[Senate Hearing 107-511]
[From the U.S. Government Publishing Office]



                                                        S. Hrg. 107-511
 
         THE ROLE OF THE BOARD OF DIRECTORS IN ENRON'S COLLAPSE
=======================================================================



                                HEARING

                               before the


                PERMANENT SUBCOMMITTEE OF INVESTIGATIONS

                                 of the

                              COMMITTEE ON
                          GOVERNMENTAL AFFAIRS
                          UNITED STATES SENATE

                      ONE HUNDRED SEVENTH CONGRESS

                             SECOND SESSION

                               __________

                              MAY 7, 2002

                               __________

      Printed for the use of the Committee on Governmental Affairs








                        U.S. GOVERNMENT PRINTING OFFICE
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_____________________________________________________________________________
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                   COMMITTEE ON GOVERNMENTAL AFFAIRS

               JOSEPH I. LIEBERMAN, Connecticut, Chairman
CARL LEVIN, Michigan                 FRED THOMPSON, Tennessee
DANIEL K. AKAKA, Hawaii              TED STEVENS, Alaska
RICHARD J. DURBIN, Illinois          SUSAN M. COLLINS, Maine
ROBERT G. TORRICELLI, New Jersey     GEORGE V. VOINOVICH, Ohio
MAX CLELAND, Georgia                 THAD COCHRAN, Mississippi
THOMAS R. CARPER, Delaware           ROBERT F. BENNETT, Utah
JEAN CARNAHAN, Missouri              JIM BUNNING, Kentucky
MARK DAYTON, Minnesota               PETER G. FITZGERALD, Illinois
           Joyce A. Rechtschaffen, Staff Director and Counsel
              Richard A. Hertling, Minority Staff Director
                     Darla D. Cassell, Chief Clerk

                                 ------                                

                PERMANENT SUBCOMMITTEE ON INVESTIGATIONS

                     CARL LEVIN, Michigan, Chairman
DANIEL K. AKAKA, Hawaii,             SUSAN M. COLLINS, Maine
RICHARD J. DURBIN, Illinois          TED STEVENS, Alaska
ROBERT G. TORRICELLI, New Jersey     GEORGE V. VOINOVICH, Ohio
MAX CLELAND, Georgia                 THAD COCHRAN, Mississippi
THOMAS R. CARPER, Delaware           ROBERT F. BENNETT, Utah
JEAN CARNAHAN, Missouri              JIM BUNNING, Kentucky
MARK DAYTON, Minnesota               PETER G. FITZGERALD, Illinois
        Elise J. Bean, Acting Staff Director and Staff Director
            Robert L. Roach, Counsel and Chief Investigator
                 Kim Corthell, Minority Staff Director
                     Mary D. Robertson, Chief Clerk










                            C O N T E N T S

                                 ------                                
Opening statements:
                                                                   Page
    Senator Levin................................................     1
    Senator Collins..............................................     6
    Senator Lieberman............................................     9
    Senator Durbin...............................................    11
    Senator Bunning..............................................    12
    Senator Fitzgerald...........................................    42
    Senator Carper...............................................    46

                               WITNESSES
                          Tuesday, May 7, 2002

John H. Duncan, former Executive Committee Chair, Board of 
  Directors, Enron Corporation, Houston, Texas...................    13
Herbert S. Winokur, Jr., Finance Committee Chairman, Board of 
  Directors, Enron Corporation, Greenwich, Connecticut...........    16
Robert K. Jaedicke, former Audit and Compliance Committee Chair, 
  Board of Directors, Enron Corporation, Bozeman, Montana........    19
Charles A. LeMaistre, M.D., former Compensation and Management 
  Development Committee Chair, Board of Directors, Enron 
  Corporation, San Antonio, Texas................................    21
Norman P. Blake, Interim Chair, Board of Directors, Enron 
  Corporation, Rosemont, Illinois................................    25
Charles M. Elson, Director, Center for Corporate Governance, 
  University of Delaware, Newark, Delaware.......................    93
Michael H. Sutton, former Chief Accountant, Securities and 
  Exchange Commission, Williamsburg, Virginia....................    96
Robert H. Campbell, former Chairman and Chief Executive Officer, 
  Sunoco, Inc., and Current Board Member of Hershey Foods, CIGNA, 
  and Pew Charitable Trusts, Coronado, California................    99

                     Alphabetical List of Witnesses

Blake, Norman P.:
    Testimony....................................................    25
    Prepared statement...........................................   181
Campbell, Robert H.:
    Testimony....................................................    99
    Prepared statement with an attachment........................   195
Duncan, John H.:
    Testimony....................................................    13
    Prepared statement...........................................   113
Elson, Charles M.:
    Testimony....................................................    93
    Article submitted for the Record.............................   185
Jaedicke, Robert K.:
    Testimony....................................................    19
    Prepared statement with attachments..........................   155
LeMaistre, Charles A., M.D.:
    Testimony....................................................    21
    Prepared statement with an attachment........................   176
Sutton, Michael H.:
    Testimony....................................................    96
    Prepared statement...........................................   191
Winokur, Herbert S., Jr.:
    Testimony....................................................    16
    Prepared statement with attachments..........................   116

                                Exhibits
                              May 7, 2002

 1. GRed Flags Known to Enron's Board, chart prepared by the 
  Permanent Subcommittee on Investigations.......................   203

 2. a. GSelected Observations, 1998 Financial Reporting (Source: 
  February 7, 1999, Andersen Presentation to Audit Committee.)...   204

    b. GDraft Minutes, Meeting of the Audit and Compliance 
  Committee of the Board of Director, Enron Corporation, February 
  7, 1999........................................................   205

 3. GSelected Observations, 1998 Financial Reporting (Source: 
  February 7, 1999, Andersen internal document related to 
  presentation to Enron Audit Committee.)........................   208

 4. GTranscription of handwritten note of David Duncan on Exhibit 
  #3 (above.)....................................................   209

 5. GLetter from Arnold and Porter to Permanent Subcommittee on 
  Investigations, dated May 2, 2002, regarding Tom Bauer and 
  handwritten notes on Exhibit #3 (above.).......................   210

 6. GHigh Priority Financial Reporting Risk Areas, Ongoing--1999 
  Specific (Source: May 3, 1999, Andersen Presentation to Enron 
  Audit Committee.)..............................................   211

 7. a. GHigh Priority Financial Reporting Risk Areas, Ongoing--
  2000 Specific (Source: May 1, 2000, Andersen Presentation to 
  Enron Audit Committee.)........................................   212

    b. GSummary of Fees--Activity Overview (Source: May 1, 2000, 
  Andersen Presentation to Enron Audit Committee.)...............   213

    c. GDraft Minutes, Meeting of Audit and Compliance Committee 
  of the Board of Directors, Enron Corporation, May 1, 2000......   214

 8. a. G2000 Audit Update, Selected Observations--Financial 
  Reporting (Source: February 12, 2001, Andersen Presentation to 
  Enron Audit Committee.)........................................   218

    b. G2000 Audit Update, Status and Required Communications 
  (Source: February 12, 2001, Andersen Presentation to Enron 
  Audit Committee.)..............................................   220

 9. GHigh Priority Financial Reporting Rish Areas, Ongoing--2001 
  Specific (Source: April 20, 2001, Andersen Presentation to 
  Enron Audit Committee.)........................................   221

10. a. GApproval Report, May 18, 2000, Andersen Internal 
  Assessment of Enron............................................   222

    b. GFS Misstatement Risk, November 22, 1999, Andersen 
  Internal Assessment of Enron...................................   226

11. GSpecific References to Whitewing/Nighthawk/Osprey in Enron's 
  Board/Committee Presentations, table prepared by the Permanent 
  Subcommittee on Investigations.................................   228

12. GMinutes, Meeting of the Board of Directors, Enron 
  Corporation, December 9, 1997..................................   231

13. GMinutes, Special Meeting of the Board of Directors, Enron 
  Corporation, February 1, 1999..................................   240

14. GMinutes, Meeting of the Board of Directors, Enron 
  Corporation, September 17, 1999................................   244
15. GSeptember 17, 1999, Facsimile to Members of the Board of 
  Directors regarding Condor flowcharts: Condor Transaction, Step 
  1--December 1997 and Condor Transaction, Step 2--September 1999 
  (Source: September 1999, Presentation to the Board of 
  Directors.)....................................................   253

16. GWhitewing, 1997-2001, chart prepared by the Permanent 
  Subcommittee on Investigations.................................   256

17. GEGF Execution Schedule, 2000 Balance Sheet Management 
  (Source: August 2000, Finance Committee Presentation.).........   257

18. GReferences to LJM Controls and Waivers in Board/Committee 
  Presentations, table prepared by the Permanent Subcommittee on 
  Investigations.................................................   258

19. GProject LJM Board Presentation, June 28, 1999: Economics of 
  ENE Stock Positions; Current ENE Stock Positions of Little 
  Value to Enron; Transaction Summary; Direct Value to Enron; 
  Benefits to Enron; A. Fastow Involvement; Key Elements of 
  Transaction to be Approved; Transaction Structure; Steps to 
  Complete the Transaction.......................................   261

20. GLJM2 Summary (Source: October 11-12, 1999, Finance Committee 
  Presentation.).................................................   271

21. GLJM2 Co-Investment, L.P., Private Placement Memorandum, 
  Merrill Lynch & Co. (Source: October 1999, LJM2 Co-Investment, 
  LP Private Placement Memo.)....................................   272

22. GLJM Investment Activity, 1999 (Source: February 7, 2000, 
  Audit Committee Presentation.).................................   277

23. GLJM2 Update (Source: May 1, 2000, Finance Committee 
  Presentation.).................................................   278

24. a. GEnron Corp, Review of LJM procedures and transactions 
  completed in 2000, February 12, 2001; LJM Investment 2000 
  Activity With Enron; Related Party Transactions--LJM 2000, 
  Internal Policies and Procedures, (February 2001) (Source: 
  February 12, 2001, Audit and Finance Committee Presentation.)..   279

    b. GNotes of Dr. LeMaistre regarding call to Andrew Fastow on 
  LJM-related compensation.......................................   283

25. GLJM Investments, Annual Partnership Meeting, October 26, 
  2000 (Source: October 26, 2000, LJM Investments Partnership 
  Meeting Presentation.).........................................   284

26. GEnron, Code of Ethics, July, 2000...........................   291

27. GThe Raptors, 2000-2001, chart prepared by the Permanent 
  Subcommittee on Investigations.................................   300

28. a. GMinutes, Meeting of the Finance Committee of the Board of 
  Director, Enron Corporation, May 1, 2000.......................   301

    b. GProject Raptor, Hedging Program for Enron Assets; 
  Purpose; Vehicle Structure; Project Raptor--Risks, Mitigants; 
  (Source: May 1, 2000, Project Raptor Finance Committee 
  Presentation.).................................................   306

29. GMinutes, Meeting of the Board of Directors, Enron 
  Corporation, May 2, 2000.......................................   311

30. a. GMinutes, Meeting of the Board of Directors, Enron 
  Corporation, August 7-8, 2000..................................   319

    b. GProject Raptor II (Source: June 22, 2000, Executive 
  Committee Meeting, Project Presentation.)......................   327

31. GEnron Deal Summary (Raptor). (Source: April 18, 2000, Enron 
  and LJM2 Deal Approval Sheets: Raptor.)........................   328

32. GStock Price Risk in Financings, Potential Required Future 
  Equity Issuance. (Source: April 2001, Finance Committee 
  Presentation.).................................................   334

33. a. GOctober 2-5, 2001, E-Mails regarding Enron Stock 
  transactions (REDACTED by the Permanent Subcommittee on 
  Investigations)................................................   335

    b. GSEALED EXHIBIT: October 2-5, 2001, E-Mails regarding 
  Enron Stock transactions (UNREDACTED)..........................     *
34. GThe Luntz Research Companies, October 19, 2001, Memorandum 
  to Ken Lay, Grey Whalley, and Mark Frevert, regarding Initial 
  Focus Group Observations & Recommendations.....................   339

35. a. GEnron Board Member, Total Compensation--Fiscal Year 2000, 
  chart prepared by the Permanent Subcommittee on Investigations.   348

    b. GEnron Board of Directors, Estimated Equity Compensation, 
  1991-2000, chart prepared by the Permanent Subcommittee on 
  Investigations.................................................   349

36. a. GKen Lay's Repayment of Cash Loans By Transferring Enron 
  Stock Back to Enron, chart prepared by the Permanent 
  Subcommittee on Investigations.................................   350

    b. GInteroffice Memorandum from Kenneth L. Lay, dated 
  November 20, 2000, regarding $4 Million Enron Line of Credit...   351

    c. GLetter from Kenneth Lay to Paine Webber, Inc., dated 
  November 20, 2000, regarding sale of 49,950 Enron shares for 
  repayment of $4 million line of credit.........................   352

37. GEnron's Many Strands: Executive Compensation; Enron Paid 
  Huge Bonuses in '01; Experts See a Motive for Cheating, March 
  1, 2002, New York Times........................................   353

38. a. GDecember 31, 1999, Excerpts from SEC Form 10-K, Enron 
  Footnotes, Related Party Transactions..........................   359

    b. GDecember 31, 2000, Excerpts from SEC Form 10-K, Enron 
  Footnotes,  Related Party Transactions.........................   360

    c. GSeptember 30, 2001, Excerpts from SEC Form 10-Q, Enron, 
  Description of Restatement Items...............................   362

39. GPrivate Equity Strategy (Source: October 2000, Finance 
  Committee Presentation.).......................................   370

40. GSummary of Investment Portfolio as of March 31, 2001 
  (Source: April 2001, Finance Committee Presentation.)..........   371

41. a. GPortfolio Summary as of March 31, 2001 (Source: April 
  2001, Finance Committee Presentation.).........................   372

    b. GPortfolio Summary as of June 30, 2001 (Source: August 13, 
  2001, Finance Committee Presentation.).........................   373

42. GFinance Related Asset Sales, Prepays and 125 Sales (Source: 
  August 2001, Finance Committee Presentation.)..................   374

43. GEnron Board of Directors--Financial Ties to Enron, chart 
  prepared by the Permanent Subcommittee on Investigations.......   375

44. a. GPartnership Spurs Enron Equity Cut, October 18, 2001, The 
  Wall Street Journal............................................   376

    b. GEnron CFO's Partnership Had Millions in Profit, October 
  19, 2001, The Wall Street Journal..............................   378

45. GMinutes, Meeting of the Board of Directors, Enron 
  Corporation, October 7, 2000...................................   380

46. G2001 Proxy Statement for Enron Corp. with list of Directors.   383

47. a. GCorporate Governance Guidelines of The Board of Directors 
  of Enron Corp..................................................   385

    b. GEnron Corp. Audit and Compliance Committee Charter (As 
  Amended February 12, 2001).....................................   393

    c. GEnron Corp. Finance Committee Charter....................   396

    d. GEnron Corp. Compensation Committee Charter...............   398

    e. GEnron Corp. Nominating Committee Charter.................   401

48. GEnron Corp. Business Risk Management Process Overview, chart 
  prepared by Arthur Andersen....................................   403

49. GAudit and Compliance Committee Calendar of 2001 Activities..   404

50. GArthur Andersen Report to the Audit Committee of the Board 
  of Directors, Enron Corp., August 2000.........................   405

51. GApplication of Mark-to-Market and Fair Value Accounting, 
  October 11, 1999, Arthur Andersen Presentation to Enron Corp...   407

52. GLetter to Enron Corp. Compensation & Management Development 
  Committee Members, dated April 13, 2001, regarding Potential 
  Proxy Q & As, attaching table entitled Confidential For Enron 
  Board of Directors, Public Relations, Investor Relations & HR 
  Use Only, Potential Questions--Enron Proxy 2001................   416

53. GEnron Interoffice Memorandum to Enron Corp. Board of 
  Directors, dated November 2, 2001, regarding Management 
  Committee Compensation Summary and attaching copy of November 
  2, 2001 letter to Enron Compensation Committee from Towers 
  Perrin regarding observations regarding the Ken Lay insurance 
  swap approved by Enron's Compensation Committee................   422

54. GEnron Corp. Compensation Committee 12/20/01 meeting, Agenda 
  Item No. 6, Other Business--6(a) Employment Agreement 
  Summaries; 6(b) Kenneth L. Lay, changes To Current Employment 
  Agreement Provisions...........................................   425

55. GDefendant Andersen Exhibit 763 and 764 (Arthur Andersen 
  email, May and June 1999, re: Enron), U.S. v. Arthur Andersen 
  (USDC SD Texas, Criminal Action No. H-02-0121).................   428

56. a. GExcerpts from Minutes, Special Meeting of the Board of 
  Directors, Enron Corp., June 28, 1999..........................   432

    b. GMinutes, Meeting of the Finance Committee of the Board of 
  Directors, Enron Corp., October 11, 1999.......................   436

    c. GMinutes, Meeting of the Board of Directors, Enron Corp., 
  October 11-12, 1999............................................   444

    d. GMinutes, Meeting of the Finance Committee of the Board of 
  Directors, Enron Corp., December 13, 1999......................   448

    e. GMinutes, Meeting of the Board of Directors, Enron Corp., 
  December 14, 1999..............................................   452

    f. GDraft Minutes, Meeting of the Audit and Compliance 
  Committee of the Board of Directors, Enron Corp., February 7, 
  2000...........................................................   458

    g. GDraft Minutes, Meeting of the Finance Committee of the 
  Board of Directors, Enron Corp., August 7, 2000................   462

    h. GMinutes, Meeting of the Finance Committee of the Board of 
  Directors, Enron Corp., October 6, 2000........................   468

    i . GMinutes, Meeting of the Board of Directors, Enron Corp., 
  October 7, 2000................................................   481

    j . GDraft Minutes, Meeting of the Audit and Compliance 
  Committee of the Board of Directors, Enron Corp., February 12, 
  2001...........................................................   500

    k. GMinutes, Meeting of the Finance Committee of the Board of 
  Directors, Enron Corp., February 12, 2001......................   506

    l.  GMinutes, Meeting of the Finance Committee of the Board 
  of Directors, Enron Corp., October 8, 2001.....................   511

    m. GDraft Minutes, Meeting of the Audit and Compliance 
  Committee of the Board of Directors, Enron Corp., November 2, 
  2001...........................................................   517

57. GLetter from PriceWaterhouseCoopers LLP, dated August 17, 
  1999, to Enron Capital Management, regarding fairness opinion 
  between Enron Corp. and LJM Cayman, L.P., for put option on 
  Rhythms NetConnections Inc. stock..............................   520

58. GLJM2 Co-Investment, L.P., Supplement Number One To Private 
  Placement Memorandum, December 15, 1999........................   525

59. a. GArthur Andersen Memorandum, December 31, 1999, regarding 
  LJMII Partnership Structure....................................   526

    b. GArthur Andersen Memorandum, December 31, 1999, as amended 
  October 12, 2001, regarding LJMII Partnership Structure........   529

60. GMajor Transactions, Largest 10 Transactions (June 30-
  December 31) (Source: August 2000, Finance Committee 
  Presentation.).................................................   532

61. GEnron Interoffice Memorandum, March 8, 2001, regarding LJM 
  Approval Process--Transaction Substantiation...................   533

62. GEnron Interoffice Memorandum, March 28, 2001, regarding 
  Related-Party Proxy Disclosures................................   538

63. GArthur Andersen Memorandum, February 9, 2001, regarding LJM 
  Related Party Transactions.....................................   540

64. GDraft Enron Corp. Memorandum, September 2001, regarding 
  Project Raptor--Addendum.......................................   542

65. GEnron Corp. Interoffice Memorandum, August 16, 2000, 
  regarding EITF Issue Update....................................   544

66. GEnron Corp. email, December 12, 2000, regarding EITF 00-19 
  Year End Implications..........................................   546

67. GArthur Andersen email, August 23, 2001, regarding 
  Documentation of Client Call...................................   550

68. GEnron Corp. draft responses to the Securities and Exchange 
  Commission's questions on the LJM transactions, November 2, 
  2001...........................................................   553

69. GRaptor Hedging Strategy Analysis, Enron Corp. Risk 
  Assessment and Control Presentation, 2001......................   556

70. GEnron Global Markets, Enron's Funds Flow Targets, March 2001   562

71. GEnron Global Assets and Services, Equity Value Schedule, As 
  of June 2001...................................................   564

72. GSummary Notes from Enron Corp. Board of Directors Meetings, 
  November through December 2001.................................   565

73. GArthur Andersen documents related to Joseph Berardino's 
  visit to Enron Corp. in February 2001, decision to retain Enron 
  Corp. as a client, and removal of Carl Bass from Enron Corp. 
  engagement team in March 2001..................................   566

74. GAdditional materials from Arthur Andersen, some with David 
  Duncan's handwriting, related to Enron Corp. accounting 
  practices......................................................   589

75. GStoel Rives LLP Memorandum, December 8, 2000, regarding 
  Traders' Strategies in the California Wholesale Power Markets/
  ISO Sanctions, provided by Enron Corp..........................   592

76. GSeth Vance, Schroder Salomon Smith Barney, email, October 
  2001, to Andrew Fastow.........................................   600

77. a. GMemorandum of the Special Committee of Enron's Board of 
  Directors, January 8, 2002, Interview of Herbert S. Winokur, 
  Jr.............................................................   601

    b. GMemorandum of the Special Committee of Enron's Board of 
  Directors, January 11, 2002, Interview of Dr. Robert Jaedicke..   612

    c. GMemorandum of the Special Committee of Enron's Board of 
  Directors, January 14, 2002, Interview of John Mendelsohn......   621

    d. GMemorandum of the Special Committee of Enron's Board of 
  Directors, January 30, 2002, Interview of Norman Blake.........   623

    e. GMemorandum of the Special Committee of Enron's Board of 
  Directors, January 21, 2002, Interview of Ronnie Chan..........   629

    f. GMemorandum of the Special Committee of Enron's Board of 
  Directors, January 10, 2002, Interview of Paulo Ferraz Pereira.   634

    g. GMemorandum of the Special Committee of Enron's Board of 
  Directors, January 14, 2002, Interview of Wendy Gramm..........   638

    h. GMemorandum of the Special Committee of Enron's Board of 
  Directors, January 10, 2002, Interview of Lord John Wakeham....   644

78. GRemarks by Securities and Exchange Commission Chairman 
  Arthur Levitt, ``The Numbers Game,'' September 28, 1998........   645

79. a. GReport and Recommendations of the Blue Ribbon Committee 
  on Improving the Effectiveness of Corporate Audit Committees...     *
    b. GReport and Recommendations of the Blue Ribbon Committee 
  on Improving the Effectiveness of Corporate Audit Committees, 
  Overview and Recommendations section...........................   652

80. GClarifications and supplemental questions and answers for 
  the record of Messrs. John Duncan, Herbert Winokur, Norman 
  Blake, Dr. Charles LeMaistre and Dr. Robert Jaedicke...........   665

81. GSupplemental questions and answers for the record of Michael 
  H. Sutton......................................................   684

82. GSupplemental questions and answers for the record of Robert 
  H. Campbell....................................................   690

83. GStatement for the Record of Ira M. Millstein, Co-Chairman of 
  the Blue Ribbon Committee on Improving the Effectiveness of 
  Corporate Audit Committees.....................................   696

84. GReport of Investigation by the Special Investigative 
  Committee of the Board of Directors of Enron Corp., William C. 
  Powers, Jr., Chair, Raymond S. Troubh, Herbert S. Winokur, Jr., 
  February 1, 2002, (``Powers Report'')..........................     *

85. GThe Outside Directors' Response to the Permanent 
  Subcommittee on Investigations' Report: The Role of the Board 
  of Directors In Enron's Collapse...............................   715

86. GInstitutionalizing Good Governance: Keys to Success, article 
  by Rosemarie B. Greco in Director's Monthly, the official 
  newsletter of the National Association of Corporate Directors, 
  January 2002...................................................   751

 * May be found in the files of the Subcommittee









         THE ROLE OF THE BOARD OF DIRECTORS IN ENRON'S COLLAPSE

                              ----------                              


                          TUESDAY, MAY 7, 2002

                                       U.S. Senate,
                Permanent Subcommittee on Investigations,  
                  of the Committee on Governmental Affairs,
                                                    Washington, DC.
    The Subcommittee met, pursuant to notice, at 9:37 a.m., in 
room SH-216, Hart Senate Office Building, Hon. Carl Levin, 
Chairman of the Subcommittee, presiding.
    Present: Senators Levin, Lieberman, Durbin, Carper, 
Collins, Bunning, and Fitzgerald.
    Staff Present: Elise J. Bean, Acting Staff Director and 
Chief Counsel; Linda J. Gustitus, Chief of Staff for Senator 
Levin; Mary D. Robertson, Chief Clerk; Stephanie E. Segal, 
Professional Staff Member; Ross Kirschner, Deputy Investigator; 
Jamie Duckman, Majority Accountant; Kim Corthell, Republican 
Staff Director; Alec Roger, Counsel to the Minority; Claire 
Barnard, Investigator to the Minority; Jim Pittrizzi, Detailee/
General Accounting Office; Joyce Rechtschaffen, Staff Director 
and Counsel, Governmental Affairs Committee; Marianne Upton 
(Senator Durbin); Joe Bryan (Senator Levin); Bill Weber 
(Senator Durbin); Cindy Lesser (Senator Lieberman); Kathleen 
Long (Senator Levin); Holly Schmitt (Senator Bunning); Anne 
Fisher (Senator Cochran); Bob Klepp and Trent Kittleman 
(Senator Thompson).

               OPENING STATEMENT OF SENATOR LEVIN

    Senator Levin. Good morning, everybody. The Subcommittee 
will come to order.
    On December 2, 2001, the seventh largest corporation in 
America collapsed. Its stock, having plummeted from $80 a share 
to practically nothing in less than 10 months, the reins of 
what was once a high-flying company of $100 billion in gross 
revenues and 20,000 employees were handed over to a Federal 
bankruptcy judge. That collapse has rolled like a tidal wave 
across the corporate boardrooms of America, across Wall Street, 
and across the entire investing community, which now includes 
over half of U.S. households.
    With this tidal wave, we are all asking two questions: What 
happened at Enron, and could it happen again? Today, we hope to 
help answer the first question in order to ensure that the 
answer to the second question will become ``no.''
    One of the key players responsible for overseeing the 
operations of our publicly held corporations is the Board of 
Directors. Directors are charged by law to be the fiduciaries, 
the trustees who protect the interests of the corporate 
shareholders. In that capacity, they are supposed to exercise 
their best business judgment on behalf of those shareholders. 
They are supposed to be independent. And while they are not 
expected to be detectives, they are expected to ask tough 
questions of management, to probe opaque answers, and to 
display sufficient skill and fortitude to say no to 
transactions that do not look right.
    Along with management and the auditors, the Board shares 
the responsibility to provide to the company's shareholders a 
financial statement that is a fair representation of the 
financial position of the company. As the Second Circuit Court 
of Appeals held in a widely quoted opinion, technical 
compliance with Generally Accepted Accounting Principles may be 
evidence of acting in good faith, but it is not necessarily 
conclusive: The ``critical test,'' the court said, is ``whether 
the financial statements as a whole fairly present the 
financial position'' of a company. Enron's financial statements 
did not, and the Board's role in that failure is before us.
    Today, we have five key members from the Enron Board of 
Directors to tell us what they knew about the financial 
condition of Enron, when they knew it, and what they did about 
it. In other words, what role did the Board play in these 
events?
    The Subcommittee issued over 50 subpoenas for documents to 
Enron, Arthur Andersen, members of the Enron Board, and 
officers of Enron. Staff has reviewed about 300 boxes of 
documents to date, and conducted interviews with 13 current and 
past Board members. Each Board member complied with the 
document subpoenas and willingly appeared for interviews. We 
appreciate their cooperation and their voluntary appearance 
today.
    We have found that when you pare down the hundreds of 
incredibly complex financial transactions that were the 
hallmark of Enron, you realize that many were nothing more than 
smoke-and-mirrors bookkeeping tricks, designed to artificially 
inflate earnings rather than achieve economic objectives, to 
hide losses rather than disclose business failures to the 
public, to deceive more than inform.
    The decisions to engage in these accounting gimmicks and 
deceptive transactions were fueled by the very human but 
unadmirable emotions of greed and arrogance. Putting a growth 
gloss on the balance sheet pumped up the stock price, and the 
rise in stock price, regardless of the underlying true value of 
the company, was, for many, the measure in the 1990's for 
judging corporate success. The Board that was supposed to be 
the check on the greed and the arrogance, in fact, was not. 
Here is how it happened.
    Enron was in transition from an old-line energy company, 
with pipelines and power plants, to a high-tech global 
enterprise engaged in energy trading and international 
investment. It experienced large fluctuations from quarter to 
quarter in its earnings. Those large fluctuations affected the 
credit rating Enron received, and the credit rating affected 
Enron's ability to obtain low-cost financing, attract 
investment, and increase its stock price.
    In order to smooth out its earnings and avoid the natural 
dips, Enron engaged in a variety of complicated transactions 
that relied on structured finance, derivatives, and other 
arrangements that, while legal if done right, are nonetheless 
designed to massage a company's financial statement to make its 
financial condition look better than it really is.
    While it is not uncommon for a company to use these 
devices, they are also used somewhat sparingly. Enron, however, 
made them a high art form and used them aggressively, and in 
some cases, improperly. When used extensively and when they 
become dominant, when they involve billions of dollars, $27 
billion in assets at Enron's peak, the real impact of these 
complex transactions on a financial statement is to cover up 
reality with a glitzy coat of paint. The financial statement 
becomes a fiction, and that is what happened at Enron.
    Step by step, Enron shifted a larger percentage of its 
assets into these structured finance arrangements, not for any 
real business purpose, but in order to make Enron look more 
profitable than it really was. Funds flow and the appearance of 
funds flow became the Enron mantra in order to keep Enron's 
credit rating up and its stock price climbing, and the Board of 
Directors went along with it.
    In many actions starting in 1997, when the Board first 
approved Whitewing, through the summer of 2001, just before 
things fell apart publicly, the Board of Directors went along 
with management's wishes. The Board relinquished its role of 
questioner and adopted the role of facilitator. It succumbed to 
the Enron ether of invincibility, superiority, and gamesmanship 
in manipulating Enron's financial statement to keep the Enron 
stock price soaring. This is a company, we are told, that had 
televisions in its elevators in order for employees to monitor 
Enron's stock price at all times.
    The financial transactions that the Board approved were 
used to make debt look like equity, to make loans look like 
sales, to make poorly performing assets look like money makers, 
and to make Enron-controlled entities look like legitimate 
third parties. By the time of the collapse, Enron held almost 
50 percent of its assets off its books, and what started as a 
useful tool to address specific business problems had become a 
way of life.
    As long as Enron's stock was rising, these elaborate 
financial structures did what they were designed to do, make 
Enron's financial condition look better than it was. But once 
Enron stock started falling, these financial structures 
collapsed on themselves like a house of cards, revealing at the 
end that there was no ``there'' there. These transactions 
involved a number of deceptions that pushed the limit of 
accepted accounting practices and, at times, exceeded them. And 
parenthetically, if it turns out that Generally Accepted 
Accounting Principles allow such deceptions, then those 
accounting principles need to be changed.
    One type of deception that Enron used was to report on the 
company's financial statements the sale of an asset despite an 
understanding that Enron would buy it back after the financial 
statement was filed, or despite a hidden guarantee that the 
entity buying the asset would receive a certain rate of return. 
Five of the seven assets sold this way to the LJM partnership 
at the end of the last two quarters of 1999 were bought back by 
Enron, sometimes within 6 months' time. But those guarantees 
did not show on Enron's books as a liability. Only the sales 
showed as funds flow.
    Another type of deception made what was essentially a loan 
look like a sale, so the company's financial statement 
reflected the transaction as income or cash flow instead of 
debt.
    A third type of deception inflated the value of the assets 
that Enron held for sale. For example, Enron would buy a power 
plant on day one for $30 million, and within a month or so 
would begin carrying it on Enron's books as an asset worth $45 
million. Two weeks ago, Enron filed a statement with the SEC 
declaring that it is going to write down its assets by another 
$14 to $24 billion, a staggering sum, due to overvaluations on 
the books and ``accounting errors or irregularities.''
    Another type of deception, the Raptors, used Enron stock to 
backstop a risk that the LJM partnership and its investors were 
supposed to be assuming for Enron, and the risk retained by 
Enron was not disclosed on the company's financial statements 
in a meaningful way.
    As these structured financial transactions grew in number, 
size, and frequency, and as 50 percent of Enron's assets were 
moved off Enron's books, no one on the Enron Board said that 
their fiduciary duty required them to blow the whistle and 
prevent a deceptive picture of Enron's financial situation from 
being presented to the public.
    During the 13 interviews, the Board members told us that 
they had not been aware of the depth of Enron's problems or the 
extent of these structured transactions and accounting 
gimmicks, and most said they had no inkling that Enron was in 
troubled waters until mid-October 2001. But look at this chart 
that the Subcommittee staff has put together,\1\ identifying 
numerous red flags presented to the Board of Directors from 
February 1999 on, that signaled the risks Enron was taking, and 
that should have alerted the Board to probe and then to change 
course.
---------------------------------------------------------------------------
    \1\ See Exhibit No. 1 which appears in the Appendix on page 203.
---------------------------------------------------------------------------
    The staff has identified well over a dozen of these red 
flags, but I am just going to highlight a few. In February 
1999, the Board's Audit Committee was told by Arthur Andersen 
directly that Enron's accounting practices were high risk and 
pushed limits.
    In June 1999, the Board approved at a special meeting and 
without prior Finance Committee consideration the creation of 
the LJM partnership, and waived the conflict of interest 
provision of the Enron code of conduct. The Enron Chief 
Financial Officer, Andy Fastow, served as the managing partner 
of LJM, something no Board member had ever approved or heard of 
prior to this. The Board was to approve a code of conduct 
waiver for Fastow three times over the next 16 months.
    In September 1999, the Board approved moving off the Enron 
balance sheet a $1.5 billion joint venture called Whitewing, 
which was established by the Board in December 1997 to get a 
loan that looked like equity, and then used from 1999 on to 
purchase assets that Enron wanted to move off its books.
    In May 2000, the Board approved the first Raptor 
transaction, a vehicle designed to hedge Enron investments by 
using Enron stock to backstop the hedge, which amounted to 
Enron hedging with itself.
    By October 2000, the Board knew that Enron had $27 billion 
in assets, almost half of its assets, off its balance sheet.
    In April 2001, the Enron Board knew that 64 percent of 
Enron's assets were troubled or not performing and that 45 
million shares of Enron stock were at risk in Raptors and 
Whitewing.
    Starting with the creation of Whitewing in 1997 and with 
its deconsolidation in 1999, the Board started to wade into 
dangerous waters. With the establishment of the LJM partnership 
and the waiver of the code of conduct, they were up to their 
necks, and with the Board's approval of the Raptors, the Board 
was swimming way over their heads. In the end, Enron drowned in 
its own debt. As the chart shows, the Board had ample knowledge 
of the dangerous waters in which Enron was swimming and it did 
not do anything about it.
    The Board told the Subcommittee staff that because each of 
Enron's transactions was approved by Enron management, whom 
they saw as some of the most creative and talented people in 
the business, and because the transactions had been approved by 
Arthur Andersen, a top auditing firm, and by Enron's lawyers 
and private law firms like Vinson and Elkins, by the credit 
rating agencies, or by investment bankers who had a significant 
stake in a lot of these transactions, the Board assumed that 
the transactions were OK. Now, I can see why you might rely on 
a company auditor or an outside attorney, but the Board must 
exercise independent judgment. The Board is not supposed to be 
a rubber stamp for auditors or attorneys.
    Also, the people that the Board relied on were conflicted 
in their roles involving Enron, and the Board knew it. First, 
the Board knew that Enron's management handed out bonuses like 
candy at Halloween. Employees were given huge bonuses for 
closing deals, and many of these deals proved damaging to 
Enron. For instance, two executives closed a deal on a power 
project in India, which is now a financial disaster, and got 
bonuses in the range of $50 million. The head of one Enron 
division who was moved out of the company walked away with more 
than $250 million in the year that he was shown the door. The 
temptation to self-enrichment at Enron was overwhelming.
    Arthur Andersen was conflicted, because it served Enron as 
both an auditor and a consultant, and, for 2 years, it also 
served as Enron's internal auditor, essentially auditing its 
own work. Enron was Andersen's largest client, and in 2000, 
Andersen earned over $50 million in fees from the company. 
Employees of Andersen routinely crossed over to work for Enron, 
and an Andersen employee who actually questioned Enron 
practices while serving on the audit team was promptly 
reassigned to another client at Enron's urging.
    Relying on outsiders, conflicted or not, does not relieve 
the Board from the ultimate responsibility to make sure that at 
the end of the day, Enron was operating properly and Enron's 
financial statement was a fair representation of Enron's 
financial condition. The Board failed in that responsibility.
    The structured debt and guarantees overwhelmed Enron's 
ability to pay, and that meant bankruptcy for the corporation, 
huge pension losses for employees, investment losses for 
stockholders, and business losses for hundreds of small 
companies that did business with Enron, while the officers of 
the corporation walked away with fortunes.
    Today, we are going to go over the decisions that the Board 
made on a number of these transactions, as well as the 
decisions that they made with respect to compensation. We will 
also look at the interlocking financial relationships that some 
members of the Board had with Enron.
    Following the Board, we will hear in a second panel from 
several experts in the field of corporate governance, and I 
expect that we will be taking a break for lunch sometime around 
12 or 12:30.
    Senator Collins.

