The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron (62 page)

Lay was stunned. “Why?” he asked. Skilling’s first response was that he wanted to spend more time with his family; his children were approaching college age, and if he didn’t spend the time with them now, he would never have the opportunity. Lay later said that when he pushed further, Skilling told him that he was under a great deal of pressure—he was taking the stock price decline personally, and he couldn’t sleep at night.

What happened next is still a mystery—one that only two people know the answer to. The common perception is that Lay was horrified at the prospect of losing Skilling. It wasn’t that he was happy with his CEO’s performance; he blamed Skilling for the falling stock price just as much as Skilling blamed himself. But what sort of message would it send to the already shaky market if the new CEO left after only six months? And since Skilling had not yet picked a chief operating officer, the only obvious successor was Lay himself. Lay hadn’t had much to do with running Enron for years; he really didn’t know much about the inner workings of the company. On top of that, he was contemplating leaving the company himself; rumor had it that he would make a graceful exit by running for mayor of Houston. Lay has said that he asked Skilling to reconsider over the weekend.

When the two met again on Monday morning, Skilling was still adamant about resigning. Lay called another board participant and told him Skilling was resigning. This person replied: “Don’t let this happen. You don’t want this to happen.” Lay told some board members that Skilling was going through a bad patch and that he was working very hard to keep him. He later claimed that some of the members of the board spoke to Skilling and urged him to stay.

Skilling has told a very different story. He has claimed that Lay made no effort to convince him to stay and that he would have been willing to stay for up to six months to ease the transition. He has also told friends that not one board member ever called him.

If Skilling had indeed been willing to stay for a transition period, the board never knew that. One former outside board member recalls, when he first learned that Skilling wanted to resign, expressing his concerns to Lay. “I thought Skilling’s resignation would hurt the company’s credibility and told Lay to try to talk him out of it. If he couldn’t, I asked Lay to try to get Skilling to stay on for an additional six months to a year to facilitate a smooth transition. This would have given us time to rebuild our senior management team. Lay apparently raised this with Skilling, because he told me well before the August 2001 board meeting that Skilling said he wanted to resign after the second-quarter earn-
ings release and was unwilling to stay on for even a day after the August board meeting.”

Not having fun anymore?
Whoever said being a CEO was supposed to be “fun”? Board member John Duncan later told investigators that he was “disappointed” with Skilling’s decision. “Skilling had been with the company for ten years and knew what being CEO entailed,” Duncan also said.

What is clear is that Skilling’s decision was kept very, very quiet.

After meeting with Lay, Skilling had lunch with Cliff Baxter. Baxter looked fabulous. He was spending time on his boat and clearly enjoying his new life. A few days later, Skilling took his daughter, Kristin, on vacation. They didn’t return until July 22.

 • • • 

Ken Lay had a great deal more on his mind than Jeff Skilling’s unhappiness. Although it seems almost unfathomable, Lay was fighting off his creditors. To the outside world, Lay was the very picture of corporate success, as Enron itself had been for so long. But in truth, here was a more telling way in which Lay personified the company he led: like his company, Lay’s financial strength was an illusion.

Even in retrospect, Lay’s financial catastrophe is hard to fathom. Over the previous few years, he had realized over $200 million from salary, bonus, and the exercise of Enron stock options; as of early 2001, he owned some five million Enron shares that were then worth $350 million. In 2001, as part of a plan to diversify his holdings, he was cashing in options—almost $30 million worth in the first six months of the year. And as chairman, he was still being paid an annual salary of $975,000.

Lay’s finances, however, were built around the belief that Enron’s stock would never go down. During most of the 1990s, Lay had most of his net worth in Enron stock. In 1999, his advisers began pestering him to diversify. But he did so in a manner that wound up, in effect, doubling his bet on the stock. Here’s what he did: Lay pledged almost all of his portfolio of liquid assets—primarily Enron stock—as collateral for bank and brokerage loans. According to the
New York Times
, Lay had loans from PaineWebber, First Union, and the small Compass Bank, in addition to multiple lines of credit from Bank of America: a $40 million line for him and Linda, a $10 million line for his family partnership, and another $11.7 million line that allowed him to buy a piece of Houston’s new professional football team. By early January 2001, Lay owed $95 million to his various creditors.

