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

by Bethany McLean

  Fallon soon began to agitate about the staggeringly high costs in the broadband business. Along with Greg Whalley, he came up with a plan, which the two men presented to Skilling. They would take over Broadband, chop the costs dramatically, and bury it in the wholesale business. Though Rice was planning on leaving, the idea of reporting to Whalley infuriated him. Rice told Skilling that he wouldn’t work for Whalley. Here was the climactic confrontation between the old guard and the new, but it was so preordained it was largely anticlimatic. At a meeting on June 15 with Rice and Fallon, Skilling made his decision: broadband would merge into wholesale. The young guns had won.

  The next day, Fallon headed down to the EBS floor and began firing people; eventually he fired 50 percent of the staff. He walked into David Cox’s office and said, “Get out.” He also fired Kristina Mordaunt (who soon rejoined Fastow at Global Finance). EBS executives were calling Rice frantically; Rice, in turn, called Fallon to tell him that was not the way to do things. Fallon stormed into Skilling’s office and asked, “Who’s really in charge here?” The firings continued.

  A few days later, Rice phoned Skilling to say that his decision was final: he was leaving. Skilling said, “Well, I was afraid I was going to have to fire you anyway.” Rice felt betrayed. “One or two years ago, Skilling would have told Fallon to get the fuck out,” he later told a friend.

  Yet even so, Skilling was unwilling to cut the cord. Over a breakfast, he asked Rice to stick around, telling him that they’d come up with something else for him to do. “Don’t go,” Skilling said. “I know how you feel. Why don’t you stick around? We’ll have some fun, and we’ll leave together.”

  Skilling started to wipe tears from his eyes. “The traders have taken over,” he told Rice darkly. “These guys have gotten so powerful that I can’t control them anymore.” Rice agreed to stay through the end of the third quarter—he had options vesting. But in truth, Rice was gone. When you added up all the stock he had cashed in over the years, it came to over $70 million.

  The official announcement that Broadband would be merged into Wholesale went out on July 12. The debacle had cost Enron some well over $1 billion.

  A few people were starting to rethink their life at Enron. One veteran executive had seen the way Enron changed people. “You could see the green MBAs coming in, so happy-go-lucky and innocent,” he said. “Within six months, they’d become assholes.” When broadband’s failure was announced, this same executive was shocked to see people from other divisions trading high-fives. Weren’t they all part of the same company? The PRC sickened him, too. “This place has bad karma,” he told his boss.

  • • •

  In late June, Skilling flew to California, where he was the keynote speaker at San Francisco’s Commonwealth Club. It was about a week after he’d made his widely publicized crack comparing California to the Titanic. Just two days earlier, the FERC had imposed price controls all across the West in an effort to stem the power crisis. Politicians were vowing to punish wrongdoers. For Skilling, this was decidedly hostile territory; many Californians saw him as the person most responsible for their suffering. He insisted on going anyway—he believed his words could convince people to see it Enron’s way.

  Before the speech, Skilling asked Richard Sanders and Mark Haedicke for an update on PG&E’s bankruptcy plans. At the end of a brief meeting, Sanders told Skilling about Death Star, Ricochet, and Fat Boy. Skilling lowered his head. Sanders does not think he had known about the schemes before then.

  When Skilling arrived at the Commonwealth Club, it was surrounded by protestors. Many of them wore pig masks and waved signs saying “Skilling is a pig!” A security guard told him, “We don’t know if we can protect you.” A few minutes into his speech, a woman in the third row got up from her seat, ran up to him, and smashed a raspberry pie in his face. Skilling had pie everywhere, dripping down his face and all over his suit. He wiped off his face and managed to finish his speech. Although he stayed calm at the time, the incident rattled him. “I was exhausted. I was just fucking beat,” he later told friends. “This is nuts.”

  That day the stock closed at $44.05. Never again did Enron stock close above $50 a share.

