Enron
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Obviously, the contexts were doing this episode because of F.

X, right? It's a related party transaction.

One could say it's like, L, J, it's like the rapture.

What is his kids? And is why I fray. The psychopath can't possibly be fraud if it's named after my family.

I feel like this story is like americans. I go in.

yes. Oh, my god. yes.

Busy, you wait, you wait, you who? Easy, you see me down. Welcome two, season eleven.

episode seven of acquired the podcast about great technology companies. Well, sometimes not so great companies and the stories and play books behind them.

not so great companies and the stories and cooked books behind them.

Oh, there you go. That's a dad joke. Is a dad joke. I am bang gilbert and I am the cofounder and managing director of seattle based pioneer .

square labs in our venture fund, psl ventures. And David and i'm an anal investor based in sec .

o and we are your hosts. Well, listeners. IT brings me no joy to do this episode, but IT seems all to appropriate in this moment. In 2， today, we tell the story of enron. IT was the seventh biggest company in amErica by market cap.

IT was heralded as the pioneer of a new business model during a new technology era, executives had endorsements, or at least friendships and public appearance with multiple U. S. presidents. IT had the houston astros baseball stadium and ron field bearing its name. IT was even named fortune magazines most innovative company six years in a row.

including in two thousand and one the year he went back pt.

unbelievable. Less than a year after IT stocked at an all time non filed for the largest bankrupcy in american history. To that point, this story is every bit as crazy as the F, T, X story that we are all watching in play out in real time.

The parallels are totally uncanny. A financial trading company that got over leverage, thought they could do no wrong, and got tangled up in a web of self dealing to try and paper over their problems. Individuals profit richly, while shareholders were on the wiser. The biggest difference really is that somehow anyone managed to do IT all as a public company in a plane daylight the entire time and with much bigger dollar amounts.

We have a big thank you to say here. The idea for this episode came from our good friend and past acquired guest reMarks. I was in new york on the way back from lesson, and I had breakfast at the entire, and we are talking about F, T, X.

Of course, everything going on. I like, how can acquire, add to the conversation right now about F, T, X. And he was like, i've got a good ah you guys should do and on and I was like, boom, that is what acquired can add to this conversation.

Well, on the F, T, X notes of service to say we will definitely be appending a new intro to that episode indeed. Okay, listeners, now is a great time to tell you about long time friend of the show service now.

yes, as you know, service now is the A I platform for business transformation, and they have some new news to share. Service now is introducing A I agents. So only the service now platform puts A I agents to work across every corner .

of your business. yeah. And as you know from listening to us all year, service now is pretty remarkable about embracing the latest AI developments and building them into products for their customers. AI agents are the next phase of this.

So what are A I agents? A I agents can think, learn, solve problems and make decisions autonomously. They work on behalf of your teams, elevating their productivity and potential. And while you get incredible productivity enhancements, you also get to stay in full control with service.

Now, AI agents proactively solve chAllenges from IT hr, customer service, software development. You name these agents collaborate, they learn from each other, and they continuously improve handling the busy work across your business so that your teams can actually focus on what .

truly matters ultimately, service. Now an agenda. I is the way to deploy AI across every corner of your enterprise. They boost productivity for employees and rich customer experiences and make work Better for everyone.

Yep, so learn how you can put A I agents to work for your people by clicking the link in the show notes or going to service now docotor ash, A I dash agents after the episode, join the slack, thirteen thousand smart, curious thought for well researched people are in there, and we will be discussing this episode without further a due. David, take us in listers, this is not investment, ted, by a state. And I may hold investments in the companies we discuss, although I don't think you can invest in any these companies anymore.

I've got a fun little thing that i'll bring up right at the end of the episode about investing in and around. That blew my mind when I learned this.

All right, all right. This show is for informational and entertainment purposes only. David, over to you.

I feel like we also need to disclaimer that this is not accounting advice.

This is not accounting advice.

This is going to be fun because this is such history now and run, and there are many really good books out there. So you read the smartest guys in the room right by bathroom, clean. yeah.

And I read conspiracy of fools by court icon world, both of which I think I are really good. Conspiracy fools is go great. That is a very, very well researched history of iron.

And I thought a good place to start is right at the end of the prolog of conspiracy of fools curd. I can wald write this. I just thought I was so perfect to frame the non story and the F.

T. X. Story today. He says. This then is more than the tale of one companies fall from Grace. IT is at its space. The story of a ringing period of economic and political tumbled as revealed through a single corporate scandal.

IT is a portrait of an amErica in upheaval at the turn of the tour first century, a country torn between its worship of fast money and it's zeal for truth between greed and high minded ness between wall street and main street. Ultimately, IT is the story of the untold damage ricked by a nation's fly. I follow that in time. We are all but certain to see, again.

it's so literally, my god, those words, after trying to consume and and seeing out of anon stuff over the last couple weeks, the thing that occurs to me is this is something that can only occur to this height in a ball market where there is so much capital saturating, so many opportunities that people are willing to go way out on the curve looking for returns where there's so much formal playing into IT that they sort of have to pile into these low disclosure, super risky type of assets because everything else is uh, already at all time highs and crazy multiples.

And of course, it's the people's fault driving the car that gets us here. But the environment are around. The car on the road is definitely .

facilitating IT. What the investor community, as we saw happen over the last couple years here, just loses all incentive and desire to ask questions yeah um that is what happened twenty plus years ago. So how did we get there then?

And where did iron come from?

Where did iron come from? We start in the nineteen seventies in the united states, where a series, for those of you who know your american and deed, world history, a series of oil crisis and energy Prices shock the nation and the world. First in one thousand nine hundred and seventy three, when OPEC, the organization of petroleum exporting countries starts an oil embargo on the U.

S. And other western nations, and the Price of energy triples. Think about this, were talking about the impact of the russia, ukraine in war on Prices in year of this was waivers.

The consequences of that, where that the stock market crashed immediately, the economy entered a huge recession. This was the end. This was the slammer of the door on the post.

Worlds are two american economic growth miracle. This killed IT. And when we've talked about this on the show a few times, the nineteen seventies were brutal. We talk about interest rates going so high.

IT was because of this, the first oil shock in one thousand nine hundred seventy three, and the second in one thousand nine hundred and seventy nine. Unemployment hits ten percent. C, P, I, and inflation is above five percent for pretty much the entire decade.

IT hits a high of twelve point four percent in one thousand and eighty. wow. And famously, when paul Walker takes over as chairman of the fed in one thousand nine hundred and seventy nine brings the hair down. He brings the hammerdown I didn't realize how how this was.

He raised the fed funding that was at zero a year ago, that was a zero year ago and that everybody y's freaking out because it's at what like three and a half now or something like that people think that might go to four, five. That's crazy and that's tanking the economy. Do you know how high voca raised IT in the .

early one thousand .

and eighty ten percent above nine percent?

wow. I assume I had to, because I had always heard that mortgage had eighteen. So I was assumed that the mortgage .

had to be higher than the fed fundi think of. I mean, that's like the base lowest interest story possible. So mortgage is must have been in the toys at that point time.

Wow, crazy, my god.

And that finally did break the back of inflation, but the cost was immense. Doing this research really helps me understand more about the eighties. You know, in the gogogo years of the eighties, IT was because coming out of this horrible decade of the one thousand nine hundred and seventy.

oh yeah, of course, this was the birth of the wall street mania because the super high interest rates from the Walker era would have had to unbelievably low multiples on any asset you could buy. So of course, you've got tons of room to run on investing at bargain basement Prices for things that are gone to go up.

Now what was that? That precipitated all this link? I said I was the energy crisis, oil shocks and the energy shocks.

So starting in the mid seventies, and IT takes really fifteen, twenty years for all this legislation to win to the government. The U. S.

Government starts deregulating the energy markets in the us. So if you go back to episodes on rock file standard oil, the initial energy markets in the U. S. Were many up, like if a standard oil, right? And then when the government brought the hammer down on standard oil and the energy monopoly, everything got regulated, and utilities, energy producers all became regulated, government entities where Prices of energy were set by the government.

When you say regulated, you know, there's different flavors of this. There is something where the government could actually own the utility and you pay the government for the services. But there's also a sort of middle ground where something is so important to the public that Price controls are put into place or the free market is not allowed to rain free. The government would do something like grant and exclusive monopoly to a certain company and say, but the Prices have to be here or but you can't make that much margin on IT.

You know this makes sense, especially in the post world war two, american economy and way of life power. Is critically important, electricity, gasoline, for homes, for businesses, for commuting, for factories. All this step takes power like you want stability and low Prices.

yep. But then after the seventies, of course, this all gts shook up. So in one thousand nine hundred seventy eight, jimmie Carter signs the national energy act, which starts to open back up parts of the energy economy in the U.

S. To free market competition. And the first big area of the energy industry that the regulators is the natural gas industry. So enter one, Kenneth lee lay lay, like our first protagonist of this season, sam walton lay was born in roll messeri in one thousand forty two.

After welton, his father was a bath test preach, who ran a general store at the misery countryside that ended up fAiling and lager up, very, very poor. But his family believed in education, and when his older sister graduated high school, his family wanted her to go to college, so they moved the whole family to columba misery. Wow, it's like.

literally the same story. It's crazy, literally.

It's the same story so that he could live at home, which was the only way they could afford for her to attend, to go to the university of missouri at columbia, very, very lovely place, which we have now been to multiple times for a capital camp. So SHE goes to the university, missouri, can would follow in her footsteps, also go to the university of missouri, where he would discover a live long passion for economics.

He's a star student in the economics department. He graduates. He goes on to work in the oil industry.

After graduates on the nights and weekends while he's working in the industry, he completes A P. H. D. In economics.

And then one day he gets a call in the middle seventies from his old advisor from missouri, his old professor, who just got nominated to the federal power commission. Right is all in this. Deregulation is starting to percussion its way through the government. And so he calls up late and says, come join me here in dc and helped me work through all of this with the government and the industry. So lay ends up serving as the deputy under secretary of energy in the department of the interior, right? As these oil shocks are happening in the regulation is starting to be talked about after a few years, he goes back in the industry at florida gas, a pipeline company, florida as the president and number two Operator within the company.

So so far in this guy's career, he sounds like the real deal, he totally is P. H. D, economist, civil servant, working in the government, getting dc exposure, going in the industry to actually get some Operating experience, grew up in a hard era and sort of like had to fight his way through university.

Yeah, he's never deployed for combat, but during the a. Nome, he ends up going to the navy. He becomes like a naval intellect office.

By all outward appearances. He seems like a real good guy at this point time. He marries his college. Sweet, hard, you know, true american story. So late seventies, early eighties, he's the number two executive at this natural gas pipeline company in florida. And in one thousand nine hundred eighty two, his former boss had moved over the big leagues in the energy industry, head gone to a company called trans co energy based in houston, texas, which is silicon .

valley of the oil and gas sector.

silicon value of the oil and gas sector, the new york city to the financial industry of the oil and gas sector. everything. If you want to be in energy in america, you want to be in texas, either in dallas or houston.

But I think at this point time, houston probably have yeah. So lay is now in the big time. And as is fitting for now being in the big time and of the era, he leaves his wife behind in florida and moves to houston with his new wife, who was his secretary at florida. Guess.

unfortunately, classic for this story.

a classic. This is not the last time we're going to hear something to this effect in people's personal lives, in the iron story. So right? As he arrives in his stand at transco, two things are happening.

One, as i've been talking about all long here, deregulation is finally percuss ating through to industry. Carter sign the energy act. It's in false swing.

But too surprisingly, here in one thousand nine hundred eighty two, energy Prices fall for the first time in a decade. So as a result, right after lay shows up, trans go runs into a problem. It's contracted to buy a whole bunch of oil and gas assets from various producers, various drillers, you know, around texas and around the country.

And those contracts have transco buying the assets at an ever increasing Price because the Prices of oil and gas have only been going up for last decade, but market Prices have just fAllen. So they're really kind of in the larcher. People think the chance go might go under, lay remembers.

He's A P. H. D. Economist, and he's really quite brilliant. He comes up with an idea based on all of the economic theory that he knows he's like, what if we set up a trading market for the oil and gas that we're contracted to buy and especially in natural gas, which is now deregulated enough that I think we can do this.

And rather than us, is the pipeline company buying all of this gas from the producers? We will just Operate the pipelines in the middle and we'll make this market and we'll let the end consumers of the gas, you know, the is the utilities. Consumers aren't buying this directly, but the utility companies are will let them, through us, trade with the producers.

And we can create a spot market for energy. This becomes a huge success. This is like a massive, massive innovation.

And so transco o was doing this.

Transco is doing this. So lay he becomes like a total industry legend, key pones that so before trans go in lay the whole idea of like any form of trading or financialization of energy of oil and gas didn't really exist because I was all regulated by the government before that.

right? Not to mention securities ation wasn't a trend even in finance today. You can securities anything we had. Of course, in two thousand and eight, everyone became familiar with the term mortgage bac securities. But securities ation in the eighties and nineties became all the age and finance to basically get anything off your books. You could increase the velocity at which a financial company could Operate by packaging up risk and selling IT to someone else so that you could make new loans off your book or something like that. And of course, this was going to come to energy at some point, but it's important to remember that security zone is still a reasonably new concept even on wall street.

Yeah, there are two things. One, this is not yet securities ation of energy assets. This is simply just making a market for the first time between producers and consumers of the energy where they can buy and sell on the spot market .

at a real time, appropriate Price.

real time Price like today, I need energy. I am going to look at the market that trans go is now making. I am going to buy as a consumer of energy at today is market Price, wherein the past IT was all long term contracts that the pipelines had entered into with the producers and then the consumers of the energy would buy from the .

pipelines are I see okay. So we're like, craw, walk, run.

craw up. Yeah, yeah. This is crawling. But as I said, this is leg.

This is lyth's baby. literally. This is the opening of the fly gates.

And he was the very perfect person to do this because he had the industry experience. He's now been close to a decade working in the industry. He had the economics training and he had the government experience. He knew that the deregulation was now at the rate point that had trickled out into industry enough that this is possible. So he really was the perfect person to do this. Um so on the back of that in june of one thousand and eighty four lay remember his number two a transco he gets poached by another big houston energy company, houston natural gas, to come over as the CEO the number one he's made IT to the top he's made his mark he is the bic shot at this point and he said, yeah, they were a big publicly traded energy company in houston probably, I want to say, like a billion billion and a half market cap called public company.

So definitely a great promotion for ham, a job to sort of move up in the ranks by joining the other company. But it's not like he's sort of on top of the world yet at this point. He's got bigger competitors that he is dealing with.

He does for the moment. So then the very next year, in one thousand nine hundred eighty five, he gets a call from the CEO of one of the larger competitors, a company called into north, which was not based in houston but rather based in omaha. A few companies based in mamah, a asa small .

head office based in oh.

exactly small head office despite being based on the mahadeo in their north at this point in time. No, berger halfway involvement is the largest pipeline company in america, and they are relatively conservative kind of old school in many ways. This we'll see sort of parole nebrasky despite having the largest pipeline in the country.

And they were being pursued by the corporate. Rather, it's so fly how everything is coming together here. And they quiet a season defamed one thousand nine hundred eighty corporate ratter erin Jacobs, but not that irin. I'm going to say .

I remember reading this and looking IT off being like a good wow. It's not our coco land.

I first heard about this other bizarre or when Jacobs when doing the research for the cocom episode, because every time I typed into google, I would occasionally get hits for some other famous business person that clearly was not like the hero or when Jacob s, but the anti hero or when Jacobs.

So ninety eighties corporate raider r erin Jacobs is pursuing into north, and the C E O of inner north wants to merge with H N G as almost like a kind of poison pilled like make the combined company too big for Jacobs. Are any other reader to pursue? So they negotiate to deal into north and a buying H N G for two point three billion dollars, which was a forty percent premium stock Price.

which is big. I mean, usually the floor of what a board to, I accept, to something around twenty percent, but a forty percent premium. They paid a pretty penny to go by. Candle ys H N G here.

IT wasn't quick case of mino swallowing the whale like they were closer in size than the capital's A B C D E. But definitely into north was the bigger company. But IT was clear that lay and the H N G guys, we're gna be running the shell from then on.

Hm, yeah I think the death iy cleans. So IT puts IT in this way where it's almost like in our north godhood wink, where they knew they were paying a lot, but they knew I was important to get. But then once they started looking at the deal with a couple of months of retrospect CT, they were like, wait minute, we gave H N G A lot of board seats and their executives are having a lot of influence on the combined company. And wait a minute, we just gave wait the company.

yes. And specifically, this culture clash manifest in the question of where the headquarters for this new company is gonna. The old into north management team and board members.

They, of course, want to keep the company in oaa. All the board members are sort of of politically connected in omaha. They, like you, would not want this company moving to the big city of houston, taken all these jobs at a oma.

It's important that the company stays here and lay. Of course, he's very political. He's very diplomatic heart of willing to say the right things to appease the board.

But he has no interested in moving to omaha like he's in the big city in houston. He's a player in the industry. He's now a texas oil man. He wants to stay in.

He's them. yeah. And to be super clear here, inter north had a ridiculously valuable hard asset. This is now quoting from bathie book. Among its twenty thousand miles of pipeline was a genuine prize. Northern natural, the major north south line feeding gas from texas into IOS, minnesota and much of the rest of the west. So this is sort of the first example of someone in and on land getting the Better part of an economic deal even though on the other side of the deal, there is a real hard asset that has quantifiable value for and users for customers yeah eventually .

as well see they give up on even Carrying about that. yes. So like, say, this culture clash between the two companies manifest itself in the headquarters location.

So what do they do? They do what any managed with the regular would do when you're trying to justify your decision to the board. They hire mckinsey and company.

You can make this stuff .

you don't can make this time this pick up completely freking key to the story, like no headquarter study, no n run. Uh because the desk on which the assignment lands is a Young hot shot super star junior partner at machinery in the houston office. One, Jeffery skilling, who had joined mckinsey, harvard business school, where he was a Baker scholar in the top five percent of the class.

And famously, I think he had quite the reputation there. I think you, I was happy to broadcast the story he got in, because the a dean of harvard business school interviewed him on a trip to houston. I think skilling was working in houston and at the time you had graduated from mm. u. And the dean interviewed and asked him if he was smart and skilling replied to the dean, i'm I think smart and he didn't say in exactly those words .

is a family friendly pocket. You know, we're not just skillings.

although we will actually say the words of some profanity that killing others later, because IT is absolutely key to the story. Skill shows up in omaha to present to the board his findings, which is that obviously, the company should be unused. And even all the political wrangling aside, IT makes sense that the largest pipeline company in the world at that point time should be based in houston.

not a Normal house. And we should be clear here. There's this interesting thing going on at the time with natural gas, where it's sort of perceived as the good guy and you're already starting to see this american iron toward the dirty big oil and coal and natural gas, which is, of course, a previously thought to be useless bye product of extracting crude oil.

