Investigations into the collapse of Enron reveal the involvement of the U.S. political and policy-crafting establishment and the auditing-consulting industry.
THE stunning collapse of Enron, the 'icon' of the New Economy, threatens to envelop the politics of the United States in the biggest scandal since Watergate. When Enron filed for bankruptcy on December 2, 2001 - the biggest such case in U.S. history - it was largely seen as an instance of a gigantic corporate failure. Events in recent weeks have, however, unravelled a web of intrigue involving the company, the U.S. political and policy-crafting establishment at its highest levels, and the auditing-consulting industry. The Enron affair has also exposed the failure of multiple regulatory agencies to protect the public interest against the avarice of corporate entities.
Since January, the media have been agog with revelations about Enron's practices and ties to the political establishment in both wings of Congress. Tales of shredded documents by the truckloads surfaced, involving the culpability of its own auditor, Arthur Anderson, a mega consulting and auditing company. There were reports that Enron executives had sought help from top administration officials. Reports emerged that the company's top officials wilfully ignored internal warnings about accounting irregularities, even as they sold their own Enron stocks. There was outrage when it was revealed that top executives had pocketed millions of dollars even as the company was lurching towards a collapse. Kenneth Lay, Enron's chairman until recently, cancelled a scheduled appearance before a congressional committee on February 4, citing "a prosecutorial atmosphere in Congress". In response to a subpoena, Lay agreed to appear before a Senate committee on February 14. Meanwhile, the Justice Department is conducting its own criminal investigation into the collapse.
The collapse of Enron - which exploited the 1990s deregulation of the energy industry to become the seventh biggest company in the U.S. according to the Fortune 500 list - will have implications not only for business, but also for politics and wide areas of public policy in the U.S. It will result in a strong public demand for greater control and oversight by statutory regulators. Political issues such as campaign finance reform are back in focus. Moreover, there is public outrage over the role of giant corporations in defining government policies on energy, utilities and taxation. There is unease in corporate circles about lax governmental regulation and the role of statutory auditors who looked the other way when their corporate clients acted against shareholders' interests.
In an unprecedented move, on January 30, the General Accounting Office (GAO), the independent and non-partisan agency of Congress, announced that it was suing the White House for having failed to provide it with information on the formulation of the Bush administration's energy policy last year. On January 29, 2001, President Bush established the National Energy Policy Development Group, which was chaired by Vice-President Dick Cheney. For over nine months the GAO has been demanding that Cheney provide it with details of his meetings.
Cheney has admitted that he met key Enron officials six times in 2001, but has refused to reveal details of the discussions. He said this would jeopardise the President's and his own ability to "get unvarnished advice from any source we want". Critics of the government allege that the Energy Group was formed to circumvent the provisions of the Federal Advisory Committee Act (FACA), which requires presidential consultation on policy matters to be open to the public with records of proceedings. In particular, the GAO has sought logs of Cheney's meetings with details of where they were held, who was present and the subjects discussed. The GAO has said that it is seeking details on how the policy was arrived at. There has been intense speculation that Enron may have had an important role in the drafting of the policy. Congressman Henry Waxman (Democrat), ranking member on the Committee On Government Reform, has revealed that the final policy bears extraordinary resemblance to the proposals Enron made to the task force headed by Cheney. A report prepared by Waxman's office, "How the White House Energy Plan Benefited Enron," released on January 16, compares the task force's report and Enron's proposals.
The first of the six meetings took place on February 22, 2001, about three weeks after the formation of the task force. The last was on October 16, 2001, a few days before Enron announced a $1.2 billion reduction in shareholder value following the "restatement" of its accounts for the preceding three years.
Specifically, the report of Waxman's office pointed out that at least 17 policies in the White House coincided with those suggested by Enron "which benefited Enron financially". The report observed that "the energy plan even offers U.S. backing for natural gas development in India, where Enron has a major natural gas-fuelled power plant that has been embroiled in financial difficulties." It conceded that while other corporations may also benefit, "it is unlikely that any other corporation in America stood to gain as much from the White House energy plan as Enron".
