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At the end of November, NVIDIA put out an internal memo (that was leaked to Barron’s reporter Tae Kim, who is a huge NVIDIA fan and knows the company very well, so take from that what you will) that sought to get ahead of a few things that had been bubbling up in the news, a lot of which I covered in my Hater’s Guide To NVIDIA (which includes a generous free intro).
Long story short, people have a few concerns about NVIDIA, and guess what, you shouldn’t have any concerns, because NVIDIA’s very secret, not-to-be-leaked-immediately document spent thousands of words very specifically explaining how NVIDIA was fine and, most importantly, nothing like Enron.
As an aside: NVIDIA wrote this note as a response to both Michael Burry and a guy called “Shanaka Anslem Perera,” who wrote a piece called “The Algorithm That Detected a $610 Billion Fraud: How Machine Intelligence Exposed the AI Industry’s Circular Financing Scheme” that I’ve been sent about 11 times. The reason I’m not linking to this piece is simple: it’s full of bullshit. In one part, Perera talks about “major semiconductor distributor Arrow Electronics” stating things in its Q3 2025 earnings about NVIDIA, yet Arrow makes no statements about NVIDIA of any kind on its earnings call, 10-Q or earnings presentation. If you need another example, Perera claims that when “Nvidia launched the Hopper H100 architecture in Q2 fiscal 2023—also amid reported supply constraints and strong demand—inventory declined 18% quarter-over-quarter as the company fulfilled backlogged orders.” Actually looking at NVIDIA’s inventory for that period shows that inventory increased quarter over quarter.I have not heard of Perera before, but his LinkedIn says he is the “CEO at Pet Express Sri Lanka.” I would suggest getting your financial advice elsewhere, and at a minimum, making sure that you read outlets that actually source their data.
Anyway, all of this is fine and normal. Companies do this all the time, especially successful ones, and there is nothing to be worried about here, because after reading all seven pages of the document, we can all agree that NVIDIA is nothing like Enron.
No, really! NVIDIA is nothing like Enron, and it’s kind of weird that you’re saying that it is! Why would you say anything about Enron? NVIDIA didn’t say anything about Enron.
Okay, well now NVIDIA said something about Enron, but that’s because fools and vagabonds kept suggesting that NVIDIA was like Enron, and very normally, NVIDIA has decided it was time to set the record straight.
And I agree! I truly agree. NVIDIA is nothing like Enron.
Putting aside how I might feel about the ethics or underlying economics of generative AI, NVIDIA is an incredibly successful business that has incredible profits, holds an effective monopoly on CUDA (explained here), which powers the underlying software layer to running software on GPUs, specifically generative AI, and not really much else that has any kind of revenue potential.
And yes, while I believe that one day this will all be seen as one of the most egregious wastes of capital of all time, for the time being, Jensen Huang may be one of the most successful salespeople in business history.
Nevertheless, people have somewhat run away with the idea that NVIDIA is Enron, in part because of the weird, circular deals it’s built with Neoclouds — dedicated AI-focused cloud companies — like CoreWeave, Lambda and Nebius, who run data centers full of GPUs sold by NVIDIA, which they then use as collateral for loans to buy more GPUs from NVIDIA.
Yet as dodgy and weird and unsustainable as this is, it isn’t illegal, and it certainly isn’t Enron, because, as NVIDIA has been trying to tell you, it is nothing like Enron!
Now, you may be a little confused — I get it! — that NVIDIA is bringing up Enron at all. Nobody seriously thought that NVIDIA was like Enron before (though JustDario, who has been questioning its accounting practices for years, is a little suspicious), because Enron was one of the largest criminal enterprises in history, and NVIDIA is at worst, I believe, a big, dodgy entity that is doing whatever it can to survive.
Wait, what’s that? You still think NVIDIA is Enron? What’s it going to take to convince you? I just told you NVIDIA isn’t Enron! NVIDIA itself has shown it’s not Enron, and I’m not sure why you keep bringing up Enron all the time!
