The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron (11 page)

The most dangerous problem of all is the very thing that makes mark-to-
market accounting seem so seductive in the first place: growth. When the initial deals are cut and all the potential profits are immediately posted, a company using mark-to-market accounting appears to be growing rapidly. Wall Street analysts applaud, and the stock rockets upward. But how do you keep that growth rate up? True, you’re still receiving the cash from past contracts. But you can’t count it in your profits, because you’ve booked it already. It’s as if you have to begin every quarter fresh. If you did one deal last quarter, in order to show growth you have do two the next and four the quarter after that and eight after that and on and on. And if you’re promising Wall Street that your earnings will increase at a 15 percent annual clip, well, soon enough you’re on a treadmill that becomes faster and steeper as the company gets bigger.

Despite the potential dangers Skilling had little difficulty convincing Kinder, Lay, and Enron’s board to see things his way. On May 17, 1991, some 11 months after Skilling joined Enron, the audit committee of Enron’s board approved the use of mark-to-market accounting for Skilling’s new business. Now all he had to do was persuade the Securities and Exchange Commission. As it turns out, that wasn’t much more difficult. In a letter dated June 11, 1991, Enron asked the SEC not to object to Enron’s new choice of accounting methodology. Among Enron’s arguments was that “as a trader” Skilling’s new business “creates value and completes its earnings process when the transactions are finalized” and that “other commodity trading businesses which are analogous” used mark-to-market accounting. Enron included a missive from its accountants at Arthur Andersen stating that mark-to-market accounting was indeed preferable.

Over the next six months, at least eight letters were exchanged between the agency and the company, and two meetings between Skilling and other Enron representatives and the SEC staff took place. A review of the correspondence shows that the SEC was focused on a key issue: how would Enron estimate price? The agency even suggested that Enron consider some additional disclosure to investors in its financial filings until it got a better sense of the reliability of its estimates. Enron resisted, asserting that mark-to-market earnings would be calculated based on “known spreads and balanced positions” and that its numbers would not be “significantly dependent on subjective elements.” At which point, the SEC essentially caved.

On January 30, 1992, the SEC told Enron that it would not object to the use of mark-to-market accounting beginning that year. On getting the word, Skilling was ecstatic. He quickly gathered his troops in the conference room of the thirty-first floor, where his group had its offices. To celebrate, he brought in champagne: champagne to toast an accounting change! By 2
P
.
M
.
, most of Skilling’s staff, which numbered around 50, were reveling in the celebration.

And then Enron did something quite telling. Less than two weeks later, on February 11, Enron sent the SEC a letter informing them that it had decided that the “most appropriate period” for the adoption of mark-to-market accounting was not 1992 after all. Rather, Enron wrote the agency that it planned to apply mark-to-market accounting to the year that had just ended: 1991. Since Enron had not yet filed its financial statements for 1991, it could now do so using the new accounting methodology. Enron said the impact on earnings was “not material.” In the big picture, that was true: Enron reported $242 million in earnings that year. But earlier in the year Skilling’s division had estimated that its mark-to-market earnings for 1991 transactions would be about $25 million. That number, assuming it held up, amounted to half the profits in Skilling’s new division.

 • • • 

There was one last lingering issue: Bankers Trust. Practically from the moment Skilling brought Bankers Trust in, he regretted it. He hated the way the New York bankers treated the Texans like rubes. He hated even more the fact that he had agreed to give such a large percentage of Enron’s trading profits to Bankers Trust, especially once he decided that his team didn’t really need the bank’s expertise in derivatives. He and his group could learn how to do it themselves—
indeed, they
were
learning how to do it themselves.

Bankers Trust felt the same way about Enron: why did they need to be in partnership with these guys when they could run their own trading operation and keep
all
the profits? They were contemptuous of the Enron traders and too arrogant to hide it. They would openly complain that they were working with neophytes. Meetings soon deteriorated into pitched battles about who was assuming what risk and how much each of the partners should be compensated.

Finally, in June 1991, Bankers Trust decided to pull out of the deal. In retrospect, it was a foolish move, given the extent to which Enron soon dominated the natural-gas trading business—and the sweet deal Bankers Trust had extracted from Skilling. And the Bankers Trust executives only compounded their mistake by the way they went about their departure. They did it in the dead of night, without ever informing anyone at Enron, and as they walked out the door they pulled a dirty trick. Knowing the bank was going to walk away from Enron, one of its executives called in a junior employee named Kevin Hannon and ordered him to delete all the files containing the trading information. Over one summer week-
end, Hannon did just that. He then jumped on a plane and flew back to New York.

