Conspiracy of Fools (42 page)

“Vince,” Buy said, “what can I do for you?”

“My group has finished pricing this Rhythms option.”

“Great.”

“But I have some things I wanted to say,” Kaminski continued. “I am very uncomfortable with this whole thing. This is a cockamamy idea.”

The word came out “coke-a-memmy.” Buy stared at Kaminski, not quite sure what he was saying. Kaminski realized that Buy hadn’t understood him.

“This idea is so stupid,” he said, “only Andy Fastow could have come up with it.”

Buy smiled. “Yeah, it’s Andy’s idea. He’s going to be the guy who runs the partnership.”

What?
They weren’t just going to set it up—Fastow
himself
was going to run it?

“Enron should never go forward with such a thing,” Kaminski said. “It is a terrible conflict of interest.”

Buy held up a hand. “Wait a minute, Vince. Don’t just jump to a conclusion. Look at the entire transaction. Analyze the whole thing, then tell me what you think.”

Kaminski nodded.

“But get Stinson Gibner involved,” Buy said. “I want to hear what he thinks, too.”

They agreed that Buy would poke around for more information about the planned deal. After that, the three of them could take up the issue again the following week.

Kaminski would be out of town for a few days after that, but he promised Buy that he would have the full analysis wrapped up by Monday, June 21. He figured there wasn’t a rush.

Exactly one week later, on June 18, Lay walked into his personal conference room at 10:00
A.M
. and found the place packed. Skilling was there waiting, along with Fastow, Causey, and a couple of Enron lawyers. The air inside the room was electric.

“Okay, what’s this about?” Lay asked.

Skilling spoke first. “As you may remember, Ken, we made an investment in Rhythms NetConnections, and it’s gone up quite a bit in value,” he said. “Now, it’s very volatile, and we’ve been looking for some way to lock in the gains.”

He nodded toward Fastow. “Andy and his people have looked at alternatives. And I think they’ve come up with a creative way to accomplish what we need.”

Fastow pulled himself up straight. “Thanks, Jeff.”

He brought out a PowerPoint presentation and passed it around. Skilling was right, there were a number of ways to lock in the gains, Fastow said. But none offered Enron strong protection against future losses in Rhythms.

“So,” Fastow said, “we’ve come up with a better idea, a structure that gives us a pretty clean hedge.”

He explained it in broad terms—the off-balance-sheet fund, the stock from Enron, the put option. “Now, we’ve concluded that the best way of structuring this would be for me to be the general partner of the fund,” Fastow said. “That would give us more control over it.”

Lay nodded.
Interesting
.

They had already approached two large investors, CSFB and Greenwich NatWest, and they seemed interested, Fastow said.

“Now,” he said, “I have to admit, I’m concerned about doing this. I wouldn’t want to damage my career at Enron or damage my compensation possibilities here.”

He smiled. “Because, clearly, Enron’s going to continue to be a far more important source of income for me.”

Fastow was lying. Already bankers looking at the deal understood that he could rapidly make in excess of twenty million dollars from the fund, far more than his Enron pay.

“Despite my reservations, I’ll be willing to invest money in it, raise some capital for it, and serve as the general partner,” Fastow said. “It’s the best way to get the deal done quickly. It’s the right thing for Enron.”

Lay nodded, intrigued by the idea. Not only did Fastow do a good job; here he was, taking on personal risk to benefit Enron. Lay couldn’t have been more impressed.

He pressed his hand on the table and stood. “All right,” Lay said. “I’ll take this to the board, and tell them I support it.”

The chairman had spoken. Lay headed out the door. Then Skilling stood and looked at the others in the room.

“Get it done,” he ordered them.

———

“This deal should not be done,” Kaminski said. “It is terrible for the company.”

It was three days later, Monday, June 21. Kaminski and Gibner had spent the weekend working on their analysis, with each of them relying on different mathematical models. But both calculations had reached the same conclusion: this idea was a disaster waiting to happen.

“Explain,” Buy said.

First, the conflicts. No company had ever put its chief financial officer in such a position, and for a very good reason. The CFO needed to be on the company’s side, not his own.

“You can already see why, the way the partnership is structured,” Kaminski said. “The payout of the structure is completely skewed against Enron shareholders.”

