Enron Explained

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In 1999, a 37-year-old Andrew Fastow received a CFO Magazine award for capital structure work at Enron. Back then, people inside and outside of the Houston-based company, including stock analysts and credit-rating experts, were falling over themselves to say good things about Enron’s spectacular transformation from domestic pipeline business to fully integrated global energy company. Referring to the firm’s use of unique financing techniques as groundbreaking, a Lehman Brothers executive noted: “Thanks to Andy Fastow, Enron has been able to develop all these different businesses, which require huge amounts of capital, without diluting the stock price or deteriorating its credit quality — both of which actually have gone up.” At the time, Fastow was extremely proud to have helped Enron increase its market capitalization from about US$3.5 billion in 1990 to around US$35 billion in 1999 without issuing a whole lot of equity. “We’ve increased shareholder value, grown the balance sheet, maintained a stable outlook from the rating agencies, and achieved a low cost of capital,” he told CFO Magazine. Simply put, Fastow felt like a creative corporate hero, not a criminal. That changed in 2002, when he was indicted on multiple counts of fraud, money laundering and conspiracy. Today, after serving a reduced sentence for cooperating with the U.S. investigation into Enron’s collapse, Fastow accepts full accountability for the immeasurable damage caused by what he calls flaws in his character that enabled him to justify clearly questionable interpretations of accounting laws. In this Ivey Business Journal interview, the world’s most infamous finance executive talks to Ivey Business School Professor Gerard Seijts about how a good kid from a good home, who received a good education from good schools, ended up a willing participant in one of the largest corporate frauds in U.S. history.

IBJ: Andy, a lot of people know you just from what happened at Enron, so can you please tell us a bit about your upbringing and how you ended up at Enron?

AF: Sure, I was born in New Jersey, growing up in a town with a population of just a few thousand people. It was a great place where people knew all their neighbours and nobody locked their front door. I was raised in a warm and loving middle-class home by very ethical and moral parents, who expected their kids to be respectful of others inside and outside the family. I certainly made mistakes growing up, as most teenagers do. But when I made mistakes, my parents sat me down and we talked about it. They helped me understand right and wrong and taught me the difference between important and unimportant things. So I was raised to understand what was expected from me as a child, as an adult, as a family member and as a member of the community. That was the kind of upbringing I had.

IBJ: Was this ethical foundation diluted at school or by some other influence?

AF: Well, that question implies that some major event turned me from a good person into an evil one. And my life just isn’t that interesting. I attended a spectacular high school with great teachers. I did the things that normal kids do. I drank and didn’t pay enough attention to school work, things like that. But I was president of the student council and I won an outstanding citizenship award for doing the most charity and community work of all the students in my school. So I was a pretty typical high school kid, one who tried to do the things that were the right thing to do. I then went off to Tufts University, which is just outside Boston, where I had a double major in economics and Chinese. I attended college with a good group of students, many of whom are still friends. I had lots of interaction with my professors and I graduated summa cum laude, so if you look back at my life, you’d say I was a good kid who received a very good education.

IBJ: OK, so how did you end up at Enron?

AF: After I graduated from Tufts, I was hired by Continental Bank in Chicago, which was one of the large money centre banks in the United States at the time. This was before Continental was acquired by Bank of America. I entered the bank’s credit training program, which was a two-year program that taught new employees about various areas of the bank while they worked during the day and did MBAs at night. After my training period, I primarily did three things at the bank. First, I did work-outs for distressed loans, mostly to large industrial and agricultural equipment companies. Then, I moved to a group that arranged leveraged loans for takeovers, which you may remember was a big deal in the 1980s. After that, I moved into securitizations. Now, at that time, there was already credit card securitizations and home mortgage securitizations, but I worked in a group that developed bank loan securitizations, packaging bank loans to back securities. Today, we call them collateralized loan obligations, which are now relatively common, but Continental was the first bank to do them. So few people in the country were doing securitizations of wholesale assets like bank loans, and I was one of those people. Anyway, I worked at Continental for about seven years, and then — through several serendipitous encounters — my experience at the bank attracted the attention of a headhunter hired by Enron. It was an interesting conversation. “I’ve never heard of Enron,” I said. “What kind of company is it?” The headhunter replied, “Well, it’s a gas company.” Knowing nothing, I asked, “Natural gas or gasoline?” He said, “It’s a natural gas pipeline company,” and he invited me to Houston to learn more. “I’ll meet with you and the company,” I said, “but I’m going to embarrass you and myself.” So I went to Enron and sat down with Jeff Skilling, who was starting a new subsidiary of the company at the time. The first thing I said to Skilling was, “Look, I know nothing about Enron. I know nothing about natural gas, and I know very little about energy.” Skilling’s response was: “Perfect! That’s just what we’re looking for.” A month later, I moved to Houston.

