Requiem For Enron: There's Enough Blame To Go Around For The Collapse Of The Energy Giant: From Executives To Auditors To Financial Analysts To CongressJan 7, 2002 | Insight On The News Lawsuits, class actions and congressional and federal probes now are under way to try to ascertain how much of Enron Corp's collapse was due to corruption and how much was the result of bad investment decisions and the recession. As far as those who lost on the energy trader are concerned, the main question is: Who knew what and when about the financial shenanigans used to obscure Enron's $40 billion-plus debt.
There were few naysayers around when Enron Chief Executive Officer (CEO) Jeffrey Skilling bragged last summer that the Houston-based energy trader would "become the biggest corporation in the world." Everyone loved Enron back then: Business analysts, banks and economists were lauding the company for its radical new ways of doing business; politicians, too, Republicans and Democrats alike. President George W. Bush was lent a corporate jet for the election campaign by Enron's founder, Kenneth Lay.
Bush enjoyed being associated with a Texas company that epitomized the roaring, risk-taking New Economy of the 1990s. Other politicians looked at Enron and salivated about all that money. At a time when it was praised by management gurus as a hotbed of entrepreneurial innovation and a model for companies in the 21st century, what politician wouldn't want to be mentioned in the same breath as Enron?
Only a few months later, however, the boast of Skilling, Lay's handpicked successor as CEO is being recalled with embarrassment by Washington politicians and with great bitterness by aggrieved Enron employees, many of whom likely will suffer the Christmas double whammy of losing both their jobs and 401(k) balances, while their bosses took care of themselves.
Along with investors and an army of creditors desperate to claw back billions of dollars in losses, they are asking why the alarm wasn't raised earlier on a company whose share price plunged from a summer high of $90 to a December penny stock. Fair-weather politicians also are eager to identify the reasons for Enron's crash, although doubts remain that Congress will admit to its own indirect contribution--namely, the weakening of securities-fraud legislation in the 1990s that some lawyers say has encouraged auditors and investment banks to be negligent.
"We have been warning for years about weaknesses in the watchdog system," says New York attorney Mel Weiss, who helped investors recover $800 million in the investigation of junk-bond king Michael Milken. "We have warned about conflicts of interest with the big auditing firms who use auditing as a loss-maker to attract more-lucrative consulting contracts, and we have warned that the Securities and Exchange Commission [SEC] is not able to keep pace with the explosion in capital formation. Congress removed a useful deterrent when it made it harder for plaintiffs to sue for fraud."
Enron, which reported almost $50 billion in assets, has gone from ruling the world to being the worlds' biggest corporate bankruptcy, dwarfing the previous record, Texaco's $35.9 billion bankruptcy case filed in 1987. The unraveling came quickly amid disclosures of inflated Enron earnings to the tune of $600 million over five years and massive hidden debt. Was Skilling inviting nemesis when he boasted in the summer of Enron's golden future or advancing cynically the effort to disguise what Gary Hindes of Deltec Asset Management has dubbed a "corporate black hole"? "Until the forensic accountants can get in there and sort things out you just don't know what Enron's worth," said Hindes.
Even if the company is auctioned off following its Dec. 2 filing for Chapter 11 bankruptcy, the ramifications, economic, political and legal will be long-lasting. About the only silver lining from Enron's crash is the timing. Analysts say that if it had come earlier or later, when the economy was not flooded with liquidity by the Federal Reserve, the firm's collapse could have posed a serious threat to the financial markets.
Enron insiders believe the firm's thunderous fall was due both to corruption and commercial stupidity. A senior Enron executive tells INSIGHT: "Skilling was out of control; we didn't know half that was going on. My impression is that his cover-up was an effort to buy time. He was the Micawber of the New Economy," certain that something would turn up.
But, as Enron employees point out, he was not a poor Micawber. During the year Skilling, a former McKinsey & Co. consultant who was recruited by Lay to become the nuts-and-bolts man at Enron, quietly was unloading stock, making 37 trades to sell $62 million worth of Enron shares.
