Enron: The Smartest Guys in the Room Review

In the documentary, “Enron: The Smartest Guys in The Room,” we learn about the corruption that led to the bankruptcy of the 7th largest international company at the time. The Enron case will go down in history as a textbook example of large-scale fraud that started in its infancy and snowballed to a position where it could no longer continue. The company’s financial statements— the simplest way to demonstrate the corporate financial position of the firm— were eventually not able to be reported.

When the CEO, Jeff Skilling, aggressively replied to an analyst about the financial statements, it foreshadowed the collapse of the company. This company was rooted in lies and deceit from the very beginning. I will begin with an overview of the company and the scandal that unfolded, and touch on many events that led to the collapse. I will also touch on events that contributed to the over inflation of the stock, as well as the unethical business decisions that practices that were used to undermine the core structure of their business.

Enron was founded in Omaha, Nebraska out of a merger of two gasoline companies. Kenneth Lay, a PhD in Economics, was appointed Chairman and CEO. Ken lay immediately moved the company to Texas to focus the company on the natural gas industry. The first issue at the company arose when the company made risky investments in order to seek unprecedented gains. Traders at Enron hedged company funds in the oil trade market and lost $90 million over the course of five days.

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Arthur Anderson, the company’s accounting firm lied on the accounting statements to misrepresent Enron’s financial position.

With a need to revive the company, Ken Lay appointed Jeff Skilling, a visionary with an MBA from Harvard. Jeff Skilling proposed trading natural gas a commodity, which the company quickly adopted to make profit. He also instituted mark to market accounting at Enron, a form of accounting that allowed assets to be marked down at current market price, and their foreseen future gains could also be reported as profit before the profit was realized. Arthur Anderson and the Securities and Exchange Commission both approved this new accounting strategy for Enron. In the documentary, Amanda Martin described the new accounting strategy as, “Very subjective… it left it open for manipulation.” Enron was able to forecast futures of natural gas sales and record them as earned revenue on their accounting statements. In doing so, Enron was able to inflate earnings and deliver bonuses to executives based on revenue that not yet realized. This resulted in inflation of company stock. This process proceeded for the next 10 years, and the company began to devise clever business schemes to hide debt when their projected profits did not meet future projections.

Jeff Skilling was a risk taker and he perpetuated a macho and aggressive culture within the company. Enron would not do business with companies that didn’t agree with their practices, and they eventually became the biggest bull in their respective market. Skilling devised a program commonly termed, “Rank and Yank,” which forced employees to rate their peers and caused 10% of the employees to be fired every year. The trading floor was comprised of employees that worked surplus hours, and traders would often do anything necessary to ensure their bonus, even if it meant treating others unethically. With this aggressive corporate culture, and their promise to make 10-15% returns annually, Skilling quickly moved into other forms of energy trading to increase the stock price.

Employees were encouraged to put their maximum allowance into their 401K’s, although the employees did not know of Enron’s actually financial position. Enron invested in a risky energy project in India, in which they reported potential earnings and shelled out bonuses to executives. In reality, the company lost $1 Billion on the project, and the debt had to be dealt with. Enron devised a plan to merge with Portland General Electric, which owned rights to the California electric grid. They covered up the losses by creating new revenue potentials in new markets, as well as using employee’s investments in Enron to hide the loses.

Again, in an attempt to expand into new markets, Enron claimed to develop a superior technology in the midst of the high technological boom. The technology was never released; however, they were able to report future earning due to their mark to market approach. They also partnered with Blockbuster to stream movies over the internet, and reporter $53 million in earnings from the deal that eventually fell through. At this time, many of the executives began selling personal stock totaling $1 Billion. At this point, due to a tremendous PR overhype, Enron stock was trading at $90 per share. Fortune magazine rated Enron as the World’s most innovative company for two consecutive years.

A newly appointed CFO, Andrew Fastow, was appointed to a position where Enron was actually $30 Billion dollars in debt. He developed many shadow companies, called Special Purpose Entities, most that were used to hide the financial losses of the company. He was definitively tasked with hiding Enron’s debt. With these companies, almost all major banks were turning a blind eye on the situation, in search for profit. Arthur Anderson was paid $1 million dollars a week to be part of the fraudulent business schemes. In several shadow companies, most notably a company called LJM, Fastow was able to ensure Enron profits by representing both sides of the companies to ensure profit.

Attempting to stay afloat, Enron emerged in the California free market electricity business. They began trading electricity and arbitraging money out of California to seek profit. This resulted in public outrage, as people were randomly left without power due to market manipulation by Enron and other electricity traders. This became a government issue; however, Kenneth Lay had recently become the energy secretary under George W. Bush, and Enron was able to continue its practices. They conducted a plan to remove the current governor from California, who despised Enron’s practices, and were able to position Arnold Schwarzenegger in office to continue their profitable business practices in California.