IBJ: What were your title and responsibilities when you joined Enron?

AF: Senior management wanted to acquire oil and gas production, but they needed to do it off balance sheet, and securitization is an off balance sheet financing technique. At the time, each Enron subsidiary had its own finance person to do off balance sheet financing. So I was specifically hired to work at a subsidiary at the manager or director level, something below vice president, to figure out a way to securitize oil and gas production.

IBJ: What attracted you to the job?

AF: Two things. First of all, while we loved Chicago, my wife’s family was in Houston, and we wanted to be near one of our families when we decided to start our own family. Secondly, the job represented a new challenge. I was being hired to be the guy who could figure out how to securitize oil and gas production, which would be a big achievement.

IBJ: What year are we talking about?

AF: This was in 1990.

IBJ: OK, so about 14 years later, you pleaded guilty to securities and wire fraud and agreed to cooperate with the U.S. investigation into the collapse of Enron. But what many people fail to understand is that you never set out to commit a crime or hurt anyone, right? In fact, you often felt like kind of a hero for helping the company?

AF: That is correct. This is the result of a character flaw of mine, but it never dawned on me that what I was doing could hurt anyone. My initial job was to do off balance sheet financing. And that evolved into doing structured finance, specifically to help the company meet its financial objectives. One of those financial objectives was to appear more creditworthy, or healthier, which lowers the cost of financing and expands access to capital. The way I saw it, at least at the time, was that this benefits the shareholders and employees, driving growth along with share-price increases. So I saw it as doing something good. But before we go further, let me say that what I did was absolutely wrong. Sitting here today, I believe that I was guilty of committing fraud, and I’m very sorry for that. I’m very sorry for my actions. So I’m not trying to make excuses when I say I thought I was doing something good. I’m simply telling you what I was thinking at the time, not trying to justify my actions. It’s very important that you understand where I’m coming from. The fact that I did not see what I was doing as fraud, and the fact that I was not thinking that what I was doing could hurt people, doesn’t mitigate what I did. It indicts me further for lacking the character required to identify those things.

IBJ: Right. And context is also important here, since what was widely considered acceptable in the accounting world has changed dramatically since the fall of Enron. So it is important to understand that when everyone was saying how innovative Enron was as a company, you didn’t see that as a joke. You believed it. You thought you were being really innovative, in a good way, correct?

AF: Yeah! We thought we were rocket scientists. Whenever a bank, an accounting firm, or a law firm came up with a new financing structure, they came to Enron with it first because they knew we would take the time to understand it and see if it made sense, and work with them on it.

IBJ: So you actually felt creative rather than criminal?

AF: Again, it never even dawned on me that what I was doing was criminal. The media portrayed us as a bunch of sinister guys sitting in a dimly lit room trying to think of ways to rip people off. It wasn’t that way. When we did these creative deals, they weren’t hidden. We had parties to celebrate them. We got awards for them. Magazines wrote articles that extolled the virtues of them. I’m not sure that it’s fair to give myself the benefit of the doubt, but I like to think that I wouldn’t have done what I did if it had dawned on me that my actions were potentially criminal. It just never did.

IBJ: Did you think in terms of business ethics?

AF: Well, I’m in my mid-50s, so business schools didn’t have comprehensive courses on ethics when I did my MBA. The word “stakeholder” wasn’t even used. When I was in business school, there was only one word — shareholder. And I thought what I was doing was good for shareholders and employees, so I thought I was doing my fiduciary duty.

