Conspiracy of Fools (51 page)

“That’s bullshit,” McMahon shot back. “I’ll take care of it.” He hung up and dialed Fastow at the office. The secretary answered; she and Fastow were often in early. She put McMahon right through.

“Andy, it’s Jeff. Look, we’ve got a problem with the Yosemite deal.” Fastow snorted. “Yeah, apparently you guys are being real jerks about the fee.”

“I don’t think you have all your facts straight, Andy,” McMahon replied. He explained how Kopper was making a mistake on the basis points.

“Look, your guys are negotiating way too hard on this deal,” Fastow responded.

My
guys? Don’t we all work for you?

“This deal needs to get done,” Fastow continued. “Tell them to stop pushing so hard. Just get it done.”

McMahon sat up straight. “Now, hold on!” he said. “We are not just going to get this deal done and pay ten times the market rate for fees. We’re supposed to do this stuff at arm’s length, and this is not arm’s length.”

“Well, Michael tells me that you’re just being outrageous. So talk to Michael. I just need a deal.”

“No, I will not talk to Michael!” McMahon shot back.

He took a deep breath. “Look, Andy,” he said. “
This
is the whole problem. You’re the referee, and you’re conflicted. It sucks that it’s set up this way, but that’s where we are. You’re going to have to deal with this.”

McMahon ran through the numbers one more time. “I’m going to support my guys on this,” he said. “We won’t close this deal if you want a million dollars.”

He paused. “Then I’m going to go to Skilling and tell him that we’re not closing this deal because of this, and we’ll have to find somebody else to buy the certificates”

Fastow was silent for a moment. “I’ll call back,” he finally said. The line disconnected.

Twenty minutes later, McMahon, dressed in shorts and a T-shirt, was in his kitchen in bare feet, pouring a cup of coffee. The phone rang. It was Fastow. His words were short and clipped; he made no attempt to mask his fury.

“We’ll do it at $100,000, just to get this deal done,” he said. “But get it done today.”

Fastow insisted that McDowell be told that the negotiations were finished, no question. McMahon agreed and called Brown.

“Okay, I’ve talked to Andy, and it’s all sorted out,” he said. “Tell Doug we need to get this closed today.”

Brown thanked McMahon, asking how Fastow had taken it.

“He was pissed,” McMahon said.

The Yosemite deal wrapped up in a matter of hours. LJM2 agreed to pay $35 million for the certificates; no cash would trade hands for months. It would receive $100,000 for replacing Condor so quickly.

But Fastow still didn’t want to own the certificates. He wanted to be paid a fee and to help Enron pretty up its books. He had no plans of hanging on to his new purchase for long. After all, LJM2’s reporting year was about to end. And the Yosemite certificates weren’t the kinds of things Fastow wanted his investors to see.

For LJM2, there were two and a half days left.

The rest of that Wednesday was a blur of deal making.

That same day, LJM2 purchased twenty-four million dollars’ worth of notes and equity of MEGS, the natural-gas-gathering system in the Gulf of Mexico. Again, the structure was another short-term sale. Enron agreed to resell the MEGS securities to a permanent buyer within ninety days.

The deals were producing lots of benefits for Enron, creating new earnings and pulling weak assets off the books. Still, there was a problem. As always, Enron’s mark-to-market accounting was generating lower cash flow than profits. That kind of statistic would be the perfect tip-off that Enron was
swimming in much choppier waters than it appeared. But how could Enron get cash if it wasn’t flowing out of its businesses?

Borrow it. Using an innovation developed by Citibank, Enron launched Project Nahanni, named for a Canadian national park known for its wolves. As always, an array of entities with cryptic names was involved. But the outcome was simple: Enron, in effect, borrowed almost half a billion dollars and used the money to buy Treasury bonds—calling that a merchant investment. Then it immediately sold the bonds, with Enron’s accountants arguing the proceeds could now be presented as cash flow from operations.

In a few hours on the last day of 1999, in a borrow-buy-and-sell frenzy that a child could understand, Enron generated more than 40 percent of the $1.2 billion in operating cash flow it would report for the year, almost all of it in money that would be returned to Citibank in a couple of weeks. With interest.

Thursday. Two days left.

