Problems Deciding What to Say

Thinking back over the day’s events, Lay’s attention was grabbed by the dialogue between Skilling and the directors. Blake and Duncan had seemed convinced that Skilling was leaving to escape Enron’s problems, possibly ones the board didn’t know about. Could that be the case?

The whole scenario made Lay nervous. He wasn’t sure that he was on top of all the necessary details. In recent years, Lay had left more and more of the operating work to Skilling. Assuming a senior statesman role, Lay had concentrated on building relationships with key politicians, lobbying for more market deregulation and, not coincidentally, planning for his departure from Enron. Was it possible that he hadn’t paid enough attention to the details of what Skilling was doing? Was it also possible that on some level, he had decided that was the best thing to do?

Lay realized that he didn’t have much time to get this right. The risks, for Enron and for him personally, were quite substantial. The markets would be unnerved by Skilling’s departure. If Lay said the wrong things, he could scare the analysts and bankers; they could pummel Enron’s stock price, undermine its credit rating, and constrict its financial liquidity. On the other hand, if he painted what later proved to be too rosy a picture, Lay risked destroying his credibility at the outset of his return.

Lay also knew that both he and Enron faced serious legal consequences if he made incorrect statements or omitted matters that would be material to investors. As Enron’s CEO, Lay had repeatedly been briefed on legal guidelines for discussing company results. Consequently, Lay was aware that if he made misleading statements, he could be liable under the Securities Exchange Act of 1934. During Lay’s tenure as CEO, this law and related federal and state regulations had been interpreted more and more broadly by regulators, plaintiff’s lawyers, and judges. Attachment 1 provides more details on the legal framework surrounding communications by the executives of publicly listed companies.

There was also the matter of his personal financial situation. Ken Lay was hugely invested in Enron’s stock. His family had advised him to diversify, and he had done so; however, Lay had diversified in a curious, risky fashion. He had borrowed a lot of money, about $95 million and secured the loan with his Enron stock holdings. Lay had then invested the proceeds in “alternative investments,” many of them speculative, almost all of them illiquid. He had not counted on Enron’s stock falling. Each time it fell, Lay received margin calls from his bankers. Enron’s stock, which had been over $80 per share early in the year, was now down to just under $43 a share. The level of Enron’s stock price was thus important to Lay for reasons over and above the company’s welfare.

If he were to convey a sense of confidence about Enron’s prospects without misleading the markets or employees, Lay needed to assess where the company stood. Lay decided to think back over his conversations with Skilling. Maybe those discussions held clues to any “submerged logs” Skilling was leaving behind. Lay also decided to revisit the company’s major issues and decisions over the past two years.

Before deciding what to say to employees, analysts, and bankers, he would need to know whether something was about to blow up.

Skilling Decides to Call it Quits

Ken Lay had had premonitions that Skilling was struggling with the CEO job. Early in June 2001, Lay and John Duncan, chairman of the board’s Executive Committee, took an overseas trip. Lay used the opportunity to share his concerns about Skilling: “Jeff Skilling really isn’t a happy camper. There’s a lot of frustration and stress … I just wanted you to know that he’s not enjoying his job. I’m trying to help, but he’s just having a rough time right now … When somebody gets unhappy, sometimes they do weird things.”⁴

The conversation was only a mention item, a note of caution to a key director. Lay subsequently made similar comments to Herb Winokur, chairman of the Finance Committee.

There the matter rested until Friday, July 13. Lay had just returned from another trip and another unsuccessful effort to resolve the troubled Dabhol power project. Skilling showed up for a scheduled afternoon meeting. He went through a checklist of current items. This took about ten minutes. Then he mentioned another item. “I’ve come to a decision that I need to share with you. I’ve decided I want to resign.”⁵

Even knowing that Skilling had been struggling, Lay was not prepared for this bombshell. He probed Skilling’s reasons and heard about family and health concerns. Lay voiced concern about damaging investor confidence. He asked Skilling to reconsider, to take the weekend and reflect on what he was saying. Skilling agreed but indicated that his decision was “pretty firm.”

