There are business scandals that are so vast and so penetrating that they profoundly shock our most deeply held beliefs about the honesty and integrity of our corporate culture. Enron Corp. (ENE ) is one of them. This financial disaster goes far beyond the failure of one big company. This is corruption on a massive scale. Tremendous harm has befallen innocent employees who have seen their retirement savings disappear as a few at the top cashed out. Terrible things have happened to the way business is conducted under the cloak of deregulation. Serious damage has been done to ethical codes of conduct held by once-trusted business professionals.
It is difficult not to contrast the professionalism of modestly paid firefighters and police doing their duty on September 11 with the secretive and squirrely behavior of six- and seven-figure accountants, lawyers, CEOs, bankers, and financial analysts who failed at their duty with Enron. The remarkable letter by Enron whistle-blower Sherron Watkins to Chairman Kenneth L. Lay in August that presciently warns of accounting scandals reads like a road map of corporate corruption, subterfuge, and manipulation. She worries about the world perceiving Enron's "past successes as nothing more than an elaborate accounting hoax".
The Enron debacle calls into question a host of other aggressive accounting techniques used across a wide spectrum of Corporate America--most of them quite legal. And that's precisely the point. It's getting harder and harder to know what a company actually earns and what its stock is actually worth. An astonishing 723 companies have been forced to restate and lower their earnings since 1997. With enormous pressures to produce earnings growth, auditors are being turned into enablers. They forsake their traditional role of outside skeptic for that of inside business partner and they reject their age-old function of discloser of information for that of master magician who hides the financial rabbit.
Investor confidence is crucial to the success of our economic system. This confidence is threatened by not only the Enron scandal but by the dramatic decline in accounting standards. People increasingly feel the game is rigged. Unless Washington and business professionals seize the moment to clean up the mess in the market economy, they risk a major populist backlash.
In the end, Enron was able to enlist precisely those referees who, in the past, would oversee and check its behavior--accountants, lawyers, bankers, legislators, even regulators--in the pursuit of higher earnings. Many were tempted by a piece of the equity action and compromised their integrity. Enron paid big fees to many of these professionals to help manufacture its earnings, and together they created the mechanisms for evading the financial truth.
Watkins says as much. She talks of partnership deals that temporarily inflate the stock price, allowing execs to cash out options: "It's a bit like robbing the bank in one year and trying to pay it back two years later." She adds, "nice try but investors were hurt" when they bought stock that later fell. In a free-market economy, companies are supposed to fail because of the business cycle or bad business decisions. Failure from loose and sleazy practices, if not outright fraud, is another matter.
We now know that something went seriously wrong in the march to deregulation. There is no question that deregulated markets are generating lower costs, higher growth, and lower unemployment for the U.S. economy. But dereg ideologues, such as Enron's President Jeffrey K. Skilling and the company's political allies in Washington, convinced the nation deregulation meant no regulation. A big mistake. Enron and other companies used the transition to deregulation to gain access to Congress and regulators and write their own rules. They persuaded the Commodity Futures Trading Commission to let Enron and a few other companies run largely unregulated energy-derivatives trading businesses. Wendy Gramm, who at the time was head of the CFTC, later joined Enron's board of directors--on the audit committee.
Financial complexity made it easy to mask the truth and play financial games. The financialization and securitization of the real economy into mathematical bits and bytes allowed Enron and others to massage earnings results in infinite ways. Off-balance-sheeting financial engineering became the requisite way to boost earnings and stock prices. Hundreds of companies have done it. Common standards were replaced by idiosyncratic measures. Slowly but surely, the financial truth disappeared. No one, not the accountants or lawyers or bankers or Wall Street analysts, protested as the bottom line became a fiction. On the road to deregulation, basic building blocks of capitalism--clarity, transparency, fairness, openness--were sacrificed. Everything the public needs to evaluate risk, value stocks, and participate in an equity culture was undermined. Americans embraced the equity economy in the '90s because they believed they could participate in it fairly. They didn't expect to see their 401(k)s go up in smoke.
Who can come to the rescue? The reputations of many of the professionals who were counted on to safeguard the economic system lie in tatters. Corrupted by the chase for an ever-greater piece of the action, accountants, lawyers, analysts, and managers have shirked their duty on a scale not seen since the 1920s. Conflicts of interest abound as accounting firms sell services to the companies they audit and accountants jump to the corporations whose books they examine. The accounting profession has successfully fought all attempts at reform, rebuffing efforts to end conflicts of interest, impose stricter oversight, or increase liability for their actions. In short, most certified public accountants feel little duty to the public at large.
Nor do lawyers see themselves as officers of the court, which they are. Vinson & Elkins LLP was asked by Enron Chairman Lay to check out whether Watkins' seven-page warning of financial deceit warranted action. It came back with a "No." Wall Street analysts stopped being honest when their compensation became contingent on their firms getting investment-banking business from the companies they covered. And bankers are too busy selling fee-based services to carry out due diligence on loans and debt. They have enormous conflicts of interest. The Glass-Steagall Act was passed in 1933 to stop those conflicts. Its repeal in 1999 has ushered in their return.
What's to be done? Restoring investor confidence in the system of equity capitalism is crucial to the economy's health. The continued deregulation of the economy and the privatization of services depends on the integrity of the financial reporting system. If the investing public is going to participate, it must see a fair and transparent system.
The pendulum is swinging toward reform. The accounting changes required are all too obvious. But change must go beyond the scope of the financial implosion. The buying and selling of political access is not in the best interests of the country. It is unseemly to have the head of the Justice Dept., as well as the entire Houston branch, recuse themselves because of conflicts on the Enron case. A sense of outrage is growing. The lesson from the Enron debacle should be to restore basic integrity to the bottom line, ethics to business professionals, and clout to overseers that even a deregulated economy need.
Essay by Bruce Nussbaum