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(7/25/02) - The amount of the thievery was breathtaking, scores of millions of dollars at last count. And it seemed to go on forever. But the people who should have been watching the money at the SG Cowen and Lehman Brothers brokerage firms never even noticed.

When Samuel Glazer, the co-founder of Mr. Coffee, received his monthly statements from Lehman Brothers in 2001, they showed that he had nearly $24 million in extremely safe bonds, mostly U.S. Treasury bonds.

"He thinks that money is there waiting for him," said his lawyer, Robert Duvin, of Cleveland. ,p> It wasn't. Mr. Glazer's money had been stolen. Last January he got a call from a Lehman official informing him that instead of $24 million, he really had just $15,000 in his account.

Mr. Glazer was one of many SG Cowen and Lehman Brothers customers whose assets were lost to the frenzied thievery of a broker named Frank Gruttadauria. Mr. Gruttadauria spent a month in hiding earlier this year and then surrendered to the F.B.I.

Federal investigators have said that over a 15-year period, Mr. Gruttadauria looted as much as $125 million from investors, papering over his scheme year after year with phony account statements that showed a total value of more than a quarter of a billion dollars. According to investigators, those statements were figments of Mr. Gruttadauria's larcenous imagination. They listed, among other things, nonexistent holdings and transactions that never occurred.

So how, you may wonder, could such monumental thievery go undetected for so long at firms of the stature of SG Cowen and Lehman Brothers? Assuming there were no other individuals directly involved in the fraudulent activity, there is only one conclusion that rings true. The people who should have known what was going on didn't want to know.

What we have here is a massive breakdown of the internal controls that are supposed to protect customers and promote confidence in the industry. Top officials at both companies kept their blinders firmly in place and covered their ears to make sure they wouldn't hear anything untoward.

Mr. Gruttadauria was a managing director of SG Cowen and ran its Cleveland office. When Lehman Brothers bought SG Cowen's brokerage arm in the fall of 2000, it not only failed to detect the continuing fraud, it offered Mr. Gruttadauria a $5 million bonus to stick around.

Except for The Wall Street Journal, this story has not gotten a lot of national attention. For individual investors, it goes right to the heart of the trust issue that has big business and the national markets in such turmoil.

Who's safe if a broker can steal money by the millions and get away with it for a decade and a half? In a letter that he sent to the F.B.I. in January, Mr. Gruttadauria said, "I can hardly believe that I could have done this without detection for so long."

The pain inflicted by this scheme has been profound. Several of Mr. Gruttadauria's clients were elderly, and the investments they thought he was making were supposed to carry them through retirement.

Mr. Glazer opened his account with $5 million in July 1998. Said his lawyer, Mr. Duvin: "He never got — and I want to say this slowly — he never got a single honest piece of paper out of the account. He never got a single honest transaction. Ten days after he opened it up, $800,000 was taken out of the account. And within a short period of time, everything was gone."

But Mr. Glazer continued receiving statements showing that his account was flourishing.

Investigators said that when a client wanted to withdraw money from an account, Mr. Gruttadauria would be forced to make fraudulent transfers from other accounts. The fraudulent activity became a way of life in his office, and still no one noticed.

Mr. Glazer and many of the other victims have sued SG Cowen and Lehman Brothers in an effort to recover the stolen money. Mr. Glazer is also seeking $500 million in punitive damages from each company.

In a significant ruling last Friday, a federal judge said that seven of the plaintiffs, including Mr. Glazer, could have their cases heard at a jury trial. The companies, which had hoped to force the cases into arbitration, have already appealed the ruling.

(7/17/02) - A federal grand jury is investigating how the Washington, D.C., chapter of the United Way spent donations, the charity's lawyer said yesterday, just four months after the charity announced that a special audit had found nothing significant amiss with its finances or management practices.

Among the issues the grand jury is understood to be examining are repeated salary advances and credit card charges by Oral Suer, who was the charity's president for 27 years until he was succeeded by Norman O. Taylor in January 2001. After Mr. Suer retired, he received a $6,000-a-month consulting contract and continued to use one of the American Express platinum cards that the charity issues to its executives.

Mr. Suer also received a pension settlement of more than $1 million.

While grand jury proceedings are secret, the government made sure yesterday that there was a public record of its investigation.

Two F.B.I. agents walked into the offices of the United Way of the National Capital Area shortly before noon and signed the guest register, listing their names and employer, before asking to meet with Mr. Taylor, said Tony DeCristafaro, his spokesman.

Mr. Taylor was served a grand jury subpoena for "a list of the board of directors and financial records, pension records, money collected and disbursed," said Irv Kator, the charity's general counsel.

"We are not sure why they're doing this," Mr. Kator said, "but we will cooperate and give them any records they want."

Mr. Kator said he did not know if the pension payment was covered by the subpoena.

The United Way, which raises money for social services agencies in the District of Columbia as well as nearby suburbs in Maryland and Virginia, has until next month to present the documents to federal prosecutors in nearby Alexandria, Va., Mr. Kator said.

