Politics & Prose March 2002

The Enron Ponzi Scheme

The Enron Ponzi Scheme

How many people were "Enroned"? How wide will the circle of corruption spread?
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It was Adam Smith who identified what turned out to be the central ethical fault line in Enron. The corporation, he wrote in The Wealth of Nations, was an inherently corrupting business form. The problem was the separation of ownership from control. In partnerships and sole proprietorships, the forms he preferred, the owners ran the business. In contrast, managers hired by the owner-stockholders ran the corporation. And the owners were too busy to monitor how their money was spent by the managers. So managers were institutionally liable to what Smith called "negligence" and "profusion." Negligence, because the business was not the consuming dedication of their lives, as it is for partners and sole proprietors; it was merely a job. Profusion, because they could reward themselves by lavishing other people's money, which spends so much easier than our own, on fine dinners, handsome equipages, and all manner of other frippery—and disguise their profusion as business expenses. Smith's distrust of the corporation had empirical backing in the disgraceful behavior of the East India Company, the Enron of his day, a monument to negligence and profusion.

A bankruptcy auction of Enron's gilded London office turned up the following evidence of profusion: an electric train set used to deliver bonuses to high-performing executives; a high-tech gym; a ToneZone for aromatherapy, tanning, and beauty treatments; pricey paintings and sculptures; a 33-foot maple veneer conference table inlaid with solid walnut; and even marble-covered garbage bins, to deposit decorous garbage from the twelve cafés on the premises. As for negligence, the destruction or rather auto-collapse—as no competitor or regulatory change can be considered responsible—of the nation's seventh largest corporation retires the cup. But this was a kind of negligence bound up with profusion. Criminal negligence.

If Enron were a morality play it would be called Conflict of Interest. Conflicts of interest were forbidden in the contracts signed by Enron executives—were even grounds for termination. Yet they were the chief motivational tool at Enron. Let's start inside the company and work outwards, seeking, like Diogenes, to find an honest man or woman. What is a conflict of interest? Consider this example from the Enron petri dish. You are Andrew Fastow, Enron's CFO, and you have this problem. You have set up more than 3,000 partnerships to hide Enron's losses of more than $500,000,000. An Enron comptroller is pressing you on the unsavory details of your scheme. You get him transferred. His replacement you cut in on the deal. He gives you $5,000 to invest in one of the partnerships and two months later gets a $1,000,000 return. Your problem has disappeared. You have snared him in what we might call an Enron. You yourself are mega-Enroned, as overseer and beneficiary of partnerships from which you have gained $30 million dollars.

Bonuses were another way to Enron, to use the verb form. Bonuses were tied to profits and stock price. The purpose of the partnerships was to overstate Enron's profits. The bonuses were a persuasion to silence. Two other Enron executives, according to The New York Times, "who were primarily responsible for reviewing the partnership dealings to protect against conflicts of interest also profited by the reports of strong financial performance made possible by those transactions."

A corporation's board of directors, made up of disinterested persons of reputation, represents the stockholder-owners to the manager. The institution is an attempt to deal with the agency problem raised by Adam Smith. At Enron, however, the board was not disinterested but Enroned by means ranging from corporate contributions to the campaign of the senator-husband of one member to sizeable gifts to the favorite charities of another. The board approved the partnerships, and Fastow's conflict of interest in them. Thousands of partners have yet to be named. Will board members turn out to be among them?

The law firm responsible for vetting the legality of the partnerships was Enroned by its desire to keep Enron as a client. Arthur Andersen, Enron's accountant, was Enroned: Andersen's consulting division helped Enron set up the partnerships Andersen's auditing division then reviewed on behalf of investors. Andersen has offered gulled investors a $750,000,000 settlement. The big financial services firms who helped finance the partnerships, on the one hand, while, on the other, analyzing their business potential for a public unaware of this nexus—these great names in finance were Enroned. Enron functioned in a regulatory black hole dug by Enroned politicians. Of the twenty-three senators on one committee questioning Enron figures, only one, Daniel Inouye of Hawaii, had never received contributions from either Enron or Arthur Andersen. Enron was the largest contributor to George W. Bush's political career. Was his vice president Enroned when preparing a Bush energy program favorable to Enron? Karl Rove, Bush's political advisor, held Enron stock while deliberating on the energy program with Enron officials. Was he Enroned? Was the White House counsel, Alberto Gonzales, who received campaign contributions from Enron, Enroned when he found Rove innocent of being Enroned? Did Enroning secure the silence of the Administration officials—the Treasury Secretary, the Commerce Secretary, the President's Chief Economic Advisor, and the President's Chief of Staff—who knew Enron was on the ropes last fall but said nothing to the Securities and Exchange Commission or the public? They said nothing while state pension funds were losing $2.9 billion on a company legitimated by an Enroned board, blessed by Enroned lawyers, pronounced robust by Enroned accountants, and hailed as a "strong buy" right up until the eve of its bankruptcy by Enroned investment bankers.

