Why Enron Went Bankrupt

This article in the Harvard Business Review is the most lucid explanation of Enron’s bankruptcy to date. The most stunning paragraph is this:

As the value of the assets in the SPEs became impaired, Enron faced an unpleasant choice: issue new equity as promised, thereby diluting current shareholders and causing a drop in stock price, or risk a loss of Enron’s investment-grade rating and potentially destroy the firm.

Enron’s CEO at the time, Ken Lay, decided against issuing the stock (and against living up to the financial structure created by Fastow), apparently believing that (a) dilution would cause an even greater loss of confidence than would the impairment of Enron’s balance sheet from including the SPEs and (b) the rating agencies would back down. Instead, the rating agencies downgraded Enron, the trading operations were forced out of business, $4 billion of debt was accelerated, and Enron was forced to file for bankruptcy.

Nobody’s ever said it quite like that. Quite so clearly and simply and powerfully.

What is staggering about this is that it is the exact opposite of what was publicized by pundits, newspapers and naysayers. In his analysis published in HBR, Professor Weiss explains that the “oft-maligned” SPEs actually would have saved Enron, had it not been for Lay unwinding them. Let that sink in a moment: unwinding Raptor actually caused the bankruptcy.

Quite simply, a number of Enron assets (such as the Azurix, International, and Merchant Investments HAD declined in value. Even if these assets were on-balance sheet, Enron would have had to issue a ginormous amount of equity in order to maintain the investment-grade rating. When Lay backed out of his pledge to do so, it was game over with the agencies.

The argument to date has been a total non-sequitor: Enron went bankrupt because it was being forced to issue equity. That’s like saying a sick patient died because he was being forced to take life-saving medicine. The issuance of new equity was the life-saving medicine. It pains me to say that Ken Lay and Greg Whalley took the medicine away.

Announcement of Kevin Hannon and Greg Whalley’s New Positions

This is a document announcing the Kevin Hannon’s and Greg Whalley’s new positions inside Enron.

The Perfect Ten-Year Circle

It has been, I think, four or five weeks since I talked to Sean. We tend to talk every day but he’s been busy traveling to Japan and England. Then today I picked up the phone and it was Sean calling, having arrived in New York maybe two hours before. “I was catching up with your blog,” he informed me.

This was news. He doesn’t care about Enron. I didn’t even know he read my blog. After I posted this picture he said he was never going to read it again because he just didn’t want to know what the hell I was saying:

Sean said, “Do you know a guy named Greg Whalley?”

I nearly screamed. In fact, I might have screamed. Okay, I screamed. “How do you know Greg Whalley?” I demanded.

Then he told me a story of such crazy serendipity that it left me dazzled and dazed. When he was leaving for Tokyo, he yanked his suitcase out of the closet and a wheel popped off, so he used an older one that had all the requisite parts, including wheels. The morning after he arrived in Tokyo, he was looking for his hotel card key so he could leave the hotel and he unzipped a compartment in his case, thinking he might, for some reason, have thrown it in there. His fingers brushed something, he grabbed it and pulled up a business card for one Greg Whalley of Enron Corporation.

It had been in that case for at least ten years. I have begged him to mail it to me, and he says he will drop it in the post on Monday. Meanwhile, there is a story behind how Sean ended up with Greg Whalley’s business card. However, he doesn’t know what it is. He says he has no memory of meeting with anyone from Enron. He says that the name “Ken Rice” sounds familiar – which might make sense if he was dealing with Whalley because they were both traders. But he draws a blank when I ask for names and dates and places.

How could any mortal forget anything to do with Enron? It is impossible! I have to send Sean to a hypnotist or something, because somebody has to go into his brain and bring out the ore. I must know the story of how he came into possession of Greg Whalley’s business card. I will feel completely ripped off and incomplete if I don’t know it. It can not be allowed to die.

Today In Enron History

Wednesday, October 24, 2001.

The stock opened at $19.74 and would close at $16.41 at extremely heavy volume. The stock lost 17.4% of its value.

First thing in the morning, Andy Fastow and Whalley discussed the problems with the banks – or, more to the point, the problem the banks were having with Fastow. Andy said that he understood he was no longer effective in the role of CFO, and Whalley agreed. Andy then said he would talk to his team and McMahon and get back to him. Whalley politely said okay.

He showed Andy out and saw several others, including McMahon, waiting to speak to him. He asked them to head upstairs and he’d join them in a few minutes.

