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  “How’d this happen?” he demanded of Hall. Charles Koch was incensed with Dean Watson and some of the MBAs who’d worked on the Purina acquisition, Hall remembered. Charles Koch was staring at a catastrophe, and one that appeared to have been entirely avoidable.

  * * *

  Dean Watson’s life was a rapid rotation of flights between Wichita and St. Louis, and conference calls with angry bankers and furious customers who demanded that Purina Mills live up to its contract obligations. “Every assumption we had made had just been blown out of the water. We’re in just an awful, awful spot,” Watson said. “We knew what we wanted to do, we just didn’t have the time to do it. . . . Honestly we were just like, ‘Holy shit.’ ”

  During one meeting, Watson was interrupted by one of his attorneys bursting into the room. The attorney had just tried to call one of his counterparts in Wichita and was told that nobody in Wichita could speak to him.

  “What do you mean they can’t talk to you?” Watson remembers asking. The attorney said there had been an order given from on high in Wichita: all communication between Wichita and Purina Mills must cease.

  Another executive came into the office with a worried look on his face. He told Watson that he too had been cut off from talking with a counterpart at Koch Industries. Four or five senior people gathered in Watson’s office, wondering how to move forward.

  Watson did the only thing he knew to do. He called Charles Koch to ask what was going on.

  “He said, ‘Well, we’re doing this for the protection of Koch Industries. We need to narrow the scope of the interface. You will be given a person that you can talk to—so all your communication will go through that person,’ ” Watson recalled.

  Watson felt that Charles Koch made the right decision for Koch Industries. It was important to protect Koch from the burning building that was Purina. But Watson still argued against the move. He didn’t think it would help Purina survive.

  Charles Koch tried to calm his young protégé. “He chuckled, in that laugh of his, and he goes, ‘Dean, don’t worry. Everything will be all right,’ ” Watson remembered.

  “That was the last thing I ever heard from Charles Koch.”

  * * *

  Watson was in Wisconsin, attending one of the countless “pig meetings,” when he got a phone call. His attendance was requested at the Crestview Country Club in Wichita. He needed to meet with the three men who comprised Purina Mills’ board of directors. The men had been appointed by Koch Industries, and they were not friendly toward Watson. They were the only people who could fire him.

  Watson arrived early at the country club. The parking lot was nearly empty. Watson spotted a car there that he knew belonged to one of Koch’s directors. He peered inside the car windows and saw three suitcases in the back. That meant the directors would be catching a flight to St. Louis directly after the meeting. It was likely to be a short encounter.

  Watson had no illusions about what was underway. “I’ve been in business a long time. I’ve seen what happens at Koch,” he said.

  Watson walked into the spacious clubhouse and proceeded up a flight of stairs to a meeting room often used by Koch. The room had big windows looking out over a putting green. The three directors were waiting for him.

  “I said, ‘Okay, boys. Let’s get this over with.’ ”

  Watson was fired from Purina Mills at that meeting. But he still worked for Koch Industries. He was told at the country club that he needed to go to Koch headquarters to speak with Bill Hanna, the president of the company.

  Hanna ran the company while Charles Koch was preoccupied with his legal troubles in Wichita. Hanna also sat in on the key meetings about Koch Agriculture and oversaw many of the vital decisions for the business. He had been a mentor to Watson and told Watson that he was an example of what a Koch employee should be, an example who should be emulated by other business leaders.

  The meeting with Hanna was also short. “He told me, ‘I never believed in what you were doing. You and Charles were so far out there, I kind of let you go,’ ” Watson remembered. “The second thing he said is that ‘I’ve talked to everybody else, and nobody else wants you.’ ”

  None of the other business divisions at Koch would hire Watson. After breaking this news, Hanna complained about a knee problem he was having and made other small talk. Then Watson was shown out.

  “The meeting lasted about five minutes. Twenty-year career. Just, boom. Just like that.” Watson returned to negotiate his severance package, doing so across the table from an old drinking buddy. Both times Watson was in the office, Charles Koch’s door was closed.

