The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron (73 page)

Then came the clincher: Lay wasn’t going to leave. Enron was prepared to take Joe Foster on but only as an interim
vice chairman.
Watson called Foster to apologize; he thought Enron had already committed to make the move. “I’m embarrassed,” Watson told him. “You shouldn’t be embarrassed,” Foster responded. “But good luck, buddy, because you’re going to
need
it.”

Talks among Dynegy, the banks, and the credit agencies continued late into the night on Tuesday, even after Watson went to bed telling his board and advisers that he’d pretty much made up his mind. The banks weren’t stepping up the way Enron needed, he reasoned, thus making the repayment of all the debt impossible. It just wasn’t going to work. And he’d also had a bellyful of Enron. He didn’t trust any of its numbers, and he didn’t want anything to do with its culture. “At the end,” he later told friends, “you couldn’t
give
it to me.”

The next morning, Wednesday, November 28, as Watson waited, the rating agencies made the first move. S&P downgraded Enron two notches, deep into junk-company territory, citing its “loss of confidence that the Dynegy merger will be consummated.” Moody’s and Fitch soon followed. The downgrades immediately triggered $3.9 billion in Enron debt.

Watson placed a call to Lay to tell him the Dynegy board was terminating the deal. “I’m disappointed this didn’t work out; I wish you the best of luck,” Watson said. “I’m disappointed, too,” Lay responded. “I’ll go on to our other alternatives.”

Enron Online shut down that morning. Enron shares closed the day at 61 cents.

 • • • 

At six o’clock that evening in Houston, Ken Lay met with the Enron board. He announced the demise of the deal with Dynegy and explained that it was likely to produce a court battle over the ownership of Enron’s Northern Natural Gas pipeline, to which Dynegy was laying claim. A financial consultant offered the board a discussion “on alternatives to bankruptcy.” Even now, for all its problems, the trading business remained Enron’s great hope—or at least that’s how Enron’s board saw it. The adviser noted that his firm had contacted a number of prospects who might be interested in “financing or purchasing an interest.” Treasurer Ray Bowen, who had quickly moved to more closely monitor the company’s liquidity, noted that Enron’s cash stood at $514 million.

Then Charles LeMaistre moved for approval of a new Enron Corp. Bonus Plan. This special fund, board minutes noted, would set aside $55 million “for the purposes of retaining key people given the uncertainty surrounding the Company’s business and the need to maximize the value of the Company.” The funds, which required the recipients to remain with the company for just 90 days, would be distributed to more than 500 employees. The biggest payments, of course, went to trading executives: Lavorato got $5 million, Louise Kitchen $2 million, and Jim Fallon $1.5 million.

There was one other piece of business. With the end of the Dynegy deal and Enron’s fate uncertain, Ken Lay offered to fall on his sword. He “advised the Board that they continued to have the right to choose another chief executive officer for the Company and indicated that the Board should take whatever action is determined to be in the best interest of the Company,” according to the minutes. “He stated the importance of the Board and the chief executive being very aligned going forward and stated his willingness to serve in that capacity.”

With that, Lay left the room so the board could talk in private. A few minutes later, the directors adjourned, without taking any further action.

 • • • 

For four days, Enron lingered painfully in the land of the undead, and Ken Lay remained in open denial. “As you have heard,” Lay advised employees, “Dynegy is terminating the merger agreement today. Among other things, this means we are now free to pursue other alternatives—which we are actively doing.”

In the meantime, there would be some layoffs “to establish a more solid footing for the rest of Enron,” Lay advised. “Although there are no guarantees, you should know that we are still in this fight and remain absolutely committed to protecting the value of the ongoing businesses of Enron. . . . Even six or so weeks ago, none of us could have imagined that we would be where we are today. We will not recover in six weeks what we have lost, but we will work to stabilize and rebuild this great company. As always I appreciate the extraordinary contributions each of you make. Thank you, Ken.”

But as Enron’s cash rapidly dwindled, others harbored few illusions. Enron’s debt—both on the balance sheet and off—totaled a staggering $38 billion. On December 1, retail chief Dave Delainey responded to a former Enron executive who had e-mailed him with suggestions for making improvements at EES. “Dick, thanks for your e-mail,” Delainey wrote. “I don’t think I disagree with any of the points you made. . . . Unfortunately, a lot of these changes in thinking, sales and cost structure are too little too late. It is highly unlikely at this point that EES will exist beyond next week.”

