December 28, 2001
From the desk of Jane Galt:I'm BAAAAAACK! After a much
I'm BAAAAAACK!
After a much deserved hiatus, spent preparing for Christmas (which culminated in a seven hour train ride to scenic Newark, New York, where I spent 3 straight days cooking for my grandparents before returning to work), I have emerged from retirement to rant about the Enron debacle -- or more specifically, Reason's reaction to it. Which is retarded. Flailing to explain the failure of a market oriented system, Reason strives to argue that no one really did anything wrong. Bullshit. As Reason points out, Enron's entire company match, up to 6% of salary, was in company stock. Let's think about that. The contribution limit for a 401K, provided you don't hit the salary caps, is 15% of salary. (Or at least it used to be when I had, you know, a regular job.). So our hypothetical Joe blow making, say, $50,000 annual, and contributing the maximum, is putting $7,500 into his 401K. The company puts in $3000 worth of company stock as a match. Even if the stock appreciates exactly in tandem with the rest of his investment choices, and Mr. Blow appropriately diversifies the rest of his portfolio into non-oil related, countercyclical investments, almost 30% of his 401K will be invested in company stock which cannot be sold until he turns 50. Since this is about 30% more than any sane financial advisor would allow Mr. Blow to invest in the company for which he currently works, Enron was pushing extremely unsound financial practices on its employees. Remember, that $3000 is not free money -- it is in lieu of other compensation that Enron would otherwise have to give. It also, through the imaginitive accounting used for ESOPs, does not show up on the balance sheets the way that cash would, plus it supports the stock price by providing a large pool of owners who can't sell even if -- well, even if the stock goes to 33 cents. So Enron gets three for the price of one -- conserves cash, gooses its balance sheet, and supports its stock price. The employees get -- 33 cents.Even if you work for a fantastic company, one with extremely low volatility and sound management practices, this is a dreadful idea. Why? Imagine Joe's great-grandfather, Hiram, a respectable accountant with an extremely stable firm for which he has labored all of his adult life. He not only draws a good salary as he nears retirement age, but has a lucrative junior partnership in his firm from which he will be able to draw over half his salary when he retires, enough to comfortably live out his golden years. He has other investments, of course, but Hiram is counting on the firm to provide the bulk of his funds.
Unfortunately, some young whippersnapper in Detroit starts churning out automobiles, and the buggy whip manufacturer which employs Hiram experiences a couple of years of declining earnings. Several years later, the firm merges with two other manufacturers, leaving Hiram on the street. At 58, it is hard to find another post. His junior partnership is diluted by the merger, then wiped out entirely three years later when the combined firms go bankrupt together. Had Hiram purchased some stocks and bonds instead of that junior partnership, he would be able to retire comfortably instead of moving in with Joe's grandfather and spending his last years crammed in a back bedroom listening to the grandkids screaming through the walls.
Joe's great-grandfather is what my Investments professor called extremely undiversified. Undiversified holdings increase volatility, which is to say the likelihood of extreme events. You can get extremely rich, as you would if you'd plowed all your money into Microsoft. Or you can lose everything, as the Enron folks did. What's worse, they had their entire financial worth tied up in the company, because their jobs were there too. Houston doesn't have a ton of large companies to work for -- and 60 is no time to be looking for a job. Enron should never have allowed, much less encourage (or really, forced) employees to be so undiversified.
Legal? Almost. Nothing restricts companies from offering their matchings in company stock (although -- gasp -- in the opinion of this near-libertarian, the SEC should.) In this case, however, there were two problems. The first is that executives engaged in a clearly criminal (at least to me, and all my b-school buddies) concealment of the actual financial condition of the firm. This means that they were committing fraud by giving employees compensation which they knew to be worth less than the face. Whether this is legally fraudulent I know not, but it certainly meets my definition of fraud, particularly as the executives were the only people who could know the firm's true condition, negating any cries of caveat emptor. They did this at least in part to inflate the value of the firm's stock, delaying the reckoning long enough for at least some of them to sell out large Enron positions. (I'm not saying this is why they pushed the company stock; only that it had this effect). Secondly, they caused employee accounts to be frozen during critical periods (though from what I've seen of the matching plan, so much of those 401k's were in matching stock that couldn't be sold -- because the average Joe Blow contributes much less than 15% of his salary -- that the lockup period wouldn't have helped much.) They maintain it was routine. I maintain that if they had given a rat's ass about their employees, they would have delayed the routine. But of course, having a block of owners that couldn't sell delayed the reckoning by at least a couple of days. Do I know that this factored into the decision? No. But at the very least it showed callous disregard for the employees it subsequently dumped on the street.
Yes, people should behave responsibly. No, you can't protect people from being idiots. And sometimes managers do their best and the companies fail anyway. I don't think that you can prevent people from buying their company's stock with their own money. But it seems to me that you can prosecute the criminal fraud and negligance perpetrated by Enron's directors and captive board (four doctors on a fifteen person board? None of whom, apparently, understood anything about the oil, commodities, or financial markets in which Enron was involved, nor how to read a balance sheet or income statement?) More importantly, you can strip their assets in a civil suit and hand them over to those devastated people near retirment who are losing their houses along with their jobs (and ending up with nothing from the sale, due to the Enron-led collapse in Houston real-estate prices), and have no realistic prospects of either getting another job, or retiring any time soon.
Posted by Jane Galt at December 28, 2001 12:03 PM | TrackBack | Technorati inbound links