The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron (68 page)

When everyone was on, LeMaistre began reading: “We very much appreciate your willingness to meet with us. Andy, because of the current controversy surrounding LJM1 and LJM2, we believe it would be helpful for the board to have a general understanding of the amount of your investment and your return on investment in the LJM entities.”

Then the first question: “What was your aggregate income attributable to LJM1 and LJM2, inclusive of salary, consulting fees, management fees, partnership distributions, and gain on the sale of your partnership interest?”

For more than a year, Fastow had bobbed and weaved, dodging bosses, lawyers, and security regulations to avoid addressing this very question. But now, backed into a corner, he gave the directors a startling answer: he had made $23 million on LJM1 and another $22 million on LJM2. Fastow was telling them he’d pocketed $45 million—on a partnership that was supposedly occupying him just three hours a week! And he’d made the money doing deals with
Enron
. “Incredible,” LeMaistre scrawled on his script.

In fact, Fastow’s true take was even larger: $60.6 million.

What was his rate of return? LeMaistre asked. Fastow said that he had invested $1 million in LJM1 and $3.9 million in LJM2 but couldn’t immediately tell them his rate of return.

Did he know of any other Enron employees besides Kopper who had “any economic interest” in the LJMs or had received “any benefit” from them? Fastow told them he did not—saying nothing about Glisan, Mordaunt, and the others who were members of the Southampton partnership.

And, finally, did he know any other “potentially troublesome matter of which we should now be apprised in connection with the LJM relationship?”

“No.”

 • • • 

At 8
A
.
M
.
the next day, Greg Whalley walked into a conference room on the fiftieth floor of the Enron Building where a handful of executives were already gathered. They included Ken Lay; treasurer Ben Glisan; former treasurer Jeff McMahon, now running Enron Industrial Markets; and Andy Fastow.

Whalley pointed to Fastow: “You’re not the CFO anymore,” he told him. Then he pointed to McMahon: “You are.” As the meeting continued, the talk turned to a finance issue. When Fastow tried to chime in, Whalley instantly shot him down. “Didn’t you hear me?” Whalley snapped. “You’re
fired
.”

Fastow and his wife were supposed to have lunch that day. He e-mailed her to cancel. “Sweetheart, I can’t do lunch because I’ve got to be here to find out my final status (reassigned, leave of abs, gone), work out details with ENE, and help with press release. Love you.” Lea Fastow e-mailed back with some advice. “Important,” she wrote. “The press release needs to say that you voluntarily stepped down due to your reduced effectiveness as CFO as a result of the character assassination.”

In fact, Fastow was officially placed on a leave of absence, but McMahon’s appointment as his replacement was announced immediately. Just 24 hours after Lay publicly insisted that Fastow’s character was being unfairly maligned, the CFO was gone.

By the close of the day’s trading, Enron shares had fallen to $16.41.

 • • • 

Not long after word of his “leave” got out, Andy Fastow received a call from his old boss, Jeff Skilling. In the two months since leaving Enron, Skilling had closely monitored events at the company. Even now, he checked in regularly with the PR department, asking Mark Palmer, “What are you hearing?” and volunteering his advice for dealing with the company’s growing problems.

As Skilling watched from the sidelines, his frustration had grown. “Somebody needs to say something,” Skilling railed. “The stuff being written is just crazy! It’s not the company I know.”

“Andy, what is going on?” Skilling now asked Fastow.

“Jeff, I don’t know,” the deposed CFO responded. “They won’t tell me. I don’t think I did anything wrong.”

While Fastow was trying to sound chipper, Skilling could tell that he was down in the dumps. Skilling told his old colleague he should get on antidepressants and start seeing a psychiatrist—just as Skilling had done.

Scott Gieselman, a Goldman Sachs energy banker in Houston, was still in his office when the phone rang. It was late Wednesday night, October 24. Jeff McMahon, who had replaced Andy Fastow as Enron CFO that morning, was on the other end of the phone. “What can you monetize for me in the next 24 hours?” asked McMahon. He sounded frantic.

