[Senate Hearing 107-773]
[From the U.S. Government Publishing Office]
S. Hrg. 107-773
COLLAPSE OF ENRON
=======================================================================
HEARING
before the
COMMITTEE ON COMMERCE,
SCIENCE, AND TRANSPORTATION
UNITED STATES SENATE
ONE HUNDRED SEVENTH CONGRESS
SECOND SESSION
__________
FEBRUARY 12, 2002
__________
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SENATE COMMITTEE ON COMMERCE, SCIENCE, AND TRANSPORTATION
ONE HUNDRED SEVENTH CONGRESS
SECOND SESSION
ERNEST F. HOLLINGS, South Carolina, Chairman
DANIEL K. INOUYE, Hawaii JOHN McCAIN, Arizona
JOHN D. ROCKEFELLER IV, West TED STEVENS, Alaska
Virginia CONRAD BURNS, Montana
JOHN F. KERRY, Massachusetts TRENT LOTT, Mississippi
JOHN B. BREAUX, Louisiana KAY BAILEY HUTCHISON, Texas
BYRON L. DORGAN, North Dakota OLYMPIA J. SNOWE, Maine
RON WYDEN, Oregon SAM BROWNBACK, Kansas
MAX CLELAND, Georgia GORDON SMITH, Oregon
BARBARA BOXER, California PETER G. FITZGERALD, Illinois
JOHN EDWARDS, North Carolina JOHN ENSIGN, Nevada
JEAN CARNAHAN, Missouri GEORGE ALLEN, Virginia
BILL NELSON, Florida
Kevin D. Kayes, Democratic Staff Director
Moses Boyd, Democratic Chief Counsel
Jeanne Bumpus, Republican Staff Director and General Counsel
C O N T E N T S
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Page
Hearing held on February 12, 2002................................ 1
Statement of Senator Allen....................................... 23
Statement of Senator Boxer....................................... 15
Article from the San Jose Mercury News, dated February 10,
2002,
entitled, Enron Collapse Strongly Felt in California; From
Pensions to Energy Prices, Effect on Government Is Broad... 16
Statement of Senator Breaux...................................... 9
Statement of Senator Brownback................................... 20
Statement of Senator Burns....................................... 5
Prepared statement........................................... 6
Statement of Senator Carnahan.................................... 21
Statement of Senator Cleland..................................... 13
Statement of Senator Dorgan...................................... 2
Statement of Senator Ensign...................................... 22
Statement of Senator Fitzgerald.................................. 3
Statement of Senator Hollings.................................... 1
Article from The New York Times, dated January 13, 2002,
entitled, Enron's Collapse; Complex Web of Relationships in
Boom and Bust.............................................. 44
Statement of Senator Hutchison................................... 10
Statement of Senator Inouye...................................... 5
Prepared statement........................................... 5
Statement of Senator Kerry....................................... 7
Statement of Senator Lott........................................ 25
Statement of Senator McCain...................................... 1
Statement of Senator Nelson...................................... 23
Statement of Senator Smith....................................... 14
Statement of Senator Snowe....................................... 12
Statement of Senator Stevens..................................... 8
Statement of Senator Wyden....................................... 11
Witnesses
Lay, Kenneth L., Former Chairman and CEO, Enron.................. 25
Powers, Jr., William C., Member of the Enron Board of Directors
and
Chairman of the Special Investigation Committee................ 26
Prepared statement and executive summary..................... 29
Letter dated February 6, 2002, from William C. Powers, Jr. to
Joseph F. Berardino........................................ 69
THE COLLAPSE OF ENRON
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TUESDAY, FEBRUARY 12, 2002
U.S. Senate,
Committee on Commerce, Science, and Transportation,
Washington, DC.
The Committee met, pursuant to notice, at 9:30 a.m. in room
SR-253, Russell Senate Office Building, Hon. Ernest F.
Hollings, Chairman of the Committee, presiding.
OPENING STATEMENT OF HON. ERNEST F. HOLLINGS,
U.S. SENATOR FROM SOUTH CAROLINA
The Chairman. The Committee will come to order. For the
record, this Committee on Commerce conducted its first Enron
hearing on December 18, and shortly after that hearing, Mr.
Kenneth Lay, the Chairman, committed to testifying on Monday,
February 4. However, on Sunday night, February 3, Mr. Lay's
attorneys notified the Committee that Mr. Lay would not appear,
and so we canceled that hearing, and the Committee voted
unanimously on February 5 to authorize the Chairman of the
Committee to issue a subpoena to compel the appearance of Mr.
Lay before the Commerce Committee on February 12. The Committee
was notified on Sunday night, February 10, that Mr. Lay would
appear before the Committee but would assert his Fifth
Amendment right against self-incrimination.
We have a vote in about an hour's time. I know the Members
are anxious to make their opening statements, but the request
is to please make them as brief as possible, because if we went
to all 23 Members it would be about an hour and 40 minutes, and
I would like to get through the opening statements and swear
the witness prior to that vote.
I am going to yield from side to side here. My Ranking
Member, Senator McCain.
STATEMENT OF HON. JOHN McCAIN,
U.S. SENATOR FROM ARIZONA
Senator McCain. Thank you, Senator Hollings, and I will
make a very brief statement.
In a speech given by Mr. Kenneth Lay on April 6, 1999, at a
conference sponsored by the Center for Business Ethics
entitled, ``Corporate Governance: Ethics Across the Board,''
Mr. Lay described the qualities he demanded in a Board member.
I quote: ``It is no accident that we put strength of character
first. Like any successful company we must have directors who
start with what is right, who do not have hidden agendas, and
who strive to make judgments about what is best for the
company, and not about what is best for themselves or some
other constituency.''
He went on to say that, ``Once such a board is in place,
what does a CEO--and in particular, this CEO--expect from these
principled, wise, and experienced directors? Again, our
corporate governance guidelines are simple and straightforward.
The responsibility of our board--a responsibility which I
expect them to fulfill--is to ensure legal and ethical conduct
by the company and by everyone in the company. . . .''
As Enron's Chairman of the Board, and CEO since 1986, Mr.
Lay was expected to live up to these principles and ensure that
others in his company did the same. According to the Powers
report however, senior management at Enron made a mockery of
Mr. Lay's words and turned the principles he described on their
head.
The Powers report indicates that for years Enron engaged in
financial games, hiding massive debt from its shareholders and
misrepresenting its economic conditions to the public and to
many Enron employees. Yet, after years of business shenanigans,
and pointed warnings that Enron was going to ``implode in a
wave of accounting scandals,'' the New York Times has reported
that during an online chat with Enron employees, as late as
September 2001, Mr. Lay called Enron's stock, ``an incredible
bargain,'' and said that, ``the third quarter is looking
great.''
Mr. Lay, I regret that you have chosen not to explain to
this Committee, to the American public, and to your former
employees how you, and others in senior management and on the
Board of Enron apparently failed so completely to fulfill your
responsibilities.
Thank you, Mr. Chairman.
The Chairman. Thank you. Senator Dorgan.
STATEMENT OF HON. BYRON L. DORGAN,
U.S. SENATOR FROM NORTH DAKOTA
Senator Dorgan. Mr. Chairman, Mr. Lay's attorneys have told
us that he will invoke his Fifth Amendment right against self-
incrimination, and he certainly has that right. I must say, I
am disappointed by that decision. I think Mr. Lay has a story
to tell. We and the American people would like to hear that
story. The bankruptcy of this corporation is not a garden-
variety business failure. It is a bankruptcy framed by very
serious questions about the behavior of officers, directors,
and the accounting firm that audited the corporation's books.
It appeared to me that we have seen a corporation here
inside the records that I have seen consistently challenging
and bending the rules, manipulating financial information to
hide debts, and booking profits that did not exist.
Some eight weeks ago, Ms. Janice Farmer sat in our witness
chair. She was an Enron employee, and she told us that the
bankruptcy demolished her life-savings. On behalf of Ms. Farmer
and thousands of other Enron employees who lost their
retirement accounts and investors who lost their savings, we
have an obligation to ask how is it that 29 Enron executives
and directors at the top were able to earn over $1 billion in
stock sales from 1999 through mid-2001, while people at the
bottom ended up losing everything.
We know that the Enron Corporation created many secret
partnerships and subsidiaries off the books. They were kept off
the books, despite the fact they burdened the company with
additional debt. According to the Board of Directors' report,
some of the partnerships were reporting income they didn't earn
and incurring debt for the Enron Corporation that was never
reported.
Although it appears we will not hear from Mr. Lay today, we
will receive testimony from a second panelist, Mr. William
Powers, the head of the special investigative committee that
was established by the Enron Corporation's Board of Directors.
Mr. Powers is Dean of the University of Texas Law School. He is
here today to discuss with the Committee the findings from his
examination of a few of the now more infamous transactions
between Enron and third party entities that eventually led to
this corporation's collapse, just one of which, Mr. Chairman,
the report documented and documented a number, of course.
Mr. Fastow, the CFO, invested $25,000 of his own money and
60 days later took $4\1/2\ million from the corporation. This
is a publicly traded corporation. That money belongs to the
American stockholders. They had trust in the executives, trust
in the corporation, trust in the accounting firm, and that
trust was broken in this case. We need to put the pieces
together to find out what has happened, and the hearing process
that we will begin in this Subcommittee is an attempt to do
that, Mr. Chairman.
The Chairman. Thank you. Senator Fitzgerald.
STATEMENT OF HON. PETER G. FITZGERALD,
U.S. SENATOR FROM ILLINOIS
Senator Fitzgerald. Thank you, Mr. Chairman.
Mr. Chairman, during the past several weeks I have spent a
significant amount of time going over the rubble that is Enron.
I was disappointed to learn that you, Mr. Lay, have no
intention of testifying this morning, because I have lots of
questions that I think are important to ask you. And you know
what, Mr. Lay, I thought that after any role you might have
played in bankrupting a $100-billion-a-year company,
devastating the retirement savings of thousands of your
employees, spreading fear through millions of Americans
concerned about their investment, and calling into question the
very integrity of our capital markets, I thought that you might
think it was important to answer those questions, too, but
apparently you do not. Apparently you do not think it is the
least you can do.
As part of the investigation underway by my subcommittee,
the Consumer Affairs Subcommittee, I have looked at literally
hundreds of documents, and I have heard or read the testimony
of many others, of the many others who have already testified
before this Committee or other congressional committees. There
is a great deal of information out there. You cannot help but
get angry once you begin to put together the pieces of the
puzzle.
You know what I have seen, Mr. Lay? I have seen
ridiculously complex transactions that boil down to simple
games. For example, over and over again, Enron would transfer
questionable assets to partnerships, and the partnerships would
pay Enron inflated amounts for the questionable assets, and
where did the partnerships get the money they paid to Enron?
The partnerships raised their money from lenders or investors
who often were relying on some form of guarantee or credit
support from Enron itself, sometimes in the form of Enron's own
stock.
Enron seems to have installed insiders as general partners
of these partnerships, perhaps because honest outsiders would
not have consented to pay Enron such inflated amounts for such
questionable transactions. Even though Enron was really just
indirectly borrowing money, it nevertheless often appears to
have reported the transactions on its income statements in a
way that encouraged the false perception that these essentially
borrowed proceeds were recurring earnings, all the while, of
course, keeping the ballooning debt off its own balance sheet
and parked precariously on the partnerships' books.
As earlier debts came due, Enron would indirectly borrow
even more money, both to pay off maturing obligations and to
book even more fictitious income. This game kept driving
Enron's earnings per share and stock price higher and higher
and making senior managers whose personal portfolios were
packed full of Enron stock richer and richer. This game worked
until some investors and some reporters began to ask questions.
At that point, new investors and new lenders became more
difficult to attract, and the pyramid began to collapse.
So what have I concluded? Mr. Lay, I have concluded that
you are perhaps the most accomplished confidence man since
Charles Ponzi. I would say you were a carnival barker, except
that would not be fair to carnival barkers. A carnie will at
least tell you up front that he's running a shell game. You,
Mr. Lay, were running what purported to be the seventh largest
corporation in America. What is incredible to me is how long
you kept it going, and how almost nobody called you on it.
There were a couple that could not be fooled, though,
weren't there? Why is it, Mr. Lay, that occasionally some
people will take a stand? Sharon Watkins took a stand. Sharon
Watkins, a good life, a nice house, a great kid. She had
everything to lose when she essentially told you that your
company was a sham. She had every reason to walk away, but she
stood and spoke, and you, Mr. Lay, you have every reason to
stand and speak, but you will walk away. You will raise your
right hand, you will take the Fifth, and then you will walk out
that door, and when you walk out that door, it will be a
stunning coda to the collapse of Enron.
Mr. Chairman, I would encourage my fellow Committee Members
not to allow the absence of Mr. Lay's testimony to be an
impediment in our continuing search for the explanations and
ramifications of this significant event.
Thank you.
The Chairman. Senator Inouye.
STATEMENT OF HON. DANIEL K. INOUYE,
U.S. SENATOR FROM HAWAII
Senator Inouye. Thank you, Mr. Chairman.
The circumstances surrounding the collapse of Enron may
never be fully uncovered. However, we can clearly see that the
implosion of this once-towering giant has left tens of
thousands of investors with enormous financial losses, a large
number of employees without jobs, and pension savings
eliminated.
In the first grips of this crisis, passions are running
high, even in this Committee, and it is only natural that
persons and organizations of all persuasions are pressing for
an immediate adoption of hastily drafted legislation. As we
grapple with this sad chapter in our nation's history, we need
to restore public confidence in our financial reporting and
market systems, and I am certain that the Chairman will use his
leadership wisely to guide us toward a rational response.
Mr. Chairman, I ask that my full statement be made a part
of the record.
[The prepared statement of Senator Inouye follows:]
Prepared Statement of Hon. Daniel K. Inouye,
U.S. Senator from Hawaii
Mr. Chairman and Members of the Committee:
There can be no doubt the full circumstances surrounding the
collapse of the Enron Corporation have yet to be uncovered, and may
never be fully uncovered. However, at present, we can clearly see that
the implosion of this once towering giant has left tens of thousands of
investors with enormous financial losses, a large number of Enron
employees without jobs, and their entire pension savings eliminated. We
can also see that the plummeting value of Enron stock and its resulting
ripple in the financial markets has had devastating effects on other
pension systems as well. Even Hawaii is not immune to such effects. In
the weeks and months to come, I fear we may learn of further impacts
from the Enron collapse.
The viability and confidence of our financial market systems are
dependent upon accurate and reliable information. Like everyone, I am
most disturbed by the allegations of reckless investment practices,
false reporting and illegal accounting practices, use of off-the-book
balance sheets to conceal debts and liabilities and inflation of
corporate earnings. Even savvy investors failed to detect Enron's
financial troubles. Obviously, the collapse speaks to the possible
failures in oversight of our financial market systems.
In the first grips of this crisis, passions are running high, and
it is only natural that persons and organizations of all persuasions
are pressing for the immediate adoption of hastily-drafted proposals.
While there can be no doubt that corrective measures to restore public
confidence in our financial markets will be necessary, I believe
strongly that such measures must be the product of careful study and
thoughtful analysis. I am confident that the Chairman will use his
leadership wisely to guide us toward a rational response.
As we grapple with this sad chapter in our nation's history, we
need to restore the public confidence in our financial reporting and
market systems.
The Chairman. Senator Burns.
STATEMENT OF HON. CONRAD BURNS,
U.S. SENATOR FROM MONTANA
Senator Burns. Thank you, Mr. Chairman. I want to thank my
Committee Members as we try to unravel the Enron disaster. I
have a complete statement that I will put in the record this
morning. I do want to read a paragraph.
Congress is tasked with the responsibility to the American
people. We are not here to judge or convict, but we are here to
assure the American people and the American investors in
circumstances such as this the folks that are at the helm do
the right thing, and that is to protect the right people, in
other words, the transparency in the market. We need protection
from people who have little control over a situation, and I
consider this an extremely important task as our nation's
economy and also our basic principles of our economic systems
have been jeopardized by this collapse.
We have an opportunity here today to listen from a man who
was there at the building of this company, had a lot to do with
its leadership, in fact everything to do with its leadership,
and it was on his watch that the wreck occurred, so much
knowledge that he would have to help us either determine what
should be done and what should not be done, as there are many
people that one could point their finger. There is enough blame
to go around, from banks and partners who financed the debt,
pushed them into a gray area of accounting procedures, to
Arthur Andersen for not reporting the financial situation
correctly, or Mr. Lay and the Board of Directors for allowing
it, or stock analysts for overvaluing its worth.
That does not change a thing. We can write out a laundry
list of people to blame, and Enron's employees will not
suddenly have a solid future, and private investors will not
magically see their stock gain in value, and retirees will not
see their 401(k) plans suddenly emerge.
What we have to do is glean our way through the information
here and fulfill our responsibility to the American people, to
the employees and the investors, and to ensure that our system
works.
I ask unanimous consent my entire statement be made a part
of the record.
The Chairman. It will be included.
[The prepared statement of Senator Burns follows:]
Prepared Statement of Hon. Conrad Burns,
U.S. Senator from Montana
Thank you Mr. Chairman for holding this hearing. We have all
witnessed a business failure of the largest magnitude in our history.
What we have been told, and what we have learned through the press and
information we have gathered has prepared us for this important
hearing. We have before us today, the one person that was-in-large-
part, the builder of Enron Corp. But, it was also on his same watch
that the immense collapse occurred. Not many times in our history have
we had a single witness who represents such a large proportion of
institutional knowledge as we do today in Mr. Lay.
We welcome Mr. Lay here today. I am hopeful that the information
offered today can further enlighten this Committee and the American
people of the events that led to this collapse. While I respect Mr.
Lay's decision to invoke his Constitutional prerogative, I am
disappointed in the fact that Mr. Lay intends to utilize his
Constitutional right not to answer our questions.
I am hopeful he can fill in the blanks and connect the dots. I am
hopeful we can answer to the 4 W's. Not only What, but When it was
apparent that there were these internal problems, Why management acted
the way they did, and Who were the principals. I believe we should be
here to listen and be prepared to act based on the information
collected and on the facts as they are known.
Congress is tasked with a responsibility to the American people. We
are not here to judge or convict but we are here to ensure the American
people that when a circumstance such as this, the folks that are at the
helm do the right thing and that is protect those who have little to
control the situation or have the ability to protect themselves. I
consider this an extremely important task as our nation's economy and
the basic principles of capitalism have been jeopardized by the Enron
collapse.
Not disregarding any illegal action or crime, I encourage Mr. Lay
and other current and former Enron associates to assist us in our
effort to re-instill public confidence in their investments. This is
not about Enron executives, this is about the nation's economy.
I don't think it is out of line to ask the important question of
what now? What are Enron's plans for break-up and their actions and
plans for former and present employees who lost so much.
We have a business crises on our hands that has overriding
implications on the corporate world and its relationship to the
investing world and to the loyal employees whose talents were, in large
part, used to build such an enterprise.
From what we have heard from employees and investors over the past
few weeks, many conclusions can be drawn. One overwhelming conclusion
is that the leadership of a huge company failed to protect their own
employees and on the surface, only thought about themselves. This, my
fellow Committee Members is not the sign of good leadership. If there
is an overwhelming dedication from the ranks of the employees with a
high degree of loyalty, then there should be no less degree of
dedication and loyalty expected from their leadership.
As I believe we will hear from Mr. Powers later today, there is no
shortage of people to blame. Whether we blame the banks and partners
who financed Enron's debt and pushed them to use gray-area accounting
procedures, or Arthur Andersen for not reporting the financial
situation correctly, or Mr. Lay and the board of directors for allowing
it, or stock analysts for overvaluing Enron's worth, that doesn't
change anything. We can write out a laundry list of people to blame and
Enron's employees won't suddenly have a solid future. Private investors
won't magically see their stock gain value. Retirees' 401(k) plans
won't suddenly re-appear.
One thing we can do is untangle the events that led to this point.
Then we must find out which rules were bent or broken along the way,
and the rules that should have been in place but did not exist. Once
these important questions have been answered, we can address policy
concerns at the SEC, FASB and other agencies with jurisdiction or
ultimately Congress. In short, Congress WILL take action to make sure
this collapse and the ramification can be prevented when such a
circumstance happens again.
Neither Congress nor the federal government will ever be able to
keep companies from going bankrupt. Pending national security issues,
that is not the role of Congress. However, one thing the federal
government should guarantee is that investors know the truth. Our
entire financial system relies on the transparency of a publicly traded
company's value. With Enron, it is becoming clear that was not the
case.
Finally, I believe that it is important to remember we cannot
legislate morality, that is something we expect of all Americans
regardless of whether they are powerful corporate executives or blue
collar workers working to put food on their family's table. From the
perspective of American morality there should be no difference. To
think otherwise is a crime of humanity.
The Chairman. Senator Kerry.
STATEMENT OF HON. JOHN F. KERRY,
U.S. SENATOR FROM MASSACHUSETTS
Senator Kerry. Mr. Chairman, thank you very much.
There are so many aspects of the Enron situation that it is
hard to narrow it down, but I am going to try and focus on a
couple of things very quickly, but let me just say that
obviously, Mr. Lay, the anger here is palpable. Companies do
come and go, as I think the Vice President said at some point,
and people understand that when they invest, they take risks.
But, this clearly is so far beyond any normal market
undertaking, or opportunity for any investor, and the
implications for people who trusted in the system, trusted the
nature of disclosure, the nature of audits and so forth.
As Senator Burns stated, the implications for them are
deep, and obviously lives have been ruined, many lives at the
top and at the bottom. That is a tragedy in and of itself, but
it raises critical questions for all of us. The stewardship of
a major public corporation, as Senator McCain said, the words
he quoted of you, is a major trust. It is a public trust in its
own way, and we in this country spend a lot of time trying to
convince other nations of the virtue of transparency,
accountability. We try to sell that through the framework of
our trade regime of WTO. We try to spread capitalism around the
world for its virtues, and here is an example of abuse that
runs deep, not just within Enron itself, but further than that.
I think it is safe to say that no Member of this Committee
believes that Arthur Andersen invented this method of
accounting. These accounting errors send shivers through the
stock market and elsewhere in this country, as people
contemplate what may be behind it.
I just want to direct my colleagues to one particular
component of this that I have been harping on for a number of
years, because as we fight a war on terrorism, and as we talk
about holding other systems accountable so we can follow the
flow of money, all of us in this Congress allowed to stand for
too long a system that undermines our capacity to do that, and
that is offshore subsidiaries and tax havens.
There is a fine line between tax avoidance and tax evasion.
As we all know, shelters have been legal in certain structure
when they do legitimate business, but countless companies--and
Enron took this to the heights unparalleled--go way beyond any
concept of legitimacy, and so you have Exxon-Mobil with 140
offshore subsidiaries, Wal-Mart with 12, General Motors 316,
Ford 73, General Electric 24, IBM 89, AT&T 36, and Verizon 21.
I would respectfully suggest to my colleagues that all of
those might bear some analysis, but Enron had 2,832--in Aruba,
Barbados, Bermuda, Virgin Islands, Caymans, Turks and Caicos,
Bahamas, Barbados, Bermuda--just on it goes, 2,832 entities in
which they were allowed for years to hide profits, losses, move
the entire accountability and transparency of a company so that
they could turn around and say to the American citizen, not
only did we not pay taxes, but Uncle Sam owes us over $250
million.
Now, that is the law, and it bears looking at, and it bears
changing. Shame on us for allowing it to stand, but more shame
on them for not understanding the virtues of real
accountability, real transparency, real business, and real
responsibility to the American people, and I regret very deeply
we are all reduced to these opening statements, which have
their own sense of futility, because questions will not be
answered, because the truth will not be forthcoming today, and
there is a statement of its own in that fact.
Thank you, Mr. Chairman.
The Chairman. Thank you. Senator Stevens.
STATEMENT OF HON. TED STEVENS,
U.S. SENATOR FROM ALASKA
Senator Stevens. Mr. Chairman, I remain concerned, as you
and I were last week, that five or six committees are involved
and have jurisdiction over these events, and I remain convinced
also we must have a select committee to investigate into this
situation.
In my State, the teacher's fund, the State's permanent
retirement fund suffered substantial loss, and I do believe
that there has to be some way to convince the public that we
are committed to honesty and integrity in our investments
process, and to assure, as Senator Kerry says, their
transparency, full disclosure, but that is going to take a long
time, and it is not going to get anywhere if we have five or
six committees all asking Mr. Lay and others to come forward
and have a Fifth Amendment taken before each committee.
I do believe we need a select committee. I would welcome
seeing that our Chairman and Ranking Member of the Subcommittee
being named the head of that committee, but in any event, just
think Banking, Finance, Judiciary, this Committee, there are so
many committees that are going to be involved here. Our duty is
to try to make sure that this situation does not occur again,
and to make certain that the private sector understands that we
are going to be the watch dogs of the process to prevent it
from happening again if it is at all possible, and so I would
urge you to pursue again, as I will today at noon with the
leaders, the concept of a select committee.
Thank you very much.
The Chairman. Well, I agree with you, Senator. It is
heartening to see that the Intelligence Committees on both the
House and the Senate side now have combined in order to bring
order out of chaos with respect to our doubts of intelligence
causing 9/11. I would hope we could get one. I hope somebody
else, of course, would be the chairman, because it is the
principal responsibility of the Banking Securities and Finance
Committees here. That is what has really occurred.
Senator Breaux.
STATEMENT OF HON. JOHN B. BREAUX,
U.S. SENATOR FROM LOUISIANA
Senator Breaux. Thank you, Mr. Chairman.
I am disappointed also that Mr. Lay is not going to be
testifying. I do not think anybody in Congress or probably in
Washington or anywhere else really thought that he was going to
testify. If I was his attorney, I would certainly be advising
him to take the Fifth Amendment, which is what he is going to
do this morning, based upon the advice of counsel.
I share some of the comments I think that Senator Kerry
made, and the question is, is this the tip of the iceberg? I
mean, did Enron invent this process, did Arthur Andersen invent
this process, or is this, in fact, a process that is being used
far too often by a number of publicly traded companies in this
country, and so I think we have an obligation to look at Enron,
we have an obligation to look at other companies that may also
be engaged in some of the practices. I doubt whether Enron was
the first to invent this process.
