Following the Trail: As Enron
Inquiry Intensifies, Midlevel Players Face Spotlight --- They Could Help
Prosecutors Build a Criminal Case Against Top Executives --- Seven Areas of
Vulnerability
Federal investigators are ratcheting up the
pressure on Enron Corp.
In recent weeks, people close to the case
say, agents from the Federal Bureau of Investigation have stepped up their
interviewing of a group of former and current managers who handled accounting
and finance issues at the energy company, which is now in bankruptcy
proceedings. Their aim: to squeeze these midlevel players for information that
could lead to the indictments of former top brass, including Chairman Kenneth
Lay, Chief Executive Jeffrey Skilling and Chief Financial Officer Andrew
Fastow. Although the investigation is still in its
early stages, the broad outline of the government's strategy is starting to come
into focus. Officials are trying to determine if Enron violated
accounting rules when it established several outside ventures that inflated
earnings and hid debt. In addition, authorities are examining whether
Enron employees improperly benefited from investments in some of these
now-infamous outside ventures at the company's expense.
In one instance, midlevel employees enjoyed
a near-$1 million windfall, perhaps at the company's expense. In another, one
Enron executive and his domestic partner ended up with a questionable
$12.6 million payment, part of which may have wound up in the hands of
Enron's then-CFO. Investigators are also looking at whether Army
Secretary Thomas White, a former Enron executive, engaged in insider
trading -- something he has denied.
Justice Department lawyers now believe that
two Enron officials, Vice President Rodney Faldyn and senior director
Ryan Siurek, are among the midlevel managers who can provide crucial details
about some of the outside ventures. People familiar with the matter say the two
men are especially important because they have the potential to help prosecutors
build a case against Mr. Skilling, who has denied any wrongdoing. Neither Mr.
Faldyn nor Mr. Siurek is believed to be a target of the criminal investigation.
Their attorney, Michael Levy, declined to comment. Enron's attorney,
Robert Bennett, has said the company is cooperating with authorities.
Proving a case against senior Enron
executives won't be easy -- even with an army of federal prosecutors and
investigators whose ranks have grown so fast that the government has been forced
to seek extra office space in Houston. The company's Byzantine financial
structure will be difficult to unravel. Another difficulty for prosecutors:
Enron executives can point the finger at its auditor Arthur Andersen LLP,
which signed off on key transactions. For instance, in early February, Mr.
Skilling testified repeatedly at hearings in the Senate and House that he relied
on accountants to tell him what was proper. Andersen, which is also the subject
of investigations, has denied responsibility.
Here is a look at seven key areas of
vulnerability for Enron as prosecutors begin to make their case. It is
drawn from interviews with government officials and with current and former
Enron executives and lawyers close to the case. It is also drawn from
internal company documents, including a report issued in February by a special
committee of Enron's board.
In the case of four finance vehicles known
as the Raptors, it might. The Raptors were set up to allow Enron to guard
against a decline in the value of investments in volatile high-technology and
energy stocks. In order to keep these "accounting hedges" off Enron's
books, the Raptors had to be independent. Under accounting rules, this meant
outside investors in the Raptors had to put up equity equal to at least 3% of
their total capital. In this case, the so-called outside investor was a private
partnership run by Mr. Fastow, Enron's CFO. The partnership provided four
different Raptor vehicles with $30 million each.
But every time one of the Raptors received
the $30 million, it quickly returned roughly $40 million to the Fastow-led
partnership, LJM2 Co-Investment LP. So was this a return on the partnership's
investment -- meaning that the Raptor had somehow generated $40 million in
profit? Or was this a return of the partnership's investment, with $10 million
in profit?
If it was the latter, that meant the
Fastow-led partnership had essentially already gotten its money back, and
therefore no longer had sufficient equity at risk for the Raptors to be
considered independent. If they weren't independent, then they should have been
included on Enron's balance sheet.
The payments from the Raptors to the
Fastow-led partnership prompted discomfort among some Enron managers. For
example, Mr. Faldyn, who worked in Enron's accounting operation, heading
a group that at its peak included about 30 people, told special-board
investigators that "there were numerous discussions about whether there was
sufficient equity at risk" in the Raptors after the Fastow-led partnership had
received its payout. Ultimately, according to Mr. Faldyn, Enron consulted
with its accountants at Arthur Andersen and decided that it would treat the
situation as if the Raptors had not returned the partnership's investment, and
therefore were still independent.
