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PORTFOLIO / PENGUIN

THE SMARTEST GUYS IN THE ROOM

Bethany McLean and Peter Elkind were Fortune senior writers when this book was originally published in 2003.

McLean’s March 2001 article in Fortune, “Is Enron Overpriced?” was the first in a national publication to openly question the company’s dealings. She now lives in Chicago with her husband, Sean Berkowitz, who was the head of the Enron Task Force when they met in 2006. McLean is a contributing editor at Vanity Fair and a columnist at Reuters.

Elkind, an award-winning investigative reporter, is the author of The Death Shift and Client 9: The Rise and Fall of Eliot Spitzer. A former editor of the Dallas Observer, he has been an associate editor at Texas Monthly and written for The New York Times Magazine and The Washington Post. Now editor-at- large at Fortune, he lives in Fort Worth, Texas.

For Chris —B.M.

For Laura —P.E.

PORTFOLIO / PENGUIN Published by the Penguin Group Penguin Group (USA) LLC

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USA | Canada | UK | Ireland | Australia | New Zealand | India | South Africa | China penguin.com A Penguin Random House Company First published in the United States of America by Portfolio, a member of Penguin Group (USA) Inc., 2003 Updated paperback edition published 2004 This edition with a new foreword and afterword published 2013

Copyright © 2003, 2004 by Fortune, a division of Time, Inc. Foreword copyright © 2013 by Joe Nocera Afterword copyright © 2013 by Bethany McLean and Peter Elkind Penguin supports copyright. Copyright fuels creativity, encourages diverse voices, promotes free speech, and creates a vibrant culture. Thank you for buying an authorized edition of this book and for complying with copyright laws by not reproducing, scanning, or distributing any part of it in any form without permission. You are supporting writers and allowing Penguin to continue to publish books for every reader.

Grateful acknowledgment is made for permission to reprint the following copyrighted works: “Hotel Kenneth Laya” by James A. Hecker, © 1995 James A. Hecker. Used with permission; “Perfect Day” by Tim James and Antonina Armato, © 2001 WB Music Corp., Out of the Desert Music, and Tom Sturges Music o/b/o Antonina Songs. All rights reserved. Used by permission of Warner Bros. Publications U.S. Inc. and Tom Sturges Music.

THE LIBRARY OF CONGRESS HAS CATALOGED THE HARDCOVER EDITION AS FOLLOWS: McLean, Bethany. The smartest guys in the room : the amazing rise and scandalous fall of Enron / Bethany McLean and Peter Elkind. p. cm. Includes index. ISBN 978-1-59184-008-4 (hc.) ISBN 978-1-59184-660-4 (pbk.) ISBN 978-0-69815882-5 (eBook) l. Enron Corp.—History. 2. Energy industries—Corrupt practices—United States. 3. Business failures—United States—Case studies. I. Elkind, Peter. II. Title. HD9502.U54E5763 2003 333.79'0973—dc21

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FOREWORD

In February 2001, as the editorial director of Fortune magazine, I helped edit a short, rigorous story—just four pages long—by a young writer named Bethany McLean, who had joined the magazine some six years earlier from Goldman Sachs and quickly become one of Fortune’s brightest stars. Her story was entitled, simply, “Is Enron Overpriced?”

At its core, Bethany’s article asked one very straightforward question: How does Enron make its money? For years the company had been a Wall Street darling, its stock moving steadily upward with each new quarter’s rising profits. It was seen as the paradigmatic example of a company that had transformed itself from an old-economy stalwart—operating pipelines that moved natural gas —to a new-economy marvel, creating dazzling efficiencies and hedging risks (like the weather!) that no one had ever thought to hedge before. Just a month before Bethany’s story ran, Businessweek had put Enron’s chief executive, Jeffrey Skilling, on its cover, posing with what appeared to be harnessed electricity in his hand, with the cover line “Power Broker.”

But Bethany had been poring through Enron’s financial documents, and what she realized was not just that they were complicated (most big companies have complicated financials) but that they were incomprehensible, even indecipherable. She started calling around to the Wall Street analysts who were so bullish on Enron, asking her simple question.

Some of them told her that Enron was a company you just had to trust. One analyst admitted to her that the company’s earnings were “a black box.” When she reached Skilling himself, the Enron CEO first complained that she “didn’t get it,” something he often said to people who questioned Enron. Then he hung up the phone on her. The Enron public-relations department insisted that if she would just come to Houston and visit the company’s headquarters, the fog would soon lift. But with our deadline fast approaching, the Enron PR department decided that if Mohammed wouldn’t come to the mountain, they would have to

visit Fortune. The company sent a small contingent to New York to meet with Bethany and her editors, including me. Andy Fastow, the company’s chief financial officer, led the Enron team.

It would later be blindingly obvious that Fastow had not told us the truth— how could he, given that much of Enron’s earnings were the result of accounting manipulations that created the illusion of profitability? But even in the moment it was clear that Fastow’s goal was pretty much the same as those financials Bethany had been poring through: to obfuscate and confuse. I can’t remember all the details, but I vividly recall Bethany asking sharp, pointed questions about the company’s business model and Fastow responding with lengthy, nearly unintelligible answers about how Enron was like Toyota, how it should be thought of as a logistics company, etc., etc.—even though Enron’s main business wasn’t actually moving anything from place to place, but rather trading.

And then something happened that Bethany and I would never forget. As the meeting was drawing to a close and the Enron executives were putting on their coats, Fastow turned to Bethany and said, “I don’t care what you say about Enron. Just don’t make me look bad.”

