Review of The Smartest Guys in the Room by Bethany McLean and Peter Elkind

The Smartest Guys in the Room

It is almost 20 years since the bankruptcy of Enron and the resulting scandal. We are now able to review the event less emotionally and we know about other events that happened later.  Events like the demise of the sub-prime mortgage market, the Worldcom scandal, The Parmalat incident, and others.  In a sense we are in a better position to assess what happened and to learn from the past.

In any company, it is the culture that determines how it behaves.  The following is taken verbatim from the text:

“There is a reason companies value team players, just as there’s a reason that people who get along with others tend to do well in corporate life.  The reason is simple:  you can’t build a company on brilliance alone.  You need people who can implement these ideas and are well compensated for doing so.”

This review will focus on the major players of Enron and how a culture of “me first” led to the demise of what was once considered “a cool company.”

Ken Lay, founder and CEO.  The brilliant executive (GPA 4.0) who would be a socialite.

Education:  University of Missouri (BA, MA); University of Houston (PhD)

Fraternity: Beta Theta Pi. Served as president of the local UofM chapter.

Officer Candidate School (OCS) for the US Navy.  Achieved the rank of lieutenant. Was the special assistant to the Navy comptroller and financial analyst at the Pentagon.

Past employment:  Pentagon, Florida Gas, Humble Oil (now Exxon), Transco.

Earnings at Enron:  more than $220 million in cash and stock.

Ultimate ambition:  to be Secretary of the Treasury (US).  Major contributor to the Republican Party.  Big mistake was not to support George W. Bush (the younger one) in his run for President.  W never forgave him, so was passed over for this role.

Fatal flaw:  Did not realize that misbehaving executive had to be “taken to the woodshed”.  Tended to trust his team and was slack when he needed to enforce rules.

Ken Lay’s major obsession was deregulation.  Whether it be the markets for gas, oil, electricity, anything.  He firmly believed that regulation destroyed markets and that Enron would profit as these were lifted.  In terms of gas, he was correct.  The distribution of natural gas was regulated at the State level and transporting it from one State to another was not profitable.  It was cheaper to burn the stuff off at the well head.  It is what motivated him to join the Houston Natural Gas company as CEO and merge it with Omaha based InterNorth to form Enron. 

At the University of Missouri, Ken began to form lifelong relationships.  Every position he held and every club he joined added to his network.  This he used to further his ambitions.  By means of this network he became an assistant at the Federal Power Commission and later a Deputy Undersecretary of Energy in the Interior Department.  Eventually this network led him to Florida Gas, then to Transco, and later to the Houston Natural Gas Company.

A preacher’s son, Ken hated confrontation and avoided making tough decisions.  This led to a slack enforcement of rules.  As any student who has ever lived in a university residence soon learns:  the rules don’t matter as much as what gets enforced.  Enforcement was very slack at Enron.  Executives soon learned that, with minor exceptions, they could get away with anything.

He enjoyed the trappings of success.  Enron’s fleet of corporate jets was at one time referred to as the Lay family taxi.  This after his daughter moved to Monaco.  He used an Enron jet to deliver her bed to her new home.  Apparently, there are no Wal-Marts in the entire principality of Monaco.  It pleased him to be the front man of an exciting company.  He met business leaders and maintained his Washington contacts.  In Houston he and his wife (his second wife) attended state dinners, became part of the glitterati, and gave lavishly to charities (Enron’s money mostly).  It was rumored that he would run for mayor, but his eye was on Washington instead.  Many publications, including The Economist, wrote favorable articles about Enron and his leadership.  This showed another flaw in his character:  he believed his own press clippings.  This often results in a huge ego boost and an acceptance of the status quo.  Both eventually transpired.

Rich Kinder, COO.  Why it’s a good idea to keep in the boss’s “good book.”

Education:  The University of Missouri (BA, JD)

Fraternity:  Sigma Nu

Past employment:  Florida Gas Transmission (attorney)

Political affiliation:  Republican. Member of Rudi Giuliani’s presidential committee.

Earnings at Enron:  Severance package included a $3.8 million loan forgiveness and $1.1 million severance pay.  Sold his Enron shares for $40 million.

Best exit move:  Purchased Enron Liquid Pipelines (the pipes) from Enron for $40 million.

