quarterly-report.com Political Commentary by James R. Audet

Black Friday, February 15, 2002
President George W. Bush declares Yucca Mountain, Nevada as the depository for the nation's nuclear waste.

"Accounting and auditing in this country is in a state of crisis," says Paul A. Volcker, former Chairman of the Federal Reserve, who has been hired by the Andersen Company in the wake of the bankruptcy of the energy trading company, Enron.  In October 2000, Enron’s financial cover was blown and the financial house of cards that Andersen helped to create collapsed in five weeks.  The implosion of Enron is the largest bankruptcy in American history.  What is so staggering, so appalling, so outrageous is that this once $50 billion company melted to nothingness during the period November 8, 2001, when it restated its earnings retroactive to 1997, to December 2, when it filed bankruptcy. ^1/

The Enron bankruptcy demonstrates that the U.S. financial reporting system is broke. Accountants have so comprised the integrity of their profession that there is little reason to believe any financial reports filed with the Securities and Exchange Commission. ^2/

Conflicts of interest in the field of accounting have corrupted audit standards. ^3/ Accounting’s house of cards is GAAP, the Generally Accepted Accounting Principles.  These standards are aptly named, for the gaping holes in GAAP’s indeterminate "principles" have given license to charlatans, crooks, and felons to defraud Americans of a trillion dollars.  The Enron bankruptcy has caused GAAP to tumble to the ground with nary a generally accepted principle still standing.  Craftily built by The Financial Accounting Standards Board (FASB), GAAP is often the tool of greedy businessmen to camouflage the true financial condition of their companies.

The corruption in the administrative systems that govern financial reporting is endemic. Culpable of negligence and misfeasance in the Enron disaster are the Securities and Exchange Commission, The Federal Energy Regulatory Commission (FERC), the Energy Department, The Commodity Future Trading Commission (CFTC), and of course, the US Congress and the Office of the President.  Also negligent are the New York Stock Exchange, the financial media, and of course, banks and investment firms, which loved Enron for the prodigious fees that it paid for financial services.

Enron, however, represents but the visible part of the financial reporting iceberg.  What lies below the surface is 20 times larger.  In fact, the dirty secret of the longest peacetime expansion in the nation’s history is a trillion dollars in fraud from the promotion and selling of US technology stocks in the 1990’s.  How much growth of the last ten years came from cooking the books?  The Enron disaster is but a mere scandal compared to the trillion dollars investors have lost in high tech and "dot com" stock swindles.

Enron’s orgy of greed began in 1992 with the passage of the National Energy Policy Act which allowed power producers to compete for the sale of electricity to utilities.

The 1992 Act gave Enron the springboard it needed to catapult itself from a small gas pipeline company to the seventh largest US corporation.  For a half a decade, 1995 through 2000, it achieved a 40 percent annual increase in the value of its stock.  Regretfully, during this period of spectacular growth, Enron was blissfully ignored by the SEC, which did not audit the company’s financial reports in any year from 1997 through 2001.

Enron was recklessly empowered by the Commodity Futures Trading Commission (CFTC), which issued an exemption for futures trading in energy derivatives.  This was Enron’s most lucrative business. ^4/  Speculators, including Enron, used these financial instruments to drive the cost of wholesale electricity to astronomical levels.  As it grew in size, the Enron octopus bought off political candidates with hundreds of thousands of dollars in campaign contribution to guarantee its success. ^5/  The utter neglect of FASB, the SEC and the CFTC permitted Enron to run amuck and steal both investors and employees life savings.

The Enron Conspiracy of Corruption

Enron’s strategic plan was to dominate –- monopolize -- the US energy trading market.  It was able to execute its plan beyond a felon’s wildest dream.  The report of a special committee of the Enron Board of Directors, chaired by William C. Powers (Powers Report), condemned Enron Chief Executive Officer (CEO) Kenneth L. Lay and former CEO Jeffrey K. Skilling, Chief Financial Officer Daniel Fastow, and other Enron managers and consultants for maladministration of Enron stockholder equity. ^6/

From 1983 until his resignation in 2002, Kenneth Lay hosted the orgy of greed that was Enron. ^7/  His amoral record of carnage is incredible.^8/  Five thousand employees were fired.  Individual accounts in the Enron 401K retirement plan were left virtually worthless after Enron’s stock fell to penny stock levels.  Millions of other private pension plans suffered horrendous losses.  Overall, the losses may amount to 60 billion dollars.

