We all remember where we were the morning of 9/11. I was just a little more than a week into my Congressional Fellow orientation. My class of 30 other Congressional Fellowship colleagues and I took it as a sign that this coming term was going to present new and difficult, yet exciting challenges. Indeed the experience was all that and more. But now at the end of the term, I am struck by how I see our nation in a different light that I didn't expect even then.
Don't get me wrong. I've been fortunate to live the experience to the hilt—being at the wrong place at the wrong time for the anthrax attack and having to take antibiotics, attending lavish star-studded receptions and galas, getting occasional back slapping from Senators, working for the Chairman of the Senate Armed Services Committee in the midst of two wars, and drinking Manhattans late Friday afternoons with the rest of the Permanent Subcommittee on Investigations staff in a custom that allegedly dates back to Senator Harry Truman, chairman of the Senate's first incarnation of that investigative committee.
The main issues I worked on were Energy, Enron, and 401(k) reform. My principal focus was the Enron Investigation, where my boss, Senator Levin, chaired a bipartisan inquiry that examined the role of the financial institutions. It was an alarming experience to discover that many of the biggest, most trusted banks in the world were knowing, willful counterparties to Enron's deceptive transactions in return for hundreds of millions of dollars in fees. I played a significant role in unraveling and exposing billions of dollars of previously undiscovered Enron debt.
At its most fundamental level, I wasn't expecting the institution of the Congress to be perfect, and, of course, it isn't. But I've been able to see real dangers first hand of which freedom-loving people need to be aware. They aren't in the obvious places. The most alarming to me is voter turnout—often in the single digits of eligible voters. When people don't vote, outside interests fill the vacuum and undermine the legitimacy of our democratic institutions. Significant racial, regional, cultural, and partisan polarization now generates substantial internal friction along clear fault lines that divide society. Of course terrorism is also a significant outside threat and needs to be taken seriously, but this internal polarization is just as important if not more. Ironically, scholars are just now beginning to realize that much of the polarization actually arises from nothing more than structural shortcomings in our voting system—specifically our zero-sum, single-member district, winner-take-all "democracy technology." In other words, this is fundamentally a technical issue having to do with an increasingly complex nation simply outgrowing its original voting method design.
Post fellowship I am spending part of my time working on navigation-related projects and part of my time founding a nonprofit organization that will apply the new insights into these structural issues. It will leverage the Internet to help young people "get out the vote" and make voting more effective in general.
The fellowship experience has been profound, not only for the day-to-day life and the insights that it catalyzed, but also for its impact in shaping my own career. This was absolutely a first class experience, and I wholeheartedly recommend it to all.
Past reports from Dr. Cohen follow....
For better or for worse, there may not soon be a more eventful time to move to Washington, D.C., where a new definition of "business as usual" has cropped up. Sept. 11 struck halfway through our two-week fellowship orientation. One slight interruption to my placement process occurred when, a few minutes before, I unknowingly (twice) walked through what had just become the "anthrax hot zone" of the Hart Senate Office Building. So now I have the distinct privilege of joining the ranks of those lucky senators and staff now on the CDC 60-day regimen of government-issue antibiotics.
I am pleased to report that I have accepted an offer with the office of Sen. Carl Levin (D-Mich.) and have spent about two weeks on the job so far as of this writing (Nov. 12, 2001) -- acquiring my sea legs on some current issues in the automotive industry. Sen. Levin is chairman of the Armed Services Committee and the Permanent Subcommittee on Investigations (Governmental Affairs Committee). He also serves on the Small Business and Select Intelligence Committees. I look forward to a challenging and exciting time ahead, and I appreciate the sponsorship of the ION for making this fellowship possible.
Senator Carl Levin (D-Mich.) was running a double header today. He was simultaneously chairing the Armed Services Committee hearing and shuttling over to a concurrent Governmental Affairs Committee hearing on the Enron 401(k) disaster. (By the way, did I also mention the TV crew from back home that was following him around to capture "A day in the life of Carl Levin"?)
It was my job to support him on the Enron hearing. In spite of the fact that I had not ever done anything like this previously, the day before I was summarily informed that I would be going solo. And yes, I'll admit to being a bit nervous. I had had only a couple of days to assemble the briefing notebook and formulate questions-all with only limited notice of who would actually be showing up on the panel. Because Sen. Levin also had to prepare for Armed Services, of course I never had a chance to go over any of the material with him prior to the actual hearing!
Sen. Levin sponsored the portion having to do with CAFÉ-the so-called Levin-Bond Amendment on Corporate Average Fuel Economy. CAFÉ happens to be an important issue back home in Michigan with the big three auto companies and workers. Although it certainly has its controversial tradeoffs (mostly related to foreign oil dependence and greenhouse gas emissions), his key amendment passed 62-38-an overwhelming political victory.