You can make gasoline that you make all this great stuff out of crude oil. And then there's this natural gas which didn't have great use cases until lots of scientific discoveries and reasons why we all use IT to heat our homes now or or many people use to heat their homes. But IT was viewed as this sort of like next great frontier of saudi clean energy. And so was a place where a lot of people in the energy business wanted to be going.

yes. Oh, such a good point. I'm glad you put here. We should discuss a little bit. Natural gas had lots of things going for IT. One was soft of the environment, all, you know, cleaner than oil, you know, all that too was that certainly IT was the first part of the energy industry to be deregulated enough that you could do interesting things with IT.

But three, I think probably the biggest tail wind in its favor in amErica was, you know, you said oil had started to develop the started dirty connotation. I think a lot of that was because of OPEC and oil embargoes like here's this foreign il that amErica is dependent on I mean, even to this day, like you know, how much are politicians campaigning produce our dependence on foreign oil? Yeah, August back to the one .

thousand nine and seventies. Yeah yeah. It's interesting how a the natural gas was the sort of electric power of its day in terms of perception.

IT was the test love one thousand eight.

Not to mention there's all these just phenomenon, all other not on effects to a way you can pipeline and you move IT all over the place. You can store IT really easily. You can store lots of energy in a super dense way in case you don't IT in one place, but you do need IT another has these great sort of natural properties that make IT not only really useful for the end consumer, but as the deregulation is coming in, IT makes IT a great asset to use in your free market enterprise.

okay. So back to this fateful H. N. G.

Into north board mining in omaha. I think this is now ninety five thousand. Six skilling. The hotshot machines is consultant is sitting there in the waiting room, getting ready to go present to management in the board when the prior C E O, the number one member lay is number two after the merger walks out, an informed killing that he's going to keep on going because he has just been fired by the board and lay has engineered the queue that lay is now the CEO of the company. So they're really a much time for the headquarters discussed in this board meeting.

And what time they do have the board is like, no, obviously we're keeping him in the omaha and lays the consulate. Politician he knows Better than the press is likely like he just got what he wanted. He's not going to fight with his new board at this board .

meeting to the very end for kenly. I don't think you ever said anything in a public or suda public context that was confrontational or pissed anybody off .

to the very bitter end. So the headquarter er's move does not happen at that meeting. IT does happen shortly there after. But this is where skilling and lay meat for the first time and lay comes out his very sort of politician manner.

After the board meeting is over, he apologizes to killing for all the drama, he says, you look, i've read your work on the study. You really did an excEllent, excEllent job. Like I would love to keep the relationship going with you in machinery.

We're going na have a lot of work to do at this combined company. I want you to be our mckinsey partner back in houston who's going to lead a whole bunch of strategic condition tips for us. yes.

So IT begins and so IT begins. So lays now settle in. He's in charge, he's chairman, he's the C.

E. O. And he decides that he wants to get a new name for this company, ato H N G, into north. That sounds too old and know it's breaking ing of his predecessor.

And IT is true that all these energy companies had just the worst names. I mean, it's all these like completely meaningless prefixes. And so fixes like co and corp and into and it's like an office space intertech. They're all named something like that.

yes. Well, maybe this is the begetting of the modern era of that because they go and they hire very expensive naming in branding consultants. The log a would actually come a little later, but including a few years later, paul rand would design the and round logo. This would be the last logo that the legendary poll and designed .

before he died. He, of course, designed the IBM logo, the next next logo, the U. P. S. Logo, maybe.

And he very much has his style. C, you think the IBM logo, or if you know the next logo, you know Steve jobs is next leg at the n round. Logo is like they're .

all kind in the same style. A, B, C, yell, press.

westerhouse. Westing house. Yeah, my grandfather worked for westing house, really.

Yeah, the legendary and run would be the last logo he designed before he died. Wow, what a legacy. So the naming consults separate from paul.

They come up with a brilliant new idea for the company. They want to name IT enter on almost, almost. Lay loves IT board loves IT. Lay loves that. Everybody so excited, they announced that.

And the name comes from its support monto N E N for energy T E R as a nod to into north, get that to legacy back in there and then on at the end, because that sounds cool and modern. Enter on so you know that they didn't check though in the dictionary, because enter on is actually a medical term IT is a word IT is a medical term. IT comes from a greek word, and IT means the industrial digestive tract of a living creature and is particularly used for embryos.

So like, but the digestive tract of embryos is an enter on. So they kind of get piled in the press for this leg. So concerned about appearances, he goes, not lay, never loses his cool as well.

See throughout the story, he loses his cool here, goes completely ballistics, yelling at the naming consultants. Everybody demands that they do another study change IT. And so they come back.

Now, what if we just get rid the turn and we saw that to and around, which lay probably love because he's like getting, you know, hate those guys. There was the old guys get rid of them. So he ends up getting exactly what he wants.

Headquarters moved to houston. He's the C E. O and chairman, iron future looking, you know, IT is baby is a refounding. You know, new story, new era for the energy industry.

yep. So that sort of the end of chapter one, you get this merger. The real pipeline companies, they have got hard assets. They have sort of a new corporate culture with a new leader and they're delivering .

real value to customers. Yep, and they're running the probe o trading playbook that lay pioneered back in his early days and pretty quickly after this. They actually face their first trading scandal.

Did you read about this? I did. It's such a predecessor like it's such an obvious personality flaw of kent lays to look the other way.

And it's like, amazing that IT happened. what? Ten years before the big scandal.

So two traders at the new iran who actually, based in new york, they start ezzard money from the company. They're filing fake trades. They are filing fake tax returns.

They're creating false bank accounts. They have a false bank account, famously, I think, in the name of a mr. m. Yes, which clearly to give you a window into the sophistic nature of traders and trading cultures.

just write that out and figured out for yourself. So the company .

picks up on this IT comes to lay's attention. And uh, you know, everybody recommends the company's auditors, the author Anderson, and recommended the board.

the premiere accounting firm of the day premiere .

big five accounting firm at the time. They recommend that lay and company should fire these guys. Obviously, they're stealing from the company. They're false ying trades and lays like, well, you know, this guy is really bad.

It's bad what they did, we should sensor them for sure, know we should set up some controls, make sure this doesn't happen again. But they are really good traders. You know that they really made a lot of money for the firm. I don't think we should fire though, you know that that feels like a big step. Nobodies like um okay.

they were funding money .

to their own bacon, but really let's a slight and he is immediately rewarded for his faith in them and his decision here almost immediately. They do what any software people in a situation like that would do, who just get away with one, they go away, risk on, so they go until and they rack up within the next few months, almost a billion dollars. One b, that's a bee, a billion dollars. This is in the late dates of trading losses. Is that would be enough to bring down the whole for at the get go when you ve got .

to think the enterprise value of the combined company, I don't haven't in front of me, but you had A I don't know, five fish billion dollar company by a two and half fish billion dollar company. And so you know, whole enterprise value, the firm can keep more than ten billion dollars.

and these two bosses just wrapped up a billion dollars in trading losses this time late does fire them, unfortunately for Young iran and for lay.

But unfortunately for the rest of the world, this happens early enough in the quarter that the trading floors able to dig out enough of these losses, that they don't have to a report the whole billion dollar loss come earnings s time and only end up reporting, I think, less than one hundred billion dollars of losses. So company miraculously survives. So you would think that lay would learn his lesson here. But no, this is kind of play we're dealing with.

And let's for a moment say, why are there traders? That's an interesting thing that's happening here. I thought this was a pipeline company. I thought this was a logistics company that move natural gas from one place to another and charge customers for the services associated with that. Well, the traders originally are there, to your point, to sort of help match supply the demand.

You know, it's not like everybody just got a computer in front of them where they can automatically be buying the right products to fit their needs at the right Price at this moment in time, sort of need to interface with people. And those people can quote spreads wherever they want. They can say, ah i've got a cell er for this Price and you're the buyer and i'm sort of sensing that you'll buy for that Price.

Okay, our match makes supply to demand are called a spread. I think I can make the most possible money on this trade and will go with that. And so this is the beginning of them being both a logistics, energy, transportation company and also a financial organza of sorts, a trading desk.

yes. A trading desk, a proto financial institution for the energy industry? yes. So speaking up back to houston and the promised machines, e strategic engagement, it's happening. Jeff schelling is lead hot shop partner to develop a strategic plan for this, everything the new finance, trading, Operations of and run. And one day, scaling has an absolutely brilliant idea, brilliant by his own estimation, and he proclaims that to everybody how brilliant IT is.

What if iran goes one step further from ladies kind of original innovation of creating a spot market for energy? And rather than just being sort of the facilitator or of the market being the pipeline in the middle, what if non started acting even more like an investment bank in this industry, the phrase that he uses for this ideas and run becoming a, quote, bank for gas. And the idea is that they can go to oil and gas producers, to drillers, and they can buy up a lot of the future production that's going to come out of their wells, kind of almost like the old companies used to do.

But rather than andon than being the customer for what's going to come out of those wells, they retook age, everything here. This is the security zone that you are talking about, the medical. And they replaced all of these future energy commodities they sliced in this set.

And then they resell IT to buyers, to consumers of energy and kind of whatever timelines in term length they wanted. So we've gone now the industry from the pipelines, by the assets, from the producers, by the energy commodities, from the producers and then sell them to customers. Lays innovation is like create a market where you let the producers in the customers trade directly .

today in real time spot markets where everyone is subject to, I don't know what tomorrow's Prices are gonna or quote, IT to you tomorrow, so you you have inherent risk, tomorrow's Price could be higher. So sorry.

but that is what IT is. yeah. So skillings innovation here is let's turn this into a full fledge kind of financial derivation atis market and let buyers and sellers right contracts and buy contracts for any amount of this commodity in the you at a set Price. So true futures contract.

And the most sort of early legitimate use case for this is imagine you are a local utility who's trying to provide natural gas to your town. And you know you've been using this great spot market that iron stood up to figure out, you know, what's the Price going to be tomorrow? You're pretty worried about its skyrocketing in the event of some unknown blacks, one event or something like that.

So wouldn't be nice if you could head your exposure to that risk by also negotiating a futures contract where you say, let me lock in a certain rate. And yeah, I know it's going to be more expensive than that is now, but at least nothing bad can happen and then I can sort of be predictable in the way that i'm thinking about what my space gonna over the three months. So that's like a super legitimate use case of one of these futures contracts that they could trade using and run.

You can imagine all sorts of utility here. Yeah, so and one does IT the pioneer this market that would come to be known and is, I think I assume, very, very large part of the energy market today called energy derivatives, scaling and iron, invented and pioneering.

And at this point, the energy is the underlying asset. The derivation itself is not particularly interesting other than its own utility. For if you are actually buying or selling the underlying asset, that's like an important thing to note.

Everyone will lose their heads later and get excited about the derivative on its own. They don't care what is a derivative of. It's a tradition that numbers go up, numbers go down. IT reminds me a lot of some of cypher over the last year. It's like trading doge coin, right?

Does anybody even know what this coin is or is supposed to do?

Does anybody care? No, but I can speculate on IT. And so there is a very interesting, almost innocent, early beginning of why you would offer energy derivative that completely falls apart over time as everyone loses their head, then skilling still outside, right? When he .

pitches this for moment. And the next thing they realized this is A A new concept they need to bring to the market. How are they gonna boot strap up this new teriparatide market? Well, they kind of need the producers to get on board.

They need to get the supply, the raw supply, that they can. Then financialization security, zed, turn into these derivatives. And the way that they can really convince producers to want to to do this is if they fund them.

So just like an investment bank, they now start going up doing these development deals and co development deals with drillers saying, hey, we'll fund you. We will finance your exploration, you're drilling. And as part of financing that iran is going to lock up the rights to then securitize the future production out of your assets.

which again, on its own, not a malicious strategy. Think about a welcome episode. Hey, tony, will you spin up a new venture, the Walker invest, to make flip phones that use CDMA, so we can prove everyone else in the market that CDMA is viable.

Technology will invest in IT. Readers have to provide these strategic assets. You can only half of blab law blaw IT is a common way to bootstrap and ecosystem to use your dollars to incentitive vise other participants to bring a thing into ecosystem.

And you know, honestly, like if the story were to stop there, this probably would be a great company, bringing huge innovation to a commodity market. Yeah, probably this market should work this way. IT should be financialization. Securitized energy assets are commodities. Yep, unfortunately, that is not where the story ends far, far, far from IT. So one thousand, nine, ninety now or a couple years into the lay and run era and lay and the vice chairman of the company, I am rich kinder, who later would leave in run before all the dirt hits the fan and start kinder Morgan.

You can think of rich kinder for now as the hard asset guy. He's the guy that really understands the intrinsic value of delivering hydroid carbons through a pipe to customers and trying to build a company that is just executing really well on doing that.

yes. So the two of them, they work on convincing killing. They think this is a big idea and this is the future of that run.

They work on convincing skillings to leave mckinsey and come over and join nan as the full time C E. O of this new gas bank that they're gona call the iron finance division. And very telling, move tells you a lot about what you need to know about jeff s.

Killing as a person. They're talking about this. They are negotiating. He decided he wants to take them up on the offer, is going to leave my kinsey.

He calls them up to do the final negotiations of the terms of his offer. He calls them up from the hospital where he is with his wife, while his wife is in labor. With there, I think second d that tells you where his priority is lie. Obviously, that marriage does not last too much longer.

How easy? Obviously there.

Yeah, obviously, obviously. So skilling comes in. He takes over and run. Finance starts this new division.

IT is worth pointing out the thing that he made a necessary condition in order for him to join and do this. Do you know what that thing is?

Oh.

I don't IT was that jeff skilling insisted that in order to join iron and start this new division can lay and the board had to agree to use market to market accounting.

I did not realize that going was looking that ahead, admit a condition of its joining.

This shows how unbelievably savi he is. He sort of realize he could not build the business.

He is eating smart court, yeah.

And he could not build a business that he wanted to without doing this. He literally called IT. And this is in the smartest guys in the room. I lay my body across the tracks issue joining the company.

I wonder if we talked about IT from the delivery room.

awful. All right. So what is mark work to kind is worth, uh, because we'll get into this advance. Ch, but let's understand IT conceptual. yeah.

IT ends up taking a while for and around to be able to implement this that will .

get into but go for IT. So Normally, if you are in the business of delivering gas to customers who will pay for IT, you account for the cost that IT takes to physically move the gas when you deliver IT at the time you're delivering IT and the cash that your customers pay you, that's your revenue and you recognize that when they pay you.

But imagine you in a different business like trading stocks, you probably should be accounting for the market value of everything you buy and sell, whether or not you have actually sold IT. Like if you bought tesla at twenty dollars a share and is now with two hundred dollars a share, you should reflect that you have a game. I'll be at an unrealized one. This is mark to .

market accounting and famously, all VS do this right. Talk about mark to of your portal right?

Company raised and up Brown from third party who setting a new Price, that is what the market is saying this asset is worth and you get to account for that value even though you haven't actually received the cash. You know, just because you sold your tesla shares, that doesn't mean that you don't have an unrealized gain or just because VC hasn't realized the liquidity event from that company, IT doesn't mean that the company is not worth more. So killing, obviously really wanted this market to market treatment. And while you can imagine that it's probably easy to abuse market to market accounting rules, IT is probably okay if you can avoid the temptation, but IT is worth pointing out that and run when they did adopt this, became the very first non financial company to use this method.

Yeah well, oh, boy, we are going to talk quite a bit more about market market accounting in a minute, but let's just say the potential for a little tme of abuses hi, very, very high, especially for what is an Operating company, not actually a financial firm. yeah.

Market market accounting to me is the epidemic with great power comes great responsibility because IT really does open up this question of like, okay, well, what is the market Price and how do you discover the true market Price of something once I was not paying you for IT and giving you the cash? Doesn't IT seem a little squishy to say what the thing is actually worth.

Oh, put a IT in that we're going where are you going to come back to that? So um killing, I guess, after this layers body on the tracks moment in the delivery room at the hospital he comes in, he johns andron running the new andron finances division where he see of the division, he gets a big equity stake in the company. Time to the performance of division.

Think a lot as we go to this story about incense and the behavior that they drive. So he models this division just like an investment. Think he starts building out big trading floors in the n round office and houston.

He don't wants to have this beat. Just like wall story. You know, here in histon brings on trade type folks, most famously his side character here, mostly because nobody could ever actually figure out of from the outside what this guy actually did IT and run.

But this guy named lupe e who R I was up and run, but this guy getting out, oh, if you've watched the movie of the smart guise in the room, its a really good movie. The movie version of the book is so made two thousands like they use all this weird be old footage so lue, guess that nobody could ever actually figure out from the outside what he does IT in on. But one thing that he becomes really known for is his love of strippers.

And not just conceptual. He would eventually leave his wife and marry a stripper. Yes.

in the movie, I think they literally say he was obsessed with strippers s he'd like, bring him to the office. He'd leave for hours at a time.

every single day after work, go to the strip club. He knew, like all the strip club around usta.

So doing the movie, they are showing all this moral foot. Like this is A A documentary about an accounting fraud and all I said not to nowhere there's all this be al footage of strip clubs. Don't watch this movie with .

your kids yeah i'd like super explicit, be real footage of trip club you like wow.

where that come from? IT was super expensive and it's not like this was actually footage of luu in the strip club. It's B O footage.

strip clubs, loe pie. I think the thing that he did, just like clarify a little bit, is he basically heard the traders think about traders in the eighties. They hire these people who, uh, one of the quotes is if I was on my way to the bathroom and someone said that I could double my pay by stepping on someone's throat, I would absolutely step on its throat. That's the type of people they're hiring to make money both for and ron and for themselves and lupe. I is sort of the cowboy who's sort of flink hurting a mall.

So look, the other reason that we break them up, I guess, because of his obsession with tripper s you, then he said he leaves his wife that he's been with for twenty years. He runs off with the stripper. Because of that, he gets divorced from his wife.

He ends up leaving non well before default. And he sells his stock to finance the divorce for a quarter billion dollars. He makes two hundred and fifty million dollars.

He saw the stock at the top, I don't think, with any notion of what was about to have.

No, he had to finance the divorce.

crazy.

