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What Happened at Enron?

The tragic consequences of the related-party transactions and accounting errors were the result of failures at many levels and by many people: a flawed idea, self-enrichment by employees, inadequately designed controls, poor implementation, inattentive oversight, simple (and not so simple) accounting mistakes, and overreaching in a culture that appears to have encouraged pushing the limits. Our review indicates that many of these consequences could and should have been avoided. Report of Investigation: Special Investigative Committee of the Board of Directors of Enron Corporation, Board of Directors, Enron, February 1, 2002, pp. 27-28. What I can tell you straight up front is that life hasnt been the same ever since the collapse. Working at Enron was like dope. You couldnt get enough of it. Youre surrounded by talent, money is good, lavish expense accounts, and youre all on a race against a snowball called MTM aka, the accounting magic called mark-to-market! Pretty exciting, huh? Well, not if you were one of the thousands who doubled or nothing their 401Ks on Enron... hows that for starters? I see the corporate world and life under a whole different light now. Unfortunately, I see Enrons everywhere. They are just not as good, and are probably still around because they are not as greedy as Skilling, Fastow and Lay. Former Enron Employee I do feel sadness and a sense of responsibility for the shareholders, but equity is called equity for a reason. Rebecca Mark-Jusbasche, Fast Company, September 2003, p. 78.

On December 2, 2001, Enron Corporation filed for bankruptcy protection under Chapter 11. One of the most highly publicized business debacles in history, settlements, criminal charges, civil charges, and workouts will continue for years. But outside of the courts and sensational press, what really happened? What caused the collapse of what at one time was the sixth largest company in the United States? In the following pages we explore the Enron storyits business and business model, its leadership and leadership values, and its culturein an attempt to not only answer the question of what happened, but what may be learned from this failure.

Ken Lay and Enron Corporation

Although a cast of characters were involved in the Enron passion play, one person stands out as the thread which binds all others together throughout Enrons rise and fallKenneth L. Lay. A small-town Missouri boy who wanted out, Lay earned his BA and MA in economics at the University of Missouri. After short spells at Humble Oil in Houston and in the U.S. Navy, where he found his way to the Pentagon, Lay returned to Houston where he earned his PhD in economics at night at the University of Houston. He then returned to government service, first at the Federal Energy Regulatory Commission (FERC), then the Department of the Interior. Throughout his time in Washington, Lay focused on what he believed to be the inevitable movement towards deregulation of the U.S. energy sector. And he believed vociferously in its correctness.
Copyright 2004 Thunderbird, The Garvin School of International Management. All rights reserved. This case was prepared by Professor Michael H. Moffett for the purpose of classroom discussion only, and not to indicate either effective or ineffective management.

After only 18 months in Washington, however, Ken Lay joined Florida Gas in 1973 as Vice President for Corporate Planning, rising to President of the pipeline division in 1976, and finally to the Presidency itself in 1979. Two years later, Lay moved to Transco Energy in Houston, and from there to Houston Natural Gas. There, at the age of 42, Lay became the Chief Executive Officer in June 1984. At Houston Natural Gas, Lay began executing the strategy which he would pursue above all others for the next 17 yearsget big fast. Enron was created in 1985 when InterNorth of Omaha acquired Houston Natural Gas.1 The combination created the single largest operator of gas pipelines in the United States. Ken Lay was named CEO of the combination in February 1986. The combined company was named Enron.2 Lay instantly became the fifth highest paid CEO in the United States. Working closely with his Chief Operating Officer (COO), Rich Kinder, Ken Lay undertook a rapid growth strategy for the newly created and named company. Three events in Enrons early years provide some insight into the emerging nature of the organization. The three events were: (1) the organizations response to an ethical crisis; (2) the interest in new business development ideas sourced from outside consultants; and (3) the readiness of the organization to use new financial reporting techniques as part of their commercial strategy. Each would have a lasting impact. Ethical Dilemma. One of the early tests for corporate leadership occurred in 1987 in Enrons crude oil trading operations located in Valhalla, New York.3 After it was discovered that several of the traders were booking and settling falsified trades, Ken Lay reorganized the unit and altered its reporting structure. Rich Kinder wanted it shut down, but Lay did not. Within months, the traders were once again out of control, and losses were approaching $150 million. Two were eventually found guilty of fraud, and Enron was able to manage the loss back to a mere $80 million. Outside Influence. Ken Lay engaged McKinsey Consulting immediately following Enrons formation to evaluate the companys strategy. The head of the McKinsey team was Jeffrey Skilling, a graduate of Southern Methodist Universitys School of Engineering and Harvard Business School (MBA 79), and by all opinions before and afterthe smartest man in the room. McKinsey Consulting was widely considered the best and the brightest of the time, and among its many talents, Skilling stood out. Few people had ever moved up faster at McKinsey, where Skilling made partner in five years and Director in ten.4 By 1989, Jeff Skilling directed McKinseys global energy practices, and was in need of a new challenge. As early as 1985, Jeff Skilling had been amazed by what he considered the backwardness of the natural gas industry. One of his earliest proposals to Enron had been to apply principles of market making, commonly used in the financial sector, to natural gas. Although Enrons Board had thought the idea idiotic in 1985, Skilling was given the opportunity to realize his dream in 1989 by joining Enron and creating a gas bank, a natural gas trading business. Skilling saw the companys pipeline, which connected producers and buyers, as a potential market maker. By being between the suppliers and demanders, the firm was uniquely positioned to understand what gas was available from what sources at which points in time. Enron could then use that information for trading purposes in understanding the
This case draws heavily on a multitude of books, articles, and reports, including The Smartest Guys in the Room, by Bethany McLean and Peter Elkind, Portfolio/Penguin, 2003; Power Failure, by Mimi Swartz and Sherron Watkins, Doubleday, 2003; Enron: The Rise and Fall, by Loren Fox, Wiley & Sons, 2003; Pipe Dreams, by Robert Bryce, Public Affairs, 2002; Report of Investigation: Special Investigative Committee of the Board of Directors of Enron Corporation, Board of Directors, Enron, February 1, 2002. 2 Enron was chosen after a failed first attempt to name the company Enteron, which was found at the last minute to mean alimentary canal; intestines. 3 Power Failure, pp. 3132. 4 One who did move as fast as Skilling at McKinsey was Lou Gerstner, who eventually took the reins of IBM.
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needs of buyers of natural gas. The company essentially created and operated its own futures market in natural gas. In a natural gas market suffering a painful transition following deregulation as Ken Lay had foreseen, Enron quickly expanded sales and profits by offering both buyers and sellers longer-term fixed prices with little new investment in assets. This asset-light strategy became a centerpiece of Skillings approach to expanding the business.
To be a player in this business, you just needed to understand the price of natural gas and the concept of risk. In the coming years, Wall Street firms piled into the business, but Enron always had a huge advantage. Its immense network of physical assets, its ability to tie all the moving pieces together and provide physical delivery of the gas itself, and its long history in the gas business gave it insights its Wall Street competitors could never match. These, alas, were lessons Enron would one day forget.5

Financial Reporting. The third event which would create ripples within Enron for years to come was Jeff Skillings insistence on the use of an accounting technique common to financial services, but unheard of in the energy industrymark-to-market accounting (MTM). MTM would allow Enron to recognize the sales and earnings on deals today, although most of the actual sales and profits and cash flows would not actually occur until way into the future. Skilling had, in fact, told Ken Lay that he would not join Enron unless he could employ MTM. Skilling successfully convinced both Ken Lay and Rich Kinder, then COO of Enron, that MTM made sense if they were to build a trading business. After some delay and deliberation, the Securities and Exchange Commission (SEC) approved the request in January 1992.

