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Prof: 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.
Prof: 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.
Prof: Only for you, not for us.
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-- Prof: 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.
Prof: 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.
Prof: 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.
Prof: 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.
Prof: Much more like Enron?
Jim Alexander: Yeah.
Prof: So Enron is a very young entity,
and grew up in the period after the fall, so to speak?
Jim Alexander: Yes.
Prof: would you let them off the hook a little about that
or not?
Jim Alexander: Enron off the hook?
Prof: Yeah.
Jim Alexander: In--by what?
Prof: I don't think you will.
Jim Alexander: By saying,
how would I let them off the hook, by the way?
Prof: 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.
Prof: That's correct.
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.
Prof: 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-- Prof: Can you rub that
point in a little more.
Jim Alexander: Well-- Prof: 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.
Prof: 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.
Prof: 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.
Prof: 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.
Prof: Decent guy in your impression?
Jim Alexander: He was at least as nice as
most people I met, yeah.
Prof: How do nice and decent connect in your mind?
Jim Alexander: Not at all but--
Prof: Okay so he was-- Jim Alexander:
--decent, decent I mean
that's--interpersonally he was not abrasive that's one way.
Prof: 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.
Prof: So he was, quite literally,
the smartest guy in the room?
Jim Alexander: Yes, I think he was.
Prof: 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.
Prof: 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.
Prof: 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.
Prof: Now-- Jim Alexander:
So they waived the corporate conflict of interest
policy in his case.
Prof: 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."
Prof: 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.
Prof: 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 *** 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--
Prof: 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.
Prof: There was one more sentencing to prison this very
week.
Jim Alexander: I saw that.
Yeah I know I thought it was all over.
Prof: 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.
Prof: 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.
Prof: 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.
Prof: 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.
Prof: 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.
Prof: 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.
Prof: 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.
Prof: 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.