But prosecutors could try to use a
statement by Mr. Fastow against him. In April 2001, he told his limited partners
in LJM2, a group that included giant financial institutions such as Citicorp and
J.P. Morgan, that "the return of and return on capital for all four of the
Raptor vehicles has already been realized." Therefore, he added in a letter to
his investors, LJM2's investment was "not at risk" anymore.
A spokesman for Mr. Fastow declined to
comment on the Raptors and all other transactions mentioned in this story. An
Andersen spokesman, Patrick Dorton, said: "The Enron board and management
hold responsibility for initiating, conceiving and approving these transactions,
not the auditors. These deals were structured by Enron employees, their
lawyers and investment bankers."
Statements by another executive may also
help prosecutors in connection with the Raptors. In May 2000, according to the
special board investigation, the directors on Enron's Finance Committee
were told by corporate Treasurer Ben Glisan Jr., a Fastow protege, that the
maximum LJM2 would receive from its investment in the Raptors was 30% a year.
But Mr. Fastow's partnership made many, many times that amount by his reckoning.
He told LJM2's investors in October 2000 that returns on the Raptors ranged from
more than 150% to nearly 2,500%.
For prosecutors, the disparity could be
useful in showing that the Raptors were used to defraud Enron and its
shareholders to the advantage of LJM2.
Last December, Mr. Glisan gave federal
investigators a proffer, a statement outlining his knowledge that authorities
could pursue in exchange for immunity from prosecution or a possible
plea-bargain arrangement. But people familiar with the matter say that the
government never responded -- a sign that it's still assessing whether to seek
Mr. Glisan's cooperation or make him a target of the investigation. Mr. Glisan's
attorney, Henry Schuelke, didn't return numerous phone calls seeking comment.
Their gambit was successful -- at least for
a time. By shoring up the Raptors with millions of shares of Enron stock,
whose value could be used to offset the investment declines, they managed to
stave off reporting more than $500 million in losses for about six months.
In his testimony before Congress, Mr.
Skilling tried to distance himself from the Raptors restructuring. "I can state
here today that I did not have any knowledge that the transaction was designed
to conceal losses," Mr. Skilling testified on Feb. 7 before a House
subcommittee.
But in their interviews for the special
board investigation, Messrs. Faldyn and Siurek suggested that Mr. Skilling knew
much more than he has let on, raising the possibility that prosecutors could
lodge a perjury charge against him.
Mr. Faldyn said he understood from Richard
Causey, Enron's chief accounting officer, that Mr. Skilling had made the
restructuring of the Raptors a "top priority."
Mr. Siurek, who came to Enron in
1999 from Arthur Andersen and was put to work on creating the Raptors in early
2000, said that he, too, "has no doubts" that Mr. Skilling knew about the
Raptors' troubles. After helping out on the restructuring, he received a call
from Mr. Skilling congratulating him. "It was Siurek's understanding that
Skilling was the ultimate decision-maker concerning the restructuring," the
interview notes with him state.
A spokeswoman for Mr. Skilling declined to
comment beyond testimony given before Congress. Mr. Causey's attorney, Reid
Weingarten, declined to comment.
As rich a vein as the Raptors may be for
prosecutors, they also underscore some of the challenges that the government
faces in assembling its case. Much of what Messrs. Siurek and Faldyn say they
believe Mr. Skilling knew is based on second-hand information from Mr. Causey.
Other potential witnesses from Enron's accounting and legal department,
meanwhile, were asked to sign off on narrow aspects of a given transaction,
meaning the government might have to call dozens of people to piece together the
story.
For prosecutors, this is the key question
when it comes to Chewco, a venture that Enron helped set up in late 1997
and that was used to keep more than $700 million in debt, related to various
energy investments, off its books. To meet this aim, it was essential that
Chewco be considered a separate entity from Enron, with outside investors
putting up the 3% equity requirement -- just like with the Raptors.
