Prologue: Seventeen Million Reasons
The Light Standard
The weather system roaring through New Orleans on the afternoon of March 18, 1996, was not a hurricane or even a tropical storm, but it was enough, with sustained winds of nearly sixty miles per hour, to drop a six hundred twenty-six pound metal street light fixture onto Nathaniel Joseph’s head. Mr. Joseph was in the process of closing his family business, Mitchell Fruit Stand, when the corroded light pole buckled and collapsed. The light standard crashed to the sidewalk below, collapsing the canopy of the business and striking Mr. Joseph. Knocked to the ground by the force of the impact, the business owner was severely injured. Mr. Joseph underwent several back surgeries and will require medical care for the rest of his life. Mr. Joseph and his wife, Kecia, filed suit against Entergy New Orleans, the electric utility responsible for the maintenance of the city’s light standards. After a bench trial, the court found Entergy totally liable for Mr. Joseph’s injuries and awarded the couple just over $3 million. That singular event should have been an issue only between those who were supposed to maintain the corroded light pole and Mr. Joseph, but, as you will see, the repercussions from this incident rippled far beyond the parties involved.
Cooking Books, Cajun Style
Entergy is the only Fortune 500 company headquartered in downtown New Orleans. Indeed, the Entergy building is something of a downtown landmark, towering over the French Quarter just a few blocks away. The Louisiana Superdome is two blocks to the southwest. Mother’s, a unique New Orleans restaurant, is four blocks in the opposite direction. We know Mother’s well; we relied on the Cajun-style home cuisine for our daily sustenance while we spent months working for the city of New Orleans. Our job involved auditing Entergy’s financial records related to street lights, such as the one which fell on Mr. Joseph. All of the city’s light standards – the poles like the one that struck Mr. Joseph – are actually owned by the city of New Orleans. For most of the 20th century, the City of New Orleans paid Entergy to maintain the street lights. Entergy was, and, as far as we know, still is, claiming the lights as an $8 to $12 million asset on behalf of Entergy New Orleans. Quite simply, the utility has been misrepresenting its financial condition. While $8 to $12 million may be a drop in the bucket to a giant company like Entergy, the same amount is a substantial consideration for the Entergy New Orleans subsidiary. We believe Entergy is on the shakiest of financial footings, and, as you will see, it is not just our own experience which tells us so. Entergy New Orleans is one of the smallest subsidiary companies owned by Entergy Corp. The New Orleans operation provides power only within the city limits. Our audit work was completed in 1994, a couple of years prior to the time when Mr. Joseph had his encounter with one of the light poles. Our audit demonstrated that the city had bought and paid for all of the street lights –in spite of the fact that Entergy was carrying between $8 and $12 million in street lights on its corporate balance sheet. Imagine selling an automobile and then going to the bank to get a loan using the auto as collateral. The process requires you to tell the bank you still own the car. That is effectively what Entergy did. In August 2003 the firm went to Wall Street to borrow $100 million, using assets as collateral. Listed among those assets were New Orleans street lights, which Entergy did not own. In other words Entergy misrepresented its financial condition, claiming to own assets which did not legitimately belong to the firm.
Seventeen Million Reasons
The key word is legitimately. We cannot hold Entergy to a legitimate standard of behavior because the utility has often demonstrated that it possesses none. Over the years we have recovered millions of dollars in Entergy overcharges for our clients. As early as 1988, we discovered Entergy had overbilled Texas’ Sam Houston State University more than $155,000. The next year we recovered nearly $60,000 for the city of Huntsville, Texas, and a similar amount for Lamar University – both Entergy clients. In 1990 we recovered nearly $100,000 in overcharges for the city of Beaumont and more than $31,000 for the city of Orange. Both are Texas cities served by Entergy subsidiaries. Two years later we found Entergy New Orleans had overcharged the city’s water and sewer board more than a million dollars. The next year we recovered $400,000 for the city itself, and in 1994 we reclaimed $6 million in overcharges for New Orleans street lights that were either nonfunctional or nonexistent. Much of that amount was billed as maintenance and repairs that were never done. Six million dollars was the amount for which the city settled; the actual overcharge, we believe, was nearly double that amount. We will give you detailed information about some of these episodes later in this book, but it is important to understand that the heavy hits Entergy sustained on behalf of overbilled clients did not stop there:
- In 1995 we recovered $80,000 for the CNG Towers complex.