The first thing the following Monday, Lay wandered over to Skilling’s office. After pleasantries, Lay commented: “So, maybe you’ve decided to change your mind?”⁶ Skilling hadn’t. Lay tested this decision several ways, repeatedly finding Skilling’s mind made up. Then the conversation took a different turn. Yes, Skilling still cited family reasons and leaving being the right thing for him. But then he added:

“And probably, this is the best thing for the company too … Given all the problems and everything going on, I think people might be reassured by you coming back in … certainly the stock price hasn’t performed well. Maybe by you stepping back in, it will restore confidence that obviously we’ve lost.”⁷

This was a very different rationale. Lay knew that Skilling was attuned to, even obsessed with, the progress of Enron’s stock price. Its continuous negative trend since Skilling had assumed the CEO role had obviously gnawed at him. (Attachment 2 charts the trajectory of Enron’s stock price in 2001.) Still, Skilling typically was characterized by a brusque, almost arrogant confidence. It was not like him to imply that someone else, let alone his predecessor, could do a better job.

Lay decided to press Skilling on what lay behind what amounted to an admission of job failure:

“I think there’s a very large risk here that it [your resignation] will further shake confidence. You haven’t been CEO very long and for you to step down like this may not be perceived well. The directors have a question, Jeff. Do you know something we don’t know?”⁸

Skilling was obviously surprised by the question. After replying that he didn’t think so, Skilling cycled quickly through Enron’s major business units. Wholesale was tearing it up, Retail was fine, Broadband was troubled but that was now submerged into Wholesale. India was India, as Lay, who was heading the Dabhol troubleshooting, clearly knew. No, things were pretty good. Skilling then promised that just to make sure, he would review matters with Rick Causey and get right back to Lay.

That same morning, Skilling dropped into Causey’s office. “Rick, I need to ask you. Is everything okay? Anything on the horizon that worries you?”⁹ Causey thought and then responded: “No … Well, the Raptors. We’ve got some that are in the money, some that are out of the money … That’s just a wash, though. No, I think things are about as good as they have ever been.”¹⁰ Lay got this feedback shortly thereafter.

Later that month, Enron’s management committee began reviewing the company’s second-quarter 2001 results (see Attachment 3 for highlights). Earnings were on track. Cash flow, however, had been a negative $1.3 billion for the first six months of 2001.

Preparations went forward for Skilling’s resignation. It would be announced to the board at its August meeting. The Board reconvened on August 14. Prominent on the agenda was a report from CFO Andy Fastow on Enron’s financial condition. His report was not reassuring. Enron’s total debt, both on and off-balance sheet, had climbed to $34.3 billion, an increase of over $14 billion from the prior year. Cash flow for the first half of 2001 was down $2.3 billion versus the same period in 2000.

Lay tried to connect these facts with the “everything’s fine” picture Skilling had painted. The facts didn’t fit neatly together. Lay decided to stretch his memory further, casting it back over all the major reviews and events of the last twenty-four months. (Attachment 4 provides a summary of Ken Lay’s major business involvements, 1999–2001.)

What was the condition of Enron as Jeff Skilling was leaving the bridge?

Assessing the Broader State of Enron

Lay thought back over the presentations he’d received over the last two years. His mind focused first on the most recent briefings.

The most concerning issue seems to be near-term pressure on Enron’s financial position. Cash flow has turned negative, and debt levels are way up. Wall Street’s analysts are starting to notice and complain. How much is this influencing stock price performance?

On the other side, earnings are on track. I’m not really sure what’s going on in Retail, but its weight in earnings is small. Although Broadband and International are troubled, Wholesale is turning in a stellar performance. Its performance has been so good that a large reserve ($1 + billion) was tucked away at year-end 2000; this could be used to help meet earnings targets in 2001. The pipelines continue to make money, as does Portland General. So, earnings are not going to be a problem. Sooner or later, this Wholesale performance will reverse the negative cash flow trend, right?

It is worrisome that events in California seem to suggest fewer trading profits going forward. There also seem to be problems collecting monies owed us and some potential for nasty litigation. We’ve faced that before, however; we are well connected politically, especially with George Bush now in the White House.

We’ve been doing a lot of deals with Andy Fastow’s partnerships. Now we’re up to LJM3. Many of those deals were fixes for short-term problems. The truth is, I don’t remember much about the details of the transactions.

Skilling did have Enron’s risk managers look closely at our ability to withstand a major external-event crisis in the financial markets. The advice seems to be that Enron would need to have several billion dollars of reserve liquidity. Fastow and Glisan have indicated that Enron has reserve bank lines that more than total that amount.

