Oregon State Bar Bulletin — JULY 2003
| Lessons from the Obituary |
Enron’s financial free-fall, handcuffed executives, bankruptcy and bad name have been much worse than a colossal embarrassment to those in the energy business. The Enron (and Arthur Andersen) scandals have tainted solid firms with hard assets – those that had nothing to do with Enron but have been linked with its problems merely because they are energy companies. While the fallout from the scandal is far from over, it may be time to stop hand-wringing and start the conversation about what it will take to prevent another Enron.1
Background
Enron was formed in 1985 as a small, regional gas
pipeline company. By 2000, it had become the United States’ leading
energy firm; a market maker in energy derivatives, tradable
pollution rights and broadband capacity, in addition
to many more recognizable energy commodities.2 Transformed
from a stodgy, hard-asset utility company into one that
traded in intangibles, the company’s strategy was built
on the belief that more money could be made buying and
selling financial contracts linked to the value of assets,
than in actually owning the assets themselves.3
Enron’s reported annual revenues grew from under $10 billion in the early 1990s to $101 billion in 2000, making it seventh on the Fortune 500 list. Enron’s stock was trading at more than $80 per share in January 2001; by January 2002, it had declined to less than 70 cents per share.4 Enron filed for Chapter 11 bankruptcy protection on Dec. 2, 2001.
Enron fell fast. The day after it filed for bankruptcy protection, the company laid off over 4000 of its employees, giving each of them 30 minutes to clean out their desks. In January 2002, Cliff Baxter, a former Enron vice chairman, committed suicide. Over several days in February 2001, Enron’s chief executives appeared before Congress. Enron’s CEO, Ken Lay, along with other top Enron executives, invoked the Fifth Amendment. Today, the company is managed by a professional bankruptcy or 'turnaround' consultant who expects to make $20 million stabilizing the company.5
What Enron Did Wrong
Legally, Enron did many things wrong, several of
which involved its outside auditor and consultant,
Arthur Andersen. Federal securities law requires financial
statements of publicly traded companies to be certified
by an independent auditor.6 In this context,
the word 'independent' should mean that the
auditor does only audit work for the audited firm.
In Enron’s case, Andersen had a lucrative consulting
contract with the company, and certifying its true – and
dismal – financial picture obviously would have meant
the end of the consulting work. While the SEC’s use
of the word 'independent' would seem to have
prevented the relationship, many Big Five accounting
firms had consulting arms that worked for the firms
they audited. The new Sarbanes-Oxley Act of 2002, Congress’s
response to the Enron/Andersen scandal, prevents these
close relationships that are clearly conflicts of interest.
15 U.S.C. § 7245.
One of the most vivid images of Andersen and Enron’s corruption was that of the Andersen audit partner-in-charge feeding volumes of documents into a shredder with full knowledge of the government’s impending investigation of Enron. While the Sarbanes-Oxley Act has some specific corporate document retention provisions, the shredding violated long-enacted federal obstruction of justice and common law spoliation of evidence rules, not to mention federal and state discovery requirements.
Enron’s creative accounting allowed the company to park unprofitable businesses in so-called special purpose entities ('SPEs') that did not follow the independence and other rules for legitimate SPEs. (In a spectacular lapse in judgment, Enron’s board voted to waive conflict of interest rules, allowing Andy Fastow, Enron’s CFO, to manage off-the-books SPEs for lucrative compensation.)7 The SPEs’ financial statements were not consolidated with the corporation’s financial statements, misleading investors and regulators about the company’s worth. Because Enron invented some of its assets, such as non exchange-traded energy contracts, the company had considerable latitude in valuing them. Investor confidence and federal securities rules both require that outside investors be able to rely on company statements about net income and contingent liabilities. When Enron investors relied on the company’s distorted numbers, they were fatally misled.
Finally, but by no means exhaustively, Enron insiders sold huge blocks of company stock in the weeks before the company’s demise. In contrast, employees who had invested in Enron’s 401(k) plan, (62 percent of which was Enron stock) were prevented from changing their investment profiles during the same time period.
Legal Consequences
Congress responded to the Enron/Andersen and other
recent corporate scandals by enacting the Sarbanes-Oxley
Act of 2002, the first major overhaul of the nation’s
corporate governance laws since the Great Depression.
There should be no question, however, that what Enron
did was wrong under a variety of laws and rules already
in place, including: federal securities laws, common
law fraud and negligent misrepresentation, spoliation
of evidence, obstruction of justice, attorney and accountant
rules of ethics, Generally Accepted Accounting Principles,
Federal Accounting Standards Board guidance and the common
law of corporate stewardship, including the fiduciary
duties of care and loyalty to shareholders.8 Enron’s
violations of existing laws and rules demonstrate that
something more than legal constraints is needed to remedy
systemic corporate corruption.
What Is the Antidote?
One writer, analyzing Enron’s accounting transgressions,
notes that Enron illustrated an essential characteristic
of creative accounting: 'When accounting rules
are written very specifically, clever accountants find
ways to circumvent them; when they are written far
more generally, proper accounting treatment can be
overly reliant on the good faith of company management.'9 Accounting
rules aside, what is striking about the observation
is its focus on the human element involved. 'Clever' accountants
can circumvent specific rules; lax company managers
can fudge general ones.