Enron Capital and Trade Resources

Skilling began building his business and extending his influence immediately upon joining Enron in 1990. Originally termed Enron Finance, the unit was combined one year later with Enron Gas Marketing. This was a major development, as it provided an established and steady earnings base to buoy his struggling unit. The following year, the business unit base was extended once again, this time with the addition of the intrastate Houston pipeline business. The new combined unit was named Enron Capital and Trade Resources (ECT). ECT occupied the 39th floor of the Enron building, and immediately became a subculture all its own. Whereas the majority of Enrons traditional employees were from the various engineering and science fields related to natural gas and pipeline operations, ECT recruited primarily MBAs, who were selected on the basis of their intellect and ambition. Skilling encouraged out-of-the-box thinking and behavior, with the culture of the 39th floor often characterized as the anti-Enron Enron. Interestingly, Skilling supported the development of a very loose culture, one which encouraged risk-taking and deal-making, but simultaneously did not expect loyaltyonly performance. Star traders like Lou Pai, famous for temperamental outbursts and a multitude of indiscretions such as taking groups of employees during the workday to strip clubs, were rarely scolded but highly compensated. Ken Lay and Jeff Skilling both became known as pushovers to prima donna traders or deal-makers who demanded promotions, bonuses, and perks. Even the occasional disgruntled employee who did walk was welcomed back to the firm, typically with promotions and bonuses.6 From the very beginning, however, Enron recruited the best and the brightest. The company quickly gained a reputation as supporting and rewarding entrepreneurial thinking. In the words of a
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The Smartest Guys in the Room, p. 38. Cliff Baxter was one of the very high-maintenance merger and acquisition prima donnas who was welcomed back. Having quit and rejoined the firm a half-dozen times, Baxter left Enron for Koch Industries in 1995. Baxter, after only weeks on the job with Koch, called Skilling asking to return. Once accepted back, Baxter left Koch with no notice.
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former employee, If you could show that something new and different could make money, you could do it. The companys loose culture translated into a distaste for bureaucracy and a corporate belief in free markets.

Enron International
Although Rebecca Mark is typically associated with Enron International, it was John Wing who was largely responsible for its early growth. Wing was the driving force behind the development of the Teeside gas-fired cogeneration power plant in the United Kingdom which eventually went online in 1993. The Teeside project was the source of considerable profit in its early years, but eventually became the source of significant losses. Enron had entered into a long-term take-or-pay contract for North Sea gas from a newly developed J-Block in order to provide adequate feedstock for the cogen plant. Unfortunately, Enron entered into a long-term price which was locked in when prices were at historical highs. Finally, in 1997, Enron was able to negotiate a $450 million settlement payment to end its longterm commitment to take-or-pay at astronomical rates the gas originating from J-Block. Some of the post-Enron press has simplistically categorized Rebecca Marks and Jeff Skillings approaches to business as being asset heavy and asset light, respectively. Both Mark and Skilling were pursuing booked earningsaccounting earnings, because that was the criteria for success at Enron. Although they achieved these ends differently (Mark via power projects and pipelines, Skilling by way of trading activities and power sales), both were pursuing short-term recognition of financial results on business lines which often required years of delivery and execution to actually create value. Rebecca Pulliam, like Ken Lay, grew up on a Missouri farm. After graduating from Baylor University with a degree in psychology, she took an internship in juvenile counseling, but quickly found the work did not fit her natural optimism. After finishing a Masters degree in international management, again at Baylor, she took a position with First City National Bank in Houston (ironically, where Jeff Skilling spent several formative early years of his career). At First City, she met and married an Arthur Andersen employee, Thomas Mark. In 1982, Rebecca Mark joined the Treasury group at Continental Resources, a gas company in Houston, which was in turn acquired by Houston Natural Gas just prior to its becoming a part of the newly created Enron. Within Enron, Mark went to work for John Wing. As John Wings protge, Rebecca Mark learned the business inside out. While under Wings tutelage, Mark returned to school, earning her Harvard MBA while still working full time for Enron on Teeside and related deals. Contrary to her expectations, however, when John Wing left Enron in 1991, Ken Lay broke up Enron International into geographic regions, giving Mark control over only the emerging markets segment (Enron Development). Not to be thwarted, Mark embarked on a whirlwind jet tour of empire building. In 1992, Enron Development purchased 17.5% of Transportadora del Sur, an Argentine natural gas pipeline. In 1993 and 1994, power plant projects were sold in the Philippines, Guatemala, and Guam; pipeline projects were under way in China and Colombia, and, eventually, the ill-fated Dabhol, India, power project. Whereas others tried to sell themselves as the companies and agents of technology and low-cost efficiency, Mark combined her personal style and positivism with a sales strategy of accomplishing the impossible. Ironically, Rebecca Mark still found herself competing against John Wing in these early years. Even though Wing had left Enron in 1991, he continued to work as a freelance originator of international projects on behalf of Ken Lay. The competition came to a head in a hotel lobby in Shanghai, China, in 1994 when both Wings and Marks teams came face to face. Mark demanded that Lay resolve the conflict, but he took no action. Rich Kinder did, and soon after negotiated an exit agreement for Wing. Enron International, under first John Wing and later Rebecca Mark, signed and sealed new power and pipeline projects at a breakneck pace. The difference was that by the time Enron International grew to size and influence in the mid-1990s under Rebecca Mark, projects recognized earnings up front
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using the same mark-to-market accounting as employed in the trading businesses. These projects committed Enrons capital resources for years to come, and, in many cases, locked in cash-flow shortfalls for as many years as well. In the rush to sign and deliver deals, inadequate due diligence became common, overly aggressive bidding promised unprofitable margins, and a growing disdain for the costs and complexity of project execution characterized deals. Deals were done at the expense of delivery. Enron Development would often sign and book deals which later proved to be dead in the water. Accounting rules required that projects which were no longer in progress be written down in current earnings. Enron Development fought these write-offs at every turn. Rich Kinder had instructed the unit that these unrecognized losses, called snowballs within Enron, be kept below $90 million in total. In early 1996, however, they soared to over $200 million. The Dabhol, India, project was a microcosm of Enrons business model.7 In December 1993, after roughly 18 months of negotiations, Enron Development signed a long-term power sales contract with the electricity board of Maharashtra, India (MSEB). Enron would build a 2000-megawatt natural gasfueled power plant at an estimated cost of $2.8 billion. The Maharashtra energy board agreed to buy 90% of the power produced by the plant at a U.S. dollar-denominated price for a minimum of 20 years. From the very beginning, problems mounted. It took Mark more than two years and millions of dollars in negotiations, court cases, and contract restructurings to get the financing in place. Within months, a change in the Maharashtra government resulted in an outpouring of project opposition. Once again, Mark went into overdrive for months of negotiations and renegotiations. Finally, on February 23, 1996, a new contract was signed between Enron and the MSEB. By December, financing was in place and the projects construction resumed. But opposition continued, and it became clear that the MSEB would never be willing or able to pay for the power (estimated at over $30 billion for the project life). The project was dead. In the words of one Wall Street Analyst on Enrons India activities, Ive never been to another country where every single person hates one company. Phase I of the project was operational for only a short period of time, and Phase II, as of December 2003, was still only 80% complete. The Dabhol power plant today is considered a failure for everyone involved but Rebecca Mark. Mark earned bonuses for both the original deal and the successful renegotiation. In 1996, Enron International generated 15% of Enrons total earnings, and was expected to grow at double-digit rates for years to come. Rebecca Mark was named CEO of Enron International. Many people believed that Rebecca Mark would be Enrons next CEO.

