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Enron's Chairman Received Warning About Accounting
DON VAN NATTA Jr. with ALEX BERENSON . NY Times . 15 january 2002

WASHINGTON, Jan. 14 — A senior Enron employee explicitly warned the company's chairman in August that several years of improper accounting practices threatened to bring down the company, Congressional investigators said today.

"I am incredibly nervous that we will implode in a wave of accounting scandals," the employee, Sherron S. Watkins, wrote in an unsigned seven- page letter to Kenneth L. Lay, Enron's chairman and chief executive. Excerpts from the letter were released today by the House Energy and Commerce Committee, one of five Congressional committees investigating Enron's collapse.

The company, which once had a market value of $70 billion, filed for bankruptcy protection on Dec. 2 after acknowledging that it had overstated its profits by nearly $600 million.

The seven-page letter suggests that Mr. Lay had been warned about the company's accounting problems at a time when he was assuring employees and investors that Enron's stock would rebound. Disclosure of the letter came as a lawyer for Mr. Lay said that he had used company stock to repay a loan, raising questions about whether Mr. Lay shed some holdings as the stock declined. [Business Day, Page C1.]

The letter could also bring significant new problems for Enron; its accounting firm, Arthur Andersen; and Vinson & Elkins, the company's law firm, at a time when the Justice Department has dispatched dozens of prosecutors and federal investigators to Houston, where a federal task force's wide-ranging criminal inquiry will be based.

The letter from Ms. Watkins, a vice president of corporate development, was sent to Mr. Lay between Aug. 14, when the company's chief executive, Jeffrey K. Skilling, suddenly resigned, and Aug. 31. In an Aug. 21 letter, Mr. Lay sought to reassure Enron employees that the company was on solid footing, writing, "One of my highest priorities is to restore investor confidence in Enron. This should result in a significantly higher stock price." At the time, Enron shares were trading at almost $37. By late November, it was trading as low as 30 cents a share.

After receiving the letter, Mr. Lay asked Vinson & Elkins to investigate the issues raised in it. But the company insisted that the law firm limit its investigation to a review of whether the letter contained new factual information, not a wider inquiry into whether Enron was properly accounting for its profits and losses. On Oct. 15, Vinson & Elkins found that Enron had committed no wrongdoing, lawyers involved in the matter said.

Ms. Watkins could not be reached for comment today. Her husband, Richard Watkins, referred phone calls to a lawyer.

In the letter, Ms. Watkins raised concerns about Enron's accounting practices and asked whether company partnerships were being used to hide losses and inflate the company's stock price. These are among the issues now being investigated by the Justice Department, the Securities and Exchange Commission, the Department of Labor and members of Congress.

Federal investigators are trying to determine whether Enron executives, armed with inside information about Enron's financial condition, sold their own stock before the improper accounting methods were publicly disclosed in October. Thousands of Enron employees, who were barred from selling the stock for six weeks in the fall, lost vast amounts of their retirement savings.

In her letter, Ms. Watkins expressed anguish about the accounting practices of four Enron partnerships and the involvement in one deal of the company's former chief financial officer, Andrew S. Fastow. She also complained to Mr. Lay that several senior Enron employees had repeatedly raised questions and concerns about Enron's accounting methods to senior Enron officials, including Mr. Skilling.

Philip H. Hilder, Ms. Watkins's lawyer, said in an interview tonight that Ms. Watkins worked for Mr. Fastow, who ran two of the partnerships that Enron allegedly used to inflate its profits, between July and September. After September, Ms. Watkins "asked to be reassigned," Mr. Hilder said.

He said he did not believe the company retaliated against her for writing the letter. He would not comment on whether investigators had contacted her.

Excerpts of the letter were released today by Representative Billy Tauzin, the Louisiana Republican who is chairman of the House Energy and Commerce Committee, and Representative James C. Greenwood the Pennsylvania Republican who is the head of the investigations subcommittee.

People who have reviewed the full text of her letter said Ms. Watkins wrote Mr. Lay: "I have heard one manager-level from the Principal Investments Group say, `I know it would be devastating to all of us, but I wish we would get caught. We're such a crooked company.' "

Ken Johnson, a committee spokesman, said today, "Obviously this is an explosive new development in our investigation that clearly shows that top Enron executives were warned of serious financial problems months before the company reduced shareholder equity."

Robert S. Bennett, Enron's Washington lawyer, protested the committee's release of excerpts from the letter. "I think it's very unfair for committees of Congress who profess to be conducting fair and objective investigations to be selectively releasing documents with their spokespeople putting spins on them," he said.

He said Mr. Lay acted "very, very responsibly" and was concerned about the issues raised by Ms. Watkins and referred them to Enron's outside law firm for investigation.

Congressional investigators who have reviewed the full text of her letter said Ms. Watkins began it with two prescient questions: "Has Enron become a risky place to work? For those of us who didn't get rich over the last few years, can we afford to stay?"

She then went on to express deep concerns about the accounting practices used by Arthur Andersen involving three partnerships by the names of Condor, Raptor and Whitewing.

Ms. Watkins complained about the opaque structure of the Enron partnerships that were used to conceal losses. "Is there a way our accounting gurus can unwind these deals now?" she asked. "I have thought about how to do this, but I keep bumping into one big problem — we booked the Condor deals in 1999 and 2000, we enjoyed a wonderfully high stock price, many executives sold stock, we then try to reverse or fix the deals in 2001 and it's a bit like robbing the bank in one year and trying to pay back two years later. Nice try, but investors were hurt."

She continued, "They bought at $70 and $80 dollars looking for $210/ share and now they're at $38 or worse. We are under too much scrutiny and there are probably one or two disgruntled redeployed employees who know enough about the funny accounting to get us in trouble." She also includes a page of suggestions on how to untangle the accounting irregularities.

Vinson & Elkins concluded its inquiry on Oct. 15, just one day before Enron announced its third quarter earnings and a $1.2 billion reduction in shareholder equity due to losses later associated with partnerships involving Enron officials.

Ms. Watkins also told Mr. Lay that "several senior Enron employees `consistently and constantly' questioned the corporation's accounting methods to senior Enron officials, and directly" to Mr. Skilling, about transactions involving L.J.M., an Enron partnership.

The House Energy Committee sent letters of inquiry today to Mr. Lay; Arthur Andersen's managing director, Joseph F. Berardino; and Joseph C. Dilg, the managing partner of Vinson & Elkins. The committee letters demanded more information about the way they addressed the concerns raised by Ms. Watkins.

Joe Householder, a spokesman for Vinson & Elkins, which has 860 lawyers in nine offices worldwide, said lawyers were reviewing the committee's letter. "On this issue," he said, "we just aren't prepared to comment because we want to review the letter first."

Today, several Enron officials questioned whether it was proper for Vinson & Elkins to conduct a supposedly independent inquiry of Enron's accounting practices.

"There are so many Vinson & Elkins lawyers working for Enron that they have office space in the company's headquarters in Houston for extended periods of time," said one Enron official, who spoke on condition of anonymity.

A Vinson & Elkins lawyer said the firm was owed more than $5 million when Enron petitioned for protection last month under Federal bankruptcy law. The lawyer added that Enron was among the law firm's most lucrative clients.

At some point after the Vinson & Elkins inquiry began, Ms. Watkins met with Mr. Lay for an hour to express her concerns in person, Congressional investigators said. They said they did not know exactly when the meeting took place.

Enron admitted in November that it used partnerships like those mentioned in the letter to overstate its profits by $586 million since 1997. To raise money, the partnerships, which included both Enron and outside investors, took out loans that were indirectly guaranteed by Enron.

The partnerships would then buy investments that Enron had made at prices that enabled Enron to claim the investments had been profitable. But because Enron had guaranteed most of the money the partnerships had used to buy assets from it, the company was essentially selling assets to itself.

The L.J.M. partnerships are even more questionable, because they were controlled by Mr. Fastow, who earned more than $30 million running them. Mr. Fastow should not have been allowed to work for both Enron and the partnerships, critics say.