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The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron
The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron By Bethany McLean and Peter Elkind. Penguin Group, NY, NY, 2003. 414 pages; $26.95. ISBN 1-5918-4008-2 Reviewed by Larry M. Parker Case Western Reserve University
The Smartest Guys in the Room is a superb book about the Enron disaster. Fortune writers McLean and Elkind have done a masterful job of exploring the complexities of Enron. In general, the authors have presented a detailed, factual analysis without being judgmental. At first this reviewer was surprised the authors could present such incredibly unethical actions, both personal and corporate, in such a detached manner. However, one can appreciate the benefit of this approach. Many readers probably become increasingly angry as they progress in the book with the people and events the authors described. If the authors had injected their indignity (which they did only indirectly through quotes from others), I suspect some could have become too upset to finish the book. The accounts are often almost unbelievable. A drawback of this approach is that at times this reviewer felt he was reading a very long newspaper article, rather than an amazing story ‘‘of human weakness, of hubris and greed and rampant self-delusion; of ambition run amok; of a grand experiment in the deregulated world; of a business model that didn’t work; and of smart people who believed their next gamble would cover their last disaster – and who couldn’t admit they were wrong.’’(p. xxv). Much of the book describes the cast of characters. It is fascinating to read about each person, but almost overwhelming to try to imagine all these people together in one organization. Any one of the key individuals seemed capable of severely tainting an organization, and some of the supporting characters were at least as deplorable as the key people. It is truly a situation in which a fiction writer would not be bold enough to invent such people, because readers of fiction would probably not be able to believe such lowlife could exist – at least, not within one entity. Ken Lay, founder and CEO of Enron, may be the most well-known Enron figure, and clearly set the tone 353
354
LARRY M. PARKER
for the culture of Enron. Lay was, among other things, a ruthless hypocrite who pretended Enron was based on ‘‘Christian values’’ (p. 3). He touted Enron as sincere, honest and respectful, operating with ‘‘absolute integrity.’’ (p. 89) In a memo he stated ‘‘Ruthlessness, callousness and arrogance don’t belong here y . We work with customers and prospects openly, honestly and sincerely y’’ (p. 89). But in reality the completely dysfunctional culture created largely by Lay and COO Jeff Skilling created ‘‘corporate killers’’ (p. 121) who were encouraged to backstab and take advantage of anyone – customer, supplier, lender or fellow employee. Skilling, a former McKinsey consultant, persuaded outsiders that he was reinventing corporate culture by creating a Darwinian meritocracy. He believed that team players were losers. Skilling, whose personality seems almost maniacal, created a ‘‘chaotic, destructive free for all.’’ (p. 56). The authors describe many other fascinating characters in addition to Lay and Skilling to help explain the development of the entire Enron culture. A good example is John Wing, a ‘‘forgotten man of the Enron saga’’ (p. 44). This reviewer had never heard of him, but he was key to understanding much of the Enron culture. Wing was the founder of Enron International. He was loud, irritating, arrogant, cunning, fast, decisive and relentlessly ruthless. This executive was the first to demonstrate that Lay could be weak and indecisive, bullying the CEO time and again. Wing was one of the few who made real profits for Enron instead of just accounting or paper profits, but he was so nasty even Enron fired him three times – and rehired him each time. In addition to showing the path around Lay, Wing blatantly and repeatedly exploited Enron for his own gain, setting the stage for others to realize such actions would be tolerated, even encouraged. Wing pocketed millions when he left Enron, and was succeeded by Rebecca Mark, who had become successful in large part by sleeping with the boss, and who also succeeded in looting Enron. Mark and Wing also helped set the sexual precedent for the permissiveness that seemed prevalent in Enron. In fact, Wing escaped unscathed because he sold his Enron stock after Rich Kinder, President and COO of Enron, was ushered out by Lay. Lay moved Kinder out because Kinder was having an affair with Lay’s executive secretary, infuriating Lay, even though Lay was having an affair with another of his secretaries. A member of the Enron Board of Directors, when asked about this apparent hypocrisy, simply summarized that ‘‘Some people would make the point that it was his own secretary, versus the boss’s secretary.’’ (p. 97). Chapter 11, Andy Fastow’s Secrets, alone might be worth the price of the book. Early in the chapter the authors explain, ‘‘there are only three ways for companies to fund y growth. They can take on debt, issue stock,
Book Review
355
