Are you one of the smartest guys in the room? – Part 2

Enron couldn’t continue to use its dishonest accounting methods indefinitely. The business viewed them as a safety net that would keep its operations looking fine until Skilling came up with a different strategy to generate genuine profits.

Since retail power had begun to be regulated by state governments by the middle of the 1990s, Skilling’s initial plan was to enter the electrical energy sector. Enron was betting that the market would eventually become deregulated and that, once it did, they would be in a perfect position to sell power directly to households and businesses across the nation.

The main issue was that local energy companies coordinated a vigorous pushback against deregulation, which only convinced a few states to reduce rules after all. Additionally, Enron invested over $20 million in advertising to attract new customers in California, a state that actually permitted Enron to sell power directly to consumers. Consumers weren’t prepared to switch away from the dependable service they had previously used, despite the discounts Enron could provide.

Additionally, Enron just didn’t belong in the electrical industry. For instance, Enron claimed to drastically enhance efficiency in order to win over clients, but the problem was that they had no idea how to achieve it.

Skilling’s initial strategy failed, but what about his second? Well, it also ended up being a terrible failure. Skilling said that broadband will be Enron’s next great thing and questioned why the company couldn’t sell bandwidth like it did natural gas. Therefore, Enron stated in 1999 that it will soon be able to provide real-time bandwidth-on-demand. It would create a sophisticated new broadband network system to accomplish this.

Enron portrayed its system at the time as “lighted, tested, and ready.” However, in practice, it wasn’t even close to being commercially operational, and a lot of the technology they promised never even left the lab. The truth was that Enron couldn’t and never would offer bandwidth-on-demand.

You might find it difficult to trust Thomas Kuhn, head of the Edison Electric Institute, when he said that Enron executives had “the air of whiz kids, of golden boys who could do no wrong” given what you now know about Enron. In fact, Bill Gates of Microsoft and Steve Jobs of Apple were cited in the same sentence as Skilling and Lay.

Analysts had unwavering faith in Enron’s success. Consider the January 2000 Enron annual analysts conference, a yearly event at which Skilling and other executives discussed the performance of each business unit. The best part of the meeting? Enron officials announced the business will become “the world’s largest supplier of premium broadband delivery service” when announcing its new broadband strategy. Even more outrageously, Skilling estimated that the new business would be worth an astounding $29 billion!

Naturally, the atmosphere in the room became insane, with 200 analysts frantically calling their trading desks to urge them to buy Enron. The company’s shares increased 26 percentage points as a result in just one day. In fact, none of the experts present dared to pose a challenging query because Enron was universally praised.

Even while it appeared that the analysts themselves were unaware of what was going on, a surprising number of people were aware of what was really going on with Enron. For instance, many of the analysts were aware that the company’s recorded earnings were significantly higher than the real revenue. Indeed, midway through 1999, J.P. Morgan analyst Kyle Rudden stated, “ENE [Enron’s stock ticker] is not a cash story… Enron has a lot of latitude in how it structures contracts and, consequently, books earnings.

But the analysts knew more than that. Additionally, they were aware that Enron had substantial amounts of off-balance-sheet debt—debt that doesn’t appear on a company’s statement of financial position—but they rarely brought it up in their reports.

Skilling was atop Enron’s pinnacle on December 13, 2000, when the corporation announced that he would succeed Ken Lay as CEO. Business Week published a respectful cover article in honor of his promotion, naming him America’s second-best CEO, only behind Microsoft’s Steve Ballmer. In fact, Skilling had only been employed for three months.

However, despite the admiration for Skilling, doubts about Enron’s success were starting to emerge. According to a report by Jonathan Weil for the Texas Journal, a regional supplement of the Wall Street Journal, on September 20, 2000, energy dealers’ dependence on mark-to-market accounting, Enron’s key strategy for recording profits before the money ever arrived, was highlighted.

An influential hedge fund manager called Jim Chanos read the news and started looking into it. He found that despite Enron reporting consistently rising profits, the company itself didn’t seem to be making any money at all. He expressed his doubts about Enron to Fortune magazine, and in March 2001, a piece with the title “Is Enron Overpriced?” was published. The article noted Enron’s poor cash flow and increased debt, but it also showed the growing suspicion about Enron among investors.

When Skilling abruptly resigned as CEO, that suspicion intensified. The business announced his retirement on August 14, 2001, and stated that Ken Lay will take up the position. Investors were told by Skilling that there was “nothing to reveal, the company is in terrific shape,” and “this is purely a personal decision.”

