A decade later, Enron verdicts still serve as lessons in accountability.
Court cases remind business leaders of their accountability
TEN years ago this month, a Houston jury convicted Enron Chairman Ken Lay and former chief executive Jeff Skilling of fraud and conspiracy in the energy company’s 2001 collapse. Lay died before his sentencing. Skilling, fined $45 million and sentenced to more than 24 years in prison before having it reduced, could be eligible for release as early as next year.
Enron’s chief book cooker, Andy Fastow, is already out and hitting the speaking circuit.
In the ensuing decade since the trial, Enron has become both a shorthand for fraud and a source of entertainment. It was the punchline for a movie (the remake of “Fun with Dick and Jane”) and provided fodder for a London musical. But in business circles, Enron often is dispatched to the distant past as a freak anomaly with no bearing on how companies operate now.
At its heart, though, Enron was a manifestation of human failing, and for that reason, its demise is as relevant today as ever. Hubris drove Lay, Skilling, Fastow and others to believe they were business wizards who could make risk disappear. Their financial strategy focused on the short term — book the revenue and earnings now, drive up the stock price, and worry about the business later.
Unfortunately, that mindset is still alive and well. Valeant Pharmaceuticals International, a West Coast drug maker was recently laid low by a business model that has a painfully familiar ring to Houstonians who remember the Enron era.
Valeant CEO Mike Pearson, a former McKinsey & Co. consultant like Skilling, developed a strategy to remove risk from drug-making. Pearson argued that companies spent too much developing new drugs with no guarantee of success. So he bought companies that had already developed them, then cut costs and raised prices.
Since Pearson took over in 2008, Valeant spent almost nothing — just 3 percent of sales — on research and development. It ruthlessly cut staff at the companies it bought and it jacked up drug prices so high that Pearson and other execs got hauled before Congress to explain themselves.
It also embraced Fastowesque accounting, taking advantage of tax havens, using complicated inter-company relationships and embracing a financial opacity that shrouded the acquired companies’ performance. No matter, though. Valeant’s stock soared, rewarding Pearson and other executives in the process.
Then reality caught up with the accounting. Now, Valeant is restating earnings; its shares have lost 85 percent of their value; the Securities and Exchange Commission is investigating; and Pearson is on his way out.
Meanwhile, another company, SunEdison, became a Wall Street darling by setting up affiliated investment vehicles, known as “yieldcos” to finance the rapid expansion of its solar panel business. SunEdison built solar installations, then off-loaded them to the yieldcos, which would use them to create a dividend stream for investors. After questions arose about the related-company relationships and the financial engineering behind them, in- vestors fled the stock, sending it into a tailspin. The company reportedly is now on the brink of bankruptcy.
Both companies believed, as Enron executives once did, that they had found the long-sought alchemy to make risk disappear.
Fastow couldn’t tame risk, nor could Enron’s bankers, who deluded themselves into believing that Enron’s failure didn’t discredit its strategies. Citigroup and others used similar off-books structures —
the yieldcos of their day — that helped feed the mortgage crisis of 2008.
Even the near destruction of the global economy and the imposition of regulations that Wall Street continues to whine about didn’t drive home the lesson.
Adecade after Enron’s collapse, investors — individuals, institutions and the new cool kids of finance, private equity firms — continue to chase the dream of risk-free reward. Enron’s ghosts still stir their hearts.
Risk and reward, though, are the yin and yang of capitalism: One cannot exist without the other.
Risk can’t be eliminated. It can’t be engineered out of existence. It is baked into every business decision, and if it isn’t accounted for — accurately and transparently — it may lie dormant in a forgotten crevice of the balance sheet for a while, but eventually it will return with a vengeance.
As I wrote at the time, the verdicts against Lay and Skilling were about responsibility. They were a reminder — then and now — of what we expect from leaders of public companies: honesty, transparency, accountability.
Enron’s demise was an embarrassing blot on a city that prides itself on business, and many around town would like to forget it. Valeant, SunEdison and others still to come — and make no mistake, there will be others — remind us of the lessons we can’t afford to forget.