Friday, April 13, 2018

The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron

In line with my annual financial independence goals for this year I pressed on with the reading list. “the smartest Guys in the room” is about rise and fall of Wall street  darling an  American corporation called “Enron”, which took down auditing company “Arthur Andersen”.
      At its peak Enron shares were worth $90.75 and on December 2, 2001 (when it filled for bankruptcy) were trading at $0.26 . The company was chasing dream of deregulation through the vast network of political donations (former Secretary of State Heinz Alfred Kissinger (naturalized USA citizen as of 1943, son to German Jews) served as advisor, along with  James Baker  and many others).
       Here is some interesting quotations from the book: “…When people describe Skilling they don’t just use the word “smart”; they use phrases like “incandescently brilliant” or “the smartest person I ever met”…He could instantly simplify highly complex issues into a sparkling, compelling image.
…Skilling also had tendency to oversimplify, and he largely disregarded – indeed, he had an active distaste for – messy details involved in executing a plan. What thrilled Skilling, always, was the intellectually purity of an idea, not the translation of that idea into reality.

  …When you use conventional accounting , you book the revenues and profits that flow from the contract as they come through the door. But under the mark-to-market method, you can book the entire estimated value for all years on the day you sign the contract. Changes in that value show up as additional income or losses in subsequent periods. ..Taken to its absurd extreme, this line of thinking suggests that General Motors should book all the future profits of a new model automobile at the moment the car is designed, long before a single vehicle rolls off the assembly line and sold to customers…On January 30, 1992 the SEC told Enron that it would not object to the use of mark-to-market accounting beginning that year…to celebrate Skilling brought in champagne: champagne to toast accounting change.

     …Skilling had imported from his consulting days: an elaborate peer-review system. At McKinsey, Skilling had served on the powerful committee that assessed the performance of all consultants worldwide. One of the first things he did upon joining Enron was set up a similar system, officially called the Performance Review Committee (PRC)…over the time, its goal distorted, and the PRC had more to do with manipulating the system than with honestly evaluating talent. Employees called it “rank-and-yank”.
      Twice a year every employee (except Skilling) from managing director down to secretary, underwent individual review. It began with extensive written “feedback reports” from bosses and colleagues that assessed their performance on five sets of criteria.  The real action took place at string of marathon sessions held at local hotels, where panels would debate and rank each employee on scale of 1 to 5 – 1 being the best and 5 – the worst.  Most of ranking categories involved collaborative qualities, such as “teamwork/interpersonal” and “communication/setting direction”. What really counted was the bottom line.   If they were making money and being total jerks to people, we had always forgive them for that.  They might be a 5 in teamwork but if they were a 1 in earnings, they were a 1. ..Still it was not all just about money. It was also about friendship. Executives simply refused to tell the truth about weak members of their team with whom they were friendly….It became a question of who could argue better, who could debate better and, in some case, who could shout the loudest. Those rated a 1 got huge bonuses. A ranking 2 or 3 could cost vice president a six-figure sum.  Because Skilling insisted that the ranking be distributed along a curve, at least 10 percent of the workforce had to be placed in the bottom group, marked for execution… Predictably the sessions got ugly. ..As Skilling and his defenders saw it, the PRC produced the best of Enron, rewarding brains, innovation, and dedication. But many thought it brought out the worst of Enron: ruthlessness, selfishness, and greed”.
   This type of methodology is wide spread in a lot of industries in nowadays and indeed nothing has changed in last 20 years. In the weak organization, it even got perverted where bottom line is no longer important, you could  hide behind teamwork, doing nothing.

      Arthur Andersen were brought down by its treatment on Enron. The Arthur Andersen early moto was “think straight, talk straight”. Once in the firm’s young and lean years, Andersen auditors told  railway company client that it had to change a certain accounting practice, to the detriment of reported profits. When the company’s president demanded that the firm reverse itself or lose account, Andersen famously retorted that “There is not enough money in the city of Chicago” to make him change the firm’s decision. Anderson lost the account. Months later the railroad company was bankrupt. Consulting spoiled it, consultants generated far more money than their accounting counterparts and had far more status. The pressure to generate fees was intense, and so was the pressure to hold on to clients. Andersen abandoned its old moto “think straight, talk straight”, its new slogan was “simply the best” 0 those who kept their clients happy, especially the handful of clients Andersen labelled its crown jewels. Enron was one of them.  In 2000 alone, Enron paid Arthur Andersen $52 million, over half for consulting services.   It is a fascinating story about Corporate America.

Where are the Enron people now?
Only one in jail with imminent release, only two others went to jail but free now:
    Andrew Fastow (CFO) sentenced in for six years, served only 5 and half (November 7, 2006 - May 16, 2011 ), with the rest as house arrest.  Fastow is sentenced to six years in prison, four years less than his plea agreement stipulated in January 2004. Works as principal at KeenCorp with headquarters in Rotterdam, Zuid-Holland, the Netherlands (Western Europe).
    Richard Causey (CAO) sentenced for 5 and 1/2 years, served under 5 years (January 3, 2007 - October 14, 2011). New York times described the Chief Accounting Officer: " an unlikely character type to be playing such a profound role in a major fraud case". Running his own financial advisory services since 2011, providing advice to small business owners and investors on accounting and finance related matters.
      Jeffrey Skilling sentenced for 24 years and four months, currently serving. Under the agreement with federal prosecutors, Skilling could be released as early as this year.  (December 13, 2006 - now) His sentenced reduced by 10 years when he agreed to stop challenging his conviction and forfeit roughly $42 million that will be distributed among the victims of the Enron fraud. He paid his lawyers $20 million dollars.
    The book has cast of characters. I checked them and all of the people of working age, are happily employed, post Enron scandal. If you would steal a car and this was widely known it would be hard to find a job, particularly involving cars. This does not seem to apply in corporate governance, finance area. Post 2008 financial crisis nobody went to jail at all.

What is other take from the book about Enron?
It is ironic that in in 1995 Enron is named "America's Most Innovative Company" by Fortune. The firm goes on to win this award for six consecutive years. Bethany McLean printed article in 2001 in Fortune "Is Enron overpriced", which the book says: "was the first in a national publication to openly question the company dealings".  In 2000 Forbes wrote: "No company illustrates the transformative power of innovation more dramatically than Enron. Over the past decade Enron's commitment to the invention--and later domination--of new business categories has taken it from a $200 million old-economy pipeline operator to a $40 billion new-economy trading powerhouse. "
A lot of people from all walks of life made money on Enron – accountants, lawyers, writers, analysts, judges.. all the expenses on investors and employees who lost they life time savings.
This is a reality of modern corporate and finance worlds – every learning, sprawling system at your expense.
The book highly recommended, especially for the people who are not risk averse in the investments.

The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron by Bethany McLean (2004-09-30)

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