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

by Bethany McLean

  One analyst, Prudential’s Carol Coale, wrote a tough note to her clients the next morning, openly questioning whether Skilling was really leaving for personal reasons. She pointed out that he was gettting married soon and had moved into the house he’d just finished building. She pointedly suggested that his departure might well mean that there were deeper problems at Enron than the company was acknowledging.

  Coale, who is based in Houston, was one of the most influential Enron analysts. She formally warned the company that she was considering downgrading the stock; Lay was supposed to have lunch with her to allay her concerns. But when she arrived at Enron’s headquarters and got to the executive suite, she bumped into Skilling, who had begged Lay to let him talk to her. He told her that he was so sure Wall Street wanted him gone that he was surprised the stock hadn’t gone up on the news. Coale told him that she didn’t buy his story. In vague terms, Skilling began to talk about the personal reasons he had for leaving. “He was close to tears,” Coale recalls. “It was very emotional. And it made me very emotionally upset. I walked out of the meeting, and I was very shaken.” She was convinced enough by his explanation that she wound up not changing her rating on the stock.

  Most of the analysts reiterated their buy ratings as well. “Intensive meetings with ENE management continue to show no truth to any of the speculations,” said CSFB’s Curt Launer, who also kept his price target at $84 a share. But by now, even some of the bulls on Enron stock had become nervous. UBS Warburg’s Ron Barone kept his buy rating but offered a warning instead of his usual reassurance. “The reality is Enron has lost substantial employee talent over the past 12 months,” he wrote in a note to his clients. “In addition . . . the company has been plagued with a series of negative issues while its overall quality of earnings has deteriorated, its level of behind the scenes engineering has increased, and its overall standing with the Street has plunged.” Merrill Lynch’s Donato Eassey actually downgraded the stock.

  Over at Kynikos, Jim Chanos, who once thought the bottom for Enron’s stock was some $30 a share, shorted what he calls an “aggressive” amount of stock. Chanos had uncovered something new. Skilling’s departure coincided exactly with the release of the second-quarter 10-Q, which showed that despite Enron’s stellar earnings, its cash flow from operations was a negative $1.3 billion for the first six months of the year. That day, Enron’s stock fell 6 percent, to $40.25. Premiums in the credit derivatives market shot up almost 20 percent.

  • • •

  If the outside world was mystified by the personal reasons, most people inside Enron were equally bewildered—and worried. For years, everyone at Enron had banked on Skilling’s brilliance. Mark Palmer’s catchphrase was, “I’m not necessarily long Enron, but I’m long Jeff Skilling.” Others felt the same way. In many quarters, the confusion quickly turned into caustic anger. “You don’t do that,” says a former executive, meaning “quit.” “You don’t do that if you’re running the 7-Eleven on the corner.”

  On the trading floor, some decided that his abrupt departure wasn’t that surprising after all. “With that type of personality, there’s the wild-card factor,” says one former trader. “There’s a little secretiveness and a lot of unknowns.” Some decided they didn’t care; watching Skilling hype broadband all the way down had dented their faith. “The bloom was off the rose,” says one. Yet other traders quickly came up with their version of a Titanic joke: “Women and children first—right after Jeff.”

  But true to trader form, they didn’t waste a lot of time worrying about why Skilling had left. Almost immediately, it was yesterday’s news, and now, Skilling was definitively no longer one of them. “You’re either in the fight or you’re not,” is how one former trader puts it. Besides that, they had something far more important to worry about. Who was going to take Skilling’s place in Enron’s office of the chairman and get in line to be the CEO when Lay stepped aside?

  The already difficult task of explaining Skilling’s departure became even more difficult the next morning, when the Wall Street Journal printed a story by reporter John Emshwiller, who had interviewed Skilling. Instead of sticking to the script, Skilling told Emshwiller that Enron’s stock had been “kind of an ultimate scorecard”; the Journal cast the plunging stock price as the main reason for his resignation. Skilling said that if the stock had stayed up, “I don’t think I would have felt the pressure to leave.” The story infuriated Ken Lay, who saw Skilling’s comments as a betrayal of the company. Who was going to believe “personal reasons” after that?

