Tag Archives: Enron

Enron in Edinburgh

I’ve finally seen Enron on stage. Briefly, for those who don’t know, Enron used clever and initially legal accounting techniques to big up their profits and tuck their losses away out of sight and, for a while at least, out of mind.   Not the most obvious material for a play. However my initially-not-very-interested-in-the-subject husband came away enthralled by the story and with a reasonable understanding of  hedging, trading above book and the role and effects of the raptors. So kudos to Lucy Prebble for that. Plus, it’s excellent.

Enron the Play

Enron is not a Greek  tragedy of our times, even though the tale includes hubris, ethical dilemmas (not that many of those, actually) and a suicide.  It’s too technical to be a farce, not quite funny enough to be a pantomime (“We did nothing wrong” “Oh yes you did” “Oh no we didn’t”)  so a musical play is just about right.

The staging is arresting: the two main numbers are the trading floor in the first act (which is the poster-piece for the play) and the California power-cuts in the second.  Both of these are great set pieces, but I was mightily irritated by the first which showed traders in the brightly coloured trading jackets of an open outcry trading floor.  You see, Enron’s not just a story about greed, it’s a story about vision.  Like it or lump it Skilling really was a visionary and the people who worked there really were the smartest guys in the room.   So Enron pioneered online trading – “Enron Online”: the clue was in the name.  I accept that having 8 men wildly gesticulating their buy and sell messages is much more theatrical than having 50 of them crouched over computer terminals.  But the inaccuracy  annoyed me so much I couldn’t pay attention to the rest of the first half.  And  it detracts from the tension between bricks and clicks which is one of the more interesting things in the Enron story.  You see, they weren’t just crooks, they were also visionaries.  Skilling really was trying to bring about a technological future the rest of the world just didn’t get at the time.  A future that we live in now. Video on demand, anyone?

The four main parts in the play are Chairman, Ken Lay, CEO Jeffrey Skilling, CFO Andy Fastow and hot business babe “Claudia”, whose career and character echoes that of Rebecca Marks.  (Marks left before the proverb hit the fan, was not involved in the frauds, and would be  in a position to sue if her lawyers felt like it). This drastic pruning is I think fair. However I was unconvinced by the characterisation of Fastow as a jittery nerd.  From my reading of just about every book available, Fastow was neither fawning nor socially inept; like the others he was clever and corrupted by his own ambition.  I was also surprised by the presentation of Skilling and “Claudia” as sexual partners. Their rival visions for the organisation were more than enough reason for them to dislike each other without  any need for urgent and unsatisfactory sex. Which brings us back to the bricks and clicks tension:  “Claudia” in the play and Marks in reality focused on traditional businesses, power plants, water companies, pipelines and the like.  Ok, they were hubristic failures, but they did raise cash in the fire sale.  Skilling’s vision was to change the nature of business by introducing trading into markets which hadn’t been traded before.  They were both wrong of course, which ultimately was why Enron fell.

One thing that fascinated me was that at no point in the play did the Edinburgh audience applaud when I was there on Saturday night; not the set-pieces, not the soliloquies, and very nearly not at the end.  There must have been several people in the theatre that night, or over the run at least, who could have written the equivalent play about RBS and I could have had a good stab at writing one about HBOS myself.  Edinburgh is not unsophisticated financially, even if its financial services companies are banks rather than trading houses or accountancies.

Maybe the sights and sounds of plunging share-prices, lost life savings and venial leaders were just the teensiest bit too close to home.

Other stuff I’ve written about Enron.

No more kool-aid any more: Sherron Watkins and Enron

Power Failure

  • I am taking an ethical stand
  • You are a whistle-blower
  • He is a grass

The ethical complexities of whistle-blowing tap deeply into the issues of divided loyalties.  It is hard to predict what you’d do faced with this sort of dilemma, and I’ve always been interested in the stories of those who have. Power Failure is co-credited to Sherron Watkins the woman usually described as ‘the Enron whistle-blower’.  I was eager to compare it with Cynthia Cooper’s book Extraordinary Circumstances about blowing the whistle in Worldcom which I reviewed a while ago.