On Monday morning an Enron executive named Lou Pai came running up to Skilling. “Those fuckers,” he yelled. “They erased all the tapes!”

“Who?” asked a surprised Skilling.

“BT,” replied Pai. “They’re gone!” It was a crisis but not a protracted one. An Enron employee worked around the clock for the next month to rebuild the files, and the Enron trading desk was in the black by July. Never again did Jeff Skilling involve an outside party in his trading operation. “This is
our
business,” he thought. And it was.

Even as Jeff Skilling was beginning to build one part of the new Enron, a second executive was etching out another new part of the company. He was every bit as aggressive as Skilling and every bit as arrogant. He also ran his division with every bit as much autonomy—more, actually. For years, he managed a billion-dollar portfolio of Enron projects from offices near his home in the Woodlands, 30 miles north of downtown Houston, and simply refused all entreaties that he move his operation to the company’s headquarters. In his fiefdom, he demanded total loyalty—to himself, not Enron.

In other ways, though, he and Skilling could not have been more different. He had not the slightest interest in intellectually pure theories; he viewed himself as being a part of the rough-and-tumble, focused only on getting the job done, whether it was building a power plant or completing a deal. He had about him an aura of mystery, which he encouraged. He was loud and profane, and though he had it in him to kill with kindness, he had no qualms about browbeating people into submission. His personality was volcanic. His name was John Wing, and the division he helped create was eventually called Enron International. In time, the part of the company he started became one the linchpins of the modern Enron. Wing, though, was long gone by then.

To a large extent, John Wing is the forgotten man of the Enron saga. On one level, that’s completely understandable: he left the company nearly a decade before Enron imploded, so one could hardly blame him for what happened. When Enron was flying high, Wing’s contributions were also usually ignored; his eventual successor at Enron International was his former protégé and lover, a woman named Rebecca Mark, who, in the mid-1990s, was the single most glamorous figure at the company and hardly the type to deflect credit to her ornery predecessor.

But internally, the Enron old-timers never forgot John Wing. With his over-the-top personality, Wing was a mythic figure, by far the most memorable character of Enron’s early days. He was also a genuine moneymaker. At a time when nothing else was working, Wing’s early deals brought the company badly needed cash. His greatest triumph, a landmark power project in England called Teesside, pushed Enron onto the world stage and gave it credibility and profits—real profits, not the mark-to-market kind—that the company milked for the next decade. It was Enron’s first international development deal, and while the company did dozens of such ventures in the years that followed, none earned nearly as much.

This is not to say that people at Enron
liked
John Wing. On the contrary: many of the company’s executives loathed him. They viewed him as a master manipulator who took care of himself first. He was so divisive a figure yet so valuable that he was cut loose—and brought back—three separate times. After each parting, Wing somehow emerged with an even richer deal than he had before. His ultimate take from the company exceeded $25 million.

None of this was lost on other Enron executives, including Skilling and Mark. Wing was Enron’s first true prima donna. He was the first Enron executive to get genuinely rich, the first to insist that he get a piece of the projects he developed, the first to bully Lay into letting him do whatever he wanted, and the first to see Enron not as a place for a long, happy career but rather as a place for mutual exploitation. He was hardly the last. Other executives saw what Wing got away with and realized they could do whatever they wanted, too.

“I can be your greatest friend or your worst enemy,” John Wing liked to tell new acquaintances. At Enron, he was both.

 • • • 

John Wing is 57 now and semiretired, tending to his many investments and moving with the climate from his home base in suburban Houston to his cabin in Aspen to his winter residence in Hawaii to a sprawling farmhouse he owns in upstate New York. Even in semiretirement, though, he hasn’t exactly mellowed. With his booming voice, craggy features, and bulldoglike build, he remains a physically intimidating man, even though he stands less than six feet tall. A West Point graduate, he laces his conversation with the kind of moral certainties one typically associates with military men: “Never,
ever
abandon your wingman.” And: “Never,
ever
do the easy wrong instead of the harder right.” His bluntness can be startling. His judgments are fierce and unyielding, and when it comes to
much of Enron’s old senior leadership, largely unflattering. And though he firmly believes that Lay made a huge mistake in finally letting him go in 1991, he
also understands why his departure was inevitable. As he once put it in an interview, “I’m basically unemployable and a pain in the ass inside the corporate culture.”