While Skilling was waiting for something to turn up for Enron, where was Arthur Andersen LLP, Enron's auditor? It failed to ask probing questions about the byzantine off-the-balance-sheet partnerships with innocuous-sounding names such as Osprey, Marlin and Whitewing that Skilling and his sidekick, former chief financial officer Andrew Fastow, used to disguise the parlous state of the company. Fastow personally made $30 million on the partnership a conflict of interest, say Enron employees.
And where, too, was the company's independent auditing committee that appears to have been asleep at the switch? Nervous federal regulators say there is plenty of blame to be spread. They concede that the U.S. financial and political establishments have much to answer for, either as direct players or negligent observers.
Skeptical voices were few and far between. A Fortune magazine article in 1996 that was loudly positive about the company did note some doubts about Enron's methods of "managing" its earnings and cast doubt on Enron's use of "marking-to-market" accounting, which counted proceeds from long-term gas contracts as present income. The magazine said: "According to several former employees, this practice simultaneously inflates current earnings and creates a `feeding frenzy' as executives scramble to make new deals to prop up future profits."
With so many culprits available for criticism in Enron's crash, the focus is becoming blurred. But at the center of America's largest-ever corporate bankruptcy stand Lay and Skilling. Together they had guided the company into becoming a natural-gas and electricity-trading powerhouse boasting a market capitalization at one time of $80 billion. Not bad for a business started in 1985 from the merger of two pipeline companies. Enron became the dominant trader in the newly deregulated market for energy, buying and selling contracts on gas and electricity among other things, and establishing markets in financial derivatives related to energy. Increasingly, though, it traded purely financial products, including credit derivatives, and under the direction of Skilling moved further away from its core energy business, buying a water plant in Britain and a power distributor in Brazil.
Awful investment decisions followed in quick succession, say Enron insiders, as the company branched out and acted as a hedge trader in multiple commodities, services and products, including broadband capacity.
All looked rosy as Enron's revenue soared from $14 billion in 1991 to $100 billion in 2001, and its average annual profit growth for the decade was a startling 29 percent. That attracted an "A" from Wall Street rating agencies such as Standard & Poor's and Moody's Investor Service. But behind the scenes the books were being cooked and the earnings figures inflated as competitors started to bite into Enron's profit margins and international investments failed to perform well.
The first public signs to break through Enron's secretive corporate culture came in August when Lay nonchalantly dismissed questions about a $1.2 billion reduction in shareholder equity related, he said, to accounting errors involving an Enron partnership run by Fastow. Furthermore, he denied all knowledge of the Enron partnerships involving Fastow and Skilling. Belatedly that has earned Lay condemnation if he didn't know, he, too, was failing in responsibility, and for many his claim is unbelievable.
"First, founders of companies don't tend to ignore what's going on with their babies and, second, he knows all about accounting practices," says a Wall Street banker who spoke on condition of anonymity. In fact, the 59-year-old Enron chairman studied economics at the University of Missouri, earned a doctorate in the subject and, as a naval officer serving in the Pentagon worked to develop more efficient accounting systems. Lay also served as an aide to a federal-government regulator for the natural-gas industry.
SEC sources tell INSIGHT that they also find it unlikely that Lay didn't know Enron was slipping rapidly into trouble; along with Skilling, Lay steadily dumped personal Enron stock throughout the year, selling in 457 trades $74 million worth of shares.
Lay and Skilling were not alone in dumping shares. Other senior executives also bailed out, including Lou Pai, director of Enron's energy-services operation, who sold shares totaling $353.7 million; Rebecca Mark-Jusbasche, head of Enron's Indian power plant and its water company, who walked away with $79.5 million; Ken Harrison, head of Enron's Portland General Electric subsidiary, who took home $75 million; and Kenneth Rice, head of Enron Broadband Services, who sold shares worth $72.8 million. Speaking on the Don Imus Show, Sen. John McCain (R-Ariz.) said it's going to be difficult to "explain how executives of the company were unloading stock right and left while the employees were not able to do so."
The dumping of stock by Lay and Skilling for that matter sticks in the craw of Enron employees. They were blocked by the company from selling their stock options as the crunch loomed following the formal disclosures by Enron that it had shifted billions of dollars in debt off its balance sheet and into an array of complex partnerships.
