PLSC 270: Capitalism: Success, Crisis, and Reform

Lecture 9

 - Guest Lecture by Jim Alexander: Managing the Crooked E


Jim Alexander, former CFO of the Enron subsidiary Enron Global Power and Pipeline, offers an insider’s account of Enron’s corporate culture and operations before the company’s spectacular fall. The leaders of Enron, Mr. Alexander asserts, disregarded concerns over the company’s ethics. Enron strategically found and exploited loopholes in accounting regulations to make their transactions as opaque as possible. Lack of regulation and oversight allowed Enron’s traders to inflate their numbers. Organizations that were in a position to oversee Enron’s operations sometimes faced grossly misaligned incentives that rewarded negligence. Mr. Alexander emphasizes the notion of the “rational economic man” in Enron’s corporate culture, and its predominance over notions of ethical corporate behavior.

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Capitalism: Success, Crisis, and Reform

PLSC 270 - Lecture 9 - Guest Lecture by Jim Alexander: Managing the Crooked E

Chapter 1. Introduction [00:00:00]

Professor Douglas W. Rae: Let me give a forward to you of today in relationship to the week afterward. Today we have Jim Alexander on Enron, and we’ll do this as a conversation, except that at a certain point he’s going to just do a little straight lecturing on some basics related to unfamiliar ideas in the HBS case, or potentially unclear ideas. This is a — the Enron case is arguably the most important meltdown in modern history of American capitalism. It is certainly the one which had riveted the world’s attention more than any other, and Jim was there at the beginning — not at the beginning, but there in an almost perfect vantage point. So we’re fortunate to have him today. Before I go further I should say it’s his birthday, and he, I think he doesn’t want me to tell you how old he is.

Student: Happy twenty-eighth!

Jim Alexander: Thank you. I needed that.

Professor Douglas W. Rae: On Monday we’ll have Richard Medley, founder of Medley Global Advisors, and that case is about his selling — Medley selling Medley Global Advisors and quitting. The question is: How could a business have tens of millions of dollars worth of value when it is in entirely framed around the personality of one person? The answer is he got it done, and he will be a very interesting guest. He’s completely unpredictable and he is famous, or infamous, for George Soros’ attack on the pound sterling. This was nearly twenty years ago, when Soros’ famous hedge fund decided it was going to attack the pound sterling, and Richard Medley was then working for Soros and Medley had inside information about the behavior of the central banks of continental Europe, and was able to predict their behavior. So Soros — the Soros fund made well over a billion dollars on one transaction in an attack on the value of the pound. The attack was controversial and Medley’s role in it was controversial, and we’ll have some fun with him about that.

You should begin now reading Posner; the pages are small, but it’s a dense book. It’s a challenging book, and you’ll need it for Wednesday of next week when we have Will Goetzmann in as a guest. Will is the director of the Yale International Center for Finance, and like Jim, a Yale College alum, and again like Jim, something of a renaissance man. He’s going to be talking about the crash of 2008, which is a pretty intricate story, and the Posner is easily the best book written about it, though not easily the easiest book written about it. Without further ado, Jim is a 1973 graduate of Yale College and let’s talk to him about your life after Yale. There is life after Yale College and how it began for you and how it carried forward until the date you arrived at Enron.

Jim Alexander: I’ll shorten the version. The details get to be sort of tedious.

Professor Douglas W. Rae: Only for you, not for us.

Chapter 2. Enron Backgrounder with Jim Alexander [00:04:38]

Jim Alexander: Okay, well anyway, I went to HBS because all the smart people were going into law or medicine. I had a primitive sense of markets and I knew that I should avoid the smart people, much as I did in my classes. I then, from HBS went to Aetna Life and Casualty, investing their money, bond investment department; till my then wife announced either we could leave Hartford or she could leave Hartford, at which point I sort of started searching for a job in New York, and landed one at a venerable old firm called Kuhn, Loeb & Co., may it rest in peace, which promptly merged out of existence about nine months after I joined it. At the time it merged into Lehman Brothers, at the time I listened to my uncle, who was a client of Lehman, and avoided Lehman. And I went to work at First Boston; another may it rest in peace actually, sort of firm. Then in an astonishing move of true idiocy, I went to back to Lehman in 1981 in their energy department because I was interested in energy, until Shearson acquired Lehman and it had all the human characteristics of Lehman, and the economic characteristics of Shearson; i.e., the worst of both worlds. Then I, being the flying Dutchman of finance, went to Drexel until it went poof and it went broke in 1990. I then had one last job in conventional investment banking with a New Orleans firm till the head of the firm announced that I had an “uneconomic attachment to quality,” which was about the worst thing he could say about anyone, so I took my quixotic approach and became a consultant charging sort of minimum wage by investment banking standards and —

Professor Douglas W. Rae: Which is maximum wage by college professor standards.

