Looking at the Enron affair in terms of the ordinary investor, what's going
on? What's the significance of Enron?
The significance is something major. Enron is not an isolated event. Enron
represents perhaps a pinnacle of something that's been happening for about 65
years, since the Great Depression.
A number of laws were passed back in the 1930s that were designed to protect
investors. And gradually, what has happened is that those laws have been eaten
away at by corporate executives, by Wall Street, by accountants, so that now
the laws we have in place more or less protect those special interests at the
expense of investors, rather than the other way around.
Gradually, over the last 20 years, executives, accountants, and Wall Street
types have figured this out, and you've seen a variety of things happen as
these laws have allowed it. Executive compensation has skyrocketed, so that
it's now normal to get $100 million even if you fail. Accountants come to
managers and suggest ways to alter the books to create a misleading picture,
when before they were the policemen of that. Wall Street participates in deals
which they know eventually will bring companies down. They do it because they
can, because there aren't consequences.
The laws have changed enough over the last 65 years that it is now relatively
risk-free to run a major company into the ground and keep the change, with
nothing following after you.
How did that happen?
Corporations, of course, are where the money is, and people are attracted to
money -- both fraudsters and Street people. And when you have laws on the books
and infinite time and a great deal of lobbying money, you go to lawmakers year
after year, and you change this bit, then you change this bit. And gradually
you wear the laws away. ...
You'll notice what happens is that when these companies fail... even in the
case of Enron, a major implosion, the seventh-largest company on earth
disappearing from the face of the earth in a few months -- so far, the only
indictment has been against a company; not even the main company, not Enron,
the auditors. But not against individuals.
So if you are an individual, you are an auditor, let's say, and Enron's
management says to you, "Come on help us cook the books here," you know the
worst thing that's going to happen is your company will pay a fine. Does that
deter you? I doubt that it does for most people. That's a fairly removed thing.
There's a common theme here in most of these major frauds. And that is that the
boards of directors and the CEOs do not go to jail and they do not pay fines.
The worst thing that happens is the company pays a fine. It becomes a cost of
business.
You're talking about the outsiders, the ordinary investors, and the
insiders, the corporate executives, boards of directors, lawyers, accountants
and so forth. What you're suggesting now, I guess, is that the game which was
set up to protect the outsiders is now tilted heavily in favor of the
insiders.
That's exactly what's happened, and of course, the outsiders were at risk.
You have to remember that shareholders of large publicly traded companies are
at risk, even if we have good laws in place. If 3,000 people own General Motors
or 3 million people own pieces of General Motors, there's no one person in a
position, if General Motors starts to go bad, to step forward and say, "Let's
fix the situation." It costs too much, and you don't have enough power. So even
if we have good laws that protect investors, it's very hard in large publicly
traded companies for anyone to step forward and fix problems. ...
What if you have deceptive accounting? What if you have fraud? What if you
have a dispute? The laws that got passed in the 1990s -- for example, the tort
reform law of 1995 -- did that affect the balance of power between the
stockholders and management?
A little bit. It's not as substantial as some of these other things, because as
the laws that affect how shareholders can sue are so bad that it only made it a
little bit worse.
There are basically two ways shareholders can sue if they think something has
gone wrong with the company. They can either sue the company, which is suing
themselves. So if you're General Motors shareholders and you sue General Motors
and you win a million dollars, you're taking money out of one pocket and you're
putting it in your other pocket, with the lawyers keeping a chunk in the
middle. So that's one way you can sue.
The other way you can sue, if you don't want to do that, is to ask the board of
directors for permission to proceed with a lawsuit. And guess what? They turn
you down. So that was the law before this changed.
But there are people who said that corporations, management and boards were
less afraid of the SEC, because it was so overloaded and couldn't keep up with
17,000 publicly traded companies and 7,000 brokerage firms. They were more
afraid of lawyers like Bill Lerach filing lawsuits than they were of the SEC,
and that the 1995 law didn't cripple them, but it severely made his job more
difficult -- not only his job, but that of other people like him.
I'm not sure that it made it that much more difficult. Yes, it's true that
companies fear lawsuits from the private sector more than they do from the SEC.