Michael Kopper, an Enron executive
who was put in charge of Chewco, raised this money by getting a loan from
Barclays PLC, the British bank, for two paper vehicles that he had helped
create. Known as Big River LLC and Little River LLC, they were to act as the
independent investors in Chewco. But there was a catch: Barclays would only lend
the money -- $11.5 million in total -- if an Enron affiliate turned
around and deposited more than half that amount into two accounts at Barclays,
helping ensure repayment of the loan. The Enron affiliate complied.
The upshot: Enron was backing the
loan. Little River and Big River never had enough of their own money truly at
risk in Chewco to satisfy the 3% rule. Yet for the next four years, Enron
treated Chewco as if it did meet the 3% standard, allowing the company to tamp
down its debt and bolster its earnings.
Last October, at a meeting with fellow
Enron officials and Andersen accountants, a mid-level company executive
named Shirley Hudler pulled the funding-agreement documents for the Barclays
accounts from her files, according to interview notes taken by the outside
lawyers conducting the special board investigation. The document, dated Dec. 30,
1997, laid bare for all a devastating fact: Enron had wrongly accounted
for Chewco for four years -- an arrangement that had led the company to
improperly inflate its earnings by some $400 million.
Another Enron employee told the
special board investigators that, when Mr. Glisan saw a document about the
Barclays accounts, the Enron treasurer, reacted strongly. "We're toast!"
Mr. Glisan said, according to this employee.
The employee told the special board that he
interpreted Mr. Glisan's response as one of utter surprise. But others at
Enron say they believe Mr. Glisan and some of his superiors were aware of
the troubling nature of Chewco from the outset. If that's true -- and federal
prosecutors can prove it -- the Chewco transaction could trigger charges of
securities fraud against the company or individuals or both, lawyers following
the investigation say. Related charges of mail or wire fraud are also possible.
One key witness will surely be Ms. Hudler,
who handled some transactions involving Chewco. The FBI has expressed its
interest in speaking with her, according to people familiar with the situation;
Ms. Hudler is considered a potential witness, not a target, these people say. In
her interview for the special board investigation, she noted that Mr. Glisan
"oversaw the transaction" that had set up Chewco. She added that Mr. Glisan and
other Enron executives shouldn't have been "surprised" last fall about
the 3% equity violation because the reserve accounts had been "mentioned in the
closing binder" four years earlier -- a document that higher-ups typically would
have seen.
When Chewco was launched in 1997, some
Enron executives received a life-size head of the Star Wars character
Chewbacca to commemorate the deal. Last year, when Enron decided to buy
out Chewco, Mr. Kopper and his domestic partner, William Dodson, received
something much more substantial: $12.6 million.
A big question for prosecutors is whether
Mr. Fastow, the CFO, also profited circuitously from the Chewco closeout -- and,
if so, whether that constituted a breach of his fiduciary duty to Enron.
The size of the payment to Messrs. Kopper
and Dodson was a concern to some inside Enron from the time it had first
been contemplated a year earlier, in 2000. Then-Treasurer Jeff McMahon, for one,
believed a much smaller payment from Enron -- $1 million -- was fair,
given that Messrs. Kopper and Dodson had invested only $125,000 in Chewco to
begin with, and they already had received hundreds of thousands of dollars in
fees over the years.
But Mr. Fastow struck a much more favorable
deal for Mr. Kopper -- and a much less favorable one for Enron. In his
interview for the special board investigation, Mr. McMahon said that Mr. Fastow
told him that he himself had negotiated a $10 million figure with Mr. Kopper,
and that "Skilling was okay with buying out Chewco at that price."
Mr. Fastow also saw to it that Messrs.
Kopper and Dodson received another $2.6 million to cover their tax bill. One of
Enron's senior attorneys, Jordan Mintz, was upset at the notion of
forking over this additional sum. He argued that Enron had absolutely no
obligation to make such a payment. But Mr. Mintz told the special board
investigation that Mr. Fastow, once again, claimed to have called Mr. Skilling
and received his approval. The $2.6 million was a go.
But prosecutors may ask whether this was
simply a scheme to funnel money to Mr. Fastow. Around the same period that
Enron bought out Mr. Kopper, he personally acquired Mr. Fastow's position
in LJM for an undisclosed sum.