It was such a jarring thing for him to say on the eve of what was clearly going to be an unflattering article about his company. In retrospect, it was a tip- off—to the mentality of the people running Enron and to the fact that there was indeed something fishy about those financial statements—Fastow was, after all, Enron’s CFO. It was a real signal that Bethany—whose story wound up raising all the right questions, even if she didn’t yet have all the answers—was on to something.

Some articles drop like bombshells. Bethany’s wasn’t like that. Instead, it slowly seeped into the consciousness of Wall Street. Enron’s stock had been in the 70s when Bethany’s story was published, not far from its all-time high. Ever so steadily, it began to sink. In April, Skilling was questioned on a conference call by an investor who asked his own tough questions. “Asshole,” Skilling muttered under his breath. In August, Skilling suddenly and unexpectedly quit as chief executive—a move that was all the more stunning because he had taken over as CEO just six months earlier from Enron founder Ken Lay. Though Skilling had effectively been running the company for years, everyone knew how much he had wanted the actual title of chief executive. His resignation triggered a flurry of skeptical stories and questions.

And then came October. With the stock having fallen into the high 30s—and Lay, back as CEO, trying to persuade a now-skeptical Wall Street that

everything was fine—the Wall Street Journal revealed that Fastow had made tens of millions on the side running a pair of limited partnerships that had done business with Enron. That story helped accelerate the feeding frenzy that was already developing, both in the press and on Wall Street, around Enron. By November, Fastow was gone, sacrificed by Lay as he desperately tried to keep Enron afloat. But like any company that trades for a living—just like Lehman Brothers or Bear Stearns seven years later—once Enron had lost the confidence of its trading partners, it was toast. On December 2, 2001, the company filed for bankruptcy.

Even then, though, nobody knew the full story of what had brought down Enron. Fastow’s LJM partnerships got the immediate blame—both inside and outside of Enron—but one of the main points of The Smartest Guys in the Room is that Fastow wasn’t actually the one who brought down Enron. His chicanery —which he’d later testify was approved by Skilling—was actually what was propping up Enron. The real story was that Enron’s businesses weren’t making much money, and that much of their profits were phony. The whole point of Fastow’s dealings, from Enron’s point of view, was to make it appear that the company was a profit machine that it clearly wasn’t. (And if Fastow skimmed a little on the side, well, what can you do?) Enron’s aura had been such that nobody had ever bothered looking into the internal strife, the macho posing, the rampant greed—and the dysfunction in the company’s executive suite, starting with the out-to-lunch Lay and the emotionally unstable Skilling.

Right after Enron filed for bankruptcy, Bethany wrote a terrific cover story about the company’s decline and fall in which she touched on some of these larger themes. In editing the article I realized how well-sourced she was, but I could also clearly see that there was a much bigger, more important story here than simply a crooked CFO who was lining his pockets. Her story made it obvious that the rise and fall of Enron would make a terrific book.

So I went to my bosses and suggested that we—Fortune magazine—take advantage of Bethany’s Enron reporting and write a book about what had happened. Because there was so much to unravel, I suggested she team up with Peter Elkind, a Texas-based Fortune writer who had written a series of fabulous investigative sagas for the magazine. Happily, everyone agreed. In 2003, Portfolio published the first edition of The Smartest Guys in the Room. I am biased, of course, but I contend that it remains the single most authoritative account of this landmark event.

It is far more than that, though. The Smartest Guys in the Room is an almost

anthropological examination of the nature of corporate scandal. Why do values go awry? What happens when the wrong person gets a big job? Why is it so tempting to post false profits instead of telling the truth? How distorting is the prospect of stock market riches?

In the immediate aftermath of Enron, there were at least a half-dozen other big corporate blowups: WorldCom turned out to be cooking its books, and CEO Bernie Ebbers went to jail. Tyco became embroiled in scandal, and its chief, Dennis Kozlowski, also went to prison. But none of these disasters have resonated like Enron. At many business schools, studying Enron is part of the curriculum. Just recently, Andy Fastow, who was released from prison in 2011, gave an unpaid speech in Las Vegas at a conference of fraud examiners. He drew a full-house crowd of 2,500 people. Afterward, some of the fraud examiners and convention staffers asked to have their pictures taken with him. Explained one: “He’s part of history.”

Enron remains the defining scandal of the 21st century. None of those other scandals had the staying power—or the canary-in-the-coal-mine quality—of Enron. This was partly because no other modern-day company, prior to the financial crisis of 2008, had Enron’s vaunted reputation. But it is also because almost everything we later found out about how Enron operated was a harbinger of scandals yet to come. Off-balance-sheet vehicles. Banks doing things they shouldn’t to generate fees. Ratings agencies giving safe ratings to investments that were clearly doomed to fail. Corporate executives using every means possible to maximize short-term revenues—and boost their own multimillion- dollar bonuses—even when those means were, at best, unethical.

Congress held hearings in the wake of the Enron bankruptcy; it even passed a law, Sarbanes-Oxley, that was intended to prevent future scandals. (Among other provisions, the law calls for the CEO and CFO of a publicly traded company to sign a document attesting to the validity of its numbers. Despite numerous instances of post-Enron fraud, the power of that document has never been tested in court.) Newspapers and magazines wrote dozens of articles about how to prevent future Enrons. Jeffrey Skilling and Kenneth Lay were tried and given lengthy sentences (Lay, of course, died of a heart attack before he ever spent a day in jail). And then we all moved on.

