When Enron needed cash, the company’s chief financial officer had just the answer: a web of companies that would keep the firm’s liabilities off its books – and make him rich. In the second extract from his new book, Robert Bryce describes the rise of ‘a master of creative financing’

Tuesday November 5, 2002 The Guardian

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By mid-1999 Enron had a sticky finance problem. A year earlier, the company had invested $10m (£6.4m) in a fledgling internet service provider called Rhythms NetConnections. In early 1999, Rhythms had gone public and the internet bubble had sent its stock into the stratosphere. On the first day of trading, the company’s stock closed at $69. Suddenly, Enron’s share in the company was worth about $300m. But Enron couldn’t sell it. Under the terms of its original investment, Enron had agreed to hold the shares until the end of 1999.

After thinking about the matter for some time, Andy Fastow, Enron’s cocky young chief financial officer, came up with a convoluted plan to help Enron preserve the value of its Rhythms NetConnections investment. The plan would be executed by a new limited partnership called LJM Cayman, LP, which would be controlled by Fastow. The name had Fastow’s personal stamp on it, created from the initials of Fastow’s wife, Lea, and the couple’s two children.

LJM1 would function as a parking lot for Enron, a place where the company could stow and retrieve assets. Those assets would be hidden from Wall Street and small investors because LJM would not be owned by Enron. Therefore, all of LJM1’s functions and assets would be separate from Enron’s balance sheet. Unlike an earlier off-balance-sheet deal, Whitewing, LJM1 would be controlled by an Enron insider, Fastow. On June 18, 1999, Fastow met with chairman Ken Lay and CEO Jeff Skilling. He proposed to create LJM1 with an investment of $1m of his own money and $15m from two limited partners. Additional capital for the new entity would come from Enron, which would invest 3.4m shares of restricted stock in LJM1. Lay and Skilling apparently thought Fastow’s idea was a good one, even though on the surface it appeared that LJM1 failed to meet the test for off-the-balance-sheet deals. LJM1 was going to be used to move debts and risky investments (including Rhythms) off Enron’s balance sheet. But to do that, LJM1 had to satisfy three requirements:

· At least 3% of the equity had to come from outside (that is, non-Enron) investors.

· The entity could not be controlled by Enron.

· Enron was not liable for any loans or other liabilities.

LJM1 might have qualified under two of the three. But how was Enron going to be able to prove that LJM1 wasn’t controlled by Enron when the company’s CFO was managing all of the investments? It appears that neither Lay nor Skilling thought about it. Nor did Lay consider how much money Fastow might make on the assets he was buying from Enron. After a bit more discussion, Lay agreed to bring Fastow’s proposal to the Enron board of directors at the board meeting on June 28, 1999.

At that board meeting, after a short debate, the company’s board of directors agreed to waive Enron’s ethics policy, which prohibited the company’s officers from doing deals directly with the company, and approved the LJM1 deal. The approval opened the floodgates. And LJM1 became the cornerstone of Fastow’s financial house of cards.

No one at Enron – or anyone else, for that matter – ever accused Fastow of excessive humility. And throughout 2000 and early 2001, the company’s chief financial officer was at the apogee of his self-diagnosed genius. Fastow was fully convinced that his skein of partnerships and off-the-balance-sheet entities, with its mind-numbingly complicated spider’s web of interconnections and interdependent relationships, was the ultimate advance in financial engineering. “I can strip out any risk,” Fastow once bragged to a co-worker.

It is not just his colleagues who were convinced. At the end of 1999, CFO magazine had named him one of their CFOs of the year, giving him its “CFO excellence award for capital structure”, an award given to him for helping make Enron into “a master of creative financing”. The magazine praised Fastow’s work on the financing structure, which he created so that Enron could buy water company Azurix, as well as several power plants, while keeping the debts off its balance sheet. When the award was announced, Skilling praised Fastow to CFO magazine, saying that Enron needed “someone to rethink the entire financing structure at Enron from soup to nuts. Andy has the intelligence and the youthful exuberance to think in new ways. [He] deserves every accolade tossed his way.”

