For a few years at the turn of the millennium, Enron was the most admired company in America. Fortune magazine named it the country’s most innovative company six years running. It had transformed itself from a sleepy Texas gas-pipeline operator into a dazzling, futuristic energy-trading colossus, the seventh-largest corporation in the United States, run by men celebrated as the smartest in any room they entered. And then, over the course of a few months in the autumn of 2001, it simply ceased to exist — collapsing into what was, at the time, the largest corporate bankruptcy in American history, wiping out some eleven billion dollars in shareholder value and the retirement savings of thousands of its own employees.
What makes Enron different from Ponzi or Madoff is that there was no single hidden vault of lies, no secret floor where the fraud was manufactured. The fraud was built into the accounting, in plain sight, blessed at its foundation by the regulators and signed off year after year by one of the most respected auditing firms in the world. Enron didn’t hide its crime in a back room. It published it, in its annual reports, and dared anyone to understand it.
A pipeline company and a preacher’s son
Enron was born in 1985 from the merger of two pipeline companies — Houston Natural Gas and the Omaha-based InterNorth. The man who emerged on top of the combined company was Kenneth Lay, the son of a Missouri Baptist preacher, a man who had climbed out of genuinely modest beginnings on the strength of a doctorate in economics and a true believer’s faith in the free market. He even spent a small fortune on consultants to find the new company a name; the first choice, “Enteron,” was hastily abandoned when someone pointed out it was a medical term for the digestive tract. They settled on Enron.
Lay’s faith was in deregulation — the dismantling of the old rules that had kept energy a staid, regulated utility business of fixed prices and physical pipelines. Deregulation cracked that world open, turning natural gas, and later electricity, into something that could be traded like a financial instrument. Lay was the evangelist of this new world, a man of vision and political connections rather than operational detail. He built the cathedral. Other men would fill it with rot.
The visionary who understood the new world best was Jeffrey Skilling, a brilliant, intense, arrogant former McKinsey consultant whom Lay brought in to run the trading business. Skilling’s great idea was to make Enron a kind of bank for natural gas — buying and selling on long-term contracts, smoothing out prices for producers and consumers and pocketing the spread. It was genuinely clever. It turned a commodity into a financial product and Enron into something more like a Wall Street trading house that happened to own some pipelines. Skilling believed in being “asset-light” — that owning physical things like power plants was a drag, and that the real money was in trading, in intellectual capital, in the deal. And the culture he built to match was Darwinian: a notorious performance-review system, nicknamed “rank and yank,” in which employees were graded on a curve and the bottom tier was fired every single cycle. It bred a workforce of brilliant, aggressive people incentivized to book profits now, and to never, ever be the one who raised a hand to ask whether the numbers were real.
The third man was Andrew Fastow, the young financial whiz Skilling hired and eventually made chief financial officer — the engineer who would build the machinery that hid the truth.
Booking tomorrow’s dinner today
The original sin had a dull, technical name: mark-to-market accounting. When Skilling joined, he insisted on the right to use it, and in 1992 the Securities and Exchange Commission gave Enron permission — making it the first non-financial company allowed to use the method for complex long-term contracts.
Here is what it meant, and why it poisoned everything. Suppose Enron signed a twenty-year contract to supply gas. Under normal accounting, you book the profit as it actually arrives, year by year. Under mark-to-market, Enron could estimate the entire future stream of profit from that twenty-year deal, calculate its value today, and book all of it as current earnings the moment the ink was dry. The profit was a projection — a guess about what might happen over two decades — recorded as though the cash were already in the bank.
The consequences were slow poison. Reported profits and actual cash diverged wildly: Enron could announce soaring earnings while almost no real money came through the door. The estimates were Enron’s own to make, so aggressive assumptions meant bigger profits today. And worst of all, it created an addiction. Once you’ve booked twenty years of a deal’s profit upfront, that deal can never help you again — so to show growth next quarter, you need a bigger deal, and a bigger one after that, forever. Mark-to-market was a treadmill that only ever sped up.
The aggressive deals and the inflated assets generated enormous real debt and real losses, and a company whose entire stock price depended on looking like a flawless growth machine could not let that debt appear. This is where Fastow earned his keep. Beginning in the early 1990s, he built a sprawling network of what were called special purpose entities — ostensibly independent partnerships into which Enron could shovel its debt and its failing assets so they vanished from the balance sheet. On paper, Enron looked nearly debt-free. In reality it owed more than thirty billion dollars, hidden in this shadow structure.
The names of these entities have become legend, partly because Fastow’s team christened them with a strange playfulness. There was JEDI, a partnership co-owned with a California pension fund. When Enron wanted to buy out the pension fund’s stake but keep the debt off its own books, Fastow created a new entity to do the buying and named it Chewco — after Chewbacca. The Star Wars joke was buried inside the machinery of a multibillion-dollar fraud. Chewco was supposed to have genuinely independent outside investors to keep it legitimately off Enron’s books; it didn’t — its financing was secretly backed by Enron’s own stock. Through Chewco alone, Enron reported some four hundred million dollars in fictional profit while concealing roughly six hundred million in debt.
Fastow’s most brazen creations were the partnerships he named LJM — after the initials of his wife, Lea, and their two sons, Jeffrey and Matthew. Through LJM, Fastow set up entities that did deals directly with Enron, buying its troubled assets and taking on its risk, while Fastow himself ran both sides and held a personal financial stake. The chief financial officer of Enron was sitting on both sides of deals with his own company. When the truth finally came out, it emerged that Fastow had personally pocketed forty-five million dollars from the LJM partnerships — an astonishing sum for a sitting CFO, especially since he claimed to spend no more than a few hours a week on them.