There are people who believe that Rich Kinder’s departure was a sad day for Enron.  He was a qualified manager whom Ken Lay knew from UofM and, possibly, may have saved the company had he been promoted to CEO.  Others believe that the rot had already set in and that Enron’s ultimate demise was inevitable.  We will never know because Ken was having doubts about him.  Something about not being “polished” enough.  Rich’s divorce and later marriage to Ken’s trusted assistant, Nancy McNeil, sealed his fate.   Lay considered the office affair to be underhanded, although he himself carried on an affair with his own secretary, who later became his second wife.

Nonetheless, it ended well for Rich.  His parting wish was to buy Enron Liquid Pipelines.  This he did with part of his severance package.  He later contacted an old friend from UofM, William Morgan.  Together they formed Kinder Morgan Energy Partners.  In 2020, as EMI, it had equity of $25 billion and was an S&P 500 component company.

Jeff Skilling, CFO.  Why being brilliant and finding the next big enchilada are often not enough.

Education:  Southern Methodist University (BA), Harvard Business School (MBA)

Fraternity:  Beta Theta Pi.

Past Employment:  First City National Bank in Houston, consultant for McKinsey & Company and later became their youngest ever partner.

His best idea:  created a forward market for natural gas.

His worst ideas:  Using mark-to-market accounting.  An employee rating system that came to be known as “rank and yank.”

Salary:  started at $245,000, later bumped to $400,000.  Eventually it was $1.3 million plus a cash bonus of $3.9 million plus $1.2 million under a performance union pay.  This last was based on Enron’s stock appreciation relative to other investments.

Jeff Skilling was a person of ideas.  Not being from the petroleum industry meant that he was not stuck in its prevailing mind set.  Having worked at a bank meant he could come up with the idea of a Gas Bank.  Basically, gas was sold under contract and purchased under another contract.  Should suppliers be reluctant to sell, they would be given a loan to develop supply.  Thus, buyers at one end and sellers at the other end were matched with Enron acting as an intermediary, just like a bank.  Finally, these contracts can be securitized, that is, the anticipated cash flow can be sold as an asset.  It was the right idea at the right time, after this market was finally deregulated.

His second idea was to use mark to market accounting (MTM).  This calls for an explanation.  Mark to market accounting, also referred to as fair value accounting, is a means of recording the fair value of assets or liabilities based on current market prices.  An asset, such as a contract to deliver gas, is booked as revenue immediately based on a discounted cash flow.  The value of this asset is then adjusted quarterly, or yearly, based on its value in an open market.  It works very well for stock portfolios in brokerage firms.  There current market values are easily accessible online and any gains, or losses, are booked.  The difference at Enron is that it controlled the market.  It was not an open market.   Ken Lay did publish procedures as to how these assets were to be reviewed and adjusted, but these were never followed.  They were more for show, to make investors in Enron feel that their shares were being looked after.  Occasionally a whistle blower would bring breaches of policy to the attention of Ken Lay, in every case he or she found themselves on the open job market.

So why did Jeff Skilling insist on using MTM.  Even made it a condition of his employment.  Check his bonus earnings above.  Bonus payments were based on estimated future earnings which were usually exaggerated and seldom, if ever, adjusted.  Also, Skilling vision of Enron was that of an asset light trading company.  In a perfect world this may have worked.  However, this was not to be.  McKinsey & Company, Skilling’s former employer, was (and likely still is) a snake pit and it was this culture that was being transferred to Enron.  Things like checks and reviews made no sense if people were individually judged solely on what profits they brought into the company.  Those not contributing to earning were unceremoniously yanked.

Rebecca Mark, head of Enron International.  The jet setter international executive.

Education:  William Jewell College in Missouri.  Transferred to Baylor University in Texas.  BA in psychology and a Masters in International Management.   Harvard Business School, MBA.

Past employer:  First National Bank of Houston.

Earnings at Enron:  Salary $710,000 and 450,000 additional stock options.  In 1998 and 1999 Enron forgave over $1.6 million in loans.  After leaving Enron, she sold her shares for $82 million.

Slept with the boss (John Wing). Both were married to other people at the time.  Later was in open competition with John Wing.

