Tag Archives: business ethics

No more kool-aid any more: Sherron Watkins and Enron

Power Failure

  • I am taking an ethical stand
  • You are a whistle-blower
  • He is a grass

The ethical complexities of whistle-blowing tap deeply into the issues of divided loyalties.  It is hard to predict what you’d do faced with this sort of dilemma, and I’ve always been interested in the stories of those who have. Power Failure is co-credited to Sherron Watkins the woman usually described as ‘the Enron whistle-blower’.  I was eager to compare it with Cynthia Cooper’s book Extraordinary Circumstances about blowing the whistle in Worldcom which I reviewed a while ago.

I was curious to understand the differences in the two women’s experiences. Cooper was head of internal audit and her job was to prevent just the sort of fraud (simple, but huge) which she found at Worldcom. The horns of her particular dilemma were her professional accountability vs corporate loyalty. Watkins on the other hand was only one of dozens of insiders expressing concern about Enron both within and without the company, others had leaked for years to market analysts, to the press, even to Yahoo message boards. Watkins just happened to be the one who failed to maintain her anonymity.  The irony is that she kept her concerns within the company, taking them to CEO Ken Lay instead of narrow-casting them outside.

This is one of the few books about Enron not put together from clippings, and it shows.  Swartz clearly obtained access to a number of senior or at least central insiders.  It provides a real sense of why Enron was an addictive place to work, which I’ve not found in any other book.   The only other book with an Enronian’s name on the cover Brian Cruver’s book, ‘Enron, Anatomy of Greed‘, but he arrived late and was just one of thousands of low-level employees dismissed with a $4,000 pay-off just before Christmas 2002.

Reading both these books though, three things stand out for me other than the eye-wateringly huge amounts of money.

The first is the absolute importance of operational controls. Yes, ethics and risk management matter both morally and in business terms, but operational controls come first, because operational chaos not only permits these kinds of fraud it may even require them.  Frequent organisational re-structures and high levels of executive churn are bad signs.  Beware of companies which are overly acquisitive or growing too fast, because things will fall down the cracks.

The second is that it is hard to be faced with the morning-after when you have stopped drinking the kool-aid.  ‘Power Failure’ and ‘Extraordinary Circumstances’ both touch on how difficult it was for Watkins and Cooper to determine what the right thing to do was, let alone how hard it was to do it.  I’d like them to have covered the consequences to themselves in a bit more detail, but I guess we don’t like the idea that good people can suffer for doing what’s right.

Finally, while reading the book I found myself wondering what it is like to be Jeffrey Skilling or Andy Fastow right now, in jail.

Enron was a long time ago and I do feel that I’ve read all I need to on the subject, but Lehmans, Goldman, RBS and HBOS remind us that arrogance, chaos and greed enable companies to fall as well as rise.

PS – ‘Power Failure’ is written in the third person by journalist Mimi Swartz. For a more a direct insight into Watkins herself look at the BBC programme Hard Talk where Watkins exchanges wry regrets with the HBOS whistle-blower, Paul Moore.  (This will only be watchable for another two months).

Enron – a case of moral bankruptcy

Enron Logo - “The Crooked E”I’m currently reading a couple of books about Enron and fascinating they are too, if you like that sort of thing, which I do.

What happened with Enron then?

Very briefly: they borrowed from the future to make themselves look profitable in the present, but no-one can do that indefinitely. Astonishingly, for most of the time they were within the letter of the law. Remember, a company’s Annual Accounts are supposed to be an account or an explanation presented to the owners which explains what their officers and employees have been up to during the previous 12 months. However, by the late 1990s there were many different ways of accounting for any given set of facts.

Of course, after a while the actions they took were definitely outside the law. In some cases corporate officers defrauded Enron itself in a complex game of financial cups and peas, in others they defrauded Enron’s owners by lying to Wall Street, and a huge number of senior executives quietly jumped ship during Enron’s last year of trading cashing in tens or hundreds of millions of dollars worth of Enron stock in the process, walking and quacking like insider traders as they pocketed the cash and “retired”.

Reading the various books on the subject, it’s clear that most of those involved either had no sense of right or wrong or let it erode over time. The question always seems to have been “is it legal?” not “is it right?”. These were people who had ferocious intellects but who had no moral sense and no internal breaking systems. Some of them saw laws and lawmakers as opponents to outwit. Others among them didn’t take laws that personally – they just thought the law applied to other people.

Reading the books though, I find myself wondering how such seriously intelligent people could be so stupid. How could they think that they could operate the company on a giant Ponzi scheme forever?

They separated out economics from accounting, and separated cash from profit. The economic reality – the truth of the cashflow – was that they frequently cut unprofitable deals. You see, they booked all the future profits of a deal when it was struck regardless of when or whether the cash flowed in by using what is called “mark to market” accounting. Worse than this: executives were rewarded regardless of how profitable the deal turned out to be because they got their bonuses when the deal was signed.

