[Senate Prints 107-70]
[From the U.S. Government Printing Office]


107th Congress 
 2d Session                 COMMITTEE PRINT                     S. Prt.
                                                                 107-70
_______________________________________________________________________
 
         THE ROLE OF THE BOARD OF DIRECTORS IN ENRON'S COLLAPSE


                               __________


                              R E P O R T

                            prepared by the

                       PERMANENT SUBCOMMITTEE ON

                             INVESTIGATIONS

                                 of the

         COMMITTEE ON GOVERNMENTAL AFFAIRS UNITED STATES SENATE



[GRAPHIC] [TIFF OMITTED] CONGRESS.#13



                              July 8, 2002




                       U. S. GOVERNMENT PRINTING OFFICE
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                   COMMITTEE ON GOVERNMENTAL AFFAIRS

               JOSEPH I. LIEBERMAN, Connecticut, Chairman
CARL LEVIN, Michigan                 FRED THOMPSON, Tennessee
DANIEL K. AKAKA, Hawaii              TED STEVENS, Alaska
RICHARD J. DURBIN, Illinois          SUSAN M. COLLINS, Maine
ROBERT G. TORRICELLI, New Jersey     GEORGE V. VOINOVICH, Ohio
MAX CLELAND, Georgia                 THAD COCHRAN, Mississippi
THOMAS R. CARPER, Delaware           ROBERT F. BENNETT, Utah
JEAN CARNAHAN, Missouri              JIM BUNNING, Kentucky
MARK DAYTON, Minnesota               PETER G. FITZGERALD, Illinois
           Joyce A. Rechtschaffen, Staff Director and Counsel
              Richard A. Hertling, Minority Staff Director
                     Darla D. Cassell, Chief Clerk

                                 ------                                

                PERMANENT SUBCOMMITTEE ON INVESTIGATIONS

                     CARL LEVIN, Michigan, Chairman
DANIEL K. AKAKA, Hawaii              SUSAN M. COLLINS, Maine
RICHARD J. DURBIN, Illinois          TED STEVENS, Alaska
ROBERT G. TORRICELLI, New Jersey     GEORGE V. VOINOVICH, Ohio
MAX CLELAND, Georgia                 THAD COCHRAN, Mississippi
THOMAS R. CARPER, Delaware           ROBERT F. BENNETT, Utah
JEAN CARNAHAN, Missouri              JIM BUNNING, Kentucky
MARK DAYTON, Minnesota               PETER G. FITZGERALD, Illinois
         Elise J. Bean, Acting Staff Director and Chief Counsel
                 Kim Corthell, Minority Staff Director
                     Mary D. Robertson, Chief Clerk
                            C O N T E N T S

                                 ------                                

                                                                   Page

SUBCOMMITTEE INVESTIGATION.......................................     1

SUBCOMMITTEE FINDINGS............................................     2

    (1) Fiduciary Failure........................................     3

    (2) High Risk Accounting.....................................     3

    (3) Inappropriate Conflicts of Interest......................     3

    (4) Extensive Undisclosed Off-The-Books Activity.............     3

    (5) Excessive Compensation...................................     3

    (6) Lack of Independence.....................................     3

SUBCOMMITTEE RECOMMENDATIONS.....................................     4

    (1) Strengthening Oversight..................................     4

    (2) Strengthening Independence...............................     4

BACKGROUND.......................................................     5

    Fiduciary Obligations of Boards of Directors.................     5

    Enron Corporation............................................     6

    Enron Board..................................................     8

FACTUAL BASIS FOR FINDINGS.......................................    11

    Finding (1) Fiduciary Failure................................    11

    Finding (2) High Risk Accounting.............................    14

       Andersen Briefings on High Risk Areas.....................    15

       Other Evidence of Board Awareness of Enron's High Risk 
      Accounting.................................................    20

    Finding (3) Inappropriate Conflicts of Interest..............    23

       Board Approval of LJM With Few Questions Asked............    24

       Flawed Controls to Mitigate LJM Conflicts.................    27

       Inadequate Board Oversight of LJM Transactions With Enron.    29

       Inadequate Board Oversight of Fastow's LJM Compensation...    32

       LJM Profits at the Expense of Enron.......................    34

    Finding (4) Extensive Undisclosed Off-The-Books Activity.....    36

       Whitewing.................................................    36

       LJM Partnerships..........................................    39

       The Raptors...............................................    40

       Inadequate Public Disclosure..............................    47

    Finding (5) Excessive Compensation...........................    48

    Finding (6) Lack of Independence.............................    51

       Board Independence........................................    51

       Auditor Independence......................................    53

CONCLUSION.......................................................    55

Appendix 1: Red Flags Know to Enron's Board......................    56

Appendix 2: Sherron Watkins' Letter to Board Chairman Kenneth Lay 
  (8/15/01)......................................................    57


                        THE ROLE OF THE BOARD OF



                     DIRECTORS IN ENRON'S COLLAPSE

                              ----------                              



                       SUBCOMMITTEE INVESTIGATION

    On December 2, 2001, Enron Corporation, then the seventh 
largest publicly traded corporation in the United States, 
declared bankruptcy. That bankruptcy sent shock waves 
throughout the country, on both Wall Street and Main Street 
where over half of American families now invest directly or 
indirectly in the stock market. Thousands of Enron employees 
lost not only their jobs but a significant part of their 
retirement savings; Enron shareholders saw the value of their 
investments plummet; and hundreds, if not thousands of 
businesses around the world, were turned into Enron creditors 
in bankruptcy court likely to receive only pennies on the 
dollars owed to them.
    On January 2, 2002, Senator Carl Levin, Chairman of the 
Permanent Subcommittee on Investigations, and Senator Susan M. 
Collins, the Ranking Minority Member, announced that the 
Subcommittee would conduct an in-depth investigation into the 
collapse of the Enron Corporation. The following month the 
Subcommittee issued over 50 subpoenas to Enron Board members, 
Enron officers, the Enron Corporation, and the Andersen 
accounting firm. Over the next few months, additional subpoenas 
and document requests were directed to other accounting firms 
and financial institutions. By May 2002, the Subcommittee staff 
had reviewed over 350 boxes of documents, including the 
available meeting minutes, presentations, and attachments for 
the full Board and its Finance and Audit Committees. The 
Subcommittee staff also spoke with representatives of Enron 
Corporation and Andersen, as well as numerous financial 
institutions and experts in corporate governance and 
accounting.
    During April 2002, the Subcommittee staff interviewed 13 
past and present Enron Board members, none of whom had 
previously been interviewed by the U.S. Department of Justice, 
Federal Bureau of Investigation, or the Securities and Exchange 
Commission. These lengthy interviews, lasting between 3 and 8 
hours, were conducted with the following Enron Board members: 
Robert A. Belfer, Norman P. Blake, Jr., Ronnie C. Chan, John H. 
Duncan, Dr. Wendy L. Gramm, Dr. Robert K. Jaedicke, Dr. Charles 
A. LeMaistre, Dr. John Mendelsohn, Paulo Ferraz Pereira, Frank 
Savage, Lord John Wakeham, Charls Walker, and Herbert S. 
Winokur, Jr. All Board members appeared voluntarily, and all 
were represented by the same legal counsel.
    On May 7, 2002, the Subcommittee held a hearing on the role 
and responsibility of the Enron Board of Directors to safeguard 
shareholder interests and on its role in Enron's collapse and 
bankruptcy. Two panels of witnesses testified under oath. The 
first panel consisted of five past and present Enron Board 
members, including the current Board Chairman and the past 
Chairmen of the key Board Committees. The witnesses were as 
follows:

        Norman P. Blake, Jr. (1994-2002), Interim Chairman of 
        the Enron Board and former member of the Enron Finance 
        and Compensation Committees, has extensive corporate, 
        Board, and investment experience, including past 
        service on the Board of General Electric, and current 
        service as Audit Committee Chairman of the Board of 
        Owens Corning;

        John H. Duncan (1985-2001), former Chairman of the 
        Enron Executive Committee, has extensive corporate and 
        Board experience, including helping to found and manage 
        Gulf and Western Industries;

        Herbert S. Winokur, Jr. (1985-2002), current Board 
        member, former Chairman of the Finance Committee, and 
        former member of the Powers Special Committee, holds 
        two advanced degrees from Harvard University and has 
        extensive corporate, Board, and investment experience;

        Dr. Robert K. Jaedicke (1985-2001), former Chairman of 
        the Enron Audit and Compliance Committee, is Dean 
        Emeritus of the Stanford Business School, and a former 
        accounting professor; and

        Dr. Charles A. LeMaistre (1985-2001), former Chairman 
        of the Enron Compensation Committee, is former 
        President of the M.D. Anderson Cancer Center, a large, 
        well-respected, and complex medical facility in 
        Texas.\1\
---------------------------------------------------------------------------
    \1\ Two Enron Directors, Mr. Blake and Mr. Winokur, who were 
members of the Board at the time of the May 7 hearing, resigned from 
the Enron Board on June 6, 2002.

    The second panel consisted of three experts in corporate 
---------------------------------------------------------------------------
governance and accounting:

        Robert H. Campbell is former Chairman of the Board and 
        Chief Executive Officer of Sunoco, Inc., and current 
        Board member at Hershey Foods, CIGNA, and the Pew 
        Charitable Trusts;

        Charles M. Elson is Director of the Center for 
        Corporate Governance, University of Delaware, and a 
        former member of the Board of Sunbeam Corporation; and

        Michael H. Sutton is the former Chief Accountant of the 
        Securities and Exchange Commission from 1995 to 1998.

                         SUBCOMMITTEE FINDINGS

    Based upon the evidence before it, including over one 
million pages of subpoenaed documents, interviews of 13 Enron 
Board members, and the Subcommittee hearing on May 7, 2002, the 
U.S. Senate Permanent Subcommittee on Investigations makes the 
following findings with respect to the role of the Enron Board 
of Directors in Enron's collapse and bankruptcy.

          (1) Fiduciary Failure. The Enron Board of Directors 
        failed to safeguard Enron shareholders and contributed 
        to the collapse of the seventh largest public company 
        in the United States, by allowing Enron to engage in 
        high risk accounting, inappropriate conflict of 
        interest transactions, extensive undisclosed off-the-
        books activities, and excessive executive compensation. 
        The Board witnessed numerous indications of 
        questionable practices by Enron management over several 
        years, but chose to ignore them to the detriment of 
        Enron shareholders, employees and business associates.

          (2) High Risk Accounting. The Enron Board of 
        Directors knowingly allowed Enron to engage in high 
        risk accounting practices.

          (3) Inappropriate Conflicts of Interest. Despite 
        clear conflicts of interest, the Enron Board of 
        Directors approved an unprecedented arrangement 
        allowing Enron's Chief Financial Officer to establish 
        and operate the LJM private equity funds which 
        transacted business with Enron and profited at Enron's 
        expense. The Board exercised inadequate oversight of 
        LJM transaction and compensation controls and failed to 
        protect Enron shareholders from unfair dealing.

          (4) Extensive Undisclosed Off-The-Books Activity. The 
        Enron Board of Directors knowingly allowed Enron to 
        conduct billions of dollars in off-the-books activity 
        to make its financial condition appear better than it 
        was and failed to ensure adequate public disclosure of 
        material off-the-books liabilities that contributed to 
        Enron's collapse.

          (5) Excessive Compensation. The Enron Board of 
        Directors approved excessive compensation for company 
        executives, failed to monitor the cumulative cash drain 
        caused by Enron's 2000 annual bonus and performance 
        unit plans, and failed to monitor or halt abuse by 
        Board Chairman and Chief Executive Officer Kenneth Lay 
        of a company-financed, multi-million dollar, personal 
        credit line.

          (6) Lack of Independence. The independence of the 
        Enron Board of Directors was compromised by financial 
        ties between the company and certain Board members. The 
        Board also failed to ensure the independence of the 
        company's auditor, allowing Andersen to provide 
        internal audit and consulting services while serving as 
        Enron's outside auditor.

                      SUBCOMMITTEE RECOMMENDATIONS

    Based upon the evidence before it and the findings made in 
this report, the U.S. Senate Permanent Subcommittee on 
Investigations makes the following recommendations:

          (1) Strengthening Oversight. Directors of publicly 
        traded companies should take steps to:

          L  (a) prohibit accounting practices and transactions 
        that put the company at high risk of non-compliance 
        with generally accepted accounting principles and 
        result in misleading and inaccurate financial 
        statements;

          L  (b) prohibit conflict of interest arrangements 
        that allow company transactions with a business owned 
        or operated by senior company personnel;

          L  (c) prohibit off-the-books activity used to make 
        the company's financial condition appear better than it 
        is, and require full public disclosure of all assets, 
        liabilities and activities that materially affect the 
        company's financial condition;

          L  (d) prevent excessive executive compensation, 
        including by ----

            L  (i) exercising ongoing oversight of compensation 
        plans and payments;

            L  (ii) barring the issuance of company-financed 
        loans to directors and senior officers of the company; 
        and

            L  (iii) preventing stock-based compensation plans 
        that encourage company personnel to use improper 
        accounting or other improper measures to increase the 
        company stock price for personal gain; and

          L  (e) prohibit the company's outside auditor from 
        also providing internal auditing or consulting services 
        to the company and from auditing its own work for the 
        company.

          (2) Strengthening Independence. The Securities and 
        Exchange Commission and the self-regulatory 
        organizations, including the national stock exchanges, 
        should:

          L  (a) strengthen requirements for director 
        independence at publicly traded companies, including by 
        requiring a majority of the outside directors to be 
        free of material financial ties to the company other 
        than through director compensation;

          L  (b) strengthen requirements for Audit Committees 
        at publicly traded companies, including by requiring 
        the Audit Committee Chair to possess financial 
        management or accounting expertise, and by requiring a 
        written Audit Committee charter that obligates the 
        Committee to oversee the company's financial statements 
        and accounting practices and to hire and fire the 
        outside auditor; and

          L  (c) strengthen requirements for auditor 
        independence, including by prohibiting the company's 
        outside auditor from simultaneously providing the 
        company with internal auditing or consulting services 
        and from auditing its own work for the company.

                               BACKGROUND

    Fiduciary Obligations of Boards of Directors. In the United 
States, the Board of Directors sits at the apex of a company's 
governing structure. A typical Board's duties include reviewing 
the company's overall business strategy; selecting and 
compensating the company's senior executives; evaluating the 
company's outside auditor; overseeing the company's financial 
statements; and monitoring overall company performance. 
According to the Business Roundtable, the Board's ``paramount 
duty'' is to safeguard the interests of the company's 
shareholders.\2\
---------------------------------------------------------------------------
    \2\ ``Statement on Corporate Governance,'' The Business Roundtable 
(9/97) at 3.
---------------------------------------------------------------------------
    Directors operate under state laws which impose fiduciary 
duties on them to act in good faith, with reasonable care, and 
in the best interest of the corporation and its shareholders. 
Courts generally discuss three types of fiduciary obligations. 
As one court put it:

        ``Three broad duties stem from the fiduciary status of 
        corporate directors: namely, the duties of obedience, 
        loyalty, and due care. The duty of obedience requires a 
        director to avoid committing . . . acts beyond the 
        scope of the powers of a corporation as defined by its 
        charter or the laws of the state of incorporation. . . 
        . The duty of loyalty dictates that a director must act 
        in good faith and must not allow his personal interest 
        to prevail over the interests of the corporation. . . . 
        [T]he duty of care requires a director to be diligent 
        and prudent in managing the corporation's affairs.'' 
        \3\
---------------------------------------------------------------------------
    \3\ Gearheart Industries v. Smith International, 741 F.2d 707, 719 
(5th Cir. 1984).

