News tonight for the AM: Top Executives Blamed in Enron's Fall
Internal Investigation Details Failure to Supervise Partnerships
By Peter Behr and David S. Hilzenrath
Washington Post Staff Writers
Sunday, February 3, 2002; Page A01
Enron Corp. collapsed last fall because of massive failures by its management, board and outside advisers as well as self-enrichment by some employees "in a culture that appears to have encouraged pushing the limits," according to an internal report released yesterday.
The extraordinary 218-page report by a special committee of the company's board of directors -- filed yesterday with a federal bankruptcy court in New York just as senior Enron executives are preparing to testify before Congress -- found that Enron's rosy picture of financial success from the late 1990s through last summer was essentially a fiction. A handful of top managers covered up nearly $1 billion losses in the 12 months that ended last September, a period during which senior executives sold millions of dollars worth of Enron shares.
The managers created a web of complex outside partnerships that facilitated the "manipulation of Enron's financial statements" and through the partnerships "were enriched by tens of millions of dollars they never should have received," the report said.
Senior officers and the board of directors made a "fundamentally flawed" decision that ultimately led to the collapse of the company, once ranked as the nation's seventh-largest corporation.
The board, on recommendation from chairman Kenneth L. Lay and president Jeffrey Skilling, waived ethics rules in 1999 and allowed Enron's chief financial officer, Andrew Fastow, to head up private partnerships that would buy and sell assets with the company, even while Fastow kept his position at Enron. The board and top executives then neglected to monitor Fastow's activities, or even ask how much he made -- $30 million -- until last October, after media reports.
In one transaction in 2000, Fastow turned one partnership investment of $25,000 into a personal $4.5 million profit in two months. He also brought two other employees into the deal, with each making $1 million off a $5,800 investment in the same period.
The report describes Fastow as the primary creator of Enron's deceptive finances, while criticizing Lay for being inattentive. While Skilling minimized his role, his account is disputed by some other executives.
Fastow's representatives would not discuss his side of the story.However, a former Enron executive in Houston who worked closely with Fastow said: "Andy was really sharp. He got approval for everything he did."
The $1 billion in overstated profits from September 2000 to September 2001 is much more than the $586 million over five years that the once high-flying energy trader reported last November after revealing accounting errors related to some of the partnerships. That announcement triggered a dive in Enron's stock price, costing shareholders and employees billions of dollar and prompting a dozen congressional and federal investigations into the Houston company's demise.
The report released yesterday does not specifically address whether Enron officials violated securities laws. It was prepared under the direction of William Powers Jr., dean of the University of Texas School of Law, who joined the board Oct. 31 after Enron first reported its third-quarter loss and appointed a special investigating committee.
"Enron engaged in transactions that had little economic substance and misstated Enron's financial results, and the disclosures Enron made to its shareholders and the public did not fully or accurately communicate relevant information," the report said. It portrayed Enron officials as determined to disclose as little as possible about the partnerships. Fastow, in particular, wanted to avoid disclosing his millions of dollars in fees from the LJM deal in the annual proxy statement, the report said.
"That impulse to avoid public exposure, coupled with the significance of the transactions for Enron's income statements and balance sheets, should have raised red flags for senior management, as well as for Enron's outside auditors and lawyers. Unfortunately, it apparently did not," the report said.
"The tragic consequences" of mishandling the partnerships "were the result of failures at many levels and by many people: a flawed idea, self-enrichment by employees, inadequately-designed controls, poor implementation, inattentive oversight, simple (and not so simple) accounting mistakes, and overreaching in a culture that appears to have encouraged pushing the limits," the report concluded.
It assessed blame on many:
• Enron founder and longtime chief executive Lay was "the captain of the ship," but he did not ensure that those who reported to him were performing their oversight duties properly. He acted more as a director than a member of management and bears "significant responsibility" for permitting the company's chief financial officer to profit from the partnerships. Lay resigned last month on the insistence of Enron's creditors.
• Jeffrey Skilling, who had been president and was chief executive for six months before resigning last August, bears "substantial responsibility" for the failure to monitor dealings between Enron and the partnerships. He urged the board to approve the arrangement with Fastow, the report said. Other Enron employees accuse Skilling of approving a partnership transaction last March that was designed to conceal large operating losses from the board. Skilling denies that charge.
• The board of directors, which waived Enron's conflict-of-interest rules to allow Fastow to run the partnerships, called LJM and Chewco, "failed . . . in its oversight duties." Though it set up procedures to monitor Fastow's compensation, board members never followed up.
