The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron (28 page)

The person who best symbolized the unseemly closeness between the com-
pany and its accounting firm was David Duncan, who was just 38 years old when he was put in charge of the Enron account in 1997. Born in Lake Charles, Louisiana, and raised in Beaumont, Texas, Duncan joined Andersen’s Hous-
ton office in 1981, straight out of Texas A&M. Rick Causey started at the firm around the same time, and the two men became fast friends. That didn’t change after Causey moved to Enron. They often lunched together at Nino’s, an Italian restaurant frequented by Enron and Andersen employees. They co-
chaired the Open Heart Open, a Houston golf tournament that benefited the American Heart Association. On at least one occasion, Causey took Duncan and a handful of Andersen accountants to the Masters. Duncan also served on the American Council for Capital Formation—one of Charls Walker’s groups—with Ken Lay.

Did this bother anyone at Andersen? Actually, it did, but not the people who mattered. There were accountants among the rank and file who thought that Duncan was far too close to his client. But most of Duncan’s bosses viewed him as a rising star who did exactly what he was supposed to do—generate 20 percent to 25 percent in additional fees from Enron each year. Duncan had become a partner in 1995 and took over the Enron account two years later; by 2000, his annual salary hovered around $1 million. He was on Arthur Andersen’s firmwide strategic advisory council and in the fall of 2001 was invited to join chairman Joe Berardino’s advisory council, which consisted of just 21 partners. At the time of Enron’s collapse, he had a shiny life with his wife and three daughters and an expensive house in Houston’s affluent Memorial area. All thanks to the Enron account.

The problem, of course, wasn’t merely that Duncan was going to the Masters with Causey; it was that he saw things the way the client wanted him to see them and gave his assent to Enron accounting treatments that bore little relationship to economic reality. Did he know how far out on the edge Enron’s accounting was? Of course he did. But he was being rewarded at Andersen for keeping the client happy—and that meant becoming every bit as creative as Enron was.

Within the firm, Enron was labeled “high risk.” That in itself was not unique; Andersen had other clients in the same category. But over the years, the firm’s internal notes on Enron showed just how high risk this client was. “Client is a first mover, and expects to push the edges of established convention, and where they can, create new convention . . . often in very gray areas,” wrote one partner in early 2001. “The transactions are complex, and there is no clear written literature with respect to these transactions,” noted another. Enron, said Andersen, had a “dependence on transaction execution to meet financial objectives.” An internal Andersen appraisal of the client noted that Enron’s “accounting and financial risk” were “very significant.” Andersen said the same thing about Enron’s use of “form over substance” transactions.

“There are a number of areas,” the firm pointed out to Enron’s board in a 2000 audit update, “where accounting rules have not kept up with the company’s practices. . . . Categorization of activities between certain segments, operating vs. non-operating or recurring vs. non-recurring can be highly judgmental.” Duncan’s own appraisal of Enron’s accounting? “Obviously we are on board with all of these [transactions],” he jotted in a handwritten note after Andersen had completed its 1998 audit, “but many push limits and have a high ‘others could have a different point of view’ risk profile.”

But just like the Enron executives, Duncan couldn’t see where the cumula-
tive effect of his decisions was leading. Yes, all the incentives inside Andersen pushed him to see things the way the clients wanted him to see them: his big salary, his rapid rise, his status inside the firm were utterly dependant on keeping Enron happy. But he had started smoking the dope, too, abandoning the auditor’s role of skeptic and becoming a believer himself. Enron was a great company, wasn’t it? Enron’s finance executives were whizzes. They were all on the cutting edge. Sure, they were stretching the rules, but the Andersen team always had a rationale as to why they weren’t
breaking
the rules. Given the firm’s experience with the Waste Management scandal, the firm could hardly afford another big accounting scandal. Yet in signing off on one risky accounting treatment after another, that was the very large risk Duncan was taking. And he never seemed to realize it until it was much too late.