- In 1996 another $70,000 for the New Orleans Centre was recovered.
- In 1998 we recovered $280,000 for the Texas Department of Transportation.
- In 2000 we recovered more than $90,000 for Louisiana State University.
- In 2001 we recovered another $1,800,000 for the City of New Orleans.
We were far from through with Entergy. In 2002 we recovered $50,000 in Entergy overbillings for the United States Coast Guard, and over the next two years, we recovered another $7,427,000 for the city of New Orleans. Suffice it to say the folks at Entergy New Orleans had many good reasons to dislike us … more than seventeen million of them! We were convinced, after our initial engagement with the city of New Orleans in 1994, that Entergy would live up to its agreement with the city and effectively restore street lighting which had deteriorated substantially since the utility stopped repairing the lights in 1987. In 2000 when the city’s director of utilities began to talk with us about coming back to town for another audit, our response was less than enthusiastic. Our reasoning was simple: Entergy had learned what was wrong, admitted that the problems existed, and promised to fix them. That, we thought, was that.
The Second Battle of New Orleans
The settlement notwithstanding, the city’s director of utilities asked us to offer a proposal for a return engagement. We offered to perform a small fee-based audit that would help us discover if a second audit would be worth our while. When we arrived in New Orleans in late 2000, we found a lot of things had gone wrong. Specifically, the work Entergy had pledged to do with regard to street lights had not been done. In 1996 Entergy had entered into a new agreement with the city; the utility agreed to handle street light maintenance, and the city would pay for time and materials. When we examined the street light billings, we found the following:
- Work had been billed for but not performed.
- Work done for others had been billed to the city.
- Time sheets had been altered to show workers had spent more time working on street lights than they had actually spent.
- The city had been billed twice for the same work.
Those were just violations of the 1996 agreement. We discovered that the city of New Orleans and Entergy had entered into another, more recent compact as well. Auditing the billings delivered under the 1999 contract uncovered the following: An invalid contract – this new agreement between Entergy and the City of New Orleans had never been submitted to the city council for approval and was not, therefore, legally executed.
- Entergy had billed the city for street lights that did not exist.
- Again, Entergy had billed for work not performed.
- Again, Entergy had done work for others and billed the city.
- Again, Entergy had falsified time sheets to increase billings.
- Entergy had not provided periodic reports of work done, which were required by the 1999 contract.
- Entergy had never provided required drawings of the city’s underground street lighting circuits.
The 1999 contract included a penalty clause; fines for Entergy’s violations in these areas had grown to several million dollars by the time we began our second audit. Unbelievably, the new city administration chose to waive the penalties. We found it hard to understand why elected officials, who had sworn to uphold the charter of the city and the constitution of the state, had chosen to let Entergy off the hook. Indeed, we could not comprehend the reasoning behind the Mayor’s appointment of an Entergy attorney – a lawyer with no experience in municipal law – as the new City Attorney.