The son of a farmer and schoolteacher from upstate New York, Wing went to both West Point and Harvard Business School, where, like Skilling, he graduated a Baker Scholar. In the army, he flew intelligence missions in Vietnam, leaving active duty in 1973 with the rank of captain and a Bronze Star. One result of his military background was that he preferred hiring other military men at Enron: they thought the way he did and knew how to get things done. Wing’s intelligence background also helped create a sense of danger and intrigue, which he reveled in. From time to time, he’d simply disappear from Enron’s offices, stirring rumors that he was off on a secret mission for the CIA.

Wing hooked up with Lay at Florida Gas in 1980 at the age of 34, shortly after earning his MBA from Harvard. Though they were hardly kindred spirits, the two men became friends. They lived just a few houses apart from each other in Winter Park, their wives were close, and their children played together. When Lay got his divorce, Wing served as his court witness. After Lay left for Transco, Wing took a job at General Electric, developing power plants for the company’s new CEO, Jack Welch. Lay hired him again, as senior vice president in charge of strategy, shortly after taking over at HNG. It was in that capacity that Wing negotiated the merger with InterNorth, essentially picking the larger company’s pockets.

That negotiation was classic Wing and a good part of the reason Lay liked having him around. He could move fast and decisively. He fought for every inch of advantage. He was a cunning negotiator and hard-nosed adversary. And he was absolutely fearless. “John has balls of steel,” says one former deputy. “If you were on the other side of the table, there was hell to pay.” Wing was also relentless. No one was better at ramrodding a deal or a project through to completion; Wing blew through deadlocks like a load of TNT clearing a beaver dam.

Wing used his volcanic personality as a tactical weapon, especially in the middle of a deal. Lawyers drove him crazy. He once gave a speech advising anyone who wanted to complete a power project to “get all the lawyers in one room, then shoot ’em—in the
mouth,
because it’s impossible to miss.” In late April 1985, he was in New York, baby-sitting the legal teams rushing to tie up final details of the InterNorth merger so the deal could be publicly announced. When progress ground to a halt, Rich Kinder roused Wing from his hotel bed in the middle of the night. Dressed in his workout clothes, Wing stomped into the Wall Street offices where the 30 lawyers from the two sides filled a conference room. “Let’s play a little game here,” he began. “Let’s all get up and stretch. Now everybody who is trying to get this deal done, go to this end of the room. Everyone who is trying to fuck this thing up, go to that end of the room.”

Even apart from the HNG-InterNorth negotiations, Wing had more than proved his worth to Lay. Since the early 1980s, Lay had been eager to invest in cogeneration projects—plants that not only provided electric power but also captured the heat from the plant’s turbines for sale as steam, typically to an industrial facility adjacent to the plant. A well-designed cogen project was clean and profitable and far more efficient than a conventional plant that ran on coal or fuel oil. It also, of course, provided a big new customer for natural gas.

Soon after Wing joined HNG, he’d gotten the company into the cogen business. Within a few years, Wing had brought Enron into three cogen projects: two in Texas, one in New Jersey. All were big moneymakers, not just for Enron but for Wing himself. He insisted on getting a small piece of each project. Lay, in a pattern that repeated itself over and over, acceded to his demand. Wing’s payout amounted to $100,000 or more annually for each plant for up to 20 years. There was, however, one noteworthy difference between Wing’s deal and the many deals Lay cut with other executives in later years. For Wing to get his maximum payout, the cogen plants first had to do well for the company: in this case, they needed to return at least 25 percent annually on Enron’s investment. In fact, all three plants racked up much bigger returns. As Wing later put it, “If I didn’t produce hugely for the shareholders, the compensation was extremely pedestrian. If I did produce hugely for the shareholders, there was something in it for me.”

 • • • 

Just weeks after the HNG-InterNorth merger closed, Wing made the first of his many trips through Enron’s revolving door. Citing Omaha-Houston corporate politics, Lay told Wing that he wasn’t going to be able to give him the job of running the combined company’s power business. That job, Lay said, had been promised to an InterNorth executive. Instead, Lay offered Wing the job of presiding over the company’s pipelines. Wing said no; pipelines were too boring.