Whalley immediately went to Ken Lay’s office and informed him he was firing Andy Fastow and replacing him with Jeff McMahon. Lay hesitated. He still wanted to believe Andy was the old Andy Fastow – the brilliant star who had the world by the balls. He said he’d take it up with the board. Whalley felt that Lay didn’t quite understand the urgency of the matter. NO BANK WOULD DO BUSINESS WITH ENRON IF ANDY FASTOW WAS CFO! So he basically gave Lay an ultimatum: either Enron would have a new CFO or it would have a new COO.

Whalley left Ken’s office and hustled up to the meeting with Andy, McMahon and others. Without board approval, he fired Andy Fastow and replaced him with McMahon. Both were shocked. Not that it was done, but that it was done like that. Whalley understood the situation. He was an excellent COO, seeing what was in front of him, not what he wanted to see. And he was moving quickly to fix it as best he could. He was sort of a little like Jeff Skilling in this way. Whalley immediately moved on to the next order of business: pulling down the revolving credit lines, which McMahon suggested the day before. Fastow objected but nobody listened.

McMahon deputized Ray Bowen, then they assembled a team who would try to rescue Enron from financial meltdown. He said he’d meet Bowen in the new Enron tower on the fourth floor in thirty minutes. There was no time to waste.

Dazed from being fired, Andy Fastow made it to his office in time to field a phone call from Jeff Skilling. Skilling had no idea that he’d just been fired and was surprised by the news. He tried to say a few encouraging words to his old friend, but Andy quickly got off the phone with him. Andy dialed his attorney, David Gerger. He then got in touch with Michael Rubenstein, another attorney. Andy and Lea had a conference call with Rubenstein that lasted two hours.

Ken Lay was spending the day in a management meeting at the Four Seasons Hotel. He directors listened as Ken Lay expressed concerns that Andy Fastow might not be able to fulfill his role as CFO any longer. He was unaware that Whalley had already tossed him out and filled the position with McMahon. John Duncan mentioned that his call with Andy the previous day had revealed that Andy made much more money on the LJMs than they’d been led to believe. He admitted to $45 million. Ken Lay was shocked; he felt then that he had been deceived by Andy Fastow. He would have to be terminated. But there was a catch. Andy Fastow had an employment contract that stated the board needed special cause to fire him. So one of the board members made a motion that Andy Fastow would take a leave of absence and McMahon would replace him, effective immediately. It passed unanimously.

McMahon was trying to keep calm over in the new Enron building, but he could not believe his ears. The financial SWAT team he’d assembled needed answers – how much cash Enron had on hand, how much it owed, a maturities schedule for debt. And nobody could produce any of it.

Ken Lay kept thinking about Jeff’s offer to come back to Enron. He was desperate and needed something to stop the vortex of doom that was sucking them all down. And maybe Jeff was that thing. He asked Whalley to meet with him and he agreed. He’d go to Jeff’s house — there was no frecking way Jeff could show up at the building without causing a huge commotion.

Jeff was waiting for him. Before he even stopped his car in Jeff’s drive, Jeff was outside, walking toward him. “What the fuck is going on?” Jeff demanded.

“It’s bad,” Whalley said. “Really, really bad.”

Back inside, they discussed facts and figures. Whalley estimated they needed about $3.2 billion to keep the trading business alive.

Jeff was immediately animated. He wanted to jet to New York immediately – just let him change out of his shorts and shave, and he was ready. He believed that if he could meet with the bankers, tell them there wasn’t a problem, that the banks would get their money back, it would all be okay. This was freaking Enron! There was no problem Enron couldn’t handle. It was the darling of Houston.. a shining star on Wall Street.

Whalley returned to the office a true believer. He told Lay that they should bring Skilling back. They decided they’d talk to the management committee about it.

But it wasn’t happening. Back at Jeff’s house, the phone wasn’t ringing. Jeff wasn’t having it. He called Whalley back, demanding to know what was going on, and trying to impress upon him that they needed to be in New York that night. They needed to be taking bankers to dinner, proving themselves. Whalley, who had shown a penchant for speed with Andy Fastow, said there was simply nothing to do: they had to have a management meeting.
When the call finally came, it was not good news. Skilling could not return to Enron. The management team had suddenly turned a cold shoulder to their former CEO.

This was one of those “if only…” moments. If only Jeff had been permitted to return. If the market saw that he was truly invested in the company, that he loved it… if only. Maybe there would have been a slight slowing of the hemorrhaging, just enough to catch their breath. Just enough to calm the panicking markets.

But it wasn’t to be. Skilling was out and he was going to stay out.

