A scandal wouldn’t be a scandal if it didn’t rock a market segment right off its foundation and lead to fundamental changes that would be felt for years, but some scandals in the corporate world are bigger than others. In fact, some of them can alter the shape of how business is done for generations or more. Some change the way the world works forever!
Here are 5 corporate scandals that had long-term effects on the business world.
The South Sea Company Bubble of 1720
Corporate scandals have been around for a long time, as the South Sea Bubble of 1720 shows. In fact, the South Sea Company collapse serves as a prototype for almost every corporate scandal that ever came after it. It had insider trading, bribery, corruption, fraud, smuggling of illicit goods, you name it.
The South Sea Company was conceived initially as a vehicle for consolidating and servicing the national debt of the United Kingdom. As part of the scheme, it was awarded a royal monopoly on trade with South America… a continent controlled at the time by mortal enemy Spain.
Despite this lack of potential trading partner, the company advertised itself as the greatest thing since imported tea (a trade that had flooded the coffers of its predecessor, the East India Company, to vast amounts of wealth). Politicians and the public alike scarfed up shares, in some cases borrowing the money to buy more shares using previous tranches as security. Everyone wanted a piece of the action.
Only there was no action—a disgusting sideshow in slave smuggling brought in some money, but nothing compared to the skyrocketing share price. The vast amounts started to encourage other startups with similarly vague value propositions… one famously promised investors that it was “…a company for carrying out an undertaking of great advantage, but nobody to know what it is.”
As payments on the subscribed shares came due, however, the fact that there was nothing behind them became clear. The entire economy of the United Kingdom collapsed.
Unfortunately, this is a bubble no one learned from—economies have gone on to build, pop, and suffer from them since, perhaps revealing more about human nature than the business world.
The Teapot Dome Scandal in the 1920s
The Teapot Dome Scandal in the early 1920s had it all: corruption, bribery, business malfeasance, national security concerns, and impacts rising to the highest levels of government.
And it all started with a pile of rocks in Wyoming that looked a little bit like a teapot.
The rock formation sat on top of a pocket of oil, discovered right around the time that the U.S. Navy was busy modernizing ships to burn oil instead of coal. In the interests of national security, the Navy Department was granted control of several prospective oil fields to provide strategic reserves.
But Interior Secretary Albert Fall had other ideas, convincing President Harding to transfer the fields to his control. It wasn’t an innocent move; Fall had been bribed by executives at Sinclair Oil and Pan American Petroleum to grant them leases to drill the field on very favorable terms, which he promptly did.
Unfortunately for Fall, he wasn’t very good at concealing his newfound wealth. Congress investigated and uncovered the scheme. In a case that reached the Supreme Court, Fall became the first former Cabinet official ever jailed for actions in office for accepting the bribes. Harry Sinclair was jailed for contempt of court, but no other oil company executive was convicted. Instead, the leases were invalidated and returned to the Navy. It wasn’t until 1976 that another drill touched the Teapot Dome field.
The long-term effects of Teapot Dome on the business world have arguably been beneficial. A more intense level of scrutiny over bribery and backroom deals resulted from the case, including increased Congressional oversight and the power of Congress to compel testimony. Harding died in office before the case came to trial, but many historians believe it would have led to his impeachment (despite his lack of direct involvement), which has been a cautionary tale to subsequent administrations.
The Bernie Madoff Ponzi Scheme
Bernie Madoff’s elaborate Ponzi scheme lasted for nearly twenty years, which is a mad sort of success all by itself. Under the guise of managing investments, largely of charitable institutions and wealthy individuals, Madoff kept the shell game going longer than anyone could have imagined before it all fell down.
One of the most disconcerting things about the Madoff scandal was that Bernie was seen as one of the masters of Wall Street. A self-made guy who had started as a penny-stock trader and become the biggest market maker on NASDAQ over the course of more the forty years, it seemed beyond possible that he would be running a scam.
That’s because it was a smart scam—Madoff didn’t get greedy. Although he was paying off early investors with the money of subsequent investors, his claimed returns were roughly half of what he was actually bringing in, allowing him to keep the shell game going for more than twenty years before running out of cash.