  So did Skilling have personal reasons beyond the falling stock price? In conversations with friends, he has blamed a number of things. He has claimed that he was burned out, just like Rice and Pai and Baxter. (“I had to do this. I had to do this. I could not continue to work. This was brutal. This was a brutal ten years. I don’t think anyone realizes how hard it is to build a company.”) He has talked about the problems in his personal life. (“I broke up my marriage. I didn’t pay attention to my kids.”) He has talked about the way he felt handcuffed by the board. (“I didn’t like the fact that the board was Ken’s. No matter what I did, I was never going to be in a position to run the company.”) And he has blamed Baxter’s departure. (“That hurt.”)

  If indeed there was one specific personal reason, no one, not even his closest friends, knew what it was. But the explanation at the other end of the spectrum—that Skilling saw what was coming and tried to escape—is also probably simplistic. It is difficult to find any evidence that Skilling—who once told BusinessWeek that he had “never not been successful at work or business, ever”—has ever admitted that he failed at Enron. Not even to himself.

  What seems clear is that Skilling’s comment to the Wall Street Journal came the closest to the truth: no matter what the real condition of Enron’s business, if the stock had continued to climb, Skilling would not have quit. Skilling wasn’t lying when he said he was leaving for personal reasons—the stock’s steep fall was personal. For Jeff Skilling, Enron’s stock price was one of the most deeply personal things in his life.

  • • •

  The day after Skilling resigned, his brother Mark flew in from Turkey. When he left on August 23, Skilling also left town for a rafting trip with his son. Meanwhile, Rebecca Carter began working out the details of her separation agreement from Enron. She negotiated a severance of $875,000.

  Skilling told friends he had lots of plans. He wanted to go to Africa for a few months and drive from Cape Town to Nairobi. He wanted to learn to speak a foreign language fluently. He was talking to universities about teaching. Of course, true to Enron form, he was also continuing to collect money from the company—Ken Lay couldn’t even cut Jeff Skilling off. In return for consulting services, Skilling was slated to get office space, an assistant paid for by Enron, and $60,000 a month. (He never got any of this money.)

  Skilling also took care of his own finances. Since May 2000, he had sold over 450,000 shares of Enron worth some $33 million. In mid-September, he sold another 500,000 shares, bringing his total proceeds to over $70 million.

  As for Skilling’s mood, it seemed to oscillate between depression, righteous indignation, and manic excitement about the next big enchilada. When he came by Enron’s office on August 22 to show his brother what a cool company he had run, an Enron veteran named Jim Schwieger, who had worked at the old InterNorth, saw him. Schwieger says that Skilling’s eyes were bloodshot and he was unshaven. Schwieger ran after him down the hall just to say, “Jeff, we’re all adults. People had the option to sell at $89. You can’t take responsibility for that.” Skilling shook his hand. He later told a friend he was surprised by the weird quiet in the halls. He had expected people to be high-fiving him, congratulating him on his new life.

  A few days later, the Houston Chronicle published an interview with Skilling in which he ranted about how people couldn’t get that he had quit for personal reasons. “I deserve a break. I honestly believe that.” He added, “
If people come back and write the history of Enron Corporation, they’ll look at my tenure as CEO. It was not great for the stock price. I wish it wasn’t that way. It is what it is. I think what I would ask, and I would hope people would look at, is what earnings did.”

  Skilling also told the paper that his business career wasn’t finished. “I think that there will be some new big idea,” he said. “I don’t know what that big idea will be.” To find it, he planned to rent office space—with Ken Rice and Lou Pai.

  CHAPTER 21

  The $45 Million Question

  Two days after becoming CEO of Enron once again, Ken Lay arrived for an all-hands meeting at the Imperial Ballroom of the Hyatt Hotel, just down the street from Enron headquarters. There, he found himself greeted like a Roman hero, returning from genteel retirement to resume command of the republic at a fateful moment. Hundreds of Enron employees packed into the ballroom jumped up to applaud—and kept applauding—until Lay, wearing shirtsleeves and an aw-shucks grin, finally quieted down the room. “Well, I’m delighted to be back,” he announced.

