Riding High
Power on Parade at Bush Inauguration
As a chilly rain soaked the streets of Washington on Jan. 20, 2001, the motorcade
of President George W. Bush moved past the reviewing stand, near where he had
just taken the oath of office. As the new president headed toward Pennsylvania
Avenue, the cheers of supporters mixed gamely with the boos of protesters, an
aural reminder of the divisions that had split the country during one of its most
disputed elections ever.
Nearby, in the exclusive "Pioneers" box on the parade route, Ken Lay watched the
festivities. He was there amidst an elite group of about 200 men and women who
had each raised $100,000 for Mr. Bush's campaign. Nearby, other Enron
executives watched the parade from the elegant Willard hotel and office complex,
two blocks from the White House, where the company's law firm, Vinson & Elkins,
has its Washington office.
It had been a weekend to savor. Enron and its top two executives had kicked in
$300,000 for the inauguration, and the company was one of the few to donate
$50,000 for the Texas State Society's 2001 Black Tie and Boots Inaugural Ball,
where Mr. Bush and the first lady stopped by to salute their Texan friends,
including Mr. Lay.
The day after the inauguration, Mr. Lay attended a private luncheon at the White
House, where he was able to spend a few minutes with the new president, a
luncheon guest said. That night, Enron hosted a private dinner for several
congressmen. Mr. Lay did not attend, but his second in command, Jeffrey K.
Skilling, did.
Enron's sharp elbows had already been noticed in Washington. Curtis L. Hébert
Jr., then chairman of the Federal Energy Regulatory Commission, had gotten a call
from Mr. Lay early in the year. As Mr. Hébert recalled the incident, Mr. Lay said
that Enron would continue to support him in his new job if he dropped his
reservations about electricity deregulation. Mr. Hébert said he had refused. In an
interview earlier this year, Mr. Lay remembered the events differently, saying that
Mr. Hébert sought Enron's support at the White House. Either way, the message
was clear: Enron, a generous contributor to the Bush campaign, would use its
White House access to advance its interests.
Its power base in Houston seemed secure. Its stock price was hovering around $80
a share - not its high, but not far from it. And on Feb. 5, scores of special bonus
checks were cut for Enron executives, who would collect tens of millions of dollars
because of the company's strong reported profits.
The mood that same day was far less jubilant in the nearby offices of Arthur
Andersen, Enron's outside accounting firm. There, David B. Duncan and Thomas
H. Bauer - two of the firm's lead accountants on the Enron account - joined a
group of six colleagues in a conference room for a meeting. Six more Andersen
executives were patched in by speakerphone.
For a significant amount of time, according to notes of the meeting, the Andersen
accountants debated a critical point: What should they do about two partnerships
- called LJM1 and LJM2 - that had been set up 18 months earlier by Enron's
chief financial officer, Andrew S. Fastow?
Since mid-1999, Enron had engaged in a score of transactions with the Fastow
partnerships. It sold the LJM1 partnership a stake in a Brazilian power project
and, later, purchased it back. It sold the same partnership a stake in any future
gains on one of its technology investments, a complex arrangement that allowed it
to report a paper profit on the deal.
On its face, this arrangement partly reflected a common financing technique:
decreasing the company's risk by moving its holdings into separate partnerships
that could be sold to outside investors more willing to assume those risks. And
Enron's board, which had approved Mr. Fastow's dual role in 1999, had ordered
that top management - Richard A. Causey, the chief accounting officer; Richard
B. Buy, the chief risk officer; and Mr. Skilling - carefully monitor these deals.
Later, the board's special investigators concluded that these partnerships, and
others they spawned, had been twisted at Enron into a tool for making the
company seem far more profitable that it really was.
If those allegations are true, there is no sign from the notes of the Feb. 5 meeting
at Andersen's Houston office that anyone there knew it. Still, the accountants
seemed uncomfortable with the LJM arrangement. To solve that, they drew up a "to
do" list, which included suggesting that a special committee of the Enron board be
set up to review the fairness of the LJM deals, according to the notes. They also
decided to make sure with Enron that LJM met accounting tests that allowed it to
be treated as a separate entity, rather than as a subsidiary whose financial results
would have to be shown on Enron's books.
