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

by Bethany McLean

  One wonders now whether Fastow recognized that he was creating an illusion, especially as the pressure increased, and the sums became larger, and the chicanery required to pull it all off grew more brazen. For the most part, Fastow seemed to exhibit great pride in the work he was doing—he even bragged about some of Enron’s more clever structures. But every once in a while, he would show that he could glimpse a more terrifying reality. Once, a banker asked him what would happen to Enron if the deal flow ever stopped.

  “It implodes,” Fastow responded.

  • • •

  Fastow’s role made him the kind of figure he’d always wanted to be at Enron: truly indispensable. He had never stopped seething over the fact that people in finance weren’t considered as important at Enron as the deal makers or the traders, and part of his motivation was to change that perception. Thus, within months of taking on the CFO role, he tripled the finance staff to over 100 and, as he later boasted, “transformed finance” into an internal capital-raising machine. He set up the group to resemble nothing so much as an investment bank, up to and including selling its services to other parts of the company. (In fact, Enron even set up a small group that tried to capture underwriting fees on the company’s own deals.) One in-house presentation laid out all the things that Global Finance could do for Enron’s divisions. The aim, the presentation declared, was “to craft solutions to help business units achieve their goals. . . . Common business unit goals include earnings, fund flows . . . balance sheet management, return on invested capital.” Later, after explaining the various vehicles Global Finance had at its disposal to “craft solutions,” the presentation added, “There is no obligation to use these vehicles. They are one option for achieving business unit goals.” But of course almost every part of Enron used them, even the divisions run by executives who detested Fastow.

  Like its leader, the top executives in Global Finance all had chips on their shoulders. Their attitude, says a former finance executive, was that “we’re working really hard to fix the mistakes the rest of the company is making.” They worked terrible hours. To anyone who crossed them, they could be verbally abusive: one person described theirs as a “bully culture.” The finance executives resented having to clean up behind the deal makers who dug the holes and resented even more, as one employee put it, “that the people who dug the holes walked off with the loot.” Because they were the ones who saved the company every quarter, they saw themselves as heroes. As an in-house lawyer named Kristina Mordaunt, who worked for a period in Global Finance, later told investigators: “Everyone was applauding the finance team for its efforts. Enron was hiring smart investment bankers, creating new structures, and getting the market used to them. . . .”

  One of the few high-ranking Enron executives who ever expressed concern about Fastow was Cliff Baxter, though he, too, found times when he had to rely on Global Finance. He’d often complained to Skilling that Fastow was a little too clever. Baxter used to say that it was always worth paying a little more to ensure that a deal was clean. With Fastow, he’d add, you could never tell whether deals were clean because they were so complicated.

  Even with his new higher profile, Fastow remained a shadowy figure to the rank and file. He didn’t seem to care whether people outside his own small circle liked him. He spent most of his time with members of his own group and with the bankers and investment bankers who aided and abetted the Global Finance team. Under his leadership, Global Finance was tight-knit, secretive, and seemingly untouchable. Soon after taking over corporate finance, Fastow began freezing out Bill Gathmann, the corporate treasurer, by holding meetings without him. (Gathmann was soon replaced by an executive named Jeff McMahon.) And while the Global Finance staff could sit in on meetings taking place in other parts of Enron, outsiders were not allowed to attend Global Finance meetings. Just as Skilling had gathered loyalists around him, so did Fastow.

  The most important Fastow disciples were a pair of executives named Michael Kopper and Ben Glisan. Kopper, who was three years younger than Fastow, arrived at Enron in 1994. A Long Island native, he went to Duke and the London School of Economics and was working in structured finance for Toronto Dominion bank when Enron came calling. He was 29 when he joined the company.

