The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron (69 page)

On October 26, Andersen audit-practice director John Riley, in town to help sort out the Enron accounting, heard a high-pitched whine in the office. “What’s that noise?” he asked Duncan. “You guys have a shredder up here?” Duncan told him the Enron team was merely destroying routine client documents. “Well,” Riley responded, “this wouldn’t be the best time in the world for you guys to be shredding a bunch of stuff.” Four days later, David Stulb, an in-house Andersen investigator, arrived in Houston to discuss the Enron situation. Duncan pulled out the cover page on Jim Hecker’s e-mail about his conversation with Sherron Watkins—with its remark about “smoking guns you can’t extinguish”—and announced: “We need to get rid of this.” Stulb instructed him to keep it, then notified his bosses in New York that “Dave Duncan needs some guidance on document retention.”

Finally, the shredding stopped—but only after Andersen received a subpoena from the SEC. Adlong, Duncan’s assistant, sent out a final e-mail on the subject: “Per Dave: no more shredding. If you are asked, tell them Dave said we can’t. We’ve been officially served by the attorneys for our documents.”

 • • • 

Even as Andersen was shredding documents, it was also stumbling across huge mistakes hidden in Enron’s books. One after another, they were blowing up, like long-buried land mines.

The first involved Chewco, the Kopper-managed SPE that Fastow formed back in 1997 to buy out CalPERS’s 50 percent interest in JEDI, its investment partnership with Enron. The deal had kept more than $600 million in debt off Enron’s books. With Fastow and Kopper now gone, Enron accountants had finally shown an Andersen partner documents revealing that Enron, under a secret side deal, had put up cash collateral to help provide the 3 percent outside equity Chewco required. This meant that Chewco didn’t really qualify as a third-party SPE; both it and JEDI should have been consolidated on Enron’s books.

Andersen also learned of another reason why Chewco’s dealings probably didn’t merit off-balance-sheet treatment: the outside partnership was really controlled (and partly funded) by Kopper, then an Enron employee; Kopper, in turn, had tried to disguise his role by transferring his controlling interest to Bill Dodson, who—unbeknownst to Andersen—was Kopper’s domestic partner.

The second big revelation involved LJM1; this mistake dated back to 1999. After studying the documents, Andersen realized that LJM Swap Sub—the partnership subsidiary that helped generate the secret windfall for the NatWest bankers and their Enron counterparts—had never been properly capitalized with 3 percent outside equity. This meant that its transactions also had to go back on Enron’s books.

This time, Andersen resolved: no more games. Enron would need to restate its earnings all the way back to 1997, adding debt to its teetering balance sheet and wiping out a big chunk of its reported profits. All this was horrible news—for both Arthur Andersen and Enron.

As each deal painfully unraveled, Whalley convened a meeting to brief a half-dozen senior executives, including Lay, about Enron’s latest accounting disaster. Chewco proved especially challenging to explain, especially as the discussion turned to the related-party issue. “There’s just one problem,” someone said. “We’re not sure whether the related party is Michael Kopper—or Michael Kopper’s gay lover.”

Ken Lay turned pale. “His
gay lover?
What the fuck is going on around here?”

“C’mon Ken,” Whalley responded, after a moment of shocked silence. “Haven’t you seen the way Michael Kopper dresses?”

 • • • 

As Enron’s troubles continued to gather, like the ghosts of quarters past, Lay seemed almost paralyzed. “He was curled up in the fetal position the whole time,” says an Enron executive in the thick of it all. Lay continued to believe that Enron would survive this crisis, just as it had survived those in the past. He also continued to believe it was still primarily a public-relations problem.

In late October, Lay received advice on how to manage the situation from an unlikely quarter—Sherron Watkins. The Enron whistle-blower met with Lay again, this time bearing a letter with her advice on spinning Enron’s crisis. Offering herself as Lay’s personal crisis-management adviser, Watkins urged him to blame his subordinates—to “admit that he trusted the wrong people” and announce that “the culprits are Skilling, Fastow, Glisan, and Causey as well as Arthur Andersen and V&E.”

