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What You Need to Know About Enron

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In a nation where more than half of all households are invested in the stock market, the largest corporate bankruptcy in US history should put the fear of God in us. Primarily, it seems to have fueled fears about our retirements. It's true the Enron scandal is mind-boggling and complicated. Kenneth Lay, the former chairman and CEO of Enron (and former buddy of President Bush), said that all those partnerships and inflated profits were too hard for him to understand; in August, Lay said it was all "way over my head." Lay has a kind, grandfatherly reputation, which he seems to be trying to resurrect. But he understood enough to make off with $200 million dollars in just under three years. Maybe he should have spent less time in his five -- yes, five -- ski houses in Aspen, CO, and more time boning up on the company he was supposedly running.

We could, of course, wait for the inevitable Hollywood epic to tackle Enron's collapse and to digest its lessons for us -- to tar the villains and to lionize those few who tried to blow the whistle. But before Miramax or HBO gets to it, even the most financially uneducated layperson can understand enough about Enron to see that change is necessary.

What follows is an imaginary conversation, intended as a kind of primer -- not only things you might want to know about Enron, but things that bear repeating about Enron. Enron's collapse is symptomatic of a deep-seated disease. All of our retirements, and very possibly the future of our democracy, are at stake.

What happened?

Enron traded energy, at first. It was good at trading energy. It created an online commodities market for energy, which basically meant it created a marketplace where people could buy and sell energy. Enron also produced energy. Its commodities market was a big change from the rule of state-regulated monopolies. Trading energy was a fine business idea, possibly even a groundbreaking one. It was not, as Enron had us believing for a while, the be-all end-all of corporate creativity.

The people at Enron were smart, but not as smart as they thought. They tried to trade it all: energy, "weather derivatives," broadband Internet access, water, news, you name it. They failed. They lost, according to Newsweek's estimates, $2 billion on broadband, $2 billion on water investments, $2 billion on a Brazilian utility and $1 billion on an electricity plant in India.

In order to hide their debt, Enron engaged in "aggressive accounting." They created partnerships with nominally independent companies. Those companies were headed by Enron execs, and backed, ultimately, by Enron stock. But Enron did not count their "partners"' debt as its own. This is called "off-balance-sheet" accounting. Enron also found fancy ways to count loans from banks as "profit."

Isn't that illegal?

That's the multibillion-dollar question. No less than 10 congressional committees, the Justice Department, the FBI, a host of investigators for civil suits and the Securities Exchange Commission (SEC) are all looking into whether Enron and/or its accounting and consulting firm, Arthur Andersen, broke the law.

Another emerging issue centers on Enron and Western energy markets. A lot of the market figures aren't public, but the evidence suggests that Enron controlled a huge portion of the California energy market, among others. When you control the supply of a vital commodity like energy, you can manipulate the price. Only slightly simplified, the story goes something like this: Enron lobbies to deregulate market. Market deregulates. Enron gains control of market. Prices are suddenly very high. Enron reaps huge profits. California Governor Gray Davis and Senator Barbara Boxer (D-CA) have asked federal regulators to investigate whether Enron engaged in price manipulation.

Did Enron fix California's energy prices? Did Enron deliberately mislead investors? Did they deliberately hide debt and mislead their shareholders? Did they base their profits on estimates they knew were inflated? Does unloading your own stock, while you urge or force your employees to buy or keep it, qualify as illegal insider trading? We shall see.

Don't the accountants who let them get away with this have to answer for something?

Andersen signed off on Enron's books for years. Andersen also helped Enron structure its deals and accepted cushy consultancy fees, all the while acting as an "external auditor" checking Enron's books. That's not illegal, per se. Most of the so-called Big Five accounting companies have similar conflicts of interest. The former head of the SEC, Arthur Levitt, thought those conflicts were so glaringly inappropriate that he tried to outlaw them two years ago. His efforts at reform were defeated by vigorous opposition from the industry, which loosed hordes of lobbyists onto Capitol Hill. Congress responded by pressuring Levitt against reform.

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