The Two Faces of Enron

One year ago, Enron was riding high as one of America's most successful corporations -- on the outside. Beneath the surface lay a series of byzantine partnerships and financial strategies that would eventually collapse and bring the once-proud energy-trading giant to its knees. Kurt Eichenwald and Diana B. Henriques of The New York Times report on the last 11 months of the company and its spectacular downfall.

Kenneth Lay strode onto a ballroom stage at the Hyatt Regency Hill Country Resort in San Antonio, Texas, walking between two giant screens that displayed his projected image. Before him, bright light from the ballroom's chandeliers spilled across scores of round tables where executives from the Enron Corp. waited to hear the words of Lay, their longtime chairman and chief executive.This meeting of hundreds of Enron executives in the first week of January 2001 was a time of revelry, a chance to celebrate a year when business seemed good -- even better than good. At night, according to executives who attended, champagne and liquor flowed from the open bar, while fistfuls of free cigars were available for the taking. Executives could belly up to temporary gambling tables for high-stakes games of poker. Others found their excitement in the company-sponsored car race; one executive had even hired a truck to transport his three Ferraris from Houston for the event.

Now, as waiters wearing bolo ties scurried about, the executives listened eagerly to Lay's descriptions of Enron's recent year of success -- and the new successes that were within reach. Already, Enron was near the top of the Fortune 500, a multibillion- dollar behemoth that had moved beyond its roots in the natural gas business to blaze new trails in Internet commerce. For 2001, Lay said, the company would take on a new mission, one that would define everything it did in the months to come: Enron would become "the world's greatest company." The words replaced his image on one of the screens.

But it was not to be. For, unknown to almost everyone there, Enron was secretly falling apart. Even as the celebrations unfolded, accountants and trading experts at the company's Houston headquarters were desperately working to contain a financial disaster, one that threatened -- and ultimately would destroy -- everything Enron had become. A handful of executives were struggling to sound the alarm, but with Enron's confidence in its destiny, the warnings went unheeded.

"We were so sure of what we were doing and where we were going," one executive who attended the San Antonio meeting said. "We didn't know we were living on borrowed time."

Investigators picking through the wreckage of Enron, seeking to understand what caused its collapse in December, have explored its byzantine partnerships and financial strategies. From these details, a clearer picture has begun to emerge about what happened inside the thick walls of Enron during its last 11 months. It is two completely different tales -- the public image, polished by its most senior officers, of an innovative powerhouse on the verge of reshaping the world, and the hidden truth of a company plagued by secrets, whose executives were struggling to hold it together. It was like a gleaming ocean liner seemingly powering forward, its passengers dining in luxury, while, below the waterline, its sweaty crew frantically bails against the force of an in-rushing sea.

By the final days, the sea had won. Attempts by Enron executives to seek a rescue from their powerful friends in Washington and last-ditch efforts to save the company through a merger had ended in failure. When the company finally sought bankruptcy protection, it marked the biggest, fastest corporate collapse in American history.

Details of Enron's last year were pieced together from internal records of the company and its auditor, audio and video tapes, court documents, partnership records, congressional testimony and information from a report by a special committee of the company's board and from interviews with current and former executives, government officials and lawyers involved in the case.

With the speed in which they traveled from confidence to collapse, executives who once thought they could see their futures clearly and who believed in their employer have found their faith fundamentally shaken. "Given the events at Enron, given the short time period in which it happened, given the economic disaster, it fundamentally challenges everything I think about the way companies work," said Allan Sommer, former vice president for corporate systems at Enron. "If Enron was able to hide this the way they did, why couldn't other companies do it, too?"

High Power on Parade

As a chilly rain soaked the streets of Washington on Jan. 20, 2001, the motorcade of President George W. Bush moved past the reviewing stand, near where he had just taken the oath of office. As the new president headed toward Pennsylvania Avenue, the cheers of supporters mixed gamely with the boos of protesters, an aural reminder of the divisions that had split the country during one of its most disputed elections ever.

Nearby, in the exclusive "Pioneers" box on the parade route, Ken Lay watched the festivities. He was there amidst an elite group of about 200 men and women who had each raised $100,000 for Bush's campaign. Nearby, other Enron executives watched the parade from the elegant Willard hotel and office complex, two blocks from the White House, where the company's law firm, Vinson & Elkins, has its Washington office.

It had been a weekend to savor. Enron and its top two executives had kicked in $300,000 for the inauguration, and the company was one of the few to donate $50,000 for the Texas State Society's 2001 Black Tie and Boots Inaugural Ball, where Bush and the first lady stopped by to salute their Texan friends, including Lay.

