Who Stole the American Dream? (18 page)

Nationwide, the scale of stock option cheating was staggering. But the public knew little about it because this corporate fraud took place behind closed doors. Except for a few high-profile cases such as Apple’s, most of the bogus option deals got no media attention. In part, this is because the SEC under Bush relied mostly on internal company probes to ferret out wrongdoing rather than launching its own legal actions.

In
one revealing case, William McGuire, former CEO of United-Health Group, was forced out by his own board in October 2006 because an internal inquiry found he had been backdating and manipulating stock options for eight years—from 1994 through 2002. To settle claims by both his company and the federal government, McGuire eventually agreed to forfeit $620 million of his $1.1 billion in stock option gains.

The size of McGuire’s settlement suggests the huge sums at stake. In a detailed study, professors at Harvard and Cornell documented options cheating on an epidemic scale. At least 850 CEOs, they said, were involved in fraudulently manipulating stock options, dishonestly cheating their own employees as well as mutual fund and 401(k) investors.
One reason so many CEOs got away with options cheating was that some corporate board members got payola, too. As the Harvard-Cornell team put it, there were “lucky directors” motivated to manipulate the option dates of their “lucky CEOs” because the board members also “luckily” got backdated options.

Some of the sharpest criticism of the stock options game came not from academics or liberal politicians, but from staunch capitalists such as John C. (Jack) Bogle, founder and longtime chairman of the Vanguard mutual fund family. Bogle contended that ordinary shareholders were being cheated by the massive stock grants given to CEOs because the value of everyone else’s shares was being diluted by the gift of free or low-cost shares to the executive elite. In his
book
The Battle for the Soul of Capitalism
, Bogle derided the whole concept as a smokescreen for a massive “wealth transfer to [corporate] insiders” from ordinary investors.

Bogle also derided the idea that stock options linked the interest of management with the interest of shareholders. “This oft-repeated and widely accepted bromide turns out to be false,” Bogle protested. “Managers don’t
hold
the shares they acquire [like shareholders]. They
sell
them, and promptly…. We rewarded our executives not for the reality of creating long-term economic value but for pumping up the perception of short-term stock market prices.”

Even before the Great Recession hit, there was a rising chorus of criticism. At Harvard Business School, one of the original seedbeds of the pay-for-performance concept,
dissenting academics charged that this concept of pay was narrowing the focus of CEOs and corporations, at a high cost to society at large. “The dominant ethos today legitimates the notion that human beings are relentless market maximizers who need literally to be
bribed
to focus solely on shareholder value—undermining other commitments managers might have to employees, customers, the community, or larger national and global concerns such as the environment or human rights,” asserted Harvard Business School professors Jay Lorsch and Rakesh Khurana. “It relieves the corporate institution of any meaningful responsibility to anyone but the transitory group of stockholders who buy and sell shares constantly.”

By 2002, even Michael Jensen was dismayed.
Executive stock options, Jensen told
The Economist
, had turned into “managerial heroin” that encouraged CEOs to focus on short-term highs with destructive long-term consequences. “Once a firm’s shares became overvalued,”
The Economist
explained, paraphrasing Jensen, “it was in managers’ interests to keep them that way, or to encourage even more overvaluation, in the hope of cashing out before the bubble burst. Doing this not only meant being less than honest with shareholders, or being creatively optimistic with corporate accounts. It also encouraged behaviour that actually reduced the value of some firms to their shareholders….”

But the real political firestorm over stock options was triggered by an obscure quasi-regulatory body, the Financial Accounting Standards Board, or FASB, known in Washington lingo as “Faz-bee,” whose officials SEC chairman Arthur Levitt nicknamed “the gnomes of Norwalk,” because Norwalk, Connecticut, is FASB’s home. In 1993, FASB announced its intention to issue an accounting rule that would end “the freebie” for stock options on grounds that failing to charge options as a business expense was deceptive accounting. To fix that, FASB would require companies to “expense” executive stock options—charge them as a cost against the corporate balance sheet, the same as salaries.

Corporate America went ballistic. Congress was inundated with phone calls, emails, and visiting delegations of CEOs. Business groups issued “Chicken Little” warnings: The stock market would collapse, companies would fold, unable to recruit top talent without the lure of options; the economy would be irreparably damaged. Arthur Levitt and the SEC, which oversees FASB, were besieged. Corporate leaders argued that options were not an expense because no check was issued and also that options could not be precisely valued because of fluctuations in stock prices. This ignored the fact that companies already valued stock options on their tax returns, as required by the IRS.

“
During my seven and a half years in Washington …,” Arthur Levitt later wrote, “nothing astonished me more than witnessing the powerful special interest groups in full swing when they thought a proposed rule or a piece of legislation might hurt them, giving nary a thought to how the proposal might help the investing public. With laserlike precision, groups representing Wall Street firms, mutual fund companies, accounting firms, or corporate managers would quickly set about to defeat even minor threats. Individual investors, with no organized labor or trade association to represent their views in Washington, never knew what hit them.”

