The Hindu Business Line : Lessons from the Enron verdict

Enron began to implode when it announced a $638-million quarterly loss in October 2001 and filed for bankruptcy protection in December 2001. The company is now being wound up. This is probably a good time to reflect on the Enron saga.

Another chapter in the Enron saga came to a close on May 25 when both Ken Lay, former Chairman, and Jeffrey Skilling, former CEO, were found guilty of fraud and conspiracy charges in a trial that lasted 15 weeks. Lay was found guilty on all six counts that he was charged with, and Skilling on 19 out of 28. In a separate case, Lay was also found guilty of bank fraud and making false statements to banks. The date for sentencing has been set for September 11, so they have some time to mull over their convictions, before they receive sentences that could run to several years.

Enron, as a company, began to implode when it announced a $638-million (Rs 2,871 crore) quarterly loss in October 2001 and filed for bankruptcy protection in December 2001. At that time, a special Enron Task Force was created by the US Federal Government to conduct the inquiries. The company is now in the process of being wound up.

This is probably a good time to reflect on what lessons one can learn, if one wanted to.

The defence argument

Top management has the responsibility to manage the company and has to accept the blame when it fails to do so. The surprising basis of the defence in this case was that there really was no problem in the company, and if there were any, it was everyone else's fault and not theirs (the management's)! Skilling left the company in August 2001 within months of being made CEO, for `personal reasons'. The popular interpretation is that he knew the implications of the fraud that was going on and tried to escape. His attorney famously said, "This is not a case of `Hear no evil, see no evil'." It is a case of "There was no evil." Lay came back as the CEO when Skilling quit but did nothing to fix the problems. Yet, their defence was that it was all the fault of the CFO, Andrew Fastow, who had set up the off-balance-sheet entities to hide the company's problems and that they did not have anything to do with it.

Since Fastow had already pled guilty, they probably thought they could get away with it. But the prosecutors provided sufficient evidence to show that they knew or should have known. Lay was privately selling his stock holding in the company at the same time he was publicly maintaining that the company was a good buy. Even if the defence argument was true, it was an admission that as the top two officers of the company, they were not doing their jobs and should still have been convicted!

Role of auditors

The case certainly shook our faith in auditors. Here were professionals who were supposed to know what was going on and had the responsibility to report irregularities to the shareholders. They not only did not do their job, but were assisting the company in its shady activities. They were caught shredding documents after the investigation had begun.

Arthur Andersen, the giant audit firm, paid the ultimate price by going under, and about 28,000 innocent people lost their jobs as a result of a few senior partners. The company had become too close to those it was overseeing, and using its influence to direct other consulting contracts to itself. Investigative reporting has an important role to play in the corporate world. With the board failing to do its job (more on that later), the auditors in cahoots with the company, and the government regulators filing reports that they were receiving, it was left to an investigative reporter from the Wall Street Journal to first understand the implications of the footnote in the company accounts and raise the red flag.

The story highlighted the Off-Balance-Sheet entities (to which Enron's losses had been shifted to make the company's balance sheet look good) and further reports showed how it was done and named the people involved. This triggered alarm in the stock market, a few short sellers drove down the stock, and then slowly the scandal started seeing the light of day.

Employee goodwill for the company crashed rapidly when the details of the scandal started being reported. Many executives of the company could not believe that here was a firm that seemed to have been built on sand. Although considered an energy and gas company, it seemed to be making most of its money through questionable or fraudulent accounting practices and not through normal business practices. When the leaders were charged, there was not one among the thousands who had worked with them who came forward to say what great leaders they were! The testimonials were from their outside connections or business associates.

The political connection

Where are your friends when you need them? Chairman Ken Lay was on a first name basis with the US President and contributed to the political campaigns, and was highly regarded within the local community.

Readers in India are aware of how the company was able to get the backing of the State Department and get the US Ambassador to India make statements in support of the company's position in the Dabhol Power Company dispute. Leading newspapers were quick to represent this as a test case to see if India was open for business. All connections, however, vanished from the scene. Lay's own charm and charisma broke down under prosecutor's questioning.

Lessons

There is one uncomfortable lesson that should make all governance experts sit back and think — the board of directors of a company has become a tool that can be manipulated; and nothing in the fall-out of Enron has changed that. When the Sarbanes-Oxley legislation was passed, it only tightened accounting rules and made the CEO and others personally responsible for the reliability of the accounting statements. It did not make the board of directors any more responsible.

As the Enron scandal started to unravel, the members of the board quietly submitted their resignations and are in hiding, so to speak. This was a board with significant conflict of interest issues: Some members were receiving consulting contracts from the company, others had quid pro quo deals with the company, and a couple representing educational institutions were receiving philanthropic donations for their institutions.

No one was in a position to look management in the face and ask hard questions. They did not even have the knowledge, having admitted at one time that the off balance sheet entities were too complicated to understand.

This board must also surely go on record in the Guinness Book for knowingly making an unethical decision. They passed a resolution suspending the company's code of ethics to approve a contract that was in violation of their own code, and then promptly reinstated the code! The ostrich that buries its head in the sand now has a worthy successor in Enron. The board had failed in its basic duty of supervising the management and did not pay any price for it.

Fastow had pleaded guilty to charges and served as the prosecution witness. Several other former senior Enron executives are still on trial on various charges of conspiracy, money laundering, and wire fraud. Lay and Skilling are possibly now planning their appeals but legal experts seem convinced that the guilty verdicts will hold.

Thus, they will join the group of other top US corporate leaders who already are or have been in jail lately: Martha Stewart, and the top managers of Tyco International, WorldCom, and Adelphia Communications, among others. Hopefully, corporate managers are now shaken up enough to realise that white-collar crime also does not pay, and errors of omission are as severe as errors of commission.

(The author is professor of international business and strategic management at Suffolk University, Boston, US. His Internet address is cgopinat@suffolk.edu)

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