Enron
Travel back with us to the granddaddy fraud of them all, 2001’s then-largest bankruptcy in US history and the impetus for the famous Sarbanes-Oxley Act.
Recorded when the FTX fraud was dominating headlines. Ben and David debated if and how Acquired could uniquely add to the conversation. Then they realized there was an angle so perfect that we had to drop everything and enter Acquired research overdrive: Enron. Travel back to the granddaddy fraud of them all, 2001’s then-largest bankruptcy in US history and the impetus for the famous Sarbanes-Oxley Act. So much of Enron’s history parallels FTX that the uncanniness is almost unbelievable — right down to the same CEO running the two bankruptcies.
Company Overview
Company Name: Enron Corporation
Founding Year: 1985 (formed from the merger of Houston Natural Gas and InterNorth)
Headquarters Location: Houston, Texas
Core Business and Significance: Enron began as a natural gas pipeline company but evolved into a financialized energy trading firm, pioneering spot and derivatives markets for energy commodities. Its significance lies in its meteoric rise as the seventh-largest U.S. company by market cap and its infamous collapse in 2001, which exposed massive accounting fraud and led to the Sarbanes-Oxley Act.
Timeline
1973–1979: Energy crises, including the OPEC oil embargo, triple energy prices, crash the stock market, and trigger a recession, setting the stage for energy market deregulation.
1978: President Jimmy Carter signs the National Energy Act, initiating deregulation of the natural gas industry.
1982: Kenneth Lay, at Transco Energy, pioneers a spot market for natural gas, a significant innovation in energy trading.
1984: Lay becomes CEO of Houston Natural Gas (HNG), a major publicly traded energy company.
1985: InterNorth acquires HNG for $2.3 billion at a 40% premium, forming the basis for Enron; Lay maneuvers to gain control, with headquarters later moving to Houston.
1986: The combined company rebrands as Enron, dropping the initial name “Enteron” after discovering it means “intestinal digestive tract.”
Late 1980s: Enron faces its first trading scandal, with two New York traders embezzling funds and later racking up nearly $1 billion in losses; Lay opts not to fire them initially.
1990: Jeff Skilling joins Enron from McKinsey to lead the Enron Finance division, insisting on mark-to-market accounting as a condition.
1991–1992: Enron convinces the SEC to allow mark-to-market accounting, becoming the first non-financial company to do so, enabling revenue recognition of projected future cash flows.
1996–2001: Enron’s revenues grow 7.5x from $13.3 billion to over $100 billion, fueled by mark-to-market accounting and special-purpose entities (SPEs); named Fortune’s “Most Innovative Company” six years in a row, including 2001.
1997: Enron expands into electricity, water, and bandwidth trading; launches Enron Energy Services (EES), staging a fake “war room” to impress analysts.
1999: Enron launches Enron Online, an electronic trading platform where it acts as the counterparty to every trade; CFO Andrew Fastow campaigns for CFO of the Year.
2000: Enron’s stock peaks at $90 per share; the company rebrands as “the world’s leading company”; Skilling negotiates a $20 million payout if not made CEO by year-end.
September 2000: Short seller Jim Chanos questions Enron’s financials, sparking scrutiny.
March 5, 2001: Bethany McLean publishes “Is Enron Overpriced?” in Fortune, highlighting opaque financials.
April 17, 2001: On an earnings call, Skilling calls analyst Richard Grubman an “asshole” for questioning the lack of a balance sheet with earnings reports.
August 2001: Skilling resigns as CEO, citing “personal reasons”; Lay resumes the CEO role.
September 12, 2001: Enron’s commercial paper fails to turn over, signaling a liquidity crisis, exacerbated by the 9/11 attacks.
October 12, 2001: Arthur Andersen begins shredding Enron-related documents.
October 16, 2001: Enron reports $638 million in losses and restates $1.2 billion in shareholder equity due to improper SPE accounting.
October 22, 2001: The SEC launches an inquiry into Enron’s accounting.
