Rupert Murdoch, the international media mogul and chairman of News Corporation, was at his desk in his New York office. It was ten on the morning of December 16, and Murdoch had just heard that his visitor had arrived. A secretary escorted Ken Lay in, and Murdoch stood.
“Ken, good to see you,” Murdoch said.
Lay nodded. “Thank you, Rupert. How have you been?”
Lay and Murdoch had bumped into each other in the past, usually at the annual World Economic Forum in Davos, Switzerland. But this meeting was all business. The two men walked over to a conference table and sat.
“So, Ken, what brings you to New York?” Murdoch said.
“Well, Rupert, we’ve got some exciting projects under way, and I wanted to discuss them with you, because I think there’s a good chance we could work together.”
Enron was moving fast to expand its broadband division, Lay said, and was looking at streaming video across a cutting-edge network. Murdoch—through his Fox network and movie studio—had plenty of video content. The two companies were a natural to work together, Lay said.
“We’ve developed some top-notch technology,” he said. “Head and shoulders above anything else out there.”
The two companies, he continued, should see what they could do for each other. After forty-five minutes, Murdoch promised to have his staff check into what Enron was up to. This broadband effort, he said, really sounded top-rate.
Bill Collins, an executive in Enron Communications, was sick of the hype, the lies. All around him, executives babbled about their technology, their strategies, the importance of broadband for Enron’s future. There was a time when Collins, as director of business development, was a believer; now he thought the whole thing was a crock.
The division was a mess. The people running it had no technology background. No one was making tough choices about how to target resources. Worst of all, nobody was being honest about the troubles they faced. What worked in small demos was proving a lot tougher in the real world.
On December 20, Collins was ready to throw in the towel. He was weeks from quitting in frustration, but before he did, he wanted somebody to hear the truth. He banged out an e-mail to one of his supervisors. Enron’s ballyhooed effort to develop a software-driven network was fizzling, he wrote, with no market share, no purchasers, and no users. Enron talked a good game but wasn’t playing one.
“I don’t care what lipstick and rouge you paint that bitch up with,” he typed. “She’s still just dead meat lying on the sofa.”
LJM2 had only been around for weeks but was already driving Bill Brown crazy. Brown, who worked with McMahon, had started negotiating with Kopper over some deals—if it could be called negotiating. Kopper had attended Enron’s strategy sessions; he knew the prices it would accept and wasn’t willing to discuss paying a penny more.
After a particularly infuriating morning, Brown headed to McMahon’s office. Through the glass wall he could see McMahon at his desk and hurried in.
“Man, Jeff, this thing with Andy and LJM really sucks,” he said. “It’s crazy. We walk in, and before we make our pitch, they’re telling us they know what we’ll take. It’s like selling a house when the buyer knows your bottom line. There’s not a lot of negotiating going on.”
McMahon sighed. More trouble. “Yeah, you’re right, that’s a problem.”
The solution was obvious. “I’ll take care of it,” McMahon said. “I’ll talk to Andy.”
“Look, this whole LJM thing is starting to become a problem internally,” McMahon said.
Sitting across from Fastow in his fiftieth-floor office, McMahon recounted his conversation with Brown.
“That’s not right, Andy,” McMahon said. “And how do you think the guys negotiating for Enron feel, knowing you own a piece of this thing? You’re also the guy who’s going to compensate them. So if they cut too good a deal for Enron, you’re going to find out about it.”
Fastow waved a hand dismissively. He wouldn’t punish anyone for acting on Enron’s behalf, he said.
“You’re missing the point, Andy. It’s the perception. If they perceive that by negotiating too hard they’re costing you money, they can’t help but wonder about the effect it will have on their bonus, on promotions.”
Fastow didn’t like the direction of this conversation. “I would never do that,” he repeated.
“That’s not enough,” McMahon replied. “It’s just ‘Trust me, I’m Andy Fastow.’ That’s not going to do it. You’ve got to fix the problems this thing creates.”
