The Ripple Effect

;Forgive Michael Useem if he sounds a bit gleeful when he talks about Enron. Where other observers see a tragic tale of executive avarice, Useem, a management professor at the University of Pennsylvania's Wharton School, sees the case study of a lifetime. Indeed, Enron is fast becoming as useful to Useem and his colleagues as "Hamlet" is to the English department. "From a teaching standpoint this has everything," Useem enthuses, describing how he's using the scandal to lead classroom discussions about leadership, auditing, executive compensation and culture. At law schools, too, Enron seems destined to land on syllabuses for years to come. "I think it's as fascinating as the Watergate hearings," says Duke University law professor James Cox, who's using Enron to teach about conflicts of interest and the obligations of directors. "Every day there's a new revelation."

For many of us, though, the Enron news is coming a bit too fast and furiously. Amid wall-to-wall cable coverage and endless opining about what it all means, it's hard to discern the moral to this story. Is it just corporate thievery on a grand scale? Or, as New York Times columnist Paul Krugman has suggested, is Enron's fall an epochal event that will change our lives more than September 11? If you haven't made up your mind, take heart: even if you don't know JEDI from Chewco, or if you plead the Fifth on whether Andy Fastow or Jeff Skilling really knew what was happening, the larger lessons of Enron are beginning to emerge. Two years after the Internet bubble burst and a year after the nation's longest economic expansion came to an end, Washington's frenzy to enact post-Enron reform suggests the energy company's collapse may go down in history as the true market correction. The scandal has illustrated just how lacking in skepticism we were in an era when every business plan was brilliant and stocks almost always moved up. In the wake of the collapse, politicians, regulators and corporate boards are rethinking some of the most basic concepts of corporate life. What are "earnings"? How should we pay executives? What do analysts mean by "strong buy"? Some see a pause, at least momentarily, from the greedy, go-for-broke ethos of the long boom as investors reassess their appetite for risk. One New York City bookstore tells the story: in the window once reserved for "The Millionaire Next Door" lies a new title called "Investing for Cowards." Says Kirk O. Hanson, a business-ethics professor at Santa Clara University: "I think Enron will become the morality play of the New Economy."

The most immediate Enron effect is already rolling through your portfolio. Although the S&P 500 is down 4.5 percent since the beginning of the year, certain stocks have taken a heavy beating. They're mostly companies with complicated business models or confusing financial statements--like Tyco. But the concern is spreading: last week even General Electric chairman Jeffrey Immelt had to reassure investors about the strength of GE's financial controls, and the Securities and Exchange Commission began investigating accounting irregularities at Global Crossing. Beyond the short-term turbulence, experts worry that investors' newfound doubts about companies' financials will cause them to pay less for stocks. Yale professor Robert Shiller says that even if investor skepticism doesn't hurt valuations, stock prices could still wobble if stricter accounting standards give companies less leeway to puff up earnings. Those factors--along with the chance that more accounting scandals could lead to a sharp market decline--have some economists sounding gloomy. Says Mark Zandi of "I view this as a very significant threat to the fragile recovery we're all anticipating."

Some investors' faith has already been shaken. Several clients of Judi Martindale, a financial planner in San Luis Obispo, Calif., have grown so distrustful that they want to move out of stocks entirely. "They're terrified--they see people whose lives have been turned upside down," says Martindale. Others, like Mike Kubin, 51, who owns a New York City advertising firm and has a seven-figure portfolio, are rethinking the pick-stocks-yourself ethos that blossomed in the late '90s. To Kubin, mutual funds have never looked better. "I don't want to wake up at 3 a.m. freaking about my investments," he says.

In boardrooms, the biggest fallout from Enron may be a rethinking of how CEOs make their fortunes. Those Enron execs sitting before Congress made hundreds of millions from stock options, and some observers are fingering this pay device as a co-conspirator in Enron's fall. Options came into fashion in the 1980s to align execs' interests with shareholders'. During the '90s, CEOs began getting ever-bigger piles of them, and options trickled down to lower-paid workers. Today more than 12 million Americans--nearly one in 10 workers--has options. At Enron, one in six did. That's why Frederic Cook, a pay consultant to corporate boards, attributes part of Enron's problems to "a culture of personal greed and intoxication with stock-price appreciation."

If the option orgy is the problem, how do you solve it? Most of the proposals aren't new, but they seem to be gaining momentum. For instance, boards could begin "indexing" the options, so they pay off only if the company outperforms the market or its peer group. The most novel idea is a concept called clawback provisions, which would require CEOs to pay back gains on options if their company goes bankrupt. Even some executives think that's a smart idea. "It's just too easy for the unscrupulous to run the company in the short term, make everything look wonderful and get out when the stock is at the top," says Robert Lutz, vice chairman at General Motors.

