The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron (60 page)

Finally, he was concerned that Enron was not disclosing how much money Fastow was making from LJM, as the law seemed to require. As a rule, if top executives are making substantial sums from an entity that does business with the company, they have to tell shareholders. Although there’s some murkiness surrounding the rules—and Mintz knew that Enron relished murky areas—he felt that the company’s failure to disclose Fastow’s LJM income was hard to justify.

At the end of 2000, he talked to Fastow. “You want to know how much I’ve made?” Fastow asked playfully. He told Mintz that he probably shouldn’t tell him until he’d talked to his lawyer at Kirkland & Ellis. “Let’s figure out a way not to disclose it,” he said. Then, Fastow said, “Hell, if Skilling knew how much I made, he’d have no choice but to shut LJM down.”

On March 8, Mintz sent a memo to Causey and Buy—which he copied to Fastow—listing all the problems he saw with LJM. “Enron does not consistently seek to negotiate with third parties before it transacts with LJM,” he noted; thus, there was little evidence of either “accounting substantiation” or of the board carrying out its fiduciary duties. He also talked to them about Fastow’s compensation. Causey was unperturbed. “I don’t care how much Andy’s making,” he told Mintz. “This is a win-win situation for the company.”

Rick Buy had his own problems. Late in 2000, Skilling had formed a new übergroup called the Policy Committee. It consisted of a dozen male Skillingites—but not Buy, who was deeply upset by his exclusion. He was all too aware of his impotence. In frustration, he told Mintz he was considering leaving Enron to work for LJM. Yet at other times, he complained that LJM made him uncomfortable. Then, that winter, doctors discovered a tumor on his tongue. Buy had surgery and took a vacation to recuperate.

Mintz did get a reaction—a huge one—from Fastow. Michael Kopper came storming into Mintz’s office with the memo, flung it across his desk, and said, “What do you want to do, shut us down?”

When Enron’s 2000 proxy was filed in late March, it contained no information about Fastow’s pay. Mintz, relying on lawyers from Enron and Vinson & Elkins, had used a loophole to avoid disclosing what Fastow was earning. Because not all transactions between LJM2 and Enron had officially settled, the lawyers maintained that they couldn’t calculate Fastow’s income yet. Never mind that Fastow had received millions in partnership management fees and distributions.

The last thing Mintz wanted, though, was for Fastow to relax. And so he sent another memo, this time directly to Fastow, the next day, telling him that the lack of disclosure likely couldn’t continue and that “the decision not to disclose in this instance was a close call; arguably, the more conservative approach would have been to disclose the amount of your interest.”

In early May, Skilling gave Fastow an additional responsibility: he became head of corporate development—incredibly, this was the group in charge of finding buyers for projects Enron wanted to unload. This new conflict didn’t bother Fastow any more than any of the old ones. In a staff meeting, Fastow said bluntly, “We’re going to start selling a shit load of assets to LJM.” For Mintz, that was the last straw. Looking for more ammunition, Mintz sent a letter to a lawyer he knew in the Washington office of Fried Frank Harris Shriver & Jacobson, a tony New York law firm. Mintz was referred to an SEC expert at the firm, to whom he sent a huge pile of Enron and LJM documents, seeking his opinion on the adequacy of the company’s public disclosures. (Fried Frank later opined that Enron should “consider supplementing the prior disclosures . . . especially on such points as the purpose of the specific transactions entered into and the ‘bottom-line’ financial impact on the Company and the LJM Partners.”)

Mintz also took another, far more drastic step. He resolved to take his concerns directly to Skilling. Buy warned him against doing so. “Jeff is very fond of Andy,” Enron’s chief risk officer said. “ I wouldn’t stick my neck out.” But Mintz did exactly that. Because Skilling had not signed many of the LJM2 documents, Mintz, on May 22, sent him a memo in a “personal and confidential” envelope. The memo informed Skilling that Mintz had a batch of LJM approval forms awaiting Skilling’s signature and that he would “arrange to get on your schedule” so the CEO could sign them. Mintz hoped that the forms would alert Skilling to the “dysfunctionality” involving LJM2 and hoped the ensuing conversation with the CEO would make him reconsider whether Fastow’s partnership was really such a great idea.

