Cartoon by ©Sage Stossel.

For several weeks earlier this year, there was a spate of breast-beating among news media critics on how the press “missed” the Enron scandal. Such stories are almost inevitable anytime there is a financial scandal. People who lose money are always looking for someone to blame. The news media are a convenient target. Even when reporters are crucial in unearthing the misbehavior, there is a tendency to overlook their work. The stories can be complex and, in the early stages, only partially complete. And reporters and editors whose organizations did miss the story are only too happy to agree that “everyone” missed it, because a blame widely shared can feel like it is less of a problem.

With Enron, however, it is not just that the scandal was not missed by the news media. Rather, the scandal was actually uncovered by the relentless, careful, intelligent work of two Wall Street Journal reports, Rebecca Smith and John Emshwiller. Without their reporting, the Enron scandal almost certainly would not have come to light when it did and conceivably might never have surfaced. Yet their reporting was largely ignored, not by investors, among whom it has had major impact, but by many of the nation’s news media pundits.

Indeed, many in the press leapt with a vengeance onto the Enron story only when it seemed to have the makings of a political scandal rather than being a “business story.” Members of the press, not unlike members of Congress, seem to have an easier time recounting tales of political contributions and influence peddling than matters of accounting, regulation and financial disclosure.

The enormous scale of Enron’s political investments and most of what it had gained from them were already well known and documented in detail by several newspapers, including the Journal, in early 2001. What it got from the Bush administration seems largely confined to participating in private strategy sessions about energy policy, while the company’s more significant political favors occurred earlier, during the Clinton administration, with support from the ranks of Democrats and Republicans alike. Doubtless, there are more skeletons to come rattling out of this closet—involving tax laws and rulings, regulatory actions, patronage jobs for political operatives, and so on—but they are of relatively minor significance when compared with the business and regulatory aspects of this story.

The real Enron scandal resides in the failure of institutions—accountants, lawyers and outside corporate directors—that have been relied upon for more than half a century to keep America’s capital markets the most honest, transparent and, therefore, the most successful in the world. Far more than the corrupting influence of corporate money on politics, the story of Enron speaks to the corrupting temptations for corporate managements to maintain at all costs the appearance of consistently rising profits—of “beating the Street.”

What was the Enron debacle? Simply put, it began in the 1990’s, when Chairman Kenneth Lay, advised by blue-chip consultants McKinsey & Company, moved to transform the company from one whose business was based on hard assets such as energy transmission lines to one whose business was based on the trading of increasingly complex securities. To support that trading, the company needed to be able to borrow large sums of money, and thus needed to maintain a high credit rating. To keep that credit rating high, it increasingly used the device of “special purpose” partnerships, into which it dumped assets it didn’t want on its own balance sheet and thereby hid its ballooning debt.

Soon, Enron had a whole bunch of these partnerships, essentially controlled by its own executives. Some of those executives—exactly which ones will come out in the investigations now under way—found that the partnerships had additional uses as well. In particular, they could be used to generate phony paper profits through convoluted transactions with Enron, an advantage that came in handy as Enron needed to generate ever-advancing earnings to sustain its stock price. And, in another exquisite bit of corruption, Enron executives who participated in the ownership or management of the partnerships found that they could enrich themselves personally through such dealings.

How did they get away with this? The company’s books were so opaque that only astute and well-informed insiders could figure them out. The company’s accounting firm, Arthur Andersen, which also did millions of dollars in consulting business with Enron, was deeply involved in the creation of these partnerships. Additionally, Enron’s outside directors voted to suspend their ethical rules in handling the partnerships. And the company’s outside lawyers dropped the ball on numerous occasions.

How did the public finally become aware of this scam?

The Enron fortress was so powerful, its reputation so great, that it easily withstood the occasional potshots fired at it by quizzical journalists, renegade analysts, and hopeful short-sellers. A story in the Texas regional section of The Wall Street Journal in 2000 by Jonathan Weil, now the Journal’s national accounting reporter, raised questions about one aspect of the company’s accounting practices, but wasn’t followed up in the full run of the paper. A piece in Fortune magazine in March 2001 asking whether Enron was overpriced was followed a few weeks later by another in which the magazine praised it as one of a few “winning companies” and “digitizing superstars.”

What was required to penetrate the Enron citadel were people who knew the company, its people and its industry, who understood the tricks and danger signs in financial reporting, and who had the patience and determination to stick with the subject for a sustained period of time. Journal reporters Smith and Emshwiller did just that. They decisively cracked the Enron mystery, and publication of their reporting triggered the collapse of the energy giant. Their reporting showed that Enron’s profits were heavily based on aggressive accounting, the liberal use of off-balance-sheet partnerships and misleading statements to regulators and the public. In 10 days, beginning with the publication of the Journal’s first explosive story on October 17, 2001, Enron’s stock plunged 60 percent. By December, a company that a year before was valued by the stock market at $70 billion sought bankruptcy protection and became the subject of a Securities and Exchange Commission investigation and Congressional probes.

