Enron: The Rise and Fall

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The word "Enron" has officially entered the American vocabulary -- not as the symbol of excellence and innovation that Chairman Kenneth Lay envisioned but as the corporate embodiment of greed, excess, and unprecedented fraud. Never in history has one company plummeted so quickly from the heights of power and glory to the depths of public humiliation, bankruptcy, and criminal investigation, dragging so many individuals and firms down with it. Simultaneously fascinating and frightening. Enron: The Rise and Fall ...
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The word "Enron" has officially entered the American vocabulary -- not as the symbol of excellence and innovation that Chairman Kenneth Lay envisioned but as the corporate embodiment of greed, excess, and unprecedented fraud. Never in history has one company plummeted so quickly from the heights of power and glory to the depths of public humiliation, bankruptcy, and criminal investigation, dragging so many individuals and firms down with it. Simultaneously fascinating and frightening. Enron: The Rise and Fall provides today's most illuminating and entertaining look on what was right -- and wrong -- with late twentieth-century corporate America.
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Editorial Reviews

From Barnes & Noble
Loren Fox's in-depth investigation into the American tragedy known as Enron takes us from the company's humble beginnings through its meteoric ascent and into its accounting abyss. This chronicle is not without moments of high irony. Fox relates with obvious relish, for instance, Wall Street's and the media's praise of industry frontrunner Enron as the epitome of innovation. Both anecdotal and analytical, Enron: The Rise and Fall is a cautionary yet thoroughly entertaining tale.
From the Publisher
“…offers a candid examination of Enron’s evolution, its culture, its rise and its downfall …a clear and enjoyable read.” (City to Cities, July 2004)
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Product Details

  • ISBN-13: 9780641649196
  • Publisher: Wiley, John & Sons, Incorporated
  • Publication date: 9/20/2002
  • Edition number: 1
  • Pages: 384
  • Product dimensions: 6.50 (w) x 9.16 (h) x 1.26 (d)

Meet the Author

LOREN FOX is a former senior editor at Business 2.0, the award-winning business magazine, and a leading authority on business strategy. Previously, Fox was finance editor of Upside magazine. He also spent five and one-half years as editor and reporter for Dow Jones News Service, where he covered the energy industry and Enron. His work has appeared in The Wall Street Journal, Barron’s, Salon.com, and other media.
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Read an Excerpt


Politicians, journalists, laid-off workers, and curious onlookers milled about Washington, D.C.'s Russell Senate Office Building. Traditionally this dignified, marble-laden building is the scene of budget conferences, discussions of international treaties, and historic hearings such as those on Watergate. But on the morning of February 12, 2002, the building was abuzz with a different kind of subject: the fall of Enron Corp.

The columned, high-ceilinged hearing room grew quiet at the appearance of Kenneth Lay, Enron's former chief. Lay, in a gray suit, sat calmly in the front row while members of the Senate Committee on Commerce, Science and Transportation—Democrats and Republicans alike—glowered down from the raised dais and disparaged him with zeal. "The anger here is palpable," explained Senator John Kerry (D-Massachusetts). "Lives have been ruined."

"The bankruptcy of this corporation is not a garden-variety business failure," said Senator Byron Dorgan (D-North Dakota).

Indeed, Enron's failure was anything but typical; it was one of the most thrilling rise-and-fall sagas of recent years. Starting in 1985, Enron grew in a decade and a half from a large natural-gas pipeline company to an energy-trading firm that bought and sold gas as well as electricity. In the late 1990s, Enron had even evolved beyond energy trading, trafficking in metals, paper, financial contracts, and other commodities. By that time, so much of its business came from trading that Enron had essentially stopped being an energy company and functioned as a kind of bank. That transformation spurred massive expansion, so that fromrevenue of $4.6 billion in 1990, Enron grew to $101 billion in revenue in 2000. That made Enron the seventh-largest company in the United States, bigger than IBM or Sony. Lay and other top executives landed on the covers of business magazines, and the company was hailed as a model for innovation.

Ken Lay was at the Senate hearing, however, not because of Enron's rise but because of its downfall. To help sustain its rapid growth, the company played fast and loose with its accounting, hiding debt and inflating profits. The previous October, the company revealed that its use of semi-independent investment partnerships, some of which were run by Enron's own chief financial officer, reduced shareholder value by $1.2 billion, and that sparked an accounting scandal that spiraled out of the company's control. On closer examination, these partnerships appeared to do nothing more than shuffle debt and hide losses. The Securities and Exchange Commission, which oversees the stock markets, launched an inquiry that caused trading partners to back away from Enron. Enron's stock price tumbled from a high of $90 to a piddling 36 cents, wiping out more than $60 billion of shareholder value—even as Lay and other top officers sold much of their own stock for millions of dollars. After the market lost confidence in Enron and a last-minute merger attempt fell through, Enron's descent came to a thundering crescendo on December 2, 2001, when it filed for bankruptcy; with assets of roughly $62 billion, it was at the time the largest bankruptcy in U.S. history. Enron was facing hundreds of creditors, more than four thousand angry ex-employees— some of whom had lost all their retirement savings—and a criminal probe by the U.S. Justice Department.

In that hearing room, senators took the opportunity to lecture Lay because, as Senator Conrad Burns (R-Montana) put it, "it was on his watch that the wreck occurred."

