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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 h
ave 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 Oct
ober, 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 $5,80
0 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 error
s 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 t
he 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 j
oined 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 t
he 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 outsid
e 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, i
nattentive 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 memb
er 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 th
e 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 Fast
ow'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 transac
tions 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 committ
ee.
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 Thurs
day.
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," L
eonard 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 le
ngth, 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 di
sclosed.
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 LJ
M 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 c
ause 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
� 2002 The Washington Post Company
End<{{{
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