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September 11, 2003

Policy Break--Securities Fraud and Its Enablers


So, did you hear about Ben Glisan Jr., the ex-Enron executive who—after diligently helping to defraud investors of billions of dollars—has admitted to securities fraud and was sentenced to all of five years in prison?

Do you ever wonder what is going on in government prosecutor’s heads when they cook up deals like this? I sure do.

According to the New York Times story, which you can read here, the five year sentence is

…fairly long…compared with those given in many white-collar convictions that result from pleas.

Now, see, if I was a prosecutor that would make me inclined to try the son of a bitch so we could throw him away for lots longer. But I guess I must lack the special prosecutorial point of view or something. Because if I would have contemplated doing a deal with Mr. Glisan, I would surely have insisted that he co-operate with the investigation in order to cut a deal, and the real prosecutors didn’t feel that way:

“We have witnesses, and Mr. Glisan is not currently one of them,” said Leslie Caldwell, head of the Justice Department’s Enron task force. “He was never cooperating, and we never expected him to cooperate.”

Huh? Did I get that right? This guy is shaving all sorts of time off his sentence but couldn’t be bothered to cooperate? What the hell is going on here?

Apparently, what’s going on here is a need to look busy on the part of prosecutors who must be taking a lot of bathroom breaks and long lunch hours on the taxpayer’s dime:

“It was critically important for the government to show some tangible progress, and that is what this plea provided them,” said Robert Mintz, a former federal prosecutor who is now a partner at McCarter & English in Newark. “The opportunity of the government to show an Enron executive leaving the courtroom and heading directly to jail was a significant step for the government in demonstrating to the public that they are moving the case forward.”

If letting guys like Glisan off easy is the government’s idea of “moving the case forward,” my suggestion is that we just disband the Enron task force before we waste any more millions on it. This is some kind of bizarre public relations act, not law enforcement.

The core of the problem here, as the (non-) prosecutions of management-insiders at Enron, Worldcom, Tyco and companies too numerous to mention demonstrates, lies in the ludicrously stringent definitions of securities’ fraud enshrined in our nation’s laws. To get a guilty conviction on a management-insider, you have to prove misrepresentation of facts to the public, that the facts were material, that the defendant was aware that he was misrepresenting, that he was standing on his left leg while singing the Star Spangled Banner while performing the misrepresentation, and…(most importantly) that the defendant knew in his heart that what he was doing was wrong!

Enough is enough, guys; public markets are a chump’s game if enormous information asymmetries between insiders (like Mssrs. Fastow and Glisan) and outsiders (like everybody else) are tolerated with a nod and a wink. If an officer of a public company materially misrepresents facts of importance to investors, said officer should be in for serious consequences without having to prove first that he or she was in a “wicked” state of mind. (I grant you, accidents can happen, so I would put in a high threshold for what I would define as material.)

Moreover, something serious has to be done about the accounting profession and its very profitable role in enabling securities fraud. Under generally accepted accounting principles—known as GAAP—there are tons and tons of variances permitted in the accounting treatment of almost any situation. The effect of this is two fold: first, it allows companies to select the treatment that reflects most favorably on their company—that is, to manipulate numbers with the goal of fooling investors legally—and second, it makes it almost impossible to prove that corporate insiders knew they were doing something illegal when cooking the books and not just making an innocent "error" when dealing with a very fuzzy topic. The net effect of the accounting profession, I would suggest, is probably to suppress or garble information valuable to investors, rather than acting as the investors’ watchdogs. It would be more honest at this point for public companies to issue completely unaudited financial statements with no pretense of objectivity--at least that way investors would know to be on their guard.

The whole experience reminds me of the villain in “Blazing Saddles” who pauses in the middle of cooking up a fiendish scheme and says, “But is it legal?” He consults his law book for real estate law, is referred to the section on scams and swindles, and concludes, “Ah, yes, it’s perfectly legal.”

Maybe we could get Mel Brooks to take over the Enron task force. At least then we'd get some entertainment for our money.



P.S. Maybe I'm being too harsh on our government watchdogs. After all, the SEC extracted an agreement from Glisan that he won't ever be an officer of a public company again. I guess that showed him!

posted by Friedrich at September 11, 2003


Friedrich -- I understand that you think that five years is obviously not long enough, but do you have any reason to believe there's a significant chance he'd have received a longer sentence at trial?

