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Power Failure

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As Enron crashes, angry workers and shareholders ask, Where were the firm's directors? The regulators? The stock analysts?

Charlie Sanchez was working at his computer in the eight-man office of Houston-based energy market managers Gelber & Associates last Wednesday when the quotes for natural-gas futures went blank. Then West Coast spot prices for gas vanished. One by one the handful of markets that update continuously on his screen darkened like spent light bulbs. "Within a minute the screen was blank," recalls Sanchez. There was nothing wrong with his PC. But there was something terribly wrong with the company that managed all those quotes: the brash energy-trading giant called Enron.

After weeks of escalating financial troubles, business had effectively collapsed in many of Enron's most important markets. Only months earlier, Enron was considered one of the most innovative U.S. companies, having brought new-economy tools such as Internet trading and sophisticated hedging strategies to the old business of matching producers and consumers of electricity, oil, natural gas--and eventually some 800 other commodities and services. Its operations directly or indirectly touch almost every American home and business.

Enron's immolation--sparked by slumping energy prices, dubious accounting and trading practices and piles of debt--surprised just about everyone from regulators to investors to thousands of soon-to-be-jobless Enron employees. Now, as the company prepares to file for bankruptcy protection in the U.S., probably this week, huge questions loom as to how widespread the damage will be, who is to blame and what is going to be done about it.

No fraud or other illegal behavior has been proved--though those issues will be examined in a spate of lawsuits, congressional hearings and an investigation by the Securities and Exchange Commission. This much seems clear: what went wrong was not Enron's business plan--which other firms are already emulating. Rather, Enron's fatal flaw was management hubris, tacitly encouraged by board members, regulators, politicians and stock analysts--many with financial ties to Enron--who looked the other way as warning lights began to flash. Feeling it could do no wrong, the company too often pursued unprofitable markets, obscured the costs and stiff-armed anyone who asked for an explanation. It began taking sides in complicated trades instead of simply matching buyers and sellers, and its hedges then backfired.

Enron shareholders, including large mutual funds and pension funds, took a nasty hit as the stock lost 99% of its value over the past year, dropping to 26[cents] at Friday's market close. The Alliance Capital family of mutual funds doubled down on its Enron stake this summer as the energy company's share value dropped from $49 to $27, according to filings at the SEC. Alliance declined to comment on whether it has sold any of the 43 million Enron shares it owned as of Sept. 30.

Enron's 401(k) plan, available to its 21,000 employees and loaded with the company's stock, has been devastated. The company owes banks billions of dollars. Payment of those loans is in doubt, as is payment on hundreds of millions of dollars in obligations to Enron's trading partners. But those losses appear to be sufficiently spread out to make a wider financial crisis unlikely. There's been no talk of a bailout like the one in 1998 for the failed hedge fund Long Term Capital Management. And so far, energy prices are stable--good news for consumers heading into winter.

Still, there's a search for accountability, to make sure nothing like this happens again. John Dingell, ranking member of the House Energy Committee, said it best: "Where was the SEC? Where was the Financial Accounting Standards Board? Where was Enron's audit committee? Where were the accountants? Where were the lawyers? Where were the investment bankers? Where were the analysts? Where was common sense?" Byron Wien, an investment strategist at Morgan Stanley Dean Witter, says, "This is an indictment of a lot of different things, from the debt-rating agencies to bank lending practices."

There have been warnings in the accounting abuses revealed by smaller corporate blowups in recent years, including appliance maker Sunbeam in 1998 and travel-services firm CUC International after it became Cendant in a 1997 merger. But Enron fell much harder and faster. Its stock had nearly tripled in two years, to $90 in August 2000. It booked sales of more than $100 billion last year, seventh on the FORTUNE 500. Its chairman, Kenneth Lay, 59, was a celebrity in Houston, a pillar of civic and charitable causes. An early financial supporter and confidant of George W. Bush, Lay was the only energy executive to be invited for a one-on-one with Dick Cheney when the Vice President was framing the Administration's energy policy. Enron led the energy industry in 1999-2000 campaign contributions, giving both parties--but mostly Bush and the G.O.P.--$2.3 million overall, nearly twice as much as Exxon-Mobil, according to the Center for Responsive Politics.

Just 10 years ago, Enron was a stodgy pipeline company, generating 85% of its revenue through the transmission of natural gas. By this year, although the company still controls 30,000 miles of pipeline, 80% of its revenue was generated on trading screens. Enron made markets in everything from energy to paper to broadband capacity. Says Peter Fusaro, president of Global Change Associates, a consultancy that has studied Enron: "They tried to commoditize everything."

And they were well on their way. Before resigning in August, Enron's hard-charging chief operating officer, Jeff Skilling, was using supercomputers and fiber-optic cable to operate a global trading grid. The ultimate goal was never to touch another cubic foot of natural gas, yet to make billions by trading it. By 1998 Skilling's vision was taking shape, and he had become Lay's heir apparent.