No one can say for sure whether a more rigorous Washington response to Enron might have prevented the financial crisis of 2008. But I tend to think so. Both Enron and the financial crisis were the products of the same deregulatory impulse that seized Washington in the 1990s. Enron had exposed the deep,

systemic flaws of the ratings agencies. The off-balance-sheet vehicles Enron used were the same kind of vehicles banks used to hold their collateralized debt obligations—the so-called toxic assets that did so much damage to the financial system when they collapsed. And they existed for the same reason: to hide debt.

On one level, the Enron scandal, as told in the pages that follow, is simply a great, rollicking tale. When Bethany and Peter set out to write The Smartest Guys in the Room, telling that story is all they were really trying to do. But it is impossible to read this book today, a decade after it was first published, and not wonder what might have been—if everyone had been willing to pay just a little more attention.

Joe Nocera July 2013

Op-Ed columnist The New York Times

AUTHORS’ NOTES AND ACKNOWLEDGMENTS

Enron is well on its way to becoming the most intensively dissected company in the history of American business. This book is published as that process continues, with investigations and litigation that will surely drag on for years. Because our aim has been to chronicle the company’s rise and fall—amazing and scandalous indeed—we have deliberately ended our narrative with Enron’s filing of the largest bankruptcy case in U.S. history. We leave it to others to describe the resulting investigations and trials, as well as the jockeying over Enron’s spoiling remains.

Enron’s story is a sprawling tale, and, during the 16 months of intensive reporting that produced this book, it has taken us down many trails. A good portion of our work involved poring through a mountain of public and private documents involving Enron and the colorful cast of players—executives, bankers, auditors, lawyers, investors, and analysts—who appear in these pages. We have reviewed divorce records, executive calendars, personnel files, court records, depositions, personal e-mails, letters, consultants’ studies, internal memos and presentations, board minutes, SEC filings, congressional testimony, and dozens of reports from Wall Street analysts. This massive written record, much of it contemporaneous with what we describe, has provided an extraordinary window into events involving Enron.

Ultimately, though, this is a story about people. We believe we have gained considerable insight into the thinking and behavior of virtually every major character in this book. We have conducted hundreds of interviews with people who worked at every level of the company, from the fiftieth-floor executive suite to the board of directors to the secretarial pool, in addition to scores of others who worked outside Enron. Yet for an assortment of understandable reasons—in some cases, involving the continuing criminal investigations; in other cases, involving the stigma that results from any association with Enron—many of those who spoke to us insisted on talking on “background” only. Under this

arrangement, the information provided was on the record—we could use it freely —but we could not identify the source by name. This allowed many sources who would otherwise have been constrained to speak openly to us. On occasion, with those who saw themselves as likely government targets, facing possible surveillance, our arrangements assumed a cloak-and-dagger quality, with clandestine meetings arranged through coded messages. A few other individuals discussed events in great detail but only through trusted personal surrogates. The result is a book that relies, in considerable part, on unnamed sources.

We are exceedingly grateful for the cooperation, trust, and patience of all those (both named and unnamed) who spoke with us—in more than a few cases, a dozen times or more. Their participation in this project was an act of faith, and their insight has been invaluable.

• • •

This book was made possible through the support of Fortune magazine. The idea for it took hold shortly after Enron filed for bankruptcy, when we realized that there was an extraordinary and compelling business narrative in the company’s collapse and that we wanted to tell that story. We also realized something else: piecing together the fall of Enron was going to be an unusually challenging reporting task. For the reasons discussed above, many of the principals were hardly in a position to talk publicly about their experience. Enron’s financial machinations were also complicated, requiring considerable time and effort to understand—and then to explain.

What made our work manageable was the active involvement of Joseph Nocera, editorial director for the magazine. He served as impresario for this project, guiding us as we did our reporting, then acting as editor extraordinaire once we started writing. He is a true partner in the creation of this book. We are grateful to his wife, Julie Rose, too, who lived through the challenging times of this endeavor along with the rest of us.

Rik Kirkland, Fortune’s managing editor, allowed us to dedicate a year and a half to this project and never wavered from his strong and vocal support. Jeff Birnbaum tapped into his wealth of Washington sources, landing key interviews and pulling together the Washington angles to the Enron story. Colleagues Carol Loomis, Carrie Welch, Laury Frieber, Pattie Sellers, Tim Smith, David Rynecki, David Kirkpatrick, and John Helyar were generous with their advice and wisdom. Brian O’Reilly shared the extensive interviews he conducted with

Enron executives for his story, “The Power Merchants,” published in Fortune’s April 17, 2000, issue. We received valuable reporting aid from former Fortune reporter Suzanne Koudsi. The Time Inc. Business Research Center, especially Doris Burke and Patricia Neering, provided fabulous research help. Arlene Lewis Bascom kept track of the book’s finances. Alix Colow pulled together the photos. Former Assistant Managing Editor James Impoco edited the original Enron story in Fortune written by coauthor McLean and was there with an encouraging word when we most needed it. Time Inc. editor in chief Norman Pearlstine and editorial director John Huey gave their blessing to this project. We hope the result justifies so much faith in us from so many.

