Tactical Lessons for Internal Resistance

The first lesson in ethical resistance is to not work the problem alone. To an astonishing degree whistleblowers tend to be lone individuals who pit themselves against management and its full arsenal of weapons. Usually this is a lopsided encounter.

Looking back on her course of action, Sherron Watkins’ principal conclusion was that she should have formed a group of resisters, combined their findings and gone as a group to Enron’s Board Audit Committee. In reaching this conclusion, Sherron cites the example of another firm where such a “resistance group” persuaded the Board to oust a corrupt CEO.

To not have to face an ethical crisis alone, one must pre-establish a network of confidants. Such networks can offer more than just group support. They can provide vital information from other sectors of the firm; they also can provide channels for getting messages to executives you can’t reach on your own. To the extent one’s network includes people in the gatekeeper functions, i.e., Controllers, Audit and Law, they can provide technical advice and even a timely investigation. Tactical options then multiply.

To pre-establish such a network, ethically oriented young professionals should seek out like-minded individuals shortly after they join the firm. Many of these can be found in the gatekeeper functions. Getting together informally, taking an interest in control practices and relevant legal issues, such activities both advance professional understanding and cement relationships that can be called upon in a “live fire” situation.

Turning now to specific tactical advice, the first topic is Internal Audit. This is a powerful function inside many firms. It usually has a direct line to top management and the Board Audit Committee. Operating managers are also very cautious about triggering and then failing audits. Such outcomes are often “career limiting experiences.”

Study the status of Internal Audit within your firm. Determine whether it has political clout and independence. If it does, make sure you have communications channels to Audit that don’t require going through your boss or your boss’ boss. Well run firms will create these channels, sometimes in the form of an anonymous phone line or mailbox. If such channels to Audit don’t exist, try to create them informally.

Internal audit must constantly look after its own political capital. Arguably this is something that Enron Audit failed to do (although management was more at fault for not being properly receptive to findings). The best way for Audit to protect its political capital is to be useful to the core business. Its investigative capabilities can help management diagnose business issues and correct faulty risk management. It should cultivate and advertise these capabilities.

Ethically oriented individuals and functions like Internal Audit need champions within top management. Such champions provide support in battles over problematic proposals and protection against subsequent retaliation. In Enron’s case, it is tempting to conclude no such champions were available. Indeed, both Lay and Skilling seem to have been fatally flawed on controls from the outset. Enron’s CFOs were largely ciphers or corrupt.

Yet, it would be wrong to conclude that no champions were available. Controls champions come in two varieties. There are those who believe in controls on the merits. There are others for whom taking an ethical stance is convenient from a career perspective. This can happen after a scandal when someone is put in charge of the cleanup. Sometimes merit and career come together in a key executive. Rich Kinder was such a figure within Enron. Lay put him in charge of the oil trading cleanup. One wonders what might have happened if Skilling’s brand of mark-to-market (MtM) accounting had been brought to Kinder’s attention before it nested into Enron’s firmament. Kinder eventually left Enron and went on to build Kinder Morgan into a largely scandal-free industry giant.

Business managers should also not underestimate their ability to knock aside problematic accounting proposals. Business unit leaders are usually delegated considerable control over their operations. When senior managers promote dubious accounting fixes, business unit heads can resist by saying they conflict with plans to run the business. Numerous options exist for delaying or sidetracking accounting proposals while operating plans are moved ahead.

Appealing to outside gatekeepers that have not been compromised is a critical tactical option. This course redirects problematic proposals to parties that should be less susceptible to management pressure. Arthur Andersen (AA) had the right idea when it redirected Skilling’s dubious MtM proposal to the SEC. AA then unaccountably failed to prepare the ground at the SEC, and Skilling walked away with a surprise favorable decision. It was a fatal error. The manipulative accounting virus was let loose, and Arthur Andersen’s ability to oppose Enron on an accounting decision never recovered.

Another opportunity to redirect a decision appears to Ben Glisan in the “An SPE Too Far?” Glisan has the opportunity to seek an accounting opinion from Arthur Andersen, and encourage that opinion to state that Barclays’ demands don’t work. Doing so would give Glisan the means to redirect Andy Fastow’s wrath against Barclays. The probable outcome would have been Barclays’ accepting altered terms; alternatively, a replacement bank could have been found. Instead, the flawed Chewco deal went forward, leaving a time bomb that exploded at the worst time, October, 2001.

