Skilling refused.
“That just opens us up for lawsuits, Rebecca,” he snapped. “If somebody in the bowels of Enron hears about some water opportunity and we don’t bring it to you, we’re liable for it. There’s no way I’m setting that up.”
Mark was furious. “But if the corporate-opportunity language isn’t there, then anytime you want, you could go into the water business and compete against us!”
Skilling opened his eyes wide and smiled. “That’s right. We could. We won’t. But we could.”
It was a delicious moment for Skilling. Everything at Enron was about to change. With Mark gone, there would be no more battles where she could go around his back to Lay. She would be off at Azurix. And he could run Enron the way he wanted, without interference.
Two days later, just before three o’clock, a woman tapped lightly on the large wooden door to Skilling’s office. Skilling stood, delight on his face. “Hey, Mary,” he said. “Come on in.”
Mary Joyce, who managed executive-compensation issues at Enron, stepped inside and took a seat. Soon they were joined by Rick Causey, Joe Sutton, and a few other executives. Skilling’s face grew serious. He had waited for this moment for years. He wanted to enjoy it.
“Okay, we’re making some big changes in the compensation for international,” he said. “We’re doing away with the old contracts. No more big bonuses on closing.”
Sutton seemed to have anticipated what was coming. Mark wasn’t even out the door yet, and Skilling was tearing up her business. “Jeff,” he began.
Skilling didn’t wait for the objection.
“We’re going to a single, standardized compensation plan. Everybody goes through the PRC, everybody gets ranked, everybody gets paid according to their rank.”
There were some protests, but they all knew it was pointless. The bonuses that Skilling and his team had railed against for almost a decade were dead.
Late on March 16, Fastow reached for the phone. The Azurix stock offering was another great opportunity, a chance to punish a Wall Street firm that wasn’t cheering loudly enough for Enron. Fastow was looking forward to it.
This time his target was Don Dufresne with Salomon Smith Barney, part of Citigroup. As a stock analyst, Dufresne had always been too cautious in his ratings for Fastow’s taste. He told investors that Enron had potential, but also sizable risk. That wasn’t the kind of analysis Enron’s management wanted to hear—or to be told to investors. Dufresne, they were convinced, just didn’t get it.
But they wanted to be sure his firm did. Enron had just announced plans for the Azurix offering. Merrill, which had ingratiated itself to Enron by firing Olson, was lead underwriter. Salomon was allowed only a trivial role.
On the call, Fastow spoke with Robert Holloman, head of Salomon’s investment banking group for energy. His message was identical with the one conveyed the year before to Merrill.
“Don Dufresne is just not constructive in his views about Enron,” Fastow complained. “He wasn’t supportive in our stock offering. And I think that showed up in the fact that you guys sold fewer shares than any other manager.”
Holloman pressed Fastow. Were there problems with his company’s investment-banking services?
“Nothing like that,” he said. “Dufresne is the one reason you guys don’t have a big role in Azurix. We want to see progress in your equity-research view of us before our relationship can really progress.”
Within months, Dufresne was gone, giving Fastow another notch in his belt. In his place, Citi installed a new analyst, one recommended by Enron itself. Salomon Smith Barney’s rating on Enron stock went up.
Wall Street got the message. Questioning Enron cost business. So questioners lost jobs.
———
Fastow’s approach was subtle, almost seductive. With Mike Jakubik shoved aside, Fastow and Kopper were ready to start on this new equity-fund idea. But McMahon had been right: neither of them knew much about raising private equity. So they needed help from someone who did. The answer was obvious: Jim Timmins, the executive hired to handle relationships with the pension funds.
One afternoon Fastow spoke to Timmins. “We need to come up with ways to attract passive equity to our deals,” he said. “Come back to me with any ideas you’ve got.”
Timmins was excited. “Sure, Andy. Sounds great.”
Timmins went off to work on the project. Fastow was eager to hear his ideas, particularly on which institutional funds to contact. Then he could steal them for himself and Kopper.
