Conspiracy of Fools (83 page)

He thanked Lay and hung up.

Just outside Lay’s office door, Watkins was waiting. It was before one o’clock on August 22, the time of her appointment. She was terrified and anxious; she hadn’t slept well in days. She had written a series of new memos explaining the problems, then rewritten them again and again to make them easier to understand.

At that moment, Lay was wrapping up a lunch with Greg Whalley, whom he had unofficially selected as Enron’s new president. Heading into the waiting area, he saw Watkins and broke into a smile.

“Hi, I’m Ken Lay.”

Watkins stood, shaking Lay’s hand. “Sherron Watkins”

“Well, glad you could stop by. Come on in.”

Lay headed into his office, escorting Watkins to the small conference table. They both sat down.

“All right, then,” he began. “I understand you have some concerns about some transaction issues. I’d very much like to hear what those concerns are.”

Watkins ran through her materials, laying out the problems she had found. The Raptors, she said, were set up in a way that would not withstand public scrutiny. LJM, which provided the necessary three percent equity, had gotten its money back out of other payments from Enron. It had no skin in the game. It all looked like one big bet on Enron stock, put together in hopes that a rising share price would bail the company out of its investment losses.

But everything had gone against Enron. Its stock had fallen; its merchant investments had soured. There was a cavalcade of other issues, including rumors of a handshake deal between Fastow and Skilling guaranteeing that the LJM funds would never lose money. Lay’s eyes wandered, but he did seem to be paying attention. He interrupted.

“Andy’s a good CFO, right?” he asked. “He’s doing a good job, right?”

Watkins fumbled with her answer. “Well, uh, sure.”

She went on. Soon Lay interrupted again.

“Are you saying that from the standpoint of the accounting, these are done inappropriately?” he asked. “Do you think something illegal’s been done here?”

Watkins shook her head. “No, I’m not saying that. Technically, maybe the argument can be made that the accounting is correct. But in the end, this will not stand up to public scrutiny. It doesn’t look right.”

Although he wasn’t sure of Watkins’s facts, Lay was convinced that she was
someone to take seriously. Obviously, a lot of thought had gone into this. Her material was too extensive to have been thrown together overnight. But there was still one matter that concerned him.

“Have you shared this with anyone outside the company?” he asked.

Watkins shook her head. “No,” she said.

As the meeting approached its conclusion, Watkins offered her suggestions of how to clean up the mess.

If he was planning to promote Fastow or Causey in the wake of Skilling’s departure, she said, Lay should postpone his decision. The company should hire an independent law firm to investigate—but
not
Vinson & Elkins, since that firm had worked on the deals. A large accounting firm—but
not
Andersen—should review everything. Then, once everybody understood the real impact of the transactions, Enron should develop a plan to fix everything—hopefully one that could be done quietly. But if not, then one with a complete public- and investor-relations campaign.

There were a few people that the lawyers should interview to find out if Watkins was wrong. She listed McMahon, Rick Buy, Mark Koenig, and Greg Whalley. Cliff Baxter was also mentioned by Watkins as someone with concerns. Lay asked if he could keep the memos that Watkins had brought in, and she agreed.

Lay suddenly became animated. “Now, what can I do for
you?”
he asked.

Watkins had thought about that. “I don’t think I can keep working for Andy,” she said. “It might be best if I moved to Cindy Olson’s group until another job turns up.”

Watkins seemed to have planned for everything.

“This doesn’t have to be done today,” Watkins said. “I’m taking a short vacation to Mexico starting tomorrow. Nothing would have to be set up until I’m back.”

“All right,” Lay said. “I’ll speak to Cindy and see if we can get an answer before you return.”

Lay thanked Watkins for coming. Whether she was right or wrong, he thought, he admired her for her courage.

After Watkins left, Lay carried her memos down to Jim Derrick and described his discussion with her. He held up Watkins’s papers. “These are my only copy,” he said, “but I’m going to leave them with you.”

Watkins had raised serious issues, Lay said, and he wanted them investigated quickly. As for who should conduct the inquiry, though, Lay wasn’t ready to accept Watkins’s counsel. A new law firm would take weeks getting
to know the players and the issues. If there really was a big problem, it should be evident to Enron’s closest advisers.

