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Enron: Let Us Count the Culprits


Enron Corp.'s (ENE) bankruptcy is a disaster of epic proportions by any measure--the height from which it fell, the speed with which it has unraveled, and the pain it has inflicted on investors, employees, and creditors. Virtually all the checks and balances designed to prevent this kind of financial meltdown failed. Unless remedied, this could undermine public trust, the capital markets, and the nation's entire equity culture. Even now, no one really knows what liabilities are buried inside dozens of partnerships or the role ex-CEO Jeffrey Skilling played in creating a byzantine system of off-balance-sheet operations. A culture of secrecy and a remarkable lack of transparency prevented any realistic assessment of the company's financial risk. Nothing less than an overhaul of the auditing profession is now required to police accounting standards. Wall Street, mutual funds, and the business press would also do well to rethink why each, in its own way, celebrated what is now revealed to be an arrogant, duplicitous company managed in a dangerous manner.

What is increasingly clear is that Skilling, a former McKinsey & Co. consultant and Harvard Business School grad, tried to craft Enron as a new kind of virtual trading giant, operating outside the scrutiny of investors and regulators. Enron's numerous partnerships were shrouded in secrecy, tucked away off the balance sheet. They were used to shift debt and assets off the books while inflating earnings. The chief financial officer ran and partly owned two partnerships, a clear conflict of interest. Enron leveraged itself without a reality check by any outsider.

ASLEEP. Hardly anyone inside the company was urging caution, certainly not chairman Ken Lay. The independent auditing committee on the board of directors was clearly asleep. Given Enron's arcane financial engineering, the committee probably relied on Arthur Andersen, the auditor, for information. But Andersen didn't blow any whistles. No surprise there. It made more money selling consulting services to Enron last year than it did auditing the company. Criticizing Enron's books might have jeopardized consulting work. Similar conflicts of interest stopped Wall Street analysts from pulling the plug on Enron. Even as Enron slid toward bankruptcy, "buy" recommendations were being issued by analysts whose firms were doing investment-banking business with the company, or were hoping to.

Did anyone really know what was going on inside Enron? The rating agencies, Moody's Investor Service and Standard & Poor's, presumably had better access than average investors, but neither downgraded Enron's credit rating to below investment grade until the bitter end. The rating agencies argue that had they downgraded Enron sooner, they would have simply pushed the company into bankruptcy earlier. Here's a flash: So what? Moody's and S&P have one basic job--assessing risk for investors. If they couldn't penetrate Enron's complex financial engineering, the rating agencies should have said so.

The business press, including BusinessWeek, did no better. It celebrated Skilling's vision of Enron as a virtual company that could securitize anything and trade it anywhere. The press blithely accepted Enron as the epitome of a new, post-deregulation corporate model when it should have been much more aggressive in probing the company's opaque partnerships, off balance sheet maneuvers, and soaring leverage.

TRAGIC. Enron's fall is made all the more tragic because of the pain inflicted on its thousands of employees. Not only are many losing their jobs, but some 12,000 are also losing most of their retirement savings. In perhaps its most egregious risk-management error, employees mostly held Enron stock in their 401(k)s, yet the company prevented them from selling until they reached the age of 54. People could only watch as the stock plummeted from $89 to a dollar. Diversification, particularly in retirement accounts, is the cardinal rule in managing risk. Enron broke that rule, as have other companies.

Enron's tale is a clarifying event. It reveals key weaknesses in the financial system that must be corrected as the U.S. moves forward in the 21st century. If America is to have an equity culture in which individuals invest in stocks and provide the capital for fast economic growth, the market must be able to correctly value companies. This requires making financial data readily available and easily comprehensible.

To restore public confidence, several steps should be taken. After accounting disasters at MicroStrategy, Cendant, Lucent, Cisco, and Waste Management, it is clear that self-regulation is not working. Conflicts of interest within auditing firms remain widespread. Investors can ignore analysts on TV who work for investment firms. But someone has to play the role of the honest watchdog. Unless the Big Five auditing firms clean up their act, they will wind up with a federally chartered oversight body. It is equally clear that current standard accounting rules aren't sufficient. Loopholes allowed Enron to fool everyone, making a mockery of public disclosure.

Regulators should also insist that corporations give their employees choice in their 401(k)s. Some 30% of assets held in 1.5 million 401(k) plans are in the stock of the company sponsoring the plan. This lack of diversification puts too many people at risk.

In the end, the Enron story is about a secretive corporate culture that failed in its primary business mission: to manage risk. Had the Federal Reserve and other central banks not flooded the global economy with liquidity in recent months, Enron's collapse could have posed a deep threat to the financial markets. It's past time to fix the system.


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