There was also that Enron-specific scenario, whereby a combination of a falling stock price and a debt downgrade whipsaws the company. But what were the chances of such adverse events piling one atop the other? Surely, a company with Enron’s reputation could count on support from its lenders. Our management team is also bright and capable of reacting to crises.

That management team has changed a lot, however. Rebecca Mark, Ken Rice, Cliff Baxter, and Lou Pai are all gone; now, Jeff is gone, too. I am going to have to find a new chief operating officer. The Wholesale Traders probably think they now run the place and that Greg Whalley has to be the choice. We’ll see. Rebuilding the management team could be one of my major challenges.

Lay found it difficult to draw hard-and-fast conclusions. He had Skilling and Rick Causey’s word that things were OK. Sure, there were problems, but Enron always faced problems. What distinguished the company was the sheer ability of its management to fashion solutions or to create new opportunities to overcome its problems. Was now any different?

Still, there was a worrying confluence of issues: financial pressures combined with fewer trading opportunities and intractable problems in Broadband and International. Moreover, Lay sensed that he didn’t know enough details to know whether this set of problems was harder than those faced before; if Jeff Skilling did know something critical, it would be in the details.

Focusing on the Task at Hand

Lay turned to his immediate challenges. What should he say to the financial analysts about Skilling’s departure? What should he say to Enron’s employees? Was there to be any difference in the two messages?

Both groups will want to know why Skilling is leaving. Frankly, we’re not entirely sure we understand his reasons. Do we stand by Skilling’s rationale and affirm that his reasons also represent our assessment? Or, do we imply that we too are surprised and cautiously looking to see whether there’s more here to understand?

Both groups, but especially the analysts, will want to test if Skilling is leaving because of problems within Enron. What do we say here? The markets and rating agencies want to be reassured.

This is the tricky part. It is easy to make reassuring statements. However, you don’t want them immediately undermined by new developments or discoveries. On the other hand, appearing scared or confused will only feed doubts in the markets and among our employees.

That does bring up the question of what I signal about Enron’s outlook. Is it to be the same outlook, that is, the same business model with the same expectations for dynamic revenue and earnings growth? Or, do I signal that my plans include some sort of reassessment or restructuring to address any of the business issues that have developed?

Part of that signal will involve what I communicate about the future management team. Will I really be running the show? If so, for how long? Or, is my primary task to hold the fort and rebuild the management team? If so, do I signal that now?

At last, Lay glanced down at a set of notes developed by Investor Relations. The notes contained recommendations for handling the analyst conference call that would follow Enron’s issuing the announcement of Skilling’s resignation. Lay noted its key points:

• Both Lay and Skilling need to affirm that Jeff’s reasons for leaving are purely personal and that everything at the company is fine.
• Skilling should anticipate being pressed to explain his reasons for resigning. He should stick to the explanation that it is personal and as such, he can gracefully decline to provide details. General references to family are fine. Skilling should be prepared to refute specific questions as to whether he has health problems or internal political reasons for leaving.
• Lay, as the returning CEO, should especially affirm his confidence in the company’s future.
• It is also recommended that Lay preempt any concerns as to whether Skilling’s resignation relates to unknown problems in trading, accounting, reserves, or other similar issues.

As for the employee meeting, Enron staff had already drafted an invitation whose message was consistent with the Investor Relations’ notes (Attachment 5). Lay’s brief called for him to express his enthusiasm for being back and to treat the company’s known problems as similar to issues successfully resolved in the past. If Lay wanted to signal any change in direction, he should express this in terms of reaffirming the values that had made Enron great. Finally, it was recommended that all employees be given a one-time stock option grant. This would both signal confidence in the future and help cement employee loyalty for the ride back up.

Attachment 2

Performance of Enron Stock During Skilling’s Tenure as CEO

Author’s Note

After a series of cases focused on executives within the Enron hierarchy, this case returns to the view from the top. Ken Lay has found himself thrust back into the CEO position. He has twenty-four hours after Jeff Skilling’s resignation to prepare for briefings to Wall Street analysts and Enron’s employees. What does he tell them?

