Enron, Ep 5: The Enablers

You're listening to Bad Bets, a podcast from the Wall Street Journal that unravels big business dramas that have had a big impact on our world. This first season chronicles the collapse of Enron. I'm John M. Schweiler. The moment Enron went bust, was nowhere near the end of its story. The public outrage around Enron has started to build even before the company filed for bankruptcy. Afterwards, it exploded. Congress and federal criminal investigators were pressing to find out who was accountable from company officials to the institutions that enabled their dealings. Stay with us. Up to this point, we've mostly told you that in Tellus Bankruptcy in December 2001, Enron had lots of admirers. But even before Enron collapsed, there were public officials in one corner of the country who believed company executives were, well, trucks. Everyone loved to say how great Enron was, and they shared it out to be a toll and complete con. That's former California Governor Gray Davis. He's not just talking about Enron's alleged accounting frauds. He's talking about Enron's role in the California electricity crisis. That in 2000 and 2001, cost the state billions of dollars and left hundreds of thousands of people literally in the dark. The California's return to the dark ages came at mid-morning when power was cut to half a million customers. Without warning, the lights went out across whole neighborhoods. Stop lights out, cars colliding, gas pumps idle, automatic telemachines out of servants, all part of the blackout. The California electricity crisis began in the spring of 2000. For years Enron had lobbied tirelessly for the deregulation of electricity markets across the U.S. Saying it would lower electricity bills. One of the most ardent advocates on behalf of Enron was CEO Ken Lay. He had very strong contacts with people in Washington, D.C. He had a lot of influence. And again, he was always urging everyone to open up markets, let these competitive forces bring benefits to consumers. That's my colleague Rebecca Smith. She covered Enron and the California energy crisis for the journal. Before the market was deregulated, local utility companies made, sold and delivered energy to customers. The rates were set by state and federal regulators. But they weren't very efficient. And many people thought that breaking up this system would bring prices down through competition. When California deregulated the retail energy market, the utility companies sold most to their power plants to independent power companies. And the state set up institutions for electricity trading. You could think of them as sort of like auction houses. They were where the producers and the energy traders like Enron would offer power for sale each day. So they'd tell the auction house how much electricity they had and what the price was they wanted for it. The exchanges, these auction houses, would then pick the winning bids until they had enough to satisfy the need for power that day. So basically the utilities were required to buy all of their electricity from these new auction houses. And they had to pay whatever the market charged. But instead of this competition bringing down prices, the opposite happened. In May of 2000, the price spikes began and they kept coming in waves. People sell electricity prices at times reach 10 or 20 times normal levels. That's what the power suppliers were demanding. Of course, summer temperatures push up electricity use and a drought in the Pacific Northwest had cut down hydroelectric supplies. But that didn't fully explain the high prices. At times, the amount of electricity offered for sale seemed suspiciously small as if the suppliers were withholding power to drive prices up. In the past few days, there wasn't enough electricity being offered to keep all the lights on. And that's when the rolling blackouts hit parts of the state. But it wasn't just the electricity producers. Many state officials also suspected that the traders were manipulating the new markets. And in the opinion of former governor Davis, the leader of the band by far was Henry. Now it was never proven that Enron orchestrated the California crisis. But the company was already the biggest electricity trader in the country through their platform, Enron Online. And they were one of the most powerful players in California's new markets. The markets had complex rules. Enron quickly found ways to exploit them and make lots of money. They had a bunch of strategies to do that. And they gave them colorful names, ricochet, get shorty, fat boy. One of the strategies that they called Death Star involved Enron traders scheduling a bunch of power shipments in California, even though they knew the grid couldn't handle them. Couldn't handle that volume at those particular points. Then Enron would offer to "relieve the congestion if they were paid a fee." So essentially they were creating a problem for the grid and then offering to solve it if they were paid enough. In 2006, at the beginning of the lay-skilling trial, recordings of phone calls between Enron traders talking about the strategy surfaced. Here's an excerpt from one. "So the room is true. This is the **** taking all