A spokesman for Paul J. McNulty, the United States attorney in Alexandria, declined comment.

Questions about how the nation's second largest United Way handled the more than $90 million it raises annually were brought to Mr. Kator last year by a board member, Ross W. Dembling, a lawyer in Tysons Corner, Va. Mr. Dembling was told a few weeks later that his term on the board would not be renewed.

The board's chairwoman, Gwendolyn Boyd, wrote memorandums saying that an investigation found no merit to the issues raised by Mr. Dembling. Later Ms. Boyd acknowledged that no one was interviewed and no records were examined before she wrote the memorandums.

After The New York Times reported on these events in January, some board members pressed for more disclosure, including the circumstances under which Mr. Taylor was ousted as head of the United Way in Baltimore in 1995. Mr. Taylor received a substantial payment from the Baltimore United Way in return for promising not to sue that charity, officials there confirmed, but the amount has never been revealed despite a federal law requiring disclosure of charity executive compensation.

On April 2 Anthony J. Buzzelli, a Deloitte & Touche managing partner and a board member of the Washington United Way, said that a special audit he was in charge of had found nothing significant amiss in the handling of the charity's finances. Board members were not allowed to see the audit until May 8, when they discovered that the inquiry covered only an eight-month period and left many questions unanswered.

I Don't Want to Sound Critical of United Way…But...

(7/9/02) - An Attractive title and good pay weren't Kathleen Britton's only priorities during her recent job hunt. She says she was equally keen to find a new employer with a squeaky clean reputation.

Ms. Britton, 45 years old, was an assistant vice president at a New York brokerage house and was laid off in December, she says, partly because she raised concerns about certain practices in the investment-banking unit. Regulators later interviewed her for a related investigation.

When Ms. Britton joined the firm in 1995, she says she ignored her qualms about a questionable prior dealing, which had been settled with authorities, because the brokerage house enjoyed widespread respect in the industry. She says she expects to accept a position next month at a big financial-services firm, and this time, she says, she checked out her new employer much more thoroughly. "I trusted my ethics and my judgment," she says.

The current wave of corporate scandals is leading more job seekers to go to greater lengths to gauge would-be employers' ethical standards and practices. They are poring over Internet message boards looking for staffers' appraisals of management, checking financial histories and seeking meetings with present and past employees. The downside: It's impossible to uncover everything about a corporation's moral weak spots in advance.

Gun-shy candidates say they fear that joining an unethical employer could endanger their tenure, retirement savings and self-esteem. As countless Arthur Andersen LLP staffers are discovering, working for a business with a damaged reputation can also impede future job prospects by leaving a black mark on a resume.

Many companies have begun to notice heightened concerns about ethical standards among both job seekers and recent hires. "With respect to new employees that have come in the last few months, I've had seven to nine who've said to me that one of the reasons they came to UTC is that they had researched our ethics program," says Patrick Gnazzo, vice president of business practices for manufacturer United Technologies Corp. in Hartford, Conn. "I haven't noticed that before in any great degree."

Mr. Gnazzo anticipates a further increase in ethics-related inquiries when United Technologies recruits at business schools in the fall. Describing the company's dedication to high ethical standards "is a great recruiting tool," he says. In 1986, United Technologies started an "ombudsman/dialog" program that lets employees inquire anonymously about ethics issues. The program has received nearly 56,000 inquiries.

Some job seekers figure out how well a company puts its values into practice from clues they collect during job interviews. A red flag should go up, for instance, if a hiring manager promises an excessive severance package following a layoff without first consulting a higher-level executive. "That tips you off about a lack of controls," says Richard Bayer, chief operating officer of the Five O'Clock Club, a New York-based national career-counseling organization.

Despite their more extensive checks, some new hires don't discover corporate ethics shortcomings until after they arrive. Mark Tremont says he thought he had thoroughly investigated a West Coast start-up before he became its chief financial officer several months ago. The 54-year-old executive consulted his personal network to learn about the company's finances and business practices. He also spent about two weeks in face-to-face discussions with top managers there.

Once he started work, however, Mr. Tremont says that he grew uncomfortable with how the chief executive had handled several past financial transactions. The CEO "didn't lie, he didn't do anything illegal," Mr. Tremont says. "He just dealt in a gray area I didn't want to deal in."

Mr. Tremont says he quit three weeks after he arrived. "My personal reputation was worth more than anything," he says. Now, the Bellevue, Wash., resident says he is doing volunteer work part-time while he searches for another position.

Other applicants putting would-be employers under a microscope feel frustrated by how little information they can glean in advance. "From the outside, it's really hard to tell," says a former television producer for a public-relations agency in New York.

She says questionable billing practices and "an accumulation of inappropriate behavior" led her to quit the agency in April 2001 without lining up another position. The 34-year-old producer says she is now seeking a corporate-communications position at a pharmaceutical company in part because the drug industry is considered to be highly regulated.

