Enron – 10 Years later

Today is Election Day and I hope everyone gets out and exercises their right to vote (I mailed my ballet in yesterday.).  The good news is that after today we will see far fewer (none for a while?) political advertisements!  I want to mention that it was 10 years ago today that Enron executives sent an e-mail that encouraged some of their employees to donate directly to California governor Gray Davis rather than pay for a $10,000 seat fund raising dinner that was planned for him.   If you recall California was having significant energy problems and Enron was an energy trading company that was probably looking to influence the politician.  By the way, you can actually search through Enron E-mails if you are interested in reading them.

Enron was still a “high flyer” in November of 2000 as their stock was close to its all time high.  The stock was at $84 on 11/2/2000 and $90 was the highest level in Aug of 2000.  The company had a market capitalization close to $60 Billion.  As we know it collapsed in 2001 (along with several other companies) and eventually this led to our government passing the Sarbanes Oxley law in 2002.  I know hind sight is 20-20, but here is a look back at all the “red flags” that were flying before when Enron collapsed and some other interesting information that came out afterwards:

Proposed Accounting Rules

In June of 1999, CFO Magazine predicted that a “new accounting rule could trip up Enron” since “Enron does not consolidate a number of highly leveraged subsidiaries in which it owns”

CFO Excellence

Enron’s star CFO (Andrew Fastow) was awarded CFO Magazine’s “CFO Excellence Award for Capital Structure Management” in 1999.   You can read a 1999 interview (from CFO in Jan. 2002) of Mr. Fastow.

Auditor Independence

Enron paid Arthur Andersen $50 million in fees in 2000 ($25 Million for an audit fee and $25 Million for various Consulting).  I learned in my auditing class (a few years ago – back in 1988) was “without Independence there is no audit function.”   The accounting industry (specifically the AICPA) adamantly opposed and SEC proposal in 1999 (A. Levitt) that have mandated separation of audit services and consulting services.

Auditor Effectiveness (200 of 10,000 Publicly Traded Companies)

Bill Mann, of Motley Fool, noted the following “200 companies had to restate earnings in the year 2000, that is one out of every 50 public companies.  This is the most history”.  I guess the trick to investing is to find a company that falls into the 99% of “properly stated” and of course profitable companies.  However, as investors, we know that there is systematic (or market risk) and non-systematic (or individual company risk), so when the market hears one blow-up it impacts the whole market.  “One bad apple spoils the bunch.”

Business Models

Red Herring magazine warned of the fallacy of Enron’s basic business model in Aug / Sept of 2001 with the comment: “Though Enron is the undisputed champion of energy, its grandiose plan to achieve the same success in other commodities is extraordinarily ambitious”.

Audit Committees (The Watchdogs)

The head of Enron’s audit committee (Dr. Robert K. Jaedicke) was an accounting professor and former dean of their business school at Stanford University.  Yes, John Elway (1983 graduate) and Tiger Woods (late 1990’s attendee) are famous Stanford students – maybe Stanford should be looked at for athletics and not academics.

Analyst Independence

Now, let’s look at the Finance Profession.  All but two analysts (17 of 19) covering Enron in October of 2001 had rated Enron as a “buy.”   Why?  Like Andersen, conflict of interest and no independence.  The analysts that rate company stocks work for the SAME firms that perform Investment Banking activities.  Do you think Goldman Sachs or Merrill Lynch will be able to “sell” investment banking activities to Procter and Gamble or Wal Mart if their analysts have these stocks rated at less than a “buy.”?  Argus Research is one of the two firms that rated Enron stock a “sell” (albeit at $20 per share).  Guess what?  Argus Research does NOT do Investment Banking activities, so they should be able to objectively rate a stock.

An Analyst Sounds the Alarm

One Wall Street Analyst (PaineWebber’s Chung Wu) made a brave call on Aug. 21st (2002) and urged Enron employees that Enron’s “financial situation is deteriorating” and that they should “take some money off the table.” Within hours, PaineWebber fired Mr. Wu.

The Cry for Independence

Bill Mann, of the Motley Fool Web Site, testified in front of Congress on Dec. 18th, 2001 (after the fall), and noted one report: “An April 1999 speech from U.S. Securities & Exchange Commission Chairman Arthur Levitt cited a study that found “sell” recommendations account for just 1.4 percent of ALL analysts’ recommendations, compared to 68% of all recommendations being “buys”.”  Mr. Levitt pushed for greater independence rules for both CPA firms and Wall Street Analysts; however, his efforts were not successful.  Mr. Levitt gets my full support to scream, “I told you so” to everyone.

Ethics and the Board

My personal favorite Enron blurb is from the WSJ (Feb 1st, 2002, page C1), they note that Enron’s Board of Director’s “suspended the corporate ethics code to allow Mr. Fastow (CFO) to head the partnerships” where all the debt was carried.  This amazes me, does this mean that we should suspend our code of ethics from time to time.

Record Retention

On the topic of shredding, the administrative assistant of the fired Andersen partner (David Duncan) stated that Andersen hauled off “32 trunks of shredded documents that were the size of foot lockers,” three days PRIOR to the Andersen memo about “record retention” and how unnecessary documents should be destroyed.  After the memo, Andersen shredded even more.


Lastly, I have to include a technology consideration from Robert Cringely (who is one of my favorite IT writers).  He noted that “Andersen had a backup strategy that includes a “byte-level differential backup” of all employee laptops into a “data vault” whenever they touch the network” – so all Andersen ELECTONIC information should be recovered – but paper (ONLY) information can still be shredded.  Moral of this – do not capture your meeting minutes on diskette unless you know you want them forever.

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