It's not just because the SEC is overwhelmed; it's because the SEC has also
been, in my opinion, co-opted by these special interests. It's no longer the
regulator that protects investors that it should be. And so, yes, the private
lawsuits do worry companies.
The trouble is they don't fix the problem. You can't sue the wrongdoers. We
could sue Enron. Bill Lerach has sued Enron on behalf of one of the
institutional investors. But if he wins, he'll get a check from Enron. He won't
get a check from Kenneth Lay. He won't get a check from Jeff Skilling. He won't
be sending anybody to jail. He won't be banning anyone from the business. So
the shareholders of Enron, who have already lost most money, will merely take
the remaining money and pay it to themselves.
Of course, there's some shame involved, and so there is a policing effect, and
it is important to have those lawsuits continue. But it's a limited deterrent.
...
Another big issue that came up in the 1990s was this issue of expensing
stock options. To some people, that was an important part of what was driving
Enron -- that you had executives who were getting huge stock options, not just
at Enron but lots of other companies and that that focused their minds on one
thing alone, which is boosting the stock price, because it was going to make
the most money for them personally. ... What's your take on that?
I think that's absolutely the case. At Enron, the executives had the ability,
by jacking up the stock price, to take hundreds of millions of dollars out of
the company and keep them through the vehicle of stock options. If they had not
had that vehicle, they would not have had the ability in a short period of time
to siphon that amount of money out of the company.
What stock options have done in Enron's case, and in other cases, is turn the
companies into Ponzi schemes -- the kinds of schemes that two-bit criminals
used to engage in, where they would lie to little old ladies. They would get
enough money into the company that they could pay the first investors who've
been in, and they've taken enough money, suck all the money out, disappear, and
the thing crashes. Stock options have allowed executives of major companies to
turn those companies into Ponzi schemes, because they can very quickly siphon
out hundreds of millions of dollars to themselves by stock options.
But it's even quicker if you give someone a loan from the company and then they
use stock options to pay back the loan, because then they can postpone for a
year and a half having to disclose to the public. And so it's a way to dump
your stock options, without signaling to the public that you're dumping your
stock options. So the big thing in the last five years has been the companies
giving hundred-million dollar loans to the executives, the CEOs at least,
because it's a way they can get stock options dumped. It's bad stuff. ...
One of the things that we heard from Ken Lay's lawyer to explain the fact
that Ken Lay was selling off whatever it was -- I think it was $4 million worth
of stock options every week, was a terrific rate -- that he was doing this was
he was just repaying loans. The poor man was overburdened with loans, and so he
had to sell all these stock options to pay off his loans. What's going on
here?
Something that is fascinating is going on there that most people don't
understand. Companies, CEOs, people like Ken Lay, have learned that if they get
a loan from their company to them, and then they pay back their loan with stock
options -- stock that they've been given through options -- they can delay for
over a year disclosing to the public the fact that they're dumping their stock
options.
Normally, if you're a CEO and you sell stock, you need to tell the public right
away that you're selling stock. But if you know your company is going to fold
because there's all sorts of fraud and you've got to get out first before the
stock price plummets, you want to delay revealing the fact that you're selling
your stock. The normal rules are, if you sell stock, you got to tell the
public. So how do you get around that? You get the company to give you a big
loan. And then the way you pay back the loan is you return your stock to the
company as a loan repayment. That gets you your cash out of the company, and
you don't have to tell the public for over a year.
So it's a way of hiding what the CEO is doing when he's dumping the
stock?
Yes, when you need to dump the stock and hide it from the general public, a
loan is your answer. ...
Had the FASB rule on expensing stock options passed, would that have been
some deterrent to what Enron ultimately did?
Had FASB changed the rules and required companies to show stock options as an
expense, I think Enron and a number of the other companies that have tanked
through fraudulent bookkeeping would have been held back considerably, because
their schemes depended on postponing public revelation of the losses. And if
stock options had to show up as an expense, then a lot of the money that was
quietly being siphoned off would have been publicly siphoned off, and it would
have been a deterrent. ...
If that is the case, what is the other way?
There was a massive lobbying campaign that went on to prevent the charging of
stock options to earnings. We were in the middle of it, so I experienced it.
