Enron: Uncovering The Uncovered Story

(Columbia Journalism Review, March/April 2002)

The man who first laid Enron bare was not a journalist. In October 2000, a hedge-fund manager named James Chanos began to scrutinize the company's financial statements and was astonished by what he discovered: murky references to "related party" transactions involving Enron's senior officers, and massive insider selling. Chanos attacked the documents, filling the margins with exclamation points and notations, and marking dubious footnotes with yellow Post-its. In November 2000, he shorted the stock, and the result, when the price plunged, was a windfall for himself and his clients. In February 2001, Chanos tipped off a reporter at Fortune, Bethany McLean, who in March, published a story entitled "Is Enron Overpriced?" That story was a link in a chain of events that eventually destroyed the company and ignited one of the most explosive corporate scandals in U.S. history.

It's a scandal with numerous culprits and accomplices, some of whom were named in a page-one story in The New York Times on January 14 by the business writer Gretchen Morgenson. "The bull market euphoria," Morgenson wrote, "convinced analysts, investors, accountants, and even regulators that as long as stock prices stayed high, there was no need to question company practices." One could add an additional culprit to that list: the Fourth Estate.

"Gurus, analysts, and the media must take some blame for what happened," Richard Lambert wrote in the Financial Times on December 15. At least one major American publication concurs with that bleak assessment. In a December 17 editorial headlined let us count the culprits, Business Week lashed out at Wall Street, mutual funds, and the rating agencies, urging them to rethink why "each, in its own way, celebrated what is now revealed to be an arrogant, duplicitous company managed in a dangerous manner." And then, in a moment of unusual candor, the magazine issued its own mea culpa: "The business press, including Business Week, did no better. It celebrated [ex-ceo Jeffrey] Skilling's vision of Enron as a virtual company that could securitize anything and trade it anywhere. The press blithely accepted Enron as the epitome of a new, post-deregulation corporate model when it should have been much more aggressive in probing the company's opaque partnerships, off balance sheet maneuvers, and soaring leverage." As Business Week's editor, Stephen Shepard, puts it, Enron "was not the press's finest hour."

How, and why, did it happen?

In recent months, journalists have undertaken a ferocious assault on Enron. Two seasoned reporters from The Wall Street Journal, Rebecca Smith and John Emshwiller, led the pack. In a devastating fusillade of articles in mid-October, they forced Enron's clandestine "partnerships" out into the open, as Enron's stock price tumbled. The Journal followed up with a massive barrage of detailed, critical reporting, some of which contained bold assertions about energy policy and deregulation. On November 30, Smith, one of the country's leading energy reporters, wrote a page one story, shock waves: enron's swoon leaves a grand experiment in a State of disarray. "It was one of the great fantasies of American business," Smith's article began. "A deregulated market that would send cheaper and more reliable supplies of electricity coursing into homes and offices across the nation."

This kind of skepticism is a relatively recent development, since energy deregulation was an idea that the business press – including The Wall Street Journal – did much to promote. For years, the Journal's editorial page argued strenuously for deregulation, and adopted a celebratory tone when that finally began to occur in energy markets in the mid-1990s. Some of that exuberance, in turn, was echoed in the Journal's news columns. In a Journal "Energy" special report on September 13, 1999, Gaston F. Ceron, a reporter for Dow Jones News Service, breathlessly wrote: "Energy companies are trying all sorts of ways to compete in their new unregulated, anything-goes world. Some are acquiring, some are merging, many are charging into new markets with innovative products. New blood has infused much of the industry, raising bright, energetic newcomers into the top ranks at some of the most innovative energy companies." In contrast to the "boringly predictable" regulated utilities of old, which were "safe havens for widows and orphans," the newcomers, Ceron insisted, "hold the promise of skyrocketing returns." Ceron's article proceeded to list "the most active and interesting energy companies." Enron topped his list.