Uh, so he ends up becoming the second largest landholder in colorado, still like a multi hundred millionaire this day.

crazy. Other than a few people who go until like build real value after this by creating real businesses, he's the one who economically benefit the most of any of general people, unable, able in any state at a jail.

The big higher that killing makes as he setting up this division is one Andrew festal, a former banker from content mental illness I bank, where he worked in chicago and he was part of the structured financing division a oy. Annoy had the glorious honor of becoming the largest bank failure in history until washington mutual during the financial crisis.

This is the sort of cloth that fast now is cut from when skilling is recruiting him to come in and run structured finance at iron. He talks with them, and here's about his experience. And he's lake user, are the man for the job.

And you look at andy, fast down, you hear him talk, and you can not want to trust him. He's the picture of a polished, thoughtful finance executive who's thought this through, who has all the eyes dated in the tears crossed. He's good looking like he's the picture of the like, successful eighties confident business man, but with no slime on him. When you hear skilling talk, you're like, i'm not sure this guy is my best interest at heart. The thing with fast I was you actually do think he is your best interest at hard.

He's like the american psychology. He's like a banker. Yeah, he is a banker, accept he just comes from the bank that was the largest bank failure in history.

So he comes in and skilling sets him to work doing structure financing. The primary thing they're doing is they are packaging up these financing deals that and ron had started doing for the producers for the drilling st. Remember, they're n to kick start the market boost strap supply for the terrific market.

So they're doing all these finances for drillers out there, for oil producers didn't really want those assets on the n round books. And so they devise the scheme that they become a one way through are their Anderson, through the accountants and auditors of using special purpose entities to package up these investments that they're making in producers and get him off of the n round books and IT. Turns out they learn through doing this that at the time, if you set up a separate legal entity from the company, a special purpose entity is different than a special purpose vehicle that, you know, people use for investing in startups to days.

This, a special purpose entity, if you set this up as long as at least three percent, three one, two, three percent of the capital in that entity comes from outside investors, you can still have the company itself o ninety seven percent of the economics of identity, and you can remove IT from your consolidated accounting books. You can just wipe IT out of your accounting, say this is now owned, controlled by an independent third party entity. And the test for IT being independent is that three percent, a minimum of three percent of the capital comes from outside sources.

We live in a system that enabled this fraud. I want to keep reiterating that over and over and over again until serbians oxley passed in two thousand and two because of this scandal and some other scandals, but largely because of iron, we just existed in a system where all of this was exploitable. And just waiting for someone who did not have the scripts es to just finally come in and exploit all these loops totally.

There were no lids on the cookie jars. There were no lids, no lids.

And you might ask what this doesn't seem like that big a deal. Imagine these things are like hugely loss making, but you're trying to go tell equity investors, people who own and on stock how great your company is. IT would be great if all their losses weren't showing up in your financial statements.

And one doesn't care about the quality of the assets or projects that is investing in with these producers. IT just wants to lock up the contracts for what someone would project. The future oil and gas is going to come out of these wells.

And one doesn't actually care if they are well runner, they're going to make money or evaluations makes sense. This one lack of the deals. So they lot of really bad deals.

Yeah massive inside of me slightness. And you say we we're going to get in a market to market accounting yet, but I have to index ce. okay. So i'm in run, I make a crap investment in your oil production project and I say I want you to exclusively trade the financial derivatives around all the natural gas flowing out of your production facility through and run and you say OK and I say, how much do you think is going to eventually flow out of that?

And you tell me a number and I say, well, if I take the most aggressive possible circumstance for what the Price of that could be over time and the amount of volume that that could produce over time, and I take the most aggressive possible stance on the amount of interesting financial instruments that I could make out of that, I think you and I can agree that this deal that we're signing is a ludicrously valuable deal for me and run the right to generate all this revenue from trading the assets that come out of your production facility. Let's write this down. Let's paper this the discounted future cash flows of all of the money that i'm going to make from your production facility.

That's really big. What you're telling me, these numbers that you put on paper that maybe I encourage due to make them higher.

right? That's really great. I don't care about my equity investment in your thing like we're going to put that often to a special purpose entity. We're ever going to talk about IT again, I don't really care that is zero. But hey, I use mark market accounting.

So because I just signed this deal where all of the future cash fulls of this thing are looking really good, i'm going to recognized that is revenue today. And I know not cash today, but my income statement here. You Better bet that I am generating a turn of income from this deal that we just signed OK.

So there is a bit of both story and exportation we got to talk about here. So if we have talked a bunch about market market accounting despite killing apparently laying himself on the tracks about this being non negotiable coming in, IT wasn't like and ran could just say and skilling could just say, oh, we're doing market market accounting.

They to make the case to are their understand of the auditors that Anderson could get comfortable with them doing this. Anderson says, like, I don't know, this is really out there like very borderline, that you guys could use market to market accounting as an Operating oil and gas company. I don't know that we feel comfortable with this unless the S.

C, C signs off on IT. And so skilling is like, great. Let's take this to the S.

C. C. So Anderson and takes IT to the sec. The ssc rejects IT.

They come back to skilling and they like, as expected, the S. C, C is like, this is crazy. You can do this skillings. Like, I want to go talk to the S.

C. C. And he's a lucrine ly compelling character. There is an intellectual purity about him, where he can create an argument that sounds really, really compelling.

This has worked for him many times in his life. So he's like, sure. Leggo explained to the sec.

They'll get IT. And he spends this story that amazing. The S.

C. C. Somehow becomes convinced that this is a good idea. And they sign off on IT.

I think this is really an interesting points story. This is the only instance where you have someone who is complicit in allowing iron to run the playbook that they did, who doesn't have a conflict of interest. Anderson, tax was getting paid tons of fees. The lawyers who signed off on lots of stuff over the years, we're getting paid tons of fees. All the employees at all the stock they were incentivize for IT to go up.

Yeah, this is the one really puzzling one.

This is one word like the person whose job IT is at the esc to approve this or not approve IT, they don't have a vested interest.

Here's a probably also a good point to bring up the arthritis in conflict. It's not just that everyone is a big auto claim for him at this point time. Please surveys, actually, in preto fall of artha Anderson, all the accounting firms had attached consulting arms under the same roof. So Anderson had Anderson consulting, which would go on to become actually after the demise of Anderson.

This is nuts. I know the guy really grass. This.

the conflict .

is among this whole thing, took down Arthur Anderson. And what they did for the consulting ARM was the rebranded at the center and span IT out into its own.

And at this point time, all the senior partners that the format is one in the same. They're all making money from these engagements. Andron became Anderson's biggest client in the world.

They were making fifty million dollars a year from iron, half of which was ordered in tax fees and half of which was consulting fees. At any point time, everyone could just maybe be hard for them to switch their auditors, but they could switch their consultants at the drop of a hat. There were huge incentives for Anderson and till let them get away with what they wanted to keep the client happy. IT was their biggest client in the world.

There were no lids on the cookie jars.

okay. So miraculously for the evil guys that this gets through the S E C. Now we've explained a little bit thus far about how good market market accounting can be for and run. It's so much Better than that. Better.

Better for running a pumped m.

This is where the whole thing comes together. And just like an unbelievable way, the parallel cyp t they're crazy. Once the implement market market accounting, then you explained a little bit the deals there a minute ago.

You do a deal with a producer and you say, hey, whether or not you're going to be able execute on these plants, let's pump up these projections, make them look as big as possible. And then I iron will recognize as a revenue today, my projected cash flow is based on this excel reached for the next twenty years. The ACC allowed them to go out to twenty years that they could collapse into today revenue. So twenty years of future cash lows. I mean, we've recognized that as a revenue today with like no expenses associated with IT.

Here's why you could argue that sort of fair because there's at least twenty years of future cash flows baked into the stock Price of any asset. So you know, if i'm buying a stock and holding IT on my books in the enterprise value of that stock, I am accounting for twenty plus years in the future of the cash lows are coming up.

And then and you know, one other maybe sliver of a justification in our world talking about this sounds utterly and sand like. You know, you're talking about like startups, new projects. Who knows if these things are gonna text startups or what not? This is a different world, you know, alien gas.

You can be pretty sure if you have a site of geology, site that you've done enough exploration on the site, you've decided you're gna build a well, you can be pretty sure you're going to get asset out of that site exactly how much on what schedule you don't know. But like you're gonna get useful commodity stuff and there's going to be a market for that commodity. You will make money out of this site, how much money that is up for debate and what the Price of the commodities will be over the twenty years.

That's also fluctuates. That's up for debate. But it's not like you're not going to get anything how to this.

okay. So that's partial one. If my market market accounting is just this, but nan's uh, for iron, but it's double that.

Remember, these special perfect entities is killing and fast or are now setting up and they're offloading. They're selling point quote, selling these assets that and one doesn't really won on its books. They're selling off to the special perfect size because those are also transactions.

Iron now gets to book those essentially phony sales as a revenue. So they're double different. They do a deal with the developer. They recognize this revenue. Twenty years of forecasts of cash flows out of that said.

oh, just from their equity value in the project.

Then a week later, they turned around and they sell that project. They're equity in that project to a phony special preferential for some astronomical Price. And then they recognize that value from the transaction as revenue even though they own ninety percent of the entity that they .

just sold IT to crazy. And all the while, I no cash has .

actually changed hands totally. This is like the ultimate ani scheme. wild. It's totally wild. So all of that is bad enough.

Let's make IT even worse if you are trying to create as a beautiful and amazing a income statement as possible. Obviously, market to market accounting is great for all the reasons we and investors love IT. You can inflame your revenues hugely etter at r.

There's one problem. And that problem is that at all one time, this is the opposite of A R R. There is no recurring revenue.

here. You are taking all the future income revenue, cat ho, you're collapsing IT to a single moment in time. So whatever deals you do in one year, you're starting from zero. The next year, you get no future benefit on your income statement from deal.

You're freezing every amount of possible upside out of the future and into today. And so you're just constantly making IT harder on yourself to achieve anything in the future because you've already recognize at all. And basically, if you don't do borrow different deals next year, IT doesn't matter how good at every contracted variety sign is and how amazing all those projects are doing, you have an actual zero in your revenue category without doing more deals totally.

And so like any house of cards here, this all looks great. But there's literally no way that this doesn't all blow up. It's all just completely inflated. Once they start down this path, there is no scenario where this ends. Well, it's just a question of how long the fuse is until the bomber is up.

Yeah, you're borrowing on the future in such a big way.

well. And because there's no underlying reality at a certain point like the deals couldn't quote that they're doing on the front end are not good deals because everybodies incentivised to pump the numbers. The producers are incentivised to pump the numbers to get more money. Andrs instead vice to pump the numbers to book more revenue even though they're paying for the deals. And then the bigger the deal Price, the bigger the value value that they offload IT for to the special purpose taties that they book their revenue again.

yeah. And the most devilishly difficult thing about all this is once the train gets set in motion and you start putting up these numbers and you start reporting them in your financial statements, you massively catched the attention of investors, and you then have to keep IT going because people start to invest. Your stocks starts to go up because no one seen an income statement like this.

This is crazy. This is the future. There's lots of reasons to believe that it's going to mean not. And you start believing the numbers, you start committing other people to believe the numbers, and then you got ta move mountains every quarter to make the numbers keep going up.

So this whole deville st. Fly will really gets put in place by nineteen ninety six, like it's really humming and they would have a five year run from one thousand nine hundred ninety six to two thousand one, during which revenues grew seven point five x during those five years they went from thirteen point three billion in thousand nine hundred ninety six sex to over a hundred billion in the year two thousand. And every year during that period, from ninety six, three, two thousand one, the company would go bank up to the end of two thousand one.

which were the six years that they were fortunes. Most innovative company?

Yes, fortune magazine. Remember, this is going to come back up with the particular publication named the america's most innovative company, and in the year two thousand, also named them america's best managed company. Uh and valuable.

So um back to the midd nineties, on the back of all of these huge wins, the transformation of the company skilling gets promoted from just being head of the enron finance vision to president and C O. O of the entire company, number two, behind lay, who still the chairman and CEO, but he basically just takes on a elder statement role. He's out there smoothing politico s he becomes super close with the bush family, super, super close and fast.

Now he gets quite. The media realize out of this. He goes from being like a jack of all trades, canonic bid level executive in the finance division, to the CFO of the entire company.

And structured finance kind of becomes its own division. They start relying on IT as a profit center, not just like a CFO, to manage the finances of the business, but they're like, can you come up with new financial products to generate revenue on your own?

So when skilling gets elevated number two and fast out IT to see of other company, they start articulating as the company strategy that the finance department is going to from being the shared the resource costs center to a profit generating division of the company. The fact that this didn't really is like massive alarm bells ls through out the entire investor community is just crazy.

The thing I want to continue to harp on is IT would have if the incentives weren't so dramatically misaligned, everyone benefitted from this thing going up. You like the ratings agencies benefited from this thing going up. Everybody who ever bought and ron stocks saw IT going up.

So they wanted to continue to see IT going up these deals. You know the enron's flying around doing deals, you know who they need for deals, investment bankers. And you know what investment bankers also have analysts. And you know those analysts are going to say by IT is just like the whole world was making so much money, at least on paper, from this happening, that why would you ever wanted to stop happening?

And like group been saying, they need to keep doing bigger and bigger deals. So what does non do they start heavily investing in their international division. They've a exciters y to the us.

With all the producers in the us, like we can go out to other countries, both developed and developing countries, and especially in developing countries, we can do these massive, massive production deals they had, just like fuel all of us. So they go to, famously, india, brazil, argentina. And they financed like multibillion dollar energy projects.

India is the worst of them. This power plant that they finance, IT, is L N G. Local financial gas on the coast of india that they find.

But multibillion dollars. India doesn't have the technology, the grid, the demand anyway, to actually use this. The project just becomes this smoking creator on the indian coastline.

I think it's still never opened. The half completed building is still just sitting there .

at various points in time. I think they have technically turned IT on, but not like actually really like yet still just sitting there. But then on books, billions of dollars of revenue and then they off load the as that everything we've talked about like it's just this meta tis zing cancer on the world yeah.

The one thing that is incredible about what their claim ing is the key thing to develop a society is widely available energy.

So there is this notion of like OK, if the way to accelerate a country that is becoming, I don't know if developed country is the correct parallel anymore, but an economy that has high employment, high quality of life, a good mixed between information work and physical work, making real things in the real world, growing gd peg, rapidly, becoming a player on the worlds stage, what's we want to call IT, every single thing requires massive amounts of energy as a precondition. One major reason why the U. S.

Got to be such an incredible superpower is we burned tons of fossil fuels over the eighty years in order to accomplish all the things we have today and achieve the quality of life that most people in the U. S. Have to. So there is a real well founded argument to me made that IT is both good for these countries to come in and do this, and veil needed anyway. So there's a huge market opportunity that we're sort of pulling forward to now by creating a ton of energy capacity there.

Oh, you can really see how the insidious political dangerous of this comfort politically, this looks fantastic. And ron is financing the energy development of india, brazil. Politicians love this. Here's this to innovative of american company who man so as this kids, bigger and bigger and bigger, remember the key on the back end to making this work of these special, proper entities. Now you only need to come up with three percent outside capital, but non starts doing so many deals that are so big and they're all floats, so many assets, IT actually becomes kind of a problem, finding enough suckers to pony up even three percent of the capital needed to be uploading these assets.

And by the way, we should say, how does anyone have a capital because they are not generating a lot of cash flow. It's worth knowing that on the earnings calls, they are releasing a profit law statement. And then like a little few weeks later, coming out with a baLance sheet and a cash flow statement. So you say, well, how are they financing ninety seven percent of these projects? Well, first of all, lot of times they're doing code development deal.

So they're like getting a government to pony up a bunch of a cash and run ponies, upper bunch of sort development resources in people, which, by the way, they are terrible at because actually what they become good at as a financial dirt s trading firm and not actually having the human power to go and execute on building these really complex projects. But they are getting cash from somewhere where they get IT from investors, the american public. So as the stock starts to run, they do more and more issuances of new stock at these new strategy, spheric Prices to bring cash in the door since the Operations are not actually producing a lot of real cash. So the fly will sort of looks like pump the stock, issue more equity, take the cash from that new public funding aries that you've just done and shake in the american public, the tree of the american public, take that cash and use that as the sort of ninety seven percent that you need to stuff into a special purpose entity to go and financial project.

It's actually it's used that cash to finance these crappy development deals they are doing all over the world. On the back end, there's actually no cash because n run is the buyer and the seller, they're just taking IT off the books. They're not actually buying anything. There's no cash changing ends .

ah and so you really start to wonder, like I don't think this was the plan the whole time. I think that was the that once you started needing to show growth and you've already pulled forward all the revenue out of next year in the last year, then you gotta do something and you have to get infinitely creative in your way to show income on the income statement and see you start spinning up all these divisions to do crazy stuff.

So like we're saying, that dynamic gets the point where it's so big they can't find enough suckers to even do three percent of the equity and capital in these crappy deals again in rounds on both sides of even though the special property tidy is independent. So faster and skill to come up with yet another brilliant idea, rather than going doing road shows, signing up in on other entities to do this. What if they had their own fund, a captive fund, part of the end around family, but was separate, was independent, that could put up this three percent of the equity needed for every deal?

God, we could call this episode arms length, but not really.

So they, they go to understand milk. what? What if we do this? What if, andy, what if fast now sets up this fund and is the general partner in IT and we only use this for you to stuff that helps and and like, yes, he's the CFO of iron. It'll also be the general partner of this fund. You know it's going to do deals with any and it's only deals that are gna be good for anyone and understands like a that seems really bad. You should probably go to the board and get sign off on this very, very obvious conflict of interest.

yeah.

So they do. They take this to the board and they present IT passed out, presented to the board is like i'm willing .

to fall on this sd, to do this for you guys.

I'm taken one for the team guys.

Never mind the fact that like he has full private equity economics on this deal. Never know if it's two and twenty or whatever is, but there is management fees there is Carry like he is the general partner of a private equity fund that is only getting good deals because you know that he is gonna screw and on to get the private equity fun to get great terms on these deals. Uh, so he's pitch in the board.

He's pitch in the board. The board is like, great. Thanks for taking one for the T.

U. andy. This is going to be great for anyone. Really appreciate your hard work. Basically bunch at a boy and slapped on the back. So yeah, as you mention, this is a private equity fund that he gets to present management fees. Twenty person of the profits ends up across a series of funds being hundreds and hundreds .

of millions of dollars. Studies that I think fund one was small ish.

but fun two was two hundred million. Actually, the minute here, the management fees of a fund, in theory, supposed to support the cost of ring the fund, you know, like head count, aries, rent, office space, all the resources you need. He's the C, F, O.

