23. The End: Enron and Andersen’s Collapse
How things developed at Enron
Enron was the most admired company in the US in de 90s. From being an anonymous Texan gas pipeline network company it became the paradigm of innovation, creating new markets all over the US and in many other countries. The prestigious McKinsey consultancy set Enron as the example to follow; as the new business paradigm. Their top executives were those nearest to be “masters of the Universe”.
Andersen also counted Enron as example of one of its best clients.
This background helped much to give the executives and Enron itself an unassailable aura.
Its climb in the stock exchange was meteoric.
One of the keys for its fast growth was the application of very high doses of financial engineering to its operations. Enron made massive use of mark to market accounting (market price valuation of a company’s assets), a technique that was known and accepted by the SEC and perfectly legal in the USA. But that technique was carried to show as profits cash flows that would be produced only in the future, what meant imbalances in its financial statements. Moreover, Enron took to extremes the techniques of maximum leverage when making acquisitions or entering into new projects.
As a consequence of such highly aggressive policies (but in the line of value creation for the shareholder so much in fashion at the time), it needed great financing volumes. However this financing could not exceed a certain proportion of the shareholders funds to prevent a rating reduction under the minimum required by its finance providers (BBB+).
In order to “park” (off-balance sheet) these liabilities, one of the operations that Enron made with growing frequency was to create instrumental companies out of its own orbit. They were called SPVs, special purpose vehicles. Not only Enron did that. Many other companies were practicing the same sport in those years. Even now it’s being used. Its existence poses more difficulties in the study of any corporation.
These SPVs had to be independent of Enron so that the mother company should not be under the obligation to consolidate its accounts; otherwise there would be no point in their creation. The problem was that they were not independent. And even some were clumsily done by Enron’s own executives. It seems that this lack of independence was hidden to Andersen’s auditors.
At that time, Enron’s CEO, Jeff Skilling, an ex McKinsey (number one worldwide firm for strategic consulting), in a results reporting presentation, came even up to calling stupid a newsman that dared to ask him why they did not publish their financial statements.
The magnitude of the deception grew over time. Andersen began finding that the SPVs were not independent in spite of the framework set up to hide it from them. And even found that one SPV belonged to Enron chief accounting officer and his family. When Andersen denounced it to Enron’s management no satisfactory response was given and the deception started to come uncovered.
Andersen revised totally its auditing conclusions and presented serious changes to the financial statements. Enron in sum was pumping up its profits and hiding liabilities. Its executives, furthermore, were getting rich on their side, at the expense of the company they should serve.
At a given moment, summer 2001, Jeffrey Skilling resigned, alleging personal reasons. What happened really was that he was overwhelmed by the magnitude of the disaster and wanted to get out of the way.
With the CEO’s departure panic broke in the markets and Enron’s shares plummeted down. The final result is known; bankruptcy, thousands of shareholders’ savings evaporated.
The accusing finger pointed at Andersen first. Even before pointing at Enron’s executives.
The just pay for the sinners
Nobody can deny that Andersen’s intervention in the Enron case did not respond to the patterns of excellence advocated in this book. On the contrary, it was foolish and deserved sanction. We don’t dare to call it crime because, as we’ll see later on, no criminal offense was found by the courts. But we understand there was ground for an accusation because of the way things happened, with the absurdity of the paper shredding episode as culmination of the insanity shown in the process.
Does that mean that all Andersen’s personnel around the globe should be blamed for this professional negligence centered in a US client? Were we all guilty of professional negligence, as some people claimed?
We believe that the generalization was -is- totally unfair. The professional principles of the immense majority of ex-Arthurs were -and still are- valid and unchanged, based on the seven columns spelt out in this book.
On the other hand, other professional services firms have gone through isolated negligence episodes; among them the four big still active auditing firms (Ernst&Young, Price Waterhouse, KPMG and Deloitte). What made the Enron episode different was an accumulation of negative circumstances, and also that Andersen as a Firm did not know how to act rightly once becoming conscious of the fraud that was Enron’s accounting.
Probably the magnitude of the problem was underestimated, with the feeling that it could be managed without taking exceptional measures. There was a serious error of judgment.
In addition, what happened with the other culprits?
- investment banks that designed and financed the SPVs in exchange of fat profits
- rating agencies, that for years gave high ratings to the company
- market analysts that were receiving limited and biased information and made no complaint
A misguided intervention...
Andersen’s intervention was clearly misguided, condensing in at least three mistakes:
- Not finding a correct reaction
That was Andersen’s biggest sin: reacting by destroying information.
Although the document shredding episode is somewhat confused, the undeniable truth is that it publicly projected a guilty image that de facto condemned the Firm in the media. A condemnation that remains firmly in the whole planet’s media, and in the public opinion shaped by them. - Not managing the media
The Andersen case is studied in journalism schools all over the world as an example of what should not be done when confronted with the need to manage an image crisis.
Andersen did not know how to manage the crisis with the media and with the public administration agencies. Or at least did not know how to do it in the special circumstances of the case.
