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

by Bethany McLean

  Meanwhile, Fastow, Kopper, and the NatWest bankers were busy laying their plans. On Wednesday, March 1, after calling ahead to discuss arrangements for a fly-fishing excursion, Fastow left Houston for a five-day trip to the Cayman Islands. There he met with Darby and Bermingham, who participated in a Campsie board meeting authorizing Darby to negotiate the official deal to sell NatWest’s stake. Over dinner, according to the government, Fastow privately told Bermingham that they had to “move quickly” on their private transactions. Kopper, who was handling many of the details, wrote in his work notebook: “Gary Mulgrew—spoke to AF, everything moving as planned.”

  The purchaser for both the NatWest and CSFB stakes in Swap Sub was a newly formed partnership, called Southampton Place, controlled by Kopper. This partnership was named for the upscale Houston neighborhood where both Fastow and Kopper lived. It paid the banks for their Swap Sub shares in late March. After it did so, it still had about $19 million in secret profits to divvy up. According to the government, this is how it was done. Fastow and Kopper transferred about half the equity in the now valuable Southampton into yet another partnership, Southampton K. On April 27, the NatWest bankers bought Southampton K by wiring Kopper a token $250,000 from Bermingham’s account in Moorgate, England.

  The next day, prosecutors say, Fastow called Mulgrew, who was in Toronto, to give him the happy news: they had just made $7 million. The money—$7,352,626, to be precise—arrived on May 1 by wire transfer to a Cayman Islands account. The three men split the money, about $2.4 million apiece. By late July, all three had resigned from their jobs at NatWest and entered a genteel retirement. (The three men were later indicted. “Really sorry, but no comment,” said Bermingham when contacted in England. Mulgrew and Darby could not be reached for comment.)

  The rest of the windfall went to a select handful of people Fastow had chosen to reward. Though no one else at Enron knew it, Fastow had invited six limited partners into the partnership; most were deeply involved in the ongoing dealings between LJM and Enron. Everyone hit the jackpot: the Fastow Family Foundation, set up by the CFO and his wife, invested $25,000 and received almost $4.5 million. Kopper, who also plunked down $25,000, also got $4.5 million. Ben Glisan, the deal’s accountant, and Kristina Mordaunt, then general counsel for Enron Global Finance, each chipped in $5,800 and walked away with $1 million. Three other Enron and LJM employees—Kathy Lynn (Michael Kopper’s old boss), Anne Yaeger, and Michael Hinds—put up less than $3,000 each and banked between $416,000 and $520,000.

  Altogether, the Southampton investors received $12.3 million on a collec-

  tive two-month investment of a mere $70,000. When asked later how they justified receiving such outrageous returns, the employees essentially explained that Fastow and Kopper had assured them it was all right so they didn’t ask any questions.

  The big Southampton score was only a fraction of the Fastow family’s take from its $1 million investment in LJM. In July 2000, Fastow received an $18 million distribution from LJM1. His management fees from the fund, which did just two more deals with Enron, totaled another $2.6 million. The Fastows’ total secret take, just from this one partnership, ultimately reached a staggering $25.1 million.

  Michael Kopper was doing well in LJM1 also. His take from the fund totaled $12 million.

  About a month after the payments arrived, Fastow flew the entire group to the Mexican resort of Los Cabos for a four-day midweek celebration. Michael Kopper and Bill Dodson were there; so were Ben Glisan and his wife; Kathy Lynn; Kristina Mordaunt and her husband; Anne Yaeger and her Enron fiancee, Trushar Patel; even Kopper’s Enron secretary and his LJM assistant, along with their husbands. Everyone had a glorious time in the sun.

  And why not? LJM picked up the $52,000 tab. And most of them had just made a fortune.

  • • •

  For Fastow, LJM1 was merely the warm-up. Just months after the entity was up and running, he returned to the Enron board, seeking approval for what he’d really wanted all along: a big, all-purpose private equity fund. Named LJM2, this fund would have far more outside money to play with—Fastow hoped to raise a minimum of $200 million—and do lots of Enron deals. As he described it in materials submitted to the directors, the fund was designed to help Enron by providing a “source of private equity for Enron to manage its investment portfolio risk, funds flow, and financial flexibility.”

