Enron. Can We Look
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In 1942 Kenneth Lay was born in Tyrone, Missouri. A small county town far from big city life. By 1968 he joined the Navy and did his tour of duty as a financial analyst. While working for the government he completed his PhD in economics and had helped the Pentagon save several billion dollars.
In 1985 Ken Lay was in charge of Houston Natural Gas. His company was acquired by InterNorth. The name chosen to call this new entity was Enteron. It was soon discovered that Enteron was a Greek word for bowels. It was changed again to Enron.
By 1987 the first scandal hit. Traders in the New York office had lost over a billion dollars via unauthorized trading. The money was hid by routing it through a shell company. Three years later the traders were convicted of fraud and tax violations.
In the late 80’s Ken Lay and colleague Richard Kinder decided the future was in the unregulated world of energy. The focus of operations was on selling gas and trading funky products. Enron soon became the preeminent energy derivatives company. Oil, gas, bandwidth, rain and even snowfall. They traded it.
In 1990 Ken Lay brought aboard McKinsey & Company consultant Jeff Skilling to run trading and finance. Skilling was intelligent, ruthless and by the end of this saga, went a little nuts. His organizational changes brought intense competition to the trading floor.
By the mid 1990’s the international operations began to flourish. Enron took 80% control in a power plant built for the Maharashtra State Electricity Board in India. The only stipulation was that Maharashtra had to buy all its power from the plant for the next 20 years. Local constituents were not pleased. Either was the World Bank.
Richard Kinder, the voice of reason left his position as COO in 1996. Among infighting, Jeff Skilling took over the role as president and COO. Through derivatives, Enron entered into many businesses unrelated to the gas industry.
“Just know the rules better than anybody else. Then you’ll make money. - Jeff Skilling
Pete Wilson, Governor of California signed a bill deregulating electricity. The electricity trading group realized this bill was a maze of loopholes waiting to be exploited. Jeff Skilling made sure that happened.
The trading group found ways to resell electricity to utility companies at prices much higher than before. When the scheme went public, needless to say California was pissed.
Andrew Fastow, a rising star from finance & operations had a great idea to help fund company growth as well as give the balance sheet an extreme makeover: Special Purpose Entities (SPE).
SPE’s are allegedly independent partnerships that allowed Enron to borrow money without calling it debt. Arthur Andersen, you remember them, said as long as at least 3% of the money invested in SPE’s came from outside the company, they are considered seperate entities. Fastow did what he could to bend the rules. He was able to reclassify borrowed money as revenue.
The SPE's that Andrew Fastow developed were given names. Most were named after Star Wars characters or reptiles from Jurassic Park.
The independent "entities" Andy Fastow recruited to borrow "revenue" were often employees, customers, relatives or friends. They were all promised to be “taken care of.”
The bottom line: Enron borrowed huge sums of money from investors and reported the debt as revenue. Only if real life were like that. Wait. That was real.
Fastow wanted recognition. He wanted fame. Ken Lay nominated him as CFO magazine’s “CFO of The Year.” He won and got his face on the cover. The Finest in Finance was the cover title.
Certain analysts were willing to look closer at the balance sheets. Those who did discovered something was wrong. John Olson, analyst for Merrill Lynch downgraded the stock. Fastow was livid and threatened to cut Merrill from a stock offering unless they fired Olson. Olson was duly fired.
SPE’s weren’t the only deceit Fastow specialized in. If Enron had a deal in which the revenue were to be paid out over 10 years, they booked the entire revenue at once. For example in 1997 they booked $500 million in profit. However the total earnings were more in line of $8 million.
The company made SPE’s a part their strategy. They had used them to hide outrageous amounts of debt for so long that they needed to create more SPE’s to inflate revenue.
Ken Lay became suspicious of Fastow’s use of SPE’s. It was discovered that Fastow was actually making money for himself from the SPE's. He paid himself a self-appointed fee for working with these vehicles. His side income totaled $40 million. Ken Lay fired Fastow.
All was not lost however. Naming rights were bought from Houston’s baseball park. Enron Field was born. Cost: $100 million. Irony: Priceless.
This is the end. My only friend, the end. - Jim Morrison
Andy Fastow was arrested and convicted. His release date is December 2011 from the Federal Correctional Institution in Bastrop, Texas.
Jeff Skilling became CEO and Andersen’s auditors were asking questions. The energy company's business was critical to Arthur Andersen. The managing partners made sure any inquires were answered in a way to please the client. Not protect the public.
Company attorneys alerted Enron management of the impeding trouble the SPE’s would bring. Sherron Watkins a company accountant sent Ken Lay an anonymous email warning “I am incredibly nervous that we will implode in a wave of accounting scandals.”
The financial stements from 1997 to 2001 were restated. Earnings were $586 million less and debt was $2.6 billion greater. Around this time the energy firm Dynergy considered buying the troubled firm. It backed out.
The press began to publish articles about Enron’s woes. Management’s defense was Arthur Andersen says we’re kosher. So we’re kosher.
Once the collapse seemed inevitable and the stock went from $90 to single digits, Andersen knew they had to act fast. What better way than shred documents. As many as you can get your hands on. Bring out the blender.
During the meltdown Skilling resigned. His behavior was erratic to say the least.
As the last days loomed, Ken Lay contacted the government about his problems. He hinted at a bailout, but nothing was done. Enron collapsed and brought jobs, pensions and lives with it.
Jeff Skilling suffered a nervous breakdown on the streets of New York City in April 2004. He harassed several passersby's and accused them of being undercover FBI agents. He was convicted of several counts of felony and is serving a 24 year prison sentence.
Ken Lay died on July 5, 2006 of a heart attack.
Lea Fastow, wife of Andy Fastow was sentenced to one year in jail as part of her involvement.
Merrill Lynch paid $80 million in fines but never admitted any guilt.
Arthur Andersen is history.
The board of directors took the Colonel Klink from Hogan Heroes defense. They knew nothing, saw nothing. The board claimed management cleverly disguised the deceit.
Several hedge funds and short sellers looked at Enron's numbers and decided to short the company's future. Needless to say, they made a lot of money.
I’m sure corporate America has learned many lessons from this tragedy and are implenting controls to insure the safety of their shareholders.
Wink-wink.