Everyone, everybody who works on the fund is an end run employee. N run is paying. The self is of everybody.

The office is in run. There's no headcount, there's no funds. You know, all the bloomberg terminals, all the legal, all the accounting.

he's pulling someone off their day job every time they needed, negotiate a deal between his fund and ron and saying, okay, you wear the non hat on this time and negotiate against me and all where the private equity hat and they're calling that arms length.

So all the manage of these, there's no expense at the surgery flowing to him. The real kicker, you are joking about this before the, and that should have told everybody where his real incident of lies. He decides to name the sweet of funds, L, J, M.

capital. What is L, J. M. Stand for? IT stands for lia, Jeffery and Matthew, which are the names of his wife and kids. So there is no question who is benefiting from what is going on here. And it's not, in run.

unbelievable. And there's the square list most circuitous route to trying to find disclosures on this. Whenever it's convenient to say so, there are claims that the board was fully on board with this. Whenever you are looking for the smoking gun is really difficult, find anyone signatures or discussion of this in the board minutes.

It's especially difficult to find just skilling signature on anything even though the whole agreement was skilling will sign off as the final approved on, I think, deals, but definitely faster s compensation from this. There are documents that surface that have a variety of signatures on them. But not guilty. He very intentionally was like, uh, not actually gna sign off on this, but it's kind of good for everyone that that happens. So i'm going to let keep happening.

What is is good because these funds, this vehicle, you know, everything that fast is now running, can put up the three percent capital for this special preferential, so they don't need to involve any outside people in all of this.

Not to mention all the people investing capital are these big banks. And so IT further entrenches major financial institutions, maryann J. P.

Morgan, all these big people that and ron wants to continue to have incentivise further success further in owning assets that are associated with them. run. yes.

So everybody in non is so helped up about this that in one thousand nine hundred ninety nine fast out starts a campaign with iron, with lay and skilling in the P. R. People in nra to get himself nominated for the CFO of the year in the CFO magazine annual rankings of c he ends up not winning, but he does get a special award from CFO magazine for CFO excEllence in the category of capital structure management.

So they do, over a few years, tons, tons of these deals. And two things are always true about the deals. One fast out is finding a way for fast out to benefit and and get rich.

You know, L, G, M, we know who number one is here. Two, and ran also benefits because it's now just turbo charging this whole fly wheel in getting the bad stuff off the baLance sheet. And booking revenue is associated with these deals eventually.

And rn also makes fast out the head of corp. dev. So he is now the head on all sides of the transactions. He's the CFO. He is the head of corporate development who would be the person charged with negotiating the underside of the table against the outside investors that will. But he runs.

Everything is so, so wild at the time that they do end up actually disclosing this, which I don't want to flash too far for it's worth showing this detail. They do sort of disclosed. They say, oh, there exists identity that's managed by a member of the management team that does deals with thn run like one sense and then when the shit really hits the fan, they say, oh, well, a previously disclosed entity did deals this quarter, but that's been previously disclosed. There ends up being like a billion dollar a loss or some crazy, don't quote me on that, but some massive, massive loss. And they'll like all we disclosed this whole thing before and IT all tied back to this one sentence or they're just saying a member of the management team has a related title that does transactions with and run.

So this is where everything starts on ravel. Investors in the media start asking around about this, like by this point time, or now in .

only two thousand and one.

a lay has now step back to just be chairman. Skilling has been promoted to the CEO of the whole company fast or still CFO plus, head of cord plus running these LG m funds, unrelated funds, people turn, ask around about what's going on on and and and people assume when this discourager comes out that is skewing who's running these funds and like, oh my god, is the C E O doing this so um I think it's the world street journal calls up and run P R. And they're like, oh, what's up? P, R, and like and then and P R is like, I know it's not getting, don't worry, it's faster.

Which is immediately three.

one of the still one of the us. Everybody hated festive, apparently especially laid .

in the game here because people could figure out that he was getting rich on these L. G, M. structures.

He actually had. L, J, M. Three was in the works to be a billion dollar fun. And if that came together, he was just onna, peace out and go do that.

You just can't make this stuff up. So as that all starts happening fast out and skilling in the company and eventually decide R I and d, you've really taken one for the team here. You can either stay at non be the CFO and had a corp dev or you can go run these funds.

You can no longer do both. People are asking too many 是。 And so fast ague asked for some time the weekend to go think about, to talk to his wife, comes back to scaling and he's lake.

I'm loyal iron. I'm staying here. I'm going to give up and to sell off my interest.

sell my interest. I going to get all my economics out of the interests. While there are an all time high here.

does back before the funds, when they were just doing kind of one off deals fast, i've had a direct report in the finance organization 概念， Michael copper. And he and copper came to A A understanding a lot of understanding .

around this company.

And here's this giant cookie jar of all these deals that then round doing and there's no lid on IT and they could kind of work together to skim a few chocolate chips out of the cookie. And so they were in khuds together, and they've done a transaction together where again, before the funds, one of the investors that come in on one of the projects was campers, the big california state employee pension retirement fund. They had done h one of these offloading projects with and run.

this is with iron energy services. This was one hundred and thirty million ideal ji, yeah. Do you know speaking of X, T, X, who the other big investor was along with calpers?

Oh, I don't know.

I didn't see this. You cannot make this stuff up. The ontario teacher is .

pension plan. I think I can see that. Ah uh, who are also, of course, big investors and F, T X, right? yes.

Oh, so this particular entity is called the jete entity, the kelpies in the ontario teachers fund. Hood invested in and and ran and faster. I wanted to do an even bigger deal with.

I am helpers said, okay, I we're interested in a bigger deal, but we want to get our capital out of ji one, get that capital out, put even more capital into jet. I too. And so fast I was like, aha, I see an opportunity to enriching yourself.

So he draps copper into service here, and they create an entity called tuko, short for tobacco. And sticking with the star wars, the am here. Remember, this is all got to be fully independent.

But fast and copper both work at and run. And why did fast now target copper as as a couples here? Copper was game. And this is the nineteen nineties in america. Gay amErica is not legal in texas.

I don't know. He was legal anywhere.

Certainly was not legal in texas and IT was not legal federally in amErica at the time. So coppers domestic partner, a guy named bill, does son. He's not legally married to copper and he's not part of any run. So they set up dodson as the outside investor in tuko to buy out the judy assets from kalpas, and then fast out and copper create a secret spread chy. This is the begin of their certain affaires .

deals together when the second set of book starts being created. That is a dangerous time.

yes. So on coppers homo laptop, they have the secret spread shi, where they keeping track of all the deals, where they use dodson as the front for any time they need to offload from the offload. They use this deal to enrich themselves.

How any these guys plead not guilty.

unbelievable. And so copper starts cutting checks from all the money they're making that dodson is making. Copper starts cutting checks to leave a festal and his life. And so that's how they spread the money around.

unbelievable.

So now flash forward back to an and is once again taking one for the team and selling off his general partner membership in the L. G. M.

funds. Who does he sell IT to? He sells them to copper. wow.

And they use the same scheme for andy.

Of course, they still stay involved and be getting a at least of fifty, fifty of not more share of everything.

And this is like you when he's fAllen into his knees and told skilling, you're the only girl at the dance. You're the only one for me. I'm for going this whole grand idea I had around all these economics from the L. G. And partnerships.

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It's probably worth flashing back to like the nineteen ninety seven time for him to start talking about what was happening outside the office of the CFO at run. Because they're go and nuts. They've realized that theyve accounted for all the future points on the board last year.

And so they ve got to do a whole bunch of stuff to show a bunch growth because boy is the stock pumping and boy is the stock need to pump in order for them to continue all these new equity issuances to give them the cash to do all this wild stuff. So they've got the pipeline for not particularly interested in that very old business that's kind of hard to warm, fake or tinker with the innovate on top of. And so they're like, okay, the trading business, you know sometimes we take big losses, but sometimes we wild speculation can give us really big profits or at least paper profit.

So let's trade more stuff so they get in to the electricity business. So this is for the first time they move beyond natural gas. Of course, they find out that trading power is hard because unlike giant's pipelines and tanks where you can store natural gas, you can store electron's famously, batteries are very inefficient ent.

So it's not you can charge up batteries and store all the electron's there for a while until you need them somewhere else. You basically need to be producing the electrons at the exact same rate that you are consuming them. So that makes an electricity market interesting, but much harder than what they were doing, a natural gas.

They also expand into water, especially internationally, that also very hard because all water droplets are not created equal. There's different impurities, different Cindy ties that you have to treat. Of course, in the U.

S. There's also no federal order requiring those who own water pipes to let anyone move stuff around inside of them the way that you have in natural gas and electricity. These people who owe the water pipes own the water pipes.

And if they want to tell you you can't put your stuff in here and you can't make money off our asset, they're lot to do that. So what else happens? They spend up trading teams for pope on paper, whether derivative fit medals trading until they finally stumble on the thing that is really going to make that money. Band with fiber optic network internet band .

and around .

the tech company and .

around the tech, the stock goes nuts when this kids one quick note that we would be remiss if not talking about on this episode with regard to the power trading that they get into electricity trading. They become a key player in the total disaster, that is the california blackouts.

It's hard to know if they caused IT or if they just profit IT from IT. They certainly .

profit IT and they might have .

helped cause yes. So what happened here? This is we're talking about. So the california power markets were being deregulated, much like the natural gas markets, but not fully the enron traders.

Who are these pure capitalists? Are these peer sort of like if there is a dollar on the table? IT is my ethical responsibility to go take IT, no matter what the impacts are, because I have an intellectual purity.

I don't think a lot intellectual, a justification going more visceral.

No, I think there is. I think it's a deeply philosophical thing. Or people believe that free markets are virtuous. And the only sort of virtuous thing to do is to have everything be a completely deregulated open free market and lay the rules of the game out clearly, and then play the game. However, the rules say that you can play them.

Guess english, two classes. I think the killings, and like the cannet lays of the world, fit that, bill. I think a lot of the actual data day traders are more just like, read me, need to like trader make money.

guys. yeah. So what happened here? Well, the state of california decided that they didn't want to go full free Marks. So the'd put in lots of safety measures.

That ended up being the opposite of that because usually when you add a new sort of mechanism into a free market, IT can be played in a variety of different ways. So on the one hand, IT seems reasonable to have controls in place. On the other hand, that entered a lot of new rules under the playing field for these traders to exploit.

So people would run experiments to test. If they were exploitable, they would see the results, and then they would go hard and they would be rewarded for going hard. And so you know, a company is not on the right side of history when memo starts circulating on the floor with names like that star, fat boy, get shorty and rick.

These are various trading strategy in the california energy market yeah just .

four of the trading strategies, but it's worth articulating some of the crazy stuff they did. So what is death star? Well, he was this experiment where iron went into the market and filed an imaginary transmission schedule in order to get paid to alleviate congestion that didn't really exist.

So this sort of like, can we Spike something to watch the impact on something else and then make money from a contract on the impact of IT somewhere else? Or fat boy was a scheme where and ron would submit scheduled to the marketplace, reflecting demand that wasn't actually there. And then watching what sort of happened when that the man tried to be fulfilled and there was nowhere to put IT.

So then there was a big extra amount of electricity being produce somewhere they can profit from that get shorty selling power that and ron didn't actually have for you as reserves with the expectation that and ron would never actually be called upon to supply the power. Or I could just buy IT later at a lower Price. Or the worst of them all, ricki or iron, would work with someone who's generating power in california utility.

Is this where they have them shut IT down for?

No, this was where they would export IT out of the state, and they had control over the transport on line so they could do that. And then when california realized a crap, we need energy, then they would have a contract in place where anyone would get paid to bring you back in a much, much higher Prices, which the industry was start calling this mega launder ing, because that's really what IT was.

And I think what they would do is part of IT to his color generation plans, where they had relationships ts, and like encourage them to shut down for maintenance at specific points in time when they knew IT would caused blackouts .

and Spike the Price. And exactly what I did. So I mean, I am confident that people died from this. This is one of those things we're like if you're randomly depriving huge sas of california from power, hospital, schools, people's homes, it's not funding games. I mean, that is profiting from terrible harm fold activities to people.

And this has such far reaching impact. I mean, this was one of, if not the, major reason the california governor, gray Davis, gets recall and then annual sports and eager gets elected governor. Like this was the key issue. And and around another trading companies were totally manipulating the market.

So power trading, this whole thing is going on. That sort of one corner of and ron, another corner of and ron, is this thing. And ron energy services, which this, I believe, is the division that love pie ran, yes.

But in ninety seven, this was the current hotness for what to get investors excited about as the future of that run because they sort of had done the we're a pure marketplace than were a financial derivative. And they got market market accounting and started doing all the international development. They started doing power while and on energy services, is this thing that skilling really wants to sell, this story about how he's taking off.

And so let me just read this passage from the smartest guys in the room, because I think this probably articulates the insidiousness of the iron culture Better than anything else. So analysts come to houston. They tour the sixth floor of the E.

E. S. War room. There they be held the very picture of a sophisticated, booming business, a big open room bottling, with people all busy working the telephones, hunch, dover computer terminals, seemingly cutting deals and trading energy giant plasma.

A screens displayed electronic maps, which could show sites of E, E S as many contracts and prospects commodity Prices danced across. Electronic ticker IT was impressive, recalled john alson, who at the time covered the company for mural lynch. IT was a variety beef activity. IT was also a variety.

Shame the war room had been rapidly fitted out explicit to impress the analyst, though E, E, S was just then gearing up skillings and pie had staged at all to convince the visitors that things were really hopping on the day the analyst rived. The room was filled with non employees. Many of them, though, didn't work on the sixth floor at all.

There were secretary E S. Staff from other locations, non E, E, S, employees who have been drafted for the occasion coached on the importance of appearing busy. One, an administrative assistant named kim Garcia, recalls being told to bring her personal photos to make IT look as if SHE actually worked at the desk where he was sitting.

SHE spent most of the time talking to her girlfriends on the phone. After getting the all clear signal, garci a packed up her belongings and returned to her real desk on the night floor. The analyst had no clue they've .

been hoodwink ked. Oh god, this is like a classic .

boiler room rules. This is great. And that was ninety seven. That was four years before the fall. They were pulling crap like that.

So we talk about the prob and services and internet division.

absolutely, and run the internet company. Suddenly, magically, I mean, this company be started by merging two pipelines. And here they are, the seventh most valuable company in the world, because there somehow the company that's going to capitalize on this new internet thing.

Did you read about how they did a deal with black Peter? This, this is the best. I think this is like.

truly, you can make the stuff .

to required before the .

blockbuster netlist thing and before black bust or even considered streaming. They offered a video on demand product that was provided by non's fiber. Somehow iron was doing the servers and digital delivery video on .

demand being like um if you are like a cable or satellite subscriber on your cable box, you could get video on demand, right? Like this is wasn't the internet. This is an internet streaming. This is like on demand, but via the cable infrastructure.

I think that's right. I think they only had bad movies. I don't think they were able to block of good ones. I don't think however they indebt delivering yet. I don't think the consumer .

demand was really there. The service never launched. But of course, with indian's market to market, they booked over one hundred million dollars in revenue on day one for IT. And then they offload project to a special purpose tty.

One hundred and ten million, even Better, David. So they oflag IT to a special purpose taking. At some point.

They took up the contract. I know of his iron or black bosch, but they basically said, this deal, socks. No one wants this. So you know what they did.

They created an even bigger impact to revenue in the positive direction like more than one hundred million dollars because a new thing had happened. It's not a contract, is the lack of a contract. So now they have the ability to do deals with everyone.

They are not locked into an exclusive deal with blockbusters. So that creates a huge amount of future value for and run the company, their shareholders. And so they literally recognized revenue even bigger than the blockbuster .

deal after the lack of blockbuster. Do I do wicked stuff?

I mean, this is where you're just like you guys are criminals OK.

So before we come back to the wheels, started to follow part in two thousand, one, there's one more peace of the intervening ago years. We should talk about you want talk about and run online?

yes. So of course, we were referring to the band with trading, which also is much more difficult than trading natural gas.

I would like how exactly is that all gonna trading available band with, especially when there's like the last mile problem to everyone's homes and if someone needs more band with in one place than another, like how's I going to work you you just physically and White in the wires or I don't think I think people just didn't really understand these concepts yet. And so there's like lots of excitement around what enron's doing in trading band with around being an internet company. But they actually do launch an internet product.

Now the internet product is really just to advantage their in house business. And this one, to me, seems like it's probably not fraud. It's just an example of like evil, but beneficial for shareholders business strategy. In november of ninety nine, they launch something I god iron online.

And what this is, is IT allows all of enron's counterparties to trade with them electronically so they stand up and exchange like a exchange you can access through a web browser, much like F, T, X. But and ron itself is the counter party to every trade. They don't even pretend that they're not on the other side of most transaction.

哦， i didn't make the F, T, X, almeta connection in this. This is too good.

IT is just the crazy thing where they're just like, yeah, where are the counterparty to every single trade here. So so we're going to generate a little bit of spread on the exchange, and we're probably gonna get beneficial pricing being the counter party because we have the most information in the market for everything that's being traded on here because IT is our marketplace and we're going to use that information.

It's a pretty savy data advantage. Now unfortunately, what they do with that data advantages, they do manipulate markets. And that, I believe, leads to part of the downfall case against them, where they are controlling commodity places and stuff like that. But that I thought in ninety nine, that really is a, is a pretty savy way to use the internet for evil.

You know, a really fundy thing maybe we will talk about this morning. Playbook is at the same time, this is, I think, really best reflected in both scaling and festive. They were also smart and yet also so stupid. The combination of brilliance and stupidity in one person, in one group of people, really something.

it's almost like I was smart, but IT was a cognitive distant where, like, they just thought the rug was infinitely large, that they could just keep sweeping stuff under IT and that at some point that would never become an issue for them. And in skillings, you watch some of his testimony because everyone else pleaded the fifth skilling stood trial and try to defend himself.

He really does look like a who thought he did nothing wrong is crazy to me. How killing. I mean, I think he really was delusional that there was so much innovation here that he thought I was OK. I don't know there are examples of where you could draw different conclusion, but you're right, they were smart and I don't know that they were also stupid. I think they also just had a lot of cognitive discounts that IT somehow wouldn't all come tumbling down.

