PUNISHED? Investigations have placed most of the individual responsibility on the traders who sought to influence the Libor rate, as well as the managers who encouraged them, the brokers who helped carry out the schemes, and the rate-submitters themselves. As the extent of the Libor fraud became clear, more than one hundred traders or brokers were fired or suspended. Bank executives pled ignorance of the misconduct, but a number of them, including former Barclay’s CEO Bob Diamond and Rabobank CEO Piet Moerland, have been forced out. As part of its 2015 settlement, Deutsche Bank was obligated to fire seven employees.

However, regulators came under criticism for being slow to respond to the allegations, and some politicians called for stiffer penalties for the individuals responsible. In 2013, for instance, the UK’s then-Chancellor of the Exchequer George Osborne announced that he wanted the fine for RBS to come out of bankers’ bonuses rather than taxpayer funds.

Since 2015, over twenty people have also been criminally charged in connection to Libor-related fraud by both UK and U.S.

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authorities. The UK’s Serious Fraud Office (SFO) has charged twelve people over Libor, beginning with the 2015 trial of Hayes. He was convicted of leading a conspiracy by recruiting traders and brokers at other banks to manipulate Libor, and was sentenced to fourteen years in prison. However, the SFO prosecutors faced a setback in January 2016 when six of Hayes’ alleged co-conspirators, brokers at three UK firms, were acquitted of all charges. Hayes is also appealing his conviction. In July 2016, a separate SFO prosecution resulted in the conviction of three Barclays traders, who received prison sentences of between two and six years.

Other cases are ongoing.

The first U.S. convictions came in November 2015, with a New York judge sentencing two former Rabobank employees to one to two years in prison. In June 2016, the DOJ indicted two former Deutsche Bank traders and revealed that several others had pleaded guilty. In total, the DOJ has charged sixteen people in connection to its Libor probe.

WHAT ARE SOME IMPLICATIONS OF THE LIBOR SCANDAL? Despite the scandal, Libor continues its role as the primary benchmark for global lending rates. However, the efforts of authorities to increase the oversight and accountability of the Libor system have spurred debate over whether reforms go far enough.

One of the first impacts of the Libor investigation was to raise questions over the role of central banks, in particular the Bank of England, in failing to address, or even abetting, problems with the system. As New York Fed economists David Hou and David Skeie explain, the New York Fed communicated its concerns over Libor manipulation to the Bank of England in 2008, and suggested reforms to the system that weren’t followed up. And in 2012, Bank of England officials strenuously denied allegations that the central bank had encouraged some UK banks to underreport their borrowing costs at the height of the 2008 crisis.

Benchmark Administration, increasing penalties for manipulation, and a more transparent process for setting the rate. The Libor mechanism was kept for existing contracts and new contracts were allowed to use either Libor or a transaction-based benchmark rate until the ongoing reforms of the system are completed.

In that sense, according to the Wall Street Journal’s Francesco Guerrera, the 2012 Barclays settlement could potentially hold the “seeds” of a new regulatory regime. As part of the deal, Barclays “must now base its submissions on market prices rather than some hazy estimate of borrowing costs,” he wrote. Administration of Libor has been shifted to ICE, which is ultimately required to anchor its Libor calculations in more concrete transactions data which would be more difficult to manipulate. That process is underway, with ICE having proposed a system, still under development, to do so.

LIBOR

As a result, the UK government began considering reforms to Libor, whose regulation, as a London-based benchmark, falls under the UK’s purview. The UK Parliament passed legislation in 2012 to strengthen financial regulation in general, and reform the Libor system in particular. The 2012 law created the Financial Conduct Authority (FCA), a new government agency with centralized and expanded powers to investigate and regulate financial markets, including Libor.

Subsequent changes to Libor were based on the recommendations of a UK government report led by UK financier Martin Wheatley, who became the first head of the FCA. While many commentators in the United States argue that Libor had been totally discredited and should be scrapped in favor of a new rate based on real transaction data, the Wheatley report advocated more gradual changes. In addition to the creation of the FCA, these included the transfer of Libor to a new entity, the ICE

Former Barclay's trader Jay Merchant - The Guardian

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05

BY ERIC LIPTON JUNE 27, 2006 WASHINGTON, June 26 — Among the many superlatives associated with Hurricane Katrina can now be added this one: it produced one of the most extraordinary displays of scams, schemes and stupefying bureaucratic bungles in modern history, costing taxpayers up to $2 billion.

A hotel owner in Sugar Land, Tex., has been charged with submitting $232,000 in bills for phantom victims. And roughly 1,100 prison inmates across the Gulf Coast apparently collected more than $10 million in rental and disaster-relief assistance.

There are the bureaucrats who ordered nearly half a billion dollars worth of mobile homes that are still empty, and renovations for a shelter at a former Alabama Army base that cost about $416,000 per evacuee.

And there is the Illinois woman who tried to collect federal benefits by claiming she watched her two daughters drown in the rising New Orleans waters. In fact, prosecutors say, the children did not exist.

The tally of ignoble acts linked to Hurricane Katrina, pulled together by The New York Times from government audits, criminal prosecutions and Congressional investigations, could rise because the inquiries are under way. Even in Washington, a city accustomed to government bloat, the numbers are generating amazement.

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"The blatant fraud, the audacity of the schemes, the scale of the waste — it is just breathtaking," said Senator Susan Collins, Republican of Maine, and chairwoman of the Homeland Security and Governmental Affairs Committee.

Such an outcome was feared soon after Congress passed the initial hurricane relief package, as officials at the Federal Emergency Management Agency and the American Red Cross acknowledged that their systems were overwhelmed and tried to create new ones on the fly.

"We did, in fact, put into place never-before-used and untested processes," Donna M. Dannels, acting deputy director of recovery at FEMA, told a House panel this month.

"Clearly, because they were untested, they were more subject to error and fraud."

Officials in Washington say they recognized that a certain amount of fraud or improper payments is inevitable in any major disaster, as the government's mission is to rapidly distribute emergency aid. They typically send out excessive payments that represent 1 percent to 3 percent of the relief distributed, money they then ask people to give back.

What was not understood until now was just how large these numbers could become.

The estimate of up to $2 billion in fraud and waste represents nearly 11 percent of the $19 billion spent by FEMA on Hurricanes Katrina and Rita as of mid-June, or about 6 percent of total money that has been obligated.

