Is Microsoft caught in a pyramid accounting scheme?

Is Microsoft caught in the grips of a pyramid scheme? An interesting set of prophetic sounding articles from a couple of years back desribe how Microsoft hid losses through book keeping tricks...

In a piece written in 1998 an author took Microsoft to task for an accounting pyramid scheme which allowed the company to book profits in years where there were actually losses. This would done through stock options, which were then added to earnings, hiding losses, a process the author describes as a pyramid scheme (since while these stock options, through book keeping, can hide losses, and be booked as earnings, and thus go into the profit column of the ledger, keeping that stock price high, in the end they remain liabilities, and each year there is a loss demand even more of that tricky accounting, a process that cannot go on forever.

In his introduction to a synopsis discussing this issue, he wrote..

http://billparish.com/20000222fraudfactsupdate.html

"PORTLAND, OR - In October, 1998 Parish & Company released a study indicating that the Microsoft Corporation had erected a financial pyramid scheme. Sadly, Microsoft employees were prepaying their own wages and the public and private retirement systems being pilfered just as Charles Keating plundered the Savings and Loan banks. Since then, other companies are now being forced to aggressively adopt similar techniques in order to compete yet these companies will fail because Microsoft's situation is unique. The pyramid is now accelerating and destabilizing both the stock market and overall economy, corrupting the Federal Reserves efforts to control the money supply and triggering false inflation. Microsoft, once a great technology company, has indeed become a "pied piper" of financial fraud."Recent events have vindicated his concern over tricky bookkeeping and its potential effects on the economy. The next year, in 1999, he wrote the following piece on the same subject...

http://billparish.com/msftfraudfacts.html

"The fundamental problem is that Microsoft is incurring massive losses and only by accounting illusions are they able to show a profit. Specifically, Microsoft is granting excessive amounts of stock options that are allowing the company to understate its costs. You might ask yourself, what would happen to Microsoft's stock price if the public suddenly realized that they lost $10 billion in 1999 rather than earning the reported $7.8 billion? If 80 percent of its stock value or roughly $400 billion is the result of a pyramid scheme, one might also ask what kind of effect this could have on the retirement system."

Little did he know at the time, that such tricky book keeping was only the very tip of a very large hidden ice berg. Hwe deserves credit for being prescient. There are, however, certain aspects of his analysis that I find very questionable. For example, he places an extreme importance on a single company, Microsoft, seeming to hold Microsoft (like Insull at Edison Electric) responsible for an approaching stock market crash, yes, even for a coming depression (remember that this piece was written in 1999). His analysis of the reasons for stock market crashes is also questionable, as is his assertion that 'the economy is very strong,' and that 'we should only need to correct 20 per cent.'

He writes, "Many believe that the stock market crash of 1929 caused the Great Depression yet history clearly shows that it was instead simply bad government policy that was manipulated by leaders such as Insull. Today many now fear a similar stock market crash but in reality the economy is very strong and, if we can reform this pyramid at Microsoft, the overall market should not need to correct more than 20 percent."

When stocks, like Cisco, are given strong buy ratings by analysts, and are trading at 40 times earnings, you have to wonder if a 20 per cent correction is reasonable. (If we ignore capital gains, this means you would expect to hold Cisco for 40 years to recoup your investment just based on earnings. This would be less than 3 per cent. With some bonds at 6 per cent, a person could do better in bonds. All throughout the markets stocks are valued at these sorts of high P/E ratios, and when you consider how fraudulent the book keeping is, and how these earnings are being exposed as fakery due to rampant book cooking in recent years, and you can understand that in many cases these high P/E ratios do not accurately reflect the actual ratio, and once this accounting fraud is factored out, stocks are actually trading at even higher P/E ratios than those reported. It is this fact that more than anything was responsible for driving this phony book keeping in the first place (the earnings just weren't there, and the end result would be a run down in the price of the stock - companies like Enron and WorldCom were dependant on these inflated stock prices to support their debt ratings and aquisition binges, and thus they deliberately cooked the books.) One also only needs to look at a stock chart covering the decade of the 90s to see a massive run up in the values of stocks (a sharp spike climbing heavenward - the surest sign of a market being fueled more by speculation than reality - note the rise of the day trader). Fortune magazine has a list of the biggest money losing corporations for 2001, and all of these big corporations lost hundreds of billions of dollars all told, so the problems we see currently have deep roots, and there is more going on here than just Microsoft capsizing the market with a pyramid scheme worth a few tens of billions of dollars.

