Conspiracy of Fools Read online

  ———

  The dilapidated black truck rumbled over the rural Missouri road, veering ever closer to the edge. In the flatbed, dozens of crated-up chickens squawked, scratched, and clucked as the truck headed out of a speck of a town called Raymondville. It was 1948, and Ken Lay’s father, Omer, was struggling for the second time to keep a general store afloat. Omer had taken to purchasing chickens from local farmers, selling them at a profit in nearby cities, and on this day he had gambled everything on a single shipment. But his driver had knocked back a few drinks and now was weaving all over the road. The weight of the truck shifted, until it flipped over in a terrible crunch of metal and wood. The driver survived, but most of the chickens were killed—right along with Omer’s business.

  The accident was a turning point for the struggling, deeply religious Lay family. With two daughters and Kenny, their six-year-old middle child, Omer and his wife, Ruth, had hoped the store might allow them to settle down, maybe own their own place. Now those dreams were gone.

  Omer took a job in Mississippi selling stoves door-to-door, bouncing his family around the state but never seeing enough success to make ends meet. The family hit bottom one Thanksgiving when Ruth—the spark plug of the household who delighted in nothing more than whipping up family feasts—could only afford to serve luncheon meat. Admitting defeat, the Lays moved to a Missouri farm with some of Ruth’s family until Omer could get back on his feet. Soon he found work in sales and a spot preaching at a church.

  Around that time, young Kenny—he was usually “Kenny” as a child, never “Ken” and rarely “Kenneth”—scouted up some jobs for before and after school so that he could help the family. He delivered newspapers, mowed grass, baled hay, anything he could find. Between Omer and Kenny, money was coming in, and the Lays were able to settle in a home just off a dirt road cutting through Rush Hill.

  Within a few years the financial troubles returned. Lay’s older sister, Bonnie, headed to college, and the cost was far more than the family had anticipated. The only way the family could scrape together the money for college, they decided, was for the kids to live at home. So the Lays moved again, this time some fifty miles southwest to Columbia, the college town for the University of Missouri.

  Lay’s big moment in college came in his sophomore year, when he signed up for introductory economics, taught by a popular professor, Pinkney Walker. Lay found himself mesmerized by Walker’s lectures laying out free-market theories; this, he decided, was what he wanted to study. Walker was impressed with the smart young man and became a mentor for young Lay. With Walker’s encouragement, Lay stayed on at school after his senior year to obtain his master’s degree. But that was enough for Lay; he was eager to get out and start earning some money.

  He took a job with Houston-based Humble Oil & Refining, later part of Exxon, helping set up the company’s corporate-development department for what seemed a princely salary of thirteen thousand dollars a year. With his career blooming, Lay felt ready to settle down, and in June 1966 he married his college sweetheart, Judith Ayers.

  Lay took to the job, enthralled as he debated topics like the future growth rate of the American economy. But soon a new opportunity emerged. His company’s chief executive was looking for a speechwriter, and Lay got the assignment, winning the chance for a close-up view of life at the top of the corporate world. He liked what he saw.

  For many young American men, the late 1960s were a time for putting plans on hold. The Vietnam War was escalating, deferments were running out, and the draft loomed. Lay did his best to avoid the military, keeping the job that gave him a deferment and studying nights for his doctorate. Still, he found the arrangement distasteful and wound up attending the Navy’s officer candidate school in Rhode Island starting in January 1968. From there, it was on to the Pentagon, where he was hired to apply his economics knowledge. Lay soon found himself assembling econometric models and later analyzed the economic effects of military spending for his doctoral thesis.

  When his time in the military was up, Lay was eager to return to the corporate world. But then Pinkney Walker, his old economics professor, was named to the Federal Power Commission, and he persuaded his star student to join him as his technical assistant. After eighteen months, Lay was asked to serve as deputy undersecretary of energy for the Department of the Interior; he accepted and was named to the post in October 1972 at the age of thirty. In a little more than a year, he was ready to move on.

