33 ELR 10485 | Environmental Law Reporter | copyright © 2003 | All rights reserved

The Enron Story and Environmental Policy

Victor B. Flatt

(BRACKET)Editors' Note: This Article is excerpted from Enron: Corporate Fiascos and Legal Implications (Nancy Rapoport & Bala G. Dharan eds., forthcoming Foundation Press 2003).(BRACKET)

The author is the A.L. O'Quinn Chair in Environmental Law, University of Houston Law Center.

[33 ELR 10485]

There are many aspects of the Enron saga that would give pause to someone who thinks about the environment and its problems. One of the most obvious is the concern that allowing unregulated trading of energy might not account for the costs of environmental externalities that are concurrent with energy production and usage.1 Another worry is that reducing the cost of energy may increase consumption and accelerate environmental degradation. However, these are concerns with the concept of energy trading itself, and would be problematic even if (and especially if) Enron had been a well-run and managed company that traded and delivered energy exactly as promised. As such, these are policy questions that exist aside from the demise of Enron and present important issues that are still to be examined in any and all aspects of energy deregulation.

Instead of concerns about energy trading in general, the demise of Enron presents a more fundamental question about the ability of government regulators to curb harmful or illegal behaviors in the face of structural incentives to commit them. More pointedly, can the regulated ever police themselves, and if so, under what circumstances? This question is germane to environmental protection because two strands of environmental regulatory theory may depend on it—the possibility of potential polluters controlling their own pollutants and complying with laws on a voluntary basis, and the dependence on this compliance mechanism in market-based pollutant trading regimes that involve the elimination of command-and-control regimes.

In order to understand the lesson that Enron teaches about the practicalities of environmental compliance and enforcement, this Article will review the collapse of Enron and its relation to problems inherent in a regulatory scheme that purposefully relies on self-policing for compliance. Then, this Article will examine why Enron engaged in certain policies in the newly deregulated California energy market in 2000, and why complex trading schemes are difficult to monitor. And last, this Article will examine what these occurrences suggest about the future of using environmental policies that depend on complex trading regimes and purposefully rely or (because of the complexity of the trading regime or elimination of command-and-control equipment) must rely on self-policing for compliance.

The Collapse of Enron

The merger of Houston Natural Gas and Internorth, in 1985, gave birth to Enron, the first nationwide natural gas pipeline network.2 In early 1986, Ken Lay was named chairman and chief executive officer.3 A few years later, Enron began opening overseas offices in England in order to take advantage of the privatization of its power industry.4 An ambitious company, it shifted from the regulated transportation of natural gas to unregulated energy trading markets, under the impression there was more money in buying and selling financial contracts linked to the value of energy assets than in actual ownership of physical assets.5 Jeffrey Skilling entered the scene in 1989, launching a program under which buyers of natural gas locked in long-term supplies at fixed prices.6 In the following years, Enron continued to expand worldwide with pipelines in South America, and power plants in England and India.7 Over this period, billions of dollars were spent in acquiring and building new sites and companies.

Over time, Enron also developed a slew of financial strategies skirting and sometimes outright defying the boundaries of the law, which assisted in the appearance of profitability.8 The strategies helped to prevent the discovery of Enron's true precarious position. The strategies to conceal information were so successful that billion-dollar Wall Street firms were surprised when Enron collapsed.9

Nominally, Enron and its auditors used the flexible generally accepted accounting principles (GAAP) rules governing how accounting data is to be compiled in order to show [33 ELR 10486] how operating results were in line with projections and expectations.10 GAAP allows choices among several accepted accounting methods, all of which require some kind of estimations or assumptions.11 The rules of GAAP do require "consistency principles" so the company will apply the same accounting principles to the same transactions similarly from year to year.12 This allows financial data to be scrutinized and understood over time. However, this principle does not apply to new business activities.13 When Enron changed from a natural gas pipeline business to an energy and commodities trader, it fell within the new business exception and did not have to adhere to the "consistency principles," which allowed it to avoid using the same accounting principles.14

Enron also utilized pro forma reporting, by which numbers are disclosed "as if" certain assumptions apply.15 Enron used this scheme to misrepresent net income from its operations by characterizing billion-dollar expenditures as "one-time" or "nonrecurring" charges.16 In effect, the company overstated its restructuring charges to clean up its balance sheet, took a large one-time earning hit, and reversed some of those charges at a later date, adding them back into the income in a period where earnings fall short.17 Although this is commonly seen in the normal course of businesses, it does not follow GAAP.18 Excluding the nonrecurring items allowed Enron to exceed its estimated earnings, when in actuality it was not able to match investor expectations.

Enron also provided incomplete financial statements dating back to 1996. Financial statements include several components in order to make it complete, including balance sheets, income statements, and statements of cash flow.19 Enron failed to provide the balance sheet, statement of cash flow, or statements of changes in owner's equity.20 The failure to provide such information misled investors. Decisions based on the income statement alone could not provide the full financial picture necessary to make informed investor decisions. Misleading financial statements misrepresented valuable information needed by investors, creditors, and lenders and undermined the credibility of the capital market.21

Enron also distorted its financial condition by transacting business with related parties. These related-party transactions usually involved special purpose entities (SPEs)—a legitimate way to limit exposure to risks, if the SPEs have appropriate independence.22 However, Enron used SPEs to self-deal and give the impression of a highly lucrative business, when in fact no money was changing hands, and the SPEs were not independent.23 Enron was able to manipulate reporting, hide debts, and shelter poor performing assets through these related-party transactions.24 These internal business transactions also allowed Enron to meet its earnings expectations and sustain an inflated stock price. Although GAAP requires detailed disclosure of related-party transactions in financial statements, Enron never revealed such details.25

Another financial strategy used by Enron was the false recognition of revenue. Under GAAP, an enterprise cannot recognize revenue until the business has substantially completed performance in a bona fide exchange transaction.26 Enron improperly recognized revenue from transactions with its SPEs.27 These were sham transactions in which Enron reported revenue it had not earned. In addition, Enron failed to report its indebtedness to creditors in guaranteeing the debt of its SPEs.28 Again, GAAP requires material indebtedness to be disclosed, and again Enron failed to disclose.