Senator Peter Fitzgerald (R-Illinois) called Lay an "accomplished confidence man," and went on to lambaste him: "I'd say you were a carnival barker, except that wouldn't be fair to carnival barkers. A carnie will at least tell you up front that he's running a shell game. You, Mr. Lay, were running what purported to be the seventh largest corporation in America."

The senators also seized on Lay's well-known political connections, which included strong ties to the Republican Party. He had been a top contributor to George W. Bush long before Bush rose to the presidency, earning the affectionate nickname "Kenny Boy" from the Texas politician. Enron had also enjoyed a swaggering reputation as a powerful lobbying force in Washington, arguing for the deregulation of energy markets that created the opportunities for Enron's trading business. Senator Ernest "Fritz" Hollings (D-South Carolina) said, "There's no better example than 'Kenny Boy' for cash-and-carry government," and said he hoped this would lead to campaign finance reform.

And Enron, which once championed the liberation of energy markets from government oversight, was accused of tainting free-market economics. "This is not capitalism," said Senator Gordon Smith (R-Oregon). "This is a conspiracy that may be a crime."

Lay did not respond to the hail of criticism, and everyone knew he would stay silent. He'd twice backed out of previously scheduled appearances before the committee, and Congress went so far as to issue subpoenas to compel his testimony. A few weeks before appearing in front of the committee, Lay's attorney had written to Congress to explain that the 59-year-old executive felt he wouldn't get a fair hearing. "Judgments have been reached and the tenor of the hearing will be prosecutorial," the attorney wrote. So Lay took the Fifth Amendment—his constitutional right to remain silent rather than say something that might incriminate himself.

Instead of answering the senators, Lay waited until every member of the committee had spoken. Then he read a brief statement. "I come here today with a profound sadness about what has happened to Enron, its current and former employees, retirees, shareholders, and other stakeholders," he said.

He explained feeling torn about taking the Fifth. "I am deeply troubled about asserting these rights, because it may be perceived by some that I have something to hide. But after agonizing consideration, I cannot disregard my counsel's instruction. Therefore, I must respectfully decline to answer, on Fifth Amendment grounds, all the questions of this committee and subcommittee and those of any other Congressional committee and subcommittee."

Meanwhile, in League City, Texas, Robert Smoot was watching the hearing on television with mixed feelings. Smoot, married with an 11- year-old daughter, had been laid off from Enron that December. As he watched Lay get humiliated by Congress, part of Smoot felt sorry for the former CEO, but part of him felt Lay had it coming. "Someone had to say that," he said. "He should've known what was going on. He's the captain of the ship."

An electrical engineer, Smoot was out of work and hadn't had a job interview since January. In addition, he and the others laid off in December had received just $4,500 of severance pay, rather than the sort of severance to which they would normally be entitled, larger sums based on how long they had worked at Enron. For him, that would be worth several months' salary—if the bankrupt company ever paid it. Instead, Smoot was spending down his savings. "We're doing okay right now, but that money's going to run out," he said. "I'm angry at what happened— treating the people who were laid off like trash."

The dramatic collapse of Enron took people like Robert Smoot completely by surprise. But most people were surprised. There were innocent victims like Smoot, who lost not only his job but also thousands of dollars in worthless stock options and in the Enron stock he'd bought with his 401(k) retirement savings plan. There were public pension funds, which had seen their Enron investments plunge to minuscule value. There were small investors who'd had their faith in the market shaken. There were the banks that had lent Enron billions and could expect to get just a small portion of the loans back. There were the politicians scrambling to distance themselves from this omnipresent campaign contributor. And there was the U.S. stock market, which was convulsing with fears that more accounting implosions lay hidden in any number of large corporations.

The senators disapproving of "Kenny Boy" were frustrated because they'd wanted to grill him for answers that might explain what happened to Enron. But even if Lay had testified that day, he could have given only part of the explanation. Because the Enron story was much larger than just Lay.

The heart of the story, of course, is Enron. The company, which at its height had more than 20,000 employees and operations in 40 countries, pioneered real innovations, many of which are still in use; rather than just sell energy to a factory, Enron could package that energy in an array of customized contracts, delivering more energy in December than in November, or making sure that contract provisions guaranteed certain prices. It created or entered new markets—allowing financial calculations on even the weather itself—and eventually built an Internet trading system that handled billions of dollars in commerce. But the early successes fueled an ever-larger ambition, causing the company to overreach. As its markets matured and became less profitable, Enron was forced to continually enter new fields to keep up its rapid growth. Fixated on its stock price, Enron pursued a strategy of growth and more growth, often at the expense of profits.

A big part of the story was that energy trading operation—a Byzantine market that exists behind the gas and electricity business and is every bit as large and sophisticated as the stock market. Enron handled roughly one-quarter of all trading in electricity and natural gas in the United States, a dominance that would be unheard-of in the world of stocks. As that market developed over the course of the 1990s, it became so complex that even after Enron's collapse it was difficult to tell whether some of Enron's maneuvers to hide loans as trades and to bury debt in special partnerships had violated any rules.

The stars of the story were Enron's top executives, including Lay and the man who became his trusted lieutenant, Jeffrey Skilling. Enron's leaders had been held up as a creative force that had injected "New Economy" spark into an old-economy, industrial company by emphasizing intellectual prowess over pipelines and power plants. But somewhere along the line, either at the behest of Lay and Skilling or under their noses, Enron executives in the late 1990s began to fool around with the books in order to support the huge growth engine. They created special partnerships that weren't reported on Enron's books, which were able to make its earnings and debt levels look better than they really were. As Enron grew as a financial firm, it increasingly relied on such accounting trickery to keep its credit rating high, making it seem a solid and reliable trading partner.

