Conspiracy of Fools (45 page)

Strange
. An Enron executive was negotiating with an Enron executive—to sell something from Enron? Not his place to question.

Enron was selling part of Cuiabá?
To LJM?
That Fastow partnership? Carl Bass was thunderstruck. This Rhythms hedge was bad enough, but now Andersen was letting Enron sell assets in a deal that couldn’t be audited. Andersen must not have thought this through. He hunted down Duncan.

“Dave, about Cuiabá. Are we certain they can do transactions like this with this partnership?”

“Oh yeah,” Duncan responded. “I’ve run it up the flagpole. It’s a legitimate deal.”

Legitimate?
Bass seethed. Andersen was compromising itself for fat fees from an out-of-control client. Well, Bass hadn’t left for the PSG yet. He was still responsible for international accounting. And, by God, he was going to do everything he could to stop this one.

The deal terms were more outrageous than Bass had imagined. LJM didn’t even plan to put in any cash up front for its Cuiabá stake. Fastow just wanted to commit to pay in the future and receive ownership based on that.

Bass put his foot down. There could not be a sale here unless LJM ponied up the money. Enron squawked, pleaded, argued. But Bass held firm. Enron and Fastow backed down.

But Bass’s biggest impact on the Cuiabá negotiations derived from something he had done years before with John Stewart from the Professional Standards Group. Something no one at Enron knew anything about.

The accounting was the big problem. As Castleman and Lipshutz struggled through their bizarre transnational discussions, they kept tripping up on new rules.

Recently, the accounting rule setters had issued a revised policy for power plants; now they were considered real estate. Under the old rules, Enron had been able to enter into “sales” of plants to off-books entities, structuring the deals to retain the future risks—and benefits—of ownership. It was a sale in name only, but the rules allowed it. That’s why the change stung; real-estate rules were tougher. A “sale” was a sale.

No one knew the change had been driven by someone who worked in the building. Carl Bass had quietly lobbied for more than a year on the reformulation, all to block some of Enron’s irrational transactions.

But Fastow liked things the way they used to be. Even with the new rules, he wasn’t interested in letting his fund take the risk of owning a stake in some lousy foreign power plant. Fastow boasted to Kopper and others that he and Causey had struck a verbal deal. LJM would not be a true owner of Cuiabá, just a temporary warehouse for it. Under the agreement, Fastow said, Enron would be responsible for finding another buyer—and if it couldn’t, the company would buy the stake back from LJM, at a profit to the fund.

The deal Fastow was describing was hard to believe. Was it even legal? He
had managed to avoid the consequences of the change in accounting rules, and structure another “sale” where Enron held on to all the risks of ownership. With this deal, Enron’s profits would soar. Fastow’s fund would look smart. Everybody would be happy.

Ken Lay walked down a richly appointed hallway in a Manhattan office building. The place was elegant, with expensive artwork and rich, lustrous paneled walls. These were the offices of a business that clearly spent to impress, to show off its financial prowess with every meticulous—and expensive—detail. That was a good sign; today Lay hoped to persuade his counterpart here to do business with Enron’s retail division.

Lay approached the reception desk.

“Ken Lay to see Dennis Kozlowski, please.”

Kozlowski headed Tyco International, a global conglomerate that dabbled in everything from fire alarms to disposable surgical devices. He was a corporate dynamo, a man whose name was whispered in comparison to Jack Welch, the General Electric chairman and renowned management guru. Kozlowski and Tyco were exactly the kind of clients Enron wanted—visionary, innovative, aggressive.

Moments later, a door opened. A hulking man with a large, bald head bounded in. “Ken,” he said, thrusting out a beefy hand. “Dennis Kozlowski.”

The two wandered back to a conference room, where Lay was introduced to Mark Swartz, Tyco’s CFO. The conversation was pleasant enough. They parted amicably, with the gears in motion for a final deal. Lay liked the men; they struck him as smart and honest.

None of them could have imagined that in less than three years, they all would be indicted—Lay for his role in the Enron debacle, Kozlowski and Swartz for taking hundreds of millions of dollars out of Tyco for themselves.

Fastow was almost giddy.