Some businesses resist prospects' inquiries about their less-than-comprehensive ethics programs, though. Job hunters should view such hesitation as another reason to look elsewhere, experts suggest. "If an organization is uncomfortable with you asking questions, then I would say that that's a sign right there," says Linda K. Trevino, a professor of organizational behavior at Pennsylvania State University's Smeal College of Business.

Ms. Trevino gives her business students a list of questions to help clarify a company's culture and the effectiveness of its ethics program. She believes it's more important than ever to conduct this "ethical culture audit." The list includes: "Is integrity emphasized to recruits and new employees?" and "Are people of integrity promoted? Are means as well as ends important?"

At the nation's biggest companies, it's relatively simple for applicants to find out official ethics policies. Most have adopted ethics codes and describe their ethics programs on corporate Web sites.

But job seekers shouldn't be overly impressed simply because a company has a code, cautions Edward Petry, executive director of the Ethics Officer Association, a professional group in Belmont, Mass., with 805 members. According to Mr. Petry, it's more important to find out how easily employees can get guidance on ethics issues and what kind of ethics training a company offers.

Mr. Petry also urges candidates to ask whether a potential employer has an ethics officer -- and whether that individual reports to the chief executive and the board audit committee. Another thing to watch for is whether a company integrates its purported values into performance appraisals and compensation plans.

"You'll find that very few do," he reports.

A Job Seeker's Ethics Audit

Some probing questions to ask about a prospective employer:

-- Is there a formal code of ethics? How widely is it distributed? Is it reinforced in other formal ways such as through decision-making systems?

-- Are workers at all levels trained in ethical decision making? Are they also encouraged to take responsibility for their behavior or to question authority when asked to do something they consider wrong?

-- Do employees have formal channels available to make their concerns known confidentially? Is there a formal committee high in the organization that considers ethical issues?

-- Is misconduct disciplined swiftly and justly within the organization?

-- Is integrity emphasized to new employees?

-- How are senior managers perceived by subordinates in terms of their integrity? How do such leaders model ethics behavior?

It's one of the most precious commodities a small business can have, but it's one many company owners don't try hard enough to keep -- their workers' loyalty.

"The importance of workplace loyalty is greatly underrated," said Diane Arthur, head of her own management consulting firm in Northport, N.Y., and author of "The Employee Recruitment and Retention Handbook."

"Employers are saying, `They don't have a sense of commitment to us, so we can't afford to have a sense of loyalty to them,' " said Arthur, who described owners who don't value their workers' loyalty as shortsighted.

If employees feel loyal to a company, they're likely to be more productive and make an extra effort for the business. And they're likely to stay, keeping the business stable and allowing the owner to concentrate on sales and earnings, not hiring replacement staffers.

The problem, consultants say, is that employers don't understand that in order to get loyalty from workers, a boss has to be loyal to them in the first place. "Loyalty should be initiated by the employer," Arthur said.

The weak economy isn't helping the situation.

"Employers for the most part believe that because we're in a tight economy, it's now an employer's marketplace and no longer an employee's marketplace," said Beverly Kaye, an employee retention consultant in Sherman Oaks, Calif.

"That is not necessarily so. Don't relax, don't think that you've got them and they've got no choice. Good, talented people will always have choices."

Leigh Branum, a vice president with Right Management Consultants in Overland Park, Kan., put it bluntly, saying some employers have the attitude that if workers aren't happy, "don't let the door hit you on the way out. They've got to get rid of that mind-set."

Consultants say it's not that hard to foster worker loyalty. Just about every business owner can find ways to make employees feel better, and in turn, care more about the business.

But don't for one minute think that giving someone a paycheck is all you need to do. Branum, whose company does exit interviews for other businesses, said that most managers think their workers have left because of money.

In reality, "you couldn't pay enough money to keep them," said Branum, who wrote "Keeping the People Who Keep You in Business."

What's more important to employees is a belief that they can grow and develop in their work, said Gary Topchik, managing partner of Silverstar Enterprises Inc., a Los Angeles-based management consultancy.

"If someone is on a career path and they have a good sense that they're moving up or the president or the owner of the company will take care of them and they have a good future, there's a strong sense of loyalty," said Topchik, who wrote the book "Managing Workplace Negativity."

It's possible to give employees that sense even in businesses like a gas station or dry-cleaning store, Topchik said. If an owner tells a worker, "I'm going to teach you how to manage," it can go a long way toward making even the least experienced, unskilled employee feel loyal, he said.

Jana Matthews, a consultant in Boulder, Colo., and co-author of "Building the Awesome Organization," said that helping employees understand their role in the company's mission will also help. So, in the dry-cleaning example, she suggested an owner convey to workers, "our business is to help people walk out of here looking their best ... the issue isn't just dry cleaning clothes."

A small business actually has an advantage when it comes to nurturing loyalty, Matthews said. "The good news about being in a small company is believing you can have an impact."

