McMahon gaped at him. An 8,000 percent return. “You’ve gotta be kidding,” he said. “Ten million?” Fastow nodded.
“Ten million dollars? Why don’t you just tell Michael to check what company is on his paychecks. He works for Enron. Ten million is unconscionable.”
“I think it sounds fair,” Fastow said with a shrug.
No way, McMahon said. This money would go to Kopper’s domestic partner or Kopper himself. It was extortion.
“I will not allow this company to pay ten million dollars for this,” McMahon said. “Tell Michael there’s no deal.”
At his home on the evening of Friday, January 28, David Bermingham of Greenwich NatWest sat in front of his computer, crunching some LJM1 numbers. He hit the “return” button and up popped a figure he was happy to see.
Bermingham was analyzing the value of Swap Sub, set up by LJM1. That entity held a huge slug of the Enron shares gifted to LJM1 and was legally responsible for making good on the Rhythms hedge. In essence, for the Rhythms hedge, LJM1 collected cash from investors, Swap Sub did the business. For a long time Swap Sub wasn’t exciting. Weeks before, on January 5, Bermingham had reviewed an analysis showing Swap Sub had a value of negative twenty-five million dollars.
Then, it happened. Scott McNealy walked into a room. Analysts went nuts, and so did Enron’s stock price. Now it wasn’t just the usual lot of shareholders who had a paper fortune—so did Swap Sub. Bermingham’s calculations showed that if the Rhythms hedge was shut down and the value of Swap Sub distributed, the LJM1 investors would make millions.
That got Bermingham thinking. His office was in turmoil. National Westminster, the parent of Greenwich NatWest, looked like it would soon be acquired by Royal Bank of Scotland. Greenwich was sure to be sold. Bermingham and his pals—who had brought LJM1 to the bank—could be out on the street. Then this windfall of profits would go to—whom? RBS? That, Bermingham decided, just wasn’t right.
Not when there was another choice: the guys who worked on the deal. Bermingham, Giles Darby, Gary Mulgrew. They should make the profits. They might be able to pull it off, with help—from Fastow, probably Kopper, too. Then it could work. The next day, Bermingham typed an e-mail to Darby, explaining his analysis of LJM1 and Swap Sub.
“There is quite some value there now,” Bermingham typed. “The trick will be in capturing it. I have a couple of ideas but it may be good if I don’t share them with anyone until we know our fate!!!” The next conspiracy had begun.
The conference call between Houston and Chicago had been dragging on for more than thirty minutes. The Andersen accountants had been intensely reviewing Project Raptor for days; now, on February 3, they were trying to decide whether the deal could be done under the accounting rules.
Calling from Houston with the Enron engagement team were David Duncan and Deb Cash, along with Carl Bass, now with the Professional Standards Group. On the line in Chicago were John Stewart and Jim Green, both from the PSG.
The whole idea, as described by Duncan and Cash, struck Bass as ludicrous. Enron was just shifting around assets and pretending to set up a hedge—with itself.
“This whole deal has no substance,” Bass said. “All the money at risk comes from Enron. How is this a hedge?”
Duncan countered with a monologue on the three percent rule. But the accountants in Chicago were unconvinced.
“Why not bring in a real third party, like Goldman Sachs, to do a straight hedge?” Bass asked.
“They don’t want to do that,” Duncan said. “It would be too expensive.”
That spoke volumes. If the market won’t provide the hedge at a low price, there was probably a good reason.
“Look, David, the way it is put together is just not going to work,” Green said.
“Well, wait a minute,” Duncan responded. “Listen to this. What if we make these changes?”
A nip here, a tuck there, and everybody started signing on. It made Bass’s head ache. Whether Raptor could be twisted to meet some tortured interpretation of the rules wasn’t the point. The deal did nothing. It didn’t protect against losses. Apparently, the client didn’t care. Enron just wanted protection from having to report losses.