Lastly, Enron did not treat stock option grants to employees as a form of compensation and did not deduct same from the company's profits. Though not illegal, this practice does allow the posting of financial data that may not be complete, especially in Enron's case, as stock options represented a very large and important form of employee compensation. If Enron had reported the granting of stock options in the manner that had been proposed by the Financial Accounting Standards Board (FASB), the profits claimed from 1998 through 2000 would have been reduced by approximately $ 188 million.29

How did such problems occur, and what does this have to do with regulation in general and environmental regulation in particular? The answer is that the scandal should not have occurred if regulation were effective and worked as it should. The first problem was internal. With the continual growth of Enron and its stock, officers perceived the company as infallible.30 They believed Enron would best achieve success without regulation, and exemplified that view internally by setting minimal administrative controls—plans of organization, procedures, and records that lead up to management's approval of transactions.31 Internal [33 ELR 10487] controls are only effective when those bearing responsibility for developing, implementing, and overseeing them stress the need to comply with all policies and procedures through self-adherence. An example of the lack of internal controls occurred in 1999, when Enron's board waived conflict of interest rules three times by allowing the chief financial officer (CFO) to create private partnerships to do business with the firm.32 This poor internal oversight allowed illegal concealment of debts and losses that would have a significant impact on Enron's reported profits.33

Not only did self-regulation fail, Enron's auditors were also compromised. An auditor examining Enron's transactions should have been able to correctly understand what had occurred, required the reporting of such, and ordered changed practices. The Securities and Exchange Commission (SEC) used auditing as its primary method of regulation of information for large publicly traded companies. But Enron's auditors also sold Enron creative financial structuring advice. In addition to the use of SPEs, Enron also purchased advice from its accounting firms and several large banks that justified it in showing enough losses that it paid almost no income tax for many years, despite the vast profits that were simultaneously reported to shareholders and the SEC.34

The use of large accounting firms to perform auditing and nonauditing services created a potential conflict between auditor independence and company gain. During 2000, Enron paid $ 52 million to Arthur Andersen: $ 25 million for auditing services, and $ 27 million for nonauditing services, essentially advice for structuring business deals. Andersen estimated the retention of Enron as a client would procure $ 100 million a year.35 In order to satisfy GAAP, the auditor must remain independent. The vast amounts of money that Andersen received could easily have compromised its incentive to audit independently. Andersen's extensive consulting work for Enron may have compromised its independence and its judgment in determining the nature, timing, and extent of audit procedures. Further, it may have deterred Andersen from asking that Enron's management exercise its responsibility to revise financial statements.36

But even if Enron and its accountants' internal controls were lacking, why were applicable laws and regulations not enforced? Where were the governmental oversights or watchdogs? In the Enron case, the accounting and regulatory standard-setting model made by the SEC was ineffective in addressing accounting oversight and auditor controls.37

The SEC has the statutory authority to set accounting principles,38 but for over 60 years it has relied on the industry to police and regulate itself.39 The SEC has generally acquiesced to the rules and standards adopted by the FASB, otherwise known as GAAP. But it failed to acknowledge inherent incentive problems in the industry, such as one company creating and auditing the same accounting devices, which should have suggested problems with self-enforcement. After the Andersen debacle, it has become evident that self-regulation is inadequate and that the industry needs stronger and more independent oversight. The FASB had been called upon to address concerns about timeliness, transparency, and complexity in financial standards before Enron's collapse,40 but when it tried to implement regulations to more tightly monitor the energy trading industry, substantial lobbying efforts by the accounting community guaranteed the failure of such efforts.41

Deregulation of the accounting industry, coupled with the complexity of the energy markets it was auditing, created a complex system that was very difficult to monitor and indeed remained largely unmonitored.42 This might suggest a need for a return to some stringent government oversight, but as a result of Enron's influence the government failed to use existing enforcement powers that could have prevented corporate abuses of market power.43 Throughout Enron's lifespan, it aggressively lobbied for less regulation and oversight by the U.S. Congress, the Commodity Futures Trading Commission (CFTC), the SEC, and the Federal Energy Regulatory Commission (FERC).

Enron's lobbying successes can be traced historically. The complexity of the deregulated system began emerging in the late 1980s and 1990s. However, through a series of decisions, FERC authorized "power marketers" like Enron to operate with little oversight of the energy market.44 Soon after these decisions, Enron petitioned the chairwoman of the CFTC, Wendy Gramm, to exempt energy derivatives from regulation. She initiated two actions in 1993 and Enron was granted its petition; it was exempted from CFTC oversight.45 Five weeks after stepping down from her post, Ms. Gramm was named to Enron's board of directors.46 The lobbying continued; it was so aggressive and successful that staff members of one congressional committee asked a lobbyist for the Enron-led industry to negotiate the provisions of a bill directly with regulators.47 The CFTC was further removed from regulating when Congress passed the Commodity Futures Modernization Act in December 2000. The bill codified the CFTC's decision in exempting energy contracts from oversight.48

There were also problems caused by legislative changes. According to Richard Walker of the SEC: "Increases in financial fraud [are] partially attributable to court rulings limiting corporate liability for financial fraud and the Private Securities Reform Act of 1995, which removed joint and [33 ELR 10488] several liability."49 Restrictions on the ability of shareholders to pursue claims encouraged illegal behavior.50

As a result of increasing incentives for self-regulated entities to act illegally, a lessening presence of watchdog organizations, and an increasing dependence on self-regulation, financial accounting scandals occurred at Enron and other companies. Enron is a result of the complete breakdown of corporate governance and professional gatekeeping systems. The Enron saga is an important lesson for environmental regulation because it indicates that reliance on self-regulation alone, when there are incentives to cheat, is a dangerous proposition.

Enron and California Energy Deregulation

If the collapse of Enron due to financial improprieties is an example of how self-regulation will not force companies to follow the law when there are contrary incentives, Enron's practices in California's energy market provides an example of how difficult it is to regulate a complex trading system to achieve desired results even if companies follow the letter of the law. Unlike the regulation of its financial documents, which failed to pick up explicitly illegal behavior, Enron could simply take advantage of possibly legal loopholes in the creation of a regulatory scheme to trade energy.51

Deregulating the California market was proposed as the solution to the state's high energy costs and an end to the archaic monopolistic structure in favor of a competitive market place.52 California, eager to be the first in the new market structure, passed legislation implementing the restructuring of the energy market in both houses without any dissenting votes. Unfortunately, the idea that deregulation could not make matters any worse was wrong; the hastily forced through legislation deregulating the California energy market utterly failed.53

In order to understand the complex deregulation scheme, a brief history is necessary. California's energy problems began in 1973 with brownouts. Utility companies could not build power plants fast enough to keep up with rapid population growth in the West.54 Further, technological stasis was inhibiting. The creation of bigger generators failed to produce power without costly equipment breakdowns. Finally, environmental pressures to pursue conservation and refrain from building nuclear power plants hampered growth. Under this pressure many power plants changed to oil, which was cleaner than coal and cheaper in the 1960s.55 Unfortunately, the oil embargo of the 1970s resulted in large cost increases for consumers.

Politicians created the Public Utility Regulatory Policies Act in 1978, designed to prevent further energy crises like that of 1973. It contained a provision aimed at encouraging the production of electricity from unconventional sources. This allegedly opened the door for deregulation.56 It required utility companies to buy power from qualifying facilities (QFs) or small independent producers who created electricity from wind, solar radiation, burning of biomass, or cogeneration.57 These QFs were not regulated like traditional power companies. As a result, they were able to enjoy much more freedom to engage in alternative power production.58

QFs were extremely successful in producing cheap power. This weakened the justification for the natural monopoly status of power companies, and spurred policymakers to consider the benefits of the free-market principle.59 Further, the conservation movement continued to promote conservation over construction. Utility companies lacked the support needed to justify their monopoly status.

