The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron by Bethany McLean and Peter Elkind
"If I had to describe my sixteen years of corporate work with one phrase, it would be 'pretending to add value.'"
—Scott Adams, creator of Dilbert
I.
We all have our failures, our embarrassing moments, our simian exigencies that ever urge us to short-term expedience. Confiteor, mea maxima culpa, dimitte mihi—all that good stuff, let me get back to practical matters, thank you very much.
But can you imagine living an existence so abject, so corrupt, so base, an enormity so egregious that you can't but burst and collapse into a veritable black hole that absorbs and annihilates everything in the immediate vicinity, such that in your self-contained universe you become a veritable byword and your story mandatory reading for anyone interested in pursuing a career even remotely related to yours?
Ecce, Enron.
Just as the sinking of the Titanic was for the 20th century, if not a pivotal moment, then at least an iconic one, I suspected the collapse of Enron will, along with the 9/11 attacks which precipitated the bankruptcy thereof in some complex economic way, be considered critical and definitive for the 21st century, because, so I was told, it revealed deep weaknesses in not just accounting controls (Enron's auditor, Arthur Andersen, was brought down with the ship) but also in the capitalist system itself. Enron, as a byword for corporate, has implanted itself in the public consciousness---hence my interest in this topic.
I wasn't terribly inclined to start such a massive book on such a sordid topic as corporate politics. But whenever I looked at the Wikipedia page for the Enron scandal with a mind to make some sense of the matter, every time I got to the section that details the causes thereof, I would read something like "Enron earned profits by providing services such as wholesale trading and risk management"—and just a few sentences later there I would hit the limit of my intelligence and education. I chose to read Smartest Guys in the Room, hopeful that in it I would find an accessible narrative; after all, in theory, one can only achieve "best-selling" status if people from diverse backgrounds can buy and read it.
And, after going through years of journalism, all distilled into nearly five hundred pages, the facts rendered as thoroughly and limpidly as they could ever be for a layman—I still don't really know how Enron made money in the first place.
Perhaps they never did.
The Smartest Guys in the Room is written in a very plain, unadorned style suitable for an investigative report. It's length, I suppose, is quite justified given the history of the company, the characters and their history, and the divers endeavors (which, whether in accounting or business were largely, abstrusely fraudulent, or whose ethical considerations were, at the very least, questionable). This book seems largely written for documentary and historical aims, rather than to provide any esthetic edification to the reader—a work whose longueurs may be worthy for the annals but which is a bit tedious as a medium for a cautionary tale.
It wasn't too long into it that I gave up trying to understand what Enron was doing, because I realized that even attempting to do so might lead me into the same iniquity that had taken the corporation itself. If Enron's accounting maneuvers appear confusing, that was the point—they made them deliberately complex in order to hide their failures (and I deliberately use the word "failures" instead of "debts," because the latter has more accounting connotations, which I, for obvious reasons, want to avoid), to the point that it required years of hearings, investigations, and trials to figure out what the hell had happened.
II.
The purpose of this section is to describe the substance of Enron's fraud in the plainest language I can muster. Perhaps this review can serve to help those who should find themselves in the same position as I was prior to my reading this book: wanting to know the details of quite possibly the biggest corporate fraud in history but getting continually caught up in the details and complexity.
The source of money—the location of money—the flux of money. If these three be the Trinity, then ACCOUNTING is perhaps the LORD thy God, in which the three are consubstantial. Come tax time, all of us too painfully know the moral obligation to track and plan our finances—and the punishments for not doing so.
A naive view of accounting—one even I admittedly held for too long, which perhaps bewrays the lack of complexity, and according meagerness, of my finances—would be something like: "What's the big deal? Money is money—you use it to buy things." But then that raises the question—what, exactly, is money? Is it just a store of value? But if that's the case, an asset like a computer, which is indisputably valuable, should be considered "money"—and, if that's the case, shouldn't fluctuations in its value (whether from upgrades or depreciation) be reflected somehow on the financial statements?
