Under the surface of the current anti-capitalist protests, from Wall Street to London, is a decade-old sore that never healed. On Oct. 16, 2001, Enron hosted the earnings call that first alerted the world to the toxicity of its off-balance-sheet arrangements. It triggered a death spiral. By Dec. 2, Enron was bankrupt. Within a year, Arthur Andersen, its auditor, had disintegrated.
Enron was turned into books, films, a play and a byword for fiduciary failings and fraud. But the real lessons went unheeded.
Instead, many read the sermons – the importance of ethics, governance and transparency, the dangers of complexity, short-termism and one-sided incentives – in the same way they had read Michael Lewis’s Liar’s Poker, about the Salomon Brothers trading scandal of the mid-1980s: not as a warning, but, in the author’s words, “as a how-to manual.”
Here’s what the world should have learnt from Enron.
• Bad culture starts at the top. As leaders of the company, Ken Lay and Jeff Skilling took credit for the growth of Enron, but they bore the responsibility for allowing a tangle of self-dealing and scandal to bring it down. The companies that failed during the financial crisis – AIG, Bear Stearns, Lehman Brothers among them – failed largely due to their leaders’ hubristic sense of their own impregnability.
• Bad outcomes often result from many small steps, not single reckless leaps. The Enron board’s notorious decision to waive its code of conduct and allow its chief financial officer to serve as general partner for an off-balance-sheet vehicle was the culmination of a series of smaller decisions. Directors were led step by step into the mire.
• Conflicts of interest and ill-conceived monetary incentives oil bad behaviour. Sherron Watkins, the Enron whistleblower, told me last week: “I’ve been speaking about this for 10 years and I’ve come to the sad conclusion that when a lot of money is pouring on top of your head, it really clouds your judgment.”
The consequences of Enron directors’ clubiness (lubricated by consulting payments or donations to some directors’ favourite charities) were compounded by conflicts at Andersen, which earned more from consulting for Enron than from monitoring its books.
Yet U.S. boards remain bastions of resistance to the checks and balances on shareholder democracy. European regulators have only recently rejoined the battle with professional services firms over the consulting-audit conflict. While fewer companies now award straight stock options, poor pay structures polluted judgments at banks in the run-up to the crisis and encouraged the short-termism that still blights much corporate decision-making.
• Complexity obscures weakness. The complicated derivatives and off-balance-sheet vehicles that undermined banks in the financial crisis were the inheritors of the exotically titled partnerships – Chewco, Jedi, the “Raptors” – that helped entangle Enron’s legitimate businesses.
Having built such structures, their architects, if they understood them at all, naturally preferred obfuscation to openness.
• Lack of trust destroys goodwill. Fraud and conspiracy were the charges that earned jail time for Lay, who died shortly after sentencing, and Skilling, who continues to appeal. But the endgame started with the collapse of trust in the trading business at Enron’s core. As one ex-staffer puts it now: “The facts kept turning out worse than the reports.” That sounds eerily close to the crisis of confidence that has afflicted – and, in some cases, continues to afflict – the banks.
There are few comforts. The Dodd-Frank act that followed the banking crisis was more enlightened than the knee jerk Sarbanes-Oxley act that followed Enron. Boards are generally more wary of groupthink.
But, like Renaissance sages who kept a skull on their desks to remind them of their mortality, executives, directors, auditors and regulators should keep Lay and Skilling’s 2000 letter to shareholders (”Enron [is]the right company with the right model at the right time”) on hand.
Within six or seven years of the fastest fall from grace of any Fortune 500 company, we had largely forgotten the fatal flaws that caused it. Instead, we fostered an even grander, greedier, more systemic scandal. Such willful blindness makes me worry what catastrophes we are now cultivating for the years ahead.