Enron was told strategy in Calif. could be illegal
Dec. 12, 2002, 4:40PM
By HARVEY RICE
Copyright 2002 Houston Chronicle
chron.com
SACRAMENTO, Calif. -- Despite a warning the practices could be
considered criminal, Enron energy traders may have kept using
strategies to manipulate the electricity market during California's
energy crisis, according to interviews and documents.
An Oct. 30, 2000, memo written by an outside law firm detailed
the charges Enron and its employees could face. One was wire
fraud, a charge that Timothy Belden, former chief trader for Enron
Power Marketing in Portland, Ore., pleaded guilty to in October.
He is now cooperating with prosecutors.
"If Enron is found to have engaged in deceptive or fraudulent
practices, there is also the risk of other criminal legal theories
such as wire fraud, RICO (racketeering statute), fraud involving
markets and fictitious commodity transactions," the memo reads
in part. "In addition, depending upon the conduct, there may be
the potential for criminal charges prosecuted against both
individuals and the company."
The memo and other documents from federal regulatory
proceedings cast some light on the federal grand jury investigation
in San Francisco that snared Belden.
"It's clear that these same documents are in the hands of both
federal and state investigators," said a source familiar with the
documents.
The eight-page memo by Gary Fergus and Peter Meringolo,
lawyers who then worked for Brobeck, Phleger & Harrison in San
Francisco, was written after the California Public Utility
Commission obtained subpoenas for Enron documents and the
state's attorney general publicly threatened to prosecute Enron
officials.
About a month before the memo was written, Belden had briefed
Fergus and other Enron attorneys on Enron's trading tactics, the
documents show.
On Nov. 4, a team of attorneys again huddled with Belden, Jeffrey
Richter, then head of the short-term trading desk, and John
Forney, then head of the real-time trading desk, according to the
documents.
The traders told the lawyers of the strategies they were using to
exploit anomalies in California's regulatory regime. The following
month, the lawyers then wrote a memo outlining those strategies,
which were given catchy names, such as Death Star, Fat Boy and
Get Shorty.
That memo, by Enron attorney Christian Yoder and then-outside
attorney Stephen Hall, whom Enron later hired, was released
voluntarily by Enron to the Federal Energy Regulatory
Commission, which made it public by putting it on its Web site. It
was the chief reason the federal grand jury was impaneled in
June.
"According to the lawyers, once the memo was written, the traders
were instructed not to use the strategies," said Christian
Schreiber, investigator for the California Senate committee
investigating market abuse during the energy crisis. "We believe it
continued."
He said an analysis of power trades has shown that the strategies
were used until the FERC imposed a price cap on energy sales in
June 2001 -- at least six months after traders were supposedly
told to stop using them.
And Belden, when he entered his plea, stated that the practices
were used in 2001.
Robert McCullough, managing partner of McCullough Research,
said his analysis shows that Enron traders continued to use some
of the strategies into 2001, but were forced to discontinue others
because of the changes in the way regulators scheduled power
transmissions.
"Fat Boy probably lasted to the bitter end," McCullough said. In that maneuver, traders
would schedule more power for transmission the next day than its customers would
need, then sell the unused power at favorable rates when demand exceeded supply.
Erik Saltmarsh, acting executive director of the state Electricity Oversight Board, said his
staff's analysis of electricity movement in 2001 also indicated that Enron continued to
use the practices long after the warning memo was written.
An Enron spokeswoman declined comment. She said the company was cooperating with
all investigations.
Richard Sanders, then Enron's assistant general counsel, testified to Congress that he
ordered a halt to the practices after he learned about them. Sanders and Hall made
similar statements in depositions, but said the order was not issued in writing and they
never verified whether traders had heeded their advice.
A source familiar with the proceedings challenged those assertions: "It made no sense
that they would not have issued an order like that in writing."
Schreiber said the memo outlining the possible criminal charges was sent to Enron
executives. "It was probably seen by the general counsel and probably some of the Enron
board members," Schreiber said.
Neil Egelston, a Washington attorney who represents several former board members, said
the board was not shown the Oct. 30, 2000, memo.
"To the contrary, the board was informed by Enron management at several meetings that
Enron's conduct in California was proper," Egelston said.
Some attorneys believe the FERC documents indicate where the federal grand jury
investigation is headed.
Federal investigators have been mining information from the FERC and California
agencies, which allege that Enron wasn't the only company to manipulate state energy
markets.
If the federal investigation follows the path used by other investigations, prosecutors will
be seeking testimony from Enron employees who worked with Belden and from traders
at other energy companies who are alleged to have used the same questionable
strategies.
At an October news conference to announce Belden's guilty plea, Kevin Ryan, U.S.
attorney for the Northern District of California, said he hoped to use Belden "as a window
into upper levels of Enron management."
Belden's former boss, John Lavorato, then president and chief executive of Enron
Americas, is cooperating with federal investigators but has not yet been asked to testify
before the grand jury, a source close to Lavorato said.
Lavorato reported to then-general counsel for trading Greg Whalley, who has been
questioned by FERC investigators. Whalley reported to Mark Frevert, then a senior
executive at Enron, who reported to then-Chief Executive Officer Jeff Skilling.
Enron officials told Congress that Skilling was not notified of the questionable trading
strategies until June 2001.
Investigators also are interested in Forney and Richter because their trading desks used
the questionable trading strategies, documents show. Forney acknowledged in a FERC
proceeding that he also is cooperating with federal investigators.
FERC documents show that Forney devised a gaming strategy named "Forney's perpetual
loop," which allowed Enron to get paid for power it never moved.
Richter, a math teacher at Humble High School before joining Enron in 1997, took the
Fifth Amendment in response to nearly every question in his deposition.
Attorneys for Forney and Richter could not be reached for comment.
Court documents indicate that the grand jury investigation will cast a wide net that may
drag in other energy companies. In November, the jury issued subpoenas to Dynegy,
Southern Co., AES Corp., Duke Energy, Mirant Corp., Reliant Resources and Williams
Cos.
"The jig is up," said Michael Aguirre, a former federal prosecutor now in private practice
in San Diego who has filed a taxpayer lawsuit against Enron and other energy
companies.
"Where the government casts its net, the nature of the net, the size of the net and
number of the nets indicate that they are now into a major price-fixing case," Aguirre
said. "What they started looking at was market manipulation, then, as they got into it,
they started to see evidence of collusive price-fixing.
"This is the most pervasive illegal activity to hit the United States since mob operations in
New York," Aguirre said. "It's going to lead to the collapse of power companies."
A preliminary FERC investigation asked 130 sellers of wholesale electricity to affirm
under oath whether they had engaged in improper strategies used by Enron.
The FERC report also said that the strategies contributed to California's power crisis,
even when drought conditions and other factors were considered.
"These now infamous trading strategies have adversely affected the confidence of markets
far beyond their dollar impact on spot prices," the report said.
Enron earned about $1.8 billion by trading energy in 2000-2001, the FERC said. Exactly
how much of that came from improper trading strategies is difficult to determine, the
report said.
The FERC estimated, however, that Enron earned $33 million in fees for power
transported along a single line.
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