    In most States, directors also operate under a legal 
doctrine called the ``business judgment rule,'' which generally 
provides directors with broad discretion, absent evidence of 
fraud, gross negligence or other misconduct, to make good faith 
business decisions. Most States permit corporations to 
indemnify their directors from liabilities associated with 
civil, criminal or administrative proceedings against the 
company, and most U.S. publicly traded corporations, including 
Enron, purchase directors' liability insurance that pays for a 
director's legal expenses and other costs in the event of such 
proceedings.
    Among the most important of Board duties is the 
responsibility the Board shares with the company's management 
and auditors to ensure that the financial statements provided 
by the company to its shareholders and the investing public 
fairly present the financial condition of the company. This 
responsibility requires more than ensuring the company's 
technical compliance with generally accepted accounting 
principles. According to the Second Circuit Court of Appeals, 
this technical compliance may be evidence that a company is 
acting in good faith, but it is not necessarily conclusive. The 
``critical test,'' the Court said, is ``whether the financial 
statements as a whole fairly present the financial position'' 
of the company.\4\
---------------------------------------------------------------------------
    \4\ U.S. v. Simon, 425 F.2d 796, 805-6 (2nd Cir. 1969), cert. 
denied, 397 U.S. 1006 (1970) (quoting, in part, the trial judge). See 
also 15 U.S.C. 77s and 78m (``Every issuer . . . shall . . . keep 
books, records, and accounts, which, in reasonable detail, accurately 
and fairly reflect the transactions and disposition of the assets of 
the issuer.'')
---------------------------------------------------------------------------
    Over the years, blue ribbon commissions, corporate 
organizations, and academic scholars have addressed the 
fiduciary obligations of Boards of Directors of publicly traded 
companies, including their role in ensuring accurate financial 
statements. In 1999, the Committee of Sponsoring Organizations 
of the Treadway Commission issued a report on ``Fraudulent 
Financial Reporting 1987-1997; An Analysis of U.S. Public 
Companies,'' evaluating 200 cases of publicly traded companies 
involved in financial statement fraud. Among other findings, 
the report stated that companies with fraudulent financial 
statements appeared to have boards ``dominated by insiders'' 
and ``weak'' audit committees that rarely met. The report 
stated that its results ``highlight the need for an effective 
control environment, or `tone at the top' '' and urged 
improvements in companies' internal controls, governance and 
ethics.
    In 2000, the Blue Ribbon Commission on Improving the 
Effectiveness of Corporate Audit Committees issued 10 
recommendations identifying best Committee practices at 
publicly traded companies. The Commission recommended that all 
publicly traded companies establish an audit committee with a 
formal charter and members who are independent and 
``financially literate,'' at least one of whom has accounting 
or financial management expertise. The Commission recommended 
that audit committees: (1) evaluate the objectivity and 
independence of the company auditor; (2) discuss the 
``auditor's judgements about the quality, not just the 
acceptability, of the company's accounting principles as 
applied in its financial reporting,'' including the ``clarity 
of the company's financial disclosures and degree of 
aggressiveness or conservatism of the company's accounting 
principles''; (3) determine that the company's financial 
statements are ``fairly presented in conformity with generally 
accepted accounting principles in all material respects''; and 
(4) discuss with the auditor ``significant [accounting] 
adjustments, management judgement and accounting estimates, 
significant new accounting policies, and disagreements with 
management.''
    The Commission report states: ``Board membership is no 
longer just a reward for `making it' in corporate America; 
being a director today requires the appropriate attitude and 
capabilities, and it demands time and attention.'' The report 
urges boards of directors to ``understand and adopt the 
attitude of the modern board which recognizes that the board 
must perform active and independent oversight to be, as the law 
requires, a fiduciary for those who invest in the 
corporation.''
    Enron Corporation. At the time of Enron's collapse in 
December 2001, Enron Corporation was listed as the seventh 
largest company in the United States, with over $100 billion in 
gross revenues and more than 20,000 employees worldwide. It had 
received widespread recognition for its transition from an old-
line energy company with pipelines and power plants, to a high 
tech global enterprise that traded energy contracts like 
commodities, launched into new industries like broadband 
communications, and oversaw a multi-billion-dollar 
international investment portfolio.
    One of Enron's key corporate achievements during the 1990's 
was creation of an on-line energy trading business that bought 
and sold contracts to deliver energy products like natural gas, 
oil, or electricity. Enron treated these contracts as 
marketable commodities comparable to securities or commodity 
futures, but was able to develop and run the business outside 
of existing controls on investment companies and commodity 
brokers. The nature of the new business required Enron's access 
to significant lines of credit to ensure that the company had 
the funds at the end of each business day to settle the energy 
contracts traded on its on-line system. This new business also 
caused Enron to experience large earnings fluctuations from 
quarter to quarter. Those large fluctuations potentially 
affected the credit rating Enron received, and its credit 
rating affected Enron's ability to obtain low-cost financing 
and attract investment. In order to ensure an investment-grade 
credit rating, Enron began to emphasize increasing its cash 
flow, lowering its debt, and smoothing its earnings on its 
financial statements to meet the criteria set by credit rating 
agencies like Moody's and Standard & Poor's.
    Enron developed a number of new strategies to accomplish 
its financial statement objectives. They included developing 
energy contracts Enron called ``prepays'' in which Enron was 
paid a large sum in advance to deliver natural gas or other 
energy products over a period of years; designing hedges to 
reduce the risk of long-term energy delivery contracts; and 
pooling energy contracts and securitizing them through bonds or 
other financial instruments sold to investors. Another high 
profile strategy, referred to as making the company ``asset 
light,'' was aimed at shedding, or increasing immediate returns 
on, the company's capital-intensive energy projects like power 
plants that had traditionally been associated with low returns 
and persistent debt on the company's books. The goal was either 
to sell these assets outright or to sell interests in them to 
investors, and record the income as earnings which top Enron 
officials called ``monetizing'' or ``syndicating'' the assets. 
A presentation made to the Finance Committee in October 2000, 
summarized this strategy as follows.\5\ It stated that Enron's 
``[e]nergy and communications investments typically do not 
generate significant cashflow and earnings for 1 to 3 years.'' 
It stated that Enron had ``[l]imited cash flow to service 
additional debt'' and ``[l]imited earnings to cover dilution of 
additional equity.'' It concluded that ``Enron must syndicate'' 
or share its investment costs ``in order to grow.''
---------------------------------------------------------------------------
    \5\ Hearing Exhibit 39, ``Private Equity Strategy'' (Finance 
Committee presentation, 10/00), included in the hearing before the 
Permanent Subcommittee on Investigations on The Role of the Board of 
Directors in Enron's Collapse, May 7, 2002, S. Hrg. 107-511.
---------------------------------------------------------------------------
    One of the problems with Enron's new strategies, however, 
was finding counterparties willing to invest in Enron assets or 
share the significant risks associated with long-term energy 
production facilities and delivery contracts.\6\ The October 
2000 presentation to the Finance Committee showed that one 
solution Enron had devised was to sell or syndicate its assets, 
not to independent third parties, but to ``unconsolidated 
affiliates''--businesses like Whitewing, LJM, JEDI, the Hawaii 
125-0 Trust and others that were not included in Enron's 
financial statements but were so closely associated with the 
company that Enron considered their assets to be part of 
Enron's own holdings. The October 2000 presentation, for 
example, informed the Finance Committee that Enron had a total 
of $60 billion in assets, of which about $27 billion, or nearly 
50 percent, were lodged with Enron's ``unconsolidated 
affiliates.''
---------------------------------------------------------------------------
    \6\ As part of its asset light strategy, during the summer of 2000, 
Enron worked on a transaction called ``Project Summer'' to sell $6 
billion of its international assets to a single purchaser in the Middle 
East. Enron's Directors indicated during their interviews that this 
deal fell through when the purchaser's key decisionmaker became ill. 
Enron then pursued the asset sales on a piecemeal basis, using 
Whitewing, LJM, and others.
---------------------------------------------------------------------------
    All of the Board members interviewed by the Subcommittee 
were well aware of and supported Enron's intense focus on its 
credit rating, cash flow, and debt burden. All were familiar 
with the company's ``asset light'' strategy and actions taken 
by Enron to move billions of dollars in assets off its balance 
sheet to separate but affiliated companies. All knew that, to 
accomplish its objectives, Enron had been relying increasingly 
on complicated transactions with convoluted financing and 
accounting structures, including transactions with multiple 
special purpose entities, hedges, derivatives, swaps, forward 
contracts, prepaid contracts, and other forms of structured 
finance. While there is no empirical data on the extent to 
which U.S. public companies use these devices, it appears that 
few companies outside of investment banks use them as 
extensively as Enron. At Enron, they became dominant; at its 
peak, the company apparently had between $15 and $20 billion 
involved in hundreds of structured finance transactions.
    Enron Board. In 2001, Enron's Board of Directors had 15 
members, several of whom had 20 years or more experience on the 
Board of Enron or its predecessor companies. Many of Enron's 
Directors served on the boards of other companies as well. At 
the hearing, John Duncan, former Chairman of the Executive 
Committee, described his fellow Board members as well educated, 
``experienced, successful businessmen and women,'' and 
``experts in areas of finance and accounting.'' \7\ The 
Subcommittee interviews found the Directors to have a wealth of 
sophisticated business and investment experience and 
considerable expertise in accounting, derivatives, and 
structured finance.
---------------------------------------------------------------------------
    \7\ Hearing Record at 14.
---------------------------------------------------------------------------
    Enron Board members uniformly described internal Board 
relations as harmonious. They said that Board votes were 
generally unanimous and could recall only two instances over 
the course of many years involving dissenting votes. The 
Directors also described a good working relationship with Enron 
management. Several had close personal relationships with Board 
Chairman and Chief Executive Officer (CEO) Kenneth L. Lay. All 
indicated they had possessed great respect for senior Enron 
officers, trusting the integrity and competence of Mr. Lay; 
President and Chief Operating Officer (and later CEO) Jeffrey 
K. Skilling; Chief Financial Officer Andrew S. Fastow; Chief 
Accounting Officer Richard A. Causey; Chief Risk Officer 
Richard Buy; and the Treasurer Jeffrey McMahon and later Ben 
Glisan. Mr. Lay served as Chairman of the Board from 1986 until 
he resigned in 2002. Mr. Skilling was a Board member from 1997 
until August 2001, when he resigned from Enron.
    The Enron Board was organized into five committees:

          (1) The Executive Committee met on an as needed basis 
        to handle urgent business matters between scheduled 
        Board meetings. Its members in 2001 were Mr. Duncan, 
        the Chairman; Mr. Lay, Mr. Skilling, Mr. Belfer, Dr. 
        LeMaistre, and Mr. Winokur.

          (2) The Finance Committee was responsible for 
        approving major transactions which, in 2001, met or 
        exceeded $75 million in value. It also reviewed 
        transactions valued between $25 million and $75 
        million; oversaw Enron's risk management efforts; and 
        provided guidance on the company's financial decisions 
        and policies. Its members in 2001 were Mr. Winokur, the 
        Chairman; Mr. Belfer, Mr. Blake, Mr. Chan, Mr. Pereira, 
        and Mr. Savage.

          (3) The Audit and Compliance Committee reviewed 
        Enron's accounting and compliance programs, approved 
        Enron's financial statements and reports, and was the 
        primary liaison with Andersen. Its members in 2001 were 
        Dr. Jaedicke, the Chairman; Mr. Chan, Dr. Gramm, Dr. 
        Mendelsohn, Mr. Pereira, and Lord Wakeham. Dr. Jaedicke 
        and Lord Wakeham had formal accounting training and 
        professional experience. Dr. Mendelsohn was the only 
        Committee member who appeared to have limited 
        familiarity with complex accounting principles.

          (4) The Compensation Committee established and 
        monitored Enron's compensation policies and plans for 
        directors, officers and employees. Its members in 2001 
        were Dr. LeMaistre, the Chairman; Mr. Blake, Mr. 
        Duncan, Dr. Jaedicke, and Mr. Savage.

          (5) The Nominating Committee nominated individuals to 
        serve as directors. Its members in 2001 were Lord 
        Wakeham, the Chairman; Dr. Gramm, Dr. Mendelsohn, and 
        Mr. Meyer.

    The Board normally met five times during the year, with 
additional special meetings as needed. Board meetings usually 
lasted 2 days, with the first day devoted to Committee meetings 
and a Board dinner, and the second day devoted to a meeting of 
the full Board. Committee meetings generally lasted between 1 
and 2 hours and were arranged to allow Board members, who 
typically sat on three Committees, to attend all assigned 
Committee meetings. Full Board meetings also generally lasted 
between 1 and 2 hours. Special Board meetings, as well as 
meetings of the Executive Committee, were typically conducted 
by telephone conference.
    Committee chairmen typically spoke with Enron management by 
telephone prior to Committee meetings to develop the proposed 
Committee meeting agenda. Board members said that Enron 
management provided them with these agendas as well as 
extensive background and briefing materials prior to Board 
meetings including, in the case of Finance Committee members, 
numerous Deal Approval Sheets (DASHs) for approval of major 
transactions. Board members varied in how much time they spent 
reading the materials and preparing for Board meetings, with 
the reported preparation time for each meeting varying between 
2 hours and 2 days. On some occasions, Enron provided a private 
plane to transport Board members from various locations to a 
Board meeting, and Board members discussed company issues 
during the flight. Enron also organized occasional trips abroad 
which some Board members attended to view company assets and 
operations.
    During the Committee meetings, Enron management generally 
provided presentations on company performance, internal 
controls, new business ventures, specific transactions, or 
other topics of interest. The Finance Committee generally heard 
from Mr. Fastow, Mr. Causey, Mr. Buy, Mr. McMahon, and, 
occasionally, Mr. Glisan. The Audit Committee generally heard 
from Mr. Causey, Mr. Buy, and Andersen personnel. The 
Compensation Committee generally heard from the company's top 
compensation official, Mary Joyce, and from the company's 
compensation consultant, Towers Perrin. On occasion, the 
Committees heard from other senior Enron officers as well. At 
the full Board meetings, Board members typically received 
presentations from each Committee Chairman summarizing the 
Committee's work and recommendations, as well as from Enron 
management, and, occasionally, Andersen or the company's chief 
outside legal counsel, Vinson & Elkins. Mr. Lay and Mr. 
Skilling usually attended Executive, Finance, and Audit 
Committee meetings, as well as the full Board meetings. Mr. Lay 
attended many Compensation Committee meetings as well. The 
Subcommittee interviews indicated that, altogether, Board 
members appeared to have routine contact with less than a dozen 
senior officers at Enron. The Board did not have a practice of 
meeting without Enron management present.
    Regular presentations on Enron's financial statements, 
accounting practices, and audit results were provided by 
Andersen to the Audit Committee. The Audit Committee Chairman 
would then report on the presentation to the full Board. On 
most occasions, three Andersen senior partners from Andersen's 
Houston office attended Audit Committee meetings. They were D. 
Stephen Goddard, head of the Houston office; David Duncan, head 
of the Andersen ``engagement team'' that provided auditing, 
consulting, and other services to Enron; and Thomas H. Bauer, 
another senior member of the Enron engagement team. Before 
becoming head of the Houston office, Mr. Goddard had led the 
Enron engagement team for Andersen. Mr. Duncan became the 
``worldwide engagement partner'' for Enron in 1997, and from 
that point on typically made the Andersen presentations to the 
Audit Committee. The Audit Committee offered Andersen personnel 
an opportunity to present information to them without 
management present.
    Minutes summarizing Committee and Board meetings were kept 
by the Corporate Secretary, who often took handwritten notes on 
Committee and Board presentations during the Board's 
deliberations and afterward developed and circulated draft 
minutes to Enron management, Board members, and legal counsel. 
The draft minutes were formally presented to and approved by 
Committee and Board members at subsequent meetings.
    Outside of the formal Committee and Board meetings, the 
Enron Directors described very little interaction or 
communication either among Board members or between Board 
members and Enron or Andersen personnel, until the company 
began experiencing severe problems in October 2001. From 
October until the company's bankruptcy on December 2, 2001, the 
Board held numerous special meetings, at times on almost a 
daily basis.
    Enron Board members were compensated with cash, restricted 
stock, phantom stock units, and stock options.\8\ The total 
cash and equity compensation of Enron Board members in 2000 was 
valued by Enron at about $350,000 or more than twice the 
national average for Board compensation at a U.S. publicly 
traded corporation.\9\
---------------------------------------------------------------------------
    \8\ See Hearing Exhibits 35a and 35b on Enron Board Member 
compensation, prepared by the Subcommittee based upon information in 
Enron filings with the Security and Exchange Commission (SEC). Phantom 
stock units at Enron were deferred cash payments whose amounts were 
linked to the value of Enron stock.
    \9\ See ``Director Compensation; Purposes, Principles, and Best 
Practices,'' Report of the Blue Ribbon Commission of the National 
Association of Corporate Directors (2001) at page V (average total 
Board compensation at top 200 U.S. public corporations in 2000, was 
$138,747).

                       FACTUAL BASIS FOR FINDINGS

        Finding (1): The Enron Board of Directors failed to 
        safeguard Enron shareholders and contributed to the 
        collapse of the seventh largest public company in the 
        United States, by allowing Enron to engage in high risk 
        accounting, inappropriate conflict of interest 
        transactions, extensive undisclosed off-the-books 
        activities, and excessive executive compensation. The 
        Board witnessed numerous indications of questionable 
        practices by Enron management over several years, but 
        chose to ignore them to the detriment of Enron 
        shareholders, employees and business associates.

    One of the striking features of the Enron collapse is the 
company's abrupt and dramatic transformation from a well-
respected and award-winning company to a disgraced and bankrupt 
enterprise in less than 3 months. Steady revelations since 
October 2001 have raised questions about numerous aspects of 
the company's operations, from its extensive undisclosed off-
the-books dealings, often with companies run by Enron 
personnel,\10\ to an April 2002 SEC filing announcing that the 
company's financial statements were unreliable and the book 
value of its assets would have to be written down as much as 
$24 billion,\11\ to its apparent manipulations of the 
California energy market,\12\ to tax strategies which 
apparently included Enron's ordering its tax department to 
produce billions of dollars in company earnings through the use 
of complex tax shelters.\13\
---------------------------------------------------------------------------
    \10\ See, for example, Hearing Exhibit 44, ``Partnership Spurs 
Enron Equity Cut, Wall Street Journal (10/18/01).
    \11\ Form 8-K filed by Enron Corporation with SEC (4/22/02).
    \12\ See, for example, Hearing Exhibit 75, memorandum by Christian 
Yoder and Stephen Hall of Steol Rives L.L.P. to Richard Sanders (12/8/
00) regarding ``Traders'' Strategies in the California Wholesale Power 
Markets/ISO Sanctions,'' analyzing strategies used by Enron energy 
traders in the California wholesale energy markets during 2000.
    \13\ See ``Enron's Other Strategy: Taxes; Internal Papers Reveal 
How Complex Deals Boosted Profits by $1 Billion,'' Washington Post (5/
22/02).
---------------------------------------------------------------------------
    During their Subcommittee interviews, the Enron Directors 
seemed to indicate that they were as surprised as anyone by the 
company's collapse. But a chart produced at the Subcommittee 
hearing marks more than a dozen incidents over 3 years that 
should have raised Board concerns about the activities of the 
company.\14\ The first listed incident, in February 1999, is an 
Audit Committee meeting in which Board members were told that 
Enron was using accounting practices that ``push limits'' and 
were ``at the edge'' of acceptable practice. Three times in 
1999 and 2000, the Board was asked to and approved an 
unprecedented arrangement allowing Enron's CFO to set up 
private equity funds, the LJM partnerships, to do business with 
Enron for the purpose of improving Enron's financial 
statements. The Board also approved moving an affiliated 
company, Whitewing, off the company books, while guaranteeing 
its debt with $1.4 billion in Enron stock and helping it obtain 
funding for the purchase of Enron assets. Committee and Board 
presentations throughout 1999, 2000, and 2001 chronicled the 
company's foray into more and more off-the-books activity. 
Three times in 2000, the Board was asked to and approved 
complex transactions called the Raptors, despite questionable 
accounting and ongoing risk to the company. The Board was also 
informed that, in 6 short months, LJM had produced over $2 
billion in funds flow for Enron, and Enron's gross revenues had 
jumped from $40 billion in 1999 to $100 billion in 2000. These 
figures are striking, yet apparently no Board member questioned 
them.
---------------------------------------------------------------------------
    \14\ Hearing Exhibit 1, ``Red Flags Known to Enron's Board,'' 
prepared by the Subcommittee and attached to this report as Appendix 1 
on page 56.
---------------------------------------------------------------------------
    In 2001, evidence began to mount that not all was well at 
Enron. The company's stock price began declining. In March 
2001, a prominent Fortune article questioned the company's 
opaque financial statements.\15\ In April, Board members were 
told that 64 percent of Enron's assets were ``troubled'' or 
performing ``below expectations.'' \16\ They were also told of 
international assets that were overvalued on Enron's books by 
$2.3 billion.\17\ In mid-2001, the company's high profile, 
extensive broadband investments began to lose value. During the 
summer, the Board watched Mr. Fastow sell his LJM stake and Mr. 
Skilling suddenly resign from the company. In her letter to Mr. 
Lay on the day after Mr. Skilling's resignation, Sherron 
Watkins wrote, ``Skilling's abrupt departure will raise 
suspicions of accounting improprieties and valuation issues. . 
. . The spotlight will be on us, the market just can't accept 
that Skilling is leaving his dream job.'' \18\ But neither 
Board Chairman Lay nor any other Board member used the Skilling 
departure as a red flag warranting a hard look at Enron's 
operations. Even in early October 2001, when told of an 
anonymous employee letter warning of company problems and an 
$800 million earnings charge from the Raptors termination, the 
interviewed Board members told the Subcommittee staff they had 
left the October Board meeting feeling the company was still on 
track.
---------------------------------------------------------------------------
    \15\ ``Is Enron Overpriced?'' by Bethany McLean, Fortune (3/5/01).
    \16\ See Hearing Exhibit 40, ``Summary of Investment Portfolio'' 
(Finance Committee presentation, 4/01), indicating that 10 percent of 
Enron's global investment portfolio was ``troubled'' and 54 percent was 
performing ``below expectations.'' See also Hearing Exhibit 41b, 
``Portfolio Summary'' (Finance Committee presentation, 8/13/01), 
showing that, although the overall percentage of underperforming assets 
were nearly the same at 67%, the percentage of assets in the 
``troubled'' category had quadrupled, from 10% to 45%.
    \17\ Hearing Exhibit 71, ``Enron Global Assets and Services; Equity 
Value Schedule'' (6/01), Bates E103411.
    \18\ Sherron Watkins' letter to Board Chairman Kenneth Lay (8/15/
01) at 1, attached to this report as Appendix 2 on page 57.
---------------------------------------------------------------------------
    But the company was not on track. In mid-October 2001, 
press reports began leaking Enron's extensive undisclosed off-
the-books dealings with LJM and the millions of dollars Mr. 
Fastow had made at Enron's expense. Reports also emerged about 
Enron's dealings with JEDI and a previously undisclosed related 
company called Chewco which was owned and operated by another 
Enron employee Michael Kopper and which, due to improper 
accounting years earlier, Enron had to consolidate on its books 
in 2001, with a $500 million loss. Also disclosed in October 
2001 was a $1.2 billion reduction in shareholder equity, which 
arose from an incorrect accounting methodology Enron used for 
the Raptors, which Andersen had advocated but later decided was 
in violation of generally accepted accounting principles and 
had to be changed. Investors reacted to these disclosures by 
selling Enron stock, causing a further decline in Enron's stock 
price. In November, a proposed merger with Dynegy failed. 
Credit rating agencies then dropped Enron's rating to below 
investment grade, and its collapse into bankruptcy followed.
    While the evidence indicates that, in some instances, Enron 
Board members were misinformed or misled, the Subcommittee 
investigation found that overall the Board received substantial 
information about Enron's plans and activities and explicitly 
authorized or allowed many of the questionable Enron 
strategies, policies, and transactions now subject to 
criticism. Enron's high-risk accounting practices, for example, 
were not hidden from the Board. The Board knew of them and took 
no action to prevent Enron from using them. The Board was 
briefed on the purpose and nature of the Whitewing, LJM, and 
Raptor transactions, explicitly approved them, and received 
updates on their operations. Enron's extensive off-the-books 
activity was not only well known to the Board, but was made 
possible by Board resolutions authorizing new unconsolidated 
entities, Enron preferred shares, and Enron stock collateral 
that was featured in many of the off-the-books deals.
    The Subcommittee's findings related to the Enron Board 
build upon the findings made by the Special Investigation 
Committee set up by the Board itself under the chairmanship of 
William Powers, Jr. On February 1, 2002, the Powers Committee 
issued a report concluding that the Enron ``Board of Directors 
failed . . . in its oversight duties'' with ``serious 
consequences for Enron, its employees, and its shareholders.'' 
\19\ With respect to Enron's questionable accounting practices, 
the Powers Report concluded that ``[w]hile the primary 
responsibility for the financial reporting abuses . . . lies 
with Management, . . . those abuses could and should have been 
prevented or detected at an earlier time had the Board been 
more aggressive and vigilant.'' \20\
---------------------------------------------------------------------------
    \19\ Hearing Exhibit 84, ``Report on Investigation by the Special 
Investigative Committee of the Board of Directors of Enron 
Corporation'' (2/1/02), which is retained in the files of the 
Subcommittee, (hereinafter ``Powers Report'') at 22.
    \20\ See Powers Report at 24.
---------------------------------------------------------------------------
    During their interviews, all 13 Enron Board members 
strongly disagreed with the Powers Report conclusions that the 
Board had failed in its oversight duties. They contended that 
they had reasonably relied on assurances provided by Enron 
management, Andersen, and Vinson & Elkins, and had met their 
obligation to provide reasonable oversight of company 
operations. During the hearing, all five Board witnesses 
explicitly rejected any share of responsibility for Enron's 
collapse. John Duncan, former Executive Committee Chairman, 
testified that the Board ``worked hard'' and ``asked probing 
questions.'' He said the problem at Enron was that Enron 
management did not ``tell the truth,'' and both management and 
Andersen personnel ``were well aware of the problems facing the 
company and they did not tell us.'' \21\ Mr. Winokur, former 
head of the Finance Committee, testified that Enron was ``a 
cautionary reminder of the limits of a director's role'' which 
is by nature a ``part-time job.'' \22\ He stated, ``We cannot, 
I submit, be criticized for failing to address or remedy 
problems that have been concealed from us.'' \23\
---------------------------------------------------------------------------
    \21\ Hearing Record at 14-15.
    \22\ Id. at 18.
    \23\ Id. at 19.
---------------------------------------------------------------------------
    But much of what was wrong at Enron was not concealed from 
its Board of Directors. High risk accounting practices, 
extensive undisclosed off-the-books transactions, inappropriate 
conflict of interest transactions, and excessive compensation 
plans were known to and authorized by the Board. The 
Subcommittee investigation did not substantiate the claims that 
the Enron Board members challenged management and asked tough 
questions. Instead, the investigation found a Board that 
routinely relied on Enron management and Andersen 
representations with little or no effort to verify the 
information provided, that readily approved new business 
ventures and complex transactions, and that exercised weak 
oversight of company operations. The investigation also 
identified a number of financial ties between Board members and 
Enron which, collectively, raise questions about Board member 
independence and willingness to challenge management.
    The failure of any Enron Board member to accept any degree 
of personal responsibility for Enron's collapse is a telling 
indicator of the Board's failure to recognize its fiduciary 
obligations to set the company's overall strategic direction, 
oversee management, and ensure responsible financial reporting.

