PORTFOLIO / PENGUIN
THE SMARTEST GUYS IN THE ROOM
Bethany McLean and Peter Elkind were Fortune senior writers when this book was originally published in 2003.
McLean’s March 2001 article in Fortune, “Is Enron Overpriced?” was the first in a national publication to openly question the company’s dealings. She now lives in Chicago with her husband, Sean Berkowitz, who was the head of the Enron Task Force when they met in 2006. McLean is a contributing editor at Vanity Fair and a columnist at Reuters.
Elkind, an award-winning investigative reporter, is the author of The Death Shift and Client 9: The Rise and Fall of Eliot Spitzer. A former editor of the Dallas Observer, he has been an associate editor at Texas Monthly and written for The New York Times Magazine and The Washington Post. Now editor-at-large at Fortune, he lives in Fort Worth, Texas.
For Chris
—B.M.
For Laura
—P.E.
PORTFOLIO / PENGUIN
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First published in the United States of America by Portfolio, a member of Penguin Group (USA) Inc., 2003
Updated paperback edition published 2004
This edition with a new foreword and afterword published 2013
Copyright © 2003, 2004 by Fortune, a division of Time, Inc.
Foreword copyright © 2013 by Joe Nocera
Afterword copyright © 2013 by Bethany McLean and Peter Elkind
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THE LIBRARY OF CONGRESS HAS CATALOGED THE HARDCOVER EDITION AS FOLLOWS:
McLean, Bethany.
The smartest guys in the room : the amazing rise and scandalous fall of Enron / Bethany
McLean and Peter Elkind.
p. cm.
Includes index.
ISBN 978-1-59184-008-4 (hc.)
ISBN 978-1-59184-660-4 (pbk.)
ISBN 978-0-698-15882-5 (eBook)
l. Enron Corp.—History. 2. Energy industries—Corrupt practices—United States. 3. Business failures—United States—Case studies. I. Elkind, Peter. II. Title.
HD9502.U54E5763 2003
333.79'0973—dc21
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FOREWORD
In February 2001, as the editorial director of Fortune magazine, I helped edit a short, rigorous story—just four pages long—by a young writer named Bethany McLean, who had joined the magazine some six years earlier from Goldman Sachs and quickly become one of Fortune’s brightest stars. Her story was entitled, simply, “Is Enron Overpriced?”
At its core, Bethany’s article asked one very straightforward question: How does Enron make its money? For years the company had been a Wall Street darling, its stock moving steadily upward with each new quarter’s rising profits. It was seen as the paradigmatic example of a company that had transformed itself from an old-economy stalwart—operating pipelines that moved natural gas—to a new-economy marvel, creating dazzling efficiencies and hedging risks (like the weather!) that no one had ever thought to hedge before. Just a month before Bethany’s story ran, Businessweek had put Enron’s chief executive, Jeffrey Skilling, on its cover, posing with what appeared to be harnessed electricity in his hand, with the cover line “Power Broker.”
But Bethany had been poring through Enron’s financial documents, and what she realized was not just that they were complicated (most big companies have complicated financials) but that they were incomprehensible, even indecipherable. She started calling around to the Wall Street analysts who were so bullish on Enron, asking her simple question.
Some of them told her that Enron was a company you just had to trust. One analyst admitted to her that the company’s earnings were “a black box.” When she reached Skilling himself, the Enron CEO first complained that she “didn’t get it,” something he often said to people who questioned Enron. Then he hung up the phone on her. The Enron public-relations department insisted that if she would just come to Houston and visit the company’s headquarters, the fog would soon lift. But with our deadline fast approaching, the Enron PR department decided that if Mohammed wouldn’t come to the mountain, they would have to visit Fortune. The company sent a small contingent to New York to meet with Bethany and her editors, including me. Andy Fastow, the company’s chief financial officer, led the Enron team.
It would later be blindingly obvious that Fastow had not told us the truth—how could he, given that much of Enron’s earnings were the result of accounting manipulations that created the illusion of profitability? But even in the moment it was clear that Fastow’s goal was pretty much the same as those financials Bethany had been poring through: to obfuscate and confuse. I can’t remember all the details, but I vividly recall Bethany asking sharp, pointed questions about the company’s business model and Fastow responding with lengthy, nearly unintelligible answers about how Enron was like Toyota, how it should be thought of as a logistics company, etc., etc.—even though Enron’s main business wasn’t actually moving anything from place to place, but rather trading.
And then something happened that Bethany and I would never forget. As the meeting was drawing to a close and the Enron executives were putting on their coats, Fastow turned to Bethany and said, “I don’t care what you say about Enron. Just don’t make me look bad.”
It was such a jarring thing for him to say on the eve of what was clearly going to be an unflattering article about his company. In retrospect, it was a tip-off—to the mentality of the people running Enron and to the fact that there was indeed something fishy about those financial statements—Fastow was, after all, Enron’s CFO. It was a real signal that Bethany—whose story wound up raising all the right questions, even if she didn’t yet have all the answers—was on to something.