The next morning, Bass arrived early in the office. He had been thinking a lot about Raptor since the previous day, and his doubts had hardened into conviction. Nobody should be doing this deal. He logged on to the Andersen system and addressed an e-mail to Stewart and Green.
“I am still bothered by the transaction we discussed yesterday,” Bass typed.
Essentially, he wrote, Enron was jury-rigging a contraption to hedge with itself. “I have to ask myself, why not do a straight deal with Goldman?” Bass typed. “They said so themselves. It will be too expensive.”
And why was Enron providing the capital Talon would use for hedging? “Because,” Bass wrote, “no bank is dumb enough to loan money whose payment is dependent on changes in the value of an Internet stock”
At 6:38 A.M., Bass hit the “send” button.
The response came back in just over an hour. Stewart wrote that it sounded like Bass was arguing Talon would have to be consolidated into Enron. “We should discuss it some more,” he wrote. “You have some good points.”
Three days later, Azurix was ready with its latest plan to save the company. At a board meeting, Rebecca Mark explained that the company was on the verge of a big announcement: it was about to plunge into the dot-com mania, a surefire way to drive up the stock price.
The idea was to create a sort of Enron Lite, a trading business designed not for gas and electricity, but for water. Not long ago, Enron had introduced an operation called Enron Online that allowed it to serve as a principal for energy trades over the Internet, and it had grown like gangbusters. Well, this new idea—water2water.com—would do the same thing, Mark said. It would be a huge business.
The directors listened, skeptical. Online trading for electricity and gas made sense, since those commodities were pretty much the same all over. But water? Upstate New York wouldn’t trade with downstate. Different localities had different qualities; it simply wasn’t standardized. Of course, there were industrial uses for water, like applications for farms. But why would potential customers turn to the Internet when they could just turn on the spigot?
As Mark rambled on about the latest brainstorm, the directors grew restless. They had made it clear to her repeatedly that they wanted to see belt-tightening in the company. Yet here she was, proposing more spending. All told, she still planned to burn through in excess of $100 million a year.
And Mark thought even that was tight. “Again,” she said, “I would advise that the best option is to pursue an aggressive growth strategy rather than cutting back.”
The directors jumped on her. “Rebecca, that is not going to happen,” Pug Winokur said. “We have turned aside that idea, and we are not going back to it.”
Skilling picked it up from there. “Rebecca, this is just not enough. I mean, look at this. You’ve got something like thirty million dollars here for computer-system development.”
“That’s for the Internet water exchange,” she said. “That will give us a significant growth in market cap.”
Skilling sucked in a breath. Spending millions just so Azurix could bandy about the word “Internet”? Did she really think that would make investors clamor for Azurix stock? Was there any real business plan here?
“Rebecca, you need to cut the burn rate way back,” one of the directors said. “Down to forty million”
Mark’s face fell. “Wait a minute—”
“Forty million, Rebecca,” Skilling interrupted. “That’s all you’ve got. Figure out how to make it work.”
Mark was stunned. There was no way she could pursue her vision with just forty million dollars. She wouldn’t be able to make acquisitions. No bidding, no public relations. Forget the corporate jets. Azurix would be reduced to managing the water assets it already owned. It was a dreadful prospect.
“I can’t in good conscience do this,” she said. “We would have to cut the water2water site, which is going to be gigantic. It would mean abandoning it.”
Lay spoke up. “Rebecca, we need to see this alternative. Run the scenario, and show us what it means.”
After the meeting broke up, Mark, Lay, and Skilling stayed behind. It was time for another talk.
Lay was the first to speak. “Rebecca, I want to stress that this is very serious. And to tell you the truth, I don’t think the board has confidence in the case you’re making.”
He eyed her, seeing if this was getting through.
“I think we need to see something that is a much more significant effort to ratchet this back,” he said. “I want you to know that’s what the board wants.”
Mark nodded. “I got that loud and clear,” she said.
All right, Lay replied. He and Skilling left the room and climbed onto the elevator.