        Finding (2): The Enron Board of Directors knowingly 
        allowed Enron to engage in high risk accounting 
        practices.

    One of the most disturbing developments in the 
Subcommittee's investigation was the accumulation of evidence 
that the Enron Board knowingly allowed Enron's use of high risk 
accounting practices. All three of the expert witnesses at the 
May 7 hearing expressed surprise and concern at the role of the 
Audit Committee in countenancing these practices. Mr. Campbell, 
who has extensive corporate management and Board experience, 
testified that he could not ``imagine . . . sitting down with 
the auditors and being told that we are using high-risk 
auditing practices and just agreeing with that.'' \24\ He 
called ``[g]oing forward with that kind of an environment'' 
equivalent to ``going down a slippery slope,'' and said Board 
approval of high risk practices ``is unlike any board that I 
have ever seen or heard of.'' Mr. Elson, a corporate governance 
expert, testified that being told of high risk activities by 
the company's outside auditor ``is a giant red flag'' that 
should have caused Board members to ask ``an awful lot of 
questions'' and might have necessitated bringing in a third 
party to evaluate the company's accounting practices.\25\
---------------------------------------------------------------------------
    \24\ Hearing Record at 109.
    \25\ Id. at 109.
---------------------------------------------------------------------------
    Andersen Briefings on High Risk Areas. The charter of the 
Enron Audit Committee explicitly requires the Committee to 
ensure the independence of the company's auditors, assess 
Enron's internal controls and the quality of its financial 
reporting, and review Enron's financial statements.\26\ 
According to the charter, the Audit Committee's ``principal 
functions'' also include:
---------------------------------------------------------------------------
    \26\ Hearing Exhibit 47b, ``Enron Corp. Audit and Compliance 
Committee Charter'' (2/12/01), Bates CL382-84.

        --``[d]iscuss[ing] with the independent auditor 
        information relating to the auditor's judgments about 
        the quality of the Company's accounting principles, 
        including . . . the clarity and completeness of the 
        Company's accounting information contained in the 
---------------------------------------------------------------------------
        financial statements'';

        --determin[ing] whether Enron's ``internal financial 
        controls . . . provide reasonable assurance that the 
        Company's publicly reported financial statements are 
        presented fairly in conformity with generally accepted 
        accounting principles''; and

        --``[a]pprov[ing] major changes and other major 
        questions of choice regarding the appropriate 
        accounting principles and practices to be followed when 
        preparing the Company's financial statement for the 
        purpose of making recommendations to the Board of 
        Directors as necessary.''

    Materials produced by the Enron Audit Committee and 
Andersen indicate that Andersen personnel regularly briefed the 
Enron Audit Committee about Enron's accounting practices, and 
that Andersen regularly informed the Audit Committee that Enron 
was using accounting practices that, due to their novel design, 
application in areas without established precedent, or 
significant reliance on subjective judgments by management 
personnel, invited scrutiny and presented a high degree of risk 
of non-compliance with generally accepted accounting 
principles.\27\
---------------------------------------------------------------------------
    \27\ See Hearing Exhibits 2 through 9, Andersen presentations to 
Enron Audit Committee.
---------------------------------------------------------------------------
    For example, one such briefing took place on February 7, 
1999, during an Enron Audit Committee meeting attended by all 
of the Audit Committee members, four Andersen representatives, 
and several senior Enron officers, including Mr. Lay and Mr. 
Skilling.\28\ This Committee meeting took place in London, 
during the first leg of a company-sponsored trip for Board 
members to inspect Enron operations in England and India. It 
was followed by a full Board meeting the next day. Audit 
Committee Chairman Dr. Jaedicke presided over the meeting which 
lasted about 90 minutes. The four Andersen representatives 
present were Stephen Goddard, head of the Andersen office in 
Houston; Douglas King, head of the Andersen office in London; 
David Duncan, head of the Enron engagement team, and Thomas 
Bauer, a senior member of the Enron engagement team.
---------------------------------------------------------------------------
    \28\ Hearing Exhibit 2b (Audit Committee minutes from 2/7/99).
---------------------------------------------------------------------------
    The Committee minutes report that, at the February 1999 
meeting, Mr. Duncan reviewed Enron's 1998 financial statements, 
audit and internal controls. The minutes state that Mr. Duncan 
then ``reviewed selected observations by Arthur Andersen 
including a risk profile analysis of accounting judgements, 
disclosure judgements, and rule changes. He was joined in the 
discussion by Mr. Bauer.'' \29\ In connection with its risk 
profile of Enron, Andersen provided Audit Committee members 
with a one-page document entitled, ``Selected Observations 1998 
Financial Reporting.'' \30\ This document identified four 
accounting issues at Enron: ``Highly Structured Transactions,'' 
``Commodity and Equity Portfolio,'' ``Purchase Accounting,'' 
and ``Balance Sheet Issues,'' three of which also had sub-
issues. Each issue was followed by a ``Risk Profile'' table 
with three headings: ``Accounting Judgements,'' ``Disclosure 
Judgements,'' and ``Rule Changes.'' The table then assigned an 
``H,'' ``M,'' or ``L'' rating to each element of the Risk 
Profile. The ``H'' stood for ``High,'' the ``M'' for 
``Medium,'' and the ``L'' for ``Low.'' Each of the listed 
accounting issues was followed by one, two, or three ``H's,'' 
meaning it was rated as high risk.
---------------------------------------------------------------------------
    \29\ Hearing Exhibit 2b (Audit Committee minutes from 2/7/99) at 2.
    \30\ Hearing Exhibit 2a, ``Selected Observations 1998 Financial 
Reporting'' (Audit Committee presentation, 2/7/99).
---------------------------------------------------------------------------
    Andersen's legal counsel told the Subcommittee staff that 
this document was intended to inform the Audit Committee that 
Enron was using a number of high risk accounting practices. 
Andersen's legal counsel explained that this document was 
intended to advise the Audit Committee that, even with 
Andersen's backing, Enron's use of the identified accounting 
practices invited accounting scrutiny and ran the risk that the 
company could later be found to be in noncompliance with 
generally accepted accounting principles. In addition, 
Andersen's legal counsel indicated that the firm intended to 
convey to the Audit Committee that Enron's use of highly 
structured transactions, with multiple special purpose entities 
and complex overlapping transactions, ran the risk that, if one 
element failed, the entire structure might fail and cause the 
company to fall into noncompliance.
    Another document with the same heading, ``Selected 
Observations 1998 Financial Reporting,'' was used by Mr. Duncan 
as his personal talking points for the February 1999 
briefing.\31\ This document lists nine accounting practices, 
followed by a Risk Profile table using the same H, M, and L 
system. Each of the identified accounting practices is followed 
by one, two, or three ``H's,'' meaning each had been rated as a 
high risk. A handwritten note by Mr. Duncan in the lower right-
hand corner of the document states:
---------------------------------------------------------------------------
    \31\ Hearing Exhibit 3, ``Selected Observations 1998 Financial 
Reporting'' (David Duncan talking points for Audit Committee 
presentation, 2/7/99), a copy of which was not provided to the Audit 
Committee during the meeting.

        ``Obviously, we are on board with all of these, but 
        many push limits and have a high `others could have a 
        different view' risk profile.'' \32\
---------------------------------------------------------------------------
    \32\ Hearing Exhibit 3, ``Selected Observations 1998 Financial 
Reporting'' (David Duncan talking points for Audit Committee 
presentation, 2/7/99), a copy of which was not provided to the Audit 
Committee during the meeting. See also Hearing Exhibit 4, prepared by 
the Subcommittee, transcribing the handwritten note by David Duncan and 
other information contained in Hearing Exhibit 3.

While Mr. Duncan did not make himself available in response to 
a Subcommittee request to elaborate on this note, his colleague 
Mr. Bauer confirmed through legal counsel that Mr. Duncan had 
conveyed this information to the Audit Committee. In a letter 
dated May 2, 2002, Mr. Bauer's legal counsel wrote the 
---------------------------------------------------------------------------
following:

        ``As you requested, on behalf of Tom Bauer, a partner 
        in Arthur Andersen, I am responding to your inquiries. 
        . . . To the best of Mr. Bauer's knowledge, the 
        handwriting on the document . . . is the handwriting of 
        David Duncan. It reflects what Mr. Duncan and others 
        discussed at an Enron Audit Committee meeting held on 
        February 7, 1999. . . . The risk profile of Enron as 
        reflected in the document was discussed at that meeting 
        with and among the members of the Audit Committee and 
        the representatives of the Company who attended. . . . 
        Certain risk areas were described as `pushing the 
        limits', as reflected in Mr. Duncan's notes, or as 
        being `at the edge.' '' \33\
---------------------------------------------------------------------------
    \33\ Hearing Exhibit 5, letter dated 5/2/02 from Bauer's legal 
counsel to the Subcommittee.

    In short, on February 7, 1999, Andersen informed the Audit 
Committee members that Enron was engaged in accounting 
practices that ``push limits'' or were ``at the edge'' of 
acceptable practice. In the discussion that followed, Andersen 
did not advocate any change in company practice, and no Board 
member objected to Enron's actions, requested a second opinion 
of Enron's accounting practices, or demanded a more prudent 
approach.
    The February 1999 meeting was not the only briefing in 
which Andersen notified the Audit Committee that Enron was 
engaged in high risk accounting practices. In fact, similar 
briefings took place once or twice each year from 1999 through 
2001, with similar presentations prepared by Andersen.\34\ The 
presentations regularly identified high risk areas such as 
Enron's use of highly structured transactions and related party 
transactions. Minutes from an Audit Committee meeting in May 
2000, for example, state: ``Mr. Duncan discussed the financial 
reporting areas that [Andersen] had determined to be high 
priorities due to inherent risks that were present. He stated 
that the ongoing high priority areas included structured 
transactions, the merchant portfolio, commodity trading 
activities, project development activities and intercompany and 
related party transactions.'' \35\ Handwritten notes on the 
bottom of a 2001 presentation to the Audit Committee, added by 
the Enron Corporate Secretary during the course of Andersen's 
oral presentation, state: ``There are a number of areas where 
accounting rules have not kept up w/ the Company's practices 
and some interpretation is necessary.'' \36\ Andersen's legal 
counsel representatives told the Subcommittee staff that each 
presentation was intended to convey the same message to the 
Audit Committee, that Enron was using high risk accounting 
practices.
---------------------------------------------------------------------------
    \34\ See Hearing Exhibit 6 (Audit Committee presentation, 5/3/99); 
Hearing Exhibit 7a (Audit Committee presentation, 5/1/00); Hearing 
Exhibit 8a (Audit Committee presentation, 2/12/01); and Hearing Exhibit 
9 (Audit Committee presentation, 4/20/01).
    \35\ Hearing Exhibit 7c (Audit Committee minutes from 5/1/00) at 2.
    \36\ Hearing Exhibit 8a (Audit Committee presentation, 2/12/01).
---------------------------------------------------------------------------
    Other internal Andersen documents offer additional proof 
that Andersen viewed Enron as engaged in high risk accounting. 
For example, most large auditing firms, including Andersen, 
perform an annual client risk analysis to ensure the firm 
understands each client and how much effort will be required in 
an audit to ensure that the client complies with generally 
accepted accounting principles. Andersen's 1999 and 2000 client 
risk analyses placed Enron in its category for ``Maximum'' 
risk.\37\ The 2000 analysis, which was signed by David Duncan 
and four other Andersen partners, identified several ``Risk 
Drivers'' for Enron, including stating that Enron ``Management 
Pressures'' were ``Very Significant'' and that the ``Accounting 
and Financial Reporting Risk'' associated with Enron was also 
``Very Significant.'' The analyses offered some specific 
comments explaining the maximum risk rating, including the 
following:
---------------------------------------------------------------------------
    \37\ Hearing Exhibits 10a and 10b, excerpts from Andersen's 1999 
and 2000 annual client risk analysis of Enron Corporation.

        ``Enron has aggressive earnings targets and enters into 
        numerous complex transactions to achieve those 
---------------------------------------------------------------------------
        targets.''

        ``The Company's personnel are very sophisticated and 
        enter into numerous complex transactions and are often 
        aggressive in structuring transactions to achieve 
        derived financial reporting objectives.''

        ``Form over substance transactions.''

    An email dated February 6, 2001, sent to David Duncan and 
Thomas Bauer by another Andersen partner, Michael D. Jones, 
offers further proof that Andersen viewed Enron as engaged in 
risky accounting. This email summarizes a meeting held the 
previous day by 14 senior Andersen partners to decide whether 
the firm should retain Enron as a client. The email indicates 
that the group was aware of and uneasy about a number of 
accounting practices and transactions at Enron. The email, 
included in Hearing Exhibit 73, states:

        ``Significant discussion was held regarding the related 
        party transactions with LJM including the materiality 
        of such amounts to Enron's income statement and the 
        amount retained `off balance sheet'. The discussion 
        focused on Fastow's conflicts of interest in his 
        capacity as CFO and the LJM fund manager, the amount of 
        earnings that Fastow receives for his services and 
        participation in LJM, the disclosures of the 
        transactions in the financial footnotes, Enron's [Board 
        of Directors'] views regarding the transactions and our 
        and management's communication of such transactions to 
        the [Board of Directors] and our testing of such 
        transactions to ensure that we fully understand the 
        economics and substance of the transactions. . . . A 
        significant discussion was also held regarding Enron's 
        [mark-to-market] earnings and the fact that it was 
        `intelligent gambling'. . . . We discussed Enron's 
        dependence on transaction execution to meet financial 
        objectives, the fact that Enron often is creating 
        industries and markets and transactions for which there 
        are no specific rules which requires significant 
        judgement and that Enron is aggressive in its 
        transaction structuring. . . .
          ``Ultimately, the conclusion was reached to retain 
        Enron as a client citing that it appeared that we had 
        the appropriate people and processes in place to serve 
        Enron and manage our engagement risks.''

    In a meeting prior to the May 7 hearing, Andersen's legal 
counsel told Subcommittee staff that Andersen clearly 
considered Enron to be engaged in high risk accounting. In 
response to a question, one of Andersen's attorneys said that 
it would be ``ridiculous'' to characterize Enron as engaged in 
mainstream accounting.
    During the hearing, Dr. Jaedicke, the former Audit 
Committee Chairman, said that ``[w]e knew that the company was 
engaged in high-risk and innovative transactions,'' but did not 
recall being told that the company's accounting practices 
``push limits.'' \38\ He testified:
---------------------------------------------------------------------------
    \38\ Hearing Record at 30-31.

        ``David Duncan did tell us on several occasions that 
        these were complex transactions, that they were complex 
        structures, that Enron was a complex company. They were 
        moving very fast, and very careful accounting judgments 
        were required. . . . I do not recall him saying, well, 
        `others could have a different view.' But I think all 
        of us understood that these were highly structured, new 
        kinds of transactions, but . . . Enron paid Arthur 
        Andersen some pretty hefty fees, to try to be in on the 
        beginning of these transactions so that those 
        accounting judgments . . . would be properly made. . . 
        . Now, when we would ask them [Andersen], even in 
        executive session, about, OK, how do you feel about 
        these, the usual expression was one of comfort. It was 
        not, these are the highest risk transactions on our 
        scale of one to 10. . . .'' \39\
---------------------------------------------------------------------------
    \39\ Id. at 29 and 32.

