The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron (65 page)

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Most of Enron’s senior executives had multimillion-dollar contracts that ran for another year or more. Ken Lay had made it a top priority, after taking over as CEO, to negotiate more generous deals to lock them into the company for even longer.

Mark Frevert, for example, already had an existing deal, expected to total $6.7 million in 2001, that ran for two more years. But he’d received a promotion to the armchair job of vice chairman, a move that once would likely have produced a
cut
in pay. Lay extended his contract through 2004, boosting his base salary to $600,000, making him eligible for a seven-figure bonus, and awarding restricted stock grants valued at $2 million and options valued at another $5.5 million. Rick Causey was already bound to Enron through July 2002; Lay gave him a two-year extension, providing $600,000 in signing and retention bonuses plus restricted stock grants and options valued at another $1.5 million. Rick Buy, whose contract had expired, got a new deal through 2004 that included $800,000 in bonuses plus stock and options worth $1 million.

And Fastow? He’d always been the board’s golden boy—the directors viewed him as one executive Enron couldn’t afford to lose. Now, Lay negotiated an especially stunning deal for the CFO, even while he was still officially under investigation. Under Fastow’s old contract, he was bound to Enron through February 2003. His new agreement ran through March 31, 2005, on far more generous terms. Fastow’s base salary would rise from $400,000 to $600,000 a year, and he would get an annual “bonus target” of $1 million plus incentive compensation of $750,000 cash and Enron stock and options worth $3.45 million. Fastow’s expected new annual take: $5.8 million.

Fastow also requested his own extraordinary version of a Kinder clause. He wanted to be considered “involuntarily terminated,” with a payout of $5.7 million for each year that remained on his deal, if he wasn’t awarded his targeted compensation, if he wasn’t appointed to the office of the chairman within a year, or if the composition of Enron’s board changed by more than 20 percent. Even the Enron directors wouldn’t go for that. The agreement instead provided that involuntary termination would give Fastow a cash payment of $2.35 million for each remaining year of his contract.

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Among the many people Sherron Watkins told about her concerns was her
old boss at Arthur Andersen, a Houston audit partner named Jim Hecker. Hecker was the CPA who lampooned Enron’s risky accounting with his satirical song, “Welcome to the Hotel Kenneth-Lay-a.” After a lengthy conversation with Watkins, Hecker wrote a long note to the file about her complaints, which he then sent on to Enron audit partners David Duncan and Debra Cash with a message: “Here is my draft memo, for your review for ‘smoking guns’ that you can’t extinguish.”

In fact, though Watkins didn’t know it, Arthur Andersen had already begun taking a closer look at the Raptors. The inevitable had already arrived: with Enron (and New Power) shares plunging and the value of the Raptor assets sinking, the springtime cross-collateralization fix couldn’t hold any longer. After allowing Enron to avoid more than a billion dollars in losses in 2000 and 2001, the Raptors, even on a combined basis, were once again underwater by hundreds of millions of dollars—and Enron was again staring at the prospect of having to take the hit. The situation had gotten even worse after Septem-
ber 11, when the terrorist attacks on the World Trade Center towers and the Pentagon sent financial markets reeling, temporarily dropping Enron shares close to $25.

And the credit deficiency wasn’t the only problem. In poring over the Raptor files, Andersen auditors realized they had made a huge accounting error on Enron’s balance sheet. Several entries involving the funding and restructuring of the Raptors had been mistakenly booked as a boost in shareholder equity, which reflects a company’s net worth. The screwup was missed for months. Now Enron needed to reverse the entries, cutting its shareholder’s equity by $1.2 billion at the worst possible moment.

The wiser minds at both Andersen and Enron had long since been ignored. Carl Bass and John Stewart, partners in Andersen’s PSG consulting group, discovered that David Duncan, head of the Enron team, had written memos that reported they’d signed off on virtually all aspects of the accounting for both the Raptors and LJM. In fact, both Bass and Stewart had been consulted on only limited issues and had strongly objected on some of those.

Likewise, Enron’s Vince Kaminski, who’d earlier been cut out of discussions about the Raptors, had been consulted on questions about the vehicles’ restructuring without being told what was really going on. He soon found out enough to conclude that Enron’s accounting treatment was downright fraudulent and that he was being used as an accessory. Enron hedging with itself, he later noted tartly, was “an act of economic self-gratification.” He informed Buy he wouldn’t let his group do any more work on the Raptors, even if it meant his being fired. Well, he didn’t have to worry about
that,
Buy replied; in the post-Skilling era, Enron’s new mantra was: “We’ll be honest.”