The Energy Policy Act of 1992 allowed restructuring of the regulatory landscape, and set the stage for deregulation.60 The Act required power generators to compete on the wholesale level and allowed states to begin retail competition as well. Congress exempted more independent producers from traditional regulation and even permitted independents to transmit power over the utility companies' power lines.61 "Retail wheeling," a process by which distant producers can use another company's network to reach retail customers, directly opened up new business opportunities.62

After marathon closed-door negotiation, the California Legislature unanimously passed deregulation legislation commonly known as AB 1890.63 Due to the diversity of groups involved in the drafting process, the legislation only provided broad parameters for the structure of deregulation.64 Environmental and consumer groups attempted to repeal the new statute. However, after the utilities spent $ 40 million to defeat a ballot measure, these groups realized deregulation was going to happen whether or not they liked it, and reluctantly participated.65 The legislation became effective January 1, 1998. By trying to appease all parties involved, AB 1890 ended up being more of a political compromise than a reflection of the technical complexities of the industry.66 It left all responsibility to develop and implement the mechanisms to the California Public Utility Commission [33 ELR 10489] (CPUC) and FERC.67 The purpose of AB 1890 was to promote competition in California's electricity market, so as to eventually lead to lower electricity prices.68 California split its electricity market into three components in order to implement the "open market" concept: (1) generation; (2) transmission; and (3) distribution.69

AB 1890 and the CPUC created new rules for selling electricity in California. These included the creation of the California Power Exchange (PX), a nonprofit trading exchange for 24-hour-ahead electricity sales and purchases, and the Independent System Operator (ISO), a private nonprofit organization that managed the day-to-day operations under FERC.70 The PX was the market place for buying and selling electricity, known as the "wholesale power pool," while the ISO was to ensure the reliability of the transmission grid.71 Under this structure all generators sold their power to the PX. The PX then set the price through an auction process. During the auction process all generators bid their electricity into the PX and the PX sold the same electricity the next day at the "clearing price."72 The legislation also enacted a statutorily defined "transition period" during which retail rates would remain frozen at levels thought to be sufficient for investor-owned utilities (IOUs) to recover transition costs over and above operation costs. The freeze set rates at levels 10% below those in effect in June 1996.73

Beginning in May 2000, demand began to exceed supply, causing costs to skyrocket. Wholesale rates increased by 938% from December 1999 to December 2000.74 The retail price freezes affected Pacific Gas and Electric Company (PG&E) and other power suppliers dramatically. The frozen rates forced the IOUs to absorb all of the high wholesale costs.75 Further, demand was not stifled by high cost because consumers were not affected by price fluctuations. Even though wholesale prices were extremely inflated, consumers enjoyed the same electricity rates under the AB 1890 price freeze.76 Unfortunately, regulatory action was not taken to correct the situation until IOUs were at the brink of bankruptcy. On April 6, 2001, PG&E, California's largest IOU, filed for bankruptcy.77 At the same time, FERC did not monitor how power was coming into the California grid from out of state.78 Nor did it investigate the price spikes related to the interstate energy trading.79

So what went wrong in California? Several key features of the California system helped to create the 2000-2001 crisis: (1) the PX's market structure flaws; (2) the ISO's market structure flaws; (3) CPUC's prohibition on long-term contracts and other risk reducing tools; (4) CPUC's forced divestiture of the IOU's generation; and (5) FERC's failure to timely respond to the crisis.80

Both the PX and the ISO were designed in ways that failed to address the underlying technology and economics of electricity.81 The PX day-ahead and hour-ahead markets are considered "spot markets," meaning that purchases are based on each day's price for electricity.82 This effectively creates individual markets for each hour and day of the year. Spot pricing in any market creates the risk of volatile prices, subjecting both the buyer and the seller to risk. In the PX market, however, structural flaws resulted in the majority of the price volatility risk being borne by California's IOUs.83

The PX buying and selling mechanisms, fueled by CPUC's requirement that all IOUs purchase all their power from the PX, functioned like an auction house.84 Power generators would bid their output in the PX at various prices and purchasing IOUs would submit bids on a daily basis.85 The clearing price was equivalent to the most expensive megawatt price paid by any purchaser from the PX.86 If a supplier bid over the clearing price it could not sell anything into the market; however, those bidding under the clearing price received the clearing price bid anyway.87 Therefore, even if a supplier submitted a lower bid that could have been accepted by the PX in a competitive marketplace, California's IOUs were forced to pay the highest possible price that was bid into the PX.88 This market structure proved to be a fatal flaw, due to the fact that IOUs could not enter into long-term contracts or other price-hedging products.89

CPUC also required the utilities to give control of their transmission facilities to the ISO.90 The ISO was responsible for ensuring that all electricity demand was met.91 If there was not sufficient supply in the PX to meet the state's demand, the ISO was required to purchase and provide electricity outside the PX market to make up for the shortfall.92 The ISO charged the PX, who in turn charged the IOUs.93 This structure left the IOUs with no ability to protect themselves from these unexpected prices and further created an incentive for gaming the system. Sellers learned to use this structure to their advantage by realizing the ISO would pay any price; indeed it was required by law to pay any price, in order to keep the transmission grid operating.94 Therefore, on days when forecast weather was likely to demand all of the power, sellers knew they did not have to participate because [33 ELR 10490] the ISO would call in the next day and offer higher prices.95 In effect this lowered the amount of power available in the grid, forcing the ISO to act as a buyer of high cost spot power, which was being held off the market so that the ISO would buy it in the spot market. In effect, electric-generating facilities took electricity out of the market to sell the exact same generation at a much higher price, thus vastly inflating profits. The California system had no mechanism to accommodate these unexpected outcomes.96

Moreover, California could not directly regulate the suppliers themselves. When the CPUC required that California utilities divest themselves of their fossil generation facilities, IOUs had to rely primarily on out-of-state suppliers.97 It was CPUC's contention that divestiture was a necessary condition for competition to properly function.98 This left California generation capacity in the hands of out-of-state companies like AES, Duke, Dynegy, and Enron, who sold their power into the PX market. While these companies generated record high revenues during the last half of 2000, the California IOUs suffered crippling financial losses.99

Another problem resulting from the market structure was how it limited long-term contracts. AB 1890 resulted in 80% to 85% of all transactions going through the PX or the ISO daily spot market, while other electricity marketers in the world operate with 80% to 85% of all transitions through long-term forward contracts.100 Due to the lack of forward contracting opportunities, sellers were forced to take what they could from short-term contracts without any guarantee of payment on subsequent days. This led sellers to bid higher than their marginal operating costs; consequently, the market was not an accurate reflection of true costs.101

The role of the FERC has also been criticized in light of the deregulation disaster because major suppliers were out-of-state, and came under FERC's regulatory jurisdiction. FERC allegedly adhered too strongly to a free market ideology despite mounting evidence that it was not working.102 Most importantly, FERC failed miserably in its duty to discipline the anticompetitive behavior driving the increases.103 Even at the genesis of deregulation, FERC was advised as to the potential problems deregulation would produce.104 It obtained reports as early as 1996 commenting on the potential for price manipulation and weakness in the deregulation scheme.105 FERC ignored such reports and signed off on the deregulation plan. Critics have charged that "FERC's failure to act [] forced California into [an] energy crisis of unprecedented proportions."106 There appear to be two reasons FERC was so uninvolved: (1) it misunderstood and misdiagnosed California's problem as being a supply and demand imbalance; and (2) its entire program of promoting competitive wholesale market would have been threatened by any other interpretation of the cause of the California crisis.107 A recent report notes how few resources FERC spent and spends on controlling anticompetitive behavior in the energy market.108 Therefore, FERC laid the blame on flaws in the design of the California system, thus deflecting attention from its own possible deficiencies.109 In essence, FERC claimed no responsibility for the crisis,110 even though there is evidence that structural features of electricity markets limit the ability of regulators to rely on the traditional aspects of competitive markets.111