Stop being an asshole. NVIDIA is not Enron!
Look, NVIDIA’s own memo said that “NVIDIA does not resemble historical accounting frauds because NVIDIA’s underlying business is economically sound, [its] reporting is complete and transparent, and [it] cares about [its] reputation for integrity.”
Now, I know what you’re thinking. Why is the largest company on the stock market having to reassure us about its underlying business economics and reporting? One might immediately begin to think — Streisand Effect style — that there might be something up with NVIDIA’s underlying business. But nevertheless, NVIDIA really is nothing like Enron.
But you know what? I’m good. I’m fine. NVIDIA, grab your coat, we’re going out, let’s forget any of this ever happened. Wait, what was that?
First, unlike Enron, NVIDIA does not use Special Purpose Entities to hide debt and inflate revenue. NVIDIA has one guarantee for which the maximum exposure is disclosed in Note 9 ($860M) and mitigated by $470M escrow. The fair value of the guarantee is accrued and disclosed as having an insignificant value. NVIDIA neither controls nor provides most of the financing for the companies in which NVIDIA invests.
Oh, okay! I wasn’t even thinking about that at all, I was literally just saying how you were nothing like Enron, we’re good. Let’s go home-
Second, the article claims that NVIDIA resembles WorldCom but provides no support for the analogy. WorldCom overstated earnings by capitalizing operating expenses as capital expenditures. We are not aware of any claims that NVIDIA has improperly capitalized operating expenses. Several commentators allege that customers have overstated earnings by extending GPU depreciation schedules beyond economic useful life. Rebutting this claim, some companies have increased useful life estimates to reflect the fact that GPUs remain useful and profitable for longer than originally anticipated; in many cases, for six years or more. We provide additional context on the depreciation topic below.
I…okay, NVIDIA is also not like WorldCom either. I wasn’t even thinking about WorldCom. I haven’t thought of them in a while.
On June 25, 2002, WorldCom, the second-largest telecommunications company in the United States, admitted that its accountants had overstated its 2001 and first quarter 2002 earnings by $3.8 billion. On July 21 of the same year, WorldCom filed for bankruptcy. On August 8, 2002, the company admitted that it had misclassified at least another $3.8 billion.In the investigation that followed the initial revelations by WorldCom, it was revealed that the company had misstated earnings by approximately $11 billion. This remains one of the largest accounting scandals in United States history. The fall in the value of WorldCom stock after revelations about the massive accounting fraud led to over $180 billion in losses by WorldCom’s investors.WorldCom, which began operating under the name Long Distance Discount Services in 1983, was led by one of its founders, CEO Bernard Ebbers, from 1985 to 2002. Under Ebbers’s leadership, the company engaged in a series of acquisitions, becoming one of the largest American telecommunications companies. In 1997, the company merged with MCI, making it the second largest telecom company after AT&T. In 1999, it attempted to merge with Sprint, which would have made it the largest in the industry. However, this merger was scrapped due to the intervention of the Department of Justice, which feared a WorldCom monopoly.WorldCom stock, which rose more than 50 percent on rumors of this merger, began to fall. Ebbers then tried to grow his company through new customers rather than corporate mergers, but was unable to do so because the sector was saturated by 2000. He borrowed significantly so that WorldCom would have enough cash to cover anticipated margin calls, commonly used to prove that a company has funds to cover potential speculative losses. Desperate to keep his company’s stock prices high, Ebbers pressured company accountants to show robust growth on earnings statements.
…NVIDIA, are you doing something WorldCommy? Why are you bringing up WorldCom?
To be clear, WorldCom was doing capital F fraud, and its CEO Bernie Ebbers went to prison after an internal team of auditors led by WorldCom VP of internal auditing Cynthia Cooper reported $3.8 billion in “misallocated expenses and phony accounting entries.”
So, yeah, NVIDIA, you were really specific about saying you didn’t capitalize operating expenses as capital expenditures. You’re…not doing that, I guess? That’s great. Great stuff. I had literally never thought you had done that before. I genuinely agree that NVIDIA is nothing like WorldCom.
