The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron

by Bethany McLean

  CHAPTER 10

  The Hotel Kenneth-Lay-a

  Reported earnings follow the rules and principles of accounting. The results do not always create measures consistent with underlying economics. However, corporate management’s performance is generally measured by accounting income, not underlying economics. Therefore, risk management strategies are directed at accounting, rather than economic, performance.

  —Enron in-house risk-management manual

  When, exactly, did Enron cross the line? Even now, after all the congressional hearings, all the investigative journalism, all the reports, lawsuits, and indictments, that’s an impossible question to answer. There have been accounting frauds over the years where companies created receivables out of whole cloth or shipped bricks at the end of a quarter instead of products. In such cases, someone at a company has to consciously consider the fact that he or she is about to commit a crime—and then commit it.

  But for the most part, the Enron scandal wasn’t like that. The Enron scandal grew out of a steady accumulation of habits and values and actions that began years before and finally spiraled out of control. When Enron expanded the use of mark-to-market accounting to all sorts of transactions—was that when it first crossed the line? How about when it set up its first off-balance-sheet partnerships, Cactus and JEDI, with such reputable investors as General Electric and CalPERS? Or when it categorized certain unusual gains as recurring? Or when it created EPP, that “independent” company to which Enron sold stakes in its international assets and posted the resulting gains to its bottom line?

  In each case, you could argue that the effect of the move was to disguise, to one degree or another, Enron’s underlying economics. But you could also argue that they were perfectly legal, even above board. Didn’t all the big trading companies on Wall Street use mark-to-market accounting? Weren’t lots of companies moving debt off the balance sheet? Didn’t many companies lump onetime gains into recurring earnings? The answer, of course, was yes. Throughout the bull market of the 1990s, moves like these were so commonplace they were taken for granted, becoming part of the air Wall Street breathed.

  Besides, the big Wall Street investment banks, not to mention the nation’s giant accounting firms, had a huge vested interest in the kinds of moves Enron was making to create accounting income. Even before the dawning of the 1990s bull market, a new ethos was gradually taking hold in corporate America, according to which anything that wasn’t blatantly illegal was therefore okay—no matter how deceptive the practice might be. Creative accountants found clever ways around accounting rules and were rewarded for doing so. Investment bankers invented complex financial structures that they then sold to eager companies, all searching for ways to make their numbers look better. By the end of the decade, things that had once seemed shockingly deceptive, such as securities that looked like equity on the balance sheet but for tax purposes could be treated as debt, now seemed perfectly fine. Securitizations exploded, with everything from lotto winnings to proceeds from tobacco lawsuits being turned into securities that could be sold to the investing public.

  In the wake of Enron’s collapse, the mood changed virtually overnight, and creative became a very bad word, synonymous with deceptive. But it’s impor-

  tant to remember that it wasn’t always that way. That statement in Enron’s risk-management manual perfectly captured the sentiment of the times. In fact, the material in the manual, developed with the help of a consulting firm, was used throughout the energy-trading industry.

  Of course it wasn’t only the times that caused Enron to get ever more creative. It was also necessity. A company like General Electric might employ a little financial ingenuity to hit its earnings target on the nose quarter after quarter (as, indeed, it did), but even without such strategies, GE had a hugely profitable business. That wasn’t true of Enron. Especially in the latter part of the 1990s, Enron didn’t have anywhere near enough cash coming in the door. Eventually, the whole thing took on a life of its own, with an insane logic that no one at the company dared contemplate: to a staggering degree, Enron’s “profits” and “cash flow” were the result of the company’s own complex dealings with itself. At which point, of course, there could hardly be any doubt: Enron had most certainly crossed the line.

