The Enron Cases

Three comprehensive accounts of the Enron story provided most of the material from which these cases were constructed:

1. Mimi Swartz with Sherron Watkins, Power Failure: The Inside Story of the Collapse of Enron, New York: Doubleday, 2003.
2. Bethany McLean and Peter Elkind, The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron, New York: Penguin, 2003.
3. Kurt Eichenwald, Conspiracy of Fools: A True Story, New York: Random House, 2005.

The last two works are built upon the one(s) before, telling the same story but with progressively more detail and data. With minor exceptions, they agree on the stories told in these case studies. The Author’s Notes provide comments clarifying where one or another provided unique information or detail. Conspiracy of Fools, coming last and with the benefit of extensive interviews with the major protagonists, provides most of the insider-account material.

Other, earlier accounts were less useful but contributed in spots: Robert Bryce, Pipe Dreams: Greed, Ego, and the Death of Enron, New York: Perseus, 2002,

Loren Fox, Enron: the Rise and Fall, Hoboken, N.J.: Wiley, 2003, and Peter C. Fusaro and Ross M. Miller, What Went Wrong at Enron: Everyone’s Guide to the Largest Bankruptcy in U.S. History, Hoboken N.J.: Wiley, 2002.

The Report of the Special Investigation Committee of the Board of Directors of Enron Corporation (the Powers Committee Report), issued on February 1, 2002, is an indispensable guide to the details of Enron’s most complex and ethically questionable transactions. The Powers Committee had unique access to Enron’s internal information, to its then-current and now former executives, and to independent accounting and legal advice (Deloitte & Touche LLP and Wilmer Cutler, respectively). The starkness and clarity of the report’s conclusions, such as the importance it attributed to Enron’s Chewco-related accounting restatements (October 2001), helped identify which events were critical to Enron’s ethical decomposition. Many of the Enron’s SPE details and structural diagrams presented in the cases were also taken from or confirmed by the Powers Committee Report.

The Final Report of Neal Batson, Court-Appointed Examiner re: Enron Corp., et al., Debtors, Appendix C, provides extensive information and analysis of the role of attorneys in various Enron episodes. Batson was appointed by the U.S. Bankruptcy Court, Southern District of New York. This appendix covers the conduct of both in-house and outside counsels in many of Enron’s questionable transactions, including Condor, Chewco, the LJM deals, and the Raptors. Vinson and Elkins’ conduct of the Sherron Watkins investigation is also covered. The report is extensively documented, draws upon depositions of key figures, and provides considerable legal analysis regarding proper and questionable conduct by the various attorneys.

Enron: Corporate Fiascos and Their Implications, eds. Nancy B. Rapoport and Bala G. Dharan, New York: Foundation Press, 2004, is a valuable anthology of analytical pieces on Enron’s demise. Portions of the book deal directly with ethics issues. Some articles provide technical material on Enron’s accounting methods. Bala G. Dharan’s article was particularly useful in this regard. Leslie Griffin’s article, “Whistleblowing in the Business World,” provided legal background and insights helpful to understanding Sherron Watkins’ situation. Griffin’s article also throws light on the dilemma of in-house counsels, such as Jordan Mintz, as they consider whether to work ethics issues inside the company or to take them to external regulators.

Brian Cruver’s Anatomy of Greed: Telling the Unshredded Truth from Inside Enron (New York: Carroll & Graf, 2002) provides a personal memoir of an Enron new hire who joined the company early in 2001. Much of the book is anecdotal, but it does capture some sense of Enron’s culture. Cruver’s description of the motivational signs posted as one drove up Enron’s parking garage is telling for both what is emphasized and what is left out. Cruver’s account also includes reproductions of some companywide e-mails, including the e-mail announcement of Jeff Skilling’s resignation, which is incorporated into Case Study 13 as an attachment.

Sherron S. Watkins’ “Ethical Conflicts at Enron: Moral Responsibility in Corporate Capitalism,” California Management Review, Summer 2003: is a helpful look back at Enron’s demise by perhaps its most famous resister. The article also provides insights into Watkins’ thinking at the time and includes her reflection that in retrospect she should have taken her complaint to the Audit Committee of the Enron board.

