Deregulation, Political Corruption,
Corporate Fraud and the Enron Debacle
By Andrew Wheat
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 Enrons 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 nations 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 buyers biding
price and a sellers asking price.
In recent years, however, other energy companies launched competing trading
operations, squeezing Enrons 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. Enrons 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.
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 states
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 Californias 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 deregulations
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: Californias Engineered Energy
Crisis and the Potential of Public Power, Multinational Monitor,
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 Enrons aggressive political machinations. Enrons deregulatory
vision encompassed staggering expenditures to restructure the nations
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 Enrons 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 worlds
poorest country in 1995 if Mozambique failed to give Enron a pipeline
contract [See 1995s 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,
Enron has paid Texas Senator Phil Gramms 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 Thatchers energy secretary, joined Gramm on the boards
audit committee (which was supposed to independently review Enrons
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;
Then-Argentine Public Works Minister Rodolfo Terragno has said,
over Bushs denial, that the current U.S. president lobbied him
to give Enron a $300 million pipeline in 1988, when the elder Bush was
Enrons 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 Enrons money, reflecting
the preference of Enron Chair Ken Lay. Yet many Democrats also ate at
Enrons trough. The center reports that 71 percent of U.S. senators
and 43 percent of House members took Enron money.
Enrons 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.
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 Bushs entire
political career. Over the years, Bush received $774,100 from Enron (excluding
Enrons $2 million in soft money donations to the GOP since Bushs
presidential bid) and achieved frequent-flier status aboard
Enron corporate jets. For his part, Bush has championed Enron causes from
Austin to Washington. Bushs greatest gifts to Enron as governor
Deregulating the states 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
Enrons 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
administrations energy policy.
Then-FERC Chair Curt Hebert said that Lay warned him in 2000 that he
would lose Enrons 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.
Although some institutional investors already had grilled Enron to try
to make sense of its impenetrable financial statements, the first public
sign that Wall Streets darling might be troubled came in August
2001. That is when Ken Lays handpicked successor resigned just six
months after taking the helm. Investors simply did not believe that CEO
Jeff Skillingthe hard-driving force behind Enrons decision
to shed hard assets like pipelines and power plants for energy tradingreally
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 its 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
Fastows 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
Enrons 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 Enrons
way of not disclosing that Fastows 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 Enrons 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 stocks 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 Enrons
value was built on market trust. When that trust disappeared, so did Enron.
People did business with Enrons 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 Enrons
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 Enrons 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 Enrons 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 Enrons financial numbers. When credit agencies prepared
to downgrade Enrons rating to near-junk status, CFO Fastow futilely
lobbied them to raise Enrons 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 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.
Enrons colossal failure is a cautionary tale of a corporate giant
that operated without meaningful checks and balances. Enrons failure
followed a stunning string of failures. These included Enrons 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 Enrons 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 Enrons 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 dont 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 Californias [deregulation] experience
and youve got a failed experiment, says deregulation critic
Doug Heller of Californias 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 Andersens independence was compromised
by the $27 million in non-auditing fees that it billed to Enron). Pitts
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. Pitts 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 debateand may even passreforms to prevent employees from
sinking most of their pension funds into their employers stockas
Enron employees did to ruinous effect. But it is unlikely that the same
government officials who spent the span of Enrons 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 Enrons void to finance the
next election season.