Take our 2022 Survey. You could win AirPods Pro 2's! >>


Season 11, Episode 7

ACQ2 Episode

November 28, 2022
November 28, 2022

The Complete History & Strategy of Enron

The FTX fraud has dominated headlines now for weeks, during which we’ve debated if and how Acquired could uniquely add to the conversation. Then we realized there was an angle so perfect that we had to drop everything and enter Acquired research overdrive: 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. So much of Enron’s history parallels FTX that the uncanniness is almost unbelievable — right down to the same CEO running the two bankruptcies. Sit back and enjoy this crazy tale of villainy, greed, and the nature of humans and money. Maybe just don’t take notes on this one…

If you want more Acquired, you can follow our public LP Show feed here in the podcast player of your choice (including Spotify!).





We finally did it. After five years and over 100 episodes, we decided to formalize the answer to Acquired’s most frequently asked question: “what are the best acquisitions of all time?” Here it is: The Acquired Top Ten. You can listen to the full episode (above, which includes honorable mentions), or read our quick blog post below.

Note: we ranked the list by our estimate of absolute dollar return to the acquirer. We could have used ROI multiple or annualized return, but we decided the ultimate yardstick of success should be the absolute dollar amount added to the parent company’s enterprise value. Afterall, you can’t eat IRR! For more on our methodology, please see the notes at the end of this post. And for all our trademark Acquired editorial and discussion tune in to the full episode above!

10. Marvel

Purchase Price: $4.2 billion, 2009

Estimated Current Contribution to Market Cap: $20.5 billion

Absolute Dollar Return: $16.3 billion

Back in 2009, Marvel Studios was recently formed, most of its movie rights were leased out, and the prevailing wisdom was that Marvel was just some old comic book IP company that only nerds cared about. Since then, Marvel Cinematic Universe films have grossed $22.5b in total box office receipts (including the single biggest movie of all-time), for an average of $2.2b annually. Disney earns about two dollars in parks and merchandise revenue for every one dollar earned from films (discussed on our Disney, Plus episode). Therefore we estimate Marvel generates about $6.75b in annual revenue for Disney, or nearly 10% of all the company’s revenue. Not bad for a set of nerdy comic book franchises…

Season 1, Episode 26
LP Show
November 28, 2022

9. Google Maps (Where2, Keyhole, ZipDash)

Total Purchase Price: $70 million (estimated), 2004

Estimated Current Contribution to Market Cap: $16.9 billion

Absolute Dollar Return: $16.8 billion

Morgan Stanley estimated that Google Maps generated $2.95b in revenue in 2019. Although that’s small compared to Google’s overall revenue of $160b+, it still accounts for over $16b in market cap by our calculations. Ironically the majority of Maps’ usage (and presumably revenue) comes from mobile, which grew out of by far the smallest of the 3 acquisitions, ZipDash. Tiny yet mighty!

Google Maps
Season 5, Episode 3
LP Show
November 28, 2022


Total Purchase Price: $188 million (by ABC), 1984

Estimated Current Contribution to Market Cap: $31.2 billion

Absolute Dollar Return: $31.0 billion

ABC’s 1984 acquisition of ESPN is heavyweight champion and still undisputed G.O.A.T. of media acquisitions.With an estimated $10.3B in 2018 revenue, ESPN’s value has compounded annually within ABC/Disney at >15% for an astounding THIRTY-FIVE YEARS. Single-handedly responsible for one of the greatest business model innovations in history with the advent of cable carriage fees, ESPN proves Albert Einstein’s famous statement that “Compound interest is the eighth wonder of the world.”

Season 4, Episode 1
LP Show
November 28, 2022

7. PayPal

Total Purchase Price: $1.5 billion, 2002

Value Realized at Spinoff: $47.1 billion

Absolute Dollar Return: $45.6 billion

Who would have thought facilitating payments for Beanie Baby trades could be so lucrative? The only acquisition on our list whose value we can precisely measure, eBay spun off PayPal into a stand-alone public company in July 2015. Its value at the time? A cool 31x what eBay paid in 2002.

Season 1, Episode 11
LP Show
November 28, 2022

6. Booking.com

Total Purchase Price: $135 million, 2005

Estimated Current Contribution to Market Cap: $49.9 billion

Absolute Dollar Return: $49.8 billion

Remember the Priceline Negotiator? Boy did he get himself a screaming deal on this one. This purchase might have ranked even higher if Booking Holdings’ stock (Priceline even renamed the whole company after this acquisition!) weren’t down ~20% due to COVID-19 fears when we did the analysis. We also took a conservative approach, using only the (massive) $10.8b in annual revenue from the company’s “Agency Revenues” segment as Booking.com’s contribution — there is likely more revenue in other segments that’s also attributable to Booking.com, though we can’t be sure how much.

Booking.com (with Jetsetter & Room 77 CEO Drew Patterson)
Season 1, Episode 41
LP Show
November 28, 2022

5. NeXT

Total Purchase Price: $429 million, 1997

Estimated Current Contribution to Market Cap: $63.0 billion

Absolute Dollar Return: $62.6 billion

How do you put a value on Steve Jobs? Turns out we didn’t have to! NeXTSTEP, NeXT’s operating system, underpins all of Apple’s modern operating systems today: MacOS, iOS, WatchOS, and beyond. Literally every dollar of Apple’s $260b in annual revenue comes from NeXT roots, and from Steve wiping the product slate clean upon his return. With the acquisition being necessary but not sufficient to create Apple’s $1.4 trillion market cap today, we conservatively attributed 5% of Apple to this purchase.

Season 1, Episode 23
LP Show
November 28, 2022

4. Android

Total Purchase Price: $50 million, 2005

Estimated Current Contribution to Market Cap: $72 billion

Absolute Dollar Return: $72 billion

Speaking of operating system acquisitions, NeXT was great, but on a pure value basis Android beats it. We took Google Play Store revenues (where Google’s 30% cut is worth about $7.7b) and added the dollar amount we estimate Google saves in Traffic Acquisition Costs by owning default search on Android ($4.8b), to reach an estimated annual revenue contribution to Google of $12.5b from the diminutive robot OS. Android also takes the award for largest ROI multiple: >1400x. Yep, you can’t eat IRR, but that’s a figure VCs only dream of.

Season 1, Episode 20
LP Show
November 28, 2022

3. YouTube

Total Purchase Price: $1.65 billion, 2006

Estimated Current Contribution to Market Cap: $86.2 billion

Absolute Dollar Return: $84.5 billion

We admit it, we screwed up on our first episode covering YouTube: there’s no way this deal was a “C”.  With Google recently reporting YouTube revenues for the first time ($15b — almost 10% of Google’s revenue!), it’s clear this acquisition was a juggernaut. It’s past-time for an Acquired revisit.

That said, while YouTube as the world’s second-highest-traffic search engine (second-only to their parent company!) grosses $15b, much of that revenue (over 50%?) gets paid out to creators, and YouTube’s hosting and bandwidth costs are significant. But we’ll leave the debate over the division’s profitability to the podcast.

Season 1, Episode 7
LP Show
November 28, 2022

2. DoubleClick

Total Purchase Price: $3.1 billion, 2007

Estimated Current Contribution to Market Cap: $126.4 billion

Absolute Dollar Return: $123.3 billion

A dark horse rides into second place! The only acquisition on this list not-yet covered on Acquired (to be remedied very soon), this deal was far, far more important than most people realize. Effectively extending Google’s advertising reach from just its own properties to the entire internet, DoubleClick and its associated products generated over $20b in revenue within Google last year. Given what we now know about the nature of competition in internet advertising services, it’s unlikely governments and antitrust authorities would allow another deal like this again, much like #1 on our list...

1. Instagram

Purchase Price: $1 billion, 2012

Estimated Current Contribution to Market Cap: $153 billion

Absolute Dollar Return: $152 billion

Source: SportsNation

When it comes to G.O.A.T. status, if ESPN is M&A’s Lebron, Insta is its MJ. No offense to ESPN/Lebron, but we’ll probably never see another acquisition that’s so unquestionably dominant across every dimension of the M&A game as Facebook’s 2012 purchase of Instagram. Reported by Bloomberg to be doing $20B of revenue annually now within Facebook (up from ~$0 just eight years ago), Instagram takes the Acquired crown by a mile. And unlike YouTube, Facebook keeps nearly all of that $20b for itself! At risk of stretching the MJ analogy too far, given the circumstances at the time of the deal — Facebook’s “missing” of mobile and existential questions surrounding its ill-fated IPO — buying Instagram was Facebook’s equivalent of Jordan’s Game 6. Whether this deal was ultimately good or bad for the world at-large is another question, but there’s no doubt Instagram goes down in history as the greatest acquisition of all-time.

Season 1, Episode 2
LP Show
November 28, 2022

The Acquired Top Ten data, in full.

Methodology and Notes:

  • In order to count for our list, acquisitions must be at least a majority stake in the target company (otherwise it’s just an investment). Naspers’ investment in Tencent and Softbank/Yahoo’s investment in Alibaba are disqualified for this reason.
  • We considered all historical acquisitions — not just technology companies — but may have overlooked some in areas that we know less well. If you have any examples you think we missed ping us on Slack or email at: acquiredfm@gmail.com
  • We used revenue multiples to estimate the current value of the acquired company, multiplying its current estimated revenue by the market cap-to-revenue multiple of the parent company’s stock. We recognize this analysis is flawed (cashflow/profit multiples are better, at least for mature companies), but given the opacity of most companies’ business unit reporting, this was the only way to apply a consistent and straightforward approach to each deal.
  • All underlying assumptions are based on public financial disclosures unless stated otherwise. If we made an assumption not disclosed by the parent company, we linked to the source of the reported assumption.
  • This ranking represents a point in time in history, March 2, 2020. It is obviously subject to change going forward from both future and past acquisition performance, as well as fluctuating stock prices.
  • We have five honorable mentions that didn’t make our Top Ten list. Tune into the full episode to hear them!


  • Thanks to Silicon Valley Bank for being our banner sponsor for Acquired Season 6. You can learn more about SVB here: https://www.svb.com/next
  • Thank you as well to Wilson Sonsini - You can learn more about WSGR at: https://www.wsgr.com/

Join the Slack
Get Email Updates
Become a Limited PartnerJoin the Slack

Get New Episodes:

Thank you! You're now subscribed to our email list, and will get new episodes when they drop.

Oops! Something went wrong while submitting the form

Transcript: (disclaimer: may contain unintentionally confusing, inaccurate and/or amusing transcription errors)

David: Obviously, the context is we're doing this episode because of FTX.

Ben: Right. It's a related party transaction, one could say.

David: It's like LJM.

Ben: It's like the Raptors.

David: You know what LJM stands for, right?

Ben: It's his kids and his wife, right? What a psychopath. Can't possibly be fraud if it's named after my family.

David: I feel like this story is like American Psycho in Houston.

Ben: Yes. Oh, my god. Yes.

Welcome to season 11 episode 7 of Acquired, the podcast about great technology companies—well, sometimes not so great companies—and the stories and playbooks behind them.

David: Not so great companies and the stories and cooked books behind them.

Ben: Oh, there you go.

David: That's a dad joke.

Ben: That is a dad joke. I am Ben Gilbert, and I'm the co-founder and Managing Director of Seattle-based Pioneer Square Labs and our venture fund, PSL ventures.

David: I'm David Rosenthal, and I'm an angel investor based in San Francisco.

Ben: And we are your hosts. Listeners, it brings me no joy to do this episode, but it seems all too appropriate in this moment in 2022. Today, we tell the story of Enron. It was the seventh biggest company in America by market cap. It was heralded as the pioneer of a new business model during a new technology era.

Executives had endorsements, or at least friendships and public appearances with multiple US presidents. It had the Houston Astros' baseball stadium, Enron Field, bearing its name. It was even named Fortune magazine's most innovative company six years in a row.

David: Including in 2001, the year it went bankrupt.

Ben: Unbelievable. Less than a year after its stock hit an all time high, Enron filed for the largest bankruptcy in American history to that point. This story is every bit as crazy as the FTX story that we are all watching play out in real time. The parallels are totally uncanny.

A financial trading company that got over leveraged, thought they could do no wrong and got tangled up in a web of self-dealing to try and paper over their problems. Individuals profited richly while shareholders were none the wiser. The biggest difference really is that somehow, Enron managed to do it all as a public company in plain daylight the entire time and with much bigger dollar amounts.

David: We have a big thank you to stay here. The idea for this episode came from our good friend and past Acquired guest, Andrew Marks. I was in New York on the way back from Lisbon, and I had breakfast with Andrew.

We were talking about FTX, of course, and everything going on. I was like, how can Acquired add to the conversation right now about FTX? He was like, I've got a good idea. You guys should do Enron. I was like, boom, that is what Acquired can add to this conversation.

Ben: On the FTX note, suffice to say, we will definitely be appending a new intro to that episode.

David: Indeed.

Ben: For our presenting sponsor of this episode, we are back with Fundrise CEO, Ben Miller, to share more about their growth tech investing business, the Fundrise Innovation Fund.

David: You've now been investing out of the innovation fund for a few months. Give us the pitch. What's the offering?

Ben Miller: Right now, what do companies need more than anything else? Its funding. They have to have enough capital to get across the next 18- to 24-month downturn. We are providing $10 million uncapped safes for technology companies with at least $10 million in revenue and high growth. So 10 for 10, I'd say.

David: It's like ESPN 30 for 30, the Fundrise 10 for 10.

Ben Miller: Yeah, so uncapped safe. We don't set the price, the market does.

Ben: Is there a discount, or do you just convert at the next round?

Ben Miller: Convert to the next round. We're thinking of a flat 10% discount. But the more important thing is that the company gets to extend their runway, and we get to invest in the best companies.

Ben: Why does this make sense for you? Why are you okay doing these uncapped notes right now?

Ben Miller: The most important thing in venture capital is to invest in the best companies, period, end of story. We provide the companies, essentially, the best price set by the market, and we get into the best companies.

David: It's so great. You think back a year or two ago, doing uncapped safes and growth stage companies, that was the total fools thing to do. But now in this market, I think it's actually brilliant because the days of companies just raising their next round at ludicrous prices are probably not going to happen. I think you can get in at a great price. This is an awesome product for founders to get the runway to get to that next round.

Ben Miller: Right. It's fundamentally a fit to our structure of an open-ended evergreen fund with no carried interest.

Ben: You are doing these uncap notes, but you're also participating in growth rounds. Is that right? If they've got a term sheet and other investors, you can also participate in that round.

Ben Miller: That's basically almost the same as an uncapped safe, because you're going into a round that was priced, and you're extending the runway. The smart CEOs know that the most important thing is time.

Ben: Our thanks to Fundrise. If you want to join the over 350,000 individuals investing with Fundrise, you can click the link in the show notes. If you're a founder and want to get in touch about having the Innovation Fund participate in your next funding round, email notvc@fundrise.com.

After this episode, join the Slack. Thirteen thousand smart, curious, thoughtful, well-researched people are in there, and we'll be discussing this episode. Without further ado, David, take us in. Listeners, this is not investment advice. David and I may hold investments in the companies we discuss, although I don't think you can invest in any of these companies anymore.

David: I've got a fun little thing that I'll bring up right at the end of the episode about investing in Enron that blew my mind when I learned this.

Ben: All right. This show is for informational and entertainment purposes only. David, over to you.

David: I feel like we also need a disclaimer that this is not accounting advice.

Ben: This is not accounting advice.

David: This is going to be fun, because this is such history now (Enron) and there are many really good books out there. You read The Smartest Guys in the Room, right?

Ben: By Bethany McLean. Yup.

David: And I read Conspiracy of Fools by Kurt Eichenwald, both of which I think are really good. Conspiracy of Fools is great. It is a very, very well-researched history of Enron. I thought a good place to start is right at the end of the prologue of Conspiracy of Fools. Kurt Eichenwald writes this, and I just thought it was so perfect to frame the Enron story and the FTX story today.

He says, "This, then, is more than the tale of one company's fall from grace. It is at its base, the story of a wrenching period of economic and political tumult as revealed through a single corporate scandal. It is a portrait of an America in upheaval at the turn of the 21st century, a country torn between its warship of fast money, and its zeal for truth between greed and high mindedness between Wall Street and Main Street. Ultimately, it is the story of the untold damage wreaked by a nation's folly, a folly that in time, we are all but certain to see again."

Ben: It's so literary. My God, those words. After trying to consume an insane amount of Enron stuff over the last couple of weeks, the thing that occurs to me is this is something that can only occur to this height in a bull market, where there's so much capital saturating so many opportunities that people are willing to go way out on the risk curve looking for returns, where there's so much FOMO playing into it that they have to pile into these low disclosure, super risky type of assets, because everything else is already at all time highs and crazy multiples. Of course, it's the people's fault driving the car that gets us here, but the environment around the car on the road is definitely facilitating it.

David: The investor community as we saw happen over the last couple of years here just loses all incentive and desire to ask questions. That is what happened 20+ years ago. How did we get there then?

Ben: And where did Enron come from?

David: Where did Enron come from? We start in the 1970s in the United States, where—for those of you who know your American and, indeed, world history—a series of oil crises and energy crises shock the nation and the world. First, in 1973, when OPEC (Organization of Petroleum Exporting Countries) starts an oil embargo on the US and other Western nations, and the price of energy triples.

Think about this. We're talking about the impact of the Russia-Ukraine war on prices in Europe. This was way worse. The consequences of that were that the stock market crashed immediately. The economy entered a huge recession. This was the end. This was the slamming of the door on the post–World War II American economic growth miracle. This killed it.

We've talked about this on the show a few times. The 1970s were brutal. We talked about interest rates going so high. It was because of this, this first oil shock in 1973 and the second in 1979. Unemployment hits 10%. CPI and inflation is above 5% for pretty much the entire decade. It hits a high of 12.4% in 1980.

Famously, when Paul Volcker takes over as chairman of the Fed in 1979, he brings the hammer down. I didn't realize how high this was. He raised the Fed funds rate that was at zero a year ago, and that everybody's freaking out, because it's at 3½ now or something like that. People think it might go to four or five. That's crazy, and that's tanking the economy. Do you know how high Volcker raised it in the early 1980s?

Ben: Ten percent?

David: Above 19%.

Ben: Whoa. I assume it had to be, because I had always heard that mortgages hit 18%, so I always assumed that the mortgages had to be higher than the Fed funds rate.

David: Yeah. I don't think it was above 19% for long, but when it was, that's the base lowest interest rate possible. Mortgages must have been in the 20s at that point in time.

Ben: Wow, crazy.

David: My God. That finally did break the back of inflation, but the cost was immense. Doing this research really helped me understand more about the 80s, in the go-go years of the 80s. It was because coming out of this horrible decade of the 1970s.

Ben: Of course, this was the birth of the Wall Street mania, because the super high interest rates from the Volcker era would have led to unbelievably low multiples on any asset you could buy. Of course, you've got tons of room to run on investing at bargain basement prices for things that are going to go up.

David: Yup. Now, what was it that precipitated all this? Like I said, it was the energy crises, oil shocks and the energy shocks. Starting in the mid 70s—and it takes really 15–20 years for all this legislation to wind through the government—the US government starts deregulating the energy markets in the US.

If you go back to our episodes on Rockefeller and Standard Oil, the initial energy markets in the US were monopolies. It was Standard Oil, right? When the government brought the hammer down on Standard Oil and the energy monopolies, everything got regulated. Utilities, energy producers, all became regulated government entities, where prices of energy were set by the government.

Ben: When you say regulated, there are different flavors of this. There's something where the government could actually own the utility, and you pay the government for the services. But there's also a middle ground, where something is so important to the public that price controls are put into place or the free market is not allowed to reign free. The government would do something like grant an exclusive monopoly to a certain company and say, but the prices have to be here or but you can't make that much margin on it.

David: This makes sense. Especially in the post–World War II American economy and way of life, power is critically important. Electricity, gasoline for homes, for businesses, for commuting, for factories, all this stuff takes power. You want stability and low prices. But then after the 70s, of course, these all gets shook up.

In 1978, Jimmy Carter signs the National Energy Act, which starts to open back up parts of the energy economy in the US to free market competition. The first big area in the energy industry that deregulates is the natural gas industry, so enter one Kenneth Lee Lay.

Like our first protagonist of this season (Sam Walton), Lay was born in rural Missouri in 1942 after Walton. His father was a Baptist preacher who ran a general store out in the Missouri countryside. That ended up failing, and Lay grew up very, very poor, but his family believed in education. When his older sister graduated high school, his family wanted her to go to college, so they moved the whole family to Columbia, Missouri.

Ben: Wow. It's literally the same story. That's crazy.

David: Literally, it's the same story, so that she could live at home, which was the only way they could afford for her to attend the University of Missouri at Columbia. Very, very lovely place, which we have now been to multiple times for Capital Camp.

She goes to the University of Missouri. Ken would follow in her footsteps, also go to the University of Missouri, where he would discover a lifelong passion for economics. He's a star student in the economics department. He graduates. He goes on to work in the oil industry after he graduates.

On the nights and weekends while he's working in the industry, he completes a PhD in economics. And then one day, he gets a call in the mid-1970s from his old adviser from Missouri, his old professor, who just got nominated to the Federal Power Commission, right as all of this deregulation is starting to percolate its way through the government.

