Conspiracy of Fools (50 page)

Minutes later, Kopper was on the fiftieth floor, heading down the hallway to Fastow’s office. He ambled in and took his usual seat on the couch. Fastow came over.

“What would you think of LJM providing capital in order to buy some Nigerian power barges from Enron at year-end?” Fastow asked.

He laid out the details. It would only entail a few million dollars, he said, and there wouldn’t be much risk; there would be a letter of credit from Citibank protecting the investment. Doing the deal would help the Africa group meet its year-end financial goals. But there was even more of a reason to step up to the plate at the last minute.

“If LJM could do this deal,” he said, “I’d look like a real hero to Jeff Skilling.”

Soon after, Fastow sent the paperwork for the barge deal down to Kopper, who was dismayed by what he saw. The letter of credit was long and complicated, with too many outs for the bank. The power purchase agreement with Nigeria wasn’t even signed. All in all, the deal looked like a loser. He went upstairs to Fastow and let him know.

Fastow took it in stride. “Don’t worry if we can’t get it done through LJM,” he said. “McMahon’s working on another deal.”

McMahon picked up the phone and dialed Merrill Lynch. The firm had already proven it would be there when Enron needed it; on that very day its
capital-investment group was putting together a five-million-dollar check for a piece of LJM2. Maybe the firm would be willing to help Enron out of its current jam. McMahon, as the chief contact with the financial institutions, had been asked to make the call.

He reached Robert Furst, one of the Merrill bankers in charge of the Enron relationship. “Rob, we need help,” McMahon said. “We’ve been negotiating to sell some power barges in Nigeria, but the deal’s not coming together.”

It was imperative for the deal to get done by year’s end, McMahon said; otherwise, Enron could miss its numbers.

“So what we’d like to do is sell the interest to Merrill Lynch, just as a bridge to permanent equity,” he said.

With that, McMahon said, Enron would be able to book an additional ten million dollars in profits.
^*

While the total price would be twenty-eight million dollars, Merrill would only have to put up seven million of its own cash; Enron itself would lend the rest. Merrill would only hold the barges six months, no more. By that point, Enron would find a way to take the firm out of its investment. And for doing the deal, McMahon promised, Merrill would get a substantial return—more than 22 percent.

This wasn’t the kind of thing Merrill did; investing in power barges was a little out of its field. But Furst liked the idea. He had reached similar arrangements with clients when he worked at Credit Suisse First Boston. He didn’t see why Merrill couldn’t step up to the plate. “I’ll run it past everybody,” Furst said.

Merrill already had good reason to be nervous about its Enron relationship. That same day, it was hard at work on a transaction with another Enron division, designed to manufacture more than fifty million dollars in earnings for the company by year-end.

The idea had originated earlier that month in a telephone call from Cliff Baxter—first to the relationship bankers Rob Furst and Schuyler Tilney, then to Daniel Gordon, the firm’s twenty-three-year-old whiz kid who had built its energy-trading business from scratch.

At first, Gordon was dubious. Baxter’s plan was economically irrational. He wanted Merrill to enter into back-to-back long-term electricity trades with Enron, each the mirror image of the other. They would be structured to cancel each other out to the penny. If the first trade eventually forced
Merrill to pay Enron a dollar, the second trade would require Enron to give it back. By any reasonable expectation, the whole thing would be a wash. And Baxter wanted to put it together in a few days, in a deal that would normally take months to negotiate.

Still, Gordon was intrigued by the accounting sleight-of-hand that Enron had devised for the deal. One transaction would require physical settlement—meaning that months in the future, Enron would have to deliver electricity to Merrill. But the other trade would require financial settlement—meaning that at the same time, Merrill would have to deliver the cash value of that electricity. And, Causey believed, a financially settled transaction could be marked to market; a physically settled one could not. So Enron could recognize tens of millions of dollars in profits that, in truth, were a mirage.

It was an ingenious scheme to allow Enron to dig itself out of a hole—Gordon understood that. But he also saw a potential windfall for himself and his firm. Enron was desperate. If it didn’t hit its numbers, its executives wouldn’t get their bonuses. For a transaction with no real economic impact, Merrill could charge fees that would make a loan shark blush.