LJM2 had owned its Yosemite certificates less than twenty-four hours, so now it was time to sell. And Fastow had the perfect buyer: Condor, the entity Andersen ruled couldn’t purchase the certificates from Enron. But Andersen never said anything about LJM2 and didn’t audit the fund. If LJM2 wanted to make the sale, nobody was around to stop it.

Months after the sale, when LJM2 finally had to pay Enron for the certificates, Condor was there with a thirty-five-million-dollar loan for the fund. Once the cash was passed to Enron, Condor forgave the loan. It accepted the certificates as payment in full. LJM2 never had a dime at risk; it had simply been a front for Condor, to escape the accountants’ prying eyes. And it had been paid $100,000 for its trouble. Fastow was still peeved it wasn’t a million.

That same day in New York, executives with Merrill Lynch gathered for an urgent meeting. On the table were the back-to-back electricity trades that Enron had proposed weeks before. It was a riskless deal; Merrill couldn’t lose a dime. And Enron had agreed to pay through the nose—a fee with a present value of seventeen million dollars.

But there was a lot of uneasiness in the room. Fifty million dollars in profits from trades that cancel each other out? Trades that, far from enriching Enron, would cost it seventeen million dollars? This gimmick was going too far.

No, the participants agreed, they couldn’t just approve the deal, not without an assurance that Andersen signed off. The meeting broke up; Schuyler Tilney and Robert Furst phoned Causey to say they needed him on the line answering questions if this idea was going to have any chance.

Hours later, the Merrill group reconvened. Causey joined the meeting from Houston. His voice crackled over the speakerphone. “I’ve heard about your concerns,” Causey said. “I want to assure you that I’m aware of the accounting for these transactions and that Arthur Andersen has approved what we are planning to do.”

That wasn’t good enough, not for a scheme this bizarre. The Merrill executives weren’t prepared to just take Causey’s word.

“Can we speak to the accountants at Arthur Andersen ourselves?” one Merrill executive asked.

“No,” Causey replied. “I have to oppose that.”

There had to be some sort of compromise. What about, one Merrill executive asked, giving the firm a warranty? Causey could write a letter affirming Andersen’s approval, stating explicitly that Merrill never provided accounting advice on the deal. It wouldn’t change the issues; Enron would still report huge profits that weren’t really there. But at least Merrill would be protected if Enron’s game ever became public.

“I think we can do that,” Causey said.

New Year’s Eve. Last day.

The Causey letter was faxed to Merrill, and the trades went forward. Enron booked its last fifty million dollars in profits.

The company had hit the earnings projections. The fire drill of the last few weeks brought in not only almost $500 million in cash flow but also around $125 million in profits—about half what Wall Street hoped the business would generate in the fourth quarter.

All it took was paper shuffling, accounting errors, and some sweetheart deals. That, and a few crimes.

Ben Glisan was feeling uncomfortable.

He had heard about the barge deal—and about the commitments made to Merrill to get it done quickly. The whole idea struck him as just too desperate. Why would Enron want to rush out, doing backflips to lure Merrill into such a deal? What would Wall Street think if word got out about Enron’s desperation for a mere twelve million dollars in profits?

Glisan tracked down McMahon at his office. For a minute, Glisan explained his worries about how the transaction—coupled with all the efforts Enron made to get it done—would be perceived by company bankers.

McMahon was unruffled as he listened, slipping on his suit jacket in preparation for his next meeting.

“I have no problem with a handshake deal,” he said.

Then he headed out.

About two weeks later in Scottsdale, spirits were high among the Enron executives gathered at the Phoenician hotel for their annual management-committee retreat. Enron looked as though it was running on all cylinders, cranking out great numbers. Sure, there were those crazy end-of-the-quarter periods, but no one could argue with success.

They met in the boardroom of the hotel’s Canyon Building on January 13, a Thursday. With Lay chairing, the heads of each division spelled out their expectations for the coming year. That was followed by discussions of their plans for the annual meeting with Wall Street analysts, scheduled for the next week in Houston.

Happy days. Wholesale was blowing the doors off the barn. Retail eked out a small profit. The pipelines—well, the pipelines always made money. There were problems of course, but solutions were in the offing. Finance was working on those hedges for the merchant investments. A lot of international was on the block. So was Portland General. Lots of cash could come in soon.

