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July 7, 2006

Enron--Have Some of the Guilty Gone Unpunished?

By Cal Payne
Senior Director, Energy Risk Management Ken Lay’s passing and being just days away from the sentencing of Jeffery Skilling have most people ready to close the criminal prosecution chapter of the book on Enron. There has certainly been some debate about the government application of the law to create the charges that they were convicted of and the varying application of prison term lengths. Was justice served? Certainly the most famous of Enron’s management have seen their day in court, but are there other “guilty” parties or “enablers” that have gone unpunished? Who are they and what did they do?The Commercial and Investment Banks

The ongoing negotiations between the commercial and investment bankers and the Enron bankruptcy committees has reaped billions of settlement dollars from those institutions involved for their role in the debacle. They are not surrendering those settlement dollars out of the kindness of their hearts. They are doing so because their actions or the structures they proposed were major contributors to what went wrong at Enron yet none of them have seen a prison term that I am aware of.

The investment and commercial banking community has long been a source of creativity, providing tools to their corporate customers, covering a wide range of business issues and perhaps, business opportunities. Some of the products created really push the envelope, walking a fine line between what is allowed by statute or accounting standard and what is outright prohibited, or at least violating the “spirit” of the law, rule or regulation. In almost every case, the application of that type of tool does little, if anything, to create transparency regarding a company’s operations or health to the casual or even the highly experienced investor who put their money in that company’s stock. Andy Fastow could not have accomplished the fraud he facilitated without the help of the banking community whether we are talking about the structures themselves, the independent investment money they provided, or the transactions they entered into that incorporated guarantees that violated the underlying principles that would make the structure used valid.

Investment bankers that worked with Enron are highly compensated individuals that made millions off of that account. The big dollars involved raises questions about the impartiality of their judgment related to their overall business relationships with Enron. Regardless, it was their actions that also contributed to the ability of Enron to create fraudulent representations of their real financial performance, yet it is doubtful any of the bonus dollars individuals made off the account have been or ever will be returned.

There has been some criticism leveled concerning the negative aspects of the culture that existed in portions of Enron’s business, especially in the energy merchant side. While there are many positive aspects to what I consider a highly accountable, creative, and entrepreneurial environment, it can degrade to a culture where underlying company values are discounted and internal behavior becomes predatory. Oddly enough, investment banking served as a primary model for the culture they were striving for. A contributing factor to that culture was a compensation program that rewarded results where traders and originators could literally make millions if they delivered. Pay for performance, theoretically characterized by lower base salaries with almost unlimited upside bonus potential. That is quite an incentive to perform, but without the proper management can lead to behaviors that are potentially destructive to the overall organization and certainly inconsistent with the company’s stated values. This certainly happened at Enron as demonstrated by the transcripts of trader telephone conversations related to market manipulations in California.

Auditors and Attorneys

One of the most common refrains heard from the board and management team at Enron related to the special purpose entities that were key to its downfall was that the questionable structures they used were approved by the auditors and the attorneys. We all know what happened to Arthur Andersen, their Houston practice, and rest of their organization. They were put out of business and many exceptional people there having nothing to do with Enron lost their jobs and their fortunes. But what about the attorneys that approved those structures? Enron’s outside counsel, Vinson & Elkins, conducted the investigation following the whistle blower letter from Sherron Watkins and they did not find anything warranting further investigation. It does not appear any of these individuals or firms will incur fines or face prosecution.

The failing of the attorneys and auditors to do a thorough and independent job has been a subject of great analysis and new regulations. A major factor that will be difficult to completely eliminate, however, is the strong glare of big bucks that can make you blind to what otherwise should be obvious potholes in the road. The Enron account was a plum that many organizations coveted. Working with Enron often meant generating huge fees. Did the average of one million dollars a week in fees received by Andersen affect how they responded to accounting issues? Did the millions of dollars in fees paid to bankers affect their decisions? The same applies to their legal representation. Did the potential to lose an account if the “right” answer was not arrived at impact their decisions? What do you think?

It has been well-documented that individuals like Fastow used the threat of pulling business or excluding business from bankers if he did not get what he wanted. It is easy to give the next project to another legal, banking, or accounting firm if the incumbents are not willing to support the position of an out of control or overly aggressive executive. The loss of those substantial fees can be an overpowering incentive to accommodate a customer and rationalize decisions that a firm would reject otherwise. However, pressure from the customer and the loss of fee income is no justification for rationalizing away your integrity and putting your reputation at risk.

