(Newsweek) Ken Lay and Jeff Skilling have both been found guilty in the collapse of Enron and the related frauds they were accused of.
Enron was another case of cherry-picking the evidence that supported the claims made, and denying that there was anything that did not support "The Official Story." And "The Official Story" was that there had never been a company like Enron before.
It was magic! Enron created value in imaginative ways never before seen in the Business world! Look at all the analysts who supported the stock. Look at the stock analysts who kept reporting that Enron was beating revenue estimates! Look at the banks who (for high fees) were willing to lend Enron money. Look at the personnel system that routinely measured employees by the amount of revenue they brought in, and quickly replaced the lower half of the performers with new, hungrier, more imaginative salespeople. Because Enron was going to the stars, and everyone who was connected to it was getting rich.
And over it all were the geniuses who had created this money machine out of a stogy old electric utility. Ken Lay and Jeff Skilling. They, of course, were being rewarded for their foresight and imagination, and they continued to explain what a great miracle Enron was - even as it was falling apart.
Because there was nothing new here. Just some fancy accounting tricks that beginning accountants know are bad news. Booking revenue far in advance of when it was realized (actually due and received), then selling stock based on the increased price justified by the high revenue. Just meet or beat the stock analysts' revenue estimates. Considerations of how collectible that revenue was weren't realistic, because the next month the shortfalls would be covered up by more false revenue.
But of course, such advance revenue schemes appear in the Cash Flow statement. Such booked revenue isn't confirmed by the cash collected. So Enron did the imaginative thing. I've heard that they didn't publish a cash flow statement (not confirmed.) Booking revenue before it is received, of course, leads to the problem that the company runs short of cash to pay its bills, unless it can borrow more cash. Enter the banks.
The banks were happy to lend more cash to the magic money machine that was Enron, the one that Fortune Magazine had touted as the nations most innovative company for six years running. The fees for making those loans were high. The only issue that could cause a problem is if Enron had so much debt on its books that there was a chance they couldn't pay it all back. But Enron was famous for being such an innovative company, and the revenue kept growing year after year. Enron was creating all new markets as an energy broker and exploiting them. And the balance sheet showed relatively little debt compared to the revenue that was being reported. How could the banks go wrong - other than NOT lending the money and getting the fees.
Here we come to the Chief Financial Officer of Enron, Andrew Fastow. Enron needed to borrow money to pay its suppliers, but Enron had too much debt on the balance sheet for the banks to be comfortable lending money. Solution? Get the debt off the balance sheet somehow. Andrew, being a CPA who was as imaginative as the salespeople he was working around, quickly saw the answer.
The answer was the now-famous 0ff-the-books-partnerships. Fastow sold the excess debt to the partnerships and at the same time gave them enough of Enron's constantly rising stock to balance the debt with "assets." As needed, the partnerships could sell the constantly rising stock to pay the debt as it came due, and the increase in the stock prices also gave the partnerships a profit. The banks saw that the debts were balanced by assets, so they were happy to lend the partnerships the money to buy the debt from Enron in the first place. The banks got high fees for those loans, Enron booked the payments for the debt as revenue. The partners in the partnerships got profits. Andrew Fastow was happy to be one of the partners, and collect an additional fee for brokering the loans from the banks. Everyone was happy. As long as Enron stock went up.
The auditor should have stopped Fastow. But the Auditor was a partner of Andersen Accounting, one of the big five accounting firms, and was getting really big fees for his audit gig - as long as he reported that everything in the financial statements was being done correctly. Any hint that there was a problem in the financial statements and Enron would find another auditor who was more amenable to persuasion - and high fees. Used to be that all partners in a partnership collects a share of the partnerships' fees but were personally responsible for the partnerships' losses. In those days, partnerships like Andersen Accounting had internal review teams that checked on the work of each partner, especially on big accounts like Enron. But Accountants and Lawyers didn't like being responsible for each other, so they got federal law changed so that such partnerships were limited liability organizations, like buying stock. Once that happened, the internal review teams were an unnecessary expense, and tended to slow down deal-making.
Of course, Enron was a ponzi scheme. It couldn't last forever. If Ken Lay ever said publicly "Enron is in for a rough patch in the near future." the whole rickety structure would collapse. If a bank refused to provide a loan, it would come down. If the auditor did an honest audit, it would collapse. It only worked as long as Enron stock increased in value.
When one analyst started questioning the "Enron story" his bosses got phone calls telling them to back off. Since the analyst worked for an investment bank, all it took was a few threats to stop selling stocks and bonds through that bank, and the analyst was informed that he should stop reporting bad news about Enron if he wanted to keep his job. Investment banks operate on fees from the companies they sell things for, and of course, those are high fees. Wouldn't want to lose those fees.
Is it any surprise that Ken Lay and Jeff Skilling were out touting Enron even in the last days as it was collapsing? They had hundreds of people whose jobs and retirements depended on Enron stock continuing to increase in value. Sure it was a fantasy, but it had been a fantasy for years and the stock kept going up. If they could just resell the original fantasy, everything would be alright.
So Ken Lay and Jeff Skilling went out and lied. They had to to keep the fantasy in place. But the fantasy disappeared anyway, and now they are going to prison for their lies.
So what did Lay and Skilling to that was criminal? The courts say they lied, because lying is against the law. Poor leadership is not illegal.
Ken Lay was convicted of six counts of wire fraud and securities fraud. Jeff Skilling was convicted of 19 out of 28 charges, most of then wire fraud and securities fraud, and the remainder were about lying to the auditors. What they really did was fail leadership 101.
The military teaches that a leader is responsible for everything his subordinates do or fail to do. A squad leader can watch his nine men to see what they are doing and not doing, but what does a General do? He listens when problems are presented and he investigates to make sure that routine is followed. No one tells a general what he is doing wrong. The same is true for CEOs.
Ken Lay and Jeff Skilling instead did not listen to problems reported to them, or as in the case of Ken Lay when a Sharon Watkins, a Vice President of Accounting, told him that the structure of Enron was about to collapse, he passed it off to his law firm. The law firm essentially said she was wrong and wrote the problem off. The accountant was transferred, considered for firing, and has had trouble getting work since Enron collapsed. The rule is "Spread the best news, shoot the messangers of bad news."
When pushing high energy sales people who are rewarded big for success and fired for failure, the financial controls are critical. In Enron's case, the financial controls were non-existent. That is where Lay and Skilling failed.
Did their people fail them? Sure, but the structure and culture of Enron made it a certainty that people would take big risks to get big rewards. So they took big risks, and avoided being the messanger of bad news because that was another way of getting fired. This is the organization that Ken Lay and Jeff Skilling set up. Lay and Skilling failed leadership 101. This is failed leadership at work.
Sound similar to the Bush administration? It should. Sunbeam and Worldcom also followed much the same process into oblivion. Sure is a shame the U.S. can't declare bankruptcy in Iraq, but that would change nothing there. Iraq comes from the same process. Dream big, act boldly, and shoot the messangers who deliver any bad news.
Everyone has forgotten how to survive a scam. The final step is to get out of town before the whole thing collapses. Jeff Skilling tried, but it too late.
When you hear Ken Lay blame everyone else for a "Run on the Bank", look at him carefully. He is a failed leader, blaming everyone else for what was his responsiblity.
For more on Enron, the Houston Chronicle is always the place to go.
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