He calls up Lay and says, come join me here in DC and help me work through all this with the government and the industry. Lay ends up serving as the deputy undersecretary of energy in the Department of the Interior right as these oil shocks are happening and deregulation is starting to be talked about. After a few years, he goes back into industry at Florida Gas, a pipeline company in Florida, as the President and number two operator within the company.

Ben: So far in this guy's career, he sounds like the real deal.

David: He totally is.

Ben: PhD, economist, civil servant, working in the government, getting DC exposure, going into industry to actually get some operating experience, grew up in a hard era, and he had to fight his way through adversity.

David: Yup. He's never deployed for combat. But during Vietnam, he ends up going into the Navy. He becomes a naval intelligence officer. By all outward appearances, he seems like a real good guy at this point in time. He marries his college sweetheart. True American story.

Late 70s, early 80s, he's the number two executive at this natural gas pipeline company in Florida. In 1982, his former boss had moved over to the big leagues in the energy industry. He'd gone to a company called Transco Energy based in Houston, Texas, which is...

Ben: Silicon Valley of the oil and gas sector.

David: The Silicon Valley of the oil and gas sector, the New York City to the financial industry of the oil and gas sector. Everything, if you want to be in energy in America, you want to be in Texas. Either in Dallas or Houston, but I think at this point in time, probably Houston.

Lay is now in the big time. As he's fitting for now being in the big time and of the era, he leaves his wife behind in Florida and moves to Houston with his new wife who was his secretary at Florida gas.

Ben: Unfortunately, classic for this story.

David: Classic. This is not the last time we're going to hear something to this effect in people's personal lives in the Enron story. Right as he arrives in Houston at Transco, two things are happening: (1) As I've been talking about all along here, deregulation is finally percolating through to industry. Carter signed the Energy Act. It's in full swing.

But (2) surprisingly here in 1982, energy prices fall for the first time in a decade. As a result, right after Lay shows up, Transco runs into a problem. It's contracted to buy a whole bunch of oil and gas assets from various producers, various drillers around Texas and around the country. Those contracts have Transco buying the assets at an ever increasing price, because the prices of oil and gas have only been going up for the last decade, but market prices have just fallen.

They're really in the lurch here. People think that Transco might go under. Lay—remember, he's a PhD economist and he's really quite brilliant—comes up with an idea based on all of the economic theory that he knows. He's like, what if we set up a trading market for this oil and gas that we're contracted to buy, especially in natural gas, which is now deregulated enough that I think we can do this?

Rather than us as the pipeline company buying all of this gas from the producers, we'll just operate the pipelines in the middle, and we'll make this market. We'll let the end consumers at the gas—the factories, the utilities, consumers aren't buying this directly but the utility companies are—through us, trade with the producers, and we can create a spot market for energy. This becomes a huge success. This is a massive, massive innovation.

Ben: So Transco is doing this?

David: Transco is doing this. Lay, he becomes a total industry legend. He pioneers this. Before Transco and Lay, the whole idea of any form of trading or financialization of energy, of oil and gas, didn't really exist because it was all regulated by the government before then.

Ben: Right. Not to mention, securitization wasn't a trend even in finance yet. Today, you can securitize anything. We had, of course, in 2008, everyone became familiar with the term mortgage-backed securities. But the securitization in the 80s and 90s became all the rage and finance to basically get anything off your books.

You could increase the velocity at which a financial company could operate by packaging up risk and selling it to someone else, so that you could make new loans off your books or something like that. Of course, this was going to come to energy at some point, but it's important to remember that securitization is still a reasonably new concept, even on Wall Street.

David: Yup. Two things. One, this is not yet securitization of energy assets. This is simply just making a market for the first time between producers and consumers of the energy, where they can buy and sell on the spot market.

Ben: At a real time appropriate price.

David: Real time price. Like today, I need energy. I'm going to look at the market that Transco is now making. I am going to buy as a consumer of energy at today's market price. Whereas in the past, it was all long-term contracts that the pipelines had entered into with the producers, and then the consumers of the energy would buy it from the pipelines.

Ben: I see. Okay, so we're like crawl-walk-run here.

David: Yeah, this is crawling. But as I said, this is Lay. This is Lay's baby. Literally, this is the opening of the floodgates. He was the very perfect person to do this, because he had the industry experience—he's now been close to a decade working in the industry—he had the economics training, and he had the government experience. He knew that the deregulation was now at the right point. It had trickled out into industry enough that this is possible, so he really was the perfect person to do this.

On the back of that in June of 1984, Lay—remember he's number two at Transco—gets poached by another big Houston energy company, Houston Natural Gas, to come over as the CEO, the number one.

He's made it to the top, he's made his mark. He is the big shot at this point in Houston. They were a big publicly traded energy company in Houston, probably, I want to say a billion, a billion-and-a-half market cap, call it a public company.

Ben: Definitely a great promotion for him, a job to move up in the ranks by joining this other company, but it's not like he's on top of the world yet at this point. He's got bigger competitors that he is dealing with.

David: He does for the moment. Then the very next year, in 1985, he gets a call from the CEO of one of the larger competitors, a company called InterNorth, which was not based in Houston, but rather based in Omaha, Nebraska. A few companies based in Omaha, Nebraska.

Ben: Small head office based in Omaha.

David: Exactly small head office. Despite being based in Omaha, though, InterNorth, at this point in time—no Berkshire Hathaway involvement—is the largest pipeline company in America. They were relatively conservative, old school in many ways as we'll see parochial Nebraska company despite having the largest pipeline in the country. They were being pursued by the corporate raider. It's so funny how everything is coming together here in the Acquired season. The famed 1980s corporate raider, Irwin Jacobs, but not that Irwin Jacobs.

Ben: I was going to say, I remember reading this and looking it up and being like, okay, good, wooh, it's not our Qualcomm Irwin.

David: I first heard about this other bizarro Irwin Jacobs while doing the research for the Qualcomm episode, because every time I type it into Google, I would occasionally get hits for some other famous business person that clearly was not like the hero Irwin Jacobs, but the antihero, Irwin Jacobs.

1980s corporate raider Irwin Jacobs is pursuing InterNorth. The CEO of InterNorth wants to merge with HNG as almost like a poison pill to make the combined company too big for Jacobs or any other raider to pursue. They negotiated a deal. InterNorth ends up buying HNG for $2.3 billion, which was a 40% premium to the stock price.

Ben: Which is big. Usually, the floor of what a board will accept is something around 20%. But at a 40% premium, they paid a pretty penny to go buy Ken Lay's HNG here.

David: It wasn't quite the case of minnows swallowing the whale. They were closer in size than the Cap Cities/ABC deal. But definitely, InterNorth was the bigger company, but it was clear that Lay and the HNG guys were going to be running the show from then on.

Ben: I think Bethany McLean puts it in this way, where it's almost like InterNorth got hoodwinked, where they knew they were paying a lot, but they knew it was important to get. But then once they started looking at the deal for a couple of months in retrospect, they were like, wait a minute, we gave HNG a lot of board seats, and their executives are having a lot of influence on the combined company. Wait a minute, we just gave away the company.

David: Yes. Specifically, this culture clash manifests in the question of where the headquarters for this new company is going to be. The old InterNorth management team and board members, of course, want to keep the company in Omaha, and all the board members are politically connected in Omaha. They're like, we don’t want this company moving to the big city of Houston taking all these jobs out of Omaha. It's important that the company stays here.

Lay, of course, he's very political. He's very diplomatic. He's willing to say the right things to appease the board, but he has no interest in moving to Omaha. He's in the big city in Houston. He's a player in the industry. He's now a Texas oilman. He wants to stay in Houston.

Ben: To be super clear here, InterNorth had a ridiculously valuable hard asset. This is now quoting from Bethany's book. "Among its 20,000 miles of pipeline was a genuine prize, Northern Natural, the major north-south line feeding gas from Texas into Iowa, Minnesota, and much of the rest of the Midwest."

This is the first example of someone in Enronland getting the better part of an economic deal, even though on the other side of the deal, there's a real hard asset that has quantifiable value for end users, for customers.

David: Eventually, as we'll see, they give up on even caring about that. Like we're saying, this culture clash between the two companies manifests itself in the headquarters location. What do they do? They do what any management teaming company would do when you're trying to justify your decision to the board. They hire McKinsey & Company.

Ben: You can't make this stuff.

David: You totally can't make this stuff up. This becomes a completely freaking key to the story. No headquarters study, no Enron, because the desk on which this assignment lands is a young hotshot superstar, junior partner at McKinsey in the Houston office, one Jeffrey Skilling, who had joined McKinsey after Harvard Business School, where he was a Baker Scholar, top 5% of the class.

Famously—I think he had quite the reputation there; I think he was happy to broadcast the story—he got in because the dean of Harvard Business School interviewed him on a trip to Houston. I think Skilling was working in Houston at the time. He had graduated from SMU. The dean interviewed him and asked him if he was smart. Skilling replied to the dean, I'm effing smart. He didn't say it in exactly those words.

Ben: This is a family-friendly podcast. We're not Jeff Skilling.

David: Although, we will actually say the words of some profanity that Skilling utters later, because it is absolutely key to the story. Skilling shows up in Omaha to present to the board his findings, which is that obviously, the company should be in Houston. Even all the political wrangling aside, it makes sense that the largest pipeline company in the world at that point in time should be based in Houston, not in Omaha.

Ben: We should be clear here, there's this interesting thing going on at the time with natural gas, where it's perceived as the good guy. You're already starting to see this American ire toward the dirty big oil, coal, and natural gas, which is, of course, a previously thought to be useless byproduct of extracting crude oil.

You can make gasoline out of it, you can make all this great stuff out of crude oil, and then there's this natural gas, which didn't have great use cases until lots of scientific discoveries and reasons why we all use it to heat our homes now or many people use it to heat their homes. But it was viewed as this next great frontier of pseudo clean energy. It was a place where a lot of people in the energy business wanted to be going.

David: Oh, such a good point. I'm glad you paused here, and we should discuss a little bit. Natural gas had lots of things going for it. One was the environmental, cleaner than oil, and all that. Two was that certainly it was the first part of the energy industry to be deregulated enough that you could do interesting things with it. But three, I think probably the biggest tailwind in its favor in America was, and you said oil had started to develop this dirty connotation, I think a lot of that was because of OPEC and the oil embargo. It's like, here's this foreign oil that America is dependent on. Even to this day, how much are politicians campaigning on reducing our dependence on foreign oil, blah-blah-blah-blah-blah. It all goes back to the 1970s.

Ben: It's interesting how natural gas was the electric power of its day in terms of perception.

David: It was the Tesla of the 1980s.

Ben: Not to mention there are all these just phenomenal other knock-on effects to it. You can pipeline it. You move it all over the place. You can store it really easily. You can store lots of energy in a super dense way in case you don't need it in one place, but you do need it and another. It has these great natural properties that make it not only really useful for the end consumer, but as this deregulation is coming in, it makes it a great asset to use in your free market enterprise.

David: Back to this fateful HNG-InterNorth board meeting in Omaha in, I think this is now 1985 or 1986. Skilling, the hotshot McKinsey consultant, is sitting there in the waiting room, getting ready to go present to management and the board when the prior CEO, the number one—remember, Lay is number two after the merger—walks out and informs Skilling that he's going to keep on going because he has just been fired by the board, and Lay has engineered the coup that Lay is now the CEO of the company.

They don't really have much time for the headquarters discussion in this board meeting and what time they do have. The board is like, no, obviously, we're keeping it in Omaha, and Lay's the consummate politician. He knows better than the press' luck. He just got what he wanted. He's not going to fight with his new board at this board meeting.

Ben: To the very end, for Ken Lay, I don't think he ever said anything in a public or pseudo public context that was confrontational or pissed anybody off.

David: To the very bitter end. The headquarters move does not happen at that meeting. It does happen shortly thereafter, but this is where Skilling and Lay meet for the first time. Lay comes out in his very politician manner after the board meeting is over. He apologizes to Skilling for all the drama.

He says, look, I've read your work on the study, you really did an excellent, excellent job. I would love to keep the relationship going with you and McKinsey. We're going to have a lot of work to do at this combined company. I want you to be our McKinsey partner back in Houston, who's going to lead a whole bunch of strategic initiatives for us.

Ben: Yes, so it begins.

David: And so it begins. Lay is now settled in. He's in charge, he's the chairman, he's the CEO, and he decides that he wants to get a new name for this company. HNG-InterNorth sounds too old and it's reeking of his predecessor.

Ben: It is true that all these energy companies have just the worst names. It's all these completely meaningless prefixes and suffixes, like Co, Corp, and Inter. It's like an office space, Intertek. They're all named something like that.

David: Maybe this is the beginning of the modern era of that, because they go and they hire very expensive naming and branding consultants. The logo would actually come a little later, but including a few years later, Paul Rand would design the Enron logo. This will be the last logo that the legendary Paul Rand designed before he died.

Ben: He of course designed the IBM logo, the NeXT logo, the UPS logo, maybe?

David: He very much has his style. If you think of the IBM logo or if you know Steve Jobs' NeXT, at the Enron logo, they're all in the same style.

Ben: ABC, Yale Press, Westinghouse.

David: Oh, Westinghouse. My grandfather worked for Westinghouse.

Ben: Really?

David: Yeah. Oh, legendary. Enron would be the last logo he designed before he died. Woof. What a legacy. The naming consultants separate from Paul, come up with a brilliant new idea for the company. They want to name it and Enteron.

Ben: Almost.

David: Lay loves it. The board loves it, Lay loves it. Everybody's so excited. They announced the name. It's a portmanteau. EN for energy, TER as a nod to InterNorth to get that bit of legacy back in there, and then ON at the end, because it sounds cool and modern. Enteron.

They announced it. They didn't check, though, in the dictionary, because Enteron is actually a medical term. It is a word. It is a medical term. It comes from a Greek word. It means the intestinal digestive tract of a living creature and is particularly used for embryos, so like the digestive tract of embryos is an enteron. They get pilloried in the press for this.

Lay is so concerned about appearances, he goes nuts. Lay never loses his cool as we'll see throughout this story. He loses his cool here. He goes completely ballistic, yelling at the naming consultants. Everybody demands that they do another study, change it.

They come back and they're like, well, what if we just get rid of the TER and we shorten it to Enron? Which Lay probably loves, because he's like, yeah, I hate those guys. The old guys, get rid of them.

He ends up getting exactly what he wants. Headquarters moves to Houston. He's the CEO and chairman. Enron, future-looking, it's his baby, it's a refounding new story, new era for the energy industry.

Ben: That's the end of chapter one. You get this merger. They're real pipeline companies, they have hard assets. They have a new corporate culture with a new leader, and they're delivering real value to customers.

David: Yup, and they're running the proto trading playbook that Lay pioneered back in his early days. Pretty quickly, after this, they actually face their first trading scandal. Did you read about this?

Ben: I did. It's such a predecessor. It's such an obvious personality flaw of Ken Lay to look the other way. It's amazing that it happened 10 years before the big scandal.

David: Two traders at the new Enron who were actually based in New York started embezzling money from the company. They're filing fake trades. They're filing fake tax returns. They're creating false bank accounts. They have a false bank account, famously, I think in the name of Mr. M. Yass, which clearly, this will give you a window into the sophomoric nature of traders and trading cultures.

Ben: Just write that out and figure it out for yourself.

David: The company picks up on this. It comes to Lay's attention. Everybody recommends the company's auditor, and Arthur Andersen recommended the board.

Ben: The premier accounting firm of the day.

David: Premier big five accounting firm at the time. They recommend that Lay and the company should fire these guys. Obviously, they're stealing from the company, they're falsifying trades, and Lay's like, well, these guys, it's really bad. It's bad what they did. We should censor them for sure. We should set up some controls to make sure this doesn't happen again, but they're really good traders. They've really made a lot of money for the firm. I don't think we should fire them. That feels like a big step. Everybody's like, uh, okay.

Ben: They were funneling money to their own bank accounts.

David: Yeah, but Lay lets it slide. He is immediately rewarded for his faith in them and his decision here. Almost immediately, they do what any sophomoric people in a situation like that would do who just got away with one. They go way risk on.

They go on tilt, and they rack up within the next few months, almost a billion dollars, one B, that's a B, a billion dollars—this is in the late 80s—of trading losses. That would be enough to bring down the whole firm at the get-go.

Ben: You got to think about the enterprise value of the combined company. I don't have it in front of me, but you had a $5-ish billion company buy a $2½-ish billion dollar company. The whole enterprise value of the firm can't be more than $10 billion.

David: These two bozos just racked up a billion dollars in trading losses. This time, Lay does fire them. Fortunately, for young Enron and for Lay, but unfortunately for the rest of the world, this happens early enough in the quarter that the trading floor is able to dig out enough of these losses, that they don't have to report the whole billion dollar loss come earnings time, and only end up reporting I think less than $100 million of losses. The company miraculously survives. You would think that Lay would learn his lesson here, but no. This is what we're dealing with.

Ben: Let's for a moment say, why are there traders? That's an interesting thing that's happening here. I thought this was a pipeline company. I thought this was a logistics company that moves natural gas from one place to another and charges customers for the services associated with that.

The traders originally are there, to your point, to help match supply to the demand. It's not like everybody just got a computer in front of them where they can automatically be buying the right products to fit their needs at the right price at this moment in time. You need to interface with people. Those people can quote spreads wherever they want.

They can say, ahh, I got a seller for this price, and you're the buyer and I'm sensing that you'll buy for that price. Okay, I'll match, make supply to demand. I'll quote a spread where I think I can make the most possible money on this trade, and we'll go with that. This is the beginning of them being both a logistics energy transportation company and also a financial organization of sorts, a trading desk.

David: Yes, a trading desk, a proto financial institution for the energy industry. Speaking of, back to Houston, and the promised McKinsey strategic engagement. It's happening. Jeff Skilling is lead hotshot partner to develop a strategic plan for this very thing, the new finance and trading operations of Enron.

One day, Skilling has an absolutely brilliant idea. Brilliant by his own estimation and he proclaims it to everybody how brilliant it is. What if Enron goes one step further from Lay's original innovation of creating a spot market for energy? Rather than just being the facilitator of the market being the pipeline in the middle, what if Enron started acting even more like an investment bank in this industry?

The phrase that he uses for this idea is Enron becoming a "bank for gas." The idea is that they can go to oil and gas producers to drillers, and they can buy up a lot of the future production that's going to come out of their wells. Kind of almost like the old companies used to do. But rather than Enron then being the customer for what's going to come out of those wells, they repackage—this is the securitization that you were talking about a minute ago, Ben—all of these future energy commodities. They slice it and dice it, and then they resell it to buyers, to consumers of energy, on whatever timeline and term length they want.

We've gone now, the industry, from the pipelines, buy the assets from the producers, buy the energy commodities from the producers, and then sell them to customers. Lay's innovation is to create a market where you let the producers and the customers trade directly today.

Ben: In real time, spot markets, where everyone is subject to, I don't know what tomorrow's price is going to be. I'll quote it to you tomorrow, so you have inherent risk that tomorrow's price could be higher. So sorry, but that is what it is.

David: Skilling's innovation here is, let's turn this into a full-fledged financial derivatives market, and let buyers and sellers write contracts and buy contracts for any amount of this commodity in the future at a set price, so true futures contracts.

Ben: The most early legitimate use case for this is imagine you are a local utility who's trying to provide natural gas to your town. You've been using this great spot market that Enron stood up to figure out, what's the price going to be tomorrow. You're pretty worried about it skyrocketing in the event of some unknown Black Swan event or something like that.

So wouldn't it be nice if you could hedge your exposure to that risk by also negotiating a futures contract, where you say, let me lock in a certain rate? Yeah, I know it's going to be more expensive than it is now, but at least nothing bad can happen, and then I can be predictable in the way that I'm thinking about what my spin's going to be over the next three months. That's a super legitimate use case of one of these futures contracts that they could trade using Enron.

David: You can imagine all sorts of utility here. Enron does it. They pioneer this market that would come to be known and I think it still assumes a very, very large part of the energy market today, called energy derivatives. Skilling and Enron invents it and pioneers it.

Ben: At this point, the energy is the underlying asset. The derivative itself is not particularly interesting other than its own utility for if you are actually buying or selling the underlying asset. That's an important thing to note.

Everyone will lose their heads later and get excited about the derivative on its own. They don't care what it's a derivative of. It's a tradable thing that numbers go up numbers go down. It reminds me a lot of some crypto over the last year. It's like trading Dogecoin.

David: Right. Does anybody even know what this coin is or what it's supposed to do? Does anybody care?

Ben: No, but I can speculate on it. There is a very interesting, almost innocent, early beginning of why you would offer energy derivatives that completely falls apart over time as everyone loses their head. Skilling's still outside when he pitches this idea.

David: He's still at McKinsey at this point. Yes, for the moment. In this next thing, they realize this is a new concept they need to bring to the market. How are they going to bootstrap up this new derivatives market? They need the producers to get on board. They need to get the supply, the raw supply that they can then financialize, securitize, and turn into these derivatives. The way that they can really convince producers to want to do this is if they fund them.

Just like an investment bank, they now start going out and doing these development deals and co-development deals with drillers, saying, hey, we'll fund you. We will finance your exploration, your drilling. As part of financing that, Enron is going to lock up the rights to then securitize the future production out of your assets.

