CFO’s Deals Detailed by Enron
At least 13 times in the last three years, private partnerships headed by Enron Corp.’s chief financial officer cut deals with the energy giant in which the executives representing Enron were his own subordinates.
These arrangements by ousted CFO Andrew S. Fastow created a jungle of conflicts of interest in Enron’s executive suites and were a key factor in the financial problems leading to the company’s Dec. 2 Chapter 11 bankruptcy filing, according to findings of the special Enron panel that examined the partnerships.
The report, released Saturday, provides a wide-ranging indictment of the company’s management and financial practices. Much of the focus is on Fastow, however, as it offers the most detailed account yet of the off-the-books partnerships he oversaw.
“The transactions between Enron and the [Fastow] partnerships resulted in Enron increasing its reported financial results by more than a billion dollars, and enriching Fastow and his co-investors by tens of millions of dollars at Enron’s expense,” said the report, released this weekend.
Enron’s internal investigation alleges that Fastow, a former banking executive who became Enron’s CFO four years ago at age 36, raided the energy giant from the inside, exposing his employer to deepening risk while orchestrating side deals that paid him at least $30 million.
“Fastow, as CFO, knew what assets Enron’s business units wanted to sell, how badly and how soon they wanted to sell them and whether they had alternate buyers,” the report said. “He was in a position to exert great pressure and influence, directly or indirectly, on Enron personnel who were negotiating” with the entities in which he had a personal financial stake.
Gordon Andrew, a spokesman for Fastow, declined to comment.
The 203-page report was written by a three-member panel led by William Powers, the University of Texas Law School dean appointed to the Enron board specifically to conduct the inquiry.
Enron had turned to Fastow in the late 1990s to devise a strategy that would allow the energy giant to keep investing in new businesses while keeping the company’s credit ratings strong.
Fastow responded by increasing Enron’s use of so-called special-purpose vehicles--corporate entities that can be used to absorb gains and losses as long as they are controlled and partially owned by outside investors.
Enron had used such financing at least once before, cutting a joint-venture deal with the California Public Employees’ Retirement System. But Fastow added a twist--he proposed that Enron engage in deals with an ostensibly independent entity run by one of Enron’s own executives.
The technique worked for a time. By moving assets and liabilities off its books, Enron was able to inflate its profit and credit rating--fueling its swift ascent on Wall Street and pumping up the value of its executives’ stock options.
But amid increased scrutiny last year, Enron decided that many of the outside entities weren’t truly independent. On Oct. 16, it was forced to disclose a $1.2-billion drop in shareholder equity, and the resulting decline in its credit ratings led the company to file for bankruptcy protection.
Much of the problem arose from three partnerships engineered or partially owned by Fastow.
Chewco Investments
Fastow’s first such off-the-books design for Enron was Chewco Investments--named for the Chewbacca character in the “Star Wars” films. He planned to use Chewco, financed with bank loans, to buy out the California pension system’s share of a joint venture that Enron wanted to keep off its books.
But the venture was hardly independent, the report found: The bank loans used to fund it were guaranteed by Enron, and initially, Fastow planned to manage it himself while continuing as Enron’s CFO.
Fastow told employees that Enron’s then-president and his mentor, Jeffrey K. Skilling, had approved of his participation in Chewco as long as it didn’t have to be disclosed in Enron’s regulatory filings, the internal probe found.
When Enron’s in-house lawyers told him his involvement would have to be disclosed, Fastow substituted one of his lieutenants, Michael Kopper, to run the partnership.
Although Chewco “apparently required little management” aside from preparing unaudited financial statements for internal use, Kopper received about $2 million in fees, the report said. During certain periods of Chewco’s existence, these management tasks “appear to have been performed by Fastow’s wife,” the report said.
LJM Cayman
Chewco was just the start of Fastow’s deal making. In June 1999, he formed a partnership called LJM, with the letters representing the first initials of the names of his wife and two children.
Fastow formed LJM Cayman to shield Enron from possible losses from its $10-million investment in a start-up Internet service provider called Rhythm NetConnections Inc.
As part of the plan, Fastow told Enron’s board that he would serve as the general partner of LJM Cayman and would invest $1 million of his own money. In return, he would be paid fees including 100% of the proceeds of the sale of any assets until he had reached a rate of return of 25%. But he said he would not receive any gains from increases in the price of Enron stock paid to LJM Cayman.
The board approved the arrangement, waiving Fastow’s potential conflict of interest.
In a complex swap, Enron moved the risk from the Internet company to LJM Cayman in exchange for more than $170 million in paper increases on Enron stock locked up in a contract with an outside investment bank.
Enron in early 2000 decided to sell the Rhythm shares and had to unwind the deal with LJM. Fastow negotiated the deal with Enron’s chief accounting officer, Richard Causey--another potential conflict.
An executive who has been interviewed by congressional investigators said Causey “was intimidated by Andy and didn’t think it was his role” to haggle with him.
Causey could not be reached for comment.
According to the calculations of the board investigators, the final deal resulted in Enron giving up options and cash worth $70 million more than the restricted shares it received.
The transaction also exposed another potential conflict. In March 2000, Fastow had allowed a handful of Enron executives to participate in LJM Cayman. These executives--who included Fastow and Kopper--signed an agreement to form an entity called Southampton Place, which acquired a stake in LJM Cayman.
The deal enabled a Fastow family foundation to receive $4.5 million about two months after Fastow made an initial investment of $25,000. Two other employees who each invested about $5,800 received about $1 million each in the same period.
The special committee found that Fastow’s financial stake was inconsistent with his representation to Enron’s board that he wouldn’t receive any value from Enron stock involved in the LJM Cayman transaction.
The panel also found that at least two of the executives who received windfalls from LJM Cayman were representing Enron at the time in transactions with another Fastow-created entity.
LJM2 Co-Investment
In October 1999, Fastow engineered the creation of another, far larger entity called LJM2 Co-Investment. Again, he would serve as the entity’s general partner while maintaining his post as Enron’s chief financial officer. The plan was to raise money from outside investors and purchase assets from Enron and enable the energy giant to remove debt from its books.
To raise funds, LJM2 sent an offering memorandum to potential investors. In an usual move, the document emphasized Fastow’s position as Enron CFO, noting that LJM2 would have access to “investment opportunities that would not be available otherwise to outside investors.” Critics say it is improper for Fastow to dangle the possibility of using inside information for investors’ benefit.
The report said the deals often took place under terms that were “remarkably favorable” to LJM2 while serving no apparent business purpose for Enron. For example, in one of the deals, Enron agreed that an LJM2 affiliate wouldn’t have to start absorbing Enron losses until the Fastow-controlled LJM2 received an initial return of $41 million, or 30%, on its initial $30-million investment.
The report concluded that the troubles created by Fastow’s partnerships would have come to light far sooner if the board itself had exercised closer oversight.