Some articles drop like bombshells. Bethany’s wasn’t like that. Instead, it slowly seeped into the consciousness of Wall Street. Enron’s stock had been in the 70s when Bethany’s story was published, not far from its all-time high. Ever so steadily, it began to sink. In April, Skilling was questioned on a conference call by an investor who asked his own tough questions. “Asshole,” Skilling muttered under his breath. In August, Skilling suddenly and unexpectedly quit as chief executive—a move that was all the more stunning because he had taken over as CEO just six months earlier from Enron founder Ken Lay. Though Skilling had effectively been running the company for years, everyone knew how much he had wanted the actual title of chief executive. His resignation triggered a flurry of skeptical stori
es and questions.
And then came October. With the stock having fallen into the high 30s—and Lay, back as CEO, trying to persuade a now-skeptical Wall Street that everything was fine—the Wall Street Journal revealed that Fastow had made tens of millions on the side running a pair of limited partnerships that had done business with Enron. That story helped accelerate the feeding frenzy that was already developing, both in the press and on Wall Street, around Enron. By November, Fastow was gone, sacrificed by Lay as he desperately tried to keep Enron afloat. But like any company that trades for a living—just like Lehman Brothers or Bear Stearns seven years later—once Enron had lost the confidence of its trading partners, it was toast. On December 2, 2001, the company filed for bankruptcy.
Even then, though, nobody knew the full story of what had brought down Enron. Fastow’s LJM partnerships got the immediate blame—both inside and outside of Enron—but one of the main points of The Smartest Guys in the Room is that Fastow wasn’t actually the one who brought down Enron. His chicanery—which he’d later testify was approved by Skilling—was actually what was propping up Enron. The real story was that Enron’s businesses weren’t making much money, and that much of their profits were phony. The whole point of Fastow’s dealings, from Enron’s point of view, was to make it appear that the company was a profit machine that it clearly wasn’t. (And if Fastow skimmed a little on the side, well, what can you do?) Enron’s aura had been such that nobody had ever bothered looking into the internal strife, the macho posing, the rampant greed—and the dysfunction in the company’s executive suite, starting with the out-to-lunch Lay and the emotionally unstable Skilling.
Right after Enron filed for bankruptcy, Bethany wrote a terrific cover story about the company’s decline and fall in which she touched on some of these larger themes. In editing the article I realized how well-sourced she was, but I could also clearly see that there was a much bigger, more important story here than simply a crooked CFO who was lining his pockets. Her story made it obvious that the rise and fall of Enron would make a terrific book.
So I went to my bosses and suggested that we—Fortune magazine—take advantage of Bethany’s Enron reporting and write a book about what had happened. Because there was so much to unravel, I suggested she team up with Peter Elkind, a Texas-based Fortune writer who had written a series of fabulous investigative sagas for the magazine. Happily, everyone agreed. In 2003, Portfolio published the first edition of The Smartest Guys in the Room. I am biased, of course, but I contend that it remains the single most authoritative account of this landmark event.
It is far more than that, though. The Smartest Guys in the Room is an almost anthropological examination of the nature of corporate scandal. Why do values go awry? What happens when the wrong person gets a big job? Why is it so tempting to post false profits instead of telling the truth? How distorting is the prospect of stock market riches?
In the immediate aftermath of Enron, there were at least a half-dozen other big corporate blowups: WorldCom turned out to be cooking its books, and CEO Bernie Ebbers went to jail. Tyco became embroiled in scandal, and its chief, Dennis Kozlowski, also went to prison. But none of these disasters have resonated like Enron. At many business schools, studying Enron is part of the curriculum. Just recently, Andy Fastow, who was released from prison in 2011, gave an unpaid speech in Las Vegas at a conference of fraud examiners. He drew a full-house crowd of 2,500 people. Afterward, some of the fraud examiners and convention staffers asked to have their pictures taken with him. Explained one: “He’s part of history.”
Enron remains the defining scandal of the 21st century. None of those other scandals had the staying power—or the canary-in-the-coal-mine quality—of Enron. This was partly because no other modern-day company, prior to the financial crisis of 2008, had Enron’s vaunted reputation. But it is also because almost everything we later found out about how Enron operated was a harbinger of scandals yet to come. Off-balance-sheet vehicles. Banks doing things they shouldn’t to generate fees. Ratings agencies giving safe ratings to investments that were clearly doomed to fail. Corporate executives using every means possible to maximize short-term revenues—and boost their own multimillion-dollar bonuses—even when those means were, at best, unethical.
Congress held hearings in the wake of the Enron bankruptcy; it even passed a law, Sarbanes-Oxley, that was intended to prevent future scandals. (Among other provisions, the law calls for the CEO and CFO of a publicly traded company to sign a document attesting to the validity of its numbers. Despite numerous instances of post-Enron fraud, the power of that document has never been tested in court.) Newspapers and magazines wrote dozens of articles about how to prevent future Enrons. Jeffrey Skilling and Kenneth Lay were tried and given lengthy sentences (Lay, of course, died of a heart attack before he ever spent a day in jail). And then we all moved on.
