How to create a culture that lasts

House of cards

When the accountants have no idea what’s going on, leaders struggle to explain the choices they’re making, and even savvy Wall Street-types who dig into this stuff for a living are thoroughly baffled, you can bet something bad is about to happen.

Such was the situation faced by a dominant company focused on energy trading, with the trendy made-up name of Enron.1 It had ridden the wave of deregulation to shake up a staid industry, in the process becoming a favorite of both the media and investors. Its executives lived lifestyles commensurate with their success, with access to a fleet of no less than six corporate jets used indiscriminately for both business and pleasure.

Several top leaders amassed paper fortunes in the tens if not hundreds of millions of dollars, using their new wealth to rise in political and social prominence. Ambitious university graduates were choosing the company over more traditional, stable options. A business magazine named it “most innovative” several years in a row.

But this dazzling trajectory obscured the fact that much of its success was based on extremely creative interpretations of the rules, and in many cases on outright lies. Like a gambler that doubles down on a bad bet in a desperate attempt to make up losses, employees were forced to make increasingly outrageous assumptions to maintain the fiction of growth.

Trading is already hard to understand, with a dizzying array of instruments and entities involved, mixed with the inherent subjectivity of forecasting. The true economics of deals can take years to fully manifest. Enron exploited this complexity on an unprecedented scale, creating opaque structures of dubious purpose that both outsiders and insiders found too complex to parse.2

The company’s audit firm Arthur Andersen, which was presumably looking into such things, generated huge fees from its traditional accounting services but also from lucrative consulting work, which it was loathe to disrupt by probing its star client’s activities too aggressively.

In the final, heady years of dealmaking Enron extended itself far beyond traditional energy selling. It created an online trading platform, which was very much of the moment in 1999 when anything with a dotcom veneer turned to gold. In a poetic twist it even made an ill-fated foray into broadband and video-on-demand services in conjunction with Blockbuster Video (of course), which would later have its own well-publicized descent into bankruptcy.

As always, things that cannot go on forever don’t. Journalists had been asking hard questions, and the fact that no one could adequately answer how money was being made led to growing suspicion. Financial results were becoming shakier, executives were cashing out and leaving, and accounting irregularities were starting to leak past the veil of secrecy. Ratings agencies were forced to downgrade Enron’s credit, which for a trading intermediary meant an accelerating death spiral.

In the end Enron’s demise would be as swift as it was spectacular, wiping out thousands of jobs and billions of dollars in savings, including the retirement accounts of hapless former employees who had the misfortune of putting all their eggs in one very precarious basket.

Among the collateral damage the implosion managed to also bring down its auditor, once one of the world’s most prestigious firms, destroying a reputation built up carefully over almost 90 years.3

Known unknowns

How could an organization as sophisticated as Enron, with the caliber of talent it attracted, engineer such a complex and slow-moving fraud without anyone speaking up? No one acted entirely alone, nor could they have. A business as complicated as theirs required the involvement or at least complicity of a diverse cast of characters, from lawyers to financial analysts to accountants.

The causes were myriad, but a big factor was the tremendous secrecy built into the corporate culture. If the stock price was rising, there was little reason to stop and consider the broader implications of their work. Employees learned that probing into the details would only lead to trouble, so they remained willfully ignorant.

One whistleblower recognized the depth of the problem, going so far as to lay out the issues in memos and then a direct conversation with the founder. The company responded by investigating whether she could be fired and glossing over the problems she raised, trying its best to shoot the messenger. Her predictions of how it could it all come undone weren’t far off from what eventually happened.

The board that was supposed to provide oversight was kept in the dark, even approving proposals for transactions that turned out to be absurdly self-dealing. They had every reason to keep quiet, for as long as everything appeared rosy they benefited financially along with everyone else. In the meantime, executives extracted even more from a business that was rotting from the inside.

Staff were rewarded on their ability to execute deals, details of which were kept closely wrapped up. A pitiless ranking and firing system ensured that staff would fight each other to stay in the good graces of their superiors and avoid getting bounced after review season. This led to a mercenary culture where any gains were personal, and any risks were someone else’s problem.

The big picture was obscured, so that even with thousands of people involved in the details, no one was able to change the overall direction before the outcome was inevitable.

Open the books

In the aftermath, regulators responded by drafting dense new rules that attempted to stamp out the practices that led to the demise of Enron and its accounting firm. The regulatory burden involved symbolic gestures, like corporate officers publicly signing off on their financial reports.4

Several Enron executives went on trial for fraud, and their defense attempted to deflect culpability by focusing on how little they knew about what was actually going on. In one sense this was true—it was impossible for any single leader to fully comprehend the nuances of every arcane maneuver, but this was by design. In any case juries did not buy the excuse, and multiple leaders ended up serving prison terms.

Arthur Andersen was carved up for parts by its competitors, and while the U.S. Supreme Court ultimately overturned its conviction it was far too late to reassemble what had been broken. Pockets of the old firm exist in places, but there will be no resurrection. In a miserable coda to the whole affair, Enron’s founder and CEO was found guilty of fraud but died of a heart attack before sentencing, vacating his conviction.5

Enron was not alone in putting a shiny overlay on a toxic culture. This can work for a time, but will not forever. Use these diagnostic criteria to evaluate if your culture is on a viable path:

• Information is available: Information is essential for the smooth running of an organization. If everything is on a need-to-know basis, and no one knows who needs to know, ask yourself why. If employees can’t be trusted with even the basic contours of how their organization functions, either the work is shady or staff are untrustworthy. Either one is a major red flag.
• Explanations should illuminate: the denser the corporate jargon becomes, the more suspicious you should be. As it scrambled to stay afloat, Enron’s explanations became inscrutable to the point of parody. This happened for good reason, as even the brilliant minds behind its machinations found it hard to keep track of everything. Communicating simply requires clear understanding. Obfuscation strongly implies the presence of something worth hiding.
• Bad news is good news: any organization, no matter what sector or size, must deal effectively with unpleasantness. Pretending otherwise can have effects ranging from inconvenient to deadly. An effective team has channels for confronting what is wrong, ineffective or unexpected. The normal, counterproductive tendency is to hide it, and it becomes even stronger as the stakes grow higher. If telling the truth is punished, don’t be surprised when everyone starts to lie.

How are you telling the truth, and creating an environment that makes sure it can be heard?

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References

Reporter Bethany McLean was among the first to question Enron’s story in a prescient article in Fortune, and she later covered the outcome of the fraud trial.

The Journal of Accountancy has a detailed look at the Enron situation, written in 2002 before the messy denouement.

The Guardian wrote on Enron’s lavish spending on private jets.