Conflicts of Interest
What an eerie experience it was for all of us in the bankruptcy field to listen to the stories about Enron and its various officers, directors and outside professionals. All of us were gripped by the drama, the greed, the real stories behind the compelling congressional testimony. We know that in the not-so-distant future, a movie will be made revealing what "really happened." Of course, that part of the experience is one we shared with everyone else. Not everyone saw Enron the way bankruptcy professionals did, however.
First, there was the story that so many lawyers, accountants, turnaround specialists—even judges!—saw coming long before the actual bankruptcy filing. I recall being at a conference in November, where some judges wondered whether the filing would be that week, in their court, and whether they really wanted such a monumental case, as we all knew it would be even before the filing. Then there were the lawyers whose firms were obviously already in the running to handle some piece of the case when it was filed. (There was, interestingly enough, no question that it would file; there was only a question of precisely when and where.) Bankruptcy professionals saw the signs well in advance: the desperate effort to find a buyer, the equally desperate reach for cash, the obvious disconnect between how high-flying the stock had been so very recently and how great was the sudden need for cash to stem the hemmoraghing.
What we did not know at that time were the reasons why. Yet to be revealed were the internal memoranda to the chief executive officer, sounding the alarm about the internal vehicles then being used to disguise liabilities, the impropriety of using one's own stock to bolster the value of related entities, and so perhaps misleading investors and regulators.
What struck me as I watched the news stories unfold and listened to the explanations from those at the center of the storm was that, for the first time, in a glaringly public forum, commentators began to talk about the need for reducing or eliminating conflicts of interest. And they spoke as though they were discovering a new atomic element. Some editorialists suggested that, out of the debacle, Congress might be moved to enact a raft of new rules about conflicts, a corporate version of post-Watergate legislation, as though such rules had never before been used in this environment (and wasn't it about high time that they were, etc., etc.).
[W]e the investing public do not always know who in fact really is solvent, who really is healthy out there.
In some ways, maybe the commentators and editorialists were right in their observations. For years now, we've all been told (often with the patience that a parent uses to explain adult subjects to children) by the wheeler-dealer wags of Wall Street that we just didn't understand about these things; everyone was, in fact, being very professional and were simply devising new methods, means, devices and strategies to efficiently develop capital to fuel the American engine of capitalism. Never mind that investment banks first designed the securitization vehicle, then marketed it to their other customers. Never mind that the self-same accounting firm did the audits and offered a broad array of other (and profitable) consulting services for their client corporations. Never mind that law firms offered the opinion letters that investors and banks had to have to put their money into these bankruptcy-remote devices, then investigated (for the Board) transactions they themselves had helped to put together.
The conflicts were there all along—and still are. What is more, the conflicts may be more deeply embedded than even Congress is comfortable with. The watchdog designed to protect investors and to assure transparency draws substantial guidance from accounting principles that are developed within the accounting profession. Boards of directors of corporations are selected only superficially by the stockholders—in fact, it is precisely because the shares of most public companies are so widely held that the real power in selecting directors lies with the officers of the company: The supervised hand-pick their supervisors. Small wonder then that the Enron Board did not see this coming. They came from far-flung locations, and being a director was not a full-time job for most of them. They relied on the information that was fed to them by the officers of the company, and the most important information they used as a barometer was earnings and stock price.
For those of us who do bankruptcy regularly, try this simple test. Apply the bankruptcy prism to the kinds of relationships that we have seen exposed in the media for the last four months or so. Use the conflict-of-interest rules that bankruptcy demands for the employment of professional persons. Would any of my colleagues comfortably approve hiring the same accounting firm to do the annual audit and provide other consulting services at the same time? Many of my colleagues would not permit such a retention, even seriatim. Would a law firm that helped to design some of the partnerships or affiliated securitization vehicles be permitted later to serve as counsel for the debtor-in-possession?
I do not here suggest any actual liability on the part of the firms that represented Enron before the bankruptcy was filed; after all, their retention and services may very well have been consistent with existing rules for companies that are not in bankruptcy. What I do suggest, however, is that we bankruptcy professionals have always been sensitive to the dangers inherent in conflicts of interest, and routinely submit ourselves to a set of standards that, for the most part, preserves the integrity of our system. Occasionally, someone tries to introduce non-bankruptcy rules of engagement into the bankruptcy arena. Usually, it blows up and further exposes what's wrong—not here inside the bankruptcy arena, but out there in the marketplace.
I have a modest suggestion for Congress and the federal agencies that are already hard at work crafting new rules to insure greater transparency and accountability in the marketplace. Take a look at what we are doing over here in bankruptcy, where transparency and accountability have been watchwords for decades. Over here, professionals who transgress the conflict-of-interest rules (even if the transgression is nothing more than failing to disclose the existence of the conflict) risk not only losing their fees but having to repay whatever fees they've already received. Over here, the bonus rules are quite a bit more strict. Here, transparency begins with schedules and statements of affairs that do not require an accounting professional or investment analyst to decipher. Over here, the heavy scrutiny of creditors, shareholders and the court exposes flaws in management much more quickly: Little wonder that the average tenure of senior management for public companies that enter bankruptcy is an estimated six months of the filing. And corporate self-dealing? The smallest sanction is losing one's job. From there, the stakes go up dramatically: Examiners get appointed, trustees get appointed and letters get written to federal investigatory agencies.
Of course, the rules are different in bankruptcy because the rules are always different for insolvent enterprises. Solvent enterprises are a different story and have the privilege of operating by different rules. Yet the lesson of the past few months is that, precisely because of the laxity of those rules, we the investing public do not always know who in fact really is solvent, who really is healthy out there. I would not apply wholesale the conflict-of-interest rules we use in bankruptcy to the marketplace. But there are lessons to be learned, analogies to be drawn. And isn't it ironic, at the end of the day, that the bankruptcy system has so much to say to the larger marketplace about integrity, transparency and accountability?