I've actually been think about this recently, both in the context of F, T, X, and just generally also being any parent makes you think about some other stuff like it's probably good to be smart. It's certainly good to be of above average intelligence, good for you as your success in the world. But there is a certain point, I think, where like increased intelligence either is neutral or negative, two year ultimate happiness. And I think it's cases like this like non like ft, like there's no question that as a lot of the people involved in F T X now over brilliant, but like they're too smart, like they end up hurting themselves, you know. And like the n one cases.

the same thing and is that the smarts are, is at the coker. Ss, because clearly what was happening here is they just thought no one, whatever catch up. I think that is really what started to come out is, I mean, first, I went five years without having to disclose how much compensation he was getting from the L J.

M. partnerships. He just thought i'll just keep self dealing.

but you're in about skilling. It's a little more than that. We're killing. He's the only one who doesn't end up leading the fifth like he defends himself to the end .

which he later says was stupid by the way, he's like, I should have listen to my a council just like everyone else is .

council and this is like the smart, stupid thing like he am. I think maybe it's that he just completely fell in love with his own ideas yeah, because he's always talking about how brilliant is, how I think smart is.

And I always worked. I think that's the crazy thing is that always worked every time to bring back to the story from that ninety nine, two thousand period. And this is, I think, rumour.

I don't think this was in the court documents, but lots of substantiation around the rumor. He managed to convince lay that he should get twenty million dollars in cash if he was not made CEO of and run by the end of two thousand. Like, what I mean, this guy is so good at convincing people to do stuff.

He convinced the S. C. C. That marked accounting would be a good thing, right?

As, like, oh, if you fire me, you have to pay me twenty million dollars unless you, anna, make me city of the company. And the only negotiating position that he had was, otherwise i'll just quit me. You'll be screwed without me. I was quit right now and laid sign that deal. They needed him around so bad.

Ah well, speaking of skilling quitting, let's move the story towards that, shall we?

Yeah so the first cracks in the armor start in september of two thousand. So the stock is still on its way up and hasn't pete yet. But you have a short seller name, jim channels, who for the first time is starting to make noise around just the most basic fundamentals here.

Hey, i'm reading your corner reports and they're completely impossible. You're technically disclosing a bunch of stuff. I have no idea what you're disclosing.

Can you help me understand the business? How do you make money? And you then start to have reporters getting involved because reporters love getting tips from short cellars.

Can shorts sellers have a massive financial incentive to go and investigate and figure out what companies are gna fail? And that's a really good where there's smoke, there's fire for reporters. So you know, reporters start getting involved.

And the big question is sort of like, how does and on make money? And as people start digging with skewing and with lay and with fast down and granting interviews and doing the server stuff, nobody can figure this out. No one can figure that out.

And you get conflicting statements like you hear skilling say that could not be more obvious. You need to dig in to understand our business were very clear. We're very communicative.

We're not hiding anything. And then two sentences later, you hear something like but we don't want to tell our competitors how we make money. So of course, we're share details like that. And you like, sorry.

what the cognitive .

this is just crazy. You so one .

of the reporters, the channels, I don't know one of her or the only reporters that he goes to is death in the claim at fortune. At a fortune, the same publication that dave had around the most innovative invest managed computing america. amazing. yes. So SHE publishes on march fith two thousand, one article entitled is iran overPriced question work.

which is wonderfully innocuous oh, it's merely a Price issue.

It's not that bad of an article for men runs perspective like the biggest question IT raises is not one of fraud is exactly what you said then it's like and round is a black box. Nobody can figure out what's going on here, but there's no accusations of fraud or anything wrong going on. It's set up. There have been some other articles, but this is the first big article I kind of questioning what's going on .

IT and run the subhead is is IT in a bunch of complex businesses, its financial statements are nearly inpenetrable. So why is and run trading at such a high multiple? That is the most innocent ous and reasonable question to ask.

Because when you go and compare IT, you actually do industry comparables before the fall. It's stocks treating in at all time high. Everything seems up into the right. In fact, just in that january, january of a one theyve rebranded from the worlds leading energy company to the world's leading company, literally the subway, the tagline for the company.

oh, can we talk about the company slogan that they used in their commercials, which was ask why, literally, the company, company that would people ask them why, like about how their finances? They can tell you there was .

discussion of whether they should be the world's coolest company. But literally the only reason they didn't do that is because I didn't translate well. So they just went with the worlds leading company. There is video footage of jeff skilling unveiling the new slogan at a shareholder meeting in everyone clapping like, the worlds leading company has not a mission. What do we do?

I want to be the world's leading pog, what do you think?

But that's actually a thing.

I guess that is the .

thing anyway. So the financials it's worth highlighting. The good time to pick is maybe march of two thousand.

IT was trading at fifty five x trAiling earnings, which if you look at, you think it's an energy company, you compete against duke energy, which is a reasonable competitor. It's two and a half times the multiple you like. Um okay.

Well, maybe it's more than an energy company. Maybe I missing something here. It's international company yeah but they'd like OK. Well, maybe it's like a trading firm that maybe it's like a gold sax. Golden sex is only trading at this point at seventeen times earnings.

So why is iron trading at fifty five times earnings? And and he started and like, well, when I can see gold sex is earnings, I can sort of tie IT out to the rest of financial statements and see earnings eventually showing up as cash. But this is a company that's trading two and a half to three times higher than any reason comp.

And if you actually start diggin and looking at their free cash flow or looking at any return on investment metrics that you decide to pick is terrible. There's no cash and there's really no return on invested capital ever showing up. And sometimes they return on invested capital actually less than their cost of capital. So when you look at the cash of this business is awful.

yes, indeed, IT is.

And the first part, the high multiple is and run over Price question. That's a reasonable conversation to have. And this is a good thing that front of the show and reMarks pointed out. When you see terrible returns on invested capital and you see no free cash flow showing up ever or poor free cash flow dynamics, that's probably when there's .

fraught if there's very high revenue growth, very high reported earnings and profit on the income statement and there is low return on investigator and poor free casual dynamics, probably you rate our screens will be going off.

yep. And this, of course, is a thing that short sellers pay a lot of attention to. They look for companies that have all of those matrix that we just described trending and exactly those directions because that's probably where there is a big accounting issue that's about to happen.

And the big connect dissents, I think, is the reported profits versus the cash for because you think about like startups, right? Lots of starts, for instance, can be reporting high revenue growth but be burning light cash as they are investing in growth and Operations in n rad's case. And in the case of a lot of frauds, they're reporting high revenue growth and high profits on the income statement, but also writing cash.

Yep, so people are starting to figure this out. Short sellers, journalists. And eventually, finally, finally, some analysts managed to shake loose of the my job is to say and run is awesome. And they started to ask hard questions on learnings calls because for the longest time, IT has been that you were rewarded for saying, and ron's great, because the stock would go up and then you would look like a genius.

And any time anybody said and ron wasn't great, either they were proven wrong by the stock Price or they would get slapped at work because they're saying, hey, they see huge kind of us. We do lots of business with them. And one did lots of business with everybody.

kept everybody on the payable. So are you talking about the if a seventeen th two thousand .

one earning skull I am where .

one a Richard gartman of high fields capital actually hedge fund and had a short position on in run, asks skilling. I think this is killing's first earnings call as actual C. E. O.

Number one of the company. Man.

he does not go well.

spoiled early because he's been running the big profit center forever in trading and he's been trying to mash era the business and saying with can lay as we're still logistics company. But they obviously ted, the crap out of their segments and their financial reporting can't tell that all the money is actually being made by trading.

Money being made court and quote all the year income being generated on the income statement comes from trading, which you kind of can't tell anyway. So now he finally steps into the C. E. O. Role in is responsible .

for these earnings calls. And here's the question. Tell me if you think this is like overly combative or merits a like nuclear level response, grubin asks why iron, unlike ninety nine percent of other companies out there when they report earnings, why do they only report an income statement and they don't report their baLances or casual statement? And those things only get reported bently, he said earlier in the weeks or months later in the S.

C. C. Official, you know, thank you. And ten klink, why not you reported all at once, like everybody else.

And I think his literal words, he says you seem to be the only financial institution incapable of producing a baLance shit with earnings.

okay. So maybe like a little flip. Yes, a killing response by I forget how you started the answer. He says something like, thank you very much for the question or something like that.

Yes, IT is really says as well. First of all, thank you very much. We, at all。

And everybody in the room about the costs, look around if they like, did the CEO what just happened of the seven largest company in the world just call an analyst and as hole on an earnings call, yes, yes, indeed. That is exactly what what happened.

He does apologize. He says, i'm sorry, i've been at a real sort of lack of sleep. He's been making noise internally to can lay even only a few months on the job of saying i'm not having fun in this job.

Of course, kenley is sort of parting back time and private, closed to our rooms like this was supposed to be fun. I thought this was something you wanted. I thought you knew how hard this was. And skilling isn't thriving as A C. E. O.

So scaling starts spiring. More bad news starts coming out. This is after this, when induce speculation about the california power market manipulation starts coming .

out N P G N E files for chapter of bankrupcy in April of two thousand, one, two.

So things are still going at the attack bubble starting to burst that's affecting the market. The n round stock starts following from the all time high in the fall of the previous year. Just above ninety dollars to share falls down into the forties. So like pretty bad, it's lost like over half its value.

And just to make A F, T, X comparison here, I mean, lots of the time you get away with poor accounting and you know a lots of lay way from investors in a bull market. And then when the bubble pops in, the equities market, like the dot com bubble happened, or january of twenty twenty two happened in text dogs, and you start to see the tie go out combined with other potentially tractive lower risk places to put capital.

You started sort of scrutinising things that were really high risk places to put capital or things that we're at high multiples or things that weren't quite connected to intrinsic value, like crypto, to, like a lot of people are relocating cyp to sing, why am I investing this again? And so you start to have these two things are a little bit different, like the Prices of crypto falls. So IT causses margin calls for crypto hedged funds, which then sort of unravels the whole beast.

But it's the same dynamic of the tide going out, which I think right is a hard mark right course guess to the show and data of you um or .

buffet I don't know which one got IT from the other yeah when .

the tide goes out, you see who's swiming without there swim shrinks on.

But it's so true that that's when the stuff actually gets scrutinized. Everybody was just making money all the way up. And so now that there's real shaking is in the equity of market in two thousand, one from the outcome bubble bursting, everyone's reexamining, everything they assumed to be true before and it's feeling much more reasonable to ask questions like, hey, can you produce a baLance?

So what happens next? Nobody inside or outside the company could predict within a couple months by August of two thousand. One skilling had just taken over at the beginning of the year as C.

O. At the company. In the beginning of August, scaling goes to lay, who's still the chairman of the born, and says, i'm quitting. I am resigning. I woud, I can handle this.

And he sites personal reasons. I don't want to blame this on my family. So I can't in the press release say that I want to spend more time with my family even though I do. All you can say is personal reasons, and i'm out just because .

my mental health is falling apart. And I can take IT.

I want to spend time teaching. I want to do panthry pic efforts. This isn't what I wanted.

This isn't fun. Ba ba blah in conspiracy fools and IT sounds like as the same in smart guys in the room. IT is sort of painted as like, yeah, he really was having a mental breakdown and that was the motivation.

Here you have to ask though, the tide is going out. Skilling is as much as anybody. Everybody y's to blame here certainly lays to blame fast as to blame. But I think you are you killing is like the most to blame.

Killing was the architect of the demise. Lay, you could make an argument, was out to lunch the whole time. He was a key enable, or at the very least.

and fast certainly was evil, but was acting on direction from skilling. Yeah.

sometimes, other times he saw a cash grab opportunity for himself.

Well, he was in sitting for himself, but in terms of, like, damage to the company, and like perpetuating this house of cards, scaling with the architect to the house cards. So you gotta ask, does he see the the times going out in the market? This house is gonna collapse.

I need to get out now. And he started selling stock as he's leaving. And then after he leaves, he sells a lot of in run stock.

And all the executives were at this. Kinlay had been on a selling plan for the last couple years.

So we need to talk about how kenley was selling.

Kinlay was so overleveraged he had received advice from his money manager or saying, you really should diversify. All of your wealth is set up in and on stock is all you've had since one thousand nine hundred eighty six, and it's really run. And so what he does and it's so confusing because he's savi, I don't know why he does this.

Instead of diversifying, he like claims he is diversifying, but what he's actually doing, he is double down. So instead of selling his andon stock, he starts taking margin loans against his andron stock and using that to invest in other things. Now and on stocks starts collapsing, he starts getting margin called. And so he's then needing to sell andron stock in order to service the debt that he used to invest in these other projects.

This is my own speculation. This is not eluded to in certain ly, not in conspiracy of fools. But when I took a step back and looked at what was going on, here you lay is not a boys. Oh, he may have been out to lunch, but he knew what was going on here for sher. And like, he is proudly just as evil as any of them.

And when we say out to launch physically, what was he doing? He was taking one of the iran corporate jets around, sometimes to vacation with his family, is sometimes to pick his daughter up from france, but often to D, C.

to hub with the bush family and other people in the bush administration. And even in between the two bush administrations with the the administration, he gave a much of money there too, and did meetings with clinton administration officials. So I think what might be going on here, yes, can had most of his networks in anon stock.

And then he started doing margin loans against that, stuck with banks. And then we would get the margin calls me would have to repay them. But the way he repaid them was he took cash loans from god.

cash around.

and can backed his collateral for that cash that he ended up then repaying the loans to n run with was the n run stock that he originally had taken the margin loans against. So he got the cash out of and run, used IT to repay the loans that he had gotten the money from the banks, right? And then the repayment mechanism of all this is ken's equity goes back to the company.

So nowhere do sales show up. Nowhere does this show up to any publicly available information that can lay is selling his on shares. IT just looks like there's the entire delusion happening at the company.

The companies, are we purchasing shares? So I think you could make an argument. This is all circumstantial that this is like totally indefer ious, a way to get money out without alerting the market that the chairman is selling.

I think you nailed IT. I think there's another thing that's in smarter guys in the room where they references to the fact that I don't think for his particular sales, they classified under some weird thing where they didn't have to disclose until after the fiscal year rather than in quarter. And so he was able to sell an enormous amount before having .

IT reported yeah all told I think lay cells about three hundred million dollars worth of van around stock via these transactions. Skillings cells about two hundred million. And fast out on a bunch of the other executives sell a whole bunch too.

And fast out actually make sixty million dollars from the L. J. M. Partnerships, from fees, Carry and selling partnership interest. So he actually makes more from the lj, then I think he does, in total.

compete on ever, which the board never knew. And then as everything is really starting to evolve and will get into that now, at one point, the board corners fast out and they asked him, how much money have you made from these partnerships? Ts, and he tells them, and they immediately fire him.

So and here's the one twins of a smoking gun on skilling of why he was quitting, that a wall street journal reporter sort of unrest in a conversation with him. It's an a soda inoculation versatility kind of am leaving for personal reasons about blad. He drops one line and he goes and watching the stock pace falls.

So depressing. I probably won't quit, not for that. And then the report goes, wait, what? That doesn't sound like a personal reason. That sounds like a business reason. Yeah, that's when they can really take that all and run with IT and realize all the layers of what's going on here. A big one was and this is a thing that had got way reformed after n ron, all communication from the company to employees to investors and between the board and executives to set their compensation is about the stock Price, yes.

they're always saying by the stock, yes.

not about any intrinsic characteristics the companies is not giving guidance on. Just hey, here's what we think revenues is gonna be they're not telling employees what you should tell employees, which is I don't really know if this will go up or down, but here's the direction I think the intrinsic measurable parts of the business are going to go. What everyone is telling everyone is I think the stocks will go up. What can lay, what skilling or telling people is, stock should be one hundred and twenty five. What's IT doing down at forty?

This is terrible that these videos you can find of lay at employee all hands where he gets a question card of should employ st investing and around stock in their four one case. This is the same time that lay is doing the structure transactions we are talking about to offload his n run stock, selling his shares and he says, I think you should put all of your four N K in on stock and I don't see any reason why the stock and two or three x what IT is now next year brutal. It's brutal.

And when you comp all these executives and the incentivize their bonuses against the stock rise rather than against. Again, things in the companies is control, like its revenues, like its performance. And you tied all the stock performance, then IT intensifies everyone to these crazy things of pump the stocks .

so they get their bonuses. okay? So killing surprise, resigns, lay comes back in into the Operator. See as C, E, O.

And he surprised, resigns same day with no transition.

Yeah, no. trances. Just like i'm out. Go on.

So lay comes back in and two things happen. One, he asks, fast out the CFO. He's trying to get a handle. You'd like what's going on here again. He's been out to launch fr years at this point but metaphorically and literally speaking and he asked fast out to say, like, okay, what's the current debt obligations of and ran like I know what's on to add obligations. We with all these special present, we've done fast, like, I don't know, let me go work on that.

Come back to you. And the answer was literally that they didn't know, because they did not keep this stuff in a centralized location. They signed all this paper through all these different entities. And there was not a central ledger anywhere who I was what to do.

So he comes back, lay in the board and says our actual obligations are thirty four billion dollars, which the dead on the baLance chief was twelve point eight billion dollars. So everybody is like shocked, like it's become clear, like this is like a major liquidity existent al crisis for the company and the company .

has no cash flow. So it's like, oh, well, maybe we can service that dead with next quarter. No, no, no, no, no. There is no cash coming in the door.

So then right around the same time, a VP in corrective named sharing walkings rates first in anonymous memo and then he puts her name on IT and asked for a private meeting with kenley about this memo that SHE rates where she's trying to be a whistle blow here, she's like, look, what's going on. Has reached such a crazy pet and all these L, G, M. Transactions that are happening and everything finances doing in all these off books entities.

SHE writes in the memo quote, I am incredibly nervous that we will employ in a wave of accounting scandals. And late meat with her reads the memo. But just like back in the day with the rope traders.

he doesn't do anything. No need for confrontation. I don't think we should do anything about this.

No need for action. This is August two thousand. one. Think about that. We are now mere days away from september eleven. September eleven happens, terrible, heavy, sly, awful, but in a crazy way, this was a reprieve for, and like, he took everybody's eye off the ball of the investor community in the press of how bad things were getting IT in run.

IT also gave them covered to say, she's every stocks down right now, right?

And they needed this because, partially due to the events of the temple event, but this was a ticking time bomb. Was onna happen anyway, the morning of september twelve, the next day when the financial markets reopen and rs commercial paper 儿， the overnight loans don't turn over. There is no buyers for the overnight and run commercial paper, which a quick primary. We won't get IT up too many details here because Frankly, I don't understand all them. But for treasury and corporate finance, most large companies and especially trading Operations they have with called overnight commercial paper, which are very, very short term loans that they used to finance the daily cash obligations of the company, like paying payroll, you know, paying vendors that can stop, right?