Ben: Which again, on its own, not a malicious strategy. Think about our Qualcomm episode. Hey, Sony, will you spin up a new venture that will co-invest in to make flip phones that use CDMA so we can prove to everyone else in the market that CDMA is a viable technology? We'll invest in it. You just have to provide these strategic assets, you can own half of it, blah-blah-blah. It is a common way to bootstrap an ecosystem to use your dollars to incentivize other participants to bring a thing into your ecosystem.

David: Honestly, if the story were to stop there, this probably would be a great company, bringing huge innovation to a commodity market. Yeah, probably, this market should work this way. It should be financialized and securitized. Energy assets are commodities.

Unfortunately, that is not where the story ends, far, far, far from it. In 1990—now we're a couple of years into the Lay Enron era—-Lay and the vice chairman of the company, a guy named Rich Kinder, who later would leave Enron before all the dirt hits the fan and starts Kinder Morgan.

Ben: You can think of Rich Kinder for now as the hard assets guy. He's the guy that really understands the intrinsic value of delivering hydrocarbons through a pipe to customers and trying to build a company that is just executing really well on doing that.

David: Yes. The two of them work on convincing Skilling. They think this is a big idea and this is the future of Enron. They worked on convincing Skilling to leave McKinsey and come over and join Enron as the full-time CEO of this new gas bank that they're going to call the Enron finance division.

In a very telling move, it tells you a lot about what you need to know about Jeff Skilling as a person. They're talking about this and they're negotiating. He decides he wants to take them up on the offer. He's going to leave McKinsey.

He calls them up to do the final negotiations of the terms of his offer. He calls them up from the hospital, where he is with his wife while his wife is in labor with their (I think) second child. That tells you where his priorities lie. Obviously, that marriage does not last too much longer.

Ben: He's obviously there.

David: Yeah, obviously. Skilling comes in, he takes over Enron finance, starts this new division.

Ben: It is worth pointing out that the thing that he made a necessary condition in order for him to join and do this. Do you know what that thing is?

David: I don't.

Ben: It was that Jeff Skilling insisted that in order to join Enron and start this new division, Ken Lay and the board had to agree to use mark-to-market accounting.

David: I did not realize that Skilling was looking that far ahead and made it a condition of his joining.

Ben: This shows how unbelievably savvy he is. He realized he couldn't build a business.

David: He is effing smart according to him.

Ben: He could not build the business that he wanted without doing this. He literally calls that, and this is in The Smartest Guys in the Room, it's ‘lay my body across the tracks’ issue about joining the company.

David: I wonder if he talked about it from the delivery room.

Ben: Awful. All right. What is mark-to-market accounting? Because we'll get into this a bunch, but let's understand it conceptually.

David: Yeah. It ends up taking a while for Enron to be able to implement this that we'll get into, but go for it.

Ben: Normally, if you're in the business of delivering gas to customers who will pay for it, you account for the cost that it takes to physically move the gas when you deliver it at the time you're delivering it. The cash that your customers pay you, that's your revenue, and you recognize that when they pay you.

Imagine you're in a different business like trading stocks. You probably should be accounting for the market value of everything you buy and sell whether or not you have actually sold it. If you bought Tesla at $20 a share, and it's now worth $200 a share, you should reflect that you have a gain, albeit an unrealized one. This is mark-to-market accounting.

David: Famously, all VCs do this, right? We talk about marks of your portfolio.

Ben: Right. Company raises an up round from a third-party who's setting a new price. That is what the market is saying this asset is worth. You get to account for that value, even though you haven't actually received the cash. Just because you haven't sold your Tesla shares, it doesn't mean that you don't have an unrealized gain. Or just because the VC hasn't realized the liquidity event from that company, it doesn't mean that the company is not worth more.

Skilling obviously really wanted this mark-to-market treatment. While you can imagine that it's probably easy to abuse mark-to-market accounting rules, it is probably okay if you can avoid the temptation. But it is worth pointing out that Enron, when they did adopt this, became the very first non-financial company to use this method.

David: We're going to talk quite a bit more about mark-to-market accounting in a minute. Let's just say the potential for a litany of abuse is high, very, very high, especially for what is an operating company, not actually a financial firm.

Ben: Mark-to-market accounting to me is the epitome of with great power comes great responsibility, because it really does open up this question of, okay, well, what is the market price? And how do you discover the true market price of something? When someone's not paying you for it and giving you the cash, doesn't it seem a little squishy to say what the thing is actually worth?

David: Oh, put a pin in that. We're going to come back to that. Skilling, I guess, after this lay his body on the tracks moment in the delivery room at the hospital, he comes in, he joins Enron running the new Enron finance division, where he is CEO of the division, he gets a big equity stake in the company tied to the performance of his division. Think a lot as we go through this story about incentives and the behavior that they drive.

He models this division just like an investment bank. He starts building out big trading floors in the Enron office in Houston. He wants to have this be just like Wall Street here in Houston. He brings on trader-type folks. Most famously—he's a side character here, mostly because nobody could ever actually figure out or from the outside what this guy actually did at Enron—this guy named Lou Pai who already was at Enron, but this guy, oh, my God.

Ben: I can't even hear his name without chuckling.

David: If you've watched the movie, The Smartest Guys in the Room, it's a really good movie. The movie version of the book, it's so mid-2000s. They use all this weird B-roll footage. Lou, like I said, nobody could ever actually figure out from the outside what he does at Enron. But one thing that he becomes really known for is his love of strippers.

Ben: Not just conceptually, he would eventually leave his wife and marry a stripper.

David: Yes. In the movie, I think they literally say, he was obsessed with strippers, he'd bring them to the office, he'd leave for hours at a time.

Ben: He would, every single day after work, go to the strip club. He knew all the strip clubs around Houston.

David: During the movie, they're showing all this B-roll footage. This is a documentary about accounting fraud. All of a sudden, out of nowhere, there's all this B-roll footage of strip clubs. Don't watch this movie with your kids.

Ben: Yeah, and super explicit B-roll footage of strip clubs. You're like, whoa, where did that come from?

David: It was super explicit. It's not like this was actually footage of Lou in the strip club. It's B-roll footage of strip clubs.

Ben: Lou Pai. I think the thing that he did—just to clarify a little bit—is he basically herded the traders. Think about traders in the 80s. They hired these people who, one of the quotes is, "If I was on my way to the bathroom, and someone said that I could double my pay by stepping on someone's throat, I would absolutely step on his throat." That's the type of people that they're hiring to make money both for Enron and for themselves. Lou Pai is the cowboy who's herding them all.

David: Lou, the other reason we bring him up, I guess, is because of his obsession with strippers. Ben, you said he leaves his wife that he's been with for 20 years. He runs off with a stripper. Because of that, he gets divorced from his wife. He ends up leaving Enron well before the fall. He sells his stock to finance the divorce for a quarter billion dollars. He makes $250 million.

Ben: He sold a stock at the top, I don't think with any notion of what was about to happen.

David: No, he had to finance the divorce.

Ben: Crazy.

David: He ends up becoming the second largest landholder in Colorado. He's still a multi hundred millionaire to this day. Crazy.

Ben: Other than a few people who go on to build real value after this by creating real businesses, he's the one who economically benefited the most of any of the Enron people.

David: Unbelievable.

Ben: And he stayed out of jail.

David: The big hire that Skilling makes as he's setting up this division is one Andrew Fastow, a former banker from Continental Illinois bank, where he worked in Chicago and he was part of the structured financing division at Continental Illinois. Continental Illinois had the inglorious honor of becoming the largest bank failure in history until Washington Mutual during the financial crisis.

This is the cloth that Fastow is cut from. When Skilling is recruiting him to come in and run structured finance at Enron, he talks with him. He hears about his experience and he's like, you, sir, are the man for the job.

Ben: You look at Andy Fastow and you hear him talk, you want to trust him. He's the picture of a polished thoughtful finance executive who's thought this through, who has all the I’s dotted and the T’s crossed. He's good looking.

He's the picture of the successful 80s confident businessman, but with no slime on him. When you hear Skilling talk, you're like, oh, I'm not sure this guy has my best interests at heart. The thing with Fastow is you actually do think he has your best interests at heart.

David: He's like the American Psycho guy, He's like a banker.

Ben: Yes.

David: He is a banker, except he just comes from the bank that was the largest bank failure in history. He comes in, and Skilling sets him to work doing structured financing. The primary thing that they're doing is they're packaging up these financing deals that Enron had started doing for the producers, for the drillers. Remember, they're trying to kickstart the market, bootstrap supply for this derivatives market. They're doing all this financing for drillers out there for oil producers.

They don't really want those assets on the Enron books. They devise this scheme that they become acquainted with through Arthur Andersen, through the accountants and auditors, of using special-purpose entities to package up these investments that they're making in producers, and get them off of the Enron books.

It turns out, they learn through doing this, that at the time, if you set up a separate legal entity from the company, a special-purpose entity—this is different than a special-purpose vehicle that people use for investing in startups today—as long as at least 3% of the capital in that entity comes from outside investors, you can still have the company itself own 97% of the economics of that entity, and you can remove it from your consolidated accounting books. You can just wipe it out of your accounting. Say, this is now owned and controlled by an independent third-party entity. The test for it being independent is that a minimum of 3% of the capital comes from outside sources.

Ben: We live in a system that enabled this fraud. I want to keep reiterating that over, and over, and over again. Until Sarbanes-Oxley passed in 2002 because of this scandal (and some other scandals, but largely because of Enron), we just existed in a system where all of this was exploitable and just waiting for someone who did not have the scruples to just finally come in and exploit all these loopholes.

David: Totally. There were no lids on the cookie jars.

Ben: There were no lids.

David: No lids.

Ben: You might ask, this doesn't seem like that big a deal. Imagine these things are hugely loss-making, but you're trying to go tell equity investors—people who own the Enron stock—how great your company is. It would be great if all their losses weren't showing up in your financial statements.

David: Enron doesn't care about the quality of the assets or projects that it's investing in with these producers. It just wants to lock up the contracts for, as someone would project, the future oil and gas that's going to come out of these wells. Enron doesn't actually care if they're well-run, are they going to make money, or the valuations make sense. They just want to lock up the deals. They do a lot of really bad deals.

Ben: Yup, massive incentive misalignment. You said we weren't going to get into mark-to-market accounting yet, but I have to introduce. Okay, so I'm Enron. I make a crap investment in your oil production project.

I say, I want you to exclusively trade the financial derivatives around all the natural gas flowing out of your production facility through Enron. You say, okay. I say, how much do you think is going to eventually flow out of that? You tell me a number.

I say, well, if I take the most aggressive possible circumstance for what the price of that could be over time, and the amount of volume that that could produce over time, and I take the most aggressive possible stance on the amount of interesting financial instruments that I could make out of that, I think you and I can agree that this deal that we're signing is a ludicrously valuable deal for me, Enron.

The right to generate all this revenue from trading the assets that come out of your production facility, let's write this down. Let's paper this. The discounted future cash flows of all of the money that I'm going to make from your production facility, that's really big.

David: What you're telling me, these numbers that you put on paper that maybe I encouraged you to make them higher.

Ben: Right, that's really great. I don't care about my equity investment in your thing. We're going to put that off into a special-purpose entity. We're never going to talk about it again. I don't really care if that goes to zero. But hey, I use mark-to-market accounting.

Because I just signed this deal, where all of the future cash flows of this thing are looking really good, I'm going to recognize that as revenue today. I know I'm not going to get the cash today, but my income statement, yup, you better bet that I am generating a ton of income from this deal that we just signed.

David: Okay, so there's a bunch of both story and explanation we got to talk about here. We've talked a bunch about mark-to-market accounting. Despite Skilling apparently laying himself on the tracks about this being non-negotiable coming in, it wasn't like Enron could just say and Skilling could just say, oh, we're doing mark-to-market accounting. They had to make the case to Arthur Andersen, to the auditors that Anderson could get comfortable with him doing this.

Andersen says, I don't know. This is really out there, like very borderline that you guys could use mark-to-market accounting as an operating oil and gas company. I don't know that we feel comfortable with this unless the SEC signs off on it. Skilling is like, great. Let's take this to the SEC.

Andersen takes it to the SEC, the SEC rejects it. They come back to Skilling and they're like, as expected, the SEC is like, this is crazy, you can't do this. Skilling is like, I want to go talk to the SEC.

Ben: He's a ludicrously compelling character. There is an intellectual purity about him, where he can create an argument that sounds really, really compelling. This has worked for him many times in his life, so he's like, sure, I'll just go explain this to the SEC, they'll get it.

David: He spins this story that amazingly, the SEC somehow becomes convinced that this is a good idea. They sign off on it.

Ben: I think this is really an interesting point in the story. This is the only instance where you have someone who is complicit in allowing Enron to run the playbook that they did who doesn't have a conflict of interest. Andersen tax was getting paid tons of fees. The lawyers who signed off on lots of stuff over the years were getting paid tons of fees. All the employees had all this stock. They were incentivized for it to go up.

David: This is really the puzzling one.

Ben: This is one where the person whose job it is at the SEC to approve this or not approve it don't have a vested interest.

David: Here's probably also a good point to bring up the Arthur Andersen conflict. It's not just that Enron is a big audit client for them. At this point in time, pre Sarbanes-Oxley and pre the fall of Arthur Andersen, all the accounting firms had attached consulting arms under the same roof. Andersen had Andersen consulting, which would go on to become Accenture after the demise of Andersen.

Ben: This is nuts. I don't think I really grasped this.

David: The conflict here is events.

Ben: This whole thing took down Arthur Andersen. What they did for the consulting arm was they rebranded it Accenture and spun it out into its own thing.

David: At this point in time, all the senior partners at the firm, it's one in the same. They're all making money from these engagements. Enron became Andersen's biggest client in the world. They were making $50 million a year from Enron, half of which was audit and tax fees, and half of which was consulting fees.

At any point in time, Enron could just maybe be hard for them to switch their auditors, but they could switch their consultants at the drop of a hat. There were huge incentives for Andersen to let them get away with what they wanted to keep the client happy. It was their biggest client in the world.

Ben: There were no lids on the cookie jars.

David: Miraculously, for the evil guys at Enron, this gets through the SEC. Now, we've explained a little bit thus far about how good mark-to-market accounting can be for Enron. It's so much better than that.

Ben: Better, better for running a pump and dump.

David: This is where the whole thing comes together in just an unbelievable way. The parallels to crypto, they're crazy. Once they implement mark-to-market accounting, Ben, you explained a little bit the deals there a minute ago. You do a deal with a producer and you say hey, whether or not you're going to be able to execute on these plans, let's pump up these projections, make them look as big as possible. Then I, Enron, will recognize as revenue today, my projected cash flows based on this Excel spreadsheet for the next 20 years.

The SEC allowed them to go up to 20 years so that they could collapse into today revenue. So 20 years of future cash flows, they recognize that as revenue today with no expenses associated with it.

Ben: Here's why you could argue it's fair, because there are at least 20 years of future cash flows baked into the stock price of any asset. If I'm buying a stock and holding it on my books, in the enterprise value of that stock, I am accounting for 20+ years and the future of the cash flows that come out of it then.

David: One other maybe sliver of a justification. In our world, talking about this sounds utterly insane. You're talking about startups and new projects. Who knows if these things are going to work, tech startups or whatnot. This is a different world in oil and gas. You can be pretty sure if you have a geologic site that you've done enough exploration on the site, you've decided you're going to build a well, you can be pretty sure you're going to get assets out of that site.

Exactly how much and on what schedule, you don't know. But you're going to get useful commodity stuff and there's going to be a market for that commodity. You will make money out of this site. How much money? That is up for debate. What the price of the commodities will be over the 20 years, that also fluctuates. That's up for debate, but it's not like you're not gonna get anything out of this.

Okay, that's part one of why mark-to-market accounting is just this bonanza for Enron, but it's double that. Remember these special-purpose entities that Skilling and Fastow are now setting up. They're offloading. They're "selling" these assets that Enron doesn't really want on his books. They're selling off to the special-purpose entities.

Because those are also transactions, Enron now gets to book those, essentially phony sales. It has revenue, so they're double dipping. They do a deal with a developer, they recognize as revenue, 20 years of forecasted cash flows out of that asset.

Ben: Oh, just from their equity value in the project.

David: Then a week later, they turn around, and they sell their equity in that project to a phony special-purpose entity for some astronomical price. Then they recognize that value from the transaction as revenue, even though they own 90% of the entity that they just sold it to.

Ben: Crazy. All the while, no cash has actually changed hands.

David: Totally. This is like the ultimate Ponzi scheme.

Ben: It's wild.

David: It's totally wild. All of that is bad enough. Let's make it even worse. If you are trying to create as beautiful and amazing an income statement as possible, obviously, mark-to-market accounting is great for all the reasons we just discussed. Investors will love it. You can inflate your revenues hugely, et cetera.

There's one problem, and that problem is that it's all one time. This is the opposite of ARR. There is no recurring revenue here. You are taking all the future income, revenue, cash flow, you're collapsing it to a single moment in time. Whatever deals you do in one year, you're starting from zero the next year, you get no future benefit on your income statement from those deals.

Ben: You're squeezing every amount of possible upside out of the future and into today. You're just constantly making it harder on yourself to achieve anything in the future because you've already recognized it all. Basically, if you don't do more different deals next year, it doesn't matter how good every contract you've already signed is and how amazing all those projects are doing. You have an actual zero in your revenue category without doing more deals.

David: Totally. Like any house of cards here, this all looks great, but there's literally no way that this doesn't all blow up. It's all just completely inflated. Once they start down this path, there's no scenario where this ends well. It's just a question of how long the fuse is until the bomb blows up.

Ben: You're borrowing on the future in such a big way.

David: And because there's no underlying reality at a certain point. The "deals" that they're doing on the front end are not good deals, because everybody's incentivized to pump the numbers. The producers are incentivized to pump the numbers to get more money. Enron's incentivized to pump the numbers to book more revenue, even though they're paying for the deals. Then the bigger the deal price, the bigger the dollar value that they offload it for to the special-purpose entities that they book the revenue again.

Ben: The most devilishly difficult thing about all this is, once the train gets set in motion, and you start putting up these numbers, and you start reporting them in your financial statements, you massively catch the attention of investors. You then have to keep it going, because people start to invest, your stock starts to go up, because no one's seen an income statement like this.

This is crazy. This is the future. There are lots of reasons to believe that it's going to be nuts. You start believing the numbers. You start convincing other people to believe the numbers, and then you got to move mountains every quarter to make the numbers keep going up.

David: This whole devilish flywheel really gets put in place by 1996. It's really humming. They would have a five-year run from 1996 to 2001, during which revenues grew 7.5X during those 5 years. It went from $13.3 billion in 1996 to over $100 billion in the year 2000. Every year during that period from 96 through 2001, the company would go bankrupt at the end of 2001.

Ben: Which were the six years that they were Fortune's most innovative company.

David: Yes. Fortune Magazine—remember, this is going to come back up with the particular publication—names them America's most innovative company, and in the year 2000, also names them America's best managed company. Unbelievable.

Back to the mid-90s. On the back of all of these huge wins, this transformation with the company, Skilling gets promoted from just being head of the Enron finance division to President and COO of the entire company. Number two behind Lay, who's still the chairman and CEO, but he basically just takes on an elder statesman role.

He's out there schmoozing Politico. He becomes super close with the Bush family, super, super close. Fastow gets quite the meteoric rise out of this. He goes from being a jack-of-all-trades, mid-level executive in the finance division to the CFO of the entire company.

Ben: And structured finance becomes its own division. They start relying on it as a profit center. Not just a CFO to manage the finances of the business, but they're like, can you come up with new financial products to generate revenue on your own?

David: When Skilling gets elevated to number two and Fastow to CFO of the company, they start articulating as the company strategy that the finance department is going to go from being this shared resource cost center to a profit-generating division of the company. The fact that this didn't raise massive alarm bells throughout the entire investor community is just crazy.

Ben: The thing I want to continue to harp on is, it would have if the incentives weren't so dramatically misaligned. Everyone benefited from this thing going up. The ratings agencies benefited from this thing going up. Everybody who ever bought Enron stock saw it going up, so they wanted to continue to see it going up.

These deals, Enron's flying around doing deals, do you know who they need for deals? Investment bankers. Do you know what investment bankers also have? Analysts. Do you know what those analysts are going to say? Buy. It is just like the whole world was making so much money at least on paper from this happening that, why would you ever want it to stop happening?

David: Like we've been saying, they need to keep doing bigger and bigger deals. What does Enron do? They start heavily investing in their international division. They've saturated the US with all the producers in the US. They're like, we can go out to other countries, both developed and developing countries, and especially in developing countries, we can do these massive, massive production deals that just fuel all of this.

They go to famously India, Brazil, Argentina, and they finance these multibillion dollar energy projects. India's the worst of them. This power plant that they finance, and it's LNG (Liquefied Natural Gas) power plant on the coast of India that they financed, multi billion dollars, India doesn't have the technology, the grid, the demand anyway to actually use this. The project just becomes this smoking crater on the Indian coastline.

Ben: I think it's still never opened. The half completed building is still just sitting there.

David: At various points in time, I think they have technically turned it on, but not actually. Yeah, it's still just sitting there. But Enron books billions of dollars of revenue and then they offload the assets. Everything we've talked about, it's just this metastasizing cancer on the world.