The opportunity to cross to-do's off the list came just one week later, on Feb. 12.
That day, the Enron board's audit and compliance committee held a meeting, and
both Mr. Duncan and Mr. Bauer from Andersen attended. At one point, all Enron
executives were excused from the room, and the two Andersen accountants were
asked by directors if they had any concerns they wished to express, documents
show.
Subsequent testimony by board members suggests the accountants raised nothing
from their to-do list. "There is no evidence of any discussion by either Andersen
representative about the problems or concerns they apparently had discussed
internally just one week earlier," said the special committee report released last
weekend.
That same day, though, Enron's board approved a big decision: Mr. Skilling, long
the second in command at Enron, would be taking over as chief executive. Mr. Lay
would remain as chairman.
In stepping aside, Mr. Lay left to Mr. Skilling - whose manner was seen by many
as far more abrasive and abrupt - the delicate task of explaining Enron to its
critics. By the time Mr. Skilling was named chief executive, the company had
become a lightning rod for political outrage over the electric power crisis in
California, which was experiencing brownouts and price spikes. Enron's traders
bought and sold electric power, and California utility officials were accusing it and
other national power companies of manipulating that esoteric market to reap
windfall profits at consumers' expense. Enron and other major trading companies
denied the accusation, but there were demands for a full-scale investigation.
In late March, a television crew from "Frontline (news/quote)," the PBS news
magazine, visited Enron's sleek office towers in Houston as they prepared a
documentary on the power crisis. Mr. Skilling responded to the company's critics
on camera. "We are doing the right thing," he said during an interview in a fishbowl
room at the edge of Enron's busy trading floor, where traders were buying
kilowatt-hours in one part of the country to sell at higher prices elsewhere. "We are
looking to create open, competitive, fair markets. And in open, competitive, fair
markets, prices are lower and customers get better service."
He added: "We are the good guys. We are on the side of the angels."
After the interview, as Mr. Skilling led the film crew out onto the trading floor, he
was asked what his top priority would be as chief executive. His answer came
lightning-fast: "To get the stock price up," he said.
Few people outside Enron knew how important that single goal was.
Seeking a Quick Fix
Struggling to Avoid Posting Huge Losses
What made Enron's stock price so important was the fact that some of the
company's most important deals with the partnerships run by Mr. Fastow - deals
that had allowed Enron to keep hundreds of millions of dollars of potential losses
off its books - were financed, in effect, with Enron stock. Those transactions could
fall apart if the stock price fell too far.
Indeed, Enron's contracts with some of these partnerships had provisions, called
triggers, that required Enron's stock price to stay above certain specific levels. If it
did not, and if Enron's own credit rating fell, Enron faced a variety of
consequences, all of them damaging to its reported profits.
When Enron's stock was trading as high as $90, the stock prices attached to these
triggers - $57.78 a share in one case, $47 a share in another, $28 in a third - no
doubt seemed absurdly low. But as Enron's share price hovered around $70 a
share in early March, the risk these trigger provisions would be activated grew.
Enron's deals with a quartet of Fastow partnerships known as the Raptors - deals
that were keeping roughly $504 million in red ink off Enron's books - were
especially worrisome.
For months, Enron's accountants had been struggling to keep the Raptors afloat.
Like many of the Fastow partnerships, they were financed, directly or indirectly,
with Enron stock. They had been formed to assume the risks of future losses on
Enron's portfolio of volatile technology stocks, so that Enron could erase those risks
from its own financial statements.
But under accounting rules, Enron could only keep those losses off its books if the
Raptors remained financially healthy enough to fulfill their obligations. As the
Nasdaq boom in technology stocks fizzled, the losses that the Raptors had
promised to cover were ballooning. At the same time, Enron's stock was falling in
value, reducing the Raptors' ability to cover those losses. The Raptor structure was
in peril, and if it failed, Enron would have had to accept that $504 million write-off.