  CHAPTER 20

  “I Want to Resign”

  “I hereby resign my position as Chief Executive Officer of Enron Corp.” So begins the handwritten note addressed to Enron’s board of directors. That first line is scratched out. In his small, barely legible handwriting, the writer starts over: “After much consideration [crossed out] evaluation and consideration, I have decided [crossed out] concluded that I cannot be effective in carrying out my duties as President and Chief Executive Officer of Enron Corp. Please accept my resignation effective immediately. . . .”

  Jeff Skilling wrote his first resignation note on April 30, 2001, just three months into his tenure as CEO. He never sent it. But from the day he took the job he secretly had one thing uppermost in his mind: quitting.

  In all the time he had been at Enron, Skilling had always seemed supremely confident; there was never so much as a crack in the facade he presented to the world. But now that he was CEO, the facade was crumbling; there was something raw about Skilling’s angst. He never seemed so alone as he did once he took the job—and once things started to go awry. His old allies were leaving, and he missed them terribly—missed the good times that they represented, when they were all so excited to come to work every day and invent a new industry.

  Earlier that spring, another old buddy, Amanda Martin, came to see him. She knew Skilling well, and she could see that he was falling apart. “You’ve got a problem,” she said. “The people you’re closest to and loyal to, you’ve made too much money for them. The next layer down, the Whalleys, the Fallons, they will slit your throat if it means they’ll get to the trough faster.” Once, Skilling would likely have thrown her out of his office for making a remark like that. Not now. Skilling stared out the window in silence for a few moments and then said in a sad voice, “Mandy, you’re most likely right.”

  Another colleague remembers telling him, “Ken Rice and Lou Pai are not your friends,” and he replied, “They’re all I’ve got.” Now he didn’t even have them anymore.

  The stock price had fallen by nearly half since August. Skilling kept do-

  ing what he’d always done—talking it up to analysts and institutional in-

  vestors, making it sound as if Enron was still the greatest, coolest company ever. But they weren’t buying it anymore. People in the investment community were asking tough questions and were no longer so willing to accept Skilling’s tried-and-true answers. The Enron CEO had always embraced the idea that the stock market was his ultimate report card. Now that it had gone against him, he felt enormous pressure to turn it around. But he couldn’t.

  Then there were the pressures of actually trying to run the business. Ken Lay was nearly useless. Lay was in exit-strategy mode, planning his retirement from Enron and, as ever, preoccupied with the trappings of his office. Just before Skilling took over as CEO, Lay appeared in his office. The stock had already started to fall, the broadband business was in meltdown, and the entire state of California was blaming Enron for turning out the lights. In the midst of all this, there was Enron’s chairman, holding fabric swatches for decorating the new $45 million G-5 corporate jet he’d ordered for Enron. “What interior configuration do you like, Jeff?” Lay asked.

  Among the executives who reported to Skilling, the battle raged over who would become the new chief operating officer—a post he seemed incapable of filling for fear of driving away someone he thought he needed. The traders were far more loyal to Whalley than to him. And suddenly, Skilling was no longer infallible. Always before, when Skilling said the stock would go up, it went up. But not this time; now, his insistence that the stock was worth $126 a share had the scent of desperation. Skilling now hated riding in the elevator with employees.

  Always before, Skilling was able to come with a new big enchilada to dr
ive the business—and the stock price. That was the part of being a businessman that he loved. But he was out of big ideas. Righting Enron required lowering everyone’s expectations—something he could not bring himself to do—and fixing problems, which he hated. “It was getting hard,” says a former executive, “and Jeff doesn’t do hard.”

  To those around Skilling, the signs of his emotional distress were clear. “He was spiraling,” says one. In the best of times, Skilling was a volatile, moody character. A few years earlier, when he was still COO, he gave the finger to an employee who had almost run into his car during the morning parking rush. It was hardly the sort of gesture one expected from a big-time corporate executive. But Skilling blew off complaints about the incident, word of which spread like wildfire. “I’m an entrepreneur, not a politician,” he said.