              OPENING STATEMENT OF SENATOR COLLINS

    Senator Collins. Thank you, Mr. Chairman. Today is the 
first in a series of hearings to be held by the Permanent 
Subcommittee on Investigations into the events that led to the 
bankruptcy of the Enron Corporation. As a result of the 
company's downward spiral and ultimate bankruptcy, 
shareholders, both large and small, individual and 
institutional, lost an estimated $60 billion. This includes 
more than 15,000 Enron employees and retirees who had a 
significant proportion of their pension funds invested in the 
company's stock. They lost an astounding $1.3 billion. The 
collapse of Enron caused thousands of Americans to lose their 
jobs, to lose savings, and to lose confidence in corporate 
America.
    Unraveling the complexities of what happened, determining 
who is responsible, and prosecuting those individuals will take 
the Department of Justice, the Labor Department, and the 
Securities and Exchange Commission many months and possibly 
years. The Subcommittee's job is not to duplicate those 
efforts, but rather to examine the actions taken by all of the 
players who contributed to Enron's demise in order to 
illuminate the public policy issues. By doing so, the 
Subcommittee can help focus the debate in Congress, in State 
legislatures, and in corporate board rooms across the Nation on 
what measures should be taken and by whom to minimize the 
chances of another Enron-like debacle.
    In this first hearing, the Subcommittee will examine the 
role played by Enron's Board of Directors in the company's 
bankruptcy. I want to acknowledge the Board's full cooperation 
with this investigation. I also want to take a moment to praise 
Senator Levin and the dedicated both Majority and Minority 
Subcommittee staff who have been tireless in their efforts to 
unravel a very tangled web of conflicts of interest, unusual 
transactions, and lax oversight.
    Corporate boards play an essential role in the American 
economy. They are the single most important guardians of a 
company's shareholders, and as such, they have a fiduciary duty 
to promote the interests of the corporation, to act in good 
faith, and to exercise their best judgment.
    When Korn/Ferry, a major corporate recruiter, polled 
corporate directors in 2001 to determine the outstanding 
capabilities of board members, it identified one single trait 
that stood significantly above all the others. That trait is a 
willingness to challenge management decisions when necessary.
    There is no question that directors generally should be 
able to rely on the representation of management and 
independent experts. But directors have an obligation to do 
more than simply accept what they are told, occasionally ask 
whether there are any problems, and inquire whether the 
accountants agree on the propriety of actions presented for 
their approval. Prudent directors retain their objectivity and 
to some degree, a healthy skepticism. They must be willing to 
ask the tough questions of management, recognize those 
situations where independent expert advice should be sought, 
and exercise heightened diligence when a company is pursuing 
unfamiliar or new territory.
    Enron was a company that prided itself on its innovation. 
CEO Jeffrey Skilling often boasted of Enron's pioneering 
efforts as it transformed itself from a traditional energy 
company to a global enterprise creating new markets and 
businesses. In contrast, it appears that the Board of Directors 
continued to perform its duties as if Enron were still an old-
line, conservative energy company, at a time when it appears 
they should have been far more probing, given Enron's 
metamorphosis into an energy trading company.
    Serving as a director for a corporation as complicated as 
Enron obviously is not an easy task. Enron was one of America's 
largest corporations. It had thousands of partnerships, joint 
ventures, and other special purpose entities, many of which 
were engaging in transactions that can only, and barely even 
then, be followed with the aid of complex diagrams. In fact, 
the Board members interviewed by the staff appear to have been 
unaware that Enron has some 3,000 related entities, including 
600 using the same post office box in the Cayman Islands. I 
would argue that should have been another red flag.
    The complexity of the responsibility is precisely why 
Enron's Directors were paid hundreds of thousands of dollars 
per year in cash, stock, and options. While the exact amount of 
compensation can be difficult to determine, depending on how 
one calculates the value of stock options, there is no question 
that Enron's Board members were among the most highly 
compensated in the world.
    Today, we will ask five Enron Directors what they did to 
protect shareholders and why they believe that they failed in 
doing so. We will also hear an evaluation of their efforts from 
some of the leading experts on corporate governance. I am 
particularly interested to learn more about the Board's 
response to the large stock sales engaged in by Enron's 
management, its reaction to the departure of a CEO who left 
after only 6 months on the job, and its decision to approve a 
waiver of Enron's code of conduct to allow the Chief Financial 
Officer to engage in business deals with the company.
    This latter decision is the Board action that I find among 
the most inexplicable. During the investigation, the 
Subcommittee spoke with many experts on corporate governance, 
and not a single one had ever heard of a public company 
ratifying a similar proposal.
    I want to understand also the Board's view of what now 
appears to be the obvious conflicts of interest that 
contributed to Enron's collapse and to explore whether the 
Board, and its Audit Committee in particular, believed that 
they acted prudently in monitoring the outside auditor, 
Andersen. Actually, Andersen, as we know, was more than the 
outside auditor, which is another issue in and of itself. The 
Board, with Andersen's endorsement, approved many of the 
transactions described by Senator Levin that enabled the 
company to paint a false picture of its financial health and 
Enron employees to enrich themselves at the expense of the 
corporation, its shareholders, and ultimately its creditors.
    We are still working to unravel the complexities of these 
transactions, which has proven to be a monumental task. It is 
troubling to me that in staff interviews, Board members have 
provided little insight into major transactions. For example, 
not one Board member could explain or recall a $2.2 billion 
Board resolution that approved the issuance of preferred Enron 
stock to an outside investor. Now, I certainly do not expect 
the Board members to have perfect recall of every deal that 
they approved, but I would hope that transactions that rise to 
the threshold of multiple billions of dollars would be 
memorable to at least someone on the Board.
    In addition, we will discuss some of the alleged conflicts 
of interest created by some of the Board members' other 
relationships with Enron. Was the Board's vigilance dulled by 
large consulting fees, corporate contributions to their 
favorite charities, and other business relationships? Every 
corporate governance expert with whom we spoke was critical, 
for example, of any Board member having a consultant contract 
with Enron. At a minimum, such relationships do not foster the 
appearance of propriety and financial independence of Board 
members.
    Mr. Chairman, the Enron case is uncannily similar to 
another business failure that occurred some 70 years ago. In 
the early 1930's, an electric holding company called Middle 
West Utilities collapsed under the weight of stock fraud and 
cooked books. Middle West was comprised of so many interlocking 
boards that it took the Federal Trade Commission 7 years to 
fully comprehend its structure, which involved 284 affiliates. 
Underneath its incredibly complex structure lay an immense 
amount of debt taken on as it expanded in the 1920's. 
Ironically, Middle West's auditor was a relatively new firm 
named Arthur Andersen.
    There is, however, one significant difference between 
Middle West's and Enron's executives. The Middle West CEO's 
considerable fortune of around $150 million was tied up in 
Middle West holdings and disappeared with the company. In 
contrast, many of Enron's managers were making tens and, at 
least in one case, hundreds of millions of dollars by dumping 
their Enron stock before the corporation's collapse.
    Although imperfect, it is important to remember that today, 
our systems of accounting and financial regulation are the best 
in the world. That makes the Enron case all the more troubling, 
because it simply should not have happened. It represents a 
colossal failure of virtually every mechanism that is supposed 
to provide the checks and balances on which the integrity of 
our capital markets depend. And in that system, the Board of 
Directors is supposed to provide the first line of defense by 
overseeing the conduct of management.
    There are already encouraging signs that many directors in 
the wake of Enron's collapse are taking their roles much more 
seriously. As we seek answers in the Enron case, we should be 
careful not to act precipitously without understanding the true 
nature and extent of the problems underlying the corporation's 
bankruptcy. The testimony we will hear this morning about the 
role of the Board of Directors should provide some answers. It 
should also yield valuable lessons for strengthening our free 
enterprise system, restoring public confidence in our capital 
markets, and ensuring that small investors, in particular, have 
access to complete and accurate information to guide their 
investment decisions.
    Senator Levin. Thank you very much, Senator Collins.
    The Chairman of our full Committee, Senator Lieberman.

             OPENING STATEMENT OF SENATOR LIEBERMAN

    Senator Lieberman. Thank you, Senator Levin. Thanks to you 
and Senator Collins and your staff of the Permanent 
Subcommittee on Investigations for holding this important 
hearing, which really does initiate the next phase of the 
Senate Governmental Affairs Committee's investigation of the 
scandalous collapse of the Enron corporation.
    Over the past 6 months, we have all heard many reports 
about who failed Enron's shareholders and employees leading up 
to the company's fall. Obviously, the company's management has 
been cited, Arthur Andersen, government watchdogs, stock 
analysts, and even rating agencies. There were bad decisions, 
breakdowns, and some betrayals at several points and links in 
the oversight chain. Today, we focus on another group that must 
accept some of the blame for failing to uncover the crookedness 
in the company's behavior and books, and that is the Board of 
Directors.
    Textbooks tell students that the board of directors is a 
group of people elected by the shareholders to watch over the 
management of a corporation on behalf of the shareholders. 
Board members are, in that sense, like trustees or guardians 
for the shareholders and, in a larger sense, for the integrity 
and reliability of our economic system.
    In fact, because of their essential role, directors by law 
owe special duties to the corporation and particularly to its 
shareholders, duties of loyalty and care. Loyalty, meaning 
freedom from conflicts of interest--in other words, serving 
shareholders and only shareholders with independence and 
undivided attention. Care, meaning doing their work 
responsibly, thoroughly, and in good faith.
    By all appearances, unfortunately, Enron's Board of 
Directors failed their shareholders on both counts.
    First, about the Directors' loyalty to their shareholders, 
even though a majority of Enron's Board was made up of outside 
directors, meaning directors not in Enron's management, a 
stunning 10 of the 15 most recent outside Directors had 
conflicts of interest, including contracts with Enron, common 
ties or contributions to charities, and memberships on the 
board of other companies doing business with Enron.
    For example, charities close to some of the Directors were 
supported heavily by Enron and its officers. Two Directors 
earned more than $6.5 million in consulting fees from Enron 
since 1991. One Director served on the board of a company that 
in 1999 signed a $1 billion energy management agreement with an 
Enron affiliate.
    Arrangements like these can divide or even redirect a 
director's loyalties to the hand that feeds them, management, 
and away from their single-minded responsibility to the 
shareholders. Consulting contracts or large donations to 
favored charities, just as a matter of human nature, can 
whittle away the objectivity directors must bring to every 
decision they make and leave shareholders without the 
protectors that they need.
    Second, regarding the Directors' duty to take care and be 
diligent in overseeing the management of the company, my 
colleagues have spoken to this, and the fact is, unfortunately, 
that the more we look, the more evidence we find of inadequate 
oversight. In 1999, as has been said, the Board went so far as 
to suspend Enron's Code of Ethics on two separate occasions to 
allow the company's Chief Financial Officer, Andrew Fastow, to 
run partnerships that would enter into deals with Enron. That, 
to me, was extraordinary, and extraordinarily irresponsible. 
Rather than raising a red flag, the Board gave a green light to 
Mr. Fastow to, as Sherron Watkins put it in her testimony 
before the Senate Commerce Committee, ``put his hands in the 
Enron candy jar.''
    As the shareholders' elected representatives, it seems to 
me that the board of directors has an affirmative obligation to 
ask questions and get answers, and these Directors were and are 
qualified individuals, very qualified, with a professional 
understanding of industry. They had impressive credentials--
former Chairman of the Executive Committee of Gulf and Western 
Industries, former Chairman of the U.S. Commodity Futures 
Trading Commission, former Secretary of State for Energy of the 
United Kingdom, professor of accounting and former Dean of the 
Stanford Business School.
    The question is, why all that experience and so much more 
accomplished so little for the shareholders of Enron in the 
end.
    To me, the Directors' lack of due diligence is even more 
troubling in light of the fact that some of them profited so 
much from their positions as Board members. In stock sales 
alone over the years studied by our staff, some made hundreds 
of thousands of dollars and a few made more than $1 million. In 
that sense, I am sad to say that the Board of Directors did not 
just fiddle while Enron burned, some of them toasted 
marshmallows over the flames, even as those flames shook our 
economy and engulfed the dreams of thousands of dedicated Enron 
employees who lost not only their jobs, but their retirement 
security.
    The failures of Enron's Board of Directors are a warning 
that we must heed, particularly because of the more than 100 
million Americans who are now, in one way or another, stock 
investors, owners of stock, particularly those millions of 
middle-class Americans who entered the market over the last 20 
years. They are shaken and they are asking, if the 
distinguished Board of Enron failed in this case, as they did, 
to represent the shareholders adequately, how many other boards 
of how many other American corporations might be similarly 
negligent?
    After all, investment capital is the lifeblood of our free 
market economy. So the belief that directors are failing their 
shareholders is a threat to the health of our economic system. 
We cannot let it grow or go untreated. We all must work 
together now to restore investors' confidence, and quickly.
    There are many proposals of potential reforms that have 
been made to strengthen directors' accountability. I believe we 
should give the SEC new powers to remove negligent directors 
from their boards and prohibit them from future service on the 
boards of any other public companies. I am also very interested 
in proposals that have been made to ban or limit company stock 
sales by directors for the duration of their terms on the 
boards and to impose mandatory term limits on directors.
    I strongly support the call to the stock exchanges to adopt 
listing requirements that would obligate companies to limit the 
number of insiders who can serve on boards, to restrict 
directors from serving on more than a given number of boards, 
and to prohibit behavior such as that we have all described 
this morning by Enron's Directors, some Enron Directors, that 
amounts to conflicts of interest.
    As usual, self-regulation by the companies and by the stock 
exchanges would, in my opinion, be the most direct and 
effective path to reform. But if there is inadequate self-
regulation, there is no question that some government action 
will be necessary to prevent the most egregious abuses of 
responsibility by boards of directors.
    Mr. Chairman, about 100 years ago, the famous satirist 
Ambrose Bierce defined a corporation as, ``an ingenious device 
for obtaining individual profit without individual 
responsibility.'' Let us work together now to make sure that 
cynical joke does not become a prophecy. Let us make sure that 
directors are accountable and vigilant, that they act as the 
shareholders' first line of defense against corporate 
negligence, mismanagement, or corruption, and that they give 
investors the confidence our economy needs to grow as robustly 
as we all want it to. Thank you very much.
    Senator Levin. Thank you very much, Senator Lieberman. 
Senator Durbin.

              OPENING STATEMENT OF SENATOR DURBIN

    Senator Durbin. Thank you, Mr. Chairman. I will be very 
brief and I thank you for this hearing.
    I think it is fair to say that the Enron experience has 
shaken corporate America to the core. I think it has shaken 
America to the core because of the victims. Those victims are 
scarcely represented at these Congressional hearings, not only 
employees that have lost their jobs at Enron and related 
companies, but the investors, the pensioners, all of those 
victims will only have the comfort of reading these transcripts 
or watching C-SPAN. That is as close as it gets.
    The theory behind corporate governance is that the board of 
directors is supposed to be defending them, too. But as we look 
at the report from the Powers Committee and others, it is not 
very encouraging in terms of the role of the Board of Directors 
at Enron. In fact, the Powers Report says point-blank, ``The 
Board of Directors failed, in our judgment, in its oversight 
duties.'' That is a stunning condemnation.
    Enron has called into question corporate governance and 
corporate honesty. It appears now when you look at the salaries 
being paid to some of the people who were clearly deceiving 
everyone in sight, they were being treated like corporate 
royalty in a Nation which long ago decided that royalty was not 
going to be part of our future.
    I am going to be asking these Board members, some of whom I 
know and have worked with and respect very much, whether they 
were misled, whether or not as directors of a corporation of 
this size and importance they had the tools or gave the time 
that was necessary to do their job right.
    I am always fascinated by how many people express an 
interest in how many boards of directors they serve on, and I 
just wonder if that is a real service, a real dedication, and a 
real commitment, or just another notch on your gun, another 
line on your resume, whether or not members of boards of 
directors of important companies really take that job as 
seriously as they should if this system is to work.
    I think that as we look at the challenge we have before us, 
that this hearing of this Subcommittee will lead us to ask some 
hard questions, lead us to, I hope, pass some important 
legislation, because if all of these hearings on Capitol Hill 
are just about face time on the nightly news, we have failed 
those employees and those pensioners and the people that count 
on this government to enact laws to protect them. Thank you, 
Mr. Chairman.
    Senator Levin. Thank you very much, Senator Durbin. Senator 
Bunning.

              OPENING STATEMENT OF SENATOR BUNNING

    Senator Bunning. Thank you, Mr. Chairman. Enron's collapse 
has not only affected its shareholders and employees, but it 
will continue to have tremendous ramifications on the markets, 
specific sectors of the economy, and in the way stock analysis, 
credit rating agencies, and accounting firms do business. The 
status quo in many of these industries is no longer acceptable, 
and I suspect Congress and Federal agencies will be making 
several reforms over the next couple of months and years to 
prevent another company from slipping through the cracks. 
Congress will never be able to prevent another Enron from 
happening, but we can make it more difficult.
    Today, we will be looking at the role Enron's Board of 
Directors played in the company's collapse. As has been said 
before, the Powers Report that was published in February is 
fairly critical about some actions taken by Enron's Board of 
Directors, while also acknowledging that critical information 
was withheld. I hope this Subcommittee can get answers today to 
some important questions about decisions the Directors made and 
their relationships with the company's management and outside 
contractors.
    What is striking about the Enron collapse is that so many 
people, both inside and outside the company, failed to ask the 
questions that needed to be asked. Enron's failure did not 
occur because one person dropped the ball. Instead, it was an 
across-the-board failure of many individuals. In hindsight, I 
am sure that many of them wish that they had done more.
    Thank you for coming today. I appreciate the time you have 
taken, and I am looking forward to hearing from you today on 
the Enron collapse. Thank you.
    Senator Levin. Thank you, Senator Bunning.
    We will now introduce our first panel of witnesses this 
morning who are either current or former members of the Board 
of Directors of Enron Corporation. These are the five men that 
we have at our witness table.
    John Duncan, the former Executive Committee Chair for Enron 
Corporation; Dr. Herbert Winokur, Enron Corporation's Finance 
Committee Chair; Robert Jaedicke, former Audit and Compliance 
Committee Chair for Enron; Dr. Charles LeMaistre, former 
Compensation Committee Chair; and finally, Norman Blake, who is 
the Interim Chairman of the current Board of Directors and a 
former member of the Compensation and Finance Committees.
    Pursuant to Rule VI of this Subcommittee, all witnesses who 
testify before the Subcommittee are required to be sworn. I now 
would ask our witnesses to please stand and raise your right 
hand.
    Do you solemnly swear that the testimony that you will give 
before this Subcommittee will be the truth, the whole truth, 
and nothing but the truth, so help you, God?
    Mr. Duncan. I do.
    Mr. Winokur. I do.
    Mr. Jaedicke. I do.
    Dr. LeMaistre. I do.
    Mr. Blake. I do.
    Senator Levin. We are going to use a timing system today. 
About a minute before the red light comes on, you will see the 
light change from green to yellow, which will give you an 
opportunity to conclude your remarks. We have your written 
testimony, which will be printed in the record in its entirety, 
and so we would ask that you limit your oral testimony to no 
more than 10 minutes.
    Mr. Duncan, let us start with you.

  TESTIMONY OF JOHN H. DUNCAN,\1\ FORMER EXECUTIVE COMMITTEE 
  CHAIR, BOARD OF DIRECTORS, ENRON CORPORATION, HOUSTON, TEXAS

    Mr. Duncan. Chairman Levin, Senator Collins, and Members of 
the Subcommittee, good morning and thank you for the 
opportunity to address this Subcommittee. My name is John 
Duncan. From 1967 to 1985, I was a Director of Enron's 
predecessor company, Houston Natural Gas, and I was there when 
Enron began in 1985. I have served as the Chairman of the 
Executive Committee since 1986. Thus, I am the Enron Director 
who has served the longest period of time. Until the Fall of 
2001, I considered Enron one of the great companies of this 
country, and I was proud to be one of its directors. I resigned 
from the Board in March 2002.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Duncan appears in the Appendix on 
page 113.
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    After receiving my bachelor's degree in business 
administration at the University of Texas, I set out to become 
a businessman, to start and run my own company. With the 
exception of the first job, in a family business, and a stint 
in the U.S. Air Force during the Korean War, I have not drawn a 
paycheck from a company of which I was not either the founder 
or the co-founder.
    As co-founder and President of Gulf and Western and founder 
of Gulf Consolidated Services, both companies had small 
beginnings and wonderful success stories. During the course of 
my career, I have served on the board of seven New York Stock 
Exchange Companies, and, Senator Durbin, not all at one time. I 
have also served and chaired the boards of several important 
Texas institutions, including the Chancellor's Council of the 
University of Texas System, Southwestern University in 
Georgetown, Texas, the Board of Visitors at M.D. Andersen 
Cancer Center, and all the metropolitan Houston YMCAs.
    I provide that background to the Subcommittee to 
respectfully suggest that I have had substantial experience and 
exposure to the workings and to the role and to the duties of a 
board of directors. I also know a board's limitations. That is 
what I want to talk about today. In particular, I want to focus 
on what I believe are the elements of an effective board and 
why I believe the tragic events of Enron occurred.
    First, I believe the directors must be individuals who 
possess integrity and intelligence. They also should 
collectively bring a broad spectrum of knowledge and experience 
in the areas of business and finance and in the particular 
fields that the company is in. People usually acquire this 
experience by having operated a company with a significant 
budget or by having obtained unique experience from other 
professions that are relevant to the company's mission.
    The Directors of the Enron Board certainly possess, in my 
opinion, these qualities. My colleagues are highly ethical and 
of good character. As far as intelligence goes, I can simply 
say that if education is any measure, I believe I was one of 
only two directors who did not have a master's degree or a 
doctorate degree. Our directors are experienced, successful 
businessmen and women, experts in areas of finance and 
accounting, and have had experience in leading large 
institutions. Others, like our overseas directors, brought 
experience in certain areas of the world in which Enron saw 
great business potential.
    Second, I believe the board must be dedicated and diligent 
in addressing the matters that are presented to it. The 
directors need to do their homework, analyze the issues, ask 
penetrating questions, and make decisions that are always in 
the best interest of the shareholders.
    In my opinion, the Enron directors met this criteria. We 
worked hard. We prepared for meetings. We asked probing 
questions and imposed specific controls and procedures that 
management and outside advisors were required to follow. I know 
that my colleagues here today will address those items in more 
detail. We were also willing to say ``no'' to management when 
we did not agree with its recommendations.
    A good example of exercising a board's responsibility and 
to act independently in the company's best interest occurred 
only last September, when all the indicators that we had were 
still positive and before any of the outside directors was 
aware that Enron was in trouble. We were presented two 
transactions at the Executive Committee and the Board; 
management requested to authorize the purchase of two pulp 
paper mills at a price in excess of $300 million cash. We did 
not approve these acquisitions because we were concerned about 
a prior acquisition in the same field; we did not like the 
purchase price; and we wanted to preserve our financial 
flexibility in the light of the September 11 tragedies. We 
postponed our decision, but we now know that subsequent events 
soon overtook us and the company.
    I did not sit on the Audit Committee or the Finance 
Committee, but I did sit in as a guest at a number of their 
meetings. I witnessed my colleagues asking probing questions of 
management and independent accountants. In my opinion, these 
committees and these members thoroughly executed their duties.
    Third, I think that a board cannot be successful unless it 
feels comfortable relying on the intelligence and integrity of 
the management, as well as other advisors who present matters 
to the board. With over 20,000 employees working at the 
company, with over 200 lawyers writing contracts every day, and 
with over 400 accountants posting the daily books, we, the 
directors, had to rely on the reports given to us by the 
officers of the company. Frankly, there is no other way that we 
could direct effectively a company of that size. We felt 
confident relying on the senior management of the company, as 
we truly believed we had hired some of the best and the 
brightest in the industry. National, independent publications 
lauded the Enron officers for their intelligence, leadership, 
and creativity.
    Finally, I believe the management and other advisors 
reporting to the board must tell the truth. They must tell the 
complete truth, good or bad, in order for the board to make 
informed decisions. We now know this did not happen at Enron. 
The Board had implemented mechanisms and controls to ensure, at 
the very least, it obtained early warning signals of any 
impending problem. Among other procedures, we created a risk 
management officer position, and we staffed that department 
with nearly 100 employees. That officer and that department was 
responsible for reporting to the Board the most significant 
concerns and credit issues that faced the company. That did not 
happen.
    It is now quite clear that significant information about 
related party transactions was withheld from us. We were not 
aware, for example, of the problems of Chewco. They were 
withheld from us for years. We were not informed about Raptor 
III. We were not told about the $800 million recapitalization 
of the Raptors in late 2000 and 2001. We were not told that 
employees, in addition to Andy Fastow, were participants in a 
number of partnerships, and we were unaware of their 
substantial windfall profits.
    As late as the August 14, 2001 Board meeting, the Board was 
briefed on the financial condition of the company. Your staff 
has that briefing. The report was--earnings were up, balance 
sheet was stable, except maybe a credit rating improvement in 
the year 2002. Various Power Point slides given at that same 
meeting indicated to the Board that the company's good business 
was still improving as usual. The Powers Report and the reports 
we now have read in the press indicate that for many months, if 
not years, certain members of management and our outside 
auditors were well aware of the problems facing the company, 
and they did not tell us.
    In sum, I do not believe that Enron's fall would have been 
avoided had the Board asked more questions, implemented more 
controls, or avoided certain financing projects, because they 
were too complicated or risky. Rather, I believe if management 
had implemented the Board's controls, as they assured us they 
had, if just one of the Board's officers or employees had 
fulfilled his or her corporate duty to reveal these problems or 
to any one director, or if the outside auditors had executed 
their obligation to convey to us concerns they privately 
expressed and documented amongst themselves, that I and we 
would not be here today.
    I thank you for allowing me to make this statement.
    Senator Levin. Thank you very much. Dr. Winokur.

  TESTIMONY OF HERBERT S. WINOKUR, JR.,\1\ FINANCE COMMITTEE 
   CHAIR, BOARD OF DIRECTORS, ENRON CORPORATION, GREENWICH, 
                          CONNECTICUT

    Mr. Winokur. Chairman Levin, Senator Collins, Members of 
the Subcommittee, good morning and thank you for the 
opportunity to address you. My name is Herbert S. Winokur, Jr. 
I currently am a member of the Board of Directors of Enron 
Corporation. I have served as Chairman of the Finance Committee 
of the Board of Directors and have been a member of the Board 
since the mid-1980's. I volunteered for and served as a member 
of the Board's special investigative committee, the Powers 
Committee, to understand what happened at Enron.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Winokur appears in the Appendix 
on page 116.
---------------------------------------------------------------------------
    I appreciate the opportunity today to talk with the Members 
of this Subcommittee about the involvement of Enron's Directors 
in the related party transactions that have received so much 
attention and about our oversight of Enron more generally.
    In my opinion, and it is only my opinion, one of the 
principal causes of Enron's failure was the loss of lender and 
investor confidence that resulted from the three significant 
restatements to Enron's financial statements presented in 
October and November 2001. Two related to earnings restatements 
for 4 and 2 years, respectively, and the third, a significant 
reduction in shareholder equity. While a related party was 
involved in each transaction, the related party aspect does not 
appear to have been a factor in any of the accounting errors.
    In none of these three restatements did the Board or its 
Audit Committee have prior knowledge of the errors that were 
required to be corrected. In each case, Enron's management had 
approved the original financial statement presentations, and as 
appropriate, Arthur Andersen had certified or reviewed them.
    With that in mind, I would like to discuss three areas. 
First, how Enron's Board of Directors and Finance Committee 
discharged its obligations; second, the specific circumstances 
in which we approved the LJM structures and the controls we put 
in place; and finally and very briefly, certain of the hedging 
transactions that the Board approved.
    Enron's Finance Committee reviewed regularly the company's 
financial ratios and liquidity. At our meetings, Enron 
management routinely presented Enron's actual and projected 
financial ratios and near-term liquidity, a report on 
relationships and meetings with the credit rating agencies, and 
an analysis of Enron's borrowing costs relative to those of its 
competitors, which informed us of the market's contemporaneous 
view of Enron. Between meetings, we also received and read 
reports on Enron from Wall Street equity and debt analysts, 
including the analysts' detailed financial projections.
    Let me turn to the Finance Committee's involvement in the 
approval and oversight of the LJM partnerships. The press and 
others have reported repeatedly that Enron's Board waived the 
code of conduct when it permitted Enron's Chief Financial 
Officer, Andy Fastow, to serve as general partner of LJM1 and 
LJM2. The Board did not.
    For many years, Enron has maintained a code of conduct with 
which every employee must comply. It also permits the Chief 
Executive Officer to make a determination that an officer's 
investment ``presents no probability of any conflict of 
interest.''
    When the Board approved LJM1 in June 1999, the Board 
adopted and ratified the determination by the Office of the 
Chairman that Andy Fastow's participation as managing partner 
``will not adversely affect the interests of the company.'' The 
Board was told that PricewaterhouseCoopers would be rendering a 
fairness opinion on the transaction between LJM and Enron with 
which we were presented and that Mr. Fastow would have no 
direct pecuniary interest in the Enron stock, which was used as 
part of that transaction as credit support. Enron publicly 
disclosed this transaction, including the related party aspect, 
and Arthur Andersen reviewed it as part of its 10-Q review in 
June.
    At the October 1999 Finance Committee and Board meetings, 
Mr. Fastow recommended to obtain quick, flexible equity to 
Enron with reduced transaction costs, that he be permitted to 
organize and serve as managing partner of LJM2, a newly formed 
fund with outside investors that would be an alternative and 
optional source of private equity. There would be no 
requirement that Enron trade with LJM2. He proposed that the 
Chief Accounting Officer review and approve all transactions 
between Enron and LJM2.
    The Finance Committee, after questioning, learned that 
Arthur Andersen was fine with the partnership structure and 
that LJM2's limited partners were expected to be institutional 
investors who would be able to remove Mr. Fastow without cause. 
The Finance Committee augmented these controls by requiring 
that the Chief Risk Officer also review and approve all 
transactions and that the Board's Audit Committee review all 
transactions annually and make any recommendations it deemed 
appropriate. The Board ratified the Office of the Chairman's 
determination that Mr. Fastow's participation would not 
adversely affect the interest of the company. Enron publicly 
disclosed LJM2 as a related party transaction.
    Updates given to the Finance Committee about the LJM 
transactions were positive. At the May 2000 Finance Committee 
meeting, Mr. Fastow reported that he was personally devoting 
approximately 3 hours a week to the investment vehicles. We 
were also told that LJM2's investments had a projected rate of 
return of 17.95 percent. Mr. Causey, the Chief Accounting 
Officer, told us that Arthur Andersen was comfortable with the 
governance structure of LJM. We, of course, now know that the 
LJM2 investors received much higher returns.
    The minutes of the October 2000 Finance Committee also show 
that the Committee continued to focus on Mr. Fastow's dual 
role. Mr. Fastow described to the Committee six of the 
mechanisms that had been put in place to mitigate any potential 
conflicts, one of which was that Messrs. Buy, Causey, and 
Skilling approve all transactions between the company and LJM 
funds. A second was that Mr. Fastow maintain his fiduciary duty 
to Enron. In addition to these controls that Mr. Fastow 
described, the Committee instructed management that the Board's 
Compensation Committee review Mr. Fastow's compensation and 
that the Finance Committee, in addition to the annual review by 
the Audit Committee, conduct a quarterly review of the 
transactions between the company and the LJM funds.
    The Finance Committee received its first quarterly and the 
Audit Committee its second annual report on the related party 
transactions with LJM on February 12, 2001, from Mr. Causey. 
Mr. Causey discussed the Board-established guidelines for 
transacting with LJM. He then told the Board that the company 
had adopted certain procedures and controls in response to the 
Board's direction and reviewed the checklist review 
complemented by the adoption of additional controls. Mr. Causey 
informed the Finance Committee that the controls ``had been 
discussed with the Audit and Compliance Committee and commented 
that the process was working effectively.''
    The preceding, I submit, illustrates that the Board applied 
Enron's code of conduct when it ratified management's 
recommendation regarding LJM1 and LJM2 and added substantial 
additional controls to ensure that all of the Enron LJM 
transactions would be in the best interest of the company. The 
record also indicates that the directors regularly monitored 
the LJM transactions and management's involvement. We asked for 
and repeatedly received reports informing us that the controls 
were working and that there were no concerns raised either by 
management or our outside auditors.
    Let me turn to the financing. Enron has been criticized for 
its use of off-balance-sheet financing or special purpose 
vehicles to raise debt and equity. This practice is common and 
permitted by the accounting rules, if structured correctly. For 
example, leasing companies and reinsurance companies exist to 
provide off-balance-sheet financing to their customers. The 
Board also has been criticized for authorizing hedge 
transactions involving these vehicles that made use of Enron 
stock for credit support. Let me respond.
    Enron owned certain highly volatile high-technology 
investments. That combination of volatile investments and 
required mark-to-market accounting had the potential to create 
instability and unpredictability in Enron's income statement. 
Putting in place hedges to mitigate these risks made good 
business sense. In fact, companies have been sued by their 
shareholders because they failed to put in place hedges on 
significant and volatile investments.
    Management wanted, appropriately, to use the significant 
unrealized value and forward contracts on Enron stock most 
effectively for the benefit of Enron's stockholders. It 
informed the Board that the proposed hedge transactions did so. 
Outside auditors concurred, or in one case, provided fairness 
opinions.
    In conclusion, what happened at Enron has been described as 
a systemic failure. I see it instead as a cautionary reminder 
of the limits of a director's role. A director's role, by its 
nature, is a part-time job. By force of necessity, we could not 
know personally all of Enron's employees. As we now know, key 
managers and employees whom we thought we knew proved to 
disappoint us significantly, and outside advisors whom we 
believed to be critical components of an effective oversight 
role failed in their duty. Arthur Andersen's failure to 
disclose its concerns to the Board, as well as management's 
marked disregard for the required internal controls and lack of 
candor with respect to information owed to us deprived the 
Board and deprived me of the ability to deal proactively with 
these problems. We cannot, I submit, be criticized for failing 
to address or remedy problems that had been concealed from us.
    Three months ago, days after the release of the Powers 
Committee report, I appeared before a House subcommittee. At 
that time, I was deeply disturbed and disappointed with what I 
had learned. I also squarely disagreed with certain 
conclusions, particularly about the directors' judgment and 
oversight, presented in the report, which disagreement I 
expressed during my testimony.
    Even with the benefits of a few more months to review these 
issues, I remain resolute in my belief that we were diligent 
and dedicated to our charge. Based on the recommendations, 
advice, and information we received from management and our 
advisors, we, the directors, acted in good faith and attempted 
to pursue the best interests of Enron and its shareholders. 
However, I deeply wish that at least one person in management, 
an employee, or an outside advisor, someone had come forward to 
the Board with his or her concerns when we could have addressed 
them.
    I am prepared to respond to any questions from the 
Subcommittee. Thank you.
    Senator Levin. Thank you very much. Dr. Jaedicke.

TESTIMONY OF ROBERT K. JAEDICKE,\1\ FORMER AUDIT AND COMPLIANCE 
    COMMITTEE CHAIR, BOARD OF DIRECTORS, ENRON CORPORATION, 
                        BOZEMAN, MONTANA

    Mr. Jaedicke. Chairman Levin, Senator Collins, and Members 
of the Subcommittee, good morning and I also thank you for the 
opportunity to address the Subcommittee. My name is Robert 
Jaedicke. I served as the Chairman of the Audit Committee of 
the Board of Directors of Enron Corporation. As part of an 
overall restructuring of the Board, I recently resigned as a 
director, having served since the mid-1980's.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Jaedicke with attachments appears 
in the Appendix on page 155.
---------------------------------------------------------------------------
    Let me tell you very briefly about my background. I joined 
the faculty of the Stanford Graduate School of Business in 
1961. I served as Dean of the school from 1983 to 1990. At that 
time, I returned to the faculty of the Business School, and I 
retired from the university in 1992.
    Throughout my tenure as Chairman of the Enron Board's Audit 
Committee, I was committed to ensuring that it was an effective 
and actively functioning body. Over the last few years, we 
undertook to review and strengthen our already vigorous control 
systems. In 1999, we began a number of initiatives to ensure 
that we remained a ``best practices'' audit committee. 
Throughout 2000 and into 2001, our committee worked with Arthur 
Andersen to make sure that we complied with the recommendations 
of the Securities and Exchange Commission, the New York Stock 
Exchange, and the Blue Ribbon Committee on Improving the 
Effectiveness of Corporate Audit Committees. That effort 
culminated in February 2001, when the Audit Committee drafted a 
new charter that was approved by the full Board.
    The lifeblood of the work of any audit committee is the 
development and implementation of adequate controls, many of 
which cross-check each other. The committee's responsibility is 
to review reports from management and the outside auditors, to 
review the adequacy of internal controls, and to oversee the 
filing of financial statements. The committee's effective 
oversight also depends on the full and complete reporting of 
information to it. Without full and accurate information, an 
audit committee cannot be effective. The audit committee does 
not manage the company and does not do the auditing.
    It is my understanding that audit committees of most 
corporations, like Enron, typically meet for a few hours 
several times a year. Warren Buffet wrote to the New York Stock 
Exchange Chairman and CEO Richard Grasso in 1999, and I quote, 
``An audit committee that meets for a few hours several times a 
year is simply not going to pick up anything that is missed by 
the outside auditors. Therefore, the task of the audit 
committee should be to hold the feet of the outside auditors to 
the fire.'' In that same letter, Mr. Buffet also stated, and I 
quote, ``Simply put, audit committees cannot act as auditors. 
Their true job, and I would argue the only important function 
that they can adequately discharge, is to make sure that the 
auditors do their job instead of becoming subservient to 
management.''
    I agree. We held regular meetings at least four or five 
times a year; always four, usually five. At meetings, we 
received reports from a broad range of senior management and 
Arthur Andersen personnel. Audit Committee meetings regularly 
included three Arthur Andersen partners, Enron's Chief 
Accounting Officer, Chief Risk Officer, General Counsel, Chief 
Internal Auditors, Mr. Lay, Mr. Skilling, and other senior 
officers and outside advisors, as appropriate. We were entitled 
to rely on these reports. We asked questions. We provided 
oversight. We received several special reports on accounting 
policies. And we continually discussed the adequacy of our 
internal controls. I respectfully submit that we did our job.
    At each Audit Committee, it was my invariable practice to 
hold--or at least offer to hold--an executive session with the 
Arthur Andersen representatives where they could meet with us 
without management present. There, Arthur Andersen could freely 
report to the committee any matters of concern that made the 
auditors uncomfortable, including whether they had any 
significant disagreements with management, whether they had 
full cooperation of management, whether reasonably effective 
accounting systems and controls were in place, whether there 
were any material systems and controls that needed 
strengthening, and whether they had detected instances where 
company policies had not been fully addressed.
    Arthur Andersen did not raised concerns about the 
partnerships in these executive sessions. In fact, they 
normally reported to us that the structures and transactions 
were complex, they required judgment, but that they were in at 
an early stage to understand and review the transactions and 
that they were comfortable with the accounting treatment.
    Last February, Alan Greenspan testified before the 
Congress, ``I have served on too many audit committees to know 
that even though I would consider myself independent, I would 
consider myself knowledgeable, I did not know what questions to 
ask the Chief Financial Officer during meetings to find out 
what it is that conceivably is wrong in the corporation, and he 
was not about to tell me.''
    I agree with Mr. Greenspan. We did everything possible to 
ensure that our controls and procedures were being followed. To 
my knowledge, we were one of the few major corporations that 
required Arthur Andersen or their outside auditor to give an 
attest opinion on the management's assertions that our controls 
were adequate.
    What happened at Enron, as my colleague has indicated, has 
been described as a systemic failure. I agree with him as it 
pertains to the Board. I see it as a cautionary reminder, also, 
of the limits of the director's role. We served as directors of 
what was then the seventh-largest corporation, which required 
us to confine our attention to the broad policy decisions. At 
meetings of the Board and its committee, in which all of us 
participated, these issues were considered and decided on the 
basis of summary reports, corporate records, upon which we were 
entitled to rely. We also relied on the honesty and integrity 
of management, their subordinates and advisors, and on the 
integrity of the information we were receiving. At the time, we 
had no doubt--we had no reason to doubt the integrity of either 
the management or the advisors.
    We did all this and more. Sadly, despite all that we tried 
to do in the face of all the assurances that we received, we 
had no cause for suspicion until it was too late.
    Thank you very much, and I am prepared to respond to 
questions from the Subcommittee.
    Senator Levin. Thank you very much, Dr. Jaedicke. Dr. 
LeMaistre.