"This started off as a disaster-relief program, but it turned into a cash cow," said Representative Michael McCaul, Republican of Texas, a former federal prosecutor and now chairman of a House panel investigating storm waste and fraud.

The waste ranged from excessive loads of ice to higher-than-necessary costs on the multibillion-dollar debris removal effort. Some examples are particularly stark.

The $7.9 million spent to renovate the former Fort McClellan Army base in Anniston,

an airfield in Arkansas, where FEMA is paying $250,000 a month to store them.

The most recent audit came from the Government Accountability Office, which this month estimated that perhaps as much as 21 percent of the $6.3 billion given directly to victims might have been improperly distributed.

"There are tools that are available to get money quickly to individuals and to get disaster relief programs running quickly without seeing so much fraud and waste," said Gregory D. Kutz, managing director of the forensic audits unit at the G.A.O. "But it wasn't really something that FEMA put a high priority

HURRICANE KATRINA FRAUD

Ala., included fixing up a welcome center, clinic and gymnasium, scrubbing away mold and installing a protective fence between the site and a nearby firing range. But when the doors finally opened, only about 10 people showed up each night, leading FEMA to shut down the shelter within one month.

The mobile homes, costing $34,500 each, were supposed to provide temporary housing to hurricane victims. But after Louisiana officials balked at installing them inland, FEMA had no use for them. Nearly half, or about 10,000, of the $860 million worth of units now sit at

An FBI SWAT Team helps local law enforcement on the streets of New Orleans after Hurricane Katrina.

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Mike Keafe - FEMA Relief Fraud

on. So it was easy to commit fraud without being detected."

The most disturbing cases, said David R. Dugas, the United States attorney in Louisiana, who is leading a storm antifraud task force for the Justice Department, are those involving government officials accused of orchestrating elaborate scams.

One Louisiana Department of Labor clerk, Wayne P. Lawless, has been charged with issuing about 80 fraudulent disaster unemployment benefit cards in exchange for bribes of up to $300 per application. Mr. Lawless, a state contract worker, announced to one man he helped apply for hurricane benefits that he wanted to “get something out of it,” the affidavit said. His lawyer did not respond to several messages left at his office and home for comment.

“The American people are the most generous in the world in responding to a disaster,” Mr. Dugas said. “We won’t tolerate people in

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a position of public trust taking advantage of the situation.”

Two other men, Mitchell Kendrix of Memphis and Paul Nelson of Lisbon, Me., have pleaded guilty in connection with a scheme in Mississippi in which Mr. Kendrix, a representative for the Army Corps of Engineers, took $100 bribes in exchange for approving phantom loads of hurricane debris from Mr. Nelson.

In New Orleans, two FEMA officials, Andrew Rose and Loyd Holliman, both of Colorado, have pleaded guilty to taking $20,000 in bribes in exchange for inflating the count on the number of meals a contractor was serving disaster workers. And a councilman in St. Tammany Parish, La., Joseph Impastato, has also been charged with trying to extort $100,000 from a debris removal contractor. Mr. Impastato’s lawyer, Karl J. Koch, said he was confident his client would be cleared.

A program set up by the American Red Cross and financed by FEMA that provided

$12 million in federal aid, much of it in the form of rental assistance.

Investigators also turned up one individual who had received 26 federal disaster relief payments totaling $139,000, using 13 Social Security numbers, all based on claims of damages for bogus addresses.

Thousands more people may be charged before the five-year statute of limitations on most of these crimes expires, investigators said.

There are bigger cases of government waste or fraud in United States history. The Treasury Department, for example, estimated in 2005 that Americans in a single year had improperly been granted perhaps $9 billion in unjustified claims under the Earned-Income Tax Credit. The Department of Health and Human Services in 2001 estimated that nearly $12 billion in Medicare benefit payments in the previous year had been based on improper or fraudulent complaints.

Auditors examining spending in Iraq also have documented hundreds of millions in questionable spending or abuse. But Mr. Kutz of the accountability office said that in all of his investigative work, he had never encountered the range of abuses he has seen with Hurricane Katrina.

R. David Paulison, the new FEMA director, said in an interview on Friday that much work had already been done to prevent such widespread fraud, including automated checks to confirm applicants’ identities.

“We will be able to tell who you are, if you live where you said you do,” Mr. Paulison said.

But Senator Collins said she had heard such promises before, including after Hurricane Frances in 2004 in which FEMA gave out millions of dollars in aid to Miami-Dade County residents, even though there was little damage.

Mr. Kutz said he too was not convinced that the agency was ready.

“I still don’t think they fully understand the depth of the problem,” he said.

HURRICANE KATRINA FRAUD

free hotel rooms to Hurricane Katrina victims also resulted in extraordinary abuse and waste, investigators have found.

First, because the Red Cross did not keep track of the hundreds of thousands of recipients — they were only required to provide a ZIP code from the hurricane zone to check in — FEMA frequently sent rental assistance checks to people getting free hotel rooms, the G.A.O. found.

In turn, some hotel managers or owners, like Daniel Yeh, of Sugar Land, exploited the lack of oversight, investigators have charged, and submitted bills for empty rooms or those occupied by paying guests or employees. Mr. Yeh submitted $232,000 in false claims, his arrest affidavit said. His lawyer, Robert Bennett, said that Mr. Yeh was mentally incompetent and that the charges should be dismissed.

And Tina M. Winston of Belleville, Ill., was charged this month with claiming that her two daughters had died in the flooding in New Orleans. But prosecutors said that the children never existed and that Ms. Winston was living in Illinois at the time of the storm. The public defender representing Ms. Winston did not respond to a request for comment.

Charities also were vulnerable to profiteers.

In Burbank, Calif., a couple has been charged with collecting donations outside a store by posing as Red Cross workers. In Bakersfield, Calif., 75 workers at a Red Cross call center, their friends and relatives have been charged in a scheme to steal hundreds of thousands of dollars in relief.

To date, Mr. Dugas said, federal prosecutors have filed hurricane-related criminal charges against 335 individuals. That represents a record number of indictments from a single hurricane season, Justice Department officials said. Separately, Red Cross officials say they are investigating 7,100 cases of possible fraud.