Because accounting can get so complicated so fast, and because each accounting maneuver is fertile ground for corruption, there are certain rules, laws, and audit procedures public corporations have to follow when it comes to their financial reporting. But, of course, with all rulesets, especially ones that are broad and complex, there's room for interpretation. Sometimes one person will think one thing (almost always to his benefit), another person (the person who loses) disagrees, there's a lawsuit, they go to the courts, i.e., capitalism.
In fact, there are even scholars who think "objectivity in accounting is largely a myth . . . arguing that accounting should be approached as a form of 'dialogue' through which accountants can construct, 'read' and probe situations in a variety of ways."
So, very briefly: in its years of business Enron took broader and broader interpretations of accounting rules and made transaction after transaction that had apparently no purpose but to obfuscate their commercial failures—till their books had no connection to the reality of the corporation's economic position.
For example, Enron decided—which seemed quite innocuous at the time, as this was what many companies do—that they would declare the entirety of the profits of any new deal they signed immediately upon their signing it (a convention known as mark-to-market accounting). Dispensing with the inconvenient question of how could one possibly know how much a 10-year contract would return in the end—maybe something changes, maybe your partner doesn't want to do business anymore, maybe some commodity you depend on becomes prohibitively expensive due to factors outside your control—their financial statements used incomprehensibly complex and generous models or simply vague statements such as "Management's best estimates."
. . . the idea was all and the idea, therefore, should be the thing that was rewarded. [Jeff Skilling, the CEO,] felt that a business should be able to declare profits at the moment of the creative act that would earn those profits. Otherwise businessmen were mere coupon clippers, reaping the benefit of innovation that had been devised in the past by other, greater men. Taken to its absurd extreme, this line of thinking suggests that General Motors should book all the future profits of a new model automobile at the moment the car is designed, long before a single vehicle rolls off the assembly line to be sold to customers. Over time this radical notion of value came to define the way Enron presented itself to the world, justifying the booking of millions in profits on a business before it had generated a penny in actual revenues. In Skilling's head, the idea, the vision, not the mundane reality, was always the critical thing.
—Excerpt from The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron, by Bethany McLean and Peter Elkind
And here is one of the best advantages of doing business this way: say some deal falls through or you lose a bunch of cash, you can simply "revisit" those old models, change some assumptions, and thereby you can reveal profits you didn't even know existed!
Enron employed other tricks. Deal makers regularly revisited large existing contracts—some more than five years old—to see if they could somehow squeeze out a few million more in earnings. Sometimes the contracts were restructured or renegotiated; other times, they were simply reinterpreted in ways that made them appear more profitable. “When the last-minute call for earnings went out,” says one high-level deal maker, “I’d go: ‘Which contracts did I do five years ago that had potential value?’ A lot of them you could remark.” Skilling himself labeled the contract portfolio “a gold mine.”
Earnings projections on mark-to-market deals, based on complex models, were reexamined. Was it possible to be a little more optimistic? A small move in a long-term pricing curve could generate millions in extra accounting profits. The curves often went so far into the future that drawing them was already little more than an educated guess. The danger was that skewing curves to generate more profits was not only improper but also raised the likelihood that the curves would turn out to be way off base, producing a big mismatch between Enron’s projections and a reality it would eventually have to face. But that, of course, was a future concern, far removed from the crisis of the immediate quarter.
But these financial "disclosures" were deliberately engineered to be impenetrably complex. Before long, Bethany McLean, one of the co-authors of this book, revealing the nakedness of the Enronperer, wrote, in March of 2001, less than a year before the bankruptcy, an article for Fortune entitled Is Enron overpriced? which title, I am told, is still reckoned as the favorite for Most Prescient Understatement of the Century. And a courageous piece of journalism it was, to ask the blatant question that the fake news (NO STOP THIS IS NOT THE TIME OR PLACE) everyone was being willfully blind to and bear the risk of ignominy ("What, you don't understand Enron, the coolest, fastest-growing company in America? What the hell kind of business journalist are you?")
