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

by Bethany McLean

  as they have—looks like they are grabbing for anything and everything. I guess Jeff S. and Cliff B. timing of leaving Enron could not have been better—?”).

  Fastow responded that afternoon. “Needless to say, this has been quite an experience,” he wrote, “but the great thing is that today I had breakfast with my family, drove my kids to school, had coffee with my wife, and soon I’m going for a run. I’m sure I’ll have moments of frustration, but right now this is OK. I wish I could be in there helping Enron, but they’ve got a lot of smart people that will figure this out.”

  At the same time, Fastow was playing hardball with Enron. His attor-

  neys threatened legal action, insisting that Fastow—officially still on leave of absence—had been involuntarily terminated without cause, triggering the severance provision in his new contract, worth more than $9 million. (The board dithered over Fastow’s status for weeks until concluding that it had grounds to fire him for cause.)

  Fastow’s friends at Merrill, meanwhile, prevailed on Michael Kopper to stop making new LJM2 investments. In fact, noted Rob Furst, in an e-mail to Schuyler Tilney and two other Merrill bankers, Kopper now said he would “orderly liquidate the partnership.” With Fastow’s departure from Enron, LJM2’s critical edge—its knowledge advantage—was gone. Kopper had to recognize, Furst noted, that “the premise for which the money was raised . . . is valid no longer.”

  • • •

  As the Enron mess mushroomed and the Houston auditors belatedly scrambled to get a handle on it, Andersen executives in Chicago finally realized that Enron’s problems could imperil the entire firm. Even as David Duncan and others were generating a written record of what was going on, a 38-year-old in-house lawyer named Nancy Temple had begun looking over their memos, advising them to edit out language, and even destroy documents that might look bad in court. As it turned out, this campaign to sanitize Andersen’s files proved even more lethal than the firm’s craven accounting.

  Temple became involved in September, when it first became apparent that Enron’s accounting might require restatement. On October 9, during a conference call with two top Andersen lawyers, she jotted a note: “Highly probable some SEC investig[ation].” This alone was cause for alarm. Andersen had just paid a $7 million fine in connection with the billion-dollar accounting fraud at Waste Management; it was operating under an SEC cease-and-desist order barring it from further misconduct. Thus for Andersen, as Temple noted, an En-

  ron restatement posed a huge danger—“probability of charge of violating C+D in WM.”

  The next day, Andersen’s practice director in Houston, Michael Odom, gave a videotaped talk to a conference room jammed with audit managers—including Duncan—on the touchy subject of destroying files. In the Waste Management case, Andersen’s records had provided government regulators and plaintiffs’ lawyers with all the ammunition they needed. Andersen didn’t want that to happen again.

  Under the firm’s document-retention policy, everything that isn’t an essen-

  tial part of the audit file—drafts, notes, internal memos, and e-mails—should be promptly discarded, Odom said. Once a lawsuit was filed, nothing could be destroyed, he noted. But “if it’s destroyed in the course of the normal policy and litigation is filed the next day, that’s great, you know, because we’ve followed our own policy, and whatever there was that might have been of interest to somebody is gone and irretrievable.”

  Two days later, on Friday, October 12, Temple, fresh from sifting through the embarrassing internal memos revealing the audit team’s rejection of the PSG’s advice on the Raptors, offered her own prod, advising Odom in an e-mail: “It might be useful to consider reminding the engagement team of our documentation and retention policy. It will be helpful to make sure that we have complied with the policy.”

  Such helpful reminders about document retention were starting to produce results. When David Duncan’s assistant, Shannon Adlong, arrived for work the following Monday, she noticed bags filled with paper ribbons in the office break room, where the shredder was located. “There was food everywhere,” she later recalled, “like they had been there the whole weekend.”

  On October 16, Temple e-mailed Duncan on the subject of his memo documenting events surrounding Enron’s third-quarter earnings release, the one that criticized Enron’s characterization of its big write-off as a nonrecurring charge. Temple offered Duncan “a few suggested comments for consideration.” She encouraged “deleting reference to consultation with the legal group and deleting my name on the memo. Reference to the legal group consultation arguably is a waiver of attorney-client privilege and if my name is mentioned it increases the chances that I might be a witness, which I prefer to avoid.” She also advised “deleting some language that might suggest we have concluded the release is misleading”—even though that is exactly what Andersen had concluded.

