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Smitten by the genius with which it manipulated successive
U.S. presidencies, the late great Enron Corporation tried
to manipulate its own investors. Shareholders — who had
not balked at Enron’s political machinations — forced
it into the largest bankruptcy in U.S. history by dumping
its stock when they learned that Enron had played them for
chumps.
From humble origins in the 1985 merger of two gas companies,
Houston-based Enron transformed itself into the nation’s
seventh-largest reporter of corporate revenues. It did so
by pioneering energy trading and flimflam accounting. At its
peak, Enron controlled a fourth of all U.S. gas and electricity
trades, profiting from the spread between a buyer’s biding
price and a seller’s asking price.
In recent years, however, other energy companies launched
competing trading operations, squeezing Enron’s profits.
At the same time, Enron launched disastrous financial trading
ventures that took it away from its core energy business,
trading such disparate commodities as water, paper, steel,
computer bandwidth and weather derivatives.
Rather than admitting to a lull in its breakneck growth,
the company took ever-bolder steps to cook its books. Enron
pumped up reported earnings and hid mountains of debt to preserve
the illusion of its once-stellar performance. Enron’s
colossal failure required a string of failures by Enron management,
its “independent” board of directors, the legal
and accounting professions, investors, stock analysts, credit
rating agencies and numerous government officials and regulators.
Energy revolution
Enron doggedly pursued a vision in which natural gas would
supplant other electric-generating fuels and consumers would
buy kilowatts from competing suppliers rather than from a
monopoly. It is no coincidence that a one-time gas company
spearheaded this deregulation, since the United States effectively
deregulated gas a decade before electricity.
Responding to supply shortages in 1978, Congress deregulated
gas producer prices. From 1985 (when Enron formed) through
1992, the Federal Energy Regulatory Commission (FERC) issued
rulings that eventually permitted open access to private gas
pipelines, thereby relieving gas distribution bottlenecks.
Subsequent steps by FERC and the Commodities Futures Trading
Commission created huge gas futures markets that allowed industrial
consumers to hedge the prices that they pay for energy commodities.
Congress took the first step toward electricity deregulation
in 1978, when it authorized FERC to let private power producers
compete in wholesale markets. This allowed industrial power
users to bypass the utility monopolies, which still controlled
the residential power market. FERC started approving such
licenses in the late 1980s. Congress gave deregulation another
nudge in 1992, when it deregulated wholesale markets further
and required utilities to share transmission lines, thereby
allowing utilities in high-rate states to buy power from cheaper,
out-of-state suppliers.
California drove the electric deregulation experiment home
in 1996, when its legislature unanimously passed a sweeping
bill to deregulate the state’s residential electricity
markets. A slew of other states followed suit, including such
major markets as Pennsylvania, Illinois, New York and Texas.
Acute labor pains accompanied the birth of deregulated electricity
markets. The scorching summer of 1998 brought severe power
shortages and price spikes of up to 20,000 percent to Midwestern
and Eastern wholesale markets. Since California’s residential
electricity market opened in 1998, few households have switched
electricity providers, yet consumers periodically have been
hit by rolling blackouts and skyrocketing power bills. As
deregulation’s leading proponent and beneficiary, Enron
became a deregulation poster boy widely accused of profiteering
from a complex system that few people understand [See “Power
Struggle: California’s Engineered Energy Crisis and the
Potential of Public Power,” Multinational Monitor, June
2001].
Political power trader
To become the energy power broker that revolutionized how
electricity flows into sockets, Enron had to master political
power first, turning power trading into a double entendre.
Residential electric deregulation would likely not be any
more than a distant notion in the United States without Enron’s
aggressive political machinations. Enron’s deregulatory
vision encompassed staggering expenditures to restructure
the nation’s electricity infrastructure. Yet the greatest
obstacles were political, since Enron targeted a monopoly
system that fed vast fortunes and bureaucracies. To clear
these hurdles, Enron bred and fed armies of politicians in
Houston, many state capitals, Washington and even abroad.
Enron inundated these politicos with lobbyists and contributions,
and ushered a steady stream of once and future public officials
though its revolving doors.
