Enron: capitalism in a nutshell

by Anna Pha

Enron's annual report for 2000 (dated April 2001), painted a glowing 
picture of rapidly rising profits and great prospects for the future: Sales 
and other revenues had risen from US$13.2 billion in 1996 to over US $100 
billion in 2000. Income before interest and taxes rose 72 per cent in the 
previous year to US$2.3 billion. "The company's total return to 
shareholders was 89 percent in 2000..." "Our results put us in the top tier 
of the world's corporations." "In 2000 Enron used its networks to deliver a 
record amount of physical natural gas, electricity, bandwidth capacity and 
other products." Emerging markets "present a $3.9 trillion opportunity for 
Enron, and we have just scratched the surface." "Our talented people, 
global presence, financial strength and massive market knowledge have 
created our sustainable and unique businesses." Enron also boasted of "Risk 
management skills that enable us to offer reliable prices as well as 
reliable delivery." What more could a shareholder ask for?

This rosy picture of "the largest energy company in the world" was 
confirmed by market analysts, high share prices, and "Fortune" magazine's 
accolades. The prestigious business publication named Enron as "America's 
Most Innovative Company" , "No. 1 in Quality of Management" and "No. 2 in 
Employee Talent" of all American companies.

Ranked among the 10 largest corporations in the US, Enron was held up as a 
model corporation, encapsulating the wonders and genius of capitalism.

And that is exactly what it was, but perhaps not quite in the way that 
those making such claims would have seen it.

Within 12 months Enron had collapsed and was filing for bankruptcy.

Behind the glossy fagade, lay the main ingredients of capitalism: greed, 
bribery, corruption, deceit, parasitism, speculation, insider trading, 
scams, nepotism, tax avoidance, environmental destruction, human rights 
abuses, exploitation, theft of workers' entitlements, job losses, use of 
state machinery against workers and Indigenous peoples, cosy relationships 
with government, and monopoly manipulation of prices and markets.

Enron was one of the most powerful corporations in the world. It (including 
executives) was the largest donor to President George W Bush's election 
campaign. Its executives and board members also had strong ties to, Cheney, 
Rumsfeld, Baker, the Secretary of the Army, the US Trade Representative, 
Bush's economic adviser, the Securities Exchange Commission, its auditors, 
banks, the Attorney General, supreme court judges, leading Republican and 
Democrat figures, to name a few.

Its core business is not energy, but energy-focused financial services. It 
is in reality an investment bank and broker, dealing in debt and equity 
securities (shares) and high risk derivatives*.

According to its annual report it buys and sells "virtual electricity", 
offers a "virtual gas transportation service", weather risk management, 
trades in currencies and acts as an intermediary in the energy and other 
sectors.

And it now appears that it made virtual profits.

It does own a few utilities and pipelines and sells some real electricity 
and natural gas, although this is not its main business.

It is very much part of what is described as the "new economy".

Enron was also moving into the broadband area, developing a fibre-optic 
network in the US and had launched a rapidly growing internet venture 
(EnronOnline) for trading purposes.

EnronOnline had overnight become the largest e-commerce site in the world 
in terms of dollar volume of trade — logging close to US$200 billion on 
30,000 transactions in just one year.

Globalisation was high on the agenda, with operations in India, Turkey, 
China, the Philippines, Burma, Brazil, Argentina, Australia, Europe, as 
well as in North America.

It played a major role in the drafting of the WTO's General Agreement on 
Trade in Services (GATS), with a view to opening up and deregulating energy 
markets around the world for its own exploitation.

It had not only not paid income tax in four of the last five years, but 
claimed in its 2000 annual report, to have US$254 million in tax credits 
for future years.

According to Public Citizen's (Ralph Nader's organisation) research, Enron 
has 2,832 subsidiaries and other offshoots, 874 of them located in the 
Hayman Islands and other tax havens where they are protected by weak bank 
disclosure laws. You would never guess this reading its annual report.