But the maneuver appeared odd without a doubt. Why would a CEO who is so ambitious go abruptly after only six months on the job? It was inevitable that Skilling’s abrupt resignation would spark new rumors about possible issues at Enron. One day after Skilling’s resignation, Sherron Watkins, a mid-level Enron veteran, sent Ken Lay an anonymous letter in which he expressed his “extreme nervousness” that “we will disintegrate in a wave of accounting issues.”

But Lay didn’t seem concerned, and one Enron executive claimed that Ken believed nothing could be done to fix what was already good about Enron. Regardless of what Lay had to say, Enron was about to enter a cash crunch due to its enormous debt and falling stock.

A handful of the agreements Enron had made to raise money called for the rapid repayment of billions of dollars in debt if the company’s stock price and credit rating fell below a predetermined threshold. Enron’s stock had already fallen below the upper bounds of these arrangements because the media exposed how it was manipulating its numbers, and the company’s credit rating was getting close to junk status.

For instance, Enron’s stock had fallen from a peak of $90 per share in August 2000 to less than $20 per share in October 2001. The company’s executives had to quickly locate two or three billion dollars, or its terrified creditors would shut it down. However, even that was out of the question because the banks had already stated that Enron’s credit line was completely depleted.

Merging with Dynegy, another Houston-based energy trader that Enron had long detested, was their only chance to avoid bankruptcy. Wall Street traders and Dynegy officials both had second thoughts about the agreement shortly after it was announced; after all, did Dynegy truly know what a merger with Enron would entail?

In brief, the sale fell through, and on December 2, 2001, Enron, seeing no other options, filed the largest bankruptcy case in American history. After Enron’s bankruptcy, all parties involved, including the board of directors, denied any involvement. But by 2003, the United States Department of Justice’s prosecutors had issued a huge list of indictments, and their elaborate scheme was beginning to unravel. 25 former Enron executives were among the 33 people who ultimately faced charges.

Here is what happened to the individuals at the top, including Mark, Lay, Skilling, and Fastow. Fastow entered a guilty plea to all charges in 2004. He was freed in 2011 after serving six years in prison and acknowledging that he had “acted in schemes to enrich [him] and others at the cost of Enron’s stockholders.” Later, he continued, “I and other top management employees of Enron deliberately falsified Enron’s publicly disclosed financial statistics. Our goal was to deceive investors and others about Enron’s genuine financial situation in order to artificially boost the stock’s price and maintain Enron’s credit rating.

Before spending a day behind bars, Ken Lay passed dead. He had been charged with ten charges, including fraud, making false representations, and conspiracy. Despite entering a not guilty plea to each allegation, he was found guilty of them all. However, on July 5, 2006, before the court had decided on his punishment, he passed away from a heart attack while walking with his wife outside of Aspen, Colorado.

In 2004, 35 counts against Jeffrey Skilling, including conspiracy, fraud, and insider trading, were brought against him. Despite insisting that he “had no notion that the corporation was in anything than outstanding form,” Skilling was found guilty of 19 of his charges. He received a $45 million fine and a term of more than 24 years in jail in 2006.

Rebecca Mark, too? In August 2000, before the controversy became widely known, she departed Enron. When Enron was at its highest, she sold her stock, making a staggering $82.5 million. Mark has never been charged with any offences.

Enron, a global energy company, inflated its stock by dishonest business practices, such as a toolbox of accounting frauds and a poisonous deal-making environment. Due to the company’s dishonest business practices, it was inevitable that it would fail, which resulted in the largest bankruptcy case in US history as well as numerous indictments.

Don’t allow stock prices become an obsession is the lesson to be learned. Jeff Skilling’s thoughts became exclusively focused on Enron’s stock price. When he wasn’t in the office, he would call in several times per day to check on the stock’s performance because the company’s performance on Wall Street was like his report card. It’s important to monitor your company’s finances, but Skilling’s fixation set off criminal tendencies and got Enron into trouble in the end. Remember that, generally speaking, the faster a stock climbs, the more likely it is to decline shortly after. So put your attention towards fostering modest but steady business growth rather than merely concentrating on securing a rising stock price!

Check out my related post: What can we learn about culture from the Enron?


Interesting reads:

https://www.goodreads.com/book/show/113576.The_Smartest_Guys_in_the_Room

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