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Using financial rules to hide the truth

ALBUQUERQUE, N.M. — Andrew Fastow held up a trophy given to him by CFO Magazine and an ID card issued to him when he was imprisoned for six years by the federal government.

He got both for doing exactly the same thing: creating some of the most complicated and arcane financial deals seen in American business up until that time. Fastow and many other observers say finance has become even more obscure since he was chief financial officer of Enron Corp.

Addressing an audience of students, faculty and others at the University of New Mexico last Monday, Fastow blamed only himself. “I believe I was guilty of crimes,” he said. He concluded his presentation by showing a photo of himself in handcuffs being led to prison. Those who want to demonize corporate villains will get no argument from Andrew Fastow.

But there are much bigger problems here than the greed of corporate executives and the fecklessness of regulators. Everything Fastow did was approved by accountants, lawyers and Enron’s board of directors. The same kinds of things happened at Lehman Bros., Bear Stearns, Morgan Stanley, Goldman Sachs, AIG and the other companies that brought us the financial system collapse of 2008.

Former Enron executive Andrew Fastow, who pleaded guilty in 2004 to criminal charges in the Enron financial scandal, spoke recently at the University of New Mexico about business regulation and ethics. (Pat Sullivan/The Associated Press)

Former Enron executive Andrew Fastow, who pleaded guilty in 2004 to criminal charges in the Enron financial scandal, spoke recently at the University of New Mexico about business regulation and ethics. (Pat Sullivan/The Associated Press)

Company brass can follow the letter of the law, obey all the rules and completely misrepresent their company’s financial condition, all at the same time. Fastow said Enron executives saw the complexity of accounting rules as an opportunity to finagle, not as a problem.

When markets come to their senses and recognize that companies like Enron and Lehman aren’t nearly as profitable as they claim, share prices collapse, investors’ wealth is wiped out, employees lose their jobs, retirees lose their pensions.

Fastow said his crime wasn’t that he violated the rules. It’s that he used the rules to hide Enron’s true financial condition. He obeyed the rules but violated the principles of financial transparency and rectitude that the rules attempt to uphold.

Enron had been a boring pipeline operator in Houston until Kenneth Lay built it into a commodities trading and energy generating powerhouse. The company reported enormous profits and became a darling of Wall Street. In early 2001 executives, including Fastow, were awarded millions of dollars in bonuses. Enron’s share price was soaring.

Enron was able to report those profits by moving debt, risk and expenses off of the accounts it reported publicly into entities the company was not required to disclose. Fastow was responsible for creating those entities.

Without a good bit of accounting training you really can’t follow how he did it, but the upshot was that, while the company was reporting enormous profits, its off-the-books financial transactions were bleeding the company dry. Enron reported what it had to, but what it reported was completely misleading.

Even Fastow couldn’t follow some of it. In a meeting with his lawyers and accountants, he read a disclosure statement Enron was going to include in its required financial reporting documents. He said he couldn’t understand a word of it. A lawyer thanked Fastow for noticing that the disclosure was technically correct but wholly unenlightening. That was his job, the lawyer said.

By the end of 2001, Enron had entered bankruptcy proceedings. Kenneth Lay was convicted of securities and wire fraud a few years later and faced up to 45 years in prison, but he died before he could be sentenced.

Fastow was charged with 98 criminal counts, pleaded guilty to two of them, and testified against other Enron executives, including Lay.

The 2008 financial crisis was more of the same. AIG never spelled out for investors what would happen if it had to honor commitments to insure companies against losses on mortgage-backed securities. Lehman did not reveal the garbage its mortgage-backed securities contained. The rules were followed and investors were misled.

This unprincipled approach to finance continues. Fastow said companies still use financial alchemy to artificially improve their revenue. Companies and governments change investment return assumptions to hide unfunded pension liabilities. Banks sell financial instruments designed to keep risk and debt exposure off the public financial statements.

No one complains about financial chicanery when times are good. People who bought Enron for around $60 early in 2000 and sold it for $90 in August 2000 were happy. Those who sold it in November 2001 when it was worth $1 were not.

Albuquerque accountant Carl Alongi points out that, while financial reports didn’t disclose Enron’s true condition, they did say there were lots of off-the-books transactions occurring. That should have been a red flag, but people bought Enron anyway.

Fastow scoffs at calls for more regulation. New rules just generate more fees for the accountants and lawyers who thrive on finding wiggle room.

Fastow said companies can be kept honest by in-house whistle-blowers who have first-hand knowledge of malfeasance and, especially, by short sellers. A short seller makes money by betting against a stock whose value is built on fantasy or worse. They can make a fortune by giving the house of cards a little nudge.

UpFront is a daily front-page news and opinion column. Comment directly to Winthrop Quigley at 823-3896 or Go to to submit a letter to the editor.