The second question that I really think needs to be
answered, and that is that is it possible that these types of
transactions--over 2,800 subsidiaries, special purpose entities
or partnerships that in effect were off the books in being able
to hide the debts and liabilities--based upon accounting
practices, or based upon the law, the federal law in many
cases, whether, in fact, these were legal transactions.
I for the life of me cannot imagine the law firms that are
involved in this looking at these transactions and concluding
that they were all illegal and then telling the companies to go
forth and do it again. I bet they were probably saying yes,
these things are legal under the current law, and they should
not be. I mean, if they are, then it is our obligation to look
at the law and make the changes necessary to make sure that
this does not happen again in the future. It should not be
legal if, in fact, it is. I am not sure whether it is or not.
We should find that out, and then make recommendations on the
law.
A final point is that accounting services that are doing
audit practices clearly should not, cannot, must not in the
future be engaged and also involving themselves with internal
audits of a company, or preparing balance sheets for the
company if, in fact, they are in charge of auditing the
company.
There has to be a clear separation. The confidence of the
capitalistic system in publicly traded companies in this
country are truly at stake. If we cannot rely on outside
auditors making statements about the condition of a publicly
traded company, then, in fact, the whole system of how we do
business in this country is at stake, and so there are a lot of
things we need to investigate, and I applaud the Chairman for
his work in this matter.
The Chairman. Thank you. Senator Hutchison.
STATEMENT OF HON. KAY BAILEY HUTCHISON,
U.S. SENATOR FROM TEXAS
Senator Hutchison. Thank you, Mr. Chairman.
Mr. Chairman, I think everyone has acknowledged that Mr.
Lay is going to take the Fifth Amendment today. This is not a
criminal investigation. That is your right to do, but there are
legitimate questions that Congress needs to have the answers
to, and those are the questions that will keep from happening
what happened at Enron, and I would just ask Mr. Lay to
consider talking about laws that need to be changed, whether it
is regarding accounting procedures--I think we are now seeing
the ripple in the stock market. Every company that comes
forward with an accounting practice that seems out of the
ordinary is suffering for it, so what are the accounting
processes that are out of the ordinary that are OK, which ones
are not OK, how can we fix the accounting standards so that our
stock market remains strong and the confidence of consumers
remains strong?
I have introduced a pension reform bill. Others on this
Committee and in other parts of Congress also have introduced
pension reform bills. I would like to know what we need to do
in the way of information to protect employees' 401(k)'s. These
are legitimate questions for Congress to ask, and I would like
to ask Mr. Lay if he would consider answering them, because our
job is going to be to try to protect a company from getting out
of control, but it is not a criminal investigation, and I think
Congress needs to ask these questions. We do need answers.
I think we need to stabilize the stock market so there is a
confidence here, and I would just also like to know what the
CEO of a company could do, what should one do when they see the
clear evidence? We do not know when you knew that something was
wrong, but clearly, when there was a free fall in the stock, at
some point the head of this company knew that it was cratering.
What can a CEO do in that instance when it is in free fall to
protect employees, to protect stockholders?
I think these are legitimate questions, and I would like
for Mr. Lay to try, rather than just taking the Fifth, as it is
his right to do, look for the answers that he can give that do
not have a criminal implication but would be helpful in giving
Congress the information it needs to not overreact and not
underreact, but do the right thing for the stockholders and the
employees of this company and America.
Thank you, Mr. Chairman.
The Chairman. Senator Wyden.
STATEMENT OF HON. RON WYDEN,
U.S. SENATOR FROM OREGON
Senator Wyden. Thank you very much, Mr. Chairman.
Mr. Chairman, over the last couple of weeks, as this
Committee and others requested the appearance of Mr. Lay and
other top Enron executives, many Americans have been asking,
why would these Enron executives testify? What do they have to
gain by testifying? I strongly support the constitutional
protections afforded Mr. Lay and all witnesses, but
respectfully submit that the questions should not be, what do
the Enron executives have to gain by testifying, but, rather,
it is what they owe the American people at this point.
Certainly, my constituents at home in Oregon who have had
their 401(k)'s go from $900,000 to $100,000 in value, their
first preference is to try to put Humpty Dumpty back together
again. They know that is not very probable, but now they want
an explanation, and at this point, like so many Americans, I am
just incredulous.
We are talking about accounting reforms, for example, now
in the U.S. Congress. I wrote a law, over the opposition of the
accounting profession requiring that accountants actively look
for fraud and bring it to the attention of government
regulators if they find any evidence that it is taking place.
As far as I can tell, that law was honored more in the breach
than in the observance in this case, but we will not know until
we get to the facts.
The fact of the matter is, it is just not possible to
determine why the Enron ship is at the bottom of the ocean
unless you hear from the captain, and I am especially troubled
that we will not hear today because of the headlines in this
morning's paper. The headlines this morning say, for the first
time that Mr. Lay had a direct role in approving one of the
most controversial of all the partnerships, the transactions
between Enron and LJM2, a coinvestment transaction, and for the
first time now there are reports that there is a direct link
between Mr. Lay and this particular partnership.
But it is not possible to piece this story together just by
these newspaper headlines, so I think that given the number of
Oregonians and the number of Americans that have been hurt, Mr.
Chairman and colleagues, we just have to go forward and use all
the investigative powers to find the facts, and I look forward
that we will continue to do that in a bipartisan way.
The Chairman. Very good.
Senator Snowe.
STATEMENT OF HON. OLYMPIA J. SNOWE,
U.S. SENATOR FROM MAINE
Senator Snowe. Thank you, Mr. Chairman.
I, too, join my colleagues in expressing regret that Mr.
Lay will not be testifying and, although he is invoking the
Fifth Amendment, that is his right to do so, his silence and
the silence of other top executives will not deter us in
pursuit of the truth, because as it has already been said, this
bankruptcy is not a typical bankruptcy. It is a fairly of truly
Homeric proportions. $67 billion in investor money has been
lost, including the $1 billion belonging to the hard-working,
trusting, loyal Enron employees, more than $1 billion.
Mr. Powers testified before Congress last week. In offering
his special investigative report, he said this tragedy was the
result of failures at many levels and by many people, a flawed
idea, self-enrichment by employees, inadequately designed
controls, poor implementation, inattentive oversight, simple
and not-so-simple accounting mistakes, and overreaching in a
culture that appears to have encouraged pushing the limit.
This is a scathing indictment, calling into question,
certainly the illegalities of Enron's actions and the failure
of top executives to put in place proper safeguards for
investors and employees. It certainly shows that corporate
corruption can have a profound influence in undermining the
public's confidence in the underpinnings of our economic
institutions, so the public has a very real and vested
interested in getting at the truth to know what laws may have
been broken and how we prevent such a catastrophe from
recurring in the future.
The chairman of the SEC said last week in testimony that
our federal security laws are predicated on the philosophy that
investors must be fully informed and confident that our markets
are free from fraudulent, deceptive, and manipulative conduct.
By every account that was not the culture, certainly not the
transparency that existed with respect to Enron's bookkeeping.
The special investigative report went on to say, there is a
systemic and pervasive attempt by Enron's management to
misrepresent the company's financial condition. In the report's
words, there is a fundamental fault of leadership and
management. Leadership and management began at the top with the
CEO, Ken Lay, and that is why we wanted to hear from you today,
Mr. Lay, because we wanted to get to the bottom of this by
starting with the man at the top, and it is all the more
critical, given the serious plausibility gap that exists
between the facts as we know them and the assertions that have
been made by you and other top executives that you were not
aware of the precarious financial structure of Enron with
respect to these partnerships, and that they created that
precariousness, and that you did not purposely misrepresent the
company's financial picture.
The fact is, you founded Enron. You set up its structure,
set the tone, you served as its chief executive officer for
more than 15 years, with the exception of 6 months when you did
not have your hand on the corporate helm, and even then you
served as Chairman of the Board, and you may well not have
known all of the details of all the financial transactions of
your company, but the minutes do show you were at a meeting in
November 1997 when the Chewco partnership was created and
approved, and that partnership served as a marked departure
from the previous practices of Enron and ultimately contributed
to two-thirds of Enron's overstatement of income since 1997.
It has been further reported that the Board waived the code
of ethics rules to allow CFO Fastow to participate in the LJM
partnerships with your recommendation, and at least with one of
the partnerships the Board assigned responsibility to you to
represent Enron in the event of any changes in the terms of the
transactions from those presented to the Board, and the report
found that there were significant changes for which there were
no actions by you and others.
When you factor in the sheer size of the LJM partnerships
alone, it accounted for at least 40 percent of Enron's
reportedly pre-tax income of $1.4 billion by the year 2000. I
am just underscoring the fact that it raises serious and
legitimate questions. How could you and others have not known
the potential and serious financial ramifications that these
partnerships posed to the company, that they obviously were
critical components of Enron? They obviously contributed great
wealth to those at the top.
3 years ago, a Germany company called off a merger because
it found your finances so troubling. Did that not send up a red
flag? And, of course, as the memo from vice president Watkins,
and obviously within a week of your assuming the CEO position
again in August, you met with Ms. Watkins because you obviously
found her heart-stopping memo foretelling the potential
implosion of your company, that her concerns were obviously
serious and credible, so you met with her, but yet you did not
follow her suggestions that Enron hire outside consultants and
lawyers to avoid a conflict of interest.
In fact, they were told not to second-guess the accounting
treatment of these partnerships, and so obviously we have a
number of questions. There are a number of implausibilities
that need to be addressed. You, as CEO, had the responsibility
of creating a culture of honesty, responsibility, integrity,
and trust, and obviously that did not happen in this instance,
and now it is the employees and investors who are bearing the
brunt of these massive schemes and failures.
Thank you, Mr. Chairman.
The Chairman. Senator Cleland.
STATEMENT OF HON. MAX CLELAND,
U.S. SENATOR FROM GEORGIA
Senator Cleland. Thank you, Mr. Chairman.
Mr. Lay, I truly regret your failure to appear before this
Committee last week and your decision not to answer any
questions today. It seems that the veil of secrecy that has
surrounded Enron decisions by top executives continues. As CEO
of Enron, you held your company out to the public as a
successful and wise investment behind this veil of secrecy. It
is high time for Enron to answer to the public for the
decisions you and others at Enron made that caused so many
people to lose so much.
This Committee is made up of publicly elected officials,
and I believe you have a responsibility to answer to us. The
real people you have the responsibility to answer to are the
American people, the hundreds of thousands of people who had
trust in your company and invested in it, particularly 262,000
Georgia teachers that lost $127 million when your company
collapsed.
Dan Scotto, the Wall Street analyst who was dismissed from
his job last year for writing an unflattering report, and now
we know a realistic report on Enron, drew the appropriate
comparison between Enron and the story of the emperor who
paraded through town with no clothes as everyone stared, afraid
to speak up. We now know Enron had no clothes.
On August 15 of last year, Enron Vice President Sharon
Watkins wrote a letter to you detailing questions about
accounting practices of concern, and saying, ``I am incredibly
nervous we will implode in a wave of accounting scandals.'' How
right she was.
On August 29, a middle manager who had been laid off by
Enron sent an e-mail to the Board of Directors saying the house
of cards are falling, you are potentially facing shareholder
lawsuits, employee lawsuits, heat from analysts and newspapers.
The market has lost overall confidence, and it is obvious why.
How prophetic these words were. These two employees were
willing to stand up and ask questions. Why weren't you and
Enron's Board of Directors?
Much has been made of the lock-out period employees faced
in October of last year when they were unable to transfer
rapidly declining shares of Enron's stock out of their 401(k)
plans. Even if the change of plan administrators that caused
the lock-out had previously been scheduled, why, in the light
of the announced third quarter losses and the pending FEC
investigation and knowing that Enron shares were plunging, was
the lock-out period not postponed? How did so many people fail
to say what was needed to be said, or ask what needed to be
asked?
I am looking forward to working with this Committee, as
well as the Governmental Affairs Committee on which I serve, as
we determine how a disaster like Enron can be prevented in the
future.
Thank you, Mr. Chairman.
The Chairman. Senator Smith.
STATEMENT OF HON. GORDON SMITH,
U.S. SENATOR FROM OREGON
Senator Smith. Thank you, Mr. Chairman. As I evaluate my
own feelings this morning, I have really one emotion, and that
is that of sorrow. I am sorry specifically for the people of
Enron and its affiliates, who have lost so much, and I am also
sorry for the cause that Enron championed, which was free
markets.
Oregon has a particular history with Enron, because of a
merger that was concluded in 1997 with Portland General
Electric. I first became acquainted with Enron as the president
of the Oregon State Senate. I wondered at the time of that
merger how this was going to work, because Enron's whole pitch
was deregulating electrical markets, and the Pacific Northwest
has a highly regulated market. Nevertheless, the merger was
concluded, and Enron's officials, its representatives made a
great pitch to deregulate our markets.
I had some trepidation about how this was all going to work
until about a year ago today, when the California market began
to experience incredible difficulties with its experience in
reregulating its markets. I do not call it deregulation. But I
joined with Senator Feinstein in doing something that was
frankly anathema to my own beliefs, and that is government
interference in markets, because I, prior to politics, believed
and practiced in business a free market profession, and it
seemed very clear to me that what was going on was not a free
market, but the right of a few to rig a market to the harm of
many people.
Now, it is one thing to hold back your product to drive up
a price if nobody needs your product. It is quite another
thing, and it is the very reason why we regulate our energy
markets, when the product is so fundamental to the ability of
people to have a job, to be warm in the winter, and to have
light at night, to have a system that a few are able to game to
the great harm of so many.
And so the sorrow I feel is that our confidence in free
markets is so shaken by this episode, but I say to people who
wonder about this, this is not capitalism. This is a conspiracy
that may be a crime. The courts will determine that, not this
Committee, but when I called, with Senator Feinstein, for FERC
intervention in the market, I did not have the evidence that I
have now. I had a strong suspicion.
It was not until I read in the New York Times an Enron
official quoted on November 10, 2001, that I fully comprehended
the Enron Corporation's philosophy. Said he, Enron's
achievement in creating, quote, regulatory black holes, close
quote, fits nicely with what he called the company's core
management philosophy, which was to be the first mover into a
market and make money in the initial chaos, and the lack of
transparency. That is what I feared when I called for price
caps. That is what I know today is what went wrong.
Others have observed, Mr. Chairman, that this has many
other facets. This story, we have to figure out how to make
sure that it is never repeated again, to the harm of consumers,
but specifically to all the people in Enron, in PGE, and to
those who purchased its stock, trusting that what they were
being told was the truth, but it was not, and our job is to see
that the truth is told in the future to all people who want to
have and should have confidence in our free market system.
The Chairman. Very good.
Senator Boxer.
STATEMENT OF HON. BARBARA BOXER,
U.S. SENATOR FROM CALIFORNIA
Senator Boxer. Thank you very much, Mr. Chairman. I want to
associate myself with the remarks of Senator Smith and, of
course, many of my colleagues as well, but in this I want to
build on what he said, because our states really got the brunt
of this, as well as, of course, the employees that were treated
so terribly, and the shareholders, so in my four or five
minutes I think I can tell you the story of California.
Mr. Lay, I know you are not going to talk to the Committee.
You have a right not to, but I have a chance to talk to you, so
that is what I am going to do, is talk to you.
I have very strong feelings about what Enron did to my
state. I would like to put in the record an article that just
ran in the San Jose Mercury News just two days ago, ``Enron
Collapse Strongly Felt in California.'' I would like to put
that in the record.
The Chairman. It will be included.
[The information referred to follows:]
Enron Collapse Strongly Felt in California; From Pensions to Energy
Prices, Effect on Government Is Broad
San Jose Mercury News, February 10, 2002
by Brandon Bailey and Chris O'Brien
As the nation's leading cheerleader for energy deregulation, Enron
played a major role in shaping the California power market that
imploded in crisis last year. Now the company's spectacular collapse is
threatening to cause statewide aftershocks for years to come.
The force of Enron's collapse is being felt throughout state
government, where it may affect attempts to renegotiate power
contracts, to probe allegations of market manipulation, and to obtain
refunds from energy companies accused of gouging.
The unfolding debacle has touched the state employees pension fund,
which invested in some dubious Enron partnerships, and has helped
derail expansion plans of Calpine that would have made the San Jose
company the largest energy generator in the world.
State officials hope that new Enron investigations will persuade
other power companies to lower prices, by giving the state leverage in
renegotiating $40 billion worth of electricity contracts that were
signed last year when prices were at their peak.
But some analysts warn that Enron's collapse could leave the state
vulnerable to a new cycle of power shortages, by making investors
reluctant to finance new power plants.
With revelations about Enron coming almost daily, the state's
energy market could find itself operating under a cloud of uncertainty
and turmoil for years to come.
``It's the fear factor people have about another Enron,'' said Gary
Ackerman of the Western Power Trading Forum, an industry association.
``Which company is going to be next?''
Enron was never a major producer of electricity in California.
Instead, the Houston-based company carved out a role in the middle. It
bought power from generators and resold it to other traders as well as
to California utilities and the agencies that assumed the role of
buying power when the market began to collapse last year.
Estimates of Enron's California market share vary, because most
trading information is never made public. Government agencies say they
are barred from releasing such data. But Enron claimed to be the West's
biggest energy trader, with about 20 percent of the market nationwide.
Enron denies gouging
Enron has denied charges of price gouging in California. But the
company made one agency's confidential ``top 10'' list of power
suppliers that together reaped $500 million in excess profits during
one key period of 2000.
What is clear is that Enron became an economic and political force
in California--a presence both in the clubby hallways of the state
Capitol and in the anonymous conference rooms where engineers and
number-crunchers hammered out the state's new power system.
In the early 1990s, Enron was among the first advocates of a
sweeping reorganization of California's wholesale energy market.
Joining forces with the state's manufacturers and large industrial
firms, which wanted lower prices, Enron and its allies succeeded in
getting California to adopt deregulation.
``Enron was the leader of the pack,'' said Eric Woychik, an
economic consultant who participated in the early discussions. ``They
were involved in every argument.''
Once deregulation was enacted in 1996, allowing customers to buy
electricity from other sources besides the state's utilities, Enron
moved quickly to establish itself in the wholesale market. At the
height of the power crisis, energy traders said, Enron's Web site
became the first thing they checked every morning to learn the day's
opening price.
Enron gave more than $680,000 in campaign contributions to
politicians of both major parties. It hired experts away from
California's utilities and state energy agencies to represent its
interests at regulatory hearings and in the Capitol. Its chairman,
Kenneth Lay, called federal regulators and Gov. Gray Davis to promote
his prescription for a free-market solution to the state's energy woes.
Critics today say the cumbersome market structure that California
adopted was difficult to monitor and easy for smart traders to abuse.
Enron officials denied that was their goal. In interviews last
year, they said they originally pushed for a different kind of market
structure.
Others were less forgiving.
``They didn't get everything they wanted, but they got enough to
make a bundle of money,'' said Michael Shames of the Utility Consumers
Action Network. ``They helped design a mechanism that they later
exploited.''
By the year 2000, wholesale energy prices had soared throughout
California, driving Pacific Gas & Electric Co. into bankruptcy and
forcing the state to take over the utilities' role of buying power for
California consumers.
Davis and other critics lumped Enron with power suppliers they
accused of profiteering.
But after months of investigations, state officials have been
frustrated in their attempts to clearly define Enron's role in
California and how it might have contributed to the crisis.
Since Enron didn't own much generating capacity, it had little
leverage to influence market prices, said Severin Borenstein, director
of the University of California's Energy Institute.
``To know what their role was, you have to know the whole web of
contracts they signed with producers and consumers,'' he said. ``And
those are not public.''
Consumer lawyer Michael Aguirre, after investigating the state's
energy market for more than a year, believes Enron was able to
influence prices through complex trading agreements. But unless
investigators force the disclosure of detailed trading records, he
said, ``We'll never know exactly'' what happened.
Records subpoenaed
California's attorney general and a state Senate investigative
committee both have issued subpoenas for Enron records, and both say
the company has dragged its feet.
While the threat of shortages has subsided, the state still is
saddled with $40 billion in long-term energy contracts it signed last
year. With prices much lower today, critics say the state panicked and
agreed to pay too much.
California officials have had little leverage to renegotiate those
deals. But last month, the chairman of the Federal Energy Regulatory
Commission promised a new inquiry into whether Enron used its market
power to drive up prices.
If that investigation shows market prices were artificially
inflated or unreasonable, officials say, it could be grounds for
invalidating other contracts. Steve Maviglio, a news officer for Davis,
said officials are hoping to convince other suppliers that ``it's in
everybody's best interests'' to renegotiate before the investigation is
completed.
Enron's collapse has also sent ripples through the state's business
and investment communities.
The University of California says it lost nearly $145 million on
its investments in Enron stock, while two of the state's public-
employee pension funds also lost nearly $90 million.
The respected California Public Employees Retirement fund, which
had been known as an advocate for stronger corporate governance, was
embarrassed by revelations that it had invested in one of the dubious
partnerships that Enron used to hide its debt from investors.
Calpine scales back
Close to home, San Jose-based Calpine has struggled to avoid being
tarred with comparisons to Enron. Its stock price has declined 68
percent since Enron declared bankruptcy. Last month, Calpine announced
that it would slow a plan to build dozens of new power plants in an
effort to soothe the nerves of investors.
The Enron bankruptcy also has created uncertainty for thousands of
businesses and institutions that get natural gas and electricity
directly from Enron, mostly under contracts they signed a few years ago
when Enron was trying to build a retail business.
But many of those customers oppose a plan by state regulators that
could force them back to their local utilities, which are charging
higher rates. That includes the University of California and California
State University systems, which use Enron power at most of their
campuses.
``So far, service is continuing undisturbed and the lights are
still on,'' said Charles McFadden, a University of California
information officer. He said the university expects to save about $12
million this year on a contract it negotiated with Enron in 1998.
Notes: Investigating Enron
What Enron Left Behind
How the collapse of Enron affects California now and down the road:
California continues to pay for electricity at prices far
above market rates, under long-term contracts signed when
prices peaked.
State officials hope to prod other power companies to lower
prices by giving the state leverage in renegotiating $40
billion worth of electricity contracts.
Enron's collapse could leave the state vulnerable to a new
cycle of power shortages, by making investors reluctant to
finance new power plants.
San Jose-based energy company Calpine has slowed down plans
to build dozens of new power plants.
University of California and state employees retirement
funds suffered multimillion-dollar losses through Enron
investments.
Senator Boxer. Mr. Lay, my state was bled dry by price-
gouging. Many pension plans went under--I should not say ``went
under,'' lost hundreds of millions of dollars, because there
was a limit on what they could put into Enron, I might say, a
limit that I support, in 401(k) plans as well, but what you did
to the employees was without conscience. That is how I feel.
I am going to tell this California story in three to four
minutes, really using the words of the principals more than
anything else. Originally, Enron said that California would
save billions of dollars by deregulation. This is a quote from
Jeffrey Skilling. Under deregulation, California, ``would save
about $8.9 billion per year,'' but that did not happen, Mr.
Chairman. As a result of the market manipulation during this
deregulation, California paid a huge amount for electricity and
let us look at this. We went from paying $7.4 billion for all
of our energy needs the next year to $27.1 billion. Look at
this, a 400 percent increase, or, I should say, 266 percent
increase in spending on electricity and a 4 percent increase in
demand, so while the Administration was saying, you use too
much electricity, we had gone up 4 percent, prices went up 266
percent.
Californians were begging for help. We were asking FERC to
help us. Right before you and Senator Feinstein did your bill,
Bob Filner and I did ours, the same bill, FERC, please impose
some type of cost-based pricing. Nothing really happened.
What was Enron saying during this crisis? Jeffrey
Skilling's quote: ``We are the good guys. We are on the side of
the angels.'' That is what he was saying in public, but what
Enron was really thinking was that California was being played
for a fool, and this is what he said at a conference, ``You
know what the difference is between the State of California and
the Titanic? At least when the Titanic went down, the lights
were on,'' so in public we are the good guys, in private making
jokes that our consumers were being destroyed.
It took a long time for FERC to help us, and we spent a
long time wondering why. It was almost a year. Well, the San
Francisco Chronicle helped us to understand it.
Mr. Lay, I wanted to ask you about this. You were at a
meeting with Dick Cheney, and this is what--you handed him a
memo, ``The Administration should reject any attempt to re-
regulate wholesale power markets by adopting price caps or
returning to archaic methods of determining the cost-base of
wholesale power. Price caps, even if imposed on a temporary
basis, will be detrimental to power markets and will discourage
private investment. . . .''
And lo and behold, Vice President Cheney said when asked by
the L.A. Times about price caps, ``I do not see that as a
possibility, and, in fact, any package you can wrap it in, any
fancy rhetoric you can prop it up with, it does not solve the
problem.'' So, clearly, we saw the Enron philosophy being
carried out here.
Now, I also want to know who Enron spoke to at FERC. In
January I wrote to FERC Commissioner Wood, asking him for a
listing of all meetings and phone calls between Enron
executives and FERC. I still have not received this
information. They keep saying it is coming. They will not give
me a date certain. I hope FERC does not stonewall us the way
Enron has and, if necessary, Mr. Chairman, I may call on you to
help get that information.
FERC finally acted. The business community in California
was at its wit's end, Mr. Chairman. We were going under. We
could not take these prices any more, and when FERC acted and
they imposed soft caps. The electricity price went down, and we
were doing just fine, and during that period of time. Mr. Lay,
I wanted to ask you about this, because we now know, because we
have seen it in your SEC filings, that during this time
California was keeping you afloat with these prices, you were
unloading your shares of stock during this period, millions and
millions and millions of dollars during this period, telling
your employees everything was great and they should buy. So Mr.
Lay, we got relief. There were no more blackouts.
There is just one more piece of the puzzle, and then I am
done. As soon as this happened, what did some of your allies
do? I wanted to ask you about this. There was a television
campaign to blame Governor Gray Davis for this crisis. They
called it ``gray-outs,'' for Gray Davis. They said, he is
pointing fingers and blaming others. Gray Davis says he is not
responsible for California's energy problem, but there are
gray-outs from Gray Davis, so this became political.