Ben: The one thing that is credible about what they're claiming is the key thing to develop a society is widely available energy. There is this notion of like, okay, if the way to accelerate a country that is becoming—I don't know if developed country is the correct parlance anymore—an economy that has high employment, high quality of life, a good mix between information work and physical work, making real things in the real world, growing GDP rapidly, becoming a player on the world stage, whatever you want to call it, every single thing requires massive amounts of energy as a precondition.

One major reason why the US got to be such an incredible superpower is that we burned tons of fossil fuels over the last 80 years in order to accomplish all the things that we have today and achieve the quality of life that most people in the US have today. There is a real, well-founded argument to be made that it is both good for these countries to come in and do this, and they'll need it anyway, so there's a huge market opportunity that we're pulling forward to now by creating a ton of energy capacity there.

David: You can really see the insidious political tendrils of this company. Politically, this looks fantastic. Enron is financing the energy development of India, Brazil, Argentina, blah-blah-blah. The politicians love this. Here's this innovative American company. Whoo, man.

As this gets bigger, and bigger, and bigger, remember the key on the back end to making this work for the special-purpose entities. Now, you only need to come up with 3% outside capital. But Enron starts doing so many deals that are so big, and they're offloading so many assets, it actually becomes a problem finding enough suckers to pony up even 3% of the capital needed to be offloading these assets.

Ben: By the way, we should say, how does Enron have the capital? Because they're not generating a lot of cash flow. It's worth knowing that on their earnings calls, they are releasing a profit and loss statement, and then a little few weeks later, coming out with a balance sheet and a cash flow statement.

You say, well, how are they financing 97% of these projects? First of all, a lot of times, they're doing co-development deals. They're getting a government to pony up a bunch of cash, and Enron ponies up a bunch of their development resources and people, which by the way, they're terrible at, because actually, what they become good at is a financial derivatives trading firm and not actually having the human power to go and execute on building these really complex projects.

But they are getting cash from somewhere. Where are they getting it from? Investors, the American public. As their stock starts to run, they do more and more issuances of new stock at these new stratospheric prices to bring cash in the door since the operations are not actually producing a lot of real cash.

The flywheel looks like pump the stock, issue more equity, take the cash from that new public fundraise that you've just done and shaking the American public, the tree of the American public, take that cash, and use that as the 97% that you need to stuff into a special-purpose entity to go and finance a project.

David: It's actually not that. It's to use that cash to finance these crappy development deals they're doing all over the world. On the back end, there's actually no cash because Enron is the buyer and the seller. They're just taking it off the books. They're not actually buying anything. There's no cash changing hands.

Ben: You really start to wonder, like, I don't think this was the plan the whole time. I think it was the fact that once you started needing to show growth and you've already pulled forward all the revenue out of next year and the last year, then you got to do something. You have to get infinitely creative in your way to show income on the income statement, so you start spinning up all these divisions to do crazy stuff.

David: Like we're saying, that dynamic, it's the point where it's so big, they can't find enough suckers to even do 3% of the equity and capital in these crappy deals. Again, Enron's on both sides of, even though the special-purpose entity is "independent."

Fastow and Skilling come up with yet another brilliant idea. Rather than going and doing roadshows signing up other entities to do this, what if they had their own fund? A captive fund, part of the Enron family, but was separate, was intended, that could put up this 3% of the equity needed for every deal?

Ben: God, we could call this episode, arm's length, but not really.

David: They go to Andersen and they're like, what if we do this? What if Andy, what if Fastow sets up this fund and is the general partner in it, and we only use it for stuff that helps Enron? Yes, he's the CFO of Enron. He'll also be the general partner of this fund that's going to do deals with Enron, but it's only deals that are going to be good for Enron.

Andersen's like, that seems really bad. You should probably go to the board and get sign off on this very, very obvious conflict of interest. They do. They take this to the board, and they present it. Fastow presents it to the board as...

Ben: I'm willing to fall on the sword to do this for you, guys.

David: I'm taking one for the team, guys.

Ben: Never mind the fact that he has full private equity economics on this deal. I don't know if it's 2 in 20 or whatever it is, but there are management fees, there's carry. He is the general partner of a private equity fund that is only getting good deals, because you know that he is going to screw Enron to get the private equity fund to get great terms on these deals. He's pitching the board.

David: He's pitching the board. The board is like, great. Thanks for taking one for the team, Andy. This is going to be great for Enron. I really appreciate your hard work. Basically, a bunch of attaboys and slaps on the back.

Yeah, as you mentioned, this is a private equity fund that he gets to present management fees, 20% of the profits. It ends up across a series of funds being hundreds and hundreds of millions of dollars that he's managing.

Ben: I think Fund I was smallish, but Fund II $was 200 million.

David: Yeah, we'll get into what it is exactly in a minute here. The management fees of a fund (in theory) are supposed to support the cost of running the fund, like headcount, salaries, rent, office space, all the resources you need. He's the CFO of Enron. Everybody who works on the fund is an Enron employee. Enron is paying the salaries of everybody. The office is Enron. There's no headcount, there are no funds. All the Bloomberg terminals, all the legal, all the accounting...

Ben: He's pulling someone off their day job every time they needed to negotiate a deal between his fund and Enron and saying, okay, you wear the Enron hat this time and negotiate against me, and all wear the private equity hat, and they're calling that arm's length.

David: All the management fees, there are no expenses, they're just straight flowing to him. The real kicker—you're joking about this before the episode, and that should have told everybody where his real incentive lies—he decides to name the suite of funds, LJM Capital. What does LJM stands for? It stands for Lea, Jeffrey, and Matthew, which are the names of his wife and kids. There's no question who is benefiting from what is going on here, and it's not Enron.

Ben: Unbelievable. There's the squirreliest, most circuitous route to trying to find disclosures on this. Whenever it's convenient to say so, there are claims that the board was fully on board with this. Whenever you're looking for the smoking gun, it's really difficult to find anyone's signatures or a discussion of this in the board minutes.

It's especially difficult to find Jeff Skilling signature on anything, even though the whole agreement was Skilling will sign off as the final approver on (I think) deals, but definitely Fastow's compensation from this. There are documents that surface that have a variety of signatures on them, but not Skilling's. He very intentionally was like, I'm not actually going to sign off on this, but it's good for Enron that it happens, so I'm going to let it keep happening.

David: It's good because these funds, this vehicle, everything that Fastow is now running can put up the 3% capital for this special-purpose entity. They don't need to involve any outside people in all of this.

Ben: Not to mention, all the people investing capital are these big banks. It further entrenches major financial institutions—Merrill Lynch, JP Morgan—all these big people that Enron wants to continue to have incentivized for their success further in owning assets that are associated with Enron.

David: Yes. Everybody in Enron is so hyped up about this that in 1999, Fastow starts a campaign within Enron with Lay, Skilling, and the PR people in Enron, to get himself nominated for the CFO of the year in the CFO magazine annual rankings of CFO. He ends up not winning, but he does get a special award from CFO magazine for CFO excellence in the category of capital structure management.

They do have a few years, tons, tons of these deals. Two things are always true about the deals: (1) Fastow is finding a way for Fastow to benefit and get rich, LJM. We know who number one is here. (2) Enron also benefits, because it's now just turbocharging this whole flywheel and getting the bad stuff off the balance sheets, and booking revenue is associated with these deals.

Eventually, Enron also makes Fastow the head of corp dev. He is now the head on all sides of the transactions. He's the CFO, he is the head of corporate development, who would be the person charged with negotiating the Enron side of the table against the outside investors, the LJM, but he runs everything.

Ben: It's so, so wild. At the time that they do end up actually disclosing this— I don't want to flash too far forward, but it's worth sharing this detail, they do disclose it—they say, oh, there exists an entity that's managed by a member of the management team that does deals with Enron. That's one sentence. Then when the shit really hits the fan, they say, oh, well, a previously disclosed entity did deals this quarter, but that's been previously disclosed.

There ends up being like a billion dollar loss or some crazy—don't quote me on that—some massive, massive loss. They're like, oh, we disclosed this whole thing before. It all ties back to this one sentence, where they're just saying, a member of the management team has a related entity that does transactions with Enron.

David: This is where everything starts to unravel. Investors and the media start asking around about this. By this point in time, we’re now in…

Ben: Early 2001.

David: Yeah. Lay has now stepped back to just be chairman. Skilling has been promoted to be CEO of the whole company. Fastow is still CFO plus head of corp dev, plus running these LJM funds, unrelated funds. People are starting to ask around about what's going on at Enron.

People assume when this disclosure comes out that it's Skilling who's running these funds. They're like, oh, my God, is the CEO doing this? I think the Wall Street Journal calls up Enron PR and they're like, yo, what's up here? Enron PR is like, oh, no, it's not Skilling, don't worry. It's Fastow.

Ben: Who just immediately gets thrown under the bus.

David: Thrown under the bus. Everybody hated Fastow and the company, apparently.

Ben: Especially late in the game here, because people can figure out that he was getting rich on these LJM structures. He actually had LJM III in the works to be a billion dollar fund. And if that came together, he was just going to peace out and go do that.

David: You just can't make this stuff up. As that all starts happening, Fastow, Skilling, and the company eventually decide, all right, Andy, you've really taken one for the team here, you can either stay at Enron, be the CFO and head of corp dev, or you can go run these funds. You can no longer do both. People are asking too many questions.

Fastow asked for some time—the weekend—to go think about it, talk to his wife. He comes back to Skilling and he's like, I'm loyal to Enron. I'm staying here, I'm going to give up. I'm going to sell off my interest.

Ben: Sell my interest. I'm going to get all my economics out of the interest while they're at an all time high.

David: Here's what he does. Back before the funds, when they were just doing one-off deals, Fastow had a direct report in the finance organization, a guy named Michael Kopper. He and copper came to an understanding.

Ben: A lot of understanding around this company.

David: Here's this giant cookie jar of all these deals that Enron is doing, and there's no lid on it. They could work together to skim a few chocolate chips out of the cookie jar. They were in cahoots together.

They had done a transaction together, where again, before the funds, one of the investors that have come in on one of the projects was CalPERS, the big California State Employee Pension Retirement fund. They had done one of these offloading projects with Enron.

Ben: This is with Enron energy services. This was the $130 million deal.

David: Jedi?

Ben: Yeah. Do you know, speaking of FTX, who the other big investor was along with CalPERS?

David: Oh, I don't know. I didn't see this.

Ben: You cannot make this stuff up. The Ontario Teachers' Pension Plan.

David: Oh, I think I did see that, who were also of course, big investors in FTX, right?

Ben: Yes.

David: This particular entity was called the Jedi entity, the CalPERS and the Ontario Teachers' fund had invested in. Enron and Fastow wanted to do an even bigger deal with them. CalPERS said, okay, we're interested in a bigger deal, but we want to get our capital out of Jedi1, get that capital out, and put even more capital into Jedi2. Fastow was like, aha, I see an opportunity to enrich myself.

He drafts Kopper into service here. They create an entity called Chewco, short for Chewbacca and sticking with the Star Wars theme here. Remember, this is all got to be fully independent, but Fastow and Kopper both work at Enron. Why did Fastow target Kopper as his accomplice here? Kopper was gay, and this is the 1990s in America. Gay marriage is not legal.

Ben: In Texas.

David: I don't know if it was legal anywhere. Certainly, it was not legal in Texas, and it was not legal federally in America at the time. Kopper's domestic partner, a guy named Bill Dodson, is not legally married to Kopper, and he's not part of Enron. They set up Dodson as the outside investor in Chewco to buy out the Jedi assets from CalPERS. Then Fastow and Kopper create a secret spreadsheet. This is the beginning of their nefarious deals together.

Ben: When the second set of books starts being created, that was a dangerous time.

David: Yes. On Kopper's home laptop, they have this secret spreadsheet, where they're keeping track of all the deals, where they use Dodson as the front for anytime they need to offload from the offload. They use this deal to enrich themselves. Unbelievable.

Ben: How did any of these guys plead not guilty?

David: Unbelievable. Kopper starts cutting checks from all the money they're making, that Dodson is making. Kopper starts cutting checks to Leah Fastow, Andy's wife. That's how they spread the money around.

Ben: Unbelievable.

David: Now, flash forward, back to when Andy is once again taking one for the team and selling off his general partner membership in the LJM funds, who does he sell it to? He sells them to Kopper. They use the same scheme for Andy, of course, to still stay involved and be getting at least a 50/50, if not more share of everything.

Ben: This is like when he's fallen to his knees and told Skilling, you're the only girl at the dance. You're the only one for me. I'm foregoing this whole grand idea I had around all these economics from the LJM partnerships, not so much.

All right, David, I think this is a good spot to welcome our second sponsor of the episode, Vanta, the world leader in automated security and compliance. We are huge fans of Vanta and their approach to the whole compliance process—SOC 2, HIPAA, GDPR, and more. We've got CEO and co-founder, Christina Cacioppo, with us today.

David: Today, let's go back to the beginning and the core, SOC 2. I'm just starting out as a company, as a founder. I need SOC 2 compliance, whether it's to close a big deal or to work with a big partner. Why should I choose Vanta, and how can you help me on that front?

Christina: SOC 2 is our bread and butter. Vanta is the first, the most trusted, and the most complete way to get a SOC 2, so breaking those down. First, we started this market in 2018. We saw the problem at Dropbox, working on Dropbox Paper, and trying to take it to market. We saw the problem with our friend’s startups that actually weren't getting SOC 2s because they were so onerous. But instead, we're going through security questionnaire, security review gauntlets.

We're pretty confident about where the market’s going and have the most customers. Because we've been in this the longest and actually have really close relationships with the auditors that actually do the reports, we're the only company that is able to sell the audit along with Vanta in a truly seamless experience. This took us a few years to do. Now we're able to have the software, the audit. It all works together again in one seamless way.

David: It turns out building software that works with people is not a trivial task, right?

Christina: No. It takes much longer, it turns out, than building just the software, yes. The third bit most complete is just, to get a SOC 2, there's a bunch of surface area. There are about 12 or so separate security tools or processes that you want to implement in HR and IT policies and processes, too. We're the only player in the market that covers that whole range of them to our customers. That means it's faster, it's more cost efficient. There's a lower total cost of ownership for them. To your point, they can go back to the beer recipe.

Ben: Our thanks to Vanta, the leader in automated security and compliance software. If you are looking to join Vanta's 4000+ customers to get compliance certified in weeks instead of months, you can click the link in the show notes or go to vanta.com/acquired for a 10% discount.

David: Thank you, Vanta.

Ben: It's probably worth flashing back to the 1997 timeframe to start talking about what was happening outside the office of the CFO at Enron, because they're going nuts. They've realized that they've accounted for all the future points on the board last year, so they got to do a whole bunch of stuff to show a bunch of growth, because boy is the stock pumping and boy does the stock need to pump in order for them to continue all these new equity issuances to give them the cash to do all this wild stuff.

They've got the pipelines. They're not particularly interested in that very old business that's hard to fake, tinker with, or innovate on top of. They're like, okay, the trading business, sometimes we take big losses, but sometimes wild speculation can give us really big profits or at least paper profits. Let's trade more stuff. They get into the electricity business.

For the first time, they move beyond natural gas. Of course, they find out that trading power is hard, because unlike gigantic pipelines and tanks where you can store natural gas, you can't store electrons, famously, batteries are very inefficient. It's not like you can charge up batteries and store all the electrons there for a while until you need them somewhere else. You basically need to be producing the electrons at the exact same rate that you are consuming them.

That makes an electricity market interesting, but much harder than what they were doing in natural gas. They also expand into water, especially internationally. That's also very hard because all water droplets are not created equal. There are different impurities, different salinities that you have to treat. Of course in the US, there's also no federal order requiring those who own water pipes to let anyone move stuff around inside of them the way that you have in natural gas and electricity.

These people who own the water pipes own the water pipes. If they want to tell you, you can't put your stuff in here and you can't make money off our assets, they're allowed to do that. What else happens? They spin up trading teams for pulp and paper, weather derivatives, freight, metals trading, until they finally stumble on the thing that is really going to make them money—bandwidth. Fiber optic network.

David: Internet bandwidth.

Ben: Enron, the tech company.

David: Enron, the tech company. The stock goes nuts when this gets announced. One quick note that we would be remiss if not talking about on this episode with regard to the power trading that they get into the electricity trading, they become a key player in the total disaster that is the California blackouts.

Ben: It's hard to know if they caused it or if they just profited from it.

David: They certainly profited and they might have helped cause it.

Ben: What happened here? This is worth talking about. The California power markets were being deregulated much like the natural gas markets, but not fully. The Enron traders, who are these pure capitalists, they're these pure sort of like, if there's a dollar on the table, it is my ethical responsibility to go take it no matter what the impacts are, because I have an intellectual purity to...

David: I don't think there's a lot of intellectual justification going on. More visceral.

Ben: No, I think there is. I think it's a deeply philosophical thing, where people believe that free markets are virtuous. The only virtuous thing to do is to have everything be a completely deregulated, open, free market, lay the rules of the game out clearly, and then play the game however the rules say that you can play them.

David: And there are two classes. I think the Skillings and the Kenneth Lays of the world fit that bill. I think a lot of the actual day to day traders are more just like red meat traders make money guys.

Ben: What happened here? The state of California decided that they didn't want to go full free market. They'd put in lots of safety measures that ended up being the opposite of that, because usually when you add a new mechanism into a free market, it can be played in a variety of different ways.

On the one hand, it seems reasonable to have controls in place. On the other hand, it entered a lot of new rules onto the playing field for these traders to exploit, so people would run experiments to test if they were exploitable, they would see the results, and then they would go hard, and they would be rewarded for going hard. A company is not on the right side of history when memo starts circulating on the floor with names like Death Star, Fat Boy, Get Shorty, and Ricochet.

David: These are various trading strategies in the California energy market.

Ben: Just four of the trading strategies, but it's worth articulating some of the crazy stuff they did. What is Death Star? It was this experiment, where Enron went into the market and filed an imaginary transmission schedule in order to get paid to alleviate congestion that didn't really exist. This sort of like, can we spike something to watch the impact on something else and then make money from a contract on the impact of it somewhere else?

Fat Boy was a scheme, where Enron would submit a schedule to the marketplace reflecting demand that wasn't actually there, and then watching what happened when that demand tried to be fulfilled, and there was nowhere to put it, so then there was a big extra amount of electricity being produced somewhere. They could profit from that.

Get Shorty, selling power that Enron didn't actually have for use as reserves with the expectation that Enron would never actually be called upon to supply the power or it could just buy it later at a lower price.

Or the worst of them all, Ricochet, where Enron would work with someone who's generating power in California, a utility.

David: Was this where they had them shut it down for maintenance?

Ben: No, this was where they would export it out of the state, and they had control over the transmission line, so they could do that. Then when California realized, oh, crap, we need energy, then they would have a contract in place, where Enron would get paid to bring it back in at much, much higher prices, which the industry will start calling this megawatt laundering, because that's really what it was.

David: I think what they would do as part of it, too, is call up generation plants where they had relationships, and encourage them to shut down for maintenance at specific points in time when they knew it would cause blackouts and spike the price.

Ben: It's exactly what it did. I am confident that people died from this. This is one of those things, where if you're randomly depriving huge swaths of California from power—hospitals, schools, people's homes—it's not fun in games. It is profiting from terrible harmful activities to people.

David: This has such far reaching impacts. This was one of, if not the major reason that California Governor Gray Davis gets recalled, and then Arnold Schwarzenegger gets elected governator. This was the key issue. Enron and other trading companies were totally manipulating the market.

Ben: Power trading, this whole thing is going on. That's one corner of Enron. Another corner of Enron is this thing, Enron energy services, which I believe is the division that Lou Pai ran. But in 97, this was the current hotness for what to get investors excited about as the future of Enron, because they had done the, we're a pure marketplace than we're a financial derivatives, then they got mark-to-market accounting and started doing all the international development. They started doing power.

Enron energy services is this thing that Skilling really wants to sell the story about how it's taking off. Let me just read this passage from The Smartest Guys in the Room, because I think this probably articulates the insidiousness of the Enron culture better than anything else.

“Analysts come to Houston. They tour the sixth floor of the EES war room. There, they held the very picture of a sophisticated booming business, a big open room bustling with people, all busy, working the telephones, hunched over computer terminals, seemingly cutting deals and trading energy. Giant plasma screens displayed electronic maps, which could show sites of EES as many contracts and prospects. Commodity prices danced across an electronic ticker.

‘It was impressive,’ recalls John Olsen, who at the time covered the company for Merrill Lynch. It was a veritable beehive of activity. It was also a veritable sham. The war room had been rapidly fitted out explicitly to impress the analysts. Though EES was just then gearing up, Skilling and Pai had staged it all to convince the visitors that things were really hopping.

On the day the analysts arrived, the room was filled with Enron employees. Many of them, though, did not work on the sixth floor at all. They were secretaries, EES staff from other locations, non-EES employees who had been drafted for the occasion, and coached on the importance of appearing busy. One administrative assistant named Kim Garcia recalls being told to bring her personal photos to make it look as if she actually worked at the desk where she was sitting.

She spent most of the time talking to her girlfriends on the phone. After getting the all clear signal, Garcia packed up her belongings and returned to her real desk on the ninth floor. The analysts had no clue they had been hoodwinked.”

