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

by Bethany McLean

  A more extreme version of this thinking was that Enron’s sins were not incompetence and fraud but rather innovation and free-spiritedness. Enron’s dwindling collection of defenders made the same argument as Michael Milken’s defenders had in the 1980s: They were being prosecuted because they were a threat to staid, old corporate America. “You can always tell who the pioneers are, because they’re the ones with arrows in their backs,” became their refrain.

  But that was a minority perspective. Most former Enron employees voiced outrage upon learning how their company had remained such a highflier for so long. Their faith in Enron—their pride in working for the coolest company in America—had been shattered. It was as though they all were now wearing a scarlet E.

  By the fall of 2003, almost two years into the Justice Department’s investigation, complaints about the failure to charge Enron’s top executives—and speculation that they would escape prosecution entirely—became deafening. The country was reeling from a wave of corporate scandals that had come to light in the wake of Enron: Tyco; WorldCom; Adelphia; HealthSouth; Martha Stewart and ImClone. In all of these cases the CEOs had already been charged with crimes. Why, many people were asking, were Ken Lay and Jeff Skilling still free men? For most Americans, Enron remained the überscandal: not just the first, but the most brazen and the most devastating.

  The truth is that the Enron Task Force was struggling to put the pieces together, slowed by Enron’s complexity, internal conflicts over investigative strategy, and changes in its leadership—it would have three directors in less than five years.

  A case this complex required cooperating witnesses—insiders who cut deals to help the government in return for lighter sentences—and by mid-2003, the dominos were just beginning to fall. The first were Michael Kopper and Tim Belden, who both pled guilty and promised to cooperate in return for leniency. This provided the feds with a critical window into the complex worlds of Global Finance and California energy trading. (Both agreed to disgorge millions in ill-gotten gains—in Kopper’s case, $12 million; in Belden’s case, $2.1 million. When Belden appeared in court to plead guilty to manipulating California’s energy market he told the judge, “I did it because I was trying to maximize profits for Enron.” His lawyer later said that his tactics simply reflected the way Enron had trained Belden to do business.)

  Then, in September 2003, Ben Glisan pled guilty to one count of wire and securities fraud for his role in Talon, better known as Raptor I. “This trans-

  action . . . was accounted for in a manner inconsistent with its economic substance,” read his plea agreement. Glisan didn’t agree to cooperate, but he immediately began serving a five-year prison sentence, becoming the first Enron executive to go to jail.

  In early October, the SEC announced that Wes Colwell, the former chief accounting officer of Enron North America, had settled his case. Colwell was not charged with criminal offenses, but he did agree to cooperate—which was a huge win for prosecutors given the complexity of Enron’s accounting. The nature of the charges against him revealed how the investigators’ strategy was shifting. The SEC’s complaint noted that Colwell, along with unidentified “others,” had carried out a “fraudulent scheme” that involved “manipulating Enron’s publicly reported earnings through a variety of devices designed to produce materially false and misleading financial results.” Instead of focusing on narrow illegal acts, prosecutors were now building the case that Enron was fundamentally a fraud—and it didn’t matter if this particular accounting move, or that one, was technically legal. Taken in their entirely, Enron’s accounting practices violated the law because they perpetrated that fraud.

  This broader strategy became more obvious a few weeks later. On Octo-

  ber 29, 2003, Dave Delainey, the former head of Enron North America and then of EES, pled guilty to one count of insider trading and agreed to forfeit a combined $8 million to the SEC and the Justice Department. Again, the admissions were sweeping. The Delainey indictment noted that “from at least 1998 to 2001, Enron’s executives and senior managers engaged in a wide-ranging scheme, through a variety of devices, to deceive the investing public about the true nature and profitability of Enron’s businesses by manipulating Enron’s publicly reported financial results and making false and misleading public representations.” The indictment covered everything from the improper reserves set up to conceal the profits the traders made in California to the burying of the EES losses in the wholesale business to the manipulation of Mariner’s valuation to the Raptors. And Delainey had admitted to it all and agreed to cooperate. (Delainey would later be sentenced to two and a half years in prison.)

