The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron

by Bethany McLean

  Indeed, one of the reasons the Enron scandal burst from the business page onto the front page was its political dimension: Lay was said to be a good friend of the new president. In truth, although George W. Bush gave Lay the chummy nickname Kenny Boy, Lay was never especially close to him; his real friendship was with Bush’s father, former president George H. W. Bush, who lived in Houston. Of course, Lay also knew Cheney: Cheney had served as CEO of Halliburton, a large Texas-based energy company. Later, when Cheney ran for vice president, Enron helped throw him a lavish luncheon. During the first Bush administration, Ken and Linda Lay were invited to sleep in the White House, and in 1991, Bush even offered Lay the position of commerce secretary when the incumbent, Texas businessman Robert Mosbacher, announced he was stepping down. Lay declined, telling Bush that he wasn’t ready to leave Enron. In fact, although Linda was vocal about her desire to be a top Washington hostess, Lay thought he could do better than commerce secretary; he wanted to be treasury secretary. Walker had told him that was the only government position a man of his stature should even consider.

  But Lay made a fatal miscalculation with George W. Bush that permanently strained the relationship. In 1993, when Bush was preparing to run for governor of Texas, he had made the ritual pilgrimage to Houston to get Lay’s blessing. Bush asked Lay to serve as the Houston finance chairman for his campaign. Lay, however, rebuffed the candidate, explaining that it wouldn’t be appropriate since he was then serving as chairman of the Business Council for Ann Richards, the Democratic governor. Richards was a popular governor and Bush a neophyte politician; nobody gave him much of a chance of winning. Somewhat condescendingly, Lay expressed the hope that even if Bush were defeated, the experience “wouldn’t prevent him from running again.” Still both he and his wife wrote checks to Bush for $12,500. Rebecca Mark and Jeff Skilling also contributed to the Bush campaign.

  As election day drew near and the polls showed that Bush might well score an upset, Lay called Bush’s finance chairman and said his wife was going to write another check for $12,500. Although Enron and the Lays ended up giv-

  ing far more to Bush than to Richards, Lay’s lukewarm embrace left its mark. George W. Bush’s finance chairman that year was Rich Kinder. Years later, when George W. Bush was running for president against Al Gore, Lay was named one of the Pioneers: people who had raised at least $100,000 for Bush’s presidential campaign. The leader of the Harris County Pioneers, however, was once again Kinder.

  Was there a business purpose to all of Lay’s Washington schmoozing and fund-raising? Of course there was. Enron’s business needed favorable rulings and legislation to thrive, and that meant it needed the government to institute rules and laws to help spur deregulation along. But Washington was also a personal indulgence for Lay. He spent so much time there because he loved the world of policy and politics and he truly believed in the virtues of deregulation. He argued consistently that deregulation would save consumers money; he used to claim that between 1985 and 1996, consumers had saved some $30 billion a year as a result of the lower natural gas prices deregulation helped usher in. “He knew his stuff, and he spoke from the heart,” recalls one person who worked with Lay on policy issues. Always, he cast himself as on the side of the angels. After all, wasn’t natural gas helping to wean America from its dependence on foreign oil? Wasn’t it helping control pollution? Yes, increased reliance on natural gas helped Enron, but it helped everybody.

  There were times when Lay’s lobbying seemed at odds with his oft-stated belief in free-market solutions. A classic example was Enron’s dependence on such government agencies as the Overseas Private Investment Corporation and the Export-Import Bank, which provided loans and loan guarantees for development projects in the third world. In many cases, these agencies were an important source of financing, since banks were often leery of the risks. Rebecca Mark’s business would have been much smaller without such backing; between 1989 and 2001, some 20 governmental or quasi-governmental agencies, including OPIC, the World Bank, and the Export-Import Bank, approved $7.2 billion in public financing for 38 separate Enron International projects in 29 countries, according to a study done by the Washington, D.C., Institute for Policy Studies. Skilling, who was always Mark’s biggest critic, used to heap scorn on her reliance on government-backed financing, claiming that it was hypocritical for a company that supposedly worshiped at the altar of the free market.

