The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron
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But he was also eager to sound a warning about current corporate practices. “The last reason I’m here,” he continued, “is because, in my opinion, the problem today is ten times worse than when Enron had its implosion. . . . The things that Enron did, and that I did, are being done today, and in many cases they’re being done in such a manner that makes me blush—and I was the CFO of Enron.”
But if Andy Fastow learned his lesson, it’s not clear anyone else did. Which is more than a little bit ironic, because even after Enron was out of the headlines, the scandal reverberated through the worlds of both business and popular culture. Everyone began talking about the importance of ethics. There were conferences (“Best Practices: A Blueprint for the Post-Enron Era”), academic papers (“Enron Ethics: Culture Matters More than Codes”), and case studies (“Enron and World Finance: A Case Study in Ethics”) devoted to the topic. At business schools across the country, ethics classes proliferated. Harvard, for instance, added a compulsory, full-length ethics class in 2004. Overall, the number of schools requiring a course in ethics, business in society, or a similar topic jumped from 34 percent in 2001 to 79 percent in 2011, according to the results of a survey by the Aspen Institute.
Perhaps not incidentally, the name “Enron” also became a cultural byword. In 2005, a documentary film made by Alex Gibney and bearing the title of this book had its premiere at the Sundance Film Festival. The following year, the film was nominated for an Academy Award. (It lost to March of the Penguins.) In 2009, a young British playwright named Lucy Prebble scored a huge hit in London’s theater world with her play about Enron, which literally brought Fastow’s Raptors to life as debt-eating monsters. The play even opened on Broadway but didn’t fare well after a devastating review in the New York Times.
The reaction wasn’t all just talk and show. Laws were changed, too. It was immediately after Enron’s bankruptcy, in the summer of 2002, that President George W. Bush signed the 66-page law known as Sarbanes-Oxley (officially titled the “Public Company Accounting Reform and Investor Protection Act”). While invoking Franklin D. Roosevelt at the bill’s signing, Bush declared that “the era of low standards and false profits is over; no boardroom in America is above or beyond the law.” He added that “free markets are not a jungle in which only the unscrupulous survive or a financial free-for-all guided only by greed,” and also said that “tricking an investor into taking a risk is theft by another name.” Although this didn’t get as much press, in 2006, Bush also signed the Credit Rating Agency Reform Act. Citing Standard & Poor’s and Moody’s failure to lower Enron’s credit ratings in a timely fashion, Alabama Republican Senator Richard Shelby said that the bill addressed an “industry that was beset by conflicts of interest and a lack of competition,” and that “ultimately, this compromised the integrity of the market and investors paid the price.”
The government’s aggressive prosecution of the former Enron executives (along with former WorldCom, Tyco, and Adelphia chiefs) was supposed to underscore the notion that everything was different now. We agreed. In Fortune, we called the trial of Ken Lay and Jeffrey Skilling “a milestone in American business history.” After the two men were convicted, we said, “The rules are now clear and the risks of another Enron that much lower. The message is not to start down the slippery slope . . . fudging the numbers, operating deeply in the gray zone, deliberately obscuring what’s going on in your business, isn’t just wrong. It’s a crime.” We added, “Maybe, just maybe, a couple of decades in the slammer for Ken Lay and Jeff Skilling will send the message home.”
As we wrote those words in the spring of 2006, the financial crisis was already underway, even if no one knew it yet. (So much for investors being protected and rating agencies being reformed!) Thanks in part to those conflicts of interest and lack of competition that Senator Shelby had talked about, along with a good helping of old-fashioned greed, the credit rating agencies had assigned AAA ratings (even safer than Enron’s rating) to billions of dollars of mortgage-backed securities that should have been labeled “junk.” If “tricking an investor” (let alone a homeowner) into taking a risk is indeed “theft by another name,” then Wall Street banks certainly stole; they packaged up bad securities and sold them to investors, sometimes while enabling a hedge fund client to profit by betting against the securities—or betting against the securities themselves. Firms around the country were engaging in what can only be called “fudging the numbers” by obscuring the amount of bad mortgage-related products on their balance sheets. Indeed, Citigroup later agreed to pay the Securities and Exchange Commission $75 million to settle charges that while it told investors its exposure to subprime mortgages was $13 billion, the real number was $50 billion. Its former CFO and head of investor relations agreed to pay $100,000 and $80,000, respectively. Neither they nor the firm admitted or denied guilt.
The government’s response to the financial crisis was both similar to its response to Enron—and very, very different. Once again, Congress quickly passed new legislation. In the summer of 2010, President Barack Obama signed the ponderous Dodd-Frank Wall Street Reform and Consumer Protection Act, which weighed in at 2,319 pages, even though much of the specifics of the new rules weren’t included because they were left up to regulators. (And they still are: As of summer 2013, Dodd-Frank rulemaking, which is technically complex and therefore highly vulnerable to a flood of lobbying dollars from the financial industry, is only about 40 percent complete.)