  Of course, he’d never been gone. Ken Lay had been the one constant at Enron since its birth in 1985 and had been richly rewarded for his role. But that was lost on most of this crowd—especially the older hands—who held Skilling responsible for all that had gone awry. With Enron’s stock below $38 a share, they were desperate for a savior.

  As in ancient times, there were plotters in the room. The traders, led by Greg Whalley, were particularly wary of Lay’s “return.” Furious as they were at Skilling for abandoning them, they’d always viewed Lay as little more than a political fixer, not really a part of Enron’s actual business. All that really mattered to them was who Lay named as chief operating officer. Rumors were already flying, and there weren’t many names the traders deemed worthy of their respect.

  Earlier, Lay had signaled his view of Enron’s condition—and his mission—in the e-mail he wrote announcing Skilling’s departure. “I want to assure you I have never felt better about the prospects for the company. . . . One of my top priorities will be to restore a significant amount of the stock value we have lost as soon as possible. . . . Our performance has never been stronger. Our business model has never been more robust; our growth has never been more certain.”

  Now, standing before the faithful, Lay insisted that there was nothing wrong with Enron that a good dose of PR couldn’t cure. “I’m excited,” Lay declared. “I think we’ve got a lot of great stuff going on. We’re not getting much credit for it in the marketplace for damn sure, but we will.”

  Lay sounded remarkably glib, even dismissive, about any business issues; it was as though he were reading from one of Skilling’s leftover scripts. California was to blame for its problems. (“Now, I will tell you what I think about California. No, I really won’t—probably not in mixed company.”) Dabhol was a mere annoyance. (“Well, India’s India, and that’s about the best we can do. . . . It seems to pop up about every five years.”). EES, which had just announced layoffs, “just keeps banging away and just keeps growing at a tremendous rate.” Lay even waxed optimistic about broadband and repeated Skilling’s mantra to Wall Street: “We are not a trading company; we are a logistics and service company.” Enron, he declared, has an “unassailable competitive advantage unless we shoot ourselves in the foot.”

  In fact, as Lay described it, there was really just one area where things needed to change—values. “I think we slipped a little bit on this recently, and we’ve got to restore it,” Lay declared. “Values are incredibly important to the fiber of this company.”

  Finally Lay turned to the topic uppermost on everyone’s minds—the collapse of the stock. When he agreed to return as CEO, the board awarded him a big new slug of Enron stock and options. (Under continuing pressure from creditors, Lay also persuaded the board to give him $10 million cash in exchange for two annuities he owned, even though a board consultant concluded that the cash value of the contracts was just $4.7 million.)

  Now, to loud applause, Lay announced a special onetime options grant, vesting immediately, to every Enron employee, amounting to 5 percent of base salary. The stock was surely near “the bottom of this cycle,” Lay said, and “we want you to enjoy the ride back up.”

  About an hour after the employee meeting, Lay boarded an Enron jet and flew to New York. He was headed to a hastily called dinner meeting at the Four Seasons to calm the analyst community. Andy Fastow met him there; the Enron CFO had flown up that morning to meet with rating-agency analysts and to have lunch with two LJM investors who had recently learned of Fastow’s decision to sell his interest in the partnership and turn it over to Michael Kopper. Fastow, who harbored aspirations of becoming COO himself, was conspicuously making the point that he’d cast his lot with Enron. That very day, he later let it be known, he’d bought 10,000 shares of Enron stock on the open market.

  Enron shares had slipped six dollars just since Skilling had quit. Eager to convince the two dozen invited analysts that Skilling’s departure did not signal some big problem at Enron, Lay detailed (off the record, of course) how Skilling had unraveled under the pressure of the job; one analyst later told a reporter that Lay said Skilling had been going “kind of nuts.” Lay promised more open communication with Wall Street and clearer financial reports and repeated his pitch about the health of the business. The analysts came away convinced, standing behind their buy ratings. “The Enron machine is in top shape and continues to roll along,” Lehman’s Richard Gross advised investors. CSFB’s Curt Launer pointedly stuck by his $84-a-share target price.