And I have never experienced a more carefully organized, highly orchestrated
across-the-board effort to prevent something from happening.
You had groups, mainstream business lobbies; you had the Silicon Valley
lobbies; you had the accountants, who in theory shouldn't care what the rules
are, they should just want to apply them. [They were] all calling on every
senator and congressman, leaning on the SEC, visiting members of FASB,
threatening the budget of FASB, threatening the budget of the SEC, working with
any kind of trade association they could swing in, kicking in large campaign
contributions. It was one of the most impressive lobbying efforts on earth. It
was protecting CEOs' pay packages.
It was what?
Protecting CEOs' pay packages.
So that's why it generated such enormous heat?
I mean, there's nothing in CEOs' salaries that compares to the number of CEO
stock options. It was protecting CEOs' pay packages. They were out in force.
...
Sen. Joe Lieberman sponsored the resolution that overwhelmingly passed in
the Senate to oppose the expensing of stock options. Why would Lieberman of
Connecticut be so desperately interested in this, to take the lead?
The insurance companies are in Connecticut and the accountants are heavily
based in Connecticut. FASB is in Connecticut. Both Sen. Lieberman and
Sen. Dodd have historically been very protective of accountants and very
protective of executives, even though they talk a good liberal Democratic line.
If you look at the votes and you look at the actions, it's not there. ...
What were you doing at that point? Were you testifying for or against
[FASB's proposed rule]?
We actually wanted a change that was not charging stock options to earnings,
but that was not leaving it quite uncharged. It was kind of a complex middle
ground, because stock options are a weird thing from an accounting point of
view. They are a way that money is transferred from shareholders to executives.
They don't transfer money from the company to executives, so it's not a check
that comes out of the company. It's basically like printing of money that
dilutes all of the money in the world. When you print up extra stock options,
the stock that the average shareholder has becomes worth less. So it's a very
different kind of value transfer.
And we proposed a solution that was trying to capture the fact that it was
compensation -- it was valuable; it was a cost of production, but it wasn't
transferred from the company to the executives. It was transferred from the
shareholders.
Unfortunately, I think we played a bad role, because we were proposing a middle
ground, and that meant that we weren't opposing those who wanted to prevent
changing. And therefore, I think we probably let them be victorious and block
FASB. ...
Also, at least you have the figures that the companies are using on their
tax statements.
Right. It seems to be a bit much that companies can say these things are a cost
of production and they have a knowable value for purposes of taxes, but then
turn around and say for purposes of accounting, they have a value, and if there
was any value, we couldn't figure it out; and gosh, we just -- they're just not
there.
Double standard?
Double standard. ...
Why didn't the watchdogs bark about deceptive accounting practices at Enron,
Sunbeam, Waste Management, Cendant -- the whole slew of them?
The watchdogs now work for executives, accountants and Wall Street. They don't
work to protect shareholders.
But the original idea in the SEC law that was passed in the 1930s was to
have a lot of--
It was to protect investors. That's the purpose of the SEC. We have a new
chairman of the SEC, Harvey Pitt. I represent $2 trillion worth of investors of
all types. He has never called. He has never visited.
He has, however, visited with accountants frequently. He has asked them to
write rulemakings for him. He has considered opposing them, lock, stock and
barrel in the form that they have proposed. He has talked about spending
weekends to prepare, in case Arthur Andersen goes under. I would love to think
of him spending a weekend to prepare when investors go under. He has talked
about a kinder and gentler SEC, when already the letters that we write to the
SEC on major issues don't even get answered. ...
We wrote a letter four years ago to the SEC, saying all of these director
conflicts of interest that are implicated in Enron and many of these other
frauds don't have to be disclosed; only a small number are disclosed, and we
want all director conflicts to be disclosed. They haven't answered. Harvey Pitt
hasn't answered.
Harvey Pitt has spent a lot of time on a lot of accounting issues, but we
haven't heard from him. And the words that I hear out of his mouth post-Enron
make me think that he is remembering his former clients more than he is
remembering us.
