Regulation

Enron So Far

Scandal-mongers will want to keep an eye on four central issues.

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By now you must know that we're in the midst of the largest corporate bankruptcy in U.S. history—though it's only the largest if you ignore inflation. You probably also know that the company in question is Enron—billed as America's seventh largest corporation, another convenient fiction to hype its importance. There are many other things you may know. President Bush and Enron Chairman Kenneth Lay were hot tub buddies who once had a campaign financial menage a trois with then-Texas Governor Ann Richards. Enron executives got rich while average workers stayed poor. Its auditing firm, Arthur Andersen, plans to change the final "e" to an "o" in an attempt to remain in business.

There's plenty of entertainment—and some important lessons about greed, honesty, and the importance of maintaining a diverse investment portfolio—buried in the shenanigans of the leading players, with more yet to come:

Endwrong

Enron was a gas company that morphed into, in the words of one prescient wag, "a hedge fund sitting on top of a pipeline." That is, instead of dealing with the mundane business of building plants, generating power, and delivering it to customers, Enron decided there was more money to be made in trading energy—first natural gas and then electricity—as a commodity. In doing so, it did some truly great things, such as replacing top-down, inefficient bureaucracy with competition. But it also caught New Economy dementia and started dealing in stuff as diverse as home videos and broadband.

And while it may have been an innovative company, it wasn't a forthcoming one. It set up several off-the-books financing companies, a common practice that allows a business to hide debt for large projects. Enron's innovation was that it didn't back them with any real assets—like, say, a power plant—but simply with Enron stock. Wall Street analysts admit to never really understanding how Enron made its money. "Enron's discussion of its finances reads like something written in German, translated to Chinese and back to English by way of Polish," cracked Forbes.com. Analysts didn't care, so long as the stock price stayed high. But when the bubble started to deflate, they started asking questions.

Enron turned out to be in a much weaker financial position than it claimed. On October 16, it reported a third-quarter loss of $618 million, announcing also that it would write down $1.01 billion in investments, including $35 million to a partnership. On November 9, it restated its earnings over four years, wiping out $586 million—roughly 20 percent of what it claimed to have made. The losses were pegged to the partnerships. Investors and customers lost confidence in the company and it quickly collapsed, laying off 4,000 employees and putting Houston's art world in peril. On its way down, its executives put in calls to top Bush administration officials looking for help; so did its chief creditor, Clinton Treasury Secretary Robert Rubin. They didn't get any.

It's a scandal of first-rate proportions that's getting larger every day. But what kind of scandal is it? It's being covered out of D.C. Politicians with time on their hands due to the country's empty bank account are trampling each other in the rush to announce investigations. But it has yet to become a political scandal. The politicians are doing a great job distorting much of what we do know, even as they help us learn more.

Scandal-mongers will want to keep an eye on four central issues: the 401(k) wipe out, executive fraud, political influence, and energy policy influence. The categories aren't neatly distinct, and advocates combine and conflate them to make their points.

Working Retirement

The tear-jerking tragedy (Venus) and fist-thumping, red-in-the face outrage (Mars) of the Enron collapse is the wipe-out of employee 401(k) balances, which were heavily invested in Enron stock. Way back in December, victims of the collapse traveled to Capitol Hill to testify about how they lost everything while executives walked away rich. CNN's Bill Press laid out the conventional wisdom in a December column. "The human impact is staggering," he wrote. "Those 11,000 employees whose 401(k) funds were invested exclusively in Enron—and who were forbidden by Enron's own rules from diversifying—today have no retirement plan at all."

This story is as phony as an Enron financial statement. Any retirees who lost everything committed two sins of investing: They put all their eggs in one basket and then didn't watch it. Outside of a 10-trading-day period from October 26 to November 12 when accounts were frozen so Enron could change plan administrators, all employees were free to sell any Enron stock they purchased for the 401(k) account. (Attorneys suing on behalf of investors say the freeze actually started on October 17.) Any employee over 50—which includes most retirees—could have sold even the stock the company put in their accounts for free. There are no reports of any executive selling Enron stock after September 17, when retired CEO Jeff Skilling sold 500,000 shares. Chairman Kenneth Lay last sold shares on July 31. (Word is that he figured the stock would go back up and was waiting to get a better price.)

That's not to say employees don't have a legitimate beef. It just has nothing to do with their status as 401(k) investors and everything to do with their status as investors, period.