Lay then used the money he had borrowed to make other investments. He turned some of it over to various money managers. He also made a series of high-risk illiquid investments. (At the same time, Kopper and Fastow were putting their ill-gotten gains into municipal bonds.) With his son, Mark, Lay invested in privately held technology companies, including one called EterniTV, a start-up that planned to deliver video services over the Web, and EC Outlook, a supply-chain-management software company. (EterniTV was supposed to deliver its services by Enron Broadband.) He invested nearly $20 million in Questia, a Houston company that sold access to online books. He was so excited about Questia that he joined the board and pushed Skilling to invest, too. (Skilling declined.)

The parallel was eerie: to a stunning degree Lay’s personal finances resembled Enron’s dealings with the Raptors. But in a sense, Lay was making an even bigger bet on Enron stock than Andy Fastow had. Because so many of his investments—including his three multimillion-dollar homes in Aspen—were illiquid, Enron stock was the primary means by which he supported his loans. So long as Enron stock kept rising, Lay was fine. But if Enron’s stock went south, Lay was in big trouble, and the further it fell, the deeper his trouble.

And Lay had left himself very little room to maneuver: as was the case with many of Enron’s own deals, Lay’s arrangements with his banks contained triggers, according to the
New York Times
. If Enron stock fell below $80, he faced margin calls. If the stock fell below $60, he would almost certainly be in violation of his loan terms. In 2001, as Enron stock hit the $80 trigger and then the $60 trigger, Lay, just like his company, became desperate.

Frantic for a way out, Lay decided to secretly take advantage of a little-known quirk surrounding executive loans: they can at times be paid off by selling stock back to the company. What’s more, unlike regular executive stock sales, which have to be disclosed almost at once, these sales don’t have to be disclosed until after the end of the year. Back in May 1999, Lay had modified his loan agreement to include this loophole; starting in November 2000, Lay began repeatedly drawing down a $4 million line of credit he had with Enron, using it to pay off his creditors and then repaying the loan by selling stock. As Enron’s stock fell and the margin calls came faster—he got 15 written margin calls in total—Lay used it with increasing frequency. In June alone, he took out a total of $24 million in loans from Enron, repaying them by selling stock. By late July, he had sold $52 million in stock this way. One board member later called the practice Lay’s “ATM approach.”

Lay later argued that his stock sales were not a sign that he no longer believed in the company; rather, he sold because he had no choice. By using the secret loans to pay the margin calls instead of selling shares outright, he was bettting that Enron’s stock would rebound and he would thus have to sell fewer shares to repay the company. In order to avoid selling Enron stock, Lay got at least one creditor to accept illiquid collateral instead. He began trying to sell his interest in the football team. That summer, Lay converted some 200,000 options into stock—and didn’t sell. At the end of July, he also stopped his daily sales of 2,500 shares because he thought that Enron shares, then around $45, were underpriced.

But it’s hard to believe that Lay didn’t have another motive in choosing this method for repaying his creditors: he could keep it secret, at least for a while. He did not tell Jim Derrick, Enron’s general counsel. He did not tell Enron’s directors; they publicly professed horror when they found out. As director Charles LeMaistre later told a congressional committee, “One of the lines in the Enron code says that you will do nothing to hurt the interest of Enron, and taking this much money out and repaying it with stock when the stock is declining certainly is very devious. It is very difficult for me to understand why that did not hurt Enron.” Nor did Lay tell investigators who explicitly asked him about his stock sales shortly after Enron collapsed. Instead, he said that
Enron
decided whether loans were to be repaid in stock or cash and that he had “made some payments for the loan toward the end of 2001.”

What’s impossible to know is how Lay’s financial crisis factored into his feelings about Skilling’s performance as CEO. Today, Lay insists that it didn’t. But given how critical Enron’s stock price was to his own fortunes, how could it not?