IBJ: And what about the corporate board? Was anybody asking if you were doing anything too risky or wrong?

AF: Enron’s directors actively encouraged what we were doing. All of the financing deals were approved. I mean, think about it, you cannot do billion-dollar financing at any company without board approval. Now, I know the narrative that the board spun when Enron started falling apart was that company directors didn’t know what was going on, but subsequent documents that came out, especially in the trials of Jeff Skilling and Ken Lay, showed that the board was aware of everything and actively involved.

IBJ: How aware and involved?

AF: If you don’t mind me being a little longwinded, I can give you a great story about that.

IBJ: Sure, go for it.

AF: I actually had a spreadsheet that tracked the impact of every one of our structured finance deals on our credit rating. It showed how the deals allowed us to be rated BBB+ when we were really a BB- company. Most people have a hard time believing I gave this spreadsheet to the board. But this was the year 2000, not 2016. And after looking at what we had done, a director on Enron’s finance committee looked at me and, pardon my language, announced: “Fastow, you are a fucking genius.” Now, in today’s environment, that probably wouldn’t happen, at least not everywhere. But even back then, the head of Enron’s finance committee wasn’t calling me a genius for figuring out how to deceive people. He was thinking about all the equity that we wouldn’t have to issue operating with a BBB+ rating. He saw value creation for shareholders and employees because we saved on share dilution.

IBJ: No directors faced charges, right?

AF: None of the board members were prosecuted criminally. But they were sued and my understanding is that some settlement dollars came out of pocket. I think it was meant to send a message that some price has to be paid for governance mistakes like this. But I’m guessing the end result wasn’t particularly painful for any one of non-executive directors, since sitting on a board of a company the size of Enron typically means you’re pretty well off.

IBJ: Was there any time when you wondered if what you were doing was wrong?

AF: Well, I wouldn’t use the word “wrong,” but there was a point in time when I started to get concerned about our regulatory filings. It was early 2001, when Enron was reporting record earnings for fiscal 2000, and a copy of the draft 10-K, the annual report form required by the Securities and Exchange Commission, supposedly giving the regulators a comprehensive summary of a company’s financial performance, was being circulated to senior management for comment. I remember thinking to myself, “Wow, this filing really does not describe a company anything like Enron.” Wondering if that was a problem, I called a meeting, which included our chief accounting officer, inside and outside legal counsel, as well as two partners from Arthur Andersen. After hearing my concerns, the head of Arthur Andersen’s energy practice turned to me and said, “Andy, every single deal you’ve done at Enron has been approved. Every deal is technically correct, and therefore by definition, whatever pops out the bottom is not materially misleading.” I turned to the lawyers and said, “I’m reading the related party disclosure, and I’m the related party, but I can’t understand what you’ve written.” One of the lawyers looked at me and said, “Thank you. I get paid to write technically correct, incomprehensible disclosures.” Now, at that point, if I was doing my job and had the character required to do it right, I should have said, “The whole point of calling this meeting was because this is misleading, so it doesn’t matter that it’s technically correct.” But I didn’t. I accepted what I was told. Remember, the rules allowed off balance sheet financing, which is done by 95 per cent of the companies in the United States. And every single deal that I did at Enron was approved by the accountants, auditors, attorneys and the board of directors. This is the whole point of the lecture I now give to business audiences on lessons learned. It’s dangerous to ignore the principles behind the rules because it is possible to follow all the rules and still commit fraud and be misleading.

IBJ: When you became aware that authorities had launched an investigation, what was the worst-case scenario in your mind?

AF: The worst-case scenario I could imagine was that Enron would have to restate earnings, and that I might get sued. No one imagined any criminal charges until the very end of 2001. If you look back in history, the government didn’t even have prosecutors involved until 2002, because it was initially considered a civil matter.

IBJ: So is corporate governance better or worse today?

