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Enron Letter Suggests $1.3 Billion More Down the Drain
GRETCHEN MORGENSON . NY Times . 17 january 2002

The letter that the Enron executive Sherron S. Watkins sent to the chairman of the company provides a few new details about Enron's web of partnerships and raises the possibility that the company might have to reduce its past earnings by $1.3 billion more than it already has.

The letter discloses for the first time the existence of an entity called Condor, which was financed with Enron stock and which made investments that generated $800 million in cash for Enron. An industry expert who has studied the letter says there is a question about whether that $800 million should be deducted from earnings.

The letter also says that another entity, Raptor, a previously disclosed investment vehicle owned by another Enron partnership, generated $500 million in revenue. Enron does not appear to have written that off either, but may have to do so.

Because so much remains unknown about the partnerships, Ms. Watkins's letter is being widely parsed for information about deals between Enron and related parties and for signposts to future, possibly damaging disclosures about the company. The letter, written last August, was released on Tuesday by a Congressional subcommittee that is investigating Enron.

Robert F. McCullough, a principal in McCullough Research, a utility industry consulting firm in Portland, Ore., has studied the letter closely. Though much of it concerns the close ties between Enron and partnerships that had not been disclosed to shareholders until recently, he said that what is new are the references to the $500 million generated to Enron by Raptor and the $800 million generated to Enron by Condor. Neither amount appears to have been identified by the company or noted in its restated financial statements for the quarter ended in September.

"We've now learned something that goes beyond what we knew from the quarterly," Mr. McCullough said. "And in terms of analysis it's more important to me that we now have the possibility that there's $1.3 billion of additional income statement items that may need to be removed before we get to the bottom of this."

Getting to the bottom of Enron's 3,000 or so partnerships and subsidiaries, nearly 900 of which are offshore, will not be easy. What is known is that the dealings between Enron and the various partnerships were not conducted at arm's length, as the company contended until questions arose last fall. In some partnerships, Enron's shareholders were responsible for partnership debts even though they did not benefit from the entities.

As questions about the partnerships grew last fall, Enron was forced to concede that the partnership results should in fact have been included in the company's financial statements. So in its third-quarter filing with regulators, Enron consolidated the results of several partnerships, including those known as JEDI and Chewco, into its own statements, deducting $1.2 billion from its net worth and wiping out $586 million in profits over the previous five years. The company also wrote off more than $1 billion worth of failed investments in water companies, broadband trading and retail electricity sales. The disclosures prompted the loss of confidence in Enron that sealed its fate and led to its filing for bankruptcy.

A phone call late yesterday to Mark Palmer, an Enron spokesman, seeking comment about these issues was not returned.

For anyone trying to digest fully the role that the partnerships played in Enron's demise, the Watkins letter is only a tantalizing tidbit. The letter shed light on investments made within Raptor, a company that is owned by LJM2, one of the partnerships that Enron consolidated in its financial statements last fall.

Ms. Watkins's letter displayed a firm grasp of the arcana of accounting. She came to Enron eight years ago from the accounting firm of Arthur Andersen. Andersen is Enron's auditor, and the partner at the firm who oversaw the Enron account has been fired for directing the destruction of documents relating to Enron's financial statements.

Raptor, which was financed and backed by Enron shares, appears to have been a vehicle that invested in publicly traded stocks. The partnership had holdings in Avici Systems (news/quote), a troubled maker of high-speed data networking equipment that Enron bought equipment from; Hanover, a gas equipment company; and the New Power Company, an Enron subsidiary.

Early on, as Ms. Watkins's letter pointed out, these investments rose in value, throwing off $500 million in revenue in 2000. But by early 2001, the value of the investments had plummeted, and the collateral backing them — Enron shares — began to fall, too. This gave Enron an unpleasant choice. It had to put up more collateral to shore up the partnership's holdings, or it had to reflect the lower value of the portfolio in its financial statements. Raptor wound up costing Enron $1 billion, which it wrote off in the third quarter last year.

In her letter, Ms. Watkins recapped the events surrounding the Raptor transactions and foreshadowed the losses there that Enron owned up to a little more than a month after Ms. Watkins sent her letter. "Raptor looks to be a big bet," Ms. Watkins wrote. "If the underlying stocks did well, then no one would be the wiser. If Enron stock did well, the stock issuance to these entities would decline, and the transactions would be less noticeable. All has gone against us."

Mr. McCullough said that the $500 million in revenue that Enron booked from Raptor in 2000 had not been mentioned in the company's quarterly filing as part of its adjustments involving Raptor. "Nowhere in the quarterly does Enron unwrap any income statement items pertaining to Raptor," Mr. McCullough said. These gains may have offset losses elsewhere and therefore were not identified by Enron, but it is also possible, he said, that Raptor could produce another downward adjustment to income of $500 million at Enron.

The new entity identified by Ms. Watkins as Condor produces additional concerns. In the letter she wrote: "To the layman on the street it will look like we recognized funds flow of $800 mm [million] from merchant asset sales in 1999 by selling to a vehicle (Condor) that we capitalized with a promise of Enron stock in later years." Then, Ms. Watkins questioned the company's recognition of that $800 million as cash flow, noting that it might be more accurate to consider it cash received in exchange for issuance of company shares.

"Condor has not surfaced elsewhere in Enron's financial statements," Mr. McCullough said. "Over all, Condor would seem to be a concern in addition to those recognized by Enron in the third quarter 10-Q," he said, referring to an S.E.C. form. "This leaves open a possibility that the $800 million is an additional issue to be unwrapped."

Through her lawyer, Ms. Watkins, a vice president for corporate development at Enron, has declined to comment further on her letter.

The letter was remarkable for its odd combination of clear respect for a superior and decidedly straight talk. It is addressed to the chairman, Kenneth L. Lay, suggesting that Ms. Watkins was far down the management pecking order and had had little interaction with him. Yet her tone was also aggressive at times. "Employees question our accounting propriety consistently and constantly," she wrote. "This alone is cause for concern."

Mr. McCullough said the letter showed both courage and a command of Enron's financial statements. "That is a career-ending letter in most contexts," he said. "Her language may not be clear, but she has a lot more detail than we've seen out of Enron."