“We’re going to build a business,” Mark said, “where you can be rewarded for being nice, too.”
The vision captivated Martin. She was on board.
Over time, she and Mark discussed the business. First thing, it needed a name. Martin pulled a face at Mark’s first idea—Water Mark. A little too egocentric. But eventually a name was found, a name that they knew could change the nature of business: Azurix.
His chin in one hand, Skilling flipped to the second page of a report on another proposed international deal, this one in Brazil. He sat at the circular conference table in his office, his back to his desk, as he listened to Joe Sutton, the new division head, make the pitch.
It was just past one o’clock on June 30. Skilling was silent—every motion, every breath exuding boredom. He turned to the third page. Then he saw it. A map.
A map of Brazil and its neighbors. It showed the asset—Elektro Eletricidade e Serviços S.A., Brazil’s sixth-largest electricity distributor—and flows of electricity from power generators moving out onto the grid. Suddenly, Skilling understood. This wasn’t some tired power plant. This was an access point to the grid. An asset that would allow Enron to build a South American trading operation.
As Sutton droned on, Skilling looked up with a smile. “I like this deal,” he said. “I want to do this deal”
Sutton barely noticed. He turned to the next page. Ray Bowen, who was working on the financing for the deal, raised a hand, trying to make Sutton stop.
One thing I learned as a banker: once the guy says yes, you stop talking, he thought.
Sutton looked up, realization sinking in. Skilling was ready to go. “Okay,” Skilling said. “How do we get this done?”
“This is a very sensitive project we’re about to discuss. So I’d prefer if only people directly involved remained in the room.”
Joe Sutton glanced around the fiftieth-floor boardroom. Most of the people attending the board’s executive committee meeting didn’t need to be there.
“I agree,” Skilling chimed in. “People who aren’t needed should leave.”
It was past seven on the morning of July 14. Sutton watched silently as half a dozen executives stood to leave. Once the room settled down, he began his pitch for Elektro.
Under Mark, he said, Enron had already invested some $700 million in Brazil, mostly for the construction of a gas power plant in Cuiabá. Now that country was beginning to sell government-controlled energy assets. A large stake in Elektro—90 percent of the voting shares and more than 40 percent of the economic interest—was coming on the market. An aggressive bid would give Enron a strategic leg up in Brazil.
To finance the purchase, Sutton said, international would rely on Fastow’s group. Then, Fastow explained how he planned to have banks lend the total amount for the closing, after which parts of the financing would be sold off.
“This is a fabulous project,” Lay said. “It’s really going to bring some significant value to the company.”
The directors turned to Skilling; if anyone would oppose the transaction, it would be him.
“I agree with Ken and Joe,” Skilling said. “This is a great opportunity to apply our strategies from wholesale trading in North America to Brazil.”
The directors watched Skilling with expressions of awe. He was holding out the prospects of repeating his domestic success in Latin America.
“This is different from asset development,” Skilling said. “This is a core position. Much like we used Portland General in North America, we can use Elektro in Brazil.”
Still, a few problems emerged. Sutton acknowledged that Enron hadn’t reviewed all of Elektro’s financial and operational data; his team just hadn’t had the time. But he had confidence, he said, in their analysis.
No one asked, wasn’t Enron taking a huge flier? International had always been power plants and pipelines. Electricity distribution was a lesser known beast, and a heavily regulated one at that. Worse, Enron would be using billions in borrowed dollars to purchase a company with cash flow in the real, Brazil’s currency. If the real collapsed, Elektro’s flow of currency would be unchanged, but the value of the cash in dollars—needed to pay lenders—would drop. With this deal Enron would be making a billion-dollar bet on the currency of a Latin American government.
There wasn’t time for much discussion, Sutton cautioned. Enron had to enter its bid in just forty-eight hours. After thirty minutes of discussion, the vote was unanimous. Enron would bid for Elektro.
Two days later at nine o’clock, a silence descended over the crowd gathered in a small auditorium at Bovespa, the Sào Paulo stock exchange. As everyone watched, four envelopes were brought to the stage. This was the moment of truth. The high bidder would own a huge stake in Elektro.
One at a time, an official sitting at a long table tore open the envelopes. The first contained a bid for just over $700 million. The Brazilian government officials were delighted; they had set a minimum price of about $640 million. This was a good sign.
The second envelope. The official sliced one end with a letter opener, removing the slip inside. The bid from Terraco Participacoes, the entity formed by Enron.
“De Terraco Participacoes” the official began. He then recited the number. The crowd exploded in cheers.
Just under $1.3 billion. Enron had bid almost twice the government’s asking price. In the jubilance that followed, it took several more minutes to open the other bids, but that was a formality. The auction was over.
Enron had wildly overpaid for a stake in a company with risks its executives only vaguely understood.
The Enron directors who gathered in the thirtieth-floor video conference room on July 21 were a surly, short-tempered bunch. It wasn’t just all the chatter about the embarrassing price Enron had coughed up for Elektro. Now, only five days after committing more than a billion dollars to Brazil, the managers were back again, this time for two billion dollars—for the water business.