We are appreciative of our many colleagues in journalism who broke fresh ground in reporting on Enron, notably Forbes’s Toni Mack, who was asking tough questions back in 1993 and was generous with her friendship and counsel a decade later; freelance writer Harry Hurt; Texas Monthly’s Mimi Swartz; Delroy Alexander, Greg Burns, Robert Manor, Flynn McRoberts, and E. A. Torriero of the Chicago Tribune, for their excellent four-part series on the fall of Arthur Andersen; Peter Behr and April Witt, for their early five-part series on the demise of Enron in the Washington Post; and the Houston Chronicle’s Tom Fowler and Mary Flood, who overcame the hometown paper’s coziness with Enron’s hierarchy to dig into the story. University of San Diego law professor and author Frank Partnoy offered early insights into Enron that were very helpful. The work of Wall Street Journal reporters Rebecca Smith and John Emshwiller made them players in the Enron tale. In the postbankruptcy period, the New York Times, led by Kurt Eichenwald, blanketed the story, covering dozens of angles. We also want to acknowledge the work and generous encouragement of Times business writer David Barboza and Washington correspondent Rich Oppel.

Amid much finger pointing in the nation’s capital, several congressional committees did yeoman work. The U.S. Senate’s Permanent Subcommittee on Investigations, through its detailed reports and hearings on Enron’s incestuous relationship with commercial and investment banks, shed considerable light on dark corners of the Enron tale. We are grateful for the assistance of the committee and its staff, including Elise Bean, Robert Roach, and Mary Robertson. The Senate Committee on Governmental Affairs produced enlightening work on the watchdogs that didn’t bark—government regulators, Wall Street analysts, and credit agencies.

Our stalwart agent, Liz Darhansoff, served as a fierce negotiator, sage critic,

and fervent advocate. Our editor, Adrian Zackheim, instantly understood how a complex business story could make a gripping tale and was with us all the way. We’d also like to thank Will Weisser, Mark Ippoliti, Alex Gigante, David Hawkins, and Bonnie Soodek.

Finally, we owe our greatest debt to our loved ones. Bethany’s parents, Helaine and Robert McLean, while far removed from the

specifics of Enron, added their wisdom to the age-old human elements of the story. Her sister Claire McLean offered constant words of encouragement and perfect company for the occasional shoe-shopping break. Bethany’s husband, Chris Wilford, kept a glass (or two) of wine waiting long into the night. And Barolo provided a constant reminder of what it really means to be a bulldog.

David Elkind, Ellen Duncan, and Mary Clare Ward aided this project in untold ways. Laura Elkind, Peter’s wife, did double duty, offering insightful editorial suggestions and tending bravely to the home front (Stephen, Landon, George, Adele, and Sam) while enduring long absences and late nights of writing with remarkable patience, support, and grace.

To all of them, we are especially grateful.

—Bethany McLean and Peter Elkind September 2004

CONTENTS

Foreword by Joe Nocera Authors’ Notes and Acknowledgments Cast of Characters Our Values Introduction

CHAPTER 1. Lunch on a Silver Platter 2. “Please Keep Making Us Millions” 3. “We Were the Apostles” 4. The First Prima Donna 5. Guys with Spikes 6. The Empress of Energy 7. The 15 Percent Solution 8. A Recipe for Disaster 9. The Klieg-Light Syndrome 10. The Hotel Kenneth-Lay-a 11. Andy Fastow’s Secrets 12. The Big Enchilada 13. “An Unnatural Act” 14. The Beating Heart of Enron 15. Everybody Loves Enron 16. When Pigs Could Fly 17. Gaming California 18. Bandwidth Hog 19. “Ask Why, Asshole” 20. “I Want to Resign” 21. The $45 Million Question

22. “We Have No Cash!” 23. The Pursuit of Justice Afterword Index

CAST OF CHARACTERS

Ken Lay—Founder, chairman, and CEO of Enron. Jeff Skilling—President and chief operating officer. Served as CEO from

February to August 2001. Andrew Fastow—Chief financial officer. Rebecca Mark—CEO of Enron International and later of Azurix.

Jim Alexander—CFO of Enron Global Power and Pipelines (EPP). John Arnold—Enron’s young trading superstar. Ron Astin—Vinson & Elkins lawyer. Cliff Baxter—Jeff Skilling’s chief deal maker and trusted confidant. Briefly

served as CEO of Enron North America. Tim Belden—West Coast power trader who figured out how to game the

California market. Arthur and Robert Belfer—father-son Enron directors and New York–based

investors. Louis Borget—CEO of Enron Oil. Went to jail as a result of Enron Oil scandal. Ray Bowen—Enron finance executive. Became treasurer after Ben Glisan was

fired. Ron Burns—Former CEO of Enron’s pipeline division. Briefly co-CEO with

Skilling of Enron Capital and Trade Resources (ECT). Rick Buy—Head of Risk Assessment and Control division (RAC). Rebecca Carter—Enron’s corporate secretary and Skilling’s second wife. Rick Causey—Chief accounting officer. Margaret Ceconi—Former GE manager who joined Enron Energy Services

(EES). Later tried to blow the whistle. David Cox—Enron Broadband Services’ chief deal maker. Wanda Curry—Enron accountant who dug up problems at EES. Dave Delainey—Executive who took over EES from Lou Pai.

