Chapter Thirteen

Ken Lay
– Friends in High Places

Ken Lay’s memorial service was some event. More than 1,000 mourners gathered on Wednesday 12 July 2006 at the First United Methodist Church, Houston, including former president George Bush and his wife Barbara, and former US secretary of state James Baker. Also present were ex-secretary of commerce Robert Mosbacher, former Enron president John Seidl, and Drayton McLane, owner of the Houston Astros baseball team.

The Reverend William Lawson, a Houston civil rights leader, addressed the congregation with some strong words, likening Lay to James Byrd, a black man who was dragged to death in a racially motivated murder near Jasper, Texas, in 1998. ‘Ken Lay was neither black nor poor, as James Byrd was,’ said Lawson, ‘but I’m angry because Ken was the victim of a lynching’.

A friend of the Lay family went on to describe Ken as a ‘good, honest, God-fearing friend who did not have a criminal bone in his body.’ He added: ‘What really makes me sad today… is that Ken may not be remembered for these enviable qualities. Instead, many will remember him for the Enron bankruptcy, the indictment and the trial. Overzealous federal prosecutors and media have vilified an exceedingly good man’.

It is more likely than not that Lay will be remembered for his criminal role in the bankruptcy of the once-mighty Enron Corporation, of which he was head man. Found guilty, alongside former Enron chief executive Jeffrey Skilling and others, of conspiracy and fraud, Lay was due to be sentenced when he died of heart failure in Aspen, Colorado, on 5 July 2006. He was 64.

Kenneth Lee Lay was born in 1942 in Tyrone, Missouri, a so-called bellwether state in the United States on account of its mirroring the demographic, economic and political make-up of the nation. It was a modest upbringing. Lay’s father was a Baptist minister and tractor salesman, but the pair shared a work ethic and intellect.

Lay was president of his fraternity at the University of Missouri, where he graduated with economics qualifications in 1965. He then worked as an economist at Exxon Mobil, before successfully completing a PhD in economics at the University of Houston, Texas, in 1970. This was a man who understood numbers.

Before embarking on his business career, Lay turned to politics. He was a technical assistant to the commissioner of the Federal Energy Regulatory Commission and later deputy under secretary for energy of the US Department of Interior. Also while in Washington, Lay was an assistant professor at George Washington University, teaching graduate courses in micro- and macro-economic theory and government–business relations.

While this background is impressive on some levels, it is not the sort of knowledge and experience that automatically leads to success as an entrepreneur. Being highly numerate and a great business brain are different things entirely – something Lay, Enron and the wider business world would find out soon enough.

Back then, Lay was amazed by the inefficiency of America’s natural gas market. In the 1970s, US regulators did not allow interstate pipelines to pay more than 20 cents per thousand cubic feet for gas. When they were outbid by unregulated state pipelines, the regulators did not raise the maximum price threshold. Instead, they imported gas from Algeria at 10 times the domestic price. By the late 1970s, this system was on the brink of collapse, with gas shortages resulting in schools and hospitals going unheated. It did not take a PhD to spot the opportunity. Economics master Lay lobbied hard for deregulation of the market.

At the same time, he was a strong supporter of George W Bush in his efforts to become governor of Texas. When Bush was elected, Lay benefited from a law that deregulated the Texas electricity markets. Lay continued to support Bush and Cheney in their bid for the White House, becoming a so-called ‘Pioneer’, a supporter who collected more than US $100,000 for the campaign. He also let Bush and Cheney use his personal Enron jet to woo voters. And around the same time, during the early 1980s, he entered the world of business with the aim of capitalizing on his groundwork.

Lay took the position of president of the Continental Resources Company before joining Transco Energy Company in 1981 as president, chief operating officer and director. He joined small pipeline business Houston Natural Gas in June 1984 as chairman and chief executive officer. When it merged with Omaha-based InterNorth, Lay took the helm and the company name was changed to Enron. That was 1985.

