It's never a good sign when a pack of Wall Street Journal reporters start nipping at your heels, rending your financial filings into tiny shreds and howling at every daily downgrade in your stock price and bond credit rating. But such has been the fate of Enron Corp. over the past two weeks: The company that Wall Street and the financial press lauded above nearly all others at the turn of the century is suddenly teetering on the brink, desperate for infusions of capital, seeking a "white knight" buyer and suffering from the unwanted attentions of a formal SEC investigation.
As the world economy sinks ever further into recession, stories of high fliers brought down to earth are hardly unusual. But Enron's abrupt transformation into dot-com blow-out wannabe deserves special attention -- and for those of us who live in California, impels the kind of schadenfreude that you can't shake, no matter how hard you try.
Enron is the natural gas, electricity, pulp, paper and bandwidth trader named by Fortune Magazine's readers as the most innovative corporation in the land six years in a row. Enron's leader, Ken Lay, is a close friend of the Bush family, and was the largest single campaign donor to George W. But even though the business press was anointing Enron's every move during the late '90s with capitalism's finest holy water, the company didn't penetrate the wider public consciousness until the California energy crisis.
Then, as Enron raked in billions of dollars of profits on its electricity and gas trades nationwide while blackouts plagued Californian citizens, Enron suddenly became the perfect symbol of the new "robber barrons" -- the Texas energy companies who were supposedly taking California to the cleaners (although Enron itself played a much smaller role in California's crisis than other companies). Not everyone saw Enron as villain. Sure, to many Californians, Enron was a greedy price-gouger making hay off environmentally obsessed yuppie SUV drivers; but from a free-market point of view, Enron was the perfect avatar of deregulation -- a company that profited by being smart, ruthless and constantly on the lookout for new markets.
Ken Lay, who at one point was considered for the post of "energy czar" in the Bush administration, did take every opportunity to use California's woes to push his particular political line. The problem with California's "flawed" deregulation plan, he noted, was that it wasn't deregulated enough. And not only did California need more deregulation, he said in interviews with the likes of CNBC and Thestreet.com and anyone else who would listen, but it also needed more "transparency" -- by which he meant that energy consumers, producers and traders needed clearer information on demand and pricing, and more freedom to move power around wherever it was needed.
Far be it from me to defend California's electricity deregulation plan in any way, shape or form -- "flawed" is a particularly limp word to use to describe a strategy that was cooked up by Republican appointees to the state's Public Utilities Commission at the behest of California's own energy utilities but ended up driving those very utilities to bankruptcy and beyond. But it is interesting to contemplate, in light of recent Enron developments, this call for "transparency."
Because "transparency" is precisely what Enron has long been dead set on preventing with regard to its own operations -- not just for competitors and consumers, but also for its investors, Wall Street analysts and now, belatedly, the federal government. When the going was good, and Enron was reporting mind-blowing profits, few people cared that they couldn't make head nor tail of Enron's accounting tricks, or that no one outside of the company could figure out exactly how Enron was making its money. But once Enron started to report losses, the emperor's clothes fell off with impressive quickness.
Although it's still far from clear precisely what kind of games Enron's executives were playing with their own numbers, the more we learn suggests that it was precisely the kind of classic three-card-monte hide-the-money finagling that true "transparency" would have prevented. Now the company appears to be in big trouble -- on Thursday, it restated its earnings for the last five years, and according to reports in the Wall Street Journal and the New York Times, it may be on the verge of being purchased by a much smaller competitor, Dynegy.
One wonders if Enron could have avoided such an unhappy fate if it had benefited from some stricter government supervision, or, dare we say, regulation?
Rumors of trouble at Enron have been swirling since at least early this spring. One of Enron's more recent initiatives was an attempt to start trading bandwidth as a commodity, just as it did gas and electricity. But its investments in fiber optic capacity, and other telecommunications forays, proved disastrously expensive when the entire telecom sector crashed.
Then came CEO Jeff Skilling's sudden resignation barely six months after he was promoted as Lay's hand-picked successor. As the person most identified with the transformation of Enron from old-economy pipeline owner to new-economy wheeler and dealer, Skilling was the epitome of Enron's smarter, better, more ruthless corporate culture. His departure shocked Wall Street.
