By Steven Pearlstein
Thursday, July 6, 2006; D01

At one point during the recent Enron trial, prosecutors cross-examining Ken Lay asked the former chief executive how he could have allowed a friendly analyst to report that he was a net buyer of Enron stock at a time when, in fact, he was unloading more than half of his Enron shares.

"I suppose it depends on how you define 'net buyer,' " Lay replied, in a splendid display of Clintonian hair-splitting.

And from that moment, it became pretty clear to me who killed Enron.

It was Ken Lay himself.

Yes, Ken Lay, who engineered the merger of two obscure natural gas pipeline companies and magically transformed it into the seventh-largest public company in the United States.

Ken Lay, the self-made son of a Baptist preacher who put himself through college and graduate school and won the Horatio Alger Award set up by the champion of "positive thinking," Norman Vincent Peale.

Ken Lay, who leveraged his Washington experience and connections of the 1970s to make Enron a big winner from natural gas deregulation -- and then did it again with his campaign to launch the country on an unproven experiment in electric power deregulation.

Ken Lay, who carefully built a reputation as Mr. Houston, bringing the Astros downtown and spearheading countless civic, cultural and charitable causes.

Ken Lay, whose old-world charm and politeness earned him the extraordinary loyalty and affection of Enron employees -- the same loyal employees whose warnings about the company's financial problems he stubbornly ignored.

For many who knew him well, it was simply inconceivable that Ken Lay could have known about, let alone encouraged, the kind of financial shenanigans that led to the downfall of a company that was his life's work and the source of his power and fortune. But what they missed, and what a jury came to conclude, was that like many in corporate and public life, Lay had become a con man, unable to untangle truth from fiction.

The remarkable rise and tragic fall of Ken Lay is really a story about a man whose optimism was finally outrun by reality. Early on, he found he could succeed by putting the best face on things, stretching the truth, dismissing the doubts of naysayers. But in the end, those habits became his undoing.

The pattern began two years after the merger of Omaha's InterNorth Inc. and Houston Natural Gas Corp. in the mid-1980s, when newly formed Enron was in a financial bind because of a sharp drop in the price of natural gas. The company was able to avoid defaulting on its $4 billion in debt because of some fortuitous profit racked up by a small trading subsidiary in Valhalla, N.Y., which had decided to short the price of crude oil.

In fact, the trading profit at Valhalla was so significant, it could not have been achieved without massively violating the company's trading guidelines. But as chief executive, Lay repeatedly ignored such warnings until an audit revealed that some of the profits were based on falsified transactions designed to fatten traders' bonuses. Instead of firing the traders and informing shareholders, however, Lay persuaded directors to keep things quiet, at least until the company could unwind some of its potentially devastating trading positions. Only six months later did the company came clean, blaming "rogue traders" for a reported $140 million pretax loss that wiped out about half of Enron's profit for the year.

Years later, it would be with the same unshakable confidence that Lay would embark on his civic activities, as he sought to persuade city residents, and the rest of the world, that the cultural and aesthetic wasteland that was downtown Houston could be transformed into a vibrant urban center.

In pressing his campaign for electric power deregulation, Lay lavished millions of dollars on state and federal politicians of both parties, framing the issue as one of free-market efficiency against the entrenched interests of monopoly utilities and their regulators. The experiment finally collapsed with the 2001 power crisis in California, with allegations that Enron and other companies had manipulated the wholesale price of power. Lay immediately, and indignantly, denied the charges, but apparently never bothered to check them out. State investigators soon uncovered the trading tickets and tape recordings that proved beyond doubt that market manipulation was a major factor in the California crisis.

For a corporate executive, of course, it would be unseemly to boast about political connections and influence, even when you're on a first-name basis with the president of the United States or you give his parents a lift to the inauguration in the company jet. But Lay was more than disingenuous in denying his influence over federal energy policy during the early years of the Bush administration. In fact, his post-election memos to the new White House became the centerpiece of the Cheney energy plan. And Lay was able to handpick two members of the Federal Energy Regulatory Commission, where continued support and expansion of electricity deregulation was crucial to Enron's growth strategy.

Even when it came to dealing with Jeff Skilling's sudden resignation as Enron's chief executive, in August 2001, Lay apparently saw it as his duty to calm investors rather than rattle them with the truth. Although he expressed shock and disappointment at the news of Skilling's resignation, he'd known about it for weeks. And contrary to Lay's statements that he'd done everything he could to get the sometimes brash and dismissive Skilling to change his mind, Skilling reportedly told friends that he would have been willing to stay for several months, if only he'd been asked.

I suppose it is possible that a man who thinks as broadly about things as Ken Lay, and who spent as much time dealing with civic and public policy matters, might have left it to others to check over those funny-sounding off-balance-sheet transactions that he approved at the urging of then-Chief Financial Officer Andy Fastow. But when the Wall Street Journal starts running stories about such deals and trading counter-parties and credit-rating agencies start inquiring about them, the handbook for chief executives and chairmen of the board is pretty clear about what to do:

You cancel your appointments, summon your top outside and internal auditors and begin grilling everyone who knows anything about those deals, one by one, until you finally shake the truth out of them.

What you don't do -- unless you're Ken Lay and you're miffed that anyone would dare to question your integrity -- is get on a conference call with industry analysts and declare that you "and the board of directors continue to have the highest faith and confidence in Andy and believe he is doing an outstanding job as CFO." The next day, Fastow was gone.

Were those instances of willful deception? Or are they examples of the self-deception that becomes ingrained after years of obfuscation and half-truths, part of the corporate leadership game? Because of an untimely death in Aspen, we'll never know for sure.

Steven Pearlstein can be reached atpearlsteins@washpost.com