A year later, Watkins' (Enron) memo tip of iceberg

Houston Chronical ^ | 8-12-02 | TOM FOWLER

[lewislynn]

A year later, Watkins' memo tip of iceberg

By TOM FOWLER
Copyright 2002 Houston Chronicle

As the business world raised a collective eyebrow at the resignation of Enron Chief Executive Jeffrey Skilling a year ago this week, another executive inside the company was busy trying to raise alarms.

On Aug. 15, Sherron Watkins, a former Arthur Andersen accountant-turned-Enron vice president, fired off a lengthy memo to Chairman Ken Lay laying bare her concerns over accounting issues that were threatening to boil over and expose the company to deep losses.

"I am incredibly nervous that we will implode in a wave of accounting scandals," she wrote as she outlined teetering efforts to hide losses in stock investments, inflated reports on the value of overseas assets and suspicious manipulations of some energy deals.

When the memo was released by a congressional committee in January, it turned what was then just a record-breaking bankruptcy into a full-fledged scandal. It revealed that the problems were known and documented at all levels of the company even earlier than previously reported.

A look at the memo to Lay a year after it was written shows that most, but not quite all, of Watkins' concerns and suspicions have been proved, says Robert McCullough, a Portland, Ore.-based energy analyst.

"But what she didn't know at the time was that the small scandals she knew were simply the tip of the iceberg," McCullough said. "The reality was that she offered her work as a fireman to the chief arsonist."

Like many Enron employees in the summer of 2001, Watkins was familiar with the company's growing addiction to complicated accounting as a way to grow revenue. When she was asked to help figure out a particularly difficult problem with four accounting partnerships, called the Raptors, she learned more than she wanted to.

The Raptors were partnerships created to keep Enron from having to report the decreasing value of its investments in a number of technology companies. For example, a $10 million investment in Rhythms NetConnections grew in value to $300 million when its stock price skyrocketed in the late 1990s. The company reported that growth as income.

Enron didn't want to have to report any drop in Rhythms stock as a loss in the future, however, so it created the Raptor partnerships to essentially bet against the drop in value.

The Raptors' main assets were Enron stock, but they needed a small amount of outside capital to make them independent for accounting purposes. Investments from LJM2, a partnership started by Enron's former Chief Financial Officer Andrew Fastow with money from more than a dozen investment banks and individuals, appeared to meet that requirement.

As the value of the investments dropped throughout 2000 and 2001 and the price of Enron stock dropped, the Raptors became unstable. Watkins joined an effort to keep the partnerships from going bankrupt in 2001.

Her in-depth knowledge of the Raptors' problems, combined with the sudden departure of Skilling on Aug. 14, led Watkins to first write anonymously to Lay about the problems, and later discuss them in person.

In the memo she questions the structure of the Raptors, saying she can't find who is responsible for losses to them. She says if it turns out to be Enron, then " ... we do not have a fact pattern that would look good to the (Securities and Exchange Commission)."

The concern is later supported by an internal report by Enron's board of directors in February that showed only Enron and its stock were at risk in the partnerships. And internal LJM2 documents show that the investors were able to get back all of their money plus additional cash before the Raptors could begin to operate.

Watkins also questions whether the company's international assets have been overvalued, and if the creation of a partnership called Condor that was used to buy certain Enron assets to keep them off the company's books was really reported properly.

Internal Enron documents and numerous reports from current and former employees now show that the value of many overseas assets were inflated, often as part of an effort to secure larger bonuses for executives negotiating those deals. The company has since said the value of its assets could be off by as much as $14 billion.

Watkins' memo also mentioned concerns that Enron's retail business, Enron Energy Services, may have falsified the values of some of its trading positions. Another letter from former Enron worker Margaret Ceconi to Lay, written later that August and released in February, discussed those problems further.

