Customer Reviews

Smartest Guys in the Room

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This book will be especially valuable to those who have a keen interest in "the amazing rise and scandalous fall of Enron." I also commend to their attention Smith and Emshwiller's 24 Hours: How Two Wall Street Journal Reporters Uncovered the Lies that Destroyed Faith in Corporate America. The "smartest guys in the room" included Kenneth Lay, Jeffrey Skilling, Rebecca Mark, Andrew Fastow, Kenneth Rice, and Clifford Baxter. Whereas Smith and Emshwiller explored the same company as investigative reporters, McLean and Elkind seem (to me) to have approached their subject as corporate anthropologists. Both books reach many of the same conclusions as to what happened...and why.

Two significant differences are that Smith and Emshwiller limit their attention primarily to a period in 2002 extending from October 16th (when Enron announced huge losses caused by two partnerships) to December 3rd (when Enron filed for Chapter 11 bankruptcy); McLean and Elkind cover a two-year period of the company's "amazing rise and scandalous fall." Also, McLean and Elkind devote far more attention to each of the "smartest guys"; Smith and Emshwiller seem far less interested in them, except in terms of the impact of their mismanagement and corruption. Let's say there are two books about the collapse of the twin towers at the World Trade Center; one focuses on the human tragedies associated with it whereas a second book addresses design, construction, and structural issues. Obviously, both approaches are valid.

McLean and Elkind suggest that the eventual collapse of Enron was caused less by the greed of senior-level Enron executives than it was by their arrogance and incompetence. Their lack of basic business acumen is astonishing as is their defiance of regulatory agencies and contempt for customers. None of them seems to have had a moral "compass." They exemplified, indeed nourished a culture of brutal competition between and among their subordinates. Each used Enron as a personal ATM as well as a means by which to structure all manner of corporate partnerships and high risk/high yield investments without fear of any personal liability. If one prospered, so did they. If it failed, the loss was Enron's. On to another.

Primary blame for all this must be shared by Lay, Skilling, and Fastow. McLean and Elkind rigorously examine the inadequacies of each, suggesting that if only one of the three had not been involved, it is probable that Enron would not have had the problems it did. Attorneys, accountants, brokers (notably Merrill Lynch) and bankers (especially Citibank and JP Morgan Chase) apparently were aware of Enron's bending and then breaking of various laws but were earning so much in fees that they chose to remain at the Enron "trough" side-by-side with Lay, Skilling, Fastow, and other Enron executives.

Consider this brief excerpt from Chapter 10 (page 149):

Here's how another former employee explains the process: "Say you have a dog, but you need to create a duck on the financial statements. Fortunately there are specific accounting rules for what constitutes a duck: yellow feet, white covering, orange beak. So you take the dog and paint its feet yellow and its fur white and you paste an orange plastic beak on its nose, and then you say to your accountants, `This is a duck! Don't you agree that it's a duck?' And the accountants say, `Yes, according to the rules, this is a duck.' Everybody knows that it's a dog, not a duck, but that doesn't matter, because you've met the rules for calling it a duck."

There are so many other brief, equally revealing excerpts which I am tempted to include but won't. Earlier, I suggested that McLean and Elkind display in this volume many of the skills of a corporate anthropologist. I also commend them on their skills as storytellers. Of course, it helps to have many colorful characters and such an interesting narrative. Among business books, this is one of the rare "page turners." If Enron remains a classic example of organizational dysfunction, my guess is that this book will remain the definitive analysis of the causes and effects of that dysfunction.

There's blame galore to go around for the spectacular downfall of Enron Corp in that sober year of 2001. Accountants, rating agencies, regulators, lawyers, consultants, bankers--and these are just the bad actors outside the corporation. Look inside, where Bethany McLean and Peter Elkind treat their readers to a thorough journalistic scouring, and the smell of the rot almost wafts off the pages.

The authors rightly spend the vast majority of the book examining the personalities and circumstances that allowed the company to become what it was at the end of its life. Mix a potion that's one part hardscrabble Harvard MBAs, one part energy deregulation, and one part hysterical bull market, and you've got a financial molotov cocktail. Sadly, as we all know now, it was largely the little guy who paid the price for all the hubris of the players in this story, a fact that tends to get lost in the authors' painstaking recreation of the most complicated shell game in history.

