Conspiracy of Fools

by Kurt Eichenwald

  A second’s hesitation. “Well, when you didn’t get back to me,” Siurek said, “I just assumed you were approving the entry. I figured it was all okay.”

  It wasn’t. Enron and Andersen, until recently the financial darlings of Wall Street, were on the verge of discovering a mistake. A $1.2 billion overstatement of Enron’s total equity. One that might have been stopped if an e-mail had been opened.

  Ray Bowen had been out of the office for days, returning finally on August 20, eager to learn more details about Skilling’s resignation. The only person who might know, he decided, was Andy Fastow. He made an appointment to see him.

  When the time came around for the meeting, Bowen walked in and dropped into the chair in front of Fastow’s desk, skipping all the pleasantries.

  “One question, Andy,” Bowen said. “Why did he quit?”

  Fastow raised his arms. “Ray, I don’t know. I’m angry with him for quitting on me, but I’m as surprised as you are.” He shook his head. “You know, I love the guy. I wouldn’t be where I am today without him. But I don’t know if he’s got a kid problem or a drug problem. It just doesn’t make any sense to me.”

  “What do you think’s going to happen, Andy?” Bowen asked.

  “I think Ken will name somebody as president soon.”

  “Are you on that list?”

  Fastow grimaced. “I don’t think so,” he said.

  Rick Buy. Of course. Watkins should call him. He was chief risk officer. He would want to know about what she had found. She had worked with Buy in the past. He wouldn’t stand for cutting corners on the accounting.

  She dialed Buy’s office, only to find he was on vacation. She left a message, asking him to call as soon as he could. He got back to her later that day.

  “Rick, there’s something very serious I need to talk to you about,” Watkins said. She launched into a detailed description of the problems she had dredged up.

  “I’ve got everything written up. I’ve gone back and done some longer memos on this,” she said. “Would you like to see all of my materials?” She heard a deep sigh. “No,” Buy said, sounding deflated. “I’d rather not.”

  Watkins pressed ahead. Everywhere she turned, she heard the same tune: the entities were fine, because Andersen had signed off on them. Maybe so, but the real question was, did Andersen understand the mess it had approved? Watkins, a former Andersen accountant herself, decided to seek out Jim Hecker, an Andersen partner and an old friend from her days at the firm’s Houston office.

  “Jim, it’s Sherron! How are you?”

  Hecker settled in his chair. The call had come out of the blue, and as Watkins made small talk about the job market and Skilling’s resignation, Hecker waited for her to come to the point.

  The conversation hit a momentary lull.

  “Jim,” Watkins said, “do you know much about Enron’s recent structured transactions?”

  Hecker had never done any work for Enron, but Watkins’s questions, and the details she had uncovered, worried him. Andersen had survived its walk through fire with the Waste Management case. The last thing it needed now was another scandal. Senior partners needed to know about this. And the Andersen team on the Enron account, too.

  For a week Jim Derrick, Enron’s general counsel, hadn’t done much about the anonymous letter’s allegations. He’d kicked it back to the executives who had created the Raptors to ask if they had any second thoughts; they didn’t.

  But by identifying herself as the memo’s author, Watkins had inadvertently created a real legal issue. An employee had raised allegations against her boss. If they made a mistake, Enron could be sued.

  Derrick spoke with a deputy general counsel, Sharon Butcher, and asked her to contact Vinson & Elkins to get some advice on the legal ramifications of the situation. Butcher telephoned Carl Jordan, an employment lawyer at the firm, and briefed him. Then she got to the question.

  “Sherron Watkins works with corporate and ultimately reports to Fastow,” she said. “What do we do with her?”

  And suppose Enron decided to fire Watkins or demote her to a do-nothing job? What, Butcher wanted to know, were the dangers to the company?

  Well, Skilling figured, it had been a week. Maybe now was a good time to drop back in at Enron. His brother Mark was in town to talk about helping manage Jeff’s finances. It would be nice to give him the Enron grand tour.