In Watkins’s scenario, the party line would go like this: “Ken Lay and his board were duped by a COO who wanted the targets met no matter what the consequences, a CFO motivated by personal greed and 2 of the most respected firms, AA&CO and V&E, who had grown too wealthy off Enron’s yearly business. . . .” Lay should exploit his personal goodwill to sell the story, Watkins wrote—after all, “nobody wants Ken Lay’s head.” (For her part, Watkins had sold off her own modest Enron stake, unloading a grant of shares for $31,000 in August after writing her letter to Lay and netting $17,000 from a sale of options in October. Watkins said she’d sold the first block for “tax reasons” and the second over concerns about the impact of September 11.)

Inevitably, Lay reacted to the crisis by seeking to cash in his political chips, looking to win help for Enron through his powerful Washington connections. He called Secretary of the Treasury Paul O’Neill, himself a former CEO; former Treasury secretary Robert Rubin, now at Citigroup; Secretary of Commerce Donald Evans, an old Texas hand; even Alan Greenspan.

Lay spoke darkly about the impact Enron’s failure might have on global energy markets; he likened its plight to that of Long-Term Capital Management, the giant hedge fund that was rescued by a 1998 federal bailout; and he wondered aloud what a few well-placed calls might do to pry an extra billion or two loose from the banks and keep the rating agencies from downgrading Enron’s debt.

Yet despite all of Lay’s presumed clout, no one did anything meaningful to intervene. It seemed as though everyone was turning on Enron, even those that the company had always been able to manage—first Wall Street, then the media, now Washington.

Lay sought comfort from a few trusted Houston ministers. Dr. Steve Wende, the pastor at First United Methodist, a large downtown church, recalls that Lay would periodically interrupt his business day to call “because he felt like he needed God’s help.” Lay and the minister would then pray together over the phone. Lay spoke to Wende about the press’s “unfair” treatment of Enron and how he’d made “a number of mistakes early in his life.” Lay told Wende he believed he could save Enron, and he wanted to do it “God’s way.”

In the darkening days of October, Lay’s family sought to offer the beleaguered CEO their own special form of solace. Earlier in the year, Lay’s son Mark had left behind his troubled business career—including a string of ventures that did business with Enron—to enroll at Southwestern Baptist Theological Seminary in Houston. Now he began e-mailing biblical passages to his father. In one accompanying note, Mark likened his father to Solomon (“there is no doubt God has already given you great wisdom”).

In another installment, which Mark titled “Take it to them,” the younger Lay offered his father “bullet points” about the tale of King Hezekiah, “the most Godly man . . . after him there was none like him among all the kings of Judah.” Hezekiah, too, had found himself under siege, Mark told his father: “The Assyrians surrounded his city with a great army. He went to God with great faith and honored God. God sent an angel.”

. . . And it came to pass that night, that the angel of Jehovah went forth and smote in the camp of the Assyrians a hundred fourscore and five thousand: and when men arose early in the morning, behold, these were all dead bodies.

A day later, Linda Lay received an e-mail from a friend named Phyllis Bronson, a Ph.D. “new medicine” expert in mood disorders, such as anxiety and depression. Bronson, a biochemical nutritionist, lived in Aspen, where the Lays vacationed.

“So much for your quieter time of life,” Bronson wrote. “After seeing the NY Times article yesterday, I am glad for Enron that Ken is back at the helm; I trust he will persevere and be more than successful in whatever he does.” She went on: “I am concerned about his level of stress, and would highly recommend that he keep up that anxiety control formula, taking two after meals 3x a day. I have stronger things in my arsenal if needed. Also, perhaps when he is here sometime, I could check his blood chemistry for stress factors and optimal brain function.”

Linda responded on Tuesday, October 30:

Dear Phyllis,

Bless you for your care and concern. I have forwarded on to Ken’s office and will get him to Aspen as soon as the smoke clears. He is burning the candle day and night with very little sleep. I am praying hard for him and Enron and know that he has the strength, wisdom, skills and courage to persevere and succeed. I will stay in touch.

Love, Linda.

Linda sent the e-mail on to Ken’s office, with her own accompanying note:

Dear Ken,

I am packaging up extra anxiety control pills to go down to your office. Please have Earl [Lay’s driver] pick them up at the front door. I love you, Linda.

 • • • 

In the thick of Enron’s crisis, there were some bankers who caught the scent of opportunity. With Fastow gone and the company in desperate straits, they were finally in the driver’s seat. They’d consider lending Enron money, but now it would be on
their
terms.