AF: Well, we have not addressed the problem. The narrative that was spun after the downfall of Enron pointed to a few bad apples doing some things that no one else knew about. The board supposedly just wasn’t paying attention. But that isn’t accurate. All the deals that constituted fraud at Enron were approved by top management and the board of directors because they were deemed technically legal. We all do this. We rationalize and say, “This is OK because technically I haven’t broken any rules.” We do it at work and we do it in our personal lives, especially when filing taxes. We don’t break rules… we get around rules. Even presidential candidates do it with their super PACs, which serve the same purpose as off balance sheet financing. Think about it. Super PACs are ostensibly separate and independent organizations that technically can’t coordinate with a candidate, but somehow they do exactly what the candidate wants all the time. My point is that it is still common for people, businesses and politicians to follow rules in ways that undermine their principles. So when you ask about corporate governance, the real question is, “Are misleading deals still being done?” And the answer is yes. In fact, the exact same kind of deals are being done today, and by the way, some of them make me blush — and I was the CFO of Enron.

IBJ: On that note, if you were company CFO, how is it that you could be surprised by how the company appeared in regulatory filings?

AF: That’s actually a really good question. You’d never know this from the articles published, which pretty much got it all wrong, but Enron had a very peculiar organizational structure. The traditional CFO position was separated into five different roles. As CFO, I was responsible for financings. But I was not responsible for accounting and reporting. For that, we had a chief accounting officer. Then we had a chief risk officer to track and manage the risk books and an M&A person — we called it corporate development — and an investor-relations person. All five positions were at the same level, so we did not report to each other. So I did not approve any of the accounting at Enron. I relied on the chief accounting officer to decide if our deals were being accounted for correctly. That’s not an excuse. Remember, I’m not trying to blame the accountants. The moment I thought that our financial statements were wildly misleading, I should have said, “It doesn’t matter what you guys say anymore, this is misleading.” I didn’t, and that’s why I accept the blame. I was the gatekeeper. I could have just said, “No, we can’t do this.” Instead, I accepted the presented approach, so I was an active participant.

IBJ: So one of the big takeaways here is the need to respect both laws and their underlying principles, right?

AF: Right. Everyone needs to be more careful about what they rationalize simply because it is technically legal. Aggressive rationalizing leads you to follow rules in a way that undermines the principle behind the rule. And so when you go too far it is possible to technically follow the rules and commit fraud simultaneously. As I mentioned earlier, think about tax shelters. Most people would not use a tax shelter that was obviously illegal, right? But they are happy to avoid paying taxes if they can get an opinion from a tax accountant telling them the tax shelter being used is technically legal. There is an entire industry of people who do nothing but find technically legal ways to lower individual and corporate tax bills even though everybody knows the objective is to get around the underlying principle that says everyone is supposed to pay taxes. Why? Because it is easy for companies and individuals alike to say, “This is OK because technically I haven’t broken any rules.” And when something is technically legal, it is also easy to ignore the cost of your actions. Avoiding taxes, for example, comes with a cost because some of those unpaid tax dollars could have gone to cancer research or prosthetic limbs for veterans or aid for the homeless.

IBJ: How did your time in prison affect you? Are you a different person?

AF: I’m a lot more thoughtful about what I say and what I do. And I spend more time thinking about doing the right thing as opposed to just doing what you might do for a career or something else. So I hope that I’m a better person, but only time will tell.

IBJ: You have described the vacation-like reputation of America’s minimum-security prisons as “garbage.” But after agreeing to testify as a government witness, you are now living fairly well, despite forfeiting $30 million and spending about five years in a U.S. prison. So what do you say to folks who think the punishment for white-collar crimes needs to be dramatically increased?

AF: First of all, let me say, the terrible thing about prison is not the pain of incarceration, it’s the pain of separation from your family. Family is what you care about most, and interaction is very limited. And in the U.S. minimum-security system, you are allowed to speak with family on the phone for less than five minutes a day. If you’ve ever gone on a long vacation without your children, think about how much you miss them. Now, think about not being able to go home to them. You can’t help them if they need help. You can’t support them. It feels awful, and you feel that way 24 hours a day, every day. Now, as far as whether or not that is sufficient penalty, views will differ depending on what objective you have in mind. There are three reasons to put people in prison. One, you want to stop criminals from being able to do what they did wrong again, right? Two, you want to deter other people from committing a similar crime. The third reason is punitive in nature. People like to punish other people, right? It’s a natural human reaction or emotion. My sentence probably won’t deter anyone. I mean, Jeff Skilling was given a 24-year sentence, and I don’t think it is deterring corporate crime. But even without prison, there is no way I could do it again because there is no way I would be allowed to be CFO anywhere else. And the pain of separation was punitive.