    During their interviews, a number of Enron Board members 
stated that Enron was engaged in complex accounting and was 
operating in areas with few established accounting guidelines, 
but most declined to characterize Enron's accounting as high 
risk or aggressive. Mr. Blake characterized Enron as engaged in 
``leading edge,'' not ``aggressive'' accounting. Lord Wakeham, 
a chartered accountant and chairman of an audit committee at 
another company, said that Enron was engaged in business 
transactions that had ``not been done by many companies in the 
world'' and were ``relatively new.'' He indicated that he 
believed Enron's practices were within the bounds of generally 
accepted accounting principles since they had been approved by 
Andersen. He told the Subcommittee staff that he had believed 
Andersen would stand by their accounting advice and was shocked 
when, in 2001, Andersen began to reverse course and repudiate 
the accounting methodologies and judgments it had earlier 
provided.
    Other Evidence of Board Awareness of Enron's High Risk 
Accounting. In addition to the Audit Committee's receipt of 
explicit briefings on Enron's high risk accounting practices, 
many other documents demonstrate that the Board knowingly 
allowed Enron to use high risk accounting techniques, 
questionable valuation methodologies, and highly structured 
transactions to achieve favorable financial statement results.
    In April 2002, for example, Enron filed with the Securities 
and Exchange Commission (SEC) an 8-K filing indicating that the 
company had on its books assets that were overvalued by 
billions of dollars, apparently due to questionable valuation 
methodologies.\40\ In this filing, Enron announced its intent 
to write-down $14 billion in the book value of its assets due 
to ``historical carrying value[s]'' which ``may have been 
overstated due to possible accounting errors or 
irregularities'' and another $10 billion in ``downward 
adjustments on certain price risk management assets and 
collateral'' involving unspecified ``forwards, swaps, options, 
energy transportation contracts utilized for trading activities 
and other instruments with third parties.'' \41\
---------------------------------------------------------------------------
    \40\ Form 8-K filed by Enron Corporation with SEC (4/22/02).
    \41\ Id. at 2-3.
---------------------------------------------------------------------------
    The evidence indicates that at least some of these 
valuation issues were brought to the attention of Enron Board 
members. For example, in 1999, Audit Committee members were 
given a nine-page presentation on mark-to-market and fair value 
accounting issues, and told how Enron divisions were expanding 
their use of fair value accounting which ``require[d] 
continuous revaluation of asset[s] and liabilities'' on Enron's 
books.\42\ In May 2000, Board members were told about a dispute 
between Enron divisions on how energy derivatives and contracts 
should be valued on Enron's books and did not object when the 
company decided to go with the more aggressive valuation 
model.\43\ From 1999 through 2001, Board members were regularly 
briefed about Enron's ``merchant assets,'' an accounting 
classification that Enron used to justify recording on its 
books a higher market value for certain assets, rather than a 
lower, historical cost.\44\ Once Enron recorded the higher 
market value, however, if that market value later fell, it is 
unclear whether Enron would record the lower value. One 
document provided to the Finance Committee in the summer of 
2001, for example, lists Enron's international merchant assets 
and indicates that they were overvalued on Enron's books by 
$2.3 billion, compared to their market value as then determined 
by Enron's own staff.\45\
---------------------------------------------------------------------------
    \42\ Hearing Exhibit 51 (Audit Committee presentation, 10/11/99), 
Bates JW779-87, at 2.
    \43\ Hearing Exhibit 28a (Finance Committee minutes, 5/1/00) at 4-
5.
    \44\ See, for example, references to Enron's merchant assets or 
merchant portfolio in Audit Committee presentations, Hearing Exhibit 2 
(Audit Committee presentation, 2/7/99); Hearing Exhibit 6 (Audit 
Committee presentation, 5/3/99); Hearing Exhibit 7a (Audit Committee 
presentation, 5/1/00); Hearing Exhibit 7c (Audit Committee minutes, 5/
1/00) at 2; Hearing Exhibit 9 (Audit Committee presentation, 4/20/01); 
as well as in Finance Committee presentations, Hearing Exhibit 56d 
(Finance Committee minutes 12/13/99) at 2; Hearing Exhibit 56e (Board 
minutes 12/14/99) at 4; Hearing Exhibit 28a (Finance Committee minutes, 
5/1/00) at 4; and Hearing Exhibit 56k (Finance Committee minutes 2/12/
01) at 2.
    \45\ Hearing Exhibit 71, ``Enron Global Assets and Services; Equity 
Value Schedule'' (6/01), Bates E103411. Despite the huge valuation gap, 
none of the interviewed Board members could recall either inquiring 
into this difference or determining whether Enron's assets were 
correctly valued in its financial statements. See also Watkins' letter 
to Board Chairman Lay (8/15/01) at 1, attached to this report as 
Appendix 2 on page 57. (``We do have valuation issues with our 
international assets and possibly some of our EES [mark-to-market] 
positions.'')
---------------------------------------------------------------------------
    Other documents, such as Board and Committee presentations 
and Deal Approval Sheets (DASHs), routinely presented complex 
structured transactions for Board approval, at times with 
schematic charts mapping out multiple special purpose entities 
and complex financing arrangements.\46\ When Enron presented 
for Board approval the Rhythms and Raptors transactions, for 
example, explained more fully below, Enron and Andersen 
personnel explicitly told Board members that the proposed 
transactions involved innovative uses of derivatives, Enron 
stock, forward contracts, and off-the-books special purpose 
entities.\47\ Finance Committee presentations also alerted 
Board members to Enron's increasing use of ``Prepays'' and 
``FASB 125 Sales,'' complex transactions that used 
sophisticated accounting rules to add billions of dollars to 
Enron's reported earnings and cash flow.\48\
---------------------------------------------------------------------------
    \46\ See, for example, Hearing Exhibit 15 (Whitewing), Hearing 
Exhibit 19 (LJM1) and Hearing Exhibit 28b (Raptor I). See also, for 
example, Hearing Exhibits 56d and 56e (Finance Committee minutes from 
12/13/99 at 3; and Board minutes from 12/14/99 at 5).
    \47\ During his Subcommittee interview, Mr. Blake stated that he 
was told and had understood that the Raptor transactions involved 
``very creative'' accounting. The Subcommittee staff was told by an 
Enron employee who overheard it that Mr. Blake also commented to Mr. 
Fastow that Enron ought to get ``a patent'' on the Raptor structures to 
sell them to other companies.
    \48\ See, for example, Hearing Exhibit 42, ``Finance Related Asset 
Sales; Prepays and 125 Sales'' (Finance Committee presentation, 8/01), 
showing dramatic increases in the dollar value of ``Prepays'' and 
``FASB 125 Sales'' at Enron over a 3-year period. Total dollar value of 
these transactions climbed from $6.7 billion in 1999, to $9.2 billion 
in 2000, to $6.5 billion in the first 6 months of 2001. The 
Subcommittee's analysis indicates that ``Prepays'' refers to prepaid 
forward contracts under which, in essence, Enron received an advance 
payment for a commitment to deliver a commodity, such as natural gas, 
in the future. The evidence also indicates, however, that the forward 
payments actually operated as loans that were disguised as trading 
activity, in order to be booked as cash flow from operations rather 
than debt on Enron's financial statements. FASB 125 is an accounting 
rule intended to allow investment companies such as stock brokerages to 
recognize earnings and cash flow from the sale of ``financial assets'' 
such as stock or mortgage backed securities. The Subcommittee analysis 
indicates that ``FASB 125 Sales'' refers to Enron's practice of selling 
a portion of its interest in a hard, physical asset like a power plant 
to a third party; classifying the instrument used to convey that 
interest as a ``financial asset'' under FASB 125; and then recognizing 
immediate earnings and cash flow from the sale. Both types of 
transactions raise numerous accounting issues.
---------------------------------------------------------------------------
    The Powers Report criticized Enron for engaging in 
``significant transactions'' that were ``apparently designed to 
accomplish favorable financial statement results, not to 
achieve bona fide economic objectives or to transfer risk.'' 
\49\ The Powers Report also criticized Enron actions to 
``conceal from the market very large losses resulting from 
Enron's merchant investments'' and to ``circumvent accounting 
principles'' through the use of complex transactions ``that 
lacked fundamental economic substance.'' \50\ All of the Board 
members interviewed by the Subcommittee staff denied approving 
particular transactions or accounting practices for the reasons 
described in the Powers Report. Yet numerous presentations 
described or urged Board approval of transactions in light of 
their favorable impact on Enron's financial statements. For 
example:
---------------------------------------------------------------------------
    \49\ Powers Report at 4.
    \50\ Id. at 4-5.
---------------------------------------------------------------------------
        --LLJM1 and LJM2, Mr. Fastow's private equity funds, 
        were lauded for producing over $2 billion in ``Funds 
        flow'' for Enron and over $200 million in Enron 
        ``Earnings.'' \51\
---------------------------------------------------------------------------
    \51\ Hearing Exhibit 23, ``LJM2 Update'' (Finance Committee 
presentation, 5/1/00).

        --LA presentation identifying $2 billion in past and 
        planned Enron asset sales during 2000, primarily to 
        LJM2 and two other unconsolidated affiliates, Whitewing 
        and the Hawaii 125-0 Trust, is characterized as a 
        ``2000 Balance Sheet Management'' effort.\52\
---------------------------------------------------------------------------
    \52\ Hearing Exhibit 17, ``EGF Execution Schedule; 2000 Balance 
Sheet Management'' (Finance Committee presentation, 8/00). The document 
indicated that about $1.5 billion of the $2 billion total involved 
LJM2, Whitewing or Hawaii 125-0 Trust.

        --LThe Board itself apparently set ``funds flow and 
        balance sheet ratio targets'' for Enron to achieve, as 
        shown by an Enron Global Markets presentation reporting 
        on the company's actual versus targeted 
        performance.\53\
---------------------------------------------------------------------------
    \53\ Hearing Exhibit 70, ``Enron's Funds Flow Targets'' (Enron 
Global Markets presentation 3/01), Bates EC27671 (reporting on ``Enron 
Corp. funds flow and balance sheet ratio targets set by the Board of 
Directors versus actual results'').

        --LEnron's 10 largest transactions in the second half 
        of 2000 are described to the Finance Committee in terms 
        of their balance sheet impact, producing ``Positive 
        Funds Flow,'' ``Debt reduction,'' or ``Balance Sheet 
        protection'' for the company.\54\
---------------------------------------------------------------------------
    \54\ Hearing Exhibit 60, ``Major Transactions; Largest 10 
Transactions (June 30-December 31)'' (Finance Committee presentation, 
12/11/00), Bates EC24832.

        --LEven a tax matter, identified as the ``Tammy Tax 
        Advantaged Transaction,'' is explained to the Finance 
        Committee in terms of producing $500 million in ``Debt 
        reduction'' for the company.\55\
---------------------------------------------------------------------------
    \55\ Id. See also ``Enron's Other Strategy: Taxes; Internal Papers 
Reveal How Complex Deals Boosted Profits by $1 Billion,'' Washington 
Post (5/22/02), alleging 11 tax transactions at Enron were undertaken 
to produce earnings or cash flow on Enron's financial statements.

    Still another indicator of Enron's high risk accounting is 
the long list of related entities disclosed in Enron's 10-K 
filings for 1999 and 2000, which were approved and signed by 
Enron Board members. These filings list almost 3,000 separate 
entities, with over 800 organized in well-known offshore 
jurisdictions, including about 120 in the Turks and Caicos, and 
about 600 using the same post office box in the Cayman Islands. 
No Board member who signed the 10-K filings expressed an 
objection to or concern about Enron's thousands of related 
entities or the complex transactions in which they were 
involved.
    When confronted by evidence of Enron's high risk 
accounting, all of the Board members interviewed by the 
Subcommittee pointed out that Enron's auditor, Andersen, had 
given the company a clean audit opinion each year. None 
recalled any occasion on which Andersen had expressed any 
objection to a particular transaction or accounting practice at 
Enron, despite evidence indicating that, internally at 
Andersen, concerns about Enron's accounting were commonplace. 
But a failure by Andersen to object does not preclude a finding 
that the Enron Board, with Andersen's concurrence, knowingly 
allowed Enron to use high risk accounting and failed in its 
fiduciary duty to ensure the company engaged in responsible 
financial reporting.

        Finding (3): Despite clear conflicts of interest, the 
        Enron Board of Directors approved an unprecedented 
        arrangement allowing Enron's Chief Financial Officer to 
        establish and operate the LJM private equity funds 
        which transacted business with Enron and profited at 
        Enron's expense. The Board exercised inadequate 
        oversight of LJM transaction and compensation controls 
        and failed to protect Enron shareholders from unfair 
        dealing.

    The Enron Board's decision to waive the company's code of 
conduct and allow its Chief Financial Officer (CFO) Andrew 
Fastow to establish and operate off-the-books entities designed 
to transact business with Enron was also highly unusual and 
disturbing. This arrangement allowed inappropriate conflict of 
interest transactions as well as accounting and related party 
disclosure problems, due to the dual role of Mr. Fastow as a 
senior officer at Enron and an equity holder and general 
manager of the new entities. Nevertheless, with little debate 
or independent inquiry, the Enron Board approved three code of 
conduct waivers enabling Mr. Fastow to establish three private 
equity funds in 1999 and 2000, known as LJM1, LJM2 and 
LJM3.\56\
---------------------------------------------------------------------------
    \56\ The initials ``LJM'' apparently refer to Mr. Fastow's wife and 
children. Of the three LJM entities approved by the Enron Board, only 
LJM1 and LJM2 became active. LJM1 was organized as a limited 
partnership in the Cayman Islands and refers to a company named LJM 
Cayman, L.P. LJM2 was organized as a Delaware limited partnership and 
refers to a company named LJM2 Co-Investment, L.P. In each instance, 
the entity that served as the general partner of LJM1 or LJM2 and was 
responsible for running the equity fund on a day-to-day basis was 
wholly owned by Mr. Fastow through a complex set of intermediaries. 
LJM1 and LJM2 also each had a variety of limited partners, most of whom 
were third party investors such as banks, pension funds, or insurance 
companies who contributed capital to the fund. See Powers Report at 68-
74. In the case of LJM1, Mr. Fastow and five other Enron employees 
later formed a partnership known as Southampton, L.P. and took 
ownership of a key LJM1 subsidiary. Id. at 92-93.
---------------------------------------------------------------------------
    The Enron Board approved code of conduct waivers for Mr. 
Fastow knowing that the LJM partnerships were designed to 
transact business primarily with Enron, and controls would be 
needed to ensure the LJM transactions and Mr. Fastow's 
compensation were fair to Enron. The Board failed, however, to 
make sure the controls were effective, to monitor the fairness 
of the transactions, or to monitor Mr. Fastow's LJM-related 
compensation. The result was that the LJM partnerships realized 
hundreds of millions of dollars in profits at Enron's expense.
    Enron's code of conduct for its employees expressly 
prohibited Enron employees from obtaining personal financial 
gain from a company doing business with Enron.\57\ This 
prohibition could be waived, however, by the CEO upon a finding 
that a proposed arrangement would ``not adversely affect the 
best interests of the Company.'' \58\ In the case of the LJM 
partnerships, Mr. Lay approved waiving the code of conduct 
prohibition for Mr. Fastow, but also asked the Enron Board to 
ratify his decision, even though Board concurrence was not 
explicitly required by company rules.\59\ Evidence introduced 
in the Andersen criminal trial indicates that the idea for 
Board ratification may have originated with Andersen. 
Apparently, a number of senior Andersen personnel, including 
David Duncan, had serious concerns about the LJM proposal and 
were reluctant to support it. Benjamin Neuhausen, a member of 
Andersen's Professional Standard Group, wrote in a 5/28/99 
email to David Duncan:
---------------------------------------------------------------------------
    \57\ See Hearing Exhibit 26, ``Enron Code of Ethics'' (7/00) 
(``Business Ethics'') at 12:
       ``LEmployees of Enron Corp. . . . are charged with conducting 
their business affairs in accordance with the highest ethical 
standards. An employee shall not conduct himself or herself in a manner 
which directly or indirectly would be detrimental to the best interests 
of the Company or in a manner which would bring to the employee 
financial gain separately derived as a direct consequence of his or her 
employment with the Company.''
    \58\ Hearing Exhibit 26 (``Conflicts of Interest, Investments, and 
Outside Business Interests of Officers and Employees'') at 57:
       ``L[N]o full-time officer or employee should . . . [o]wn an 
interest in or participate, directly or indirectly, in the profits of 
any other entity which does business with or is a competitor of the 
Company, unless such ownership or participation has been previously 
disclosed in writing to the Chairman of the Board and Chief Executive 
Officer of Enron Corp. and such officer has determined that such 
interest or participation does not adversely affect the best interests 
of the Company.''
    \59\ At the hearing, Mr. Winokur and Dr. Jaedicke contended that 
the Board did not actually ``waive'' the company's code of conduct, but 
``applied'' it in the LJM matters. Hearing Record at 17, 59-60. 
However, all three LJM presentations explicitly request Board approval 
of a code of conduct waiver. Hearing Exhibit 19, ``Project LJM Board 
Presentation'' (``Waiver of Code of Conduct'') at 8; Hearing Exhibit 
20, ``LJM 2 Summary'' (``Ratify decision of Office of the Chairman to 
waive Code of Conduct in order to allow A. Fastow participation in LJM2 
as General Partner''); Hearing Exhibit 56h, ``LJM3 presentation to the 
Finance Committee,'' page entitled ``LJM3'' (``Ratify decision of 
Office of Chairman to waive Code of Conduct in order to allow A. Fastow 
involvement as General Partner of LJM''), Bates EC 25373-80 and RJ903.

        ``Setting aside the accounting, idea of a venture 
        entity managed by CFO is terrible from a business point 
        of view. Conflicts galore. Why would any director in 
        his or her right mind ever approve such a scheme?'' 
        \60\
---------------------------------------------------------------------------
    \60\ Hearing Exhibit 55, ``Defendant Andersen Exhibit 763,'' U.S. 
v. Arthur Andersen (USDC SD Texas, Criminal Action No. H-02-0121).

---------------------------------------------------------------------------
Mr. Duncan responded in a 6/1/99 email as follows:

        ``[O]n your point 1 (i.e., the whole thing is a bad 
        idea), I really couldn't agree more. Rest assured that 
        I have already communicated and it has been agreed to 
        by Andy that CEO, General [Counsel], and Board 
        discussion and approval will be a requirement, on our 
        part, for acceptance of a venture similar to what we 
        have been discussing.'' \61\
---------------------------------------------------------------------------
    \61\ Id. ``Defendant Andersen Exhibit 764.'' Andersen personnel 
also had significant accounting-related concerns with LJM, in a number 
of areas discussed in this email and other documents. One major concern 
was that LJM was being established as a special purpose entity outside 
of Enron's control, yet was to be managed by a senior Enron officer. 
Mr. Fastow contended that LJM would not be under his or Enron's 
control, because LJM's limited partners could remove him at will. 
Andersen noted in an internal memorandum, however, that the limited 
partners could remove him only if they obtained supermajorities in two 
separate votes, which Andersen said ``was at the very upper limit of 
what may be acceptable.'' Hearing Exhibit 59, ``Memorandum to the Files 
by David Duncan and others'' (12/31/99, as amended 10/12/01), Bates 
AASCGA(TX)1375-78, at 2. Andersen nonetheless eventually gave its 
approval to the LJM partnerships.