Jordan Mintz’ battle with Andy Fastow provides a final example of redirection, this time to an outside gatekeeper. As an attorney, Mintz could seek an outside legal opinion. He requested an opinion on the public disclosure of Fastow’s compensation from his LJM partnerships. To get an objective opinion, he went to a firm that did not have other Enron business. This opinion helped Mintz confront Skilling with the necessity of disclosing Fastow’s compensation. This was a complication Skilling didn’t need at that moment. It resulted in Skilling forcing Fastow to step down as LJM’s General Partner; this action was the beginning of the end of Fastow’s influence at Enron.

Carefully feeding managers information which they do not know, and which, once disclosed, poses important risks, is another important tactic. The word “carefully” is included here because if done inexpertly, this tactic can get the messenger shot. Often it is best to feed the information in digestible bites, and to combine it with suggestions on how to manage the consequences. Enron Treasurer Jeff McMahon possessed such information about Fastow and LJM. He knew chapter and verse about LJM’s inappropriate related-party behavior and had a good understanding that Fastow had lied about his LJM compensation to Skilling, Lay and the Enron Board. If McMahon had found a better way to feed this information to Skilling and Joe Sutton, Fastow’s damaging reign might have ended sooner.

Vince Kaminski spent a year studying Enron’s neglected risks. At that point he possessed considerable information which management needed to know but arguably wasn’t eager to learn. Vince tried several routes to get his information in front of a receptive audience; the message never got across. His best bet probably would have been Greg Whalley, then the head of Enron trading. Kaminski struggled with the unfortunate reputation of being a Cassandra. Whalley brushed him off. A more careful approach would have calculated how Kaminski’s information could be made to dovetail with Whalley’s career interests. This was another example of finding a situational champion, one for whom a knowledge of dangers is personally convenient. Kaminski could have presented the information in terms of the dangers it posed to Enron’s credit rating and thus to the size “book” that the traders would run. He also could have shown how the financial function did not have a handle on vital conditions. Whalley might then have seen opportunity as well as danger in the information, and joined Kaminski in an effort to rectify the situation. Whalley could have used the information to strengthen his position as a CEO candidate, and to protect his wholesale trading franchise.

Sherron Watkins has been celebrated for her effort to pass vital information to Ken Lay. She also has been criticized for her handling of that information; most specifically, her identity as a “whistleblower” has been questioned because she never disclosed any information outside of Enron. Her famous memo to Ken Lay was only discovered after Enron failed.

Subsequent conversations with Sherron have identified numerous tactical lessons; these start with the “don’t go it alone” message highlighted above. As to her warning message to Ken Lay, it is important to note how Sherron seeded her memo with more than problems. She also made extensive recommendations on how Lay might handle the problems she had highlighted. In fact, Watkins wrote two follow-up memos containing even more specific action steps.

Staying constructive and outlining a viable alternative course of action—this is perhaps the most important concept for an internal resister to keep in mind. Senior executives instinctively react against negative surprises. They usually operate with a sense of “my plate is already full.” Many have learned to distinguish those that only bring problems from those that also bring solutions.

Advancing alternative business plans helps the resister avoid being labeled a “problems-only” player. This may help assure basic warnings get serious consideration. If the suggestions are sound, the resister may be brought onto the “troubleshooting” team. At a minimum, constructive alternatives help inoculate the resister from being labeled a rogue bent on bringing down the company.

Sherron’s last tactical lesson concerns the value of having a personal lawyer.

This idea is most relevant to critical situations, such as when one is disclosing very sensitive information to the CEO or the Board. A personal attorney multiplies a resister’s tactical options. The attorney can pursue contacts without having to follow the chain of command. He can maintain the resister’s anonymity until it is advantageous to give that up. He can negotiate terms of disclosure on behalf of his client, and document them. He can remind corporate officers and directors of their personal liability, and when doing so, embody that threat. Finally, he can discuss the client’s options for going to appropriate authorities, and be the agent to take such action if that becomes necessary.

Personal attorneys are not cheap and many are reluctant to get involved. Watkins takes pains to emphasize the difficulty resisters face in retaining counsel in the midst of a crisis. With that said, she and others were able to obtain suitable counsel. The record also substantiates that these attorneys proved effective in helping their clients. Students of the financial crisis cases will see this when they review Sherry Hunt’s situation at Citigroup.

Watkins is less than enthusiastic about the role of the financial press. She does not see them as helpful recipients of important disclosures. In her view, The Wall Street Journal, The New York Times, Fortune and the others were late and timid in investigating Enron. Sherron’s experience certainly doesn’t add up to a conclusion that the press is never a useful way to combat corruption. Watkins’ view does, however, stand as a cautionary note. The financial press, if they are approached at all, must be approached with the expectation that the firm’s investor relations function will use all its leverage to silence the story.