“She hasn’t thought this through,” Lay said suddenly. “She doesn’t understand the severity of it.”
Skilling felt a wave of relief. Lay got it.
That same afternoon, directors from Enron’s audit committee clustered around the circular table in the boardroom to hear the final wrap-up for 1999, checking for accounting problems that might need attention. Robert Jaedicke, the Stanford Business School dean who chaired the committee, recognized David Duncan for Andersen’s annual audit review. As usual, everything sounded great.
“Arthur Andersen’s financial statement opinion for 1999 will be unqualified,” Duncan said. “There were no significant audit adjustments, or disagreements with management, or other significant difficulties.”
Later in the meeting, Jaedicke introduced a new topic. “As you know, we have approved the participation by Andy Fastow in certain investment vehicles called LJM1 and LJM2,” he said. “It is our committee’s responsibility to review Enron’s participation in transactions with those vehicles, to ensure they were done at arm’s length.”
Jaedicke recognized Causey, who proceeded for several minutes to rattle off deals, including the flood from year-end. He left out a few, but no one noticed.
“It is my opinion,” Causey said, “that all of these deals have been conducted on an arm’s-length basis.”
There were no questions. The presentation had taken less than ten minutes. The committee moved on.
Having two chief executives in Enron Broadband just wasn’t working. Rice and Hirko kept stumbling over each other, and they both knew it. Someone had to step aside, and they agreed it should be Rice.
The job had become a bore. Rice didn’t want to manage people anymore and would rather do deals. They made up a title, chief commercial officer. The agreement reached, they went to Skilling with the news. He was delighted that the two had solved the problem on their own. Later that day, Skilling dropped by Rice’s office.
“I really appreciate you guys working this out,” he said. “It’s a pretty good solution.”
“Yeah, I think it’ll work out well.”
“So what’s it going to cost me?” Skilling asked.
Rice didn’t flinch. It had never occurred to him that Skilling would pay him to leave a job he didn’t want. It looked as though the first deal he would negotiate in his new position would be one for himself.
“Dunno,” he said casually. “Let me think about it.”
The price tag was big. His years at Enron had made Rice wealthy, so he asked to have his entire salary and bonus converted into stock options from then on. Skilling agreed without hesitation.
McMahon was losing hope of ever falling asleep. LJM2 was eating at him; he knew that he had to do something. He just didn’t know what. About two in the morning, he reached for the television remote and clicked on the set. Beside him, his wife, Margaret, stirred.
“What’s the matter?” she mumbled.
McMahon’s eyes stayed locked on the television. “I’m stressed about this Andy thing. I don’t know what to do.”
“If you’re that troubled, talk to him again.”
McMahon said nothing for a moment. “Maybe I should leave the company,” he said.
“Then leave. No job is worth this. Get another one.”
She smiled. “Just stop waking me up in the middle of the night.”
A while later, McMahon shut off the television. Things couldn’t continue like this. Something had to give.
It was over. He was quitting. Everything he had seen about LJM2 was just too over the top, too unethical. Jim Timmins couldn’t put up with it anymore.
Timmins, Enron’s contact with the pension funds, had at one point been eager about the company setting up its own equity fund. But then Fastow took the idea and bastardized it, putting himself in control, creating conflicts of interest that Timmins found grotesque.
Plus, he was already hearing plenty from his contacts in the institutional-investor world to make him worried. Pension-fund managers were uncomfortable with the whole thing, couldn’t understand what Enron was doing, and told Timmins about their concerns.
Originally, Fastow had wanted Timmins along on the road show for LJM2. But as his discomfort with the deal became evident, Timmins was cut out. He eventually told Kopper that he wanted nothing to do with LJM2, that he feared bad things would come from it. He quickly saw the results: his bonus that year was his worst ever.
Finally, by February, Timmins realized that he couldn’t continue at a company that would do such a thing. He went to see Fastow. His message was blunt. “I don’t agree with what you’re doing with LJM,” he said. “I don’t want any part of it. I want to leave Enron.”
