Good news all around, the directors muttered happily. They had survived the Skilling resignation; they had survived September 11. Enron’s future looked pretty bright.
That same week in Chicago, risk-management executives at Andersen ran Enron’s financial figures through FIDO, a fraud-detection software. A staffer checked the results.
A red alert. Enron’s financial statements filed the previous June set off a fraud warning. One of the executives running the test, Mark Zajac, wrote up an e-mail on October 9 to Duncan and two of his superiors, alerting them. It was always possible that this was a fluke, generated by legitimate business activity. But still, Zajac cautioned, the accountants needed to heed the warning.
“It is imperative that you evaluate the results carefully and objectively before reaching any conclusion,” Zajac wrote, “because of the significant adverse impact of failing to detect a material financial statement fraud.”
Kaminski had been out of the office for a few days, recruiting potential analysts from Berkeley. With him out of the way, the finance division struck. Executives descended, asking analysts to sign off on the numbers for the unwinding of the Raptors, including the thirty-five million dollars to LJM2. When mid-level analysts refused, the executives went down the chain to the associates.
But each time, the analysts sent the request to Shanbhogue, Kaminski’s second in command. He killed every attempt. No approvals, he repeated, until Kaminski saw all the legal documents. He never would.
Members of Andersen’s Houston office were listening to Michael Odom, a practice director. It was the morning of October 10, and Odom was letting everyone know that they needed to be careful with their paperwork.
Andersen had a policy, he said, requiring the destruction of records that weren’t needed for the finished audit files. It worked well, he said, and auditors in Houston needed to be sure they were in compliance.
“We’ve had several cases where we’ve produced documents in litigation recently where we found a lot of stuff that we shouldn’t have retained,” he said.
Of course, once the firm was sued, Odom said, nobody could destroy documents anymore. “But if it’s destroyed in the course of the normal policy and litigation is filed the next day, that’s great,” Odom said. “We’ve followed our policy, and whatever there was that might have been of interest to somebody, uh, is gone.”
The next day, John Stewart saw Nancy Temple walking down a hall at headquarters. He stopped her.
“Nancy,” he said, “I have to tell you, I am still very uncomfortable with deleting the e-mails and destroying the draft documents in the Enron situation. It is the type of material that I very well could need in the future.”
“Tell you what, John,” Temple replied. “Why don’t you get a set of the documents you want to keep, and I’ll hold them for you. But otherwise, comply with the policy and dispose of the other material.”
Stewart wasn’t happy about the idea. But he agreed.
Temple was at the office early the next morning, October 12. With all of this discussion about documents, it was apparent that few in the firm understood Andersen’s retention policy. Whatever they could dispose of had to go. The team working on the Enron account in particular had to understand that.
She typed an e-mail to Odom. “Mike,” she wrote. “It might be useful to consider reminding the engagement team of our documentation and retention policy. It will be helpful to make sure that we have complied with the policy.”
Temple included a link to the policy, contained on Andersen’s internal Web site. Then, at 8:53, she hit “send.”
———
That same day at Enron, top management was completing its draft earnings release for the third quarter.
There was some debate about what else to include. Of course, there was the matter of the $1.2 billion reduction in shareholder equity, caused by the accounting error. Causey argued it had no place in the press release; the announcement was about earnings, and the equity reduction was a balance-sheet issue. It should, he said, be released with Enron’s quarterly SEC filing in a few weeks.
There was some debate, and a compromise was struck. They wouldn’t disclose the equity reduction in the press release, but would mention it on the analysts’ call. Besides, there was going to be plenty to absorb in the earnings release itself. Enron would be announcing a huge loss, largely as a result of shutting down the Raptors.
As they finished up the release, Lay reflected that the entities that had caused so much controversy in recent months were now going to vanish. “Well,” he told the group, “this ought to please Sherron Watkins.”
That evening, David Duncan was in his office, reading through the draft press release. His eyes fixed on the third paragraph:
Non-recurring charges totaling $1.01 billion after-tax, or $(1.11) per diluted share, were recognized for the third quarter.
There they were—the Raptor losses, blended in with a couple of other problems Enron was cleaning up. Still, a word in the release made him uncomfortable.
Non-recurring. That is what Causey always called the losses. But that might be misleading. Enron had reported the gains locked in by the Raptors as recurring; in other words, they could be expected to happen again. Now that there were losses, it wanted to shift to “non-recurring.”
This wasn’t something to ignore. Duncan had been through the fire the past few weeks over the Raptors. He wasn’t about to sit on a decision like this without kicking it up the line. He went to consult with members of the risk-management group and legal. They would know what to do.
Two days later, on Sunday, Duncan finally spoke with Rick Causey.
“Rick, we recognize that press releases are solely the company’s responsibility,” he said. “But we have very strong concerns that labeling these charges as nonrecurring could be very confusing to investors.”
There were instances, Duncan said, where the SEC filed actions against companies using such terms in a misleading way. Andersen’s advice, Duncan said, was to consider removing the word, or at least have the lawyers review it to make sure it was not inappropriate.
Causey was calm. “I hear what you’re saying,” he said.
