Running head: ENRON: THE SMARTEST GUYS IN THE ROOM
Enron: The Smartest Guys in the Room
Sion Kim
Salt Lake Community College
SION KIM1
ENRON: THE SMARTEST GUYS IN THE ROOM
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Abstract
Enron was once a company that captivated the world. It was the 7th largest company in America
with revenues of nearly $111 billion during 2000. Enron Corporation was an American energy
and services company that was started in 1979 and ultimately bankrupted in 2001 due to massive
amounts of corporate fraud and corruption. At the end of 2001, it was revealed that the reported
financial condition was founded by an institutionalized, systematic, and creatively planned
accounting fraud, known as “mark-to-market” accounting. By analyzing the choices that Enron
made, we can see how such a powerful company like Enron can spiral down to bankruptcy from
choices that are stemmed from fraud and corruption.
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Enron: The Smartest Guys in the Room
The documentary, Enron: The Smartest Guys in the Room, tells the story of the Northern
Natural Gas Company was an American energy and services company formed in 1932 and later
reorganized in 1979 into Enron Corporation. The company was based in Houston Texas,
employed approximately 20,000 staff and was one of the world’s major electricity and natural
gas providers. Towards the end of 2001, it was revealed that Enron was committing massive
amounts of fraud in their reported financial figures through an institutionalized, systematic, and
creatively planned accounting fraud. Through the economic lens, I was able to see the rise and
fall of Enron and how exactly they were able to get away with the amount of fraud that have
been committed for such a long time.
Who was responsible for the downfall of Enron? Before their bankruptcy, Enron was the
nation’s seventh largest corporation and was valued at $70 billion. In charge of Enron were two
men, Ken Lay and Jeff Skilling, who were known as the smartest guys in the room. Ken Lay was
a PhD. in economics and he became very early on an advocate for deregulation. Lay was
thinking about energy markets, particularly the natural gas industry, that would be deregulated
and was very restricted by regulation which he pushed aggressively in Washington to change all
of the regulation. When the energy markets were finally deregulated, Ken Lay was pushed to
found Enron in 1979. Ken Lay thought Enron would be able to take advantage of the
government’s decision to let gas prices float with the currents of the market because of its vast
networks of natural gas pipelines.
Even in the beginning of Enron’s life, there was what is known as the Valhalla scandal. In
1987, there was an issue that involved the misappropriation of monies by two traders that made
bets for Enron on whether the price of oil would rise or fall. Oil trading is very risky but
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somehow Enron Oil always seemed to win. According to Mike Muckleroy, ex-Enron executive,
you can lose ten times the original investment. There were off-shore accounts, phony books, and
a trail that led from the company’s treasurer to mysterious accounts that no one could find. The
treasurers presented falsified bank records to the board of Enron and then later admitted that they
had put company profits into personal accounts. The board told Ken Lay that his were
manipulating earnings, destroying trading records, and investing way beyond their limits. Ken
Lay decided to and did nothing to change how the traders were operating because of his
reasoning that this was the only part of the company that was making any money. The traders
were not fired or even disciplined. Ken Lay sent a letter to his traders that said “please keep
making us millions”. Instead of reducing the risk that the traders were creating, Ken encouraged
them to gamble more. Eventually the traders luck ran out and gambled way too deep into the
company’s reserves. It was soon after this their fraud was discovered. Ken Lay says that he too
was shocked by what the traders were doing giving the appearance that he did not know. With his
traders in jail, Ken Lay needed someone to make profits for the company. That man was Jeff
Skilling.
Jeff Skilling was a guy with big ideas. Ken Lay hired Jeff Skilling for that very reason.
Jeff Skilling was a graduate from the Harvard Business School. One of Jeff Skilling’s big ideas
was to find a new way to deliver energy. Rather than being bound by the physical flow of pipe
lines, this made Enron become kind of a stock market for natural gas. Jeff Skilling transformed
energy into financial instruments that could be traded like stocks and bonds which then made
Enron become the largest buyer and seller of natural gas in North America.
Another thing that Jeff changed in Enron, which is said to be the beginning of the
ultimate fall of Enron, was their accounting system. Jeff Skilling had one specific condition that
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had to be met before he agreed to join Enron. That condition was that he would be allowed to use
a certain kind of accounting known as “mark-to-market”. Mark-to-Market accounting allowed
Enron to book potential future profits on the very day a deal was signed. No matter how little
cash Enron actually got, to the outside world, Enron’s profits could be whatever Enron said they
were. This gave Enron the ability to be very subjective and manipulative or in other words,
commit fraud, with their records. Mark-to-Market accounting played such a huge role in the
downfall of Enron by the way this accounting system allowed Enron to commit fraud after fraud
until there was so much that they could no longer cover it up.
Stocks also played a big factor in the downfall of Enron. During the time when it was the
biggest bull market in the world, Ken Lay was promoting Enron’s stocks. Enron was on a
mission to win a game to capture the hearts and minds of stock analysts. As long as a company
met or exceeded the annual projections for quarterly earnings per share, the stock went higher.
The game they were playing was called “pump and dump”. Top executives would push the stock
price up and then cash in their multimillion-dollar options. Towards the end of Enron’s company
life, Enron was hiding the fact that is was $30 billion in debt. Enron was losing money on a cash
basis year after year, and yet it was reporting profits. The chief financial officer, Andy Fastow,
had to figure a way to convince people that Enron’s stock was strong and profitable.
Fastow created hundreds of special companies to solve his problem, which he called,
“Structured finance”. He would give the illusion that Enron’s stock was still healthy by making
its debt disappear. To outside investors, it looked like cash was coming in the door. In reality,
Enron was just stashing its debt in Andy Fastow’s special companies where investors could not
see it. One of Fastow’s special companies was called LJM which did magic for the company and
even gave Andy the opportunity to steal money from Enron little by little. There is a secret
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videotape that surfaced after the bankruptcy where Fastow can be seen selling LJM to a group of
Merrill Lynch Bankers. He pitches them on the benefits of investing in a fund that only buys
assets from Enron. In a sense, he was pitching himself to the investment bankers that he could
guarantee profits for LJM even though there was a conflict of interest by having a dual role as
Enron’s CFO and as the head of LJM. If the banks committed to this deal, which they did, this
allowed Fastow to let the banks gamble with Enron’s stock. 96 individual bankers invested at
least $25 million each in LJM because of the prospect of returns that would exceed 2,000%.
With so much fraud and corruption in the company, who is to blame for the downfall of
Enron? Was it Ken Lay? Jeff Skilling? The Enron fraud is the story of synergistic corruption.
There are supposed to be checks and balances to prevent fraud in the system. Lawyers,
accountants, and banks are supposed to say no to fraud and corruption. Instead of saying no,
Enron was able to pay handsomely for their “services” which allowed Enron to keep doing the
things that they were doing. From the Enron story, we can learn that fraud is a short term
solution. When a company commits fraud, they have to commit a little more fraud the next
quarter to make up for last quarter, and then more and more each quarter until it gets too out of
hand to contain.
ENRON: THE SMARTEST GUYS IN THE ROOM
References
Gibney, A. (Director). (2005). Enron: The Smartest Guys in the Room [Motion picture].
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