The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron (71 page)

Lay, Causey, and the board were furious.
Flip-flop, flip-flop
—how could Enron trust its auditors on
anything?
Why hadn’t these problems been uncovered long ago? If Andersen had done its job properly, Lay complained, “we wouldn’t be here today.” True enough. In its accounting work for Enron, Andersen had been sloppy and weak. But that’s how Enron had always wanted it. In truth, even as they angrily pointed fingers, the two deserved each other.

 • • • 

In the first full week of November, Enron’s very survival seemed to hang on delicate issues of timing. The SEC was demanding that Enron make another painful disclosure—immediately. After launching its formal investigation and reviewing Lay’s performance on the October 23 conference call with analysts, the agency fired off a private letter to McLucas, complaining of Enron’s “apparent unwillingness to provide meaningful disclosure to the investing public” about the “nature” and “performance” of Fastow’s partnerships. The letter demanded that Enron disclose such information “in a form that a reasonable investor would find helpful and would understand” and that it do so “in short order, certainly no later than Monday, November 5, 2001.” At the same time, Arthur Andersen was insisting that Enron’s restatement be issued as soon as possible lest they all get into
more
trouble for market manipulation.

Yet however fast everyone was moving, the Dynegy deal wouldn’t be ready to announce until late in the week. If Enron couldn’t break the good news first, the weight of the combined disclosures to the SEC would almost certainly sink the company.

Enron asked McLucas to “grovel” with the feds for an extension. He explained to the government regulators that the company was preparing a major restatement and the required disclosure and could announce both simultane-
ously but needed a little more time. The SEC gave the company until Thursday, November 8.

Meanwhile, Enron discovered even more bad news to disclose. Kristina Mordaunt had confessed her involvement in Fastow’s lucrative Southampton partnership and revealed the names of other employees who’d been involved, too, including treasurer Ben Glisan, who’d remained silent about the matter through this entire period. Glisan and Mordaunt, the only ones who remained on Enron’s payroll, were swiftly fired. An Enron executive named Ray Bowen replaced Glisan as corporate treasurer.

Enron spent the week riding a rollercoaster. On Monday, Fitch, citing “an erosion in investor confidence,” cut Enron’s debt to one notch above junk status; Moody’s and Standard & Poor’s had already downgraded a few days earlier. The stock tumbled below $10. On Wednesday, shares dropped 25 percent more on news that Enron was unable to line up $2 billion it was seeking from private investors. The stock recovered after a well-timed leak, released before the market closed, that Dynegy was in talks to buy Enron.

By Thursday, November 8, everything was ready to go. The boards of Enron, Dynegy, and ChevronTexaco had approved the merger. The rating agencies had been privately briefed. The press releases were prepared.

First, Enron announced its restatement, consolidating the troubled partnerships and rewriting more than four years of its accounting history. About $586 million in profits—20 percent of Enron’s previously reported net income dating back to 1997—was simply erased. In a 21-page SEC filing, Enron told the truth about these issues for the first time. Partnerships were named, transactions described, and financial details disclosed. Fastow, Enron conceded, had made “more than $30 million” from the partnerships.

The merger was supposed to be announced Thursday, too. But at seven that morning, Moody’s called with startling news: it planned to cut Enron’s debt rating again, this time
below
investment grade. Moody’s thought the combined company’s balance sheet would be shaky, and it didn’t like the terms of the merger—it gave Dynegy and the banks too many outs.

This couldn’t be allowed to stand.
A junk-bond rating would pull the triggers on billions of Enron debt. The game would be over—for the Dynegy deal
and
for Enron. McMahon begged Moody’s to hold off. If the rating agency didn’t like the deal, they could
change
it. Moody’s was noncommittal but agreed to listen.

Everyone then went into mad-scramble mode. Moody’s executives started getting calls from powerful people like New York Stock Ex-
change CEO Richard Grasso and ChevronTexaco’s CEO. Former treasury secretary Rubin called a treasury official. A meeting was quickly arranged between the rating agency and bank heavyweights—J. P. Morgan Chase CEO William Harrison, vice chairman Jimmy Lee, and Citi investment-banking chief Michael Carpenter. By the end of the day, the deal had been changed. The easy outs were eliminated, and the two banks, which were also serving as Enron’s financial advisers, tentatively agreed to commit $500 million in equity capital. Moody’s was appeased; the deal could go forward.