Jim Alexander: I don’t know. Economic college professor standards it’s not — I think Steve Ross makes a lot of money.

Professor Douglas W. Rae: He doesn’t make it here or at MIT though.

Jim Alexander: That’s a separate issue. Anyway — so I was — one of my past clients, and I was there, actually, at the start of Enron, because I was there — we helped refinance Enron’s huge amounts of debt that were about to go into default until we had done something when the — when Enron was created in 1984 or 1985, I think. One of my clients who had been at Enron, I became an investment — conventional investment banking — I became a consultant to Enron, started working on their attempt to roll up their aggregate into one legal entity, all of their foreign projects. After a while the complexities were such that virtually no one had the institutional memory required to be able to complete the deal except for one or two people and they needed someone who knew what their — knew the story to be able to really stay on with the company, and they asked me if I wanted to do that and I ended up agreeing. Then I was there a full nine months until — this was in 1994, I was there about nine months before I, the general counsel and the controller, all resigned in the fall of 1995.

Professor Douglas W. Rae: So you spent those nine months, all of them, I think, as Chief Financial Officer of Enron Global Pipeline & Power?

Jim Alexander: Yes I was — those nine months were spent at the subsidiary level as the CFO of this one little subsidiary company of theirs. But during that time anyone who walked the halls of Enron could pick up lots of information, and the only issue was whether you wanted to ignore it or not, and of course a lot of people’s excellent livelihoods depended on their ignoring the information freely available in the halls, which turned out generally to be quite accurate.

Professor Douglas W. Rae: Was the ethical texture of Enron noticeably different from the general mind run of investment banking as you had experienced it?

Jim Alexander: Well that’s an excellent question. The problem is there — you can either trace a declining curve — constantly declining curve in investment banking from the time I entered investment banking in 1975, or postulate a somewhat easier, sort of old style investment banking and new style. The old style really was a gentleman’s game, I’m not talking about pre-SEC, pre-1929 crash, but certainly when I entered there was an old generation that was quite ethical, upright, and gentlemanly. Of course those people died out or were pushed off the edge and were replaced by people quite a different ilk, who were much more like Enron.

Professor Douglas W. Rae: Much more like Enron?

Jim Alexander: Yeah.

Professor Douglas W. Rae: So Enron is a very young entity, and grew up in the period after the fall, so to speak?

Jim Alexander: Yes.

Professor Douglas W. Rae: would you let them off the hook a little about that or not?

Jim Alexander: Enron off the hook?

Professor Douglas W. Rae: Yeah.

Jim Alexander: In — by what?

Professor Douglas W. Rae: I don’t think you will.

Jim Alexander: By saying, how would I let them off the hook, by the way?

Professor Douglas W. Rae: Well you’d say they were brought up by wolves and therefore behave like wolves. Their — all the advice they got was —

Jim Alexander: Well if you are a wolf you are typically brought up by wolves.

Professor Douglas W. Rae: That’s correct.

Chapter 3. Enron: What Went Wrong? [00:10:47]

Jim Alexander: The — one of the things as I’ve been listening to your course, all the lectures and looking at the readings, one of the things that I’ve been trying to piece in my own mind together is: What went wrong? When did, in the course of development of the theory of capitalism, did the theoreticians decide there was no need for morality, and when did morality get replaced by efficiency? At Enron it would be a situation where the ethical extremes — the ethical environment was so completely different that it begs the question of what is morality? And what do we base it on? Because the people who work there would find any concepts of morality laughable and merely a trap for the unwary.

Professor Douglas W. Rae: Fascinating. The case has lots of jargon in it that is business speak, and Leslie Hough and some others have suggested that it might be useful to go through some of that background language before we do the case, and I’m going to descend to the audience and take in the lecture.