A 300 percent rate of return. The
way he and Kopper figured it, LJM was already hitting those numbers in a little over ten weeks. Not all of that could go Fastow’s way; the board had specifically restricted him from taking personal profits from increases in the price of Enron stock turned over to LJM by the company. But they were well on their way to finagling around that.

And now Fastow was ready to move to his biggest project of all. In his LJM presentation to the board, he had suggested it would be a precursor to an even larger fund. None of the directors gave the idea much thought, but Fastow brought it up again to Skilling in August, describing the fund as a way to manage risk and improve its balance sheet. Skilling thought the idea sounded good.

Fastow had the plan laid out. He had hired Merrill Lynch to sell the fund; he had snagged Jim Timmins’s top-ten institutional investors. And he was set to use Timmins’s idea of creating an Enron fund that became independent from the company. It would be his way out, his step toward becoming a fund manager full-time. No more begging for bonuses. He would be wealthy. He would be a player in Houston society.

Fastow had no doubt: LJM2 would transform his life.

“LJM2 will have a lot of unique features,” Fastow said. “It will have access to massive deal flow from Enron. It will, in truth, be a virtual Enron.”

It was 9:15 on the morning of September 16. Fastow had traveled to New York to present his big proposal to Enron’s bankers. His first visit was with Chase Capital Partners, an investment arm of Chase Manhattan bank. He had described his vision weeks before to Rick Walker, Chase’s banker in charge of Enron, and had won him over. Walker pushed Chase for the investment; it would make Fastow wealthy, he wrote his bosses, and buy the bank a lot of business from Enron.

But in the meeting this day, as Fastow described LJM2, the Chase executives seemed perplexed. Why would a CFO do this? Why would the company want him to?

“This pool of capital is viewed as a good thing by the board,” Fastow said. “LJM2 will be the best bid on lowball deals by virtue of having better information.”

And despite the demands of his CFO job, there was no danger he would neglect the fund. “Half my time will be effectively spent on LJM2’s business because of the overlap with Enron,” Fastow said.

The rewards would be ample. Look at the first LJM, he said. Its returns were hitting 300 percent. There was plenty of reason to expect that LJM2 would do even better.

Just before lunch that day, Fastow headed to Merrill Lynch’s offices at the World Financial Center to visit with its private-equity group. Already Merrill had a special relationship to LJM2; it had agreed to raise money from institutional and wealthy investors. Now Fastow was asking Merrill’s principals to kick in a few million of their own.

“This is what I want to be my next step,” Fastow told the group. “I want an investment business, and this is a unique opportunity to set it up with unique access to deals and to develop that track record I need to develop.”

The story he spun now differed from what he had told the board. No more breast-beating about his sacrifice. No words of concern about his
position at Enron. Instead, just the bald truth: he wanted a more lucrative career. But why should they believe he could deliver stellar performance?

“Let me simply say I can do twice better than anyone else because I will have better information than anyone else,” Fastow said.

The bankers laughed. The idea was just audacious.

Fastow displayed a chart headlined “Involvement of Principals in Price Funds.” Listed on it were the names of LJM2’s professional staff: Fastow, Kopper, Glisan, and Anne Yeager.

For nearly an hour, Fastow wove his tale of riches to come, opportunities to seize, deals to be done. The bankers ate it up. He was so pleased with the reaction, Fastow couldn’t help taking a dig at his outside advisers.

“The only thing that’s amazing to me,” he said, “is that our really smart investment bankers didn’t figure this out first.”

Four days later, on September 20, Jimmy Lee, chief of global investment banking at Chase, sat at his rosewood desk, glancing over the pages of Fastow’s presentation.

This is just stupid
. Fastow was clearly out of his league and didn’t understand much about private investments. But Enron was a big client. Chase couldn’t blow this off. He reached for a pen and scribbled the name of a banker, Rod Reed, across the cover sheet. He asked Reed to review the proposal with Rick Walker, along with Arnie Chavkin, a principal of Chase Capital Partners.

“I am skeptical because the guy running it is inexperienced and sounds very naïve,” Lee wrote. “However, the relationship is very big and important. We ‘may’ have to do a little.”

Lee sent the material on its way. His message was clear: The corporate client was a player. If Chase needed to invest in the CFO’s silly pet project, so be it.

