Conspiracy of Fools

by Kurt Eichenwald

  Bowen called Mary Perkins, Enron’s executive in charge of cash transfers. “We’re not going to pay our bills today,” he said simply. Perkins paused. “Oh,” she said. “Okay.”

  Got to admire her composure, Bowen thought. He had no doubts that his instructions had thrown her off stride.

  In the morning, Bowen said, they were going to hear from Moody’s. If the credit agency gave the green light to the merger, then everybody would have to be paid immediately. That meant all the wires needed to be set up, ready to go.

  “Well,” Perkins said, “I can get the payments loaded into the Fed system early in the morning. Then the payment will flow when the Fed opens.”

  Fine, Bowen said. In that event, Enron would pay what it owed, plus overnight interest. Everybody would likely just assume Enron was a little more disorganized than usual.

  The answer from Moody’s came back early the next morning. It agreed to grant Enron a BBB-minus rating, the lowest ranking within the critical investment-grade level. It wasn’t great, downgrading Enron by one notch, but it would keep the company alive. Bowen immediately called Perkins.

  “It’s a go!” he said. “We’re making the payments.”

  “Thank God!” She hit the button.

  The next morning, a voice mail and an e-mail were waiting for David Duncan when he arrived in the office. They were from Nancy Temple, the Andersen lawyer working on the Enron debacle. Andersen, she told him, had finally been served by the SEC with a subpoena in the investigation. He should suspend the use of the firm’s document policy, she said.

  Duncan punched a few buttons on his phone, forwarding Temple’s message to his secretary, Shannon Adlong.

  “This is from Nancy Temple,” he said. “Make sure everyone is notified to suspend the policy.”

  Just past noon, Adlong listened to the message. She opened up an e-mail, addressing it to most of the assistants in the office. She placed the cursor in the subject heading.

  No more shredding, she typed.

  But it was too late; the crime had been committed. Hundreds of e-mails had been deleted, and thousands of pieces of paper documenting details of Andersen’s dealings with Enron were now little more than confetti.

  Late that afternoon, what seemed to be the final obstacle to the merger was cleared away. The Chevron board approved the deal. Chuck Watson called Lay to let him know.

  “It’s all set,” he said. “They signed the merger papers.” Dynegy would now invest $1.5 billion in Enron to keep it afloat and was authorized to invest $1 billion more at closing. Lay felt both relieved and deflated. His company was saved; he was losing his company.

  “Congratulations, Chuck,” he said softly, muttering a few words about how far they had come so quickly.

  Watson was eager to proclaim his victory. “We want to announce it tonight,” he said, “as soon as possible.”

  Lay sighed. “We’ll be right over.”

  The press conference that Friday night embittered Enron’s senior managers. Any hopes they had of clinging to shreds of power, or even respect, were shattered.

  Watson placed strict limits on the number of them who could attend, and Lay was given all the prominence of the janitorial staff. He was allowed to say virtually nothing and made little effort to hide his dissatisfaction. Dynegy was the victor. Enron was on its knees, vanquished by its smaller rival; the white flag had been unfurled.

  That night, the younger Enron managers went to Kenneally’s, the dimly lit Irish pub. Gloom hung in the air. These were executives who for years had delighted in deriding Dynegy as a cheap imitation of Enron. Now the upstart was running the show—and rubbing their noses in it.

  Someone tried to liven up the mood. Dave Delainey, the head of retail, hoisted a glass. “Guys, this is a reverse merger,” he thundered. “They may think they’re buying us, but give it two months, and we’ll be running the place!”

  Nearby, Ray Bowen laughed and swigged his Foster’s lager.

  “Maybe,” he said softly. “Whether this merger happens or not, time will tell.”

  Three days later, Monday, November 12, one of Andy Fastow’s last remaining financial land mines exploded.

  The shambles of the finance division’s records made it almost impossible for the new team to find every detail—in particular, the triggers embedded in structured deals. To get better pricing for the deals, Fastow had agreed to terms allowing banks and investors to demand money or stock from Enron if its share price fell to certain levels or its credit rating dropped—usually below investment grade.