Congressional investigators, meanwhile, have referred another 7,000 cases of possible fraud to prosecutors, including more than 1,000 prison inmates who collected more than

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06 DEC 18TH 2008 | THE ECONOMIST BERNARD MADOFF worked as a lifeguard to earn enough money to start his own securities firm. Almost half a century later, the colossal Ponzi scheme into which it mutated has proved impossible to keep afloat—unlike Mr Madoff’s 55-foot fishing boat, “Bull”.

The $17.1 billion that Mr Madoff claimed to have under management earlier this year is all but gone. His alleged confession that the fraud could top $50 billion looks increasingly plausible: clients have admitted to exposures amounting to more than half that. On December 16th the head of the Securities Investor Protection Corporation, which is recovering what it can for investors, said the multiple sets of accounts kept by the 70-year-old were in “complete disarray” and could take six months to sort out.

It is hard to imagine a more apt end to Wall Street’s worst year in decades.

The known list of victims grows longer and more star-studded by the day. Among them are prominent billionaires, including Steven Spielberg; the owner of the New York Mets baseball team; Carl Shapiro, a nonagenarian clothing magnate who may have lost $545m; thousands of wealthy retirees; and a cluster of mostly Jewish charities, some of which face closure. Dozens of supposedly sophisticated financial firms were caught out too, including banks such as Santander and HSBC, and

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Fairfield Greenwich, an alternative-investment specialist that had funnelled no less than $7.5 billion to Mr Madoff.

Though his operation resembled a hedgefund shop, he was in fact managing client money in brokerage accounts within his firm, seemingly as Merrill Lynch or Smith Barney would. A lot of this came from funds of funds, which invest in pools of hedge funds, and was channelled to Mr Madoff via “feeder funds” with which he had special relationships. Some banks, such as the Dutch arm of Fortis, lent heavily to funds of funds that wanted to invest.

On the face of it, the attractions were clear. Mr Madoff’s pedigree was top-notch: a pioneering marketmaker, he had chaired NASDAQ, had advised the government on market issues and was a noted philanthropist.

Turning away some investors and telling those he accepted not to talk to outsiders produced a sense of exclusivity. He generated returns to match: in the vicinity of 10% a year, through thick and thin.

That last attraction should also have served as a warning; the results were suspiciously smooth. Mr Madoff barely ever suffered a down month, even in choppy markets (he was up in November, as the S&P index tumbled 7.5%). He allegedly has now confessed that this was achieved by creating a pyramid scheme in which existing clients’ returns were topped up, as needed, with money from new investors.

He claimed to be employing an investment strategy known as “split-strike conversion”.

This is a fairly common approach that entails buying and selling different sorts of options to reduce volatility. But those who bothered to look closely had doubts. Aksia, an advisory firm, concluded that the S&P 100 options market that Mr Madoff claimed to trade was far too small to handle a portfolio of his size. It advised its clients not to invest. So did MPI, a quantitative-research firm, after an analysis in 2006 failed to find a legitimate strategy that matched his returns—though they were closely

Perhaps the biggest warning sign was the secrecy with which the investment business was conducted. It was a black box, run by a tiny team at a very long arm’s length from the group’s much bigger broker-dealer. Clients too were kept in the dark. They seemed not to mind as long as the returns remained strong, accepting that to ask Bernie to reveal his strategy would be as crass as demanding to see CocaCola’s magic formula. Mr Madoff reinforced the message by occasionally ejecting a client who asked awkward questions.

The trading business was hardly pristine either. It had been probed for front-running (trading for its own account before filling client

BERNIE MADOFF

correlated with those of Bayou, a fraudulent hedge fund that had collapsed a year earlier.

This was not the only danger signal. Stock holdings were liquidated every quarter, presumably to avoid reporting big positions. For a godfather of electronic trading, Mr Madoff ran the business along antediluvian lines: clients and feeder-fund managers were denied online access to their accounts. Even more worryingly, he cleared his own trades, with no external custodian. They were audited, of course, but by a tiny firm with three employees, one of whom was a secretary and another an 80-year-old based in Florida.

Dave Grandlund - Bernie Madoff and SEC

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orders) and separately found guilty of technical violations. Some clients reportedly suspected that Mr Madoff was engaged in wrongdoing, but not the sort that would endanger their money. They thought he might be trading illegally for their benefit on information gleaned by his marketmaking arm.

This failure of due diligence by so many funds of funds will deal the industry a blow.

They are paid to screen managers, to pick the best and to diversify clients’ holdings—none of which they did properly in this case. Some investors are understandably irate that their funds—including one run by the chairman of GMAC, a troubled car-loan firm—charged above-average fees, only to plonk the bulk of their cash in Mr Madoff’s lap. This is the last thing hedge funds need, plagued as they are by a wave of redemption requests.

Financial firms that dealt with Mr Madoff are bracing themselves for a wave of litigation as individual victims go after those with deep pockets. Hedge funds will also face pressure to accept further oversight. But the affair shows the need for the government to enforce its rules better, rather than write new ones, argues Robert Van Grover of Seward & Kissel, a law firm.

Mr Madoff’s investment business was overseen by the Securities and Exchange Commission (SEC), but it failed to carry out any examinations despite receiving complaints from investors and rivals since as long ago as the late 1990s. As a Wall Street fixture, Mr Madoff was close to several SEC officials.

His niece, the firm’s compliance lawyer, even married a former member of the team that had inspected the marketmaking division’s books in 2003—though there is no evidence of impropriety.

Right: Bernie Madoff

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In a rare mea culpa, Christopher Cox, the SEC’s chairman, has called its handling of the case “deeply troubling” and promised an investigation of its “multiple failures”. Having already been lambasted for fiddling while investment banks burned, the commission is now likelier than ever to be restructured, or perhaps even dismantled, in the regulatory overhaul expected under Barack Obama. As The Economist went to press Mr Obama was expected to name Mary Schapiro, an experienced brokerage regulator, to replace Mr Cox. The rules themselves will need changing, too. All investment managers, not just mutual funds, could now be forced to use external clearing agents to ensure third-party scrutiny, says Larry Harris of the University of Southern California’s Marshall School of Business.

Regulation of financial firms’ accountants may also need tightening. And more could be done to encourage whistle-blowing. Mr Madoff claims to have acted alone. But given the huge amount of paperwork required to keep his scam going, it seems unlikely that no one else knew about it.