  They drove downtown, with Skilling eager for the visit. Probably, he figured, there would be lots of backslapping, with people congratulating him for striking out on a new life. In no time, the brothers were walking the halls at Enron, but the reaction was far from what Skilling had anticipated. People grew quiet as he approached, didn’t say hello until he did. He had expected almost a hero’s welcome, but instead he was getting the cold shoulder. Apparently, all anybody cared about was learning the reason he had left.

  How many times did he have to explain this? What the hell was the matter with everybody?

  Jeff McMahon was driving home. He had heard from Cindy Olson that day that Watkins had come forward, and learned that she was now scheduled to speak directly with Lay about her concerns. McMahon was pleased and figured he might help her out.

  He punched the main number for Enron into his car speakerphone and asked for Lay’s office. McMahon listened to the recorded voice of Lay’s assistant, Rosalee Fleming, instructing callers to leave a message.

  That’s bogus. He hated it when executives didn’t record their own voicemail message. It was just too regal.

  The line beeped. “Ken, it’s Jeff McMahon,” he said, giving his job title. He figured there was a good chance Lay might not know who he was.

  He explained that he had heard about the Watkins letter and knew she was scheduled to meet with him soon.

  “As a matter of background, I’ve known Sherron for twenty years and find her to be pretty credible,” he said. He gave a quick rundown of his relationship with her.

  “So, probably you’re wondering why I’m leaving this message,” McMahon continued. “I just wanted you to know that she’s not some lunatic-fringe employee. She’s knowledgeable enough to be concerned about these issues. So I’d just ask that you take her seriously.”

  He thanked Lay and hung up.

  Just outside Lay’s office door, Watkins was waiting. It was before one o’clock on August 22, the time of her appointment. She was terrified and anxious; she hadn’t slept well in days. She had written a series of new memos explaining the problems, then rewritten them again and again to make them easier to understand.

  At that moment, Lay was wrapping up a lunch with Greg Whalley, whom he had unofficially selected as Enron’s new president. Heading into the waiting area, he saw Watkins and broke into a smile.

  “Hi, I’m Ken Lay.”

  Watkins stood, shaking Lay’s hand. “Sherron Watkins”

  “Well, glad you could stop by. Come on in.”

  Lay headed into his office, escorting Watkins to the small conference table. They both sat down.

  “All right, then,” he began. “I understand you have some concerns about some transaction issues. I’d very much like to hear what those concerns are.”

  Watkins ran through her materials, laying out the problems she had found. The Raptors, she said, were set up in a way that would not withstand public scrutiny. LJM, which provided the necessary three percent equity, had gotten its money back out of other payments from Enron. It had no skin in the game. It all looked like one big bet on Enron stock, put together in hopes that a rising share price would bail the company out of its investment losses.

  But everything had gone against Enron. Its stock had fallen; its merchant investments had soured. There was a cavalcade of other issues, including rumors of a handshake deal between Fastow and Skilling guaranteeing that the LJM funds would never lose money. Lay’s eyes wandered, but he did seem to be paying attention. He interrupted.

  “Andy’s a good CFO, right?” he asked. “He’s doing a good job,
right?”

  Watkins fumbled with her answer. “Well, uh, sure.”

  She went on. Soon Lay interrupted again.

  “Are you saying that from the standpoint of the accounting, these are done inappropriately?” he asked. “Do you think something illegal’s been done here?”

  Watkins shook her head. “No, I’m not saying that. Technically, maybe the argument can be made that the accounting is correct. But in the end, this will not stand up to public scrutiny. It doesn’t look right.”

  Although he wasn’t sure of Watkins’s facts, Lay was convinced that she was someone to take seriously. Obviously, a lot of thought had gone into this. Her material was too extensive to have been thrown together overnight. But there was still one matter that concerned him.

  “Have you shared this with anyone outside the company?” he asked.

  Watkins shook her head. “No,” she said.

  As the meeting approached its conclusion, Watkins offered her suggestions of how to clean up the mess.