I was curious to understand the differences in the two women’s experiences. Cooper was head of internal audit and her job was to prevent just the sort of fraud (simple, but huge) which she found at Worldcom. The horns of her particular dilemma were her professional accountability vs corporate loyalty. Watkins on the other hand was only one of dozens of insiders expressing concern about Enron both within and without the company, others had leaked for years to market analysts, to the press, even to Yahoo message boards. Watkins just happened to be the one who failed to maintain her anonymity.  The irony is that she kept her concerns within the company, taking them to CEO Ken Lay instead of narrow-casting them outside.

This is one of the few books about Enron not put together from clippings, and it shows.  Swartz clearly obtained access to a number of senior or at least central insiders.  It provides a real sense of why Enron was an addictive place to work, which I’ve not found in any other book.   The only other book with an Enronian’s name on the cover Brian Cruver’s book, ‘Enron, Anatomy of Greed‘, but he arrived late and was just one of thousands of low-level employees dismissed with a $4,000 pay-off just before Christmas 2002.

Reading both these books though, three things stand out for me other than the eye-wateringly huge amounts of money.

The first is the absolute importance of operational controls. Yes, ethics and risk management matter both morally and in business terms, but operational controls come first, because operational chaos not only permits these kinds of fraud it may even require them.  Frequent organisational re-structures and high levels of executive churn are bad signs.  Beware of companies which are overly acquisitive or growing too fast, because things will fall down the cracks.

The second is that it is hard to be faced with the morning-after when you have stopped drinking the kool-aid.  ‘Power Failure’ and ‘Extraordinary Circumstances’ both touch on how difficult it was for Watkins and Cooper to determine what the right thing to do was, let alone how hard it was to do it.  I’d like them to have covered the consequences to themselves in a bit more detail, but I guess we don’t like the idea that good people can suffer for doing what’s right.

Finally, while reading the book I found myself wondering what it is like to be Jeffrey Skilling or Andy Fastow right now, in jail.

Enron was a long time ago and I do feel that I’ve read all I need to on the subject, but Lehmans, Goldman, RBS and HBOS remind us that arrogance, chaos and greed enable companies to fall as well as rise.

PS – ‘Power Failure’ is written in the third person by journalist Mimi Swartz. For a more a direct insight into Watkins herself look at the BBC programme Hard Talk where Watkins exchanges wry regrets with the HBOS whistle-blower, Paul Moore.  (This will only be watchable for another two months).

Book Review: WorldCom ‘Extraordinary Circumstances’ by Cynthia Cooper

Extraordinary Circumstances

Extraordinary Circumstances

I’ve wondered for a while why there are over half a dozen books about the collapse of Enron, but only two about WorldCom. Maybe it was because Enron happened first.  Maybe it was because Enron disappeared but WorldCom survived in the form of MCI, who presumably have lawyers. Maybe it’s because Enron’s story is sexier and more complex.

One of the few books available about WorldCom was written by the Vice President of Internal Audit, Cynthia Cooper: Extraordinary Circumstances the Journey of a Corporate Whistleblower.  Let’s get the housekeeping out of the way: it’s written in the present tense and has no illustrations, and both these things are constantly annoying.

So what actually happened at WorldCom?  According to Cooper, it was a fairly simple accounting fraud, well hidden but nowhere near as specialised as the off-balance sheet stuff at Enron, and it was committed to save the company not so a Fastow-figure could skim off illicit cream for personal gain. Basically, WorldCom played PacCom in the 1980s and 1990s munching up telecoms and internet companies but failing to integrate them.  Cooper asserts that it wasn’t the fraud or exposing the fraud that killed WorldCom; it became a dead company walking when the internet bubble burst in 2000 and sucked telecoms into its wake.

