Markkula Center of Applied Ethics

Enron: We Slept Through Class

By William K. Black

Yesterday, the first Enron insider pleaded guilty to fraud. The government is plainly gunning for his boss, the former chief financial officer, Andrew Fastow.

Enron should teach us three fundamental lessons. First, we slept through class when the same lesson was taught 15 years ago. Enron pioneered no new fraudulent techniques. Indeed, compared to Michael Milken (the "junk bond king" at Drexel) and Charles Keating (Lincoln Savings), Enron's scams were far less sophisticated. The S&L debacle displayed all of the fraudulent practices used by Enron, including suborned audit firms (Arthur Andersen gave "clean" audit opinions to Lincoln Savings) and the cultivation of politicians (the senators who became known as "the Keating Five" and Jim Wright, the Speaker of the House). No serious reforms came even though the debacle cost the taxpayers $150 billion.

Second, stock bubbles make possible massive fraud. The nation is very lucky that Keating and Milken were, owing to confessing that they were felons, unable to take part in the recent high technology bubble. Keating and Milken were unable to fleece many shareholders in the 1980s. In the 1990s, however, money poured into the stock market, often coming from first time investors excited at the prospect for instant wealth. Stock prices in a bubble no longer reflect real economic fundamentals, which makes it easy to loot shareholders. Even so, Enron CEO Kenneth Lay, a protege of Milken, lacked the master's touch. Enron was shooting fish in a barrel and still couldn't top Keating's record of losing $3 billion in a single S&L failure.

Third, the new "financial sophistication" we developed in the 1980s and 1990s has failed. Instead, things we have known for thousands of years have proven to be true. Enron had little concern about conflicts of interest. Enron's board of directors authorized their chief financial officer (CFO) to be in a naked conflict of interest on the now notorious Enron-funded partnerships. (Enron created them to defraud shareholders by hiding real losses and creating phony profits.) Enron thought its CFO would cheat others but remain loyal to Enron. Modern "law and economics" corporate governance theory says conflicts of interest authorized by the board are fine. History suggests that maximizing conflicts of interest is a superb way to get ripped off. Surprise. Enron's board now says the CFO ripped off Enron as well as the shareholders. There is no honor among thieves.

Keating's response to a similar problem illustrated his superior flair for fraud. His guy in charge of ethics and regulatory compliance (which meant he was in charge of the opposite) embezzled money from Lincoln Savings. Keating found out and had to get rid of him. Firing him would have been a tad embarrassing, so Keating drafted a resignation letter from the guy that said he was leaving because he couldn't stand to deal with the reprehensible regulators who were so unfair to his wonderful boss, Charles Keating. Keating sent it to the top regulator; noting that it was a travesty when regulators forced such wonderful men out. Now that's chutzpah!

Ethics Center Visiting Scholar William K. Black is assistant professor at the LBJ School of Public Affairs, University of Texas at Austin. He was director of litigation for the Federal Home Loan Bank Board.

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