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Ten Responses to the Enron Crisis for Socially Responsible Investors
Joan Bavaria
President of Trillium Asset Management
February, 2002

Enron's "implosion" is not just a headache for money managers, although it is certainly that. Enron's collapse has become totemic. This single breakdown is challenging confidence in: the stock market, the trading process, rating agencies, energy policy, corporate governance, our retirement fund laws, executive compensation, board compensation, the financing of politicians, the banking system, the commodity options concept, trading regulation, the accounting and audit system, corporate philanthropy, regulatory oversight, privatization of water and other "public" assets, globalization, secrecy havens, and probably our business education system and other systems I haven't thought of. To add insult to injury, as I write this the company is still spending money on executive jets and top-priced seats at Houston Astros games. (While we're at it, we should add "access to sporting events" to the list of big issues we should investigate in the wake of this scandal.)

Dr. Robert Schwartz, one of the original investment professionals in socially responsible investing, told me that he did not own a share because he "didn't know it well enough". No prudent investor knew this company well enough to give it money, it is now clear. Truly knowing the company might have been impossible. I would like to be able to say that Trillium Asset Management did not own a share of Enron on behalf of our clients. However, like many other professionals, we held it in our diversified client portfolios, exiting (for social and financial reasons) well before it became a penny stock but still not fast enough.

Now, just like everyone else, we are wondering what could have been different. Milt Moskowitz, who has been analyzing the social profiles of companies for over three decades, mused, "Enron made our Fortune list for three years in a row. Did we make a mistake? Not by the lights of our methodology, which relies strongly on the opinion of employees who worked there. They loved the place." It is important for all of us to remember that most of the employees who worked for this company are on top of the list of victims. I had some personal contact with middle managers of Enron over the past several years; these were people responsible for environmental performance who became interested in CERES and the idea of environmental reporting. I remember one of them taking notes at a CERES conference in San Francisco, as he quietly sat on the side of a noisy room bent over a legal pad balanced on his knee. I wonder where and how he is. The people I knew believed management's line about wanting to become "the" environmentally progressive energy producer" and worked to make that happen.

The senior Enron executives staged a terrible robbery with none of the flash and guts of old-fashioned bank robbers like Jesse James or Bonnie and Clyde. Enron's robbers are well-educated bullies, cowards and sneaks. Unfortunately for investors, in business it is almost always impossible to anticipate white -collar robbery. It is anecdotal, unpredictable and never, ever disclosed! As the weeks pass, we find that a few short sellers or focused analysts spotted danger, but no-one spotted a scandal as monumental as what has unfolded.

Critically, forces within the business and political worlds that have evolved in the past several decades abetted the behavior of these managers. Enron was an accident waiting to happen. The socially responsible investment community has a special role to play as these issues are addressed. On February 19, The Financial Times, in an article titled "Comment After Enron: Reforms to restore confidence in business", said "the most important reform - one that runs throughout the accompanying articles - is to move towards a simpler set of rules, coupled with a new determination on the part of all participants to act in accordance with their spirit, not merely their letter".

The socially responsible investment community is used to the subtlety inherent in the "spirit" of rules and regulations. "Although there is no guarantee that a company that routinely considers the social and environmental impacts of its policies will be less prone to fraud, greed and arrogance, we would like to think so," Milt said.

Many of the issues are not new to us. The traditional financial and political communities will be leading reform around some of the issues. But here are a few of the issues socially responsible investors should engage and watch:

    1. Transparency. We need to continue to work for more transparency around all aspects of corporate operations. When asked for disclosure of policies or results, companies will use cost, competitive secrecy, fear of misinterpretation or fear of lawsuit to fight the release of information. These objections are usually surmountable and sometimes downright bogus. "Transparency" of the future will include more disclosure of such items as off-balance sheet debt and secret off-shore tax havens. The traditional financial community will push for this, and should be supported by the SRI Community. A coalition known as the Corporate Sunshine Working Group is pushing the Securities and Exchange Commission to require greater disclosure from companies on their environmental liabilities. CERES and the GRI have made gigantic strides around the environment and other sustainability issues. These efforts must be continued and expanded. Most importantly, a population of information consumers must be built (consisting of various stakeholders) for these reports to grow and flourish. Apathetic stakeholders could mean that current momentum on the part of companies to issue reports will dissipate.

    2. The Audit. The integrity, independence and reputation of the audit must be restored. The system of trust that is the stock market depends on it. My very first active social investment client wanted to file resolutions objecting to the appointment of one of the "big ten" accounting firms as auditor of a company she held in her portfolio. She protested on the grounds that there was a conflict of interest that was present in the relationship. This issue has been dormant within our community for years but should be revived. In addition, we must fight against the conflict of interest inherent when the auditor also serves as a business consultant.

