The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron (32 page)

Even today, it’s murky who knew what when. Glisan later insisted that he did not know about the collateral or that Kopper was the only other outside investor. Others, however, say he was present in meetings in which it was discussed, and handwritten notes that investigators say were his cite Chewco’s “unique characteristics” as “extreme leverage . . . minimization of third party capital.” The form transferring the collateral into the reserve accounts was signed by an Enron executive named Jeremy Blachman, who had helped Glisan land his job at Enron. Blachman later said that he didn’t know the details. The Arthur Andersen partner who worked on Chewco, Tom Bauer, had been Glisan’s boss before Glisan moved to Enron. Bauer later said that he didn’t know about the collateral or about Kopper’s involvement, either. Although Ken Lay and several other board members later said they didn’t remember Chewco, the executive committee of the board approved it on November 5, 1997.

It’s very clear who benefited. One executive says that it was the Chewco deal that helped secure Fastow the CFO job—who else could have pulled it off? And Enron did well, too. Keeping JEDI off its balance sheet boosted its earnings by hundreds of millions of dollars over the next few years. Enron used JEDI to book income from various derivatives trades related to the appreciation of the Enron stock that JEDI held—$126 million in the first quarter of 2000, for instance. Enron also found other ways to book earnings from Chewco: by charging it a $10 million structuring fee on the loan it extended and by marking-to-market the ongoing management fees it charged Chewco. (That alone added over $20 million to earnings in 1998.) Later, Enron used the increased value of its shares in JEDI to raise hundreds of millions more in off-balance-sheet debt. And Chewco also provided a chunk of the independent equity in Whitewing—meaning, of course, that Whitewing probably wasn’t really independent, either.

All those benefits help explain why everyone was willing to look the other way. And while they averted their eyes, Fastow and Kopper profited. On January 6, 1998, just seven days after the deal closed, Chewco borrowed more from JEDI and paid a management fee of $141,438 to Kopper and Dod-
son. In other words, they recovered their investment and then some in the space of a week. Kopper was paid $500,000 a year to manage Chewco, $1.5 million in total. In December 1998, Fastow had Enron pay Chewco a $400,000 nuisance fee to amend an agreement. According to the government, Kopper kicked $67,224 back to Fastow, his sons, and the Fastow Family Foundation, a purported charity he set up. They did not report this money to the IRS, either, the government claims. The government also says that some $54,000 was paid to Lea Fastow as “administrative fees.” Much later, at Fastow’s direction, Enron repurchased Chewco. Kopper got some $13 million, despite arguments from others at Enron that the Chewco stake was worth no more than $1 million. No one understood why Fastow was willing to push so hard on Kopper’s behalf.

This was the deep, dark secret buried within Global Finance.

Enron’s accounting games were never meant to last forever. All the frantic gimmicks and desperate machinations—rushing deals, restructuring contracts, setting up off-balance-sheet partnerships, monetizing power plants, generating cash through prepays—all that was meant merely as a bridge, a sort of giant corporate Band-Aid. The goal was to maintain the impression that Enron was humming until Skilling’s next big idea kicked in and started raking in
real
profits.

Skilling had a special name for the sort of transcendent business idea he was counting on. He called such a business “the big enchilada.” Gas and power trading, of course, each received this designation. But in the years after he was named president of Enron, there were two big new hopes that Skilling bet on above all.

The first was Enron Energy Services (known as EES), aimed at capturing the retail side of the market: providing electricity, gas, and energy management directly to businesses and homes. Skilling put one of his most trusted deputies, Lou Pai, in charge of EES. The second had nothing to do with energy at all: it was Enron’s venture into the high-tech world of broadband. It was run by another key Skilling lieutenant, Ken Rice.

The company’s ambitions for these two new divisions were nothing short of astounding: Skilling used to publicly predict that EES would one day be bigger than all the rest of Enron, while Ken Lay proclaimed that Enron’s broadband venture would “dwarf” gas and power trading. In classic Enron fashion, the company spared no expense getting these businesses off the ground, spending billions. But Skilling also put Enron in a terrible bind: having spent all that money and having raised expectations so high, the big enchiladas simply had to work. There was no room for failure.

In Skilling’s mind, though, there was no way he was going to fail. He had always succeeded before, and his successes had transformed the company. Why would it be any different with EES and broadband? “I
am
Enron!” he once exclaimed over drinks, in a moment of euphoria. As Rich Kinder might have put it, he was indeed now “smoking his own dope.”

 • • • 

In retrospect, it’s a little surprising that Skilling would put so much emphasis on EES, for Enron’s retail effort was not some late-1990s brainstorm. It had a long and tortured history at Enron. This was the piece of the company Andy Fastow had tried to run back in 1996, when he’d spent nine months unable to devise a business plan before finally returning to finance, his tail between his legs. (His replacement was Rick Causey, who had an even shorter stint before being promoted to chief accounting officer.)

