Conspiracy of Fools (48 page)

Weeks before, Lay had invited Milken to attend Enron’s annual San Antonio management conference out of a mounting sense of anxiety. In meetings, in hallways, in every discussion at the office, Lay had detected a growing swagger, an unrestrained boastfulness in the executive ranks. A culture of arrogance had emerged, a sense of infallibility bestowed by Enron’s seemingly boundless ability to hit profit targets. With even faster growth sure to come, Lay wanted to teach his executives the value of humility.

And who better than Milken to warn about the perils of hubris? From his bond-trading desk in the 1980s, Milken had transformed the investment firm Drexel Burnham Lambert from a Wall Street also-ran to a powerhouse. Lots of struggling companies—Enron included—had turned to Milken and his financing machine. But as they went from triumph to triumph, Milken and his acolytes had grown arrogant. They had displayed a ruthlessness toward rivals, a belief that they were above it all. And when prosecutors came down on the firm, pushing Milken out, his followers committed the sin of doing bad deals. After the marketplace refused some Drexel junk bonds, the firm bought them itself. As the junk market tumbled, so did the debt-laden Drexel—straight into bankruptcy.

To Lay, the similarities between Drexel and Enron were too stark for comfort. Both had burst almost overnight from obscurity to world fame. Both were populated by young, well-paid, aggressive executives pumped up with their own self-importance. A sermon from Milken on the evils of over-confidence might strike fear in their hearts. How could anyone miss the
connection? They were virtually the same story, just without the crimes and bankruptcy, of course.

The two men walked past Charlie’s Long Bar on their way to the Brady room. Management committee executives already crowded the conference table; a buffet lunch was laid out along counters on the wall. After a few minutes of quiet chatting, Lay tapped his glass with a knife.

“All right, everyone,” Lay began. “All of you are aware of at least some of Mike Milken’s background, and he certainly has had the experience of growing a very, very successful finance-trading organization.”

Milken was the master of analyzing risk, Lay said, a man who focused on seeing where a company would be in a year rather than on where it had been in the prior quarter.

“I thought there were some things we could learn from Mike as to his experiences at Drexel, both from the good times and the bad,” Lay said. “And he’s been kind enough to come out and share that with us today.”

The executives applauded politely.

“Thank you, Ken,” Milken said. “It’s an honor to be here among the executives behind this dynamic and creative company. The people of Enron have plenty to be proud of.”

But success could breed carelessness, Milken said. For twenty minutes he laid out a brief history of Drexel and its demise. His audience listened politely, and afterward asked plenty of questions. Lay thought the event went well.

He was wrong. That night several executives crammed Charlie’s bar, tossing back drinks as they laughed about Lay and his guest. What was he thinking? Why bring that
criminal
to talk to them? The jokes flew, many at Milken’s expense, and quite a few at Lay’s. One executive laughed that it was a pity Fastow wasn’t joining in the fun. His famously nasty wit would have certainly livened things up that night.

But Fastow had other priorities. During Milken’s speech, he was in London, raising money from Enron’s European banks for LJM2.

After months of work, struggling with the labyrinths of securities laws, the restructuring of LJM1 was finished.

The Sails proposal—first raised by CSFB at an August meeting in London—had locked in LJM1’s profits on its Enron stock. Now CSFB and Greenwich NatWest were guaranteed huge returns from LJM1’s holdings in Enron. And by transforming Enron stock into cash, Fastow obtained access to an additional twenty-five million dollars, money that the company’s directors had prohibited him from ever receiving.

Now the ugly part—taking credit. Sure, Fastow made out like a bandit. But the bankers wanted to trumpet
their
success as well. After all, bonus time was rolling around in their shops, too.

In early December, David Bermingham, a banker on the deal with Greenwich NatWest, typed an e-mail to a colleague, Gary Mulgrew, touting the deal as a Greenwich brainchild. What they had done, he wrote, “is to strip out 94% of the value remaining in the vehicle after Fastow put his grubby little fingers in the till.” And that money, he typed, went straight to profits for Greenwich NatWest.

“What we have executed was not Enron’s idea, or Fastow’s idea, or CSFB’s idea, it was OUR idea,” he typed.