Above all, however, investors need to help themselves. This pyramid scheme may have been unprecedented, but the lessons are old ones: spread your eggs around and, as Mr Harris puts it, “investigate your good stories as well as your bad ones.” This is particularly true of money managers who work deep in the shadows or seem beyond reproach—even more so during booms, when the temptation to swindle grows along with the propensity to speculate. There will always be “sheep to be shorn”, as Charles Kindleberger memorably wrote in “Manias, Panics and Crashes”. Let us hope they never again line up in such numbers.

BERNIE MADOFF

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07

BY SIMON ROMERO AND RIVA D. ATLAS JULY 22, 2002 | NY TIMES

WorldCom, plagued by the rapid erosion of its profits and an accounting scandal that created billions in illusory earnings, last night submitted the largest bankruptcy filing in United States history.

The bankruptcy is expected to shake an already wobbling telecommunications industry, but is unlikely to have an immediate impact on customers, including the 20 million users of its MCI long-distance service.

The WorldCom filing listed more than $107 billion in assets, far surpassing those of Enron, which filed for bankruptcy last December. The WorldCom filing had been anticipated since the company disclosed in late June that it had improperly accounted for more than $3.8 billion of expenses.

Few experts or officials expect WorldCom's service to deteriorate noticeably, at least in the near term. ''I want to assure the public that we do not believe this bankruptcy filing will lead to an immediate disruption of service to consumers,'' Michael K. Powell, chairman of the Federal Communciations Commission, said last night.

But industry consultants said they could not imagine how the belt-tightening expected in bankruptcy would improve service that is already, in some respects, sloppy.

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WorldCom's collapse has already reverberated through jittery financial markets, and is likely to be felt in the wider economy, with banks, suppliers and other telephone companies devising strategies to contain their exposure.

WorldCom, built through rapid acquisitions, accumulated $41 billion in debts. Founded in 1983 as LDDS Communications, it became the nation's second-largest long-distance company and the largest handler of Internet data.

Company executives said they intended to remain in business, and have been promised new financing from banks to do so. ''We are going to aggressively go forward and restructure our operations,'' John W. Sidgmore, WorldCom's chief exeutive, said in an interview last night. ''I think ultimately we will emerge as a stronger company.''

While WorldCom has already cut its work force significantly, Mr. Sidgmore said last night that he did not expect further layoffs for the time being. He said he would remain WorldCom's chief but would be joined by a chief restructuring officer brought in by creditors.

Some creditors, however, have questioned whether Mr. Sidgmore, who has served on WorldCom's board for years, should remain in charge. Mr. Sidgmore took over as chief executive in late April after the board ousted Bernard J. Ebbers, one of the company's founders.

Shareholders, who owned what was once one of the world's most valuable companies, worth more than $100 billion at its peak, are expected to be virtually wiped out. With the bankruptcy filing, control passes instead to the banks and bondholders who financed WorldCom's growth.

Besides its own overambitious strategies and flawed accounting, WorldCom also fell victim to a glut of telecommunications capacity.

Cheap and plentiful financing allowed companies rapidly to build transcontinental and transoceanic fiber optic networks in the 1990's.

The additional capacity resulted in lower prices for WorldCom's services, which include basic

WORLDCOM

Mike Keafe - WorldCom Collapse

phone service and the transmission of Internet data for large companies.

Mr. Sidgmore said last night that he was opposed to breaking up WorldCom and selling its pieces, aside from an effort already under way to part with peripheral units like businesses in Latin America and some other operations.

This approach would rule out selling UUNet, a large Internet backbone operation, or MCI. But once the company reorganizes, and investors gain a better understanding of its twisted finances, WorldCom could become an attractive acquisition target, analysts say.

WorldCom’s crisis deepened last month when it disclosed that Scott D. Sullivan, the chief financial officer, had devised a strategy that improperly accounted for $3.85 billion of expenses. Mr. Sullivan was fired by the board and David F. Myers, the financial controller, resigned.

The Securities and Exchange Commission has charged WorldCom with fraud and the

Justice Department has begun a criminal investigation of its business practices.

In an attempt to regain its credibility, WorldCom’s board elected two new members to replace Mr. Sullivan and Mr. Ebbers: Nicholas deB. Katzenbach, a private attorney who was attorney general in the Johnson administration; and Dennis R. Beresford, a former head of the Financial Accounting Standards Board and a professor of accounting at the Terry College of Business at the University of Georgia.

The two were also appointed to a special committee to oversee the internal investigation being led by William R. McLucas, the former chief of the enforcement division of the S.E.C. WorldCom filed for bankruptcy shortly before 9 last night in Federal District Court in Manhattan.

Its international operations, which include companies in Brazil and Mexico, were not included.

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-- improving the odds that the company could emerge from bankruptcy as a going concern.

The creditors first in line to be repaid will be the three institutions -- Citigroup, J. P. Morgan and General Electric Capital -- that have pledged to arrange a loan of up to $2 billion, known as debtor in possession financing, to WorldCom. The lenders were comfortable pledging the funds in part because of the company’s stream of customer payments, such as phone bills, one executive close to the company said last week. Citigroup is leading the new financing in part to protect what it is already owed by WorldCom. WorldCom’s bankruptcy filing, like Enron’s last December, came on a Sunday. Companies often prefer to file over the weekend, because the status of any business transactions in process at the time of a filing would be open to question in court.

WorldCom’s lenders and its bondholders were taking steps, even before the bankruptcy filing, to protect their claims. Just over a week ago, the banks that participated in the earlier $2.65 billion loan tried, unsuccessfully, to get a court order limiting WorldCom’s access to the loan. The banks ultimately reached a settlement with WorldCom that placed few restrictions on the company’s ability to use the cash.

Left: Benard Ebbers - CEO of WorldCom

Below: WorldCom Logo on entrance to offices.

WORLDCOM

The filing will relieve WorldCom of about $2 billion of interest payments in the coming year. Lower debt costs could allow WorldCom to compete on a stronger footing with its rivals, involving a potential price-cutting strategy that has analysts concerned about the wider strength of the telecommunications industry. ‘’WorldCom probably won’t get any new big contracts from its current customers, but it probably won’t lose any either, because of the difficulty and complexity involved in switching carriers,’’ said Glen Macdonald, a vice president with Adventis, a consulting firm in Boston.

