“Okay, Wade,” he said. “What’s your assessment?”
Cline looked Skilling in the eye.
“It’s bad,” he said. “We’ve got a big problem here.”
Arthur Levitt needed an ally in the accounting industry. And he found one at Arthur Andersen in a soft-spoken yet scrappy managing partner named Joseph Berardino.
After spending his full career at Andersen, Berardino was a favorite to be the firm’s new chief executive. But even as his star was rising at Andersen, Berardino was becoming Levitt’s secret weapon. Quietly, he broke ranks with other accounting firms, working with Levitt to hammer out a compromise on the auditor-independence rules.
The presidential elections were a little more than a month away. Levitt knew he didn’t have a lot of time.
Fall’s arrival broke the California heat wave, but anxieties about the marketplace and trader gaming made the state’s energy crisis only grow worse.
Gray Davis, the state’s governor, became desperate. Things were out of control. The system seemed on the verge of collapse. Davis was ready to turn anywhere for help. So on October 2 at nine o’clock, he was in his office with two aides, preparing for a conference call. A secretary let Davis know everyone was on the line. He hit the button on his speakerphone. “This is Gray Davis,” he announced.
“Governor, good morning. Jeff Skilling at Enron.”
They spent more than half an hour brainstorming. From Enron’s side, Greg Whalley, the company’s top energy trader, and Steve Kean, its senior government-relations executive, helped out. But for the most part, the conversation was all Skilling and Davis.
The state couldn’t afford to pay hundreds of dollars for every megawatt hour, which last year cost less than twenty dollars, Davis said.
“It’s easy to fix,” Skilling said. The problem, he said, was that California bought most of its power shortly before it was needed, in the spot market. That left the state subject to the vagaries of market fluctuations. Instead, it should strike long-term contracts, locking in prices for years. Such deals could probably be purchased for less than fifty dollars a megawatt hour right now.
“That’s interesting,” Davis replied. “Give me some of the numbers on that.”
Skilling sketched out the details. The best way to handle it was through an online auction, he said. That would prove to suppliers that there was a market at a lower price. Davis said he would look into it.
The call ended, and Skilling felt pumped. Enron might have its foot in the door in helping put together a huge set of power contracts. Maybe the California mess could be fixed soon—and all to Enron’s advantage. After all, the contracts could be marked to market. Daily sales couldn’t.
The next day, Richard Sanders and his newly assembled team of lawyers and economists arrived in Portland, ready to hear from the Enron traders about California. The two primary lawyers working on the trading floor, Christian Yoder and Stephen Hall, joined the group.
Legally, things had worsened. The California Public Utilities Commission had served Enron with a subpoena seeking voluminous records. Sanders’s suspicions of oncoming litigation were already starting to look prescient. The team was taken to a conference room, where they met Tim Belden, the head of the trading desk, along with other traders, including John Forney, father of the Forney Perpetual Loop.
Sanders opened things up. “Just to make sure everyone is clear. We are here as representatives of the company. We are not your lawyers. We do not represent you.”
That was fine with Belden, but not Forney. He worried about his job, he said, and declined to speak with the lawyers. With Forney gone, Belden launched into a lecture about the California market. It dragged on for hours, until Belden said he was ready to discuss his traders’ specific strategies. The economists were booted out of the room; this was for lawyers only. Belden approached a whiteboard and wrote the names that his traders had given to their various ploys. Death Star. Fat Boy. Ricochet.
Sanders looked at the list with dismay. It almost didn’t matter whether the methods Enron employed in these schemes were legitimate, not with these kinds of names. Such in-your-face flamboyance would be enough to sway a jury. Topping it off, they were juvenile. Sanders couldn’t understand how someone like Belden would tolerate something so sophomoric.
Gary Fergus, another lawyer in the room, spoke up. “Why would you use names like that?” he asked.
Everybody laughed. “Yeah,” Sanders said. “Why didn’t you use names like ‘Mama’s Cooking’ or ‘Baby’s Baby’?”
