The queasy ‘Enron feeling’ that directors must never ignore

Probably the most consequential meeting in modern corporate governance took place on June 28, 1999. What made it so noteworthy was that those present — the board members of Enron — utterly failed to appreciate its possible consequences.

If they had, they would surely have refused in effect to waive the energy group’s code of conduct, allowing Andy Fastow, the chief financial officer, to set up and run off-balance-sheet vehicles that finally helped bring the whole company down. Enron filed for bankruptcy 20 years ago this week.

That collapse exposed a culture of smug negligence in US boardrooms. At worst, such complacency allowed excess and fraud to flourish. Enron was the forerunner of other US corporate scandals that I covered from New York, including Tyco and WorldCom.

Three months before Enron went bust, WorldCom’s board notoriously approved a $6bn deal in 35 minutes at little notice and with no written materials. “Pardon me while I throw up,” responded one director when asked to recall that moment.

The balance between the animal spirits of entrepreneurial executives and the measured caution of the board is delicate. Nothing would get done if risk-averse directors spent every meeting fighting nausea. But it is worth reminding today’s board directors about Enron and other disasters, even if it triggers queasiness, because, as the scandal fades in memory, the risk that they repeat old errors increases.

Scandals at Wirecard, the German payments group, Greensill, and Theranos, whose disgraced founder Elizabeth Holmes is now on trial, bear some Enron pockmarks. The Theranos board, for instance, like Enron’s, was a dazzling array of high-profile names.

Some elements of governance have, however, changed for the better.

The “you scratch my back, I’ll scratch yours” approach to board appointments has largely ended. Many cross-directorships, where individuals served on each others’ boards, were unwound. Investors now frown on “overboarding”, or the holding of multiple board positions. The Sarbanes-Oxley Act, requiring executives to sign off on accounts, has become a norm, even though business decried it as an unconscionable burden when it was approved in 2002.

“Unquestionably, boards are sharper, more independent, more focused, and more engaged,” says Nell Minow, vice chair of ValueEdge Advisors and a longstanding critic of poor governance and campaigner for shareholder rights.

Still, since 2001, the message of the Enron affair about compliance and good governance “may have lost its sizzle”, lawyer Michael Peregrine and governance professor Charles Elson have warned in a post for Harvard Law School. The pendulum risks swinging back towards over-mighty executives.

Minow likens regulatory attempts to improve governance to a race between safe-makers and safe-crackers: “Each time you make a better safe, they come up with better tools.” Structural solutions take time to implement, too. The US Securities and Exchange Commission just approved proxy access rules, simplifying the election of directors, that have been under on-off discussion since before Enron’s fall.

The gulf between rhetoric and reality remains a danger. Enron was ostensibly a blue-riband model. The head of its audit committee was Bob Jaedicke, a Stanford accounting professor, for instance. While board members’ reputations were indelibly blemished, and some had to contribute to the settlement of a $168m shareholder lawsuit in 2005, the harm was limited. After returning to the UK from New York in 2003, I gave a talk about governance at a dinner hosted by a parliamentary group. To my astonishment, the vote of thanks was given by former minister and Enron ex-director Lord John Wakeham.

Board membership is still seen by too many would-be directors as a comfy path from high executive office to retirement, rather than a vital public duty, with serious responsibilities.

In 1999, Enron’s then chief executive Kenneth Lay, who died before going to jail for his role in the scandal, lauded the importance of a “strong, independent, and knowledgeable board” in a speech to an ethics conference. He underlined how Enron sought “principle-centred directors” with “independent and inquiring minds”. He went on: “We want board members whose active participation improves the quality of our decisions.”

Enron’s directors faced a fraud of baffling complexity. But all the rules and codes in the world should not relieve today’s directors of the obligation to challenge executive over-reach, because they are the ones in the room when such decisions are taken. To put it another way, if the post-Enron sizzle is not to be lost, and public trust maintained, then it is board members who must keep on feeling, and applying, its heat.

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Twitter: @andrewtghill

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