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CNN Live Today

Interview with Donald Ratajczak

Aired June 28, 2002 - 13:18   ET

THIS IS A RUSH TRANSCRIPT. THIS COPY MAY NOT BE IN ITS FINAL FORM AND MAY BE UPDATED.


THIS IS A RUSH TRANSCRIPT. THIS COPY MAY NOT BE IN ITS FINAL FORM AND MAY BE UPDATED.
FREDRICKA WHITFIELD, CNN ANCHOR: The pink slips are flying at WorldCom. The nation's second largest long distance provider is laying off thousands of workers today in hopes of staving off bankruptcy. The move comes days after WorldCom revealed that it hid almost $4 billion in expenses.

Also today, Xerox revealed its own accounting debacle. The office equipment maker says it improperly posted about $2 billion in revenues over the past five years. But it appears Xerox's problems could be much bigger than the company claims, leading to more calls for increased accountability.

(BEGIN VIDEO CLIP)

GEORGE W. BUSH, PRESIDENT OF THE UNITED STATES: I believe if somebody is running a corporation, if somebody has got responsibilities to shareholders and employees, they have the responsibility to be aboveboard at all times, to be frank and honest with all numbers.

(END VIDEO CLIP)

WHITFIELD: Now for more on this, our Miles O'Brien is standing by, and he's got more -- hey there, Miles.

MILES O'BRIEN, CNN ANCHOR: Fredricka, is there an economist in the house? Well, as a matter of fact there is. Don Ratajczak is here. He was with Georgia State for many years down at the Economic Forecasting Center there. Now, he is a freelance economist, and he is here to help us understand a little bit about how corporations can cook the books.

We won't do a how-to for you, just so we don't encourage any more of this activity. But, Don, let's go through the list here on the top five ways a big corporation can hide something on the order of $2 billion to $4 billion. Take a look at the full screen if we could on some of our possibilities. Put it there on the big screen.

No. 1 on our list is inflate sales revenue. That seems fairly straightforward. How do they do that?

DONALD RATAJCZAK, ECONOMIST: Well, what you do is, and what Xerox has done, is basically book your orders as if they are already revenues. So you haven't spent any money trying to meet anyone's needs. Let's say you get a $1 million order. You put the $1 million in as revenues. No costs kicks up your profits.

O'BRIEN: All right. Don Ratajczak, we are going to get a microphone on you. Let's take a break. Let's get that microphone on him. We'll be back with more of this, Fredricka. You can hear him OK? Oh, wait a minute. There he is. It just fell off of his tie.

Let's go to No. 2 on the list, while he prepares the microphone on the tie. Make capital expenses into operating expenses. This is a man who needs no microphone here. He speaks loudly and carries a big stick.

RATAJCZAK: OK.

O'BRIEN: Tell me about making capital expenses into operating expenses.

RATAJCZAK: Well...

O'BRIEN: (UNINTELLIGIBLE) a little more esoteric for those of us...

RATAJCZAK: No. 2 is...

O'BRIEN: ... who have difficulty balancing our checkbooks.

RATAJCZAK: Yes, this is what apparently WorldCom did. And say if you buy a $1 million machine, basically the machine is going to last let's say 10 years. So you charge $100,000 a year off of the machine.

O'BRIEN: A depreciation kind of thing, right?

RATAJCZAK: Right. But if in fact you can grab expenses, like the oil that you have to keep trucks going with and all of that, and instead of saying they are normal courses of operations, create them as capital.

O'BRIEN: Ah!

RATAJCZAK: Say that they are capital, and then you write them off over 10 years, even though you used them up in one.

O'BRIEN: So you are writing off an oil change over 10 years...

RATAJCZAK: Right.

O'BRIEN: ... and which obviously doesn't make a lot of sense in the real world.

RATAJCZAK: Right. So what you have done is in effect lowered the amount of expenses for this year, and so it adds to profits. Well, it doesn't add to any cash flow, but it adds to profits.

O'BRIEN: All right. Let's go to the Enron favorite here, creating outside entities. I guess the obvious reason is that it takes it away from the focus of the main corporation if you create outside entities. Are these outside entities not subject to the same sort of scrutiny by the SEC and shareholders as the main corporation?