We wanted to find out who paid for those ads. We know who
headed up the group. We know who that is, but it was--I will
give you the name for the record, Mr. Scott Reed, but we do not
know who paid for the ads, and we have had to sue to find out,
and so I wanted to ask you if you knew anything about this ad
campaign which tried to take the blame away from where it
belongs and to make it political and put it onto the Governor,
but you know, we are going to find out, because there is a
lawsuit on it.
Secrecy, as Senator Cleland says, surrounds this whole
Enron disaster. We cannot even find out who paid for ads
blaming our Governor for this disaster. We cannot find out much
of anything, but whether it is one committee or six--and
frankly, Mr. Chairman, I do not care if it is one committee or
six, if it takes six to get to the bottom of it, I am all for
it. If it takes one, that is fine, too, but we will find out
the truth.
Thank you.
The Chairman. Senator Brownback.
STATEMENT OF HON. SAM BROWNBACK,
U.S. SENATOR FROM KANSAS
Senator Brownback. Thank you, Mr. Chairman.
It is important that oversight hearings like this happen so
we can get facts about what happened at Enron and why it
happened, and what we can do to make sure it does not happen
again. I was hopeful that we would be able to get that done
today, but it appears as if we are not going to hear many facts
in the testimony today, and I regret that, but I do hope it is
going to be coming out in the near future.
I am concerned particularly about several issues that I
want to raise here, and some of my colleagues have already
raised some of these already, but I want to reiterate them,
because I think they are things that are important for us as a
policy determination as we move forward.
I am particularly concerned about reform, particularly in
pension areas. 401(k)'s and other private sector retirement
savings plans have been an important and successful part of the
retirement strategy for many working Americans, and we owe it
to the American public to do what we can to strengthen employee
pensions and to make appropriate changes to the laws that are
necessary for us to strengthen those pension plans. I think
that is something that clearly the situation calls out for.
Nearly half of all Americans invested directly or
indirectly in the equity market's corporate financial
community, and the regulators need to restore the public's
trust in our capital markets, and continue to provide financial
leadership. More importantly, the thousands of Enron retirees
and employees whose savings were wiped out and the millions of
anxious investors in the United States and around the world
demand that leadership.
Now, the threat of new laws and regulations should not be
the sole motive here. Rather, the corporate community's own
desire to win back the public's confidence should be the
driving force. It has to demonstrate quickly and effectively in
their own initiative why the average investors should trust
them again with their money.
As it has already been reported by the special
investigative committee from Enron, the collapse of Enron is a
result of a management team and its Board, together with the
auditors, failing to do the right thing. I wish we could hear
more specifically about that today from the CEO of the company.
These include bad investments and new economy ventures, off-
balance-sheet entities being set up with creative accounting to
hide massive losses from such ventures--most of these ventures
were collateralized by Enron stock--and finally, the true
financial picture being hidden from the investment community
through obscure reporting.
Actions like these led to the collapse of confidence in
reporting and integrity in the management. No company, however
strong its business model, can survive that kind of
catastrophe, those failures in internal controls. The corporate
community should take some immediate steps in several areas.
First, I call on corporate boards to strengthen the
requirements for financial experts on audit committees. Audit
committees need to be proactive and engaged, and willing to
challenge management and the auditors. We should also review
various proposals for reform of the Financial Accounting
Standards Board. There are going to be some accounting issues
we need to look at as well.
Mr. Chairman, I appreciate you holding this hearing, and
Mr. Lay, I know you can feel a palpable sense of
disappointment, anger that a number of us have heard from our
constituents who have lost millions of dollars in this. They
want answers. We want answers. We were hopeful we were going to
get some of those today so we could move forward with the
public policymaking process. I would hope at some point in time
we are going to get those.
Thank you.
The Chairman. Very good. Senator Carnahan.
STATEMENT OF HON. JEAN CARNAHAN,
U.S. SENATOR FROM MISSOURI
Senator Carnahan. Thank you, Mr. Chairman. The reason the
scandal is so offensive to most of us is that Enron's conduct
violated the most basic of moral principles, principles that
all of us tried to instill in our children--honesty, integrity,
trust, fair play, and personal responsibility. These are the
core values for most American values, and the foundation on
which our nation is built. When these core values are
shattered, America is weakened.
Any institution without moral bearings is like a ship
without a rudder. In light of recent events, idealistic young
people once drawn to a career in business or finance might well
have reason to reconsider. Enron has given pause to investors
wondering where to place their savings for safe and reasonable
return.
Mr. Lay, we are all stunned and confused by Enron's
behavior, and especially by your unwillingness to come clean
with the American people. We want to know how one of the
nation's largest corporations under your watch evaporated in a
matter of months. We want to know, or have an explanation for
why the man who was at the helm of the ship allowed it to sink.
Like passengers aboard the Titanic, thousands were blissfully
unaware that hidden below the waterline lurked a danger over
which they had no control.
Surely you have some explanation for this unparalleled
corporate tragedy and erosion of moral values, but all we have
heard is the one explanation offered by Mr. Skilling. He told
Congress that he was unaware of the true condition of Enron,
that he was unfamiliar with the financial schemes being used to
hide the company's losses and to mask its debts, but I find
ignorance a difficult defense. You and the top executives at
Enron were paid enormous sums of money presumably because of
your financial and management expertise. It was your job to
understand what the company was doing. It was your job to
approve or disapprove of its course. Your failure has
disheartened employees and investors alike.
My heart goes out to the thousands of loyal Enron workers
who lost not only their jobs but their life savings. They
trusted you, and you told them that they should invest in Enron
stock, and they trusted you when you told them to hold onto
those investments. Enron's so-called aggressive accounting
practices not only produced four years of false financial
statements, it created a legacy of lost confidence.
Fortunately, America's premier businesses, both small and
large, do not look at what they can get away with through the
use of cavalier accounting methods. They want to do the right
thing for their employees and shareholders, and the right thing
for their communities and the nation.
Somehow, Enron got off course, and I am sorry you have
chosen not to help us uncover what went wrong, because in
failure there are always lessons to be learned, but despite
your unwillingness to speak, I will continue to ask the
question that I find so terribly haunting, a question that gets
to those core values that define us as Americans. I want to
know why no one in authority at Enron stood up and said, this
is wrong.
The Chairman. Thank you. Senator Ensign.
STATEMENT OF HON. JOHN ENSIGN,
U.S. SENATOR FROM NEVADA
Senator Ensign. Thank you, Mr. Chairman.
Mr. Chairman, I think that it is critical that the Congress
take its time to examine this important issue. Many times we
react because the emotions are high, and I think it is critical
that we take the time to find out all of the facts in this
case, because while we want to find out what happened here,
this is more of an academic process at this point, but also a
legal process for the Congress to find out what happened in an
effort to prevent this from happening again. It is critical
that we restore our confidence in our financial markets, our
public markets, in the accounting profession and in the legal
profession.
The public must know when they are investing in their
401(k) plans that they have the confidence in transparent,
reliable information. The facts presented on a financial
statement must be true. Right now, there are a lot of questions
in people's minds, that when they are reading these public
companies' financial statements, is anything else going on like
what happened at Enron?
Mr. Lay, last year at a shareholders meeting you said some
of your best and your brightest people could actually bring
your company down, because some of their best ideas--while they
had some of the best ideas--also could have some of the worst
ideas. You said, because of that, it was critical that you and
your management team watch closely and know what your employees
were doing. I think this is critical for any effective
management organization.
You also said at that time that in an interview I saw last
night on television, or it was during the shareholders'
meeting, you talked about your corporate culture, and how
integrity was one of the most important parts of your corporate
culture, and integrity had been slipping a bit.
Mr. Lay, I think that as a manager, as a CEO, you had an
incredible responsibility of such a large company to the
public, to your employees, to your customers, and as CEO, you
ultimately were responsible for Enron corporate culture,
because it is set at the top. As any CEO understands, and it is
I think deplorable, (1) that either you did not know what was
going on, or (2) that if you knew what was going on. How did
you think that you could get away with it?
It seems so obvious to anyone who looks at it that this was
a pyramid scheme that was doomed to fail. You cannot set up
false earnings and expect that not to be found out at some
point. At some point you have to pay the piper, as they say.
Senator Kerry mentioned earlier about how we want to, and
we try to go into emerging markets and talk about the wonderful
things that capitalism has done for our country, and we talk
about the rule of law, and transparency, and how it is so
important for people to be able to have confidence in how they
are investing in the free market system.
Mr. Lay, I believe you bear a great deal of responsibility
for shaping the confidence of us being able to export
capitalism, of us being able to tell our story, and it is going
to be a challenge for the Congress, regulators, everybody
involved, and the accounting profession, for us to bring that
confidence back to what it was.
I hope that you decide at some point to do the right thing.
You know, everybody makes mistakes in life, and I hope you
learn from your mistakes, and you are willing to try to make up
for those mistakes by taking full responsibility for what
happened, telling your story, and helping us prevent it from
happening in the future.
Thank you, Mr. Chairman.
The Chairman. Very good. Senator Nelson.
STATEMENT OF HON. BILL NELSON,
U.S. SENATOR FROM FLORIDA
Senator Nelson. Thank you, Mr. Chairman. It is a tough time
for you, Mr. Lay. It is a tough time for the nation. I wanted
to ask you just a quick question about the Florida retirement
system. It was one of 33 pension funds, and it is the one that
got hit the hardest.
When the stock was dropping after the SEC had announced its
investigation, the money manager for the Florida retirement
system, whose former manager still sits on the Enron Board,
that money manager was purchasing about 3 million shares as the
stock was dropping, which begs the question, what was the
communication, if any, from the company or those around the
company to the fourth largest pension fund in the country about
acquiring the stock, and why was that stock acquired?
Mr. Chairman, that is what I would ask. Thank you.
The Chairman. Very good. Senator Allen.
STATEMENT OF HON. GEORGE ALLEN,
U.S. SENATOR FROM VIRGINIA
Senator Allen. Thank you, Mr. Chairman.
While Mr. Lay most likely will be not answering any
questions today, exercising his Fifth Amendment rights, I will
not comment on the exercise of those rights, or that legal
judgment. I do share the sorrow and the aggravation and the
frustration and the sentiments of all of my colleagues who have
spoken before me. This Enron situation and the questions
surrounding this financial implosion have shaken the
credibility of the current system of security standards.
It has brought to bear questions as to the ethics, the
accuracy of accountants' reports, those of consultants,
lawyers, and corporate boards, as well as questioning even the
safeguards and the people who were supposed to ensure that
whether they were employees and retirees or other investors
have accurate information and all of this we see with the
evaporation of people's retirement savings, with the collapse
of the Enron stock.
Moreover, it has been said by Senator Smith, Senator Ensign
and others that what you have here, Mr. Lay, is something that
when I speak to Boy Scout groups and others--I do not know who
the quote is from, but here is where the sadness is. There is a
saying that when wealth is lost, a little bit is lost, when
health is lost, something significant is lost, but when
character is lost, all is lost.
Officers of publicly traded companies have a primary
responsibility and duty to serve honestly. The owners of the
company, the shareholders, clearly the chief officers of Enron
failed in their duty, and shamefully breached that trust. That
is a sad situation, and it is a responsibility you will bear,
maybe not in this Committee, but in your conscience and I know
when you go to sleep every night.
I am confident, though, Mr. Chairman, that through careful
examination of the facts and information that we learn from
these hearings, as well as what we read, we will be able to
come to proper safeguards for the future. The public and this
Congress will learn the truth, what went wrong, and work to
ensure that it does not occur again.
It is my hope that Mr. Lay will not escape liability,
whether that his criminal or civil, for any violations of law
or fiduciary duties. As I said when we had this subpoena vote,
let us be realistic and understand that all of these
allegations of whether there is destruction of evidence,
insider trading, fraud or other illegalities will be prosecuted
and published to the maximum extent of the law in the courts. I
and other members of this Committee need to be focused on
prevention in the future so that such fraud, such misleading
statements, such neglect or breach of fiduciary responsibility
as to the financial condition of a company does not occur in
the future.
Knowledge and information are very powerful tools that all
investors need to have. I am optimistic, Mr. Chairman--maybe at
this time when people are frustrated we should not be
optimistic, but I am optimistic that there is enough goodwill
and good effort here on a bipartisan basis in this Congress, as
well as those in other branches, to work together on retirement
security changes, put in proper safeguards, make sure that
employees who work hard and save for their future do not have
it swindled.
Mr. Lay, you will be held accountable in another venue. As
far as the Senate and the House and others, we will work
carefully and hopefully, also responsibly to prevent such
actions and activities from occurring in the future.
Thank you, Mr. Chairman.
The Chairman. Senator Lott.
STATEMENT OF HON. TRENT LOTT,
U.S. SENATOR FROM MISSISSIPPI
Senator Lott. Mr. Chairman, thank you. I know there have
been a lot of opening statements, and I have reviewed a lot of
what has been said, and I do not want to attempt to add to all
of that. I think it is appropriate we have this hearing. This
clearly is a tragedy, and a lot of innocent people have been
hurt, and we need to find out why that happened and how it
happened, and what we can do to prevent this sort of thing in
the future.
I hope the administration will pursue what happened
aggressively both at the Justice Department and the Securities
and Exchange Commission, and I hope that we, after appropriate
hearings, which is our role, will move as quickly as possible
to see if we can develop legislation that would be more helpful
to the employees and the stockholders in a situation like this,
and also take a serious look at the accounting rules on the
books.
So while I am sure it will be easy to do a lot of political
positioning on this, and I am not accusing anybody of doing
that, I hope that what will come out of it is not just finger-
pointing but some results, and I would like to be a part of
that.
Thank you, Mr. Chairman.
The Chairman. Very good.
Well, much has been said about the development of a culture
of corporate corruption, but there is also the culture of
political corruption, and maybe we can get some good out of
this whole situation in that there is no better example than
Kenny boy for cash and carry government. I hope that this
shames us into acting over on the House side and then on the
Senate side and send a campaign reform bill to the President.
We have got to clean up our own and maybe that is the good we
will get out of this situation.
Mr. Lay, would you please take the witness chair there and
let me swear you in. Would you raise your right hand, please?
Do you swear that the testimony that you give to this Committee
will be the truth, the whole truth, and nothing but the truth,
so help you God?
Mr. Lay. I do.
The Chairman. Thank you. Mr. Lay, do you have a statement
for the Committee?
STATEMENT OF KENNETH L. LAY, FORMER CHAIRMAN AND CEO, ENRON
Mr. Lay. A very brief statement, Mr. Chairman.
Mr. Chairman, I come here today with a profound sadness
about what has happened to Enron, its current and former
employees, retirees, shareholders, and other stakeholders. I
also wanted to respond to the best of my knowledge and
recollection to the questions you and your colleagues have
about the collapse of Enron. I have, however, been instructed
by my counsel not to testify based upon my Fifth Amendment
constitutional rights.
I am deeply troubled about asserting these rights, because
it may be perceived by some that I have something to hide, but
after agonizing consideration I cannot disregard my counsel's
instructions. Therefore, I must respectfully decline to answer
on Fifth Amendment grounds all the questions of this Committee
and Subcommittee, and of those of any other congressional
committee and subcommittee.
When providing their instruction, my counsel referred me to
an excerpt from a unanimous Supreme Court decision of less than
a year ago. Quote: ``One of the Fifth Amendment's basic
functions is to protect innocent men.'' I respectfully ask you
not to draw a negative inference because I am asserting my
Fifth Amendment constitutional protection on instruction of
counsel.
Thank you, Mr. Chairman.
The Chairman. Well, under that circumstance, Mr. Lay, the
Committee excuses you, and I want to turn the investigation
over to the Chairman of our Consumer Subcommittee, Senator
Dorgan.
Senator Dorgan. Mr. Chairman, thank you very much. We have
a series of three votes that will begin in about five minutes.
I believe it would be best if the Committee takes a brief
recess. We will reconvene at 11:30 a.m.
[Recess.]
Senator Dorgan. The hearing will reconvene. If we can have
people take their seats and close the door, my colleagues will
be here momentarily. We had a series of three votes, as I
previously announced. They took longer than expected, and I
apologize for the delay. As I indicated previously, we were
going to be hearing from Mr. William Powers, Jr. He is now at
the witness table. Mr. Powers is a member of the Enron Board of
Directors, I believe made a member of the Board of Directors
last fall, and Chairman of the Special Investigative Committee
that was enabled by the Board of Directors to evaluate what had
happened in a number of areas with respect to the Enron
Corporation.
Mr. Powers, you have testified previously on the U.S. House
side of this Capitol, and we now ask for your appearance today
before the Senate. Our colleagues will be appearing shortly,
but what I would like to do is to ask you to provide us with
your statement today, following which we will ask a series of
questions. Mr. Powers, your entire statement will be made a
part of the permanent record of the Committee, and we would ask
you summarize, but we want you to take as much time as you feel
is necessary, as well.
STATEMENT OF WILLIAM C. POWERS, JR., MEMBER OF THE ENRON BOARD
OF DIRECTORS AND CHAIRMAN OF THE
SPECIAL INVESTIGATION COMMITTEE
Mr. Powers. Thank you, Mr. Chairman. Mr. Chairman,
distinguished Members of the Committee, my name is William
Powers. I am the Dean of the University of Texas Law School.
For the past three months, I have served as Chairman of the
Special Investigative Committee of the Board of Directors of
Enron Corporation. I appreciate the opportunity, Mr. Chairman,
to come here today and testify to the Committee.
As you know, during October of last year, questions were
being raised about Enron's transactions with partnerships that
were being controlled by its Chief Financial Officer, Andrew
Fastow. In the middle of October, Enron announced that it was
taking an after-tax charge of more than $500 million against
its earnings because of transactions with one of those
partnerships. Enron also announced a reduction in shareholder
equity of more than a billion dollars.
At the end of October, the Enron Board established a
special committee to investigate these matters, and then asked
me if I would join the Board for the purpose of chairing that
committee and conducting that investigation. With the help of
counsel from Wilmer, Cutler & Pickering here in Washington, and
professional accounting advisors from Deloitte & Touche, we
have spent the last three months conducting that investigation.
Our committee's report was filed on February 2. It covers a
lot of ground and it will, I hope, be a helpful starting point,
but only a starting point, for the necessary further
investigations by congressional committees, by the Securities &
Exchange Commission, and by the Department of Justice. A copy
of the executive summary to that report is attached to my
statement here.
Many questions are currently part of the public discussion,
such as questions related to the employees' retirement savings
plans, as Senator Hutchison and many others made in their
remarks this morning, and sales of Enron securities by
insiders. All of those are important issues. They are matters
of vital importance, but they went beyond the charge that we
were given here.
The employees loss to their retirement plans is a tragic
story, but again, we did not address that or any of those other
matters in our report. We were charged with investigating
transactions between Enron and partnerships controlled by its
Chief Financial Officer, or people who worked in his
department. That is what our report discusses.
Mr. Chairman, as I have said before, what we found in our
investigation was absolutely appalling. First, we found that
Fastow and other Enron employees involved in these partnerships
enriched themselves in the aggregate by tens of millions of
dollars they should have never received. Fastow got at least
$30 million, Michael Kopper at least $10 million, and two
others, $1 million each, and still two more amounts that we
believe were in the hundreds of thousands of dollars.
Second, we found that some transactions were improperly
structured from an accounting point of view. It is important to
note that if these transactions had been structured correctly,
or properly, Enron could have kept assets and liabilities,
especially debt, off of its balance sheet, but Enron did not
follow the proper accounting rules.
But beyond these, we found something even more troubling
than those individual instances of misconduct, or failures to
follow the accounting rules. We found a systematic and
pervasive attempt by Enron's management to misrepresent the
company's financial condition. Enron management used these
partnerships to enter into transactions that it could not or
would not do with unrelated commercial entities. Many of the
most significant transactions apparently were not designed to
achieve any bona fide economic objectives. They were designed
to affect how Enron reported its earnings to its shareholders
and the public.
As our report demonstrates, these transactions were
extremely complex, and I will not try to describe them in any
detail here, but I do think it would be useful to give just one
example. It involves efforts by Enron to hedge against losses
on investments that Enron had made. Enron was not just a
pipeline and energy trading company. It also had large
investments in other businesses, some of which appreciated
substantially in value. These were volatile investments, and
Enron was concerned because it had recognized the gains when
these investments appreciated, and it did not want to recognize
the losses if the investments declined in value, so Enron
purported to enter into certain hedging transactions in order
to avoid recognizing losses from these investments.
The problem was, these hedges were not real. The idea of a
hedge is normally to contract with a creditworthy outside
partner that is prepared, for a price, to take on the economic
risk of an investment. If the value of the investment goes
down, that outside party will bear the loss. That is not what
happened here, though. Essentially, Enron in these transactions
was hedging with itself.
The outside parties with which Enron hedged were the so-
called Raptors. The purported outside investor in them was a
Fastow partnership. In reality, these were entities in which
only Enron had any real economic stake, and whose main assets
were Enron's own stock. The notes of Enron's corporate
secretary from the meeting of the Finance Committee regarding
the Raptors captures the reality. Those notes say, ``does not
transfer economic risk, but transfers P&L volatility.''
These were not real economic hedges. They just affected
Enron's earnings statements by allowing Enron to avoid
reporting losses on its investments. As it turned out, the
value of Enron's investments fell at the same time the value of
Enron's stock fell, and the Raptors became unable to meet their
obligations on the supposed hedges, but even if the hedges had
not failed in the sense I just described, the Raptors would
have paid Enron with the stock that Enron had provided in the
first place. Enron would simply have paid itself back.
This raises an important point that is easy to miss in the
thicket of these very complex transactions. There has been a
great deal of discussion about who understood what about
Fastow, and about Fastow's partnerships, but there is no
question that virtually everyone, everyone from the Board of
Directors on down, virtually everyone understood that the
company was seeking to offset its investment losses with its
own stock. That is not the way it is supposed to work. Real
earnings are supposed to be compared to real losses.
As a result of these transactions, Enron improperly
inflated its reported earnings for a 15-month period, from the
third quarter of 2000 through the third quarter of 2001, by
more than $1 billion. That means that more than 70 percent of
Enron's reported earnings for this period were not real.
How could this have happened? The tragic consequences of
the related party transactions and accounting errors were the
result of failures at many levels, and by many people. There
was a flawed idea, self-enrichment by employees, inadequately
designed controls, poor implementation, inattentive oversight,
simple and not-so-simple accounting mistakes, and overreaching
in a culture that appears to have encouraged pushing the
limits.
Whenever this many things go wrong, it is not just the
active one or two people. There was misconduct by Fastow and
other senior employees of Enron, terrible misconduct. There
were failures in the performance of Enron's outside advisors,
and there was a fundamental default of leadership and
management.
Leadership and management begin at the top with the CEO,
Ken Lay. In this company, leadership and management depended as
well on the Chief Operating Officer, Jeff Skilling, and it
depended on the Board of Directors. In the end, this is a
tragedy that could have and should have been avoided.
Mr. Chairman, I hope that our report and the work of this
Committee will at least help reduce the danger that this will
happen again to some other company.
Thank you, Mr. Chairman.
[The prepared statement and executive summary of Mr. Powers
follow:]
Prepared Statement of William C. Powers, Jr., Member of the Enron Board
of Directors and Chairman of the Special Investigation Committee
Mr. Chairman and distinguished Members of the Committee. My name is
William Powers. I am the Dean of the University of Texas Law School.
For the past three months, I have served as Chairman of the Special
Investigative Committee of the Board of Directors of Enron Corporation.
I appreciate the opportunity to come and testify before you today.
As you know, during October of last year, questions were being
raised about Enron's transactions with partnerships that were
controlled by its Chief Financial Officer, Andrew Fastow. In the middle
of October, Enron announced that it was taking an after-tax charge of
more than $500 million against its earnings, because of transactions
with one of those partnerships. Enron also announced a reduction in
shareholder equity of more than a billion dollars. At the end of
October, the Enron Board established a Special Committee to investigate
these matters, and then asked me if I would join the Board for the
purpose of chairing that Committee, and conducting that investigation.
With the help of counsel from Wilmer, Cutler & Pickering and
professional accounting advisors from Deloitte & Touche, we have spent
the last three months conducting that investigation.
Our Committee's Report was filed on February 2. It covers a lot of
ground and will, I hope, be a helpful starting point for the necessary
further investigations by Congressional Committees, by the Securities
and Exchange Commission, and by the Department of Justice. A copy of
the Executive Summary is attached to my Statement here.
Many questions currently part of public discussion--such as
questions relating to the employees' retirement savings and sales of
Enron securities by insiders--are beyond the scope of the charge we
were given. These are matters of vital importance. The employees' loss
of their retirement plans is a tragic story. But we did not address
these matters in our Report.
We were charged with investigating transactions between Enron and
partnerships controlled by its Chief Financial Officer, or people who
worked in his department. That is what our Report discusses. Mr.
Chairman, as I have said before: What we found was appalling.
First, we found that Fastow--and other Enron employees involved in
these partnerships--enriched themselves, in the aggregate, by tens of
millions of dollars they should never have received. Fastow got at
least $30 million, Michael Kopper at least $10 million, two others $1
million each, and still two more amounts we believe were at least in
the hundreds of thousands of dollars.
Second, we found that some transactions were improperly structured
from an accounting point of view. It is important to note that, if they
had been structured correctly, Enron could have kept assets and
liabilities (especially debt) off of its balance sheet. But Enron did
not follow the accounting rules.
But we found something even more troubling than those individual
instances of misconduct, and failures to follow accounting rules. We
found a systematic and pervasive attempt by Enron's Management to
misrepresent the Company's financial condition. Enron Management used
these partnerships to enter into transactions that it could not, or
would not, do with unrelated commercial entities. Many of the most
significant transactions apparently were not designed to achieve bona
fide economic objectives. They were designed to affect how Enron
reported its earnings.
As our Report demonstrates, these transactions were extremely
complex. I won't try to describe them in detail here. But I do think it
would be useful to give just one example. It involves efforts by Enron
to ``hedge'' against losses on investments it had made.