By the time of Fastow’s firing, Enron’s “perception” problem had evolved into something far worse—a cash crisis. With Enron’s stock continuing to sink, panic was taking hold. The immediate problem was that Enron had been unable to roll its commercial paper—the portfolio of unsecured short-term loans that all big companies use to fund their day-to-day needs. Renewing such debt was normally a routine matter. Though the amounts involved were huge (for Enron, about $2 billion), the exposure was so brief (as little as 24 hours) that, for lenders, it was really nothing to worry about—unless they had reason to wonder if the company would survive long enough to pay it back.

And in Enron’s case, that’s just what was happening. McMahon was shocked to hear this. “If we can’t roll commercial paper, we can’t pay the janitor,” he told Whalley. “We have
no cash!
”

McMahon and Whalley quickly set up a special war room over in Enron’s new Cesar Pelli–designed headquarters across the street, where the traders had just started moving in. They summoned a clutch of corporate finance executives, lawyers, and the heads of Enron’s business units for quick briefings to get a fix on the situation.

Enron, McMahon quickly realized, needed a billion, maybe two to three billion,
fast
—before word trickled out and a rush of panicked creditors shut the company down. The new CFO launched a desperate phone-a-thon, dialing up the big banks, and asking them—on a moment’s notice—to write checks for $500 million or more.

The banks were welcome to sell or lend against anything Enron owned, McMahon advised. If it would help persuade Goldman Sachs to open its coffers, he told Gieselman, Enron would even give the firm full access to its secret trading books. “Nothing is off limits,” he said. “What do you want?”
But this time, the answer came back from everyone: nothing. No one would move that fast, not for Enron, not now.

When that failed, Enron had no choice but to immediately deploy its backup plan. On Thursday, the company drew down the $3 billion in backup credit lines to its commercial paper. To Wall Street, this was instant confirmation of Enron’s desperate straits. Virtually all large companies have such backup credit as part of their financing structure, and they’re technically entitled to tap it whenever they want. But no lender ever expects—or wants—it to be used, since the debt is totally unsecured.

Enron tried to cast this act of desperation as a strategic move, one intended “to dispel uncertainty in the financial community.” It was supposed to offer proof that the banks (which actually had no choice in the matter) were standing squarely behind the company. In a late-afternoon press release, McMahon was quoted explaining the drawdown this way: “We are making it clear that Enron has the support of its banks and more than adequate liquidity to assure our customers that we can fulfill our commitments in the ordinary course of business. This is an important step in our plan to restore investor confidence in Enron.”

The same release announced that Enron Online had completed an “above average” day, with more than 8,400 trading transactions involving 1,387 counterparties. “We are especially gratified by this strong vote of confidence from both our customers and banks because that, more than anything, should enable the financial community to look beyond today’s headlines and focus on the inherent value of our company,” said Lay. As ever, Enron was trying hard to deliver the message that everything was fine.

Incredibly enough, that’s what Lay, at least, truly seemed to believe. As one Enron executive put it: “Ken thought there was nothing wrong with Enron that what was right with Enron couldn’t fix.” And what was right, above all, meant the trading business. After Skilling quit, Lay had hired Gieselman and his colleagues at Goldman Sachs to assess Enron’s finances. Fastow quickly encouraged them to focus their attention on finding a buyer for the pipelines, the only steady cash generator Enron had left. The thought was that everything would be fine if Enron could simply unload the pipelines to lighten the company’s debt and unburden the trading business.

In the middle of all this sat McMahon, who had finally gotten the job he’d wanted, though the circumstances couldn’t have been worse. Of the people now leading the company, he was the only who really understood corporate finance. Whalley had no experience in these matters. Neither he nor Lay could be much help in managing the cash crisis.

McMahon was operating under several serious handicaps. He hadn’t worked in corporate finance for a year, and he had no idea where Fastow had buried the bodies. Nor did he have any easy way of finding out. Under Fastow, Enron had operated quarter to quarter. The company lacked the kind of sophisticated cash-management systems that big companies required. McMahon couldn’t even find a maturity schedule showing when all Enron’s debt would need to be repaid—a basic tool in corporate finance. In fact, with all the tangled off-balance-sheet machinations—obscuring what obligations were truly Enron’s, obscuring even what was truly debt—no one could immediately tell McMahon how much money Enron owed.

