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December 24, 2005

Thinking about the WSJ's Enron conflict of interest

Emshwiller.jpgThe Chronicle's Loren Steffy thinks I'm stretching a bit in noting the conflict of interest that the Wall Street Journal has apparently decided to overlook in allowing John Emshwiller to report on the upcoming trial of the Enron Task Force's legacy case against key former Enron executives Ken Lay, Jeff Skilling and Richard Causey. Candidly, I don't think the point is a stretch at all. The following explains why.

Along with many others, Emshwiller has promoted the now common theme that Enron was merely a house of cards and that the company's intrinsic instability was hidden from the investing public by a deceitful management team. That view has been readily embraced by a wide-range of societal forces, such as publicity-seeking politicians who don't allow facts to get in the way of demonizing unpopular entreprenuers for political gain, government prosecutors who improperly expand the reach of criminal laws to further their careers, competing businesspeople and lawyers seeking to profit from Enron's demise, and a general public that finds it easy to resent wealthy businesspeople, particularly after the bursting of a stock market bubble. These societal forces believe that they understand the Enron morality play so thoroughly that otherwise thoughtful and intelligent people lose the capacity for independent thought regarding Enron and reject any notion of ambiguity or fair-minded analysis in ferreting out the truth of what really happened at Enron.

Unfortunately, this common view of Enron ignores the more nuanced view of a growing number of business experts who have studied Enron's core businesses and have a far better understanding of Enron's business practices than most of those who have promoted the Enron morality play. In many ways, Enron was an innovative firm, both in its primary business activities and in the ways in which it raised money. Experts in structured finance and derivatives recognize this and have already written extensively about Enron's remarkable innovation (see, for example, Christopher Culp and William Niskanen's Corporate Aftershock: The Policy Lessons from Enron and Other Major Corporate Corporations and Culp's subsequent book, Risk Transfer: Derivatives in Theory and Practice). Even Enron's original purpose in using special purpose entities ("SPE's") -- at least before former Enron CFO Andrew Fastow and henchman Michael Kopper hijacked them -- was sound and creative. With equity owned primarily by investment banks and other financial institutions, the SPE's were initially intended to be private equity funds with completely seperate management from Enron. The main attraction of the SPE's for investors was the funds' preferred right to invest in Enron assets, which benefitted Enron by allowing the company to preserve liquidity and hedge risk.

A side effect of this drive toward innovation was that Enron pushed the edge of the envelope between beneficial innovation, on one hand, and excessively complicated transactions that appear to have been designed to confuse more than to accomplish a legitimate business purpose, on the other. Fastow and Kopper's shenanigans with certain of Enron's SPE's are a good example of the latter type of activity.

Nevertheless, Enron was engaged in mostly legitimate and beneficial financial activities, including energy trading, structured finance and other financing transactions that had literally never been attempted before, and certainly never on the scale that Enron generated them. The societal demonization of Enron contributed substantially to an enormous amount of unnecessary wealth loss as many of the markets for such beneficial and innovative financial transactions shriveled in the wake of Enron's liquidation. Consequently, it is critically important in determining the truth of what happened at Enron -- particularly when the futures of three men and their families are at risk -- to distinguish between Enron's role as a legitimate, innovative company and the fraud that took place. Emshwiller's already published views toward Enron reflect that he is a poor choice to make that key distinction.

In fact, the situation with Emshwillier, the WSJ and Enron is eerily reminiscent of a situation that arose at the Journal almost 20 years ago in connection with Rudolf Giuliani's career-boosting prosecution of Michael Milken. Back then, it was WSJ reporter James Stewart who became the mouthpiece for Giuliani's propaganda campaign that demonized Milken's revolutionary financing techniques that literally unlocked billions in shareholder wealth during the 1980's. Stewart followed up his highly misleading WSJ reporting on Milken with a book that perpetuated the same prosecutorial myths about Milken and utterly ignored Milken's role in the tremendous wealth creation and innovation in financial markets that occurred during the 1980's. Daniel Fischel brilliantly exposed both Stewart and Giuliani's duplicity with regard to Milken in his 1995 book, Payback: The Conspiracy to Destroy Michael Milken and his Financial Revolution. Despite the wise perspective that Fischel provides regarding the grave danger to justice, the rule of law and wealth creation that results from unleashing the power of government against the unpopular businessperson of the moment, precious few of the hundreds of people with whom I have spoken or corresponded regarding the Enron case even know about Fischel's book, much less have read it.

Given the WSJ's experience with Stewart in the Milken debacle, it's at least odd that the Journal appears to be overlooking the high risk that a similar journalistic failure may occur in regard to Emshwiller's coverage of the Lay-Skilling-Causey trial. The warning signs are clearly there -- Emshwiller completely missed on the government's overreaching destruction of Arthur Andersen and has largely ignored the prosecutorial misconduct that has marred the Enron Task Force's handling of all of the Enron-related prosecutions. Perhaps most notably, Emshwiller has said virtually nothing about the outrageous miscarriage of justice that landed four Merrill Lynch executives in jail for doing nothing other than being involved in a relatively small transaction with the social pariah Enron.

So, count me as skeptical that Emshwiller is capable of providing the type of objective reporting regarding the Lay-Skilling-Causey trial that readers of America's leading financial newspaper deserve. The Wall Street Journal can do much better.

Posted by Tom at December 24, 2005 6:10 AM |

Comments

Wonderful, illuminating post, Tom, which you may have to "re-run" if the New York Times deploys Kurt Eichenwald to cover the upcoming Causey/Lay/Skilling trial. We will continue to count on you for the nuanced view.

Posted by: forrest at December 24, 2005 8:23 AM

entreprenuers?

Enron claimed to be in the Fortune top ten and not any of the top three had one dollar of their own funds invested. All they had was paper wealth, generated by their fraud.

Second, you insult Michael Milken by including Lay and Skilling with him. Milken was wrongly prosecuted but not by the public nor politicians. If you have actually read Fischel, then you know that entrenched crooked management in American business was responsible for his prosecution, that and jealous competing investment bankers.

Posted by: Moe Levine at December 24, 2005 12:32 PM

Moe, your first observation is superficial and largely meaningless (that Lay and Skilling didn't have any of their own funds invested in Enron) and your second observation is based on a dubious conclusion (that Enron's wealth creation was based on fraud).

The cases of Milken and Drexel, on one hand, and Lay, Skilling and Enron, on the other, are quite similar. Although Enron used different techniques in its approach to wealth creation than Milken and Drexel used, that doesn't make Enron's any less valid. And the fact that Fastow and his relatively small number of cohorts at Enron committed fraud doesn't mean that Lay and Skilling were involved in that fraud any more than Boesky and Levine's fraud meant that Milken was involved in theirs.

Posted by: Tom K at December 24, 2005 1:17 PM

Isn't the question, not whether some innovative risk-managment tools were invented, but whether fraud was committed by Fastow, Skilling and Lay? The Soviet Union, Communist China, etc. also came up with some great innovations but in corrupt, unethical and malicious systems, led by self-serving idealogues at the top. A financial house of cards can still be built on a good technological foundation.

Let the jury decide who is guilty of fraud instead of arguing about media bias. Isn't it consistent though that the authors of Smartest Guys in the Room would be "biased" against Lay and Skilling after they had already made their case in the book?

Posted by: JT at March 7, 2006 2:14 PM

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