What about those times Andersen did object to an Enron transaction? At such times, Enron put the firm under intense pressure. There were times when Causey and others would ask that certain accountants who weren’t “responsive” enough be moved, and Duncan complied. Knowing just how important the $1 million-a-week account was to Andersen, Enron also kept competing firms lurking in the wings. From time to time, Causey would throw a small bit of business to Ernst & Young or PricewaterhouseCoopers, just enough to remind Andersen who was running the show. Inside Global Finance, Arthur Andersen was viewed as “a manageable issue,” says a former Enron employee. “They were pretty easy to push around and bully into doing whatever we wanted them to do.” A midlevel Andersen accountant named Patricia Grutzmacher later testified in court, “When you look at a deal and you give the answer no, and then they appeal the no, and the answer ends up being yes, you just wonder, you know, why are you even there?”

Andersen had a small elite group that formed something called the Professional Standards Group, which was supposed to make independent rules on particularly tricky accounting issues. Starting around 1999, more and more of the PSG’s time was consumed by Enron; at one point, Andersen’s Houston office was calling the PSG practically on a daily basis. The PSG was supposed to have the final word on any technical accounting question. If the client team wanted to reject the advice, the issue was supposed to be settled by higher-ups at the firm. In addition, the team was supposed to speak to the client with one voice. But Causey understood how the PSG worked and insisted that he be consulted when Enron accounting issues were brought to the PSG’s attention. As Duncan told his partners, Enron demanded “more face time with Chicago to ensure their views are heard directly.” Causey expected Duncan to be Enron’s advocate in dealings with the PSG. Duncan obliged.

These weren’t just issues that cropped up at the end. The cross-fertilization between client and firm, the willingness of Andersen to push the envelope on accounting decisions, the aggressiveness with which Enron pressed the accountants to see things its way—those were there, in one form or another, for years. As early as 1995, back when Kinder was still president of the company, a Houston-based Andersen auditor named James Hecker decided to have a little fun at Enron’s expense. Hecker never worked on the Enron account, but at lunches and other social occasions, he would hear auditors on the Enron account talk about strategies to “minimize losses” and take liabilities “off the balance sheet.” He heard chatter that Enron was, as he later put it, “very opportunistic in trying to achieve objectives.” Hecker later used the word “shambolic” to describe Enron’s accounting, not that it was completely a sham but that it was substantively illogical, like a duck that’s really a dog. One day, Hecker wrote a parody, which he showed to a few colleagues. Sung to the tune of “Hotel California,” he called it the “Hotel Kenneth-Lay-a”:

Welcome to the Hotel Mark-to-Market

Such a lovely face

Such a fragile place

They livin’ it up at the

Hotel Cram-It-Down-Ya

When the suits arrive, bring your alibis

Mirrors on the 10-K, makes it look real nice

And she said, we only make disclosures here

Of our own device

And in the partners’ chambers

Cooking up a new deal

3% in an SPE

But they just can’t make it real

Last thing I remember I was running for the doors

I had to find the entries back

To the GAAP we had before

“Relax,” said the client

“We are programmed to succeed

You can audit any time you like

But we will never bleed”

Just as the cozy relationship between Enron and Andersen wasn’t a secret, it was also no secret on Wall Street that Enron was an aggressive user of structured finance devices such as special purpose entities (that’s the SPE in Hecker’s song), securitizations, and off-balance-sheet partnerships. “If there was a whiz-bang structure somebody had, the place to sell it was down there on Smith Street, because they were buying,” says one banker. Andy Fastow’s team, says another banker, were “black belts in structured finance.”

“It started out as pure, clear, legitimate deals,” says a former senior Enron executive. “And each deal gets a little bit messier and messier. We started out just taking one hit of cocaine, and the next thing you know, we’re importing the stuff from Colombia.”

In the spring of 1998, shortly after Andy Fastow became Enron’s chief financial officer, he approached Jeff Skilling about using the equity markets to raise money. Selling new shares of stock is one of the most common ways a corporation can raise capital, and in the middle of a roaring bull market, it’s one of the easiest ways as well. Unlike debt, the money never has to be paid back; investors are betting that the company will use the capital wisely and that the stock will go up as a result. If it doesn’t, the investors, not the company, take the hit.