    Board Approval of LJM With Few Questions Asked. Board 
approval proved easy to obtain. The first LJM presentation made 
to the Board took place on June 28, 1999, at a special Board 
meeting held by teleconference.\62\ The Board was told that 
LJM1 would be set up as a special purpose entity that would not 
be on Enron's balance sheet, and it would be owned in part and 
managed by Mr. Fastow. Its first transaction, which was 
presented to the Board for approval, involved a high tech stock 
called Rhythms NetConnections, which Enron had purchased at the 
company's initial public offering for $10 million and whose 
value had skyrocketed to about $300 million. Enron had already 
recognized the appreciation in the stock price as earnings on 
its financial statements, and wanted to protect its income 
statements from any loss if the stock price fell. The Board was 
told that, through a novel and complicated transaction, LJM1 
could provide a ``hedge'' on the Rhythms stock ``at no cost to 
Enron.'' Better yet, LJM1 could pay Enron $50 million in cash 
to do so, which the Board was reminded ``counts as funds 
flow.'' The Board was also told that LJM1 would not be limited 
to that single transaction, but could ``negotiat[e] with Enron 
for purchase of additional merchant assets.'' \63\
---------------------------------------------------------------------------
    \62\ Hearing Exhibit 19, ``Project LJM Board Presentation'' (6/28/
99).
    \63\ Although some Board members described LJM1 as an entity that 
engaged in a single transaction, LJM1 was designed to engage in 
multiple transactions and did so. LJM1's ability to engage in multiple 
transactions was made clear not only in the Board presentation, but 
also in the Board minutes which state: ``In addition, LJM may negotiate 
with the Company regarding the purchase of additional assets in the 
Merchant Portfolio.'' The Board presentation also characterized LJM1 as 
a possible ``Future Investment Management Company,'' and suggested that 
LJM1 might be used to ``[c]apture Cuiaba/Electro value,'' referring to 
investments Enron held in two other energy projects. LJM1, in fact, 
entered into two additional multi-million dollar transactions involving 
purchasing an interest in a Brazilian power plant owned and run by 
Enron, and purchasing Osprey debt certificates from Whitewing which 
LJM1 held for 3 months before selling them to Chewco. See also Powers 
Report at 70.
---------------------------------------------------------------------------
    The Board members interviewed about this matter generally 
acknowledged that the LJM1 transaction was unprecedented, both 
because of the CFO's code of conduct waiver and the nature of 
the Rhythms transaction which supposedly allowed LJM1 to hedge 
a highly volatile stock at no cost to Enron and to pay Enron 
$50 million as part of the hedging structure. Despite these 
highly unusual features, the Board ratified the code of conduct 
waiver and approved the LJM1 proposal with little study or 
debate. For example, contrary to the Board's usual practice, 
the LJM1 proposal was never reviewed by the Finance Committee 
before it was submitted to the full Board for consideration. It 
was presented to the Board itself for the first time in written 
materials faxed to Board members 3 days before the special 
meeting. During the meeting itself, Board discussion of the 
proposal appears to have been minimal. The Board minutes show 
that the special meeting considered a number of matters in 
addition to the LJM1 proposal, including resolutions 
authorizing a major stock split, an increase in the shares in 
the company's stock compensation plan, the purchase of a new 
corporate jet, and an investment in a Middle Eastern power 
plant.\64\ Mr. Lay also discussed a reorganization underway at 
Enron. Yet the entire meeting lasted 1 hour.\65\
---------------------------------------------------------------------------
    \64\ Hearing Exhibit 56a (Board minutes 6/28/99).
    \65\ Id.
---------------------------------------------------------------------------
    When asked why the Board moved so quickly on such an 
unusual proposal, the Board members suggested during their 
interviews that they had seen LJM1 as involving a single 
transaction, the Rhythms stock ``hedge,'' for which the company 
had obtained a fairness opinion from an outside accounting firm 
and which involved little risk to Enron.\66\ At the hearing, 
Dr. Jaedicke, former head of the Audit Committee, explained 
that the Board meeting took place shortly before the close of 
the second quarter reporting period in 1999, and the company 
``did not want to be in the position of having a fair value 
investment, a stock on their books, a mark-to-market [asset], 
without a hedge.'' \67\ Enron obtained Board approval of LJM1's 
formation and the Rhythms transaction on June 28, 2 days prior 
to the end of the reporting period on June 30.
---------------------------------------------------------------------------
    \66\ The evidence indicates, however, that the Board could not have 
relied on the fairness opinion in deciding to move quickly in June 
1999, because that opinion was not mentioned in the Board presentation 
and was not provided by PriceWaterhouseCoopers until 2 months later--
after the transaction itself was completed. See draft fairness opinion 
(8/13/99), Bates EC2 13298; and Hearing Exhibit 57 (final fairness 
opinion 8/17/99), Bates AASCGA1949.2-49.6 (the final fairness opinion, 
conveyed by letter from PriceWaterhouseCoopers, explicitly notes that 
it is evaluating a completed transaction which became ``effective as of 
June 30, 1999'').
    \67\ Hearing Record at 61.
---------------------------------------------------------------------------
    About 3 months later, in October 1999, the Board was asked 
to approve a second LJM partnership, LJM2, described as a 
``[f]ollow-on private equity fund to LJM1.'' \68\ The 
``purpose'' of creating LJM2 was described as providing a 
``source of private equity for Enron to manage its investment 
portfolio risk, funds flow, and financial flexibility.'' \69\ 
In his Subcommittee interview, Mr. Blake described LJM2 as an 
``extension of Enron'' intended to serve as an ``empty bucket'' 
for Enron assets. He said that LJM2 was supposed to create ``an 
internal Enron marketplace'' in which Enron business units 
could sell Enron assets to Mr. Fastow's fund allegedly in 
``arm's length'' negotiations at less cost and at a quicker 
pace than would be possible in transactions with a completely 
independent party. Due to Mr. Fastow's participation, the Board 
was asked to ratify a second code of conduct waiver that would 
allow him to set up and manage LJM2, hold an ownership interest 
in the fund, locate additional investors and financing, and 
receive compensation for his efforts.
---------------------------------------------------------------------------
    \68\ Hearing Exhibit 20, ``LJM 2 Summary'' (10/11/99).
    \69\ Id.
---------------------------------------------------------------------------
    This time the LJM2 proposal went first to the Finance 
Committee, which approved it in a 90-minute meeting on October 
11, 1999, after what Mr. Winokur, the Committee Chairman, 
described as ``a vigorous discussion.'' \70\ The following day, 
Mr. Winokur recommended LJM2's approval to the full Board. The 
Board approved it on October 12, 1999. Although Enron Board 
members contend they routinely challenged Enron management 
proposals, Mr. Fastow had apparently been so confident of Board 
approval that he had already completed negotiations with 
Merrill Lynch to develop an LJM2 marketing strategy and had 
approved an LJM2 private placement memorandum which Merrill 
Lynch released on October 13, 1999, 1 day after the Board 
meeting scheduled to approve LJM2's formation.\71\
---------------------------------------------------------------------------
    \70\ Hearing Record at 63.
    \71\ Hearing Exhibit 21, ``LJM2 Co-Investment, L.P. Private 
Placement Memorandum'' (10/13/99). See also Hearing Exhibit 58, 
``Supplement Number One to Private Placement Memorandum'' (12/15/99), 
Bates LJM58123, at 1.
---------------------------------------------------------------------------
    No Board member recalled asking to see or actually 
reviewing the private placement memorandum or other LJM2 
marketing materials, either then or later. One Board member, 
Robert Belfer, told the Subcommittee staff that he actually 
received the memorandum in the mail, offering him the 
opportunity to invest in LJM2, but threw it away without 
reading it. At the hearing, Mr. Winokur testified that the 
Finance Committee had been told that Enron's legal counsel, 
Vinson & Elkins, had reviewed the memorandum and relied on the 
law firm to alert the Board to any problems.\72\ He indicated 
that Vinson & Elkins never told the Board anything was amiss, 
which is why the Board never requested or reviewed the 
material. Had the Board reviewed the memorandum, the Directors 
would have learned that it named not only Mr. Fastow, but also 
two other senior Enron financial officers as LJM2 principals, 
Michael Kopper and Ben Glisan, both of whom worked for Mr. 
Fastow and neither of whom had obtained a code of conduct 
waiver to participate in LJM2. The memorandum also explicitly 
touted the officers' inside access to Enron information and 
``deal flow'' as selling points for the LJM2 fund.
---------------------------------------------------------------------------
    \72\ Hearing Record at 64.
---------------------------------------------------------------------------
    In October 2000, the Finance Committee and the full Board 
approved the establishment of LJM3, with a third code of 
conduct waiver and even less debate.\73\ That same month, LJM 
issued its first annual report to its investors laying out its 
activities and returns, but, again, no Enron Board member 
requested or reviewed this report.\74\ Had they reviewed it, 
the Board members would have learned that LJM claimed to be 
making substantial profits from its deals with Enron and might 
have reconsidered the conflicts of interest inherent in the 
transactions.
---------------------------------------------------------------------------
    \73\ Hearing Exhibit 56h, ``LJM3 presentation to the Finance 
Committee'' (10/6/00), Bates EC 25373-80.
    \74\ Hearing Exhibit 25, ``LJM Investments Annual Partnership 
Meeting'' (10/26/00).
---------------------------------------------------------------------------
    At the Subcommittee hearing on May 7, all three of the 
expert witnesses expressed surprise and dismay that the Enron 
Board had approved the LJM arrangement in light of the clear 
conflicts of interest. The arrangement essentially permitted 
Enron's top financial control officer--an individual with 
personal knowledge of Enron's assets, liabilities and profit 
margins--to set up his own company and sit on both sides of the 
table in negotiations between his business and his employer. 
The expert witnesses could not recall a similar situation at 
any other publicly traded company; nor could any Board member 
identify a precedent for the Board's decision. The Powers 
Report called the LJM arrangement ``fundamentally flawed.'' 
\75\ Mr. Campbell, former Chairman of the Board of a major 
publicly traded company, told the Subcommittee staff that had 
he been confronted with a similar proposal by a CFO, he would 
have told the CFO ``no''; if the CFO managed to bring up the 
proposal at a Board meeting he would have voted ``no''; and if 
the Board had adopted the proposal over his objection, he would 
have resigned from the Board the next day. But the interviewed 
Enron Board members refused to acknowledge any lapse in 
judgment. Most, in fact, defended the decision to authorize the 
LJM partnerships and declared that they would support a similar 
arrangement at another company if appropriate approvals and 
controls were provided.\76\
---------------------------------------------------------------------------
    \75\ Powers Report at 9.
    \76\ See, for example, Hearing Record at 62, in which Dr. Jaedicke 
testified that another board on which he serves considered authorizing 
a similar outside equity fund to be run by a senior company officer. 
Dr. Jaedicke testified that he was prepared to support this 
arrangement, but did not actually have the chance to do so, because it 
ultimately did not go forward.
---------------------------------------------------------------------------
    Flawed Controls to Mitigate LJM Conflicts. Most of the 
interviewed Board members said they had not been troubled by 
the conflicts of interest posed by the LJM partnerships due to 
the controls adopted to mitigate the conflicts. These controls 
were intended to ensure the fairness of both the LJM 
transactions with Enron and the amount of LJM-related 
compensation paid to Mr. Fastow. But the evidence indicates 
that these controls were poorly designed and implemented, and 
the Board itself paid insufficient attention to the LJM 
partnerships.
    The Board relied on Enron management to develop and 
implement the day-to-day controls needed to monitor LJM, and 
limited its own oversight to less frequent and more generalized 
reviews. The nature and extent of the LJM controls actually put 
into place by Enron management varied over time. The original 
LJM1 presentation in June 1999 did not specify any 
controls.\77\ The LJM2 presentation in October 1999 specified 
just one control--that Chief Accounting Officer Richard Causey 
``approve all transactions between Enron and LJM.'' \78\ The 
LJM3 presentation 1 year later, in October 2000, recited a 
longer list of controls: Mr. Causey, Mr. Buy, and Mr. Skilling 
would ``approve all Enron-LJM transactions''; the Audit 
Committee would conduct an annual review of LJM transactions in 
February; and Mr. Fastow's ``economic interest in Enron and 
LJM'' would be presented to Mr. Skilling for his review.\79\ At 
that same October 2000 meeting, the Finance Committee decided 
to institute two more controls, to begin a quarterly review of 
LJM transactions by the Finance Committee and to conduct a one-
time review of Mr. Fastow's LJM compensation by the 
Compensation Committee.
---------------------------------------------------------------------------
    \77\ Hearing Exhibit 19, ``Project LJM Board Presentation'' (6/28/
99).
    \78\ Hearing Exhibit 20, ``LJM 2 Summary'' (10/11/99).
    \79\ Hearing Exhibit 56h, ``LJM3 presentation to the Finance 
Committee'' (10/6/00), Bates EC 25378. An LJM presentation to the Audit 
Committee in early 2001, Hearing Exhibit 24, ``Review of LJM procedures 
and transactions completed in 2000'' (2/12/01) at 2B-4, identified many 
of the same controls as those listed in October 2000.
---------------------------------------------------------------------------
    The Powers Report, which examined Enron management's actual 
implementation of the day-to-day controls over the LJM 
transactions, determined that the controls were structurally 
flawed and poorly executed.\80\ On paper, prior to Enron's 
engaging in a transaction with LJM, Enron personnel were 
supposed to complete a Deal Approval Sheet (DASH) that set out 
the major elements of the transaction and a LJM Approval Sheet 
with a checklist of items intended to ensure arms-length 
transactions and fair prices. These documents required 
signatures from two or more high level Enron officials, such as 
Mr. Causey, Mr. Buy, and Mr. Skilling. The Powers Report found, 
however, that ``the process was not well-designed, and it was 
not consistently followed.'' \81\ Some LJM transactions took 
place without any DASH or LJM Approval Sheet, others relied on 
a DASH or LJM Approval Sheet that did not contain the required 
signatures, and still other deals were closed before the 
documentation was completed.\82\ The Powers Report found that, 
in at least 13 instances, the persons negotiating the Enron-LJM 
deals--on both sides of the table--reported to Mr. Fastow, and 
that Mr. Fastow, on occasion, ``pressur[ed]'' them ``to obtain 
better terms for LJM.'' \83\
---------------------------------------------------------------------------
    \80\ Powers Report at 165-66.
    \81\ Id. at 170. See also Hearing Exhibit 61, internal Enron 
memorandum from Jordan Mintz, legal counsel, to Mr. Buy and Mr. Causey 
(3/8/01), criticizing LJM transaction approval process, Bates VEL524-28 
(``[T]he Company needs to improve both the process it follows in 
executing such transactions and implement improved procedures regarding 
written substantiation supporting and memorializing the Enron/LJM 
transactions. . . . [F]irst is the need for the Company to implement a 
more active and systematic effort in pursuing non-LJM sales 
alternatives before approaching LJM . . .; the second is to . . . 
impose a more rigorous testing of the fairness and benefits realized by 
Enron in transacting with LJM.'') (Emphasis in original.)
    \82\ Powers Report at 170.
    \83\ Powers Report at 166.
---------------------------------------------------------------------------
    The interviewed Board members told the Subcommittee staff 
that, after the October 2000 meeting in which the Finance 
Committee was told that Mr. Causey, Mr. Buy, and Mr. Skilling 
would ``approve all Enron-LJM transactions,'' they assumed Mr. 
Skilling was actively reviewing the Enron-LJM transactions. Mr. 
Skilling testified at a House hearing, however, that he had 
been unaware of any obligation to review the LJM transactions 
and did not, as a matter of course, review them for fairness or 
sign the relevant documents.\84\ Mr. Causey and Mr. Buy have 
indicated that each reviewed the LJM transactions and signed 
the relevant documents, but considered only narrow procedural 
or risk issues; neither reviewed the transactions for their 
overall fairness to Enron.\85\
---------------------------------------------------------------------------
    \84\ See Hearing before the U.S. House of Representatives 
Subcommittee on Oversight and Investigations of the Committee on Energy 
and Commerce (2/7/02) (hereinafter ``House Hearing'') (Mr. Skilling: 
``I was not required to approve those transactions.''). The minutes 
indicate that Mr. Skilling was present at the October 2000 Finance 
Committee meeting when Mr. Fastow stated that Mr. Skilling, as well as 
Mr. Causey and Mr. Buy, were reviewing the LJM transactions, but Mr. 
Skilling testified that he did not recall hearing that statement at the 
meeting. The LJM Approval Sheets frequently listed Mr. Skilling as a 
required signatory, and Enron's legal counsel Jordan Mintz attempted on 
several occasions to obtain Mr. Skilling's actual signature for 
particular LJM transactions, but was unsuccessful. Mr. Skilling 
testified at the House hearing that he never received the documents to 
sign them. Mr. Mintz' March 2001 memo, cited above, Hearing Exhibit 61, 
called for ``[b]etter contemporaneous involvement by the [Office of the 
Chairman] regarding review and approval of Enron's transacting with 
LJM, i.e. sign-off by Jeff Skilling on a more regular basis.'' See also 
Powers Report at 169 (``Skilling appears to have been almost entirely 
uninvolved in overseeing the LJM transactions, even though in October 
2000 the Finance Committee was told by Fastow--apparently in Skilling's 
presence--that Skilling had undertaken substantial duties.'')
    \85\ See Powers Report at 168.
---------------------------------------------------------------------------
    The LJM compensation controls at Enron were even more 
haphazard. The Subcommittee is unaware of any standard form or 
procedure that was developed by Enron management to review Mr. 
Fastow's compensation, and it is unclear whether any 
compensation review ever took place by any Enron officer.\86\ 
During their interviews, many Board members indicated that the 
Board had assumed Mr. Skilling, who was Mr. Fastow's immediate 
supervisor, was reviewing Mr. Fastow's LJM compensation. Mr. 
Skilling has indicated, however, that he never examined or 
requested specific information about Mr. Fastow's actual LJM 
compensation.\87\
---------------------------------------------------------------------------
    \86\ See discussion in Powers Report at 163-65.
    \87\ See House Hearing (2/7/02), in which Mr. Skilling testified 
that the only LJM compensation review he performed was in October 2000, 
after a Board meeting directing him to review Mr. Fastow's ``economic 
interest'' in the company. Mr. Skilling testified that, in response to 
the Board request, he reviewed a handwritten document provided by Mr. 
Fastow projecting his possible LJM returns over a 5-year period using 
certain assumptions, the 5-year total of which Mr. Skilling recalled 
was ``something on the order of $5 million.'' When asked whether it was 
true that Mr. Fastow had already obtained $30 million from LJM in its 
first year of operation, Mr. Skilling testified, ``I don't know. . . . 
I have no first-hand knowledge of that.'' See also Powers Report at 
164-65.
---------------------------------------------------------------------------
    The Powers Report concludes that the LJM controls ``were 
not effectively implemented by Management, and the conflict [of 
interest] was so fundamental and pervasive that it overwhelmed 
the controls as the relationship progressed.'' \88\
---------------------------------------------------------------------------
    \88\ Powers Report at 171.
---------------------------------------------------------------------------
    Inadequate Board Oversight of LJM Transactions With Enron. 
The Enron Board failed to uncover the deficiencies in the LJM 
controls or to make up for them through its own oversight 
efforts.
    The Audit Committee was charged by the Board with 
performing an annual review of the LJM transactions. This task 
was apparently assigned to the Audit Committee, because its 
charter included ensuring compliance with Enron's code of 
conduct and the LJM transactions were being reviewed to ensure 
that Mr. Fastow was complying with his fiduciary obligations to 
Enron.
    On paper, the Audit Committee conducted two annual reviews 
of LJM transactions in February 2000 and February 2001. In 
reality, these reviews were superficial and relied entirely on 
management representations with no supporting documentation or 
independent inquiry into facts. At the first review in 2000, 
the Audit Committee was given a single sheet of paper listing 
the names of eight transactions that LJM had entered into with 
Enron in 1999.\89\ The only information provided for each 
transaction was the name of the ``investment,'' the 
transaction's approximate dollar value, and a description of 
the transaction in ten words or less. The Committee spent 
between 15 and 30 minutes reviewing the list with Mr. 
Causey.\90\ The Audit Committee did not go into the details of 
any specific transaction, nor did it review any Deal Approval 
Sheet (DASH) or LJM Approval Sheet, even though these documents 
were typically only a few pages long and would have provided 
key information. In fact, the Audit Committee members admitted 
they never requested or reviewed a single DASH or LJM Approval 
Sheet for any LJM transaction with Enron.\91\
---------------------------------------------------------------------------
    \89\ Hearing Exhibit 22, ``LJM Investment Activity 1999'' (2/7/00).
    \90\ Hearing Record at 66-67; Subcommittee interviews of Audit 
Committee members. See also Powers Report at 162 (``the reviews were 
brief, reportedly lasting 10 to 15 minutes'').
    \91\ Hearing Record at 71; Subcommittee interviews of Audit 
Committee members; House Hearing (2/7/02) (testimony by Dr. Jaedicke).
---------------------------------------------------------------------------
    The Audit Committee's second review of LJM transactions was 
equally cursory. In February 2001, the Audit Committee received 
a two-page list of LJM transactions in 2000, again with minimal 
information, and again spent between 15 and 30 minutes going 
over it with Mr. Causey.\92\ Twelve LJM transactions with Enron 
were listed. The only information provided for each transaction 
was the name of the ``investment,'' a dollar value, and a short 
description of the transaction.\93\ Again, no DASH or LJM 
Approval Sheet was requested or reviewed by any Audit Committee 
member.
---------------------------------------------------------------------------
    \92\ Hearing Exhibit 24, ``Review of LJM procedures and 
transactions completed in 2000'' (2/12/01).
    \93\ The largest transaction on the list involved ``$127 million'' 
and was identified as ``Raptors I, II, III, IV''--a particularly 
interesting description, since the Board has steadfastly maintained it 
knew of only three Raptor transactions and was never informed of the 
Raptor involving Enron's warrants for stock in The New Power Company 
(TNPC). See, for example, Hearing Record at 15; Powers Report at 116. 
Had the Audit or Finance Committee asked why four Raptors were listed, 
the Board might have learned of the Raptor transaction involving 
Enron's TNPC stock.
---------------------------------------------------------------------------
    The Finance Committee also looked at LJM on several 
occasions. In May 2000, the Finance Committee received a 
general ``LJM2 Update'' reciting the overall benefits that LJM2 
had provided to Enron in its first 6 months of operation.\94\ 
This update reported that LJM2 had produced over $2 billion in 
``Funds flow'' for Enron, over $200 million in ``Earnings,'' 
and ``8 days/6 deals/$125 million'' for Enron in the fourth 
quarter of 1999. Although these figures are remarkable for any 
new business, there was apparently no discussion of how LJM2 
was able to produce such large benefits for Enron in so short a 
time period. The update also reported that LJM2 had a projected 
internal rate of return of about 18 percent. This figure is 
much less than the 69 percent that LJM would claim in its 
October report to investors, but, as mentioned earlier, the 
Board members relied on Enron management for its information on 
LJM and none requested or reviewed a copy of LJM's first annual 
report.\95\
---------------------------------------------------------------------------
    \94\ Hearing Exhibit 23, ``LJM2 Update'' (5/1/00).
    \95\ Compare Hearing Exhibit 23, the LJM2 presentation to the 
Finance Committee on 5/1/00, with Hearing Exhibit 25, LJM's 
presentation to its own investors at its first annual partnership 
meeting on 10/26/00.
---------------------------------------------------------------------------
    Several directors noted that the May 2000 update given to 
the Finance Committee also contained a handwritten note by the 
Corporate Secretary stating that Mr. Fastow had indicated he 
was spending only 3 hours per week on LJM matters. They said 
this figure left the impression that Mr. Fastow was not earning 
much money from the operation and that LJM was not very active. 
Yet this impression is in direct contrast to the information in 
the update itself which reports $2 billion in funds flow for 
Enron and $200 million in earnings. One Board member, Mr. 
Blake, indicated during his interview that he had taken special 
note of the $2 billion figure, which made him well aware of LJM 
and its importance to Enron, yet neither he nor any other 
director asked how LJM was able to produce such huge funds flow 
with such minimal effort by Mr. Fastow.
    In October 2000, when LJM3 was proposed to the Finance 
Committee, the presentation included another general update on 
the benefits that the LJM partnerships were providing to 
Enron.\96\ LJM1 was described as having provided ``a gain of 
approximately $175 million for Enron'' and the purchase of a 
``minority interest in Cuiaba so that Enron could deconsolidate 
the project.'' LJM2 was described as having invested over $400 
million in 21 transactions with Enron. It was after receiving 
this update, showing multiple high dollar transactions, that 
the Finance Committee decided to impose the two additional 
controls--a quarterly review of LJM transactions by the Finance 
Committee, which was to be in addition to the annual Audit 
Committee review, and a one-time review of Mr. Fastow's 
compensation by the Compensation Committee.
---------------------------------------------------------------------------
    \96\ Hearing Exhibit 56h, ``LJM3 presentation to the Finance 
Committee'' (10/6/00), Bates EC 25373-80.
---------------------------------------------------------------------------
    The Subcommittee learned, however, that the Finance 
Committee subsequently conducted only one quarterly review of 
LJM transactions, which took place in February 2001. This 
review was as superficial as that conducted by the Audit 
Committee. The Finance Committee used the same two-page list of 
LJM transactions as the Audit Committee and spent about the 
same amount of time on the document.\97\ There was no detailed 
discussion of the transactions, and no Finance Committee member 
could recall seeing any DASH or LJM Approval Sheet for any LJM 
transaction, even though some exceeded the $25 million 
threshold for DASHs provided to the Finance Committee for 
review.\98\
---------------------------------------------------------------------------
    \97\ Hearing Exhibit 24, ``Review of LJM procedures and 
transactions completed in 2000'' (2/12/01).
    \98\ Hearing Record at 71; Subcommittee interviews of Finance 
Committee members; House Hearing (2/7/02) (Mr. Winokur: ``We saw DASH 
sheets, but never the LJM approval sheets. And we didn't see DASH 
sheets that related to the LJM transactions, to the best of my 
knowledge.'').
---------------------------------------------------------------------------
    The Finance Committee did not conduct any other quarterly 
review of LJM transactions. When asked why the Finance 
Committee did not conduct a quarterly review at the next 
Finance Committee meeting in May 2001, Mr. Winokur indicated 
that he had not received a quarterly report from Enron and had 
assumed without checking that no LJM transactions had 
occurred.\99\ When asked why the Finance Committee did not act 
at the next meeting in August 2001, Mr. Winokur said that he 
was told at the August meeting that Mr. Fastow had sold his 
interest in the LJM partnerships in June, the ``related party 
aspect'' of the LJM transactions had disappeared, and no more 
reviews were necessary.\100\ Mr. Winokur admitted, however, 
that neither he nor any other Board member had inquired about 
who bought Mr. Fastow's interest in LJM, in order to verify 
that no conflict of interest remained.
---------------------------------------------------------------------------
    \99\ Id. at 72.
    \100\ Id. at 71. Fastow actually sold his LJM interest in July 
2001. See Hearing Exhibit 38c, excerpt from Enron's 10-Q filing for the 
third quarter of 2001 (11/19/01) at 1; Powers Report at 73.
---------------------------------------------------------------------------
    In fact, in a puzzling display of disinterest, none of the 
interviewed Board members recalled making any inquiry into 
LJM's new ownership despite LJM's having just generated $2 
billion in funds flow for the company. Had anyone inquired, 
they would have learned that the new owner of LJM2 was Mr. 
Fastow's former top staffer, Michael Kopper, whose personal 
knowledge of Enron finances and longstanding close association 
with Mr. Fastow raised a similar set of conflicts of interest 
concerns.\101\ Mr. Winokur testified at the hearing that, had 
he known of Mr. Kopper's role, he ``would have wanted to 
continue the reviews'' to ensure LJM's dealings with Enron were 
fair.\102\
---------------------------------------------------------------------------
    \101\ Mr. Kopper had been an Enron employee, working for Mr. 
Fastow, until he resigned in July 2001, after purchasing Mr. Fastow's 
stake in LJM2. Mr. Kopper had also been actively involved with JEDI, 
Chewco and LJM1.
    \102\ Hearing Record at 73.
---------------------------------------------------------------------------
    Inadequate Board Oversight of Fastow's LJM Compensation. 
The Board's role in overseeing Mr. Fastow's LJM compensation 
was even more lax. For the first year, the Board apparently 
relied on Mr. Skilling to review Mr. Fastow's LJM-related 
income and asked no questions. In October 2000, after LJM1 had 
been operating for more than 1 year and the Finance Committee 
was told that LJM1 and LJM2 were engaging in multiple, high 
dollar transactions with Enron, the Finance Committee asked the 
Compensation Committee to conduct a one-time review of Mr. 
Fastow's compensation.
    Dr. LeMaistre, then Chairman of the Compensation Committee, 
was present at the Finance Committee meeting, and attempted to 
obtain the requested information on Mr. Fastow's LJM 
compensation. He indicated during his interview and at the 
hearing that, after the Finance Committee meeting, he asked 
Enron's senior compensation officer, Mary Joyce, to provide him 
with information on the outside income of all of Enron's 
``16(b) officers,'' a reference to top company officials 
identified according to an SEC regulation.\103\ He said during 
his Subcommittee interview that he did not specifically name 
Mr. Fastow to Ms. Joyce because he did not want to start any 
office gossip. Ms. Joyce did not provide him with the 
information he requested. He said that he asked her a second 
time to obtain the information, but she again did not do so. He 
admitted that he never actually named Mr. Fastow to her or 
insisted that she obtain information about his LJM 
compensation. Instead, Dr. LeMaistre let the matter drop.
---------------------------------------------------------------------------
    \103\ Hearing Record at 68-69.
---------------------------------------------------------------------------
    At the hearing, Subcommittee Chairman Levin and Dr. 
LeMaistre had the following exchange.