  He latched on to a senior-level position at Florida Gas, a sleepy pipeline company in Winter Park, thanks to an old acquaintance, W.J. “Jack” Bowen, its chief executive. Lay found the smaller company suited him. But the following year his pal Bowen left for Transco Energy, a pipeline giant in Houston, turning the top job over to Selby Sullivan, his second in command. Over the next seven years, Lay moved up the corporate ladder until he was president.

  Still, at times he chafed under Sullivan, whose management style he found unnervingly erratic. One night Lay received a phone call at home from Sullivan, asking him to handle an early-morning meeting in Orlando. Lay agreed, and the next morning attended the meeting. But when he called in to the office, a panicked assistant told him Sullivan was pacing the halls, screaming, “Where’s Lay?”

  Sullivan’s frequent explosions were always followed by long apologies, a habit Lay began to exploit. When important decisions needed to be made, Lay would anger his boss on purpose, then wait for the inevitable mea culpa. Only then would he present the issue that needed a decision, making clear how he wanted things to go. More often than not, the contrite Sullivan agreed, not knowing he had been manipulated by his young president.

  In Washington, D.C., the group of energy-industry executives milled about the hallway of the Capitol Hill office building, grabbing refreshments between meetings of the American Gas Association. Ken Lay scooped up a couple of hors d’oeuvres and noticed his old pal Jack Bowen. They chatted a few minutes, with Bowen asking about life in Florida. It was the spring of 1981, and Lay intimated he didn’t plan to hang around Winter Park much longer. While he didn’t mention it, Lay was tiring of Sullivan’s antics and was eager to run his own show. He also had personal issues; his marriage was troubled and was on the verge of falling apart. Bowen walked away convinced he might be able to steal his former colleague for Transco.

  Two weeks later, Bowen called, asking Lay to join Transco as his number two and heir apparent. Lay agreed and, days before his departure, filed for divorce.

  It seemed a glorious time to live in Houston. The oil shocks of the 1970s had pushed energy prices through the roof, levitating the town in a bubble of economic growth. Throughout the industry it became a matter of faith that oil prices, which had already tripled, would do it again, surpassing one hundred dollars a barrel. But just after the thirty-nine-year-old Lay arrived, the good times stopped rolling. Oil prices cracked, and soon crashed.

  Pipeline companies like Transco suddenly found themselves in a bind. Under old regulations, they were required to have adequate supplies to fill their pipelines before expanding their markets or capacity. To accomplish that, they entered into “take or pay” contracts with producers, committing to buy a set percentage of a well’s production over years—whether customers needed it or not. And they agreed to pay ever increasing rates. After all, if energy companies could sell oil at a hundred a barrel, they sure wouldn’t spend time looking for gas selling at thirty.

  Reality wasn’t quite that simple. When oil prices fell, the contracts kept gas at high prices, meaning that while producers might want to drill it, customers didn’t want to use the more expensive fuel. Pipeline companies were left with contracts worth billions for gas that nobody wanted.

  The problem hit Transco hard. Shortly after Lay joined, he found that the company, which had assured him it had no take-or-pay exposure, had failed to properly account for its contracts. If oil prices kept falling, he figured, his new employer would go bust. So Lay corralled a group of Transco analysts and u
rged them to play around with a new idea: setting up a spot market for gas. That would jettison the old system in which producers sold gas to pipeline operators, who sold it to distributors, who sold it to the final customers. Instead, in a spot market, producers—or at least the ones who released Transco from its contracts—would sell directly to customers; Transco would then be paid to move the gas through its pipeline.

  It seemed like a great idea. Lay worked for months obtaining the necessary regulatory approvals, and then sat back to watch it succeed. Problem was, no one was interested. On the first day of trading, Lay was on vacation in Florida with his new wife, the former Linda Phillips Herrold, his onetime secretary at Florida Gas. After some time puttering around the hotel, he called in to hear how things had gone. Not a single trade had taken place. Same on the second day. And the third. No one was willing to be the first producer to break ranks and utilize the new system.

