THE FALL OF ENRON | Catastrophe
Hidden Debts, Deals Scuttle Last Chance
By Peter Behr and April Witt
Washington Post Staff Writers
Thursday, August 1, 2002; Page
A01
Last of five articles
On Nov. 1, 2001, as the
stock markets opened,
Enron announced that help
was on the way: Its two lead
bankers, J.P. Morgan Chase
and Citigroup , had agreed
to provide $1 billion in
additional loans, doubling
the company's stockpile of
cash.
Enron chairman and chief
executive Kenneth L. Lay
seized on the news as a
rallying point. The cash "will
further solidify Enron's
standing as the leading
market maker in wholesale
energy," he declared.
But time and cash were
running out on Enron Corp.
As November began,
investors were fleeing the
Houston company and its
stock was in a free fall
because of damaging
disclosures about its
finances. Some energy
companies were refusing to
trade with it, and its funds
were quickly being depleted.
The banks had long been
Enron's indispensable
partners, publicly and
privately. They had raised
billions of dollars for the
company, promoted its stock
and invested in the private
LJM2 partnership that had
become Enron's torment.
Now they were trying to
protect their investment.
The next evening, Nov. 2,
the audit committee of
Enron's board of directors
assembled for a report on
the company's cascading
problems.
The mood quickly turned
foul.
Lay took aim at his
company's accountants,
Arthur Andersen LLP,
according to detailed notes taken by Andersen attorney Nancy
Temple. Andersen auditors had recently reversed a decision
they had made back in March involving complex investments
called the Raptors. As a result, Enron had to report a
half-billion-dollar loss in October. Enron executives resented
what they called the "flip-flop."
In good times, Enron's executives, lawyers and accountants
worked together to keep the company's deal factory humming.
Now they pointed fingers at each other, Temple's notes show.
"If we had done this right in the first quarter, we wouldn't be
here today," Lay said, referring to the accountants' reversal.
Chief Accounting Officer Richard A. Causey -- on the hot seat
as Enron's problems mounted -- tried to share blame with
Andersen and the company's equally prestigious outside law
firm, Vinson & Elkins LLP.
An Andersen partner shot back that the accountants would
have done better if Enron hadn't concealed the role of an
Enron executive, Michael J. Kopper, as an investor in an
off-balance-sheet partnership.
This kind of hidden arrangement was an especially sore
subject. Shocked board members had learned a week earlier
that Andrew S. Fastow, Enron's ousted chief financial officer,
had pocketed $45 million from the LJM partnerships. The
board had granted him permission to run LJM despite the
conflict of interest.
Now, board members learned that Kopper, Fastow's former
right-hand man at Enron, had secretly made millions running
an Enron-backed partnership called Chewco.
"Who withheld the facts? Did Fastow know?" one board
member demanded. No one offered answers, Temple's notes
show.
"We have to tell the SEC," said board member Wendy L.
Gramm, the notes record.
Three days later, on Nov. 5, Fitch Ratings, one of the
credit-rating agencies whose decisions would now determine
whether Enron survived, downgraded the company's debt to
the lowest investment grade. Another rating agency, Moody's
Investors Service, was on the verge of doing the same.
Devastating Disclosures
On Nov. 8, the news that had demoralized the audit
committee burst into public view.
In a report to shareholders and the Securities and Exchange
Commission, the company admitted that it had broken
accounting rules in a deal with Fastow's LJM1 partnership
and Chewco. Correcting those errors would force Enron to
restate its profit figures back to 1997. That would erase $586
million from its bottom line.
Enron was under scrutiny from the SEC and an investigative
committee launched by its board.
Big secrets kept coming out.
For a company that depended on the confidence of its lenders
for its trading, the disclosures were devastating. The
credit-rating agencies and the banks wouldn't like the news.
That same day, Robert E. Rubin, the former Treasury
secretary now with Citigroup Inc., called Peter R. Fisher, an
undersecretary of the Treasury. Rubin asked what Fisher
thought of the idea of calling the rating agencies to
encourage them to work with Enron's bankers to see if there
was an alternative to an immediate credit downgrade. Fisher
responded, the Treasury said later, that he didn't think that
was a good idea. He didn't make a call.
Enron's stock closed at $8.41 a share that day, a 90 percent
plunge from its peak the year before.
An Unlikely Savior
The company's only hope for survival now hinged on a
takeover by its smaller Houston rival, Dynegy Inc. For Lay, it
was a humbling position. Dynegy had been Enron's overlooked
little brother, following its footsteps through the 1990s.
Outside of the energy-marketing industry, Dynegy was an
unknown. That was about to change.
On Nov. 9, as both Moody's Investors and Standard & Poor's
downgraded Enron's debt to just above junk-bond status,
Dynegy announced an agreement to buy its rival.