        ``Dr. LeMaistre: I asked Mary Joyce about it.
        Sen. Levin: And what did she tell you?
        Dr. LeMaistre: She said she did not have the 
        information.
        Sen. Levin: Did you say, well, I want it?
        Dr. LeMaistre: She knew that I wanted it . . .
        Sen. Levin: Did you get it?
        Dr. LeMaistre: I did not.
        LSen. Levin: This is the heart of the problem. You have 
        got a Board that says, I want it. You have got a 
        request for it. It does not come and you do nothing. 
        That is an approach which is unacceptable for a 
        Board.'' \104\
---------------------------------------------------------------------------
    \104\ Id. at 68.

    One year later, despite the Finance Committee's directive, 
Dr. LeMaistre had not obtained any information about Mr. 
Fastow's LJM compensation. Nor had any other Board member taken 
any steps to obtain this information. In October 2001, a Wall 
Street Journal article was published detailing Enron's 
transactions with LJM and alleging that Mr. Fastow had received 
compensation from LJM business transactions in excess of $7 
million.\105\
---------------------------------------------------------------------------
    \105\ Hearing Exhibit 44b, ``Enron CFO's Partnership Had Millions 
in Profit,'' Wall Street Journal (10/19/01).
---------------------------------------------------------------------------
    In response, the Board directed two of its members, Dr. 
LeMaistre and John Duncan, to telephone Mr. Fastow and obtain 
information about his LJM investment and compensation. During 
his interview, Dr. LeMaistre told the Subcommittee staff that 
he asked the General Counsel of Enron, James Derrick, to draft 
specific questions for him to use in his conversation with Mr. 
Fastow. Mr. Derrick faxed a document with the questions to Dr. 
LeMaistre, who was then in Colorado.\106\ After changing the 
order of the sentences to put the reference to ``[w]e very much 
appreciate your willingness to visit with us'' first, Dr. 
LeMaistre told the Subcommittee that he used the document as a 
script in his conversation with Mr. Fastow, as follows:
---------------------------------------------------------------------------
    \106\ Hearing Exhibit 24b, script and handwritten notes of 
conversation between Dr. LeMaistre, John Duncan, and Mr. Fastow in 
October 2001. John Duncan was in Houston during the telephone call with 
Mr. Fastow and did not request or use the document faxed to Dr. 
LeMaistre.

        ``We very much appreciate your willingness to visit 
        with us. Andy, because of the current controversy 
        surrounding LJM I and LJM II, we believe it would be 
        helpful for the Board to have a general understanding 
        of the amount of your investment and of your return on 
        investment in the LJM entities. We understand that a 
        detailed accounting of these matters will soon be done 
        in connection with the response to the SEC inquiry. In 
        responding to our questions with respect to your 
        interest in the LJM entities, we would appreciate your 
        including any interest . . . that the members of your 
        family may have had in the entities.'' \107\
---------------------------------------------------------------------------
    \107\ Hearing Exhibit 24b.

When Chairman Levin asked Dr. LeMaistre why his tone was so 
deferential to Mr. Fastow, Dr. LeMaistre said that the language 
had been drafted by legal counsel and he was concerned about 
seeking information from a special purpose entity that was 
supposed to be separate from Enron.
    Dr. LeMaistre's handwritten notes on the document indicate 
that Mr. Fastow admitted receiving LJM compensation totalling 
$45 million, $23 million from LJM1 and $22 million from LJM2. A 
handwritten note in the margin of the document states 
``incredible,'' which Dr. LeMaistre said was his reaction to 
the compensation total, which was much greater than he had been 
expecting. Dr. LeMaistre also noted that Mr. Fastow declined to 
provide information related to his LJM investment return and 
promised to provide that information the next day. Mr. Duncan 
said during his interview that when Mr. Fastow failed to 
telephone with the information at the time promised, Mr. Duncan 
called him and was told by Mr. Fastow that he had not had the 
chance to obtain the requested information and would provide it 
later. Mr. Fastow apparently never provided that information to 
the Board.
    Dr. LeMaistre and Mr. Duncan reported the October 23 
conversation to the other Board members in a telephone Board 
meeting the next day. The other directors expressed surprise at 
the large amount of compensation, and the decision was made to 
place Mr. Fastow on leave immediately. Mr. Fastow was placed on 
leave on October 24, 2001.
    During his interview, Dr. LeMaistre noted that he asked Mr. 
Fastow whether any Enron employee other than Mr. Fastow and Mr. 
Kopper had ``any economic interest in or derive[d] any benefit 
from'' the LJM partnerships.\108\ He said that Mr. Fastow had 
replied ``no,'' which the Board later discovered to be untrue. 
He and other Board members said that it was during the Powers 
investigation that they first learned of the Southampton 
partnership, which Mr. Fastow had established with five other 
Enron employees to invest in LJM1 and enabled these additional 
Enron employees to benefit financially at Enron's expense.
---------------------------------------------------------------------------
    \108\ Id.
---------------------------------------------------------------------------
    LJM Profits at the Expense of Enron. Records indicate that 
LJM was a very profitable venture. Its 2000 annual partnership 
meeting report boasts of 23 investments with Enron and a 69 
percent rate of return in its first year of operation, which 
Enron Board members with investment experience told the 
Subcommittee staff was a very high rate of return.\109\ These 
Board members observed that all of LJM's transactions with 
Enron had turned a profit for LJM, which they said was also 
unusual for an equity fund. According to LJM, some of the 
transactions, such as the Raptors, had produced returns as high 
as 2,500 percent. Mr. Fastow told the Board that he had earned 
$45 million on a $5 million investment in LJM1 and LJM2 in just 
2 years.\110\ Other Enron employees also admitted to 
significant LJM returns in a short period, including two who 
received immediate returns of $1 million each on individual 
investments of $5,800.\111\
---------------------------------------------------------------------------
    \109\ Hearing Exhibit 25, ``LJM Investments Annual Partnership 
Meeting'' (10/26/00). For example, both Mr. Belfer and Mr. Savage 
described the LJM returns as unusually lucrative.
    \110\ Hearing Exhibit 24b, script and handwritten notes of 
conversation between Dr. LeMaistre, John Duncan, and Mr. Fastow in 
October 2001.
    \111\ These Enron employees were members of the Southampton 
partnership that purchased LJM1's key subsidiary. Powers Report at 93 
and 95.
---------------------------------------------------------------------------
    LJM transacted business with essentially one company, 
Enron, which meant that virtually all of its profits were at 
Enron's expense.\112\ Its purchase of Enron assets was, on more 
than one occasion, followed by an Enron buyback at a higher 
price.\113\ Its investment in Enron's Osprey and Yosemite 
projects earned LJM lucrative returns on projects 
collateralized with Enron stock. When Enron unwound the Rhythms 
transaction with LJM1, Enron paid LJM1 a $30 million 
termination fee, even though the Rhythms ``hedge'' should have 
resulted in LJM1's paying Enron millions of dollars.\114\ The 
same thing happened when Enron unwound the Raptors; Enron paid 
LJM2 a termination fee of $35 million, even though the poor 
performance of the assets ``hedged'' in the Raptors should have 
resulted in LJM2's paying money to Enron. Instead, Enron 
recorded a $710 million loss in earnings and a $1.2 billion 
reduction in shareholder equity.\115\ While Enron appeared to 
benefit in the near-term from its dealings with LJM, its 
benefits were primarily paper gains in the form of increased 
funds flow, lower debt levels, and inflated earnings on its 
financial statements. In the long-term, it was LJM that 
benefited financially at Enron's expense.
---------------------------------------------------------------------------
    \112\ The Subcommittee has identified only two LJM transactions, in 
August and September of 2000, that were with a counterparty other than 
Enron.
    \113\ For example, in 1999, LJM1 purchased an interest in the 
Cuiaba power plant project in Brazil which allowed Enron to move the 
project off its balance sheet while recognizing certain earnings. In 
2001, Enron repurchased LJM's interest at a much higher price, 
notwithstanding the project's having experienced in the interim severe 
construction problems, cost overruns and legal difficulties.
    \114\ The Powers Report describes this termination payment as a 
``huge windfall'' for LJM1. Powers Report at 89.
    \115\ See Hearing Exhibit 27, ``The Raptors,'' prepared by the 
Subcommittee. See also Powers Report at 129.
---------------------------------------------------------------------------
    Board members justified allowing Mr. Fastow to manage and 
own an equity stake in the LJM partnerships in part by 
stressing the controls established to ensure that his and LJM's 
dealings with Enron would be fair. But those controls were 
poorly implemented, and the Board itself exercised poor 
oversight of LJM's transactions and Mr. Fastow's compensation. 
The result was that hundreds of millions of dollars that should 
have stayed with Enron shareholders instead lined the pockets 
of LJM investors and Mr. Fastow.
    A number of Board members claimed that the Board had been 
misled or misinformed regarding key aspects of the LJM 
partnerships. For example, Board members said they were not 
told how many Enron employees held ownership interests in LJM, 
how much time Enron employees were spending on LJM deals as 
representatives of LJM, how many deals LJM had underway with 
Enron, how the deals were being negotiated, and how much profit 
LJM was making at Enron's expense. While the evidence seems to 
bear out the claims that the Board did not have complete 
information about LJM's owners, employees, transactions and 
profits, the facts also establish that the Board members were 
given ample information about the conflicts of interest 
underlying the LJM partnerships, the many related party 
transactions that went on between LJM and Enron, and the huge 
amounts of money flowing through the LJM structures. The 
information it had should have triggered a demand for more 
detailed information and, ultimately, a change in course. But 
the Board allowed the LJM-Enron transactions to go forward with 
few questions asked. All of the consequences that followed, 
including the Raptor debacle, flowed from the initial Board 
decision to allow the LJM partnerships. While the Board was 
advised that Enron management and Andersen supported going 
forward, the final decision on whether to allow Mr. Fastow to 
form, manage and profit from the LJM partnerships rested with 
the Board itself. The Board cannot shift the responsibility for 
that decision to any other participant in the Enron tragedy.

        Finding (4): The Enron Board of Directors knowingly 
        allowed Enron to conduct billions of dollars in off-
        the-books activity to make its financial condition 
        appear better than it was, and failed to ensure 
        adequate public disclosure of material off-the-books 
        liabilities that contributed to Enron's collapse.