But the story of Enron's fallout could provide the material for a whole other book. In this one we get the tale of the players, people like Ken Lay, Jeff Skilling, Rebecca Mark and Andy Fastow, all filled with an equal mix of remarkable brilliance and fatal arrogance. All are indicted by these authors as rabid players in a game they made up themselves, deeming themselves beyond the petty world of rules and regulation. But coming in for equal excoriation is the system itself, the web of enablement and intimidation that allowed Andy Fastow to quietly hammer together the company's coffin in the form of a maze of phantom accounting entities designed to prop of the appearance of the corpse inside. The most unnerving theme the book treats indirectly is the effect of mass psychology--the way exceptional personalities distort and transform reality on a systemic scale. And it offers little in the way of how something like this could ever be prevented in the future.

One word of warning for people not acquainted with basic finance: this is a complicated story, about erstwhile geniuses in the arcane use of financial products and regulatory loopholes. Though it's enjoyable even if one can't follow every detour down each accounting scheme, some knowledge of Wall Street and its workings seems necessary to understand the implications of the book overall. Given the fact that most experts didn't understand what went on here, the authors do their best to keep things as simple as possible, often using helpful metaphors and simple summations after a few pages of analysis, but they have no choice but to assume a level of sophistication among their readers.

Which leads to one gripe. In "The Smartest Guys In the Room" not a single institution or individual player involved with Enron escapes the authors' finger-pointing notice, with but one exception. Where were the journalists in all this? Why did short-sellers have to be the ones to ask all the tough questions? Bethany Mclean should take understandable pride in being the first one to pry the door open on Enron's malfeasance, but she was just a little late. One would think that with the mass of financial journalists on CNBC, the Journal, the Times, etc., that just one would have bucked the collective cheering squad and dug deeper into what this supposedly invincible company was up to. But of course, this was the bull market. A time when everyone was exuberant when they should have been scared.

The authors describe a complicated critical mass of personalities that caused the Enron meltdown. McLean and Elkind have written a book about human behavior in a pressure cooker where top dogs vie for power. Enron executives cannibalized their own company with Wall Street's help. Financial engineering may have assisted these people, but their willingness to do it in the first place is a question of character.

I also recommend a book that explains how structured finance can be used to funnel money out of companies and which explains Enron's disguised loans: Tavakoli's "Collateralized Debt Obligations and Structured Finance."

Like many, I followed the Enron disaster as it unfolded with a certain curiosity usually reserved for matters closer to home. Somehow, the more I learned, the more intrigued I became at the sheer magnitude of the arrogance, incompetence and irresponsible management displayed by executives who were surely thought to be `the smartest guys in the room'. Fearing the media at large was skewing the coverage afforded to Enron on a whole, I looked forward to a book or report that would serve as a definitive look into the entire Enron affair with the type of thoughtful and provocative investigation that "The Smartest Guys In The Room" provides. Having been extremely disappointed with another recently read Enron expose, I could not recommend "The Smartest Guys In The Room" highly enough. Not only do McLean and Elkind do an excellent job in uncovering the facts, they do so in a crisply entertaining and enticing manner that kept me interested and consumed the entire way through. From the opening chapter, the authors flush out the characters, establish the timeline and ultimately piece together an incredibly insightful story of greed, ignorance and outright superciliousness, worthy of anyone's time and attention. "The Smartest Guys In The Room" is an incredible section of work that deserves to be recognized as the truly inspired endeavor that it is.

It is by now a cliché that arrogance and myopia contribute to many a downfall, whether the downfall is personal or corporate. This book proves that point aptly. Hubris and a sincere belief that Enron could do no wrong in the world contributed to an atmosphere of injudicious superiority. Combine that tumultuous atmosphere with ineffective, weak-willed executives and poor business management skills, Enron always was a precarious edifice awaiting its fate.