Ceron was not the only Journal reporter whose copy crackled with enthusiasm about Enron: Rebecca Smith, whose coverage of the California energy crisis garnered her a Pulitzer Prize nomination, also produced upbeat stories about the company. On April 13, 2000, Smith hailed Enron's first-quarter earnings, which had nearly tripled from the previous year to $338 million, in a story bursting with effusive pronouncements. "The real story isn't the earnings," crowed one analyst from Goldman Sachs quoted by Smith. "It's what lies ahead. This isn't your father's natural-gas company." "We see continued momentum," remarked a PaineWebber analyst quoted in the piece. "They have a massive infrastructure built." Ceo Jeffrey Skilling himself joined the chorus: "It's absolutely astounding," Skilling informed Smith. "It feels like we're being swamped with new opportunities." The piece was entirely devoid of skeptical voices.

These days, Smith is contrite. "We were all duped by Enron," she says. "I thought Enron was a stellar company. I thought it was enormously ambitious, and I thought that if it fell to earth that would probably be the reason. But I never thought it was because it had a corrupt financial structure."

In the heady business climate of the late 1990s, other newspapers, too, rushed to embrace Enron. In March 1999, James Flanigan, a Los Angeles Times business columnist, rejoiced that the energy market was no longer "a staid business of regulated monopolies" but a "beehive of financially savvy companies" like Enron. Later, when Enron came under attack for its role in the California energy debacle, Flanigan was reluctant to back off. "There is no doubt that Enron is a thought-provoking company," he wrote on January 28, 2001, "at a critical juncture in world business history." Other business columnists echoed that view. On August 19, 2001, in response to Skilling's resignation and a concurrent fall in the stock price, the Houston Chronicle business columnist Jim Barlow announced: "It's still a company with innovative people who have shown they can turn ideas into profitable businesses. That's why the current problems will blow over."

To excavate back issues of magazines like Forbes, Fortune, Worth, Business 2.0, and Red Herring is to enter a parallel universe of cheerleading and obsequiousness, a universe where applause obliterated skepticism. In April 2000, Fortune, for instance, published a long tribute to Enron. The gaudy, sycophantic lead deserves to be reproduced in full, for it is a cautionary specimen of credulous, fin de siécle financial journalism:

Imagine a country-club dinner dance, with a bunch of old fogies and their wives shuffling around halfheartedly to the not-so-stirring sounds of Guy Lombardo and his All-Tuxedo Orchestra. Suddenly young Elvis comes crashing through the skylight, complete with gold-lamé suit, shiny guitar, and gyrating hips. Half the waltzers faint; most of the others get angry or pouty. And a very few decide they like what they hear, tap their feet . . . start grabbing new partners, and suddenly are rocking to a very different tune. In the staid world of regulated utilities and energy companies, Enron Corp. is that gate-crashing Elvis. Once a medium-sized player in the stupefyingly soporific gas-pipeline business, Enron in the past decade has become far and away the most vigorous agent of change in its industry.

Enron was not one of those "boringly predictable" energy utilities for widows and orphans, but a secular religion. Worth, like many others caught up in the dot-com fever, was enamored of Enron's massive online trading operation, which, it reported in December 2000, had executed more than 350,000 transactions totaling $183 billion in little under a year. Concluded Worth: "Enron's mix of the old and new economies should appeal to all but the most conservative investors." Enron came apart last October, but many business magazines remained true believers until the very end. Two months earlier, Forbes had assured its readers: "Enron has grown into the world's largest electricity marketer since we last wrote about it. Now a new surge in revenues might be in the offing." In its September 2001 issue, Red Herring insisted: "Forget about Microsoft. America's most successful, revered, feared – and even hated – company is no longer a band of millionaire geeks from Redmond, Washington, but a cabal of cowboy/traders from Houston: Enron." On August 13 Business 2.0 hit the streets proclaiming "The Revolution LIVES," with a photo of Jeffrey Skilling sharing the cover. The ceo resigned the next day.