For years, Enron’s retail business wasn’t much more than a vague concept, revolving around the idea that just as the wholesale electricity market had been deregulated, so, too, would the retail market one day. And when that happened, Enron needed to be in a position to sell power (and even gas) directly to consumers nationwide, cutting America’s utilities out of the picture. It was a given that Enron would make money doing so, because, well, Enron always made money in the wake of energy deregulation.

It’s also surprising because unlike natural gas or wholesale power, there was no big move afoot to deregulate the retail energy market. This was never a case of Lay and Skilling’s seeing what was coming, then trying to get out in front of it. Retail electricity (which was the primary focus of Enron’s effort) was regulated at the state level, and states were exceedingly wary of introducing uncertainty into something so important to voters. Nor were federal legislators much interested in getting involved. Instead, this was a case of Enron’s hubris getting the best of it. Because Skilling and Lay believed retail power
should
be deregulated, they convinced themselves they could make it happen. They would use Enron’s lobbying might and their own powers of persuasion to bring around a reluctant Congress. Anybody could see that power deregulation was a no-brainer.

Both Skilling and Lay naturally came to the issue with a strong free-market bias in favor of deregulation. Skilling viewed it primarily in business and economic terms: it would be a good thing for the capitalist markets—and a good thing for Enron—if retail electricity were freed from government oversight. But Lay turned it into much more than that. He cast the issue as a
cause.

Utilities were “cozy monopolists,” who used their protected position to gouge consumers, he declared. In Lay’s dreamy vision, once electricity was deregulated, opening the door to competition by companies like Enron, prices would tumble, saving consumers (according to an Enron-funded study) from $60 billion to $80 billion a year. Lay liked to call the potential savings “one of the largest tax cuts in U.S. history.” As he saw it, Enron would earn the nation’s gratitude for having served as “the people’s cops”—breaking the grip of the utility industry, creating a new world where consumers would be able to choose their own energy provider. “It will be just like with the different competing telephone companies who offer a full line of telecommunications services today,” Lay said. “You’ll be able to call up and order all your energy from Enron.”

In the press coverage surrounding the Enron bankruptcy, a myth has sprung up, according to which Ken Lay always got his way in Washington. Though he did win plenty of favors over the years, on this critical issue—the issue that probably meant more to his company’s future than any other—Lay got nowhere. By the mid-1990s, Enron was putting its Washington muscle behind an audacious idea: a piece of legislation that would preempt the states, forcing them to deregulate whether they wanted to or not. Enron built up its already formidable lobbying office, took out newspaper ads, and spent millions.

It is conceivable—not likely, but possible—that had this bill passed, the Enron story would have turned out differently. But it didn’t pass; at every turn, Lay and Enron were roundly rebuffed. This was partly because the utilities had far closer ties to legislators than Lay did, and they fought back fiercely. Congressmen who had regularly taken Lay’s campaign contributions refused to back Enron’s deregulation bill. Far from being a no-brainer, in Washington, the bill was a nonstarter, something Enron was utterly unwilling to accept.

Another problem, though, was Skilling. Unlike Lay, Skilling had no patience for the capital. On the contrary, his contempt for Washington was palpable. “How can you stand your job?” he asked an Enron Washington lobbyist after a meeting on Capital Hill. “These guys are absolute idiots.” One senior member of the Enron government staff says: “Jeff thought you could throw money and buy people and they did what you told them to do.”

By 1999, Enron’s annual government affairs budget had climbed to more than $37 million. Yet it couldn’t even get a retail-energy bill out of committee. Skilling took his case to Texas Republican Joe Barton, chairman of the House Energy and Power Subcommittee, who was preparing legislation offering incentives for states to embrace electricity deregulation. Barton was a natural Enron ally, and his bill was a small measure of progress.

Not good enough, Skilling told Barton in a meeting in the congressman’s office; he expected the congressman to support an Enron-backed bill that would set a firm deadline for requiring deregulation. Such a bill didn’t have the votes to pass, Barton responded, and he didn’t favor preempting the states anyway.

“You need to change your opinion,” Skilling scolded. As horrified aides for both men watched, Skilling started lecturing the congressman. Wasn’t it
obvious
what needed to be done?

“I may not have as many millions as you do, but I’m not an idiot,” Barton bristled. “You can run your company the way you want, and I’m going to run my committee the way I want.” The meeting was soon over.

By then, though, Enron was already deploying Plan B, hiring scores of lobbyists in a massive effort to promote deregulation before each of the 50 state legislatures. As far back as July 1996, in fact, Lay had written a “Dear George” letter to Texas Governor Bush, urging his support for a state law to deregulate the retail market quickly. “We can’t afford to wait,” Lay warned. “Delay is dangerous. . . . It’s time to let the forces of the market work their magic. . . . The nation’s new energy system is being installed now.” Incredibly, Lay, who was at that very moment working to
preempt
state regulation, argued that Bush needed to act because Texas ought to have the opportunity to craft the new rules for itself. “Our place in the new system will be decided by us, or for us,” Lay wrote. “I want that decision to be made in Austin, not in some other state’s capital, or in Washington.”