At least, such is the narrative that the authors offer. They argue that Enron, over the past 15 years, repeatedly found itself in financial trouble, and, rather than come clean to the Street, used financial engineering strategies to make its numbers appear better than they were. This practice arose out of a fanatical devotion to the company's stock price; the company's stock price would not continue to rise if the company missed the Street's earnings expectations for the quarter. Since so much of the executives' wealth was tied up in Enron stock and options, financial shenanigans became a self-fulfilling prophecy. After all, the authors point out, if most of your wealth is tied up in a company's stock, don't you have an incentive to do everything possible to keep its stock at a high level? Certainly, at this point, financial chicanery becomes more attractive than financial fidelity.

Therein lies the fundamental flaw of Enron (as well as numerous other bubble companies): the very compensation scheme created by the company to inculcate a sense of loyalty in its executives created a conflict too gross to manage adequately. The conflict in this instance is, in retrospect, a simple one: executives had all the incentive in the world to keep their company stock at a high level because all of their wealth, and their future wealth, was tied up in the company. Therefore, there was little incentive for them to be straightforward with the Street, or, for that matter, the company's finances. Enron thus became a delusional place where it could do no wrong and its managers were businesspeople par excellence.

All of this is false of course. Enron's managers are human after all, and all humans are susceptible to the foibles and follies of people everywhere; no matter how smart a group of executives, nor the sterling reputations of the schools from which they received their MBAs, absent sound business principles, ignorance becomes bliss and delusion becomes reality.

The authors are at their best when they explain the source of Enron's executives' arrogance, and the consequences for the company of that arrogance. It is important, therefore, to understand the company's hierarchy. The company was run by its founder, Ken Lay. Despite having the title of CEO, he played a role more akin to Chairman of the Board or a statesman: he spent most of his time away from the company, hobnobbing with celebrities and heads of state, and otherwise embodying the rock star CEO mentality. Business is just another form of theater, a la Sean Penn walking down the red carpet at the Oscars. Thus, other executives, from Jeff Skilling, on down, basically ran the show, and their outsized, narcissistic personalities therefore dictated a lot about the Enron culture.

Skilling came from McKinsey, the famous consulting firm full of Harvard and Wharton MBAs. As we all know, people with MBAs from Harvard and Wharton can be very intelligent. But they can also be very arrogant and dismissive of those they consider to be their intellectual inferiors; the authors imply that Skilling demonstrated the worst tendencies of a Harvard MBA, and, absent any checks in his behavior, his arrogance and condescension became the shaky cornerstones of the poorly constructed edifice that became Enron.

The metaphor of a poorly built structure is, at the end, the appropriate one for Enron. Despite the thousands of worker bees carrying out the daily operations of the company, the executives at the top were maniacally focused only on telling the Enron story: manipulating the Street into thinking that Enron was the greatest thing since sliced bread. Their thought was that as long as the stock keeps going up, and the Street believes in the Enron story, then there is no need to make the hard business decisions that are actually quite unpleasant to deal with. Enron had no organization and no comprehension of the risks it faced, either in its daily operations or in its financial engineering. One need not be an architect or engineer to know that structural integrity is important to the sanctity of a building. Such is the lesson we learn from the Enron fiasco: image is nothing when it is created only for the purpose of supplicating the Street and propping up the stock.

Incidentally, the title of this review comes from a reference in the book. The authors quote an accountant who explains that Enron used creative accounting techniques that often hewed to the letter of the law but violated its spirit. Under this logic, if you have a dog, but you paint its fur yellow and paste a beak on it, you technically have a duck, if by "duck" you understand it to mean "an animal with yellow fur (feathers) and a beak." In other words, if a transaction meets the technical requirements for it to be considered, say, revenue, then it need not matter that, in substance, it's not really revenue but debt.

The authors have done a masterful job of describing the critical mass of complicated personalities that contributed to the Enron meltdown. McLean and Elkind are keenly perceptive about human nature at its worst, and paint colorful portraits of the personalities of Enron's top honchos. The behavior of Enron executives jockeying for position at the expense of their corporation is infuriating.

