Who Killed Enron

And it was in those too-clever-by-half financial structures that Enron sowed the seeds of its undoing. Before we proceed to the story of Enron's final days, let's get out our trusty lightsabers and take an accounting trip, one made more lively by some Enron financial techie's fondness for "Star Wars."

Our case involves something called JEDI, as in Jedi knight. JEDI stands for Joint Energy Development Investments, which was an investment partnership between Enron and the California Public Employees Retirement System, known as Calpers. Enron and Calpers invested $250 million each into the partnership in 1993. JEDI prospered--the Force must have been with it--as Enron deftly bought and sold energy stocks, power plants and other investments, earning a 23 percent annual return for Calpers. Very nice. So Calpers welcomed Enron's offer in late 1997 to do a sequel. They ramped up JEDI II, with each side putting up $500 million. But first, Calpers wanted to cash in its JEDI I stake, worth $383 million. Enron obliged. Instead of liquidating the partnership, Enron went looking for someone to ante up $383 million to take Calpers's place. That would keep JEDI I off Enron's balance sheet and its profit-and-loss statement. Making JEDI I part of Enron would have cut the company's reported profits sharply, and increased its reported debt by more than $500 million.

To solve this problem, Enron ginned up Chewco Investments--as in Chewbacca the Wookiee. Chewco was a partnership of Enron executives and some undisclosed outsiders. Chewco didn't have $383 million sitting around. So Enron lent it $132 million and guaranteed a $240 million loan. This left about $11.5 million for Chewco to come up with. Not a whole lot, given the size of the deal. But $11.5 million was an important number. Why? Because it was more than 3 percent of Chewco's capital. And what's magical about that number? Clearly you're not an accountant. If outsiders put up at least 3 percent of the capital, accountants are allowed to keep the deal off the parent company's books. But Enron couldn't even get this right. It turns out that Enron had provided collateral for about half of Chewco's $11.5 million investment. This meant Chewco had only about 1.5 percent at risk, not 3 percent. So JEDI and Chewco should have been treated as part of Enron by Arthur Andersen from late 1997 on. But they weren't. In congressional testimony last month, Andersen chief executive Joseph Berardino admitted the accounting was wrong, but said it wasn't Andersen's fault because no one told his firm about the collateral Enron had provided. What Berardino didn't say then (and he wouldn't talk to us) is that even if Chewco had met the 3 percent rule, the result would still be outrageously misleading. Keeping JEDI and Chewco off the books inflated Enron's 1997 profits by 75 percent. And the move inflated profits for three more years, for a total of $396 million. Did keeping JEDI and Chewco off Enron's books when their impact was so great "present fairly" Enron's financial situation, as Andersen certified? Not to me. But I'm only an English major.

Now, to the death spiral. Enron had started 2001 in great shape. Its stock was $83, close to its previous high of $90. CEO Jeff Skilling said in January that the stock was really worth $126. But rather than heading north, Enron stock started falling as the year wore on. The continuous decline in Internet and telecom issues helped drag it down, as did falling natural-gas prices. What some Enron insiders knew--but outsiders didn't--is that the falling stock price was going to cause trouble, big time. That's because Enron was going to have to fork over lots of money, or give ruinous amounts of stock, to institutions that had lent billions to Enron's off-balance-sheet entities. The commitment to provide that stock made the off-balance-sheet entities creditworthy, because it reassured lenders about getting their money back.

Skilling quit unexpectedly in August, triggering speculation that something was amiss (he said he wanted to spend more time with his family). Skilling wouldn't talk to NEWSWEEK, but his spokesman said that Skilling "left believing the company was in very good shape." Asked if Skilling felt any responsibility for Enron's failure, his spokesman said he believes that "what happened to Enron is a tragedy. He does not understand the reasons for it."

The reasons, actually, are sort of obvious. The end began on Oct. 16, when Enron held a conference call to discuss its third-quarter profits. Or, more accurately, losses. Buried in its release was the fact that Enron's net worth had mysteriously shrunk by $1.2 billion. That was because of a complex off-balance-sheet deal involving four partnerships called Raptor, but Enron didn't explain that.