If you think about what's a company like microsoft have seventy thousand employees, and you think about how much money they need every two weeks to pay all those people, they don't just keep an enormous part of their treasury in cash to pull that off. They effectively have like a margin loan against their treasury that they use that actually finances the short term cash flow needs to the company.

And this is super star tear. Every large public company does this. And IT is shocking. If your paper doesn't, what called turn over, which get repurchased.

you know, everyday, right? I'd like if microsoft asked me, can you let me some money for the next twenty four hours? I promise i'll give me back to you with this tiny amount of interest. And actually, if you're open to IT, would you begin to keep a Green to do that every day for the next five years? Every day, if they come to me every day, I want to be like, sure.

on september twelve. And rs, commercial paper doesn't turn over. Nobody is is there to buy IT? Now if this were not september twelve, two thousand, one that would have been game over for iran like right there, that would have been the end. But everybody's a little distracted because .

they generate cash flow in no other ways. There is no other way to tap any cash.

Everybody's a little distracted. They're able to pull through at least another couple weeks later, though I kind of early october, everybody's recovered enough now in the rest of the financial community from september element that they resume the questioning of and run the world street journal, starts running stories about L, G, M.

And speculating on how much they think faster might have pulled out of these entities and earned for himself at the expense of the company. Are the Anderson starts getting real nervous about their in enabling all of this. And then Arthur Anderson.

sort of premeditate tes, there might be an investigation at some point, and we are not allowed to destroy the evidence once there has been an investigation notified to us. So maybe let's get ahead of IT and let's shed more documents then we've ever shreds in the entire history of the firm before we get serve something by an attorney.

So aren't there Anderson legal on october twelve, sends an email to the houston .

office on this email, literally .

directing them in writing in an email to start destroying any and all non finalized documents that are related and run either digital or physical quote in accordance with the firms document retention policy. We've never sent anything like this or done anything like this for any other clients.

And then they followed up with the second sense that says, just so that were in accordance with the policy. Yes.

the policy, this is the policy.

This is a regularly scheduled. Of course, i've just reminding you to do the regularly scheduled policy, which the email may set the policy, but you know, do with the policy.

says so that housing office of rather Anderson, they go on for weeks like the volume of evidence destroyed here, tens of thousands of emails deleted. That's like the easy to get your mind around the amount of physical documents that they share. They cannot physically shred the paper fast enough.

They're shutting one ton of paper every single day. That's the maximum capacity. This goes on for weeks, dozens of tons of paper that they shred of documents related to iran. My god, if they weren't guilty before, they share the guilty of something bad now.

And I think you might know more than I do here, but I think Arthur Anderson went under, not because they were found guilty of anything, but because when this all started playing out, and they win in the news as being iron auditors for all this document destruction, for being really sloppy, they were complicit and sloppy and run needed to do a handful of the statements. They were just straight up Arthur Anderson's fault. I think their customers all just left. And so Arthur Anderson basically ran out of business.

Well, it's somewhere in between. So Anderson itself, I don't believe, ever faces any certainly no criminal actions for its direct role within iran, I don't believe, but they do face criminal action from the department of justice and the sec over destroying of the documents. And as a result of that, the sec in two dozen, two middle two thousand and two revokes Andersons C, P. A. License, so literally bars them from H.

I didn't realize that, okay.

date already started to lose tsc clients because, shocker, Anderson was also the auditor of world com, which would be an even bigger bank of sea that would happen shortly after. And run, they start, started to lose clients. And then the C, C, revoked their license.

And at the end of the firm play, it's done. It's over. They employ eighty five thousand people gone.

and IT really was the most repeatable firm .

in the world. And IT was destroyed. It's over, but back to end on. So I was october twelve that Anderson started threading on october sixteen th. Then like you are saying in rn reports earnings, they announced six hundred and thirty eight million dollars of losses for like the first time on their income statement and they said they have to do a restate ment of shareholder equity and restate one point two billion dollars worth of shareholder equity related to improper accounting of of books entities.

And this is the rafters, right? I think this is the raptors.

IT may have been some others too.

I love that called the raptors. okay? This is fast out. There's four entities raper. One, two, three and four. They also have other names for some reason that they are like referred to in multiple ways, but they're all found SHE vehicles that and ron basically using to hide large dead loads they're Carrying in huge losses. In fact, I think the raptors start cosigning deals or at least sort of commingling so that if one can't pay something off and the other ones .

on the hook for IT, I think the rates are also like pop. Is that biggest, most grandest example of iran's to slake awfulness in accounting? The raptors, I believe, were hedgers intended to be hedgers on some of iran's investments, but the actual mechanism in the underlying collateral that they used for the hedge was in run stock itself. So they became this like massively toxic, like they didn't actually heard anything. And all I did was double the exposure to like a broad based stock market hit.

IT kind of feels like even if non hadn't started falling apart before september eleven, september eleven would have been the trigger because I had all this correlated risk. So as soon as their stocks stopped going up for any reason, then the whole thing would crumble.

And indeed, that is what happens. So october twenty second, the sec announced that they are launching an inquiry into n. rs. Accounting the next day.

The toy third is when the board calls in fast out and demands to know how much money he's made in the L. G. M. funds. They find out, they fire him.

They instead the former company treasure, jeff mic man, who had been the treasure, but then fast out, had asked to him because he wasn't loyal enough to fast out. He comes back into the finance department. This time is the CFO. Mike man learns that not only did fast out not know how much debt and run as an organization had, he also didn't know how much cash they had. And he also didn't know the maturity schedule of the debt, so he didn't know, and that nobody in finance new the company know when they had to repay the dead.

which to me, this is the biggest example of thought. The rug that they were sweeping stuff under was infinitely large because they had no plan to service any of this debt or track any of IT. There was no plan. They just somehow never thought they would eat to or would catch up to them.

I don't know what I guess you you know you've been episode. If the markets had always been good and this I always gone up, they always could just issued more equity to cover any cash needs that they had, right? But obviously, that's not onna happen now.

So that takes make man and his new team a couple days to pull all that together. When they do, they figure out the company is basically already insolvent, so they need emergency financing. So they do the only thing that they can do, which is they pulled down all the revolving credit lines they have with all of their banks. These are outstanding revolving line to credit or revolving line to credit banks.

They actually went and asked the banks, hate, can we get new that lines with you? And every single one said no. And so they pulled the credit lines, which the banks have no option. It's already negotiated in sign and round .

you down the credit lines.

yes. So and round draws down those credit lines and that they issue a press release that they've done this in order to a assure shareholders that you know, they're a great financial footings. Now they have all this cash and b show the bank support and that they stand behind and run you like, no.

try and finding the tooth nail on all of this. yeah. So how do they do that? The credit agencies immediately downgrade and runs credit. And finally, they is shocking that they.

until the time, and shows you .

how much of a this thing.

no one has been actually underwriting this company to decide .

if their credit worthy or not. So at this point, it's obvious even to the most prevent beevers or head in the sand people at the company, you can make your argument of which category of the executives and the board stud in with that, but it's obvious and runs in the death spiral. So two things happen.

One can lay starts calling around to all of his political connections in the bush administration, basically with his hand out, looking for a bail out kind like um you know what would happen in in two thousand and eight and the financial crisis the bushed administration does not give iran a bail out so there's no days there. Once that becomes clear, he does the only next thing that is even any remote possible chance of saving the company, which is he reaches out to the C. E. O of enron's largest competitive energy and tries to broker a deal.

He also tried to line up a bunch of private equity. He was gonna for a take private. They called warm buffet. Buffet was completely uninterested. They called ten other. They're looking for capital sources, anybody that's got cash or the ability to take us private, let's do IT and no bites. So let's trying get acquired.

So they go to the cross town rivals in houston energy who got no press .

and no fan fare over the last several years. But they're kind of the same thing. I think they're pipeline and trading .

in conspiracy of fools out enough. This is in smart skies. In the room there's quotes from and round people talking about energy. Is the burger king to A N rds mcDonald .

and much lower multiple. They have no sort of big story.

So here's what happens. The strike, a super fast, you know, eleven hour deal save ron, prevented from filing from bank PCA damage, is ggt na acquire iron for eight billion dollars and all stock deal no cash but and ran of course needs more cash to survive until the deal can close and energy can complete its to diligence so energy lens wanted a half billion dollars two and running cash to help and run through the liquidity crisis and the loan is secured by iron's core original pipeline assets. So back to the national north days, like these valuable actual Operating pipelines, the only thing that is like actually tangible in the company.

And I think J P. Morgan comes into the deal too. And the J P. Morgan Mandates that.

But they also Mandate that all future iron investment banking business will be handled by J. P. Morgan over the next eighteen months. There's an internal memo, a jp organ that's like these guys are going to need a lot of investment banking help, and we're gonna .

mate that we get those fees. So the deal gets signed IT gets announced to the market on november nine, two thousand, one in the intervening period, while all the documents are being prepared and the age is doing its the origins on the deal IT comes out.

Remember tuko that we were talking about a while back, the tuba a the andy faster w and Michael copper total front to buy out the tax equites that they thought they're sealed up well right at this time. SAnderson, who's now fearing for its own skin, they're looking back through all this because everything is going on and they're like they discover about copper and dodson and like this crazy domestic partnership front, they are not married. Their technical doesn't isn't spouse.

And they say this is no good. We can count that it's not independent. We're gonna have to restate everything, all the assets. So what you go and ji.

it's like restating years all .

the way back to ninety, ninety seven, we're going to have to reconcile all of assets and liabilities back onto iron's baLance sheet, undue the market to market accounting on the revenue side. This comes out during that period. So there's a further service.

You know, equations have run on the bank with then run liquidity dries up even more. IT blows through the one and a half billion dollars. The energy went IT and is out of money again.

I can't let you get away with this though. I run on the bank thing. The context you use IT is totally fair in the context that the iron executives were using IT in this period.

IT was a completely unfair analogy. They were like, oh, is really a run on the bank. If people had gotten from those dn journalists in the short sellers writing that story, we would have been fine. And no runs on the bank are an issue when the bank is being irresponsible. You can't say I was just to run on the bank because if the bank is running able, there's a problem.

And specifically, I think where all that money goes and the run on the bank nature of this is, remember andrs an active trader in the markets, while none of their counter parties are willing to trade with them anymore without like cash guarantee backing up the trade. So they use up all the liquidity, basically cash, guaranteeing all the trade settings that they are doing.

So at the end of the month, on november twenty twenty eight, two thousand, one energy walks away from the deal. The deals cancelled. The news of this hits the press ten thirty A M assume central time on november twenty eight.

Amazingly, this is just like an amazing coincidence. Who knows? You know, i'm sure nothing was told. The confidential information theatre preplanned at ten twenty am, ten minutes before the news comes out, can lays wife sells five hundred thousand chairs of iron stock that the can, whatever her name that delay family foundation held.

unbelievable.

You cannot make this stuff up once the news comes out, everybody knows. And round is bankrupt. The stock crashes down to sixty one cents a share when IT becomes obvious.

down from eighty two dollars a share earlier that year and ninety the year before.

Okay, so sixty one sense. Keep that in mind. That is what the stock is trading up.

by the way. That can lay thing like he, the lay family foundation, made some money on the way out. Do you know about the other sixty million dollar thing?

Oh, i'm not sure I do.

As a part of the dyne term sheet upon completion of the deal, can lay just got sixty million dollars in cash as like a bonus was .

a part yeah because he was leave as part of .

the deal exactly. And there was such a revolt among employees who are all like actively losing their life savings and retirement, or like hello. And so he ended up realizing the optics were bad enough that he actually put that into the company.

He didn't ded up not matter in anyway because the energy deal didn't happen. But yeah crazy. okay.

So it's clear and around is gonna all for bankrupt in the coming stock goes down to sixty one cents on december second, indeed just a few days later, and run files for chapter eleven bankrupcy at the time, the largest bankrupcy in U. S. history. And as you said at the top of the show, IT would not be for long though, because six months later will come, would be larger.

And since then, there have actually been five chapter eleven bankrupcy that are larger like crazy that like this was the largest at the time twenty years ago. But now you've got laman washington and mutual world com G M. Like much bigger bankrupcy than in one sense.

I think lemon is the .

lemon is largest. It's the only one in the like high hundreds of billions where as iron had sixty three billion in assets before filing.

So iran is over, literally, given the colorful, the right word, evil, I think going to say evil customer characters here everything goes just about, as you could predict, the justice department begins a criminal investigation. Just about everybody accepts killing starts running left and right, trying to cop a please deal .

IT is worth before getting into the sentencing and trials, like what is bankrupcy and what happens in their bankrupcy proceedings. So I decided this was the time to learn the difference between chapter seven and chapter eleven in bankrupcy that were actually thought about IT before. It's pretty interesting.

Both of them are options that you have when a business can no longer pay its creditors ors. Chapter seven is when you just want to liquidate these Operations, you turn IT over to a trustee and say, we are done forever. Chapter eleven is this like interesting temporary thing where you are saying we would like to reorganize?

The data stays in control, though I data, it's like CoOperation. The company that owes the money to all the creditor stays in control. And the court, a judge and the debt basically need to come up with a reorganization plan and the agree on that. And then there's execution of the plan.

And I think the creditors, the people who the company owes money .

to also have to agree. So what happens is john ray gets brought in as the chief administrative officer who is currently serving the same role over at F T X and he comes in to basically be the administrator while its in chapter eleven to come up with a deal interestingly enough there was actually a person who has hired before him, Stephen Cooper.

And he came up with a plan and got something together in the court to generate seventeen cents on the dollar. Well, Cooper worked for a consulting firm that managed to get sixty million out before the board realized that he was not the most economical choice for the creditors. So they fired him and brought in ray, who I think was like a board member.

They kind of redo the board during chapter eleven also. And ray kyn, and he basically figured out a way to get twice as much out to creditor. So creditors love john ray.

He was able to get thirteen billion out to creditors, which is about thirty six cents on the dollar, much Better than the seventeen cents that Stephen Cooper that his plan called for. But I was reading an article in two thousand seven. IT had still not yet been fully sorted out by two thousand and seven. So six years afterwards.

yes. So I think what you're referring to with the sense of the dollar is dollars to the creditors, to non's dead holders. You, not to equity holders, not to people who held the stock.

Correct, equity holders are wiped.

Ha ha, we got to get to the end of the right, right. Remember the sixty one cents of share. So one thing though that you did just jog my memory on that we missed in the note.

I swear IT wasn't intentional, but we will we don't want to bury IT too far in the footnotes like and run here. I do have an obligation to bring up you mentioned the board and that reminded me we ve got a little bit of a knock against hbs and harvard business school earlier with skilling. And you know, being such a lustre ous alumnae, we would be a remise.

I would be remiss if I didn't also knock my own business school on a motor. The stanford business school you're coming about, the board reminded me, do you know who folks listening? I'm sure very, very few of you know this, but the chair of the OTC committee of iron's board during all the years that all this was going on was the dean of stanford business school who was an accounting professor. Kind of hard to argue that he shouldn't .

known Better. Kind of hard to argue little aside here. Do you know what john RAID did before coming in to and run? Let's been an important focus of two episodes on acquired.

oh, I would guess, black buster but that can be rich because they hadn't gone bank up .

the yeah no blockbusters. I'll to be another hand after bankrupcy. After Jerry restructured and IT came out of chapter eleven, IT was sold to put your health way, I should know, but I don't. Through the loom.

through the room. yes. books? yes.

So john ray, sort of unexpected acquired superhero.

Wow, that's awesome. Get to have him on the show. He is a little busy right now.

He is a little busy charging fourteen hundred dollars an hour .

for his services worth that if he can get a good outcome for the creditors.

So with the path from sixty one cents a share, yeah.

well, the justice partment opens up a case. Everybody started trying to cut these deals. One of the iron senior executives, who we haven't talked about on this episode, Cliff baster, sadly commit suicide. I really sad.

He actually had left iron a good bit before that sometime in the last year, but felt so sort of depressed and responsible. And I think his note was about not being able to spend time within the other people that were a part of his community after losing so much for so many people totally.

and skilling, even though killing to quit months before, like obviously he's implicated. Now this, they layer up and fight, which practically they have to. Because, like we said, everybody else started to trying to cut pleaders.

Why would the feds cut pleaders with people? It's because they wanted get the people at the top and get them to testify against them. So lay and killing, no kind.

There's no way out for them to how you get a mod. Boss, it's like the classic playbook.

totally. So I think copper in Michael, copper, I think, is the first person to cut deal he rats out, fast out, testifies against them. Fast out initially also tries to fight and lawyer of black lane killing.

But the fed's ultimately, end of getting him to cave when they bust his wife, lea, for tax evasion, for everything that he was involved in. H, yeah, also, he also worked at the company. He was in the system treasures and run too fast out ends up doing six years in prison. Lia does one year.

And we should say fast out. Basically he admitted fault and then would double down on at any time. He's asked for the rest of in prison, out of prison.

He's like a, what we do is illegal. What we do is completely wrong. I feel terrible for the people. You can actually hire festive as a speaker. Now to come and talk about corporate responsibility in the corporate culture, which is nuts, will include a link in the shower notes to book in if you would like to have met your event.

News eventually comes out through all of this, about lays close ties with the bush family and everybody in the bush political cabinet in the White house. So president bush, is this, George w. Bush, the sun? At this point, he calls a press conference and claims in this press conference that like, hey, I barely know this guy, you know, know he was like, he donated to some of my campaigns, but I don't, I can't really remember his name.

He was, earlier in the press, refer to him as Kenny boy, my friend.

Obviously, that was completely wrong. The push family was very close. So close, in fact, that went w was inaugurated.

George H. W. And barbra bush traveled from houston to washington for the inauguration with lay on the on corporate .

CT what really nobody .

comes out look and good here. We talked about how are the Anderson um they are dead. They're over. And then the culmination you know politically in in terms of canada impact on the economy and the markets from all this is pretty shockingly quickly. I didn't realize how fast this happened july seventh, two thousand, two. So just to know what's that, six plus months after the iron banker, cy, president bush signed into law, the sarbanes actually act that was pushed very quickly and almost uni through both of congress.

I just look crazy. IT was approved in the house, four, twenty three in favor, three opposed, eight obstinate, and the senate was ninety nine to one. Sarabands oxley, like everyone lined up for this.

could you imagine anything today getting those kind of votes? yeah.

And lots of people can be mad about sarbanes actually because that makes IP owing and being a public company really hard. And so that actually kicked off stay private longer. Or you could argue that IT was a huge impact in the early twenty tens of company is staying private forever.