There were other perils. Many of Fastow’s structured-finance vehicles, which seemed so clever—even elegant—not long before, now stood revealed as rickety contraptions, lashed to one another and rigged to explode. The problem was that several of the deals, including Marlin and Osprey, had triggers requiring the immediate payback of billions in debt if Enron’s share price fell below certain floors and its credit rating dropped too low. The stock price had already crashed through the floors; the challenge was to keep the credit ratings from dropping as well. After learning that Enron was drawing down its credit lines, S&P changed Enron’s “credit outlook”—an interim step toward a ratings change—from stable to negative. Fitch had already done the same. Moody’s had Enron’s rating under review.

There was another frightening problem that was already taking hold. By its nature, a giant trading operation depends on credit to survive—it is the oxy-
gen for the business. This was especially true of Enron, because of the giant cash needs of Enron Online. Rating-agency downgrades—even just shattered confidence—would prompt trading partners to start demanding cash collateral, producing what would amount to a run on the bank. If that couldn’t be stopped, a few billion dollars of cash wouldn’t last long.

As things stood at the moment, $2 billion from the credit lines would be needed just to pay off the commercial paper loans. This meant that Enron was already down to its last billion, and that was disappearing fast. As one Enron executive later put it: “Trading companies fall quickly—like a helicopter running out of fuel.”

 • • • 

In the aftermath of his departure from Enron, Andy Fastow assumed a pose of being at peace with the world. On the day Enron had tapped its backup credit lines, he received a supportive e-mail from Seth Vance, a London-based banker for Citigroup. “Hang in there,” Vance wrote. “The news will subside and I’m sure when the facts are out, it will be clear that everything you did was approved by the board. Shareholders will sue over anything when they lose as much
as they have—looks like they are grabbing for anything and everything. I guess Jeff S. and Cliff B. timing of leaving Enron could not have been better—?”).

Fastow responded that afternoon. “Needless to say, this has been quite an experience,” he wrote, “but the great thing is that today I had breakfast with my family, drove my kids to school, had coffee with my wife, and soon I’m going for a run. I’m sure I’ll have moments of frustration, but right now this is OK. I wish I could be in there helping Enron, but they’ve got a lot of smart people that will figure this out.”

At the same time, Fastow was playing hardball with Enron. His attor-
neys threatened legal action, insisting that Fastow—officially still on leave of absence—had been involuntarily terminated without cause, triggering the severance provision in his new contract, worth more than $9 million. (The board dithered over Fastow’s status for weeks until concluding that it had grounds to fire him for cause.)

Fastow’s friends at Merrill, meanwhile, prevailed on Michael Kopper to stop making new LJM2 investments. In fact, noted Rob Furst, in an e-mail to Schuyler Tilney and two other Merrill bankers, Kopper now said he would “orderly liquidate the partnership.” With Fastow’s departure from Enron, LJM2’s critical edge—its knowledge advantage—was gone. Kopper had to recognize, Furst noted, that “the premise for which the money was raised . . . is valid no longer.”

 • • • 

As the Enron mess mushroomed and the Houston auditors belatedly scrambled to get a handle on it, Andersen executives in Chicago finally realized that Enron’s problems could imperil the entire firm. Even as David Duncan and others were generating a written record of what was going on, a 38-year-old in-house lawyer named Nancy Temple had begun looking over their memos, advising them to edit out language, and even destroy documents that might look bad in court. As it turned out, this campaign to sanitize Andersen’s files proved even more lethal than the firm’s craven accounting.

Temple became involved in September, when it first became apparent that Enron’s accounting might require restatement. On October 9, during a conference call with two top Andersen lawyers, she jotted a note: “Highly probable some SEC investig[ation].” This alone was cause for alarm. Andersen had just paid a $7 million fine in connection with the billion-dollar accounting fraud at Waste Management; it was operating under an SEC cease-and-desist order barring it from further misconduct. Thus for Andersen, as Temple noted, an En-
ron restatement posed a huge danger—“probability of charge of violating C+D in WM.”

