Conspiracy of Fools (29 page)

Every element of the deal was hardwired; Kopper and Dodson couldn’t possibly lose. Not even their relatively paltry $125,000 investment was at risk.
Within seconds of making the investment, they received a management fee from Chewco of more than $140,000—an immediate return of all of their capital, plus a ten percent profit. And they still retained ownership of the entity.

But the Chewco deal created an issue for Kopper and Fastow. With RADR, Fastow had been the big financial winner. Kopper had come out in the best position on Chewco. There were going to be plenty of future deals, plenty of opportunities to even up the books. But somebody needed to keep score, to make sure things eventually balanced out.

The job went to Kopper. Fastow instructed him to start a running tally of who had earned what off of their side deals—and keep it on his personal laptop. This wasn’t the kind of data that should appear on Enron’s computer system.

After the holiday financial rush, everyone could finally relax. Work at Enron was always a fire drill at year-end as deals to help the company make its numbers raced through. But, still, 1997—with Chewco, JEDI II, and the sale of seven percent of EES—was a standout.

Staffers sent around jokes, congratulating themselves on their achievement. “Top 10 Reasons Why We Thought It Was a Good Idea for You to Spend Your Christmas Holidays and Year End with Us,” one parody read. Number nine: “Making sure that Enron hits its earnings targets.”

Over the weeks that followed, Enron assembled its final numbers for the year, and executives liked what they saw. More than half a billion in profits—
half a billion
.

But there were some problems. First, there was this international deal called J-Block. Despite its bad experience with take-or-pay contracts, Enron had entered into one early in the decade to buy gas for its power plant in Teesside, England. The international team was sure gas prices would rise; they fell, leaving Enron in the hole for billions. Skilling had settled that problem earlier in the year, costing the company $450 million after taxes.

Then there was MTBE. After years of trying, Enron had pushed MTBE onto mark-to-market accounting. But then the government changed the rules on the fuel additive. Enron shut down the business, costing another $74 million after taxes.

That left $105 million. But there were more squirrelly numbers. Enron had included the $51 million in profits from the Bonneville Power contract, even though Andersen said it shouldn’t. Without it, the annual profits would have been just $49 million.

That amount contained the sale of the seven percent stake in EES. And
that
deal was done in exchange for a
commitment
to pay, not for cash up front.
Still, Enron reported the whole thing—$61 million. Under proper accounting, only $20 million should have been reported.

With all the errors, omissions, and bad business decisions excluded, Enron’s total earnings for 1997 should have been $8 million, on $20 billion in reported revenue.

The evidence of trouble at Enron was there for anyone to see—anyone, that is, who could figure out the real numbers.

Kopper bent his knees as he glanced at the golf ball resting on a tee near his feet. He shot a look down the fairway for the fifteenth hole on a course at Sugar Creek Country Club. In a single effortless motion, he brought his arms back and swung. The ball soared away.

Behind him, Ray Bowen, his colleague from Enron, watched with envy as the ball sailed into an ideal position. Bowen wasn’t much of a golfer and had been whacking the ball all over the place that day. But he could appreciate athletic skill when he saw it.

“Very nice,” he said.

Kopper looked at him, his face confident. “Thanks.”

It was January 1998, and the two men were taking time to get to know each other. Now that they were the co-heads of special projects, they needed to establish a rapport.

They climbed into the golf cart, heading after their balls. In the driver’s seat Kopper looked relaxed, dressed in slacks and a sweater. The two rode in silence until they had the course to themselves.

“You know, Ray,” Kopper said suddenly, “you can make a lot of money at Enron working for Andy.”

Bowen glanced over at Kopper. He had already heard the rumors swirling around the office, something about Kopper snagging a piece of Chewco with Fastow’s permission.

“Yeah?” Bowen said.

“Yeah. Andy will really take care of you. He’s done that with me.”

Bowen’s expression didn’t change. “Yeah, I’m kind of aware of that. I’ve heard the rumors.”