TESTIMONY OF CHARLES A. LeMAISTRE,\1\ M.D., FORMER COMPENSATION 
AND MANAGEMENT DEVELOPMENT COMMITTEE CHAIR, BOARD OF DIRECTORS, 
             ENRON CORPORATION, SAN ANTONIO, TEXAS

    Dr. LeMaistre. Chairman Levin, Senator Collins, Members of 
the Subcommittee, we are delighted to be here to participate in 
your investigation. Senator Durbin, I want to assure you that 
we were shaken to the core, also. It is a very good description 
of what happened by the events that we first learned about on 
October 17, that our controls were not being followed. The 
Board thereafter took immediate action on several fronts, one 
of which was very valuable to you in your investigation, the 
no-holds-barred Powers Report, which enlightened all of us as 
to where the problems were.
---------------------------------------------------------------------------
    \1\ The prepared statement of Dr. LeMaistre with an attachment 
appears in the Appendix on page 176.
---------------------------------------------------------------------------
    My name is Charles LeMaistre. I am a physician by 
profession. I am also President Emeritus of the University of 
Texas M.D. Anderson Cancer Center and former Chancellor of the 
University of Texas System. For 17 years, I have served on the 
Enron Board. For most of those years, I have held a position as 
Chairman of the Compensation and Management Development 
Committee. I resigned in March 2002 as a part of the 
restructuring of that Board.
    I would like to directly address some of the questions that 
have been raised regarding compensation and the bonus process 
for executives. The Compensation Committee's basic 
responsibility is to assure that the senior executives of the 
company are compensated effectively in a manner consistent with 
the compensation strategy stated to the shareholders. The 
Committee considered internal equity, competitive compensation 
practices, and the requirements of appropriate regulatory 
bodies.
    The philosophy behind the executive compensation is to 
reward executive performance that creates long-term shareholder 
value, in essence, a pay-for-performance philosophy that 
benefits the shareholder. Executives had the opportunity to 
earn up to the 75th percentile or higher of the compensation 
rates at comparable competitive companies, subject to obtaining 
a performance at 75th percentile or higher.
    As a first step in this process, we received the 
recommendations from management and discussed their 
justifications fully. We also relied almost always on the 
outside executive firm, Towers Perrin, to independently review 
the recommendations and give us advice and a recommendation 
regarding the various compensation issues brought to the 
committee. Based on that advice, the committee arrived at 
proposals for presentation to the Board, and they deliberated 
on these very carefully and for long hours in order to arrive 
at a common position.
    In recent years, the Compensation Committee was dealing 
with Enron's evolution from a pipeline company to an energy 
trading company that engaged in sophisticated and complex 
financing structures. Enron sought out different talent for its 
management in the energy trading business. To hire and 
successfully retain these highly-sought individuals, Enron 
needed to offer compensation packages equivalent to, and 
sometimes better than, those offered by the competition. Enron 
believed that the talented individuals leading the company were 
one of the most valuable assets the company had and critical to 
its success. Towers Perrin was often asked to craft 
compensation packages, stress test the executive compensation 
plan, and conduct surveys of competitive practices to be sure 
Enron was well positioned in the marketplace.
    Let us go into some compensation-related issues. First, 
with regard to Ken Lay, the media and others have raised many 
questions about Mr. Lay's compensation. In particular, I would 
like to address the $141 million he received in total 
compensation for the year 2000. It has been suggested that this 
level of compensation was unreasonably high and over 10 times 
the average received by the CEOs of the top 200 companies.
    First, I believe that comparing Mr. Lay's total 
compensation against the average salary of the CEO in a top 200 
company does not necessarily yield an accurate picture. Because 
Mr. Lay's compensation placed him in the top 10 highest-paid 
CEOs, I believe that comparing his compensation to those in 
that category is more accurate. Within the top ten, Mr. Lay was 
ranked seventh that year. Enron, coincidentally, was ranked as 
the seventh largest company. The average compensation for the 
top 10 CEOs was about $169 million. The top compensation was 
$293 million. I have attached a chart to my statement that 
presents this information.
    Second, I think it is important to break out what comprises 
Mr. Lay's total compensation package to determine the actual 
cost to the company for that year. A very large portion of the 
total compensation is at risk under the pay-for-performance 
philosophy. The portion at risk depends upon meeting 
competitive criteria for the future value from stock options 
exercised to be realized and from restricted stock payouts to 
be realized. For this portion at risk, the executive is 
rewarded only if the shareholder is rewarded.
    If the ``at risk'' portion is subtracted from the total, 
you arrive at about $10 million, which I believe is a more 
accurate representation of what Mr. Lay's 2000 compensation 
cost the company that year. I also note that 2000 was an 
extraordinary year for Enron and its shareholders, which 
accounts for the large increase in bonus for that year. That is 
roughly $10 million, including his base salary of $1.3 million 
and a bonus of $7 million. Mr. Lay's compensation was disclosed 
and footnoted and detailed in the proxy statement each year.
    Next, Andy Fastow's salary from the LJM partnerships. On 
October 19, 2001, the Wall Street Journal reported that Mr. 
Fastow and possibly some of his partnership associates received 
more than $7 million in compensation from the LJM partnerships. 
Let me comment on what I know about his LJM compensation.
    On October 19, a special meeting of the full Board was 
called to discuss Mr. Fastow's compensation from the LJM and 
other related matters. We went into it in some detail, and on 
October 22, 2001, the Board authorized Mr. Duncan, Chairman of 
the Executive Committee, and myself, as Chairman of the 
Compensation Committee, to inquire directly of Mr. Fastow as to 
his compensation from the partnerships. Enron's General Counsel 
drafted the questions we would ask. I called Mr. Fastow on 
October 22 and arranged for a conference call the very next 
day.
    On that call, Mr. Duncan and I asked Mr. Fastow about the 
amount of his investment in LJM1 and LJM2 and his return on 
those investments. Mr. Fastow responded that his commitment in 
LJM1 and LJM2 was $1 million and $3.9 million, respectively. He 
stated that his income from LJM1 was $23 million, and 
approximately $22 million from the LJM2. On October 24, the 
very next day, the Board met. Mr. Fastow was relieved of his 
responsibility as Chief Financial Officer.
    I do not believe that the Board of Directors would ever 
have approved Mr. Fastow's participation in the partnerships if 
we had known he would be generating such compensation. Indeed, 
we were told just the opposite. Very conservative yields should 
come from the formulas that were presented to the Board. If 
management had instituted the controls that the Board 
authorized, Mr. Fastow's compensation would have been reported 
to Mr. Skilling, the Audit Committee, the Finance Committee, 
and the Compensation Committee.
    On October 6, 2000, the Finance Committee meeting minutes 
clearly show from his own presentation that Mr. Fastow was 
aware of the six controls imposed by the Board on his 
participation in LJM, including his responsibility to review 
with Mr. Skilling ``his economic interest in the company and 
the LJM funds.'' Following Mr. Fastow's presentation, the 
Finance Committee then added to the existing controls a 
quarterly review of the LJM transactions and a review by the 
Compensation Committee of Mr. Fastow's LJM compensation. That 
meant there would be two full reviews by the Finance Committee 
and the Audit Committee, one on a quarterly basis and the other 
on an annual basis, through which that information should have 
come in addition to the newly authorized review by the 
Compensation Committee.
    Enron's Performance Unit Plan has been confusing to many. I 
would like to comment briefly on it. Prior to 1999, Enron 
granted performance units to corporate and certain operating 
company executives who were not in an Enron long-term incentive 
plan at that time. These operating company executives were, for 
the most part, in commercial support and in the pipeline 
business. Enron was a highly decentralized company at that 
time.
    The first performance units were awarded in 1987 and the 
last in 1998. The units have a life of 4 years, so the payouts 
could still be continuing as of last year. Awards were based on 
Enron's total shareholder return over the 4 years. The 
participants were nominated by the Office of the Chairman and 
approved by the Compensation Committee. There was a limit of 
three million performance units per individual. Performance was 
measured against that of a performance of peer group of 
companies with a payout scale of one to seven. Each unit was 
assigned a valuation of $1. A ranking of one had a payout of 
$2, twice the value, and a ranking of seven did not pay out 
anything. In the event that the total shareholder return did 
not exceed the cumulative percentage for the 90-day Treasury 
Bill, a performance unit would have no value.
    In conclusion, I believe that our Committee and the Enron 
Board endeavored to manage carefully and effectively Enron's 
executive compensation while the company was rapidly evolving, 
growing, and undertaking new business opportunities. The 
Committee sought and relied on the advice of outside executive 
compensation experts to ensure our recommendations and 
decisions were consistent with the marketplace. Although the 
Board was willing to award compensation that was competitive 
and deserved, it certainly did not approve and was not made 
aware by management that some individuals reaped huge profits 
at the company's expense or that others abused certain benefits 
in ways for which they were not designated.
    Thank you very much for your attention. I will be pleased 
to answer your questions.
    Senator Levin. Thank you very much, Dr. LeMaistre. Mr. 
Blake.

   TESTIMONY OF NORMAN P. BLAKE,\1\ INTERIM CHAIR, BOARD OF 
        DIRECTORS, ENRON CORPORATION, ROSEMONT, ILLINOIS

    Mr. Blake. Thank you, Mr. Chairman. It is good to be here, 
Senator Collins and Members of the Subcommittee. It is 
certainly a privilege to be here and I thank you for the 
opportunity.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Blake appears in the Appendix on 
page 181.
---------------------------------------------------------------------------
    My name is Norm Blake. I am Interim Chairman of the Board 
of the Enron Corporation. I have been a Director of Enron since 
1993. Since the onset of bankruptcy, five members of the Board 
and I have been actively engaged in the development of a newly 
constituted Board of Directors in cooperation with Enron's 
Creditors Committee. It is the intention of these Board members 
and me to resign from the Board once an orderly and effective 
transition of authority has taken place. We are now serving on 
a pro bono basis in recognition of our responsibility to serve 
the interests of Enron's stakeholders and employees.
    My background can essentially be characterized as having 
extensive management and leadership experience in a variety of 
industries, with significant involvement in financial services. 
Over the last 12 years, I have been Chairman and CEO of three 
different Fortune 500 companies and held board membership 
positions in others. Much of my earlier business career was 
with the General Electric Company, with my latest position in 
1984 being Executive Vice President of Financing Operations for 
the General Electric Credit Corporation.
    My colleagues in their statements today will discuss the 
Board's and its committees' respective roles and involvement in 
the related party transactions. I would like to focus on 
certain issues that have been raised with respect to the Board 
and the outside Directors as a collective unit.
    I will begin by saying unequivocally that I am proud to 
have served as a member of the Board with such capable, hard 
working, intelligent, and ethical individuals. Personally, I 
believe while we may have initially just been a collection of 
individuals, we have now evolved into a very cohesive and 
collegial group. Moreover, in my view, this Board has remained 
diligent and dedicated to its responsibilities throughout the 
process.
    Although we, at the time, had much confidence and respect 
in the abilities of the management of the company, we did, in 
fact, operate independently and did, in fact, exert our 
influence, and at times, contrary to the wishes of management. 
For example, the decision made by the majority of the Board to 
acquire Wessex and form Azurix was made over the dissention of 
two Directors and abstention of another. More recently, 
management's intention to acquire a pulp mill in October of 
last year was resisted by the Board to the extent that the 
decision was not made to make the acquisition.
    Allow me to put Enron into perspective over the last couple 
of years, and as cited by many of you this morning. By 2000, 
Enron was one of the 10 largest companies in the United States. 
Enron had begun a transformation from a traditional pipeline 
and energy company with substantial fixed assets to an 
innovative energy trading company that showed tremendous 
potential but required liquidity and creditworthiness.
    My personal focus as a member of the Board and its Finance 
Committee had been Enron's liquidity and financial leverage in 
furtherance of this strategy. As a Board, we were attentive to 
and working with management and outside experts to realize this 
mission. We believed that the company was successful in moving 
in that direction. In late 2000 or early 2001, no one had 
predicted by the end of 2001, Enron would file for bankruptcy. 
In fact, as late as October 2001, we were informed by 
management that we were ahead of plan in terms of earnings and 
that creditworthiness and liquidity issues were manageable.
    A central issue at hand involves Enron's intentions in 
establishing SPEs. I would like to provide an opposing point of 
view to that held by many that the intention of Enron in 
establishing these partnerships was to manufacture earnings. To 
the contrary, it is my opinion that the primary purpose of 
these partnerships was to improve liquidity and get debt off 
our balance sheet. The LJM partnerships were specifically 
constituted for that purpose, and by the way, I would contend 
that many companies establish SPEs for exactly such a purpose.
    Of course, now, with the benefit of hindsight, committees 
of Congress, the media, government officials, financial 
experts, and others have tried to dissect and examine what went 
wrong at Enron. Over the past several months, several questions 
have been raised with respect to the Directors as a group. In 
particular, people ask if the Board failed in its oversight 
duty, whether Enron was moving so quickly that independent 
directors could not keep up.
    I think not. We worked hard. We worked very hard. We came 
prepared and we asked questions. We were sent materials in 
advance of meetings and it seemed that each Director reviewed 
them and came to the meetings prepared. Sometimes before a 
Board meeting, after spending many hours in preparation for 
these meetings, I would speak with Mr. Skilling about the 
balance sheet issues or with the Chief Risk Officer, Rick Buy, 
about liquidity, leverage, and credit issues.
    I know that my fellow Director Pug Winokur, who is here 
today, spent time with Enron's Chief Financial Officer, Andy 
Fastow, before meetings, asking him a variety of questions. And 
Dr. LeMaistre, who is also appearing with us today, spent much 
of his time in advance of upcoming Compensation Committee 
meetings with Enron's human resource and compensation staff, as 
well as external consultants, to ensure himself that he 
understood all the technical aspects of Enron's compensation 
plans and to be in a position to evaluate recommendations made 
by management. He took his job very seriously, as we all did. 
In short, I believe, judged by any standard, that this Board 
executed its duties to the company and its shareholders.
    During Board and committee meetings, we did, in fact, 
question management. For example, during October 1999 Finance 
Committee, in which we discussed the LJM2 partnership, the 
Board material discloses that I specifically asked whether 
Arthur Andersen had reviewed the partnership. We were told by 
the Chief Accounting Officer that Arthur Andersen was, ``fine 
with it.'' If we had been told that Arthur Andersen had not 
reviewed the structure or that Arthur Andersen had 
reservations, this Board would never have approved it.
    The first Raptor transaction was brought to the Finance 
Committee, in May 1, 2000. The minutes reflect the Chief 
Accounting Officer told us that, ``Arthur Andersen LLP had 
spent considerable time analyzing the Talon structure and the 
governance structure of LJM2 and was comfortable with the 
proposed transaction.'' This advice was critical to our 
decision to authorize this transaction. Some commentators have 
since suggested that the structure of this transaction was 
inappropriate on its face. This is not the advice that we 
received. My fellow directors asked questions pertaining to 
propriety and the oversight of these transactions. We did not 
rubber stamp management's recommendations and requests.
    Even with the benefit of hindsight, I cannot speculate as 
to what else we could have done to ensure that our controls and 
procedures were followed. We put the right controls in place 
and we asked the right questions. These directors were a smart 
and talented group of people who brought a diversity of 
experience and expertise to the Board. Unfortunately, I believe 
that we were uninformed because management and outside experts 
who reported to us failed in their jobs and did not give us 
full and complete information.
    Again, I thank you for being here today. I welcome the 
opportunity to answer your questions. Thank you, sir.
    Senator Levin. Thank you very much, Mr. Blake.
    Let me start with you, Dr. Jaedicke. You were Chairman of 
the Audit Committee. The Audit Committee got an annual briefing 
from Andersen about its accounting policies and its practices, 
as you have testified. We have a number of excerpts from those 
briefings in the exhibit book, and I wish you would turn to 
Exhibit 2.\1\
---------------------------------------------------------------------------
    \1\ See Exhibit No. 2 which appears in the Appendix on page 204.
---------------------------------------------------------------------------
    Mr. Jaedicke. Yes, sir.
    Senator Levin. Exhibit 2 is part of the Andersen briefing 
on February 7, 1999. It relates to the Enron financial 
reporting in 1998, which was the previous year that had just 
finished. Now, this was an unusual Audit Committee meeting, 
because instead of taking place in Houston, it took place in 
London. Do you remember this meeting in London?
    Mr. Jaedicke. Yes, I do.
    Senator Levin. Thank you. The Board's minutes reflect that 
David Duncan, the Andersen partner who headed the Enron audit 
team, and that Tom Bauer, who was also on the audit team, and 
that Steve Goddard, who was head of the Andersen office in 
Houston, were in attendance. Those were the three Andersen 
partners who typically dealt with your Audit Committee and the 
Board, and the minutes show that all of the Audit Committee 
members were there, as well as another Andersen employee and 
several members of Enron management, including Mr. Lay and Mr. 
Skilling.
    Now, this chart, or this document that you're looking at 
says at the top ``Risk Profile,'' which means the risk to Enron 
that its accounting practices may not be found to be in 
compliance with sound accounting practices. And you will see 
there the letters ``H'', ``M'', and ``L'', and those letters 
stand for high, medium, and low risk. So ``H'' stands for high, 
``M'' for medium, and ``L'' for low risk.
    Andersen was telling your Audit Committee about the risks, 
and the first item you will see on the list is highly 
structured transactions. These are the elaborate transactions 
which I talked about in my opening statement. And the chart 
here shows high risk, ``H'', circled for emphasis, in all three 
categories, including accounting judgments. So the document 
indicates--and this is a document from your files, so we know 
you were shown this document--that Enron was engaging in high-
risk accounting practices when it came to those structured 
transactions. Do you remember that presentation?
    Mr. Jaedicke. Yes, I do. Would you like me to comment on 
it, sir?
    Senator Levin. Feel free to do that.
    Mr. Jaedicke. I think the way--the interpretation--this was 
a template given to the Audit Committee to try to help us--to 
help us understand the kinds of accounting policies that were 
important to the company.
    Now, maybe ``risk'' is a poor term, but if you look, for 
example, at highly structured transactions, I think the way to 
read this, and I think the comments generally support this, is 
to say energy asset securitizations--now, this is in 1998--that 
the accounting judgments--read ``H'' as important. They are 
important because there is a risk that----
    Senator Levin. I am going to read ``H'' for what it stands 
for, which is high.
    Mr. Jaedicke. The risk, the judgments, they are complex. 
They need to be made very carefully.
    Senator Levin. Are you denying that ``H''----
    Mr. Jaedicke. Now just let me----
    Senator Levin. Excuse me. Are you denying that ``H'' means 
high?
    Mr. Jaedicke. OK, high. Disclosure judgment, the importance 
is high. The risk is high. It needs to be done carefully. The 
rule change--risk in the sense of rule change, I think simply 
means there is a high probability that the rules in this area 
will develop and can change, and they did.
    Now, if you just allow me to contrast that with something 
like purchase accounting down in the middle of the page, to 
judge whether the purchase accounting can be used instead of, 
say, a pooling of interest, that is an important, in your 
terms, high-risk area. You need to make a very careful 
judgment. But then if you move over, the disclosure is ``M''. I 
would assume that is medium. And it is because that issue has 
been around for a long time and there is a fair amount of 
guidance on it. It was already in existence in 1998. And if you 
go to the rule change, under ``L'', some rule change coming 
along, the odds were fairly low. About the only one at that 
time that was under consideration was to do away with pooling.
    And so I think what this is and what we used it for was a 
way of saying, well, where are the sensitive areas, what are 
their disclosure characteristics, and what are the odds that 
rule changes will come along and somehow change what either we 
have to do or the way we have to disclose or the way in which 
the accounting has to be done. That is my interpretation, sir.
    Senator Levin. Well, these are not my terms. These are 
Arthur Andersen's terms and they are circled. The ``H'' is not 
my term. It stands for high. You can say that the ``H'' under 
rule changes means there is a high risk that the rule may 
change, and I fully agree with you, but by that same logic, the 
``H'' under accounting judgments means there is a high risk 
involved in that judgment.
    So, Dr. Jaedicke, these are not my terms. These are the 
documents presented to you with ``H'', high risk, circled by 
Arthur Andersen in 1999.
    Next, Exhibit 3.\1\ The handwriting on this document 
belongs to David Duncan.
---------------------------------------------------------------------------
    \1\ See Exhibit No. 3 which appears in the Appendix on page 208.
---------------------------------------------------------------------------
    Mr. Jaedicke. Yes.
    Senator Levin. It is his handwriting on it, and this is 
basically Andersen's version of the previous exhibit, with the 
same matrix, but now it is a document with their talking points 
for the presentation that was made to you at that London Audit 
Committee meeting.
    I would like to direct your attention to the handwritten 
note in the lower right-hand corner. It is hard to read, so we 
put it up on the board here and made that Exhibit 4.\2\ This is 
what that note says at the bottom. ``Obviously, we are on board 
with all of these, but many push limits and have a high `others 
could have a different view' risk profile.'' High-risk profile. 
This is Duncan's note on this document. Then it lists those 
various accounting practices which you also see on Exhibit 4.
---------------------------------------------------------------------------
    \2\ See Exhibit No. 4 which appears in the Appendix on page 209.
---------------------------------------------------------------------------
    So not only was the Audit Committee told by Andersen that 
although Andersen was on board, that many of Enron's accounting 
practices, in the words used there, his note, ``push limits,'' 
and that others could view them as outside of compliance with 
Generally Accepted Accounting Principles. Now, do you remember 
David Duncan telling that to the Audit Committee on February 7, 
1999?
    Mr. Jaedicke. I do not remember David Duncan telling us 
this particular note. David Duncan did tell us on several 
occasions that these were complex transactions, that they were 
complex structures, that Enron was a complex company. They were 
moving very fast, and very careful accounting judgments were 
required.
    He also would, on occasion, try to indicate to us how much 
guidance was available on those. But in terms of--and I do not 
recall him saying, well, others could have a different view. 
But I think all of us understood that these were highly 
structured, new kinds of transactions, but please, sir, keep in 
mind, that was one reason that Enron paid Arthur Andersen some 
pretty hefty fees, to try to be in on the beginning of these 
transactions so that those accounting judgments, they 
understood the transaction and that the accounting judgments 
would be properly made.
    Senator Levin. You do not remember David Duncan notifying 
your Committee that these were high-risk accounting approaches?
    Mr. Jaedicke. I remember these--this chart, sir. I cannot 
say that I remember this quote that is in the bottom of his--
the lower right-hand corner of the----
    Senator Levin. If he had told you that they were high-risk 
accounting approaches, would you remember it?
    Mr. Jaedicke. I think I would. I do not quite--we knew 
these were important transactions.
    Senator Levin. I am using the words ``high risk.'' You can 
try to change that from a ``H'' to an ``I''. I am saying that 
the ``H'' was circled. It was Andersen's word. It was presented 
to you in the document in Exhibit 2. We have Duncan's note 
saying specifically that these push limits. Those are his words 
on his copy of the document, and you are saying you do not 
remember him using the words ``push limits,'' is that correct?
    Mr. Jaedicke. I do not remember the words ``push limits.''
    Senator Levin. OK. Let me just keep going, then. Now, 
Andersen also rated the accounting risks that Enron was taking. 
They did their own rating, which is reflected in the documents 
which you have just seen. This analysis is done at accounting 
firms for a number of reasons, and the Andersen analysis upon 
which those first two documents were based are Exhibits 10a and 
10b. If you could look now at Exhibits 10a and 10b----
    Mr. Jaedicke. Exhibits 10a and 10b----
    Senator Levin. Let me go back. I missed a document that I 
wanted to show you, Exhibit 5,\1\ so if I could just interrupt 
the flow here for a moment----
---------------------------------------------------------------------------
    \1\ See Exhibit No. 5 which appears in the Appendix on page 210.
---------------------------------------------------------------------------
    This is a letter that we received last week from legal 
counsel representing Arthur Andersen's partner, Tom Bauer, who 
was at that London meeting and participated in the discussion. 
Here is what this letter says, and this, again, is Exhibit 5 in 
the book. ``Certain risk areas were described as pushing the 
limits, as reflected in Dr. Duncan's note, or as being at the 
edge.''
    So now we have Exhibit 2, which you acknowledge was before 
you, with that circled ``H'' for high-risk accounting 
approaches. We have Exhibit 3, which has Duncan's note as to 
what he was telling you. And now we have an exhibit which 
supports those two earlier exhibits. This is a letter which 
says that Mr. Bauer remembers that, ``Certain risk areas were 
described as `pushing the limits,' as reflected in Mr. Duncan's 
notes, or as being `at the edge'.''
    So now we have got that memory of Bauer, which is added to 
Exhibits 2 and 3. So now your memory differs also with Bauer as 
well as with the exhibit itself.
    Now I want to move you over to Exhibit 10.\2\ This is a 
document which was Arthur Andersen's internal document, but 
upon which Exhibits 2 and 3 had either been based, or it is 
similar to a document in which those conclusions were reached.
---------------------------------------------------------------------------
    \2\ See Exhibit No. 10 which appears in the Appendix on page 222.
---------------------------------------------------------------------------
    First, if you would turn to Exhibit 10a.\3\ This is for the 
year 2000. This is for a later year, and I am going to give you 
this and then go back to 1999. Take a look, if you would, at 
the line which is marked on the first page there in which it 
says, ``Accounting and Financial Reporting Risk--Very 
Significant.'' ``Management Pressures''--do you see that, on 
driver number five? Do you see that on the front page? 
``Management Pressures--Very Significant.''
---------------------------------------------------------------------------
    \3\ See Exhibit No. 10a which appears in the Appendix on page 222.
---------------------------------------------------------------------------
    This document, signed by David Duncan, this risk 
classification offers several comments which justify their 
conclusion. On the front page, under ``Management Pressures,'' 
``Enron has aggressive earnings targets and enters into 
numerous complex transactions to achieve those targets.'' Also 
on the front page, ``The Company's personnel are very 
sophisticated and enter into numerous complex transactions and 
are often aggressive in structuring transactions to achieve 
derived financial reporting objectives.''
    The 1999 risk analysis is Exhibit 10b and it uses similar--
let me get you to the third page of Exhibit 10a before we turn 
to Exhibit 10b. It's under ``Risk Classification and 
Rationale.'' It says, ``Risk Classification: Maximum.'' Do you 
see that there?
    Mr. Jaedicke. I see it.
    Senator Levin. Do you see where it says ``Prior Year Risk 
Classification,'' and it says ``Maximum'' ? Now, these are risk 
classifications.
    Mr. Jaedicke. I see it.
    Senator Levin. Now we will go back to 1999 and Exhibit 
10b.\1\ And again, these are further evidence not only that 
Andersen considered Enron to be engaged in high-risk accounting 
and had management pressure, but they also substantiate the 
Duncan note, the Bauer letter, and Exhibit 2 which was directly 
presented to you and which talked about high-risk accounting 
transactions.
---------------------------------------------------------------------------
    \1\ See Exhibit No. 10b which appears in the Appendix on page 226.
---------------------------------------------------------------------------
    But if you will look now on Exhibit 10b, you will see under 
``Complex/risky transactions,'' where it says, ``Form over 
substance transactions.'' ``Form over substance 
transactions''--this is 1999, now, we are talking about. The 
box that they check is ``Very Significant.'' So your auditor 
viewed Enron accounting practices as being high risk. They said 
that the use of form over substance transactions was very 
significant and that very strongly supports the Duncan note as 
to what he told you in London in 1999 and Exhibit 2, which was 
directly handed to you and which said that your accounting 
practices were high-risk practices.
    And despite all of that, what you are saying is you do not 
remember or you deny that your auditor told you in 1999 and 
2000 that you were engaged in high-risk accounting practices, 
is that correct?
    Mr. Jaedicke. We knew that the company was engaged in high-
risk and innovative transactions. But if you contrast this, if 
David Duncan had given this to the Audit Committee, my guess is 
the discussion would have been a lot different than it was.
    If you go back and you look at the Audit Committee, the 
various meetings, Senator, you would find that on almost every 
agenda, there were listed--you would look at what were the 
audit emphases of the past quarter and what were the audit 
emphases of the quarter coming up, and they would almost always 
list related party transactions, structured transactions, 
securitizations, and mark-to-market and fair value. Those were 
almost always areas of emphasis.
    Now, when we would ask them, even in executive session, 
about, OK, how do you feel about these, the usual expression 
was one of comfort. It was not, these are the highest risk 
transactions on our scale of one to 10 or whatever this is. If 
the information in this kind of a document had been conveyed to 
us in the terms that it showed here, the template that you 
showed me, the ``H''s were almost always interpreted, at least 
by me, as saying if you want a template of those accounting 
areas that are important to Enron and deserve our emphasis, 
that is where you would look, and the ``H''s were no surprise. 
Those were almost always on the agenda of the Committee.
    Now, this kind of information, where you say pushing the 
limits or whatever--form over substance, I never, ever heard 
that term used.
    Senator Levin. The reason that----
    Mr. Jaedicke. That I recall.
    Senator Levin. The reason that is so important is because 
what was presented to you were the ``H''s, not ``I''s, not 
``M''s, not ``L''s, ``H''s, high-risk accounting judgments. You 
acknowledge that. Now the question is, well, wait a minute. Did 
that mean what it said? Then you have got a note 
contemporaneously from Duncan, as well as from the other 
witness who was there, saying you, in fact, were informed that 
these were pushing the limits at that meeting. You deny hearing 
that, but there is very strong evidence that, in fact, that 
occurred--the evidence: Contemporaneous notes, statement of 
another witness, and the internal documents of Arthur 
Andersen--show that was, indeed, their conclusion.
    You put all that together, and the evidence is pretty 
strong that you were informed these were high-risk accounting 
practices but that you did not act on those notes and that 
information. That is what jumps out from these exhibits and 
from this testimony. So weigh that against ``you do not 
remember''--it seems to leave me with one conclusion. You may 
not remember----
    Mr. Jaedicke. All I said was I do not remember the 
particular wording of the comment that you showed me on that 
particular--on that slide.
    Senator Levin. Thank you. Senator Collins.
    Senator Collins. Thank you, Mr. Chairman.
    Dr. Jaedicke, in an interview with the Subcommittee staff, 
Lord Wakeham indicated that he had been concerned that 
Andersen's high level of involvement with the company meant 
that Anderson might be too close to Enron's management. As 
Chairman of the Audit Committee, did you ever have a similar 
concern?
    Mr. Jaedicke. Well, Senator, we--on the independence issue, 
for the last couple of years, we had a very sort of set pattern 
of trying to assure ourselves that, in fact, Arthur Andersen 
was independent. It worked like this.
    There is a series of criteria and guidelines that are set 
forth by, for example, the Independent Standards Board. We 
would discuss those usually in the August meeting and we would 
also hear from Arthur Andersen how their internal processes on 
affecting the independence issue worked, and those stemmed all 
the way from saying, well, how do you monitor and handle the 
relationships of family members, all the way over to saying, 
what do your internal dispute resolutions look like for partner 
disputes? How do they work at the local level? How do they work 
at the Chicago level? How do they work worldwide? And they 
would go over in August with us all of the--sort of their 
internal processes for assuring independence.
    And then in the February meeting, when we reviewed the 
financials and we had to make a recommendation to the auditors, 
we heard a representation from the Arthur Andersen engagement 
team that the firm had assessed its independence using these 
procedures and criteria and that they believed they were 
independent. So in February, we would receive their 
independence--or, excuse me, their representation.
    Senator Collins. I understand that the Audit Committee 
accepted the representation of Andersen that it was 
independent, but I do not understand why the Audit Committee 
would accept that assertion given that Andersen had consulting, 
and internal and external auditing roles for Enron. 
Essentially, was not Andersen passing judgment on its own work? 
We have talked with numerous experts who are very critical of 
having the outside auditor also do some internal auditing as 
well as consulting work. Does that not set up a situation that 
is just ripe for conflicts of interest?
    Mr. Jaedicke. Let me speak to the so-called integrated 
audit, which is commonly phrased as doing the internal 
auditing. You have to keep in mind that Enron probably had 
about on the order of twice as much internal auditing as Arthur 
Andersen did. We had a Risk Control Group that consisted of, I 
do not know, 100 people or more. We had the Enron Assurances 
Group, which were a group of internal auditors that had 
internal auditors in each business unit, and we had an 
Information Technology Auditing Group.
    Now, that alone would be a sizeable amount of internal 
auditing. What the integrated audit tried to do, two things. 
One is to say, Arthur Andersen, you have to review the adequacy 
of internal controls in order to make a judgment on the 
fairness of the financial statements. What we would like you to 
do is to go farther than that and do enough internal auditing 
on the adequacy of the internal controls, where you control the 
scope, not management, such that you can give us an attest 
opinion on management's assertion that the controls are 
adequate.
    Now, I was in favor of that because otherwise, you get the 
assertion that says, we do not know of any material weaknesses. 
It is a very positive opinion.
    But the other thing I wish to emphasize is they were not 
auditing their own work. For example, my colleague Dr. Winokur, 
and I, worked for a couple of years responding to drafts from 
the management who was working on a risk management policy, not 
only for the trading, but for liquidity and many other things. 
When the Board adopted that policy, it was our policy, but what 
we wanted Arthur Andersen to tell us is, we have done enough 
auditing to assure you that it is the management's contention 
that it is adequate and we also will be able to tell you it is 
being followed. That is what we were after.
    Senator Collins. Were you aware that the fees paid to 
Andersen had increased dramatically, from $29.6 million in 1998 
to $46.4 million in 1999?
    Mr. Jaedicke. That is total.
    Senator Collins. That is total.
    Mr. Jaedicke. Yes. Well, we were reported the fees, but I 
think about half of that, Senator, would be the baseline and 
the integrated audit--the baseline integrated audit and the 
fees that they charged us to express an accounting opinion on 
the transactions.
    Senator Collins. My point is that this work was pretty 
lucrative for Andersen and Andersen was playing more and more 
of a role and passing judgment on transactions that were risky, 
to say the least. Should it not have been a red flag to the 
Audit Committee, given how lucrative this business was, that 
Andersen might not be as forthcoming as it should have been? 
You have been very critical of Andersen for not sharing 
information. Should these not have been red flags that Andersen 
was playing more and more of a role, such that Lord Wakeham 
raised a concern about it?
    Mr. Jaedicke. Are you asking for my opinion?
    Senator Collins. I am.
    Mr. Jaedicke. In my opinion, I did not see it as a red 
flag. I saw it actually as some comfort that said the 
management is willing to pay fees large enough to get Arthur 
Andersen to tell us in a positive way whether our internal 
controls are adequate and functioning, rather than to have an 
internal auditor working for the company do it, which was 
always, to me, a problem.
    Senator Collins. Let me ask you this question. The SEC had 
a blue ribbon commission in 1999 and 2000 that made several 
suggestions to ensure the independence of auditors. Are you 
familiar with those?
    Mr. Jaedicke. Well, I am familiar with some of their rules.
    Senator Collins. Let me ask you about a specific one, if I 
may. One of the recommendations that the SEC made was that the 
Audit Committee obtain a written statement from the auditor 
listing all of the relationships between the auditor and the 
company, and that the Audit Committee should then discuss each 
of those relationships and pass judgment--the Audit Committee 
should pass judgment, not the auditor passing judgment on 
itself--on whether or not any of those relationships 
compromised the independence of the auditor. Was that done?
    Mr. Jaedicke. The review of independence in August, I 
think, would have included that, because I think one of the 
criteria or one of the issues that you had to look at had to do 
with those relationships, and they reported to us on, well, 
what are the firm's policies when you have people go to work 
for Enron? They also reported to us at one point, and I would 
have to look at the details because I have forgotten it, that 
there was a small joint venture, I believe on some software, 
and I really have to go back and look at it and see what the 
details were. It was considered to be immaterial, but it was 
disclosed to the Audit Committee.
    Senator Collins. Dr. Jaedicke, you have a lot of 
experience. Have you ever known an auditor to come in and say, 
``we are not independent,'' or ``we are too close to 
management'' ?
    Mr. Jaedicke. No, I guess----
    Senator Collins. Is it not the job to be----
    Mr. Jaedicke. They would not last very long if they did 
that.
    Senator Collins. Exactly my point.
    Mr. Jaedicke. I agree.
    Senator Collins. When the auditor is making over $40 
million a year, the auditor is not likely to come to the Audit 
Committee and say anything other than that it is independent. 
Is it not the job of the Audit Committee to make sure that the 
auditor truly is giving full, accurate, and independent advice 
to the Board?
    Mr. Jaedicke. I think the way we tried to do that, 
Senator--I agree, we should try to do it--was to say OK and 
once a year, at least, lead us through all of the controls that 
the firm has in place to help assure their independence. Again, 
an Audit Committee's work is on the adequacy not only of the 
company's controls but also of the controls of their outside 
advisors, and we did that.
    Senator Collins. As the Chairman of the Audit Committee, 
you were the Board member most responsible for ensuring that 
there was full and complete and accurate communication between 
Andersen and the Board. In your tenure as Chairman, how often 
did Andersen tell you of problems that concerned Andersen with 
the management of Enron?
    Mr. Jaedicke. Well, they would usually--let me define 
problems. They would usually--these would usually come out in 
the form of saying, for example, we are engaged in a review of 
the internal controls of the new businesses, and then we 
would--and so they would--there was reason to believe you 
needed to concentrate on the controls. There was need for, for 
example, some pre-measurement type of controls in Enron Energy 
Systems at one point. We were concerned about were there access 
issues in Enron On-Line. Now, things of that nature would come 
out in talking to the Audit Committee and then we would follow 
that.
    And if you looked, for example, at the minutes, you would 
find that the next meeting, they would say, significant 
progress has been made in these areas. And so they did--the 
types of problems that they talked to us about were usually in 
connection with their auditing emphases or the controls that 
were inherent in a particular business unit or things like 
that, and they brought those to our attention.
    Senator Collins. Mr. Duncan, in February 2001, Fortune 
magazine ran an article about Enron and questioned whether its 
stock was overpriced. According to the story, the company was 
described by one analyst as impenetrable, a black box to 
outsiders. Another said the lack of clarity was a red flag. You 
told the Subcommittee staff that you remembered the article, 
that it was not flattering, that you were concerned about it. 
Did you ask Andersen to take a look at the allegations in the 
article?
    Mr. Duncan. I did not. You must remember, I was not on the 
Audit Committee. But to answer your question, I did not ask 
Andersen to take a look.
    Senator Collins. Did you bring it up in your role as Chair 
of the Executive Committee to any of the executives of Enron?
    Mr. Duncan. I do not remember doing so.
    Senator Collins. Dr. Jaedicke, did you bring it up to the 
other members of the Audit Committee or to Andersen and ask 
them to look into it? Fortune magazine is a well-regarded 
publication and these were pretty serious criticisms of the 
business for which you were on the Board. Did you take any 
action in response to it?
    Mr. Jaedicke. Not in response to that particular article, 
ma'am, no.
    Senator Collins. Mr. Duncan, in October 2001, and I 
actually want all of the panel to answer this question, the 
Board became aware that an Enron employee had written an 
anonymous letter to Ken Lay. We now know this as Ms. Watkins' 
memo. Mr. Lay advised you that he had met with the employee and 
turned the matter over to Vinson and Elkins for further review. 
He obviously thought the charges were serious enough to warrant 
a review, but then he reported to you that there was no 
substance to the charges.
    I would like to ask each of you, and since my time is fast 
running out, if I could just get a quick answer, did you ask to 
see the Watkins memos? Mr. Duncan.
    Mr. Duncan. I did not.
    Senator Collins. Dr. Winokur.
    Mr. Winokur. I did not.
    Senator Collins. Dr. Jaedicke.
    Mr. Jaedicke. We asked for a written report after they gave 
us an oral report and they had characterized the essence of Ms. 
Watkins' comments in that oral report, and we asked for a 
written report afterwards, which we got, but not until fairly 
late.
    Senator Collins. Did you see her memo which warned that the 
company could implode in a wave of accounting scandals?
    Mr. Jaedicke. The first time we asked for the report, at 
least the Audit Committee did not get the memo. Now, I am 
talking about December.
    Senator Collins. Right. But did you ask----
    Mr. Jaedicke. Then we asked for the memo.
    Senator Collins. When did you ask for the memo?
    Mr. Jaedicke. When we got the written report from Vinson 
and Elkins, which turned out to be--you have got to remember, a 
lot of things happened--which turned out to be at the December 
Board meeting in 2001. That is when I got the memo.
    Senator Collins. Dr. LeMaistre.
    Dr. LeMaistre. My recollection is exactly like Dr. 
Jaedicke's. We got the memo after we heard the report. We only 
had an oral report saying that there was going to be an 
investigation. When the investigation was reported, we asked to 
see the memo.
    Senator Collins. Mr. Blake.
    Mr. Blake. Mine is very similar, and I do specifically 
remember asking for a written--we did not have a copy of the 
letter at the time that the report was given to the Board and 
we specifically asked also for a copy of the letter as well as 
a report from Vinson and Elkins.
    Senator Collins. Dr. Jaedicke, former SEC Chairman Rod 
Hills has said very strongly that he feels the Audit Committee 
should have engaged an outside firm to review the allegations 
in the memo rather than leaving it up to the CEO. Could you 
comment on that?
    Mr. Jaedicke. Yes, I could comment on that, Senator. The 
memo was--actually, memos. There were, I think, two of them, a 
letter and a memo that were given to Mr. Lay, in August at some 
point. Mr. Lay handled those as they would have been handled 
under the code of conduct. They would have required an 
investigation. And we did not hear about the results of that 
investigation. We did not hear there was an investigation 
underway until about the time of the October Audit Committee 
meeting. By that time, the investigation had been completed.
    The investigation turned up no new information. I can come 
back to that if you like. But it also--some of the issues that 
she had brought up were not even verified by the people whom 
she had named, or at least who were thought to know something 
about them. The investigation was completed and it did not say, 
I do not think, that there was nothing, there were no problems. 
I think what it said is that no further investigation seems 
warranted.
    Senator Collins. That really is not my point. My point is 
that the CEO chose the firm to do the investigation of the 
allegations against the firm, and Rod Hills says, as a former 
SEC Chair, and I agree with him, that it would have been better 
and would have allowed for a more thorough review of the 
allegations for the Audit Committee to control that.
    But let me move just quickly to another point, if I may.
    Senator Levin. I wonder if I could just intervene for one 
second----
    Senator Collins. Please go ahead.
    Senator Levin [continuing]. Because I want to just pursue 
one aspect of the point which Senator Collins just raised to 
make sure I understand your answer. No one on the Board saw a 
copy of the Watkins memo until after the Powers Committee 
report was completed, is that correct?
    Mr. Jaedicke. No. I do not think----
    Senator Levin. In that case, I will let your answers stand 
the way they were.
    Senator Collins. Thank you.
    Dr. LeMaistre, you attended the October 6, 2000, Finance 
Committee meeting in which Mr. Winokur suggested that Andrew 
Fastow's compensation should be reviewed by the Compensation 
Committee, is that correct?
    Dr. LeMaistre. That is correct.
    Senator Collins. And I believe Dr. Winokur proposed that 
review as a control to mitigate Mr. Fastow's conflict of 
interest. Yet, it is my understanding that the Compensation 
Committee did not at that time follow through on that 
recommendation. Can you explain why?
    Dr. LeMaistre. Yes. The Compensation Committee was aware 
that there had been controls put in place for Mr. Fastow to 
report his compensation. They were aware of the fact that his 
approved compensation on both LJM1 and LJM2 was to be modest.
    Second, we knew there were reports coming on an annual 
basis and on a quarterly basis and we expected information to 
come through these reports and that management, as they should 
have done, bring that to the Compensation Committee. I inquired 
on two occasions of our staff, after the first quarterly report 
subsequent to that, whether we received any information on a 
16(b) officer outside compensation. The answer was no. The 
second time I inquired was a few months later, in August or 
September, I believe, and we still had not received the 
information. With all of the events that transpired, the next 
trigger became, of course, the October 17 or 19 revelation that 
he was alleged to have made $7 million.
    Senator Collins. That was the story in the Wall Street 
Journal.
    Dr. LeMaistre. Yes Ma'am, that is correct.
    Senator Collins. So it took a story in the Wall Street 
Journal to prompt your going back. You had asked twice, had not 
gotten the information. But it was only when the Wall Street 
Journal learned that there was an important issue here and 
actually gravely understated the amount of money that Mr. 
Fastow was making that you pursued this?
    Dr. LeMaistre. That is correct.
    Senator Collins. Thank you, Mr. Chairman.
    Senator Levin. Senator Lieberman.
    Senator Lieberman. Thanks, Mr. Chairman. Thank you, 
gentlemen.
    Yesterday, attorneys for Enron provided several documents 
to the Federal Energy Regulatory Commission which related to 
what I would consider to be highly questionable trading 
strategies used by Enron in the California and Western 
electricity markets in the year 2000 energy crisis, and 
apparently continuing into 2001. These documents, which, as I 
am sure you know, have now been made public by FERC and which I 
had a chance to look over this morning were prepared for 
Richard Sanders, a senior official of Enron, by attorneys from 
both inside and outside the company, apparently in anticipation 
of possible regulatory sanctions, investigations, and 
litigation arising out of the crisis, or perhaps, I suppose, 
just as notification to the traders.
    They are very interesting documents because they describe a 
range of different strategies with very colorful names, such as 
Death Star, Get Shorty, Wheel Out, Fat Boy, Ricochet, and 
others by which Enron's traders maximized profits while gaming 
the system and taking advantage of the energy crisis in 
California.
    One memo which I have looked at, dated December 8, 2000, 
specifically discusses the California market regulations 
against gaming and other predatory market behavior after it 
describes the strategies that the Enron traders were following, 
and in my opinion, may have been violating, although the memo 
is, in that sense, as I read it, you might say value neutral. 
It does not make a recommendation. It describes the strategies 
and then the sanctions that can be applied by the California--
against Enron should the activities be discovered, and that is 
a direct quote, ``should it discover such activities, a 
California system operator could take these actions against 
Enron.''
    So I want to ask a series of questions about that. First, 
was the Enron Board of Directors aware of the trading practices 
and strategies used by Enron's traders in the California and 
Western markets? Mr. Duncan or Mr. Blake?
    Mr. Blake. No, sir. We were not aware of those specific 
strategies, and if I may add, the first time I was aware of 
those strategies was when Pug Winokur and I, who are on the 
Restructuring Committee of the Board, were given those 
documents 2 weeks ago to this day and I subsequently, as Acting 
Interim Chairman, set up a Board meeting for that following 
Thursday, at which time we discussed it with the Board. I 
think, in fairness, the predisposition was to make this 
disclosure as responsibly and as quickly as possible. We 
instructed our counsel to investigate further because Rob 
Walls, who Mr. Walls is the now-current General Counsel, but 
was not there before, just came upon these memos.
    Subsequently, the following week, last week, there was 
further discussion of this report by counsel, actually last 
Sunday morning, by counsel and the management and we, as a 
Board, moved to direct specifically the release of that 
information yesterday.
    Senator Lieberman. I appreciate the speed with which you 
did move. What was your reaction when you saw the documents 2 
weeks ago?
    Mr. Blake. I was extremely upset and disappointed.
    Senator Lieberman. Did you read them as I did, that they 
seemed to be both descriptions of strategies that were 
questionable and then an indication of what the penalties were, 
but almost a directive about how to avoid the law instead of 
how to comply with it? Am I overreaching, or was that part of 
your reaction?
    Mr. Blake. Well, in candor, my reaction was very much 
similar to yours. It certainly appeared on its face, although 
it was sort of a description of the practices, but from what I 
could discern, certainly questionable practices, seemingly 
gaming the system--I think those are the exact words I used at 
the Board meeting--very offensive to me personally and members 
of the Board.
    Senator Lieberman. I appreciate that answer.
    Dr. Winokur, perhaps as Chairman of the Finance Committee 
it is appropriate to ask you that question, also.
    Mr. Winokur. Sir, in terms of the recent 2 weeks, I was 
exactly where Mr. Blake was. There were five meetings from 
October 2000 to August 2001 in which there were reports to the 
Board of Directors by management about California, and we asked 
questions, including are we doing anything wrong? There is a 
lot of bad press. Are we doing everything that we are supposed 
to do to comply? We had reports from our General Counsel on 
litigation. We had reports from our Chief Regulatory Executive. 
We had reports from the senior people. And at no time ever were 
we given any information or hint of information that we might 
be out of compliance with the trading rules.
    Senator Lieberman. So that, again, as far as any of you 
know, and particularly the two of you, the Enron Board was not 
aware of these memos until 2 weeks ago, and, therefore, aware 
of any of the legal and financial liabilities that might be 
incurred by the trading strategies, is that correct?
    Mr. Winokur. Yes, sir, we were not aware.
    Senator Lieberman. Right. Let me ask this question about 
this matter, and this is as we try to work our way through what 
is the appropriate and required role for boards of directors. I 
mean, ideally--well, I suppose the first question has an answer 
to itself, which you have already given. You actually asked 
questions. I mean, there was a lot of public commentary when 
this was going on, particularly from people in California and 
our colleagues who represent California here in the Senate or 
the House that Enron was profiteering, whatever the word was. 
So you asked questions, then, of the employees and really got 
what you now know are inadequate answers?
    Mr. Winokur. Yes, sir. I lived in Los Angeles for 7 years 
and was on the board of UCLA Hospital, so I have a lot of 
friends there. I responded to the press statements and said, 
are we asked questions, are we doing anything wrong? Is there 
anything we should be talking about here? We had reports in 
these five meetings from our General Counsel, our Chief 
Regulatory Officer, and the senior executives, not everybody at 
every meeting, but in those series of meetings, all those 
people reported, and not once did we hear anything that 
suggested any impropriety in California.
    Senator Lieberman. Let me ask it in a different way, a 
different kind of question, which is, both stepping back and 
looking back--and here it sounds to me like you had public 
notice--you asked the question, you dispatched your 
responsibility.
    More generally speaking, what can we expect of directors in 
terms of their oversight of activities such as trading 
practices of a corporation? Let us say it would not have fit 
the public interest because there was not that much interest in 
the California price spikes during that time period, so how 
would you set a standard for what directors should expect to 
know?
    Mr. Winokur. Sir, I am not sure I was qualified, but it 
seems to me that if we ask the senior people responsible for 
that line of business and we ask separately the General Counsel 
to give us reports on what is going on, and we, third, set up a 
risk system to measure quantitatively how the trading system 
has worked, I am not sure I have any other suggestions. I am 
sorry.
    Senator Lieberman. Anyone else? Mr. Jaedicke.
    Mr. Jaedicke. It is a very thoughtful question. As far as 
the trading is concerned, we, of course, paid an awful lot of 
attention to the financial measures to say, do not take too 
much risk. Do not have too many open positions. We had an 
elaborate policy on that.
    Now, one part of that policy was that we were in the 
process of developing even more, was something called 
operational risk, and operational risk, we did not have it 
fully developed in terms of what all it meant, but surely, 
whatever it meant, it meant that you would try to put in 
control systems that would assure you that you were complying 
with the law. Our other compliance systems involving the 
internal and external legal people, you would expect that to be 
part of the systems and to be reported if they were not 
followed.
    Senator Lieberman. Let me move on to one additional area of 
questioning. I thank you for that answer. As I am sure you 
know, there has been a lot of concern among the employees, 
former employees, particularly, of Enron, and, of course, that 
concern has been expressed over the months since early December 
by members of Congress about the inequity, perceived inequity 
of the bonuses given to various higher-level employees of Enron 
at the same time the 4,000 or 5,000 employees who were laid off 
were given severance payments that were greatly below what they 
expected.
    In the case of some of the bonuses, I gather that to get 
and keep the money, they had to agree to stay for 90 days. Some 
of the bonuses exceeded $1 million. One was even $5 million. 
That is contrasted with the employees, who, by my recollection, 
received an average of about $4,500 each, which, as I said, was 
a fraction of what they had expected in the way of severance.
    According to Mary Joyce, who I know you know is a VP of 
Compensation at Enron, the issue of severance was discussed at 
a meeting of the Compensation Committee of the Board just 
before bankruptcy, but she has said to us that she did not 
remember the substance of the discussion. Dr. LeMaistre, you 
are the Chairman of the Compensation Committee. I believe, if 
my records are right, that Mr. Duncan, Mr. Jaedicke, and Mr. 
Blake are members of the Committee.
    So my question, obviously, is can you remember and describe 
for us what was discussed at that meeting about the severance 
payments, and particularly, did anyone ask if it was possible 
to compensate these people more fairly for the employees, that 
is, the lower-level employees, for their service to the 
company?
    Dr. LeMaistre. Senator Lieberman, I recall that very 
clearly and I would ask my colleagues to comment on it, to add 
additional things. It is a very important question.
    The severance plan presented by management to us required 
several different areas of interrogation by us of management, 
and the plan actually was moot because we went into bankruptcy 
before it was acted upon, if we are talking about the same 
severance plan, and I assume we are.
    The W.A.R.N. (Workers' Adjustment and Retraining 
Notification Act) provisions can be exempted in bankruptcy and 
all that is allowed to be paid, if the bankruptcy court agrees, 
is the $4,500 per employee. So I think that explains the 
problem.
    Yes, we did discuss this. The Board of Directors met on 
December 2, which I think is the day we went into bankruptcy. 
The Directors agreed to work without compensation and expressed 
the desire that our fees go to the employees or to an 
employees' fund. Later, we were told it was too complicated to 
work that out.
    We discussed this because we were very much concerned about 
what was happening to the employees. I would remind you, one of 
the prime reasons everyone should be concerned about that is as 
far as I know now, a very small number of employees created a 
major part of the internal problems at Enron and there were 
more than 20,000 very honest people there----
    Senator Lieberman. Correct.
    Dr. LeMaistre [continuing]. And those are the ones that 
suffered.
    Senator Lieberman. Who suffered? So am I hearing you 
correctly, that you would have wanted to give the 4,000 or 
5,000 employees something closer to the severance payments they 
thought they were entitled to under their agreements, but you 
could not do it according to bankruptcy law?
    Dr. LeMaistre. Well, we were--if I recall correctly, and I 
would ask the members of the committee to comment, the first 
discussion was on a Saturday, December 1, and I think the next 
day, Sunday, December 2, we were ready to propose this. 
Unfortunately, Enron had filed for bankruptcy at 2 a.m. in the 
morning on Sunday, and so we were governed by bankruptcy law.
    But to answer the other part of your question, the high 
bonuses that you----
    Senator Lieberman. Right.
    Dr. LeMaistre [continuing]. Alleged to be high. Those were 
for traders. We felt that the traders were the group that was 
essential to hold the company together. In the weeks 
approaching bankruptcy, we were trying desperately to hold on 
to them. We were trying to merge with Dynegy, and the traders 
were of primary interest to Dynegy. That was really the group 
they wanted.
    Second, we knew that they were being sought by many other 
companies because of Enron's public problems, and, therefore, 
we were trying to give them a 90-day stay bonus----
    Senator Lieberman. I see.
    Dr. LeMaistre [continuing]. Which had a draw-back on it. 
They had to repay if they did not.
    Senator Lieberman. If they----
    Dr. LeMaistre. If they did not stay.
    Senator Lieberman. For the 90 days?
    Dr. LeMaistre. Yes, that is correct.
    Senator Lieberman. So that explains my other concern, which 
was why you would give such large bonuses for people who are 
only staying 90 days, and you are saying you were doing it 
because they were traders and you wanted them for that period 
of time.
    The light is up, so I am going to close in a minute on my 
time. Do I take it that bankruptcy law did not similarly 
prohibit the company from paying the large bonuses----
    Dr. LeMaistre. That occurred before we were under 
bankruptcy.
    Senator Lieberman. You made the decision before?
    Dr. LeMaistre. Timing, yes.
    Senator Lieberman. OK. My time is up. Thank you.
    Senator Levin. Senator Fitzgerald.
    Senator Fitzgerald. Thank you, Mr. Chairman. This is my 
first meeting at the Governmental Affairs Committee and this 
Subcommittee. I just joined the Committee, and I appreciate you 
having me on. I think I get assigned to all the committees 
investigating Enron.
    Senator Levin. The Chairman, I think, wants the honor of 
welcoming you----
    Senator Lieberman. Yes.
    Senator Levin [continuing]. But we welcome you to the 
Subcommittee today, and the Chairman can do that appropriately.
    Senator Lieberman. Thank you, Senator. Senator Fitzgerald, 
we welcome you here. This is a very interesting Subcommittee 
with very significant oversight responsibility and we are 
delighted to have you and I am sure you will contribute 
substantially to our work.

