“I take full responsibility for what happened at Enron. But saying that, I know in my mind that I did nothing criminal.”
– Kenneth Lay, Enron Founder and Chairman
“I wish I could undo what I did at Enron but I can’t. I understand that I deserve punishment. Your honor, I accept the prison sentence that you are about to impose and will serve it without bitterness.”
– Andrew Fastow, Enron CFO
“Was I believer in Enron Corporation? Yes, sir, I was.”
– Jeffrey Skilling, Enron CEO
On December 2nd 2001, Enron filed for Chapter 11 bankruptcy.
What drove Enron into bankruptcy in what seemed like just a matter of weeks and what lessons can be made? That is the topic of this anniversary blog post. With eleven years hindsight, it is a story about brilliant corporate innovation and also, as so often in corporate disasters, a story about greed.
Enron Corporation was an American energy, commodities, and services company based in Houston, Texas. Before its bankruptcy Enron employed approximately 20,000 staff and was one of the world’s major electricity, natural gas, communications, and pulp and paper companies, with claimed revenues of nearly $101 billion during 2000.
At the end of 2001, it was revealed that Enron´s reported financial condition was sustained by an institutionalized, systematic, and creatively planned accounting fraud, known as the Enron scandal. Enron has since become a well-known example of willful corporate fraud and corruption.
So, what was the story and what lessons can be learned?
Enron was a knowledge economy company, a thinking-outside-the-box, paradigm-shifting, market-making company. In fact, it ranked as the most innovative company in America. Fortune Magazine named Enron "America’s Most Innovative Company" for six consecutive years.
So, what did Enron do?
What’s so innovative about that?
When Enron got started in the 1990s, natural gas and electricity were produced, transmitted and sold by state-regulated monopolies. They were often bloated and inefficient.
Enron used Wall Street magic to transform energy supplies into financial instruments that could be traded online like stocks and bonds. These contracts guaranteed customers a steady power supply at a predictable price.
The company did a lot of stupid things, but introducing the laws of supply and demand into the energy system was smart business and is, by and large, good for customers.
So where did Enron go wrong?
As often happens with buccaneering entrepreneurs, Enron got a case of hubris. It figured if it could trade energy, it could trade anything, anywhere, in the new virtual marketplace. Newsprint. Television advertising time. Insurance risk. High- speed data transmission. All of these were converted into derivative contracts that were sold to investors.
Enron poured billions into various trading ventures, and some failed. It turned out Enron was good at inventing businesses, but terrible at the tedious work of running them, judging by appalling internal management audits.
As the bets started to go horribly wrong all at once, Enron may have felt compelled to pump up its revenues and profits using ever more ingenious tactics. Enron tried to be a worldwide commodities broker and market maker to the world, open 24 hours a day, unlike banks, which have a much stronger balance sheet, and the market fell for it.
For a time, Enron swept its failures into creative hiding places creating offshore trusts, companies and other conspicuous legal vehicles, but ultimately the truth came out, confidence in the company collapsed and bankruptcy followed.
How did Enron hide its mistakes?
To keep its mystique alive and its stock price growing, Enron set up partnerships where it could bury its losses, or generate imaginary revenues. Here’s one of the more audacious examples:
Enron invested a lot of money in a joint venture with Blockbuster to rent out movies online. The deal flopped eight months later. But in the meantime Enron had secretly set up a partnership with a Canadian bank. The bank essentially lent Enron $115 million in exchange for Enron’s profits from the movie venture over its first 10 years. The Blockbuster deal never made a penny, but Enron counted the Canadian loan as a nice, fat profit.
Did Enron break the rules?
The illegalities included accounting fraud, insider trading and illegal destruction of documents, among other crimes. But rules were for sissies. The Enron executives were invincible innovators, who sneered at rules. In that respect, Enron was the quintessential 1990’s company.
What’s that supposed to mean?
The company embodied the get-obscenely-rich-quick cult that grew up around the intersection of digital technology, deregulation and globalization. It rode the zeitgeist of speed, hype, novelty and swagger.
Petroleum was hopelessly uncool; derivatives were hot. Companies in the 1990s were advised to unload the baggage of hard assets, like factories or oilfields, which hold you back in the digital long jump, and concentrate on buzz and brand.
The accountants who tried to impose the traditional discipline of the balance sheet were dismissed as "bean-counters," stuck in the old metrics.
