Here’s a Simple Lesson on Business Ethics From the Former CFO of Enron

Here’s a Simple Lesson on Business Ethics From the Former CFO of Enron

Legal and ethical aren’t necessarily the same thing.

by Tracy Alloway

July 2, 2015 — 8:55 PM SGT

Andrew Fastow, the former chief financial officer of Enron was a speaker at Camp Alphaville, a conference hosted by the Financial Times‘ well-known finance blogAlphaville. Since leaving prison, he’s been talking to business students about ethics in business. The point he makes, perhaps unsurprisingly, is that business ethics can be a tricky thing. Practices that are perfectly legal and wide-spread can be unethical. While the off-balance sheet transactions that triggered Enron’s collapse were approved by the company’s lawyers, accountants and management, Fastow said, he nevertheless deserved to go to jail for misleading investors. As Fastow said at the event on Wednesday: “I wasn’t the chief finance officer at Enron, I was the chief loophole officer.” To illustrate his point, the former CFO now-turned business consultant outlined a few accounting scenarios that one may or may not think are misleading. He points out that many of them are in wide use and are perfectly legal under current regulations.

Here are some his samples:

U.S. Oil and Gas Valuations

Energy companies used $95/barrel to value their oil reserves at the end of 2014.

The price of oil at the end of last year was about $50 a barrel.

But: U.S. securities and accounting regulators require companies to value reserves using the average price of oil on the first day of each of the preceding 12 months (i.e. $95 a barrel, according to Fastow). Sure it’s legal, but is it realistic, Fastow asked?

Special Purpose Entities

Your company is going to acquire a $1 billion pipeline using an off-balance sheet entity in order to lower its financing costs and save about $50 million per year.

Your bank sets up a special purpose entity (SPE) and your company contributes $30 million in equity to the vehicle while the bank lends it $970 million.

The SPE buys the pipeline and allows your company to use it for 10 years.

But: It may sound like a sketchy off-balance sheet arrangement but this is a standard synthetic lease. U.S. companies have over $1 trillion of these off-balance sheet operating leases. There are over $2 trillion off-balance sheet operating leases worldwide, Fastow said.

Expected rate of returns

Money market accounts yield almost zero percent for investors and yields on the 10-year U.S. Treasury are at 2.4 percent.

As an investor, what would you expect your rate of return to be over the next 20-years?

But: The 100 top U.S. public companies with defined benefit pension assets of $1.3 trillion have an average expected rate of return of 7.5 percent. Three of them are over 9 percent, according to Fastow. That’s allowable but if these pension plans were to use a much lower rate of return they would probably find themselves underfunded.

As Fastow put it, even if companies keep to all the rules and regulations they still have an incredible ability to distort or flatter the appearance of their financial health. The former Enron CFO said his “number one rationalization” when it came to the Enron transactions that became his downfall, was that the practices were approved and he was following the rules.


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