As time went by, and a deal proved itself to be less profitable than they had said that it would be, Enron should have shown that as a loss. But they were immensely reluctant to do that, and of course the bonuses were long spent.

An example (please skip this bit if your eyes glaze over whenever you see numbers)

Let’s say they built a power-station at a cost of perhaps $1bn and that they struck a 20 year agreement to sell the power at a rate of £100m a year. By normal accounting methods, the power-station would show a cash income from year one, but would take 10 years to pay for itself. What Enron did was to show £1bn as profit in the first year, on the basis that this was how much profit they thought they’d make over the whole 20 years of the deal.

There are lots of problems with this, but here are two to start with:

It is much harder to show an increase in profits if you book all your profits in the first year. Using normal accounting rules, the power station would not clear its building costs until year 11, but from then on if you want to show $2bn profits, you only have to make $1.9bn because you’ve already got $100m coming in from the power station. But using mark-to-market accounting rules you are starting from zero every single year.

This effect is exacerbated if your power station does not in fact have an income of $100m every year. Say it only makes $75m. Then if you are using mark-to-market rules you should actually declare a loss on your your books of $25m every single year even when you’ve cleared your building costs and are actually in profit.

Ok, that was very technical thank you Aphra, but what makes it interesting?

The focus on the here and now, on the deal and not on its fulfilment, was the nub of Enron’s problems. But you cannot run a business not serve your customers, you cannot run a business and ignore the cash.

It seems simple doesn’t it? Simplistic even. And that’s what I find fascinating about Enron: how so many very clever people (and they were very clever – they came from Harvard and McKinsey and Arthur Andersen) how so many very clever people could be so incredibly stupid. If you have no cash income, you’ll have no business.

The second thing I find fascinating about Enron is how many people outside Enron happily pocketed the consultancy fees and commissions that Enron paid them to hold the cups and hide the peas in my previous metaphor. Enron asked the banks and other institutions to “invest” in “assets” which Enron would then “buy back”. That sounds like a securitised loan to me. Doesn’t it sound like a securitised loan to you? But Enron called it a sale, and booked the first half of the deal accordingly though I’ve no idea how they booked the second half. The banks and other investors were paid handsome fees for these transactions. Again, these are very bright boys indeed so it is no surprise that some of them worked out that the deals were not entirely as Enron was painting them, but as Kipling puts it “them that asks no questions isn’t told a lie”. There was money to be made.

The third thing that I find fascinating is how many of Enron’s corporate officers came from relatively humble backgrounds. Kenneth Lay (Enron’s long-term CEO) grew up on a mid-western farm. Rebecca Mark (who dashed around the world, riding on elephants, building power stations and running Enron International) was from the Midwest. Jeff Skilling (who was the inside guy to Lay’s outside guy and was briefly CEO) came from a blue-collar background in blue-collar towns. These were not decadent second- third- or fourth-generation American aristos, not Hiltons or Bushes or Kennedeys. The guys that ran Enron liked the part of the American Dream which gets very rich indeed, but ignored the part that learns all it needs to know at kindergarten.

The fourth thing I find fascinating is that every single person involved seemed to think that someone else was checking up on things. Enron blamed its auditors, Arthur Andersen, for letting them get away with it. Andersens blamed Enron’s financial officers for pushing the line too far. Wall Street was told that “Risk Assessment and Control” stopped risky deals from being cut. But the RAC employees claimed that they merely there to advised and could not veto. The fascinating thing is not that everyone blames everyone else, it is that everyone genuinely seems to think that they themselves were not in any way to blame.

And finally, and this is what really gets me, they were a bunch of fucking amateurs. Highly educated amateurs, admittedly, but none of them had actually run anything. Kenneth Lay’s CV comprised academia and a little bit of government work until he got given a company to run. He was a supreme politician and played good cop to Skilling’s bad cop. One cannot call Skilling an amateur: Harvard MBAs and McKinsey consultants are not amateurs, but he was a dangerously brilliant and lop-sided specialist who should never have taken on general management by becoming CEO of various subsidiaries and ultimately of Enron itself. Andrew Fastow, who became CFO, was not even an accountant: his background was financial instruments.

I think it’s the lack of self-awareness that fascinates me; and integrity is the sternest form of self-awareness. Were they venal or just un-reflecting? I don’t know.

So there you go. If you want a quick rattle through Enron’s last 200 days then read “The Anatomy of Greed” which was written by an outsider on the inside, an Enron employee who was kept in the dark and fed the same bullshit as everyone else. If you want to get down and dirty with the detail read “The Smartest Guys in the Room” which is fascinating and dispassionate especially where the authors’ shocked incredulity occasionally breaks through. If you want something online that’s more informative than Wikipedia go to Risk Glossary.

The second book is particularly thought-provoking, and I guess the thought it provokes the most is “just how unusual was Enron?”