the money back from you guys. I love money you guys stole from the support grandmother of California. Yeah, grandma and Millie, man. But she's the one who couldn't figure out how to **** out on the butterfly ballot. So she has a snatch, she wants her **** money back. "I'm gonna call the power you, you churn it, you can't drive up a **** for **** $250,000, I'm gonna earn it." These recordings suggest that Enron traders were knowingly manipulating the market and didn't care about the impact it was having. It gives the appearance that you're actually relishing the pain that you're causing. There's a gleefulness about that. But these recordings came out much later. During the crisis itself, the utilities were begging for mercy. The prices were astronomical and they couldn't afford to pay them. They were asking for price caps. But Enron was fighting back as were the other power traders. By April of 2001, though, the biggest utility in the state Pacific Gas and Electric had gone bankrupt. And the state of California? Well it had incurred billions of dollars in debt because it was forced to step into bi-electricity on behalf of the state's consumers. I mean, it was a real mess. But even in public, Enron showed little sympathy for California's blackouts. Speaking at a June 2001 technology conference in Las Vegas, then Enron's CEO Jeff Skilling cracked, "What's the difference between California and the Titanic?" At least when the Titanic went down, the lights were on. Enron and other electricity marketers were laughing all the way to the bank. During this period Enron and others were reporting jaw-dropping profits. Enron made an estimated $1.8 billion in 2000 and 2001, just from electricity trading. A few of Enron's California energy traders later admitted to conspiracy to commit wire fraud. Most got probation. The top Enron execs were never charged. By June 2001, California started coming out of the crisis. This month's later, Enron filed for bankruptcy. Now to be clear, the California crisis didn't cause Enron's bankruptcy. In fact, if anything, all that market manipulation actually padded Enron's bank account. But Enron's bankruptcy gave California critics a new national stage for their complaints. California Senator Barbara Boxer brought up Jeff Skilling's snide jokes about her state when she grilled him in a hearing in February 2002. From everything I can put together, Mr. Skilling, you helped cause these anxieties while you laughed about it. The people of California were not laughing then, they're not laughing now. Our state wants justice. Boxer wasn't the only one who wanted to hold Enron execs accountable. The public pressure was immense. And two groups took swift action. Congress held extensive hearings about the company's collapse. And the Justice Department created the Enron Task Force, a team of dozens of federal prosecutors and investigators from around the country. They would undertake the largest criminal probe in US history focused on one corporation. Between them, Congress and the Task Force were not just investigating Enron's executives, but also the support system that allowed the company's suspected misdeeds to occur. That included the auditors who were supposed to have ensured that Enron's financial dealings were above board. I asked if the account was signed off on it, if it looked okay, and I was told that it was, and went along with it. And the Wall Street banks that helped finance and profit it from, questionable deals that powered Enron's rise. If you thought it was a bad body, you reported to compliance in Maryland and she said, are you kidding? That's not what compliance is for. Did they ask the tough questions? Or did they turn up blind eye? The Department of Justice leave as a matter of policy that the devastation that was caused by Enron's collapse. Could not have happened without these enablers. You're listening to season one of Bad Bets, the story of Enron's collapse. This is episode five, The Enablers. After Enron declared bankruptcy, it didn't take long for Congress to spring into action. If this were just another business failure, there would be no need for congressional hearings. But it is anything but just another failure. That Senator Byron Dorgon of North Dakota at the first hearing on December 18, 2001, just over two weeks after Enron's bankruptcy filing. More than $60 billion in value has been lost in just months. Some at the top of the pyramid got rich, many at the bottom lost everything. It appears to me to be a combination of incompetence, greed, speculation with investors' money, and perhaps some criminal behavior. Nearly a dozen committees and subcommittees held hearings. Members of Congress questioned those inside Enron. Execs, board members, average employees. They also brought in the net, grilling Wall Street analysts and bankers, credit rating agency officials, pension plan and accounting experts, and federal regulators. The question here is, what happened? How did it happen? Who was responsible for it happening? And what can we do to prevent this sort of thing from happening again? Some top Enron execs, including former chairman Ken Lay, and former chief financial officer Andy Fasthal, declined to testify