  Temple later explained her aim to an outside lawyer for Andersen, saying she was “trying to balance documenting our discussion with possible subsequent challenges that we somehow had a responsibility to follow up when we knew the client had issued a press release that was potentially misleading.”

  In the days to come, Temple continued to edit internal documents even as they were being generated; at one point, she suggested deleting senior Andersen partners from the circulation list for Enron e-mails because it “increases their likelihood of being a witness.”

  Duncan, of course, was forwarded Temple’s reminder about document retention. Although he later said he took it as a coded message to start destroying Enron files, he was too busy dealing with the Enron crisis to do much about it for a week. By October 23, the matter had become more urgent. The SEC inquiry had been announced, Andersen was taking a closer look at more of its old accounting decisions involving Enron, the first lawsuits against the energy company had already been filed, and Enron, just that morning, had held its disastrous conference call with the analysts. Andersen’s window of opportunity for cleaning up its Enron files might slam shut at any moment.

  At 1:30 P.M. that day, Duncan presided over an all-hands meeting of the Enron team, where, among other matters, he noted that Andersen would invariably become involved in the SEC inquiry and reminded his team to comply with the firm’s document policy. Immediately, Andersen’s Houston office began working overtime shredding documents.

  One day into it, Adlong, Duncan’s assistant, dispatched an e-mail: “ARRR-

  GGHHH, send more shredding bags! (just kidding we have ordered some).” The machine at Andersen’s Enron office was quickly overwhelmed; dozens of trunks and boxes filled with documents—more than a ton of paper—were shipped to the main downtown office, where files awaiting destruction spilled out into the hallways outside the shredding room. It was more than the entire Houston office typically shredded in an entire year. The load was so great that Andersen summoned a shredding truck from a local disposal company called Shred-It. (The company’s motto: “Your secrets are safe with us.”) Andersen’s offices in London, Portland, and Chicago joined in, shredding their Enron documents. In addition to the paper, almost 30,000 e-mail messages and computer files were deleted.

  On October 26, Andersen audit-practice director John Riley, in town to help sort out the Enron accounting, heard a high-pitched whine in the office. “What’s that noise?” he asked Duncan. “You guys have a shredder up here?” Duncan told him the Enron team was merely destroying routine client documents. “Well,” Riley responded, “this wouldn’t be the best time in the world for you guys to be shredding a bunch of stuff.” Four days later, David Stulb, an in-house Andersen investigator, arrived in Houston to discuss the Enron situation. Duncan pulled out the cover page on Jim Hecker’s e-mail about his conversation with Sherron Watkins—with its remark about “smoking guns you can’t extinguish”—and announced: “We need to get rid of this.” Stulb instructed him to keep it, then notified his bosses in New York that “Dave Duncan needs some guidance on document retention.”r />
  Finally, the shredding stopped—but only after Andersen received a subpoena from the SEC. Adlong, Duncan’s assistant, sent out a final e-mail on the subject: “Per Dave: no more shredding. If you are asked, tell them Dave said we can’t. We’ve been officially served by the attorneys for our documents.”

  • • •

  Even as Andersen was shredding documents, it was also stumbling across huge mistakes hidden in Enron’s books. One after another, they were blowing up, like long-buried land mines.

  The first involved Chewco, the Kopper-managed SPE that Fastow formed back in 1997 to buy out CalPERS’s 50 percent interest in JEDI, its investment partnership with Enron. The deal had kept more than $600 million in debt off Enron’s books. With Fastow and Kopper now gone, Enron accountants had finally shown an Andersen partner documents revealing that Enron, under a secret side deal, had put up cash collateral to help provide the 3 percent outside equity Chewco required. This meant that Chewco didn’t really qualify as a third-party SPE; both it and JEDI should have been consolidated on Enron’s books.