There were suspicions about the consistency of his returns—which no one could replicate with public market data—but the apparent stability and liquidity of his fund ensured no one paid attention to the naysayers.
But the Great Recession finally called Bernie’s bluff… no one was making new investments as the market cratered.
The resulting calamity shut down a number of companies and charitable foundations who suddenly found their investments frozen or evaporated. Individuals as varied as Steven Spielberg and Sandy Koufax lost substantial amounts. Four different individuals either associated with or affected by the fraud committed suicide, including Madoff’s eldest son.
More than 19 individuals or associated firms were investigated as a result of Madoff’s collapse. Madoff himself was found guilty and sentenced to 150 years in prison. Only a fraction of the missing $64 billion is expected to ever be recovered. Penalties for firms that invested with Madoff without vetting his organization, including a large number of charitable foundations, are expected to reach $1 billion.
The outcome resulted in intense scrutiny of both money managers and the Securities and Exchange Commission, which at several points nearly uncovered the scam before dropping investigations.
Enron was an American energy company that was looking to change the face of energy management in the United States, creating markets around the sale of electricity and natural gas. As a market leader, the company’s stock price shot through the roof.
But some of the numbers supporting those prices were cooked—Chairman Ken Lay and CEO Jeff Skilling shuffled financing structures and debt around to artificially inflate the company’s revenues.
Analysts grew suspicious and the executives became defensive. Skilling sold off $33 million in shares and then resigned as the stock price faltered under continuing examination. By the end of 2001, the company was bankrupt, and those executives and others were on trial. Twenty-one people were found guilty and sentenced for the coverup.
The scandal also resulted in a major sub-scandal, when respected accounting consultancy Arthur Andersen was convicted of shredding evidence for their client during the course of the investigation. Although the conviction was reversed on appeal, the company’s position as an unbiased auditor was so called into question that it surrendered its accounting licenses and effectively ceased independent operation.
The Enron scandal reshaped the corporate accounting environment in the United States by leading to the Sarbanes-Oxley Act of 2002. Much more stringent requirements for reporting and responsibility of public companies and accounting firms, including criminal penalties for boards of directors, have substantially altered the business landscape.
The Subprime Mortgage Scandal of 2007
The one that is fresh in everyone’s mind is the scandal that came most recently. It’s also one of the biggest, with the longest-lasting effects. Some may play out over generations and the ultimate outcomes still aren’t clear today.
The scandal also had complex causes, but the immediate issues were rising levels of subprime lending and the resulting increase in speculative housing investments. Financial industry deregulation and legal supports for low-income homebuyers fueled the bubble.
The outcome, however, was direct enough for businesses and individuals alike: a recession deeper and longer than any since the Great Depression. Six percent of the American workforce lost their job; estimates indicate that around 40 percent of 2007 GDP output was lost and the stock market dropped by 50 percent.
The market didn’t recover to pre-recession levels until 2013, but the long-term effects of the crisis in the business world will last longer. The most immediate and obvious effect was the tightening of credit—loans, once easy and almost automatic, dried up, as did investment as a whole. A 2015 paper from Harvard found a so-called investment hangover effect from the recession, where a generation of individual investors are skeptical of putting their money into the market. Sixty percent of millennials distrust financial markets.
At the same time, they are also facing inordinately high costs for higher education as scholarship funds were wiped out and universities were forced to raise tuition rates. Although more people go back to school in a recession, they come out saddled with more debt—forced to take jobs rather than risks, this can further the retrenchment of big business instead of innovative startups in the U.S. economy. Their retirement investing will also be curtailed during important years, which will likely mean an older workforce in the future since they will be unable to retire early.
Other effects are more insidious. The heavy involvement of the government in bailing out financial institutions may have twin effects on the business environment:
- So-called “too big to fail” businesses may continue to conduct risky operations with the assurance they will be rescued with public money if they should fail.
- There are new and powerful movements calling for more government control and regulation of business generally to prevent future bailouts, notably the new Consumer Finance Protection Bureau.
These perspectives will color the business environment for at least a generation.