IBJ: You have two boys. Can you describe what it was like explaining that you had to go away to prison?

AF: It’s very difficult telling your children you’re going away to jail because you made very bad mistakes. It’s awful. But my wife and I did everything we could to be honest with our boys. They were both young at the time, but we tried to help them understand what was happening and deal with it. It wasn’t a surprise when I left. My wife and I decided early on how we were going to deal with it. I couldn’t undo mistakes made, but we could try to demonstrate to our children how to deal with it in the most appropriate way. We had time to talk about what was going on, and so we talked about what they might hear, and how they might react if someone said something that was insulting or offensive. It was a long process, and while it sounds a little cliché, I hope they took away from it that I admitted my mistake, took responsibility for my actions, accepted my punishment and tried as best I could to correct the problem, working with the government and the plaintiffs’ attorneys to recover what amounted to $6 billion.

IBJ: When it comes to respecting the principle behind the rule, do you see any reason to expect that things will ever really improve?

AF: Well, despite the fact that I do think some of the deals being done today are worse than what we did at Enron, I’m actually optimistic — and here’s why. I don’t believe that the solution to this issue will appear through some miraculous piece of legislation. It’s going to occur through slow, cultural change. Think back to the comment I made earlier about my business education, which didn’t include classes on ethics. For a long time, ethics was not taught in business schools. So my generation was taught to make the decisions that can be justified, but are best for shareholders, not employees or the community or the environment. Now, ethics is part of the business-school curriculum. As a result, students are now exposed to a fundamentally different decision-making process with a fundamentally different vocabulary, so they develop a different view of the world. And as they slowly rise through the business community, this difference hopefully will be reflected in the decisions made by companies. I think, by the way, Ivey’s focus on leader character development is very valuable.

IBJ: Thank you. What else do you think business schools could or should be doing to address the business world’s potential for wrongdoing?

AF: Well, don’t take offence, but it appears to me that business schools spend a lot of time talking about scenarios that are too black and white — like the presumption that Enron was the result of a bunch of guys trying to break the rules when it was really a bunch of guys operating in the grey area. So when I look at business-school case studies, I see a lot of silly scenarios… I shouldn’t say “silly,” but I see cases that are too black and white, like “Should you pollute the river at night when nobody is looking?” or “Should you sell tainted baby formula?” Those kinds of scenarios might happen in the real world, but they are not likely to happen. People don’t walk up to you and say, “Hey, do you want to join a Ponzi scheme?” Crossing the line typically results from operating in the grey area, where things are allowed, even if they may not be advisable because they are ethically challenged or involve too much risk. When students walk out of my Enron lecture, they say, “Oh my goodness, I probably would have done that deal, but if I didn’t do that deal, I probably would have been fired! How do I deal with that kind of situation?” That’s real life. So I think a curriculum with more grey-area focus would be helpful.

IBJ: Do you have any advice for young business students?

AF: A few things. First, businesses really do operate to a large degree in grey areas, so today’s students will eventually be put in a position that pressures them to compromise principles. So they need to expect it and get ready for it because it’s coming. Second, understand that there is no hard and fast rule on what to do in that situation. The third thing I’d say is I’m not going to tell anyone how far to go when it comes to compromising personal ethics or taking risks or operating in the grey. Everyone must figure out personal comfort zones for themselves. But it is a good idea for business students to graduate with a set of questions that they can ask themselves to help them identify when they are leaving their comfort zone. I now have my own set of questions, but I’m not going to tell anyone what to ask themselves. Each person has to do it on their own. My mistake, my biggest mistake, was I didn’t question. I wasn’t asking questions of myself. So if business grads start out just thinking about it, that’s a huge step forward.

IBJ: What is your advice for corporate directors today?