  This time, there were a few questions about controls on the CFO’s plans to greatly expand his personal business dealings with Enron. But Fastow had anticipated all of them. Rick Causey and Rick Buy were to approve all transactions between Enron and LJM, he said. The audit committee of the board would review all LJM transactions yearly. And Fastow would receive nothing more than “typical” private-equity-fund fees and the modest “promote” normally granted its managing partner on his personal investment. What did Andersen think? They’re fine with it, responded Causey, running interference for Fastow. But the conflict . . . Not a problem, insisted Causey. The partnership agreement gave the investors the right to oust Andy, thus keeping him from having too much power.

  As he’d done with LJM1, Lay exempted Fastow from the Enron code of ethics; on October 12, 1999, so did the Enron board. It is clear that Fastow regarded this second board vote as yet another formality. He had already retained Merrill Lynch, which had no objections to Fastow’s latest approach, to market the fund to wealthy investors. And he had begun with friendly banks to start lining up commitments. Merrill formally released the placement memo on Octo-

  ber 13, the day after the Enron board’s vote.

  Over the course of the next 18 months, as LJM2 completed more than 20 transactions with Enron involving hundreds of millions of dollars, Enron’s full board and its finance committee received several updates on the fund’s rapid-fire activity. Throughout that time, the directors remained utterly sanguine about the CFO’s role. Indeed, each presentation seemed only to reinforce their sense that Fastow was engaged in selfless behavior, risking his own capital and committing his own time, all for the good of Enron. “Gosh, Andy, it sounds like you’re the meat in the sandwich,” remarked director Jerry Meyer during one meeting. Meyer was so impressed with the CFO’s presentation that he worried Enron was exploiting Fastow. “Why do you want to put a busy guy in this position?” he asked Lay.

  Throughout, Fastow insisted to the board that both his personal time commitment and his investment profits were limited. Seven months after winning approval for LJM2, he informed the board’s finance committee he was spending only three hours a week on the partnership. And he repeatedly claimed that his compensation from the fund was modest, far less than the money he made from Enron. Fastow emphasized the care he was taking to avoid improperly exploiting his powerful role at Enron for the benefit of LJM2. Always, he insisted that his real goal was to help Enron.

  Fastow was telling a very different story to Wall Street, however. While reassuring the board that he was safeguarding Enron from any damage resulting from his conflict, he was bragging to investors about how they could profit from it. In fact, this was LJM2’s main selling point. The partnership’s intimate ties to Enron, boasted the LJM2 placement memo, would provide “an unusually attractive investment opportunity.” After all, it noted, LJM2 would be managed “on a day-to-day basis by a team of three investment professionals who all currently have senior level finance positions with Enron.” The team was the Holy Trinity of Enron Global Finance: Fastow, Kopper, and Glisan. (Neither Kopper nor Glisan, who later insisted his inclusion in the prospectus was a “mistake,” had requested waivers for their own conflicts.)

  Just how would their involvement translate into fat returns for investors? They would provide privileged access to Enron’s deal flow (“opportunitities that would not be available otherwise to outside investors”), they’d exploit Enron’s desperation to close deals quickly (LJM2 “will be positioned to capitalize on Enron’s need to rapidly access outside capital”), and they’d bring to the fund their “fam
iliarity with Enron’s assets and their understanding of Enron’s objectives.”

  The memo explicitly boasted that Fastow’s insider status “will contribute to superior returns.” The partnership’s goal, it added, was to generate an annual internal rate of return for investors “in excess of 30%” after payment of all fees. On the issue of compensation too, the offering memo was instructive: Fastow and company would receive an annual fee of 2 percent of investors’ capital—at the fund’s projected $200 million minimum, that amounted to $4 million a year just for starters—plus 20 percent or more of the partnership’s total return.