  But Lay had no such qualms. In congressional testimony in 1995 he said, “Public finance agencies are the only reliable sources of the financing that is essential for private infrastructure projects in developing countries.” The following year, amid threats to cut funding for OPIC and the Ex-Im Bank, Lay warned that such moves “will change our strategy.” And in early 1997, he asked Bush, then the governor, to lobby on behalf of OPIC and the Ex-Im Bank, saying that “these export credit agencies . . . are critical to U.S. developers like Enron.”

  • • •

  As Enron grew, so did Lay’s paycheck. In 1990, Lay owned some 300,000 shares of Enron stock and his total cash compensation amounted to about $1.5 million. By the mid-1990s, his salary alone was approaching $1 million and his annual bonus usually exceeded $1 million. And that was just the start. He owned 3 million shares of stock. He had options worth tens of millions. Every year, the board of directors showered him with more options, and every year, Lay realized millions more by exercising some of those options. He had a $4 million line of credit from Enron. He also got something called performance unit payments, which paid Enron executives in cash if the company’s stock outperformed certain other investments. Those payments put even more millions in Lay’s pocket. And just as quickly as he made money, Ken Lay spent it: he owned a high-rise multimillion-dollar condominium in River Oaks, the most exclusive section of Houston, which was decorated by Linda with the best of everything. He bought multimillion-dollar vacation homes in nearby Galveston and in Aspen. He generously subsidized the spending habits of children, stepchildren, and relatives. “Ken,” says an old friend, “liked the complete lifestyle.”

  Just as he wanted outsiders to see him as a good and thoughtful man, he wanted Enron employees to see him the same way. He was the keeper of Enron’s “vision and values,” which Lay later defined as “respect, just treating other people the way we want to be treated ourselves; integrity, making sure that we do have absolute integrity, we’re honest, we’re sincere, we mean what we say, we say what we do. . . .” In one memo sent to staff, he wrote, “As a partner in the communities in which we operate, Enron believes it has a responsibility to conduct itself according to certain basic tenets of human behavior that transcend industries, cultures, economics, and local, regional and national boundaries.” He added that “Ruthlessness, callousness and arrogance don’t belong here. . . . We work with customers and prospects, openly, honestly and sincerely. . . .”

  But at the very top of the company, the handful of insiders who dealt with him regularly had a hard time taking all this seriously—in no small part because Lay’s own actions at times belied his stated creed. He rarely said something difficult to an underling, because he hated unpleasantness. The result was that his key executives found that he could be deceitful, willing to say things that just weren’t true in order to keep people from getting mad at him. Most executives believed Lay’s makeup included an unhealthy capacity for self-delusion: he tended to deceive himself about harsh truths he didn’t want to face. “He invents his own reality,” says one.

  His top executives were also dismayed at the way he and his family openly fed at the Enron trough. “If you’re the CEO of a public company, it isn’t yours,” says a former executive, but Lay seemed oblivious of such distinctions. Over the years, he seemed to have cultivated a powerful sense of personal entitlement. Not only did he use the company’s fleet of airplanes for his private use; so did his children. Enron employees called the planes the Lay family taxi, so frequently did family members use them. Linda Lay used an Enron plane to visit h
er daughter Robyn in France. Another time an Enron jet was dispatched to Monaco to deliver Robyn’s bed.

  An even bigger issue was nepotism. Ken and Linda Lay had five children between them; four of the five worked at either Enron or Azurix, a water company Enron started in 1998. Enron employees were encouraged to make their travel plans through Lay/Wittenberg Travel Agency in the Park, which was 50 percent owned by Lay’s sister Sharon. In fact, Lay himself initially owned a minority interest in the travel agency, which he sold after being warned about the impropriety. Early on, following the advice of an Enron lawyer, Lay agreed to put Enron’s multimillion-dollar travel account out to bid. On one occasion, according to two people involved in the process, when an overzealous Enron administrator hired an outside consultant to oversee the bidding process, Lay’s sister actually lost. So she was then given an opportunity to match the low bid. Travel Agency in the Park retained Enron’s account as long as Ken Lay remained at Enron. In just two years, 1997 and 1998, Sharon Lay’s agency earned $4.5 million in commissions thanks to Enron.