Enron’s Other High Flyers

During the course of the Enron trials, we have heard from or seen a long list of Enron employees who are under investigation, convicted, and in some case actually serving time for their misdeeds. When you look at some of the significant issues and transactions that brought the company down, there are some personalities that have avoided the attention of the prosecutor and will probably never see the inside of courtroom.

Many have likely forgotten Rebecca Mark and the large losses sustained by Enron in transactions she spearheaded like the India power plants and the water business, Azurix. Those transactions alone were responsible for huge demands on capital, negative cash flows in a company starving for capital, and as they failed, enormous accounting write-offs. She made millions during her tenure at Enron but left a legacy of failed investments that helped bring it to its knees. I should mention that she has returned some of the money she earned in 2005 as part of a shareholder lawsuit, but does that does not begin to cover the damage the activities under her direction did to the company .

Can anyone forget the well-documented antics of Lou Pai, who ran the disastrous Enron effort into retail energy delivery? The losses incurred in that business were enormous and the company’s efforts to hide the performance of that unit are now legendary. He ended up with a fortune estimated to be in excess of $200 million and departed the company just prior to its collapse. Unlike Rebecca Mark, it appears he has yet to return any of the money he made while he was there. He had to know that the retail effort was hemorrhaging money and that the public pronouncements regarding that business were inaccurate and misleading yet so far there’s no mention of him visiting with a jury in the future.

There are others out there that come to mind like their former treasurer and eventual CFO Jeff McManon, and Enron’s head trader who later became Enron’s president, Greg Whalley, both of whom have avoided prosecution. There are still many questions in some circles of what role they may have played in the Enron debacle. Were the improper actives that took place in the trading organization condoned by Whalley? Did he, in fact, offer to cover significant losses in other parts of the company by the manipulation of reserves? Was McManon doing his job to ensure that the activities in the financial organization were above board? Was he a hero or an accomplice? There are probably many differing answers and opinions regarding those questions and we will most likely never know what roles they played other than what we read in the many Enron books and magazine articles that have been published since the company’s demise.

People like Rebecca Mark and Lou Pai may not have violated any laws, but they certainly ran business units that contributed mightily to the implosion at Enron. Making bad business decisions is not a crime (if it was many, of us would be in trouble) but do not discount their role in damaging the company they worked for and their contribution to the destruction of shareholder value.

Jail Time Issues

There are some dramatic differences in the sentences handed out in these recent cases. It appears by the sentences seen so far that if you agree to cooperate with the government, your sentence is much lighter than if you attempt to defend yourself by going to trial. A case in point is Andrew Fastow, who was sentenced to 10 years for his role in the Enron debacle after pleading guilty to fraud charges and cooperating in the investigation of his colleagues. While some people may be sympathetic to is relatively young man with a young family, there is no question that he did extraordinary damage to his firm and others through his actions and greed. While Mr. Fastow received 10 years while an accountant from Dynegy, he chose to defend himself against much lesser charges received 24 years. That individual’s sentence is now being challenged as too severe, but how could that difference between the two individuals actions be so extreme? Another question that begs to be answered: Does cooperating with the government entitle Fastow to a sentence as short as ten years?

Closing Thoughts

The Enron story will become a permanent fixture in the classrooms of universities throughout America and other parts of the world. An extraordinary case study to be discussed, analyzed, and reviewed in classes covering the areas of finance, governance, and ethics. That is one positive coming out of all this misery, where the Enron story is used as a tool to instruct our business leaders of tomorrow. I cannot help but feel badly for those dedicated Enron employees that worked up and down their pipelines, went to work in their many different locations, did the best they could, did the right things and ended up with two weeks pay and the loss of their nest eggs they held in company stock. The relief they may get will never cover the loss they have incurred because of the actions of a few. Certainly perfect justice has not been served, but hopefully enough justice to prevent future debacles from occurring.

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UtiliPoint’s IssueAlert^® articles are compiled based on the independent analysis of UtiliPoint consultants. The opinions expressed in UtiliPoint’s^® IssueAlert^® articles are not intended to predict financial performance of companies discussed, or to be the basis for investment decisions of any kind. UtiliPoint’s sole purpose in publishing its IssueAlert articles is to offer an independent perspective regarding the key events occurring in the energy industry, based on its long-standing reputation as an expert on energy issues.
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