The story cannot be told without describing Enron's corporate culture of innovation and competitiveness, where employees enjoyed autonomy if they produced quarterly results. That culture fed its appetite for new ideas and for creative, hardworking people. But the drive and independence also helped enable financial deception, because the company encouraged experimentation but discouraged anything other than success.

In its effort to create new markets, Enron inevitably had some misses along with its hits; for instance, it had an energy outsourcing business whose profits were questionable, and a business trading telecommunications network capacity, known as bandwidth, which lost hundreds of millions of dollars. Reluctant to acknowledge stumbles, the company relied even more on accounting trickery to paper over the losses.

The story included Enron's accounting firm, Arthur Andersen. Andersen, which, like other big accounting firms, also did consulting work for Enron, signed off on the company's questionable accounting practices. Frankly, the accounting rules were vague enough and the company's deals complex enough that it was often difficult to tell when Enron violated rules. But Andersen downplayed questions about the accounting. It was only in October 2001 that Andersen reined in some of the more creative accounting moves, and that began Enron's downward spiral. Andersen then compounded its errors by shredding Enron-related documents when it knew the company was being probed.

Wall Street also had a big part in the story, because it wanted so much to believe in Enron's wondrous story and it helped keep the stock inflated. Analysts touted Enron's stock, even as the investment banks that employed them tried to get business with Enron. Although Enron's financial statements were opaque, that didn't bother the Wall Street machine so long as Enron's stock continued rising throughout the jubilant stock market of the mid and late 1990s. They were held in thrall with the Enron story, even if the company wasn't really quite as successful as it portrayed itself. That's why Wall Street and the business community so easily felt betrayed by Enron when Andersen revealed one accounting mishap. When the world got a peek at its rickety financial underpinnings, the market lost confidence in the company. Without confidence, hence without trading partners, Enron's core business withered quickly. The cash stopped coming in, the debt grew, and the company came crashing down. The result was the bankruptcy, thousands of layoffs, several congressional investigations, and the potential for criminal charges.

The Enron story, with all its moving parts, is a tale of genuine achievement, but also of arrogance, ambition, and deceit. It's the story of how so many people and agencies missed the cracks in Enron's facade, in part because the system was set up that way. In short, it's the story of how American capitalism worked at the close of the twentieth century.

* * *

Many businesspeople like to portray themselves as rags-to-riches successes, in accordance with the American love of individualism and self-reinvention. Although he didn't start in rags, Kenneth Lee Lay really did rise from modest circumstances. He was born to a rural family on April 15, 1942, in Tyrone, a medium-sized town in Missouri.

His father, Omer, was a Southern Baptist minister who usually held down a couple of other jobs to support the family, such as selling farm equipment and working at a feed store. Omer married Ruth Rees in 1937, and they had three children: Bonnie the oldest, Ken in the middle, and Sharon the youngest.

When Ken was six, the family moved to Rush Hill, a tiny town in the center of the state, a little more than 100 miles northwest of St. Louis. Omer became the minister of the nondenominational Rush Hill Community Church, but still had to work other jobs. Although they pinched pennies, the Lay children never went without food or clothes. And though Omer and Ruth had never gone to college, they wanted their children to go. Omer was an optimist, someone who believed that even if circumstances were difficult or complicated, things would work out later. It was a trait that influenced his son.

By the time he was nine, Ken was helping bring in money with parttime work, such as driving tractors on neighboring farms and delivering papers. Working on tractors gave young Ken Lay time to think, and his thoughts sometimes turned to the business world, a world that seemed very far away from the small towns and farms he knew.

Omer and Ruth Lay realized they wouldn't be able to give their children college educations if they stayed in Rush Hill. So the summer after Lay's sophomore year in high school, the family moved to Columbia, Missouri, so Ken and his sisters might be able to live at home and attend the University of Missouri (eventually, all three obtained degrees from the university). In Columbia, Lay wound up at Hickman High School, where he worked hard and got good grades. He played slide trombone in the school marching band, sang in a choir, and was elected graduated 10th out of the class of 276 students.

With the help of scholarship money, loans, and various jobs, Lay put himself through the University of Missouri at the Columbia campus. He joined the Theta Beta Pi fraternity, and, in an early testament to his political skills, he became president of the frat in his junior year. It was also in college that he seriously studied economics, learning the value of free markets, imbued with competition and unhampered by massive regulations. In college, he also learned the basics of accounting by taking 12 hours' worth of classes to help prepare him for business; ironically, his understanding of accounting would years later prove a major issue in Enron's collapse. Lay graduated Phi Beta Kappa with honors in 1964, and then, at the urging of an economics professor, he stayed one more year to collect a master's degree in economics.

Finally leaving Missouri, Lay moved to Houston to work as a corporate economist at Humble Oil, a large and well-known oil company that eventually became part of energy giant Exxon. Energy wasn't an industry he'd thought about much growing up in Missouri, but he was attracted to its importance in national affairs. "I was very impressed with the capital-intensive nature of it, which, with my economics background, I found very interesting versus a more labor-intensive type of industry," he told one writer. "It required a lot of long-range planning and interface with government and regulatory bodies, which also tended to fit into my economics training." While working for Humble, he earned a doctorate in economics from the University of Houston in night school. And in 1966, Ken married Judie Ayers, whom he'd met in French class at the University of Missouri.