Anyway, also glad to hear about the depreciation stuff, looking forward to reading-
Third, unlike Lucent, NVIDIA does not rely on vendor financing arrangements to grow revenue. In typical vendor financing arrangements, customers pay for products over years.
NVIDIA’s DSO was 53 in Q3. NVIDIA discloses our standard payment terms, with payment generally due shortly after delivery of products. We do not disclose any vendor financing arrangements. Our customers are subject to strict credit evaluation to ensure collectability. NVIDIA would disclose any receivable longer than one year in long-term other assets. The $632M “Other” balance as of Q3 does not include extended receivables; even if it did, the amount would be immaterial to revenue.
Erm…
A Brief History of Lucent Technologies (And No, It Really Isn’t Like NVIDIA Either)
Alright man, if anyone asks about whether you’re like famed dot-com crashout Lucent Technologies, I’ll be sure to correct them. After all, Lucent’s situation was really different — well…sort of. Lucent was a giant telecommunications equipment company, one that was, for a time, extremely successful, really really successful, in fact, turned around by the now-infamous Carly Fiorina.
From a 2010 profile in CNN:
Yet Fiorina’s campaign biography quickly skates over the stint that made her a star: her three-year run as a top executive at Lucent Technologies. That seems puzzling, since unlike her decidedly mixed record at HP, Fiorina’s tenure at Lucent has all the outward trappings of success.Lucent reported a stream of great results beginning in 1996, after Fiorina, who had been a vice-president at AT&T (T), helped oversee the company’s spin-off from Ma Bell. By the time she left to run HP in 1999 revenues were up 58%, to $38 billion. Net income went from a small loss to $4.8 billion profit. Giddy investors bid up Lucent’s stock 10-fold. And unlike HP, where Fiorina instituted large layoffs—a fact Senator Boxer loves to mention whenever possible—Lucent added 22,000 jobs during Fiorina’s tenure.
NVIDIA, this sounds great — why wouldn’t you want to be compared to Lucen-
In 1997 Fiorina took over the group selling gear to such “service provider networks.” The company reported that sales to such networks climbed from $15.7 billion in fiscal 1997 to $19.1 billion in 1998. In 1999 they hit an amazing $23.6 billion. In the midst of this rise Fortune named Fiorina — then largely anonymous outside of telecom — to the top of its first list of the country’s most powerful women in business. A star was born.As Wall Street became fixated on equipment companies’ growth, the whole industry entered a manic phase. With capital easy to come by, Qwest, Worldcom and their peers laid more fiber and installed far more capacity than customers needed. Much like the housing bubble that was just beginning to inflate, easy credit fed the telecom bubble.Lucent and its major competitors all started goosing sales by lending money to their customers. In a neat bit of accounting magic, money from the loans began to appear on Lucent’s income statement as new revenue while the dicey debt got stashed on its balance sheet as an allegedly solid asset. It was nothing of the sort. Lucent said in its SEC filings that it had little choice to play the so-called vendor financing game, because all its competitors were too.
Oh.So, to put it simply, Lucent was classifying debt as an asset (we’re getting into technicalities here, but it sort of was but was really counting money from loans as revenue, which is dodgy and bad and accountants hate it), and did something called “vendor financing,” which means you lend somebody money to buy something from you. It turns out Lucent did a lot of this.
In the giant PathNet deal that Fiorina oversaw, Lucent agreed to fund more than 100% of the company’s equipment purchases, meaning the small company would get both Lucent gear at no money down and extra cash to boot. Yet how could such a loan to PathNet make sense for Lucent, even based on the world as it appeared in the heady days of 1999? The smaller company had barely $100 million in equity (and that’s based on generous accounting assumptions) on top of which it had already balanced $350 million in junk bonds paying 12.25% interest. Adding $440 million in loans from Lucent to this already debt-heavy capital structure would jack the company’s leverage up to 8 to 1, and potentially even higher as they drew more of the loan.