Jim Derrick—Enron’s general counsel. Joseph Dilg—Vinson & Elkins lawyer. Bill Dodson—Michael Kopper’s domestic partner. John Duncan—Enron director and chairman of the board’s executive

committee. Gave Lay his first job as CEO. Jim Fallon—Trading executive who took over Broadband after Ken Rice left. Lea Fastow—Andy Fastow’s wife and former assistant treasurer at Enron. Mark Frevert—Longtime Enron executive. Became vice chairman in the last

months. Ben Glisan—Fastow’s structured-finance accounting whiz. Became Enron

treasurer. Wendy Gramm—Enron director and former chairman of the Commodities

Futures Trading Commission. Wife of U.S. Senator Phil Gramm of Texas. Rod Gray—Rebecca Mark aide. Worked at both Enron International and

Azurix. Mark Haedicke—General counsel, Enron North America. Gary Hamel—Management guru who touted Enron. Kevin Hannon—Former Bankers Trust employee who became Ken Rice’s

deputy at Enron North America and Enron Broadband. John Harding and Steve Sulentic—Louis Borget’s direct superiors at Enron

during Enron Oil scandal. Joe Hirko—Former Portland General CFO who served as co-CEO of Enron

Broadband with Rice. Forrest Hoglund—CEO of Enron Oil and Gas. Kevin Howard—Enron Broadband finance executive who worked on Project

Braveheart. Ron Hulme—Lead McKinsey & Company partner on the Enron account. Robert Jaedicke—Enron director, and chairman of the audit committee. Former

dean of the Stanford Graduate School of Business. Vince Kaminski—Head of Enron’s Research Group. In-house skeptic of

Fastow’s deals. Bob Kelly—John Wing deputy. Rich Kinder—President and chief operating officer before Skilling. Left to start

Kinder Morgan. Louise Kitchen—Trading executive who implemented idea for Enron Online. Mark Koenig—Enron’s head of investor relations. Michael Kopper—Fastow’s top deputy and investor in Chewco partnership.

Later left Enron to run Fastow’s LJM partnerships. Mike Krautz—Enron Broadband finance executive who worked on Project

Braveheart. John Lavorato—Greg Whalley deputy. Later became head of trading in North

America. Judith Lay—Lay’s first wife. Linda Lay—Lay’s former secretary and second wife. Mark Lay—Lay’s son, who worked for the company and later joined a

company that did business with Enron. Robyn Lay—Lay’s stepdaughter, who once had an Enron jet deliver her bed to

Monaco. Sharon Lay—Lay’s sister, whose Houston travel agency got most of its

business from Enron. Charles LeMaistre—Enron director and chairman of board compensation

committee. Former president of the University of Texas M. D. Anderson Cancer Center.

Kathy Lynn—Worked for Fastow at Global Finance. Later employed by Fastow’s LJM partnerships. Investor in Fastow deal.

Kevin McConville—Head of Enron’s Industrial Group. Every deal his group made went sour.

William McLucas—Wilmer, Cutler & Pickering lawyer, special counsel to Enron.

Jeff McMahon—Enron’s corporate treasurer until replaced by Glisan. Became CFO after Fastow was fired.

Nancy McNeil—Lay’s secretary and Kinder’s second wife. Amanda Martin—Enron executive who later joined Azurix. Thomas Mastroeni—Treasurer of Enron Oil under Borget. Pled guilty in the

Enron Oil scandal. R. Davis Maxey—Masterminded Enron tax-avoidance schemes. Jordan Mintz—General counsel for Fastow’s Global Finance division.

Pressured Fastow to give up the partnerships. Kristina Mordaunt—In-house lawyer, served as general counsel of Global

Finance and Broadband division. Made $1 million on a $5,800 investment in one of Fastow’s deals.

Mike Muckleroy—Executive who bailed out the company during the Enron Oil scandal.

Cindy Olson—Head of human resources.

Lou Pai—Skilling lieutenant who headed early trading operation. Later CEO of EES.

Mark Palmer—Enron’s head of corporate communications. Ken Rice—Key member of Skilling’s inner circle. CEO of Enron Wholesale

and, later, Enron Broadband Services. Richard Sanders—Head of litigation for Enron North America. Mick Seidl—Enron president during Enron Oil scandal. John Sherriff—Whalley deputy and head of Enron Europe. Susan Skilling—Jeff Skilling’s first wife. Joe Sutton—Rebecca Mark’s longtime deputy. Took over Enron International

after she left. Beth Tilney—Enron executive and Lay confidante. Married to Merrill Lynch

investment banker Schuyler Tilney. John Urquhart—Enron director. Former executive vice president at General

Electric. Lord John Wakeham—Enron director and former British secretary of state for

energy. As government official, approved Teesside. Pinkney Walker—economics professor at the University of Missouri. Lay’s

first mentor. Charls Walker—Enron director and top Washington lobbyist. Pinkney

Walker’s brother. Chris Wasden—Azurix executive. Sherron Watkins—Global Finance executive. Wrote whistle-blowing letter to

Ken Lay. Greg Whalley—Head of the trading operation in late 1990s. Became president

and COO after Skilling resigned. General Tom White—Enron international executive. Later Pai’s number two at

EES. Became secretary of the army in the George W. Bush administration. John Wing—Launched Enron’s international business. Built Teesside. Herbert (Pug) Winokur—Enron director, former Pentagon official. David Woytek—Enron auditor during Enron Oil scandal. Anne Yaeger—Global Finance employee who left to work for the LJM

partnerships. Investor in Fastow deal.

THE ACCOUNTANTS

Carl Bass—member of Andersen’s Professional Standards Group. Chief Enron skeptic in the firm.

Joseph Berardino—CEO of Arthur Andersen. David Duncan—Lead Arthur Andersen partner on the Enron account. James Hecker—Andersen partner who penned “Hotel Kenneth-Lay-a.” John Stewart—Head of Andersen’s Professional Standards Group. Nancy Temple—Andersen lawyer.

WALL STREET AND THE BANKS

Ron Barone—Analyst for PaineWebber and later UBS Warburg. Dan Bayly—Merrill Lynch’s global head of investment banking. David Bermingham, Giles Darby, and Gary Mulgrew—NatWest bankers

who allegedly conspired with Fastow to steal millions that belonged to the bank.