In 1968, as America's war in Vietnam escalated, Lay chose to leave Humble Oil for Naval Officer Candidate School in Rhode Island. He was soon at the Pentagon, where he spent his three-year tour working for the Assistant Secretary of the Navy for Financial Management. The Pentagon was a prestigious climb from little Rush Hill, and he took advantage of the opportunity by leading a study of defense spending that earned him plaudits; the study was later credited with saving the Pentagon billions of dollars. Lay also used the findings from this study—notably, the impact of defense spending on the economy—for the basis of his Ph.D. dissertation at the University of Houston. After his 1971 disharge, he stayed in Washington, D.C., working for two years at the Federal Power Commission, the precursor to the Federal Energy Regulatory Commission (FERC).

At the Power Commission, he was an assistant to Pinkney Walker, the economist who had urged Lay to get a master's degree and was then a commissioner. (Years later, Lay would donate money and help raise funds for a Pinkney Walker Endowment at the University of Missouri.) Lay spent less than two years at the Power Commission, which helped oversee the natural gas and electricity industries, but the time was crucial. It gave him insights into regulation of energy, and, of course, the often mysterious workings of government. During that time he was promoted to deputy undersecretary for energy of the U.S. Department of the Interior. While in Washington, Lay was also an assistant professor at George Washington University, teaching graduate courses in micro- and macroeconomic theory and government-business relations.

In 1973, Lay joined natural-gas utility Florida Gas as vice president for corporate development, and moved his family to Winter Park, in central Florida. He rose through the ranks. He became an active member of the community, serving on various boards and raising money for the arts and education. Lay also started to develop his management style of surrounding himself with smart people and making sure they were included in decision making. But although he had attained some measure of the business success he'd longed for back on the tractor in Missouri, there were problems. In 1979, Florida Gas was purchased by Continental Group, a diversified industrial company that started off making cans. After a couple of years, Lay didn't like management changes. Also, he and Judie grew apart, not helped by Ken's long hours at work. In 1981 they divorced amicably (although Judie stayed behind in Winter Park when he returned to Houston, and she remained friendly with the Lay family). Ken Lay had always been the sort of hard worker who seemed married to his job. Shortly after his divorce he married Linda Phillips, who was his secretary.

Jack Bowen, who had been Lay's boss at Florida Gas, had by now moved on to a natural gas pipeline company based in Houston called Transco, which supplied a majority of the gas to the New York-New Jersey area. Bowen brought Lay to Transco in 1981 as his right hand, and Lay rose to president and chief operating officer.

Unlike Florida Gas, which distributed natural gas directly to homes and businesses, Transco operated interstate gas pipelines. Some of these went to utilities like Florida Gas, but some went to large businesses; it's interesting to note that home use is not the major end point of gas— more than 60 percent of gas is used for other purposes: as fuel for factories; as a raw material for chemicals (processing gas will extract from it such chemicals as butane and propane, known as "natural gas liquids"); and as a fuel for electricity-producing power plants. The vast majority of U.S. natural gas wells are drilled in five regions: the Texas/Louisiana Gulf Coast; West Texas; New Mexico; a large swathe of land stretching from Kansas to Oklahoma; and the Rocky Mountains. There's also Canada's gas industry, which is centered in Alberta (roughly north of Montana). More than 280,000 miles of gas pipelines sprawl across North America to transport natural gas from processing plants in those producing regions to the various customers around the continent, whether those customers are local gas utilities or paper mills.

In later years, Enron presented itself as having evolved from just a sleepy, simple gas pipeline company. But running a pipeline system is not easy. Because it's a gas, transportation is more difficult than it is for oil, which can be stored in barrels and moved by ship, train, or truck. Gas pipelines use compressors to push gas across states, operating at high pressures that must be closely monitored. The industry was tightly regulated. For decades, gas producers explored for gas and pumped it out of fields, selling the gas to pipelines at prices set by the federal government. The pipelines, in turn, sold their gas to local gas utilities, also at governmentset rates; the government allowed the pipeline operators to earn what it considered a fair profit. With these strict controls in place, there was no competition and no "market" setting the prices.

By the time Lay was at Transco, this setup had begun to change. The strict regulation of the gas industry provided little incentive to increase gas production, and that led to gas shortages in the 1970s. In 1978, the government began to lift its control of gas prices at the wellhead—in other words, the prices that natural gas producing companies could fetch for their gas. Also, to avoid similar shortages in the future, many pipeline companies signed long-term "take-or-pay" contracts with gas producers, guaranteeing a minimum amount of gas would be purchased and thus creating a reliable demand for gas. The take-or-pay contracts typically called for a pipeline company to buy 70 percent of the gas that a field (a collection of wells) could deliver, and the pipeline could either "take" ownership of the gas or else "pay" the producer for it and pay a penalty. Either way, the producers got their money. It was then up to the pipeline company to sell this gas to local utilities or anyone else.

If Ken Lay the economist had wanted an illustration of how badly the government could screw up a market, he picked the right time to join Transco. The 1978 change worked well, and gas production soared. But shortly afterward, an economic slowdown hurt the nation's appetite for gas. This larger supply and smaller demand pushed prices down; gas that had cost as much as $6 per thousand cubic feet dropped to $3. By the early 1980s, there was actually a glut of gas. Unfortunately for the pipeline companies, they were saddled with take-or-pay contracts that they'd signed when gas was scarce and prices were high—which meant that pipeline companies had expensive gas they were trying to sell at above-market rates. Sometimes the pipeline company could come to terms with producers; in 1984, for instance, Transco reduced the terms of one take-or-pay contract from $380 million to $240 million.

