Fastow’s explanation of Enron’s business did not exactly provide the promised clarity. On the contrary. Here’s how Fastow explained Enron’s business model: “We create optionality. Enron is so much more valuable—hence our stock price—because we have so much more optionality embedded in our network than anyone else.” Fastow then compared Enron to Toyota; Enron, too, was an “assembler” rather than a “manufacturer.” “Our disclosure is more complete than anyone’s,” Fastow insisted. A moment later, he seemed to say precisely the opposite: “We don’t want to tell anyone where we’re making money.” Like Skilling, Fastow insisted that Enron did not make its money speculat-
ing. “It’s not trading, it’s optimization,” he said. The proof? Enron’s earnings record in the wholesale business. “We have for 20 straight quarters exceeded the previous one. There’s not a trading company in the world that has that kind of consistency.”
When McLean asked Fastow about the related-party transactions, he replied, “One of our senior executives runs that fund. It’s confidential who it is.” (In fact, a line in Enron’s 1999 proxy statement disclosed that the senior executive was Fastow.) Why did Enron need to do business with the related party? “We’re always looking to hedge risks, to sell risks,” Fastow replied. “We want to sell, but we don’t want the information to get into the market . . . it adds to our optionality.” And “we strip out the price risk, we strip out the interest-rate risk, we strip out all the risks. What’s left may not be something that we want. We want the contract, but we don’t want the power plant. We’re not investing for the whole thing—we wanted the optionality. Once we’ve gotten that piece, we want to sell off the other pieces.”
After two hours, the meeting came to a close. Koenig and Palmer left the room; Fastow lingered for a moment. After he gathered up his things, he paused. “I don’t care what you say about the company,” he said finally. “Just don’t make me look bad.”
In retrospect, the story that ran in Fortune, which was published on Febru-
ary 19, barely scratched the surface. Headlined “IS ENRON OVERPRICED?” it asked far more questions than it answered: “How exactly does Enron make its money? . . . ‘If you figure it out, let me know,’ laughs credit analyst Todd Shipman at S&P. ‘Do you have a year?’ asks Ralph Pellecchia, Fitch’s credit analyst, in response to the same question.” The story noted Enron’s lack of cash flow and climbing debt. And it quoted some analysts defending the company. “Enron is no black box,” says Goldman’s Fleischer. “That’s like calling Michael Jordan a black box just because you don’t know what he’s going to score every quarter.” The Fortune story didn’t even mention Enron’s odd dealings with the related parties.
At Enron’s February 21 all-employee meeting, there was one question about the story. To Enron’s employees, Skilling not only admitted that the company was a black box—something he’d flatly denied to McLean—but he seemed proud of it. “Yes, it is a black box,” he said, “but it is a black box that’s growing the wholesale business by about 50 percent in volume and profitability. That’s a good black box. And we’ve been absolutely up front with the analysts.”
He later added: “People will take shots at us because the p/e ratio is high. I personally believe that the p/e ratio is justified because we’re growing very quickly in earnings and revenues and we have the strongest position in every market that we’re in. But it is going to take a little while to get that across and I think we can expect these kinds of articles to come out over the next couple of months because we really are the only ones left with this high p/e ratio. I personally think it’s justified. . . . I think we’re going to have a great year this year, and I think that’s going to push the stock price up.”
Enron’s stock, which had been at $82 after its analyst conference, sank to $68.50 by February 28.
• • •
With Enron’s stock sputtering, the Raptors again began springing leaks, and the desperation kicked in all over again. This time, Causey and Fastow, with the help of other Enron accountants, including a young ex-FASB intern and Arthur Andersen alum named Ryan Siurek, came up with what they thought was a permanent solution. The Raptors were restructured so that they could prop each other up forever. In other words, as long as one Raptor could pay for the losses sustained by the others, Enron could avoid disclosing the losses. To do this, Enron had to contribute yet more stock and more derivatives on its shares. In exchange, the Raptors gave Enron $828 million in notes receivable.
