“Well, Mr. President, we were proud to play a role.” Mr. President? For Lay, it was such a strange thing to say. This was just good old George.
By noon, the White House brunch had begun to wind down, with most of the guests preparing to return to their lives. A White House staffer found the Lays, with word that former President and Barbara Bush were ready to leave. The Lays walked to an exit where they had agreed to meet before heading back to the airport together. The Bushes arrived, accompanied by the new President and Laura.
All the members of the Bush family hugged, making jokes about the hard part now beginning. The Bush parents headed out the door. The new President shook Lay’s hand.
“Take good care of them, Ken,” he said gently.
The next afternoon, Jeff Skilling was on a conference call, reviewing Enron’s quarterly performance with Wall Street analysts, when suddenly he gagged. He reached for a Diet Coke and took a sip, trying to clear his throat.
“I really apologize,” he told the listeners. “I sat outside in the rain in Washington, D.C., watching the inauguration, and I’m really paying for it.”
A moment later, Skilling broke into a coughing fit and hit the phone’s mute button. He returned, apologizing again. All in all, he said, Enron had experienced another fantastic quarter and was looking forward to a great 2001. “Let me comment for just a minute on California,” he said. “The situation in California had little impact on fourth-quarter results. Let me repeat that. For Enron, the situation in California had little impact on fourth-quarter results.”
There were several reasons, Skilling said. Enron was not a power generator in California and didn’t have significant investments in the state. He mentioned nothing about the billion dollars in California trading profits that Enron had stashed away in accounting reserves.
———
Later that same week, Linda Lay sat beside her husband on the Enron corporate plane as they traveled to Davos, Switzerland, for the World Economic Forum. On her lap she held the latest report on the family finances.
“Ken,” she said, “I’m really uncomfortable that we have so much debt.”
Lay smiled. All the borrowed money didn’t matter. They owned plenty of assets, particularly Enron stock. This was all part of the strategy to diversify their investments while still holding on to the company’s shares.
“Honey, it’s really all right,” he said. With a net worth upwards of $400 million, he added, having $70 million in debt really wasn’t a big deal.
It was to her, Linda retorted. The number bothered her a lot, she said. She had fretted about the debt before, but this time she seemed more disturbed by it than usual. Lay thought about his options.
Enron offered Lay and a few other executives short-term lines of credit, which allowed them to borrow as much as four million dollars at a time. Lay’s stepson and financial adviser, Beau Herrold, had told him that he could use it to pay some of the bank loans. If necessary, he could repay the company with Enron stock. When the stock price went up, he could repay his debt without trouble.
He promised to call Beau and get it taken care of.
After months of betting on the collapse of Enron’s stock price, Jim Chanos, the New York investment manager, was ready to share his research with the world. Soon a group of other short sellers would gather in Florida for their first annual “Bears in Hibernation” meeting to swap ideas, and Chanos was planning to lay out his case against Enron. The more people who knew about what he had discovered, the faster the stock price would drop and the quicker his bet would make money.
Of course, there was a better way to get the word out: take the story to some enterprising journalist. Bethany McLean, a reporter at Fortune, seemed a perfect choice. She would understand the problems Chanos saw.
In several phone calls, Chanos and his chief operating officer, Doug Millett, pitched her the Enron story. The company, they said, was nothing more than a hedge fund sitting on top of a pipeline. But despite having the risks of a high-stakes trader, it had the returns on investment of a car company.
“Would you put your money in a hedge fund earning a seven percent return?” Chanos asked.
Their barbs intrigued McLean. She set to work.
———
At three on the afternoon of February 2, Mintz appeared in Causey’s doorway. For weeks he had watched the finance division do cartwheels to avoid disclosing Fastow’s LJM compensation. The time had come to short-circuit the whole effort. Causey was the way to get it done.
The next directors’ meeting was ten days away, and some committees had asked for details of Fastow’s LJM compensation. Mintz figured that no one could object to making sure the board got what it wanted—from Causey.
Mintz sat across from Causey and explained the work he had been doing on the question of disclosing Fastow’s compensation. “I think it’s a big number, but Andy’s never told me,” he said. “From reading the board minutes, it seems the directors want to know what it is.”
He watched Causey for a second, then took the plunge.
“So I think it’s important for you to make sure it gets before the board how much Andy is making from LJM.”
Mintz stopped. He was uneasy telling somebody higher up the corporate ladder how to do his job. Causey nodded.
“Yeah, I understand that’s important,” he said.
At about that same moment, Fastow was carrying a single sheet of lined paper down a hall on the fiftieth floor. He tapped on the door to Skilling’s office and walked inside.
Skilling had been thinking about the compensation issue and had suggested that Fastow review the LJM numbers with him, to be sure they were ready if the board asked about them.
“Okay,” Skilling said as he joined Fastow at the conference table, “let’s take a look at this.”
Fastow showed him the sheet of paper. On one side, it showed his interest in Enron stock and options, assuming a 15 percent return each of the next five years. All told, Fastow’s Enron stake would bring in about seventy million dollars in profits. That struck Skilling as reasonable.