Ripping off the investors is bad enough, but some of the executives cannibalized their own company with Wall Street's help. Financial engineering may have assisted these people, but their willingness to do it in the first place is a question of character. McLean and Elkind do a masterful job of implying the contributing elements of lack of character. This is a well written and fascinating book. This is not so much a book about finance as it is a book about human behavior in a social crucible where power and high rewards are at stake. This book will become a classic in business school ethics courses and organizational behavior courses.

"Collateralized Debt Obligations and Structured Finance" by Tavakoli will become the textbook of choice for any graduate school developing a course in this subject. It's clever in explaining structured finance including Enron's disguised loans. The author gives reasons why investment banks and sureties who aided Enron had their own failings in how they distributed internal social rewards. It's a structured finance text that warns against and suggests defenses to this kind of behavior and starts out saying that one should expect fraud and be prepared to diffuse it.

If you have any interest in the sticky wicket of corporate ethics, you've gotta read this book. Bethany McLean, who wrote the original article that helped start the ball rolling on Enron's inevitable collapse, and co-author Peter Elkind have done a masterful job documenting the rise and fall of Enron, an energy company that was, more or less, a tissue of lies.

The amazing things that stick out in my mind are how easy it was for almost all the participants in the unquestionable fraud that was Enron to justify what they were doing, to themselves and many others, before and even after the collapse. And how worthless it all was--most of them weren't very happy, even when Enron was riding high. And, for a few extra million bucks, they've pretty much made a mess of their lives.

The authors seem incredulous that, after giving the copious documentation of poor management and outside fraud, that most of the former Enron executives consider themselves victims of everything except their own greed and incompetence.

Yet does it surprise anybody that a company who was run by a management team that considered the most relevant aspect of Enron's business to be that "it was a really cool company" was, in fact, a mess? That the "loose-tight" management practices and Enron and praised by consulting firm McKinsey consulting were, in fact, all loose? McKinsey, a consulting firm that prides itself on radical management thinking and outside-the-box creativity (Tom Peters, one of McKinsey's most famous former employees, has made a very good living advocating management practices, and certainly attitudes, not so different from what Enron put into practice) has since tried to distance itself from its close relationship with Enron, and the authors don't pursue that connection very doggedly. But I am prone to wonder if, in a way, McKinsey isn't just as complicit as Arthur Andersen was in contributing to the debacle that was Enron.

Although McKinsey didn't actively participate in the fraud, book-cooking, legal manipulations, and outrageous debt that eventually brought Enron down--at least, not directly--certainly the McKinsey attitude was exhibited all throughout Enron. Certainly, Jeff Skilling--as guilty as anyone in Ernon's downfall--would have been a proud McKinsey case study, before the fall. He managed Enron "loose-tight", he hired creative and talented people with no experience in the Energy industry, he "innovated" with all sorts of new non-managing management techniques. He was a McKinsey golden-boy.

Somewhere out there, I'm sure there were some Tom Peters' seminars extolling the virtues of Enron's modern management and "super cool" corporate culture. The fact that the company cooked the books while leaking money all over the place not withstanding.

But, Arthur Andersen is out of business and the company that probably contributed more to the mindset that eventually put Enron out of business is still doing pretty well. Too bad nobody at McKinsey or Arthur Andersen suggested Enron might benefit from, say, talented people with actual experience in the energy industry. Or real oversight. Or actual cashflow.

Another interesting point made by the authors is the complicity of the analysts, who, unlike Arthur Andersen or Citibank, had no real vested interest in covering up the fraud. Yet, they touted Enron, even while observant short-sellers decided Enron was fatally flawed beneath the surface, and ended up reaping a windfall on their shorted positions, with no more information than what was publically available.

If we take nothing else from the sad tale of Enron, I hope we at least take this: mark-to-market accounting, that allowed Enron to legally book future profits, sometimes profits that would accrue over 20(!) years, as profits for that quarter, is little better than SEC-sanctioned fraud. Thus, while making almost no real money, Enron booked huge deals where the real money was far off in the future, paid huge bonuses to the deal makers on projected (re: made up, often wildly optimistic) profits, and thus, on that score, legally defrauded the stockholders.

A great anecdote is the one where, while the stock price is plunging into the toilet and it's becoming clear Enron is going to have to be bought, or go belly-up, Ken Lay asked Jeff Skilling to help him choose from the fabric swatches he has for the new interior of their just purchased G5 corporate jet.

