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Saturday, March 06, 2004

Enron, Martha, and Corporate Crime 

Yesterday, Martha Stewart was found guilty of conspiracy to violate securities laws, obstruction of justice, and making false statements. She faces a potential sentence of 16 months in prison. The verdict in this case got me thinking: Why is it that the media goes out of their way to tie Martha Stewart to Enron? The New York Times story on her conviction mentions the Houston energy company as early as the second paragraph.

Linking Martha to Enron is misleading. I think the media groups them together because both were involved in white-collar crime, and because Martha gives an otherwise boring story celebrity appeal. An expose on the technical details of Enron's fraud would put viewers to sleep, but the chance to see a celebrity get nailed keeps people tuned in. This is problematic, because it may keep people from realizing that Enron's crimes were far more serious.

Investors trade stocks based on the future prospects of a company as represented by that company's financial statements. The statements report the company's profit or losses for the year, as well as the assets and debts that the company has accumulated over its lifetime. What Enron executives essentially did was to create small private companies (or trusts) that were subsidiaries of Enron. They then used these trusts to take out loans to finance Enron's business activities. The executives did not disclose the amount of these loans on Enron's balance sheet, arguing that they were not required to because the loans had nominally been taken out by subsidiaries. This failure to disclose debt is illegal because it fails the requirement that financial statements present a "true and fair view" of the firm. (Exciting stuff, huh?)

If a company lacks the cash to pay off its debts it goes into bankruptcy. In most cases, investors can avoid these companies by looking at their balance sheets. An investor looking at Enron's balance sheet in 2000 would have seen a company in perfect financial health. Enron's executives knew better. They realized that the Enron's share price of $80 was ridiculously high for a company on the verge of bankruptcy, and sold their shares.

Essentially, Fastow, Skilling, and Lay inflated the value of their stock by lying, and sold their personal holdings for over $1 billion dollars. In addition, Enron's pension plan legally required employees to hold Enron stock in their pensions until they reached age 50. As the stock collapsed, Enron's employees watched helplessly as their total retirement savings fell by $1 billion dollars. The Enron's fraud also reduced the value of the entire stock market, as foreign and domestic investors became skeptical of US accounting numbers.

By contrast, Martha Stewart made $45,000. While she took advantage of insider information, she didn't lie to anyone in the course of making that money. Martha owned shares in a pharmaceutical company called IMClone. When she found out that IMClone's ant-cancer drug Erbitux had not received FDA approval she sold her stock in the company. This sale was illegal because it occurred two days before Erbitux's rejection was publicly announced.

While Martha's actions were illegal, her 16 month punishment bothers me because insider trading happens on Wall Street every day. The systematic manipulation of accounting statements to artificially inflate stock prices does not. Martha's case went to trial because she is famous, and because financial crimes are currently in vogue. This would be easier to swallow if more of Enron's executives were held accountable for their crimes. So far, CEO Ken Lay and the other guys at the top have escaped prosecution. Maybe Martha should have gotten her act together and, like Enron's execs, given more money to Bush's 2000 campaign.
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