The rating agency downgraded Enron the next day, Friday, when the merger was officially announced but did keep it a notch above junk status. S&P downgraded it one step too. Enron now barely clung to its investment-grade standing. After the previous day’s earnings restatement, the Dynegy deal was now the only thing keeping Enron alive.

The terms of the company’s sale made clear just how far Enron had fallen. Watson had agreed to pay about $9 billion in stock—0.2685 Dynegy share for each Enron share—and to assume Enron’s outstanding debt. For its $1.5 billion capital infusion, Dynegy would get preferred stock in Enron’s prized Northern Natural pipeline system; if the deal fell through, Dynegy would have to the right to buy it.

And there would be no danger of the predator’s quickly being eaten by the prey—as had happened 16 years earlier when Omaha’s InterNorth had bought Lay’s Houston Natural Gas. Watson, Bergstrom, and Dynegy CFO Rob Doty would sit atop the combined company. Dynegy directors would dominate the board, with 11 of 14 seats. There would be no place for Ken Lay, except possibly a seat on the board. Of Enron’s senior executives, only Whalley would have a major role, with the title of executive vice president. Watson, too, was eager to keep the traders happy.

On the day the company’s sale was announced, Lay denied it was the product of desperation. “We had other alternatives,” he told skeptical reporters. During the week, Enron publicly insisted that it had plenty of cash, that its trading business was doing fine, and that it was paying all its bills. In fact, none of these things was true.

Early on Thursday night, during the tense hours while Enron was waiting to hear whether Moody’s would pull the plug, Jeff McMahon delivered a sobering report to the board. According to board minutes, the CFO “expressed concerns on the inadequate level of financial liquidity, noting that the Company had begun to defer certain trade payments currently due, noting that if the Moody’s published debt rating was not maintained at investment-grade, significant obligations would become due immediately and the Company would be illiquid.”

 • • • 

Wall Street seemed to like the deal—at first.

In the days following the announcement, Enron’s shares rose 16 percent, to $10; Dynegy’s were up 19 percent. The two CEOs said all the right things. Lay, though, seemed a bit desultory, shell-shocked that it had come to this. “This is a very reflective time for me,” he told the press and analysts. “I did not expect to some day be involved in creating the next world-leading energy-merchant company by merging Enron into another company.”

Watson insisted his team had been extraordinarily conservative in sizing up the deal. They were cautious in projecting Enron’s future earnings; they made a big allowance for Enron litigation; and they weren’t counting on a penny of the $400 million in savings they were expecting from combining the two companies’ operations. Still, he said, the numbers came out great. Once the deal closed in late 2002, Enron would boost Dynegy’s earnings per share by about 35 percent. “From a financial standpoint,” Watson declared, “there’s nothing but upside in this transaction.”

At the same time, Watson realized, this was a huge, high-stakes gamble. If it worked, he’d end up running a powerhouse—the world’s dominant energy trader, with prized power plants and pipeline systems, revenues of more than $200 billion, more than $90 billion in assets, and 25,000 employees. He’d have vaulted Dynegy from obscurity into the ranks of America’s biggest companies. Even those in Dynegy’s camp marveled at the turn of events. “That Enron, who had been the big bully, kicking sand at everyone, was in a position to be acquired by Dynegy—on Dynegy’s terms—was amazing,” says a key Watson adviser.

There were also mammoth risks. Enron had been generating bad news practically daily—any more might drag it under, and Dynegy could be caught in the undertow. Besides, everyone knew Enron was a snake pit. Was there anyone there Watson could really trust?

Wall Street started to wonder too. For all the deal’s potential, powerful doubts lingered. Did Dynegy really know what it was getting into? How could Watson, after only two weeks of due diligence, really be sure there weren’t more surprises lurking? And what about the problem of melding the two companies: how would Watson keep Enron’s sharpies from eating his choirboys for lunch?
Could Chuck really pull it off?

