Top Enron Corp. executives last fall curbed an in-house investigation into allegations of financial impropriety within the company’s controversial partnership trading program, an accounting scheme that concealed nearly $600 million in losses and eventually caused the energy giant to file for bankruptcy, according to a confidential review by the company’s lawyers.
The 10-page review, obtained Tuesday, was conducted to address Enron Vice President Sherron Watkins’ allegations of accounting and ethical improprieties. Enron instructed the lawyers to avoid “second guessing the accounting advice and treatment” provided by Andersen, according to the law firm’s report.
The review also noted that Enron did not want a “detailed analysis of each and every transaction,” despite complaints by Watkins that the company’s partnership trading scheme might soon “implode in a wave of accounting scandals.”
Dated Oct. 15, the review by the Houston law firm of Vinson & Elkins found that Enron’s board of directors gave its approval to the partnership trading practices and voted to waive the company’s code of ethics to allow a top Enron officer a position within several key partnerships.
That executive, Chief Financial Officer Andrew Fastow, was fired in October after making an estimated $30 million on the partnerships. He is one of several top Enron executives who face criminal and regulatory investigations about Enron’s business practices and the sale of personal stakes of Enron stock in the weeks before bankruptcy.
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While the legal review found no reason for “a further widespread investigation,” it notes that “there is a serious risk of adverse publicity and litigation” that the partnership arrangements might invite.
The company filed for bankruptcy six weeks after the report was delivered. Once an energy and trading powerhouse valued at more than $70 billion, Enron faces criminal and regulatory investigation, as well as the scrutiny of six congressional committees.
The latest inquiry was announced Tuesday, when Sen. Paul Sarbanes (D-Md.), chairman of the Senate Banking Committee, asked the General Accounting Office to study two key issues raised by the Enron failure: defects in the auditing of corporations, and protections for workers’ nest eggs under 401(k) retirement plans.
The Senate Finance Committee also announced it would examine Enron’s use of the tax code, and whether the company used unauthorized shelters to avoid paying taxes.
Employees and shareholders who lost billions of dollars when Enron filed for bankruptcy on Dec. 2 have filed 45 separate lawsuits. Most note that while Enron prevented its employees from selling stock bought through the company retirement plan, top executives sold nearly $1 billion of their own stock in the months leading up to the company’s failure.
Enron’s collapse took on political implications last week when the White House disclosed that the company’s chairman, Kenneth Lay, made calls to administration officials in the weeks leading up to the bankruptcy filing.
The White House said Tuesday that it would not engage in a “fishing expedition” and detail every telephone call or other contact Enron executives had with administration officials before the company collapsed.
White House vows follow-up
“If there’s a suggestion of wrongdoing, we will pursue it,” said Ari Fleischer, President Bush’s spokesman.
“The White House will continue to be helpful and provide information that is relevant, especially if anybody has any allegations of wrongdoing by anybody in the White House,” Fleischer said. “Bring those allegations of wrongdoing forward, and we will examine them.”
Four months before Enron’s bankruptcy filing, Watkins made allegations of wrongdoing through company channels. In a seven-page letter to Lay, Watkins said: “I realize that we have a lot of smart people looking at this and a lot of accountants including AA&Co [Andersen] have blessed the accounting treatment. None of that will protect Enron if these transactions are ever disclosed in the bright light of day.”
Watkins’ letter, which she wrote anonymously but later acknowledged as her own, prompted the Vinson & Elkins review. Later, Watkins met with Lay, “for approximately one hour to express her concerns, and provided him with materials to supplement” her letter, the legal review states.
But company executives decided to limit their look into Watkins’ allegations. Vinson & Elkins notes that its inquiry “would be continued to a determination whether the anonymous letter and supplemental materials raised new factual information that would warrant a broader investigation.”
The lawyers concluded a broader investigation wasn’t necessary.
How letters became public
The full text of Watkins letter was released Tuesday by the House Energy and Commerce Committee, which is investigating Enron’s collapse. It reveals a deeply concerned employee who at once offers advice for how things might be fixed and warns that things might go terribly wrong.
In another section of the letter, Watkins reports how disgusted other employees were with the partnership trading scheme and the accounting practices it employed:
“I have heard one manager-level employee from the principle investments group say, `I know it would be devastating to all of us, but I wish we would get caught. We’re such a crooked company.'”
In particular, Watkins reported to Lay that the gains the company had recognized in trading partnerships it called Raptor, Condor and Whitewing were tumbling with the company’s stock, even though they were, on paper, independent of Enron.
The partnerships, formed by Enron and outside investors, raised capital by taking out loans that were backed up indirectly by Enron. The partnerships then purchased Enron investments at prices favorable to Enron, thus padding the company’s balance sheet.
In her letter Watkins expressed concern about several of the partnerships, including Raptor, that had been capitalized with Enron stock. As Enron stock lost value, so did the partnerships. In the first quarter of 2001, she noted that Enron committed more shares to revive Raptor’s value. She estimated that Raptor would need a third-quarter infusion of $250 million.
Raptor “is thinly capitalized,” she wrote Lay, “with no party at risk except Enron.”