Enron's headquarters in Houston exuded success. The garage housed Ferraris and Porsches, and the company's new skyscraper was going up next door. But Skilling made a huge mistake. Enron, already saddled with about $5 billion in money-losing investments from utilities around the world, borrowed $1 billion more in the past three years to get into the business of trading data-transmission capacity on fiber-optic cables.

To minimize the impact of this debt on Enron's financial statements, Enron insiders say, Skilling and chief financial officer Andrew Fastow created complicated private partnerships that did business with Enron but whose finances were not subject to much scrutiny. When these partnerships first began to come under the microscope three months ago, Enron was unwilling to explain them fully. In August, Lay, who is paid to look out for shareholder interests, told the New York Times, "I just can't help you on that...You're getting way over my head." An Enron spokesperson says the remark was taken out of context.

In the face of confusion about Enron's finances, investors began to flee the company's stock. Rating agencies downgraded their assessments of the safety of Enron's bonds. Those moves caused lenders to demand immediate payment of hundreds of millions of dollars in debt. And those who had traded with Enron became reluctant to continue, for fear they would not be repaid.

Losing business, Enron executives tried to sell the company to competitor Dynegy, but that deal fell apart last week. The death blow came on Nov. 19 in a filing by Enron with the SEC, detailing $690 million in debt that had to be paid almost immediately. Enron's stock plunged. "We were renegotiating daily because every time I turned around their stock price was falling," Chuck Watson, CEO of Dynegy, told TIME. "It got to the point where there was hardly any equity left in the business." Says a source close to Lay: "The Greeks would have loved this story. It's got hubris, ambition and a great disaster at the end."

That disaster falls on many shoulders. Washington policymakers must determine how to better regulate an obviously undersupervised energy-trading market--but without creating so much red tape and uncertainty that they choke off development of new wells, pipelines and power plants. "Our committee is keenly aware of the need for enhanced oversight," says Senator Jeff Bingaman, the New Mexico Democrat who chairs the Energy and Natural Resources Committee and has called for hearings on the Enron debacle.

Another stage in this drama is the impact on the administration of 401(k) retirement plans. Bobbie and Jerry Dotson are Enron employees who live in Baker, Fla. They lost most of their life savings of $1.5 million when Enron's stock tanked, taking down their 401(k) account, which was loaded with company shares. Bobbie, 62, put in for retirement last month. She had anticipated a monthly check of at least $800 plus her pension. Now she will consider herself lucky to get even the estimated $317 monthly pension that company officials recently quoted to her. "We trusted the company because we had so many years with them," she says.

The Dotsons have a familiar problem. Many 401(k) plans do not give employees the flexibility to diversify properly, and even when they do, employees hold a large slug of their employer's stock--an average of 62% in Enron's case. In 1996, Senator Barbara Boxer, a California Democrat, introduced a bill that would have required that 401(k) plans have no more than 10% of assets in the sponsoring company's stock. Firms that offer 401(k) plans lobbied against it, and the bill went nowhere. Now, "Enron is a call to arms," says Mike Scarborough, president of Scarborough Group of Annapolis, Md., which advises 401(k) participants. "Corporations need to do something about that, or change will get forced down their throats."

The demise of Enron further tarnished the reputations of stock analysts at big brokerage firms, who already stood accused of urging investors to buy the shares of troubled companies that did business with their firms. J.P. Morgan Chase maintained a "long-term buy" rating until Nov. 29, when the stock closed at 36[cents] off its December 2000 high of $84.62. The bank has loans out to the company totaling $900 million and stood to collect millions of dollars in fees for advising on the aborted Dynegy deal.

Analysts looked the other way early last year when Enron shares were soaring and the company let it be known that it might sell shares of stock in its online-trading operations. Not wanting to miss a shot at the underwriting assignment, analysts were reluctant to be tough. "When you question them in detail, they get offended," says Brian Youngberg, who recently began covering Enron for brokerage Edward Jones and began downgrading the stock in October. "It's been their culture not to disclose things."

Too few analysts asked why Lay and Skilling were eager sellers of their personal holdings of Enron stock during the first part of 2000. Murky accounting should have been another red flag. Says Rob Plaza, who follows Enron's stock for Morningstar and concedes he might have been more sharp-eyed: "If they're so profitable, why did they need all that borrowed money?"

Lawmakers may bring the hardest questioning--and the most trouble--to accountants and auditors. Arthur Andersen occupied an entire floor of Enron's headquarters, and was paid $54 million to both audit and advise the company. That relationship and previous impropriety charges against Andersen may leave it as exposed as Enron to a damaging investigation. "When I entered the business, there was an adversarial relationship between accountants and companies, and you had confidence in the numbers," says Morgan Stanley's Wien. "Today the relationship is more collegial, and you can't have that confidence." And now we know just what a crisis of confidence can do.



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Cover Date: December 10, 2001

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