    3. Off Balance Sheet Transactions. Socially responsible investors might consider careful scrutiny of the balance sheet as part of routine social analysis, looking for signs of off-balance sheet or hidden transactions. Responsible companies have nothing to hide. 4. Campaign Finance Reform. Once campaign finance reform legislation has passed, socially responsible investors should begin to ask companies for information on their contributions, even if they are channeled to obscure non-profits in lieu of political parties or politicians. Hopefully, this legislation will not be passed with huge loopholes and will have more integrity than the version that exists as I write. On February 15, The San Francisco Chronicle quoted a "GOP Strategist" as saying "you don't have to be that bright to figure out the loopholes. They are big enough and obvious enough to drive a trailer truck through".

    5. Boards of Directors. Boards should be closely monitored for independence, diversity, interlocking positions and conflicts of interest. Board compensation should not be so excessive as to discourage questions and dissonance in Board meetings. The CEO of a company should not also chair the Board of Directors. Trillium Asset Management has no excessive director paychecks, and we have always cultivated a relatively large, independent Board. This practice has served us extremely well over the years as we have benefited from the advice and counsel of these dedicated people.

    6. Executive Compensation. Top management is paid too much and is often encouraged by complicated compensation packages to think share valuation at the expense of sound management. Top managing executives' pay should not be so linked to the short-term valuation of shares and options to tempt managers to foreclose on the future of a company for the benefit of their short-term enrichment. Shareholders should continue to advocate more balanced compensation plans. According to Sarah Anderson, John Cavanagh and Ralph Estes of the Institute for Policy Studies and Chuck Collins and Chris Hartman of United for a Fair Economy, a 2001 study showed that over the course of the 1990s, corporate profits rose 108 percent, supporting an S&P 500 Index increase of 224 percent. After nearly two decades of real wage declines, workers' pay has risen 28 percent in the 1990s (before adjusting for inflation). Meanwhile, CEO pay has risen 443 percent. If average production worker pay had risen at the same rate as CEO pay between 1990 and 1998, worker pay would be $110,399 today, rather than the current $29,267. The minimum wage would be $22.08, rather than the current $5.15 per hour.

    7. Ethics Policies. Internal ethics statements and policies should be scrutinized, disclosed and discussed at shareholder and Board meetings. Mere disclosure does not guarantee compliance. We can ask companies how they monitor internal compliance.

    8. Tax Policies. The SRI community should put its weight behind all efforts to increase the short-term capital gains tax or otherwise change the tax structure to encourage long term ownership of stock. Since it costs some investors no more to cash out of a stock after ten minutes than it does after ten years, flipping and short term trading is encouraged. The short-term focus of Wall Street causes honest corporate managers to eye Wall Street minute by minute when they should be looking out for the long-term welfare of their company. All of us close to the nerve-wracking earnings vigilantes know that there has been a lot in it for companies to manage earnings so they avoid disappointing analysts by even a penny. Anything that can be done to reasonably lengthen horizons of business plans and reports would help relieve the tendency to cut corners and manipulate quarterly results.

The following issues are long-term systemic issues that are not headline-grabbing but are extremely important for the health of our global systems:
    9. Renewable Energy. Socially responsible investors should continue to advocate sustainable sources of energy. Distressingly left out of most of the public debate around Enron, energy issues sit at the heart of both this scandal and the terrorist acts of the fall. The earth's oil and gas supplies are finite, and the most promising future reserves lie in the politically unstable Caspian region. This country is dependent on external sources for what remains the essential plasma of our economy and life style. Even moving global warming and other threats aside, this dependence on extracting an essential component of our economy from others is foolish. Alternative sources of energy must be encouraged and developed. The more enlightened of the energy companies understand this, but in the past two decades the economic system in this country has taken a distressing step backwards away from support of alternative clean fuels.

    10. Sustainable Investments. The SRI community should advocate legislation that requires pension managers to ask companies in which they invest for long-term planning that addresses sustainability issues (environment, human rights, community interaction). This practice is growing in Europe. Enron's culture was one of quick enrichment where the end justified the means. While such disclosure on sustainability might not have spotlighted the Enron scams, it might have given alert stakeholders pause.

It will take considerable time and effort to climb out of the mayhem that is the Enron scandal. The multitude of lawsuits will take years and years to resolve. But Enron must be understood in the context of the systems that allowed all this to happen right under our noses. Socially responsible investors, finding new allies for old campaigns and new issues upon which new campaigns can be built, can and should make use of this moment of introspection and re-construction to advocate for some fundamental systemic changes.

 

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