Congress seems likely to demand a re-examination of options, too. Legislation being introduced this week by Sens. Carl Levin and John McCain would end the generous tax write-offs given to companies whose employees exercise options, a move Congress tried, without success, to implement in the 1990s. Options "create an unhealthy temptation for executives to push the accounting envelope," Levin told NEWSWEEK. "This is broader than Enron--it's an endemic problem." But skeptics say that if tax-code changes make companies less inclined to give out options, they'll simply stop giving them to lower-ranking workers. "Believe me, this will not stop options from going to the people at the top," says consultant Webb Bassick of the Hay Group. "All this legislation will be is an invitation for consultants and accountants to figure out a way around it, and we will. That's what we're paid to do."

Fixing pay packages seems easy compared with correcting the most shocking failures brought to light by Enron: the lack of oversight by accountants. One of the biggest bean-counting blunders has already been fixed voluntarily by the Big Five firms. They'll no longer take lucrative consulting fees to set up accounting systems for companies they also audit. Fixing the broader accounting problems raised by Enron won't be as easy. Accounting rules are written by a group called the Financial Accounting Standards Board, which has a reputation for moving too slowly, even by Washington standards. There's a joke in accounting circles that it takes four years for FASB to create a rule and four minutes for a creative bean counter to find a way around it. FASB chairman Edmund Jenkins admits their rule making "needs to be more efficient," but he argues that the real problem is how the rules are enforced.

That's where the SEC comes in. That agency made some real strides to protect investors under chairman Arthur Levitt, who left last year, but critics have complained (perhaps unfairly) that new SEC chairman Harvey Pitt has too many ties to industry to go tough on the accountants. Those critics were encouraged last week when a Levitt pal, former SEC general counsel Harvey Goldschmid, was nominated to join the five-member commission; he's expected to favor stricter oversight. But no matter who chairs SEC meetings, the trouble may lie in the trenches. Topflight lawyers and accountants prefer more lucrative, less bureaucratic jobs; if you're going to analyze financial statements all day, would you rather work for the SEC or Goldman Sachs? "Even if Congress gave us money for 100 new accountants, it would take us years to fill those positions," says Laura Unger, an outgoing SEC member.

Even as the televised investigations continue, eager congressmen are readying two dozen bills to prevent Enron redux. Beyond the bills to change the treatment of options and rein in auditors, most of the bills attempt to protect retirement funds. Enron workers' 401(k)s, swollen with Enron stock, evaporated with the company. There's disagreement about how many companies face the same risk, but a study of 219 companies by DC Plan Investing, a management newsletter, found 25 had more than 60 percent of assets in their own stock (Procter & Gamble, Sherwin-Williams and Abbott Labs had more than 90 percent). The right fix for that problem is still in play. President George W. Bush has proposed a plan that limits "lockdown" periods, when employees can't shift funds, but he opposes capping workers' investments in their employers' stock. Democratic Sens. Barbara Boxer and Jon Corzine are sponsoring a bill that would limit that allocation at 20 percent.

While employees' vaporized 401(k)s evoke sympathy, the behavior of Enron's directors provoke scorn. Ultimately, experts say, those directors take much of the blame for Enron's fall because they're the overseers who are paid to prevent blowups like this from hurting shareholders. "Everybody is saying 'Thank God it isn't me [on that board]'," says Yogan Dalal, a venture capitalist at the Mayfield Fund. In Silicon Valley, where start-ups have typically had small, clubby boards, there's already talk of how the Enron scandal will change board composition. If the Enron effect causes directors' workloads to increase, boards may add members. But some speculate that Enron's 14-member board made it too easy for directors to pass the buck and assume the guy across the table knew what was going on. Either way, watching Enron's directors get hit with lawsuits and subpoenas won't make board candidates eager to leap at directorship offers. "In recent years it's already been more challenging to attract outside board members," says David Kixmiller, who recruits directors at the search firm Heidrick & Struggles. Enron could make it worse, he says.

For all the table pounding, though, there's a sense among seasoned observers that scandals rarely provoke the radical changes reformers envision. Despite all the hand-wringing, "as the economy starts to pick up and people see possibilities and new ways to make money, we'll just start all over again," says Matt Robbins, a 61-year-old government employee in Atlanta. Indeed, those who see Enron as anything more than a pause to the greed-is-good mentality are ignoring centuries of human history, says Patti Houlihan, a financial planner in Oakton, Va. "Greed was what limited partnerships were all about, greed was what the dot-coms were all about and greed is what Enron is all about," she says. "The question is: what's the next thing?" And for all the professed shock caused by Enron's fall, let's recall that Americans are none too trusting of business even in scandal-free times. In a Gallup poll, only 28 percent of people said they had a great deal or quite a lot of confidence in big businesses; America's blue chips only narrowly beat such PR-challenged groups as Congress and HMOs. For many people, Enron's fall has only confirmed their attitudes about fat cats. It's one part of the Enron story that doesn't need a correction.