Jim Alexander: Lecture!? Well — anyway — well Enron, like a number of other firms, got very involved in commodities and commodity financing, and commodity contracts. If you’re the typical commodity small producer — often times over leveraged, hand to mouth existence, really can’t take a big flying leap and then hope to make a lot of money — what you typically start to do is, in the case of an oil and gas producer, let’s say gas producer in particular, I have a general view as to what I’m going to produce each month. These are prices not production amounts, but I have a general idea of what I’m going to produce in January, February and on and on. It’s very hard to shut down a gas well, it’s typically not really done, you typically just produce flat out and then try to do the best you can with your price realizations.

When I know I’m going to be producing a certain amount, and the first question is okay do I take a flyer or not? Most people who have a lot of debt or are squeezed for other reasons don’t take a flyer, so what they do is they can go to a commodities broker and say, what price will you give me for each month for the rest of the year? Or else they can go to a commodities exchange and get the same result. What they do is they’ll say, okay, I’ll sell you the equivalent of 1,000 barrels of oil and gas terms in January for $5, equivalent price in February, and it’ll be slightly declining in spring as a result of expected lack of demand for gas, than it’ll level out in summer and then it’ll start going up. The commodities broker will commit to buy a certain amount each month.

Now if you’re the producer though, there’s only one problem: you don’t — you expect to be able to produce, but what if something goes wrong with your well? Well if something goes wrong with your well you’re committed to sell each month. What often times will happen is that instead of actually committing to sell a certain amount each month, the producer will buy a put so that in case the price does go down he can make money but he’s not obligated to sell a certain volume. What you start doing is having many variations on a theme of helping producers and consumers who are on the other side, who also want to hedge, they want to determine their costs of goods sold. You start having very many types of mechanisms, contractual mechanisms to allow producers to fix to varying extents the likelihood of certain outcomes for their firm for the year, and they get hugely complex. This is just the start.

There are huge numbers of variations on the theme; ways that you can lock in certain types of spreads, ways that you can hedge all sorts of variables beyond just the price in south Louisiana. That’s what Enron got in the business of doing. If you look at it the first twelve months there’s a very broad, liquid market, whether it was done by the commodity exchanges, or competing traders, everyone — a very clear forward market, everyone can see this. If you’re looking at taking positions as an Enron, to the extent they relate to widely traded commodities, in short periods of time going into the future, it’s very obvious what you have. You can tell whether you’re making money every day by what happens to the commodity relative to the risk positions you’ve put yourself in.

That’s — if Enron had stayed with this type of situation, they wouldn’t have made a lot of apparent money, but they’d be alive today. It’s a tough business, it’s a low margin business, but you can make a lot of money in it if you stick to your knitting. If you want to make a lot of money very quickly, you start looking at other approaches. If you sort of look — and this is for a trading company, and manufacturing companies have different types of situations — but you start with the lowest risk type of asset and that would be cash. Presumably fairly highly rated, short-term loans to the best types of corporations, or ideally the U.S. Government; that’s great but that’s a very low return asset. Marketable securities, still very liquid, but you’re starting to increase the volatility of the returns, and you can make more money here, but it’s another place where you have to — you really have an information advantage.

What we’re doing is we’re descending — we’re going from things that are easily valued to more and more difficult. Exchange traded derivatives, that’s the type of thing I was talking about where you have a — it’s called a forward market where people can sell or buy commodities for very clear prices, and it’s very well known what exactly the market is, although the farther you go out on the forward market, the less liquid it is. Even here we’re starting to get to a situation where I know that I’ve committed to — say, if I’m an Enron I’ve committed to buy the equivalent of a million barrels of oil a year out; well, how do you value that? You get one value if you’re saying well, I’m going to liquidate it, and another value if you’re saying how much would someone pay for it. So even there you’re starting to have divergences in terms of how you look at value, which can be exploited. Then we started going — as we get further down in terms of the levels of certainty, you have certain types of derivatives like options, which might, instead of being a year out, might be five years out. People can take these sorts of algorithms, useful in inferring — or infer the algorithm from the existing trading of short-term options, apply them to long term options, and you get a value which is plausible. So it’s based upon clear market inputs, but a result which is not self evident because there is no clear trading market.