http://www.fortune.com/lists/G500/losers.html

They also have a page describing the record breaking number of bankruptcies lately

http://www.fortune.com/indexw.jhtml?channel=artcol.jhtml&doc_id=208698

All this leads me to question his '20 per cent correction' prediction and even more questionable is his assertion that somehow Microsoft is responsible in some key way for what is now happening on Wall Street. The problem goes deeper than just one company, and as for his suggestion that Microsoft was the 'pied piper' of recent accounting fraud (written before the frauds were known), well who knows where they all got the idea from. (Like minds think alike, do they not. At least the accounting trickery that Microsoft was doing was quasi legal, as I understand it, although ethically questionable, and the author of these pieces suggests that due to lack of disclosure, it could be argued that the legal is actually criminal, something to battled out in court, I suppose, but it does bring to mind that ethical question about this kind of book keeping trickery...)

I also question the author's analysis of the cause of the Great Depression. He alludes in particular to the CEO of Edison Electric practicing financial trickery of the type we are seeing recently as a direct cause of the depression, and then attempts to link this with what he refers to as a pyramid accounting scheme at Microsoft to then suggest (in 1999, when he wrote this piece) that Like Edison Electric, Microsoft would be responsible for another depression, or so he seems to suggest to my reading of his piece, and this section lacks credibility with me. Rather, I would think, such tricky accounting as what we are being exposed to lately, is a symptom, rather than a root cause, and the last refuge of really big corporations trying to fend off the coming day of judgment on the stock boards. Personally I have always thought that Einstein's analysis of the depression was the most sensible mathematical explanation of what happened (there are those who might want to quote Marx and his analysis of the inherent stresses in capitalism, but Marx was a philosopher, and also wordy and could be difficult to understand as a result, while Einstein had a talent for describing the situation in a way anyone could instantly relate too.) Basically what Einstein had to say was that the competitive drive to accumulate personal wealth, combined with the required need to drive down wages and increase productivity, inevitably led to an imbalance in the aquisition and untilization of capital that sooner or later led to the capsizing of the economy. So then the rich got richer, the workers got poorer, not to mention laid off, and soon the economy began to slide into a pit, since there was no longer enough 'consumers' to buy all the products being produced, since money became concentrated in a small percentage of the population, and the economy slid into depression, with ever increasing unemployment, which after many years finally bottomed out in the mid thirties, along with the stock market, which hit rock bottom about the same time, and then wallowed there until pulled up by the 'Keynesian spending' and government managed economy of World War two (there was no real 'free market' during the war, as the economy was completely managed, prices were set and fixed in Washington, profits dictated, etc). So then a depression is not caused by one company like Microsoft cooking the books, but rather such corporate conduct is a symptom of other underlying causes, and the stresses and internal contradictions of the system which when played out, as Einstein suggested just using common mathematics, capsizes the economy.

Now having said this, what is the point to be considered in his argument? Well, I suggest that if one can ignore what seem to be his exagerated imputation of importance to Microsoft, and his (to me) somewhat weird sounding suggestions of a huge market collapse that is the sole responsibility of Microsoft running a pyramid scheme, this still leaves one to consider that pyramid scheme, as he calls it, as just one more in a long line of such accounting tricks, not the center of the financial universe, which he seems to be suggesting in his articles (thus losing some credibility I think, which is unfortunate), but nevertheless important in its own way, since it would be one more example of a really big corporation, which suffered losses, and had no earnings to report in glowing fashion to that Wall Street stock market, using tricky accounting and reporting earnings to keep their stock price inflated. Just on that basis alone it is worthwhile to consider what he has to say, especially true today (his piece was dated in late 1999) now that their is a receptive audience, since it has proven to be the case that this desperate and tricky accounting was actually systemic and wide spread from the time he wrote his pieces to today, with companies uncooking their books going back years to reveal all those hidden away losses...

