Yesterday, the Securities and Exchange Commission (SEC) was asked to investigate whether Enron’s directors should be removed from the boards of other public companies. There’s no word on whether the SEC will comply, or how long such an investigation might take. But as the SEC considers the request, Harvard should embark on its own investigation—whether Harvard Corporation member Herbert S. “Pug” Winokur ’64-’65, an Enron director since 1985, should remain on the University’s highest governing body.
Winokur’s part in the Enron debacle is illustrated by a fascinating report released last Friday, written by a special investigating committee appointed by Enron’s board. According to the report, in the late 1990s Enron had made risky investments that threatened to drag down the company’s stellar earnings. The company wanted to prevent potential losses on these investments from tarnishing its New Economy image. Enron therefore transferred the investments to shell companies with names like “Raptor,” selling them Enron stock in exchange for IOU’s. Since 3 percent of the companies belonged to outsiders—whose investments, to sweeten the deal, were insured against loss—the companies wouldn’t be considered part of Enron and losses on the risky investments wouldn’t show up on Enron’s income statements.
It didn’t help Enron that the outsiders were actually insiders; former Chief Financial Officer Andrew S. Fastow allegedly made millions from these partnerships. But the bigger problem was in the accounting gimmick itself. If Enron stock went up more than the bad investments went down, the shell companies could cover the loss and the trick would work. But if both the investments and Enron’s stock price went south, the shells would run out of money—and Enron could either try to bail them out with more stock or admit to its shareholders that the IOU’s were worthless. The unexpected shortfall of $544 million announced last October sent Enron’s stock price into collapse and the company into bankruptcy.
Generally accepted accounting principles prohibit firms from using their rising stock price as a form of income. But that’s exactly what some of these shell companies were designed to do. As the report states, the transactions were just “transfers of economic risk from one Enron pocket to another, apparently to create income that would offset [losses] on Enron’s income statement.”
How much of this did Winokur know? In a May 2000 meeting on “Raptor I,” the board’s finance committee—of which Winokur was chair—was given information “strongly suggesting, if not making perfectly clear, that the Raptor vehicle was not a true economic hedge.” Notes taken at the meeting by Enron’s corporate secretary describe Raptor as follows: “Does not transfer economic risk but transfers [profit-and-loss] volatility.”
As a result, it’s hard to believe that Winokur didn’t know what Enron was getting into. What did the presentation describe as the principal risk the transactions posed? “Accounting scrutiny.” The second risk was that Enron stock would go down, in which case (according to an Enron internal memo) the program would “terminate early and may return credit risk to Enron.” But that risk was not always adequately disclosed to the shareholders whom it was Winokur’s duty as a director to represent. They stayed invested in the company even when the Raptor vehicles were collapsing and Enron’s losses piled up unseen.
These deals only constitute a minor portion of the report, which spends most of its time detailing the conflicts of interest of various executives. Senior management may well have had its hands in the cookie jar. But the report barely scratches the surface in uncovering the company’s hundreds of complex partnerships and submerged debts. How much remains to be discovered, and how much did the directors know that the average shareholders did not?
The report’s ability to answer these questions is limited by its own conflict of interest, as Winokur was one of the co-authors. He apparently recused himself from sections of the report specifically evaluating the board’s actions. But every time the report pins the blame on top executives who kept the board in the dark, it partially absolves the directors from responsibility. The report goes to great lengths to show Fastow and his treacherous underlings as the real villains in this morality play, as well as to explain and justify the board’s repeated decisions to suspend conflict of interest rules. The strongest accusation leveled at the board of directors over Raptor I is that the proposal “deserved closer and more critical examination”—this for a proposal allegedly conceived and presented as a means of concealing pertinent information from shareholders.
The presence of an active director on the investigative committee compromises the report’s appearance of objectivity. Representatives holding hearings on Enron have publicly questioned Winokur’s role, and the board-commissioned report could be interpreted as a whitewash, designed to shift attention away from the directors just in time for Congressional hearings and investor lawsuits. As a result, we may wait years to learn the full story on who knew what and when.
But we already know some parts of the story, and they don’t look good for Winokur. Perhaps Winokur really didn’t know what was happening at Enron; perhaps he slept comfortably through meetings, trusted management wholeheartedly and ignored every red flag. But this brings us back to the original question: is he the right person to govern Harvard?
The seven-member Corporation is our board of directors, obligated to represent Harvard’s interests in overseeing present management. It chooses its own successors, and its decisions are subject to little effective review. Given his experience at Enron, even when cast in the most favorable light, is Winokur the right person to exercise this authority? Are there no better candidates to serve on the board of the Harvard Management Company, which oversees the endowment, or on the Committee on Shareholder Responsibility? Can Winokur be trusted to guard the guardians?
Thousands of Enron employees and stockholders lost their life savings on Winokur’s watch. What reason do we have to believe that Harvard’s interests will fare better?
Stephen E. Sachs ’02 is a history concentrator in Quincy House. His column appears on alternate Tuesdays