By any account, this would have been a tough year for Roger Sant. The co-founder and chairman of Arlington-based AES Corp. oversees a highly leveraged global power company that had been considered a well-run, high-flyer by Wall Street. But these days Sant is beset by problems as far-flung as his global empire. Electricity prices are low in Europe, there’s political turmoil in Latin America and nuclear saber rattling on the border between Pakistan and India, where AES runs some large money operations. In the last year its stock has lost nearly 90 percent of its value, prompting the resignation of CEO Dennis W. Bakke. “Clearly, we over invested in Latin America and didn’t pay enough attention to our balance sheet,” says Sant.

As if these burdens weren’t enough, AES has still another problem. Since the epic flameout of energy trading giant Enron, AES’ prominence in the energy market and complex financial statements make it look a little too much like the infamous Houston-based energy trader. Sant explains that AES is not really in the same business as Enron — now a poster child for corporate arrogance run amuck. “The trading operation is what got Enron and the others into trouble. We build power plants and operate them, and we don’t trade kilowatt hours.”

Unfortunately for Sant, that distinction seems lost in today’s risk-averse market and the growing disillusionment among investors for boardroom hubris. Nor is Sant the only top executive defending his company’s honor these days. After all, Enron wasn’t the only firm playing numbers games (see page 10). Companies big and small are scrambling to either hide their own transgressions or prove to a skeptical world that they’re one of the good guys. Not since the Great Depression has corporate America’s credibility been so strained.

What happened? The bull market of the 1990s, says Michael Dooley, a professor at the University of Virginia law school. With stock prices soaring, “all of a sudden it was possible [for corporate executives] to become not merely wealthy but ridiculously rich,” by generating fast, consistent growth. Investors, mesmerized by the double- and sometimes triple-digit gains that became common as the market soared, were willing to buy into virtually any pie-in-the-sky business model that included pretty numbers or the prospect thereof.

Abandoning their role as watchdogs, regulators, from Federal Reserve Chairman Alan Greenspan on down, were loath to do anything that might derail the New Economy gravy train. So the bubble expanded, the most extreme envelope-pushers reaped the biggest rewards and practices that seem downright crazy in retrospect became commonplace.

Transparency went out the window as many a corporate board became dominated by cosseted insiders all too ready to load up their plates with boom-time goodies. They granted themselves ever-higher pay packages, while the incomes of rank and file workers stagnated. To keep Wall Street happy — and to maximize the value of executive stock options — companies began manipulating earnings by booking fictitious sales, failing to disclose potential problems and occasionally hiding liabilities in off-balance-sheet entities, a lá Enron.

The people who should have acted as a brake on the process got sucked in as well. Investment banks paid their analysts to generate underwriting business rather than pick promising stocks. Accounting firms overlooked questionable practices in order to generate more consulting opportunities, sometimes designing the very strategies that their auditors were forced to ignore. Board members cut deals with their companies that created often-undisclosed conflicts of interest. And in-house lawyers signed off on the above in order to keep their jobs.

When companies did disclose their more questionable strategies, it was often in financial statements that were about as accessible as a Boolean algebra text. The result: Lots of problems at lots of companies, and a corporate culture that has some serious explaining to do.

Luckily, Virginia corporations weren’t among the worst offenders, says Ruble Hord, a partner in the Richmond office of the Todd Organization, a benefits consultancy. “By and large the corporate culture here is very conservative…[Virginia’s leading companies] tend to have realistic goals and expectations,” says Hord. Indeed, nothing on the scale of Enron has happened here, and few observers expect that it will.

Yet a quick read of recent corporate proxies and other public documents turns up plenty of red flags. Lafarge North America in Herndon, for instance, pays its auditor, Arthur Andersen, more for non-auditing work than for auditing. AOL Time Warner laid off thousands of its Northern Virginia workers in 2001, just before announcing that the pay of its six top executives rose by an average of 16 percent in the prior year. Circuit City Stores, despite a stock price that’s down by two-thirds from its bull market high, protects the jobs of its executives with a “poison pill” that makes it difficult for outsiders to take over the company and replace management.

And who can forget Roanoke-based Optical Cable, where CEO Robert Kopstein borrowed against his vast holdings of company stock to speculate in other tech stocks? When the market tanked, Kopstein was forced to sell, causing Optical Cable’s price to crater.

There are plenty of other examples, along generally the same lines. None of it is illegal, and some is even defensible, at least when viewed through the benign lens of the 1990s boom. But the post-Enron markets have developed an aversion to gray areas and are punishing companies whose finances are too opaque, business methods too aggressive, or insider relationships too cozy.

