Conspiracy of Fools (13 page)

“This is an approach that would give you guys a real leg up on your competitors,” Bower said.

“It’s great,” Fastow replied. “It’s exactly the kind of deal Enron wants to do.”

Months of work ensued. Then, on May 17, 1993, Skilling, Fastow, and Amanda Martin appeared in the glass-and-mahogany corporate boardroom before the executive committee of Enron’s directors. John Duncan called the meeting to order and asked Lay to open things up.

“We have several items,” Lay said. “But the primary purpose of our meeting is to consider a joint venture with Calpers that Andy and his team have been working on.”

The broad outlines of the deal were left for Kinder to describe. It all sounded too good to be true. What, one of the directors asked, were the potential profits?

Fastow studied a sheaf of papers. “We’ve done a detailed analysis of the estimated impact this would have on our financial reporting for the next few years.”

He laid out the numbers and the directors’ eyes lit up. The potential was huge. With little additional debate, the directors unanimously approved the concept. The joint venture was named JEDI—ostensibly for Joint Energy Development Investments, but in truth as a tip of the hat to Fastow’s affection for
Star Wars
.

The project would soon be well known within Enron. It would take almost a decade for it to become infamous.

Just blocks from Enron’s headquarters, on the twenty-third floor of Two Shell Plaza, Toni Mack was going through her mail. A reporter at
Forbes
, Mack had written for years about the travails of the energy industry, early on spotting Lay’s efforts to solve the take-or-pay problems. Long ago she had decided
Enron was about the only company putting together a crackerjack strategy for deregulation, and always made sure to keep an eye on its business.

Sitting at her steel-case desk, Mack picked up a long envelope stamped with a logo she recognized.
Enron
. Probably the company’s annual report to shareholders for the prior year, 1992. She tore open the envelope and pulled out the document. A splash of colors danced across the cover in an illustration depicting Enron’s impact on the world.

Mack grabbed a highlighter and began reading. On page fifty she saw a summary of Enron’s accounting policies. The usual boilerplate, until she reached the seventh entry:
Enron accounts for its price-risk management activities under the mark-to-market method of accounting
.

“Huh?” Mack said aloud.

In the next two paragraphs Enron spelled out its methods for counting profits in Skilling’s division. Mack’s highlighter marked almost every word.
What the heck does that mean?

Mack hit the phones, calling sources in the industry. But the more questions she asked, the more puzzled she became. While the accounting was mark-to-market, it wasn’t being handled the old-fashioned way, with trading prices dictating values; instead, Enron was using its own projections to fold anticipated income from decades-long contracts into the current year. It struck her as horribly aggressive. What if the other party to the contract went bankrupt? What if energy taxes changed? If, oh, natural gas was outlawed? This newfangled accounting seemed highly risky, and Mack thought investors needed to know about it.

Mack’s article appeared in the May 24, 1993, issue of Forbes. While acknowledging Enron’s business successes, the piece focused on its accounting risk—the potential for unexpected events to erode previously reported profits. She pointed out that with profits of each contract reported the first year, Enron needed to sign up increasing numbers of contracts each year to keep growing.

Mack believed she had untangled the threads of a complicated corporate tale. But Wall Street analysts—many at firms already lapping up banking fees from Enron—issued reports saying mark-to-market made no difference. None confronted the substance of Mack’s analysis.

Days later, Mack received a hand-delivered letter from Ken Lay. How could Mack criticize mark-to-market, he asked, when the SEC and Arthur Andersen had approved the approach? Mack wrote back, appealing to Lay’s sense of history. The take-or-pay debacle proved the industry’s shortcomings in making long-term assumptions; imagine, she wrote, how bad that episode would have been if gas companies had been forced to reverse previously reported profits.

But Lay—and Skilling—were unmoved. The risks
Forbes
was warning about were imaginary, they told colleagues. Mack, they insisted, just didn’t get it.

Could Enron use mark-to-market accounting in a business that, at this point, had no real market?