  By the fifth day of failure, Lay headed back to Houston. He and his team worked the phones, persuading a few independent producers to try the new market. From there, Lay reached out to other contacts; the breakthrough came when Shell Oil announced it would use the spot market. Within eighteen months, the spot market had pretty much taken over all new contracts, and Lay emerged as an industry legend, a man who had transformed certain disaster into a new business. Plenty of other companies took notice.

  On a Thursday afternoon in May 1984, Lay was in the Woodlands, a part of suburban Houston, playing tennis with a Transco banker, when he heard he had a call. He ambled off the court and picked up the phone. On the line was John Duncan, chairman of the executive committee of Transco’s smaller rival Houston Natural Gas, or HNG. Duncan said that the HNG board was eager to meet with Lay for breakfast that Saturday; Lay thought the suggestion sounded suspiciously like the opening gambit in an effort to persuade Transco to purchase HNG.

  That Saturday, Lay drove over to Duncan’s home near the Houston Country Club for breakfast. Over eggs and toast, Duncan lobbed in a surprise: the HNG board wasn’t interested in Transco; they were interested in Lay. They wanted to bring him in as chairman and chief executive. Lay was flattered but dubious. Over the weekend, though, Duncan and other HNG directors kept up the pressure, throwing all kinds of incentives into the mix. By Sunday, Lay agreed to come aboard, so long as Bowen, who was counting on him to take over Transco, gave his blessing.

  The next morning, Monday, Lay arranged to have a private lunch with Bowen and spent the entire meal spelling out the details of the HNG approach. Bowen seemed a little disappointed HNG hadn’t asked him. On the other hand, he wasn’t about to block the move.

  “I’m not going to stand in your way,” Bowen said. “So you go ahead, become a CEO right now.”

  The decision was made. Ken Lay, the kid from rural Missouri, became chairman and chief executive of a major corporation in June 1984, at the age of forty-two.

  It could be argued that the creation of Enron was set in motion on April 21, 1985, when a thirteen-year-old Texas boy decided to phone Zurich.

  Earlier that day, the teenager, Beau Herrold, had taken a message for his stepfather from Sam Segnar, chief executive of InterNorth, an Omaha energy company. Beau told the caller that his stepfather, Ken Lay, was traveling with his mother, Linda. As instructed, he refused to say where Lay was or how to reach him. Still, Beau chewed over the call; it somehow seemed urgent enough that he decided to let his stepfather know about it right away. He checked his parents’ itinerary and saw that they would be arriving at the Dolder Grand Hotel in Zurich. Beau called and left a message for Lay with the front desk.

  That evening at eleven, the Lays arrived at the hotel from the latest meeting with European investors. At the front desk, Lay picked up Beau’s message and, after checking in, called the boy. Lay knew Segnar’s name, and certainly knew his company, InterNorth, a rival, but he had no idea why the man was calling. Taking a seat at a small desk in the one-bedroom suite, he dialed Segnar at home. As the phone rang, Lay glanced out the window, admiring the lights of Zurich twinkling under a cloud-filled sky. Segnar answered, and the two men spent a moment exchanging pleasantries. Then Segnar sprang the question.

  “Ken,” Segnar said, “would you have any interest in putting our two companies together?”

  The idea struck Lay out of the blue. He barely knew what to say. “Well, Sam,” Lay finally replied, “truthfully, I’ve never really thought about it before.”

  There were plenty of reasons to do it, Segnar said. Both companies were pursuing a strategy based on the idea that fully deregulated markets were coming in the gas industry. Both understood that the biggest pipeline systems would be the winners. Both had been snapping up smaller pipelines and were often competing bidders. Fighting over scraps made no sense when they both could achieve their shared goal through a single merger—with each other.

  Segnar had plenty of other justifications for pushing the deal, but many of those went unmentioned. Irwin Jacobs, the feared corporate raider, was loading up on InterNorth stock. If Segnar didn’t take control of his own destiny, Jacobs might do it for him. A major acquisition, like HNG, would load the company up with debt and make it far less attractive as a candidate for a hostile takeover.