Enron used its (off the books) subsidiaries and partnerships to borrow 
money for eventual use by Enron. This enabled Enron to raise capital 
without the debt appearing on its books, thus boosting its reported results 
and maintaining its credit rating and share prices.

Enron's collapse

Enron's collapse was just as spectacular as its meteoric rise.

Different aspects of Enron's collapse and the role of its auditors Arthur 
Andersen are now the subject of seven Senate Committee, four House 
Committee, Justice Department, Labor Department, and Securities Exchange 
Commission inquiries as well as trade union and shareholder court actions.

The evidence mounts, the public want action. No wonder Bush wages war!

With elected supreme court judges funded by Enron, and almost half of 
Congress in receipt of Enron donations, it will be interesting to see 
whether those behind the collapse or who played an indirect role are 
brought to justice.

Shareholders are reported to have lost around $65 billion in investments. 
Shares fell at one point to as low as US26 cent from a high of over US$90.

When Enron filed for Chapter 11 bankruptcy on December 2, 2001, there had 
already been unheeded warnings that the company could "implode in a wave of 
accounting scandals". It is the largest corporate bankruptcy filing in the 
US.

One such warning came from a senior officer of the corporation, in an 
anonymous letter last August to chairman Kenneth Lay. The letter questioned 
whether the company's complicated and largely undisclosed deals with 
partnerships set up by Enron officials had helped inflate the company's 
stock price and, in the end, would be found out to be an "elaborate 
accounting hoax".

Last November, Enron was forced to include a few of these partnerships on 
its books and restate its results for the past five years. In doing so it 
downgraded reported profits by almost US$600 million and reduced previously 
announced shareholders' equity by US$1.2 billion. By then the company was 
under investigation by the Securities and Exchange Commission.

It was in this restatement that Enron revealed some of the activities of 
its partnerships ("Special Purpose Entities") and incorporated some of them 
into the consolidated accounts of the company.

A report commissioned by Enron and released on February 2, 2002 said the 
company had falsely overstated profits by nearly US$1 billion in the year 
before it collapsed.

"What emerged at Enron, as described in the report, was a culture of 
deception, where every effort was made to manipulate the rules and disguise 
the truth as part of an effort by executives to falsely pump up earnings 
and earn millions of dollars for themselves in the process", wrote Kurt 
Eichenwald, in "The New York Times".

"Money was siphoned back and forth between multiple entities, disguising 
its true ownership and in turn providing false information about the 
financial state of Enron", said Mr Eichenwald.

Secret partnerships

In recent months revelations have emerged of a complex maze of intertwining 
partnerships — some involving Enron and its executives, including its 
chief financial officer Anderew S Fastow.

These Enron partnerships did business with Enron and with each other and 
formed other partnerships. Much of this business did not appear in Enron's 
official annual report.

Billions of dollars (with them profits and debts) were transferred back and 
forward, along with various speculative instruments, with (often paper) 
profits and losses being transferred. Both sides of these transactions were 
at times carried out by the same Enron official, unbeknown to Enron's 
workforce or shareholders.

Fastow reportedly made more than US$30 million from his own investments in 
these partnerships.

Michael J Kopper, a managing director of Enron's finance division and his 
partner, made at least US$10 million on a US$125,000 investment in the 
Chewco partnership. Kopper also raked in US$1.6 million in management fees, 
although the report says there was very little to manage.

Several others made US$1 million on investments of $5,800.

One of the aims was to transfer Enron's debt outside the company and get it 
off the books, without giving up control of the assets that stood behind 
the debt.

Not surprisingly document shredders have been working overtime.

Making markets

This "largest energy company in the world", in fact owned few utilities. 
Deregulation of the energy markets had made it possible for a new breed of 
corporation to buy and sell electricity without necessarily generating or 
delivering any electricity to the door.

These "electricity marketers" could buy and sell electricity over and over 
again before it reached the domestic or commercial user. It is similar to 
the model which is being introduced to Australia in the name of 
competition.