Moreover, with fewer employees, it's easier for the boss to stay in closer contact with the staff.

Contact and communication are crucial to building a sense of loyalty. So is a willingness to listen.

"Ask them, `How am I doing?' " Arthur said. "But if they tell you and you ignore or rationalize it, you won't have any loyalty. Be honest and sincere."

Along that line, if you feel an employee is disloyal, try to find out why.

"Listen to their anger. Don't just say, `He was in a snit,' " said Kaye, co-author of "Love 'Em or Lose 'Em."

Of course, positive feedback -- verbal and written -- goes a long way. Kaye said of her employees, "I thank them often and I thank them in writing."

Consultants also say rewards such as free lunch and gift certificates are a great idea -- yes, they cost money, but they are great investments in creating loyalty.

KANSAS CITY, Mo. (AP) -- A month before Kansas City, Mo.-based Aquila Inc. announced plans to fire 500 employees to save nearly $35 million a year, five top executives were paid a total of $30 million in bonuses.

Leo Morton, a senior vice president and chief administrative officer, said the incentive pay was crucial because it awarded performance that was excellent at Aquila last year.

"No one anticipated where we are today," Morton said.

When the board's compensation committee decided in February to award bonuses beyond the established salary and incentive packages, it cited rapid growth the previous year. But already, Aquila's stock price had fallen from a high of $37.55 in May 2001 to $23.53 on Feb. 1.

Still, the committee of three board members:

- Determined the nearly $6 million in salary and bonuses destined for chairman Richard Green Jr. was insufficient because of his work in cultivating the company's energy trading operation. As a result, the committee put an additional $4.5 million in "discretionary" cash and stock into his paycheck in "recognition of his contribution," pushing his total compensation to more than $10.3 million.

- Decided Robert Green, president and chief executive, deserved an extra $4.5 million in cash and stock. He wound up receiving more than $9.4 million in salary and bonuses.

- Gave three other executives a total of $12 million in bonuses on top of their salaries, most tied to existing incentive packages.

The bonuses were paid in March. A month later, Aquila, formerly known as UtiliCorp United Inc., announced that it would fire 500 employees, a move that would save about $35 million a year. That was soon followed by additional layoffs and the announcement of a cut in dividends for shareholders and of asset sales to further conserve cash.

Aquila has announced a cutback this year in long-term incentive pay, which was a part of the executive bonuses awarded last year.

In its report filed in March with the Securities and Exchange Commission, the committee - whose members are paid about $100,000 annually to serve as directors - said higher compensation was justified because aggressive financial goals set for Aquila had been achieved.

(7/8/02) - SAN FRANCISCO -- Power and energy companies are fast becoming a primary target of computer hackers who have managed to penetrate energy control networks as well as administrative systems, according to government cyber-terrorism officials and private security experts.

Experts cite a number of potential sources for the post-Sept. 11 increase in hacker attacks, including industrial espionage and malicious mischief, but Ronald Dick, director of the FBI's cybercrime division, said he is concerned that the nation's power grid now may be moving into the cross-hairs of cyber-terrorists.

"The event that I fear most is a physical attack in conjunction with the success of a cyber attack on an infrastructure such as electric power or 911," the emergency telephone system, Dick said.

The raft of recent attacks has been confirmed by private computer security companies.

Riptech Inc., an Alexandria, Va., security firm, said that since January, 14 of its 20 energy-industry clients have suffered severe cyber attacks that would have disrupted company networks if they had not been detected immediately. The number of attacks is up 77% since last year.

Power and energy companies experienced an average of 1,280 significant attacks each in the last six months—far more than companies in any other industry sector—according to Riptech's semiannual client analysis.

"Unequivocally, these nets are vulnerable to cyber attack, and, unequivocally, one outcome could be disruption of power supplies," said Tim Belcher, Riptech's chief technology officer.

Last year's power crisis in California, the Enron Corp. scandal and the declaration of bankruptcy by Pacific Gas & Electric Co. have revealed an industry that is fragile, high- profile and wracked with confusion and administrative chaos. Experts suspect that the glare of adverse publicity has drawn the attention of not just joyriding hackers, but also corporate saboteurs and terrorists.

More than 70% of the attacks came from North America and Europe, suggesting that traditional hackers are now turning to a fresh and vulnerable victim. The second-most popular hacking target among Riptech clients was financial service companies, a longtime hacker favorite. Riptech, which serves Fortune 500 corporations, smaller companies and government agencies, was founded by former top Defense Department officials to provide computer security.

A geographical analysis of Riptech data also shows that a small number of attacks—1,260 out of a total of more than 180,000—originated in countries where terrorists groups are known to be concentrated. Hackers in those countries targeted power and energy companies more consistently and aggressively than any other industry. The most active attacks originated from Kuwait, Egypt and Pakistan—countries that have relatively developed computer networks and a growing pool of experienced hackers.