  And then there was Lay’s son, Mark, who was one of Skilling’s first employees. After leaving Enron, he eventually joined a small company called Bruin Interests, which had contracts to store natural gas in facilities owned by Enron. In late 1994, lawsuits were filed alleging that Bruin’s executive team, including Mark Lay, had embezzled more than $1 million from a bankrupt company that Bruin had bought earlier that year. According to the New York Times, the U.S. attorney decided not to pursue the criminal case, but Mark Lay paid nearly $315,000 to settle a related civil suit. (He later told the Times that he “trusted the wrong people and ended up in a transaction that everybody decided was wrong.”) While some of this was still going on, Enron decided to do a deal with another small company that Mark Lay had gotten involved with. Enron agreed to reimburse over $1 million of this company’s expenses; as part of the deal, Mark got a three-year contract with Enron guaranteeing him almost $1 million in salary and bonuses, plus 20,000 Enron options.

  • • •

  • • •

  Ken Lay’s increasing distance from Enron didn’t matter very much to the executives under him. After all, Rich Kinder was running the show.

  Kinder had mellowed a bit since his early days as chief operating officer. Though he still presided over a brutal weekly divisional meeting every Monday morning, he no longer reduced employees to tears, as he once had. Even so, he remained a demanding boss. Once, during a performance review, he told an employee that she’d done a great job, but then only gave her 2 on a scale of 1 to 5. Why, she asked, hadn’t he given her a 1—which stood for excellent? “Nobody’s excellent,” Kinder responded.

  Unlike Lay, Kinder was an utterly practical businessman who saw his job as solving problems and making sure Enron delivered on the earnings targets it promised to Wall Street. Every year, he created a list of Enron’s top ten problems—its alligators—and spent the rest of the year working relentlessly to kill the alligators. He understood the innards of Enron’s various businesses, even the new one Skilling was building. And he commanded respect from Enron’s top executives in a way that Lay never did. “Lay was not a good manager,” says one former executive flatly. “Kinder was a good manager.”

  Although they got along, there was always some underlying tension between the two men. Lay seemed to look down his nose at Kinder, according his talents limited value, and viewing him as having too many rough edges. “Ken was the visionary, and Rich was the deep-down operator, who would go beat up people,” says a former high-ranking executive. “It was like the patrician who has to hire the Mafia.” Kinder seemed to resent Lay’s condescension. The Enron CEO failed to appreciate that it was the company president—and his willingness to roll up his sleeves—who made his grandiose lifestyle possible. “There are lots of visionaries,” says one longtime friend of Kinder’s. “There are very few people who can actually run a company.”

  Kinder had another issue: he badly wanted to be Enron’s CEO. In the early 1990s, Lay had promised to hand over the top job to Kinder but had second thoughts, and concluded that he wasn’t ready to give up his position. At the time, Kinder agreed to stay on as his number two, but in his next employment contract, he negotiated a provision stating that if he and Enron were “unable to agree upon an acceptable employment position,” Kinder could leave the company, and his outstanding loan would be forgiven. Though it wasn’t spelled out any further, both Lay and Kinder understood what the language meant: that at some point in the not-too-distant future, Lay would make Kinder the CEO of Enron. From Kinder’s perspective, that was the only “acceptable employment position.” And, according to Enron executives close to both men, Lay had assured Kinder that would happen when his own contract expired at the end of 1996.

  In the aftermath of the Enron bankruptcy, there are many in and around the company who embraced the theory that it might have been avoided if Lay had kept his promise and made Kinder CEO. Many former Enron executives believe that he tempered the company’s natural aggressiveness and brought a sense of discipline it badly needed. He was also the one person at the top of Enron who looked skeptically at things, consistently asking, “Are we smoking our own dope? Are we drinking our own whiskey?” After Kinder left, this theory goes, the inmates were running the asylum.