The Houston cabal was amply rewarded with distinguished rankings in various annual surveys. For six years in a row, industry insiders voted Enron "Most Innovative" among Fortune's "Most Admired Companies" – a list that purports to be "the definitive report card on corporate reputations." (In February 2001, Enron ranked second in "quality of management" as well.) In January 2000, Business Week showcased Kenneth Lay as one of the "25 Top Managers" of 2000. Lay and Skilling stood out in Worth's annual surveys of the "50 Best ceos." In 2001, Skilling – "hypersmart, hyperconfident," gushed Worth – garnered the number two position. For a quote, Worth went to his colleague, Ken Lay, who remarked: "I'm not sure he has a nonstrategic bone in his body."

The print media coverage of Enron's top executives was pure hagiography. According to Fortune, Kenneth Lay was a "revolutionary," while Worth, explaining Lay's "personal strengths," quoted an analyst saying he possessed "the best combination of vision and execution of anyone." Jeffrey Skilling, in Fortune's sonorous pronouncement, was "the most intellectually brilliant executive in the natural gas business." He was also, Fortune suggested, an unpretentious, all-American family man – "a lively, impish character who disdains the huge, serene, high walled office he occupies atop the Enron building, forty stories above downtown Houston. 'Too quiet. Too removed,' he complains. (His kids often play Koosh ball in it and store their racquets in a corner.)"

Another media darling was Rebecca Mark, who led Enron's international initiatives before she was fired in 2000, and who reportedly made $79.5 million from the sale of Enron stock. During Enron's heyday, reporters approached Mark with a People magazine-like sensibility. "With honey-blonde hair, big brown eyes and dazzling white teeth that offset a toast tan," Forbes gushed in 1998, "Rebecca Mark could be taken for a movie star." Lou Pai, a top Enron executive, one who pocketed $354 million after unloading five million shares of Enron stock in 1999 and 2000, also got the rock-star treatment. "Pai is bursting with competitive energy," Forbes wrote in July 2000. "Skilling calls him 'my ICBM.'"

Not every news organization bowed to the cowboy traders from Houston. By and large, Business Week's coverage of Enron in the 1990s was free of boosterism and free-market zealotry. For one thing, it didn't descend into hero worship. When Forbes (and Fortune) depicted Rebecca Mark as infallible, Business Week declined to worship. "It has been a rough few weeks for Rebecca P. Mark," the magazine reported in September 1995. "On August 3, [Mark] had her biggest deal, in India, abruptly cancelled after a state government review . . . Then, back in the U.S., on a vacation to unwind, she was tossed into a cactus while on a horseback excursion."

Even more skeptical was The Economist, which generally refused to mount the Enron bandwagon. In 1998, The Economist noted that while "Enron's famously pushy lobbyists are doing their best to force the pace" of electricity deregulation, the company's goal of turning electricity into "a price-driven commodity" is "quite a gamble." "Spend long enough around top Enron people," the magazine wrote in a searching report in June 2000, "and you feel you are in the midst of some sort of evangelical cult. In a sense you are. Mr. Lay, with his 'passion for markets,' is the cult's guru." The Economist zeroed in on Lay's hubris: "Asking him to admit even the slightest mistake is tougher than pulling teeth. This is odd, for the blunderbuss approach to innovation that is intrinsic to such an opportunistic firm as Enron is bound to produce a few failures. Given all his successes, surely failures should be proudly displayed as red badges of courage?" Concluded The Economist: "Is Enron really so flawless?"

Even those magazines that were somewhat skeptical of the company never took the time to investigate Enron's byzantine finances. One journalist who made that effort was Jonathan Weil of The Wall Street Journal. Educated at the University of Colorado and Southern Methodist University Law School, Weil got his first job at the Arkansas Democrat-Gazette in Little Rock, where he spent some two years before moving to the Journal's Texas staff in 1997 as a contributor to the weekly Texas Journal, a four-page stand-alone section that appeared inside Texas editions of the Journal. (Texas Journal was shut down, along with the other zoned editions, in late 2000.)

