Skilling didn’t know it, but this was the third version of the equity fund. Jakubik, someone who would have far less of a conflict than the CFO, had already been sandbagged and pushed aside in favor of Kopper. Now Fastow was supplanting Kopper. With Chewco, Kopper was already way ahead on the financial rewards from secret side deals. The numbers Kopper kept in the file on his laptop left no doubt this fund should go Fastow’s way.
With the fund, Fastow told Skilling, there wouldn’t be a need for investment bankers. That meant a higher purchase price and lower transaction costs.
“Well, yeah,” Skilling said. “But it’s got a conflict-of-interest issue.”
Fastow nodded eagerly. “Yeah, that’s true,” he said. “But the whole issue is, is it cheaper, are we getting more benefit to shareholders by doing it this way.”
Skilling thought about that. “Yeah, that’s right,” he said. “All right, go ahead. Look into it.”
The discussion lasted a minute or so; neither man even bothered to sit down. Ever so nonchalantly, the most destructive move in Enron’s history was under way.
“How the hell could you give away ten percent of the fucking company?”
Skilling glared across the table in the thirty-sixth-floor conference room at Ken Harrison and Joe Hirko, the Portland General executives now running Enron Communications. They stared back, unbending.
It was the morning of April 29, and Skilling had just discovered the unit’s dirty secret: its managers had been giving out large chunks of itself to new employees. Private stock options—essentially bestowing ownership in the division—had been distributed like paper. Such a move was commonplace in privately held high-tech start-ups, to attract top talent. But this was different; Enron, a public company, was paying for everything. Now a bunch of untested new employees owned a large part of an Enron division and had been lobbying to sell it to the public.
“So this is what all that IPO talk was about, so your guys can each make a quick fifteen or twenty million bucks!” Skilling railed. “This is nuts!”
“We think it makes sense,” Harrison continued. “You have to understand the way this business works—”
“It’s not gonna happen, Ken! You want to fight about this, I’ll fight it all the way to the board.”
Skilling leaned in, glowering. “We are not doing an IPO of this business. It can’t stand on its own.”
“We think—” Harrison began.
“You want our money, but you want separate governance so you can pass out stock options?” Skilling roared. “It ain’t gonna happen! It is not gonna happen!”
“Fine,” Harrison said. “We’ll take it to the board.”
But Skilling would win his battle in a matter of weeks. The directors decided to keep Enron Communications as a core division and repurchase the stock options that had been distributed so casually.
It was going to cost Enron hundreds of millions of dollars to recover from this blunder. Now Skilling knew how he would use all those earnings magically created by Rhythms. If only they could figure out how to hedge them.
Fastow and a small band of supporters were already hard at work on figuring out how to safeguard the Rhythms treasure chest. The key would be Fastow’s new equity fund.
The outside fund could be the third party that provided Enron with a hedge against a price decline in Rhythms. It would offer what no rational investor could: an agreement to assume the risk of owning Rhythms. No financial firm would do that without being paid a fortune.
Of course, neither would Fastow.
Azurix needed a win.
Rebecca Mark’s water company was weeks from going public but still hadn’t done a big deal since Wessex the year before. Mark was already promising Enron-style profits—annual returns of 20 percent, twice as much as competitors. To pull that off, Azurix needed transactions. And now Mark thought she had found one.
It was called AGOSBA, an acronym for Administración General de Obras Sanitarias de Buenos Aires. A governmental body in Argentina was selling the rights to operate water services for six areas around Buenos Aires. In running the numbers, financial analysts at Azurix had calculated that the present value of the cash flows came in at about $333 million. Initially Mark and her team planned to bid between $321 million and $353 million for the deal, a range that almost guaranteed a healthy return.
But as the date of the Azurix IPO approached, their eagerness to trumpet a big acquisition prompted them to revise their offer up to more than $400 million. They justified the increase among themselves by extolling the virtues of the Wessex managers now at Azurix; they had no doubt that those executives could work magic in Argentina.