  But not always. There was one deal where the critical trigger had been placed at BBB-minus, one notch above junk. The rating just bestowed on Enron by Moody’s.

  The first person at the company to learn about it was Bowen, in a call from Bill Fox, a banker from Citibank.

  “Hey, Ray,” Fox said, “now that you guys are BBB-minus, I seem to remember that Rawhide had a trigger event at that level.”

  Rawhide. Bowen knew it was one of the finance group’s off-books entities, used to raise more than half a billion dollars a few years back. He didn’t know anything about the terms, but he couldn’t imagine this was true. What idiot would put an investment-grade trigger in a finance deal?

  “Why don’t you guys go check it and see if we’ve got an issue here?” Fox asked.

  Bowen got off the phone and called someone in finance. “Hey, can one of you guys go look at the Rawhide documents, ’cause Bill Fox is telling me we’ve hit a ratings trigger.”

  The answer came back soon. Fox was right. And the trigger was a doozy. Enron owed all the money it had borrowed through Rawhide. Some $690 million, due fifteen days after the trigger was hit. And until Fox called, no one at Enron knew the repayment clock was already ticking.

  “That can’t be right,” McMahon protested, throwing up his hands. “That’s just insane!”

  Bowen was standing in front of McMahon, having just broken the news of the Rawhide trigger. “It’s right,” he said simply.

  “Ray, we’ve never done deals where we allow for debt acceleration in the investment-grade category!” he shot back. “Why would someone do that?” Bowen shrugged. “I have no idea. But we’ve checked it. That’s what they did.”

  McMahon put a hand over his face. This was too much.

  In Washington, a mealtime crowd filled Il Radicchio, an Italian restaurant near Capitol Hill. A waitress made her way through the mass of people, placing an iced tea in front of David Cavicke, a staff member on the House Energy and Commerce Subcommittee on Oversight and Investigations. At the other side of the two-person table sat Mark Paoletta, chief counsel and a top investigator for the subcommittee.

  For days, Cavicke had been lobbying Paoletta to go all-out on Enron. The subcommittee investigated issues relating to business and energy, with a bent toward potential wrongdoing. By that standard, Enron seemed to hit the trifecta. Cavicke, who spent years working on Wall Street, had been telling Paoletta that the Enron affair seemed huge. So today Paoletta had taken Cavicke out to lunch, giving him the time to make his case.

  “What happened at Enron is amazing,” Cavicke said, his voice animated. “It is just the most massive fraud!”

  Cavicke had been reviewing the documents, particularly the recently filed 8-K. He spelled out everything he had learned from the records. More important, he said, this pointed up fundamental issues relating to the reliability of company financial reports. It was exactly the kind of thing the subcommittee should be jumping on.

  For about an hour, Cavicke walked through the details of what happened at Enron. By the time Paoletta’s chicken sandwich arrived, he had pretty much made up his mind. This was something he needed to raise with Jim Greenwood, the congressman who chaired the subcommittee.

  Enron employees had been blocked from making changes in their retirement plans for ten workdays. But too much was happening; it was, executives decided, a terrible time to prevent the workers of Enron from being able to make decisions
about their investments, particularly since the vast majority of them held huge stakes in the company’s stock.

  So on November 12, the lockout was ended. Employees could go in and buy and sell whatever shares they felt necessary. In the ten days of trading they had missed, the stock had dropped to $9.98 a share, a decline of $3.83. In some ways, that worked to their advantage: the stock price now was higher than it had been on five of those days. Anyone who wanted to sell could make more money than was possible during half of the lockup period.

  But the end of the restrictions did not bring on a flood of selling. Instead, Enron employees, apparently believing this was a great opportunity to snap up cheap shares, became net buyers of the stock.

  Chuck Watson was on the road, busy selling investors on the Dynegy-Enron merger. No one had told him about the Rawhide debacle unfolding back in Houston. But then again, no one at Dynegy would know about it for days.

