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Copyright 1995 The New York Times Company
The New York Times

November 24, 1995, Friday, Late Edition - Final

SECTION: Section A; Page 1; Column 1; National Desk

LENGTH: 3700 words

HEADLINE: PRISONS FOR PROFIT: A special report;
Jail Business Shows Its Weaknesses

BYLINE: By JEFF GERTH and STEPHEN LABATON

DATELINE: CENTRAL FALLS, R.I., Nov. 17

BODY:
Two years ago, the owners of the red cinder-block prison in this poor mill town threw a lavish party to celebrate the prison's opening and show off its computer monitoring system, its modern cells holding 300 beds and a newly hired cadre of guards.
But one important element was in short supply: Federal prisoners.
It was more than an embarrassing detail. The new prison, the Donald W. Wyatt Detention Facility, is run by a pri-vate company and financed by investors. The Federal Government had agreed to pay the prison $83 a day for each pris-oner it housed. Without a full complement of inmates, it could not hope to survive.
So the prison's financial backers began a sweeping lobbying effort to divert inmates from other institutions. Rhode Island's political leaders pressed Vice President Al Gore while he was visiting the state as well as top officials at the Justice Department to send more prisoners. Facing angry bondholders and insolvency, the company, Cornell Correc-tions, also turned to a lawyer who was then brokering prisoners for privately run institutions in search of inmates.
The lawyer, Richard Crane, has done legal work for private corrections companies and Government penal agencies. He put the Wyatt managers in touch with North Carolina officials. Soon afterward, 232 prisoners were moved to Rhode Island from North Carolina, and Mr. Crane was paid an undisclosed sum by Cornell Corrections.
But the new batch of inmates included 18 murderers, a surprise for local leaders who say they were promised the prison would hold white-collar and less violent prisoners.
The story behind the Wyatt prison is a stark example of some of the pitfalls involved in putting prisons under the control of private companies. Those pitfalls include overly generous contracts and the hiring of companies that are diffi-cult for the Government to supervise.
But since Wyatt opened, the Clinton Administration has quietly proposed to have such companies run most new low-security Federal prisons and detention centers. The proposal is meant to help fulfill President Clinton's campaign pledge to slash the growth of employees on the Federal payroll.
The Justice Department has already put control of a few of its jails in private hands. And in the next few weeks, the Administration is expected to complete a plan to open a privately run prison in Taft, Calif., that could become the stan-dard contract used by the Federal Government around the nation.
But some experts say Mr. Clinton's plan is fundamentally flawed because the Bureau of Prisons, the unit of the Jus-tice Department that oversees most Federal prisons, does not need fixing. They argue that it already does a good job.
"We have a well-functioning prison system, a minimum of scandals, no escapes, few riots," said Philip B. Hey-mann, who was the Deputy Attorney General as the White House began formulating the new policy and is now a pro-fessor at Harvard Law School. "I hear a shift to something that is defensible ideologically. But the justifications for it are satisfying what is sort of an arbitrary political target. Prisons are a very sensitive thing to run. This is the No. 1 place I wouldn't try and play games with for reasons of political accounting."
Administration officials acknowledge that the policy to privatize more prisons has some weaknesses. For example, they say that although the plan is based on Mr. Gore's sweeping review to reinvent government, it ignored critical con-clusions from that review.
In addition, White House and Justice Department officials say they have no studies showing that the policy will save money, and in some instances, the department has found that its use of privately run prisons costs more. In fact, an examination of Federal contracts with privately run prisons and jails showed that many are overly generous, leaving significant financial risk with the Government.
Moreover, just as the Justice Department has been struggling to allay public concern about the Government's con-trol of Federal agents in the aftermath of the deadly debacles at Ruby Ridge in Idaho, and Waco, Tex., the prison priva-tization policy cedes broad law-enforcement responsibilities to private contractors who assert they are not subject to Federal rules.
And interviews with Administration and prison officials raised questions about the ability of the Justice Department to oversee the expensive and complex new policy, although the department is preparing a new bureaucracy and set of procurement rules to exert more control over its contractors.
Mr. Heymann's successor at the Justice Department, Deputy Attorney General Jamie Gorelick, has overseen the new policy. She declined to be interviewed, referring questions to the Justice Department's chief spokesman, Carl Stern.
In response to written questions, Mr. Stern wrote that the privatization effort was a "pilot program" spearheaded by a White House effort "to make government more efficient by privatizing heretofore governmental functions." He ac-knowledged that "there are concerns that must be addressed before any programmatic commitment can be made to pri-vatization."
Meanwhile, as the Government increasingly turns to private companies to run prisons, those businesses are hiring a growing number of former senior law-enforcement officials. At the same time, industry representatives are occasionally providing help to Federal officials in developing the privatization plan. A new revolving door has opened in Washing-ton.

