The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron (36 page)

Fastow’s happy limited partners were two of his Tier 1 banks: Credit Suisse First Boston, which had invested through an entity established in the Cayman Islands named ERNB (the initials stood for Enron’s Rhythms Net Bet), and Greenwich NatWest, a British bank that had named its Cayman Islands subsidiary Campsie Limited. Each had sunk $7.5 million into the venture—and as the size of the gain became clear, Fastow agreed to a series of complex transactions that guaranteed each a profit of more than $20 million.

NatWest was represented by a colorful trio of United States-based Brits from the structured-finance department: Gary Mulgrew, Giles Darby, and David Bermingham. The three men’s exploits had been chronicled in a British novel by a former colleague named Robert Kelsey,
The Pursuit of Happiness: Overpaid, Oversexed and Over There,
that told how they courted an especially aggressive Houston energy giant named Hardon. In the book, the bankers schmoozed the company’s officials “and made sure they got what they wanted. And what they wanted was usually a round of golf, a nice dinner, and a visit to a local strip club.”

In late 1999, as the NatWest bankers were working up proposals to extract the bank’s profits from LJM, they began turning their attention to Swap Sub as well, allegedly with an eye toward lining their own pockets. Detailed federal court filings, including lengthy e-mail excerpts, offer a vivid account of what government prosecutors later charged was an elaborate fraud.

For months, the limited partners had officially written off their stake in the Swap Sub as worthless; that’s because they assumed that after it had paid off the put option, there would be nothing left in the entity. But Enron’s stock had risen so fast that it covered the put option with millions left over, and no one at the bank seemed to have noticed. In late January, Bermingham e-mailed his NatWest colleague Darby that he had been studying the bank’s stake in Swap Sub and realized that “there is quite some value there now. The trick will be in capturing it. I have a couple of ideas but it may be good if I don’t share them with anyone until we know our fate!!!” The three men had reason to be worried about their future: two bigger banks were in a bidding war to gobble up NatWest’s parent.

By February 19, the government charges, the three were at work on a PowerPoint presentation for a meeting with Fastow where they would present ideas on how they could restructure Swap Sub—and split the spoils. “For your info,” Bermingham e-mailed Darby and Mulgrew, “our minimum profit per these slides would be $8m, rising to $17m for the middle bit, and then finally up to around $30m. Everybody wins.” The following day, Bermingham wrote Mulgrew that they would do well to assure Fastow a hefty payout. “If I knew there was a realistic way to ‘lock in’ the $40m and give him $25m, we would also jump all over it I guess, since it would give us $15m. . . . I will be the first to be delighted if he has found a way to lock it in and steal a large portion himself.” Bermingham added: “We should be able to appeal to his greed.”

The three men were soon covering their tracks with their colleagues. Responding to a query from another NatWest banker, Bermingham claimed that he and his two colleagues were traveling to Houston to do a deal and their boss was “in the loop” but that he should “not speak to anyone” about the matter and “just act dumb please.” Then he wrote his coconspirators: “This is an attempt to head the obvious off at the pass and keep the lid on the thing. Large numbers of people are asking what we are up to. I hate lies.”

On February 22, the three British bankers arrived in Houston. Fastow had scheduled plenty of time for them: a leisurely dinner that evening and four more hours the next day. According to the government, the bankers sat down with the Enron CFO and offered a slide presentation laying out several illicit scenarios. One involved selling Swap Sub’s Enron shares for cash, then buying them back a few days later (presumably to get around the prohibition on Fastow’s profiting from the Enron stock). But that wouldn’t work, the bankers’ slide presentation noted: “Problem is that it is too obvious (to both Enron and LPs) what is happening (ie, robbery of LPs), so probably not attractive.”

By the time the bankers left Houston on February 24, they had allegedly come up with a plan. Working hand in glove, Fastow, Kopper, and the trio from NatWest would orchestrate the bank’s sale of its valuable interest in Swap Sub for a relative pittance, then secretly transfer most of the stake to themselves and split millions. When he got back to New York, Mulgrew told his boss, according to the government, that Fastow had informed him that Enron was willing to pay NatWest $1 million for its Swap Sub stake. Mulgrew added that this sum was all the stake was worth and urged his boss to accept the modest return. Mulgrew got the go-ahead.

