Over the years, Wall Street has had its share of scandals, many of which left despair and loss in their wakes. These include everything from insider trading to fraud that cost investors millions of dollars. To fully understand the impact these crooked individuals had on financial history, we must examine the people themselves, what they did and the legacy their misdeeds left behind. While no two are alike, what these men share is the lasting effects of their crimes, which are still felt byMain Street
many years later. This article will examine four of the most famous and unscrupulous Wall Streeters: Michael de Guzman, Richard Whitney, Ivan Boesky, Michael Milken and Bernard Ebbers.
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The Canadian Miner: Michael de Guzman
Michael de Guzman was the man many believe was the perpetrator of the famous Bre-X debacle. De Guzman was the chief geologist for Bre-X, and he had access to core samples retrieved from a mine in Indonesia. When the gold deposit numbers came in a little below average, De Guzman helped contribute to the biggest mining fraud in modern history by faking the samples to indicate a massive gold find. As time went on, the estimates were increased to as much as 200 million ounces. To get a handle on this number, the U.S. Treasury Department has about 250 million ounces of gold in its reserves.
This fraud was accomplished by inserting gold into the samples to make it look like there was much more gold in the Indonesian mine than there really was. As a result, the 4-cent penny stock quickly climbed to as high as C$250 (adjusted for splits). For investors, this meant that a $200 investment would have ballooned to $1.25 million.
However, independent geologists were suspicious of the mine's supposed riches, and the Indonesian government started moving in. De Guzman couldn't take the heat and ended up jumping from a helicopter. Bre-X stock did the same, costing its investors $6 billion.
The Unlucky Gambler: Richard Whitney
Richard Whitney was the president of the New York Stock Exchange (NYSE) from 1930 to 1935. On October 24, 1929 (Black Thursday), acting as an agent for a pool of bankers, he bought shares in many companies, creating a dramatic turnaround in the market. This caused him to be falsely hailed as a hero to the market, but the inflated stocks inevitably crashed five days later. (For more on this time period, read What Caused The Great Depression? and The Crash Of 1929 - Could It Happen Again?)
Whitney was an unlucky gambler who played penny stocks and blue-chip stocks aggressively. To cover his losses, he would borrow money from friends, relatives and business acquaintances. This allowed him to buy even more stock in a market that was collapsing, which made his problems even worse.
Despite his losses, he continued to live a lavish lifestyle. When he could no longer borrow any more money, he began to embezzle it from his customers as well as from an organization that helped widows and orphans. His fraud became more perverse when he looted the NYSE's Gratuity Fund, which was supposed to pay $20,000 to each member's estate upon death.
After an audit discovered the crime, he was charged with two counts of embezzlement and sentenced to five to 10 years in prison. As a result of his misdeeds, the newly formed Securities and Exchange Commission (SEC) set caps on how much debt firms can have and separates customer accounts from the property of brokerage companies. (Find out how this regulatory body protects the rights of investors in Policing The Securities Market: An Overview Of The SEC.)
The Market Manipulator: Ivan Boesky
Ivan Boesky's career on Wall Street began in 1966 as a stock analyst. In 1975, he started his own arbitrage firm, and by the 1980s, his net worth was estimated to be in the hundreds of millions. Boesky looked for companies that were takeover targets. He would then buy a stake in those companies on speculation that news of a takeover was going to be announced, then sell the shares after the announcement for a profit.
Throughout the 1980s, corporate mergers and takeovers were enormously popular. According to a December 1, 1986, article in Time Magazine, there were almost 3,000 mergers worth $130 billion in that year alone. However, Boesky's alarming success in this strategy was not all instinct: Before the deals were announced, the prices of the stocks would rise as a result of someone acting on inside information that a takeover or leveraged buyout (LBO) was going to be announced. This is a sign of illegal insider trading, and Boesky's involvement in this illegal activity was discovered in 1986 when Maxxam Group offered to purchase Pacific Lumber; three days before the deal was announced, Boesky had purchased 10,000 shares.
As result of these and other insider-trading activities, Boesky was charged with stock manipulation based on inside information on November 14, 1986. He agreed to pay a $100 million fine and serve time in prison. He was also banned from trading stock professionally for life. He cooperated with the SEC, taping his conversations with junk-bond firms and takeover artists. This led to both investment bank Drexel Burnham Lambert and its highest-profile executive, Michael Milken, being charged with securities fraud.