  But if it’s impossible to mark the moment Enron crossed the line, it’s not hard at all to know who led the way. That was Andrew Fastow, the company’s chief financial officer. He was 28 years old when he first joined Enron in late 1990, hired as one of Skilling’s early finance guys at ECT. Skilling wanted him precisely because he knew how to set up complicated financial structures, specifically securitizations. Fastow became Enron’s Wizard of Oz, creating a giant illusion of steady and increasing prosperity. Fastow and his team were the financial masterminds, helping Enron bridge the gap between the reality of its business and the picture Skilling and Lay wanted to present to the world. He and his group created off-balance-sheet vehicles, complex financing structures, and deals so bewildering that few people can understand them even now. Fastow’s fiefdom, called Global Finance, was, as Churchill said about the Soviet Union, a riddle wrapped in a mystery inside an enigma that was Enron’s string of successively higher earnings. “Andy was a master at walking in, always at the end of the quarter or the end of the year,” says Amanda Martin. “The fat was in the fire and about to ignite. He’d say, ‘give me the ball,’ and he’d come through every time. That’s why Jeff and Ken loved him.” Like everyone at Enron, Fastow was handsomely rewarded for this work. But for him it wasn’t enough. So over time Fastow found other ways to pay himself. Some of these ways his superiors knew about. Others they didn’t know about—but should have.

  • • •

  Andrew Fastow grew up in New Providence, New Jersey, a suburb about 25 miles from New York City. His father, Carl, was a buyer for drug-store and supermarket chains; his mother Joan worked as a real-estate broker once the children were grown. The second of three sons, Fastow was a huge Star Wars fan and played tennis and trombone; he was well liked enough to be elected student council president his senior year of high school.

  Even as a high school student, Fastow burned with ambition. It was an odd kind of ambition, though: not necessarily to be the best but to be seen as the best. A high school English teacher later described him as a “wheeler dealer” because he would try to negotiate better grades. He was also part of a group that lobbied the New Jersey Board of Education to have a student named to the board. Fastow was that student. (After graduation, he came to one board meeting smoking a pipe.)

  Fastow seems to have never had a moment’s doubt that he was destined for business, specifically for finance. At Tufts, where he went to college, Fastow majored in economics and Chinese—the latter because he thought it would aid his business career—and graduated summa cum laude in December 1984. Tufts is where Fastow met his wife, Lea Weingarten. She was a sophomore and had come a week early to serve as a host adviser for the incoming freshman, one of whom was Fastow. Upon sighting him, she confided to a friend, “God, I think he’s cute, but he’s only a freshman. Should I date him?” The two soon started dating.

  Weingarten is a name many Texans know instantly. For decades, the Weingartens have been one of Houston’s wealthiest and most prominent families. Lea’s great-grandfather founded a supermarket chain that dominated southeast Texas; though the family sold the business to Grand Union in 1980, an offshoot, the publicly traded Weingarten Realty Investors, owns shopping centers throughout the Southwest. (Jack Weingarten, Lea’s father, worked for the chain but never ran it.)

  Despite her wealth—or, perhaps, because of it—Lea Weingarten had a far more difficult childhood than her future husband. Her mother, Miriam Hadar, whom Jack married in 1961, was a beauty queen who had been named Miss Israel and was a semifinalist in the 1958 Miss Universe contest. In 1968, when Lea was six years old, her parents’ marriage disintegrated, and they became enmeshed in an ugly divorce that consumed the better part
of three years. Miriam accused Jack of being physically and verbally abusive, dependent on drugs and alcohol, and “unstable emotionally”; Jack countered that Miriam missed the “glitter and high living” of her previous life and was guilty of “misconduct with other men during her entire marriage.” The divorce was granted in late 1970, with Jack Weingarten getting custody of Lea and her brother, Michael. The judge said that the children should grow up in Houston, a city “in which their name is associated with the finest of Jewish example and tradition.” Miriam moved back to Israel.

  In high school, Lea Weingarten was a sensitive and insecure girl who struggled with her weight. In college, she was still heavy but dressed well and appeared to be upbeat and happy. As she got older, she slimmed down and became a woman whom friends describe as “unpretentious” and “gracious.”