In 1989, thanks to deregulation, Enron began to trade natural gas and the company thrived. By 1992 Enron was the largest dealer in natural gas in North America. Over the coming decade it built up a bewildering array of assets in the energy sector.

It owned a large network of natural gas pipelines that stretched across the United States, including Northern Natural Gas, Florida Gas Transmission, Transwestern Pipeline Company and a partnership in Northern Border Pipeline from Canada. It also owned pipelines in Colombia, Argentina, Bolivia and Brazil. Enron owned or operated 38 electric power plants worldwide, including in the United Kingdom, throughout Central and South America, in mainland Europe, China and India. It owned wind-generation facilities, hydroelectric and thermal plants. It also moved into paper, pulp and recycling facilities, operated a timber company in Canada and ran an oil and gas exploration, development and production business.

It is hard to say what gave Lay the confidence to diversify in this way. In November 1999 Enron launched an online trading platform called EnronOnline, enabling the company to further develop and extend its abilities to negotiate and manage its trading business. It also launched a service to enable people to trade in the United States’ spare broadband capacity.

By 2001, Enron had become a conglomerate that owned and operated gas pipelines, electricity plants, pulp and paper plants, broadband assets, and water plants internationally, and traded extensively in financial markets for the same products and services.

The impact on the share price was huge: Enron’s stock increased by 56 per cent in 1999 and 87 per cent in 2000. In August 2000, at the height of the dotcom boom, Enron’s stock price hit an all-time high of US$90.56 and its market capitalization exceeded US$60 billion, 70 times earnings and six times book value. Enron was rated the most innovative large company in America in Fortune’s Most Admired Companies survey for six consecutive years, from 1996 to 2001. Yet on 2 December 2001, Enron filed for Chapter 11 bankruptcy: the biggest in US history. More than 4,000 people lost their jobs, and entire life savings went up in smoke. The stock price fell to US$0.10, losing investors something like US$11 billion.

The collapse caused the dissolution of Enron’s auditors Arthur Andersen, which at the time was one of the five largest accounting firms in the world. The criminal charges that followed Enron’s demise lead to the US government introducing the Sarbanes–Oxley Act in 2002, significantly raising criminal penalties for securities fraud, for destroying, altering or fabricating records in federal investigations, or any scheme or attempt to defraud shareholders.

The shame of this story is the tens of thousands of innocent men and women who were caught up in the fallout from the deceit – not only Enron employees, but those at Arthur Andersen and all those at supplier companies who relied on global behemoth Enron for their monthly pay cheque. Ken Lay went to his grave professing his innocence, blaming others, as well as the media, and talking about God. It is odd how many failed business leaders cite God in their defence. Perhaps the enormity of Lay’s crimes meant that it was too much for him to bear alone. The fact that he went into business with good intentions – and did some charity work along the way – maybe led Lay to hope that he would be able to redeem himself in front of his Maker. The man was mistaken. There were early signs that Lay’s management style, and his ability to hire the right people, had serious faults.

In 1987, two Enron traders got into trouble by betting on the oil markets, resulting in consistent and suspiciously high profits for Enron. The CEO of that business, Louis Borget, was also discovered to be diverting company money to personal offshore accounts. Yet Lay did not fire or discipline them. Instead, he encouraged them to ‘keep making us millions’, as they were making profits for the otherwise struggling company. Further bigger gambles almost cost Enron dear, and the two were finally sacked and later convicted for their crimes. Lay, meanwhile, denied having any knowledge of their activities.

In 1990, Enron hired former McKinsey consultant Jeff Skilling. During his admissions interview for Harvard Business School, he was asked if he was smart, to which he allegedly replied ‘I’m f****** smart.’ We shall see.