The Firm, chaired at the time by Joe Berardino, did not know how to avoid the media and public opinion condemnation that in fact provoked the charge by the Department of Justice. The fight with the media and the Government was unequal, because there are well-founded suspicions that the media and the Justice Department actions were spurred by the Bush administration.
George W. Bush had just been named President of the United States and did not wish to see himself associated in the bankruptcy scandal hitting the company of one of his main donors and friends, Kenneth Lay, Enron’s CEO and chairman.
Not even a well prepared firm could have faced the attack of the US republican politicians and Andersen was not even a prepared firm.
Very few remember that in January 2002, five months before the opening of the trial against Andersen on obstruction of justice charges that would end with the verdict on 15 June 2002, President Bush allowed himself the following joke in the course of a speech he made in Washington, referring to Sadam Hussein and the famous hidden weapons of mass destruction: "The good news is he is willing to let us inspect his biological and chemical warfare installations. The bad news is that he insists Arthur Andersen to do the inspection!".
To all ex Arthurs, it was offensive and embarrassing. - Not being able to fence in and isolate the problem
The lawyers counseling the Firm did not show due professional competence, neither in the courts nor to foresee and limit the consequences of the affaire.
The charge by the Justice Department entailed the ban to practice auditing in the US and a global reputation loss of such dimension that forced the national firms belonging to Andersen Worldwide to hurriedly dissociate themselves from the Firm and search protection at some of the big auditing firms, that were happy to pick up the remains of the shipwreck.
The participants in the “rescue” were the other four big firms: KPMG, PriceWaterhouse and , above all, Ernst&Young and Deloitte.
The choice of the firm to join depended on the national partners in each country. The majority opted for Ernst&Young and Deloitte.
In Spain, the auditing Firm joined Deloitte. The law and tax advice practice went independent (Garrigues). The consulting division, Andersen Business Consulting, was sold to KPMG Consulting Inc. that later changed its name to BearingPoint. A part of the Corporate Finance practice went independent, creating Ambers.
A misguided intervention… but not a criminal one
We believe that Andersen’s intervention in Enron can be rightly described as misguided, be it foolish or incompetent, but not as criminal.
The absolutory sentence passed by the US Supreme Court, on 31 May 2005, unfortunately three years after the case, proved that the Justice Department accusation was unjustified, and still less justified was the ban on the practice that had been ordered immediately after, the final blow to the Firm.
The subsequent US Supreme Court ruling, however, was useless to wash up Andersen’s image, and still less to call back to life a Firm that was by that time absolutely dead.
The price of integrity
The contradiction between the emphasis on Results and the rest of the principles came to a head during the 90s. It was necessary to grow and earn money at all costs, and those who did it were rewarded and recognized. Everything was justified to emulate AC. These were years with a certain leadership crisis and the Firm was obsessed by internal rivalry matters.
David Duncan, the partner in charge for Enron, was a young rising star in Andersen in those years. Enron, with almost 100 million dollars in yearly fees, was his life, and what was giving him money, fame and power in and out the Firm. When he had to oppose all that and give priority to Integrity, he was short of the wisdom, the force or the will to do it. Furthermore, he culminated his work with the most stupid document destruction that could be imagined. An action without any sense, that helped nobody. And that was the basis for a criminal charge and for the extinction of a great Firm.
The price of integrity and, in a way, the Firm’s price was that one: 100 million dollars in fees. A trifle compared with the destruction caused.
Enron and Andersen were victims of financial engineering, but above all victims of the lack of integrity of their high executives. Many innocent people (shareholders, suppliers, employees, partners, etc.) paid a hard penalty.
Homicide or suicide?
A mix of both things.
There were elements of homicide, with Enron’s executives and the politicians in Bush team as the culprits. We cannot forget that above all the Enron’s case happened because their top executives proved to be criminals.
Enron’s CEO, Kenneth Lay, died of a heart attack in 2006, when he was expecting a 45 years sentence. Jeffrey Skilling was sentenced in 2006 to 24 years in prison. Andy Fastow was sentenced to just 6 years because of cooperation with Justice and will be freed in 2011.
But Andersen’s end was, above all, suicide. The chronicle of a suicide foretold.
Since the split in two business units in 1989, all the way through 90s decade, the consultancy explosion, the corporate operations and a certain crisis in auditing, Arthur Andersen found itself lost aimlessly and with manifest lack of leadership, made worse by the evidence of a strong leadership at Andersen Consulting.
At AC they knew what they wanted. Not at AA. The sensation at the time was that of being in a great house that squandered the wealth accumulated by the family in the past. The reaction was misguided. It was the search for growth at any price, improved profitability, AC emulation. But good judgment was lost.
The Results and Ambition columns grew and pushed the model out of balance. Even the rest of the columns helped to extend the problem. Discipline, respect for the status quo, hierarchy, cooperation were fatally effective when the leaders, above all in the USA, went away from the Firm’s basic principles, washed their hands of the model that had shaped the Firm, because very few dared to denounce it.