As Enron spiraled toward bankruptcy, its banks labored to minimize their losses. Marc Shapiro, the J. P. Morgan Chase executive, e-mailed two bank colleagues about his efforts to recover money from Enron before it was too late: “On several occasions during the week of November 26, I called Ken Lay, CEO of Enron, to request the return of excess collateral that Enron was holding for our account. My first call was midday on Wednesday, November 28. I requested return of about $50 mm, representing collateral held by Enron in excess of what we owed them. I next called late in the day on 11/29 to inquire about the status, and I indicated that they now owed us about $100 mm. Ken said that they were reviewing their cash position, and he did not know if they would have sufficient cash to pay. I called again at midday on Friday, only to be told that a decision would not be made until the end of day. Ken called on Friday afternoon to say that they did not have sufficient cash to return our collateral or anyone else’s.”

 • • • 

Sunday, December 2, was the day it finally happened. Electronically, at 2
A
.
M
., Enron’s lawyers filed the largest bankruptcy case in U.S. history. The Chapter 11 papers had been rushed together. Just days before, everyone was focused on
the Dynegy deal. Once that collapsed, bankruptcy was really Enron’s only
alternative.

After the papers were filed, a six-man contingent from Enron flew to New York on Sunday afternoon for a routine court hearing on “initial orders,” which would allow the bankrupt company the ability to conduct ordinary business, like paying employees and vendors. But this bankruptcy was obviously anything but routine. The courthouse was jammed with lawyers and press. Ken Lay flew up with the group—he felt it was the right thing to do—but it was decided that his presence in the courtroom would only turn the occasion into more of a circus.

The Enron contingent included CFO Jeff McMahon, Enron Wholesale general counsel Mark Haedicke, and associate counsel Richard Sanders. An adviser from the Blackstone Group and a Weil Gotshal lawyer were there, too. Lay was still in denial, a posture he maintained indefinitely. “We were the quickest ones in,” he told the group, “and we’ll be the quickest ones out.”

They traveled on the crown jewel of the Enron air fleet, the $45 million G-5 corporate jet, whose interior design was personally selected by Lay. After the jet reached cruising altitude, Lay rose from his leather chair to serve everyone sandwiches and fruit, as he had so many times before. They stayed in New York’s plush Four Seasons Hotel. Heading back to Houston, Sanders was sickened by the opulence of it all, the money Enron still spent freely when the company had just gone broke.

“We should have flown up on Southwest Airlines,” he said, “and stayed at the Ramada Inn.”

Enron’s shocking collapse triggered an intense and angry search for answers:
How could this have happened? Who was to blame?

Virtually everyone who played a part in the debacle came under the microscope of public and legal scrutiny: executives, accountants, bankers, analysts, lawyers, company directors. But for a time, precious few were willing to admit that they bore any responsibility for the biggest corporate scandal in American history. Wasn’t anybody sorry?

The after-the-fact rationalizations were strikingly similar to the mind-set that produced the Enron disaster in the first place. The arguments were narrow and rules-based, legalistic in the hairsplitting sense of the word. Some were even arguably true—in the way that Enron itself defined truth. The larger message was that the wealth and power enjoyed by those at the top of the heap in corporate America demand no sense of broader responsibility. To accept those arguments is to embrace the notion that ethical behavior requires nothing more than avoiding the explicitly illegal, that refusing to see the bad things happening in front of you makes you innocent, and that telling the truth is the same thing as making sure that no one can prove you lied.

Take Arthur Andersen, for example. Just six months after Enron’s bankruptcy, the firm was found guilty in a Houston courtroom of destroying evidence—those thousands of pages of Enron-related material that had been shredded at the prodding of David Duncan and Nancy Temple. As a firm, Andersen was finished even before the trial, decimated by client defections after its federal criminal indictment.

Andersen’s conviction would later be overturned by the U.S. Supreme Court, citing a flawed jury instruction. Though this would do nothing to alter the firm’s fate, it encouraged those who insisted that Andersen itself was a victim—a victim of an unjust, politically motivated prosecution, and a victim of Enron itself.

The firm’s partisans pointedly noted that despite the obstruction-of-justice charge that had taken it down, no one had found it guilty of fraudulent accounting. Andersen argued that some dubious Enron accounting moves were merely management’s business decisions that were outside the province of its auditors. Andersen viewed its responsibility as limited to ensuring that the transactions complied with specific accounting principles. And except where Enron lied, Andersen argued, they did technically comply—allowing Enron, through clever use of the rules, to transform dogs into ducks.

Of course, this argument utterly ignores the larger truth, which is that those transactions added up to a completely illusory picture of Enron’s financial health, to which Andersen was also legally required to attest. History will record that Arthur Andersen, in the legal system’s judgment of its role at Enron, was ultimately found not guilty. But in any commonsense accounting of what happened, it surely was not innocent.