  If he was planning to promote Fastow or Causey in the wake of Skilling’s departure, she said, Lay should postpone his decision. The company should hire an independent law firm to investigate—but not Vinson & Elkins, since that firm had worked on the deals. A large accounting firm—but not Andersen—should review everything. Then, once everybody understood the real impact of the transactions, Enron should develop a plan to fix everything—hopefully one that could be done quietly. But if not, then one with a complete public- and investor-relations campaign.

  There were a few people that the lawyers should interview to find out if Watkins was wrong. She listed McMahon, Rick Buy, Mark Koenig, and Greg Whalley. Cliff Baxter was also mentioned by Watkins as someone with concerns. Lay asked if he could keep the memos that Watkins had brought in, and she agreed.

  Lay suddenly became animated. “Now, what can I do for you?” he asked.

  Watkins had thought about that. “I don’t think I can keep working for Andy,” she said. “It might be best if I moved to Cindy Olson’s group until another job turns up.”

  Watkins seemed to have planned for everything.

  “This doesn’t have to be done today,” Watkins said. “I’m taking a short vacation to Mexico starting tomorrow. Nothing would have to be set up until I’m back.”

  “All right,” Lay said. “I’ll speak to Cindy and see if we can get an answer before you return.”

  Lay thanked Watkins for coming. Whether she was right or wrong, he thought, he admired her for her courage.

  After Watkins left, Lay carried her memos down to Jim Derrick and described his discussion with her. He held up Watkins’s papers. “These are my only copy,” he said, “but I’m going to leave them with you.”

  Watkins had raised serious issues, Lay said, and he wanted them investigated quickly. As for who should conduct the inquiry, though, Lay wasn’t ready to accept Watkins’s counsel. A new law firm would take weeks getting to know the players and the issues. If there really was a big problem, it should be evident to Enron’s closest advisers.

  So why not bring in Vinson & Elkins? The two men talked it through and agreed that consulting Enron’s old law firm was the best course. Derrick raised a point about the complexity of revisiting all of the accounting again.

  “We don’t want to reinvent the wheel here,” Lay said.

  After Lay left, Derrick picked up the phone to call Joe Dilg, a senior partner at Vinson & Elkins. He talked about the anonymous letter and the new material from Watkins. Dilg promised to get started right away.

  Derrick sent over the Watkins material. Other than the original, unspecific letter, he had never read any of it.

  About that time, Vince Kaminski was downstairs at his desk, reviewing his e-mail. He noticed a message that had been forwarded to him earlier that day and clicked it open.

  It was from one of his analysts, Rudi Zipter, raising a question about the Raptors. With the stock market getting hammered lately, it said, both Enron stock and the value of some of its largest hedged assets had been falling.

  “OOPS!” Zipter wrote.

  Zipter mentioned something about the finance group having put a collar on the Enron stock to prevent it from falling too steeply. Kaminski knew that wasn’t right. Enron had required that the stock not be hedged and, as a result, sold it to the Raptors at a discounted price. A collar would mean there was a hedge. In other words, Enron would have sold its stock at a discount based on a lie. It couldn’t be true.

  Kaminski started typing a response. “Makes sense,” he wrote, saying he would set up a meeting.

  He thought for a second. “Another question,” he wrote. “Do you know if the collar was hedged by the equity desk?”

  Joe Dilg quickly assembled his investigative team. After reading the Watkins material, he realized that one of his partners, Ron Astin, had worked on several of the transactions. He discussed it with Astin, and the two decided that since Vinson & Elkins had played no role in conceiving of the deals, it wouldn’t be conflicted in investigating them.

  Next, Dilg recruited one of his litigation partners, Max Hendrick III, to help out. After being briefed, Hendrick got on the phone with Astin and ran through the issues. Astin mentioned that he had long been bothered by one aspect of the Raptors: the deal that had been struck to hand LJM2 an amount of money equal to the cash it kicked in, plus a 30 percent return, before the entities engaged in any hedging.

  “This is the troubling part,” Astin said. “As a practical matter, LJM has its investment back.”