“Let’s see what we can do,” Gordon said.

Baxter started working closely with Tilney and Furst, trying to put together the deal. The structure was designed so that the financial settlement would not even begin until September 2000, more than nine months away. Still, Baxter suggested the deal would never reach that point.

Enron, he said, would probably cancel the whole thing before September. But not until after it reported earnings from trades that everyone already knew would never be settled.

December 22. Ten days to go.

The riskiest portion of an Enron pool of poorly performing financings—doled out mostly by the merchant-investing effort—was sold. They went to LJM2 and an affiliate of Whitewing. For its piece, LJM2 paid Enron more than thirty-two million dollars, money it borrowed from the affiliate.

The transaction didn’t bring profits to Enron; the loans were sold for the value listed on the books. But now Enron was able to avoid revealing how risky they were. Their value was collapsing; under accounting rules, Enron might have been required to recognize its low likelihood of being repaid, and taken a hit to earnings. Now it didn’t have to.

That same day, Merrill convened a meeting in New York to formally consider the Nigerian barge proposal. Furst, the relationship banker, stressed
that the deal was crucial to staying on Enron’s good side. But at least one executive—James Brown, head of the project and lease finance group—just as emphatically urged the firm to walk away.

“We really have to think about the propriety of what Enron is suggesting here,” Brown said. “I seriously question their proposed accounting. I don’t think the transaction can be counted as a sale.”

That wasn’t all. Even after the investment, Brown noted, Merrill wouldn’t have any real control over the barges themselves. And what was this about Merrill holding the investment for just six months? That didn’t sound right, and there wasn’t anything in writing. Worst of all, Brown said, the economics smelled bad.

“They plan to book a twelve-million-dollar gain,” he said. “But we’re only investing seven million dollars. How can that be?”

To Brown, the proposal had all the earmarks of profit manipulation. “Play out a scenario,” he said. “What if sometime in the future, Enron has some credit meltdown and falls apart, and it comes out that we were involved in this, with all our concerns about the accounting? Would that damage our reputation?”

But Brown found himself with few supporters. This wasn’t an earnings manipulation, some of the bankers said. Clearly, twelve million dollars wasn’t going to be material for Enron, not when the rest of its earnings were so strong. And of course, Enron almost certainly was consulting Andersen to make sure the accounting was appropriate. And as for that fantasy about the collapse of Enron—
of Enron
? Ridiculous.

Brown had raised one good point, the group decided. Merrill was going into this without enough protection. It wouldn’t mind buying the stake so long as it was assured that it wouldn’t actually have to
own
it. So before the committee approved anything, they issued one requirement. Daniel Bayly, the head of investment banking, had to get Fastow’s assurance the buyout would take place. They wouldn’t go as far as demanding that the agreement be in writing; Fastow’s word would be enough.

About that moment, in Santa Clara, California, Lay and Skilling were walking into the headquarters of Sun Microsystems. Behind them were a handful of executives from Enron Communications, including Hirko and Rex Shelby. The mood was one of nervous excitement. In a few minutes, they would be meeting Scott McNealy, Sun’s CEO and an industry legend, in hopes of persuading him to join forces with Enron.

The men headed to reception. A baby-faced executive with a broad smile
and a ponytail appeared. He was Jonathan Schwartz, vice president of Sun’s strategic investments. After being introduced to Lay, Schwartz escorted everyone back to a conference room next to McNealy’s office.

McNealy arrived in jeans and a golf shirt, accompanied by Sun’s president, Ed Zander, and a few sales executives. There were greetings all around, and everyone took a seat.

“I really appreciate you taking the time to meet with us,” Lay began. He gave a quick description of Enron’s intelligent network, then turned the meeting over to Skilling.

“Our people believe your servers will work best for us,” Skilling said. “But we want to see if we can do more and create a relationship beyond just buying servers.”

The key would be Enron Communications’ latest initiative, he said. It was trying to create a software interface to allow outside programmers access to the special functions in its network, to be used in the writing of other computer applications. It would be called the Broadband Operating System, or BOS. And Sun could help.