before Congress. But one exec did show up. Former CEO Jeff Schilling. Perhaps he believed he was innocent and therefore had nothing to fear. Or maybe he thought he was smart enough and convincing enough to win people over. He'd done it for years at Enron. (soft music) Members of Congress pressed skilling about the potentially criminal financial engineering at Enron, including those transactions connected to Andy Fasthal's LGM partnerships. And the hedges that Enron used to avoid having to report large losses, the raptors. Schilling said he was familiar with the deals, generally speaking. - I was familiar with the raptor transaction as it was approved by the Board of Directors and understood the terms that that was presented to the Board of Directors, how that transaction operated. - He said he'd asked if the accountants, the experts, had signed off on them. And that since they had, he went along with it. Many senators, including Arizona Republican John McCain, were incredulous. - Was it your responsibility to know? - As I said, Senator, I am not an accountant. - I am not an accountant. - He said that again and again. I will stay right now that I'm not an accountant. - So who were the accountants? - Enron's collapse happened under the watchful eye of Arthur Anderson, the auditing firm that was supposed to ensure Enron's financial statements were accurate. - Arthur Anderson. At the time, it was one of the big five accounting firms in the US, with 85,000 employees around the world. Their clients read like a who's who of corporate America? Delta, Merck, Freddie Mac. But Enron was one of his biggest. In the year 2000, Enron paid Anderson over $50 million in auditing and consultant fees. As auditors, it was their job to check the books, to ensure that corporate clients follow accounting regulations and provide accurate information to investors. Which means that firms like Anderson, hold an important role in corporate America's system of checks and balances. But members of Congress had strong suspicions that instead of keeping Enron in line, Anderson may have helped the company cross the line. At one point, Anderson had as many as 150 staffers working inside Enron's headquarters in Houston. And Enron often hired Anderson accounts to fill his own ranks. Ties were so close, employees celebrated in office birthdays together, raised money for charities on the weekend, went on ski trips to Colorado. And some worried that this issue was much bigger than just Anderson and Enron. Here's former SEC chairman Arthur Levin, testifying at a February 2002 hearing. Enron's collapse did not occur in a vacuum. Its backdrop is an obsessive zeal by too many American companies to project greater earnings from year to year. At one time, I referred to this as a culture of gamesmanship. What was once unthinkable in business has become ordinary in our highly competitive economy, more and more business leaders, our employing financial maneuvers that approach and sometimes cross ethical boundaries. Accounting rules are dealt with in terms of what I can get away with, or if it isn't expressly forbidden, it's okay. - But in Anderson's case, the issue of whether it acted ethically when it came to Enron became a much more tangible question, one about shredding documents, possibly hampering a federal investigation, obstructing justice. Congress wasn't looking at Arthur Anderson just because it'd go over seen Enron's books, though that likely would have been reason enough. There was something else. Something Anderson did in Enron's final months that put the accounting firm squarely in lawmakers crosshairs. Back in August 2001, senior executive Arthur Anderson had become aware of Enron's quote, "nooming problems" according to a later Supreme Court decision. In September, Anderson formed a crisis response group to deal with anticipated attention from the federal government. On October 19, Anderson's suspicions were confirmed when they received a copy of a letter from the SEC announcing that it had been formally investigating Enron for months. Just a few days later, on October 23, David Duncan, the lead Anderson partner on the Enron Account in Houston, directed firm personnel to the shredder. Anderson employees in four different offices in the US and Europe destroyed almost two tons of Enron-related documents. In January 2002, Anderson disclosed that the shredding had taken place, adding fuel to the firestorm that was already raging over Enron's collapse. Members of Congress had questions. - What exactly was shredded? Could you enlighten us about what we now know about those files? What did they pertain to? Was it the partnership agreements? - That's representative Ed Royce of California, questioning Arthur Anderson's CEO, Joseph Barardino. - Well, unfortunately, it's hard to recreate shredded documents. We have been trying to recreate whatever's possible to recreate. And we're able to recreate a lot of it. Could you give us some insight since you've got some of the puzzle pieces together as to the subject matter of what was shredded? I know I cannot, I just don't know. - Barardino declined a comment for this podcast. While Congress could shine a spotlight on Anderson, more direct