Rebecca Mark’s career is a textbook example of how eternal optimism and skillful negotiation can carry the day.  She took over from John Wing when his contract was terminated.  Her job was to invest Enron’s wealth (based on stock market value) in power projects around the world.  Her visits were always welcome.  The reason: her visits often meant the investment of millions of dollars.  A good example is the Dabhol project in the Indian state of Maharashtra.  It put her at odds with Jeff Skilling.  First because her activities were in direct contrast to Skilling’s vision of Enron as a “asset light” company.  His goal was to generate profits from trades, buying and selling contracts for gas.  Second because she was his main competitor to replace Ken Lay as CEO. 

On paper, she generated profits for Enron.  But only on paper.  Returning to the power station in Dabhol, ultimately Enron lost its $900 million investment.  However, Rebecca Mark’s overly optimistic projections were accepted by Ken Lay. These were booked as revenue using mark to market accounting rules and meant a bonus payout of $20 million.  Most of it went to Mark.  With her share she bought a Jaguar XK8 (ruby red), a Land Rover (for the kids), a lake house, a ten acre retreat in Taos, and an apartment on Manhattan’s Upper East Side.  There was a wide disconnect at Enron from confidence that was a result of its rising share value and reality.

Andy Fastow, CFO.  Wizard of financial smoke and mirrors and Czar of off the books securitization.

Education:  Tuff University, BA in Economics and Chinese (summa cum laude).  Northwestern University Kellogg Graduate School of Business, MBA.

Past employers:  Continental Illinois Bank, where he became an expert in various types of financing and securitization.  CCC Information Services.

Married into a wealthy and prominent Texas family, the Weingartens.

Starting salary at Enron: $225,000.  By 1990 this increased to over $1 million including bonuses.  It was augmented by many backroom deals estimated to be as much as $60.6 million in total.

Andy Fastow joined Enron because Jeff Skilling was impressed by his resume.  He was oblivious to the fact that resumes tend to be exaggerated and Fastow’s much more so than usual.  What impressed him most was his background in securitization.  Enron needed to free up cash for major project Skilling envisioned and felt that Fastow’s experience in this field was what was needed.  Securitization was very new back then.  Basically, it involves combining asset backed securities (ABS) such as mortgages, leases, and loans, then pooling them, and later transforming them into securities that can be sold to investors.  The process can be easily abused.  Remember the subprime mortgages crisis that contributed to a global recession in 2007.  Continental Illinois, being risk averse, had many rules and regulations regarding them.  Enron had none.

Fastow himself was very insecure.  He was jealous of the high salaries, stock options, and bonuses of his colleagues.  He, on the other hand, was considered to be out of his depth.  Even his knowledge of accounting was suspect.  He was also a finance guy, not a source of profit.  Furthermore, he did not fit into Houston’s more casual lifestyle, despite being married to an heiress.  At one time Skilling wanted to hire Denise McGlone, the former CFO of Sallie Mae, as Enron’s CFO.  Andy had a melt-down.  Became totally withdrawn.  Later complained forcefully to Ken Lay.  Lay, being Lay, relented and eventually Fastow got the job, despite being less talented.

In spite of his short comings, he was ambitious and anxious to show his worth. So, he invented structured finance. It became a source of around $20 billion in capital per year.  In short, he found loopholes in accounting rules that allowed off balance sheet entities to hold Enron’s debt.  These debts paid high returns to a select group and earned Fastow exorbitant fees for his services.  In return Enron was able to publicly present a sanitized balance sheet and the veneer of continued growth.  The reward was a continued rise in the value of its stock.  The increased share value was used as security to fund more off balance sheet entities.  And this continued until 2007.

Fastow also securitized (he preferred to use the term monetized) assets of various Enron divisions.  Cash flow from these assets were sold at a discount and, using mark-to-market accounting rules, recorded as income.  As long as Enron held cash generating assets, it could show a smooth progressing on income that is favored by wall street investors.  This too resulted in an increased value of its stock. 

Fastow invented another method to generate cash. In simple terms, money was loaned to a customer to pay for deliveries in advance.  These were call pre-pays and became a major source of cash.  On the books the money advanced balanced the money received.  In fact, the money loaned was securitized (monetized) and shown as income using mark-to-market accounting rules.  Debt continued to pile up and eventually totaled $38 billion, of which only $13 billion appeared on the balance sheet. 

