Fastow Under Investigation

Enron

Fastow under investigation Jeremy Weinstein examines the indictment of former Enron chief financial officer Andrew Fastow and speculates on his – and the Enron management’s – motives

n October 31, 2002, Andrew Under laptop and desktop computers. It is also success on the part of Fastow and other Fastow, the former chief supervision: apparent from the particulars of the money Enron senior management; and (e) financial officer of Enron, Andrew Fastow is laundering counts that Fastow’s wife, Lea personal enrichment of Fastow and O was indicted on 78 federal driven from the Weingarten Fastow, has personal exposure others at the expense of Enron, its share- counts of money laundering, wire fraud, federal to criminal charges, which may end up as holders and others to whom they owed a securities fraud, conspiracy and obstruc- courthouse a pressure point applied on Fastow in the duty of honest services.” tion of justice. Two months earlier, one of course of the unfolding drama. The means of the schemes included: Fastow’s chief lieutenants, Michael “(a) Enron’s engaging in fraudulent trans- Kopper, had entered into a co-operation Ends and means actions with SPEs; (b) Enron filing mate- agreement with the Department of Justice The indictment states that, starting in rially false and misleading financial and pled guilty to one count of wire fraud 1997, Fastow and others devised statements with the SEC [US regulator for a kickback to Fastow from fees he schemes to defraud, with goals including: the Securities and Exchange Commis- received from a special-purpose entity “(a) falsification of Enron’s reported sion]; (c) Enron’s making false and (SPE) used to manipulate Enron’s finan- financial results so that Enron would misleading public statements about cial statements. appear more successful than it was; (b) Enron’s financial performance; and (d) The indictment makes it clear that artificial manipulation of the share price Fastow’s and others’ taking advantage of Kopper’s co-operation will loom large in of Enron stock; (c) circumvention of their simultaneous control over SPEs and Fastow’s prosecution. For example, the federal regulations so that Enron could Enron’s business operations.” obstruction of justice count alleges that obtain benefits to which it was not enti- Kopper admitted to much of this in

Fastow persuaded Kopper to destroy Photos: Reuters/Popperfoto tled; (d) illusion of business skill and his co-operation agreement. Similar

26 I January 2003 allegations are made in pending SEC including Fastow and former Enron chair- provide that a party holding an AA rating enforcement actions. man Kenneth Lay – intentionally deceived need only post collateral to the extent that Fastow’s indictment includes specific it in order to obtain a BBB+ credit rating the position needed more than a $50 charges that he: for Enron and while lobbying to increase million collateral threshold against it, with that rating. that collateral threshold falling to $15 ● took a kickback from Kopper of fees In fact, an Enron presentation to S&P million for a party holding a BBB+ rating. from an SPE transaction; on January 29, 2000, coquettishly includes Most in the industry set a collateral thresh- ● manipulated reported financial results the following: “Kitchen Sink Disclaimer: old of zero for a counterparty at or below by improperly parking poorly perform- Enron does not recommend using this BBB–, the lowest investment grade. ing deals off-balance-sheet in SPEs; analysis for anything other than illustra- ● manufactured earnings through sham tive purposes and for the purpose of Free credit transactions with SPEs; concluding that the off-balance-sheet obli- One could argue, then, that Enron’s main ● transferred power plants that benefited gations are not material to Enron’s consol- goal in using SPEs to move debt off its from ‘qualified facility’ (QF) special idated credit analysis. Cigarette smoking balance sheet was to fool the credit rating treatment to SPEs without transferring may be harmful to your health.” The pres- agencies to grant it higher ratings than it control away from Enron, thus keeping entation also lists as a “myth” that Enron’s deserved, which it could use to obtain free, the QF status under false pretences “management does not communicate its unsecured lines of credit for the amount of through transactions in which he true financial position to the investor margin it would have had to post as collat- skimmed payments for himself, his community or the rating agencies.” eral were its true credit rating known. With wife, his children and Kopper; and Yet Moody’s, another major credit the false credit rating – as well the false ● improperly inflated the value of rating agency, said its March 2000 increase financial statements in published reports – Enron’s investments by backdating of Enron’s credit rating from Baa2 to Baa1 Enron was able to obtain hundreds of transactions. was based on the misleading and incom- millions of dollars’ worth of free credit plete information it got from Enron. from its trading counterparties, many of The abovementioned sham transactions brought Fastow “continued prestige, salary, bonuses and other benefits from The sham transactions cited in the indictment brought Fastow Enron”, as well as management fees and skimmed-deal profits. continued prestige, salary, bonuses and other benefits from The victims include “Enron and its shareholders”, “the investing public” and, Enron, as well as management fees and skimmed-deal profits in one count, UK bank NatWest. NatWest bankers, believing they were to be laid off in a restructuring, tricked the bank into Trading counterparties rely on credit whom would probably not even have done selling its interest in an SPE at a fraction ratings not only in choosing with whom business with Enron in the first place had of its real value and then split the profits to do business, but also in supplying their they been aware of the company’s true with Fastow’s people. counterparties with trading lines of credit. credit standing. After any trade is entered into, the market That is also why Enron’s loss of its A private matter? will move, and the trade will be profitable, investment-grade credit rating pushed the While the indictment states that Enron’s or not. The financial risk of the other firm into bankruptcy. The downgrade management, including Fastow, used SPEs party’s performance increases as the posi- moved the collateral thresholds on Enron’s to “avoid inclusion of unfavourable infor- tion moves in a party’s favour. Public trading contracts to zero and triggered mation in its reported financial statements, derivatives exchanges do not take on any collateral calls, thus forcing the company thereby presenting itself more attractively of this risk. For example, if a trader were to post the margin it should have been post- to Wall Street analysts, credit rating agen- to buy a crude oil futures contract for ing all along and pay for the credit it had cies and others”, it is noteworthy that the 1,000 barrels on the New York Mercantile until then been getting for free. This is indictment focuses on “public” statements Exchange, for every dollar the market what former Enron president Jeffrey and “reported” results. In other words, not price of oil fell, he would be required to Skilling, in his testimony before Congress, charged as predicate acts in the indictment post $1,000 in margin cash collateral. mischaracterised as a “classic run on the and not listed among the victims of any of However, parties to private, over-the- bank” causing Enron’s downfall. the indictment’s 78 counts are the private counter derivative products, can choose to While waiting for Fastow’s possible statements Enron and its officers made to allow each other leeway with regard to conviction and jail sentence, one hopes the credit rating agencies and the trading posting margin cash collateral, by requir- that prosecuting authorities will examine counterparties with whom it did business. ing it only above a set ‘collateral thresh- how Enron’s management and Enron itself, As US credit rating agency Standard & old’. Such thresholds can be seen as free, as a criminal enterprise, obtained credit Poor’s (S&P) pointed out in March in its unsecured lines of credit and are – in bilat- under false pretences from Enron’s trad- testimony to Congressional committees eral contracts such as the collateral annex ing counterparties, which included feder- investigating Enron, in assigning ratings to to the International Swaps and Deriva- ally insured financial institutions and state public companies, the agencies are often tives Association Master Agreement and and federal government agencies. EPRM given access to non-public information, on the Edison Electric Institute Master Power which they rely in addition to public Purchase and Sale Agreement – set at Jeremy Weinstein is an attorney in Walnut reports when assigning credit ratings. levels tied to a party’s credit rating. Creek, California. S&P says senior Enron executives – For example, the agreement could e-mail: [email protected]