In October 2000, a public interest group submitted a petition requesting FERC to take action by finding the California market not competitive and the resulting prices to be unjust and unreasonable.112 The petition also requested that FERC impose a cap on the price of energy.113 In response, FERC did find the prices unreasonable, but instead of implementing price caps, it proposed remedies to address some of the issues the energy market was facing.114 Finally, in December 2000, FERC issued an order eliminating the IOUs' requirement to sell and buy all their energy through the PX, allowing them to enter into long-term contracts, and establishing a "soft cap" of the single-price auction system.115 FERC continued to make small steps in assisting California, but most would agree that its actions did very little to ease the burden or remedy the crisis in the short term.116

FERC's greatest failure occurred when it refused to enforce the Federal Power Act117 and issue refunds of the excessive charges incurred from May-October 2000.118 Generators profited exponentially from overcharges, yet FERC did nothing to sanction those who had caused "unjust and unreasonable" wholesale rates.119 It was estimated that had FERC acted in a reasonable time, it could have saved Californians billions of dollars.120 At the most critical moment of the California crisis, FERC walked away from its role as a regulator, leaving the market wide open for enormous profits at California's expense.121

The central feature of the 2000-2001 California energy crisis is the failure of the state and federal regulating institutions to properly regulate market behavior by generators and traders. The market design had flaws, but the crisis was caused more precisely by a failure to understand the inherent rationale of regulation or to regulate in the face of those flaws.122 Deregulation will always have surprises. Its power is that it allows companies to search for and exploit efficiencies. [33 ELR 10491] Enron and other wholesale out-of-state power suppliers did just that. What they did may not have been necessarily illegal, though one could argue that it caused "unreasonable" wholesale rates. But the real problem did not lie with those companies. They were doing what they should have been expected to do—exploiting the system for their benefit. The problem was in failing to aggressively examine the newly deregulated system and correct the flaws that existed so that the original goal of using efficiencies to lower prices for consumers would be met. Instead deregulation resulted in creating enormous profits for the energy industry. FERC in particular depended on the market to discipline the system and provide checks and balances toward the ultimate goal of lower prices. It failed to examine ahead of time the ways that advantage could be taken of the system and the necessary implementation of rules to control that. In a system in which the rules are not clear, the regulated will push as close to what is arguably allowed as possible. Moreover, as with the accounting strategy wherein there was a dependence on self-regulation, there is evidence that energy companies generally engaged in false reporting in those areas which required voluntary reporting, such as the reporting of trades used in setting market prices.123 The dispute over whether the trading schemes in California themselves were in fact illegal illustrates this precisely.124

One could argue that such close monitoring and correction was unreasonable because while the system could be monitored and corrected, substantial resources would be required to do so. This goes against the grain and the purposes of deregulation and calls into question a one-size-fits-all mantra. The fact that Enron schemes such as "Fat Boy" and "Death Star" were later shown to take advantage of the simplistic system indicates that these devices would have been discovered earlier had there been sufficient staffing to monitor the market. Yet appropriate staffing to monitor such a complex market might require a disproportionately large commitment of resources and personnel, perhaps hundreds of people to monitor the 56,000 simultaneous markets that existed in the California system. As Darren Bush and Carrie Mayne noted: "Regulation is an essential protection against such exercises [of power manipulation]."125 This in turn makes deregulation look less attractive, or perhaps not as efficient. But this is a lesson that must be recognized. Deregulation alone will not meet particular goals. To meet particular goals, deregulated systems, particularly complex ones that do not have clear boundaries, may require high monitoring costs. These costs must be considered in determining whether deregulation, or a one-size-fits-all market-based strategy, is a more efficient system than traditional command-and-control regulation.

The Enron Debacle as an Example of the Problems With Voluntary Enforcement and Large-Scale Market-Based Trading Schemes

What are the lessons of Enron's financial misstatements and its role in profiting in the California energy deregulation? Though the Enron problem has been described as the work of greedy, corrupt individuals, the market games played in the California energy deregulation, and the illegal and/or misleading accounting devices that helped misstate earnings were inevitable given the way Enron's core business and accounting practices were regulated, and the manner in which deregulation was set up in California.

This is because, in the aggregate, human behavior will lead to personal wealth accumulation to the detriment of others as long as this behavior is allowed. With Enron, a nondeveloped oversight of the then-new industry of energy trading and the lack of oversight of the accounting industry ensured that anything not explicitly forbidden would occur. Indeed, even things that are explicitly forbidden will occur when there is no system to prevent some from occurring. In the vernacular, we would say that Enron took everything that was not nailed down. This is the most important lesson we can take from the Enron debacle, and the one that has greatest implication for the future of environmental protection.

Because this assertion is central in forming the basis for the claim that environmental protection must, indeed can only, occur in particular ways, it deserves further explication. I will begin with a quote from the seminal piece by Prof. Carol Rose on why certain kinds of environmental protection are needed.126 In explaining why cooperative systems of resource control do not generally work when many people have access to the resource, she states:

Why does everyone overfish, even to the detriment of the body of water and its living stocks? According to the economic account, everyone does so because each user knows that, even if any particular individual refrains from fishing so intensely, everyone else will continue to fish, and in fact the other might just fish a little bit more to take up the slack left by any moderate fisher. The moderate fisher in short would just be a sucker."127

This is in fact, always the result when organisms compete for limited resources. Though some animal species cooperate in large groups, if members of that species or other animals are recognized as foreign, they are driven away. The law of animals operates in such a way that unless cooperation has evolved as an evolutionary positive, most animals exist by taking what is needed for support.128 This could occur through grazing, attacking, killing, or stealing. When animals share a resource, such as a water hole, the flourishing of one species or animal depends on lack of success for the other. The paradigmatic conception of survival is a zero sum game because there are only so many resources.

The only reason we tend to forget this preeminent principle in looking at human interaction is because human ingenuity has allowed us to opt out of the zero sum game and actually increase overall resources. Since the beginning of recorded history, this increase has been accompanied by laws and moral codes (such as property law and laws that prohibit the harming of another) that limit this principle in individual actions.129 The problem is that we forget these laws are in [33 ELR 10492] derogation of the basic animal rule and are not the norm. They only came into existence because humans were able, as a group, to perceive the universal advantages of protecting individual accumulations.130 This is because an increase in overall resources is possible only if we protect individual incentives for accumulation and production.