Those disclosures sunk desperate buyout negotiations Enron was having with its smaller rival, Dynegy Inc., which pulled out from purchasing Enron on Nov. 9, precipitating the final collapse of the company.
Questions remain, though, not only about the mishandling of Enron by its corporate officials and their cooking of the books but the laggardly reaction of the rating agencies and the auditors.
In June, Standard & Poor's warned Enron that it was concerned about the firm's underperforming international assets. But the agency didn't alter its credit rating of the company, being satisfied apparently with the assurances Enron executives gave about the future. Skillings' abrupt departure as CEO in August didn't trigger alarms on Wall Street or among the business press. As summer came and went there was no way for ordinary investors to know a hurricane was brewing.
The rating agencies now say they were worried about Enron, but felt that downgrading the company's investment rating sooner would only have brought on bankruptcy quicker. According to Standard & Poor Director Todd Shipman, the core energy business still looked good and no one at the agency knew the scale of the off-the-books debt. The agencies were aware that a downgrading of Enron would result in a credit squeeze for the company and, along with a plunge in shares, would lead to trading partners losing confidence that the company would have the cash to pay bills.
Mutual-fund analysts and investment banks, including Citibank and J.P. Morgan Stanley, continued to talk up the company and to give it a "buy" rating, all in a bid, say Wall Street analysts, to shore up the energy trader and their large investment in and loans to Enron.
Enron's woes are sure to shake up the accounting and auditing industries. Arthur Andersen has egg on its face for not catching Enron's overstated earnings and for failing to scrutinize the company's off-the-books partnerships, which showed the company to be much more in debt than was stated on its balance sheets.
"I think it's obviously time for a very thorough review of the state of auditing in not only the Enron case but generally speaking," House Energy and Commerce Committee Chairman Billy Tauzin (R-La.) told the Washington Post.
Concerns have been voiced for years about possible conflicts of interest arising from accounting firms performing consulting services for the companies they audit. Critics charge that this leads them to go easy on the companies they work for and to turn a blind eye to problems. Others say that technology has overtaken accounting standards, making it hard to scrutinize 21st-century financial deals.
Whatever the case, the industries are going to have to do a lot to win back public confidence, experts say. "Arthur Andersen was paid $25 million to do audits for Enron," Dale Oesterle, a professor at the University of Colorado School of Law who specializes in securities law, tells Insight. "It's hard for Arthur Andersen to be an independent certifier of Enron when such a huge percentage of Arthur Andersen's revenues are coming from Enron. And it was not only getting money for auditing, it was also doing other work for Enron very lucrative consulting services worth $27 million."
Lynne Kiesling, director of economic policy for the Reason Public Policy Institute and a senior lecturer in economics at Northwestern University, thinks the issue is more about outdated practices than conflicts of interest. A former international-taxation consultant at the Chicago office of the accounting firm PricewaterhouseCoopers, she says firms usually have good firewalls between their accounting and consulting services.
Nevertheless, Kiesling says, there is going to be greater scrutiny of business practices that were overlooked, such as "off-the-balance-sheet partnerships" that allowed Enron to be much more leveraged than investors realized. "Enron executives structured their debt in a way that didn't show how leveraged they were" Kiesling tells INSIGHT.
Fred Smith, president of the free-market Competitive Enterprise Institute, says the accounting practice hasn't caught up with complex financial transactions such as derivatives that Enron used. "New technologies and new economic instruments often aren't accounted for very well, and derivatives are one of those areas," Smith says. "The accounting profession does have to get better at understanding how to put those kinds of thing into a record."
Lawmakers have put on their best we're-gonna-get-to-the-bottom-of-this-financial-fiasco face, promising to expose the culprits. But Washington insiders remain doubtful about how fierce congressional inquiry will be in the coming weeks as many on Capitol Hill and in the White House have been recipients of Enron's financial benevolence. Both the right and left pushed away from the Enron table fat and happy.
According to the Center for Public Integrity, a Washington-based nonprofit government-watchdog organization, the Democrats in 1996 received a little more than $200,000 from Enron, while the Republicans tucked away nearly $1 million from the company's political-action committee and individual employees. In the 2000 election, Enron was America's 36th-largest donor, contributing $2,445,898, with 72 percent of that landing in Republican coffers.