Making matters worse, some industrial customers were switching from gas to oil, which fell in price in the early 1980s. Transco and other pipeline companies developed business units that "marketed" gas, selling excess gas outside of long-term contracts, but often at discount rates.

Having learned the pipeline industry, in June 1984 Lay jumped to Houston Natural Gas, another pipeline company, where he finally had the top job of chairman and chief executive. When Lay joined, HNG was trying to surf the waves of change buffeting its industry, and it had survived a takeover attempt a few months earlier by fellow pipeline operator Coastal Corp. In addition to giving Ken Lay his first job as CEO, Houston Natural Gas was crucial because it would later help form the company that became known as Enron.

* * *

It's possible to say that Enron was a child of deregulation. Although Enron's domain would later expand to include electricity and electric deregulation, in the early years deregulation concerned natural gas. For gas, deregulation—in essence, allowing some free-market competition into an industry that had been strictly regulated by the government—didn't happen in one dramatic stroke of a pen, but in a series of steps.

The first step had been the 1978 deregulation of gas prices. In the early 1980s, gas producers were selling much of their gas at market prices, although there was an oversupply of gas. Transco's response was to foster sales of excess gas through a "spot" market for gas, a move Lay helped lead. As opposed to long-term contracts, this allowed monthly allotments of gas to be bought and sold literally on the spot, during the same week each month (known as "bid week"). At Transco, Ken Lay guided the effort to gain federal regulatory approval for gas producers and pipelines to sell natural gas directly to large wholesale buyers on a spot basis. The spot market was also completely guided by market prices, rather than long-term contracts. This spot market involved traders haggling over the phone for gas that would be transferred between pipelines at interconnect points known as "hubs."

At HNG, Lay continued to push the spot market of natural gas. He teamed up in late 1984 with Transco and four other pipeline companies, investment bank Morgan Stanley, and law firm Akin, Gump, Strauss, Hauer & Feld to create Natural Gas Clearinghouse—a gas sales consortium aimed at supporting a national spot market for gas. The Clearinghouse proved successful enough that in late 1985 Morgan Stanley took majority control of it and turned it into a semi-independent gas marketing firm.

At the same time, the hard times for gas pipeline operators had been sparking an urge to merge companies, a result of both a shakeout of smaller players and an effort to spread their high costs over larger operations. Feeding the merger trend was the stock market: Some smaller pipeline companies' stock prices fell to cheap levels. Lay decided that if HNG, fresh from rejecting the overtures of Coastal, were to remain independent, it would have to be bigger. And so Lay proceeded with his first reinvention of a major corporation.

HNG's pipeline system was mostly within the borders of Texas, but it needed to go national. Late in 1984, Lay paid a total of $1.2 billion to buy two pipeline systems—Transwestern Pipeline, running from Oklahoma and West Texas to California, and Florida Gas Transmission, the sole supplier of gas to Florida—more than doubling the size of HNG's pipeline network and stretching it from California to Florida. (The Florida pipeline had once belonged to Lay's old employer, Florida Gas.) Lay also focused the company on natural gas, selling off a coal mining business, a barge and tugboat outfit, and other interests. Now HNG was one of the largest pipeline companies in the United States, with a diversified customer base of local utilities, refineries, and chemical companies. The big acquisitions increased HNG's debt, but that also made the company less attractive as a takeover candidate.

Then in 1985, a second step was taken in gas deregulation. As in 1978, the order (officially known as Order 436) came from the Federal Energy Regulatory Commission (FERC), a little-known U.S. agency that regulates the country's natural gas industry, hydroelectric projects, oil pipelines, and wholesale rates for electricity. This order essentially encouraged pipeline companies to voluntarily make their lines available to all gas utilities, which meant that local utilities could buy gas from the producers and then pay the pipeline just for transporting the gas. It meant pipeline companies had to separate their businesses of gas transportation and gas sales.

Against this backdrop, pipeline companies continued to merge. Early in 1985, the rebuffed suitor Coastal Corp. bought another pipeline company, American Natural Resources, for $2.5 billion. Finally, the pressure to consolidate was too much. Over a period of roughly two weeks, HNG executives negotiated a deal with InterNorth, a much larger pipeline company based in Omaha, Nebraska. On May 3, the two companies unveiled the news: InterNorth agreed to buy Houston Natural Gas for $2.3 billion in cash, or $70 per share of stock—a nice premium over the $46.88 price that HNG's stock was at just two days earlier. The deal would join InterNorth's pipelines in Western Canada, the American Southwest, and the Rocky Mountains with HNG's network. The deal also called for Samuel Segnar, the chairman and CEO of InterNorth, to head the combined company until 1987, when he would be succeeded as top dog by Lay.

The merger wasn't without obstacles. InterNorth was paying a high price for Lay's company. And one large InterNorth shareholder, Irwin Jacobs, opposed the deal. Jacobs, a Minneapolis-based financier known as "Irv the Liquidator," made a name taking on such well-known companies as ITT and Walt Disney. But the merger deal allowed InterNorth to begin buying HNG's stock, so Jacobs couldn't stop the deal. Shareholders of the two companies approved the deal in July. A new company was born, HNG/InterNorth, with $12.1 billion worth of assets, 15,000 employees, and the nation's second-largest pipeline network (after Tenneco).