Shannon Adlong stepped off the elevator onto the thirty-seventh floor of Three Allen Center, Andersen’s offices for its Enron team. Adlong, Duncan’s secretary, had brought her teenage daughter to work with her that morning, but immediately began to worry this wasn’t a day for family visitors.
The place bustled, the trash cans overflowed. And around the office she periodically heard the whirring sound from the firm’s shredders. Obviously, people were getting rid of paperwork. She wandered by the break room and saw two large bags of shredded papers. Walking toward her office, Adlong noticed Kimberly Scardino, one of the auditors on the Enron account. She asked what was going on.
“Dave got an e-mail on Friday from the legal department in Chicago,” Scardino said. “They want us to be in compliance with the document-retention policy.”
Adlong nodded and headed back to her desk.
That same night, Duncan tracked down Causey to ask about the press release scheduled to go out the next day. What procedures had been conducted to make sure the use of the term “non-recurring” wasn’t misleading? Duncan asked.
“Normal legal review,” Causey replied. But no changes had been made. “Non-recurring” had been kept in the release.
The next morning, Rebecca Smith from the Journal stared at the laptop computer perched on the edge of her bed. She was checking the newswires, seeing if anything was happening that day that might need her attention.
Smith and Emshwiller were still hot on the LJM2 story. Enron had played hardball, refusing to provide any comment other than a terse written statement that said nothing. Probably, the reporters figured, the story would be ready to go soon.
The Enron release came across the wires. In the headline, Smith saw something about $1.01 billion in nonrecurring charges. The release attributed a chunk
of that—some $544 million—to the termination of a structured-finance deal involving “a previously disclosed entity.”
What the heck is that? Could it possibly be LJM?
Smith looked around for other details, but there was nothing to answer her question. There was a story hidden somewhere behind the obfuscation. She felt it in her gut.
She sent a message to her boss, Jonathan Friedland. Something was up.
“This is Ken Lay, chairman and CEO of Enron.”
It was the next morning at nine. Lay was sitting at a table, looking down at a speakerphone, as he opened up Enron’s third-quarter analysts’ conference call.
“I will provide a brief overview of our quarterly results, and then open the call for questions.”
At that time in Fredericksburg, Texas, Jeff Skilling was standing by a four-poster bed in a tiny bed-and-breakfast. He had traveled there with Rebecca Carter, along with his brother Mark and his wife. But before he joined the fun that morning, he wanted to find out about Enron’s quarterly results.
Skilling held a phone to his ear. He had just dialed into the Enron conference call, hoping to hear about its performance. Lay’s disembodied voice echoed over the line.
“For the third quarter 2001,” Lay said, “Enron reported strong recurring operating performance, which included a 35 percent increase in recurring net income.”
Whoa! Skilling thought. That’s strong as hell.
He listened as Lay ran through a couple of other numbers; everything sounded wonderful. He hung up; that was all he needed to know. Heading out of the room, he saw his brother and slapped him a high five.
“Company’s doing great!” he exclaimed.
Back in Houston, the call continued.
“As these numbers show, Enron’s core energy-business fundamentals are excellent,” Lay said. “We are recording nonrecurring charges of slightly over one billion dollars this quarter.” Even so, Lay said, the company was on track to hit its fourth-quarter targets—and for 2002 to boot.
Later, he returned to write-offs. He spelled out the reasons for the charges: $287 million because of troubled Azurix assets, $180 million of costs associated with shrinking Broadband, and the termination of some structured-finance arrangements. He didn’t call them the Raptors.
“In connection with the early termination, shareholders’ equity will be reduced approximately $1.2 billion,” he said, “with a corresponding significant reduction in the number of diluted shares outstanding.”
He mentioned nothing about the accounting error responsible for the huge revision.
Emshwiller was on the phone with Mark Palmer, quizzing him about the write-downs disclosed in the earnings release.
“Is LJM that ‘previously disclosed entity’?” he asked. “And if so, how much of the write-off was due to LJM?”
“You wouldn’t be wrong if you said less than half but more than a quarter,” Palmer replied.
Emshwiller tried to contain his excitement. “So maybe a little over $200 million?”
“Maybe a little under,” Palmer replied.
After getting off the phone, Palmer figured he better double-check his information. He dialed Causey. “Rick,” he said, “how much of the $544 million in the release is the cost of undoing the LJM deals?”
Causey didn’t hesitate. “Thirty-five million.”
“What!” Palmer exclaimed. Oh, I hope I didn’t hear that right.
“Mark,” Causey said, “if we hadn’t hedged these deals, we would have lost this much money. The only charge attributable to undoing the deals with LJM is the thirty-five million we paid them to let us blow this up.”
Palmer asked a couple of other questions, then hung up. He immediately dialed Emshwiller.
Palmer sounded out of breath.
“I was wrong; I made a mistake,” he said. The $200 million wasn’t from LJM.
“So how much was related to LJM?” Emshwiller asked. “Thirty-five million,” Palmer said.
“Thirty-five million,” Emshwiller repeated, his tone sagging. “That’s right.”
Emshwiller was disappointed. Still, the story wasn’t dead. Enron lost thirty-five million dollars to the investment fund formerly owned by its CFO. That was still something.