  Andersen also learned of another reason why Chewco’s dealings probably didn’t merit off-balance-sheet treatment: the outside partnership was really controlled (and partly funded) by Kopper, then an Enron employee; Kopper, in turn, had tried to disguise his role by transferring his controlling interest to Bill Dodson, who—unbeknownst to Andersen—was Kopper’s domestic partner.

  The second big revelation involved LJM1; this mistake dated back to 1999. After studying the documents, Andersen realized that LJM Swap Sub—the partnership subsidiary that helped generate the secret windfall for the NatWest bankers and their Enron counterparts—had never been properly capitalized with 3 percent outside equity. This meant that its transactions also had to go back on Enron’s books.

  This time, Andersen resolved: no more games. Enron would need to restate its earnings all the way back to 1997, adding debt to its teetering balance sheet and wiping out a big chunk of its reported profits. All this was horrible news—for both Arthur Andersen and Enron.

  As each deal painfully unraveled, Whalley convened a meeting to brief a half-dozen senior executives, including Lay, about Enron’s latest accounting disaster. Chewco proved especially challenging to explain, especially as the discussion turned to the related-party issue. “There’s just one problem,” someone said. “We’re not sure whether the related party is Michael Kopper—or Michael Kopper’s gay lover.”

  Ken Lay turned pale. “His gay lover? What the fuck is going on around here?”

  “C’mon Ken,” Whalley responded, after a moment of shocked silence. “Haven’t you seen the way Michael Kopper dresses?”

  • • •

  As Enron’s troubles continued to gather, like the ghosts of quarters past, Lay seemed almost paralyzed. “He was curled up in the fetal position the whole time,” says an Enron executive in the thick of it all. Lay continued to believe that Enron would survive this crisis, just as it had survived those in the past. He also continued to believe it was still primarily a public-relations problem.

  In late October, Lay received advice on how to manage the situation from an unlikely quarter—Sherron Watkins. The Enron whistle-blower met with Lay again, this time bearing a letter with her advice on spinning Enron’s crisis. Offering herself as Lay’s personal crisis-management adviser, Watkins urged him to blame his subordinates—to “admit that he trusted the wrong people” and announce that “the culprits are Skilling, Fastow, Glisan, and Causey as well as Arthur Andersen and V&E.”

  In Watkins’s scenario, the party line would go like this: “Ken Lay and his board were duped by a COO who wanted the targets met no matter what the consequences, a CFO motivated by personal greed and 2 of the most respected firms, AA&CO and V&E, who had grown too wealthy off Enron’s yearly business. . . .” Lay should exploit his personal goodwill to sell the story, Watkins wrote—after all, “nobody wants Ken Lay’s head.” (For her part, Watkins had sold off her own modest Enron stake, unloading a grant of shares for $31,000 in August after writing her letter to Lay and netting $17,000 from a sale of options in October. Watkins said she’d sold the first block for “tax reasons” and the second over concerns about the impact of September 11.)

  Inevitably, Lay reacted to the crisis by seeking to cash in his political chips, looking to win help for Enron through his powerful Washington connections. He called Secretary of the Treasury Paul O’Neill, himself a former CEO; former Treasury secretary Robert Rubin, now at Citigroup; Secretary of Commerce Donald Evans, an old Texas hand; even Alan Greenspan.

  Lay spoke darkly about the impact Enron’s failure might have on global energy markets; he likened its plight to that of Long-Term Capital Management, the giant hedge fund that was rescued by a 1998 federal bailout; and he wondered aloud what a few well-placed calls might do to pry an extra billion or two loose from the banks and keep the rating agencies from downgrading Enron’s debt.

  Yet despite all of Lay’s presumed clout, no one did anything meaningful to intervene. It seemed as though everyone was turning on Enron, even those that the company had always been able to manage—first Wall Street, then the media, now Washington.

  Lay sought comfort from a few trusted Houston ministers. Dr. Steve Wende, the pastor at First United Methodist, a large downtown church, recalls that Lay would periodically interrupt his business day to call “because he felt like he needed God’s help.” Lay and the minister would then pray together over the phone. Lay spoke to Wende about the press’s “unfair” treatment of Enron and how he’d made “a number of mistakes early in his life.” Lay told Wende he believed he could save Enron, and he wanted to do it “God’s way.”

