Conspiracy of Fools (34 page)

A month later in a London restaurant, McMahon handed his menu to the waiter after ordering dinner. Across the table, Mike Jakubik sipped his drink and waited.

“Anyway,” McMahon said, “I’ve been in this new job for only a few months. And it’s already clear this company rides it right to the edge on liquidity every month.”

Liquidity
. McMahon was talking about the lifeblood of business. Enron, he was saying, was cutting it close on the cash it needed to pay for its daily business operations.

“Basically,” McMahon continued, “Enron is really good at spending money and not very good at selling anything.”

Jakubik smiled. “Okay.”

“A lot of our problem comes from our investment portfolio,” McMahon said. “We’re investing six or seven billion dollars, but we’re not earning cash.”

“Okay,” Jakubik said. “So where would I come in?”

“We need to hire someone who will be responsible for financing this big position. We’ve just been basically writing checks, and we need to stop that.”

The job would be investment czar for Enron, McMahon said, responsible for managing the portfolio. Lots needed to be sold. There would need to be equity funds to purchase company assets. Other assets might go elsewhere. But in the end Enron’s investments would be used to bring in cash.

“Jeff,” Jakubik replied, “that sounds interesting.”

As dinner wrapped up, Jakubik felt excited. Effectively, he would be an investment banker with one client. This was the type of creative idea that gave Enron such a market aura. Who wouldn’t want a job like that?

The crowd gathered for dinner at New York University applauded warmly as Arthur Levitt, the SEC chairman, walked across the dais toward a podium.

It was September 28, 1998. For Levitt, this was the moment; he was ready to throw down the gauntlet. Corporate America was out of control, relying too much on gimmicks and games to keep the music going.

The evidence was everywhere. In the past nine months, scores of corporations—including investor favorites like Waste Management and Sunbeam—had restated previous financial filings, revealing that profits from prior periods had relied on bad accounting. The SEC was already investigating one accounting firm, Arthur Andersen, which represented both Waste Management and Sunbeam, to determine how things had gone astray. Among regulators, it was already an article of faith that Andersen’s fast-growing clients should face tough questions. But the market simply zoomed on.

So Levitt decided to come out with guns blazing.

“Increasingly,” he said, “I have become concerned that the motivation to meet Wall Street earnings expectations may be overriding commonsense business practices. Too many corporate managers, auditors, and analysts are participants in a game of nods and winks.”

Levitt paused, then continued.

“Wishful thinking may be winning the day over faithful representation,”
he said. “I fear that we are witnessing an erosion in the quality of earnings, and therefore the quality of financial reporting. Managing may be giving way to manipulation. Integrity may be losing out to illusion.”

This was no secret, Levitt implied. Regulators knew, executives knew. The market was punishing companies with real numbers, while competitors were rewarded for playing games.

The honest executives “know how difficult it is to hold the line on good practices when their competitors operate in the gray area between legitimacy and outright fraud,” Levitt said. “A gray area where the accounting is being perverted; where managers are cutting corners; and where earnings reports reflect the desires of management rather than the underlying financial performance.”

It was a moment virtually unparalleled in the sixty-five-year history of the SEC. A chairman for the agency was announcing that the success of untold numbers of corporations was the result of dreams, not dollars. But the warning went unheard. The day after the speech, the Dow Jones Industrial Average closed above 8,000. Over the next two years, it would climb almost another four thousand points—the unprecedented price increase later derided as the bubble.

And the stock price of Enron, Andersen’s biggest client, went right along for the ride. Without question.

MORNING IN HOUSTON BROUGHT
only darkness and flooding. Ominous pitch-black clouds of Tropical Storm Frances had rolled in overnight from the Gulf of Mexico, dumping sheets of water. Swollen bayous around the city spilled into the streets, trapping cars and buses in swirling torrents.

Just past eight that Friday morning in September 1998, Michael Jakubik, the Bankers Trust deal maker from London, walked out of the St. Regis hotel and into the deluge.
Not a good start
. Not today, when he was interviewing with Jeff Skilling and Andy Fastow about joining Enron.

