Enron board aware of deals
Records show directors knew about suspect partnerships
By Robert Manor and Delroy Alexander
Chicago Tribune staff reporters
Published February 13, 2002
Enron Corp. executives repeatedly briefed the company's board of directors about the suspect partnerships and murky accounting that later brought down the energy giant, internal Enron documents show.
Records obtained by the Tribune appear to contradict claims in a recent report commissioned by the board that the directors were passive participants in one of the biggest corporate debacles in history.
Enron's board received detailed presentations from former chief financial officer Andrew Fastow and others about the partnerships that crippled the company, minutes of board meetings show. Moreover, the directors approved many of the practices Fastow used to shift debt off Enron's books, the documents reveal.
At the same time other documents portray Andersen--which audited Enron and certified its financial statements as accurate--as bungling and deeply involved in Enron's questionable accounting.
Together, the documents and the report by Enron's board give the clearest picture yet of the events underlying the company's stunning collapse.
Enron and Andersen have been trading blame in recent weeks, each trying to shift responsibility to the other.
Earlier this month the board's version of events--known as the Powers report after its author, Enron director William Powers Jr.--detailed how Andersen helped Enron organize a series of partnerships to inflate the company's earnings and shield it from losses.
"Andersen did not fulfill its professional responsibilities in connection with its audits of Enron's financial statements," the report says.
But Andersen says Enron's board knew what it was getting into when it approved formation of the partnerships in the late 1990s and is responsible for what happened later. "It is very clear that the Enron board had a full understanding of the risks related to its business decisions," said Patrick Dorton, a spokesman for Andersen.
Minutes of Enron board meetings show Enron's directors were given detailed information about the partnerships. "It's no surprise that the report of the Enron board reaches self-serving conclusions that push blame and responsibility away from the board of directors," Dorton said.
Enron declined to comment for this story. But Powers testified before Congress on Tuesday, and his remarks seemed to acknowledge that the board of directors is more responsible than some at first believed.
"There was a fundamental default of leadership and management," Powers said. The failure began at the top, with former Enron Chairman Ken Lay, ex-Chief Executive Jeffrey Skilling, and "the board of directors," Powers said.
Some observers say both Andersen and the board are responsible for Enron's failure. "There was a culture of impropriety at Enron," said Robert Mittelstaedt, a vice dean at the University of Pennsylvania's Wharton School. "Andersen bought into that culture."
"Andersen was seriously complicit in this failure," Mittelstaedt said. "But you cannot blame this totally on Andersen. The board has responsibility too."
The partnerships
The roots of Enron's disintegration lie in a series of partnerships set up to hide debt and inflate income. When these practices came to light, Enron was driven into bankruptcy.
Although the Powers report indicates the board was told little about the partnerships, minutes of the board meetings appear to show otherwise.
For example, at the December 1997 meeting of the board, a top Andersen auditor explained that Enron was guaranteeing a $383 million loan to buy out one of its partners in Jedi, the earliest of the Enron partnerships.
At the June 1999 meeting of the board, chief financial officer Fastow proposed that he head another partnership, LJM. Fastow was later to earn $30 million in questionable deals between LJM and Enron.
Four top Enron executives at the meeting answered "questions from the directors regarding Mr. Fastow's involvement in the partnership and the economics of the transaction," the minutes say.
While it appears that over the next two years no one told the board that Fastow had grown extremely wealthy from the partnerships, it also appears board members had ample opportunity to ask whether Enron was being cheated.
At an Oct. 11, 1999, meeting of the board's finance committee, Fastow updated the directors about the progress of the partnerships. He asked the board to waive its conflict of interest prohibition so he could continue his financial interest in the partnerships.
Top Enron executives "answered questions from the committee concerning the role of other partners, the review by Arthur Andersen LLP and the benefits to the company," the minutes say. After discussing the partnerships, the committee agreed to suggest to the full board of directors that it waive the conflict of interest rule.
At a board of directors meeting held on Oct. 12, director Herbert Winokur Jr. made a motion to allow Fastow to take a management position with a partnership that would do business with Enron.
Winokur, who helped author the Powers report and conduct its investigation of the suspect partnerships, recused himself during preparation of the report from any role looking into Fastow's conflict of interest, the report says.
Winokur also had business with Enron on the side. In Enron's proxy statements filed with the Securities and Exchange Commission, Winokur disclosed that he has a financial interest in National Tank Co., a supplier of more than $2.5 million worth of oil field equipment, services and spare parts to Enron subsidiaries between 1997 and 2000.
Attorney Neil Eggleston represents 12 of the board's members and strongly defended Winokur. He also played down the significance of the board discussions.
"This is all not news," Eggleston said, adding, "Congress has those minutes."
At the May 2000 meeting of the board's finance committee, Ben Glisan Jr., who was shortly to become Enron's treasurer, gave details about Project Raptor, a new series of partnerships.