Energy power systems have ironically become a choice target because of efforts to modernize them for greater efficiency. The weak link—a group of remote control devices known as Supervisory Control and Data Acquisition systems—"have been designed with little or no attention to security," according to a recent report by the National Research Council, an arm of the National Academy of Sciences.

The systems, which are used to control the flow of oil and water through pipelines, and monitor power grids, were once impervious to hackers because they were completely isolated from other computer systems.

Today many such systems are connected to the Internet, and therefore vulnerable to hacking. The FBI also blames a rapid increase in hacking attacks in recent years on the proliferation of hacking software posted online. Such tools require little computer expertise, are readily available worldwide and are becoming increasingly simple to use. Some are directly applicable to electrical power systems.

"One of the places [hackers] are certainly attacking are those known vulnerabilities," Dick said. "The rise in the number of incidents reflects of the ease with which these tools are utilized."

Surreptitious hacking tests conducted by special Defense Department information warfare squads known as "red teams" in 1997 found power grid control systems susceptible to attacks; recent, similar vulnerability testing by Riptech for its own clients resulted in network penetrations virtually 100% of the time, Belcher said.

"Two years ago, there were people who didn't have a clue—who said, 'Why would somebody want to attack us?' That is not the case today," said Will Evans, vice president of People's Energy, a diversified power company in Chicago.

"The problem is not today, but tomorrow," he said. "Whatever you've got today someone may discover and exploit against that tomorrow.... You need to finance a very active cyber-security program."

Evans, consistent with the policy of nearly all energy companies, declined to comment on specific attacks against his company.

Even using advanced computer forensic methods, law enforcement officials cannot identify the individual hackers behind the barrage of attacks on power companies.

The Washington Post reported last month that some government officials suspect the Al Qaeda terrorist network of plotting cyber-terrorist actions against power stations and emergency services in the San Francisco Bay Area.

Riptech's Belcher, a former cyber-security consultant for the Defense Department, is skeptical of such claims, saying that the ability to wage effective information warfare is many levels beyond the ability to merely penetrate a network.

"I see no evidence that there are expert cyber-terrorists today," he said.

Although a concentration of attacks come from countries identified with terrorist groups, he cautioned that many such countries are major energy producers—suggesting that the hacks may be the product of more mundane industrial espionage, rather than terrorism. Similarly, Hong Kong—a key financial center—is a hotbed for cyber attacks on the financial services industry, he said.

But some experts believe that some of the attacks may be a kind of training exercise for terrorists. Al Qaeda worked for three years on the Sept. 11 attacks, according to U.S. intelligence agencies, and may be making a similar investment in cyber-terrorism.

"The terrorists out there are well-educated and determined to get the training and knowledge to carry this out, and they are very patient," Dick said.

A number of terrorist organizations have developed rudimentary technical skills. For example, in 1997, the Tamil Tigers, a Sri Lankan rebel army known for terrorist bombings and assassinations, hacked into and shut down the servers of Sri Lanka's embassies in Seoul and Washington.

"Why haven't they done more of it? My main hypothesis is that they didn't need to because their conventional weapons—the gun and the bomb—were adequate," said Bruce Hoffman, a terrorism expert with the Rand Corp.

But the new war on terrorism has hampered terrorists' ability to operate elaborate base camps, and has dramatically tightened security for physical infrastructure—from airports to power plants to government buildings.

Cyber-warfare may represent a safer, more effective alternative.

"You don't need training camps or a robust logistical and intelligence support structure," said Hoffman, "just a modem and a safe house.... This is the ultimate anonymous attack."

Employee Advocate: This article is presented only as relevant news. We have never endorsed any illegal action - physical, cyber, or otherwise.

PORTLAND — The head of the Bonneville Power Administration (BPA) said yesterday that he is returning a $7,500 bonus because he "didn't feel right" about accepting it when his agency is losing money. Steve Wright's action drew praise from Congress and utility executives, who say he is a model for corporate executives.

"A lot of CEOs can learn a lesson from him," said Sen. Patty Murray, D-Wash. "It was a classy move."

Wright, who earns $138,000 annually as BPA administrator, received the bonus from the U.S. Department of Energy for his leadership efforts during the Western energy crisis.

But Wright said in a memo to BPA employees that he was transferring the money to the Bonneville budget because agency workers have suffered budget cuts and that it was "my responsibility as the person in charge to make a personal sacrifice."

Wright said the bonus came as "a total surprise," and he had no plans to make his decision public until reporters obtained a copy of the June 18 memo.

"I've read about corporate executives getting big bonuses when their companies are losing money, and I realized that now I was in same boat, and it just didn't feel right," Wright said.

Bonneville estimates it may have to raise wholesale electric rates by up to 11 percent in October to cover its operating costs as it struggles to get out of high-price contracts, including pacts with Enron, signed as energy costs skyrocketed last year.

The BPA generates power from its system of hydroelectric dams on the Columbia River and from the Hanford nuclear plant, but it also must buy power on the spot market to cover some of its obligations to utilities.