Lou Pai, CEO. The invisible CEO

Education:  University of Maryland, BS, MS in Economics

Past Employers:  Economist at the Securities and Exchange Commission, Conoco

Salary:  $400,000 plus annual bonus of up to $300,000.  Later extended to $700,000 if certain performance targets were met.  Also use of corporate jet up to a value of $70,000 annually.

Fatal flaw:  infatuated with strippers.  A frequent, and welcome, guest at Houston’s strip clubs.

Skilling’s vision for Enron was that of a trading company.   To implement this there was no better man than Lou Pai.  Chosen for his background in exchange transactions, he was the chief architect of this system and also proved to be a skilled trader.  This alone made him very valuable to Skilling and earned him a promotion to CEO.  This despite his management style which included abuse of colleagues and underlings.  He was considered to be a back stabber and someone not to be trifled with.

Other companies would not have put up with Pai’s antics.  He was a frequent visitor to Houston’s topless bars and strip clubs such as Rick’s Cabaret, the Men’s Club, and Lipstick.  To be fair, the VIP rooms at these places were part of the high octane culture of Houston’s oil and gas industry.  However, for Pai they became an obsession.  Even Ken Lay wanted his head when he learned that these activities where being charged to his Enron credit card, often for more than $1,000 a night. However, Skilling stood by his man.  He needed Lou to do his dirty work:  firing people, calling their ideas stupid, and anything else that he was not comfortable doing by himself. Most important, under Lou’s leadership the trading desk made money.

Despite his abrasiveness, his Enron career ended well.  He sold his stock for over $50 million while it was still highly valued.  This was more by accident than design.  He fell in love with a former exotic dancer, Melanie Fewell.  She became pregnant and Lou need money to divorce his wife.  No information was given as how Ms. Fewell paid for her divorce.  Eventually they married, and Lou spent less and less time at the office and more and more time at their ranch in Colorado.  When, at last, Lou’s contract was terminated, hardly anyone noticed.   

The Traders.  A band of pirates without the respectability.

Jeff Skilling’s vision of an asset light company would naturally result in Enron being a trading company with a band of overachieving traders.  Their first head was Lou Pai until he was transferred to another division.  From day one they developed and independent culture that centered on making money.  As Skilling himself once said: “if you tell one of these guys to turn left, even if he wanted to turn left, will ask how much will you pay me to turn left”.  They developed an arrogant disregard for their own company, their own customers, and everything else.  All that mattered was making money, for themselves.  And this they did. 

They gambled on anything.  The number of Big Macs one could eat or on games of Omaha.  They had a messianic view of the purity of open markets.  Anything was tradable and, if it was not, then it did not exist.  Such a group, with total disregard of hierarchy, chooses their own leader.  And their chosen leader was Greg Whalley.

Greg Whalley.  Proof that you can take the boy out of an M1 Abrams tank, but you can’t take an M1 Abrams tank out of the boy.

Education:  West Point with a degree in Economics, Stanford Business School.

Past employer:  US Army, 6 years as a tank captain.

Favorite book:  The Fountainhead by Ayn Rand.

Greg Whalley had two attributes that endeared him to Skilling and made him a successful trader.  For one, he was intelligent.  Rough around the edges, always direct, but smart.  The second, he was a natural gambler.  He ran a betting pool at Enron ostensibly to teach his traders about risk and reward.  Many executives actually bought it.  He was aggressive and commanded respect, even from the traders.

The major complaint Whalley and the traders had was a perceived lack of respect from people in the executive suite.  They believed that the profits they generated entitled them to more recognition.  Still Skilling and Lay continued to present Enron as a logistics company and not as a trading company.  They also failed to realize that their profits were being generated at a time of expanding markets and volatility.  This eventually changed.  As anyone who trades knows, big gains can turn into big losses overnight.  The amounts they traded were staggering.  Most companies place limits on their traders to minimize risk.  Enron did this in the beginning.  However, Enron being Enron, these rules were stretched and then disregarded entirely.   It was just not in the nature of traders to follow rules.