The day after the inauguration, Lay attended a private luncheon at the White House, where he was able to spend a few minutes with the new president, a luncheon guest said. That night, Enron hosted a private dinner for several congressmen. Lay did not attend, but his second in command, Jeffrey Skilling, did.

Enron's sharp elbows had already been noticed in Washington. Curtis Hebert Jr., then chairman of the Federal Energy Regulatory Commission, had gotten a call from Lay early in the year. As Hebert recalled the incident, Lay said that Enron would continue to support him in his new job if he dropped his reservations about electricity deregulation. Hebert said he had refused. In an interview earlier this year, Lay remembered the events differently, saying that Hebert sought Enron's support at the White House. Either way, the message was clear: Enron, a generous contributor to the Bush campaign, would use its White House access to advance its interests.

Its power base in Houston seemed secure. Its stock price was hovering around $80 a share -- not its high, but not far from it. And on Feb. 5, scores of special bonus checks were cut for Enron executives, who would collect tens of millions of dollars because of the company's strong reported profits.

The mood that same day was far less jubilant in the nearby offices of Arthur Andersen, Enron's outside accounting firm. There, David Duncan and Thomas Bauer -- two of the firm's lead accountants on the Enron account -- joined a group of six colleagues in a conference room for a meeting. Six more Andersen executives were patched in by speakerphone.

For a significant amount of time, according to notes of the meeting, the Andersen accountants debated a critical point: What should they do about two partnerships -- called LJM1 and LJM2 -- that had been set up 18 months earlier by Enron's chief financial officer, Andrew Fastow?

Since mid-1999, Enron had engaged in a score of transactions with the Fastow partnerships. It sold the LJM1 partnership a stake in a Brazilian power project and later purchased it back. It sold the same partnership a stake in any future gains on one of its technology investments, a complex arrangement that allowed it to report a paper profit on the deal.

On its face, this arrangement partly reflected a common financing technique: decreasing the company's risk by moving its holdings into separate partnerships that could be sold to outside investors more willing to assume those risks. And Enron's board, which had approved Fastow's dual role in 1999, had ordered that top management -- Richard Causey, the chief accounting officer; Richard Buy, the chief risk officer; and Skilling -- carefully monitor these deals.

Later, the board's special investigators concluded that these partnerships, and others they spawned, had been twisted at Enron into a tool for making the company seem far more profitable that it really was.

If those allegations are true, there is no sign from the notes of the Feb. 5 meeting at Andersen's Houston office that anyone there knew it. Still, the accountants seemed uncomfortable with the LJM arrangement. To solve that, they drew up a "to do" list, which included suggesting that a special committee of the Enron board be set up to review the fairness of the LJM deals, according to the notes. They also decided to make sure with Enron that LJM met accounting tests that allowed it to be treated as a separate entity, rather than as a subsidiary whose financial results would have to be shown on Enron's books.

The opportunity to cross to-do's off the list came just one week later, Feb. 12. That day, the Enron board's audit and compliance committee held a meeting and both Duncan and Bauer from Andersen attended. At one point, all Enron executives were excused from the room, and the Andersen accountants were asked by directors if they had any concerns they wished to express, documents show.

Subsequent testimony by board members suggests the accountants raised nothing from their to-do list. "There is no evidence of any discussion by either Andersen representative about the problems or concerns they apparently had discussed internally just one week earlier," said the special committee report released earlier this month.

That same day, though, Enron's board approved a big decision: Skilling, long the second in command at Enron, would be taking over as chief executive. Lay would remain as chairman.

In stepping aside, Lay left to Skilling -- whose manner was seen by many as far more abrasive and abrupt -- the delicate task of explaining Enron to its critics. By the time Skilling was named chief executive, the company had become a lightning rod for political outrage over the electric power crisis in California, which was experiencing brownouts and price spikes. Enron's traders bought and sold electric power, and California utility officials were accusing it and other national power companies of manipulating that esoteric market to reap windfall profits at consumers' expense. Enron and other major trading companies denied the accusation, but there were demands for a full-scale investigation.

In late March, a television crew from "Frontline," a news magazine, visited Enron's sleek office towers in Houston as they prepared a documentary on the power crisis. Skilling responded to the company's critics on camera. "We are doing the right thing," he said during an interview in a fishbowl room at the edge of Enron's busy trading floor, where traders were buying kilowatt-hours in one part of the country to sell at higher prices elsewhere. "We are looking to create open, competitive, fair markets. And in open, competitive, fair markets, prices are lower and customers get better service."