“What do you mean?”

Kaminski looked somber. “It’s heads, the partnership wins, tails Enron loses.”

Fastow would receive money early in the partnership’s life, largely from huge management fees. But Enron’s payout, if it ever came, would be very late in the deal—meaning that it was betting this fund would hold together.

“But the structure is simply unstable,” Kaminski said. “It’s a partnership funded with Enron stock, and if Enron stock drops at the same time Rhythms stock drops, the partnership will be unable to meet its obligations.”

The probability of such a dual decline was uncomfortably large, Kaminski said. He stood at the whiteboard, capturing the cold, mathematical reality. The deal would make Fastow rich but could leave Enron’s shareholders holding the bag.

Buy held his chin. “This really surprises me,” he said, staring at a graph of the profit distributions. He chuckled. “Now I understand why Andy’s doing this. Next time he’s running a racket, I want to be part of it.”

Kaminski stood still. “What are you going to do?”

“What can I do? I’ll try to stop it.”

“Would you like me to write up my analysis in a report? Would that help?”

Buy shook his head. He picked up a single chart Gibner had produced. “Don’t worry about it. I’ll handle it.”

The e-mail that David Bermigham clicked open was nothing if not effusive. It was from a Greenwich NatWest colleague, Mike Ellison, and was all about the Fastow fund deal.

Ellison had figured out that if Greenwich NatWest invested in it, the bank would do well. It could recognize profits from the recent climb in Enron’s stock value almost immediately, profits that would count toward the bankers’ bonus pool.

“This is a GREAT deal, I love it (greed and avarice),” the e-mail read. “And the year-end bonuses raise their ugly heads!”

Officials from Greenwich NatWest checked things out a few more times—meeting with Skilling and Fastow, making sure this deal wasn’t a symptom of some hidden financial trauma at Enron. They concluded it wasn’t and tossed up their hands. It was crazy; it was reckless, but it would be profitable. Greenwich NatWest signed on as an investor.

Over at CSFB, Robert Jeffe was still wrestling with his discomfort about the Fastow proposal. It struck him as more than just reckless. It seemed downright sleazy.

Jeffe and his colleagues decided to play it safe. Adebayo Ogunlesi, the head of CSFB’s energy group, called Skilling to see if Enron was really behind this off-the-wall idea. Skilling assured him that management knew everything Fastow was doing and backed him 100 percent.

The bankers were in a corner. They knew Fastow had the ability to decide what business went to which bank, and that he had been more than willing in the past to retaliate against institutions that didn’t play ball. If they followed their ethical instincts and turned away, the fund would never get put together by the end of the quarter. Fastow would punish CSFB. They knew it. They personally would pay a price for trying to uphold integrity at Enron.

CSFB approved the investment.

In a government office in the Cayman Islands, Cindy Jefferson pulled together a stack of papers faxed from the United States. It was the afternoon of June 21. Jefferson, the deputy registrar of exempted limited partnerships, thumbed through the sixteen pages. They concerned three partnerships, managed by some fellow named Andy Fastow.

Nothing unusual. Americans were always registering partnerships in the Caymans, where bank secrecy laws were strict and tax codes lax. Fastow, through lawyers at Kirkland & Ellis, was applying for his partnerships to be exempt from tax in the Caymans. Such applications were so common that Jefferson’s entire day was spent approving them.

She reached for her stamp, pressing it onto the first page of each application. Then she filled out a certificate declaring the partnerships registered.

Fastow’s fund—and the related entities—could now open for business. But
he had dispensed with the original name, Martin, replacing it with the initials of his wife, Lea, and his two boys, Jeffrey and Matthew. From now on, the fund would be known as LJM.

Enron needed to get rid of one of its international projects, a power plant in Cuiabá, Brazil. The company had a high-priced gas-supply contract with the plant but couldn’t use mark-to-market accounting to recognize all the earnings. After all, the fuel was being sold to Enron itself.

But if someone else purchased part of the plant, not only could Enron shuck some $200 million of debt from its books, it could transform the gas contract into $65 million in profits. Still, finding a buyer would be tough. Cuiabá was a debacle, with construction delays and financing problems.