            OPENING STATEMENT OF SENATOR FITZGERALD

    Senator Fitzgerald. I am pleased to be aboard, and all of 
you, thank you. Some of you, I have met you in the Commerce 
Committee, which has also had several hearings on Enron.
    Some of you may know my theory on Enron. I was the one who 
described Enron as a gigantic pyramid scheme or Ponzi 
operation, and if I could just explain why I say that. Mr. 
Blake made mention earlier of the SPEs being used to improve 
liquidity and get debt off the balance sheet. After going 
through several of those SPE transactions and all the 41 boxes 
that were delivered to the Commerce Committee, I concluded that 
what Enron was doing was creating off-the-books partnerships, 
instructing those off-the-books partnerships to borrow money, 
in essence, and then Enron would transfer assets to the off-
the-books partnerships. The partnerships would borrow money, 
while Enron had typically guaranteed their borrowings, and then 
the SPEs or the partnerships would pay Enron for some asset 
that Enron had transferred to the SPE.
    But Enron had always provided a credit support in all the 
cases I looked at for the borrowings of the SPE, and if you 
really reduce this to simple terms, Enron was simply borrowing 
money, filtering the borrowings through the off-the-books 
partnerships, and then booking that borrowed money as income, 
and that is how you built up some $20 billion worth of off-the-
books indebtedness. But Enron was contingently liable for that 
indebtedness, and when you filed for bankruptcy in December, it 
was because you had a very familiar problem. You had too much 
debt. You had several billion dollars worth of indebtedness 
coming due and Enron could not pay it.
    Now, I think these specific transactions were very well 
disguised. I think that the management obfuscated enough, used 
high-falluting sounding language to describe all these 
transactions to make them sound legitimate. I think it would be 
very difficult, you would really have to be on your guard to 
figure out what they were up to.
    But I have also felt that in the hands of management was 
plenty incentive to engage in this kind of pyramid scheme, to 
keep booking fictitious earnings, and that incentive was to 
keep the stock price up, and they wanted to do that because 
many of them had millions or tens of millions, and in some 
cases hundreds of millions of dollars worth of stock options in 
their hands.
    Now, many of the senior managers cashed in their stock 
options and got out of the company before it all spun out of 
control. There are many people who got out of the company, 
having successfully cashed in millions of dollars worth of 
stock options. I think Mr. Baxter, who committed suicide, got 
out a long time ago. Others, the Army Secretary, got out quite 
some time ago.
    Mr. Skilling tried to get out last summer. He succeeded in 
cashing in, I think, $78 million worth of his options, of 1.7 
million options in 2000 and 2001. He got out. I have heard 
reports that Mr. Lay had lined up a job at another company and 
was planning to get out. He cashed in in the last 2 years $82 
million worth of options. In all, the top 29 executives at 
Enron cashed in some $1 billion worth of options in the last 3 
years, according to reports that I have read.
    I have several questions for you. I notice that the 
compensation of the Board, total compensation in fiscal year 
2000 for each Board member was roughly an average compensation 
of $329,000 per Board member. Some got less, some got more, 
depending on what committees they chaired, what committee 
meetings they attended. Only a small portion of that 
compensation was cash compensation. The average Board member 
got $78,000 in cash compensation, but the average Board member 
got $250,000 in stock options.
    The question I have to ask to you is, your interests were 
to see that the stock price kept going up, given that your 
compensation was so heavily weighted towards options. Did you 
all not have a financial interest in seeing those options go up 
and always be in the money? I understand you could exercise 
them--they did not expire for 10 years, and so you did not have 
pressure to cash them in right away.
    But do you care to comment on that issue? I mean, were your 
interests really aligned with the interests of the long-term 
shareholders? How many shares did each of you own outright in 
Enron, excluding options? How many shares? Mr. Blake.
    Mr. Blake. I cannot quite remember, sir. I bought some 
initial shares of both Enron and Enron Oil and Gas and EOTT and 
Northern Border Partners when I first joined in 1993 as a 
statement of interest in the company, and----
    Senator Fitzgerald. How much do you think you had----
    Mr. Blake. I might guess----
    Senator Fitzgerald. What was your cost basis?
    Mr. Blake. Maybe about 3,000 shares, something of that 
nature.
    Senator Fitzgerald. And would that be, like, $30,000, or--
--
    Mr. Blake. Yes. Well, I also made a purchase in October 
2001 that was $80,000, so I would say probably something in 
excess of $100,000.\1\
---------------------------------------------------------------------------
    \1\ See Exhibit No. 80 which appears in the Appendix on page 665.
---------------------------------------------------------------------------
    Senator Fitzgerald. Dr. LeMaistre.
    Dr. LeMaistre. I had--I lost approximately $3.5 million in 
shares of the restricted stock, which is a gift, of course, and 
in the stock options, I cannot give you the exact total, but I 
would say something in the order of maybe 40,000, 50,000 of 
beneficially owned stock----
    Senator Fitzgerald. Forty or 50,000 shares?
    Dr. LeMaistre. Yes, something like that.
    Senator Fitzgerald. That you had bought outright, or had--
--
    Dr. LeMaistre. Had bought outright, maybe more than that. I 
cannot remember the exact figure----
    Senator Fitzgerald. And that you owned in your own account?
    Dr. LeMaistre. That is right, and----
    Senator Fitzgerald. What would your cost basis have been in 
that, roughly?
    Dr. LeMaistre. Well, they were bought all the way back to 
1991, so I would have to recalculate that to tell you that. I 
would assume--I really could not answer it accurately without 
looking at notes. I would be happy to do that.
    Senator Fitzgerald. A hundred-thousand dollars, maybe?
    Dr. LeMaistre. Probably.\1\
    Senator Fitzgerald. About $100,000.
    Dr. LeMaistre. A little more than that, I think, but----
    Senator Fitzgerald. A little more than that?
    Dr. LeMaistre. Yes.
    Senator Fitzgerald. Mr. Jaedicke.
    Mr. Jaedicke. I could give you the information. I would be 
glad to send the exact information. My recollection is it would 
be slightly over 20,000 shares, many of which were taken as 
part of Board compensation.
    Senator Fitzgerald. But what would your cost basis for what 
you had----
    Mr. Jaedicke. Well, the cost basis of the shares taken for 
Board compensation would be that I was paid ordinary income at 
the time I got them. So, I do not know, I suppose it would be 
between $20 and $30 or $40 a share. I do not know what the 
average would be. Again, I can supply that to you.\1\
    Senator Fitzgerald. I would be very interested in that. Dr. 
Winokur.
    Mr. Winokur. Yes, sir. I own approximately 80,000 shares. I 
have a cost base of about $1.8 million or $1.9 million. Some of 
those were shares I bought. Some of those were shares from 
options that I exercised and did not sell. I have never sold a 
share of stock.\1\
    Senator Fitzgerald. So you had some skin in the game, as 
SherronWatkins would say?
    Mr. Winokur. Yes, sir.
    Senator Fitzgerald. Mr. Duncan.
    Mr. Duncan. I now own 167,000 shares. I have owned those 
shares from the beginning. I cannot now recall my cost basis. I 
do recall that the options that I exercised only last year, and 
held, I did pay ordinary income tax on them, so that changes 
the arithmetic a little. But broad general statement, I lost 
over $10 million.
    Senator Fitzgerald. How much money do you think you had 
invested, though, your total cost basis----
    Mr. Duncan. Well, if you go back----
    Senator Fitzgerald. Now, did you acquire those shares from 
prior companies that Enron merged with?
    Mr. Duncan. No. When Enron sold for cash--excuse me. When 
Houston Natural Gas sold for cash to InterNorth, then I took my 
proceeds and invested the proceeds in Enron.
    Senator Fitzgerald. OK.
    Mr. Duncan. At that particular time, if my memory serves 
me, it was about $1.5 million.\1\
---------------------------------------------------------------------------
    \1\ See Exhibit No. 80 which appears in the Appendix on page 665.
---------------------------------------------------------------------------
    Senator Fitzgerald. So some of you did have substantial 
investments in the company, and I would think your personal 
financial interests were, for some of you, very closely aligned 
with those of ordinary shareholders.
    Did any of you think about what kind of temptations, 
though, could be in the hands of senior managers when they 
stood to make the kind of sums Mr. Skilling and Mr. Lay did by 
cashing in their options, because cannot any company 
fictitiously goose-up its earnings per share to keep its stock 
price high, for a while, at least, until other people catch on? 
When there is so much in options outstanding in the hands of 
senior management, does that not begin to worry some of you as 
Directors that, ultimately, their interests could no longer be 
allied with the interests of the long-term shareholders? They 
could just try to goose the stock price, cash in their shares, 
and get out of the company? Would any of you care to comment?
    Dr. LeMaistre. Let me make a comment, Senator Fitzgerald, 
that first, the policy of awarding stock was to ensure that 
they kept their eye on the ball and saw that the stock price 
increased for the shareholders' benefit, because that is really 
what the shareholder does, he invests in a company and wants 
that stock to increase. So that over the period of time, to 
have the stock increase, the employees win, but also the 
shareholders win. So I think that it is a two-edged sword. If 
one gets the incentive so high that is all that people are 
really working for in order to cash out----
    Senator Fitzgerald. As Chairman of the Compensation 
Committee, did you ever worry that maybe the incentives were so 
high, there were so many options outstanding, that, boy, maybe 
we have a problem here, because some people play a game here?
    Dr. LeMaistre. I did not worry about it, primarily because 
I talked to our Towers Perrin consultant every year about 
whether our scale of pay, our programs, including the incentive 
pay that we had, especially the incentive pay, was commensurate 
with exactly what was being done by companies our size. We had 
our last report as of the spring of 2001 that said we were 
right on target with where we were supposed to be.
    Senator Fitzgerald. Can you think of any other motivation 
that management would have had to engage in such aggressive 
accounting and gimmicks to keep the earnings up, other than to 
keep the share price up to keep their options in the money, 
because they were getting very rich very quickly on this scheme 
while everybody else was--all your other rank-and-file 
employees were wiped out, pension funds were wiped out, and $60 
or $70 billion in market capitalization was lost, but a lot of 
your inside management got very rich and came out very well on 
the whole thing. Can any of you think of any other motive that 
management would have had for deceiving the Board and deceiving 
the public?
    Dr. LeMaistre. Senator, I do not want to monopolize the 
time, the other Subcommittee Members may want to speak to this, 
but I will say that we thought the integrity and honesty of our 
employees, especially those in key positions, was intact, and 
that was the most important thing. We had quarterly reviews of 
all of the higher-level echelon officers by Mr. Lay directly to 
the Compensation Committee and then a very large review 
annually in our management development responsibility. So we 
thought we knew these individuals well. I have no answer for 
your question except that the problem was, in my opinion, 
dishonesty and lack of integrity.
    Senator Fitzgerald. Mr. Chairman, I appreciate the 
Subcommittee's time, and all of you, thank you for being here 
today.
    Senator Levin. Thank you, Senator Fitzgerald, and again, it 
is great having you with us. Senator Carper.