  In the darkening days of October, Lay’s family sought to offer the beleaguered CEO their own special form of solace. Earlier in the year, Lay’s son Mark had left behind his troubled business career—including a string of ventures that did business with Enron—to enroll at Southwestern Baptist Theological Seminary in Houston. Now he began e-mailing biblical passages to his father. In one accompanying note, Mark likened his father to Solomon (“there is no doubt God has already given you great wisdom”).

  In another installment, which Mark titled “Take it to them,” the younger Lay offered his father “bullet points” about the tale of King Hezekiah, “the most Godly man . . . after him there was none like him among all the kings of Judah.” Hezekiah, too, had found himself under siege, Mark told his father: “The Assyrians surrounded his city with a great army. He went to God with great faith and honored God. God sent an angel.”

  . . . And it came to pass that night, that the angel of Jehovah went forth and smote in the camp of the Assyrians a hundred fourscore and five thousand: and when men arose early in the morning, behold, these were all dead bodies.

  A day later, Linda Lay received an e-mail from a friend named Phyllis Bronson, a Ph.D. “new medicine” expert in mood disorders, such as anxiety and depression. Bronson, a biochemical nutritionist, lived in Aspen, where the Lays vacationed.

  “So much for your quieter time of life,” Bronson wrote. “After seeing the NY Times article yesterday, I am glad for Enron that Ken is back at the helm; I trust he will persevere and be more than successful in whatever he does.” She went on: “I am concerned about his level of stress, and would highly recommend that he keep up that anxiety control formula, taking two after meals 3x a day. I have stronger things in my arsenal if needed. Also, perhaps when he is here sometime, I could check his blood chemistry for stress factors and optimal brain function.”

  Linda responded on Tuesday, October 30:

  Dear Phyllis,

  Bless you for your care and concern. I have forwarded on to Ken’s office and will get him to Aspen as soon as the smoke clears. He is burning the candle day and night with very little sleep. I am praying hard for him and Enron and know that he has the strength, wisdom, skills and courage to persevere and succeed. I will stay in touch.

  Love, Linda.

 
Linda sent the e-mail on to Ken’s office, with her own accompanying note:

  Dear Ken,

  I am packaging up extra anxiety control pills to go down to your office. Please have Earl [Lay’s driver] pick them up at the front door. I love you, Linda.

  • • •

  In the thick of Enron’s crisis, there were some bankers who caught the scent of opportunity. With Fastow gone and the company in desperate straits, they were finally in the driver’s seat. They’d consider lending Enron money, but now it would be on their terms.

  At first, Enron didn’t fully appreciate just how much things had changed. Immediately after drawing down its backup credit lines, the company informed the banks it needed an extra $2 billion cash, at least. Despite its predicament, Enron executives still thought they could borrow the money unsecured, as they always had. To head off a panic, they wanted to announce the deal the following Monday, October 29—just five days after Fastow was ousted. As one Wall Street analyst put it: “They were beggars long before they knew they were beggars.” Enron quickly got a reality check. The banks flatly turned the company down.

  J. P. Morgan Chase and Citi agreed to talk about lending an extra $1 billion, though Enron clearly needed much more. But now, they were demanding the only real collateral the company had left, the Transwestern and Northern Natural pipeline systems. For years, Enron’s natural-gas pipelines had been an afterthought. Now they were the company’s lifeline.

  And the pipes weren’t all the banks wanted. J. P. Morgan Chase and Citi extracted commitments that Enron would use them exclusively for all its investment-

  banking work for the next 18 months. “Due to the company’s recent liquidity issues, J. P. Morgan is well-positioned to realize further business,” a Morgan internal memo crowed. “In addition to our leadership role in the arrangement of $1.0 billion in financing . . . we have been mandated as a strategic advisor to Enron with an initial retainer provided of $15 million. Further, we anticipate additional restructuring and arrangement fees going forward.”