Financial Focus
The financial philosophy which emerged at Enron in the 1990s was one which catered nearly exclusively to Wall Street. All other things ignored, it was all about earnings. Both Ken Lay and Jeff Skilling believed that the market rewarded earnings growth over all other, including cash flow and quality of earnings. In the first half of the 1990s, when Enrons business results were still primarily from gas pipeline operations, earnings and cash flows were largely aligned. When earnings were recognized (recorded as occurring), they were realized (showing up as cash flow). Exhibit 1 illustrates this relative balance, as Enrons net business cash flows (cash flows from operating activities less cash flow committed to investing activities) remained either slightly positive or balanced. Earnings were growing throughout this 1991 to 1996 period, and the Enron story was growing in marketplace. But with the growth of Skillings gas bank and associated businesses, net business cash flows moved radically into deficit. Mark-to-market accounting was employed to a larger and larger extent to

The Dabhol, India, project is analyzed in depth in Enron and the Dahbol Power Company, by Andrew Inkpen, Thunderbird Case A07-02-0008.

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reflect all of the earnings associated with a trade or deal up front. As Enrons business grew into power trading, broadband, and other market-making activities, the gap between reported earnings and cash flows grew. Exhibit 1
$1,000 $500 $0 -$500 -$1,000 -$1,500 -$2,000 -$2,500 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000
Earnings Operating CFInvesting CF

Enrons Growing Discrepancy Between Earnings and Cash Flow (millions)

The financial schism between earnings and cash flow was not, however, confined to Jeff Skillings trading activities alone, but alsoand possibly in the end more significantlyto the companys growing international commitments generated by Rebecca Mark at Enron International. Rebecca Mark, who has often been characterized as the champion of the asset-heavy Enron business as opposed to Jeff Skillings asset-light investment philosophy, was also focused on what was rewarded at Enron: deals done. Once following this path, the company was indeed on dope, as a former employee notes. Income from pipelines was recurring; it came regularly and predictably. Earnings from deal-making and trading was not. New deals and new trades were needed at an ever-increasing pace if the company was going to fulfill the promise made by Ken Lay to Wall Street of 15% annual growth, year in and year out. Lay, in the end, came to believe that Jeff Skilling would be able to deliver on the 15% promise; he had no such confidence in Rich Kinder or Rebecca Mark.

The Performance Review Committee

To motivate the needed deals at Enron, rewards were based only on what deals had been signed in the current period. This reflected Jeff Skillings belief in the value of confrontational debate; only through debate would the best ideas rise to the top. He also believed that ideas and intellect were the true sources of value, not the execution of those ideas or the management activities required to deliver on the promises. And what motivated people who created or possessed these ideas? In the words of Jeff Skilling:

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Ive thought about this a lot, and all that matters is money. You buy loyalty with money. This touchy-feely stuff isnt as important as cash. Thats what drives performance.8

The performance review process which emerged within Enron reflected this philosophy. Every employee was the subject of an intense review process conducted twice a year by the Performance Review Committee (PRC). After the submission of detailed performance reports for each individual, a series of committee meetings were held, often far into the night, in which a business unit leader promoted, defended, and negotiated their own peoples futures against other business units. What was increasingly valued at Enron, however, was clear. During one specific PRC session, Skilling yelled another director down saying, This guy has spent 30 years in the same job in oil and gas. If hes that good, hed be a trader by now.9 The PRC, in a system affectionately referred to as rank and yank, rated everyone from 1 (highest) to 5 (lowest). Each employee under review, represented by a name card, was then pushed, thrown, and prodded up and down the conference room table. Although employees were rated on a breadth of criteria, it was widely known that deals done and bottom-line results were all that mattered. Only deals done this year mattered; no credit was given for historical performance. A final rating of 1 was considered premier, and often meant promotion and stock option bonuses. Those receiving a rating of 2 or 3 would be entitled to hundreds of thousands of dollars worth of salary benefits and bonuses. Those with a rating of 4 or 5 (and it was required that certain percentages of the total be given 5s) were given roughly six months to improve their rating or they were fired. As the marathon evaluation sessions grew into weekends and nights, it was often who could deal most effectively, yell the loudest, or stay on the debate the longest who got their people rewarded. For the names on the table, however, a weak leader was costly.

Leadership Transition
Ken Lay had always led Rich Kinder to believe that he would eventually assume the role of CEO. Kinders no-nonsense approach to business, concentrating on management, execution, and control, was thought to be a valuable counterbalance to Ken Lays aggressive grow-the-business fast, hands-off approach. Kinders roots were in the gas pipeline business, and he had always been highly suspicious of Jeff Skillings trading enterprises and Rebecca Marks deal-based endeavors. But Lay had always been somewhat condescending in his attitude towards Kinder, and Kinder openly resented it. In 1992, Kinder made it known that he wanted to move to the CEO position. Lay was reluctant. In the following contract negotiation, Kinder had a clause added to his contract stating that in the event that he and Enron were unable to agree upon an acceptable employment position, he could leave the company with bonuses. The implicit understanding between the two was that Kinder would become CEO at the end of Lays contract in December 1996. In mid-November 1996, Enrons Board met in New York. Although Kinder expected Lay to resign and Kinder to be offered the CEO position, Lay accepted a new five-year contract as Chairman and CEO. Lay later told Kinder that, although he had supported him for the position, the Board had refused.10 Kinder received a parting gift of $2.5 million in cash, forgiveness of his outstanding Enron loan of $4 million, and an indeterminate number of additional vested stock options.11 Although Lay
The Smartest Guys in the Room, p. 55. The Price and the Fall of Enron, Tom Fowler, Houston Chronicle, October 20, 2002. 10 A multitude of stories surrounds Ken Lays and Rich Kinders relationship. In 1996, Rich Kinder began an affair with Ken Lays longtime personal assistant and senior vice president, Nancy McNeil (they were later married). When Lay was told, he was purportedly furious and felt like both had betrayed his trust. 11 Prior to leaving Enron, Rich Kinder acquired something else of extraordinary value: an agreement to purchase from Enron a pair of natural gas pipelines for $40 million in cash. Enron sought no additional outside bids and no fairness opinions on the sales price from consultants or auditors. Rich Kinder formed a partnership with another University of Missouri fraternity brother (Ken Lay was also one), Bill Morgan, creating the highly successful enterprise known today as Kinder Morgan.
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had originally intended to leave the long-dead office of President at Enron vacant, Jeff Skilling moved quickly to fill the post himself, probably to prevent other suitors such as Rebecca Mark from filling the slot. On December 10, 1996, Jeff Skilling was made both President and Chief Operating Office of Enron Corporation.

