Lessons of the Enron Debacle By Stephen J. Butler

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While many Enron employees watch their 401(k) retirement accounts reduced to ashes, their experience offers valuable lessons for the rest of us. My insights into the Enron situation come from anecdotal evidence supplied during two timely conversations.

On a jogging trail last week, I overtook a neighbor who is a recently-retired, high-ranking Chevron executive. “How about that Enron deal?” I puffed, knowing that he had often played a role in major Chevron negotiations.  Earlier in the weekend, at a dinner party, I had discussed Enron with a professor of business ethics from one of the nation’s foremost graduate business schools.  Between the two discussions, I’m afraid I learned more than I wanted to know.

First, some background.  Houston-based Enron is a huge energy trading company that buys and sells energy to be delivered and sold at various times in the future.  The money that it commits to these purchases is largely Other People’s Money -- known in the business world as “OPM.”  On roughly $20 billion worth of energy, for example, Enron may have had only $4 billion of its own money invested.  The rest has been borrowed.

 To grossly oversimplify, there is now a big question as to how much of its own money Enron ever had.  When a company is so highly leveraged in an industry that has widely fluctuating prices, a huge amount of equity can disappear overnight.  With extremely complicated transactions, it is difficult to pinpoint a firm’s net worth or profits with any accuracy.  It will remain for the courts to decide if Enron was behaving illegally or just unethically.  

Dynegy is the Texas company that was negotiating to purchase what was left of its former biggest competitor.  This much smaller company (owned 25% by Chevron-Texaco) is in essentially the same business but with different arithmetic.  In Dynegy’s case, 80% of what they trade is done with their own money and only 20% is borrowed.  Although they are smaller than Enron, they are better equipped to weather the storms of plunging energy prices. On November 28, Dynegy pulled out of the prospective purchase of Enron, and the major credit-rating agencies downgraded Enron’s debt to junk status.

Enron had a trading model that worked extremely well for natural gas and other energy-related commodities.  However, in all such trading, models get stale and need to be changed when competitors start adopting the same model.  The window of opportunity to make big money can slam shut very quickly in the global, electronically-traded energy markets. 

Pressed to maintain its edge and keep its stock price high, Enron tried aiming its trading expertise at unfamiliar commodities. (Remember the Hunt brothers and their attempts to control the silver markets?  What is it with these Texans?)  Enron also invested in hard-dollar assets like power plants in India.  These acts of desperation turned out to be bad ideas.

Now, this high-flying behemoth that had paid its former president almost one quarter of a billion dollars in compensation is in big trouble.    

Meanwhile, at dinner, my friend the ethics professor mentioned that one of his former students had been in a senior position at Enron until resigning about a year ago.  Despite being close to the top of the management pyramid, the former student had elected to leave what should have been the professional opportunity of a lifetime.  However, this person felt that it was only a matter of time before ethical problems would catch up with the company, and the concern had prompted the call for advice to the ethics professor.

So much for history. What can we, as retirement investors, learn from the Enron employees who have experienced huge losses on the Enron stock in their 401(k) plan? An Oregon-based employee who has lost $400,000 has filed a class action suit.  Another way of asking this question is, “Where does investor stupidity end and where does a legitimate lawsuit begin?”

Enron made its 401(k) matching contribution in the form of Enron stock. To complain about this is to look a gift horse in the mouth.  The company didn’t have to offer any match.  From Enron’s perspective, a match in company stock did not cost the company any cash and the company received a tax deduction for it.  A match in any other form might have been much smaller or non-existent. 

For many years, the match in company stock was like manna from heaven when the share price was rising. The company’s stock was in the low teens in early 1998 and traded around $60 at the end of 2000. Today’s complaint about the match as a forced march into Enron stock is not a valid criticism.

Employees who elected to invest in Enron stock with major portions of their own voluntary 401(k) contributions can only blame themselves for not diversifying. They had other investment choices, including a safe money market fund.  Employees, after the fact, are now trying to maintain that they would have been able to time the market and anticipate when Enron’s stock would have started to plunge.  In reality, most would have taken major losses before electing to bail out. 

In the middle of all this turmoil, Enron decided to change retirement plan administrators.  This usually means that employees will experience a “blackout period” during which they cannot change their investment mix in their account.  In other words, during the blackout, they would not be able to sell the Enron stock in their accounts or make any other changes.  Usually blackout periods are for one to three weeks, but in Enron’s case, it turned out to be unusually long -- almost two months.  Again, employees have no guaranteed right to move money anytime.  The plan sponsor (their employer) is the legal administrator of the plan and can elect at any time to limit the plan’s flexibility due to practical considerations.

It may sound like the employees are getting the short end of the stick.  However, their salvation lies in the information that was provided to all investors—not just the 401(k) participants.  If Enron deliberately mislead ALL investors, then a legitimate class action suit may generate an award someday to those who have been put at a disadvantage.  In this case, the CPA auditor, Arthur Andersen, and its insurance carrier may be called upon to satisfy claims if nothing is left of Enron.    Also, if it can be determined that the blackout period was deliberately extended to lock up employee money rather than for routine administrative reasons, then Enron could be further liable.

Overall, there are two lessons from the Enron debacle. First, always diversify your 401(k) money. Spread the investments over a number of different types of funds.  Company stock should never represent more than 10-20% of your entire retirement plan account balance.  Take the company matching contribution into consideration when making this calculation.

Second, always roll your money over into a self-directed IRA when you leave a company. I make this point constantly in my column, but it bears repeating. The most tragic figures of this story will be those former Enron employees who left their money in the plan long after they had terminated employment and who could have rolled it free and clear of a problem like this.  The now-common daily-valued 401(k) plans with Internet access and the “feel” of a brokerage account have lulled many employees into a false sense of security.  It is easy to forget that this is a company plan that’s subject to much that can go wrong. Your own IRA, controlled entirely by you and which offers no limitations on investment choices, is the best bet for anyone. 

One other point – keep in mind the 1960’s mantra, “Question Authority.”  If a few more graduates from the now-popular business ethics classes had done so, Enron and its employees might have avoided the problems they are alleged to have today.

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