Enron executives railed privately about the banks’ “strong-arm tactics” and “extortion”—oblivious of the rich irony. Indeed, Enron tried to turn the tables on Goldman, demanding that it either lend the company money or make an equity investment if it wanted to keep earning advisory fees. When the Goldman executives kept asking sticky questions, the relationship ended with a major blowup. “Get out of our offices right now unless you’re willing to cut a check,” Whalley told Gieselman.
Still, by November 1, Enron was able to announce that it had secured another $1 billion in financing. But as it turned out, $250 million of the package was merely the refinancing of an existing loan from Citi that was expiring at year-end. It improved the bank’s collateral position but gave Enron no new cash. Even after hocking its pipelines, Enron had generated only $750 million more, which wasn’t going to last long.
• • •
One of the prices of becoming a supplicant is having to expose yourself to unfamiliar scrutiny. Before the crisis—still only a few weeks old—Enron had protected its darkest secrets, allowing the company to freely spin its tale of an untroubled, ever-brighter future. But Enron’s need for money forced the company to open its books to the banks. As they burrowed in, Enron’s lenders experienced their own revelations about the business they financed for so many years.
It was hardly news that the international assets had been a money pit, that Azurix had been a disaster, that Enron had spent far too much on broadband. But one of the company’s fundamental premises was that all was well at the core trading operation—that Enron Wholesale, where trading was harbored, was not only hitting its lofty numbers but would generate bigger profits in the years to come. Indeed, saving the trading operation became the core premise of Enron’s survival strategy, even though it would consume billions in precious cash. As the Whalley-led management team saw it, this was the company’s crown jewel, its only path to salvation.
But for the banks, even trading had now become suspect. In one memo to an Enron finance employee, Deutsche Bank’s Paul Cambridge openly wondered whether Enron was making up some of its trading profits. “With regard to the risk book, a constant concern for our derivatives and credit people is Enron’s mark-to-market methodology,” he noted. “There is a concern that as an unregulated trader, the mark to market is very much an Enron-driven internal process as opposed to seeking three quotes etc. etc. This is exacerbated by the belief that a significant component of the risk book is either illiquid long-term trades or exotics (weather derivatives paper etc).”
J. P. Morgan Chase dispatched a full due-diligence team to Houston to test Enron’s claims that the core business was in good shape. The SWAT team soon reported back with fresh intelligence after a bank executive named Charles Freeman found, to his surprise, an Enron executive who was “a straight shooter, and seemed to know just what was going on, and where the money is or isn’t.”
“I was struck by the [cash flow] analysis shown to us,” Freeman advised. “The key question in my mind is the reason ENE has had to continually raise very large sums through prepays and the other off-balance-sheet financing.” One explanation, from Enron treasurer Glisan, was that “the rating agencies needed to see that there was cash flow to match MTM [mark-to-market] earnings.” But Freeman was skeptical of this. “The real reason,” he wrote, “must be their need to finance all the businesses that are soaking up cash.”
The evidence was in Enron’s cash-flow schedule—“an eye-opener,” Freeman reported. It broke down the separate businesses inside Enron Wholesale, showing earnings and cash flow for the first nine months of 2001. “The core Enron North America is the cash producer—everything else is soaking up cash,” Freeman reported. But the “key question”—which he couldn’t yet answer—was whether the trading operation’s cash flow had been “puffed up” by “hidden financing.” From “a number of comments made by Enron people,” he wrote, it was “clear,” despite the company’s assurances, that 2002 trading profits were going to drop. The only issue, he wrote, is “by how much.”
Freeman also spotted the hidden stinkers. The trading division “is carrying a bunch of loss-making businesses,” he reported. “This explains the need of ENE to close large prepay financings in Q4 (this year and in previous years) to get the cash needed to stay afloat.” The “biggest culprit,” he added, was EES. “There have been big losses in this retail book, carried on wholesale’s books.” The numbers he’d been given put EES’s trading losses at $496 million for the first quarter and $230 million for the second. Enron’s European operation too—long touted as a “barn-burner” and reporting profits—was barely scraping along.
