This website provides a look, from a distinct vantage point, into some of the problems coming to light with the Enron bankruptcy. Lawmall's Arthur Andersen website should be read together with this Enron website, see Don't Cry for Arthur Andersen - Millions of Americans Lost Their Savings and/or Jobs during AA's Auditing Leadership">.
It might be useful to know that I am a former securities attorney, Wall Street lawyer, inventor, antitrust litigator, author, and creator of this family of websites collectively referred to as www.lawmall.com, and I have an extended business background (having founded, financed and run a business for 18 years).
With this background, I can see that the Enron problem has some useful aspects. It permits the politicians, public and press to focus at the same time on numerous ways in which some major corporations are able to go beyond their intended purpose and severely injure the persons and institutions which give them permission and capital to operate.
Enron, as a convenient overall name for these problems, is not readily or entirely curable, because there are too many institutions which benefit from business as usual. The only hope is that some things can be done to reduce the impact of Enron.
Competition is one alleged justification for putting up with Enron. Unless business is free to compete (some persons argue), we unnecessarily stifle legitimate businesses by leaning too heavily on the Enron situation. This translates into an argument (being made by persons against changing the status quo) that little should be done to correct Enron because Enron is already being punished by market forces which have pushed Enron Corp. into bankruptcy.
This argument tends to forget that Enron insiders have walked away with billions of dollars taken from someone, and those someones are investors, Enron employees and middle management, landlords, banks and others. Clearly there should be a way to wrest the illegal gains from the persons who have used Enron to profit personally while Enron Corp. was on its course of self destruction (known to the real insiders).
Enron points out that even with a major financial disaster, there are winners (Enron insiders, Enron accountants, Enron experts, Enron inside shareholders who bought at pennies per share) and there are losers (the persons who bought Enron shares at high prices, Enron employees, Enron employees who bought Enron shares at high prices and were not allowed to sell their shares during a critical period prior to bankruptcy, landlords who find that they cannot require Enron to honor their leases due to the bankruptcy filing, and others too numerous to describe fully).
Enron is only a public display of what is going on generally with some major corporations. The stock goes up; the public gets sucked in; investment bankers and related institutions make hundreds of millions of dollars moving the company's assets around; insiders take obscene salaries and incentives out of the corporation; the financial condition of the corporation is not revealed through various tactics to be discussed below (including but not limited to certain aspects of "globalization", and to mergers and acquisitions, restated financials, failure to reflect lawful earnings separate from illegal earnings; and some other things which will come to mind when writing below); and finally the corporation goes under but the insiders keep their huge share.
We pretty much have to give up on creating direct competition for any major companies. The tendency is the other direction, thanks to a U.S. governmental merger policy in which virtually anything is permissible. The alleged justification for this is that one big company selling everything to everybody would be most efficient, and we have to assume (I believe the federal regulators and politicians want us to conclude) that unregulated monopolies will pass on their economies to the public by charging low prices. Of course, this would never happen and goes against the economic model for a monopoly.
In casting about for something else to suggest, I am reminded of "shadow" warrants or stock which provide a measure of compensation by pretending there is a security and analyzing what its value would be, and using such value as the basis for paying the promised compensation.
Why not have "shadow" competition. This is a way in which it could be done: To add one requirement for every accounting firm which certifies financial statements for public companies (or gives the firm's professional opinions that such financial statements were prepared in accordance with generally accepted accounting principles and SEC regulations).
This new requirement would be to prepare, file and publicly disseminate quarterly reports for the accounting firm which are drawn as a composite from the financials of their clients, to show the extent (weighted and unweighted) of any understated financials (as such understatements of earnings or assets become apparent) to give a higher rating to the accounting firm, and using overstated financials (as such overstatements of earnings or assets become apparent through restatements of financials and bankruptcies) to give a lower rating to the accounting firm.