  Kopper wasn’t the person from Toronto Dominion whom Enron wanted to hire. Enron had been recruiting Kopper’s boss, a more senior banker named Kathy Lynn; she brought him with her into the company. (Although Kopper joined at a fairly junior level, he still got a signing bonus of $20,000 and a salary of about $85,000 a year.) But Kopper quickly leapfrogged Lynn, becoming fast friends with both Fastow and his wife, Lea. In an early performance review, Rick Causey noted that Kopper was a “valuable asset to Enron” and good at “keeping the banks focused on Enron’s goals”; he ranked him in the top 10 percent. Later reviews add that Kopper “conveys a win-win attitude.” (Perhaps as testimony to how worthless the reviews could be, Kopper’s reviews also claim that his “deals are structured so that they are always clear . . . no unnecessary complexity,” that “risks are clearly identified,” and that Kopper “sacrifices personal good for others and the team.”) The only critical comment: “customers sometimes think you negotiate too hard.” Of course at Enron, that wasn’t necessarily a bad thing. In 1996, Kopper signed a new employment agreement, giving him a salary of $135,000, a signing bonus of $100,000, and guaranteed bonuses of $100,000 for each of the next two years. By 1997, Kopper headed Fastow’s special projects group.

  Kopper was gay, and over the years, he became more open within the company about his sexuality. Fastow could not have cared less; his reaction upon learning that Kopper was gay was “So what?” Kopper and his partner Bill Dodson, who worked in finance at Continental Airlines, lived in a starkly contemporary house that featured a glass staircase. The two traveled widely, and within Enron, Kopper was known as a jet-setter and a fashion hound who favored Prada suits. Although Kopper made over $1 million in cash salary and bonus in 2000—and had millions in Enron stock—those who know him could see how it wouldn’t be enough. “Given the opportunity to make money, he wouldn’t spend much time thinking about it,” says a former executive.

  Within Enron, Kopper was even less well known than Fastow. After Enron’s bankruptcy, Ken Lay said he didn’t even know who Kopper was. Some of those who did know him, though, disliked him intensely. He was temperamental and difficult to work with—and in doing his boss’s bidding, he amplified Fastow’s flaws. “He would wind Andy up, tell tales, and make it worse,” says one former executive. “People wouldn’t cross him because they knew there would be an explosion from Andy.” People who knew them both also considered Kopper smarter than Fastow; some view Kopper, not Fastow, as the brains behind the most complicated of Enron’s off-balance-sheet vehicles. Says one former executive: “Kopper would make the bullets, and Fastow would fire them.”

  The other Fastow disciple, Glisan, joined Enron as a 30-year-old accountant in late 1996. Like Kopper, Glisan also shot through the ranks. But to insiders, Glisan didn’t seem anything like Kopper or Fastow—at least at first. When he joined Enron, he wasn’t arrogant or hot-tempered, and he got along with just about everybody. A native Texan who grew up in a blue-collar neighborhood outside of Houston, Glisan seemed thrilled to have made it as far as he had—at one point, Kopper described him as a “workhorse carrying one of the heaviest loads in the group.” He struck many people as a Boy Scout who wasn’t capable of imagining a dishonest deed, much less carrying one out.

  Glisan came to Enron the same way so many others did, through Arthur Andersen’s Houston office. He attended the University of Texas, where he majored in finance, graduating in 1988. After working as a lending officer at Bank One in Austin, he went back to UT for his MBA, where he earned a 4.0 grade point average. He then joined Coopers & Lybrand in Dallas as one of two MBAs hired into a pilot management development program to provide “audit and consulting services on high-risk engagements” (a small irony). In January 1995, Gli
san accepted a position in Arthur Andersen’s Houston office, where he worked mainly on ECT. He stayed for only a year and half, at a salary of $66,000, before being recruited to Enron, where his salary increased to just over $100,000. (He also got a signing bonus of $15,000 and, of course, the promise of lots of options.)

