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'Bigger Than Enron'
With Hedrick Smith
Producer, "Frontline"
Friday, June 21, 2002; 3 p.m. EDT
The meteoric rise and stunning collapse of Enron caused many to question why the watchdog system that was supposed to protect investors failed to sound any alarms about the company's dubious financial underpinnings. But Enron and Arthur Andersen are the tip of the iceberg. In the late 1990s, Enron was just one of the more than 400 corporations forced to dramatically restate their value because of accounting lapses, failures or fraud. What went wrong?
FRONTLINE's "Bigger Than Enron," airing Thursday, June 20, at 9 p.m. EDT on PBS (check local listings), looks at an oversight system gone soft and how market deregulation and conflicts of interest eroded the system of controls designed to protect stockholders. Producer Hedrick Smith was online Friday, June 21, to talk about what he learned from SEC officials, corporate executives, members of Congress, and investor advocates.
The transcript follows.
Editor's Note: Washingtonpost.com moderators retain editorial control
over Live Online discussions and choose the most relevant questions for guests and hosts; guests and hosts can decline to answer questions.
washingtonpost.com:
When Enron revealed that it had overstated earnings and understated debt by over a billion dollars, it sent a shock wave through the financial markets. Since then, we have seen the demise of a Wall Street darling, the Big Five becoming the Big Four, as well as a host of other scandals that have rocked investor confidence. How do you think corporate America can win investors trust back and how long will it take?
Hedrick Smith: It's not going to come easy. The public is really disillusioned. And the disillusionment deepens every time there is a new Global Crossing, Tyco, Adelphia, and on and on.
The first thing leders in the corporate community can do is to speak out, in the way Paulson of Goldman Sachs did, and admit there's a serious problem, not just in public perception but in corporate behavior. Cynicism about the markets will continue until ordinary people believe that CEOs and top invesment bankers and responsible regulators and politicians are talking to them straight. When the public hears either genuine or mock outrage at bad behavior and financial wrongdoing, and then discovers that the people shouting the loudest helped to create the problem several years ago, the public distrust only deepens.
It's going to take strong, clear, public self-criticism on the part of Corporate America. But it's going to take a lot more than words. It's going to take a change in the way financial and corporate institutions do business, such as separating the consulting and auditing functions of the accounting business, or such as separating the roles and rewards of stock analysts who work for investment banks who make their big money serving corporations whose stock their analysts are promoting.
People are finally catching on to the game. People are finally seeing that in fact who pays the piper calls the tune. And the public no longer believes that there are these so-called "Chinese walls" within the same companies.
The real question for Corporate America to answer is this -- is there money to be made by honestly serving investors without simultaneously trying to serve corporate clients?
Brooklyn, N.Y.:
How guilty is the "free press" for not proactively reporting on Enron before its collapse? Business press is enabled to report on wrongs only when the peg is a broken law; this seems to be a problem in our new world of Clintonian self-regulation. Will Enron cause the media and the media-consuming public to raise their standards and their self-esteem?
Hedrick Smith: There's no question that the financial media generally failed in its job of policing not only Enron, but lots of other corporations. And hopefully, the exposure of Enron, Tyco and Global Crossing, has already bred a far greater skepticism of the financial press.
However, that being said, it is very difficult for reporters to get behind financial numbers of a company that are not only highly complex and made deliberately difficult to understand by the company, but also which have been approved by auditors that until fairly recently the press assumed -- falsely -- were doing their job in making sure the books were honest.
But, you should note that the Wall Street Journal, in its Texas editions, in September 2000, began to point out problems in Enron's accounting in various energy contracts. And that led some short sellers, like Jim Chanos, on Wall Street to begin questioning Enron's profits and actually investing against Enron. It was also the Wall Street Journal in August 2001 that broke stories on Enron's finances that triggered the SEC's investigation of Enron.
So even though the Journal was a minority of one or two -- because Fortune magazine also ran a big story in March 2001 questioning Enron's finances -- the media did better than the stock analysts, the bond rating agencies, the investment banks and the auditors.
Grand Rapids, Mich.:
How can we get our congressmen and the Bush administration to actively particpate in policing the markets and restructuring the regulatory regime?
Hedrick Smith: Believe it or not, they actually pay attention to mail -- and better yet -- visits from their own constituents. So write them, organize local groups to go lobby them, show up at their district public meetings when they go home to meet with the voters, ask about it, ask about it, ask about it, and ask about it some more until they begin to respond. That's how hired-gun lobbyists work in Washington -- relentlessly.
It is very tough for ordinary voters and ordinary investors to be heard. It takes persistence.