At CSFB, bankers took a broader view: Not only had the firm made fat profits, it also had stuffed cash into Fastow’s pocket. He was sure to ship more Enron deals their way now.

That same week, Mary Beth Mandanas, a CSFB banker, typed a report to her bosses. If LJM1 was liquidated now, she wrote, CSFB and Greenwich NatWest would walk away with almost $13 million, almost double the $7.5 million they had contributed five months before. But Fastow was the biggest winner: his one-million-dollar investment was now worth $17 million, not including $5.3 million in management fees.

This transaction, Mandanas typed, “provided a significant return to CSFB and has further enhanced our relationship with Andy Fastow, CFO of Enron Corp.”

Paul Riddle, a banker from First Union, was on the phone with McMahon, and he sounded annoyed. “I understand from Kelly Boots that you guys are doing a bond deal.”

“Yup, that’s right,” McMahon replied. Here it came, he thought, a pitch for a piece of the action.

Instead, he got a second of silence.

Then Riddle spoke. “I’m a little confused about the process. Kelly tells me it’s going to be competitive.”

Huh?
Of course it was competitive; almost every bond offering was. Banks and investment houses bid for the lead role, with the cheapest proposal usually winning.

“Would you expect anything different from us, Paul?”

“Well, yeah. I was pretty much told by Fastow that by investing in LJM2, we would get the next bond deal.”
LJM2. Again
.

“I gotta tell you, Paul,” McMahon said, “I was not told that by Andy, ever.
I think you misunderstood. We’ve talked about it, and I’ve been telling everyone that LJM investment and Enron business are completely different.”

Riddle’s voice hardened. “Jeff, I didn’t misunderstand Andy. I know what he told me. And he told me I would get the next bond deal if we invested in LJM2.”

McMahon wanted nothing to do with this. “Tell you what. Call Andy, because if you cut a deal with Andy, then you should talk to Andy and get that deal done.”

“But …”

“Paul, did
I
tell you that you had a deal?”

“No.”

“Then talk to the person who did.”

The moment the call ended, McMahon dialed Fastow.

“Andy, this is Jeff. I just got a very disturbing phone call from Paul Riddle,” he said. “He says he was promised the next bond deal for investing in LJM2.”

Fastow answered fast. “Oh, that’s just not true.”

“Well, he said that’s what you promised him.”

“It’s not
true
. Tell him no.”

“Okay. I just wanted to make sure that’s the deal. None of this stuff is tied.”

“None of this stuff is tied. That’s correct.”

The call finished quickly, and McMahon hung up. He brought his hand to his face as he stared at the phone console.

Bullshit
. Riddle hadn’t been the first banker to call. McMahon had already heard the same thing—less bluntly—out of Merrill.
Everybody
hadn’t misunderstood.

McMahon had no doubt. Andy Fastow was lying.

Anxiety permeated the room. Enron’s stock had been falling—it was now in the high thirties—and the employees at the December 1 company-wide meeting weren’t happy about it. When the time came for questions, the first to be asked was what they planned to do to get the price back up.

“I don’t ever want us to be satisfied with a stock price,” Lay replied. “I think there’s no reason to think that over the next two years we can’t double it again.”

Later, the head of human resources, Cindy Olson, stepped up to answer questions. She received one anonymously, written on a card. She glanced it over.

“Should we invest all our 401(k) money in Enron stock?” she read out loud. She looked up. “Absolutely!”

She turned and smiled at Lay and Skilling. “Don’t you guys agree?”

Skilling smiled back. “You’re doing good,” he said.

After weeks of work, Rebecca Mark and the financial team from Azurix were ready to present their plan to save the company. A special board meeting was called at Allen Center. Mark’s message was blunt: to move forward, Azurix had to step on the gas and buy more water companies.

“We’ve considered alternatives,” Mark said, “and we believe going for aggressive growth is the best approach.”

The status quo would not bring the dynamic shock to the marketplace that Azurix needed. And cutting back—well, that would just pull the company out of the competition. It would be an admission of failure.

Rod Gray, the company’s CFO, explained the numbers. Skilling could feel his temper getting the best of him as he listened. He wasn’t going to stand for another gamble based on Mark’s cocky prognostications.

“Wait, Rod. How can you keep raising money for acquisitions without putting your credit rating at risk?”