Finally, and this is what Enron really got into, you have an unimaginably diverse one off deals. I’ll give you an example. A family wishes to buy price protection twenty years out against increases in Yale tuition costs. That sounds farfetched but that’s the sort of thing that Enron was doing — not with Yale tuition costs but taking very exotic situations and then pricing them. I sort of took an example $40,000 $50,000 $60,000 $70,000 a year, year’s out, and I’m sure we’d all have a point of view as to how Yale’s tuition is going to go up. I mean if it continues constant it goes up probably about inflation plus 2% or 3% a year, you’d have a curve but it would be very judgmental, there would be some plausibility to it, but who knows and no one else is making a market in this. If you’re Enron and you’ve staked a huge amount of money, for example on this one trade, how do they decide how much money they’ve made in a given year? Well the answer is they use their own curves, and if they want to make more money they just change the assumptions. Who’s to say they’re wrong? No one, and that was what was happening.

You have one off assets, risk positions, which were nearly impossible to value, where the ability to recognize income could be affected with the stroke of a pen. If you’re able to recognize income pretty much any way you want, perversely your view of the risk of that type of asset — it’ll slowly start creeping into your mind that it’s a low risk asset because it always has this wonderful profitability that never seems to go down, never problematic. Now normally you would expect external auditors to question these assumptions, but Arthur Andersen was making $50 million bucks a year off of Enron; are they going to question anything? No. They could basically create income any time they want. The problem, though, is you end up having increasing divergence between the income you’re creating and cash, real cash flow, and you’re having increasing divergence between what I might call the intrinsic risk of an asset category and the risk that you perceive based upon your own manipulative control over recognition of profits.

That becomes the source of Enron’s own downfall is that they — right at the start of each transaction they were manipulating the numbers. It wasn’t a top down type of adjustment like Worldcom, where basically all the people at the subsidiary level were doing honest things, and then at the top they started monkeying with the results. At Enron every single transaction was gamed to figure out how it could create income, maximize income, short term income, but once you start doing that it starts becoming harder, and harder, and harder to figure out, well, where should I be investing my money? Where should I be placing my — how should I be adjusting my risk portfolio? How much debt should I take on? Because no one has any idea what the risk is, and no one has any idea what the profitability is. That sounds crazy but that’s what it was.

One of the things — so you have on the asset side of the business where you’re actually taking risks on behalf of the firm and working with outsiders and making money that way, that was all screwed up. They had another problem. We have basically — every public company has to provide annually something called a balance sheet, and an income statement. The balance sheet is supposed to represent the market value, but in general terms, the market value of what you own and the obligations you have to outsiders, which offset some of those assets and give you a net result, which is what the stockholders really have in the firm. You might have a $1,000 worth of assets, you might have debt, long-term debt, and it could be a mortgage to someone of $500. You subtract that and you get stockholder’s equity because stockholders own the residual when a firm is liquidated of $500, so assets always by definition equal the sum of debt — of liabilities and stockholder’s equity.

You may say well — if you’re Enron — well, I don’t want to show all that debt. What you can do, and I think the techniques would take too long today — I mean I wasn’t set up to go through the techniques. I can if people really want, but it would have to be another day. Basically the accounting rules, like the Internal Revenue Code, have this series of precise procedures, criteria tests for determining how accounting will work. The problem with that is that if you are really smart you can figure out how to end up with the economic equivalent of a given treatment but have it appear just the way you want in the account. Right here, I could take this debt and I could move it and associated assets $500 out of each column and I end up with $500 of assets and $500 of stockholder’s equity; smaller firm, to be sure, but no debt. There are techniques which exploit loopholes, so that something that is in economic terms a debt suddenly disappears, or that if I want to be able to sell assets to myself I can create an alter ego, something that looks a little bit like an independent company but isn’t. I can recognize gain on the sale even though I’m really selling it to myself, and that’s because the loopholes in the accounting allow you to achieve form over substance. To break the code though you have to have a complacent auditor, and in the case of Arthur Andersen, over half of their services weren’t even auditing services, they were consulting services, so they were completely bought off. You also have to have —

Professor Douglas W. Rae: Can you rub that point in a little more.

Jim Alexander: Well —

Professor Douglas W. Rae: Make sure they don’t miss that.