Enron issued a press release in the mid-afternoon:

ENRON NAMES JEFF McMAHON CHIEF FINANCIAL OFFICER

FOR IMMEDIATE RELEASE: Wednesday, October 24, 2001

HOUSTON – Enron Corp. announced today that it has named Jeff McMahon chief financial officer. McMahon had been serving as chairman and CEO of Enron’s Industrial Markets group. From 1998 to 2000, McMahon was Enron’s treasurer.

“Jeff has unparalleled qualifications and a deep and thorough understanding of Enron,” said Kenneth L. Lay, Enron chairman and CEO. “He has the trust and confidence of our investors and financial institutions.”

Andrew Fastow, previously Enron’s CFO, will be on a leave of absence from the company. “In my continued discussions with the financial community, it became clear to me that restoring investor confidence would require us to replace Andy as CFO,” Lay said.

McMahon, 40, joined Enron in 1994 and spent three years in the London office as chief financial officer for Enron’s European operations. Upon returning to the United States, McMahon was executive vice president of finance and treasurer for Enron Corp. In 2000, he was named president and chief operating officer of Enron Net Works, where he had responsibility for Enron’s e-commerce activities.

McMahon has a bachelor’s degree in business from the University of Richmond in Virginia. He is a Certified Public Accountant, SFA registered and is a member of the American Institute of Public Accountants and Association of Corporate Treasurers.

Sherron Watkins was thrilled by the changing of the guard in the upper echelons of Enron. With her nemesis out as CFO and her friend Jeff McMahon in the power position, she thought for sure she could leverage the situation. In fact, she was pretty sure Jeff McMahon needed her advice on lots of things – like whether to get rid of Glisan. Now there was no love lost between Glisan and McMahon, but Sherron Watkins was not in a position to be advocating for firings. In any case, as soon as the email announcing McMahon’s new position was sent, she drafted a letter to McMahon:

—–Original Message—–
From: Watkins, Sherron
Sent: Wednesday, October 24, 2001 4:12 PM
To: McMahon, Jeffrey
Subject: Your new CFO spot and the job I want

Jeff, Congratulations, you deserve the job and can do it superbly! You know you will need to replace Ben Gilson as Treasurer – possibly with Bill Brown.

My issue, and I feel very strongly about this, is that I want to be on the crisis management team to determine how we save our trading franchise. It can disappear over night and I believe there’s more bad news coming re: these raptor deals (ie, restatement). I have clearly proven myself to be the only person at Enron that had the character, at great risk to my own career, much less personal risk, to go to Ken Lay and let him know what was going on here. I resent all these late comers joining the band wagon – it’s damn easy to make a statement now, when Ken has made the hard decision to unwind these deals and write them off. Mainly I resent being stuffed into a holding tank, I should not be the pariah here! Despite your comment to me several weeks ago when I told you that’s how I felt and you replied “what did you expect?” I have been professional in this 100%, I went to Ken and Ken alone, in contrast to yesterday’s VP Jim S. who put Ken on the spot by asking unanswerable questions at the all employee meeting. I hope to meet with Ken Lay soon. But I’d like to talk to you about my role in the ‘inner circle’, because I firmly believe I deserve it and have proven so by my past evaluations of the negative impact of these structures and then by my actions in doing something about it. You can help me with your endorsement of me to Greg Whalley, Mark Frevert and Ken Lay. I hope I have it. Thanks and good luck in the new job,

Sherron

What a delusional psychopath.

But anyway, after she sent that crazy, self-serving email, she forwarded it to Cindy Olson with a message:

—–Original Message—–
From: Watkins, Sherron
Sent: Wednesday, October 24, 2001 4:14 PM
To: Olson, Cindy
Subject:FW: Your new CFO spot and the job I want

Cindy, I sent this to Jeff McMahon today. I wanted you to see it. You can forward it to Ken if you’d like – I am very interested in speaking with him as soon as that can be arranged. I very much appreciate your insightful and professional support of me in all of this from day one! Thanks, Sherron.

Need I point out that Enron was on fire and this woman was only concerned with her career. McMahon was tied up with the financial SWAT team all day, trying to figure out the real position of Enron. He didn’t have time to baby-step Sherron Watkins career up the ladder. I do love the fact that she thinks she belongs in the “inner circle.” Again, I repeat what one of her former bosses told me: she was one of 180 VPs, she was utterly undistinguished and she knew absolutely nothing about deals. He did say she was aggressive and ambitious though, and that comes through in these emails.

Jeff McMahon called Ken Lay that afternoon, not to discuss the social climbing Watkins but to apprise him of the situation Enron was really in. Thirty billion in debt, about $10 billion current. They had to visit with the banks and try to renegotiate the debt. McMahon then called Whalley and told him the same thing.