Another way to go is to put pressure on local, state and regional institutional investors, such as city and state retirement programs or even corporate retirement programs, to push for the expensing of stock options, the right of shareholders to vote on stock options, the requirement that auditing firms be hired not by corporate management but by the auditing committees of the corporations.
In Michigan, one of your senators, Carl Levin, is taking the lead on legislation to require corporations to expense stock options on their balance sheets in the same way they do on their tax returns. This is a smart move. Be sure to give the senator your support if you agree with him and with me.
I suspect that Sen. Stabenow supports it, but I'm not certain if she's stated her position publicly.
But more important, be sure that both of them, as well as your members of Congress, give strong support of those provisions of the bill now moving through the Senate, authored Sen. Paul Sarbanes of Maryland, that require the mandatory rotation of corporate auditors every five years, and strictly limit the amount and kind of consulting work that auditors can do. It's also important to get that bill to increase the number of "public" members on the oversight board. Right now the bill calls for three "public" members and two accounting members, which makes the board vulnerable to dominance by the accounting professsion.
Arlington, Va.:
Between your program and a recent New Yorker profile, I felt for Arthur Levitt. It must be so frustrating to keep preaching something and supposedly be given the force of government, but no one listens.
Question: How much do you think the Clinton administration contributed to the atmosphere and apparent "de-fanging" of the SEC?
Hedrick Smith: The limits on Arthur Levitt's power as chairman of the SEC were primarily imposed by his oversight committees in Congress, and not from the president or the White House in the Clinton administration. I've never heard Levitt complain of lack of backing from the White House. However, it is probably true that he might have done better if the president had specifically gone out in public and fought for Levitt on a couple of the issues that we profiled, but presidents always have to reckon what issues they want to use their political capital [for].
And as you recall, Clinton was feeling all the pressures of impeachment during the time Levitt was engaged in some of his biggest battles with Congress -- not a time when Clinton's support would have cut much ice on Capitol Hill.
Philadelphia, Pa:
Before Enron there was Reliance Group Holdings which left big New York banks, bondholders, stockholders, policyholders and employees out in the cold. You are not kidding when you say beyond Enron, where are we going to be if the insurance industry collapses. What about the standards of actuaries, insurance rating agencies and state insurance departments. The Washington Post broke the story of "Watergate" where were they on "Unicover." Reinsurance is one big shell game. It is not just the accounting industry that is letting us down.
Hedrick Smith: Thanks for the tip on the insurance industry story. Please send me all information on the story, and how to contact you.
Maybe the biggest problem of all is the decline of ethics in the marketplace. Why do you think that's happening?
Because the problem is not just the failure of specific institutions in one arena or another. It's not just games of smoke and mirrors in one sector of the economy or the other. It's a breakdown of the honesty of commercial relationships -- between an Enron and consumers in California, between the management at Sunbeam or Waste Management and the stockholders in that company, between the accountants and the boards of directors who they kept in the dark about the financial shenanigans, and on and on.
As former Fed chairman Paul Volcker said to me, "Years ago, my mom and dad taught me what was right and wrong."
What ever happened to that concept in the go go '90s, when everyone was out to make money, damn the consequences!
Dallas, Tex.:
Harvey Pitt seems to be against expensing stock options and doesn't plan on making that one of the changes he will push. If he is against this method of correcting corporate Board behavior of handing out outlandish CEOs income/salary pay packages, what does he proposed in order to correct this problem and protect investors from having a company's value drained in this manner?
(I also do not believe the "justification" they are trying to sell, that this is the only way to get CEO's to work for a company. What a crock!)
Hedrick Smith: Harvey Pitt's answer on the stock options question is that you can't calculate their value accurately, which Warren Buffett and others dispute. Mr. Pitt's way of dealing with the problem is to ask the New York Stock Exchange, NASDAQ and others, to require the companies listed in those exchanges to have all executive stock option packages approved by shareholders. In other words, he puts the responsibility for solving that problem on someone else, and we have no way of knowing whether that reform will happen.
Historically, that used to be the requirement -- namely, stock options had to be approved by stockholder vote. My opinion is that stock options are so important financially to CEOs that they will fight just as hard to keep stock exchanges from imposing the rules that Mr. Pitt suggests as they did to kill the proposal of the FASB in 1994 to require the expensing of stock options.
In other words, that's just a diversionary tactic. The SEC could require it. And that would be the simplest way to get the job done. Otherwise, it's going to take legislation in Congress, and that's a real uphill battle.
Houston, Tex.:
In all the investigating that I have watched I have not seen the one investigation that would reveal the most insight to Enron and other scandals (Cisco for instance has lost far more in value than Enron). And that is to put the senators, congressmen, presidents and other politicians under oath and give we the investor the same power as they enjoy. How can we ever do this?