The New Enron

With the ascension of Skilling to the COO position, Skillings ECT subculture moved to the drivers seat within Enrons complex web of business units and corporate cultures. There had always been a number of obvious differences in the subcultures across business units. And although both trading and international had increasingly shared accounting practices, there were still fundamental differences in how business was done and the personality characteristics of those doing it.
The battles between traders and the deal-makers were also aggravated by cultural differences. The origination teams cultivated personal relationships with customers and hammered out deals with them over many months. The traders did business by phone and computer in a matter of seconds. The originators viewed the traders as bloodless mercenaries, who, as one prominent member of the group put it, would sell their mom for a buck. The traders viewed the originators as dinosaurs, destined for extinction; they believed they were bringing harsh economic efficiency to what had long been a good-old-boy business.12

In Enron-speak, the traditional operators and originators simply didnt get it. Jeff Skilling often characterized Enrons corporate culture as loose-tight. The loose was the noholds-barred approach to creativity and business development. Taking risk was considered a necessary part of Enrons innovation (Fortune Magazine annually anointed Enron Americas Most Innovative Company). The tight, as Skilling described it, was the organizational processes within Enron to manage the risk. All transactions requiring the investment of capital by Enron had to go through the Risk Assessment and Control Group (RAC), an in-house consultancy which evaluated the expected risks and returns on the proposed investments. Enron was very proud of its ability to manage risk, not take risk. Skilling now moved Enron into power trading in a bigger and bigger way. This was a truly powerful move, and resulted in a significant repositioning of much of the companys core returns. The energy trading business, primarily electrical power in North America, boomed in the 1996 to 2000 period. Wholesale energy services grew from $12 billion in 1996 to nearly $95 billion in 2000. Although many people still considered Enron a natural gas company, it had become a nearly pure trading company by the late 1990s. Wholesale energy services made up more than 94% of Enrons revenues in 2000. Appendix 2 provides additional detail on Enrons revenues by business segment. By Ken Lays vision, Enron had indeed gotten big fast. In 2000, Enron broke the $100 billion in revenues mark for the first time. Its market capitalization, the value of the total outstanding shares of the company, was now worth roughly $70 billion. Enrons perception of its own core competence was changing. Its expertise was not confined to building and operating natural gas pipelines and power plants, or even to the trading of natural gas and electrical power. Its self-defined competence was simply in trading. The evolving strategy was to create markets where markets had never existed, exploit them for all they were worth, and when profits declined with increasing competitor entry, move on to the next cutting edge market creation. Between 1996 and 2001, Enron tried, sometimes failed and sometimes succeeded, in trading water, weather derivatives, bandwidth, and coal, to name but a few. As an analyst at Bear Stearns noted, Enron aims to commoditize the uncommoditizable.13 Enrons venture into water was something of a microcosm of the companys transition from a bricks-and-mortar business to a clicks-and-mortar trading house. In July 1998, Enron paid $2.4 billion
12 13

The Smartest Guys in the Room, p. 63. Enron Corp, Bear Stearns, January 26, 2001, p. 15.
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for Wessex, a British water utility company. The company, like Portland General Electric (PGE) before it, was the first step in acquiring a producing company to provide the backbone to a growth strategy of ownership, operations, and trading in a new market. Rebecca Mark, hungry to prove her worth in an organization now under the influence and control of Jeff Skilling, accepted the Chairman and CEO position of the newly created water business, Azurix. Azurix strategy was to acquire water utility companies all over the globe and create a consolidated giant that would be the global leader in the water industry. Many believe the venture was dead on arrival. Mark went about the building of the company much as she had with Enron International: jet-setting all over the world trying to kick-start deals. Underfunded from the start, Mark spent lavishly in hiring and sales support, with little success. Enron and Mark took Azurix public on June 9, 1999, raising $700 million, of which only $300 million was available for the business after Enron itself had funneled much of the cash back into the corporate parent. In February 2000, Azurix and Rebecca Mark announced a new strategy: Azurix would become a trading company for water rights. It was an admission of failure of the utility acquisition strategy, and, in the eyes of many, an act of desperation. But water was not a commodity by traditional standards, and the idea simply did not fly. During an internal meeting evaluating different turnaround strategies for Azurix in March 2000, one staff member noted cynically that the stock will only triple when pigs can fly. Rebecca Mark, not to admit failure, responded:
I grew up in Missouri on a pig farm, and I know a lot about pigs. And I am here to tell you, sometimes pigs do fly.14

By August 2000, the writing was on the wall. Rebecca Mark resigned as CEO of Azurix. She then exercised stock options and liquidated shares totaling more than $80 million on her way out of Enron. A few months later, Enron announced it would buy back all outstanding shares of Azurix and shut it down. Many believed the failure of Azurix was proof of the failure of the old Enron; others, the failure of the new. Regardless, it sealed the fate of Rebecca Mark and eliminated the last remaining threat to Jeff Skilling within Enron.

Feeding the Beast

A particularly troublesome feature of Enrons emerging business model was that revenues were growing much faster than earnings. The cost of undertaking these new trading ventures and creating all-new markets was, in the words of one former executive, hideous. The salaries, bonuses, start-up costs, and general lack of control over all operating costs drowned whatever profits arose from new ventures. Even the more successful trading lines, including electricity, did not generate the margins the marketplace had come to expect from Enron and its older portfolio of businesses. As illustrated in Exhibit 2, the actual operating income (IBIT, income before interest and taxes) by business line was not growing in line with revenues. The growing deficit in corporate cash flows illustrated previously in Exhibit 1 also led to a more fundamental financial management problem for Enronthe growing need for external capital, or, as it was described in-house, feeding the beast. Rapidly escalating investments in new businesses, whether the Portland General Electric (PGE) acquisition of 1997 or the power projects pursued by Rebecca Mark globally, were absorbing more capital than the current business could self-finance. Enrons cash flows fell increasingly behind its investments and sales. Enron needed additional external capitalnew debt and new equity. Ken Lay and Jeff Skilling, however, were both reluctant to issue large amounts of new equity because it would dilute earnings and the holdings of existing shareholders. The debt option was also limited, given the already high debt levels Enron was carrying (and which it had carried since its inception), which left it in the continuously precarious position of being rated BBB, just barely investment grade by credit agency standards.
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The Smartest Guys in the Room, p. 257.

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Exhibit 2
$2,500 $2,000 $1,500 $1,000 $500 $0 -$500

Entrons Earnings by Segment (IBIT, millions)

1996
Transp & Dist

1997
Wholesale Energy

1998
Retail Energy

1999
Broadband

2000
E&P Other

IBIT = income before interest and taxes

Although Jeff Skilling had first employed the concept of a fund of capital to be created to support business development within Enron with the creation of the Cactus Fund in 1991, it was Andrew Fastow who took the concept to a whole new level. Andrew Fastow and his wife, Lea Fastow, had both joined Enron in 1990 after being introduced to Jeff Skilling socially (Lea was from a prestigious Houston family). The couple had met while attending Tufts University in Boston, and after graduation they both joined Continental Bank of Chicago, earning MBAs at Northwesterns Kellogg School at night. Lea Fastow moved into the treasurers office at Enron, while Andy Fastow was added to the staff in Enron Gas Services and later ETC. Fastows personality was something of an enigma. Generally considered mild-mannered and quiet, he quickly became known for his fiery temper and heavy-handed approach to dealing with both employees and in bank relationships. But he delivered solutions which soon made him invaluable in the world of growing problems at Enron. Unfortunately, as it became apparent in later years when promoted by Skilling to the CFO position, Fastow did not really have the skill or interest for financial management. Fastow was uninterested in the managerial and control functions of funding and managing a corporation; he was, however, very interested in deal-making and its accompanying rewards. Fastows experience in banking, specifically in the use of special purpose entities (SPEs), a common tool in financial services, was his ticket up the corporate ladder at Enron.
Many of the transactions involve an accounting structure known as a special purpose entity or special purpose vehicle (referred to as an SPE in this Summary and in the Report). A company that does business with an SPE may treat that SPE as if it were an independent, outside entity for accounting purposes if two conditions are met: (1) an owner independent of the company must make a substantive equity investment of at least 3% of the SPEs assets, and that 3% must remain at risk throughout the transaction; and (2) the independent owner must exercise control of the SPE. In those circumstances, the company may record gains and losses on transactions with the SPE, and the assets and liabilities of the SPE are not included in the companys balance sheet, even though the company and the SPE are closely related. It was the technical
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failure of some of the structures with which Enron did business to satisfy these requirements that led to Enrons restatement.15