No one can say for sure whether a more rigorous Washington response to Enron might have prevented the financial crisis of 2008. But I tend to think so. Both Enron and the financial crisis were the products of the same deregulatory impulse that seized Washington in the 1990s. Enron had exposed the deep, systemic flaws of the ratings agencies. The off-balance-sheet vehicles Enron used were the same kind of vehicles banks used to hold their collateralized debt obligations—the so-called toxic assets that did so much damage to the financial system when they collapsed. And they existed for the same reason: to hide debt.
On one level, the Enron scandal, as told in the pages that follow, is simply a great, rollicking tale. When Bethany and Peter set out to write The Smartest Guys in the Room, telling that story is all they were really trying to do. But it is impossible to read this book today, a decade after it was first published, and not wonder what might have been—if everyone had been willing to pay just a little more attention.
Joe Nocera
July 2013
Op-Ed columnist
The New York Times
AUTHORS’ NOTES AND ACKNOWLEDGMENTS
Enron is well on its way to becoming the most intensively dissected company in the history of American business. This book is published as that process continues, with investigations and litigation that will surely drag on for years. Because our aim has been to chronicle the company’s rise and fall—amazing and scandalous indeed—we have deliberately ended our narrative with Enron’s filing of the largest bankruptcy case in U.S. history. We leave it to others to describe the resulting investigations and trials, as well as the jockeying over Enron’s spoiling remains.
Enron’s story is a sprawling tale, and, during the 16 months of intensive reporting that produced this book, it has taken us down many trails. A good portion of our work involved poring through a mountain of public and private documents involving Enron and the colorful cast of players—executives, bankers, auditors, lawyers, investors, and analysts—who appear in these pages. We have reviewed divorce records, executive calendars, personnel files, court records, depositions, personal e-mails, letters, consultants’ studies, internal memos and presentations, board minutes, SEC filings, congressional testimony, and dozens of reports from Wall Street analysts. This massive written record, much of it contemporaneous with what we describe, has provided an extraordinary window into events involving Enron.
Ultimately, though, this is a story about people. We believe we have gained considerable insight into the thinking and behavior of virtually every major character in this book. We have conducted hundreds of interviews with people who worked at every level of the company, from the fiftieth-floor executive suite to the board of directors to the secretarial pool, in addition to scores of others who worked outside Enron. Yet for an assortment of understandable reasons—in some cases, involving the continuing criminal investigations; in other cases, involving the stigma that results from any association with Enron—many of those who spoke to us insisted on talking on “background” only. Under this arrangement, the information provided was on the record—we could use it freely—but we could not i
dentify the source by name. This allowed many sources who would otherwise have been constrained to speak openly to us. On occasion, with those who saw themselves as likely government targets, facing possible surveillance, our arrangements assumed a cloak-and-dagger quality, with clandestine meetings arranged through coded messages. A few other individuals discussed events in great detail but only through trusted personal surrogates. The result is a book that relies, in considerable part, on unnamed sources.
We are exceedingly grateful for the cooperation, trust, and patience of all those (both named and unnamed) who spoke with us—in more than a few cases, a dozen times or more. Their participation in this project was an act of faith, and their insight has been invaluable.
• • •
This book was made possible through the support of Fortune magazine. The idea for it took hold shortly after Enron filed for bankruptcy, when we realized that there was an extraordinary and compelling business narrative in the company’s collapse and that we wanted to tell that story. We also realized something else: piecing together the fall of Enron was going to be an unusually challenging reporting task. For the reasons discussed above, many of the principals were hardly in a position to talk publicly about their experience. Enron’s financial machinations were also complicated, requiring considerable time and effort to understand—and then to explain.
What made our work manageable was the active involvement of Joseph Nocera, editorial director for the magazine. He served as impresario for this project, guiding us as we did our reporting, then acting as editor extraordinaire once we started writing. He is a true partner in the creation of this book. We are grateful to his wife, Julie Rose, too, who lived through the challenging times of this endeavor along with the rest of us.
Rik Kirkland, Fortune’s managing editor, allowed us to dedicate a year and a half to this project and never wavered from his strong and vocal support. Jeff Birnbaum tapped into his wealth of Washington sources, landing key interviews and pulling together the Washington angles to the Enron story. Colleagues Carol Loomis, Carrie Welch, Laury Frieber, Pattie Sellers, Tim Smith, David Rynecki, David Kirkpatrick, and John Helyar were generous with their advice and wisdom. Brian O’Reilly shared the extensive interviews he conducted with Enron executives for his story, “The Power Merchants,” published in Fortune’s April 17, 2000, issue. We received valuable reporting aid from former Fortune reporter Suzanne Koudsi. The Time Inc. Business Research Center, especially Doris Burke and Patricia Neering, provided fabulous research help. Arlene Lewis Bascom kept track of the book’s finances. Alix Colow pulled together the photos. Former Assistant Managing Editor James Impoco edited the original Enron story in Fortune written by coauthor McLean and was there with an encouraging word when we most needed it. Time Inc. editor in chief Norman Pearlstine and editorial director John Huey gave their blessing to this project. We hope the result justifies so much faith in us from so many.
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