At least 10 congressional committees are inquiring into the Enron collapse. In addition, three federal agencies are investigating the company. The Justice Department is investigating the possibility of fraud in Enron's off-the-books deals with its more than 2,800 partnerships and subsidiaries and its accounting practices. The Labour Department is investigating the possibility of the company management's impropriety in preventing its employees from selling their stocks in retirement plans. The Securities and Exchange Commission (SEC) is investigating whether the company violated securities laws by misleading investors about its condition, particularly as reflected in its balance sheets. In addition, the company faces at least 80 lawsuits from its employees who have alleged that widespread insider trading by Enron's top management has resulted in their savings being wiped out.
On October 16, 2001, Enron disclosed a $1.2-billion decrease in company value and a $618-million loss in the third quarter. It also revealed that most of the losses were made by investment partnerships managed by Enron's Chief Financial Officer Andrew Fastow. Further revelations showed that the company knew at least four years ago about the complex web of subsidiaries and partnerships and about the accounting tricks that were being employed. On October 23, Kenneth Lay reassured investors, even as Arthur Andersen stepped up the disposal of Enron-related documents.
Meanwhile, the SEC opened an informal probe. Between October 26 and 29, Lay called Federal Reserve Board Chairman Alan Greenspan, Treasury Secretary Paul O'Neill, and Commerce Secretary Don Evans, in an attempt to avert a downgrading of the company's debt status by rating agencies. The Bush administration later claimed that the very fact that it did nothing to protect or save Enron is an indication that no special favours were extended. But critics say that there was nothing the Bush administration could have done at that late stage.
Other critics argue that those who are trying to explain the Enron debacle in terms of mere political connections are barking up the wrong tree. They point out that at least 71 Senators and 188 Congressmen - on both sides of the political divide - have received money from Enron. And, 51 of the 56 members of another investigative committee, the House Energy and Commerce Committee, received money from either Enron or Arthur Andersen. They argue that the quid pro quo for corporate largesse to politicians is to be found in government policy - specifically the deregulation of energy markets in general and electricity in particular.
The stunning rise of Enron is to be found in its "innovations" since the early 1990s. The deregulation of energy markets in the early 1990s offered opportunities for companies like Enron which lobbied aggressively for changes in the regulatory framework. Enron's business model was premised on the proposition that it could make more money speculating on electricity contracts rather than by actually generating power. This required the removal of the government from the picture as an overseer. Regulation also prevented trade from taking advantage of short-term opportunities by manipulating the supply and demand situation. Enron also saw in the volatility of energy markets - particularly because electricity as a commodity cannot be stored - greater opportunities for speculation. Later it extended this business model to a whole range of products, betting on bandwidth, the weather and other unusual 'commodities'.
On February 1, 2001, the White House confirmed that Kenneth Lay had suggested nominees to the Federal Energy Regulatory Commission (FERC). It admitted that two of the eight nominees in Enron's list - among them the current chairman of the FERC, Pat Wood - were appointed by Bush in August. Wood is an advocate of market-oriented regulation of utilities, a position that coincides with that articulated by Enron.
Political connections played a major role in Enron's fortunes. In 1992, Dr. Wendy Gramm, chairperson of the Commodity Futures Trading Commission (CFTC), exempted Enron's trading of futures contracts from government oversight, in response to a request from Enron. At that time, Enron was a significant source of campaign financing for Wendy Gramm's husband, Republican Senator from Texas, Phil Gramm. Within a week of granting the exemption, Wendy Gramm quit the CFTC. A few weeks later she joined the Enron board's audit committee.
