Silent Watchdogs

JIM LEHRER:

On Enron, earlier this week our economics correspondent Paul Solman of WGBH-Boston conjured up the magic behind Enron's accounting practices. Well, tonight, he tries to untangle the world of the financial watchdogs.

PAUL SOLMAN:

If ever there were a maverick businessman on the go, it would be my old college classmate Peter Siris, professional New York investor, member of many boards of directors, former Wall Street analyst, and financial columnist who warned readers of his New York Daily News column that year that Enron was cruisin' for a bruisin'.

PETER SIRIS, Hedge Fund Manager:

I had always thought that Enron was a fraud, and, and I'm on record in my newspaper as saying that.

PAUL SOLMAN:

A year ago, though, no one was listening, perhaps because no one wanted to. And that leads to the big question: How representative is Enron of the whole system? Because in this case, the auditors, boards of directors, and stock analysts, the private sector watchdogs, didn't blow the whistle, because they were arguably better off not blowing the whistle. It's something Siris says he saw years ago as an analyst, when he denounced a particular stock.

PETER SIRIS:

And I talked to friends and they would say to me, why did you do something stupid like that? I said the company was a house of cards. It was going to fall apart. I wanted to bring to it people's attention. They said, "You're an idiot. We're not doing business with you anymore." Now the company did fall apart. It was a house of cards, and they never did business with me again.

PAUL SOLMAN:

Really?

PETER SIRIS:

Because if you don't own a stock, you don't care that somebody says, "Don't buy it." You own ten million shares of a stock and somebody says, "This stock is a fraud," and the stock goes down, you hate that person. They made your stock go down, okay? So one of the reasons you don't see analysts put out "sell" recommendations on stocks is it only makes enemies.

PAUL SOLMAN:

Today, amidst government hearings and daily revelations, it seems the Enron empire had no clothes. But even last fall, analysts were still touting Enron's stock because, given the cozy relationships that can develop in a successful company, the naked truth might have been antisocial. After all, friendships can be involved, and often are– with board members, for instance.

PETER SIRIS:

They're friends of the company, and they go out there and they have… They go out and they have parties together and they have meetings — four, six, twelve times a year with a group of people, and it's a very collegial atmosphere, you don't want to rock the boat. We're going to Enron Field to see the Astros play today. Who wants to sit here and talk about, you know, talking about some sort of partnership when we can see the Astros and sit in the dugout?

PAUL SOLMAN:

We're not talking about all boards, of course. It's just that there is a danger in the cozy collegiality with management evident at Enron. And, says Fortune Magazine's Bethany McLean, who last March became one of the first to write negatively about Enron, there was a similar coziness between the company and its auditor, Arthur Andersen.

BETHANY MCLEAN, Fortune Magazine:

A number of Andersen partners went on to get very high-profile jobs at Enron. Enron's chief financial officer, current chief financial officer, Jeff McMann, came from Arthur Andersen. Enron's chief accounting officer came from Arthur Andersen.

PAUL SOLMAN:

So you've got… So you've got an auditor essentially compromised.

BETHANY MCLEAN:

Mm-hmm.

PAUL SOLMAN:

Compromised, that is, by relationships that were anything but arm's length, as McLean has written, in an atmosphere of heady enthusiasm. Moreover, enthusiasm tends to feed on itself, and spread. Last February, McLean's own publication crowned Enron America's "most innovative" company for the sixth year in a row, as voted by its peers. It came in second in quality of management, says the annual survey's editor, Lisa Munoz.

LISA MUNOZ, Fortune Magazine:

They also scored quite high in employee talent, although they're not in the top three. They also scored quite high in any of the other categories– social responsibility, quality of products and services, use of corporate assets, all of these things that, of course, are being called into question now.

PAUL SOLMAN:

Thus, when it came to Enron, seldom was heard a discouraging word, and the bubble grew. But to put the Enron story in a larger context for a moment, bubbles can endanger an economy. The fact is that the U.S. brand of free-market capitalism, especially in an era of deregulation, depends on private sector watchdogs doing their job, and with Enron, they didn't. Columbia Law Professor John Coffee.

JOHN COFFEE, Columbia Law School:

The system of corporate governance we have assumes that there are going to be a series of watchdogs– auditors, audit committees, securities analysts, outside directors, bond-rating agencies — that are going to examine and test the credibility of your statements. All of them failed in this case.

PAUL SOLMAN:

The importance of such failure is arguably profound. It's one thing to see crony capitalism in Indonesia and even Japan, where relationships seem to drive investment instead of open competition; it's quite another to bring it all back home.

JANICE FARMER, Enron Pensioner:

I trusted the management of Enron with my life savings. Senators, I won't mince words here. They betrayed that trust.

PAUL SOLMAN:

So many investors ruined, and you start to wonder about the fabled transparency of U.S. firms, which brings us back to a second aspect of the watchdogs' failure at Enron: They weren't just cozy with the company; they also had genuine economic incentives to look the other way, or so claims Peter Siris, again citing how the firm handled its board.

PETER SIRIS:

They gave big fees to the directors, and they also greased the directors' charities. I mean, for a lot of these people, it's big compensation.

PAUL SOLMAN:

Enron's board ranked seventh in the nation in compensation, nearly $400,000 in cash and stock, which raises the issue of "you scratch my back, I'll scratch yours."

PETER SIRIS:

Just remember, the board votes on the compensation of the management, okay? Now, who votes on the compensation of the board?

PAUL SOLMAN:

The management.

PETER SIRIS:

Hey! So let me ask you– you're the president of the company; I'm on the board. I say, "Look, Paul, you know, don't you think you should give us board members an extra $50,000 a year in compensation this year? What do you think?"