California.  Gaming the market

California deregulated its energy market in 1998.  This is what Ken Lay often championed with the furor of a preacher delivering a sermon (he was, incidentally, the son of a Baptist minister).  Thus, it would have made sense for Lay to have Enron do whatever it could to be sure its introduction was successful.   California could have become a model for open energy markets elsewhere.  By 1998 the idea of deregulation had taken hold and jurisdictions like Texas and Alberta were willing to implement some form of it. So, from a strategic viewpoint it would have been logical for Enron to have consultations with the California Public Utilities Commission (CPUC) to be sure it was done properly.  However, the traders what’s-in-it-for-me culture would not allow it.

CPUC, the organization responsible for the new rules, tried to please everyone with the result that it pleased no one.  The regulations it produced was riven with loopholes.  To begin, California created two quasi-governmental organizations to manage the process.  One was the California Power Exchange (Cal PX) whose job it was to set hourly prices through actions held the previous day.  The other was the Independent System Operator (ISO) in charge of managing the State’s network of transmission lines.  The rules these organizations followed assumed that producers would “play nice”.  This lasted for three months.

Enron’s power traders were led by Tim Belden, a Berkeley graduate with little regard for rules.  His team found many ways to take advantage of Cal PX and ISO.  Their schemes included submitting a schedule for non-existent demand (called Fat Boy), filing an imaginary transmission schedule in order to get paid to alleviate a congestion that did not exist (the Death Star), selling power that Enron did not have (Get Shorty), and buying power then selling it back at a higher price (the Ricochet). 

How did Greg Whalley explain all this to Cal PX.  Imagine this scenario.  Suppose that one night you had gone to bed and forgot to lock the garage.  Next morning you discovered that your car was stolen.  Eventually the thief is found and taken to court.  At his trial he tells the judge: “your honor, I am not to blame.  I merely called the owner’s attention to deficiencies in his lights out and lock up protocols.  I am actually the good guy here.  Had I not stolen the car he would not be aware of his mistakes, and anyway, someone else would have robbed him”.   Absurd as this sounds, it was exactly what Whalley told Cal PX investigators.  And they bought it, mostly.  The fine was $25,000.

What Greg Whalley did not tell Cal PX and later to the Federal Energy Regulatory Commission (FERC) was that Enron made a profit of $2.2 billion as a result of these transactions.  I’m sure our mythical thief also profited but for much less.  Despite any reservations, Skilling was glad to book these profits.  As for deregulation of energy markets, it lost much of its luster.

Arthur Andersen.  What’s wrong with accounting

Founded in 1919 by Arthur E. Andersen.  Defunct 2002.

Revenue in 2002:  $9.3 billion

Succeeded by:  Accenture, Andersen Tax

There was a time when audited financial statements were not required.  Accounting firms competed for business and strove to show the benefits of their work.  They succeeded very well because eventually the Security and Exchange Commission (SEC) made it a requirement that listed firms present audited statements.  Some say the profession took a turn for the worst after this.  Instead of having to prove their worth, accountants now tried to limit their liability.  Read the audit statement of any Canadian firm and you will find the words “Although the audit is designed to provide reasonable assurance of detecting errors and irregularities that are material to the financial statements, it is not designed and cannot be relied upon to disclose all fraud, defalcations, or other irregularities.”  This is often the opposite of what the general public believes to be the purpose of audits.

Accounting is now governed by rules to which financial statements must conform.  The UK and other European countries have moved to financial statements based on principles.  In the US, accounting is still governed by rules.  To illustrate the difference, I will take an example from the McLean and Elkind text:

Suppose your financial statements must show that you have a duck.  These are hard to procure so you decide to use your dog.  But first you must check the rules.  And according to the rules a duck has (1) yellow feet (2) a white body and (3) an orange beak.  So you dye your dog’s feet yellow, its body white, then glue an orange beak over its snout.  You then take this animal to your accountant and say: “this is a duck.”  Your accountant would then find his/her copy of the rules and find that a duck is defined as an animal having: (1) Yellow feet. Check  (2) White body. Check  (3) Orange beak.  Check

Your accountant would they say “yes, this is a duck” and sign off on your financial statements.

In an accounting system based on principles your accountant would say:

“According to the rules this is a duck, but IN PRINCIPLE, that’s a dog.”  He/she would then NOT sign off on your financial statements.