It was a fascinating and extraordinary experience to witness the development of this bill up close and first hand. I was even in a position to make a modest contribution to moving this legislation forward, including working with the senator and senior staff to compile its tax credit provisions for hybrid and fuel cell vehicles.
This is a bipartisan investigation. Although Sen. Levin's committee staff takes the lead, committee and personal staff from both parties attend all meetings and collaborate. It is a meticulous, comprehensive study emphasizing the study of more than one million subpoenaed documents (and rising) accompanied by interviews with current and former employees of Enron, Arthur Andersen, the infamous partnerships, major financial institutions, and others. This comprehensive groundwork prefaces PSI's public hearings. In fact, PSI has not yet conducted a single Enron hearing as of this writing.
Having the senator put me on his investigation with a small handful of other very talented and dedicated staffers was certainly a privilege. Although the work may not be as technical as what I thought I was getting into with this fellowship, I am grateful for this opportunity. I think that we have a unique story to tell and a valuable role to play in getting this investigation done correctly. No other investigative body will be in a position to be this comprehensive.
A few years ago, I started a company in Silicon Valley to develop some of these markets that could benefit from this new technology. My expectations going into Washington were that I would work in technology policy areas related to civil aviation and the military. In fact, when Enron broke, the office ended up tapping my background in business more so than any other qualification. While the small company that I started may not be of quite the same scale, I don't have a problem at all with being on the investigation team-it has been a fascinating new and unforeseen experience. But what I believe is most important is that the Enron story affects us all, and we must do everything we can to prevent anything like it from ever happening again.
I've been through a few documents so far (personally, I'm up to about 120,000!-many of which are significantly revealing). In addition to examining documents, we also spend a good deal of time meeting with various outside individuals and groups. PSI's charter is to investigate Enron as a whole, including its outside partnerships, Arthur Andersen, and the Enron board of directors.
I have been studying a class of transactions and partnerships that are yielding significant insight into vulnerabilities in our financial system. Properly presenting this material publicly in a hearing format we believe will be the most effective in leading to corrective measures.
It's not often that a fellow stumbles into a position where he is suddenly at the heart of a key congressional investigation on the heels of a major international scandal. I've seen and learned much more than I ever expected, and yet I don't even feel like I've gotten started yet! There's much more work to do. Soon we'll be conducting our first hearings on the matter and getting our findings out in the open.
I'd like to express my thanks to the ION for making this experience possible. This is an extraordinary program with an opportunity to work at the heart of significant issues that affect all of us worldwide. I am deeply indebted to the ION for this mind-expanding and truly profound experience. I'd also like to thank the first ION congressional fellow, Phil Ward, for all his help. Although Phil has now headed back to Texas at the completion of his term, he has been a great source of frequent advice and practical suggestions for the fellowship and in helping me get acclimated quickly.
Summer 2002: Busting the Big Banks
"You've just found a billion-dollar footnote, Clark," said the chief investigator of the Senate Permanent Subcommittee on Investigations as I showed him a certain subpoenaed Enron document. Not exactly a typical moment for a congressional fellow.
I am the 2002 ION Congressional Fellow working for Sen. Carl Levin (D-Mich.). Sen. Levin is chairman of both the Armed Services Committee and the Investigations Subcommittee. It is in his latter capacity that I have been serving him since January when the subcommittee began its work on Enron. Our charter has been to get to the bottom of what really happened at Enron with an aim toward helping the Congress craft more effective legislation in response. Unlike any other investigation associated with the collapse of Enron, we have taken substantial time outside of the media spotlight (seven months) to formulate conclusions (to be disseminated publicly) and have done so with the benefit of meticulous study of the actual internal documents (more than a million pages worth) obtained from an array of document subpoenas (at least 60) backed up by interviews with the actual people who witnessed or were central to the collapse (over 300 hours worth).
Not What I Expected
I did not exactly expect to be doing something like this when I came out here, but I am certainly grateful for the opportunity. My own technical background is in high-integrity, centimeter-level GPS positioning. Having founded a GPS company in Silicon Valley, I have come to appreciate some of the challenges of business. Although my charter is nominally a Science and Technology Policy Fellowship, it made more sense as the Enron investigation was commencing for the senator to tap my business experience.
Here I am getting a first hand look at how politics in Washington, D.C. really works. At the very highest level, it has been no different from what I had expected prior to coming here. But seeing it at work, close up on a day-to-day basis has been a profound experience. Yes, there is a fair amount of "sausage" made1 on Capitol Hill, but there are also occasional reassuring signs that democracy may still truly work-in spite of its seemingly awkward progress in fits and starts.
When we started out our investigation, each member of our team (roughly 10 people) picked a specific aspect of Enron to investigate. These aspects included its board of directors, its auditor, Arthur Andersen, and the infamous partnerships of Enron. On one hand there were hundreds of these partnerships and on the other hand there were the obvious ones that were in the newspapers every day.