Another option, Whalley said, was a merger. A merger with someone with a stronger balance sheet would at least save the company – there was no shame in that. McMahon said he’d give it some thought.

That night, McMahon and some other guys met at a dim, dank Houston landmark bar called Kenneally’s that supposedly serves the best pizza in town. McMahon had been thinking about Whalley’s idea of a merger. He threw it out there to see what the guys thought.

They pondered who would be a good candidate for a merger. Exxon? Shell?

“Dynegy,” someone said.

Ex-Enron Exec Sued By Art Gallery

From Bloomberg is this bizarre story:

Enron Corp.’s former chief operating officer of global markets, Jeff Shankman, was sued by a New York art gallery for allegedly trying to extort more than $150,000 by claiming a painting he bought was a forgery.

Historical Design Inc., an art gallery on East 61st Street in Manhattan, said Shankman purchased three works of art in November 1997 for $40,000. The gallery said Shankman complained this year that one of them, a gouache painting called “Les Visiteurs” signed by J. Lambert-Rucki, was a fake. He threatened to “go public” unless he was paid least $150,000, the gallery said in court papers.

“Shankman, a former high-echelon Enron executive and art dealer, maliciously formulated and carried out a fraudulent plan or scheme seeking to extort cash from the plaintiff,” the gallery said in a complaint filed Oct. 7 in New York State Supreme Court in Manhattan.

The gallery, which is seeking at least $400,000 in damages and other fees, contends the artwork belongs to Enron’s shareholders and creditors and that Shankman “wrongfully took possession of it for his own use and benefit.”

Shankman, who headed trading in markets from commodities to foreign exchange and equities at Enron before its 2001 collapse, started a Houston-based energy hedge fund called Trident Asset Management LLC in 2006 with Andy Weathers, a former trader at CenterPoint Energy Inc.

Shankman couldn’t be reached immediately for comment yesterday. A telephone number listed for Trident was disconnected.

`Worthless Forgery’

Historical Designs claims that in 1997, Shankman had the art shipped care of Enron to a Houston address. The gallery said it hadn’t seen the works or heard from Shankman until this June, when he claimed that the Lambert-Rucki painting he’d bought was a “worthless forgery.”

The gallery said its own investigation determined that Enron paid for the art, according to the complaint. Shankman rejected the gallery’s requests to examine the painting, the gallery said. Historical Designs said Shankman “kept increasing the size, amount and the urgency of his demands to plaintiff for IMMEDIATE CASH ONLY.”

Shankman claimed the gallery was “in the business of selling forgeries,” and said “consumers need to be protected” from Historical Designs, the gallery said in the complaint.

Enron was the world’s largest energy trader, with a market value of as much as $68 billion, before it collapsed in December 2001. Once the nation’s seventh-largest company by sales, it had a budget of $20 million to purchase art for its 50-story Houston headquarters.

Warhol, Katz

Enron sold its art collection, generating $1.74 million in auctions in 2004. The trove of 48 contemporary works amassed by the company included pieces by Andy Warhol, Donald Judd, and Alex Katz, according to documents filed in U.S. Bankruptcy Court in New York. The art collection was liquidated to help pay more than $67 billion of company debt.

The energy trader appointed an art-selection committee, which included Lea Fastow, former assistant treasurer and wife of former Chief Financial Officer Andrew Fastow. Shankman served on that committee, the gallery said in court papers.

Lea Fastow served a one-year prison term for failing to report income from Enron’s off-books partnerships controlled by her husband and was released from prison in July 2005.

Stuart Serota, a lawyer for the gallery who filed the complaint, didn’t return a call seeking comment yesterday.

Queer.

I don’t have any opinion on this at all because I don’t know very much about Shankman. I do know that after the collapse of Enron, Shankman wasn’t given a retention bonus and seemed very bitter about it, testifying for various plaintiffs against Enron. He said some disparaging things about lead trader John Lavorato and Greg Whalley who was a trader at Enron and became President after Jeff Skilling resigned. He emphasized the dog-eat-dog culture at Enron, an accusation that always sounds funny to me; these people didn’t have to work at Enron. Had Shankman, or anyone else, disliked the corporate culture they could have found a job hugging dolphins. Alas, they didn’t. Shankman himself was compensated in the millions and there is no record at all that he objected to the culture when he was working there. That’s not to say that he didn’t believe it to be a brutal culture; he just never spoke up about it.

All that ,of course, has nothing to do with the accusation of extortion. I am just bemused that so many of the Enron folks end up in the most interesting situations.