October 23, 2001: Fastow is fired after revealing $60 million earned from LJM partnerships.
November 9, 2001: Dynegy agrees to acquire Enron for $8 billion in stock, lending $1.5 billion secured by Enron’s pipelines.
November 28, 2001: Dynegy cancels the acquisition after discovering Chewco’s improper accounting; Enron’s stock falls to 61 cents; Lay’s wife sells 500,000 shares minutes before the news.
December 2, 2001: Enron files for Chapter 11 bankruptcy, the largest in U.S. history at the time, with $63 billion in assets.
2002: Sarbanes-Oxley Act is passed, reforming corporate accounting practices.
2005–2006: Lay and Skilling face trial; Skilling is convicted on 19 of 28 counts, Lay on 6 counts; Lay dies of a heart attack before sentencing; Skilling is sentenced to 24 years, later reduced to 14.
2008: Enron’s bankruptcy proceedings conclude, distributing $6.79 per share to equity holders from $7.2 billion in bank settlements.
Narrative
Enron’s story, as narrated by Ben and David, is a gripping saga of ambition, deception, and collapse, set against the backdrop of deregulated energy markets. Born from the 1985 merger of Houston Natural Gas (HNG) and InterNorth, Enron was led by Kenneth Lay, a PhD economist whose early career embodied the American dream. Rising from rural poverty in Missouri, Lay leveraged his industry and government experience to pioneer a spot market for natural gas at Transco Energy in 1982, capitalizing on the 1978 National Energy Act. This act, spurred by the 1970s oil crises that tripled energy prices and plunged the U.S. into recession, deregulated natural gas, enabling Enron’s transformation. Lay’s ascent to CEO of the merged entity, rebranded as Enron in 1986 after a naming mishap, positioned Houston as the epicenter of a new energy era. The hosts convey this period with enthusiasm, portraying Lay as a charismatic visionary before his ethical lapses surfaced.
The narrative takes a darker turn with Jeff Skilling’s arrival in 1990, a McKinsey consultant who insisted on mark-to-market accounting to join Enron. This method, approved by the SEC, allowed Enron to recognize 20 years of projected cash flows as immediate revenue, creating a financial house of cards. Skilling’s “gas bank” concept turned Enron into a derivatives trading powerhouse, moving beyond pipelines to financialize energy commodities. Ben and David adopt a critical tone, likening Enron to “American Psycho in Houston,” as Skilling and CFO Andrew Fastow used special-purpose entities (SPEs) to hide billions in losses and debt. Fastow’s LJM partnerships, named after his wife and children, epitomized self-dealing, enriching executives while deceiving investors. The hosts marvel at the audacity, detailing how Enron’s revenues soared from $13.3 billion in 1996 to over $100 billion in 2000, earning it Fortune’s “Most Innovative Company” title six years running, including 2001.
Enron’s expansion into electricity, water, and bandwidth trading, including a failed Blockbuster video-on-demand deal, and the 1999 launch of Enron Online, fueled its meteoric rise. However, the hosts emphasize the fragility of this growth, driven by accounting manipulations rather than value creation. Infamous episodes, like the staged Enron Energy Services “war room” in 1997 and California energy market manipulation causing blackouts, reflect Enron’s ethical decay. By 2001, scrutiny from short seller Jim Chanos and reporter Bethany McLean exposed Enron’s opaque financials, with Skilling’s earnings call outburst signaling mounting pressure. His August 2001 resignation, followed by the SEC’s inquiry and Dynegy’s failed $8 billion acquisition, led to Enron’s December 2001 bankruptcy—the largest in U.S. history at the time. The episode’s tone shifts to reflective, noting the Sarbanes-Oxley Act’s reforms and the irony of a $6.79 per share payout to equity holders in 2008 from bank settlements, highlighting Enron’s legacy as a cautionary tale of hubris and misaligned incentives.