              OPENING STATEMENT OF SENATOR CARPER

    Senator Carper. Thanks, Mr. Chairman, and to each of you, 
welcome and we appreciate your time and your testimony today 
and your responses to our questions.
    Before I was elected as Senator about 2 years ago, I served 
as Governor of Delaware for 8 years. One of the things I 
learned as Governor was that when things went well, I was wise 
to share the credit. When things went badly, I was wise to 
assume the blame. One of my frustrations in listening to the 
testimony here this morning, and frankly, listening to the 
comments of those who served in very senior positions at Enron, 
relatively few people seem willing to accept the blame.
    I, for much of my life, served in the Navy as a Naval 
flight officer, about 23 years, in fact, on active and reserve 
duty. In the Navy, we have a tradition, and a proud tradition, 
that the captain of the ship assumes the responsibility when 
things go badly, or the commanding officer of the squadron that 
I served in assumed responsibility, was held accountable and 
responsible when things went badly.
    Obviously, from your testimony today, you believe that you 
were deceived and misled. Who bears the responsibility? If not 
the Board, if not the Audit Committee, if not those with whom 
you served, if not the Chairman, who does deserve the blame? 
Who should step forward and say, this is my fault?
    Mr. Jaedicke. Are you directing that at me?
    Senator Carper. From any of you, please.
    Mr. Blake. Well, I will speak for all the Board and say 
that we feel terrible, what has happened here, and we have 
scrutinized our own behavior and we have asked the question 
numerous times, what could we have done differently? I am 
absolutely convinced, sincerely, honestly convinced that the 
controls, had they worked, this would not have happened, and I 
feel absolutely misled in light, too, with that question.
    I do not know where the fault lies. I mean, I accept the 
same philosophy as you do, and as the CEO of many companies, it 
is my ship and I am totally responsible for its conduct and the 
companies that I run. I absolutely philosophically totally 
agree with you, without exception. I do not know where the 
fault lies here. I do not know enough of the information. I do 
not want to get into personalities today, but----
    Senator Carper. If you do not, and those of you with whom 
you serve--excuse me for interrupting, but if you do not know 
where the fault lies, how are we going to figure that out?
    Mr. Blake. We do not know the facts, sir. I do not know 
what Ken Lay knew or did not know. I would love to know. I 
would like to know what Jeff Skilling knew and what he did not 
know, because I look to them as leaders of the company, 
responsible to the Board in the exercise of their particular 
responsibility as the chief executives of the company and 
responsible for the ship. I want the answer, too. I do not have 
an answer. If I had the facts, I would give it to you, honest.
    Mr. Winokur. Senator, I served on the Powers Committee, the 
special investigative committee, and as that report indicates, 
there is considerable ambiguity in exactly who knew what, when, 
and how, because our committee was not able, as government 
agencies can, to subpoena people, to force them to talk, and so 
on. So I think all of the interviews have been provided to you 
and there are numerous investigations underway by people who 
have the ability and the authority to find out answers to those 
questions.
    But I concur with what Norm said. I think we reacted as 
best we could to the information we had. We relied on the 
candor of management. We relied on our advisors to do their 
job, which was to confirm what we were being told, and there is 
a lot left to be learned, unfortunately, as the Powers 
Committee report indicates.
    Senator Carper. Anyone else?
    Mr. Jaedicke. I agree with the two statements that have 
been made. I guess all I would say to elaborate on that, or to 
maybe bring up another point, is to say--and I guess I am 
speaking from the viewpoint of an Audit Committee, although I 
think it would be the same for a Board, as well, is that there 
is this classic problem that the information that the Board 
needs to do the oversight, not entirely, but largely comes from 
management. And so the people you are supposed to be overseeing 
do control a great deal of the information.
    Now, how do you deal with that? Well, you try to put 
controls in place. You also hire an external auditor. We had 
within Enron an organization that I thought supported that, 
those kinds of checks and balances, because, for example, we 
had a separate financial officer, a separate accounting 
officer, and a separate risk control officer, a separate legal 
officer. None of those were combined and all of them reported 
in at the same level.
    Dr. LeMaistre makes a very good point, also, with this 
whole thing, you hire one of the best accounting firms in the 
business, or at least that was their reputation. The same with 
legal. You try to assess management, and we had no reason to 
distrust management or our outside advisors. Where you feel let 
down is when you do not get the information that you need to 
act, and I do not know how you can act if you do not have that 
information.
    Senator Carper. What punishment is appropriate for those 
who have led to this debacle? And again, this is for any of 
you.
    Mr. Winokur. Senator, I will just speak for myself. I am 
not a lawyer, and I am certainly not a criminal lawyer, I am 
not a civil lawyer. I do not have any idea what is appropriate. 
I hope the investigation pursues everything it can to find out 
everything it can because I think all of us, you, the 
Directors, the employees, deserve to know who knew what, when, 
how, and why. But I could not comment on the----
    Senator Carper. Anyone else?
    Mr. Duncan. Only that we share your frustration.
    Senator Carper. I serve on three committees that have 
conducted parts of the hearings into Enron and we will 
presumably be developing a legislative package to address a 
number of the suggestions that we have heard throughout the 
course of the last several months. They include the roles of 
the auditing firms, the independent audit, whether they should 
rotate firms, whether we should rotate lead auditors, issues 
involving independence of the board, how many independent 
directors should there be, what constitutes a breach of 
independence, issues involving 401(k)'s, how long people should 
have to hold their company stock in order to vest.
    Some of the people who have testified to us have said, you 
should legislate little. You should let the market force the 
corrections and punish those who make the reforms, adopt the 
reforms, and that is the better approach. We have heard from 
people who say the SEC should do certain things, that the board 
exchange, the New York Stock Exchange and others, should push 
various reforms.
    In the end, what should the Congress do? What should we do 
in some of the areas that I have mentioned or others that I 
have not touched on? What should we do as legislators?
    Dr. LeMaistre. Senator, I would like just to agree with 
you. I think there is much the Congress can do once the facts 
are known. I think the only thing the Congress can do now, 
though, is to await the final understanding of exactly how this 
happened, how Enron was brought down and by whom, and where 
controls need to be placed, not by the Board but by either law 
or by the voluntary organizations, and businesses that do this, 
such as the auditors.
    But there is going to be a role for legislation. It may be 
a mid-point between those that said, leave it alone and let it 
happen, and those of us who are a little bit emotional about 
getting everything done right now. I think the best thing to do 
is to let the process of justice go through here where we will 
find out everything, and I am looking forward to that 
understanding, because I could answer your question better 
then.
    I will say this to you. A Board like this one that has been 
through what we have been through would be willing to help you 
in any way we can and tell you where we think, in some more 
detail than we can do today, what really happened and why we 
were let down. I think we do not know enough today to tell you 
more about what is the real problem.
    Mr. Blake. Senator, if I could add one thing, I want to go 
back to the point you made. It gets down to the leadership. You 
cannot legislate leadership. It gets down to what the role of a 
leader of an organization is, the culture of the organization 
he is responsible for, the discipline and the incentives put in 
place to encourage character, honesty and integrity as an 
offset to greed or whatever may be the other compelling factor 
in someone's mind.
    I have been associated with some very successful companies 
as an employee and as a leader of that company, and stressing 
values above performance, values above compensation, a sense of 
integrity and sense of purpose about the company, is what it is 
all about. There has to be a higher purpose for that company 
ultimately to be successful. It should not be motivated by 
short-term windfalls of stock prices. It should be motivated by 
the vision of the company. It should become sort of imbibed in 
the person. You know what I am talking about. That is what real 
leadership is about.
    So I have to say my honest answer to your question, it 
starts with leadership. Forget about anything else. It starts 
with leadership, and if it is not there, then the company will 
fail.
    Senator Carper. Well, there are certain things we can do. 
We are not very good at legislating integrity or character, but 
that is obviously what is needed to best ensure that these 
kinds of things do not happen again.
    Anybody else in terms of--I know my time is expiring.
    Mr. Duncan. Senator, I would agree that it would be very 
difficult to legislate integrity. It would be very difficult to 
write the law on leadership and character. But there are some 
issues, in my opinion, that your Subcommittee and this Congress 
and this Senate should consider, and one of them is that stock 
option problem of how it is accounted for.
    And one of the problems that really is a catch-22, if the 
Dow had not moved from 3,000 to 10,000 while these employees 
had their options, their 7- and 10-year options, then they 
would not be so rewarded. But when the whole market moves up 
and they want to go to work for options and the overhang of the 
stock is one of the things that we kept worrying about. We 
worried that we wanted to compare ourselves with other 
companies on the overhang, i.e., the amount of options that 
were out in relation to the total number of shares of stock, 
and was that in the ballpark, and if it was in the ballpark and 
if we thought we were hiring and were hiring the youngest, the 
brightest leaders, then they wanted options and we would issue 
options.
    But once issued, if they were 10-year options and the whole 
market triples, then you have a catch-22 there, which is an 
incentive to get out, and I do not know the answer to that. If 
we would have issued these options in 1970, at the end of the 
10-year period, they would not have any profit because the 
market did not move. And so I do not know how you put that into 
legislation.
    I will say that one of the reasons, in my opinion, that the 
American system has worked so well for the majority of the 
leaders is because they had options and they led the company 
with leadership and integrity and they made themselves and 
their families some money. So if that had to have been removed 
from the system entirely, I do not think the American economy 
would be doing as well as it is today.
    Senator Carper. Thank you for those comments, and Mr. 
Chairman, thank you for allowing me the time.
    Senator Levin. Thank you, Senator Carper. Senator Durbin.
    Senator Durbin. Thank you, Mr. Chairman. Let me say at the 
outset that I am personally familiar with one of the members of 
the panel. Dr. LeMaistre and I became acquainted almost 20 
years ago. Dr. LeMaistre, you are one of my heroes----
    Dr. LeMaistre. Thank you, sir.
    Senator Durbin [continuing]. What you have done in the 
field of public health has saved countless lives, not just in 
Texas, but in our Nation and around the world----
    Dr. LeMaistre. Thank you, Senator.
    Senator Durbin [continuing]. And I am truly sorry that you 
are in this predicament now and wearing a different hat, but I 
wanted to start off by saying my admiration for you has not 
been diminished in any way whatsoever by this.
    But I want to raise this question. Let me concede at the 
outset I am a liberal arts lawyer. I am not a business major, 
so I struggle to understand a lot of the things that you talk 
about, which are common parlance for people who are involved in 
business. But occasionally, I rely on folks that I think really 
get to the core of the issue for me, and the person that I turn 
to once a year and make sure I never miss his views on life is 
a fellow by the name of Warren Buffet, who puts out the 
Berkshire Hathaway Annual Report. It should be ``must'' reading 
for everyone in Congress, if not everyone in business, because 
I think Warren Buffet has proven that you can do things 
differently and still be very successful.
    Here is what he said in his most recent report to the 
shareholders of Berkshire Hathaway. He said, ``Though our 
corporate performance last year was satisfactory, my 
performance was anything but. I manage most of Berkshire's 
equity portfolio and my results were poor, just as they have 
been for several years.''
    He goes on to say, ``One of my ground rules is applicable. 
I cannot promise results to partners. But Charlie Munger,'' who 
is his vice chairman, ``and I can promise that your economic 
result from Berkshire will parallel ours during the period of 
your ownership. We will not take cash compensation, restricted 
stock, or option grants that would make our results superior to 
yours. Additionally, I will keep well over 99 percent of my net 
worth in Berkshire. My wife and I have never sold a share, nor 
do we intend to.''
    ``Charlie and I are disgusted by the situation so common in 
the last few years in which shareholders have suffered billions 
in losses while the CEOs, promoters, and other highers-up who 
fathered these disasters have walked away with extraordinary 
wealth. Indeed, many of these people were urging investors to 
buy shares while concurrently dumping their own, sometimes 
using methods that hid their actions. To their shame, these 
business leaders view shareholders as patsies, not partners. 
Though Enron has become the symbol for shareholder abuse, there 
is no shortage of egregious conduct elsewhere in corporate 
America.''
    My question to you, because some of you--Mr. Duncan, you 
talked about your business experience and your success--and 
others, as well, have dedicated your lives to American 
business. You have taken risks. Some have succeeded and some 
have failed. For your successes, you have been rewarded, and 
that is the nature of capitalism and free enterprise, as it 
should be.
    But reflect for a moment on what it says to America that we 
can step back and look at this viper's tangle of Enron and 
judge that Mr. Lay was worth over $140 million a year to create 
this fraud on the American public, or that Mr. Fastow was 
discovered to be making an additional $15 million which had not 
quite come to light. Think about what this says to the rest of 
America that wants to believe this is on the square. I do not 
think it meets the standard and test which Warren Buffet is 
talking about here.
    I think Enron, as I said at the outset, has shaken us to 
the core. I do not think any Americans are opposed to success. 
That is what America is all about. That is the American dream. 
But this is not success, this is fraudulent conduct that has 
resulted in unjust rewards.
    I would like to ask you, Dr. LeMaistre, you deal in your 
hospital situations with some of the most gifted men and women 
in the world, skilled people who give more of their lives than 
any of us even in Congress and receive a tiny fraction of what 
some of these corporate officers were receiving. Help me put 
this in perspective. Help me understand why we should use as a 
standard who is making the most in business to decide who is 
worth an extra dollar.
    Dr. LeMaistre. Senator, your quote and your question come 
right to the point. I think that it is difficult for someone 
who has come from a purely academic background to speak to this 
because M.D. Anderson is an academic institution and we do not 
use the same pay methods that we are talking about.
    The real problem, it seems to me, is that we need more 
disclosure from the leadership of business as to what the 
principles are on which they are operating their companies. We 
had an inquiry earlier about what went on in California, for 
example. This Board was never told of any illicit practices 
that were going on in California. I think that the leadership 
should be required to tell a board and the shareholders what 
their practices are going to be. We know in medicine exactly 
what they are going to be and we have a high standard, and if 
it is not met, then there is a remedial action taken.
    As a consequence, I would like to see the same stringent 
approach to the responsibility for leadership, including 
boards, and all of business, because I think we can find ways. 
I think it is going to require, though, as I said before you 
came back in, that we really understand thoroughly what 
happened at Enron. I think the Powers Report is a first, and a 
very quick look at that, and until we get testimony under oath, 
I do not think we are going to fully know exactly why charges 
like gaming are being made in this thing.
    Senator Durbin. Let me use another illustration and then 
ask the other panelists to comment, as well. About a month ago, 
the New York Times in the business section published the 
salaries of the top 100 executives in the United States and 
they compared what they were making to the performance of their 
corporations. Now, you have heard this story repeatedly, how 
boards of directors have repeatedly given bonuses and extra 
payment while the company is going into the dirt.
    If you are standing on the outside looking in from the 
viewpoint of an average citizen or a worker or an investor or 
someone whose pension is on the line, you have got to say this 
is an upside down world. There must be such a closed culture 
within American corporations that they believe they are 
royalty, that they can treat one another with royal conduct 
even if they have not performed accordingly. When I look at 
some of these salaries that are being paid here, this goes way 
beyond incentive compensation.
    Mr. Duncan, you started long ago. Your opening testimony 
talked about your distinguished career in business. You have 
seen some dramatic changes in executive compensation, have you 
not?
    Mr. Duncan. I certainly have.
    Senator Durbin. Are they fair?
    Mr. Duncan. What a comp committee has to do in today's 
world is try to determine whether that executive is the best 
and then determine what he can get if he walks across the 
street.
    When I was President of Gulf and Western, there were two 
guys working there, Michael Eisner and Barry Diller. They made 
a lot more than I did. Why? Because they could walk across the 
street and get more money, and representing the shareholders, 
we did not want them to walk across the street.
    So one of the catch-22s that you face is that you have to 
pay the going rate. Now, the second part of your question, is 
the going rate ludicrous? Yes. But when you have a large 
corporation and you have 20,000 employees and you want the 
corporation to succeed, then you cannot ignore what the going 
rate is, whether you think it is right or wrong.
    And incidentally, I like Warren Buffet's approach. He is my 
hero, too. But he can talk with luxury because he is the second 
richest man in the United States. So he can enjoy saying, ``I 
am not taking a dollar.'' But the young guy who is fresh out of 
MBA school, who has kids that are growing up and knows what he 
can get if he walks down the street, you cannot ignore that, 
either, and it is a tough problem, and it is helped by the fact 
that the Dow keeps moving and stock options are in the mix. It 
is really helped by that fact, because everybody starts reading 
what the other guy is making.
    Senator Durbin. I could defer to our Chairman on the stock 
option question. We are both cosponsors of legislation which he 
has introduced on this issue.
    But Dr. Winokur, would you comment on this executive 
compensation? What is, I think, brewing in this land is a 
feeling of disgust about how much people are being paid and how 
the chasm between the average person who gives his life to 
Enron, puts his entire pension and future in that Enron 401(k) 
and sees it disappear while others are skating away with second 
and third multi-million-dollar homes, there is a basic 
injustice here. There is a feeling of privilege which is not 
part of the American experience. Could you comment on that, as 
well?
    Mr. Winokur. Yes, sir. I manage a private investment 
partnership with a number of financial institutions involved 
and the way our partners get paid is after our limited partners 
have been paid all their money, and a return on their money, 
and all that cash has been sent out, then we split what is left 
if any is left. So I am the last guy in the food chain, so I am 
very sympathetic to both you and Warren Buffet and Charlie 
Munger's point.
    I would just make one suggestion of an item to consider as 
the Chair and you consider the stock option matter. It has 
seemed odd to me in the companies in which we invest that if we 
issue stock, restricted stock, to the employees, there is a 
charge to earnings. If we issue stock options, there is not a 
charge to earnings, a point you obviously know well. But if we 
issue options but the options vest only on achievement of 
performance criteria, there is a charge.
    Now, it would seem to me it would go the other way around, 
that is, that you would want to give people incentives not to 
receive compensation unless they have actually performed, as 
opposed to, as my colleague, Mr. Duncan, said, have a ride on 
the market. I do not know if that is helpful, but it is 
something that has occurred to me.
    Senator Durbin. Well, I stopped short of reading the next 
sentence in Warren Buffet's report, but I am going to read it 
now since it is an open invitation. He says in his annual 
report, ``One story I have heard illustrates the all-too-common 
attitude of managers toward owners. A gorgeous woman slinks up 
to a CEO at a party and purrs, `I will do anything, anything 
you want. Just tell me what you would like.' With no 
hesitation, he replies, `Reprice my options.' '' [Laughter.]
    A lot of us believe that this option business has gotten 
completely out of hand, not just for tax purposes but as 
incentives for compensation. I thank you for your testimony 
today, and Mr. Chairman, thank you for this hearing.
    Senator Levin. Thank you, Senator Durbin.
    We are going to proceed for perhaps 45 minutes to an hour 
here and then break, perhaps completing this panel, but perhaps 
not.
    I am absolutely amazed at your denial of any responsibility 
for what happened at Enron. From the outside, Enron appears as 
a case where insiders made fortunes, much of it based on stock 
options, jacking up share prices, while the shareholders were 
left holding an empty bag. That is from the outside. From the 
inside, I think there is responsibility just from what we are 
going to go into right now and what we have gone into. What the 
Board knew should have triggered on the part of the Board a 
heck of a lot greater vigilance than it did.
    In the words of the Powers Report, which we are going to 
try to demonstrate here factually with documents, ``The 
financial reporting abuses of management could and should have 
been prevented or detected at an earlier time had the Board 
been more aggressive and vigilant.'' That is the Powers Report. 
You deny even that, that you could have been more aggressive 
and vigilant. You just point your fingers at management, and 
let me tell you, they bear a lot of the responsibility, plenty 
of it, and their time will come.
    But now, you should step up to the plate. You are the 
Board. You are the captain of this ship that went down, and you 
are denying any responsibility.
    All of those red flags which we are going to go into, you 
say you did not see them, they were not there, you were not 
told. There were plenty of things you were told and that you 
knew which should have triggered much stronger action on your 
part. I want to go into some of those right now because I do 
not think the facts support your denial of any responsibility, 
and I just don't buy it.
    There is responsibility in this Board and it should be 
accepted. Otherwise, directors are going to duck responsibility 
in all corporations, blame it on people who did not tell them 
things, even though there were warning signals and even though 
there were facts, much more than warning signals, facts which 
we are going to go into which were brought to the attention of 
the Board and which should have triggered action on the part of 
the Board.
    First, I want to talk about Whitewing, one of these complex 
transactions. This was an early step which you took as a Board 
which waded into dangerous waters.
    The strategy of Enron was to become asset-light. That means 
selling assets to or syndicating, sharing the liability or risk 
of assets, with a third party. The money raised from the sale 
of these assets was then to be used for new instruments that 
would offer a higher return, and the sales would improve your 
balance sheet.
    Enron called these assets that were held for sale merchant 
assets. I want to talk to you about how Enron set about selling 
these assets and finding outside investors to invest in them, 
and I will be asking most of these questions of Mr. Winokur, as 
Chairman, and Mr. Blake. Both of you were on the Finance 
Committee.
    First, back in 1997, according to the CFO magazine, Enron 
is having a challenging year. The debt is the result of 
enormous growth. It was higher than was consistent with your 
credit rating, and retaining a high credit rating was critical 
to the success of your trading business. So with that 
background, Mr. Blake first, what can you tell me about 
Whitewing and Nighthawk?
    Mr. Blake. Well, as the chart indicates,\1\ this is a means 
by which to substitute equity for debt, and that is the $1 
billion that comes in from Whitewing is proceeds that can be 
used to pay down debt, and when you are transferring 
convertible preferred stock to Whitewing.
---------------------------------------------------------------------------
    \1\ See Exhibit No. 15, chart entitled ``Condor Transaction,'' 
which appears in the Appendix on page 253.
---------------------------------------------------------------------------
    Senator Levin. Now, when you talked to our staff, did you 
tell them that you did not have much recollection of this?
    Mr. Blake. That is correct. I did, Senator.
    Senator Levin. So you have refreshed your recollection 
since then?
    Mr. Blake. Yes, I have.
    Senator Levin. Fine. Mr. Winokur, what can you tell me 
about Whitewing and Nighthawk?
    Mr. Winokur. Nighthawk, which is really an entity owned by 
Citibank, put up $500 million. Enron put up $500 million into 
Whitewing, which was an LLC, and that company took the $1 
billion and paid it back to Enron, so Enron had net $500 
million with which it could pay down its debt or make further 
investments.
    Senator Levin. All right. Now, when you met with my staff, 
did you also tell my staff you did not have much recollection 
of that transaction?
    Mr. Winokur. Yes, sir.
    Senator Levin. Now that you have refreshed your 
recollections, Enron was borrowing a half-a-billion dollars 
from Citibank, but it did not show up on the balance sheet of 
Enron as debt but rather as preferred shares, which looked more 
like equity than debt. It was a loan disguised as equity in 
order to avoid showing debt on the books. Now, look at page 2 
of Exhibit 15.\1\
    Mr. Winokur. Sir, I believe it was accounted for as a 
consolidated subsidiary with a----
    Senator Levin. Was it shown as a loan?
    Mr. Winokur. It was shown as--the entity was consolidated 
and the $500 million of Citibank was a minority interest.
    Senator Levin. But was it shown as a loan?
    Mr. Winokur. No, sir.
    Senator Levin. That is, in effect, what it was.
    Let us go now to 1999. The Board is now getting into deeper 
and deeper water. This time, Jeff Skilling tells the Board 
about his asset-light strategy, and Andrew Fastow is talking 
openly about the determination to sell assets. The market goes 
for it. Enron's stock price continues to go up.
    This Nighthawk-Whitewing deal had worked like a charm. 
Enron borrowed a half-a-billion dollars in funds without 
appearing to burden the company with more debt. Now, it needed 
more money to invest in broadband and other new ventures, but 
it did not want to directly borrow the money and put the debt 
on the balance sheet, so now you have to figure out a new way 
to bring funds into Enron.
    So the second stage of Whitewing comes along. It is a trust 
called Osprey. Now, first, Mr. Winokur, did you tell my staff 
you basically did not remember much about the Osprey 
transaction?
    Mr. Winokur. Yes, sir.
    Senator Levin. And, Mr. Blake, did you also tell my staff 
you did not remember much about that transaction?
    Mr. Blake. Yes, sir.
    Senator Levin. OK. Now, this was a transaction where Osprey 
raised $1.5 billion by selling bonds to outside investors and 
used it to buy a stake in Whitewing. Enron deconsolidated 
Whitewing, so it took Whitewing off the Enron books. This chart 
is the second page of that Exhibit 15.\1\ It lays out this 
structure of Whitewing with Osprey. Basically, what the Board 
did here was use Enron stock as collateral for Osprey's $1.5 
billion borrowing.
---------------------------------------------------------------------------
    \1\ See Exhibit No. 15 which appears in the Appendix on page 253.
---------------------------------------------------------------------------
    Mr. Duncan, I believe that you were there when you moved to 
approve that transaction, is that correct?
    Mr. Duncan. That is correct.
    Senator Levin. And, Mr. Blake, you seconded that?
    Mr. Blake. That is correct.
    Senator Levin. A billion-and-a-half dollars. At least when 
my staff talked to you, no memory of that. Osprey had come up 
15 times in presentations to the Finance Committee and to the 
entire Board.
    Now, Mr. Winokur, do you know what Whitewing did with the 
$1.5 billion that it got from Osprey?
    Mr. Winokur. Well, it repaid Citibank the $500--actually, 
$570 million, because that was--there was an accrual, and part 
of the reason was that the convertible preferred stock that had 
been in Whitewing had appreciated significantly and that was 
not part of the consideration to Citibank.
    Senator Levin. Did it also buy Enron's assets?
    Mr. Winokur. It bought merchant assets at no gain or loss. 
Those were merchant assets.
    Senator Levin. All right.
    Mr. Winokur. And the debt----
    Senator Levin. Did Enron have to sell these in order to go 
through its asset-light strategy? Was that part of the 
strategy, to sell these assets?
    Mr. Winokur. Well, it was part of the strategy to sell the 
assets when it was time to sell them. I do not know 
specifically what the motivation was behind each individual 
sale.
    Senator Levin. But you do remember the meeting where Mr. 
Fastow, the Chief Financial Officer, talked openly about the 
need to sell assets back in 1999, and Skilling talking about 
the asset-light strategy? Do you remember that?
    Mr. Winokur. I understand that strategy, yes, sir.
    Senator Levin. Do you remember that?
    Mr. Winokur. Yes, sir.
    Senator Levin. Was this part of that strategy?
    Mr. Winokur. Yes, sir. I would also like to say that the 
bonds were rated and the equity in affiliates, which is where 
Whitewing was then carried, showed the consolidated balance 
sheet for all of the equity and affiliate transactions.
    Senator Levin. Now, were the bondholders--did they have a 
guarantee that if the assets did not generate cash to pay them 
back on their bonds, that Enron shares would be used to pay 
them back?
    Mr. Winokur. Yes, sir, and that was fully disclosed, as 
well.
    Senator Levin. These were promises that were made to the 
bondholders that Enron shares would be used if they did not 
get----
    Mr. Winokur. They were made to the bondholders and 
disclosed in Enron's financials, yes.
    Senator Levin. So they could not lose. The bondholders 
could not lose. Enron stock was there to guarantee the return, 
is that the bottom line?
    Mr. Winokur. Well, they could lose if Enron went bankrupt 
and could not make good on its----
    Senator Levin. Right. Other than that, though, Enron stock, 
no matter how much was needed, was used to back up that bond 
return, is that correct?
    Mr. Winokur. It was not an infinite quantity of stock, as I 
recall. It was either convertible preferred stock in a fixed 
amount or common shares.
    Senator Levin. You think that there was a limit on how much 
stock could be converted or used to pay for those bonds?
    Mr. Winokur. I think it was convertible preferred stock was 
available, as well.
    Senator Levin. So was there, then, in effect, either 
through convertible preferred stock or otherwise, a guarantee 
as long as Enron was in business that whatever amount of stock 
of Enron was needed to pay those bond holders, it would be 
used?
    Mr. Winokur. It was contingent support, sir.
    Senator Levin. Contingent?
    Mr. Jaedicke. That would have been disclosed in the 
footnote.
    Senator Levin. I am asking you, what was there? Was there 
any limit on how much Enron stock, preferred or otherwise, 
could be used to back up the payment of those bonds to the 
bondholders? That is a simple question.
    Mr. Jaedicke. Was there any limit?
    Senator Levin. Yes. As long as Enron was in business, was 
there any limit to the amount of stock?
    Mr. Jaedicke. I think the only limit that would come into 
play would be that there is a transaction approval process on 
the sale and purchase of assets and the issuance of stock. It 
would have had to come to the Board.
    Senator Levin. My question is, to repay those bondholders 
what they were guaranteed, was there any limit on the number of 
shares of Enron stock that had to be or would be sold, if 
necessary, to pay them back? That is my question.
    Mr. Jaedicke. The market would have imposed the limit, just 
like they would have imposed a limit on how much you can 
borrow.\1\
---------------------------------------------------------------------------
    \1\ See Exhibit No. 80 for clarification which appears in the 
Appendix on page 665.
---------------------------------------------------------------------------
    Senator Levin. I am talking about the number of shares 
sold, not the value of----
    Mr. Jaedicke. I do not think--no----
    Mr. Winokur. Sir, the minutes say that there were reserved 
20 million additional shares of common stock and 100,000 
preferred shares of the company for issuance under the share 
settlement agreement.
    Senator Levin. Take a look at Exhibit 32,\1\ if you would, 
the ``Stock Price Risk and Financing.''
---------------------------------------------------------------------------
    \1\ See Exhibit No. 32 which appears in the Appendix on page 334.
---------------------------------------------------------------------------
    Mr. Winokur. Yes, sir.
    Senator Levin. Do you see that risk on Osprey?
    Mr. Winokur. Yes, sir.
    Senator Levin. Ten thousand shares if it went down to $40?
    Mr. Winokur. Ten million shares, yes.
    Senator Levin. Ten million shares if it went down to $40?
    Mr. Winokur. Yes, sir.
    Senator Levin. If it went down to $20, what would be the 
risk?
    Mr. Winokur. I cannot do that calculation.
    Senator Levin. But whatever was necessary?
    Mr. Winokur. No. The share settlement agreement that I just 
read--now, again, I do not have the detailed document--said 
that a certain amount of common stock or preferred stock was 
reserved for issuance, and that is why I said to you that I 
believe that there was a contingent limited guarantee.
    Senator Levin. You believe it was limited as to how many 
shares would be sold to pay back those bondholders, is that 
what you are saying?
    Mr. Winokur. In 1999, when this was done, to the best of my 
knowledge.
    Senator Levin. Let me just make sure here that we are on 
the same wavelength. We are talking about the number of shares, 
not the amount of the dollars to be repaid. But what I am 
asking you again is, was there any limit on the number of 
shares of Enron that would be sold to pay back the bondholders? 
That is my question. You are saying the answer is yes. Is that 
your answer?
    Mr. Winokur. To the best of my recollection--this was a 
transaction that happened 3 years ago--I am referring to the 
minutes which says there will be reserved 20 million additional 
shares of common stock and 100,000 preferred shares of the 
company for issuance under the share settlement agreement. That 
is my only recollection, is what is here.
    Senator Levin. You do not know, then, whether or not there 
was any limit?
    Mr. Winokur. I do not know----
    Senator Levin. You know how many were reserved, but you do 
not know whether there was a limit?
    Mr. Winokur. Well----
    Senator Levin. Under the agreement--I am just trying to get 
an answer.
    Mr. Winokur. I only know what is in the minutes, sir.
    Senator Levin. All right. You do not know, then, whether 
there was a limit or not.
    Next, LJM. Now getting more and more dangerous and deeper, 
here is another off-the-books entity that Enron helped to 
create which bought Enron assets. With the Board's approval of 
the partnership, here is what happened. On June 28, 1999, the 
Board held a special meeting in which all five of you 
participated either by phone or in person. You approved the 
creation of LJM1, and for the first time, you waived Enron's 
conflict of interest provision in your code of conduct to allow 
the Chief Financial Officer, Andrew Fastow, to take an 
ownership interest and act as the general partner of the LJM 
partnership.
    Now, Mr. Winokur, under the normal order of business, this 
matter was not first presented to the Finance Committee, is 
that correct?
    Mr. Winokur. Yes, sir. That is correct. It was not 
presented.
    Senator Levin. It was not presented to the Finance 
Committee. The Finance Committee was skipped. Why was that?
    Mr. Winokur. Well, this was not a regularly scheduled 
meeting of the Board.
    Senator Levin. You had a lot of special meetings of the 
Board.
    Mr. Winokur. Special meeting. I cannot tell you why there 
was not a special Finance Committee meeting.
    Senator Levin. Did you ask?
    Mr. Winokur. I do not recall asking why there was not a 
special Finance Committee meeting, no.
    Senator Levin. Now, you testified this morning that the 
Board did not waive the code of conduct.
    Mr. Winokur. Yes, sir.
    Senator Levin. That was your testimony this morning. Take a 
look at Exhibit 19, if you would.\1\
---------------------------------------------------------------------------
    \1\ See Exhibit No. 19, entitled ``Key Elements of Transaction to 
be Approved,'' which appears in the Appendix on page 261.
---------------------------------------------------------------------------
    Mr. Winokur. Sir, I know that the chart uses the term----
    Senator Levin. That is your chart, is it not?
    Mr. Winokur. No, this is management's chart.
    Senator Levin. Was it presented to you?
    Mr. Winokur. It was presented to us, and in the resolution 
that the Board approved, we ratified management of the Office 
of the Chairman's decision that permitting Mr. Fastow to 
participate in this would not be adverse to Enron.
    Senator Levin. Well, that is a different issue. The 
question is whether or not it was considered inside Enron, as 
well as by the rest of us, as a waiver of your code of conduct. 
Your own document says, ``waiver of code of conduct,'' yet you 
testified this morning that there was no waiver of a code of 
conduct. I am just presenting you with your own document.
    Mr. Winokur. Sir this is----
    Senator Levin. It says it was.
    Mr. Winokur. This was management's presentation to the 
Board. We applied the code of conduct. The Chief Executive has 
the ability to make a determination, as I said in my statement 
this morning, that permitting Mr. Fastow to make this 
investment would not have any probability of conflict of 
interest, and we ratified that decision, which is applying the 
code of conduct.
    Senator Levin. Applying the code of conduct. Let us take a 
look at Exhibit 20.\2\ Now, the second time it is presented to 
you as a waiver. It has got the Enron logo on there. Look at 
the bottom, Finance Committee, Board of Directors action 
requested. ``Ratify decision of Office of the Chairman to 
waive--not apply--waive code of conduct in order to allow A. 
Fastow participation.''
---------------------------------------------------------------------------
    \2\ See Exhibit No. 20 which appears in the Appendix on page 271.
---------------------------------------------------------------------------
    Now, did you tell them, hey, wait a minute, do not present 
that to us as a waiver. Present that to us as an application. 
You did not tell them that, did you?
    Mr. Winokur. When we approved it at the Board meeting, that 
is what we approved, the application.
    Senator Levin. I understand that. That was the first time.
    Mr. Winokur. The resolution following this meeting, which 
was in October 1999, has the same language.
    Senator Levin. Right. I understand. But it is presented on 
Enron documents the second time now as a waiver. That is the 
way it was viewed inside Enron by the management. That is the 
way it is viewed by me. But you are saying, no, we did not 
waive it, we applied it. I am just asking you this question. 
When this was presented to the Board as a waiver in the Enron 
document Exhibit No. 20,\1\ did you object to the presentation 
of it to you as a waiver?
    Mr. Winokur. I did not treat it as a waiver. I did not 
object to the words in this document.
    Senator Levin. You did not tell management, hey, wait a 
minute. You are asking us to waive----
    Mr. Winokur. Yes, sir.
    Senator Levin [continuing]. For the second time. We are 
telling you, we are not waiving. We are applying. Did you do 
that?
    Mr. Winokur. We did that in the Board approval.
    Senator Levin. You told them, this is not a waiver? Did you 
ever use the words, ``This is not a waiver'' in the Board 
approval?
    Mr. Winokur. No, sir.
    Senator Levin. No.
    Mr. Jaedicke. Mr. Chairman, can I----
    Senator Levin. Sure.
    Mr. Jaedicke [continuing]. Just inject that I think if 
you--I am not absolutely sure of this, but I think if you look 
at the minutes of that meeting, you will find that Fastow 
himself says in presentation--this slide does not say it, but 
that it requires the Board to ratify the decision of the Office 
of the Chairman----
    Senator Levin. Right.
    Mr. Jaedicke [continuing]. That his--it requires a finding 
and a recommendation that it will not--that there appears to be 
a zero probability that it will be adverse to Enron. Now, he 
did not use zero probability, but----
    Senator Levin. That is his opinion.
    Mr. Jaedicke. But he presented it, I think, properly, is 
what the minutes indicate.
    Senator Levin. He presented it in this document as a 
waiver. Was that proper?
    Mr. Jaedicke. The document----
    Senator Levin. Is that proper?
    Mr. Jaedicke. No.
    Senator Levin. Thank you. Now, LJM1 is an extremely unusual 
arrangement. You set up a private equity fund. You waive the 
code of conduct, or in your words, you approve a deviation from 
it, and install Enron's CFO as the managing partner of the 
fund. Each of you said during your interview that you had never 
approved a similar arrangement before and you were unaware of 
any company that had its CFO running a private equity fund on 
the side. So far, are you with me?
    Mr. Winokur. Yes, sir.
    Senator Levin. None of the experts we have contacted have 
ever heard of such an arrangement, either. But LJM1 was made 
after 3 days notice of the proposal, no prior Board discussion 
with either Enron management or Andersen, no written legal 
opinion, no prior Finance Committee review. Now, some of you 
told us that the Board was told that speed is of the essence. 
Is that your understanding? Was speed of the essence?
    Mr. Winokur. I do not recall saying that.
    Senator Levin. You do not remember----
    Mr. Jaedicke. I think I can speak to that.
    Senator Levin. Is that what you were told, that speed is 
of----
    Mr. Jaedicke. Well, the meeting took place in the middle of 
June. The end of June was the end of the quarter, second 
quarter. Shortly after that, you had to issue financial 
statements. They had the Rhythms stock. The Rhythms stock had 
gone up greatly and they wanted to get it hedged. We thought 
this was a valid hedge. We did not--I think the reason they 
wanted it done by the end of June is because they did not want 
to be in the position of having a fair value investment, a 
stock on their books, a mark-to-market, without a hedge. So 
there was--the hedge should have been put on by the end of 
June.
    There were other items on the agenda of that June 
Committee, sir. I do not know, we had a stock split. There were 
two or three other items on the agenda, and I think it was 
not--I think we can probably find other decisions were made 
that necessarily did not go through a particular committee.
    Senator Levin. This was an unusual transaction, was it not?
    Mr. Jaedicke. Well, you mean----
    Senator Levin. No one had ever heard of an equity fund like 
this before.
    Mr. Jaedicke. What is the unusual transaction?
    Senator Levin. To create an equity fund to buy your own 
assets.
    Mr. Jaedicke. Sir, I am sorry. We approved a specific 
transaction, which was a Rhythms hedge, and the company--we did 
it with Fastow. That was different. But the use of hedges and 
the use of at least what I would call less-than-perfect 
correlation hedges, was explained in detail in the annual 
report. I mean, that was part of the strategy.
    Senator Levin. But you have said that now the only purpose 
of this was to acquire a hedge.
    Mr. Winokur. Sir, LJM2, which was set up in October, was, 
in fact, an alternative optional source of capital.
    Mr. Jaedicke. That was different. I am sorry. I thought you 
were talking about LJM1.
    Senator Levin. I am talking about LJM1. Is it not true that 
LJM1, in addition to the hedge, which you said was its only 
purpose, could negotiate with the company regarding the 
purchase of additional assets? Is that not true?
    Mr. Jaedicke. That is true.
    Senator Levin. So it was not just for the hedge. It had an 
additional purpose, which was to buy assets.
    Mr. Jaedicke. And in the meantime, you would put in the 
controls that were necessary.
    Senator Levin. I understand, but you just said a minute ago 
the sole purpose----
    Mr. Jaedicke. Sir, I would just like to point out to you--
--
    Senator Levin. But you just said a minute ago the sole 
purpose was for the hedge. I am just pointing out to you that 
it had an additional purpose, which was to buy assets.
    Mr. Jaedicke. I told your staff this, that the ironic part 
of this is--I have been in a situation recently where I would 
have been prepared to have an inside transaction, in this case, 
with an equity fund that was run by a very senior--not the CFO, 
but a very senior person in the company. It turned out the 
transaction did not--because I thought in that case, as this 
case, that you could do it better inside than you could 
outside. It was cheaper. It was quicker. It was more efficient. 
That was the thought on LJM1. And on the related party, I just 
happened to be in a similar position with a very similar fund. 
It did not take place, but I would have supported it.
    Senator Levin. In October 1999, more than 3 months after 
you approved LJM1, the Finance Committee was asked to approve 
LJM2. Mr. Fastow now was proposing another vehicle that would 
complete a large number of deals with Enron and push further 
the Enron strategy to move assets off the books.
    Mr. Winokur, I believe you told the staff that before the 
Finance Committee meets, you typically meet with Enron 
management to set the agenda and to discuss the issues, but 
that did not happen with LJM2, did it?
    Mr. Winokur. Well, we had a telephonic meeting in advance 
to go over the agenda. I have no reason to believe it did not 
happen.
    Senator Levin. Did you not tell us the first time you heard 
about this was at the Finance Committee meeting on October 11?
    Mr. Winokur. I do not recall whether there was a telephone 
meeting or not.
    Senator Levin. When was the first time you heard about 
LJM2?
    Mr. Winokur. At the meeting, unless we had a telephonic 
meeting to describe the agenda. Sir, I do not remember which.
    Senator Levin. Is not the creation of LJM2 something that 
you, as Chairman of the Finance Committee, should have been 
consulted on before the day that you were expected to make a 
decision?
    Mr. Winokur. Well, to make a recommendation, yes, sir.
    Senator Levin. To make a recommendation. Well, it is a 
decision to make a recommendation. But my question is, should 
you not have been consulted before the day that you were 
expected to make a decision or a recommendation?
    Mr. Winokur. Sir, I do not recall when I learned of the 
LJM2 matter, whether it would have been with the material that 
was provided in advance of the meeting or in a telephonic 
conversation or at the meeting itself.
    Senator Levin. But my question is a little different. 
Should you not have been consulted about this transaction, this 
proposal, prior to the meeting, as Chairman of that Committee?
    Mr. Winokur. The principal purpose of a pre-meeting was to 
make sure that we had the agenda laid out, not so much 
necessarily to go through individual items in detail.
    Senator Levin. Was LJM2 on the agenda?
    Mr. Winokur. I do not have the agenda here.
    Senator Levin. Do you remember whether it was on the 
agenda?
    Mr. Winokur. Well, I believe it was, yes, sir.
    Senator Levin. This is a major transaction. We are talking 
billions of dollars. You are now telling us that you would not 
normally have discussed a transaction of that magnitude prior 
to it appearing on the agenda at the Finance Committee?
    Mr. Winokur. Sir, we were talking about organizing a fund 
that might raise $200 million that would be alternative and 
optional as a source of funds for Enron. It did not require--
there was no specific transaction being proposed except the 
organization of the fund and the ratification of the decision 
to permit Mr. Fastow to participate in it. There was no sale 
being discussed.
    Senator Levin. It was a fund, however, which would openly 
now have a member of the Enron management participate in an 
outside company whose purpose was to purchase assets, is that 
correct?
    Mr. Winokur. Yes, sir. We had a vigorous discussion at the 
meeting.
    Senator Levin. And you decided to let him do it?
    Mr. Winokur. We decided to ratify the decision of the 
Office of the Chairman.
    Senator Levin. Another off-balance-sheet vehicle, buying 
assets. But this time and the time before, this is really 
interesting, this time, when we talk about LJM, now you have 
got a guy who is management who is on the other side of the 
table. He is buying assets from you, and he is wearing both 
hats. He is now playing a key role in the sale, setting the 
sale price, and he is also buying at the same time. You put 
certain what you call protective devices in place, but they 
sure did not work very well.
    Mr. Winokur. Sir, the concept of LJM was to provide bridge 
financing for the business unit heads who wanted to sell 
assets. They were not required to sell them to LJM2. They had 
their own financial incentives. They had their own operational 
capabilities. So LJM2 was an alternative and optional source of 
capital for them. If they did not like the price LJM2 was 
offering, they did not have to use it.
    Senator Levin. Why did you create LJM2? What was wrong with 
Whitewing?
    Mr. Winokur. Whitewing was a very large vehicle. It was 
expensive and time consuming and complicated to create. To have 
an independent, smaller, private vehicle which would provide 
bridge financing for smaller transactions seemed like a 
perfectly reasonable thing to do.
    Senator Levin. Let me show you Exhibit 21,\1\ if you would. 
This is the way LJM was being marketed. The first page of the 
text, in the middle, says, ``Under Mr. Fastow's management, the 
Partnership expects to have the opportunity to co-invest with 
Enron'' and then ``acquire existing Enron assets on a highly 
selective basis. This access to deal flow should provide the 
Partnership with unusually attractive investment 
opportunities.'' The memo goes on to say it is going to be 
managed by a ``team of three investment professionals who all 
currently have senior level finance positions with Enron.'' 
Then if you look at the end of this document, the last line, 
``The Partnership should also benefit indirectly from time 
spent by the Principals in evaluating and structuring 
investments for Enron, as many of these investments may become 
candidates for investment by the Partnership.''
---------------------------------------------------------------------------
    \1\ See Exhibit No. 21 which appears in the Appendix on page 272.
---------------------------------------------------------------------------
    They are touting their inside information in Enron as they 
are selling the interest in that LJM partnership. That conflict 
of interest is being sold as a plus to people who are 
investing. Now, did you ever inquire as to how they were 
marketing this? Did you ever ask for any marketing documents 
like this?
    Mr. Winokur. We asked and were told that Enron's counsel, 
Vinson and Elkins, had reviewed drafts of the document. I did 
not actually see this document until my work on the Powers 
Committee, and we, of course, were never told that Mr. Kopper 
was a participant. Mr. Glison said in his Powers interview that 
his name was erroneously included here.
    Senator Levin. Mr. Glison was not erroneously included, 
though.
    Mr. Winokur. Well, as it turned out.
    Senator Levin. Right. But what I am saying is, you never 
asked to see documents?
    Mr. Winokur. This was an independent, separately organized 
entity. We asked our counsel to review the drafts to make sure 
the disclosures were proper.
    Senator Levin. And did your counsel tell you that it is OK 
to tout a conflict of interest as a way to sell something?
    Mr. Winokur. They did not.
    Senator Levin. Have you asked them about why they did not?
    Mr. Winokur. Well, I did not ask Vinson and Elkins, no, 
sir, but the Powers Committee report makes it clear that Vinson 
and Elkins reviewed these drafts. They would have done that and 
reported through the Enron legal chain and no one came 
forward----
    Senator Levin. And after you heard that they approved this 
kind of marketing, using a conflict situation to sell an 
interest, saying that: Hey, I have got an inside position. We 
are in Enron, three of us. We are in a great position to help 
this partnership that is buying things from Enron get a good 
deal. That is being used, touted. And you are saying your 
lawyer saw that and approved it. Then my question to you is, 
after you heard that he had approved it and after you now have 
read this, have you ever asked your lawyer, how in heaven's 
name could you have approved that? That is my question.
    Mr. Winokur. Sir, first of all, we knew that a possibility 
is that Enron would be selling assets to LJM2. One of the 
reasons for establishing LJM2 was to provide an optional 
alternative source of capital to buy assets from Enron, and the 
benefit of having Fastow, who is the only person we knew about, 
involved in this is that he would know the assets, and the 
benefit of having the other people inside Enron who ran 
divisions to go to Fastow, if they did not like Fastow's bid, 
they did not have to take it. We also had the Chief Risk 
Officer and the Chief Accounting Officer reviewing each 
transaction. So the fact of the conflict was known from the 
beginning.
    Senator Levin. Exhibit 16,\1\ if you will take a look at 
it, will show you how you could have sold these assets without 
that kind of a conflict. This is the result, though, of what 
happened. When LJM bought these Enron assets--now we are 
talking LJM again--Enron tacitly agreed to buy some of them 
back if LJM could not sell them. Are you aware of that?
---------------------------------------------------------------------------
    \1\ See Exhibit No. 16 which appears in the Appendix on page 256.
---------------------------------------------------------------------------
    Mr. Winokur. No, sir.
    Senator Levin. When that happened, Enron paid more to LJM 
than Enron had paid to buy the asset in the first place. Are 
you aware of that?
    Mr. Winokur. No, sir.
    Senator Levin. In negotiating the sale of assets to LJM, 
Fastow clearly had a superior bargaining position over Enron 
personnel because both sides reported to him. Are you aware of 
that?
    Mr. Winokur. Well, the operating divisions did not report 
to Mr. Fastow.
    Senator Levin. Were there people involved on the Enron side 
making a decision who did report to Fastow?
    Mr. Winokur. We later found that was the case. That was not 
consistent with the controls that we had put in place.
    Senator Levin. Those controls were not working very well, 
were they?
    Mr. Winokur. We were told they were and they obviously 
turned out not to be.
    Senator Levin. So that, at a minimum, the controls you put 
in place did not function to protect Enron.
    Mr. Winokur. Well, Mr. Fastow told us in October with Mr. 
Buy, Mr. Causey, and Mr. Skilling sitting right there, that the 
three of them were reviewing every transaction with LJM.
    Senator Levin. My question, though, is a little different. 
My question is the controls that you put in place did not work 
very well.
    Mr. Winokur. Well, we did not know that.
    Senator Levin. I am just saying----
    Mr. Winokur. We were told that they----
    Senator Levin. They did not work very well.
    Mr. Winokur. Well, they should have worked, but people did 
not do them.
    Senator Levin. Did LJM investors get a 69 percent return on 
their investment?
    Mr. Winokur. I saw a presentation through my Powers work to 
the LJM investors that showed a very high rate of return. I 
think that was the number you are quoting.
    Senator Levin. And would you agree that when LJM was 
benefitted to that extent, that would be at the expense of 
Enron?
    Mr. Winokur. Yes, sir.
    Senator Levin. And Fastow would profit from that?
    Mr. Winokur. Sir, in May 2000, Mr. Fastow told us he was 
spending approximately 3 hours a week on these vehicles and the 
vehicles were earning approximately an 18 percent return.
    Senator Levin. But my question is a little different. Do 
you agree that Fastow, when a 69 percent return was obtained by 
LJM, personally benefitted from that huge return?
    Mr. Winokur. Absolutely.
    Senator Levin. OK. That is the outcome of that conflict of 
interest--one of the outcomes, because you have got a guy on 
the other side of the table now who is doing the negotiating 
who, when he is putting on the LJM hat, gets a 69 percent 
return at the expense of Enron. That is the outcome of the 
conflict of interest.
    Mr. Winokur. But his supervisor, Mr. Skilling, and his 
peers, Mr. Buy and Mr. Causey, we were told that they were 
reviewing each and every transaction. Mr. Causey, Mr. Buy, and 
Mr. Skilling had no economic interest in LJM. Their interest 
was in Enron stock. If they had known, presumably, they would 
have taken steps to make sure that LJM was not making a 69 
percent return. We were told they were on top of each and every 
transaction.
    Senator Levin. And when you found out to the contrary, you 
asked them about it?
    Mr. Winokur. I found out the contrary in the Powers 
investigation.
    Senator Levin. That is the first time you knew?
    Mr. Winokur. Yes, sir.
    Senator Levin. On the LJM transaction reviews, let us go on 
to that, Mr. Jaedicke. The Audit Committee had the primary 
responsibility for reviewing these transactions. It conducted 
two annual reviews of LJM transactions, one on February 7, 
2000, and the other a year later in February 2001. First of 
all, is it true that the Audit Committee spent no more than 30 
minutes at each meeting going through the LJM transactions?
    Mr. Jaedicke. I am sorry, who said that?
    Senator Levin. I am asking you, is it true?
    Mr. Jaedicke. Is it true that we spent no more than 30 
minutes?
    Senator Levin. On the LJM transactions during those Audit 
Committee meetings.
    Mr. Jaedicke. Well, we did not necessarily review each 
individual transaction. We reviewed the type of transactions. 
We asked pointed questions about are these done at arm's length 
or fair to Enron. We were assured that they were. Arthur 
Andersen was sitting there. That footnote is in the annual 
report and it is an auditable footnote, and neither management 
nor Andersen--management cannot make that representation to us 
unless they have some reason, and Andersen has to audit it.
    Senator Levin. I understand, but my----
    Mr. Jaedicke. So a half-hour? Yes, I would imagine that was 
probably 25 percent of the time in a typical Audit Committee, 
but we had the information before, and I do not know how many--
I do not know how much time people spent on the exhibits and so 
on when they were given to us.
    Senator Levin. OK.
    Mr. Jaedicke. All I can say is I think the--even though we 
did not have the information we needed, we were not told the 
truth, in fact, I think we spent a sufficient amount of time--
--
    Senator Levin. That was not my question.
    Mr. Jaedicke [continuing]. To carry that out.
    Senator Levin. My question was, is it true you spent no 
more than 30 minutes? It is just a simple, direct question.
    Mr. Jaedicke. I would suppose that would be true.
    Senator Levin. Thank you. Now, on LJM3, on October 6, 2000, 
Fastow proposed LJM3 to the Finance Committee and asked for a 
third waiver. The Committee approved that waiver. At the same 
time, Dr. Winokur, I believe you proposed that the Compensation 
Committee review Fastow's LJM compensation. Mr. Blake, you 
proposed that the Finance Committee review Enron's transactions 
with LJM every quarter.
    Mr. Blake. Yes, sir.
    Senator Levin. So now I want to focus on the October 6, 
2000, meeting, where Fastow proposes LJM3 to the Finance 
Committee, asks for the waiver, and gets it. But now, Dr. 
Winokur, you are proposing that there be a review of his 
compensation, and Mr. Blake, you are proposing that the Finance 
Committee review the transactions every quarter. These 
proposals were unanimously agreed to at the meeting. So the 
Committee now imposes some reviews. Now, let us talk about the 
follow-through on those decisions.
    First, I think I asked Dr. LeMaistre about this one. You 
attended the Finance Committee meeting on October 6 when that 
proposal was adopted for the Compensation Committee to review 
Mr. Fastow's compensation. But that review was not completed in 
2000. In fact, it was not done that year at all, was it?
    Dr. LeMaistre. As far as I know, it was not.
    Senator Levin. Now, why didn't you promptly do the review 
since you had that vote?
    Dr. LeMaistre. Primarily because we did not have the 
information, and it was our understanding at the time that 
Fastow's compensation was to be under the control of formulas. 
It was to come through with the other reports on the quarterly 
base and the annual base and it did not.
    Senator Levin. In other words, you are saying it was not 
intended that you review that compensation immediately? You 
were supposed to wait?
    Dr. LeMaistre. Mr. Winokur's direct words in that meeting 
were, ``Perhaps it would be a good idea to have the 
Compensation Committee take a look at information regarding his 
compensation.'' It was a remark that would indicate to me that 
they already had the compensation there, and that turned out 
not to be the case at the end of the first quarter when I 
checked, and, therefore, that is basically the reason I did the 
checking.
    Senator Levin. When did you do the checking?
    Dr. LeMaistre. After the first quarter of 2001.
    Senator Levin. It was reported in the Wall Street Journal--
we have gone into this today--that Mr. Fastow had made millions 
of dollars more from LJM. When was that?
    Dr. LeMaistre. That was on October, 19, 2001.
    Senator Levin. It was only then?
    Dr. LeMaistre. That was the first time that any of us knew 
that there was something wrong going on.
    Senator Levin. Right, but you had made inquiry about his 
compensation. Didn't you ask the Compensation Officer at Enron, 
Mary Joyce, about it?
    Dr. LeMaistre. I asked Mary Joyce about it.
    Senator Levin. And what did she tell you?
    Dr. LeMaistre. She said she did not have the information.
    Senator Levin. Did you say, well, I want it?
    Dr. LeMaistre. She knew that I wanted it and I asked----
    Senator Levin. Did you get it?
    Dr. LeMaistre. I did not.
    Senator Levin. This is the heart of the problem. You have 
got a Board that says, I want it. You have got a request for 
it. It does not come, and you do nothing. That is an approach 
which is unacceptable for a Board. Those folks are supposed to 
be reporting to you. You are the captains. You make a decision. 
We want to find out about this compensation. You make an 
inquiry of an employee and she says she does not have the 
information, she will get back to you. She does not, and 
nothing happens. There is a Wall Street Journal article a year 
later. That is not the way a Board can operate and carry out 
its fiduciary duties, folks.
    Dr. LeMaistre. I did have a subsequent conversation to see 
if the information had been obtained. It had not, and that is 
immediately prior to all of the things that unfolded very 
rapidly in the fall. But let me make it clear----
    Senator Levin. Should you have gotten that information?
    Dr. LeMaistre. Yes, I should have gotten it and I should 
have gotten it through channels. It was Mr. Skilling's 
responsibility to have put that through and he did not. It did 
not come through any of the transactions. Mr. Fastow, in his 
declaration of the controls on him, said he reported that 
information to Mr. Skilling.
    Senator Levin. But you had a conversation now with this 
employee, Mary----
    Dr. LeMaistre. Mrs. Joyce, yes.
    Senator Levin. Mary Joyce, and you asked her for 
information----
    Dr. LeMaistre. Yes.
    Senator Levin [continuing]. And she did not get it to you.
    Dr. LeMaistre. She had not received it, that is correct.
    Senator Levin. And did you ask her to get it?
    Dr. LeMaistre. I asked--I told her I wanted all of the 
information on any 16(b) officer that had outside income----
    Senator Levin. And would that include Fastow?
    Dr. LeMaistre. Of course, yes.
    Senator Levin. Sure. That was the reason you called, was it 
not?
    Dr. LeMaistre. That is right.
    Senator Levin. You did not mention his name?
    Dr. LeMaistre. No, I did not mention his name.
    Senator Levin. Even though that is why you called?
    Dr. LeMaistre. That is exactly right, but I wanted it on 
all 16(b) officers.
    Senator Levin. And you did not get it.
    Dr. LeMaistre. I did not get it, but if I had gotten it, I 
would have had some other people involved in there, as you now 
know.
    Senator Levin. Good. The point is, you did not get it and 
you did not act to get it and that is----
    Dr. LeMaistre. I did not act to get it primarily because it 
was supposed to come through with the other reports and it did 
not.
    Senator Levin. But did she not tell you she would get it to 
you?
    Dr. LeMaistre. No, she did not.
    Senator Levin. You did not say you wanted that information? 
You are doing this report for the Board. You are told, hey we 
would like to know more about it, and you just call up and 
say----
    Dr. LeMaistre. She said she did not have the information. I 
said, well, let me know when it gets there.
    Senator Levin. And did she?
    Dr. LeMaistre. She did not let me know, so I asked again a 
few months later and she did not have it, and that was in 
August or September.
    Senator Levin. Did you just throw your hands up? I mean, 
she does not have it.
    Dr. LeMaistre. Well----
    Senator Levin. Why does she not have it? You are a Board 
member. You are paid a lot of money. You are carrying out a 
Board direction. You want information. You do not get it. She 
will call you when she gets it. She does not call you. Two 
months later, she still does not have it.
    To me, that is an approach which is totally unacceptable, I 
have got to tell you. I think that is what characterized the 
Board--is that it was deferential to management. I want to go 
into another document on that.
    When you were told, finally, after you found out how much 
money--if you would take a look at Exhibit No. 24b.\1\
---------------------------------------------------------------------------
    \1\ See Exhibit No. 24b which appears in the Appendix on page 283.
---------------------------------------------------------------------------
    Dr. LeMaistre. All right.
    Senator Levin. So now it appears in the Wall Street 
Journal, and the Board asks, I think, both Mr. Duncan and Dr. 
LeMaistre to call Fastow. I think, Dr. LeMaistre, you said in 
your interview that you asked the Enron General Counsel to 
write the questions that you would ask Mr. Fastow on the phone, 
and Exhibit 24b is the document that the General Counsel faxed 
to you with your notes from that phone conversation, is that 
correct? We are looking at Exhibit 24b now.
    Dr. LeMaistre. That is correct, Mr. Chairman.
    Senator Levin. OK. And here is the note that he typed for 
you. ``Andy, because of the current controversy surrounding 
LJM1 and LJM2, we believe it would be helpful for the Board to 
have a general understanding of the amount of your investment 
and of your return on investment in the LJM entities. We 
understand that a detailed accounting of these matters will 
soon be done in connection with the response to the SEC 
inquiry. We very much appreciate your willingness to visit with 
us.''
    This is a guy who is supposed to be working at your 
direction, and you cannot get much more deferential and 
obsequious than that. And not only that, you then want to make 
sure that he understands right up at the front how much you 
appreciate his willingness to visit with you, and I presume you 
take a line, circle that, ``We very much appreciate your 
willingness to visit with us,'' and make sure that goes at the 
top.
    Why do you not call up and say, ``What in God's name is 
going on? We just read something in the Wall Street Journal 
here that just shakes the heck out of us. Is it true? How much 
money did you make? What is your return?'' That is not what 
comes out here.
    You apparently, when he told you how much money he made, 
found it to be--I think this is your handwriting?
    Dr. LeMaistre. That is correct, sir.
    Senator Levin. ``Incredible'' is your word.
    Dr. LeMaistre. Mr. Chairman----