or draw from their existing cash flow y . But all three of these tactics were ruled out by Enron.’’ (p. 150). Fastow’s job largely consisted of taking care of this situation. Securitization and establishment of Special Purpose Entities (SPEs) were the keys to his success – as long as it lasted. Fastow’s early securitizations (basically, selling future revenues from contracts at a discount to generate cash) were actually legitimate, and sucked in institutional investors such as CALPERS and G.E. Later deals became more and more shaky, with few of the SPEs actually meeting the 3% requirement to remain off the books of Enron. But Fastow, aided by his equally manipulative lieutenants Ben Glisan and Michael Kopper, became a master of form over substance, and the auditors, Arthur Andersen, did not object. His deals deftly generated paper profits and cash, hid debt, and sometimes converted debt to equity. His manipulations fit nicely with Enron’s overall approach to business, which had evolved to making deals of little substance. Few of the deals made by Fastow or Enron traders made sense. But Enron’s Risk Assessment and Control (RAC), a dazzling group of risk assessment specialists who were supposed to stop moves that were too risky, was too weak to do anything. The head of RAC, Rick Buy, and the chief accounting officer, Rick Causey, were completely unable to stand up to Skilling, Fastow and other Enron executives. The auditors, Arthur Andersen, were more interested in facilitating Enron’s plans than critically examining them. The authors make it obvious that Enron was doomed long before its actual collapse. Rank and file auditors of Arthur Andersen, as well as national level partners, understood that Enron was trouble. Chase took out a billion dollar insurance policy to cover risk associated with Enron, and Citibank spread its risk by selling notes to investors. Those in the natural gas industry would no longer deal with Enron if it could be avoided. It is clear that Enron was in an inescapable death spiral of arrogance, greed, dishonesty, deceit, corruption and backstabbing. Enron executives were magicians capable of transforming the grim reality into the magnificent illusion desired by Skilling and Lay. But virtually all of the Enron’s efforts, well described by the authors, simply delayed disaster. Enron was truly a financial time bomb that had to eventually explode. The Enron forays into electricity (including the California power fiasco) and almost comical broadband trading (‘‘they didn’t really have any business’’ (p. 284)) described in later chapters simply provide the context for the denouement of the Enron tragedy. Another impressive aspect of this book is that so much insight is provided into so many arenas. Enron International transactions help us understand why so many people in many countries distrust global capitalism. For
356
LARRY M. PARKER
example, the $20 billion Dabhol, India, scheme is one of the great international financial disasters, and probably deserves a book of its own. It stands as ‘‘the biggest fraud in India’s history’’ and made India ‘‘a country where every single person hates one company.’’ (p. 79). We can also understand how Enron’s machinations provide abundant and appropriate ammunition for opponents of mark to market accounting and deregulation. Additionally, it is staggering to see how bright people from stalwart institutions such as McKinsey, Harvard and the late Arthur Andersen can become enmeshed in destructive patterns of greed. Enron, as presented by McLean and Elkind, provides a microcosm in which we can see much of what troubles society. The book does not provide an easy story line to follow, but it is well worth the effort to study the book and piece the facts into a remarkable tale.
The Smartest Guys in the Room is a superb book about the Enron disaster. Fortune writers McLean and Elkind have done a masterful job of exploring the complexities of Enron. In general, the authors have presented a detailed, factual analysis without being judgmental. At first this reviewer was surprised the authors could present such incredibly unethical actions, both personal and corporate, in such a detached manner. However, one can appreciate the benefit of this approach. Many readers probably become increasingly angry as they progress in the book with the people and events the authors described. If the authors had injected their indignity (which they did only indirectly through quotes from others), I suspect some could have become too upset to finish the book. The accounts are often almost unbelievable. A drawback of this approach is that at times this reviewer felt he was reading a very long newspaper article, rather than an amazing story ‘‘of human weakness, of hubris and greed and rampant self-delusion; of ambition run amok; of a grand experiment in the deregulated world; of a business model that didn’t work; and of smart people who believed their next gamble would cover their last disaster – and who couldn’t admit they were wrong.’’(p. xxv). Much of the book describes the cast of characters. It is fascinating to read about each person, but almost overwhelming to try to imagine all these people together in one organization. Any one of the key individuals seemed capable of severely tainting an organization, and some of the supporting characters were at least as deplorable as the key people. It is truly a situation in which a fiction writer would not be bold enough to invent such people, because readers of fiction would probably not be able to believe such lowlife could exist – at least, not within one entity. Ken Lay, founder and CEO of Enron, may be the most well-known Enron figure, and clearly set the tone 353
354
LARRY M. PARKER
