Ex-Workers Say Unit's Earnings Were 'Illusory'
It was run by Lou L. Pai, who sold $353 million in
Enron stock over the last three
years, more than any other
Enron executive, and Thomas E.
White, who left Enron to become
secretary of the Army last June
The New York Times
January 25, 2002
By ALEX BERENSON
A major division of the Enron Corporation
overstated its profits by hundreds
of millions of dollars over the last
three years, and senior Enron
executives were warned almost a
year ago that the division's profits
were illusory, according to several
former employees.
The division, <b?Enron Energy
Services, competed with utilities
to sell electricity and natural gas
to commercial and industrial
customers. It was run by Lou L.
Pai, who sold $353 million in
Enron stock over the last three
years, more than any other
Enron executive, and Thomas E.
White, who left Enron to become
secretary of the Army last June.
Energy Services accounted for a
small part of Enron's revenue but
was promoted by the company as
a big growth opportunity. Unlike
the complex partnerships and
other entities that Enron used to
move debt and losses on outside
investments off its books, this
unit was a real business with
more than 1,000 employees and
customers like J. C. Penney.
But former employees, including
three who were willing to be
identified, suggest that Energy
Services used shoddy accounting
practices to create "illusory
earnings," in the words of Jeff Gray, who joined Enron in
2000 and worked at the division for most of 2001.
For example, by estimating that the price of electricity
would fall in the future, Enron could book an immediate
profit on a contract.
The employees' allegations raise fresh questions about Mr.
White's role at Enron, where he was an executive for 11
years. In a disclosure last May, just before he became
Army secretary, Mr. White reported that he owned more
than $25 million of Enron stock and would be paid $1
million in severance from Enron.
Because he went from the Army to Enron and back to the
Army, Public Citizen and others have voiced concerns
about potential conflicts. While he was at Energy Services,
it sold a $25 million contract to the Army. As secretary, he
said that he would move energy services at bases to
private companies, like Enron.
A spokesman for Mr. White did not return repeated calls
for comment. Mr. Pai, the former chairman, and a
spokesman for Enron also did not return calls. Peggy
Mahoney, a spokeswoman for Energy Services, said the
division's financial results had accurately reflected its
business. "It was no pie in the sky," she said.
Enron created Energy Services in 1997 to take advantage
of the deregulation of electricity markets nationally. It
promised to cut its clients' energy costs by installing
energy- saving equipment and finding cheaper natural gas
and electricity.
Energy Services operated as essentially a freestanding
company, but its results were included in Enron's
financial statements, which were audited by Arthur
Andersen. Energy Services organized itself so that it could
use a financial reporting technique called mark-to-market
accounting, which Mr. Gray and other former employees
said the division had abused to inflate its profits.
Under traditional accounting, companies book profits only
as they deliver the services they have promised to
customers. But Energy Services calculated its profit very
differently. As soon as it signed a contract, it estimated
what its profits would be over the entire term, based on
assumptions about future energy prices, energy use and
even the speed at which different states would deregulate
their electric markets.
Then Energy Services would immediately pay its sales
representatives cash bonuses on those projections and
report the results to investors as profits. By making its
assumptions more optimistic, the division could report
higher profits.
As a result, the sales representatives and senior managers
pressed the managers who made the central assumptions
about deregulation and energy prices, said Glenn
Dickson, a manager at Energy Services who was fired in
December.
"The whole culture was much more sales driven than
anything else," Mr. Dickson said. "The people that were
having to sign off on the deals with a gun to their head
knew that it wasn't a good deal."
Mr. Dickson and other former employees said senior
executives at Energy Services knew that their
assumptions were unreliable. At the same time, expenses
ballooned as Energy Services found that the costs of
managing its contracts were higher than it had projected.
"They knew how to get a product out there, but they
didn't know how to run a business," said Tony Dorazio, a
former product development manager at Energy Services.
In 1999 and 2000, under the leadership of Mr. Pai and
Mr. White, Energy Services would sign almost any deal, a
former employee said. But by the end of 2000, the
executives were no longer paying much attention to daily
operations, Mr. Dickson said.
None of the former employees said they knew whether Mr.
Pai or Mr. White were aware of any accounting lapses at
Energy Services. With Energy Services hemorrhaging cash
in 2000, even as it began to report profits to investors, the
unit began reviewing some of the contacts to determine
whether it had overstated its profits. But publicly, Enron
continued to promote Energy Services' prospects. A year
ago, Jeffrey K. Skilling, Enron's president at the time, told
Wall Street that the division was worth about $20 billion.
"They said at one point they expected it to be as large as
wholesale," said Jeff Dietert, an analyst at Simmons &
Company in Houston. Enron's wholesale trading division,
which bought and sold electricity and natural gas
worldwide, was the source of most of its profits.
The division generated $165 million in operating profit on
$4.6 billion in sales in 2000, in contrast to a loss of $68
million on sales of $1.8 billion in 1999, according to
Enron's 2000 annual report.
Even as Enron promoted the division's potential, it
accelerated its review of the contracts and brought in new
management. By February 2001, Enron had transferred
Mr. Pai out of the division and named David Delaney, who
came from the wholesale business, as its top executive. A
former brigadier general, Mr. White remained until he
became secretary of the Army.
A former employee said that in February or March 2001,
senior managers within Energy Services spoke to Richard
A. Causey, Enron's chief accounting officer, to discuss
potential losses associated with a handful of large
contracts. The potential losses on those deals topped $200
million, the employee said.
About the same time, Mr. Delaney discussed the potential
losses with Mr. Skilling and other top corporate
executives, this employee said.
Sales slowed last year as Mr. Delaney forced the division
to use more conservative and accurate projections when
deciding on a contract, Mr. Dickson said. The move
frustrated some sales representatives, but stemmed
losses, he said.
Although Energy Services publicly reported profits until
Enron collapsed, it continued to lose money last year
because of the unprofitable contracts, employees said.
Margaret Ceconi, a former sales manager, sent a letter in
August to Kenneth L. Lay, then Enron's chairman, saying
that Enron had hidden losses on its contracts by putting
them in the wholesale division.
"It will add up to over $500 million that E.E.S. is losing
and trying to hide in wholesale," Ms. Ceconi wrote in her
letter, which was previously reported in The Houston
Chronicle.
Today, Energy Services is essentially a shell. After filing
for bankruptcy Dec. 2, Enron walked away from many
contracts, an action allowed under bankruptcy rules.
Energy Services' decision to exit so many contracts,
including its largest, a $2.2 billion contract signed only
last year with Owens-Illinois, the giant glass and plastic
maker, is proof of the problems at the division, former
employees said.
"They kept telling me, and I heard it many a time, that it
was a sound business plan," Mr. Dorazio said. "After being
in this business for 21 years, it didn't seem sound to me."
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