The timing has created suspicions. The
lawyers for the special board investigation asked Enron's former general
counsel, James Derrick, whether the $12.6 million "was used by Kopper to pay
Fastow for his share" of LJM. If the government concludes that this is what
happened, Messrs. Fastow and Kopper could be charged with breach of fiduciary
duty on the grounds that they intended all along for Enron's money to
wind up in Mr. Fastow's pocket.
Mr. Kopper's attorney, Wallace Timmeny,
declined to comment. Mr. Dodson couldn't be reached.
Now those who reaped such big profits are
likely to be confronted by federal prosecutors who want to know: Was it all just
a fraud to rip off the company?
In early 2000, Mr. Fastow and Mr. Kopper
offered a handful of their colleagues at Enron an opportunity to invest
in Southampton. Mr. Kopper told Ms. Mordaunt that Southampton was being created
to buy out an interest in another limited partnership, known as LJM Cayman, that
was set up by Mr. Fastow.
Ms. Mordaunt cut her $5,800 check in March
2000. "The next time she heard about the investment was when Kopper called her
in May or June asking for wire transfer instructions," according to the special
board investigation. The other $1 million windfall recipient, Mr. Glisan, told
the special board investigation that Mr. Fastow was the one who had invited him
into Southampton. Meantime, Mr. Fastow's family foundation collected $4.5
million on a $25,000 investment, while Mr. Kopper and two other lower-level
employees made unknown sums on Southampton.
In her interview with the special board
investigation, Ms. Mordaunt said that she didn't ask any questions about how she
reaped such an extraordinary return. The special board report makes it clear
that the investigators believe the transaction was done at Enron's
expense. Ms. Mordaunt and her attorney didn't return calls seeking comment.
The report states that Enron paid a
Southampton-owned entity some $17 million as part of a complex deal to buy back
some of its own shares. The entity had come to own the stock through a series of
transactions involving Enron and the Fastow-led LJM Cayman.
Mr. Fastow signed for Southampton. Mr.
Causey, the Enron chief accounting officer, signed for the company. The
special board report concludes that Enron in effect overpaid to buy back
its own stock, giving a "huge windfall" to Southampton. "It is difficult to
understand why Enron's accounting personnel" let the deal proceed, the
report says.
In all, the report adds, Southampton and
the other investors in LJM Cayman "walked away with tens of millions of dollars
in value that, in an arm's length context, Enron would never have given
away."
Of particular concern to the board
investigators was that Mr. Fastow brought Mr. Glisan into Southampton around the
same time that Mr. Glisan was negotiating on Enron's behalf with another
Fastow-led partnership. On the other side of that deal was none other than Mr.
Fastow. Likewise, Ms. Mordaunt represented Enron as a lawyer in at least
one transaction with a partnership run by Mr. Fastow.
Both Ms. Mordaunt and Mr. Glisan told the
special board investigation that they never put LJM's interests ahead of
Enron's -- and never were asked to -- in return for a piece of
Southampton. Still, defense lawyers say that they expect the government to lean
on some of the Southampton investors, seeing if they can get them to provide
damning information on Enron higher-ups in exchange for immunity or a
lesser charge.
In mid-2000, Enron joined with
Viacom Inc.'s Blockbuster unit to roll out an exciting-sounding new
service: Customers across the U.S. would be able to choose from among thousands
of movies, including hot new features, sent via telephone lines to their
televisions at home.
But the business foundered. At its peak, in
March 2001, Braveheart provided only about 1,000 test customers with movies in
four U.S. cities -- many of whom didn't even pay. Blockbuster, for its
part, never accounted for any financial gain or loss from the venture, which it
termed a "pilot project."
Not Enron. Enron claimed
$110.9 million in profits from Braveheart in the fourth quarter of 2000 and the
first quarter of 2001, a calculation company officials have declined to explain.
This was clearly aggressive accounting. Prosecutors want to know if it went so
far as to constitute fraud.
With that possibility in mind, FBI agents
have been asking questions of associates of Army Secretary White, vice chairman
of Enron's energy services unit before he came to the Pentagon. Mr. White
sold $3.08 million, or half of his holdings, last October as Enron
started to crumble and he was making calls to former colleagues and friends at
the company. Mr. White has denied any wrongdoing. "I never sold any stock based
on what anyone told me at Enron," he told reporters last month.
