Enron Cited in Call for Reform
The Enron debacle signals that corporate executives are increasingly estranged from the interests of their employees and shareholders and points to the need for reform, Federal Reserve Chairman Alan Greenspan said Wednesday.
The current system creates incentives for executives “to game the accounting system” in order to boost their pay, Greenspan said in congressional testimony that represented the toughest assessment yet by a senior government official on the larger framework of the Enron Corp. meltdown.
“There has been a severance, in my judgment, of the interests of the chief executive officer in many corporations from those of the shareholders, and that should be pulled together,” Greenspan said.
At a hearing Wednesday in U.S. Bankruptcy Court in Manhattan, Judge Arthur J. Gonzalez took two steps that could be seen as shifting the balance, in a small way, toward those closer to street level.
Gonzalez approved emergency relief for Enron’s most destitute former employees. And he refused to direct an insurance company to pay out $30 million in legal fees to former and present Enron officers and directors to defend against allegations that they helped destroy the company.
Gonzalez endorsed Enron’s request to create a $5-million emergency fund for 4,500 fired employees and left the door open for a much larger payout sought by a group of workers and supported by union and civil rights advocates.
Lowell Peterson, a lawyer for 20 former employees, noted that the size of the emergency fund exactly matches that of a retention bonus recently paid to a single Enron executive, John Lavorato, chief executive of Enron Americas, to encourage him to stay on the job.
Peterson’s clients asked the court to approve severance packages of up to $30,000 apiece for all 4,500 workers, plus other salary and vacation pay he contends they are owed, for a total of about $73million.
Gonzalez deferred a decision until at least next week.
So far, the court has approved $4,500 in severance for the fired employees, but even that hasn’t been paid to all of them, Peterson said.
Not only are some of the fired workers unable to pay for medicine and in danger of losing their homes, but they also have become pariahs in their hometown of Houston, Peterson told the court.
For example, the financial-printing firm Bowne & Co. ran a help-wanted ad in the Houston Chronicle this week that said: “No current or former employees of Enron, Arthur Andersen or the U.S. government will be considered.”
Andersen, Enron’s accounting firm, is under investigation for its role in approving questionable transactions that led to the collapse of the energy-trading giant.
On the issue of insurance fees to cover executive legal bills, the judge left it up to the insurer, Aegis, to decide whether to advance money to the executives, most of whom have been named as defendants in lawsuits arising from the scandal.
Andrew J. Entwistle, lawyer for the Florida State Board of Administration, whose state-employee retirement funds lost $334 million on Enron stock and bonds, said he was “delighted” with Gonzalez’s ruling, which he said puts the burden on Aegis to screen carefully any requests for advance legal fees.
Entwistle said he hopes the insurer will reject requests by such Enron higher-ups as former Chairman Kenneth L. Lay, former CEO Jeffrey K. Skilling and former Chief Financial Officer Andrew S. Fastow, forcing them to pay initial legal expenses out of their own pockets.
All three men have been accused of profiteering by cashing in millions of dollars in stock options and, in Fastow’s case, reaping $30million in fees and profit from Enron’s controversial limited partnerships.
In testimony Wednesday before the House Financial Services Committee, Greenspan said the Enron debacle had exposed new risks and vulnerabilities in an increasingly idea-driven economy.
The nation’s financial markets appear to be correcting some of the systemic flaws revealed by Enron, by discounting the value of companies that appear to rely on accounting tricks to boost short-term profitability, he added.
Yet Greenspan said more lasting reforms are needed. “I would start off with the way we account for stock options,” he said. He cited accounting standards that create incentives for corporate executives to hype reported earnings so they can reap big gains from exercising options.
David Teece, director of the Institute for Management, Innovation and Organization at UC Berkeley, said Greenspan’s comments clearly represented a harsh new assessment of the factors present in the Enron collapse. But he cautioned that the analysis may be premature.
“This is a strong statement. You would expect pundits to say some thing like this, but Greenspan has a higher burden,” Teece said. “He should be more cautious. Everyone has a sense of distress about Enron, but all the facts aren’t out yet.”
In other developments Wednesday, former Federal Reserve Chairman Paul Volcker named two men to join him on the Independent Oversight Board examining Andersen’s role in Enron’s demise. And at a hearing in U.S. District Court in New York, lawyers squared off in what could be a dramatic legal battle over Wall Street’s role in the Enron saga.
New York investment bank J.P. Morgan Chase & Co. is trying to force 11 insurance companies to pay $965 million in Enron-related claims.
The clash involves surety bonds issued by the insurers to guarantee energy contracts between Enron and a J.P. Morgan-affiliated entity known as Mahonia Ltd.
The insurers promised to make payments to J.P. Morgan if Enron ever reneged on its Mahonia obligations, which occurred when the energy company slid into bankruptcy in December.
J.P. Morgan has portrayed the transactions as legitimate commodities trades.
But the insurers say they were actually loans disguised as trades to make Enron’s financial position appear stronger.
The insurance company allegations are central to the federal government’s own probe of Enron. Investigators believe that Enron’s ability to shield its debts through murky financial transactions contributed significantly to the company’s demise.
The outcome of the case also is critical for J.P. Morgan, whose Enron losses could total as much as $2.6 billion. The hearing Wednesday was in response to J.P. Morgan’s request that the case be dismissed.
Morgan attorney John Callagy contended that the language of the surety bonds was ironclad and did not allow the insurers to deny payment for any reason.
Under questioning from Judge Jed Rakoff, Callagy also said that the insurers were “sophisticated” businesses that willingly agreed to sell the bonds.
Rakoff pressed: “So are you saying that if a party is sophisticated it is fair game for fraud?”
Replied Callagy: “There is no evidence that this transaction has any fraud, let alone is riddled with fraud.”
Rakoff also sharply questioned Celia Barenholtz, the attorney for the insurance companies, on a central question: Did Enron and J.P. Morgan actually exchange oil and gas, or did they simply engage in paper transactions designed to mask loans?
Barenholtz contended that even if oil and gas were swapped between the two firms, the transactions were circular, meaning nothing really changed hands at the end of the deals.
Rakoff said he probably would rule by next week on J.P. Morgan’s request to have the case thrown out.
On the Andersen review board, Volcker named Charles A. Bowsher and P. Roy Vagelos to join him.
Bowsher is a former U.S. comptroller general and chairman of the Public Oversight Board, an accounting-profession oversight body that is disbanding at the end of March. Vagelos is the retired chairman pharmaceutical firm Merck & Co.
Andersen has ceded Volcker’s Independent Oversight Board the authority to make changes in its policies and take other measures, such as assigning and firing key personnel.
The panel was established after the accounting firm was widely criticized for contributing to the downfall of Enron, its former client.
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Times staff writers Jerry Hirsch in Los Angeles and David Streitfeld in San Francisco and researcher Lianne Hart in Houston contributed to this report.
