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THE REAL SCANDAL: Enron's 'crimes' were legal - legality of Enron's business practices is examined
Commonweal, March 8, 2002 by Mark A. Sargent
There was plenty of illegality in the Enron debacle. Class-action lawyers are already ferreting out the company's affirmative misrepresentations and nondisclosures of material facts ("big lies" to nonlawyers). All of these will be found to have violated the federal securities laws. Corporate executives who profited from private deals with Enron-affiliated partnerships without disclosure to the shareholders probably will be found to have violated the company's own conflict-of-interest rules and breached their fiduciary obligations to shareholders. Arthur Andersen employees appear to have shredded documents related to the Enron audit, even though they knew the documents were relevant to pending or threatened civil and criminal investigations. It also appears that some executives engaged in classic insider trading by dumping their stock at a high price before the bad news about Enron's real financial condition became public.
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The illegality is important because of the scale of the wrongdoing and its calamitous consequences for stockholders, employees, and the securities markets. But this illegality is not novel or particularly interesting. What is interesting is that legal and regulatory restraints did not work to prevent or limit the wrongdoing or to expose it to public scrutiny early enough to reduce the damage.
These restraints did not work because much of what Enron and the people around it did was either completely or arguably legal, and the watchdogs involved with Enron--its accountants, lawyers, and independent directors--allowed the company to push itself to the very limits of legality. Enron thus presents a crisis not of illegality, but of legality.
There was nothing illegal, for example, about the high concentration of Enron stock in its employees' 401(k) plans, which resulted in many lower-level employees' retirement savings going down the chute with the company's plummeting stock price. There was also nothing illegal about the company's restriction on the employees' ability to sell their Enron stock, even though senior managers were free to bail out. The use of off-balance sheet accounting to shift liabilities to affiliated "special-purpose entities," allowing the company to hide debt and inflate earnings to maintain the stock price, has become an accepted although controversial practice. The aggressive accounting techniques used by Andersen were permissible under generally accepted accounting principles (GAAP). Andersen not only fully exploited the GAAP rules to hide debt, it took advantage of the latitude given accountants to determine when financial information is not "material" and therefore not necessary to disclose, and to rely on the "reasonableness" of the dubious assumptions made by Enron managers in formulating financial data. Also permissible was Andersen's "mark-to-market" valuation technique, which allowed Enron to claim immediately projected earnings on energy transactions, even though any revenue from those highly speculative deals would be received only in the long term. Nor did the threat to an auditor's independence created by doing lucrative consulting business with the company it audits create a legal impediment to Andersen's dual auditing/consulting relationship with Enron.
The investment bankers to whom Enron confided information about their investment partnerships were not only permitted to withhold that information from their retail brokerage arms, and hence the investing public, but were required to do so because of the legally mandated "Chinese wall" between investment banking and brokerage functions in securities firms. Similarly, an argument can be made that Enron's practice of sharing substantial information about its off-the-books investments with potential investment partners (mostly large institutions), but not with its own shareholders, did not violate the securities laws. There is even an argument that many of the stock sales by Enron executives were part of preplanned program trading under their stock compensation agreements, and hence not actionable under the antifraud provisions of the federal securities laws.
Most telling, there was nothing illegal about Enron's uncanny ability to avoid regulatory scrutiny. Under both the Public Utilities Holding Company Act and the Investment Company Act, Enron managed to obtain, with public disclosure, exemptions from regulation by the Federal Energy Regulatory Commission, the Commodities Futures Trading Commission, and the Securities and Exchange Commission. The wisdom of those exemptive decisions is debatable, but they were lawful.
Significant revisions of the laws that have proven inadequate are likely. But the problem is greater than that of finding better laws. The real problem is the attitude toward legality that prevailed among Enron's independent directors, accountants, and lawyers. They may have asked themselves whether what they and Enron were doing was "legal." Very few, however, seem to have asked whether it was right. They were content to ask whether they could do it, not whether they should do it.
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