The Plan's Origins

2 Political Goals Shaped a Solution
In the fall of 1993, White House officials found themselves caught between two sensitive political goals: putting more criminals in jail and reducing the size of the Federal bureaucracy.
Both grew out of promises made by Mr. Clinton during his Presidential campaign when he adopted Ross Perot's popular theme and vowed to reduce the size of the Government. At the same time, Mr. Clinton pledged to continue put-ting more criminals in Federal prisons for longer sentences, and building more jails to house them.
Those two objectives inevitably clashed. More prisons meant more people would be needed to run them. In fact, White House budget officials began to realize that the growing stream of Federal inmates would force the Government to hire more than 4,000 new employees at new prisons by the end of the decade. How could the Justice Department, one of the few growing Federal agencies, hire thousands of new employees just as the Government was supposed to be shrinking?
The solution was an accounting sleight of hand. The department, after initial resistance, agreed to use private com-panies to run most new prisons; the employees at the new prisons would not show up on the department's official pay-roll.
In pushing the prison privatization plan, Mr. Clinton embraced the concepts behind the National Performance Re-view, Mr. Gore's 1993 study to reinvent government so that it "works better and costs less," especially the commitment to cut 252,000 Federal employees from the payroll.
But that study did not even mention as an option the hiring of private firms to operate prisons. In fact, Mr. Gore's report was cautious about making changes in the prison system, recommending only lower cost solutions to Federal prison space problems.
In addition, the privatization plan ignored some of the review's general recommendations about overhauling gov-ernment.
For example, Mr. Gore's report warned against the use of arbitrary personnel ceilings to control the work force and called on Mr. Clinton to halt the practice. It said such arbitrary ceilings would "cause inefficiencies and distortions" and "rarely account for changing circumstances."
When it came to prisons, as well as other agencies, that recommendation was never followed. Instead, the White House took the first step toward prison privatization by capping the future growth of prison employees. This move was a small part of the larger effort to cut 252,000 Federal positions, leaving the Government with less than two million ci-vilian workers in a piece of politically appealing arithmetic, officials said. In the case of prisons, the idea was that after reducing personnel, the Government would then turn to private contractors to do their work.
"We needed something to force the downsizing, we needed a target, we needed something to get people to start weeding out" Government positions, said Elaine C. Kamarck, a senior policy adviser to Mr. Gore responsible for the National Performance Review.
But Robert Dodge, an official in Mr. Gore's office, said in an interview that the decision to hire private contractors to run prisons should be based on saving money and getting better results. The personnel ceilings in the Bureau of Pris-ons was "a poor rationale" for using private companies, he said.
Even in the early stages of developing the privatization policy, questions were raised about its cost-effectiveness. Both senior Justice Department and budget officials rejected a White House analysis that suggested that the program might save money.
In a strongly worded memorandum, the Justice Department heavily criticized the proposal and noted that it failed to accurately reflect the true costs of using private companies, according to two senior Justice officials.
The Bureau of Prisons was also under no illusion that its personnel caps would save money.
"The basis of the decision is not that it's going to be less expensive," said John Clark, assistant director of the Bu-reau of Prisons, who has been overseeing the new policy.
One of the White House architects of the plan echoed Mr. Clark.
"The personnel reductions were to my mind the driving force. They are very arbitrary," said the former senior offi-cial, who spoke on the condition that he not be identified. "I would never had fought this battle but once Clinton com-mitted, the die was cast," he said.