In July 2000, Weil, thirty-one, received a call from a source, who told him: "You really ought to take a look at Dynegy and Enron." So he did. After two months of research and digging, during which time he mastered the complex accounting rules for energy derivative contracts, Weil published, in Texas Journal, an article headlined energy traders cite gains, but some math is missing. Weil's piece was a tour de force of financial reporting, one that began:

Volatile prices for natural gas and electricity are creating high-voltage earnings growth at some companies with large energy-trading units. But investors counting on these gains could be in for a jolt down the road.

Weil's Texas Journal piece, published on September 20, 2000, cast a searchlight on Enron's dubious accounting practice known as "mark-to-market accounting." Noting the huge profits that companies like Enron and Dynegy had racked up from unregulated markets, Weil wrote:

But what many investors may not realize is that much of these companies' recent profits constitute unrealized, noncash gains. Frequently, these profits depend on assumptions and estimates about future market factors, the details of which the companies do not provide, and which time may prove wrong.

Quoting various professors of accounting, who expressed doubts about the quality of earnings, Weil determined:

The heart of the situation is an accounting technique that allows companies to include as current earnings those profits they expect to realize from energy-related contracts and other derivative instruments in future periods, sometimes stretching over more than 20 years.

Weil's piece never appeared in the national edition of The Wall Street Journal; it was The Story That Got Away. Journal editors in New York never ordered a follow-up, and nearly a year would pass before Skilling's resignation inspired other Journal reporters to focus on Enron. These days, Weil, who is now the Journal's accounting reporter in New York, is rather melancholy: "I do regret not having revisited Enron," he says. "What I should have done, in retrospect, was rewrite that story for the national edition." But Weil's efforts were not in vain: On the same day his story came out in Texas, it appeared on the Dow Jones newswire, where it was seen by James Chanos, who now acknowledges Weil's Texas Journal piece as the primary catalyst for his own exhaustive research into Enron's finances. (Enron, for its part, didn't much care for Weil's piece. Several days before it appeared, Enron flew seven executives, accountants, and p.r. people to Weil's office in Dallas. After it was published, he got a laconic e-mail message from Enron's top PR man, who wrote: "As you might imagine, we had some problems with the story, principally with the lead questioning the quality of our earnings . . .")

Weil's loss was Fortune's gain. Chanos had been a source for the Fortune reporter Bethany McLean, and the short-seller, who is well known in financial circles, briefed her about Enron. "I would never have thought of looking at Enron if he hadn't tipped me off," McLean says. "There's no question about that. I'm not a beat reporter, so there's no reason I would have looked at Enron." After doing her own analysis of Enron's finances (without the benefit of Weil's piece, which she says she never saw) and conferring with skeptical analysts, Mclean, in March 2001, produced "Is Enron Overpriced?" – a piece that bristled with questions like "How exactly does Enron make its money?" and general inquiries about the company's financial health. When she attempted to interview Skilling, he said her questions were "unethical" and hung up on her. Enron executives flew to New York to answer her questions. Later, Kenneth Lay himself called Fortune's managing editor, Rik Kirkland, and implied he should spike McLean's piece; Kirkland refused. (McLean and her editor, Joseph Nocera, along with the Fortune writer Peter Elkind, have since signed a book deal with Penguin-Putnam, reportedly for more than $1 million.) Ever so slowly, skepticism started to spread. On May 9, 2001, Peter Eavis, of TheStreet.com, tipped by another short-seller, mentioned the shady "related entities" and linked one to Andrew Fastow, Enron's former chief financial officer.

On August 14, Skilling resigned, which raised the suspicions of Enron watchers on and off Wall Street. "It did not sound right to me," recalls the Journal's Los Angeles bureau chief, Jonathan Friedland, who coordinates the paper's electricity coverage. Friedland, along with Smith and Emshwiller, began to peruse Enron's financial statements, and quickly realized, in Friedland's words, that "things weren't adding up at Enron." Moreover, sources close to Enron began to furnish the Journal with documents. On August 28, Smith and Emshwiller reported that cfo Fastow had "quietly ended" his management of certain "limited partnerships." The team knew they were on to a significant story, but September 11 impeded their progress.