He added: "We are the good guys. We are on the side of the angels."

After the interview, as Skilling led the film crew out onto the trading floor, he was asked what his top priority would be as chief executive. His answer came fast: "To get the stock price up," he said.

Few people outside Enron knew how important that single goal was.

Seeking a Quick Fix

What made Enron's stock price so important was the fact that some of the company's most important deals with the partnerships run by Fastow -- deals that allowed Enron to keep hundreds of millions of dollars of potential losses off its books -- were financed, in effect, with Enron stock. Those transactions could fall apart if the stock price fell too far.

Indeed, Enron's contracts with some of these partnerships had provisions called triggers that required Enron's stock price to stay above certain specific levels. If it did not, and if Enron's own credit rating fell, Enron faced a variety of consequences, all of them damaging to its reported profits.

When Enron's stock was trading as high as $90, the stock prices attached to these triggers -- $57.78 a share in one case, $47 a share in another, $28 in a third -- no doubt seemed absurdly low. But as Enron's share price hovered around $70 a share in early March, the risk these trigger provisions would be activated grew. Enron's deals with a quartet of Fastow partnerships known as the Raptors -- deals that were keeping roughly $504 million in red ink off Enron's books -- were especially worrisome.

For months, Enron's accountants had been struggling to keep the Raptors afloat. Like many of the Fastow partnerships, they were financed, directly or indirectly, with Enron stock. They had been formed to assume the risks of future losses on Enron's portfolio of volatile technology stocks so that Enron could erase those risks from its own financial statements.

But under accounting rules, Enron could keep those losses off its books if the Raptors remained financially healthy enough to fulfill their obligations. As the Nasdaq boom in technology stocks fizzled, the losses that the Raptors had promised to cover were ballooning. At the same time, Enron's stock was falling in value, reducing the Raptors' ability to cover those losses. The Raptor structure was in peril, and if it failed, Enron would have had to accept that $504 million write-off.

One reason the Raptors were so shaky may have been the fact that, according to the board report, they had already paid out more than $160 million to Fastow's LJM partnerships, whose investors included Merrill Lynch, J.P. Morgan Chase, Citigroup, the MacArthur Foundation and the Arkansas Teacher Retirement System.

As the March deadline for financial reporting approached, and as Enron's stock continued a slide that brought it below $60 a share, the company's financial experts struggled to find a way to make the Raptors strong enough to meet the accounting tests that allowed Enron to avoid reporting the huge losses. According to the board committee's report, Enron employees said Skilling was "intensely interested" in the Raptor credit problems and called resolving them "one of the company's highest priorities." Skilling disputes that account, insisting that he was only vaguely aware of the credit problems.

Finally, on March 26, just days before the end of the first quarter, the accountants found a way to refinance the Raptors, using a series of complex and fragile transactions that were still vulnerable to further declines in Enron's stock price. The accountants and financial officers celebrated their ingenuity, according to the board report. But they had merely put off the inevitable.

"Especially after the restructuring," the report says, "the Raptors were little more than a highly complex accounting construct that was destined to collapse."

But while this frantic rescue effort was under way, Enron executives put the final touches on a separate deal that allowed some of them to get millions. The same day the Raptor deal was completed, Enron did another deal, this one with a supposedly unrelated partnership named Chewco.

Chewco owned a stake in yet a third Enron-linked partnership, called JEDI, and wanted to sell that stake to Enron. Enron agreed to buy it for $35 million. What few inside Enron -- and almost no one outside Enron -- knew was that Chewco was actually controlled by Michael Kopper, a managing director on Fastow's staff. After all the debts and fees were settled, Kopper and his domestic partner, William Dodson, had gotten about $10 million from their Chewco investment, according to the board's report. Neither Kopper nor Dodson have returned repeated telephone calls seeking comment.

Two weeks later, on April 17, Enron presented its first-quarter results to investors, and the company's executives were positively giddy. With the huge Raptor losses shuffled away, Enron reported $425 million in earnings, another banner quarter.

That day, the company set up a conference call with Wall Street analysts. As they waited on hold for the executives to come on the line, the analysts listened to faint music. Suddenly, an operator broke in, announcing the arrival of Enron's top brass.

"I hope you all heard that music that was on," Skilling announced, according to a tape recording of the conversation. "We're all dancing here. It's pretty good stuff."

For about 15 minutes, Skilling laid out the details of Enron's performance. Nothing was said by any of the Enron executives about the Raptors, the single most important transaction in the quarter.

