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

by Bethany McLean

  As ever, the analysts gushed. “A lot of times what might seem surprising or illogical turns out to be right when Enron does it,” wrote Schroder & Company’s Ray Niles. But the acquisition was an almost immediate disaster. Just about six months after the deal was announced, Brazil devalued its currency. The move instantly sliced Elektro’s value. But in March 1999, Enron increased its ownership of Elektro from 47 percent to 100 percent at an undisclosed cost, perhaps because if a third party had bought the stake, Enron might have had to write down its existing stake. Elektro’s value continued to plummet as Brazil’s economic problems worsened. (The Elektro purchase was funded partly by an SPE. Enron later repaid the banks that funded the SPE by selling 25 percent of Elektro to Whitewing for $461.5 million. A year later, Enron estimated the value of that stake at $245 million.) Enron’s other South American assets—the same assets Skilling had been touting ever since he’d toured the region with Mark several years before—also sank in value.

  Mark, of course, was running Azurix by then. No matter: Skilling needed someone to blame, and he blamed her. Never mind that both he and Lay had signed off on the Elektro deal, and Mark’s signature was nowhere to be found. Never mind that Lay had been enthusiastic about the purchase. The executives running the South American division were Mark’s acolytes; they wouldn’t so much as lift a finger without her approval.

  For most of the 1990s, Mark’s business had been a story about the future. Although Enron earned development and construction fees, which it was able to book as earnings, the serious profit was supposed to come after its projects were up and running. And by the end of the decade, that future was supposed to have arrived. Wall Street analysts had been predicting for years—based on the guidance they’d received from Enron—that International would be producing upward of $350 million in earnings by 2000. In early 1999, Goldman’s Fleischer predicted that EI would grow its earnings at a 25 percent clip for the forseeable future.

  But with 2000 fast approaching, it was becoming obvious inside Enron that these figures were astronomically off base. Like most Wall Street frenzies, the international development craze was wildly overhyped. In the wake of the Asian crisis of 1998 and the resulting economic meltdown in emerging markets, the values of virtually all energy assets collapsed—it didn’t matter who owned them. Even so, some of Enron International’s assets were almost comically awful, and others were fields of dreams. A power plant it built in China was never commercially operated. The Dominican Republic plant was padlocked for a time. The plant in Cuiabá, Brazil, was hundreds of millions of dollars over budget. In Poland, there were difficulties getting the government to pay Enron for a plant it had built. A planned pipeline in Mozambique never happened, nor did a $500 million plant in Indonesia or a $200 million plant in Croatia. And that doesn’t even include the greatest debacle of them all—Dabhol, the $3 billion project that remains shuttered to this day.

  Skilling would rage at International’s problems and at the woman he held responsible for them. As was always the case with Skilling, he deeply resented having to deal with “her mess.” “It was not my vision,” he told friends. “I built a business. Now, I’m spending all my time cleaning up messes. It’s the last thing I want to be doing.”

  It was at a budget-planning session for the year 2000 that Skilling discovered just how bad things really were. He was expecting the international executives to present plans to bring in $500 million in operating profit; instead, they projected less than $100 million. He thought at first they were lowballing him, giving him a number they knew they could beat. He soon discovered that just the opposite was true: the $100 million was a stretch. “We invested $5 billion in equity to earn $90 million?” he asked in disbelief.

  Amanda Martin remembers seeing Skilling around this time. He seemed more distraught than she had ever seen him. Although he had asked her to come by to discuss Azurix, he didn’t want to talk about the water business. It was International’s problems that were on his mind. “Just fix it,” Skilling said about Azurix. “You’re my friend. We can’t take any more hits.”

  Not long afterward, a near miracle took place: an investor group from the United Arab Emirates expressed interest in purchasing 80 percent of Enron’s international assets. It represented a potentially astounding escape: the ini-

  tial offer valued all of EI at more than $7 billion. Enron called the deal Project Summer.

  Cliff Baxter’s handwritten notes show that the potential buyers were valuing Enron’s Dabhol stake at $950 million at a time when it was on Enron’s books for $714 million. And they put a value of $4.3 billion on the South American assets, compared with Enron’s book value of $3.4 billion. Once Skilling concluded that the buyers were real, he got so excited that he assigned a team to help Enron figure out what it should do with the massive inflow of cash it would soon be getting from the Middle Eastern investors.

  By that point, Enron was also planning to sell Portland General for $2

  billion—Skilling had decided he no longer needed the hard asset to trade electricity—and so everyone thought they would soon be awash in cash. The Global Finance team believed the smartest thing to do with the money was to pay down debt to make the ratings agencies happy. Ben Glisan also observed in handwritten notes that the sale would get rid of the project finance debt associated with EI, which, he wrote, Moody’s considered “a large overhang.” Glisan also hoped the cash would allow Enron to sweep away some of the structured finance deals. “Scary places gone,” he noted.