One reason the Raptors were so shaky may have been the fact that, according to
the board report, they had already paid out more than $160 million to Mr. Fastow's
LJM partnerships, whose investors included Merrill Lynch (news/quote), J. P.
Morgan Chase (news/quote), Citigroup (news/quote), the MacArthur Foundation
and the Arkansas Teacher Retirement System.
As the March deadline for financial reporting approached, and as Enron's stock
continued a slide that brought it below $60 a share, the company's financial
experts struggled to find a way to make the Raptors strong enough to meet the
accounting tests that allowed Enron to avoid reporting the gargantuan losses.
According to the board committee's report, senior Enron employees said Mr.
Skilling was "intensely interested" in the Raptor credit problems and called
resolving them "one of the company's highest priorities." Mr. Skilling disputes that
account, insisting that he was only vaguely aware of the credit problems.
Finally, on March 26, just days before the end of the first quarter, the accountants
found a way to refinance the Raptors, using a series of complex and fragile
transactions that were still vulnerable to further declines in Enron's stock price.
The accountants and financial officers celebrated their ingenuity, according to the
board report. But they had merely put off the inevitable.
"Especially after the restructuring," the report says, "the Raptors were little more
than a highly complex accounting construct that was destined to collapse."
But while this frantic rescue effort was under way, Enron executives put the final
touches on a separate deal that allowed some of them to get millions. The same day
the Raptor deal was completed, Enron did another deal, this one with a supposedly
unrelated partnership named Chewco.
Chewco owned a stake in yet a third Enron-linked partnership, called JEDI, and
wanted to sell that stake to Enron. Enron agreed to buy it for $35 million. What few
inside Enron - and almost no one outside Enron - knew was that Chewco was
actually controlled by Michael J. Kopper, a managing director on Mr. Fastow's staff.
After all the debts and fees were settled, Mr. Kopper and his domestic partner,
William D. Dodson, had gotten about $10 million from their Chewco investment,
according to the board's report. Neither Mr. Kopper nor Mr. Dodson have returned
repeated telephone calls seeking comment.
Two weeks later, on April 17, Enron presented its first-quarter results to investors,
and the company's executives were positively giddy. With the huge Raptor losses
shuffled away, Enron reported $425 million in earnings, another banner quarter.
That day, the company set up a conference call with Wall Street analysts. As they
waited on hold for the executives to come on the line, the analysts listened to faint
music. Suddenly, an operator broke in, announcing the arrival of Enron's top
brass.
"I hope you all heard that music that was on," Mr. Skilling announced, according to
a tape recording of the conversation. "We're all dancing here. It's pretty good stuff."
For about 15 minutes, Mr. Skilling laid out the details of Enron's performance.
Nothing was said by any of the Enron executives about the Raptors, the single
most important transaction in the quarter.
"So in conclusion, first-quarter results were great," Mr. Skilling said. "We are very
optimistic about our new businesses and are confident that our record of growth is
sustainable for many years to come."
With that, the executives opened the call for questions. When asked about reserves
the company had for its exposure in California - where the state's biggest utility,
Pacific Gas and Electric (news/quote), had filed for bankruptcy protection in the
wake of the power crises there - Mr. Skilling almost bristled. Enron had been in
the business for 10 years, he said; it analyzed the credit quality of every trading
partner it had - some 5,000 in total - every day. There was no reason for anyone
to worry about credit exposures; Enron knew everything it needed to know.
Later in the call, Richard Grubman from Highfields Capital Management was called
on to speak. Mr. Grubman was not a booster of Enron stock - indeed, he had
made investments that would have allowed him to profit if the stock declined -
and he questioned why Enron did not release its balance sheet, listing its assets
and liabilities, at the same time it reported its profits.
Mr. Skilling said that was not Enron's policy, but Mr. Grubman pressed the issue.
"You're the only financial institution that can't produce a balance sheet or a cash
flow statement with their earnings," Mr. Grubman said, at last.
Mr. Skilling paused. "Well, thank you very much," he said. "We appreciate it."
Then Mr. Skilling turned to his colleagues in Houston, and muttered a vulgarity.