And so it went. The securities analysts who had covered Enron—many of whom had buy recommendations on the stock right up until the end—claimed that Enron had lied to them. “It now appears that some critical information on which I relied for my analysis of Enron was incomplete or inaccurate,” CSFB’s Curt Launer told Congress. The analysts for Standard & Poor’s and Moody’s offered a similar lament, insisting that the information they were given justified Enron’s investment-grade debt ratings. To be sure, Enron, with Andersen’s assistance, did everything it could to camouflage the truth, but there was more than enough on the public record to raise the hairs on the neck of any self-respecting analyst. Analysts are supposed to dive into a company’s financial documents, pore over the footnotes, get past management’s assurances—and even to get past accounting obfuscations. Their job, in short, is to analyze. If the analysts covering Enron had done that, how could they not have seen a very different story? The short sellers surely did.

Then there were the banks and investment banks—the best supporting actors of the Enron scandal—without whose zealous participation Enron’s financial shenanigans would simply not have been possible. Hauled before the Senate Permanent Subcommittee on Investigations in the summer of 2002, the bankers could only duck and weave, always denying responsibility. “We have been one of the parties substantially harmed by its [Enron’s] failure,” said a J. P. Morgan Chase banker. Citigroup said it had believed “Enron was making good-faith accounting judgments that were reviewed by Arthur Andersen, which was then the world’s premier auditing firm,” and that the “Audit Committee of Enron’s board exercised meaningful supervision over the company’s accounting policies and procedures.” In other words, it wasn’t our responsibility.

And here’s the most amazing denial of all: Even Enron’s board of directors—the people formally entrusted with serving as a check on management and with guarding the interests of the shareholders—disclaimed any responsibility. The board said it relied on the advice of Enron’s accountants and lawyers, and that’s where the blame really lies. In response to bitter criticism from Congress, the directors issued a report claiming that they “in good faith . . . prudently performed their fiduciary duties based on the information provided to them.” As for Enron’s accounting contortions, according to the board’s statement, the audit committee “knew that Arthur Andersen was paid specifically to ensure that the ‘innovative structures’ conformed to GAAP, and hence took comfort that Arthur Andersen ‘was OK’ with them.”

Some board members pointed the finger at Enron’s management. Longtime director John Duncan told investigators after the bankruptcy that he thought “Skilling was brilliant. He was extremely articulate and always seemed to have the right answer.” But, the investigators continued, “Duncan has discovered many facts that make him believe that Skilling did not keep the board fully informed. He cannot recall any discussions with Skilling that the company was encountering or was susceptible to any financial problems.” Another director privately put it this way: “The board was duped. I don’t see any other answer. These things could not have happened without Skilling being a part of it.” The board’s lawyers have reread every presentation Enron executives gave to them, added a director. “There was nothing there for the board to have reason to suspect something was wrong.”

Of course, there was plenty there to inspire the board to ask tougher questions, had it been so inclined. Was it really “prudent” for Enron, with its lack of cash flow, to have $38 billion in debt? Wasn’t the directors’ responsibility broader than merely listening to “the information provided to them”? According to that narrow, legalistic mind-set, the answer was simple: No.

No matter who you asked, it was always somebody else’s fault.

 • • • 

In time, these arguments stood revealed as contemptible excuses. Everyone came to pay a price—in one way or another.

In the immediate, surreal aftermath of Enron’s bankruptcy, lawyers of all sizes and stripes descended on 1400 Smith Street, along with dozens of FBI agents, who confiscated hard drives, hauled off boxes of documents, and excitedly pawed through Fastow’s office in search of the smoking gun. They were gathering evidence for the Justice Department’s newly formed Enron Task Force—a special team of federal prosecutors and FBI agents recruited from across the country, bent on getting to the bottom of things.

In late January, word emerged of Cliff Baxter’s suicide. His body was discovered less than two months after the bankruptcy filing and ten days after Sherron Watkins’s letter, released by congressional investigators, threw the unwelcome media spotlight in his direction by saying he’d “complained mightily” about LJM. Baxter’s handwritten suicide note, left on the dashboard of his wife’s car, parked in the family garage, was ordered released over the protests of his widow. “I am so sorry for this,” he wrote. “I feel I just can’t go on. I have always tried to do the right thing but where there was once great pride now it’s gone. I love you and the children so much. I just can’t be any good to you or myself. The pain is overwhelming. Please try to forgive me. Cliff.”

For several years after the bankruptcy filing, Enron continued to operate as a sort of corporate zombie, with thousands of people still required to sort out what was left for creditors, and to operate the pipelines and power plants around the globe. In mid-2002, the new postbankruptcy management wrote down the value of Enron’s assets by a stunning $14 billion, attributing some $3 billion of the hit to “possible accounting errors or irregularities.” A series of reports from a court-appointed bankruptcy examiner—totaling more than 4,000 pages in all—offered an encyclopedic accounting of what had gone wrong, apportioning blame to Enron’s management, directors, bankers, outside accountants, and lawyers. Overall, it appears that Enron’s businesses lost well over $10 billion in cash over the course of their lives.