  For quite a while after the Enron bankruptcy, Andy Fastow had his own line of defense: He pointed the finger right back at Enron. According to people in his camp, Skilling and the other Enron executives created businesses that were either huge cash drains or didn’t make nearly as much money as Enron needed them to. Fastow was charged with the impossible task of raising the capital that allowed the company to appear successful and kept the stock price going up.

  As Fastow saw it, he was hardly the only one who had cashed in from the convoluted financings he had cooked up. Everyone at Enron had benefited: the stock options worth millions; the excessive pay; the Enron lifestyle—Fastow had made all that possible. In his view, every Enron millionaire owed him a debt of gratitude. And yet now they were all throwing him to the wolves. There wasn’t much doubt that Fastow felt embittered, viewing himself as the fall guy for everything that had happened at Enron.

  And in a sense, Fastow was right. Those who wanted to blame all of Enron’s woes on the greedy former CFO claimed that Enron had been a good business brought down by Andy Fastow. But that was never true. Ultimately, Enron was a bad business that was, for a time, propped up by Andy Fastow.

  Rationalizations notwithstanding, Fastow’s situation became far more difficult once Kopper and Glisan pled guilty—and the date of his wife’s trial drew closer. After all, if he and Lea were both convicted, their two children could be left without a parent to raise them for years.

  On January 14, 2004, in a highly unusual package deal, both Fastows pled guilty, setting in motion a strange chain of events. Lea admitted to filing a false income tax return in exchange for a likely prison sentence of five months—brief enough to ensure that she was released before her husband began his sentence. Andy pled guilty to one count of conspiracy to commit wire fraud and one count of conspiracy to commit wire and securities fraud, and accepted a ten-year prison sentence. He agreed to forfeit $23.8 million and abandon claims to another $6 million. Prosecutors believed that that covered most of what was left from LJM and Enron after Fastow’s massive legal bills. He also agreed to cooperate with investigators, acknowledging that he had “engaged in schemes to enrich myself and others at the expense of Enron’s shareholders.” More importantly for the prosecution’s ongoing efforts, he also admitted: “I and other members of Enron’s senior management fraudulently manipulated Enron’s publicly reported financial results. Our purpose was to mislead investors and others about the true financial position of Enron, and consequently, to inflate artificially the price of Enron’s stock and maintain fraudulently Enron’s credit rating.” (Citing Fastow’s cooperation with the government and his apparent remorse, the presiding judge ultimately sentenced him to just six years in prison.)

  Within weeks, former chief accounting officer Rick Causey was also indicted for what the government called Enron’s “scheme” to meet or beat Wall Street’s earnings expectations without regard to economic reality. Causey pled not guilty, and began preparing to defend himself by arguing that Enron’s accounting met the technical requirements. “He has done nothing, absolutely nothing, wrong,” said one of his lawyers.

  Lea Fastow’s deal, meanwhile, ran into trouble with another Houston judge. Convinced that she was getting off too easy, this judge took the highly unusual step of refusing to sign off on the agreement struck between her lawyers a
nd federal prosecutors. The on-again off-again plea bargain was finally sealed in May 2004, just weeks before trial, when Lea Fastow pleaded guilty to a single misdemeanor of filing a false tax return. She was ordered to serve a one-year sentence at a grim federal detention center in downtown Houston. After her release, she opened an art-consulting business in Houston.

  In July 2004, prosecutors scored another coup: Ken Rice, Skilling’s old friend, pled guilty to securities fraud for misleading analysts about the capabilities of Enron’s broadband business. Rice agreed to cooperate with the government, pay a $1 million fine, forfeit $13.7 million in cash and property, and accept a sentence of up to ten years. (Hannon soon pled guilty as well.) A year later, Rice was billed as the government’s star witness in the criminal trial of his former colleagues in Enron’s broadband business. But the trial, which ran aground on mind-numbing detail, went badly for the government, producing a hung jury or acquittal on all counts. Prosecuting the five men again required three separate retrials. Ultimately, charges against Scott Yeager were abandoned, while Mike Krautz won acquittal. Joe Hirko pled guilty to a reduced charge, forfeited $7 million, and served about 16 months. Kevin Howard and Rex Shelby cut deals that resulted in brief periods of house arrest.

