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

by Bethany McLean

  Lay opened the call by telling the analysts he was eager to address their questions and expressing his dismay at Enron’s stock price, then flirting with $20. “To say the least, we are very, even extremely, disappointed with our stock price, particularly since our businesses are performing very well and we are continuing to conduct business as usual,” he said.

  Before turning the call over to Fastow, who was supposed to reassure investors about the state of Enron’s finances, Lay paused to make clear that he was standing by his man. “I and Enron’s board of directors continue to have the highest faith and confidence in Andy and believe he is doing an outstanding job as CFO,” Lay declared.

  After Fastow gave his presentation, the questions came fast and furious. What would Enron’s earnings for 2000 and 2001 look like without the LJMs?

  Causey told the analysts the absence of the partnerships would have had a “minimal impact.” Enron, he said, could have simply done the same deals with other “third parties.”

  Richard Grubman, the short seller Skilling had called an asshole, took his turn. He asked about Marlin, the Enron debt vehicle that financed Azurix. By Grubman’s calculations, its assets were worth less than its debt; thus Enron was left holding the bag. Causey and Grubman argued over the analyst’s numbers until Lay jumped in. “Now I know you want to drive the stock price down, and you’ve done a good job at doing that, but I think that’s that,” he scolded.

  “That’s pointless,” Grubman shot back.

  “Let’s go to the next question, Richard,” said Lay. “You’re monopolizing the conference. We’ve got a lot of people out there with real serious questions.”

  “I would appreciate an answer to the question,” Grubman responded. “That’s fine if you move on. I think everybody understands why.”

  One analyst asked what would happen if Enron’s debt fell below investment grade.

  Lay dismissed the possibility: “First of all, we’d have to be downgraded three notches to go below investment grade. And there’s—at least we don’t think there’s any chance of that.”

  The analyst pressed the ugly hypothetical, and Glisan finally acknowledged that such a downgrade would trigger other repayment obligations for Enron. The company’s entangled financial structure was becoming a public issue.

  “Let’s take a stab at the worst-case scenario here,” said another analyst. The worst-case scenario wouldn’t happen, Lay protested.

  Asked about Fastow’s partnerships, Lay insisted that the board had put controls in place to make sure that the interests of Enron shareholders wouldn’t be compromised. “And I will also say,” added Lay, waxing indignant, “that having checked just in the last several days, these procedures have been rigorously followed. So we do not—we’re very concerned the way Andy’s character has been kind of loosely thrown about over the last few days in certain articles, as well as, of course, the integrity of the company.”

  “With all due respect,” retorted Goldman Sachs analyst David Fleischer, usually a company supporter, Enron’s credibility was now being “severely questioned.” There was a need for “much more disclosure,” Fleischer continued. “There is an appearance that you’re hiding something . . . that maybe there’s something beneath the surface going on that is less than—that may be questionable.”

  “We’re trying to provide information,” Lay insisted. “We’re not trying to conceal anything. We’re not hiding anything.”

  John Olson, Lay’s old nemesis, told the Enron chief it would be “important in terms of credibility” for Fastow to describe his role in the LJMs and how “closely monitored” he had been.

  But Lay wasn’t about to be that open. The SEC investigation would reveal everything, he insisted. There were legal issues involved. “I would prefer that Andy not get in too much detail as far as LJM. And let me say,” Lay rushed to add, “there was a Chinese wall between LJM and Enron.”

  After the disastrous conference call ended, the Enron brass rushed over to the Hyatt for another packed all-employee meeting—held in a distinctly different climate. With Enron’s stock heading toward $19, Lay evoked the events of September 11. “Just like America is under attack by terrorism,” he declared, “I think we’re under attack.”

  Lay tried to tell his employees he shared their pain. “I am absolutely heartbroken about what has happened, both the last few months and, more importantly, the last several days.” He’d taken a financial hit right along with them, he said. “I’ve lost a substantial portion of my net worth.” Yet Enron had done everything appropriately, Lay insisted. What no one had properly appreciated “was how difficult it was to explain it—the perception of it.”

  Lay then launched into a history of all the near-death experiences Enron had survived. The nationalization of its Peruvian oil and gas interests in 1985. The drop in gas prices in 1986. The Enron Oil scandal in 1987. J-Block in 1997. Enron always came back stronger, “and that’s exactly what I think is going to happen here.”

  “I also know that many of you who were a lot wealthier six to nine months ago are now concerned about the college education for your kids, maybe the mortgage on your house, maybe your retirement, and for that I am incredibly sorry. But we’re going to get it back,” he vowed.

  Turning to LJM, Lay uttered words he soon regretted. “I and the board are also sure that Andy has operated in the most ethical and appropriate manner possible.” Still, Lay was “very sorry that this incredibly complicated thing ever happened and the damage was done to our image.”

  Several minutes into the question period, Lay was handed a written query, which he read aloud:

  “I would like to know if you are on crack. If so that would explain a lot. If not, you may want to start because it’s going to be a long time before we trust you again.”