The Enron and Andersen stories show that it is not the rare bad apples, but rather the rotten culture nurturing them that needs repair.10 In a culture that over-values money, pressure and competition, and that devalues individuals, steadiness and ethics, the bad seeds quickly become bad apples. Culture may be defined as 'The Way We Do Things Around Here' and may be hard to change. But the Enron and Andersen scandals provide an opportunity to learn from others’ mistakes. Here are some suggestions:
1. Good ethics make good business. We live in a capitalist society. But blind allegiance to profits is still blind. There is ample evidence that ethical corporations are profitable corporations. With ethical measures in place and an ethical corporate culture, employees see that their employer is trustworthy. They are more loyal, have better morale and are more likely to be innovative and cost-conscious. Suppliers, clients and investment capital are attracted to companies with good reputations. Good reputations enhance community relations and relations with regulators.
2. The message carries the most weight when it is delivered from the top. The right person to set an ethical tone for a company is the CEO. Just as employees who want to be the boss dress like the boss, employees who want to be the boss will act like the boss. The CEO must support and attend ethics training, write a message for the corporate compliance manual and other widely distributed communications, and most of all, make it clear that ethics matter and whistleblowers will be taken seriously and protected.
3. It is not enough to tell employees to 'be good' or 'do right.' Most ethics educators agree that pedantic lectures on the law and ethics can backfire, conveying the notion that management is merely concerned with protecting itself. Rather, engaging employees in discussion of ethical dilemmas and values motivates them to build a better workplace culture. Program participants should share their ethical dilemmas and work together to analyze them, rather than 'decide' them.
4. The courts and Congress have handed businesses some clues about corporate ethics and compliance programs. Use them. In the landmark 1996 In re Caremark International, Inc. Derivative Litigation, 698 A.2d 959 (Del. Ch. 1996), the Delaware Chancery Court observed that corporate compliance programs incorporating the seven mitigation elements of the United States Sentencing Guidelines for Organizations may exculpate corporate directors from liability for the entity’s wrongdoing. Well-managed corporations include these elements in their programs, because failure to do so may result in individual director liability. Under Caremark and the United States Sentencing Guidelines, companies must:
Establish compliance standards and procedures for employees and other agents that are reasonably capable of reducing improper conduct;
Assign responsibility to specific, high-level personnel within the organization to oversee compliance with these standards;
Use due care not to delegate substantial discretionary authority to people whom the organization knows or should know engaged in illegal activities;
Take steps to effectively communicate compliance standards and procedures to all employees and other agents, through training programs and publications;
Take reasonable steps to achieve compliance with its standards, for example, by using monitoring and auditing systems to detect improper conduct and by having in place and publicizing a reporting system that allows employees and other agents to report improper conduct without fear of retribution;
Enforce company standards through appropriate disciplinary mechanisms; and
Take all reasonable steps to respond to offenses and to prevent further similar offenses. U.S.S.G. § 8A1.2, comment, note 3(k).
The Sarbanes-Oxley Act of 2002 also sets specific requirements on publicly traded companies for corporate structure, accounting, auditing, fraud, liability and reporting. Some of its provisions carry criminal penalties. The President, Congress and regulators have stated their interest in prosecuting corporate wrongdoers.11 In this environment, corporate ethics and compliance programs are not a luxury.
5. Repeat as necessary. The best ethics programs permeate the workplace and are repeated and refreshed to take new laws and other developments into account. Enron had a compliance manual. Passing one out to new employees is far from enough. One-on-one consulting, small and large group workshops and interactive computer training can all be used to reinforce the ethics message.
Conclusion
Corporate cultures that encourage rule-bending, ignore
ethical lapses and promote greed provide environments
in which unethical behavior can flourish. These poisoned
environments may tempt ethical employees to act unethically.
If companies want to minimize their risk of suffering
Enron’s fate, they must establish and maintain a corporate
culture of honesty and integrity.
Endnotes
1. See Kurt Eichenwald, U.S. Indicts 11 Former Enron Executives, The New York Times , at C1 (May 2, 2003).
2. For an excellent factual account of Enron’s background, rise and fall, see Peter C. Fusaro and Ross M. Miller, What Went Wrong at Enron (John Wiley & Sons 2002).
3. Mark Jickling, The Enron Collapse: An Overview of Financial Issues, Congressional Research Service, Library of Congress, (Feb. 4, 2002), www.fpc. state.gov/documents/organization/8038.pdf, last visited on May 2, 2002.
4. Id.
5. Megan Barnett, Meet Mr. Fixit, U.S. News & World Report, at 28 (May 5, 2003).
6. Jickling, supra note 4.
7. Dorothy P. Moore, When Company Actions Veer From Values, Everybody Loses (January 28, 2002) http://citadel.edu/faculty/moore/ 2002articles/jan_28_2002.html, last visited on April 24, 2003.
8. Dave Beal, Enron Board’s Role in Scandal Scrutinized, Center for Ethical Business Cultures in the News (Jan. 20, 2002), http://www.cebcglobal.org/Newsroom/News/News_012002.htm, last visited on April 28, 2003.
9. Tao Xue, Creative Accounting and Corporate Collapse—An Insight into Enron (not dated) www.cpaonline. com.au/ 01-information-centre/12-ethics/docs/essay2002_xue.pdf, last visited on May 2, 2003.
10. Barbara Ley Toffler, Final Accounting—Ambition, Greed and the Fall of Arthur Andersen 228 (Broadway Books 2003).
11. Remarks by the President at Signing of H.R. 3763, The Sarbanes-Oxley Act of 2002, July 30, 2002, http://www.whitehouse.gov/ news/releases/2002/07/20020730-1.html, last visited on May 16, 2003.
ABOUT THE AUTHOR
Stephany Watson has practced law in Portland
for 18 years. She is a partner in the firm of Krogh & Leonard, which advises
clients and provides dispute resolution services on matters related to energy,
natural resources and corporate ethics.
© 2003 Stephany Watson