The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron (64 page)

When Watkins arrived at Lay’s office on the fiftieth floor for her 1
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appointment, the Enron chairman was winding up a private lunch with Greg Whalley, one of the candidates for Skilling’s job. As Watkins made her case to Lay, he listened attentively. In truth, none of what Watkins told him should have come as much of a surprise. He had personally approved the waiver on Fastow’s conflicts to let him run the LJMs; the Raptors had gone before both Lay and the entire board; their growing credit deficiencies were reported on daily position reports, distributed to scores of executives at Enron, and the restructuring had been disclosed in Enron’s SEC filings. Still, Lay seemed concerned and surprised at what he was hearing. Watkins later recalled that he winced when reading the comment about Enron being “such a crooked company.”

“Andy’s a good CFO, right?” Lay interrupted at one point, according to Watkins’ later account of the meeting. “He’s doing a good job, right?” Lay also noted that Enron’s accountants had reviewed the Raptors with their usual care. Perhaps so, said Watkins, but accounting rules generally barred a company from using its stock to boost its income statement, and Andersen had made mistakes in the past, as recent scandals at other Andersen clients showed. Lay asked one more question: “You haven’t gone outside the company with this, have you?” Assured that she had not, Lay ended the meeting by telling Watkins he would deal with the matter and agreed to arrange her transfer away from Fastow, most likely to Cindy Olson’s HR department.

Lay contacted Jim Derrick, Enron’s general counsel, and they quickly made arrangements to have Watkins’s allegations investigated by an outside law firm—namely, Vinson & Elkins. Watkins, of course, had explicitly offered the commonsense advice that another firm handle the matter; indeed, V&E had done legal work on the very transactions she was complaining about. But Lay later said he had concluded this conflict could be managed and that it made sense to hand the assignment to lawyers already familiar with the complexities of Enron. V&E certainly fit that bill: it was every bit as intimate with Enron as Arthur Andersen. Derrick himself was among the many Enron executives who were V&E alums.

One of the two lawyers retained to investigate Watkins’ allegations was Joseph Dilg, a senior partner who had been responsible for the firm’s relationship with Enron since 1991. Dilg had reason to be attuned to sensibilities at Enron: with annual billings running at $35 million a year, Enron was the giant firm’s single largest client. Dilg also had reason to be especially attuned to V&E’s interest; he was about to take over as managing partner of the 850-lawyer firm. Only one other V&E lawyer worked on the project: Max Hendrick III, head of the litigation department.

It was decided that Vinson & Elkins would conduct a very narrow inquiry. The lawyers later noted in their written report that no outside accounting experts were to be hired. There would be no second-guessing of Arthur Andersen’s work. And no one outside the walls of Enron or Arthur Andersen would be interviewed. This, the report would note, would serve merely as a preliminary probe, to determine whether Watkins had “raised new factual information that would warrant a broader investigation.” Preliminary or not, a special board panel later concluded that this inquiry was essentially a whitewash, noting: “The result of the V&E review was largely predetermined by the scope and the nature of the investigation and the process employed.”

Even before the investigation could begin, Enron asked another V&E lawyer—a specialist in labor law—for advice on a related matter: namely, what were the company’s options in dealing with Sherron Watkins? The two-page memo from partner Carl Jordan to an in-house Enron lawyer arrived just two days after Watkins met with Lay. It outlined how Enron should manage the situation to minimize the risk of a lawsuit from Watkins as long as she remained at Enron. (Both her new supervisor and Fastow should be told not to treat her “adversely” because she’d spoken up, Jordan advised.)

But at Enron’s request, Jordan also explored the possibility of firing her. “Texas law does not currently protect corporate whistle-blowers,” he noted. Still, he concluded, getting rid of Watkins wouldn’t be smart. It would invite the sort of ugly lawsuit that would be “very expensive and time consuming to litigate,” and the company’s books and records would then become “fair game during discovery.” In addition, Jordan wrote, “there is the risk that the discharged employee will seek to convince some government oversight agency (e.g., IRS, SEC, etc.) that the corporation has engaged in materially misleading reporting or is otherwise non-compliant. As with wrongful discharge claims, this can create problems even though the allegations have no merit whatsoever.”