Notable Facts
Market Position: Enron was the seventh-largest U.S. company by market cap, trading at 55x trailing earnings in March 2000, compared to 17x for Goldman Sachs and 22x for Duke Energy.
Innovation Facade: Named Fortune’s “Most Innovative Company” six years (1996–2001), despite growth driven by accounting fraud.
Political Connections: Lay’s ties with the Bush family included traveling with George H.W. and Barbara Bush on an Enron jet for George W. Bush’s inauguration.
Executive Enrichment: Lay sold $300 million in Enron stock, Skilling $200 million, and Fastow earned $60 million from LJM partnerships, often undisclosed.
Cultural Excesses: Trader Lou Pai’s obsession with strip clubs led to his divorce and $250 million stock sale, making him Colorado’s second-largest landholder.
Financial Metrics
Revenue Growth: Grew from $13.3 billion in 1996 to over $100 billion in 2000, a 7.5x increase, via mark-to-market accounting and SPEs.
Stock Performance: Peaked at $90 in 2000, fell to 61 cents by November 2001; 2008 settlements yielded $6.79 per share.
Debt Obligations: Reported $12.8 billion in debt in 2001, but actual obligations were $34 billion, including SPEs.
Losses and Restatements: Reported $638 million in losses in October 2001; restated $1.2 billion in shareholder equity due to SPE accounting errors.
Bankruptcy Scale: Filed with $63 billion in assets; left $1 trillion in claims to 30,000 creditors, with Citigroup claiming $5 billion.
Shareholder Base: Had 1.5 million shareholders at bankruptcy.
Data Gaps: No user metrics (e.g., pipeline customers, Enron Online users) discussed in the episode.
Transaction
The episode did not focus on a single deal, but discussed many. Below are the details of the last ditch effort deal with Dynegy:
Transaction Details: In November 2001, Dynegy agreed to acquire Enron for $8 billion in an all-stock deal, lending $1.5 billion in cash secured by Enron’s pipeline assets. The deal collapsed on November 28, 2001, after Dynegy discovered improper accounting in the Chewco SPE.
Strategic Rationale: Enron sought the acquisition to avert bankruptcy amid a liquidity crisis, as its commercial paper failed to turn over. Dynegy aimed to acquire Enron’s valuable pipelines, but hidden liabilities led to the deal’s cancellation.
Short-Term Impact: The $1.5 billion loan provided temporary liquidity, but Enron exhausted it due to counterparty demands, leading to bankruptcy days later.
Long-Term Impact: The failed acquisition marked Enron’s end, with pipelines later acquired by Berkshire Hathaway Energy. The bankruptcy triggered Sarbanes-Oxley, and 2008 bank settlements paid $6.79 per share to equity holders.
Grading
Ben and David did not assign an overall grade, focusing instead on Enron’s fraudulent collapse rather than its business trajectory. Their critical analysis implies an “F,” as Enron’s success was illusory, built on accounting manipulations rather than sustainable value. The hosts emphasize Enron’s failure to distinguish between a company and a business, with Ben noting, “Enron makes so clear that even long after you’re a startup, it is possible to have all the window dressing around a business but not a business itself.”
Good for the World vs. Bad for the World
Good for the World: Enron’s pipelines provided reliable natural gas delivery, and its spot and derivatives markets enabled price discovery and hedging, benefiting utilities. David notes pipelines as a “cornered resource,” and Ben highlights derivatives’ utility for cost stabilization.
Bad for the World: Enron’s California energy market manipulation caused blackouts, with Ben stating, “I am confident that people died from this.” Its fraud wiped out $63 billion in assets, harmed 1.5 million shareholders, and led to Arthur Andersen’s collapse, affecting 85,000 employees. International projects, like India’s unopened LNG plant, wasted billions.
Value Creation vs. Value Capture
Ben and David note that Enron “captured far more value than it created by an order of 100–1000.”
Value Creation: Enron created some value through its pipelines, delivering natural gas reliably, and its spot and derivatives markets, enabling hedging and price stability for utilities. The Enron Online platform offered real-time trading data, though used for manipulation.