  The day he was fired, Watson returned home. His wife was having a garage sale. He told her the news. That morning, he had been CEO of one of Koch’s largest and fastest-growing divisions. He joked with his wife that he’d gone from CEO to head of floor sales on their driveway.

  Even fifteen years later, the pain of this was still raw for Watson. He hashed over the details of the Purina collapse in his mind, trying to figure out exactly how he could have stopped it. In a fundamental way, Koch Industries was still his life, even though he was no longer there.

  “I swear to you, it still haunts me to this day,” he said.

  Watson never lost respect for Charles Koch and always spoke fondly of his old mentor. He never lost respect for Charles Koch’s philosophy. Watson had been one of Market-Based Management’s brightest pupils, and he always believed in its principles. The markets levied their verdict, and their verdict was sometimes harsh. It was never forgiving. He abided by the laws of the markets.

  “Oh, it’s ruthless. It’ll absolutely rip your heart out.”

  * * *

  There was only one way that Purina Mills might survive without declaring bankruptcy and defaulting on loans that Koch had taken to fund its purchase: an influx of money from Koch Industries. Purina’s leaders made a compelling case to Koch: If Koch would just invest more money, Purina could weather the downturn. In just a year or two, Purina might be able to emerge stronger than ever. Koch had owned the firm for barely a year and had invested more than $100 million of its own money. Surely Charles Koch didn’t want to lose that entire investment by sending Purina into bankruptcy.

  “True knowledge results in effective action,” as Charles Koch liked to say. Pouring money into a failing business venture like Purina Mills would not change the market’s verdict. Doing so would only steer that money away from other ventures where it could be more profitably invested. It was better to let the thing die, no matter the short-term pain that might be inflicted. This was one of the principles of Market-Based Management. What good were principles if you abandoned them when tested?

  In late August of 1999, Koch Industries informed Purina that it would get no extra money from Wichita. Koch owed Purina nothing. Soon after, Purina failed to pay $15.75 million in interest expenses that were due. Two weeks later, it failed to pay $2.1 million in principal payments. When Purina blew through its payment dates and became delinquent, it set off a cataclysmic chain of events. The banks accelerated their payment demands rather than giving Purina more breathing room. The lenders were desperate to get whatever money they could while the firm was still solvent. The frenzy only ended on October 28, when Purina filed for bankruptcy.

  With Purina in Chapter 11, Koch Industries stood to lose its $100 million investment. The bankers stood to lose much more. And they did not accept this fact easily, in part because they knew how much money Charles Koch had. Charles Koch’s wealth was well known in spite of his penchant for secrecy. Forbes magazine publicized Charles Koch’s status as a billionaire and Bill Koch’s extensive litigation that dragged the family’s finances into a public courtroom. Press reports from the Wichita Eagle to the Wall Street Journal showed that Koch Industries enjoyed billions of dollars in revenue each year. This was one of the reasons bankers had been willing to risk more than $500 million to finance the Purina Mills acquisition. Now Charles Koch was telling them t
hey would have to kiss that money good-bye. He wouldn’t pay them back.

  Koch appeared to have structured the deal in a way that protected it from the bankers’ claims. Koch used debt that was called “non-recourse” debt, meaning that lenders could not collect the debt from Koch Industries itself—they had no recourse against the parent company. They could only collect debt against the assets of Purina Mills.

  But there was a way around this clause. It was called “piercing the corporate veil.” Piercing the corporate veil is one of those arcane strategies known only to a small subset of deal makers and lawyers whose careers took off during the merger boom of the 1980s and 1990s. A banker can pierce the veil by showing that nonrecourse debt was actually a sham used by a borrower to escape liability. For nonrecourse debt to be justified, the parent company needed to be truly independent from the entity borrowing the money.