Proof of the Plot
There may be a simple explanation for this, but we suspect collusion. Entergy had friends among the city’s new officeholders; we would later discover that the utility appeared to have some law courts in its rather large pocket as well. Later in this book, you will discover that this is nothing new; we have run into case after case in which elected officials are somehow beholden to the power companies and refuse to take actions which might somehow run counter to the utility’s best interests. Along with the penalties that should have been assessed, our review of the billing records uncovered several million dollars in overcharges. Though our study was not yet complete, the press had heard about our findings and pressed an Entergy vice-president for comment. According to him, the overcharges were “just a fabrication by a greedy consultant.” We run an honest, reputable business and do a good job for our clients. Indeed, the very nature of our business requires that we maintain a spotless reputation. So, it is hard for us to hear a comment like that and not respond in some way. As we examined Entergy New Orleans’ financial statement, we were shocked to find that the street lights – which were clearly owned by the city – were listed as a utility asset. That discovery – and the VP’s comment about “a greedy consultant” – led us to request a meeting with Entergy CEO Wayne Leonard. “Mr. Leonard is the CEO of a Fortune 500 company,” we were told initially. “Everybody wants to see him, and he’s too busy to see you.” We then met with one of the company’s top-ranking attorneys and told him that Entergy’s books were cooked – and that we could prove it. That proof, however, would only be offered to the man at the top. Ranting, raving, and stomping about the room, the corporate attorney slapped his hand on the conference table in front of us and repeated that Mr. Leonard would not see us. The lawyer demanded that we tell him what we knew. Of course, we refused. When the attorney finally realized that we were serious and would not disclose our information, he stormed out of the room. “We’re outta here,” he yelled to no one in particular. Two hours later, we received a call. We got an appointment with Mr. Leonard that very afternoon. The CEO’s office occupies much of the top floor of the Entergy building. The view from that office is breathtaking; Crescent City sprawls below. The town was built up along a curve in the mighty Mississippi river; now the urban sprawl stretches away as far as the eye can see. While New Orleans itself can be a bit overwhelming with bright, garish colors, the Entergy CEO’s conference room was a muted understatement. The lighting was kept low … so low, in fact, that one could hardly see the expressions on the faces of those across the table. We would have given a lot to turn up the lights just a bit. The meeting lasted about ninety minutes. Mr. Leonard was made aware of the fact that his subordinate’s characterization of our firm as “greedy consultants” was uncalled for and inaccurate. Had we been greedy consultants, we allowed, we would have sold Entergy stock short, disclosed what we knew to the press, and covered the short when the stock fell. We could have made a lot of money that way. In addition to falsely declaring that the street lights belonged to the utility, Entergy’s books have revealed other interesting anomalies: Items that should have been written off as expenses, such as raincoats, saws, batteries, coffee cups, coffee stirrers, aspirin, and motor oil were capitalized as assets. We have pointed to these items as additional evidence that Entergy New Orleans was bent on inflating its own worth. Since our meeting with Mr. Leonard, not a single Entergy officer has disputed our findings, except to say that our findings are somehow “not material.” We have shared our documentation with Entergy’s Audit Committee, the Federal Energy Regulatory Commission, and other parties at interest. Still not one reputable individual has disputed our assessment of Entergy’s shady accounting. Even the firms responsible for auditing Entergy’s financial condition have had no comment. Price Waterhouse Coopers (PWC) was Entergy’s auditor until 2000; PWC is also the auditor of one of the largest of Entergy’s shareholders, AXA Financial Group. Since 2000, Entergy itself has been audited by Deloitte and Touche. Entergy’s legal response, in contrast, has been swift and to the point. The utility filed a motion for a protective order to keep us from disclosing their accounting misdeeds. Since then, Entergy has gone back to court three times to obtain additional protective orders that will shield the company from “greedy consultants” who wish to communicate the fact that the utility’s books appear to have been cooked. One of those protective orders in particular sought to restrain us from communicating with the Audit Committee of Entergy’s Board of Directors.
Remember the Fruit Stand?