Several case studies on Enron and ethics were published in the wake of the company’s demise. Two of the better ones were The Enron Collapse by Professor Stewart Hamilton (IMD, Lausanne Switzerland, 2003) and Broken Trust: Role of Professionals in the Enron Debacle by Professor Ashish Nanda (Harvard Business School #903-084, February 28, 2003). The former provides a condensed story of the events that caused the collapse. The latter details the role played by various professional gatekeepers and watchdogs, including the accountants, analysts, investment bankers, lawyers, consultants, and credit raters. Broken Trust highlights the conflict-of-interest issues faced by all these groups when confronting an aggressive client and as such, serves as a useful counterpoint to earlier Harvard Business School cases extolling Enron’s culture of creativity (see, for example: Enron’s Transformation: From Gas Pipelines to New Economy Powerhouse by Christopher Bartlett and Meg Glinska, HBS #301-064, March 16, 2001, and Enron: Entrepreneurial Energy by Pankaj Ghemawat and David Lane, HBS #700-079, February 17, 2000).

Numerous newspaper and magazine articles are worth reading to capture the “perception at the time” as the Enron story unfolded. Of special note are “Is Enron Overpriced?” by Bethany McLean (Fortune, March 5, 2001, pp. 123–126), “Enron Posts Surprise 3rd-Quarter Loss After Investment, Asset Write-Downs” by John Emshwiller and Rebecca Smith (The Wall Street Journal, October 17, 2001) and “Enron CFO’s Tie to a Partnership Resulted in Big Profits for the Firm” by the same authors (October 19, 2001). These and similar articles bracket the changing mood in the press toward Enron and the increasingly aggressive investigative climate that confronted Ken Lay when he returned as CEO in August 2001.

Enron’s financial data and notes are taken from the company’s 10-Q and 10-K filings with the U.S. Securities and Exchange Commission. Numerous brokerage reports reveal the financial market’s understanding or lack thereof of Enron’s financials. An interesting example of both is “The New, New Valuation Metrics: Is Enron Really Worth $126 per share?” published by John S. Herold, Inc., on February 21, 2001. The report analyzes not Enron’s stock price but Jeff Skilling’s assertion that the stock should rise to $126/ share. Although the report does latch on to Enron’s eroding profit margins, it ignores cash flow and arrives at the conclusion that $111/share was a more reasonable price (Enron’s stock never broke $90/share). This and many similar pieces testify to the longevity of Enron’s success in masking its financial issues and thus the mountain of establishment thinking facing resisters who favored more honest disclosure.

Enron’s Code of Ethics, July 2000, was taken off www.TheSmokingGun.com. ExxonMobil’s Ethics Policy is taken from the company’s Standards of Business Conduct that is provided to all executives, available to all employees and posted on the company’s Web site (www.exxonmobil.com).

Finally, various former Enron employees were willing to be interviewed and to read draft cases of which they had some personal knowledge. In particular, Jordan Mintz, Vince Kaminski, David Woytek, Jeff McMahon and Sherron Watkins reviewed the cases that involved them, providing factual corrections and enhancements.

The Financial Crisis Cases

Two accounts of the financial crisis provided invaluable details about specific financial institutions and events.

1. Bethany McLean and Joe Nocera, All the Devils Are Here: The Hidden History of the Financial Crisis; Portfolio/Penguin, New York, 2010
2. Gretchen Morgenson and Joshua Rosner, Reckless Endangerment; Times Books, New York, 2011

All the Devils Are Here is a comprehensive guide to the financial crisis. It begins at the beginning, with useful accounts of the invention of mortgage-backed securities and the evolution of subprime lending on the backs of “securitization.” It then examines each link in the chain of causation that led to catastrophe. Countrywide, Fannie Mae, the rating agencies, AIG Financial Products and the unwise leaders at Merrill Lynch and Bear Stearns are all carefully scrutinized. Important but often forgotten developments, such as the late 1990’s failure of many subprime mortgage lenders (Subprime 1.0) and the resurrection of subprime lending led by AmeriQuest, are ably recounted. McLean and Nocera usefully and correctly depict the financial crisis as the end result of a chain reaction of greed, hubris, errors and regulatory failures. The evidence they present is incorporated into many of this book’s case studies, most especially those involving Countrywide, Fannie Mae, Moody’s and Goldman Sachs.