That was the question bedeviling executives in Skilling’s group. By mid-1993, Enron had a division running that seemed to fit no place: clean fuels, which manufactured methanol and MTBE, a gasoline additive. Skilling thought the business made no sense and put Enron in danger of losing big money. But maybe, he thought, if he could re-create Enron’s approach to the gas business in clean fuels, there were dollars to be made.

To get the ball rolling, Skilling tapped Ken Rice, a top-notch marketer in his division. Skilling knew Rice’s zest for salesmanship and figured he was just what the business needed—an executive who produced results.

Skilling summoned Rice to his office. The young executive walked in and flopped down on a chair. Tall and fit with a cap of brown hair, he wore his usual outfit—jeans, a faded shirt, and boots. Skilling bluntly broke the news that he wanted Rice to take over clean fuels.

“You’re kidding, right?” Rice said. “I don’t know anything about this business.”

It didn’t matter, Skilling said. The division was a disaster, but it had a couple of valuable contracts. “If we can create a market and renegotiate those contracts,” he said, “maybe we can get mark-to-market earnings on them.”

At that point the fuels group was making profits the old-fashioned way: it made stuff and sold it at a profit. The plants were connected by pipeline to the factories that used the fuels—hardly an arrangement, Rice thought, conducive to creating a market. But if Enron could switch the accounting, big profits from the contracts could be booked right away.

Rice took a few days to think about it, then accepted Skilling’s request. By his first day on the new job, he had devised his strategy. He would build a market for the fuels. Then, once the traders had some traction, he would consult Andersen and propose switching to mark-to-market accounting. It seemed logical, similar to the path set by the original foray into gas trading.

Within days Rice figured he had it backward, at least as far as his bosses were concerned. Rick Causey, Skilling’s top accounting guru, assigned a controller to Rice, and she arrived with marching orders. The controller brought copies of the unit’s big contracts into Rice’s office and laid them out on his desk.

“Let’s talk about how we can make these mark-to-market,” she said.

Rice didn’t get it. How could plants servicing two customers through direct pipelines be a market? The controller assured him it could be handled.

Just shift the corporate entity that signed the contracts and persuade customers to agree to allow the fuels to come from any source. True, it was an artifice—why would Enron get MTBE anyplace other than the plant connected directly to the customer? But with the changes, the controller said, Enron could argue it had established a rudimentary marketplace.

“But we’ll still have only two big contracts,” Rice said. “How many will we need to be considered a market?”

The controller shrugged. “All we need to show is two or three independent deals. Causey says that will be enough to get Arthur Andersen’s approval.”

That’s all?
A little renegotiating, and suddenly Enron had hundreds of millions in new profits—on the same deals? Still, Rice figured the accountants knew what they were doing. “All right,” he said. “Let’s get on it”

Storm clouds and tendrils of mist drifted across the summit of Arrowhead Mountain in Edwards, Colorado, tempering the summer heat. On the golf course below, Ken Lay was climbing into a cart, ready to ride out to the driving range. It was early on August 14, 1993, and Lay had just arrived at the Country Club of the Rockies following a ten-minute flight from his Aspen vacation home on one of Enron’s Hawker jets. He was eager to get in a few practice swings; after all, it wasn’t every day he teed off in front of the White House press corps alongside the President.

Weeks before, Lay had received a call from the White House inviting him to join President Clinton in a game. Lay figured Clinton was inviting an assortment of business executives, maybe to spend the time seeking support on some economic issue. But days ago, his assistant had checked for final details and learned that only three people were joining Clinton. Lay would be the sole businessman. The others were Lay’s friend Gerald Ford, the former President, and Jack Nicklaus, the pro golfer. For someone like Lay, a sometime golfer, the lineup was unnerving.

As Lay’s small white cart approached the driving range, he saw Ford hitting a few warm-up balls. The cart circled to a stop and Lay hopped out. The former President set the head of his club on the ground and smiled.

“Jerry, nice to see you,” Lay said. “Looks like we’re going to have an interesting foursome today.”

“That’s an understatement,” Ford replied with a smile. “Thanks for agreeing to play, Ken.”

