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.