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WisBusiness: Edgewood College Business Ethicist Has New Book on Enron

By Brian E. Clark

A federal jury in Houston started deliberating Wednesday in the fraud and conspiracy case trail of Enron founder Ken Lay and former CEO Jeffrey Skilling. Their company was the seventh largest in the U.S. when in foundered in 2001.

Jurors are deciding 28 criminal counts against Skilling and six against Lay. Both men have denied any guilt. They face long prison terms if convicted.

Prosecutors said the two hid hundreds of millions of dollars in debt with bogus accounting and profits inflated with accounting tricks.

Edgewood College ethicist and business professor Denis Collins has watched the collapse of Enron with keen interest. Similarly, he has followed the trial of Lay and Skilling closely.

There is much to be learned from Enron’s demise, he said, and he has used the collapse of the energy trading giant and the ethical lapses of its leaders as case studies in his classes.

His new book, “Behaving Badly, Ethical Lessons from Enron,” will be published today by Dog Ear Publishing. It should be available from Amazon.com within a few days for $24.95 a copy.

WisBusiness.com Editor Brian Clark interviewed Collins on Wednesday at Edgewood College.

Brian Clark: How long do you think it will take for the jury to return a verdict for Lay and Skilling?

Denis Collins:
It could be from a few hours to a few weeks.

Clark: What prompted you to write this book?

It is a reaction to other books out there on Enron that present Lay and Skilling as a bunch of idiots and SOBs. Every report on Lay is that he is one of the nicest guys in the world and that Skilling is one of the smartest guys in the world.

My approach is that every time you make a business decision you have ethical ramifications. So my approach was to present the Enron demise chronologically. It is non-fiction, but I wrote it with chapters that end in “cliff hangers.”

And at the end of the chapter, if you are Ken Lay, you have three choices: A, B or C. Which one would you choose? The next chapter then begins with Ken Lay choosing option B and that was not a good one.

Then other bad things happened. So I’m trying to show this in real-time decision making, as opposed to just judging them after the fall of Enron. Some of these were hard business decisions and I’m not sure even what I would have done differently. I assume I would have done differently, but you never really know.

I’m trying to present these business decisions as real-life dilemmas that they have to face and their ramifications. So much in business is crisis management, with things happening “boom, boom, boom” and you have to respond. That’s about two-thirds of the book, following Enron from its beginning to the collapse.

Clark: What is the last third?

It is advice on how to minimize unethical activities in your own company. It is more practical and hands-on for people who are actually managing companies, using lessons learned from Enron. And here is how to be systematic about it.

Clark: So it’s not your belief that these guys were corrupt to the core, as the government alleges?

Chief Financial Officer Andy Fastow (who pleaded guilty to fraud charges and was given a 10-year sentence) was. But if you listen to him at the trial, he thought he was a hero. And that’s normal. He thought he was saving Enron. He would say he was being ethical. But not many ethicists would agree with him. He was the most corrupt.

I’m disappointed in the government’s case against Skilling. From most accounts, he knew what was going on since the early 1990s. So he knew for a good decade. And Andy Fastow was his right-hand man and was the guy who had to meet the numbers. So Skilling had to be aware of that.

But Ken Lay wasn’t. I think he really was oblivious for about seven-eighths of the time period in which this was all taking place. He was out there getting more customers, lobbying Congress to change energy policy in his own “master of the universe” way.

Then, for Lay, his guilt comes in after he resigned from being CEO in February of 2001 and Jeff Skilling took over. Lay stayed as chairman of the board. Then Skilling resigned in August, even though he told Lay he would step down in July.

At that point, the accountants and a few other people went up to Ken Lay and said “We have $7 billion in hidden losses. Surprise. Surprise.”

Clark: You think he really didn’t know?

From most reasonable accounts, the losses were well hidden. Andy Fastow was doing his stuff. Clearly, the chief accounting officer knew. Skilling knew it was going on, but didn’t want to be told about it because “we need to meet these numbers in any way that you have to.”

Ken Lay was out to lunch. He was the hands-off leader. His style was decentralization. He thought he could hire the right people and then trust that all the checks and balances were in place.