    Senator Levin. Yes, please.
    Dr. LeMaistre. This is drafted by legal counsel and I 
followed it directly.
    Senator Levin. Right. But is not that arrow that puts the, 
``We very much appreciate your willingness to visit with us--''
    Dr. LeMaistre. Yes, that is right, because----
    Senator Levin. That is your writing, is it not?
    Dr. LeMaistre. Yes, and may I explain it?
    Senator Levin. Sure.
    Dr. LeMaistre. The day before when I talked to Mr. Fastow, 
he was very cautious at first about this, and finally, he said 
he would be glad to talk with us. But it was a decision that he 
could have made not to talk to us, and we would have had to go 
through channels to get it, but we wanted it immediately, that 
is the reason that we did it that way.
    Senator Levin. Why do you have to go through channels? Why 
can you not just call up Fastow and say, I want to know right 
now?
    Dr. LeMaistre. I could have, but I would have not used 
language in here had I done that. I would have used----
    Senator Levin. Why did you not use language that was not in 
here?
    Dr. LeMaistre. Primarily because----
    Senator Levin. I guess that is what it comes right down to.
    Dr. LeMaistre. Well, the point is that this is what our 
General Counsel told us to use in talking about income to a 
third party investment, an SPE.
    Senator Levin. Were you mad?
    Dr. LeMaistre. I was mad after the answer to the first 
question.
    Senator Levin. Did you let him know?
    Dr. LeMaistre. Yes.
    Senator Levin. Right there on the phone?
    Dr. LeMaistre. Yes.
    Senator Levin. Good. That is a year late, but good.
    Now, there were supposed to be quarterly reviews by the 
Finance Committee, I believe, because the Finance Committee was 
supposed to begin quarterly reviews of the LJM transactions, 
according to the decision of the Committee, and the Finance 
Committee agreed. But there is only one quarterly review that 
was ever conducted by the Finance Committee, which was in 
February 2001.
    So if my recollection is correct, the decision of the Board 
was October 2000 that these quarterly reviews of these LJM 
transactions would be conducted, but there was only one, and 
that was February 12, 2001. Now, why is that?
    Mr. Winokur. The first meeting after the October meeting 
was December, which was about 6 or 7 weeks later, so I think we 
assumed that a quarterly review would have meant after the year 
end, since the October meeting would have been around the end 
of the third quarter. After the February quarter, there was not 
activity, new investments being made, and by June, Mr. Fastow 
had sold his interest, so there was no more related party 
aspect.
    Senator Levin. We will get to that in a moment, but there 
were supposed to be what are called deal approval sheets, or 
DASHs, for each of the LJM transactions, I believe, since they 
were transactions with a related party. Did you ever see those 
DASHs, those LJM DASHs?
    Mr. Winokur. No, sir. There is an LJM approval sheet and a 
DASH which is for every transaction. They are separate.
    Senator Levin. And did you ever see the DASH?
    Mr. Winokur. The regular DASHs, we saw all the time----
    Senator Levin. For LJM?
    Mr. Winokur. No.
    Senator Levin. Should you have?
    Mr. Winokur. Those were internal and those, we were told, 
were being reviewed by Mr. Skilling, Mr. Causey, and Mr. Buy. 
There would have been no reason, unless the size of the 
investment was such that it would have normally come through 
our----
    Senator Levin. So that was not normally supposed to come to 
you?
    Mr. Winokur. No, sir.
    Senator Levin. But I believe that, Mr. Jaedicke, those 
DASHs should have come to you, is that not correct?
    Mr. Jaedicke. No, sir. We did not--we reviewed the 
transactions and the type of transactions and the fairness, but 
we did not go--we are not auditors and so we did not go to the 
level of the deal approval sheets.
    Senator Levin. So those deal approval sheets were not 
supposed to go to any of the committees, is that correct?
    Mr. Winokur. Sir, transactions involving Enron's expending 
more than $75 million came to the Board for approval. 
Transactions more than $25 million but less than $75 were 
within the purview of Mr. Lay and Mr. Skilling. So our practice 
was that the transactions between $25 and $75, those DASHs were 
packaged up and we were sent them after the fact to look at, so 
we could comment on them. The deals would have been approved, 
but if any member of the Committee had any questions, he could 
bring those up.
    So the only expenditure of cash that we would have seen 
would have been above that level of $25 million, and for 
divestitures, the level was much higher. So to the extent that 
Enron was selling assets, the transaction approval process 
would not have required us to see those.
    Senator Levin. Even though there was this conflict of 
interest problem?
    Mr. Winokur. The conflict of interest was being dealt with 
because Mr. Skilling, Mr. Buy, and Mr. Causey were reviewing, 
according to what Mr. Fastow told us, every transaction.
    Senator Levin. All right, so that there was no need for a 
DASH?
    Mr. Winokur. The only need we had was what we got, and that 
was to make sure we were told regularly that the controls we 
put in place were working.
    Senator Levin. You did not need the DASH in order to 
achieve that?
    Mr. Winokur. No, sir.
    Senator Levin. That is just what I was asking. There was no 
need, then, for you, in your judgment, to get one of those 
DASHs for these transactions because you had another mechanism 
that you thought was doing the control?
    Mr. Winokur. We were told the people who did review the 
DASHs had done so.
    Senator Levin. Right, which is another mechanism.
    Mr. Winokur. Yes, sir.
    Senator Levin. Now, I believe you just testified that when 
you learned that Fastow was selling his LJM interest, that 
there was no need for a second quarterly review. But the first 
quarterly review, I believe, was February 12, is that correct?
    Mr. Winokur. Yes, sir.
    Senator Levin. When did he sell his interest?
    Mr. Winokur. I said two things. I said there were no 
transactions that we knew about that occurred with LJM after 
the February meeting. He sold his interest, I later learned, in 
June. That was disclosed to us in August, I think.
    Senator Levin. But should there not have been a quarterly 
review in June? You had one in February----
    Mr. Winokur. We have a May meeting and an August meeting, 
and so we----
    Senator Levin. A quarterly----
    Mr. Winokur [continuing]. We did not have one in the May 
meeting. At the August meeting, we were told that he had sold 
his interest in June.
    Senator Levin. Right, but since it was supposed to be a 
quarterly review, and there was one that occurred in May--there 
is one that occurred in February, should there not have been 
one in June, is my question.
    Mr. Winokur. If there were transactions to review, yes, 
sir.
    Senator Levin. In other words, when you did not get a 
quarterly report, you assumed there were no transactions?
    Mr. Winokur. Yes, sir.
    Senator Levin. And did you check?
    Mr. Winokur. No, sir.
    Senator Levin. Now, did you know to whom he sold it, by the 
way?
    Mr. Winokur. I did not know then. I learned later.
    Senator Levin. And who was that?
    Mr. Winokur. Michael Kopper.
    Senator Levin. And had you known that, would you have 
wanted those quarterly reviews to continue?
    Mr. Winokur. Well, I did not know----
    Senator Levin. Mr. Kopper was so close?
    Mr. Winokur. I did not know Mr. Kopper was involved in 
Chewco. I did not know he was involved in all the things he was 
involved in, and had he complied with the code of conduct, we 
would have gotten into that much earlier.
    Senator Levin. But did you know that he was very close to 
Fastow?
    Mr. Winokur. Well, I knew Andy had a bunch of bright people 
working for him. I did not know that Kopper was any closer to 
him than anybody else.
    Senator Levin. But if you had known, if Fastow had told you 
that he had sold his interest to Kopper, would you have said, 
``whoops, wait a minute; even though Fastow left, given our 
relationship with Kopper, we better continue----''
    Mr. Winokur. Absolutely.
    Senator Levin [continuing]. Those quarterly reviews?
    Mr. Winokur. If I had known that the related party 
relationship continued informally as well as formally, I would 
have wanted to continue the reviews, yes, sir.
    Senator Levin. Now, when you did find that out, then what 
happened?
    Mr. Winokur. Well, I did not find it out until----
    Senator Levin. August.
    Mr. Winokur. No, I found out that he sold. I do not believe 
that I found out--I do not remember exactly when I found that 
Kopper bought it. I thought it was actually during the Powers 
work that I found out who bought it.
    Senator Levin. That was the first time you learned that 
Kopper bought it?
    Mr. Winokur. That is my recollection.
    Senator Levin. Was it relevant as to who bought his 
interest? When you found that he had sold his interest, did it 
become relevant as to whom he sold it, since if he sold it to 
another related party, directly or indirectly, you would want 
the controls to continue? Should you have asked who he sold it 
to? Given that history, should you not have asked who he sold 
it to is my question.
    Mr. Winokur. I would have to look back at the August 
minutes to see what was said by Mr. Koenig about how it was 
sold. If it was said it was sold to an unaffiliated party, then 
I would not have thought more about it.
    Senator Levin. I asked you about whether or not there was 
an unwritten guarantee that LJM would not lose money in a deal 
with Enron. Were any of you aware of such a guarantee?
    Dr. LeMaistre. I was not.
    Mr. Duncan. I was not.
    Mr. Winokur. No, sir.
    Senator Levin. Mr. Duncan.
    Mr. Duncan. I was not.
    Senator Levin. I think what we are going to do here is take 
about a half-hour break. I just want to summarize this one LJM 
issue, though, before we leave to sort of tidy this thing up.
    The things that really trouble me are the lack of real 
energy and effort by the Board in a situation where you are 
using accounting methods which are clearly at the margin, high 
risk. You were so informed early. You know that you are using a 
lot of off-the-balance-sheet entities, special purpose 
entities. You are into this whole area. You decide on a 
compensation review, and despite a decision in October 2000 to 
do it, you do not do it.
    No one ever saw this LJM initial placement memo. I take 
that back. Your lawyer did, apparently, but your lawyer, when 
he saw that the conflict of interest is being touted as a 
reason for investors to buy LJM apparently was not troubled by 
that. If I understood you correctly, Dr. Winokur, you never 
asked your lawyer as to why.
    Mr. Winokur. I did not learn that until my work on the 
Powers Committee, sir.
    Senator Levin. Right, but after that, you did not ask your 
lawyer----
    Mr. Winokur. Well, I did not have direct contact with 
Vinson and Elkins at that point.
    Senator Levin. It is not the kind of active control and 
responsibility that I think we have to expect of Boards; that's 
what it comes down to. That is just on LJM, and we will go into 
Raptors when we come back, but let us take a half-hour break 
now until 2:30. Thank you.
    [Recess.]
    Senator Levin. The Subcommittee will come back to order.
    We now come to the time when the Board dives into perhaps 
the most dangerous waters of all, and these are the Raptors, 
the very complex set of transactions that the Board knew about 
and approved, despite questionable accounting and significant 
financial risk to Enron.
    The Raptor transactions consisted of a series of four 
complex transactions, each of which involved Enron, LJM2, and 
various special purpose entities. In each of the four complex 
Raptor transactions, Enron placed highly volatile shares of 
stock from companies in which Enron had invested. Enron did 
this because it had already booked as income the increase in 
the companies' share prices, and it wanted to protect itself 
from any loss if these shares dropped in price. And so Enron's 
goal was to hedge these stocks.
    The problem was that no third party would agree to enter 
into a hedge to protect Enron from a loss on those shares, so 
Enron used LJM2, set up these special purpose entities, and 
secured each of the hedges by pledging its own stock as 
collateral. Through a series of deceptive transactions and 
improper accounting entries, Enron recorded earnings on its 
books of about $1 billion, and another $1.2 billion in 
increased shareholder equity.
    If we could take a look at Exhibit 28b.\1\ This is the 
``Hedging Program for Enron Assets,'' as it is described, that 
was presented to the Board on May 1, 2000. And if you will look 
at the last page, where it says ``Project Raptor.'' When you 
look at the risks cited here, this lists the risks involved 
here, maybe, Mr. Winokur, you can explain this.
---------------------------------------------------------------------------
    \1\ See Exhibit No. 28b which appears in the Appendix on page 306.
---------------------------------------------------------------------------
    Mr. Winokur. Senator----
    Senator Levin. First of all, did you remember this before--
--
    Mr. Winokur. Yes, sir.
    Senator Levin [continuing]. When you were talking to our 
staff, did you remember this?
    Mr. Winokur. Yes, sir.
    Senator Levin. Details of this? OK. Do you want to 
explain----
    Mr. Winokur. To the best of my recollection, I did.
    Senator Levin [continuing]. What you were told back on May 
1 about the risks of Project Raptor, looking at those bullets?
    Mr. Winokur. Sir, it was Enron's staff practice when they 
presented an item for recommendation and approval always to 
describe the risks of the transaction. Every transaction 
obviously has risks and they would set them forward, and for 
each risk, they would have a mitigant. In other words, the idea 
was, this was a risk, they had already thought about it, and 
here is how they dealt with the risk.
    And in this case, one of the risks of a complicated 
structured finance transaction like this was that it would not 
be properly able to be accounted for, and the mitigant was, and 
the minutes suggest or support this, as well, that Rick Causey, 
the Chief Accounting Officer, and Andersen had been involved--
in fact, Enron paid Arthur Andersen a fair amount of money for 
helping to structure this transaction so that it would conform 
to the accounting requirements, and so that mitigant meant that 
the accounting scrutiny had been dealt with.
    Obviously, any time there is a hedge, there is a risk that 
the hedge does not work, and the mitigant there, if the hedge 
did not work, was to terminate the program. And, in fact, as I 
believe I have said here in the House, in the Powers Committee 
report, it says had the Raptor transactions been terminated in 
the first quarter of 2001 when it was clear they did not work, 
as opposed to their having been restructured without Board 
approval, I do not think, personally, Enron would be in the 
position it is in today.
    ``Counterparty credit'' just means that you have to have 
enough credit in the structured transaction to be able to 
execute the hedges you propose.
    Senator Levin. Now, first of all, what was your 
understanding of the words ``accounting scrutiny''? Does that 
mean that it might not have complied with Generally Accepted 
Accounting Principles?
    Mr. Winokur. No. That meant to me that it was important to 
make sure that the transaction was structured in a form that 
would pass accounting muster, and because Arthur Andersen had 
been paid to help work on the structuring and Rick Causey said 
they were comfortable and he was comfortable with it, that 
meant that risk was mitigated.
    Senator Levin. Did the Board understand that this was a 
true hedge?
    Mr. Winokur. Well, I did, and I believe everybody did.
    Senator Levin. If you believed it was a true hedge, why 
would there be any risk to Enron?
    Mr. Winokur. Well, Senator, we contributed unrealized gains 
on forward positions in the stock. In other words, we had an 
asset that had not previously been in Enron's income statement 
and we used that in contributing it in this structure as credit 
support for the hedge. So any time--if we contributed Exxon 
stock and the Exxon stock had gone down, that would have been 
the same issue. We would have terminated the hedge.
    Senator Levin. But my question, I think, is a little 
different, which is that if it were a true hedge, if you had 
gotten a third party to take that risk, your own stock would 
not have been at risk, would it?
    Mr. Winokur. It depends on the structure of the hedge.
    Senator Levin. If it is a true hedge.
    Mr. Winokur. Well, as I said, in my example----
    Senator Levin. Do you not transfer the risk to someone else 
in a true hedge?
    Mr. Winokur. Well, you transfer risk, but if for some 
reason the hedge does not work, then it terminates, and that is 
what I said in my example. If Enron had contributed Exxon stock 
and Exxon stock had gone down, the credit capacity of that 
vehicle would have not permitted it to be viable, and so in 
this case, instead of Exxon stock, we used unrealized gains in 
forward positions on Enron stock.
    Senator Levin. Did the Board understand that Enron stock 
would be at risk under some circumstances here?
    Mr. Winokur. Yes. In fact, we----
    Senator Levin. At the time of this deal, you realized that 
there was still a risk to Enron?
    Mr. Winokur. Well, we had a large unrealized gain in these 
forward contracts, so we understood that realized gain would be 
at risk. That was part of the structure.
    Senator Levin. If, in fact, the stock price went down and 
the unrealized gain disappeared, did the Board understand that 
then Enron would have to--that Enron stock itself would be at 
risk--not just the gain, but that Enron stock would be at risk, 
that you were not transferring the entire risk to a third 
party? Did the Enron Board understand that, or did the Enron 
Board believe that you were transferring that risk to a third 
party?
    Mr. Winokur. If the assets that were being hedged went up 
in value, then if the forward position was in decline, it would 
not have mattered, or vice-versa.
    Senator Levin. Yes. Now we are talking going down.
    Mr. Winokur. The bad outcome was that both the assets and 
the forward position went down, that is, Enron stock went down 
and Avici or whatever stock was hedged, and in that case, which 
is exactly what it says here, program terminates early in 
negotiation of an early termination agreement. So this was 
contemplated as a possibility.
    Senator Levin. The Board understood, then----
    Mr. Winokur. That this possibility could occur.
    Senator Levin [continuing]. That Enron stock was being 
pledged as collateral?
    Mr. Winokur. No, forward positions on Enron stock. It is a 
derivative instrument.
    Senator Levin. My question is, did they understand that 
Enron stock itself was being pledged as the collateral?
    Mr. Winokur. Well, my recollection is, and I could look 
back at the previous page, was that forward positions were 
being pledged. That is my recollection.
    Senator Levin. Then the answer to my question about Enron 
stock being pledged as collateral?
    Mr. Winokur. We put seven million--from the previous page, 
we put stock in and we wrote--well, here, I think this was 
forward positions, even though it says that--Senator, I am 
looking at the diagram here. I do not have from 2 years ago the 
specific terms.
    Senator Levin. Let me----
    Mr. Winokur. I believe that it was forward positions on the 
stock as opposed to the actual shares.
    Senator Levin. Forward positions on stock that Enron held 
in other companies?
    Mr. Winokur. No, that Enron was contributing unrealized 
gains in its own stock as credit support to get this structure 
organized. This structure could then purchase stock in some 
other company----
    Senator Levin. Let me try to ask the question, because it 
is an important question. Did the Board realize that Enron 
stock was being pledged as collateral for the hedge?
    Mr. Winokur. I can only answer for myself.
    Senator Levin. You cannot give me a ``yes'' or ``no'' on 
that?
    Mr. Winokur. My recollection is that we were using 
forward--unrealized gains in forward contracts. That is my 
recollection.
    Senator Levin. Therefore, the answer is you did not realize 
that Enron stock was being pledged as collateral for the hedge? 
If that is not your answer----
    Mr. Winokur. My recollection is just as I said, which is I 
believed that we were using forward contracts, unrealized gains 
in the forward contracts. That is my recollection.
    Senator Levin. Why is that not then a simple, ``no,'' that 
you did not realize that Enron stock itself was being pledged 
as collateral to obtain that hedge?
    Mr. Winokur. I do not recall that Enron stock specifically 
was being pledged----\1\
---------------------------------------------------------------------------
    \1\ See Exhibit No. 80 for clarification which appears in the 
Appendix on page 665.
---------------------------------------------------------------------------
    Senator Levin. OK.
    Mr. Winokur [continuing]. Over and above the forward 
positions.
    Senator Levin. That is good. Now, let me try to put this in 
a slightly different way. What did the Board understand to be 
the risk to Enron at the time it approved these transactions?
    Mr. Winokur. The risks that were presented to us were, 
first, that the structured finance vehicle might not be 
structured in a way to meet the accounting rules, and that was 
mitigated, we were told, because Arthur Andersen was involved 
and Rick Causey approved it.
    And second, we understood because of the forward positions 
in Enron stock that credit capacity could go away if, in fact, 
Enron stock went down, in which case the Raptors would have to 
be terminated.
    Senator Levin. Did you understand, then, that if Enron 
stock fell in value, that you would have to put up large 
amounts of Enron stock in order to pay off the guarantee to 
others who were willing to----
    Mr. Winokur. No, sir. I understood that we would have to 
terminate the arrangement because the credit capacity would 
fall.
    Senator Levin. OK. Now, when you were shown Exhibit 32,\1\ 
you asked for this, as I understand it, Mr. Winokur, the 
``Stock Price Risk in Financings''--you asked for a chart 
showing what would happen if Enron's stock kept falling in 
price. You asked the management for this.
---------------------------------------------------------------------------
    \1\ See Exhibit No. 32 which appears in the Appendix on page 334.
---------------------------------------------------------------------------
    Mr. Winokur. Yes, sir.
    Senator Levin. And by April, Enron stock had fallen from 
$80 to $60, and this shows what would happen if it fell to $40. 
It lists four deals, Osprey and three of the Raptor 
transactions, and shows that Enron would have had to come up 
with another 45 million shares of Enron stock to pay these 
entities. Now, were you surprised by what you saw?
    Mr. Winokur. Well, I appreciated being provided the 
information I had requested.
    Senator Levin. But were you surprised when you saw that 
your stock was on the hook to this extent? Did that surprise 
you?
    Mr. Winokur. Actually, sir, what I read into this was Enron 
had about 800 million shares outstanding at this point. So what 
this chart said to me is if the stock price falls by another 
third from where it is, and at that time, I think that was not 
considered a probable event, Enron would have to issue 
approximately less than 6 percent additional shares. So the 
dilution to the existing shareholders to top-up these vehicles 
would have been around 6 percent if the stock fell by a third.
    Senator Levin. And you were not surprised that your risk 
was that great in the Raptor transactions? That did not 
surprise you when you got that chart?
    Mr. Winokur. Actually, I thought that a 6 percent dilution 
matching against a one-third decline in the stock when the 
stock was not considered to be overvalued at that point, or not 
particularly--I do not recall the specifics--was not maximal 
dilution.
    Senator Levin. OK. You recognized that impact on Enron, the 
dilution of its stock which would result from the Raptor 
transactions if Enron's stock value went down, and that did not 
surprise you? You realized there was that great a risk in the 
Raptor transactions to Enron? That is all I am asking.
    Mr. Winokur. Senator, in addition, I would like to make the 
point that the fully diluted shares in the EPS calculation, 
Enron used a model to include these kinds of results in the 
fully diluted share calculation, so that the additional shares 
already were disclosed in Enron's disclosure documents and 
already were included.
    Senator Levin. When the risk was supposedly transferred, 
which was the purpose of those transactions, Enron maintained 
some significant risk, and you are telling me the Board was not 
surprised by that retained risk in Enron. Even though it was 
informed that this was a hedge transaction to transfer that 
risk to others, you are saying that the Board understood the 
extent of the risk to Enron that was left following the Raptor 
transactions, is that what you are telling me? They understood 
this?
    Mr. Winokur. Sir, the handwritten note, which is a little 
hard to read, says, ``Assumption: The value of the other 
assets,'' it looks like it says, ``were zero,'' so I viewed 
this as a worst case scenario. In other words, the assets that 
were supposed to be hedged went to zero, and I did say earlier 
that the one bad outcome is the assets that were being hedged 
and the Enron forwards both went down. So worst case, the other 
assets are not worth anything--I think that says zero, the best 
I can read it--and even in that extreme case, Enron stock goes 
down a third and all the assets we put in these vehicles are 
worthless, there is only 6 percent dilution and it has been 
fully disclosed. I do not think that was a good outcome. I also 
did not think it was a very probable outcome.
    Senator Levin. My question is neither whether it was good 
or probable. My question is, did the Enron Board understand 
when it was hedging a risk that it was maintaining a risk to 
that extent, whatever the extent is? Did it understand that?
    Mr. Winokur. Well, we assume, because in the previous 
exhibit----
    Senator Levin. Can that not be yes or no? Did it understand 
that it was maintaining a risk to this extent under the 
circumstances that you just outlined?
    Mr. Winokur. We understood that if the credit support we 
provided for the vehicle was inadequate, the vehicle would have 
to be terminated early. That was part of the presentation when 
we approved Raptor.
    Senator Levin. All right. And is not the shorthand for 
that, the Board understood that Enron was retaining a risk 
under the circumstances that you just outlined?
    Mr. Winokur. A risk, yes, sir.
    Senator Levin. And this shows the extent of the risk under 
various circumstances.
    Mr. Winokur. Under extreme circumstances.
    Senator Levin. It turned out not to be so extreme.
    Mr. Winokur. Yes, sir--what were thought to be extreme 
circumstances at the time.
    Senator Levin. And I just want to ask the other Board 
members, did they understand that this was not a hedge where 
the risk was transferred, but that a risk was retained to the 
extent that Dr. Winokur just outlined? Did you understand that, 
Dr. Jaedicke?
    Mr. Jaedicke. Yes, I did, sir, because that hedging 
strategy is explained in the annual report and had been used in 
Enron on many transactions. They are typically referred to as 
something like low-correlation hedges.
    Senator Levin. On this chart, I think it is Exhibit 27 in 
your books,\1\ when you look at that chart, we see that the 
payments by Enron to LJM2 for the Raptors were $197 million. 
That is up at the top. Do you see that number?
---------------------------------------------------------------------------
    \1\ See Exhibit No. 27 which appears in the Appendix on page 300.
---------------------------------------------------------------------------
    Mr. Winokur. Yes, sir.
    Senator Levin. And the loss to Enron is at the bottom, $710 
million. That is the outcome of this. LJM got $197 million. 
Enron lost $710 million on that transaction. Would you agree 
with that summary, Dr. Winokur?
    Mr. Winokur. Well, I would like to ask Dr. Jaedicke to talk 
about the reduction in shareholders' equity, but as far as the 
losses, I do not know where these--I have not seen these 
numbers before, obviously. The Powers Committee had some 
numbers in them that were prepared by the Deloitte people. 
Those were not other than very rough estimates and the Powers 
Report specifically said that would assume that Enron had taken 
no other action and there is nothing else going on. In other 
words, it was a number that is just pro forma, add this and 
subtract that. It is not a number that has any, at least in the 
Powers Report, had any backup that was provided.
    Senator Levin. Now, this is a number from the Powers 
Report.
    Mr. Winokur. As a member of the Powers Committee, I 
specifically said in my testimony in front of the House that 
the accounting consulting help that we got was not reviewed by 
Deloitte and Touche and did not have any independent 
verification of it and did not assume that Enron would have 
taken any other action in the interim.
    Senator Levin. All right. Going back to the $710 million, 
this is what Enron put in its SEC filing.
    Mr. Winokur. Yes, sir.
    Senator Levin. So can you accept that?
    Mr. Winokur. Yes, sir.
    Senator Levin. OK. So Enron showed a reduction in earnings 
due to Raptor termination of $710 million. The $197 million was 
made by LJM2. That is the outcome, and I am just saying, do you 
differ with those numbers?
    Mr. Winokur. I do not have any disagreement with that.
    Senator Levin. Would you acknowledge today that the Raptors 
were, in hindsight, a disaster for Enron?
    Mr. Winokur. Sir, what I would say, and I said, I believe, 
in my statement this morning, if management had come to us in 
the first quarter and said the Raptors did not work, it was a 
great idea, but it did not work and we want to cancel them, 
Enron would have taken then something like a 50-cent a share 
charge. Mr. Skilling told the Powers Committee he did not think 
at that time, in the first quarter of 2001, that Enron stock 
would have been affected materially because lots of companies 
were writing off high-tech, broadband, and other kinds of 
investments.
    So had the Raptors been terminated early, which is what we 
thought would have happened in May 2000 when we approved them 
if both the assets and Enron's forwards went down, we would 
have had a loss. It would have been a large loss, $400 or $500 
million, but it would have been manageable by Enron. And the 
fact that the $800 million of additional stock was contributed 
and the Raptors were restructured without Board approval also 
gave rise to the accounting error that led to the equity write-
off, and as I said this morning, I think that combination 
turned out to be a very bad thing.
    Senator Levin. If a real third party had participated in 
the hedge, would the outcome have been different?
    Mr. Winokur. Well, I do not know the answer to that except 
for one thing, and that is a real third party would not have 
been able, presumably, to restructure itself without Board 
approval in the way that this happened. We were not told of the 
restructure.
    Senator Levin. OK.
    Mr. Winokur. And LJM2 had many outside investors. It was a 
real third party. It had a related party as an investor, but it 
was a creditworthy third party when we dealt with it.
    Senator Levin. You have seen a number of red flags now 
along the way, starting as early as 1999, February 1999, where 
it was stated that Enron's accounting was pushing limits. We 
have seen the various ways in which fund flows were generated 
to move assets off the balance sheet with Whitewing, with LJM, 
with Raptor, and the losses that were caused here. Then we see 
a steady decline, we saw in that earlier chart, of Enron's 
stock from which it is not going to recover.
    During this time, the Board saw no red flags at all, no 
sense of trouble that lies ahead until mid-October 2001, and 
that is when you learned that Enron would take an equity write-
down of $1.2 billion. That was the first time you testified 
that you saw any sign of trouble. We have demonstrated, I 
think, plenty of signs, but nonetheless, the Board did not see 
those signs.
    But a number of people associated with Enron did see the 
writing on the wall well in advance of the announced write-
down, even if the Board did not. One example is a senior Enron 
executive who left Enron in September 2001, and despite an 
effective separation date of November 2001, this individual 
sent a series of E-mails to his stockbroker about selling Enron 
stock. So this is September 2001.
    Here is what he said on October 2, a few weeks before 
Enron's problems became public, and this is Exhibit 33a,\1\ if 
you wish to follow along. This is a senior Enron executive now. 
``I think we may want to sell some Enron calls in the next few 
days before earnings are released. I don't know anything, but I 
know how Enron works and I am sure they will be able to show 
strong recurring earnings, . . . and do some housecleaning on 
some non-productive assets.'' So he says he knows how Enron 
works and will show some strong recurring earnings, and again, 
this is additional evidence suggesting that Enron management 
was deliberately engaged in earnings management.
---------------------------------------------------------------------------
    \1\ See Exhibit No. 33a which appears in the Appendix on page 335.
---------------------------------------------------------------------------
    Then on October 4, the same person writes, ``I think we 
should begin thinking about shorting January calls on, say, 
100,000 shares at or near the money. . . . There are a number 
of analyst reports out that are really trying to push up the 
stock and with a little help from the market, they may get a 
few more points out of it over the next few days.'' Then later 
the same day, he writes, ``I believe [Enron] stock has limited 
upside in the near term and, in fact, has some downside 
exposure.''
    Now, this is a pretty strong statement given the fact that 
the stock had already fallen from $90 to about $30 a share at 
the time that he wrote these E-mails. His comments are deeply 
troubling. This is a senior officer at Enron, not yet separated 
when he begins selling calls, and a few weeks later, Enron took 
a $800 million earnings hit and a $1.2 billion reduction in 
shareholder equity. We cannot release the person's name at this 
time. We are still looking into the matter. But if the facts 
bear it out, we will be recommending to the SEC that they open 
an insider trading investigation with regard to this 
individual.
    But in terms of what he knew, what he saw from the inside, 
which you did not see until later, I am wondering whether you 
have any comments that you want to add. Does anybody want to 
add any comment to that?
    [No response.]
    Let me ask you about Ken Lay's loans. Let me ask Senator 
Carper before I get to that.
    Senator Carper. Thank you, Mr. Chairman. We appreciate your 
patience and your sticking with us into this afternoon.
    Dr. Jaedicke.
    Mr. Jaedicke. I am sorry, sir. I was not paying attention.
    Senator Carper. That is all right. I understand from the 
introduction today that you ran the business school at 
Stanford? Did you?
    Mr. Jaedicke. I was Dean of the business school.
    Senator Carper. You were the Dean of the business school. 
When I was in the Navy, we were stationed at Moffett Field, 
California, not far from where you used to hang your hat, and I 
lived in Palo Alto and Menlo Park. In fact, I lived on Santa 
Cruz Avenue, right up against the Stanford golf course, and I 
remember as a younger man going to--I am not Catholic, but I 
remember going to a lot of folk masses on Stanford at the 
campus on Sundays and very much enjoyed those. I have good 
memories. One of my best friends, my roommate for part of the 
time I was in the Navy out there, ended up going to the 
Stanford business school, I think at the time that you were 
running it, and from time to time, we talked about case studies 
in different businesses, some that did well, some that did not 
do so well.
    I think we have got a classic here that the business 
schools, I do not know about Stanford, but certainly a lot of 
them will come back to this one time and again to figure out 
how they got into trouble and how a company thought to be as 
successful and as mighty as Enron could tumble so quickly.
    How would you describe it to the next generation of 
business school students at Stanford who say, this is what 
happened and this is how they got into this mess and why they 
could not get out of it? How would you describe it?
    Mr. Jaedicke. I think, first of all, you would have to 
say--you would have to indicate that there was a lot of 
incomplete information floating around--well, I would not even 
say floating around, reported, that a lot of the reports were 
not accurate, that some of them were misleading in terms of how 
good things were or how much things had been looked at.
    I think you would have to say this is a classic case of 
having lots of overlapping controls, which I said in my 
statement, involving lots of different people, trying to get 
very good advisors, trying to cope with the problem--the 
classic problem that all boards have if you are supposed to 
monitor management and management provides you the information. 
What do you do? You put in place the best controls you can 
think of, and these did not work.
    Then I suppose you could back off and say, well, why do you 
think they do not work? We will describe to you the situation 
and then you, as students, tell us why you think they did not 
work. That is kind of the classic case, I guess, to get them to 
confront that problem. I am not sure that I would have any 
answers for them other than the integrity of the people and so 
on that were supposed to furnish information to us. It was not 
always what I would want it to be.
    Senator Carper. We talked earlier about whether or not we 
can legislate character or legislate integrity and I think we 
pretty much agreed that is a hard thing to do. I did not, but I 
might have gone on to say some folks who looked at the 
situation have suggested that while the Congress cannot 
legislate integrity or character, one of the things we can do 
is to pass laws that call for punishment for people who break 
our laws. The Congress, it is not our responsibility to 
prosecute and to convict those who have done so, but as you 
know, with our system of government, we pass the laws and then 
we leave it to the Executive Branch and the Judiciary to ensure 
that the laws we passed are enforced.
    One of my hopes of what is going to come out of these 
hearings, and we thank you again for joining us, is that the 
anger, the frustration that so many Americans feel--and you 
have heard it and you have felt it, certainly we have--will be 
transformed into ensuring that justice is done in these 
instances.
    If I could sort of segue from there, Mr. Chairman, for just 
a moment, we are going to have, I think, a second panel, I hope 
later today, with some very knowledgeable people who know a 
thing or two about corporate governance who are going to, I do 
not know that they are going to second-guess you, but they are 
going to come in and certainly give us their perspective.
    I just want to ask you a couple of questions, and I hope to 
be able to ask that panel. One of those deals with the 
independence of board members and what we can do, given your 
experience on this Board and other boards that you have served 
on, what can we do? This is for anybody on the panel. What can 
we do? What ought we do to better ensure, not just we in the 
Congress, but we collectively, to ensure that members of boards 
of directors have the kind of independence that will better 
ensure that they make decisions that represent the interest of 
the shareholders? Anyone?
    Mr. Blake. Senator, I think that I would like to respond to 
some of the comments that were made this morning, I, frankly, 
agree with. I think there has to be scrutiny relative to what 
extent of involvement a member or director has on a board with 
a company and to assess whether that could, in fact, present a 
conflict of interest situation, in other words, too much vested 
interest in the relationship with the company such that it 
cannot be--that person cannot be independent or dispassionate 
about decisions that need to be made.
    I think, also, that in this case, this Board actually 
percentage-wise has a relatively high level of independent 
directors on its Board and I think that is a good thing. There 
is probably a rationale to have some inside directors, 
particularly as it relates to continuity and succession of 
management. It is very common, for example, when one CEO was 
leaving and there may be a COO or something of that nature, 
where you want to give exposure of that potential successor to 
the board and to have that individual participate in the board. 
There is real ample justification, perhaps, of having, say, 
two, particularly in light of the succession situation. 
Otherwise, I would be more inclined to suggest that just the 
CEO should be a member, except for the isolated situation.
    Senator Carper. OK. Other thoughts on board independence? 
Other comments from any of you with respect to board 
independence, steps that need to be taken to better ensure 
board independence?
    Mr. Jaedicke. Senator, I suppose you could give the 
simplistic answer and say, well, you could pass legislation or 
come up with regulations that would say you cannot have a 
consulting arrangement. There is a trade-off here. It is 
disclosed, it is controlled, but Mr. Urquhart, for example, was 
an expert in the--ran the power division of GE. I am sure he 
gave us a lot of help overseas. It is like--I suppose you could 
say, well, maybe that individual should not serve on the Board. 
Well, the question is, can you get him?
    I do not know how to--I realize that this is my personal 
answer, and it is just an opinion. Free enterprise is great 
because it is free. Now, if you want to impose constraints on 
it, there is always a trade-off. I am not going to tell you 
that you should not impose some constraints because maybe your 
assessment of those trade-offs is different than mine. That is 
what makes a system work, I guess.
    Senator Carper. Let me just interrupt. I do not mean to be 
rude----
    Mr. Jaedicke. I do not know how to answer this.
    Senator Carper. This is not a trick question. We have got a 
lot of wisdom represented at this witness table and this is an 
issue we are going to deal with, and we can make wise decisions 
or unwise decisions, and if you have some thoughts, just share 
them with us from your heart.
    Mr. Jaedicke. I guess I do not understand what you are 
asking me, sir.
    Senator Carper. Anyone else? If not, I could restate the 
question.
    Mr. Duncan. Well, I will try that. I agree that every board 
member should be independent. Those that are not 16(b) officers 
should be totally independent, period. That, I agree to.
    I would think that a board could do something like we did, 
and that is have an annual board appraisal, and in that board 
appraisal have items that would lead one to conclude that 
member is independent. Now, how you write the textbook on that 
would take some time.
    Senator Carper. Anyone else?
    Dr. LeMaistre. I have wondered a great deal about the 
rotation of directors. It seems to me that during service on a 
board, it takes a good while to get acquainted with the 
business, especially for a physician. I can tell you that after 
a period of time, it would seem to me that a rotation would 
serve to give an indoctrination period to others coming on so 
that they could learn to be fully effective while over two-
thirds of the board would be experienced. But it is just a 
thought. I do not know whether boards do that or not. We did 
not do it at Enron. I did discuss that with some of the 16(b) 
officers as a possibility.
    I also feel that in the board's self-evaluation, there has 
to be action taken and there has been action taken in the Enron 
Board.
    Senator Carper. You say there has?
    Dr. LeMaistre. There has been when a Director was not found 
to be effective in representing the shareholders.
    Senator Carper. Dr. Winokur.
    Mr. Winokur. Sir, my colleagues are knowledgeable and, I 
think, articulate about this subject. I would just say that 
Enron's Board was voted one of the five best in the country 2 
years ago--because I still have the plaque somewhere in my 
office.
    Senator Carper. Hold on to that. [Laughter.]
    Dr. LeMaistre. But more importantly than that, we did go 
through a self-evaluation process and we attempted to conform 
with the best practices that the General Motors Pension Fund 
and all of the other governance entities did. So I think that 
independence is important, and I think a board that tries to 
improve itself all the time is important.
    Senator Carper. Thank you. Mr. Chairman, I do not want to 
go on too long. Do I have time for one more?
    Senator Levin. Sure.
    Senator Carper. What kind of future, if any, is there for 
Enron coming out of bankruptcy? What do the folks who are 
involved in still holding shares or the people who are the 
employees or were the employees who have the shares in their 
401(k)'s, what do they have to look forward to?
    Mr. Blake. Senator, not very much, unfortunately. I think 
the jury is still out, but as represented by the recent 8(k) 
filing for the write-down that I believe Senator Levin 
mentioned in his comments this morning, there is an imbalance, 
obviously, in terms of claims against the estate and assets. We 
have already stated earlier that there is no specific value and 
current equity of Enron.
    As it relates to employment as contrasts with perhaps an 
investment in Enron stock, the Board, Pug and I and the Board 
approved an organizational plan which we presented to the 
Bankruptcy Court last week called OPCO, which basically takes 
the traditional assets of the company, pipeline investments, 
power generating investments, and things of that nature, within 
which there is some level of synergy and relationship to the 
component makeup of that entity. It is hopeful that we can, 
essentially, try to sell these various business interests into 
and through a trust with something they call a 363 sale. The 
sale out of bankruptcy of these assets in a trust would take 
place whereby all the claims against the estate would be set 
aside, until such time that this OPCO company could then go 
operate as a stand alone ongoing business.
    And the view, with which I personally agree, is that the 
ongoing value of the company is better than break up or 
liquidating value of assets. Enron is one of the more efficient 
gasline, pipeline suppliers and operators in the country. It is 
one of the lowest cost producers. Its reliability is one of the 
best in the industry. So there is real value and there are 
great people in that business.
    So the hope is that we will be able to take this collection 
of assets called OPCO, have it purchased out of bankruptcy into 
a trust, and as such there would be employment for those 
employees and a livelihood to go forward, as contrasts with 
perhaps liquidating those assets. Otherwise, I think there are 
many assets that will be liquidated, and I do not want to get 
too far into discussion on that, but there are a lot of claims 
still out there and a diminishing level of assets, 
unfortunately.
    Senator Carper. All right. Thank you.
    Mr. Blake. You are welcome, sir.
    Senator Carper. Mr. Chairman, do I have time for one more?
    Senator Levin. Sure.
    Senator Carper. Just imagine for a moment that you were not 
sitting there and meeting the responsibilities that you now 
hold in your lives but you sat up here and you wore our hats 
for a while. Let me just ask each of you, if you were in the 
role of a member of the U.S. Senate, can you think of one thing 
that you would do, whether it is with respect to corporate 
governance or the role or responsibilities of the accounting 
firms and the way they are managed or governed, or 401(k)'s, 
one thing that you think needs some legislative action, needs 
to be addressed legislatively, not just the marketplace forcing 
the changes, compelling the reforms, not just the SEC, not just 
the Federal Accounting Standards Board, but something that we 
need to do, could you give me an example, each of you, just one 
example of something that the Congress needs to do to better 
ensure that this sort of thing does not happen again?
    Mr. Blake. First of all, I think the comment was made 
earlier by some of my colleagues this afternoon, this morning, 
disclosure. Truth does not hurt, and the more disclosure the 
better, as far as I am concerned. That, frankly, is the 
governing mechanism of off-balance-sheet transactions, is the 
requirement of disclosure, the adequacy and completeness of 
disclosure. I think that is a practice that probably could be 
extended beyond where it is today, personally.
    I do think there is an accountability that CEOs like myself 
have in terms of being honorable to my position and should be 
accepting of the consequences if I were to misbehave or I have 
proven to have been involved in a wrongdoing. Frankly, I think, 
personally, having such an act that would suggest criminal 
liability, if that was--it is a gray area in terms of 
negligence and whether there was really intent to deceive, but 
if, in fact, there was an intent to deceive and, in fact, it 
was a fraud and that the leader of that company was responsible 
for perpetrating that fraud, I would hope that there would be a 
criminal action against that individual.
    Senator Carper. All right. Thank you.
    Mr. Blake. That has no application to Enron. It is just a 
philosophical statement.
    Senator Carper. I understand. Thank you.
    Dr. LeMaistre. The company's most valuable asset is its 
employees. I think the 401(k) should be managed by the 
employees, but there should be some oversight to correlate with 
the top management, the CEO, and the board so that you can be 
sure that those employees who are managing the fund know fully 
what the condition of the company is, especially with regard to 
stock. But that does not happen. At Enron, there is no 
fiduciary responsibility of the Compensation Committee nor any 
management responsibility. Our only responsibility is to amend 
the original plan when amendments are required.
    Senator Carper. Thank you, sir.
    Mr. Jaedicke. Sir, I do not know that I could answer your 
question. I have been so busy that I do not really think I know 
enough about the public policy to say what you should focus on. 
I have no disagreement with what my colleagues have said here, 
but I am just really not well enough informed on this whole 
process to suggest to you anything other than something off the 
top of my head.
    Senator Carper. If something comes to mind and you would 
like to share it with us later----
    Mr. Jaedicke. I certainly will.
    Senator Carper [continuing]. We would be delighted to have 
it.
    Mr. Jaedicke. I certainly will, and I promise you I will 
think about it, and if I think I can pass along anything that 
would be of any help to you, you will hear from me.
    Senator Carper. Thanks so much.
    Mr. Winokur. Senator, this is not meant to relate to Enron, 
because I do not think it would have--I do not think it is 
particularly applicable, but I think, going forward, I would 
find it very helpful--we talked about it a little bit earlier--
if the whole issue of stock versus performance options versus 
stock options could be simplified and clarified and made people 
as agents, because employees are agents for the shareholders, 
made their incentives more closely tied. There are many people, 
including the chairman, who have thought a great deal about 
that. I do not have the specific proposals. But the more there 
is disclosure and the more the incentives are aligned with the 
owners, the better things will be.
    Senator Carper. Thank you. Mr. Duncan.
    Mr. Duncan. Senator, I agree with what my colleagues have 
said. The only thing that I would add is that the world goes on 
at a faster and faster speed. As the Internet comes into play 
in bigger and bigger portions--most of the SEC Act was, what, 
1933 or something like that--as that comes into play and 
derivatives come bigger and bigger into the world, and a 
cashless society becomes a totally cashless society, the rules 
might have to be a little different as you move into that. I do 
not think that they are overdue, but I think they will be due.
    Senator Carper. All right, thanks.
    Mr. Jaedicke. Senator, can I make one comment that may 
sound a little facetious, but he reminds me. I do not really 
believe it is facetious. It seems to me that one of the 
things--I do not think management would like this very well 
because it may disclose things that really are not vital to the 
investment decision but would give away trade secrets or 
financing secrets or something like that--I have this vision in 
the back of my head as an accountant that the way to deal with 
the disclosure problem is do away, eventually, in this 
information age, with the annual report and just send everybody 
a compact disk.
    And on that compact disk would be all kinds of information, 
and then you could maybe imbed in that--now, this sounds hare-
brained, but I do not think we are too far away from some of 
these things--the software that would say, off-balance-sheet 
does not mean out of the statements. What it means is you have 
disclosures in different places than the balance sheet and the 
footnotes. One of those footnotes would be--you were worrying 
earlier about the assets that are off the balance sheet and in 
the non-consolidated subsidiaries.
    I am sure even I could give you a piece of software so that 
you could say, well, here is a statement that is according to 
GAAP now, but those subsidiaries are not consolidated. I would 
like to see them consolidated. That would be like falling off a 
log. And then you can see all of the assets that are in that 
footnote. That would be the idea.
    Now, I realize that is kind of hare-brained, but my 
colleague has reminded me----
    Senator Carper. That is a great idea.
    Mr. Jaedicke [continuing]. That we are in a new age.
    Mr. Duncan. And it would also save the company money.
    Senator Carper. Mr. Chairman, years from now when it is 
time to send out those annual reports and we open up our 
mailboxes and out of them fall these CDs, we will know where 
the idea came from, right here on this day.
    Mr. Jaedicke. Thank you.
    Senator Carper. Thank you all. Mr. Chairman, thanks.
    Senator Levin. Let me get back to Ken Lay's loans. In May 
1999, the Enron Compensation Committee told Ken Lay that--and 
by the way, Senator Carper, because you were inquiring, I 
think, in a very gentle way, I should be done in about 10 
minutes, in case anyone else is trying to plan a schedule, too. 
[Laughter.]
    I want to take just a moment, though, on Ken Lay's loans. 
The Compensation Committee told Mr. Lay that he could repay his 
company loans with stock in May 1999. At that time, he had a 
line of credit with Enron of about $4 million, and that was 
raised to $7.5 million in August 2001.
    But in a 1-year period, from October 2000 to October 2001, 
Mr. Lay began using an ``ATM approach'' to his Enron credit 
line, as one Board member put it in his interview. If you look 
at Exhibit 36,\1\ Mr. Lay repeatedly withdrew the entire amount 
available, and then repaid the loan with Enron stock. First he 
did this about once per month, and then about every 2 weeks, 
and then on some occasions several days in a row. By the end, 
he had obtained $77 million in cash in exchange for his Enron 
stock.
---------------------------------------------------------------------------
    \1\ See Exhibit No. 36 which appears in the Appendix on page 350.
---------------------------------------------------------------------------
    Now, every Board member acknowledged to us that these 
transactions could fairly be described as stock sales. By 
characterizing them as loan repayments, though, Lay was able to 
bypass the rules for quarterly disclosure of insider stock 
sales and was able to delay reporting his stock transfers until 
the end of the 2001 calendar year plus 45 days. All the Board 
members told us that they did not know that this was going on 
at the time, and they were shocked to learn of it later. The 
facts suggest, and your reactions suggested, that Ken Lay was 
abusing his line of credit.
    First of all, do you agree that he was abusing his line of 
credit? Dr. LeMaistre.
    Dr. LeMaistre. May I comment on that in two ways. First, 
just from what I have seen of the records, this is very unusual 
behavior. This is very clearly a different pattern from what 
occurred in the previous years.
    Second, the loans were characterized as a line of credit 
and that interpretation needs always in the future to be 
clarified. I think it is a very important point.
    The third thing is that we found out about this only this 
year. I believe it was February when we finally learned of 
this, primarily because of the point you made, Mr. Chairman, 
and that is the disclosure does not come periodically forward 
to the Board or to any other Federal agency or the SEC.
    So the surprise that occurred here was one that really 
concerned all of us greatly without any understanding of why it 
was necessary. The only comment ever made to me personally by 
Mr. Lay was that he had found the previous loan useful and that 
he would like to have the loan increased to $7 million. 
Checking with Towers Perrin, I found that was a mid-line range, 
that there were loans much higher than that to executives. We 
had a lot of experience at Enron over many years with loans to 
executives. We have never seen this before. Therefore, we were 
very deeply concerned about this.
    Senator Levin. In your judgment, did this constitute an 
abuse of his line of credit?
    Dr. LeMaistre. I think it is subject to another concern. 
With the confusion over the definition of the terms, you hear 
terms like ``revolver'' and all of the other terms that would 
more characterize this used interchangeably. It is not a term I 
care to use, but I have heard that term--I think the real 
problem comes in what is the code of business conduct. One of 
the lines in the Enron code says you will do nothing to hurt 
the interest of Enron, and taking this much money out and 
repaying it with stock when the stock is declining certainly is 
very devious. It is very difficult for me to understand why 
that did not hurt Enron.
    Senator Levin. You are stopping a little short of saying 
that it was an abuse. Is that intentional?
    Dr. LeMaistre. It was intentional, yes, because I do not 
know the circumstances.
    Senator Levin. Does anyone else have a comment on that?
    [No response.]
    OK. Dr. LeMaistre, let me just ask you this. Whose job is 
it to monitor and stop that from happening? Whether you call it 
an abuse or short of that--I think it is an obvious abuse, but 
you say that you were concerned, dismayed--but in any event, 
whose job was it, if not yours and your Committee, to monitor 
that particular activity of Ken Lay?
    Dr. LeMaistre. There are three points in this. The 
Treasurer receives the request and disburses the money. A 
lawyer in the General Counsel's office receives the stock back 
and it is registered with the person who then must make the 
filing, unfortunately, 45 days after the yearend.
    To correct that, some kind of quarterly reports will be 
needed. If the CEO has the loan, the report should come 
directly to the board by the people who handle the transations.
    Senator Levin. But looking back at this now, you do not 
feel that you had any responsibility to monitor this?
    Dr. LeMaistre. We had never had any responsibility to 
monitor this.
    Senator Levin. Does anyone else want to add anything to 
that?
    Mr. Blake. Senator, I would. I do not want to go close to 
the word ``abuse,'' but I would say that as a CEO, it is not 
what you say, it is what you do. Sale of a stock in the nature 
that took place was inappropriate. And, I also personally feel 
as a member of the Compensation Committee that I agree with 
everything that Mickey said, that we did not know about this 
until February of this year. I was absolutely shocked by this. 
And I would suggest that if we had a chance to have known that 
occurred, we would have taken immediate and corrective action 
to ensure that behavior would not happen again.
    Senator Levin. See, what I would hope for would be outrage.
    Mr. Blake. Well, I can use that, too.
    Senator Levin. Good. That is what we would hope for. I have 
not felt it.
    Mr. Winokur. Senator, it would be impossible to feel 
anything other than outrage, given the amount of money that was 
lost by the employees, the amount of jobs that were lost----
    Senator Levin. I did not hear that. I gave you all a chance 
to comment. I said, is it an abuse? Dr. LeMaistre would not go 
that far. I am glad to know that once I used the term 
``outrage,'' that at least that resonates, because I have got 
to tell you, I did not sense outrage here.
    Mr. Blake. You have got it.
    Senator Levin. I have got it, OK. Good.
    Mr. Winokur. This made me very angry when I heard it.
    Senator Levin. Good. I am glad, and I wish that was 
transmitted.
    What stands out here, this is perhaps a harsh thing to say, 
but I must tell you that we have learned a lot today in terms 
of information, but what really stands out to me is the denial 
of any responsibility on your part--for what happened to Enron. 
A highly-paid Board not taking any responsibility for the 
events at Enron, with a management that was just management 
gone wild. That last question was just one of about 20 examples 
of where we had this swashbuckling management, this arrogant, 
greedy management that was stuffing their own pockets with the 
money of shareholders.
    What we need in boards are people who are willing to stand 
up to management. You have got the backgrounds to do it. You 
have got the experience and knowledge. But what comes out is 
that you all say you did not do anything wrong, and what I am 
afraid of is, too often, you did not do anything, period. I 
mean, there were a lot of warning signs along the way.
    You did not hear Andersen say that Enron used high-risk 
accounting. You did not remember the details of Whitewing as of 
3 weeks ago. There was a $2 billion off-the-books vehicle, but 
no interest in reviewing LJM's private placement memo. When you 
learned about that memo--this is the memo that was touting a 
conflict of interest that cost your company that you have the 
fiduciary duty to protect. It cost your company, that LJM 
enterprise. It made a lot of money at your expense. There was a 
conflict of interest that was inherent right in it, because the 
guy who was selling, or that you were selling assets to, was on 
both sides of the negotiating table. He did very well at LJM, 
while Enron and its stockholders were getting socked.
    But even after the lawyers told you about it or you read 
about it in the Powers Report and the lawyers were asked to 
look at this document, it touts conflict of interest. That is 
about the only thing you can say. It holds out this insider 
information that these folks had in Enron while selling 
partnership interests in LJM. You have not asked those lawyers, 
my God, how could you not have brought that to the attention of 
the Board?
    You did not press to learn Fastow's LJM compensation for 1 
year after you were supposed to look into it. The Board 
directed that you would look into this compensation. A year 
goes by. An employee of Enron says she does not have the 
information, she will get back to you. She does not get back to 
you. Nothing happens. You read about it in the newspaper.
    You did not ask who bought Fastow's interest in LJM, even 
though LJM meant $2 billion in funds flow for Enron--no inquiry 
as to who bought that interest. You knew there was something 
wrong there by then, but still, no inquiry, no questions. No 
questions about the Fortune article.
    I do not see any concern about the $27 billion that were 
represented when half of Enron's assets were off the books. 
Sixty-four percent of Enron's international investments were 
underperforming. Forty-five million shares or more of Enron's 
stock were at risk in the Raptor transactions. It does not set 
off any alarm bells. This is stuff that you knew.
    You did not ask to see Watkins' letter when it was 
presented to the Board. You got the memo summarizing it, but 
you did not ask to see that letter itself.
    Mr. Blake. Sir, I beg to differ. We did ask for the letter.
    Senator Levin. OK. Did you get it?
    Mr. Blake. Subsequently, but not right away, yes.
    Senator Levin. I will stand corrected, then. You got it 
subsequently.
    You really did not know of anything wrong, despite all of 
that, until the Wall Street Journal told everybody something 
was wrong on October 18 when the world found out. I think that 
is unacceptable, for a Board to be that out of touch with the 
reality of their own company. I think you were taken advantage 
of, too. I think your passivity was taken advantage of--I do 
not have any doubt of it--by the management.
    That placement memo that I made reference to, which has 
this touting of this insider information at your expense, was 
issued on October 13, 1999, which was just 1 day after the 
Board approved LJM2. This is a pretty complicated document here 
that Fastow put out. It was obvious he assumed that you would 
approve this 1 day before he put it out. He counted on that 
approval.
    It looks like Enron's Chief Financial Officer saw you as a 
rubber stamp. It is just deeply troubling to me, because I know 
you are good people. I have no doubt about the fact that you 
are individually good people. I do not know you personally, but 
I know your biographies and I can see that. But this 
responsibility is placed on the shoulders of good people, and 
sometimes good people do not carry out that responsibility 
well.
    The shareholders elected you to use independent, tough 
judgment, to probe for facts, not to accept whatever management 
gives you. I do not believe you looked hard. I do not believe 
you asked tough questions. I do not think you considered the 
personal motivations that prompted related party transactions 
that ultimately did contribute to your downfall.
    We have gone through the warning signs that you knew of. 
There were many of them. We have tried to go through some of 
them this morning and this afternoon. As I said, directors are 
not expected to be detectives. They are not expected to assume 
that misconduct pervades the highest reaches of management. But 
they are expected to be more than a rubber stamp for 
management. They are expected to dig for facts and understand 
complexities and to say no to transactions that do not look 
right.
    I think the shareholders deserved better than what they 
got. Too often, I believe you were followers and not leaders, 
not the captains but followers. The management there had 
created this corporate culture where anything goes as long as 
it could produce apparent profits, and those profits that 
appeared on the financial statement then increased the share 
price. That was the culture. That was the environment. That 
rise in stock price, while I am sure gave great pride to 
members of the Board, failed to stimulate even one Director to 
consider that age-old truism that if something looks too good 
to be true, it probably is.
    I hope we all learn from the Enron debacle. I hope Congress 
can pick up some of the points that are learned, whether here 
or in other committees or in the media or through just 
investigation, to take appropriate actions to tighten up the 
accounting standards, to increase independence of auditors, to 
give the SEC responsibility to require the directors and the 
auditors to be more responsible to the shareholders.
    We have our responsibility. The SEC has responsibility. But 
the first line of defense against corporate abuse lies with the 
Board of Directors. There is just no substitute for it. We can 
pass all the laws in the world and all the regulations can be 
adopted by the SEC, but the corporate governance responsibility 
must rest with the Board of Directors. I would just hope that 
in all areas, whether it is the regulatory area, whether it is 
the legislative area, or whether it is that area of corporate 
culture that so badly needs to be changed into a fiduciary 
culture, from a culture of the share price is a god, to a 
fiduciary duty is a true obligation, that is the change that 
has to be made.
    You folks have been participants in an experience which I 
am sure has been painful to you. It is painful to the 
shareholders of the company that you ran as Directors, and it 
took a toll on the economic system. But we are hoping that this 
hearing and this investigation will contribute to some 
corrections, that they will be common-sensical, that they will 
be thoughtful, that they will try to avoid unintended 
consequences. We will keep our focus on what we can properly do 
and what the SEC can properly do, and just leave to our people 
of integrity that will be on these corporate Boards the 
understanding as to that responsibility and that obligation to 
represent the shareholders and to stand up to management when 
management gives any indication that they are going in the 
wrong direction.
    We thank you. It has been a long hearing. We thank you for 
coming forth. As I said, you have done so voluntarily. You have 
cooperated with us. You have presented what we have asked for 
with documents. We would greatly appreciate your continuing 
cooperation, and we will now move to the second panel. Thank 
you all.
    The second panel of witnesses are experts in corporate 
governance and accounting. First, Charles Elson, Director of 
the Center for Corporate Governance at the University of 
Delaware, a leading expert in corporate governance issues; 
Michael Sutton, the former Chief Accountant at the Securities 
and Exchange Commission from 1995 to 1998; and Robert Campbell, 
former CEO, Chairman of the Board of Sunoco, and current Board 
member of Hershey Foods, CIGNA, and Pew Charitable Trusts.
    It is a distinguished panel. We first of all must tell you 
how grateful we are for your staying with us. I do not know 
whether we warned you that it might be this long of a wait. If 
not, I apologize for not alerting you to it, but in any event, 
we are very grateful that you stayed with us.
    As I indicated this morning, pursuant to Rule VI, all of 
the witnesses who testify before us are required to be sworn, 
so I would ask you to please stand and raise your right hand.
    Do you swear that the testimony you will give before this 
Subcommittee will be the truth, the whole truth, and nothing 
but the truth, so help you, God?
    Mr. Sutton. I do.
    Mr. Elson. I do.
    Mr. Campbell. I do.
    Senator Levin. We will try that timing system again. If you 
can see these lights, 1 minute before 10 minutes is up, the 
green will change to yellow. It will let you then conclude your 
remarks. The written testimony will be part of the record in 
its entirety, and we will start with Mr. Elson.