  But to view Kinder simply as the white knight who got away is to ignore a more complicated reality. In truth, some of the seeds of Enron’s downfall were sown on Kinder’s watch. It wasn’t just Ken Lay and the board who signed off on Skilling’s use of mark-to-market accounting; so did Kinder. And if Kinder ever actually confronted Lay about his own blind spots, it doesn’t appear to have produced tangible results.

  Kinder was also every bit as focused as Lay and other Enron executives on making Wall Street happy, thus ensuring that the stock would go up. Analysts and investors, many of whom viewed Lay as useless (“Ask a candid question, get a canned answer,” says one), vastly preferred dealing with Kinder. He was the one who told them what numbers to expect and the one who delivered on that promise. He knew how to sell the Enron story, which he did (along with Lay and other Enron executives) at extravagant ski retreats Enron threw for analysts and big institutional shareholders.

  Kinder was also the one who told Enron’s division heads the earnings they were really expected to deliver each quarter. Invariably, Kinder would accuse them of “sandbagging” him with lowball estimates and force them to stretch. “That’s bullshit,” he would say. “My grandmother could make $50 million. You can make $60 million.” For this, the Enron COO made no apologies; he believed in setting the bar high and forcing people to jump over it.

  But given the kind of company Enron was, the bar was hard to jump over consistently. And thus did Enron begin turning to aggressive accounting tactics, tactics that planted those dangerous seeds. The things Enron did in those early years were not illegal, nor did they push the boundaries anywhere near as far as it did later in the decade. But they did help mask certain unpleasant financial realities, and they pushed the company into accounting’s gray zone. Kinder, though, had a sense of where the limits were—and he knew how to maintain control. Had he stayed, Enron’s highs would never have been as high. But the lows would never have been as low.

  • • •

  Fifteen percent a year. That’s what Enron was promising investors: that its earnings per share would grow at a clip of 15 percent a year.

  That was an admittedly aggressive target, but if Enron could deliver, the company would be handsomely rewarded. Companies that grow at double-digit rates are classified by investors as growth companies, and they tend to have higher stock valuations than slower-growing companies. This was never truer than during the bull market of the 1990s, an era when growth companies were the only kind of companies investors wanted to buy. Internet stocks were growth companies, of course, and so were big technology companies like Microsoft and Cisco and Sun Microsystems. Every company, it seemed, was striving to become known a
s a growth company. The problem is that whenever a growth company disappoints Wall Street—when it announces earnings that don’t meet the aggressive target it has set for itself—the punishment is usually severe. As rapidly as growth stocks can run up when the news is good, they can spiral downward just as quickly when the news is bad.

  At Enron, as at many companies in the 1990s, a big incentive for achieving double-digit earnings growth was that it would make its executives rich. With so much of their compensation tied up in stock options, Enron executives cared deeply about seeing the stock rise as rapidly as possible: a rising stock had the potential to make them millionaires. For Kinder and Lay, it was even more explicit: it was written into their employment agreements. In early 1994, the Enron board awarded the two men enormous options packages: 1.2 million options for Lay and another million for Kinder. The vast majority of the options—80 percent—did not vest until the year 2000, meaning that the two men would not be able to cash in the options until then. But there was another provision: if Enron delivered at least 15 percent annual growth, a third of their options would vest each year. That one clause was worth millions to each man.

  But how was Enron going to hit that growth target? It wasn’t easy. Despite Skilling’s traders and Mark’s international deal makers, it was still an energy company, with an energy company’s issues. The pipeline division had become solidly profitable, but it was never going to be a fast-growing part of the company. In 1993, the pipeline division made pretax profits of $382 million; the next year, pipeline’s profits rose to $403 million—for a growth rate of just over 5 percent. Enron had a division called Enron Oil and Gas, its exploration and production arm. That part of the business was downright turbulent, with profits plunging one year, skyrocketing the next. Volatile earnings may reflect the way many businesses work, but they’re not rewarded by Wall Street, which values consistency above all else. Skilling’s ECT was generating the kind of fast-