Other Enron executives may also face
scrutiny. Mr. Lay, the former chairman, sold close to $175 million in
Enron stock between 1999 and 2001, according to trading records. Mr.
Lay's spokeswoman says he "firmly denies any allegations of wrongdoing including
insider trading." He also has denied knowing anything about the underlying
financial problems that led to Enron's collapse.
However, if prosecutors can establish that
Mr. Lay knew of Enron's financial problems and continued to sell his
shares at a time when Enron's stock price was artificially inflated by
misleading information disseminated by the company, he could face charges of
insider trading. The same thing holds true for several other top Enron
executives.
---
John R. Emshwiller contributed to this
article.
--- Inside
the Probe
By Kathryn Kranhold, Rick Wartzman and John R.
Wilke
04/30/2002
The Wall Street Journal
A1
(Copyright (c) 2002,
Dow Jones & Company, Inc.)
The Raptors
Could a felony charge hinge on the
difference between the words "on" and "of"?
Raptors Restructuring
By early 2001, the underlying
investments in the Raptors had deteriorated so severely that a team of
Enron executives began working on a major restructuring.
Chewco
When did top executives find out about
a certain loan agreement?
Kopper Payment
Southampton Place
For some Enron employees,
Southampton Place LP -- a partnership named after the upscale Houston
neighborhood where Mr. Fastow lives -- seemed the investment of a lifetime. For
instance, Mr. Glisan and an Enron lawyer named Kristina Mordaunt plunked
down $5,800 each, and a couple of months later $1 million was wired into each of
their checking accounts.
Braveheart
Of all the creative accounting that
Enron engaged in, its treatment of a project called Braveheart stands
out.
Insider Trading
Did Enron executives use inside
information to time sales of company stock and put millions of dollars into
their pockets?
Under scrutiny
-- Enron
transactions with related partnerships
Possible key witnesses for
prosecutors
-- David Duncan, lead Arthur
Andersen accountant
-- Shirley Hudler, former
senior director
-- Ryan Siurek, a senior
director
-- Rodney Faldyn, a vice president
in accounting
Department of Justice, Enron task force
-- Leslie Caldwell, director
-- Andrew Weissmann, special attorney
-- Samuel Buell, special attorney
---
The
Enron Inquiry
Some areas the Justice Department is likely to pursue
in its
investigation of
Enron.
Raptors
The Raptors were "hedging" vehicles set up to protect Enron
against
losses on certain assets. To be
considered independent for accounting
purposes--and kept off Enron's balance sheet--at least 3% of
their
capital had to be in the form of equity
from outside investors. Yet it
isn't clear
whether the 3% accounting rule was met. If it wasn't,
prosecutors could consider charging executives with
perpetrating a
fraud.
Raptor Restructuring
By early 2001, the assets held by the Raptors had deteriorated
so
much that a team of Enron
executives restructured them, staving off
the
recognition of some $500 million in losses. Former Enron CEO
Jeffrey Skilling told Congress that he wasn't aware
the restructuring
"was designed to conceal
losses." Other Enron executives suggest he
was. The upshot: If the Justice Dept. finds this to be true, it
could
consider going after Mr. Skilling for
perjury.
Chewco
Chewco was another Enron effort to keep debt off its balance
sheet.
In this case, the crucial 3% outside
equity was supposedly put into
Chewco by
independent entities. But Enron itself backed much of the 3%
infusion, eventually forcing the company to reverse
more than $400
million in earnings. If
Enron officials knew all along that Chewco
didn't qualify as a separate entity, they could face fraud
charges.
Southhampton Place
Several Enron executives were given a chance
get in on a limited
partnership set up by
Chief Financial Officer Andrew Fastow. They
reaped a windfall when an entity owned by the partnership sold
Enron
stock back to the company -- in
at least two cases, a million dollars
on a
$5,800 investment. The question is whether these profits came at
the expense of Enron shareholders, and thus
whether Enron might have
committed a
fraud.
Braveheart
Braveheart was an Enron entity that held the
company's stake in a
joint venture with
Viacom's Blockbuster unit to create an on-demand
movie business for home TVs. At its peak, the venture
counted only
1,000 test customers, yet
Enron claimed over $110 million in profits
from it based on the venture's future potential. Prosecutors are
examining whether this was fraud.
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