In a presentation you gave four years ago on rules versus principles, you made the argument that someone can follow the rules and still not do the right thing. Do you still feel that way?
I do. Because accounting rules are complex [and] sometimes ambiguous and nonsensical. There is a tremendous amount of gray area that allows management to exploit the rules and report the numbers they want. There is an entire industry of bankers, lawyers and accountants whose sole function is to help a company manage its financial reporting. It isn’t difficult to find examples of companies that technically follow the rules [that] deliver financial statements that are materially misleading.
But isn’t it the job of the CFO and the board to ferret out ambiguous statements?
Yes, but they take too much comfort from an auditor saying the financial statements are a fair representation. Despite PCAOB 203b saying that if you follow the rules, your financial statements should not be considered materially misleading, the Second Circuit Court of Appeals has said that if your financial statements are misleading, you cannot hide behind the rules.
Sounds like a gray area?
Yes. I’m not recommending that CFOs avoid the gray area. Rather, when CFOs are inevitably in the gray area, understand that your brains will not assess risk correctly.
I want to get back to that in a minute. But first I need to ask if you see any similarities between your motivations at Enron and those of Sam Bankman-Fried at FTX and Alameda?
I don’t know what was in Sam Bankman-Fried’s head. For many people, it’s greed. I was motivated not by greed but by ego. Of course, money affects how the brain works, but I would argue that ego affects the brain even more. You feel you’re accomplishing something. People believe you’re smart, and you begin to accept that adulation.
They believe you’re smart because you’ve found a way around the rules?
Yes. There’s a tendency when a company is successful that the people who should be natural skeptics become obsequious. Instead of challenging what you’re doing, they want to be part of the success. They don’t do their jobs.
Got an example?
Sure. Look, the banks knew that LJM existed, and they knew what it was doing, and not just because of the disclosures. They were investors in LJM and had details on every deal LJM did with Enron. Instead of challenging the situation, they viewed it that Enron, no matter what, would find a way to get things done and report the right numbers. Listen, I’m not blaming them or anyone else. It was my fault what I did at Enron and no one else’s. There are many examples of good CFOs doing exactly the opposite of what I did.
That presumes that some CFOs are doing what you did, motivated by ego or greed to find the loopholes.
What I’m suggesting is that CFOs who manage the financial statements aren’t necessarily thinking that what they’re doing is the wrong thing to do. When they achieve the objective, managing the financial statements to hit the numbers, they receive adulation and compensation. [This] factors into causing the brain to work even harder to find the next creative solution. The adulation feels so good, you crave it and do it again.
Do you think ego drove Bankman-Fried in his motivations at FTX?
I don’t know what was going on at FTX, but very few CFOs would even entertain the idea of doing something illegal in exchange for money. In my case, doing these structured finance deals and solving company problems was like taking drugs. It felt so great to be the hero, I wanted to do it again.