Fastow enjoyed the rewards of his special position too. On top of his salary and earnings from the sale of Enron stock ($33,675,000 between 1998 and 2001), his investments in LJM1 and LJM2 earned him no less than $45m. He was partial to fancy watches: he often wore a Franck Muller model known as a “Master Banker” (no snickering, please), a spiffy analogue watch that showed the time in three different time zones. It cost about $9,000. In late February 2000, he bought a house in the exclusive Houston suburb of River Oaks.

Other Enron big shots already lived in the same 77019 postcode. Ken Lay had been in River Oaks for years. Jeff Skilling also lived there. So it made sense that when Fastow started pulling the big money, he bought a house on Del Monte Drive in the heart of River Oaks.

“Andy wanted to keep up with the things that Skilling was doing. Skilling had a house in River Oaks. For Andy to be at that level, he needed the big house, too,” said one finance executive who worked closely with Fastow.

Fastow’s special-purpose entities became a fast and dirty way for Enron to manufacture additional revenues in a big hurry. In the last 11 days of 1999, Fastow’s companies did seven separate deals with Enron. In addition to a power plant in Poland, Fastow’s LJM2 entities bought a stake in some of Enron’s loans, bought part of Enron’s stake in a natural-gas gathering system in the Gulf of Mexico, bought a stake in a trust Enron had invested in called Yosemite, and bought part of Enron’s stake in a company that provided financing for natural-gas producers.

The advantage Fastow brought to Enron with the off-the-balance-sheet entities was the ability to do deals quickly. Enron was “looking for a quick way to sell assets to generate income,” said one long-time Enron finance person. “If you control both sides of the deal, you can do it very quickly at any price you want. That’s an advantage versus a situation where you’re trying to sell it to a third party, where it might take a year or more. It was a way for them to control the entire process.”

Fastow helped Enron control the process through a flock of entities with names such as Osprey, Osprey Trust, Timberwolf, Bobcat, Egret, Condor, Rawhide, Sundance, Ponderosa, Harrier, Porcupine and Mojave. He also created a quartet of misbegotten entities known as the Raptors.

The sham deals quickly became one of Enron’s main business units. In 1999 alone, Fastow’s deals inflated Enron’s profits by $248m – that’s more than one-fourth of the $893m in profits Enron reported that year. In between September 1999 and July 2001, Fastow’s LJM1 and LJM2 did about 20 different deals with Enron. And Fastow’s flimflam partnerships made a profit on every transaction they did with Enron. It looked as if Fastow could not lose. Using Enron’s stock instead of cash to prop up his financial house of cards seemed like a great idea. Enron’s stock had begun 2000 stuck at about $43. However, thanks to the hype surrounding Enron Broadband Services, it quickly began to climb into the ionosphere. By the middle of the year, it was trading in the $70s. On August 23, 2000, it hit its all-time high – $90 a share. Enron’s stock – it seemed – was better than cash.

Given that rising stock price, Fastow apparently convinced Enron to pledge a total of $1bn worth of its stock to the Raptors. The Enron stock would provide the “capital” that the Raptors needed to do transactions. In return, the Raptors would help Enron lock in tens of millions of dollars in gains on stock it held in newly public companies, like hardware maker Avici Systems and The New Power Company, an energy company that planned to sell electric power to individual homeowners.

While the accountants slept, Enron’s attorneys were starting to worry about the Raptor deals. On September 1, 2000, Stuart Zisman, an attorney who had been looking at the Raptors, sent an email to his superiors in Enron’s legal department that said: “We have discovered that a majority of the investments being introduced into the Raptor Structure are bad ones. This is disconcerting – it might lead one to believe that the financial books at Enron are being ‘cooked’ in order to eliminate a drag on earnings.”

Enron was cooking the books and Fastow was the chef de cuisine. So where was Andersen this whole time? It was, as usual, cashing Enron’s cheques. In exchange for its work on the Raptor deals, Andersen charged Enron a total of $1.3m.