Value Capture: Enron captured immense value via mark-to-market accounting, recognizing $100 billion in 2000 revenue, far exceeding actual cash flows. Executives like Lay ($300 million), Skilling ($200 million), and Fastow ($60 million from LJM) profited massively, while shareholders and creditors lost billions. The hosts contrast this with Google (high creation, high capture) and Wikipedia (high creation, low capture), noting Enron’s unprecedented imbalance.
Powers
Ben and David discuss two of Hamilton Helmer’s 7 Powers:
Cornered Resource (Enron Online): Enron Online’s role as the counterparty to every trade provided unique market data, akin to Citadel’s model. Ben notes this could have generated alpha, but Enron’s fraud prevented sustainable advantage.
Cornered Resource (Pipelines): Enron’s pipeline network, inherited from InterNorth, was a monopoly-like asset, as David states, “You don’t build two pipelines between two locations.” This ensured stable revenue but was geographically limited.
Final Analysis: Despite these potential powers, Enron ultimately lacked sustainable powers in the Hamilton Helmer sense. The pipeline business had a cornered resource but was constrained by geographic scope, limiting scalability. Enron Online’s data advantage was undermined by market manipulation and fraudulent accounting, failing to deliver durable profitability. Ben notes, “Even in 1999, you probably would have had a hard time coming up with power,” suggesting Enron’s high valuation was driven by hype, not defensible advantages. The hosts conclude Enron’s business lacked the structural edge to earn better returns than competitors, as its “powers” were overshadowed by a fraudulent model that prioritized stock price over intrinsic value.
Playbook
Ben and David outline several playbook themes, emphasizing Enron’s fraudulent strategies and their implications:
Most of the Con Was Through Legal Means: David notes Fastow’s post-prison message that “most of what happened was through legal means,” exploiting loopholes like the 3% SPE rule. This allowed Enron to perpetrate fraud legally until Sarbanes-Oxley closed these gaps, highlighting systemic weaknesses.
Using Off-Balance-Sheet Partnerships to Conceal Debt/Losses: Enron used SPEs to hide billions in losses and $34 billion in debt, with only 3% outside capital required for independence. Ben notes this was legal pre-Sarbanes-Oxley, enabling Enron to inflate revenues and maintain a high stock price for equity issuances.
Correlated Risk: Ben emphasizes Enron’s fatal flaw of collateralizing SPEs and hedges with its own stock, creating correlated risk. When the stock fell post-9/11, all structures unraveled, as Ben states, “They end up in this correlated risk territory,” mirroring FTX’s FTT token collapse.
The Correct Amount of Leverage Is Zero: David advocates for zero financial leverage outside mortgages, as leverage inverts the risk-reward profile, making losses unlimited. Enron’s reliance on revolving credit lines and stock-collateralized debt amplified its collapse when counterparties demanded cash, illustrating why leverage is “game over” in crises.
Enron’s Fatal Flaw: Squeezing Future Cash Flows Today: Ben articulates, “Enron’s fatal flaw is that they borrowed from the future until there was no future left to borrow from.” Mark-to-market accounting allowed Enron to recognize 20 years of projected cash flows as immediate revenue (e.g., $110 million from the Blockbuster deal), creating a non-recurring revenue model. This required constant deal-making to sustain growth, as Ben notes, “You’re squeezing every amount of possible upside out of the future and into today,” leading to a zero-revenue baseline each year.
Show Me the Incentives, I’ll Show You the Behaviors: Quoting Charlie Munger, David highlights how Enron’s incentives—tying executive compensation to stock price—drove fraud. Lay ($300 million), Skilling ($200 million), and Fastow ($60 million from LJM) sold stock to enrich themselves, with board approval for Lay and Skilling, while Fastow embezzled. This misaligned incentives, as David states, “They made more from the fraud,” prioritizing stock price over business fundamentals.