Plainly, these protective orders should not be necessary to protect a utility giant against charges of fraud. Obviously, we have shared our information with many parties, including Entergy itself. In every case we have offered to retract what we have said and apologize if we receive a Letter of Opinion from one of the “Big Four” accounting firms stating that our findings are incorrect. To date, there has been no such letter. We find the lack of response unusual, given the serious nature of the charges we have made. Additionally, we believe that the court-ordered gags effectively violate our first-amendment rights. In 2000 Entergy named our company as a party at interest in the Joseph case. You will recall that Nathaniel Joseph was struck and seriously injured by a light pole during a spring storm in March 1996. Entergy reasoned that since our firm was consulting with the city about street lighting in 1994, we should have noticed the corroded state of the light standard, anticipated that it might fall or do damage two years hence, and brought the matter to the attention of the utility. Not that such notice would have done much good. Our street light audits had uncovered a good deal of missed maintenance opportunities during the period in which Entergy was supposed to keep the city’s street lighting in good repair. We worked for the city rather than the utility, and expecting that we could, from our adversarial position, convince the utility to replace one light standard when thousands were begging for attention strikes us as somewhat foolish. Well, it did not seem foolish to a judge; Entergy is looking to our firm to repay the money it had to give Mr. Joseph and his wife. Entergy’s legal action against our company is completely unwarranted and without merit. Indeed, the suit is simply a counter-punch response because we dared to tell the truth about Entergy’s financial behavior. Naming us as a party at interest in the Joseph case is not exactly the wildest salvo fired in our war with Entergy, although the action itself is pretty difficult to comprehend with any sense of logic. Indeed, some of the legal remedies sought by the utility have provided us with an extraordinary glimpse of the illogic that appears to grip much of the New Orleans judicial process. A case in point was Entergy’s request for a local court to issue a protective order forbidding us to communicate with their board of directors’ audit committee. Entergy quite properly requested a hearing, and the court agreed to schedule the event. Before the hearing could be held, however, the court issued the requested protective order. When we asked the judge how he could issue such an order without a hearing, he responded that we simple Texans “just don’t understand how things work down here.” Amazingly enough, the magistrate delivered that line without laughing! During the months while this manuscript was being written, we have been cited twice for contempt of court as we attempted to communicate with members of Entergy’s Board Audit Committee and others about the utility’s accounting alchemy. One has to ask: Is justice blind in the Big Easy, or is justice seeing only what the courts want it to see? In the post-Enron era, when our society has been shaken to its core by corporate scandals and crooked executives, we feel an obligation to tell what we know. By doing so perhaps we can help prevent another financial disaster and avoid rocking the foundations of American business yet again. Clearly, the pro-utility courts in New Orleans do not see the situation with the same clarity. Like Entergy’s executive conference room, we believe the lights in the New Orleans courtrooms are kept low on purpose.
More Trouble in the Big Easy
For all our effort, we may be too late. You see, Entergy has been through all this yet again, in a much more public forum. In April 2001 Florida Power and Light (FPL) called off a widely anticipated merger with Entergy. Energy analysts said the breakup culminated with one of the most shocking displays of management bitterness they had ever witnessed. We imagine most analysts took a little while to recover from the shock when Entergy and FPL announced that their $15.8 billion deal would not happen. The merger would have created the nation’s largest electric company. Fred Schultz, an analyst with Raymond James and Associates in Houston, told an interviewer that “the Entergy people aired more dirty laundry than I’ve ever heard on a conference call in ten years. I was sitting here in complete astonishment.” Mr. Schultz’ amazement was widely shared, particularly by executives at Florida Power and Light. FPL blamed Entergy for the breakup, saying that Entergy had offered “significantly higher earnings projections than Entergy gave its own board and investment bankers.” We had thought Entergy cooked books for equal benefit of all concerned. That, it seemed, was not the case; the Entergy Board of Directors may have gotten something akin to the real story. Entergy CEO Wayne Leonard said that “corporate cultural differences” began to become apparent two months before the breakup was announced. According to Mr. Leonard, FPL Chairman and CEO James Broadhead called Entergy’s management style “chaotic” and told Entergy directors back in March that Leonard was not up to the job of CEO. Mr. Leonard maintained that Broadhead wanted to fire both Leonard and Entergy CFO John Wilder, who is currently CEO of TXU. If that is true, we can only applaud Mr. Broadhead’s intentions. FPL spokeswoman Mary Lou Kromer told analysts that her utility did not want to bandy words with Mr. Leonard but that FPL began to lose confidence in Entergy managers when the New Orleans group refused to explain discrepancies in financial forecasts. Around our digs that comment caused quite a chuckle, and now you know why!