 • • • 

After returning from his trip with his daughter, Skilling continued to act like
the CEO. He handled the PRC meetings at the St. Regis Hotel on the twenty-third and twenty-fourth of July and then flew to New York along with investor-relations head Mark Koenig and Andy Fastow—who was fulfilling his promise to act more like a CFO—to meet with analysts and investors. In the meetings with investors, Skilling was as arrogant and prickly as ever. He bragged that Enron’s market share in natural gas and power was over three times higher than its next competitor, Duke. “We will hit those numbers, and we will beat those numbers,” he told attendees, in response to worries about Enron’s earnings.

During the meeting, the Enron team also showed a slide entitled Recent Investor Concerns. The list included California, India, Broadband, Cash Flow & Financing Vehicles, and “Trading” in Enron’s Business Model. The executives told investors that LJM was no longer a cause for concern, because Enron was “eliminating the related-party relationship with LJM.” As for all the other problems, Skilling dismissed them. “All of these are bunk,” he said. “These are not issues for this stock.”

That weekend, Skilling went to Aspen with Rebecca Carter; he had asked her to marry him back in June, when he was already thinking seriously about leaving Enron. Upon his return, Skilling had lunch on consecutive days with Ken Rice then Lou Pai. He did not talk about work at all—which was extremely rare for Jeff Skilling.

On August 3, Skilling appeared at EES for one of his periodic state-of-the-business floor meetings. As one hundred employees gathered around, Skilling climbed on a desk and offered his usual gung-ho speech. Everything was going great, he said. EES was going to be one of Enron’s shining stars, maybe even its top division. Why in three years, Skilling predicted, EES was going to be making a half-billion dollars!

But even inside Enron, the old Skilling magic wasn’t working anymore. The questions were skeptical.
How’d we make our numbers this quarter? Why are you selling so much of your own stock?
And finally, from Margaret Ceconi:

“You say we’re going to make half a billion a year, Jeff. How in the world are we going to do that? What’s your strategy?”

“Well, that’s what you guys are for,” Skilling responded. “You guys are the creative ones—you’ve got to figure it out.” That afternoon, EES laid off three hundred people, including Ceconi.

If Skilling did have any second thoughts about his decision to leave Enron—and he has insisted that he did not—something happened that cemented his decision. On August 8, there was a massive explosion during routine maintenance work at Teesside. Three workers were killed; another man, gravely burned, was sent to the hospital. Roughly two hundred employees had to be evacuated, as black smoke billowed everywhere.

Skilling heard the news when he arrived at work that morning. He was visibly shaken and disturbed. He immediately took a company plane to England, where he met with all the Teesside employees, visited the surviving man in the hospital, and went to see the families of those who had been killed. He later told people it was the “worst day of my life.” He seemed traumatized by the deaths. “It was just awful,” he said. “These guys were good guys. The day before they were good guys, and the next day they were dead.”

It was at the end of this week that the news began to circulate inside Enron. Lay finally told another senior Enron executive that Skilling was leaving. That person was shocked. “Don’t be,” Lay said. “This has been an issue for a while.”

Over the weekend, Mark Palmer, Enron’s head PR man, met with Skilling at the home of Steve Kean, Enron’s chief of staff, to help draft the resignation press release. “You have to be prepared for people to be angry with you,” Palmer told Skilling. Skilling later called Palmer. He sounded deeply depressed. “You just have to trust me,” he said. “I had to do this.”

On August 13, Enron held its regularly scheduled board meeting. Skilling attended the day-long session in his role as CEO and board member. One of the subjects the board talked about were four new disaster scenarios Rick Buy and his risk-assessment group had put together at Skilling’s request. One scenario Buy presented envisioned a truly chilling chain of events. It begins with the announcement that Enron would miss its quarterly-earnings target, triggering a massive stock sell-off. This, in turn, leads to the collapse of the company’s balance sheet, because it forces the unwinding of all the off-balance-sheet vehicles that were capitalized with Enron stock, which prompts downgrades in Enron’s credit ratings, which trigger the material adverse change clauses in the company’s trading contracts, which cause its trading partners to start demanding that Enron post cash collateral, which of course it doesn’t have. All of this, in turn, wipes out Enron’s remaining liquidity and destroys investor confidence.