Shareholders, meanwhile, are suing everyone in sight, including management and boards of directors. “If you have a problem in a lot of governance areas, you, as a director, can be sued,” says Alan Rudnick, former general counsel for CSX and currently a professor at William and Mary’s law school. “You need [directors and officers] insurance as a backstop.” And insurance companies are demanding that their corporate customers demonstrate good governance, says Rudnick. “You have to show that the board is independent, that it’s organized properly and has the right kinds of committees. … How many insiders do you have on your board? Is a large majority independent by any definition? Who heads the audit and nominating committees? How many committee meetings did you have, and do they focus on the relevant issues?”

Adding fuel to shareholders’ anger is the greater contact they have with each other via the Internet. When the news broke last month that Tyco Chairman Dennis Kozlowski had been indicted for allegedly dodging state sales taxes on millions of dollars worth of art, 1,459 posts poured into Yahoo’s Tyco message board in the following 24 hours, running the gamut from reasoned analysis of the impact on Tyco’s already battered stock (though these were the minority) to diatribes such as “I feel sorry for you morons who still think this is a viable company!” It was a shared outpouring that would have been impossible before the Internet made message boards and e-mail pervasive.

Institutional investors, meanwhile, have stopped being passive bystanders and started pushing for better behavior from the companies in which they invest. In May, Oregon-based insurer and mutual fund manager TIAA-CREF sponsored an initiative to require software firm Mentor Graphics to put its stock option policy to a shareholder vote. The initiative won with 57 percent of shareholder votes cast. Now, says Ken Bertsch, TIAA-CREF’s director of corporate governance, his firm is lobbying the major stock exchanges to make shareholder approval of stock options mandatory for all listed companies.

So the race is on to whip governance procedures into post-Enron shape. At AES, the board now meets monthly, up from the previous five times a year. “We have telephone board meetings sometimes once a week,” for updates on management’s efforts to sell assets and cut costs, says Sant. AES is also offering the markets more financial details, breaking out the results of its largest plants and showing cash flows by region. In the past, it wasn’t clear from annual reports which plants generated which revenues and which countries ran profitable operations.

Fairfax-based American Management Systems recently formed a nominating committee, consisting of three outside directors. The committee’s job —nominating directors and officers, evaluating shareholder proposals and designing succession plans — used to be handled by the entire board, which includes the CEO and president. Now, these decisions “are fully independent of company executives,” says American Management spokesman Ron Schillereff. He stresses that this change is a normal part of the company’s evolution from “a founders’ group to a sizeable organization,” and not a response to current events.

Dominion, a Richmond-based power producer, seems to want to have it both ways. At its April shareholders’ meeting, company executives squashed shareholder moves to push renewable energy and to alter poison pills. The poison pill initiative would have required the company to put future poison pills to a shareholder vote. At the same time, taking a cue from the Enron mess, Dominion is doing what it can to make its financial reports more accessible.

If much of the above sounds like basic common sense, that’s because it is, says Drew Carneal, general counsel for Richmond-based Owens & Minor. O&M has been untouched by the governance crisis, he says, because, “We simply go by the book to make sure there are no conflicts of interest.”

O&M’s compensation committee “has no cross-pollinization,” says Carneal. That is, no O&M executives sit on the boards of its outside directors’ companies. Where some companies simply re-price options when the stock goes down, “Our plan specifically prohibits re-pricing,” says Carneal. If the stock falls, the options expire and are worthless. When O&M gives its managers stock, they’re forbidden from selling for periods ranging from one to five years. And it pays its auditors to audit, not consult.

Just about everyone from Congress to the SEC is pushing new laws to impose this kind of focus on corporations (see page 8 for more details). But rules aren’t necessarily the answer, says U.Va.’s Dooley. “Enron had in place a solid governance structure and code of ethics. They had a high-powered board, an audit committee and, what up to that time, was believed to be a very reputable accounting firm. All the structures were in place; they just weren’t implemented.”

The best guardian of corporate behavior is a wary market, says W. David Moon, head of Knoxville, Tenn.- based Moon Capital Management. “Corporate culture is cyclical. It goes from being fixed to being broken to being fixed pretty naturally. We’re in a period when excesses are being worked out and audit committees are more serious again and shareholders are paying attention.”
So will there be another Enron? Sure, says Todd’s Rubel Hord, “but hopefully not in the next 20 years.”

Return to Virginia Business - July 2002