  • • •

  Which leaves, of course, Ken Lay and Jeff Skilling.

  On January 23, 2002, Lay had been forced to resign as Enron’s chairman and CEO. He clung to a board seat until early February, when the special board committee issued its report, noting that Lay, as Enron’s CEO, was “in effect, the captain of the ship,” with “ultimate responsibility” for what had happened.

  From the very aftermath of Enron’s collapse, Lay had made clear his belief that he too was a victim—a good man who had been taken advantage of by corrupt underlings, and who was being wronged by a vicious media. Though he made virtually no public statements during this period, his surrogates offered up the notion that he had reasonably entrusted Arthur Andersen and Vinson & Elkins to tell him if there were problems, but they never had. Linda Lay appeared on the Today show to defend her husband, tearfully telling viewers that the Lay family had “gone down with the ship,” had “lost everything,” and was itself “fighting for liquidity.” (The appearance, filmed while the Lays continued to live in a $7 million Houston penthouse and own more than $20 million in other real estate, generated little sympathy.) As for the Justice Department, Lay showed visitors a sign he kept in his private office: “Cowboy’s logic: Getting up a lynch party is not group therapy.”

  And Jeff Skilling? In December 2001, Skilling told the New York Times, “I had no idea that the company was in anything but excellent shape,” and he concluded, “After much soul searching, given the information at the time, I would not have done anything different.” In the months to come, Skilling denied knowledge of all sorts of things, from Fastow’s scamming of Enron to issues as basic as the triggers in the Marlin and Osprey debts. He claimed that despite his Harvard MBA, he didn’t know enough about accounting to answer detailed questions; he had counted on those under him to make sure it was all right.

  Skilling was the one Enron executive who did not take the Fifth Amendment before Congress, though his lawyer advised him to do so. Instead, he put forth his theory that Enron was brought down by a classic run on the bank. “There was a liquidity problem, and people got scared,” Skilling said. “That’s what caused the problem. All the rest of this is ridiculous.” Acutely aware that federal prosecutors were gunning for him, Skilling railed to friends that the investigation was a “witch hunt” and an “absolute travesty.” It was “inconceivable” to him that the government could come up with a legitimate case against him. “Show me one fucking transaction that the accountants and the attorneys didn’t sign off on,” he told people. “If they concoct some bullshit, they’re going to have a fight on their hands, because it—is—not—there!” He added: “Until the day I die, I’m going to fight this thing.”

  Finally, on February 18, 2004, Jeff Skilling got his fight. A grand jury in Houston returned a thirty-five-count indictment against him, alleging conspiracy, fraud, and insider trading (seven counts would be dismissed before trial). The indictment contained damning allegations, claiming that Skilling had played a key part in the decision to bury EES’s losses in the traders’ profits, that he had lied to investors about both California and the state of affairs in broadband, and that he, along with Causey, had a handshake agreement with Fastow that ensured the LJM partnerships would make money on certain deals they did with Enron. The indictment also noted that Skilling had netted more than $89 million from selling Enron stock. Through the picture it painted of the company, the legal filing served as a sweeping indictment of Enron itself, describing a business that was operated to create the illusion of prosperity, not the reality. In other words: a fraud.

  Although Enron mania had receded by the time Skilling was charged, the TV cameras and hovering helicopters reappeared in Houston to track his walk into the courthouse. He was handcuffed, and he looked heavier and far less healthy than he had when he testified in front of Congress two years earlier. But there were indications that he was every bit as feisty. “I am not guilty of these charges,” he said firmly in court. He shook his head in amazement as he read a copy of the indictment, and his dream team of defense lawyers—including no fewer than four top attorneys—sounded publicly very much like Skilling had sounded privately. Hired gun Dan Petrocelli, who had won the civil suit against O. J. Simpson on behalf of the Goldman family, waved a copy of the indictment and told reporters dismissively: “Sixty pages of nothing.”

