Conspiracy of Fools (101 page)

So on November 12, the lockout was ended. Employees could go in and buy and sell whatever shares they felt necessary. In the ten days of trading they had missed, the stock had dropped to $9.98 a share, a decline of $3.83. In some ways, that worked to their advantage: the stock price now was
higher
than it had been on five of those days. Anyone who wanted to sell could make more money than was possible during half of the lockup period.

But the end of the restrictions did not bring on a flood of selling. Instead, Enron employees, apparently believing this was a great opportunity to snap up cheap shares, became net buyers of the stock.

Chuck Watson was on the road, busy selling investors on the Dynegy-Enron merger. No one had told him about the Rawhide debacle unfolding back in Houston. But then again, no one at Dynegy would know about it for days.

Instead, Enron and Dynegy spent the days haggling over less weighty issues: the number of Enron executives allowed to accompany Watson on the road show; whether Dynegy executives could use Enron planes; whether an Enron executive could be flown to a session on a Dynegy plane.

The bickering was already souring the relationship. Watson had wanted to come by Enron, to visit his new employees. Lay and Whalley refused; such a visit, they argued, would be demoralizing and should be delayed until they could hold their own meeting. Instead, Watson shot a video, welcoming Enron to the Dynegy family.

No one at Enron watched it.

Somehow, word got out, all over the Internet and the radio. Ken Lay stood to make sixty-one million dollars in severance if the Dynegy deal went
through. Among Enron’s traders, the response was outrage. Why, they argued, should Lay walk away from this debacle with so much cash?

Two executives, John Lavorato and Louise Kitchen, stormed up to Lay’s office after hearing the news. Lay was sitting at his desk when they arrived.

“Ken, you can’t take sixty million dollars out of the company,” Lavorato said. “The place will go nuts.”

Lay was taken aback. “I’ve got that contractual right, but it’s not built into the merger agreement,” he said.

He’d already discussed reducing the payout with Chuck Watson, he said, but certainly he was owed something.

“That won’t do it, Ken,” Kitchen said.

“If you take anything at all, there’s going to be a riot on the trading floor,” Lavorato interjected.

Lay considered that. “Okay, okay, I hear you,” he said. “Do you mind if I speak to my wife first?”

After calling to make sure Linda was there, Lay drove home to speak with her. He described the reaction among the traders. The prospect of forgoing the money her husband was due did not please her.

“We’ve already lost so much money,” she said. “We’re struggling to find what we can to pay off debt and pay taxes and keep us out of bankruptcy.”

Hundreds of millions of dollars of their wealth had vanished in the stock-price collapse, but Lay thought he had little choice. “I know I have a legal right to this money. But I think I need to walk away from it.”

Tears welled up in Linda’s eyes. But she agreed.

In Enron’s trading room, the market was evaporating. Despite the announced Dynegy merger, competitors still worried Enron might disappear without having paid its obligations under new trades. Every transaction with Enron was an act of faith they were no longer willing to take.

John Lavorato was furious. Even Dynegy, the only company selling physical gas with Enron, was refusing to make trades extending beyond one year. Lavorato got on the phone with Matt Schatzman, the head of Dynegy’s trading operation.

“You’re not helping us,” Lavorato grumbled.

“Our credit exposure to Enron is high, and if the merger falls apart, we’re on the hook,” Schatzman said. “We owe a duty to our shareholders. I’ve told our brokers not to treat you guys with any favoritism.”

Lavorato exploded. “What about the merger agreement?”

Schatzman’s tone could not have been calmer. “I don’t care,” he said. “This is business.”

There was a solution, the Enron traders decided.

If other companies were afraid Enron couldn’t pay, why not pay up front?
That
would keep the business going. All the traders had to do was post cash collateral, essentially turning hard currency over to their trading partners as a partial—or in some cases total—guarantee of payment.

After years of disregard, Enron still lacked meaningful controls over division spending or the means to track cash. Now money had arrived from Dynegy, piles of it, ready to help Enron traders prove that they were still in business. They grabbed it by the fistful, thrusting it into the outstretched hands of their trading partners.

