Enron’s Transparent Problems 

On Wednesday, the CEO of Enron, Kenneth L. Lay, expressed the “highest faith and confidence” in his chief financial officer. Yesterday, he announced that his CFO has been replaced.

Enron is having a transparency problem. I don’t mean that it’s easy to see what has gone so drastically wrong in the firm’s numbers lately but rather the opposite. In fact, it’s the maddening opacity of certain aspects of Enron’s financial dealings that has positively crushed its share price recently. It’s not that someone has found, or even claimed knowledge of, some smoking gun—it’s that no one even seems certain how to look for such a thing.

The trouble apparently began with a remark by Lay during the firm’s most recent quarterly conference call with analysts: Enron planned to repurchase 55 million shares issued as part of a transaction with a “structured finance vehicle,” and as a result its shareholder equity would shrink by $1.2 billion. This hadn’t been mentioned in the company’s actual earnings release, and people started asking questions.

The investment “vehicle” was funded by Enron and a limited partnership created by Andrew Fastow—the erstwhile CFO who is now technically on a “leave of absence.” This and transactions with similar partnership vehicles were part of a hedging strategy to balance Enron’s technology investments. The strategy doesn’t seem to have worked out very well, but the Wall Street Journal has reported that Fastow seems to have done OK, getting millions in partnership management fees. This week an SEC probe was announced.

Enron says it did nothing wrong and followed all the appropriate disclosure rules. That may well be the case—and, ultimately, the problem. It turns out that analysts and others who follow Enron have always found some elements of its financial structure to be rather bewildering, “hard to understand,” even “impossible.” But its announced earnings—which leave out some balance-sheet items—looked pretty good, and the stock was a superstar, jumping almost 200 percent over the two-year stretch ending in the summer of 2000. Having peaked at about $90 back then, it’s closer to $17 now. And because those hedging arrangements are apparently tied to the health of Enron shares, it’s now getting to the point that the fallout may well affect the company’s debt rating and its actual bottom line.

In any case, it seems that plenty of investors (large and small) were willing to overlook what they didn’t understand as long they liked what they did understand. This, I suspect, is not such an unusual investor attitude. And Enron’s case, all that confusing stuff didn’t really matter—right up until the moment that it did. Now that it does, Enron is left with not only the task of explaining itself clearly, but also of trying to convince shareholders to have more “faith and confidence” in the firm than the firm itself has turned out to have in its CFO. Even the Goldman Sachs analyst who has been a great enthusiast for the firm urged its management to overcome “the appearance that you are hiding something.” That is, the company has to not only be open with investors, but also to seem open. Doesn’t that make it sound like Enron’s future still depends as much on appearance as reality? Sure. But that’s always true with stocks. Transparently so.