Skilling joined Enron on the condition that it begin using so-called mark-to-market accounting, allowing Enron to book potential profits on certain projects immediately after the deals were signed, whether or not those projects turned out to be successful. This gave the impression that the business was highly profitable, even if that was not true. It was a bizarre way to go about business management, and it was a decision that would prove the firm’s undoing.

One of the company’s biggest failures was the construction of the Dabhol Power Plant in India. Ultimately, Enron was forced to abandon the plant when it turned out that India could not afford the power Enron was producing, losing the firm US$1 billion. But using mark-to-market accounting, Enron reported profits from the Dabhol project that never arrived. Economics master Lay must have realized what was happening.

One of Skilling’s favourite books at Harvard was said to be The Selfish Gene by Richard Dawkins, about how humanity survives by genetically passing on greedy and competitive traits. It is said that Skilling institutionalized this worldview at Enron, establishing a performance review committee that graded Enron’s employees and annually fired the bottom 15 per cent, who were deemed unsuitable for the company’s objectives. While charismatic, Skilling was also ‘very, very intimidating’, according to one former employee. ‘You were certain he was just the brightest guy around, but in hindsight I really feel we were somewhat like cult followers’.

Another Enron employee who helped cause the firm’s demise was chief financial officer Andrew Fastow. On 28 June 1999, Enron’s board of directors exempted Fastow from the company’s code of ethics so that he could run a private equity fund, called LJM1, that would raise money for and do deals with Enron. It was a tool that allowed Enron to manage its balance sheet and make investors think that it was performing better than it was. On 12 October 1999, the board again exempted Fastow from Enron’s code of ethics so that he could raise money for another fund, LJM2. Fastow went on to devise all manner of off-balance-sheet schemes that hid losses in the company. It is difficult to accept that Lay was unaware of any of it.

It is yet another example of ‘clever financial engineering’ – a precursor to the credit crunch. In the meantime, Enron traders were working out more complex ways to make money. One of these was to manipulate the California energy market, a policy that made Enron a great deal of money but that brought rolling power blackouts to the state.

While the list of dubious employees could run and run, it is worth mentioning Lou Pai, the CEO of Enron Energy Services (EES). The Chinese-born Pai was renowned for his ruthlessness – Skilling called him ‘my ICBM’ (that is, an intercontinental ballistic missile). Yet Pai was also notorious for using money from Enron to feed his habit of visiting strip clubs, and for allegedly inviting strippers into his office and onto the Enron trading floor. He resigned abruptly from EES with a US$250 million pay-off, even though the divisions of Enron he formerly ran lost a total of US$1 billion. Pai later divorced his wife and married a stripper.

It is odd that Lay, this man of God, would allow this kind of behaviour from a senior executive. It seems as though the fact that Lay made a lot of money for the company got him off the hook. Is that what it taught in Lay’s Bible? Throughout all these shenanigans, Lay was in charge of Enron. The idea that he did not know what was happening, that he was somehow insulated from all these major transactions, is laughable.

But while Skilling was aggressive and Pai a womanizer, it was Fastow’s creative accounting methods that would ultimately bring the company down.

It was Enron insider Sherron Watkins who first noticed something was wrong with the numbers. In 1996 she was working with Fastow. ‘I was starting to see Andy Fastow cross the line,’ she said, claiming he asked her to lie to one of Enron’s partners about an investment. ‘It should have been a huge warning flag,’ she says. Instead she moved to a different part of the business and became a vice president. In 2001, though, she was working for Fastow again. This time, she stumbled across evidence of massive fraud.

Watkins was looking at an Excel spreadsheet listing 200 assets that Enron wanted to sell to raise cash. Against half a dozen, she saw the name ‘Raptor’. This referred to complex off-the-books partnerships used to hedge assets. ‘I was seeing hundreds of millions of dollars in the loss column. I mean you couldn’t do the math, it didn’t work’. Watkins wrote a memo to Lay outlining her fears that Enron might ‘implode in a wave of accounting scandals’. An internal investigation dismissed her claims.