  Intrigued, Lay asked some questions and said he would get his best people working on the idea. For the next few days, he traveled through Europe with almost no sleep. During the day he met investors; all night he held strategy sessions by phone with his team. HNG wanted seventy dollars a share, InterNorth haggled for sixty-five. Segnar caved on everything, including a commitment that Lay could take over in a matter of years. The seventy-dollars-a-share deal was announced on May 2, just eleven days after the phone call to Zurich.

  There was little time for celebration. Lay had acquired new problems, as he discovered at a September reception in Houston. He hosted the get-together for the InterNorth crowd, giving them a chance to meet the city’s big oilmen. But instead, the directors trooped off to another room to verbally beat up Sam Segnar. They had grown angry about the HNG deal, which they thought had put the company too deeply in debt. Worse, they had heard rumors that Lay and Segnar had secretly agreed to move the headquarters from Omaha to Houston. Segnar denied there was any such deal, but the directors wanted to hear it from Lay—that night.

  As the last of the guests filed out of the reception, Lay headed over to meet the angry directors. He was not in a mood to play nice; a lot of effort had gone into organizing the reception, and the directors had basically insulted everyone in Houston’s energy industry. But before he could speak, the directors started in, making it clear that there was more at stake than some bruised feelings; apparently, the directors distrusted Segnar, their own CEO.

  Lay assured them that no secret deal existed, yet at the same time pushed the idea of moving the headquarters to Houston. The directors decided to hire a consultant to analyze the option. They turned to John Sawhill—a former Nixon Administration official now with McKinsey & Company, the management consulting firm—who had done work for InterNorth in the past.

  It was a decision that would bring to the company the man who ultimately redefined its future.

  ———

  “What, are you kidding me? No way.”

  Jeff Skilling almost laughed. His boss, John Sawhill, had just phoned to tell him about the HNG/InterNorth headquarters study. Skilling, at thirty-one already a rising star in McKinsey’s Houston office, was incredulous.

  “Jeff, it’s an important assignment,” Sawhill said. “It’s something the company really wants.”

  Skilling could only shake his head. He knew about the battles at HNG/InterNorth in the Houston-versus-Omaha debate. Whatever the answer, somebody at the company would be furious—and almost certainly blame the consultants.

  “How do you win this one, John? How do you decide this? I want nothing to do with it.”

  Sawhill implored his underling to reconsider, but Skilling was adamant. Finally, the two agreed to turn the job over
to McKinsey’s Washington office, effectively shielding Houston from the company’s inevitable wrath.

  For most young businessmen, such a refusal of a client request might seem risky. But not for Skilling; he was already viewed as a McKinsey wunderkind—brash and arrogant, but with the intellectual firepower to justify his lofty self-image. Born in Pittsburgh in 1953, he was the second of four children, the son of a valve salesman. The family eventually settled in Aurora, Illinois, where Skilling’s father worked with a company called Henry Pratt.

  Aurora was a typical Midwestern town, with wide-open plains and endless enthusiasm for the high-school sports teams. But Skilling, who arrived at the age of twelve, didn’t go in much for sports—or many other school activities. He was a shy, awkward kid, horribly intimidated by girls and largely bored by his teachers.

  Home life wasn’t much better. His father, Thomas, was happy-go-lucky, but he wasn’t around much; his mother, Betty, was a chronic complainer who seemed to blame her husband for a life that didn’t work out the way she hoped. Even positive events in Jeff’s life—a stellar report card, an aced test—fueled her pessimism. “You think things are going well now,” she often said. “Just wait. Things’ll fall apart. Sooner or later, they’ll get you.”

  Skilling ached for something to enthrall him and finally found his answer in the working world. His older brother Tom fancied himself an expert on weather patterns, and as a teenager found a spot doing the weather on WLXT-TV, a struggling local television station. The place was nothing much to look at; its crumbling offices had previously been a Moose Lodge. Tom persuaded the managers to hire his younger brother to fix it up. Jeff showed up every day—painting walls, scrubbing floors, doing odd jobs—but would often steal away during his break time, asking the technicians about the broadcast equipment.