Business leaders reacted so explosively because making options a corporate expense would make major companies look bad. Big-name Silicon Valley companies had been issuing such a cornucopia of stock options that if they were charged as an expense, company profits would plummet.
Merrill Lynch estimated that expensing options would slash profits among leading high-tech companies by roughly 60 percent. At Cisco, the Internet equipment giant, a yearly $2.6 billion profit would have been cut nearly in half.

Warren Buffett of Berkshire Hathaway, probably America’s best-known investor, accused Corporate America of an “Alice in Wonderland” attitude on stock options.
Buffett backed the FASB rule. Expensing options, he asserted, would be more honest because it would expose the naked truth to investors. “Options are a huge cost for many corporations and a huge benefit to executives,” Buffett declared. Failing to value options fairly, he wrote in a
Washington Post
op-ed piece, “enables chief executives to lie about what they are truly being paid and to overstate the earnings of the companies they run.”

But Congress bowed to the political heat from Corporate America. In the spring of 1994, Senator Joe Lieberman of Connecticut, then an ardently pro-business Democrat, introduced a Senate resolution that condemned the FASB rule as reckless and warned of “grave consequences for America’s entrepreneurs.” Under intense lobbying from powerful CEOs, the Senate voted 88–9 for Lieberman’s resolution. Although it was nonbinding, SEC chair Arthur Levitt took the Senate vote as a warning shot at both FASB and the SEC. Fearing that Congress would strip FASB of its powers and cut funding for the SEC,
Levitt backed down. He directed FASB to withdraw its rule.

But out of office, Levitt told me how deeply he regretted forcing FASB to retreat. “It was
probably the single biggest mistake I made in my years at the SEC,” Levitt said. A decade later, after the Enron and WorldCom scandals, in which dishonest accounting played a major role, there were new pressures in Congress from Republicans as well as Democrats for expensing stock options, but the bills died in Senate gridlock.

The hand of U.S. regulators was finally forced in February 2004, when the International Accounting Standards Board adopted universal rules to expense stock options.
Ten months later, in December 2004, America followed the world standard, adopting FASB’s Rule 123R to expense stock options.

But business opposition succeeded in stalling the new rule from taking effect until 2006. The decade-long political siege over options testified to the power of business to protect its financial interests.

JUST BEFORE SITTING DOWN
in the glittering East Room of the White House to sign the $350 billion tax cut bill of 2003, President George W. Bush thanked his cabinet, congressional leaders, and “
my friend Dirk Van Dongen.”

To most Americans, Van Dongen was an unknown. He held no elected office or high appointment. He avoided TV appearances. And he enjoyed no celebrity status. But inside the Beltway, Van Dongen was known—and is still known—as a key power player who has been an important influence in tilting Washington policy in favor of business and the super-rich. He is a no-nonsense six-footer in his midsixties, with salt-and-pepper hair and rimless glasses. He’s a master organizer who loves the power game but avoids the limelight. And he had a pipeline into the Bush White House.

Right after George W. Bush’s inauguration in January 2001, the president’s master political strategist, Karl Rove, had lunch with Van Dongen and asked him to organize and run a tax relief coalition. “
They knew I was loyal to Bush,” Van Dongen said later. “I was a Bush Pioneer, which meant you raised lot of money for the campaign—$100,000. I knew a lot of the senior staff.”

Van Dongen was Rove’s man to orchestrate the business chorus behind the Bush tax cuts. Some business leaders wanted corporate tax cuts right away, but the Rove–Van Dongen deal was individual cuts first, business tax cuts later.

So in 2001, and again in 2003, Dirk Van Dongen became the field marshal for the business lobbying forces that helped move Congress to pass two massive Bush tax cuts, the first of which delivered more than $1 trillion in lower taxes for the richest 5 percent of Americans and
added $2.9 trillion to the federal deficit.

THE ALLIANCE BETWEEN
George W. Bush and Dirk Van Dongen—“Dirkus,” the president called him—was formalized on February 23, 2001, in the Indian Treaty Room of “the old EOB,” the gray Victorian-era Executive Office Building, next door to the White House.

Bush was getting ready to go to Congress to push for his groundbreaking tax cuts that would become not only a hallmark of his administration, but a lightning rod of controversy a decade later in the 2011 congressional battle over whether the rich should pay higher taxes to help bring down the federal deficit.

Many people today forget, but even in 2001, the Bush tax cuts were so massive that they were controversial. And before President Bush went public with them, Karl Rove wanted to cement Bush’s political partnership with business on the tax package. So that morning, Bush, Rove, and Treasury Secretary Paul O’Neill walked over to the EOB to sit down with fifty leaders of the Tax Relief Coalition, a new political syndicate of powerful business trade organizations headed by Dirk Van Dongen.