Beyond Enron

The fate of Andrew Fastow and company casts a harsh light on off-balance-sheet financing.

In the end, Enron was a victim of its own success. Just as it billed itself, it was more of an asset-light investment bank than an industrial company weighed down by tangibles. But exactly as can happen with a bank, once a critical mass of customers stopped trusting Enron’s very name — effectively deeming its once-considerable knowledge capital to be worthless — it was only a matter of days before a sufficient number of others, including Dynegy, followed suit, leaving Enron a nearly empty shell.

The salvage job for what remains promises to take a little longer. Whether or not investors continue to punish off-balance-sheet gimmickry, regulators will doubtless start taking it more seriously. At press time, the Justice Department announced that it had formed a task force to coordinate the various federal investigations into Enron. While that may streamline the process, helping Enron emerge from bankruptcy more quickly, it will also expand the potential scope of prosecution of those responsible — to the level of criminality.

That alone should be a red flag for financial engineers everywhere, even if they haven’t plied their trade as fast and loose as Andy Fastow did.

Hide and Seek

Although credit analysts and the company’s auditor insist that Enron’s true condition caught them by surprise, hints of trouble might have been detected earlier than last October, when the company announced its shocking Q3 2001 results.

Fastow himself told this magazine some two and a half years ago how Enron jumped through hoops to hide the debt associated with the acquisition of three New Jersey power plants from Cogen Technologies in 1999. Said Fastow: “We accessed $1.5 billion in capital but expanded the Enron balance sheet by only $65 million.” Enron, like the overall market, was flying high back then, and as Fastow was the first to admit, “that’s a significant amount of leverage you wouldn’t want on the balance sheet.” (Fastow declined to be interviewed for this article.)

A report last September by investment manager David Tice’s firm cited those remarks. At the time Fastow made them, however, the then-37-year-old graduate of Northwestern University’s Kellogg School of Management also insisted that “we’ve completely segregated these assets, so if something were to happen here, given the high leverage, it would not be able to come back at Enron.” As it turns out, much of this purportedly nonrecourse financing has done just that, and belonged on Enron’s balance sheet from the start.

Fastow, who was appointed CFO in March 1998 after eight years with the company, also suggested to us that there was plenty more of Cogen’s type of financing off Enron’s balance sheet. “We have much more complex transactions as well,” he boasted. But only recently did investors begin to care.

The Dogs That Didn’t Bark

Why did Enron ultimately have to consolidate certain off-balance-sheet subsidiaries? And why didn’t those responsible for overseeing Enron’s activities hold it accountable for not doing so?

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