The most engaging section of the book is when Cooper tells the story of the few months before and after she and her team of internal auditors discovered the fraud, reported it to the internal audit committee and all hell broke loose. WorldCom had become a lumbering Frankenstein’s monster of acquisitions but it had no single set of operating systems. You can only only make savings from acquisitions by doing the boring operational stuff of cutting out duplication and waste. Instead it was faced with the rising costs involved in managing a hodge-podge of companies, falling revenues as telecoms tanked, and a share-price that burst with the bubble, and that was when CFO Scott Sullivan instigated the fraud. WorldCom started making a loss, but Sullivan reported non-existant profits by moving the cost of renting lines from operating costs to capital, to the tune of $3bn over 5 quarters and (according to Wikipedia) by over-stating sales.

The final few chapters of the book are among the most interesting. It’s clear that CFO Sullivan was, as the judge said, the architect of the fraud. Cooper says she could not decide in her own mind about CEO Bernie Ebbers’ guilt. The book is well lawyered, so although these doubts are phrased in the present tense they are located in the section before the jury came to their verdict.But in Cooper’s mind at that time at least the case against Ebbers was not-proven. Ebbers is serving 25 years, mainly on Sullivan’s testimony.  Sullivan has just finished a 5 year jail term.

The case against Ebbers hinged on the financial pressure he was under following the fall of telecoms stocks.  In April 2002 PacCom’s cigar-chewing, cowboy booted CEO packed up his stuff and left. He faced personal bankruptcy. He had been the king of the deal, driving forward to one takeover after another, and Cooper comments on how his personal style changed as he grew in hubris and then fear kicked in. By the end of his tenure he’d cancelled the free coffee and was issuing memos telling staff not to use the colour copiers. All his wealth was in WorldCom stock, and he borrowed against it, so when telecoms stocks collapsed he effectively ended up with ‘negative equity’ to the tune of $300 million dollars. Even so, there is no concrete proof he instigated, encouraged or permitted the fraud.  The only evidence against him was Sullivan’s testimony saying that Ebbers told him to commit fraud quarter by quarter by telling him ‘we must make the numbers’.

It’s hard to tell if this was plausible deniability in action, or a matter of style.  Cooper implies the latter, and the implication that a nod is as good as a wink in the C-Suite, or the C-Suite of WorldCom at least, is one of the other interesting aspects of the book. Because it’s a first person account, Cooper reports what was said and what she thought at various meetings throughout her career.  Most corporate auto-biographies are not about how people interact, being the narrative equivalent of a series of photographs of the mighty hunter clutching his rifle, one foot on an animal’s corpse.  Those biographies leave me wondering to what extent the C-Suite is a foreign country and how differently they do things there. Cooper casts some first-person light on this, and WorldCom appears to have been political and focused but less testosterone-fuelled than Enron, running at a rapid pace on cryptic comments, laconic remarks and inference.  One could argue, though Cooper is careful not to, that Ebbers is a modern-day Henry II.  If so, then the disparity in sentencing is troubling, to say the least.

As a British reader, there were two things I found intriguing which Cooper didn’t even notice.  One is that the main players are actively religious: Ebbers started each board meeting with a prayer, Cooper’s main contact with colleagues out of work is through their Church.  The second is that both WorldCom and Enron were companies located in the South, these are stories of hicks made good who went bad.  That’s not to say the patricians on the East Coast don’t do the same – look at our current banking crisis and the Wall St scandals of the 1980s.  Cooper mentions but does not explore the cultural differences between the various organisations that ultimately comprised WorldCom.

The book (like this review) is over-long and (unlike me) Cooper leaves it up to you to do your own analysis or not as you see fit.  But there is one extraordinary Ozymandias-like vignette:

It’s November, 2004.  The double glass doors to the executive suite are locked.  I peer through to see drops of water leaking from the ceiling in several spots, and a dimly lit room, many of the lights burned out and the remaining ones flickering, a ghostly symbol of the fall of a company and an executive team that once seemed invincible. The guard unlocks the doors and we file in.  Brown cardboard boxes are everywhere, each labeled with the name of a former WorldCom executive. There is barely room to walk. It feels as if we’re somehow trespassing on private property.  I read the names of people I used to work with as we slowly walk through. Bernie’s office is completely empty, not even a hook on the wall.