How did Enron overcome the objections of Andersen’s Professional Standards Group? Simple: this time, Duncan didn’t even consult with Andersen’s experts. “We decided to accept the client’s position,” he later said. In total, Andersen was paid about $1.3 million for its Raptor-related work.
The Raptor restructuring closed on March 26—just in time. Four days later, the first quarter came to a close, and the Raptors had shielded another $200 million in losses. And though the word Raptors was never used—and there was never any precise description of what these entities accomplished—the restructuring itself was disclosed in Enron’s first-quarter filing. Mind you, it wasn’t disclosed in a fashion that any outsider could interpret. But if you took a skeptical eye to the sentence in Enron’s first-quarter SEC filing that read “Enron received notes receivable from the Entities totaling approximately $827.6 million,” you might suspect that something enormous had happened.
Skilling later claimed that he knew very little about the Raptor restructuring. Most people don’t believe him. On the afternoon of March 26, just after the deal closed, Skilling called Siurek to thank him for his work. He has claimed that he did this at Causey’s urging and that he was only vaguely aware of the situation. “It’s conceivable that Andy could pull the wool over Jeff’s eyes,” retorts a friend. “But if Causey knew there was an earnings impact, then Jeff knew.” Causey himself told investigators that he was “certain that he told Skilling about the shortfall in the Raptor vehicles.” The investigators added: “When they found what Causey felt was a solution, Causey sought and obtained Skilling’s approval. Causey updated Skilling before executing the Raptor restructuring, during development of the restructuring plan and after determining the solution to the problem.”
There’s a second reason why Skilling’s explanation does not ring true. He was a man obsessed with Enron’s quarterly numbers. Although the traders were making a fortune during this period—enough to cover earnings shortfalls—the losses inside the Raptors would still likely have had to be disclosed to investors. Skilling later insisted that Enron could have simply taken the hit—everyone was writing down high-tech investments. But not everyone was using structured finance to prop those earnings up, and the market would certainly not have taken a write-down lightly. Could Skilling really have been only dimly aware of something with such potential to crush the stock?
Enron’s board members also insist that they were kept in the dark about the restructuring—it was never included on a list of Enron’s top credit exposures, for instance. Still, since the restructuring was disclosed in Enron’s financial statements, there are only three possibilities. They are lying. They did not bother to read Enron’s financial statements. Or they read the financial statements—but like so many others, they didn’t understand what they were reading.
• • •
On March 21, Enron’s stock fell a stunning $5.06, to $55.89. The next day, it hit an intraday low of $51.51. Enron executives, feeling blindsided by the stock’s downturn, struggled to figure out how to get it back up. Though the end of the quarter was barely a week away, the company took the unusual step of issuing
a press release announcing that it would meet earnings estimates. The next
day, Skilling held a conference call. “I just came in from South America this morning—got in at 5:30—so I’m in a really lousy mood, so I hope we get the message across quickly,” he began testily. “Enron’s business is in great shape.” Rumors had been floating in recent days
that Enron would need to do an equity offering to raise money; Skilling went out of his way to flatten the rumor. “From a credit standpoint, there is absolutely no need to issue additional equity, either this year or for the foreseeable future,” he said. “So overall, I have no understanding of why [our] stock price is in the $53, $54—that’s just crazy.”
After the call, Enron’s stock rebounded to $59.40. “$102 target likely a late 2002 event,” wrote analyst Ron Barone in what passed for conservatism—he had been predicting that the stock would reach that level in the ensuing 12 months. A few days later, Goldman’s David Fleischer added, “Investors have focused on issues we view as almost insignificant to future valuation.”
About a month later, with its stock stuck around $60 a share, Enron announced another stunning first quarter, beating its earnings estimates by two cents a share. The next morning, Causey, Koenig, Rice, and Skilling gathered at the conference table in Koenig’s office for the conference call following the earnings release. Skilling had just returned from a college tour with his daughter, Kristin; he was in an upbeat mood. “Just an outstanding quarter, another outstanding quarter,” said Skilling. We are “very optimistic about each of our businesses and confident that our record of growth is sustainable for many years to come.”