consequences would come from criminal authorities. In March 2002, the Enron Task Force indicted Arthur Anderson, charging the company with obstruction of justice and connection with shredding Enron-related documents. Besides being the Task Force's first indictment, it was also notable for charging the company itself rather than individual employees. A turn of events that few could have fathomed just a few months earlier. Andrew Weissman, the Task Force's deputy director at the time of the indictment, says it was a crucial part of the government's efforts. - When I think about that Enron investigation it's really easy to think of it as it's about the corruption of Ken Le and Jeff Skilling and Andy Fasdow and these sort of larger than life people who really didn't seem to have a moral center and did things that you think are really outrageous. And all of that's true, but that to me is not the lesson of Enron. Enron to me is a lesson about the enablers of how did all of these systems not catch it. - In early May, less than two months after the indictment the trial began. Now, given the massive destruction of Enron documents as the company was collapsing and federal investigators were closing in, you might think it would've been pretty easy to convince the jury that all that shredding was in fact criminal. As Weissman tells it, the case against Anderson was pretty straightforward. - There was a crime scene. When you know the police are coming you don't take the evidence and get rid of it. And the only documents that were suddenly being shredded as soon as they got noticed of the SEC coming were Enron documents. It wasn't generally any other documents that were being destroyed. And what are you doing that for? - The task force also had something of a star witness ready to testify. David Duncan, the Anderson partner who ordered the shredding to commence in Houston. A month before trial, Duncan pleaded guilty and agreed to help the government. On the stand, he told the jury, quote, "I obstructed justice." Duncan declined to comment for this podcast. But observers say Duncan's testimony mostly fell flat And thanks to some flip. flopping on his story during the prior months, his credibility took a hit too. In fact, Weisman says that things just weren't going all that well for the prosecution. Many of their witnesses were, like Duncan, current or former Anderson employees. So they were sort of conflicted in terms of loyalties. Things were going so poorly that Weisman and his colleagues made a risky move. They rested their case earlier than planned, hoping they could start scoring points by cross-examining defense witnesses, making them look bad. This was the defense's opening to make their case. That Anderson employees weren't trying to foil government investigators. They were just processing all those documents to get ready for an internal review by the firm's own top management. Rusty Harden, Anderson's lead attorney for the shredding case, says it was part of the normal course of business. Companies are routinely shredding documents, and accounting firms always have the position. You only keep what's necessary in the work papers to show the basis of what your conclusions were and what you were doing. Shredding became this horrible idea, and it's just not true. So Harden called witnesses who supported Anderson's argument that the shredding was routine and didn't destroy any documents that would be needed by federal investigators. But just as some of the government's witnesses seemed to help the defense, some of the defense witnesses returned the favor. As Wysman recalls, one defense witness more or less said the shredding was aimed at keeping Anderson's fate from being decided in a trial. On the stand, the prosecutor recalls, the witness essentially said, "What do you expect? We're not going to leave it to a jury to decide what we were doing." I mean, it was devastating testimony to describe why they were doing this. I mean, it was also obvious. But the jurors didn't act like it was an open and shut case. After 72 hours and 10 days worth of deliberations, tonight there's a guilty verdict in the obstruction of justice trial of Chicago-based accounting firm Arthur Anderson. The conviction was a death knell for Arthur Anderson. The guilty verdict is the first major victory for prosecutors investigating the collapse of Enron, and it could mean the end of Anderson accounting, which has already lost scores of clients and has already been forced to throw thousands of workers into the street. A few months later, Anderson surrendered to accounting licenses in the US, formally ending its accounting practice after 89 years. The big five accounting firms became the big four. Three years later, in 2005, Anderson would get a measure of redemption. The Supreme Court unanimously threw out the conviction, explaining that the trial judge made a mistake by agreeing with the government to loosen the standard jury instructions. After the Supreme Court decision, former Anderson partner David Duncan withdrew his guilty plea related to the document shredding. The government never renewed the case against him. Still, in 2002, the Anderson conviction was the first notch on the