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When George W Bush arrived in the White House, it was hardly surprising that he looked after Enron – the company had been looking after him for years. In the final extract of his book, Robert Bryce describes how the firm bought its way into Washington’s corridors of power

Wednesday November 6, 2002 The Guardian

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Surely it’s just a coincidence. What else would explain why Enron Oil and Gas, a subsidiary of Enron Corp, would have been in business with George W Bush back in 1986? Bush the Younger was many things, including the eldest son of the vice president of the United States. A successful oilman he was not. Bush’s forays into the energy business had been nothing short of disastrous. In 1984, Bush had no choice but to merge his faltering firm, Bush Exploration Company, with another company, Spectrum 7. But by mid-1986, Bush had done his magic on the privately owned Spectrum 7. The company wasn’t producing much energy of any kind, and Bush was actively trying to sell again. Despite Spectrum 7’s lousy record, it somehow got into business with Enron Oil and Gas. And on October 16, 1986, Enron Oil and Gas announced that it had completed a well a few miles outside of Midland, Texas, that was producing 24,000 cubic feet of natural gas and 411 barrels of oil per day. Enron owned 52% of the well; 10% belonged to Spectrum 7.

Now, the oil and gas business is full of speculators, and wells are often drilled with multiple investors with varying backgrounds. But the early Bush-Enron connection points out just how small the energy business is. Lay’s ties to George W Bush go back to 1980, when Bush made his first bid for the White House. Bush, who had recently served as director of the Central Intelligence Agency, needed campaign funds after his surprise win in the Iowa caucuses. So Lay, who had probably met Bush through mutual friends in the energy business in Houston, gave money to Bush’s campaign. Though Bush didn’t win, Ronald Reagan made him vice president. Bush went on to chair the panel that pushed Reagan’s task force on deregulation. One of Reagan’s biggest moves in deregulation involved the lifting of federal controls on natural gas markets, a move that Lay had long favoured.

When the elder Bush got to the White House, he didn’t forget Lay. Bush rewarded Lay during his presidency with one of the most coveted perks of being a presidential pal, a sleep-over at the White House.

When Bush the Younger decided to run for governor of Texas in fall 1993, one of his first stops on the campaign trail was Houston. During his visit, George W Bush asked Lay to be the finance chairman of his campaign in Harris County, which includes Houston. Lay didn’t take the job. He preferred to give George W Bush a $12,500 (£8,000 at today’s rates) cheque and work behind the scenes. In his stead, Bush’s campaign in the county was headed by Lay’s second in command at Enron, Rich Kinder. In all, Lay, Kinder, and other Enron executives donated $146,500 to George W Bush, almost seven times more than the amount they gave to the incumbent candidate, Democrat Ann Richards. The donations by the execs, combined with money from Enron’s political action committee, made the Houston company Bush’s biggest campaign contributor.

After George W Bush defeated Richards, Enron gave $50,000 to Bush’s inaugural committee. Lay began lobbying Bush almost immediately. In December 1994, before Bush moved into the Governor’s mansion in downtown Austin, Lay began sending him regular letters on energy policy, tax issues, lawsuit reform and other matters. That month, Lay asked Bush to appoint Pat Wood, who supported the deregulation of electric utilities, to the state’s public utility commission. Bush complied with Lay’s request. And later on, Bush would appoint Wood – again at Lay’s recommendation – to the federal energy regulatory commission.

And while Lay maintained close ties to the Bush family throughout George W Bush’s stint as governor of Texas, those connections would be even more valuable to him and to Enron if Bush the Younger could throw the Democrats out of the White House. In December 1999, while Bush was pounding the campaign trail, Lay again wrote to his friend, addressing it to “George and Laura” [Bush’s wife]. “Linda and I are so proud of both of you and look forward to seeing both of you in the White House.”

Lay had been one of Bush’s first “pioneers”, each of whom pledged to raise $100,000 for Bush. He had also made Enron’s fleet of aircraft available to his campaign. The Bush campaign used Enron’s jets to fly to different events on eight different occasions – more than any other corporation. During the 2000 election cycle, Lay contributed more than $275,000 to the Republican National Committee. Enron’s total donations to the party exceeded $1.1million. When the outcome of the election was in doubt after the polls closed in November 2000, Lay and his wife, Linda, gave $10,000 to help finance the Bush campaign’s Florida operation during the recount after the election.