  • • •

  LeMaistre prepared carefully for his conference call with Fastow late that Tuesday afternoon. Jim Derrick, Enron’s general counsel, provided a script, including introductory remarks and specific questions, and faxed it to LeMaistre, who was in Colorado. John Duncan, the second board member on the call, was patched in from Houston.

  When everyone was on, LeMaistre began reading: “We very much appreciate your willingness to meet with us. Andy, because of the current controversy surrounding LJM1 and LJM2, we believe it would be helpful for the board to have a general understanding of the amount of your investment and your return on investment in the LJM entities.”

  Then the first question: “What was your aggregate income attributable to LJM1 and LJM2, inclusive of salary, consulting fees, management fees, partnership distributions, and gain on the sale of your partnership interest?”

  For more than a year, Fastow had bobbed and weaved, dodging bosses, lawyers, and security regulations to avoid addressing this very question. But now, backed into a corner, he gave the directors a startling answer: he had made $23 million on LJM1 and another $22 million on LJM2. Fastow was telling them he’d pocketed $45 million—on a partnership that was supposedly occupying him just three hours a week! And he’d made the money doing deals with Enron. “Incredible,” LeMaistre scrawled on his script.

  In fact, Fastow’s true take was even larger: $60.6 million.

  What was his rate of return? LeMaistre asked. Fastow said that he had invested $1 million in LJM1 and $3.9 million in LJM2 but couldn’t immediately tell them his rate of return.

  Did he know of any other Enron employees besides Kopper who had “any economic interest” in the LJMs or had received “any benefit” from them? Fastow told them he did not—saying nothing about Glisan, Mordaunt, and the others who were members of the Southampton partnership.

  And, finally, did he know any other “potentially troublesome matter of which we should now be apprised in connection with the LJM relationship?”

  “No.”

  • • •

  At 8 A.M. the next day, Greg Whalley walked into a conference room on the fiftieth floor of the Enron Building where a handful
of executives were already gathered. They included Ken Lay; treasurer Ben Glisan; former treasurer Jeff McMahon, now running Enron Industrial Markets; and Andy Fastow.

  Whalley pointed to Fastow: “You’re not the CFO anymore,” he told him. Then he pointed to McMahon: “You are.” As the meeting continued, the talk turned to a finance issue. When Fastow tried to chime in, Whalley instantly shot him down. “Didn’t you hear me?” Whalley snapped. “You’re fired.”

  Fastow and his wife were supposed to have lunch that day. He e-mailed her to cancel. “Sweetheart, I can’t do lunch because I’ve got to be here to find out my final status (reassigned, leave of abs, gone), work out details with ENE, and help with press release. Love you.” Lea Fastow e-mailed back with some advice. “Important,” she wrote. “The press release needs to say that you voluntarily stepped down due to your reduced effectiveness as CFO as a result of the character assassination.”

  In fact, Fastow was officially placed on a leave of absence, but McMahon’s appointment as his replacement was announced immediately. Just 24 hours after Lay publicly insisted that Fastow’s character was being unfairly maligned, the CFO was gone.

  By the close of the day’s trading, Enron shares had fallen to $16.41.

  • • •

  Not long after word of his “leave” got out, Andy Fastow received a call from his old boss, Jeff Skilling. In the two months since leaving Enron, Skilling had closely monitored events at the company. Even now, he checked in regularly with the PR department, asking Mark Palmer, “What are you hearing?” and volunteering his advice for dealing with the company’s growing problems.

  As Skilling watched from the sidelines, his frustration had grown. “Somebody needs to say something,” Skilling railed. “The stuff being written is just crazy! It’s not the company I know.”

  “Andy, what is going on?” Skilling now asked Fastow.

  “Jeff, I don’t know,” the deposed CFO responded. “They won’t tell me. I don’t think I did anything wrong.”

  While Fastow was trying to sound chipper, Skilling could tell that he was down in the dumps. Skilling told his old colleague he should get on antidepressants and start seeing a psychiatrist—just as Skilling had done.

  CHAPTER 22

  “We Have No Cash!”

  Scott Gieselman, a Goldman Sachs energy banker in Houston, was still in his office when the phone rang. It was late Wednesday night, October 24. Jeff McMahon, who had replaced Andy Fastow as Enron CFO that morning, was on the other end of the phone. “What can you monetize for me in the next 24 hours?” asked McMahon. He sounded frantic.

  By the time of Fastow’s firing, Enron’s “perception” problem had evolved into something far worse—a cash crisis. With Enron’s stock continuing to sink, panic was taking hold. The immediate problem was that Enron had been unable to roll its commercial paper—the portfolio of unsecured short-term loans that all big companies use to fund their day-to-day needs. Renewing such debt was normally a routine matter. Though the amounts involved were huge (for Enron, about $2 billion), the exposure was so brief (as little as 24 hours) that, for lenders, it was really nothing to worry about—unless they had reason to wonder if the company would survive long enough to pay it back.

  And in Enron’s case, that’s just what was happening. McMahon was shocked to hear this. “If we can’t roll commercial paper, we can’t pay the janitor,” he told Whalley. “We have no cash!”

  McMahon and Whalley quickly set up a special war room over in Enron’s new Cesar Pelli–designed headquarters across the street, where the traders had just started moving in. They summoned a clutch of corporate finance executives, lawyers, and the heads of Enron’s business units for quick briefings to get a fix on the situation.

