Free Infectious Greed by Frank Partnoy Page A

would seize on as the cause of Enron’s demise. It was called the Joint Energy Development Investments Limited Partnership, or JEDI. Enron’s equal partner in JEDI was the California Public Employees’ Retirement System, known as CalPERS. Enron and CalPERS each invested $250 million, and they shared control.
    As with its other partnerships, Enron excluded JEDI from its financial statements. Again, the well-accepted rationale was that, because Enron controlled only 50 percent of JEDI, accounting rules did not require that Enron consolidate JEDI’s assets and liabilities. Instead, some of JEDI’s numbers were included in a footnote to Enron’s annual report.
    According to efficient-market theory, it shouldn’t have mattered where JEDI appeared in Enron’s annual report. As long as it was disclosed somewhere, the value of JEDI—positive or negative—should
have been reflected in Enron’s stock price. In other words, Enron’s executives didn’t need to feel any qualms about burying JEDI in a footnote, because sophisticated investors would spot the disclosure and buy or sell Enron stock until its price was accurate. Thus, efficient-market theory reinforced a culture of following the bare letter of the law in complex financial transactions. Doing more simply wasn’t necessary.
    For efficient-market theorists, Enron was a poster child: a profitable, flexible, and efficient firm operating in new, unregulated markets. On December 9, 1997, economist Myron Scholes, then at Long-Term Capital Management, delivered a lecture in Stockholm, Sweden, after he received the Alfred Nobel Memorial Prize in Economic Sciences for his work in options pricing. He singled out two companies—General Electric and Enron—as having the ability to outcompete existing financial firms, and noted, “Financial products are becoming so specialized that, for the most part, it would be prohibitively expensive to trade them in organized markets.” According to Scholes, Enron’s trading of unregulated over-the-counter energy derivatives was a new model that someday would replace the organized securities exchanges.
    Enron was every bit as sophisticated and aggressive as General Electric, and both companies were expanding outside the United States during the mid-1990s, just as financial risks were spreading to Mexico, East Asia, and beyond. Enron borrowed billions of dollars to fund overseas ventures ranging from a Brazilian electric plant to a United Kingdom water company. 17 (Ultimately, Enron would lose much of that money.)
    The daisy-chain deals overseas were just as complex as the structured transactions developing in the United States. For example, in 1996, Enron Europe, with the help of Goldman Sachs and J. P. Morgan, sold a stake in a power plant to an entity called Thornbeam, which sold the stake to a Dutch company called Strategic Money Management, which then issued AAA-rated notes, backed by the power plant’s assets, to a leading bank. 18 Andy Fastow also created a complex structured transaction in which Enron used a partnership called Marlin to put money into the Atlantic Water Trust, one of Enron’s many subsidiaries, which in turn invested in Azurix, a subsidiary that owned a majority of the facilities of a United Kingdom water company known as Wessex. In an interview with CFO Magazine, Fastow boasted about the deal: “What we did is we set up a trust, issued Enron Corp. shares into the trust, and then the trust went to the capital markets and raised debt against the shares in the trust, using the shares in the trust as collateral.” 19 In other
words, instead of borrowing money, Enron was using its own shares to pay for its overseas investments, a controversial practice contrary to the spirit of accounting rules, even though it was quite common and, arguably, within the letter of the law. No worries for Enron, though, Fastow assured CFO Magazine ’s readers: