The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron (24 page)

Martin immediately brought the documents to Skilling, who had often given her what he intended as a considerable compliment: “Amanda, you’re one of the smartest women we have here.” Now, insisting he knew nothing about the pay discrepancy, Skilling promised to look into it. Two weeks later, she received a check for $300,000. “Enron,” says Martin, “was a hard place for a woman to work. It was like a boys’ locker room.”

At about the same time, though, Martin also made matters considerably more awkward for herself by beginning her relationship with Rice. The situation was messy. Both were married, with children (though Martin was separated from her husband). Rice was also Martin’s boss. Not surprisingly, as the relationship became known, coworkers muttered that sleeping with the boss had accelerated her advance. One disgruntled ECT originator named Brian Barrington did more than mutter: he filed suit against the company and Rice, blaming the relationship for Rice’s refusal to overturn Martin’s decision to demote him. (The litigation aired some embarrassing discovery about Rice’s sophomoric behavior before it was finally settled out of court.)

Skilling had first picked up complaints about the relationship a few months after it began. He confronted Rice, who denied that he was involved with Martin. But Skilling eventually realized that Rice had lied to him. Rice and Martin came clean and began appearing together in public, generating even more bitter complaints of favoritism. To deal with the complaints Skilling dispatched Martin to Rebecca Mark’s new water company, Azurix. And Ken Rice? Nothing happened to him.

For his part, Skilling also began seeing someone from Enron, a woman named Rebecca Carter, a former Andersen accountant who worked on the trading floor as a risk manager. Skilling actually asked the board for permission to date her (after, according to several sources, their relationship had already begun). Skilling also gave her a big promotion, naming her to the powerful post of corporate secretary, which put her in charge of organizing board meetings and taking the official minutes, among other duties. By the time she left Enron, her salary and bonus approached $600,000.

Which was yet another problem with Skilling’s Enron. He still had his favorites, and they could still do no wrong. Skilling’s handful of direct reports, noted Alkhayat, the COO’s Egyptian-born aide, operated with his “blessed hand”; it was as if they’d been anointed by the leader as infallible and holy.

But they didn’t consider Skilling infallible. It was a given, of course, that he was brilliant and that he could get to the essence of an issue faster than anybody. But once he felt he understood the strategy, he lost interest. Execution bored him. “Just do it!” he’d tell his subordinates with a dismissive wave of his hand. “Just get it done!” The details were irrelevant.

Many times, it wasn’t even clear what Skilling wanted. He sometimes praised deals that had been carried out against his orders. He became enraptured with businesses he had initially dismissed. And he sometimes insisted he’d always opposed deals that he had actually embraced. When he gave specific directions, those unaccustomed to dealing with him sometimes made the mistake of following them too precisely. One longtime Skilling deputy says the boss’s instructions at times required translation. “We’d understand where Jeff wanted to go and what he wanted to do. A lot of people who came over later would take him literally. They’d say: ‘Jeff wants me to do this.’ I’d say, ‘Well, Jeff doesn’t want you to do something
stupid
! He wants the end results. He doesn’t know how to get there.’ ”

 • • • 

And always, hovering over everything and everyone at Enron, was Wall Street. During the Kinder era, of course, Enron executives had cared a great deal about pleasing the Street and watching the stock move upward. In the Skilling era, the stock became something else entirely: it became Enron’s obsession. A stock ticker in the headquarters lobby offered a constant update on the price of Enron shares. TV monitors broadcast CNBC in the building elevators. Employees were repeatedly encouraged to buy Enron shares; on average, they kept more than half their 401(k) retirement holdings in Enron shares. In 1998, when the stock price hit $50, Skilling and Lay treated it as a major corporate milestone, handing out $50 bills to every Enron employee. Later Lay announced a new personnel initiative: if the company hit performance targets over several years, every employee would get twice his annual salary in Enron shares.

For Skilling himself, says a former aide, “the stock price was his report card.” When it rose, he was exultant; when it dropped, he was glum. Whenever he was on the road, Skilling would call several times a day just to check on how the stock was performing. Lots of corporate executives were fixated on their companies’ stock price during the bull market of the 1990s, but Skilling’s obsession went beyond most of them. As a businessman, his thought process revolved almost entirely around the stock, to the point where he began to believe that Enron’s market capitalization—that is, the total value of the company’s stock—was the only measure the company should be concerned with. Eventually, he would justify business decisions entirely on the basis of what it would mean to Enron’s valuation.

Enron was back in Wall Street’s good graces by 1998. That year, the S&P 500 had yet another big bull market run-up, gaining 27 percent. Enron easily outpaced the market index, rising 37 percent. The analysts had all restored their buy recommendations on the stock and were once again singing the company’s praises. Enron was once again posting steady annual earnings increases of 15 percent and above. The company was beating its quarterly numbers with such regularity that it seemed almost effortless.

In fact, it was anything but effortless; there was nothing at Enron that required more effort, more cleverness, more deceit—more
everything
—than hitting its quarterly earnings targets. As out of control as Enron was on a day-to-day basis, the place went practically bonkers when the end of the quarter grew closer. For this, Skilling deserves the lion’s share of the blame.

By the late 1990s, Enron had made a fundamental shift: trading and deal making were its core. By the estimation of one former executive, of the 18,000 people Enron employed in 1999, a stunning 6,000 were doing deals of one sort or another. And the vast majority of them—perhaps 5,000—were traders and originators working in Skilling’s merchant business, the descendant of ECT. “That was our business,” Skilling would later say. “We bought and sold stuff.”