With the Raptors sinking fast, that mantra was being put to the test. As the end of the third quarter neared, Fastow and Causey argued for shoring them up yet again with millions more shares of Enron stock, pushing the problem off to a future quarter. The alternative was terminating the Raptors immediately; that would mean taking a huge hit to earnings, perhaps as much as $700 million pretax. Under an agreement negotiated between Fastow (representing Enron) and Kopper (now representing LJM2), Enron would also wind up having to pay another $35 million as a termination fee to LJM2.

Whalley wanted to pull the plug. In his first quarter as COO, he was eager to clean up as much of Enron’s dirty laundry as possible, just as Skilling had done in 1997 when he’d taken over the job. Enron was telling Wall Street it was simplifying its finances; it needed to come clean. The company could use the opportunity to toss in write-downs on other Enron disasters and get all the bad news out at once.

Lay agreed. The decision was a gamble, a bet that Enron’s spin meisters could contain the damage, just as they’d always done before. Sure, it would be ugly for awhile, but the company could absorb the hit. After all, this was
Enron
. Then they could all go about the happy business of watching the stock move back up.

Or so they thought.

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On September 25, the day the Raptors were formally dissolved, Enron received a letter from John Emshwiller and Rebecca Smith, the two
Wall Street Journal
reporters who wrote the Heard on the Street story that briefly mentioned Fastow’s partnerships. After that article appeared, Emshwiller and Smith got a tip from someone involved with LJM, telling them what they had stumbled onto. Now they were working on
another
story, and this time they were zeroing in.

The reporters submitted a list of 21 questions they wanted to cover with Lay and Fastow. The questions were devastating; there was no doubt that the two reporters had gotten their hands on the one thing no one at Enron had ever bothered to demand: partnership documents.

How much money has Mr. Fastow made from the LJM2 partnership? How does the amount compare to his compensation from Enron for his work as CFO?

How much money have Michael Kopper and Ben Glisan realized from their participation in LJM2?

Did Enron know that the general partner of LJM2 had a profit participation in the partnership that would produce millions of dollars?

Were LJM2 investors promised that they would receive special access to Enron investment opportunities, including the purchase of company assets?

Even after looking over the questions, Lay didn’t seem worried. He met with Fastow and PR chief Mark Palmer the next day about the situation. He and Fas-
tow decided they wouldn’t grant interviews to the reporters. Palmer prepared a short, nondescript response: the partnerships had all been reviewed and disclosed. Fastow was out of them. This was old news.

But Fastow was nervous. Though the
Journal
still hadn’t run a story a week after submitting its questions, he knew the problem wasn’t going away. On October 2, he responded to a cheery e-mail from his brother, Peter, a Maryland lawyer, who wondered if Andy had gotten “any perks” from a recent EES deal between Enron and the Guinness Brewery.

“I may need to take advantage of that perk,” Andy replied. “WSJ investigative reporter is doing an expose on LJM-Enron. Obviously, we’ve done everything we’re supposed to, plus some, but they are going to do a character assassination on me based on hearsay from unnamed sources. Major hack job. I probably fired one too many people this year. You may not want to be seen at the pub with me.”

Andy Fastow’s family was well acquainted with some of his partnerships. He initially tried to arrange for his wife’s wealthy family to serve as the Friend of Enron in the JEDI buyout. Skilling killed that idea, and Michael Kopper assumed that role by forming Chewco. According to the government, Fastow’s father-in-law, Jack Weingarten, once received a breakup fee from Enron after a company lawyer rejected the Fastows’ plans to have him serve as an equity investor in the RADR wind-farm deal.

More recently, Fastow had installed two in-laws—Peter’s wife, Jana Kaplan, and Lillianne Weingarten, wife of Lea’s brother Michael—as trustees of the Fastow Family Foundation. The foundation was the charitable entity Fastow created and funded with the $4.5-million windfall from Andy’s secret deal with the three NatWest bankers.