Enron was not just a pipeline and energy trading company. It also
had large investments in other businesses, some of which had
appreciated substantially in value. These were volatile investments,
and Enron was concerned because it had recognized the gains when these
investments appreciated, and it didn't want to recognize the losses if
the investments declined in value. So Enron purported to enter into
certain ``hedging'' transactions in order to avoid recognizing losses
from its investments. The problem was that the hedges weren't real. The
idea of a hedge is normally to contract with a credit-worthy outside
party that is prepared--for a price--to take on the economic risk of an
investment. If the value of the investment goes down, that outside
party will bear the loss. That is not what happened here. Essentially,
Enron was hedging with itself.
The outside parties with which Enron ``hedged'' were the so-called
``Raptors.'' The purported outside investor in them was a Fastow
partnership. In reality, these were entities in which only Enron had a
real economic stake, and whose main assets were Enron's own stock. The
notes of Enron's corporate secretary, from a meeting of the Finance
Committee regarding the Raptors, capture the reality: ``Does not
transfer economic risk but transfers P+L volatility.'' These were not
real economic hedges; they just affected Enron's earnings statement by
allowing Enron to avoid reporting losses on its investments.
As it turned out, the value of Enron's investments fell at the same
time that the value of Enron stock fell, and the Raptors became unable
to meet their obligations on the ``hedges.'' But even if the hedges had
not failed in the sense I just described, the Raptors would have paid
Enron with the stock that Enron had provided in the first place; Enron
would simply have paid itself back.
This raises an important point that is easy to miss in the thicket
of these very complex transactions. There has been much discussion
about who understood what about Fastow and his partnerships. But there
is no question that virtually everyone, from the Board of Directors on
down, understood that the company was seeking to offset its investment
losses with its own stock. That is not the way it is supposed to work.
Real earnings are supposed to be compared to real losses.
As a result of these transactions, Enron improperly inflated its
reported earnings for a 15-month period--from the third quarter of 2000
through the third quarter of 2001--by more than $1 billion. This means
that more than 70 percent of Enron's reported earnings for this period
were not real.
How could this have happened? The tragic consequences of the
related-party transactions and accounting errors were the result of
failures at many levels and by many people: a flawed idea, self-
enrichment by employees, inadequately-designed controls, poor
implementation, inattentive oversight, simple (and not-so-simple)
accounting mistakes, and overreaching in a culture that appears to have
encouraged pushing the limits.
Whenever this many things go wrong, it is not just the act of one
or two people. There was misconduct by Fastow and other senior
employees of Enron. There were failures in the performance of Enron's
outside advisors. And there was a fundamental default of leadership and
management.
Leadership and management begin at the top, with the CEO, Ken Lay.
In this company, leadership and management depended as well on the
Chief Operating Officer, Jeff Skilling. And it depended on the Board of
Directors.
In the end, this is a tragedy that could and should have been
avoided. I hope that our Report, and the work of this Committee, will
help reduce the danger that it will happen to some other company.
Executive Summary and Conclusions
The Special Investigative Committee of the Board of Directors of
Enron Corp. submits this Report of Investigation to the Board of
Directors. In accordance with our mandate, the Report addresses
transactions between Enron and investment partnerships created and
managed by Andrew S. Fastow, Enron's former Executive Vice President
and Chief Financial Officer, and by other Enron employees who worked
with Fastow.
The Committee has done its best, given the available time and
resources, to conduct a careful and impartial investigation. We have
prepared a Report that explains the substance of the most significant
transactions and highlights their most important accounting, corporate
governance, management oversight, and public disclosure issues. An
exhaustive investigation of these related-party transactions would
require time and resources beyond those available to the Committee. We
were not asked, and we have not attempted, to investigate the causes of
Enron's bankruptcy or the numerous business judgments and external
factors that contributed it. Many questions currently part of public
discussion--such as questions relating to Enron's international
business and commercial electricity ventures, broadband communications
activities, transactions in Enron securities by insiders, or management
of employee 401(k) plans--are beyond the scope of the authority we were
given by the Board.
There were some practical limitations on the information available
to the Committee in preparing this Report. We had no power to compel
third parties to submit to interviews, produce documents, or otherwise
provide information. Certain former Enron employees who (we were told)
played substantial roles in one or more of the transactions under
investigation--including Fastow, Michael J. Kopper, and Ben F. Glisan,
Jr.--declined to be interviewed either entirely or with respect to most
issues. We have had only limited access to certain workpapers of Arthur
Andersen LLP (``Andersen''), Enron's outside auditors, and no access to
materials in the possession of the Fastow partnerships or their limited
partners. Information from these sources could affect our conclusions.
This Executive Summary and Conclusions highlights important parts
of the Report and summarizes our conclusions. It is based on the
complete set of facts, explanations and limitations described in the
Report, and should be read with the Report itself. Standing alone, it
does not, and cannot, provide a full understanding of the facts and
analysis underlying our conclusions.
Background
On October 16, 2001, Enron announced that it was taking a $544
million after-tax charge against earnings related to transactions with
LJM2 Co-Investment, L.P. (``LJM2''), a partnership created and managed
by Fastow. It also announced a reduction of shareholders' equity of
$1.2 billion related to transactions with that same entity.
Less than one month later, Enron announced that it was restating
its financial statements for the period from 1997 through 2001 because
of accounting errors relating to transactions with a different Fastow
partnership, LJM Cayman, L.P. (``LJM1''), and an additional related-
party entity, Chewco Investments, L.P. (``Chewco''). Chewco was managed
by an Enron Global Finance employee, Kopper, who reported to Fastow.
The LJM1- and Chewco-related restatement, like the earlier charge
against earnings and reduction of shareholders' equity, was very large.
It reduced Enron's reported net income by $28 million in 1997 (of $105
million total), by $133 million in 1998 (of $703 million total), by
$248 million in 1999 (of $893 million total), and by $99 million in
2000 (of $979 million total). The restatement reduced reported
shareholders' equity by $258 million in 1997, by $391 million in 1998,
by $710 million in 1999, and by $754 million in 2000. It increased
reported debt by $711 million in 1997, by $561 million in 1998, by $685
million in 1999, and by $628 million in 2000. Enron also revealed, for
the first time, that it had learned that Fastow received more than $30
million from LJM1 and LJM2. These announcements destroyed market
confidence and investor trust in Enron. Less than one month later,
Enron filed for bankruptcy.
Summary of Findings
This Committee was established on October 28, 2001, to conduct an
investigation of the related-party transactions. We have examined the
specific transactions that led to the third-quarter 2001 earnings
charge and the restatement. We also have attempted to examine all of
the approximately two dozen other transactions between Enron and these
related-party entities: what these transactions were, why they took
place, what went wrong, and who was responsible.
Our investigation identified significant problems beyond those
Enron has already disclosed. Enron employees involved in the
partnerships were enriched, in the aggregate, by tens of millions of
dollars they should never have received--Fastow by at least $30
million, Kopper by at least $10 million, two others by $1 million each,
and still two more by amounts we believe were at least in the hundreds
of thousands of dollars. We have seen no evidence that any of these
employees, except Fastow, obtained the permission required by Enron's
Code of Conduct of Business Affairs to own interests in the
partnerships. Moreover, the extent of Fastow's ownership and financial
windfall was inconsistent with his representations to Enron's Board of
Directors.
This personal enrichment of Enron employees, however, was merely
one aspect of a deeper and more serious problem. These partnerships--
Chewco, LJM1, and LJM2--were used by Enron Management to enter into
transactions that it could not, or would not, do with unrelated
commercial entities. Many of the most significant transactions
apparently were designed to accomplish favorable financial statement
results, not to achieve bona fide economic objectives or to transfer
risk. Some transactions were designed so that, had they followed
applicable accounting rules, Enron could have kept assets and
liabilities (especially debt) off of its balance sheet; but the
transactions did not follow those rules.
Other transactions were implemented--improperly, we are informed by
our accounting advisors--to offset losses. They allowed Enron to
conceal from the market very large losses resulting from Enron's
merchant investments by creating an appearance that those investments
were hedged--that is, that a third party was obligated to pay Enron the
amount of those losses--when in fact that third party was simply an
entity in which only Enron had a substantial economic stake. We believe
these transactions resulted in Enron reporting earnings from the third
quarter of 2000 through the third quarter of 2001 that were almost $1
billion higher than should have been reported.
Enron's original accounting treatment of the Chewco and LJM1
transactions that led to Enron's November 2001 restatement was clearly
wrong, apparently the result of mistakes either in structuring the
transactions or in basic accounting. In other cases, the accounting
treatment was likely wrong, notwithstanding creative efforts to
circumvent accounting principles through the complex structuring of
transactions that lacked fundamental economic substance. In virtually
all of the transactions, Enron's accounting treatment was determined
with extensive participation and structuring advice from Andersen,
which Management reported to the Board. Enron's records show that
Andersen billed Enron $5.7 million for advice in connection with the
LJM and Chewco transactions alone, above and beyond its regular audit
fees.
Many of the transactions involve an accounting structure known as a
``special purpose entity'' or ``special purpose vehicle'' (referred to
as an ``SPE'' in this Summary and in the Report). A company that does
business with an SPE may treat that SPE as if it were an independent,
outside entity for accounting purposes if two conditions are met: (1)
an owner independent of the company must make a substantive equity
investment of at least 3% of the SPE's assets, and that 3% must remain
at risk throughout the transaction; and (2) the independent owner must
exercise control of the SPE. In those circumstances, the company may
record gains and losses on transactions with the SPE, and the assets
and liabilities of the SPE are not included in the company's balance
sheet, even though the company and the SPE are closely related. It was
the technical failure of some of the structures with which Enron did
business to satisfy these requirements that led to Enron's restatement.
Summary of Transactions and Matters Reviewed
The following are brief summaries of the principal transactions and
matters in which we have identified substantial problems:
The Chewco Transaction
The first of the related-party transactions we examined involved
Chewco Investments L.P., a limited partnership managed by Kopper.
Because of this transaction, Enron filed inaccurate financial
statements from 1997 through 2001, and provided an unauthorized and
unjustifiable financial windfall to Kopper.
From 1993 through 1996, Enron and the California Public Employees'
Retirement System (``CalPERS'') were partners in a $500 million joint
venture investment partnership called Joint Energy Development
Investment Limited Partnership (``JEDI''). Because Enron and CalPERS
had joint control of the partnership, Enron did not consolidate JEDI
into its consolidated financial statements. The financial statement
impact of non-consolidation was significant: Enron would record its
contractual share of gains and losses from JEDI on its income statement
and would disclose the gain or loss separately in its financial
statement footnotes, but would not show JEDI's debt on its balance
sheet.
In November 1997, Enron wanted to redeem CalPERS' interest in JEDI
so that CalPERS would invest in another, larger partnership. Enron
needed to find a new partner, or else it would have to consolidate JEDI
into its financial statements, which it did not want to do. Enron
assisted Kopper (whom Fastow identified for the role) in forming Chewco
to purchase CalPERS' interest. Kopper was the manager and owner of
Chewco's general partner. Under the SPE rules summarized above, Enron
could only avoid consolidating JEDI onto Enron's financial statements
if Chewco had some independent ownership with a minimum of 3% of equity
capital at risk. Enron and Kopper, however, were unable to locate any
such outside investor, and instead financed Chewco's purchase of the
JEDI interest almost entirely with debt, not equity. This was done
hurriedly and in apparent disregard of the accounting requirements for
nonconsolidation. Notwithstanding the shortfall in required equity
capital, Enron did not consolidate Chewco (or JEDI) into its
consolidated financial statements.
Kopper and others (including Andersen) declined to speak with us
about why this transaction was structured in a way that did not comply
with the non-consolidation rules. Enron, and any Enron employee acting
in Enron's interest, had every incentive to ensure that Chewco complied
with these rules. We do not know whether this mistake resulted from bad
judgment or carelessness on the part of Enron employees or Andersen, or
whether it was caused by Kopper or others putting their own interests
ahead of their obligations to Enron.
The consequences, however, were enormous. When Enron and Andersen
reviewed the transaction closely in 2001, they concluded that Chewco
did not satisfy the SPE accounting rules and--because JEDI's non-
consolidation depended on Chewco's status--neither did JEDI. In
November 2001, Enron announced that it would consolidate Chewco and
JEDI retroactive to 1997. As detailed in the Background section above,
this retroactive consolidation resulted in a massive reduction in
Enron's reported net income and a massive increase in its reported
debt.
Beyond the financial statement consequences, the Chewco transaction
raises substantial corporate governance and management oversight
issues. Under Enron's Code of Conduct of Business Affairs, Kopper was
prohibited from having a financial or managerial role in Chewco unless
the Chairman and CEO determined that his participation ``does not
adversely affect the best interests of the Company.'' Notwithstanding
this requirement, we have seen no evidence that his participation was
ever disclosed to, or approved by, either Kenneth Lay (who was Chairman
and CEO) or the Board of Directors.
While the consequences of the transaction were devastating to
Enron, Kopper reaped a financial windfall from his role in Chewco. This
was largely a result of arrangements that he appears to have negotiated
with Fastow. From December 1997 through December 2000, Kopper received
$2 million in ``management'' and other fees relating to Chewco. Our
review failed to identify how these payments were determined, or what,
if anything, Kopper did to justify the payments. More importantly, in
March 2001 Enron repurchased Chewco's interest in JEDI on terms Kopper
apparently negotiated with Fastow (during a time period in which Kopper
had undisclosed interests with Fastow in both LJM1 and LJM2). Kopper
had invested $125,000 in Chewco in 1997. The repurchase resulted in
Kopper's (and a friend to whom he had transferred part of his interest)
receiving more than $10 million from Enron.
The LJM Transactions
In 1999, with Board approval, Enron entered into business
relationships with two partnerships in which Fastow was the manager and
an investor. The transactions between Enron and the LJM partnerships
resulted in Enron increasing its reported financial results by more
than a billion dollars, and enriching Fastow and his co-investors by
tens of millions of dollars at Enron's expense.
The two members of the Special Investigative Committee who have
reviewed the Board's decision to permit Fastow to participate in LJM
notwithstanding the conflict of interest have concluded that this
arrangement was fundamentally flawed.\1\ A relationship with the most
senior financial officer of a public company--particularly one
requiting as many controls and as much oversight by others as this one
did--should not have been undertaken in the first place.
---------------------------------------------------------------------------
\1\ One member of the Special Investigative Committee, Herbert S.
Winokur, Jr., was a member of the Board of Directors and the Finance
Committee during the relevant period. The portions of the Report
describing and evaluating actions of the Board and its Committees are
solely the views of the other two members of the Committee, Dean
William C. Powers, Jr. of the University of Texas School of Law and
Raymond S. Troubh.
---------------------------------------------------------------------------
The Board approved Fastow's participation in the LJM partnerships
with full knowledge and discussion of the obvious conflict of interest
that would result. The Board apparently believed that the conflict, and
the substantial risks associated with it, could be mitigated through
certain controls (involving oversight by both the Board and Senior
Management) to ensure that transactions were done on terms fair to
Enron. In taking this step, the Board thought that the LJM partnerships
would offer business benefits to Enron that would outweigh the
potential costs. The principal reason advanced by Management in favor
of the relationship, in the case of LJM1, was that it would permit
Enron to accomplish a particular transaction it could not otherwise
accomplish. In the case of LJM2, Management advocated that it would
provide Enron with an additional potential buyer of assets that Enron
wanted to sell, and that Fastow's familiarity with the Company and the
assets to be sold would permit Enron to move more quickly and incur
fewer transaction costs.
Over time, the Board required, and Management told the Board it was
implementing, an ever-increasing set of procedures and controls over
the related-party transactions. These included, most importantly,
review and approval of all LJM transactions by Richard Causey, the
Chief Accounting Officer; and Richard Buy, the Chief Risk Officer; and,
later during the period, Jeffrey Skilling, the President and COO (and
later CEO). The Board also directed its Audit and Compliance Committee
to conduct annual reviews of all LJM transactions.
These controls as designed were not rigorous enough, and their
implementation and oversight was inadequate at both the Management and
Board levels. No one in Management accepted primary responsibility for
oversight; the controls were not executed properly; and there were
structural defects in those controls that became apparent over time.
For instance, while neither the Chief Accounting Officer, Causey, nor
the Chief Risk Officer, Buy, ignored his responsibilities, they
interpreted their roles very narrowly and did not give the transactions
the degree of review the Board believed was occurring. Skilling appears
to have been almost entirely uninvolved in the process, notwithstanding
representations made to the Board that he had undertaken a significant
role. No one in Management stepped forward to address the issues as
they arose, or to bring the apparent problems to the Board's attention.
As we discuss further below, the Board, having determined to allow
the related party transactions to proceed, did not give sufficient
scrutiny to the information that was provided to it thereafter. While
there was important information that appears to have been withheld from
the Board, the annual reviews of LJM transactions by the Audit and
Compliance Committee (and later also the Finance Committee) appear to
have involved only brief presentations by Management (with Andersen
present at the Audit Committee) and did not involve any meaningful
examination of the nature or terms of the transactions. Moreover, even
though Board Committee-mandated procedures required a review by the
Compensation Committee of Fastow's compensation from the partnerships,
neither the Board nor Senior Management asked Fastow for the amount of
his LJM-related compensation until October 2001, after media reports
focused on Fastow's role in LJM.
From June 1999 through June 2001, Enron entered into more than 20
distinct transactions with the LJM partnerships. These were of two
general types: asset sales and purported ``hedging'' transactions. Each
of these types of transactions was flawed, although the latter
ultimately caused much more harm to Enron.
Asset Sales. Enron sold assets to LJM that it wanted to remove from
its books. These transactions often occurred close to the end of
financial reporting periods. While there is nothing improper about such
transactions if they actually transfer the risks and rewards of
ownership to the other party, there are substantial questions whether
any such transfer occurred in some of the sales to LJM.
Near the end of the third and fourth quarters of 1999, Enron sold
interests in seven assets to LJM1 and LJM2. These transactions appeared
consistent with the stated purpose of allowing Fastow to participate in
the partnerships--the transactions were done quickly, and permitted
Enron to remove the assets from its balance sheet and record a gain in
some cases. However, events that occurred after the sales call into
question the legitimacy of the sales. In particular: (1) Enron bought
back five of the seven assets after the close of the financial
reporting period, in some cases within a matter of months; (2) the LJM
partnerships made a profit on every transaction, even when the asset it
had purchased appears to have declined in market value; and (3)
according to a presentation Fastow made to the Board's Finance
Committee, those transactions generated, directly or indirectly,
``earnings'' to Enron of $229 million in the second half of 1999
(apparently including one hedging transaction). (The details of the
transactions are discussed in Section VI of the Report.) Although we
have not been able to confirm Fastow's calculation, Enron's reported
earnings for that period were $570 million pre-tax) and $549 million
(after-tax).
We have identified some evidence that, in three of these
transactions where Enron ultimately bought back LJM's interest, Enron
had agreed in advance to protect the LJM partnerships against loss. If
this was in fact the case, it was likely inappropriate to treat the
transactions as sales. There also are plausible, more innocent
explanations for some of the repurchases, but a sufficient basis
remains for further examination. With respect to those transactions in
which risk apparently did not pass from Enron, the LJM partnerships
functioned as a vehicle to accommodate Enron in the management of its
reported financial results.
Hedging Transactions. The first ``hedging'' transaction between
Enron and LJM occurred in June 1999, and was approved by the Board in
conjunction with its approval of Fastow's participation in LJM1. The
normal idea of a hedge is to contract with a creditworthy outside party
that is prepared--for a price--to take on the economic risk of an
investment. If the value of the investment goes down, that outside
party will bear the loss. That is not what happened here. Instead,
Enron transferred its own stock to an SPE in exchange for a note. The
Fastow partnership, LJM1, was to provide the outside equity necessary
for the SPE to qualify for non-consolidation. Through the use of
options, the SPE purported to take on the risk that the price of the
stock of Rhythms NetConnections Inc. (``Rhythms''), an interact service
provider, would decline. The idea was to ``hedge'' Enron's profitable
merchant investment in Rhythms stock, allowing Enron to offset losses
on Rhythms if the price of Rhythms stock declined. If the SPE were
required to pay Enron on the Rhythms options, the transferred Enron
stock would be the principal source of payment.
The other ``hedging'' transactions occurred in 2000 and 2001 and
involved SPEs known as the ``Raptor'' vehicles. Expanding on the idea
of the Rhythms transaction, these were extraordinarily complex
structures. They were funded principally with Enron's own stock (or
contracts for the delivery of Enron stock) that was intended to
``hedge'' against declines in the value of a large group of Enron's
merchant investments. LJM2 provided the outside equity designed to
avoid consolidation of the Raptor SPEs.
The asset sales and hedging transactions raised a variety of
issues, including the following:
Accounting and Financial Reporting Issues. Although Andersen
approved the transactions, in fact the ``hedging'' transactions did not
involve substantive transfers of economic risk. The transactions may
have looked superficially like economic hedges, but they actually
functioned only as ``accounting'' hedges. They appear to have been
designed to circumvent accounting rules by recording hedging gains to
offset losses in the value of merchant investments on Enron's quarterly
and annual income statements. The economic reality of these
transactions was that Enron never escaped the risk of loss, because it
had provided the bulk of the capital with which the SPEs would pay
Enron.
Enron used this strategy to avoid recognizing losses for a time. In
1999, Enron recognized after-tax income of $95 million from the Rhythms
transaction, which offset losses on the Rhythms investment. In the last
two quarters of 2000, Enron recognized revenues of $500 million on
derivative transactions with the Raptor entities, which offset losses
in Enron's merchant investments, and recognized pre-tax earnings of
$532 million (including net interest income). Enron's reported pre-tax
earnings for the last two quarters of 2000 totaled $650 million.
``Earnings'' from the Raptors accounted for more than 80% of that
total.
The idea of hedging Enron's investments with the value of Enron's
capital stock had a serious drawback as an economic matter. If the
value of the investments fell at the same time as the value of Enron
stock fell, the SPEs would be unable to meet their obligations and the
``hedges'' would fail. This is precisely what happened in late 2000 and
early 2001. Two of the Raptor SPEs lacked sufficient credit capacity to
pay Enron on the ``hedges.'' As a result, in late March 2001, it
appeared that Enron would be required to take a pre-tax charge against
earnings of more than $500 million to reflect the shortfall in credit
capacity. Rather than take that loss, Enron ``restructured'' the Raptor
vehicles by, among other things, transferring more than $800 million of
contracts to receive its own stock to them just before quarter-end.
This transaction apparently was not disclosed to or authorized by the
Board, involved a transfer of very substantial value for insufficient
consideration, and appears inconsistent with governing accounting
rules. It continued the concealment of the substantial losses in
Enron's merchant investments.
However, even these efforts could not avoid the inevitable results
of hedges that were supported only by Enron stock in a declining
market. As the value of Enron's merchant investments continued to fall
in 2001, the credit problems in the Raptor entities became insoluble.
Ultimately, the SPEs were terminated in September 2001. This resulted
in the unexpected announcement on October 16, 2001, of a $544 million
after-tax charge against earnings. In addition, Enron was required to
reduce shareholders' equity by $1.2 billion. While the equity reduction
was primarily the result of accounting errors made in 2000 and early
2001, the charge against earnings was the result of Enron's ``hedging''
its investments--not with a creditworthy counter-party, but with
itself.
Consolidation Issues. In addition to the accounting abuses
involving use of Enron stock to avoid recognizing losses on merchant
investments, the Rhythms transaction involved the same SPE equity
problem that undermined Chewco and JEDI. As we stated above, in 2001,
Enron and Andersen concluded that Chewco lacked sufficient outside
equity at risk to qualify for non-consolidation. At the same time,
Enron and Andersen also concluded that the LJM1 SPE in the Rhythms
transaction failed the same threshold accounting requirement. In recent
Congressional testimony, Andersen's CEO explained that the firm had
simply been wrong in 1999 when it concluded (and presumably advised
Enron) that the LJM1 SPE satisfied the non-consolidation requirements.
As a result, in November 2001, Enron announced that it would restate
prior period financials to consolidate the LJM1 SPE retroactively to
1999. This retroactive consolidation decreased Enron's reported net
income by $95 million (of $893 million total) in 1999 and by $8 million
(of $979 million total) in 2000.
Self-Dealing Issues. While these related-party transactions
facilitated a variety of accounting and financial reporting abuses by
Enron, they were extraordinarily lucrative for Fastow and others. In
exchange for their passive and largely risk-free roles in these
transactions, the LJM partnerships and their investors were richly
rewarded. Fastow and other Enron employees received tens of millions of
dollars they should not have received. These benefits came at Enron's
expense.
When Enron and LJM1 (through Fastow) negotiated a termination of
the Rhythms ``hedge'' in 2000, the terms of the transaction were
extraordinarily generous to LJM1 and its investors. These investors
walked away with tens of millions of dollars in value that, in an
arm's-length context, Enron would never have given away. Moreover,
based on the information available to us, it appears that Fastow had
offered interests in the Rhythms termination to Kopper and four other
Enron employees. These investments, in a partnership called
``Southampton Place,'' provided spectacular returns. In exchange for a
$25,000 investment, Fastow received (through a family foundation) $4.5
million in approximately two months. Two other employees, who each
invested $5,800, each received $1 million in the same time period. We
have seen no evidence that Fastow or any of these employees obtained
clearance for those investments, as required by Enron's Code of
Conduct. Kopper and the other Enron employees who received these vast
returns were all involved in transactions between Enron and the LJM
partnerships in 2000--some representing Enron.
Public Disclosure
Enron's publicly-filed reports disclosed the existence of the LJM
partnerships. Indeed, there was substantial factual information about
Enron's transactions with these partnerships in Enron's quarterly and
annual reports and in its proxy statements. Various disclosures were
approved by one or more of Enron's outside auditors and its inside and
outside counsel. However, these disclosures were obtuse, did not
communicate the essence of the transactions completely or clearly, and
failed to convey the substance of what was going on between Enron and
the partnerships. The disclosures also did not communicate the nature
or extent of Fastow's financial interest in the LJM partnerships. This
was the result of an effort to avoid disclosing Fastow's financial
interest and to downplay the significance of the related-party
transactions and, in some respects, to disguise their substance and
import. The disclosures also asserted that the related-party
transactions were reasonable compared to transactions with third
parties, apparently without any factual basis. The process by which the
relevant disclosures were crafted was influenced substantially by Enron
Global Finance (Fastow's group). There was an absence of forceful and
effective oversight by Senior Enron Management and in-house counsel,
and objective and critical professional advice by outside counsel at
Vinson & Elkins, or auditors at Andersen.