Okay, NVIDIA, I hate to say this, but I kind of get why somebody might say you’re doing Lucent stuff. After all, rumour has it that your deal with OpenAI — a company that burns billions of dollars a year — will involve it leasing your GPUs, which sure sounds like you’re doing vendor financing…
-we do not disclose any vendor financing arrangements-
Fine! Fine.
Anyway, Lucent really fucked up big time, indulging in the dark art of circular vendor financing. In 1998 it signed its largest deal — a $2 billion “equipment and finance agreement” — with telecommunications company Winstar, which promised to bring in “$100 million in new business over the next five years” and build a giant wireless broadband network, along with expanding Winstar’s optical networking.
To quote The Wall Street Journal:
Winstar was one of scores of stand-alone, start-up companies created in the late 1990s to compete in the market for local telecom services. These firms, known as “competitive local exchange carriers,” or CLECs, raised billions of dollars in debt and equity financing, and embarked upon ambitious plans to compete with “incumbent” carriers. For a time in the late 1990s, their stocks were hot properties, outpacing even Internet stocks.
In December 1999, WIRED would say that Winstar’s “small white dish antennas…[heralded] a new era and new mind-set in telecommunications,” and included this awesome quote about Lucent from CEO and founder Will Rouhana:
On one level we are a customer and they are a supplier. On another level they are a financier and we are a borrower. On yet another level they are providing services around the world to accelerate our development. They also want to use our service, and have guaranteed $100 million in business.
Fuck yeah!
But that’s not the only great part of this piece:
WinStar is publicly traded (Nasdaq: WCII), has more than 4,000 employees, and reports more than $300 million in annualized core revenues.
Annualized revenues, very nice. We love annualized revenues don’t we folks? A company making about $25 million a month a year after taking on $2 billion in financing from Lucent. Weirdly, Winstar’s Wikipedia page says that revenues were $445.6 million for the year ending 1999 — or around $37.1 million a month.
Winstar loved raising money — two years later in November 2000, it would raise $1.02 billion, for example — and it raised a remarkable $5.6 billion between February 1999 and July 2001 according to the Wall Street Journal. $900 million of that came in December 1999 from an investment from Microsoft and “several investment firms,” with analyst Greg Miller of Jefferies & Co saying:
The Microsoft investment is a significant endorsement that the technology will be used more aggressively in the future," said Greg Miller, an analyst at Jefferies & Co. "WinStar can use the capital.
Cool!
Another fun thing happened in November 2000 too. Lucent would admit it had overstated its fourth-quarter profits by improperly recording $125 million in sales, reducing that quarter’s revenue from “profitable” to “break-even.”
Things would eventually collapse when Winstar couldn’t pay its debts, filing for Chapter 11 bankruptcy protection on April 18 2001 after failing to pay $75 million in interest payments to Lucent, which had cut access to the remaining $400 million of its $1 billion loan to Winstar as a result. Winstar would file a $10 billion lawsuit in bankruptcy court in Delaware the very same day, claiming that Lucent breached its contract and forced Winstar into bankruptcy by, well, not offering to give it more money that it couldn’t pay off.
Elsewhere, things had begun to unravel for Lucent. A January 2001 story from the New York Times told a strange story of Lucent, a company that had made over $33 billion in revenue in its previous fiscal year, asking to defer the final tranche of payment — $20 million — for an acquisition due to “accounting and financial reporting considerations.”
Why? Because Lucent needed to keep that money on the books to boost its earnings, as its stock was in the toilet, and was about to announce it was laying off 10,000 people and a quarterly loss of $1.02 billion.
Over the course of the next few years, Lucent would sell off various entities, and by the end of September 2005 it would have 30,500 staff and have a stock price of $2.99 — down from a high of $75 a share at the end of 1999 and 157,000 employees. According to VC Tomasz Tunguz, Lucent had $8.1 billion of vendor financing deals at its height.
