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Essentially, Enron as majority owner put no cash into the SEE. A bank
provided, virtually all of the cash, and in reality the so-called 3 percent
independent, controlling investor had very little investednot even close to the
required 3 percent threshold. Nonetheless, Chewco was considered to qualify for
treatment as an arms-length entity for accounting purposes by Enron and its
auditors, Arthur Andersen. Enrons board, and presumably Arthur Andersen, was
kept in the dark.
Kopper invested approximately $115,000 in Chewcos general partner and
approximately $10,000 in its limited partner before transferring his limited
partnership interest to William Dodson [Koppers domestic partner]. 4 The rest of
the $11.5 million$11.4, to be exactwas loaned by Barclays Bank to
Kopper/Dodson, although the original wording was unusual in that it implied that
the monies were for certificates that would generate a yield. 5
Ultimately, Kopper and Dodson created a series of limited partnerships
(LLPs) and limited companies (LLCs) through which to operate their interests, but
Kopper was de facto the managing general partner of Chewco. This meant there
was no outside investor with 3 percent of equity at risk. Moreover, Barclays
asked that $6.6 million be reserved against the $11.4, and the $6.6 million was
pledged/deposited with them, so that the resulting net of $4.8 million did not
satisfy the 3 percent rule for nonconsolidation. According to the Powers Report,
the existence of the $6.6 million reserve was well known at Enron. 6 However, in
Congressional Committee testimony, the CEO of Arthur Andersen stated that
they had reviewed and approved the financial arrangement as qualifying under
the 3 percent rule, and received $80,000 For this advice. 7 The $6.6 million
reserve was created as part of a transfer of $16.6 million from JEDI through
Chewco to two of the limited partnerships controlled by Kopper and Dodson,
namely Big River Funding LLC and Little River Funding LLC.
The entire complicated structure created for the Chewco financing
transaction can be viewed on page 51 of the Powers Report.
The Powers Report goes on to detail several subsequent transactions that
took place before Enron unraveled in late 2001 that appear not to have been in
the best interests of Enron, including:
Management and other fees paid through to Kopper amounted to $2
million for essentially little work, some of which was done by Fastows
wife; most of the rest of the work was on time that Kopper was being paid
as an Enron employee.
The fee for Enron guaranteeing the Bar-clays loan was under that called
for by the market risk assumed.
When it was decided to liquidate JEDI, the buyout of Chewcos interest was
valued at a premium of $1 million by Jeffrey McMahon (then senior vice
president, finance and treasurer of Enron). He told Fastow, who undertook
to negotiate with Kopper, and came back indicating that Skilling had
approved a $10 million payment. 8 Fastow denied this to the Powers
committee but declined to comment on a handwritten note from Kopper
Ultimately, $95 million in lost Rhythms value was offset and Enrons
income was higher as a result. In addition, Enron re-corded profit on the Enron
shares transferred. Unfortunately, LJM1 did not qualify as having 3 percent
invested by an independent, controlling general partner (because Fastow was not
independent), and the Enron stock was paid for by a promissory note, not cash.
Moreover, it became clear that the creditworthiness of the SPE depended upon
the Enron shares transferred, and since the value of Enron shares declined in
2000 and 2001, that creditworthiness was eroded below the level required to pay
Enron its offsets. Enron, it became obvious, was attempting to hedge itself
largely a game of smoke and mirrors in the absence of outside investment to
absorb the economic risk. In spite of these problems, Arthur Andersen and
Enrons law firm, Vinson & Elkins, indicated that the hedge was reasonable, and
that it could go ahead as Fastow and Glisan intended. Ultimately, however, on
reexamination by Arthur Andersen, it was determined (in October 2001) that the
financial statements for 19992001 had to be restated. In November, Enron
announced that it would restate prior period financial statements to reflect the
consolidation retroactive to 1999, which would have the effect of decreasing
Enrons net income by $95 million in 1999 and $8 million in 2000. 12.
The Powers Report describes the Rhythms transaction beginning on page
79, with a diagram on page 81 and a discussion of the hedge beginning on page
82. It is noted on page 83 that the equity of the SPE used for the transaction
(Swap Sub, of which LJM1 owned part) was negative and thus the transaction
could not have qualified for the 3 percent nonconsolidation rule. This sprung
from the fact that: At its formation on June 30, 1999, Swap Sub had negative
equity because its liability (the Rhythms put, valued at $104 million) greatly
exceeded its assets ($3.75 million in cash plus $80 million in restricted Enron
stock).13 This was what Arthur Andersen found upon reexamination in October
2001. Arthur Andersens CEO said:
In evaluating the 3 percent residual equity level required to qualify for nonconsolidation, there were some complex issues concerning the valuation of
various assets and liabilities. When we reviewed this transaction again in
October 2001, we determined that our teams initial judgment that the 3
percent test was met was in error. We promptly told Enron to correct it. 14
Within two weeks after the transaction closed on June 30, 1999, it was
realized that the volatility of earnings had not improved to the degree desired, 15
and four more derivative actions were entered into to make the hedge act more
like a swap. These did not cure the problem sufficiently, and due to the
continuing concern for the erosion of creditworthiness, the decision was made to
liquidate the hedge. In February or March 2000, Vince Kaminski estimated that
there was a 68 percent probability that the structure would default, and he
claims he relayed this to the accounting group. 16
In early March 2000, negotiations to unwind Swap Sub were begun
between Causey and Fastow with Fastow giving the impression that he had no
personal interest in the outcome which he was just negotiating for the limited
partners of LJM1. On March 8, 2000, Enron gave Swap Sub a put on 3.1 million
shares of Enron at $71.31 per share, which was $4.12 over the closing price, thus
conveying approximately $12.8 million in value to Swap Sub. Perhaps this was by
mistake. Subsequently, Fastow proposed that Swap Sub receive $30 million from
Enron for the unwind, and this was agreed to. The unwind was completed per an
agreement dated March 22, 2000, which was not subjected to an independent
fairness examination, nor was the board advised, nor DASH sheets executed.
Arthur Andersen reviewed the deal, but said nothing. Not until later was it
realized that the value ascribed to the shares reacquired by Enron was as
unrestricted shares, and no discounting was employed to reflect that they were
restricted.
As a result, an estimated $70 million more than what was required was
transferred to Swap Sub, and ultimately to Fastow and his associates. 17 In
addition, LJM1 was allowed to retain 3.6 million post-split Enron shares related to
the original transaction, which, on April 28, 2000, had an undiscounted value of
$251 million at closing price.18
Many of Enrons employees were involved in these transactions, but none
were approved to benefit as required by the Enron Code of Conduct, and the
board apparently did not know of their involvement. However, the employees
benefited mightily, as is detailed later.
In May, as noted earlier, McMahon ex-pressed his reservations about Enron
accounting and deals to Fastow and was reassigned. Glisan became the new
treasurer of Enron.
Later, the board reviewed the discussion, and gave their approval. LJM2 was
formed in October 1999, and its general partner was LJM2 Capital Management,
LP. Limited solicitation developed approximately fifty limited partners raising
$394 million including the contributions of the general partner. Again, Fastow
arranged a series of intermediaries as follows: The general partner, LJM2 Capital
Management, LP, itself had a general partner and two limited partners. The
general partner was LJM2 Capital Management, LLC, of which Fastow was the
managing member. The limited partners were Fastow and, at some point after
the creation of LJM2, an entity named Big Doe LLC. Kopper was the managing
member of Big Doe. (In July 2001, Kopper resigned from Enron and purchased
Fastows interest in LJM2.)20