• • •
After a few weeks of kicking back and watching Enron unravel without him, Jeff Skilling was getting his mojo back. Skilling had intended to ease back into the world of business. He was talking to Lou Pai about doing some deals, and he hoped to teach; he’d already agreed to offer a class at Rice University in Houston on Business Strategy and Microeconomics.
Three months earlier, when he quit Enron, Skilling felt certain that his presence had become a lead weight on the company’s stock. But Enron’s real collapse had begun only after he’d left. To Skilling, this sequence of events could only mean one thing: he hadn’t been the problem after all! What’s more, as Skilling saw it, there really wasn’t anything wrong with Enron. Like Lay, he saw it primarily as a perception problem. Despite everything, the company was still promising profits of $2.10 a share in 2002—while the stock price was down to ten dollars. Sitting on the sidelines, Skilling became increasingly agitated. This was nuts!
Whalley was smart but green, in way over his head, with little experience. Wall Street viewed him as a bully. Lay was clueless. Someone had to take charge. Skilling decided it should be him. He built Enron; now he could save it. So Skilling called Lay, offering himself as savior.
“Ken, you’ve got to bring me back.” Skilling told him. “As interim CEO, COO—something. You’ve got to get ahead of this thing!”
Skilling explained what had to be done and, as always, made it sound simple. They needed billions, he figured, and that meant they had to get on a plane to New York, right away. They needed to go see J. P. Morgan Chase vice chairman Jimmy Lee. They needed to sit down across the table and tell him face-to-face: There’s nothing wrong with Enron. You’re going to get paid back!
Never mind that the banks had already made it abundantly clear they weren’t going to hand money over to Enron anymore. Skilling had always been able to work his magic before. No one was more convincing. Even now, just listening to him, it seemed that he might be able to pull it off. It could be the best chance Enron had. “I’m very interested,” Lay told him. “Very interested.”
The next day, Lay sent Whalley to Skilling’s home. They talked about liquidity. “I’m just horseshoes-and-hand-grenades guessing,” said Skilling, “but I think you need about $3 billion.”
“Our guess is about $3.5 billion,” Whalley told him. After 30 minutes of conversation, Whalley said he was ready to welcome Skilling back.
For a few hours, back at Enron, the idea of bringing back Skilling was seriously entertained. Lay summoned a handful of executives to a conference room on the fiftieth floor to talk about it. “I think it can work,” he told the group. “What do you think?” Whalley agreed. “Jeff knows the business and can get everybody back on board,” he said. “He can go up to New York, and explain the story and get the liquidity.”
When McMahon arrived late for the meeting, he was shocked at what he was hearing. How could they even think about bringing Skilling back? Who did they think was responsible for this mess? Who was responsible for Fastow? What’s more, Jeff had walked out on them. It was as though they’d fallen back under Skilling’s spell, mesmerized by the thought of his return—like Jim Jones’s followers in Guyana, ready to drink the poisoned Kool-Aid. “You guys are out of your minds!” McMahon told them.
Whalley told Skilling the deal was o
ff. The consensus view was that his return would spook the market, Whalley explained. No one would understand.
Still, Skilling wasn’t ready to give up on the idea that he could rescue Enron. He began trying to put private equity together on his own, calling friends with big money, like the Chicago billionaire Sam Zell, who might help recapitalize the company. Baxter and Pai agreed to go in on it with him. It would be just like the ECT days. The old gang would be back.
Skilling and Baxter starting spending four to five hours a day on the phone, cooking up plans until one in the morning. It was just like the old days. Right around that time, an SEC subpoena arrived. Skilling dropped the idea.
• • •
For Enron’s directors, there was a new leading indicator of the company’s deepening problems: the presence of a fresh team of lawyers at their frequent special meetings. On Sunday, October 26, it was William McLucas, former enforcement director for the SEC. After leaving the government, McLucas went into private practice with the Washington law firm of Wilmer, Cutler & Pickering. Now he was the go-to man for companies embroiled in accounting scandals.
