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

by Bethany McLean

  And yet he was unhappy. Why? Because even though he was making more money than he’d ever made in his life (and was married to an heiress), he could see plainly that his pay wasn’t even close to what the big earners at Enron were raking in. Even worse, it probably never would be. The people who made the big money at Enron were the executives who either ran divisions or landed big deals. John Wing, Lou Pai, Ken Rice, Rebecca Mark, and others were already millionaires, thanks to their Enron compensation deals. They got huge bonuses, tons of stock options, pieces of their deals or businesses—you name it. But executives like Fastow, in finance, were never going to make that kind of money. And that’s because the finance department, important though it was to ECT’s success, wasn’t a profit center in its own right. It didn’t contribute directly to Enron’s earnings; as they say in business, it didn’t have its own P&L. (The letters P&L stand for profit and loss. The phrase means that a division isn’t just a cost center; it makes money for the company.) “The whole story about Andy is that if you didn’t have a P&L at Enron and you didn’t add a lot of money to the P&L, you weren’t a man,” says a former colleague.

  Desperate to prove that he belonged among Enron’s heavy hitters, Fastow began lobbying Skilling to give him a division to run. And because he had become one of Skilling’s favorites, Fastow got his wish. By 1996, Skilling had put Fastow in charge of a new division he’d recently set up. It was supposed to be Enron’s first foray into the retail-energy business, an effort to sell electricity and gas directly to the consumer. But nobody had figured out how, precisely, Enron was going to do that; Fastow was told to come up with the business plan for the new unit.

  Try as he might, he simply couldn’t do it. Fastow’s business plans were so poor that Skilling kept sending him back to the drawing board. “He had lots of big ideas and went in lots of different directions,” recalls a former colleague. “He would talk a big game.” But he never came up with anything that had a real shot at being a business. Within nine months, after many shouting matches with Skilling, Fastow was back in finance. Fastow saw his failure as a major humiliation, potentially fatal for his career at Enron. There was no glossing over the fact that he failed miserably. Some of the traders started calling him Andy Fast-Out.

  But within a matter of months, Skilling sent a clear signal to the rest of the organization that Fastow was not going to be punished for his failure. On January 13, 1997, just weeks after replacing Kinder as Enron’s president, Skilling named Fastow a senior vice president, in charge of treasury, risk management, pricing capital, and funding for all of Enron’s business. Fastow was also named to Enron’s management committee. He was now part of the inner circle. (Shortly after Fastow was promoted, his wife Lea, who had risen to assistant treasurer, left Enron after giving birth to their first son.)

  • • •

  To many who knew him well, Fastow seemed an incredibly insecure man. There were many people at Enron who kissed up to Skilling, but few did it as overtly as Fastow. “Gratuitous annual self promotion” reads an entry on Skilling’s calendar next to a meeting with Fastow. Fastow named his first son Jeffrey; after the birth, as Fastow was passing out cigars in the office, he had to fend off jibes accusing him of being a “suck-ass” for naming his son after his boss. According to one former managing director, Fastow replied, “Hey, who’s done more for me other than my mom and dad?”

  Fastow frequently complained about money: how he wasn’t making as much as he should. After getting his promotion to senior vice president, Fastow hired a personal image consultant to help him dress like a corporate executive; later, he started wearing double-breasted designer suits, buttoned up, making him a dandyish figure in the halls of Enron, where people tended toward 1990s-style casual cool (khakis and open-collar shirts). Before he bought a new Porsche, he polled women in the office to see whether he should buy a blue car or a black one.

  Fastow also seemed to have a split personality; he was Enron’s version of Dr. Jekyll and Mr. Hyde. “He was so mean in business but so personally delightful,” says one banker who knew him well. In a company full of strident Republicans, he was not. Years before it became a public issue, Fastow turned down a coveted invitation to attend the Masters golf tournament because women weren’t allowed in the club. He was a devoted and doting father. He was also a health nut who was known for taking long runs. And he took care of employees—certain employees, that is—whom he needed on his side. “You always knew Andy was out for himself, but as long as you made him look good, he always looked after you,” says a former colleague.

  But Fastow was also greedy and out for himself—a “take-no-prisoners political animal,” according to a former colleague—who had no qualms about taking credit for things others had done. And he had a vicious temper. “You could tell when he was about to twist off,” says one banker. “That mouth would go in a certain way, and then he’d stretch his neck. You knew he was going to explode, and it would be terrifying.” To the bankers and Wall Streeters he dealt with regularly, Fastow’s volatile fist-pounding manner came to exemplify Enron’s culture. And over the years, it only got worse. “As time went on, Andy changed,” says an early senior executive. “People started to become afraid of him and afraid to speak out. It almost created a fear factor between Andy and people who did not agree with him.”

  In late 1997, Skilling decided to search outside the company for a CFO. He met with a handful of candidates and took a particular shine to Denise McGlone, the former CFO of Sallie Mae, who in 1997 was named one of Euromoney’s top 50 women in finance for her work in risk management and derivatives. He went to New York to talk to McGlone and was impressed enough that he had her fly to Houston to make the rounds at Enron. Fastow, recalls a former colleague, “freaked out.” She continues: “I was sitting in my office. He’d been acting really weird. Skilling walked by with this woman, introducing all of us. Andy really almost had a meltdown over it. He was in his office, staring at his desk, not reading anything, not doing anything.”