Posted by: Felix on September 11, 2003 12:03 PM

You probably have a point Felix. That agreement with the SEC not to ever be the officer of a public corporation again was undoubtedly punishment enough.

I guess my real response would be to say that if such a longer sentence is not legally available, it sure should be. Securities fraud is not like murdering your adulterous spouse in a moment of rage. It's a rational act. Currently the downside of such an act isn't large enough compared with the rewards of committing fraud and (in all likelihood) getting away scot free.

Posted by: Friedrich von Blowhard on September 11, 2003 12:11 PM

He sure shouldn't have gotten 5 years (probably out in 3) in a MINIMUM security prison without COOPERATING. He should have had to at least pay the legal bills for a full damn trial in that case. I find this so outrageous as to almost not be able to speak rationally about it. Particularly since he cashed out his Enron shares, gaining from his illegal conspiracy, and I see no requirement in the deal that he GIVE THE MONEY BACK.

Posted by: annette on September 11, 2003 1:00 PM

Steal $500 from a bank - get 10 years in prison. A rather unpleasant prison.

Steal $500 million from a corporation (that you happen to work for) - maybe you'll do 2 years in a minimum security prison. And you'll have to give 10% of the loot back. Or 5%. Some people would consider a slap on the wrist worth running off with $500 million. (Or even a mere $100 million after it's all settled).

What a racket.

Posted by: some guy on September 11, 2003 2:07 PM

The accountants involved took it good and hard: Arthur Andersen, once a multibillion dollar company, is _dead_. They paid out a huge fine, huge damages, lost all their business, then liquidated. I can't swear to it, but I believe those who were AA partners all lost a fair amount of money.

Also, it is not clear to me that Enron management "defrauded investors of billions of dollars." Nearly of the money lost by Enron investors was gained by other Enron investors as the stock soared and crashed. Enron management took millions out of the company (beyond what they earned for the company's initial and genuine success), but millions are not billions.

Posted by: Rich Rostrom on September 11, 2003 5:51 PM

As in the OJ case, the closest thing to justice in the Enron cases will likely come from the civil court system. I would be shocked if Fastow, Lay, etc. manage to keep much of their wealth after plaintiff attorneys (and their own defense attorneys) get through with them.

Fastow will likely also go down on criminal charges; Lay may well not, because there's plenty of evidence that he was too busy schmoozing with politicians and playing the public role of great chairman to actually have been aware of the rampant fraud at Enron. His own history of sales of Enron stock is consistent with an almost incredible detachment from the reality of the company. In other words, he was clearly grossly negligent (which may have civil penalities) and not necessarily criminally fraudulent -- which Fastow and Skilling pretty clearly were.

Enron taught a couple of interesting lessons: Be very, very vary of the financial press, which was running articles about how Enron was the model for future companies until the very end, and be very, very wary of analysts, particularly those who aren't local enough to kick the tires. The problem was that Enron worked by "Processes Too Complicated to Be Explained" (P2C2E's in Salman Rusdie's coinage). The analysts were confronted with an inexplicable black box that was pumping out money in ever larger quantities, and, as this went on for years, began to believe it. Even Goldman's energy analyst was touting Enron almost until the blow-up, and the only faint warnings came from a Texas-based analyst who had some sense of the historical odors coming from the firm.

Posted by: rashomon on September 11, 2003 5:56 PM


I'm not sure I'm following your math. Enron's market capitalization dropped by many tens of billions. For those holding Enron stock at its height, and for those buying on the way down, these losses were real losses. (Granted, people made money on the way up, but not the same people. If they were the same people, they ended up getting hosed.) Moreover, I doubt many (any?) of the people who ended up getting hurt would have invested had they known the true, parlous state of Enron's finances, with billions of dollars of indebtedness hidden in various special purpose entities and with income puffed up via the same strategies. It all sounds like fraud causing billions of dollars of damage to me, because Enron was sho' nuff cooking the books.

P.S. It would appear to me (of course, I'm no accountant), that with the advent of derivatives contracts conventional accounting ceased to have any real meaning, because standard balance sheets and P&L statements can't capture the value (or risk) associated with such contracts until they are cashed out. As a result, while a company may publish earnings and financial reports showing it is in fine shape, growing and making good profits, a derivatives contract may be ticking away inside that financial edifice and, suddenly, trash the entire company. Is anyone out there able to either confirm or deny this theory?