Although Enron clearly needed capital—it had by then billions in debt and was preparing to spend billions on new business ventures—Skilling and Lay were cool to the idea. Skilling, in particular, was opposed to anything that might hurt the stock price, even temporarily. That’s always the danger when new shares flood the market: the new supply can outstrip the demand for the stock and push the price down. Additional shares also make it harder to hit an earnings-per-share number because there are more shares outstanding. As they say on Wall Street, existing shareholders are diluted.

But Fastow countered that the stock market would easily absorb the shares; Enron hadn’t sold a significant amount of stock in five years, and its executives could surely tell a compelling story. Eventually, Skilling and Lay relented, and Enron raised some $800 million in the offering. Less than a year later, Enron sold more stock. But after that, although Andy Fastow and his group at Global Finance generated billions of dollars of new capital for Enron, never again did they do a financing as simple and straightforward as an equity offering. By then, the era of Enron’s financial subterfuge had begun in earnest.

In Finance 101, there are only three ways for companies to fund their growth. They can take on debt, issue stock, or draw from their existing cash flow. Enron had committed to Wall Street that it was going to grow rapidly; that was an essential element of the Enron “story.” But all three of these tactics were ruled out at Enron. The company couldn’t put too much debt on its balance sheet because that would hurt its credit rating (and banks would stop lending if Enron’s debt ratios got out of whack). Nor could it use existing cash flow, since Enron didn’t have much real cash flow. And although the equity market was, indeed, available, Skilling had made it clear that he didn’t want to tap it often.

Yet Enron continued to fund its growth—to the tune of billions of dollars each year—through the miracle of structured finance. Structured finance enabled Enron to raise capital off its balance sheet to an extent no one imagined possible. According to an Enron board presentation, Fastow’s Global Finance group was raising around $20 billion worth of capital a
year,
mostly through structured finance deals. As Fastow himself once told the board, his job was to “feed the beast.”

In business terms, it was as if the company had discovered a way to defy the laws of gravity. Using off-balance-sheet vehicles and other complex transactions, Enron seemed to be able to make money magically appear without either adding debt or issuing stock. And that’s precisely how many Enron executives felt, especially those who worked directly for Fastow: they thought they
were
magicians, reinventing corporate finance, rewriting the rules of the game, thumbing their nose at the way business had always been done.

One wonders now whether Fastow recognized that he was creating an illusion, especially as the pressure increased, and the sums became larger, and the chicanery required to pull it all off grew more brazen. For the most part, Fastow seemed to exhibit great pride in the work he was doing—he even bragged about some of Enron’s more clever structures. But every once in a while, he would show that he could glimpse a more terrifying reality. Once, a banker asked him what would happen to Enron if the deal flow ever stopped.

“It implodes,” Fastow responded.

 • • • 

Fastow’s role made him the kind of figure he’d always wanted to be at Enron: truly indispensable. He had never stopped seething over the fact that people in finance weren’t considered as important at Enron as the deal makers or the traders, and part of his motivation was to change that perception. Thus, within months of taking on the CFO role, he tripled the finance staff to over 100 and, as he later boasted, “transformed finance” into an internal capital-raising machine. He set up the group to resemble nothing so much as an investment bank, up to and including selling its services to other parts of the company. (In fact, Enron even set up a small group that tried to capture underwriting fees on the company’s own deals.) One in-house presentation laid out all the things that Global Finance could do for Enron’s divisions. The aim, the presentation declared, was “to craft solutions to help business units achieve their goals. . . . Common business unit goals include earnings, fund flows . . . balance sheet management, return on invested capital.” Later, after explaining the various vehicles Global Finance had at its disposal to “craft solutions,” the presentation added, “There is no obligation to use these vehicles. They are one option for achieving business unit goals.” But of course almost every part of Enron used them, even the divisions run by executives who detested Fastow.