WorldCom, based in Clinton, Miss., scrambled in recent days to secure new financing from its banks after its cash dwindled to less than $300 million from more than $2 billion in May. WorldCom said last night that it had received commitments for up to $2 billion in additional bank financing. Such new loans to companies in bankruptcy receive top priority in repayment.

WorldCom must now deal with holders of $28 billion in bonds as well as 27 banks that loaned the company $2.65 billion last May. But in contrast with other companies that have recently filed for bankruptcy, including Enron, WorldCom has many more tangible assets, generating actual revenues, lawyers said

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OLKS AGEN

CRIME MAGAZINE

investigations, it had established that this only affected about 36,000 of the cars it produces each year.

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BY RUSSELL HOTTEN DECEMBER, 10 2015 | BBC NEWS WHAT IS VOLKSWAGEN ACCUSED OF? It's been dubbed the "diesel dupe". In September, the Environmental Protection Agency (EPA) found that many VW cars being sold in America had a "defeat device" - or software - in diesel engines that could detect when they were being tested, changing the performance accordingly to improve results. The German car giant has since admitted cheating emissions tests in the US. VW has had a major push to sell diesel cars in the US, backed by a huge marketing campaign trumpeting its cars' low emissions. The EPA's findings cover 482,000 cars in the US only, including the VW-manufactured Audi A3, and the VW models Jetta, Beetle, Golf and Passat. But VW has admitted that about 11 million cars worldwide, including eight million in Europe, are fitted with the so-called "defeat device".

The company has also been accused by the EPA of modifying software on the 3 litre diesel engines fitted to some Porsche and Audi as well as VW models. VW has denied the claims, which affect at least 10,000 vehicles.

In November, VW said it had found "irregularities" in tests to measure carbon dioxide emissions levels that could affect about 800,000 cars in Europe - including petrol vehicles.

However, in December it said that following

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THIS 'DEFEAT DEVICE' SOUNDS LIKE A SOPHISTICATED PIECE OF KIT. Full details of how it worked are sketchy, although the EPA has said that the engines had computer software that could sense test scenarios by monitoring speed, engine operation, air pressure and even the position of the steering wheel.

When the cars were operating under controlled laboratory conditions - which typically involve putting them on a stationary test rig - the device appears to have put the vehicle into a sort of safety mode in which the engine ran below normal power and performance.

Once on the road, the engines switched out of this test mode.

The result? The engines emitted nitrogen oxide pollutants up to 40 times above what is allowed in the US. WHAT HAS BEEN VW’S RESPONSE? “We’ve totally screwed up,” said VW America boss Michael Horn, while the group’s chief executive at the time, Martin Winterkorn, said his company had “broken the trust of our customers and the public”. Mr Winterkorn resigned as a direct result of the scandal and was replaced by Matthias Mueller, the former boss of Porsche.

“My most urgent task is to win back trust for the Volkswagen Group - by leaving no stone unturned,” Mr Mueller said on taking up his new post.

VW has also launched an internal inquiry.

With VW recalling millions of cars worldwide from early next year, it has set aside €6.7bn (£4.8bn) to cover costs. That resulted in the company posting its first quarterly loss for 15 years of €2.5bn in late October.

But that’s unlikely to be the end of the financial impact. The EPA has the power to fine a company up to $37,500 for each vehicle

HOW WIDESPREAD ARE VW’S PROBLEMS? What started in the US has spread to a growing number of countries. The UK, Italy, France, South Korea, Canada and, of course, Germany, have opened investigations. Throughout the world, politicians, regulators and environmental groups are questioning the legitimacy of VW’s emissions testing.

VW will recall 8.5 million cars in Europe, including 2.4 million in Germany and 1.2

million in the UK, and 500,000 in the US as a result of the emissions scandal.

No wonder the carmaker’s shares have fallen by about a third since the scandal broke.

WILL MORE HEADS ROLL? It’s still unclear who knew what and when, although VW must have had a chain of management command that approved fitting cheating devices to its engines, so further departures are likely.

Christian Klingler, a management board member and head of sales and marketing is leaving the company, although VW said this was part of long-term planned structural changes and was not related to recent events.

In 2014, in the US, regulators raised concerns about VW emissions levels, but these

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that breaches standards - a maximum fine of about $18bn.

The costs of possible legal action by car owners and shareholders “cannot be estimated at the current time”, VW added.

John Darkow - Columbia Daily Tribune, Missouri - Emission Admission - Volkswagen

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were dismissed by the company as “technical issues” and “unexpected” real-world conditions.

If executives and managers wilfully misled officials (or their own VW superiors) it’s difficult to see them surviving.

ARE OTHER CARMAKERS IMPLICATED? That’s for the various regulatory and government inquiries to determine. California’s Air Resources Board is now looking into other manufacturers’ testing results. Ford, BMW and Renault-Nissan have said they did not use “defeat devices”, while other firms have either not commented or simply stated that they comply with the law.

The UK trade body for the car industry, the SMMT, said: “The EU operates a fundamentally different system to the US with all European tests performed in strict conditions as required by EU law and witnessed by a government-appointed independent approval agency.”

But it added: “The industry acknowledges that the current test method is outdated and is seeking agreement from the European Commission for a new emissions test that embraces new testing technologies and is more representative of on-road conditions.”

THAT SOUNDS LIKE EU TESTING RULES NEED TIGHTENING, TOO. Environmental campaigners have long argued that emissions rules are being flouted. “Diesel cars in Europe operate with worse technology on average than the US,” said Jos Dings, from the pressure group Transport & Environment.

“Our latest report demonstrated that almost 90% of diesel vehicles didn’t meet emission limits when they drive on the road. We are talking millions of vehicles.”

Car analysts at the financial research firm Bernstein agree that European standards are not as strict as those in the US. However, the analysts said in a report that there was, therefore, “less need to cheat”. So, if other European carmakers’ results are suspect, Bernstein says the “consequences are likely to be a change in the test cycle rather than legal action and fines”.