Yosemite still seemed like a "black box." It was raising billions of dollars in bonds linked to Enron, yet there was no indication what the money was to be used for. (It turned out that this lack of clarity was exactly the intention of Yosemite's designers!) Then we found some documents that suggested to us that Yosemite might be similar in structure to the J.P. Morgan Chase "Mahonia" deals that had fallen into litigation where loans were disguised as commodity trades. The only problem was that we just weren't sure. I set to work trying to unscramble the complex pieces of the transaction. Finally, late one night, I broke the code. Yosemite was indeed another sham transaction to disguise loans as trades-known by Enron as a "prepay."
The "Billion-Dollar Footnote"
The next morning, I showed Roach how the deal all fit together. But instead of being elated, he drooped his shoulders in disappointment. Here's one of the places I have learned how Congress works. The problem was, even though we had this sham transaction completely understood, it seemed next to impossible to demonstrate the deception to the general public because of the sheer complexity of Yosemite's inner workings.
So out came the "billion-dollar footnote."2 I had zeroed in on a single-sentence footnote in an Enron memo that indicated that the participants knew full well that they were carrying out an accounting deception. We now had a solid case on which to proceed.
The prepays could be used to make Enron's financial statements look significantly better than they really were and improve its standing with ratings agencies and investors. Yosemite, the largest of the prepays, had been used to raise $2.4 billion for the fake trades. To top it off, Citigroup had set up Yosemite so that if Enron ever went bankrupt, the bondholders- not Citigroup-would be left holding the bag.
At this point it was becoming clear that the financial institutions were in many cases willing collaborators with Enron. Sen. Levin broadened the scope of the investigation to include financial institutions. Ultimately, when it was time to hold hearings this summer, Sen. Levin and the staff leadership chose "prepays" as a central subject.
The hearing made quite a splash. Just a few days before, I had met with a Wall Street Journal reporter in a session that had been set up by the subcommittee. There I described to him how Yosemite worked. The day before the hearing, the Journal ran the story on Yosemite on the front page. I also met with a reporter from the New York Times where I went over documents I had found relating to a Citigroup transaction known as "Roosevelt." This story also ran on the front page the day of the hearing.
The story of the actual hearing landed on the network nightly news that evening and in major papers across the nation the morning after. The story on the front page of the New York Times on July 24 stated that due to revelations from the Senate hearing the previous day, the two stocks of Citigroup and J.P. Morgan Chase "accounted for most of the 1.1 percent decline in the Dow Jones industrial average." The following Monday, the Wall Street Journal ran an editorial saying that these two banks "deserve the beating they're now getting."
Again, it was hardly a typical experience. I have had the privilege to witness and contribute to what goes into a tightly focused Senate hearing. I also perhaps helped establish its subject matter. But sadly, the hearing could never have taken place without the existence of such widespread fraudulent activity.
The impact has been exciting of course. But more importantly, we should all be disappointed by the opportunity cost associated with the billions of dollars in capital that could have been invested in bona fide economic growth for our country that instead was squandered on form-over-substance accounting deceptions.
Legislation is underway in response to corporate malfeasance. The president has already signed the McCain-Feingold campaign finance bill and the Sarbanes-Oxley accounting bill into law. I am hopeful that these and other bills now being contemplated will go a long way toward eliminating future Enrons and paving the way toward substantive market growth.
I am grateful to the ION for making this opportunity available. It is truly an experience like no other.
1 There is an old saying that there are two things that one does not want to witness being made first hand: laws and sausage.
2 Later it turned out that we had both underestimated the magnitude of the discoveries that we were making.
Fall 2002: The Rocky Road to Retirement Security
Within weeks they had lost their entire retirement savings. Last March two former Enron employees testified before the Senate Governmental Affairs Committee on the loss of their retirement savings due to the Enron collapse. The losses from Enron stock that was held in Enron 401(k) plans totaled almost $1 billion. Drops in employee stock value held 401(k) plans have resulted in losses totaling billions of dollars. It could happen again.
During the past year as ION's congressional fellow, I have been helping Sen. Carl Levin (D-Mich.), chairman of the Permanent Subcommittee on Investigations, examine what went wrong at Enron and what new legislation could help fix it. One of these reforms includes an accounting bill that Congress passed earlier this year and another is a pension bill.
As Sen. Levin's lead on the 401(k) pension reform bill, I would like to share some of the details of my work with you. Even though it doesn't have anything to do with navigation-most of my congressional fellowship work doesn't-this issue touches people's lives in a significant way. Most people have 401(k) plans, and most people are actually in a position to do something about the most significant problem with these plans-employees generally invest too high a percentage of their 401(k) portfolio in their employer's stock.