To this day, the fate of Mintz’s memo remains a mystery. Mintz insists that after he got no response, his secretary called Skilling’s office three times over a two-week period trying to set up a meeting. The lack of response was later viewed as deliberate, an attempt by Skilling to maintain his distance from the messy details of LJM. But Skilling and his assistant, Sherri Sera, have both denied to investigators ever receiving the memo or Mintz’s calls. “I would have met with Jordan in an instant,” Skilling has said. “Why didn’t Jordan come up and talk to me?”

Though Mintz didn’t know it, things were already changing. Skilling told confidants that he was beginning to worry that Fastow was spending far more than three hours a week on LJM2. “We used to talk about Enron most of the time, and now we’re spending most of the time talking about LJM and the balance sheet,” he complained. And the criticism from the investment community was intensifying. It was becoming quite clear that the existence of LJM2 was not helping Enron’s stock. If nothing else got Skilling’s attention, that certainly did.

And so, on a Friday afternoon that spring, Skilling called Fastow into his office. LJM was taking up too much of the CFO’s time, Skilling said. Now, Fastow had to make a choice. “Do you want to be CFO of Enron,” Skilling asked, “or do you want to run LJM?” Fastow asked for the weekend to think about it. On Monday, he gave Skilling the answer: “I want to be the CFO of Enron.”

Mintz later described the moment Fastow told him that he had decided to sell his interest as “melodramatic.” “I created LJM,” Fastow said. He seemed almost heartbroken at the thought of giving it up and giving up as well his dreams of LJM3. “I’m really sad I’ve got to divorce myself.” Fastow said that the partnership agreement gave him free rein to sell his interest to anyone of his choosing. A Fastow deputy kept Credit Suisse First Boston informed about his analysis of a suitable purchase price.

In late July, Fastow sold his interest in the two LJM funds. The buyer was none other than Michael Kopper, whom Fastow had persuaded to leave Enron to take over the partnership. Causey, the government later alleged, assured Kopper that the deal would be lucrative, because Enron would continue to do plenty of business with LJM to meet its financial reporting goals.

Kopper paid Fastow a total of $16.35 million. Of that amount, $15.5 million was cash; the rest came in the form of Kopper’s house, valued at $850,000, which he turned over to Fastow. (Fastow planned to give the house to his parents.)

Where did Kopper get the cash? He got a loan from Citigroup, which, according to the government, noted in a memo that the loan should be approved because “many [Enron] transactions will continue to flow through LJM.” According to the terms of the loan, though, Kopper had to repay at least $8 million by the end of 2001. That too was easy. When LJM1 sold its Cuiabá stake back to Enron, Kopper, as the new general partner, was entitled to a distribution of $7.3 million. He apparently used the proceeds to repay Citi. (Kopper’s total take from Chewco and the LJM partnership amounted to $33.5 million.)

Naturally, Kopper also was paid to leave Enron. Under the terms of his separation agreement he received $905,000. In addition, his departure was termed an involuntary termination, which meant that all of Kopper’s options and restricted stock vested. On his way out the door, Kopper asked to be able to stay in his Enron office, and he wanted all of the legal and accounting expenses he incurred in connection with the LJM purchase to be paid for by Enron. Though his request to keep his office was denied, Enron agreed to pick up the tab for Kopper’s expenses. (He kept his Enron cell phone, too.) In late August, Global Finance held a going-away party for Kopper at the Ruggles Grill. The charge was $4,815.76. Enron paid, of course.

Few at Enron knew that it was Michael Kopper to whom Fastow had sold his interest in LJM. Enron’s shareholders weren’t told. The directors say they weren’t told, either, but they didn’t ask. Nor did the board ever ask how much Fastow had made from selling his interest. As far as the board and management were concerned, Fastow’s exit from the partnership had brought an easy end to any problems anyone might have with the company’s involvement in LJM.

 • • • 

On May 6, Enron’s “mindnumbingly complex” financial disclosures became one of the subjects of a skeptical report written by Mark Roberts, a well-respected short seller and researcher who runs a firm called Off Wall Street Consulting.

Roberts dug deeply into Enron’s financial report for 2000, which had been released in late March. He noted Enron’s increased reliance on trading and the seeming cluelessness of the Street analysts who were recommending the stock. He scrutinized the related-party transactions and noted that none of the “numerous industry experts and analysts” he asked were able to explain the footnotes to him. He also noted other oddities revealed in that filing, such as the information that Enron had received $2.4 billion in proceeds from securitizations, and that Enron, by using swaps, appeared to be retaining an unknowable amount of risk. “These are, in effect, sales with recourse to Enron,” Roberts wrote.