Mark Crisson, head of Tacoma Power, was the first chief executive officer to praise Wright for returning the bonus.

"In light of what's been happening in the private sector of the corporate world, it's a refreshing change to see a public servant take his mission so seriously," Crisson said.

He noted that $7,500 is more than 5 percent of Wright's annual salary, money which Wright could have spent on his family, such as investing in a college fund for his young children.

"It's not a token amount," Crisson said, "but it's the kind of thing a good leader does."

Crisson also praised Wright for bringing a steady hand to Bonneville management during the energy crisis, and he was joined by Murray and Sen. Gordon Smith, R-Ore.

"I think Steve is setting the highest example for corporate America," Smith said.

(6/29/02) - The Xerox Corporation, which conceded earlier that as part of a settlement with the Securities and Exchange Commission it would reclassify more than $2 billion of revenue from previous years, said yesterday that it was in fact restating a much larger amount, $6.4 billion.

The result of the restatement will be to lower the company's revenues and profits in 1997, 1998 and 1999, and increase them in 2000 and 2001.

News of the restatement shook investors, who sent Xerox's shares plunging $1.90 in early trading. But the stock recovered somewhat after shareholders realized that the restatement did not include phantom sales or earnings that might lead to fresh accusations of accounting irregularities or additional S.E.C. action. Xerox shares ended down $1.03, or 12.9 percent, at $6.97.

According to Xerox, the accounting discrepancy stems primarily from a decision by Xerox to account for equipment leases in Latin America as rentals rather than equipment sales, the most conservative way of accounting for such transactions.

With the latest disclosure, the chairwoman and chief executive, Anne M. Mulcahy, said Xerox had resolved its accounting issues with regulators and was determined to "ensure the highest integrity of the company's financial reporting" in the future.

Yesterday's announcement was more ink inscribed in a dark chapter that Xerox began writing in June 2000, when it alerted the S.E.C. that it had uncovered fraudulent accounting in its Mexican operations. The alert touched off an investigation of Xerox's accounting.

The agency concluded that Xerox booked too large a percentage of its revenue and profits from equipment leases in the first few years of the leases and that it had understated finance revenues and overinflated equipment revenues. For example, Jonathan Rosenzweig, an analyst with Salomon Smith Barney, noted that in Brazil, where interest rates often balloon to 25 percent and more, Xerox allocated single-digit finance charges on money that came in on equipment leases in 1997 through 2000, and then listed the rest as revenue.

Xerox fought the S.E.C. for more than a year, insisting that its accounting methods were aggressive, but acceptably so. But in April, Xerox capitulated, agreeing to restate its earnings, change its accounting methods and pay a $10 million fine…

Enron Pension Efforts Draw Fire

(6/27/02) - SAN FRANCISCO (CBS.MW) -- You buy, you lose.

With $30 billion in debt, WorldCom, owner of long-distance carrier MCI, was one of the biggest buyers of telecom assets in the go-go years, when common stock, convertible and corporate bonds paid for the outlandish purchase of competing companies.

"There is no doubt that acquiring companies tend to lose out," says Rafe Resendes, director at Applied Finance Group in Chicago. "It is what is referred to as the winner's curse. Basically, those guys overpay in order to not lose."

Most of the gluttons, as the acquirers are known, are suffering for their purchases and multibillion-dollar writeoffs, among them AOL Time Warner, JDS Uniphase, Vivendi Universal, Tyco International, and Qwest Communications to name just a few of the best-known examples.

The clear lesson for investors, and executives, is simple: Growth is good, but only when its offspring -- investment returns -- exceeds the cost of headline-making purchases.

Resendes points to JDS Uniphase, the fiber-optics developer that was a piggish buyer of other companies, mostly using its own stock as its currency of choice.

"If you looked at the asset growth for JDSU, it was too good to be true," says Resendes. "Assets grew from $270 million in 1998 to $26 billion in 2000. Do you think a management team can really handle that kind of growth and create value for its shareholders?"

Resendes and his Applied Finance Group rate companies in part by their economic margin, a figure that basically measures how well a company's returns exceed its costs of funds (what a company pays for debt and equity capital).

"If you source funds from investors at 10 percent and you only deliver 7 percent, you are killing your investors," Resendes says.

In 1998, JDS Uniphase had an economic margin of 12 percent vs. a zero percent average for the rest of corporate America. "After huge growth in 1999, their economic margin dropped to negative 27 percent, and in 2000 with more acquisitions it continued falling, to 75 percent," says Resendes. "Not surprising that by 2001, they had given up half the returns they generated through 1998, not even counting the obscene results they generated in 1999."

The lessons learned by JDS Uniphase and scores of other companies that pursued expensive mergers and acquisitions are pacifying the gluttons. Dealogic Global M&A Review Thursday said the value of telecom "deals" fell to $79 billion in the past six months vs. $125 billion in the first half of 2001. Among computer and electronic product companies, the deals amounted to $27 billion vs. $49 billion in the first six months of last year.

