Former Enron CFO Andrew Fastow Confronts the Fraud Examiners
Andrew Fastow, the former CFO of the bankrupt energy-trading firm Enron, admitted to the wrongs he committed, but also blamed the accountants at the defunct firm Arthur Andersen, in a speech at the Association of Certified Fraud Examiners’ Global Fraud Conference.
Fastow discussed the risk-prone culture at Enron that he admitted to influencing, how the accountants and lawyers gave their approval to the transactions and deals that they helped structure, and how he finally realized what he had done wrong when he had to explain it to his son during a visit to his prison.
“First of all, let me say that I’m here because I’m guilty,” Fastow said. “In 2000, I was awarded the CFO of the Year award. My award this year is to be called the Fraudster of the Year for ACFE. That’s very difficult. I’m not going to try to suggest to you in any way that I’m not guilty, or that other people were responsible for my actions. I take full responsibility for my actions, and that will never change.”
He admitted that he could never repair the damage that he did, including the thousands of jobs lost and employees’ pensions destroyed, but said he tries to make amends by giving presentations to students, corporate directors and companies about what went wrong at Enron. He thinks the kinds of problems that led to the Houston-based energy company’s demise are even worse today.
“In my opinion, the problem today is 10 times worse than it was when Enron had its implosion in what was called the era of corporate fraud,” said Fastow. “The things that Enron did, and that I did, are being done today. In many cases, they’re being done in such a manner that makes me blush, and I was the CFO of Enron.”
Fastow was prosecuted for not complying with specific securities rules when Enron did some of its financings, he explained. “I don’t think that’s the important reason why I’m guilty,” he added. “I think I’m guilty, and the most egregious reason that I’m guilty is that I engaged in transactions that caused a misrepresentation and caused Enron to appear different to the outside world than it really was.”
Fastow acknowledged the extensive damage caused by Enron’s collapse on the employees and their families, as well as him. “I’m not going to go through the personal impact, unless you want to ask a question about it,” he said. “It’s devastating, but that’s not why I’m here. I’m not asking for sympathy. I earned that and deserved it.”
But he pointed out that Enron was a growing energy company in 2000 that operated the largest natural gas pipeline system in the country. It was also a major energy trader and had a growing energy services unit for helping other companies with their energy needs, while also providing bandwidth for video streaming over the Internet. “It had $100 billion in revenue and about $1 billion in net profit—if you want to believe those numbers—and Fortune magazine named us the most innovative company for six years in a row,” said Fastow. “I was CFO of the Year, specifically for doing off-balance sheet financing, which of course now is a pejorative. A year later, in 2001, Enron’s CEO resigns, The Wall Street Journal launches a series of articles about Enron, the SEC begins an investigation, and Enron declares bankruptcy, all in the span of about three months. In 2002, the government launched the largest criminal probe of a company in history.”
Fastow admitted that his role was engaging in structured finance transactions that intentionally created a false appearance for Enron. “What does accounting fraud mean and where does it come from?” he asked. “It starts with the fact that accounting rules and regulations, and securities laws and regulations are vague, they’re complex, they’re sometimes nonexistent, so people have to make judgments. Now how do you treat situations when you have to make judgments like that? What I did at Enron and what we tended to do as a company is to view that complexity, that vagueness, that lack of existence of rules and regulations not as a problem, but as an opportunity. When judgment is allowed and it’s vague what the rules are, it gives you vague latitude to make decisions.”
Among those judgments, which he said were common at many other corporations, was the assumption about the rate of return for Enron’s pension assets of 8 percent. “Was 8 percent legal? Was it within the law? Was it within the regulations? Absolutely. And how did it happen? Management made a presentation to the board. Eight percent is the right number. It’s better than 4 percent. They had a consultant come in and he showed with nice shiny graphs that was a good number. Then the board turned to the auditors, and the auditors said, ‘It’s within the range of acceptable assumptions. We can give you an unqualified audit opinion.’ Then the attorney said, ‘It’s legal. We’ll write the disclosure.’ Then I asked the board members, ‘Is it the right number?’ And all of them agreed it wasn’t the right number, but most of them were using that number. The companies they represented were using that number. Is that fraud? It’s not clear. But why would a company even do that? The reason is, when you increase your rate of return pension assumption, two things happen. It makes your balance sheet look better by lowering your unfunded pension liability, and it improves your income statement because when you increase value by increasing the assumption, it flows through the income statement, so earnings per share went up. That’s why it’s done. Is it wrong? Is it illegal? It’s vague.”
The main filter he used at Enron was whether the rules allowed it, or at least whether an interpretation of those rules would allow it. In addition, about half of Enron’s assets were kept off the balance sheet in special-purpose entities. He pointed out that’s often true of airline companies like United Airlines, which typically don’t include their aircraft leases on their balance sheets.