David: Oh, my God. This is like a classic boiler room ruse. This is great.

Ben: Unbelievable. That was 97. That was four years before the fall, they were pulling crap like that.

David: Should we talk about the broadband services and internet division?

Ben: Absolutely. Enron, the internet company, suddenly, magically. This company started by merging two pipelines. Here they are, the seventh most valuable company in the world, because they're somehow the company that's going to capitalize on this new internet thing.

David: Did you read about how they did a deal with Blockbuster?

Ben: Yes. This is the best. Truly, you can't make this stuff.

David: This is tailor made for Acquired.

Ben: Before the Blockbuster-Netflix thing, and before Blockbuster even considered streaming, they offered a video on demand product that was provided by Enron's fiber. Somehow, Enron was doing the servers and digital delivery.

David: This was video on demand being like if you were a cable or satellite subscriber on your cable box, you could get video on demand. This wasn't the Internet. This isn’t internet streaming. This is on demand, but via the cable infrastructure, right?

Ben: I think that's right. I think they only had bad movies. I don't think they were able to lock up good ones. However they ended up delivering it, I don't think the consumer demand was really there.

David: The service never launched. But of course, with Enron's mark-to-market, they booked over $100 million in revenue on day one for it, and then they offloaded the project to a special-purpose entity.

Ben: $110 million. Even better, David. They offloaded it to a special-purpose entity. At some point, they tore off the contract. I don't know if it was Enron or Blockbuster. But they basically said, this deal sucks. No one wants this. You know what they did? They created an even bigger impact to revenue in the positive direction, like more than $100 million because of a new thing that happened.

It's not a contract. It's the lack of a contract. Now they have the ability to do deals with everyone. They're not locked into an exclusive deal with Blockbuster. That creates a huge amount of future value for Enron, the company, and their shareholders. They literally recognized revenue, even bigger than the Blockbuster deal after the lack of Blockbuster deals.

David: Oh, I didn't see that. That's amazing.

Ben: It is wicked stuff. This is where you're just like, you guys are criminals.

David: Okay, before we come back to the wheels starting to fall apart in 2001, there's one more piece of the intervening go-go years we should talk about. You want to talk about Enron Online?

Ben: Yes. Of course, we were referring to the bandwidth trading, which also is much more difficult than trading natural gas. How exactly is that all going to work? Trading available bandwidth, especially when there's this massive last mile problem to everyone's homes? If someone needs more bandwidth in one place than another, how's that going to work? Are you just physically going to widen the wires? I think people just didn't really understand these concepts yet.

There are lots of excitement around what Enron's doing in trading bandwidth, around being an internet company, but they actually do launch an internet product. Now, the internet product is really just to advantage their in-house business. This one to me seems like it's probably not fraud. It's just an example of evil but beneficial for shareholders' business strategy.

In November of 99, they launched something called Enron Online. What this is is it allows all of Enron's counterparties to trade with them electronically. They stand up an exchange, like an exchange you can access through a web browser, much like FTX, but Enron itself is the counterparty to every trade. They don't even pretend that they're not on the other side of most transactions.

David: Oh, my God. I didn't make the FTX-Alameda connection in this. This is too good.

Ben: It is just the craziest thing, where they're just like, yup, we're the counterparty to every single trade here, so we're going to generate a little bit of spread on the exchange. We're probably going to get beneficial pricing being the counterparty, because we have the most information in the market for everything that's being traded on here, because it is our marketplace, and we're going to use that information. It's a pretty savvy data advantage.

Now, unfortunately, what they do with that data advantage is they do manipulate markets. That, I believe, leads to some part of the downfall case against them, where they are controlling commodity prices and stuff like that. But that I thought, in 99, that really is a pretty savvy way to use the Internet for evil.

David: A really funny thing—maybe we'll talk about this more in playbook—is at the same time this is (I think) really best reflected in both Skilling and Fastow, they were all so smart and yet also so stupid. The combination of brilliance and stupidity in one person and one group of people, it's really something.

Ben: It's almost like it was smart, but it was cognitive dissonance, where they just thought the rug was infinitely large that they could just keep sweeping stuff under it and that at some point, it would never become an issue for them. Skilling, you watch some of his testimony, because everyone else pleaded the fifth. Skilling stood trial and tried to defend himself. He really does look like a man who thought he did nothing wrong.

It's crazy to me how Skilling (I think) really was delusional. That there was so much innovation here, that he thought it was okay. I don't know. There are examples of where you could draw a different conclusion, but you're right. They were smart, and I don't know that they were also stupid. I think they also just had a lot of cognitive dissonance that it somehow wouldn't all come tumbling down.

David: I've actually been thinking about this recently, both in the context of FTX and just generally also, being a new parent makes you think about some of this stuff. It's probably good to be smart. It's certainly good to be of above average intelligence, good for you as your success in the world. But there's a certain point (I think) where increased intelligence either is neutral or negative to your ultimate happiness.

I think it's cases like this, like Enron, like FTX. There's no question that SBF and a lot of the people involved in FTX now meet over brilliant, but they're too smart. They end up hurting themselves. The Enron case is the same thing.

Ben: Is it the smarts or is it the cockiness? Because clearly, what was happening here is they just thought no one would ever catch them. I think that is really what started to come out. Fastow went five years without having to disclose how much compensation he was getting from the LJM partnerships. He just thought, I'll just keep self dealing.

David: You're right about Skilling. It's a little more than that with Skilling. He's the only one who doesn't end up pleading the fifth. He defends himself to the end.

Ben: Which he later says was stupid, by the way. He's like, I should have listened to my counsel just like everyone else's counsel.

David: This is the smart stupid thing. I think maybe it's that he just completely fell in love with his own ideas, because he's always talking about how brilliant he is, how effing smart he is.

Ben: And it always worked. The craziest thing is it always worked every time to bring us back to the story from that 1999–2000 period. This is, I think, rumored. I don't think this was in the court documents, but lots of substantiation around the rumor. He managed to convince Lay that he should get $20 million in cash if he was not made CEO of Enron by the end of 2000. Like, what? This guy is so good at convincing people to do stuff.

David: He convinced the SEC that mark-to-market accounting would be a good thing.

Ben: Right? It's like, oh, if you fire me, you have to pay me $20 million, unless you want to make me CEO of the company. The only negotiating position that he had was, otherwise, I'll just quit and you'll be screwed without me. I'll just quit right now. And Lay signed that deal. They needed him around so bad.

David: Speaking of Skilling quitting, let's move the story towards that, shall we?

Ben: Yeah. The first cracks in the armor starts in September of 2000. The stock is still on its way up and hasn't peaked yet, but you have a short seller named Jim Chanos, who for the first time, is starting to make noise around just the most basic fundamentals here. Hey, I'm reading your quarterly reports, and they're completely impossible. You're technically disclosing a bunch of stuff. I have no idea what you're disclosing. Can you help me understand the business? How do you make money?

You then start to have reporters getting involved, because reporters love getting tips from short sellers, because short sellers have a massive financial incentive to go and investigate and figure out what companies are going to fail, and that's a really good ‘where there's smoke, there's fire’ for reporters, so reporters start getting involved. The big question is, how does Enron make money? As people start digging in with Skilling, with Lay, with Fastow, and granting interviews and doing this stuff...

David: Nobody can figure it out.

Ben: No one can figure it out, and you get conflicting statements. You hear Skilling say, it couldn't be more obvious. You just need to dig in and understand our business. We're very clear. We're very communicative. We're not hiding anything. And then two sentences later, you hear something like, well, we don't want to tell our competitors how we make money, so of course, we're not going to share details like that. And you're like, sorry, what?

David: The cognitive dissonance is just...

Ben: Crazy.

David: Yup. The only reporter that he goes to is Bethany McLean at Fortune, the same publication that names Enron the most innovative and best managed company in America. Amazing. She publishes on March 5th, 2001 an article entitled, Is Enron overpriced?

Ben: Which is wonderfully innocuous. Oh, it's merely a price issue.

David: It's not that bad of an article from Enron's perspective. The biggest question it raises is not one of fraud. This is exactly what you said, Ben. Enron is a black box. Nobody can figure out what's going on here, but there are no accusations of fraud or anything wrong going on, et cetera. There have been some other articles, but this is the first big article questioning what's going on at Enron.

Ben: The subhead is, it's in a bunch of complex businesses. Its financial statements are nearly impenetrable, so why is Enron trading at such a high multiple? That is the most innocuous and reasonable question to ask, because when you go and compare it, you actually do industry comparables. Before the fall, stocks trading at an all time high, everything seems up into the right. In fact, just in January of 2001, they rebranded from the world's leading energy company to the world's leading company. It's literally the tagline for the company.

David: Can we talk about the company's slogan that they used in their commercials, which was, ask why? That's literally the company's logo. Then when people ask them why, about how their financials, they can't tell you.

Ben: There was discussion of whether they should be the world's coolest company. But literally the only reason they didn't do that is because it didn't translate well, so they just went with the world's leading company. There is video footage of Jeff Skilling unveiling the new slogan at a shareholder meeting and everyone clapping. It's like the world's leading company. That's not a mission. What do we do?

David: I want to be the world's leading podcast. What do you think, Ben?

Ben: But that's actually a thing.

David: I guess that is a thing.

Ben: Anyway, the financials, it's worth highlighting. A good time to pick is maybe March of 2000. It was trading at 55X trailing earnings, which if you look at, you think it's an energy company, you compete against Duke Energy, which is a reasonable competitor, it's 2½ times the multiple. You're like, okay, well, maybe it's more than an energy company. Maybe I'm missing something here.

David: It's an internet company.

Ben: Yeah. You're like, okay, well, maybe it's like a trading firm then. Maybe it's like Goldman Sachs. Well, Goldman Sachs is only trading at this point at 17 times earnings, so why is Enron trading at 55 times earnings? You're like, wait a minute. Then you start digging and you're like, well, when I can see Goldman Sachs's earnings, I can tie it out to the rest of the financial statements and see earnings eventually showing up as cash. But this is a company that's trading 2½–3 times higher than any reasonable comp.

If you actually start digging in and looking at their free cash flow or looking at any return on investment metric that you decide to pick, it's terrible. There's no cash, and there's really no return on invested capital ever showing up. Sometimes their return on invested capital is actually less than their cost of capital. When you look at the cash of this business, it's awful.

David: Yes, indeed it is.

Ben: The first part, the high multiple, is Enron overpriced question. That's a reasonable conversation to have. This is a good thing that friend of the show, Andrew Marks, pointed out. When you see terrible returns on invested capital, and you see no free cash flow showing up ever or poor free cash flow dynamics, that's probably when there's fraud.

David: If there's very high revenue growth, very high reported earnings and profit on the income statement, and there is low return on invested capital and poor free cash flow dynamics, probably your radar screen should be going off.

Ben: This, of course, is a thing that short sellers pay a lot of attention to. They look for companies that have all those metrics that we just described trending in exactly those directions, because that's probably where there's a big accounting issue that's about to happen.

David: The big cognitive dissonance, I think, is the reported profits versus the cash flow, because if you think about startups, lots of startups for instance can be reporting high revenue growth but be burning lots of cash as they're investing in growth, operations, and whatnot. In Enron's case and in the case of a lot of frauds, they're reporting high revenue growth and high profits on the income statement, but also burning cash.

Ben: Yup. People are starting to figure this out. Short sellers, journalists, and eventually, finally, finally some analysts managed to shake loose of the ‘my job is to say Enron is awesome’ thing. They start to ask hard questions on earnings calls, because for the longest time, it has been that you were rewarded for saying Enron is great because the stock would go up, and then you would look like a genius.

Anytime anybody said Enron wasn't great, either they were proven wrong by the stock price or they would get slapped at work, because they're saying, hey, that's a huge client of ours. We do lots of business with them, because Enron did lots of business with everybody.

David: Kept everybody on the payroll. Are you talking about the April 17th, 2001 earnings call?

Ben: I am.

David: Where one Richard Grubman of Highfields Capital, was actually a hedge fund and had a short position on Enron, asks Skilling. I think this is Skilling's first earnings call as actual CEO, number one of the company. It does not go well, spoiler alert.

Ben: Because he's been running the big profit center forever in trading. He's been trying to masquerade the business and same with Ken Lay as we're still logistics company, but they obfuscated the crap out of their segments and their financial reporting, so you can't tell that all the money is actually being made by trading, "money being made," all the income being generated on the income statement comes from trading, which you can't tell. Anyway, now he finally steps into the CEO role and is responsible for these earnings calls.

David: Here's the question. Tell me if you think this is overly combative or merits (say) nuclear level response. Grubman asks why Enron, unlike 99% of other companies out there, when they report earnings, why do they only report an income statement, and they don't report their balance sheet or cash flow statement? Those things only get reported, Ben, like you said earlier in the episode, weeks or months later in the SEC official 10-Q and 10-K filings. Why don't you report it all at once like everybody else?

Ben: I think his literal words, he says, you seem to be the only financial institution incapable of producing a balance sheet with earnings.

David: Okay, so maybe like a little flip.

Ben: Yes.

David: Skilling responds by, I forget how he starts the answer. He says something like, thank you very much for the question or something like that.

Ben: Yes. Here's what he says. He says, well, first of all, thank you very much, we uh… asshole.

David: Everybody in the room on the call starts looking around. They're like, did the CEO of the seventh largest company in the world just call an analyst an asshole on an earnings call? Yes, indeed. That is exactly what happened.

Ben: He does apologize. He says, I'm sorry. I've been at a real lack of sleep. He's been making noise internally to Ken Lay, even only a few months on the job saying, I'm not having fun in this job.

Of course, Ken Lay is parroting back to him and private close to their rooms like, this was supposed to be fun. I thought this was something you wanted. I thought you knew how hard this was. And skilling isn't thriving as a CEO.

David: Skilling starts spiraling more bad news, it starts coming out. This is after this, when dos and speculation about the California power market manipulation starts coming out.

Ben: And PG&E files for Chapter 11 bankruptcy in April 2001, too.

David: Yup. Things are still going bad. The tech bubble is starting to burst, that's affecting the market. The Enron stock starts falling from the all-time high in the fall of the previous year, just about $90 a share. It falls down into the $40s, so pretty bad. It lost over half its value.

Ben: Just to make an FTX comparison here, lots of the time, you get away with poor accounting and lots of leeway from investors in a bull market. Then when when the bubble pops in the equities market, like the dot-com bubble happened or January of 2022 happened in tech stocks, and you start to see the tide go out, combined with other potentially attractive, lower risk places to put capital, you start scrutinizing things that were really high risk places to put capital, or things that were at high multiples, or things that weren't quite connected to intrinsic value like crypto.

A lot of people are looking at crypto saying, why am I investing in this again? These two things are a little bit different. The prices of crypto falls, so it causes margin calls for crypto hedge funds, which then unravels the whole beast.

David: But it's the same dynamic of the tide going out, which I think is a Howard Marks quote, right? Of course, guest to the show and dad of Andrew.

Ben: Or Buffett? I don't know which one got it from the other.

David: Yeah. When the tide goes out, you see who's swimming without their swimming trunks on.

Ben: But it's so true that that's when the stuff actually gets scrutinized. Everybody was just making money all the way up. Now that there's real shakiness in the equities market in 2001 from the dot-com bubble bursting, everyone's reexamining everything they assumed to be true before. It's feeling much more reasonable to ask questions, like, hey, can you produce a balance sheet?

David: What happens next? Nobody inside or outside the company could predict. Within a couple of months, by August of 2001, Skilling had just taken over at the beginning of the year as CEO of the company. In the beginning of August, Skilling goes to Lay, who's still the chairman of the board and says, I'm quitting, I'm resigning. I'm out, I can't handle this.

Ben: And he cites personal reasons. I don't want to blame this on my family, so I can't in the press release say that. I want to spend more time with my family, even though I do. All you can say is personal reasons, and I'm out just because...

David: My mental health is falling apart, I can't take it.

Ben: I want to spend time teaching, I want to do philanthropic efforts, this isn't what I wanted, this isn't fun, blah-blah-blah.

David: In Conspiracy of Fools, and it sounds like it was the same in The Smartest Guys in the Room, it is painted as like, yeah, he really was having a mental breakdown, and that was the motivation here. You have to ask, though. The tide is going out. Skilling is, as much as anybody, everybody's to blame here. Certainly Lay is to blame, Fastow is to blame. But I think you could argue, Skilling is the most to blame.

Ben: Skilling was the architect of the demise. Lay, you could make an argument that he was out to lunch the whole time. He was a key enabler at the very least.

David: Fastow certainly was evil, but was acting on direction from Skilling.

Ben: Sometimes. Other times, he saw a cash grab opportunity for himself.

David: He was embezzling for himself, but in terms of damage to the company and perpetuating this house of cards, Skilling was the architect of the House of Cards. You have to ask, does he see that the tides are going out in the market, this house is going to collapse, I need to get out now? He starts selling stock as he's leaving. Then after he leaves, he sells a lot of Enron stock.

Ben: And all the executives were at this point. Ken Lay had been on a selling plan for the last couple of years.

David: We need to talk about how Ken Lay was selling.

Ben: Ken Lay was so over-leveraged. He had received advice from his money manager saying, you really should diversify. All of your wealth is tied up in Enron stock. It's all you've had since 1986 when it's really run.

What he does—it's so confusing because he's savvy; I don't know why he does this—instead of diversifying, he claims he's diversifying, but what he's actually doing is doubling down. Instead of selling his Enron stock, he starts taking margin loans against his Enron stock and using that to invest in other things.

Now, Enron stock starts collapsing. He starts getting margin called. He's then needing to sell Enron stock in order to service the debt that he used to invest in these other projects.

David: This is my own speculation. This is not alluded to in, and certainly not in Conspiracy of Fools, but when I took a step back and looked at what was going on here, Lay is not a bozo. He may have been out to lunch, but he knew what was going on here for sure. He was probably just as evil as any of them.

Ben: When we say out to lunch, physically, what was he doing? He was taking one of the Enron corporate jets around sometimes to vacation with his family, sometimes to pick his daughter up from France, but often to DC to hobnob.

David: With the Bush family and other people in the Bush administration. Even in between the two Bush administrations. With the Clinton administration. He gave a bunch of money there, too, and did meetings with the Clinton administration officials.

I think what might have been going on here, yes, Ken had most of his net worth in Enron stock, and then he started doing margin loans against that stock with banks. Then when he gets the margin calls, he would have to repay them. But the way he repaid them was he took cash loans from Enron, so Enron alone can cash.

Ben: Oh, my god. What a merry go round.

David: Ken backed his collateral for that cash that he ended up repaying the loans to Enron with, was the Enron stock that he originally had taken the margin loans against. He got the cash out of Enron, used it to repay the loans that he had gotten the money from the banks, and then the repayment mechanism of all this is Ken's equity goes back to the company, so nowhere do sales show up.

Nowhere does it show up to any publicly available information that Ken Lay is selling his Enron shares. It just looks like there's anti dilution happening at the company, the company's repurchasing shares. I think you could make an argument that this is all circumstantial, that this is a totally nefarious way to get money out without alerting the market that the chairman is selling.

Ben: I think you nailed it. I think there's another thing that's in The Smartest Guys in the Room, where they reference the fact that I don't think for his particular sales, they classified under some weird thing where they didn't have to disclose it till after the fiscal year rather than in quarter, so he was able to sell an enormous amount before having to report it.

David: All told, I think Lay sells about $300 million worth of Enron stock via these transactions. Skilling sells about 200 million. Fastow and a bunch of the other executives sell a whole bunch, too.

Ben: Fastow actually makes $60 million from the LJM partnerships, from fees, carry, and selling partnership interests. He actually makes more from the LJM's than I think he does in total comp at Enron ever.

David: Which the board never knew, and then as everything is really starting to devolve. We'll get into that now. At one point, the board corners Fastow and they ask him, how much money have you made from these partnerships, and he tells them, and they immediately fire him.

Ben: Here's the one twinge of a smoking gun on Skilling of why he was quitting, that a Wall Street Journal reporter unearthed in a conversation with him. It's a pseudo innocuous conversation. It's like this, I'm leaving for personal reasons, blah-blah-blah, and he drops one line.

He goes, watching the stock price fall is just so depressing. I probably wouldn't have quit if not for that. And then the reporting goes, wait, what? That doesn't sound like a personal reason. That sounds like a business reason. That's when they can really take that ball and run with it and realize all the layers of what's going on here.

A big one was—this is a thing that got way reformed after Enron—all communication from the company to employees, to investors, and between the board and executives to set their compensation, is about the stock price.

David: They're always saying buy the stock.

Ben: Yes, not about any intrinsic characteristics. The company is not giving guidance on just, hey, here's what we think revenue is going to be. They're not telling employees what you should tell employees, which is, I don't really know if this will go up or down, but here's the direction I think the intrinsic measurable parts of the business are going to go. What Enron is telling everyone is, I think the stock will go up. What Ken Lay, what Skilling are telling people is, stock should be $125 What's it doing down at $40? This is terrible.

David: There are these videos you can find of Lay at employee, all hands, where he gets a question card of, should employees invest in Enron stock in their 401(k)s? This is the same time that Lay is doing the structure transactions we were talking about to offload his Enron stock.

Ben: Selling his shares.