The factors that acted on Enron to crash its stock in the period of a month are many and complex, and I am not competent to summarize, or even understand, the minutia and their actors. But I hope, by my expenditure of time in reading this book, and this subsequent review, I can distill the essence of the collapse and thereby perhaps divert those who are too besieged by mundane concerns from perpetuating, whether deliberately or through willful blindness, a similar enormity.
When, exactly, did Enron cross the line? Even now, after all . . . that's an impossible question to answer. There have been accounting frauds over the years . . . [but in] such cases, someone at a company ha[d] to consciously consider the fact that he or she is about to commit a crime—and then commit it.
But for the most part, the Enron scandal wasn't like that. The Enron scandal grew out of a steady accumulation of habits and values and actions that began years before and finally spiraled out of control. When Enron expanded the use of mark-to-market accounting to all sorts of transactions—was that when it first crossed the line? How about when it set up its first off-balance-sheet partnerships . . . [or] when it categorized certain unusual gains as recurring? Or when it created EPP, that "independent" company to which Enron sold stakes in its international assets and posted the resulting gains to its bottom line?
In each case, you could argue that the effect of the move was to disguise, to one degree or another, Enron's underlying economics. But you could also argue that they were perfectly legal, even above board. Didn't all the big trading companies on Wall Street use mark-to-market accounting? Weren't lots of companies moving debt off the balance sheet? Didn't many companies lump onetime gains into recurring earnings? The answer, of course, was yes.
And my studies have concluded that the fall of Enron can be encapsulated with a single phrase: the inevitable fate of one who pursues the appearance of success rather than success itself.
III.
"Every single deal that I did at Enron when I was CFO was approved by Enron's accountants, the outside auditors at Arthur Andersen, Enron's attorneys, Enron's outside attorneys, the banks' attorneys, and Enron's board of directors."
—Andy Fastow, CFO of Enron (from his corporate culture talk)
The biggest takeaway is that the Enron fraud was systematic and institutional, but not a conspiracy (N.B: I am using the word "conspiracy" as a layman. Some of Enron's officers were convicted of the criminal charge known as "conspiracy," but I don't know what the technical standards/procedures are for inferring such a charge in the jurisdiction in which they were convicted.)
Systematic and institutional, in the sense that everyone on all levels, to varying degrees of cognizance thereof, participated in perpetuating the fraud (as the above quote of Fastow's illustrates); but not a conspiracy, in the sense that it seems there was never a group of people that, sitting down with the books, whispered: "We know we must do x under the law, but we're instead going to fraudulently and illegally do y because the rewards are high and maybe no one will notice, and we all agree to keep this a huge secret."
Rather, Enron's crime was born in its ethos, which can be articulated thus: "The way we do things—business, accounting, whatever—is right because we're Enron."
Smith was struck by things that most Enron employees had long since taken for granted. The abrasive, cutthroat culture. The condescension toward anyone who didn't work at Enron. And always, the obsession with the stock price at every level of the company. "Everywhere you looked, the stock ticker was going," said Smith. "In the lobby of the building. In the lobby on your floor. It was on the screen of your computer. Everybody was focused on the stock price. You couldn't get away from it. When the stock wasn't doing well, the mood changed."
A corporation having a toxic, cutthroat culture is hardly noteworthy. What is more extraordinary is that all the usual checks and balances in the capitalist system failed—from the outside auditors at Arthur Andersen who approved transactions despite that the email record shows they tried to raise concerns initially (partly because they were afraid of losing their biggest client), to the business analysts who praised the company, driving the stock up and up while the company produced nothing of value. Meanwhile, inside jokes about the "counterintuitive" accounting maneuvers openly proliferated—which, like SS's adoption of a skull as their insignia, makes you wonder how nobody realized that they were doing something wrong. (Probably anybody who did was fired.)
At the Congressional hearings into the bankruptcy, Andy Fastow (CFO) pled the Fifth, which anyone, even if the full extent of his legal education were a mere high school course in law, would have advised. Jeff Skilling's (CEO) lawyers thus advised him too, and he ignored them. There are only two ways I can conceive of this: Perhaps Skilling was simply naive; but, given the description in the book of how he maneuvered his way up from a blue-collar family to become the CEO of one of America's biggest companies, I think this is unlikely. The better explanation is that this is a man so caught up in the cult of Enron that he truly believed (and, having gotten out of prison a few years ago, apparently still believes) the collapse was the result of pure politics, and that he and Enron had done nothing wrong.