McLucas had the process down to a drill: serving as the company’s independent counsel, he’d conduct a detailed internal investigation, backed by a special team of forensic accountants, experts in dissecting complex transactions. The process would be overseen by a special board committee, which would issue a public report, aimed at reestablishing the company’s credibility by airing out all the dirty laundry.
Lay had resisted hiring McLucas and his high-powered team, insisting to Enron subordinates, “They’ll just find something wrong.” But now, he had no choice. The SEC was about to announce that it was elevating its informal inquiry to a formal investigation; Enron’s credibility on the propriety of its dealings with Fastow’s partnerships—which Lay had so doggedly defended—had evaporated. A newly appointed director, University of Texas Law School dean William Powers, would chair the special investigative committee for the board. Deloitte & Touche would do the forensic accounting.
At another board meeting two days later, there was an even more sobering legal presence: Martin J. Bienenstock, corporate America’s grim reaper. Bienenstock, with the New York firm of Weil Gotshal & Manges, was the nation’s preeminent bankruptcy lawyer. No one at Enron was ready to throw in the towel, but his appearance was a signal that the situation was becoming dire. Bienenstock’s mere presence, had it been leaked to the press, would have been sufficient to throw Enron’s stock into a further tailspin.
Enron was running out of options. Even after the new $1 billion loan from the banks—which still hadn’t closed—the big issue remained liquidity. No longer willing to trust Enron’s credit, more and more of the company’s trading counterparties were demanding cash collateral. Money was rushing out the door faster than Enron could raise it.
By early November, with the banks balking at ponying up any more cash, Enron was engaged in a wide-ranging search for capital. It was desperately trying to sell assets. It had contacted the big private equity firms. It had made inquiries to potential strategic partners, including Shell and British Petroleum, about buying a stake in the business. It had put out feelers to Omaha billionaire Warren Buffett, Saudi Prince Al-Waleed, and—indirectly—even Rich Kinder. There was time for just one more desperate Hail Mary pass—a last-ditch deal, code-named Project Notre Dame.
• • •
The day after Andy Fastow was fired, Enron pipeline chief Stan Horton sat down in a private room at Houston’s Plaza Club for his regular lunch with his old friend, Steve Bergstrom. Bergstrom, an Enron alum, was the number-two man at Dynegy. On this day, they weren’t eating alone; Horton had brought along his bosses, Enron president Greg Whalley and vice chairman Mark Frevert. As the four broke bread, Whalley posed a question that would have seemed unimaginable just a few days earlier:
Would Dynegy be interested in buying Enron?
Bergstrom was astounded. They’re in worse trouble than I thought! When lunch was over, the Enron executives returned to headquarters and reported the Dynegy president’s response to their overture. “They’re horny,” Whalley said.
For Dynegy’s top executives, the thought of acquiring Enron was indeed alluring. CEO Chuck Watson and his company had operated in the shadow of Ken Lay and Enron for more than a decade. Since 1985, when Watson had taken over the business—then called the Natural Gas Clearinghouse—Dynegy had en-
joyed a stellar run. The company had grown rapidly; its earnings and stock price had steadily climbed. It owned power plants and pipelines and traded gas and power too.
Yet Dynegy, whose headquarters was just a few blocks down the street, had always been perceived as an Enron wannabe. It was only one-third Enron’s size. As Enron emerged as the industry superstar, Enron’s executives—especially Skilling—always treated Dynegy with disdain. They regarded Watson’s company as an unimaginative pipsqueak—a stolid bunch of Enron castoffs and working stiffs, with hardly a Harvard MBA among them. Even Dynegy’s slogan seemed pedestrian: “A leading global energy company respected for the manner in which we deliver extraordinary value to our stakeholders.”
Like Lay, Chuck Watson was a pillar of the Houston community. An economics major at Oklahoma State, the 51-year-old CEO had chaired Houston’s United Way campaign, owned Houston’s minor-league hockey team, and held a minority stake in its new NFL franchise. Where Lay was cerebral and measured, Watson was blunt and folksy. A large, beefy man, he was a dead ringer for Chuck Connors with forty extra pounds. Watson also was tough and not just at the bargaining table. As he contemplated buying Enron, he’d just finished a course of radiation treatments for prostate cancer, which he’d scheduled for 4:30 A.M., so he wouldn’t miss any time at work.