As the meeting wore on, the lawyers knew they had their hands full. The strategies may have violated state anti-gouging laws, maybe even antitrust laws.
Some practices looked terrible but could probably be defended—like exporting power generated in California, where price caps were in place, and selling it out of state for more. Belden argued that the trading was just a mechanism to pull different markets into alignment. But of course, Californians plagued by brownouts and power shortages wouldn’t care much for an academic argument about why Enron was sucking electricity out of state.
Other tactics posed more than public-relations headaches. There were transactions where Enron traders had submitted false records to California or were paid for making commitments that they didn’t plan to keep.
The most egregious scam had just started. The traders discovered that if they submitted a schedule ending in a fraction—say, to sell 22.49 megawatts—they could make more money. When power flowed, California rounded the amount delivered down to 22, but at payment time it was rounded up to 23. That meant Enron was paid for a megawatt it never delivered. Multiplied by enough transactions, that could rake in serious money. So far, though, the traders had only done it twice, bringing in about fifteen thousand dollars.
Sanders was horrified. “Not only do you have to stop that, you have to send the money back immediately.”
“But if we send the money back,” one trader argued, “they’ll figure out what we did.”
Sanders stood firm. “I don’t care,” he said. “Send it back anyway.”
The next morning, Christian Yoder was at his desk. He glanced up and saw John Forney in his doorway, a troubled look on his face. “Hey,” Yoder said. “What’s up?”
Forney seemed reluctant to speak. He glanced at the floor for a moment, then looked Yoder in the eye.
“I’ve got a concern,” he said. He took a second. “Am I going to be implicated in anything serious?”
Yoder eyed him evenly. The man seemed terrified.
“I don’t know, John,” Yoder replied. “If you are, the people in the company that you need to talk to about handling it are Richard Sanders and Mark Haedicke.”
Forney glanced at the floor again, nodding. He was silent for a second. “Okay,” he finally said. “Thanks.” He turned to leave.
In Palm Beach, a crew from Florida Power & Light was at work just before 5:30 on the morning of October 6. The backhoe operator digging in the ground didn’t see that he had hit an electric cable. A second later, it sliced in two; all the power was cut to the Breakers, the oceanfront hotel where Enron’s directors and managers were mostly still sleeping, resting up for their meetings that day.
The Flagler boardroom was illuminated by candlelight. It was four hours later, and the directors from Enron’s Compensation and Management Development Committee were holding the day’s first meeting. They had awoken in near darkness. Now, they were sweating and uncomfortable, straining to read the agenda. Lay’s plans to take his directors on a fun Florida trip had been dashed.
The directors, led by Charles LeMaistre, had finished approving changes to Enron’s compensation plans when they invited Lay into the room to make a presentation. And a momentous one. He was there to announce that he was ready to start the handover of Enron to Skilling.
“Jeff has made it very clear that if we don’t make a decision about this by year’s end, then it will be time for him to seriously think about something else
,” Lay said. “I don’t believe that is an idle comment.”
Lay glanced around the table. “I think he’s ready for the job, and I am ready to step down.”
The directors made all the right noises. They were disappointed, wished Lay would stay, but could understand his desire to move on. They knew that, at his age, Skilling would not wait around much longer.
“I would like your approval,” Lay said, “to speak with the full board about this tomorrow.”
There was no formal vote, but the directors agreed.
“At this time,” Fastow said, “Enron’s management is recommending the company begin transacting with a new private-equity fund called LJM3.”
It was an hour later, and the finance committee was gathered in the Ponce de León III ballroom, listening to Fastow’s latest report. LJM1 and LJM2 had done their jobs, Fastow said, with the second fund having invested some $500 million in more than twenty transactions.
“Of course, my role in the LJM funds could create a conflict of interest,” Fastow said. “Still, we have put in place important mechanisms to mitigate those conflicts.”