Reckless Endangerment has a narrower, deeper focus. Morgenson and Rosner concentrate on Fannie Mae and mortgage lenders like Countrywide. By pursuing these stories in depth, the authors compile powerful indictments against key leaders at those firms. To a lesser extent it also provides useful information on how the investment banks persuaded the rating agencies to bestow such high ratings on securities that ultimately proved toxic. Reckless Endangerment’s special contribution is its detailed account of how Fannie Mae, under Jim Johnson, “gamed” its regulator and developed irresistible political influence in Washington. This information and its implications for the subsequent regimes of Franklin Raines and Daniel Mudd are incorporated into the Fannie Mae case study.

Four books about individual investment banks are also valuable for understanding the financial crisis in its entirety:

1. Gillian Tett, Fool’s Gold: The Inside Story of J.P. Morgan and How Wall St. Greed Corrupted Its Bold Dream and Created a Financial Catastrophe; Free Press, New York, 2009
2. William D. Cohan, House of Cards: A Tale of Hubris and Wretched Excess on Wall Street; Doubleday, New York, 2009
3. William D. Cohan, Money and Power: How Goldman Sachs Came to Rule the World; Doubleday, New York, 2011
4. Lawrence G. McDonald with Patrick Robinson, A Colossal Failure of Common Sense: The Inside Story of the Collapse of Lehman Brothers; Three Rivers Press, New York, 2009

Tett, a reporter for the Financial Times of London, tells how derivatives ended up contributing to the financial crisis. J.P. Morgan is the location for her story, as the Morgan bank was the First Mover in both collateralized debt obligations and credit default swaps. Her account of the careful financial control environment within Morgan provides a useful contrast to the rest of the Street, and her explanation of how CDO/CDS products work technically is fundamental to understanding the role these products played in the crisis.

Cohan’s two books are almost as useful a guide to the crisis as the broader accounts of McLean and Morgenson. Cohan is a former investment banker. He has a feel for the culture inside investment banks and contacts in all corners of the Street. Consequently, he gained access to a great deal of nonpublic information. His account of the two Bear Stearns hedge funds that went bust in July 2007 conveys the chilling sense of bankers slowly waking to the avalanche bearing down on them. Cohan explains how these funds were able to generate attractive returns for 40 straight months, only to scare their investors into fleeing for the exits over the subsequent 3 months. Cohan’s detailed story, including the questionable disclosure practices of fund managers, Ralph Cioffi and Matthew Tannin, are incorporated into the Bear Stearns case. Cohan also provides many of the nonpublic specifics critical to the two Goldman Sachs cases. His history of the firm provides an account of the Arrowwood conference, where Jon Corzine and Hank Paulson debated the firm’s ability to manage conflicts of interest. The reported details of their speeches show how Corzine directed the firm onto a path of more aggressive trading and an almost inevitable Goldman IPO. Paulson pushed back rhetorically, but seems to have changed little in substance, even after displacing Corzine as CEO. The outcome of this debate and the seeds it planted show up in Goldman’s “Abacus” deal. Cohan ably recounts this story in his Goldman book. Both Goldman Sachs case studies rely heavily on Cohan’s research.

Charles Ellis’ work, The Partnership: the Making of Goldman Sachs; Penguin Books, New York, 2009, reads more like an ‘authorized account.’ It is more useful for its history of Goldman’s days as a partnership than for understanding what went wrong after it became a public company.

Lawrence McDonald’s book on Lehman provides a useful account of how that firm tried to “grow” its way out of its subprime mortgage mistakes. McDonald reports how Dick Fuld and Joe Gregory paid top dollar for high-end commercial real estate and private equity funds in the year preceding Lehman’s bankruptcy. In the process, the firm’s financial structure, levered 44:1, became hugely vulnerable. This account provides the context within which Matthew Lee tried to correct poor financial practices and manipulative accounting like Repo 105. McDonald’s book itself makes no mention of these issues or of Matthew Lee.