In the middle of the question-and-answer period, a man named Richard Grubman was given the floor. Grubman, who runs a hedge fund called Highfields Capital, is another well-known short seller. Like Chanos, Grubman had taken a large short position in Enron. Koenig promptly slipped Skilling a note, informing him that the questioner was a short seller. Grubman didn’t care about Enron’s earnings. He wanted to see a balance sheet, which would have far more detailed information than the income statement Enron put out the day before.
Skilling: “We do not have the balance sheet completed. We will have that done shortly when we file the Q. But until we put all of that together, we just cannot give you that.”
Grubman: “I’m trying to understand why that would appear to be an unreasonable request, in light of your comments about daily control of all your credits?”
Skilling: “I’m not saying we can’t tell you what the balances are. We clearly have all of those positions on a daily basis, but at this point, we will wait to disclose those until all . . . the right accounting is put together.”
Grubman: “You’re the only financial institution that cannot produce a balance sheet or cash-flow statement with their earnings.”
Skilling: “Well, you’re—you—well, uh, thank you very much. We appreci-
ate it.”
Grubman: “Appreciate it?”
Skilling: “Asshole.”
Rice, who was half asleep, bolted awake. Jaws dropped around the table. A horrified Mark Palmer, listening in on the conference call with the rest of Enron’s public-relations team, immediately ran upstairs with a note to Skilling, urging him to apologize right away. Skilling looked at the note and then slipped it under a pile of papers in front of him.
The call had been piped onto the trading floor. When Skilling called Grubman an asshole, the whole floor burst into applause. Afterward, the traders gave Skilling a sign that played off Enron’s motto, “Ask Why.” It read: “Ask Why, Asshole.” Skilling proudly displayed it behind his desk.
Ken Lay, who was already upset by the declining stock, was aghast. So was Enron’s board. Big institutional shareholders called Lay to complain. “It didn’t go over well,” Skilling later admitted to friends while steadfastly maintaining that the comment was justified: “I don’t like shorts promoting their position.” But he also claimed that at that point, he didn’t care: “I was tired. I was beat.”
Over at Kynikos, Jim Chanos was in hysterics. He had never heard the CEO of a Fortune 500 company lose it like that. After listening to the conference call, Chanos was more convinced than ever that Enron was hiding serious problems. Even owners of Enron stock thought Grubman’s questions were perfectly valid—and if they hadn’t been, Skilling should have dealt with them more adeptly. “Any CEO should be able to handle the hardest of questions from the most aggressive of shorts,” says analyst Meade.
Skilling’s act was finally starting to wear thin. “After eight or ten conference calls, I started to lose faith,” says one analyst. “It was always exactly the same thing. There was never anything wrong. Four quarterly conference calls and the annual meeting, all exactly the same. It’s all great. The company is ahead of everyone. It will only get better.”
Another money manager found himself increasingly disturbed by Skilling’s stock-price fixation. In meetings with this person, he would spend 15 to 20 minutes of a one-hour presentation talking about the stock and grousing that investors weren’t recognizing Enron’s greatness. “I asked internally, have you ever come across a CEO so obsessed?” says the manager.
Skilling’s explanations for the few problems that were visible were losing credibility. For instance, Skilling used to blame Enron’s low return on capital on Mark’s international assets. Skilling claimed that the return on Enron’s other businesses—his businesses—was far higher. But he wouldn’t offer any proof. That was fine during the bull market—but this wasn’t a bull market anymore. In-
vestors complained to Enron’s investor-relations department that they didn’t want to hear excuses if they couldn’t see evidence.