Then came a $618 million third-quarter loss, including a $1.2 billion writeoff of shareholder equity associated with the winding up of some obscure partnerships that were involved in numerous transactions with Enron. And that's when the vultures started coming home to roost.
Even close readers of the Wall Street Journal's recent coverage of Enron can be excused for being confused. Enron executives refuse to talk, and the company's filings with the SEC are infuriatingly obtuse and lacking in detail.
But, in brief, what appears to have been happening is that executives of Enron, including the former CFO (ousted last week) Andrew Fastow, were involved in setting up partnerships that did business with Enron. From outside sources, these partnerships borrowed billions of dollars which were then invested in Enron -- in the purchase of assets for Enron or in other ventures. Precisely what kind of assets remains unclear; what is known, however, is that the executives of Enron who were involved in the partnerships made millions of dollars in management fees by brokering and administering the deals.
The potential conflicts of interest are obvious -- and have caught the SEC's attention. Even those of us who are not adept in the ways of high finance can sense that there might be something wrong with a CFO getting a cut out of deals that he brokers with private partnerships, of which he personally is a member. That seems to be why, just a day after a conference call with Wall Street analysts in which Ken Lay defended Fastow, the company unceremoniously dumped its CFO. And on Thursday, two other high executives, including the company's treasurer, were also dumped, on the heels of the news of Enron's earnings restatements.
What's less obvious is how the shenanigans fit into Enron's overall business strategy. By setting it up so outside partnerships borrowed money that was then used to fuel Enron's growth, Enron avoided the necessity of carrying that debt on its own books. The sums involved total billions of dollars -- a ledger entry that would have had a substantial impact on quarterly profit-and-loss figures. Additionally, carrying that debt on the books would have lowered Enron's overall credit rating, thus making it more difficult to raise money to fuel further expansion.
Enron, as is well documented in a lengthy Texas Monthly feature on the company this month, has always employed cutting-edge financial accounting strategies. For example, while fuddy-duddy old-school corporations would be inclined to book profits from a deal across the whole course of the deal's term -- periods that could stretch for years -- Enron apparently preferred booking all its profits up front, and then moving on to the next speculative market. For Enron, innovation wasn't confined to creating new markets for gas and electricity, but also for blazing new trails in the arcane world of bookkeeping.
Certainly it comes as no news flash that corporations play games with their quarterly numbers in order to make the bottom line look good and keep the stock price healthy. That's practically a business model for many companies -- including many of our dear departed friends from the dot-com world. What's depressing, if not surprising, is that the investigations always come after the damage has already been done -- after the investors have already been fleeced, and, in the case of Enron, after the executives have already sold off hundreds of millions of dollars worth of stock at the top of the market.
In a truly transparent marketplace, corporations wouldn't be able to get away with that kind of shady business. If Wall Street's best analysts can't understand a financial statement, then warning bells should be going off at the SEC. Prevention is a lot cheaper than a cure.
In the past, Enron has justified its opaque financial statements on the grounds of competition -- it would lose its competitive advantage, according to executives, if it told everybody exactly what it was doing. And there is a certain amount of sense to that: It's hard to compete if you let the world know exactly what you are up to, every step of the way. But just the same, there are responsibilities incurred by becoming a public company, and one of those is that you are, well, public. You are taking the public's money and you owe it an accounting. Already, class actions suits are mounting.
What Enron's case proves is that we can't trust companies to determine what information should fairly be withheld for competitive purposes and what should be revealed to the public. That ought to be the government's job, which implies tighter scrutiny, stricter regulations and more bite in penalties for violating them.
But don't hold your breath waiting for the results of the current SEC investigation. This is George W.'s world now. And if his administration is willing to broker a deal for Microsoft that lets the company get off with the mildest of judgments -- even after a conservative-dominated federal appeals court ruled that the company illegally abused its monopoly power -- then what do we imagine might be likely to happen to one of his best buddies, Ken Lay?
And there, at last, is our true transparency. Because the perks of getting your man elected to the top job in the land are pretty easy to see through.