In her letter, Watkins compared the problems at Enron to those that followed Andersen’s audit of Houston-based Waste Management Inc. In that case, Andersen and the waste firm paid $220 million to settle class-action lawsuits, and Andersen reached a $7 million settlement with the Securities and Exchange Commission in which it neither admitted nor denied allegations of fraud.
Ex-CEO’s departure
She also cautioned that the pending, hasty departure of former Enron CEO Jeffrey Skilling would likely raise alarm.
“Skilling is resigning now for `personal reasons,’ but I think he wasn’t having fun, looking down the road, and knew this stuff was unfixable and would rather abandon ship now than resign in shame in two years,” she wrote.
Watkins, who worked for Fastow, Enron’s chief financial officer, offered Lay ways to extricate the company from the financial accounting mess, including a public-relations plan that called for Enron to “quantify, develop damage containment plans and disclose.”
Enron’s attorneys could not be reached for comment Tuesday. Watkins’ lawyer was reluctant to call his client a whistle-blower.
“She made certain things known within the company,” said Philip Hilder. “Some say that’s being a whistle-blower. Some say that’s being responsible. Some say that’s just doing your job.”
Hilder said Watkins worked for Fastow from July until September 2001 as a vice president for corporate development.
Asked if anyone at the company had retaliated against her since her letter to Lay, Hilder replied: “Let me just say that she’s still working there. There has been no retaliation that I’m aware of.”
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Letters raise concerns of ‘smoking gun’ and ‘bad cosmetics’
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THE WHISTLE-BLOWER LETTER
Excerpts from an August letter from Sherron Watkins, Enron vice president of corporate development, to Enron CEO Kenneth Lay.
“Has Enron become a risky place to work? For those of us who didn’t get rich over the last few years, can we afford to stay?…
“I realize that we have had a lot of smart people looking at this and a lot of accountants including AA&Co. have blessed the accounting treatment. None of that will protect Enron if these transactions are ever disclosed in the bright light of day. (Please review the late ’90s problems of Waste Management–where AA paid $130+ mm in litigation re: questionable accounting practices). …
“Raptor looks to be a big bet. If the underlying stocks did well, then no one would be the wiser. If Enron stock did well, the stock issuance to these entities would decline and the transactions would be less noticeable. All has gone against us. The stocks, most notably Hanover, The New Power Co. and Avici are underwater to great or lesser degrees.
“I firmly believe that executive management of the company must have a clear and precise knowledge of these transactions and they must have the transactions reviewed by objective experts in the fields of securities law and accounting. I believe Ken Lay deserves the right to judge for himself what he believes the probabilities of discovery to be and the estimated damages to the company from those discoveries and decide one of two courses of action:
“1. The probability of discovery is low enough and the estimated damage too great; therefore we find a way to quietly and quickly reverse, unwind, write down these positions/transactions.
“2. The probability of discovery is too great, the estimated damage to the company too great; therefore we must quantify, develop damage containment plans and disclose.
“I firmly believe that the probability of discovery significantly increased with Skilling’s shocking departure. Too many people are looking for a smoking gun.”
AA&Co.: Andersen, the accounting firm formerly known as Arthur Andersen
Raptor: A trading partnership created by Enron
Hanover, The New Power Co. and Avici: Hanover and New Power specialize in natural gas services, and Avici provides fiber-optic networking equipment
Skilling: Former Enron CEO Jeffrey Skilling, who stepped down in August after only six months at the helm
A LEGAL RESPONSE
From an October letter from Max Hendrick III, of the Houston law M-^rm Vinson & Elkins, to James V. Derrick Jr., general counsel for Enron.
“Dear Jim:
“You requested that Vinson & Elkins L.L.P. conduct an investigation into certain allegations initially made on an anonymous basis by an employee of Enron Corp. Those allegations question the propriety of Enron’s accounting treatment and public disclosures for certain deconsolidated entities known as Condor or Whitewing and certain transactions with a related party, LJM, and particularly transactions with LJM known as Raptor vehicles….
“Based on the M-^ndings and conclusions set forth with respect to each of the four areas of primary concern discussed above, the facts disclosed through our preliminary investigation do not, in our judgment, warrant a further widespread investigation by independent counsel and auditors.
“Our preliminary investigation, however, leaves us with concern that because of the bad cosmetics involving the LJM entities and Raptor transactions, coupled with the poor performance of the merchant investment assets placed in these vehicles and the decline in the value of Enron stock, there is a serious risk of adverse publicity and litigation. It also appears that because of the inquiries and issues raised by Ms. Watkins, AA will want additional assurances that Enron had no agreement with LJM that LJM would not lose money on transactions with Enron and that Enron paid no fees to LJM in excess of those previously disclosed to AA. Finally, we believe that some response should be provided to Ms. Watkins to assure her that her concerns were thoroughly reviewed, analyzed, and although found not to raise new or undisclosed information, were given serious considerations.”
Condor or Whitewing: Like Raptor, investment vehicles created by Enron
LJM: Investment partner-ships affiliated with Enron
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