Fastow listed the controls: he still maintained a fiduciary responsibility to Enron, and the board could ask him to resign at any time. “As you know,” Fastow added, “Rick Buy, Rick Causey, and Jeff Skilling approve all transactions between Enron and the LJM funds.”
Nobody seemed to notice the problem. The board had never asked for Skilling to review the LJM deals. And Skilling never had; there was a place for him to sign on the approval sheets, but it was almost invariably left blank. Still, Fastow’s statement was no slip of the tongue. He had included it in his formal report submitted to the board.
Causey and Skilling joined in on the discussion. The LJM funds had brought plenty of benefits, they said. They recommended that the transactions be allowed to continue.
One director, Norm Blake, had concerns. “There are a lot of deals here, far more than we could properly review just once a year,” he said. “I would propose that the finance committee should review these quarterly.”
Pug Winokur, the chairman, had another issue. He wondered how the board was supposed to be alert for signs of conflicts when no one knew Fastow’s compensation from LJM.
“I would propose,” Winokur said, “that the compensation committee review the amounts Andy is receiving both from the LJM funds and from the company.”
The committee unanimously agreed to the two proposals. That meant once the full board gave its nod, Fastow would be required to provide details of his dealings every three months, along with a breakdown of the money he made—from every source.
The power would not come back on, so the board changed hotels, moving down the beach to the Four Seasons. The next morning, Skilling was sitting in the lobby, waiting for his breakfast companion, when he spotted John Duncan, chairman of the executive committee, walking past some lush greenery. Duncan smiled and came over.
The two sat beside each other, chatting about their relief at staying in a hotel with the electricity still on.
Duncan changed the subject abruptly.
“Jeff, I know you’re angry about everything we’ve done on the international side,” he said. “But don’t you think with all the investments we made, we’ve really created an international company?”
Duncan looked him in the eye. “Don’t you think it was worth it?”
A dozen thoughts shot through Skilling’s mind. Duncan was talking about seven billion dollars. For that amount, Enron could have taken out ads on every Super Bowl for the next fifty years and simply announced that it was an international company. It could have sent direct mail to everyone on the planet. So much money producing so little cash, dragging down the company’s overall performance. And Duncan thought it was worth it? Skilling was speechless.
Another director walked by. “Oh, there’s my breakfast meeting,” Duncan said. “See you later, Jeff.”
Duncan walked away. Skilling had never responded.
Later that day, the full board approved Fastow’s participation in LJM3. At the meeting’s end, after Skilling and other executives had left, Lay announced his plans to step down. This wasn’t the formal handover; that would happen at the end-of-the-year meeting. Even so, some directors had not expected Lay’s announcement. They pressed him to stay on as chairman, to give Skilling time to get his footing.
Lay knew Skilling would be agreeable; whenever the topic of succession came up, Skilling made the same request. It was almost as if the man were afraid of running the show alone. Lay didn’t mind keeping the title for a while. After all, what difference could another year make?
Their own annual meeting. That, Fastow thought, was what the LJM2 investors needed. A nice one in Florida, with ample golf and spa treatments. With LJM3 in the works, it would also be the perfect time to let investors know that Enron still had important deals in the pipeline that could bring fat profits to another fund.
And Skilling could be Exhibit A. He had achieved the status of a corporate rock star. If he showed up, the investors would get the message: Enron just loved the LJM funds. Fastow dropped by Skilling’s office to sound him out on the idea.
“Hey, look,” he said. “We’re getting the LJM investors together. I’d really like you to come make a presentation, to let them know Enron is still growing.”
Skilling shrugged. No big deal. “Sure.”
Jordan Mintz arrived in the finance division on October 16 as the new general counsel—but with trepidations. He was a tax specialist, not a securities lawyer, and this new job involved a lot of securities work. That day, he met with Fastow to review his duties. After going down the list, his new boss added one more item.
“Oh,” he said, “and one of the responsibilities will be to maintain the files for LJM.”
