THE FALL OF ENRON: Coming Storms
Visionary's Dream Led to Risky Business
Sunday, July 28, 2002
First of five articles
For Vince Kaminski, the in-house risk-management genius, the fall of Enron Corp. began one day in June 1999. His boss told him that Enron President Jeffrey K. Skilling had an urgent task for Kaminski's team of financialanalysts.
A few minutes later, Skilling surprised Kaminski by marching into his office to explain. Enron's investment in a risky Internet start-up called Rhythms NetConnections had jumped $300 million in value. Because of a securities restriction, Enron could not sell the stock immediately. But the company could and did count the paper gain as profit. Now Skilling had a way to hold on to that windfall if the tech boom collapsed and the stock dropped.
Much later, Kaminski would come to see Skilling's command as a turning point, a moment in which the course of modern American business was fundamentally altered. At the time Kaminski found Skilling's idea merely incoherent, the task patently absurd.
When Kaminski took the idea to his team -- world-class mathematicians who used arcane statistical models to analyze risk -- the room exploded in laughter.
The plan was to create a private partnership in the Cayman Islands that would protect -- or hedge -- the Rhythms investment, locking in the gain. Ordinarily, Wall Street firms would provide such insurance, for a fee. But Rhythms was such a risky stock that no company would have touched the deal for a reasonable price. And Enron needed Rhythms: The gain would amount to 30 percent of its profit for the year.
The whole thing was really just an accounting trick. The arrangement would pay Enron to cover any losses if the tech stock dropped. But Skilling proposed to bankroll the partnership with Enron stock. In essence, Enron was insuring itself. The risk was huge, Kaminski immediately realized.
If the stocks of Enron and the tech company fell precipitously at the same time, the hedge would fail and Enron would be left with heavy losses.
The deal was "so stupid that only Andrew Fastow could have come up with it," Kaminski would later say.
In fact, Fastow, Enron's chief financial officer, had come up with the maneuver, with Skilling and others. In an obvious conflict of interest, Fastow would run the partnership, sign up banks and others as investors, and invest in it himself. He stood to make millions quickly, in fees and profits, even if Enron lost money on the deal. He would call it LJM, after his wife and two children.
Stupid or not, Enron did it and kept doing more like it, making riskier and riskier bets. Enron's top executives, who fancied themselves the best of the brightest, the most sophisticated connoisseurs of business risk, finally took on more than they could handle.
Fastow's plan and Skilling's directive would sow seeds of destruction for the nation's largest energy-trading company, setting in motion one of the greatest business scandals in U.S. history.