This brings us to consider the tactics available when resisters decide that internal options are not viable or have been exhausted.

Tactical Lessons for Taking Ethics Issues Outside the Firm

The Enron file is not replete with instances where issues were taken outside the firm. There were no Enron external whistleblowers. As noted, Enron’s most famous whistleblower, Sherron Watkins, never notified regulators or spoke to the press.

That said, the Enron file does contain some incidents of external tactical resistance. The most interesting story concerns Margaret Ceconi, a sales executive at Enron Electric Services (EES) division. Ceconi was convinced that EES was hiding a $500 million loss, even as it continued to report profits. She contacted the SEC anonymously and posed a hypothetical accounting question. The SEC’s answer confirmed her view that Enron’s accounting was wrong. She did not pursue the matter, and the SEC never followed up. After being laid off during a reorganization, Ceconi gave a signed, 10-page letter to the Enron Board Secretary, Rebecca Carter. This letter, alleging disclosure violations, was never shown either to Ken Lay or the Board.

Once outside Enron’s walls, Ceconi adopted a different tack. She contacted Carol Coale, the Prudential Securities analyst who followed Enron. Ceconi began furnishing Coale with information to shape more challenging questions during Enron’s earnings reviews. This tactic reinforced a general toughening of the Street’s analysis of Enron; tougher scrutiny, in turn, caused Enron’s stock price to fall and played a role in Jeff Skilling’s decision to resign.

Ceconi’s story contains a number of tactical lessons. For starters, the SEC is unlikely to do anything with anonymous, hypothetical complaints. They require specific names and evidence to get interested. Ceconi may have just wanted to confirm her judgment, but she could have obtained that answer from a qualified accountant. Providing the SEC with details, up to and including the booking entries that hid the $500 million loss, might have gotten an investigation started.

As for Ceconi’s letter to the Board, it needed to be delivered directly to a well-chosen director. Especially if one suspects top management of being complicit in fraud, delivering a complaint document through channels runs the risk of seeing it sidelined. Here is one of the places where a personal lawyer can be most helpful. The attorney can help pick the best director candidate, make arrangements to visit that person away from the firm, make clear the nature of the issues, and only deliver evidence once the director has indicated receptivity.

Ceconi’s course of action with Prudential’s analyst is most interesting. This appears to be a viable way to force management to confront unpleasant facts. Passing valid information to analysts puts it out in the public domain. Management must respond or risk their credibility by appearing evasive. Investors too get what they need—important disclosures and a chance to reassess management when it reacts to the news.

Ceconi’s actions were similar to another tactic—passing information to short sellers. These investors usually are looking for bad news. Some actively seek out situations where they suspect fraud; they then sell the stock short and look to profit when the scandal comes out. During the financial crisis, some short sellers were active in reporting mortgage origination fraud to the SEC.

Short sellers were among the first to suspect Enron of fraud, and to confront the company over its opaque financial reports. The roles of James Chanos and Richard Grubman in challenging Enron’s financials are now part of company lore. Interestingly, they do not appear to have been tipped off by Enron’s resisters. Later on they may have received some quiet leaks. Passing information to short sellers is more problematic than passing it to analysts. The short seller route can instigate attacks on the company’s stock without getting the information out to the public. Still, for resisters looking for a tactic more potent than disclosure, it may be a viable option.

A final outside tactic involves using counsel to contact the regulators. As noted, counsel can test the waters while keeping the whistleblower’s identity secret. Qualified counsel may also be well versed in what the SEC or DOJ need to get interested in a case. Counsel can provide samples, negotiate on the whistleblower’s behalf, and guide the client in working with the regulators.

Implications for the Financial Crisis Cases

Students should view this distillation of Enron lessons as a tactical toolkit for the financial crisis cases. This toolkit provides options that go beyond “go along or go.” Part of addressing the financial cases involves deciding which tactics can be deployed effectively under what circumstances.

In this regard, students should assess several dimensions of the financial cases:

• Is the key decision maker part of top management or someone down in the ranks?
• Is the crisis occurring at an early or late stage in firm ethical decay?
• Are potential champions still available somewhere within the firm?
• Are gatekeepers still discharging their roles or have they been compromised?

These factors will influence the decision of whether to pursue solutions within the firm or resort to external tactics. That answer will, in turn, direct the student to the tactical options most relevant to that case.

The Enron toolkit involves one company story that unfolded during a specific era. Students should approach the financial crisis cases as both an opportunity to refine this toolkit and as a chance to seek out new options in a different era. As they scroll through the financial crisis, students will be entering a new era for communications technologies and media. Their toolkits should expand accordingly.