Worries of More Enrons to Come
Give Prices a Pounding
The New York Times
January 30, 2002
By GRETCHEN MORGENSON
Concerns about the
troubling practices that led
to the failure of Enron
(news/quote) slammed into the
stock market yesterday.
Companies whose shares took
the worst beating were those
with opaque or complex
financial statements, those
heavy with debt or those with
even a whiff of off-balance-
sheet obligations. The Dow
Jones industrial average fell
247.51 points, to 9,618.24, a
loss of 2.5 percent. The broader
Standard & Poor's 500-stock
index lost 2.86 percent of its
value, dropping to 1,100.64. The
Nasdaq composite index
dropped 2.6 percent, to
1,892.99.
"It's the cockroach theory," said
Anthony M. Maramarco,
portfolio manager at the Babson
Value Fund in Cambridge,
Mass. "There's never going to be
just one company that because
of accounting practices or
excessive debt levels will be a
problem. As a result, we go out
there and wholesale get rid of
anything that might come close
to being as tainted as what we
have identified as the initial
culprit."
Shares of financial companies
fell across the board. Stocks of
companies with troubling news,
including PNC Financial and
Tyco International
(news/quote), plunged even
more than most.
"I think what Enron has raised
is the question about all
financial reporting," said Liz
Miller, portfolio manager at
Trevor Stewart Burton &
Jacobsen, in New York. "The
detail of the reporting, the
clarity of the reporting, the
simplicity of the reporting."
Ms. Miller said it was no
coincidence that stocks took a
pounding just ahead of
President Bush's State of the
Union address and on the first
day of a two-day meeting by the
Federal Reserve Board. "I think
investors are looking for some
very high-level responses to this
condition," she said.
Selling was widespread yesterday for bank and financial
services stocks, which have made billions in loans to
companies now viewed as far riskier than they were when
the nation's economy was healthy. Shares of J. P. Morgan
Chase (news/quote) lost 6.6 percent of their value, Merrill
Lynch (news/quote) fell 7.5 percent, and Citigroup
(news/quote) shed 5.3 percent.
Telecommunications companies were hammered after
Global Crossing, a giant concern, filed for bankruptcy.
WorldCom (news/quote), the big long-distance carrier
based in Clinton, Miss., plunged to $10.40, its lowest level
since 1995. And the Williams Companies (news/quote), a
natural gas pipeline company, fell 22 percent on
disclosures that it might have $2.4 billion in unexpected
costs associated with a business that was spun off last
year.
Investors also put pressure on conglomerates with
operations that are varied, far-flung and hard to fathom.
Tyco, a company known for its complex financial
statements, lost 20 percent of its value, falling to $33.65 a
share. Contributing to investor skittishness was Tyco's
disclosure that it had paid $20 million to an outside
director and a charity he controls for help in arranging an
acquisition last year.
Even shares of General Electric (news/quote), one of the
nation's bluest chips, fell 4.4 percent, a reflection of
investors' fears that the financial statements of companies
in multiple lines of business may be too difficult to
understand.
Investors are not the only ones bringing greater scrutiny
to corporations' accounting practices. The Federal Reserve
appears to be taking a closer look at banks' financial
positions, too.
The PNC Financial Services Group (news/quote),
Pennsylvania's largest bank, announced yesterday that it
would reduce its 2001 net income by $155 million, or 53
cents a share, after Fed officials expressed concerns that
the company was improperly accounting for some problem
loans and venture capital holdings that it sold last year to
three separate entities.
PNC said it had retained only a partial interest in the
entities and had included that stake on its books, with the
approval of its auditors, Ernst & Young. But the regulators
instructed the bank-holding company to consolidate the
entire value of the holdings on its balance sheet. Walter
Gregg, a vice chairman of the bank, said PNC restated its
figures to "avoid confusion going forward and in light of
our desire to resolve the issue as quickly as possible."
Shares of Cendant (news/quote), a company with
franchises of residential real estate operations and motels
and the owner of the Avis rental car business, also fell
sharply. The company has seven partnerships that it has
used to move various operations from its books, said Jay
Leupp, a stock analyst at Robertson Stephens.
The main purpose of these deals was not to hide debt but
to avoid reporting losses, especially accounting charges for
acquisitions and other items that do not affect the
company's cash flow. Unlike Enron, Cendant disclosed
details of each partnership to investors.
Mr. Leupp said the partnerships' debt of $1 billion to $1.5
billion was "not much in comparison to Cendant's $10
billion to $11 billion in total long-term debt." He
estimated that shifting operations into the partnerships
added 20 to 30 cents to Cendant's earnings in 2001. But
investors may be nervous, he said, because once the
company moved the units into the partnerships, crucial
elements were no longer disclosed. "I wish I could see
more of the drivers of their revenue and expenses," Mr.
Leupp said.
Phone calls to Cendant were not returned late last night.
Even professional investors who know how to digest
financial statements seem to be realizing that they may
not truly know what they own.
"It has become much more difficult to make a standard
comparison among companies in a world where derivatives
and off-balance-sheet transactions are an increasingly
significant part of a company's operations," said Jonathan
Cohen, portfolio manager at JHC Capital in Greenwich,
Conn., and former chief of software and Internet research
at Merrill Lynch.
Confidence in the stock market rests on several basic
beliefs: that corporate managers will be truthful, that
auditors will be able to judge companies' financial
positions and that stock analysts and bond rating
agencies will be able to analyze how sound or promising
companies are. The fall of Enron has shattered all these
fundamental beliefs.
As a result, many investors perceive greater risk in almost
every publicly traded stock.
"If I own a lot of stocks, now I have to wonder about
whether much of the data on which I have based my
judgments is accurate or phony," said Stan Jonas,
managing director at Fimat USA, a broker-dealer in New
York. "If I don't know whether a company is honest or its
accountants are honest, I have to act as though it is
dishonest. That means I have to discount the price I will
pay for it to adjust for that risk."
Mr. Maramarco, the Babson fund manager, said his
company had had visits in recent days from two top
accounting analysts at Wall Street firms. "Both these
people, who clearly know balance sheets and income
statements inside out, have thrown up their hands," he
said. "They say there are so many ways for companies to
obfuscate their financial statements and have their
accountants sign off on it that they don't have a chance."
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