His suggestion for many of the post-Enron reforms is to give them to the New
York Stock Exchange to administer. The New York Stock Exchange is paid by
corporate executives' listing fees. The New York Stock Exchange had government
authority to protect investors. In my opinion, it doesn't. So Harvey Pitt, who
was their outside counsel knows that, and if Harvey Pitt says give the investor
protections to the other side, what else can I conclude?
So what you're saying is Harvey Pitt is not a protector of the ordinary
investor?
I haven't seen a single example to suggest otherwise.
And what's his record?
Of course he comes out of the private sector. He represented the New York Stock
Exchange. He represented each of the Big Five accounting firms. He represented
their trade association. His office of his law firm represented Enron, although
he says he didn't work on the matter. He is a youngish person. If he goes back
into the law, presumably he has to go back to those clients. And so, while you
would worry about that in general, I worry about it much more specifically,
because his post-Enron actions have been so strikingly devoid of all investor
protections.
What would be some yardsticks that would show that whether Harvey Pitt or
members of Congress are really serious about fixing the problem?
If you look at the core problems in an Enron situation, you can see they focus
around two basic things. One, the auditors are hired by the managers whose work
they're supposed to review. If my secretary hired me, how likely would I be to
correct her performance? So you have a major conflict of interest, where the
managers whose books are supposed to be reviewed are hired by the auditors and
paid them a huge amount of money.
In addition, you have boards of directors who are hired by managers -- who are
appointed by managers really, even though they're elected by shareholders --
who are supposed to oversee the company. Of course they can't. They're picked
by the executives who run the company.
And so if you want to reform those systems, you have to put in place laws that
make accountants more independent, so they actually work for the shareholders
they're supposed to. And you have to see reforms put in place to make the
boards of directors more responsive to shareholders.
But not a lot of that is creeping into the bills we see. Although there are a
few good bills that have been proposed, most of the focus is on the setup of a
new private sector entity to regulate accountants. Think about that for a
minute:
Why would you have a private sector entity regulate accountants? We have
prosecutors who do criminal laws; we have the SEC, which can prosecute for the
civil laws.
Government prosecutes people who break the law, not the private sector. If you
give authority to the private sector to oversee accountants, you have got to
know that you are doing something that's almost certain to be ineffective. And
yet most of the focus of many of the laws that have been suggested in Congress
is to set up a new private sector entity to watch over the accountants.
Let's take the Enron case as an example. Let's play it through. Jeff
Skilling and Ken Lay -- what's the auditors obligation to them? What is the
board's obligation to them? What's the relationship of Goldman Sachs and JP
Morgan and Merrill Lynch to them and Standard and Poor's and Moody's and the
other bond rating agencies? How does it work?
In Enron's case, there are some very interesting numbers, which put the
relationship in perspective. Enron is a public company. It has to hire
auditors. That is required by law. So it goes out to Andersen and it says, "We
need you as our auditors." This is of course Ken Lay, Jeff Skilling. They say
to Andersen, "We will employ you as our auditors. You need to come in and bless
our books. We will you pay you if you bless our books. Not only that, we will
pay you a half-million dollars a week just for blessing our books."...
If your job was bless the books -- get a half-million dollars a week -- would
you bless the books? You would bless the books, especially if you as the
auditor helped the FASB write the rules you were supposed to follow to bless
the books. And it turns out that the rules you have to follow when you bless
the books are really full of loopholes; they're just shot full of loopholes, so
that even without breaking the law, you can help Enron write a picture that's
not at all an accurate picture of what's going on at Enron. ...
But if you're Jeff Skilling and you're Ken Lay and you're really committing
fraud, you may think that a half-million dollars a week is not enough. So you
say, "Look, on top of that, we'll give you another half-million dollars a week.
So you can get a million dollars a week, if you'll give us consulting on the
side. Tell us what else we need to know." We've designed our systems to help us
commit fraud and you give them a million dollars a week. That's what the
situation was with Enron. And it would take a very strong person to say no to a
million dollars a week, especially when the accounting rules are as lax as they
are and as gray as they are and say, "This goes beyond."
So the relationship between managers and accountants is one of employer-
employee, even though the accountants the general public things are a watchdog
for the general public. They are an employee of management. It's the same way
on the other side.