  Instead, Enron and Dynegy spent the days haggling over less weighty issues: the number of Enron executives allowed to accompany Watson on the road show; whether Dynegy executives could use Enron planes; whether an Enron executive could be flown to a session on a Dynegy plane.

  The bickering was already souring the relationship. Watson had wanted to come by Enron, to visit his new employees. Lay and Whalley refused; such a visit, they argued, would be demoralizing and should be delayed until they could hold their own meeting. Instead, Watson shot a video, welcoming Enron to the Dynegy family.

  No one at Enron watched it.

  Somehow, word got out, all over the Internet and the radio. Ken Lay stood to make sixty-one million dollars in severance if the Dynegy deal went through. Among Enron’s traders, the response was outrage. Why, they argued, should Lay walk away from this debacle with so much cash?

  Two executives, John Lavorato and Louise Kitchen, stormed up to Lay’s office after hearing the news. Lay was sitting at his desk when they arrived.

  “Ken, you can’t take sixty million dollars out of the company,” Lavorato said. “The place will go nuts.”

  Lay was taken aback. “I’ve got that contractual right, but it’s not built into the merger agreement,” he said.

  He’d already discussed reducing the payout with Chuck Watson, he said, but certainly he was owed something.

  “That won’t do it, Ken,” Kitchen said.

  “If you take anything at all, there’s going to be a riot on the trading floor,” Lavorato interjected.

  Lay considered that. “Okay, okay, I hear you,” he said. “Do you mind if I speak to my wife first?”

  After calling to make sure Linda was there, Lay drove home to speak with her. He described the reaction among the traders. The prospect of forgoing the money her husband was due did not please her.

  “We’ve already lost so much money,” she said. “We’re struggling to find what we can to pay off debt and pay taxes and keep us out of bankruptcy.”

  Hundreds of millions of dollars of their wealth had vanished in the stock-price collapse, but Lay thought he had little choice. “I know I have a legal right to this money. But I think I need to walk away from it.”

  Tears welled up in Linda’s eyes. But she agreed.

  In Enron’s trading room, the market was evaporating. Despite the announced Dynegy merger, competitors still worried Enron might disappear without having paid its obligations under new trades. Every transaction with Enron was an act of faith they were no longer willing to take.

  John Lavorato was furious. Even Dynegy, the only company selling physical gas with Enron, was refusing to make trades extending beyond one year. Lavorato got on the phone with Matt Schatzman, the head of Dynegy’s trading operation.

  “You’re not helping us,” Lavorato grumbled.

  “Our credit exposure to Enron is high, and if the merger falls apart, we’re on the hook,” Schatzman said. “We owe a duty to our shareholders. I’ve told our brokers not to treat you guys with any favoritism.”

  Lavorato exploded. “What about the merger agreement?”

  Schatzman’s tone could not have been calmer. “I don’t care,” he said. “This is business.”

  There was a solution, the Enron traders decided.

  If other companies were afraid Enron couldn’t pay, why not pay up front? That would keep the business going. All the traders had to do was post cash collateral, essentially turning hard currency over to their trading partners as a partial—or in some cases total—guarantee of payment.

  After years of disregard, Enron still lacked meaningful controls over division spending or the means to track cash. Now money had arrived from Dynegy, piles of it, ready to help Enron traders prove that they were still in business. They grabbed it by the fistful, thrusting it into the outstretched hands of their trading partners.

  Hundreds of millions of dollars were disappearing on a daily basis. And, as the cash drain picked up speed, none of the top executives at either company had a clue that it was happening.

  “You need to call Dynegy,” Bowen told McMahon. “We’ve got this Rawhide default to deal with.”

  It was later that same week, and Dynegy had still not been notified of the Rawhide trigger. Bowen figured the problem could be averted; if the bank called in the cash, Enron could implode. Surely a solution could be negotiated.

  But McMahon was swamped and simply hadn’t gotten around to giving Dynegy the heads-up. Still, he promised Bowen that he would make the call to Enron’s new merger partner. Very soon.