Accounting Fraud and Arthur Andersen
“The trap I fell into is, if the filter you’re using is the rules allow it or may be interpreted to allow it, where do you stop? And I didn’t stop,” he said. “All of you talk about controls and systems, and we thought about that too. I thought about that. What do you do if the rules are complex, vague or nonexistent? Well, you do four things, from where I was standing. You get management and board approvals, you get legal opinions, you get an accounting opinion from outside auditors to make sure it’s OK, and then you make disclosures in your financial statements. Here’s what’s not widely reported. We did that in every deal at Enron, and still it’s considered the largest accounting fraud in history. How can that be? You’re getting approvals for deals. The attorneys and accountants are telling you it’s OK. The board is approving it, and it’s still fraud.”
He said he didn’t ask himself whether he was trying to intentionally mislead. “That’s a character flaw of mine,” he said. “That’s no one else’s fault. It’s not the gatekeepers’ fault that they gave permission to do the deals, that they approved the deals. It’s my fault only. I didn’t use the right filter, which was to ask what was the purpose of the transaction?”
Fastow was asked how he was able to convince Arthur Andersen to sign off on the fraudulent transactions. “With Arthur Andersen, we didn’t get them to do it, they were part of the transaction team,” he responded. “The attorneys and the accountants worked with the team on a constant basis. When a deal was being structured that didn’t meet the rules, they and all the other people that were parts of the deal team would try to create new structures to fit within the rules or to fit within a broad interpretation of the rules. They were part of the team. They weren’t asking for approval. They were helping us structure the deal so it was approvable.”
He recalled feeling perplexed when he read an early draft of Enron’s 10-K in early 2001, and he refused to sign off on it. He called in Enron’s chief accounting officer and the chief practice partner at Arthur Andersen to have a meeting. “I said, ‘I’m supposed to sign this, but here’s my problem. I’m CFO of Enron, but I can’t understand what this 10-K says. It doesn’t seem to me to bear any resemblance to the company we have here,’” he said. “The answer I received from Arthur Andersen was every single deal that Enron did met the accounting rules, every deal individually. Whatever drops out of the bottom is therefore by definition not materially misleading. It is what it is. I don’t think anyone believes that today. I never signed the 10-K. I was actually too uncomfortable at that point. But I didn’t think much more about it either. I just kind of accepted that was the way things were done.”
Jeffrey Skilling Prison Sentence
Fastow was indicted in 2002 and pleaded guilty in 2004 to fraud charges. He was sentenced to 10 years in prison, but prosecutors asked for a reduced sentence because he cooperated in the prosecutions of other Enron executives, so he was ultimately sentenced to six years in prison. He was asked at the conference about his former boss, Enron CEO Jeffrey Skilling, whose sentence was reduced last week from 24 years to 14 by a judge in Houston (see Enron’s Skilling to Leave Prison in 2017 after Judge Reduces Sentence).
“A lot of people like to have a great deal of discussions about appropriate prison sentences,” he said. “What’s a fair sentence, what’s not a fair sentence, what’s a punitive sentence, what’s a preventative sentence? They talk about it like it’s monopoly money. I can tell you that going to prison is terrible. You’re never comfortable. All the talk about Club Fed is garbage. You’re surrounded by very violent people, very unstable people. And prisons work hard to make you uncomfortable. But that’s not what’s bad about prison. What’s bad about prison is you’re separated from your family and the people you love. It is not the pain of incarceration. It’s the pain of separation. If you’ve ever gone on vacation for two weeks and left your children at home, remember what it felt like the day before you finally got home how much you missed your children. Multiply that by a thousand. That’s what you feel every day. You’re not there to help if help is needed, so it’s awful.
“I’m not going to comment on whether he [Skilling] deserved that, but I’m telling you it is a very significant sentence,” Fastow added. “It is a devastating sentence, even this lower sentence he just received. I don’t wish that anybody were away from their family for that period of time.”
Fastow contended that Enron did not have to go bankrupt, and Skilling should not be blamed for the bankruptcy. “I don’t know how much damage was attributed to Mr. Skilling when he was sentenced, but let me say one thing: Enron did not have to go bankrupt when it went bankrupt. The decisions that caused Enron to go into bankruptcy were made after Jeff Skilling left Enron,” said Fastow. “I don’t know how that would factor into a calculation of what he is responsible for, and if that was a factor at all in the judge’s determination, but Enron should not have gone bankrupt. It could have survived. It was decisions made in October of 2001 that caused it to go into bankruptcy.”
The speech, which closed out the ACFE conference on Wednesday, had attracted some controversy among members beforehand, with some of them criticizing the conference organizers in a LinkedIn discussion group for inviting Fastow to address the organization. ACFE officials emphasized at the beginning of Fastow’s speech that he had not been paid, and he received respectful attention during the address.
Before Fastow stepped out on stage the ACFE presented the Cliff Robertson Sentinel Award to Chinese biochemist Shi-min Fang, who has campaigned against academic fraud, scientific misconduct and pseudoscience in China in his publication and Web site “New Threads” despite retaliation from government officials and threats on his life.