Anatomy of a Corporate Scandal

How a little-known firm bribed its way to big-time problems

The companies that get into the headlines for foreign bribes are usually large multinationals with far-flung operations and sales in the billions. But right near the top of the list of the 527 U.S. firms that the Securities and Exchange Commission has cited for improper payments is International Systems & Controls, a Houston-based engineering outfit whose revenues were $276 million last year.

Hailed in the early 1970s on Wall Street as a wunderstock and in the business press as "a savvy marketer to the Third World," ISC is today in deep trouble. In the past two years, it has piled up losses totaling more than $50 million. In February, the American Stock Exchange suspended trading in ISC, after auditors found serious irregularities in the firm's financial records. The company's longtime chairman, J. Thomas Kenneally, 52, was ousted two weeks ago, and the few employees remaining in ISC's lavish skyscraper headquarters have been busy tagging the antique furniture for auction. Now company managers are bracing for another shock. They expect that later this month the SEC will bring charges against ISC for extensive bribery of foreign government officials, as well as for concocting misleading financial statements and for excessive use of corporate funds for executive perquisites.

ISC was a $25 million-a-year oilfield-equipment supplier called Houston Oilfield Material Co. back in 1962. Then Kenneally, an enterprising Minnesotan with an aristocratic manner and a flair for finance, became its president. Through a series of acquisitions, he quickly started transforming the company into a go-go builder of specialized agricultural and petroleum systems for Iron Curtain and Third World countries. By 1972 ISC was engaged in projects in 40 countries, and Kenneally was beginning to climb on the business jet-set circuit. Two years ago he and David Rockefeller, the Chase Manhattan Bank chief, were vice chairmen of the Iran-U.S. Business Council, and Kenneally was also vice chairman of the prestigious National Council for U.S.China Trade.

But there were early signs that his financial wizardry was getting him into trouble. After an attempt by ISC to take over Colorado-based Holly Sugar Corp. in 1967, the Government indicted Kenneally's partner in the scheme for violating stock-purchase margin requirements and sent him to jail. Kenneally was named as an unindicted coconspirator. ISC had acquired $1 million worth of Holly's stock through a Uruguayan brokerage firm to avoid the margin rules, and then dumped its shares, for a $1.6 million profit, after dropping the takeover bid.

The U.S. Attorney's office came after ISC again last year. Officials of a petroleum-trading subsidiary called Yen-Fuel were indicted on several counts of fraudulently importing oil into the U.S. as part of the "daisy-chain" swindles that involved several small oil firms.

ISC began to encounter severe financial problems in the early 1970s, when the cost of operating in Third World countries ballooned as a result of the rise in oil prices. ISC, which did most of its work on a fixed-cost contract basis, got caught in a classic financial squeeze. Says Senior Vice President Herman Frietsch, 39, the man who now effectively runs the company: "For a while we couldn't do anything wrong, and then after OPEC, we couldn't do anything right."

To cover its costs, the company began to generate claims for extra payments from foreign customers. A dozen lawyers were kept busy spewing out cost overrun data and then listing the claims on the asset side of the ledger as receivables even before they were submitted to the clients. The company also developed another instant-profit practice: on the day a contract was signed, it would record as earnings more than 50% of the profit expected from a job, even though the work had not begun.

Now the company must contend with the SEC. ISC has admitted to handing out bribes totaling at least $22 million between 1970 and 1976 to get building contracts worth $1 billion in nine countries. On the SEC's list of the companies that have declared the total of bribes or "questionable" payments that they have made overseas in the past 20 years, ISC ranks in eighth place, between R.J. Reynolds ($24 million) and McDonnell Douglas ($18 million)--both of which are far bigger firms.

Some ISC payments apparently went to a high-ranking Ivory Coast official in 1973 to procure a contract worth $60 million. Others went to General Anastasio ("Tachito") Somoza, Nicaragua's President, for a contract to build grain-drying facilities there in the early 1970s.

In 1976 the SEC required ISC to start an internal review, to be monitored by two outside company directors, of all sensitive payments. The directors did not prove to be independent: each was receiving $100,000 that year from the company in legal and professional fees. ISC was slow to respond to the SEC order, and at one point issued an "interim" report saying that only $400,000 of questionable payments had been discovered. The company has never revealed the names of those it bribed.

As word of the SEC investigation spread, ISC found it harder to get its clients to pay for cost overruns and other claims. And, since the company could no longer hand out bribes, it began to lose business overseas. To raise cash, the company has begun selling off its remaining profitable contracts to larger firms.

Says a former ISC executive: "Tom Kenneally's basic philosophy has alway; been, 'There's a pot of gold at the end of the rainbow, and it belongs to us.' " But it begins to look as if Kenneally may find an empty pot at the end of that rainbow.

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