This evaluation of accounting firms by monitoring and measuring any changes in accounting practices of the firms' clients would immediately impose free-market or competitive principles upon the accounting industry which has become too close to its clients, and too willing to let major accounting errors go without challenge in order to retain the errant client.
My suggested monitoring system would put the firm's entire client base at risk when permitting one client to have distorted or erroneous financial statements, and would reward a firm (and the stock of all or mosts of its clients) when the firm's report shows that the financial statements certified by it stand the test of time by not being restated to any significant adverse extent (or with the company not filing for bankruptcy within a certain period of time after certification of the company's financials).
This new type of competition to cure Enron would go from top to bottom, with investors tending not to buy or hold stocks issued by companies whose financial statements were certified by accounting firms with a below-part report; with corporations seeking to retain accounting firms with above-par reports as a way of assuring regulators, investors, audit-committee members and others that the company is trying to present accurate financial statements; and with market consequences which would penalize companies using below-par accounting firms by reducing the availability of capital, create higher interest rates, cause a loss of employment interest by key personnel and other employees, just to name some of the consequences.
Such suggested reform would require the accounting firms to keep their clients in line if the accounting firms wanted to remain in business, because when an accounting firm has a negative or declining rating, investors will stop buying the securities of the firm's client companies, and such companies will feel constrained to switch accounting firms.
Enron shows that the accounting firm is going to wind up in very serious financial difficulty, with partners jumping ship (to try to avoid liability), professional embarrassment, major and costly lawsuits for the next 5 to 10 years; and bankruptcy for many or all of the partners and some of the non-partners; and possibly for the non-equity partners who have no stake in the accounting firm except the title of non-equity partner.
If my proposal had been operating during the past few years, Enron's accounting firm would probably have had a greater concern for its own financial health by insisting upon more appropriate accounting practices for Enron Corp.
If you don't have any idea of what may be hidden by mergers, you can't begin to work on a solution. My belief is that mergers generally work (to deceive the public) by enabling the company seeking to engage in never-ending mergers to hype their stock to excessively high prices, used the high-priced stock to buy earnings of other companies cheaply (through merger), which gives the merger-minded company a false appearance of earned (and therefore future) growth, with the ability of insiders to take higher and higher (or should we say obscene) compensation until the bubble bursts.
The cure for this should be to require public companies with merger activity to separately state its earnings (a) per company; and (b) as if the mergers for the past 3-5 years did not exist - to enable the investing public and others to see what businesses are contributing to earnings, and to what extent, and to see if mergers are anything more than a way of covering up management's failure to earn money in their pre-merger businesses.
Along this line, there should be the reporting of expenses, income and profits (or losses) according to product line, to stop large companies from hiding their operations from competitors, regulators, politicians, government agencies, economists, investors and others interested in protecting and enhancing the economy.
Let's assume that somebody is in the business of pirating Hollywood's newest movie releases and selling them on the sidewalks of New York City as bargain-priced videos and DVD's. Also, let's assume that the business is very profitable and that Wall Street is interested in providing capital to enable this very successful business to expand into every city in the U.S., and into other countries of the world.
How should the earnings be reported?
The way the system seems to work now, is that the financials would show these huge earnings (in proportion to sales and invested capital), and a footnote (perhaps number 922 on the last page) might give some language which ultimately could be argued is a warning to investors that somebody might bring suit for copyright infringement or RICO, but in the opinion of counsel to the company any such claims would not be material in the operations of the Company's business.
This is the way that illegal conduct is routinely handled. The government does nothing to stop the conduct. Private lawsuits may last for 5 years or so, and settled for small amounts. Liabilities (which were never reported or reflected) will drop off as the statute of limitations bars recovery (3 years as to copyright infringement claims; 4 years as to federal antitrust and RICO claims; 1-6 years or so as to breach of contract claims, depending on state law, and whether oral or written contracts).