  Although this offering document had been completed well before the board meeting at which LJM2 was approved, it was never shown to the board, not then or at any other time. The directors and top Enron executives who presumably were supposed to be overseeing Fastow’s conflict—Lay, Skilling, Buy, and Causey—all say they never asked to see any LJM2 partnership documents. One Enron director, Robert Belfer, later said he received the LJM2 placement memo in the mail, offering him the opportunity to invest, but that he threw it away without reading it. Finance committee chairman Herbert (Pug) Winokur later explained that he didn’t need to see the memo because it had been reviewed by Enron’s lawyers at Vinson & Elkins.

  A month before the board vote, Fastow had been even more explicit about how he planned to run LJM2. With Kopper in tow, Fastow addressed salesmen from Merrill’s private-equity team in a remarkable September 16 meeting at the firm’s offices near the World Trade Center in lower Manhattan. He spoke to them for almost an hour. His remarks were preserved on videotape. There was no talk during this meeting about limiting his efforts to three hours a week. On the contrary, Fastow openly described LJM as his ticket out of Enron. “This is what I’d like to do,” he declared. “Being CFO of Enron is as good a CFO position as anyone could have in America, I think. This is what I want to be my next step. I want to run an investment business. This is a unique opportunity to set it up, with unique access to deals.”

  The Merrill group seemed taken aback at the sheer audacity of it all. Just how would all this work? Would Fastow get to see competing bids for Enron deals? Standing in front of the room, Fastow shuffled his feet and offered a cat-that-ate-the-canary grin. “It’s very hard for me not to see competing bids.” As CFO of Enron, didn’t he have an obligation to represent the company in negotiations? “I will always be on the LJM side of the transaction,” he replied. Fastow continued: “Do I know everything that’s going on? Do I have to sign off on every deal that goes in there? Yes.” He would be in the “unique position” of being able to “know everything” about all of Enron’s assets.

  The sheer volume of Enron deal flow would allow him to cherry-pick great opportunities, Fastow added. (“You’ve got $7 billion in assets coming in every year; that roughly means I’ve got $7 billion in assets coming out the other side.”) And so would Enron’s eagerness to unload assets (“If we want to sell an investment, we want it done by the end of the quarter.”) The deal selection would be “truly staggering,” Fastow promised. “The prime hunting ground is going to be highly complex structured deals that have to be moved in a short time frame”—something that was never in short supply at Enron. As for how Fastow planned to recruit fund investors, a Merrill executive stated the obvious: “Andy, as chief financial officer of Enron, is heavily banked.” This was an amazing opportunity, Fastow declared. “We have a real opportunity here to bust it wide open.”

  In the midst of this explanation of how he would play his hand in a game where he got to see all the cards, Fastow allowed himself a special moment of giddy, smug delight. “The only thing that’s amazing to me,” he said with a sly grin, “is that our really smart investment bankers didn’t figure this out first.”

  After Fastow’s appearance, even his friends at Merrill wanted a word of additional assurance that Fastow wasn’t straying too far from the Enron reservation. On October 7, Tilney and Rob Furst, a second Texas-based Merrill banker, presented Fastow with a short list of questions for Skilling.

  Had he considered how much time “Andy and his team” would be spend-

  ing on LJM2? If they raised even more than the anticipated $200 million, was Skilling still comfortable with the situation? And finally, was he comfort-

  able with “the internal mechanics put in place to resolve the conflict of interest issue?”

  Four days later, the Merrill bankers got the reply they wanted to hear. “It was apparent that Jeff Skilling has spent a great deal of time with LJM matters,” Tilney and Furst reported, in a brief memo to the “LJM due diligence File.” They added:

  Jeff is comfortable with the conflict of interest issue for the following reasons:

  1. Andy has no control of asset sale decision.

  2. Rick Causey, EVP and Chief Accounting Officer, will review all transactions.

  3. Audit Committee of the Board will receive LJM2 financial statements.

  The memo offered one final observation: “Jeff stressed how important transparency and disclosure will be to the success of the arrangement.”

  In fact, LJM2 hadn’t yet even gone to the Enron board for approval; over the duration of the fund’s life, the audit committee received none of the fund’s financial statements.