  Rick Causey, Enron’s chief accounting officer, was almost as upset as Fastow. For both men, their worry was the same: a new CFO would inevitably get between them and Skilling. They each went to Skilling and told him that either one of them would work for the other but neither would work for McGlone. They got their way. Lay told Enron’s board that he felt the best candidate was an internal one: rising star Andy Fastow. In March 1998, Fastow, just 36 years old, was named CFO of Enron. Once again, Enron had installed the wrong man in the wrong job for the wrong reason.

  “Andy didn’t have the knowledge base required to be the CFO of a major company,” says one of his former bosses at Continental. He had a narrow set of skills—creating financial structures—and lacked the experience and judicious temperament the job required, the willingness to say no to deals and the attention to basics necessary to insure that the company’s balance sheet remained strong. “Andy didn’t have a risk-control bone in his body,” says Sherron Watkins.

  He lacked something else: the knowledge that being a CFO demanded. Fastow knew so little about accounting that one person who knows him wasn’t even sure he could dissect a balance sheet. “It amazes me that you’d take a corporate finance asset-backed guy and make him CFO,” says his former boss. “That’s not what a CFO’s job really is.” Of course, the man had never worked at Enron.

  • • •

  Though he now held the exalted title of chief financial officer, Andy Fastow’s job didn’t really change at all. He still saw his primary role as creating the financial structures that would allow Enron to hit its profit targets. And even though he was now CFO, Fastow was never supposed to be able to do whatever he wanted without any oversight. There were others, both in and outside the company, whose job was to act as a check on Fastow, to perform the same kind of role as his old bosses at Continental. To put it another way, there were people whose job it was to say no to Andy Fastow when he wanted to cross the line.

  Ostensibly, the person inside En
ron who was supposed to help keep Fastow in check was Rick Causey, the company’s chief accounting officer. At most companies, the chief accounting officer reports to the CFO. But that wasn’t true at Enron. Aware of Fastow’s shortcomings, Skilling made Causey his equal and gave him many of the day-to-day responsibilities that a CFO normally handles. Causey reported directly to Skilling.

  One of Causey’s responsibilities was to determine how Fastow’s transactions were reported on Enron’s financial statement. He was also the go-between between Enron and its outside accountants at Arthur Andersen. Had he been willing to declare that Fastow’s transactions didn’t pass the smell test, it would have been impossible for Fastow to do what he did. On paper, at least, he had the authority to stop Fastow from going too far. But Rick Causey didn’t see his job in those terms. Instead, he saw his role as facilitating Fastow’s transactions. Ultimately, he was every bit as weak in his role as Rick Buy was as chief risk officer.

  A University of Texas graduate, Causey joined Arthur Andersen straight out of school and spent almost nine years there, the last half of which he worked primarily on the Enron account. In 1991, Causey joined Enron as assistant controller at a salary of $100,000 and helped do the accounting work for JEDI and Cactus. Though he never made partner at Arthur Andersen, he was promoted to chief accounting and information officer at Enron at the age of 37. To a large extent, Enron was all he knew.

  Within the company, people used to call the roly-poly Causey “the Pillsbury doughboy.” Soft-spoken, considerate, salt of the earth, he loved playing golf and attending University of Texas football games. He wasn’t a bully, either—not the way Fastow was—but he knew what he had to do, and he did it willingly. Not that he had much choice. “If he didn’t figure out a way to make things happen, he’d be fired,” says a former finance person.

  One of Causey’s big responsibilities was to keep track of where Enron stood in relation to the earnings targets Skilling had promised Wall Street. He had an army of CPAs that eventually numbered around 600, most of them spread out in Enron’s various business units. The accountants would alert Causey of impending earnings or cash flow holes so that Causey could figure out what deals needed to close where. And he would coordinate with Fastow’s finance team to figure out a way to fill the holes. “Any company worth its salt uses accounting rules to smooth small peaks and valleys,” says one former Enron accountant. “But with Enron, it got to a point where it was so prolific.” Says another former Enron accountant, “Budget shortfalls weren’t just business issues, they were accounting issues. There was an absolute conviction at Enron that clever accounting could alter the business reality.”

  Causey also had a smaller team of some 30 accountants in Houston and London called transaction support. Instead of being back-office types, these people, some of whom came from the Financial Accounting Standards Board (FASB), which writes new accounting rules, worked side by side with the finance team to structure deals. These accountants saw themselves as advisers—even gatekeepers—who guided the deal makers by telling them what the accounting ramifications would be. They also knew all the latest rules and the loopholes—and how best to exploit them—and there was often pressure from the deal makers to do just that. To this day, few of the in-house accountants believe they did anything wrong. They knew that they stretched and twisted the rules to Enron’s advantage, but they saw their actions as creative rather than misleading. And that seems to be Causey’s view as well. People who worked for him agree that he was a capable accountant who acknowledged he was pushing the limits but didn’t believe he was stepping over the line. “I always thought he had at least one foot on solid ground, not that he couldn’t stretch!” says one.

