Global Policy Forum

by Carrie Johnson

Just two years ago, the board of Enron Corp. was named one of the nation's five best. Under the headline "Enron, A Board That Runs Deep," Chief Executive magazine praised the directors for their credentials and attendance record.

The board's audit committee alone boasted such figures as Robert Jaedicke, former dean of Stanford University's graduate business school; Wendy Gramm, a George Mason University professor and former chairman of the Commodity Futures Trading Commission; and John Mendelsohn, president of the M.D. Anderson Cancer Center at the University of Texas. Also serving on the audit committee were well-connected international executives Ronnie Chan, chairman of a Hong Kong investment group; Paulo Ferraz Pereira, a Brazilian businessman; and John Wakeham, former secretary of state for energy in the United Kingdom.

Today only half of the 14 members on that board remain; the others have resigned. Critics now say that the directors were too quick to rubber-stamp the financial policies and practices that led to Enron's bankruptcy.

Enron's collapse has given new life to the debate over the responsibilities and conduct of corporate boards, as well as the ability of government regulators and the courts to enforce the rules and punish misconduct. And the case has spawned a slew of proposals from Congress, the White House and investors' groups to tighten accountability.

Under an existing legal concept known as the "business judgment rule," board members bear responsibility to protect the interests of shareholders, to stay informed of events at companies they serve and to act responsibly on that information, said Ronald Gilson, a professor at Stanford and Columbia law schools.

Business-friendly laws and the courts, which have turned back enforcement efforts in the past, may benefit Enron's directors. The courts have typically given directors a lot of leeway in their actions, lawyers said. It's not uncommon for board members to face lawsuits filed by angry shareholders, but few succeed. "Absent provable, direct fraud like secret accounts in Switzerland or the Renoir on the wall, it's almost unheard of to hold a director liable," said Nell Minow, a shareholder rights advocate at the Corporate Library in Washington.

The Enron board came in for harsh criticism in the investigative report it commissioned into the company's failure. The report by the University of Texas law school dean concluded that abuses at Enron could have been prevented -- or at least discovered more quickly -- had the board and its audit committee acted aggressively. It faulted the board "for failing to demand more information, and for failing to probe and understand the information that did come before it."

Unlike some key executives at Enron, outside members of its board of directors are not believed to have profited from the financial partnerships that concealed the company's debt problems. But the board did approve management actions that allowed chief financial officer Andrew S. Fastow to bend conflict-of-interest rules. Fastow ultimately netted more than $30 million, in addition to his Enron salary and stock options.

Other outside members of Enron's board at the time included Norman Blake, chief executive of Comdisco Inc.; John Duncan, former chairman of the executive committee of Gulf & Western Industries Inc.; Charles Lemaistre, formerly of the M.D. Anderson Cancer Center at the University of Texas; and Frank Savage, chief executive of Savage Holdings LLC.

W. Neil Eggleston, a lawyer for Enron's outside board members, defended their conduct. "The outside directors were given incomplete and inaccurate information about these partnerships and the controls they ordered were not followed," he said.

Enron's board had other financial ties to the company. Board member Robert Belfer's Belco Oil & Gas Corp. bought a business unit from Enron with money Enron later used to help fund one of the partnerships. A host of other directors accepted pricey consulting contracts or contributions to favorite charities from Enron in addition to more than $70,000 a year for serving on the board.

Eggleston called the board members' financial relationships with Enron "insignificant" and said they "in no way compromised" the board's independence.

Jaedicke and Herbert Winokur Jr., chairman of the board's finance committee, testified before Congress last month that they had trusted Enron's managers and outside lawyers and accountants to keep them informed, only to be misled. Both men said they had not known about crucial details, including a decision to refinance partnerships known as the Raptors and the creation of another entity known as Southampton, which helped remove millions of dollars in debt from Enron's books.

Winokur, chairman of Capricorn Holdings Inc., a private investment firm, said the board should not be taken to task for failing to unravel Enron's complex financial arrangements. "The reality in the modern corporation is that directors cannot, and are not expected to, manage a company on a day-to-day basis," Winokur told a House panel.

What's more, Winokur -- perhaps mindful of the legal rule in such cases -- said twice that the board made "a reasonable business judgment" to allow finance officer Fastow to participate in the off-balance sheet partnerships.

Analysts have taken issue with the amount of time the board and its audit committee spent reviewing the company's books. Minutes of meetings from 1999 and 2000 indicate the audit committee rarely took more than 75 minutes to consult with Enron executives, start to finish. "One hour right before the board meeting is not nearly long enough to get into things they ought to get into," said Bill Bishop, president of the Institute of Internal Auditors.

That reminded shareholder advocate Minow of one of the most serious shareholder cases on record, which involved the takeover of rail-car leaser Trans Union Corp. by the Pritzker family, in 1980. There, the Delaware Supreme Court ruled that Trans Union's board was "grossly negligent" for approving the company's sale within two hours and without a written summary of the deal's terms or an appropriate measure of the company's worth. Even in the Trans Union case, Minow pointed out, the Pritzkers wound up paying the fines of the board members.

When a board's failure to take certain steps leads to a problem, the Securities and Exchange Commission can issue an order forcing directors and officers to "cease and desist" their activities and perhaps fine the company, said Mark Borrelli, a former assistant enforcement director in the agency's Chicago office. The SEC also has the power to unseat directors, but that requires court approval which has been difficult to get.

For that and other reasons, lawyers said, the SEC rarely goes after board misconduct, and even when it does its enforcement power is limited. In 1997, for example, the agency issued an investigative report faulting officers and directors at W.R. Grace & Co. for failing to disclose $3.6 million in retirement benefits and other perks, including use of a corporate apartment and jet, given to departing chief executive J. Peter Grace Jr. in the company's proxy statement and other financial documents.

"Serving as an officer or director of a public company is a privilege which carries with it substantial obligations," the report said. "If an officer or director knows or should know that his or her company's statements concerning particular issues are inadequate or incomplete, he or she has an obligation to correct that failure."

W.R. Grace and three board members neither admitted nor denied the allegations, and no action was taken against them.

The SEC has said that it would like to tighten the rules and win the power to ban errant directors from serving on the boards of other publicly traded companies, without having to seek court approval. That plan mirrors a proposal made yesterday by President Bush.

Stephen Cutler, the SEC's director of enforcement, said an interview last week that board members will not be able to avoid liability "simply by burying [their] head in the sand." Others also have been urging reforms. Investor groups are calling for a fresh look at corporate and board compensation plans. The groups oppose the idea of directors and executives being paid in stock options that they can cash out in the short term, which could lead them to focus on driving up a company's stock price.

The AFL-CIO is leading a campaign to prevent Enron directors from serving on other boards, an effort applauded by shareholder groups as perhaps the only tangible consequence the board members may face.

"What will be unique about Enron is the shame is such that these directors probably can't serve on other boards," said Sarah Teslik, executive director of the Council of Institutional Investors.

Singling out directors publicly for their failure to disclose relevant information is a roundabout form of punishment -- but one that may turn out to be the most likely course in Enron and beyond. "Not imposing personal liability has been a standard part of American corporate law for 50 years," said Gilson, the law professor. "It doesn't mean we ought not hold people who adopt a strategy of opacity up to scorn and ridicule."

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