So why not bring in Vinson & Elkins? The two men talked it through and agreed that consulting Enron’s old law firm was the best course. Derrick raised a point about the complexity of revisiting all of the accounting again.

“We don’t want to reinvent the wheel here,” Lay said.

After Lay left, Derrick picked up the phone to call Joe Dilg, a senior partner at Vinson & Elkins. He talked about the anonymous letter and the new material from Watkins. Dilg promised to get started right away.

Derrick sent over the Watkins material. Other than the original, unspecific letter, he had never read any of it.

About that time, Vince Kaminski was downstairs at his desk, reviewing his e-mail. He noticed a message that had been forwarded to him earlier that day and clicked it open.

It was from one of his analysts, Rudi Zipter, raising a question about the Raptors. With the stock market getting hammered lately, it said, both Enron stock and the value of some of its largest hedged assets had been falling.

“OOPS!” Zipter wrote.

Zipter mentioned something about the finance group having put a collar on the Enron stock to prevent it from falling too steeply. Kaminski knew
that
wasn’t right. Enron had required that the stock not be hedged and, as a result, sold it to the Raptors at a discounted price. A collar would mean there was a hedge. In other words, Enron would have sold its stock at a discount based on a lie. It couldn’t be true.

Kaminski started typing a response. “Makes sense,” he wrote, saying he would set up a meeting.

He thought for a second. “Another question,” he wrote. “Do you know if the collar was hedged by the equity desk?”

Joe Dilg quickly assembled his investigative team. After reading the Watkins material, he realized that one of his partners, Ron Astin, had worked on several of the transactions. He discussed it with Astin, and the two decided that since Vinson & Elkins had played no role in
conceiving
of the deals, it wouldn’t be conflicted in investigating them.

Next, Dilg recruited one of his litigation partners, Max Hendrick III, to help out. After being briefed, Hendrick got on the phone with Astin and ran through the issues. Astin mentioned that he had long been bothered by one
aspect of the Raptors: the deal that had been struck to hand LJM2 an amount of money equal to the cash it kicked in, plus a 30 percent return, before the entities engaged in any hedging.

“This is the troubling part,” Astin said. “As a practical matter, LJM has its investment back.”

Still, that wasn’t something Enron wanted Vinson & Elkins to worry about. The firm was told not to bother retaining another accounting firm. There was no need to second-guess everybody on this. Just a fact-finding mission.

The day after his meeting with Sherron Watkins, Ken Lay was hit with another margin call from his lenders. Enron’s stock price had fallen again with the announcement of Skilling’s departure, and the banks wanted more money. Beau Herrold took care of it. He borrowed from Enron for the cash, and then repaid it with company stock, just as they had arranged. Every penny went to pay down debt.

Fastow was in a rage. Word had finally gotten around to him that, in response to this letter to Lay challenging the Raptors, the company was bringing in lawyers to dig into his work. He gathered a few trusted lieutenants in his office and told them what was happening, furiously pacing the floor as he spoke.

“There’s going to be a
fucking
investigation of this,” he screamed. “Who the
fuck
wrote this thing?”

He pounded a fist on his desk. “It’s fucking McMahon,” he growled. “McMahon is behind this thing!”

The diatribe lasted several minutes. McMahon was angling for his job, Fastow said. That’s what this was all about. When the meeting broke up, news of his outburst spread quickly through the division. It didn’t take long for one of McMahon’s friends to hear about it and call to fill him in.

Hanging up before hearing the whole story, McMahon dashed out of his office. He barked at his secretary as he passed. “Call Andy. Tell him I’m on my way up to see him!”

McMahon stormed down the hallway, not slowing as he approached Fastow’s secretary, Bridget Maronge.

“Is he ready for me?” McMahon asked sharply.

“Well …” Maronge began to answer.

McMahon blew past without waiting for a response, shoving open
Fastow’s door. From behind his desk, Fastow looked up, surprised. McMahon closed the door behind him.