Enron’s dubious accounting and reporting was gaining ever more interest from financial journalists and analysts. When questioned, the top brass were aggressive, dismissive and derisory about their accusers. In fact, for any aspiring journalist, this aggressive and dismissive reaction to questioning is a sure sign something is up.

Time and time again, Lay reassured investors and employees that there were no problems. In fact, Lay regularly encouraged employees to invest in Enron stock even as it was falling from its US$90 peak – at the same time that he, his wife, and the likes of Skilling were furiously selling off millions of dollars worth of stock in secret. On 26 September 2001, Lay told Enron employees that the firm’s stock is an ‘incredible bargain’ and that the ‘third quarter is looking great’. A month later, on 16 October, Enron reported a US$618 million third-quarter loss. It was inexcusable behaviour from Lay, and it was to prove a considerable nail in the Enron coffin.

Initially when news of the accounting problems broke, Lay continued to pledge his support for Fastow, saying he had ‘operated in the most ethical and appropriate manner possible’. The next day Fastow was booted out, and soon afterwards the Securities and Exchange Commission started a formal investigation.

While Lay attempted to sign a last-ditch deal with rival firm Dynergy to buy Enron, further downward restatements of earnings meant that it would never happen. On 23 January 2002, Lay resigned as chairman and CEO of Enron.

The court cases and charges soon came. Fastow was indicted on 78 charges of conspiracy, money laundering and fraud. He was convicted and jailed for 10 years. (His wife got one year for filing a false tax report.) Skilling pleaded not guilty to wire fraud, securities fraud, conspiracy, insider trading and making false statements on financial reports. He got 24 years in prison. Various others were charged and convicted. Others committed suicide. Enron had gone from America’s seventh-largest company to nothing: it was a bloody mess.

When, in 2002, the Enron issues came before a US Senate Commerce Committee, Lay, who was boldly stating he had done nothing wrong, pleaded the Fifth Amendment. He told the committee, ‘I respectfully ask you not to draw a negative inference because I am asserting my Fifth Amendment constitutional protection on instruction of counsel.’

The committee was not happy. Senator Ron Wyden summed it up: ‘The fact of the matter is, it’s just not possible to determine why the Enron ship is at the bottom of the ocean unless you hear from the captain.’ Senator Byron Dorgan added, ‘The bankruptcy of this corporation is not a garden-variety business failure. It’s a bankruptcy framed by very serious questions about the behavior of officers, directors and the accounting firm that audited the corporation’s books.’ Senator Peter Fitzgerald pitched in with ‘Mr Lay, I’ve concluded that you’re perhaps the most accomplished confidence man since Charles Ponzi.’

As it turns out, Lay’s heart attack proved a financial boon for his family. With no one to pass sentence on, the charges were thrown out and the family got to keep the money they made from the fire sale of Enron stocks. The Lord does indeed work in mysterious ways.

Throughout the whole Enron saga Ken Lay was central. A friend of the Bush family (George W famously referred to him as ‘Kenny boy’) and a keen philanthropist, Lay was famed for ‘an avuncular manner that endeared him to employees, business partners and politicians alike’. He was most often described as grandfatherly. Lay said he took responsibility for Enron’s collapse, but bizarrely, denied that he had done anything wrong. ‘I continue to grieve, as does my family, over the loss of the company and my failure to be able to save it,’ he said. ‘But failure does not equate to a crime’.

Lay added, ‘I lived my life in a certain way to make sure that I would never violate any law, certainly never any criminal laws, and always maintained that most important to me was my integrity, was my character and my values.’ Jurors in the trial didn’t agree. They said that neither Lay nor Skilling showed much in the way of humility on the stand. Prosecutor Kathy Ruemmler agreed. She said that their ‘extraordinary arrogance’ is the ‘exact same tactic that they used when they were running Enron’ (McLean and Elkind, 2006). In the end, they were found out.

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