The next day, Andersen’s practice director in Houston, Michael Odom, gave a videotaped talk to a conference room jammed with audit managers—including Duncan—on the touchy subject of destroying files. In the Waste Management case, Andersen’s records had provided government regulators and plaintiffs’ lawyers with all the ammunition they needed. Andersen didn’t want that to happen again.

Under the firm’s document-retention policy, everything that isn’t an essen-
tial part of the audit file—drafts, notes, internal memos, and e-mails—should be promptly discarded, Odom said. Once a lawsuit was filed, nothing could be destroyed, he noted. But “if it’s destroyed in the course of the normal policy and litigation is filed the next day, that’s great, you know, because we’ve followed our own policy, and whatever there was that might have been of interest to somebody is gone and irretrievable.”

Two days later, on Friday, October 12, Temple, fresh from sifting through the embarrassing internal memos revealing the audit team’s rejection of the PSG’s advice on the Raptors, offered her own prod, advising Odom in an e-mail: “It might be useful to consider reminding the engagement team of our documentation and retention policy. It will be helpful to make sure that we have complied with the policy.”

Such helpful reminders about document retention were starting to produce results. When David Duncan’s assistant, Shannon Adlong, arrived for work the following Monday, she noticed bags filled with paper ribbons in the office break room, where the shredder was located. “There was food everywhere,” she later recalled, “like they had been there the whole weekend.”

On October 16, Temple e-mailed Duncan on the subject of his memo documenting events surrounding Enron’s third-quarter earnings release, the one that criticized Enron’s characterization of its big write-off as a nonrecurring charge. Temple offered Duncan “a few suggested comments for consideration.” She encouraged “deleting reference to consultation with the legal group and deleting my name on the memo. Reference to the legal group consultation arguably is a waiver of attorney-client privilege and if my name is mentioned it increases the chances that I might be a witness, which I prefer to avoid.” She also advised “deleting some language that might suggest we have concluded the release is misleading”—even though that is
exactly
what Andersen had concluded.

Temple later explained her aim to an outside lawyer for Andersen, saying she was “trying to balance documenting our discussion with possible subsequent challenges that we somehow had a responsibility to follow up when we knew the client had issued a press release that was potentially misleading.”

In the days to come, Temple continued to edit internal documents even as they were being generated; at one point, she suggested deleting senior Andersen partners from the circulation list for Enron e-mails because it “increases their likelihood of being a witness.”

Duncan, of course, was forwarded Temple’s reminder about document retention. Although he later said he took it as a coded message to start destroying Enron files, he was too busy dealing with the Enron crisis to do much about it for a week. By October 23, the matter had become more urgent. The SEC inquiry had been announced, Andersen was taking a closer look at more of its old accounting decisions involving Enron, the first lawsuits against the energy company had already been filed, and Enron, just that morning, had held its disastrous conference call with the analysts. Andersen’s window of opportunity for cleaning up its Enron files might slam shut at any moment.

At 1:30
P
.
M
. that day, Duncan presided over an all-hands meeting of the Enron team, where, among other matters, he noted that Andersen would invariably become involved in the SEC inquiry and reminded his team to comply with the firm’s document policy. Immediately, Andersen’s Houston office began working overtime shredding documents.

One day into it, Adlong, Duncan’s assistant, dispatched an e-mail: “ARRR-
GGHHH, send more shredding bags! (just kidding we have ordered some).” The machine at Andersen’s Enron office was quickly overwhelmed; dozens of trunks and boxes filled with documents—more than a ton of paper—were shipped to the main downtown office, where files awaiting destruction spilled out into the hallways outside the shredding room. It was more than the entire Houston office typically shredded in an entire year. The load was so great that Andersen summoned a shredding truck from a local disposal company called Shred-It. (The company’s motto: “Your secrets are safe with us.”) Andersen’s offices in London, Portland, and Chicago joined in, shredding their Enron documents. In addition to the paper, almost 30,000 e-mail messages and computer files were deleted.