M&A Hall of Shame

Tom Taulli, the author of "The Complete M&A Handbook," tells me "M&A has proven to mean the destruction of shareholder value on average." Taulli is referring to mergers and acquisitions of the JDS Uniphase brand.

"The problem is when M&A completely dominates the thinking, creating deal fever. It is very similar to a crack addiction. And we all know that crack kills," says Taulli, a prolific financial author whose new, timely book is on short-selling.

Because of pro-forma calculations and fuzzy accounting standards, "it is easy for managements to walk on the wild side when accounting for acquisitions, especially when a company is a serial acquirer," Taulli says from his California office.

"A good historical antecedent is the 1960s with the rise of the conglomerates. There was a famous front cover of Forbes, in 1969, that had a broken-glass window and questioned whether it was the end for Litton, one of the highest-profile conglomerates of the day. It was," Taulli says.

Litton boosted earnings-per-share for many years via acquisitions. "Companies (in the '60s and the '90s) used stock to buy real assets and earnings. But real assets have diminished value if they cannot be properly managed. Competitors will come in and take advantage of the situation," he says.

Taulli's advice for investors is basic: Stay away from companies that have been aggressive with M&A -- buying 20 or more companies in the past five years. "But in the case of WorldCom, it looks like downright fraud. So, it goes beyond a crack addiction. It also involves committing crimes to get the drugs."

What about companies that use stock, and cash, to acquire technology and the companies producing that technology, yet still manage to squeeze modest profits, and a slight economic margin, out of them?

"What about Cisco?" asks Adam Epstein at Enable Capital in San Francisco. "What is it about their methodology that has made acquisitiveness moderately accretive?

Cisco has acquired about 70 companies since 1995. John Chambers, chief executive of the telecom equipment company, was reported once to have said, "If you pay $500,000 to $2 million per person ... and you lose 30 to 40 percent of those people in the first two years, you've made a terrible decision."

Cisco has spent billions of dollars buying networking equipment and software companies, and many of them, like the just-closed purchase of Navarro Networks, were privately held. Cisco on Thursday said it used $258 million of common stock to purchase remaining stakes in Navarro and another company, Hammerhead Networks. It had minority stakes in the two companies.

A charge against earnings of no more than 2 cents a share will come from the purchases, Cisco says. Ultimately, the stock market will judge whether a string of these purchases is justified. Shares of Cisco are about $2 above their September low, yet the company is still worth an astounding $100 billion, or 90 times one-year earnings.

Investigators looking into the WorldCom scandal have found no records to support decisions to shift billions of dollars in expenses on the company's books, people close to the company said yesterday — a fact that increases the likelihood that the transactions involved criminal fraud.

Instead, investigators have found that the sums involved — which reduced reported operating expenses over the last five quarters — were exactly those needed for WorldCom to meet its profit margin goals, these people said.

"From all appearances, this started with the desired profit margin and then backed into the expense number," one person close to the company said.

Moreover, in interviews with the company's board, the former chief financial officer, Scott D. Sullivan, reported that he independently decided to make the expense shifts without consulting with WorldCom's former accountants, Arthur Andersen, according to people close to the company. Mr. Sullivan also implied that he had made the decision without consulting other senior executives, they said.

The lack of records is likely to be crucial in the unfolding investigations of WorldCom. Those investigations have rapidly picked up pace in the two days since the company announced that it had improperly accounted for more than $3.8 billion in expenses.

The company has already been served with criminal subpoenas from the United States attorney in Manhattan, people close to Worldcom said. Those subpoenas seek virtually every record that went into the preparation of financial statements dating back several years, they said.

In addition, the House Financial Services Committee said yesterday that it would subpoena current and former WorldCom executives and a prominent Wall Street analyst for a hearing on July 8 on how the company overstated profits and understated expenses.

The executives who will receive subpoenas to testify are the chief executive, John W. Sidgmore; the former chief executive, Bernard J. Ebbers; and Mr. Sullivan, who was fired after an internal auditor discovered the accounting problem.

Jack B. Grubman, a prominent telecommunications analyst at Salomon Smith Barney, who played an important role in helping WorldCom grow into one of the largest telephone companies, will also receive a subpoena. Mr. Grubman, who was close to Mr. Ebbers and Mr. Sullivan, recommended to investors only on Monday that they sell stock in WorldCom, after the shares had declined 99 percent.

"Of course, we will cooperate with any inquiry, as is our practice," said Mary Ellen Hillery, a spokeswoman for Salomon. The firm handled more than $20 billion of underwriting for WorldCom in the last five years, benefiting from a close investment banking relationship with the company.

The lack of records in support of the expense transactions was first discovered by WorldCom in the days leading up to its announcement. Last weekend, Mr. Sullivan was asked to prepare a "white paper" to explain his decisions to shift billions of dollars of operating expenses into capital expense accounts. Under accounting rules, capital costs can be charged as expenses in small percentages over many years, while operating expenses must be declared in the year they occurred.