The group in Houston laughed; some of the analysts on the line, who had heard
everything, were stunned.
Questions of Conflicts
A Corporate Lawyer Raises Red Flags
For Jordan Mintz, the 20th floor of Enron's Houston headquarters was a study in
dysfunctionality.
After 18 years as a tax attorney, Mr. Mintz had been delighted in October 2000,
when he had been moved to that floor to work as a lawyer with Mr. Fastow's finance
division. After two days of orientation, Mr. Mintz set to work, finding files upon files
of documents detailing the transactions of the Fastow partnerships.
What he saw troubled him. Mr. Fastow was negotiating deals on behalf of the
partnerships across the table from his own subordinates, who were representing
Enron. Approval sheets for those deals had not been signed by Mr. Skilling, the
chief operating officer, even though they all had a line for his signature. The whole
situation seemed fraught with peril.
Mr. Mintz sought out Mr. Causey, the chief accounting officer, and Mr. Buy, the
chief risk officer. He told them he wanted to approach Mr. Skilling, now the chief
executive, about the unsigned approval sheets, and also to make sure that he was
still comfortable with Mr. Fastow's built-in conflicts.
Mr. Causey was blunt in his advice. "I wouldn't stick my neck out," he said,
according to Mr. Mintz's Congressional testimony. Mr. Mintz interpreted that as a
warning to avoid tangling with Mr. Skilling over the partnerships, he said.
Eventually, the three men agreed that Mr. Mintz should send a memo to Mr.
Skilling, diplomatically raising his concerns. So, on May 22, Mr. Mintz wrote a
confidential memo to the Enron chief executive saying he wanted to bring over the
unsigned paperwork for Enron's deals with Mr. Fastow's partnerships during the
previous year so that Mr. Skilling could sign them.
"To that end, I will arrange to get on your schedule to assist you in this regard," Mr.
Mintz wrote. "Alternatively, I can send such approval sheets to you as a package
and you can sign them at your convenience.
Mr. Skilling never responded, according to Mr. Mintz's testimony.
Increasingly worried, Mr. Mintz decided he needed an independent review of the
partnership arrangements. So without informing his superiors, he retained, on
behalf of the company, an outside law firm - Fried, Frank, Harris, Shriver &
Jacobson from Washington - to take a look.
In June, he got his answer. The Fried, Frank lawyers raised some questions about
the candor of the company's previous public descriptions of the arrangements and
made some preliminary recommendations about how to handle such disclosures in
the future if Mr. Fastow decided to sell his stake to Mr. Kopper, as he had indicated
he might do. Comforted somewhat, Mr. Mintz hoped the sale to Mr. Kopper, which
went through in July, would make life on the 20th floor a bit less difficult.
To the world outside the Enron tower, of course, the company seemed as powerful
and fascinating as ever.
On June 12, Jeff Skilling was featured as the final speaker at the Strategic
Directions technology conference in Las Vegas, where he planned to share his
vision of how Enron was creating a robust trading market in cyberspace. The
executive who introduced him noted that Enron was being hailed as "America's
most innovative company" and that Mr. Skilling had been declared "the No. 1
C.E.O. in the entire country."
With that, a video tape shows, Mr. Skilling bounded onto the stage, tieless and in a
sports coat. The Internet, he told the crowd, had barely begun to show its
usefulness to business. American industry would be transformed by its prowess,
and the future of Enron would be found there, he said. "We couldn't do what we're
doing now without the technology of the Internet," he said.
After a lengthy speech, Mr. Skilling asked for questions from the assembled crowd.
One of the last questioners asked Mr. Skilling for his thoughts about the power
crisis in California, and what the state should have done differently to avoid its
problems.
"Oh, I can't help myself," Mr. Skilling said, according to the tape. "You know what
the difference is between the state of California and the Titanic?"
The crowd laughed appreciatively.
"I know I'm going to regret this," Mr. Skilling said, almost to himself.
He looked back at the audience. "At least when the Titanic went down, the lights
were on," he said.