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Fantasy CEO – Round 4 Annual Report

Filthy LucreScores

The Times have improved the way they report the scores with separate tabs for each round. They are still not ideal in various ways – not least in that the 4th round results aren’t up yet – but I have spent too much time this week staring at spreadsheets and daring them to blink to comment on scoring this week. Shane has sent me the aggregated scores and I’ll send them to anyone playing the game who emails me at astrea_gw at yahoo dot co dot uk.

Fantasy CEO or Fantasy Marketing?

It occurred to me this week to wonder if this is a game of Fantasy CEO we are playing, or is it Fantasy Market Research?

The analysis you go through and decisions you make in Marketing and Finance are relatively detailed compared with what you do in Production. It is also glaringly obvious that IT is taken for granted. Now I find this interesting. This implies Marketing, Production and Finance strategies matter but that IT strategy is irrelevant, that it is not a business activity even. I live and work in IT so I find that rather depressing, and wonder if it’s a home truth.

There could be any number of reasons for this. Maybe business studies teachers and management lecturers don’t understand IT. Maybe market analysis can be simplified in a way that production can’t. Maybe MSI’s main customers in business schools are more interested in Marketing than in IT, Production, Engineering and the other Techie stuff. In fairness the Times haven’t enabled the Total Quality Management and concepts around production could be worked through there.

In the late1990s, the netgeist started claiming that IT strategy is the strategy: this can be argued very strongly in the case of companies like Amazon and eBay, and it is often forgotten that decisions around IT were a sub-plot in Enron’s final chapter. I get my veggies online from an organic farm and the rest of my groceries are delivered by Tescos  which shows the wide range of businesses who have moved into on-line sales. So I buy into the idea that IT strategy is the strategy, but I’ll admit that I’m biased.

A lot of IT decisions seem doctrinal anyway: some advocate getting all your software and hardware from one vendor such as, say, IBM, to pick the one remaining candidate at random. In theory everything works together and it’s the vendor’s problem if it doesn’t. Others believe you should cherry pick the best and then mix and match, getting your HR software here and your Financial software there and stitch it all together. Some believe in “off the shelf” and others believe in “bespoke”. Yes, in some circumstances one approach is better than others but you get my drift.

It is tempting to come to the judgemental conclusion that we are losing our manufacturing edge in the West because our business studies classes and business schools focus on Marketing at the expense of Production and we are turning into a hemisphere of shop-keepers. I think it’s got more to do with sweatshops and containerised shipping myself, but losing our expertise in Production does not help. We should be automating and manufacturing locally even if the factories are run by half a dozen people and we won’t be able to do that if all we know is how to spend a promo budget.

All of this is irrelevant to the Round 4 Annual Report, but having spent the first couple of weeks thinking how complicated and detailed the simulation is, I thought it worth noting some of its limitations.

This week

Well I was rather cocky when I pressed the “submit” button on Friday, but I’m feeling a lot less smug now I’ve got my reports for this round.  I’m still pants at forecasting it seems – so much so that failed to predict how much cash I’d need and ended the round needing an emergency loan.    Having been overly cautious in the first three rounds, I wasn’t cautious enough this round and I significantly over-estimated how many of my main Low Tech widgets I’d sell.  How annoyed am I?

I thought I’d pushed through a barrier this week. When I looked at the pro forma balanced scorecard I found that my predicted score was much better than before, based on sensible decisions on forecasts I had worked out rather painstakingly. It is frustrating to find I am actually less skilled at the process of analysis and decision-making than before.  I think it’s not just poor forecasting though, I think it is poor contingency planning too.  Hey ho.