    TESTIMONY OF CHARLES M. ELSON,\1\ DIRECTOR, CENTER FOR 
 CORPORATE GOVERNANCE, UNIVERSITY OF DELAWARE, NEWARK, DELAWARE

    Mr. Elson. Thank you. My name is Charles Elson and I am the 
Director of the Center for Corporate Governance at the 
University of Delaware in Newark, Delaware, and the Edgar S. 
Woolard Professor of Corporate Governance at the University of 
Delaware. I serve on several commissions of the National 
Association of Corporate Directors, on director 
professionalism, director compensation, and various other 
commissions relating to corporate governance. Additionally, I 
am Vice Chair of the American Bar Association's Committee on 
Corporate Governance and a Director of the Investor 
Responsibility Research Center here in Washington, DC.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Elson appears in the Appendix on 
page 185.
---------------------------------------------------------------------------
    I am going to talk just a little bit about the red flags, I 
think, that were raised for the Enron Board, some of which were 
talked about today, a little bit about what corporate 
governance types look for in corporate Boards, what factors 
should be present, we believe, and finally, the problems vis-a-
vis the Enron Board in meeting those requirements.
    I do not have any knowledge specifically of what occurred 
within the Enron Boardroom other than what I have read in the 
press and my comments really will be more structural in nature 
as to the internal workings. That is something that obviously 
will have to be developed later on.
    There were several flags that came before this Board and 
one wonders why they were not responded to. First and really 
most important was the waiver of the conflict of interest 
policy. That is a pretty extraordinary thing for a Board to do. 
A conflict of interest policy is laid out for very specific 
reasons. It lays out what is in the company's interest, what is 
not in the company's interest, and waivers from a code of 
ethics is not a very usual occurrence, and that is something 
that, in my view, at least, should have triggered lots of 
questions--who, why, when, and where, particularly when the 
policy was waived vis-a-vis the company's Chief Financial 
Officer. That is your chief control officer, financial control 
officer, and it is very unusual to have that officer on both 
sides of a transaction.
    Additionally as a flag, there was a lot of stock selling by 
executives of the company, again, a flag that apparently was 
not responded to.
    You had, additionally, a number of Directors on the Board 
who had financial relationships to the company itself, again, 
not a major flag, but something that should have raised some 
questions, at least amongst those who did not have those 
connections.
    Finally, vis-a-vis the audit, an auditor, Audit Committee, 
you had the independent auditor of the company acting as both 
the internal and the external auditor. That, from a governance 
standpoint, is questionable. The independent auditor also was 
taking substantial fees from the company from both audit and 
consulting work, something, again, governance types should say 
is not such a good idea.
    And finally, there apparently was a bit of a revolving door 
between the external auditor and the company's financial 
department, again, a flag, something that should have raised 
questions, not practices that in and of themselves were 
problematic, but practices that an independent Board should 
have been asking questions about and trying to get to the 
bottom, and had questions been asked, perhaps something might 
have been avoided.
    Now, the next issue is, well, OK, these flags were there. 
Why were they not responded to? What kind of Board would have 
responded to it and was this Board somehow deficient 
structurally in its composition and its procedures such that 
these flags were not responded to?
    Corporate governance types will tell you that the most 
important aspect of any Board, really two aspects, are that of 
independence and equity, independence meaning directors serving 
on the Board with no financial connection to the company 
whatsoever other than long-term equity ownership in the 
company, that is, no consulting arrangements, no business 
connections to the enterprise, no service provision to the 
enterprise, the only relationship being that of a director who 
owns equity in the company.
    The second important factor is that of equity, that each 
director should have a personally meaningful equity position in 
the company itself, that a director should be compensated in 
stock and that the director should personally invest a 
meaningful amount, meaningful such that the director is aligned 
with the shareholder interests rather than managerial 
interests, the key being substantial equity ownership provides 
that alignment.
    Independence is important for a director because it gives 
the director objectivity. The director's job is to monitor 
management for the sake of the shareholders, and independence 
gives you the effective objectivity to do that monitoring. 
Equity gives you the incentive to exercise that objectivity, 
very important.
    The two work together. They work in tandem. An independent 
board without equity is not very good to the shareholders. It 
may be objective, but there is no incentive to exercise the 
objectivity. An equity holding board without independence is no 
good. They may have incentive, but no objectivity.
    And independence is actually sort of an interesting 
concept. It is a two-way concept. Not only is it important vis-
a-vis its monitoring aspects or its creation of objectivity, 
but it is also important within the organization itself, 
because if the board is viewed as independent of management, an 
employee who believes there is a problem within the 
organization is much more likely to contact the board if there 
are problems. The difficulty with a non-independent board, a 
board that is seen as just an arm of management, is that 
complaints rarely reach the level of the board. That is why 
independence, as I said, is important for two reasons.
    Independence and equity are really the hallmarks of a good 
board, and that is something that corporate governance types 
have been calling for for a long time. The two, as I say, 
reinforce one another.
    Additionally, vis-a-vis qualifications of directors, there 
is concern about directors serving on too many boards. An over-
Board director is not a good director because, obviously, he o 
she is like a jack of all trades, a master of none. Someone who 
is on too many boards does not have the time or energy to focus 
appropriate attention on the boards on which he or she serves.
    Second, there is concern about the length of directors' 
terms. Directors who are on a board for too long, are viewed as 
becoming effectively tired, not as sharp as they once were in 
reviewing the company and much more willing to accept 
management representations than not. That is why a number of 
folks have called for term limits for directors, either through 
retirement policies or through actual 10- to 15-year terms, 
such that, at some point, someone rotates off.
    How does this apply to the Enron Board? The Enron Board was 
problematic, I think, in the independence issue. There were a 
number of directors of the company who did not meet that 
definition that I described to you, who were service providers 
or recipients of corporate largess in some way, shape, or form, 
and that, I think, was problematic.
    Additionally, you saw a conflict, I guess, vis-a-vis this 
Board in the sense that they held lots of options. There was 
equity on this Board, but there were also substantial numbers 
of company options, and a number of governance folks have 
suggested, too, that the way to incentivize a director is not 
necessarily through an option, which is an expectancy, but 
through straight equity ownership. An option is terrific on the 
upside, but on the downside, you do not lose very much. As an 
owner of a share of stock, on the downside, you lose quite a 
bit. You lose your investment and, obviously, the potential for 
upside.
    I think that was the really primary thing we saw vis-a-vis 
the Enron Board, the presence of a number of non-independent 
Directors or what folks would view as non-independents. Did 
that mean they did not exercise independent judgment? Not 
necessarily. All it means is that if one is not independent, it 
is a lot tougher to make that difficult call with management. 
You are probably more trusting of management, because, in fact, 
you have relations to management.
    Additionally, the Board of Enron served for a long time. A 
number of Directors had been there for at least 10 years, and 
again, the problem of length of service vis-a-vis being more 
accepting of management representations than not, I think, came 
into play.
    In short, there were warning signals that were present. The 
warning signals were apparently missed until it was, in fact, 
too late. Why did it occur? That will obviously be the subject 
of your hearings and review.
    But what I can say is from a structural standpoint, there 
were reasons, at least in my view, that the flags may, in fact, 
have been missed or not responded to early enough, and I think 
that this is something that this Subcommittee, and, frankly, 
the investing public, should demand of our companies, that a 
substantial majority of corporate Board members should be: A) 
independent of management, and B) own personally meaningful 
equity, long-term equity stakes in the company, equity stakes 
that cannot be sold on the short term but must be retained for 
the length of the director's service on the Board. Thank you.
    Senator Levin. Thank you very much, Mr. Elson. Mr. Sutton.