. . . the very picture of a sophisticated, booming business: a big open room, bustling with people, all busily working the telephones and hunched over computer terminals, seemingly cutting deals and trading energy. Giant plasma screens displayed electronic maps, which could show the sites of [Enron Energy Service]’s many contracts and prospects. Commodity prices danced across an electronic ticker. "It was impressive," recalls analyst John Olson, who, at the time, covered the company for Merrill Lynch. "It was a veritable beehive of activity."
It was also a veritable sham. The war room had been rapidly fitted out explicitly to impress the analysts. Though EES was then just gearing up, [they] had staged it all to convince their visitors that things were already hopping. On the day the analysts arrived, the room was filled with Enron employees. Many of them, though, didn’t even work on the sixth floor. They were secretaries, EES staff from other locations, and non-EES employees who had been drafted for the occasion and coached on the importance of appearing busy. One, an administrative assistant named Kim Garcia, recalls being told to bring her personal photos to make it look as if she actually worked at the desk where she was sitting; she spent most of the time talking to her girlfriends on the phone. After getting the all-clear signal, Garcia packed up her belongings and returned to her real desk on the ninth floor. The analysts had no clue they’d been hoodwinked.
Just as Enron’s financial executives convinced themselves that their financial shenanigans stayed within the rules, it seemed, so EES executives reasoned that this deception wasn’t a problem. Eventually, EES really would use all that space. Eventually, there would be hundreds of busy employees working the phones and trading energy and the division would be every bit as fabulous as they were telling investors. It just wasn’t quite there yet. In many ways, Skilling’s little Potemkin Village stood as the perfect metaphor for EES: so much of what outsiders were led to believe about the operation was at odds with what was really going on.
Enron is the apotheosis of the proverb: "Fake it till you make it."
IV.
. . . 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.
At this point, if any should say that Enron is what you get when a society underregulates, that we need more oversight, regulation, revolutions, socialism, communism, etc., my response would be that they do not understand the nature of Enron. Legislation, regulation, or oversight is, at best, addressing the symptoms, and not the disease, as the Enron story perfectly illustrates.
"Accounting rules and regulations and securities laws and regulation are vague. They're 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?'"
—Andy Fastow, quote from The confessions of Andy Fastow, July 1 2013, Fortune, by Peter Elkind
Do you really think that your tiny little roadblocks will stymie, even slightly, the infernally ingenious engines of the capitalist machine?
In his Meditations on Moloch, Scott Alexander observed: ". . . many of the most important competitions / optimization processes in modern civilization are optimizing for human values. You win at capitalism partly by satisfying customers' values. You win at democracy partly by satisfying voters' values. . . . But it's important to remember exactly how fragile this beneficial equilibrium is."
Yet Enron did not only find its way around this equilibrium—it prided itself in so doing. Smartest Guys documents Enron's involvement with the California electricity crisis of 2000, during which the state government, in an attempt to control the crisis, created a series of regulations; and Enron, being Enron, found loopholes in the complexity and exploited them for monetary gain, which often involved withholding power to the starved state, i.e., doing literally the exact opposite of satisfying its customers' wishes. This is just one of the many examples where Enron asked "Is there an opportunity for profit; and, if so, is it legal?" and, by a great contortion of imagination and lawyers finding that the answer to both was yes, went all out, regardless of the human lives affected as externalities.
My point is not that more people should have had harsher punishments. In fact, I'm not entirely sure what my point is. I guess what I'm saying is that it seems the problems with Enron run much deeper than questions of economic/social policy.
What about "being a good person"? Well, that's an even harder question than "what exactly happened with Enron."
V.
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.