"So in conclusion, first-quarter results were great," Skilling said. "We are very optimistic about our new businesses and are confident that our record of growth is sustainable for many years to come."

The executives then opened the call for questions and Richard Grubman from Highfields Capital Management was called on to speak. He questioned why Enron did not release its balance sheet, listing its assets and liabilities, at the same time it reported its profits.

Skilling said that was not Enron's policy, but Grubman pressed the issue.

"You're the only financial institution that can't produce a balance sheet or a cash-flow statement with their earnings," Grubman said, at last.

Skilling paused. "Well, thank you very much," he said. "We appreciate it."

Then Skilling turned to his colleagues in Houston, and muttered a vulgarity. The group in Houston laughed; some of the analysts on the line, who had heard everything, were stunned.

Questions of Conflicts

For Jordan Mintz, the 20th floor of Enron's Houston headquarters was a study in dysfunctionality.

After 18 years as a tax attorney, Mintz had been delighted in October 2000, when he had been moved to that floor to work as a lawyer with Fastow's finance division. After two days of orientation, Mintz set to work, finding files upon files of documents detailing the transactions of the Fastow partnerships.

What he saw troubled him. Fastow was negotiating deals on behalf of the partnerships across the table from his own subordinates, who were representing Enron. Approval sheets for those deals had not been signed by Skilling, the chief operating officer, even though they all had a line for his signature. The whole situation seemed fraught with peril.

Mintz sought out Causey, the chief accounting officer, and Buy, the chief risk officer. He told them he wanted to approach Skilling, now the chief executive, about the unsigned approval sheets and also to make sure that he was still comfortable with Fastow's built-in conflicts.

Causey was blunt in his advice. "I wouldn't stick my neck out," he said, according to Mintz's congressional testimony.

Eventually, the three men agreed that Mintz should send a memo to Skilling, diplomatically raising his concerns. So, on May 22, Mintz wrote a confidential memo to the Enron chief executive saying he wanted to bring over the unsigned paperwork for Enron's deals with Fastow's partnerships during the previous year so that Skilling could sign them.

"To that end, I will arrange to get on your schedule to assist you in this regard," Mintz wrote. "Alternatively, I can send such approval sheets to you as a package and you can sign them at your convenience.

Skilling never responded, according to Mintz's testimony.

Increasingly worried, Mintz decided he needed an independent review of the partnership arrangements. So without informing his superiors, he retained, on behalf of the company, an outside law firm -- Fried, Frank, Harris, Shriver & Jacobson from Washington -- to take a look.

In June, he got his answer. The Fried, Frank lawyers raised some questions about the candor of the company's previous public descriptions of the arrangements and made some preliminary recommendations about how to handle such disclosures in the future if Fastow decided to sell his stake to Kopper, as he had indicated he might do. Comforted somewhat, Mintz hoped the sale to Kopper, which went through in July, would make life on the 20th floor a bit less difficult.

To the world outside the Enron tower, of course, the company seemed as powerful and fascinating as ever.

On June 12, Skilling was featured as the final speaker at the Strategic Directions technology conference in Las Vegas, where he planned to share his vision of how Enron was creating a robust trading market in cyberspace. Skilling bounded onto the stage, tieless and in a sports coat. The Internet, he told the crowd, had barely begun to show its usefulness to business. U.S. industry would be transformed by its prowess, and the future of Enron would be found there, he said. "We couldn't do what we're doing now without the technology of the Internet," he said.

After a lengthy speech, Skilling asked for questions from the assembled crowd. One of the last questioners asked Skilling for his thoughts about the power crisis in California, and what the state should have done differently to avoid its problems.

"Oh, I can't help myself," Skilling said, according to the tape. "You know what the difference is between the state of California and the Titanic?"

The crowd laughed appreciatively.

"I know I'm going to regret this," Skilling said, almost to himself.

He looked back at the audience. "At least when the Titanic went down, the lights were on," he said.

State officials reacted in outrage when they heard of Skilling's jest, and the bad relations between California and Enron worsened. Nine days later, Skilling traveled to California, where a protester hit him in the face with a cream pie.

But that public pratfall was minor compared to the damage being inflicted on Enron's stock. By mid-June, its stock price had fallen below $50 a share, alarmingly close to those "trigger" prices that had once seemed so ludicrously remote. One trigger -- at $47 -- was embedded in the Raptor partnerships, which had been propped up so painstakingly in the spring. On Monday, July 23, Enron's stock closed at $46.66. It would never rise above $47 again.