IT’S ALL ANOTHER BLOW FOR THE DIESEL MARKET. Certainly is. Over the past decade and more, carmakers have poured a fortune into the production of diesel vehicles - with the support of many governments - believing that they are better for the environment. Latest scientific evidence suggests that’s not the case, and there are even moves to limit diesel cars in some cities.

Diesel sales were already slowing, so the VW scandal came at a bad time. “The revelations are likely to lead to a sharp fall in demand for diesel engine cars,” said Richard Gane, automotive expert at consultants Vendigital.

“In the US, the diesel car market currently represents around 1% of all new car sales and this is unlikely to increase in the short to medium term.

“However, in Europe the impact could be much more significant, leading to a large tranche of the market switching to petrol engine cars virtually overnight.”

Right: Volkswagen CEO Martin Winterkorn resigns due to scandal

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09 APPLIED CORPOR ATE GOVERNANCE CASE STUDY This Enron case study presents our own analysis of the spectacular rise and fall of Enron. It is the first in a new series assessing organizations against ACG’s Golden Rules of corporate governance and applying our proprietary rating tool.

As we say in our business ethics examples homepage introducing this series, the first and most critical rule is an ethical approach, and this should permeate an organization from top to bottom. We shall therefore always start with an assessment of the ethical approach of the organization. The way this creates the culture determines the performance in relation to the other four Rules.

THE ENRON CASE STUDY: HISTORY, ETHICS AND GOVERNANCE FAILURES Introduction: why Enron?

Why pick Enron? The answer is that Enron is a well-documented story and we can apply our approach with the great benefit of hindsight to show how the end result could have been predicted. It is also a good example to illustrate how ethics drives culture which in turn pushes the ethical boundaries and is a key influence on all the four other key elements of good corporate governance.

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Hence, in advance of using our own membership for the survey input we can apply the very detailed findings from the post crash dissection of Enron. Readers who are interested can go to Wikipedia and burrow into the history of Enron and its major players. They can also study the various accounts that have been written and which are referred to in Wikipedia.

We particularly commend “The Smartest Guys in the Room”, the story of Enron’s rise and fall,

by Bethany McLean and Peter Elkind, and we gratefully acknowledge the valuable insights we have drawn from this fascinating book in producing our Enron case study.

Below is a brief résumé of Enron’s spectacular rise in fifteen years to a market valuation of nearly $100bn and its precipitous collapse. We have prepared a detailed history (around 20,000 words) with our own annotations, which will soon be available as an ebook for those who would like to draw their own conclusions. We have also applied our proprietary survey tool to Enron and imagined how the various stakeholder groups might have responded to a business ethics survey at a critical time in Enron’s history, mid 2000, eighteen months before it suddenly collapsed. The results of this survey are summarised below.

HISTORY OF ENRON Enron was created in 1986 by Ken Lay to capitalise on the opportunity he saw arising out of the deregulation of the natural gas industry in the USA. What started as a pipelines company was transformed by the vision of a McKinsey consultant, Jeff Skilling, who had the idea of applying models used in the financial services industry to the deregulated gas industry.

He persuaded Enron to set up a Gas Bank through which buyers and sellers of natural gas could transact with each other using an intermediary (Enron) whose contractual arrangements would provide both parties with reliability and predictability regarding pricing and delivery. Enron duly recruited him to run this

trading. So on the back of his track record, Skilling was appointed Chief Operating Officer

by Ken Lay and he then embarked upon transforming the whole of Enron to reflect his vision.

Observing the dotcom boom, Skilling decided Enron could create a business based on a broadband network which could supply and trade bandwidth and he set out to build this at a great pace.

However, the experiment in deregulation in California didn’t work well and in due course was reversed with recriminations all round.

Moreover, the international business expansion wasn’t underpinned by adequate administration and many of the contracts later turned bad.

So Enron then took the decision to build on its international presence by becoming a global leader in the water industry and bought a big water company in the UK, following it up with a big deal in Argentina.

At this point, around 2000, Enron’s reputation was still riding high and Lay and Skilling

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business and he rapidly built up a major gas trading operation through the early nineties.

During this time Enron was extending its pipeline operations into a wider power supply business, initially in the USA and then on an international scale, completing a large plant at Teesside in the UK and contracting to build a huge plant near Mumbai in India. In due course it had deals all round the globe, from South America to China. The hard driving expansion of Enron’s power business worldwide created a global reputation for Enron.

Skilling’s vision was to transform Enron into a giant, asset-light operation, trading power generally and his next target was trading electricity. Lay was lobbying Washington hard to deregulate electricity supply and in anticipation he and Skilling took Enron into California, buying a power plant on the west coast.

Enron’s national reputation rested on the rapid expansion of its domestic business and its steadily growing revenue and earnings from

Stantis - Ethics and Conscience

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Cookie Jar - Ethics

were looked up to as visionary thinkers and top business leaders.

However, as we see elsewhere in this case study, the rapid expansion had run well ahead of Enron’s ability to fund it, and to address the problem, it had secretly created a complex web of off-balance sheet financing vehicles. These, unwisely, were ultimately secured, and hence dependent, on Enron’s rapidly rising share price.

Also, its hard driving culture was underpinned by incentive schemes which promised, and delivered, huge rewards in compensation packages to outstanding performers. The result was that, to achieve results, aggressive accounting policies were introduced from an early stage.

In particular, the use of mark to market valuation on contracts produced artificially large earnings, disguising for some years underlying poor profitability in major parts of the business.

This, of course, meant that Enron was not generating adequate cashflow, while spending extravagantly on expansion, and eventually it

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blew up suddenly and dramatically. Colleagues of this author who met Lay and had dealings with Enron confirm that there was scepticism in the market about Enron’s profitability and its cash position. Suspicions grew that Enron’s earnings had been manipulated and in late summer 2001 it emerged that its Chief Finance Officer had privately made himself rich at Enron’s expense through the off-balance sheet vehicles. About this time the dotcom boom ended suddenly and for Enron, this coincided with the international power business going radically wrong, the broadband business having to be shut down, the water business collapsing and the electricity services business getting into serious trouble in California. Enron’s share price started to slide and Skilling, appointed Chief Executive Officer in January 2001, resigned in August.