Kopper kept his eyes on the fairway. “Yeah, there’s stuff available. Stuff on the side. You can make money a lot of ways. You just have to ask for it.”

Was this some kind of test?
If Kopper was fishing, Bowen didn’t want to take the bait.

“I’m just not sure that’s the right kind of thing for me,” he said. “I don’t want to be too beholden to one person, even Andy. I’m not too interested in doing the kind of things I think you just did in Chewco.”

Kopper went silent, driving the cart forward.

“Okay,” he said finally. “Where’s your ball?”

On Monday they were back at Enron as co-heads of special projects, but not much work was sent Bowen’s way. Weeks later, word came down from Fastow. Maybe special projects wasn’t right for Bowen. He was moved out to work somewhere else.

Whatever the test at golf had been, Bowen had failed. Now the hunt was on for others willing to pass.

THE SIXTH FLOOR OF
the SEC’s Washington headquarters had a leaden, functional air, just anonymous office space in an uninviting government building. Elevators on either side of the H-shaped complex led to hallways of somber disposition; when office doors were closed, not a single window to the outside world could be seen.

But here, amid the austere decor, American capitalism was regulated and restrained by a cadre of government officials whose judgments could mean wealth or ruin. Every day, top lawyers and accountants bustled in and out, hoping to catch the ear of the man who ruled this realm: Arthur Levitt, the SEC chairman.

Levitt—tall and white-haired, with a talent for making those who met him feel privy to a special secret—was in his sixth year as chairman. A mix of Wall Street and Main Street, he was a wealthy former stockbroker who hobnobbed with the financial industry’s leaders but never lost sight of his modest Brooklyn roots.

In earlier years, Levitt had struck colleagues as happy-go-lucky, maybe at times a bit facile. But as SEC chairman, he had emerged as an articulate advocate for small investors. To some in business, his style was too hard-charging, too confrontational. But among the mom-and-pop investors with trillions in the markets, his was a singular dedication to their interests—championing investor education while checking some of Wall Street’s abuses.

Now, in early 1998, Levitt’s next battle was looming. The Internet boom had created a casino marketplace for stocks—frothy, exuberant, unreasonable. Signs of decay were evident. Reported profits were getting squishy, twisted, perhaps meaningless. Companies were playing games, manipulating the rules to present numbers that had little basis in reality. With easy money rolling in, investors were more than willing to turn a blind eye to the shenanigans spreading through corporate boardrooms.

It all began before Levitt took the SEC job, as a stratagem for corporations to lavish riches on top executives without reporting the costs. Corporate America had discovered the magic of a new currency—stock options, which
gave their owners the right to buy shares at a preset price. The accounting rule setters wanted the options to reflect reality. After all, the argument went, they had value and involved costs to shareholders; when an executive used the option to buy—and then sell—stock, investors lost part of their ownership in the company. But executives knew expensing options meant lower profits, possibly jeopardizing the carefully constructed gravy train.

So corporate America fought back, recruiting members of Congress to take on the SEC and the standard setters at the Financial Accounting Standards Board. Charging options as expenses would drive down stock prices, they said—a point Levitt found bizarre, since any cost would do that. But in the face of congressional wrath, Levitt, to his lasting regret, told FASB to back off. He’d had some success since then, but was losing the accounting wars—and knew it. His accounting experts wanted him to launch a new front, but he wasn’t quite sure how to do it.

Levitt stepped off the north elevator onto the sixth floor. He passed photographs of outdoor adventures—river rafting, mountain climbing—shot on Outward Bound trips he sponsored. He stepped into his office. Outside, he could see the red facade of the National Building Museum; to the right, the Capitol dome gleamed in the distance.

Levitt noticed the two large computer screens on the credenza behind his desk. Something was different; the familiar screen saver was gone. In its place, words of varying sizes bounced back and forth. Levitt moved closer, squinting until the words came into focus. He smiled.

ACCOUNTING. ACCOUNTING. ACCOUNTING
.

His staff was lobbying him again. Grab the accounting issue, they were urging, get ahead of it. Out there, right now, were companies on the path to destruction, because accounting standards had collapsed. They knew it.
He
knew it. But for now Levitt had no idea which companies they might be.