Like its leader, the top executives in Global Finance all had chips on their shoulders. Their attitude, says a former finance executive, was that “we’re working really hard to fix the mistakes the rest of the company is making.” They worked terrible hours. To anyone who crossed them, they could be verbally abusive: one person described theirs as a “bully culture.” The finance executives resented having to clean up behind the deal makers who dug the holes and resented even more, as one employee put it, “that the people who dug the holes walked off with the loot.” Because they were the ones who saved the company every quarter, they saw themselves as heroes. As an in-house lawyer named Kristina Mordaunt, who worked for a period in Global Finance, later told investigators: “Everyone was applauding the finance team for its efforts. Enron was hiring smart investment bankers, creating new structures, and getting the market used to them. . . .”

One of the few high-ranking Enron executives who ever expressed concern about Fastow was Cliff Baxter, though he, too, found times when he had to rely on Global Finance. He’d often complained to Skilling that Fastow was a little too clever. Baxter used to say that it was always worth paying a little more to ensure that a deal was clean. With Fastow, he’d add, you could never tell whether deals were clean because they were so complicated.

Even with his new higher profile, Fastow remained a shadowy figure to the rank and file. He didn’t seem to care whether people outside his own small circle liked him. He spent most of his time with members of his own group and with the bankers and investment bankers who aided and abetted the Global Finance team. Under his leadership, Global Finance was tight-knit, secretive, and seemingly untouchable. Soon after taking over corporate finance, Fastow began freezing out Bill Gathmann, the corporate treasurer, by holding meetings without him. (Gathmann was soon replaced by an executive named Jeff McMahon.) And while the Global Finance staff could sit in on meetings taking place in other parts of Enron, outsiders were not allowed to attend Global Finance meetings. Just as Skilling had gathered loyalists around him, so did Fastow.

The most important Fastow disciples were a pair of executives named Michael Kopper and Ben Glisan. Kopper, who was three years younger than Fastow, arrived at Enron in 1994. A Long Island native, he went to Duke and the London School of Economics and was working in structured finance for Toronto Dominion bank when Enron came calling. He was 29 when he joined the company.

Kopper wasn’t the person from Toronto Dominion whom Enron wanted to hire. Enron had been recruiting Kopper’s boss, a more senior banker named Kathy Lynn; she brought him with her into the company. (Although Kopper joined at a fairly junior level, he still got a signing bonus of $20,000 and a salary of about $85,000 a year.) But Kopper quickly leapfrogged Lynn, becoming fast friends with both Fastow and his wife, Lea. In an early performance review, Rick Causey noted that Kopper was a “valuable asset to Enron” and good at “keeping the banks focused on Enron’s goals”; he ranked him in the top 10 percent. Later reviews add that Kopper “conveys a win-win attitude.” (Perhaps as testimony to how worthless the reviews could be, Kopper’s reviews also claim that his “deals are structured so that they are always clear . . . no unnecessary complexity,” that “risks are clearly identified,” and that Kopper “sacrifices personal good for others and the team.”) The only critical comment: “customers sometimes think you negotiate too hard.” Of course at Enron, that wasn’t necessarily a bad thing. In 1996, Kopper signed a new employment agreement, giving him a salary of $135,000, a signing bonus of $100,000, and guaranteed bonuses of $100,000 for each of the next two years. By 1997, Kopper headed Fastow’s special projects group.

Kopper was gay, and over the years, he became more open within the company about his sexuality. Fastow could not have cared less; his reaction upon learning that Kopper was gay was “So what?” Kopper and his partner Bill Dodson, who worked in finance at Continental Airlines, lived in a starkly contemporary house that featured a glass staircase. The two traveled widely, and within Enron, Kopper was known as a jet-setter and a fashion hound who favored Prada suits. Although Kopper made over $1 million in cash salary and bonus in 2000—and had millions in Enron stock—those who know him could see how it wouldn’t be enough. “Given the opportunity to make money, he wouldn’t spend much time thinking about it,” says a former executive.