The Participants
The actions and inactions of many participants led to the related-
party abuses, and the financial reporting and disclosure failures, that
we identify in our Report. These participants include not only the
employees who enriched themselves at Enron's expense, but also Enron's
Management, Board of Directors and outside advisors. The factual basis
and analysis for these conclusions are set out in the Report. In
summary, based on the evidence available to us, the Committee notes the
following:
Andrew Fastow. Fastow was Enron's Chief Financial Officer and was
involved on both sides of the related-party transactions. What he
presented as an arrangement intended to benefit Enron became, over
time, a means of both enriching himself personally and facilitating
manipulation of Enron's financial statements. Both of these objectives
were inconsistent with Fastow's fiduciary duties to Enron and anything
the Board authorized. The evidence suggests that he (1) placed his own
personal interests and those of the LJM partnerships ahead of Enron's
interests; (2) used his position in Enron to influence (or attempt to
influence) Enron employees who were engaging in transactions on Enron's
behalf with the LJM partnerships; and (3) failed to disclose to Enron's
Board of Directors important information it was entitled to receive. In
particular, we have seen no evidence that he disclosed Kopper's role in
Chewco or LJM2, or the level of profitability of the LJM partnerships
(and his personal and family interests in those profits), which far
exceeded what he had led the Board to expect. He apparently also
violated and caused violations of Enron's Code of Conduct by
purchasing, and offering to Enron employees, extraordinarily lucrative
interests in the Southampton Place partnership. He did so at a time
when at least one of those employees was actively working on Enron's
behalf in transactions with LJM2.
Enron's Management. Individually, and collectively, Enron's
Management failed to carry out its substantive responsibility for
ensuring that the transactions were fair to Enron--which in many cases
they were not--and its responsibility for implementing a system of
oversight and controls over the transactions with the LJM partnerships.
There were several direct consequences of this failure: transactions
were executed on terms that were not fair to Enron and that enriched
Fastow and others; Enron engaged in transactions that had little
economic substance and misstated Enron's financial results; and the
disclosures Enron made to its shareholders and the public did not fully
or accurately communicate relevant information. We discuss here the
involvement of Kenneth Lay, Jeffrey Skilling, Richard Causey, and
Richard Buy.
For much of the period in question, Lay was the Chief Executive
Officer of Enron and, in effect, the captain of the ship. As CEO, he
had the ultimate responsibility for taking reasonable steps to ensure
that the officers reporting to him performed their oversight duties
properly. He does not appear to have directed their attention, or his
own, to the oversight of the LJM partnerships. Ultimately, a large
measure of the responsibility rests with the CEO.
Lay approved the arrangements under which Enron permitted Fastow to
engage in related-party transactions with Enron and authorized the
Rhythms transaction and three of the Raptor vehicles. He bears
significant responsibility for those flawed decisions, as well as for
Enron's failure to implement sufficiently rigorous procedural controls
to prevent the abuses that flowed from this inherent conflict of
interest. In connection with the LJM transactions, the evidence we have
examined suggests that Lay functioned almost entirely as a Director,
and less as a member of Management. It appears that both he and
Skilling agreed, and the Board understood, that Skilling was the senior
member of Management responsible for the LJM relationship.
Skilling was Enron's President and Chief Operating Officer, and
later its Chief Executive Officer, until his resignation in August
2001. The Board assumed, and properly so, that during the entire period
of time covered by the events discussed in this Report, Skilling was
sufficiently knowledgeable of and involved in the overall operations of
Enron that he would see to it that matters of significance would be
brought to the Board's attention. With respect to the LJM partnerships,
Skilling personally supported the Board's decision to permit Fastow to
proceed with LJM, notwithstanding Fastow's conflict of interest.
Skilling had direct responsibility for ensuring that those reporting to
him performed their oversight duties properly. He likewise had
substantial responsibility to make sure that the internal controls that
the Board put in place--particularly those involving related-party
transactions with the Company's CFO--functioned properly. He has
described the detail of his expressly-assigned oversight role as
minimal. That answer, however, misses the point. As the magnitude and
significance of the related party transactions to Enron increased over
time, it is difficult to understand why Skilling did not ensure that
those controls were rigorously adhered to and enforced. Based upon his
own description of events, Skilling does not appear to have given much
attention to these duties. Skilling certainly knew or should have known
of the magnitude and the risks associated with these transactions.
Skilling, who prides himself on the controls he put in place in many
areas at Enron, bears substantial responsibility for the failure of the
system of internal controls to mitigate the risk inherent in the
relationship between Enron and the LJM partnerships.
Skilling met in March 2000 with Jeffrey McMahon, Enron's Treasurer
(who reported to Fastow). McMahon told us that he approached Skilling
with serious concerns about Enron's dealings with the LJM partnerships.
McMahon and Skilling disagree on some important elements of what was
said. However, if McMahon's account (which is reflected in what he
describes as contemporaneous talking points for the discussion) is
correct, it appears that Skilling did not take action (nor did McMahon
approach Lay or the Board) after being put on notice that Fastow was
pressuring Enron employees who were negotiating with LJM--clear
evidence that the controls were not effective. There also is
conflicting evidence regarding Skilling's knowledge of the March 2001
Raptor restructuring transaction. Although Skilling denies it, if the
account of other Enron employees is accurate, Skilling both approved a
transaction that was designed to conceal substantial losses in Enron's
merchant investments and withheld from the Board important information
about that transaction.
Causey was and is Enron's Chief Accounting Officer. He presided
over and participated in a series of accounting judgments that, based
on the accounting advice we have received, went well beyond the
aggressive. The fact that these judgments were, in most if not all
cases, made with the concurrence of Andersen is a significant, though
not entirely exonerating, fact.
Causey was also charged by the Board of Directors with a
substantial role in the oversight of Enron's relationship with the LJM
partnerships. He was to review and approve all transactions between
Enron and the LJM partnerships, and he was to review those transactions
with the Audit and Compliance Committee annually. The evidence we have
examined suggests that he did not implement a procedure for identifying
all LJM1 or LJM2 transactions and did not give those transactions the
level of scrutiny the Board had reason to believe he would. He did not
provide the Audit and Compliance Committee with the full and complete
information about the transactions, in particular the Raptor III and
Raptor restructuring transactions, that it needed to fulfill its
duties.
Buy was and is Enron's Senior Risk Officer. The Board of Directors
also charged him with a substantial role in the oversight of Enron's
relationship with the LJM partnerships. He was to review and approve
all transactions between them. The evidence we have examined suggests
that he did not implement a procedure for identifying all LJM1 or LJM2
transactions. Perhaps more importantly, he apparently saw his role as
more narrow than the Board had reason to believe, and did not act
affirmatively to carry out (or ensure that others carried out) a
careful review of the economic terms of all transactions between Enron
and LJM.
The Board of Directors. With respect to the issues that are the
subject of this investigation, the Board of Directors failed, in our
judgment, in its oversight duties. This had serious consequences for
Enron, its employees, and its shareholders.
The Board of Directors approved the arrangements that allowed the
Company's CFO to serve as general partner in partnerships that
participated in significant financial transactions with Enron. As noted
earlier, the two members of the Special Investigative Committee who
have participated in this review of the Board's actions believe this
decision was fundamentally flawed. The Board substantially
underestimated the severity of the conflict and overestimated the
degree to which management controls and procedures could contain the
problem.
After having authorized a conflict of interest creating as much
risk as this one, the Board had an obligation to give careful attention
to the transactions that followed. It failed to do this. It cannot be
faulted for the various instances in which it was apparently denied
important information concerning certain of the transactions in
question. However, it can and should be faulted for failing to demand
more information, and for failing to probe and understand the
information that did come to it. The Board authorized the Rhythms
transaction and three of the Raptor transactions. It appears that many
of its members did not understand those transactions--the economic
rationale, the consequences, and the risks. Nor does it appear that
they reacted to warning signs in those transactions as they were
presented, including the statement to the Finance Committee in May 2000
that the proposed Raptor transaction raised a risk of ``accounting
scrutiny.'' We do note, however, that the Committee was told that
Andersen was ``comfortable'' with the transaction. As complex as the
transactions were, the existence of Fastow's conflict of interest
demanded that the Board gain a better understanding of the LJM
transactions that came before it, and ensure (whether through one of
its Committees or through use of outside consultants) that they were
fair to Enron.
The Audit and Compliance Committee, and later the Finance
Committee, took on a specific role in the control structure by carrying
out periodic reviews of the LJM transactions. This was an opportunity
to probe the transactions thoroughly, and to seek outside advice as to
any issues outside the Board members' expertise. Instead, these reviews
appear to have been too brief, too limited in scope, and too
superficial to serve their intended function. The Compensation
Committee was given the role of reviewing Fastow's compensation from
the LJM entities, and did not carry out this review. This remained the
case even after the Committees were on notice that the LJM transactions
were contributing very large percentages of Enron's earnings. In sum,
the Board did not effectively meet its obligation with respect to the
LJM transactions.
The Board, and in particular the Audit and Compliance Committee,
has the duty of ultimate oversight over the Company's financial
reporting. While the primary responsibility for the financial reporting
abuses discussed in the Report lies with Management, the participating
members of this Committee believe those abuses could and should have
been prevented or detected at an earlier time had the Board been more
aggressive and vigilant.
Outside Professional Advisors. The evidence available to us
suggests that Andersen did not fulfill its professional
responsibilities in connection with its audits of Enron's financial
statements, or its obligation to bring to the attention of Enron's
Board (or the Audit and Compliance Committee) concerns about Enron's
internal controls over the related-party transactions. Andersen has
admitted that it erred in concluding that the Rhythms transaction was
structured properly under the SPE non-consolidation rules. Enron was
required to restate its financial results for 1999 and 2000 as a
result. Andersen participated in the structuring and accounting
treatment of the Raptor transactions, and charged over $1 million for
its services, yet it apparently failed to provide the objective
accounting judgment that should have prevented these transactions from
going forward. According to Enron's internal accountants (though this
apparently has been disputed by Andersen), Andersen also reviewed and
approved the recording of additional equity in March 2001 in connection
with this restructuring. In September 2001, Andersen required Enron to
reverse this accounting treatment, leading to the $1.2 billion
reduction of equity. Andersen apparently failed to note or take action
with respect to the deficiencies in Enron's public disclosure
documents.
According to recent public disclosures, Andersen also failed to
bring to the attention of Enron's Audit and Compliance Committee
serious reservations Andersen partners voiced internally about the
related-party transactions. An internal Andersen e-mail from February
2001 released in connection with recent Congressional hearings suggests
that Andersen had concerns about Enron's disclosures of the related-
party transactions. A week after that e-mail, however, Andersen's
engagement partner told the Audit and Compliance Committee that, with
respect to related-party transactions, ``[r]equired disclosure [had
been] reviewed for adequacy,'' and that Andersen would issue an
unqualified audit opinion. From 1997 to 2001, Enron paid Andersen $5.7
million in connection with work performed specifically on the LJM and
Chewco transactions. The Board appears to have reasonably relied upon
the professional judgment of Andersen concerning Enron's financial
statements and the adequacy of controls for the related party
transactions. Our review indicates that Andersen failed to meet its
responsibilities in both respects.
Vinson & Elkins, as Enron's longstanding outside counsel, provided
advice and prepared documentation in connection with many of the
transactions discussed in the Report. It also assisted Enron with the
preparation of its disclosures of related-party transactions in the
proxy statements and the footnotes to the financial statements in
Enron's periodic SEC filings.\2\ Management and the Board relied
heavily on the perceived approval by Vinson & Elkins of the structure
and disclosure of the transactions. Enron's Audit and Compliance
Committee, as well as in-house counsel, looked to it for assurance that
Enron's public disclosures were legally sufficient. It would be
inappropriate to fault Vinson & Elkins for accounting matters, which
are not within its expertise. However, Vinson & Elkins should have
brought a stronger, more objective and more critical voice to the
disclosure process.
---------------------------------------------------------------------------
\2\ Because of the relationship between Vinson & Elkins and the
University of Texas School of Law, the portions of the Report
describing and evaluating actions of Vinson & Elkins are solely the
views of Troubh and Winokur.
---------------------------------------------------------------------------
Enron Employees Who invested in the LJM Partnerships. Michael
Kopper, who worked for Fastow in the Finance area, enriched himself
substantially at Enron's expense by virtue of his roles in Chewco,
Southampton Place, and possibly LJM2. In a transaction he negotiated
with Fastow, Kopper, and his co-investor in Chewco received more than
$10 million from Enron for a $125,000 investment. This was inconsistent
with his fiduciary duties to Enron and, as best we can determine, with
anything the Board--which apparently was unaware of his Chewco
activities--authorized. We do not know what financial returns he
received from his undisclosed investments in LJM2 or Southampton Place.
Kopper violated Enron's Code of Conduct not only by purchasing his
personal interests in Chewco, LJM2, and Southampton, but also by
secretly offering an interest in Southampton to another Enron employee.
Ben Glisan, an accountant and later McMahon's successor as Enron's
Treasurer, was a principal hands-on Enron participant in two
transactions that ultimately required restatements of earnings and
equity: Chewco and the Raptor structures. Because Glisan declined to be
interviewed by us on Chewco, we cannot speak with certainty about
Glisan's knowledge of the facts that should have led to the conclusion
that Chewco failed to comply with the non-consolidation requirement.
There is, however, substantial evidence that he was aware of such
facts. In the case of Raptor, Glisan shares responsibility for
accounting judgments that, as we understand based on the accounting
advice we have received, went well beyond the aggressive. As with
Causey, the fact that these judgments were, in most if not all cases,
made with the concurrence of Andersen is a significant, though not
entirely exonerating, fact. Moreover, Glisan violated Enron's Code of
Conduct by accepting an interest in Southampton Place without prior
disclosure to or consent from Enron's Chairman and Chief Executive
Officer--and doing so at a time when he was working on Enron's behalf
on transactions with LJM2, including Raptor.
Kristina Mordaunt (an in-house lawyer at Enron), Kathy Lynn (an
employee in the Finance area), and Anne Yaeger Patel (also an employee
in Finance) appear to have violated Enron's Code of Conduct by
accepting interests in Southampton Place without obtaining the consent
of Enron's Chairman and Chief Executive Officer.
* * *
The tragic consequences of the related-party transactions and
accounting errors were the result of failures at many levels and by
many people: a flawed idea, self-enrichment by employees, inadequately-
designed controls, poor implementation, inattentive oversight, simple
(and not-so-simple) accounting mistakes, and overreaching in a culture
that appears to have encouraged pushing the limits. Our review
indicates that many of those consequences could and should have been
avoided.
Senator Dorgan. Mr. Powers, thank you very much. Your
report is very helpful, and most of us on the Committee have
heard your testimony in the U.S. House of Representatives. We
have since that time heard testimony from others, including Mr.
Skilling. I would like to ask a series of questions to begin
with, and let me thank you again for being willing to appear
here today.
Can you tell us again what you did not investigate, and
why? We understand what you did investigate, especially with
respect to Mr. Fastow and the partnerships. What did the Board
of Directors ask you not to investigate, and why?
Mr. Powers. Well, they asked us to investigate the related-
party transactions, and the reason for that is that questions
were being raised about them in the newspapers, and
particularly The Wall Street Journal. At the time we started
our investigation, similar questions were not being raised
about other partnerships, and as several Senators this morning
mentioned, there are many, many other partnerships, other than
these related-party transactions. They were not being
questioned, and for that reason we were not asked to go into
them.
I should say it was an extremely demanding task. We had a
great deal on our plate in the 3 months we had, even in these
transactions.
Senator Dorgan. But those questions were raised at the time
that you were conducting the investigation. As I understand the
point, that they were not raised prior to the Board empaneling
you, but during the conducting of your investigation all of
these issues had been raised. I specifically wonder about
insider trading, which also would be of great significance, and
perhaps would involve the Board of Directors and key officers
of the company. Did you go back to the Board and suggest that
perhaps we need to also address insider trading? I am just
trying to understand here the focus.
Mr. Powers. Mr. Chairman, let me say here, those are
absolutely crucial and important issues that need to be
investigated. To be frank, it was all we could do, working very
diligently and very hard, to get to the bottom of these
transactions, and I think we have performed a service in
outlining these transactions, but we simply did not have the
time or the resources to look more broadly into these other
issues.
Senator Dorgan. Mr. Powers, when you looked at the related
partnerships, did you ask the corporation for the names of the
investors in the partnerships and, if you did, did you receive
those names, and let me ask, how many partnerships did you
review?
Mr. Powers. We reviewed the LJM partnerships and Chewco,
the related party, the related-party partnerships, the related-
party transactions. We did not review all the other
partnerships.
Senator Dorgan. Did you review, for example, Braveheart?
Mr. Powers. No.
Senator Dorgan. So you reviewed several partnerships. Did
you seek the names of all of the investors in those
partnerships?
Mr. Powers. We sought the materials from the partnerships,
and the partnerships did not cooperate with us.
Senator Dorgan. The partnerships did not cooperate?
Mr. Powers. The partnerships did not.
Senator Dorgan. How many partnerships do you estimate
existed in this corporation?
Mr. Powers. I have seen figures up close to 3,000, and you
are quite right, it is an important point to note we only
investigated three of them--now, they were related-party
transactions, partnerships--and found these problems.
Senator Dorgan. Mr. Powers, I believe you indicated that
you spoke with Mr. Lay. Your investigation had the opportunity
to meet with and speak with Mr. Lay and ask him questions.
Mr. Powers. Yes.
Senator Dorgan. Who did not speak with you that you
requested to speak to in this corporation? Did you have the
cooperation of all of the officers of the company and all the
directors of the company, or were there those who refused to
meet with you?
Mr. Powers. Well, the people that were then currently
employed by the company did cooperate with us. Kopper did not
cooperate with us. Others who were no longer with the company
involved in these transactions did not cooperate with us.
Fastow, we had a very--about an hour interview with him, and
there was very little information exchanged. It was not as
though he totally refused to talk with us, but he was not
cooperative in the interview.
Senator Dorgan. You met with Mr. Lay, Mr. Skilling, and Mr.
Fastow?
Mr. Powers. We met with Mr. Skilling; we had an interview
with Mr. Skilling. We met with Mr. Fastow, but extremely little
information was exchanged. I would say it was an uncooperative
interview.
Senator Dorgan. Would you agree that, based on looking at
several partnerships and telling me that you do not know who
the investors in the partnerships that you looked at were, that
for us to understand how you put the pieces of this puzzle
together, ultimately we are going to have to evaluate what are
all the partnerships and who are all the investors in these
partnerships. Would you agree that is an important piece of
information to understand what happened?
Mr. Powers. I think it is a vital piece of information, and
again, we see this as laying out some basic facts. It is a
start, but we did not have the ability to compel testimony, we
did not have subpoena power.
Senator Dorgan. Help me to understand the partnerships you
did look at. For example, if Enron owned 97 percent of a
partnership, they would have met the 3 percent test. But in
order to have records for an auditor, would the corporation not
have to have the records of that partnership, including the
outside investors, because how would an auditing firm
understand whether the 3 percent test has been met? And, if
that is the case, and I would expect that to be the case, did
you seek those records from the Enron Corporation and not get
them?
Mr. Powers. We got what we sought from Enron.
Senator Dorgan. Did you seek the names of the investors in
the three partnerships that you investigated?
Mr. Powers. I do not believe Enron had that. Enron tried to
keep a distance from these LJM partnerships.
Senator Dorgan. But I am not asking what you believe. I am
asking whether you sought the information and they refused to
provide it, or you sought the information and they said we do
not have it.
Mr. Powers. Yes. It is the latter.
Senator Dorgan. Is that not totally implausible, that a
company that has a 97 percent stake in a partnership would say
to you, an investigator on behalf of the Board of Directors, or
an auditing firm that would come in who said, show us the
records, is it not implausible for them to say, we do not have
records? That is unbelievable to me.
Mr. Powers. Well, they did not have--the LJM partnerships
would provide 3 percent equity, under this 3 percent equity
test, into a transaction with which Enron was doing business,
and as long as LJM showed up with the 3 percent equity, from
Enron's point of view, they just dealt with the general partner
of LJM.
Senator Dorgan. How would they know whether the 3 percent
test is met? I mean, I am asking not just for these three
partners, or these three partnerships, but we are going to need
to try to understand what is the quilt that was put together
here in order to understand really what is the dimension of
what happened here. What are the interlocking investments made
by whom? You indicated you limited your inquiry to the three
partnerships, and that you were unable to get the information
on who the investors were in the three partnerships because the
partnerships were separate and special purpose entities, and as
such, the information is deemed to be private.
Mr. Powers. They dealt through their general partner, and
Enron's position, what the Enron people we interviewed told us
as to why they did not know who those investors in LJM were,
was that they wanted--this is what Enron is saying to us.
Senator Dorgan. Did you believe that?
Mr. Powers. Well, I am not sure I can pass on the
credibility of it. Clearly, Fastow did not want people looking
into what was going on in those partnerships. Enron's
explanation was they wanted to keep a distance with those
partnerships, and did not look into them as to--or things like
Fastow's compensation, and issues of that sort.
Senator Wyden. Would the Chairman yield for just 1 second?
Senator Dorgan. I would be happy to yield.
Senator Wyden. There was a very significant development
today, Mr. Powers, and that was the newspaper account that
indicates that Mr. Lay personally signed off on the LJM
coinvestment deal. Did you find any evidence that that was the
case, because the news today is saying this was a deal approval
sheet from June of 2000, and that would, if confirmed, undercut
the argument Mr. Lay has been making that he did not know much
about what was going on. Can you tell us anything about this
pretty significant development today?
Mr. Powers. We note that in our report there was one
instance where we were able to identify that Mr. Lay had signed
off on a deal approval sheet for one of the underlying
transactions with LJM, and it is on, I think, page 144 of our
report.
Senator Wyden. I thank my colleague for yielding. I think
this is significant, because it is the first time at least I
have seen any evidence that he had personally signed off on one
of these questionable partnerships and this, in my view,
directly undercuts the argument that Mr. Lay did not know what
was going on. I thank my colleague very much for his courtesy
in yielding.
Mr. Powers. Senator, that is in our report. That instance
is in our report.
Senator Dorgan. I have a broad range of questions, and I
appreciate your patience. Our inquiry here is to try to have
you help us understand this operation. Based upon what you
understand, and my understanding of the records that I have
seen, was it not the case that the 3 percent in some of the
partnerships that you studied involved--controlled in some
cases by Enron employees, and if so, the entity could not
possibly have been an arm's length transaction? I am just
trying to understand how we get to the names of all the
investors and all the partnerships if you could not get to the
names of the investors in the three you studied with the
sanction of the Board of Directors to go do it.
I will come back to this question, and I also will come to
a question of while you were doing this study, reports came out
about shredding that was going on in Enron, and I will ask if
the Board of Directors might have urged you to take a look at
that, or if you asked questions of Mr. Lay, Mr. Skilling and
others who authorized shredding and what documents were
shredded.
The reason I will ask that is I think in order for you to
do your work, you are going to want to have known as you
conducted this inquiry whether the company was busy shredding
documents you needed. Clearly, the Congress is very interested
in whether the documents that were being shredded were
documents we need for this evaluation.
So I have a range of other questions. Maybe you will want
to answer the shredding question now, then I will turn to
Senator Hollings.
Mr. Powers. Well, when that first came up in the company we
read about it in the newspapers, and when the FBI came in to
investigate the company we cooperated, and I think we had a
secure system for the Enron documents that we had. There is
surely, there may be information on those documents that were
shredded that would have helped us, and surely they would help
anyone else that is investigating, and especially people with
subpoena power that can investigate.
We did not see a hole in the documentation for the
transactions we were looking into, so we were able to figure
out what these Raptor and Chewco transactions were like with
the documents we had. Whether there are handwritten notes or
other things on the other documents that we did not have, say,
multiple documentation in similar transactions, we cannot say,
and it is a serious issue.
Senator Dorgan. We will have several rounds of questioning.
Senator Hollings.
The Chairman. Well, Senator Wyden asked Dean Powers about
that sign-off on Jedi. Enron consolidated Jedi. There is no
indication in the Board minutes that this consolidation was
ever presented to the Board. Lay did not know about the
consolidation, and does not recall that the consolidation was
ever brought to the Board, yet his signature was there.
Mr. Powers. His signature, which we document in the report,
was on a transaction called Backbone, which was a transaction,
it was a sale of some dark cable to one of the LJM, I think
LJM2.
The Chairman. Well, Dean, how much does that represent? I
am trying to get to the off-balance-sheet debt, and you had
Jedi, LJM, and one other. I said you only got the three of
them. My just quick study, that would represent about $1\1/2\
to $3 billion. What would you say it would represent, how much
debt as a result of these related-party transactions? In other
words, they did not appear on the balance sheet.
Mr. Powers. I do not have the exact figure. I think the
range you suggest is about right.
The Chairman. Well, I would ask the Committee to put in the
record the assets and debts shown that appeared according to
The New York Times, that record there, and it shows some $30
billion, and yet your report only covers 3 of the $20 billion.
[The information referred to follows:]
Enron's Collapse; Complex Web of Relationships in Boom and Bust
The New York Times, January 13, 2002
by John Schwartz
The cast of characters in the Enron drama is lengthy, and their
relationships are complex.
The Executives
Kenneth L. Lay gained national fame as the chairman and chief
executive of Enron, a company that reshaped the nation's energy
markets--and notoriety as the company flamed out spectacularly. A man
with a doctorate in economics and an evangelical belief in free
markets, Mr. Lay turned an old-fashioned gas pipeline operator into the
world's biggest energy trader. But when Enron faltered, he could not
explain the company's finances to the satisfaction of Wall Street or of
Dynegy Inc., a rival that offered to rescue Enron but ultimately walked
away from a proposed merger.
Mr. Lay's longtime No. 2, Jeffrey K. Skilling, fostered a culture
at Enron described as creative and cutthroat. He led the company into
new markets, setting up trading desks for paper, chemicals, water
rights and high-speed Internet service.
Mr. Skilling was chief executive for six months, resigning last
August. He said last month that he was stunned by the company's rapid
decline.
