Conspiracy of Fools (26 page)

So who in the world was really going to own the Calpers interest in JEDI once the deal was done?

Patty Melcher? Again?

Word had quickly swept through the finance division by June 1997. Enron was negotiating a deal worth more than $300 million with the largest, most respected public retirement fund in the country. And to get investors for the other side of the deal, Fastow was hitting up … 
Patty Melcher
, a friend of his wife. It struck everyone as just so
scuzzy
, so wrong. Enron was the big leagues, not some charity fund-raiser.

But as time passed, the names of the outside investors who would purchase the Calpers interest became a deeper, darker secret. Melcher’s name was still tossed around, but the identities of everyone else stayed under wraps.

Jim Timmins, now in charge of Enron’s dealings with pension funds, was flummoxed. Here was the perfect opportunity to attract new investors; Enron could sell JEDI II to other funds, whether Calpers wanted in or not. Or it could arrange for another fund to buy Calpers’s JEDI stake. It was the kind of thing the company should be talking up. The pension plans wanted to do business with Enron; why wouldn’t Fastow jump at the chance?

Instead, Timmins was kept out of the deal on the purchase of Calpers’s interest in JEDI, spending his time on the structure of JEDI II. But occasionally he would hear of others asking about the investors buying Calpers’s interest. The answer was always the same.

Don’t worry about it
.

———

It was dubbed the “special-projects group.”

By the middle of 1997, Fastow had decided that his favorites needed their own unit within finance. This would be an assemblage of the best, a financial SWAT team. Their work would be almost clandestine. As the elite, they would not only be trusted with sensitive deals, they would be given the opportunity to make special, personal investments alongside Enron, deals that could make them rich.

The head of special projects, of course, would be Michael Kopper, Fastow’s most trusted ally. Bill Brown, another young deal maker who had worked for Enron only two years, was also named to the group in its earliest days. But its rising star was Ben Glisan, a highly skilled thirty-one-year-old accountant who had joined Enron just the year before. Glisan, another Andersen alum, was a native Texan from a blue-collar family. He seemed almost starstruck by Fastow, who eagerly took the young man under his wing.

Once special projects was assembled, Fastow met with each of its members individually to lay out their next big deal: they would buy out Calpers’s interest in JEDI. And they’d do it in a very unusual way.

“I’m putting together my own investment partnership for the Calpers buyout,” Fastow said.

Sitting nearby, Kristina Mordaunt, a lawyer and Fastow confidante, took notes. The name of the partnership would be Chewco Investments, a tongue-in-cheek continuation of the
Star Wars
theme begun with JEDI; Chewco’s name was derived from Chewbacca, the film’s fur-covered warrior.

As for investors, Patty Melcher was out. Calpers wanted the deal done quickly, Fastow said, and Melcher just wasn’t jumping when he told her to. She wanted her advisers to review JEDI’s records, to make sure she understood the investment. Enron couldn’t wait for that. So, in Melcher’s place, he said, he would bring in institutional investors. He didn’t identify them or explain how he would persuade them to blindly invest in a deal they hadn’t investigated.

Mordaunt finished her meeting with Fastow and telephoned Ronald Astin, a lawyer from Vinson & Elkins who was advising Enron on the dealings with Calpers.

“This is the proposal, Ron,” Mordaunt said. “Tell me what you think.”

The concept struck Astin as pretty out-there.

“Wait, Kristina,” he interrupted. “If you’ve got institutional investors in Chewco, why does someone from Enron management need to be involved?”

“Well, the idea is that the deal will be more attractive if they know Chewco has a manager who understands the assets,” she replied.

Astin thought about that. “All right, Kristina, but you do understand, the way this is structured, the Enron manager is going to end up with an interest in Chewco.”

“Yeah,” Mordaunt agreed. “We know that”

The projector clicked to the next slide. A chart appeared on the screen. “Okay,” Lou Pai told the assembled group. “This lays out the challenge we have.”

Pai, now head of retail, had been struggling for months to get the business off the ground. Today he had organized a presentation for Skilling and other executives, hoping to explain the difficulties the division faced.