Lay and his henchmen are no patriots.  They have weakened the national security.  Lay, Fastow, Skilling, and other Enron and Andersen executives deserve to be prosecuted to the full extent of the law.

Who paid for the outrageous enrichment of Lay and his conspirators?  In addition to the company's stockholders and lenders, innocent dupes in the Enron swindle were the ratepayers of the nation’s electric utilities.  Serious charges of rigging the wholesale energy market have been made against Enron. ⁹/  In California, the cost of wholesale electricity soared from the historical average of about 3 cents per kilowatt hour to 33 cents in January 2001, an increase of 1000 percent.  It is estimated that California ratepayers are owed $7.9 billion in refunds.  Is it a coincidence that wholesale energy prices went sky high after Enron started what would come to be its most lucrative subsidiary, Enron Online, its energy "trading" unit in 1999?  Is it a coincidence that wholesale energy prices fell 30 percent the day after Enron filed for bankruptcy?

An object lesson from the Enron debacle and other infamous corporate failures of recent history is the outrageous misuse of stock options.  The Congress and President Bush should act favorably on a congressional bill that would require that stock options be treated on company books as expense.

Enron did not act alone in its rip-off of the American economy.  Indeed, support for its pyramid of financial vacuousness was willingly provided by a company of notorious reputation and a national disgrace, the actuarial firm, the Andersen Company. ^10/

Andersen helped to move billions of dollars of debt off Enron's books through the use of countless, bizarre, special purpose entities" (SPE). ^11/   Aided and abetted by Andersen, Enron produced fraudulently iridescent financial statements that caused investors to jump into the stock.  Enron mania produced a 40 percent increase in the value of Enron stock five years in a row.  Yet, it took some 4000 of these ticking SPE time bombs to produce these results. ^12/

The SPE’s were predominately shell companies -- capitalized with Enron stock -- that permitted transactions to be booked as earnings.  SPE’s were structured to avoid consolidation of the SPE financial statements on the parent’s balance sheet.  Enron’s orgasmic addiction to SPE's is obvious.  It was able to inflate earnings and eliminate debt by capitalizing its shame SPE's with company stock.

How did Andersen justify its collusion in this Ponzi scheme?  Andersen’s CEO, Joseph Berardino, claimed in House testimony that Arthur Andersen performed Enron’s audits in accordance with GAAP. ^13/  If so, GAAP is a disaster.  There is but one fate for Andersen for its willing part in the Enron debacle: Bankruptcy and Liquidation.

The virus of deceptive accounting practices likely infects many listed stock exchange companies.  In monetary terms, the losses to individuals and pension plans from the Enron bankruptcy and other swindles in high technology will far exceed the economic cost of the September 11 tragedy and the 1980s savings and loan scandal. ^14/  This one - two punch to the American economy guarantees that the current economic slowdown - recession will continue through the year.  Moreover, all the bad news is NOT behind us.  In 2002, more companies will collapse under the weight of their accounting chicanery.  The telecommunications industry is particularly poised to provide a number of scalding failures. ^15/   Do NOT believe the reckless forecasts of scheming Wall Street "analysts" – the same Machiavellians who sold us the "dot coms" – who would have you believe otherwise.

Footnotes:

1/  Enron listed $36 billion in liabilities.  It is alleged that there may be as much as $20 billion improperly hidden for a total of $56 billion in liabilities.  Obviously, even if Enron’s assets could be sold for $50 billion, the proceeds would be well short of satisfying Enron’s $56 billion of debt.

2/  The reports of interest are customarily the 10Q (Quarterly Report) or 10K (Annual Report).

3/  Financial services firms may sell consulting services as well as audit services to their clients.  Consulting was so lucrative for Arthur Andersen that it received 27 million in consulting fees, and 25 million for audit services from Enron.  An actuarial firm that provides both audit and consulting services to the same client has an unambiguous conflict of interest.   The practice is contrary to the public interest and ought to be prohibited by statute.