Enron replaced its chief financial officer, Andrew S. Fastow, in
October, seeking to placate investors and regulators who had begun
questioning a set of unusual partnerships he arranged to shift debt off
the company's books. Two weeks later, the company revised its
accounting for the partnerships, wiping away about $600 million in
profits it had reported over the previous five years. Mr. Fastow earned
$30 million from his investments in the deals.
The Board
Enron recruited prominent people to its Board of Directors, but
given the company's collapse, analysts give them low marks. The
directors include Wendy L. Gramm, the former chairwoman of the
Commodities Futures Trading Commission and the wife of Senator Phil
Gramm, Republican of Texas.
Ms. Gramm serves on the Board's audit committee, which is
responsible for the company's accounting and financial reporting. Until
1998, she owned Enron shares; when the Gramms decided that the stock
presented conflict of interest issues, she sold her shares for
$300,000. Since then, the company has placed her Board pay in a
``deferred account'' that can be tapped later.
Also on the Board is Dr. John Mendelsohn, president of the M. D.
Anderson Cancer Center, one of Houston's most prestigious institutions.
Enron has donated more than $600,000 to the center in the last five
years. Another audit committee member, Lord John Wakeham, was in
Margaret Thatcher's inner circle when she was Britain's prime minister.
The Lawyers
No corporate crisis would be complete without celebrity lawyers,
and the Enron debacle has enlisted some of the biggest. David Boies,
who took on Microsoft in the federal antitrust suit, is representing
Mr. Fastow. Robert S. Bennett, who represented President Bill Clinton
in the Paula Jones scandal, is representing Enron in Washington.
The Politicians
Mr. Lay--``Kenny Boy'' to his friend George W. Bush--is a major
contributor to both political parties. Mr. Lay and other Enron
executives have given more than $550,000 to Mr. Bush in his political
career.
Enron's executives met with Vice President Dick Cheney four times
last year to discuss energy matters. When Mr. Cheney was chief
executive of Halliburton, a unit of the company built Houston's new
baseball stadium, Enron Field. Before he became the president's top
economic counselor, Lawrence B. Lindsey was a paid adviser to Enron.
Karl Rove, Mr. Bush's chief political strategist, and I. Lewis Libby,
Mr. Cheney's chief of staff, were investors in the company.
The ties reach far beyond the White House. The Republican national
chairman, Marc Racicot, the former governor of Montana, was a lobbyist
for the company until last week. In Texas, Mr. Bush's successor, Rick
Perry, has been criticized for appointing a top Enron executive to the
state's Public Utility Commission.
The Accountants
Joseph F. Berardino, chief executive of the accounting firm Arthur
Andersen, Enron's longtime auditor, is caught in the Enron net. In
December, he told Congress that Enron might have illegally hidden
information from its auditors. Last week, Andersen disclosed that its
employees had destroyed documents related to its auditing of Enron--
even after the government began investigating Enron's fall.
If the story seems to take on the breadth of a Cecil B. DeMille
epic, that may only be appropriate. For there is a cast of thousands:
the company's investors, including Enron employees who saw their
retirement savings disappear virtually overnight. Their loss--and their
anger--guarantee that the investigations of Enron are only beginning.
The Chairman. It says here, and I am reading from Business
Week now, Dean Powers, Enron's bankruptcy filing shows $13
billion in debt for the parent company and an additional $18.1
billion for affiliates, but that does not include at least $20
more billion estimated to exist off the balance sheet, so you
folks only looked at 3 of the $20 billion.
Mr. Powers. That is correct, and still there were these
problems we uncovered.
The Chairman. Well, this report we said will be here. We
have got Dean Powers' report, so our work is done for us, not
at all. That is just a cursory review at best, is that not
right?
Mr. Powers. Absolutely. It is a start, and we think you are
absolutely right on that.
The Chairman. And, for example, maybe you can explain the
statement on page 3. Enron utilized off-balance-sheet
transactions because the company was growing quickly, and the
balance sheet was not large enough to handle the growth. What
do you mean, they do not have that wide a piece of paper down
in Texas? What do you mean, the balance sheet was not large
enough to handle the growth?
Mr. Powers. I think they needed to take on more debt than
their balance sheet would support. That actually was Lay's
explanation when we interviewed Lay.
The Chairman. Well, to make only a cursory report just a
bare start, Dean, you attracted the rats leaving the sinking
ship. Why are you swimming toward the ship? Everybody wonders
about that, and I have got the highest respect for you and the
law school. In fact, I have worked with the business school
down there, George Kozmeski, for years, at the University in
Austin, but to take on this thing, and then be made a part of
it, put on the Board for one, just to make an investigation,
you are investigating the Board, then all of a sudden you are
part of the Board, so a Dean of a law school ordinarily would
not take on a conflict of interest, would he?
Mr. Powers. Well, I thought when I was asked that Enron was
a major company in Texas, important for the Texas economy, and
getting to the bottom of these transactions, I thought I could
do a service, and while I agree fully this is just a start----
The Chairman. So you are not near finding out what
happened, what caused their collapse.
Mr. Powers. Not near the bottom, I don't think.
The Chairman. And you are going to continue to work?
Mr. Powers. The charge of the Committee has been completed.
I think a lot of what----
The Chairman. You are not even near to making a conclusion
and yet you do not know what happened.
Mr. Powers. Well, we got on to get to the bottom of these
transactions that were being discussed in the newspapers, these
related party transactions, which do have special problems.
The Chairman. With only $17 billion not covered. Let me ask
you, you said on January 16, some 12 of you met with Mr.
Kenneth Lay to take his testimony as to what went on, is that
not correct?
Mr. Powers. Yes. I was at that interview.
The Chairman. Did you use a stenographer?
Mr. Powers. We did not. We had a 17-page single-space
memorandum. We have been working with the staff to provide the
results of all of our interviews to the Committee.
The Chairman. Now, wait a minute, you say you did not use a
stenographer, so all of you were making different notes from
time to time as he testified, were you not?
Mr. Powers. Well, somebody took notes.
The Chairman. Can you furnish those notes for us?
Mr. Powers. Well, we turned those notes as a draft into the
memorandum.
The Chairman. I understand that.
Mr. Powers. We did not keep the notes.
The Chairman. You shredded the notes?
Mr. Powers. Senator, there is nothing that is not in the
report, and this was the standard, accepted way that has been
worked by many investigators over a long period of time to do
internal investigations, is to use the procedure that we used.
The Chairman. The standard procedure is not to take down
the testimony of the gentleman that you are investigating and
otherwise, while you took some notes, to destroy the notes,
that is your testimony?
Mr. Powers. We used those to prepare a very detailed,
within 24 hours in all but a few cases, very careful, accurate,
complete description of what went on in those interviews, and I
do think that is standard practice in investigations of this
sort.
The Chairman. Thank you, Mr. Chairman.
Senator Dorgan. Senator Fitzgerald.
Senator Fitzgerald. Thank you, Mr. Chairman. Dean Powers, I
thought that the report that you did was very good, very
professional. You obviously had top people working on your
team, but I am very concerned that the Board limited your
mandate just to related-party transactions because, as I read
your report, it makes it sound like all the fake earnings were
simply being caused by one rogue CFO, and as Senator Hollings
has pointed out, your report only digs into those related-party
transactions that involved Mr. Fastow, and there were
apparently many other questionable transactions with other
partnerships or SPE's that were off the books that need to be
looked into.
Has your committee gone back to the Board and recommended
further review of more transactions?
Mr. Powers. Well, of course, the answer is we have not. The
company is in bankruptcy. Things are being done in conjunction
with the creditors' committee now. It is a very different
situation than we started, and I will be candid about it, I
need to return to devote my full time and efforts to the
University of Texas Law School, so I am not sure I am in a
position to do that.
Senator Fitzgerald. Is the Board just going to leave the
rest of the investigation to the Justice Department, the SEC,
and perhaps plaintiffs' attorneys?
Mr. Powers. Well, I think those entities are investigating,
and as far as I know the Board does not have----
Senator Fitzgerald. Why did the Board limit your mandate to
partnerships in which you had an Enron insider as general
partner of the partnership? What was the policy rationale for
limiting your review in that way?
Mr. Powers. Well, those partnerships, for the very reasons
we point out in the report, are very troubling because of the
conflict of interest with Fastow being on both sides of the
deal, were especially troubling, and questions had been raised
in the financial press, and so those were the transactions we
looked into. I do not think we possibly could have done
anything like this kind of investigation over a broader range
of transactions, which is not to say it is not important that
those investigations be done. It is crucial that they be done.
Senator Fitzgerald. Well, I think there was one written
report about the Braveheart partnership where Braveheart
borrowed $115 million from Canadian Imperial Bank of Commerce.
Enron guaranteed their borrowings, and then Braveheart took
$110 million of that and paid it to Enron for a worthless
broadband video business that had no revenues to speak of, no
clients and no income. Apparently that was not a related-party
partnership, and that is why you did not look into it.
Mr. Powers. Correct.
Senator Fitzgerald. But it is possible that there were
dozens, or even more other transactions wherein the valuation
of the asset being transferred to the partnership is in
question, and Enron could have paid an inflated price for it.
Mr. Powers. Absolutely. We found these problems in one
small area, and we do not in any way want to suggest that--much
more investigation needs to be done, and especially by bodies
with subpoena power, and who can compel testimony.
Senator Fitzgerald. You are aware, though, that your report
just focusing on those partnerships that involved the insiders
and Mr. Fastow's CFO office and Mr. Fastow himself, that that
encourages the perception which I think now is kind of out
there amongst the general public that all the troubles seemed
to stem from just this one guy.
Mr. Powers. Well, certainly we tried to be very careful in
the report to make the point you are quite right we are making,
that this looked at a very narrow part of Enron, and it does
not by any means finish appropriate investigations.
Senator Fitzgerald. Now, with respect to those transactions
you looked at between Enron and the Fastow partnerships, it
seems to me that a big question is, who was doing the
valuations of the assets being transferred from Enron to the
partnerships? Your report talks about there being all sorts of
asset sales where Enron would take an apparently questionable
asset, transfer it to the partnership, and they would get paid
a huge sum. Who was supposed to be doing the valuations?
Mr. Powers. Well, Enron did have people who did evaluations
of certain kinds of transactions like hedges, for example, but
ultimately--and that is one of the problems with these
transactions, is Fastow was often negotiating on one side and
people that worked for him were negotiating on the other side,
so these were not arm's length.
Senator Fitzgerald. There is one Board report where Fastow
said, and I can't remember what asset he said he was
transferring to a partnership, but he said they were going to
get an opinion from Price Waterhouse Cooper that in their
opinion the value being received back by Enron was more than
the value that they were transferring to LJM, and I guess that
should have raised some questions. Why is LJM giving more than
this asset is worth? That alone did not make sense. Was Price
Waterhouse Coopers involved in a lot of the valuations? Did you
see them?
Mr. Powers. In many of the evaluations of certain kinds of
transactions, other transactions were negotiated.
Senator Fitzgerald. I know you referred us to page 144 and
145, where there is that Backbone transaction, and I notice at
the end that was a deal that Mr. Lay had himself personally
approved, but I notice that in Backbone the EBS, the Enron
Broadband Services wanted to do this transaction because they
felt substantial pressure to meet their second quarter numbers.
Did Mr. Lay and Mr. Skilling produce an earnings budget,
and did they give that to people throughout the company and
pressure them to meet their earnings numbers? Did you do any
delving into that?
Mr. Powers. Not that I know of. With the chair's
indulgence, I have people who did the investigation with me, so
I want to get these accurate if I may.
From interviews, different areas did have earnings targets.
The connection of those particular earnings targets to Lay and
Skilling is more remote.
Senator Fitzgerald. Did you find out whether Mr. Lay had
hedged his own positions by entering into derivative
transactions?
Mr. Powers. I do not know whether he did or not.
Senator Fitzgerald. I gather there will be another round.
Senator Dorgan. Senator Wyden.
Senator Wyden. Thank you, Mr. Chairman.
Mr. Powers, I want to talk to you about the role of the
accountants in all of this, and I will tell you in starting, as
you know, there is a great discussion around the country about
the need for various accounting reforms, and people are pretty
much shocked to learn that there already is a federal law on
the books today that requires that accountants look for fraud
and move quickly to bring it to the attention of the Securities
and Exchange Commission if it was not corrected, and I spent
nine years trying to get this law on the books, fighting the
profession again and again.
Now, I do not want to ask you for a legal opinion here, but
I want to take you through this law, because my reading of it
is that an awful lot of it really did not seem to get much
attention from the Houston office of Arthur Andersen. Do you
have an opinion before we start in, because I am going to take
you through 10(a) of the Securities and Exchange Act to get
your opinion on each section of this law that is on the books
right now, and do you have any sense as we begin whether 10(a)
should have been triggered by what was going on?
Mr. Powers. I do not. I tried to figure out what went on
with these transactions with a lot of help, but I am not a
securities law or accounting expert.
Senator Wyden. But I guess, Dean Powers, section 2 of the
law speaks specifically to related-party transactions. Did they
comply with that section of the law? That was the area you
zeroed in on. That firm has to have procedures to look at
questionable transactions when they involve related-party
transactions, and I sure as heck do not get a sense that they
complied with it, do you?
Mr. Powers. Again, I am not an expert on the law. They
certainly did not oversee these related-party transactions.
Senator Wyden. Well, that, to me, is a violation of section
10(a). I mean, it says that they have to have procedures in
place to identify related-party transactions and then bring
them to the attention of the company. Do you get the sense that
was complied with?
Mr. Powers. The company all the way up to the Board of
Directors did know that these entities existed, and there were
related-party transactions. I am not an expert on that law, and
I do not have an opinion whether it was complied with. It
certainly raises serious issues that people who are experts on
the enforcement of that law, I agree, need to look into.
Senator Wyden. Well, with all due respect, I do not know
how you can do a thorough inquiry without putting the statute
over here that is a law on the books today. If you just look at
what is going on in this country, there is just hours and hours
of attention being devoted to having a debate about new laws.
What I just described to you is a law on the books right now to
look at related-party transactions, and I still want you to
tell me whether you looked at those related-party transactions
in conjunction with a law that is on the books right now.
Mr. Powers. We tried to figure out what had happened, and
we did not evaluate whether the conduct violated a particular
securities law or accounting law.
Senator Wyden. Well, with respect to the related-party
transactions, the ones you looked at, when it was brought to
the attention of the company, did you find any evidence that
they took corrective action? That is required by federal law.
What did you find?
Mr. Powers. We concluded that they did not oversee these
transactions adequately.
Senator Wyden. But, specifically on that point, when you
found questionable activity in the related-party transactions,
did the company, based upon your effort to examine what they
did, take corrective action?
Mr. Powers. We only delivered our report to the company,
what, on February 2.
Senator Wyden. This was required a long time before. That
is what I think we have learned, was there a discussion about
questionable activity, the law says you are required at that
point to either get it corrected by management, or it goes
directly to the SEC, and I would just like to have some sense,
as you followed the related-party transactions in those three
areas, whether you saw anything indicating that they took
corrective action. Maybe your associates would like to get into
it. It is a fairly straightforward question.
Mr. Powers. I understand. I did not come across anything
with reference to that law. I did not come across anything of
that sort. We did not find anything with reference to Andersen
that Andersen referred to that law, though Andersen did not
fully--we were not able to interview the Andersen people. We
saw some of their work papers and not others. Not to my
knowledge.
Senator Wyden. There is internal e-mail indicating that
there was concern about exposure on this. When you are talking
about a law that is on the books today, and that requires if
questionable activity is taking place with respect to related-
party transactions, I think it is important to find out if
there is any evidence, when it is brought to the attention of
the company, whether it was corrected, and you are telling me
at least at this point you have not found any evidence that it
was done, is that right?
Mr. Powers. That is correct.
Senator Wyden. Let me ask you, with respect to the
cooperation that you had from Arthur Andersen, you said you had
only limited access to the work papers in the Houston office of
Arthur Andersen. Do you believe there was significant relevant
information you were not able to uncover?
Mr. Powers. From Arthur Andersen? Yes. We did not have
access to any of their 2001 work papers. They would have been
very helpful to us.
Senator Wyden. What questions would you have liked to ask
Mr. Fastow and Michael Kopper if you had been in a position to
get access to some of those documents?
Mr. Powers. Well, we would have liked to have found out
from Kopper and Fastow more about the LJM partnerships, as I
answered earlier, that we were not able to get cooperation from
those partnerships themselves.
Senator Dorgan. Let me just ask another question if you
would yield on that point. Why were you not able to have access
to the Arthur Andersen material? Did you ask for it and Arthur
Andersen refused to provide it?
Mr. Powers. We asked from the start of the investigation.
We wanted to set up interviews with Andersen and look at their
work papers. We negotiated with them over some period of time.
We finally got access to some of their work papers. There was
talk about interviews. We tried to get copies of the work
papers, and did not. We, as I said, were not given access to
any of the 2001 work papers as those negotiations were going
on. We then--Enron discharged Arthur Andersen in January, and
the lawyers for Arthur Andersen called and said we are not
going to cooperate any further.
Senator Dorgan. That is surprising because Arthur Andersen
was employed by the company and the Board of Directors, and was
paid a significant amount of money.
Senator Wyden. Mr. Chairman, I know my time has expired. I
am concerned about these two issues. First, the question of
compliance with section 10(a), and second the question of
Arthur Andersen limiting your access to these critical
documents--I find it just totally implausible that Arthur
Andersen's office in Houston failed to understand that the
purpose of these related-party transactions was to sweep debts
and liabilities under the rug. I think just any other
explanation strikes me as totally implausible.
I hope that we will get a chance to have another round of
questioning, but I do think the combination of what looks to me
like ignoring a federal law that is on the books right now that
could have rooted out much of this trouble, plus the
unwillingness to give you access to the documents, is the kind
of one-two punch that has injured a lot of Americans, and I
look forward to the next round.
Mr. Powers. We agree. We would like to have heard
Andersen's explanation of that.
Senator Dorgan. Senator Inouye.
Senator Inouye. Thank you very much.
Dean Powers, although you were not provided access to these
records and files and reports, and although the Andersen firm
did not cooperate with you, you were able to, in your executive
summary on page 5, make certain conclusions. For example, that
the original accounting treatment was clearly wrong, and
accounting treatment was likely wrong in the other
transactions, and that Enron's records show that Andersen
received $5.7 million for advice over and above the regular
audit fees.
You were able to reach the conclusion that they were
clearly wrong. Wrong in what sense, sir?
Mr. Powers. Well, they have admitted in their restatement
some accounting errors, so clearly they were wrong in those.
Our view, based upon the accounting advice that we have, was
that they did not provide sufficient independent accounting
advice to Enron about the nature of these transactions. They
were hedging devices that were basically Enron hedging with
itself, and that is inappropriate, and Andersen would be in a
position to bring professional judgment and evaluation on that,
and they did not do it.
Senator Inouye. This may not be a proper question, but did
you believe at any time that such advice could be criminal in
nature?
Mr. Powers. Well, we did not ourselves make an evaluation
of that. It certainly is something that I know both the Justice
Department and the SEC is looking into this, and I think
appropriately so, but we did not ourselves try to ascertain
whether there was criminal conduct.
Senator Inouye. It is strange to see a firm such as
Andersen, internationally known, providing advice that would be
in your words clearly wrong in basic accounting, in the
structuring of transactions and such.
In your work as Dean of the law school, have you come
across other cases of this nature with accounting firms?
Mr. Powers. No, but that is not, accounting is not my
field. I teach product liability and tort law, mainly.
Senator Inouye. Well, I just hope that Andersen and that
firm can clarify this for us. In your work on the Board, were
you able to interview Mr. Lay?
Mr. Powers. Yes, we were.
Senator Inouye. And, did he suggest to you that he was
fully advised by Andersen?
Mr. Powers. In our interview, this is what he said to us.
He said that he thought these transactions were OK because
Andersen had signed off on them.
Senator Inouye. Because Andersen signed off?
Mr. Powers. Yes. Andersen had approved them. Yes, that is
what he said.
Senator Inouye. Did the company counsel also advise Mr. Lay
that Andersen was correct?
Mr. Powers. Other people in the company, mainly the chief
accounting officer who gave that advice, that is my
recollection of the interview.
Senator Inouye. So the legal counsel, the accounting
counsel on the Enron management team all felt that Andersen was
correct?
Mr. Powers. I do not know whether they felt Andersen was
correct. They referred to the fact that Andersen had approved
many of these transactions, had reviewed and approved many of
these transactions. That is what they said.
Senator Inouye. Do you believe there is a conspiracy
brewing here?
Mr. Powers. Well, I think people, I mean, certainly in the
finance group and in the accounting group understood these
transactions very well.
Senator Inouye. Did you understand these transactions to be
valid, illegal?
Mr. Powers. I think they understood the nature of the
transactions. It is hard for me to see how hedging with one's
own stock could be a legitimate economic hedge. As I said in my
opening statement, there are, I think it is at the Finance
Committee meeting, notes taken there that people understood
this is hedging P&L volatility, that is the accounting aspects
of it, rather than really shifting any economic risk.
Senator Inouye. So your conclusion is that they knowingly
did the wrong thing?
Mr. Powers. They knew they were hedging with their own
stock, and that was inappropriate. Whether they knew it was
inappropriate, they said in their interviews they did not
understand it to be inappropriate.
Senator Inouye. Thank you very much.
Mr. Powers. Thank you, Senator.
Senator Dorgan. Senator Carnahan.
Senator Carnahan. Thank you, Mr. Chairman. I would like to
address a few corrective measures that you might suggest to
this Committee. As you know, a record number of Americans are
participating in the stock market right now through 401(k)
pension plans and private investment accounts, and even online
trading.
The average Americans now are becoming shareholders, and
they have to rely on other people to protect their interests.
They expect management to focus on implementing a successful
and profitable business plan, and they can rely on boards of
directors to oversee the company's management and add yet
another layer of protection and, of course, they rely on
various government regulators to prevent fraud and corruption.
On all fronts, Enron's shareholders were poorly served.
In your opinion, what are some immediate steps that the
Congress could take to give investors confidence that what
transpired at Enron would not happen at other companies in the
future?
Mr. Powers. If I may preface this, I am not a securities
law or accounting expert. To me, as an investor, I might add, a
very modest investor, one key thing is transparency, that
whatever is going on financially inside the company ought to be
accessible to investors and certainly their analysts.
Not being an expert, I do not know whether that is because
there were existing laws that might have been violated, or laws
that need to be enhanced, but that does seem to be an important
area of inquiry that committees, such as this, I think as a
citizen and not as an expert, ought to look into.
I do think issues about the independence of accountants
seem to be an issue that is an important one. I do not myself
have a particular solution to that.
Can I just add, I do think that the tragedy of the retirees
in their 401(k) plans is a serious human tragedy that I do not
have the solution to that, either, but also it is something
that needs to be looked into.
Senator Carnahan. You are a relatively new member of the
Enron Board of Directors, and I am sure you are aware that the
Board is meant to represent the shareholders. Your report
indicates that the Board of Directors failed in its oversight
duties. Could you tell the Committee what reforms have been
instituted among Enron's Board to ensure that it does not
preside over a fraudulent management in the future?
Mr. Powers. I was brought on the Board to conduct this
investigation. I believe that the Board, in cooperation with
the Creditors' Committee, will be restructuring itself. I do
not know that that has taken place. I think there is a
regularly scheduled Board meeting today, and that may or may
not have occurred.
Senator Carnahan. What kind of tough questions do you think
boards should be asking of accountants and executives and
lawyers?
Mr. Powers. I think one lesson I have learned from seeing
the complexity of these transactions, if people on boards do
not understand, or claim that they do not understand what a
transaction is doing before they are asked to approve it--now,
there are many things that go on in a company that boards do
not manage the company, but when something comes to the board,
that is in their purview, they ought to understand. If it is
too complex to understand----
Senator Carnahan. They just accept the recommendation and
give it a rubber stamp?
Mr. Powers. If I were on a board and somebody came to me
with a transaction I did not understand, I would like to think
that I made sure that I understood it or not go forward with
it.
Senator Carnahan. Thank you.
Senator Dorgan. Senator Hutchison.
Senator Hutchison. Thank you, Mr. Chairman.
I want to put a little bit in perspective some of the
earlier questions about the processes for the internal
investigation, and ask you this question. You were brought on
the Board for the specific purpose of doing an internal
investigation around the end of October.
Mr. Powers. Yes, the very end of October, that is correct.
Senator Hutchison. And what was your process in determining
what an internal investigation should accomplish, and the
process that you would use to have that as differentiated from
some other type of outside investigation?
Mr. Powers. Well, actually, about, or sometime about a
week, I think, or maybe a bit more than that, before I actually
came on the Board to conduct the investigation, the Board had
set up this special committee with different people on it and
had hired Wilmer, Cutler, & Pickering, a Washington law firm.
Senator Hutchison. When you say different people, do you
mean people off the Board or people on the Board?
Mr. Powers. People on the Board who had been involved in
the transactions, and I was brought on, as was Ray Trobe, to be
a majority of the Board of people that were not there when any
of these transactions took place, but the Board had hired
Wilmer, Cutler & Pickering. They had hired Deloitte and
Touche--Wilmer, Cutler & Pickering is a leading firm in
conducting these investigations, and I think conducted a superb
investigation here, and that was how we went about structuring
how this investigation would take place.
Senator Hutchison. So you had the law firm, then, that had
done internal investigations, and the process for those was
different, and was it standard in internal investigations that
you interviewed with the group and then one person did a
memorandum about the interview and you all approved it? Was
that said to be a standard operating procedure?
Mr. Powers. Yes, it was.
Senator Hutchison. Was part of that just for time purposes
that you did not take transcripts and then store that?
Mr. Powers. I think that was part of it, but remember also
we did not have any subpoena power, and we had to rely upon the
cooperation of witnesses, and our goal was to find out what
happened, and we were not trying to replicate a criminal
investigation and, for example, we did get Ken Lay to talk with
us, so I think we were able to get information through this
process and that is why lawyers over the years have developed
these processes for internal investigations to get cooperation
with people inside the company.
Senator Hutchison. Did the nature of your internal
investigation change from October, when you started this, until
early February?