  Just three months after graduating from college, Andy Fastow married Lea Weingarten in a low-key Houston ceremony. (Years later, the two renewed their vows at the Elvis Wedding Chapel in Las Vegas.) The newlyweds then headed to Chicago, where both were enrolled in the training program at Continental Bank, a midlevel commercial bank that was just emerging from one of the biggest business scandals of the 1980s, the so-called Penn Square scandal. (It revolved around bad loans made to the oil patch during the oil boom of the early 1980s.) Rather than work a few years then take a few years to go to business school—the normal route to an MBA—the two accelerated the process. They both earned MBAs at Northwestern’s Kellogg Graduate School of Business, which they attended at night, after work.

  Fastow was instantly unpopular with his peers at Continental. He came off as arrogant, ambitious, and more than a bit of a dandy, wearing Hermès ties and Gucci shoes. Had he worked at a New York investment bank, none of these traits would have been remarkable, but at a quiet, Midwestern commercial bank like Continental, Fastow stood out. “He invoked a lot of jealousy because he was clearly on the make, almost nakedly so,” says a former boss, who also thinks there was another element to the dislike: “Both Andy and Lea were smart and gorgeous.”

  In early 1987, Fastow took a short, unsuccessful detour. He left Continental for a small, publicly traded company called CCC Information Services, which maintained a computerized database to help insurance companies set a value on cars that had been stolen or involved in accidents. Founded in 1980, CCC had almost 300 employees by the time Fastow joined and was growing like mad. “CCC couldn’t hire people fast enough in those days,” recalls one former employee. Around the time Fastow joined the company, the stock hit a high of almost $15 per share.

  That August, CCC cut a deal to sell itself for almost $100 million. But the deal fell through, and by late 1987, the stock had dropped to $6 a share. The following January, the company was sold to another bidder, a privately held company, for roughly $80 million, and Fastow beat a hasty retreat back to Continental. Although he’d been at CCC for less than a year, he claimed on his résumé that he had “launched and managed an automotive industry database management company. First year operating profit of $1 million on revenues of $7 million,” which would have represented a significant amount of CCC’s profits and revenues during that time period. Yet CCC’s financial documents don’t even mention Fastow’s operation, and former senior officials say there was nothing remarkable about his brief tenure there.

  It was during his second go-round at Continental that Fastow found his calling. Rehired as a loan officer, he sat across the credenza from a small team of executives who were doing pioneering work in securitization. He immediately gravitated to that team and maneuvered to become its newest member. He was like a “pig in shit,” recalls one of his former bosses.

  This same man claims that Fastow was “incredibly talented” at securitization, but that is hardly a unanimous view. “He was a good average performer, but you weren’t held in awe of his intellect,” says another former Continental executive. “You didn’t marvel every day at what smart things he came up with.”

  What is certainly true was that Fastow loved being on the cutting edge of finance and reveled in the work. In the late 1980s, securitization was just getting started and Continental was doing deals the likes of which no one had ever seen before. A deal led by a Continental banker named Michael Woodhead was named one of Institutional Investor magazine’s “Deals of the Year” for 1989. Woodhead had figured out a way to bundle the outstanding debt from leveraged buyouts and sell a fresh security backed by the interest on those bonds. This, in turn, freed up capital for the banks involved in the LBO game to make new loans. The deal was known as FRENDS.

  What people noticed about Fastow, even then, was how willing he was to push the limits. Because securitization is so complex and so ripe for abuse in the wrong hands, hundreds upon hundreds of pages of rules were being written to mandate what was allowed and what was not. Fastow, says one of his former bosses, “was rules-driven from day one.” By that, he meant that the future Enron CFO took it upon himself to figure out if he could accomplish his goals while following the precise letter of the rules, even if it meant violating their intent. “Andy was really into just pushing the parameters of the possible,” this person says. “I don’t know that he ever had a moral compass.” While at Continental, Fastow never crossed the line, but that was largely because his superiors were far more risk-averse than he and turned down his ideas if they thought he went too far. To this former boss, it was easy enough to see how things could have gotten out of hand at Enron: “You put Andy in an environment where he is on the same side as his manager, with the same objectives, it’s a Molotov cocktail.”