In the memo, Watkins noted that accounting firm Arthur Andersen's approval of the Raptors' restructuring may not be enough to protect Enron. She noted that the accounting firm had a string of recent problems, including a multimillion dollar settlement related to its work with Waste Management.

Ten months later, during the criminal trial of Andersen for destroying documents in order to hide its knowledge of the Raptor problems, the Justice Department led its case with those same Waste Management problems. Jurors later said that those issues were important in their decision.

In addition to placing the blame on Skilling and Fastow in the memo, Watkins points to former Treasurer Ben Glisan and former Chief Accounting Officer Rick Causey as being at the heart of the accounting problems. While it's clear Skilling and Fastow are targets of investigations, a number of sources have identified Glisan as having met repeatedly with prosecutors, likely as part of a plea-bargain agreement.

Watkins predicted that Skilling's departure would bring a spotlight on the company, but a combination of factors undermined that prediction.

Skilling and the company were consistent in spinning a message that there was "no other shoe to drop," while analysts continued to stand by the company's stock. The Sept. 11 terrorist attacks also distracted the attention of the media and other observers, so when Enron's disastrous third-quarter earnings report came out Oct. 16 few outside the company expected nearly $600 million in losses and a $1.2 billion write-down of equity.

The one issue raised by Watkins' memo that has yet to be fully vetted is her mentioning of a widespread rumor that Fastow and Skilling had a handshake agreement that the LJM2 partnership would never lose money in an Enron transaction. While Andersen officials testified in court to have heard similar rumblings, both men have denied the claims through their spokesmen.

Conclusive proof of the deal has yet to materialize, said Bala Dharan, a professor at Rice University's Jones Graduate School of Management.

"There's been the suspicion, but nothing concrete has come from it yet," Dharan said.

In later memos, Watkins tried to give Lay a road map for getting himself -- and by extension the rest of the company -- out of trouble.

Many of Watkins' suggestions were ignored. She suggested the transactions undergo a legal and accounting review by someone other than the company's law firm of Vinson & Elkins and accounting firm Arthur Andersen, but those parties were asked to do just that.

"Her efforts to save the company might have worked if these other parties were the only responsible ones," Dharan said. "But the problems were too deeply ingrained in the business."

But Watkins' instincts proved correct.

During the Andersen criminal trial held here in May and June, Andersen's own top fraud examiner, David Stulb, testified that the V&E report was a "whitewash" and was surprised that Andersen officials had not raised questions about it.

"I thought that V&E may have overreached in not only being the outside counsel to Enron but trying to conduct an independent investigation," Stulb said, noting that if Enron took Watkins' concerns seriously it would have used an independent law firm.

Watkins still works at Enron but also has spent time speaking about her experiences and has started to write a book about them. Her appearances before Congress have helped give her a bit of celebrity as a whistle-blower, but Dharan said that description is not quite appropriate.

"A typical whistle-blower would not be writing to the chairman on how to handle this problem from a marketing perspective," Dharan said. "She was just an insider who thought there were a couple of bad apples in the company and she needed to warn someone who was asleep at the wheel."

In retrospect, Watkins realizes she was a bit too optimistic, and maybe a bit naïve, about the company's willingness to respond to her concerns, according to her attorney, Philip Hilder.

Soon after writing the memo, Lay told Watkins to work with former Enron senior vice president of marketing Beth Tilney on a plan to limit the damage from the accounting problems.

It was only later that Watkins realized Tilney's husband was a Merrill Lynch executive who had invested in the LJM2 partnerships that she was criticizing. That casts serious doubt on the sincerity of Lay and others, Hilder said.

She spent several weeks devising crisis management plans and presentations, but now believes she may have been sidetracked to be kept out of the way.

"As the facts begin to unravel and a lot more is known, it becomes apparent why there may not have been the follow-up with her outcry she had hoped for," Hilder said. "It's becoming apparent the slow response was deliberate."

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[LarryLied]

a number of sources have identified Glisan as having met repeatedly with prosecutors,

He hasn't received much attention.