for the culture of Enron. Lay was, among other things, a ruthless hypocrite who pretended Enron was based on ‘‘Christian values’’ (p. 3). He touted Enron as sincere, honest and respectful, operating with ‘‘absolute integrity.’’ (p. 89) In a memo he stated ‘‘Ruthlessness, callousness and arrogance don’t belong here y . We work with customers and prospects openly, honestly and sincerely y’’ (p. 89). But in reality the completely dysfunctional culture created largely by Lay and COO Jeff Skilling created ‘‘corporate killers’’ (p. 121) who were encouraged to backstab and take advantage of anyone – customer, supplier, lender or fellow employee. Skilling, a former McKinsey consultant, persuaded outsiders that he was reinventing corporate culture by creating a Darwinian meritocracy. He believed that team players were losers. Skilling, whose personality seems almost maniacal, created a ‘‘chaotic, destructive free for all.’’ (p. 56). The authors describe many other fascinating characters in addition to Lay and Skilling to help explain the development of the entire Enron culture. A good example is John Wing, a ‘‘forgotten man of the Enron saga’’ (p. 44). This reviewer had never heard of him, but he was key to understanding much of the Enron culture. Wing was the founder of Enron International. He was loud, irritating, arrogant, cunning, fast, decisive and relentlessly ruthless. This executive was the first to demonstrate that Lay could be weak and indecisive, bullying the CEO time and again. Wing was one of the few who made real profits for Enron instead of just accounting or paper profits, but he was so nasty even Enron fired him three times – and rehired him each time. In addition to showing the path around Lay, Wing blatantly and repeatedly exploited Enron for his own gain, setting the stage for others to realize such actions would be tolerated, even encouraged. Wing pocketed millions when he left Enron, and was succeeded by Rebecca Mark, who had become successful in large part by sleeping with the boss, and who also succeeded in looting Enron. Mark and Wing also helped set the sexual precedent for the permissiveness that seemed prevalent in Enron. In fact, Wing escaped unscathed because he sold his Enron stock after Rich Kinder, President and COO of Enron, was ushered out by Lay. Lay moved Kinder out because Kinder was having an affair with Lay’s executive secretary, infuriating Lay, even though Lay was having an affair with another of his secretaries. A member of the Enron Board of Directors, when asked about this apparent hypocrisy, simply summarized that ‘‘Some people would make the point that it was his own secretary, versus the boss’s secretary.’’ (p. 97). Chapter 11, Andy Fastow’s Secrets, alone might be worth the price of the book. Early in the chapter the authors explain, ‘‘there are only three ways for companies to fund y growth. They can take on debt, issue stock,
Book Review
355
or draw from their existing cash flow y . But all three of these tactics were ruled out by Enron.’’ (p. 150). Fastow’s job largely consisted of taking care of this situation. Securitization and establishment of Special Purpose Entities (SPEs) were the keys to his success – as long as it lasted. Fastow’s early securitizations (basically, selling future revenues from contracts at a discount to generate cash) were actually legitimate, and sucked in institutional investors such as CALPERS and G.E. Later deals became more and more shaky, with few of the SPEs actually meeting the 3% requirement to remain off the books of Enron. But Fastow, aided by his equally manipulative lieutenants Ben Glisan and Michael Kopper, became a master of form over substance, and the auditors, Arthur Andersen, did not object. His deals deftly generated paper profits and cash, hid debt, and sometimes converted debt to equity. His manipulations fit nicely with Enron’s overall approach to business, which had evolved to making deals of little substance. Few of the deals made by Fastow or Enron traders made sense. But Enron’s Risk Assessment and Control (RAC), a dazzling group of risk assessment specialists who were supposed to stop moves that were too risky, was too weak to do anything. The head of RAC, Rick Buy, and the chief accounting officer, Rick Causey, were completely unable to stand up to Skilling, Fastow and other Enron executives. The auditors, Arthur Andersen, were more interested in facilitating Enron’s plans than critically examining them. The authors make it obvious that Enron was doomed long before its actual collapse. Rank and file auditors of Arthur Andersen, as well as national level partners, understood that Enron was trouble. Chase took out a billion dollar insurance policy to cover risk associated with Enron, and Citibank spread its risk by selling notes to investors. Those in the natural gas industry would no longer deal with Enron if it could be avoided. It is clear that Enron was in an inescapable death spiral of arrogance, greed, dishonesty, deceit, corruption and backstabbing. Enron executives were magicians capable of transforming the grim reality into the magnificent illusion desired by Skilling and Lay. But virtually all of the Enron’s efforts, well described by the authors, simply delayed disaster. Enron was truly a financial time bomb that had to eventually explode. The Enron forays into electricity (including the California power fiasco) and almost comical broadband trading (‘‘they didn’t really have any business’’ (p. 284)) described in later chapters simply provide the context for the denouement of the Enron tragedy. Another impressive aspect of this book is that so much insight is provided into so many arenas. Enron International transactions help us understand why so many people in many countries distrust global capitalism. For
356
LARRY M. PARKER
example, the $20 billion Dabhol, India, scheme is one of the great international financial disasters, and probably deserves a book of its own. It stands as ‘‘the biggest fraud in India’s history’’ and made India ‘‘a country where every single person hates one company.’’ (p. 79). We can also understand how Enron’s machinations provide abundant and appropriate ammunition for opponents of mark to market accounting and deregulation. Additionally, it is staggering to see how bright people from stalwart institutions such as McKinsey, Harvard and the late Arthur Andersen can become enmeshed in destructive patterns of greed. Enron, as presented by McLean and Elkind, provides a microcosm in which we can see much of what troubles society. The book does not provide an easy story line to follow, but it is well worth the effort to study the book and piece the facts into a remarkable tale.