Early in 2001, Smith and Emshwiller began digging into accounting practices in the energy trading business. First focusing on several companies, they zeroed in on Enron when its chief executive, Jeffrey Skilling, mysteriously resigned in August. Skilling, alongside longtime Chairman Lay, was the architect of Enron’s transformation from a gas pipeline company into a financial juggernaut that was more akin to a Wall Street brokerage than an old-fashioned utility. Poring over Enron’s convoluted financial statements, the Journal reporters discovered an unusual relationship between the company and its chief financial officer, Andrew Fastow. First noting this in a “Heard on the Street” column that appeared on August 28, the reporters quoted Lay acknowledging that the Fastow deals could become “a lightning rod for criticism.”

That article cracked open the door. People close to and inside the company began to confide in the Journal reporters more, giving them damaging documents, including hitherto secret papers related to partnerships run by Fastow that had major financial dealings with Enron. Working these sources and others in the trading and banking communities, they were perfectly positioned to explain to Journal readers some of the frightening facts behind Enron’s October 16 announcement of an unexpected $618 million loss, the first deviation from strong quarterly profit rises since 1997.

The loss itself and the company’s vague explanation of it didn’t faze Wall Street. Indeed, Enron’s stock rose on the news. But the next day, when the Journal’s story appeared that linked the losses to the Fastow partnerships, Enron’s stock started its 10-day decline. The following day, October 18, Smith and Emshwiller shocked the investment community with the revelation that the company had been forced to shrink its equity base by $1.2 billion as a result of losses at the Fastow-run partnerships. A day later, they dropped a third bombshell: Fastow had made millions of dollars at Enron’s expense while serving as its chief financial officer. Enron’s stock price closed at $33.84 the day it reported its huge quarterly loss. After the three Wall Street Journal stories, the stock was $20.65 and sinking fast. In a December presentation to its creditors’ committee, Enron acknowledged the impact of this trio of articles, placing the caption “WSJ articles start” at the beginning of a graphic tracing the final major decline of its stock.

Despite public assurances by Lay that everything was aboveboard, the reporters dug deeper, reporting exclusively on November 5 that other undisclosed and potentially loss-making partnerships existed. On November 8, Enron restated its earnings for the previous five years, admitting that almost half of its profits were bogus. Smith and Emshwiller capped off their reporting with an article detailing the collapse of a plan for Dynegy Inc. to acquire Enron, another story showing how the fall of Enron complicated the national effort to deregulate energy markets, and a third providing an explanation for how things had gone so wrong, so quickly, at Enron.

Coverage of a story like this makes few people happy. Thousands of Enron employees lost their jobs, while tens of thousands of investors lost major money in the stock market after mischief in the company was exposed in our paper’s series of stories. The beneficiaries were investors who decided not to buy Enron shares and hence were spared the losses and the public, who learned that some of its key institutions are badly in need of overhaul.

Since last fall, armies of reporters, at the Journal and elsewhere, have been hard at work uncovering the reach of the Enron scandal. But the true heavy lifting on this scandal was done last year by Smith and Emshwiller. Without their work, efforts launched by Enron in August to sell itself quietly to another company very likely would have succeeded. While Enron would have had to contend with its bad third-quarter earnings report, the market for the company’s stock seemed to be stabilizing before the first Smith-Emshwiller article was published. Thus, unlike the fire-sale urgency that accompanied the frenetic and ultimately unsuccessful talks with Dynegy—the most likely potential buyer—Enron might well have encountered a far more favorable selling environment, in which more than one buyer might have vied for all or part of the company. A sale would have kept the rotten Enron core undiscovered for many months, conceivably forever, if Enron’s viable businesses bounced back swiftly enough.

The collapse of Enron is the first great American scandal of the 21st century. Its enormous ramifications will consume years of investigation, prosecution, litigation and legislation. And justifiably so, because the debacle casts a shadow over so much that is central to our lives—the security of our jobs and savings; the integrity of our financial markets; the trust we place in business watchdogs like accountants, regulators and directors; and, of course, our politics.

But just as it took two experienced and determined business reporters to unveil this debacle, the problems it laid bare will require business-savvy solutions. Reforming political campaign finance is not nearly enough. What’s required are steps to restore the integrity of our accounting, legal and boardroom functions. The work of these two talented journalists has provided the critical information that is spurring the nation to start this process now.

Paul E. Steiger is managing editor of The Wall Street Journal.

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