Instead of the present procedure, which does not give fair warning to investors in an Enron situation, companies should be required to report as to whether they may be in violation of certain statutes, including the federal Robinson-Patman Act, which prohibit price discrimination. See RPAMall Website - An Extended Discussion of the Robinson-Patman Act; also, see Website on Stopping Wal-Mart and Globalization.
A precedent for this was when the SEC required public companies to disclose the extent to which they were bribing officials of foreign governments to obtain contracts.
The nation's superstores are clearly buying their goods at much lower prices per unit than their competitors, which is done through a DNA Code which is negotiated between a manufacturer and each superstore chain. The DNA Code, when all calculations are done, is the amount by which the manufacturer's invoices to the superstore are reduced, to enable the superstore to buy its goods at about 50% to 60% of the price paid by the smaller competitors. Because of the complexity and secrecy of the DNA Code discounts, none of the manufacturers and none of their superstore customers can readily calculate the true per-unit price at which they buy and sell goods, which means that investors, competitors, government agencies and others know even less, which enables violators of the Robinson-Patman Act to avoid responsibility for their violations, which decreases competition in the United States without most persons understanding how or why.
Under the Robinson-Patman Act, this difference in price is illegal (with no available defenses especially because actual per-unit costs are not known to the manufacturers or their superstore customers), and the injured competitors are provided with a remedy of treble damages and injunctive relief to stop the practice, against both the manufacturer; and the competing superstore (if the superstore induced the unlawful prices or knew that the lower prices it was obtaining were unlawful).
Every public company should be required to state its earnings in the alternative, by reporting its DNA Code arrangements with its major suppliers, and the effect that the DNA Code would have on the company's financials if the superstore were enjoined (i.e., prohibited) from receiving such (DNA Code) discount from invoice. Every small retailer in the country has one or more claims to enjoin some of the manufacturers and superstores from violating the Robinson-Patman Act, and sooner or later it may become fashionable for the federal government (through its FTC and Justice Department) to enforce the Robinson-Patman Act). Thus, there is a possibility that this discriminatory pricing practice could be enjoined, but no investor is ever alerted to this possibility, and the worst offenders predictably have the highest stock prices (creating a substantial, natural opposition to correcting the unlawful practices).
It is commonly understood by my small-business clients, several hundred of them, who are competing with major superstores in the U.S., that the superstores could not remain in business if they had to buy their goods at the same prices being paid by my clients.
Shouldn't investors be informed of this fact?
The superstores would not have to state they are violating the law; instead, they could say that they believe (based on expert advice from their accounting or law firms or accounting-consulting firms) that they are not violating the law and that they are resisting liability in one or more court actions. But the truth remains, that they are obtaining unjustified discounts which at some point will be taken away from them, which would make their businesses unprofitable, which leads into the issue of why companies seek to merge.
Companies with financial problems like to merge to spread the impact of their problems over (hopefully) untainted earnings, so that any realization by regulators, the courts, legislators or investors that the unlawful practice exists will come after the unlawful practice has already been used to buy legitimate (or comparatively legitimate) companies (or companies which were able to hide their own illegalities from the acquiring company).
These mergers then hide the continuing illegality more easily because the financials are far less specific in the industry in question, and interested persons have less information being provided with which to determine the extent of the possible illegal conduct.
There are not too many problems of this nature (such as bribing foreign goverment officials to obtain contracts). In fact, I think that violation of the Robinson-Patman Act is the one big problem, which has enabled superstores in many industries to put competing small businesses out of business during the past 15 years or so, in retail businesses for: books, appliances, videos, pharmacies, hardware, beverages, tires, auto parts, magazines, groceries, gasoline, home furnishings, and others.
Wal-Mart has now become the top retailer and is increasing market share every day. Kmart, the 2nd largest retailer (until its recent filing for bankruptcy in January 2002), is unable to compete with Wal-Mart, and one by one the other major retailers will feel the impact to the extent they try to compete directly in price. Nobody can compete in price with Wal-Mart if it is true that Wal-Mart's DNA Code with each manufacturer is a higher value per unit than any of its major competitors (such as KMart, Target and Venture). Jamesway, Bradley's, Woolworth, Montgomery Ward, J. C. Penney and others found out and closed down or filed in bankruptcy for reorganization.