The SPEs created by Andy Fastow and his assistant, Michael Kopper, served two very important purposes. First, by selling troubled assets to partnerships like LJM1 and LJM2, Enron removed them from its balance sheet, taking pressure off the firms total indebtedness, and simultaneously hiding underperforming investments. This also freed up additional room on the balance sheet to fund new investment opportunities. Secondly, the sale of the troubled investments to the partnerships generated income which Enron could then use to make its quarterly earnings commitments to Wall Street. The problem with this solution was that it was only temporary. The SPEs were largely funded from three sources: (1) equity in the form of Enron shares by Enron; (2) equity in the form of a minimum 3% of assets by an unrelated third party (in principle, although this was later found to be untrue in a number of cases); and (3) large quantities of debt from major banks. This capital base made up the right-hand side of the SPEs balance sheet. On the lefthand side, the capital was used to purchase a variety of assets from Enron. Fastow sold these partnership deals to the banks on the premise that because he was uniquely positioned as both the CFO of Enron and the Managing Partner in the SPE, he could cherry pick the assets to be purchased by the SPE. Fastow did indeed cherry pick, but they were the rotten cherries. Most of the assets purchased by the SPEs were troubled or underperforming. Exhibit 3 depicts the structure of LJM1, one of the most controversial of the SPEs. The upper half of Exhibit 3 describes the initial capitalization, with Fastow contributing $1 million, and two limited partners $15 million. Enron itself contributed 3.4 million shares of restricted stock. The $15 million in third-party equity would support a total fund of $500 million. LJM1 was approved by Enrons Board, and a waiver of Enrons Code of Conduct granted because an officer of the corporation, Andrew Fastow, would be conducting business with the corporation itself. LJM1 undertook a number of individual transactions with Enron Corp., purchasing an interest in the Cuiaba power plant in Brazil and interests in at least two other Enron SPEs. Its most controversial transaction was in the sale of a put option to Enron on 5.4 million shares of Enrons holdings of an Internet stock called Rhythms NetConnections. (A put option gives the holder the right, but not the obligation, to sell an asset at a specific price.)This was an Internet start-up company which Enron had originally invested $15 million in, only to see its investment soar to over $300 million when Rhythms went public. Jeff Skilling was particularly worried about retaining the value of these shares, fearing they would fall substantially in value (which they ultimately did). But Enrons Rhythms shares were restricted and could not be sold until the end of the year. Fastow proposed to hedge the investment by having the newly created LJM Swap Sub sell a put option on the shares to Enron, guaranteeing Enrons investment in the Rhythms stock. Unfortunately, this meant that Enron hedged with Enron, which meant there was no economic logic, only accounting manipulation. (A true hedge is when a transaction is entered into with a third party, an outside counterparty, who will take on the economic risk of a loss for a fee.) When the hedge was explained to Vince Kaminksi, Enrons head of research, his response was that it was so stupid only Andrew Fastow could have come up with it.16 One other off-balance-sheet partnership, Chewco, later proved instrumental in Enrons collapse. Chewco (named after the Star Wars character Chewbacca) was set up in 1997 to buy the California Public Employees Retirement System (CalPers) out of the Joint Energy Development Investment, or JEDI, a partnership which Enron had established in 1993. Buying CalPers out would allow it to invest in a new fund being established by Enron. Barclays Bank was to be the outside investor, providing the needed 3% of assets in equity. But Barclays was uncomfortable with the risk associated with the trans15 16

The Powers Report, p. 5. Visionarys Dream Led to Risky Business, by Peter Behr and April Witt, Washington Post, July 28, 2002.
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action and insisted on a guarantee of the initial $11.49 million it was putting up. Enron then posted $6.6 million in collateral to appease Barclays. This collateral agreement, which Arthur Andersen later argued it was never told about, should have caused Chewco to be reported with Enron on a fully consolidated basis (the guarantee breaks one of the requirements for SPEs to remain off-balance-sheet). This issue was one of the critical elements which came to the top later in October 2001. Exhibit 3 The LJM1 Special Purpose Entity (SPE)
ERNB Ltd. (CSFB)
Limited Partners

LJM Partners, L.P. (Fastow)

General Partner

Campsie Ltd. (NatWest)

$1.0 M

$7.5 M

$7.5 M $64 M note

LJM Cayman, L.P. (LJM1)

Enron Corp.
ENE shares (3.4 M)

Andrew Fastow Sole Director

Limited Partner

ENE shares (1.6 M) $3.75 M cash

Put option on 5.4 M shares of Rhythms stock with a strike price of $54/share in June 2004.

LJM SwapCo
General Partner

LJM Swap Sub, L.P.

Source: The Powers Report, Februrary 1, 2002, p. 81. LJM1 was established on June 28, 1999. The Board of Enron Corp. approved the creation of the partnership with a waiver of the Enron Code of Conduct because Andrew Fastow was an officer of the Corp. and would be conducting business with the Corp., but this transaction will not adversely affect the interests of Enron.

A final detail of the SPEs proved, in the end, devastating to the financial future of Enron. Since the primary equity in the SPEs was Enron stock, as the share price rose throughout 1999 and 2000, the SPEs could periodically be marked-to-market, resulting in an appreciation in the value of the SPE and contributing significant earnings to Enron. These same shares, once their price began sliding in 2001, resulted in partnerships which should have been marked-to-market for substantial losses, but were not. As Enrons share price plummeted in the early fall of 2001, the equity in the SPEs would no longer meet accounting guidelines for remaining off-balance-sheet. (Appendix 3 provides a brief overview of a number of the multitude of Enron partnerships.) The SPEs were becoming something of a synthetic business for Enron.
The trouble was, the Raptors, like the rest of LJM2, had become something of a dumping ground for bad properties. In an effort to make quarterly earnings (and, of course, annual bonuses), Enron originators were hooked on making deals with Fastow instead of outside third parties who would have asked a lot of questions, slowed down the process, and, in many cases, killed deals. Again, none of this mattered to most people at Enron, as long as the stock kept rising.17

The Fall of the Worlds Coolest Company

Most people associate Enrons fall with the ascension of Jeff Skilling to the office of CEO in February 2001. Although Skilling had worked tirelessly for the past decade to create the new Enron, he did not
17

Power Failure, p. 232.

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really want the job. By the spring of 2001, Jeff Skilling was burned out. Ironically, like Skilling himself, the entire point of Enronits share pricewas now sliding. Skilling was tired, wished to spend more time with his family, and felt that he was spending more and more of his time and effort plugging holes in the Enron dike: Dahbol, India, was once again in the news; Broadband was clearly failing; and Enrons role in the California power crisis was under increasing scrutiny. The CEO position required Skilling to do more of the external public relations work, an activity which he was not cut out for. A series of incidents in the spring showed cracks in the Skilling armor. The conference call of April 17, 2001, has become something of a legend. Richard Grubman, managing director of short-selling Highfields Capital Management, after being rebuffed by Skilling during a series of questions, noted, Youre the only financial institution that cant produce a balance sheet or a cash flow statement with their earnings prior to conference calls. Skillings response sent the analyst community into shock: Well, thank you very much. We appreciate that. Asshole.18 Although continuing to trumpet Enrons stock, Skilling gave increasingly vague and incomprehensible explanations. In the midst of the post-energy crisis California debate, when it was well known that companies like Enron made millions in 2000 and 2001 on gaming the power systems botched deregulated market, he made public comments and even jokes which showed, at the least, poor judgment. (Skilling: Whats the difference between California and the Titanic? At least when the Titanic went down, its lights were on.) One example of the growing tension under which Skilling fell was the August 3 Enron Energy Systems (EES) floor meeting of more than 100 employees. In the meeting, Skilling predicted that EES would be generating more than $500 million in earning within three years. One employee, Margaret Ceconi, asked, How in the world are we going to do that? Whats your strategy? Jeff Skilling answered, Well, thats what you guys are for. You guys are the creative onesyouve got to figure it out. Later that same afternoon, EES laid off three hundred people, including Margaret Ceconi. Ceconi is also remembered for an e-mail to the Securities and Exchange Commission in July 2001 in which she posed the following hypothetical question:
A public company owns an ice cream business and a popcorn business. The popcorn business is losing money, but the ice cream business is very profitable. If you move the popcorn business into the ice cream division, under accounting rules, can you avoid reporting the popcorn businesss losses?