The rules referred to about are Generally Accepted Accounting Principles (GAAP).  There are now over 10,000 pages of rules.  These rules are subject to interpretation and reviews.  Accountants at Enron and Arthur Andersen became adept at presenting any domestic animal as a duck.

Another change in the profession is that auditing and financial statement preparation became marginal activities.  The big money is now in consulting.  Accountants are now expected to recommend one of their consultants for planning, forming strategy, and other services.  There is now more emphasis on keeping the client happy.  The reasons are clear, in 2002 Enron paid Andersen $52 million and their Houston office was the company’s most profitable. 

Enron was a major track of advancement for Andersen accountants.  Over the years at least 86 were hired by Enron with the promise of higher pay and stock options.  Even the Andersen accountants spent more time at Enron than at their own office a few blocks down the street.  The Andersen employee in charge of the Enron account was David Duncan, a graduate of Texas A&M who joined them straight out of university.  His salary in 2000 was approximately $1 million and he enjoyed a commensurate lifestyle.

Wall Street. A random walk off a cliff.


Founded:  May 1792

Market Capitalization:  $26.2 trillion

When people refer to Wall Street they, of course, mean the New York Stock Exchange (NYSE).  For raising capital, New York has one of the best service infrastructures in the world.  Many will say THE best.  This not only includes brokers, but also lawyers, banks, analysts, and reporters.  Everything that a company needs to be incorporated, listed, and do business is there.  It is governed by the Security and Exchange Commission (SEC) which mandates the use of GAAP(US) and various reporting requirements.  It also investigates cases of fraud and has the power to charge people who have broken US corporate laws. Anyone who has taken business courses is familiar with theories of random walk and efficiency of what is known as “the market.”  So how does this explain how Enron avoided their scrutiny.

The simple explanation is that market efficiency is predicated on perfect information.  But then, Enron followed the rules regarding reporting and disclosure.  We know now that Enron’s management was not completely straight, but the possibility remains that Wall Street was, and continues to be, part of the problem.

For one, investors are biased.  Many are institutions and fund managers who are bound by fiduciary duties to provide the best returns possible.  So they focus on returns and value appreciation.  Few bother to examine balance sheets or read the notes appended to financial statements.  What they do look for is growth.  They expect sales to increase every year and that these sales match, or exceed, budgeted projections.  Skilling, being aware of this, incorporated it into his annual budgets.  Businesses budget in different ways.  Some use incremental budgeting where they increase sales and costs by a given percentage every year.  Others use zero based budgets where they justify all their activities and determine the costs to maintain them.  Enron based its budgets on what sales they needed to increase its share value.  It produced unrealistic revenue targets that drove division managers crazy.  So Lay looked the other way when Fastow produced his off balance sheet sales, when managers booked optimistic projections using mark-to-market accounting, or even when Whalley took advantage of California’s poorly implemented deregulation.  Enron made its sales targets, the stock appreciated, and bonuses were paid out.

Investors are not very comfortable with risk.  This is why industries associated with more risk have lower share values.  A company primarily in the trading business can expect a share valuation of 5 times earnings.  However, a logistics company is perceived as having less risk and can expect valuations of 20 times earnings.  This is why both Lay and Skilling were anxious to brand Enron as a logistics company.  Much to the consternation of Greg Whalley who knew better.  Enron could not forego the 15X downgrading of its share price.

A recent development in the markets is the rise of momentum funds.  These funds exist solely for growth and only buy shares that appreciate in value.  Enron (ENE) was such a stock and because of them, the upward trajectory of its share value accelerated.  The problem with these funds is that share price appreciation is their only criteria.  If this is not met, they will bail faster than the sailors on a sinking ship.  This has the effect of accelerating the downward movement in price.  It is one of the many factors that led to Enron’s decline.

One would expect that, since the NYSE is important to the economy, independent analysts would play an essential part of its functioning.  One would be correct but mistaken.  In fact, analysts too are subjected to persuasion.  Ken Lay used to visit the office of Merrill Lynch often.  They once made the mistake of hiring John Olson from Credit Suisse First Boston (CSFB).  At CSFB Olson had the audacity to give Enron a Hold rating.  In the world of market analysis, this is a polite way of saying Sell.  Lay reminded Herbert Allison, their president, of all the business Enron sent their way and that this was likely to decrease.  At first, Allison decided to back his employee and, sure enough, lost most of Enron’s business.  Today’s analysts are more promoters than researchers. The ones that “play ball” are the ones that get rich.  As for John Olson, he was eventually fired, Merrill Lynch needed Enron’s business more than they needed him.  In time he ended up in a small Houston firm called Sanders Morris Harris.  His feeling about Enron were eventually vindicated.