Mark and other Azurix executives took the matter to their board of directors, a group that included Lay, Skilling, Pug Winokur, John Duncan, and Joe Sutton. Amanda Martin, head of the Azurix division for the Americas, laid out the proposal. When she finished, Lay spoke up.
“We really need to win this one,” he said.
Winokur agreed. “It would be very important for the IPO pricing,” he said.
“You’re right, it is critical that we win this in order to have a good IPO,” Mark said. “So we would really like to see the board approve this number for our bid.”
Lay looked at Martin. “Amanda, will this number win?” Martin turned up her hands in a feigned shrug. “They’re sealed bids, we don’t know. But we’ve put as much juice into this as we can.”
“Where’s RAC on this?”
It was Skilling, pushing to know what Risk Assessment and Control—the group run by Rick Buy, the chief risk officer—thought of the planned bid. “We’re at the edge of RAC’s tolerance,” Martin said. Skilling pushed harder. “Have they approved this number?”
“This is the highest number they’ll approve.”
“What does Buy say?”
“He’s got warnings all over this,” Martin replied. “But he’s okay.” Mark picked it up from there. “Again, it’s important that we win this. It’s important this is approved.”
Hard to argue that point. In fact …
“Does it make any sense to push the bid price higher?” Lay asked.
They took every precaution to maintain total secrecy.
The Azurix bid for the Argentina project was not put on paper. Instead, it was loaded onto a laptop computer; no one could access the file without the password. Their phones in Buenos Aires were checked for listening devices. Azurix executives felt sure their big French competitors, Vivendi and Suez Lyonnaise des Eaux, would do anything to knock an American upstart out of the running.
On May 17, the night before the bid, an executive carrying the laptop was put on an overnight flight from Houston aboard an Enron corporate plane. The next morning, the computer was brought to the Azurix team working on the Argentina deal. The data were downloaded and examined.
$438.6 million.
Under pressure from the Azurix board, the bid had been kicked up by about thirty million dollars at the last minute. The bid was placed in an envelope and hand-carried over to a government building in Buenos Aires, where bids were scheduled to be unsealed.
José Luis Vittor, a lawyer working with Azurix, watched as the officials opened up the envelopes and read the results. The process was complex; different companies were bidding for different portions of the water services. Vittor listened as the numbers were called out, calculating the differences between what others were willing to pay and the Azurix offer. A horrible realization settled in.
Azurix had overbid—by twice the amount that anyone else in the industry was willing to pay. If profits were there to be found at such a lofty price, only Azurix could see them.
It was Brazil all over again. Only worse.
Rebecca Mark tracked down Ken Lay with the news.
“We won in Argentina,” she said. “We left some money on the table. But we’ll make it work”
Lay nodded, smiling.
“Congratulations,” he said.
Jim Timmins
was back with his proposal for an equity fund. No one had told him yet that Fastow was already putting his own together, but that was the point. Fastow just wanted to take the best of whatever Timmins suggested.
Timmins called it Enron Equity Syndication Program, or Enron ESP. The company would raise about $400 million from five or six pension funds. Then Enron would put together deals and present them to the investors. Each would be allowed to pass on three opportunities before being replaced by another institution that wanted the chance to invest.
Jeremy Blachman, a finance executive, came back to Timmins with Fastow’s verdict. “Andy doesn’t like it. It gives the investors too much voting power.”
That was the point, Timmins said. The fund would be attractive because investors would have control over what investments were made.
“Andy doesn’t want to do that,” Blachman said. “He said come back with something else.”
Busy murals of blue and purple dominated the walls of La Griglia, an Italian grill in River Oaks popular among the city’s power elite. In a secluded corner on May 21, a Friday, Amanda Martin was eating lunch with Jeff Skilling. The food was good, but the conversation was unnerving.
