Enron's Chairman Received Warning About Accounting
The New York Times
January 15, 2002
By DON VAN NATTA Jr. with ALEX BERENSON
W ASHINGTON, Jan. 14 - A senior Enron
employee explicitly warned the company's
chairman in August that several years of improper
accounting practices threatened to bring down the
company, Congressional investigators said today.
"I am incredibly nervous that we will implode in a
wave of accounting scandals," the employee,
Sherron S. Watkins, wrote in an unsigned seven-
page letter to Kenneth L. Lay, Enron's chairman
and chief executive. Excerpts from the letter were
released today by the House Energy and
Commerce Committee, one of five Congressional
committees investigating Enron's collapse.
The company, which once had a market value of
$70 billion, filed for bankruptcy protection on Dec. 2 after
acknowledging that it
had overstated its profits by nearly $600 million.
The seven-page letter suggests that Mr. Lay had been warned about the company's
accounting problems at a time when he was assuring employees and investors that
Enron's stock would rebound. Disclosure of the letter came as a lawyer for Mr. Lay
said that he had used company stock to repay a loan, raising questions about
whether Mr. Lay shed some holdings as the stock declined.
The letter could also bring significant new problems for Enron; its accounting firm,
Arthur Andersen; and Vinson & Elkins, the company's law firm, at a time when the
Justice Department has dispatched dozens of prosecutors and federal investigators
to Houston, where a federal task force's wide-ranging criminal inquiry will be
based.
The letter from Ms. Watkins, a vice president of corporate
development, was sent to Mr. Lay between Aug. 14, when
the company's chief executive, Jeffrey K. Skilling,
suddenly resigned, and Aug. 31. In an Aug. 21 letter, Mr.
Lay sought to reassure Enron employees that the
company was on solid footing, writing, "One of my highest
priorities is to restore investor confidence in Enron. This
should result in a significantly higher stock price." At the
time, Enron shares were trading at almost $37. By late
November, it was trading as low as 30 cents a share.
After receiving the letter, Mr. Lay asked Vinson & Elkins
to investigate the issues raised in it. But the company
insisted that the law firm limit its investigation to a review
of whether the letter contained new factual information,
not a wider inquiry into whether Enron was properly
accounting for its profits and losses. On Oct. 15, Vinson &
Elkins found that Enron had committed no wrongdoing,
lawyers involved in the matter said.
Ms. Watkins could not be reached for comment today. Her
husband, Richard Watkins, referred phone calls to a
lawyer.
In the letter, Ms. Watkins raised concerns about Enron's
accounting practices and asked whether company
partnerships were being used to hide losses and inflate
the company's stock price. These are among the issues
now being investigated by the Justice Department, the
Securities and Exchange Commission, the Department of
Labor and members of Congress.
Federal investigators are trying to determine whether Enron executives, armed
with inside information about Enron's financial condition, sold their own stock
before the improper accounting methods were publicly disclosed in October.
Thousands of Enron employees, who were barred from selling the stock for six
weeks in the fall, lost vast amounts of their retirement savings.
In her letter, Ms. Watkins expressed anguish about the accounting practices of four
Enron partnerships and the involvement in one deal of the company's former chief
financial officer, Andrew S. Fastow. She also complained to Mr. Lay that several
senior Enron employees had repeatedly raised questions and concerns about
Enron's accounting methods to senior Enron officials, including Mr. Skilling.
Philip H. Hilder, Ms. Watkins's lawyer, said in an interview tonight that Ms.
Watkins worked for Mr. Fastow, who ran two of the partnerships that Enron
allegedly used to inflate its profits, between July and September. After September,
Ms. Watkins "asked to be reassigned," Mr. Hilder said.
He said he did not believe the company retaliated against her for writing the letter.
He would not comment on whether investigators had contacted her.
Excerpts of the letter were released today by Representative Billy Tauzin, the
Louisiana Republican who is chairman of the House Energy and Commerce
Committee, and Representative James C. Greenwood the Pennsylvania Republican
who is the head of the investigations subcommittee.