    Enron's multi-billion dollar, off-the-books activity was 
disclosed to the Enron Board and received Board approval as an 
explicit strategy to improve Enron's financial statements. In 
fact, Enron's massive off-the-books activity could not have 
taken place without Board action to establish new special 
purpose entities, issue preferred Enron shares, and pledge 
Enron stock as the collateral needed for the deals to go 
forward. In the end, the Board knowingly allowed Enron to move 
at least $27 billion or almost 50 percent of its assets off-
balance-sheet.\116\
---------------------------------------------------------------------------
    \116\ Hearing Exhibit 39, ``Private Equity Strategy'' (Finance 
Committee presentation, 10/00).
---------------------------------------------------------------------------
    During their interviews, only one Board member expressed 
concern about the percentage of Enron assets that no longer 
appeared on the company balance sheet; the remaining Board 
members expressed little or no concern. At the May 7 hearing, 
the three accounting and corporate governance experts testified 
that they were unaware of any other public company with such a 
high percentage of its assets off-balance-sheet. Mr. Sutton, 
former SEC chief accountant, said his ``experience is that 
Enron is at the top of the scale in terms of the extent'' of 
its off-the-books activity.\117\ Mr. Campbell, who has 
extensive corporate and Board experience, testified that he 
``had never seen that amount, proportion of a company's assets 
on off-balance-sheet. Sometimes it is appropriate to have some 
items off-balance-sheet . . . but never to that extent.'' \118\
---------------------------------------------------------------------------
    \117\ Hearing Record at 104.
    \118\ Id.
---------------------------------------------------------------------------
    Whitewing. The Board's awareness and approval of Enron's 
off-the-books corporate strategy is illustrated by its years-
long involvement in the establishment, financing, and use of 
Whitewing.
    Whitewing was established by Enron, run by Enron personnel, 
and dealt exclusively with Enron in its business transactions. 
Whitewing changed its status over time from a consolidated to 
an unconsolidated Enron affiliate. From late 1999 until 2001, 
Enron pledged preferred stock and promissory notes valued at 
nearly $2.5 billion as collateral for Whitewing debt, and 
Whitewing purchased over $2 billion in Enron assets. 
Documentation reviewed by the Subcommittee shows that the Enron 
Board was informed, consulted, and exercised ongoing oversight 
of Whitewing, with full awareness of its increasing use as an 
off-the-books vehicle that Enron used to enhance its financial 
statements.
    Whitewing and its related entities, such as Nighthawk and 
Osprey, are repeatedly mentioned in Board minutes and 
presentations.\119\ In December 1997, minutes from a Board 
meeting show Board approval of the establishment of Whitewing 
as a business entity which was to be 50 percent owned by Enron 
and 50 percent owned by Nighthawk, a new special purpose entity 
set up for outside investors. The Board approved Enron's 
contributing to Whitewing $500 million in cash and Enron stock 
(later increased to $560 million), which Nighthawk investors 
matched with a contribution of $500 million in cash, most of 
which was borrowed from a Citibank-related entity.\120\ The 
Board also approved issuance of $1 billion in Enron convertible 
preferred shares to be sold to Whitewing in exchange for the 
cash and Enron stock. Because Enron gave Whitewing preferred 
shares rather than a promissory note, Enron characterized the 
$500 million in cash that Whitewing received from the Nighthawk 
investors as an equity investment, rather than a loan. In 
addition, because at that time Whitewing was a consolidated 
affiliate included in Enron's financial statements, Enron was 
able to use the $500 million for ``general corporate purposes'' 
without showing any new debt on its balance sheet.
---------------------------------------------------------------------------
    \119\ Hearing Exhibit 11, ``Specific References to Whitewing/
Nighthawk/Osprey in Enron's Board/Committee Presentations,'' prepared 
by the Subcommittee.
    \120\ Hearing Exhibit 12 (Board minutes from 12/9/97) and Hearing 
Exhibit 15 (Whitewing/Nighthawk/Osprey materials faxed to Board members 
on 9/17/99 for special Board meeting the same date).
---------------------------------------------------------------------------
    About 1 year later, in February 1999, Board minutes show 
that the Board approved a resolution to expand Whitewing's 
capacity to purchase Enron assets.\121\ In September 1999, the 
Board approved a resolution to restructure Whitewing as an 
``unconsolidated affiliate'' that could be removed from Enron's 
books.\122\ At the same time, the Board approved establishment 
of a special purpose entity called the Osprey Trust to invest 
in Whitewing, and authorized Osprey to issue $1.4 billion in 
debt instruments that could be secured by a second series of 
Enron preferred shares. By taking this action, the Board 
simultaneously moved Whitewing off Enron's balance sheet, while 
pledging Enron stock to secure Whitewing's debt. These debt 
instruments were subsequently sold to investors as bonds paying 
an 8 percent return, collateralized with Enron stock. Whitewing 
then used the funds to purchase Enron assets, injecting 
substantial cash into Enron which, in turn, reported that cash 
on its financial statements as funds flow from asset sales and 
investments.
---------------------------------------------------------------------------
    \121\ Hearing Exhibit 13 (Board minutes from special meeting on 2/
1/99).
    \122\ Hearing Exhibit 14 (Board minutes from special meeting on 9/
17/99) and Hearing Exhibit 15 (Whitewing/Nighthawk/Osprey materials 
faxed to Board members on 9/17/99 for special Board meeting the same 
date).
---------------------------------------------------------------------------
    Altogether, Whitewing entered into at least 11 transactions 
with Enron from 1999 through 2001, to buy at least $2 billion 
worth of Enron assets.\123\ These sales were part of Enron's 
``asset light'' strategy to reduce debt levels on its financial 
statements and move assets with relatively low returns into 
unconsolidated affiliates that Enron effectively controlled.
---------------------------------------------------------------------------
    \123\ Hearing Exhibit 16, ``Whitewing, 1997-2001,'' prepared by the 
Subcommittee.
---------------------------------------------------------------------------
    Board and Committee presentations show that the Board 
continued to monitor and support Enron transactions with 
Whitewing and Osprey throughout 2000 and 2001. A Finance 
Committee presentation in August 2000, for example, reported 
$561 million in Enron asset sales to Whitewing, with plans for 
additional sales of $389 million.\124\ Whitewing is described 
in the document as an ``[o]ff balance sheet vehicle to purchase 
assets from Enron.'' An Enron Deal Approval Sheet (DASH), given 
to Finance Committee members the same month reported 
refinancing Enron's interests in three power plants by selling 
them to Whitewing. This deal is explained as allowing ``Enron 
to keep the interests it holds in the assets through Whitewing 
off-blance sheet.'' \125\ A December 2000 presentation to the 
Finance Committee and February 2001 presentations on LJM to the 
Finance and Audit Committees reported LJM's sale of an interest 
in Yosemite trust investments to Whitewing. They also alerted 
Board members to LJM's participation in the ``Osprey Add-On,'' 
an effort to further increase Whitewing's capitalization 
through the issuance of over $1 billion in Osprey notes and 
certificates.\126\ This additional $1 billion enabled Whitewing 
to buy still more Enron assets which, in turn, enabled Enron to 
show additional ``positive funds flow'' on its 2000 balance 
sheet.\127\
---------------------------------------------------------------------------
    \124\ Hearing Exhibit 17, ``EGF Execution Schedule; 2000 Balance 
Sheet Management'' (Finance Committee presentation, 8/00).
    \125\ ``Enron DASH: Project Margaux'' (8/7/00), Bates RB1934-35. 
See also Hearing Exhibit 24a, ``Review of LJM procedures and 
transactions completed in 2000,'' (Audit and Finance Committee 
presentation, 2/12/01) at 2B-2.
    \126\ LJM1, LJM2, and Chewco each acquired interests in Osprey at 
various dates. LJM2 eventually acquired about 35 percent of the voting 
equity in Osprey, while Chewco acquired about 7 percent. In 2000, LJM2 
purchased about $30 million of Osprey debt certificates. See, for 
example, Enron's draft response to SEC questions (11/01) at 14.
    \127\ Hearing Exhibit 24a, ``Review of LJM procedures and 
transactions completed in 2000'' (Audit and Finance Committee 
presentation, 2/12/01).
---------------------------------------------------------------------------
    The evidence indicates that the Enron Board also understood 
that Whitewing posed some risks for Enron. An April 2001 chart 
requested by Finance Committee Chairman Winokur shows that he 
understood, and made sure that other Committee members 
understood, that millions of Enron shares had been pledged as 
collateral for Osprey debt.\128\ The chart notes that, ``Osprey 
matures in 2003 . . . Osprey shares trigger in 2003.'' Finance 
Committee members got a further update at an October 2001 
meeting in which they were told that ``the Whitewing structure 
. . . included $2.4 billion of assets and that bonds related to 
the structure would require funding in September of 2002.'' 
\129\ Full Board minutes from the next day state that the 
Finance Committee Chairman, Mr. Winokur, ``reviewed the 
maturities and refinancings planned'' for Whitewing.\130\
---------------------------------------------------------------------------
    \128\ Hearing Exhibit 32, ``Stock Price Risk in Financings; 
Potential Required Future Equity issuance'' (Finance Committee 
presentation, 4/01).
    \129\ Hearing Exhibit 56 l (Finance Committee minutes, 10/8/01), 
Bates E106602, at 2.
    \130\ See also Watkins' letter to Board Chairman Lay (8/15/01), 
warning of Enron's ``very aggressive'' accounting and ongoing risk in 
connection with the ``Condor vehicle'' whose unwinding would require 
the company ``to pony up Enron stock,'' attached to this report as 
Appendix 2 on page 57. ``Condor'' is a reference to Whitewing and the 
Osprey debt certificates. See Hearing Exhibit 15.
---------------------------------------------------------------------------
    These documents establish that, step by step, the Enron 
Board allowed the establishment of Whitewing, supported it with 
Enron stock, restructured it as an off-the-books entity, 
approved its use as an off-balance-sheet vehicle to purchase 
Enron assets, monitored billions of dollars in Enron asset 
sales to Whitewing, and monitored Whitewing's impact on Enron's 
financial statements and its claims on Enron stock. For years, 
Whitewing improved Enron's financial statements by creating the 
appearance of increased equity investments and lower debt 
ratios, and by generating more funds flow than Enron likely 
would have achieved in dealing with an unrelated party. No 
Board member claimed that Enron or Andersen personnel misled or 
misinformed the Board about Whitewing in any way. Rather, the 
evidence indicates that the Board made its Whitewing decisions 
with full information and realization of Enron's extensive off-
the-books dealings with this entity.\131\
---------------------------------------------------------------------------
    \131\ The current status of Whitewing is unclear. After Enron 
declared bankruptcy in December 2001, the Enron stock pledged as 
collateral for Whitewing's debt lost its value. Whitewing, however, did 
not declare bankruptcy, but carried on as a separate entity. 
Nevertheless, the Subcommittee staff has been told that Whitewing has 
not made any payments to its debtholders since July 2001, and it is 
unclear whether its assets--apart from the Enron stock collateral--will 
be sufficient security for the amounts owed on the bonds. As of this 
writing, Whitewing debtholders have not taken legal action to collect 
on the debt. At the same time, Enron has apparently indicated that it 
plans to include some of the assets securing the Whitewing debt in any 
reorganized company that emerges from its bankruptcy.
---------------------------------------------------------------------------
    LJM Partnerships. The Board also knowingly allowed Enron to 
establish the LJM partnerships, as explained earlier. Like 
Whitewing, LJM1 and LJM2 were explicitly established and run by 
Enron personnel. Unlike Whitewing, the LJM partnerships were 
set up from the beginning to function as off-the-books entities 
intended to transact business with Enron and improve Enron's 
financial statements.
    Over the course of 2 years, Enron entered into over two 
dozen transactions with LJM1 and LJM2 involving hundreds of 
millions of dollars. LJM1's first transaction, which was 
presented to and approved by the Board at its June 1999 
meeting, was the Rhythms stock ``hedge'' whose sole purpose was 
to protect Enron's income statement from loss if the stock were 
to drop in price.\132\ The first seven LJM2 transactions, all 
of which took place in 1999, consisted of Enron's selling 
poorly performing assets to LJM2, which enabled Enron to move 
debt off its books and show inflated earnings and cash flow 
from the asset sales on its 1999 financial statements. An 
``Update'' provided by Enron management to the Finance 
Committee reported that five different Enron business units had 
made the seven asset sales to LJM2, allowing Enron to book over 
$200 million in earnings and over $2 billion in funds 
flow.\133\
---------------------------------------------------------------------------
    \132\ Hearing Exhibit 19, ``Project LJM Board Presentation'' (Board 
presentation, 6/28/99).
    \133\ Hearing Exhibit 23, ``LJM2 Update'' (Finance Committee 
presentation, 5/1/00).
---------------------------------------------------------------------------
    During 2000 and the first half of 2001, Enron management 
entered into many more transactions with LJM1 and LJM2. Some 
were assets sales; others were more complex financial 
transactions. In more than one instance, a transaction was 
followed by Enron's repurchasing an asset or interest that had 
earlier been sold to LJM. The final list of Enron-LJM 
transactions included: Enron sales of turbines, Nigerian 
barges, and dark fiber to LJM2; LJM1 and LJM2's participation 
in Whitewing and the Osprey debt certificates; monetization 
deals in which LJM1 or LJM2 purchased interests in Enron power 
plants in Brazil, Poland, and elsewhere; LJM2's purchase of two 
tranches of Enron North America Credit Linked Obligations (ENA 
CLO); LJM2's participation in prepay transactions called 
Yosemite and Bob West Treasure; and LJM2's participation in the 
four Raptor transactions.\134\ The Enron Board clearly 
supported Enron's strategy to use the LJM partnerships to make 
Enron's financial condition appear better than it was through 
asset ``sales'' and other complex financial transactions that 
appeared to eliminate Enron debt and generate earnings or cash 
flow for Enron's financial statements.
---------------------------------------------------------------------------
    \134\ See, for example, Hearing Exhibit 22, ``LJM Investment 
Activity 1999'' (Audit Committee presentation, 2/7/00); Hearing Exhibit 
24a, ``Review of LJM procedures and transactions completed in 2000,'' 
(Audit and Finance Committee presentation, 2/12/01); Hearing Exhibit 
38c, excerpt from Enron's 10-Q filing with the Securities and Exchange 
Commission (describing LJM transactions with Enron). As explained 
elsewhere, many of these transactions appeared to benefit Enron in the 
near-term, but not in the long-term, after Enron bought back from LJM 
assets like the Cuiaba power plant interest and ENA CLO tranches, or 
allowed LJM to exit the Rhythms and Raptor transactions with 
substantial profits, even when the economics of the alleged ``hedges'' 
indicated LJM should have owed money to Enron.
---------------------------------------------------------------------------
    Whitewing and the LJM partnerships are just two examples of 
off-the-books entities that were known to and approved by the 
Enron Board. JEDI, Chewco, and the Hawaii 125-0 Trust are 
additional examples of ``unconsolidated affiliates'' that Enron 
helped to establish and run. Each has its own history of multi-
million-dollar transactions with Enron.\135\ Board minutes 
indicate Board approval of still other off-balance-sheet 
transactions involving billions of dollars. For example, a 
Board resolution in December 1999, approved the issuance of 
$2.2 billion in preferred Enron stock to an unidentified 
``outside investor group.'' \136\ Not a single Board member 
interviewed by the Subcommittee remembered this transaction, 
despite its multi-billion dollar size.
---------------------------------------------------------------------------
    \135\ See the Powers Report at 41-67, for a detailed discussion of 
JEDI and Chewco. See also, for example, Hearing Exhibit 17, ``EGF 
Execution Schedule; 2000 Balance Sheet Management'' (Finance Committee 
presentation, 8/00), showing the Hawaii 125-0 Trust engaged in hundreds 
of millions of dollars in transactions with Enron.
    \136\ Hearing Exhibit 56d (Finance Committee minutes, 12/13/99) at 
3; Hearing Exhibit 56e (Board minutes, 12/14/99) at 15. For another 
example, see Hearing Exhibit 56g (Finance Committee minutes, 8/7/00) at 
6 (Committee approval of Project Tammy involving the formation of a new 
company, Enron Finance Partners, LLC, ``to own certain of the Company's 
assets,'' assume ``$1.047 billion of the Company's intermediate and 
long-term debt,'' and obtain financing by selling $500 million in 
preferred securities to ``outside investors''); (Board minutes, 8/7/00-
8/8/00) at 7 (Board approval of ``Project Tammy'').
---------------------------------------------------------------------------
    In October 2000, the Finance Committee reviewed the chart 
showing that $27 billion out of $60 billion of Enron's assets, 
or almost 50 percent, were held off Enron's books in 
``unconsolidated affiliates.'' \137\ No Board member objected 
to this corporate strategy or urged Enron to change course.
---------------------------------------------------------------------------
    \137\ Hearing Exhibit 39, ``Private Equity Strategy'' (Finance 
Committee presentation, 10/00).
---------------------------------------------------------------------------
    The Raptors. One important example of Enron's undisclosed, 
off-the-books activity that had a dramatic, negative impact on 
the company is the Raptor transactions.\138\ The Enron Board 
knowingly authorized the Raptor transactions, despite their 
high risk accounting, lack of economic substance, and 
significant potential claim to Enron stock and stock contracts. 
The Board also failed to ensure adequate public disclosure in 
Enron's financial statements of Enron's ongoing contingent 
liability for the Raptor transactions.
---------------------------------------------------------------------------
    \138\ The Powers Report describes the Raptor transactions as having 
had ``the greatest impact on Enron's financial statements'' of all the 
transactions it examined. See Powers Report at 97.
---------------------------------------------------------------------------
    The Raptors are a series of four complex transactions that 
began in mid-2000 and terminated a little over a year later in 
2001. They were presented to the Board by Enron management as 
ingenious accounting devices that might attract ``accounting 
scrutiny'' but had been scrutinized and approved by 
Andersen.\139\ The Powers Report described them as an improper 
attempt by Enron to use the value of its own stock to offset 
losses in its investment portfolio, and ``a highly complex 
accounting construct that was destined to collapse.'' \140\
---------------------------------------------------------------------------
    \139\ Hearing Exhibit 28b, ``Project Raptor; Hedging Program for 
Enron Assets'' (Finance Committee presentation, 5/1/00) at 25.
    \140\ Powers Report at 98 and 132.
---------------------------------------------------------------------------
    In each of the Raptor transactions, Enron orchestrated the 
establishment of a special purpose entity (SPE) and arranged 
for LJM2 to provide the SPE with $30 million which Enron 
deemed, with Andersen's concurrence, to be the independent 
equity from a third party needed to qualify the SPE for 
separate accounting treatment from Enron. Enron explicitly 
assured LJM2 that it would recoup its money plus an additional 
$10 million within 6 months of each SPE's establishment. Enron 
then arranged for the Raptor SPEs to appear to hedge millions 
of dollars in volatile investments held by Enron, and made the 
SPEs appear to be creditworthy on paper--despite withdrawal of 
the LJM funds--by pledging as collateral hundreds of millions 
of dollars worth of Enron's stock, contracts to buy Enron stock 
in the future, or warrants to buy stock in a related company 
called The New Power Company (TNPC).
    Enron claimed, again with Andersen's concurrence, that it 
could use the so-called Raptor hedges to offset mounting losses 
in its investments which Enron otherwise would have had to 
report on its income statement and subtract from its earnings. 
In the space of 1 year, Enron used the alleged Raptor hedges to 
offset--or, in the words of the Powers Report, ``conceal from 
the market''--losses of almost $1 billion.\141\
---------------------------------------------------------------------------
    \141\ Id. at 4, 99, and 133. The Powers Report states at page 4 
that Enron concealed losses in its 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.''
---------------------------------------------------------------------------
    Among other problems, the ``hedges'' created by the Raptor 
SPEs had a structural defect that became evident within months 
of their creation. First, the assets that were supposedly the 
object of the ``hedges'' continued to fall in value. Then, the 
value of Enron stock and stock contracts supporting the Raptor 
SPEs' creditworthiness also began to drop. The value of the 
assets and collateral continued to decline throughout 2000 and 
2001. These declines meant that the Raptor SPEs had little or 
no economic substance--no assets or capital--to support the so-
called hedges, other than claims on Enron's own stock or stock 
contracts. To shore up the SPEs' creditworthiness on paper, 
Enron concocted, with the assistance of Andersen, several 
complex financial arrangements with the Raptor SPEs including 
placing a ``collar'' on the Raptor ``hedges'' in October 
2000,\142\ creating a 45-day cross guarantee arrangement to 
support all four Raptor transactions in December 2000, and 
restructuring the Raptors in March 2001, by placing additional 
Enron shares at risk to support them.
---------------------------------------------------------------------------
    \142\ A collar is created when a security holder purchases a put 
option at a strike price below the current market price of the security 
and sells a call option at a price above the current market price of 
the security. The collar sets limits on the gain and loss that the 
security holder can realize on the security.
---------------------------------------------------------------------------
    In August 2001, Enron employee Ms. Watkins identified and 
openly discussed the problems associated with the Raptors with 
an Andersen partner outside of the Enron engagement team.\143\ 
In September, an Enron internal memorandum announced that 
Andersen had ``changed their opinion of the proper accounting'' 
for the Raptors and no longer supported the capacity of the 
Raptor SPEs to continue to ``hedge'' Enron's investment 
losses.\144\
---------------------------------------------------------------------------
    \143\ Hearing Exhibit 67, internal Andersen email from James A. 
Hecker to David Duncan and others (8/23/01), forwarding a draft of a 
memorandum to the file by him describing his telephone conversation 
with Ms. Watkins, Bates AAHEC(2)192.1-3.
    \144\ Hearing Exhibit 64, memorandum to the Files by Enron 
employees Ryan H. Siurek and Ron Baker (9/01), regarding ``Project 
Raptor--Addendum,'' Bates E12613-22.
---------------------------------------------------------------------------
    The result was that, in October, at the end of the third 
quarter of 2001, Enron terminated the Raptor ``hedges'' and 
recorded a $710 million charge to earnings and a $1.2 billion 
reduction in shareholder equity. The earnings charge reflected 
the investment losses that the Raptors no longer concealed, 
while the equity reduction reflected an accounting change that 
Andersen made after determining that an earlier methodology it 
had used for the Raptors did not comply with generally accepted 
accounting principles. The media reported the losses, as well 
as a decision by one credit rating agency, to ``put Enron's 
long-term debt on review for a possible downgrade.'' \145\ 
Investors reacted by selling Enron shares. The resulting stock 
price decline triggered Enron's credit rating downgrades and 
its eventual bankruptcy. In many ways, the Raptors were the 
accounting gimmick that finally brought down all of Enron.
---------------------------------------------------------------------------
    \145\ Hearing Exhibit 44, ``Partnership Spurs Enron Equity Cut,'' 
Wall Street Journal (10/18/01).
---------------------------------------------------------------------------
    Enron Board members acknowledged that they were informed of 
and explicitly authorized the Raptor transactions on three 
occasions in 2000, but contend that key problems were hidden 
from them. The Raptors were first presented to the Finance 
Committee in May 2000. The presentation on Raptor I is five 
pages long.\146\ One page states the purpose of the 
transaction: ``Establish a risk management program in order to 
hedge the Profit & Loss volatility of Enron investments.'' The 
next page discusses the Raptor transaction in terms of how it 
could provide ``P&L protection'' to Enron. A handwritten note 
taken by the Corporate Secretary during Committee consideration 
of the Raptors states: ``Does not transfer economic risk but 
transfers P&L volatility.'' The final page lists three risks 
associated with the Raptors. The first risk is ``Accounting 
scrutiny''; the second is ``Substantial decline in the price of 
[Enron] stock''; and the third is ``Counterparty credit.''
---------------------------------------------------------------------------
    \146\ Hearing Exhibit 28b, ``Project Raptor; Hedging Program for 
Enron Assets'' (Finance Committee presentation, 5/1/00). The 
Subcommittee has also obtained evidence that Enron management personnel 
briefed individual Board members, including Mr. Winokur and Mr. Blake, 
at length about the proposed Raptor transactions prior to the Finance 
Committee meeting.
---------------------------------------------------------------------------
    The Raptor I presentation contains all the information 
necessary for a Board of ``experts in areas of finance and 
accounting,'' as Mr. Duncan described his fellow Board members, 
to understand that the Raptor transactions were designed to 
function, not as a true hedge, but rather as an accounting 
gimmick whose sole purpose was to improve Enron's financial 
statements. The goal of the transactions was to allow the 
company to claim that losses on investments placed in the 
Raptor ``hedge'' were offset by the alleged hedge, so that none 
of the losses would have to be reported on Enron's income 
statements. But the presentation also directs the Board's 
attention to the key factor that makes it clear the Raptor 
transaction did not offset the losses by actually transferring 
economic risk to a third party--it tells the Board that the 
Raptor transaction relies in part on Enron stock which is 
essentially pledged as collateral to secure the ``hedge.'' And 
it alerts the Board to the fact that the third party in the 
``hedge,'' the Raptor SPE, is a credit risk, since it is 
intended to be thinly capitalized with few real assets.
    The Powers Report, which examines the Raptors in detail, 
sums them up with these words: ``In effect, Enron was hedging 
risk with itself.'' \147\ The key to this analysis is 
understanding that each of the Raptor SPEs was funded with only 
two types of assets: $30 million provided by LJM2, and stock 
and stock contracts provided by Enron. Moreover, the $30 
million provided by LJM2 was only a temporary asset. Each 
Raptor transaction provided that, within 6 months, a payment of 
about $40 million was to be made to LJM2. That payment--which 
actually took place as promised in all four Raptor 
transactions--gave LJM2 not only its $30 million, but also 
about $10 million in profit on each deal.\148\ Afterward, the 
primary asset left in each of the Raptor SPEs was the SPE's 
claim on Enron stock and stock contracts. That meant, in the 
event one of the SPEs were required to pay funds to Enron, the 
primary asset available to provide those funds would be the 
SPEs' claims on Enron stock and stock contracts. Enron's 
liability for the Raptors was further increased in March 2001 
by a restructuring of the transactions that committed 
additional Enron shares. The resulting risk to Enron was 
significant, because Enron was effectively required to provide 
as many Enron shares as necessary to satisfy the Raptor 
``hedges.'' \149\
---------------------------------------------------------------------------
    \147\ Powers Report at 97.
    \148\ See also Powers Report at 102 (``Put another way, before 
hedging could begin, LJM2 had to have received back the entire amount 
of its investment plus a substantial return.'')
    \149\ See, for example, Hearing Exhibit 38c, excerpt from Enron's 
10-Q filing with the SEC (11/19/01) at 7 (Raptor SPEs were 
``capitalized with Enron stock and derivatives which could have 
required the future delivery of Enron stock. . . . In the first quarter 
of 2001, Enron entered into a series of transactions with the Raptor 
SPEs that could have obligated Enron to issue Enron common stock in the 
future in exchange for notes receivable. These transactions, along with 
a transaction entered into in 2000, obligated Enron to deliver up to 30 
million shares of Enron common stock to the Raptor SPEs in March 
2005.''); Hearing Exhibit 68, Enron's draft response to SEC questions 
(11/01) at 26 (``Enron contributed [to the Raptor SPEs] a promise to 
deliver shares and an obligation to provide more shares if the value of 
the Enron shares declined.'') See also Hearing Exhibit 27, ``The 
Raptors,'' prepared by the Subcommittee.
---------------------------------------------------------------------------
    The evidence indicates that the Board was informed of the 
risk to Enron stock when it first approved Raptor I and as the 
Raptor transactions unfolded. Evidence of the Board's knowledge 
lies, first, in the initial Raptor presentation. That 
presentation states clearly that a key risk associated with the 
Raptors is a ``substantial decline in the price of [Enron] 
stock.'' The suggested mitigant for this risk is to terminate 
the Raptor program ``early,'' in other words for Enron to pull 
out of the so-called hedge. This statement of risk shows that 
the Board was told from the beginning that Enron stock was at 
risk in the Raptor transactions and that more stock would be at 
risk if the stock price declined. A true hedge transfers risk 
to a third party--that is the purpose of a hedge. But the 
Raptors ``hedge'' transferred Enron's risk to an SPE with no 
assets other than Enron stock and stock contracts. In the end, 
only Enron remained liable for the Raptor ``hedges,'' and the 
Board was told of that risk from the inception of the 
transactions.
    The Board approved Raptor I, as well as the other Raptor 
transactions, despite the fact that the Raptor ``hedges'' did 
not transfer risk to a third party. It did so apparently 
because, as explained in the presentation on Raptor I, the 
purpose of the Raptor ``hedge'' was not to ``transfer economic 
risk'' but to transfer ``P&L volatility.'' In other words, the 
sole purpose of the Raptor transaction was to protect Enron's 
income statement from losses by allowing Enron to claim on its 
financial statements that its losses were offset, dollar for 
dollar, by the Raptor ``hedge.'' It was a paper hedge designed 
to achieve favorable financial statement results, not a 
substantive hedge that was intended actually to transfer 
Enron's risk of loss to an unrelated party.
    A second document demonstrating that the Board understood 
the true nature of the Raptors is an April 2001 chart requested 
by Mr. Winokur, then Chairman of the Finance Committee.\150\ 
Entitled, ``Stock Price Risk in Financings; Potential Required 
Future Equity issuance,'' this chart shows the number of Enron 
shares at risk in the Raptor transactions if Enron's stock 
price were to decline. At the time the chart was shown to the 
Finance Committee, Enron's stock price was about $60. The chart 
shows that for Raptors I, II, and IV, if Enron's stock price 
were to decline to $40 per share, and the Raptor SPEs' own 
assets fell to zero so that the SPEs would have to call on 
Enron's stock, Enron would be required to produce about 35 
million shares.\151\ In a true hedge, Enron would not have 
retained this type of contingent liability. But the Raptors 
were an accounting gimmick, not a true hedge. The chart shows 
that the Board was well aware of Enron's ongoing contingent 
liability for them, yet allowed the Raptors to continue.
---------------------------------------------------------------------------
    \150\ Hearing Exhibit 32, ``Stock Price Risk in Financings; 
Potential Required Future Equity issuance'' (Finance Committee 
presentation, 4/01).
    \151\ The chart also notes that the ``Raptor vehicle share 
issuances are triggered by date'' and refers to a ``restructuring'' 
that took place in the first quarter of 2001. Enron Board members have 
denied knowing about the March 2001 restructuring that placed 
additional Enron shares at risk in the Raptor hedges. Had anyone 
inquired about the chart's reference, the restructuring would have been 
disclosed in April 2001, a month after it had taken place. It is 
difficult to credit the position of the Finance Committee members that, 
despite having requested the chart, no explanation was requested or 
provided regarding its references to triggering dates and a 2001 
restructuring.
---------------------------------------------------------------------------
    During the hearing, Mr. Winokur was asked about Enron's 
ongoing liability for the Raptors. He admitted knowing that 
Enron had retained a risk despite setting up the Raptor 
``hedges,'' but declined to admit that Enron shares had been 
pledged as collateral.\152\ He stated that the Board had 
pledged ``forward positions on Enron stock,'' and not Enron 
stock itself.\153\ But the difference between pledging Enron 
stock directly and pledging contracts enabling Enron to buy its 
own stock at a specified price in the future makes no 
difference in the liability problem that confronted Enron and 
that was communicated to the Finance Committee in April 2001--
either way the Raptor SPEs had an ongoing claim on Enron stock. 
In the end, the number of Enron shares needed to support the 
Raptor ``hedges'' became so great, that the company chose to 
terminate them and acknowledge on its income statement instead 
the investment losses that the Raptors had been masking.\154\
---------------------------------------------------------------------------
    \152\ Hearing Record at 76-79.
    \153\ Id. at 76.
    \154\ See, for example, Enron's explanation for terminating the 
Raptor hedges in Hearing Exhibit 38c, excerpt from Enron's 10-Q filing 
with the SEC (11/19/01) at 7 (``[A]s a result of deterioration in the 
credit quality of the Raptor SPEs caused by the decline in Enron and 
[The New Power Company's] stock price, the increase in Raptor's 
exposure under derivative contracts with Enron and the increasing 
dilutive effect on Enron's earnings per share calculation, Enron . . . 
terminated the entities.'') See also Hearing Exhibit 44, ``Partnership 
Spurs Enron Equity Cut,'' Wall Street Journal (10/18/01), quoting 
Kenneth Lay in a conference telephone call with financial analysts 
indicating that, at the time of termination, the Raptors involved ``55 
million'' Enron shares.
---------------------------------------------------------------------------
    During their interviews, the Board members said that they 
first learned of the Raptor termination at an October 8, 2001 
Board meeting, when Enron officers announced that the company 
had decided to terminate the Raptors and take an $800 million 
earnings charge. The final charge actually recorded on Enron's 
third quarter financial statement was about $710 million.\155\ 
The interviewed Board members indicated that they had not felt 
deep concern about the charge at the time, despite its size, 
because it was a one-time event. Most said that they had left 
the October meeting thinking that the company was still on 
track, and its earnings were strong enough to withstand the 
charge.
---------------------------------------------------------------------------
    \155\ Enron's 10-Q filing with the SEC for the third quarter of 
2001 (11/19/01) (pre-tax charge was $711 million; after-tax charge was 
$544 million).
---------------------------------------------------------------------------
    The October 2001 meeting was also when the Directors first 
learned of the Watkins' letter, although she was never 
identified by name to the Board, no Board member requested her 
identity, and the letter's strong warnings about the Raptors 
apparently were not disclosed to the outside directors. The 
interviewed directors said that Enron officers referred to the 
letter during the Board meeting as coming from an anonymous 
employee. They said it was discussed during an Audit Committee 
meeting first and then during the full Board meeting. The 
company's outside legal counsel, Vinson & Elkins, made the 
primary presentations and indicated that their preliminary 
investigation of the employee's concerns had found nothing 
worth further investigation. The interviewed directors said the 
employee's concerns were characterized as having to do with LJM 
and related party transactions, and no mention was made of the 
Raptors. The Chairman of the Board, Mr. Lay, participated in 
both the Committee and Board discussions, but apparently did 
not disclose to his fellow Board members the Raptor and 
accounting concerns expressed in the letter he had received. 
The interviewed directors said that they saw neither the letter 
itself nor the Vinson & Elkins report on it until after Enron 
had begun to collapse and the Powers investigation was 
launched. Had they seen the letter, the outside Board members 
would have learned that Ms. Watkins had told Mr. Lay in mid-
August that she was ``incredibly nervous that [Enron] will 
implode in a wave accounting scandals''; that ``Enron has been 
very aggressive in its accounting--most notably the Raptor 
transactions and the Condor vehicle''; and that ``the Raptor 
and Condor deals . . . unwind in 2002 and 2003 [and] we will 
have to pony up Enron stock and that won't go unnoticed.'' 
\156\
---------------------------------------------------------------------------
    \156\ Watkins' letter to Board Chairman Lay (8/15/01) at 1, 
attached to this report as Appendix 2 on page 57. The ``Condor 
vehicle'' is a reference to Whitewing and the Osprey debt certificates 
secured with Enron stock.
---------------------------------------------------------------------------
    During their interviews, the Directors were unanimous in 
stating that, while Enron disclosed the prospective $800 
million earnings charge at the October 8 Board meeting, Enron 
management did not disclose at that meeting that the Raptors 
termination would also require a reduction in shareholder 
equity of $1.2 billion. Most of the Directors recalled learning 
of the $1.2 billion after a Wall Street Journal article quoted 
the figure following Mr. Lay's disclosure of it during a 
financial analyst call on October 17.\157\ Most of the 
Directors said they had been shocked and angry, not only at the 
loss in shareholder value, but also by learning of it from the 
media instead of Enron management. Board members later learned 
the reduction was due to an accounting correction that Andersen 
required after determining that the accounting methodology it 
had advocated for the Raptors was in violation of generally 
accepted accounting principles and had to be changed. Several 
directors said this $1.2 billion reduction was the first event 
that made them realize Enron was in trouble.
---------------------------------------------------------------------------
    \157\ Hearing Exhibit 44, ``Partnership Spurs Enron Equity Cut,'' 
Wall Street Journal (10/18/01).
---------------------------------------------------------------------------
    Despite the huge dollars involved and the significant risk 
to Enron, some Board members stated they had only a limited 
understanding of the Raptor transactions or stressed that key 
information had been withheld from them. For example, many of 
the Board members indicated they had not been told that LJM2 
had been promised, after contributing $30 million to each 
Raptor SPE, to be paid $40 million within 6 months. But the 
initial Raptor presentation and the April 2001 chart are strong 
evidence that the Board knew that Enron stock, not LJM2 funds, 
were at risk in the Raptor transactions. Another key document, 
the Enron Deal Approval Sheet (DASH) for the Raptor 
transactions, characterized Enron's financial obligation as 
providing ``a guaranty'' for the ``hedges'' and made it clear 
that LJM2 was to be paid its funds at the earliest possible 
date. In explaining the Raptor profit distributions, for 
example, the Raptor DASHs state: ``First, $41 million to 
LJM2.'' \158\ The dollar value and unusual nature of the Raptor 
transactions should have ensured that each of the Raptor DASHs 
went to the Finance Committee for review, in addition to the 
Raptor presentations, but no Finance Committee member recalled 
seeing one or requesting a copy.
---------------------------------------------------------------------------
    \158\ Hearing Exhibit 31, ``Enron Deal Summary'' for Raptor I (4/
18/00).
---------------------------------------------------------------------------
    The Board members also asserted that they had been informed 
of only three Raptor transactions and never knew about the 
Raptor ``hedge'' collateralized with Enron's warrants to 
purchase TNPC stock. Lack of knowledge of one of the Raptors, 
however, does not explain or excuse the Board's decisionmaking 
with respect to the other Raptors. Nor does it excuse the 
Board's failure to find out about all four Raptors when a 
February 2001 list of LJM transactions, shown to both the Audit 
and Finance Committees, identified all four and stated they had 
a combined value of $127 million, far larger than any other LJM 
transaction on the list.\159\
---------------------------------------------------------------------------
    \159\ Hearing Exhibit 24, ``Review of LJM procedures and 
transactions completed in 2000'' (Audit and Finance Committee 
presentation, 2/12/01) at 2.
---------------------------------------------------------------------------
    Board members recited a litany of other Raptor facts that 
were not brought to their attention. For example, Board members 
told Subcommittee staff that they had not been told that 
Andersen had raised repeated concerns about the Raptors, or 
that the Raptors began experiencing severe credit impairment 
problems just months after they were created. They said they 
had not been told about the October 2000 ``collar'' or the 
December 2000 45-day cross guarantee. The Board members also 
said they did not know that Enron had placed additional Enron 
shares at risk in a restructuring of the Raptors in March 
2001--even though, 1 month later, the Finance Committee 
requested a chart analyzing Enron's stock risk and the chart 
itself refers to the restructuring. The Board members indicated 
that Enron management and Vinson & Elkins also withheld the 
information that the Watkins' letter from August 2001, had 
described the Raptor transactions as a possible ``accounting 
scandal'' and enumerated their problems. The Board also said 
they did not know that the Raptor transactions provided LJM2 
with some of its highest returns on any investment, information 
it could have obtained if any Board member had reviewed LJM's 
first annual partnership report in October 2000.
    The Board's lack of knowledge of certain aspects of the 
Raptor transactions, however, does not justify its handling of 
these transactions. At best, it demonstrates a lack of 
diligence and independent inquiry by the Board into a key Enron 
liability. It does not excuse or explain the Board's approval 
of the Raptors based upon what they did know. It also does not 
excuse the Board's failure to ensure adequate public disclosure 
of Enron's ongoing liability for the Raptor transactions.
    Inadequate Public Disclosure. When asked about Enron's 
extensive off-the-books activity, one of the Board members, Mr. 
Blake, stated during his interview that transferring assets off 
a company's books ``is not immoral as long as disclosed.'' But 
here, too, the Enron Board failed in its fiduciary duty to 
ensure adequate public disclosure of Enron's off-the-books 
assets and liabilities.\160\
---------------------------------------------------------------------------
    \160\ Enron's Board members signed the company's 10-K filings with 
the Securities and Exchange Commission, and the Audit Committee was 
consulted about related party disclosure issues in both the 10-K 
filings and the company's proxy statements. See discussion in Powers 
Report at 181-83.
---------------------------------------------------------------------------
    Enron's initial public disclosures regarding its dealings 
with its ``unconsolidated affiliates'' such as JEDI, Whitewing, 
LJM, and the Raptor SPEs are nearly impossible to understand 
and difficult to reconcile with the transactions now known to 
have taken place. The Powers Report calls the disclosures 
``fundamentally inadequate'' and castigates Enron for proxy 
statement and financial statement disclosures that fail to 
``disclose facts that were important for an understanding of 
the substance of the transactions'' Enron entered into with 
related parties.\161\
---------------------------------------------------------------------------
    \161\ Powers Report at 178 and 187. See also Powers Report at 197.
---------------------------------------------------------------------------
    Ms. Watkins also focused on the lack of adequate public 
disclosure of the company's involvement in the Raptor 
transactions in her August 2001 letter to Mr. Lay. Her letter 
states that ``a lot of smart people'' are examining the Raptor 
transactions and ``a lot of accountants including [Andersen] 
have blessed the accounting treatment. None of that will 
protect Enron if these transactions are ever disclosed in the 
bright light of day.'' \162\ The letter continues:
---------------------------------------------------------------------------
    \162\ Watkins' letter to Board Chairman Lay (8/15/01) at 2, 
attached to this report as Appendix 2 on page 57.