“There’s quite a bit of capital available out there,” Gray responded. “It would be closer to junk rates, but I’ve been assured by our bankers that it’s available.”

With that, Skilling lost it.
Junk rates!
That would leave Azurix paying through the nose for borrowed cash. How could it bid against competitors who borrowed for less?

“Rod!” Skilling snapped. “How are we going to finance competitive bidding with junk?”

“That’s not the question I was answering. I was answering if the money is out there, and it is.”

Skilling shot a glance at Mark.

“All right. Rod doesn’t want to answer the question. Rebecca, can you answer it? How are you going to compete?”

“It will be hard,” she replied calmly. “The bids we see from other companies are aggressive. They are absolutely bidding to knock Azurix out of the business.”

Skilling sat back. He looked at the other directors and asked if management could leave the room. He wanted to speak with the board privately. Mark and the rest of the Azurix team left. The door closed behind them.

Skilling started in, furious. “This is wrong! We do this, we’re just throwing more money away,” he said. “The only strategy that makes sense now is to significantly cut back. Cut overhead. Cut staff.”

He stopped. The room was silent for a second. Lay broke the tension of the moment. “I agree,” he said.

The directors all signed on. Mark had to be told she was not thinking radically enough. Cutting back on everything was the only choice. And Lay was given the job of telling her.

The numbers at Enron for 1999 were a mess. The company had spent too much money on deals that were producing lousy returns. If it revealed its actual performance, the stock was sure to get hammered.

But all those years of throwing together structured deals had created an answer. Enron had pockets everywhere, pockets that, under the accounting rules, it could treat as independent third parties. It had created its own fanciful marketplace, one where every participant only wanted what was best for Enron. There was a trust called Whitewing, with a related entity called Condor, which had plenty of cash. Of course, there was LJM1. And now there was the granddaddy of them all, LJM2, with $250 million in cash already available to hand Enron whenever it was needed.

Still, the LJM funds wouldn’t take just anything; Fastow had already made that clear in the Cuiabá transaction, when he demanded a commitment for a future buyout. And one thing that needed to be cleared off the books—certificates in a trust called Yosemite—was the kind of low-return investment that Fastow didn’t like.

So Enron executives turned to the Condor pocket. They began working on a deal to have Condor fork over thirty-five million dollars in its cash to Enron in exchange for Yosemite certificates. With that, the certificates would disappear from the books, and Enron would get to report tens of millions of dollars in new profits—from itself.

Then, a problem. A junior Andersen accountant in London nixed the deal. Condor was simply too intertwined with Enron to be treated as a third party. Putting the certificates in
that
pocket wouldn’t change the financial reporting. Desperate, executives on the deal tracked down Fastow, begging him to let LJM2 buy the certificates—just temporarily. Fastow agreed, so long as Enron paid LJM2 a fat fee. The two sides started negotiating.

There was plenty of grumbling. Why was this junior Andersen accountant getting in the way? On December 6, Joel Ephross, now a lawyer at Enron, e-mailed Fernando Tovar, a lawyer at Vinson & Elkins, explaining the original Condor proposal and how the accountant from Andersen—AA, as he called it—had stopped the deal.

“So, now we have LJM, which is not in any way related to Enron (except
that one of its investors is an executive, but we will not talk about that) making the equity investment,” he typed. “That will satisfy AA.”

But that probably wouldn’t be the story’s end, Ephross wrote. “We will see if the junior person who has made this trouble is employed with AA after January 1st,” he typed. “However, very few people here are betting on that.”

A giant American flag hung in the twelve-story atrium lobby of the Grand Hyatt Washington hotel, just steps from the capital’s convention center. It was December 7, and the hotel was packed with accountants, all in town to hear presentations from the Securities and Exchange Commission about what their profession should be doing.

Just past eleven, Richard Walker, head of SEC enforcement, stepped up to the dais in the Constitution Ballroom. It had been a busy year for Walker. Since his boss, Arthur Levitt, had given his “numbers game” speech the year before, Walker had been working to give the words teeth. The agency had brought civil-fraud charges against officers at an array of big public companies, and then capped it off with a flourish—an accounting-fraud sweep against sixty-eight people and companies, all filed on September 28, 1999, the first anniversary of the speech.