Wal-Mart and the other superstores should be required to state their cost of goods reflecting the DNA Code discount from invoice, to enable the Robinson-Patman Act to be enforced, and to enable investors to steer clear of companies which cannot compete with Wal-Mart. Investors are the losers, not Kmart, or the other stores which are put out of business. Their officers and employees get jobs elsewhere (with their officers and insiders keeping their excessive salaries paid to or received by them - such as sales of insider stock at high prices - to assist their companies to fail in their mission). But the public investors, as always, are the losers, because they were not aware of the game, which is that the retailers with the lowest price per unit takes the business away from all others, eventually, because one by one the competitors have to drop out of business, which accounts for the ever-increasing prices of the stock of the winners.
Reporting on Robinson-Patman Act violations, or possible violations, would help to cure the problem by pointing out where the problem exists.
Likewise, manufacturers should be required to indicate in their financial statements the per unit value of the DNA Code they have negotiated with each of their top 10 or 20 customers, to enable a relatively competitive market to develop once again.
The strange thing is that manufacturers have been putting themselves out of business by engaging in violations of the Robinson-Patman Act. Every day, they are selling a higher and higher percentage of their sales at, below or near direct cost to the superstores, and an ever decreasing percentage of their sales to smaller competitors, which are the only profitable customers for the manufacturers. This has caused regional manufacturers to go out of business (because they cannot compete in giving DNA Code discounts against national manufacturers), through merger with comparatively stronger manufacturers, to try to fight the superstore customers.
But this is only a delaying action. The nation's manufacturers are losing their business to foreign manufacturers because the favored customers of the nation's manufacturers are also being victimized. The superstores are buying a higher percentage of their goods from foreign manufacturers, regardless of how favored they are with low prices from the U.S. manufacturers.
Superstores and manufacturers should be required to report on this problem to enable regulators and Congress to get involved to try to stop this internal business and job hemmoraging as soon as possible.
Because the real income for most insiders (including insiders in Enron Corp.) is the taking of their compensation through sales of insider stock, such sales should be reported in the public corporation's financial statements and SEC filings on a cumulative basis over the years (similar to the way that assets accumulated over many years by a company are reported as assets at one time), to reflect the ever-increasing value of company value or assets tranferred to insiders over time, which should be reported on a comparative basis per year, for the last 5 years, as well.
In this way a shareholder with only an interest in the assets still held by the corporation can see how much in assets were transferred, one way or another, over the years of the corporation since inception (perhaps with a 10-year limitation) to insiders, to show a more revealing picture of how corporate earnings and assets are distributed.
Also, the total compensation paid directly by the corporation to such persons during such period should be added, to give the overall compensation picture for the same periods.
Such financial reporting would make it clear, if Enron has not made it clear already, that public investors are mere expendable conduits and dupes for transferring huge amounts of corporate assets to insiders, for their personal use, while investors sooner or later are going to be left holding the bag.
Financial reform requires that the public be made aware of what is happening to their money.
This leads us to the final topic for this Enron website: Certain Aspects of "Globalization" and Their Real Purpose.
Certain aspects of "Globalization" and mergers go hand in hand. Whereas mergers enable a company to hide its poor performance through purchase of earnings (when the acquiring company's stock prices are high - and investors are at greatest risk), certain aspects of "globalization" enable the same company to hide its actual performance by incurring costs necessary to expand into other countries and give the appearance that the companies are growth companies without having to prove growth with actual earnings.
The United States is no longer a vast market to conquer. The monopolies or near monopolies have already acquired their market shares, and are growing (through merger, and inability of competitors to compete with them). And if these companies did not try to expand into other countries, there would be a day of reckoning in the U.S. which would reveal that there is very little additional growth, now that most of the independent, small businesses have been put out of business. This would be a disaster for stock prices, and for the incomes of the top company officials.
