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Even a Watchdog Is Not Always Fully Awake By:
Diana B. Henriques . For decades, there has been no more formidable advocate for good corporate governance than Calpers, the California Public Employees' Retirement System. The giant pension fund, with assets of about $144 billion, has regularly criticized corporate directors for failing to protect shareholders, and it has publicly advocated greater independence and vigilance by corporate boards and outside accounting firms. But in the case of the Enron Corporation, Calpers was the watchdog that did not bark. Records from its files show that it was alerted by its advisers in December 2000 about the serious and potentially embarrassing conflicts inherent in one of a web of private partnerships set up by Enron's chief financial officer, Andrew S. Fastow. But Calpers — which was a substantial Enron shareholder and a partner in some of Enron's earlier deals — did not confront Enron's board over its approval of the arrangement, in which Mr. Fastow ran partnerships that did business with the company. Nor did Calpers publicize its concerns that Mr. Fastow could not protect both parties' interests between the partnership and Enron. Instead, it simply declined to invest in the troublesome partnership, LJM3, and kept silent, continuing to reap profits on its other deals with Enron-linked partnerships until early last summer. The network of private partnerships presided over by Mr. Fastow played a central role in the financial restatements that preceded Enron's collapse. "You're asking, why didn't we march into the boardroom?" asked Patricia Macht, a spokeswoman for the pension fund. "That's a fair question. But at the time, this did not sound like it would be something that would bring down the entire company." She added, "To suggest that we should have done more than we did is 20/20 hindsight." Some institutional investors agree that Calpers had no responsibility to challenge Enron's board or make its concerns public — although a few said they wished the pension fund had done so before their own Enron investments plummeted in value. But several former regulators and pension fund managers strongly disagreed, saying that one did not need to know that Mr. Fastow's conflict would be fatal to know that it was a terrible risk and a poor corporate practice. "I wouldn't have bet that any board would have believed that Fastow could fill both roles," said Richard C. Breeden, a former Securities and Exchange Commission chairman. "A C.F.O., of all people, has to have an undivided loyalty to the company." The report of a special investigative committee of Enron's board, released on Saturday, reached the same conclusion. The board's decision to approve arrangements that allowed Mr. Fastow to run private partnerships that did business with Enron "was fundamentally flawed," the report noted. Roland Machold, the former director of investments for the state of New Jersey and a co-founder of the Council of Institutional Investors, said that he wondered why Calpers "did not go right to the board, as it used to do in the old days, and say they were concerned that the board had approved something so conflicted." He added, "It is perfectly legitimate to ask why they didn't act." The Enron board committee's report found that Mr. Fastow and other Enron employees had engaged in extensive conflicts of interest that enriched them at the company's expense. Enron, it said, used the network of partnerships run by Mr. Fastow to conceal the company's true financial condition from shareholders. Mr. Fastow got at least $30 million, and a second Enron executive, Michael J. Kopper, got "at least $10 million," according to the report. Barry Gonder and Rick Hayes, senior investment officers at the pension fund, had introduced the Calpers board to Mr. Fastow at a meeting in October 2000. They briefed members of the board's investment committee — who included Willie L. Brown Jr., the mayor of San Francisco and former speaker of the California assembly, and Kathleen Connell, the state controller of California — on the fund's previous private investments with Enron. "The relationship with Enron has been a model for how we want to do corporate partnerships in the future," Mr. Hayes said, describing Mr. Fastow as "the architect of our partnership over the last six years." By December, the board got a very different picture of its partners at Enron. The Pacific Corporate Group an institutional investment adviser in La Jolla, Calif., that advised Calpers on private equity deals, had studied LJM3 Co-Investment L.P., the latest partnership that Mr. Fastow was offering to the pension plan. In a draft memorandum to the pension fund, the outside advisers reported that LJM3 would invest "primarily in companies owned or controlled by Enron." In great detail, the memo outlined the conflicts of interest that surrounded Mr. Fastow and Mr. Kopper, who the Pacific Corporate Group said "owe fiduciary duties" to Enron that could conflict with their duties to the partnership and its investors. And the memo outlined an additional risk: embarrassment for Calpers. The partnership, it warned, "is a very complex vehicle designed to thread the needle of a variety of accounting, regulatory and tax issues." Given Enron's visibility and the "duality of the roles" that Mr. Fastow was taking on, the advisers noted, Calpers might find itself questioned by the financial media about its support for the arrangement. After all, it noted, Calpers was widely regarded as "the champion of activist corporate governance." Although the Pacific advisers recommended that Calpers invest up to $75 million in LJM3, it urged the fund to first have its lawyers investigate "the issue of conflicting fiduciary roles" by Mr. Fastow and Mr. Kopper — and to make sure that the pension fund's investment remained confidential until its lawyers were satisfied. "That memo is a gun pointed right at them," said Mr. Machold, the former New Jersey pension fund director. "Calpers should have been deeply concerned that the Enron board would approve something that could seriously endanger the company's reputation" among those concerned about corporate governance. 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