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Could Enron have been prevented?

Could Enron have been prevented?

As risk managers we deal with problems that run the gamut from access control to the complex mathematics of financial risk management, and, inevitably, someone had to ask us whether the collapse of Enron could have been prevented. The answer is no.

The reason for this is embarrassingly straightforward. There were three possible groups who could have prevented this. The first was management, which could have adopted better accounting practices. Unfortunately, once management has bought into the belief that the function of a corporation is to reward upper management, rather than to maximize the profit of the company’s owners (i.e., the shareholders), it is unlikely that they will behave with total propriety. This is made worse by the group dynamic of peer pressure, where otherwise honest people will do things that in retrospect should not have been done.

The second group that might have stepped in was the independent auditors. However, the independent auditors made much more money from consulting than they did from the audit, and we suspect there was a great deal of internal pressure to preserve the revenue stream, rather than endanger it through petty propriety. In a word, they were not independent. While we like to think that these actions were atypical (other partners in the firm seem astonished that those involved would have done what they did), it remains to be seen whether the innocent will be punished along with the guilty.

The third group was Congress, in its role as regulator. In 2000, Arthur Levitt, then chairman of the Securities and Exchange Commission, proposed an SEC rule that would bar accountants from also acting as consultants, because he felt it created a conflict of interest. That proposal was rejected after 46 members of Congress called or wrote personal letters to Levitt questioning the proposed rule and some lawmakers reportedly threatened to withdraw funding from the SEC.

Why would they do this? We hate to appear cynical, but if you look at the contributions by the accounting industry to senators and representatives (see http://www.opensecrets.org/news/accountants/accountants_senate.asp and http://www.opensecrets.org/news/accountants/accountants_house.asp), it is a lot of money. It doesn’t take a big stretch of the imagination to think that a senator or representative who accepts no money from the accounting industry might have fewer issues in this area than a senator who has received $482,453, or a representative who has received $286,593.

Now, the question of influence is a tricky one. Some feel that contributions allow the political process to continue, and that they, the receivers of this contributed largesse, are not, in fact, obligated to the contributors. Not unlike the way some believe that violence on television and the movies has no effect on violence among viewers, while others believe that advertising inclines people to buy the things they see advertised.

No matter what your views of these issues, if you had any money sunk into Enron stock you probably wish that either management, or the auditors, or your elected representatives had behaved better / more prudently with your money.

Is Enron relatively unique? Clearly no. Arthur Anderson had the same problems with the Baptist Foundation of Arizona several years earlier when 750 million in assets was more like 125 million in assets because most of the assets booked by the Baptist Foundation were found to be substantially overvalued. Other companies to look at: Cendant, RiteAid, and Sunbeam.

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