Perversely, Enron’s bankruptcy turned out to among the most expensive in history (exceeded since only by that of Lehman Brothers) with lawyers, accountants, restructuring consultants, and other professionals in the case receiving an estimated $1.2 billion. Others, however, did not fare so well. After more than a decade, Enron’s thousands of unsecured creditors eventually received about 53 cents on the dollar. Much of the $21.8 billion recovery came from the sale of assets such as Portland General and Enron’s remaining North American pipelines. The 2006 sale of Enron’s interest in 19 overseas power plants and pipelines—the remains of Rebecca Mark’s dearly constructed international empire—raised $2.9 billion of the total. (Dabhol, which remained idle for years after being taken over by Bechtel and GE, was not included.) Settlements with the company’s banks and law firms, accused of contributing to Enron’s demise, added to the pot (Vinson & Elkins paid $30 million).

In mid-January 2002, UBS Warburg announced that it was buying the Enron trading business, though it wasn’t exactly paying top dollar. In fact, UBS didn’t pay anything at all for the 650 Enron traders. It simply gave Enron the right to a portion of the traders’ profits—one third for the first five years—while assuming none of Enron’s past, present, or future liabilities. Greg Whalley resigned his post at Enron to join UBS.

As always, the traders cut a good deal for themselves. They were guaranteed $11 million in first-year bonuses, $6 million of which was paid by Enron. Enron itself didn’t do as well, however. UBS never paid a penny to Enron, and after laying off nearly six hundred of the traders, shuttered the Houston operation in early January 2003 and moved the few who were left to Stamford, Connecticut, where the firm’s other commodity trading operations are based. Whalley, facing growing scrutiny from prosecutors, eventually left UBS, taking a job with a Houston hedge fund set up by John Arnold, the former Enron trading superstar. (After extraordinary success with his fund, Arnold retired in 2012 as a billionaire.)

One by one, many of the energy companies that had followed Enron into the trading game announced that they were cutting back or abandoning the business entirely. The list included Dynegy. That company was already sinking under the weight of skepticism when the
Wall Street Journal
revealed that it had set up its own special-purpose entity to create cash flow. Two months later, Chuck Watson resigned as CEO. Later, Dynegy paid a $5 million fine to settle charges that it had manipulated natural-gas prices. It continues in business after a bankruptcy reorganization.

 • • • 

Except for Arthur Andersen, the institutions that had made the Enron fraud possible escaped by writing checks—and by promising to change their business practices.

Bill Lerach, the fearsome plaintiff’s lawyer, led a huge class-action lawsuit on behalf of Enron shareholders. The defendants included company executives and directors, as well as accountants, two law firms, and nine banks that did business with Enron. Nervous about their liability at trial, several of the banks began writing big settlement checks: CIBC paid $2.4 billion, J.P. Morgan Chase $2.2 billion, and Citigroup $2 billion. Others that held out—including Merrill Lynch and CSFB—ended up paying nothing. Before the case reached trial the U.S. Fifth Circuit Court of Appeals ruled that the remaining bank defendants couldn’t be held liable—even if they knowingly engaged in deceptive conduct as part of a scheme to defraud Enron investors—because they didn’t make any false statements to investors themselves. Acknowledging that the banks’ conduct was “hardly praiseworthy,” the court’s majority noted that the ruling “may not coincide . . . with notions of justice and fair play.” (The Supreme Court later supported this ruling.) Nonetheless, Lerach’s litigation produced a record $7.2 billion for shareholders, who received about 20 cents for each dollar of their losses. The plaintiffs’ lawyers in the case earned $688 million, though by then Lerach himself was sitting in federal prison after pleading guilty in a kickback scheme unrelated to the Enron case.

By then, three of the big banks had come to terms with the SEC as well. In 2003, J. P. Morgan Chase and Citigroup agreed to pay a combined $286 million for “helping to commit a fraud” on Enron’s shareholders, as SEC enforcement chief Stephen Cutler told reporters. The two banks also promised to ensure that their clients that used complex financial structures would account for them in ways that investors could readily understand.

Merrill Lynch had settled SEC charges of aiding and abetting securities fraud at Enron by agreeing to pay $80 million in fines and penalties, but it wasn’t required to acknowledge that it had done anything wrong. To escape criminal prosecution, Merrill agreed to reform the way it conducted business and to hire an independent auditing firm and an outside monitor to review its business practices for eighteen months. The SEC also charged four individual Merrill executives (including Schuyler Tilney) with aiding and abetting securities fraud. All of them left the firm; Tilney was fired after refusing to testify to the SEC and Justice Department. Their cases were ultimately settled or dropped.

The SEC’s enforcement proceedings involving Enron continued for nearly a decade after the bankruptcy filing, producing civil cases, large and small, against more than two dozen people, including many who would never face criminal charges. Notable among this group: Jeff McMahon, who paid $300,000 to settle his case, and Lou Pai, who shelled out $31.5 million.