The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron (67 page)

“There I go, making money again,” Andy e-mailed his brother. “That is even allowed in Russia and China today. The saga continues.”

As Fastow circled the wagons, some of his banker friends rushed to display their loyalty. CSFB’s Osmar Abib sent Fastow the dismissive research note that Curt Launer, his firm’s Enron-friendly analyst, wrote in response to the
Journal
stories. (“In our view, the so-called ‘LJM Partnerships’ were fully disclosed in ENE’s financial statements and were subject to appropriate scrutiny by ENE’s board, outside auditors and outside legal counsel . . . we continue to rate it Strong Buy.”) “Thought you would appreciate the support,” Abib wrote. “Hang in there.”

Enron’s stock, meanwhile, had fallen more than 20 percent during the week, to $26, and was approaching levels not seen since 1997. On Tuesday, after the earnings call, Moody’s announced it was placing the company’s long-term debt on “review” for a possible ratings downgrade.

There was yet another ominous development that week: after reading the
Journal
’s first story on Wednesday, SEC officials began an informal inquiry into Enron’s dealings with Fastow’s partnerships. Strange as it might seem, it wasn’t unusual for the agency to begin a securities probe on the basis of a media report. The SEC was short staffed and overwhelmed; its staff hadn’t conducted a routine review of Enron’s annual financial filings since 1997.

In a letter sent by the SEC’s district office in Fort Worth, the agency informed the company that it wanted to “determine the nature and amount of the interests, profits, and losses of Enron and Mr. Fastow in the Related Party transactions.” Among other items, it wanted “an accounting of Mr. Fastow’s interests in each Related Party transaction, and showing his profits or losses with regard to the individual transaction.”

Though the inquiry was short of a full-fledged investigation, it was still very bad news. On Monday, October 22, when Enron announced the informal probe—five days after getting the letter—its stock sank another 20 percent, to $20.65.

 • • • 

At this point, Lay believed he was the only one who could keep Enron together long enough to turn the ship around—and there were others telling him that as well. Lay responded to Enron’s growing problems like a politician under fire: he began polling his constituents. First, he conducted his own in-house sampling—called the Lay It On the Line survey—which revealed the unsurprising news that Enron employees were very concerned about their stock. Then he hired a political consultant—a high-profile Republican pollster named Frank Luntz—to conduct focus groups at Enron.

Luntz’s report, which landed on Lay’s desk two days after the letter from the SEC, made brutally clear that the CEO’s exalted notions of Enron’s culture were a delusion. “Instability and chaos” were defining features at Enron, Luntz said. Far from reveling in their freedom, employees complained bitterly about senior management’s “lack of corporate vision”: “there appears to be no long-term thinking, strategy, or game plan.” Enron’s constant reorganizations—six in just the previous 18 months—were a running joke. The PRC was viewed not as a meritocracy but as “punishment.” Only deal makers got ahead; “no one in the corporate leadership truly cares about those charged with executing the deals and making them actually produce profit.” Enron’s lack of discipline wasn’t something noble that nurtured creativity; it was destructive and demoralizing. Commented one Enron employee: “We’re a major corporation still acting like a dot-com start-up.”

But what Lay seems to have taken away from the exercise was Luntz’s belief that Lay alone had the “credibility, confidence, and trust” to deal with Enron’s crisis. “Ken is your most powerful weapon. A personal commitment from Ken Lay will go further than [from] the entire executive team combined,” Luntz wrote. “Employees want to see Ken Lay’s face. They want to hear from him and be led by him.”

So Lay tried to lead. On Monday, October 22, he convened a meeting at the Hyatt of Enron’s best and brightest—not just members of the management committee but all the company’s managing directors, about 80 people in all. Andy Fastow wasn’t there; he’d been instructed not to attend.

The meeting was cast as part of Enron’s new open communication in the post-Skilling era. The discussion quickly turned to Fastow’s partnerships. The board and senior management were behind Andy, he said; the managing directors needed to be supportive too. Enron had done nothing wrong, Lay insisted, “but knowing what we do now, we would never do it again.”

“I’m in the terrible position of having to disagree with you,” said Vince Kaminski from the audience.