Personal motivation aside, Watson had sound business reasons to consider a deal. For years, Enron’s high-flier status had lifted all energy companies’ shares. As Watson put it, “they had drug everybody else up.” Now, if Enron failed, they might well drag everybody else down. But the most obvious attraction was that Enron’s stock was in the toilet—not much above ten dollars. The entire company, valued at close to $70 billion less than a year earlier, could be had for less than $10 billion. If the trading business was really operating as promised—if there really weren’t any more surprises—Enron could be a steal.
Watson was in his office when Bergstrom raced in to tell him the news from lunch. A call from Lay soon followed, and the two CEOs—knowing they needed to keep any meeting secret—agreed to have breakfast at 8:30 Saturday, at the Lays’ condo in River Oaks.
Over rolls and coffee, Lay played it cool. His company was in a pinch, to be sure, but he was exploring a number of options. Still, they needed to move fast. As Lay envisioned things, the deal would be a merger of equals. They could come up with a fresh name for the new company, just as he had when Enron was born. Lay even imagined himself holding an exalted title with the new enterprise, perhaps something like chairman emeritus.
Watson wasted no time shattering such illusions. This would be an acquisition, he told Lay. Dynegy would buy Enron—for market price, without a premium. The combined company would be called Dynegy, and Watson’s team would be firmly in charge.
Lay wasn’t in much of a position to argue. The two men talked through lunchtime, hashing out how a merger might work, and agreed to set it all in motion.
One week later, on November 2, Lay placed Project Notre Dame before his board. In a handout detailing the transaction, Enron was code-named Gipper, Dynegy was Rockne, and ChevronTexaco, which owned 26 percent of Dynegy, was Heisman. The sale to Dynegy was structured to give Enron what it most needed—a quick infusion of capital. ChevronTexaco had committed to providing $2.5 billion—$1.5 billion right away and another $1 billion when the merger closed.
In truth, even that amount was far less than Enron really needed. A board document prepared by Enron’s bankers concluded it would take at least another $3 billion just to keep Enron alive through the en
d of 2002, about the time the deal was likely to close. A fundamental premise of their thinking was that the involvement by ChevronTexaco, the global oil giant, would be so reassuring to Enron’s trading partners that it would bring an immediate halt to the ongoing run on the bank. All this meant that the deal was woefully undercapitalized from the start. The Enron team saw it as a way to buy a little time—they’d find the extra billions they needed later. None of this was shared with Dynegy.
For Enron, the prospect of a sale to Dynegy was humbling. But if all went according to plan, it would preserve the core energy-trading operation and give them all a chance of staying in business. Other alternatives Enron had explored wouldn’t generate cash soon enough to keep the business alive. J. P. Morgan Chase vice chairman Jimmy Lee, sitting in with the Enron board (the bank, which was advising Enron, had agreed to help finance the deal), pointed out its crucial advantage: “Dynegy can move fast.” Enron wanted to sign the merger agreement on Sunday, November 4, and announce it the following day.
Enron desperately needed some good news, especially since it was about to drop another bombshell on the markets: the huge accounting restatement. Andersen delivered the news to the board that same weekend: Chewco and LJM1 hadn’t really qualified for off-balance-sheet treatment. And Andersen had concluded that the $1.2 billion equity write-down Enron had already disclosed—which it had previously deemed immaterial—would also require restatement.
Lay, Causey, and the board were furious. Flip-flop, flip-flop—how could Enron trust its auditors on anything? Why hadn’t these problems been uncovered long ago? If Andersen had done its job properly, Lay complained, “we wouldn’t be here today.” True enough. In its accounting work for Enron, Andersen had been sloppy and weak. But that’s how Enron had always wanted it. In truth, even as they angrily pointed fingers, the two deserved each other.
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The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron Page 64