RATAJCZAK: Well, they are, but they present themselves as much smaller entities. Some of them, in fact, are offshore. In Enron's case, there were 2,000 partnerships in the Bahamas or Bermuda, one of those places. And they had different laws, different regulations, and so as a result, you were able to hide things in those partnerships. They could, in fact, borrow the money and have a big debt, and then hand the money over to the basic company.

O'BRIEN: But how can a public company just willy-nilly start creating these partnerships which don't appear on their balance sheets? Those still must come under the rules of public scrutiny, shouldn't they?

RATAJCZAK: Well, they consolidate them, but there is a rule that if the company's investment is smaller than a certain percent, then they don't have to report...

O'BRIEN: Ah!

RATAJCZAK: ... what's happening in the outside entity.

O'BRIEN: Hence the huge number of them that we saw in the case of Enron.

RATAJCZAK: That's right.

O'BRIEN: All right. Let's go to this one, creating off balance sheet financing. What is off balance sheet financing to a layperson?

RATAJCZAK: Well, let's say here you are a company and you have built your office building, and you own it, and you have a mortgage on it. Well, in order to lower your debt, let's say you are hitting your debt limitations with the bank, well, what you do is you sell the building to another entity and then lease it back. And in the lease, of course, you are going to have to pay over a long period of time. So you really still have a debt there, but it no longer appears to be a debt.

O'BRIEN: Oh!

RATAJCZAK: The debt has vanished, and all you see is the expense of the lease for a year.

O'BRIEN: So kind of bogus leases essentially.

RATAJCZAK: Yes, and you can do that not only with buildings, but you can do that with lots of other assets as well.

O'BRIEN: All right. And finally on our list, the top five here, allow accounting discrepancies. What you are saying is the accounting department gets more than a wink and a nod here in other words?

RATAJCZAK: Well, in fact, you sometimes see these things where they say it's not material. And so what you do is you just stay under the radar screen on what's not material. And so the accountants will say, yes, that's wrong, but it's not large enough to worry about. And you do it here, and you do it there, and you do it in all other various places.

O'BRIEN: So it's, in other words, within the margin of error, but if you start adding that all up, suddenly you have got some real money.

RATAJCZAK: Yes. You hope the accountants don't put it all together, and of course, if the accountants want to have some other consulting fees, they may not be aggressive in trying to consolidate these things.

O'BRIEN: So either they don't want to because there is an inherent conflict of interest, or they simply can't see the forest for the trees because there so much out there.

RATAJCZAK: It could be complexity. Enron clearly is complex. Or it could be complicity.

O'BRIEN: All right. So what is a poor consumer to do? We have picked Yahoo! Finance to talk about some of the places where you can go and learn about some of these mutual funds and how they might be adversely affected. What do you -- as I go through this and give people the top five mutual funds that have MCI-WorldCom in them, and you take a look at them and you see, for example, this particular fund which is the Vanguard Windsor, Don.

RATAJCZAK: Right.

O'BRIEN: It has about 3 percent WorldCom. OK? Now, that doesn't seem like a lot.

RATAJCZAK: Right.

O'BRIEN: But that's probably having some impact on the bottom line for these mutual funds. What are you supposed to do if you are holding a mutual fund like that?

RATAJCZAK: Well, by now that is down to zero, and so it's not important anymore, but you have lost a lot of value obviously. Yes, you really want to look at who can be exposed. Of course, the mutual funds are doing that. They are looking at who has unusual leverage, who has done unusual expansion in the last couple of years, because that's one way you can stay ahead of the accountants. And basically, you are finding it in communications, you are finding it in some of the energy companies, the energy trading companies, and there are a few areas, the aggressive-growing companies that now you better be careful. They may have surprises in them.

O'BRIEN: So just like mama says, "if it sounds too good to be true, it probably is." So if the growth is that accelerated, hang on to your wallet.

RATAJCZAK: Well, you've got to be careful. I mean, there are some good companies that are growing appropriately. And in fact, there are some good reasons for using off balance sheet financing. But you -- it has -- are they changing their behavior? I mean, WorldCom changed the way they did things last year. And are they changing their behavior? And is someone going to tell me that?

O'BRIEN: Don Ratajczak, freelance economist, formerly with Georgia State, Center for Economic Forecasting there, which he founded. Thanks for dropping in. It really shed quite a bit of light on it for me -- hope it did for you, too, Fredricka.

WHITFIELD: I think it did. I was taking notes.

O'BRIEN: All right.

WHITFIELD: Thanks very much.

O'BRIEN: Good.

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