So what was in sarbanes? Oxy is pretty interesting. It's the kitchen sink.

IT is like, what did non do wrong? And they just peace by peace, went and figured out away to put a lid on the cookie jar. So the biggest thing is top management.

The C, E, O has to certify the accuracy of financial information, both the C E O and the C F. Oh yeah. So like huge personal responsibility, more severe penalties for fraud, new restrictions around tampering ing with or destroying evidence.

They make that a felony. They also require outside auditors to be more independent. So every tax firm has to spin off their consulting practice. You can no longer how is both under the same house, they increase the required disclosures to be a public company.

including you have to disclose all your off baLance sheet and cities.

And so there's a very interesting question. I think our server I is like, did IT work? We just went through another bull run. And so the question after surveying actually came out is really around we won't know if this works or not until the next market craziness. And so I think there's this pretty interesting thing around the result of sorber's actually being stay private longer, that it's much more likely that fraud now happens in the private market than the public market. And that is basically what we saw with theano s with F T X.

so much crib do. Yeah super, super interesting. Did you see this in the research? I found this from google. One of the provisions of services actually was actually used in prosecuting, yes, capital writers for the january six riots.

Yep, really interesting.

And what clause was that that was? Oh, that was that you can't impede an official proceeding .

and that's the like Arthur Anderson can destroy evidence thing. They were basically like the rioters are impeding official vote counting proceeding. Yeah.

something like that. But yeah, was back in the news recently.

fascinating.

So as with all huge mega scandal trials like this, like we see all the underlings, even all the way up to fast ocp medals, the actual case that the government wants is to go against lay and skilling.

go against the top. Yes, every single one of them, all the way down cut, please deal. So can rice, who had broadband, did the plea deal got a twenty seven months? And rex shelby was charged with fraud, conspiracy, money laundry? Erin, I think the deal is, if you pleaded guilty to one count of insider trading, you get two years of, there was a handful of those like this. Slap ones to get can lay in skillings yeah .

liquid proc o on the deals were all testify against skilling .

and fast out, you know.

with six years, given all that he did, that was very light.

IT feels weird to sort of judge whether a criminal penalty is harsh or not. Like acquire doesn't quite feel like the right forum for that because it's I don't know without me saying whether I think this is too harsh or not harsh enough because i'm not well.

just like this is not financial advice.

We are also not lawyers, right? But it's interesting to me that six years is an amount of time for which you can kind of go back to your life afterwards. Like if you think back to what you were doing six years ago, it's sort of the same chapter of life.

You like if you have Young kids, they're older, but they're still not out of the house. If you were mid career, you come out you're still mid career. You were in jail for six years, so that's gona mess with your career. But it's different than like a twenty five year sentence or something like that where you're like you're an entirely different human and an entirely different face of of the human existence when you come out.

So IT takes a very long time for the government to build up all the case against lay and killing. It's not until two thousand five that IT finally comes to a trial, and then the trial takes a year and a half to finish. So in may two thousand six, which is interesting, both conspiracy of fools and smart skies in the room. Came out before the trials even started. I think they felt like we just got a publish, even though the story is not over you.

The movie did to.

that's right. The movie did too. So matty dozen six, a jury finally convicts skilling of nineteen out of twenty eight eight counts of fire fraud and security fraud, and lay gets convicted on six counts of security fraud a short while later, on july fifth, two thousand six.

Before the sentencing happens, lay is found dead at his vacation home in colorado of a massive heart attack. It's interesting. I looked around that I never found any speculation on that.

There's lots speculation. The cover of the new york post had some joke about like as a photograph of candle's casket and that was .

like Jacob e's in there yeah right.

I think there is a website like they live stock market organ.

something that popped up there a lot in. Where did not I was think whether suicide or um or he actually had a heart attack or you know what who does? Yes, anyway, he's dead. The verdict against him is voted.

which is crazy, non leading the rocket sentenced IT means that whatever money he had did not get seized.

Oh interesting.

potentially hundreds of millions.

These no way he died of natural causes.

Then yeah, I think him not getting sentenced saved his .

wife and family.

Yeah yeah. speculation. And when i'd walk any I don't know anything there, I want any thoughts people have. I'd tried to find that, that was hard to find information, but in particular, because it's just hard to figure out for all the stock cells over the years plus all the borrowing that he did, what his personal baLance sheet would have looked like at this.

pointing his life anyway. Well, here's the crazy thing too. Like, despite all of this, despite all of this, when he dies, guess who comes to his funeral?

George w. Bush.

not w.

but H W, H W. wow. Because he was closer with H. W.

Yeah, I freaking believe .

the pressure at the funeral. I mean, there's a lot of people who are is a very god fearing man who are a part of his community, part of his church, felt very strongly that like this is a good person and everyone is .

coming after him is wrong. Get this, hear some excerpts from the arbitrary published in the housing chronical when he dies, quote, can spend sixty four years on earth doing god's work, helping others with love. Ken's life exemplified galleons five twenty two. But the fruit of the spirit is love, joy, peace, patients, kindness, goodness, faithfulness, gentlemen and self control. IT sound like .

the list of values and had in the lobby.

Yeah, totally key fully that that's not like what was printed in the church memorial that was published in the houston chronical.

The ironic thing about the god's work quote is jeff killing said about two years before andron collapsed that he felt andron was doing god's work.

Yeah right.

He also throughout I mean, I have like a whole list of skilling quotes here. Uh, the one says, what's the difference between california and the titanic? At least when the titanic went down, the lights were on .

the prety impulses that if you watch the query says, IT, I remember what the venue is he even says in the preview, he's like, I probably shouldn't say this, but he's the CEO of the six, seven large company in the world. And he's saying this stuff like that, oh my god, this person. So on october twenty thirty, two thousand and six, skillings is sentenced to twenty four years in prison.

Shopping is only twenty four. He appeals and get this. So he's fighting to and the appeal ends up going all the way up to the U. S.

Supreme court where I don't know what the right legal term is, but they end up sending IT back down to a lower court for responding to redo the something. The sentence gets reduced to fourteen years. Skilling ends up serving twelve in total and is released from federal custody in february twenty nineteen. So he is back out there on the streets, apparently trying to do deals. IT was reported, but I don't .

think very successfully. And in twenty twenty, jeff skilling founded a new energy trading company based on taxes called valid L, L, C, rumored to be working on the venture with lupe E.

I did see that. Ah that's maysam.

Oh my god, unbelievable.

This is we already cut some loops stuff from this episode because I was to slack. Now we can talk about this guy anymore, but that we .

gotta leave in. unbelievable. And the website was up, and now it's down, and no ones returned any press request for comment on IT. And the rumors were like two, two and half years ago at this point. So maybe that actually in then up happening, who knows?

Well, you still got some money because he did a settle with the government for six thirty one million dollars, but he still had plenty of other cash to live on them. Two fun little coder moments before we wrap up the story is proposed on things fully before we move into analysis. One, we've talked about a maha.

We've talked about every hathaway a lot on this episode. But until this moment, there has been no connection. Warn about IT charly monger. But hathaway, zero involvement with any of iron or any of enron's processor companies.

However, you remember from the energy aborted transaction, the assets that secured the one and a half billion dollars or the pipelines the original into north omaha based company pipeline. Well, when the deal falls park and then run burns with cash, energy seizes the pipelines. They Operate early like a short while. I think we know we don't really .

want this. We should sell these.

I don't know where this .

is exactly the type of thing that picture should pick up.

Who ends up bang the pipelines? But berk sha, healthy energy, wow, all comes full circle. And the company comes home to oma, to Warren buffett, warm impress.

IT could not be more .

perfect. IT could not be more perfect.

So in the end, I guess the north did have the last law.

the great city of omaha wins in the end. crazy. Okay, one more, I kept harping on the sixty one sense earlier, and IT took, you know, you, you read article that is about two thousand.

Seven things were still going on with the carcass of iron. Well, let me tell you what happens in september of two thousand, eight of all times, september of two thousand, the post bankrupcy shell corporation of in run finally finishes. They darted, disposed of all the assets, sold them off.

They finally finish settling all the lawsuits that were involved that he was pursuing. IT was persuing various lawsuits of other parties involved to try and recover some funds for equity shareholder who lost all their money, nine, nine percent share. IT was equity shareholder at this point time because I think the creditors had all already settled no years before.

Well, the biggest opportunity to recover dollars for shareholders, they determined over the years, was to sue the banks that participated in all the sAnitation with iron. And of course, banks have a lot of money. Well, in september two thousand eight, the whole sweet of settings, with a whole variety banks, G.

P. Morgan city group, various others come in for a total of seven point two billion dollars coming into this in circus of in run, which results in a distribution of six dollars and seventy nine cents to every common shareholder. So if you had bought and run equity in those days between the collapsing of the energy merger and the bankrupcy, if you had bought for sixty one sense, oh, we've had over a ten x return. If you are willing, hang on for seven years.

David wosn't thought, you have outdone yourself. Oh my god. Imagine that in two thousand, one, in two thousand and two, you know, we should go and buy some and one stock.

I think we should find way to buy some F T execute right now.

Oh my god, it's kind of incredible that there was enough to pay off any equity holders that IT wouldn't all just go to creditors. So how is IT that any remaining dollars that could go to anyone wouldn't have just gone to creditors?

I don't know for sure, but I suspect what happened was the bank of sea had been exited, I don't know for sure, but i'm speculating bankrupt had been exit in the creditor or had said, like, okay, we're good.

right? We've got we think we're gonna we ve got.

always think we're onna, get the cookie jar is closed.

Somebody googly jars piggie.

yeah, not a cooking jar. Piggy bank, is that unbelievable? A tens investment to literally buy the dip in iron. H, wow. Ow, ow, wow. Well, crazy.

And that IT ends .

up back to no mahan with person. How the way, like you just so good.

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This is a four kota episode, two people.

So I think it's interesting. One is one of the best traders from and run.

I meant that in the very best possible.

Eh, yes. John Arnold went on to start the firm at seven tourists, which is one of the highest performing hedge funds ever. So that sort of like I don't know that it's necessarily like we went on solve world piece anything but like a person that went on to build something successful after and run, which is worth calling out yeah.

I had no idea about this person. I didn't know about this fund. Apparently he was like a super, super Young hotta trader at iron.

Yeah, he's still only in his forties today.

Yeah, he got the largest cash bonus that iron ever gave to anybody who wasn't a senior executive. I think eight million dollars. wow.

Shortly before the blow up. He was never accused of any wrong doing. He was not a traitor. Supposedly was. Everything he did was about board.

But then I think he took that money, used IT as the seed money to start the firm. And then I ended up becoming one of the most successful funds of the past twenty years. wow.

Speaking of a seed to sort of start a firm, we didn't talk a lot in this episode about Richard kinder, and we didn't because, well, he was as hard driving as the rest of the non exact. He was probably the most ethical and the most honest about what really provided value to customers. Well, he was a pipeline guy.

He was a pipeline guy.

yeah. A lot of people, I think, including himself, thought he was in line to be the CEO and he was sort of kandla ys right hand man for a while upon his ex IT when he's finally decided, like the direction this is going is really just not for me. This is going in a very skilling direction.

There was sort of a sweet heart deal done for him to get a set of assets that he would use to be the sort of foundation for would become. Kinder Morgan is an energy pipeline. And today, kinder Morgan is a forty billion dollar company and kinder is a billion years.

He's worth like eight billion dollars. You know he's really good at running and managing a pipeline business. 嗯， when he saw that wasn't the focus of anyone or got out and started his own pipeline business and they'd do you know what other asset was bought from and run to become someone else .

is something business. Well, I know ubs, or my first job was at a college, bought the trading assets out of an ran, did they yeah, I think they only lasted like six months or a year graded. But obviously that's not what you're talking about.

No, G E bought the wind business from and and I believe even today is sort of the corner stones of their wind energy business. interesting. And then the last thing is i'm pretty sure several about the building.

Yes, I think that's one of the big oil companies bout the building.

All right. So let's dive and do analysis. Do you want start with power?

Yes, power. This, i'll be an interesting one.

okay. So this is Normally where we talk about what gives a company the ability to be more profitable than their closest competition. And IT feels silly, even asked the question on this episode, because this episode makes so clear the difference between a corporation and a business.

And I always thought about this on the other side of the veterum, like what a start up is a company, but it's not a business yet. It's not a machine that you can put money into an a burns capital. There's s not a business is a group of people working on a project.

But like a seed stage started, not a business. At some point you look at an apple. A company can become both a company and a business. A company owns the business, the business Operates the company is the structure around IT.

And and ron makes so clear that even long after year to start up, IT is possible to have all the window dressing around a business, but not a business itself. They are undoubted accompany a corporation, lots of structure, lots people, lots activities, lots reporting. But what is the actual business inside of iron? And of course, this is what every reporter was trying to figure out as the stock was falling. The question is, if you strip away all the terrible structure and you strip away all the self dealing and you strip away all the overvalued stock, where are the biggest pieces inside the company that are real businesses generate real value for customers and the ability to capture some of that value by the company? I suspect the trading business was pretty profitable or had the capability to be pretty profitable.

I've felt about this little bit, and we talked about a certain the earlier part of the episode where when they have first lay his original companies and then skilling and and lay together with creating the energy derivatives market, I think there's value to doing that. And had the company stopped there and just been a trading participant in the energy derivatives market, yes, there would have been value there.

I think they probably would have ended up like one of the wall street banks where, you know, like, look, some banks are stronger than others. The league tables change. It's kind of a commodity like nobody dominates the industry.

There's no like monopoly bank, but there's no loopy and they all do pretty well. I think iron probably would have ended up like that in the trading business. I don't know that there's any real specific power in the way that hamilton talks about IT, where you can literally earn Better returns than your competitors. But I think they would have been part of that ola gopal mix, so to speak.

And the argument that they could have actually done Better is I think the enron online was a real way that they could have gotten real market power. I've trying to think what that is, is probably cornered resource. They would have had Better access to information about the market than anyone else. It's almost like the set of business .

yeah so IT or F T X and ale right before IT all went wrong but is a good example yeah .

that they would have the most real time market information at a given point. And there's an open question of like would people have in the long run, continue to trade with them as both the exchange and the primary counterparty or the exclusive counterparty? They may have had to overtime pick whether they want to be a trading partner or on the exchange itself to have that access information.

But that would be a way that they could have sort of generated alpha on top of the rest of their competitors, that they could have been more profitable than other people who are offering energy trading marketplaces or other derivative marketplaces. You also have to imagine like the pipeline business was probably profitable. That's interesting because that's just a pure yeah .

that according resource for sure yeah.

you don't build two pipelines between two locations that just didn't make a lot of sense. It's a big waste resources like a highway.

You collect the toll on the highway because .

that's the highway. So in that case, they are sort of competing against other forms of powering the location that, that pipeline dumps out into. So it's know of the midwest using call instead of using this natural gas. So there isn't like a direct competitor to their pipeline business, in all likelihood.

but by their very physical to graphic nature, pipelines are limited markets. Yes, you may have a monopoly over the market you're in, but your market is limited to the physical geographic you reaches of the pipeline.

right? It's a pretty interesting question because when you analyze and run through and even if you had tried to analyze and ran in ninety nine through a hamilton and helmet lens, you probably would have had a hard time coming up with power, which should have LED you to the answer that this thing is at least overvalued.

Something on here yeah, yeah you know they don't have a google on their hands where it's like this, just cash gusher that is unbelievably defensible, high margin, durable. It's almost like company had a lot of things going for IT. They had the carma and the money raising ability and they were making a lot of money for a lot of people. So everyone was invented, but the business didn't have a lot of things going for IT.

I think you put IT so well minute to go of like this story illustrates the difference between a company and a business. Yeah, the company did really, really, really great for a really long time. The business other than the underlying pipeline and then maybe the trading Operations, but the business did not exist at the scale of the company for many years.

Fascinating.

totally fascinating play book. Well, if you want to cook your books. Here are three easy steps to success.

That is, unfortunately, the playbook. The question is probably, how did iron and managed to accomplish what they accomplished? Because no doubt they accomplish something that is hard to do. I think that's actually an interesting framing, is they manage to achieve something that to date, no other humans had been able to do, which is convinced the world that something with very little had enterprise value actually had a huge amount of enterprise .

value and show IT in accounting statements in many.

many cases, accounting statements that were legal. There's lots of things that they did that were illegal that they got prosecuted for, but there's a lot of things they did that were surprisingly legal, three percent partnerships in a lot of that stuff.

I don't know. I'm conflict adventure. On the one hand, i'm sort of loved to promote anything from andy fast out, just given the story we just told. On the other hand, he did his time. He served the sense his remorse fall in making amends.

But I think if you look at what's been reported about what he says publicly and what he says in all of his speaking engagements that he does, this is his message. Right of like, yeah, there was like illegal stuff that happened. But most of what happened, most of the can that happened was through legal means. And we were just like really, really good at finding and exploiting legal means through which to perpetrate fraud.

And that's wrong. right. Is that crazy? right? yeah. So, okay, bunch of playboy items using off baLance ch sheet partnerships to conceal billions of losses and lots of dead. To my knowledge surveys, oxy makes this impossible. Now, the next one I had is marvan observation, and it's something that I I was talking about last ten hours and separate disco we get together with our friend's at vouch.

I was talking with one of the article founders about this, the idea of correlated risk, and of course, is huge in their business since they are the insurance business, and is funny because this was before F, T. X. happened.

And we are sort of talking about the fact that a lot of the times people assume when they have like three or four layers of coverage, they're like, well, i'm covered. I'm like really secure because there is a lot of nets below me. But you have to be really good at figuring out well, others actually for layers? Or is that one layer that looks like for because often times when something starts to tank, everything around IT starts to tank too.

And so when you tie everything to this share Price and you tie everything to collateralized IT with your own stock, or in the F T X case, if you clatter ized against the F T T token, which is very, very correlated to your companies enterprise value in future prospects, you end up in this correlated risk territory. And I think so many times we're bad at seeing or don't want to see correlated risk when everything is going up. And we view things as having sort of more protection, more safety net, more separation than they do. But when you do have a bunch of risk, they're all correlated together. They fall apart so fast, they unwind in a big hurry.

Yeah, totally. I've a correlated playbook team for me coming out the epson to that correlated risk playbook team. What's up what I was been thinking about you doing the research? I cannot always had this as like part of my financial philosophy.

But then I called F T X ten. And everything is, maybe think about IT even more for me, not investment advice, and lots of very reasonable. So many people make different decisions, but there is actually an academic literature of there about this. I've decided the correct amount of financial leverage to have on financial assets is zero. The optimal amount of leverage is zero.