It's a good book and, if you're like me, you'll shake your head in wonder quite a lot. What the hell were they thinking?

In 1998, the top 200 most highly compensated employees at Enron took home $193 million. In 1999, that increased to $402 million. In 2000, it was $1.4 billion; each of the top 200 made over $1 million and 26 employees made over $10million. In 2001, the year Enron went bankrupt, 15 employees made over $10 million. (p. 241) I begin my review with this because, after reading this book, it appears to me that this sums up what the real purpose of Enron as a corporation was. It wasn't to provide benefits for its customers or shareholders (though those who sold at the right time did extremely well), it was to make money for the executives and senior employees.

The Smartest Guys in the Room tells the story of Enron, starting before its formation with Kenneth Lay's career in the energy business, to its creation out of Houston Natural Gas when it (under the guidance of Lay as CEO) purchased the InterNorth pipeline company, three times its size. HNG's skillful negotiations (by John Wing) led to the smaller company's management team ending up in charge--an acquisition that bears some similarity to tiny Global Crossing's acquisition of Frontier Communications.

The book covers a huge cast of players and some terribly complex financial arrangements (the details of which are only summarized for the layman in this book), but the narrative still works well and it reads like a mystery novel. It is as sympathetic as it can be to many of the characters and to the company--the basic ideas behind energy trading make sense, though the implementation by Enron was flawed by the fact that Enron managed everybody's trades rather than using a neutral exchange or direct exchanges between partners where neither was Enron.

It is clear that the senior leadership of Enron who were not complicit in the arrangements designed to conceal debt from shareholders and the general public were at the very least negligent in their fiduciary responsibilities--Lay's main offense seems to be a completely reckless disregard for what was going on in his company, and it's somewhat
plausible that he remained a true believer until the end. The fact that he read aloud this written question in front of employees suggests a certain amount of naivete or detachment: "I would like to know if you are on crack. If so that would explain a lot. If not, you may want to start because it's going to be a long time before we trust you again." (p. 376)

The book documents the role to which there was complicity in these deceptive financial arrangements by the auditors (Arthur Andersen) and various banks (such as Citibank and J.P. Morgan Chase) which were desperate for the massive financial fees from Enron's business. It describes the poorly designed regulatory framework in California which Enron exploited to its advantage (again in ruthless and deceptive ways).

It's a large book (414 pp.) with an extensive index, but is a relatively quick read for its size. It makes it clear that Enron has earned its place in the pantheon of hated companies, but it's not so clear that the steps taken in the wake of Enron, like the Sarbanes-Oxley Act, will prevent such things from happening again--especially compared to a much simpler regulatory framework which just holds executives personally and criminally liable for corporate misbehavior.

For someone like me who sits on a corporate board and did business with Enron (and knew some of the Enron executives involved) -- this book confirms what I suspected for years before the fall: Enron was a sleazy, unethical, immoral company run by crooks. This debacle was encouraged and allowed to happen by the outside directors on the Enron Board. Only they could have stopped it. But as the book makes clear, they never asked the most basic questions any director should ask. Sadly, these directors will probably never be held accountable for their malfeasance. If justice prevails, at least Lay, Skilling and Fastow will ultimately do hard time and forfeit their enormous illegal gains. This book should be required reading for every corporate director. One disagreement with the authors; the Enron players were not the smartest. They were simply brazen, arrogant crooks who thought they were the smartest.

Enron is, of course, old news by now. The company went bankrupt in 2001, and its spectacular collapse was merely the first of a series of notorious corporate scandals. Most of the story Bethany McLean and Peter Elkind tell in their book has already appeared in newspaper and magazine accounts and in other, rush-to-publish books that hit the market during or shortly after the events described. However, these authors have assembled what may be the single most comprehensive, detailed account and written it like an anecdote-rich, lively business-based novel. We do wish they had included a timeline and a list of sources, since they have had the benefit of being able to draw on all of that other work, on indictments and on testimony before courts and Congress, but their account is engrossing and complete. If you read just one book on the Enron scandal, we believe this may be the book to read.