That this was the "legal" response that arose really should be no surprise as it recognizes and respects the basic nature of survival among animals—it respects the concept of selfishness that is the basis of capitalism. And lest we forget that "property law" and its attendant enforcement mechanisms exist in derogation of what has evolved naturally for humans and all animals for all of pre-history, one need only look back at Professor Rose's example.131 When there is no property system, the old adage still reigns. Despite vast increases in knowledge and technology, the fishers of today's lakes are no more likely to control their selfish impulses to overfish than the fishers of 8,000 years ago.132

In order to understand why Enron's actions and subsequent collapse were inevitable, we must focus on the basic primal principle of "taking" what is available. Property rights and accompanying moral codes must be seen as a derogation of what exists "naturally" before this time, and what exists in most animal species. That is, humans take whatever they can, in any way they can, without restraint, at least from noncooperating family or tribal units. This suggests that humans will work around any prohibition that is not clear, or will be tempted to take anything of value if the taking is not explicitly prohibited. An example from the common law is instructive. We would never seek to protect private property from those who would appropriate it by simply saying we will "work with those that are stealing property to make sure they don't steal so much." Nor would we say that we do not need deeds and ownership concepts because everyone will leave everyone else's valuable property alone. Similarly, we do not try to protect property rights by putting forth unclear legal norms or principles. No, we have specific, strict rules and punishments that are enforced. Without clear requirements and/or enforcement of these requirements, there is a return to the "taking" by individuals of whatever is available.

No one seriously proposes that all property rights could be protected simply by exhortation and cooperation, or that we could protect property with an incomplete system that does not make clear who has what property right and how those rights interact. The reason that we do not propose such solutions is that they clearly do not work. Absent an enforceable requirement to the contrary, the default of human behavior is to take that which is available.133 Human behavior will also fill in any interstices of ambiguity. Unclear requirements present a great possibility of noncompliance. Indeed, human ingenuity in exploiting whatever situation is presented is recognized as the efficiency of capitalism. The evolution of common law is designed to correct this problem when it interferes with a right.

Despite this truism, the Enron story shows that our government has attempted to protect valuable commodities by such clearly ineffective methods. Energy trading as a system of creating wealth (or accumulating property) has only been possible since the deregulation of certain energy markets. Yet instead of clearly protecting this newly created "property," the government began with very few rules and no appreciation for all of the conflict that might occur. That there was abuse of this system should not be a surprise.

Similarly, our accounting and auditing system is a piece of regulation that is designed to protect the "property" of equal access to information for investment purposes—a right that is recognized as necessary for the efficient functioning of our stock market and the wealth that can be produced by the access to capital it provides. Yet, oversight of this system was allowed to depend on self-regulation. Again, when the law deregulating much of our financial system finally allowed accounting firms to profit by altering their oversight to protect profit making by their advisory services, it should be no surprise that they "took" this profit as soon as it was available by failing to self-regulate.134

It now appears that Enron was even able to combine the abuses of financial misreporting with the lack of clear rules in the deregulated California energy market. Enron not only exploited loopholes in energy trading regulation in California, it was also tempted to speculate on energy prices, activity that was not reported to shareholders because of shoddy accounting practices.135

Arguably such complex systems are inherently difficult to regulate because it is too difficult to come up with clear rules that cover all of the possibilities. However, in such a case, it may be that the system should otherwise not exist. As Professor Rose notes, market-based enforcement systems are the most expensive of all to monitor and enforce.136 Some property systems simply should not be protected this way. Any advantages gained through trading schemes seeking to capture efficiencies of individual initiative might be swallowed up by the costs of enforcing those schemes. This might be the case with energy deregulation. If it is impossible to police how energy trades are occurring and at what advantage to whom, it may be cheaper to simply have fixed energy sources with fixed costs. Indeed, from the perspective of California, it seems that this might have been better for the people of that state.

What This Suggests for Certain Environmental Policy Initiatives

The protection of our environment in a "cooperative" enforcement manner or by the use of market controls and the elimination of command and control is exactly what is being proposed in many areas of environmental regulation, and indeed [33 ELR 10493] has been a cornerstone of the Bush Administration in Texas and potentially nationally.137 One of the new centerpieces of the Bush Administration is the heavily touted idea that greenhouse gases responsible for global warming can be controlled voluntarily, and that air pollution will be better controlled by trading systems.138

As the discussion above illustrates, "cooperative" strategies which depend entirely on self-regulation simply will not work if human nature holds true. And indeed, anecdotal evidence bears this out.139 The Bush Administration is so concerned that its "voluntary" greenhouse gas controls might not work that it is being accused of coercive tactics from the industry in order to demonstrate the ease and effectiveness of "volunteerism."140

Situations in which there is to be trading are more nuanced. If such trading schemes are accompanied by effective enforcement systems, they should be fine and indeed provide important efficiencies. But as we have seen, some trading systems may simply be too complex for any effective enforcement mechanism. Thus, the advisability of environmental trading schemes should be dependent on the complexity of enforcement. Where enforcement is possible through adequate resources, contains an easily identifiable mechanism such as the requirement of certain equipment, or does not have to depend on self-regulation, it should work.

The application of alternative administration regimes to the environment has been studied. The primary goal of the use of laws to protect the environment is to internalize the negative environmental externalities attributable to human existence and activities. This requires the determination of the optimal level of environmental protection and the employment of tools to get to that optimal level.141

Professor Rose categorized the tools used in the implementation of environmental policies.142 These implementation devices are entitled "do nothing," "keepout," "right-way," or "property."143 These last strategies are more commonly known as "grandfathering," "command-and-control," and "market-based" strategy.144 To these I would also add "education and exhortation." Our current environmental controls use all of these, either singly or in combination.145 However, all of these controls are not created equally. They have different effectiveness and different costs. Professor Rose's great contribution is to recognize what variables might affect the changing cost structure of each of these strategies, and to explore what those variables suggest about the employment of various strategies.146 Professor Rose characterized the variables as "system and administrative costs," "user costs," and "overuse or failure of strategy" cost.147 The first is generally the cost to the government or regulated entity of the regulation itself. This can be seen as the cost to monitor and enforce. The second cost is the cost of equipment or other requirements, which is usually borne by the regulated party. The third is the cost that comes from the ineffectiveness of a strategy, or the loss due to commons overuse.

In examining the various strategies, Professor Rose noted in particular that market-based trading strategies, while significantly reducing costs to users, might significantly increase the costs of monitoring or enforcement.148 This is because in a market system, each source must be individually monitored, and to achieve actual efficiencies, must be able to change and trade "outputs" instantaneously.149 Professor Rose speculates that a market-based control strategy might be an effective control of an environmental externality under extreme pressure because it could provide reductions at a lower cost to the polluter and with little loss due to failure of the program. But she also notes that in order to get effective reductions, enforcement is important and that this cost could be high. Thus, she concludes that market-based control strategies would be best utilized under high environmental pressure because only control of such an extreme problem could provide enough of a benefit to justify the high cost of administration. This mirrors the lessons learned above about Enron and the necessity to adequately monitor and police the California energy deregulation.