Jeff Skilling, foreseeing the downfall of Enron, left the company for “personal reasons” to potentially escape any legal trouble in the future. Ken Lay was appointed CEO of the company, where he continued to ensure investors that the company was in fine financial position. Sherron Watkins was then appointed under Fastow and realized the corruption in the company. She reported her findings to Ken Lay, which later was found by the SEC. The SEC launched an investigation as a result. Arthur Anderson then began shredding all of its papers involving Enron to hide any wrongdoing. Upon finding out of Fastow’s raptor accounts used to hide money in shadow companies, Ken Lay fired Fastow on October 24, 2001. In quick decline, Enron declared bankruptcy on December 3rd, 2001.

Ken Lay, the Chairman and CEO, was quoted in the documentary as always display a “cloak of moral rectitude.” He was born into a family of little means. His father was a Baptist minister; however, his business tactics did not embody the values and ethics that he was raised upon. His parents had little formal education and Lay had tremendous drive to overcome his upbringing and make a better life for himself. He graduated with a Ph.D. in Economics and strongly believed in the values of free market capitalism with little government oversight. Lay was a friend of the Bush family and made monetary contributions, and supported George H. W. Bush and George W. Bush by leading several Republican committees that promoted the Bush family’s political agenda. This close relationship with the Bush family ensure that Enron was treated with more leniency in its business ventures. By tying himself to the presidential family, he was able to sustain his business practices. The California Energy Crisis was also influenced by the relationship Lay had with George W. Bush during his presidency.

In contrast to his lobbying efforts, Lay is considered to be one of the masterminds that documentary references. He was able to promote Enron through massive Public Relations campaigns to give the false sense that Enron’s finances were sound and legitimate. He lived an extravagant life, due to the personal shares he sold in Enron totaling more than $300 million. Despite his public perception, his business practices demonstrated his true side, a man that disregarded employee welfare and benefitted financially at others expense. He died of a heart attack before he could ever be sentenced for his wrongdoings.

Jeffrey Skilling, the former President and COO at Enron was seen as an innovator. He believed in extreme risk taking, and was most a major contribute to the cut-throat, macho culture of his organization. There are reports of Jeff’s extravagant trips with male executives to conduct dangerous activity, such as dirt biking through remote parts of Mexico, where people’s lives were put into danger. These trips build an the environment at Enron that encouraged risk. He was a believed in Darwinism-type business, which caused the company to “Rank and Yank” its employees to ensure that all employees were subject to his rhetoric. His most notable contribution to the Enron scandal was mark to market accounting. In this accounting procedure, he believed that those that created the idea should be compensated fully at the time the idea was conceptualized, and that future benefactors should not reap the benefits of those that created the idea, as it is not their creative mind that thought of the business venture in the first place.

In creating the one of the largest corporations, with such aggressive tactics, it became very difficult to employees to stand for their own systems of values. They were forced to follow Jeff’s rules, and when an issue arose, or when analysts were skeptical, they were to consult Jeff to solve the problem. This resulted in analysysts to rate the company’s financials off of Jeff’s responses alone, not the market data that they should have been provided. Jeff sold $200 million in personal stock at the Enron, using insider information and left the company when he foresaw its collapse. His disregard for the wellbeings of others was evident, and he was simply there to increase personal profit. Skilling served a 24-year prison sentence due to his acts of fraud and insider trading, however, was recently released.

Andrew Fastow, the former CFO at Enron is often seen as positioned to be the fallout guy, as in he was positioned to be the one to take all the blame for all the corruption that was created before he got there. He is a man that embodied greed, and his LJM company, as well as other Special Entities were used deliberately to hide wealth for himself and to disguise debt in an unacceptable accounting manner. Fastow was a man that ensured the wellbeing of the company, however, his business practices were clearly unethical.

Lou Pai, a former CEO of Enron Energy Services (EES) was referred in the documentary as the “Invisible CEO.” He was often not seen in his office and was quiet and a reluctant manager. He was tasked with increasing the sales of EES, and after his divorce from his wife, quickly sold all of his shares and netted $250 million from his tenure as CEO of the Enron branch. He contributed to the macho and reckless lifestyle of other executives in the company, where he would frequent the strip club with new traders at the company after work. He suddenly left the company and was not charged with any wrongdoing in the Enron investigation. He appeared to have little interest in managing. Instead, and often favored a role as an entrepreneur.