Ken Rice made the presentation for Enron Communications. The division was about to become a core business—renamed Enron Broadband Services—to draw attention to its advanced Internet work. That was just the first surprise planned for the analysts’ meeting. The second would be its alliance with Sun. Discussions between the two companies were winding up, and it looked like Scott McNealy himself would indeed be there to bestow the seal of approval on Enron’s technologies and strategies.

Excitement flooded the room.
Scott McNealy!
He was a legend. Enron had been in this business just a couple of years, and already had hit the jackpot. Nothing was hotter than tech stocks right now. And the company was about to tell the world that it was seizing a place at the high-tech table for the twenty-first century. No doubt, Enron’s share price was going to go through the roof in a week.

The day was not without tensions. Bonuses for 1999 had been calculated, and the management retreat seemed the perfect time to let executives know the results. Skilling and Joe Sutton, Enron’s new vice chairman, were taking people aside, delivering the financial verdicts.

As the day wore on, McMahon grew anxious. Others were already boasting—or sobbing—about their bonuses. But no one had told him anything. He tracked down Sutton.

“Listen, Jeff,” Sutton said. “In case you’re wondering why I haven’t gotten to you, it’s because Andy wants to give it to you. So find Andy and talk to him.”

Sutton went on his way. McMahon stewed; this wasn’t good news.

The Grayhawk Golf Club rests at the base of the McDowell Mountains, thirty minutes from the Phoenician hotel down Highway 101. By 2000, it had been in operation for less than six years, but its two elegant courses, Raptor and Talon, had already won the reputation as among the finest. So when Enron came to Scottsdale, Causey was adamant: he would not leave until he golfed Grayhawk.

The formal meetings wrapped up Thursday, but Causey, Fastow, McMahon, and a few others stayed behind for a day on the links. On Friday, January 14, they drove to Grayhawk, parking near the lush lawns and brilliant red flowers by the clubhouse. Inside, they headed to the pro shop. McMahon was at the register when Fastow sidled up. He still hadn’t heard about his bonus. Now seemed a good time to find out.

“Hey, Andy,” McMahon said, “are you going to tell me my bonus?”

Fastow looked surprised.

“Everyone got their review and was told their bonus,” McMahon continued. “Except me.”

Fastow shrugged. “I didn’t know that,” he said.
Lying again
. “Well, Andy, were you told yours?”

“Yeah.”

McMahon turned up his hands. “Well, there you go. So let me have it.”

“I was waiting for the board to approve it first.”

Causey wandered over. McMahon and Fastow dropped the conversation. Everyone trooped outside, where scores of golf carts waited. Causey and Fastow rode together, one cart behind McMahon. They drove out to the Raptor course; a game on Talon would have to wait for another time.

As their golf cart moved along vast stretches of green, Causey and Fastow were deep in conversation. They talked through details of Enron’s new hedging program for its merchant investments; there was still a lot of work to go, but things looked good. Everything had been so busy in December, they had never even given this project a name.

There was one quick answer. What about Project Raptor, in honor of this glorious golf course? And this deal would need a named entity set up to provide the hedge, just like LJM1 did. Luckily, there was a second golf
course here. It was decided: the hedging entity for Project Raptor would be called Talon.

Hit a few balls, back in the cart. The conversation continued. The news about Enron Communications—or Enron Broadband Services—was pretty exciting. And McNealy coming to Houston? That was unbelievable. The analysts would go nuts. That was sure to be a day for the record books on Enron’s stock price. They rode on.

Then the idea was born.

The JEDI partnership was loaded with Enron stock from the company’s original capital contribution to the deal. The previous September, Enron had put a hedge in place on the stock, locking the price in place. The value of Enron’s contribution to JEDI couldn’t go down and couldn’t go up.

But what if part of that hedge were removed temporarily? What if, before the conference, Enron replaced the hedge with one that didn’t limit any gains JEDI could recognize from increases in the stock price? The hedge could open up, the stock price would pop when McNealy walked in, the hedge could go back on. And Enron, which reported its share of any increased value in JEDI as earnings, would see that run-up translate into profits.