“By doing what?”
Plenty. Get people committed either to Enron or LJM—no more straddling the fence. Then take them out of the building, to LJM’s own offices, like any real third party.
“I don’t know,” Fastow said. “That might cost me some money.”
Like a normal business. “All right, even if that doesn’t work, at least get them off the floor so they can’t just walk into strategy meetings,” McMahon said.
Fastow didn’t answer.
“But the one thing I’m adamant on is the weekly staff meeting,” McMahon said. “Kopper shouldn’t attend.”
“I won’t do that,” Fastow snapped. “Michael is a key player here. He needs to know what’s going on.”
“But he’s the guy leading the LJM charge, and by attending the staff meeting, he knows everything.”
“He needs to know everything,” Fastow responded.
They both were silent for a moment.
“Look,” Fastow said. “Maybe if there is sensitive information we need to discuss, we just won’t talk about it in the staff meeting. We’ll arrange another meeting.”
Companies didn’t do that. What was Fastow thinking? “I don’t see how that’s going to work, Andy.”
“Well,” Fastow replied, “let me think about it.”
As McMahon headed back to his office, his mind was churning. Fastow had never even put together an investor list for him. Why should he believe he would restructure the operations of his precious fund, just to help Enron?
Eleven days left in the year. Eleven days until Enron’s books for 1999 would close. Eleven days left to make everything look better.
The flurry of planned deals weren’t going well. Enron had a pool of loans to unload but couldn’t find buyers for the riskiest portion. Same with a stake it wanted to sell in a group of Nigerian electricity barges. And with Nowa Sarzyna, a power project in Poland. And again for MEGS, a natural-gas-gathering system in the Gulf of Mexico. The marketplace was sending a message: nobody was interested, not at the prices Enron was asking.
Eleven days. Something had to be done fast. And it would. After all, that’s why LJM2 was there.
The first to go was the Polish power plant. On December 21, LJM2 bought a 75 percent interest in the Enron-formed company that owned the plant. The fund paid thirty million dollars—part loan, part investment.
But the deal had a serious flaw. Enron was bound by its credit agreement for the plant to own almost 50 percent of the project until construction was completed. The LJM2 deal would violate that agreement. Enron persuaded lenders to waive that requirement for three months. By March 31, Enron would have to own its stake again.
That didn’t matter. By then, Enron would have made its profit numbers for 1999. LJM2’s rescue mission allowed Enron to book sixteen million dollars in earnings.
Kopper hung up the phone and headed out the door of his office. Fastow had just called, telling him that they needed to get together right away.
Minutes later, Kopper was on the fiftieth floor, heading down the hallway to Fastow’s office. He ambled in and took his usual seat on the couch. Fastow came over.
“What would you think of LJM providing capital in order to buy some Nigerian power barges from Enron at year-end?” Fastow asked.
He laid out the details. It would only entail a few million dollars, he said, and there wouldn’t be much risk; there would be a letter of credit from Citibank protecting the in
vestment. Doing the deal would help the Africa group meet its year-end financial goals. But there was even more of a reason to step up to the plate at the last minute.
“If LJM could do this deal,” he said, “I’d look like a real hero to Jeff Skilling.”
Soon after, Fastow sent the paperwork for the barge deal down to Kopper, who was dismayed by what he saw. The letter of credit was long and complicated, with too many outs for the bank. The power purchase agreement with Nigeria wasn’t even signed. All in all, the deal looked like a loser. He went upstairs to Fastow and let him know.
Fastow took it in stride. “Don’t worry if we can’t get it done through LJM,” he said. “McMahon’s working on another deal.”
McMahon picked up the phone and dialed Merrill Lynch. The firm had already proven it would be there when Enron needed it; on that very day its capital-investment group was putting together a five-million-dollar check for a piece of LJM2. Maybe the firm would be willing to help Enron out of its current jam. McMahon, as the chief contact with the financial institutions, had been asked to make the call.