Finally, there is the role of credit rating agencies.  Companies like Moody and Standard & Poor are part of the fabric of capital markets.  The loan terms that a company is able to negotiate is determined by the rating assigned by these companies.  Certain pension funds are not allowed to invest in shares below a certain grade.  One would imagine that either of these firms would call attention to Enron’s situation (Enron was BBB+).  But here again these firms were frequently visited by Enron’s executives and subjected to persistent favorable arguments.  Firms are also paid to be rated.  Furthermore, agencies that relied on their rating did millions of dollars in business with Enron.  Given these facts, it is obvious that it pays to be silent and to go along.

The Culture.

I started this review by emphasizing the importance of culture and how it influences the way a company performs.  Both Lay and Skilling believed in hiring the best and most talented people.  The feeling was that these people would be able to learn anything, find the best solutions, and develop new processes by which Enron could profit.  Unfortunately, these same people are the ones who are most likely to be susceptible to arrogance and hubris.  Early success had them believe they could do anything.  Walley’s team even tried to control the commodities market in lumber.  They failed and should have realized the importance of information.  The only area in which they had an information edge was in gas markets.

Being smart does not mean that one is a good manger.  Lou Pai and Greg Whalley were very abrasive.  Pai once banished a manager to Calgary for an inappropriate joke at his expense.  Skilling was not much better and Andy Fastow went out of his way to cover up his insecurities.  What saved these people was that Enron’s stock price was doing well.  Profits and a positive cash flow can cover up a lot.  However, when events turned sour, they were not able to cope.  Skilling’s next big idea (his enchilada) never materialized.

There is a feeling of entitlement when one is considered to be the best.  Perquisites such as high salaries, substantial bonuses, access to corporate jets, stock options, etc. are often not enough.  In 2002 Enron’s top 200 people took home $1.4 billion in salaries and various benefits.  Each of the top 200 executive made over $1 million.  26 of them made over $10 million.  The next year they declared bankruptcy.

It must also be noted that it is the team players who do the work that a company needs done to survive.  They collect the bills. It must be noted that after bankruptcy was declared, investigators found over $1 million in uncashed cheques in a desk drawer.  They send out the invoices.  Enron’s customers declared that these were never correct.  They maintain good customer relations, something the traders, nor the executives, nevercared about.  In short, they do the day-to-day operations that keep the company going.

Bethany McLean.  The whistle blower.

Journalist for Fortune Magazine

Education:  Williams College in Massachusetts, BA in English and mathematics

Previous employer:  Goldman Sachs as an investment banking analyst

Salary:  Perhaps $53,000.  This is the average earning for writers at Fortune

In the end it was not the SEC, not any analyst, nor any rating agency that brought down Enron.  In tribute to a free and open press, it was a young writer for Fortune, earning perhaps $53,000, who asked the right questions and did not get any good answers. 

In 2001 she wrote a simple article: How does Enron make its money?  Before writing the article, she poured over Enron’s financial statements and found them to be confusing.  The piece ensued a visit to Fortune’s New York office by Andy Fastow and some of his finance people.  Fastow’s answers to her direct questions were lengthy and nearly unintelligible.  It became clear that he was lying.  What she wrote went against conventional wisdom.  At the time everyone believed that Enron was a cutting edge company that found new ways to make money from trades.  Few people took note.

It was after Enron began to report losses that people took notice.  They too began to ask questions that should have been posed long before.  Some of them worked for the FBI.  It is interesting that, unlike others, she had nothing to lose by reporting the truth.

The End. Finally

December 2001, a six man contingent left Houston for a routine court hearing in New York.  They took an Enron jet (cost $45 million), stayed at the Four Seasons Hotel (rooms start at $1,000 per night), they may have eaten at The Garden (daily specials between $31 to $50, cocktails start at $24).  They flew back the next day.  When you’re on the hook for $38 billion, does an extra million or so really matter.

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