A group of Azurix executives watched as a Learjet pulled up to the Enron hangar. The aircraft stopped beside an Enron jet being prepared to fly the group to Hamilton, Ontario, for a business meeting. It took a moment for them to realize the Lear had been chartered for a specific trip.
When the Enron plane was ready, the executives walked out to the tarmac. One executive, Amanda Martin, saw a car approach, ferrying Rebecca Mark. It took a moment for Martin to add up the pieces; the chartered jet was for her boss.
Mark stepped out of the car and approached her team.
“Where are you going?” she asked.
“Hamilton,” Martin responded. Azurix was negotiating to purchase some assets from Philip Services, based there. “Where are you going?”
“New York,” Mark said. “Well, have a good trip.”
Everyone flew away. On the crowded Enron plane, the Mark trip was the only topic of conversation. Finding a flight to Hamilton was difficult, and time was of the essence for this deal. But New York? There was a flight there almost every hour out of Houston. But rather than just buy a ticket, Mark had chartered a Learjet.
It gave the executives on board a very bad feeling.
The draft document was fifteen pages long, too skimpy to attract much attention from anyone. But Fastow and Kopper were sure this idea, at long last, would be the one that made them rich.
With Jakubik out of the way, and Timmins devising ideas Fastow was eager to take, the special-projects group was assembling an investment fund. Fastow had toyed with the idea for months, raising it with bankers from Merrill Lynch. Now, by March 1999, the pieces were coming together.
They had drafted an offering memorandum for a fund called Enron Merchant Partners LP. The draft still had typos, and Merrill was nitpicking aspects of the deal. But the broad outlines were all there. Kopper would run it, reporting to Fastow. Both would be investors. The fund would raise a billion dollars. If Enron needed to sell something, Merchant Partners could be there. No more hunting for investors. Enron wouldn’t have to worry about the market; it would be the market. Deals like RADR and Chewco would become part of the way Enron did business.
It was the perfect solution just looking for a problem.
CHAPTER 9
BEDLAM REIGNED AT ENRON on the morning of April 7, 1999, a Wednesday. Around the building, televisions and computers blared reports about Wall Street’s hottest new stock. Traders wanting real-time information watched their quote monitors, awed by the rapidly rising numbers.
Rhythms NetConnections—the Internet start-up that had sold a chunk of itself to Enron thirteen months before—had just gone public and, on a day that powered the Dow Jones Industrial Average past 10,000, was swept up in the get-rich-quick mania. Even by the irrational standards of the bubble market, Rhythms stood out, nearly tripling in its first trade on the NASDAQ market to fifty-six dollars. With mark-to-market accounting, Enron had just earned a fortune.
As the market’s euphoria spread throughout the building, Jeff Skilling was in a conference room presiding over another interminable planning session, this one with the merchant-investment committee of the wholesale division. Skilling was pushing the executives to find a way to protect Enron’s gains in its high-flying merchant investments with “hedges”—related investments that would go up in value if Enron’s holdings went down. Without hedges, every dollar of profit from merchant investments could turn into a loss when the market soured.
As th
e meeting droned on, Kevin Garland, from Enron’s private-equity group, glanced at his alpha pager to check something.
“Hey, Jeff,” he interrupted. “Remember that Rhythms investment we made?”
“Yeah.”
“Well, it just went public today. You know how much money we’ve made?”
A ten-million-dollar private investment, held for one year? Maybe ten million in profit? “What?” Skilling asked.
“Last I checked, we’re up around ninety million dollars.” Stunned silence. “What?” Skilling barked.
And the price just kept going. By afternoon, the value of Enron’s investment in Rhythms had climbed to nearly $400 million, up from around $28 million. Under mark-to-market accounting, each one of those dollars could be recognized by Enron as profit.