Wall Street looked to new metrics, new ways of measuring the intangible genius of innovation, and the most important metrics were the daily flickers of your stock price. Above all, everyone was looking for “the killer app”.
“The killer application” was the world-beating opportunity. Kenneth Lay called that Blockbuster deal "the killer app for the entertainment industry." As often as not, the killer app was not a new product or service, but a beautiful loophole.
In the new economy best seller "Unleashing the Killer App," the first example is a man who realizes that gas stations in Germany are exempt from the country’s rigid early-closing laws for most stores. Voila! German gas stations become virtual shopping malls. By the way, in the 1990’s, expressions like "killer app" were widely believed to have an aphrodisiac effect.
So it was about sex, after all?
Oh, absolutely. Wall Street was the new Hollywood, risk was the new testosterone, CNN business anchor Lou Dobbs was the new Marlon Brando. Accountants called themselves consultants and bought Porsche convertibles.
And how cool was Enron? In a November 2000 issue of Fortune magazine in my bookshelf, a writer likened utilities and energy companies to "a bunch of old fogies and their wives shuffling around halfheartedly to the not-so-stirring sounds of Guy Lombardo. . . . Suddenly young Elvis comes crashing through the skylight." In this metaphor, the guy in the skin-tight gold-lamé suit was Enron.
A side effect of the scandal caused the dissolution of the global accounting firm Arthur Andersen LLP, which at the time was one of the world’s main accounting companies. The company was found guilty of obstruction of justice for destroying Enron-related documents, effectively putting the 89-year-old “big five” accounting firm out of business. Just a handful of Andersen’s 85,000 employees remain, operating a conference center outside of Chicago.
Did the United States government cause the fallacy?
Yes it did. Both the Bush senior administration and the Clinton administration, and both parties in Congress collaborated to cause the mess. Attention around the Enron trials focused on a number of fascinating loopholes lawmakers and regulators secretly customized for Enron.
But, and here’s another Enron Lesson and indeed a lesson about the period, most of what Washington contributed to the glory of Enron it did in plain sight.
The American politicians of the 1980s Reagan era and the 1990s Bush and Clinton era demonized government regulation, and methodically dismantled the safeguards set up in previous downturns to protect the small investors. They promoted the cult of stock-market speculation, even calling for Social Security funds to be fed to Wall Street. They cut taxes and all but stopped auditing tax returns.
Enron spent about $6 million in political campaign contributions during the 1990s and it paid off better than most of its other investments.
Isn’t that what free markets are all about — getting government out of the way?
Yes and no. Free-marketers believe in reducing regulation. Enron believed in reducing regulation of Enron.
Enron was perfectly capable of lobbying for the federal government to take over the electric power grid from the states, hardly a free-market position, but one that would have made life easier for Enron. It lobbied for tighter regulation of air pollution, because it had figured a way to make money trading emission credits. And at the end Enron sure seemed to be fishing for a bailout.
More important, a central tenet of capitalism is that people who run companies are subject to the discipline of the marketplace, as judged by the shareholders. That can not work if the shareholders are lied to about the condition of the company.
Another Enron Lesson: The louder someone yells "free markets!" the closer you want to look at his files (assuming they have not been shredded).
But the US administration didn’t bail out Enron at the end, right?
No, the American administration declined to climb aboard that sinking ship. However in the 2008 crises it first bailed out Bear Stearns, then AIG and the big US banks and then the entire American automobile industry. Proving that lessons are quickly forgotten, bailing out Detroit is now seen as a success.
In today’s “culture of bailouts,” Enron might well have been seen as “too big to fail”. Enron had a substantial $63 billion in assets at the time of its Chapter 11 filing. With Enron you could make the case it was as systemically important as Bear Stearns in 2007.
A final Enron Lesson: When business and politics meet, it’s not a relationship, it’s a transaction.
Naturally, the top executives of Enron were imprisoned.
Enron in popular culture media
For the inquisitive reader, there is an award-winning 2005 documentary film which examines the collapse of the Enron Corporation. It is called Enron: The Smartest Guys in the Room. The movie was nominated for Best Documentary in the Oscars 2006. It is based on a book by the same name written by Bethany mcLean and Peter Elkind.
There is also, ENRON, a 2009 play by the British playwright Lucy Prebble, based on the Enron scandal. The Sunday Telegraph critic, gave it five stars, drawing parallels with the plot to that of Shakespeare´s King Lear.