Lessons unclear after fall of Enron

The spectacular collapse of Enron Corp. served as a cautionary tale for workers not to put too much of their retirement savings in their company's stock and for corporations to level with investors about their finances.

Or did it?


As Kenneth L. Lay and Jeffrey K. Skilling, Enron's former chief executives, go on trial this week on counts of conspiracy and fraud in a Houston courtroom, the debate continues over what lessons have been learned from Enron's fall.

It has been four years since an accounting scandal left the once high-flying energy trader bankrupt and its stock worthless in a case that has become synonymous with corporate corruption.


Yet nearly one in 10 workers entrusts more than 90 percent of his or her 401(k) retirement funds in the employer's stock, as many Enron employees did.

Hundreds of publicly traded companies continue to tout "pro forma" earnings that are rosier than results that hew to the nation's accounting standards.

Boards of directors still award bushels of stock options to executives, giving them a financial incentive to do what it takes to keep the stock price high.

Also, many companies, along with one of the largest lobbying groups for business, the U.S. Chamber of Commerce, are fighting to roll back some of the corporate reforms enacted by Congress and regulators after Enron declared bankruptcy in 2001.

"This is the most important corporate fraud trial in U.S. history; in many ways, Wall Street itself is on trial," said Jacob Zamansky, a former prosecutor who represents investors in private practice and plans to attend the Enron trial for his blog. "Meanwhile, companies are trying to roll back the few changes that have been made, so maybe not much has been learned from all of this."

A lot has changed since the collapse of Enron and the accounting scandals that followed at WorldCom Inc. and Tyco International Ltd.

Congress acted quickly after Enron to pass the Sarbanes-Oxley Act, the most sweeping securities legislation since the Great Depression. It resulted in greater scrutiny of accountants and a flurry of new rules intended to hold senior executives more accountable. Since then, many boards of directors have had their role as company watchdogs expanded.

"My sense from talking to people in the business world is that people are more aware and more cautious," said Joshua A. Newberg, a professor of business ethics at the University of Maryland's Robert H. Smith School of Business.


But lapses have happened. In October, Refco Inc., a commodities broker based in New York, removed Phillip R. Bennett as chairman and chief executive after an internal review found that he owed the company $430 million. Bennett was indicted within weeks on fraud charges that he and others hid losses in financial markets.

Portrayal of greed

Greed has been an oft-cited - and obvious - motivation for corporate fraud. Prosecutors are expected to portray Lay and Skilling as driven to deception for their own gain. Lay stands accused of portraying the company as healthy when he knew otherwise, while Skilling is accused of knowing that off-the-book partnerships obscured the company's financial condition. Both unloaded millions of dollars worth of stock at inflated prices, prosecutors said.

Lay and Skilling also reaped tens of millions of dollars from salary, bonuses, restricted stock and stock options that were approved by Enron's board. In court, they are expected to argue they did nothing illegal and were unaware that subordinates were cooking the books.

Nell Minow, a corporate governance specialist at the Corporate Library research group, said outsized pay for corporate executives remains the "biggest hole in post-Enron reforms." Fat compensation packages, especially stock option grants, encourage a short-term fixation with a company's share price and can be a powerful incentive for fraud, she said.

According to the group's most recent study, the median increase in total CEO pay jumped 30 percent in 2004. Moreover, six of the 10 highest-paid corporate chieftains saw their stocks underperform those of other companies in the same industry.


A push for openness

B. Espen Eckbo, director of the corporate governance center at the Tuck School of Business at Dartmouth College, said that measuring an executive's productivity and deserved pay can be difficult. He said the trend is toward improved transparency and pointed to the Securities and Exchange Commission's move this month to require greater disclosure of executive pay. "There's a push to produce more openness," he said. "There's just less of a crisis mentality; that's what's different from five years ago."

Corporate accounting, however, remains murky, experts said. The SEC suggested last year that companies could better explain their use of off-balance-sheet arrangements, which are similar to the partnerships that Enron used to conceal debt and losses.

Companies also continue to present "pro forma" earnings that don't comply with generally accepted accounting principles, or GAAP. Companies, which are required to fully explain financial results that don't comply with GAAP, say that pro forma measurements can reflect a truer picture of performance.

Gary Sutton, a corporate turnaround specialist and author of "Corporate Canaries: Avoid Business Disasters with a Coal Miner's Secrets," said pro forma results simply leave out debt or expenses that companies would rather ignore. "'Pro forma' is Latin for 'in your dreams,'" he said.

"Individual investors get too easily mesmerized by these numbers," Sutton said. "There are an awful lot of investors still today that can tell you what stock price they bought and sold at, but cannot tell you the company's true earnings per share."


Companies say they have been too bogged down with auditing financial statements since the passage of Sarbanes-Oxley, which required executives and auditors to attest to the strength of internal controls, or their ability to detect fraud and accounting errors. The SEC has signaled a willingness to revisit the requirement, especially for smaller companies.

In a white paper released last week, the U.S. Chamber of Commerce criticized the scope of the internal-controls rule. The problem is that auditors don't know when "enough is enough" and second-guess their work because they fear being liable for a mistake, however innocent, according to the chamber. The group recommends that regulators streamline accounting standards and that Congress consider a structure for accounting disputes to go through arbitration instead of court.

"The auditing profession sits on the razor's edge," said Thomas J. Donahue, president and CEO of the chamber.

The chamber also argues that accounting firms should be protected from "inappropriate" prosecution and called on Congress to establish "clear rules" for when an enterprise, rather than individuals, can be indicted. Arthur Andersen LLC, Enron's auditor, collapsed after being implicated in the fraud, though the firm's criminal conviction was overturned. "This was wrong, unfair, and bad for our economy," the group said in its report.

For their part, workers aren't heeding the mistakes of Enron employees who not only lost jobs but watched 401(k) funds that were heavily concentrated in Enron stock disappear, experts said.

When workers are allowed to put part of their 401(k) in company stocks, about 10 percent direct most of their contributions into that one stock, and more than 20 percent have a majority of the fund in their company's shares, according to the Employee Benefit Research Institute.


"Most of them are doing this out of 100 percent ignorance," said Jack VanDerhei, a research director at the institute. "And believe it or not, the ones with the highest percentage in their company's stock are the oldest."

Financial experts stress that investors need to diversify because exposure to only one stock increases risk. Many Enron employees believed the stock was a sound investment, and Lay allegedly knew he was lying when he assured employees during a September 2001 online forum that the company's quarterly performance was "looking great." Weeks later, the scandal erupted.