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. Last Updated: 07/27/2016

Enron: What Lessons for Russia?

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Due to growing cross-border investment, events in one market often highlight the significance of initiatives in another. The collapse of Enron Corp., the seventh largest corporation in the United States, is just one such event, as it accentuates the importance of a recent initiative in Russia. On Feb. 4, as more details surfaced about corporate governance failures at Enron, the chairman of the Federal Securities Commission, Igor Kostikov, unveiled the Russian "Code of Corporate Conduct" at the World Economic Forum.

The code's primary aim is to increase investment in public companies by helping them adopt "best practices" in the field of corporate governance. Though the code's provisions are voluntary, the markets should reward companies that utilize the code to move beyond compliance with the law to create business norms that engender trust in corporate behavior and enhance shareholder value.

Though there is concern that, as a nonbinding instrument, the code may not induce widespread change in Russian corporate conduct, ultimately, increased capital flow is the most effective incentive for good governance. For evidence that markets punish companies that fail to regulate themselves, take the case of Gazprom, whose share value is perennially discounted by investors due to persistent asset-stripping and other abuse of shareholders.

Moreover, the Enron case demonstrates that, in more regulated systems such as the United States, the market evaluates a company's corporate governance performance more efficiently than regulatory bodies. After learning in October 2001 that the company failed to account for and properly disclose profits and losses, shareholders lost confidence and Enron's stock nose-dived. Market capitalization decreased from over $80 billion to a couple of hundred million within a matter of weeks, forcing Enron to declare the largest bankruptcy in history. Now, top managers are under civil, criminal and congressional investigations for allegedly defrauding shareholders by creating a complex web of outside partnerships to move corporate debt off the balance sheet, reporting false profits and otherwise enriching themselves through self-dealing and insider trading.

U.S. officials are also examining why Enron's board of directors failed in its corporate governance role -- both to protect shareholder rights and to hold management accountable. Management disclosed to the board plans to move company debts off the balance sheet into outside partnerships owned and run by Enron managers. Although such transactions posed classic conflicts of interest, the board approved them. Indeed, Enron's board took the extraordinary step of waiving certain provisions of the company's code of ethics in order to permit Enron's chief financial officer to be the general partner of certain of the outside partnerships.

These events are particularly significant since many Enron board practices were contrary to recommendations for governing company decision-making set forth in the Russian code. For example, certain Enron directors who sat on the audit committee and were expected to act independently were affiliated with charities sponsored by Enron. One had a consulting arrangement with the company. The head of Enron's audit committee sat in the position for over three decades.

The Russian code advises against such practices, as they tend to encourage boards to unduly accommodate top management to the detriment of shareholders and trust in the corporation as a whole. But even the best of governance provisions will not overcome a corporate culture that rejects the values underlying transparent conduct.

Ironically, Enron's code of ethics helped the board detect violations of conflict of interest rules. According to the code of ethics, which we found being auctioned on eBay, no officer or employee should "make an investment or perform services for his or her own related interest in any enterprise under any circumstances where, by reason of the nature of the business conducted by such enterprise, there is, or could be, a disparity or conflict of interest between the officer or employee and the company."

Due to board passivity and management aggressiveness, however, Enron did not follow this prescription to prevent interested party transactions. By suspending the code of ethics, both Enron's board and management sent the message that rules could be shelved when inconvenient.

This corporate conduct defied market logic and bankrupted the company. According to a post-mortem conducted by Enron's board and released Feb. 2, suspension of the code of ethics so that the CFO could stand on both sides of transactions between the outside partnerships and Enron was what hastened Enron's demise. Though the board established procedures to monitor the partnerships, neither the board nor senior management followed through with oversight. As a result, the CFO made $30 million in personal profit from partnerships, which set the pattern for the series of transactions to inflate Enron earnings and hide billions in debt from shareholders.

The Russian code can lead companies to increased investment, capital flows and access to markets -- domestically and internationally. Adopting the code, however, will not instantly transform a company into a profitable paragon of corporate virtue, particularly if the company has a vested interest in short-term growth strategies. Enron's bankruptcy demonstrates that a company's directors and officers must create a culture of compliance by setting transparent standards of external reporting and applying them to a range of internal business procedures, practices and decisions that, together, will determine a company's level of performance and shareholder value. Effective implementation of best practices is an ongoing process that will require top managers accustomed to absolute control and secrecy to share information and decision-making not only with a board of directors, but also with their own middle management.

For Russian managers seeking evolutionary and sustained growth, the code is a vital communications tool that can enable them to apply transparent standards of external financial reporting to internal auditing and accounting. If implemented consistently, the code can help them to detect and prevent potentially costly violations of law and ethics, thereby reducing investor risk and increasing shareholder value.

Matthew Murray is chairman and Anna Ossipova is director of the Center for Business Ethics and Corporate Governance based in St. Petersburg. They contributed this comment to The Moscow Times.