Two days later, an SEC staff member called her to tell her that full disclosure of the individual businesses would be required. She let it drop, and the SEC never followed up. As the bills came due throughout the spring and early summer of 2001, Jeff Skilling found himself alone and treading water in the midst of the hundreds of sharks he had recruited and created. His longtime friends were leaving (Cliff Baxter, Lou Pai, Ken Rice), and he was afraid to appoint any of the other kill-to-eat brethren to the COO position. One of Skillings oldest friends, Amanda Martin, put it to Skilling rather directly: The people youre closest to and loyal to, youve made too much money for them. The next layer down, the Whalleys, the Fallons, they will slit your throat if it means theyll get to the trough faster.19 Skilling had drafted his first resignation letter in April but did not actually tender it until August 13. The news of Jeff Skillings resignation was bewildering to people inside and outside of Enron. Insiders were confused, feeling that Skilling was abandoning a sinking ship, all the while claiming that all was in order. To outsiders, new alarm bells sounded over fears of an imminent collision; was Enron
18 19

Pipe Dreams, p. 269. The Best and the Brightest, p. 337.

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hiding more business and financial risks than what they had reported? Two days following Skillings resignation, an anonymous memo was sent to Ken Lay. The memo was authored by a former Arthur Andersen accountant, Sherron Watkins, who had been hired by Fastow in 1993. The Watkins memo began:
Dear Mr. Lay, Has Enron become a risky place to work? For those of us who didnt get rich over the last few years, can we afford to stay? Skillings abrupt departure will raise suspicions of accounting improprieties and valuation issues....... I am incredibly nervous that we will implode in a wave of accounting scandals.20

Watkins quickly took credit for the memo and met with Ken Lay to explain her concerns. Lay responded by launching a brief investigation into Watkins accusations. While the investigation was under way (eventually reaching what many considered a self-fulfilling whitewash conclusion), Lay had his corporate lawyers examine the companys alternatives toward firing Sherron Watkins. (In the end, they chose not to, and Watkins remained with Enron until the spring of 2002.) The memo incident later became something of a lightning rod among critics who argued that Lay had chosen to ignore the obvious problems deep within the Enron organization. The following three months saw Enron enter into a death spiral. As more and more questions arose in the financial press about Fastows partnerships, Enrons share price continued to slide. The dominoes began to fall. Most of the SPEs possessed debt which contained share price triggers; in the event that Enrons share price fell below a certain level, the debt was instantly due and/or Enron was required to inject additional share equity to recapitalize the fund. As the share price fell in September and October, the triggers were pulled and the depth of Enrons total indebtedness began to be revealed. Enrons CFO, Andrew Fastow, was fired on October 24.21 The Worlds Leading Company (Lay and Skilling had earlier in 2001 debated Enrons new slogan, agreeing on the Worlds Leading Company, though their first preference had been The Worlds Coolest Company) had $13 billion on its balance sheet, but actually possessed debt obligations totaling $38 billion. Ken Lay and some of his remaining lieutenants, both inside and outside of Enron, seemingly remained in denial to the bitter end.22 November 8 saw the reconciling of the new past with the market. Arthur Andersen, after determining that Chewco had never met the requirements for SPE off-balance-sheet treatment (the memo describing the $6.6 million in Enron collateral was rediscovered), insisted that Enron restate its financial results from 1997 onwards. Enron disclosed, in a 21-page SEC filing, the impact of consolidating the off-balance-sheet partnerships. As illustrated in Exhibit 4, Enrons earnings for the 1997-2000 period were written down. On Tuesday, November 27, it was announced that the recently negotiated acquisition of Enron by Dynegy, a smaller competitor, was off. The following morning, Wednesday, November 28, 2001, Standard & Poors, Moodys, and Fitch rating services downgraded Enron from BBB- to B, reclassifying Enron from investment grade to speculative grade (junk). More debt obligations were instantly triggered. With the downgrade, most trading counterparties were prohibited from conducting business with Enron.23 On Sunday morning, December 2, Enron filed for bankruptcy protection under Chapter 11.
Enron: The Rise and Fall, p. 338F. Although it was not fully revealed until the spring of 2002 in a series of Congressional hearings, Fastow was found to have earned more than $60 million in bonuses, fees, and distributions through the multitude of partnerships. 22 The Sanford Bernstein analyst report dated November 1, 2001, by David Wideman and Duane Grubert, was entitled Enron: Reports of Death Greatly Exaggerated: Enrons Numbers Work. Outperform. 23 On Friday, November 30, an Enron trader called the author from the massivebut silenttrading floor of the new $200 million Enron building in Houston. When asked what they were doing, the trader responded, Drinking beer. Since no one can trade with us, we have four kegs sitting out on the trading floor. And we cant find out from anyone upstairs whether we are supposed to come back to work on Monday.
21 20

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In January 2002, Enrons board completed a detailed forensic analysis of selected Enron SPEs, today known as the Powers Report. Ken Lay was forced to resign first from the CEO position and then from Enrons Board; then shareholder suits, creditor suits, and a multitude of state and federal regulatory and judicial parties swarmed over the carcass.24 Exhibit 4
$1,000 $900 $800 $700 $600 $500 $400 $300 $200 $100 $0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 Earnings Restated Earnings

Enrons Earnings after Restatement (millions)

Moral of the Story

What happened at Enron? Was it the ethical and business judgment failures of select people at the top, or did it go deeper? Was Enrons leadership responsible for the creation and growth of a corporate culture which was inherently flawed? Or was it a good business burdened with bad leadership, or a bad business with bad leadership? Or was Enron a company which was the victim of a marketplace which had suddenly grown cynical as a result of the dotcom bubble and collapse of the go-go stock market of the1990s? Did this culture grow from specific instances of individual greed and leadership malfeasance, or was itin the words of former CEO Jeff Skillingthe victim of a run on the bank? You decide.
First, contrary to the refrain in the press, while I was at Enron, I was not aware of any inappropriate financing arrangements designed to conceal liabilities, or overstate earnings. The offbalance-sheet entities or SPEs that have gotten so much attention are commonplace in corporate America; and if properly established, they can effectively shift risk from a companys shareholders to others who have a different risk/reward preference. As a result, the financial statements issued by Enron, as far as I knew, accurately reflected the financial condition of the company. Second, it is my belief that Enrons failure was due to a classic run on the bank, a liquidity crisis spurred by a lack of confidence in the company. Jeff Skilling, Statement before House of Representatives, February 7, 2002.