Martin was terrified. Azurix was in trouble. It wasn’t just the ridiculous Argentina bid; the company wasn’t ready to go public. It had spent lots of money setting up offices around the world. It had signed a five-million-dollar lease on space in London, not to mention the hugely expensive Houston offices. The costs of circular staircases and limestone floors stacked up fast.
Worse, Martin thought, Rebecca Mark still seemed to have no idea how Azurix would bring in her promised hefty returns. Skilling, she thought, had to stop the IPO. Azurix needed to stay under Enron’s skirts a little longer.
“I am really concerned about the IPO,” Martin said.
Skilling watched her, chewing his food.
“I’m afraid that Azurix just isn’t ready,” she said. “Once we’re out there, we’re going to be running naked. And I’m really nervous about that.” Skilling set down his fork.
“I want my money back,” he said. “I fell on my sword for this one with the board. We didn’t have a unanimous vote. I promised them I would get our money back and that we wouldn’t make any more investments in this business.”
“But, Jeff …”
“Just get out there and do the best IPO you can. I know you can do it. Market the shit out of it. And it’s going to work. Make it happen.”
Martin took a deep breath. “Well, okay,” she said. “But I’m also concerned about Rebecca.”
Skilling cut her off. “She’s a smart woman.”
There was a pause. “You don’t want to talk about it, do you?” Martin asked.
Skilling’s face was expressionless. “No, I don’t.”
Fastow had been hitting the hustings, speaking to bankers about his fund. This was not going to be a splashy deal like the planned Enron Merchant Partners. This was smaller, for only $15 million of outside investments.
He approached Kevin Howard, the prime banker for Enron at Greenwich NatWest. “I have a deal to discuss,” Fastow said. “But I have to insist on total secrecy.”
He would be setting up a fund, tentatively called Martin, Fastow said. It would be like any special-purpose entity, with a small sliver of capital from outside, independent parties like Greenwich NatWest. Fastow would be investing himself, maybe Kopper, too. Enron would kick in more than $220 million in the form of company stock. That would back up the fund’s commitment to provide the hedge for Enron’s investment in Rhythms.
Howard listened attentively and agreed to forward the idea to bankers in structured finance. The response was uniform: what the hell was Fastow talking about?
The thing sounded like nonsense. Enron would give $220 million to its CFO, and then get that money back if its Rhythms investment lost value? Wouldn’t it get the stock back anyway, or at least be paid for it?
On May 28, David Bermingham, a structured-finance banker with Greenwich, reviewed Howard’s e-mail about the proposal. He couldn’t shake the feeling that this whole thing sounded like some sort of scam being perpetrated by Fastow. He hit “reply” and began banging out a response.
“The fact is that a two-bit LLC called Martin, owned by a couple of Enron employees, will all of a sudden be gifted $220 million of Enron stock,” Bermingham typed.
In fact, the way the deal was structured, Martin would never have to do anything for Fastow to get rich, he wrote.
Fastow and Kopper could “sell the stock in the market, pack up their bag and disappear off to Rio,” he wrote. “If you owned it, wouldn’t you? Now I’m beginning to understand why these guys are so keen to get in on it.”
Bermingham hit “return” on his keyboard.
“What am I missing???????” he typed.
“Why would any director in his or her right mind ever approve such a scheme?”
That same day, Ben Neuhausen—a partner with Andersen’s top accounting division, the Professional Standards Group—was at his computer in the firm’s Chicago office. David Duncan, the lead partner on Enron, had consulted him about some harebrained idea from the company to have its CFO manage an outside fund, one set up to do business with Enron itself.
Neuhausen was floored. The idea made no business sense, and it screamed of conflicts. So on May 28, Neuhausen began typing his response to Duncan, expressing disbelief that any company would ever try something like this.
“Even if all the accounting obstacles below are overcome, it’s a related party,” Neuhausen typed. “Would Enron want these transactions disclosed every year as related party transactions in their financial statements?”