AF: Get their heads out of their butts. Stop worrying about personal liability and start worrying about shareholders and other stakeholders by looking at the real risks and dealing with them, instead of looking the other way and being happy not knowing what is really going on.

IBJ: Do people recognize you in the street?

AF: In Houston, where I still live, yes.

IBJ: What is the reaction?

AF: I know some people still harbor ill will, but I do not encounter overt expressions of it. In fact, if I’m walking on the street and someone recognizes me, it is not uncommon for them to say something nice. I am not saying they think I’m a good guy, but some people do appreciate the fact that I am the only person from Enron who took responsibility for what happened and assisted in efforts to recover money and things like that.

IBJ: And now that you are out of prison, you try to use what happened at Enron to make a positive difference, right?

AF: Well, my ability to have a major impact on the world is limited, but I do try to do what I can, especially by making myself available to business-school students and law-school students. I hope they can learn from my mistakes.

IBJ: You are not allowed to be an officer or director of a public company. So what does the future hold for Andy Fastow?

AF: I don’t have any great career objectives, if that’s what you’re asking. My number-one priority is my family and my close friends. If I can just be the best father and husband and son and brother and friend that I can be, that’ll be a small success. I have a relatively quiet life, and sometimes just being the best you can be in your own small world is the best thing.

8 responses on “Enron Explained

  1. Simon Jacques

    Excellent interview
    Working at Enron simply meant that you were the envy of everyone period.
    A trading or a management position at Enron meant that you could earn 6 digits salary and touch 7 digits bonuses. Later these large benefits were transformed in financial losses; working at Enron has been” their career peak” have suffered from a lifetime reputational liability.
    By simply working at Enron (Front Office- Trade Marketing and Structurers, Middle office with risk collateral management, Back Office- Accounting) you couldn’t tell if the company was an accounting hocus pocus or had any wrongdoings.
    Firewalls only allow you to see on side of the book or dealings; it is true with Lehman and it is still true today if you are at a large commodity trader.
    “AF: I actually had a spreadsheet that tracked the impact of every one of our structured finance deals on our credit rating. It showed how the deals allowed us to be rated BBB+ when we were really a BB- company.”
    AF: “every single deal that I did at Enron was approved by the accountants, auditors, attorneys and the board of directors.”
    Deals allowing a company to cast it in a better way to credit agencies and investors then its real economic performance have not stopped with Enron.
    The big E was once the world’s largest energy trader but would be very small compare to what commodity traders have become today.

    Simon Jacques

  2. SSSNNN

    “Simply put, Fastow felt like a creative corporate hero, not a criminal. That changed in 2002, when he was indicted on multiple counts of fraud, money laundering and conspiracy. ”

    The problem for Mr. Fastow was that he was not working at a “two big to fail”. The folks who committed
    mass bank fraud and financial crime in 2008 make this guy look like a choir boy…and they all walk free.

    1. John Kerr

      SSSNNN, many bankers were prosecuted for political reasons to satisfy folks like you. Few were convicted, which gives confidence in the jury system. Stupidity is not illegal. There was very little bank fraud. There was a lot of poor management and they all were fired. The US Department of Justice was all over the industry and found very little fraud. The major US banks were largely run by lawyers and deal-doers with little experience with risk. It was no surprise when depression-like conditions destroyed large institutions. In fact, when the value of property drops by 50 or 75% it often doesn’t matter how well a bank is managed, it can still go under. Lending money entails risk.

  3. John Kerr

    Nice interview but Andy put a positive spin on things. Several Continental Illinois folks have told me he was despised there. At Enron he was also a nasty piece of work. He pressured many a lender into doing something stupid. I don’t believe his accounting story for a minute. His highly respected wife came from an enormously wealthy family and also worked at Continental. He didn’t even need the money but dragged her through the dirt. When Enron went down, thousands of blameless employees were tainted with the Enron name (you worked for those crooks?) and couldn’t find jobs, with their careers ruined. . I was brought Enron deals but many of them made no sense and I declined. The risks were not covered. When the company treasurer can’t properly explain how they make money and protect themselves, run for the hills. Andy did his time but he was no bystander.

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