TESTIMONY OF CURT N. LAUNER
Senate
Committee on Governmental Affairs
Enron Hearings
February 27, 2002
Introduction
Good morning, Mr. Chairman. My name is Curt Launer and I am a Managing Director at Credit
Suisse First Boston (CSFB)[1]
in the Equity Research Group. I head
the Global Utilities Research Group of CSFB that comprises 28 professionals,
including 14 senior analysts around the world.
My specific research coverage is the Natural Gas & Power
sector. As a research analyst for the
past 18 years, I have followed Enron and its predecessor companies.
My career on “Wall Street” began as a research
analyst in 1984 with the firm of LF Rothschild. In 1987, I joined Donaldson Lufkin & Jenrette and was there
until its October 2000 merger with CSFB. Prior to 1983, I was in the Energy
business as an accountant with Gruss Petroleum and Mobil Oil for three years. I
began my career in 1977 as an auditor with Arthur Young & Company following
graduation from the State University of New York at Buffalo (B.S. Accounting).
Summary.
In discussing the role of an analyst and the Enron
situation, I would like to make four main points today.
First, the role of the analyst is to make informed judgments about companies based on publicly available information. We assume such information is complete and truthful. To that end, we depend on senior corporate officials and independent accountants – who are subject to regulatory and professional standards – to ensure the accuracy of public disclosures. We rely on the same public information about a company that is disclosed to individual investors. If that information is inaccurate or incomplete, then no analyst can make sound judgments about a company. Without accurate and complete financial reporting from a company, I simply do not have the proper tools to do my job.
Second, I want to answer an obvious
question: whether inaccuracies and lack
of information in Enron’s financial reporting affected my conclusions and
ratings on Enron. The answer is
yes. Each day there are new allegations
in the media concerning Enron about which I previously was unaware. Examples include the number of off balance
sheet partnerships and the magnitude of their debt obligations, Enron’s
apparent misuse of fair value accounting, and Enron’s “Raptor” transactions.
Third, I would like to address any
questions regarding the independence of my work. The fact is that my research has no value unless investors
believe in the quality of the information provided and the sound analytical
framework upon which it is based. I
performed my analysis independently and objectively, and I never felt pressure
from Enron or any investment banker or other employee of my Firm to reach any
conclusions other than my own. Not only
have I done my work independently, but, in addition, my Firm has strict rules
that prevent me from even having access to the kind of confidential nonpublic
information that investment bankers often have. CSFB also has adopted rules banning stock ownership by analysts
in the companies we cover. We are
firmly committed to taking whatever steps are necessary to protect the
integrity of our research.
In this regard I would like to note that
my sons were each the beneficial owners of 100 shares of Enron held in trust
accounts until these shares were sold in December 2001 to comply with new CSFB
rules. My family’s only current direct
or indirect investments relating to Enron are an $18,000 investment in the
NewPower Company, a public retail natural gas and electricity provider in which
Enron has an interest, and an Enron bond held by my mother, which is now in
default.
Finally, I would like to address certain public policy
concerns raised by the Enron situation.
While we need to guard against overreaction, I applaud any effort to
craft thoughtful responses to improve the overall quality of public company
disclosures and restore confidence in our markets.
My Role as an Analyst
CSFB’s client base, the group of
customers who use my research, is largely comprised of sophisticated,
institutional investors. It is not
individual retail customers. My clients
have their own research staffs that make their own investment decisions. They look to me for quality information and
projections. They challenge information
and analysis I provide and form their own conclusions.
As a research analyst I am a user of
information provided by publicly held companies. My job is to analyze that information, bringing to it my
understanding of the industry and my experience in reviewing similar
material. I develop an understanding of
how a company generates earnings and its performance and potential as compared
to others in the industry sector I cover.
If the information a company provides is incomplete, incorrect or
misleading, my analysis will be undermined.
I begin my job by gathering and reviewing
in detail a company’s public disclosures.
These include annual and quarterly reports on Forms 10K and 10Q. Principal among the things I rely on are the
company’s audited financials. These are
the foundation for my conclusions. I
also review the company’s press releases and public statements. These steps are only the beginning. I stay informed about industry developments,
including market and regulatory issues.
I gather information from many sources, including resources in the
research area such as strategic analyses, customers of companies I follow, operating
managers and suppliers, among others. I
also review media coverage.
With this information, I work towards my ultimate
goal of estimating a company’s future earnings, cash flow, and balance sheet,
comparing those estimates to other companies in the Natural Gas & Power
sector. The critical step here,
starting with the company’s certified financial statements, is to build my own
model of the company’s future financial performance. I compare my projections both to the company’s public guidance, and
to information about other companies in the same industry. All of this work results in a report, which
includes a “recommendation” relative to the current price of the stock.
Independence and Objectivity
To protect the integrity of our research, CSFB
consistently and without exception follows “Chinese wall” procedures. These procedures separate me from other
areas of CSFB's business, particularly its investment banking arm. To maintain our independence and ensure that
our research is not influenced improperly, the research group is not permitted
access to files of the investment banking department or other units of the Firm
that handle confidential information.
Nor can we discuss such information with other employees of the Firm. In addition, the offices and floor space of
the research group are separated physically from other CSFB units, and research
analysts are not permitted unescorted access to investment banking floors.