  Now, in the wake of broadband’s failure, some speculated that he suffered from depression. He sometimes came to work unshaven and looking haggard, as if he hadn’t slept. Instead of providing ballast for Enron, he seemed to be sinking with the ship.

  Skilling had always liked passing his time at little bars where he could be anonymous. Now, he was spending more and more time smoking cigarettes and drinking white wine at a handful of bars around Houston, especially one called Muldoon’s. The owner didn’t know who he was, at least, not until much later. But Skilling was such a regular that he gave him a nickname. “Quiet Jeff,” he called Skilling.

  Mark Palmer, Enron’s top public-relations executive, who was himself under growing pressure trying to fend off the avalanche of bad press, had a meeting with Skilling one day. “There are mornings when I want to curl up in a ball,” Palmer said.

  “Man, I know exactly what you mean,” Skilling replied and then launched into his own complaint. “I’m not having any fun,” he said. “I don’t like what I’m doing. I don’t like this place. I’m having a hard time coming to work.”

  “I’m not having any fun.” For much of the time he was CEO, that was Skilling’s refrain.

  • • •

  A few days after Skilling had the pie pushed in his face in California, he and his son Jeffrey left for a trip to Spain and Morocco. They were gone from June 27 to July 8. In Enron’s early years, Skilling seldom took vacations; he didn’t like being away from work. During the trip he took to Africa with his son the previous year, for the first time he’d felt reluctant to return. This time, his reaction was even more severe. “I didn’t want to come back,” he told a friend. “I just flat out didn’t want to come back.”

  Skilling returned in time for the release of Enron’s second-quarter earnings. Some on Wall Street were speculating that Enron’s traders were caught in an enormous, wrong-sided bet, that the trading desk had stayed long even as energy prices plunged. At a minimum, investors were anxious to know what the decline meant for Enron’s business.

  On the morning of July 12, Skilling announced that Enron had beaten Wall Street’s earnings expectations for the second quarter by three cents a share. Net income was up 40 percent from a year ago. The numbers were made in the usual fashion. In May, Enron sold three power plants for just over $1 billion and included the onetime gain on that sale in its recurring earnings. In addition, traders on Tim Belden’s West Power desk and John Arnold in Houston had sensed that the market was about to turn and taken big short positions ahead of the decline.

  But, in fact, the rumors were partially correct, according to an internal presentation, dated May 22, concerning the performance of the wholesale business. It showed that the gas traders, as opposed to the power traders, had been in a huge hole. The report says that as of May 18, the gas traders were down $162 million for the quarter. Although the North American power traders were up almost $300 million—thanks to Tim Belden—hundreds of millions in additional EES losses were chewing up their gains. In all, the wholesale business was nearly $1 billion under its budget of $431 million. Yet in the last two weeks of the quarter the power and gas traders rang up an astonishing string of gains. Was it a reversal of some of the reserves stashed away from the huge gains of 2000? Or was it a sign that Enron traders, by buying or selling in huge quantities, could at least temporarily drive energy prices in the direction of their choosing? Or was it just serendipitous trading? No one may ever know.

  But while the traders were able to save earnings, there was nothing they could do about the company’s cash flow, which was melting away. In fact, they were the source of the problem. Remember the nearly $2 billion in customer deposits Enron had booked as cash flow in 2000? As energy prices collapsed, Enron had to send it all back to its counterparties and then some. As Glisan jotted in his notebook, “Margin & inventory has eaten convert proceeds.” This referred to $1.3 billion in convertible debt Enron raised earlier in the year. He continued, “Giving back margin we previously took in. Should be offset from the cash of the transaction liquidating through the book, but we have not seen that yet.”

  Yet during the conference call and the round of media interviews that followed, Skilling was his old self. “If investors played the old Bob Newhart drinking game and had to refill their mugs every time Skilling said ‘outstanding’ in relation to second-quarter performance, they would have been drunk before the question-and-answer period,” one commentator joked. The CEO pointed out that Enron had met or exceeded analysts’ earnings expectations every quarter for the past four years.