The financial crisis was “born of a failure of responsibility from certain corners of Wall Street to the halls of power in Washington,” declared President Obama. “For years, our financial sector was governed by antiquated and poorly enforced rules that allowed some to game the system and take risks that endangered the entire economy. . . . Reform will also rein in the abuse and excess that nearly brought down our financial system.” A cynic could be forgiven for thinking that sounds familiar.
This time around, though, there were no prosecutions—none—of major executives. Even civil actions by the SEC were fairly limited; in many cases, like the Citigroup case, firms paid but weren’t required to admit guilt. If individuals were named, they were often painfully junior, as in the case the SEC brought against Goldman Sachs. While the firm paid $550 million to make its case go away, the SEC named only Fabrice Tourre, a young Goldman vice president who the SEC said set up a vehicle that would enable a hedge fund to profit if people couldn’t pay their mortgages. (In August 2013, Tourre was found liable on six counts of civil securities fraud.) Countrywide Financial’s former CEO Angelo Mozilo, who was the face of the bad loans that devastated the country, was not charged criminally and settled an SEC lawsuit for just $67.5 million, which was paid not by Mozilo himself but by insurance and by Countrywide’s new owner, Bank of America. PBS’s Frontline devoted an entire documentary to the issue, called appropriately enough, “The Untouchables.” Public outrage only grew after Attorney General Eric Holder suggested that some firms were simply too big to prosecute—the economy couldn’t afford the damage that might result if the firms were tarnished. As the New York Times noted, “The same dynamic that helped enable the crisis—weak regulation—also made it harder to pursue fraud in its aftermath,” because regulators lacked the information necessary to build criminal cases.
Such criminal prosecutions are nothing if not complex. That was one of the lessons from Enron. That’s because much of what seems so wrong in commonsense terms is actually perfectly legal, and it’s hard to hold senior executives accountable when accountants and lawyers gave their blessings. Executives exploit this unfortunate reality. As Fastow explained in Las Vegas, accounting rules and regulations and securities laws and regulation are “complex . . . what I did at Enron and what we tended to do as a company [was] to view that complexity, that vagueness . . . not as a problem but as an opportunity.” The only question was “do the rules allow it—or do the rules allow an interpretation that will allow it?” Fastow insisted he got approval for every single
deal—from lawyers, accountants, management, and directors—yet noted that Enron is still considered “the largest accounting fraud in history.”
Indeed, in many ways, Enron was a legal fraud. Fastow’s guilty plea—and Skilling’s and Lay’s convictions—were due to specific incidents where prosecutors could show that the Enron executives had crossed the line. But they didn’t speak to the larger fact that Enron’s financials were basically a complete misrepresentation of reality. “I knew that what I was doing was misleading,” Fastow told the Las Vegas crowd. “But I didn’t think it was illegal. I thought: That’s how the game is played. You have a complex set of rules, and the objective is to use the rules to your advantage.”
That seems to be how the game was played in the financial crisis, too. It’s enough to make you wonder about a lot of things. Is there a way to change the laws so that there isn’t such an oxymoron as legal fraud? Or does the problem go deeper than mere laws can solve, to fundamental human failings of self-delusion, greed, and ego run amok? You could even argue that Jeff Skilling was right about at least one thing, which is that people in the modern business world are motivated by money beyond all else. As long as the prize for winning the game is wealth beyond most people’s wildest dreams, even if the victory is short term and purely selfish—because the company or the whole economy will soon fall apart—play the game they will.
The “game” Fastow identified also offers, perhaps, an explanation as to why Skilling still insists on his innocence. After his conviction, he never offered the tearful confession that people wanted to hear—or for that matter, even a smidgen of remorse. While Skilling went to prison, his lawyers continued to appeal his conviction, bringing it all the way up to the Supreme Court. In 2010, the Supreme Court invalidated one theory that the government had used to prosecute Skilling. This was a long-controversial statute that makes it a crime for an executive to deprive a company of his or her “honest services.” But the Supreme Court did not overturn Skilling’s conviction. It instead sent the case back to the Fifth Circuit Court of Appeals, which affirmed his conviction in its entirety, ruling that the verdict would have been the same even if prosecutors hadn’t used the honest services statute.
After a winding road that included another appeal to the Supreme Court (which was denied), finally, in 2013—seven years after his conviction—the government and Skilling’s lawyers reached an agreement. At a hearing on June 21, 2013, Judge Sim Lake, who had presided over Skilling and Lay’s trial, reduced Skilling’s sentence by 10 years, from 24 to 14. With credit for good time and a drug and alcohol program that many white collar defendants try to take advantage of, Skilling, who is now 59, could get another two and a half years off his sentence, meaning that he will be out of prison by his mid-60s. Most of the sentence reduction was mandated by a Fifth Circuit ruling dating back to 2009, but the government, and Judge Lake, granted him additional leeway. In exchange, Skilling agreed to abandon further appeals and gave up more than $40 million that had been held in escrow pending resolution of his appeals. The money will be distributed to Enron’s victims.