State officials reacted in outrage when they heard of Mr. Skilling's jest, and the
bad relations between California and Enron worsened. Nine days later, Mr. Skilling
traveled to California, where a protester hit him in the face with a cream pie.
But that public pratfall was minor compared to the damage being inflicted on
Enron's stock. By mid-June, its stock price had fallen below $50 a share,
alarmingly close to those "trigger" prices that had once seemed so ludicrously
remote. One trigger - at $47 - was embedded in the Raptor partnerships, which
had been propped up so painstakingly in the spring. On Monday, July 23, Enron's
stock closed at $46.66. It would never rise above $47 again.
As the stock price fell, the Fastow partnerships that had insulated Enron from
losses for years came under increasing pressure, pressure that would ultimately
send Enron into a death spiral.
By then, the world inside Enron would seem very different. On Aug. 14, stunning
the market, Jeff Skilling announced he was resigning after just six months as chief
executive, citing undisclosed personal reasons. He left assuring investors that the
finances of Enron had never been better.
More Disturbing Questions
An Employee Worries if `We Will Implode'
"Has Enron become a risky place to work? For those of us who didn't get rich over
the last few years, can we afford to stay?"
The words almost leapt off the one-page, unsigned letter to Ken Lay. After Mr.
Skilling's resignation, Mr. Lay had returned as chief executive and had been
meeting with employees, encouraging them to write about their concerns
anonymously.
But this letter was not some mundane complaint. The writer described in detail
problems with Enron's partnerships, problems that the letter claimed would cause
huge financial upheavals at the company in as little as a year. "I am incredibly
nervous that we will implode in a wave of accounting scandals," the letter's author
wrote. "Skilling is resigning for `personal reasons,' but I think he wasn't having
fun, looked down the road and knew this stuff was unfixable and would rather
abandon ship now than resign in shame in two years."
Mr. Lay took a copy of the letter to James V. Derrick Jr., Enron's general counsel,
who agreed it needed to be investigated. They decided to assign the task to Vinson
& Elkins - which had helped prepare some of the legal documents for some of the
partnerships. Enron wanted answers fast, and told the outside lawyers not to
spend time examining the accounting treatment recommended by Arthur
Andersen - although that was the heart of the letter's warnings.
The letter writer soon identified herself as Sherron S. Watkins, an accountant who
had been laid off the previous spring, after eight years, and who had then been
rehired in June to work for Mr. Fastow. Ms. Watkins and Mr. Lay made an
appointment to talk on Aug. 22. Two days earlier, Ms. Watkins shared her worries
with James A. Hecker, an Andersen accountant she knew.
"Sherron told me that she was concerned about the propriety of accounting for
certain related-party transactions," Mr. Hecker wrote in a memo to the file the next
day.
After Mr. Lay met with Ms. Watkins, Vinson & Elkins began its investigation.
Lawyers from the firm interviewed Mr. Fastow, Mr. Duncan from Andersen, and
other people involved in the transactions.
But even as the lawyers were poking through Mr. Fastow's department, his
conflicted role in the partnerships continued to create friction. Mr. Kopper, who
had sold his Chewco assets to Enron so profitably months before, was insisting that
Enron cover the $2.6 million tax liability from the sale, according to the board
committee report.
Mr. Fastow checked with Mr. Derrick, Enron's general counsel, and was told
"unequivocally" that there was no basis for it to be made, according to the board's
report. Nevertheless, Enron's treasury department received orders to cut the check.
On Sept. 18, the $2.6 million was sent to Chewco.
"There is credible evidence that Fastow authorized the payment to Chewco," the
special committee's report says, adding that the payment - done against the
explicit instructions of Enron's general counsel - was "one of the most serious
issues we identified in connection with the Chewco buyout."
Three days later, on Sept. 21, the Vinson & Elkins lawyers investigating Sherron
Watkins' warnings reported their findings to Mr. Lay and Mr. Derrick. There was no
reason for concern, the lawyers reported. Everything in Mr. Fastow's operation
seemed to be on the level. They promised a written report in a matter of weeks.
By then, it would be too late.
(Continued )
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