Ex-Workers Say Unit's Earnings Were 'Illusory'
By ALEX BERENSON
The New York Times
January 25, 2002
A major division of the Enron Corporation (news/quote) 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, 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." |