Rebecca Smith had been tied up on another interview, so she had missed Enron’s morning conference call. Still, she could review it. She called up a recorded version on her computer and hit “play.” With time running short, she fast-forwarded through Lay’s opening comments.
She went right over his statement about the $1.2 billion reduction in shareholder equity.
At his home sometime after five the next morning, Palmer padded into the downstairs office across the hall from his darkened bedroom. He was wearing shorts and a T-shirt and holding a glass of orange juice that he had just fetched from the kitchen. He sat at the desk. The computer was on.
He called up the Web site for the Journal. He saw the Enron article prominently displayed and clicked it open.
“Enron Posts Surprise 3d-Quarter Loss After Investment, Asset Write-Downs,” the headline read.
Palmer gulped the juice as he read. Not the usual earnings article. After the first paragraph, it jumped straight into a piece about LJM. It hinted at the controversy, suggesting that Fastow may have made a lot of money. There were quotes from documents sprinkled around.
Palmer relaxed. The article seemed fair; the reporters had done a good job. But it certainly wasn’t an atom-bomb kind of story. This one probably wouldn’t cause much trouble.
In the Washington offices of the SEC that morning, Linda Thomsen, a senior lawyer in the enforcement division, was in a meeting. Two young lawyers, Doug Paul and Beth Lehman, appeared in the doorway, looking excited. They signaled for Thomsen, who came out to see them in the hall.
“It looks like Enron has a huge financial issue,” Paul said. “I think we should open a case.”
Thomsen listened as the lawyers described what they knew. A big write off, tied to some related-party transactions involving the CFO. Sounded good.
“Okay,” she said. “Go see if you can grab it.”
About that same time, the phone rang on Palmer’s desk. He glanced at the caller ID, and his heart sank.
“Fastow, Andrew,” the screen read.
He reached for the phone. “Mark Palmer.”
“Mark, it’s Andy,” Fastow said.
Palmer braced for the storm.
“The story was fantastic,” Fastow enthused. “If that’s the best they can do, we’re in great shape. Everything they said had been out in the market already. I think that was a brilliant strategy you employed.”
What? “Andy, it wasn’t my strategy,” Palmer replied.
“Well, I think it was a brilliant strategy,” Fastow continued. “And I am going to remember this at the PRC.”
Palmer hesitated. “Well, okay,” he said. “I’m glad you’re happy with the story, Andy.”
He hung up the phone, seething. He had felt the thinly veiled slap—see, Mark? I was right, you were wrong—and it stung. But also, crediting Palmer with the way the story came out, and saying that he would get a boost at the Performance Review Committee, could work against him, too. When news articles were bad, would Fastow punish him?
Palmer turned around. Steve Kean was at his desk.
“Steve, you may get a call from Andy telling you that he’s brilliant and that he loved the story.”
Kean shrugged. “Well, the story’s not bad”
Palmer looked him in the eye. “Steve,” he said firmly, “this might not be the end of it.”
John Emshwiller was at his desk, taking calls from readers about his LJM story that morning. One came in from a short seller he knew. “You missed something that could be really big,” the short seller said. “What exactly did we miss?”
The $1.2 billion equity reduction, the short seller said. Lay had mentioned it on the conference call, but nobody picked up on it. Emshwiller thanked the trader and c
alled Smith. He asked if she remembered anything about an equity reduction during the conference call.
“Nothing,” she said. “But I’ll go back and check.”
“We didn’t bury it!” Palmer protested. “We talked about it!” He was on the phone with Smith, who was accusing Enron of having camouflaged the equity reduction.
“Well, how’s it tied to LJM?” she asked.
Palmer already knew what was coming. No doubt, this was the Journal’s, story for tomorrow.
The word back wasn’t good for the SEC lawyers in Washington. They had checked the division’s internal computer system and found that someone in the Fort Worth office had already opened an Enron case months before.
Thomsen got on the phone. She reached Spencer Barasch, the associate district administrator in Fort Worth.
“Spence, you’ve got an Enron case,” she said. “But we can’t tell if it’s related to what we’re looking at.”
Barasch was amused. With the announcement of the write-downs, everybody in Washington was dashing to investigate Enron. That morning, he had received the same call from Tom Newkirk, the chief lawyer on Waste Management. But the Fort Worth office read the Journal, too, and their case had been open since late August.
“It’s ours,” Barasch said. Already, he said, his lawyers were putting together a request for information from Enron, seeking documents about Fastow and his deals. It was going to Enron’s general counsel that very day.
Jim Derrick had just received the fax from the SEC in Fort Worth. They wanted everything—the offering materials for the LJM funds, records on all the transactions, and an accounting of Enron’s profit or loss on each deal.
Well, Derrick thought, at least this wasn’t a formal investigation, just a preliminary inquiry. Perhaps it wouldn’t amount to much. He picked up the phone and dialed Lay’s voice mail. Lay himself was in New York for investor meetings. Derrick silently listened until he heard the beep.
“Ken, I hope the trip is going well,” he said. “I’ve got some information I need to share with you.”
He discussed the contact from the SEC.
Conspiracy of Fools Page 69