Hedrick Smith: Years ago, I proposed in an article in the Atlantic Monthly that presidents and their Cabinet and the heads of regulatory agencies should have to undergo Question Time, the way they do in the British Parliament -- on a regular, scheduled, monthly basis.
The difficulty today is that presidents can schedule news conferences on their own whim, stretch them far apart, and duck the questions of reporters who do not have the political weight of senior members and leaders of Congress, and so the public is deprived of a direct political debate, and has to settle for snatches of news bites, often separated by several days and deliberate evasions.
But that would probably require a constitutional amendment to fix, unless it simply became a tradition that the American public insisted on and politicians welcomed as a way to join the issues. But then, politicians don't welcome that, do they?
Ogunquit, Maine:
Thank you for your fine reporting on "Frontline" last night. It looks like campaign contributions (of huge magnitude, sometimes!)have almost totally corrupted Congress. How sad. We citizens need to wake up from our comfortable sleep.
Maybe the fact that our holdings in 401k plans, mutual funds, and stocks themselves may take a "dive" shortly due to phony accounting and the greed of people in high places -- if this situation is not corrected -- just maybe this will wake us up. I myself, armed with knowledge, am writing a letter to our local paper this week. I've got to do what I can to mobilize citizen awareness. After all, David did overcome Goliath that day. Thanks again.
Hedrick Smith: You're right on point. There is no question that political campaign contributions not only influenced those who spoke out on behalf of the interests of the accounting profession and corporate America in the issues that we profiled in "Bigger Than Enron."
But those same contributions, or the fear of losing them, also influenced the politicians on Capitol Hill who did NOT speak out on behalf of consumers and investors for fear of alienating future campaign contributors.
The influence of campaign contributions is also hanging over Congress right now, and affecting how it is handling the post-Enron need for reforms. Very few politicians want to publicly stake out a position on an issue as seemingly minor as expensing stock options when they fear it's going to offend a whole host of potential corporate and executive contributors to their campaigns
We have just seen the board of directors of CalPers, the largest pension fund in America, vote down the recommendation of its staff to fight for the expensing of its stock options in all companies where it holds investments, because of the heavy lobbying of corporate interests in California on the CalPers board, which includes heavy representation of California politicians who want to raise money for their campaigns from those corporations.
Good for you for trying to do something at the grass roots. That's the only way change will happen.
Highland Park, Ill.:
I missed the program and would like to see it. Will it be re-broadcast? Thank you for doing the work on this program and many other in-depth reports. I hope you continue with this excellent work.
Therese Waldron
Advocate for more Hedrick Smiths washingtonpost.com:
You can find out when a program will be re-broadcast on the Frontline Web site.
Hedrick Smith: Please feel free to call David Fanning, the executive producer of "Frontline," at (617) 300-3500. Because, frankly, we ourselves do not know if or when the program will be re-broadcast. So if you find out, let us know -- but don't tell my friend David that I sent you.
Washington, D.C.:
What happened to the employees and stockholders of Sunbeam? Are pensions devastated?
Hedrick Smith: On Sunbeam, I can't give you the particulars about how much money was lost by employees with 401(k) plans, but it was substantial, just as it was at Enron. The stock totally collapsed after the truth came out about its accounting and its true financial state. So shareholders and employees got hit very hard.
Washington, D.C.:
Hey Hedrick this is John Allen, the Web programmer form Modus.
In YOUR opinion, when this is all sorted out in the courts, do you think:
1. That the executives for Enron and Anderson should be FORCED to return profits made by thier shifty accounting?
2. Will be made to give money back to those who lost so much?
Hedrick Smith: It's perfectly clear that Bill Lerach, the attorney for the Enron stockholders Legal Coalition, is going after all potential sources of money to recover stockholder losses, and that includes the personal funds of high corporate executives. So that's already on the table. And I would guess, though it is only a guess at this point, that if there are court decisions that high Enron executives were guilty of insider trading or taking funds out of the company at a time when they knew the company's accounts were questionable while they were urging stockholders and employees to keep holding Enron stock, then they're likely to be ordered by the courts to pay back some funds.
Frankly, I do not know what the legal precedents are, but I suspect that for there to be generic settlements, they will have to be found guilty of financial fraud or some wrongdoing.
However, they may be forced to cough up some of their own funds in an effort to try to settle the stockholders' suits out of court. That did happen, for example, to Al Dunlap, the former CEO of Sunbeam. Lerach's firm made it a condition of settling the lawsuits against Sunbeam that Dunlap would have to pay $15 million out of his own pocket, and Dunlap agreed to that condition in order to settle the lawsuit and not to go to court, where he and others stood the risk of being penalized even more.