Over the next few months, the companies went about integrating their operations, with the headquarters technically in Omaha but many corporate offices in Houston. There were suspicions, though, that HNG and InterNorth executives were jockeying for position. In November, Segnar surprised the industry by stepping down early, elevating Lay to CEO. In a statement, Segnar explained that the restructuring of the gas industry was happening so quickly that he wanted the new management team in place right away. Others wondered if Lay, the consummate politician, had outmaneuvered Segnar. The following February, Lay completed his ascension when the acting chairman of HNG/InterNorth stepped down and Lay was named company chairman. But the company continued to grapple with a difficult business environment—for 1985 it reported a loss of $14 million.

A new year, however, brought a new challenge. To come up with a better name than simply HNG/InterNorth, the company hired the consultants Lippincott & Margulies, who suggested "Enteron." Of Greek origin, Enteron suggested energy and sounded futuristic, and had the sort of vague dynamism that's popular in corporate names. In addition, "enteron" had an industrial meaning of "a pipeline system transmitting nourishment."

However, less than two days before the new name was to be unveiled, company employees learned that "enteron" also has the medical meaning of "alimentary canal, intestines, guts." Not pleased that their new corporation's name referred to the bowels, the company demanded a new name. The board told Lippincott & Margulies that it had 24 hours to come up with a new moniker, and the firm quickly shortened the name to Enron.

* * *

The newly christened Enron began confronting challenges. First, the company consolidated control over the combined HNG and InterNorth organizations. When the Enron name was adopted in April, the company had already cut 1,000 jobs from the combined companies. Lay promised that another 500 jobs would be cut by the end of 1986. This was typical. Any merger is predicated in part on the ability to lay off redundant staff, and the elimination of 1,500 jobs was expected to save Enron $70 million a year.

Although Enron originally kept its main office in Omaha, where the larger InterNorth had been headquartered, Enron's headquarters officially moved to Houston as of July 1, 1986. The company gave strategic reasons for the move, saying that Houston was an acknowledged center for the energy industry, and that situating its corporate offices with the offices running its pipelines, gas processing, and other major operating groups would improve overall coordination. But the fact also remained that Lay was in Houston and had become the company's head honcho.

Another obstacle was the lingering presence of Irwin Jacobs, whose reputation at the time put him in the company of such financiers as Carl Icahn and T. Boone Pickens. Earlier in the decade, Pickens and other corporate raiders had helped ignite a wave of mergers in the oil industry that resulted in big names such as Getty Oil and Gulf Oil being devoured by other oil giants. It was Pickens who famously said he could make more money drilling on the floor of the New York Stock Exchange than drilling in Texas. While this was going on, the pipeline mating game that produced Enron had yet to run out of gas.

In this environment, Jacobs had held onto his InterNorth stock, which was converted into Enron shares. By July 1986, Jacobs had increased his ownership in Enron shares to an 11.4 percent stake. This sparked speculation that he'd try to take over Enron. But the speculation turned more to the thought that Jacobs would try to "greenmail" the company. Greenmail, which rose to prominence in the 1980s, worked like this: a financier bought a major stake in a company, threatening a takeover attempt, then backed off after the company agreed to buy back the financier's stock at a premium. This had worked before at larger companies. At the same time, an insurance and finance company called Leucadia National bought a 5.1 percent stake in Enron and disclosed that it might try to take over the company.

Faced with these not entirely covert challenges, Enron decided in the fall of 1986 to shake Jacobs and Leucadia once and for all. After consulting with two investment banks, Lazard Freres and Drexel Burnham Lambert, Enron bought Jacobs' and Leucadia's shares for a total of $348 million. Enron paid $47 per share for 7.4 million shares of stock. In line with greenmail maneuvers of the time, the $47 price was a slight premium: Enron's stock had closed at $44.38 the day before. Reportedly, Jacobs made an estimated $14 million profit on the deal.

The stock purchase was funded in a slightly complex manner. Enron's employee retirement plan had done well enough that by mid-1986 it had $230 million in excess funds. Enron created a new employee stock ownership plan (ESOP) by rolling over the $230 million and adding $105 million it borrowed from a bank. That $335 million ESOP acquired the Jacobs and Leucadia stock. The company also took a charge to earnings for the remaining cost of the stock purchase.

This wasn't the most popular move that Enron could have made. The stock dropped nearly 9 percent on the day it was announced. None other than T. Boone Pickens, who had made greenmail raids on Phillips Petroleum, among other companies, criticized Enron. "Enron's executives have folded in a big way," he said. Lay later explained to employees that the buyback "defused a potentially disruptive situation," and putting 16 percent of the company's stock in the ESOP made the company less vulnerable to raiders. But for all of Pickens' bluster, he did make one interesting point: Enron had earlier planned to use the $230 million in retirement plan overfunding to reduce company debt.

Debt was a real concern at Enron. Combining the debt of HNG and InterNorth, especially after Lay's HNG had bought two big pipeline systems, had the left the company owing a lot of money. Adding the millions it cost to buy back stock from Jacobs and Leucadia didn't help matters. In addition, the energy business was going through rough times due to low oil and gas prices. To cut costs, Lay froze salaries of the 60 top-paid employees at Enron, and the company sold some real estate, including an apartment in New York and a ranch in Colorado. Enron also formed a cost reduction committee at the end of 1986 headed by an executive named Richard Kinder.