But there was a hitch. Under its deal with Rhythms, Enron could not sell its shares until six months after the public offering. The condition was standard fare for an IPO; no start-up wanted big shareholders dumping stock just as trading began. If Rhythms’ stock price collapsed while Enron was still required to hold on to the shares, the huge, unanticipated windfall in the second quarter could transform into a huge, unexpected loss in the third.
“This is what I’m talking about,” Skilling told the assembled executives. “This is why we need to figure out how to put together some good hedges”
A good hedge on Rhythms would avoid the black eye of a loss down the road, he said. It was a serious problem. They had to find a solution.
Setting up a hedge is a bit like taking a photograph. The idea is to capture a moment in time, freezing it in place. But as blurs and dark streaks can distort a snapshot, unanticipated imperfections can sabotage a hedge.
The reasons for wanting to lock things in place vary. With Rhythms, it was simple financial management: The price run-up brought in profits that Enron didn’t want to lose. Setting up a hedge at the high price—snapping the picture at that moment—would theoretically allow Enron to halt everything at the best possible point for the company.
But what sounds easy in theory is difficult in practice. A perfect hedge would move up in value the exact amount that the investment moves down—the posed professional portrait of the financial world. Owning a stock, for instance, is usually a bet that its price will go up; investors can also bet that the price will go down—by borrowing shares and selling them, in what is known as a short position. So a perfect hedge for a stock would be to short the same stock. But that would be the same as selling, so for Enron that wasn’t an option.
There were messier alternatives. The most obvious was to set up a different short position, betting that prices would fall in the stocks of an array of companies similar to Rhythms. That would protect Enron from a price collapse in high tech, but not from problems limited only to Rhythms.
There was, in theory, one more possibility. Enron could pay a third party to assume the risk that Rhythms’ price would fall. Wall Street often sells what are known as put options on a stock—in effect, agreeing to purchase the stock at a set price in the future. If Enron could find an investment bank to sell it a put option—and agree, for a fee, to purchase Rhythms at its high-flying price six months in the future—then its profits would be locked in.
Unfortunately, that was impossible. Such a deal would likely violate Enron’s agreement with Rhythms. Worse, no investment bank would sell a put option on a volatile, thinly traded stock like Rhythms without receiving a gargantuan fee—cutting into the profits Enron wanted. This was business, not love. No one would take on the risk of an almost-inevitable price decline just because Enron needed them to. Certainly not without some sort of inside deal.
Later that same day, April 7, reporters and photographers watched as Ken Lay shook hands with Drayton McLane, owner of the Houston Astros. They were on the northeast side of downtown, ready to make the formal announcement: Enron had agreed to pay $100 million for the right to name the new ballpark being built for the team. From now on, the Astros would play in Enron Field.
Lay thought it was a great arrangement. The money would be owed over thirty years, but during that time the retail business would manage the energy contracts at the baseball stadium, hopefully bringing in as much as $200 million. It was win-win all around.
Lay and McLane made a few statements for the reporters. Enron was excited to be part of the ball club, Lay said, and looked forward to opening day in 2000, when the ballpark would be ready for use.
“We’ll do what we do best, which is manage energy and facilities,” Lay said. “And we’ll let the Astros do what they do best, which is winning baseball games.”
“Isn’t there another way to look at this?” David Duncan implored. “It’s really important to Causey.”
Duncan was on the phone with Carl Bass, haggling over some international deal designed to defer taxes Enron owed. But Bass had come back and said no, it couldn’t be done. Now Duncan was pleading with him to try again, to find a way to let the tax expense go unrecognized that year.
“Not a lot I can do, Dave,” Bass said.
Duncan pushed back one more time.
“Okay, tell you what,” Bass said. He would call Andersen’s top accounting experts in Chicago and ask them to review the deal one more time to see if he had missed anything.
He hadn’t, they reported back. Bass figured it wasn’t a big deal. The taxes owed were less than fifteen million dollars. Enron couldn’t possibly need profits that badly.