All of this was certified by Enron’s outside auditor, Arthur Andersen, one of the world’s “Big Five” accounting firms — the supposedly independent watchdog whose job was to vouch that the books were honest. Andersen was not independent. It earned enormous fees from Enron, for auditing and for lucrative consulting both, and it signed off, year after year, on the accounting that hid the thirty billion in debt.
And while the paper empire soared, the men at the top sold their own stock — Lay and Skilling cashing out hundreds of millions — even as they urged their employees to keep buying Enron shares and holding them in their retirement accounts. That asymmetry, the insiders selling while the rank and file were told to buy, is the moral crime at the dark heart of the whole story.
The question nobody could answer
The thread that began to unravel it all was pulled by a young Fortune reporter named Bethany McLean, in an article published in March 2001 with a deceptively simple title: “Is Enron Overpriced?” She didn’t allege fraud. She just pointed out that nobody could actually explain how Enron made its money. The company traded at fifty-five times its earnings, priced for perfection, yet its financial statements were, in her word, nearly impenetrable. Even the professional analysts who covered the stock for a living couldn’t explain the earnings. When she pressed, Enron stonewalled, calling the details proprietary. Fastow told her the company had over a thousand separate trading “books” and then said, in a line that should have ended his career on the spot: “We don’t want to tell anyone where we’re making money.” The few hard numbers McLean could extract were alarming — a company supposedly minting cash was, on inspection, drowning in debt and generating almost no actual money.
She had been pointed toward the story, in part, by a short-seller named Jim Chanos, who had read Enron’s filings, concluded the whole thing didn’t add up, and was betting heavily against the stock. He was the rare investor who profited from seeing the truth that everyone paid to be optimistic refused to see.
Then came the warning from inside. An Enron vice president named Sherron Watkins wrote a now-famous memo to Ken Lay in the summer of 2001, after Skilling’s sudden departure, telling him plainly that she was “incredibly nervous that we will implode in a wave of accounting scandals.” Lay did not act on it.
And Skilling’s departure was the loudest alarm of all. In August 2001, at the apparent height of Enron’s success, having become chief executive only months earlier, Jeffrey Skilling abruptly resigned, citing vague “personal reasons.” For the architect of the entire machine to walk away suddenly, just before the digging started, was a klaxon to anyone listening.
From there the collapse came fast. That October, Enron announced a shock loss and a massive reduction in shareholder equity as the off-balance-sheet machinery began bleeding back onto the books. The SEC opened an investigation; Fastow was fired. The company was forced to restate years of earnings, publicly admitting that profits it had reported going back to 1997 had been fiction. A desperate rescue merger with a rival, Dynegy, was announced and then collapsed within weeks once Dynegy saw the true depth of the rot. The credit agencies downgraded Enron to junk, triggering billions in debt that came instantly due. On the 2nd of December, 2001, Enron filed for bankruptcy.
As it imploded, its auditor panicked. In the early weeks of 2002, it emerged that Arthur Andersen had been shredding Enron-related documents in its Houston office — its general counsel had warned that the firm’s email records “looked too clean.” The lead Andersen partner on the Enron account had overseen the destruction of, by some accounts, more than a ton of paper.
The wreckage
The first giant to fall was the auditor. Arthur Andersen was convicted of obstruction of justice in 2002, and because the SEC does not accept audits from a convicted felon, the eighty-nine-year-old firm surrendered its licenses and effectively ceased to exist, its tens of thousands of employees scattered. In one of the great ironies of American legal history, the Supreme Court unanimously overturned that conviction in 2005, ruling the jury instructions had been flawed — but by then it was a verdict delivered over a grave. The firm was already dead, destroyed by the indictment three years before the Court said it had been flawed.
Andrew Fastow, the engineer, was indicted on dozens of counts, pleaded guilty, agreed to surrender more than twenty million dollars, and — crucially — agreed to cooperate against his former bosses. He ultimately served six years. His wife Lea also pleaded guilty to a tax charge and served a short sentence, a detail that sharpened the domestic tragedy of a man who had named his crimes after his own children.
The marquee trial of Kenneth Lay and Jeffrey Skilling took place in Houston in 2006. Both were convicted of conspiracy, fraud, and related charges. Skilling drew the harshest sentence: twenty-four years, later reduced on appeal to fourteen, of which he served about twelve before his release. Ken Lay never served a day. He died of a heart attack in July 2006, about six weeks after his conviction but before his sentencing — and because he died before he could exhaust his appeals, a court vacated his conviction entirely, a galling outcome for the victims who watched the patriarch escape both prison and a final verdict by dying.
Beneath the executives were the real victims: more than twenty thousand Enron employees who lost their jobs, and many who lost their life savings, because their retirement accounts had been loaded with Enron stock — stock they had been encouraged to hold even as the insiders sold, and which they were locked out of selling during the critical window as the price collapsed toward zero. The smartest guys in the room got rich and got out. The people who answered their phones and ran their pipelines got nothing.
The lasting consequence was written into law. The catastrophe of Enron, alongside the near-simultaneous collapse of WorldCom, produced the Sarbanes-Oxley Act of 2002, which revolutionized corporate governance in America — forcing chief executives and chief financial officers to personally certify their financial statements, strengthening auditor independence, mandating rigorous internal controls, and creating a new board to police the auditors. Every public company in America still operates under the regime that Enron’s collapse created. It was paid for with twenty thousand jobs and the savings of thousands of families — the price of a company that confused the story of value with value itself, and a culture so certain it was the smartest in the room that it forgot to ask whether any of it was real.
Power and Pelf 