A Unique Perspective
I am fortunate to have had the opportunity to observe 401(k) plans from a different perspective. Before I became a congressional fellow, I founded a company called IntegriNautics. The company's products tap GPS as a fine guidance sensor to precisely control heavy machinery in agriculture, aerospace, and mining. One of the first things I did at the company was to set up a top-tier 401(k) plan even though we were a small organization at the time. One of the virtues of 401(k) plans is their accessibility. Even small companies can use them to be more competitive in the marketplace.
Enron exposed a serious flaw in ERISA-the set of laws that govern 401(k) programs. Even today this flaw needs to be addressed. The problem is a lack of diversification. Through no real fault of their own, employees are still loading their plans with too much of their own company stock.
What the Experts Say
Portfolio managers on Wall Street and Nobel prize winning economists advise not investing any more than 5 percent of a mutual fund in any one security. For 401(k) plans even a 20 percent concentration is already on the high side. Yet the concentration value for many Fortune 500 companies is as high as 90 percent.
Obviously, we all hope that there will be no more corporate implosions like Enron or Worldcom. But already there have been far too many cases where a company stock has dropped precipitously leading to layoffs and loss of 401(k) value. Even in a healthy economy, the worst scenario is to lose your job and retirement savings at the same time.
Retirement Security. Surveys show that employees really like their 401(k) plans. Day trading aside, these plans have become a serious means to retirement security. More than $2 trillion is now invested in 401(k) plans. There is a lot of retirement security riding on good management of this money.
Pressure to Pump Up Concentration. Both employees and employers have plenty of reasons for employees to invest in their own companies. There is constructive potential here for aligning employee-employer interests-at least to a point. And, through some special tax splicing, companies receive a significant tax break-the "ESOP dividend deduction"-when they have company stock in an employee's plan. Taxpayers contribute millions of dollars annually to companies who have concentration levels that are higher than what the experts say these levels should be.
Taxpayer Backing. Taxpayers bankroll individual pension plans with over $100 billion worth of salary deferrals annually. This is the largest tax expenditure in existence. It surpasses the medical and home mortgage interest deductions.
Given the advice of Wall Street experts and economists, if your are saving for retirement-or at least backing someone else's retirement through tax deferrals-diversification is the most important strategy. Taxpayers should insist that their money be invested according to the best practices available.
The overwhelming majority of companies, both public and private, do not even offer company stock for their 401(k) plans. The pension reform legislation under consideration mostly addresses those who do. Passing any such legislation failed in the 107th Congress perhaps as an early casualty of the Iraq situation, but it will likely be taken up again early next year.
The fundamental tension has to do with how to lower concentration for retirement savings without restricting employee choice. Unfortunately the pressures to increase concentration have not gone away. In spite of billions of dollars of recent losses to plans holding company stock, the 401(k) program has the strongest proclivity of any retirement plan in existence to push up employee concentration.
Initial proposals that used caps or constraints met with resistance. Perhaps the most effective solution would use a lottery to pick a non-insider employee from a pool of volunteers.1 The employee trustee would have the opportunity to speak out to plan participants about over concentration. Employees would then be free to make their own decisions about whose advice they will heed when it comes to their own money.
401(k) Retirement Road Map
Obviously there are many types of retirement savings plans available to companies and their employees. But to the extent that a 401(k) plan is used as a retirement plan, the following practices will both maximize the return of the taxpayer investment in 401(k) deferrals and create a healthier relationship between employers and employees because employers will be looking out for the retirement security of their employees.
Employees should follow the advice of Wall Street portfolio managers and Nobel Prize winning economists: Keep the concentration of company stock in 401(k) plans low.
Employers should implement policies that keep the concentration of company stock in 401(k) plans low: Matching in company stock can be a good thing in moderation.
Although these formulas may seem simple, they go a long way toward solving the problem.
It has been fascinating to be a part of the ebb and flow of this bill as well as to work through the politics and policy behind it. I think that I understand the forces that drive up concentration and create the urgent need for this legislation. But until this bill does go through, I also can't help but wonder what would need to happen for this issue to resolve itself. A small handful of people at their own companies could take personal responsibility-both for themselves and for others-for keeping the road to retirement security from being so rocky.
I am grateful to the ION for making my congressional fellowship possible. It is and has been an extraordinary experience.
Notes: 1. That employee would serve as a minority trustee on the 401(k) plan board. This board is mostly ministerial and having such a trustee would not have any affect on the company's control of the plan. It is not commonly appreciated that a plan's assets are entirely owned by employees-not the company. This includes the company stock held by the plan. Therefore, there is an intrinsic conflict of interest because the fiduciaries of the plan also happen to be company insiders. The employee trustee doesn't eliminate the conflict of interest, but it probably mitigates it enough.