One of Roberts’s most devastating revelations had to do with Enron’s cash flow. In 2000, Enron reported an unprecedented $4.8 billion in operating cash flow. Roberts noted that almost $2 billion of it was from customer deposits—because energy prices were so high, Enron’s counterparties had to provide more collateral. But this money didn’t really belong to Enron. If prices fell, it would have to be returned to the counterparties. Roberts also noted that another $1 billion in cash flow had come from a onetime sale of inventory. (Although Roberts didn’t know it, another $1.5 billion in cash flow was the result of prepay transactions.) In other words, much of the $4.8 billion in cash flow wasn’t cash flow at all. It was merely the illusion of cash flow.

Though most of the mainstream business press was unaware of Roberts’ report, it was widely circulated among hedge-fund managers and other large institutional investors. A reporter named Peter Eavis, who wrote for the popular online financial site, TheStreet.com, followed up on Roberts’s research and began writing a string of negative stories about Enron. Slowly, the heat was being turned up.

 • • • 

There was yet another disaster brewing: broadband. All through the winter and into the spring, even as telecom and Internet companies were collapsing, Skilling continued to insist that Enron Broadband Services was right on track. On March 23, when he conducted that conference call to assure Wall Street that Enron would hit its earnings targets, he claimed that the broadband trading business was “absolutely developing, it is ahead of plan.” He also said he was “very optimistic” about the content business. Falling prices, Skilling insisted, were helping Enron gain access to network capability at lower prices, decreasing the required capital expenditures.

A few weeks later, Skilling gave a presentation at a Salomon Smith Barney investment conference in Manhattan and insisted, yet again, that collapsing prices would be good for Enron’s broadband traders. Chanos attended the conference; it was the one time he saw Skilling in person. As he listened to him explain why collapsing prices were good, Chanos thought, “Are you crazy? There won’t be anybody left for you to trade with!”

Inside Enron, the mismatch between rhetoric and reality was becoming increasingly stark. In fact, EBS quietly spent much of the first quarter redeploying people out of the division. In late March, Peter Eavis wrote a story for TheStreet .com citing the redeployments as evidence that EBS might be underperforming. That day, the stock fell over 8 percent. Two days later, CBS MarketWatch, another online financial site, quoted Skilling as saying that the rumors of broadband job cuts were “absolutely not true”; Enron’s PR department said the redeployments were “standard daily practice” and went so far as to say there were sixty job
openings
in broadband.

In late March, one EBS employee sent an anonymous letter to
Fortune
. “When Jeff Skilling says that it is ‘absolutely not true’ that there are job cuts in Broadband Services, he is not telling the truth. There have been job cuts of about 30%. These are ‘redeployments,’ which means that the person has 45 days to find a job elsewhere at Enron or they are terminated. Unfortunately, the other parts of Enron are also ‘redeploying’ people so that you are being laid off. I asked my boss who is a senior person in Enron Broadband Services about Mr. Skilling’s quote. He said that he could not believe that Jeff had said this to the media. He said that he was in the meeting with Jeff where these decisions were made and that the job cuts might have been twice as large except for the need to maintain the perception that the Broadband Services business unit was being successful. I am sorry that I can’t provide my name, but I don’t want to be redeployed also. Employees at Enron know what the truth is. All you need to do is ask them.”

During the next few months, EBS had its last gasp. A handful of executives argued that Enron needed to either acquire another company—in other words, buy a real business—or shut down EBS. Several people pushed the idea of acquiring PSI Net, an Internet service provider. (It later declared bankruptcy.) Skilling and Rice opposed the deal. Then, the Enron team briefly toyed with the idea of buying WorldCom, but they quickly realized that the combined debt made the deal impossible. With that, executives who had options elsewhere at Enron began to flee.

During this period, Skilling’s moods seemed to swing wildly. In Portland, where dozens of people were redeployed, Skilling gave a mid-March speech telling them that the industry was in a meltdown. Yet that spring, Skilling also gave a pep talk to the broadband troops in Houston. Some 50 to 100 broadband employees stood around him as he spoke. “We are perfectly positioned in broadband,” Skilling insisted. “This is just like gas.” One executive recalls, “I could look around and see people saying, ‘This is bullshit.’ People thought he was nuts. Everyone was tired of hearing him say everything was just perfect.”