  Still, Skilling had one final item on his agenda before the international assets went away. He was determined to show the board, once and for all, what a dis-

  mal failure Mark had been as the head of International. The Arabs might value EI at over $7 billion, but he wanted Enron’s directors to understand that the assets weren’t worth anything close to that amount. That summer, Skilling assigned an in-house accountant the task of evaluating the International division, and he personally supervised the work. The analysis the accountant came up with showed that Mark’s business was earning a mere 2 percent return on equity—a pathetic amount, given the capital Enron had expended and the risks it had taken. And that didn’t even include the huge potential liabilities associated with some projects, such as Enron’s guarantees of debt.

  When Mark learned what Skilling was up to, she promptly got her own numbers cruncher, who sat down the hall from Skilling’s accountant, to work up a competing set of numbers. Mark’s analysis showed, not surprisingly, that the international business had been a success, producing over $1 billion of cash and earnings and making a 12 percent compound annual return over its history.

  It is astonishing, of course, that two high-ranking executives, working for the same company, sitting on the same board, and evaluating the same business, could come to such wildly varying conclusions. It spoke volumes about the murkiness of Enron’s numbers, about the way this company viewed earnings and margins and all the other financial benchmarks by which we gauge American corporations. It also said a great deal about the inability of top executives at Enron to work together or even communicate. Everything was perception; nothing was real.

  “Figures lie, liars figure,” says one of the accountants who worked on the analysis. He adds that “if it had been Skilling that was being measured, he would have found a way to show a 20 percent return.” Yet the accountant went on to note an even more astonishing fact: viewed through their respective prisms, they were probably both right. Skilling evaluated the international assets based on what they’d cost, how much they were earning at that moment in time, and what the market value was. He didn’t include any of Andy Fastow’s funny business: the accounting structures that were designed to book earnings from the international assets. On that basis, the returns were unacceptably low.

  But as Mark never tired of pointing out, there was funny business, lots of it. Enron played the same accounting games with its international assets as it did with every other part of the business.
Over and over again, Enron had monetized its power plants and other overseas projects, either through securitizations or by selling stakes in them to one of its many off-balance-sheet partnerships, including LJM, then booking the sale to its bottom line. Her analysis included some of these profits.

  Although the company didn’t break out International when it reported its earnings, both Lay and Mark used to boast about the division’s importance to the company’s bottom line. In 1997, according to one internal analysis, Enron booked $152 million in international earnings; the following year, earnings rose to $246 million. But those numbers didn’t reflect ongoing profits; rather they were a case of stealing from the future. Because of these financing techniques, Mark’s assets did bring cash into Enron, cash that her loyalists say was plowed into the enchiladas like EES and broadband. Her assets, she bitterly told one friend, “were just cannon fodder to feed the machine.”

  But the Enron board wasn’t about to get into a debate on the subject. Skilling was still viewed as a man building great, profitable businesses, while Mark was viewed, suddenly, as a loser, a failure at a company that simply didn’t believe that it could fail.

  The climactic board meeting took place on Tuesday, August 8, 2000. As late as 6:30 Sunday evening, Mark had tried to argue her case privately to Lay. Lay, furious about Azurix, didn’t want to hear it. At the board meeting, Skilling disemboweled Mark, laying out his case in clear, damning detail—the poor return on her assets, the projects that hadn’t worked, the years of stumbles and mistakes.

  When Mark asked for the chance to respond, nobody on the board would even look at her. They all looked down at the floor. Mark told the board that if there were better places to put the money—like broadband and EES—that was fine, but she didn’t agree with Skilling’s analysis. And then she left the boardroom, citing another meeting she had to attend. Later, it wasn’t Skilling who made the harshest comments about Rebecca Mark: it was Ken Lay.

  Lay spent the next weekend in Aspen and, after a brief business trip in the early part of the following week, went over to the Azurix offices to meet with Mark. That’s when he told her that it was time for her to leave both Azurix and Enron. Mark agreed. But she insisted that she be paid the remainder of her $710,000 Azurix contract. Lay paid her.

  And the Middle Eastern buyer? All summer long, the negotiations dragged on. Mark’s old deputy, Joe Sutton, had found the prospective buyer and was planning to leave Enron and help the Arab investors manage the assets. If Sutton negotiated the deal for Enron, he would have an obvious conflict of interest, not unlike the conflict Fastow had with LJM. But in this case, Skilling wasn’t about to look the other way; he brought in Cliff Baxter to finish the negotiations. There was a huge internal uproar when Sutton managed to get a guarantee from Lay that the international team’s options would vest upon completion of the sale. Typically, Lay didn’t bother to ask what the number was; when Skilling discovered that it came to $300 million, he threw a fit.

  But he was ready to do the deal anyway. Skilling and Lay had the final papers drawn up, and Skilling even met with two Enron public-relations executives to prepare a press release. The last round of negotiations—which would culminate with the signing of the papers—was set to take place in London.

  Then a final piece of bad luck: during that final round, the scion of the family making the purchase became deathly ill. Without his permission, no one had the authority to guarantee the purchase. The deal fell apart.