Going Private
A Cool Reception Across the Board
In the middle of last year, the White House sent its proposal to privatize prisons to the Justice Department, where it was greeted with a frosty response, according to officials involved in the discussions.
To help overcome the resistance of senior officials at the Justice Department and the Bureau of Prisons, the plan's architect at the White House, Christopher Edley Jr., asked Mr. Gore's office to turn up the heat.
Mr. Edley, an associate director of the Office of Management and Budget, enlisted the aid of Ms. Kamarck, Mr. Gore's senior policy adviser overseeing his government review. She then called her friend, Ms. Gore lick, the Deputy Attorney General, who oversees the day-to-day operations of the Justice Department.
"I convinced Jamie to do more of it," Ms. Kamarck recalled. In exchange, she said, the White House agreed to scale back the initial proposal so that it only applied to low-security institutions and jails where defendants and aliens await-ing trial are held.
After the Justice Department finally signed onto the plan, the proposal was buried deep in the Clinton Administra-tion's budget plan, presented to Congress last January, where it received little attention. It required four new prisons to immediately come under private control in New York, California, Mississippi and Arkansas. The Bureau of Prisons estimated the plan would eliminate more than 1,600 new positions on its books.
But officials in Arkansas and Mississippi objected to the change and helped persuade their senators to block the Administration from using money to hire companies to run the prisons in their states.
Surprisingly, the proposal was also coolly received in the House, where Republicans have long sought to create new opportunities for businesses to take over government functions. Although the House included a scaled-back version of the policy in its appropriation bill for the Justice Department this year, in a report accompanying the bill, the Repub-licans said the Administration's plan had gone "too far too fast." Noting that the Bureau of Prisons had "relatively lim-ited experience regarding the cost and performance of private prisons," the report called for a comprehensive study of the policy's costs and benefits.
The House bill, and its Senate counterpart, are being considered by a Congressional conference committee. In the meantime, the Administration is moving ahead only with its plans to privatize the prison in Taft, Calif.
Drafts of the contract for that prison, more than 140 pages of minute detail, cover everything from the prisoners' daily food regimen of "heart healthy diets," to prohibitions on using inmates for medical experiments, to requiring intel-ligence gathering by the companies to avoid uprisings.