The story on the slide was the same one Skilling had heard before. Because of high fixed costs, the potential profit margin for the business was low. Pai began explaining the numbers. Skilling didn’t want to hear it.

“Lou, you’re too fucking smart for this,” he snapped. “I don’t want to ever see this slide again.”

Pai’s face was hard. “Jeff, it’s the truth”

“I just don’t want to ever see that slide again.”

Pai slammed a hand on the table. “It’s the fucking facts, Jeff!”

“It may be the facts,” Skilling shouted back. “But I don’t want you to think about it that way!”

“Well, if you think it’s going to be the retail provision of gas and power, that math suggests it’s not!”

The angry back-and-forth continued for a few minutes, then both men fell into a sullen silence. The lights came up and, after failing in an effort to go forward with the meeting, the discussion ended and everyone left the room. As the retail executives headed to their offices, some couldn’t help but wonder whether it was time to start looking for another job.

“Hey, Carl, can I talk to you for a second?”

Tom Bauer, the Andersen accountant for Enron’s trading operation, walked into the office of Carl Bass, the resident accounting wonk in the Houston office. Bass turned from his computer.

“What’s up, Tom?”

He was having a problem with an Enron accounting issue, Bauer said. As part of the Portland General merger, Enron had acquired a supply contract with Bonneville Power in Seattle. The contract was worth millions, and Enron wanted to book the value as income right away.

Bass shook his head and laughed. “They came to me with the same question last year, on another contract from Portland General,” he said. “But that
one would have been at a loss. So they wanted to know if they could avoid the loss by counting it against the purchase price.”

The logic was simple. If a company acquired for ten million dollars had, say, a million dollars in immediate losses from an outstanding contract, then the real purchase price was eleven million. Of course, that’s a two-way street: if the acquired company came with immediate profits, the purchase price should be reduced. Otherwise, Enron was simply using its cash to purchase instant income.

“I gave them a memo on this,” Bass said. “I already answered the question.”

Bauer looked uncomfortable. There was clearly a lot of pushback from Enron on this one. “We’re going to need to make the case again,” he said.

The group of accountants walked alongside the stainless-steel oyster bar at Tony Mandola’s Gulf Coast Kitchen, a 120-seat seafood restaurant in Houston. Leading the way, Rick Causey headed to a table near the back. He sat, picking up a napkin and placing it on his lap. Bauer, Bass, and David Duncan took the remaining seats.

The Andersen accountants had invited Causey to lunch to let him know the bad news. They couldn’t support booking the Bonneville contract as income. As the lead partner, it was Duncan’s job to tell the client the decision.

Everyone ordered, and small talk soon dwindled out.

“Okay,” Causey said, “so what’s up?”

Duncan looked down at the table. It was about that Bonneville contract, he said. “Well, our thinking is—now, it’s our advice at this time,” Duncan stammered. “There are lots of really complicated issues here, and some of them are not real clear …”

Bass and Bauer glanced at each other.
What was Duncan talking about?
Why was he dithering? Bass tapped his palm against the tips of his fingers.

“Wait, time out,” he said. “Rick, we can’t support booking this as income.”

They had consulted the firm’s top accounting experts in the Professional Standards Group, Bass said, and consulted the Houston practice. All were in agreement.

Bass vaguely shrugged. “So that’s the answer.”

Wait a minute, Causey argued. It
was
income. He rolled out his arguments, but Bass and Bauer just shook their heads. Sorry, they said. Duncan sat at the table, silent.

Causey refused to give up. He hurried back to the office, placing calls to Andersen’s Houston managers and making his case. But despite the protests, none of them would back down.

Well,
tough
. The financial statements were from Enron, not Andersen. Causey wasn’t
required
to take their advice. If he thought they were wrong, he could take it to the mat and report the income. And he did.

Andersen, still certain the accounting was in error, put the item on what is known as the adjustment sheet. Under the rules, if the numbers on the sheet were high enough, the company had to report them. But Duncan, having lost the accounting issue, argued that the amount was not material when viewed a particular way.
That
was an audit judgment—the area where Duncan had far more control. His argument won out; the dispute was kept hidden.