Start, I Mean Stop the Shredding

In its last few years of life, Enron lived as it died—not by the sword, but by creative accounting. Start with the claim that Enron is America's seventh largest company. Enron had 19,000 employees. Citigroup, one of its most generous creditors, has 238,000; Phillip Morris employs 140,000; IBM 312,000. Andersen, its former auditor, employs 85,000, at least for now. You get the point. It was only the seventh largest company by revenues, and those revenues were not only mythical—the company booked money long before it ever flowed in the front door—but were mostly the product of an accounting loophole. According to Forbes.com, Enron booked the gross value of trades as revenue, while Wall Street firms book only their net take.

But this Texas-size tall tale, which serves the interests of the politicians and media, is benign compared to Enron's real accounting scandal. The question is not whether the books were cooked. They were, as Andersen's global managing partner testified before Congress in December. The question, to employ a scandal cliché, is who knew how fraudulent they were, and when they knew it. If executives such as Lay knew the company was teetering on top of nothing but hype yet continued to (1) sell stock for millions and then (2) talk the faltering stock up to investors and employees in order to keep the company from, well, crashing, they deserve, at the very least, a series of dates with Saddam Hussein in the next South Park movie.

With every passing day, it's harder to imagine that the top executives and auditors didn't know everything. One clue is that Andersen's chief Enron auditor, David Duncan, ordered "an expedited effort to shred documents" the day after the SEC announced an investigation of Enron. The shredding occurred until November 9, when his secretary sent out another message: "Stop the shredding."

Another gun barrel spewing smoke is the memo by former Enron Vice President Sherron S. Watkins, supposedly written to Ken Lay sometime in August. The letter is a bit too perfect, with two especially suspicious aspects. There's no date on it: It's simply reported to be from August. And though the letter was supposed to be written to Lay, at one point it refers to him in the third person. Wrote Watkins, "I believe Ken Lay deserves the right to judge for himself what he believes the probabilities of discovery to be and the estimated damages to the company from those discoveries…"

But she nailed it, writing, "I am incredibly nervous that we will implode in a wave of accounting scandals." And: "I realize that we have had a lot of smart people looking at this and a lot of accountants including AA & Co. have blessed the accounting treatment. None of that will protect Enron if these transactions are ever disclosed in the bright light of day."

Watkins raises an interesting point. It may be a good idea for companies to have smart chefs in their executive dining rooms, lest the food get boring and the suits start wandering out for expense-account lunches at Gentlemen's Clubs. (This is especially a problem in Texas.) Companies may even want to retain smart lawyers. But accountants, like journalists, should think of themselves as dumb. That way they'll do their jobs, by asking plenty of dumb questions.

What's their job? For Watkins, "The overriding basic principle of accounting is that if you explain the 'accounting treatment' to a man in the street, would you influence his investing decisions? Would he sell or buy the stock based on a thorough understanding of the facts? If so, you best present it correctly and/or change the accounting."

Watkins' letter also made it clear that other employees inside Enron had raised similar questions with executives or considered the company "crooked."

Screw Your Neighbor

It appears not only that Enron executives realized their accounting was fantasy, but that the company's outside auditor and perhaps even its law firm did as well. That's what all those noisy, annoying legislators are looking into now.

David Duncan—the man in charge of the Enron account, who Andersen fired on Tuesday—made rounds in D.C. on Wednesday, presumably ratting on his former firm. "Any half-witted investigator has all the tools now, with the names of lawyers, accountants, and employees involved to play one against the other in their statements and inconsistencies," says a former Hill staffer. "They'll be able to pry out some truth as the threat of jail and penury are present and real serious in dimension."

The suspects have already started to turn on each other. Enron, for example, blames its outside auditors and counsel. "All of those partnerships had been through review processes and approval processes that were set up with and in many cases worked out with Arthur Andersen as our outside auditors, plus outside legal counsel," company mouthpiece Mark Palmer told the Associated Press.

Meanwhile, Andersen's global managing partner is pointing the finger at Enron, even as he admits his own company's "errors in judgement." "The company did not reveal to us that it had this agreement with the financial institution," C.E. Andrews told the Senate Commerce Committee on December 18. "We have notified Enron's audit committee of possible illegal acts within the company," he later added.

The law firm, Vinson & Elkins—conveniently shielded by Texas law from being sued for malpractice by anyone but Enron—points to both, indicating that the practices were known all the way to the top. "Arthur Andersen consulted with its senior technical experts in its Chicago office regarding the technical accounting treatment on the Condor/Whitewing and Raptor transactions, and the Andersen partners on the Enron account consulted with AA's senior practice committee in Houston on other aspects of the transactions," Vinson & Elkins wrote in a report addressing Watkins concerns. "Enron may also take comfort from AA's audit opinion and report to the Audit Committee which implicitly approves the transactions involving Condor/Whitewing and Raptor structures in the context of the approval of Enron's financial statements."