Posted by: Friedrich von Blowhard on September 11, 2003 6:08 PM

I think the crux of the matter is what you said here:

"public markets are a chump’s game if enormous information asymmetries between insiders (like Mssrs. Fastow and Glisan) and outsiders (like everybody else) are tolerated with a nod and a wink"

Insider trading WOULD make that informational playing field much more equal, as buying or selling of shares by insiders tells you a LOT about a companies actual health, as it's their own money on the line.

Banning insider trading makes the execs play all these silly accounting games to make the kind of money they want, while blinding outsiders to valuable information. Reporting requirements should be kept, but the actual restrictions on insider trading should be scrapped.

Posted by: David Mercer on September 12, 2003 6:26 AM

FvB---Your analysis of derivative risk is accurate, in that the mark-to-market at any given moment on a derivative can change dramatically as markets move, and only unwinding the derivative transaction prior to the stated maturity date actually generates the need to produce (or receive) actual cash to cover the value of the derivative at that moment. (If you hedge your interest rate on a loan at 8% and rates go down to 7%, and you want to repay that loan early, thus breaking the fixed rate contract, you will need to pay the bank a sum to compensate them for repaying a higher-yielding loan early). Thus it is an ever-moving target. The presence of these types of financial vehicles makes investing on a company-by-company basis very sophisticated and risky, and the only solution I can think of is to return to the basics of diversification. The people who took the biggest bath on Enron were those who invested only in Enron. Stock picking is a fulltime and demanding job and you gotta be able to take your hits. I agree with David that looking at the trading of insiders is one valuable piece of information, but not the only one, and I think the risks of abuse by senior execs makes insider trading need some regulation. Otherwise, equity capital really will become scarce, because everybody really is at the mercy of endless manipulation. (Even more than they now know they always were...). I think people in general lost track of how risky picking individual companies is during the 90's, when everything just went up, up.

Posted by: annette on September 12, 2003 7:26 AM

Whew! Annette knows her derivatives. She must be reading her Joe Bob Briggs.

This is what I know: if you see the word associated with a company in any way, shape, or form, dump all your stock that instant. Thank goodness my happy little small-town broker is very good keeping track of these things.

Posted by: j.c. on September 12, 2003 2:28 PM

I haven't seen 'em all, but I've seen a number, and I've never seen a public company in the last 10 years with no derivatives risk. Most private companies over $20 million in revenues have it, too.

Posted by: annette on September 12, 2003 4:41 PM


If I bought Enron at 5, and it goes to 100, I have a profit of 95 "on paper". If Enron goes to 0, I lose that "paper profit", and my original 5. The 5 is my real loss. The other 95 was fairy gold. If I bought at 100, then I lose 100. But where did my money go? Not to Enron management, unless I happen to buy the stock from them. It went to other shareholders. Some investors lost billions on Enron. Others _made_ billions: they benefited, unwittingly, from Enron's deceptive reporting. The winners nearly equal the losers. Only a small amount of that money stayed with Enron management.

It might be more correct to say that Enron's management destroyed the company by greed-driven mismanagement. Enron was genuinely successful up to a point. Then they had some problems. Had they acknowledged the problems, the stock price would have fallen 50%-70%, wiping out management's options and probably getting them fired. So Enron covered up and kept the stock rising. When the truth came out, it wasn't that bad (profits were only 2/3 of what had been claimed). But the reaction to the cover-up ruined Enron's trading business and credit rating, leading to total bankuptcy.

Posted by: Rich Rostrom on September 17, 2003 3:54 PM

I did a search in the search engines on "professional accountant blog" and I found your web blog.
I am a Chartered Accountant in Halifax, Nova Scotia, Canada and thus my interest in searching for a company blog on the WWW looking to see how the rest of the world thinks about accountants and see what trends and technology are happening in the world. I also was interested in a blog for myself and possibly leading to a blob for my accounting business, you never know, that is if I can understand the technology of operating a blog and from what I see I am somewhat hesitant at the present time.
It has been interesting reading.

Respectfully yours
Stephen B.,
A Halifax Chartered Accountant

Posted by: Halifax Accountant on February 11, 2004 11:12 AM

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