Other helpful Financial Crisis works include Michael Lewis’ The Big Short: Inside the Doomsday Machine; Norton, New York, 2010, Monica Langley’s Tearing Down the Walls: How Sandy Weill Fought His Way to the Top of the Financial World … and Then Nearly Lost It All; Free Press, New York, 2004, and Andrew Ross Sorkin’s Too Big to Fail: The Inside Story of How Wall Street and Washington Fought to Save the Financial System –and Themselves; Viking/Penguin, New York, 2009. Lewis’ book focuses on how a small group of outsiders saw the mortgage crisis coming years in advance, and then tells the story of how Goldman figured this out before the rest of the Street. Lewis also offers views and some information as to how the rating agencies were rendered malleable by their investment banking clients. Langley’s work is an account of how Sandy Weill overturned Glass-Steagall and converted Citibank into Citigroup. Langley’s telling of the story is helpful for understanding how difficult it then became to manage the Citigroup conglomerate. Sorkin’s book was the first high profile account of the financial crisis causes and the fateful events of September 2008. As such, it was a valuable work for later authors and especially useful as regards AIG. Hank Paulson’s book, On the Brink: Inside the Race to Stop the Collapse of the Global Financial System, Business Plus, New York, 2010, gives his version of the critical events of 2008, but sheds little light on crisis causes or on his time at Goldman Sachs.

Internet articles provide a wealth of technical information about developments on Wall Street and the specifics of individual episodes. A good example of the former is David Freidland’s article, About Hedge Funds, http://www.magnum.com/hedgefunds/. Friedland’s piece provides both a basic outline of what hedge funds do and examples of the wide variety of strategies they use. Excerpts are attached to the Bear Stearns case as background to that story. The internet is also a great source for specific documents and technical explanations of transactions. This proved very helpful in the Lehman Brothers case where the internet provided the text of whistleblower Matthew Lee’s letter, Letter to Lehman Brothers financial management; dealbook.nytimes.com, March 19, 2010. It also provided the explanation for Lehman’s controversial Repo 105 transactions, The Origins of Lehman’s “Repo 105”; dealbook.nytimes.com/…/the-british-origins-of-lehmans-accounting-, March 12, 2010.

Watchdog blogs are a relatively new and useful resource. This is especially the case when they are written by well-connected industry experts. One such blog is Francine McKenna’s re: The Auditors, http://retheauditors.com. McKenna, a former Price Waterhouse CPA, understands both the accounting technicalities and the political relations between CPA firm and client. Without fail she was able to shed light on the accounting manipulations at AIG, Citigroup, Fannie Mae and Lehman. In the process, she raised many valuable questions about the conduct of the public accounting firms. For example, several accounts of Price Waterhouse’s conduct towards AIG are largely positive. McKenna pointed out the firm’s failure to uncover former CEO Greenberg’s years of manipulation, and that PW knew about AIG-FP’s subprime exposures six months before it finally forced an AIG admission of “material controls weakness.”

Lawsuits brought by regulators were especially valuable for understanding the ethical and financial control lapses at financial firms. The Securities and Exchange Commission’s Complaint, Goldman Sachs and Fabrice Tourre, Defendants; Washington, DC, April 16, 2010, contains many key facts about Goldman’s Abacus 2007 deal. These include, for example, the fact that Tourre never disclosed to the outside portfolio selection agent that John Paulson would be shorting rather than investing in the CDO. Similarly, the SEC’s complaints against Citibank provide critical data about its recurring violations. The SEC’s Order Instituting Cease and Desist Proceedings in the Matter of Gary L. Crittenden and Arthur H. Tildesley, Jr.; July 29, 2010 documents the bank’s use of SIVs to window dress its balance sheet and then its failure to adequately disclose the firm’s subprime mortgage exposure. The information contained therein is so convincing as to leave one wondering why the SEC’s action was limited to Gary Crittenden and Arthur Tildesley as opposed to CEOs, Charles Prince and Vikram Pandit, who were also legally liable under Sarbanes-Oxley.

The U.S. Department of Justice’s action against CitiMortgage sheds great light on the Sherry Hunt-Citigroup case. Most of this information can be found in Bharara, Preet, United States Attorney for the Southern District of New York, United States of America ex. rel. and Sherry A. Hunt, Plaintiffs Against Citigroup, Citibank NA Inc. and CitiMortgage Inc., Defendents; 11 Civ. 05473, New York, February 14, 2012. The DOJ’s settlement announcement, wherein CitiMortgage did not contest Justice’s findings, corroborates Hunt’s testimony to third parties and journalists.

Bankruptcy examiner reports are excellent, largely unbiased sources of financial analysis for trouble firms. The report by Anton R. Valukas, Report of the Lehman Brothers Bankruptcy Examiner, Volume 3; March 11, 2010, leaves little doubt as to Lehman’s high risk leveraging strategy and its attempt to disguise this exposure through the use of Repo 105.