"When I became CFO, never once did I ask myself the question: was what I was doing ethical? . . . The only question I asked myself is: am I following the rules? And, in fact, I entered into transactions that I knew were intentionally, materially misleading. The rationalization I used was, hey, I'm following the rules; so it's okay. . . . If I don't do it, someone else will do it first, and they'll get an advantage."
—Andy Fastow, during an interview on day 1 of the 2017 PLUS D&O Symposium
The whole Enron story got me thinking about the nature of lying and deception. Specifically, is a lie "wrong" if it doesn't technically break the rules?
Upon hearing the very word "lie" itself, the mind instantly responds with aversion, ascribing to the sound all these negative connotations. Why is that?
The religious would say that lying is enjoined by the commandments; the secular would say that it erodes social trust.
I find both answers unsatisfying. After all, there are numerous examples in the world's religious texts (and real life) where everyone understands that, in some specified circumstance, lying is the "godly" option; and we also all know that there is no correlation—and even an inverse correlation—between a person's truthfulness and his success in obtaining public offices (and my sister, a forensic accountant, assures me that for every one Enron, there are ten others that no one has noticed).
Furthermore, lying seems to be a prerequisite for doing any kind of business. I can't tell you how many times I've been told by people to "be honest" in job interviews—while simultaneously instructed to reframe my "weaknesses" as "strengths," to not say that you left your last job because management was toxic, to say that you are interested in this company in this particular rather than that you saw the ad for the position opening and you needed a job, etc.
But I see no meaningful difference in not technically lying and "actual lying."
Whom, exactly, was Enron trying to convince? Shareholders? Themselves? Someone else?
VI.
The scariest thing is that I have absolutely no difficulty seeing myself perpetuating something horrific like Enron.
I'm a hypothetical Enron officer. I find all my worldly needs satisfied; I have endless money, women, respect, and influence. Ethics? Nothing but a word for ivory-tower philosophers; I'm focused on real-world business. Besides, I have too much to lose. Why should I speak up and thereby risk being destroyed by the powers which, only by great political dexterity, I exploit while simultaneously keep at bay lest they get out of control and destroy me myself?
Or, which is more likely to be the case for most people: I have a family I have to feed. My boss comes to me and says: "Approve this transaction which we are prepared to defend as legal with the full force of our lawyers, or you're fired." Should I really let petty workplace disagreements get in the way of providing for my loved ones?
So I did: I lied in the job interview. I lied about the progress of my work. I lied that it wasn't my fault. And why not? After all, everyone does it, and I don't want to be left behind.
And without fail, every single time, whether in a day or in a few years, somehow, somewhere, it has come back to punish me.
Am I, like Enron, just "bad at business"? Or is it that lies, even the not-technically-ones, scale very poorly; and we, as the myopic, short-lived apes we are, simply mistake superficial expedience—which, by its tenuous nature, cannot long abide—as good sense, and, when the edifice inevitably crumbles, are unable to trace the chain of ever-compounding falsities?
I hoped that writing this review would help me answer the questions that have tormented me my entire adult life; but, unfortunately, I fear that I'm nowhere closer. My only solace is that when I look back at all the times I didn't do my best, spent more time appearing productive than actually being productive, constructing political and legal devices rather than engineering ones, blaming others so as to divert responsibility from my position, to continue to collect a salary a not-insignificant multiple of the median for the population, and when I see all the judgments whose memories still, to this day, rise to the present moment and smite me once more, I can remember Smartest Guys, and maybe practice some self-forgiveness—for, though I may have been duplicitous, wasteful, and unproductive, at least I wasn't as duplicitous, wasteful, and unproductive as Enron.
But, behold: I see Enron's fixation on nice-looking financial statements and its stock price while the company essentially had no, even negative, productivity; I see some affinity between Enron's "not-technically-lies" and those in my own life; I see the times when I sought the mere appearance of wealth, truth, etc. while neglecting them in essence. And though I still absolutely cannot understand, much less apply, that strange and incomprehensible apothegm "thou shalt not bear false witness," I do think I'm beginning to have some glimpses as to why "Thou shalt not make unto thee any graven image" is canonically superordinate.