Mr. Powers. No. We kept our same task. We worked very
carefully with the SEC. We provided them documents and some
briefings. At some point the Justice Department did start to
investigate, and we worked with them to be sure we would be
providing them with any documents or information they would
need, but that basic investigation to just simply find out what
happened we followed through with.
Senator Hutchison. How did the SEC come into this? Did they
ask to see the progress, the SEC?
Mr. Powers. The SEC started an inquiry and then finally an
investigation. They were, I think, willing to let us
investigate. We did provide them with a lot of documents, and
we were in constant contact with them to make sure that we were
fulfilling our obligations to them.
Senator Hutchison. The last question on this point. You
said that this is the end of your investigation. Do you intend
to stay on the Board of Enron?
Mr. Powers. No. I intend to resign from the Board of Enron
as soon as I am assured that I have fulfilled my obligations to
the SEC.
To come back to the notion that our report is just a start,
but that start and our task of the special committee is over,
and I need to devote full time to being the Dean of the law
school.
Senator Hutchison. Let me just ask you again, back on the
things that you have learned from which we could fashion the
right approach to reform, I think there must be some reform,
probably, in accounting procedures and transparency, and also
on pensions. In what you saw in the transparency and accounting
processes, was the information available and given to outside
people, whether it was an analyst or a Board member, that would
have given them an indication that something was this wrong at
Enron?
Mr. Powers. Well, certainly not this wrong. The disclosures
to the investing world did disclose that there were
transactions between an entity owned by Fastow and Enron. They
were not kept secret in that sense.
Senator Hutchison. Excuse me, but you said Mr. Fastow
actually pursued an ethical clearance on those, did you not?
Mr. Powers. Yes. The Board approved Fastow's involvement,
but I was talking about, that was at the Board. The disclosure
of those transactions to the public. They were disclosed in
minimal terms, and as we point out in the report, they were
not--there was a lot of information about those transactions
that was not fully disclosed.
Senator Hutchison. Even when the Board was required to act,
were they required to say it was OK for Mr. Fastow to have his
joint role? Were they told that it was within the code of
conduct?
Mr. Powers. They made the findings. This is now disclosures
to the Board. I was talking earlier about disclosures to the
public, but disclosures to the Board. For example, the Board
did not look into what Fastow's compensation was. They did not
insist that he tell them what that compensation would be.
Senator Hutchison. Would there have been any reason to
question that there was not added compensation for this other
partnership?
Mr. Powers. Well, by the time they got to LJM2 it was a big
enough partnership that it should have raised red flags that
there may be quite a bit of compensation available there just
because of the size and the nature of the partnership. LJM1 did
not have that much money in it.
Senator Hutchison. Well, I see my time is up. Is there
anything else that you would say we should look at in reform on
making those transparencies transparent to an average board
member or analyst, or stockholder?
Mr. Powers. I think it is absolutely crucial there be
transparency to the public and to the shareholders.
Senator Hutchison. Of information that is made available to
the board? Should it all be there?
Mr. Powers. I think enough information should be disclosed
in the financial statements in a clear enough way that makes
the investing public understand, either understand the nature
of the business and its financial risks, or understand that it
is too complicated and they cannot understand it, but it ought
to be disclosed to the public.
Senator Hutchison. Thank you, Mr. Chairman.
Senator Dorgan. Senator Nelson.
Senator Nelson. Thank you, Mr. Chairman. Mr. Powers, I am
going to ask you a series of questions that you may, in your
investigation, have come into confrontation with some of the
facts that might illuminate the answers to some of these
questions, but just to lay the predicate, our Florida
retirement fund is one of the largest in the country. It is the
fourth largest pension fund in the country, and just to give
you a sense of what was happening I will quote from a New York
Times article that sums it up pretty quickly.
Last October, after Enron announced $1.2 billion in losses,
and the SEC opened its investigation, the fund, meaning the
Florida retirement fund, bought $7.1 million more of Enron
stock, and after Enron's Chief Financial Officer, Fastow, was
ousted on October 24, the fund bought another $16.1 million
worth of stock, and when Enron announced last November that it
had overstated its profits, the fund bought still another $11.7
million.
The story also reported that an Alliance Capital executive,
which was the outside money manager that was buying this, Frank
Savage, also is a member of Enron's Board. Do you know Frank
Savage?
Mr. Powers. I do know Frank Savage. I do not know his
connection with the pension fund.
Senator Nelson. When Mr. Lay took over as CEO last August,
he publicly stated that he wanted to focus on investor
confidence and, during the course of your investigation, did
you review any policies or communications on whether Enron
executives or Board members promoted the purchase of the stock
by public institutional investors, such as the Florida
retirement fund?
Mr. Powers. No, we did not look into that. It is an
important issue, but we did not investigate that.
Senator Nelson. From what you observed, do you have any
opinion on corporate executives or Board members soliciting the
purchase of stock by employees or others?
Mr. Powers. I do not. They should follow the legal
requirements and be truthful, but I do not have an opinion on
that.
Senator Nelson. Between June and November of last year, do
you have any personal knowledge if any Board members or Enron
executives made calls to public institutional investors to
promote the stock?
Mr. Powers. I do not have any knowledge of that.
Senator Nelson. Are you aware of any Board members with
direct or indirect ties to Florida and outside money managers
that purchased stock for the state pension fund?
Mr. Powers. No, I do not, Senator.
Senator Nelson. Other than what I just told you about Mr.
Savage?
Mr. Powers. That is correct.
Senator Nelson. It is my understanding he resigned from
that outside money manager in August. There had been plenty of
Enron stock that had already been purchased, but it was not at
this particular time when the stock was plummeting in value.
On November 19, Enron filed its quarterly report to the SEC
revealing that the company owed $690 million in loans. Do you
know if anyone in Enron made calls to money managers and others
to stabilize the stock before the loans came due?
Mr. Powers. I do not know.
Senator Nelson. You obviously see where my line of
questioning is going, which is what I am concerned about. Does
Enron have a conflict of interest policy for its Board of
Directors?
Mr. Powers. Yes.
Senator Nelson. Do you know if that conflict of interest
policy would cover any of these things we are talking about
here?
Mr. Powers. I do not. I would have to look more carefully
at them.
Senator Nelson. Your committee report describes hands-on
participation by Arthur Andersen in structuring some of the
partnerships which your committee saw as a major part of the
auditor independence problems between the company and Arthur
Andersen.
Mr. Powers. Yes, that is correct.
Senator Nelson. I agree with your committee's evaluation of
the auditor independence and, thus, a number of us are working
on legislation to change the rules so that accountants could
not perform any management consulting for firms that they
audit. Do you think, on the basis of what you have seen here,
that companies should consider changing their auditors, say,
every 5 to 7 years?
Mr. Powers. Well, as I said, I am not an expert in
accounting, and I am reluctant to have a firm proposal. I will
say the issues you are raising were surprising to me how much
involvement an accounting firm could have on the audit side and
what has come to be called the consulting side, although I do
understand sometimes the audit function has to take place
during the actual implementation of the transactions, as well.
Senator Nelson. A number of us are also interested in the
Board of Directors' independence. The Council of Institutional
Investors, Arthur Levitt, and others have recommended that
company boards meet a strict definition of independence, and
that means no additional consulting fees, use of the corporate
aircraft, and support of director-connected philanthropies and
institutions. Do you have any sense in Enron's case how many
current Board members could meet this standard?
Mr. Powers. I do not. I assume many of them have used the
corporate jet. On the other issues, I do not know.
Senator Nelson. Like director-connected philanthropies and
so forth, you just do not know that?
Mr. Powers. Correct.
Senator Nelson. I want to look into also directing the SEC
to amend disclosure rules requiring specific disclosure of any
links between the directors and the company and the company
executives. In your investigation, do you have a sense of how
many current Board members have other relationships with the
company?
Mr. Powers. I do not, one way or the other. I do not know
if they have other relationships with the company.
Senator Nelson. This Committee has requested further
information from Enron on all of its partnerships. Do you have
a sense of when we will be able to see any additional
information from the company on the investors in these
partnerships?
Mr. Powers. I do not. I certainly--I mean, as I told
Senator Hutchison, I will not be a Board member very long. I
certainly would support, as has our special committee, support
any information that is helpful in these investigations, but I
do not know when the company's lawyers are going to be able to
respond to that.
Senator Nelson. Mr. Chairman, may I ask just one quick
final question? In 1999, Enron was reviewing the possibility of
a merger with a German company called Eon. Media reports
indicate that the German company did not pursue the merger
partially because of their concerns about the Enron
partnerships that you looked into. Did your Committee look back
at this failed merger and investigate why the company did not
at that point review the structure and debt of those
partnerships?
Mr. Powers. We did not.
Senator Nelson. Thank you, Mr. Chairman.
Senator Dorgan. We likely will be dealing with the pension
issues as the subject of a future hearing.
Senator Nelson. What issues?
Senator Dorgan. The pension fund issues you raised.
Senator Nelson. Thank you very much.
Senator Dorgan. Let me ask, Mr. Powers, I think you
described this morning the purpose of the investigation was
narrower than it was to look at the transactions with three
partnerships. You did that and you issued a report early in
February, and Mr. Lay resigned late in January.
As a Board member, did Mr. Lay resign prior to the report
because he would have been dismissed when the report came out?
Did Mr. Lay resign under pressure from the Board?
Mr. Powers. I think Mr. Lay resigned with a suggestion from
the creditors' committee due to the bankruptcy.
Senator Dorgan. So, if he had not resigned voluntarily, the
Board was prepared to take action to vacate that?
Mr. Powers. Well, the Board did not--we had not given the
Board the report. I believe after our report came out Mr. Lay
then resigned as a director also.
Senator Dorgan. As a Board member, though, knowing what you
know from the report, would you have wanted Mr. Lay to remain
on?
Mr. Powers. No, and I think that was the feeling of the
rest of the Board, as well.
Senator Dorgan. Let me ask, other employees now inside the
Enron Corporation who have not yet been identified in your
report publicly, for example, because you looked at only three
partnerships, and because we know there are hundreds, perhaps
thousands, as a Board member are you worried there are others
inside the corporation who were involved in the construction of
these partnerships who are still at their desks on the job?
Mr. Powers. Let me first say, the huge majority of all
Enron employees are honest and hard-working. Would I be worried
that there might be issues elsewhere in the company? I would be
worried. I have no--we did not investigate them, but it
certainly would call for scrutiny.
Senator Dorgan. But because you examined only three
partnerships, and you described why you choose those three, one
would logically be worried, based upon what you found in those
three, that there are other things happening in perhaps other
partnerships.
Mr. Powers. One of the things we point out in the report is
that there was a corporate culture of extreme aggressiveness in
pushing to and beyond the limits, and that would raise
concerns.
Senator Dorgan. I called it a corporate culture of
corruption. Would that be accurate?
Mr. Powers. Certainly in these partnerships I think that is
accurate.
Senator Dorgan. Let me ask you about Mr. Skilling's
statements for a moment. Mr. Skilling testified, as you know,
in the U.S. House of Representatives before a subcommittee, and
Mr. Skilling stated with regard to the LJM partnerships he
believed at that time there were adequate controls in place,
that the controls were being complied with, and that he was
discharging to the full extent of his mandate his obligations
to the Board with respect to the process that as in place. Can
you respond to that? Do you believe Mr. Skilling is accurate in
that representation?
Mr. Powers. Well, with respect to oversight of the
transactions with the LJM partnerships, there is very strong
evidence that Mr. Skilling was to play a substantial role in
overseeing those transactions to make sure that they were at
arm's length.
For example, at a Finance Committee meeting, the minutes
discuss or show Fastow describing to the Finance Committee
Skilling's role. I think Mr. Skilling said he was in and out of
that meeting. The minutes show in the very next paragraph that
Skilling and Fastow went on to describe more of what the
benefits were, that the evidence shows that--and certainly the
Board believed he was taking a much more robust oversight role
than his testimony indicated, and I must say his testimony was
consistent with the testimony he gave to us when we interviewed
him. He said he was only vaguely familiar with the
transactions.
Senator Dorgan. But in his testimony, he said, look, I did
everything that was required of me. It seems to me your report
says that is nonsense.
Mr. Powers. Our conclusion is that is not true, is that he
did not perform the oversight functions that the Board thought
he was performing.
Senator Dorgan. Now, I want to ask a couple of other
questions. One, let me just ask the question about what the
Board now is doing. You are now a member of the Board of
Directors. I think you recognize from the questions asked today
there is much you did not investigate that perhaps, if you were
on a board launching an investigation today, you would
certainly say, let us look at this insider trading, and a whole
series of things, but because this report does not include
that, we now have a partial portrait of three partnerships, and
then we have a cascade of other charges and allegations and
information that is coming out. I mentioned Braveheart as one.
What is the Board doing now? Is the Board of Directors now
saying, whoa, wait a second, there is a whole lot more here
that we did not look at, we need on an internal basis now to
take a look at these issues? Is that what the Board is
thinking, or is the Board thinking, well, we just looked at
these three areas and we did not ask anybody to look at
anything else, so we will just wait and see what others
uncover?
Mr. Powers. I think the Board, at the Board meeting that I
intended to present this report, there was a great deal of
discussion of setting up a process to restructure the Board,
and that given Enron's bankruptcy needs to be done with close
consultation with the creditors. It is my prediction that over
a short period of time, with the cooperation of the creditors'
committee, the Board will be entirely restructured, with the
exception of Mr. Trobe, who was brought on, as I was, to
conduct this investigation.
Senator Dorgan. What does restructure mean?
Mr. Powers. New Board members.
Senator Dorgan. Dumping the old Board members? So the old
Board members will be dumped?
Mr. Powers. Yes.
Senator Dorgan. And replaced by new Board members?
Mr. Powers. Yes. I think that is--I cannot say that for
certain, but that process was put in place last week, I think
with the anticipation that there would be a totally new Board
with cooperation of the creditors.
Senator Dorgan. I suspect you do not know the answer to
this, but let me ask, in recent days we have discovered that
just prior to the recalculation of profits, or actually losses
for the company, that about $55 million in bonuses were given
to the employees in the Enron Corporation. Did you come across
that information as you took a look at what was going on?
Mr. Powers. Yes.
Senator Dorgan. Was that something that the Board of
Directors was knowledgeable of and approved of?
Mr. Powers. Yes, and the advice of the bankruptcy lawyers
was that it was--and this is what they were saying, was it was
important to keep the trading business operating. In fact, the
trading business was sold to UBS Warburg so that there would be
some asset for the creditors, including the employees, and
those who were creditors of the company, and that that was a
necessary thing to do in bankruptcy to keep people who would
keep the profitable parts of the business running.
Senator Dorgan. Do we have a list, or did you get a list of
who received those bonuses?
Mr. Powers. I am not sure. I would have to check my
records.
Senator Dorgan. If you did, would you make those available
to us?
Mr. Powers. Yes.
Senator Dorgan. I am going to extend my questions just for
a few minutes, then I will recognize my two colleagues.
I want to refer you to a memo by Sharon Watkins of last
August, and she wrote a memo to Mr. Lay in which she talked
about, she is nervous that this will implode in a wave of
accounting scandals. It will be seen as nothing but an
elaborate accounting hoax.
She said, we booked the Condor and Raptor deals. We enjoyed
a wonderfully high stock price and many executives sold stock,
and that is the key issue here. We booked these deals, we
enjoyed a wonderfully high stock price, many executives sold
stock, and when we then tried to reverse or fix these deals,
like robbing a bank in 1 year and trying to pay it back two
years later, this and several other things in the material I
have looked at from the boxes of material we have received from
the company, and from the report that you have authored,
suggests to me that a lot of activity occurred here in order to
boost stock value so that insiders could profit, and they did
immensely, $1.1 billion in stock sales by insiders.
Now, that includes the Board of Directors and officers of
the corporation. You did not take a look at that, but should
one? Should one not take a hard look at that, especially
inasmuch as it was not just officers, but Board of Directors of
the company and, from the Watkins' memo and others, the
implication seems to be that this was more than just booking
some profits and so on, and the consequences of which people
were able to sell stock at high prices?
The implication is that this was a scheme, this was a
deliberate kind of scheme in which you could pump it up, sell a
bunch of stock, get rich quick, and then you leave the cleanup
to somebody else at some later date and do not worry about the
consequences.
Mr. Powers. Well, I agree that is a very serious issue that
is raised by her letter, and several of the questions today
about trading by insiders and, yes, my opinion is that does
need to be investigated. We did not investigate it, but it does
need to be investigated.
Senator Dorgan. In your report on page 73, you said LJM
had--excuse me, quote, ``we understand that LJM ultimately too
had approximately 50 limited partners,'' and then you mentioned
some of them, Home Assurance, Arkansas Teachers Retirement,
MacArthur Foundation, Merrill Lynch, J. P. Morgan, Citicorp,
First Union, DeutscheBank, GE Capital, Kleinwort Benson. The 50
limited partners, is that a population that you are certain of?
Did you see the names of the 50 limited partners, or is that
what you were simply told?
Mr. Powers. I think it is what we were told, and some we
knew without going into the partnership documents. If I could,
with your indulgence.
Senator Dorgan. Sure.
Mr. Powers. That--actually, that particular list came from
an Andersen work paper that we were allowed to look at but not
copy, and I am informed that we just wrote down that list.
Senator Dorgan. So we know that that work paper in the
possession of Arthur Andersen--I am sorry. Proceed, if you want
to amplify.
Mr. Powers. We have our copy that we would be happy to
provide.
Senator Dorgan. Does that have the 50 names on it?
Mr. Powers. We do not have the paper. We have a list that
we copied down, is my understanding, that we just physically
wrote down, but we do have that list.
Senator Dorgan. Let me try to understand, because
ultimately, as I have indicated previously, we are going to try
to get to the partners, the partnerships I should say, and all
the investors of LJM2. Do you feel confident that there were
approximately 50 partners?
Mr. Powers. That is the only source we have, in my
understanding now, is that piece of paper in the Andersen work
papers we did go look at.
Senator Dorgan. And, you believe the company did not have
that information, but the accounting firm did? I am talking
about the corporation.
Mr. Powers. We were not able to find that within the
company. We cannot for sure say somebody in the company did not
have it, but we were not able to find that list from inside the
company.
Senator Dorgan. As I indicated earlier today, I talked with
Mr. Cooper, the interim CEO of the company, who has pledged to
make available all of the information that he has, and
especially on the investors in the partnerships, so you tell me
that you received that information from Arthur Andersen, from a
work paper from Arthur Andersen that you could not keep, is
that right?
Mr. Powers. That is one of them, that when we went and then
wanted copies, we did not get copies, but they had written down
those 50 names.
Senator Dorgan. So you have those 50 names?
Mr. Powers. Yes.
Senator Dorgan. You will provide them to this Committee?
Mr. Powers. Absolutely.
Senator Dorgan. Well, that is a very small start. We have
been, as you know, for a month and a half on this Committee
asking the corporation and asking all who are relevant to
receive these requests that we need to understand what is the
matrix of the investors, friends, businesses, and others who
were brought into this web, this complex web of partnerships,
who are they, how much did they invest, did they always make
money on these investments?
It looks to me like the corporation was back-stopping
everything with respect to these investments, so we need to get
that information, and at least today at 1:30 in the afternoon
we will get the first 50 names, and we appreciate our ability
to do that, and that comes courtesy of your copying a piece of
information given by Arthur Andersen but then subsequently
taken back by them, so we will hope the rest of the names will
not be quite so hard to receive, or to achieve, and we will
see.
I have a couple of other questions, but let me go on to
Senator Fitzgerald next, and then Senator Wyden.
Senator Fitzgerald. Dean Powers, your report, and I think
the page is 133 if I recall correctly, is the one--I am saying
it off the top of my head. I believe that is the page where you
have the chart that shows how most of the company's earnings
during the 15-month period were coming from the Raptor
entities.
Mr. Powers. That is correct.
Senator Fitzgerald. From the third quarter of 2000 through
the third quarter of 2001, Enron reported earnings of $1\1/2\
billion, and according to your calculations of your committee,
Raptor's contribution to those earnings was over $1 billion,
$1.77 billion, so I calculate that to be 71 percent of Enron's
earnings coming from roughly transactions with Raptors. During
that 15-month period, and as your report in my judgment
conclusively demonstrates, those earnings are fictitious.
Now, you previously said you only looked at transactions
with three partnerships, and this is a company that has how
many partnerships?
Mr. Powers. I have read in the high 2,000's.
Senator Fitzgerald. Is it your belief that there were
transactions during that period with other partnerships that
you were not looking at?
Mr. Powers. Well, there are certainly issues and
transactions in following those other partnerships. I would say
these partnerships in our view were designed with this, the
goal you see on page 133 in mind.
Senator Fitzgerald. There is no other reason to form these
partnerships?
Mr. Powers. There is no bona fide economic purpose for the
hedging transactions.
Senator Fitzgerald. I guess what I am getting to, it is
possible, since you only looked at three of these, that all of
Enron's earnings for that period were fictitious, because the
rest, the $429 million of their earnings without transactions
with Raptors could have been generated by transactions with
other partnerships that were beyond the scope of your
committee.
Mr. Powers. That is correct. We did not validate the other
sources of that income.
Senator Fitzgerald. My theory for a long time, and before
your report came out, was that they really had a very simple
scheme. They would simply borrow money, and by filtering the
borrowed money through partnerships, they would report that
money as earnings, and the way they would accomplish that is,
they would enable the partnership to find investors or find
lenders by providing some underlying credit support or
guarantee from Enron, and then they would use the pretext that
they were selling an asset, or as you point out, oftentimes its
asset sales, other times it is hedging transactions under the
pretext of doing an asset sale to one of these partnerships.
They would take some questionable asset, transfer it over
to the partnership, cause the partnership to pay a huge amount
for the asset, and then Enron would book that as earnings, and
at the end of the day they were really just borrowing the
money, and the technical reason they had to file bankruptcy, I
would imagine, is all these debts caught up with them and they
had billions of dollars in indebtedness that they had to repay,
and they could not pay it.
I guess it is very difficult for me to believe that the
senior managers of Enron could have just been floating around
the office, coming in every day, working very hard, and be
totally unaware that at least 71 percent of their income was
coming from bogus transactions. I mean, am I missing something
here? Is it plausible to you that Skilling and Lay just had no
idea where even in a general sense their company was getting
their earnings?
Mr. Powers. I share your concern that you would think they
would know where their earnings were coming from. I agree.
Senator Fitzgerald. And had you not just joined the Board
in October, but from what I have read, for years the hit on
Enron, or the criticism that some financial writers had made,
and of course there is that famous Fortune Magazine article
that seems very prescient now by Bethany McLain. That was
about, almost a year ago, where she asked the question, can
somebody just explain where Enron earns its money, and Lay and
Skilling constantly had a hard time answering questions from
analysts and reporters.
They could never explain simply how Enron made its money,
could they? I mean, did you ask people, did your committee ask
people within Enron how they thought the company earned money?
Mr. Powers. Our company did not look into that, and I do
not want to just keep repeating it, we had a very full plate
over a three month period. We did not ask where the other
income was coming from. We found out where $1 billion of the
income was coming from with these hedge relationships.
Senator Fitzgerald. Now, did you interview Mr. McMahon?
Mr. Powers. Yes. I did not personally, but the committee
staff did.
Senator Fitzgerald. And the committee also interviewed Mr.
Skilling?
Mr. Powers. Yes.
Senator Fitzgerald. And you found, the committee found the
discrepancy that was apparently last week at the House hearing
between Mr. Skilling's version of what Mr.McMahon had said to
him and what Mr. McMahon said he had told Skilling? Can you
refresh my recollection on what your committee found Mr.
McMahon said he said to Skilling?
Mr. Powers. McMahon said that he said to Skilling, and he
told us in his interview that he raised issues about these
related party transactions that were more than a mere complaint
about McMahon's compensation, as Skilling had tried to
characterize it, and McMahon did have talking points, a copy of
talking points, so that meeting----
Senator Fitzgerald. Has he turned those talking points over
to you?
Mr. Powers. Yes.
Senator Fitzgerald. Could this Committee get a copy of
those, and those are represented by McMahon to be
contemporaneous talking points?
Mr. Powers. Yes.
Senator Fitzgerald. And so does your committee come to a
conclusion about who was telling the truth in that situation,
or are you just reporting what your interview showed?
Mr. Powers. We tried to report what our interview showed,
but I will say McMahon's version is supported by McMahon's
document.
Senator Fitzgerald. Did you interview Sharon Watkins?
Mr. Powers. We asked, and she declined to be interviewed, I
must say for understandable reasons. She did not talk with us.
Senator Fitzgerald. Why would she not? What are the
understandable reasons? She was the one who kind of----
Mr. Powers. I meant to say, I do not think she thought she
had something to hide. She preferred not to talk with us.
Senator Fitzgerald. Did you talk to any people down below
who told you that it was widely known that something was awry
in the way the company was always able to book earnings?
Mr. Powers. Well, we certainly--I mean, that was the impact
of the Watkins' letter.
Senator Fitzgerald. She knew that. Did she believe----
Mr. Powers. We did interview--we interviewed over 60
people, I believe. We did interview people who were further
down who had problems and issues with particular transactions.
Senator Fitzgerald. If I could conclude, and I am running a
little bit over, and if Senator Wyden would just indulge me, I
do want to followup.
One thing that is very prominent in your report is a
criticism of the accounting firm, and I would stipulate that
Arthur Andersen certainly should have flagged these hundreds,
perhaps thousands of what appear to have been questionable
transactions, but I do have a question in that it is possible
that in some cases, let us say, an asset sale to a partnership,
the partnership could have complied with the accounting rules
for being a legitimate, off-the-books partnership, as long as
it really had 3 percent ownership by bona fide outside people.
And it seems to me that the question of fraud arises
specifically with respect to the valuations of the assets that
were transferred from Enron to the partnerships, and I guess
that I want to reiterate what I suggested earlier, that we need
to know a lot more about how those valuations were done, and
your report also says that sometimes Enron would sell an asset
to the partnership right before the end of the quarter, clearly
designed to boost their earnings, but then after the quarter
was over, the partnership would sell the asset back to Enron
for even more than Enron had sold the asset to the partnership
in the first place, and then I imagine the partnership was
booking income on its books and showing its partners that it
was making a profit, while Enron was showing that it was also
making a profit at the close of its reporting period. Do you
know if the reporting periods of the partnerships and Enron
overlapped?