Similarly, enforcement schemes that depend on an administration to monitor an overall "level" of desired environmental quality, which can be degraded from various and dispersed sources also present the difficulty of monitoring multiple sources simultaneously. Both the Clean Water Act (CWA)150 and the Clean Air Act (CAA) originally only required the maintenance of an ideal standard of environmental protection, without requiring any particular command-and-control system to get there.151 The states were supposed to ensure that this level was met. But without any mechanisms for compliance, any capacity to monitor, or any standards to govern, both provisions failed miserably.152 The [33 ELR 10494] part of the modern CWA that still requires the maintenance of overall water quality whether technological or process controls work or not, the total maximum daily load (TMDL) program, lay unenforced for decades.153

The failure of this as a strategy was recognized by Congress as recently as 1990. Part of the 1990 CAA Amendments altered the requirements for regulating hazardous air pollutants.154 Prior to 1990, the Administrator was supposed to set emissions limitations at the place which would adequately protect public health.155 But in the case of hazardous air pollutants, many of which were carcinogenic, this was difficult to do in any principled manner. The George H.W. Bush Administration was bogged down and only listed eight pollutants in a 20-year period even though thousands more were clearly at issue.156 Again, the certainty that came along with command-and-control regulation outweighed the supposed efficiencies that could come from a standard that allowed maximum flexibility but contained no mechanism or resources to enforce this mechanism.

In such cases, it is not that inefficient regulation is eliminated, but that there is no regulation at all. Not because it is not necessary or required by law, but that it is impractical and difficult. This theory of environmental regulation and the history of the success or failure of programs might suggest that our administrators would be wary of enforcement schemes that rely on monitoring of divergent, multiple sources simultaneously or that depend heavily on self-regulation, but this is not the case.

The current Administration, pointing to the success of market-based regulation in controlling acid rain,157 suggests that it can be replicated in many if not all areas, and that command-and-control regulation or direct emissions controls may be unnecessary.158 A superficial glance at only the acid rain trading provision might support this theory.

The acid rain provisions that went into effect in 1990 allowed fossil fuel-fired power plants to control emissions of sulfur dioxide (SO2) not just by installing particular required equipment, but by allowing them to try other control methods and to purchase and sell rights to pollute.159 This allowed some companies to invest in expensive pollution control equipment because they could sell the additional "control" to other polluters. Similarly, some polluters could avoid purchasing expensive technology by purchasing the right to pollute from others who had installed higher than needed capacity due to the incremental nature of pollution control.160 In terms of lowering the costs to the regulated parties, this program has worked remarkably well.161

Also of import is that it has happened without enormous administrative cost.162 However, this does not provide evidence that we should eliminate command and control or completely rely on more market-based control strategies. The acid rain SO2 trading program is somewhat unique among market-based schemes, and unique in such a way that it would work well. Since the number of SO2 producers in the program is fairly small, they are similar types of entities, the trades are for relatively long time periods and the sources are already regulated, the cost of ensuring that the trades are complied with is small.163 Only a few hundred reports have to be examined. This does not require an enormous expense and thus does not require that the government depend on self-regulation for compliance.164

Of greater applicability might be the situation of states that have attempted to create trading programs for many if not all pollution sources. So far, these programs have been disastrous. According to the U.S. Environmental Protection Agency (EPA) Inspector General, "state emissions programs to control air pollution are hobbled by a lack of adequate oversight from the EPA, lax enforcement, and bad emissions data."165 The California Regional Clean Air Incentives Market (RECLAIM) program, which attempted to trade nitrogen oxide (NOx) emissions between stationary and mobile sources, has failed to meet its predicted pollution reductions from 10 years ago, and was characterized by EPA's Region IX as having serious compliance problems.166

Moreover, there is mounting evidence that even compliance backed by actual data supplied by regulated industry may be suspect. There are increasing cases of falsification of pollution data reported to regulatory agencies.167 An article chronicling this problem notes that "lab fraud hampers an environmental protection system that frequently relies on voluntary compliance."168

Thus, the only lesson that can be drawn from the success of the acid rain trading program is that we can assume that market-based strategies are more likely to be efficient overall when there is opportunity for innovation or there are economies of scale in the control of that pollutant, and those efficiencies are not squandered either by enormous administrative costs or through regulatory failure because of lack of compliance and effective enforcement. Without market efficiencies, the preferred method of control could simply be mandated at no loss of efficiency, and there would not be the additional costs of administration of the market mechanism. Similarly, the efficiencies produced by market-based controls are more useful if they can be won without significantly increasing the cost of enforcement. Thus, we would expect that systems that are easy to enforce on individual regulated entities, due either to their limited number or other regulation, would be better suited to market-based control strategies, because greater efficiencies (such as lower pollution [33 ELR 10495] control costs to the regulated entity) would not be eaten up by the additional costs of administration.

So though the one large-scale market trading mechanism in environmental policy does work, it does not provide the relevant example for wholesale changes in environmental policy. It is based on a unique set of circumstances that are limited to particular types of control. The general model of broad-based national market-based regulation and reliance upon self-regulation is found in the Enron story. Enron's activities were subject to mature regulatory regimes, the SEC and FERC. The SEC continued to rely on self-regulation by accountants even when a new incentive was introduced that encouraged accountants to fail to comply. FERC assumed that the market would regulate itself even in the absence of clear information or requirements for the selling of wholesale electricity into the California markets. Of course, effective FERC regulation would also have been very costly.

But the proposals to alter environmental policy in this same manner march on. Several commentators have repeatedly suggested that the flaws with state regulation in the 1960s, before the advent of the strict command-and-control regime, have been remedied and that the states now have the capacity to regulate complex ambient programs with multiple sources and/or trading schemes.169 President George W. Bush has indicated a preference for "cooperative" enforcement, and actively pursued such a strategy as governor of Texas.170 Parts of the Clean Skies Initiative, a series of legislative changes proposed by the Bush Administration and introduced in both houses of Congress, represent this change in focus. Though the most publicized part of the program deals with expanding the fossil fuel-fired utility cap-and-trade program for SO2 to NOx and mercury (which face some of the similar "market" advantages of the acid rain deposition program), other parts are more problematic.

In addition to the cap-and-trade program, the Clear Skies proposal seeks to alter the CAA hazardous air pollutant program by eliminating the requirement for maximum achievable control technology.171 As noted below, this provision was added in 1990 precisely because of EPA's inability to determine what might be unhealthy and thus require regulation. But this is all of the hazardous air pollutant program that would remain under the Bush initiative.172 Moreover, the program would eliminate new source review (NSR) for power plants, eliminating any incentive for upgrades that would ultimately result in cleaner plants overall.173 Instead, plants will simply buy and sell pollutants.174 While total pollutants may be reduced overall, it is not clear that they will be reduced compared to the current alternatives. The Bush Administration has already moved to alter the NSR program to eliminate some situations that would require the installation of more stringent pollution control equipment.175 One study noted that this would increase pollution compared to current controls.176 It should be noted that the current acid rain provisions work in tandem with NSR and other portions of the CAA.177 One of the reasons that power plants are easy to monitor is that they utilize similar equipment and are already regulated. A completely unfettered market across numerous pollutants might present a more difficult administration picture.