Lucent was still a real company selling real things, but had massively overextended itself in an attempt to meet demand that didn’t really exist, and when Lucent realized that, it decided to create demand itself to please the markets. To quote MIT Tech Review (and author Lisa Endlich), it believed that “setting and meeting [the expectations of Wall Street] “subsumed all other goals,” and that “Lucent had little choice but to ride the wave.”
To be clear, NVIDIA is quite different from Lucent. It has plenty of money, and the circular deals it does with CoreWeave and Lambda don’t involve the same levels of risk. NVIDIA is not (to my knowledge) backstopping CoreWeave’s business or providing it with loans, though NVIDIA has agreed to buy $6.3 billion of compute as the “buyer of last resort” of any unsold capacity. NVIDIA can actually afford this, and it isn’t illegal, though it is obviously propping up a company with flagging demand. NVIDIA also doesn’t appear to be taking on masses of debt to fund its empire, with over $56 billion in cash on hand and a mere $8.4 billion in long term debt.
Okay, phew. We got through this man. NVIDIA is nothing like Lucent either. Okay, maybe it’s got some similarities — but it’s different! No worries at all. I know I’m relaxed.
You still seem nervous, NVIDIA. I promise you, if anyone asks me if you’re like Lucent I’ll tell them you’re not. I’ll be sure to tell them you’re nothing like that. Are you okay, dude? When did you last sleep?
Inventory growth indicates waning demandClaim: Growing inventory in Q3 (+32% QoQ) suggests that demand is weak and chips are accumulating unsold, or customers are accepting delivery without payment capability, causing inventory to convert to receivables rather than cash.
Woah, woah, woah, slow down. Who has been saying this? Oh, everybody? Did Michael Burry scare you? Did you watch The Big Short and say “ah, fuck, Christian Bale is going to get me! I can’t believe he played drums to Pantera! Ahh!”
Anyway, now you’ve woken up everybody else in the house and they’re all wondering why you’re talking about receivables. Shouldn’t that be fine? NVIDIA is a big business, and it’s totally reasonable to believe that a company planning to sell $63 billion of GPUs in the next quarter would have ballooning receivables ($33 billion, up from $27 billion last quarter) and growing inventory ($19.78 billion, up from $14.96 billion the last quarter). It’s a big, asset-heavy business, which means NVIDIA’s clients likely get decent payment terms to raise debt or move cash around to get them paid.
Everybody calm down! Like my buddy NVIDIA, who is nothing like Enron by the way, just said:
Response: First, growing inventory does not necessarily indicate weak demand. In addition to finished goods, inventory includes significant raw materials and work-in-progress. Companies with sophisticated supply chains typically build inventory in advance of new product launches to avoid stockouts. NVIDIA’s current supply levels are consistent with historical trends and anticipate strong future growth.
Second, growing inventory does not indicate customers are accepting delivery without payment capability. NVIDIA recognizes revenue upon shipping a product and deeming collectability probable. The shipment reduces inventory, which is not related to customer payments. Our customers are subject to strict credit evaluation to ensure collectability.
Payment is due shortly after product delivery; some customers prepay. NVIDIA’s DSO actually decreased sequentially from 54 days to 53 days.
Haha, nice dude, you’re totally right, it’s pretty common for companies, especially large ones, to deliver something before they receive the cash, it happens, I’m being sincere. Sounds like companies are paying! Great!
But, you know, just, can you be a little more specific? Like about the whole “shipping things before they’re paid” thing.
NVIDIA recognizes revenue upon shipping a product and deeming collectability probable-
Alright, yeah, thought I heard you right the first time. What does “deeming collectability probable” mean? You could’ve just said “we get paid 95% of the time within 2 months” or whatever. Unless it’s not 95%? Or 90%? How often is it? Most companies don’t break this down by the way, but then again, most companies are not NVIDIA, the largest company on the stock market, and if I’m honest, nobody else has recently had to put out anything that said “I’m not like Enron,” and I want to be clear that NVIDIA is not like Enron.