Such niceties were lost on Fastow. After meeting with Lay, Watkins left town for a vacation to Mexico, she recalled in
Power Failure
, her account of life at En-
ron, coauthored with Mimi Swartz. In the meantime, the investigation had begun—and Fastow had found out who had fingered him. After receiving a copy of Watkins’s letter from Derrick, he confronted McMahon, accusing him of conspiring with Watkins in hope of landing the CFO’s job. Fastow also demanded that Watkins be fired immediately and her laptop confiscated. When Watkins returned from her trip, she later recalled in
Power Failure
, her new boss, Cindy Olson, advised her that “Andy is not behaving appropriately.”

 • • • 

Sherron Watkins wasn’t the only Enron employee writing a letter to her superiors warning about the company’s accounting. On August 29, after she was laid off from her job at EES, Margaret Ceconi, who had previously e-mailed the SEC anonymously, wrote her own signed letter to the Enron board, addressing it to Cindy Olson and board secretary Rebecca Carter. It ran ten pages long and warned of huge woes at EES, including wasteful spending, customers threatening to sue over broken promises, and unprofitable contracts that had been booked for profits. But the most alarming part of the letter alleged “SEC violations” involving more than $500 million in losses that EES was “trying to hide in wholesale. Rumor on the 7th floor is that it is closer to $1 billion.” Yet “somehow EES to everyone’s amazement, reported earnings for the second quarter.” She went on: “EES has knowingly misrepresented EES’ earnings. This is common knowledge among all the EES employees, and is actually joked about. But it should be taken seriously.”

“Some would say the house of cards are falling,” Ceconi wrote. “You are potentially facing shareholder lawsuits, Employee lawsuits. . . . Heat from the analysts and newspapers. The market has lost all confidence and it’s obvious why. You, the board, have a big task at hand. You have to decide the moral or ethical things to do, to right the wrongs of your various management teams. I wish you luck.”

The letter was never shown to Lay or the Enron board. Ceconi spotlighted serious problems, but because she had been laid off, it was easier to dismiss her letter as the bitter rantings of a disgruntled former employee—which Enron did.

Ceconi, meanwhile, had also begun anonymously e-mailing, then calling, Prudential analyst Carol Coale. Using the e-mail name of enrontruth, she began feeding Coale tough questions to ask at analysts meetings and conference calls.

And then, on September 30, while out for drinks and dinner at a Houston tapas bar called Mia Luna’s, Ceconi ran into a table full of high-ranking EES managers, including division CEO Dave Delainey, COO Jeremy Blachman, and star sales executive Angela Schwarz. Ceconi sauntered by their table on the way out. “What are y’all doing here?” she asked. “Trying to figure out how you’re going to make up the numbers again this quarter?” The encounter turned into a shouting match. As Blachman tried to escort her out, Ceconi pulled away and told gawking bystanders: “He’s from Enron—he thinks he owns everybody and everything!”

In the aftermath of the episode, Ceconi again reported her complaints to the SEC through its Web site, this time identifying Enron as engaging in the abusive accounting. But nothing happened.

 • • • 

In the wake of the Watkins letter, Fastow lost whatever chance he had to move up. Instead, on August 28—14 days after Skilling’s resignation was made public—Lay announced that Greg Whalley, 39, would take over as president and COO while the 46-year old Mark Frevert would assume the senior-statesman role of vice chairman; both would join Lay in the “office of the chairman.” Frevert was an old Enron hand; he’d started in origination, then helped launch Enron’s trading operation in Europe before returning to Houston to serve as chairman and CEO of the wholesale business. But the key player was Whalley. The “union boss” was now the second-most powerful man at Enron.

Whalley strongly suspected that all wasn’t well, and he wasted no time digging in. At 1:01
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on the day after his promotion was announced, Whal-
ley e-mailed investor-relations chief Mark Koenig about Lay’s latest cheery pronouncement. “I guess Ken told someone today that we would make the numbers,” Whalley wrote. “We need to be careful until we know what the numbers are.”

In truth, Lay seemed preternaturally calm. In early September, he laid plans to assemble his newly appointed 25-member management committee for a two-day off-site meeting. It was to begin on a Thursday night with cocktails and a working dinner. Lay’s proposed agenda for the next day began with two of his favorites, Cindy Olson and PR guru Beth Tilney (wife of Merrill banker Schuyler), tackling the topics of “culture” and “vision and values.” Among the issues for discussion: “image and reputation” (“What is it? How do we communicate it?”) and “How do we define Enron?” (“Not a trading company/More than a trading company/A trading company”). Next up: employee compensation and new businesses. The topics of risk management, electricity markets, concerns about the third quarter, and international asset sales were put off until the end of the day.

