Beware The Clever Exexutive

How could we begin a discussion about corporate fraud, without mentioning Enron? If the name doesn’t ring a bell, here’s the rundown: Formed in Houston, Texas in 1985, Enron was a trailblazer in the field of energy commodities and services, and a place brimming with brilliant and innovative minds who helped Enron earn Fortune magazine’s title of “America’s most Innovative Company” for six consecutive years (!) from 1995 to 2000. Eventually claiming revenues of $100 billion in the year 2000- the last year of its existence as a going concern- the company imploded in December 2001 as it came to light that senior executives had created an elaborate system of institutional accounting fraud, in order to hide billions of dollars of debt from creditors and investors. In the end, investors lost tens of billions of dollars; 20,000 Enron employees lost their jobs as well as billions of dollars in pension benefits; several Enron executives went to prison; and the scandal brought down their external auditor, Arthur Anderson (effectively reducing the ‘big five’ of accounting firms down to the ‘big four’ that we know today).

Whew- what a mouthful of accolades! Today, the name Enron itself has become a byword for institutionalized corporate fraud.

So how could it come to this? We know that the very vast majority of Enron employees were people of great integrity who worked to the highest standards of their professions.

But quite unlike natural disasters such as meteor strikes, tornados or hurricanes, corporate fraud isn’t an act of nature- it’s an act of human invention. Fraud is also not random- it comes through the moral failure of an individual or group, and through failings in the prevailing corporate culture. The roots of moral weakness can be traced to our very upbringing- where our values are established. But where does corporate culture come from? Well, you’ve probably guessed it…it comes from ‘The Top’.

In the case of Enron, ‘The Top’ was the person of Mr. Jeffrey “Jeff” Skilling. Jeff joined Enron at the executive level in 1990 from McKinsey, and acted as the CEO of Enron until shortly before its disintegration in 2001. Knowing many ex-Enron employees and having read the case studies, books and articles on Enron, I found that -for all of the hundreds of pages of complex accounting schematics about the system of fraud itself- the rotten culture established by Enron’s senior executives was its greatest failure -its Achilles heel- with roots very much (though not exclusively) grown in soil that was fertilized by Mr. Skilling.

Ah, the beginnings of rottenness are so often sown in youth- and grow over time through the act of being rewarded for behaviors that really should have been reprimanded. The fate of Enron was perhaps sealed in a very simple story about Mr. Skilling- over a decade before he joined the company.

The year was 1977. Two years after graduating from college and working for a bank in Houston in a corporate planning role, young Jeff had applied to Harvard Business School. As the legend goes: when asked by the HBS admissions interviewer if he was ‘smart’, Skilling reportedly responded that not only was he smart, but “I’m f***ing smart.” I suppose that in the parallel universe occupied by HBS recruiters in 1977, young Jeff’s vanity and vulgarity provided precisely the answer that the admissions officer wanted to hear. So instead of giving Mr. Skilling a lesson in the virtues of humility and civility with a sound rejection, his braggadocio was rewarded, and Skilling went on to graduate at the top of his HBS class. The rest is tragic corporate history.

Let’s pause for a moment. If a candidate for a job in your firm would respond to an interview question like Jeff did above, would you hire them? (If you answered Yes, please consider calling AscentWorks Partners for a corporate culture consultation right now!)

Under Skilling’s later ‘leadership’ (as there is such a thing as ‘bad leadership’ after all), Enron was a place where you were either ‘great, or ‘gone’. Skilling is said to have designed Enron’s corporate culture off of the Richard Dawkins book “The Selfish Gene”, which Skilling reportedly interpreted (falsely according to Dawkins himself) as a transmission of Darwinian natural selection onto the business world- a world where money and fear become primary drivers of employee behavior. The consequence for Enron was the creation of an environment where only the strong survived. The weak were eliminated through the Enron rating system, in which at least 10% of employees were required to receive the lowest-possible rating each year and were fired if they couldn’t find a new internal opportunity within two weeks (a rating system now known across the business world as “rank and yank”). In such a toxic corporate culture, where the ‘swagger of the clever’ prevails, I suppose that many an honest employee felt pressure to do whatever they needed to do- to survive to see another bonus check.