As result of Boesky's actions, Congress passed the Insider Trading Act of 1988. The act increased penalties for insider trading, provides cash rewards to whistle-blowers and allows individuals to sue for damages caused by insider trading violations. (For background reading, see Defining Illegal Insider Trading and Uncovering Insider Trading.)
The Junk Bond King: Michael Milken
In the 1980s, Michael Milken was known as the junk bond king. A junk bond (also called a high-yield bond) is nothing more than a debt investment in a corporation that has a high probability of default, but provides a high rate of return if it does pay the money back. If you wanted to raise money through these bonds, Milken was the person to call. He used them to finance mergers and acquisitions (M&As) as well as leveraged buyouts (LBOs) for corporate raiders. (Despite their reputation, the debt securities known as "junk bonds" may actually reduce risk in your portfolio. Learn more in High Yield, Or Just High Risk?)
But what he was doing was nothing more than creating a complex pyramid scheme. When one company would default, he would then refinance some more debt. Both Milken and Drexel Burnham Lambert would continue to make their fees as a result of this behavior. The company made at least half of its profits from the work of Milken. (Considering joining an "investment club" that promises phenomenal returns on your sign-up fee? Read What Is A Pyramid Scheme?)
Later on, Milken also started purchasing stock in companies that he knew would become potential takeover targets. Boesky, when charged with insider trading in 1986, helped implicate both the firm and Milken in several insider trading scandals. This led to criminal charges against the firm and more than 70 charges against Milken, who pleaded guilty, was sentenced to 10 years in prison and paid $1 billion in fines.
It is argued that the savings and loan crisis (S&L) in the late 1980s and early 1990s occurred because so many institutions held large of amounts of Milken junk bonds. After he was released from prison, Milken focused his attention on his foundation, which supports cancer research.
The Financial Statement Fraudster: Bernard Ebbers
Bernard "Bernie" Ebbers was the CEO of a long-distance telecommunications company called WorldCom. In less than two decades, he took the company to a position of dominance in the telecommunications industry, but shortly thereafter, in 2002, the company filed for the largest bankruptcy in U.S. history. (As soon as you invest in a company, you face this risk. Find out what it means in An Overview Of Corporate Bankruptcy.)
Over a six-year period, the company made 63 acquisitions, the largest of which was MCI in 1997. All of these acquisitions created problems for the company because it was difficult to integrate the old company with each new one. The acquisitions also threw massive amounts of debt on the company's balance sheet. To keep earnings growing, the company would write off millions of dollars in losses it acquired in the current quarter and then move smaller losses going forward to create the perception that the company was making more money than it really was. This gave WorldCom the ability to take small charges against its earnings every year and spread the large losses over decades. This schemed worked until the U.S. Justice Department denied the company's acquisition of Sprint in 2000, fearing that the combined companies would dominate the nation's telecommunications industry. This forced WorldCom to make the previous mergers work for them, and meant that it would only be a matter of time before all the losses that they were taking from other acquisitions would affect the company's growth. (For related reading, see Cooking the Books 101.)
When WorldCom filed for bankruptcy, it admitted that it inappropriately booked the losses from its acquisitions from 1999 to 2002. Ebbers also took personal loans from the company. He resigned as CEO in April 2002 and was later convicted of fraud, conspiracy and filing false documents with the SEC. He was sentenced to 25 years in prison.
Ebbers' legacy led to tighter reporting standards with the creation of the Sarbanes-Oxley Act of 2002, as well as the forbidding of personal loans to company officers and stiffer penalties for financial crimes. (Learn about how a company keeps its management in check can affect the bottom line in Governance Pays.)
The Bottom Line
Since Wall Street's earliest days, there have been criminals who have tried to disguise themselves as honest business people. Many of these crooks rose quickly to power only to have a hard crash landing in the end. This was exactly the case with Ivan Boesky, Michael Milken, Bernard Ebbers and Richard Whitney. What their examples show is that in spite of regulations, people will still try to find ways around the laws or simply disregard them for one purpose: greed at all costs.
For more on this subject, read Handcuffs And Smoking Guns: The Criminal Elements Of Wall Street, The Ghouls And Monsters On Wall Street and Tales From Wall Street's Crypt.