  In Chicago, the mood in the board meeting at Andersen was grim. The firm’s lawyers had briefed the directors about the deepening crisis at Enron, then talk had turned to the threat from an onslaught of litigation. Joe Berardino did his best to assure everyone that Andersen was on top of everything. There was no reason for fear.

  “We’ve got our top legal counsel on it, our top risk managers all over it,” he told the board. “We’ve got all the processes in place now to manage this risk.”

  Still, there was no doubting the consequences, he said. “We’re going to lose business over this,” he said. “It is just too big. But we can’t panic.”

  He looked at the worried faces around him. “We just have to live our values. Then we can get through this.”

  ———

  On Friday, November 16, Lay relaxed in his Galveston home, reading a draft of Enron’s upcoming quarterly report, known as a 10-Q. Despite Causey’s earlier misgivings, Enron had managed to pull everything together in time to meet an extended deadline. It was all set to be filed on Monday.

  There were plenty of new details in the document, some pretty horrifying. There was information about Enron’s rating setting offa trigger, putting it on the hook for almost $700 million. And details of how the cash position was worsening. This was sure to bother the folks at Dynegy. Well, by now, Lay assumed, somebody at Enron had forwarded it to Watson or one of his top executives. Dynegy, he thought, would have plenty of time to absorb the news.

  He was wrong.

  The next day, Saturday, a full contingent from the finance staff was in the office. There was much work to be done, with the quarterly financial filing due and a meeting scheduled between Enron and its banks.

  Mark Muller mentioned Rawhide to McMahon, saying that Rob Doty, Dynegy’s CFO, needed to be told about the default.

  “You need to call,” Muller said. “It’s going to be a headline issue in the 10-Q.”

  McMahon nodded. “Yeah, you’re right. I’ve got to do that, I guess. I’ll go give him a call right now.”

  He wandered into an office and picked up the phone. Doty wasn’t in on Saturday; the voice-mail system picked up.

  “Hey, Rob, Jeff McMahon,” he began. “Listen, Enron made a mistake.” The Rawhide financing, he said, had a trigger at BBB-minus, not at a junk rating like the rest of Enron’s deals. The company was now technically in default on Rawhide, and debt repayment had been accelerated.

  “It will all be disclosed in the 10-Q we’re filing Monday,” Mc
Mahon said in the recording.

  Rob Doty was beside himself. He had arrived at the office early Monday and heard McMahon’s bombshell. Now he was trying desperately to get Enron’s quarterly report. It was about to be filed with the public, and Dynegy, which had just sunk a billion and a half dollars into Enron, still hadn’t seen the damn thing.

  Doty got on the line with the finance group. “Look, I don’t care if you don’t have a final version,” he snapped. “At least send me the draft copy!”

  It arrived by e-mail at 10:53 that morning. The teams at Dynegy set to work reviewing the pages. Then, in the afternoon, Enron filed its final version with the SEC. Dynegy received its copy at about the same time every investor in the country had access to it.

  Doty was flipping through the latest document, when he stopped short. “Wait a minute,” he told his colleagues. “There are pages here that weren’t in the earlier draft.”

  More than $1.5 billion! Gone!

  Doty and his team hit the roof. The filing was loaded with information that Dynegy knew nothing about. The money it had recently injected into Enron had disappeared, just like that. But where had it gone? Doty had no way of knowing that Enron’s traders had gotten hold of it and were tossing it out the door to stay in the market.

  The business was falling apart, too. Trading activity was dropping, and fourth-quarter results were expected to be a train wreck. The European trading profits were all but wiped out. Then there was the debt-maturity schedule. Doty had believed Enron would have at most $800 million of debt to repay by year-end, but that had grown by two billion dollars. What was going on? How had Enron not known this earlier? Had this company not had a debt-maturity schedule prepared long ago?

  On top of it all, Enron had just announced that, technically, it was insolvent. It had $2.8 billion in almost immediate obligations, and only $1.2 billion in cash. Why would anyone have faith in a company in that position?

  Doty rushed out of the room. He needed to find Chuck Watson. It was very possible that, even with the tight restrictions that kept Dynegy from walking away from the merger, Enron may well have just met all of the requirements.