“We need programming assistance,” Skilling said. “We need your help to pull this together and get it out.”

McNealy held his chin in his hand. He glanced over at Schwartz. “What do you think, Jonathan?”

The two companies would be a perfect match, Schwartz said. Enron was doing big things. The company was willing to use Sun’s Java programming language for its network. Yes, Sun had plenty of reasons to be interested.

Zander jumped in. “How many people are we talking about?”

“Twenty or thirty,” Schwartz said.

Zander looked almost ill. “
Twenty or thirty?
Are you kidding me? You know the load those guys have right now.”

Everybody had been prepared for this to be a tough sell. It was the end of the 1990s. Software programmers were in hot demand and hard to find. But Schwartz held his ground.

“This could be very, very important,” he said. “The first mover on this will have the big advantage.”

The Enron executives watched as McNealy, Schwartz, and Zander laid out their positions. But there was no mistaking their enthusiasm for putting together an alliance. Before he left, Lay wanted to raise one other issue. He turned to McNealy.

“Scott, I think our people have been talking a bit about this,” he said. “But we would be delighted if you could come to our annual analysts’ conference
in Houston, and maybe make a few comments to the analysts about our relationship. And more importantly, about what you think about some of our technology.”

McNealy shrugged. “If it works with my schedule, I’d be happy to.”

Lay beamed. He had thought McNealy would be tough to convince. This was almost too easy.

McNealy pushed his hands on the table and stood. “Listen, Ken, come on out here again when you have more time,” he said, shaking Lay’s hand. “You and I can go out and play a couple of rounds of golf.”

“I’d like that,” Lay replied.

Schwartz escorted everyone out. The group headed through security to a courtyard outside the building.

Skilling nudged Lay. “So, Ken, what do you think?”

Lay smiled. “Boy, this could really be great,” he said. “This could really be a turning point.”

The next day, the conference call about the Nigerian barges was arranged between Fastow and Bayly from Merrill. Joining on the line was a group that included Robert Furst, as well as McMahon and Schuyler Tilney—both of whom were on vacation.

“Okay,” Bayly began. “Well, Andy, thanks for taking the time. We just want to nail down a few items.”

Fastow knew the words to use. He wanted to steer away from terms like “promise”;
that
would guarantee Merrill its money back, meaning the sale wouldn’t be real. But that was exactly the assurance he wanted to give.

A transcript of the call, he knew, would look like Enron had committed that Merrill would lose no money; LJM2, he promised, would be available to take the firm out. He felt sure Bayly heard the implicit message. Fastow was proud of himself. He thought he was being awfully clever.

The call lasted a matter of minutes. When it was over, Bayly called Jim Brown at Merrill. He had just gotten off the line with Fastow, Bayly explained. “I’m satisfied,” he said. “Go ahead and close the deal with Enron.”

Three days. Wednesday, December 29.

The ringing phone woke Jeff McMahon first, before his wife. He glanced at the time—7:30 in the morning, during his vacation. He leaned up in bed and reached over for the phone, noticing the caller ID read “Enron Corp.”

He picked up. “Hey, come on, I’m on vacation.”

Bill Brown was on the line. “Sorry to bother you so early on vacation. But we’ve got a problem with Yosemite.”

Yosemite
. McMahon remembered. Enron wanted to sell some certificates issued by the Yosemite trust—originally to some entity called Condor. After Andersen nixed that idea, the decision was made to do the deal with LJM2.

“What’s the problem?” McMahon asked.

“Kopper wants a fee for LJM2 that’s way outside market rates, and this thing is supposed to be arm’s-length.”

“Well, tell him it’s not going to work.”

They had, Brown replied. Doug McDowell, the executive handling the deal, was holding tough. But Kopper was arguing such deals paid a certain number of basis points, each worth one-one-hundredth of a percent of the total. He was messing up the math, saying LJM2 was owed one-tenth of a percent for each basis point. At most, Brown said, Enron should pay $100,000, but Kopper wanted a million.

“Now Kopper’s saying he’s going to go to Fastow unless we agree to the fee,” Brown said.