In 1999 and 2000, Enron stepped up its campaign for further deregulation of energy markets, spending at least $3.45 million on this. In December 2000, Phil Gramm piloted a Bill through Congress, significantly without a committee hearing. The Bill was passed although this contradicted the President's Working Group on Financial Markets which had warned against deregulating energy trading because traders would be in a position to manipulate supply and demand. And it paved the way for Enron to launch EnronOnline, which soon gained access to the energy market in California.
Between 1996 and 2000, Enron reported an increase in sales from $13.3 billion to $100.8 billion. It more than doubled its reported sales between 1999 and 2000. Before it declared bankruptcy, Enron had said it was on track to double revenue again this year. Had it done so, it would have become the second-largest corporation in the world in terms of sales. Much of this huge increase in revenue has now been attributed to Enron's ability to take advantage of the system of deregulation and its sharp accounting practices.
Between June and December 2000, before Gramm's Bill was passed, although California experienced significant power spikes, there was just one Stage 3 emergency requiring a "rolling blackout". Between December 2000 and June 2001, when federal regulators imposed price controls, there were 38 Stage 3 emergencies. Enron, the prime lobbyist for Gramm's legislation, gained significantly. Its unregulated power auctions enabled its wholesale services division's revenues to increase from $12 billion in the first quarter of 2000 to $48.4 billion in the first quarter of 2001. Later, federal and state investigators revealed that power producer and trading companies had created artificial shortages in order to charge more for power.
Meanwhile, Enron took advantage of the lax regulatory regime. It formed a network of more than 2,800 subsidiaries and partnerships, of which 874 were in offshore tax havens, mostly the Cayman Islands. Bush's presidential campaign received significant financial support from Enron - nearly $114,000.
The growing public outrage in California over escalating power tariffs forced federal regulators to impose round-the-clock price controls over the entire western electricity market on June 19, 2001. Companies like Enron operating power auctions could no longer manipulate supply and overcharge customers. With no power generating assets to fall back upon, Enron's business came to a halt. Debts piled up and the company could no longer maintain the fiction that its books were claiming. Weeks later, in August, Chief Executive Officer Jeff Skilling resigned. Although company vice-president Sherron Watkins raised the problems in accounts with Lay in August, Lay continued to assure employees and investors that all was fine. Meanwhile, he and several other top executives continued to dump their own stock and continued to receive significant bonuses.
Since the collapse, accountants have said that Enron's revenue was grossly exaggerated because of its exploitation of loopholes in accounting rules to book revenue from huge energy-derivative contracts at their gross value, rather than net value as is normally the case with securities transactions. Analysts reckon that the difference between the gross and net values could be as much as a thousand-fold. Many of the transactions as in energy derivatives were rolled over several trades, often among its numerous partnerships. This meant that revenues were not only a multiple of their net values but they were counted several times as separate transactions, implying further inflation of revenues.
Speaking to National Public Radio, Lynn Turner, former chief accountant at the SEC, said that the network of Enron's partnerships enabled the company to keep debts off its own balance sheet in order to command a higher credit rating from lenders. They were also used to keep losses off financial statements. Turner blamed Wall Street analysts because they "cosy up to company executives so that they can get underwriting business". The result is that company statements are rarely questioned aggressively by the so-called analysts.
David Cay Johnston, a journalist who won the Pulitzer Prize for his reporting on the iniquitous nature of U.S. tax laws, pointed out that companies like Enron have a variety of ways to avoid paying taxes. An "incredibly complex" system of trading transactions enables companies to transfer profits to tax havens such as the Cayman Islands. A recent report by Johnston revealed that Enron had not paid any taxes in four of the last five years; instead, it was refunded $382 million.
More than 4,000 employees have already been sacked by the company and many of them have lost all their savings, which were invested in the company's 401(k) retirement plans. The plan explicitly prohibited employees from accessing their savings till they reach the age of 50.
A gigantic systemic failure, engineered by those handling the levers of policy, appears to lie at the root of the Enron debacle. Arthur Levitt, former chairman of the SEC recently observed that "traditional gatekeepers have failed to do their job".
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