Beyond campaign contributions, there are a number of Republicans who profited from Enron's early success, including James Baker III, a former U.S. secretary of state who sat on Enron's board, and Robert Mosbacher, a former U.S. commerce secretary who was onboard as a consultant.
Lawrence Lindsey, the president's top economic adviser, received $50,000 from Enron in 2000 for consulting fees, and Karl Rove, senior adviser to the president, sold "up to $250,000" in Enron stock to avoid a conflict of interest. Army Secretary and newly named Pentagon liaison to the Homeland Security Office Thomas White was vice chairman of Enron Energy Services in charge of commodity and capital management, among other things, and a member of Enron's executive committee and CEO for Enron Operations Corp. Sen. Phil Gramm (R-Texas), former chairman of the Senate Banking Committee, can claim Enron as his 12th-largest contributor during the same time that his wife, Wendy, who has been nicknamed "the Margaret Thatcher of financial deregulation," sat on Enron's board. She also was on Enron's independent audit committee.
Although Enron politics leaned to the right, it was during the Clinton administration that the Export-Import Bank (which is supported by taxpayer funds) subsidized Enron to the tune of nearly $630 million. To date, just $5 million has been returned to the taxpayers and, given the company's Chapter 11 filing, it remains doubtful if additional payments will be made on the loans. And the company had plenty of Democrat friends, including former Treasury secretary Robert Rubin, a fellow Harvard Endowment board member with Herbert "Pug" Winokur, the chairman of Enron's finance committee as well as a member of the company's executive committee, and former Texas governor Ann Richards.
In some ways those political friendships and connections may have deterred pertinent questions from being raised sooner about the health and management of a company that has become America's biggest corporate bankruptcy. Worse, in the minds of some, they constituted seals of approval.
Nobody is watching financial watchdogs
"All the safeguards failed," says New York attorney Mel Weiss. The doyen of class-action lawsuits, he sees auditor Arthur Andersen LLP as having more than egg on its face with the Enron Corp. collapse, maintaining there was negligence involved.
"The auditing profession is a grotesque failure," Weiss says. "There are only five major auditing firms now, and do you imagine you can audit any big company without having a conflict of interest?" he asks.
Already a half-dozen lawsuits have been filed against what was until recently the seventh-largest corporation in the United States. Nearly as many federal agencies and congressional committees have announced investigations of the company that was the dominant deal-maker in the gas and oil industries. Weiss already is preparing a class-action lawsuit against Enron.
Weiss sees the fall of Enron as yet another example of a financial watchdog system that is not working. He blames Congress for the problem, arguing that it undermined a legal deterrent in the 1990s by making it harder for plaintiffs to sue those who "aid and abet" financial fraud. His bugbear is the Private Securities Litigation Reform Act, passed by Congress in 1995 after strenuous lobbying by the Big-Five auditing firms.
"They teamed up with the high-tech industries. That was a powerful alliance and well-funded with booming stocks in a booming economy. They were able to pull off one of the most scandalous frauds on Congress by selling the argument there was a litigation explosion," says Weiss.
He adds: "We came in with charts showing that the numbers of cases hadn't risen that much at a time that capital formation had increased by a multiple of thousands. The number of public companies was hugely greater. The opportunities to commit fraud had increased and, if anything, it was surprising that so few cases were brought," he argues.
The changes in the law were detrimental, Weiss contends, by making it harder for plaintiffs to sue and by neglecting a provision enabling auditors and investment banks to be sued for aiding and abetting fraud. "Two years later they added fuel to the fire by passing a law that took away the ability to file such securities-fraud cases in state courts."
Weiss argues that the Securities and Exchange Commission [SEC] never will be in a position to know exactly what is going on inside large companies and that the threat of massive lawsuits would assist in keeping auditors and securities firms on the straight and narrow.
Critics of Weiss maintain that class-action lawsuits can have a disastrous effect on the financial markets, paralyzing companies and deterring risk. They also fear vexatious lawsuits that companies in the end decide to settle because it is much cheaper to give in than to fight.