  Enron, McMahon quickly realized, needed a billion, maybe two to three billion, fast—before word trickled out and a rush of panicked creditors shut the company down. The new CFO launched a desperate phone-a-thon, dialing up the big banks, and asking them—on a moment’s notice—to write checks for $500 million or more.

  The banks were welcome to sell or lend against anything Enron owned, McMahon advised. If it would help persuade Goldman Sachs to open its coffers, he told Gieselman, Enron would even give the firm full access to its secret trading books. “Nothing is off limits,” he said. “What do you want?”

  But this time, the answer came back from everyone: nothing. No one would move that fast, not for Enron, not now.

  When that failed, Enron had no choice but to immediately deploy its backup plan. On Thursday, the company drew down the $3 billion in backup credit lines to its commercial paper. To Wall Street, this was instant confirmation of Enron’s desperate straits. Virtually all large companies have such backup credit as part of their financing structure, and they’re technically entitled to tap it whenever they want. But no lender ever expects—or wants—it to be used, since the debt is totally unsecured.

  Enron tried to cast this act of desperation as a strategic move, one intended “to dispel uncertainty in the financial community.” It was supposed to offer proof that the banks (which actually had no choice in the matter) were standing squarely behind the company. In a late-afternoon press release, McMahon was quoted explaining the drawdown this way: “We are making it clear that Enron has the support of its banks and more than adequate liquidity to assure our customers that we can fulfill our commitments in the ordinary course of business. This is an important step in our plan to restore investor confidence in Enron.”

  The same release announced that Enron Online had completed an “above average” day, with more than 8,400 trading transactions involving 1,387 counterparties. “We are especially gratified by this strong vote of confidence from both our customers and banks because that, more than anything, should enable the financial community to look beyond today’s headlines and focus on the inherent value of our company,” said Lay. As ever, Enron was trying hard to deliver the message that everything was fine.

  Incredibly enough, that’s what Lay, at least, truly seemed to believe. As one Enron executive put it: “Ken thought there was nothing wrong with Enron that what was right with Enron couldn’t fix.” And what was right, above all, meant the trading business. After Skilling quit, Lay had hired Gieselman and his colleagues at Goldman Sachs to assess Enron’s finances. Fastow quickly encouraged them to focus their attention on finding a buyer for the pipelines, the only steady cash generator Enron had left. The thought was that everything would be fine if Enron could simply unload the pipelines to lighten the company’s debt and unburden the trading business.

  In the middle of all this sat McMahon, who had finally gotten the job he’d wanted, though the circumstances couldn’t have been worse. Of the people now leading the company, he was the only who really understood corporate finance. Whalley had no experience in these matters. Neither he nor Lay could be much help in managing the cash crisis.

  McMahon was operating under several serious handicaps. He hadn’t worked in corporate finance for a year, and he had no idea where Fastow had buried the bodies. Nor did he have any easy way of finding out. Under Fastow, Enron had operated quarter to quarter. The company lacked the kind of sophisticated cash-management systems that big companies required. McMahon couldn’t even find a maturity schedule showing when all Enron’s debt would need to be repaid—a basic tool in corporate finance. In fact, with all the tangled off-balance-sheet machinations—obscuring what obligations were truly Enron’s, obscuring even what was truly debt—no one could immediately tell McMahon how much money Enron owed.

  There were other perils. Many of Fastow’s structured-finance vehicles, which seemed so clever—even elegant—not long before, now stood revealed as rickety contraptions, lashed to one another and rigged to explode. The problem was that several of the deals, including Marlin and Osprey, had triggers requiring the immediate payback of billions in debt if Enron’s share price fell below certain floors and its credit rating dropped too low. The stock price had already crashed
through the floors; the challenge was to keep the credit ratings from dropping as well. After learning that Enron was drawing down its credit lines, S&P changed Enron’s “credit outlook”—an interim step toward a ratings change—from stable to negative. Fitch had already done the same. Moody’s had Enron’s rating under review.

  There was another frightening problem that was already taking hold. By its nature, a giant trading operation depends on credit to survive—it is the oxy-

  gen for the business. This was especially true of Enron, because of the giant cash needs of Enron Online. Rating-agency downgrades—even just shattered confidence—would prompt trading partners to start demanding cash collateral, producing what would amount to a run on the bank. If that couldn’t be stopped, a few billion dollars of cash wouldn’t last long.

  As things stood at the moment, $2 billion from the credit lines would be needed just to pay off the commercial paper loans. This meant that Enron was already down to its last billion, and that was disappearing fast. As one Enron executive later put it: “Trading companies fall quickly—like a helicopter running out of fuel.”

  • • •

  In the aftermath of his departure from Enron, Andy Fastow assumed a pose of being at peace with the world. On the day Enron had tapped its backup credit lines, he received a supportive e-mail from Seth Vance, a London-based banker for Citigroup. “Hang in there,” Vance wrote. “The news will subside and I’m sure when the facts are out, it will be clear that everything you did was approved by the board. Shareholders will sue over anything when they lose as much