From Lay’s perspective, and he is the most fascinating person because he also had the greatest responsibility and has taken the biggest fall. From his point of view, he believed the auditors would have caught any problems. And the auditors never said there was a problem. Or the lawyers would have told him, and the lawyers never said there was a problem. Or the board of trustees.

So there were all these checks and balances, but none of them worked. Until Skilling resigned and then they had to tell Lay that he had to deal with the problem. At that point he was guilty.

Clark: So what are the lessons to be learned from this whole mess?

There are two different categories of lessons. One is the kind of business problems that will get you into hot water. From the beginning of Enron back in 1985, there was way too much debt. They were way, way over-extended.

So the question is how do you respond to too much debt. But you want to look good to Wall Street. There is the temptation to pad the revenue to make it look better. That happened at Enron.

Another lesson from Enron is that after you are padding the revenue, it gets harder and harder to meet the next year’s forecasts because Wall Street wants 15 percent improvement every year. So now you want 15 percent improvement over false numbers. It gets harder and harder and harder.

Therefore, games have to be played. And as the snowball heads downhill, you end up giving power to the most unethical people in your organization because they don’t mind cooking the numbers.

Clark: Like Andy Fastow?

He had no problem cooking the numbers. He enjoyed the challenge of it. As soon as you start playing those games, you are empowering unethical bullies. There were a lot of ethical people at Enron, but they gave power to a small group that liked the intellectual challenge of cooking the numbers.

So once you empower the bullies, what do you do? You have to attack the bully. You can’t let that person run free because a bully always wants more. Fastow grew to control more and more and his power base grew and grew over time.

Skilling and Fastow hid their transactions from Arthur Andersen auditors, who were paid $50 million to not look too hard. Andersen no longer exists. Fastow got 10 years in jail and that was a light sentence. He should have gotten more.

Clark: How did he testify in the Skilling and Lay trial?

He said Skilling knew, but not Lay. Skilling was his immediate boss.

Clark: Do you use Enron in your classes?

Yes, and I’ll be doing it tonight in my class of adult returning students who are all employees at local companies.

Clark: Back to Lay. How did he handle it when he was told the company had $7 billion in hidden losses?

He had 30 days before Enron had to make its quarterly report to Wall Street. Do you say, “Hey, by the way, we have $7 billion in hidden losses?” At that point, he asked for advice from his team of managers, who advised him that they probably could get away with announcing $1.2 billion and explain it and be forgiven and then fix the “problems” over the next three months.

But they couldn’t explain $7 billion. That would open up too many cans of worms. They couldn’t explain $7 billion. So they announced the $1.2 billion and then things got worse because it was bad enough to alarm people. They never got a chance to fix things. Six weeks later, Enron was dead.

Clark: Didn’t Lay try to blame the Wall Street Journal and journalists in general for Enron’s demise?

Yup. The Wall Street Journal was the amplifier and he wished the amplifier would have shut up. It was absolutely sour grapes. Business people generally do not want to be in the press, especially in negative stories.

Clark: But Enron wasn’t unique, was it?

No, you had Ebbers at WorldCom and then Andersen had three or four other major clients. Only half of Andersen’s $50 million annual contract at Enron was for auditing. The other half was for consulting. And Andersen got that fee by pleasing Enron. That was an inherent conflict, which is why you can’t do it anymore. For 10 years, people were saying that shouldn’t be allowed, but it was. The accounting field changed in the late '80s and early '90s. Instead of looking for fraud, they just had to make sure there were systems in place to prevent fraud. They no longer were investigators.

To clean that up, Sarbanes-Oxley was passed as the club that everyone is now being smacked in the back of the head with. It came about because of Enron and WorldCom and others.

The ethical question for auditors, who had to help increase Enron revenue by 15 percent to get promoted, was “what do you do if you think that your biggest client might be fudging the numbers?” That’s a good question for my students.

Do you tell them “cut it out” and possibly lose the contract or get fired by the bullies? Or do you cover your eyes. It comes down to personal integrity.

Clark: Does personal integrity too often go out the window when big bucks are involved?

That’s often why people get in trouble. Most business people are good folks, but we are all good and bad. If temptations are high, people falter.

