If capitalists were angels - Sherron Watkins - The Fall of Enron - Interview

Internal Auditor, April, 2003 by Nancy Hala

No longer recoiling at being called a whistleblower, this former Enron vice president talks about her views on corporate governance, ethics, and the role internal auditors must assume to challenge and overcome the scourge of corporate fraud.

AS AN ENRON CORP. VICE PRESIDENT, SHERRON Watkins sent a memo to Chairman Kenneth Lay outlining improper accounting methods she'd discovered throughout the organization. It was a move that analysts sometimes use to mark the beginning of the energy giant's eventual downfall.

Now, two years later, Watkins speaks regularly on the need to raise awareness about the significant pressures in the daily office environment relating to performance, governance, and accountability and about the corresponding relative weakness of watchdog groups responsible for monitoring corporate behavior. Watkins, whose recent book, Power Failure, which outlines the events leading to the demise of Enron, also talks about corporate responsibility, leadership, and the need for corporate governance reform and fundamental change, not only in the accounting industry but also on Wall Street.

Ms. Watkins, how did Enron's corporate culture contribute to the corruption of its governance infrastructure?

On paper, Enron had everything you would imagine from a Fortune 50 company. It had the right code of conduct and ethics program. CALpers, one of the largest public pension funds, was an investor and performed its own due diligence on Enron before investing; CALpers gave Enron passing grades on its corporate governance.

Outwardly, our corporate values were respect, integrity, communication, and excellence. The problem was the other component of our culture, which was known as a "loose-tight" management structure. "Loose" meant that with regard to commercial revenue-generating endeavors, Enron did not superimpose a strict hierarchy. The goal was for great ideas to float up and be heard, rather than be stifled by an unimaginative boss. This was a big reason we all loved working at Enron -- we could each be something of an entrepreneur. The "tight" aspect of this management style referred to tight risk management and spending controls to make sure the company was not wasting time or money on half-baked ideas.

Over time, however, another management model, informally called "rank and yank" and instituted by Enron's Performance Review Committee (PRC), had a way of marginalizing what were supposed to be tight controls. The PRC applied a forced bell curve that comprised about 5 percent of employees at the top and 40 percent spread out in the next two groups -- these three groups were the primary bonus categories. Then there was about 30 percent in the middle and two groups toward the end, with at least 8 percent of the employees getting "yanked" (meaning fired) for poor performance. As for those individuals in charge of control, they soon learned that if they did not help commercial dealmakers achieve financial goals by pushing deals through the system, the PRC would complain about them. The culture should have dictated that the control professionals with the most complaints be rewarded for doing their job and throwing up red flags on suspicious deals. But that didn't happen at Enron and in time, the tight controls fe ll away.

For their part, the dealmakers had to chase new business ferociously or be persecuted by the PRC. Another company less focused in this way might have stopped and explored deals that were confusing and difficult to understand, just to make sure they held water.

Describe the overall decision-making process at Enron.

The decision-making procedures were correct, but the controls were marginalized. In my opinion, the biggest problem was that Enron outsourced its internal audit function. On top of that, it outsourced the internal audit function to the company's external auditors, Arthur Andersen. The fact was junior auditors at Andersen were not going to challenge deals that senior Andersen auditors and senior Enron executives had approved.

Companies must have a strong internal audit function, one that reports directly to the audit committee. In the last year before Enron's bankruptcy, the company hired vice presidents for each business unit to coordinate with the Andersen internal auditors to review controls and procedures. These vice presidents went to Richard Causey, Enron's then executive vice president and chief accounting officer, and asked him what kept him awake at night. Causey said, "Nothing."

Did you ever go to the Internal auditors with your questions and concerns about the "creative accounting" you uncovered?

Who knew who they were? There was no place for me to voice my concerns, either to the internal audit function or the audit committee. Remember, I was not in the accounting department. But even if I were, I think I would have known it would have been fruitless, because I would have had access to junior auditors who were simply not in the position to raise the flags that would have hurt their senior auditors and account executives.