So what else have I learned so far?

I think I’ve finally realised that the advice about forecasting is just that – advice. I was trying to follow it as a process and getting frustrated with the vagueness of it all. Once I realised that they describe an art not a science I felt happier.  Mind you it’s an art I obviously haven’t mastered. In real life I’d like to think it’s nearer a science, otherwise how can I possibly take people who work in Marketing seriously?

I’m getting more comfortable using the tool itself, which makes using it quicker and slicker.

More usefully, I’m getting a more intuitive understanding of the balanced scorecard, (see previous post) and beginning to understand the pros and cons of the different ways of financing a company.

Or at least I thought I was doing all these things until I got this rounds results.  Still, I’m buggered if I’m letting one bad round put me off.  It’s worrying that I am going to be so extremely pushed for time over the next two weeks.

Next Week

Next week I plan to email some of the visitors to this site and asking them how they play the game – how long they spend on it, how much relevent experience they already have, how much is new, stuff like that.  If I get any replies I’ll pull out some extracts and publish them here, though possibly not until the week after next depending on other commitments and time.

Enron – a case of moral bankruptcy

Enron Logo - “The Crooked E”I’m currently reading a couple of books about Enron and fascinating they are too, if you like that sort of thing, which I do.

What happened with Enron then?

Very briefly: they borrowed from the future to make themselves look profitable in the present, but no-one can do that indefinitely. Astonishingly, for most of the time they were within the letter of the law. Remember, a company’s Annual Accounts are supposed to be an account or an explanation presented to the owners which explains what their officers and employees have been up to during the previous 12 months. However, by the late 1990s there were many different ways of accounting for any given set of facts.

Of course, after a while the actions they took were definitely outside the law. In some cases corporate officers defrauded Enron itself in a complex game of financial cups and peas, in others they defrauded Enron’s owners by lying to Wall Street, and a huge number of senior executives quietly jumped ship during Enron’s last year of trading cashing in tens or hundreds of millions of dollars worth of Enron stock in the process, walking and quacking like insider traders as they pocketed the cash and “retired”.

Reading the various books on the subject, it’s clear that most of those involved either had no sense of right or wrong or let it erode over time. The question always seems to have been “is it legal?” not “is it right?”. These were people who had ferocious intellects but who had no moral sense and no internal breaking systems. Some of them saw laws and lawmakers as opponents to outwit. Others among them didn’t take laws that personally – they just thought the law applied to other people.

Reading the books though, I find myself wondering how such seriously intelligent people could be so stupid. How could they think that they could operate the company on a giant Ponzi scheme forever?

They separated out economics from accounting, and separated cash from profit. The economic reality – the truth of the cashflow – was that they frequently cut unprofitable deals. You see, they booked all the future profits of a deal when it was struck regardless of when or whether the cash flowed in by using what is called “mark to market” accounting. Worse than this: executives were rewarded regardless of how profitable the deal turned out to be because they got their bonuses when the deal was signed.

As time went by, and a deal proved itself to be less profitable than they had said that it would be, Enron should have shown that as a loss. But they were immensely reluctant to do that, and of course the bonuses were long spent.

An example (please skip this bit if your eyes glaze over whenever you see numbers)

Let’s say they built a power-station at a cost of perhaps $1bn and that they struck a 20 year agreement to sell the power at a rate of £100m a year. By normal accounting methods, the power-station would show a cash income from year one, but would take 10 years to pay for itself. What Enron did was to show £1bn as profit in the first year, on the basis that this was how much profit they thought they’d make over the whole 20 years of the deal.

There are lots of problems with this, but here are two to start with:

It is much harder to show an increase in profits if you book all your profits in the first year. Using normal accounting rules, the power station would not clear its building costs until year 11, but from then on if you want to show $2bn profits, you only have to make $1.9bn because you’ve already got $100m coming in from the power station. But using mark-to-market accounting rules you are starting from zero every single year.