The board of directors, which is the other watchdog for Jeff Skilling, Ken Lay
-- they select people. They select their friends. In the case of Enron, they
selected people who lived overseas, people who were retired and wanted to serve
on a lot of boards so they didn't necessarily want to pay attention. Maybe
people who wanted contributions for their foundations or the hospitals they
worked for and they said, "Come serve on our board." The directors get elected
by shareholders, but they're picked by Jeff Skilling and Ken Lay.
And there is a system in corporate boards where CEOs talk to each other. If
you're a difficult director and you ask questions, the CEOs tell each other and
they say, "You don't want this person on your board, because he asks bad
questions." And so you not only stop serving on the Enron board, you stop
serving on other boards. So you have a board of directors that is picked by
these people that know that if they ask questions, they go off the board.
...
And so the two safety nets that are supposed to work... The board of directors
and the auditors actually act as employees to management.
What about the law firm? What about Vinson & Elkins?
I think Vinson & Elkins acted fairly similarly, from what I can read in the
papers. They claim that they are in a little bit of a different situation,
because auditors owe a duty to the public, and they owe a duty only to the
company. But I think they misstate there.
Think about this very carefully. The law firm is hired by the company to work
for the company. The law firm is not hired to protect Jeff Skilling and to
protect Kenneth Lay. It's 101 law school ethics: If you are paid by the
company, but you are asked to do something that is not in the company's
interest, but that is in the personal interest of some of the employees, you
must say no.
And so it's not enough for the law firms to say, "We didn't owe the public an
obligation." They did owe the company an obligation. They owe the shareholders
an obligation. And to help design vehicles which have the CFO on the other side
of the table from the company, you cannot fail to note --even as a lawyer, not
a businessperson -- that that is not something in the company's interest.
You've made a comparison talking about people being an employee and telling
the managers what the managers want to hear.
We all know that if fifth graders hired their teachers, teachers would give all
A's. We also know that if fifth graders were told to write the grading
standards, fifth graders would write very easy grading standards. That's
exactly the situation we currently have. Managers hire auditors to bless the
books. Auditors bless the books. Auditors write standards for auditors to
follow. Auditors write easy standards to follow.
So what you're saying is we shouldn't be surprised that things go
awry?
They can't go any other way. People invariably act in their self-interest, and
it really is unfair to expect that an auditor who is making a half-million
dollars a week for auditing the books is going to be a whistleblower. He or she
isn't.
By the time we get on the air in late June, it's either going to be gone or
absorbed or something, but the odds are strong that it's going to be gone.
There's also been a lot of talk in the accounting firms that they're going to
divest themselves of their consulting businesses to one degree or another. The
disappearance of Arthur Andersen, and even the declaration of the other
accounting companies that they're going to separate their auditing and their
consulting businesses -- does that get rid of the problem?
It doesn't get rid of the problem. Clearly if you have ten conflicts of
interest and you reduce them down to five, that's probably a little bit better;
but it leaves you five. You have to remember that, in the Enron case, they were
getting a half-million dollars a week to audit and a half-million dollars a
week for consulting. So if you remove the half-million dollars a week they were
getting for consulting, you're still left with the half-million dollars a week
they were getting for auditing. That's a substantial motivator for most people,
especially the billing partner. So I'm not convinced that the separation of
consulting from accounting will make a great deal of difference.
What about the disappearance of Andersen? The implication of that would be
that Andersen was a bad actor and the weakest, at least in terms of its ethics
of the accounting businesses. Does that solve the problem?
Andersen's disappearance could have at least one good effect, and that is if it
disappears because of the criminal indictments. If they follow through and if
any of the individuals are indicted, that could serve as a signal to auditors
everywhere that they have to do a better job.
You need to picture yourself as an auditor -- not today, but five years from
now. Enron has gone away. We've forgotten what Enron means, and you're sitting
at a conference table at the Enron of the future. And the Jeff Skilling of the
future says to you, "I need your help here. I need you to help me with the
books. We're going to try to, you know, paint a picture that's really not
fair."