4/  The Chairperson at the time of the CFTC ruling was Wendy Graham, the wife of Senator Graham of Texas.  Mrs. Graham resigned her position with the CFTC in 1993.  She joined Enron’s Board 6 months after approving the ruling that was favorable to the company.  The integrity of this woman is highly suspect.

5/  Enron, Lay and other senior executives contributed $1.7 million in soft money donations to politicians in the 2000 election cycle.  Electric utility soft money contributions in the 2000 election cycle were approximately $8 million.

6/  Lay and Fastow invoked the Fifth Amendment and refused to testify before Congress. Skilling did testify.  His explanation for what happened at Enron may be comprehensively summarized using his own words, "I don’t recall."

7/  Twenty-nine (29) Enron insiders earned 1 billion in stock sales in 2001.

8/  Kenneth Lay’s wife, Linda, is as amoral as her husband.   In a disgraceful appearance on the NBC television program, "Today," January 29, Linda Lay claimed that she and her husband were broke, in spite of the fact that they pocketed $101 million in proceeds from the sale of Enron stock between October 1998 and November 2001.

9/  Before the Senate Energy and Natural Resources Committee, Robert McCullough, an energy consultant whose clients include utilities in the Northwest, testified that the price of unregulated financial energy contracts on the West Coast dropped 30 percent on Dec. 3, the day after Enron filed for bankruptcy.

10/  Arthur Andersen’s recent record of malpractice.

On March 5, 2002, Andersen agreed to pay $217 million to the Baptist Foundation of Arizona Liquidation Trust to settle claims of malpractice.

In July 2001, Andersen paid $7 million to the SEC to settle a civil fraud complaint of improper bookkeeping at Waste Management Inc.  Andersen also joined Waste Management in settling a $220 million class action lawsuit.

In May. 2001, Andersen agreed to pay Sunbeam shareholders $110 million to settle a securities fraud lawsuit.

Andersen paid tens of millions of dollars to settle claims by federal regulators and private investors in connection with its audits of Charles Keating’s infamous Lincoln Savings and Loan which became the notorious symbol for the savings and loan crisis of the 1980s. 

11/  Three percent of the equity of the SPE must be at risk and must come from sources independent of Enron or a related party.  Enron or an Enron employee may not control the SPE.  Under these conditions, the contingent liability of the SPE does not have to be disclosed on Enron’s balance sheet.  The viability of these SPE’s often rested solely on Enron’s ever-increasing stock price.  As Enron’s stock started to decline, the ratio between Enron’s investment (its stock) and non-Enron equity fell below the required 3 percent.  Once a critical mass of non-conforming SPE’s was reached, Enron’s stock fell to penny levels faster than the Titanic sank to the bottom of the Atlantic.

The consequences of the three percent rule are mind-boggling.  If a company is capitalized with 3 dollars cash and 1 share of Enron stock worth 97 dollars, the only way the SPE can remain off the Enron balance sheets is if Enron’s stock does not fall below 97 dollars.  If Enron’s stock falls to $50, the value of the SPE is halved, the SPE no longer meets the three percent rule.  Consequently its balance sheet must be consolidated with the Enron’s financial statements.  Enron then must reflect a 50 percent loss on its investment in the partnership.  In the vernacular of "Wall Street," this has the effect of "nuking" a balance sheet."

12/  Nearly three thousand of these were offshore partnerships, begging the question whether these were legitimate enterprises or merely shell companies to shield Enron from income taxes.

13/  When asked why a company would want to move an SPE off the books, Berardino testified, "...to show a better financial position."  What!

14/  Citizens of Nevada bear a special consequence of the Enron monopoly.  The primary electric provider, Nevada Power, seeks a $921 million rate increase to recover costs associated with its purchase of power in 2001 from the rigged wholesale electricity market.  This amounts to about $461 for every Nevada resident, $1,226 per household and $1,489 per Nevada Power customer.   Madness!

15/  The telecommunications firm, Global Crossing, filed for bankruptcy -- the fourth largest in US history -- on January 28, 2002.  Their auditor is Arthur Andersen.  Claims of deceptive accounting practices have been leveled against Andersen and Global Crossing.

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