An additional trigger in Ken Lays contract raised momentary outrage within Enron when it was announced that Lay was entitled to a $60 million severance agreement. Lay, under pressure, chose to forego the payment.
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24

16
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 $5,562,670 $5,812,527 $7,985,800 $8,984,000 $9,189,000 $13,289,000 $20,273,000 $31,260,000 $40,112,000 $100,789,000 3,633,655 4,222,395 5,566,026 6,517,000 6,733,000 10,478,000 17,311,000 26,381,000 34,761,000 94,517,000 1,929,015 1,590,132 2,419,774 2,467,000 2,456,000 2,811,000 2,962,000 4,879,000 5,351,000 6,272,000 35% 27% 30% 27% 27% 21% 15% 16% 13% 6% 58,959 1,018,783 851,273 353,272 202,130 368,114 332,017 90,898 NA 241,119 4.3% 657 241,776 101,218 -22,615 306,185 118,591 NA 332,522 249,095 NA 453,000 251,675 NA 520,000 251,242 90,468 NA 328,800 5.7% 135,254 NA 332,522 4.2% 167,000 NA 453,000 5.0% 285,000 NA 520,000 5.7% 271,000 NA 584,000 4.4% NA 584,000 255,124 376,019 732,524 330,282 419,268 458,188 137,123 300,149 467,776 441,000 177,000 273,000 620,000 432,000 471,000 284,000 805,000 474,000 439,000 274,000 855,000 600,000 -194,000 401,000 95,000 -90,000 80,000 105,000 0.5% NA 105,000 311,246 59,178 1,137,909 393,045 75,743 1,255,041 1,088,990 84,000 1,226,000 1,157,000 79,000 1,327,000 1,050,000 89,000 1,558,000 1,164,000 102,000 1,570,000 1,290,000 NA 2,674,000 2,205,000 827,000 50,000 550,000 878,000 175,000 NA 703,000 2.2% NA 703,000 661,761 NA 3,238,000 2,113,000 870,000 541,000 656,000 1,128,000 104,000 NA 1,024,000 2.6% -131,000 893,000 715,527 NA 3,464,000 2,808,000 855,000 298,000 838,000 1,413,000 434,000 NA 979,000 1.0% NA 979,000 751,628

Appendix 1

Statements of Consolidated Income, Enron Corporation, 1991-2000

(000s of dollars)

Net sales Cost of goods Gross profit Gross margin (%)

R&D expenditures Selling, G&A expenses EBITDA

Depreciation & amortization Non-operating income Interest expense Earnings before tax (EBT)

Income taxes Minority interest (income) Net income before extra income Net income/sales

Excluded items & other Net income Outstanding shares

Source: SEC filings and Enron Corporation

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1993 1,386 1,386 6,201 5,450 751 399 385 $7,986 683 789 $20,263 1997 7% 3% 4% 86% 3% 0% 4% 0% 100% 1,072 750 $31,260 1998 6% 2% 4% 87% 3% 0% 2% 1% 100% $13,289 1996 6% 6% 0% 90% 88% 2% 0% 0% 5% 0% 100% 1993 17% 17% 0% 78% 68% 9% 0% 0% 5% 0% 100% 1994 10% 10% 0% 84% 80% 4% 0% 0% 5% 0% 100% 1995 9% 9% 0% 86% 77% 9% 0% 0% 5% 0% 100% 1994 938 938 7,558 7,166 392 489 651 $8,985 1995 805 805 7,903 7,064 839 481 (2,095) $9,189 1996 748 748 11,894 11,681 213 647 1997 1,402 656 746 17,334 1998 1,833 637 1,196 27,220 1999 2,013 634 1,379 35,501 1,518 429 $40,112 1999 5% 2% 3% 89% 4% 0% 1% 2% 100% 2000 2,955 699 2,256 94,906 4,615 408 $100,789 2000 3% 1% 2% 94% 5% 0% 0% -2% 100%

Appendix 2

Enron Corporations Revenue by Business Segment, 19922000

(millions of $) 1992 Transportation & Distribution 1,419 Gas Pipeline Group 1,419 Portland General Wholesale Energy Services 4,737 Domestic Gas & Power 3,872 International Gas & Power 865 Retail Energy Services Broadband Services Exploration & Production 260 55 Corporate & Other Total Revenues $6,416

(percent of total) 1993 Transportation & Distribution 22% Gas Pipeline Group 22% Portland General 0% Wholesale Energy Services 74% Domestic Gas & Power 60% International Gas & Power 13% Retail Energy Services 0% Broadband Services 0% Exploration & Production 4% 0% Corporate & Other Total Revenues 100%

Source: Bear Stearns, Enron Corporation, January 26, 2001, p. 81. Note that Enron ceased separating reported revenues between domestic and international operations in 1997.

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Appendix 3 Name Cactus JEDI I Chewco Marlin

Selected Enron Special Purpose Entities (SPEs) Date 1991 1993 1997 1998 Purpose Created by Jeff Skilling to provide funding for natural gas production and trading by Enron in the faltering deregulated natural gas markets Organized as a partnership with capital from the California Public Employees Retirement fund (CalPers) Set up specifically in order to buy CalPers interest out of JEDI, allowing it to free up capital to invest in other Enron transactions Created by Andy Fastow to take Azurixs debt off the Enron books; Marlins debt was due at the end of 2001, when Azurixs capital would not cover it, and when Enron would be on the hook for the balance; Marlin was restructured in the summer of 2001 to avoid this Fastow set up this $500 million SPE specifically to hedge Enrons investment value in Rhythms. Fastows expanded internal fund which eventually possessed 50 limited partners and conducted 20 different transactions with Enron, and was representative of the peak of Fastows influence upon the firm. Created by Andy Fastow to take failing assets off Enrons books, create short-term earnings for Enron, and enrich he and his partners (also called Talon, Timberwolfe, Bobcat, and Porcupine). Raptor IV was specifically created to hedge The New Power Company (entity given to Lou Pai), but capitalized with New Power warrants.

LJM1 LJM2

1999 1999

Raptors I-IV

2000

Appendix 4

Enrons Values

Communication We have an obligation to communicate. Here, we take the time to talk with one another and to listen. We believe that information is meant to move and that information moves people. Respect We treat others as we would like to be treated ourselves. We do not tolerate abusive or disrespectful treatment. 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 wont do it. 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. Source: Enron Annual Report, 2000, p. 53.

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Appendix 5

Prepared Statement of Jeffrey Skilling, Former President and CEO of Enron Corporation, Congressional Hearings, February 7, 2002