And you know that you're getting whatever is the equivalent of a half-million
dollars a week five years from now. Do you say yes, or do you say no? Will it
make a difference if Andersen gets fined? Probably not. Will it make a
difference if accountants at Andersen go to jail? It might, because I know if I
were sitting at the table, the thought that I might go to jail is going to have
a different effect than the thought that my employer might pay a fine.
So if Andersen disappears from the face of the earth through criminal
indictments and through charges sticking to individuals, it might actually have
a salutary effect on the other accounting firms. Will it be a bad thing that
there will be the Big Four instead of the Big Five? I don't think so. ...
I realize that Enron and Sunbeam are very different companies. One is
dealing with a very tangible household, a set of household products. The other
starts out dealing with utilities and then gets into derivatives and all kinds
of other stuff. There's a difference in the scale and the sophistication of the
practices. But are there are parallels in a way? Are Sunbeam and Enron kind of
on a continuum that illustrates general problems?
Sunbeam, Enron, Livent, Lucent, Rite Aid, Oxford, Cendant, Global Crossing,
PNC, Kmart are all examples of companies just in the last five years that have
used the laxness in accounting rules and the weakness in boards of directors to
show results that haven't really been there, to avoid facing problems that have
been there, and to siphon out money at the top for executives when the
performance isn't there to back it up -- and then have hell to pay.
Sunbeam and Enron share the same auditor.
Same auditor as Waste Management. In fact, although the Big Five used to be
thought of by a lot of people as essentially interchangeable, Andersen does
seem to have a pattern of being there in the worst cases of fraud. And perhaps
if you were a fraudster and you recognized this, you might seek them out.
...
There is one large group of people involved in this whole numbers game, the
whole investment game, that we really haven't talked about except in passing,
and that's the investment banks -- the JP Morgans, the Goldman Sachs, Merrill
Lynch, Citigroup, what have you. When you were talking about the fifth grader
paying the teacher and getting a good grade, to what extent is there that kind
of a relationship between the investment banks and Enron or companies like
Enron, getting these special financial entities?
I think it's frequently the case -- and it's a very scary thing, or it should
be a scary thing for most Americans to think about -- that the large financial
institutions on Wall Street have financial interests that vary from the average
investors. And they're quite willing to pursue their interest at the expense of
investors. Often, their interest is furthered if they can cut some kind of
special deal with companies, even if the results of that special deal are
something disastrous for investors.
I don't know whether all of the investment banks that had a hand in the various
Enron financings knew the depth of the problems. It's hard to believe that most
of them didn't have a pretty good sense. I mean, they are a sophisticated
people. And to see the CFO being put on the opposite side of the table from his
own company -- if that didn't set off alarm bells, I don't know what would. But
of course the investment banks' calculation is most likely to be, "Hey, even if
the company is going to crash, can I get my money out first?"
I suspect that some of those entities miscalculated on the answer to that
question. But you know if you are an investor, you need to be aware of the fact
that Wall Street may cut deals that harm you if it helps them.
So it's another example of the insider-outsider game, where the insiders
know the rules, get advance knowledge, may get special treatment; and the
outsiders, the general public, is excluded from the opportunity and excluded
from the knowledge?
That is an exact example of that.
It seems as if this whole story, going back to your original answer to the
first question, is very much about we had a system that we thought was set up
to protect us, the general public. We had auditors, we had investment banks, we
had a Wall Street analyst, we had bond-rating agencies. We had the SEC all set
up to protect and make sure there was a level playing field, that we all had
roughly the same amount of information about the same time. It's not working
that way at all.
It doesn't work that way because the people with power don't want it to work
that way. The single thing that Enron proves better than any other company
because of its sheer size is that none of the safety nets worked at all.
The analysts were silent until days before bankruptcy. The rating agencies,
which get inside information about how a company operates, were silent. The
SEC, which can get any information it wants -- it has subpoena power -- it is
obliged to review companies' financials every few years; and it didn't for
Enron. It said nothing. The SEC, which can adopt rules to prevent some of the
things that caused Enron, did nothing. The board of directors was silent at the
time; they're silent even now. The accountants, the auditors, whose sole role
is to assure the public that the books present an accurate picture, didn't do
that. Every safety net designed to protect investors failed completely with
Enron.
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