  What they were doing—what some might even privately admit they were doing—was gaming the system. By the 1990s, it took literally tens of thousands of pages to list all of the nation’s accumulated accounting rules, known as General Accepted Accounting Principles, or GAAP. (When a company presents its financials to the public, the numbers must be in compliance with GAAP.) Every time the Financial Accounting Standards Board wrote a new set of rules, it did so to help ensure that a company’s books reflected its underlying reality.

  But interpreting those rules has always been more art than science, reliant in no small part on the good faith of those applying them in everyday situations. For very smart people who saw the rules as something to be gotten around, well, it wasn’t all that hard to do—in fact, some former Enron employees argue that the rules themselves provided a road map. And Enron, which prided itself on employing only the very smartest people, took that view further than any company that’s ever existed. “We tried to aggressively use the literature to our advantage,” admits a former Enron accountant. “All the rules create all these opportunities. We got to where we did because we exploited that weakness.”

  Here’s how another former employee describes the process: “Say you have a dog, but you need to create a duck on the financial statements. Fortunately, there are specific accounting rules for what constitutes a duck: yellow feet, white covering, orange beak. So you take the dog and paint its feet yellow and its fur white and you paste an orange plastic beak on its nose, and then you say to your accountants, ‘This is a duck! Don’t you agree that it’s a duck?’ And the accountants say, ‘Yes, according to the rules, this is a duck.’ Everybody knows that it’s a dog, not a duck, but that doesn’t matter, because you’ve met the rules for calling it a duck.”

  And there was the ultimate problem. With Enron’s financial team working feverishly to exploit the rules, there was no one willing to say that the duck was still a dog. Because they could come up with plausible rationales for why a given structure was technically valid, they believed they were on the right side of the law. They were, in fact, proud of what they were doing. In their view, they were doing what every other company was doing, except that they were doing it better and smarter, because they were Enron, where everything was done better and smarter. But while people at Enron were smart about bending the rules, they were not smart at all about understanding where all that bending was taking them.

  • • •

  Besides, hadn’t the outside auditors at Arthur Andersen signed off on the transactions and structures Fastow and his crew were devising? Hadn’t Enron’s longtime accountants bestowed their blessing on all that financial cleverness? For that matter, hadn’t Arthur Andersen been intimately involved in helping Enron set up these structures—as well as helping to devise the accounting treatment? After all, the outside auditors are the ones who sign off on publicly filed financial statements, giving their word that they “present fairly, in all material respects” the financial condition of a company. They are supposed to be stick-in-the-muds who say no far more often than they say yes.

  The accountants should have been a potent check on Fastow. But Andersen, despite having more qualms than Causey or any other high-ranking executive inside the company, had great difficulty saying no to Enron. The accountants in Arthur Andersen’s Houston office worked so closely with Enron that they came to see the world in the same way as Enron executives. Nor did they want to risk losing one of their biggest clients. This was also part of the modern bull market: a gradual disintegration of the high standards that accountants had once proudly upheld.

  There is a sad irony in the fact that Arthur Andersen was brought down by the Enron scandal. For much of its history, Andersen was the most upright of the nation’s accounting firms and took enormous pride in that reputation. An accounting firm’s primary allegiance is supposed to be to the investing public, not the company whose books it is auditing. No firm took that mission as seriously as Arthur Andersen. It was founded in 1913 by a Northwestern University professor (whose name, naturally enough, was Arthur Andersen). One of the firm’s early mottos was “think straight, talk straight,” a saying from his Norwegian mother. Andersen was a principled, even self-righteous, man, and the firm’s lore is full of stories about his standing up to t
he corporations that employed his accountants. Once, in the firm’s young and lean years, Andersen auditors told a railway company client that it had to change a certain accounting practice, to the detriment of reported profits. When the company’s president demanded that the firm reverse itself or lose the account, Andersen famously retorted that “There is not enough money in the city of Chicago” to make him change the firm’s decision. (Throughout its life, Chicago was Andersen’s home base.) Andersen lost the account. Months later the railroad company was bankrupt.

  Arthur Andersen started the first training school for accountants, recruiting young men straight out of college so he could indoctrinate them in the Andersen way. They all had to dress the same, use the same methods, offer the same level of service, and uphold the same high standards. Competitors seethed at what they saw as Andersen’s arrogance and labeled its staffers Androids. The founder could not have cared less.

  Andersen’s successor, Leonard Spacek, who ran the firm from 1947 to 1963, was every bit as principled and every bit as self-righteous, often publicly scolding his profession for—as he put it in a 1957 speech—“failing to square its so-called principles with its professional responsibility to the public.” He regularly berated the Securities and Exchange Commission for not doing a good enough job rooting out accounting fraud, claiming that the SEC was “at best a brake on the rate of retrogression in the quality of accounting,” and continued his crusade for high standards even after he’d retired from the firm. The Financial Accounting Standards Board, which was formed in 1973, came about largely because of Spacek’s incessant lobbying.