After looking over the schedule, Whalley fired off a blunt e-mail to Lay: “I’m sorry I haven’t been more involved in setting this up, but I think the agenda looks kind of soft,” he wrote. “At a minimum, I would like to turn the schedule around and hit the hard subjects like Q3, risk management, and asset sales first. I would also like to see a discussion on our funds flow, and our balance sheet. If we don’t get these things right, none of the rest of it matters. . . . Also,” Whalley went on, offering no deference to Lay’s favorites (jokingly known as “Ken’s harem”), “I notice that Cindy Olson and Beth Tilney are in attendance. This should only be for presentation, as they are not members of the management committee.”

By the time of the management retreat, the issue of Fastow’s partnerships had surfaced—just barely—in the
Wall Street Journal
. In an August 28 Heard on the Street column, headlined “Enron Prepares to Become Easier to Read,” reporters Rebecca Smith and John Emshwiller had detailed Lay’s promise of a “humbler,” more open company. In a three-paragraph discussion buried deep in the story, they also noted that CFO Fastow “had quietly ended his ownership and management ties with certain limited partnerships” effective July 31. The story did not identify the partnerships as LJM.

At the off-site, nine days later, there was considerable grumbling about Fastow’s passion for SPEs. The commercial executives complained that while they were making money for Enron, Fastow’s finance people kept muddying the waters by stashing their assets in SPEs. Recounting the meeting, Lay later said he asked the two dozen top Enron managers how many of them had made use of Fastow’s structured vehicles. The answer: pretty much everyone.

 • • • 

It took Joe Dilg and Max Hendrick about a month to make up their minds about Sherron Watkins’s allegations. The Vinson & Elkins lawyers interviewed nine Enron executives and two Arthur Andersen partners. Under the ground rules, Jeff Skilling, Cliff Baxter, and Michael Kopper were all off limits because they had left Enron.

While Jeff McMahon openly voiced his problems with Fastow’s conflict, neither McMahon nor anyone else (except Watkins, of course) presumed to question Andersen’s judgments about Enron’s accounting. In fact, McMahon told the lawyers that a lot of the LJM transactions had been “highly beneficial” to Enron. Greg Whalley said flatly he didn’t share Watkins’s concerns. Causey and Buy insisted everything had been carefully reviewed—by management, lawyers, accountants, and the Enron board—and disclosed (if opaquely) in Enron’s public filings. The view among Enron executives, the lawyers noted, was that the Raptors and Condor were “clever, useful vehicles.”

Fastow himself had barely calmed down by the time of his own interview. Everything had been blessed, he pointed out to the V&E lawyers, not only by Andersen accountants but by lawyers from Vinson & Elkins. The letter writer, he said, was simply “second-guessing” Andersen’s judgment. While he applauded the employee’s “fortitude” for speaking up, he voiced suspicion about her motives, telling Dilg and Hendrick that the letter writer was “acting in conjunction with a person who wants his job,” namely, McMahon. The LJM-Enron relationship, he said, was “good for LJM and great for Enron.”

On September 19, while the investigation was still officially under way, Joe Dilg and his wife hosted a dinner for two Enron couples—including Andy and Lea Fastow—to introduce them to the new headmaster of the private school that all their children attended. Two days later, Dilg and Hendrick stopped by Lay’s office at
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. Their written report wouldn’t be ready for three more weeks, and they wouldn’t officially inform the board’s audit committee of the matter until early October. But they were ready to give Ken Lay an oral report on their conclusions: while Fastow’s “apparent” conflict of interest presented “potential bad cosmetics” if subjected to a media exposé or a lawsuit, they had found nothing to warrant a full-fledged investigation.

Lay was delighted. In his opinion, Andy was a fine CFO, and Lay was bent on making sure he didn’t join the recent exodus of top Enron executives. With the lawyers’ finding and Fastow’s sale of LJM, Lay considered the matter closed. He moved forward with his plans to tear up Andy’s contract and reward him with a rich new pact.