  Glisan was a highly skilled accountant who understood all of the nuances of his craft. “He was very clued up about accounting,” says another Enron accountant. “He knew exactly what to say to bankers and accountants to appease any concerns they might have.” In a 1999 review, Kopper wrote that Glisan knew “exactly when and how to make trades and negotiate a deal.” (He also wrote that Glisan was “always working to create solutions with Enron’s best interests in mind.”) One person who worked closely with Glisan saw something else. If he saw something unethical, says this executive, “Ben was not mature enough to make a noise and stop it.” Another former executive puts it this way: “He wasn’t willing to be his own guy.” Over time, Glisan’s affability slowly morphed into the swaggering arrogance that characterized so many Enron executives. “It was painful when he didn’t get his way,” says an ex-colleague. “He would browbeat people.”

  Like many Enron executives, Fastow used the semiannual Performance Review Committee to push his people ahead and buy their loyalty. Though the original purpose of the PRC had become largely perverted, most executives at least went through the motions. Fastow didn’t bother. “People were expected to cite anecdotal evidence and provide rational backup,” says one former senior executive. “Andy didn’t do that. He just dug his heels in.” Skilling was the only one who could get Fastow to back off, but if he didn’t rein Fastow in, the group would often just cave and give Fastow’s people the top ranking so they could move on and go home.

  The public high point for Fastow came in 1999, when CFO Magazine gave him a CFO Excellence Award, an honor he’d actively campaigned for. “Our story is one of a kind,” Fastow told the magazine. He explained that Enron couldn’t dilute its shareholders by issuing equity, and couldn’t jeopardize its credit rating by issuing debt. He went on to describe how Enron issued off-

  balance-sheet debt, backing it up with Enron stock. This was the tactic that later triggered Enron’s final crisis. But in 1999, with Enron’s stock on the rise, its credit-rating intact, and its earnings headed ever upward, there wasn’t so much as a whisper of doubt or complaint. On the contrary. “He has invented a groundbreaking strategy,” said a Lehman Brothers banker quoted approvingly in the story. An analyst at one of the credit-rating agencies touted Fastow’s ability to “think outside the box.” And Skilling took the opportunity to publicly celebrate his protégé. “We needed someone to rethink the entire financing structure at Enron. . . . [Fastow] deserves every accolade tossed his way.”

  • • •

  There are several different ways to think about Andy Fastow’s deals. One is in terms of what was disclosed. Contrary to popular belief, many of the entities Enron created to play its financial games were not only revealed in the company’s publicly filed financial documents but were things Fastow was only too happy to boast about. Wall Street analysts often mentioned the company’s “innovative” financing tools in their reports. Credit-rating agencies knew about much of Enron’s off-balance-sheet debt. But there were other deals in which the circle of outsiders in the know was small—and the disclosure in Enron’s financial documents was purposely vague—because Enron knew that real disclosure would raise too many questions. And finally, there were deep, dark secrets that no one knew about except Fastow and his closest associates, including Kopper and Glisan.

  A second way to think about the deals is in terms of their purpose. All the structured-finance deals Fastow and his team cooked up were meant to accomplish a fairly simple set of goals: keep fresh debt off the books, camouflage existing debt, book earnings, or create operating cash flow. At their absolute essence, the deals were intended to allow Enron to borrow money—billions upon billions of dollars that it needed to keep itself going—while disguising the true extent of its indebtedness. What made Enron’s transactions so bewildering was not their purpose so much as their sheer multiplicity. Enron would mutate every vehicle it created to strip more and more accounting benefits from it and would often use one vehicle as a building block for another, so that unraveling one transaction would mean unraveling a half-dozen others. “It looks like some deranged artist went to work one night,” is how Enron’s postbankruptcy CEO, Steven Cooper, summed up the resulting tangle.

  To see how Enron used these building blocks—and how they mutated in complexity—consider a structure called Whitewing. Whitewing began life in December 1997 as something called a minority-interest transaction, which took advantage of various accounting rules governing the way business ventures with third parties are reported in a company’s financial statements. Enron borrowed $579 million from Citigroup and then raised another $500 million, mostly debt from an entity affiliated with Citi, plus a sliver of equity from other investors. Whitewing, in turn, used this money to buy $1 billion in Enron preferred stock. (The remaining $79 million was used to help pay the investors their return.)