The water business! Why? Sure, a few weeks back, the board had agreed to Rebecca Mark’s request to see if there were opportunities there. But none of them ever imagined she would be coming back so quickly, asking to spend almost as much as Enron had committed to its India power plant.
The video conference system was turned on, and the meeting began. The images of Rebecca Mark and Cliff Baxter filled the screen, broadcast from London. They had been there for weeks, negotiating to purchase a British water company called Wessex Water Services.
The idea was called Project Trident, Mark said, and it would be the heart of their water strategy. Enron would set up a new, stand-alone company to purchase and manage Wessex. With that company, Enron could get its foot in the door of the growing market. All for just $2.25 billion.
The directors glanced at Fastow.
“The price shouldn’t be a problem,” he said. “We can pay that without hurting our balance sheet.”
The finance team had constructed a device for raising the money, he said. It involved a labyrinth of financing that created risks most of the directors—and Fastow himself—failed to understand. In its simplest form, Enron would set up a couple of off-books entities—the Marlin Water Trust and the Atlantic Water Trust. Enron owned half of Atlantic, which in turn owned the company that would purchase Wessex. The result was that a lot of the acquisition and its related costs could be kept off Enron’s books.
The co-owner of Atlantic was Marlin, which would borrow more than a billion dollars from institutional investors. To attract them, Fastow sweetened the deal, committing Enron to repay whatever Marlin couldn’t—in company stock, if necessary. Enron would be like a parent co-signing the world’s biggest car loan for a teenager. But the nettle was in the details. If Enron’s credit rating fell below investment grade when its stock price dropped beneath $37.84, Marlin debt holders could demand repayment.
Fastow wrapped up his pitch. Lay, sitting in the center seat, glanced around. “Any questions?” he asked.
Not a
second passed. Norm Blake, a director, slammed a hand on the table. “I don’t know what the hell we’re doing,” he blurted out. “What’s the Street going to think when Enron puts a couple of billion into water companies?”
Pug Winokur, the head of the finance committee, joined in. “I agree with Norm. This isn’t our area of expertise.”
Other directors sat still; Enron’s boardroom was rarely a place of confrontation. All eyes turned to Lay.
“Norm, Pug,” he began, his voice soothing, “it’s a good deal. It looks and smells just like an energy development, except it’s water. Buying this company would give us the expertise in water that we need.”
“I hear that, Ken,” Winokur replied. “But if you believe you have limited capital in an organization, you’ve got to be careful where you put it. And I don’t want to do some big water project and forgo something in energy.”
“That’s not a problem,” Fastow responded. “Capital is not an issue for Enron.”
Skilling took the floor. “Right,” he said. “By doing this deal, we’re not forgoing some other transaction.”
“Come on, Jeff!” Blake spluttered. “You don’t have anything else on the table today. But tomorrow, next month, next year, there will be opportunities.”
As the argument heated up, John Duncan, head of the executive committee, tried playing peacemaker.
“You know,” he said gently. “These are all good questions, but I think we need to side with the chairman on this one. Ken’s done the due diligence here.”
Crossing his arms in disapproval, Winokur stared at Fastow. “We really have enough capital for this?”
“Yes,” Fastow responded. “This structure works.”
“But this can result in Enron issuing equity,” Winokur said. “And the question I have is, should we issue a billion in equity for water? Or for energy?”
“Well,” Lay began, “it makes sense as—”
“I don’t care,” Blake interrupted. “It doesn’t make sense to me.”
Lay paused. “Well, Norm, if you would let me finish, I could explain to you why it does make sense.”
After allowing Lay to speak for a minute, Duncan rejoined the fray. “All right,” he said. “Well, I suggest we side with the chairman.”
From one end of the table, Ken Harrison, the former chairman of Portland General and a man who had been listening quietly throughout the meeting, spoke up. “Well, my opinion is …”
A stunned silence. Lay’s face seemed to register a wide look of surprise that Harrison was even speaking.
“There’s a lot of opportunity in energy, and we shouldn’t turn away from our core business,” Harrison continued. “Ken, I think this idea is wrong.”
A pause. “All right,” Lay said. “Thanks, Ken.”
He turned his attention back to Winokur and Blake.
“I think we need to go into executive session,” Duncan said suddenly. “Outside directors only.”
Lay, Skilling, and Harrison left the room, waiting outside the door. Other executives, including Fastow, McMahon, Rice, and Causey, headed back to their offices. They got on the elevator, and the snickering began. The board’s pecking order had been established, and for some reason Ken Harrison was at the bottom.
“Hey,” Rice said. “Anybody want to take the bet how much longer Harrison is with the company?”
The executives were reduced to helpless giggles.
Back in the conference room, Duncan waited until everyone was gone. He glanced around the table.
“Listen,” he began. “I understand your concerns. But we need to support the chairman.”
Less than twenty minutes later, the directors called Lay, Skilling, and Harrison into the room.
“Mr. Chairman,” Duncan said, “we’re ready to consider the question on Project Trident.”
Lay took his seat and picked up his gavel. “We’re now going to consider the resolution,” he began.
In ten minutes it was over. One director abstained. Two others, Blake and John Urquhart, voted no. But the others approved sending Enron into a new multibillion-dollar business, using financing they wouldn’t fully understand until years later, when it helped to destroy the company.
