Free Infectious Greed by Frank Partnoy Page B

“We have disclosures about it in the footnotes, which help our investors and the rating agencies understand all of this.”
    The legal changes of 1994 and 1995—including restrictions on securities lawsuits, incentives for companies to compensate executives with stock options, and various forms of deregulation—enticed Enron executives to take advantage of accounting rules, and contributed to the company’s developing mercenary culture. In 1994, Enron created an entity called Enron Capital LLC, incorporated in the regulatory haven of the Turks and Caicos, to deal in financial markets without complying with U.S. securities laws. 20 In 1996, the Federal Energy Regulatory Commission began deregulating energy markets, in response to lobbying from Ken Lay and other energy firms. The more Enron did deals in the shadow of the law, the less legal rules seemed to matter. At the same time, most Enron executives received substantial numbers of stock options, which rewarded them for pushing short-term accounting profits. The options grants ranged from five percent of annual base salary to hundreds of thousands of options for top executives, far more than their counterparts at Cendant, Waste Management, Sunbeam, and Rite Aid. In all, Enron’s executives would make more than a billion dollars from these options.
    Enron’s risk-management manual explicitly encouraged employees to adhere to the letter of accounting rules, even if they were contrary to economic reality. It stated: “Reported earnings follow the rules and principles of accounting. The results do not always create measures consistent with underlying economics. However, corporate management’s performance is generally measured by accounting income, not underlying economics. Risk management strategies are therefore directed at accounting rather than economic performance.” In other words, Enron managers were encouraged to focus on the accounting effect of their decisions more than their real economic impact. This was true even when Enron was dealing with issues of risk, where real economic impact should have mattered more to the company than accounting disclosures.
    As Enron’s board of directors became more international, to reflect the company’s new global businesses, it became less effective in monitoring
Enron’s management. Lord John Wakeham, former leader of the British House of Commons, and minister of energy, previously had permitted Enron to build England’s largest power plant at Teesside, and now received even more money as a consultant to Enron than as a board member—both at the same time. 21 The five-member audit committee of Enron’s board of directors was hardly full of watchdogs, either. Ronnie C. Chan, chairman of the Hang Lung Group in Hong Kong, and Paulo V. Ferraz Pereira, a senior officer of Group Bozano in Brazil, lived outside the United States and had little experience with U.S. accounting. Wendy Gramm, the former chair of the Commodity Futures Trading Commission, was conflicted as a direct beneficiary of Enron’s political and charitable largesse. Her free-market policy group in Washington, D.C., received $50,000 from Enron and another $10,000 from a foundation set up by Ken Lay. Her husband, Texas senator Phil Gramm, received $97,350 of aggregate donations from Enron, plus additional funds raised by Mark Brickell, the J. P. Morgan lobbyist, one of Wendy Gramm’s comrades. 22 (Not surprisingly, the newspaper Barron’s called the Gramms “Mr. and Mrs. Enron.”) John Mendelsohn, president of the Anderson Cancer Center at the University of Texas, benefited indirectly from Enron’s $1.6 million of donations to the Center.
    That left the chair of the audit committee, Robert K. Jaedicke, a respected emeritus professor of accounting at Stanford. In spite of his accounting expertise, Jaedicke did not grasp the complex disclosure issues presented by the managers he was