After a few minutes of conversation, the two men hit some practice balls. Another cart came around, carrying Nicklaus, and everyone exchanged greetings.

The first sign of Clinton’s arrival was the sudden emergence of reporters. He showed up on a cart driven by the course’s golf pro and spoke a few kind words to Ford before turning to Lay and clasping his hand.

“Ken, I’m delighted you could join us,” Clinton said.

“Well,” Lay said, glancing around at the famous men, “it certainly looks like it’s going to be interesting.”

They climbed into two carts and rode out to the first tee, Clinton and Nicklaus in the lead, Ford and Lay following. The four men teed up, but only two balls made it on the fairway—one from Nicklaus and one from Lay. The presidents’ had both veered off: the Democratic President’s ball to the left, the Republican’s to the right.

After nine holes riding with Ford, Clinton invited Lay to accompany him in his cart. The two men spent time discussing their lives, their thoughts, and their games as the press corps snapped photos.

The game ended hours later, and all the players went on their way. Any thoughts that the defeat of President Bush would significantly blunt Enron’s influence at the White House had evaporated with the first swing of a club.

Skilling threw his arms up in disgust.

“Why wouldn’t they do this?” he shouted. “It makes all the sense in the world!”

Two of Skilling’s lieutenants had just delivered the bad news: the electric utilities had no desire to hitch themselves to his latest idea. Since 1994, Skilling had been trying to build on Enron’s success in gas by expanding into electricity. It was an audacious, if logical, move. While the folks at Enron could spout chapter and verse about gas, they didn’t know much about electricity trading. But that business dwarfed the gas industry, with transactions totaling close to $100 billion a year. Baby steps toward deregulation were forcing utilities to open their transmission lines to anyone, and Skilling wanted Enron to jump in with both feet.

He tossed the trading business to Lou Pai; the first transactions began in June. He pulled Rice back from clean fuels and put him in charge of negotiating long-term power contracts with the utilities.

Then it struck him—
the Idea
. Enron should form a consortium with, say, half a dozen electric utilities. Skilling hated owning assets, so the utilities would be responsible for building and operating the power plants. Enron would stick with what it did best—marketing and trading the power that the plants produced. It seemed breathtaking in its simplicity and moneymaking promise.

Skilling summoned Cliff Baxter, an investment banker who had joined
Enron years before. The two had become close friends, despite Baxter’s penchant for challenging Skilling’s views, a cocksureness that few others in the building dared display. This time was no different.

“Jeff,” he scoffed on hearing the idea, “you’re out of your fucking mind”

A deal involving at least seven parties? Laughable. It was hard enough to get
two
to agree on anything. Skilling’s vision might be shrewd, but it could never be implemented.

Undaunted, Skilling assigned Baxter and Rice to get out on the road and pitch the idea to utilities. They did—and came back empty-handed, just as Baxter had predicted. The utilities’ response had been blunt: they could handle their own business, thank you very much. They didn’t need some upstart coming in to tell them how things should be done.

Baxter and Rice reported the reaction to Skilling and tried hard not to roll their eyes as he railed about the stupidity of utilities executives.

For years to come, Rice and Baxter would joke about Skilling’s brainstorm. Funny or not, it revealed to them something essential about Skilling’s character: he might not always be right, but he was never in doubt.

The battle lines had been drawn.

The pitched competition between Jeff Skilling and Rebecca Mark was rapidly becoming almost mythic inside Enron. He thought her international projects were mismanaged and undermined the company; she thought his trading business nothing more than air and bluster.

None of the sniping was a secret; the two would fight each other face-to-face. But increasingly Mark was hearing criticism around the company that her projects were lousy, that her team never sweated the details, that they were all rushing to close the next deal simply to cash in on a big payday.

On some levels, Mark thought there was room for criticism; the setup was all wrong. Her team was charged solely with developing the projects, never operating them. If they were operators, too, her team could learn firsthand about what was needed on the front end for the deals to work. They would be less tied financially to just developing the next project. The pace of new projects would slow down, but Enron would improve operations.