  In October 2000, Joe Sutton was asked to leave. Over the course of the next few months, other international executives were fired, too. The irony was that their options all vested once they were let go and they were able to cash out, winding up with the same $300 million they would have received if Project Summer had gone through.

  The following February, the company’s international developers were summoned to Houston and told that Enron International was being shut down. If they wanted to stay at Enron, they needed to find new jobs at either EES or broadband. A few weeks later, EES held a job fair at the Hyatt—a typically lavish affair with a baseball theme, including fake grandstands and peanut salesmen. Many international employees ended up working for one of the two big enchiladas.

  • • •

  In the end, Rebecca Mark was one of the lucky ones: even though it hadn’t been her choice, she got out at the top. Soon after she started Azurix, she had begun selling her Enron shares; by spring 2000, she had sold her entire stake, over $80 million worth. Had she stayed, that stake would have been worth nothing.

  But she could never quite bring herself to see it that way. Instead, she continued to boil over about what Skilling and Lay had done to her. Without her projects, Enron would have been exposed years earlier, she would say; her deals gave the company real assets. Those were the assets the company put into its off-balance-sheet vehicles, thereby raising cash. Yes, the rate of return on some of her projects may have been low, but her side of the company was real, unlike Skilling’s. Even Azurix, for all its problems, always made a profit, a real profit.

  “My stuff was discounted because it could be analyzed,” Mark told one friend. Skilling’s team, she added bitterly, “lived off us for so many years, sucking our blood.”

  Mark also never stopped believing that success was just around the corner, and this was especially true of her tenure at Azurix. If only Enron hadn’t been so eager to pull money out of the company . . . if only Skilling hadn’t been such an impediment . . . if only Enron had been willing to commit more capital and given it more time.

  “It just needed time,” she told a friend years later. “With time, it would have all been fine, just fine.”

  CHAPTER 17

  Gaming California

  Aside from his age, Tim Belden didn’t fit the profile of a typical Enron trader.

  Thin and slightly balding, he favored the rumpled look of the academic researcher he’d once been. He had a master’s in public policy from Berkeley and spent five years working as a researcher at the Lawrence Berkeley National Laboratory, where he coauthored papers on energy markets and lost money investing in environmentally friendly wind projects. His Enron colleagues called him a tree hugger because he rode his bike to work. He was 30 when he joined the company in 1997.

  But looks can be deceiving. Not only was Belden an Enron trader, he was one of the leaders of a group of hyperaggressive West Coast electricity traders who operated out of Portland General, the Oregon utility Enron purchased in 1997. He was, as they liked to say at Enron, intellectually pure—a trader who believed in the beauty of free markets and had no scruples when it came to exploiting inefficiencies to make money. He struck others in the industry as very knowledgeable, and while he was affable enough to outsiders, he had traces of Enron mean. (He once asked an interviewee named Lynn Brewer what the square root of 363,000 was.) It wasn’t long before Belden caught the notice of Whalley and the other top trading executives in Houston; within a year and half, he was named an Enron vice president.

  Belden had always had a bit of the mad scientist in him, and in the late spring of 1999, he began working on an intriguing idea. Deregulation of California’s energy market had gone into effect the year before, creating an enormous opportunity for energy traders, who were suddenly in the position of buying and selling a huge portion of the state’s electricity. The sheer complexity of the rules governing deregulation seemed to make them exploitable in another way as well. Clever traders could find loopholes in the thousand or so pages of rules and game the system in much the same way Andy Fastow’s team gamed the accounting rules. For instance: what would happen if a trader sold energy to the state for the next day but scheduled it in such a way that the electricity couldn’t possibly be delivered? What would a move like that do to the price of electricity? That’s what Belden wondered and what he set out to learn with his little hands-on experiment.

  • • •

  California. Outside of Washington, D.C., was there any place Enron spent

&
nbsp; more time maneuvering than California? California was so big, so important, so influential—and this big, important, influential state was also moving more quickly than most others to deregulate its retail energy markets.

  Enron hired lobbyists by the bushelful. It doled out tens of thousands of dollars in campaign contributions to California politicians. Lay and Skilling made stump speeches touting deregulation’s benefits. In one appearance before the California Public Utilities Commission (CPUC), Skilling claimed that the state would save $8.9 billion a year: “Let me tell you what you can buy every year,” he said. “You can triple the number of police in Los Angeles, San Francisco, Oakland, and San Diego, and you could double the number of teachers.”

  Then, after energy deregulation took place in California, Enron’s EES division spent millions more in an attempt to make itself into a high-profile energy retailer, selling electricity directly to consumers. Though that effort was a bust, deregulation still gave the company a tremendous vested interest in the state. And, finally, once the California experiment became an out-and-out debacle, bankrupting the state’s largest utility and wreaking havoc on its economy, Enron had yet one more reason to focus on California: to defend itself from the near-universal belief among Californians that Enron was the company that turned out the lights. Although the accusations were only partially true—many of the other parties involved in this mess behaved no better—Enron’s size and its undisguised disdain for the state’s suffering made it the prime target.