Wall Street's message is trust no one
Paranoia is order of the day, so Krispy Kreme
Doughnuts gets a grilling
David Teather in New York
Thursday February 7, 2002
The Guardian
Krispy Kreme Doughnuts is not a complicated company. It
doesn't trade in difficult to understand intangibles - it sells
doughnuts and pastries. The business was the second-best
performing flotation on Wall Street in 2000 and recently reported
a 68% increase in profits. In fact, Krispy Kreme is just the kind
of "simple" company that investors are being advised to retreat
into.
But Krispy Kreme has not escaped the paranoia running
rampant on Wall Street. Hoping to promote a new
doughnut-making machine during a television interview on CNBC
this week, the chief executive of the company, Scott Livengood,
found himself instead being grilled about accounting practices
relating to retail property leases.
Trust no one. That is the message emerging from a Wall Street
just beginning to feel the full effects of the collapse of Enron, the
energy firm that fell so mightily last month. It has not escaped
the notice of investors that before the bankruptcy of Enron the
company was handing out paperweights festooned with the
company's supposed ethics.
Shifting focus
The effect has been dubbed Enronitis - an appropriate term
because it has spread through the markets like a virus. In the
space of a few weeks, investors have witnessed the biggest ever
bankruptcy in Enron, the fifth-biggest in telecoms company
Global Crossing - and the largest ever retail collapse, at Kmart.
Another wave of companies has either delayed reporting or
restated profits as they come under new levels of scrutiny.
As the events that led to the implosion at Enron have become
clear - the huge debts hidden in offshore ventures, the forced
restatement of accounts - so the focus is shifting firmly to the
checks and balances that were supposed to have pre vented
this kind of thing from happening. A big-five accounting firm
missed the debts that Enron was hiding offshore, regulators did
not recognise what was going on and the banks lending billions
of dollars failed to spot anything. The highly paid Wall Street
analysts following the company continued to post "buy" notes
on Enron shares close to the end. The fundamentals have been
shaken.
If they were unable to protect investors from the alleged
corruption at Enron then why should they be trusted elsewhere?
Are the profits of some of the biggest companies traded on Wall
Street little more than the results of clever accounting, which will
result in more corporate disasters?
A survey for Wall Street Reporter magazine among institutional
investors suggests that there has been a serious impact on
confidence. The survey found that after the Enron collapse 43%
of the 266 respondents were worried about the potential for
widespread fraud.
"People are questioning the fundamentals and the reliability of
financial reporting," says publisher Jack Marks. "There is almost
a crisis of confidence. People are afraid to buy stocks at the
moment because they are worried there are ticking bombs out
there ready to go off. Enron was such a huge company that it
has really shaken people. The impact is very real."
Research note
Credibility and debt levels are becoming crucial indicators. An
early sign of the anxiety caused by Enron's implosion was the
speed with which the discount retailer Kmart dropped into
bankruptcy.
The company fell victim to a crisis in confidence triggered by a
single research note from an analyst who said the company
could face a shortage of cash. Kmart sank into a spiral. The
shares collapsed, debt-rating agencies downgraded the
company and it was forced into Chapter 11 protection when a
big supplier stopped shipping groceries. Kmart, too, has asked
regulators to investigate claims from an employee that its
accounting has been irregular.
A disturbing pattern of cover-ups and conspiracies is beginning
to emerge. Global Crossing, the telecoms firm, is also subject
to questions about its accounting methods. As with Enron, it
has emerged that a whistleblower had warned the board at
Global Crossing months before the collapse that executives had
"intentionally misled" investors.
There have been suggestions that those in the banks and
accounting firms who had sniffed the alleged corruption in Enron
were silenced because they were in conflict with the fee-earning
of other divisions in the banks or auditors. Daniel Scotto, an
energy analyst at the investment bank BNP Paribas, claims he
was fired for attempting to expose the problems at Enron - an
allegation denied by the bank.
The fears are focused on either complex conglomerates or
new-economy companies, many of which have yet to report
profits and do not produce goods that have an easily
recognisable value. Tyco, the conglomerate which makes
everything from fire extinguishers to medical supplies and
bought Conservative party treasurer Michael Ashcroft's ADT, is
now coming under similar pressure.
The group announced surprise plans to split into four to combat
accusations about lack of transparency but the action has not
been enough to stop the rumours of murky accounting methods.
It has already been dubbed Enron mark two amid allegations
that it had not disclosed billions of dollars worth of acquisitions
that were flattering its growth rates. It was also disclosed that
the company paid one of its board directors $20m to help
engineer one of those deals.
Ed Yardeni, chief investment strategist at Deutsche Bank,
argues that the post-Enron environment is exposing tricks that
became commonplace in the hubris of the stock market boom.
The bull market of the 90s, he says, caused many good
managers to turn bad as they raced to keep up with the
ever-increasing expectations of Wall Street. As the bull market
ran out of impetus many were forced to resort to gimmicks to
give investors what they wanted. "This exercise could trigger a
wave of restatements of previous results," he says.
Name and shame
The intense interest in the Enron affair has forced the previously
arcane activities of Wall Street into a wider view that could
cause a fundamental change. The tabloid New York Post, part of
Rupert Murdoch's News Corporation, has begun a campaign to
name and shame the analysts that continued to issue "buy"
notes on Enron and Global Crossing almost to the end.
Comparisons have been drawn with the Wall Street crash of the
30s as a wave of fraud was uncovered. That led to the
introduction of proper regulation. In 2002, the response is similar
and the rules are being tightened again. A new watchdog for the
accountancy profession is being set up and there are calls to
separate consulting from auditing. The credit rating agencies are
speeding up their assessments of a company's debts.
The fall of Enron came at a critical time for the markets, which
were building a fragile self-confidence. The key indices have
fallen sharply in recent weeks. Restoring confidence in a market
battered first by a tough economy, terrorism on an
unprecedented scale and now with its fundamental beliefs
shaken will not be an easy job. |