Standing at a row of metal filing cabinets, Mintz pulled open a drawer and ran his finger across the green hanging folders. Finally, he saw the label he wanted.
LJM. There were no subcategories, just a large brown folder inside stuffed with paper. Mintz carried it to his desk and pulled out the scores of documents and printed e-mails inside. Before long, his eyes were bulging.
This is unbelievable. Deal upon deal, totaling hundreds of millions of dollars. All done with an entity controlled by the CFO. How could Enron tolerate this?
There was a lot for Mintz to learn, fast. Enron was not the kind of place where somebody struggling to master a problem would be thrown a rope. More likely an anchor. He didn’t want people to see him trying to get his arms around all this, and end up thinking he was stupid.
Mintz set his course. He would have to educate himself on everything about the LJM deals from the beginning. Review the board minutes, examine the deal documents, talk to everybody involved. Then he’d know the whole story.
It didn’t take long for Mintz to figure out that the LJM acolytes formed their own cult inside Enron. Strange doings caught his attention from the beginning. For one, Kopper was running legal meetings, discussing how Enron could avoid disclosing information about the LJM funds. Then Mintz came under pressure from Kopper and Glisan to fire a lawyer they accused of not being responsive enough during an LJM deal. And throughout the department, Mintz detected an unmistakable odor of anxiety among executives about the conflicts involving their boss that Enron tolerated.
He needed to speak with Fastow again, this time solely about the deals with LJM.
The Raptors didn’t work. After all the careful planning, all the consulting from Andersen, all the confident boasting about the finance group’s genius, the supposedly brilliant hedges were failing just weeks after their creation.
The problem was exactly what Stuart Zisman had detected: executives had used the vehicles as a dumping ground for financial toxic waste. Some investments in Raptor I collapsed in value so quickly that they couldn’t even be hedged before losses piled up. Fastow and his colleagues dealt with that easily—backdating the documents, making it appear the hedges were i
n place when values of the merchant investments were at their peak. But that immediately locked in huge losses for the Raptors.
Worse, the third Raptor was hit by a double whammy: After a week of trading, New Power’s stock price began deteriorating. Those shares, of course, were hedged by the third Raptor and were its only significant asset. So it owed Enron more money even as its capital dried up.
If something wasn’t changed, the Raptors might be deemed “impaired”—a five-dollar accounting word meaning that they couldn’t pay their debts. That would leave Enron having to report the losses from its merchant investments.
Fastow and Causey acted quickly. On October 20, they created a “costless collar,” obligating Enron to pay Raptor I for any losses it suffered if Enron shares fell below eighty-one dollars. The idea was to make sure that Raptor I would not suddenly become impaired because of a drop in Enron stock.
Raptor I had become an absurd circle. If Enron’s stock price fell below the target, the company owed Raptor I money, which Raptor I would then have to pass back to Enron to make up for the losses in merchant investments. Enron, by any definition, was hedging with itself.
Fastow made room on his calendar for Mintz on October 23. The two men, both carrying pads of paper to take notes, sat at the office conference table. Mintz asked what Fastow expected from him regarding LJM. Fastow spoke about all the paperwork to be handled—deal sheets, closing documents, and the rest. Mintz listened uncomfortably.
“Let me give you my overview of why LJM exists, and why Skilling and the board approved it,” Fastow began.
LJM could move quickly, he said, and be available for any crisis when Enron needed to sell fast. “LJM is close to the company, we understand the deals. There won’t be weeks of negotiations, with lawyers dragging everything out.”
Mintz scribbled notes, trying to hide his revulsion. What Fastow was describing was simply perverse, like justifying incest because the brother really knew the sister well.
Or was it? He thought of all those gold-plated names he had seen on LJM documents: Arthur Andersen, Vinson & Elkins. Their experience was much broader than his, and they had pronounced LJM squeaky-clean. Maybe there was something he didn’t understand.
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