Monday, July 27, 2009

Enron ... ah, memories

Yes, in discussing yesterday the Tollgrade proxy fight I said that Rhythm NetConnections, a company on the resume of a member of one of the contending boards, had had something-or-other to do with the Enron collapse of 2001, but I couldn't be more specific.

I've now found the specifics. Enron did have a large long equity position in RN, an Englewood-Colo. based tech company. One of Enron's infamous special-purpose entities(SPEs), LJM1, was created specifically to hedge this position out of a (well-founded) concern that RN's price might fall. The arrangement was (typically) Byzantine for Enron. But the general idea was that the SPE, which was itself funded in part by Enron's stock, would agree to compensate Enron if the value of RN's stock declined.

Rebecca Smith and John R. Emshwiller, in their book about Enron, 24 DAYS, related a conversation between Enron's chief risk officer, Rick Buy, and the head of its research group, Vince Kaminski. The story is told on the authority of Kaminski alone -- Buy doesn't remember the conversation (which is rather different of course from denying that it happened).

Anyway, the story goes that Kaminsky looked into the LJM/NC deal and said, "This is so stupid only Andy Fastow could have thought of it."

Fastow was the CFO, and directly in the chain of command above Buy, who was in turn Kaminski's boss. Kaminski thought of him as a lightweight in financial matters, but not until this point as dangerous.

Buy replied by saying that yes, it was Andy's idea, and that Andy was also going to run LJM1 as its general partner. This seemed like an absurdly bad idea to Kaminsky. An SPE is supposed to be an independent entity, or else the company spinning it off is merely (in this case) giving its stock to itself as an accounting trick. For the CFO of the parent company to be the general partner of the SPE makes it clear that is exactly what it was -- at best!

Anyway, Kaminsky expressed roughly that idea to Buy. Buy agreed but said there was nothing he could do about it, and said, "Next time Fastow is going to run a racket, I want to be part of it."

So the rather tenuous connection between RN is that a fear of a drop in RN's sales price set the above machinations into motion, and they contributed to the greater rot in that organization. Interesting, and a nice nostalgic blast, but not really a help to stockholders in Tollgrade I think.

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