At Andersen’s Chicago headquarters, John Stewart sat at his desk, preparing to do battle over Enron. As the top member of the firm’s Professional Standards Group, or PSG, Stewart was Andersen’s star analyst on generally accepted accounting principles, or GAAP, the rules applied by every American corporation in reporting financial performance.

Now, having read Enron’s latest filings, Stewart believed the company was violating the rules—with Andersen’s knowledge. He had noticed one of the games pumping up the numbers: the sale of seven percent of retail had created sixty-one million dollars in profits over three years. But Andersen was allowing it all to be booked as 1997 income, even though only twenty million dollars had been paid. It was wrong.

Stewart fired up his computer. He popped open a new e-mail, typing in the address for Patty Grutzmacher, who worked on the Enron account in Houston. He typed the issues that had been raised, then gave his opinion.

“I do not agree that Enron can book all the gain up front,” Stewart typed. “The SEC is clear on this point.” He hit the “send” button.

Nothing would change. Enron had already told the public about the income. Andersen certainly wasn’t going to force the company to turn around and tell the world that its reported profits were nothing more than phantoms.

The public image of Enron and the reality of its operations were diverging more each day—and not just because of accounting gimmicks.

Enron was becoming a virtual cult of creativity, often placing swagger over substance. New ideas were celebrated for their newness, for their potential; tried-and-true businesses like the pipelines were almost derided. This was a company where a thousand flowers bloomed, where the only impediment to pursuing a new project was initiative. The usual controls—expense limits, financing constraints—vanished. First-class travel became a standard, except for those who relied on the growing fleet of corporate jets. Everything—flat-screen monitors, computers, pads of paper—was purchased with no centralized control.

Worse, Enron was diversifying into business after business with no unifying strategy. By 1998, it was operating pipelines and international power plants. It was trading gas and electricity. It was managing energy needs of commercial customers and providing electricity to small consumers through retail. It was starting to dabble in the water business. Portland was building its Internet network, while London was secretly constructing an automated energy-trading system. Houston was creating and trading financial derivatives to protect customers from the business effects of bad weather. Enron was becoming anything and everything.

At the same time, it was beginning to operate like an investment fund, purchasing stakes in companies on the public and the private markets. These “merchant investments” were often in fields far from Enron’s expertise, like high-tech. Executives who found investments—particularly deals that brought quick profits—were virtually guaranteed fat bonuses. There were no rewards for holding down costs.

Enron’s buying spree mirrored events in the marketplace. The dot-com boom was pushing stock prices beyond reason. The eye-glazing basics were no longer the backbone of investing; if a stock price climbed because other investors believed, that was good enough.

So began the twisted interplay between Enron and the market. As prices rose, so did asset values, including for many of the company’s merchant investments. With mark-to-market accounting, those increases translated into reported profits. So long as markets kept climbing, Enron could do no wrong. It was bathed in an aura of infallibility.

Still, with so much of the reported profits tied to mark-to-market accounting, Enron brought in comparatively little actual cash, the commodity desperately needed to pay for all of the spending and new businesses. Fastow’s group filled the gap. Ever more complex ways of borrowing were assembled. Bank loans were structured to look like gas trades, known as prepays, and were reported as operating cash flow. Off-books deals were assembled to funnel in other money from banks and outside lenders. Even the tax department got involved, structuring deals that created future tax benefits, which Enron claimed all up front.

The setup was unsustainable. Enron’s heavy spending for everything—fat salaries and bonuses, new businesses, parties at Planet Hollywood—came, in large part, from borrowed cash. Enron was getting deeper into a hole, betting on a conviction that the marketplace would keep rising. And then, when it did, going double or nothing.

Blocks from the White House, Skilling hustled down I Street. It was January 29, 1998, and he had been in Washington since the night before, schmoozing with members of Congress and energy regulators. But the most important meeting was coming up: he was about to interview a person who might be Enron’s next chief financial officer.