  On his resume, Fastow bragged about FRENDS and took full credit for himself. (“Created and sold first security backed solely by senior LBO bank debt. . . . Sourced assets from ten banks and placed securities with investors in 23 countries. . . . Directly responsible for pretax profit contribution of $12.8 million.”) But this, too, was an exaggeration. “Andy was the number two guy in a two-man group, but it was not his idea and he was the follower not the leader,” says a former Continental hand.

  Meanwhile, over at Enron, Jeff Skilling, newly hired to get the Gas Bank up and running, decided he needed a finance executive who knew something about securitization. Skilling, after all, wanted to free up capital so he could do more natural-gas deals, and he thought that securitization was one way to do that. An executive search firm found Fastow, who was more than ready to leave the bank for Enron. At Continental, promotions and pay raises were slow in coming, bonuses were small, and a young executive on the make had to be willing to spend long years in the trenches. Not yet 30 years old, Fastow was already getting impatient. Besides, Houston was his wife’s hometown.

  Skilling was dazzled by Fastow’s résumé, never for a moment questioning whether any of it was exaggerated. Fastow’s experience “launching and managing” a business at CCC meant that the young finance whiz had an “entrepreneurial bent,” Skilling concluded. His work “creating and selling” FRENDS meant that he could come up with new ideas to free up capital. And he had other attributes, too. For instance, Fastow claimed on his résumé that at Continental he was responsible for “continuing education of commercial bank lending and portfolio officers regarding accounting and risk adjustment implication of asset securitization.” “I just went agog,” Skilling later said. “He was perfect. Absolutely perfect.”

  Gene Humphrey, who was then Skilling’s finance head, was less certain. He was actually more impressed with Lea Fastow, whom Enron brought into the company’s treasury department. (Indeed, many people at Enron thought she was the smarter of the two.) Still, this was 1990 and Enron was still a pipeline company; star corporate finance prospects weren’t exactly rushing to apply for the position. In November, Skilling offered Fastow the job, and he took it. His title was manager, his starting salary was $75,000, up from the $68,000 he’d made at Continental, and his signing bonus was $20,000. He was also guaranteed a bonus of at least $25,000 in the following year. He began work on December 3, 1990
.

  Early on, one of the gas-bank executives took Fastow to meet a crusty Oklahoma oil producer. It was instantly clear that Enron’s new finance guy was out of his element. The oilman had a wad of chewing tobacco the size of a baseball in his cheek and periodically interrupted the conversation to spit a stream of brown juice into a tin can, leaving Fastow in a state of shock.

  For the most part Fastow didn’t stand out in his first few years at Enron—certainly, not many people would have guessed that he would one day ascend to become the CFO of a Fortune 500 company. “I thought he was a strange little guy . . . he didn’t talk much, but he came up with creative structures,” says one executive. “He might not have been the brightest guy in the world, but he was very, very hardworking,” says another. Not long after he arrived, one executive assistant says, he skipped a vacation cruise the Weingarten family had planned to the Galápagos Islands because he was too busy with work. Fastow was also a big practical joker who would throw slimeball goo against glass walls as a joke and kept Frisbees and other toys all over his office.

  ECT was small in those days, and Fastow rose rapidly. He worked on the first Cactus deal, was the leader in developing the JEDI partnership, and helped devise the EPP strategy. In 1992, Gene Humphrey wrote in a performance review that “Andy is and is continuing to develop into one of the strongest financial innovators that I have worked with. He has a strong and solid future at Enron.” (Humphrey noted, however, that Fastow needed improvement in the “personal relationship skills useful in the heat of negotiation. Sometimes a kind word is more useful than a blunt assertion.”) By mid-1993, Fastow was a vice president, and his performance reviews were increasingly positive. In 1994, Fastow received raves for his “creativity, vision, persistence, initiative, presentation skills” and his “innovative thinking on new deal structures.” He was told, though, that he needed to develop “strong lasting relationships” with capital providers such as banks and insurance companies and to “negotiate with a win/win attitude.” By late 1995, Fastow had become a managing director, with a salary that topped $225,000.