It is already in operation in the telecommunications sector in the form of 
parasitic sellers who buy bulk discounted time from Telstra and onsell it 
to consumers at a higher price.

This type of marketing creates no new value but is a means of creaming off 
layers of profit, as the marketers buy up the available electricity and use 
the monopoly control to supply and extract super profits.

Businesses relying on electricity cannot cope with such volatile and 
unpredictable prices so Enron (and other such outfits) comes to their 
rescue offering new services — financial mechanisms that allow them to 
hedge their bets against market extremes.

Enron found a means of creating crises and then profiting from those crises 
through purely parasitic and high risk speculative derivatives and other 
products — what it called "price risk management".

Enron literally spoke of "creating new markets" in its annual reports. This 
proved to be a very lucrative exercise, generating millions of dollars of 
income. Supply manipulation, the creation of artificial shortages by Enron, 
was a major factor behind the blackouts in California.

When the Californian authorities were forced by public pressure to re-
regulate energy and cap prices, Enron came crashing down. (More on Enron's 
energy marketing and deregulation in a future issue of "The Guardian".

Employees hardest hit

There have been many casualties including shareholders and pension funds 
and Enron's workforce who lost jobs, retirement savings and other savings 
in Enron shares (under an employee share scheme). Many politicians, judges 
and government officials have lost a lucrative source of funding, and are 
now running for cover.

Sixty-two per cent of the retirement assets of Enron's employees in the US 
were invested in Enron stock. Enron had used its own stock to match 
employee contributions to the employees' 401 (k) (equivalent to 
superannuation funds in Australia) retirement fund.

Many employees had invested more of their money into company stock, 
believing the company's hype about how good it was. After all they had seen 
the value of their savings (in the form of Enron shares) rise at a 
phenomenal rate over a few years.

But when the company adjusted its results in October 2001, and the shares 
were in full flight downwards, Enron employees found the company had 
"locked down" their pension fund so that the employees could not sell off 
their stock.

Shares that were trading at US$33.84 when the lockdown came into effect, 
were worth less than US$10 a month later. 

The 11,000 Enron employees have lost hundreds of millions, possibly 
billions of dollars, some their entire retirement savings.

"At the peak, I had $350,000 in my Enron 401 (k) account. Now its worth 
about $20,000. A handful of people at the top made a lot of money. It was 
insider trading", said Al Kasewaeter, a tester and former lineman for 
Enron's wholly owned subsidiary Portland General Electric in Oregan.

Enron board chairman, Kenneth Lay reportedly got in early selling off more 
than $200 million worth of stock options. Another executive, Lou Pai sold 
stock in excess of US$353 million.

"Ken Lay knew the ship was sinking, yet he kept telling us to buy Enron 
stock. They were siphoning off our retirement funds to keep the ship 
afloat. When our Enron stock hit 76 cents a share, they e-mailed us and 
said we are now free to sell them."

While freezing workers' shares and telling them to buy, the executives sold 
fast, pocketing US$1.1 billion!

The Portland workers are represented by the International Brotherhood of 
Electrical Workers (IBEW) which has filed a lawsuit against Enron on behalf 
of nearly 1000 workers at that plant.

There are many questions to be answered about the political and economic 
system that enabled Enron to function and its executives to profit as they 
did, at the expense of thousands of shareholders and employees.

Enron is a case study of capitalism, of deregulation and self-regulation, 
of privatisation, of corporate retirement schemes, of government business 
relations.

It raises serious questions about the legal, financial, accounting and 
auditing practices of the big multinational corporations. How many more 
Enrons are waiting to blow up? It must also be asked how can such debacles 
be avoided in the future?

These issues will be looked at in future issues of The Guardian.

* * *

* Derivatives (options, swaps, futures, warrants, etc) can be bought and 
sold like shares, they give the owner the right to buy shares in a company 
at a fixed date, usually at a fixed price. Companies can issue them without 
including them in the balance sheet. They are high risk and speculative. 
They are a gamble on the future price of a product or shares.