Jim Alexander: Okay, so the way the system worked when I started in finance, you had people of high reputation who were the — you might call them sort of the trust gatekeepers. They would have included major accounting firm, high quality law firm, and a high quality board of directors. The problem is that very often the reality of the — put it another way — the perception of reputation, and trust, and quality lags the reality. In other words, if you want to make a lot of money in a short period of time, you take a firm that has existing good reputation, and you use that reputation to be able to generate high profits in the short-term. The way you do that is you say, Arthur Anderson, well the high quality firm, so I don’t have to worry about funny stuff in the accounting. I don’t have to worry if I’m a reader of those financial statements, an investor, I don’t have to worry about whether they’re basically disguising debt or whether they’re basically creating their own earnings out of thin air, because Arthur Andersen is a high quality firm.

Generations of people could have built up the reputation of the firm, but maintaining a reputation, like maintaining a building, requires a lot of ongoing investment. And if you really want to get a lot of cash flow in a short period of time, you just let it start to disintegrate, but people won’t notice what’s really going on for a long period of time, and while you’re fooling them, you if you’re Arthur Andersen, and Enron, one of their clients, can make a lot of money. Because this is easy money. This is easy, because basically you don’t have to create value, you merely have to engage in an exchange with another member of the capitalist society who thinks they’re informed, but isn’t. That’s — I mean when we think about how capitalism creates value, to my way of thinking, its part — it’s a series of informed and voluntary exchanges. What does it mean to be informed? One of the problems with capitalism as it exists and not as I read some of these crazy economists, is — almost no one is true rational economic man. There are probably a few geniuses that are, but most people don’t have the time, don’t have the intellect, or don’t have the cynicism to understand what they’re up against. So they say, well, a good firm I don’t have to worry about it.

Well the answer is you do have to worry about it. That’s why, in my view, this all came a cropper in the last ten or twenty years, is that the self imposed restrictions which limited short-term self interest kept the whole system stable for many decades. Once people started to say, “Well I don’t have to worry about ethics, I mean that’s — I just have to worry about being rational and realizing my own goals,” well the answer at that point is the whole system starts to go, and this is a perfect example because these are people, the people who engaged in this sort of deception, did not have any ethics and would actually view ethics as laughable. That’s really important to realize what people are up against and that is — their view is if they’re creating economic efficiency even though they lost sight of that too, who cares about ethics? Ethics is another constraint of the little man.

Professor Douglas W. Rae: Let’s just make sure you link this to off balance sheet accounts. Did you see the connection there?

Jim Alexander: The techniques are — they’re intricate. I was going to bring a piece of paper and have it xeroxed but it’s a diagram of a transaction among eight different entities involving probably 1,500 pages of documents. To be able to exploit every loophole possible to create an alter ego entity which you control, but what looks independent enough to be able to shuffle off maybe a billion dollars worth of debt, a billion dollars worth of assets. I didn’t — it’s one of these things where here’s the problem: in modern finance one of the tools of the trade is obfuscation. The transactions are meant to be mind bogglingly complex so lesser people, lesser intellects who rely on reputation to simplify their lives will fall for it. They’ll say, “I don’t understand this stuff, but I know that guy on the board, now he’s a quality guy.” The problem then is, well, how do you know? “Well I’ve asked Joe, Joe says he’s a quality guy.” Well how does he know? How can you ultimately investigate all these things? Well the answer is, you don’t have the time, and you may not have the intellect, and you certainly don’t have the money to be able to hire people to do.

That’s how you can start to game this whole system because there are a lot of people who expect that the old rules of reputation and quality, which were developed after the 1929 crash as part of an overall change in our system, still prevailed. They didn’t, because basically everyone started being lulled into this strange sort of idea that markets are perfect, and rational people will always come up with the most economically beneficial solution. I agree with that, if, in fact, there are some limits, because the fact is, when I think of capitalism creating value, I think of it getting around constraints. What types of constraints? The constraints are physical constraints, or maybe legal constraints where the law really is sort of a dead letter or a bad idea. Like creating the wheel, you have a — getting around some of the constraints of gravity, or creating writing, getting around other constraints. I mean those are — those in my way of thinking are very beneficial ways of solving — of problem solving. The other constraints that people have started to view as just a minor problem for lesser people, are ethical constraints.

Professor Douglas W. Rae: So there’s an intersection between sheer complexity and ethical relaxation? A year ago when things got really ugly, Steve Schwartzman put together a little roundtable which I attended in New York, and Nancy Peretsman made the most interesting point, which is the one you just made, that if there are asset categories which are so intricate that nobody has really worked through, nobody has really worked through all the mechanics of the thing in a way that allows them to understand the impact of all the variables of the system, then the — all the sort of market mechanisms which enforce a degree of rationality are disconnected from the instrument.

