Ethics and Bad Cosmetics

["Henry C.K. Liu" <hliu@xxxxxxxxxxxxxx>]

The following information on Enron is now in the public dormain.

Enron faced accounting improprieties and valuation issues.

The valuation issues could be fixed and reported with other goodwill
write-downs.

But two major deals that unwind in 2002 and 2003 present problems.
Enron booked profit of $1.35 billion from deals (Condor and Raptor) in
1999 in the form of funds flow from merchant asset sales by selling to
vehicles that Enron capitalized with a promise of Enron stock in later
years.  There is a question about whether this was a funds flow or cash
from equity issuance. But the real problem began when the market values
of these assets dropped by 98% which forced Enron to issue new stocks to
offset these losses.

To make matters worse, when the Condor and Raptor deals were booked in
1999 ans 2000, Enron enjoyed the resultant rise in stock price, Enron
executives sold shares at the high price.  The company then tried to fix
the deals in 2001.  "It's a bit like robbing the bank in one year and
trying to pay it back 2 years later," as Sherron Watkins wrote in her
"annonymous" letter to Kenneth Lay, the Chairman.  Of course, the
problem turned out much worse, because the company could not even fix
the deals, meaning the bank robbers were unable to pay back the loot.
The public investors were encouraged to buy Enron at $80 to look for
$120, but ended up zero, while Enron insiders sold at the $80-60 range.

The key, as Ken Lay wrote in his letter to Enron employees at the time
of the resignation of Skilling (President of Enron), was to prevent
share value from falling.  If no one was wiser to the real risk and
liability that Enron faced, the deals would hold.  Actually, by then the
game was over, because the losses had already occured and could not be
reversed without fatal damage to Enron.  Vinson & Elkins, Enron's legal
counsel, concluding on October 15, 2001 (when Enron was still selling at
$38) from an investigation precipated by the Watkins letter, that all
was legal and in order.  It warned nevertheless: "Our preliminary
investigation, however, leaves us concern that, because of the bad
cosmetics involving the LJM entities and Raptor transactions, coupled
with the poor performance of the merchant invesment assets placed in
those vehicles and the decline in the value of Enron stock, there is
serious risk of adverse pubilicity and litigation."

In other words, if the deals did not lose money, the accounting
impropreties and the bank robbing were no big deal.

Bad Cosmetics was defined by V&E as follows:
"Concerns were frequently expressed that the transactions involving
Condor/Whitewing and Raptor could be protrayed very poorly if subjected
to a Wall Street Journal expose or class action lawsuit.  Factors
pointed to in support of these concerns include (i) the use of Enron
stock to provide equity necessary to do transactions with
Condor/Whitewing and Raptor; (ii) recognizing earnings through
derivative transactions with Raptor when it could be argued that there
was no true 'third party' involved in those transactions; (iii) because
both merchant investment value and Enron stock have fallen, the Raptor
entities may not be able to satisfy their obligations to Enron, thus
raising the question "Who unltimately bears the loss?"; (iv) the
apparent conflict of interest raises questions as to the valuation of
assets sold to or that were the subject of transactions with Raptor and
the timing of those transactions (generally at a point when the
valuation was at a historical high point).

It was not much different from what JP Morgan and Rockerfeller did in
the old days.  The only two differences were that they did it when it
was still legal and they made money, and Enron lost money and the courts
will soon decide whether it was legal.

Ethics is more than merely avoiding bad cosmetics.

Henry C.K. Liu