Enron was not only a financial Ponzi scheme but an ethical one. The whole charade would have ended if one man or woman who knew or suspected the truth had stood up and said no, I will not be Enroned into silence. Even Sherron Watkins, the internal whistle-blower, said she did not go to the board with what she knew for fear of losing her job. She did, however, sell some of her Enron stock, getting off the ship before it sank with nary a whisper to the crew. And she was the best of the lot.

Why did no one stand up? Let's apply moral realism to the question, seeking not to forgive but to understand.

It is hard to stand up: our ethical Occam's Razor need cut no closer than that. How many of us have kept in our seats when the path of right lay up the hill, so clear but so difficult, before us? Unlike physical courage, writes one ethicist, moral courage is "lonely courage." Frank Serpico, the New York City policeman who exposed corruption in the department, was ostracized by his fellow officers, beaten, and nearly killed for his lonely courage.

Another reason people don't blow the whistle is that they would have to blow it on themselves. "The only way you get to know these things," says a social worker who has worked with whistleblowers, "is that you have been in the thick of it." J. Clifford Baxter, the Enron vice president who committed suicide in January, took his concerns about the partnerships to Skilling, was ignored, then, having made his feeble gesture, sold his stock for millions and retired. Whistleblowers, says the social worker, often "take on the guilt of the organization." The weight of Enron's guilt may have been too much for Baxter to bear.

Countervailing ethical demands also keep us from acting ethically. Ibsen's Dr. Stockman, in Enemy of the People, stands up to expose a public health scandal—and his righteousness destroys his family. Many of us would be moral lions if we did not have kids.

Then there is the "Everybody does it" defense. At Enron, pretty nearly everybody did do it. Over the last two years, while Enron was collapsing, almost 2,000 of its executives got $432 million in bonuses. One trader, on receiving a paltry $500,000, threw his computer screen across the trading floor. "Well, we've all got to drink the Kool-Aid," a top executive remarked after Lay, Skilling, and Fastow directed him to do a bogus deal. They got drunk on the Kool-Aid at Enron. It was a milieu of corruption.

It was also a milieu of rules-are-for wimps innovation. Enron was reinventing the energy market. Fleets of Porsches were in the garage and testosterone was in the air. As Marie Brenner reports in a must-read article in the current Vanity Fair, one vice president displayed a "hottie board," which ranked the women of Enron on their sexuality. When women complained, they were told, He is making us money. Leave him alone. Care for some Kool-Aid? "Every great business person has been in some way a rule breaker," writes the business historian Richard Tedlow. Yes, but some rules are duties, and some are laws. The ethical compass to tell the difference was broken at Enron. To succeed at business, says Warren Buffet, who should know, you need brains, energy, and character. No wonder Enron failed.

The Smithsonian has begun an Enron collection with two items: a coffee mug and an Enron ethics manual--almost certainly inviolate.

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Jack Beatty is a senior editor at The Atlantic Monthly and the editor of Colossus: How the Corporation Changed America, which was named one of the top ten books of 2001 by Business Week. His previous books are The World According to Peter Drucker (1998) and The Rascal King: The Life and Times of James Michael Curley (1992). More

Jack Beatty"The Atlantic Monthly is an American tradition; since 1857 it has helped to shape the American mind and conscience," senior editor Jack Beatty explains. "We are proud of that tradition. It is the tradition of excellence for which we were awarded the National Magazine Award for General Excellence. It is the tie that binds us to our past. It is a standard we won't betray."

Beatty joined The Atlantic Monthly as a senior editor in September of 1983, having previously worked as a book reviewer at Newsweek and as the literary editor of The New Republic.

Born, raised, and educated in Boston, Beatty wrote a best-selling biography of James Michael Curley, the Massachusetts congressman and governor and Boston mayor, which Addison-Wesley published in 1992 to enthusiastic reviews. The Washington Post said, "The Rascal King is an exemplary political biography. It is thorough, balanced, reflective, and gracefully written." The Chicago Sun-Times called it a ". . . beautifully written, richly detailed, vibrant biography." The book was nominated for a National Book Critics' Circle award.

His 1993 contribution to The Atlantic Monthly's Travel pages, "The Bounteous Berkshires," earned these words of praise from The Washington Post: "The best travel writers make you want to travel with them. I, for instance, would like to travel somewhere with Jack Beatty, having read his superb account of a cultural journey to the Berkshire Hills of western Massachusetts." Beatty is also the author of The World According to Peter Drucker, published in 1998 by The Free Press and called "a fine intellectual portrait" by Michael Lewis in the New York Times Book Review.

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