Enron sold off businesses and other assets through 1987, but it was still highly "leveraged," which meant that it was carrying a lot of debt compared to its assets. Starting 1987 off on a sour note, Moody's Investors Service, a leading agency that reviews the credit of corporations, downgraded Enron's debt rating in January. Moody's lowered Enron's main credit rating from a low investment grade to a high speculative grade. This meant that many of Enron's bonds could be bought only by investment funds that dealt in junk bonds. For that reason, issuing any more bonds would require paying a very high interest rate on them. Moody's explained that it expected "neither cash flow nor capital structure will show substantial improvement in the near term," and "debt leverage has not improved."

Enron refinanced some of its debt in 1987 with a sale of 12-year instruments known as debentures. The company raised $585 million in February selling this debt, underwritten by Drexel Burnham Lambert. But at the end of the year, Enron had $3.43 billion in long-term debt, and that didn't count short-term obligations, such as loans that were due within six months. Wall Street often measures the debt load of a company by comparing how much debt it has to its total capitalization—capitalization being the company's stock market value (the stock price times its total shares of stock) minus its debt. At the end of 1987, Enron's debt equaled a whopping 75.6 percent of its total capitalization. A debt-to-capital ratio above 50 percent is often considered high, so Enron's was towering.

The company did make some progress. In the first quarter of 1988, Enron lowered its debt-to-capital ratio to roughly 67 percent. Moody's raised Enron's debt rating back up to investment grade, although the rating was "Baa," the firm's lowest investment-grade rating. But the campaign against debt wasn't over. At the April 1988 annual shareholder's meeting, Lay said: "One major 1988 objective is to reduce Enron's debt." By the end of the year, debt-to-capital slipped to 65.7 percent. But debt would remain a constant issue for Enron for the rest of its existence.

While grappling with its debt, Enron was also wrestling with its take-or-pay contracts. At one point these totaled more than $1 billion in high-priced commitments. But the FERC encouraged gas producers to renegotiate these pacts with pipeline companies, and over the course of the late 1980s Enron resolved thousands of take-or-pay deals.

Renegotiating these contracts didn't help endear Enron to the small and medium-sized natural gas producers, who were also hurt by low gas prices. Enron and other pipeline companies often agreed to buy additional gas beyond that covered in the take-or-pay contracts if the producer agreed to lower the take-or-pay prices. "Small producers sometimes felt Enron was taking advantage of them in price negotiations," and thought the company arrogant, according to Raymond Plank, chairman and CEO of oil and gas producer Apache Corp. It wouldn't be the last time that Enron was accused of arrogance.

* * *

Enron had its share of tussles, but it was surviving and making money. In 1987, it generated $5.9 billion in revenue, and it earned $53.7 million from its "ongoing" operations, which were those that it didn't sell or shut down.

The company was already conducting some energy trading, because it had a small oil-trading operation based in New York. Oil trading had grown in the 1980s, and by 1987 companies bought and sold not only barrels of oil in spot markets but also financial contracts for oil. Enron Oil, as the business was known, reported a nice little profit in 1985 and 1986. Two senior traders at the subsidiary felt confident enough from their prior success to try to make some big bets. But their big bets ran into trouble. They invested a lot in bets that oil prices would rise, only to see oil prices fall. Then they switched tactics and bet that oil prices would keep falling. But oil prices rose instead. The result was losses on both ends.

But the two traders not only were making unauthorized trades, they went 10 to 20 times past the company's internal limits on trade sizes and losses. Worse, they weren't reporting these trades to Houston. Instead, the traders kept the actual trades on a second set of books, and sent false records to headquarters. They evidently hoped to trade their way out of the losses before their deceit was uncovered. But Enron investigated and uncovered the fraud. The result was a loss to Enron of $142 million, including an $85 million charge to its 1987 earnings. Enron Oil was shut down entirely.

Enron fired the two traders, Louis Borget and Thomas Mastroeni, and sued them in civil court—partly because they'd constructed bogus trades before 1987 that led Enron to pay them sizable bonuses. In 1988, the U.S. Attorney's office investigated their secret trading as well. Federal investigators found that the traders created a shell company with which they conducted dozens of fake trades. In 1990, the two pleaded guilty to conspiracy to defraud and to filing false tax returns.

The trading scandal took Enron out of the oil-trading business, but it did raise an interesting question. Would energy trading have any place at the company? After all, Enron was "trading" gas contracts in the spot market, although gas wasn't being bought and sold like stocks. Perhaps it was time to look at other opportunities.

By selling off ranches and other peripheral businesses, Enron had trimmed down to a company that was mostly a pipeline operator. It owned 37,000 miles of pipelines all over the country. Thanks to changes in regulations, the pipelines were shifting toward a model whereby they transported the gas for government-approved fees, while Enron had a separate, unregulated unit that sold the gas to utilities and other users. Enron also owned gas processing plants, which extracted ethane, propane, and other chemicals out of the raw gas, and Enron sold those chemicals on the market as well. The company also owned some interests in power plants.

Enron also had an oil and gas producing business, aptly named Enron Oil & Gas, which explored for and produced a good amount of natural gas. It sold a lot of its production to Enron, assuring Enron of gas supplies and giving Enron a way to benefit just in case gas prices rose. In the late 1980s, most of its reserves were in the United States and Canada, although it had interests in a few international areas, including Ecuador, Syria, Egypt, and Malaysia.