The Enron debacle illustrates that there is no panacea in self-regulation, market trading, market controls, and market efficiencies. Some examples of energy deregulation have been notably efficient and the large-scale market mechanism of the acid rain deposition program has been successful. But that success is not attributable solely to the fact that "market" mechanisms are used. The Enron collapse shows that when self-regulation is undermined by incentives to cheat, as it was in Enron's financial reporting, it will not work. The California story also shows that the trades that can in fact bring great profit may not meet the goals of lower costs that lead to the establishment of the market in the first place. If the goal of deregulation includes lower cost, then the program must have enforcement mechanisms to control the schemes that participating companies will engage in for self-benefit. After all, their participation is to make a profit. This can be expensive to monitor. Therefore, if there are to be trading schemes that allow for rent-seeking behavior by participants (which is necessary to capture efficiencies), these must be controlled in order to preserve other goals. Self-regulation cannot be counted on, and if government regulation is too expensive or difficult, the savings of the "market" program may be illusory. The Enron story allows us to see what will happen in complex trading schemes and self-regulation in the face of opposing incentives. It is the story of human behavior itself. This lesson must be learned in formulating environmental policy. A large-scale market-based strategy, involving acid rain deposition, has worked, but it is the exception, not the rule. Enron is the rule. This is the legacy for environmental policy of the collapse of Enron.

1. By deregulating energy and increasing competition among companies, we encourage them to produce power by the least expensive means. If environmental externalities, such as dirty air or impacts on animal habitat, are not part of that cost equation process, those that have major externalities will be the lowest cost producers, thus encouraging further environmental degradation.

2. Enron Timeline, HOUS. CHRON. ONLINE (Jan. 17, 2002), available at http://www.chron.com/cs/CDA/printstory.hts/special/enron [hereinafter Enron Timeline].

3. Id.

4. Id.

5. MARK JICKLING, CONGRESSIONAL RESEARCH SERV., THE ENRON COLLAPSE: AN OVERVIEW OF FINANCIAL ISSUE (2002), available at http://fpc.state.gov/documents/organization/9110.pdf [hereinafter ENRON COLLAPSE].

6. Enron Timeline, supra note 2.

7. Id.

8. See infra notes 11-31 and accompanying text.


10. Arlette C. Wilson & Walter M. Campbell, Enron's Aggressive Accounting, 5 FUTURES & DERIVATIVES L. REP. 12 (2002).

11. Manuel A. Rodriguez, The Numbers Game: Manipulation of Financial Reporting by Corporations and Their Executives, 10 U. MIAMI BUS. L. REV. 451 (2002).

12. Id.

13. Id.

14. Id.

15. Id.

16. Id.

17. Id.

18. Id. at 461.

19. Id. at 451.

20. Id.

21. Id.

22. A special purpose entity is a business established

to perform no function other than to develop, own, and operate a large, complex project so as to limit the number of creditors claiming against the project. A special purpose entity provides additional protection for project lenders, which are usually paid only out of the money generated by the entity's business, because there will be fewer competing claims for that money and because the entity will be less likely to be forced into bankruptcy. A special purpose entity will sometimes issue securities instead of just receiving a direct loan.

BLACK'S LAW DICTIONARY 1405 (7th ed. 1999).

23. Wilson & Campbell, supra note 10, at 12.

24. Id.

25. Id.

26. Rodriguez, supra note 11, at 462 (citing Arthur Levitt, The Numbers Game: Manipulation of Earnings in Financial Reports, CPA J., Dec. 1998, at 14).

27. Wilson & Campbell, supra note 10, at 12.

28. Rodriguez, supra note 11, at 462.

29. Full Disclosure, NAT'L J., Feb. 23, 2002, available at http://www.nationaljournal.com.


31. Id.

32. Robert K. Herdman, Testimony: Are Current Financial Accounting Standards Protecting Investors?, 1324 PRAC. L. INST. CORP. L. & PRAC. COURSE HANDBOOK SERIES 695, 779 (2002) [hereinafter HANDBOOK SERIES].

33. ENRON COLLAPSE, supra note 5.

34. David Cay Johnston, Wall St. Banks Said to Help Enron Devise Its Tax Shelters, N.Y. TIMES, Feb. 14, 2003, at Cl.

35. Id.

36. Id.

37. Rodriguez, supra note 11, at 452.

38. Id.


40. HANDBOOK SERIES, supra note 32, at 698.

41. Firms Campaign to Soften FASB Stock Option Rule, CORP. ACCT. INT'L, May 1, 1995; see also Rodriguez, supra note 11, at 481.

42. Rodriguez, supra note 11, at 481.

43. Id.

44. FACT SHEET, supra note 39, at 1.

45. 7 U.S.C. § 6b.

46. FACT SHEET, supra note 39, at 2.

47. Id.

48. Private Securities Reform Act of 1995, Pub. L. No. 106-554, § 1(a)(5), 114 Stat. 2763 (1995).

49. William S. Lerach, "The Chickens Have Come Home to Roost," How Wall Street, the Big Accounting Firms, and Corporate Interests Chloroformed Congress and Cost America's Investors Trillions, HANDBOOK SERIES, supra note 32, at 759, 770.

50. Id.

51. It should be noted that the "schemes" Enron put to use in the California market were not clearly legal. Indeed, the company had been advised by counsel that the trading devices might be illegal. See Harvey Rice, Enron Was Told Strategy in California Could Be Illegal, HOUS. CHRON., Dec. 12, 2002, at 1A. The ambiguous nature of these schemes is a result of a complex system in which what was legal and illegal could not be easily defined.

52. Mike Stenglein, The Causes of California's Energy Crisis, 16 NAT. RESOURCES & ENV'T 237 (2002).


54. Jamaca Potts, Power Loss: The Origins of Deregulation and Restructuring in the American Electric Utility System, by Richard F. Hirsh, 26 HARV. ENVTL. L. REV. 269, 273 (2002).

55. Id.

56. Id.

57. Id.

58. Id.

59. Id.

60. Timothy P. Duane, Regulation's Rationale: Learning From the California Energy Crisis, 19 YALE J. ON REG. 471, 496 (2002).

61. Id.

62. Potts, supra note 54, at 277.

63. Duane, supra note 60, at 496.

64. Id.

65. Id.; HARVEY WASSERMAN, CALIFORNIA'S DEREGULATION DISASTER (2001), available at http://www.nirs.org/monoline/califdereghw.htm.

66. Duane, supra note 60, at 496.

67. Stenglein, supra note 52, at 273.

68. Id.

69. Id.


71. Stenglein, supra note 52, at 237.

72. Id.

73. Id.

74. Id.

75. Id.

76. Id.

77. Id.

78. Id. at 241-73.

79. Id.

80. Id.

81. Duane, supra note 60, at 498.

82. Darren Bush & Carrie Mayne, In (Reluctant) Defense of Enron: Why Bad Regulation Is to Blame for California's Power Woes (or Why Antitrust Law Fails to Protect Against Market Power When the Market Rules Encourage Its Use) (forthcoming 2003) (manuscript at 1, on file with author).