Enron’s share price then rapidly declined, triggering repayment clauses in the financing vehicles which Enron couldn’t handle. Its credit rating went to junk status, which caused

ETHICAL ASSESSMENT Enron didn’t start out as an unethical business. As we have seen in this case study, what introduced the virus was the pursuit of personal wealth via very rapid growth. This led to the introduction of quite extreme incentive schemes to attract and motivate very bright and driven people, which, in turn, led to an unhealthy focus on short term earnings.

The next step was, naturally, to look at how earnings could be massaged to achieve the aggressive revenue and earnings targets.

Since the massaged figures for growth in earnings still left a shortfall in cash, Enron quickly maxed out on its borrowing abilities.

But issuing more equity would have hurt the share price, on which most of the incentives were based. So schemes had to be created to produce funding secretly and this funding had to be hidden. In this way, an amoral and unethical culture developed in Enron in which customers, suppliers and even colleagues were misled and exploited to achieve targets. And the top management, who were rewarding themselves with these same incentive schemes, boasted that a pure, market-driven ethos was propelling Enron to greatness and deluded themselves that this equated to ethical behaviour. Lay even lectured the California authorities, whom Enron was cheating, that Enron was a model of business ethics.

IMPACT ON CORPORATE GOVERNANCE Our five Rules of Good Corporate Governance start with the need for an ethical culture.

Having established that Enron’s culture became progressively more deficient in this regard, let’s consider briefly the impact of this failure in business ethics on the other Rules.

Clear goal shared by all key stakeholders Lay and, particularly Skilling, engendered in all the staff of Enron the goal of driving up the share price to the virtual exclusion of all else. The goal of achieving a long term satisfaction from a stable customer base took a distant second place to signing up deals. In California, the customers were deliberately exploited by the traders to the maximum extent their ingenuity could achieve. Even internally, the Chief Finance Officer’s funding scheme was designed to make him rich at his employer’s expense.

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Finally, the respected Arthur Andersen allowed greed for fees to over-rule the strong business ethics tradition of its founder and caused it to succumb to bending and suspending its professional standards, with fatal results.

ENRON

the share price to collapse and triggered further crystallising of debt obligations. Banks refused further finance, suppliers refused to supply and customers stopped buying.

At the beginning of December 2001, Enron filed for the biggest bankruptcy the USA had yet seen.

This, in turn, took down one of the largest accounting firms in the world, Arthur Andersen, which was deemed to have so compromised its professional standards in its dealings with its client Enron that it was in many ways complicit in Enron’s criminal behaviour.

STRATEGIC MANAGEMENT As a McKinsey consultant specialising in strategy, Skilling had a very clear vision, at least initially, of what he wanted Enron to achieve.

However, he wasn’t interested in management per se and allowed operational management to wither. But his vision of a huge trading enterprise wasn’t carried down to the next level of developing and implementing practical business plans, as evidenced by his crazy launch into broadband, a field in which he had no personal knowledge or experience and in which Enron had almost no capability or likelihood of raising the funds required to implement the project ORGANIZATION RESOURCED TO DELIVER Skilling became COO on the departure of a very tough and experienced predecessor. Even

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at that point, Enron had been expanding at a rate which outran its ability to set up appropriate and adequate administrative systems and controls. Added to which it had always been short of funds. Skilling’s lack of interest in operational management meant that on his appointment at COO, he made a poor situation much worse by making bad managerial appointments.

His focus on rapid growth incentivised by very generous compensation schemes, and with inadequate spending controls, created a totally dysfunctional organization.

TRANSPARENCY AND ACCOUNTABILITY From the early stages, Enron’s focus on earnings and share price growth and the related financial incentives led to a necessary lack of transparency as the figures were fiddled.. One could argue that Enron felt very much accountable to their shareholders for delivering consistent above average growth in Enron’s market capitalisation. However, this growth was achieved by subterfuge and deception. Certainly the dealings in California were as far from transparent as it was possible to be.

Conclusion and rating by our Survey tool The flaws in Enron should have been spotted from early on, and indeed were periodically commented on by various observers from the early nineties onward. If independent ethical and corporate governance surveys had been conducted by independent parties they would have highlighted the growing problems. To illustrate, consider the hypothetical survey summarised in the following chart.

The scores out of ten (high is good) result from a set of questions which aim at deriving an independent, unbiased view from the interviewees, based on observations of corporate behaviour. What we have called the “sniff test” represents the personal view of the interviewee and would take into account their gut feel about Right: Enron CEO Ken Lay

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the corporation and its management and owners. The highlighted scores would point the observer to clear problem areas.

One would conclude from this survey in June 2000 that: • neither customers, suppliers, financiers nor local communities rated Enron’s morality in terms of business ethics • customers and local communities thought they were breaking regulations • customers and suppliers thought they were probably bending their own rules • customers, shareholders, suppliers, financiers and local communities thought they were not truly honest.

It is clear with the benefit of hindsight that what started out as an imaginative and ground-breaking idea, which transformed the natural gas supply industry, rapidly evolved into a megalomaniac vision of creating a world-leading company. Intellectual self confidence mutated into contempt for traditional business models and created an environment in which top management became divorced from reality. The obsessive focus on driving the share price obscured the lack of basic controls and benchmarks and the progressive dishonesty in generating revenue and earnings figures in order to deceive the stock market led to the management deceiving themselves about the true situation.

Right up to nearly the end, Enron complied with all its regulatory requirements. The failings in these regulations led directly to SarbanesOxley. But all the extra reporting in SarBox didn’t prevent the global financial meltdown in 2008 as the banks gamed the regulatory system.

Now we have Dodd-Frank. What we actually need is independent Corporate Governance surveys.

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10

BY VIK AS BAJAJ SEPT. 17, 2008 | NY TIMES The financial crisis entered a potentially dangerous new phase on Wednesday when many credit markets stopped working normally as investors around the world frantically moved their money into the safest investments, like Treasury bills.

As a result, the cost of borrowing soared for many companies, while the stocks of Wall Street firms like Goldman Sachs and Morgan Stanley that only a couple of weeks ago were considered relatively strong came under assault by waves of selling. Investors were so worried that they snapped up three-month Treasury bills with virtually no yield and they pushed gold to its biggest one-day gain in nearly 10 years. Stocks fell by nearly 5 percent in New York.

The stunning flight to safety, away from other kinds of debt as well as stocks, could cause serious damage to an already weakened economy by making it more expensive for businesses to finance their daily operations.

