Enron Lessons From Jim Chanos

Jim Chanos, one of the shorts whom Ken Lay fingered as having destroyed Enron, wrote a magnificent piece on the op-ed page of Tuesday's Wall Street Journal. I found three of his ten lessons from the Enron to fit with my own philosophies. They range from corporate governance to sell-side analysts, to CEO character. I'd like to share them in this piece.

Chanos' first point is one I've believed for many years. It is that we need something other than rule-based, SEC-required accounting systems and audits.

Today's audits are a joke. They are the minimum effort required to pass SEC muster and keep everyone's insurance premiums for malpractice within reason. If you've ever read the actual statement by the auditing firm on the average 10K, then you know it's virtually worthless to investors.

I suggested, post-Enron and Tyco, that the SEC repeal the requirement for auditing. Then encourage auditing and insurance firms to team up and offer "platinum standard" audits which truly protect and inform shareholders. The implication would be, were an S&P500 firm to decline to purchase such and audit, that the firm's management was concerned it would not be given the seal of approval.

However, on the "carrot" side, imagine how much shareholder value would be created by paying for and passing a really tough audit. An audit that came with meaningful insurance covering the financial statements' accuracy and authenticity?

Sadly, in our current regulatory climate, we have over-regulation of the wrong kind, which only serves to drive new listings and capital formation activity overseas. If the Chinese get this right, while we continue to "enforce" current processes, be very afraid.

The second point I liked in Jim Chanos' piece is about sell-side analysts. He says that they "...don't "do" complex."

So true. Actually, they don't do very much at all that isn't sales-related, Elliot Spitzer notwithstanding. Chanos focuses on the weakness of the system, whereby senior analysts defer to the junior ones for technical replies to their understanding of companies which they cover.

I should be careful what I wish for here, because the existence of such narrowly-focused, junior analyst corps, really makes my own job easier. Sector-focused analysts help reduce the chances that others will observe what I have about the actual performance of consistently superior companies.

However, so long as people actually listen to these sell-side Street analysts, Enron-like situations will occur.

Finally, Chanos speaks to character. This is so crucial. Look around at some of the sitting CEOs of America's large-cap companies: Jeff Immelt, Jamie Diamond and Bob Nardelli, to name a few. What are we to think of executives who gladly take excessive compensation for mediocre performance? Do you think that someone who does that is magically going to try harder in order to continue to be lavishly paid? Not likely.

CEO compensation has to be dramatically rethought. But it starts with boards of directors who actually have a stake in the company's performance. It's a character issue all the way around.

In any case, I found Chanos' comments to be a delightful read, and very shrewd.