A Learning Experience

Justice Officials Admit Mistakes
Justice Department officials admit that their record of using prison companies has been plagued by costly mistakes. Repeatedly, prison and Administration officials say, the companies have negotiated lucrative contracts in which the businesses involved have been able to recover their financing costs unusually fast and shift huge medical expenses for inmates to the Government.
The experience of the United States Marshals Service, the unit of the Justice Department that holds and transports prisoners both before and during trial, is one such example. The service uses hundreds of local- and state-owned institu-tions to house its 22,000 inmates. Less than a dozen of these, including the one in Central Falls, are privately run. In fact, the Wyatt prison was named for the United States Marshal who helped get the institution built by projecting the numbers of inmates that would need housing. A political appointee, he was out of office by the time the prison opened.
The privately operated jails cost the marshals 24 percent more than the public ones in the same region, marshals of-ficials say. While reluctant to draw any broad conclusions from that statistic, the officials acknowledged costly contract-ing errors by the Marshals Service.
For instance, the service hired the nation's largest prison company, the Corrections Corporation of America, to build and operate the Leavenworth Detention Center in Leavenworth, Kan., a maximum security jail that opened in 1992.
The marshals paid the company $113.70 a day for each of the first 198 prisoners. Each additional prisoner cost the marshals $18.05, which an official described as the company's out-of-pocket or variable expense of each inmate.
The costs of the first 198 prisoners covered repayment for the company's construction costs to build Leavenworth, an unusually generous repayment schedule that enabled the company to recover its capital costs in five years. Construc-tion costs are typically financed over 20 to 30 years.
"Five years is unbelievable, it's amazing," said Mr. Crane, the lawyer who brokered the prisoner deal in Rhode Is-land and who was Corrections Corporation's general counsel until the late 1980's. "No wonder it's more than $100 per diem."
Doctor R. Crants, the chairman and chief executive of Corrections Corporation, defended the arrangement, saying the Government got a fair price considering the expenses incurred by the company both in building the jail and in su-pervising the inmates.
But officials at the Marshals Service eventually recognized they had made a mistake and renegotiated the contract last April, slightly lowering the rate they paid for prisoners.
The Marshals Service is not the only unit of the Justice Department to negotiate such a contract. At the Federal de-tention center in Eloy, Ariz., which opened last year and is the first privatized jail in the Bureau of Prison's system, offi-cials also agreed to a rate that enabled a company to recover its construction costs in five and a half years.
In the future, officials said, newly constructed prisons will be owned by the Federal Government so that construc-tion costs will not be covered by the daily reimbursement for supervising prisoners.
The contracts have had other problems, too. Both the Bureau of Prisons and the marshals signed contracts in which prison companies paid the medical costs for treatment of inmates inside the institution, while the Government picked up the cost when prisoners sought special treatment outside. As a result, company doctors would regularly refer prisoners to outside specialists merely to shift the costs onto the Government, Mr. Crane and Federal prison officials said.
After a Justice Department study found that medical costs for prisoners had grown to $250 million last year, from $175 million in 1991, the Bureau of Prisons decided to renegotiate the medical costs at two Texas prisons.

A Revolving Door
Federal Workers Join Private Ranks
Federal officials say they are comfortable with letting private companies run Federal prisons because the industry has become mature, gaining experience running state and local jails. But Federal officials have also grown comfortable with the prison industry because its ranks now include many former colleagues as senior and other law-enforcement officials have taken positions at private corrections companies, Washington's latest revolving door profession.
The industry leader is the Corrections Corporation of America, a 12-year-old company based in Nashville. Some of the company's officials are former Federal prison employees, and the company's director of strategic planning, Michael Quinlan, headed the Bureau of Prisons in the Bush Administration.
Another industry leader is the Wackenhut Corrections Corporation of Coral Gables, Fla. Its directors include Nor-man A. Carlson, Mr. Quinlan's predecessor as the director of the prisons bureau, and Benjamin R. Civiletti, a former Attorney General.
The Acting Attorney General in the first months of the Clinton Administration, Stuart Gerson, is on the board of Esmor Correctional Services of Sarasota, Fla. Four months ago, the Immigration and Naturalization Service, a unit of the Justice Department, canceled its contract with Esmor after an uprising at its detention center in Elizabeth, N.J. An investigation by immigration officials concluded that Esmor, trying to cut costs, had failed to train guards, some of whom beat detainees.
The revolving door is beginning to work both ways. Not only has the private sector turned to former Federal offi-cials, the Government has also started to look to industry leaders for aid in developing plans to hand new prisons over to private management.
Mr. Crane, a general counsel at the Corrections Corporation in the 1980's, was retained briefly as a consultant by the Bureau of Prisons to help write a model contract that is going to be used to hire the company to run the Federal prison in Taft.
"The fact they brought me in shows they have something to learn," Mr. Crane said.