The bankers who received Lee’s instructions didn’t feel any better about Fastow’s proposal than he did. A lot of it struck them as wrongheaded.

Chavkin couldn’t make sense of the fund’s fee structure. Fastow said LJM2 would receive two percent of its total capital, but at the same time Enron was paying for finding and structuring deals. Fastow’s information came from his work at Enron, work he was paid to do. Even the cost of LJM2’s staff was being picked up by Enron. What was the management fee for? Shouldn’t a portion go to Enron? What about all the oversight needed to monitor the conflicts, would Enron be reimbursed? And generally, why would this fund be considered independent of Enron at all?

He directed his questions to Rick Walker. On the morning of September 27, Walker contacted Fastow with the concerns. Fastow had plenty of answers. Not
all
the deals would come from Enron, he said; that’s why there was a management fee. And Enron would be reimbursed for expenses.

Walker had one more question Chavkin wanted asked.

“Andy,” Walker said, “can I call Skilling?”

At Merrill Lynch, they were wondering the same thing. Had Skilling thought this through? Had Enron put in place the mechanics to deal with conflicts?

Two Merrill bankers in charge of the Enron relationship—Schuyler Tilney and Robert Furst—e-mailed Fastow with their questions. It was clear they needed to speak with Skilling. Their chance would come days later—on the morning that the Enron board gave LJM2 its full blessing.

A pattern was quickly established. If a bank or brokerage had a financial interest in Enron’s fees, it was hit up for Fastow’s new venture. Starting at 1:30 on the afternoon of September 27, multiple forty-two-page documents went out—to Bankers Trust, CIBC Oppenheimer, Lehman Brothers, and many others. Included was a short note from Fastow himself along with his lengthy slide presentation boasting of the benefits of LJM2.

Nothing came on LJM2 stationery; there were no fund offices to contact. Instead, everything arrived on Fastow’s letterhead from Enron. The document had been faxed from the machine he shared with Causey. Even the fax cover sheet came with the Enron logo.

The unspoken message was hard to miss. No matter what was said about the fund’s independence, this was an Enron appeal. For a venture operated by the man who awarded many of the company’s fees.

Sitting in an antique armchair in his family room, Lay opened his briefcase and pulled out the latest issue of
CFO
magazine, glancing at the cover.
The Finest in Finance
. Lay smiled to himself.

He found the table of contents, looking for Fastow’s name. Beneath it were the words “How Enron financed its amazing transformation from pipelines to piping hot.”

Lay turned to the article. “When Andrew S. Fastow, the 37-year-old CFO of Enron Corp., boasts that ‘our story is one of a kind,’ he’s not kidding,” it began.

Lay liked the piece. This fellow Banham, who wrote it, captured everything pretty well: asset securitization, special-purpose entities, the reduction of balance-sheet debt. Fastow was obviously as creative and sharp as Lay and Enron’s directors had come to believe.

———

“So,” Skilling said, “what do you need to know?”

It was October 11, and Skilling was speaking with Schuyler Tilney and Robert Furst from Merrill.

“Well, Jeff,” Tilney began. “First, thanks for taking the time to speak with us.”

“No problem.”

“We’ve got just a few questions regarding LJM2. I’m sure they’re issues you’ve already considered.”

Had Skilling thought about the time Fastow would spend with LJM2? Was he comfortable with the controls for the conflicts? Had the board reviewed those? Skilling’s answers were detailed and knowledgeable. He had obviously spent time on the workings of LJM2. The bankers were impressed.

“And really, on conflicts, I am very, very comfortable,” Skilling said. “It’s under control.”

“What will be the mechanisms for that?” Furst asked.

“Well, first of all, Andy has no control over our decision to sell an asset. So if we sell something to LJM2, it’s because
we
want to sell it. If LJM2 gets it, it’s because LJM2 gave the best offer.”

“Okay.”

“And because Andy will know more about the assets, we’re not going to be forced to leave money on the table because of bad bids. If LJM2 wins, it’s because they had the best bid, probably because they knew the most.”

“All right.”

“Plus, none of this is taking place in a vacuum,” Skilling continued. “Rick Causey is going to review every transaction with LJM2 to make sure it’s in Enron’s interest. And the audit committee of the board will receive LJM2’s financial statements.”