Another major fund manager had loaded up on Enron stock mainly because he believed in the company’s deregulation story. Even in the midst of the California debacle, Skilling and Lay continued to insist that the trend towards deregulation was unstoppable. Skilling went so far as to say that the fiasco would “push forward more open competitive markets.” Few agreed with him. The mutual fund company began dumping its Enron shares.
As people began to question Skilling’s credibility, other things began to matter—such as the whole logistics company rationale. Many had never believed it. On Wall Street, people knew people who traded with Enron; to them it was obvious the company was speculating. But during the bull market, they let Skilling have his conceit. Now, it became one more reason to doubt him. “He’s either compulsively lying, or he’s refusing to recognize the truth,” one portfolio manager remembers thinking.
Skilling knew that his credibility was slipping. “Am I the liability here?” he asked several analysts. In early May, he and Rebecca Carter flew to Turkey for the wedding of his brother, Mark, who had moved there to become a writer. Upon his return, Enron’s stock was still stuck at around $60. Skilling was beside himself.
• • •
Someone inside Enron finally became uncomfortable enough about LJM to try to do something about it. In October 2000, Fastow had booted out his general counsel at Global Finance and brought in a lawyer named Jordan Mintz, who had spent the previous four years in Enron’s tax department.
Like many Enron employees, Mintz had known of the existence of LJM. Now, in his new post, he began to learn the gory details—and the more he learned, the more panicked he got. LJM, he thought, was “potential dynamite.” His first impression was simply that everything was a mess. Files were an absolute shambles. Documentation was scattered; required signatures on approval forms were missing. In addition, LJM people and Enron people were working side by side, and one could scarcely tell who was wearing which hat—and when. “This is certainly a shit load of dysfunctionality,” Mintz thought.
Mintz also worried that the disclosure about LJM in Enron’s public filings was inadequate. Though he understood, as he later put it in an e-mail, that Enron’s goal was “to be as innocuous as possible in terms of description, detail, etc.,” he maintained that they would all be better off if Enron provided “evidence of Senior Management and the board’s carrying out their fiduciary duties, absence of a ‘sweetheart deal’, and the ‘legitimacy’ of the financial treatment resulting from the transaction.”
Finally, he was concerned that Enron was not disclosing how much money Fastow was making from LJM, as the law seemed to requ
ire. As a rule, if top executives are making substantial sums from an entity that does business with the company, they have to tell shareholders. Although there’s some murkiness surrounding the rules—and Mintz knew that Enron relished murky areas—he felt that the company’s failure to disclose Fastow’s LJM income was hard to justify.
At the end of 2000, he talked to Fastow. “You want to know how much I’ve made?” Fastow asked playfully. He told Mintz that he probably shouldn’t tell him until he’d talked to his lawyer at Kirkland & Ellis. “Let’s figure out a way not to disclose it,” he said. Then, Fastow said, “Hell, if Skilling knew how much I made, he’d have no choice but to shut LJM down.”
On March 8, Mintz sent a memo to Causey and Buy—which he copied to Fastow—listing all the problems he saw with LJM. “Enron does not consistently seek to negotiate with third parties before it transacts with LJM,” he noted; thus, there was little evidence of either “accounting substantiation” or of the board carrying out its fiduciary duties. He also talked to them about Fastow’s compensation. Causey was unperturbed. “I don’t care how much Andy’s making,” he told Mintz. “This is a win-win situation for the company.”
Rick Buy had his own problems. Late in 2000, Skilling had formed a new übergroup called the Policy Committee. It consisted of a dozen male Skillingites—but not Buy, who was deeply upset by his exclusion. He was all too aware of his impotence. In frustration, he told Mintz he was considering leaving Enron to work for LJM. Yet at other times, he complained that LJM made him uncomfortable. Then, that winter, doctors discovered a tumor on his tongue. Buy had surgery and took a vacation to recuperate.
Mintz did get a reaction—a huge one—from Fastow. Michael Kopper came storming into Mintz’s office with the memo, flung it across his desk, and said, “What do you want to do, shut us down?”
The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron Page 54