It had been more than a month since McMahon pitched the idea of making him Enron’s investment czar, responsible for managing billions of dollars in holdings—setting up equity funds, selling assets, everything. Even though it meant moving his family from London, the opportunity seemed too enticing, one that could lead to even bigger things in the private-equity business. That is, if Enron hired him.

Jakubik approached a couple of taxis before finding a driver willing to brave the weather. About twenty minutes later, the cab pulled up to corporate headquarters. Jakubik hustled in through the pelting rain and was directed to the fiftieth floor. Upstairs, it was empty and dark, with rain drumming on the floor-to-ceiling windows. Lightning flashed outside, and a sharp clap of thunder shook the room. A door opened, and a small man emerged, making his way through the shadows toward his visitor.

“Mike?” the man said.

“Yeah?”

A few steps closer. A hand thrust out.

“Jeff Skilling.”

They sat on either side of Skilling’s desk, talking. Jakubik was awed. Here was
the
guy, the oracle of corporate strategy, speaking to him like a peer.

“So of course, in this job, you’ll come to my weekly staff meetings,” Skilling said.

Wow
. “All right.”

Skilling turned on the charm, jabbering about Houston and his family. But he asked nothing. It struck Jakubik as an oddly nonchalant stance toward a candidate for what would be one of the most powerful positions at the company.

“I leave it up to the guys to judge brainpower and whether you’re appropriate for the job,” Skilling said. “If they’re fine with you, I’m fine with you.”

He leaned in. “But I am eager for your questions.”

“Okay. Why do you think this job’s important?”

Skilling shrugged. “I trust Jeff and Andy, and they tell me this is important. That’s good enough for me.”

The telephone rang. Skilling grabbed it. “Hello?”

A pause. “No, let me pass you to the operator.”

Jakubik stifled a smile. With no one else on the floor, the oracle was now the receptionist.

For fifteen minutes, Jakubik tossed questions at Skilling, but the answers were perfunctory. His would-be boss seemed distracted, even indifferent. Whenever the phone rang, he snatched it up. Not one call was for him.

Okay, Jakubik said. This job will involve stepping on a lot of toes. Every asset, every business that needs to be sold was purchased or built by somebody in the building.

“Everybody’s going to claim I’m selling the company’s crown jewel,” Jakubik continued. “So I’m worried about coming here, only to find nothing can be sold.”

Skilling shook his head. “That’s not how Enron works,” he said. “If Andy and Jeff say we need liquidity, then we’ll do it. They tell me to do it, I’ll do it.” Jakubik nodded.
Okay, good enough
.

Suddenly Skilling stood, signaling an end to the interview. The two walked back to reception and said their goodbyes.

“Stay dry,” Skilling said.

About that time, Fastow was in his office, hanging up his raincoat in a hidden closet. He walked to his desk, rubber duck boots still sloshing, and told his secretary to send Jakubik back whenever Skilling was done.

Jakubik arrived minutes later. Fastow spun toward him on his desk chair. “Sorry about the water,” Fastow said wryly. “So how’d it go with Skilling?”

I have no idea. Why didn’t the guy ask me anything?

“I think it went fine,” Jakubik said.

Fastow nodded. “Okay, good.” He paused. “So what’s it gonna take to get you here?”

“Well, I’d like to hear how you see the job.”

Fastow leaned back. “This company has to do a better job of financing our merchant investments. They’re a drag on the balance sheet.” He laid out the same concerns McMahon had described weeks before. Enron needed to set up equity funds, sell assets, create new sources of cash.

“I haven’t worked with you,” Fastow said. “But everyone who has says you’re the right guy. We need someone with your talents who understands private equity.”

Jakubik said nothing. This was flattering.

“We’re going to be looking to you,” Fastow continued. “You’re empowered. You’ll be the guy to make these calls. You’re going to be running this thing.”

He paused. “So, what’s it gonna take to get you here?”

“This is a copy of an address given a few weeks ago by Arthur Levitt from the SEC,” David Duncan said.

