At Large April 2002

How to Stuff a Wild Enron

Everyone blames too little regulation for the Enron mess, but maybe the culprit was too much
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Beyond a certain point complexity is fraud. It's the Airline Ticket Price Axiom. Am I getting the best deal on my airline ticket? How could I know? To map the labyrinth of airline-ticket pricing structure I would have to spend a greater value in time, at the minimum-wage billing rate, than the value of the money I'd save. Or it's the Finnegans Wake Postulate. We all know that Joyce, the old soak, was just scribbling a learned version of what Jack Nicholson typed in The Shining.

Maybe "complexity is fraud" doesn't apply to mathematics or the physical sciences. Nevertheless, when someone creates a system in which you can't tell whether or not you're being fooled, you're being fooled. This is true in the intellectual food chain from the fine arts, literature, and sociology on down.

And Enron was pretty far down—down there among the cunning weasels of ratiocination. What Enron was doing, what caused investors to embrace it in a rapture of baffled awe, was hiding debt. Several friends of mine who work in finance tried to give me a simplified model of the kind of thing Enron would do: Enron would have some business in which it had invested a lot of money. But that business wasn't making a profit. Enron would form a partnership with outside investors. The partnership would buy the business. But almost all the money to buy the business would be lent to the partnership by Enron, usually in the form of stock. Enron would count the sale of that business as income and count the loan to the partnership as an asset. The unprofitable business would disappear from Enron's financial statement, because under accounting conventions, if a mere three percent of capital is brought into a partnership from outside a corporation, then the corporation doesn't have to carry that partnership on its books. Enron's liabilities were turned into black ink.

Enron engendered these partnerships with wild fecundity and in many variations; but some of the most important of them, to stay vital, depended on a high market price for Enron stock. Meanwhile, Arthur Andersen auditors were standing by reciting the only joke that makes accountants laugh: "Q. What's two minus two? A. Whatever the client wants it to be."

I've got to hurry and hire Arthur Andersen before everyone in the firm gets sent up the river to Club Fed. I'm going to tell my new accountants, "I had this expensive divorce. But I figure you can list it as an asset. Because, believe me, no matter what that divorce cost, it was worth it."

Enron was, by the common if not by the legal definition, defrauding the people who bought its stock. Is there something in the American capitalist system that encourages such fraud? Yes: the regulations against it. Generally accepted accounting principles consist of 144 standards, each requiring a volume of explication. Title 17 of the Code of Federal Regulations, covering commodity and securities exchanges, is 2,330 pages long. Federal tax law runs to 3,778 pages, with an additional 12,888 pages of IRS tax code regulations.

There are plenty of places to hide in this vast briar patch of dos and don'ts. Enron broke the rules of ethics. But the corporation's worst sins seem to have been lawful: the Gordian partnership ties, the tales of profit and growth enhanced for dramatic effect, the taxes avoided by sending revenues on vacation to the Cayman Islands, the freezing of employee 401(k)s in the ice-cube tray of the company's own stock, the auditing firm with about half its Enron fees gained from provision of other accounting services, so that Arthur Andersen accountants were cooking the very books that Arthur Andersen auditors were expected to swallow. And so on. According to The Economist, even Kenneth Lay's eleventh-hour stock sales may not have violated SEC regulations, because Lay was selling the stock to repay personal loans from the corporation; hence insider-trading restrictions did not (for reasons known only to someone who reads and marks with Hi-Liter pens all 2,330 pages of Title 17) apply.

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