Lay encouraged the risk-management wizard to speak his mind, so Kaminski stepped up to the microphone. Enron should never have gotten involved in Fastow’s private partnerships, Kaminski said. “The Raptors were not only improper,” he declared. “They were terminally stupid.” The company’s murky dealings had caused a crisis, Kaminski said. “The only fighting chance Enron has is to come clean.”

Lay looked stunned; this was getting out of hand. “Enough, Vince,” Whalley interrupted, and he led Kaminski from the podium.

 • • • 

Later that same day, a few hours after the managing directors meeting, Enron’s board met. Unsure whether he was officially persona non grata, Andy asked a board secretary to “double-check that Ken wants me to attend.” He didn’t.

Among the directors, there was much concern about the impending rating review by Moody’s, which had advised the company that it would be focusing on three issues: negative cash flow from operations, slow progress in the promised asset sales, and the likelihood of more write-offs involving Dabhol, Azurix, broadband, and California.

The most pressing discussion was about Fastow. It was now painfully obvious that the media knew more about Andy’s partnerships than the Enron board did. The directors struggled to recall just what they had been told about the money Fastow made from the partnerships. The minutes noted: “Mr. Lay asked for a discussion regarding if the members of the Board had any recollection of information regarding the financial returns by Mr. Andrew S. Fastow in conjunction with certain financial arrangements.”

In fact, the board
had
requested that information earlier. Back in October 2000 in Palm Beach, when Fastow won approval for LJM3, the directors actually asked the compensation committee to check on the CFO’s compensation from the partnerships. The committee chair, LeMaistre, even made a feeble attempt to carry out the request. Initially, he asked Mary Joyce, an Enron compensation executive, to give him information on the outside income for all of Enron’s top management. LeMaistre later explained that to avoid spreading office gos-
sip he didn’t ask specifically about Fastow. When Joyce said she didn’t have the information, he asked her to let him know when she did. Six months later, he asked again. When no information arrived, LeMaistre simply dropped the matter.

Now the board belatedly resolved to do the obvious: ask Fastow directly.

 • • • 

Andy Fastow was up early the next day, Tuesday, October 23. At 6:36
A
.
M
.
, he
e-mailed his office: “Mickey LeMaistre called and asked that I have a conference call today at 4
P
.
M
. with him and John Duncan. I’m not sure who is supposed to arrange it. Could you coordinate?”

Fastow then headed into the office, for an 8:30
A
.
M
. analysts conference call. Determined to reclaim the initiative, Lay scheduled the call to address “investor concerns.” The executive team carefully prepared for the session with Enron’s outside accountants and lawyers. Vinson & Elkins partner Ron Astin displayed a Q&A script he’d marked up to the group—Lay, Fastow, Koenig, Causey, and Buy were all in the room. Included in the talking points was that Fastow had come up with the idea for LJM and presented it to the Enron board. “This is wrong!” Fastow screamed; LJM was
Skilling’s
idea.

Lay opened the call by telling the analysts he was eager to address their questions and expressing his dismay at Enron’s stock price, then flirting with $20. “To say the least, we are very, even extremely, disappointed with our stock price, particularly since our businesses are performing very well and we are continuing to conduct business as usual,” he said.

Before turning the call over to Fastow, who was supposed to reassure investors about the state of Enron’s finances, Lay paused to make clear that he was standing by his man. “I and Enron’s board of directors continue to have the highest faith and confidence in Andy and believe he is doing an outstanding job as CFO,” Lay declared.

After Fastow gave his presentation, the questions came fast and furious. What would Enron’s earnings for 2000 and 2001 look like without the LJMs?

Causey told the analysts the absence of the partnerships would have had a “minimal impact.” Enron, he said, could have simply done the same deals with other “third parties.”

Richard Grubman, the short seller Skilling had called an asshole, took his turn. He asked about Marlin, the Enron debt vehicle that financed Azurix. By Grubman’s calculations, its assets were worth less than its debt; thus Enron was left holding the bag. Causey and Grubman argued over the analyst’s numbers until Lay jumped in. “Now I know you want to drive the stock price down, and you’ve done a good job at doing that, but I think that’s that,” he scolded.