The Future

Regulating Costs, And Setting Rules
As the Government embarks on privatizing prisons, officials say they are confident they will not repeat their earlier mistakes.
"We've learned from our experience," said Mr. Clark, the assistant director of the prisons bureau. One major change is that the Government intends to pay companies for every bed in a prison, regardless of whether they are filled. Gov-ernment officials said the provision is in the interests of both parties because it eliminates the uncertainty and potential problems that could occur by manipulating prison populations. The model contract will also try to control medical costs by shifting more of the burden to the companies, Mr. Clark said.
But experts, Government officials and industry executives continue to debate how much, if anything, is saved by privatizing prisons and whether companies can do a better job than governments. Some states have found cost savings of 10 percent or more. But the Federal Government's experience is limited and it has only begun to realize the rever-berations from the new policy. Difficult legal issues have yet to be sorted out. Some experts have raised concern, for instance, about the ability of the Government to control the contractors.
"It's harder to enforce Federal and constitutional rules," said Mr. Heymann, the Deputy Attorney General in the first year of the Clinton Administration. "You can't fire or discipline employees. The Federal Government can't issue orders to private guards."
At the privately run prisons, officials believe that in some cases, Federal rules may not apply to them, and there is some confusion about how government regulations affect private contractors.
The Attorney General's new policy on the use of deadly force is a case in point. John Glutch is the warden at the Eloy Detention Center in Arizona. When questioned about the applicability of that policy in a recent interview, Mr. Glutch said, "The Federal rules don't apply to us just because we have Federal inmates."
The Attorney General's new policy, which was issued to address criticism at Congressional hearings over the con-duct of Federal agents at Ruby Ridge, permits the use of deadly force against prisoners when they are escaping.
Mr. Stern, the Justice Department spokesman, said the corrections companies "are mistaken" if they think the rules do not apply to them.
Joseph Ponte, the director at the Wyatt Detention Facility in Rhode Island, takes a different view. He said he was unfamiliar with the month-old Federal guidelines. His prison's policy gives far greater latitude to the guards, permitting them to use firearms merely "to protect property which if compromised could reasonably be used in an escape."
Mr. Stern said the Central Falls lethal force policy was not in conformity with the Attorney General's new guide-lines, going significantly beyond them. He said that Federal contract officials had been instructed to review existing contracts to make sure they conform to the new policy.
As the Government grapples with these issues, the prison industry has welcomed the new Federal policy as a lucra-tive opportunity.
Speaking of the new contract that he helped the Government to write, Mr. Crane said: "This is the best of all possi-ble worlds. There's very little risk."

GRAPHIC: Photos: The Donald W. Wyatt Detention Facility in Central Falls, R.I. (pg. A1); The Federal Government pays $83 a day for each prisoner as part of a deal with a private company that operates the Donald W. Wyatt Detention Facility in Central Falls, R.I. A prisoner recently checked out the recreation area in the two-year-old prison.; When the privately run Donald W. Wyatt Detention Facility opened in Rhode Island, it faced a significant problem: it had few prisoners. So the company managing the prison worked out a deal with North Carolina officials to transfer 232 prison-ers to it. A guard recently escorted a prisoner to his cell. (Photographs by Keith Meyers/The New York Times) (pg. B18)

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The New York Times
Gore and prison! and (Wackenhut or Cornell)














