The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron (27 page)

One of Causey’s big responsibilities was to keep track of where Enron stood in relation to the earnings targets Skilling had promised Wall Street. He had an army of CPAs that eventually numbered around 600, most of them spread out in Enron’s various business units. The accountants would alert Causey of impending earnings or cash flow holes so that Causey could figure out what deals needed to close where. And he would coordinate with Fastow’s finance team to figure out a way to fill the holes. “Any company worth its salt uses accounting rules to smooth small peaks and valleys,” says one former Enron accountant. “But with Enron, it got to a point where it was so prolific.” Says another former Enron accountant, “Budget shortfalls weren’t just business issues, they were accounting issues. There was an absolute conviction at Enron that clever accounting could alter the business reality.”

Causey also had a smaller team of some 30 accountants in Houston and London called transaction support. Instead of being back-office types, these people, some of whom came from the Financial Accounting Standards Board (FASB), which writes new accounting rules, worked side by side with the finance team to structure deals. These accountants saw themselves as advisers—even gatekeepers—who guided the deal makers by telling them what the accounting ramifications would be. They also knew all the latest rules and the loopholes—and how best to exploit them—and there was often pressure from the deal makers to do just that. To this day, few of the in-house accountants believe they did anything wrong. They knew that they stretched and twisted the rules to Enron’s advantage, but they saw their actions as creative rather than misleading. And that seems to be Causey’s view as well. People who worked for him agree that he was a capable accountant who acknowledged he was pushing the limits but didn’t believe he was stepping over the line. “I always thought he had at least one foot on solid ground, not that he couldn’t stretch!” says one.

What they were doing—what some might even privately admit they were doing—was gaming the system. By the 1990s, it took literally tens of thousands of pages to list all of the nation’s accumulated accounting rules, known as General Accepted Accounting Principles, or GAAP. (When a company presents its financials to the public, the numbers must be in compliance with GAAP.) Every time the Financial Accounting Standards Board wrote a new set of rules, it did so to help ensure that a company’s books reflected its underlying reality.

But interpreting those rules has always been more art than science, reliant in no small part on the good faith of those applying them in everyday situations. For very smart people who saw the rules as something to be gotten around, well, it wasn’t all that hard to do—in fact, some former Enron employees argue that the rules themselves provided a road map. And Enron, which prided itself on employing only the very smartest people, took that view further than any company that’s ever existed. “We tried to aggressively use the literature to our advantage,” admits a former Enron accountant. “All the rules create all these opportunities. We got to where we did because we exploited that weakness.”

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

And there was the ultimate problem. With Enron’s financial team working feverishly to exploit the rules, there was no one willing to say that the duck was still a dog. Because they could come up with plausible rationales for why a given structure was technically valid, they believed they were on the right side of the law. They were, in fact, proud of what they were doing. In their view, they were doing what every other company was doing, except that they were doing it better and smarter, because they were Enron, where everything was done better and smarter. But while people at Enron were smart about bending the rules, they were not smart at all about understanding where all that bending was taking them.

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Besides, hadn’t the outside auditors at Arthur Andersen signed off on the transactions and structures Fastow and his crew were devising? Hadn’t Enron’s longtime accountants bestowed their blessing on all that financial cleverness? For that matter, hadn’t Arthur Andersen been intimately involved in helping Enron set up these structures—as well as helping to devise the accounting treatment? After all, the outside auditors are the ones who sign off on publicly filed financial statements, giving their word that they “present fairly, in all material respects” the financial condition of a company. They are supposed to be stick-in-the-muds who say no far more often than they say yes.

The accountants should have been a potent check on Fastow. But Andersen, despite having more qualms than Causey or any other high-ranking executive inside the company, had great difficulty saying no to Enron. The accountants in Arthur Andersen’s Houston office worked so closely with Enron that they came to see the world in the same way as Enron executives. Nor did they want to risk losing one of their biggest clients. This was also part of the modern bull market: a gradual disintegration of the high standards that accountants had once proudly upheld.

There is a sad irony in the fact that Arthur Andersen was brought down by the Enron scandal. For much of its history, Andersen was the most upright of the nation’s accounting firms and took enormous pride in that reputation. An accounting firm’s primary allegiance is supposed to be to the investing public, not the company whose books it is auditing. No firm took that mission as seriously as Arthur Andersen. It was founded in 1913 by a Northwestern University professor (whose name, naturally enough, was Arthur Andersen). One of the firm’s early mottos was “think straight, talk straight,” a saying from his Norwegian mother. Andersen was a principled, even self-righteous, man, and the firm’s lore is full of stories about his standing up to the corporations that employed his accountants. Once, in the firm’s young and lean years, Andersen auditors told a railway company client that it had to change a certain accounting practice, to the detriment of reported profits. When the company’s president demanded that the firm reverse itself or lose the account, Andersen famously retorted that “There is not enough money in the city of Chicago” to make him change the firm’s decision. (Throughout its life, Chicago was Andersen’s home base.) Andersen lost the account. Months later the railroad company was bankrupt.

Arthur Andersen started the first training school for accountants, recruiting young men straight out of college so he could indoctrinate them in the Andersen way. They all had to dress the same, use the same methods, offer the same level of service, and uphold the same high standards. Competitors seethed at what they saw as Andersen’s arrogance and labeled its staffers Androids. The founder could not have cared less.