The underlying theme here is Fraud, and the environment in which it grows best. Wherever humans work -regardless of their profession- there is a chance of Fraud occurring, and there’s always an entirely human rationale behind it. No matter how much you earn, no matter how important your family name is, no matter what brand of car you drive, no matter what school you graduated from- people commit fraud for any number of very human reasons: greed; craving of recognition; satisfying special family needs; drug or gambling addiction; or the simple desire to maintain performance targets at work. So, if you have humans walking around at your place of business- Congratulations! -you have the chance of Fraud occurring.

So how can you lower the chance of Fraud in your company? What are the ingredients to this toxic mix of factors that promote Fraud? The Association of Certified Fraud Examiners calls these factors the ‘Fraud Triangle’. The Triangle’s components are: Pressure, Opportunity, and Rationalization.

1. Pressure: this is about the Culture in your organization. If your company culture encourages staff to take risks or act unethically- even to the point of knowingly committing a criminal act- ‘for the good of the firm’, your organizational culture is rotten. A rotten corporate culture is the common denominator in almost every corporate scandal throughout the history of business.

2. Rationalization: this is where the Values of the human beings in your company come into play. Having a rotten corporate culture is vastly different than having just a single rotten apple within your company. Degraded values can lead bad actors to justify their dishonest or criminal actions.

3. Opportunity (or more aptly ‘perceived’ opportunity): this is about Controls- or the lack thereof within a company. Opportunity relates to the ability of an employee to actually commit fraud.

It’s one thing to think about it, and it’s quite another to be able to do it. For fraud to occur, there’s often a huge, gaping hole in your company’s control framework.

In the end, the Enron story highlights how a company consisting of 99.99% honest and hardworking people can have their jobs either endangered or destroyed, and the reputation of their company tarnished, by a mere handful of rotten and misguided colleagues-turned-criminals.

Questions for Thought

· Do you think that winning the “America’s most Innovative Company” award for so many years in succession played a role in Enron’s pushing the boundaries of what was legal, to maintain their place on top of the hill? If the company had not failed in 2001, would they have won that year as well?

· Can you relate the “Fraud Triangle” to the Enron case? Can you tie Enron’s Culture and Value system to the negative outcomes of this case?

· Does your company approach problems as challenges to be overcome ethically, or as mere ‘hinderances’ to be skirted around by any means possible?

· Does unethical behavior get a pass in your company, or even worse- is it rationalized and rewarded?

· Think about where the opportunities for Fraud may exist in your company. Do you have a Control Framework that will act as a ‘net’ to catch bad actors? If yes, is your Control Framework up-to-date? Who is ‘checking the checkers’?

· Do you want to test for potential gaps in your Fraud Prevention framework? AscentWorks can assist you to go from strength-to-strength by assessing and mitigating your risk of Fraud.

Additional Notes

To be fair, although Jeff Skilling was a major player in Enron’s organizational culture, he was in fact only the Number Two Person in the firm behind CEO Kenneth Lay, who held the top role from 1985 to 2001. Lay, Skilling, and CFO Andrew Fastow (a Skilling hire) were convicted for their part in the scandal, with Skilling receiving the harshest sentence of the three- 17 years in prison. Mr. Skilling was released from prison in February 2019, and at the time of this writing, is reportedly planning a comeback with a new venture in the oil and gas industry. (Jeff, I can recommend some extremely capable Risk Advisors to you, so please don’t hesitate to call!)

I used the Enron scandal as a centerpiece of Fraud in this article, due to its wide notoriety. That said, the author is embarrassed to admit that I had the choice of so many corporate scandals to choose from, to illustrate how ‘clever’ executives, in a rotten corporate culture, with lacking controls, and degraded values, can bring destruction on their companies. To name only a few of the most recent famous cases: the Wirecard $2bn balance sheet fraud; the VW emissions scandal; the FIFA bribery scandal; the Theranos blood testing fraud; and the Wells Fargo phony accounts scandal.

The list will surely go on, so please make sure your company doesn’t join it.

Recommended Reading

McLean, Bethany; Elkind, Peter (2003). The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron. Portfolio. ISBN 1-59184-008-2.

For Thought

For Thought