BYLINE: By GRETCHEN MORGENSON

BODY:
WHEN Enron caved in last December, investors with the good fortune to have none of the energy giant's stock in their portfolios no doubt breathed a collective sigh of relief.
But it has become increasingly clear in the two months since Enron's bankruptcy filing that an investor did not have to own Enron shares to have been hurt by the largest business scandal in decades. Each revelation in the saga has added to suspicion that Enron may not be an anomaly, that much greater risk resides in stocks today than investors had thought.
So it is not all that surprising that stock prices have sunk since early December. Recent data has shown that an economic recovery may be imminent, but the Standard & Poor's 500-stock index has fallen almost 4 percent since En-ron failed, while the Nasdaq composite has lost almost 6 percent. Only the Dow Jones industrial average has held its own, losing just 1 percent in the last two months.
If and when the Enron mess fades from view, stock prices may well rebound, reflecting the expected economic re-surgence.
But Enron's aftershocks could instead have a more lasting and deleterious effect, not only on the shares of compa-nies that are aggressive in their accounting, as Enron was, but also on stock prices over all. In that new world, compa-nies may be forced to make adjustments that will hurt their results. Among other things, they will incur higher expenses and pay more to borrow -- lowering reported earnings. And earnings -- the genuine, unadulterated kind -- are what shellshocked investors suddenly care deeply about.
In the broadest sense, Enron has shown investors that very bad things can happen to companies that engage in ques-tionable practices to keep reported earnings up and stock prices aloft. But during the bull market of the late 1990's, few investors cared about nitty-gritty details. Little wonder that the current rush to examine corporate accounts is turning up disturbing questions at several companies, including Tyco International, the AES Corporation and the Elan Corporation. In recent days, their stock prices slumped. Any company is now suspect if it has used a lot of off-balance-sheet financ-ing, has made many acquisitions, has used joint ventures to create revenue or has been a serial user of restructuring charges.
"All of these mechanisms that were designed to present a company's financial condition in the best possible light are now going to meet a very much higher standard of review and disclosure," said Jonathan Cohen, portfolio manager at JHC Capital in Greenwich, Conn., and former chief of software and Internet research at Merrill Lynch. "Undoing these mechanisms is going to take air out of the dirigible that has been inflated over the course of many years."
Investors hoping for a quick rebound in stock prices must face another harsh reality, gleaned from history. Crises that occur in the midst of bull markets typically wind up delivering only short-term blows to stocks, but crises in bear markets usually exacerbate the existing downturn. And the bear market continues.
"People expect that the effects of a crisis will quickly be overcome and the market will go up," said Stephan R. Crandall, principal at Crandall, Pierce & Company, an investment research firm in Libertyville, Ill., who has studied market reactions to dire events going back to 1940. "But there hasn't been a crisis yet, if we are in a bear market that has lifted us into a bull market. The reality is, you always come back to the fundamentals that were in place prior to the cri-sis."
THE Enron collapse, coming on the heels of a wild spike and distressing decline in stock prices, has so angered in-vestors that they are forcing executives to change their practices. "Up until very recently, management was rewarded by engaging in certain types of bad behavior," said Howard Schilit, president of the Center for Financial Research and Analysis in Rockville, Md. "Now that reward structure has been flipped 180 degrees. The market is saying, 'We are fed up with people not telling us the truth.' "
Companies that continue to operate in the old, anything-goes mode will be punished by investors, Mr. Schilit pre-dicted. Other companies -- those with simple accounting, understandable businesses and internally generated earnings growth rather than growth by acquisition -- will be rewarded by fresh investor appreciation.
Regulators are already mandating some behavioral changes. Last Thursday, for example, the Securities and Ex-change Commission proposed new rules for analysts that call for increased oversight of research department activities by firms' compliance departments. This oversight would increase costs and reduce profits at brokerage firms.
Executives at many companies, meanwhile, are scrambling to meet new demands from investors for clarity and to-tal accuracy in financial disclosures. Some companies are being forced to restate recent earnings to reflect a new, more conservative approach to accounting.
Last Wednesday, the Cornell Companies, an operator and builder of prisons, said that it was examining its off-balance-sheet transactions and that its past financial reports, which had been audited by Arthur Andersen, might have to be revised. Cornell's shares fell 43 percent on the news.