Over the next two months, the government charges, Fastow, Kopper, and their bank collaborators operated on two levels: openly generating the paperwork and winning the approvals needed to complete the official transactions with their respective employers and simultaneously carrying out the covert maneuvers needed to divert the deal’s riches to themselves.

A key part of the machinations was ensuring that Enron would unwind Swap Sub on generous terms. Fastow took care of that. By spring, Enron was ready to liquidate its position. The lockup had expired; the Rhythms shares had started to fall (the company was heading toward bankruptcy). It took Enron several months to unload its Rhythms position.

But the Enron shares held by Swap Sub had soared to $70, up from $56. Fastow proposed to Causey that Enron pay Swap Sub $30 million for the return of the remaining shares. Mike DeVille, an Enron finance executive who worked for Causey, thought Fastow’s partnership was “making a killing.” Investigators also later concluded that Enron substantially overpaid in the deal. Neither Rick Buy’s RAC nor any outside accountants reviewed the terms. Fastow told Causey the $30 million was going to the limited partners: $10 million to CSFB and $20 million to NatWest. In fact, while CSFB was indeed getting $10 million, NatWest’s share was only $1 million.

Meanwhile, Fastow, Kopper, and the NatWest bankers were busy laying their plans. On Wednesday, March 1, after calling ahead to discuss arrangements for a fly-fishing excursion, Fastow left Houston for a five-day trip to the Cayman Islands. There he met with Darby and Bermingham, who participated in a Campsie board meeting authorizing Darby to negotiate the official deal to sell NatWest’s stake. Over dinner, according to the government, Fastow privately told Bermingham that they had to “move quickly” on their private transactions. Kopper, who was handling many of the details, wrote in his work notebook: “Gary Mulgrew—spoke to AF, everything moving as planned.”

The purchaser for both the NatWest and CSFB stakes in Swap Sub was a newly formed partnership, called Southampton Place, controlled by Kopper. This partnership was named for the upscale Houston neighborhood where both Fastow and Kopper lived. It paid the banks for their Swap Sub shares in late March. After it did so, it still had about $19 million in secret profits to divvy up. According to the government, this is how it was done. Fastow and Kopper transferred about half the equity in the now valuable Southampton into yet another partnership, Southampton K. On April 27, the NatWest bankers bought Southampton K by wiring Kopper a token $250,000 from Bermingham’s account in Moorgate, England.

The next day, prosecutors say, Fastow called Mulgrew, who was in Toronto, to give him the happy news: they had just made $7 million. The money—$7,352,626, to be precise—arrived on May 1 by wire transfer to a Cayman Islands account. The three men split the money, about $2.4 million apiece. By late July, all three had resigned from their jobs at NatWest and entered a genteel retirement. (The three men were later indicted. “Really sorry, but no comment,” said Bermingham when contacted in England. Mulgrew and Darby could not be reached for comment.)

The rest of the windfall went to a select handful of people Fastow had chosen to reward. Though no one else at Enron knew it, Fastow had invited six limited partners into the partnership; most were deeply involved in the ongoing dealings between LJM and Enron. Everyone hit the jackpot: the Fastow Family Foundation, set up by the CFO and his wife, invested $25,000 and received almost $4.5 million. Kopper, who also plunked down $25,000, also got $4.5 million. Ben Glisan, the deal’s accountant, and Kristina Mordaunt, then general counsel for Enron Global Finance, each chipped in $5,800 and walked away with $1 million. Three other Enron and LJM employees—Kathy Lynn (Michael Kopper’s old boss), Anne Yaeger, and Michael Hinds—put up less than $3,000 each and banked between $416,000 and $520,000.

Altogether, the Southampton investors received $12.3 million on a collec-
tive two-month investment of a mere $70,000. When asked later how they justified receiving such outrageous returns, the employees essentially explained that Fastow and Kopper had assured them it was all right so they didn’t ask any questions.

The big Southampton score was only a fraction of the Fastow family’s take from its $1 million investment in LJM. In July 2000, Fastow received an $18 million distribution from LJM1. His management fees from the fund, which did just two more deals with Enron, totaled another $2.6 million. The Fastows’ total secret take, just from this one partnership, ultimately reached a staggering $25.1 million.

Michael Kopper was doing well in LJM1 also. His take from the fund totaled $12 million.