Legendary examples of Enron’s aggressive use of such
political carrots and sticks include:
• When ex-President Bush took a Gulf War victory tour
in 1993, Enron paid members of his entourage — including
former Secretary of State James Baker and Gulf War Lieutenant
General Thomas Kelly — to lobby Kuwait for contracts
to replace its destroyed power plants;
• Clinton cabinet members — including National
Security Advisor Anthony Lake — threatened to cut off
U.S. aid to the world’s poorest country in 1995 if
Mozambique failed to give Enron a pipeline contract [See
“1995’s Ten Worst Corporations,” Multinational
Monitor, December 1995];
• Ken Lay told the Financial Times in August that if
Maharashtra state does not start paying Enron for power
from Enron-built generators, the U.S. government could stop
“providing any aid or assistance” to India [See
“Enron Deal Blows a Fuse,” Multinational Monitor,
July/August 1995].
• Enron has paid Texas Senator Phil Gramm’s wife,
Wendy, $50,000 a year to sit on its board since 1993, just
after she began deregulating energy futures markets as chair
of the Commodities Futures Trading Commission;
• Fellow board member John Wakeham, who deregulated
UK energy markets as Margaret Thatcher’s energy secretary,
joined Gramm on the board’s audit committee (which
was supposed to independently review Enron’s cooked
books);
• Senator Phil Gramm championed the 2000 Futures Modernization
Act that further slashed commodity futures regulation and
granted special exemptions to Enron;
• In 1996, Texas Supreme Court justices — who
received more money from Enron than any other corporate
donor —slashed $224,989 off the taxes that a lower
court said Enron owed to a school district; and,
• Then-Argentine Public Works Minister Rodolfo Terragno
has said, over Bush’s denial, that the current U.S.
president lobbied him to give Enron a $300 million pipeline
in 1988, when the elder Bush was vice president.
Enron’s PAC, executives and treasury spent $10.2 million
to influence the U.S. government in the 1998 and 2000 election
cycles, according to the Center for Responsive Politics. This
includes $6.7 million spent on federal lobbyists and $3.5
million that Enron showered on federal PACs and candidates.
Republicans got most of Enron’s money, reflecting the
preference of Enron Chair Ken Lay. Yet many Democrats also
ate at Enron’s trough. The center reports that 71 percent
of U.S. senators and 43 percent of House members took Enron
money.
Enron’s political influence went far beyond Washington,
as the company led the charge to deregulate state electricity
markets nationwide. Enron spent $726,643 to influence California
politicians in 2000 and the first nine months of 2001. In
its home state of Texas, Enron spent $5.8 million to lobby
and fund state politicians in the 1998 and 2000 election cycles,
according to Texans for Public Justice.
Fueling Bush
No other politician approaches the benefits that George W.
Bush has reaped from Enron. During the 2000 presidential campaign,
the Center for Public Integrity named Enron as the single
largest patron of Bush’s entire political career. Over
the years, Bush received $774,100 from Enron (excluding Enron’s
$2 million in soft money donations to the GOP since Bush’s
presidential bid) and achieved “frequent-flier”
status aboard Enron corporate jets. For his part, Bush has
championed Enron causes from Austin to Washington. Bush’s
greatest gifts to Enron as governor were:
• Deregulating the state’s electricity markets
in 1999;
• Passing tort laws that make it harder for people
to recover damages from businesses in court (Ken Lay is
a major underwriter of the powerful Texans for Lawsuit Reform
PAC); and
• Coddling Enron and other polluters that own filthy
“grandfathered” plants with exemptions from Texas’
30-year-old clean-air laws [See “Dirty Old Grandfathered
Plants,” Multinational Monitor, June 1998].
Enron’s influence trailed Bush to Washington. The retired
general that Bush tapped as Army secretary headed an Enron
subsidiary that won contracts to privatize Army-owned utilities.
“I see no reason whatsoever why the Army is in the energy
business,” Secretary Thomas White said last year. U.S.
Trade Representative Robert Zoellick and White House economist
Lawrence Lindsey were paid Enron advisers before Bush appointed
them to his administration. Bush tapped Enron lobbyist and
former Montana Governor Marc Racicot to head the national
Republican Party in late 2000.
Bush named Ken Lay to his Energy Department transition team
and resisted calls for price controls when Enron and other
power companies were accused of price gouging to exploit the
West Coast power crisis. Lay reportedly was the only energy
executive who had a private audience with Vice President Dick
Cheney when he huddled with industry representatives to draft
the administration’s energy policy.