PAUL SOLMAN:

"Yeah, my own compensation is coming up as well."

PETER SIRIS:

"I think, I think… Let's put it this way: I think you should deal with the board first. Then I'm sure the board will be happy to deal with your compensation." This is… Hey, this is a good system.

PAUL SOLMAN:

Technically, directors represent shareholders, but they're picked by management, as are the auditors.

JOHN COFFEE, Columbia Law School:

I think the basic story of what's happened over the last five to ten years is that, for the auditors, the costs of acquiescing to management– that is, the possible liabilities– have radically diminished while at the same time the benefits of acquiescing to management have radically increased.

You can now make a great deal of money by being very cooperative because you can sell management very lucrative consulting business that is much more profitable than being a staid, old-fashioned auditor. A study has been done by, of all people, Arthur Andersen that finds that the rate of earnings restatements by publicly reporting companies has increased 47 percent over the last three years.

I think that's a proof that the old system isn't working, that the auditors are not deterred, and that they are also much more seduced by the benefits of being able to sell consulting and other services to the company.

PAUL SOLMAN:

Then, again, there are the Wall Street analysts, and here, Siris may shock you.

PETER SIRIS:

The economics are very simple: You get paid for being a cheerleader if you're an analyst.

PAUL SOLMAN:

Now, analyst meetings can be rah-rah rallies, as we saw at Enron's Houston neighbor and rival, El Paso, last year. But more important, the analysts work for the same big Wall Street firms– Merrill Lynch, Goldman Sachs, Morgan Stanley– that get huge fees for doing deals with firms like El Paso and Enron, which in turn wants the analysts to pump their stock price.

PETER SIRIS:

So, you know, who are you going to give investment banking business to, the guy who says "sell" or the guy who says "you're geniuses, we love your company"?

PAUL SOLMAN:

Now put yourself back in the analyst's shoes: Do you say, "sell Enron" and make a normal salary?

PETER SIRIS:

Or do you join the chorus, put a "buy" out on stock, and your firm gets $5 million of fees from doing a secondary, and you get your million dollars for your cut?

PAUL SOLMAN:

Your cut, as a salary or bonus or something.

PETER SIRIS:

As a bonus for bringing in investment banking business into the firm.

PAUL SOLMAN:

Really? And that's actually how it works?

PETER SIRIS:

Yeah. I mean, you think I'm… We went to school together; you think I'd make up a story like this for your benefit?

PAUL SOLMAN:

That is…

PETER SIRIS:

That's how… That's how it works.

PAUL SOLMAN:

I asked Siris, who can be a little sweeping in his indictments, if he had evidence of this. As usual, he was not at a loss for words.

PETER SIRIS:

When I was in industry and I was a senior financial executive at two New York Stock Exchange companies, then the analysts would always say to me, "you've got to put us in the deal because, you know, my compensation depends on getting a piece of this sale." I used to say to the analysts, "You want to be in the deal? We're going to earn $1.35 next year– this is what each division is going to make, this is what the company is going to do. And if you write or say anything different from what I'm telling you, you won't be in our next offer."

PAUL SOLMAN:

You mean, "Your company, your bank, will not get a piece of the action."

PETER SIRIS:

When I was in industry and then…

PAUL SOLMAN:

You would actually say that to them.

PETER SIRIS:

Absolutely. Why are you looking at me like it's strange? I wanted one story out there. I wanted every analyst to have the same story, and if they weren't willing to go along with exactly the way I wanted that story managed, I wouldn't take their phone calls.

PAUL SOLMAN:

Now, speaking of stories being managed, where were we, the media, in all this? One Fortune reporter did blow the whistle, but in general, desirable as juicy exposes are, on the business beat they're very hard to come by.

BETHANY McLEAN:

If you have a company, like in the case of Enron, where the auditors, the management, the board, the Wall Street analyst community, portfolio managers have signed off on the company, and you're the one who doesn't get it, there is a major disincentive to continue to ask questions in the hope of arriving at something that's contrary in wisdom. In some cases it may not be there.

It's not always obvious. Every company doesn't have fraud at the core of it. Every company isn't careening toward bankruptcy as Enron is. So when do you keep asking the questions in hoping that there is something there and that you might be missing something, or when do you stop and say ok, I've talked to 100 people and I've heard all of this and this is the story?

PAUL SOLMAN:

There is one private player with an incentive to sniff out flimflam. The unpopular Wall Street analysts short sellers, those who hope that the stock will go down, like Jim Chanos, who bet heavily against Enron. And although he profits by getting bearish news first, he's worried that America's investors are increasingly vulnerable.

JAMES CHANOS, Hedge Fund Manager:

At the end of the day, if corporate management is willing to look you straight in the eye and lie to you, a lot of people will believe them. And there's a growing subset of companies in the United States where corporate managements are willing to look you right in the eye and lie to you. And I think it's an outrage. And it continues.

PAUL SOLMAN:

Growing.

JAMES CHANOS:

Growing. Growing number.

PAUL SOLMAN:

Isn't this… Aren't they all going to be chastened by what's happened here?

JAMES CHANOS:

We'll see. I mean, there have been a number of debacles where you would think– Sunbeam, Waste Management, Cendant, multibillion-dollar frauds; not the size of Enron, certainly– where you would think someone should have been led off in handcuffs and wasn't.

PAUL SOLMAN:

Now, perhaps, with all the attention being given to Enron, government will take a more active watchdog role, but in the end, for an economy that has long prided itself on getting investor money to the most efficient users of it, there may be nothing worse than a generation of executives who may be able, in effect, to "take the money and run" – or should we say – "Enron."