Enron's Problems Go Way Beyond Its CFO

This article originally appeared on Oct. 24, 2001.

Enron's (ENE) problems won't go out the door with Andrew Fastow.

The finance chief, who was replaced Wednesday, came under scrutiny as the executive who orchestrated and profited from a hedging deal that went sour, saddling Enron with a $1.2 billion charge to equity. As details of this deal and others have emerged over the past two weeks, Enron stock has collapsed, falling 54% in just seven days.

Wednesday, the stock fell a further 17% on enormous volume, signifying that once-faithful mutual fund holders were bailing. Also Wednesday, a raft of once-friendly analysts downgraded the stock. Faced with betrayal on that scale, Enron management at last felt compelled to act; a press release says Fastow is taking a leave of absence. He's been replaced by Jeffrey McMahon, formerly CEO of Enron's industrial markets group.

How might the Enron bulls spin this? Likely, they will point to McMahon's alleged opposition to Fastow's role in the big hedging deal, called LJM2, to show that the "Fastow era" is over. The Wall Street Journal, citing anonymous sources, reported Tuesday that as treasurer at Enron McMahon complained about Fastow's possible conflict of interest. Probably, the fear was that Fastow couldn't serve Enron and LJM2 equally, especially as he was allegedly making a lot of money from LJM2.

Clearly, if McMahon turns out to be a new broom, that's a positive for Enron. An Enron spokeswoman declined to comment on whether The Journal's account of McMahon's stance on LJM2 was correct.

Not much else is encouraging, however. Fastow's departure shows that it took massive drops in Enron stock to force senior management into action. On a difficult conference call Tuesday, CEO Ken Lay gave Fastow resounding backing. It took Wednesday's plunge to get Lay to sign off on a new CFO. In other words, Lay listens only when the market screams and hollers. How much further does the stock have to fall to bring further much-needed reforms at the company?

The spokeswoman responds that Lay had discussions with analysts Tuesday and Wednesday that led him to the conclusion that Fastow's replacement was necessary to rebuild investor confidence.

Plunging Investors not liking Enron here

Enron culture is thick with financial sorcery. People got upset by one shadowy deal, but no one knows exactly how the company's core energy trading business makes money. It's hard to believe the LJM2 deals were done in isolation and without the knowledge of the board.

In fact, the chatter is that Fastow and former CEO Jeff Skilling proposed the LJM2 transactions to the board after it was reluctant to enter the broadband business. The board apparently feared the volatility that might come from being in broadband, so Fastow allegedly proposed LJM2 as a way to hedge that volatility away. This meant LJM2 entered agreements that gave it access to increases in the value of broadband assets but protected Enron from the downside. Should the whole board be on the hook, too? The spokeswoman responds that the board would not have entered the LJM2 transaction if it had not thought it would benefit Enron and its shareholders.

Lay has shown himself to be woefully out of touch with the market's views. Arguably, that's downright reckless for a trading company that is dependent on potentially skittish short-term financing. Letting things get this bad has risked good faith among Enron counterparties and bankers. It shows an unhealthy reluctance to address key problems until they're unavoidable. The spokeswoman responds that the company is now working hard to improve transparency.

Any efforts in that direction will be much appreciated, but is it any wonder people compare this lot to Long Term Capital Management?

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