  Lawyers pored over the details of the Purina acquisition with the goal of proving one argument: that Purina was essentially a division of Koch Industries, not an independent company. If they could show that Koch was responsible for what happened at Purina, then Koch would be on the hook for Purina’s bad debt.

  This was not a particularly hard case to prove. Dean Watson, for example, had been Purina’s CEO. But had he ever truly been independent from Koch Industries? When Watson was in trouble, he called Wichita. Purina’s payroll was processed in Wichita, along with other administrative functions. One of Purina’s most vital business activities—buying the grain to make its feed—had been shifted to Koch Industries’ trading floor. It was impossible to make the argument that Koch was not fundamentally involved in Purina’s daily operations.

  The banks would sue Koch in order to pierce the veil, and going to court was a risky proposition for Koch Industries. Piercing the veil was a “binary” proposition: either the bankers pierced the veil, or they did not. With a single verdict, a bankruptcy judge could expose Koch to enormous liabilities.

  If Koch lost the court battle, it could also affect the entire system that Charles Koch built over thirty years. By the late 1990s, the company was an impossibly dense interlocking set of supposedly independent subsidiaries and joint ventures. This arrangement allowed Koch to become enormous by swallowing up dozens of smaller companies while shielding it from the full liability of owning each of those companies. If a Koch subsidiary went bankrupt, then Koch would only lose its investment in that subsidiary; it wouldn’t be on the hook for all the debt and outstanding obligations of that subsidiary. But if banks in the Purina bankruptcy pierced the veil, it could call into question the walls between all of Koch’s divisions. “Imagine all the Koch subsidiaries,” said the financier who worked on the Purina bankruptcy. “The last thing Koch wants to do is guarantee all the obligations of these entities.”

  Lawyers working for the banks determined that their case was strong enough to make it past the first hurdles of a lawsuit. This meant that Koch faced the real risk of trial, and the bankers’ negotiating team highlighted this risk to Koch’s attorneys. The negotiators dropped the word “litigation” a lot. They made it clear what kind of dirty laundry would be dragged into open court. They emphasized just how eager they were to file a complaint. In short, they leveraged the legal threat into a bargaining chip.

  Koch finally agreed to pay $60 million to help Purina emerge from bankruptcy in a stronger position. This was a coup for the banks. A worst-case scenario for Koch was losing its entire investment in Purina of $100 million. By the end of its negotiations with the creditors, Koch lost all that money and paid an extra $60 million on top of it.

  This failure would reshape Koch Industries going forward. The company fortified its corporate veil, creating a corporate structure that was even more complex and opaque than before. Koch called its divisions “companies” and treated them like independent entities to make sure the veil was strong. Koch might publicly claim that its various business units had so much autonomy only due to the tenets of Market-Based Management. But the real reason was to avoid liability.

  After the banks were paid off, Charles Koch began to dismantle Koch Agriculture. It was a very public failure. For the first time in memory, Koch Industries made sweeping staff cuts in Wichita. Roughly five hundred employees and three hundred contractors lost their jobs. Many of those jobs were at the highest reaches of the company. Brad Hall gutted Koch’s development group, for example, firing most of its employees. The group had grown bloated, unwieldy, and ineffective. So had many other parts of the company.

  “I told Charles, we ought to be in the Harvard Business Review as an example of piss-poor management,” Hall recalled.

  * * *

  I. The investigators were hired by a firm called Decision Strategies International, which was under retainer, according to documents uncovered by the Times.

  II. Dean Watson did not remember this encounter. He said it was rare for him to lose his temper at work, and if he did lose his temper, it would have run counter to the teachings of MBM, which does not seek to coerce or control employees.

  CHAPTER 10

  * * *

  The Failure

  (2000)

  Charles Koch drove himself to work every day. He was a billionaire, but he still drove a sensible sedan to the office. He arrived at the Tower early and often walked up the back stairwell to his office on the third floor. Charles was the most powerful person in the company. During the course of his day, he seldom encountered people who were not directly answerable to his authority. But as he climbed the stairs to work, and as he sat at his desk and looked out over the flat grasses north of Wichita, it could be said that Charles was, in many important ways, a failure.