  The Whitewing structure was not a secret—it was disclosed in Enron’s financial statements—but the $500 million showed up on the financial statements not as debt but as a minority interest in a joint venture. “The primary purpose of the transaction had been to convert debt to equity” is how corporate treasurer Jeff McMahon later described the transaction to Enron’s board. That was true only in a technical sense. The $500 million hadn’t been converted; it had only been disguised. Enron was still responsible for paying the money back. This was one of the first times that Enron used its stock—the value of the preferred shares in Whitewing—to support an off-balance-sheet financing. It was not the last.

  This time, the bet on Enron stock was highly successful. Within a few years, the value of the preferred stock Whitewing owned had risen substantially. So Fastow’s team decided to pay back Citigroup, issue yet more debt, and remove Whitewing from Enron’s balance sheet altogether. It did so in a fall 1999 deal that Ben Glisan put high on his list of accomplishments for that year. In order to move Whitewing off its balance sheet, Enron needed more independent equity. So it created an entity called Osprey, which, through yet another entity, raised $100 million in “equity” (actually, certificates that paid a fixed return) from various banks and insurance companies. At least $1 million of that supposedly independent money came from a handful of investment bankers at Donaldson, Lufkin & Jenrette, the firm that was paid to sell the deal. Then, Osprey sold another $1.4 billion in debt to institutional investors. That $1.5 billion was used to buy a “limited partnership interest” in Whitewing. Under accounting rules, Whitewing now qualified for off-balance-sheet treatment: it was partly owned by that ostensible third party, Osprey. About one-third of the new money went to pay back Citigroup’s original Whitewing loan. The remainder was set aside to purchase assets from Enron. Whitewing was precisely the kind of vehicle that Fastow’s Global Finance team marketed internally to help business units meet their financial goals.

  And what was supporting that $1.4 billion in debt? (Which was also not a secret: in fact, the credit rating agencies rated that debt.) Mainly, it was the value and dividends from the Enron preferred stock plus the value of the assets Whitewing bought. But that wasn’t all. Enron also promised that if the assets in Whitewing weren’t sufficient to pay back the money—which would come due in early 2003—it would make up the difference by issuing stock. And if it couldn’t issue enough stock, it would pay cash. There were also triggers built in to reassure investors: If Enron’s credit rating fell below investment grade and, in addition, its stock fell below $28, the investors could demand to be paid back immediately. In other words, although the Osprey debt was technically off-balance-sheet, investors and rating agencies knew that the obligation ultimately belonged to Enron. As if there was any doubt about whose debt it really was, all they ha
d to do was flip open the Osprey offering document, which is all about . . . Enron. Later, in 2000, Osprey sold approximately $1 billion in additional debt. As part of the inducement to new investors, Enron raised the trigger price on its stock to $59.78.

  Thus was Enron stock supporting a pool of debt that was being used to buy Enron’s assets and create cash flow. If that sounds like impossibly circular logic, in commonsense terms it was. According to the court-appointed examiner in the Enron bankruptcy case, the company used the Whitewing structure to buy at least $1.6 billion in assets from various divisions in the company. The examiner also says that Whitewing was, in effect, used to refinance hundreds of millions in Enron debt.

  Another kind of minority-interest transaction took place toward the end of 1999, when Enron was desperate to show cash flow. In a deal called Project Nahanni, Enron, in essence, borrowed $485 million from Citigroup and raised a sliver of equity ($15 million) through a minority-interest financing, used that money to buy Treasury bonds, sold the Treasury bonds, and booked the proceeds as cash flow from operations under the pretext that buying and selling bonds was part of Enron’s day-to-day business. That $500 million represented a staggering 41 percent of the total $1.2 billion in operating cash flow that Enron reported that year. Then, right after the first of the year, when the camouflage was no longer necessary, Enron repaid Citi. Over the years, there were many more minority-

  interest financings, with names like Rawhide, Choctaw, and Zephyrus, all done with Wall Street’s help, that allowed Enron to pretty up its financial statements.