David: He says, I think you should put all of your 401(k) in Enron stock, and I don't see any reason why the stock shouldn't be 2X or 3X what it is now or next year. Oh, it's just brutal. It's brutal.

Ben: When you comp all these executives and incentivize their bonuses against the stock price rather than against, again, things in the company's control—its revenues, its performance—and you tie it all to stock performance, then it incentivizes everyone to do these crazy things of pump the stock so they get their bonuses.

David: Okay. Skilling surprise resigns. Lay comes back into the operator seat as CEO.

Ben: He surprise resigns the same day with no transition.

David: Yeah, no transition. He's just like, I'm out. Gone. Lay comes back in and two things happen. One, he asks Fastow, the CFO, he's trying to get a handle on what's going on here. Again, he's been out to lunch for years at this point, both metaphorically and literally speaking.

He asked Fastow to say like, okay, what's the current debt obligations of Enron? I know what's on our balance sheet, but let's add up all the obligations we have with all these special-purpose entities that we've done. Fastow is like, I don't know. Let me go work on that, and I'll come back to you.

Ben: And the answer was literally that he didn't know, because they did not keep this stuff in a centralized location. They signed all this paper through all these different entities, and there was not a central ledger anywhere with who owes what to who.

David: He comes back to Lay and the board and says, our actual obligations are $34 billion, while the debt on the balance sheet was $12.8 billion. Everybody is shocked. It's become clear. This is a major liquidity existential crisis for the company.

Ben: The company has no cash flow. It's like, oh, well, maybe we can service that debt with next quarter's cap. No, no, no, no, no, there is no cash coming in the door.

David: Then, right around the same time, a VP in corp dev named Sharon Watkins writes first an anonymous memo, and then she puts her name on it, and asks for a private meeting with Ken Lay about this memo that she writes, where she's trying to be a whistleblower here. She's like, look, what's going on has reached such a crazy pitch and all these LJM transactions that are happening, and everything finance is doing, and all these off books entities.

She writes in the memo, "I am incredibly nervous that we will implode in a wave of accounting scandals." Lay meets with her, reads the memo. But just like back in the day with the rogue traders, he doesn't do anything.

Ben: No need for confrontation, I don't think we should do anything about this.

David: No need for action. This is August 2001. Think about that. We are now mere days away from September 11th. September 11th happens. Terrible, obviously awful. But in a crazy way, this was a reprieve for Enron. It took everybody's eye off the ball of the investor community and the press of how bad things were getting at Enron.

Ben: It also gave them cover to say, geez, every stock's down right now.

David: They needed this, because partially, due to the events of September 11th, but a ticking time bomb was going to happen anyway. The morning of September 12th, the next day, when the financial markets reopen, Enron's commercial paper, their overnight loans, don't turn over. There are no buyers for the overnight Enron commercial paper

Quick primary. We won't get into too many details here because, frankly, I don't understand all of them. For treasury and corporate finance, most large companies, especially trading operations, have what's called overnight commercial paper, which are very, very short-term loans that they use to finance the daily cash obligations of the company, like paying payroll, paying vendors, that kind of stuff.

Ben: Right. If you think about what a company like Microsoft has, 70,000 employees, and you think about how much money they need every two weeks to pay all those people, they don't just keep an enormous part of their treasury in cash to pull that off. They effectively have a margin loan against their treasury that they use that actually finances the short-term cash flow needs of the company.

David: This is super standard. Every large public company does this. It is shocking if your paper doesn't do what's called turnover, which gets repurchased every day.

Ben: If Microsoft asked me, can you loan me some money for the next 24 hours, I promise I'll give it back to you with this tiny amount of interest. Actually, if you're open to it, would you be game to keep agreeing to do that every day for the next five years? Every day, they come to me? Every day, I'm going to be like, sure.

David: On September 12th, Enron's commercial paper doesn't turn over. Nobody's there to buy it. Now, if this were not September 12th 2001, that would have been game over for Enron right there. That would have been the end. But everybody's a little distracted.

Ben: Because they generate cash flow in no other way, so there's no other way to tap any cash.

David: Everybody's a little distracted. They're able to pull through for at least another couple of weeks. Later, though, by early October, everybody's recovered enough and the rest of the financial community from September 11th that they resume the questioning of Enron.

The Wall Street Journal starts running stories about LJM and speculating on how much they think Fastow might have pulled out of these entities and earned for himself at the expense of the company. Arthur Andersen starts getting really nervous about their role in enabling all of this.

Ben: Arthur Andersen pre-meditates. There might be an investigation at some point. We are not allowed to destroy the evidence once there's been an investigation notified to us, so maybe let's get ahead of it. Let's shred more documents than we've ever shredded in the entire history of the firm before we get served something by an attorney.

David: Arthur Andersen legal on October 12th sends an email to the Houston office literally directing them in writing in an email to start destroying any and all non-finalized documents that are related to Enron, either digital or physical. "In accordance with the firm's document retention policy." They've never sent anything like this or done anything like this for any other client.

Ben: And then they followed up with a second sentence that says, just so that we're in accordance with the policy.

David: Yes, the policy. This is the policy.

Ben: This is regularly scheduled. Of course, I'm just reminding you to do the regularly scheduled policy, which this email may set the policy, but do what the policy says.

David: The Houston office of Arthur Andersen, they go on for weeks. The volume of evidence destroyed here, tens of thousands of emails deleted, that's the easy to get your mind around, the amount of physical documents that they shred, they cannot physically shred the paper fast enough.

They are shredding one ton of paper every single day. That's the maximum capacity. This goes on for weeks. Dozens of tons of paper that they shred documents related to Enron. My God. If they weren't guilty before, they sure look guilty of something bad now.

Ben: You might know more than I do here, but I think Arthur Andersen went under not because they were found guilty of anything, but because when this all started playing out and they went in the news as being Enron's auditors for all this document destruction, for being really sloppy, they were complicit and sloppy, Enron needed to do a handful of restatements that were just straight up Arthur Anderson's fault. I think their customers all just left, so Arthur Andersen basically ran out of business.

David: It's somewhere in between. Anderson itself, I don't believe, ever faces certainly no criminal actions for its direct role within Enron, but they do face criminal action from the Department of Justice and the SEC over destroying of documents. As a result of that, the SEC in the middle of 2002 revokes Andersen's CPA license.

Ben: Oh, I didn't realize that. Okay.

David: They had already started to lose tons of clients because, shocker, Andersen was also the auditor of WorldCom, which would be an even bigger bankruptcy that would happen shortly after Enron. They'd already started to lose clients, then the SEC revokes their license. And that's the end of the firm. It's done. It's over. They employed 85,000 people. Gone.

Ben: It really was the most reputable firm in the world.

David: And it was destroyed. It's over. Back to Enron. It was October 12th that Andersen starts shredding. On October 16th, Ben, like you were saying, Enron reports earnings. They announced $638 million of losses for the first time on their income statement. They say they have to do a restatement of shareholder equity and restate $1.2 billion worth of shareholder equity related to improper accounting of off-books entities.

Ben: This is the Raptors, right?

David: I think this is the Raptors. It may have been some others, too.

Ben: I love that it's called the Raptors. Okay, this is Fastow. There were four entities, Raptor I, II, III, and IV. They also have other names for some reason that they referred to in multiple ways, but they're off balance sheet vehicles that Enron is basically using to hide large debt loads they're carrying and huge losses. In fact, I think the Raptors start co-signing deals or at least commingling, so that if one can't pay something off, then the other one’s on the hook for it.

David: I think the Raptors are also like, what's the right word, apotheosis? Is that the biggest, most grandest example of Enron's awfulness in accounting? The Raptors, I believe, were intended to be hedges on some of Enron's investments. But the actual mechanism and the underlying collateral that they used for the hedge was Enron stock itself. They became this massively toxic. They didn't actually hedge anything, and all it did was double the exposure to a broad based stock market hit.

Ben: It feels like even if Enron hadn't started falling apart before September 11th, September 11th would have been the trigger, because they had all this correlated risk. As soon as their stock stopped going up for any reason, then the whole thing would crumble.

David: Indeed, that is what happens. October 22nd, the SEC announces that they are launching an inquiry into Enron's accounting. The next day, the 23rd is when the board calls in Fastow and demands to know how much money he's made in the LGM funds. They find out they fire him. They instate the former company treasurer, Jeff McMahon, who had been the treasurer, but then Fastow had ousted him, because he wasn't loyal enough to Fastow.

He comes back into the finance department this time as the CFO. McMahon learns that not only did Fastow not know how much debt Enron as an organization had. He also didn't know how much cash they had, and he also didn't know the maturity schedule of the debt. Thus, nobody in finance knew the company to know when they had to repay the debt.

Ben: Which to me, this is the biggest example of they thought the rug that they were sweeping stuff under was infinitely large, because they had no plan to service any of this debt or track any of it. There was no plan. They just somehow never thought they would need to or would catch up to them. I don't know.

David: I guess to what you've been saying the whole episode, which is true, if the markets had always been good and the stock price had always gone up, they always could have just issued more equity to cover any cash needs that they had. But obviously, that's not going to happen now.

It takes McMahon and his new team a couple of days to pull all that together. When they do, they figure it out, the company is basically already insolvent, so they need emergency financing. They do the only thing that they can do, which is they pull down all the revolving credit lines they have with all of their banks. These are outstanding revolving lines of credit cards, revolving lines of credit with banks.

Ben: They actually went and asked the banks, hey, can we get new debt lines with you? And every single one said, no. They pulled the credit lines, which the banks have no option. It's already negotiated and signed.

David: Enron drew down the credit lines.

Ben: Yes. Enron draws down those credit lines. Now they issue a press release that they've done this in order to: (a) assure shareholders that they're under great financial footings, now they have all this cash, and (b) show the bank support and that they stand behind Enron. You're like, no, no, they have no choice.

David: The banks are fighting them tooth and nail in all this. After they do that, the credit agencies immediately downgrade Enron's credit rating. Finally, it's shocking that they hadn't until then.

Ben: Moody's, they've been complicit the whole time.

David: It shows you just how much of a racket this thing is.

Ben: No one has been actually underwriting this company to decide if they're credit worthy or not.

David: At this point, it's obvious. Even to the most fervent believers or head-in-the-sand people at the company, you can make your argument of which category each of the executives and the board stood in with that. But it's obvious that Enron's in a death spiral.

Two things happened. One, Ken Lay starts calling around to all of his political connections in the Bush administration, basically with his handout looking for a bailout, kind of what would happen in 2008 in the financial crisis. The Bush administration does not give Enron a bailout, so there's no dice there.

Once that becomes clear, he does the only next thing that is even any remote possible chance of saving the company, which is he reaches out to the CEO of Enron's largest competitor, Dynegy, and tries to broker a deal.

Ben: He also tried to line up a bunch of private equity. He was going to go for a take private. They called Warren Buffett. Buffett was completely uninterested. They called 10 other. They're looking for capital sources. Anybody that's got cash or the ability to take us private, let's do it, and no bites. So let's try and get acquired.

David: They go to the crosstown rivals in Houston Dynegy.

Ben: Who got no press and no fanfare over the last several years, but they're the same thing. I think they're pipeline and trading.

David: In Conspiracy of Fools, I don't know if this is in The Smartest Guys in the Room, there are quotes from Enron people talking about Dynegy as the Burger King to Enron's McDonald's.

Ben: They're trading at a much lower multiple. They have no big story.

David: Here's what happens. They strike a super fast 11th hour deal to save Enron, prevent it from filing from bankruptcy. Dynegy's going to acquire Enron for $8 billion, an all stock deal, no cash. But Enron, of course, needs more cash to survive until the deal can close, and Dynegy can complete its due diligence.

Dynegy lends $1.5 billion to Enron in cash to help Enron through their liquidity crisis. The loan is secured by Enron's core original pipeline assets. Back to the InterNorth days, those valuable actual operating pipelines, the only thing that is actually tangible in the company.

Ben: I think JP Morgan comes into the deal, too. JP Morgan mandates that, but they also mandate that all future Enron investment banking business will be handled by JP Morgan over the next 18 months. There's an internal memo at JP Morgan that these guys are going to need a lot of investment banking help, and we're going to mandate that we get those fees.

David: The deal gets signed. It gets announced to the market on November 9th, 2001. In the intervening period, while all the documents are being prepared, and Dynegy is doing its due diligence on the deal, it comes out. Remember Chewco that we were talking about a while back, the Chewbacca, the Andy Fastow and Michael Kopper total front to buy up the toxic waste that they thought they'd sealed up?

Right at this time, Andersen, who's now fearing for its own skin, they're looking back through all this because everything's going on and they're like, they discover about Kopper, Dodson, and this crazy domestic partnership front. They're not married, so technically, Dodson isn't a spouse. They say, this is no good. We can't count that, it's not independent. We're going to have to restate everything, all the assets associated with Chewco and Jedi.

Ben: It's like restating years worth of earnings.

David: All the way back to 1997, we're going to have to reconsolidate all of those assets and liabilities back on to Enron's balance sheet, undo the mark-to-market accounting on the revenue side. This comes out during that period.

There's a further equivalent of run on the bank with Enron. Liquidity dries up even more. It blows through the $1.5 billion that Dynegy lent, and it's out of money again.

Ben: I can't let you get away with this, the run on the bank thing. The context you use it, it is totally fair. In the context that the Enron executives were using it, in this period, it was a completely unfair analogy. They were like, oh, it was really a run on the bank. If people hadn't gotten spooked from those darn journalists and the short sellers writing that story, we would have been fine.

And no, runs on the bank are an issue when the bank is being irresponsible. You can't say, oh, it's just a run on the bank, because if the bank is runnable, there's a problem.

David: Specifically, I think where all that money goes and the run on the bank nature of this is, remember, Enron is an active trader in the markets. None of their counterparties are willing to trade with them anymore without cash guarantees backing up the trade. They use up all the liquidity, basically, cash guaranteeing all the trade settlements that they're doing.

At the end of the month, on November 28th, 2001, Dynegy walks away from the deal. The deal's canceled. The news of this hits the press at 10:30 AM, I assume, Central Time on November 28th. Amazingly, this is just like an amazing coincidence. Who knows?

I'm sure nothing was told, or confidential information shared, or pre planned. At 10:20 AM, 10 minutes before the news comes out, Ken Lay's wife sells 500,000 shares of Enron stock that the Ken and—whatever name—that the Lay Family Foundation held.

Ben: Unbelievable.

David: You cannot make this stuff up. Once the news comes out, everybody knows Enron is bankrupt. The stock crashes down to 61¢ a share when it becomes obvious.

Ben: Down from $82 a share earlier that year and $90 the year before.

David: Okay, so 61¢. Keep that in mind. That is what the stock is trading at.

Ben: By the way, the Ken Lay thing, he and the Lay Family Foundation made some money on the way out. Do you know about the other $60 million thing?

David: I'm not sure I do.

Ben: As a part of the Dynegy term sheet, upon completion of the deal, Ken Lay just got $60 million in cash as a bonus.

David: It was a golden parachute. Yeah, because he was going to leave as part of the deal.

Ben: Exactly, and there was such a revolt among employees who are all actively losing their life savings and retirement, were like, hell no. He ended up realizing the optics were bad enough that he actually put that into the company.

David: It ended up not mattering anyway because the Dynegy deal didn't happen, but yeah, crazy. It's clear Enron is going to file for bankruptcy in the coming days, stock goes down to 61¢. On December 2nd, indeed, just a few days later, Enron files for a Chapter 11 bankruptcy at the time, the largest bankruptcy in US history. Ben, as you said at the top of the show, it would not be for long though, because six months later, WorldCom would be larger.

Ben: Since then, there have actually been five Chapter 11 bankruptcies that are larger. Isn't that crazy that this was the largest at the time 20 years ago, but now you've got Lehmann, Washington Mutual, WorldCom, GM, much bigger bankruptcies than Enron since?

David: I think Lehman is the largest, right?

Ben: Lehmann is the largest. It's the only one in the high hundreds of billions, whereas Enron had $63 billion in assets before filing.

David: Enron is over, literally, given the colorful—is that the right word—evil. I think we mean to say evil cast of characters here. Everything goes just about as you could predict. The Justice Department begins a criminal investigation just about everybody except Skilling starts running left and right trying to cut a plea deal.

Ben: It is worth before getting into the sentencing and trials, what is bankruptcy and what happens in their bankruptcy proceedings? I decided this was the time to learn the difference between Chapter 7 and Chapter 11 bankruptcy, because I've never actually thought about it before. It's pretty interesting. Both of them are options that you have when a business can no longer pay its creditors.

Chapter 7 is when you just want to liquidate, cease operations, you turn it over to a trustee and say, we are done forever. Chapter 11 is this interesting temporary thing, where you are saying, we would like to reorganize. The debtor stays in control. By debtor, it's like a corporation. The company that owes the money to all the creditors stays in control. The court—a judge—and the debtor basically need to come up with a reorganization plan, agree on that, and then there's execution of the plan.

David: I think the creditors, the people who the company owes money to...

Ben: Also have to agree. What happens is, John Ray gets brought in as the chief administrative officer who is currently serving the same role over at FTX. He comes in to basically be the administrator while it's in Chapter 11 to come up with a deal.

Interestingly enough, there was actually a person who was hired before him, Stephen Cooper. He came up with a plan and got everyone together on the court to generate 17¢ on the dollar.

Cooper worked for a consulting firm that managed to get $60 million out before the board realized that he was not the most economical choice for the creditors. They fired him and brought in Ray, who I think was a board member. They redo the board during Chapter 11 also.

Ray came in and he basically figured out a way to get twice as much out to creditors. The creditors love John Ray. He was able to get $13 billion out to creditors, which is about 36¢ on the dollar, much better than the 17¢ that Stephen Cooper, that his plan called for. I was reading an article in 2007. It's still not yet been fully sorted out by 2007, so 6 years afterwards.

David: I think what you're referring to with the cents on the dollar is dollars to the creditors, to Enron's debt holders, not to equity holders, not to people who held the stock.

Ben: Correct. Yeah, equity holders are wiped.

David: Hang on, we got to get to the end of the episode.

Ben: All right.

David: Remember the 61¢ a share? One thing, though, that you did just jog my memory on that we missed in the notes. I swear it wasn't intentional, but we don't want to bury it too far in the footnotes like Enron here. I do have an obligation to bring up. You mentioned the board, and that reminded me, we got a little bit of a knock against HBS (Harvard Business School) earlier with Skilling and being such an illustrious alumni here.

We would be remiss, I would be remiss if I didn't also knock my own business school alma mater, the Stanford Business School. Your comment about the board reminded me, do you know who—folks listening, I'm sure very, very few of you know this—the chair of the audit committee of Enron's board during all the years that all this was going on, was the dean of Stanford Business School, who was an accounting professor. Kind of hard to argue that he shouldn't have known better.

Ben: Kind of hard to argue. A little aside here. Do you know what John Ray did before coming into Enron? It's been an important focus of two episodes on Acquired.

David: I would guess Blockbuster, but that can't be right, because they hadn't gone bankrupt yet.

Ben: Yeah, it's not Blockbuster. I'll give you another hint. After bankruptcy, after John Ray re-restructured and it came out of Chapter 11, it was sold to Berkshire Hathaway.

David: Shoot. I should know, but I don't.

Ben: Fruit of the Loom.

David: Fruit of the Loom. Yes, Brooks.

Ben: Yes. John Ray, as sort of an unexpected Acquired superhero.

David: Wow. That's awesome. We got to have him on the show. He's a little busy right now.

Ben: He is a little busy charging $1400 an hour for his services.

David: Wow. Worth it if he can get a good outcome for the creditors.

Ben: Yup. The path from 61¢ a share.

David: The Justice Department opens up a case. Everybody's tied to trying to cop plea deals. One of the Enron senior executives who we haven't talked about on this episode, Cliff Baxter, sadly commit suicide.

Ben: Really sad. He actually had left Enron a good bit before this sometime in the last year, but felt so depressed and responsible. I think his note was about not being able to spend time with any of the people that were a part of his community after losing so much for so many people.

David: Totally. Ken Lay and Skilling, even though Skilling quit months before, obviously, he's implicated in all this, they lawyer up and fight, which practically they have to because, like we said, everybody else starts trying to cop plea deals. Why would the Feds cop plea deals with people? It's because they want to get the people at the top and get them to testify against them. Lay and Skilling, though, there's no way out for them.

Ben: It's how you get a mob boss. It's the classic playbook.

David: Totally. I think Michael Kopper is the first person to cut a deal. He rats out Fastow and testifies against him. Fastow initially also tries to fight and lawyer up like Lay and Skilling, but the Feds ultimately ended up getting him to cave when they bust his wife, Leah, for tax evasion for everything that she was involved in. Also, she also worked with the company. She was an assistant treasurer at Enron, too. Fastow ends up doing six years in prison. Leah does one year.

Ben: We should say, Fastow, basically, admitted fault, and then would double down on it. Anytime he's asked for the rest of time in prison, out of prison, he's like, oh, yeah, what we did was illegal, what we did was completely wrong, I feel terrible for the people. You can actually hire Fastow as a speaker now to come and talk about corporate responsibility and corporate culture, which is nuts. We'll include a link in the show notes to book him if you would like to have him at your event.

David: News eventually comes out through all of this about Lay's close ties with the Bush family and everybody in the Bush political cabinet in the White House. President Bush—this is George W. Bush, the son at this point—calls a press conference and claims in this press conference that, hey, I barely know this guy. He donated to some of my campaigns, but I can't really remember his name.