Dale Oesterle, who has written papers for the free-market Cato Institute, argues against a post-Enron increase in regulation and litigation, saying the SEC has contributed to the problem with audits by insisting on a one-size-fits-all rule for auditing. "What I find problematic is that its an all-or-nothing audit," he says. "You either get a clean bill of health or you get an audit with reservations. It seems to me that if you had the market controlling this rather than the [SEC] rules, you'd have a lot of different kinds of audits that people could choose from."
Oesterle explains: "You could envision where you get an `A' or a `B' or a `C' audit, and you tell everybody which one you paid for. A `C' audit is a lighter audit, and an `A' audit is a real strict audit. You could choose which one you wanted, and it would be priced in the markets accordingly. The SEC doesn't allow that."
Who is Kenneth Lay?
Recipient of the Horatio Alger Award in 1998, Ken Lay's story is a classic rags-to-riches tale. Raised in a farm family in Tyrone, Mo., a small town in the Ozarks, Lay worked as a field hand when he was 12 and put himself through the University of Missouri by working at construction jobs, according to Mosaics, a magazine for alumni of the university's College of Arts and Sciences. After earning a master's in economics, Lay followed his mentor, Professor Pinkey Walker, to the Federal Energy Regulatory Commission in Washington. There, Lay learned about the energy industry and political lobbying, knowledge he assuredly put to use while chief executive officer of Enron Corp. Later he would earn a doctorate at the University of Houston.
"Lay plays the role of the classic `Mr. Outside,' jetting around the world opening doors for the company and schmoozing his mostly Republican contacts in Washington," said Fortune magazine in 1996. But Lay courted Democrats, too. He served on an advisory commission for Ann Richards, George W. Bush's predecessor as governor of Texas. A place was found on the Enron board for former Commodity Futures Trading Commission chairman Wendy Gramm, wife of Sen. Phil Gramm (R-Texas).
Lay owned one of the first beach houses in the fancy Galveston, Texas, resort community of Kahala Beach Estates, called the "Hamptons of the Gulf Coast." At a typical party in the neighborhood, "the brunch menu included Bloody Marys garnished with grilled jumbo shrimp, mushroom frittatas with peppered bacon, mesquite-grilled salmon on a bed of black beans, and, for dessert, iced cappuccino and chocolate-covered frozen bananas," according to the populist Texas Monthly.
Lay gave generously to his alma mater, in 2000 bestowing on Mizzou a $1.1 million chair in economics. "Endowing a chair in economics is at least one way I can partially repay the school for all it has given me," Lay told Mosaics last year. "Business is primarily a matter of knowing how to think logically, solve problems and be creative, all of which we learn, at least in part, in the pursuit of a liberal arts and science education."
Enron's collapse takes employees with it
Linda Roberts has been in the oil and gas business for 30 years. She has just walked away from a 23-year career with Enron with nothing to show for her two decades of work for the energy trader. "I started with Northern Natural Gas Company and was there when it was merged with Houston Natural Gas and then again when it became Enron. The demise of Enron is the most incredible thing I've ever witnessed."
Roberts tells INSIGHT, "The company gave 4,000 people about an hour-and-a-half to pack their personal belongings and get out of the building. There was no dignity afforded to these people who have given so much of themselves to this company. I lost 23 years of stock and all of my retirement. Just in my 401(k) this year, alone, I invested $60,000 and I've lost 97 percent of that. The difference between us and the Jim Jones cult is that they walked down the path, drank the poison and died. We walked down the path, drank the poison and lived."
Like Roberts, Georgi Landau also was with Enron from the company's founding. She was a "specialist senior global manager." Although the title is flowery, Landau says, she "processed legal contracts, financial agreements worth millions of dollars."
After 23 years with Enron and its predecessors, once given her walking papers Landau says with deep sadness that she wasn't even allowed to wait inside the building to wait for a ride home.
Landau tells INSIGHT, "I went to lunch and came back to find people leaving the building in droves carrying boxes. I was told I was being laid off, but they haven't given us any information about severance benefits, pay or pension benefits. Everything I've learned about the bankruptcy I've learned from the media. Everything I had in retirement is gone. I'm not old enough to retire so, like so many others, I have to try to find another job and start over. I'm in shock. I can't believe this has happened."