An Industry Beset
Electricity is a unique consumable. Except for a brief delay lasting only a few nanoseconds, electricity is produced as it is consumed. In other words manufacturing of electricity takes place at nearly the same time that electricity is used. Power providers operate via a demand system; their production and distribution apparatus must be capable of delivering enough electricity to satisfy consumer demand, on demand. On a hot summer afternoon in Texas, for example, every office air conditioning system is running at full blast, and when the workers go home, the residential air conditioning units are turned on or thermostats turned down. This, then, is “peak” demand, the point at which the utilities must supply the most power for a given period of time. During off-peak hours, as much as half of the electric company’s generating capacity may be idle. Most Americans still do not understand electric utilities, and many consumers have only a vague grasp of the intricacies of regulation and deregulation. This is a paradox of sorts; regulation, in particular, seems easy enough to grasp. The real difficulty lies in understanding how power companies have manipulated the regulators. Regulators at state and local levels have traditionally limited the utilities to recovery of costs and a specific margin of profit. It did not take long for the power companies to discover that the best way to increase their profit margin was to increase the costs incurred in the production of electricity. Over the past several decades, electric utilities have become remarkably innovative in developing new and improved methods of increasing their costs of production. In a word, regulators have been effectively co-opted by the power companies. A case in point: Although we have shared detailed information about Entergy’s apparent financial misrepresentation with numerous regulators, the regulators have done nothing. Of course, no matter how long or how loudly one blows the proverbial whistle, there is no guarantee anyone will listen. Candidly, we expected action of some sort – even if all we received was an allegation of error on our part or a curt dismissal. The Securities and Exchange Commission does maintain a file on the matter, but they have not contacted us in over a year.
On the Cusp of Change
The hard standards by which we have judged electric utilities over the past century are long outdated. Today, the entire electric industry is in a state of flux. In a very real sense, this book has been written to expose utility malfeasance and promote reform, but it is also intended to dispel confusion and inform. In our first chapter, we explore the monopolistic practices that have been the norm for electric companies during the last century. Throughout this first chapter and each successive chapter, we offer compelling case studies to prove our point. In chapter two, you will find a brief history of electric utilities and a description of the internal process of industry regulation. Chapters three and four examine deregulation – the perils and potential of utilities competing in the open market. Finally, chapter five points toward a new beginning for electric utilities – a new vision of the future which requires, perhaps unrealistically, that the utilities learn to adapt to changing circumstances in an honest and decent way, just as other industries have. More than anything else, this fundamental paradigm shift would herald a return to a standard of ethical behavior that we have a right to expect. We have every reason to expect that the herald to ethical standards will be largely ignored. As you will see, ethical behavior is a quality in short supply in the electric utility industry. In decades past, power companies could generally do whatever they wanted – and they did. Because the industry and the world around it are both in a state of flux, those days will soon be over. Change will happen, as surely as the bright light of day follows the darkest night. Whether or not the utilities can put themselves back on the road toward honest earnings and ethical standards remains to be seen. Until the power companies themselves offer some proof of their future intentions, their past history gives us every reason to doubt their future conduct. Is the past really just prologue? From our vantage point, we cannot tell. Change is on the cusp; we cannot portend how the power companies will react to it, but one thing is certain: As deregulation becomes the order of the day in state after state, the easy life enjoyed by America’s electric utilities is coming to a rather abrupt halt. Now, companies like Entergy must prepare to atone for past sins with some of their own lifeblood … or some will most assuredly drown in it.