Jim Alexander: Yes, I agree that if there’s — if you had accountants and boards of directors who, in effect, did not give traders the benefit of the doubt, it probably would be okay. But the fact is most people will give the benefit of the doubt to people they view as smarter, and that is — that’s the road to extinction.

Professor Douglas W. Rae: Right, that is the road to extinction. Let’s talk about the road to Houston. You — the book, Smartest Guys in the Room, where you are referred to, at one point, as the fly in the ointment from Enron’s point of view. The most conspicuous characters there are Lay, Skilling, and Fastow. Tell us a little bit about those guys.

Jim Alexander: Well Lay was someone who always operated from 30,000 feet, a big picture guy, super — all about strategy, never got into the operating details, never really wanted to know anything. If you produced consistent results, there were absolutely no questions asked. He didn’t want to know.

Professor Douglas W. Rae: Decent guy in your impression?

Jim Alexander: He was at least as nice as most people I met, yeah.

Professor Douglas W. Rae: How do nice and decent connect in your mind?

Jim Alexander: Not at all but —

Professor Douglas W. Rae: Okay so he was —

Jim Alexander: — decent, decent I mean that’s — interpersonally he was not abrasive that’s one way.

Professor Douglas W. Rae: Okay.

Jim Alexander: Skilling was the genius, true genius who spanned a huge range of intellectual expertises. There are a lot of people in life who can only look at the details, but are very good at details; and there are other people who seem only to be able to grasp the big picture, but then cannot convert it into actual specifics of action. Skilling was able to move seamlessly from the most detailed aspects of each transaction to the broadest reach of corporate vision in a way I’ve never seen before. He was very, very skilled.

Professor Douglas W. Rae: So he was, quite literally, the smartest guy in the room?

Jim Alexander: Yes, I think he was.

Professor Douglas W. Rae: As for Fastow?

Jim Alexander: Arthur Andersen has been killed off, so one cannot — one can without legal risk say whatever you want about Arthur Andersen. There are others that — there’s another party that I’ll leave it as the elephant in the room, that helped Fastow. Let’s just say that the professionals who should have been showing some small degree of allegiance to the shareholders instead helped Fastow concoct all these gnarly schemes, because he himself was completely unable to do so. He was just someone who was a — like Rosencrantz and Guildenstern, one of the indifferent children of the earth.

Professor Douglas W. Rae: He was not a peer of Skilling’s?

Jim Alexander: No, he was a joke. He was a joke. He was a foil. All he was — he was — you had to have somebody that was basically in there in addition to the professionals from the outside, and he was there but he didn’t do anything.

Professor Douglas W. Rae: Fastow gets positioned on both sides of many transactions, was his story. And they talked their way through the obvious conflict of interest by claiming his special expertise justifies the role.

Jim Alexander: They were able to get deals done much more quickly because he knows the assets so well.

Professor Douglas W. Rae: Now —

Jim Alexander: So they waived the corporate conflict of interest policy in his case.

Professor Douglas W. Rae: Now if Skilling and Lay had been able to program you entirely as they wished would your role have been analogous to Fastow’s role?

Jim Alexander: Sure, sure, sure. Skilling asked me to — in effect to be Fastow when I started at EPP, and I just said, “No I was hired to be CFO of EPP and that’s all I’m going to do.”

Professor Douglas W. Rae: Okay, so let’s talk about the early days when you’re in the role of CFO at EPP. How does the — what’s it like when you get up in the morning and go to work, and the phone rings and you’re off to the day’s adventure.

Jim Alexander: Well, all right, so EPP was 51% owned by Enron, 49% by the public. The — while I was the CFO and then later President of EPP, the CEO and Chairman of the Board was Rod Gray who was an executive at Enron; the parent is where he made most of his money from the parent. What would happen is that Rod would come up with some new scheme for Enron to be able to dump some expenses on the minority — on EPP, but really I wasn’t concerned about Enron, I was concerned about the minority shareholders. Minority shareholders, which was not theirs to pay in my view, and maybe once a week he would come up with some new scheme and maybe over the first six months it probably totaled $50 or $75 million dollars worth of schemes that we just had to keep shooting down. Of course once he did that, every time Enron wanted to sell us a project, the process being so tainted, we had to trade very hard because in effect I was trading with my own boss.