In the white paper, according to people who have read it, Mr. Sullivan explained that he thought the expenses involved an investment in telecommunications line capacity, which would provide increasing revenue in future quarters. Therefore, he argued, it was appropriate to defer expenses until those future quarters.

Mr. Sullivan presented his case to the company's directors, who were dumbfounded as they listened to the explanation, according to people close to the company. Afterward, the directors asked the company's accountants, KPMG, if the explanation sounded appropriate, and the auditors said it did not.

Afterward, according to people close to the company, Mr. Sullivan was questioned more thoroughly. Where, he was asked, was the documentation that supported the dollar figures he chose to shift from operating to capital expense accounts? Each time, according to people close to the company, Mr. Sullivan replied that he had none.

"There was no model he was using in coming up with those numbers," one person close to the company said.

Corporate transactions, particularly those involving billions of dollars in capital, generate reams of paper that are used to explain to auditors and accountants how values were selected, all in an attempt to ensure that managers do not simply create numbers to achieve desired results. The lack of such records in the WorldCom case has led investigators to believe that the transactions had no business basis.

The discrepancies were discovered by an internal auditor during a routine check of the capital accounts. Repeatedly, according to people close to the company, the auditor could find no records to support the full dollar amounts in the accounts, a suspicious clue that ultimately led to the discovery of the shifting of expenses.

The ease of the discovery led some directors to question openly why the discrepancies had not been detected by Andersen, WorldCom's former accountant. The lead Andersen partner on the WorldCom account was changed in 2001, according to people who have reviewed records of the accounting. That partner, Melvin Dick, earlier this month became the chief financial officer of Coldwater Creek, a clothing retailer. Mr. Dick did not return calls.

Separately, WorldCom showed signs of losing business yesterday as customers flocked to competitors for local and long-distance phone service. SBC, the large local telephone company based in San Antonio, said last night that call volumes surged an average of 25 percent yesterday at call centers that specialize in handling customers who want to switch their local service to SBC.

The Financial Services Committee focused on WorldCom yesterday as a growing list of banks disclosed losses on the company's bonds and stock. The financial services industry has also come under scrutiny for financing WorldCom's rise and promoting its prospects even as they began to dim last year.

"Sadly, the news brings us yet another incident of accounting overreach," said Representative Michael G. Oxley, Republican of Ohio and chairman of the Financial Services Committee. "These alleged short-term gains created by the executives are going to cause long-term pain for WorldCom families."

As WorldCom prepared to lay off 17,000 employees, or about a fifth of its work force, part of a program intended to cut $2 billion of costs, the company was also struggling yesterday to avoid an exodus of senior executives.

A retention program created two years ago that paid more than 550 top executives an average of $425,000 each to prevent them from leaving the company expires July 30. Recruiters said yesterday that many senior operating, marketing and technology executives at WorldCom were planning to leave the company.

Treasury Secretary Paul H. O'Neill called for thorough prosecution yesterday of the executives responsible for the accounting irregularities at WorldCom. The Securities and Exchange Commission filed fraud charges against WorldCom on Wednesday. The Justice Department and another House committee, Energy and Commerce, opened investigations of the company's accounting practices this week.

The House Energy and Commerce Committee requested last night that WorldCom turn over a detailed list of financial records to the committee by July 11.

In addition to information on WorldCom's accounting in 2001 and 2002, the period already under scrutiny for the $3.8 billion in transfers, the committee requested details on WorldCom's accounting for swaps of communications capacity, transactions that have raised concern at companies like Global Crossing and Qwest Communications.

The collapse in value of WorldCom's stock and bonds, meanwhile, continued to reverberate among investors. State pension funds lost at least $1.6 billion, according to preliminary estimates that still exclude large state pension systems like those in Texas and Massachusetts.

The California Public Employees' Retirement System, the nation's largest pension fund, with nearly $150 billion of assets, estimated that it lost $565 million on its investments in WorldCom securities. The New York State Common Retirement Fund said yesterday that it lost about $300 million on WorldCom-related investments.

"As a nation, we believe in holding individuals accountable for their actions when a crime is committed, and that value must extend to corporations — such as WorldCom — and their executives," H. Carl McCall, the New York State comptroller, said in a statement.

WorldCom's extensive international operations, meanwhile, showed signs of strain yesterday. Shares in Embratel Participações, the Brazilian long-distance carrier that is WorldCom's largest international subsidiary, fell 13 cents, to 62 cents, in trading in New York yesterday, even after the company said it was operationally and financially independent of WorldCom.

The company has retained Goldman Sachs to advise it on selling Embratel and its unit in Mexico, Avantel, people close to WorldCom said yesterday, but the possibility of completing such deals is considered difficult because of recent pressure on Brazil's financial markets and WorldCom's woes, analysts said.