Some economists worry that a psychology of fear has gripped investors, not only in the United States but also in Europe and Asia. While investors’ decision to protect themselves may be perfectly rational, the crowd behavior could cause a downward spiral with broader ramifications.

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“It’s like having a fire in a cinema,” said Hyun Song Shin, an economics professor at Princeton. “Everybody is rushing to the door.

You are rushing to the door because everyone is rushing to the door. Clearly, as a collective action, it is a disaster.”

Faltering confidence could have an infectious effect in Asia, whose savings has essentially bankrolled America for decades. “Asia, perhaps more than other markets, is a bit more volatile, a bit more based on sentiment,” said Dan Parr, the head of Asia-Pacific for brandRapport, a consulting firm with an office in Hong Kong. “It doesn’t take much for the man on the street to become very, very concerned.”

In early trading in Japan, the Nikkei index fell 3 percent.

Despite government efforts to reassure investors over the last 10 days by rescuing some giant institutions — Fannie Mae, Freddie Mac and American International Group — many investors remain worried that the financial system has been badly battered and that more firms may fail as Lehman Brothers did.

The Federal Reserve has greatly expanded its lending to banks and securities firms this year and is continuing to relax rules that govern financial companies in hopes of alleviating the credit squeeze. Central banks globally are also injecting more money into their economies and lowering reserve requirements for their own institutions out of concern that the problems in the American financial system will inflict further damage.

If the problems in the financial system persist, businesses will have less money to put to work, job cuts will spread and consumers, already fearful, will have less money to spend, knocking the economy down another notch.

High borrowing costs will further weaken the housing market, which is still struggling. The Commerce Department reported Wednesday that housing starts fell to their lowest level since early 1991.

Flashes of fear were evident Wednesday as investors clamored for government debt. When

2008 FINANCIAL CRISIS

Pat Bagley - Salt Lake Tribune

investors bid up the price, the yield falls, and it sank on three-month Treasury bills to 0.061 percent, from 1.644 percent a week ago. The yield was the lowest in more than 50 years.

In the stock market, the Standard & Poor’s 500-stock index fell 57.20 points, or 4.71 percent, to 1,156.39, the lowest close in more than three years. The Dow Jones industrial average fell 449.36 points, to 10,609.66.

Worries over financial investments hammered even the well-regarded Wall Street firms of Goldman Sachs, whose shares fell nearly 14 percent, to $114.50, and Morgan Stanley, whose shares dropped more than 24 percent, to $21.75.

Now, both firms are reconsidering what their best strategies might be in such a fearful market.

In addition to shares of financial companies like Bank of America, those of other bellwethers like General Electric have also tumbled.

Responding to this pressure, the Securities and Exchange Commission proposed new rules on short selling, or betting on falling share prices, and even suggested that hedge funds and others might have to disclose short positions, a proposal that is likely to meet stiff resistance.

One key overnight lending rate was above 5 percent on Wednesday, more than double its level a week earlier. GMAC, the auto finance company owned in part by General Motors, had to pay interest of 5.25 percent on Wednesday for a form of short-term financing known as one-week commercial paper, up from 4 percent the previous day.

Businesses, stung by high interest rates, may be forced to trim expenses, an ominous turn in a slowing economy with unemployment rates on the rise.

“This is throwing sand in the gears of the economy,” said G. David MacEwen, chief investment officer for the bond department of American Century Investments. “The economy depends on credit to finance homes, automobiles, student loans, and inventories.”

Local governments and other enterprises will feel pressure, too. The city of Chicago and Lincoln Center in New York postponed debt offerings because they would have to pay such high interest rates to investors, said Daniel S. Solender, director of municipal bond management at Lord Abbett & Company.

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Money market funds braced for possible fallout from the disclosure that one big fund’s net assets fell below $1 a share, because it had held securities issued by Lehman Brothers. It is so rare for money market funds to fall below that threshold that many investors consider them as safe as cash or a checking account.

Some mutual fund companies reported that customers were moving money from broader money market funds that have had higher yields to more conservative funds within the same company, Peter Rizzo, a senior director of Standard & Poor’s, said late Wednesday afternoon. The overall effect is to reduce the appetite for securities of companies with anything other than the most stellar reputations.

Governments around the world stepped up their efforts to ease the strain on the global financial system. The Bank of England

extended a special bank lending program for three more months, while central banks in Japan and Australia injected more money into their banking systems. Russia injected money into its banks and lowered reserve requirements.

In New York, the Federal Reserve on Tuesday night said it would extend an $85 billion credit line to the insurer A.I.G. and receive the rights to a nearly 80 percent stake in the company. The deal came just after the government refused financial support to Lehman, leading it to file for bankruptcy on Monday.

The Treasury and Fed also said they would auction more Treasury bills. The Fed will use the securities to manage its balance sheet and inject more money into the financial system.

Because the Fed has expanded its lending to banks and securities firm this year, some analysts had grown concerned that the central bank

Christopher Crotty worked on the floor of the New York Stock Exchange. Credit Richard Drew

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could not fall across the board and that most of the bets made by Wall Street traders were inherently safe.

Now, there are signs that psychology is driving a reverse line of thinking. People are assuming that things will get worse and that any move by the Fed or the Treasury is a step down, not a step closer to improvement.

“There has been a tremendous amount of denial over the past two years, three years,” said Barry Ritholtz, chief executive of Fusion IQ, an investment firm, and author of The Big Picture blog.

The Treasury’s benchmark 10-year note rose 6/32, to 104 28/32, and the yield, which moves in the opposite direction from the price, fell to 3.41 percent from 3.44 percent late Tuesday.

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might run out of Treasury securities to conduct its operations. Mark Gertler, an economics professor at New York University, said the Fed was trying to balance two interests: protecting against a crisis but telling the market that it will not bail out every troubled institution. Despite the stress in the markets, he said, the Fed’s actions may have averted a worse outcome.

“Maybe this is being Pollyannaish, but they have been successful in signaling that the bailouts are no longer automatic, and thus far they have prevented a market meltdown,” Mr. Gertler said.

The dramatic events of the last year have called into question much of what policy makers, economists and investors once espoused about the financial system. As recently as the spring of 2007, many in Washington and New York continued to say housing prices Wall Street Blockchain

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