  Five months later, on July 7, 2004, it was Ken Lay’s turn. The grand jury indicted him on eleven counts (one would later be dropped), including conspiracy, making misleading statements, wire fraud, securities fraud, and bank fraud. Although Lay was primarily accused of covering up Enron’s problems in the summer and fall of 2001, after he had taken over from Skilling, his charges were added to the existing indictment against Skilling and Causey—meaning that the government planned to try the three men together. Like so many others caught up in the Enron scandal, Lay had to make the humiliating, handcuffed “perp walk” in front of the television cameras. At his arraignment that day, he pled not guilty.

  True to form, Ken Lay immediately went on a public relations offensive. Unlike Skilling, who spoke through his lawyers, Lay presided over a packed press conference in which he placed all the blame for Enron’s problems on Andy Fastow and portrayed himself as a CEO who had operated above the fray. But the indictment contradicted that point of view. While prosecutors did not allege that Lay was the man pulling the strings, they did charge that he was well informed of many incriminating details, including the problems at EES, the required write-downs at Azurix, and the meltdown in the Raptors—and that despite his knowledge, he “failed to disclose numerous dire facts about the state of Enron’s business.”

  Thus, the battle was joined, setting the stage for what would be billed as the biggest corporate fraud trial ever. Jury selection wouldn’t begin until January 30, 2006—more than eighteen months later. Lay used part of that time to make his case in public, setting up a Web site (kenlayinfo.com), appearing on Larry King Live and 60 Minutes—and even taking public potshots at the Enron Task Force. A month before his trial was to start, Lay shocked a business-lunch crowd at the Houston Forum during a speech by insisting that “Enron was a strong, growing, profitable company even into the fourth quarter of 2001”—and by attacking his government pursuers by name.

  • • •

  Skilling reacted to his indictment by sinking deeper into a funk, revealing a side of his complex character that most people hadn’t seen before—the side that had more in common with the desperate, distraught man who had spent countless evenings brooding darkly in bars in the months after Cliff Baxter’s suicide. In April 2004, New York City police picked him up at 4:00 a.m. on the streets of Manhattan, believing, according to a wire-service “police source,” that he wa
s an “emotionally disturbed person.” Skilling was heavily intoxicated, and, according to the source, he had accosted people in two bars and on the sidewalk, pulling at their clothes and accusing them of being FBI agents who were following him. (His lawyer said his client had a very different story: A pair of men had attacked Skilling and his wife on the street, pushing them to the ground.) After the incident, Skilling was taken to a hospital for observation before being released. Prosecutors soon after filed court papers accusing Skilling of violating the terms of his $5 million bond, and a judge ordered the former Enron CEO to stop drinking, perform community-service work, and abide by a curfew. Skilling’s lawyers disclosed that he had recently begun treatment for alcohol abuse, and added that he was looking forward to his day in court.

  As the January 2006 trial date loomed, Skilling threw himself into his defense. Days before jury selection, he and Petrocelli launched their own PR offensive, granting a string of media interviews during which they led reporters through the suite of offices the defense team had leased across the street from the federal courthouse in downtown Houston. Both men spoke of how the defendant had worked tirelessly for months on trial preparations, even helping build the office shelving with his own hands.

  Skilling was bankrolling the biggest piece of a spectacularly expensive defense effort. For more than a year, his lawyers had generated a stream of pretrial motions, including a request for a change of venue (ultimately denied) that included a public-opinion poll of Houston-area residents’ attitudes toward the defendant and Enron (many of them associated Skilling with terms like “pig” and “economic terrorist”); the motion was supported by five separate defense experts. According to Petrocelli, the tab for defending Jeff Skilling would ultimately top $70 million (more than $30 million still unpaid as of September 2006). Ken Lay’s defense, which included one accounting expert whose fees totaled more than $1 million, would reportedly cost another $20 million. A sizable chunk of the costs was covered by Enron’s insurance.