Enron's outside auditor, Arthur Andersen LLP, "did not fulfill its professional responsibilities" in its auditing work, the report said. It noted that Andersen was paid $5.7 million specifically to review and approve the setup of the partnerships that led to Enron's downfall.
The company's outside law firm, Vinson & Elkins, "should have brought a stronger, more objective and more critical voice" to its review of Enron's required disclosures to investors about the convoluted partnership transactions and Fastow's role in them, the report said.
William McLucas, former head of enforcement at the Securities and Exchange Commission; his law firm, Wilmer, Cutler & Pickering; and the accounting firm Deloitte & Touche did the investigative work for the special committee.
The report said Fastow, Michael J. Kopper, a Fastow aide who made $10 million from the partnerships, and Ben F. Glisan Jr., an Enron accountant who later became the company treasurer, declined to be interviewed.
Many of those criticized in the report could not be reached for comment last night. Lay is scheduled to testify before a Senate committee tomorrow. Skilling and Fastow are supposed to appear before a House committee Thursday.
Enron lawyer Robert Bennett said the report shows "that while there is certainly criticism to go around or blame to go around . . . it's very clear that a great deal of information was not provided to the board." Bennett said Enron "did an honorable job in investigating its own problems and publicly releasing a report about them."
Neil W. Eggleston, a lawyer for Enron's outside directors, said the board "was advised by management and its outside auditor that these transactions were appropriately accounted for, and the board relied on that advice."
Andersen spokesman Charlie Leonard dismissed the report's findings, noting that the authors were "hand-chosen by the Enron board and their conclusions appear to be very self-serving."
"The report fails to make clear that all of these partnerships were business decisions conceived of and initiated by Enron and the economic consequences of those business decisions rest with Enron and not its auditors," Leonard said.
He also said Andersen failed to receive critical information from Enron on the Chewco partnership, which was responsible for 80 percent of the earnings restatement. "We attempted to speak with them, and they didn't speak with us," he said.
A spokesman for Vinson & Elkins said: "We are confident that when all the facts are known about the role we played, it will be seen that we met our professional obligation."
The committee's criticism of Enron's top management centers primarily on Skilling's failure to oversee the LJM partnership deals. Enron used the LJM partnerships as depositories for assets it wanted to get off its books, especially near ends of quarters, the report said.
While that by itself was not improper, it said, there are "substantial questions" about whether the sales were legitimate.
Five of the seven assets sold to the LJM partnerships in the second half of 1999 were quickly repurchased by Enron. The partnerships made a profit on every transaction, even when the assets involved had declined in value.
There is "some evidence" that Enron agreed to protect the partnerships against losses on three assets that it later repurchased from LJM. And, the report said, Fastow claimed that the deals generated profits for Enron of $229 million -- about 40 percent of Enron's pre-tax profit for that six-month period.
On the transactions in which Enron remained exposed to the assets' losses, "the LJM partnerships functioned as a vehicle to accommodate Enron in the management of its reported financial results," the report said.
The LJM partnerships and a related group of private investment entities called Raptor presented a deeply troubling issue to Enron , the committee's report said.
The entities were created to enter into complex financial deals with Enron designed to protect the company against a drop in the value of various Enron assets and properties. If the transactions had truly been at arm's length, they might have been justified, but Enron, through Fastow, controlled LJM and the Raptor entities. He had committed Enron's stock to guarantee repayment of LJM's outside investors.
The steep fall in Enron's stock price that began a year ago doomed that strategy. With no offsetting gains from the LJM deals, Enron faced a potential $500 million loss from its energy operations that would have had to be disclosed in March 2001. Enron hid the problem through other Raptor transactions without notifying its directors, the committee said. Finally, last October, Enron's share price had dropped so low that losses had to be disclosed.
The committee concluded that Lay did not appear to have any managerial responsibilities for the LJM partnerships. His role was the same as that of other Enron directors, who relied on company officials to make sure the LJM and Raptor transactions were properly handled.
Skilling was charged by the board to oversee the transactions, but appears to have been "almost entirely uninvolved" in their oversight. His signature is missing from many of the LJM deal documents, the committee said.
In March 2000, Enron's treasurer, Jeffrey McMahon, said he complained about the LJM deals to Skilling, warning of the serious conflict of interest resulting from Fastow's role.
Skilling told the committee that he does not remember the conversation that way and recalls only a discussion of McMahon's compensation. The committee concluded that even if Skilling's version is right, there was enough cause for him to seek the facts and act to protect Enron.
"Neither Skilling nor McMahon raised the issue with Lay or the board," the report said.
Staff writer Jackie Spinner contributed to this report. The full text of the Enron report is on www.washingtonpost.com
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