For real, Enron was a criminal enterprise. It broke the law, it committed real deal, actual fraud, and NVIDIA is nothing like Enron. In fact, before NVIDIA put out a letter saying how it was nothing like Enron I would have staunchly defended the company against the Enron allegations, because I truly do not think NVIDIA is committing fraud.
That being said, it is very strange that NVIDIA wants somebody to think about how it’s nothing like Enron. This was, technically, an internal memo, and thus there is a chance its existence was built for only internal NVIDIANs worried about the value of their stock, and we know it was definitely written to try and deflect Michael Burry’s criticism, as well as that of a random Substacker who clearly had AI help him write a right-adjacent piece that made all sorts of insane and made up statements (including several about Arrow Electronics that did not happen) — and no, I won’t link it, it’s straight up misinformation.
Nevertheless, I think it’s fair to ask: why does NVIDIA need you to know that it’s nothing like Enron? Did it do something like Enron? Is there a chance that I, or you, may mistakenly say “hey, is NVIDIA doing Enron?”
Is NVIDIA doing Enron stuff?
Heeeeeeyyyy NVIDIA. How’re you feeling? Yeah, haha, you had a rough night. You were saying all this crazy stuff about Enron last night, are you doing okay? No, no, I get it, you’re nothing like Enron, you said that a lot last night.
So, while you were asleep — yeah it’s been sixteen hours dude, you were pretty messed up, you brought up Lucent then puked in my sink — I did some digging and like, I get it, you are definitely not like Enron, Enron was breaking the law. NVIDIA is definitely not doing that.
But…you did kind of use Special Purpose Vehicles recently? I’m sorry, I know, you’re not like Enron! You’re investing $2 billion in Elon Musk’s special purpose vehicle that will then use that money to raise debt to buy GPUs from NVIDIA that will then be rented to Elon Musk.
This is very different to what Enron did! I am with you dude, don’t let the haters keep you down! No, I don’t think a t-shirt that says “NVIDIA is not like Enron for these specific reasons” helps.
Wait, wait, okay, look. One thing. You had this theoretical deal lined up with Sam Altman and OpenAI to invest $100 billion — and yes, you said in your latest earnings that “it was actually a Letter of Intent with the opportunity to invest,” which doesn’t mean anything, got it — and the plan was that you would “lease the GPUs to OpenAI.”
Now how would you go about doing that NVIDIA? You’d probably need to do exactly the same deal as you just did with xAI. Right? Because you can’t very well rent these GPUs directly to Elon Musk, you need to sell them to somebody so that you can book the revenue, you were telling me that’s how you make money. I dunno, it’s either that or vendor financing.
Oh, you mentioned that already-
-unlike Lucent, NVIDIA does not rely on vendor financing arrangements to grow revenue. In typical vendor financing arrangements, customers pay for products over years. NVIDIA’s DSO was 53 in Q3. NVIDIA discloses our standard payment terms, with payment generally due shortly after delivery of products. We do not disclose any vendor financing arrangements-
Let me stop you right there a second, you were on about this last night before you scared my cats when you were crying about something to do with “two nanometer.”
First of all, why are you bringing up typical vendor financing agreements? Do you have atypical ones?
Also I’m jazzed to hear you “disclose your standard payment terms,” but uh, standard payment terms for what exactly? Where can I find those? For every contract?
Also, you are straight up saying you don’t disclose any vendor financing arrangements, that’s not the same as “not having any vendor financing arrangements.” I “do not disclose” when I go to the bathroom but I absolutely do use the toilet.
Let’s not pretend like you don’t have a history in helping get your buddies funding. You have deals with both Lambda and CoreWeave to guarantee that they will have compute revenue, which they in turn use to raise debt, which is used to buy more of your GPUs. You have learned how to feed debt into yourself quite well, I’m genuinely impressed.
This is great stuff, I’m having the time of my life with how not like Enron you are, and I’m serious that I 100% do not believe you are like Enron.
But…what exactly are you doing man? What’re you going to do about what Wall Street wants?