Within Enron, Kopper was even less well known than Fastow. After Enron’s bankruptcy, Ken Lay said he didn’t even know who Kopper was. Some of those who did know him, though, disliked him intensely. He was temperamental and difficult to work with—and in doing his boss’s bidding, he amplified Fastow’s flaws. “He would wind Andy up, tell tales, and make it worse,” says one former executive. “People wouldn’t cross him because they knew there would be an explosion from Andy.” People who knew them both also considered Kopper smarter than Fastow; some view Kopper, not Fastow, as the brains behind the most complicated of Enron’s off-balance-sheet vehicles. Says one former executive: “Kopper would make the bullets, and Fastow would fire them.”

The other Fastow disciple, Glisan, joined Enron as a 30-year-old accountant in late 1996. Like Kopper, Glisan also shot through the ranks. But to insiders, Glisan didn’t seem anything like Kopper or Fastow—at least at first. When he joined Enron, he wasn’t arrogant or hot-tempered, and he got along with just about everybody. A native Texan who grew up in a blue-collar neighborhood outside of Houston, Glisan seemed thrilled to have made it as far as he had—at one point, Kopper described him as a “workhorse carrying one of the heaviest loads in the group.” He struck many people as a Boy Scout who wasn’t capable of imagining a dishonest deed, much less carrying one out.

Glisan came to Enron the same way so many others did, through Arthur Andersen’s Houston office. He attended the University of Texas, where he majored in finance, graduating in 1988. After working as a lending officer at Bank One in Austin, he went back to UT for his MBA, where he earned a 4.0 grade point average. He then joined Coopers & Lybrand in Dallas as one of two MBAs hired into a pilot management development program to provide “audit and consulting services on high-risk engagements” (a small irony). In January 1995, Glisan accepted a position in Arthur Andersen’s Houston office, where he worked mainly on ECT. He stayed for only a year and half, at a salary of $66,000, before being recruited to Enron, where his salary increased to just over $100,000. (He also got a signing bonus of $15,000 and, of course, the promise of lots of options.)

Glisan was a highly skilled accountant who understood all of the nuances of his craft. “He was very clued up about accounting,” says another Enron accountant. “He knew exactly what to say to bankers and accountants to appease any concerns they might have.” In a 1999 review, Kopper wrote that Glisan knew “exactly when and how to make trades and negotiate a deal.” (He also wrote that Glisan was “always working to create solutions with Enron’s best interests in mind.”) One person who worked closely with Glisan saw something else. If he saw something unethical, says this executive, “Ben was not mature enough to make a noise and stop it.” Another former executive puts it this way: “He wasn’t willing to be his own guy.” Over time, Glisan’s affability slowly morphed into the swaggering arrogance that characterized so many Enron executives. “It was painful when he didn’t get his way,” says an ex-colleague. “He would browbeat people.”

Like many Enron executives, Fastow used the semiannual Performance Review Committee to push his people ahead and buy their loyalty. Though the original purpose of the PRC had become largely perverted, most executives at least went through the motions. Fastow didn’t bother. “People were expected to cite anecdotal evidence and provide rational backup,” says one former senior executive. “Andy didn’t do that. He just dug his heels in.” Skilling was the only one who could get Fastow to back off, but if he didn’t rein Fastow in, the group would often just cave and give Fastow’s people the top ranking so they could move on and go home.

The public high point for Fastow came in 1999, when
CFO Magazine
gave him a CFO Excellence Award, an honor he’d actively campaigned for. “Our story is one of a kind,” Fastow told the magazine. He explained that Enron couldn’t dilute its shareholders by issuing equity, and couldn’t jeopardize its credit rating by issuing debt. He went on to describe how Enron issued off-
balance-sheet debt, backing it up with Enron stock. This was the tactic that later triggered Enron’s final crisis. But in 1999, with Enron’s stock on the rise, its credit-rating intact, and its earnings headed ever upward, there wasn’t so much as a whisper of doubt or complaint. On the contrary. “He has invented a groundbreaking strategy,” said a Lehman Brothers banker quoted approvingly in the story. An analyst at one of the credit-rating agencies touted Fastow’s ability to “think outside the box.” And Skilling took the opportunity to publicly celebrate his protégé. “We needed someone to rethink the entire financing structure at Enron. . . . [Fastow] deserves every accolade tossed his way.”