About a month after the payments arrived, Fastow flew the entire group to the Mexican resort of Los Cabos for a four-day midweek celebration. Michael Kopper and Bill Dodson were there; so were Ben Glisan and his wife; Kathy Lynn; Kristina Mordaunt and her husband; Anne Yaeger and her Enron fiancee, Trushar Patel; even Kopper’s Enron secretary and his LJM assistant, along with their husbands. Everyone had a glorious time in the sun.

And why not? LJM picked up the $52,000 tab. And most of them had just made a fortune.

 • • • 

For Fastow, LJM1 was merely the warm-up. Just months after the entity was up and running, he returned to the Enron board, seeking approval for what he’d really wanted all along: a big, all-purpose private equity fund. Named LJM2, this fund would have far more outside money to play with—Fastow hoped to raise a minimum of $200 million—and do lots of Enron deals. As he described it in materials submitted to the directors, the fund was designed to help Enron by providing a “source of private equity for Enron to manage its investment portfolio risk, funds flow, and financial flexibility.”

This time, there were a few questions about controls on the CFO’s plans to greatly expand his personal business dealings with Enron. But Fastow had anticipated all of them. Rick Causey and Rick Buy were to approve all transactions between Enron and LJM, he said. The audit committee of the board would review all LJM transactions yearly. And Fastow would receive nothing more than “typical” private-equity-fund fees and the modest “promote” normally granted its managing partner on his personal investment.
What did Andersen think?
They’re fine with it, responded Causey, running interference for Fastow.
But the conflict . . .
Not a problem, insisted Causey. The partnership agreement gave the investors the right to oust Andy, thus keeping him from having too much power.

As he’d done with LJM1, Lay exempted Fastow from the Enron code of ethics; on October 12, 1999, so did the Enron board. It is clear that Fastow regarded this second board vote as yet another formality. He had already retained Merrill Lynch, which had no objections to Fastow’s latest approach, to market the fund to wealthy investors. And he had begun with friendly banks to start lining up commitments. Merrill formally released the placement memo on Octo-
ber 13, the day after the Enron board’s vote.

Over the course of the next 18 months, as LJM2 completed more than 20 transactions with Enron involving hundreds of millions of dollars, Enron’s full board and its finance committee received several updates on the fund’s rapid-fire activity. Throughout that time, the directors remained utterly sanguine about the CFO’s role. Indeed, each presentation seemed only to reinforce their sense that Fastow was engaged in selfless behavior, risking his own capital and committing his own time, all for the good of Enron. “Gosh, Andy, it sounds like you’re the meat in the sandwich,” remarked director Jerry Meyer during one meeting. Meyer was so impressed with the CFO’s presentation that he worried Enron was
exploiting
Fastow. “Why do you want to put a busy guy in this position?” he asked Lay.

Throughout, Fastow insisted to the board that both his personal time commitment and his investment profits were limited. Seven months after winning approval for LJM2, he informed the board’s finance committee he was spending only three hours a week on the partnership. And he repeatedly claimed that his compensation from the fund was modest, far less than the money he made from Enron. Fastow emphasized the care he was taking to avoid improperly exploiting his powerful role at Enron for the benefit of LJM2. Always, he insisted that his real goal was to
help
Enron.

Fastow was telling a very different story to Wall Street, however. While reassuring the board that he was safeguarding Enron from any damage resulting from his conflict, he was bragging to investors about how they could
profit
from it. In fact, this was LJM2’s main selling point. The partnership’s intimate ties to Enron, boasted the LJM2 placement memo, would provide “an unusually attractive investment opportunity.” After all, it noted, LJM2 would be managed “on a day-to-day basis by a team of three investment professionals who all currently have senior level finance positions with Enron.” The team was the Holy Trinity of Enron Global Finance: Fastow, Kopper, and Glisan. (Neither Kopper nor Glisan, who later insisted his inclusion in the prospectus was a “mistake,” had requested waivers for their own conflicts.)

Just how would their involvement translate into fat returns for investors? They would provide privileged access to Enron’s deal flow (“opportunitities that would not be available otherwise to outside investors”), they’d exploit Enron’s desperation to close deals quickly (LJM2 “will be positioned to capitalize on Enron’s need to rapidly access outside capital”), and they’d bring to the fund their “familiarity with Enron’s assets and their understanding of Enron’s objectives.”