  Still, that wasn’t something Enron wanted Vinson & Elkins to worry about. The firm was told not to bother retaining another accounting firm. There was no need to second-guess everybody on this. Just a fact-finding mission.

  The day after his meeting with Sherron Watkins, Ken Lay was hit with another margin call from his lenders. Enron’s stock price had fallen again with the announcement of Skilling’s departure, and the banks wanted more money. Beau Herrold took care of it. He borrowed from Enron for the cash, and then repaid it with company stock, just as they had arranged. Every penny went to pay down debt.

  Fastow was in a rage. Word had finally gotten around to him that, in response to this letter to Lay challenging the Raptors, the company was bringing in lawyers to dig into his work. He gathered a few trusted lieutenants in his office and told them what was happening, furiously pacing the floor as he spoke.

  “There’s going to be a fucking investigation of this,” he screamed. “Who the fuck wrote this thing?”

  He pounded a fist on his desk. “It’s fucking McMahon,” he growled. “McMahon is behind this thing!”

  The diatribe lasted several minutes. McMahon was angling for his job, Fastow said. That’s what this was all about. When the meeting broke up, news of his outburst spread quickly through the division. It didn’t take long for one of McMahon’s friends to hear about it and call to fill him in.

  Hanging up before hearing the whole story, McMahon dashed out of his office. He barked at his secretary as he passed. “Call Andy. Tell him I’m on my way up to see him!”

  McMahon stormed down the hallway, not slowing as he approached Fastow’s secretary, Bridget Maronge.

  “Is he ready for me?” McMahon asked sharply.

  “Well …” Maronge began to answer.

  McMahon blew past without waiting for a response, shoving open Fastow’s door. From behind his desk, Fastow looked up, surprised. McMahon closed the door behind him.

  He pointed a finger at Fastow. “I’ve gotta talk to you,” he said. Fastow got up. The two executives stood on either side of the desk, glaring at each other.

  “I hear you’re telling people I wrote this memo about this Condor and Raptor stuff,” McMahon snarled.

  “I don’t know what else to conclude!”

  McMahon’s face was hard. “First off, I didn’t write it. But that’s not even relevant, Andy. If you continue to slander me around here, you’ve got a problem with me. If you think
I’ve done something, come see me. Don’t start leaking stuff out. I didn’t write it, so cut it out.”

  Fastow’s eyes narrowed. “Well, I don’t know who else would try to damage my—”

  “Why are you so paranoid about me wanting your friggin’ job?” McMahon snapped. “I don’t want it! I never wanted it! I don’t know what your issue is.”

  “I just figure there are people out to get me in the company,” Fastow replied, “and you’re one of them.”

  Man, McMahon thought, something’s wrong with this guy.

  “I could care less about what you do or how you do it, Andy,” McMahon shot back. “And I want you to tell me right now that you’re going to stop talking about this memo and me, because I didn’t write it!”

  The two stared at each other in silence. The air in the room was electric. “Okay,” Fastow finally said, backing down. “I’ll take your word for it”

  “Fine!” McMahon barked. He marched out of the room, passing Fastow’s stunned secretary. Though his face was red with anger, he felt ecstatic. After all these years, the confrontation had felt great; he had finally let Fastow have it. And the delicious encounter was made all the sweeter by the fact that he knew the identity of the letter writer Fastow so desperately wanted to track down.

  On the morning of August 28, a new article about Enron appeared in The Wall Street Journal. It wasn’t a big scoop, just a “Heard on the Street” column, the feature that typically ruminates about a company’s prospects—and, by extension, about the potential direction of its stock price.

  The article was written by Rebecca Smith and John Emshwiller, the first from their reporting partnership. It described how Lay was promising to divulge more information to investors and to abandon the in-your-face management style that had apparently alienated so many of them.

  Deep in the article, three paragraphs appeared—the first mention of the LJM funds in a national newspaper. The article didn’t disclose the funds’ name and reported that Fastow had sold his interest in them. Still, it described some of their workings and quoted Lay as saying that they had become a “lightning rod” for criticism of the company.