Saturday, December 2, 2017

Happy Enron-versary...Sweet 16

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Sixteen years ago, the then-largest bankruptcy in U.S. history was filed.  Back in 1984 and 1985, when Ken Lay took the helm of Houston Natural Gas, HNG’s earnings were nose-diving on the collapse in gas consumption as cheap oil was putting the squeeze on a business that had been flourishing since its start in 1925.  InterNorth – a gas company founded in 1930 in Omaha and stretching to Minnesota gas fields in 1932 – was a conservative, profitable energy conglomerate seeking to avoid the break-up axe of Irwin Jacobs.  In 1985, InterNorth spent $2.3 billion to acquire HNG giving HNG’s investors a 40% market premium.  A decade later, Ken Lay was presiding over what Fortune magazine described a “America’s Most Innovative Company” – a designation that the magazine awarded from 1996 until… the music stopped today in 2001.

What was so innovative?  Selling commodities like oil, water and telecom hardly makes a company innovative.  Doing big deals, paying break-up fees to opportunistic financiers, hosting lavish parties and having financial statements that look like a tangled web of tangled webs – none of these are innovative.  And when Warren Buffett bought the still profitable Northern Natural Gas Company for $928 million (the legacy of InterNorth) – returning its ownership to Omaha there still was no innovation.  Regrettably, try as one may to find “innovation” befitting Fortune’s pronouncements, the only thing that surfaces is professional collusion and fraud.

Arthur E. Andersen earned his accounting credentials working as the assistant to the comptroller at Wisconsin-based Allis-Chalmers before becoming Illinois’ youngest CPA at the age of 23.  Somewhat ironically, Allis-Chalmers (a massive agricultural, industrial and machine conglomerate) itself was born of an opportunistic bankruptcy liquidation in 1860, was nearly wiped out in the “financial panic” of 1873 had, to re-organize itself in 1912, and plead guilty to price fixing and bid-rigging in 1960.  When Arthur Andersen founded his accounting practice in 1913 he rapidly built a reputation of advocating for the professionalization of accounting to serve the transparency interests of investors rather than the promotional interests of clients.  Arthur died in 1947 but his firm still turned down business (and lost clients) due to its reputation for being a stickler for rules in the 1970s.  Watching its competitors enrich themselves on client-favored accounting and consulting, the tide began to turn in the 1980s and revenue became more valuable than reputation.  When David B. Duncan’s assistant sent the damning e-mail on November 9, 2001 that instructed staff to “stop the shredding” (of evidence), he merely punctuated the end of the “innovation” Fortune and the stock market celebrated. 

In a sad commentary on justice in white-collar crime, Mr. Duncan’s guilty plea (which carried with it a 10-year prison sentence) was currency that he used to keep himself out of jail until the Supreme Court overturned Arthur Andersen’s conviction in 2005 at which time David withdrew his plea.  In 2008, the SEC settled with him stating that he failed to “exercise due professional care and the necessary skepticism,” to avoid defrauding the market.  No fine was levied against him.

Enron and Arthur Andersen got caught.  Each day, far greater damage is being done in the financial markets and, each day, the perpetrators of these injustices are celebrated.  Over the past several weeks, I’ve had the great fortune of meeting several of these white-collar criminals-in-waiting.  They live in beautiful suburbs in Boston, New York, London, Singapore, Geneva, Melbourne and Hong Kong.  They send their 1.2 children to private schools, drive their 3.3 cars parked in their 4 car garage homes inhabited by their picture-perfect families doing weekend sporting activities before or after attending the religious service of their heritage.  Each day they tell their clients that they’re doing right by them out of one side of their mouth knowing full well that, in reality, they are cutting fee deals with fund mangers and distributors, influencing financial advisors, and playing fast and loose with their fiduciary management of the funds of billions of people because they know they’ll never get caught.


“David,” said one of them a few weeks ago, “you don’t get it.”

“Don’t get what?” I replied.

“Picture a 53 year-old school teacher.”

“OK.”

“Do you really think that she’d ever understand the difference between the returns that she sees on her annual financial statement and what she could have made?” the chief investment officer asked me.

“Yes,” I started, “I suspect she’d get the math if she saw it.”

“Yes,” he said, “but that’s the point.  Each year the law makes her put money into our fund.  Each year we tell her how her retirement has grown.  And next year, she’ll pay us more money to manage for her again.”

“Yes,” I acknowledged, “I’m sure that’s the case.  But don’t you have an obligation to insure she’s getting the best return?”

“Nope,” he smugly replied.  “No law says that we have to deliver best performance.  We just have to manage our clients’ accounts.”

If the same woman, walking down the street in a major city had her handbag snatched losing $250 dollars, we’d call that theft.  But if that woman lost $2,500 last year by this one firm’s sub-optimal allocation, it’s called a “service”.

But thankfully, the 99%ers now have their day of reckoning with the Man!  Anonymous crypto-currencies and block chain are giving power back to the people, right?  After all, it was the government and Big Brother that created runaway speculation on energy banks in Houston, that created credit default swaps for no-documentation mortgages, and rating agency fraud (which has still gone unprosecuted).  If we have an opaque, digital, anonymous system based solely on a speculative algorithm with no verification methodology to confirm provenance, that should fix these horrible abuses, right?

Greed and opacity were all Enron can claim as Innovation.  Complicity and subterfuge were all Arthur Andersen could claim as Innovation.  Financial illiteracy is all the chief investment officer of a few weeks ago can claim as Innovation.  And casino-fueled hype is all Bitcoin can claim as Innovation.  It is not innovation to sate the avarice that besets a population that prefers anonymous excess to rational sufficiency.  And with Bitcoin now at $10,908.01 and the Facebook founding Winklevoss twins becoming reportedly the first bitcoin billionaires – are we really a more egalitarian, democratic, society?

Sixteen years later and we’ve learned nothing.  Our governments and their regulators have done nothing.  The public is not more protected.  And to be sure, our behavior evidences that we still place blind trust… blindly!  Put a runaway speculation opportunity in front of the average person and, guess what?  Speculation happens.  The solution to Enron / Arthur Andersen wasn’t to separate the assurance and consulting businesses of accounting firms.  The answer wasn’t to throw millions of dollars into investigations and prosecutions so that guilty partners could live in their Texas mansions in retirement.  The solution was for individuals – you and me – to improve our financial literacy.  To see where our dollars flow in our daily lives and to learn enough to hold our 401(k)s and pensions accountable.  But here’s the trouble.  We made movies like The Smartest Guys in the Room, Inside Job, and The Big Short but have no concept of the current, looming pension, Social Security, and insurance crisis of the mid-2020s.  Oh, yes!  Another GFC of larger proportions is already infecting the market today.  And like the GFC, it doesn’t take prediction to see it coming.  It just takes reading public documents, doing a little math and recognizing that even the criminals are telling us that its coming.  But like the GFC, we’ll stick to being surprised. 



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