Then, in June, an answer. Ben Glisan searched out Kent Castleman, an executive working on the Cuiabá deals, to speak with him.

“Kent, I wanted to talk with you about Cuiabá. Global finance may have found a buyer.”

This was good news. “Great. Who is it?”

“It’s called LJM,” Glisan replied.

Kaminski needed an answer. He had heard nothing from Buy about the fate of this terrible Fastow idea for almost two weeks. So now, on June 25, he strode into Buy’s office.

“What happened with Rhythms?” Kaminski asked.

Buy gave him a sheepish look. “I couldn’t stop it,” he said. “The momentum was too strong.”

Kaminski’s face hardened.

“It will be fine,” Buy said. “It’s just temporary.”

“That’s fine, Rick,” Kaminski replied. “But it is still a terrible conflict of interest.”

Kaminski turned to leave, furious. Buy had faced a choice, he thought, between confrontation now or shame later. And he had chosen shame.

Wendy Gramm pulled off to the side of a road in northern Virginia, parking near a pay phone. Gramm—former chair of the Commodity Futures Trading Commission, wife of Texas Senator Phil Gramm, and current director of Enron—needed to hurry if she was going to call in time for the meeting of the board scheduled for today, June 28.

She pushed open her car door and hustled to the phone, carrying a sheaf of papers faxed to her for today’s meeting. As she dialed in, the wind picked up, rustling her papers. She couldn’t hear all that clearly, either. Well, no big deal.

———

“Wendy!” Lay intoned. “Glad you could join us.”

Gramm’s voice echoed over the speakerphone, along with the sounds of passing cars. “Wouldn’t miss it, Ken.”

The meeting began. “Let’s come to order,” Lay said. “We have a number of issues to deal with today.”

The first, Lay said, was a vote on whether Enron should split its stock, two for one. Doubling the number of shares, but halving the price, would send an upbeat signal to the marketplace. It would be a testament to the directors’ faith in the stock’s future, and keep the cost in the reach of small investors.

“Do I have a motion?” Lay asked.

Gramm’s voice came over the speakerphone, moving to adopt the stock-split resolution. The vote was unanimous.

“Next issue,” Lay said. He recognized Skilling, who explained that Fastow was there with a proposal.

A slide clicked up onto the screen, with the words “Project LJM Board Presentation.” Fastow gave the same run-through he had provided to Lay days before.

“The benefits from LJM are enormous,” Fastow said. “It immediately shifts the mark-to-market risk in Rhythms in our merchant-equity portfolio.”

This might also be a precursor, Fastow said, the first step toward setting up a larger equity fund that could be available for Enron. This first fund could also be used for other transactions, he said—perhaps capturing the value of Enron’s investments in Brazil, like Cuiabá.

“Now, even though LJM will be capitalized with Enron stock and I will be an investor in LJM, I will not receive any current or future financial benefit from the appreciation of the Enron stock it holds.”

But there were issues for him, Fastow said. “I do have serious concerns about me being general partner,” he said. “But if the board and the company want me to do this, I’ll be happy to do it.”

“Andy, so long as this is a small part of your activities,” Pug Winokur said, “there’s no reason this should interfere.”

The board asked a series of questions—nothing complicated. For most of the directors, what Fastow was describing was going past them. They quickly approved the resolution to allow for Fastow’s participation in LJM.

The next day, Jim Timmins stood before Fastow and Kopper, making his big pitch for an Enron equity fund. Neither told him that the board had just approved one, although it was far smaller than what Timmins had in mind. “Okay, so here’s the idea,” Timmins said. “We raise money for the fund
under the Enron name. But we let it become more independent over time. The perception will still be that it has access to Enron deal flow.”

In essence, the manager would ultimately run a fund that was separate from Enron but that had the credibility of the company name. Fastow was intrigued. He was already planning another fund something bigger and more lucrative in the future. Maybe Timmins had laid out the perfect structure for it.

“Okay,” Fastow said. “Let me give it some thought.”

Vince Kaminski was at his desk late on a Friday afternoon when the telephone rang. Skilling’s name flashed on the caller ID. Kaminski reached for the handset.

“Hi, Vince. This is Jeff Skilling.”