Good morning, Chairman Greenwood and members of the Committee. My name is Jeff Skilling. I worked for Enron for over 10 years, leaving in August of 2001 after being CEO for six months. During my time at Enron, I was immensely proud of what we accomplished. We believed that we were changing an industry, creating jobs, helping resuscitate a stagnant energy sector, and, by bringing choice to a monopoly-dominated industry, were trying to save consumers and small businesses billions of dollars each year. We believed fiercely in what we were doing. But today, after thousands of people have lost jobs, thousands have lost moneyand, most tragically, my best friend has taken his own lifeit all looks very different. As proud as I was of what we tried to accomplish at Enron, as I sit here today, I am devastated by, and apologetic about, what our company has come to represent. I know that no words can make things right. Too many have been hurt too much. I am here today, because I think Enrons employees, shareholders, and the public at large have a right to know about what happened. I have done all I can to help this investigation. I have testified for two days at the SECspoken on three occasions to the Special Board Committeeand have spoken to the staff of this Committee. I have not exercised my rights to refuse to answer a single questionnot one. And I dont intend to start now. So, let me first talk about Enron and its demise. First, contrary to the refrain in the press, while I was at Enron, I was not aware of any inappropriate financing arrangements, designed to conceal liabilities, or overstate earnings. The off-balance-sheet entities or SPEs that have gotten so much attention are commonplace in corporate America; and if properly established, they can effectively shift risk from a companys shareholders to others who have a different risk/reward preference. As a result, the financial statements issued by Enron, as far as I knew, accurately reflected the financial condition of the company. Second, it is my belief that Enrons failure was due to a classic run on the bank, a liquidity crisis spurred by a lack of confidence in the company. At the time of Enrons collapse, the company was solvent and highly profitablebut, apparently, not liquid enough. That is my view of the principal cause of its failure. Now, let me address some of the questions about my specific involvement in these events. First, I left Enron on August 14, 2001, for personal reasons. At the time I left the company, I fervently believed that Enron would continue to be successful in the future. I did not believe that the company was in financial peril. Second, similarly, I did not dump any stock in Enron because I knewor even suspectedthat the company was in financial trouble. In fact, I left Enron holding almost the same number of shares that I held at the beginning of 2001: On January 1, 2001the start of my final year at EnronI owned approximately 1.1 million shares of Enron. On August 14, the day I left, I owned about 940,000 shares. Indeed, in June of that year, I terminated an SEC-sanctioned stock sale plan, and elected to hold on to more Enron shares. Third, with regard to the socalled LJM Partnerships, the Powers Report criticizes me for supposedly not taking a more active role in reviewing the conflict of interest arising from the involvement in those partnerships of Enrons then-CFO. I believed at that time that there were adequate controls in placethat the controls were being complied with and that I was dischargingto the full extent of my mandatemy obligations to the Board with respect to this process. Fourth and finally, the Powers Report also criticizes me for supposedly approving the restructuring of certain hedging transactions. The Report then suggests that if the account of other Enron employees is accurate, that transaction was designed to conceal losses on some of Enrons investments and that I may have withheld information from the Board about that restructuring. I can state here today that I did not have any knowledge that that transaction was designed to conceal losses, and I did not do anything to withhold information from the Board. Ours was a company that emphasized creativity, but always in a manner that relied on the advice of the best people we could findboth those inside the company and the lawyers and accountants outside the company who advised us. With that, Mr. Chairman, I am prepared to answer any questions that you may have.
Source: Hearing before the Subcommittee on Oversight and Investigations of the Committee on Energy and Commerce, House of Representatives, U.S. Congress, February 7, 2002 (text of prepared statement)

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Appendix 6

Enron Stock Sales, October 19, 1998 - November 27, 2001 Position at Enron CEO, Enron Energy Services Chairman, Enron Member of Board of Directors Chief Executive Officer, Azurix CEO, Enron Broadband Services Member of Board of Directors Chief Executive Officer, Enron Chief Executive Officer, Enron Europe CEO, Enron Transportation Vice Chairman CEO, Enron Communications Vice Chairman Chief Financial Officer Chief Accounting Officer General Counsel Chief Risk Officer Executive Vice President Executive Vice President Executive Vice President, Chief of Staff Treasurer Executive Vice President Member of Board of Directors Member of Board of Directors Member of Board of Directors Member of Board of Directors Member of Board of Directors Member of Board of Directors Member of Board of Directors President Enron Broadband Services Chief Operating Officer, Enron Totals Shares Sold 3,912,205 4,002,259 2,065,137 1,895,631 1,234,009 1,011,436 1,307,678 986,898 830,444 688,996 473,837 619,898 687,445 208,940 230,660 140,234 129,153 83,183 64,932 39,630 32,960 35,000 21,200 38,160 17,344 13,360 8,000 10,328 unknown unknown 20,788,957 Share Proceeds $ 270,276,065 $ 184,494,426 $ 111,941,200 $ 82,536,737 $ 76,825,145 $ 75,416,636 $ 70,687,199 $ 54,831,220 $ 47,371,361 $ 42,231,283 $ 35,168,721 $ 34,734,854 $ 33,675,004 $ 13,386,896 $ 12,563,928 $ 10,665,595 $ 9,110,466 $ 6,505,870 $ 5,166,414 $ 2,739,226 $ 2,506,311 $ 2,009,700 $ 1,705,328 $ 1,639,590 $ 841,768 $ 841,438 $ 337,200 $ 278,892 unknown unknown $ 1,190,488,473

Name Lou Pai Ken Lay Robert Belfer Rebecca Mark Ken Rice Ken Harrison Jeffrey Skilling Mark Frevert Stan Horton Joe Sutton Joe Hirko J. Clifford Baxter Andy Fastow Rick Causey James Derrick Rick Buy Mark Koenig Cindy Olson Steve Kean Jeff McMahon Michael McConnell John Duncan Norman Blake Joe Foy Charles LeMaistre Robert Jaedicke Ronnie Chan Wendy Gramm Kevin Hannon Greg Whalley

Source: Mark Newby, et al. vs. Enron Corp., et al., Securities and Exchange Commission filings, Congressional testimony, Enron Corp. press releases. Gross proceeds do not include any potential costs in stock sales.

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Appendix 7

The Enron Culture, Excerpt from To Our Shareholders, Annual Report 1999

The Enron Culture Creativity is a fragile commodity. Put a creative person in a bureaucratic atmosphere, and the creative output will die. We support employees with the most innovative culture possible, where people are measured not by how many mistakes they make, but how often they try. Our culture of innovation is difficult to duplicate. Individuals are empowered to do what they think is best, and most of our outstanding initiatives in 1999 came directly from our own ranks. Our philosophy is to not stand in the way of our employees, so we dont insist on hierarchical approval. We do, however, keep a keen eye on how prudent they are, and rigorously evaluate and control the risk involved in each of our activities. We insist on results, and the results have been quite good. Throughout this annual report, you will see how enthusiastic, motivated people have created their own networks of Enron-wide talent and resources to quickly advance ideas. We are doing something that is recognized outside the company. This year, in addition to again naming us Americas Most Innovative Company, Fortune ranked Enron No. 1 in Quality of Management and No. 2 in Employee Talent of all American companies. The magazine also acknowledged us as one of the 25 best places to work in America. We recognize that our intellectual capital is our most important asset, and we cherish it. All employees are shareholders. Our values of communication, integrity, respect, and excellence are equally applicable to our dealings with each other as with our customers and suppliers. Increasingly, energy will serve as our entre to customers who can benefit from Enrons intellectual capital and services. The fundamental skills and expertise we use to develop energy and communications solutions can be applied to many situations that inhibit our customers profits and growth. It is that core of expertise, rather than tradition, that will define Enron in the future. Kenneth L. Lay Jeffrey K. Skilling Joseph W. Sutton
Source: Enron Annual Report, 1999, p. 5.

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Appendix 8

Key Enron Management during 2000-2001 Ken Lay Jeff Skilling Andy Fastow Rick Causey Ben Glisan Rick Buy Rebecca Mark Cliff Baxter Lou Pai Ken Rice Joe Hirko Stan Horton

Position and Office Chief Executive Officer and President Chief Operating Officer Chief Financial Officer Chief Accounting Officer Treasurer Chief Risk Officer CEO, Azurix CEO, Enron North America CEO, Enron Energy Services CEO, Enron Broadband Services CEO, Enron Communications CEO, Enron Transportation

Note: These are approximate dates for the people filling these specific positions.

Appendix 9

Hotel Kenneth-Lay-A by James Hecker, an Arthur Andersen auditor assigned to the Enron Account

(Sung to the tune of Hotel California by The Eagles.) Welcome to the Hotel Mark-to-Market Such a lovely face Such a fragile place They livin it up at the Hotel Cram-It-Down-Ya When the suits arrive, bring your alibis Mirrors on the 10-K, makes it look real nice And she said, we only make disclosures here Of our own device And in the partners chambers Cooking up a new deal 3% in an SPE But they just cant make it real Last thing I remember I was running for the doors I had to find the entries back To the GAAP we had before Relax, said the client We are programmed to succeed You can audit any time you like But we will never bleed Source: As quoted in The Smartest Guys in the Room, 2003, p. 149.