To: JBTFD who wrote (1080 ) 4/2/2002 11:39:37 AM From: JBTFD Respond to IV. Conclusion How did Enron lose so much money? That question has dumbfounded investors and experts in recent months. But the basic answer is now apparent: Enron was a derivatives trading firm; it made billions trading derivatives, but it lost billions on virtually everything else it did, including projects in fiber-optic bandwidth, retail gas and power, water systems, and even technology stocks. Enron used its expertise in derivatives to hide these losses. For most people, the fact that Enron had transformed itself from an energy company into a derivatives trading firm is a surprise. Enron is to blame for much of this, of course. The temptations associated with derivatives have proved too great for many companies, and Enron is no exception. The conflicts of interest among Enron's officers have been widely reported. Nevertheless, it remains unclear how much top officials knew about the various misdeeds at Enron. They should and will be asked. At least some officers must have been aware of how deeply derivatives penetrated Enron's businesses; Enron even distributed thick multi-volume Derivatives Training Manuals to new employees. (The Committee should ask to see these manuals.) Enron's directors likely have some regrets. Enron's Audit Committee in particular failed to uncover a range of external and internal financial gimmickry. However, it remains unclear how much of the inner workings at Enron were hidden from the outside directors; some directors may very well have learned a great deal from recent media accounts, or even perhaps from this testimony. Enron's general counsel, on the other hand, will have some questions to answer. But too much focus on Enron misses the mark. As long as ownership of companies is separated from their control - and in the U.S. securities market it almost always will be - managers of companies will have incentives to be aggressive in reporting financial data. The securities laws recognize this fact of life, and create and subsidize "gatekeeper" institutions to monitor this conflict between managers and shareholders. The collapse of Enron makes it plain that the key gatekeeper institutions that support our system of market capitalism have failed. The institutions sharing the blame include auditors, law firms, banks, securities analysts, independent directors, and credit rating agencies. All of the facts I have described in my testimony were available to the gatekeepers. I obtained this information in a matter of weeks by sitting at a computer in my office in San Diego, and by picking up a telephone. The gatekeepers' failure to discover this information, and to communicate it effectively to investors, is simply inexcusable. The difficult question is what to do about the gatekeepers. They occupy a special place in securities regulation, and receive great benefits as a result. Employees at gatekeeper firms are among the most highly-paid people in the world. They have access to superior information and supposedly have greater expertise than average investors at deciphering that information. Yet, with respect to Enron, the gatekeepers clearly did not do their job. One potential answer is to eliminate the legal requirements that companies use particular gatekeepers (especially credit rating agencies), while expanding the scope of securities fraud liability and enforcement to make it clear that all gatekeepers will be liable for assisting companies in transactions designed to distort the economic reality of financial statements. A good starting point before considering such legislation would be to call the key gatekeeper employees to testify. Congress also must decide whether, after ten years of steady deregulation, the post-Enron derivatives markets should remain exempt from the regulation that covers all other investment contracts. In my view, the answer is no. A headline in Enron's 2000 annual report states, "In Volatile Markets, Everything Changes But Us." Sadly, Enron got it wrong. In volatile markets, everything changes, and the laws should change, too. It is time for Congress to act to ensure that this motto does not apply to U.S. financial market regulation.