So it can happen.
Durham, NC:
Should the SEC appoint different auditors to perform the audits of the publicly traded companies each year to make the process an arms length endeavor so that the accounting firms would report the truth--knowing that they would be followed in a subsequent year by another firm. Also, wouldn't it be reasonable for the SEC to accept the money from the publicly traded company for the audit and make the assignment without the audit firms having to vie for the contract.
Hedrick Smith: You raise two very good suggestions. The first is rotating auditors. Given the complexity of lots of businesses today, it may not make a lot of sense to rotate auditors every year. A green auditor may not catch what a more experienced auditor would catch. But rotating auditors every five years is an important provision in a Senate bill authored by Paul Sarbanes of Maryland. The accounting industry is up in arms about that provision, and Harvey Pitt, chairman of the SEC, opposes it and has been lobbying against it. But investor advocates think it's a good idea.
The other idea, of having auditors hired by the SEC instead of being hired by their corporate clients, is also sensible. After all, in the field of banking, where the public has a strong interest in making sure the books are right, that there's no stealing going on, we have state and federal bank examiners who go around and check the books. In other words, government regulation is taken as the norm in that industry.
So why not in accounting and auditing?
The answer is that right now, the chairman of the SEC opposes that provision, and the prevailing climate in Congress is also against it. But strong public pressure and/or a shift in the balance of power in Congress toward those who favor serious reform could have an impact.
Rockville, Maryland:
I've noticed that corporate board members increasingly buy options at $0.00 rather than the market price. This being the case, they stand to profit so long as the stock does not plummet to zero. Buying periodically at $0.00 and selling periodically at something greater than zero is a guaranteed income regardless of business success. How did this start?
Hedrick Smith: Something doesn't sound quite right here. Lots of corporate executives get outright grants of stock from their corporations -- grants, as opposed to options. Obviously, a grant guarantees absolute gain because the cost is zero.
But options are customarily issued with what is known as a "strike price," normally the price of the stock on the day the option is issued, sometimes with a discount of 10 or 15 percent. Then if the stock price goes up, the option holder can exercise the right to buy the stock at the strike price and make a profit on the difference between the strike price and the sales price.
The real catch on executive stock options is that when a stock price goes down after the strike price is issued, corporate exeuctives go back to their boards and get those options canceled, and new options issued at the new, lower stock price. So once again, they get a chance to buy low and sell high, operating from a lower price. And if the stock price keeps going down, then they go back to the board again and get the options re-issued.
So the net effect, as you point out, is an "I win, you lose" situation for the CEO as compared to the ordinary shareholders.
San Francisco, Calif.:
Who restores the moral structure to this country's business and government communities? I was thoroughly disgusted by the greed, unethical conduct, and knowingly deceiptful actions of government officials and private big business alike. As a "regular" citizen the level of frustration with not being able to have my voice heard feels like a chokehold. Where's the fix? How is it cleaned up?
Hedrick Smith: That's a very important question. And there's no simple answer.
Restoring ethics and morality to the marketplace, and also to politics, is a matter of individual leadership by captains of industry and public officials. Our leaders have to simply say, "That may win me votes, or make more money, but it's not right and I'm not going to do it."
In terms of the fix, we as individuals and organizing as groups, have to put pressure on our public institutions. In California, for example, the board of the biggest pension fund in the country, CalPers, just voted, about 10 days ago, against expensing stock options on corporate balance sheets because of the pressure of corporate lobbying on the board members, several of whom are California politicians who want to raise campaign funds from those very same corporations.
This vote overrode the strong recommendation of the staff of CalPers, that executive stock options should be counted as an expense against corporate income to make corporate books more honest, and to put more restraints on the behavior of high corporate executives. In the past, CalPers has been a leader in pushing for improvements and reforms in corporate goverments. But in this vote, it backtracked from that record and from its responsibility.
I don't know how much coverage this vote was given in the California press, but it ought to be vigorously debated by people all across your great state. Here is an issue that directly affects masses of state employees whose retirement pensions are held by CalPers and who already have sustained significant losses from Enron, Cendant, Waste Management, Tyco, Xerox, Lucent, Sunbeam, Rite-Aid, and on and on.
If a state pension fund with such a widely democratic membership can balk at making such a simple and responsible decision, the odds of restoring the morals of the marketplace are not good. But that is something that voters, citizens, newspapers, radio stations and state employees in California can have a real impact on.
Good luck.
washingtonpost.com:
That wraps up today's show. Thanks to everyone who joined the
discussion.
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