Duncan passed a pile of stapled printouts down the boardroom table to the directors on Enron’s audit committee. It was about 4:30 on the afternoon of October 12, a day of scheduled board meetings. Duncan had just finished discussing Andersen’s view of Enron’s accounting practices. It seemed the right time to bring the Levitt accounting speech to the attention of the directors.

“This speech is really the official notice of an SEC initiative to take a tougher view of corporate accounting practices,” Duncan said. “It is very detailed, and everyone would be well served to read it.”

Causey, sitting nearby, motioned for a slide to go up on the screen. “Levitt Speech: Five Popular Earnings Management Practices,” it read. Underneath the heading was a list of five abusive tactics Levitt had criticized.

“I would like to address each one of these,” Causey said. Levitt’s tough talk wasn’t aimed at anything Enron was doing, he said. The company had no giant restructuring charges, and it didn’t use creative acquisition accounting—two of the biggest sins Levitt had singled out.

On the other hand, Levitt had also attacked accounting abuses that Enron would have to guard against. One was the premature booking of revenue—a temptation that, happily, Enron had not succumbed to, Causey said.

“We do recognize a good portion of our revenue quickly, under mark-to-market accounting,” Causey said. “But, as you remember, the SEC approved our approach a number of years ago. So that is not a concern.”

Last, materiality. Levitt had warned companies not to abuse the practice that allowed them to avoid reporting accounting errors that affect less than a defined percentage of income. Causey glanced at Duncan.

“Now, we have had a dispute with Andersen about the proper accounting for a contract that we acquired as part of Portland General,” Causey said. “We’ve disagreed on the accounting, and that disagreement has not been resolved.”

However, the net effect was not reported to investors, Causey said, because Andersen had made the determination that the numbers were not material.

Duncan jumped in. “I think that judgment is valid.”

The directors listened, content with what they heard. Whomever Levitt was criticizing, they certainly weren’t like Enron.

Later that night, at 8:15, the board gathered in the fiftieth-floor conference room for its regular meeting. They still had not recovered from their heated debate over the water business. Some directors worried there was no overarching strategy for the decisions being made at Enron. Lay had heard the grumbling and decided to address it head-on.

About forty minutes into the meeting, Lay glanced around the circular table. “There have been a lot of concerns, expressed by a number of you in recent meetings, about the state of the company,” he said.

He nodded toward Skilling. “Jeff has prepared a presentation to lay out where we’ve been, where we are, and where we’re going.”

“Thank you, Ken,” Skilling said. A slide, showing the Enron logo, clicked up on the screen. “At our last board meeting, a number of you expressed some concerns about a number of areas,” he began.

Click
. The concerns. A loss of focus. Too rapid an expansion in international. Too many acquisitions of regulated businesses. Worries about the balance sheet and liquidity. Too many diverse activities in individual business units—what Skilling called “conglomeration.”

But Enron’s performance had been stellar, Skilling said, rushing through the slides. By diversifying its business interests, the company had seen its stock dramatically outperform other energy companies. The trading business in particular was in a unique position to generate profits.

Another slide. “For our international effort, we have developed an excellent platform network in both the Southern Cone in Latin America and in India,” he said. “We are going to have strong earnings and cash flow as these projects move toward completion.”

The new business would make things even better. The company had a lot of upside—potentially increasing its stock price by twenty dollars a share—because of its strong entry in the telecom and water businesses.

“Our key concern, of course, is of a liquidity meltdown, and the impact
that would have both on our balance sheet and on our trading capabilities,” he said.

That concern, he said, was mitigated by unexpected strengths—momentum in retail, a shakeout in power trading, and general stability in the wholesale business.

The presentation was impressive. The directors asked questions; Skilling and Lay fielded them deftly. It sure sounded like management knew what it was doing and where it was headed. Maybe those worries had been for nothing.

After going late into the evening, the directors reconvened at eight the next morning. After the first hour, Pug Winokur, the finance chairman, took the floor. His committee had approved a range of issues, he said.