Other companies may be compelled by their auditors to bring debt that had been shunted off to so-called special-purpose entities back onto their balance sheets. That would cause problems for many companies. Not only would com-panies face severe limits on their future borrowing capacity, they would also increase their interest expenses and reduce their earnings. Lower earnings would mean less money to finance operations or research and development. And it would mean fewer dollars to buy back shares, an activity that has helped many companies keep their stock prices up in times of poor performance.
Because they are hidden from view, off-balance-sheet obligations at companies are impossible to assess fully. Cer-tainly, banks and brokerage firms are heavy users of so-called structured financing methods, as are companies that have financing arms to help customers buy their goods -- like Ford Motor, General Electric and I.B.M.
Andrew Smithers, who runs Smithers & Company, an economic consulting firm in London, offered one way to judge the size of off-balance-sheet debts: look at total debt in the financial sector, which has been rising faster in recent years than that of businesses and households. As recently as 1996, financial debt amounted to 32 percent of total debt in the private sector. Now it stands at 36 percent.
Some financial debt is household obligations, like automobile leases, Mr. Smithers said. But he thinks most of it represents off-balance-sheet debts of corporations.
"U.S. companies are already highly leveraged," he said. "It is unlikely that they could take on balance sheet much of their off-balance-sheet debt without many companies being in breach of their debt covenants." If, for example, just half of all financial debt were moved onto corporate balance sheets, the leverage would jump to 163 percent of compa-nies' net worth, based on replacement cost of assets, Mr. Smithers said.
If their balance sheets are hobbled by such crushing debt loads, companies will no longer be able to tap debt mar-kets for capital. They will instead have to go to the equity markets. That won't help investors, though: a jump in the supply of shares could also depress stock prices over all.
Another hit to earnings, though probably not in the immediate future, involves the current accounting for stock op-tions. Now, companies take tax deductions when their workers exercise options, but if three senators have their way, those companies will be forced to compute the costs of options grants and deduct them from revenue. Most companies do not do this, referring to the costs of such grants only in footnotes to their financial statements.
As a result, companies benefit from options grants in two ways. First, the grants make companies' earnings look better than they would if options were deducted from revenue, as are other employee costs. Second, companies receive a tax benefit equal to the difference, known as the spread, between the strike price of an option and the price of the stock when an employee exercises it.
Because option grants have become so huge in recent years, changing the way companies account for them could put big pressure on earnings. According to Sanford Bernstein & Company, a brokerage firm in New York, the value of such grants at the nation's 2,000 largest companies rose to $162 billion in 2000 from $50 billion in 1997. Bernstein es-timates that if the nation's 500 largest companies had deducted the cost of options from their revenue, their annual profit growth from 1995 to 2000 would have been 6 percent instead of the 9 percent that was reported.
In recent years, companies that are heavy users of options, including Microsoft, Cisco Systems and Dell Computer, have erased much if not all of what they owed in taxes. But when it became clear that stock option deductions had helped to wipe out more than $625 million in taxes that Enron owed to the government from 1996 to 2000, concern about preferential treatment of corporate stock options got new life.
The three senators -- Carl Levin, the Michigan Democrat; John McCain, the Arizona Republican; and Peter G. Fitzgerald, the Illinois Republican -- are expected to introduce legislation this week requiring companies to deduct stock option costs from their revenue if they intend to take the tax deduction for options that are exercised.
"With Enron, you saw excessive incentives within that company to pump up their per-share earnings to keep their options in the money at all times," Mr. Fitzgerald said. "I am concerned that overuse of stock options could promote further the pump-and-dump syndrome that we've seen from companies like Global Crossing."
As a matter of course, corporate lobbyists will mount a feverish campaign to defeat such a bill. But after the Enron collapse, misleading accounting -- an accurate description of the current treatment of stock options -- is a no-no, and the lobbyists may be beaten back.
Enron-related pressure on earnings comes as corporate profits are already declining. According to Moody's Inves-tors Service, profit margins sank in the third quarter of 2001 to 7.5 percent, the lowest since the 7.4 percent at the end of 1982.
THAT is all the more reason for investors to obsess about earnings and the true value of a company rather than its share price.
John C. Bogle, founder and former chairman of the Vanguard Group, the mutual fund giant, sees another implica-tion from the Enron mess. "There will also be a much more rigorous focus on what realistic growth for a company can be," he said.
That would indeed be a tectonic shift for investors. For years, the corporate fabulists were in charge. Now, it's the realists' turn.

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