This effect is exacerbated if your power station does not in fact have an income of $100m every year. Say it only makes $75m. Then if you are using mark-to-market rules you should actually declare a loss on your your books of $25m every single year even when you’ve cleared your building costs and are actually in profit.

Ok, that was very technical thank you Aphra, but what makes it interesting?

The focus on the here and now, on the deal and not on its fulfilment, was the nub of Enron’s problems. But you cannot run a business not serve your customers, you cannot run a business and ignore the cash.

It seems simple doesn’t it? Simplistic even. And that’s what I find fascinating about Enron: how so many very clever people (and they were very clever – they came from Harvard and McKinsey and Arthur Andersen) how so many very clever people could be so incredibly stupid. If you have no cash income, you’ll have no business.

The second thing I find fascinating about Enron is how many people outside Enron happily pocketed the consultancy fees and commissions that Enron paid them to hold the cups and hide the peas in my previous metaphor. Enron asked the banks and other institutions to “invest” in “assets” which Enron would then “buy back”. That sounds like a securitised loan to me. Doesn’t it sound like a securitised loan to you? But Enron called it a sale, and booked the first half of the deal accordingly though I’ve no idea how they booked the second half. The banks and other investors were paid handsome fees for these transactions. Again, these are very bright boys indeed so it is no surprise that some of them worked out that the deals were not entirely as Enron was painting them, but as Kipling puts it “them that asks no questions isn’t told a lie”. There was money to be made.

The third thing that I find fascinating is how many of Enron’s corporate officers came from relatively humble backgrounds. Kenneth Lay (Enron’s long-term CEO) grew up on a mid-western farm. Rebecca Mark (who dashed around the world, riding on elephants, building power stations and running Enron International) was from the Midwest. Jeff Skilling (who was the inside guy to Lay’s outside guy and was briefly CEO) came from a blue-collar background in blue-collar towns. These were not decadent second- third- or fourth-generation American aristos, not Hiltons or Bushes or Kennedeys. The guys that ran Enron liked the part of the American Dream which gets very rich indeed, but ignored the part that learns all it needs to know at kindergarten.

The fourth thing I find fascinating is that every single person involved seemed to think that someone else was checking up on things. Enron blamed its auditors, Arthur Andersen, for letting them get away with it. Andersens blamed Enron’s financial officers for pushing the line too far. Wall Street was told that “Risk Assessment and Control” stopped risky deals from being cut. But the RAC employees claimed that they merely there to advised and could not veto. The fascinating thing is not that everyone blames everyone else, it is that everyone genuinely seems to think that they themselves were not in any way to blame.

And finally, and this is what really gets me, they were a bunch of fucking amateurs. Highly educated amateurs, admittedly, but none of them had actually run anything. Kenneth Lay’s CV comprised academia and a little bit of government work until he got given a company to run. He was a supreme politician and played good cop to Skilling’s bad cop. One cannot call Skilling an amateur: Harvard MBAs and McKinsey consultants are not amateurs, but he was a dangerously brilliant and lop-sided specialist who should never have taken on general management by becoming CEO of various subsidiaries and ultimately of Enron itself. Andrew Fastow, who became CFO, was not even an accountant: his background was financial instruments.

I think it’s the lack of self-awareness that fascinates me; and integrity is the sternest form of self-awareness. Were they venal or just un-reflecting? I don’t know.

So there you go. If you want a quick rattle through Enron’s last 200 days then read “The Anatomy of Greed” which was written by an outsider on the inside, an Enron employee who was kept in the dark and fed the same bullshit as everyone else. If you want to get down and dirty with the detail read “The Smartest Guys in the Room” which is fascinating and dispassionate especially where the authors’ shocked incredulity occasionally breaks through. If you want something online that’s more informative than Wikipedia go to Risk Glossary.

The second book is particularly thought-provoking, and I guess the thought it provokes the most is “just how unusual was Enron?”