Jim Chanos—Short seller who runs the hedge fund Kynikos Associates. Early short seller of Enron stock.

Carol Coale—Prudential analyst. Viewed as authoritative voice on Enron. Donato Eassey—Analyst with Merrill Lynch. Replaced John Olson after he was

fired. Anatol Feygin—J. P. Morgan Chase analyst. David Fleischer—Goldman Sachs analyst. Robert Furst—Merrill banker who worked with Schuyler Tilney. Scott Gieselman—Goldman Sachs investment banker. Rick Gordon—Head of Merrill Lynch’s energy investment banking group. Richard Gross—Analyst with Lehman Brothers. Richard Grubman—Short seller who runs the hedge fund Highfields Capital

Management. Early short seller of Enron stock. Curt Launer—Enron-friendly analyst with Donaldson, Lufkin & Jenrette and,

later, Credit Suisse First Boston. James (Jimmy) Lee—Head of investment banking at Chase Manhattan Bank.

Named vice chairman when Chase bought J. P. Morgan. Andre Meade—Commerzbank analyst. Ray Niles—Analyst with Schroder & Company and later Citigroup. John Olson—Analyst with Sanders Morris Harris. Longtime Enron skeptic. Mark Roberts—Short seller who operates a firm called Off Wall Street. Robert Rubin—Member of the office of the chairman of Citigroup. Former

treasury secretary in the Clinton adminstration. Marc Shapiro—Vice chairman of finance and risk management at Chase

Manhattan Bank. After the merger of J. P. Morgan and Chase, became a vice

chairman of J. P. Morgan Chase. Longtime acquaintance of Lay’s. Schuyler Tilney—Merrill Lynch investment banker. Firm’s primary contact

with Enron and Andrew Fastow. Rick Walker—Chase Manhattan (later J. P. Morgan Chase) banker, served as

key contact with Enron.

THE JOURNALISTS

Peter Eavis—Reporter for Thestreet.com. John Emshwiller and Rebecca Smith—Wall Street Journal reporters who

exposed Fastow’s partnerships in October 2001. Harry Hurt III—Wrote skeptical 1996 story about Enron for Fortune. Toni Mack—Wrote skeptical 1993 story about Enron for Forbes. Jonathan Weil—Wall Street Journal reporter who raised question about mark-

to-market accounting in September 2000.

THE ACQUIRERS

Chuck Watson—CEO of Dynegy, Enron’s crosstown rival. Steve Bergstrom—President of Dynegy.

OUR VALUES

RESPECT: We treat others as we would like to be treated ourselves. We do not tolerate abusive or disrespectful treatment. Ruthlessness, callousness, and arrogance don’t belong here.

INTEGRITY: We work with customers and prospects openly, honestly, and sincerely. When we say we will do something, we will do it; when we say we cannot or will not do something, then we won’t do it.

COMMUNICATION: We have an obligation to communicate. Here, we take the time to talk with one another . . . and to listen. We be- lieve that information is meant to move and that information moves people.

EXCELLENCE: We are satisfied with nothing less than the very best in everything we do. We will continue to raise the bar for everyone. The great fun here will be for all of us to discover just how good we can really be.

—From Enron’s 1998 Annual Report

INTRODUCTION

On a cool Texas night in late January, Cliff Baxter slipped out of bed. He stuffed pillows under the covers so his sleeping wife wouldn’t notice he was gone. Then he stepped quietly through his large suburban Houston home, taking care not to awaken his two children. The door alarm didn’t make a sound as he entered the garage; he’d disabled the security system before turning in. Then, dressed in blue jogging slacks, a blue T-shirt, and moccasin slippers, he climbed into his new black Mercedes-Benz S500 and drove out into the night.

At 43, John Clifford Baxter, the son of a Long Island policeman, had made it big in Texas. Before quitting his job eight months earlier, he had served as vice chairman of a great American corporation, capping a decade-long career as the company’s top deal maker. Baxter was rich, too—thanks to a generous helping of stock options, a millionaire many times over. But as he cruised the empty streets of Sugar Land, Texas, Baxter was drowning in dark thoughts. Always given to mood swings, he had become deeply depressed in recent days, consumed by the spectacular scandal that had engulfed his old company.

Everyone seemed to be after him. A congressional committee had already called; the FBI and SEC would surely be next. Would he have to testify against his friends? The plaintiffs’ lawyers had named him as a defendant in a huge securities-fraud suit. Baxter was convinced they were having him tailed—and rummaging through his family’s trash. Then there was the media, pestering him at home a dozen or more times a day: Did he know what had gone wrong? How could America’s seventh-biggest company just blow up? Where had the billions gone? No one, at this early stage, viewed Baxter as a major player in the company’s crash. Yet he took it all personally. In phone calls and visits with friends, he railed for hours about the scandal’s taint. It’s as if “they’re calling us child molesters,” he complained. “That will never wash off.”

Desperate to get away, he’d spent part of the previous week sailing in the Florida Keys. Sailing was one of Baxter’s passions. For years, he’d

decompressed floating on Galveston Bay aboard his 72-foot yacht, Tranquility Base. But he’d sold the boat several months earlier. When Baxter returned from Florida, his doctor prescribed antidepressants and sleeping pills and told him to see a psychiatrist. He’d called the shrink’s office that day to make an appointment. But when the receptionist explained that the schedule was booked until February, Baxter hung up—he wasn’t going to wait that long.

