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|(US) 5/06 - Studying Enron: A Case Hi...
Post Number: 178
Best of Black Box? N/A
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|Posted on Monday, May 15, 2006 - 11:51 am: ||
I just finished the book "The Smartest Guys In The Room" by Bethany McLean and Peter Elkind. It's a piece of "corporate archeology" examining what went wrong and what caused the collapse. (I haven't seen the documentary of the same name but I'm told the book is much more detailed in all respects.)
It's fascinating reading and I think it has lessons for citizens looking at election processes.
In the Enron collapse, a lot of things added up including a truly diseased corporate culture. Executives graded each other on a scale that elevated "deal making" way past such things as customer service, operations and the like, affecting bonuses and the whole direction of the company. The worst effect was that the small group in charge of making sure deals were legal and profitable was reviewed by the same "go-getters" who viewed them as stumbling blocks to the deals – each of which netted the deal-makers immediate commissions. The result was a runaway train with the brakes deliberately disconnected.
Enron soon turned towards high-risk commodity trading of (mainly) natural gas and electricity as their main profit center, because that was nothing but high-flying deals.
Enron basically committed two classes of outright fraud:
* The gaming of the California energy marked from 1998 - 2001. They were bad guys but surprisingly not the worst, at least not in terms of dollar amounts stolen from the state. On the contrary, they were almost bit players except that they did some key early experimenting in how to rig the market.
* The real games were all related to artificially raising their stock prices. This took all kinds of forms and it's probably an oversimplification to lump them into a "class of fraud" at all.
Enron publicly downplayed the role of the trading desk because companies based on trading never have high stock valuations. The Wall Street traders understand their own volatility (and that of similar outfits) all too well.
Enron took steps to move debt off their books while secretly still being on the hook for the debt. The most common method was to set up an "outside investment partnership" that borrowed money and then bought poorly-performing Enron assets. The debt was backed by Enron stock. These "outside" partnerships were really portions of Enron for all practical purposes. In addition to hiding debt, most of these personally benefited insiders with obvious conflicts of interest. The net result of these various "outside" investment groups was to double Enron's total debt load in comparison to what the investing public knew about. Needless to say, when we're talking about a public company this is very illegal. Worst yet, almost all of the secret debt was "rigged to explode": the moment the stock dropped and/or the credit rating sank to pre-set points, the debts came suddenly due.
Another "stock fraud problem" involved the use of "Mark to Market accounting". In this weird form of booking income, the total value of a deal is booked the moment the contract is signed. In some markets this makes sense but if the deal comes unglued or becomes devalued they're supposed to adjust the numbers downward to match. Enron consistently didn't do that correctly and often didn't do it at all in deals worth up to hundreds of millions of dollars.
Between the off-books debt and the unreported earnings losses they were running a giant Ponzi/Pyramid scheme.
They knew it would come unglued unless they found a new revenue stream quickly. Right up to 2001 they thought they would have it in either retail energy sales or the new broadband business. Both fizzled.
OK, so why is this interesting to people interested in election reform?
Because the stock fraud required the active participation of a frighteningly large number of people and major corporations.
* Moody's and Standard & Poor's were the credit rating companies that didn't look deeply into Enron's books. They bought the hype and ended up acting as enablers. Their lack of oversight was a key factor in the whole mess and has some interesting parallels to the ITAs (Wyle, Ciber and Systest).
* The Securities and Exchange Commission didn't look at them hardly at all between 1997 and Enron's collapse in 2001. They make a pretty good stand-in for NASED and/or the EAC.
* Arthur Anderson was Enron's main accounting firm. Internal memos that survived the mass shredding as it all came unglued showed that they knew what was going on. They were pressured by Enron to sign off on shady deals if they wanted to keep the account. Individual accountants who blew the whistle internally were moved off the Enron account at Enron's demand. AA knew about both the failure to report losses and the secret debt issues.
* Over a dozen banks competed for Enron business. The biggest (JP Morgan Chase and Citigroup/Citibank) definitely knew full well what the actual debt load was and probably most of the others as well. In some cases the banks treated large complex financial structures as Enron debt internally but portrayed it as something else (generally outside investment portfolios) to new outside investors. The secret debt was the single biggest financial problem Enron faced.
The truth: Enron's real debt was up near $38mil when the public "knew" it was about half that. My take from the book is that in rough numbers, at least 100 people outside of Enron knew this truth spread among at least half a dozen companies or more. Inside Enron? At least triple that would have a reason to suspect and at least 50 knew it stone cold. Many more inside Enron knew about at least some of the failure to report losses.
Conventional wisdom is that you can't hide secrets that big among that many people. In fact that's almost something we've been counting on in election reform to put a cap to the potential problems. We've been assuming that outright election fraud would have to be isolated among small groups and would have difficulty crossing company lines or extending deeply into the political/government worlds.
I'm no longer convinced this is the case, and here's why: the ONLY thing that caused Enron to come unglued was the stock market collapse of 2001. That devalued Enron's stock price, which eventually caused one piece after another of the "off books secret debt" to come due at a time when Enron didn't have the cash reserves (caused by rising stock prices) to cope. The house of cards collapsed before new hard-cash revenue streams came online.
I'm not saying for sure that there are election-rigging schemes going on that involve multiple corporations or other entities (political parties, government agencies, etc.). I'm saying that after reading this book, I'm no longer convinced that it's impossible or even very unlikely.
The final collapse of Enron wasn't caused by internal whistleblowers or outside audits. Once Arthur Anderson realized the game was up, their reaction was literally to start shredding over 30,000 documents. The sinking stock caused the banks to talk to each other about the hidden debt load, collectively shake their heads in back-room meetings and cut off the cash flow...at which point reality hit. They ran out of money and ground to a halt.
The big lesson: we can't count on internal whistleblowers. We can't count on corporate or government oversight to make sure corporate ethics in a field like voting stays pure.
We have to do it ourselves.
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TRIPLE PROTECTION FOR ELECTION 2006 - STARTING NOW:
(1) Use Freedom of Information, public records requests ("All American Paper Chase")
(2) Try Dumpster Diving for Democracy
(3) Candid America Project - Don't leave home without your camcorder
HOW TO DO IT: http://www.bbvforums.org/forums/messages/6/6.html
Frequent Voting Rights Forum Participant
Post Number: 2440
Best of Black Box? N/A
Votes: 0 (A keeper?)
|Posted on Monday, May 15, 2006 - 12:49 pm: ||
Jim, thanks for writing this up with such clarity. I see what you mean about realizing that similar kinds of collusion and secrecy could also develop in relation to voting systems.
It's a great warning not to depend on any particular person or whistleblower.