Fastow argued, saying that the fund was good for Enron, but Timmins would have none of it. Still, Fastow wasn’t eager to see Timmins storm out in a huff. He offered to let the executive continue working at Enron for months, so he could use the office to look for another job. Then, when something good came along, he could move on.
Timmins thought the offer was fair. He didn’t realize that Fastow had just set up a situation that made sure no one would have cause to ask the real reason Timmins was leaving.
———
Somehow, Andy Fastow had to get twenty-five million dollars. If that could happen, the bankers at Greenwich NatWest were certain they could persuade him to help rip off their employer.
The three bankers—Bermingham, Darby, and Mulgrew—had been perfecting their plan for weeks. The idea was simple. Nobody at Greenwich NatWest, other than the bankers themselves, knew that Swap Sub, the partnership controlled by LJM1, was now worth millions. Everyone assumed it was valued at nothing. There was no need for the hedge anymore; the restriction against selling the stock was gone. So if the hedge was shut down, there would be tens of millions of dollars in Enron stock locked up inside Swap Sub. Whoever owned it owned the profits.
If all of them worked together—the bankers, Fastow, Kopper—they could pull off the perfect con. Fastow and Kopper could make some lowball offer of their own for NatWest’s stake in Swap Sub, and the three bankers could tell their superiors it was a good price. Then, once they owned Swap Sub, they could turn around and sell its shares for tens of millions of dollars—and divvy up the loot.
Bermingham had been working hard on a presentation for Fastow and Kopper, showing how much money could be made. There had already been some preliminary discussions, and the two seemed amenable. But Mulgrew didn’t like what he saw in Bermingham’s analysis; Fastow might not be getting enough. The more available for him, the greater the chance the bankers would get their millions, too. Mulgrew e-mailed Bermingham with his concerns about Fastow.
“If I knew there was a realistic way to lock in the $40m, and give him $25m, we would jump all over it I guess, since it would give us $15m,” he typed. “I will be the first to be delighted if he has found a way to lock it in and steal a large portion for himself.”
But with all the cash sloshing around, Mulgrew felt sure there was a way to bring Fastow on board. “We
should be able,” he typed, “to appeal to his greed.”
Two days later, on February 22, the bankers flew to Houston to meet with Fastow and Kopper. Normally, the Greenwich banker in charge of the Enron relationship, Kevin Howard, would be there. But Darby asked him not to attend, with a cryptic comment about becoming rich.
Once they were all in a room, Bermingham made the presentation. “We’ve put together several alternatives for this transaction,” he explained. “Any one of them will lead to the result we’re trying to achieve.”
The different proposals had the same objective: cheating NatWest. But there were challenges. Under the rules originally issued by Enron’s board, Fastow couldn’t profit from the company’s shares in LJM1. And that was exactly what would happen here.
There was a way around that, Bermingham said. Once the Rhythms hedge was unwound, perhaps LJM1 could do some sort of transaction converting the Enron stock into another asset, which could then be sold.
But, Bermingham warned, that involved a lot of moving parts and might raise suspicions among NatWest and CSFB.
“It might be too obvious,” he said. “There’s a bigger chance they’ll figure out they’re getting robbed.”
That wasn’t the only problem. “Also,” Bermingham said, “that way, there’s no certainty we’ll make money.”
Cliff Baxter’s effort to sell the international power plants was going full force. He had hired Morgan Stanley Dean Witter to help and quickly concluded that there weren’t buyers around who wanted the whole thing. Probably, Baxter decided, it was best to try and unload them one region at a time.
The first planned sale was called Project California, and it bunched together Enron’s energy assets in Latin America. Any buyer would gain entrée to Guatemala, Brazil, El Salvador, Venezuela—a cross section of the region. Skilling liked the idea and asked Causey to run numbers on each regional slice of the international assets. That way, they would know what to expect as the sales effort moved forward.
Conspiracy of Fools Page 42