There are those who believe that this is a travesty and that if we can’t make anyone pay for their roles in the financial crisis, well, then Jeff Skilling should pay all the more. “As if you didn’t know this already, we’re coddling criminals in America,” wrote the Los Angeles Times in an editorial. “What’s most unfortunate about the Skilling deal is that it comes at a time when the government’s efforts to punish white-collar fraud have lost all credibility.” The Times argued that the deal was especially “unsavory” given that Skilling is “one of the precious few executives whom the justice system succeeded in making into an example.” (Given the role Enron played in manipulating California’s energy market, the Times’s rage is understandable.)
But there is another side. At the sentencing hearing in June, Lake, according to the Houston Chronicle, noted that Skilling was also the architect of Enron’s rise from an obscure pipeline company to an innovative and diverse energy giant and that he will end up spending more time in prison than anyone else connected to the company’s collapse. Everyone else convicted in the case is already out of prison. “The two most significant factors are the need for the sentence to deter others from similar action and to reflect the seriousness of the offense,” Lake said. “The court is not persuaded a longer sentence is necessary.” To be sure, Skilling has paid a heavy price, more than mere years could ever cost: During the time he’s been in prison, both his parents and the youngest of his three children have died.
Maybe it’s worth a different kind of comparison between Enron and the financial crisis. The difference between the way Enron executives behaved and the way highly paid people at so many of our financial firms behaved isn’t the difference between black and white. If it’s anything, it’s a shade of grey—the difference between a prosecutable lie and deliberately looking the other way, the difference between Enron’s illusory profits and the profits of many financial firms, which quickly turned into huge losses.
In a way, seen through the lens of the housing bubble, Enron even has some redeeming qualities. It genuinely was an innovative company that was trying to change and create businesses. It may well even have succeeded if its executives hadn’t been so intent on making profits appear in the company’s reported financial statements long before they actually appeared in its coffers. Energy trading, which Enron pioneered, is very real today, as is video on demand—which was supposed to be part of Enron’s broadband business. Corporate energy-efficiency retrofitting—the intended business of EES—is all the rage today.
Compare all that to the making of loans to people who couldn’t pay them back and the packaging of those loans into securities to be sold to clueless investors. The former was genuinely creative; the latter was simply opportunistic and destructive. Or to put it a different way, there was so much possibility in Enron, and there could have been a different ending. There was never going to be anything but a bad ending to the inflation of home prices. By some measures, maybe the Enron guys really were the smartest guys in the room.
Despite all the scandals, there is plenty that is right with American business today. Silicon Valley continues to create companies that change the way we live. Technical innovations are transforming the energy business. And, across the country, tens of thousands of people whose names we’ll never know regularly make tough decisions to behave ethically in the face of constant temptation to do otherwise. But if there’s anything that’s become clear in the last ten years, it’s that what can go wrong with business is something that can’t be isolated to Enron—or fixed by the simple act of making one man our pariah. In the end, that’s why the Enron story will always be relevant: It’s a tale of human nature, a morality play for our age.
Still, it’s hard not to wish for that naïve time when Enron was shocking, when we believed President Bush when he said that Sarbanes-Oxley would rein in greed, and when we really, truly thought that the act of putting Jeff Skilling and Ken Lay behind bars would solve everything.
Bethany McLean
Peter Elkind
August 2013
Ken Lay in late December 2000, when Enron was on top of the world and Lay was widely viewed as a business visionary. (Pam Francis, Sipa Press)
Jeff Skilling at the height of his power and fame, outside Enrou’s gleam ing headquarters in downtown Houston. (Wyatt McSpadden)
Rebecca Mark was Enron’s most glamorous executive—and Skilling’s fiercest rival. (Barron Claiborne, CORBIS—Outline)
Andy Fastow, the mastermind behind the financial schemes that helped bring the company down, made more than $60 million from the two private funds he ran. (Gamma)
The “crooked E”—Enron’s famous logo outside its headquarters. (Gamma)
Enron’s massive trading floor. In 2001, trading profits covered up huge losses in EES. (Paul S. Howell, Liaison)
Skilling deputy Ken Rice ran the ill-fated broadband division—and was lat
er charged with fraud and insider trading. (Brett Coomer, GettyImages)
Lou Pai, another trusted Skilling lieutenant, was best known for two things : cashing out of Enron at the top of the market and his infatuation with strippers. (Wyatt McSpadden)
Cliff Baxter was Enron’s moody, hypersensitive deal maker and Skilling’s closest friend at the company. (Gamma)
A storage tank in Dahbol, India, under construction in 2001. It was part of Enron’s most audacious, and most troubled, power project ever. (Sherwin Crasto, AP)
Rebecca Mark, who struck the $3 billion Dahbol deal, lights a ceremonial candle at the plant in early 1997. (Pablo Bartholomew, Liaison)
Fastow lieutenant Ben Glisan created many of Enron’s most fiendishly complex financial structures. (David J. Phillip, AP)
Michael Kopper, Fastow’s other top deputy, was involved in many of Fastow’s sleaziest deals. (Mark Wilson, GettyImages)
Skilling led small groups of Enron executives and customers on daredevil expeditions, including this one, in 1996: a twelve-hundred-mile road race in Jeeps and on dirt bikes called the Enron Baja Off-Road Rally. The bikes line up for the day’s race.