Financial Myths: Where There’s Smoke, There’s Fire

Michael McTague  |

This adage implies that rumors derive from facts. An accusation of wrongdoing strongly implies guilt. According to the US Department of Justice, 93% of prosecutions result in conviction. In the Myth Busting business, these facts dispel the notion that one is innocent until proven guilty.

The US Department of Justice acts accordingly. Based on a rash of settlements between the government and various businesses who agree to pay hefty sums but deny wrongdoing, it seems that many may be guilty even without clear evidence from the accuser. At least, they risk being found guilty as the government presses its weight on the company and a jury. Mark Cuban recently spent more money to defend himself from an insider trading charge than the potential fine he faced. He won the case. According to The Wall Street Journal the government holds little clear evidence against SAC Capital’s CEO but plans to bring suit, expecting that their prowess alone will sway a jury.

So, while expensive attorneys argue effectively that smoke only proves mist from a cloud or a waterfall or an automobile or debris from construction pollution that drifted across the Pacific Ocean, smoke proves fire for the majority of people.

The majority of people are deluged with stories of sinking business ethics from insider trading and Ponzi schemes to companies denying product imperfections. In a Pew Survey a few years ago, corporate CEO’s received a positive rating from only 24% of respondents and only 25% said corporate board members possess high ethical standards.

Many investors worry about the honesty of the companies that hold their cash. So, the search is on: How do we know a company is ethical? Smart Markets provides some wisdom about a company’s reputation. If one looks at the Message Board of a public company on Yahoo Finance, the notes with many replies often prove juicy, indicating possible product failures and inappropriate action inside the company. Investors love rumors.

In this installment, we will consider two companies. One suffered from a horrendous reputation and turned it around; the second is currently under the microscope for wrongdoing.

In the 1960s Dow Chemical ($DOW) decided to continue manufacturing napalm, despite its ugly image as a deadly war chemical. Later the company regretted its stand. Over the decades, Dow has worked hard to improve its image. The most dramatic public evidence is its beautiful Human Element commercials. No crass commercializing, just enjoying the beauty of human nature with spectacular photography. The company name barely appears. This “image advertising” has propelled Dow to a better place. Like every company, Dow has had its ups and downs but its reputation today is far ahead of where it stood in the Vietnam period. In 2012, Dow achieved gross profit of nearly $9 billion.

Our second example looks at dirty doings inside higher education, specifically some for-profit chain schools. While the majority of colleges -- both for profit and not-for-profit -- perform an outstanding service, the chains have produced more smoke than a national brushfire. Among the worst is Career Education Corporation ($CECO), which in August, 2013 agreed to a $10 million settlement with New York State. The company admitted no wrongdoing. According to Huffington Post, the settlement includes a $1 million penalty and sets up a $9 million restitution fund for students misled by CECO’s false claims.

In this case, the smoke came from fire. The specific complaints and lawsuits from students and past graduates are alternately disgusting and funny. CECO promised high paying jobs. But New York State found that Career Education Corporation manipulated the records to show more job placements than were achieved and to show a higher percentage of students working in the field for which they were trained. Among the most laughable is a criminal justice program graduate reported by CECO as being “employed in field.” In fact, he was handling parking tickets.

The for-profit chains kick up a substantial trail of smoke. CECO is so fixed on obtaining government funding from Pell grants and government loans, it has been accused of the following:

The Empire State is not alone. California found that CECO, which operates approximately 87 schools nationally, had “willfully” misled students to get them to enroll. Pennsylvania and New Jersey investigated CECO campuses. Their accrediting bodies and the Securities and Exchange Commission have also investigated a range of ethical issues. The company has also been involved in numerous disputes with regulatory agencies and with the US Department of Education. Various lawsuits by students and graduates have peppered the organization’s history as well. Of course, as with the New York State settlement, they do not admit wrongdoing.

Like mice scurrying when the mousetrap snaps, CECO managed to move its share price up at the end of 2013 shortly after the New York settlement. But the good news proved short lived.

Twelve state Attorney Generals opened 2014 with inquiries, which led to a drop in their share price. Smart Markets has also been catching up with them. CECO’s revenue slipped from 2010 to 2012 by a massive 28% and profit dropped 37%.

So, it seems that this adage stands the test of time. Where there’s smoke, there’s fire. In the next issue, we will look at other aspects of ethics in American business.


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Michael McTague, Ph.D. is Executive Vice President at Able Global Partners in New York, a private equity firm.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not necessarily represent the views of Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to:

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