  • • •

  As CFO of Enron, Andy Fastow was indeed “heavily banked”—and he didn’t hesitate to use this leverage as he set about raising money for LJM2. For the banks, the calculation was simple: Fastow maintained a stranglehold on doling out Enron’s extraordinarily lucrative banking and financing work—and he kept score. Ponying up for LJM2 was a price the banks needed to pay to retain his favor. Fastow made the connection overt: his annual appraisal of individual bank performance explicitly noted their level of participation in LJM.

  Fastow had begun hitting on banks to commit to LJM2 months before the fund had even won board approval. One of his prime targets was Chase Manhattan Bank, which was hungering for more Enron business. The maneuvering that preceded the bank’s inevitable decision to pony up illustrates just how openly Chase viewed LJM2 as a ticket to more Enron business.

  Chase Manhattan’s Houston relationship manager, Rick Walker, was almost as close to Fastow as Merrill’s Schuyler Tilney. Fastow wanted the bank to commit to a $20 million investment in LJM2. In August 1999, Walker sent a long memo to his two bosses, Jimmy Lee, head of global investment banking, and Todd Maclin, head of the global oil and gas business, supporting Fastow’s request that Chase serve as an “anchor investor” for his fund.

  The request should be viewed as “a relationship-driven exercise,” Walker wrote. While Fastow was anticipating 30 percent returns, Walker was eyeing other benefits, such as “substantial financing and M&A opportunities” from LJM2 and “continued deal flow from Enron Corp.” Noted Walker: “Andy has always performed on his promises to help Chase with its investment banking strategies. . . .” Though Walker knew Fastow was likely to hand the job of marketing LJM2 to Merrill, the CFO had hinted that Merrill’s role might be “limited” and Chase might get future LJM business. “This is a carrot from Andy to Chase,” reported Walker, “and one I think we should consider taking.”

  Walker advised his bosses that money invested in LJM2 was practically a sure bet. “Andy’s position with Enron affords him superior insight into Enron’s merchant portfolio,” he noted, and the fund’s ability to move quickly “will command a premium from Enron.” Unlike the Enron board, Walker also harbored no illusions about Fastow’s motivation. The CFO’s involvement, he noted, would have “significant impact on [Fastow’s] wealth.”

  Walker didn’t just send the memo to his bosses. He also quietly faxed it to Fastow, with a personal message on the cover sheet: “Andy—Following is my draft memo—most of which I wrote last week. I’m looking forward to your comments and also discussing your schedule—do you still want to meet with Jimmy Lee next Wednesday morning? I’m currently holding my schedule open so that I could be there with you
. . . Rick.”

  Maclin, who had recently joined Walker on a weekend fishing trip with Fastow, strongly backed the investment. Their time with Fastow, he wrote Lee in a follow-up memo, had made it clear that a $20 million commitment to LJM would produce “deal flow out of the fund” for Chase and “a closer relationship with Enron leading to more M&A and corporate finance opportunities with the company.” When Lee scheduled a meeting with Fastow, Maclin noted: “. . . he is very important to the business flow out of Enron. . . . The $20 million investment in his LJM2 fund is important to him, and I believe it will buy us a lot from Enron in return, especially since it’s Andy’s baby.”

  But after meeting with Fastow, Lee had some doubts. He forwarded the LJM materials to another bank executive with the hand-scrawled message across the cover sheet: “Will you please look into this with Rick Walker. It is a ‘captive’ fund to Enron. I am skeptical because this guy running it is inexperienced & sounds very naïve. However, this relationship is very big and important. We ‘may’ have to do a little. J.”

  Ultimately, Lee agreed to put $10 million in the fund. After getting the news, Maclin jotted a note to Walker reminding him that the bank was expecting a quick payoff: “Rick—Now that you got your $10 mil, we need an M&A mandate—something big & high profile. When do we go ask Fastow for this order??” It didn’t take long for the returns to start flowing. Within months, Chase had received $650,000 in LJM underwriting fees.