On October 16, Enron announced a $618 million third-quarter loss. The next day, Smith and Emshwiller tied the losses to the partnerships, and identified them by name: LJM and LJM 2. When Lay let drop in a conference call that Enron had shrunk its shareholder equity by $1.2 billion, the Journal pounced on the slip, and immediately tied the shrinkage to the Fastow partnerships. On October 19, the Journal reported that Fastow made millions off those partnerships. After years of skulduggery and deception, Enron's denouement was finally at hand: the company's stock price accelerated its downward trajectory from which it never recovered, and other news organizations, along with the SEC, began to take notice. Today, enthusiastic top Wall Street Journal editors repeatedly suggest that their efforts put the company out of business. "I think," says deputy managing editor Daniel Hertzberg, "it's fair to say that, without the stories that Smith and Emshwiller wrote, Enron would have gotten on fine. There is no evidence that it would have collapsed."

Amid the wreckage of Enron, one question looms large: Should the press have tackled Enron earlier? Some journalists contend that it was virtually impossible to do so. "If a company is lying to the SEC," says Jonathan Friedland of the Journal, "and to regulators, and it's getting its accountants to sign off on its lies, and it's getting lawyers to offer opinions congruent with those lies, it's impossible to find that stuff out unless you have a whistleblower come forward." It's a compelling argument with a strong element of truth, but it overlooks the fact that reporters and analysts (like Weil and Chanos and McLean) who plunged into Enron's finances became instantly suspicious about what they found. If the U.S. press had followed up on the questions posed by The Economist in June 2000 – and by the Texas Journal three months later – the contours of the story could have emerged earlier.

Others think the press missed a series of red flags. In a recent article in the Los Angeles Times, David Shaw listed a few of them: "There was a major, longtime discrepancy between Enron's profits and its cash flow. Its return on investment also was remarkably low for such a high-risk venture. Its financial statements were incomprehensible." Others point to the suspicious unraveling of Enron's much-touted deal with Blockbuster in March 2001, and the subsequent resignation of Jeffrey Skilling in August. "We all had an amazing clue when Skilling resigned in August," says Stephen Shepard of Business Week. "We could have said, something is really fishy here. Unless they are really sick, ceo's just don't resign like that with no explanation. We could have said: 'Let's put a team of people on this and see what's really going on.' We and others didn't do that." "I really believe that every story has its time," says Rebecca Smith of the Journal. "And what was required for the Enron story to break the way it did was for the company to be brought to its knees in a single quarter on its earnings."

But the press didn't only miss a series of red flags; the problems go deeper. In the wake of Enron's collapse, many business journalists have expressed uneasiness about the uses and abuses of analysts, whose ebullient praise for Enron ("this isn't your father's natural-gas company") reverberated so widely in the business press. Too frequently during the 1990s, says Jonathan Weil, financial journalists "outsourced their critical thinking skills to Wall Street analysts, who are not independent and, by definition, were employed to do nothing but spin positive company news in order to sell stock." Adds Weil: "There was hardly a Wall Street analyst covering the stock whose firm was not getting sprinkled with cash in some form or another by Enron."

Gretchen Morgenson of The New York Times concurs. "Business reporters should probably not quote analysts at all," she says. "If they do quote them, they should at least identify the firm and the firm's relationship to the company that they're talking about." Asked why skeptical voices were generally absent from her early Wall Street Journal stories about Enron's quarterly earnings, Rebecca Smith pauses and then replies: "I don't know what to say. There was not exactly a groundswell of people at that point feeling anything other than that Enron had another in a long procession of good quarters."

