Prevention Better Than Mitigation

Stephen DeAngelis

December 14, 2006

One corporate accounting scandal that failed to catch wide public attention occurred at Rent-Way before the more infamous scandals at Enron, WorldCom, Tyco and other companies were uncovered. Unlike those cases, however, the CEO, William E. Morgenstern, was not involved and, over the next half dozen years, he did everything in his power to uncover and correct criminal activity once it was discovered [“Poisoned by Scandal, Craving an Antidote,” by Charles Duhigg, New York Times, 10 December 2006]. On that fateful day in 2000:

Morgenstern … was preparing for bed when a woman called to warn him that the company he had built from scratch was about to fall apart. In the days before that call, Mr. Morgenstern had been scrambling to reconcile discrepancies he had discovered in Rent-Way’s books. He had much at stake. Since its founding in 1981 in Erie, Pa., Rent-Way had grown into a national powerhouse by renting furniture and electronics to low-income consumers through more than 1,100 stores. The stock price had tripled since its initial offering in 1993, making Mr. Morgenstern a Wall Street darling and propelling dozens of Erie families who had invested in the company to sudden wealth. When he discovered the accounting problems, Mr. Morgenstern initially hoped for a quick explanation. But interviews with executives led to more questions. Then came the midnight phone call: a weeping employee told him that for three years Mr. Morgenstern’s top deputies had forced her to cook Rent-Way’s books. Mr. Morgenstern then called the company’s lawyer in a panic. What, he asked, should they do?

Morgenstern was a man of ethics and integrity and did what CEOs at other scandal plagued corporations viewed as unthinkable — he asked the SEC to investigate.

“There was a stunned silence from the regulators,” said one participant in the call. “Then the S.E.C. attorney said, ‘Can you say that again?’ ” The S.E.C. had good reason for surprise. Rent-Way’s openness was unusual, especially in an era when other companies actively masked glaring frauds or covered up problems to avoid the legal and financial complications they might incur. “There’s a huge amount of pressure to fight,” said Lanny J. Davis, a lawyer who has advised many besieged executives, including the HealthSouth founder Richard M. Scrushy, the former White House occupant Bill Clinton, and, for a period, Mr. Morgenstern. “If you let regulators in, you lose control of everything. Suddenly, they start exposing problems you didn’t know existed. Some say the safest route is to fight and hope regulators won’t be able to make their case.”

In addition to contacting the SEC, Morgenstern and his board fired the culpable executives. They hoped that their openness and quick action would contain the crisis. In Duhigg’s words: “Rent-Way’s own journey, which came to a head last month, offers a chilling lesson: Even the most virtuous decisions have unforeseen, often damaging, consequences, and full disclosure may create as many problems as it solves.”

“We were committed to not letting this company be brought down by a small group of people engaged in criminal activity,” said William Lerner, a Rent-Way director and former S.E.C. official. “We were determined to do everything as morally and ethically as we could.” Initially, Rent-Way’s open-door strategy had little effect. When its stock began trading after the fraud was revealed, shares plummeted 75 percent within hours. Law firms began encouraging investors to file class-action suits.

Morgenstern received personal threats, but he continued his struggle to save the company. They sold off some of their stores to try to reduce debt, but the scandal had increased the interest rates banks charged Rent-Way. The scandals that followed over the next few years meant that the climate for scandal tainted companies was toxic.

Despite the good words from the law enforcement authorities, the financial markets continued to batter Rent-Way. Its interest payments consumed more and more cash, and the stock price refused to budge.

The final nail in Rent-Way’s coffin was the rise in gas prices that hit its customer base hard — people who frequent rent-to-own businesses are generally from low income families. With gas prices high, less disposable income was available for TVs, appliances, and furniture. The company was put up for sale and its main competitor, Rent-A-Center, bought it in November.

Crisis consultants say the lessons from Rent-Way’s experiences are troubling. “This company did the right thing in letting the S.E.C. and the public know about the fraud as quickly as possible,” said Ron Hartwig, a crisis communications expert now with the J. Paul Getty Trust. “But when you’re besieged by lawyers and reporters and shareholders, it’s easy to lose control. If executives don’t appear to have a plan, if they don’t seem to know all the answers, everything begins to slip away. Sometimes being honest and forthright isn’t enough.” For Mr. Morgenstern, who now lives in North Carolina and is seeking new business opportunities, that has been the hardest lesson of all. “I did everything that I thought was right, but in some ways it didn’t matter,” he said. “This wasn’t a broken company. And when I found illegal activity, I exposed it. But that shouldn’t have ended a great company. I don’t know what else we should have done.”

Being resilient means being compliant. Morgenstern’s story underscores the fact that prevention is always better than cure — in most cases, there isn’t a cure for a corruption-riven organization. Having a system in place that helps identify problems early — either criminal or unintentional — should be part of any resilient enterprise’s infrastructure. This is especially true since SEC regulators are about to place more focus on having an acceptable compliance system in place.