Professor Douglas W. Rae: What risks did you feel yourself exposed too in that situation?

Jim Alexander: Well I didn’t worry about legal risks because I was doing the right thing. I just assumed I had no career, I was going to have no career. But on the other hand, it was a little company, and I had helped father this little company that Enron was trying to tear apart, and so I would be goddamned if they were going to get away with it until they finally announced they were taking away my accounting staff, and than they were going to bill me for the cost but have them report to Skilling’s group and that’s —

Professor Douglas W. Rae: That’s a convenient —

Jim Alexander: That was very convenient. At that point the general counsel, the controller and I all resigned. By the way, the only disclosure of a resignation was mine. They never disclosed the fact that general counsel resigned or the controller resigned. The person who replaced me ultimately indicted — I’m not sure whether she was sent to jail, indicted, paid a big fine, and I think turned state’s evidence.

Professor Douglas W. Rae: There was one more sentencing to prison this very week.

Jim Alexander: I saw that. Yeah I know I thought it was all over.

Professor Douglas W. Rae: Now Spinnaker Exploration was the next chapter for you, am I right?

Jim Alexander: Yeah, I helped start Spinnaker the year after I got fired — or actually that — my position is I was fired, their position is I quit at Enron. It was a — just as Enron was based on making money off of false information, Spinnaker was an attempt to make money off of good information. It’s completely different ways of playing information.

Professor Douglas W. Rae: Give us the capsule of the business model for Spinnaker.

Jim Alexander: It was a — it was engaged in exploration for oil, mostly gas in the Gulf of Mexico, with the basic strategic point of view that most independent oil and gas companies, whether through the overconfidence of their CEOs or macho man mentality, systematically undervalue information, and would rather drill ten dry holes than spend 10% of the money buying a good data set. So we got the best data we could, seismic data which allows you probable inferences about the structures underneath the earth and sometimes some direct insight into whether gas is around. Anyway, we bought a lot of seismic data, spent a lot of time with processing, spent a lot of time making sure we had the best exploration group we could find, and went into business on that basis.

Consistent with our view that information is key, not only do we try to get the best external information, but we also made sure that internally there was a free flow of information so that, for example, every Monday we had a meeting with all the employees where everything was up for discussion. There were no questions barred and all the answers were candid on the basis that it doesn’t do any good to have great external information if the internal flows are not good, and the internal flows won’t be good unless you truly care about what employees think.

Professor Douglas W. Rae: Spinnaker was actually — was and is a quite spectacular success.

Jim Alexander: Well it was bought by Norsk Hydro a couple of years ago but it was a multibillion dollar company certainly when it was bought, and it was started in a $50 million dollar venture capital deal at the start.

Professor Douglas W. Rae: Spinnaker, I’ve heard you say, that Spinnaker was the inverse of every decision rule common to Enron.

Jim Alexander: Whenever we weren’t sure what to do, we thought what would Enron do, we did the reverse.

Professor Douglas W. Rae: Well that’s — let’s finish we’ve got about 90 seconds. Let’s finish with — Jim is a scholar of the Old Testament at the Yale Divinity School.

Jim Alexander: Scholar is a little strong — student.

Professor Douglas W. Rae: I don’t know many people who have read as many sources on arcane aspects of the Old Testament as you. I think you’re pretty serious.

Jim Alexander: I like esoterica of all types. That’s why I was in project finance.

Professor Douglas W. Rae: Give us — are we all — is American capitalism in a state of advanced moral and ethical decay or —

Jim Alexander: Not necessarily. If people can grasp the requirements, the need for ethics just to keep the system going. If people don’t come to grips with that I think it’s just going to get worse and worse.

Professor Douglas W. Rae: There’s a big point there. Think now back to Smith’s invisible hand, and to Hayek and the creative powers of a free society. All of that thinking has built into it at the very most basic level, an assumption about truth telling and access to broadly correct information. And every single tenant of the tradition which runs from Adam Smith through modern economics is founded on that. And for Smith the ethical side was explicit with a theory of moral sentiment. The way economics is taught, and the way business management is taught, the emphasis on an ethical commitment to prove has been somewhat submerged. It doesn’t have the simple status for us intellectually that it did for Smith’s generation. I think that’s a fair statement. Jim this has been, as it always is, very illuminating, and even inspiring. Thank you very much. I got to watch out for my job if you get good at the blackboards.

[end of transcript]

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