It's not enough, some journalists insist, to fine-tune reporting techniques. For them, the fall of Enron is not merely a story about a company that cooked its books and lied to its employees, but a window into larger, more systemic questions about the role of the press in making sure that important policy shifts are debated and discussed. "There's been almost no debate about deregulation," says American Prospect co-editor (and Business Week columnist) Robert Kuttner. "It's just been taken for granted in the business press, and in the editorials, and to some extent in the halls of Congress, that deregulation is just the right and the natural thing to do. It's the 'wave of the future,' and markets 'work,' and all of the ancient, well-documented reasons why there are market failures somehow have allegedly been overtaken by the New Economy. It was nonsense then and it's nonsense now."

Kuttner is not alone now in wondering if deregulation might have gone too far. On January 15, 2002, a page one Wall Street Journal headline read: why we had glass-steagall. Passed in 1933 in response to public concern over Wall Street chicanery, the Glass-Steagall Act created statutory barriers between investment banking and commercial banking. After years of lobbying by Wall Street, the act was abolished by Congress in 1999, an abolition whose implications were mostly ignored by the press. With attention now focused on Enron's bankers – including J.P. Morgan Chase and Citigroup, who were among the major beneficiaries of Glass-Steagall's repeal – some journalists are finally posing hard questions about Glass-Steagall's demise. The Economist recently wondered: "Might J.P. Morgan and Citi have let their lending standards slip in order to win investment banking business from Enron?" and pointedly inquired: "Was America wrong to scrap the laws that kept commercial and investment banking apart?"

Is Enron ultimately a story about people who broke the rules, or about how the rules got shaped? Those "boringly predictable" – and regulated – energy utilities of old, it might be noted, did not generally create hidden partnerships and clandestine bank accounts in the Cayman Islands. Given the fact that Enron benefitted from at least two forms of deregulation – energy and banking – and fought to keep its commodity trading unregulated as well, the time is clearly right for the press to promote a discussion of the subject. For instance, was energy deregulation a "fantasy," as Rebecca Smith suggested in the Journal on November 11? Or is energy deregulation a necessary and sound idea that must continue apace, as the Journal's editorial page defiantly argued on December 12?

In the end, what can the press learn from this affair? Certain things are obvious: Business reporters should ponder their reliance on Wall Street analysts, while expanding their contacts to include consumer advocates, mavericks, and independent-minded employees. The "underlying problem" for business journalists, says Business Week's Shepard, is that corporate "accounting has gotten very difficult to understand." In his view, there is a clear lesson for Business Week: "We're all going to get a lot more sophisticated about accounting," he says. "You can't take for granted the signed accountant's statement anymore. You really have to look into it a little bit more, and when there's a little bit of trouble, you really have to dig in." (See "Avoiding Future Enrons")

With Enron in flames, some business journalists think the time is right for a wide-ranging assessment of the business press's overall performance in recent years. "Throughout the 1990s," says Gretchen Morgenson, "a lot of people just bought into the baloney about the bull market. Most journalists bought into that baloney right alongside investors and didn't ask the tough questions. That applies not only to Enron but to a large variety of companies, who really got off Scot free." The cheerleading of the dot-com era, she believes, must give way to widespread skepticism – a quality in short supply. "You can't teach people to be skeptics; they have to sort of have it in their blood," she says. "They have to be willing to take the heat from asking tough questions. Not everybody does; not everybody wants to; not everybody has the constitution for that. So you can't really force that on people, but you have to encourage it. You have to allow it to flourish. You have to make your newsroom a place where that kind of thinking is welcome."

Revelations about Enron's myriad tentacles, which encircled politicians of every stripe and journalists as politically dissimilar as Paul Krugman and William Kristol (see page 13), have led some commentators to evoke the great scandals of the Gilded Age. But this time around, there were no Ida Tarbells – just a handful of skeptical reporters, and one ingenious money manager, who, by employing the time-honored techniques of investigative reporting, enriched himself and his clients, and put his country's press to shame.