  Although Skilling finally had to publicly admit defeat on broadband—“there’s a meltdown out there”—he reassured investors that Enron would quickly reduce costs to “match the revenue opportunities available.” To Bloomberg News, which asked about Dabhol, Skilling insisted that Enron had “zero intention of taking any economic loss on the project. Zero.” He was also quick to downplay the importance of broadband to the company’s prospects. “The real story for Enron,” he told CNNfn, “is this strong, strong growth and strong profitability of our energy business.”

  But neither sixteen straight quarters of increased earnings nor the reiteration of buy ratings from the analysts did anything for Enron’s stock, which stubbornly refused to climb above $50 a share.

  Instead, in private deliberations in sequestered boardrooms, major institutions were beginning to reevaluate their position on Enron. Unlike the public buy recommendations from the equity analysts, though, these private decisions never came to the attention of the small investor. Between March and the end of June, four large holders—Janus, Fidelity, American Express, and American Century—sold a total of 21.3 million shares, according to an internal Enron document.

  One major Wall Street firm that traded with Enron began to watch its exposure more carefully and ever so slowly cut back the amount of money it would allow Enron to owe at any point. “We thought Enron was a very funky animal that kept getting funkier and funkier,” says a credit officer there.

  Remember the credit derivatives market that Enron had hoped to break into? Many banks use that market to hedge their exposure to loans. Buying credit protection is a very private way to protect themselves against the possibility that a company’s credit might slide. Derivatives on Enron’s credit had always been expensive—which meant there had long been higher-than-normal nervousness about its credit worthiness. Now, according to Creditex, a credit-derivatives firm, the premiums to buy an Enron credit-derivative began to skyrocket, which meant that the market’s perception of the risk was increasing dramatically.

  Enron’s bankers at J. P. Morgan Chase were especially nervous. On the day of Enron’s earnings announcement, Anatol Feygin, the J. P. Morgan analyst, reiterated his buy rating on Enron shares in an upbeat report. On that same day, James Ballentine, a J. P. Morgan banker, sent an e-mail to a number of other executives at the bank, including Ken Lay’s old acquaintance Marc Shapiro, who was vice chairman in charge of risk management. The executives wanted to know “what has been done on Enron,” and Ballentine was updating them. He sent them a list of the bank’s current exposure, which included loan commitments of $60
5 million and counterparty exposure of $275 million.

  Ballentine also told his colleagues a stunning fact. “Net short positions add up to $295 million, which is one of the five-largest short positions in the North American corporate book,” he wrote. In other words, one of Enron’s biggest lenders was also betting against it. “We will look to add to our short positions on an opportunistic basis. . . .” Ballentine added.

  Something else happened on July 12—something important because it shows the extent to which Enron’s enablers became complicit in the deception. Remember Marlin, Enron’s oh-so-clever way to get the Azurix debt off its balance sheet? The debt, which amounted to almost $1 billion, was due at the end of 2001, and just as the short sellers had long suspected, Azurix wasn’t worth nearly enough to pay it back. Which meant, of course, that Enron itself was on the hook for the money.

  Back when Marlin was set up, in 1998, Enron promised to issue stock if the assets backing Marlin proved insufficient to repay the debt. But now that the moment was arriving, Enron was adamant about not wanting to issue new stock. Given the questions that were swirling around the company, that was the last thing Enron wanted to do.

  Once again, Enron’s enablers came to the rescue, allowing Enron to refinance the Marlin debt. In a CSFB-led deal, Enron raised a fresh $1 billion to pay off old investors and extend the terms of the debt for another two years. This new deal contained the same provisions as the old one: all the debt came due at once if Enron lost its investment-grade rating status—and if its stock fell below $34.13.

  The most shocking fact was this: there was clear evidence that Enron would have to pay the Marlin debt in some fashion, because in the offering documents, bankers estimated the value of the Azurix stake supporting it at a maximum of $700 million and as little as $50 million. Yet the rating agencies didn’t sound any alarms, and the accountants still allowed Enron to classify the Marlin debt as “off-balance-sheet.”