Interviews with whistleblowers provided information for the Moody’s and Citigroup cases. McLean and Morgenson’s accounts of the crisis leave little doubt that the rating agencies were major contributors to the debacle. Thus, it was very useful to have access to a Moody’s insider who could describe what was happening inside that firm before and during the crisis. Eric Kolchinsky was a Moody’s Managing Director. In August, 2007, he was in charge of rating subprime mortgage CDOs. He had personally experienced Moody’s retreat from a quality ratings process, its deferral to the Wall Street banks on critical methodology matters, and its reluctance to face the consequences of its mistakes. Kolchinsky provided long interviews and personal documents covering events at Moody’s from 2007-09. All of this is incorporated into the two Moody’s cases. Similarly, Richard Bowen provided copies of his testimony before the Financial Crisis Inquiry Commission,

Hearing on Subprime Lending and Securitization and Government Sponsored Enterprises, Testimony of Richard M. Bowen III, April 10, 2010. This material shaped the Citigroup Underwriting Standards case and contributed to the Sherry Hunt-CitiMortgage case.

As a final comment, the financial crisis continues to reverberate with new revelations and legal actions. Gretchen Morgenson’s weekly column in the Sunday The New York Times Sunday edition is a rich source of continued scrutiny for past problematic events. CBS’ 60 Minutes pursued financial crisis stories for some time, asking the question why more major figures have not been prosecuted. In the process it interviewed Lehman’s Matthew Lee and CitiMortgage’s Sherry Hunt. These interviews were made available online.

The Post-Financial Crisis Cases

The post-crisis cases were derived in part from press accounts and articles detailing these recent events. Of these, several were especially detailed and revealing. The Street’s “How Did the Fraud Against Citi’s Banamex Work?” was especially helpful in describing exactly how the bribery was effected via false invoices to Pemex, while Business Insider’s “Citi’s Banamex, regulator clash over who played key role in loan fraud” shed light on the complex web of misconduct among higher level Banamex officials. Gillian Tett’s Financial Times article “Libor’s value is called into question” and Carrick Mollenkamp’s “Bankers Cast Doubt On Key Rate Amid Crisis” helped unpack the particulars of how bankers cooperated to move the benchmark rate in directions that earned them profits. The Wall Street Journal’s “How One Goldman Sachs Trader Made More Than $100 Million” triggered my interest in its implications for the Volcker Rule and resulted in the “chipping away at the Volcker Rule” case.

A range of semiofficial sources provided detailed accounts of key leaders or firm perspectives at specific points in time. Of these, Morgan Stanley CEO John J. Mack’s testimony before the Congressional Financial Crisis Inquiry Commission was especially helpful in outlining his (and maybe Wall Street’s) self-assessment regarding that crisis. The Report of the Business Principles and Standards Committee at Goldman Sachs shed light on how that firm analyzed its conflicts of interests and what it was prepared to do, and not do, to address said conflicts. This was instrumental to considering CEO Blankfein’s options as he weighed specific conflicts inherent in Goldman’s advisory relationship with El Paso.

Since several of these cases resulted in enforcement actions, the published official complaints/settlement agreements proved an especially comprehensive and valuable form of source materials. The particular complaints/settlements and the cases they pertained to are listed just below:

Although the post-Crisis cases are of recent vintage, several published books provided valuable accounts and/or background. Patricia Beard’s Blue Blood and Mutiny: The Fight for the Soul of Morgan Stanley offers an excellent account of John Mack’s departure from and return to that firm. As such, it sets the stage well for the actions Mack will take in the wake of the financial crisis. Jonathan Macey’s The Death of Corporate Reputation: How Integrity Has Been Destroyed on Wall Street provides an excellent account of the negotiating back-and-forth among Kinder Morgan and El Paso, and of Goldman’s efforts to cope with its advisory conflicts. This work also quotes at length from Chancellor Strine’s Opinion, which served to direct this author to review that document in its entirety. Chancellor Strine did not find for the plaintiffs in this case, largely on technical grounds. However, his expressed opinions on the conflicts and conduct of Goldman Sach’s and El Paso CEO Doug Foshee leave little doubt that the Chancellor does not believe that many issues which surfaced in the Financial Crisis are settled and behind us.