Andersen’s successor, Leonard Spacek, who ran the firm from 1947 to 1963, was every bit as principled and every bit as self-righteous, often publicly scolding his profession for—as he put it in a 1957 speech—“failing to square its so-called principles with its professional responsibility to the public.” He regularly berated the Securities and Exchange Commission for not doing a good enough job rooting out accounting fraud, claiming that the SEC was “at best a brake on the rate of retrogression in the quality of accounting,” and continued his crusade for high standards even after he’d retired from the firm. The Financial Accounting Standards Board, which was formed in 1973, came about largely because of Spacek’s incessant lobbying.

Spacek was also interested in computers and technology, and when employees came to him with an idea—that Andersen should help corporations figure out how to use these complicated new machines—he helped push it forward, setting up the industry’s first consulting arm. What he failed to realize was that consulting would play a major role in corrupting both the accounting profession and Andersen itself.

Over time, consulting became the tail that wagged the dog. Consulting divisions—which included not only computer assistance but business strategy and risk management, among other things—grew much faster than the auditing divisions, which at many firms became practically loss leaders to help get the consultants in the door. The consultants themselves generated far more money than their accounting counterparts and had far more status. Along with the rise of consulting came a new focus on the bottom line. Accountants hired to audit a company’s books were also expected to help persuade their clients to use the firm’s consultants as well. By the 1990s, there were few firms willing to quit an account on principle, as Arthur Andersen had done so long ago; there was simply too much money at stake. Not surprisingly, accounting standards eroded, and accounting fraud mushroomed.

At Andersen, the growth and success of its consulting division, Andersen Consulting, led to a long, simmering feud between the accountants and the consultants. In a partnership where profits were shared, the situation became so bitter that in 1989 the consultants were spun off into a separate business unit, but they were still required to share their profits with their poorer audit cousins. (In 1997, the consulting side produced 56 percent of the firm’s revenues—and consulting was growing at nearly twice the rate of auditing.) As a firm, Andersen had two cultures, the sleek, self-satisfied consultants—and the downtrodden auditors who only had to look across the hallway to see that they weren’t keeping up. In December 1997, after several years of open warfare, the consultants voted to split off entirely. The auditors demanded over $14 billion; in 2000, a judge ruled that they would get just $1 billion. The Andersen accountants, left with a slow-growing audit business—it was the smallest of the Big Five accounting firms—began aggressively building a new consulting arm of their own. The pressure to generate fees was intense, and so was the pressure to hold on to clients. Even before Enron, Andersen had been embroiled in several high-profile accounting scandals, including Sunbeam and Waste Management.

In the Waste Management case, Andersen paid $75 million to settle civil lawsuits, agreed to pay a $7 million fine to the SEC, and promised not to repeat its conduct. In the wake of its settlement with the SEC, the firm circulated a memo to all its partners: “One of the most important lessons from litigation involving our profession is that client selection and retention are among the most important factors in determining our risk exposure. . . . have the courage to say no to relationships that bring unacceptable levels of risk to our firm.”

Andersen had long since abandoned its founder’s old motto, “think straight, talk straight”; instead, its new slogan was “simply the best.” But by the late 1990s, “simply the best” had a different meaning than it might once have had at Arthur Andersen. Those partners who were viewed internally as simply the best were the ones who kept their clients happy, especially the handful of clients Andersen labeled its crown jewels. Enron was one of them.

Practically from the day Enron was formed, the company was a big client for Andersen’s Houston office. Between 1988 and 1991, Andersen earned $54 million in fees from Enron. By the late 1990s, that number had skyrocketed; in 2000 alone, Enron paid Arthur Andersen $52 million, over half for consulting services. Enron was one of Andersen’s top four clients, and it dominated the attention of the Houston office, which, thanks to its aggressive energy practice, was the largest and most profitable office in the firm. Within Andersen, the Houston office had a reputation: it was the place to go if you wanted to make partner quickly, and the Enron account was a large part of the reason why. In addition to its external auditing, Andersen at various times also had consulting contracts to handle Enron’s internal auditing and was in charge of auditing Enron’s internal-control system.

Even that doesn’t begin to describe how close Andersen and Enron were. Over the years, Enron hired at least 86 Andersen accountants, who were lured by the promise of higher pay and Enron stock options. Over time, many important finance jobs at the company were held by people who had worked on the Enron account at Arthur Andersen. Andersen often complained that Enron was raiding its staff, but the firm was also rather proud of it. Although Arther Andersen’s Houston office was just a few blocks from the Enron building, most of the 100 or so Andersen employees who worked on the Enron account spent almost no time there;
their
offices were at Enron, where they worked alongside the company’s own accountants. They adopted the same business-casual style that was prevalent at Enron, making it hard to tell who was the auditor and who was the client. “It was like these very bright geeks at Andersen suddenly got invited to this really cool, macho frat party,” Leigh Anne Dear, a former Andersen accountant, told the
Chicago Tribune
.

In April 2000, when Arthur Levitt, then the SEC chairman, tried to force accounting firms to separate their consulting and accounting practices, Enron leapt to its accountant’s defense. “For the past several years, Enron has successfully utilized its independent audit firm’s expertise and professional skepticism to help improve the overall control environment within the company,” wrote Ken Lay to the agency. “I believe independent audits of the internal control environment are valuable to the investing public. . . .” After a bitter fight, Levitt largely backed down.

Enron and Andersen even bragged about their closeness in a promotional video. “We basically do the same types of things . . . we’re trying to kinda cross lines and trying to, you know, become more of just a business person here at Enron,” said one Arthur Andersen accountant in the video. Added another, “Being here full time year round day to day gives us a chance to chase the deals with them and participate in the deal making process. . . .”