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Living in a House of Cards

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Meanwhile, after folding Enron International in 1998, Skilling effectively shut down Enron Global Markets group last summer, telling employees that the company wanted to dump its traditional asset base in favor of its trading operations. A former executive with the Global Markets group says that, as far as he could tell, Enron Global Markets was making money for the company, booking almost $80 million in earnings in 2000.

Still, he remembers one incident that makes him wonder how much of that profit was real. Just before Christmas that year, his boss called and said he "needed" another $20 million in the fourth quarter. Because the group marked the value of its assets to market, the executive went back and examined the group's holdings for a plant or a small energy concern that might have been undervalued. When he reported the bad news, his boss told him to look again.

"We had already marked everything that we could based on our accounting policies, which basically stated that you couldn't mark it up to a higher level unless a third party was willing to come in and pay that much," he says. "We did have two companies that were in the early stages of another financing round, and they had term sheets that suggested a higher price could be had at some point. We had no deals yet, but I said, 'I suppose if we took a very aggressive stance, we could say that based on these term sheets, [the financing] is going to happen.' I effectively took $20 million of accounting profits out of 2001 and brought it back into 2000.

"That was the kind of thing that was happening all the time," he continues. "The attitude was: 'The most realistic assessment of the future was whatever made my bonus bigger at year-end. I'm not going to be here in five years anyway when it all comes crashing down, so who cares?' "

The former executive says that however misleading the transaction appeared, it was approved by Arthur Andersen and Enron's chief accounting officer, Richard Causey. Rick Buy, head of Enron's Risk Assessment Group, which signs off on the final valuation of assets for marked-to-market accounting purposes, found nothing objectionable about it either, he recalls.

"It was effectively being forced on us that it was top down, that the accountants were telling us, 'This is the way we want to account for this deal, this is what we're going to do here,' " he says. "It all seemed very strange in certain cases. But, my God, we had all these controls in place and everyone has signed off on it, it must be okay."

It wasn't okay, though, and neither were many similar transactions between Enron and its off-balance-sheet partnerships. According to the Powers committee, while Enron's board of directors relied on Causey and Buy to protect the company's interests, neither "had the necessary time, or spent the necessary time" to scrutinize the transactions closely.

Then again, Buy in particular had a mandate to ignore reality when necessary. Consider this clause from Enron's risk assessment manual: "Reported earnings follow the rules and principles of accounting. The results do not always create measures consistent with underlying economics. However, corporate management's performance is generally measured by accounting income, not underlying economics. Risk management strategies are therefore directed at accounting rather than economic performance."

In his interview with the Powers committee, Lay said he began to prepare Skilling for the CEO position some months before the transfer of power in February 2001. Lay said Skilling "appropriately slowed the flow of information" to his former boss, who remained chairman of the Enron board of directors. Meanwhile, Lay told interviewers, he began focusing on other areas of Enron's business, problems in California in particular.

For Lay and Enron, California was like the entryway to the Garden of Eden, the first substantially deregulated power market in the country. And thanks in large part to Lay's political stroke and largesse -- Enron's officers, directors and employees gave millions in campaign contributions individually and through a political action committee -- it certainly wouldn't be the last. Pennsylvania, New Jersey and Delaware had banded together to create a deregulated market on the East Coast, and two dozen other states, including Texas, were moving toward giving consumers a choice between private energy companies and public utilities.

Enron Online made a mint selling megawatt-hours on the spot market in California, where rates at one point were several hundred times the norm and a series of rolling blackouts darkened areas of the state. Earnings for Enron Wholesale Services increased from $12 billion in the first quarter of 2000 to $48.4 billion during the same three-month period a year later. According to several lawsuits filed last year, however, those profits were the result of price manipulation by Enron and other energy companies, including Reliant and Dynegy.

Enron could never hope to sustain those profits in any event, especially after the Federal Energy Regulatory Commission imposed price caps in California. There was also increased competition from other energy companies whose trading operations were starting to cut into Enron Online's market share. Where Enron had really hoped to distinguish itself in California and elsewhere was in retail power-management contracts.

Enron Energy Services was supposed to be Enron's most promising business unit, the crown jewel of the corporation in the eyes of some. In reality, it was a bust right from the start. The idea was that because of deregulation, the CEOs and CFOs of businesses that consume a lot of energy, such as manufacturing plants, shopping malls and apartment complexes, would look for the best deal on electricity and natural gas. But could they find it? That's where Enron came in. EES would handle everything -- purchasing, delivery, metering and billing -- and guarantee significant savings to boot. This was an extremely appealing offer, says Margaret Ceconi, who negotiated such deals at EES.

Compared to off-balance-sheet financing, Ceconi's experiences at Enron -- which she has shared with the SEC and expects to someday share with the Department of Justice and Congress -- have the dual virtues of simplicity and clarity of intent. And they speak volumes about the company Ken Lay so awkwardly called "one of the best places to work in the world."

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