Lay blames the lawyers, speaking through Enron's recently-retained attack attorney (and former counsel to President Clinton) Robert Bennett. "Mr. Bennett argues that Mr. Lay would have conducted a more thorough investigation of the partnerships if his attorneys had recommended it," reports Wednesday's Wall Street Journal. "I think this shows Ken Lay's good faith in the matter," Bennett told the Journal.

Beltway Boys

Back in the Washington, Bennett complains that the issue is becoming too political, which of course is why he was hired. Yet so far, the financial scandal hasn't become a political one. Not that no one's tried to make it one.

The issue exploded on Washington last Thursday after it was revealed that Enron executives had contacted several federal officials as their company ran out of cash. This, combined with Enron's generous contributions to President Bush and others in his administration, threatened to engulf the White House. But when it turned out that nobody seems to have done anything on Enron's behalf in response to the calls, and that one of the last callers was Democratic economic guru Robert Rubin, the Democrats didn't quite know what to do. Sen. Joseph Biden (D-Del.) declared on Meet the Press that there'd be hell to pay if the Bushies intervened, while Rep. Henry Waxman (D-Calif.) indicated in a letter that the scandal was that the Bushies didn't do anything.

The scandal also has an energy-policy angle, one that predates Enron's financial collapse. It seems that Vice President Richard Cheney's energy task force met with industry executives while drafting the administration's energy policy. The real scandal is that we have an "energy policy," as opposed to keeping federal planners away from the marketplace. But Waxman is upset that the meetings weren't open to the public, or at least recorded for the public, and he and Rep. John Dingell (D-Mich.) have been trying to get Cheney to come clean for months. Cheney's office has admitted that the energy policy staff met with Enron officials six times. It denies ever talking about Enron's finances, and advised Waxman that it hoped this information would "help you avoid the waste of time and taxpayer funds on unnecessary inquiries."

There are plenty of way the financial scandal could turn into a political one, and plenty of people are working hard to make that happen. Once congressional staffers start rummaging through documents and lawmakers start questioning key players, evidence of influence, either from Cheney's task force or from other officials, may very well turn up. Yesterday, for example, the White House disclosed that former Enron retainee and current Bush economic adviser Lawrence Lindsey directed a study of the likely effects of an Enron collapse in October. Who else did what? We learn more every day.

And Enron is not the only relevant player. Vinson & Elkins is an extremely political law firm that is no stranger to some in the administration. According to The Wall Street Journal, White House spokesman Dan Bartlett says he didn't know of any contacts between Vinson & Elkins attorneys and administration officials regarding Enron. "One thing is clear," Bartlett told the Journal. "This administration has taken no action to benefit or to attempt to help the Enron company."

The first statement has enough Clintonian holes in it to solve L.A.'s traffic congestion at rush hour. The second statement is cut and dried. If it turns out to be wrong, the scandal explodes.

Who Loses, Who Loses More

Enron investors, including many states and institutions, are of course big losers, perhaps in more ways than one. Employees are also in trouble: I wouldn't want to be dependent on a job at Andersen to make my rent. More of the obvious: Attorneys will make out like bandits, or perhaps like Enron senior executives a year before the crash.

Criminal investigations are underway, and they're less noisy but more deadly than the more numerous congressional investigations. At the height of California's energy crisis, state attorney general Bill Lockyer quipped, "I'd love to personally escort Lay to an 8-by-10 cell that he could share with a tattooed dude who says, 'Hi, my name is Spike, honey.'" He may have to satisfy himself with Lay sharing a cell with his buddies at Andersen.

The rest of us may lose in more subtle ways. The core of this scandal is fraud, which is to say human nature, and there's not much Congress can do about that. The accounting profession will certainly get tighter rules, either imposed by themselves or from new regulations. Meanwhile, legislators will push, perhaps with Bush's help, for more regulations on 401(k) plans, principally limiting the portion of plans that can contain company stock. This is a record-keeping nightmare and will upset employees of large companies, who typically are eager to invest in what they deem to be good deals. (Imagine if Microsoft employees were not allowed to purchase Microsoft stock.) So far there's been no talk of putting more regulation on the energy industry, but of course Waxman is in the minority and can't hold his own hearings. That too may change come November.