This can’t be right.
Jeff McMahon, Enron’s new treasurer, pored through the Elektro paperwork again. Nothing. It wasn’t there.
He called Ray Bowen, who had handled the financing.
“Ray, listen, I’m looking through Elektro,” McMahon began. “Did you know we didn’t hedge the currency risk?”
Hedge the currency risk. In the lingo of finance, McMahon was highlighting the critical risk of Elektro: Enron had done nothing to protect itself from a decline in the value of Brazilian currency.
“Yeah, Jeff, I know,” Bowen replied. “That is absolutely the front-and-center issue on this deal.”
This was nuts. “Well, why did we do the deal then?”
Bowen chuckled. “Go ask Sutton, Skilling, everybody. The risk was right up there. In every discussion I talked about how we were taking a big bet on the real.”
“Well, why did we do that?” McMahon asked sharply.
“Hey, Jeff, I don’t know, I’m just the funding guy. This was the commercial guys’ call.”
Bowen wasn’t going to take the blame here.
“Come on, Jeff,” he said. “You had to have known.”
McMahon thought a moment. “God, yeah, probably. I must have known at some point. It just went by me.”
John Olson’s career at Merrill Lynch ended in August 1998. His protests and calls to Lay proved fruitless. He was officially let go for failing to forge strong relationships with the firm’s bankers. His replacement, Donato Eassey, didn’t have that problem. Early on, he upgraded Enron’s rating.
The three percent. Enron seemed to always be hunting for the equity slice for its structured deals. Maybe, McMahon thought, there was a better way. What if Enron started its own equity funds, raising cash that would be available when needed? That would speed up deal making.
In his first months as treasurer, McMahon was working to expand the universe of Enron investors. Its debt was triple-B, not great. More investors were available for A-rated companies. But equity investors took higher risks; Enron just had to find them. Setting up its own private-equity fund was the answer. He took the idea to Fastow.
“Hey, Andy, listen, I’ve been thinking about how we could make it easier and faster to raise our equity tranches, how to expand our investor base.”
He wanted to look into hiring someone with expertise to put together and manage an equity fund, McMahon said.
“And I’ve already figured out who I want to hire,” he said. “Mike Jakubik at Bankers Trust in London.”
“Jakubik?”
“Yeah, I think he’d be perfect.”
Fastow considered it. He’d been thinking about creating some captive equity fund for months, even talked about it with some Enron bankers. If McMahon knew somebody to run such an effort, Fastow said, all the better.
A month later in a London restaurant, McMahon handed his menu to the waiter after ordering dinner. Across the table, Mike Jakubik sipped his drink and waited.
“Anyway,” McMahon said, “I’ve been in this new job for only a few months. And it’s already clear this company rides it right to the edge on liquidity every month.”
Liquidity. McMahon was talking about the lifeblood of business. Enron, he was saying, was cutting it close on the cash it needed to pay for its daily business operations.
“Basically,” McMahon continued, “Enron is really good at spending money and not very good at selling anything.”
Jakubik smiled. “Okay.”
“A lot of our problem comes from our investment portfolio,” McMahon said. “We’re investing six or seven billion dollars, but we’re not earning cash.”
“Okay,” Jakubik said. “So where would I come in?”
“We need to hire someone who will be responsible for
financing this big position. We’ve just been basically writing checks, and we need to stop that.”
The job would be investment czar for Enron, McMahon said, responsible for managing the portfolio. Lots needed to be sold. There would need to be equity funds to purchase company assets. Other assets might go elsewhere. But in the end Enron’s investments would be used to bring in cash.
“Jeff,” Jakubik replied, “that sounds interesting.”
As dinner wrapped up, Jakubik felt excited. Effectively, he would be an investment banker with one client. This was the type of creative idea that gave Enron such a market aura. Who wouldn’t want a job like that?
The crowd gathered for dinner at New York University applauded warmly as Arthur Levitt, the SEC chairman, walked across the dais toward a podium.
It was September 28, 1998. For Levitt, this was the moment; he was ready to throw down the gauntlet. Corporate America was out of control, relying too much on gimmicks and games to keep the music going.
The evidence was everywhere. In the past nine months, scores of corporations—including investor favorites like Waste Management and Sunbeam—had restated previous financial filings, revealing that profits from prior periods had relied on bad accounting. The SEC was already investigating one accounting firm, Arthur Andersen, which represented both Waste Management and Sunbeam, to determine how things had gone astray. Among regulators, it was already an article of faith that Andersen’s fast-growing clients should face tough questions. But the market simply zoomed on.
So Levitt decided to come out with guns blazing.
“Increasingly,” he said, “I have become concerned that the motivation to meet Wall Street earnings expectations may be overriding commonsense business practices. Too many corporate managers, auditors, and analysts are participants in a game of nods and winks.”
Levitt paused, then continued.
“Wishful thinking may be winning the day over faithful representation,” he said. “I fear that we are witnessing an erosion in the quality of earnings, and therefore the quality of financial reporting. Managing may be giving way to manipulation. Integrity may be losing out to illusion.”
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