He reached Robert Furst, one of the Merrill bankers in charge of the Enron relationship. “Rob, we need help,” McMahon said. “We’ve been negotiating to sell some power barges in Nigeria, but the deal’s not coming together.”
It was imperative for the deal to get done by year’s end, McMahon said; otherwise, Enron could miss its numbers.
“So what we’d like to do is sell the interest to Merrill Lynch, just as a bridge to permanent equity,” he said.
With that, McMahon said, Enron would be able to book an additional ten million dollars in profits.*
While the total price would be twenty-eight million dollars, Merrill would only have to put up seven million of its own cash; Enron itself would lend the rest. Merrill would only hold the barges six months, no more. By that point, Enron would find a way to take the firm out of its investment. And for doing the deal, McMahon promised, Merrill would get a substantial return—more than 22 percent.
This wasn’t the kind of thing Merrill did; investing in power barges was a little out of its field. But Furst liked the idea. He had reached similar arrangements with clients when he worked at Credit Suisse First Boston. He didn’t see why Merrill couldn’t step up to the plate. “I’ll run it past everybody,” Furst said.
Merrill already had good reason to be nervous about its Enron relationship. That same day, it was hard at work on a transaction with another Enron division, designed to manufacture more than fifty million dollars in earnings for the company by year-end.
The idea had originated earlier that month in a telephone call from Cliff Baxter—first to the relationship bankers Rob Furst and Schuyler Tilney, then to Daniel Gordon, the firm’s twenty-three-year-old whiz kid who had built its energy-trading business from scratch.
At first, Gordon was dubious. Baxter’s plan was economically irrational. He wanted Merrill to enter into back-to-back long-term electricity trades with Enron, each the mirror image of the other. They would be structured to cancel each other out to the penny. If the first trade eventually forced Merrill to pay Enron a dollar, the second trade would require Enron to give it back. By any reasonable expectation, the whole thing would be a wash. And Baxter wanted to put it together in a few days, in a deal that would normally take months to negotiate.
Still, Gordon was intrigued by the accounting sleight-of-hand that Enron had devised for the deal. One transaction would require physical settlement—meaning that months in the future, Enron would have to deliver electricity to Merrill. But the other trade would require financial settlement—meaning that at the same time, Merrill would have to deliver the cash value of that electricity. And, Causey believed, a financially settled transaction could be marked to market; a physically settled one could not. So Enron could recognize tens of millions of dollars in profits that, in truth, were a mirage.
It was an ingenious scheme to allow Enron to dig itself out of a hole—Gordon understood that. But he also saw a potential windfall for himself and his firm. Enron was desperate. If it didn’t hit its numbers, its executives wouldn’t get their bonuses. For a transaction with no real economic impact, Merrill could charge fees that would make a loan shark blush.
“Let’s see what we can do,” Gordon said.
Baxter started working closely with Tilney and Furst, trying to put together the deal. The structure was designed so that the financial settlement would not even begin until September 2000, more than nine months away. Still, Baxter suggested the deal would never reach that point.
Enron, he said, would probably cancel the whole thing before September. But not until after it reported earnings from trades that everyone already knew would never be settled.
December 22. Ten days to go.
The riskiest portion of an Enron pool of poorly performing financings—doled out mostly by the merchant-investing effort—was sold. They went to LJM2 and an affiliate of Whitewing. For its piece, LJM2 paid Enron more than thirty-two million dollars, money it borrowed from the affiliate.
The transaction didn’t bring profits to Enron; the loans were sold for the value listed on the books. But now Enron was able to avoid revealing how risky they were. Their value was collapsing; under accounting rules, Enron might have been required to recognize its low likelihood of being repaid, and taken a hit to earnings. Now it didn’t have to.
That same day, Merrill convened a meeting in New York to formally consider the Nigerian barge proposal. Furst, the relationship banker, stressed that the deal was crucial to staying on Enron’s good side. But at least one executive—James Brown, head of the project and lease finance group—just as emphatically urged the firm to walk away.