If an investment banking team wants my expertise on
the industry or the markets, I am (to use the industry’s jargon) “brought over
the wall" under a set of strict conditions to maintain the independence of
our research. In order to bring me over
the wall, the banking team must contact the Control Room of the Firm, a unit within
the Firm’s Legal and Compliance Department that is responsible for compliance
review of research, and requests that an analyst be “brought over the
wall.” Either a member of the banking
team or the Control Room contacts a research supervisor and discusses
the request to bring an analyst “over the wall.” The research supervisor then decides whether it is appropriate
for that to occur. When we are “over
the wall” we are very carefully limited to the use of previously published
research in our comments and other public information.
As I have previously noted, CSFB now bans stock
ownership by me and my family in companies I cover. CSFB not only complies with the Securities Industry Association’s
Best Practices for Security Analysts but also has worked with the SEC, the
NYSE, and the NASDR to create new rules for analysts and investment banks,
which after months of work were recently announced. These new requirements will mandate disclosure of existing
investment banking relationships and ownership in a company by the firm or by
analysts if their firms allow analysts to own stock (which CSFB does not).
CSFB takes the rules regarding analyst independence
and objectivity seriously and again, I have never been pressured in any manner
to alter my research or recommendations by any part of the firm.
Coverage of Enron
In general, I believe that Enron
as a company was unique in terms of its complex business model, rapid growth,
aggressive accounting and contract valuation, and “dot-com”
characteristics. Enron utilized
outside financings, outside partnerships, fair-value accounting and other
techniques and vehicles. Some companies may use one of these techniques; Enron
used all of them in an array of interwoven transactions that were apparently
not fully disclosed and that we are just beginning to understand.
It now appears that some critical information on
which I relied for my analysis of Enron was inaccurate or incomplete. One example was a disturbing press report
after Enron filed for bankruptcy protection.
In January 1998, I attended an analyst meeting at Enron along with over
100 analysts. During this meeting we
toured a trading floor of Enron Energy Services. In viewing the activity in the trading room, I was impressed at
the progress Enron had made in developing this business. It has been alleged that Enron may have
“staged” the activity on that trading floor and if these allegations were true,
the progress they were making was illusory.
In addition, as has been reported, during the August
15, 2001 analyst conference call following Jeff Skilling’s resignation, I
specifically asked him whether his departure suggested that there were likely
to be future disclosures with respect to Enron’s finances. Mr. Skilling responded that there was
“nothing to disclose” and that the company was in “great shape.”
Another example of the lack of completeness in
Enron’s disclosures involves the question of how approximately $1.5 billion in
cash from ChevronTexaco/Dynegy provided to Enron was used. It does not appear to have gone to its
intended purpose of satisfying Enron’s pending debt obligations.
Furthermore, Enron never publicly
disclosed the alleged use of the Raptor investment vehicles. It now appears that these entities may have
engaged in trades with Enron simply to establish artificially higher asset
values. If this is true, those trades
would have artificially inflated Enron’s financial statements.
Had I known of any or all of these items, this
information would have significantly affected my analyses and
recommendations.
However, in my opinion, much of the public debate
surrounding Enron’s demise misses crucial points related to the firm’s
finances, accounting and structure. In
general, we should not regard complex financings or off balance sheet financings
as problematic in and of themselves – some very sound firms use such
mechanisms. Even earnings restatements
may not be fatal where the underlying business of the company is sound. Here again, Enron was a different
matter: even its restatements appear to
have been incomplete and inaccurate, and thus they too exacerbated Enron’s
downward spiral.
If Enron had taken the appropriate steps, I believe
that the company could have survived. A
substantial capital infusion, combined with complete disclosure of off balance
sheet liabilities and debt levels plus a decision to slow growth could in my
opinion have resulted in Enron’s survival. These actions may not have restored
the share price to historic highs, but the interests of employees, shareholders
and communities would have been improved.
Essentially
these are the elements that could have been provided by the Dynegy merger.[2]
Indeed, it appears that ChevronTexaco and Dynegy had much the same view of
Enron as I did. ChevronTexaco was
willing to commit $2.5 billion in cash to its view of Enron and Dynegy was
willing to issue $8.5 billion worth of additional shares to acquire Enron.
In sum, hindsight allows a view that I, as an
analyst, never had. I based my views
and ratings on the information that was available at every step of the
way.
Policy
Implications of Enron Collapse
As an analyst for 18 years, I have
watched with interest the policy debates that have taken place over the last
two years about disclosure and the role of analysts. It is time to recognize
that the corporate disclosure system can be improved.
The
goals of "full disclosure" to investors and analysts (immediate,
complete and clearly understandable disclosure from all publicly registered
companies) and "equal access to information" (providing that
information to everyone) are both extremely important. There can, however, be a tension between the
two, and, with Enron, the balance has tipped decidedly against "full
disclosure."
The
Securities and Exchange Commission (SEC) adopted regulation FD in 2000 in order
to promote "equal access" by preventing the selective disclosure of
information to some individuals, but not the public at large. As laudable as that goal is, the regulation
can be used as an excuse by company officials, as it was by Enron, to duck
tough questions from analysts and thus, thwart "full
disclosure." The point, of
course, is that those tough questions should be answered and the answers made
available not just to the questioners but also to the public. That is not what
always happens. And that is certainly
not what happened in the case of Enron.
I am aware that there are many
initiatives being currently considered to improve corporate disclosure. The focus of any such changes should be more
complete, more timely, and more understandable disclosure. To accomplish these goals, we should
consider full disclosure of off-balance sheet financing and related party
transactions, more accelerated disclosure of insider transactions and corporate
reports, and enhanced disclosure of stock option programs. It should also require greater scrutiny of
accountants and other professionals, and additional resources for regulatory
agencies like the SEC.
Thank you again for the opportunity to appear today
and I will be happy to answer any questions.