People who have reviewed the full text of her letter said Ms. Watkins wrote Mr. Lay:
"I have heard one manager-level from the Principal 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.' "
Ken Johnson, a committee spokesman, said today, "Obviously this is an explosive
new development in our investigation that clearly shows that top Enron executives
were warned of serious financial problems months before the company reduced
shareholder equity."
Robert S. Bennett, Enron's Washington lawyer, protested the committee's release
of excerpts from the letter. "I think it's very unfair for committees of Congress who
profess to be conducting fair and objective investigations to be selectively releasing
documents with their spokespeople putting spins on them," he said.
He said Mr. Lay acted "very, very responsibly" and was concerned about the issues
raised by Ms. Watkins and referred them to Enron's outside law firm for
investigation.
Congressional investigators who have reviewed the full text of her letter said Ms.
Watkins began it with two prescient questions: "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?"
She then went on to express deep concerns about the accounting practices used
by Arthur Andersen involving three partnerships by the names of Condor, Raptor
and Whitewing.
Ms. Watkins complained about the opaque structure of the Enron partnerships
that were used to conceal losses. "Is there a way our accounting gurus can unwind
these deals now?" she asked. "I have thought about how to do this, but I keep
bumping into one big problem - we booked the Condor deals in 1999 and 2000,
we enjoyed a wonderfully high stock price, many executives sold stock, we then try
to reverse or fix the deals in 2001 and it's a bit like robbing the bank in one year
and trying to pay back two years later. Nice try, but investors were hurt."
She continued, "They bought at $70 and $80 dollars looking for $210/ share and
now they're at $38 or worse. We are under too much scrutiny and there are
probably one or two disgruntled redeployed employees who know enough about
the funny accounting to get us in trouble." She also includes a page of suggestions
on how to untangle the accounting irregularities.
Vinson & Elkins concluded its inquiry on Oct. 15, just one day before Enron
announced its third quarter earnings and a $1.2 billion reduction in shareholder
equity due to losses later associated with partnerships involving Enron officials.
Ms. Watkins also told Mr. Lay that "several senior Enron employees `consistently
and constantly' questioned the corporation's accounting methods to senior Enron
officials, and directly" to Mr. Skilling, about transactions involving L.J.M., an Enron
partnership.
The House Energy Committee sent letters of inquiry today to Mr. Lay; Arthur
Andersen's managing director, Joseph F. Berardino; and Joseph C. Dilg, the
managing partner of Vinson & Elkins. The committee letters demanded more
information about the way they addressed the concerns raised by Ms. Watkins.
Joe Householder, a spokesman for Vinson & Elkins, which has 860 lawyers in nine
offices worldwide, said lawyers were reviewing the committee's letter. "On this
issue," he said, "we just aren't prepared to comment because we want to review the
letter first."
Today, several Enron officials questioned whether it was proper for Vinson & Elkins
to conduct a supposedly independent inquiry of Enron's accounting practices.
"There are so many Vinson & Elkins lawyers working for Enron that they have
office space in the company's headquarters in Houston for extended periods of
time," said one Enron official, who spoke on condition of anonymity.
A Vinson & Elkins lawyer said the firm was owed more than $5 million when Enron
petitioned for protection last month under Federal bankruptcy law. The lawyer
added that Enron was among the law firm's most lucrative clients.
At some point after the Vinson & Elkins inquiry began, Ms. Watkins met with Mr.
Lay for an hour to express her concerns in person, Congressional investigators
said. They said they did not know exactly when the meeting took place.
Enron admitted in November that it used partnerships like those mentioned in the
letter to overstate its profits by $586 million since 1997. To raise money, the
partnerships, which included both Enron and outside investors, took out loans that
were indirectly guaranteed by Enron.
The partnerships would then buy investments that Enron had made at prices that
enabled Enron to claim the investments had been profitable. But because Enron
had guaranteed most of the money the partnerships had used to buy assets from
it, the company was essentially selling assets to itself.
The L.J.M. partnerships are even more questionable, because they were controlled
by Mr. Fastow, who earned more than $30 million running them. Mr. Fastow
should not have been allowed to work for both Enron and the partnerships, critics
say.
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