The deal would combine the companies under Dynegy's
founder and chief executive, Chuck Watson. Although it might
take six months to complete, Dynegy and its major investor,
ChevronTexaco Corp., pledged to pump $1.5 billion
immediately into Enron's parched bank accounts. Enron put
up a large pipeline network as collateral.
That day was a triumph for Watson -- who would run the
combined companies -- after years spent in Enron's shadow.
Now, incredibly, Enron had stumbled and fallen into his lap.
He insisted that Enron's problems were manageable.
"We know the company well," Watson said at a news
conference. "It's not like we just started fresh. I'm confident
that it's as solid as we thought it was."
But Watson and Dynegy were in for some surprises.
Four days earlier, Andersen had notified Enron about
"possible illegal acts" involving the Chewco partnership. No
one told Dynegy, company executives would later say.
Soothing Analysts
As part of the Dynegy deal, Lay was scheduled to get a
"golden parachute" -- a payoff that amounted to $60 million to
buy out his three-year contract. But on Nov. 13, after the perk
was disclosed by Bloomberg News, Lay announced that he
would forgo it. It didn't look good at a time when many of his
employees and investors were losing millions as the
company's stock plunged.
The next day, Nov. 14, he presided over a conference call with
analysts, working hard to persuade Wall Street and the
energy markets that the deal would succeed.
Lay shouldered responsibility for the mismanagement and
concealment that marred the company's performance.
Investigations were continuing and might turn up new facts
but the culture of secrecy had ended, he promised.
"Everything we know now, you know," he said.
He turned the hard questions over to Enron's new top
operating officers, President Greg Whalley and Chief
Financial Officer Jeffrey McMahon.
Whalley confirmed that energy companies that once looked to
Enron as the industry leader now wanted no part of the
long-term energy transactions that were Enron's specialty.
But he said things were looking up.
Whalley denied that Enron was facing a cash drain. The
company had the cash it needed, McMahon added.
Double-Edged Provision
But cash was draining out of Enron, undercutting the
energy-trading operation that had been its crown jewel.
It would now become its millstone.
Nearly all of Enron's revenue was coming from its
energy-trading operations. EnronOnline, its nearly
two-year-old Web-based trading operation, was the leading
U.S. trader of gas and electricity. The company praised it as
the perfect synthesis of a dot-com "new economy" venture
and a staple of the old economy, gas.
Enron's energy trading generated most of its record $101
billion in revenue in 2000, more than double the year before.
But its profits were paper thin. In 2000, the company made
only a penny on the dollar. Its profit picture was worsening in
2001, and its need for cash was increasing.
In 2000, the company's cash flow from operations had actually
declined by $2.5 billion, analysts calculated. The company
was spending cash faster than it was coming in in the first
half of 2001, too, Causey had told the board in August.
In its customary hard-nosed fashion, Enron had insisted that
its trading partners have adequate credit to make good on
contracts when they came due. If a trading partner ran into
financial trouble that lowered its credit rating, Enron could
demand an immediate cash deposit to take care of the
problem.
But this provision, written into Enron's contracts, cut both
ways.
By mid-November, the energy traders still willing to do
business with Enron were insisting on burdensome upfront
cash deposits, accelerating the company's cash drain at the
worst possible time.
'A $690 Million Bullet'
On Nov. 19, the big public news of the day was the filing of
the company's quarterly financial report. Enron revealed that
it had run through more than $1.5 billion in cash since
announcing the Dynegy deal, just 10 days before. Much of the
cash was apparently extracted by companies now demanding
more collateral from Enron on existing long-term energy
transactions.
That was just part of the bad news.
Enron had told Dynegy before their merger that its European
trading operations had a $53 million operating profit in the
July-September quarter. But in its disclosure, Enron reported
that its European operations had actually taken a $21 million
loss.
Most devastating was Enron's disclosure that a $690 million
loan, due to be settled in two years, might have to be repaid
within weeks because of the latest drop in Enron's credit
rating, to one level above junk-bond status.
If Enron's credit rating was reduced to junk status,
confidential clauses in its financing contracts required it to
accelerate payments on an additional $3.9 billion in debt from
two off-the-book partnerships. Analysts immediately
concluded that Enron couldn't pay.
The appearance of these obligations was the last crack in
Enron's carefully crafted facade.
The magnitude of Enron's debt had been one of its most
carefully guarded secrets, a fundamental reason for the web
of private and off-balance-sheet financial deals Fastow's team
had spun.
In September, Enron had said its debts totaled $12.5 billion.
But it had billions more in off-balance-sheet obligations.
Enron's two lead bankers had become important enablers in
the company's efforts to disguise its debt, a Senate
subcommittee would later conclude. The banks deny that
assertion.
Officials at J.P. Morgan and Citigroup worked with Enron
finance executives to develop a series of transactions called
prepays that on the surface looked like sales of commodities
-- in most cases, natural gas. But they worked like hidden
loans, Senate investigators said.