Cliff Baxter, former vice chairman at Enron, suffered from Bipolar Disorder and was known as very charismatic and negotiating deals with other companies. He is seen at the beginning of the documentary, committing suicide in his BMW, which occurred a month after the company went bankrupt. He was attacked by Bethany McLean and Sharon Watkins in their whistleblowing reports, which likely contributed to his death to some extent. He was put in the limelight for cashing out $33 million in shares from Enron and was in news coverage because of the whistleblowing reports. To quote Skilling in his testimony before Congress, he stated, “There was no one that didn’t know that Cliff was heartbroken [due to the Enron Bankruptcy].” His suicide letter expressed guilt for his wrongdoing in business practices and emphasizes the net-loss of the bankruptcy for many executives.

George W. Bush, Former President of the United States, had a strong connection to Ken Lay, due to family ties, and due to his support in getting Bush elected. It is with this relationship that George W. Bush did not pursue action during the California Power Crisis. The relationship the two men had helped ensure the prominence of Enron in the market. The president allowed Enron to conduct business practices that were questionable, that most companies without a political connection could not have got away with for so long.

Bethany McLean, former Fortune reporter and American journalist was featured in the documentary for her attempt to attack Skilling and Fastow on their business practices at Enron. The company. Especially Skilling saw this as an attack and ensured that she would not be able to write a report that defamed Enron in a manner that was suitable. She was pressured by her Fortune boss to write a more modest article about Enron, most likely because Enron had so many powerful business partners that could hurt the magazine’s brand and reputability.

Sharon Watkins, a VP of Corporate Development at Enron, and commonly known as the whistleblower, forced the company to be investigated by the SEC, which ultimately let to Enron’s bankruptcy. Her anonymous letter to Lay stated Enron would “implode in a wave of accounting scandals.” Due to the inaccuracies in the accounting statements seen under Fastow, the letter to Ken Lay that was disseminated to the New York Times for publication. This resulted in the SEC to investigate Enron’s finances. Watkins was an anomaly in management in Enron for multiple reasons. She was female, almost 40 years older than much of her colleagues and was married. Many of these factors may have contributed to her decision to become a whistleblower, as her values did not appear to match the standard person in upper management at the company.

Kenneth Lay and Jeff Skilling led Enron with great Charisma. However, when overdeveloped, this can lead to manipulative tactics embodied in the Dark Triad. Skilling was said to have “radiated so much charisma that he induced blind obedience to his followers.” His “Rank and Yank” program was an example of manipulation that kept employees under his obedience. Along with charismatic behavior was the unwieldy risk-taking strategies of the company.

The culture appropriation created by upper management force traders to embody the same type of mentality. It was certainly a successful strategy to increase productivity and force innovation. Enron’s acculturation process enabled employees to have confidence in themselves and the organization, which is an admirable quality in executive leadership. Amanda Martin in the movie stated, “If we were smart, anything could be accomplished. There was a reaffirmation that this could be big.” I think this was an effective strategy used by Enron, however, the lack of transparency and dishonest business practices did not allow for the company to sustain growth, only debt. It was noted in the documentary that Shilling noticed that the traders were becoming too unwieldy for him to manage, and this created a problem for the company and its reputation. The traders did not embody the ethics that Ken Lay often displayed publicly; his personal ethics and mores were embodied by the traders instead.

The most prominent issue that led to the company’s downfall was the advent of the mark to market approval, which allowed an unreasonable amount of gambling on future profits. The SPV’s developed were needed to sustain the snowballing effect that was created by the mark to market earnings. The mark to market accounting practice, in my opinion was rooted in Enron’s ties to political leaders, which brought a safeguard to their wrongful business practices. Not only is Enron to blame for this economic tragedy, but Arthur Anderson and the banks that knowingly engaged in wrongful business practices.

The corporate culture perpetuated by upper management created an atmosphere that was inherently unethical and built on greed. In order for a company to sustain long-term growth, increase in stock price is not the only thing that needs to be managed. The company ethos and mission need to be clear and honest, so that the employees on all levels conduct themselves as a community, not as single workers with their own motives.

Furthermore, diversity is a quality that Enron did not have. Managers hired people that were like them, creating an ecosystem that can create issues in groupthink. Sharon Watkins did not embody the typical employee, and this resulted in the company’s downfall after she noticed the unethical nature of their accounting practices. Diversity offers a checks and balances approach, which allows companies to be more transparent and honest about their business practices. Enron built a company where the ethics and behaviors of employees were aligned, but in a way that perpetuated greed and self-interest. A diversity requirement could solve many issues in future companies.

In conclusion, Enron was a textbook case of poor business practices that aren’t sustainable. Greed and self-interest will never be the solution to long-term growth in a company. On a positive note, the company has caused substantial regulatory reform, so that future companies cannot conduct poor business practices. The Enron case demonstrates how leaders must uphold strong ethics when conducting business, or else the company will eventually cease to exist.