At first, Enron didn’t fully appreciate just how much things had changed. Immediately after drawing down its backup credit lines, the company informed the banks it needed an extra $2 billion cash, at least. Despite its predicament, Enron executives still thought they could borrow the money unsecured, as they always had. To head off a panic, they wanted to announce the deal the following Monday, October 29—just five days after Fastow was ousted. As one Wall Street analyst put it: “They were beggars long before they knew they were beggars.” Enron quickly got a reality check. The banks flatly turned the company down.

J. P. Morgan Chase and Citi agreed to talk about lending an extra $1 billion, though Enron clearly needed much more. But now, they were demanding the only real collateral the company had left, the Transwestern and Northern Natural pipeline systems. For years, Enron’s natural-gas pipelines had been an afterthought. Now they were the company’s lifeline.

And the pipes weren’t all the banks wanted. J. P. Morgan Chase and Citi extracted commitments that Enron would use them exclusively for all its investment-
banking work for the next 18 months. “Due to the company’s recent liquidity issues, J. P. Morgan is well-positioned to realize further business,” a Morgan internal memo crowed. “In addition to our leadership role in the arrangement of $1.0 billion in financing . . . we have been mandated as a strategic advisor to Enron with an initial retainer provided of $15 million. Further, we anticipate additional restructuring and arrangement fees going forward.”

Enron executives railed privately about the banks’ “strong-arm tactics” and “extortion”—oblivious of the rich irony. Indeed, Enron tried to turn the tables on Goldman, demanding that it either lend the company money or make an equity investment if it wanted to keep earning advisory fees. When the Goldman executives kept asking sticky questions, the relationship ended with a major blowup. “Get out of our offices right now unless you’re willing to cut a check,” Whalley told Gieselman.

Still, by November 1, Enron was able to announce that it had secured another $1 billion in financing. But as it turned out, $250 million of the package was merely the refinancing of an existing loan from Citi that was expiring at year-end. It improved the bank’s collateral position but gave Enron no new cash. Even after hocking its pipelines, Enron had generated only $750 million more, which wasn’t going to last long.

 • • • 

One of the prices of becoming a supplicant is having to expose yourself to unfamiliar scrutiny. Before the crisis—still only a few weeks old—Enron had protected its darkest secrets, allowing the company to freely spin its tale of an untroubled, ever-brighter future. But Enron’s need for money forced the company to open its books to the banks. As they burrowed in, Enron’s lenders experienced their own revelations about the business they financed for so many years.

It was hardly news that the international assets had been a money pit, that Azurix had been a disaster, that Enron had spent far too much on broadband. But one of the company’s fundamental premises was that all was well at the core trading operation—that Enron Wholesale, where trading was harbored, was not only hitting its lofty numbers but would generate bigger profits in the years to come. Indeed, saving the trading operation became the core premise of Enron’s survival strategy, even though it would consume billions in precious cash. As the Whalley-led management team saw it, this was the company’s crown jewel, its only path to salvation.

But for the banks, even trading had now become suspect. In one memo to an Enron finance employee, Deutsche Bank’s Paul Cambridge openly wondered whether Enron was making up some of its trading profits. “With regard to the risk book, a constant concern for our derivatives and credit people is Enron’s mark-to-market methodology,” he noted. “There is a concern that as an unregulated trader, the mark to market is very much an Enron-driven internal process as opposed to seeking three quotes etc. etc. This is exacerbated by the belief that a significant component of the risk book is either illiquid long-term trades or exotics (weather derivatives paper etc).”

J. P. Morgan Chase dispatched a full due-diligence team to Houston to test Enron’s claims that the core business was in good shape. The SWAT team soon reported back with fresh intelligence after a bank executive named Charles Freeman found, to his surprise, an Enron executive who was “a straight shooter, and seemed to know just what was going on, and where the money is or isn’t.”

“I was struck by the [cash flow] analysis shown to us,” Freeman advised. “The key question in my mind is the reason ENE has had to continually raise very large sums through prepays and the other off-balance-sheet financing.” One explanation, from Enron treasurer Glisan, was that “the rating agencies needed to see that there was cash flow to match MTM [mark-to-market] earnings.” But Freeman was skeptical of this. “The real reason,” he wrote, “must be their need to finance all the businesses that are soaking up cash.”