I’m serious though. NVIDIA isn’t like Enron
Enron was a criminal enterprise! NVIDIA is not. More than likely NVIDIA is doing relatively boring vendor financing stuff and getting people to pay them on 50-60 day time scales — probably net 60, and, like it said, it gets paid upfront sometimes.
NVIDIA truly isn’t like Enron — after all, Meta is the one getting into ENERGY TRADING — to the point that I think it’s time to explain to you what exactly happened with Enron. Or, at least as much as is possible within the confines of a newsletter that isn’t exclusively about Enron…
What Exactly Was Enron?
The collapse of Enron wasn’t just — in retrospect — a large business that ultimately failed. If that was all it was, Enron wouldn’t command the same space in our heads as other failures from that era, like WorldCom (which I mentioned earlier) and Nortel (which I’ll get to later), both of whom were similarly considered giants in their fields.
It’s also not just about the fact that Enron failed because of proven business and accounting malfeasance. WorldCom entered bankruptcy due to similar circumstances (though, rather than being liquidated, it was acquired as part of Verizon’s acquisition of MCI, the name of a company that had previously merged with WorldCom that WorldCom renamed itself to after bankruptcy), and unlike Enron, isn’t the subject of flashy Academy-nominated films, or even a Broadway production.
Editor’s Note: Hi! It’s Ed’s editor Matt here! I actually saw the UK touring production of Enron in 2010 at Newcastle’s Theatre Royal. It was extremely good. From time to time, new productions of it show up (from what I can tell, the most recent one was in October at the London Barbican), and if you get a chance to watch it, you should.
It’s not the size of Enron that makes its downfall so intriguing. Nor, for that matter, is it the fact that Enron did a lot of legally and ethically dubious stuff to bring about its downfall.
No, what makes Enron special is the sheer gravity of its malfeasance, the rotten culture at the heart of the company that encouraged said malfeasance, and the creative ways Enron’s leaders crafted an image of success around what was, at its heart, a dog of a company.
Enron was born in 1985 on the foundations of two older, much less interesting businesses. The first, Houston Natural Gas (HNG), started life as a utility provider, pumping natural gas from the oilfields of Texas to customers throughout the region, before later exiting the industry to focus on other opportunities. The other, InterNorth, was based in Omaha, Nebraska and was in the same business — pipelines.
In the mid-1980s, HNG was the subject of a hostile take-over from Coastal Corporation (which, until 2001, operated a chain of refineries and gas stations throughout much of the US mainland). Unable to fend it off by itself, HNG merged with InterNorth, with the combined corporation renamed Enron.
The CEO of this new entity was Ken Lay, an economist by trade who spent most of his career in the energy sector who also enjoyed deep political connections with the Bush family. He co-chaired George H. W. Bush’s failed 1992 re-election campaign, and allowed Enron’s corporate jet to ferry Bush Sr. and Barbara Bush back and forth to Washington. Center for Public Integrity Director Charles Lewis said that “there was no company in America closer to George W. Bush than Enron.”
George W. Bush (the second one) even had a nickname for Lay. Kenny Boy.
Anyway, in 1987, Enron hired McKinsey — the world’s most evil management consultancy firm — to help the company create a futures market for natural gas. What that means isn’t particularly important to the story, but essentially, a futures contract is where a company agrees to buy or sell an asset in the future at a fixed price.
It’s a way of hedging against risk, whether that be from something like price or currency fluctuations, or from default. If you’re buying oil in dollars, for example, buying a futures contract for oil to be delivered in six months time at a predetermined price means that if your currency weakens against the dollar, your costs won’t spiral.
That bit isn’t terribly important. What does matter is while working with McKinsey, Lay met someone called Jeff Skilling — a young engineer-turned-consultant who impressed the company’s CEO deeply, so much so that Lay decided to poach him from McKinsey in 1990 and give him the role of chairman and CEO of Enron Finance Group.
Sidenote: Enron had a bunch of subsidiaries, and some had their own CEOs and boards. I mention this because you may be a bit confused, as Lay was CEO of Enron writ large. In essence, it’s a bit like how Sam Altman is CEO of OpenAI and Fidji Simo the CEO of Applications.This bit isn’t important, but I want to be as explicit as possible.