The way to continue their growth, but at the expense of the U.S. economy, is to expand their operations into other countries, by opening up stores, and by opening up manufacturing or assembly plans, to take advantage of far lower labor rates (which shows up in company financials as increased profits, but which show up in American towns and villages as a higher unemployment rate and corresponding tax on the businesses which remain).
Why bother to pay American workers $15 to $25 per hour when you can use cheap labor in Mexico, China, Thailand, Malaysia or other fashionable place where labor is unorganized and the political scheme prohibits labor unrest through appropriate repressive activities.
As a by-product of such "globalization" activities, the major U.S. companies become truly international, with no real allegiance to the U.S., except for the desire to obtain continued handouts from the various governments in the U.S. which fail to recognize that handouts to a Fortune 500 company such as Enron is comparable to giving money away to a Japanese or Swedish company (see How Major Companies Steal Jobs from Communities in What Is Known Euphemistically as "Economic Development Funding" and see How to Stop Wal-Mart and Globalization; and even less allegiance to the plight of the U.S. towns and workers which have been deserted in favor of manufacturing in foreign countries at 1/10th or 1/20th of the cost.
Who benefits from this? Clearly, we have seen no benefit for towns, small businesses or employees. The persons who benefit the most are the "globalizing" businesses and their excessively-compensated officials and other insiders, the foreign employees and officials who benefit from this movement of jobs and business from the U.S. to the then-fashionable foreign countries, the U.S. politicians who seek and obtain handouts from these companies, and possibly the airlines and telecommunications companies which enable these international companies keep everything functioning smoothly to rip off United States interests.
Clearly, the taxes for the "globalizing" companies go down, because of the greater ability to hide earnings through Enron-type activities, and this places a higher debt and higher tax structure on the persons (invidividuals and smaller businesses) left behind in the U.S.
Of course there is little or no benefit which the average person is going to realize in the U.S. from this "globalizing" activity, contrary to the representations of our politicians, who were paid to take that position through paltry election-type handouts from time to time. A handout of $5,000 buys approximately $1 billion of the public's tax money given to the favored corporation(s) (a rough estimate, but possiably too low).
The persons in the U.S. who are most benefited seem to be: (i) the persons working for minimum wage and no benefits for 28-hour weeks at the nation's superstores; (ii) the persons who buy from the superstores because they save 15 cents per unit on some products, and fail to take the cost of travel and the value of their own time into account when deciding to shop at the superstore; (iii) investors who own a few hundred shares of stock in the superstore(s) and see the stock going up in value as their only hope to offset their lack of any business or job opportunities and ingrained poverty; and (iv) the politicians who permit this decline in the U.S. economy to take place believing that if they don't take the money then some other politician will, and the public will never understand in any event.
It is obvious to me that there is a need for a national trade association to deal with Robinson-Patman Act enforcement on behalf of all small businesses and consumers in the U.S. to try to add some political muscle to the current situation in which there is very little favoring small businesses and the consumer.
Enron was a good thing for the country, because it exposed what is going on with hundreds or thousands of public corporations. Many of the Enron employees who were "hurt" were obtaining higher incomes than they could have earned elsewhere (and therefore were beneficiaries of Enron more than victims of Enron).
The cure for future Enrons is public disclosure and competition. Make the accounting firms compete by requiring reports on their own professional performance, in such a way as to show where the firms allowed improper financial statements (a factor which would cause a firm to lose clients) and to show where the firms produced proper financial statements (a factor which would cause a firm to acquire clients).
Also, assets escaping from the corporation into the hands of insiders should continue to be monitored, to enable current investors see where there investment has been (and continues to be) siphoned off, to the detriment of investors and the ability of the corporation to continue its operations.
Yes, Enron may turn out to be a most favorable and profitable event for investors.
Carl E. Person, Editor, LawMall, email@example.com