The Smartest Guys in the Room The Amazing Rise and Scandalous Fall of Enron by Bethany McLean and Peter Elkind Portfolio © 2003 434 pages Focus Take-Aways Leadership & Mgt. • Enron, a massive energy management fi rm, turned out to be a house of cards. Strategy • Its strong written code of ethics apparently did not infl uence day-to-day operations. Sales & Marketing • Jeff Skilling, hotshot COO and, later, CEO, spun fantastic tales about Enron’s rich Corporate Finance prospects. Analysts, auditors and reporters believed him without skepticism. Human Resources • Instead of stopping the fraud, Enron’s board rubber-stamped management. Technology & Production • Enron made Andy Fastow its CFO in ‘98 despite his lack of accounting know-how. Small Business • As CFO, Fastow used his considerable power on Wall Street to intimidate, manipulate and ultimately destroy people who should have policed his conduct. Economics & Politics • He helped engineer and personally profi ted from shady transactions that allowed Industries & Regions Enron to hide massive debts and report good results — until it declared bankruptcy. Career Development • Enron’s failure shook confi dence in American markets and corporate governance. Personal Finance • Enron’s board and the various independent analysts who covered the company denied Concepts & Trends any responsibility for their failure to know and tell the truth about the massive fraud. • Skilling told Congress that Enron’s only problem was liquidity and the ensuing panic was like a run on a bank. He denied personal, corporate or accounting wrongdoing. Rating (10 is best) Overall Applicability Innovation Style 9 7 8 10 To purchase individual Abstracts, personal subscriptions or corporate solutions, visit our Web site at www.getAbstract.com or call us at our U.S. offi ce (954-359-4070) or Switzerland office (+41-41-367-5151). getAbstract is an Internet-based knowledge rating service and publisher of book Abstracts. getAbstract maintains complete editorial responsibility for all parts of this Abstract. The respective copyrights of authors and publishers are acknowledged. All rights reserved. No part of this abstract may be reproduced or transmitted in any form or by any means, electronic, photocopying, or otherwise, without prior written permission of getAbstract Ltd (Switzerland). Relevance What You Will Learn In this Abstract, you will learn the whole, detailed story of the rise and fall of Enron. Recommendation Enron is, of course, old news by now. The company went bankrupt in 2001, and its spectacular collapse was merely the fi rst of a series of notorious corporate scandals. Most of the story Bethany McLean and Peter Elkind tell in their book has already appeared in newspaper and magazine accounts and in other, rush-to-publish books that hit the market during or shortly after the events described. However, these authors have assembled what may be the single most comprehensive, detailed account and written it like an anecdote-rich, lively business-based novel. We do wish they had included a timeline and a list of sources, since they have had the benefi t of being able to draw on all of that other work, on indictments and on testimony before courts and Congress, but their account is engrossing and complete. If you read just one book on the Enron scandal, getAbstract.com believes this may be the book to read. Abstract The End At 2:00 a.m. on Sunday, December 2, 2001, attorneys for Enron fi led a petition for Chapter 11 bankruptcy. Enron had no choice — it had tried to arrange to be acquired or merged, but its overtures had been rebuffed. This was an astonishing end to the U.S.’s “It is utterly beyond seventh largest fi rm. question that in reshaping Enron after he was Six months later, a court found Enron’s auditor, Arthur Andersen, guilty of destruction of named its presi- evidence. The evidence consisted of memoranda, letters and thousands and thousands of dent, Skilling pages of other information about Enron. David Duncan, the Arthur Andersen partner who turned it into a had helped instigate the document shredding, also pled guilty to obstruction of justice. place where fi nan- cial deception became almost Securities analysts tried to use the Andersen convictions as an excuse for their own inevitable.” malpractice. They claimed that Enron manipulated its accounting but that since a respected auditor, Arthur Andersen, had signed off on the accounting, they could hardly be blamed for relying on the numbers. Their claims rang hollow to those who knew how Wall Street worked. Most securities analysts labored for banks and brokerage fi rms that had done big business with Enron, and they had paid for that privilege by ensuring that their analysts sang Enron’s praises. Some of those major banks and brokerage fi rms became targets