Is what Microsoft doing technically 'illegal'? It seems to depend on the whole legal issue of disclosure, as the author suggests in his pieces. if it is technically 'legal' is it morally justifiable or acceptable. Is it really ethical to turn to such trickery just to keep people buying your stocks. Let's just say that if I was sucked into to buying some stock by some tricky accounting, I would not think so, especially today, stuck with that worthless stock, or with a few bucks in my pocket if by some luck I actually managed to unload that stock on someone else who felt like taking a chance on it. In otherwords, if you are losing money, is it justifiable to tell the markets you are turning a profit? Is tricky book keeping the same as turning a profit? In the case of worldcom they got the debit column confused with the credit column, you know expenses and income, one going in and one going out, two different columns. Basic accounting. IN the case of Microsoft it seems they exploited a ethically questionable loophole, and just put off those bad earnings for some other day, which is why the author refers to this as a pyramid scheme, because sooner or later a debt, which is what this is, becomes a debt, and cannot pretend to be an earnings anymore. For example, by handing out these billions in stock options, Microsoft gets interest free loans, but nevertheless the stock options represent debt, and yet through some weird accounting practice, it is declared as earnings, thus wiping out losses from sales and allowing Microsoft to send a glowing report to Wall Street about how wonderful everything is going. The author suggests that this is 'legal' according to the Generally Accepted Accounting Practices, but a violation of the ammendments to the accounting practices rules. He also suggests that it is 'illegal' because it is 'undisclosed'. Sounds like a really messy lawsuit there with lots of that hair splitting, Microsoft arguing on the technical issues that it was technically legal, even though it seems unethical. Well those lawyers could splitting hairs over a case like that one for years...

The author sounds rather prophetic at times, writing as he did in 1999. He compares Microsoft's accounting techniques, to what turned out to be a sleepiong dragon underlying the whole stock market, as recent events have shown, in late 1999 saying "Another more recent example might be Waste Management, another monopoly that used pyramid like accounting techniques only to be forced to restate several years of earnings. Key to both these situations are estimating techniques that grossly underreported debt pyramids and operating costs." He also pretty accurately predicted the results of these types of accounting tricks, which turned out to be only the tip of a hidden floating ice berg, when he wrote, 'This situation is not about stock valuation, product quality or whether or not Microsoft has monopoly power in its markets. Nor is it part of a pro or anti-Microsoft movement. This situation is instead a shining example of financial fraud and corruption enabled by bad government policy. If not quickly and aggressively addressed, we will all be losers as credibility in our financial markets is destroyed.'The end result of such a 'pyramid scheme' managed through accounting, is that Microsoft was able to report debt (through stock options) as earnings, and was also able to translate this into spendable cash for aquisitions. However, somewhere down the road debt is simply debt, even if it is not reported as debt. While this may be technically 'legal', it is highly questionable, since if you buy a stock one thing you would want to know is the amount of true debt you are buying into, and that would include the liabilities of such stock options, reported as earnings as they were. Furthermore, while those stock options put off a day of reckoning, by allowing earnings to be reported during years in which their were actually losses (thus preserving stock price) at some point in the future those stock options must become actual losses, since they are a form of debt, and if it should be the case that they become debt in a year of losses, all that has happened is that losses have been deferred for another day, and probably I am sure they hoped, a much better day, but such a pyramid scheme, as the author of these critiques describes it, leaves one wondering if it might not turn out to be a much blacker day, losses compounded with the deferred losses of previous years, through the magic of modern day corporate accounting after all...