In June, in fact, the three trustees—Andy, Jana, and Lillianne—traveled with their spouses to the foundation’s first “annual meeting,” which Andy convened at the Cheeca Lodge resort in the Florida Keys, a favorite of the Bush family. The foundation picked up the tab for the four-day event, which—between massages, manicures, tennis lessons, and fly-fishing—included a single 30-minute business meeting. The final item on the agenda: hiring Fastow’s father as foundation administrator.

Although he’d reluctantly cut his official ties with LJM in selling out to Kopper in late July, Fastow was still spending time on the partnership, reassuring nervous investors that LJM would remain “uniquely positioned” to benefit from its relationship with Enron. Fastow even planned to attend the annual LJM2 partnership meeting in October, but Kopper canceled it, citing the tragedy of September 11.

Through it all, Andy remained the picture of a devoted family man. He regularly left work for long lunches with his wife, whom he affectionately called the “Shag Queen” in an e-mail. Every week, he penciled two hours into his busy schedule for a special “Dad’s night with the boys.” Lea Fastow, meanwhile, was busy with Enron’s new art committee, which she chaired—it had been given a $20 million budget to build a collection for display in the new Enron building. It also gave her an opportunity to scout new cutting-edge acquisitions for the Fastows’ own collection.

The Fastows were spending much time planning their River Oaks dream home, then being built on a site they bought for $1.3 million. Their 11,493-
square-foot house would feature Italian blue flagstone flooring and museum-quality lighting for artwork. (The Fastows also had two vacation homes, one in Galveston on the Texas coast and another in Norwich, Vermont.)

With his new River Oaks estate, his vacation retreats, his Porsche, his family’s art collection, Lea’s family connections, even his own charitable foundation, Andy Fastow, at the age of 39, had truly arrived. Although he’d never been a commercial deal maker, his years at Enron had made him a very rich man. In 2000 alone, he’d sold Enron shares worth more than $18 million—and even after the big price drop, he still held shares that were worth another $10 million. The Fastows’ income had multiplied along with Andy’s rise, from a reported $1,287,543 on the joint tax return he filed with Lea for 1997 to more than $2 million in 1998, $9,129,602 in 1999, and an astonishing $48,583,318 in 2000. (According to the government, the Fastows hadn’t even reported all their taxable income.)

Of course, although no one at Enron knew it, the bulk of the Fastows’ money hadn’t come from Andy’s work as CFO of Enron. It had come from his private partnerships’ dealings
with
Enron. By the time he cashed out of the LJMs, his total take—including management fees, partnership distributions, and the buyout by Michael Kopper—had reached a grand total of more than $60.6 million.

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When Enron’s directors gathered in Houston for the October 8 board meeting, it was a little harder than usual to keep the spotlight on the good news. The company had finally found another buyer for Portland General, though the deal
wasn’t supposed to close until late 2002 on considerably less generous terms. And Enron’s core businesses—now redefined to exclude broadband—were performing well, according to management reports.

But Dabhol remained a debacle. Elektro, the Brazilian utility company Enron bought in 1998, was really worth a billion dollars less than the amount reflected on Enron’s books. Indeed, Enron’s entire global assets division had earned a pathetic $12 million in the first nine months of 2001. And the broadband business was barely breathing. It closed the third quarter with a feeble $4 million in revenues and an $80 million loss.

For the first time, the board learned of the Sherron Watkins letter, identified only as having come from “an employee.” But Joe Dilg assured the audit committee that it wasn’t a problem; his preliminary investigation had already concluded there was no need to look any further. No Enron director asked to see Watkins’s letter, with its provocative warning that Enron might “implode in a wave of accounting scandals,” and there was no specific discussion of her concerns about the Raptors. Afterward, Jim Derrick asked if he could officially advise Andy Fastow that he was off the hook. He was told to go ahead.

The next morning, when the board reconvened in executive session, it learned about the giant charge Enron planned to take against third-quarter earnings. It was due to be announced the following week. There was discussion about the likely market reaction—Ben Glisan had already been making the rounds of the credit-rating agencies to give them a heads-up. Finance committee chairman Pug Winokur reported the rating agencies “were expected to afford the company time in executing its asset-sales program.” Winokur also noted “the positive objectives of the Company to simplify its financings, produce quality earnings, and reduce debt.” None of the directors were really worried. This would surely be just a bump in the road.