Publicly, Watson assured Wall Street that his team had considered all the angles. “We looked under the hood and—guess what? It’s just as strong as we thought it was,” he said. Dynegy had been doing business with Enron for 15 years, Watson noted. “We know the company well. It’s not like we just started fresh.” And: “Culturally, it’s a good fit. There has been great mutual respect between us over the years.”

Watson’s plan was to shut down everything at Enron that wasn’t making money. He’d keep the gas and power traders but get rid of all the exotic stuff. Metals trading? There were 200 guys on the payroll, but the business wasn’t making a dime. Pulp and paper? Weather derivatives? Freight? He’d shut them all down, too, and unload all the overseas assets, what little was left of broadband, and maybe even EES. Then he’d pay down the debt and recapitalize the operation, unwinding the entire off-balance-sheet mess.

What Watson didn’t fully appreciate is how Enron felt about Dynegy. He’d assumed that his company would be greeted as a savior, the only thing keeping the sheriff from locking the doors. But many Enron employees—especially the traders—weren’t seeing things that way at all. In truth, many at Enron didn’t expect to ever work for Dynegy, merger or no merger. Some thought of Watson’s company as nothing more than a temporary refuge. They’d play out the deal for a few months until some really
smart
money came along and paid Dynegy to walk away. Others figured after the merger closed, they’d ultimately wrest control by dint of stronger will and superior brainpower. “They were going to save us,” says one Enron executive, “but typical of the Enron swagger and arrogance, we all just thought we’d take over Dynegy.”

On many floors at 1400 Smith Street, in fact, Dynegy was regarded as simply
unworthy
of buying Enron. The traders were in open revolt from the moment they got wind of the deal. In truth, they’d been in a rage for weeks, furious about the events that sent the stock into a tailspin. Much of their pay was in En-
ron shares, and the company’s string of ugly accounting revelations confirmed all their longstanding suspicions. As they saw it, they were being cheated—
robbed
—by the same corporate incompetents their business had been carrying for years.

It was especially galling to contemplate working for Dynegy, a competitor they’d always held in contempt, where multimillion-dollar bonuses were rare and where they simply wouldn’t have the freedom to make glorious, outsize bets. “They sold us short,” said one trader, describing the mood.

On a weekend, the brethren gathered in one trader’s backyard, and started plotting. They
were
like a union. Now they had leverage, and they intended to use it. All of Enron’s old guard—Rice and Pai, Baxter and Mark—had walked away with fortunes. They wanted theirs, too—but not in Dynegy stock. They didn’t want to scuttle the company’s chance of survival, and some even worried about looking greedy. But in the end, they were resolved: if they were going to stick it out and go to work for Dynegy, they told Whalley, they wanted to get big bonuses for the year—and they wanted them in cash, up front,
now.
Or they’d blow up the entire deal!

Whalley moved quickly to put down the rebellion. He proposed a big retention package (officially termed performance bonuses), providing payments to 76 key gas and power traders and originators that averaged close to $1 million apiece. When Watson heard, he erupted. “These are
performance
bonuses? The company’s on its
ass!
” The pool was cut by a third, to a more modest $50 million, and Dynegy signed off. Still, at least 12 employees got more than $1 million; John Arnold topped the list at $8 million. (Whalley himself didn’t take a bonus.)

And that wasn’t the only surprise. Watson soon learned that Lay, under the change in control provision of his new contract, was entitled to a huge cash payout when the sale closed—$60.6 million. When the news broke, four days after the merger was announced, the outrage was instantaneous—from the traders. Whalley’s top deputies, John Lavorato and Louise Kitchen, marched into Lay’s office. “This is killing morale,” they told him. With the stock’s collapse, people had lost their retirement money and college savings; with the sale to Dynegy, there’d be layoffs. There’s blood in the streets, they said—
you can’t take $60 million.

Lay was taken aback. “Well, is it okay if I call my wife first?” he asked. Lavorato and Kitchen stepped outside Lay’s office. What they didn’t know was that Lay needed the $60 million, that he was struggling to pay off his debts. But Lay did realize that he simply couldn’t keep the money, not now. After ten minutes, Lay stepped out and told the traders he was giving up the payout.

Afterward the traders joked about using the $60 million to launch a contest to boost sagging morale. Each week, they’d award one lucky Enron employee $1 million. “Win Ken’s money,” they’d call it.