  TESTIMONY OF MICHAEL H. SUTTON,\1\ FORMER CHIEF ACCOUNTANT, 
   SECURITIES AND EXCHANGE COMMISSION, WILLIAMSBURG, VIRGINIA

    Mr. Sutton. Chairman Levin, Senator Collins, Members of the 
Subcommittee, thank you for inviting me to share my thoughts 
with you today.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Sutton appears in the Appendix on 
page 191.
---------------------------------------------------------------------------
    First, let me comment briefly on my background and 
experience. I was Chief Accountant of the Securities and 
Exchange Commission from June 1995 to January 1998. Prior to 
holding that office, I was a senior partner in the firm of 
Deloitte and Touche, responsible for developing and 
implementing firm policy relating to accounting and auditing 
and practice before the SEC. My career with Deloitte and Touche 
spanned from 1963 to 1995. As a retired partner, I receive a 
fixed retirement benefit from that firm. Presently, I undertake 
from time to time independent consulting and other assignments 
in the field of accounting and auditing regulation and related 
professional issues.
    Effective oversight by Boards of Directors is at the heart 
of the financial reporting processes that serve and protect the 
interest of investors and the public. Without effective 
oversight, important checks on the integrity, judgment, and 
performance of management are compromised. Without effective 
oversight, critical safeguards of the rigor and objectivity of 
the independent audit are weakened.
    As we have seen in the case of Enron, failures of the 
corporate governance processes can be devastating and the 
investing public, rightly so, is asking, ``Can we rely on 
corporate governance, oversight by Boards of Directors and 
audit committees, to ride herd on management and see to it that 
auditors do their jobs? ''
    We would like to believe that Enron is an anomaly, that the 
governance issues raised are isolated to this case, but they 
are not. While Enron has become a poster child for a system out 
of control, the underlying concerns about the diligence of 
Boards of Directors and audit committees reach far more broadly 
into our corporate and capital market culture.
    As we look at the issues today, it should be abundantly 
clear that there is no higher goal for financial reporting than 
providing useful and reliable information that promotes 
informed investment decisions and confidence in the system. It 
also should be abundantly clear that without diligent, probing 
directors and audit committees and dispassionate, independent 
auditors, the quality of financial reporting can be and will be 
systematically undermined. Without adequate checks that must 
come from effective governance, conflicts of interest can, and 
will, go unchallenged.
    One of the most practical and effective steps in reforming 
the financial reporting system, in my view, would be to 
immediately revisit and rewrite our corporate governance 
policies and guidelines to clearly break the bonds between 
management and the independent auditor and to unmistakably 
spell out the responsibilities of boards of directors and audit 
committees to shareholders and the investing public. Management 
should be the subject of, and not the manager of, the 
independent audit relationship and process.
    The ultimate responsibility for full and fair disclosure to 
shareholders, and the direct responsibility for the independent 
audit relationship and the quality of the audit process, should 
be clearly fixed with the board of directors and its audit 
committee. The audit committee should be made up entirely of 
independent directors.
    For independent auditors, I believe that a brighter future 
begins with full acknowledgement of the reality that seems so 
clear today. Failures in our financial reporting system are 
more than aberrations. They seriously undermine investor 
confidence in the institutions that are supposed to protect 
them. They ``poison the well.''
    To restore and maintain confidence in the independent 
audit, I believe that profession will have to do three things. 
First, it will have to embrace a role that is fully consistent 
with high public expectations. In public capital markets, 
insiders have an advantage over public investors, and in that 
arena, independent auditors are expected to balance the scales 
by assuring investors that the financial reporting gives them a 
fair presentation of the economic realities of the business.
    Second, the auditing profession will have to tackle 
fraudulent financial reporting as a distinct issue with a 
distinct goal, zero tolerance. We understand that in life zero 
defects are almost never realized. Nevertheless, the public 
expects that the profession will pursue that objective.
    Third, it will have to accept and support necessary 
regulatory processes that give comfort to the public that the 
profession is doing all that it can do to prevent future 
episodes of failed financial reporting.
    With respect to accounting standards, we simply cannot 
tolerate financial reporting that ``hides the ball'' and we 
cannot tolerate processes that are not responsive to critical 
financial reporting needs. Current rules for accounting for 
SPEs, for example, are nonsensical. They can only be explained 
by accountants to accountants. More broadly, outdated rules 
governing consolidation and off-balance-sheet financing have 
become recipes for masking a company's true economic risks and 
obligations. We have a right to insist that accounting 
standards clearly reflect the underlying economics of 
transactions and events, and it is not acceptable to sit by 
while market innovations outstrip the development of needed 
guidance.
    Criticisms of U.S. standards is beginning to focus on the 
fact that they have become increasingly detailed, and arguments 
have been made that they should be broader statements of 
principle, applied with good judgment and respect for economic 
substance. I have sympathy for the desire to break the cycle of 
the mind-numbingly complex accounting rules that have become 
the norm, but to do that, I think we have to confront 
realistically the reasons why our standards have evolved the 
way they have. Here are some of the underlying pressures that 
are at work.
    Business managers want standards that provide the greatest 
flexibility and room for judgment. They want to be able to 
manage reported results, but yet be able to point to a standard 
that assures the public that they are following the rules.
    Deal makers and financial intermediaries want standards 
that permit structuring transactions to achieve desired 
accounting results, results that could obscure the underlying 
economics. In that world, creative transaction structures are 
valuable commodities.
    Auditors are pressured to support standards that their 
clients will not take issue with, and they often are restrained 
in their expected support for reporting that is in the best 
interests of investors and the public. Others, including 
legislators, some legislators, too often lose sight of the 
fundamental importance of an independent and neutral standard-
setting process. Without independence and neutrality, standard 
setters cannot effectively withstand the myriad of constituent 
pressures that they inevitably will face and make the tough 
decisions that inevitably are required.
    And then standard setters too often seem to pull their 
punches, perhaps because of the perceived threat to the 
viability of private sector standards setting, perhaps because 
of the sometimes withering strain of managing controversial 
change, and perhaps because of a loss of focus on mission and 
concepts that should guide their actions.
    As we reexamine the processes, the issue and debate should 
not be about whether accounting standards should be detailed or 
broad, but rather about what formulation of standards and 
standard-setting processes best accomplish the goal of 
providing capital markets with reliable and decision-useful 
information. We need to reenergize our standard-setting 
processes and the commitment of capital market participants to 
support a fully effective, independent standard setter. We 
should provide independent funding for the FASB, funding that 
does not depend on contributions from constituents that have a 
stake in the outcome of the process.
    We also need a more independent governance process to 
replace the current foundation board. The leadership for these 
changes should come from visionaries of unquestioned 
objectivity and demonstrated commitment to the goals of 
financial reporting and the public interest.
    At the outset, I suggested that the common interest in 
preserving and maintaining healthy capital markets far 
outweighs the concerns or goals of any particular group or 
special interest. We have to keep focusing on that fundamental 
tenet. Only a continuing commitment to that goal will guarantee 
that we continue to enjoy the best capital markets in the 
world.
    Thank you again for inviting me. I would be pleased to 
respond to your questions.
    Senator Levin. Thank you very much, Mr. Sutton. Mr. 
Campbell.

 TESTIMONY OF ROBERT H. CAMPBELL,\1\ FORMER CHAIRMAN AND CHIEF 
 EXECUTIVE OFFICER, SUNOCO, INC., AND CURRENT BOARD MEMBER OF 
  HERSHEY FOODS, CIGNA, AND PEW CHARITABLE TRUSTS, CORONADO, 
                           CALIFORNIA

    Mr. Campbell. Mr. Chairman, ladies and gentlemen, I, too, 
appreciate the opportunity to testify before this Subcommittee 
today. This Subcommittee's deliberations are extremely 
important, in my opinion, because it is a national imperative 
that we begin the process of restoring the confidence of 
investors in publicly-held companies.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Campbell with an attachment 
appears in the Appendix on page 195.
---------------------------------------------------------------------------
    For your information, my active business career has spanned 
a 40-year time period, from mid-1960 until June 2000. The 
entire career was spent with one company, the Sun Oil Company, 
or Sunoco, as it is known today, or its subsidiaries. In 1991, 
I was named President and CEO, and in 1992, Chairman of the 
Board, and I held the Chairman and CEO positions until I 
retired in June 2000.
    Before I begin, I need to make two points clear. First of 
all, any remarks that I make are my own personal belief and 
they do not necessarily reflect the beliefs of the corporations 
on whose boards I have served or am currently serving.
    And second, you need to understand that my knowledge of 
Enron and its Directors or Arthur Andersen and its partners is 
limited to what I have read in the print media or seen on 
television or heard today. I have no direct knowledge of what 
has taken place in those organizations.
    Now, in your letter of invitation to me, you asked that I 
comment on whether I thought the governance problems exposed in 
the Enron matter are unique or representative of most U.S. 
publicly-traded companies. My answer is that I certainly do not 
believe that the alleged behavior is representative of boards 
of directors in the United States today.
    In addition to Sunoco, I have been or am currently a 
Director of CoreStates Bank, before its acquisition, Hershey 
Foods, CIGNA, Pew Charitable Trusts, Rocky Mountain Institute, 
plus numerous civic and nonprofit boards. I have chaired audit 
committees. I have chaired the compensation committees. I have 
been on governance committees, finance committees, and 
executive committees, and during those 15 years, I have come to 
know probably more than 100 directors and can state from 
personal experience that the allegations that I have read in 
the print media and seen on television are not even remotely 
similar to the director experiences that I have had. 
Unfortunately, the general public seems to believe that Enron 
is typical, and I think that is terrible and it is part of the 
reason that I am here today.
    I believe the best way to explain the type of board 
governance that I am accustomed to is to cite some of the 
practices we instituted at Sunoco. The list of governance 
practices of that corporation spans four single-line typed 
pages, and you will be happy to know that I have absolutely no 
intention of reading them here this afternoon, but have instead 
submitted them as an attachment to my proposed remarks for your 
information.\1\
---------------------------------------------------------------------------
    \1\ The list of corporate governance standards appears at the end 
of Mr. Campbell's prepared statement in the Appendix on page 199.
---------------------------------------------------------------------------
    Senator Levin. Thank you.
    Mr. Campbell. In those remarks that I prepared and 
submitted for today's performance, I briefly outlined the 
company's practices in director independence, director 
compensation, and director election. I spoke of the company's 
approach to the code of ethics and to conflict of interest 
policies, the company's approach to CEO evaluation, director 
evaluation, and ``board-as-a-whole evaluation. And finally, I 
wrote of our experience in changing the independent auditors. 
Now, I am not going to take the time to read through those now, 
but I will be glad to answer any questions that you may have on 
my experience with those practices.
    You might be interested to know that Sunoco's approach to 
governance resulted in several instances of external 
recognition and culminated in that board of directors receiving 
the 1999 National Board Excellence Award from Spencer Stuart, 
the executive search firm, and from the Wharton School of 
Business at the University of Pennsylvania.
    Now, also in your letter of invitation to me, you asked if 
I might have any recommendations for new legislation or 
regulatory reforms. I will confess to you up front that my 
business career has conditioned me to seldom seek more 
legislation or regulation from government. However, I do 
believe that the current situation calls for strong action on 
the part of someone, and I would suggest four areas of focus.
    First, I believe there needs to be a more complete and 
understandable annual disclosure of the relationship between a 
director and the corporation. The typical corporate proxy today 
issued prior to an annual meeting and the election of the 
directors gives a very brief description of the director 
standing for election.
    I would like to see a much more complete description, on 
one page, of each director's relationship with that 
corporation, including not only the total compensation received 
in whatever form it takes, cash, stock, benefits, or perks, but 
also any consulting or employment contracts for them or their 
relatives, any business relationship between their company and 
the subject company. Are they a significant supplier or a 
customer? What are their financial holdings in the company they 
serve as director, stock, stock equivalents, options, bonds, 
other forms of debts, loans, etc.? I realize that some of this 
information is disclosed in other documents. However, bringing 
it all together annually in one place in an easily-read format 
and publishing it will help ensure complete disclosure of how 
independent your so-called independent directors really are.
    My second suggestion is that an annual meeting of outside 
directors, and with that I mean no CEO or other members of 
management present, be made mandatory, not just a voluntary 
good practice, and it be followed with an extensive feedback 
session to the CEO/chairman. I have instituted that on boards 
that I have been on and have found it to be of tremendous value 
to both the CEO and the outside or independent directors in 
surfacing issues early while they still can be dealt with 
constructively.
    Mr. Chairman, my experience is that you do not get in big 
trouble in one step. You get there in a series of small steps 
that progressively take you further and further away from 
acceptible behavior. It is the so-called slippery slope. That 
is why there has to be an extensive, no-holds-barred meeting of 
independent directors, regularly scheduled, at least annually, 
with no management present, because I believe in that 
discussion the best way to surface the issues that somehow just 
do not feel right in your gut as a director is to have that 
kind of discussion with your colleagues.
    Third, I believe that consideration should be given to 
limiting the years an outside auditor can serve a corporation. 
The need for a different set of eyes is currently recognized by 
the existing requirement that the partner in charge be rotated 
every 7 years. However, bringing in a new lead partner from the 
same firm to work with the existing team from that firm is 
inadequate, in my opinion. I am certain that this requirement 
would be seen as unnecessarily disruptive and expensive by most 
corporations today, but if an outside auditing firm knew that 
10 years from now, a competing auditing firm would be looking 
over and possibly commenting on their prior work, a whole new 
dynamic would be introduced in the current process.
    Fourth and finally, since good corporate governance is a 
constantly evolving process, it would be unwise to legislate or 
regulate with too much specificity. What is viewed as good 
practice this year may not be viewed as adequate in future 
years. Boards instead need to institute a continuous governance 
review process, and I believe it would be helpful if the 
following were required by regulators.
    One, corporations should be required to put their 
governance practices in writing and publish them annually in 
their proxy statements. In that manner, it would be clear to 
all shareholders how their corporation is being governed.
    And two, a board committee should be identified and held 
responsible for reviewing and updating a corporation's 
governance practices, similar to the way the audit and 
compensation committees currently have certain regulatory 
duties.
    One of Sunoco's current directors, Rosemarie Greco, 
recently published in the January 2002 edition of National 
Corporate Directors Monthly an excellent description of a 
process which a corporation can use to institutionalize the 
best governance practices.\1\ I strongly recommend you review 
her offering because it is only when the governance process is 
institutionalized that it will continue to be effective over 
time.
---------------------------------------------------------------------------
    \1\ See Exhibit No. 86 which appears in the Appendix on page 751.
---------------------------------------------------------------------------
    Again, I thank you for the invitation to be here today and 
I will be happy to try to answer any of your questions.
    Senator Levin. Thank you all for your testimony and again 
for your patience.
    Enron kept about 50 percent of its assets off its balance 
sheet, about $27 billion out of $60 billion. It also had off-
the-books guarantees that were not reported, major business 
ventures that were not disclosed to investors. Now, we have 
been told there is no way to know whether the extent of Enron's 
off-the-balance sheet activities is typical or unusual for U.S. 
companies since the activities are, by definition, off the 
books and not reported.
    How can investors rely on financial statements if a large 
percentage of a company's business activities, assets, and 
liabilities are off the balance sheet, and what accounting 
rules need to be changed, with as much specificity as you are 
willing to give us, to acquire that disclosure which you 
referred to of material off-the-balance sheet activities, 
assets, and liabilities? Maybe, Mr. Sutton, we could start with 
you.
    Mr. Sutton. Let me offer several--make a few points about 
that.
    Senator Levin. If I could interrupt for one second, I think 
you said that the current rules on these SPEs are nonsense, so 
that is the reason I am starting with you. You have made a very 
pungent point about it.
    Mr. Sutton. Let me offer a few comments to help explain why 
I said that and what the state of the art is. Off-balance-sheet 
financing is one of the most valuable commodities on Wall 
Street because markets tend--or companies perceive that markets 
tend--to value companies that have less debt on their balance 
sheet. Rating agencies also will do it. The markets, some 
segments of the markets--tend to view asset-light companies as 
being more attractive investment opportunities. That creates an 
incentive of companies to get debt off the balance sheet, to 
get asset-light, so that they will be looked at and perceived 
favorably by the market.
    What has happened in the standard-setting process, and when 
I said we need to understand what the drivers are to understand 
the problem, instead of trying to develop standards that say, 
``what is the economic substance,'' ``who has the risks and the 
benefits of these assets and liabilities,'' ``who really owns 
them,'' the standard setting has lapsed into a process of 
``what rule do I have to comply with in order to get an asset 
or a liability off the balance sheet? ''
    So that is the state of the art, and it creates a 
situation, as in Enron, where you can have substantial 
obligations, that you or I might recognize as liabilities, off 
the balance sheet, substantial assets that you or I might say, 
``well, Enron really has the risks and benefits of that asset 
off the balance sheet,'' and it is accomplished through 
accounting standards that, in part, were not complied with, and 
in part that were complied with but that were poorly designed.
    Senator Levin. Before I turn to either of the other two 
witnesses, would you have specific changes that you would 
propose? Because you are moving from a legalistic to an 
equitable or to a judgmental or, not intuitive, but something 
which is a little less legalistic in its description to 
something which is more, hey, who really has these risks and 
benefits. How do you put that in a rule?
    Mr. Sutton. You have to first articulate conceptually what 
you are trying to accomplish, and then you develop rules to the 
extent that you need to develop rules to accomplish that.
    Senator Levin. Has somebody done that?
    Mr. Sutton. Well, the FASB's charge is to do that, and I 
mentioned their mission. That is what they are charged to do. 
In my personal opinion, they have not done a very good job of 
that, particularly in recent years.
    Senator Levin. Has anybody outside of the FASB made an 
effort to design rules which would achieve that objective?
    Mr. Sutton. Well, there is a new body in place now, 
relatively new, and that is the International Accounting 
Standards Board, that has pledged, in a sense, to take a more 
principled approach. I would not suggest in any way that 
whatever approach you take is going to be easy because it is 
like any set of rules that you try to develop. There are always 
going to be those who want to game the rules. But my view is 
that you ought to develop your rules following the concepts 
that you believe are best--that give the best and fairest 
presentation, the most transparency, and develop those rules as 
best you can.
    Senator Levin. For instance, has any academic tried to 
design rules which would correct for the inadequacy of the 
current rules relative to these transactions? Is there anyone 
who has done some writing in this area in academia?
    Mr. Sutton. There is lots of writing, but there is no magic 
bullet. The magic bullet in this is having an independent 
process of highly qualified people who are clearly focused on a 
mission that is in support of what you expect financial 
reporting to be in the marketplace.
    Senator Levin. You have said you would give FASB an 
independent source of financing. You testified to that today. 
Would you also have them appointed by a different body than is 
currently the case? Would you, for instance, have the SEC 
appoint any members of that board?
    Mr. Sutton. Chairman Levin, I have not thought in detail 
about how the structure--my view is, we needed to get some 
really capable visionary thinkers who have thought about this 
issue a lot and try to develop a consensus view. It may be 
worthwhile that some part of the board would be appointed by 
the SEC. It may be--it would seem logical to me--that you would 
want a certain segment of those members who would clearly be, 
and clearly be recognized as, advocates of or sensitive to the 
needs of the investing community.
    Senator Levin. Would you give that board additional powers, 
including subpoena powers? Would you give them also powers to 
enforce rules, in other words, separate that enforcement 
function?
    Mr. Sutton. What I had in mind that we were just talking 
about would be a body that would set accounting standards. 
There is a need for--the other accounting leg of this stool is 
the accounting profession, and I would see clearly a need to 
have another body, an independent body, oversee the auditing 
profession, and that body should have appropriate investigative 
powers, in my mind.
    Senator Levin. Mr. Elson, do you have any comments on the 
subject that I have been talking to Mr. Sutton about?
    Mr. Elson. I am a transparency person. I have always been a 
big fan of transparency, and I think the more that is disclosed 
about those sorts of things, the better. But vis-a-vis the 
technical aspects of on or off-balance-sheet financing, I am a 
little out of my field.
    Senator Levin. OK. Mr. Campbell, did you have any comment 
on that?
    Mr. Campbell. No. I would agree with Mr. Sutton and Mr. 
Elson. Prior to the Enron disclosures, I had never seen that 
amount, or proportion of a company's assets off-balance-sheet. 
Sometimes it is appropriate to have some items off-balance-
sheet, where you have an investment and no control, but never 
to that extent. As to how you would correct that situation, I 
cannot offer expertise in that, sir.
    Senator Levin. Mr. Elson, have you ever seen or know of a 
company that had that many off-balance-sheet entries?
    Mr. Elson. Not that I am aware of. On the other hand, 
again, my expertise really is not in that area. It was quite a 
bit to obviously have it off the balance sheet, and obviously 
not disclosed.
    Senator Levin. Mr. Sutton.
    Mr. Sutton. Well, many companies have off-balance-sheet 
assets and liabilities, but my experience is that Enron is at 
the top of the scale in terms of the extent of it. Airlines, 
for example, would frequently have much or most of their 
aircraft off-balance-sheet through leasing arrangements and 
that would not be regarded as unusual.
    Senator Levin. Thank you. The Enron Board approved Andersen 
serving not only as the outside auditor for the company, but 
also for a couple of years as the company's internal auditor at 
the same time and paid Andersen also tens of millions of 
dollars for consulting work. The end result was that Andersen 
was essentially auditing its own work.
    Now, the Board members defended this practice by saying 
that it gave them great comfort to know that Andersen was 
involved in all of Enron's transactions from the very 
beginning. They called it an integrated audit. What is your 
reaction to this idea of an integrated audit, in which the same 
auditor is the company's consultant, internal auditor, and 
external auditor? Mr. Sutton.
    Mr. Sutton. Well, in my experience, the term or label 
``integrated audit'' generally referred to a proposal to 
combine the internal and external auditing, and so a couple of 
things I would say about that. One is that it became quite 
fashionable in the late 1990's. The second is, I think it is a 
terrible idea because it does create the situation where, on 
the one hand, the auditor is performing a management function, 
i.e., internal auditing, and on the other hand is called upon 
to examine the financial statements.
    The other aspect of it that you mentioned is consulting in 
the area of transaction structures. That clearly, in my mind, 
raises questions about auditing your own work, and it depends 
really on what was done and to what extent it was done. If the 
auditors were the creative thinkers, if you will, in terms of 
how do we accomplish a transaction to accomplish a certain 
accounting result, to me, that is over the line. On the other 
hand, you would expect a company that is getting ready to enter 
into a transaction to ask its auditor, do you have any concerns 
about this? So there is a line there that, in my mind, once you 
cross that, you have a problem.
    Senator Levin. OK. Mr. Elson.
    Mr. Elson. I guess my answer would be in two parts. First, 
vis-a-vis the internal/external audit role, I have always 
believed that they should be separated for a very important 
reason. Those are--they are watchdogs, effectively. An external 
audit, internal audit are watchdogs of the company's financial 
processes in some way, shape, or form, and anytime you 
concentrate two watchdogs in the same watchdog, you have 
effectively reduced the effectiveness by half, if you have one 
less person there.
    Second, the fashion typically today has been to outsource 
internal audit. Traditionally, it was always internal. That is 
why they called it internal audit. But there is some merit, a 
great deal of merit, to outsourcing the internal audit 
function. And when you do so, I have always felt that there is 
some benefit to separating the internal auditor from the 
external auditor because you have two different large firms in 
the company effectively, even if informally, checking each 
other's work.
    The presence of a different internal auditor or the 
presence of a different external auditor, I think acts as a bit 
of a check on the work of either party and that is a pretty--I 
think it is healthy competition. That is the first point. I 
have never, frankly, felt that the two should be combined, and 
when it was, I think 2 or 3 years ago, the SEC effectively 
allowed that, I was rather critical of that at the time and I 
still am.
    Second, vis-a-vis the consulting, the auditor consulting, 
when auditors do consulting, a lot of consulting, the question 
is, does it compromise the effectiveness of the audit itself? 
Can you trace the presence of heavy consulting work with a 
busted audit?
    I have not been made aware of any empirical data to date 
that demonstrates emphatically the correlation between 
consulting, heavy consulting, and a busted audit. On the other 
hand, from an optical standpoint, a shareholder trust 
standpoint, putting it in the same party is problematic. It 
looks problematic. It looks as though, even though one can 
argue there is a Chinese wall, if you will, between the two 
functions, there is certainly the public perception of 
potential corruption of the audit process by the desire to seek 
consulting fees, and because of that public concern, I think it 
is something that I would limit.
    Unless you have a really good reason to do it, I do not 
think I would have the external auditor doing consulting work, 
or if they did consulting work, it ought to be very limited in 
nature and in scope and only used when, frankly, you can 
demonstrate that there is nobody else out there who can deliver 
an effective service. In other words, you do not want the 
consulting to affect the audit function and you do not want 
those, certainly the members of the public who are relying on 
the financial statements, to be concerned that those financial 
statements are not reliable because someone was doing both.
    Senator Levin. I think it is more than optics. Enron paid 
Andersen $5 million in the year 2000 to help structure LJM, and 
so it would seem to me it would be pretty hard for Andersen's 
auditors to say that the Andersen consultants got it wrong. I 
think that is the problem. I think it is a real problem, but 
let me ask Mr. Campbell, do you have any comment on that issue?
    Mr. Campbell. I think what was described today as the 
integrated audit is a horrible practice and I do not think it 
should be permitted.
    As far as consulting is concerned, I think when you end up 
with an auditing firm which, first of all, bids a proposal on 
the basis of conducting the external audit and then finds over 
a period of time that the non-audit fees continue to grow, in 
my mind, that does nothing but continue to reduce, not only 
optically but in reality, the independence of those so-called 
independent auditors. There is no question, at least recently, 
there have been pressures to begin to bring that down because 
people are focusing on that issue, but it sure can reduce 
independence, in my opinion.
    Senator Levin. Thank you. This is for you, Mr. Elson. You 
have written extensively on the importance of independence and 
you have testified to that this afternoon. Exhibit 43,\1\ if 
you have a book near there, identifies some of the economic 
ties between Enron and some of the outside Directors. The Board 
members told us that none of these dollar commitments was large 
enough to have impaired anyone's judgment or to sway any 
Director from being honest and skeptical with Enron management. 
You can perhaps scan the amount of dollars that are involved in 
those items. I am just wondering what your response is to that.
---------------------------------------------------------------------------
    \1\ See Exhibit No. 43 which appears in the Appendix on page 375.
---------------------------------------------------------------------------
    Mr. Elson. I think that if amounts for consulting services 
were not meaningful, then the individuals would not have taken 
them to begin with. Obviously, they had some meaning or they 
would not have accepted compensation for services rendered.
    The problem with taking separate fees, other than one's 
directors' fees, is I think it creates a linkage between you 
and management. By taking those fees, you are effectively 
becoming part of the management team, and I think there is a 
real problem with exercising independent judgment vis-a-vis 
what the management has done if you feel part of that team, 
either through participating in the development of management 
plans and strategies or the fear that if one objects too 
strenuously, those consulting fees may disappear. That, at 
least, has been the generic critique of those.
    I think, too, the problem with them is that by taking them 
and becoming, again, part of management, in a sense, you are 
much more reticent to be critical of management, not because 
you are no longer ``independent,'' but because of the 
relationship you have with management, that financial 
management. You may take what they are telling you at face 
value without being more probative because of the relationship 
that this thing creates.
    That is why the National Association of Corporate Directors 
in their commission report on director compensation said that 
if a director's role is as a consultant, hire the director as a 
consultant. If the director's role is to be a director, hire 
them as a director. You cannot blend the two. The argument that 
we could not retain someone's consulting services unless we 
made them a director, I have never felt was a very good 
argument.
    Again, the problem here is either these fees may have 
affected their view of what was being presented to them--again, 
you have to get each of them here to testify as to whether they 
did or they did not, but certainly in the part of those within 
the organization, the presence of those relationships might 
have made the perception of those directors within the 
organization viewed as less than independent. If that were the 
case, it would be tougher for someone within the organization, 
if they objected to what was going on in management, to 
approach any of these directors because they were of the view 
that, gee, they are just part of management anyway, and that, I 
think, is the real issue here.
    In other words, independence, as I said, is a two-way 
street, and I think the presence of these relationships is not 
a good idea, and that is why the National Association of 
Corporate Directors has strenuously recommended against these 
sorts of relationships.
    Senator Levin. This is for Mr. Sutton. You were Chief 
Accountant at the SEC, and by the way, did either of you have 
any comment on that last answer before I go on?
    Mr. Campbell. Well, I would just like to point out, I think 
the consulting arrangements with directors is absolutely 
incorrect, absolutely wrong. When you accept the directorship 
of a corporation and join the board, you are paid a fee, 
obviously in the case of Enron, substantial. In my mind, your 
thoughts, your processes, and what have you, your support and 
you are there available to the management at any time they want 
to contact you. And if, in fact, they need you on an ongoing 
consulting basis, then you should not be a director of that 
corporation.
    Senator Levin. Thank you. Mr. Sutton, now a question about 
the Raptor transactions. You were Chief Accountant, as I 
indicated, for the SEC and I would like you, if you would, to 
turn to Exhibit 28b,\1\ which is the initial Raptor 
presentation to the Board.
---------------------------------------------------------------------------
    \1\ See Exhibit No. 28b which appears in the Appendix on page 306.
---------------------------------------------------------------------------
    Mr. Sutton. Exhibit 28----
    Senator Levin. Exhibit 28b. The first page states that the 
purpose of the Raptors is to establish a risk management 
program in order to hedge the profit and loss volatility of 
Enron investments. The last page of this Exhibit 28b lists the 
risks that are associated with the Raptors. The first one is 
``accounting scrutiny.'' The second one is ``substantial 
decline in the price of Enron stock,'' what would happen. I am 
just wondering, what is your reaction to the presentation, in 
particular, the focus on hedging profit and loss volatility as 
opposed to hedging real economic risk?
    Mr. Sutton. Let me couch my response in these terms. 
Obviously, we do not know what was said at the meeting, and so 
I am going--what I give you is more of a reaction based upon my 
experience and insights.
    The first thing that comes to mind is when I see the slide 
labeled ``Purpose,'' it says establish a risk management 
program in order to hedge the profit and loss volatility of 
Enron investments. The first thing that comes to my mind is, 
``what does that mean,'' quite honestly. What does it mean to 
say, ``hedge profit and loss volatility? ''
    I had a similar question in listening to the testimony this 
morning. The term ``hedge,'' in my mind and experience, refers 
to transactions that are used to transfer or alter the risk of 
the company, so that there is another party out there that you 
exchange risks with, or you transfer risk to, that has an 
economic impact. And this says ``hedge profit and loss 
volatility,'' and I do not know what that means. That is my 
first reaction.
    What was the other page?
    Senator Levin. On the last page, you have got a risk list. 
One is accounting scrutiny. The other one is a substantial 
decline in the price of Enron stock. In other words, in 
addition to trying to protect itself against paper losses here, 
not as you testified, in effect, against real economic risks, 
but against paper losses, Enron used the Raptors to hedge 
against the decline in value of certain assets, but that was 
backed by Enron shares rather than independent third-party 
equity. It was Enron shares which were put up for that hedge, 
so they are hedging against themselves, are they not, or am I 
missing something here?
    Mr. Sutton. Well, all I can interpret from the comment is 
that the risk is from a substantial decline in Enron stock, and 
then the consequences of that are identified ``as the program 
terminates early.'' I assume that would be at a loss of some 
kind, and it increases the credit risk, so I assume that is 
Enron's credit risk, but----
    Senator Levin. The risk here, as I understood it, is since 
they put up their stock as the collateral, that if, in fact, 
that stock declined in price and was called upon, then they 
would have to put up a huge amount of their own stock. So they 
were not transferring risk, they were using their own stock to 
cushion against the risk of their own assets, their own stock 
holdings going down in value. Is that a true hedge?
    Mr. Sutton. That is not what I would understand a hedge to 
be, and that would also explain, perhaps, the first slide, by 
what they meant by ``hedge profit and loss volatility.''
    Senator Levin. OK. So it is just not clear to you as to 
what----
    Mr. Sutton. It is not clear to me.
    Senator Levin. Does anyone else have a thought on this?
    [No response.]
    All right. What does a board do if they are told that high-
risk accounting practices are being used? What is their 
fiduciary duty? We will start with you, Mr. Campbell.
    Mr. Campbell. Well, first of all, I cannot imagine going 
into an audit committee room and sitting down with the auditors 
and being told that we are using high-risk auditing practices 
and just agreeing with that. I mean, my experience has been 
people would want to know, why are they high risk? How did we 
get there? Why are we using them? And what are you going to do 
to get us out of it?
    Going forward with that kind of an environment, it is what 
I said before. It is a little bit like this whole thing turns 
into one step after another. You are going down a slippery 
slope on this thing, and at what point in time do you yell, 
enough is enough?
    But having an audit committee confronted with the fact that 
you have high-risk auditing practices and then having the 
chairman take that to the board and report it to the board and 
have that board agree that is OK, it is unlike any board that I 
have ever seen or heard of.
    Senator Levin. Mr. Elson.
    Mr. Elson. My first reaction to that would have been an 
extremely queasy stomach. That is a giant red flag, being told 
that you are--for a large publicly traded company, the seventh 
largest public traded company in the country--taking serious 
accounting risks is a pretty scary thing, just to say the very 
least.
    As a director, under the duty of care, you are being 
compared to what would the reasonable director say under 
similar circumstances, and the reasonable person would 
certainly say, why are we doing this? Why is this risky? Is 
this very smart to be doing this? What is considered 
conservative treatment? Why are we not in conservative 
treatment? And how do we get ourselves out of risky treatment, 
because, obviously, risky treatment has risks. That is why they 
call it risky treatment. What are the risks before us and how 
do we restore conservative treatment?
    At that point, you want to ask an awful lot of questions, 
and if you do not get the right answers, then you need to bring 
in a third party.
    Senator Levin. OK, thank you. Mr. Sutton.
    Mr. Sutton. I would just support those comments and say 
that from the accountant's perspective, you would also expect 
some kind of dialogue to arise between the audit committee and 
the independent auditors.
    Senator Levin. One of the issues which came up had to do 
with the compensation of the Board of Directors. Exhibit 35a\1\ 
is the total compensation of Enron Board members for fiscal 
year 2000. As you can see, including stock option value which 
probably represented three-quarters of it, roughly, it was in 
the range of $320,000 to $340,000, with the cash compensation 
being roughly from $70,000 to $90,000 and the balance in stock 
option value. This is a chart from their own sources.
---------------------------------------------------------------------------
    \1\ See Exhibit No. 35a which appears in the Appendix on page 348.
---------------------------------------------------------------------------
    Mr. Elson, you particularly made reference to stock options 
as being an expectancy where you do not lose as much on the 
downside, as you put it. Even though it turned out these 
options were not worth much in many cases when they held those 
options, when they were granted those options, there was a hope 
and an expectation that they would be worth a tremendous amount 
of money. This is what the estimated compensation was, a 
quarter-million dollars in the value of those options just in 
that 1 year.
    Doesn't that create pressure on the Board, basically, to go 
along with management or with these far-out, pushing the 
envelope accounting practices which make the financial 
statement look good and then push up stock prices, because 
their options go up in value? Now, their answer today, frankly, 
was not particularly satisfactory to me because what they said 
is, well, they turned out not to have any value or they lost 
money. That is not the issue I am talking about, whether they 
ended up losing the value of those options.
    What I am talking about is when they were granted those 
options, those options had real value and great potential value 
if the financial statement continued to look good, and one way 
to make that financial statement look good was with all these 
transactions that we have heard about.
    So does that fact not create some subtle, maybe not-so-
subtle, pressure on Board members to go along with the idea 
that it is the stock price which is the end-all and be-all, and 
that is so affected by the bottom line on a financial 
statement, then to go along with accounting standards which are 
pushing the envelope? That is my question, Mr. Elson.
    Mr. Elson. Sure. Let me answer in two parts. Part one, 
share amount. This is pretty good work here. This is a lot of 
compensation for being a director. You know the old joke, good 
work if you can get it. Three or four hundred thousand dollars 
a year is quite a bit for directors. That is quite a bit over 
the norm in companies of this size and scale. These 
compensation amounts would put the Directors of Enron certainly 
in the top quartile, or probably higher, vis-a-vis similar 
compensated U.S. directors.
    The problem with paying a director too much is an obvious 
one. If management, as in many companies--I am going to speak 
generically--controls the proxy process and the compensation 
scheme for the directors becomes too high, the fear is the 
director, because of the income stream the director is 
receiving from serving as director becomes so great, that to 
object to a management proposal and potentially court non-
renomination would not be in the director's best financial 
interest, and that is where compensation that is too out-of-
the-ballpark, if you will, for a director is problematic.
    These numbers undoubtedly placed this Board pretty far up 
there in the grand compensation scheme. Again, most of the 
value was in stock options, but their cash compensation was not 
small. It was pretty high, too. But clearly, the real value was 
in the options.
    So the second part of your question, does giving director 
options make a director more likely to take risks, if you will, 
financial risks, again, that is a two-part answer. I have never 
been a big fan of options. I think they are useful in certain 
circumstances. I think they are problematic because, 
traditionally, you cannot charge--you do not charge them 
against earnings. I think there is a bill floating around that, 
Senator Levin, you have been involved in that would require 
that there be some charge for granting options. I think when 
you cannot charge them against earnings, people are a lot freer 
with them than they would ordinarily be if they had to give 
restricted stock and they give more of them.
    The problem with an option is it has a geometric upside to 
it, if you work out the math, even based on mediocre 
performance of a company, and that, to me, is problematic. 
There is no real downside. The worst you can lose is the 
expectancy of great riches. There is no real sting on the down. 
They simply become worthless. Stock is a different incentive. 
If a stock falls, you actually have a wealth decline on the 
part of the holder of the stock. In this case, they got a lot 
of options, and again, the weakness of options, I think, of 
potential on the upside rather than on the down, certainly 
comes out here.
    But your question on does it make you more risky, only if--
--
    Senator Levin. Not quite.
    Mr. Elson. Yes?
    Senator Levin. Does it make it more likely that you would 
go along with pushing the envelope on accounting standards 
which have the effect of raising that stock price and then 
raising your option amount? Does that make it more likely or 
not?
    Mr. Elson. Only if you can sell the stock underlying the 
option relatively quickly. I mean, I have always believed that 
directors should not sell their stock while they serve on the 
board unless there is a very unusual circumstance. In other 
words, as long as you are a director, you have got to hold 
company stock. You cannot be in the business of selling stock.
    I think the ability to sell your stock or exercise an 
option short-term and sell it is problematic because there is 
the risk of the informational disadvantage, if you will. I know 
that bad things are going to happen. I push the stock price up. 
I sell, and then when the bad things happen, I am long gone and 
I have taken my profit. That is the risk.
    That really does not have to do with the option, the grant 
of the option. It really has to do with the ability to sell the 
option or exercise the option and sell the stock quickly, or if 
you give a director restricted stock, the ability for the 
director to sell that restricted stock while that director 
serves on the board.
    I think that is the real issue. It has got to be, and my 
remarks earlier had to do with long-term equity holdings. If 
you give someone stock and give them the ability to sell it 
quickly, then you have got a real problem. One, you have got 
that insider trading potential. And two, it is not very good to 
the public for a director to say, gee, I think I have found a 
better place for my money and it is not on the company on whose 
board I sit. It does not look very good. For that reason, I 
think the stock holdings have to be long-term.
    So in the short, I do not think the fact that they gave 
options was problematic here vis-a-vis the question you asked, 
if, in fact, you required that the stock underlying the options 
be held long-term.
    Senator Levin. So that would cure whatever problem there is 
that I have described----
    Mr. Elson. Yes. I just do not like options.
    Senator Levin [continuing]. That prohibition. But there is 
no such prohibition, is there?
    Mr. Elson. No, sir.
    Senator Levin. OK. Now, Mr. Campbell, do you have any 
comment on that?
    Mr. Campbell. I agree that these numbers are high, and, in 
fact, if you look at it, this is for year 2000, so if you have 
multiple years of compensation and multiple stock options, then 
they could be multiples of this. I have never felt that options 
for directors are appropriate for the exact reasons that Mr. 
Elson said.
    And I would just point out to the Subcommittee that as you 
are thinking about where to go from here, part of problem, I am 
going to lay at the feet of compensation consults, which 
invariably come in and tell board compensation committees, if 
you want to compensate either your directors or your senior 
executives and your CEO at the 75th percentile range or level, 
then this is what you need to do. And then they go on to the 
next company and give the same talk. That becomes a one-way 
ratchet and it has occurred here over the past decade that is 
off the top of the scale, and I think we really need to get 
back to thinking about how do we determine what is really 
competitive out there.
    Senator Levin. It is a very important issue and it is 
essential that dialogue occur, one way or another.
    Mr. Sutton, do you have any comment on this question?
    Mr. Sutton. I do not disagree with anything that either of 
them has said. I would just add a thought that while I am not 
an expert in ethics, I have done considerable study in 
connection with the work at the Commission on Auditor 
Independence Issues. I would observe that whether it is 
selling, the pressures to sell non-auditing services, whether 
it is incentives by directors to enter into consulting 
arrangements, or whether it is what is perceived to be 
excessive compensation, those arrangements can create 
incentives that can interfere with otherwise expected 
independent behavior.
    Ethicists sometimes call that ``gray blindness,'' meaning 
that once you get so co-opted, you cannot tell the difference 
between black and white anymore, and there is that risk. Other 
incentives can give rise to it, but certainly financial 
incentives can.
    Senator Levin. You all have added a very important 
dimension to this hearing and to our investigation. The 
Congress really has a very heavy responsibility that we are 
addressing, but we are playing just a partial role in 
implementing and taking care of the problems. But your 
participation--your staying power is very much appreciated, and 
your very thoughtful written testimony, which will be made part 
of the record, and your comments in response to questions are 
very much appreciated.
    Mr. Elson, regards from Senator Carper. He had to go and 
preside this afternoon or else he would have been here to ask 
questions.
    Mr. Elson. Thank you.
    Senator Levin. I want to thank my staff for the enormous 
effort they put into going through all of these documents.
    We will stand adjourned. Thank you all.
    [Whereupon, at 4:55 p.m., the Subcommittee was adjourned.]
                            A P P E N D I X

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