Anyway, Skilling continued to impress Lay, who gave him greater and greater responsibility, eventually crowning him Chief Operating Officer (COO) of Enron.
With Skilling in a key leadership position, he was able to shape the organization’s culture. He appreciated those who took risks — even if those risks, when viewed with impartial eyes, were deemed reckless, or even criminal.
He introduced the practice of stack-ranking (also known as “rank and yank”) to Enron, which had previously been pioneered by Jack Welch at GE (see The Shareholder Supremacy from last year). Here, employees were graded on a scale, and those at the bottom of the scale were terminated. Managers had to place at least 10% (other reports say closer to 15%) of employees in the lowest bracket, which created an almost Darwinian drive to survive.
Staffers worked brutal hours. They cut corners. They did some really, really dodgy shit. None of this bothered Skilling in the slightest.
How dodgy, you ask? Well, in 2000 and 2001, California suffered a series of electricity blackouts. This shouldn’t have happened, because California’s total energy demand (at the time) was 28GW and its production capacity was 45GW.
California also shares a transmission grid with other states (and, for what it’s worth, the Canadian provinces of Alberta and British Colombia, as well as part of Baja California in Mexico), meaning that in the event of a shortage, it could simply draw capacity from elsewhere.
So, how did it happen?
Well, remember, Enron traded electricity like a commodity, and as a result, it was incentivized to get the highest possible price for that commodity. So, it took power plants off line during peak hours, and exported power to other states when there was real domestic demand.
How does a company like Enron shut down a power station? Well, it just asked.
In one taped phone conversation released after the company’s collapse, an Enron employee called Bill called an official at a Las Vegas power plant (California shares the same grid with Nevada) and asked him to “get a little creative, and come up with a reason to go down. Anything you want to do over there? Any cleaning, anything like that?"
This power crisis had dramatic consequences — for the people of California, who faced outages and price hikes; for Governor Gray Davis, who was recalled by voters and later replaced by Arnold Schwarzenegger; for PG&E, which entered Chapter 11 bankruptcy that year; and for Southern California Edison, which was pushed to the brink of bankruptcy as a result.
This kind of stuff could only happen in an organization whose culture actively rewarded bad behavior.
In fact, Skilling was seemingly determined to elevate the dodgiest of characters to the highest positions within the company, and few were more-ethically-dubious than Andy Fastow, who Skilling mentored like a protegé, and who would later become Enron’s Chief Financial Officer.
Enron’s “Creative” Accounting
Even before vaulting to the top of Enron’s nasty little empire, Fastow was able to shape its accounting practices, with the company adopting mark-to-market accounting practices in 1991.
Mark-to-market sounds complicated, but it’s really simple. When listing assets on a balance sheet, you don’t use the acquisition cost, but rather the fair-market value of that asset. So, if I buy a baseball card for a dollar, and I see that it’s currently selling for $10 on eBay, I’d say that said asset is worth $10, not the dollar I paid for it, even though I haven’t actually sold it yet.
This sounds simple — reasonable, even — but the problem is that the way you determine the value of that asset matters, and mark-to-market accounting allows companies and individuals to exercise some…creativity.
Sure, for publicly-traded companies (where the price of a share is verifiable, open knowledge), it’s not too bad, but for assets with limited liquidity, limited buyers, or where the price has to be engineered somehow, you have a lot of latitude for fraud.
Let’s go back to the baseball card example. How do you know it’s actually worth $10, and not $1? What if the “fair value” isn’t something you can check on eBay, but what somebody told me in-person it’s worth? What’s to stop me from lying and saying that the card is actually worth $100, or $1000? Well, other than the fact I’d be committing fraud.
What if I have ten $1 baseball cards, and I give my friend $10 and tell him to buy one of the cards using the $10 bill I just handed him, allowing me to say that I’ve realized a $9 profit on one of my $1 cards, and my other cards are worth $90 and not $9?
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