He pointed a finger at Fastow. “I’ve gotta talk to you,” he said. Fastow got up. The two executives stood on either side of the desk, glaring at each other.

“I hear you’re telling people I wrote this memo about this Condor and Raptor stuff,” McMahon snarled.

“I don’t know what else to conclude!”

McMahon’s face was hard. “First off, I didn’t write it. But that’s not even relevant, Andy. If you continue to slander me around here, you’ve got a problem with me. If you think I’ve done something, come see me. Don’t start leaking stuff out. I didn’t write it, so cut it out.”

Fastow’s eyes narrowed. “Well, I don’t know who else would try to damage my—”

“Why are you so paranoid about me wanting your friggin’ job?” McMahon snapped. “I don’t want it! I never wanted it! I don’t know what your issue is.”

“I just figure there are people out to get me in the company,” Fastow replied, “and
you’re
one of them.”

Man, McMahon thought,
something’s wrong with this guy
.

“I could care less about what you do or how you do it, Andy,” McMahon shot back. “And I want you to tell me right now that you’re going to stop talking about this memo and me,
because I didn’t write it!”

The two stared at each other in silence. The air in the room was electric. “Okay,” Fastow finally said, backing down. “I’ll take your word for it”

“Fine!” McMahon barked. He marched out of the room, passing Fastow’s stunned secretary. Though his face was red with anger, he felt ecstatic. After all these years, the confrontation had felt great; he had finally let Fastow have it. And the delicious encounter was made all the sweeter by the fact that
he
knew the identity of the letter writer Fastow so desperately wanted to track down.

On the morning of August 28, a new article about Enron appeared in
The Wall Street Journal
. It wasn’t a big scoop, just a “Heard on the Street” column, the feature that typically ruminates about a company’s prospects—and, by extension, about the potential direction of its stock price.

The article was written by Rebecca Smith and John Emshwiller, the first from their reporting partnership. It described how Lay was promising to divulge more information to investors and to abandon the in-your-face management style that had apparently alienated so many of them.

Deep in the article, three paragraphs appeared—the first mention of the LJM funds in a national newspaper. The article didn’t disclose the funds’ name
and reported that Fastow had sold his interest in them. Still, it described some of their workings and quoted Lay as saying that they had become a “lightning rod” for criticism of the company.

All told, the article was informative but not that damaging. Some Enron executives felt relieved at what they saw as kid-glove treatment. They had no idea that this was only round one.

He was a former Enron executive, one who believed the company had lost its way many years before. And there was no starker example than Fastow’s LJM2 fund. It was just dishonest.

That morning, the former executive was reading the
Journal
article. The reporters, he thought, were sniffing in the right area but hadn’t located their prey. Should he help them? He had access to an LJM2 offering memorandum. He knew details of the battles that had occurred over the funds. He could point the reporters in the right direction.

Still, Enron—and certainly Fastow—would lash back at him if they ever found out that he was spilling the beans to the press. But he knew the way the journalism game was played. He could extract promises of confidentiality from the reporters. His anonymity guaranteed, he could tell them everything he knew, give them documents, pile up the evidence he possessed against Fastow and the LJM funds.

He reached for the phone.

What is this?

Robert Hannan was at his desk at the Fort Worth regional office of the SEC, reading that morning’s
Wall Street Journal
. Hannan, a lawyer with the enforcement division, had been reviewing the Enron article and quickly zeroed in on the paragraphs about the Fastow partnerships.

Enron has placed billons of dollars of assets and millions of shares of its stock into complex transactions with these partnerships … Enron executives say the transactions were perfectly proper … The company asked Mr. Fastow to take part in the deals, which were done to reduce the risk of fluctuating market prices
.

Hannan wasn’t quite sure what this meant, but it sure didn’t sound good. Well, the Fort Worth regional office covered Houston. Maybe he ought to look into the matter. He fetched one of the office’s data-entry forms, to establish what was known as a matter under inquiry, or MUI. He filled in all the necessary codes and status requirements. At the bottom, in a space reserved for comments, he scrawled: “Investigation into possible accounting and related party irregularities.”