  Responding to all the intrigue about his departure, including rumors that Lay had forced him out, Skilling offered himself up for a phone interview with a Dow Jones energy columnist, insisting that he had left the fast track behind to get in touch with the important things in life, like family, building houses for poor people, and serving as a spokesman for the city of Houston. “I’ve spent the last 34 years working really hard,” said Skilling, then 47, dating that period back to his days as a 13-year-old TV-station production assistant in Aurora, Illinois. “It’s not true that I was cracking up,” he said. “Do I sound like someone who is cracking up?” As for Enron, Skilling insisted: “The company I built is doing great.”

  • • •

  Sherron Watkins wasn’t so sure. A midlevel Enron veteran, Watkins, 41, had traveled a familiar path to Enron—through the revolving doors of Arthur Andersen. Hired in 1993 by Fastow, she was like many Enron employees: bright, mercenary, and ambitious. Like many, she’d made the rounds at the company, moving from Enron Gas Services to International to Broadband. Also like many of her colleagues, Watkins had earned her biggest payday—a $175,000 bonus—from a big deal (in 1999, in Korea) that ultimately lost money. But long before that became apparent, she’d sunk the bonus money and her Enron stock options into a heady new lifestyle: a $500,000 home in Southampton, just a few blocks from Kopper and Fastow; vacations in Italy and Mexico; and a green Lexus SUV. Her base salary was about $150,000.

  Caught up as she was in the Enron whirl, Watkins nevertheless possessed a deep contrarian streak. She was stubborn and blunt, with a mouth that could embarrass a trader (“dickweed” and “circle jerk” were among her favorites). Trained as a CPA, Watkins was quick to grasp the larger meaning of numbers. Inside Enron, she was called the Buzzsaw.

  By June 2001, Watkins was an Enron vice president, married with a two-year-old daughter, and the chief breadwinner in her family. Amid broadband’s collapse, she had nervously accepted redeployment back to the domain of Andy Fastow, whom she’d never really trusted. Fastow had recruited her to work as his “eyes and ears” in corporate development. Her first task was surveying scores of Enron assets to see what could be sold.

  It didn’t take Watkins long to start fixating on all the losers Enron had hedged with the Raptors. She saw the cryptic footnotes in Enron’s SEC filings suggesting Enron had used the SPEs to avoid $500 million in losses in 2000 al
one. In the few months since the Raptors were restructured, the value of the hedged assets had continued to fall (Avici, for example, had fallen some 90 percent). Of course, that mushrooming obligation in the Raptors—hundreds of millions altogether—was supposed to be covered with millions of Enron shares, but their value had plummeted too. Watkins was also concerned about the Whitewing SPE, also known at Enron as Condor. Its debt was coming due in 2002—and its assets no longer had enough value to pay it off. This meant that Enron would be on the hook to cover the obligation, which it would be able to do only by issuing several million more shares. Her concern was turning into panic. How could all this have passed muster with Arthur Andersen? Did anyone else know?

  Watkins was not the sort to keep issues to herself. She spoke freely about it within her circle of friends, who included Kristina Mordaunt and Kathy Lynn—both secret Southampton investors—and Jeff McMahon, then running Enron Industrial Markets, whom she’d known since their days together at Arthur Andersen. About this time, she also called a friend in Global Finance. “Enron’s going down,” she announced: “Andy and Causey are going to jail.”

  Watkins was no babe in the woods. She’d helped manage the JEDI partnership for Fastow, she’d witnessed the shenanigans at broadband, she was well-versed in Andy’s conflicts at LJM. But this was far more alarming. Even as she continued to gather information, Watkins raced to frightening conclusions. This was the worst accounting fraud she’d ever seen!