The case depicts Ken Lay struggling with the dilemma of managing outside perceptions of Enron within a legal framework that requires accurate disclosure, including the avoidance of material omissions or misleading statements. Because of its deteriorating financial state, Enron is more dependent than ever on outside perceptions of its health. Mismanaging the disclosure of Skilling’s resignation could result in a crash in the stock price, the drying up of outside credit or both. Yet Lay can’t just tell the analysts, bankers, and employees reassuring sentiments. He will have to answer probing questions against a backdrop of mounting suspicion that all is not well at Enron. Can Lay do this in an accurate, not misleading way? Said differently, can Ken Lay respect the law and still say what he needs to say as regards issues’ the wrong discussion of which could destabilize his company?

This case draws heavily on the account of Jeff Skilling’s resignation presented in Conspiracy of Fools (pp. 470–487). That work charts the course of Enron’s increasing set of intractable problems, Skilling’s gradual disenchantment, Ken Lay’s notice of Skilling’s condition, and the specific conversations which Skilling and Lay held on the matter during July and August 2001. Accounts of Enron directors’ concerns over whether Skilling was “aware of something we’re not,” Skilling’s responses and the content of his consultation with Rick Causey are as reported in the same source.

This material is consistent with the account provided in The Smartest Guys in the Room (pp. 337–351). As a second source, this book adds valuable details about Ken Lay’s personal financial situation and his reaction to Skilling’s decision. It also provides an account of the August 13 financial and risk-management reviews, where Rick Buy presented the “meltdown” scenario (p. 346). Skilling and Fastow reportedly dismissed this scenario as remote, especially given Enron’s access to emergency bank lines. The account of Enron’s board learning that the company owed $34+ billion is found in Conspiracy of Fools (p. 481).

This case positions readers in Ken Lay’s shoes the night before Skilling’s resignation is to be announced. As such, the case imagines what Lay might have been thinking about as he considered what to say to analysts and employees. There is no historical record of what Lay considered prior to his conversations with these key audiences. The reflections near the end of the case are an imagined version of what he may have considered, developed by taking into account the issues he faced and what it is reasonable to assume he did and did not know at that point (see discussion of Attachment 4 below). The Investor Relations suggestions at the end of the case reflect the content of what Skilling and Lay actually told analysts and employees in their subsequent meetings.

While Sarbanes-Oxley has reinforced the legal liability facing CEOs who talk publicly about their firms, it is important to recall that a considerable body of law and liability risk was already present when Lay pondered what to say in the wake of Skilling’s resignation. Attachment 1, which summarizes the legal context at that time, was developed in consultation with a leading securities lawyer. This attorney has advised major corporate executives for more than a decade on their meetings with the press and with financial analysts. It is highly likely that, over the course of his long tenure as Enron’s CEO, a tenure that included many meetings and conversations with analysts and investors, Ken Lay would have been briefed by similar attorneys on the laws governing public company disclosure. These legal ground rules should have made it clear that Lay needed to know if Skilling was leaving hidden problems behind.

Imagining what Lay knew and considered at this pivotal moment is essential to the exercise of “standing in his shoes.” Typically, Lay is described as having been disengaged and “in exit mode.” These broad statements gloss the issue of what he was actually doing at Enron and what knowledge these activities would unavoidably have imparted. Consequently, Attachment 4 was developed to provide a historical record of Lay’s major activities during his last Enron years. This account catalogs all major Lay activities as reported in the two sources cited above. Without question, this is only a partial record; it doesn’t do justice to what Lay would have heard just by being present at routine management committee and board reviews. Still, it provides some basis for making presumptions about what Lay likely knew and therefore should have taken into account as he prepared to meet these critical audiences.

Attachment 5 is the text of the message Lay sent to employees announcing Skilling’s departure and inviting them to the all-employee meeting. This text is found in Brian Cruver’s Anatomy of Greed: The Unshredded Truth from an Enron Insider (p. 91). It is positioned here as a Draft so that readers can stand in Lay’s shoes and consider whether these are the correct messages to share with employees the next day.

This case raises one supremely difficult issue: Was an approach available to Lay at this point that would have saved Enron? Presumably, if Lay had concluded that the company was in mortal danger unless he took a certain path, the requirements of this path would have shaped his subsequent statements. In light of what actually happened, it is clear that simply expressing confidence in the company was not an adequate approach.

This question of “how to save Enron” will gain even more urgency shortly when Sherron Watkins, who was part of Lay’s employee audience, brings forward her own concerns.