Mr. Powers. I do not. From the best of our knowledge, they
were both on a calendar year, and so they were on the same
schedule of reporting periods.
Senator Fitzgerald. So it does not appear that they were
kiting these assets back and forth so they could both report--
--
Mr. Powers. Not from what we found.
Senator Fitzgerald. Thank you very much, Dean Powers.
Senator Dorgan. Senator Wyden.
Senator Wyden. Thank you, Mr. Chairman.
Dean Powers, the report states clearly that sweetheart
deals with the partnerships enriched the insiders in a variety
of ways, tens of millions of dollars, and you state that this
was done, quote, ``at Enron's expense.'' My question to you is,
is this not akin to embezzlement? I mean, it looks to me like
fancier legal footwork.
Mr. Powers. I am not a criminal lawyer. I do not know the
definition, the full definition of embezzlement. It is very
troubling behavior that ought to be investigated to determine
whether it is criminal.
Senator Wyden. Now, with respect to my constituents and how
they look at this, they look at this like there was a double
standard out there that essentially people who were powerful
made vast sums of money, and now people in Oregon, if you had
$900,000 in a 401(k), you might have $100,000, and what they
want to know is, were there adequate safeguards in place that
were in force to make sure that they would be protected? Was
that the case, or was this just bad luck, or was the deal
stacked against them?
Mr. Powers. We conclude there were not adequate safeguards
in place to prevent this from happening.
Senator Wyden. How was Mr. Lay's role--when he took over in
August, was he active? Was he an ongoing participant in what
was taking place at the company? I mean, it was clearly going
down, and they were having problems. What was his role when he
came on in August?
I mean, you have told us essentially that what Mr. Skilling
has said, that he did not really know a whole lot about what
was taking place. There are questions about that, because
certainly the broad outlines were fairly apparent. You have
told us there were not adequate safeguards in place. Mr. Lay
comes on in August. Did he move to change any of that? Did he
take steps at that point to protect the people I represent and
other Americans who are just hammered as a result of this?
Mr. Powers. Well, when Mr. Lay became the CEO again, I will
say one thing he did was unwind these Raptor transactions that
had been constantly propped up. That is what ended up causing
the restatement in earnings in October. By that point, these
Raptor transactions were unsalvagable.
Senator Wyden. Well, I think nobody is going to quarrel
with trying to deal with one transaction, but to deal with one
transaction when this vessel is just plunging and taking on
water everywhere is not much solace to the people I represent,
and if you are telling me that he found a way to address one
transaction, I guess that is one more than anybody else thinks
at this point, but given the amount of pain this inflicted, it
does not sound like much.
Tell me about Arthur Andersen finally. I think you have
already heard me say I think the Houston office of Arthur
Andersen took the public out of certified public accountant. I
mean, I do not think they complied with the law. We have gone
through that. They certainly did not assist you in your
inquiry. I mean, you were not a hostile plaintiff's lawyer, for
Pete's sake. You were somebody who was working for the Board,
and they still did not cooperate with you.
And maybe you can explain to me their documents policy.
They would let you look at some documents. They would not let
you see other documents, and then there were some documents
that they would let you copy. I mean, did they give you any
explanation as to how they have put together this curious
documents policy?
Mr. Powers. Well, we were not able to--I mean, aside from
the documents, we were not able to interview their accountants
to get that explanation. We would have liked to have asked them
those questions.
Senator Wyden. But did they tell you how they came up with
this particular policy? I mean, this firm has certainly given
us lots to be curious about.
Mr. Powers. You mean, how they decided which documents and
which not?
Senator Wyden. How they decided what they were going to let
you see, what they were going to let you copy, why that was
different from not cooperating at all.
Mr. Powers. There were long negotiations as to what we were
going to see and what we were not going to see, and over time
we got to see some things and not others.
Senator Wyden. Tell us about the negotiations. Tell us why
they would not let you see some of the things you wanted to
see.
Mr. Powers. They did not have a very fulsome explanation.
They basically made excuses that they had other demands on
their time and they would get to it.
Senator Wyden. They said they were too busy to let you see
these documents?
Mr. Powers. They dragged it on, and that was the result.
Senator Wyden. Mr. Chairman, I think that sort of sums it
up. We have now heard that these accountants, who in my view
clearly ignored a federal statute that is on the books that
requires that they look for fraud, report it to the SEC and
others when it is found, that there is strong evidence of it
now were too busy to actually cooperate with an internal Enron
investigation.
This is just unbelievable. This is not somebody who is a
hostile plaintiff's lawyer. This is somebody who is working for
the company, and a major accounting firm in this country has
said they were too busy to cooperate with an internal
investigation. I think that just sums it up, and I intend to
stay with you if we are going to go to a third round.
Senator Dorgan. Senator Wyden, thank you. Let me just
follow on that point. Enron--excuse me. Arthur Andersen was
paid $52 million in the most recent year by the corporation, I
believe. Was it $25 million for auditing fees and $27 million
for consulting fees?
Mr. Powers. I believe that is approximately correct.
Senator Dorgan. So, this is a corporation that was
receiving over $50 million from Enron for services, accounting
and audit services and consulting services, and when you,
empowered by the Board of Directors as a Board member, initiate
an inquiry, that firm said to you in effect, we will not give
you much cooperation, we will not allow you to have unfettered
access to our records. That is what you are telling us?
Mr. Powers. As I said earlier, the negotiations dragged
out, and when Enron finally discharged them, their lawyer
called and said they would not cooperate further.
Senator Dorgan. Prior to their being discharged, they were
not forthcoming and cooperative with you?
Mr. Powers. They sort of negotiated with us, and they
showed us some documents, but it dragged on.
Senator Dorgan. This is an important question. The reason I
am asking the question is, the CEO of Arthur Andersen is all
over the news saying, look, we have nothing but respect for
this process, we have tried to be available, and forthcoming
and so on. In fact, I believe that they have not been very
satisfied with your report. Has Arthur Andersen not spoken of
your report in a way that is not entirely complementary?
Mr. Powers. I have read that, yes.
Senator Dorgan. And so that company now, Arthur Andersen,
which made a substantial amount of money from Enron, I am just
trying to understand, you are saying that company did not
cooperate very well with you in terms of giving you access, or
getting you access to the information and records you needed,
is that correct?
Mr. Powers. That is correct.
Senator Dorgan. Well, let me say that I agree with Senator
Wyden, I do not have the foggiest idea why in that circumstance
that Board of Directors could not look at their audit firm and
their consulting firm and say, please cooperate, and the firm
ought to be responding by saying, our records are yours, here
they are, so that we can understand what happened. That is
unfathomable to me, that you would have had difficulty trying
to pull records out of that company, but we will get into that
at some later point in other hearings.
Mr. Powers. Mr. Chairman, could I--when I read that
testimony, I do think--Mr. Berardino and I do disagree about
the facts, and I did write him a letter telling him what I
understood the facts to be. He has not responded. We would be
happy to provide the Committee with a copy of that letter.
Senator Dorgan. Would you provide the Committee a copy? He
is certainly entitled to his opinion. I am not suggesting he
does not have a right to say whatever he wants to say about
your report, but I am very surprised they were not cooperative
with you. That is what surprises me.
[The information referred to follows:]
Enron Corp.,
Austin, TX, February 6, 2002.
Mr. Joseph F. Berardino,
Managing Partner and Chief Executive Officer,
Andersen Worldwide,
Chicago, Illinois.
Re: Enron Corp.
Dear Mr. Berardino:
In our respective testimony before Congress on Tuesday, you and I
gave different accounts of the nature of Andersen's cooperation with
the Special Investigative Committee of Enron's Board of Directors,
which I chaired. The transcript of your testimony indicates that you
said, ``The committee asked to speak with some of our people. We were
in the process of working out interviews when Enron fired us. We never
heard from the committee again.'' You are also quoted as saying, ``They
didn't make an inquiry. We offered to help. We were very available. We
begged them to talk to us.''
It appears from your testimony that you may not have been made
aware of all of the facts. Here are the facts on which I based my
testimony.
In December, my Committee's counsel (Wilmer, Cutler & Pickering)
contacted your counsel, Michael Carroll at Davis Polk & Wardwell,
seeking access to Andersen's work papers relating to the transactions
we were investigating. We also asked to interview Andersen personnel
who had provided accounting services with respect to those
transactions. Your counsel and ours had a number of conversations,
without any resolution at that point.
Early in January, as the Special Committee's work was nearing
completion, Bill McLucas of Wilmer Cutler had a follow-up conversation
with Mr. Carroll on the same subject. Mr. McLucas asked for access to
work papers and to Andersen personnel, and confirmed this in a letter
dated January 4, 2002. He attached a list of the particular
transactions of interest to our Committee. Mr. Carroll told Mr. McLucas
that he should arrange to review the work papers with his associate,
Timothy Harkness.
On January 10, 2002, Mr. Harkness told David Cohen, another
attorney from Wilmer Cutler, that some of Andersen's work papers would
be made available for our review, beginning Monday, January 14, 2002.
Mr. Harkness also told Mr. Cohen that he would be able to make copies
of documents that were of interest to the Special Committee in its
investigation.
On the morning of January 14, Mr. Cohen and several accountants
working with the Special Committee began reviewing the materials made
available by Andersen and identifying documents that the Special
Committee wanted copied.
At the end of that day, when Mr. Cohen asked to have the identified
documents copied, he was told by another of your attorneys, Jill
Mahonchak, that she was ``not authorized'' to make copies of any of
Andersen's work papers for the Special Committee. Mr. Cohen then spoke
with Mr. Harkness, who confirmed that your counsel was not authorized
to make copies of Andersen's documents for the Special Committee.
That evening, Mr. Cohen sent a letter to Mr. Harkness and Ms.
Mahonchak reminding them that the Special Committee had been promised
that it could obtain copies of Andersen's work papers. Mr. Cohen wrote:
``We had understood that Andersen wanted to cooperate fully with
Enron's Special Investigative Committee. Needless to say, full
cooperation includes permitting us to obtain copies of select documents
on a timely basis.''
Mr. Cohen also noted in his letter to Mr. Harkness and Ms.
Mahonchak that the materials provided by Andersen for the Special
Committee's review did not include any ``work papers, supporting
documentation [or] memorandum relating to Andersen's work regarding
Enron's 10-Qs for the first, second and third quarters of 2001.'' Mr.
Cohen specifically requested an opportunity to review those documents.
No one from Davis Polk or Andersen ever responded to Mr. Cohen's
letter, and Andersen never allowed the Special Committee to review any
documents pertaining to work Andersen performed for Enron during 2001.
On Wednesday, January 16, Mr. McLucas and Mr. Cohen spoke with Mr.
Carroll. They asked Mr. Carroll whether Andersen would allow the
Special Committee to obtain copies of documents identified for copying.
Mr. Carroll said that he would authorize the copying of the documents
identified by the Special Committee. Mr. McLucas and Mr. Cohen also
asked Mr. Carroll whether Andersen would allow the Special Committee to
interview David Duncan, Debra Cash, Patty Grutzmacher and Jennifer
Stevenson--Andersen personnel who were most directly involved in the
transactions the Special Committee was investigating. Mr. Carroll
responded that Andersen wanted to cooperate with the Special Committee
but he wanted to think about the issue of interviews of personnel. He
asked that the Special Committee provide a detailed list of topics that
it hoped to cover in an interview, and that he would then consider
whether to allow the Special Committee to interview the Andersen
personnel.
The next day, Thursday, January 17, Mr. Cohen made arrangements
with Ms. Mahonchak and Mr. Harkness to obtain copies of the documents
identified for copying. Mr. Cohen was informed by another attorney
working for Andersen that copies would be delivered either late in the
day on Friday or early Saturday morning. Later that day Enron announced
that its Board voted to discharge Andersen as the company's auditor.
Late in the afternoon on Friday, January 18, Ms. Mahonchak called
Mr. Cohen. She told him that, because Enron had discharged Andersen,
Andersen had decided that it would no longer cooperate with the Special
Committee. She also said that although copies of the documents
identified by the Special Committee had been made, they would not be
provided to the Special Committee. The Special Committee's counsel had
no further communications with counsel for Andersen.
Based on these facts, we stated in our Report, ``[Andersen]
permitted the Committee to review some, but not all, of its workpapers
relating to Enron. It did not provide copies of those workpapers or
allow the Committee to interview knowledgeable Andersen personnel.''
(Report at p. 34.) That seems to me to be a fair characterization of
the facts, and was the basis for the testimony I gave on Tuesday.
Sincerely yours,
William Powers, Jr.,
Member of the Enron Board of Directors and Chairman
of the Special Investigative Committee.
Senator Dorgan. Let me ask a couple of questions in
addition. You obviously took this report to the Board of
Directors, and you are now a Board member, even if it is an
interim basis. I want to know what you spoke about as a Board
of Directors, because this is obviously a closed meeting, but
minutes are taken. When you took this report to the Board of
Directors, tell me, did you tell the Board of Directors,
because they would have wanted to know, that Mr. Lay was
unaware of the structure of these partnerships, or did you tell
them that you thought Mr. Lay understood what was going on, and
just was complicit in trying to make it happen in order to
create an architecture of partnerships that were able to
inflate profits and keep debt off the books. What is it that
you told the Board about your impression of Mr. Lay's activity
here?
Mr. Powers. Well, I gave the Board an oral presentation
that was substantially what my testimony was here today, and
emphasized the point, and it was a point I tried to emphasize
in my opening statement today. There is a lot of discussion at
the Board of little details of who knew this, who knew that. As
I said, everyone was aware that they were using their own stock
to hedge these transactions, so I told the Board, not verbatim,
but I think very substantially what I told the Committee today.
Senator Dorgan. So if I were a Board member in that Board
meeting and said, Mr. Powers, you have done now a three month
investigation, rather exhaustive in this limited area, did Mr.
Lay know what was going on with all of this, and your answer
was?
Mr. Powers. Well, I think he knew some things and he did
not know other things. First, he should know more of what is
going on. He was not fulfilling his responsibilities as CEO. He
understood that they were hedging with their own stock. He
understood that they had approved and created these
partnerships with their own Chief Financial Officer. We were
limited as to what we could ascertain, and as I said earlier, I
do not in any way think this is a full report. We tried not to
go beyond what the evidence showed, and one of the difficulties
in ascertaining exactly what Lay knew is Skilling in his
report, in his interview with us, denied much knowledge of
these things at all, so as a consequence, did not have any
recollection of any conversations with Lay.
Senator Dorgan. So a Board member in that meeting would
say, Mr. Powers, you have done this extensive investigation,
what did Mr. Skilling know about what was going on, did he know
what was happening, and what is your answer?
Mr. Powers. As I said, I think there is substantial
evidence Mr. Skilling was involved. There are the minutes of
the Finance Committee meeting going over his responsibilities
that we think he did not fulfill, and with respect to the
Raptor transactions, he says he kept Skilling involved. Ryan
Cerick in his interview says when the Raptor restructuring had
been completed, Skilling called him to congratulate him
especially. I am not listing it all, but there is other
substantial evidence that Skilling was more involved than his
interview with us indicated.
Senator Dorgan. Just a couple of additional questions. As
you know, the employees were locked into their 401(k)'s because
of the change in the plan administrator. As the stock
collapsed, they were unable to sell even as officers and
directors were selling stock and making money, so the result
was some at the top got very, very wealthy, became very wealthy
as a result of this, and others lost their life savings locked
into a situation they could not change.
Have the members of the Board of Directors discussed at all
in recent months any kind of opportunity or plan to try to
remedy that for the employees? I do not even know whether it is
possible, but clearly the Board must feel, as the American
people do, that it is--and as the President has indicated--
fundamentally unfair for the folks at the bottom to be locked
in and unable to sell stock even as it was collapsing, while
the folks at the top were selling stock at a decent price and
cashing out to the tune of tens of millions of dollars. Has the
Board addressed that in terms of the fundamental unfairness to
the employees?
Mr. Powers. I think the Board has discussed the plight of
the employees, not--to my knowledge and with one exception, and
I do not mean to trivialize it, I do think there was a
discussion at the Board of--I do not know whether the Board
will get fees or not, but if they do, they would donate them to
the employees, and I am just trying to be accurate in my
testimony here. I do not mean to trivialize that as a solution
to the terrible tragedy that has befallen the employees and the
retirees.
Senator Dorgan. That also is a topic for a future hearing.
Let me finally ask you, because you were employed by the
Board of Directors, and because we have information about the
stock sales by members of the Board of Directors over some
period of time, one wonders whether even on the Board of
Directors there were winks and nods about what was happening in
the company, with Board members knowing full well what was
going on, but thinking this was too good a ride to get off.
You were employed by the Board to do the investigation.
Need there be independent corroboration of this investigation,
because this, after all, is a Board of Directors product, and
then tell me, if you would, did you feel and do you feel
subjectively that there were members of the Board that knew
exactly what was going on here and thought it was really a
pretty wonderful thing for themselves personally?
Mr. Powers. In answer to the second question, not to my
knowledge, but I was not on the Board at the time when those
events would have been happening.
On the question as to whether it needs to be corroborated,
absolutely. We were charged with trying to bring to light as
best we could what had happened in these transactions, and I
think we have done it. I think it is a start. I hope the
Committee will find it helpful, but yes, it is the Board's. The
Board commissioned it. We did not have subpoena power. We did
not have the ability to compel evidence, and other bodies in
Congress and at the SEC and at the Justice Department need to
corroborate and investigate.
Senator Dorgan. It is also the case you did not investigate
the Board, is that correct?
Mr. Powers. We were very critical of the Board's role in
this. We say the Board failed in its oversight
responsibilities.
Senator Dorgan. I understand that, but I was talking more
about Board members, and whether Board members knew of the debt
that was in place with these special purpose entities and so
on, and whether, as I indicated to you, it became such a
wonderful ride that they really did not want to get off because
it was personally enriching to them.
Mr. Powers. Well, I do think the Board was aware they were
hedging with their own stock. They were aware that they created
a situation where they were doing business with their own Chief
Financial Officer. The Board was aware of those, and we
chastised the Board for that, but there are other things we did
not look into, and they need to be looked into.
Senator Dorgan. Senator Wyden.
Senator Wyden. One last area I wanted to talk to you about,
Mr. Powers, and that is the Chewco special purpose entity, and
the reason it is important is that this is the clearest
evidence to date, essentially, of something that was actually
illegal.
As we have been talking about this afternoon, Enron needed
the independent investor to kick in at least 3 percent of the
partnership's equity, but there is certainly evidence that
Enron cheated on the 3 percent requirement, because Enron
provided the investor with a loan guarantee of about $5\1/2\
million, then everything comes to light, and the process begins
that causes the company to unravel.
My first question to you is, what is your sense of why this
remained secret for four years? I mean, this is a very
important fact in all of this. Do you have any sense of why
this did not come to light for so many years?
Mr. Powers. Well, I have a sense. We do not know for sure.
The people who were involved in the transaction, who were
involved in Chewco, had a self-interest in having Chewco
continue. They were making profits off of it.
Senator Wyden. Well, who unearthed which documents, and
what produced this effort to start finding them? I mean, it
just is right at the heart of all of this, that you have
something that certainly is the clearest evidence thus far of
illegal conduct, and it sort of takes four years for it to come
to light. What can you tell us about how these documents were
unearthed, and what caused people to start looking?
Mr. Powers. Chewco was unwound at some point, but I want to
be accurate on this.
Senator Wyden. Another way you might address it, Mr.
Powers, is where did you find these documents?
Mr. Powers. My understanding was a media report about
Chewco, and the Board then had internal accounting go back and
dig through the Chewco documents and they found the reserve
guarantees of these loans, of the Big River and Little River
loans, and that was found internally, and that correction was
made.
Senator Wyden. Now, the Chewco partnership closed on
December 30, 1997, and if it had not closed by the end of 1997,
$700 million in debt would have appeared on the Enron balance
sheet, increasing Enron's debt by approximately 10 percent.
Mr. Powers. Yes.
Senator Wyden. You also have given us information
indicating that Enron was having problems finding outside
partners. Given those facts, as I have tied them together, do
you think it is plausible that people inside of Enron believed
that they would clean up this transaction in 1998 and somehow
this fraudulent transaction would have been in the company's
interest?
Mr. Powers. Well, the people we talked to understood that
when it was first set up it did not meet the 3 percent. It was
set up quickly, and then they would try to, as you quite
rightly put it, clean it up. That is when the loans from
Barclays came in that were supposed to be investments, and we
were unable to ascertain why that mistake was made, whether it
was sloppiness, or self-interestedness, or what, because we
were not able to interview the people that were involved in
that part of the transaction.
Senator Wyden. Now, only one other question on Chewco. It
was created and approved at the November 5th meeting and,
according to the meeting notes, you were present. Was the loan
guarantee discussed at that meeting?
Mr. Powers. I was not present at that meeting.
Senator Wyden. I was under the impression, according to the
meeting notes--excuse me. I am sorry. That was Mr. Lay. I
apologize. Who then could have had the authority for that loan
guarantee?
Mr. Powers. For the loan guarantee? I am not sure whether
that would be the Board. I guess the Board would have to have
the authority to do that.
Senator Wyden. Would Arthur Andersen have known about the
loan guarantee?
Mr. Powers. We were not able to ascertain that, whether
they knew about that loan guarantee.
Senator Wyden. Do any of your colleagues know who at Enron
would have had the authority to initiate that loan guarantee?
Mr. Powers. The loan guarantee in the Board minutes is a
different loan guarantee. It is not the loan guarantee that
backed the so-called equity investments and made them nonequity
investments. It is a different loan guarantee.
Senator Wyden. What we are trying to get out, though, is an
important area, and that is that it appears that this Chewco
information that is so critical seems to be buried somewhere in
the Enron files, and we are wondering if you could give us a
little bit more information so that we could figure out a way
to go about getting it.
Mr. Powers. All the documents that we have, we have
produced to the SEC and to the Committee, and our staff would
be willing to give what help necessary to sort through that.
Senator Wyden. I would only ask, Mr. Chairman, that we
continue to work with Mr. Powers and his staff on this, because
I think the question of how these Chewco documents were
unearthed, how it was that they remained secret for four years,
when this Chewco partnership was approved, the November 5,
1997, meeting, clearly we need more information about what was
discussed at that meeting and what the circumstances were by
which the loan guarantee was approved, and we are going to ask
you some additional questions about that, Mr. Powers.
Senator Dorgan. Mr. Powers, Chewco is essential to this
because Chewco is a small little rock on the rail that threw
the locomotive off the track. If you track this down, you are
talking about a relatively small amount of money that
eventually led to the requirement that a portion of this be put
back on the books and led to a recalculation of profits or
losses, and it is central to this.
Can you tell us when the recalculation was required,
because they said, somebody said, oops, the 3 percent was not--
was that Arthur Andersen going to the corporation, or someone
in the corporation that felt they had to go to Arthur Andersen?
How did that happen?
Mr. Powers. It is my understanding it was internal
accounting, that internal accounting, once they were asked by
the Board to look into it, found the mistake, and then went to
Andersen with that information.
Senator Dorgan. Was that prior to Vinson & Elkins taking a
look at the books as a result of the request by Mr. Lay?
Mr. Powers. That was in September, and this restatement was
in October.
Senator Dorgan. So Vinson & Elkins, at the request of the
CEO, evaluated what they could and found nothing wrong,
apparently, is that correct?
Mr. Powers. This was back in the Sharon Watkins' letter. My
understanding is they went to Andersen--I did not participate
in that part of the report, as I explained, but my
understanding is, they went to Andersen and asked if the
accounting was OK.
Senator Dorgan. The Watkins' letter said to Mr. Lay there
is a problem here with potential accounting hoaxes, so on and
so forth, and it ought to be looked into, but we specifically
request Vinson & Elkins not be involved in the evaluation. That
is what Watkins was saying to Mr. Lay.
Mr. Lay subsequently asked the law firm to look into it. I
am just trying to understand the sequence of how this Chewco
issue came up and how it was redetermined with respect to the 3
percent required to be put back on the books.
Mr. Powers. To my knowledge, there was not a connection
between those, that is correct, that these were independently
caused events.
Senator Dorgan. You see, what we have got is, we have got a
corporation with a Board of Directors, we have got an
accounting firm, we have got law firms, and the architecture of
partnerships that seem to have bent and twisted the rules,
created profits that did not exist, placed debt off the books
that should not have been placed on the books, and it is a case
of kind of, see no evil, hear no evil, and we are trying to
figure out the wrong doing and each of them says, well, it was
not us.
You did an investigation on a very limited piece here. I
think it is helpful to the Congress to have the results of your
investigation, but as you said when you started today, it is
very limited, and much remains to be known, and I assume as a
current member of the Board of Directors you very much want the
rest of the information unearthed, because if you do not know
who the investors are, the hundreds and hundreds and hundreds
of other partnerships, how do you get a handle on all of this,
and how do you make sure that you have got the rot out of the
apple here?
Mr. Powers. Well, as I told Senator Hutchison, my firm
desires to resign from the Board and go back and give my full
attention to the law school, but we and the staff certainly
will help in any way we can with the materials we have to help
the Committee move forward with its very important
investigation.
Senator Dorgan. Well, nobody on the Committee is going to
resign any time soon. We are going to continue pushing very
hard for the investigation. We wish you well as you go back to
the law school. As I said, I think your report contributes to
an understanding. It is limited, and has a narrower view than
we would hope, but nonetheless is a contribution, and we
appreciate your willingness to testify today.
If you would like, you can for the record identify those
who have accompanied you today.
Mr. Powers. Yes, thank you. These are from Wilmer, Cutler,
and Pickering: Joe Brenner; Chuck Davidow; and Bill McLucas.
Senator Dorgan. First of all, we thank you for the time
today. We would like to receive the information we requested,
the 50 partners and other pieces of information you indicated
you would provide to us. We would like also to be able to
consult with you as we proceed. If there might be additional
information you have collected, that would be helpful to this
Committee.
Mr. Powers. We would be delighted to be helpful in any way
we can.
Senator Dorgan. The Committee is adjourned.
[Whereupon, at 2:10 p.m., the Committee adjourned.]