Part of Wing’s canny genius was knowing when he was in a position to employ maximum leverage. “Always make it about the other guy, never about yourself,” Wing liked to say. By that he meant that a good negotiator needs to create a set of possible outcomes that allow him to win no matter what the other side does. And so it was here. Wing told Lay that it was completely up to the CEO to decide who should get the power-business job. It didn’t matter to him one way or the other. But since the choice Lay had made required him to break Wing’s employment contract, the Enron CEO would have to pay him to go away. Wing negotiated a two-year consulting agreement that raised his guaranteed pay to $265,000 a year, included all the stock options and club memberships he’d been promised as a company executive, and maintained his payout on the existing projects. (Not that Enron was Wing’s only source of income. By then, he had already made the first of many investments that produced a fortune, betting $15,000 on a friend who was launching the Boston Beer Company. After the brewery introduced Sam Adams beer and went public, Wing’s stake was worth millions.)

Six months later, Lay called again. The company’s fourth cogen investment, a new plant in Texas City launched by the former InterNorth executive, had stalled. Lay gave Wing a new consulting deal, including an additional $10,000 a month, a $250,000 bonus for arranging the plant’s financing, up to $150,000 a year from its future profits, and more stock options. Wing completed the financing within a year.

In August 1987, Wing became an Enron employee again, this time as chairman and CEO of the company’s new cogeneration division. Now he got a five-year deal at $300,000 annually plus a 5 percent stake in the business in addition to his continuing share in all the projects. This, too, didn’t last long. By April 1988, Enron was reeling from the combined effects of the take-or-pay crisis, shrinking margins in its pipeline business, and the Enron Oil debacle. Desperate for cash, Lay decided to sell half the cogen company, whose value had soared in a matter of months. The deal with Virginia-based Dominion Energy generated $90 million for Enron and triggered a $9 million buyout for Wing. And that wasn’t all. Because Dominion didn’t want Wing to run the business, Enron also paid him under a termination agreement, giving him $400,000 a year for five years plus a consulting agreement that gave him a stake in any new investments he brought in.

Enron’s joint venture with Dominion was a bust. Part of the problem was that as cogeneration plants caught on, other companies raced to build them, so there was soon a glut of competition. Inevitably, the easy profits had dried up. The Enron-Dominion group didn’t build a single power plant; within a year, the two companies parted ways.

Even before the Dominion deal went south, Wing had begun looking elsewhere for deals. One of his strengths as a businessman was his shrewd sense of where opportunity lay. He could see that the U.S. cogen business was getting tougher. To Wing, the next big opportunity—the place where Enron could make a spectacular amount of money—was not in the United States but abroad. Specifically, it was in an industrial region in northeast England known as Teesside. England: where coal was king, where power plants were built by state-owned British utilities, and where gas-fired plants were not only unheard of; they were
illegal.
But never mind all that. John Wing was convinced that the best prospects were in England, so that’s where he headed. He was going to build a gas-fired cogeneration plant at Teesside, and not just any gas-fired cogeneration plant. He was going to build the biggest cogen project the world had ever seen: a 1,825-megawatt monster, big enough to supply 4 percent of the electricity needs for the entire United Kingdom. The estimated cost was $1.3 billion.

Had Wing lost his mind? Not at all. He was making a contrarian bet, to be sure, but one that was rooted in powerful logic and exquisite timing. What he realized was that England was poised to begin deregulating its energy industry, just as the United States had done a decade before. Ronald Reagan’s great ally, Prime Minister Margaret Thatcher, was still in power, rapidly moving her country away from government monopolies and toward free-market economics. An American company that got in early—a company that was willing to work with the government—would serve as the poster child for the benefits of privatization. Wing thought Enron ought to be that company.

Sure enough, a deregulation measure passed Parliament in 1989, and the Teesside project quickly assumed the role of privatization showcase. Wing knew better than to try to go it alone on foreign soil, so he partnered with the British chemicals giant, ICI, which had a huge industrial complex in the region. That one relationship gave the project instant credibility. Realizing the importance of staying on the right side of government officials, many still leery of deregulation, Wing and Lay skillfully courted influential players in England, most notably John Wakeham, Thatcher’s secretary of state for energy. (Lord Wakeham joined Enron’s board after his retirement from public service.) Enron became a million-dollar supporter of Prince Charles’s favorite charity, The Prince’s Trust. Wing lunched in England with the Prince of Wales, who toured Teesside after it was built; Prince Charles later attended a fund-raising lunch at Ken Lay’s home in Houston.