Hundreds of millions of dollars were disappearing on a daily basis. And, as the cash drain picked up speed, none of the top executives at either company had a clue that it was happening.

“You need to call Dynegy,” Bowen told McMahon. “We’ve got this Rawhide default to deal with.”

It was later that same week, and Dynegy had still not been notified of the Rawhide trigger. Bowen figured the problem could be averted; if the bank called in the cash, Enron could implode. Surely a solution could be negotiated.

But McMahon was swamped and simply hadn’t gotten around to giving Dynegy the heads-up. Still, he promised Bowen that he would make the call to Enron’s new merger partner. Very soon.

In Chicago, the mood in the board meeting at Andersen was grim. The firm’s lawyers had briefed the directors about the deepening crisis at Enron, then talk had turned to the threat from an onslaught of litigation. Joe Berardino did his best to assure everyone that Andersen was on top of everything. There was no reason for fear.

“We’ve got our top legal counsel on it, our top risk managers all over it,” he told the board. “We’ve got all the processes in place now to manage this risk.”

Still, there was no doubting the consequences, he said. “We’re going to lose business over this,” he said. “It is just too big. But we can’t panic.”

He looked at the worried faces around him. “We just have to live our values. Then we can get through this.”

———

On Friday, November 16, Lay relaxed in his Galveston home, reading a draft of Enron’s upcoming quarterly report, known as a 10-Q. Despite Causey’s earlier misgivings, Enron had managed to pull everything together in time to meet an extended deadline. It was all set to be filed on Monday.

There were plenty of new details in the document, some pretty horrifying. There was information about Enron’s rating setting offa trigger, putting it on the hook for almost $700 million. And details of how the cash position was worsening. This was sure to bother the folks at Dynegy. Well, by now, Lay assumed,
somebody
at Enron had forwarded it to Watson or one of his top executives. Dynegy, he thought, would have plenty of time to absorb the news.

He was wrong.

The next day, Saturday, a full contingent from the finance staff was in the office. There was much work to be done, with the quarterly financial filing due and a meeting scheduled between Enron and its banks.

Mark Muller mentioned Rawhide to McMahon, saying that Rob Doty, Dynegy’s CFO, needed to be told about the default.

“You need to call,” Muller said. “It’s going to be a headline issue in the 10-Q.”

McMahon nodded. “Yeah, you’re right. I’ve got to do that, I guess. I’ll go give him a call right now.”

He wandered into an office and picked up the phone. Doty wasn’t in on Saturday; the voice-mail system picked up.

“Hey, Rob, Jeff McMahon,” he began. “Listen, Enron made a mistake.” The Rawhide financing, he said, had a trigger at BBB-minus, not at a junk rating like the rest of Enron’s deals. The company was now technically in default on Rawhide, and debt repayment had been accelerated.

“It will all be disclosed in the 10-Q we’re filing Monday,” McMahon said in the recording.

Rob Doty was beside himself. He had arrived at the office early Monday and heard McMahon’s bombshell. Now he was trying desperately to get Enron’s quarterly report. It was about to be filed with the public, and Dynegy, which had just sunk a billion and a half dollars into Enron, still hadn’t seen the damn thing.

Doty got on the line with the finance group. “Look, I don’t
care
if you don’t have a final version,” he snapped. “At least send me the draft copy!”

It arrived by e-mail at 10:53 that morning. The teams at Dynegy set to work reviewing the pages. Then, in the afternoon, Enron filed its final version
with the SEC. Dynegy received its copy at about the same time every investor in the country had access to it.

Doty was flipping through the latest document, when he stopped short. “Wait a minute,” he told his colleagues. “There are pages here that weren’t in the earlier draft.”

More than $1.5 billion! Gone!

Doty and his team hit the roof. The filing was
loaded
with information that Dynegy knew nothing about. The money it had recently injected into Enron had disappeared, just like that. But where had it gone? Doty had no way of knowing that Enron’s traders had gotten hold of it and were tossing it out the door to stay in the market.

The business was falling apart, too. Trading activity was dropping, and fourth-quarter results were expected to be a train wreck. The European trading profits were all but wiped out. Then there was the debt-maturity schedule. Doty had believed Enron would have at most $800 million of debt to repay by year-end, but that had grown by
two billion dollars
. What was going on? How had Enron not known this earlier? Had this company not had a debt-maturity schedule prepared long ago?