In the end, Andersen ruled that a single transaction almost doubling Enron’s annual profits—from $54 million to $105 million—would not strike investors as important.

Joe Hirko, the chief financial officer of Portland General, sauntered into Skilling’s office in high spirits. After months of work, the merger was all done, and now Hirko was in Houston, eager to push his next great idea.

“I wanted to lay out some ideas we’ve got for telecom,” Hirko said.

Skilling pulled a face. Portland General, he knew, had launched a tiny telecommunications business in late 1996 called First Point Communications, with plans to lay fiber-optic cable encircling Portland for high-speed Internet communications. The whole idea made no sense to him; it just seemed like money spent for little reason. When calculating Portland General’s value, Skilling had always assumed, at best, the telecom group was worth nothing—at worst, Enron would have to shoulder the expense of shutting it down.

Now Hirko was throwing out this grand vision of building a long-haul fiber-optic network, linking Portland and Los Angeles, ultimately spanning more than sixteen hundred miles.

“You’ve gotta be kidding me,” Skilling sneered. “You want to get back-hoes out there and start digging holes? We’re not doing that. We’re not putting money into it.”

“Well, Jeff, what if we could presell something like thirty fibers? Because that will pay for the project.”

Skilling laughed. Thirty fibers was less than one-third of what Hirko was talking about putting into the ground. It was like saying he would sell a tire to pay for the car.
No way in hell
, he thought.

“Okay, sure,” Skilling said. “If you can presell a third of it and pay for the whole project, have at it.”

Approval in hand, Hirko went on his way. Weeks later, he returned, stunning Skilling with the news. He had presold the fibers and raised all the money he needed.

“Come on!” Skilling said. “Businesses don’t work that way. Why aren’t people putting in their own fiber instead of buying it from you if the prices are this screwy?”

Hirko shrugged. “It’s telecom.”

The whole thing was goofy. But suddenly Skilling wasn’t so negative about his energy company spending money to join the Internet mania.

Carl Bass skimmed through the details of the power-plant transaction, certain that Enron was pulling another fast one on the accounting. Only this time, it was following the rules. The results were just insane.

Somebody at Enron had fallen in love with obtaining financing by selling power plants to off-books partnerships. But these weren’t sales any reasonable person might expect. Under the complex deals, Enron received cash from the partnership—all borrowed—in a “sale” of the plant. But even though the company lost control of the plant, it still retained the risks of ownership. Then, sometime in the future, Enron could swap everything around and pull back most of the ownership when it wanted.

It was nuts, a way of allowing Enron to report cash flow where none really existed. But Bass had a hard enough time fighting the company when it
abused
the rules. What was he supposed to do when it was following the literal rules to an irrational end?

Bass thought about it for a moment.

Change the rules
.

What if, Bass wondered, he helped John Stewart, Andersen’s top accounting guru, persuade the rule makers to write a couple of revisions? It would be tough, but there was a logic to the plan. Accounting for real estate tended to be more onerous than for other assets. If the rule makers deemed such financings couldn’t be done with real estate, it would be a small step. Then, Bass figured, the big part. Power plants are attached to land. So shouldn’t they be real estate?

It would take almost eighteen months for Bass and his colleague to execute their subterfuge. But they would be successful in shutting down—for one of the only times—an illogical Enron accounting practice.

Causey and Enron executives cursed the real-estate rules when they were finally changed. But no one ever learned—not even Arthur Andersen—that it was two of the firm’s own accountants who had pulled it off.

———

On August 26, a wire operator at Bank One glanced at a single sheet and began typing numbers into the computer.

From Account #1883757583
.

An account in the name of Michael Kopper.

Routing instructions. Several numbers, directing the electronic system to send the money to J. P. Morgan Chase.
To Account #054-06029219
.

An account in the name of Andrew and Lea Fastow.
Total funds to be wired
. $481,850.