But that was something Skilling could never admit to the outside world. Partly that was because if Wall Street understood anything, it understood the inherent dangers of a trading operation. Back in December 1995, Skilling had gotten a taste of just how jittery Wall Street could be about trading. That month a rumor swept the Street: Enron had suffered a huge loss from shorting the gas market in the face of a cold snap that had sent prices soaring. What’s more, the rumor had it, Skilling had been led off the trading floor in handcuffs. The story was false, but it was a tale the market was more than willing to believe; Enron’s stock plummeted 27⁄8 points in a single day, wiping out $750 million in market value. The next morning, Lay, Kinder, and Skilling, who had all been skiing in Colorado, were forced to convene a conference call, where they refuted the rumors and insisted that Enron’s tight system of risk controls made such a catastrophic loss impossible. More than 170 anxious institutional investors and analysts listened in on the call.

But it wasn’t just Wall Street’s nervousness that caused Skilling to skirt the truth about its core business. This was Enron’s dirty little secret: a company built around trading and deal making cannot possibly count on steadily increasing earnings. Skilling may have sold EOG in part because of the unpredictable nature of its earnings, but what he refused to acknowledge is that there is nothing more unpredictable than a trading desk. A trading desk can make or lose tens of millions of dollars in the blink of an eye. As one former Enron managing director says, “A business that had stable and predictable earnings that’s primarily engaged in the trading of commodities is a contradiction in terms.”

Precisely because of their volatile earnings, companies whose business is primarily trading invariably have low stock valuations. Goldman Sachs, widely viewed as the best trading firm in the world, has a price/earnings multiple—the key valuation gauge—that rarely goes above 20 times earnings. (That means that the price of a share of the firm’s stock is 20 times the amount of its annual earnings per share.) Goldman Sachs never even attempts to predict its earnings ahead of time. It can’t.

Enron’s valuation was twice that size by the late 1990s, and Skilling wanted to make it go higher still. So instead of admitting that Enron was engaged in speculation, he claimed it was a logistics company, which merely found the most cost-effective way to deliver power from any plant anywhere to any customer anywhere. There was some truth to that, it just wasn’t the whole truth. The Enron trading desk, Skilling added, always had a matched book—meaning that every short position precisely offset every long position—and made its trading money merely on the commissions, not on speculative risk. Right up until the end, Skilling and his lieutenants stuck to that line, long after it had become demonstrably false.

That’s one reason why hitting the company’s earnings targets was so hard:
it wasn’t in a business that naturally generated steadily growing earnings. Here’s the second reason: Skilling’s method of arriving at Enron’s quarterly and annual targets was downright perverse. Instead of going through a rigorous budget process and arriving at a number by analyzing all the business units and their prospects for the coming year as Kinder used to do, he would impose a number based solely on what Wall Street wanted. He would openly ask the stock analysts: “What earnings do you need to keep our stock price up?” And the number he arrived at was the number Wall Street was looking for, regardless of whether internally it made any sense.

Under Skilling, the budget process at Enron was “a giant game of chicken,” recalls a former executive. “The numbers trickled down. You wanted to say, ‘Wait, I can’t do that.’ But you weren’t doing yourself a service if you did that.” Another executive adds, “It was just the allocation of big numbers. The budget process was last year’s number, plus x percent growth.”

Invariably, as the quarter drew to a close, Enron’s top executives would realize that they were going to fall short of the number they’d promised Wall Street. At most companies, when this happens, the CEO and chief financial officer make an announcement ahead of time, warning analysts and investors that they’re going to miss their number. In other words, the reality of the business drives the process of dealing with Wall Street. Not at Enron. Enron’s reality began and ended with hitting the target. And so, when the realization took place that the company was falling short, its executives undertook a desperate scramble to fill the holes in the company’s earnings. At Enron, that’s what they called earnings shortfalls—“holes.”

Calls went out from Skilling and chief accounting officer Rick Causey to the heads of the various company businesses. “We need an extra $15 million!” What rabbits could they pull out of their hats? Deal closings were accelerated so that earnings could be posted by the end of the quarter. This usually required capitulating on key negotiating points, which, over the long term, would likely cost the company millions. But that wasn’t the point: at least they’d make the quarter.

Enron also relied heavily on mark-to-market accounting to help it reach its earnings goals. Originally, mark-to-market had been used only in the accounting of natural gas futures contracts—that, after all, is what the Securities and Exchange Commission had agreed to back in 1991. Over the years, Enron had quietly extended the practice. It marked-to-market its electric power contracts and trades after it got into that business. Then, in 1996, it began booking profits on its 50 percent portion of JEDI—the partnership it had established in 1993 with CalPERS—using mark-to-market accounting. By 1997, Enron had extended mark-to-market accounting to every portion of its merchant business. It even began using the approach to book profits on private equity and venture-capital investments, where values were extraordinarily subjective. By the end of the decade, some 35 percent of Enron’s assets were being given mark-to-market treatment.

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.

Another trick was to delay recording losses. At the end of each quarter, for example, Enron was supposed to write off its dead deals. To review what needed to be booked, Causey met individually with the heads of the origination groups. At one meeting, an executive recalled, Causey kept coming back to a dead deal and asking: Was it possible the deal was still alive?

It wasn’t, responded the executive.

“So there’s no chance of it coming back?”