“We really have to think about the propriety of what Enron is suggesting here,” Brown said. “I seriously question their proposed accounting. I don’t think the transaction can be counted as a sale.”
That wasn’t all. Even after the investment, Brown noted, Merrill wouldn’t have any real control over the barges themselves. And what was this about Merrill holding the investment for just six months? That didn’t sound right, and there wasn’t anything in writing. Worst of all, Brown said, the economics smelled bad.
“They plan to book a twelve-million-dollar gain,” he said. “But we’re only investing seven million dollars. How can that be?”
To Brown, the proposal had all the earmarks of profit manipulation. “Play out a scenario,” he said. “What if sometime in the future, Enron has some credit meltdown and falls apart, and it comes out that we were involved in this, with all our concerns about the accounting? Would that damage our reputation?”
But Brown found himself with few supporters. This wasn’t an earnings manipulation, some of the bankers said. Clearly, twelve million dollars wasn’t going to be material for Enron, not when the rest of its earnings were so strong. And of course, Enron almost certainly was consulting Andersen to make sure the accounting was appropriate. And as for that fantasy about the collapse of Enron—of Enron? Ridiculous.
Brown had raised one good point, the group decided. Merrill was going into this without enough protection. It wouldn’t mind buying the stake so long as it was assured that it wouldn’t actually have to own it. So before the committee approved anything, they issued one requirement. Daniel Bayly, the head of investment banking, had to get Fastow’s assurance the buyout would take place. They wouldn’t go as far as demanding that the agreement be in writing; Fastow’s word would be enough.
About that moment, in Santa Clara, California, Lay and Skilling were walking into the headquarters of Sun Microsystems. Behind them were a handful of executives from Enron Communications, including Hirko and Rex Shelby. The mood was one of nervous excitement. In a few minutes, they would be meeting Scott McNealy, Sun’s CEO and an industry legend, in hopes of persuading him to join forces with Enron.
The men headed to reception. A baby-faced executive with a broad smile and a ponytail appeared. He was Jonathan Sc
hwartz, vice president of Sun’s strategic investments. After being introduced to Lay, Schwartz escorted everyone back to a conference room next to McNealy’s office.
McNealy arrived in jeans and a golf shirt, accompanied by Sun’s president, Ed Zander, and a few sales executives. There were greetings all around, and everyone took a seat.
“I really appreciate you taking the time to meet with us,” Lay began. He gave a quick description of Enron’s intelligent network, then turned the meeting over to Skilling.
“Our people believe your servers will work best for us,” Skilling said. “But we want to see if we can do more and create a relationship beyond just buying servers.”
The key would be Enron Communications’ latest initiative, he said. It was trying to create a software interface to allow outside programmers access to the special functions in its network, to be used in the writing of other computer applications. It would be called the Broadband Operating System, or BOS. And Sun could help.
“We need programming assistance,” Skilling said. “We need your help to pull this together and get it out.”
McNealy held his chin in his hand. He glanced over at Schwartz. “What do you think, Jonathan?”
The two companies would be a perfect match, Schwartz said. Enron was doing big things. The company was willing to use Sun’s Java programming language for its network. Yes, Sun had plenty of reasons to be interested.
Zander jumped in. “How many people are we talking about?”
“Twenty or thirty,” Schwartz said.
Zander looked almost ill. “Twenty or thirty? Are you kidding me? You know the load those guys have right now.”
Everybody had been prepared for this to be a tough sell. It was the end of the 1990s. Software programmers were in hot demand and hard to find. But Schwartz held his ground.
“This could be very, very important,” he said. “The first mover on this will have the big advantage.”
The Enron executives watched as McNealy, Schwartz, and Zander laid out their positions. But there was no mistaking their enthusiasm for putting together an alliance. Before he left, Lay wanted to raise one other issue. He turned to McNealy.
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