On the other side, Fastow had performed the same analysis for LJM. He showed about ten million dollars in profits, assuming a 25 percent annual return over the same period.
Oh, come on. Skilling was skeptical.
“Andy, you’re not going to get a 25 percent annual return,” he said. “That’s ridiculous. It’s way too high.”
Fastow shrugged. “I don’t think we’ll make 25 percent either. I’m just trying to be conservative.”
Well, Skilling said, there was conservative and there was silly. This number couldn’t possibly include expenses. Those had to be subtracted. Skilling ran numbers through his head.
“So what we’re talking about, horseshoes and hand grenades, is like two million dollars?” Skilling asked.
Fastow nodded. “Yeah, probably.”
Skilling sat back. Two million versus seventy million over five years? Well, nobody could possibly question where Fastow’s strongest financial interest lay.
By that point, Fastow’s records for the previous tax year had been submitted to his accountant. And the results were nothing like what he had just shown Skilling.
His 2000 income was more than forty-eight million dollars, almost 90 percent of it rolling from the LJM funds. And even that wasn’t all of his earnings. The Kopper kickbacks from the RADR deal were still coming in. Of course, no one would be so foolish as to declare blatantly illegal income.
“This will be the easiest year ever,” Causey boasted. “We’ve got 2001 in the bag.”
Causey glanced around the boardroom at the dozen or so top accountants from each of Enron’s main divisions. He was happy and confident. The huge, billion-dollar-plus reserve Enron had set aside in the fourth quarter was going to be the gift that kept on giving in 2001. The utilities in California were spiraling toward bankruptcy, state politicians seemed incapable of taking decisive action—yet for all that, the impact couldn�
�t possibly hurt Enron.
One accountant, Wanda Curry, wasn’t buying into the high spirits. It had been almost ten months since she and her team had been appointed to examine Enron Energy Services, and she had found a breeding ground for overvalued contracts and bad trading bets. By her calculations, EES, a Skilling baby, far from being in the black as it claimed, was losing as much as $500 million.
The meeting ended. Curry waited for the other accountants to leave the room, then approached Causey. “Rick,” she began, “we’ve got some serious problems at EES.”
Skilling was infuriated. The losses at EES were intolerable. Lou Pai, the EES chairman, argued that they weren’t real losses. The California market had just gone berserk, he said; things would return to normal if they just held on. The argument was silly. Enron used mark-to-market accounting. These losses would appear in EES’s books when the quarter closed. There needed to be drastic action. Pai was shoved aside, given a million-dollar bonus, and put in charge of a new division to oversee the creation of new businesses. To run retail, Skilling brought in a favorite from wholesale, a Canadian trader named Dave Delainey.
Delainey, working with Skilling and Causey, arranged to shift the EES trading book into wholesale. The losses would show up, but only as reduced profits of Enron’s most successful division. An announcement of huge EES losses could be avoided. Besides, wholesale was better at trading. They would disclose the change and describe it as an efficiency move. They wouldn’t have to mention the losses, they decided.
On the afternoon of February 12, Mintz sat near a giant jar of M&M’s in the Enron boardroom, watching as the directors arrived. Fastow had instructed him only hours before to attend the meeting, and he had since rushed home to put on one of his best suits. Now he worried that the corporate bigwigs might wonder why he was here.
The board meetings over the next two days were important. By the end, Skilling would officially take over as Enron’s chief executive, and Lay would be just chairman. But Mintz was less interested in corporate succession than in seeing how Causey and the board dealt with the swarming issues about Fastow’s LJM compensation.
The outcome was disappointing. Causey made an almost rote presentation about LJM2 to the audit committee. He listed the same controls that had been touted countless times before. He gave a rundown of all the great deals that the fund had made possible. And that was pretty much it.
What about the compensation? Mintz thought. Hadn’t he agreed to bring it up? Maybe it would come out in the question-and-answer period. Mintz took a breath and waited.
“All right, thank you, Rick,” said Robert Jaedicke, the head of the committee. “Now Mark Koenig is going to review our policies on communicating with analysts.”
Nothing about compensation. No questions at all.
The meeting broke, and everyone began to head out. Mintz wandered over to Derrick, Enron’s general counsel.
“You know, Jim,” he said, “I was really surprised there weren’t more questions about LJM.”
Derrick smiled. “Our directors have a lot of confidence in senior management,” he said.
———
On the sixteenth floor of the Time & Life building in midtown Manhattan, Bethany McLean, the Fortune magazine reporter, was sitting at a desk piled high with spreadsheets and other papers. It was February 13, and she was almost ready to go with her big Enron story. She had spent weeks analyzing the company’s financial data and interviewing investment professionals. Now all she needed was a comment from Enron.
That day, Karen Denne from Enron’s public-relations office spoke with her boss, Mark Palmer. She had taken the call from McLean but quickly realized this was a topic that needed to be handled higher up the line.
“Mark,” Denne said, “you need to give a call to Bethany McLean at Fortune.”
Palmer sat back in his chair. “What’s up?”
“She’s doing a story that people think our stock is overvalued. You need to talk to her.”