As the stock price fell, the Fastow partnerships that had insulated Enron from losses for years came under increasing pressure, pressure that would ultimately send Enron into a death spiral.

By then, the world inside Enron would seem very different. On Aug. 14, stunning the market, Skilling announced he was resigning after just six months as chief executive, citing undisclosed personal reasons. He left assuring investors that the finances of Enron had never been better.

More Disturbing Questions

"Has Enron become a risky place to work? For those of us who didn't get rich over the last few years, can we afford to stay?"

The words almost leapt off the one-page, unsigned letter to Ken Lay. After Skilling's resignation, Lay had returned as chief executive and had been meeting with employees, encouraging them to write about their concerns anonymously.

But this letter was not some mundane complaint. The writer described in detail problems with Enron's partnerships, problems that the letter claimed would cause huge financial upheavals at the company in as little as a year. "I am incredibly nervous that we will implode in a wave of accounting scandals," the letter's author wrote. "Skilling is resigning for 'personal reasons,' but I think he wasn't having fun, looked down the road and knew this stuff was unfixable and would rather abandon ship now than resign in shame in two years."

Lay took a copy of the letter to Enron general counsel James Derrick Jr., who agreed it needed to be investigated. They decided to assign the task to Vinson & Elkins -- which had helped prepare some of the legal documents for some of the partnerships. Enron wanted answers fast, and told the outside lawyers not to spend time examining the accounting treatment recommended by Arthur Andersen -- although that was the heart of the letter's warnings.

The letter writer soon identified herself as Sherron Watkins, an accountant who had been laid off the previous spring, after eight years, and who had then been rehired in June to work for Fastow. Watkins and Lay made an appointment to talk Aug. 22. Two days earlier, Watkins shared her worries with James Hecker, an Andersen accountant she knew. "Sherron told me that she was concerned about the propriety of accounting for certain related-party transactions," Hecker wrote in a memo to the file the next day.

After Lay met with Watkins, Vinson & Elkins began its investigation. Lawyers from the firm interviewed Fastow, Duncan from Andersen, and other people involved in the transactions.

But even as the lawyers were poking through Fastow's department, his conflicted role in the partnerships continued to create friction. Kopper, who had sold his Chewco assets to Enron so profitably months before, was insisting that Enron cover the $2.6 million tax liability from the sale, according to the board committee report.

Fastow checked with Derrick, Enron's general counsel, and was told "unequivocally" that there was no basis for it to be made, according to the board's report. Nevertheless, Enron's treasury department received orders to cut the check. On Sept. 18, the $2.6 million was sent to Chewco.

"There is credible evidence that Fastow authorized the payment to Chewco," the committee's report says, adding that the payment -- done against the explicit instructions of Enron's general counsel -- was "one of the most serious issues we identified in connection with the Chewco buyout."

Three days later, on Sept. 21, the Vinson & Elkins lawyers investigating Sherron Watkins' warnings reported their findings to Lay and Derrick. There was no reason for concern, the lawyers reported. Everything in Fastow's operation seemed to be on the level. They promised a written report in a matter of weeks.

By then, it would be too late.

The Deals Unravel

By late September, Enron was essentially doomed, although it would be weeks before that reality sank in.

As most of the nation focused on the initial horror and the anguished aftermath of the September terrorist attacks, Lay was trying to reassure his own shaken work force, already stunned by Skilling's abrupt departure and their stock's continuing decline. In e-mail messages and conversations, he assured employees that Enron was strong and that its stock -- for many, the bedrock of their retirement plans -- would rebound.

But that optimistic prospect had actually evaporated, sometime during those weeks, when auditors from Andersen discovered a mistake they had made, more than a year earlier, in Enron's books. The way they accounted for the Enron shares that had been used to finance the Raptor partnerships had incorrectly added $1 billion to the assets on Enron's balance sheet. Correcting the mistake would reduce those assets by $1 billion.

By this point, Lay and his advisers had also decided to dismantle the Raptor arrangements. That meant that the investment losses kept at bay for so long would have to be reported to shareholders. It also meant that an additional $200 million would have to be trimmed from Enron's assets.

On Oct. 15, Vinson & Elkins delivered its report saying no further investigation into the partnerships was necessary. The next day, Enron announced it was deducting $1 billion from its third-quarter earnings, producing its its first quarterly loss.

Jeff Gerth, Richard A. Oppel Jr., Richard W. Stevenson and Don Van Natta Jr. contributed to this article.