Instead of being disclosed as debt, the funds that Enron
received from the banks were commingled with trading
revenue on the company's financial statements. The
transactions were a crucial source of cash, but investors
could not tell that the funds would have to be repaid -- just
like loans. Bank officials said the deals were legal and Enron
reported them as trading transactions.
The company had raised $8 billion in this way since the
mid-1990s. As its problems mounted in 2001, Enron drew on
prepays even more heavily, raising $5 billion in the first half
of the year alone.
Watson was surprised by the debt disclosure, which he would
later call a "$690 million bullet in the head."
Watson demanded to meet with Lay the next day. He wanted
answers.
"I said that I had to know exactly where the $1.5 billion
went," Watson said later. Lay's answers didn't satisfy Watson.
A spokeswoman for Lay said he disputed Watson's account.
Had the Dynegy chief executive asked about Enron's cash
position, Lay would have turned the question over to his chief
financial officer, she said.
Watson had cast himself as Enron's savior. But he made some
Enron executives uneasy -- they wondered whether his real
goal was to scuttle the merger and run off with Enron's
pipeline.
The revelations about the $690 million obligation and the
vanishing cash gave Watson an opening to back out of the
deal.
Negotiations Seesaw
In the days after Thanksgiving, Lay tried to salvage the
Dynegy deal. He was now willing to accept less than half of
the original purchase price. Enron's major lenders, who could
not free themselves from the company without accepting huge
losses, agreed to put more money into the deal.
Gathered at a Westchester, N.Y., conference center on Nov.
23, Lay and his team met hour after hour with Dynegy
representatives. Watson, in touch by phone, stayed in Mexico
for a family vacation. Negotiations seesawed for several days.
On Nov. 26, Lay boarded an Enron corporate jet for home,
believing, aides said, that negotiators had made progress and
that an agreement was within reach.
As his plane sat ready for takeoff, Lay got a phone call.
Watson would not go along after all, aides told him.
Enron had produced too many surprises.
Watson complained that no one could tell him what Enron
was really worth. The deal was dead.
Lay had failed, and the company he had built over the past 15
years was failing with him. From the summit of success just
two years earlier, Lay could not unload his company even at a
bargain price to a smaller rival. His house of cards had
tumbled.
'A Pretty Good Meltdown'
Enron's bankers, meanwhile, were scrambling. On Nov. 26, a
J.P. Morgan banker exchanged e-mails with a business
associate quoting a colleague as saying Enron was close to
defaulting on its prepay contracts and "in the grip of 'a pretty
good meltdown.' "
The same day another J.P. Morgan banker sent an e-mail
recounting a "Large Exposures Meeting" where bankers
calculated that Enron owed the bank $353 million just on
mark-to-market energy trades. The next day, a puzzled J.P.
Morgan vice chairman responded: "still hard for me to get a
fix on this . . . What is our loss potential?"
On Nov. 28, the credit-rating agencies downgraded Enron to
junk-bond status, after concluding the Dynegy takeover would
not succeed. Enron's stock price dropped from $4.11 to 61
cents. That day, Enron shut down its online trading business,
just shy of its two-year anniversary.
Only bankruptcy was left.
A Surprise Bonus
That same day, Enron's chief tax counsel, Robert J. Hermann,
returned from vacation to find panicked colleagues
scrambling to salvage what they could of their life savings.
Word was spreading that the company might file for
bankruptcy protection that weekend.
The company was letting some executives get money out of
one of its deferred-compensation plans, where employees had
banked salaries and bonuses in flush times. By 9:30 a.m.
Hermann had submitted a form asking to withdraw $60,000
from the only plan he participated in that was permitting
withdrawals.
Anxious to help a friend, Hermann quickly e-mailed the form
to retired Enron vice president Alberto Gude. By about 10
a.m., Gude had filled out the form and shot it back.
Hermann's secretary rushed to turn it in.
Hermann, still an important Enron insider, received his
money the next day. Enron wired it into his bank account, he
said. But with money running out, Enron favored current
employees over retirees. Gude never received a penny.
Throughout the week, there had been rumors that some
people were getting generous bonuses to entice them to
remain through the difficult months ahead.
At about 5 p.m. on Friday, Nov. 30, Hermann was sitting in
his office when the phone rang. It was his boss, telling him
somewhat mysteriously to leave headquarters and meet him
across the street in Enron's new building, where builders
were still applying the final touches.
Hermann did. His boss presented him with two envelopes,
telling him one contained a bonus check for Hermann, and
the other held checks for more than a dozen key employees
in the tax department.
Hermann's heart sank. The banks were closed. By Monday
morning there wouldn't be a bank in Houston that would cash
a check from Enron.
"What good is it?" Hermann thought, walking back to his
office.
He lifted the flap on one of the envelopes. It was filled with
cashier's checks. This was Enron after all, and the company
still knew how to pay a bonus.
"I thought 'how are they going to make this work?' " Hermann
recalled. "But dammit, somebody had figured it out."
[Continued]
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