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What You Need to Know About Enron


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.

Levitt now has Congress' attention, and is in high demand. Andersen looks stupid, and is losing clients. But the rules weren't changed then and are still the same now, so it will be hard to prove that Andersen broke the rules.

Come on, someone involved in this mess must have done something illegal.

At Arthur Andersen, some employees have been shredding documents. If Andersen executives shredded documents after they were informed of the SEC's investigations, then they broke the law. (According to accounting sources, Andersen's claims that shredding client documents is customary are suspect. In accounting, the norm is to keep comprehensive, exhaustive records.)

First off, the government is investigating Andersen's destruction of documents. Destruction of evidence may be easier to prove than the charges that may come later, against both Enron and Andersen. If the government can build an airtight case around shredding, then they can use shredding charges as leverage. An Andersen executive threatened with prosecution over shredding paper can be offered a plea bargain, for example, in exchange for testimony in the more complex fraud case.

Great, so some poor schmoe at Andersen will take the fall for shredding papers, and no one else will be held accountable.

That's one possible scenario, but a lot is riding on the public's reaction. Bush made his first efforts to distance himself from the scandal after a January 26 CBS news poll reported that 6 out of 10 Americans think the administration is hiding something about Enron. Especially during big scandals, politicians are sensitive to the public's reaction, that is, the public without the funds to buy political access. The Enron scandal is just beginning. If the public stays tuned, and expresses its disgust, politicians will be forced to begin the clean up of our system.

What finally happened to bring it all crashing down?

On Octber 16, Enron held a conference call to go over its third quarter. The failure of many of its investments and the debt from its "partnerships" could no longer be swept under the accounting rug. Former CEO Jeff Skilling's sudden departure had attracted additional scrutiny. Enron's chorus of cheerleaders could no longer ignore the sucking sound that had finally become audible, to the tune of a $1.2 billion drop in net worth. The house of cards began to tumble.

Another important factor: Enron had changed. Over time, Enron sank more and more money into risky financial betting, and evolved from an energy company into what the Los Angeles Times called a "massive trading operation in derivatives, which are financial contracts that can entail significant risk." A massive derivatives trading company is a very different animal from something like, say, CalPine, an energy company that also does some trading. The derivatives beast entails a whole new world of risk.

Derivatives allow investors to bet, in effect, on fluctuations in everything from the water supply to energy prices to the weather. Wendy Gramm, the wife of Senator Phil Gramm (R-TX) chaired the Commodity Futures Trading Commission until 1993. While there, she helped make sure that Enron's brand of derivatives trading would be free of government oversight. Weeks after she left that committee, she was offered a lucrative position on Enron's board. Enron was free to calculate its profits as it saw fit, while betting on the weather.

In the end, who got screwed?

Enron's employees, clearly, were hurt the most. As many as 12,000 of them lost their life savings or their entire pension. They were forced to keep a certain percentage of their 401(k)s in Enron stock, and encouraged to invest solely in Enron. In the last few months, just as the share price was tumbling, Enron management switched pension plans and froze employee accounts. Employees watched in horror, their hands tied, as the stock lost most of its value. Illegal? Employees are suing, and intend to find out.

Who else got screwed?

Thousands of American investors have lost money on Enron stock, individually and through outfits like the Osprey Trust, an Enron entity that financed some of the company's sketchy partnerships and investments abroad. Over 50 mutual funds and insurance companies invested $2.4 billion dollars in the trust, which then lost most of its value. And don't forget investors and power plant workers in Brazil and India. Enron's reach is broad. Oddly, even K-mart employees can claim Enron victim status: K-mart's bankruptcy may have been precipitated in part by the Enron collapse (the collapse raised the price of a type of insurance called surety bonds).

A handful of reporters and analysts are now finding themselves in the spotlight due to skepticism they expressed anywhere from a few months to a year ago, back when no one would listen.

So no one listened when a few independent thinkers sounded the alarm. That's depressing. I think I'll just go diversify my portfolio to protect my retirement.

If we don't do something about the Enrons of the world, we put all of our portfolios at risk. It isn't only true believers who lost money on Enron, supposedly conservative investors sank millions into Enron stocks and funds. And they continue to sink money -- including, possibly, parts of your retirement -- into other existing Enron-esque companies.

Enron was never alone in its ways. The CEO of Global Crossing Unlimited, the largest telecommunications company ever to go belly up, is walking away with over $700 million from his bankrupted company, while the shareholders weep. Global Crossing's accounting firm is Arthur Andersen.

The share price of a Bermuda-based, Beverly-Hills-run conglomerate called Tyco is dropping after word got out that it practices "aggressive accounting." Tyco's two top execs swore their faith in the company, saying they rarely if ever sold their own stock in it. They neglected to mention the $100 million they had already cashed out. Sound familiar?

Since none of our current safeguards worked, the public should demand better safeguards. The corporate raiders are, by in large, making a killing at everyone else's expense (even if Kenneth Lay does have to sell his ski houses). Wall Street isn't likely to stand up and demand greater accountability and systemic change. It's going to have to be the public.

Michelle Chihara is a staff writer and editor at AlterNet.org. *