Enron Task Forces belt and gave them some momentum. There were still plenty of Enron officials and external parties to investigate. The pursuit of another alleged enabler would lead to another high-profile trial. This one targeted officials at one of the biggest names on Wall Street. Merrill Lynch. Along with other giant financial institutions, Merrill Lynch helped Enron raise billions of dollars to fuel his operations and ambitions and got paid big fees to do so. Merrill also has some unusual entangments with Enron. When CFO Andy Fashtow was raising money for his LJM partnerships, he reached out to Merrill. In fact, some Merrill officials put their own money into LJM. When the task force started digging into Enron's finances, though, there was a really unusual deal between Merrill Lynch and Enron that caught their eye. It involved barges. In Africa. By the late 90s, Enron owed a bunch of assets all over the world. A power plant in India, a water supply company in England, a utility company in Brazil, and of course their pipelines in the US. They were profitable, but not wildly so. Now, skilling had already begun steering Enron towards a more asset-like future, digital. But some of his projects, like Rod Van, were more experimental and were losing a lot of money. Prosecutor Catherine Rumbler says, as 1999 was coming to a close, Enron was worried it wouldn't meet Wall Street earnings projections, and execs were getting desperate. So they were looking all over the company to find earnings everywhere they could find them? They found a few nuggets of the shores of West Africa. They were looking to sell an equity interest in some electricity producing power barges that happened to be mored off the coast of Nigeria. These were huge ships parked in the ocean to produce power for Nigerian consumers. At first, Enron tried to find another energy company to buy the barges, but didn't have any takers. So, with December 31st, fast approaching, they went to Merrill Lynch. Now Merrill Lynch wasn't in the barge business, and didn't want to be. But Enron was a big client, and according to Rumbler, offered a sweetener for the deal. The CFO of Enron at the time, Andy Fasdow, got on the phone with the head of investment banking at Merrill Lynch, and gave him his word that Merrill Lynch would be taken out of the deal in six months. And a ledged secret promise that Merrill would be able to sell the barges quickly at a guaranteed profit. Transforming the deal essentially into a debt deal, or a relationship loan. A loan prosecutors argued made to look like a sale, so that Enron could report profits. In the final week of December, Merrill Lynch paid $7 million for the barges. It was a small dollar amount in the grand scheme of things, but a pretty crucial favor, according to Rumbler. And that would allow Enron to then book the deal as an earnings event. Enron logged $12 million in profits, and met its earnings projections for the quarter. Prosecutors argued in doing so, Enron lied to investors, with Merrill's help. But that wasn't all. Remember that alleged promise that Merrill would be out of the deal in six months? Well, six months later, Merrill sold the barges, add a profit, to none other than one of Enron's CFO Andy Fasdow's LGM partnerships. The whole deal was quick and successful, and according to the government, criminal. It was relatively small in terms of the overall economics, but it was very indicative of the types of schemes that the Enron executives engaged in, and how those schemes would not have been possible without the complicity of third parties. Besides being allegedly criminal, this deal was an example of the ethical minefield that the LGM operation had created. When buying the barges, Merrill dealt with Andy Fasdow, Enron's CFO. When selling them, it dealt with Andy Fasdow, managing partner of LGM. Rumbler says the deal was part of a pattern of deceit that took hold at Enron. The story of Enron is that there was not one deal that brought Enron down. It was many deals like this that over a period of, we alludged basically two years of the conspiracy, had so morphed the true financial picture of Enron. The Department of Justice pleaded as a matter of policy that the devastation that was caused by Enron's collapse could not have happened without these enablers. Eventually, the task force indicted four Merrill officials, including one who had the conversation in which Fasdow made the alleged illegal verbal guarantee, all four denied wrongdoing. At what became known as the Nigerian barge trial, the defendants claimed that there had never been such a guarantee that Enron had merely offered to help Merrill try to find a buyer for the barges within six months. And they said, because there had been no actual promise, no crime had been committed. But prosecutor Andrew Weissman says there were internal documents that suggested otherwise. One person even mentioned in their year end reviews. People talked about a side deal. One of the bragsheets at the end of the year, that one of the people who was on the deal submitted, which you did at the end of the year to justify a bonus, was that the person had created and implemented the side deal so that the deal could