———
Bass stood uncomfortably in the anteroom outside Causey’s office. It was April 10, and in recent days Causey and Duncan had been down in Augusta, Georgia, watching the Masters Tournament. But they flew back early to meet Bass and hash through the tax issue one more time.
Causey called Bass into his office, where Duncan was already waiting. The three men wandered to the formal sitting area.
“All right, we all know why we’re here,” Causey said. “I’m going to lay out Enron’s position.”
Causey spoke for several minutes. He said nothing about the rules; instead, he talked about the financial outcome Enron wanted. Bass was unmoved.
“Sorry, Rick,” Bass said. “I’ve looked at this, Chicago’s looked at this. It is what it is.”
“Wait,” Duncan said. “Rick, I hear your point. So, Carl, what if you moved your position a little bit?”
Duncan explained how he thought Bass could compromise. Bass gaped at him. Duncan was supposed to represent the firm’s opinion, not try to broker a compromise.
This isn’t a negotiation, Dave. There’s an answer. I gave it. We’re done. “So what if you did that? Do you think we could find a middle ground?” Duncan asked.
Did they not understand what accountants did? “No, Dave, there’s no middle ground. There’s an answer. The firm has put in its best people. And we have given the answer.”
Causey sighed, looking furious. “Okay, fine.”
The meeting broke up. As Bass left, anxiety welled in his mind.
God knows what these two are going to do now.
The stock analysts covering Enron were excited by the numbers coming in from Rhythms. This, they knew, could mean big income. So during a conference call on April 13, one analyst asked Skilling if Enron was booking any profits from its Rhythms investment.
“You got us,” he replied. “No, we’re carrying that on our books right now at a value of about twenty-eight million dollars”
But if Enron hadn’t yet recorded the stock’s full value, he said, it hadn’t lost sight of the profit. “Just do the math. It’s worth, at close yesterday, about $406 million, and again it’s on the books at $28 million.”
Someone mumbled a price update in Skilling’s ear.
“Oh, it’s up another fifteen dollars,” he said, chuckling. “We’re trying to figure out how we deal with this thing”
———
The next day, at the governor’s office in the Austin Capitol building, George W. Bush took out a small white postc
ard embossed with his name. He picked up a felt-tip pen to write a quick note to his friend Ken Lay.
Lay and Bush had taken a few years to get to know each other, but the relationship had finally begun to bloom around 1994. That year Bush was battling then-governor Ann Richards for her job. Lay was also close to Richards but sided with Bush, shoveling almost thirty-eight thousand dollars into his campaign—three times what he gave Richards.
Since Bush had become Governor, his friendship with Lay had strengthened. Lay had been appointed by Richards to the Governor’s Business Council, and Bush had reappointed him in 1995. When Bush started testing the waters for a presidential bid, Lay stepped up early with campaign contributions. Bush often sent Lay small Christmas gifts and frequently received reading material and letters from him.
Recently, Lay had forwarded a New York Times Magazine article written by Thomas Friedman, the Pulitzer Prize—winning writer, about the importance and challenges of globalization.
Bush dated the note and started scribbling: “Dear Ken, Thanks for the Friedman article—I too found it very interesting. All is well.”
He signed the note “GW.”
At about 10:15 on April 19, Skilling wrapped up with Fastow and his team, reviewing the agenda for the next meeting of the board’s finance committee.
“Okay, guys, this looks fine,” Skilling said as everyone stood.
Fastow lingered behind. He had asked Skilling’s secretary to squeeze in a few minutes for a quick discussion. Skilling turned to him once everyone was gone.
“Andy, what’s up?”
“I’ve got an idea,” he said. “Anytime we do a complex transaction around here, we incur an incredible cost from all the investment-banking fees.” That Skilling knew; the fees were just killers.
“So what if I set up something, an independent investment fund where I was the general partner,” Fastow continued. “To the extent you guys want to, you could offer me assets, and I would probably be able to give you a better price, because I understand the assets.”
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