These themes drove Enron’s strategy to prioritize appearances over substance, exploiting legal loopholes and market hype to sustain a high stock price. The correlated risk and leverage amplified vulnerabilities, while mark-to-market accounting created an unsustainable growth model. The hosts connect these to Powers, noting that legitimate assets were undermined by fraudulent incentives, leading to collapse under scrutiny.
Enron & FTX
Enron and FTX share striking parallels as corporate frauds fueled by bull market exuberance, yet differ in scale, structure, and regulatory context. Both companies exploited innovative facades to mask financial misconduct, capturing far more value than they created. Enron, a pipeline company turned energy trading giant, used mark-to-market accounting and special-purpose entities (SPEs) to inflate revenues from $13.3 billion in 1996 to over $100 billion in 2000, hiding $34 billion in debt. FTX, a crypto exchange, misappropriated customer funds through its hedge fund, Alameda Research, creating a $10 billion hole. Ben and David highlight the uncanniness, noting both were led by charismatic leaders—Ken Lay and Jeff Skilling for Enron, Sam Bankman-Fried (SBF) for FTX—who leveraged market hype to obscure losses.
A key similarity is correlated risk. Enron collateralized SPEs with its stock, leading to a rapid collapse when the stock fell post-9/11, as counterparties demanded cash. Similarly, FTX’s FTT token underpinned its ecosystem, and its decline triggered margin calls, unraveling the fraud. Both thrived in bull markets, with Enron’s stock hitting $90 and FTX’s valuation soaring, driven by FOMO and lax oversight. Ben notes Enron’s “borrowing from the future until there was no future left,” mirrored by FTX’s speculative crypto bets.
However, Enron’s scale dwarfs FTX’s. Enron’s 2001 bankruptcy involved $63 billion in assets and $1 trillion in claims to 30,000 creditors, compared to FTX’s $10 billion in liabilities to fewer creditors. Enron operated as a public company, subject to SEC scrutiny, yet manipulated legal loopholes like the 3% SPE rule. FTX, a private Bahamian entity, faced less regulation, enabling faster fraud but smaller impact. Enron’s collapse led to Sarbanes-Oxley, tightening public company oversight, while FTX’s fallout has yet to yield comparable reforms, as Ben suggests fraud has shifted to private markets.
Leadership dynamics also differ. Enron’s fraud was orchestrated by multiple executives, with Lay and Skilling selling $500 million in stock and Fastow embezzling $60 million. SBF’s centralized control at FTX made him the primary culprit, though his intent remains debated. Both cases highlight misaligned incentives, with David quoting Charlie Munger: “Show me the incentives, I’ll show you the behaviors.” Enron’s legacy, as the hosts reflect, is a cautionary tale of systemic failure, while FTX underscores ongoing vulnerabilities in unregulated markets.
Carveouts
Ben’s Carveouts:
Enron the Musical: A limited-run Broadway play, described as a spectacular exaggeration with raptors and stock tickers. Ben recommends the trailer for its relevance.
Andor (Disney+ Show): A Star Wars series praised for its exceptional direction and writing, surpassing other Disney+ Star Wars content.
David’s Carveouts:
Brooks Addiction Walkers: Supportive walking shoes ideal for parenting, with stylish design. David notes Velcro options exist.
JCal on the Tim Ferriss Show: A recent episode with Acquired friend Jason Calacanis, offering engaging insights from his friendship with Tim Ferriss.
Additional Notes
Episode Metadata:
Number: Season 11, Episode 7
Title: Enron
Duration: 3:32:21
Release Date: November 28, 2022
Source: Acquired website (acquired.fm) and Apple Podcasts
Related Episodes:
FTX (with Sam Bankman-Fried & Mario Gabriele): Season 9, Episode 7 (12/14/2021)
Howard Marks & Andrew Marks: Something of Value: (8/29/2022)
Berkshire Hathaway Part I: Season 8, Episode 5 (4/20/2021)