In the second half of the book, I say that you have to hire people who have the appropriate values. If you knew Andy Fastow, you would have known you couldn’t trust him from Day One.

I grew up in New Jersey and he was a “Jersey Boy.” He was good and very Machiavellian. But that is the culture in that area of the world. I wouldn’t mind hiring one or two Andy Fastows because he was good, but he’d have to follow a code of ethics. You’d have to watch him. He could be creative, but not violate the code. The code is the second step.

Clark: Don’t most companies have them?

Yes. But they are window dressing, stuck in a drawer somewhere. A lot of consulting work I do with companies is to look at their code of ethics and see how many times it was violated during the past three months. They have to talk about their hot spots and assess them.

Clark: Do they bring you in after there has been a problem?

Yes, but some do it up front. They say we are proud of our company, but we’re not perfect and say, “Can you help us out?” The federal sentencing guidelines passed in 1991 says if your company is found guilty of a crime, the penalty can be multiplied by four or be reduced to 5 percent. If we go 5 percent depends in part on whether your company meets certain criteria, including whether it has a code of ethics and does ethics training. If you commit a crime and don’t do these things, the government will smack you around.

Clark: Are they companies in Wisconsin that have had problems like Enron or is the corporate culture here different?

Culture matters. I’d say Madison is somewhat unique and the companies here are pretty high-minded with a lot of high integrity movers and shakers. Certainly, Wisconsin is a lot different than New Jersey or New York. In Jersey, it’s acceptable to stab each other in the back now and then. In Wisconsin, that would be bad manners.

Having said that, all humans are fallible. Mutual fund magnate Richard S. Strong messed up here in Wisconsin. [NOTE: He and his company, Strong Capital Management, were fined $175 million for trading violations and he was banned from the mutual fund industry.]

He said he was cheating not because he needed the money, but because he was very competitive and liked to win. He said he knew it was wrong, but that he wanted more. That’s why you need that code of ethics. You can be as competitive as you want, but you need to check in once in a while.

Clark: Should it surprise anyone that these things happen given human nature, greed, and competitiveness?

Good question. My sense is no, given television, the media and novels. Having said that, moral expectations increase over time. It’s not a bar that is static. For example, people wanted to impeach Bill Clinton for things John Kennedy did. Ethical expectations changed over 30 years. People generally want to live in a moral society. You know that funny things are going on and you can’t stop them all, but you work on little areas.

Clark: So there still have to be checks on people?

Yes. Capitalism is often presented as being without regulation in an extreme sense. But you can’t do that because we are human beings. For capitalism to thrive, people have to be extremely honest. As soon as there is dishonesty, government regulation has to step in to stop the abuse of customers, employees, customers, investors or the natural environment.

Capitalism at its heart demands honest, trustworthy relationships. So when an Enron happens, you get the Sarbanes-Oxley Act of 2002. If you play crooked games, the government will make tougher rules like auditors can no longer be consultants and you must change consultants every so many years and here are your penalties.

Other requirements include prohibiting corporations from making or offering loans to officers and board members, mandating “whistleblower” protection for persons who disclose wrongdoing to authorities and establishing a public company oversight board in charge of regulations administered by the Securities and Exchange Commission.

Clark: Have businesses accepted Sarbanes-Oxley?

No, they want to change it. It has been a real boon to the accounting industry. I believe there were hearings last week in Washington to change it. Companies are saying it’s a lot of paperwork and it’s particularly onerous for small firms.

But it is simply the swinging of the pendulum. If a lot of companies know that other companies are cheating and they don’t do anything about it, you have to slap them all. You have to inform the SEC if you know.

Clark: Other companies knew about Enron?

Investment bankers were involved and some regular bankers were aware, but they all had a financial interest to keep playing the game.

Twenty-five percent of managers surveyed acknowledged they had falsified numbers. Research has showed most of us tell one to two lies a day, 10 million people cheat on their taxes, 70 percent of all doctors lie to insurance companies and 25 percent of middle managers have written fraudulent reports. So this is human nature.

People start lying as soon as they can talk. It is simply human nature. Almost all of us cut corners and make decisions that have ethical ramifications. Enron was just played out on a much, much bigger stage.


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