Then-FERC Chair Curt Hebert said that Lay warned him in 2000
that he would lose Enron’s support at the White House
if he continued to oppose open access to privately owned power
lines. While Lay said Hebert misconstrued their conversation,
Hebert resigned last August, three weeks after denouncing
this pressure. Bush replaced him with Enron-backed Texas Public
Utility Commission Chair Pat Wood. Texas Governor Rick Perry
(who took $237,000 from Enron since 1997) then replaced Wood
with Enron de Mexico President Max Yzaguirre. In the midst
of the Enron scandal in January 2002, Yzaguirre succumbed
to widespread calls for his resignation.
Power outage
Although some institutional investors already had grilled
Enron to try to make sense of its impenetrable financial statements,
the first public sign that Wall Street’s darling might
be troubled came in August 2001. That is when Ken Lay’s
handpicked successor resigned just six months after taking
the helm. Investors simply did not believe that CEO Jeff Skilling—the
hard-driving force behind Enron’s decision to shed hard
assets like pipelines and power plants for energy trading—really
resigned for “personal reasons.” To reassure investors,
Lay resumed CEO duties, promising to improve financial disclosures
at a time when “the company is in the strongest shape
it’s ever been in.”
As the Wall Street Journal, which broke the Enron story,
later revealed, the quarterly report that Enron filed on the
day that Skilling resigned contained a time bomb. The report
alluded to hundreds of millions of dollars worth of deals
with investment “partnerships” that had been run
and partly owned by Enron Chief Financial Officer Andrew Fastow.
Though virtually unknown to outsiders, some Enron employees
complained about Fastow’s partnerships, which Enron ostensibly
used to raise hundreds of millions of dollars and to hedge
trading risks. The partnerships split Fastow between his fiduciary
allegiance to Enron investors and his personal interest in
partnerships, which earned him an estimated $30 million. Over
the next few months, Enron would disclose the existence of
many more partnerships that the company secretly used to inflate
its earnings and to hide mountains of debt.
Enron’s quarterly report issued in October 2001 stressed
that its core energy trading business fueled an impressive
26 percent increase in recurring earnings. But disturbing
revelations dampened this good news. First, Enron said it
was taking a whopping $1 billion write-off to cover losses
in such non-core ventures as computer bandwidth trades. The
report also alluded to “early termination” of “finance
arrangements with a previously disclosed entity.” This
turned out to be Enron’s way of not disclosing that Fastow’s
partnerships were forcing the company to sustain a $462 million
charge.
The same report announced an astonishing $1.2 billion reduction
in shareholder equity (the difference between Enron’s
assets and liabilities). Enron blamed this hit on an undisclosed
“accounting error.” In fact, Enron had issued 62
million shares of its own stock to the partnerships, which
promised to repay the stock’s value to Enron. Enron improperly
treated these repayment pledges as if they were cash. When
the partnerships failed to repay the value of the stock, Enron
retired it, forcing its investors to eat a $1.2 billion loss
in value.
With relatively few hard assets, an astonishing amount of
Enron’s value was built on market trust. When that trust
disappeared, so did Enron. People did business with Enron’s
coveted trading operations because they were confident that
the company could stand behind commitments to buy so much
gas, electricity or bandwidth. Many of these financial transactions
required Enron to expedite payment in the event that its credit
rating took a hit. Now the credit agencies were at the door
asking about Enron’s stealth partnerships and its trading
partners were turning to competitors. In a market sell-off,
Enron stock that sold for $80 a share at the beginning of
the year now sold for under a $1.
Teetering on the brink of ruin, Enron agreed to be taken
over by Dynegy, a smaller competitor that promised massive
infusions of cash. The day before the slated November 9 merger
announcement, however, Enron disclosed two new partnerships:
Chewco and JEDI. Enron set up these entities after it began
falling short of earnings targets in 1997. Befitting their
“Star Wars” names, Enron used JEDI and Chewco for
special effects, artificially boosting its profits and making
hundreds of millions of dollars in Enron debt vanish. Enron
now said it had overstated its earning for the past four years
by $586 million, or 20 percent. During this same period, Enron
executives and directors raided the piggy bank by selling
more than $1 billion in company stock.
Soon after this disclosure, the SEC launched a formal investigation
of the company. Enron disclosed on November 19 that its earnings
might take another $700 million haircut as a result of asset
devaluations at another investment partnership. Falling credit
ratings were triggering expedited payments of $690 million,
the company added. On November 28, Standard & Poors dropped
Enron’s credit rating to “junk” status and
Dynegy called off the merger. Enron announced on December
2 that it would file for bankruptcy.