of Securities Exchange Commission (SEC) and Justice Department investigations after the scandal broke. Merrill Lynch accepted a settlement under which “Like many of the it paid $80 million in fi nes, but it did not admit any guilt. other major play- ers in the Enron Meanwhile, Enron’s own board of directors disclaimed any responsibility for failing to saga, Jeff Skilling made his way to oversee the company’s operations or to make sure that the executives were doing business the top of Amer- legally and ethically. They said that the company’s clever managers had deceived and ican business by blinded them, presenting false numbers that they had no reason to doubt. But Enron’s sheer force of will.” fraud was hidden in plain view. Some astute short sellers and hedge fund operators saw the same numbers, knew what they meant, and bet big money on the Enron emperor’s unacknowledged nudity. Their bets paid off handsomely when Enron went down. It The Smartest Guys in the Room © Copyright 2004 getAbstract 2 of 5 strains credulity to imagine that the board members, with their access to privileged information and their power to hire or fi re managers, could not see as much as outsiders with access only to fraudulent fi nancial reports. “Baxter had a towering ego and But most people involved with Enron lost. Employees lost. Stockholders lost. Pension funds a volatile person- lost. Even people who never bought a share of Enron stock lost when Enron went down, ality…Though he because Enron’s failure rocked the fi nancial foundations of America. What happened? eventually made millions at Enron, he also com- The Frauds plained frequently Many things were wrong with Enron and, after its demise, many people were that he was under- willing to explain them. But the proximate cause of Enron’s failure was a series of paid and unappre- illegitimate fi nancial transactions involving what accountants and investment bankers ciated.” call structured fi nancings. The story of Enron’s fi nancial prestidigitation began innocuously enough in 1998, when newly appointed CFO Andy Fastow, age 36, suggested to Enron’s top managers that the company should issue additional stock. President and COO Jeff Skilling and Chairman and CEO Ken Lay were not keen on the idea because they felt that issuing more stock might hurt Enron’s stock price. Fastow convinced them. The new issue raised $800 million. Then Fastow got creative. He had to, because management had promised Wall Street that the company would grow marvelously. But growth required even more capital and Fastow had just three ways to get it: • Borrow — But the more Enron borrowed, the higher its cost of borrowing became. “To the outside world, the person Banks and bond buyers base their lending decisions on a company’s risk. The more who was Enron, a company borrows, the higher its risk and the lower its credit rating. The lower its who had a repu- credit rating, the more it has to pay to borrow. tation for turning impossible con- • Issue stock — The company had issued stock successfully, and its stock price was cepts into glittering high. However, the law of supply and demand works in the stock market as in any realities, was not other market. The more shares of stock in a company there are on the market, the Skilling. It was smaller each share is. Issuing a disproportionate number of shares “dilutes” the Rebecca Mark.” stock. As a result, the more stock there is, the smaller the share of the company each stock represents and, other things being equal, the lower the stock price. Enron’s shareholders bought their shares in expectation of rising, not falling stock prices. If the stock price started to slide, they would probably sell, forcing it down even farther. Thus, Jeff Skilling was cool to Andy Fastow’s 1998 proposed stock issue. Enron may have lucked out that time, but it couldn’t luck out every time. • Structured fi nance — Using certain innovative transactions, Enron could make bil- lions of dollars in capital appear without borrowing or issuing stock. The choice among these was no choice at all. Fastow opted for structured fi nance. The degree to which Skilling and Lay assented is still a question for the courts to decide. Many observers doubt that executives as sharp as these two could have been entirely “One of Enron’s unaware of Fastow’s creativity or innocent of any involvement in it. In fact, Cliff Baxter, key advantages another Enron executive, told Skilling he was concerned, noting, “You could never tell over its competi- tors was informa- whether deals were clean because they were so complicated.” When the dimensions of tion: it simply had Enron’s malfeasance became public, Baxter committed suicide. more of it than its competitors.” To get a glimmer of an understanding of what Fastow created, begin with Whitewing.