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The Fastow Challenge


Ross M. Miller
Miller Risk Advisors
June 1, 2004

This Memorial Day commentary was originally inspired by Memorial Day itself. Apparently, most people have forgotten what Memorial Day is really about. For some, it is a retailing event; for others, the beginning of the summer movie season. (The original title for this piece, "Open Your Eyes," was taken from the English translation of the title of the Spanish film that Cameron Crowe turned into "Vanilla Sky.") After several failed attempts at writing something about the virtues of awareness and mindfulness—they all came out way too preachy and the more I thought about it, the more I realized that my wealthiest and happiest friends tended to be the most clueless—I thought I'd take a different tack. The new name for this piece is "The Fastow Challenge."

I once worked at a company—let's call it General Electric for lack of a better name—that officially encouraged outside-of-the-box thinking and, from what their big ad campaign says, it still does. I worked at GE's central research laboratory and so I had numerous opportunities to interact with people throughout the company. Sometimes folks from the company would come up to visit the lab so they could go to strip clubs where no one knew them and sometimes we would go visit them (where, unfortunately, we were known.). When it would come time for us pocket-protector types to tell them what we could do to help them out, their most common retort was, "We've tried that already and it didn't work." I found that to be amusing given that the technology that was being pitched to them would not exist until someone ponied up the money so that we could invent it. These folks were deeply inside their own boxes and what they had tried that "didn't work" was venturing outside.

I quickly learned that my role as an outside-the-box thinker was to find things that were hiding, often in plain sight, in people's own boxes. It was virtually hopeless to get them out of their boxes (any parent of teenagers can tell you about that problem), but I could make them live happier lives without moving them. (The rare person in the company who I did manage to get out of his box would be devoured by coyotes almost immediately, so I stopped doing that.)

I thought that everyone lived in his or her own box—some larger, some smaller—until February of 2002 when I was watching the Congressional testimony about the Powers committee report on C-SPAN. The report was written by Enron's board of directors and attempted to explain what went wrong at Enron. When I saw the discussion of a deal known as "Rhythms NetConnections," it was like encountering life from another planet. As a consultant, I had been involved in putting together dozens of special-purpose vehicles, but I could never conceive of anything like what Enron had done with Rhythms.

The Rhythms deal was Enron's solution to a problem it faced in the middle of 1999 at the peak of the dotcom bubble. It had booked profits on 5.4 million shares of Rhythms NetConnections stock that it owned, but faced the prospect of sizeable losses in future quarters if the stock declined in value. Enron was "locked in" to holding the stock until the end of the year and buying insurance (in the form of put options) to protect itself against such a decline was not viable. The Rhythms deal was Enron's way of using a special-purpose vehicle to sell the put options to itself. (Yes, you read that correctly.) Of course, such a deal required capital to back it, so Enron funded the special-purpose vehicle with shares of Enron stock. (Yes, you read that correctly, too.) The architect of this deal was Andy Fastow, Enron's CFO. I can assure you that he did not learn how to do this in business school, at least not in any business school on this planet.

The beauty of this deal is that since no one had ever seriously conceived of anything like this, there was no specific law against doing it and so it was probably legal. At least that is what Enron's accountants and lawyers thought. (Arthur Andersen was put out of business for covering up its activities, not for approving this kind of deal, and Enron's lawyers still ply their trade.) Although Fastow had come up with something that was outside of everyone's box, his deal had a fatal flaw unrelated to the basic idea of Enron selling itself insurance. He cut himself, his wife, and his subordinates in on a big piece of the action and failed to secure all of the proper waivers from Enron's board. (Jeff Skilling even had the good sense not to sign off on the special-purpose vehicles that made these deals, making one wonder how they ever closed.) As a result, Andy will soon find himself inside a box not of his own making.

Through stupidity, brilliance, or most likely a rare combination of the two, Andy Fastow has set the standard for financial creativity. The various other financial scandals that percolate though the press are garden-variety frauds—changing numbers or putting them in the wrong place—that any fool could have perpetrated. The intellectual challenge to come up with a scheme that approaches this level of brilliant stupidity or stupid brilliance is what I will dub "the Fastow Challenge."

To take the Fastow Challenge in real life risks incurring burdensome legal bills in the best case and ending up in the box next to Andy's in the worst. Hence, my entry to the challenge is purely fictional and is contained within a novel that I have written entitled Rigged. This novel revolves around a scandal-in-the-making at a Boston mutual-fund company (The Lowell Group) that was recently acquired by an international conglomerate (GFF, the present-day version of Kurt Vonnegut's General Forge and Foundry, which was his fictionalization of General Electric). The story is told in the first-person by a game-theorist-turned-professional-gambler known only as Doc who runs a secret laboratory that has been cleverly hidden from the budget axe of GFF's CEO, "Megaton Mike" Quinn.

I would tell you more, but you can read the novel for yourself soon enough. The first chapter of Rigged will be making its sneak preview at next Monday (June 7). The second chapter follows on Monday (June 14) and the third on Thursday (June 17). New chapters will appear every Monday and Thursday mornings before the U.S. financial markets open throughout the summer, with the final chapter arriving just before Labor Day. You may want to think of it as summer reading for the short-attention-span crowd. And it costs absolutely nothing. All I ask is that if you pass the link to on to your friends if you like it and to your enemies if you don't.

As I get the remaining kinks out of the website, it will feature my real-life enactment of the theatre of the absurd (complete with photographic documentation) entitled "Casing Wal-Mart." This story, which goes inside a Krispy Kreme donut box, is only tangentially related to Rigged, where donuts make a cameo appearance.

Rigged itself lies very much outside the box as far as the publishing industry is concerned. For one thing, no is one murdered. I know how the formula works—the protagonist's wife or best friend or personal trainer dies in a mysterious and spectacular manner and so he has to unravel some incredible financial swindle that takes him to a secret cabal in Zurich in order to find the murderer and save his own life. Yada, yada, yada.

And then there's sex. An agent at the literary agent that represents Supreme Court Justice Clarence Thomas wrote in her opinion of the book that there's not nearly enough sex and that whatever sex there is, is not explicit enough. (I can't wait to see Clarence's memoirs.) I am saving the good sex for one of Rigged's many sequels by which time I will have gone to the University of Iowa to attend their erotica workshop.

Still, I can assure you that my small army of test-readers found an earlier version of the novel most enjoyable (if somewhat perverse) and they have provided me with lots of feedback on how to make it even more enjoyable (and less perverse), many of which I have ignored. (Hey, I live in my own box.)

Even with summer unofficially here, the commentaries will continue until I can use a vacation from them. Next week's is called "Bull for President and Other Tales." It looks at why the stock market should not care who wins the Presidential election. Assuming that I am right and the May employment figures come in soft this Friday, it will also discuss how Bill Gross and the Hoarders (tour dates and venues to be announced) will keep the Fed from hiking rates later this month; otherwise, I'll find something else to write about.

Copyright 2004 by Miller Risk Advisors. Permission granted to forward by electronic means and to excerpt or broadcast 250 words or less provided a citation is made to