Ben: He would, earlier in the press, refer to him as Kenny boy, my friend.

David: Obviously that was completely wrong. The Bush family was very close. So close, in fact, that when W was inaugurated president, George HW and Barbara Bush traveled from Houston to Washington for the inauguration with Lay on the Enron corporate jet.

Ben: What? Really?

David: Nobody comes out looking good here. We talked about how Arthur Andersen, they're dead, they're over, and then the culmination politically and in terms of the impact on the economy and the markets from all this is pretty shockingly quickly. I didn't realize how fast this happened.

July 30th, 2002, just six-plus months after the Enron bankruptcy, President Bush signs into law the Sarbanes-Oxley Act that was pushed very quickly and almost unanimously through both houses of Congress.

Ben: I just looked this up. It's crazy. It was approved in the house 423 in favor, 3 oppose, 8 abstaining, and the Senate was 99 to 1. Sarbanes-Oxley, everyone lined up for this.

David: Could you imagine anything today getting those kinds of votes?

Ben: Yeah. Lots of people can be mad about Sarbanes-Oxley because it makes IPOing and being a public company really hard. That actually kicked off stay private longer, or you could argue that it was a huge impact in the early 2010s of companies staying private forever.

What was in Sarbanes-Oxley is pretty interesting. It's the kitchen sink. It is like, what did Enron do wrong? They just piece-by-piece went and figured out a way to put a lid on the cookie jar. The biggest thing is top management. The CEO has to certify the accuracy of financial information.

David: Yeah, both the CEO and the CFO.

Ben: Yup, so huge personal responsibility, more severe penalties for fraud, new restrictions around tampering with or destroying evidence. They make that a felony. They also require outside auditors to be more independent. Every tax firm has to spin off their consulting practice. You can no longer house both under the same house. They increase the required disclosures to be a public company.

David: Including you have to disclose all your off balance sheet entities.

Ben: There's a very interesting question, I think, around Sarbanes-Oxley. It's like, did it work? We just went through another bull run. The question after Sarbanes-Oxley came out is really around, we won't know if this works or not until the next market craziness.

I think there's this pretty interesting thing around the results of Sarbanes-Oxley being stay private longer, that it's much more likely that fraud now happens in the private market than the public market, and that is basically what we saw with Theranos, with FTX.

David: So much in crypto. Super, super interesting. Did you see this in the research? I found this from googling. One of the provisions of Sarbanes-Oxley was actually used in prosecuting the capital writers for the January 6 riots.

Ben: Yup, really interesting. What clause was that?

David: It was that you can't impede an official proceeding.

Ben: That's the like, Arthur Andersen can't destroy evidence thing. They were basically like the rioters are impeding an official vote counting proceeding.

David: Yeah, something like that. But yeah, it was back in the news recently.

Ben: Fascinating.

David: As with all huge mega scandal trials like this, like we said, all the underlings, even all the way up to Fastow cop plea deals, the actual case that the government wants is to go against Lay and Skilling, go against the top.

Ben: Every single one of them all the way down and cop plea deals. Ken Rice, who led broadband, did the plea deal, got a 27-month sentence. Rex Shelby was charged with fraud, conspiracy, and money laundering. I think the deal was, if you plead guilty to one count of insider trading, you get two years of probation. There were a handful of those, like wrist slap ones, to get Ken Lay and Skilling.

David: The quid pro quo on the deals were all testify against Lay and Skilling.

Ben: And Fastow with six years.

David: Given all that he did, that was very light.

Ben: It feels weird to judge whether a criminal penalty is harsh or not. Acquired doesn't quite feel like the right forum for that. Without me saying whether I think this is too harsh or not harsh enough, because I'm not.

David: Just like this is not financial advice, we are also not lawyers.

Ben: Right. It's interesting to me that six years is an amount of time for which you can kind of go back to your life afterwards. If you think back to what you were doing six years ago, it's the same chapter of life.

If you have young kids, they're older, but they're still not out of the house. If you were mid career, you come out, you're still mid career. You were in jail for six years, so that's gonna mess with your career. But it's different from, like a 25-year sentence or something like that, where you're an entirely different human and in an entirely different phase of the human existence when you come out.

David: It takes a very long time for the government to build up all their cases against Lay and Skilling. It's not until 2005 that it finally comes to a trial, and then the trial takes a year-and-a-half to finish.

In May 2006, which is interesting, both Conspiracy of Fools and The Smartest Guys in the Room came out before the trials even started. I think they felt like we just got to publish, even though the story's not over.

Ben: Yup, and the movie did, too.

David: That's right, the movie did too. May 2006, a jury finally convicts Skilling of 19 out of 28 counts of wire fraud and securities fraud, and Lay gets convicted on 6 counts of securities fraud. A short while later on July 5th, 2006 before the sentencing happens, Lay is found dead at his vacation home in Colorado of a massive heart attack. It's interesting, I looked around. I never found any speculation on that.

Ben: There are lots of speculation. The cover of The New York Post had some joke about a photograph of Ken Lay's casket and it was like, check if he's in there.

David: Yeah, right.

Ben: I think there's a website, like kenlaylives.com, or dot-org, or something that popped up. There are a lot of that.

David: Interesting whether he actually died or not. I was thinking whether it was suicide, he actually had a heart attack, or who know? Anyway, he's dead. The verdict against him is vacated.

Ben: Which is crazy. Not only did he not get sentenced, it means that whatever money he had did not get seized.

David: Oh, interesting.

Ben: He made potentially hundreds of millions of dollars.

David: There's no way he died of natural causes then.

Ben: I think him not getting sentenced saved...

David: His wife and family?

Ben: Yeah. Speculation. I don't know anything there. I'd welcome any thoughts people have. I tried to find it, and it was hard to find information. But in particular, because it's just hard to figure out through all the stock sales over the years plus all the borrowing that he did, what his personal balance sheet would have looked like at this point in his life anyway...

David: Here's the crazy thing, too. Despite all of this, when he dies, guess who comes to his funeral?

Ben: George W. Bush?

David: Not W, but HW.

Ben: HW, wow, because he was closer with HW.

David: Yeah, un-freaking-believable.

Ben: The preacher at the funeral, there are a lot of people who, is a very God-fearing man, who were a part of his community, a part of his church, and felt very strongly that this is a good person, and everyone who's coming after him is wrong.

David: Get this. Here's some excerpts from the obituary published in the Houston Chronicle when he dies. "Ken spent 64 years on earth doing God's work, helping others with love. Ken's life exemplified in Galatians 5:22, but the fruit of the Spirit is love, joy, peace, patience, kindness, goodness, faithfulness, gentleness, and self-control."

Ben: It sounds like the list of values Enron had in the lobby.

David: Yeah, totally. Can you believe it? That's not what was printed in the church memorial. That was published in the Houston Chronicle.

Ben: The ironic thing about the God's work quote is Jeff Skilling said about two years before Enron's collapse that he felt Enron was doing God's work.

David: Yeah, right.

Ben: He also, throughout, I have a whole list of Skilling quotes here. The one says, "What's the difference between California and the Titanic? At least when the Titanic went down, the lights were on."

David: The preamble to that, if you watch the quote where he says it, I can't remember what the venue is. He even says in the preamble, he's like, I probably shouldn't say this, but he's the CEO of the seventh largest company in the world and he's saying this stuff. Oh, my God. This person.

On October 23rd, 2006, Skilling is sentenced to 24 years in prison. Shocking it was only 24. He appeals and, get this, he's fighting to the bitter end. The appeal ends up going all the way up to the US Supreme Court, where I don't know what the right legal term is, but they end up sending it back down to a lower court for resentencing to redo the sentencing.

The sentence gets reduced to 14 years. Skilling ends up serving 12 in total and is released from federal custody in February 2019. He is back out there on the streets, apparently trying to do deals. It was reported, but I don't think very successfully.

Ben: And in 2020, Jeff Skilling founded a new energy trading company based in Texas called Veld LLC, rumored to be working on the venture with Lou Pai.

David: Oh, I didn't see that. That's amazing. Oh, my God.

Ben: Unbelievable.

David: Listeners, we already cut some Lou Pai stuff from this episode because I was just like, no, we can't talk about this guy anymore. But that, we got to leave in.

Ben: Unbelievable. The website was up, and now it's down, and no one's returned any press request for comments on it. The rumors were like 2–2½ years ago at this point. Maybe it actually didn't end up happening. Who knows?

David: Lou still got some money, because he did settle with the government for, I think, $31 million, but he still had plenty of other cash to live on.

Two fun little coda moments before we wrap up the story, just to put a bow on things fully before we move into analysis. One, we've talked about Omaha, we've talked about Berkshire Hathaway a lot on this episode. But until this moment, there has been no connection. Warren Buffett, Charlie Munger, Berkshire Hathaway, zero involvement with any of Enron or any of Enron's predecessor companies.

However, if you remember from the Dynegy aborted transaction, the assets that secured the $1.5 billion worth of pipelines, the original InterNorth Omaha-based company pipeline, when the deal falls apart and Enron burns through the cash, Dynegy seizes the pipelines. They operate them for a short while, but I think we don't really want these. We should sell these.

Ben: I don't know where this is going, but this is exactly the type of thing that Berkshire should pick up.

David: Who ends up buying the pipelines, but Berkshire Hathaway Energy. It all comes full circle, and the company comes home to Omaha, to Warren Buffett's warm embrace.

Ben: It could not be more perfect.

David: It could not be more perfect.

Ben: In the end, I guess InterNorth did have the last laugh.

David: The great city of Omaha wins in the end. Crazy. Okay, one more. I kept harping on the 61¢ earlier. Ben, you read an article that as of 2007, things were still going on with the carcass of Enron.

Well, let me tell you what happens in September of 2008 of all times. September of 2008, the post bankruptcy, Shell Corporation of Enron finally finishes. They'd already disposed of all the assets, sold them off. They finally finish settling all the lawsuits that were involved, that it was pursuing. It was pursuing various lawsuits of other parties involved to try and recover some funds for equity shareholders who lost all their money.

Ninety-nine percent sure was equity shareholders at this point in time, because I think the creditors had already settled years before. The biggest opportunity to recover dollars for shareholders, they determined over the years, was to sue the banks that participated in all the shenanigans with Enron. Of course, banks have a lot of money.

In September 2008, the whole suite of settlements with a whole variety of banks—JP Morgan, Citigroup, various others—come in for a total of $7.2 billion dollars coming into this rotting carcass of Enron, which results in a distribution of $6.79 to every common shareholder.

If you had bought Enron equity in those days between the collapse of the Dynegy merger and the bankruptcy, if you had bought for 61¢, you would have had over a 10X return if you are willing to hang on for 7 years.

Ben: David Rosenthal, you have outdone yourself. Oh, my God, imagine that in 2001–2002. You know what we should go in and buy? Some Enron stock.

David: I think we should find a way to buy some FTX equity right now.

Ben: Oh, my God. It's incredible that there was enough to pay off any equity holders that it wouldn't all just go to creditors. How is it that any remaining dollars that could go to anyone wouldn't have just gone to creditors?

David: I don't know for sure, but I suspect what happened was the bankruptcy had been exited. I don't know for sure, but I'm speculating. Bankruptcy had been exited and the creditors said like, okay, we're good.

Ben: Right, we've got all we think we're going to get.

David: We've got all we think we're going to get. The cookie jar is closed. There are so many cookie jars in this episode.

Ben: The piggy bank is empty.

David: Yeah, not a cookie jar, but a piggy bank. Isn't that unbelievable? A 10X investment to literally buy the dip in Enron. Wow.

Ben: Crazy.

David: Then it ends up back in Omaha with Berkshire Hathaway. It's so good.

Ben: All right, I have two more things. But first, let's get to another sponsor of this episode. Our good friends at Pilot.

David: Indeed. Pilot, as we've talked about for years now in Acquired—we just love Pilot—they set up and operate the entire financial stack that you need as a startup and growing company. That includes finance, that includes accounting, that includes tax.

Even higher level CFO services like investor reporting to your shareholders, to your board, all of which you would be doing one of two things. Either you would be hiring an old school accounting firm, not Arthur Andersen but actually a great accounting firm, ethical accounting firm, which will cost you a lot of money. Or you would be spending half a million dollars–plus to build out your own finance team to do this. Or God forbid, the worst option you'd be doing this yourself as a CEO and learning QuickBooks.

Ben: Big waste of time. You should not be doing that.

David: None of those are good ideas.

Ben: No. So enter Pilot. They take all the headache of finance and accounting off your plate as a founder. They provide you with a team of experts and technology to set up all the financial infrastructure to do it right. They integrate with APIs, as you know, from modern tools like Stripe, Brex, Gusto, Shopify, and Square. They know how to make all of that seamlessly work with your product.

Also because this is their world, as more innovative FinTech products come out that you will want to use in your business, they will probably be the first people to integrate those directly into the platform, too. If you're using an old school accounting firm and contemplating whether you need to hire an in-house finance team, then go to pilot.com/acquired. Make your life easier. Eliminate the pain of tax preparation and bookkeeping from your company for good. What better time to do that than heading into the new year.

David: And after having listened to this Acquired episode on Enron.

Ben: Yes, and thanks to our friends at Pilot—the co-founders Waseem, Jessica, and Jeff—all Acquired listeners. If you use the link in the show notes, we'll get 20% off your first 6 months. Thanks so much to our friends at Pilot.

David: Thank you, Pilot.

Ben: All right, I have two little codas, too, before we get into analysis.

David: This is a four coda episode.

Ben: Just two people, so I think it's interesting. One of the best traders from Enron.

David: I meant that in the very best possible way.

Ben: Yes. John Arnold went on to start the firm Centaurus, which is one of the highest performing hedge funds ever. I don't know that it's necessarily like he went on to solve world peace or anything, but a person went on to build something successful after Enron, which is worth calling out.

David: I had no idea about this person. I didn't know about this fund. Apparently, he was a super, super young hotshot trader at Enron.

Ben: He's still only in his 40s today.

David: He got the largest cashed bonus that Enron ever gave to anybody who wasn't a senior executive of, I think $8 million.

Ben: Wow.

David: Shortly before the blow up, he was never accused of any wrongdoing. He was a traitor. Supposedly, everything he did was aboveboard. But then I think he took that money, used it as the seed money to start the firm, and then it ended up becoming one of the most successful funds of the past 20 years.

Ben: Wow. Speaking of seed to start a firm, we didn't talk a lot in this episode about Richard Kinder. We didn't because while he was as hard-driving as the rest of the Enron execs, he was probably the most ethical and the most honest about what really provided value to customers.

David: He was a pipeline guy, right?

Ben: He was a pipeline guy, yeah. A lot of people, I think including himself, thought he was in line to be the CEO. He was Ken Lay's right hand man for a while.

Upon his exit, when he's finally decided the direction this is going is really just not for me, this is going in a very Skilling direction, there was a sweetheart deal done for him to get a set of assets that he would use to be the foundation for what would become Kinder Morgan. It was an energy pipeline.

Today, Kinder Morgan is a $40 billion company, and Kinder is a billionaire. He's worth like $8 billion. He's really good at running and managing a pipeline business. When he saw that that wasn't the focus of Enron anymore, got out, and started his own pipeline business.

David, do you know what other asset was bought from Enron to become someone else's something business?

David: I know UBS, where my first job was out of college, bought the trading assets out of Enron.

Ben: Oh, did they?

David: Yeah. I think they only lasted like six months or a year, and then it all disintegrated. But obviously, that's not what you're talking about.

Ben: No, GE bought the wind business from Enron. I believe even today is the cornerstone of their wind energy business.

David: Interesting.

Ben: Then the last thing is, I'm pretty sure Chevron bought the building.

David: Yes, I think one of the big oil companies bought the building.

Ben: All right, let's dive into analysis. Do you want to start with power?

David: Yes, power. This will be an interesting one.

Ben: Okay. This is normally where we talk about what gives a company the ability to be more profitable than their closest competitor. It feels silly to even ask the question on this episode, because this episode makes so clear the difference between a corporation and a business.

I always thought about this on the other side of the spectrum. A startup is a company, but it's not a business yet. It's not a machine that you can put money into, and it burns capital. That's not a business. There's a group of people working on a project, but a seed stage startup is not a business.

At some point, if you look at an apple. A company can become both a company and a business. That company owns the business. The business operates, the company is the structure around it. 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. They are undoubtedly a company, a corporation, lots of structure, lots of people, lots of activities, lots of reporting. But what is the actual business inside of Enron?

Of course, this is what every reporter was trying to figure out as the stock was falling. The question is, if you strip away all the terrible structure, and you strip away all the self dealing, and you strip away all the overvalued stock, where are the biggest pieces inside the company that are real businesses, generate real value for customers, and the ability to capture some of that value by the company? I suspect the trading business was pretty profitable or had the capability to be pretty profitable.

David: I've thought about this a little bit. We talked about it, the earlier part of the episode, where they have, first, Lay in his original companies, and then Skilling and Lay together with creating the energy derivatives market. I think there's value to doing that. Had the company stopped there and just been a trading participant in the energy derivatives market, yes, there would have been value there.

I think they probably would have ended up like one of the Wall Street banks. Look, some banks are stronger than others; the league tables change. It's a commodity. Nobody dominates the industry. There's no monopoly bank, but there's an oligopoly, and they all do pretty well. I think Enron probably would have ended up like that in the trading business.

I don't know that there's any real specific power in the way that Hamilton talks about it, where you can literally earn better returns than your competitors, but I think they would have been part of that oligopical mix, so to speak.

Ben: The argument that they could have actually done better is I think that Enron Online was a real way that they could have gotten real market power. I'm trying to think about what that is. It's probably a cornered resource. They would have had better access to information about the market than anyone else. It's almost like the Citadel's business.

David: Yes, Citadel's or FTX and Alameda before it all went wrong. But Citadel is a good example.

Ben: Yeah, that they would have the most real-time market information at any given point. There's an open question of when people have, in the long run, continue to trade with them as both the exchange and the primary counterparty or the exclusive counterparty, they may have had to, over time, pick whether they want to be a trading partner or own the exchange itself to have that access to information.

That would be a way that they could have generated alpha on top of the rest of their competitors, that they could have been more profitable than other people who are offering energy trading marketplaces or other derivatives marketplaces.

You also have to imagine, the pipeline business was probably profitable. That's interesting, because that's just a pure monopoly.

David: Yeah, that's a cornered resource, for sure.

Ben: You don't build two pipelines between two locations. It just doesn't make a lot of sense. It's a big waste of resources.

David: It's like a highway. You collect the toll on the highway, because that's the highway.

Ben: In that case, they're competing against other forms of powering the location that that pipeline dumps out into. It's the Midwest using coal instead of using this natural gas. There isn't a direct competitor to their pipeline business in all likelihood.

David: But by their very physical and geographic nature, pipelines are limited markets.

Ben: Yes.

David: You may have a monopoly over the market you're in, but your market is limited to the physical geographic reaches of the pipeline.

Ben: Right. It's a pretty interesting question. Even if you had tried to analyze Enron in 1999 through a Hamilton Helmer lens, you probably would have had a hard time coming up with power, which should have led you to the answer that this thing is at least overvalued.

David: Something's going on here, yeah.

Ben: They don't have a Google on their hands, where it's just this cash gusher that is unbelievably defensible, high margin, durable. It's almost like the company had a lot of things going for it. They had the charisma and the money raising ability, and they were making a lot of money for a lot of people, so everyone was incented. But the business didn't have a lot of things going for it.

David: I think you put it so well a minute ago of this story illustrates the difference between a company and a business. The company did really, really, really great for a really long time. The business, other than the underlying pipeline and then maybe the trading operations, did not exist at the scale of the company for many years.

Ben: It's fascinating.

David: Totally fascinating.

Ben: Playbook?

David: If you want to cook your books, here are three easy steps to success.

Ben: That is, unfortunately, the playbook. The question is probably, how did Enron manage to accomplish what they accomplished? Because no doubt, they accomplished something that is hard to do. I think that's actually an interesting framing. They managed to achieve something that, to date, no other humans had been able to do, which is to convince the world that something with very little enterprise value actually had a huge amount of enterprise value.

David: And show it in accounting statements.

Ben: In many, many cases, accounting statements that were legal. There are lots of things that they did that were illegal, that they got prosecuted for, but there are a lot of things they did that were surprisingly legal. These 3% partnerships and a lot of that stuff.

David: I don't know. I'm conflicted about this. On the one hand, I sort of loathed to promote anything from Andy Fastow just given the story we just told. On the other hand, he did his time, he served a sentence. He's remorseful and making amends.

I think if you look at what's been reported about what he says publicly and what he says in all of his speaking engagements that he does, this is his message of, yeah, there was illegal stuff that happened. But most of what happened, most of the con that happened was through legal means. We were just really, really good at finding and exploiting the legal means through which to perpetrate fraud, and that's wrong.

Ben: Isn't that crazy?

David: Right.

Ben: A bunch of playbook items, using off balance sheet partnerships to conceal billions of losses and lots of debt. To my knowledge, Sarbanes-Oxley makes this impossible now.

The next one I had is more of an observation, and it's something that I was talking about the last time I was in San Francisco and we got together with our friends at Vouch. I was talking with one of the Vouch co-founders about this, the idea of correlated risk. Of course, it's huge in their business since they're in the insurance business. It's funny because this was before FTX happened.

We were talking about the fact that a lot of times, people assume when they have three or four layers of coverage, they're like, well, I'm covered. I'm really secure, because there are a lot of nets below me. But you have to be really good at figuring out, well, are those actually four layers or is that one layer that looks like four? Because oftentimes, when something starts to tank, everything around it starts to tank, too.

When you tie everything to this share price, and you tie everything to collateralizing it with your own stock, or in the FTX case, if you collateralize against the FTT token, which is very, very correlated to your company's enterprise value and future prospects, you end up in this correlated risk territory.

I think, so many times, we're bad at seeing or don't want to see correlated risk when everything is going up. We view things as having more protection, more safety net, more separation than they do. But when you do have a bunch of risks that are all correlated together, they fall apart so fast, they unwind in a big hurry.

David: Totally agree. I have a corollary playbook theme for me coming out of this episode to that correlated risk playbook theme.

Ben: What's that?

David: I've been thinking through doing the research. I've always had this as part of my financial philosophy, but then the whole FTX thing and everything has made me think about it even more.

For me, not investment advice, and lots of very reasonable smart people make different decisions, but there's actually some academic literature out there about this. I've decided the correct amount of financial leverage to have on financial assets is zero. The optimal amount of leverage is zero.

Ben: So you don't want to carry a mortgage if it were up to you?

David: I view mortgages differently.

Ben: Because it's secured?

David: Because it's secured by a physical property.

Ben: Which can change in value the same way that stock can change in value.

David: Totally. That is definitely a contradiction to the philosophy, I do have a mortgage. But when it comes to leverage other than residential mortgage, leverage in a financial sense, like trading with leverage specifically, you're always taking a very large risk.

Even if you think the risk is very small, once you start trading with leverage, you invert the magical property of venture capital, which is that the most you can lose is your money, and the most you can make is infinite. Once you start using leverage, that flips. That is how you get game over.

Ben: Or at least it equalizes.

David: At least it equalizes, yeah.

Ben: Or there's the Black Swan idea that most of the worst things to ever happen never happened before, so they're impossible to predict. I often think about the fact that even if you correctly timed it coming out of the oil crises to put a bunch of money in the stock market, and even if you were able to ride the dot-coms all the way up, and even if you managed to sell before March of 2000, and then there was a big crash, and you decided to put money back in, you would have completely gotten washed out by 9/11. You would not have forecasted the intense macro economic change that that would have brought, because there was no ability to predict it.

There are so many factors to these things. This is my lecture to myself on macro forecasting of, there's the, you have to be right twice when you're timing the market, when you're coming in and when you're coming out. But often, there's a third thing that no one could ever predict that you also have to be right about. Oh, pandemic.

David: Yup.

Ben: There's a point that I made earlier. I think it's worth trying to put in tighter words, which is, Enron's fatal flaw is that they borrowed from the future until there was no future left to borrow from. They squeezed everything by doing mark-to-market accounting out of the next 20 years in any given deal that they did, and then they got into a bunch of markets, and they recognize all the potential upside for every deal and every single one of those markets around the world in every category today.

What that leads to is, shouldn't that be one of the most valuable companies in the world if you're going to recognize across geographies, across a bunch of markets, across the next 20 years, all the upside of that as revenue today, and then you apply some DCF model to that? Well, yeah. That's why they were the seventh most valuable company in the world, because on paper, that's what they were doing.

What you're basically doing is you're double DCF-ing the value, which it took me a while to figure out, like what's going on here? But when you're discounting the future cash flows of something to the present and then recognizing the value today, they were doing that first as revenue. But then when people were trying to apply a multiple to the business, they were doing another, let's look at the next 20+ years of this business, exercise again on top of it. It was like an n² situation.

David: Then you throw these special-purpose entities into the mix where they're recognizing revenue on the way out too.

Ben: Yeah.

David: They were triple and multiplying it.

Ben: It's crazy. It's like an exercise of the most path-dependent spreadsheet of all time. There was zero resiliency in the price of the business because it contemplated.

The assumptions that were baked into the price were that everything would go right in every situation. Every asset, every deal that they did would be the most valuable that could possibly be, and that they would continue to be able to do this number of deals in more geographies and more markets for the next 20 years.

I think pretty quickly, you actually run out of value to be created in the world. At some point, you're like, you can't have a valuation that big because there's not that much value to be created. I don't think they quite bumped up against that, but that's the biggest constraint that you hit when you're doing goofy spreadsheets in this way.

And then of course, there was accounting. There was always fraud on top of it, so that was going to kill the whole thing. But assuming that that wasn't the case, what's the actual issue with mark-to-market accounting in the situations they were doing mark-to-market accounting, and then applying a more than sector multiple on the business? That is the big issue.

David: Yup. Okay, I got one more, which is in many ways, one of the most obvious smack-you-in-the-head playbook themes from this episode, which is the old Charlie Munger quote, "Show me the incentives, I'll show you the behavior." This is such a clear illustration of incentives and behavior.

We could say a bunch of trade obvious things about it. But what I wanted to talk about for a second here, it's interesting in thinking about assigning blame and intent here, and degrees of maliciousness. In retrospect now, having read Conspiracy of Fools, it was a great book, incredibly well researched, 660 pages of just very detailed, very well-written thriller style. Great book, I highly recommend it.

My biggest criticism of it, though, is that it makes Fastow out to be the primary villain. No doubt, he was a huge villain. Incredibly unethical, and on the surface, the worst of the bunch. He was helping Enron perpetuate this incredible fraud, and he was directly embezzling and stealing money through all the crazy partnerships, the Kopper deals, and all that stuff. That's really bad. Eichenwald makes him out as such to be the primary villain.

It's not that he goes easy on Lay and Skilling. They come out looking bad too, but in many ways, not as bad as Fastow. But then I was thinking about it. I don't know if it was in the movie, Smartest Guys in the Room, but Sherron Watkins, the whistleblower, gets asked at one point, what do you think of this?

It might have been later. This might have been an interview later. Do you think Fastow was really the worst person here? She was like, no. It's not just that Fastow was bad, everybody was complicit.

She didn't say this explicitly, but I thought about it. I was like, Fastow stole about $40–$60 million out of Enron directly. Lay and Skilling didn't do that, but they made hundreds of millions of dollars on the equity. They didn't need to steal the money.

Ben: Fastow was doing it without board approval. Those guys were doing it with board approval.

David: With board approval. They made more from the fraud. They were more incentivized in perpetuating the music going. Then Fastow was to directly steal. In my mind, that actually makes them worse.

Like I said, it's not like I still feel a little bit icky about promoting what Fastow is saying now, but I think my conclusion at the end of this is, Lay and Skilling truly were the worst. The government was right to cop plea deals with everybody else to really go after them.

Ben: In a Skilling-like way, you just laid that out in a logical path that's hard to argue with.

David: Maybe I'm the worst then.

Ben: I'm not going to argue with that. That's an interesting line of thinking.

David: What was your impression? I didn't read The Smartest Guys in the Room book. How does that paint the situation?

Ben: There's nothing conflicting in The Smartest Guys in the Room. I think this book definitely makes Skilling out to be the bad guy and Ken Lay out to be kind of out to lunch. He's also kind of a sympathetic figure for the first half of his career because he's this PhD, economists, civil servant, does all the right things. Whereas Skilling, nobody thinks that a management consultant is doing God's work.

Skilling is this perfectly formed character of HBS gone McKinsey, gone energy executive, gone fraudster, where it is the most classic path of corporate villain you can imagine. I think that's the case that the book makes, too.

All this is so narrative-driven. We're sitting here, we've never met any of these people. We've read books about them, we've read 30 or 40 articles, listen to some podcasts, talk to some people who were around the energy industry, but we've never met any of these people.

We are telling a story of a story. It is worth saying, especially now that we're doing some character assassinations, which normally we try not to do on Acquired, we are so far from the primary source here that this is some weird sport pontification that I think we should stop.

David: I totally agree with you. I'm glad we don't do this on Acquired normally, because this is not what the show is about, but I think it's okay in this case. We're talking about Enron here.

Ben: And we're trying to contextualize everything that's going on, specifically with FTX, but in what feels like a lot of increase in fraudulent activity recently.

Actually, speaking of FTX, did you know FTX’s 50 largest creditors sum to $3.1 billion? Let's contextualize the numbers. That's what we know today. These numbers are changing in real time. The whole was probably something about $10 billion, the equity investors are probably wiped out to the tune of $2-ish billion, at least that's the right order of magnitude.

Enron left behind a trillion dollars of claims to 30,000 creditors. Citigroup alone had $5 billion in claims. They're one of five or six big investment banks that work with them.

David: Yup, there were a million-and-a-half shareholders.

Ben: I think people forget the Enron scale. FTX is really bad. This is a terrible bunch of illegal stuff that happened, unethical stuff that happened. But the scale of Enron, I think, because it happened 20 years ago, people forget how big it was.

David: I think also on that point, on a reflective note, studying the Enron history, it's crazy seeing the length of time that it took for everything to come out and for everything to be resolved. That's a good reminder for now and for FTX. We're not even in any one yet of figuring out what happened here. It was years and years before all this stuff came out in the Enron case.

Ben: Yup, so true. I have one more observation to make, and then I'm curious to talk Sarbanes-Oxley with you. The last observation, I first had reading the book, and then I tried to search for any counterexamples and a bunch of articles and couldn't find any. I don't think there's a single interaction between Enron and a human, like most of the employees, where the human didn't make out versus the company like a bandit.

Every single time there was any confrontation—this is probably like the legacy of Ken Lay, this is his non-confrontational thing—every single person that walked away from Enron, walked away with some incredible golden parachute, or amazing sweetheart deal on an asset that they bought from the company, or sign this paper, stay quiet, and here's a bunch of money or here's a bunch of stock. Every person just pulled one over on the company and its shareholders over, and over, and over again.

I don't think the company ever had a hard line with anyone. You look at a person we didn't even talk about is Rebecca Mark, who ran all the international stuff, who ran Azurix, the international water project that both failed, but was also never set up to succeed, so it's hard to really blame her.

David: She lost billions of dollars, though. Billions.

Ben: Yup. She sold about $83 million of stock. She actually got out early enough. She was cast out by the male executives at the top in a way, where she was actually never accused of any wrongdoing and never really a part of the prosecution of any of these things. But she was a part of the gang of people who were, well, at least she massively benefited to the tune of $83 million from something that only ever hurt shareholders. No one was sitting around creating any shareholder value. Every deal cut with every employee ever who was leaving or staying, just bribed them all.

David: Yeah.

Ben: All right, let's talk about Sarbanes-Oxley. Did it work, or did it just force fraudsters and...

David: Malfeasance into the private markets?

Ben: Malfeasance to exist in the private markets or international pseudo domestic markets, wherever crypto exists. Because crypto impacts the US even for companies that aren't domiciled here. We've done a lot of things to push companies, either away from going public or away from doing business in the country. It still totally affects Americans and Canadian teachers.

David: FTX being a prime example there. This isn't a direct answer to your question. But one thing that I thought about through this whole process, about Sarbanes-Oxley and the consequence of stay private longer and whatnot, no doubt, Sarbanes-Oxley raised the cost and complexity of being a public company. No doubt.

I think, though, probably not as much as the stay private longer proponents were saying, and this might be related to what you're saying. I suspect, again, to the incentives and behaviors, a lot of the companies that stayed private longer weren't doing so for the stated reason that it was too hard and too unrest to be a public company. But they were doing it because there was too much benefit and money to be made by staying private, whether that was secondary sales, whether that was being able to prop up your company better than your business was performing, just the general opacity that the private markets afforded. Even thinking about companies like Uber, the king, the granddaddy of all of the stay private longer.

Ben: I think that's fair. I also think, what else was congress going to do? It's not like they can go create Bahamian laws. They can make it harder to invest in offshore entities, but not sure that that's necessarily good. That might be a baby bathwater situation.

You also can make it harder to be a private company, but we don't want that either. We want to encourage new business creation. We want to encourage a period before companies go public, where they can have looser relationships with their private shareholders and communicate information in a less standard way, because they're tiny companies. I think that makes a lot of sense. There's always a signal noise thing, where you want to make sure that your legislation is directed at quashing only the signal that you want without having the blast radius.

David: Which I think with those statements, Sarbanes-Oxley probably has accomplished its goals pretty well, which is to protect the broader American and investing public, shareholders, and public companies, from fraud.

Ben: Totally agree. All right, we have this section that we've done in the past called value creation and value capture. Normally, we talk about, do they create a lot of value, and if so, do they capture a lot of it? The classic example is Google creates a lot of value and captures a lot of it, and Wikipedia creates tons of value, captures very little of it.

Where does Enron fall into this? They managed to create very little value, and they captured far more value than they created by an order of 100–1000. It's probably the first time that we've ever, on this show, seen someone capture more value than they created.

David: Yeah, gosh.

Ben: By a lot.

David: By a lot.

Ben: It's pretty fascinating.

David: I don't know enough about the energy industry to say whether the innovations in financialization, securitization, creating energy derivatives, whether the existence of all that and Enron and its principles being highly responsible for creating them, whether that generated enough value to offset the massive value destruction of Enron, the company. Maybe. I'm not equipped to say.

Ben: I don't know. That actually is how I want to close the episode instead of grading, because what are we going to do? Give an F? The other thing that we've done recently is talk about forward looking narratives, but that doesn't exist here, either.

I think an interesting way to close this is by describing, what were the activities that they did that were legitimate, interesting business, value created for customers? And what was the illegitimate stuff they did?

I think it does end at pipelines being good for customers and the creation of a market. Let's be generous, both the market to buy natural gas at a real time price and also the ability to use a derivatives market to hedge those prices so businesses could do forecasting. I think that's probably where the line ends on good for the world things.

David: What about that Blockbuster video on demand deal?

Ben: I think as soon as the business became the derivatives trading as an end, rather than as a means of hedging or as a means of cash flow stabilization and price predictability, basically, everything after that was bad.

David: No arguing for me there. It makes sense to me.

Ben: All right. I know we're four hours in, but do you want to do some carve outs?

David: Yeah, we haven't done carve outs in a while.

Ben: We haven't.

David: We had some lined up for the Qualcomm episode, but we literally got yanked off stage.

Ben: We got off stage 2 hours, 29 minutes, and 30 seconds into the episode.

David: Two-and-a-half hours slot that we had.

Ben: I have one that I was prepared to give, because it's great, but I have one that's too related to this episode to not do.

David: Oh, I'm in the same boat. I think we can each do, too. Why not?

Ben: The one that's related to this episode is something that I unfortunately never got a chance to see, because it has been over for eight years, but there was a limited run Broadway play called Enron the Musical. We'll put a link in the show notes to the trailer for Enron the Musical. It is spectacular.

David: Oh, my God.

Ben: There is a moment where there's someone dancing with literal raptors. There are projections of stock market tickers and traders. The whole thing is an exaggeration.

David: And the cast of characters, you could just have so much fun.

Ben: It's perfect. It is perfect. Do you watch Billions?

David: I'm sad to admit. You know me, I don't really watch TV shows.

Ben: You would like Billions.

David: I spend my time playing video games.

Ben: At least you would really like the first two seasons of Billions. The guy who plays Ari Spyros, who works for the SEC, is in Enron the Musical.

David: That's great. Did it run on Broadway? Is this legit?

Ben: I think so, yeah. Let me see if I can pull it up. Yeah, it's on broadway.com/shows/enron.

David: Amazing. That's so great.

Ben: My second one is a Disney+ show called Andor. It is probably the best thing to happen to the Star Wars franchise since Rogue One.

David: Oh, wow.

Ben: It is extremely tightly linked to Rogue One. The direction, cinematography, writing, pacing, dialogue, character development, it is all just exceptional. Better than the Mandalorian for sure. It's the best Star Wars Disney+ thing.

David: That's great, because the Star Wars franchise has really, at least in my view, taken a big downhill turn.

Ben: It ain't what Bob Iger originally intended.

David: No. Speaking of...

Ben: Speaking of...

David: Man, we got to figure out something to do on Acquired about...

Ben: What are we going to do, Disney ++?

David: Disney++.

Ben: We should do an Iger+ episode. But honestly, we've told most of the story. Those are my two. Go watch Andor, whether or not you like Star Wars. I think that's actually the important thing is whether or not you like Star Wars, this is good, and a lot of other things relied on fan service.

David: Yes, that was the problem.

Ben: That threw out nonsensical stuff, but had enough callbacks where you're like, okay, cool. It's cool to see that character again.

David: Yeah. How's my biggest beef with episode nine? All right. Well, no holy wars here.

Ben: No holy wars. What are your carve outs?

David: My carve outs, okay. The one that I thought of is only very, very closely related to the episode, but as you were saying, one of your codas and one of my codas, the Berkshire Hathaway, Fruit of the Loom, and Brooks, I've now completely worn through two pairs of Brooks Ghosts since our episode with Jim and having Brex on Acquired.

They're fantastic. I love them. But now as a parent, I do far less actual running than I used to and a lot more walking of the stroller. The Ghosts were great as walking shoes, but they're running shoes. Brooks is a running company.

I was in the market. I completely destroyed my second pair of Ghost. I was in the market for a new pair of shoes and I was like, should I just bite the bullet, admit what I am, and get walking shoes instead of running shoes? I was like, oh, that probably means I can't go with Brooks, I’ll have to find something else.

But it turns out, I was so pleasantly surprised, Brooks makes a walking shoe called the Addiction. The Brooks Addiction, I got a pair before the trip to Portugal for Breakpoint. I love these shoes.

Ben: They just like really cushy? What's good about a walking shoe?

David: Maximum support. You know how like a running shoe, the soles are very flexible.

Ben: Do they offer it in Velcro like for when you need to...

David: They actually do. I have not yet made the jump to get the Velcro. Maybe if we have another kid, then I'll just be like, fine, give me the Velcro. My daughter's shoes are Velcro, so why shouldn't mine be?

Ben: Lean on and do it, David.

David: Lean and do it. But I got to say, these shoes rock. They don't look like old man shoes, they look like Brooks running shoes.

Ben: I bet the Velcro ones do though.

David: The Velcro ones totally do. They are so good. I now realize the difference between walking and running shoes. Running shoes, the sole is very flexible. They got these different cushioned parts of the sole based on where your foot strikes. Walking shoes, one big old slab of incredibly supportive. It's so good. I'm so old. I love it.

Ben: Wait, I'm going to interject another carve out then. This is going to be the start of holy war since this is not Brooks. I'm wearing Hoka slides right now. They're my indoor shoes.

David: Ooh, nice.

Ben: The floors of my house are really hardwood. My feet hurt from standing on hardwood barefoot for too long, so I got to do some form of indoor shoes, so I'm wearing these Hoka slides. They're very easy to get on and off. They're very cushy. I highly recommend them for anybody who's considering indoor shoes as a part of your easing into old age.

David: You're on a slippery slope. Before you know it, you're going to be on the Velcro walkers just with me.

Ben: I know, seriously.

David: All right, that's carve out number one of mine.

Ben: It's the Oraluxe, by the way.

David: Nice. My other carve out is our good buddy, an Acquired bestie, Jason Calacanis, JCal on the Tim Ferriss Show. It's one of the most recent episodes. It's really good. I think we'd talked about in some of our episodes with JCal that he and Tim are buddies. They're actually really close, longtime friends. JCal just went on Tim's show, and it's really good.

Ben: That's cool. With that, our thanks to Fundrise and Pilot. After you finish this episode, come discuss it with the 13,000 other smart, kind, thoughtful people I'm generally very appreciative of for being in the Acquired Slack with us.

I've asked a few questions recently around just like, hi, I'm a total novice on investing in corporate debt. How does one do that? How should one think about that? Is this an interesting time to do that? I got like a thousand interesting responses. Thanks to everyone who's just being a part of the community.

If you want to get Acquired merch, we now have two new shirts in addition to this sweet ACQ shirt that I am wearing. You can get a market size unconstrained shirt in two different variations with the original AWS logo–inspired design. You can also get a ‘there's always room at the top’ Benchmark-inspired shirt at acquired.fm/store. You can view my Photoshop capabilities on full display there.

David: It's so good. I'm so glad. We've been teasing this for months. I'm so glad we finally made it happen.

Ben: I know.

David: I feel like this is in the office. It's the Wayne Gretzky quote and it's like, is it the skate where the puck is going or whatever it is. And it's like, Wayne Gretzky.

Ben: Wayne Gretzky. Michael Scott.

David: Michael Scott or market size unconstrained, Jeff Bezos, Acquired podcast.

Ben: Yes, indeed. We've also had some great LP Shows recently, which you can get. I think all the episodes we've recorded are public. We're going to be recording a couple more in the next week that we're very excited about. You can find episodes of the LP Show publicly available in the podcast player of your choice by just searching Acquired LP Show. With that, listeners, we'll see you next time.

David: We'll see you next time.

Note: Acquired hosts and guests may hold assets discussed in this episode. This podcast is not investment advice, and is intended for informational and entertainment purposes only. You should do your own research and make your own independent decisions when considering any financial transactions.

More Episodes

All Episodes > 

Thank you! You're now subscribed to our email list, and will get new episodes when they drop.

Oops! Something went wrong while submitting the form