Less than 48 hours later, at about 2:20 A.M. on January 25, 2002, Baxter stopped his Mercedes on Palm Royale Boulevard, a mile and a half from his home. It was cloudy and a bit chilly that evening by Texas standards—about 48 degrees—but the sedan was tuned to an interior temperature of precisely 79. An open package of Newport Lights sat in the center console, a bottle of Evian water in the cup holder. Baxter’s black leather wallet lay on the passenger seat. Baxter parked the car in the middle of the street, with the doors locked, the engine running, and the headlights burning. Then he lifted a silver .357 Magnum revolver to his right temple and fired a bullet into his head.

• • •

Seven days later, Cliff Baxter’s friends from Enron gathered to mourn. The Houston energy giant’s collapse into bankruptcy had already become the biggest scandal of the new century. Baxter’s death had stoked the media bonfire and tossed a fresh element of tragedy into a bubbling stewpot of intrigue. Enron’s influence ranged widely—from Wall Street to the White House. So feared was this company, so powerful were its connections, so much was at stake that there was open speculation Baxter had actually been murdered—the target of a carefully staged hit, aimed at silencing him from spilling Enron’s darkest secrets. The rumblings had forced the Sugar Land police department to treat an open- and-shut case—Baxter had even left a suicide note in his wife’s car—like a capital-murder investigation, requiring DNA testing, handwriting experts, ballistics studies, and blood-spatter tests.

The Texas memorial service took place after Baxter was buried in a private ceremony in his hometown on Long Island. He was laid to rest in a plot he had secretly purchased there just a few weeks earlier, in the throes of his deepening funk. An Enron corporate jet—a remaining vestige of the company’s imperial ways—flew Cliff’s family and a few others east for the funeral.

Now it was Houston’s turn. The precise location of the service—the ballroom of the St. Regis, the city’s swankiest hotel—remained a secret until noon that

day, at the insistence of Carol Baxter. Cliff’s widow was bent on avoiding the press. She blamed reporters’ intrusions for pushing her husband over the edge. So the 100 handpicked guests who pulled up to the valet-parking station on this Friday afternoon had been summoned by furtive phone calls just two hours earlier.

For 90 minutes, those who knew Baxter—family members, fellow “boat people” from his beloved yacht club, and Enron friends—heard warm stories about his gentler side. There were images of Cliff with his family, Cliff sailing, Cliff fronting his rock band. Baxter was a gifted musician. When police found his body, there were two guitar picks in his wallet. Everyone left the service with a compact disc of his favorite songs, prepared with the help of J. C. Baxter, Cliff’s 16-year-old son. The opening track was perhaps Cliff’s favorite: a bouncy pop tune called “Perfect Day.”

On this perfect day Nothing’s standing in my way On this perfect day Nothing can go wrong It’s a perfect day Tomorrow’s gonna come too soon I could stay Forever as I am On this perfect day

It was a tragedy layered on tragedy, but there wasn’t much talk about the company’s Icarus-like fall among the former Enron executives thrust together again that afternoon. This wasn’t the time for such grim shoptalk; what’s more, their lawyers had pointedly instructed them to avoid such conversations. Ken Lay, Enron’s founding father, was conspicuously absent. At the insistence of the company’s creditors, he had finally yielded his job as CEO and chairman just two days before Baxter’s death; Lay sent his wife, Linda, to attend the service instead. Enron’s deposed chief financial officer, a onetime whiz kid named Andrew Fastow, was missing, too; he and Baxter had fought bitterly.

But former chief executive officer Jeffrey Skilling—once touted as a brilliant visionary and the man who shaped Enron in his own image—was very much in evidence. Baxter had been his closest confidant at Enron, the nearest thing Skilling, who kept his own counsel, had to a sounding board. Widely feared

during his reign at Enron, known for his unflinchingly Darwinist view of the world, Skilling spent the service in tears.

• • •

In the months after Cliff Baxter’s memorial service, Jeff Skilling could often be found in an otherwise empty hole-in-the-wall Houston bar called Muldoon’s, downing glasses of white wine. A short, fit man of 48 with slicked-back hair and cool blue eyes, Skilling typically appeared in faded jeans, a white T-shirt, and a two-day growth of beard. This is where he came to brood over what had happened at Enron—often for hours at a time.

More than anyone else, Skilling had come to personify the Enron scandal. Part of it was his audacious refusal, in the face of a dozen separate investigations, to run for cover. Alone among Enron’s top executives summoned before a circuslike series of congressional hearings, Skilling had ignored his lawyers’ advice to take the Fifth and defiantly spoken his piece. The legislators were convinced that Skilling had abruptly resigned as CEO of the company— just four months before Enron went belly up—because he knew the game was over. But Skilling wouldn’t have any of it. At the time he quit, he insisted, he believed Enron was “in great shape”; he had left for “personal reasons.” The nationally televised testimony was vintage Skilling: articulate, unapologetic, and prickly. He didn’t hesitate to lecture, even scold, U.S. senators.

“Enron was a great company,” Skilling repeatedly declared. And indeed that’s how it seemed almost until the moment it filed the largest bankruptcy claim in U.S. history. Fortune magazine named it “America’s most innovative company” six years running. Washington luminaries like Henry Kissinger and James Baker were on its lobbying payroll. Nobel laureate Nelson Mandela came to Houston to receive the Enron Prize. The president of the United States called Enron chairman Lay “Kenny Boy.” Enron had transformed the way gas and electricity flowed across the United States. And it had bankrolled audacious proj- ects around the globe: state-of-the-art power plants in third world countries, a pipeline slicing through an endangered Brazilian forest, a steel mill on the coast of Thailand.