Palmer thanked Denne, getting the number for McLean. He dialed her right away. “Bethany, Mark Palmer from Enron. I understand you wanted to check a story with us. Have you talked with anyone at Enron about this yet?”
No, McLean said. So far, she had relied on Enron’s filings and had interviewed an array of people who dealt with the company. Point by point, she described her findings. Palmer didn’t like what he was hearing.
Enron, McLean said, was a mind-numbingly complex operation that seemed to gush earnings—but from where, no one knew. The company was a black box, its financial statements impenetrable. Its earnings multiple—the ratio of its stock price to every dollar it earned annually—was more in line with a high-tech star like Cisco Systems than with other trading companies. And, of course, there was that anemic return on invested capital.
This was a tough article. Already Palmer knew that he was going to have to bring Skilling into this.
“Tell you what, Bethany …” Palmer began.
The next morning, Skilling stared down at a triangular Polycom speakerphone, anger rising in his voice.
“Enron is not a black box,” he growled. “It’s very simple to model.” As Palmer watched, Skilling delivered his personal treatise on Enron as a moneymaker. It was a logistics company, he said, moving commodities through the infrastructure to customers for the lowest possible price. Mark-to-market accounting created more earnings than cash, he said, but Enron just sold slices of its trading position in prepay transactions. And the off-balance-sheet debt was meaningless, since it mostly related to international and was not money Enron was obligated to repay.
As she listened, McLean grew concerned. Skilling’s response was so vehement, she feared she might be mistaken. Was there something she was missing?
Finally, Skilling had enough. “I see where you’re going with this,” he said.
Writing this article was unethical, he said; McLean didn’t understand Enron. She needed to sit down with its accounting and finance experts, he said, and learn about the reality of the company.
“Anyone who is successful, people would like to take them down based on ignorance,” Skilling snapped.
With that, the interview ended.
Off the line, Skilling looked at Palmer. He wasn’t going to take this. “You get Andy Fastow and Mark Koenig and get up there as fast as you can,” he said.
Palmer nodded. Fastow and Koenig, the CFO and the head of investor relations. Skilling was going all out to fight back against the article.
Skilling seethed. “I see what’s going on here,” he said. “They’re trying to take our multiple away.”
The next afternoon, Palmer bit into a thick sandwich, scraping the roof of his mouth on a sharp piece of bread crust. He was with Fastow and Koenig at an Au Bon Pain restaurant near the offices of Fortune, grabbing lunch and plotting strategy before the showdown with the journalists.
They had flown up that morning on Continental Airlines. But they had been seated in different parts of the plane, making this the first opportunity to discuss their plans for the meeting.
Fastow swallowed a bite of his sandwich.
“The approach I want to take is to just keep going over that Enron is a logistics company,” Fastow said. It was exactly like Toyota, he said. Until the rise of the Japanese carmaker, Detroit owned every step of the process in manufacturing cars. But, Fastow said, Toyota just wanted to assemble the best car, so it outsourced all the different pieces, buying the radios, the transmissions, and all the other components from whatever manufacturers made the best ones at the best price.
“We’re like that,” Fastow said. “We find the best.”
Enron was more than a trading firm, he said. The Toyota analogy would get that point across.
———
After lunch, the three Enron executives arrived at Fortune’s sixteenth-floor offices. They were escorted to a windowless, dark conference room normally used for reviewing the magazine’s photos. Joining them were McLean and two editor
s, Joe Nocera and Jim Impoco.
Palmer handled the introductions, then turned things over to Fastow, who expounded on how Enron was diverse and dynamic, providing customers with “optionality.” He largely ignored McLean at first, making his pitch directly to her editors.
He looked at them confidently. “The way to understand Enron,” he began, “is to think of Toyota.”
Toyota? What is this guy talking about?
The discussion had been dragging on and wasn’t making a lot of sense. Jim Impoco was getting annoyed. Fastow kept coming back to his analogy. Toyota, Toyota, Toyota. But everything he said was wrong. An old Japan hand, Impoco had covered Toyota for years. It didn’t negotiate with suppliers; it had long-running feudal relationships with them. It told them what to charge. If Fastow wanted to trumpet this analogy, he should at least know what he was talking about.
Fastow circled around again. “Just like with Toyota—”
Impoco couldn’t take any more. “I’m sorry,” he interrupted. “You’ve got to drop the Toyota analogy. It doesn’t make sense and shows a lack of understanding about the company. It’s making it hard for me to figure out what you’re trying to say about Enron.”
Fastow laughed nervously.
Then he moved on. He stopped mentioning Toyota.
Gradually, McLean forced Fastow to deal with her. His answers were all generalities, loaded with business-school buzzwords that might dazzle the local bridge club but weren’t going to sway sophisticated financial journalists.
As the story unfolded, the editors relaxed. Enron had been so insistent on meeting, they and McLean had feared she had missed something, some silver bullet that would kill the article’s thesis. But the more Fastow spoke, the less they worried. He didn’t marshal evidence to counter McLean’s point. He just argued that she was wrong. He wasn’t accomplishing anything. In fact, he was damaging his cause. To fly to New York to make such a feeble assault sure signaled a company desperate to keep its stock price up.
This story was going to run in the next issue. No doubt.
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