The businesses had their share of excitement, what with trading scandals and gas wells in exotic lands, but they had a cozy side, too. There could be a small-town feel to the Texas oil business, embodied by an Enron project in Martin County, Texas. There, in October 1986, Enron Oil & Gas cooperated on a well in which a 10 percent stakeholder was Spectrum 7, an oil and gas company run by George W. Bush—the same Bush who would become U.S. president in 2001. Spectrum 7, which soon was acquired by Harken Energy, took minority interests in lots of wells, and there's no evidence that Bush at that time had any special relationship with Enron or Ken Lay—this was probably coincidence. Still, if Bush had any particular sympathy for Enron and the energy business in later years, part of the reason was certainly his time in "the oil bidness" in West Texas.

But was this business of running regulated pipelines, selling some gas, and doing some drilling really what Enron wanted? Deregulation had already roiled the gas business, and more convulsions were sure to come. After conferring with consultants from McKinsey & Co., Lay wanted change. One executive who agreed with him was Richard Kinder, the man who had headed the company's cost reduction committee in late 1986.

Kinder, two years younger than Lay, was also a graduate of the University of Missouri. Armed with a law degree, Kinder entered the business world and worked as an executive at Continental when it owned Florida Gas. He moved over to Houston Natural Gas in early 1985, and rose to become Lay's chief of staff in 1987.

In late 1988, Kinder became vice chairman of Enron, and he was the de facto second in command. By then, he was more involved in running the day-to-day operations of the company, while Lay focused on the bigger picture. They were a team, with Lay schmoozing politicians and other company executives, while Kinder oversaw Enron's various operations and drove employees to meet quarterly performance targets. Not that Lay was in the dark—instead, this was part of Lay's practice of arm's-length management at Enron. Just as in the past, he found executives he could trust to run their businesses, and he let them run things. Kinder's job was making sure Enron worked, and he was good at it.

And so Team Enron was set—at least for the moment. Kinder developed a reputation as a hard-ass. But that was somewhat misleading. Like Lay, Kinder was open and approachable. On the other hand, he could also be "very tough" in demanding a lot from employees, and kept people on their toes, recalled one former executive.

One of Kinder's biggest roles was in 1988, when he and Lay held the landmark meeting that set Enron's future direction. Kinder actually led the meeting, which included some 70 top executives of the company. Rather than fight deregulation, he and Lay told the executives, Enron was going to embrace it. Deregulation had opened up an unregulated part of the gas business, which then consisted of just selling natural gas. The company was going to focus on this unregulated business and look for more opportunities in it. And the company was going to move quickly.

Although Lay was anything but flashy, he had absorbed a few lessons from his minister father, and he made it clear that the unregulated market was the new religion at Enron. The executive confab was like a management revival meeting, and executives later dubbed it the "Come to Jesus" meeting. But the path was clear. Enron was going to move into uncharted waters that would eventually change the company and the gas industry.

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Table of Contents

Preface v
Time Line vii
1 Pipeline to Profit 1
2 Where the Money Is 22
3 Major Ambition 43
4 Electrifying Opportunity 59
5 Culture of Creativity? 77
6 The Energy Buffet 98
7 Taking the Plunge 122
8 Enron Gets Wired 143
9 Power and Glory 170
10 California Dreamin' 196
11 Power Overload 221
12 Downward Spiral 247
13 Racing the Clock 267
14 Endgame 286
Epilogue 307
Author's Note 314
Notes 315
Index 357
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Interviews & Essays

A Portrait of Corporate America in the '90s
A book can be a journey of discovery for both reader and author. I wrote Enron: The Rise and Fall because I was fascinated at first by the company’s rise. As a reporter for Dow Jones News, I’d covered the energy industry in the '90s, and I thought Enron was an important and challenging subject. This collection of bright, ambitious people sat at the epicenter of several critical topics: online commerce; Wall Street’s conflicting obligations; energy deregulation; and the finance world’s attempts to turn everything into tradable commodities.

In the fall of 2001 I was talking with John Wiley & Sons, my eventual publisher, about writing a book, and I suggested profiling Enron. At the time, the company was encountering great difficulties, but I thought it would retrench and endure. I contacted Enron to see if the company would cooperate, but they put me off. No wonder. In quick succession, Enron’s weakened stock went into free fall, it struck a deal to be acquired, that deal then fell through, and Enron filed for bankruptcy.

My project’s shape changed quickly, and I agreed to write a book (without Enron’s cooperation) about why Enron went bankrupt and why it grabbed the nation’s attention. Over time, I talked to many people inside and outside Enron, including former Enron executives who would only talk confidentially. I was surprised at the details of the intense corporate culture and the recklessness with which the company pursued strategies. My research confirmed that this was a tale of ambition gone off the rails. As I’d thought, Enron did achieve genuine success early on. But in the spirit of the '90s, Enron then overreached. Chairman Ken Lay and company believed they could transform a pipeline operator into a virtual corporation that traded a dizzying array of commodities.

The result was the cooking of Enron’s books, and my book highlights the system that allowed such rule breaking. Nearly everyone shares some blame, from Republicans to Democrats, from accountants to lawyers, and from Wall Street to Main Street. Not to excuse Enron, but its story illustrates the worst excesses of what many corporations were doing. I had originally picked Enron as a subject because this intriguing corporation embodied thought-provoking business trends. In Enron: The Rise and Fall, I ended up writing about a company that embodies wider -- and darker -- business and civic lessons. Loren Fox

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