1. Enron: What matters and what doesn’t Robert J. Michaels California State University, Fullerton and Tabors, Caramanis & Associates, Cambridge MA rmichaels@tca-us.com Western Farm Credit Bank Annual Shareholders’ Meeting Dana Point, California Mar. 12, 2002

2. What was Enron? zBegan with regulated pipelines zSeized deregulated market opportunities yIn electricity and gas zStructured commodity and financial trades zVenture capitalist zInvestor in hard assets zPolitical actor

3. Why the collapse doesn’t matter zNewly competitive markets offer alternatives to Enron zNo pricing or deliverability crises with bankruptcy zThe irony: Enron’s political activities were instrumental in bringing the markets yEnron was both a political and economic competitor yMatched against experienced opponents

4. The dangers of the collapse zAn invitation to shortsighted legislation and regulations yCut competitive opportunities for business yEliminate choices by customers (reregulation) yEliminate other choices (retirements) yHinder development of useful financial tools yEncourage questionable shareholder suits

5. Enron’s Business Model zBasically a trading company y“A hedge fund sitting on top of a pipeline” zDomestic “asset light” philosophy yAnd some heavy investments abroad zLight assets can be OK for a trader yBut traders can’t usually justify P/E like Enron’s ySo Enron needed to grow earnings, steadily

6. Special-Purpose Entities zSPE’s valuable to access capital, manage risk yLeasebacks, securitizations, funding acquisitions yFASB rules zEnron SPEs removed balance sheet problems yAllowed revaluations and resales, income growth yFunding by transactions with employees y“3%” and other standards violated zTriggers on Enron share and debt status

7. Accounting and standard-setting zEnron practices the dark side of disclosure zFASB 133 -- marking derivatives to market yIntended to force reporting of losses yEnron uses it to inflate earnings yForward curves from internal data yBalance sheets not released with earnings zConsequences of FASB haste to revise

8. Directors and managers zWeakness of Enron’s Board of Directors zNeed for managerial autonomy yLed to successes like EnronOnline zStrength of Enron’s internal controls zCRO: “the board tends to be vague on risk” zAn increasingly important problem in firms with large risk exposures

9. Auditors and analysts zRole of Andersen in collapse uncertain yAndersen defense: Enron didn’t tell us yEnron defense: Andersen said it was OK zNo clear ways to change audit regulations zSome analysts saw Enron problems early yAccounting details, credit risk derivatives zConflict of interest and recommendations zInherent uncertainty in valuing company yAccounting’s long-standing crisis

10. Enron and wholesale credit zTwo different “lessons of Enron” yThe rise and the bankruptcy zNew “good Enrons” from deregulation and globalization yThe plight of mutuals, publics, and nonprofits zTaking risk management seriously

11. The future of risk zInvestor insistence on seeing downsides zCoping with technical complexity of risk analysis zThird-party risk analysis: the emerging solution yEnron’s full statement of trading book risk yRisks investors and management must know zThe emerging duty to hedge

12. What was Enron [again] zThe makings of a drama zA vision of risk measurement zThe limits of financial companies zManagement is more than risk management