83. Stenglein, supra note 52, at 239.

84. Id.

85. Id.

86. Id.

87. Id.

88. Id. at 237-38.

89. Id.

90. Id.

91. Id.

92. Id.

93. Id.

94. Duane, supra note 60, at 499.

95. Id.

96. Id.

97. Stenglein, supra note 52, at 237.

98. Id.

99. Id.

100. Id.

101. Duane, supra note 60, at 500.

102. Stenglein, supra note 52, at 241.

103. Duane, supra note 60, at 516.

104. Stenglein, supra note 52, at 271.

105. Id. at 241.

106. Id.

107. Duane, supra note 60, at 516.

108. David Ivanovich, Report Raps FERC Over Enron Schemes, HOUS. CHRON., Nov. 12, 2002, at 1B.

109. Id.

110. Id.

111. Bush & Mayne, supra note 82, at 28.

112. Stenglein, supra note 52, at 272.

113. Id.

114. Id.

115. Id.

116. Id.

117. 16 U.S.C. § 824.

118. Duane, supra note 60, at 517.

119. Stenglein, supra note 52, at 242.

120. Id.

121. Duane, supra note 60, at 517.

122. Id. at 531.

123. Laura Goldberg, New Blows to Traders' Credibility, HOUS. CHRON., Oct. 10, 2002, at 1C.

124. Rice, supra note 51.

125. Bush & Mayne, supra note 82, at 1.

126. Carol Rose, Rethinking Environmental Controls: Management Strategies for Common Resources, 1991 DUKE L.J. 1, 3.

127. Id. (emphasis added).

128. For example, wolves hunt in packs to the betterment of all.

129. Robert C. Ellikson & Charles D. Thorland, Ancient Land Law: Mesopotamia, Egypt, and Israel, 71 CHI.-KENT L. REV. 321, 337 (1995).

130. Id. at 332.

131. See supra note 128 and accompanying text.

132. Carol Kaesik Yoon, Scientist at Work, David Pauly, Iconoclast, Looks for Fish and Finds Disaster, N.Y. TIMES, Jan. 21, 2003, at F1.

133. This is not to discount the role that morality has come to play in our society and its ability to control certain behavior. However, I posit that morality alone can rarely enforce the right; there must be occasional enforcement of transgressors or the whole system collapses as everyone realizes the commons are being taken to their detriment. See Rose, supra note 126, at 1. Indeed, what we call "morality" may be another enforcement mechanism crafted by human evolution to coincide with the evolution of common law.

134. See supra section entitled, The Enron Debacle as an Example of the Problems With Voluntary Enforcement and Large-Scale Market-Based Trading Schemes.

135. Records and Interviews Show That Enron Was Speculating on Trades, N.Y. TIMES, Dec. 12, 2002, at A1.

136. Rose, supra note 126, at 21-23.

137. Business Group Readies Voluntary Initiative on Climate Change, INSIDE EPA, Nov. 15, 2002, at 2; EPA Administration Expects New Guidelines for Voluntary Emissions Reporting by 2004, 33 Env't Rep. (BNA) 2077 (2002) (detailing the Bush Administration's approach to voluntary trading and reporting of global warming emissions).

138. Administration Expects New Guidelines for Voluntary Reporting by 2004, 33 Env't Rep. (BNA) 2077 (2002). See also Clear Skies Act of 2002, H.R.5266/S.2815, 107th Cong. (2002).

139. Barnaby J. Feder, Dialogue on Pollution Is Allowed to Trail Off, N.Y. TIMES, Nov. 23, 2002, at B1 (noting that Dow Chemical's cooperative environmental program went away with the death of its major company proponent).

140. Andrew Revkin, U.S. Is Pressuring Industry to Cut Greenhouse Gases, N.Y. TIMES, Jan. 20, 2003, at A1.

141. Victor B. Flatt, Saving the Lost Sheep: Bringing Environmental Values Back Into the Fold With a New EPA Decisionmaking Paradigm, 74 WASH. L. REV. 1, 2 (1999). Though there are disagreements about where acceptable levels of environmental harm should be set, there is little dispute that subsequent action must be taken to get there.

142. Rose, supra note 126, at 1.

143. Id.

144. Id.

145. For instance the Clean Air Act (CAA) has "grandfather" provisions regarding existing stationary sources, "command and control" in the new source performance standards, and "market-based strategies" in the sulfur dioxide trading system, which is designed to control acid deposition. See generally 42 U.S.C. §§ 7401-7671q, ELR STAT. CAA §§ 101-618. One could also note that with respect to climate change gases, the strategy appears to be "do nothing."

146. Rose, supra note 126, at 1.

147. Id. at 12.

148. Id. at 21.

149. Id. at 21-22.

150. 33 U.S.C. §§ 1251-1387, ELR STAT. FWPCA §§ 101-607.


152. Id.

153. See generally OLIVER HOUCK, THE CLEAN WATER ACT TMDL PROGRAM: LAW, POLICY, AND IMPLEMENTATION (Envtl. L. Inst. 2d ed. 2002); Sierra Club v. Hankinson, 939 F. Supp. 865, 27 ELR 20280 (N.D. Ga. 1996).

154. 42 U.S.C. § 7651(a), ELR STAT. CAA § 401(a).

155. ANDERSON ET AL., supra note 151, at 1.

156. Id.

157. 42 U.S.C. § 7651(a), ELR STAT. CAA § 401(a).

158. Under the acid deposition control provision, compliance has been an "unprecedented success (over 99%)." U.S. EPA, EMISSIONS CAP AND TRADE: A BASIC EXPLANATION AND RESULTS UNDER THE ACID RAIN PROGRAM (2000), available at http://www.epa.gov/clearskies/emissions_cap_and_trade_3_14.pdf [hereinafter CAP AND TRADE].

159. Id.

160. 42 U.S.C. § 7651(a), ELR STAT. CAA § 401(a).

161. ANDERSON ET AL., supra note 151, at 1.

162. See CAP AND TRADE, supra note 158.

163. ANDERSON ET AL., supra note 151, at 1.

164. Id.

165. EPA Inspector General Calls on Agency to Improve Oversight of State Programs, 33 Env't Rep. (BNA) 2142 (2002).

166. Trading Foes Hail EPA Region IX Report Criticizing RECLAIM Program, INSIDE EPA, Nov. 22, 2002, at 7.

167. Larry Margasak, Labs Falsifying Environmental Tests, HOUS. CHRON., Jan. 22, 2003, at 3A.

168. Id.

169. See David Currie, State Pollution Statutes, 48 U. CHI. L. REV. 27 (1981); Jody Freeman, Collaborative Governance and the Administrative State, 45 UCLA L. REV. 1 (1997); C. Foster Knight, Voluntary Environmental Standards Versus Mandatory Environmental Regulation and Enforcement in the NAFTA Market, 12 ARIZ. J. INT'L & COMP. L. 619 (2001).

170. Jim Yardley, Governor Bush and the Environment: Bush Approach to Pollution: Preference for Self-Policing, N.Y. TIMES, Nov. 9, 1999, at A1.

171. See Clear Skies Act of 2002, supra note 138.

172. Id.

173. Id.

174. Id.

175. Matthew L. Wald, EPA Says It Will Change Rules Governing Industrial Pollution, N.Y. TIMES, Nov. 23, 2002, at A1.

176. Studies: New Rules Would Add Pollution, HOUS. CHRON., Oct. 24, 2002, at 2A.

177. 42 U.S.C. § 7651(a), ELR STAT. CAA § 401(a).

33 ELR 10485 | Environmental Law Reporter | copyright © 2003 | All rights reserved