go through. Prosecutors also presented a witness who had worked at Merrill. Tina Trinkel had been on a phone call where firm officials discussed the barge deal. For her, it was a memorable event. And the agent calls her in London and she says, "Not only do I remember it, I can't forget it. I left Merrill Lynch because of this deal." And she said, "Of course, there was this side deal." And she told us everything that happened on the call, and she told us she saved the paperwork and took it with her when she left Merrill Lynch because she knew one day she would need it. At trial, Trinkel testified that some person on the call said, But somebody in Iran gave his quote, "Strongest, verbal assurance that Merrill could sell the barges within six months." Whether this assurance counted as a guarantee, was at the heart of the case. Despite being disturbed by what you heard, Trinkel didn't take her concerns to her bosses according to Weissman. - She was asked the question, "Why didn't you "if you thought it was a bad body?" You reported to compliance at Merrill Lynch and she said, "Are you kidding?" That's not what compliance is for. And especially when you have the head of investment banking approving it, they weren't gonna do anything 'cause I said it. I mean, it was really devastating proof. - Trinkel did not return our request for comment. In a recent email, a spokesman from Merrill, which is now a division of Bank of America, said the firm didn't have any further comment on his dealings with Enron. He pointed to a 2003 agreement with the Justice Department where Merrill agreed to accept responsibility for the alleged criminal activity of employees. It also agreed to make some operating changes and submit to additional oversight in return for not being prosecuted. In November 2004, the jury found the four Merrill officials guilty of conspiracy and fraud. All four went to prison, with sentences ranging up to nearly four years. However, their prison stays were cut short. The Federal Appeals Court threw out most of the charges in August 2006, saying the government had misused a particular fraud statute and convicting the men. The court did note that, quote, "This opinion should not be read to suggest that no dishonest, fraudulent, wrongful, or criminal act has occurred," close quote. The government didn't retry the men, but the task force counted the Nigerian barge case as a big win. In part, because these convictions seemed likely to have some deterrent effect, the government hoped sending four Merrill officials to prison might give executives the other Wall Street giant a moment of pause before helping a client with an iffy sounding deal. But Rommler said there's another reason. The case showed that a jury would convict someone for doing what became known as a secret oral side deal. The oral side deal was definitely an MO that in particular fast-how used to get a deal done and violate the accounting rules at the same time. Prosecutors said they figured that if they could get a conviction against Merrill Lynch execs, they might be able to get the same result with N-RON execs. While they had been pursuing N-RON's enablers, those execs remained the task force's main targets. The investigations into CFO Andy Fastow and CEO Jeff Schilling had made good progress. And prosecutors felt each had fairly clear ties to N-RON's alleged fraud. But CEO and chairman Ken Lay, perhaps N-RON's ultimate figure, was much harder to pin down. In early 2004, the task force brought out a new prosecutor, John Euston, which spent the next two years helping build a case against Ken Lay. I can still remember flying into Houston, Texas for the first time and realizing I'm not sure I know what I've got myself into here. That's next on Bad Bats. We have a correction to make. Senator Byron Dorgon represented North Dakota. In a previous version of this podcast, we incorrectly stated that he represented South Dakota. This episode of Bad Bats was hosted by me, John M. Schweller. The original reporting on which this season is based was done by Rebecca Smith and me. In this episode, we also relied extensively on other reporting by colleagues at the Wall Street Journal. Bad Bats is a production of the Wall Street Journal. This season was produced in collaboration with Neon Hum Media. From the Wall Street Journal, Cateri Yohgum, is the executive producer of this podcast. Dan Rosen is the co-executive producer of WSJ Studios. Anthony Galloway is the global head of video and audio at the Wall Street Journal. From Neon Hum Media, Muna Danish and Haley Fager reported, wrote, and produced this season. Nafel Akato is the associate producer. Story editing by Annie Gilbertson and Vikram Patel. Sammy Allison is the production manager. Sound design and engineering by Scott Somerville. And the executive producers from Neon Hum are Sharam Morris and Jonathan Hirsch. This episode was fact-checked by Justin Klosko. The theme song and many of the tracks you hear in this series were composed by Hans Dale Sue. The other music in this season of Bad Bats is from Epidemic Sound and Blue Dot Sessions. Subscribe and listen wherever you get your podcasts. I'm John M. Schweiler. Thanks for listening. [BLANK_AUDIO]