Analysts and Enron

In the aftermath of the Enron collapse, executives were hauled before congress, indicted, harassed by shareholders and other angry people, ridiculed, cursed and damned. There was enough blame and shrieking outrage to go around for everyone. Including analysts.

Several analysts were investigated, questioned, and yep, even hauled before congress to explain how they “got it so wrong.”

I’ve always disliked that, but now that I am one, I dislike it even more. An analyst’s job is to find out as much information about a company as he/she can, supply that actionable intelligence to his/her client, and give an informed, balanced, non-biased recommendation on what to do with that intelligence. Some analysts, such as Aaron Diamond at the Highfields hedge, are very direct, even confrontational with their questions to the leadership of the company. I suppose, if I am being charitable, I can attribute to his desire to really understand what is going on with the company. But I think there are better ways to get that information.

At the opposite extreme, you have me. I’ve never intentionally asked a question that would put an executive in an awkward position just for the sake of making my reputation. I tend to ask very open-ended questions, very politely. If I feel like I’m being lied to – and I have – then I go Socrates on him and just keep asking deeper questions, and ask other people in the leadership to expound on the issue.

But I can only go with what I can prove. I can tell my client that company A trades at a multiple fit for a penny stock, has a Ba1 rating, and the board of directors has just resigned – all verifiable facts that I could responsibly cite to urge him to drop those shares from his portfolio. But I can’t tell my client that I get a “weird feeling” on the phone with the CEO and that I think he’s lying to me. The client needs something concrete to look at, some objective measure of what is going on inside the company.

And so it was with Enron. Analysts could speak to Jeff Skilling and the other leadership, they could scour financial reports, they could do some comparative analysis and some independent research, but if Enron was corrupt (and it was not), then they wouldn’t know it, and whatever advice they gave to their clients was based on publicly available information, thus, in conclusion, they are completely free and clear, period.

It did not work out that way though.

I always found it curious that Occam’s Razor never seemed to apply in the Enron cases. The easiest answer was never the right one. Congress viewed the fact that the analysts had no indication of corruption as an indication that the analysts themselves were involved in malfeasance. Instead of coming to the obvious conclusion that there was simply nothing odd going on, the hapless analysts were accused of being part of this make-believe crime syndicate.

In mid-September, I wrote a research note urging clients to buy a certain company. I gave my reasons, raised the price target, and hoped that I was right.

I was right. The Q3 earnings were exactly where I predicted they would be. Everyone was happy.

I kept thinking about it though, if I had been wrong… There are a million ways I could have been wrong. My company could have had a relationship with the company that I knew about but didn’t weigh as seriously as I should have. There’s supposed to be a Chinese wall between analysts and bankers, but what if not everyone in my company or the target company was honest? What if one of the guys in banking had promised the company leadership that we’d rave about the stock, even if the stock was performing badly?

There are a million ways you can screw up and only one way to get it right.

I think the analysts who covered Enron were honest. They did their own financial modeling, due diligence, and research. These people were paid to research Enron. Nobody I know would risk his/her reputation or bonus by lying about what they’d found in one of their companies. The knowledge web is strong and vast: you have your peers and bosses to ask if you find something wonky. You have other companies to compare it to. And analysts have relationships with other analysts in other companies; you can call them up and ask what they think.

The fact that this vast network of many different analysts all said the same thing, and nobody cried fraud, is an indication that there was no fraud at Enron. The congress and the DOJ were seeing what they wanted to see.

There was no fraud or conspiracy at Enron Corporation.

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