Again, the local utilities fought back fiercely, keeping deregulation at bay. Still, a handful of states did begin to open up. Limited pilot programs were approved for electricity in New Hampshire and Pennsylvania and for gas in Ohio. And one state did enact a law to deregulate energy at the retail level. That state was California; the new law was set to go into effect in 1998.

Eager to establish itself as a national alternative to the utilities, Enron plunged into the early pilot programs. In 1996, Skilling dispatched 20 sales representatives to Peterborough, New Hampshire, where the Board of Selectmen had chosen the Houston company as its “preferred” electricity provider after meeting with executives and scrutinizing Enron’s environmental record (and after the company donated $25,000 for community improvements and $1,000 for a Miss New Hampshire scholarship, among other gifts).

Although the town had only 5,300 residents, Enron decided to use Peterborough as the centerpiece for its first national advertising campaign, spending $30 million on a series of ads aimed, according to a company press release, at making Enron “one of the most recognized names in the world.” Lay’s ambition was to turn Enron into a consumer brand for energy. Ogilvy & Mather designed the ads; the famed graphic designer, Paul Rand, came up with a cool new Enron logo, the tilted, multicolored design that later became infamous as the crooked E. The company celebrated it all with a typically over-the-top Enron party, complete with fireworks, spotlights, and Elizabeth Taylor and Whoopi Goldberg look-alikes.

Philadelphia was another city where Enron tried to make inroads, offering to cut electric rates by 20 percent through 2000 if it were allowed to become the city’s default provider of energy. Enron hired political consultant Ralph Reed, former executive director of the Christian Coalition, to help its effort. But after a fierce lobbying campaign and a garish media war in which Enron executives were portrayed in ads as Texas hucksters by the lying Joe Isuzu character, the state regulators turned down the company’s plan, calling it unworkable.

Finally, there was California, the one state that was deregulating at the local level, thus theoretically allowing Enron to sell power directly to consumers. Even before deregulation took effect in January 1998, Enron began offering an eye-catching deal: it would cut customer rates by 10 percent for two years and throw in two weeks of free electricity. In the green-friendly state, Enron pitched itself as the environmentally sensitive provider, stressing its use of solar energy and wind farms, including the wind projects it continued to control through the shady RADR transactions. It spent more than $20 million, blanketing the state with direct mail and ads, in an effort to drum up customers.

Part of the California strategy involved the use of two-way wireless electric meters, which could be read remotely and eventually used to turn air-conditioning and lighting systems on and off by telephone. Enron bought thousands of them as well as millions of dollars’ worth of wireless airtime in anticipation of deploying them in California homes and businesses. But few of the meters ever made it out of the warehouse. Instead, Enron employees ended up getting Skytel pagers because the company had already paid for a massive block of airtime that it didn’t need.

Despite several months of intensive marketing, Enron signed up just 50,000 households in California, about 1 percent of the market. Contrary to Ken Lay’s expectations, consumers weren’t willing to go to the trouble of switching from their reliable old utility, even with Enron’s offer of a rate discount. All that grassroots outrage about monopoly power that Lay talked about, the pent-up rage at the utilities—it simply didn’t exist.

 • • • 

In March 1997, two months after becoming president, Skilling upped the ante. He broke out retail as a separate business, named it Enron Energy Services, and designated Lou Pai as its chairman and CEO. Skilling and Pai had a lot personally riding on EES; both men received sizable stakes in an EES phantom-equity plan, and Enron harbored hopes of one day taking EES public as a separate company. (Skilling and Pai later exchanged their phantom stakes for big blocks of Enron shares.) A few months later, Tom White, the retired general who had managed the construction of Teesside, was named Pai’s number two.

Pai got a new three-year contract, giving him an annual salary of $400,000 and an annual bonus of up to $300,000. If EES hit performance targets, Pai was eligible for a long-term incentive bonus of $700,000 over a two-year period. Later he also received $70,000 worth of free personal use of Enron’s corporate jet fleet each year. If no plane was available, Enron would charter a jet for him.

But how was this new team going to turn things around? Enron had lost $35 million on the retail business in 1996. The following year, with a hiring binge under way and the growing advertising costs, EES appeared headed for a $100 million loss. Wall Street had become agitated over the money Enron was pouring into the retail business; it was yet another reason why the stock languished in 1997.

“At the heart of the valuation of Enron as an investment today is the assessment of the move into retail energy marketing,” wrote Jefferies & Company energy analyst Larry Crowley that September. “. . . This effort has generated significant investor debate surrounding the strategy itself, the attendant risks and rewards, and its potential for ultimate success or failure.” Crowley’s own view was that EES could become “a major home run.” But he acknowledged that investor concern over “the size of the bet” resulted in Wall Street giving Enron “zero value” for EES.