It is not just outsiders who find the Enron scandal outrageous. Insiders at the company apparently found its conduct shocking, too.

Last August, four months before Enron filed for bankruptcy, a senior executive named Sherron Watkins wrote to Enron's chairman, "I am incredibly nervous that we will implode in a wave of accounting scandals." She conceded that "a lot of accountants," including Arthur Andersen, "have blessed the accounting treatment," but she insisted that "none of that will protect Enron if these transactions are ever disclosed in the bright light of day." And she noted that she was not alone; two other senior executives had also voiced objections. A midlevel employee had told her: "I know it would be devastating to all of us, but I wish we would get caught. We're such a crooked company."

Two reasons seem to explain why this crooked behavior - which cheated ordinary investors of millions of dollars - took place despite protests from within the company. The first is the character of Enron's leadership. The executives who set up the shell companies that masked Enron's true financial profile were consciously trying to deceive investors, including many of their own staff who had bet their retirement funds on Enron stock.

These executives knew they were acting dishonorably, which is why they appear to have deliberately silenced doubters. One of the doubters mentioned in the Watkins letter, Jeff McMahon, the company treasurer, was moved into a different job after questioning the shell companies. And when the letter reached Kenneth Lay, Enron's chairman, Mr. Lay's response was to ask Vinson Elkins, Enron's law firm, to look into the matter. But the letter had pointed out the firm's conflict of interest: Vinson Elkins had apparently approved some of the deals that started the shell game.

The other reason why Enron behaved scandalously is that the accounting rules themselves are a scandal. It is clear that Enron's shell companies cheated investors and appalled company insiders; it is clear that they throw into question the whole basis of stock market capitalism, which is that investors assign values to corporations by scrutinizing their accounts. And yet, unbelievably, it is not clear that these shell companies were illegal.

Equally, it is known that Enron's auditors spotted $51 million worth of problems in Enron's accounts back in 1997, yet they felt able to certify the accounts as accurate because the discrepancies were not "material." Rules that permit this sort of discretion are unworthy of the name.

Harvey Pitt, chairman of the Securities and Exchange Commission, says he wants a new system for policing auditors. His concern is welcome. As he weighs the various reform options, he should keep in mind one passage from the Watkins letter: "The overriding basic principle of accounting is that if you explain the 'accounting treatment' to a man in the street, would you influence his investing decisions?" It is extraordinary that any executive should feel the need to point this out to a corporate chairman. Mr. Pitt should not rest until chairmen start to behave differently - until accounts really do convey the information that investors need to make decisions.

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January 22, 2002.

[Source: The Washington Post, January 18, 2002]