When investors sent Enron’s ship crashing back to earth,
its storied political and mental prowess failed, leaving its
arrogant executives to bang their fists on their suddenly
unresponsive controls. Chair Ken Lay chided investors for
overreacting to a bit of bad news. In a conference call, CEO
Jeff Skilling called an analyst an “asshole” for
daring to challenge Enron’s financial numbers. When credit
agencies prepared to downgrade Enron’s rating to near-junk
status, CFO Fastow futilely lobbied them to raise Enron’s
rating, which he said would improve its performance and thereby
justify the inflated rating. But everyone else finally realized
that it was time to pull the plug on Enron.
Enron’s impact
Enron made a strategic decision in 1989 to phase out ownership
of hard energy assets such as power plants and pipelines in
order to pin its fortunes on energy trading. This proved so
successful that a decade later Enron leapt into trading a
slew of commodities and financial derivatives, becoming both
an energy company and an unregulated financial institution.
By 2000, Enron lobbyists were demanding — and receiving
— greater deregulation of both industries.
Enron’s colossal failure is a cautionary tale of a corporate
giant that operated without meaningful checks and balances.
Enron’s failure followed a stunning string of failures.
These included Enron’s managers, who grossly misled investors;
its “independent” board and the legal and accounting
professions, which signed off on bogus transactions; investors,
stock analysts and credit rating agencies, which bought or
promoted what they did not understand; and government officials
and regulators, who were too busy deregulating to check this
corporate abuse.
After Enron’s fall, the Securities and Exchange Commission,
the Justice Department, the Labor Department and many congressional
committees launched hearings, probes and investigations. This
scrutiny is unlikely to reverse the wave of electricity deregulation
that Enron pioneered. Many companies have followed Enron’s
lead into the energy trading business (with some, such as
Dynegy, Calpine and El Paso Corp., rushing to reduce debt
and improve disclosures to limit the Enron contagion). Indeed,
even bankrupt Enron has cut a deal with the Swiss bank UBS
to revive its Enron Online trading operations under a new
name.
“The industry is doing an amazing job of spin,”
says Janee Briesemeister, a Consumers Union utility analyst
in Austin. “Everyone is saying Enron has no bearing on
deregulation. I don’t think Enron will mean a devastating
[deregulation] collapse like in California. But when you have
the largest energy trading company collapse, along with all
the associated banks and everything, I think there is no question
that there will be closer scrutiny by investors and lenders.
The cost of money will be greater, slowing down electric generation
and transmission projects, and these costs will filter down
to consumers.”
“Put Enron together with California’s [deregulation]
experience and you’ve got a failed experiment,”
says deregulation critic Doug Heller of California’s
Foundation for Taxpayer and Consumer Rights. But Heller concedes
that, “The fear, however, is that people will write this
off as corporate malfeasance and leave it at that alone.”
Before Bush (who himself was once the target of an inconclusive
SEC probe) appointed him as SEC Chair, Harvey Pitt defended
such securities malfeasors as inside trader king Ivan Boesky
from the SEC. Representing the accounting industry in 2000,
Pitt helped defeat a reform that his predecessor proposed
to bar auditors from receiving additional consulting fees
from clients (critics suggest that Arthur Andersen’s
independence was compromised by the $27 million in non-auditing
fees that it billed to Enron). Pitt’s SEC has instituted
an amnesty program that minimizes or eliminates punishment
for wayward firms that turn themselves in. In a telling line
in a Wall Street Journal op-ed in December, Pitt wrote that
future Enrons can be prevented “if we focus attention
on finding solutions instead of scapegoats.” Pitt’s
SEC is unlikely to prevent future Enrons by slamming Enron
malfeasors with the maximum legal penalties.
The most likely legacy of the Enron debacle is that the accounting
police will mandate limited improvements in corporate disclosures.
Congress also will debate—and may even pass—reforms
to prevent employees from sinking most of their pension funds
into their employer’s stock—as Enron employees did
to ruinous effect. But it is unlikely that the same government
officials who spent the span of Enron’s lifetime deregulating
U.S. energy markets will muster the energy required to turn
that battleship around. The climate of inadequate regulatory
controls that fostered the Enron debacle in the first place
is likely to weather this storm, as other wealthy corporate
interests step into Enron’s void to finance the next
election season.
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