After Bush prevailed in the election (thanks to assistance by the US supreme court) Ken and Linda Lay gave another $100,000 to help finance Bush’s inaugural gala. In all, Enron and its top execs kicked in $300,000 for the inauguration festivities. Naturally enough, the day after the inauguration, Lay went to a private lunch party at the White House, where he got to schmooze with the new president one on one. A few weeks later, Lay had dinner with the president.

It wasn’t long before Enron’s bet on George W Bush was paying off in more important ways, too. Although the California energy crisis was raging throughout his first few months in office in 2001, the president refused – for nearly six months – to consider the possibility that the golden state’s power markets were being manipulated. In some parts of the state, electricity rates had gone from $30 per megawatt hour to an alarming $1,500 per megawatt hour. Rolling blackouts – and threats of blackouts – had the state in a near constant uproar. By the time Bush had spent about 180 days in the White House, the state of California had spent nearly $8 billion buying power on the open market just to keep the lights on.

Despite the crisis, Dianne Feinstein, a senator from California – the most populous state in the union – couldn’t get an appointment with Bush. The White House had plenty of time for Enron, though. On April 17 2001, Vice President Cheney had a private meeting with Enron chairman Ken Lay. During the meeting, Lay offered suggestions for Cheney’s energy task force and lobbied Cheney against price caps in California. Cheney quickly adopted Lay’s argument. The day after his meeting with Lay, Cheney mocked the idea of price caps. He told the Los Angeles Times that caps would only provide “short-term political relief for the politicians.” In late May, Bush visited California and, like Cheney, attacked the idea that price caps – something the California governor, Gray Davis, and Feinstein had been begging for – might help the state restore order to its electricity system.

Bush and Cheney were wrong. Enron and several other power companies had been manipulating the California energy market for months and collecting huge revenues for their efforts. Using strategies with colourful names like Death Star, Get Shorty, Fat Boy, and Ricochet, Enron had apparently figured out ways to play the state’s power system and drive up prices. Finally, on June 18 2001, after weeks of rising intrigue, the federal energy regulatory commission approved limited price caps for California. The move quickly settled the state’s power markets.

Enron’s connections in the White House went much further than George W Bush. The new president’s chief economic adviser, Larry Lindsey, was on Enron’s payroll before going to the White House, earning $100,000 in consulting fees from the Houston company. Marc Racicot, the former governor of Montana, lobbied for Enron before Bush named him to lead the Republican national committee. Robert Zoellick, Bush’s choice for US trade representative, served on an Enron advisory council. Thomas White, Bush’s secretary of the army, was the vice chairman of Enron Energy Services, a money-losing charade of a company. Nevertheless, when White left Enron, he owned more than $25 million in the company’s stock. Bush’s chief strategist and political guru, Karl Rove, owned more than $100,000 of Enron stock when Bush took office.

Bush’s White House provided Lay and Enron with unprecedented access. In addition to the meeting with Lay, Enron officials met with Cheney’s task force (the national energy policy development group) five times and talked to it by phone on at least six other occasions about the measure. Their effort shows. The national energy policy development group’s final report – Reliable, Affordable and Environmentally Sound Energy for America’s Future – released in mid-May 2001, contains a number of provisions very favourable to Enron. For instance, the report recommends the creation of a national electricity grid, a move that could allow Enron to trade electric power more readily in all regions of the country.

The report says permitting for gas pipelines should be expedited, a factor that would help Enron, already one of the largest pipeline companies in the world, build more capacity more quickly. The report talks about the California crisis, the need for energy efficiency, increased domestic natural gas production and, of course, India. Didn’t you know that the cost of butane in Bombay is critical to soccer moms in Seattle? Cheney’s group recommended that “the president direct the secretaries of state and energy to work with India’s ministry of petroleum and natural gas to help India maximise its domestic oil and gas production”.

Not only could Lay get Bush’s ear on appointments, he could get federal reports to mention countries like India, where Enron, with the Dabhol electricity and liquefied natural gas project (also mentioned in Cheney’s report), was a major investor.

To be fair, the energy report also discusses America’s growing reliance on energy from Mexico and Canada. But the state department, which participated in the writing of the energy report, didn’t add the India section; the White House did. Ken Lay’s money on George W Bush had been well spent.

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