What the Dog Saw

story, under the headline “IS ENRON OVERPRICED?,” ran in March of 2001. More and more journalists and analysts began taking a closer look at Enron, and the stock began to fall. In August, Skilling resigned. Enron’s credit rating was downgraded. Banks became reluctant to lend Enron the money it needed to make its trades. By December, the company had filed for bankruptcy.

Enron’s downfall has been documented so extensively that it is easy to overlook how peculiar it was. Compare Enron, for instance, with Watergate, the prototypical scandal of the 1970s. To expose the White House cover-up, Bob Woodward and Carl Bernstein used a source—Deep Throat—who had access to many secrets, and whose identity had to be concealed. He warned Woodward and Bernstein that their phones might be tapped. When Woodward wanted to meet with Deep Throat, he would move a flowerpot with a red flag in it to the back of his apartment balcony. That evening, he would leave by the back stairs, take multiple taxis to make sure he wasn’t being followed, and meet his source in an underground parking garage at 2 a.m. Here, from All the President’s Men, is Woodward’s climactic encounter with Deep Throat:

“Okay,” he said softly. “This is very serious. You can safely say that fifty people worked for the White House and CRP to play games and spy and sabotage and gather intelligence. Some of it is beyond belief, kicking at the opposition in every imaginable way.”

Deep Throat nodded confirmation as Woodward ran down items on a list of tactics that he and Bernstein had heard were used against the political opposition: bugging, following people, false press leaks, fake letters, cancelling campaign rallies, investigating campaign workers’ private lives, planting spies, stealing documents, planting provocateurs in political demonstrations.

“It’s all in the files,” Deep Throat said. “Justice and the Bureau know about it, even though it wasn’t followed up.”

Woodward was stunned. Fifty people directed by the White House and CRP to destroy the opposition, no holds barred?

Deep Throat nodded.

The White House had been willing to subvert—was that the right word?—the whole electoral process? Had actually gone ahead and tried to do it?

Another nod. Deep Throat looked queasy.

And hired fifty agents to do it?

“You can safely say more than fifty,” Deep Throat said. Then he turned, walked up the ramp and out. It was nearly 6:00 a.m.

Watergate was a classic puzzle: Woodward and Bernstein were searching for a buried secret, and Deep Throat was their guide.

Did Jonathan Weil have a Deep Throat? Not really. He had a friend in the investment-management business with some suspicions about energy-trading companies like Enron, but the friend wasn’t an insider. Nor did Weil’s source direct him to files detailing the clandestine activities of the company. He just told Weil to read a series of public documents that had been prepared and distributed by Enron itself. Woodward met with his secret source in an underground parking garage in the hours before dawn. Weil called up an accounting expert at Michigan State.

When Weil had finished his reporting, he called Enron for comment. “They had their chief accounting officer and six or seven people fly up to Dallas,” Weil says. They met in a conference room at the Journal’s offices. The Enron officials acknowledged that the money they said they earned was virtually all money that they hoped to earn. Weil and the Enron officials then had a long conversation about how certain Enron was about its estimates of future earnings. “They were telling me how brilliant the people who put together their mathematical models were,” Weil says. “These were MIT PhDs. I said, ‘Were your mathematical models last year telling you that the California electricity markets would be going berserk this year? No? Why not?’ They said, ‘Well, this is one of those crazy events.’ It was late September 2000 so I said, ‘Who do you think is going to win? Bush or Gore?’ They said, ‘We don’t know.’ I said, ‘Don’t you think it will make a difference to the market whether you have an environmentalist Democrat in the White House or a Texas oilman?’” It was all very civil. “There was no dispute about the numbers,” Weil went on. “There was only a difference in how you should interpret them.”

Of all the moments in the Enron unraveling, this meeting is surely the strangest. The prosecutor in the Enron case told the jury to send Jeffrey Skilling to prison because Enron had hidden the truth: You’re “entitled to be told what the financial condition of the company is,” the prosecutor had said. But what truth was Enron hiding here? Everything Weil learned for his Enron expose came from Enron, and when he wanted to confirm his numbers, the company’s executives got on a plane and sat down with him in a conference room in Dallas.

Nixon never went to see Woodward and Bernstein at the Washington Post. He hid in the White House.

4.

The second, and perhaps more consequential, problem with Enron’s accounting was its heavy reliance on what are called special-purpose entities, or SPEs.

An SPE works something like this. Your company isn’t doing well; sales are down and you are heavily in debt. If you go to a bank to borrow $100 million, it will probably charge you an extremely high interest rate, if it agrees to lend to you at all. But you’ve got a bundle of oil leases that over the next four or five years are almost certain to bring in $100 million. So you hand them over to a partnership—the SPE—that you have set up with some outside investors. The bank then lends $100 million to the partnership, and the partnership gives the money to you. That bit of financial maneuvering makes a big difference. This kind of transaction did not (at the time) have to be reported in the company’s balance sheet. So a company could raise capital without increasing its indebtedness. And because the bank is almost certain the leases will generate enough money to pay off the loan, it’s willing to lend its money at a much lower interest rate. SPEs have become commonplace in corporate America.

Enron introduced all kinds of twists into the SPE game. It didn’t always put blue- chip assets into the partnerships—like oil leases that would reliably generate income. It sometimes sold off less- than-sterling assets. Nor did it always sell those assets to outsiders, who presumably would raise questions about the value of what they were buying. Enron had its own executives manage these partnerships. And the company would make the deals work—that is, get the partnerships and the banks to play along—by guaranteeing that, if whatever they had to sell declined in value, Enron would make up the difference with its own stock. In other words, Enron didn’t sell parts of itself to an outside entity; it effectively sold parts of itself to itself—a strategy that was not only legally questionable but extraordinarily risky. It was Enron’s tangle of financial obligations to the SPEs that ended up triggering the collapse.

When the prosecution in the Skilling case argued that the company had misled its investors, they were referring, in part, to these SPEs. Enron’s management, the argument went, had an obligation to reveal the extent to which it had staked its financial livelihood on these shadowy side deals. As the Powers Committee, a panel charged with investigating Enron’s demise, noted, the company “failed to achieve a fundamental objective: they did not communicate the essence of the transactions in a sufficiently clear fashion to enable a reader of [Enron’s] financial statements to understand what was going on.” In short, we weren’t told enough.

Here again, though, the lessons of the Enron case aren’t nearly so straightforward. The public became aware of the nature of these SPEs through the reporting of several of Weil’s colleagues at the Wall Street Journal—principally John Emshwiller and Rebecca Smith—starting in the late summer of 2001. And how was Emshwiller tipped off to Enron’s problems? The same way Jonathan Weil and Jim Chanos were: he read what Enron had reported in its own public filings. Here is the description of Emshwiller’s epiphany, as described in Kurt Eichenwald’s Conspiracy of Fools, the definitive history of the Enron debacle. (Note the verb scrounged, which Eichenwald uses to describe how Emshwiller found the relevant Enron documents. What he means by that is downloaded.)

It was section eight, called “Related Party Transactions,” that got John Emshwiller’s juices flowing.

After being assigned to follow the Skilling resignation, Emshwiller had put in a request for an interview, then scrounged up a copy of Enron’s most recent SEC filing in search of any nuggets.