But that wasn’t the main thing bothering Neuhausen. The way this fund was being set up, it looked like Enron hoped to use it as its own little marketplace, available to purchase assets. That was fine, but Enron couldn’t then turn around and book profits from those sales to its captive fund, Neuhausen wrote. That would be going too far.
Early the following Tuesday morning, June 1, David Duncan logged on to his computer and read the e-mail message from Neuhausen that had arrived after he left on Friday. He clicked “reply” and started typing.
“On your point (i.e. the whole thing is a bad idea) I really couldn’t agree more,” he wrote.
But, he pointed out, this was far from a done deal. After all, it would have to be approved by the board, the general counsel, everybody. Once the directors realized what Fastow was up to, Duncan felt confident that they might kill the proposal outright.
“This thing is still very much in the brainstorming stage, but Andy wants to move through it very quickly to get all this done, if possible, this quarter,” Duncan typed. “Andy is convinced that this is such a win-win that everyone will buy in. We’ll see.”
If it did go through, Duncan wrote, he would need Neuhausen’s help to stop Enron from trying to book profits through sales of its assets to the fund. “I’ll need all the ammo I can get to take that issue on,” he typed.
The dark BMW 740i pulled out of the garage at Allen Center before turning onto Smith Street. Inside, Cliff Baxter gripped the steering wheel lovingly, enjoying the engine’s finely tuned growl as he drove toward Dong Ting, a favorite Chinese restaurant. Beside him, Ray Bowen glanced around, admiring the fine leather and fancy trimmings. “Nice car, Cliff,” Bowen said.
“Thanks,” Baxter responded. “I thought about getting the 750iL, but it would have been a bit too flashy.” Bowen nodded.
“You know, Ray, I don’t live in River Oaks,” Baxter said. “I could, but I didn’t want to. I live in Sugar Land, outside of town, and I wanted a nice car for the commute.”
“Well, it’s a nice car,” Bowen responded.
Baxter, who worked as the top deal maker with wholesale, had invited Bowen to lunch that day in hopes of persuading him to take a new job. The merchant-investing effort was a mess; deals were being done for all the wrong reasons, largely by executives who want
ed accomplishments to brag about when bonus time came around. But the follow-through was terrible; for every successful investment like Rhythms, there were untold numbers of disasters costing Enron plenty. Baxter wanted to set up a division of sharp-eyed finance guys like Bowen to serve as a check on the unfettered enthusiasm of the company’s deal makers.
This, Baxter said, would be real quality control, digging through the deals’ numbers and assumptions. Supposedly, this was the job Rick Buy was doing with RAC, but Baxter wasn’t impressed with their performance. They seemed to have neither the time nor the spine to root out the bad deals and stop them. Those were decisions, Baxter said, that should be made inside the wholesale family. Bowen found the idea intriguing and told Baxter it sounded like a challenge he would be eager to take on.
Baxter kept his eyes on the road.
“Well, part of that, you know, is you’ll be leaving finance,” he said. “What do you think of that?”
“I have no issues with leaving Fastow,” Bowen said. “I don’t want to be in that organization anymore.”
Baxter smiled. This was music to his ears. “Good. I’m not surprised. I’d heard you were ripe to move on.”
The two began gossiping about Fastow. Baxter clearly detested the man and his ideas. Both of them had heard about this fund that Fastow was putting together. Bowen asked Baxter what he thought of it.
“Ray, I don’t understand why we’d do that. Don’t you think there are better ways to set up a pool of capital?”
“Yeah, there are better ways.”
“Yeah, I don’t understand Skilling and Fastow. I don’t understand why Skilling sees Andy as a great CFO. I don’t think this advice is the best for the company.”
The restaurant was just ahead, at the Stuart Street intersection.
“Skilling sees Andy as a problem solver,” Baxter continued. “He’s got a blind spot when it comes to Andy. I’ve talked to him more than once about it. But he won’t listen to me about Andy. He’s just got a blind spot.”
Signaling with the blinker, Baxter turned the car in to the lot for Dong Ting and pulled up to the valet on duty.
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