Howard Marks Memo – Learning From Enron​ – 2002

The first memo of 2002 is a long one. 21 pages to be precise. As the title will tell you, it focuses on the rise and fall of Enron and the lessons thereof. In a sense, this memo is an in-depth case study of fraud and corruption. The style of the memo reminded me of Genius Isn’t Enough (and Other Lessons from Long-Term Capital Management) that H. Marks wrote in 1998. Everyone should read this memo as the lessons it contains will, most likely, stay relevant across time and space. In other words, future cases of fraud and corruption will just be old ideas embedded in new narratives.

Please comment if you have read the memo and what you thought of it. Also, if you have found a worldly wisdom in the memo that you think I should have included please comment on that as well. I’m very interested in what caught your eye while reading and why.

Worldly wisdom’s from Learning From Enron – 2002


“For those seeking an explanation for fortuitous outcomes, luck has been described as “what happens when preparation meets opportunity.” I think Enron inspires a similar explanation for corruption: it’s what happens when exigency meets moral weakness.”

My thoughts: Or more explicitly; corruption/fraud; it’s what happens when greed and envy meets ego and misaligned incentives. Having greed and envy meet ego and misaligned incentives at the top of the organisation means trouble for the whole organisations:


Corporate Rot Can Spread From the Executive Suite 


It certainly appears that Enron was a company where: 

  • hubris was encouraged, 
  • schemers rose to the top,
  • people were rewarded for ends, not means, and
  • no one ever asked “but is it right?” 


And encouraging moral behavior, perhaps above all else, is the responsibility of top management. One thing I’m convinced of is that you can’t have a great organization without someone at the top setting the tone. The Chairman and CEO can’t know everything that goes on in a company, can’t be conversant with the details and merits of every transaction, and can’t participate in any but the most senior hires. But they can create a climate where expectations are high and the emphasis is on means, not just ends. 


Aligning Interests

About a decade ago, Forbes published a special issue on executive compensation. In it, a sage, experienced director said of managers, “I’ve given up on getting them to do what I tell them to do; they do what I pay them to do.” I’ve never forgotten that statement.

When individual compensation gets into the tens or even hundreds of millions of dollars per year (including stock and options), managers profit as if they owned the company and took the risk. They appropriate a major share of profits for themselves in the good years, even though they lose nothing (other than perhaps potential or previously-accrued profits) in the bad ones.

Set up this way, management has lots of incentive to take risk and cut corners. It sure worked that way at Enron. The executives can point out that the board approved the key elements in the compensation program. But once again, I say the board’s control over management is limited.


Management should be incentivized, but constructively. Excessive, short-term focus on stock price performance is not in shareholders’ long-term interest and, in egregious cases like Enron, obviously can bring disastrous results.

My thoughts: As the old German saying goes: “Wes Brot ich ess, des Lied ich sing” (whose bread I eat, his song I sing). Furthermore, I think its fair to say that Enron’s management had a lot of incentives but few disincentives, i.e. they lacked skin in the game.


Where Does the Buck Stop?

Ours is a free market. If undeserving (or crooked) companies get capital they shouldn’t, the responsibility ultimately falls to the providers of equity capital. I’ve read everything I could on Enron, and yet there’s almost no mention that shareholders may have been remiss.

Sure, the shareholders were victims of what appears to have been organized and pervasive fraud. But no one can say there weren’t warning signs. Shareholders held and bought Enron stock although they couldn’t possibly have thought they understood the financial statements, or where the profits came from. They held while the top executives were selling. And they remained unperturbed when the CEO quit without explanation.

And I’m not just talking about individual investors. Al Harrison of Alliance, Enron’s biggest holder, has been quoted as saying he bought on “faith.” He even admits, “The company seemed to be on a deliberate path not to give full information. Shame on me for not doing something about it.” (New York Times, March 3, 2002) Good marks for candor; not so good for due diligence.

I believe many investors underestimate the difficulty of investing, the importance of caution and risk aversion, and the need for their active, skeptical involvement in the process. Caveat emptor. Or as they say on TV, “don’t try this at home.”

My thoughts: In short, grow up, stop being naive and take responsibility for your mistakes of commission (buying Enron) as well as your mistakes of omission (not selling Enron).


“What’s the bottom line, then? The real lessons from Enron, in my opinion, are these: 

  • As long as there are disclosure rules – and that’s forever – there’ll be “technically correct” statements that leave investors in the dark. In order to get numbers with integrity, you need people with integrity.
  • Rules are just the first building block in creating a safe market. We also need compliance and enforcement, neither of which will ever be 100%. Even though it’s the best in the world, our system for corporate oversight is far from perfect. The collective power of directors, auditors and regulators to protect shareholders withers in the face of serious corporate corruption. It’s amazing what con men can get away with for a while.
  • As Enron’s complex, questionable transactions indicate, the people looking for holes in the rules are often highly motivated, well financed and well advised. Those whose job it is to plug the loopholes are often over-matched, and their efforts to do so usually amount to a holding action. The furor over Enron’s accounting shows that we need the ability to insist on adherence to general principles and punish those who violate them.
  • Security analysis and knowledgeable investing aren’t easy. Investors must be alert for fuzzy or incomplete information, and for companies that don’t put their interests first. They must invest only when they know what they don’t know, and they must insist on sufficient margin for error owing to any shortcomings.
  • We all must watch out for unintended consequences, and that’s especially true when promulgating regulations. Accounting rules and option programs were created with the best of intentions, but in the extreme they led to Enron’s noxious transactions and counterproductive incentives. It’ll be no less true the next time around. 

My thoughts: The extract above is a brilliant summary of this lengthy memo. Unfortunately, I think that there is a high probability that the same list of lessons be relevant when evaluating future cases of fraud, i.e. we won’t learn.

One thought on “Howard Marks Memo – Learning From Enron​ – 2002

  1. Tack! Uppskattade detta memo, finns en hel del lärdomar om “agency costs”. Tycker det också är intressant att Enron bröt igenom alla “lines of defense” – (i) management oärliga, (ii) revisorerna gör inte sitt jobb, (iii) styrelsen låter det fortgå, (iv) investerare köper Enron utan att förstå bolaget. Sedan när Enron blev hatat, då köpte Baupost säkerställda obligationer för 10-15 cents på en dollar och gjorde uppskattningsvis 5x pengarna, så det kan vända fort…


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