As Skilling saw it, Enron had fallen victim to a cabal of short sellers and scoop-hungry reporters that triggered a classic run on the bank. Privately, he would grudgingly acknowledge occasional business mistakes—including one,

the failure of Enron’s broadband venture, that cost the company more than $1 billion. Yet Skilling remained remarkably unwilling to accept any personal responsibility for the company’s demise. “You’re not going to find one memo where Skilling said, ‘Fuck with the numbers,’ ” he told a friend. “It isn’t there.” He was reluctant even to pronounce judgment on Fastow, his handpicked finance chief, who—the U.S. Justice Department alleged—had not just done a lousy job as CFO but stolen millions and collected kickbacks right under Skilling’s nose. What happened to Enron, Skilling insisted, was part of the brutal cycle of business life. “Shit happens,” he liked to say. Enron was a victim.

Unfortunately for Skilling, no one else believed that. Enron, which once aspired to be known as “the world’s greatest company,” became a different kind of symbol—shorthand for all that was wrong with corporate America. Its bankruptcy marked not merely the death of a company but the end of an era. Enron’s failure resonated powerfully because the entire company stood revealed as a sort of wonderland, where little was as it seemed. Rarely has there ever been such a chasm between corporate illusion and reality. The public scrutiny Enron triggered exposed more epic business scandals—tales of cooked books and excess at companies like Tyco, WorldCom, and Adelphia. Enron’s wash swamped the entire U.S. energy industry, wiping out hundreds of billions in stock value. It destroyed the nation’s most venerable accounting firm, Arthur Andersen. And it exposed holes in our patchwork system of business oversight —shocking lapses by government regulators, auditors, banks, lawyers, Wall Street analysts, and credit agencies—shaking faith in U.S. financial markets.

Yet Skilling continued to plead his case with a compelling arrogance. At different times, before different audiences, he could be self-righteous, self- pitying, sarcastic, profane, even naive. Sometimes, he was all of these things at once. Periodically, he’d launch into an extended rant: about the media, about politicians, about the aggressive tactics of government prosecutors (“Welcome to North Korea”). The investigation was “a travesty,” Skilling declared. “It makes me ashamed to be an American.”

Even after the bankruptcy filing, he continued to exult over the innovative ways in which Enron went about its business. In an industry built on brawn, Enron prided itself on being a company that ran on brains. And Enron was smart —in many ways, too smart as it turned out. Just as he had when Enron was riding high, Skilling labeled ExxonMobil a “dinosaur”—as though it didn’t matter that the oil giant was thriving while Enron was nearly extinct. “We were doing something special. Magical.” The money wasn’t what really mattered to

him, insisted Skilling, who had banked $70 million from Enron stock. “It wasn’t a job—it was a mission,” he liked to say. “We were changing the world. We were doing God’s work.”

In the public eye, Enron’s mission was nothing more than the cover story for a massive fraud. But what brought Enron down was something more complex— and more tragic—than simple thievery. The tale of Enron is a 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.

In less combative moods, Skilling reflected on his plight. “My life is fucked,” he said. He would tear up as he spoke about what building Enron had cost him: he had destroyed his marriage, ignored his kids. “People didn’t just go to work for Enron,” Skilling would tell acquaintances. “It became a part of your life, just as important as your family. More important than your family. But at least I knew we had this company.”

Skilling was seeing a psychiatrist and taking antidepressants. “I view my life as over,” he said during an extended dark spell. Before his funk eased, in the months after Baxter took his own life, Skilling openly mulled over whether his friend had done the right thing. “Depending on how it plays out, it may reach a point where it’s not worth sticking around,” he said. “Cliff figured out how it was going to play out.”

CHAPTER 1

Lunch on a Silver Platter

It is no accident that Ken Lay’s career in the energy business began—and, most likely, ended—in the city of Houston, Texas.

Houston was the epicenter of that world, home to giants like Exxon, Conoco, and Pennzoil. Spindletop, the legendary field that triggered the first Texas oil boom, back in 1901, is just up the road. To the south and east, sprawled over thousands of acres, lie refineries, petrochemical plants, gas-processing facilities, and tank farms—the grimy monstrosities that feed the nation’s hunger for plastics, fertilizer, heat, electricity, and gasoline.

For most of the twentieth century, Houston’s economy rose and fell with the price of crude. In the 1970s, when an Arab oil embargo was strangling the rest of America, Houston boomed. By 1987, when lower energy prices were pumping fresh life into the country, the city was flat on its back.

Houston also perfectly reflected the culture of the energy business. It was sprawling and rough, lusty and bold, wide open to opportunity and worshipful of new money. A city built on a swamp, Houston was a place where a man with a wildcatting spirit could transform himself virtually overnight; a like-minded company could remake itself, too.

The romance and myth in the energy business, of course, had always been about oil. It was crude that built empires, inspired legends, and launched wars. It was oil that the Mideast sheiks used to hold America hostage. It was oil that created the towering fortunes of Rockefellers and Hunts.

But Ken Lay’s destiny lay in a humbler hydrocarbon: natural gas. Transparent, odorless, lighter than air, natural gas, composed mostly of methane, lies trapped in underground pockets, often beside oil deposits. America has long had vast reserves of gas, and it burns far more cleanly than either coal or oil. Yet

for the first half of the last century, America had little use for the stuff. It was a mere by-product in the quest for oil, priced so cheaply it wasn’t worth laying new pipelines to move it across the country. Instead, natural gas was usually just burned off as waste or was pumped back into the ground to maintain pressure to extract more oil.