On top of it all, Enron had just announced that, technically, it was
insolvent
. It had $2.8 billion in almost immediate obligations, and only $1.2 billion in cash. Why would anyone have faith in a company in
that
position?

Doty rushed out of the room. He needed to find Chuck Watson. It was very possible that, even with the tight restrictions that kept Dynegy from walking away from the merger, Enron may well have just met all of the requirements.

“Why did you put this out without telling us? What in the world are you doing?”

Watson was on the phone, chewing out Ken Lay. Nothing Lay said would calm his fury. He had taken a personal risk, injected his own company’s cash to salvage Enron. And for what? To get refused access to the employees? To stand by idly while Enron burned through every penny he had given them? To be kept in the dark about ominous developments until the rest of the world already knew about them?

“Well, didn’t you review this, Chuck?” Lay asked.

“We didn’t get a copy until today!”

“I can’t understand that,” Lay said. “I got mine on Friday. I read the whole thing myself over the weekend.”

Watson seethed. “Why didn’t I get a copy, Ken?”

“I just assumed you did. I didn’t know you didn’t. Didn’t even think to ask.”

They needed to meet the following day, Watson said, at the Coronado Club in downtown Houston. “I’ve got a host of problems to discuss with you, Ken,” he said. “Plan to be there about two or three hours.”

What, Lay asked, were the primary issues?

“Ken, I am a billion dollars short!” Watson snapped. “And your guys can’t tell me where it is!”

“We’re going to need to take a look at the Raptor transactions,” the Deloitte accountant said. “They involved a very aggressive accounting position.”

The Raptor transactions?
Bill Powers, head of the Enron board’s special committee, wasn’t sure what the accountant was talking about. It was that same afternoon, and Powers was receiving a primer on special-purpose entities. They had already discussed Chewco when the Raptors came up.

“Okay,” Powers said. “So explain the Raptors.”

The accountant launched into a monologue, describing how Enron shifted stock into the Raptor entities, took a small investment from LJM2, and then used the vehicles to avoid losses on its merchant investments. The concept confused Powers.
Enron
contributed the capital? Then how would it get losses compensated by the Raptors?

I guess I don’t quite get it
, he thought.

It would be weeks before Powers would realize the horrible truth. He did get it. The Raptors made no sense.

In the Rayburn House Office Building in Washington, Jim Greenwood, a Republican congressman from Pennsylvania, was standing up from his desk when he saw someone in the doorway.

“Hey, Mark, come on in,” Greenwood said.

Mark Paoletta, chief counsel for the Energy and Commerce Subcommittee on Oversight and Investigations, crossed the room and took a seat, placing a pad of paper on the table. Greenwood joined him. Paoletta flipped open a folder, glancing at a list of issues he wanted to discuss.

After several minutes, Paoletta looked down at the next item.
Enron
, it read. He pulled out a few news articles he had brought along.

“Enron,” he said, handing the articles across the table. “It’s unbelievable what’s going on there.”

Greenwood skimmed through them. A look of recognition flashed in his eyes. “Oh yeah,” he said. “I’ve seen this. It looks really interesting.”

Paoletta spent a few minutes filling him in on what he had been told by
his colleague David Cavicke days before over the Italian lunch. Greenwood was intrigued. “This sounds like an interesting one,” the congressman said. “Can we do a hearing on this?”

Paoletta nodded. “We’ll take a look at it and see if we can pull something together.”

On November 20 at eleven o’clock, Chuck Watson strode off the fifth-floor elevator in the old Southwest Bank building and headed toward the entrance of the Coronado Club. Both Watson and Lay were familiar fixtures in the stately eatery, a prime magnet for Houston’s power-lunch crowd. Watson was greeted effusively by the maître d’ and whisked to a table.

Lay and Watson said their hellos and took their seats. Their discussion was civil but tense. The Coronado was not a place where patrons glided from table to table, chatting with acquaintances. Even so, both Lay and Watson could ordinarily count on being interrupted a few times. But no one came near them today as they huddled over their meals.