"Mr. Glisan stated that Project Raptor involved establishing a risk management program to enable the company to hedge the profit and loss volatility of the company's investments," the minutes say. "Mr. Glisan then discussed Project Raptor's risk."
The committee discussed the issue and then voted to approve Raptor. Ultimately, that decision helped deliver Enron into bankruptcy.
The Raptor hedge
The Raptors were supposed to keep Enron from losing money.
Instead they illustrated poor judgment by Andersen auditors, at least according to the version of events contained in the Powers report.
Enron's investments in the stock of high-tech companies had big paper profits by the late 1990s. In 1999, Enron devised a mechanism it said would protect those profits, using a strategy known as a "hedge."
To hedge its profits, Enron created several investment entities it called Raptors. Enron gave large blocks of stock, much of it Enron's, to the Raptors. In exchange, the Raptors agreed to indemnify Enron from any decline in the value of high-tech stocks Enron owned.
"Accountants from Andersen were closely involved in structuring the Raptors," the Powers report says. "There is abundant evidence that Andersen in fact offered Enron advice at every step, from inception through restructuring and ultimately to terminating the Raptors."
The Raptor strategy would work only if Enron's stock was stable or rose, the report says. If Enron's stock declined far enough, the Raptor would not be able to make good the losses and the hedge would fail.
"The transactions may have looked superficially like economic hedges, but they actually functioned only as accounting hedges," the Powers report says. "Enron was hedging risk with itself," the report says, noting that is impossible to do.
To create the Raptors, the report says, "accountants at Enron and Andersen--including the local engagement team and, apparently, Andersen's national office experts in Chicago--had to surmount numerous obstacles presented by pertinent accounting rules."
Put another way, the Raptor hedges obscured Enron's losses, but offered no insurance to Enron because they were backed only by Enron stock.
"Andersen participated in the structuring and accounting treatment of the Raptor transactions and charged over $1 million for its services, yet it apparently failed to provide the objective accounting judgment that should have prevented these transactions from going forward," the Powers report says.
Then in September 2001, the report says, Enron and Andersen learned they had made a grotesque accounting error.
The accounting treatment for the Raptor transactions had been recorded as an increase in shareholders' equity--the value of the company to people who own its stock--with Andersen's approval. Instead it should have been subtracted from shareholders equity.
In layman's terms, it was like writing a check but recording it as a deposit.
On Nov. 8, 2001, Enron announced a $1.2 billion reduction in the company's shareholder equity.
Not the first accounting error
Andersen defended itself Tuesday, saying that in some cases Enron executives had misled its auditors. In other instances, Andersen said, Enron was blaming auditors for errors made by its own executives. And in some instances, Andersen admitted, its auditors had made mistakes.
In any case, Raptor was not the only accounting disaster at Enron.
In 1997 Enron set up a partnership named Chewco to make investments.
Under accounting rules, the partnership had to include at least a 3 percent equity investment by another party, meaning Enron could not put up more than 97 percent of Chewco's capital. If the 3 percent minimum were to be violated, the partnership's debts and assets would have to be consolidated into Enron's financial reports.
So Enron invited outside investors to put money into Chewco to satisfy the 3 percent rule. Then Chewco borrowed $383 million from two banks to invest. Enron guaranteed repayment of the loans. With Chewco off its books, Enron did not need to report its debt in its financial statements.
It was not until four years later that Enron's accountants finally learned there was not enough outside investment in Chewco--the 3 percent rule had been broken. That meant Enron had to include Chewco in its financial reports.
Andersen had reviewed the formation of Chewco, earning an $80,000 fee. But Andersen somehow missed the problems with Chewco for four years. The report says Enron accountants, not Andersen auditors, discovered Chewco's flaw.
The mistake was a massive blow to Enron.
Last November Enron announced it had overstated its income by $405 million since Chewco was formed, and its debt was nearly $2.6 billion higher than previously reported.
There were other problems with Andersen's work.
Enron and Andersen developed a formula in 1996 by which Enron could report as income the increase in the value of its stock, which was held by partnerships set up by Enron.
A fundamental accounting rule prohibits this tactic, the report says.
Nor was Andersen's advice to Enron consistent, according to the report. When the Enron stock held by the partnerships declined in value, "Enron's internal accountants decided not to record this loss based on discussions with Andersen."
The report accuses Andersen of making some truly elementary mistakes. At some point after 1999, for example, Andersen allegedly gave Enron an accounting analysis based on the wrong price of Enron's stock.
Public corporations are required by law to disclose related-party transactions, like those involving Fastow's roles at Enron and at the partnerships, in proxies and reports filed with the SEC. Enron did disclose that it was involved in large transactions with Fastow, but not much else, the report said.
For example, Enron never explained the purpose of the partnership transactions or that Fastow was making huge sums of money from the deals.
While much of the responsibility for disclosure rests with management of Enron and its lawyers, Andersen was also involved and had a duty to insist on adequate disclosure, the Powers report notes.
"The evidence we have seen suggests Andersen accountants did not function as an effective check on the disclosure approach taken by the company," the report says.
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