  The previous decade had been a public embarrassment. To the degree that Koch Industries was written about in the popular press, the stories tended to focus on Koch’s lawbreaking and litigation. To the degree that Charles Koch himself was written about, he was described as a character in a pathetic family feud that showed just how crazy billionaires could be. To the degree that Charles Koch’s tenure as CEO was written about, it was hard not to question how effective his leadership had been. He had spent years honing a management philosophy that had sown problems throughout the company. Oil gaugers interpreted Koch’s push for “continuous improvement” as a reason to steal from Koch’s customers. The refinery managers had interpreted Koch’s push for “profit centers” as a reason to dump pollution into wetlands and delay investments that would have reduced pollution. The common teachings of MBM had too often turned into a language of groupthink, prompting managers to persecute whistle-blowers rather than heed their important warnings. MBM’s focus on growth had encouraged irresponsible acquisitions that piled up losses and public failures like the collapse of Purina Mills. Koch Industries was flush with cash, thanks to the heavily subsidized and regulated oil markets that were its core business, but the failure of Koch Agriculture seemed to prove that MBM was not, in fact, a blueprint for running successful ventures in other business sectors.

  This mattered to Charles Koch. He believed that the CEO was ultimately responsible for a company’s conduct. If a company was dysfunctional, the leadership was to blame. As he said when he was being deposed by Senate investigators, “Ninety percent of the problems in industry are caused by management, not by the worker. The main management is the one that should be fired” if there’s a problem. According to this logic, there was a reasonable argument to be made that Charles Koch should be fired. Charles Koch said that the late 1990s were one of the most difficult times of his life.

  “The worst was when we had that, that trial, where we were being sued by a family and stockholders and all this stuff,” he recalled. “And I’m thinking, ‘God. Look—all the money we’ve made them, and this is what we get?’ So it was depressing. . . . It just . . . it took me a while to adjust to that.”

  Still, every day, Charles Koch drove himself into work. He parked his sensible sedan in the employee lot, and ascended the back stairwell and stati
oned himself at his desk very early. He left very late in the evening and he often took a briefcase home to review papers during his off hours. And during the long days of his workweek, as he sat at his desk, Charles Koch saw something that nobody else could see. He could see Koch Industries for what it really was. The company was intentionally opaque and secretive, and its complex network of divisions and subsidiaries was so diffuse that even some senior people at the company were not aware of the full organizational structure. But there was one focal point from which the whole machine could be observed—and that point was Charles Koch’s desk. He was the only one who could see the entire machine for what it was. And he believed in it.

  Charles Koch was in a position to see the seeds of strength in Koch Industries; seeds that might have been overlooked by other people during the turmoil of the 1990s. He saw all the elements that would later make Koch Industries one of the largest, most powerful corporations in America. Market-Based Management might have fostered business failures, but it had achieved one thing: It gave all of Koch’s employees a common language. It gave them a common mission, and this is more important than it might sound. By the year 2000, Koch Industries was a sprawling confederation of divisions spread across different segments of the economy. As many companies have discovered, this can be a recipe for disaster: it can foster fragmentation, miscommunication, and managerial fiefdoms that compete against one another. But Charles Koch had drilled into each employee the value—the necessity—of MBM. Years of doing this created a unified workforce, a workforce where employees could shift from one division to the next and understand each other perfectly.

  The fact that Koch employees thought with a long-term view was another strength. It was a strength that Charles Koch fought dearly to earn. He spent years battling to keep his company private, fighting his brother and dissident shareholders for years in court. He fought against conventional wisdom to make this happen, not just by remaining privately held, but by refusing to take large dividend payments out of his company. The reward for this struggle was the ability to think in terms of years and decades rather than in quarterly earnings or monthly reports.