So you don't want to Carry a mortgage.

If I were up well, have you mortgage is .

differently because it's secured .

because it's secured by physical property.

which can change in value the same way the stock can change in value totally.

So that is definitely a contradiction to the philosophy. I do have a mortgage, but when IT comes to leverage in a other than residental mortgage leveraged and a finial sense like trading with leverage specifically, you're always taking a very large risk yeah, even if you think the risk is very small. Once you start trading with leverage, you invert the magical property of venture capital, which is the most you can lose your money and the most you can make this incident. Yes, once you start using leverage, that flips.

That is how you get game over, or at least to equalizes.

at least to equalizes.

Or there is the like black one idea that most of the worst things to ever happen never happen before, so they're impossible to predict. I mean, I often think about the fact that like even if you correctly timed IT coming out of the oil crises to put a bunch of money in the stock market, and even if you were able to ride the dot comes all the way up.

And even if you were managed to sell before birch of two thousand and then there was a big crash and you decided to put money back in, you would have completely gotten washed out by nine eleven, like you would not have forecasts the intense macro economic change that, that would have brought because there was no ability to predict IT. And so there's like so many factors to these things. I mean, this is my like lectured of myself on macro forecasting of there's the like you have to be right twice when you're timing the market, when you're coming in and when you're coming out.

But often there is like A A third thing that no one could ever predict that you also have to be right about, oh, pandemic. yes. Well, there is one point that I would made IT earlier, I think, is worth trying to put in tighter words, which is iron's fatal flaw is that they borrowed from the future until there was no future left to borrow from.

They squeeze everything by doing market market accounting out of the next twenty years in any given deal that they did. And then they got into a bunch of markets and they recognized all the potential upside from every deal in every single one of those markets around the world, in every category two day. And so what that leads to is, should that be like one of the most valuable companies in the world, if you're going to signalize across geography, across a bunch of markets, across the next twenty years, all the upside of that as revenue today like and then you apply some D, C, F model to that.

Well, yeah, that's why they were the seventh most valuable company in the works on paper. That's what they were doing. And so what you're basically doing is your sort of double dcf in the value, which IT took me a lot of figure out like what's going on here when you're discounting the future cash flows of something to the present and recognizing the value today.

They were doing that first as revenue, but then when people were trying to apply on multiple to the business, they were doing another. Let's look at the next twenty plus of this business exercise, again on top of IT. So IT was like an inspired situation. Well, then you throw .

the special representative into the mix where they are recognizing revenue on the way out. Yeah, they were triple ulto plying IT.

It's crazy. And so it's like an exercise of the most path dependence bread sheet of all time that there was like zero resiliency in the Price of the business because IT contemplated the assumptions that were baked into the Price where that everything would go right in every situation, in every asset, every deal that, that would be the most valuable IT could possibly be and that they would continue to be able to do this number of deals in more geography and more markets for the next twenty years.

And I think pretty quickly, you actually like run out of value to be created in the world. At some point, you're like you can't have evaluation that big because there's like not that much value to be created. And I don't think they quite bumped up against that.

But that sort of the biggest constraint that you hit when you're doing goofy spread sheet this way. And then of course, there was accounting. There's always fought on top of IT. So like that was onna kill the whole thing, assuming that, that wasn't the case and that what's the actual issue with market to market accounting in the situations they were doing market market accounting and then applying a more than sector multiple on the business, that is the big issue.

yes. Okay, I got one more. yeah. Which is in many ways, one of the most obvious smart you in the head playbook themes from the episode which the altering monger quote, show me the incentives. I'll show you the behavior like this is such a clear illustration of incentives behavior. We could say a bunch of trade obvious things about IT.

But what I wanted to talk about for a second here, interesting in thinking about assigning blame and intent here, and like degrees of maliciousness in retrospect, now having red conspiracy of fools, I really, really liked great book, incredibly well researched, you know, six hundred and sixty pages of, just like, very detailed, very well written, thrilling style, great book, how they are recommended. My biggest criticism of IT, though, is that IT makes fast out out to be the primary villa. No doubt he was a huge villa and incredibly unethical.

And on the surface, the worst of the bunch. He was helping iron perpetuate this incredible fraud, and he was directly in bezzle and stealing money through all of the crazy partnerships. And like the copper deals and like all that stuff, like that's really bad and I can what makes him out as such to be the primary villain.

And it's not that he goes easy on lay and skilling. They come out looking bad too, but in many ways, not as bad as fast down. But then I was thinking about IT.

I don't know if he was in the movie smartest guys in the room, but share and walkin' the whistle blower. He gets asked at one point, what do you think this might have been later? This might be an interview later.

Do you think fast? I was really the worst person here and he was like, no, it's not just the fast. Del is bad. Everybody was complicit. And he didn't say this explicit.

But I thought about, I was like, fast out stall, about forty to sixty million out of and run directly, right, and lay in. Skilling didn't do that, but they made hundreds of millions of dollars on the equity. They didn't need to steal the money fast.

I was doing IT without board approval.

Those guys are doing IT with board APP approval. They made more from the fraud. They were more incentivized in perpetuating the music going than faster was to like directly steal, right? So in my mind, that actually makes them worse.

Like not like I still feel a little bit iki about like promoting what fast is saying now. But I think my conclusion at the end of this is lay in killing truly were the worst. And the government was right to couple the deals with everybody .

else to really go after them. I mean, in a skilling lake way, you just laid that out in a logical path that heard .

Darcy with maybe i'm the worst then .

I think i'm .

not going argue with that.

It's an interesting line of what was your impression.

I didn't read the smart sh scores in the reinbold. How does that paint the situation?

There's nothing conflicting ting in this mars guys in the room. I think this book definitely makes gilling out to be the bad guy and can lay out to be kind about to lunch and is also kind of a sympathetic figure for the first hours career because he's like this PHD economist civil survey does all the write things, where is killing? Nobody thinks that a management consulting is doing god's work.

And so like skilling is this perfectly formed character of, like H B. S gone, machines gone, energy executive gone, fradin ter, where it's like IT is the most classic path of corporate villa, you can imagine. And I think that's the case that the book makes you and not all this is so narrative of to even like we're sitting here, we've never met any of these people.

We have read books about them. We've read, I don't know, thirty or forty articles listening in podcast talk to some people who were like around the energy industry here on this kind of time. So but we've never met any these people and we are telling a story of a story. And IT is worth saying, like especially now that we're doing some character assassins, which Normally we try not to do and acquired, we are so far from the primary source here that this is like what kind of weird sport pontification that I think we should stop.

I totally agree with you, and i'm glad we don't do this on the card Normally because this is not what the show is about. But I think it's okay in this case.

we're talking about and run here. Yeah and we're trying to contextualize everything that's going on specifically with F, T, X, but in what feels like a lot of increase in fragile and activity recently, you actually speaking of F T X, did you know F T X is fifty largest creditors, some to three point one billion? Let's contextualize the numbers.

That's what we know today. These numbers are changing in real time. The whole was probably something about ten billion.

The equity investors apply White out t to the tune of two ish billion at least right order, magi ude and like iron, left behind a trillion dollars of claims to thirty thousand creditors. City group alone had five billion in claims. There are one of five or six big investment banks that work with them.

There are a million and half shareholders.

I think people forget the iron scale. F T X is really bad. This is like a terrible bunch of illegal stuff that happened, unethical stuff that happened. But the scale of non I think because IT happened twenty years ago, people sort of forget how big IT was.

I think also on that point, on a reflective note, studying the anon history, it's crazy seeing the length of time that IT took for everything to come out yeah and for everything to be resolved. So that's a good reminder for now and for F, T, X, we're not even an inning one yet of figuring out what happened here. Like, you know, IT was years and years before all this stuff came out in the another one case.

Yep, so true. I have one more observation to make, and then i'm curious to talk sabin's ox with you. So the last observation, I first had to reading the book and then I tried to search for any counter examples and a bunch of articles and couldn't find any.

I don't think there's a single interaction between and ran and a human like mostly employees where the human didn't make out versus the company like a panda every single time there was any sort of confrontation. And this is probably like the legacy of can let. This is his non confrontational thing.

Every single person that walked away from and run walked away with some kind of incredible golden parachute or amazing sweet heart deal on an asset that they bought from the company, or sign this paper and stake quiet. Here's a bunch money, or here's bunch of stock, and every person just pulled one over on the company that shareholders over and over and over again and do not think the company ever had a hard line with anyone. And you look at the a person we didn't even talk about, a rebeca mark who ran all the international staff who ran azoic s the international water project that both failed, but was also never set up to succeed. So it's hardly really blame.

SHE lost billions of dollars though. billions.

yep. And he sold about eighty three million dollars of stock. SHE actually got out early enough, and he was sort of cast out by the male executives at the top in a way where he was actually never accused of any wrongdoing and never really a part of the prosecution of any of these things. But you know, he was a part of the game of people who were, well, at least SHE, massively benefit to the two and eighty three million dollars from something that only ever hurt shareholders like no one was sitting around creating any shareholder value. And so every deal cut with every employee ever who was leaving or staying, just bribed them all.

Yeah, alright.

let's talk serbians. Oxy, so did IT work, or did I just force fraudsters and mell faces into .

the private markets.

malfeasance to exist in the private markets or like international sutter domestic markets wherever crypto o exists because like crypt to impacts the U. S, even for companies that aren't domaine iled here. So we've done a lot of things to like push companies either away from going public or a way from doing business in the country. Still totally affect americans and canadian teachers.

F tx. Being prime example there.

Yeah.

this isn't a direct answers to your question, but one thing that I thought about to this whole process about surveys, actually in the consequence of state private longer and what that no doubt server bans actually raised the cost and complexity of being a public company. No doubt, I think, though probably not as much as the state private longer proponents were saying.

And this might be related to what you're saying, I suspect again, to the intent of and behaviors glad of the companies that stayed private longer weren't doing so for the stated reason that IT was too hard and too hard to be a public company, but they were doing IT because there was too much benefit of money to be made by staying private. Whether that was secondary sales, whether that was being able to prop up your company Better than your business was performing, you know, just the general opacity that the private markets afforded, even talking about companies like goober the king, the granddaddy of all of the state, private longer. Yeah.

I think that's fair. I also think what else was congress gna do? I mean, it's not like they can go create by harman ian laws.

They can make IT harder to invest in offshore entities, but not sure that, that's necessarily good. That might be a baby bathwater situation. You also can make that harder to be a private company, but we don't want that either. We want to encourage new business creation. We want to encourage a period before companies go public where they can have looser relationships with their private or holders and communicate information or less standard way because their tiny companies like I think that makes a lot of sense. There's always a signal noise thing where you want to make sure that you're legislation is directed at quashing only the signal that you want without having the blast radius.

which I think with those statements, sarbanes actually probably has accomplished its goals pretty well, which is protect the broader american public and investing public as shareholders in public companies from fraud.

Yep, totally agree. alright. Well, we have this section that we've done in the past called value creation and value capture. Normally we talk about, do they create a lot of value? And if so, do they capture a lot of IT.

The classic examples as google creates a lot of value and captures a lot of IT, and wikipedia creates tons of value, captures very little of IT. So where does and ron fall into this? Well, they need to create very little value. And they captured far more value than they created by an order of one hundred two, one thousand. So probably the first time that we've ever on this show seeing someone capture more value than they created.

Yeah, gosh.

by a lot, by a lot. Pretty fascinating.

I don't know enough about the energy industry to say whether the innovations in financialization securitization creating energy derivatives, whether the existence of all that and and ron and its principles being highly responsible for creating them, whether that generated enough value to offset the massive value destruction of and run the company. Maybe I just am not equipped to say I don't know that actually .

is how I want to close the episode instead of greeting because like what are we going to do? Give an f and the other thing that we've done recently talk about sort of like forward looking narratives, but that doesn't exist here either.

I think an interesting way to close this by describing what were the activities that they did that we're like a legitimate, interesting business as value created for customers and what was the illegitimate stuff they did. And I think that kind of does and that, like pipelines, were good for customers and the creation of a market. And let's be generous, both the market to buy natural gas at a real time Price and also the ability to use a derivative market to hedge those Prices. So businesses could do forecasting. I think that's probably where the line ends on good for the world things.

And then once you get about that black buster video on the mo.

I think as soon as the business became the derivatives trading as an end rather than as like a means of hedging or as a means of cash love stabilization and Price predictability, I think that sort of where basically everything after that was bad.

No, working for me there makes sense to me.

All right. Well, and there were four hours in.

but you would do some carve outs. Yeah, we even done carve outs in a while. We had some lined up for the com ever said we really get yanked off stage.

We get off stage two hours twenty nine minutes and thirty seconds, the two hf .

hours lot that we had.

Ah okay, I have one that I was prepared to give because it's great, but I have one that's too related to the episode to not do.

oh, i'm in the same boat. I think we can eat you to know why not.

So the one is related to this episode is something that I unfortunately never got a chance to see because IT has been over for eight years. But there was a limited run broadway play called and run the musical, and we all put a link in the showed tes to the trailer for and on the musical IT is spectacular.

Oh my god.

there is a moment where there is someone dancing with literal rapture. Uh, there is like projections of stock market tick kers and traders. The whole thing is it's an exaggeration .

of and the caster characters like you could just have so much fun.

perfect. IT is perfect. And do you watch billions?

I'm to miti I you know me, I don't really watch T V shows. Yeah, well.

you would like billions. I spend my time .

playing video games.

At least you would really like the first two seasons of billions. The guy who plays are sparrows who, uh, works for the S, C, C, is in and run the music.

So did IT, like, run on broadway. Was this like.

I think so, yeah. Put IT up on broadway to outcome. Slash shows.

slash and run. Amazing, amazing.

So that's my friends. So great. My second one is, uh, disney plus show called and door IT is probably the best thing to happen to the star was franchise and rogue one. Oh wow. IT is extremely tightly linked to rogue one and the direction, photography, writing, pacing, dialogue, character development, IT is all of just exceptional, Better than the Mandala an for sure it's the best star wars disney plus thing.

Oh, that's great. Because the star wars franchise has really, at least in my view, taken a big downhill turn.

Yes, I didn't. Bob originally intended.

No, speaking, speaking of man, we gotto figure out something to do on the net.

Plus, like. We should do an egg plus episode, but honest, we've told most of the story. So those are my two go watch.

And or whether or not you like star world, I think that's actually the important thing is whether or not you like star wars. This is good. And a lot of other things relied on fans service.

Yes, that was the problem.

That through sort of like nonsensical stuff, but had enough call backs. really. Okay, cool. It's going to see that character again.

yep. How's my biggest beef with episode nine? Yeah, right. Well.

no holy words here. No holy words. What are .

your carrots by cara? Okay, so the one that I thought of this only very, very cause I related to the episode. But as you are saying, you're one of your code is and one of my code is the picture of the way and friday and Brooks.

So i've now completely warn through two pairs, Brooks ghosts since I episode with jim and having bricks unrequired. They're fantastic. I love them.

But now as a parent, I do far less actual running then I used to, and a lot more walking of the roller. And the ghosts were, they were great as walking shoes, but like, they're running shoes, you know, bricks. As a running company, I found out, as I was in the market, completely destroyed my second pair of gas.

As in the market for a new pair, huan was like, should I just fight the bullet and admit what I am in, get walking shoes instead of running shoes? And I was like, that probit means I can't go with Brooks, so I have to find something else. But IT turns out I was so pleasant, surprised Brooks makes a walking show called the addiction, the Brooks addiction. I got a pair before a trip to portugal for breakpoint. I whole love these shoes.

They just like, really cushy. What's good about a walking ship?

Maximum support, you know how? Like a running shoe, like it's the souls are very flexible.

They offered in voco like for when you're seven.

do they actually do? They actually do. I've not yet made the jump s to get the folker.

Maybe we have another kid, then I just feel like give me, I mean, my daughter shoes are welker, so I shouldn't might be. I got to say, these shoes rock. And they don't look like old man shoes. They look like Brooks running shoes.

I bet the vocal a ones do.

So the worker, once totally to do, they are so good. And I now realized the difference of between walking and running shoes like, you know, running shoes like the soul is very flexible. It's like to get these different questioned parts of the sole based on where the track.

Walking shoes, one big old slab of, like, incredibly supportive. It's so good. I'm so old, I love IT. I going to interject another car.

but then i'm wearing ing. And this is going to be to start a hollywood. This is not Brooks. I'm wearing hook a slides right now. There are my indorses.

Es, oh, nice.

The floors. My house are like really hardwood, and so I was like my feet hurt from standing on hardwood bear foot for too long. And as like, I got to do some form of like indoors shoes. So I wearing these hok slides are very easy, get on and off, very cushy. I highly recommend them for anybody who's considering and indoor shoes as a part of .

your easing into old age layers before you're going to be. That's part number one of mine.

It's the oral lucks, by the way. O R A L U X E nice.

nice. Um my other car vote is a good buddy acquired basic Jason kanis J K L. On a team fair show, one of the most trees episodes really good. I know I think we'd talked about and some of our episodes take that he in timor, but he's delhi c actually really close longer friends and take out just went on tim show and .

it's really that's cool. Well, with that, after you finish this episode, come discuss IT with the thirteen thousand other smart, kind, thoughtful, all people are generally very appreciative of for being in the acquired lack with us.

I've asked a few questions recently around, just like I am a total novice on investing in corporate debt, how does one do that? How should one think about that? Is this an interesting time to do that? And I got like a thousand interesting responses.

So thanks, everyone. Who is just being a part of the community. If you want to get acquired merch, we now have two new shirts. In addition to the sweet A C Q, sure that I am wearing, you can get a market size unconstrained, sure. In two different variations. With the original AWS logo inspired design, you can also get a there is always room at the top benchmark inspired shirt at acquired data m slash store, you can view my photoshop capabilities or on full display there.

So good. I was so glad we've been teased ing this for months of so glad we finally made IT happen. I know I feel like this is our it's on the office, right?

Where is the wine? Great sky. right? It's like, yeah, is that the skate where the puck is .

going or whatever?

IT is like wicked pot mice, scot market, unconstrained gf faces a yes .

indeed. We've also had some great L P shows recently, which you can get. I think all the episodes we've recorded our public, we're going to be recording a couple more in the next week that we're very excited about. And you can find episodes of the lp show publicly available in the podcast player of your choice by just searching acquired lp show and without listeners.

We'll see you next time. We will see you next time. Easy you, easy you. Busy you. Who got the true.