“That’s pointless,” Grubman shot back.

“Let’s go to the next question, Richard,” said Lay. “You’re monopolizing the conference. We’ve got a lot of people out there with real serious questions.”

“I would appreciate an answer to the question,” Grubman responded. “That’s fine if you move on. I think everybody understands why.”

One analyst asked what would happen if Enron’s debt fell below investment grade.

Lay dismissed the possibility: “First of all, we’d have to be downgraded three notches to go below investment grade. And there’s—at least we don’t think there’s any chance of that.”

The analyst pressed the ugly hypothetical, and Glisan finally acknowledged that such a downgrade would trigger other repayment obligations for Enron. The company’s entangled financial structure was becoming a public issue.

“Let’s take a stab at the worst-case scenario here,” said another analyst. The worst-case scenario wouldn’t happen, Lay protested.

Asked about Fastow’s partnerships, Lay insisted that the board had put controls in place to make sure that the interests of Enron shareholders wouldn’t be compromised. “And I will also say,” added Lay, waxing indignant, “that having checked just in the last several days, these procedures have been rigorously followed. So we do not—we’re very concerned the way Andy’s character has been kind of loosely thrown about over the last few days in certain articles, as well as, of course, the integrity of the company.”

“With all due respect,” retorted Goldman Sachs analyst David Fleischer, usually a company supporter, Enron’s credibility was now being “severely questioned.” There was a need for “much more disclosure,” Fleischer continued. “There is an appearance that you’re hiding something . . . that maybe there’s something beneath the surface going on that is less than—that may be questionable.”

“We’re trying to provide information,” Lay insisted. “We’re not trying to conceal anything. We’re not hiding anything.”

John Olson, Lay’s old nemesis, told the Enron chief it would be “important in terms of credibility” for Fastow to describe his role in the LJMs and how “closely monitored” he had been.

But Lay wasn’t about to be
that
open. The SEC investigation would reveal everything, he insisted. There were legal issues involved. “I would prefer that Andy not get in too much detail as far as LJM. And let me say,” Lay rushed to add, “there was a Chinese wall between LJM and Enron.”

After the disastrous conference call ended, the Enron brass rushed over to the Hyatt for another packed all-employee meeting—held in a distinctly different climate. With Enron’s stock heading toward $19, Lay evoked the events of September 11. “Just like America is under attack by terrorism,” he declared, “I think
we’re
under attack.”

Lay tried to tell his employees he shared their pain. “I am absolutely heartbroken about what has happened, both the last few months and, more importantly, the last several days.” He’d taken a financial hit right along with them, he said. “I’ve lost a substantial portion of my net worth.” Yet Enron had done everything appropriately, Lay insisted. What no one had properly appreciated “was how difficult it was to explain it—the perception of it.”

Lay then launched into a history of all the near-death experiences Enron had survived. The nationalization of its Peruvian oil and gas interests in 1985. The drop in gas prices in 1986. The Enron Oil scandal in 1987. J-Block in 1997. Enron always came back stronger, “and that’s exactly what I think is going to happen here.”

“I also know that many of you who were a lot wealthier six to nine months ago are now concerned about the college education for your kids, maybe the mortgage on your house, maybe your retirement, and for that I am incredibly sorry. But we’re going to get it back,” he vowed.

Turning to LJM, Lay uttered words he soon regretted. “I and the board are also sure that Andy has operated in the most ethical and appropriate manner possible.” Still, Lay was “very sorry that this incredibly complicated thing ever happened and the damage was done to our image.”

Several minutes into the question period, Lay was handed a written query, which he read aloud:

“I would like to know if you are on crack. If so that would explain a lot. If not, you may want to start because it’s going to be a long time before we trust you again.”

 • • • 

LeMaistre prepared carefully for his conference call with Fastow late that Tuesday afternoon. Jim Derrick, Enron’s general counsel, provided a script, including introductory remarks and specific questions, and faxed it to LeMaistre, who was in Colorado. John Duncan, the second board member on the call, was patched in from Houston.