        ``The overriding principle of accounting is that if you 
        explain the ``accounting treatment'' to a man on the 
        street, would you influence his investing decisions? 
        Would he buy or sell the stock based on a thorough 
        understanding of the facts? If so, you best present it 
        correctly and/or change the accounting. My concern is 
        that the footnotes don't adequately explain the 
        transactions. If adequately explained, the investor 
        would know that the ``Entities'' described in our 
        related party footnote are thinly capitalized, the 
        equity holders have no skin in the game, and all the 
        value in the entities comes from the underlying value 
        of the derivatives (unfortunately in this case, a big 
        loss) AND Enron stock and N/P.'' \163\
---------------------------------------------------------------------------
    \163\ Id.

Her comments apply not only to Enron's failure to disclose 
clearly the nature and extent of the Raptor transactions and 
the company's contingent liability for them, but also to 
Enron's dealings with its other ``unconsolidated affiliates.''
    The disclosure problem is illustrated by a comparison of 
the related party disclosures in Footnote 16 of Enron's 10-K 
filings for the years 1999 and 2000, with the disclosure 
provided by Enron on November 19, 2001, its 10-Q filing for the 
third quarter of 2001, filed more than 1 month after media 
reports began describing Enron's off-the-books activities.\164\ 
The 1999 and 2000 footnotes, each of which is about one page in 
length, provide extremely brief descriptions of LJM, JEDI, 
Whitewing, and the Raptor transactions. The footnotes provide 
minimal information about the entities themselves, their 
relationship with Enron, and the extent of their business 
transactions with the company. The 2000 footnote, in 
particular, is nearly unintelligible, and certainly fails to 
convey meaningful information about Enron's expanding business 
activities with LJM, JEDI, and Whitewing, and its participation 
in and ongoing liabilities associated with the Raptor SPEs. In 
contrast, Enron's 2001 filing provides a nine-page description 
of Enron's transactions with these entities and contains 
information which is much more extensive and understandable. 
The Raptor transactions, for example, are identified by name, 
and the nature and extent of Enron's liabilities for them are 
set out in relatively straightforward terms. So are a number of 
Enron's transactions with LJM1 and LJM2. The 10-Q filing 
demonstrates that Enron was quite capable of meaningful public 
disclosure when motivated. The Enron Board failed to provide 
that motivation.
---------------------------------------------------------------------------
    \164\ Hearing Exhibits 38a, 38b, and 38c, Enron's 10-K filings for 
1999 and 2000, and 10-Q filing for the third quarter of 2001.
---------------------------------------------------------------------------
    Once public disclosure was made of Enron's off-the-books 
activities and liabilities, credit rating agencies, financial 
analysts, and investors began to reconsider their view of the 
company, and many investors reacted by selling Enron stock. 
Enron's hidden activities and liabilities clearly damaged 
investor confidence in the company and contributed to its 
collapse.

        Finding (5): The Enron Board of Directors approved 
        excessive compensation for company executives, failed 
        to monitor the cumulative cash drain caused by Enron's 
        2000 annual bonus and performance unit plans, and 
        failed to monitor or halt abuse by Board Chairman and 
        Chief Executive Officer Kenneth Lay of a company-
        financed, multi-million dollar, personal credit line.

    Enron provided its executives with lavish compensation. On 
more than one occasion, it paid tens of millions of dollars to 
a single executive as a bonus for work on a single deal. Stock 
options were distributed in large numbers to executives. One 
executive, Lou Pai, accumulated enough stock options that, when 
he exercised them and sold the underlying stock in 2000, he 
left the company with more than $265 million in cash. Mr. Lay, 
alone, accumulated more than 6.5 million options on Enron 
stock.\165\ In 2000, Mr. Lay's total compensation exceeded $140 
million, including $123 million from exercising a portion of 
his Enron stock options,\166\ an amount which exceeded average 
CEO pay at U.S. publicly traded corporations by a factor of ten 
and made him one of the highest paid CEOs in the country.\167\
---------------------------------------------------------------------------
    \165\ ``Office of the Chair Compensation Summary'' (10/31/01), 
Bates WP1797.
    \166\ Hearing Exhibit 52, ``Confidential for Enron Board of 
Directors, Public Relations, Investor Relations & HR Use Only; 
Potential Questions--Enron Proxy 2001'' (4/13/01), Bates CL410-14, at 
1.
    \167\ See, for example, annual executive compensation survey by 
Business Week (4/16/01), which determined that average CEO pay in 2000 
at 365 publicly traded companies in the United States was $13.1 
million. In February 2001, Mr. Lay resigned his CEO post in favor of 
Mr. Skilling, but reclaimed it in August 2001, after Mr. Skilling left 
the company.
---------------------------------------------------------------------------
    The Enron Board, through its Compensation Committee, was 
not only informed of the company's lavish executive 
compensation plans, it apparently approved them with little 
debate or restraint. One Board member said during his interview 
that Enron's philosophy was to provide ``extraordinary rewards 
for extraordinary achievement''; others claimed that the 
company was forced to provide lavish compensation to attract 
the best and brightest employees. Dr. LeMaistre testified that 
he ``did not worry'' about high levels of compensation because 
he checked regularly with the Board's compensation consultant, 
Towers Perrin, and was informed that Enron was ``right on 
target'' in its compensation practices.\168\ The evidence 
suggests that keeping up with competitor pay, rather than 
overseeing existing compensation plans, was the central 
objective of the Enron Compensation Committee.
---------------------------------------------------------------------------
    \168\ Hearing Record at 46.
---------------------------------------------------------------------------
    One example of the Compensation Committee's lavish 
compensation philosophy, combined with its failure to conduct 
adequate compensation oversight, involves its May 1999 decision 
to permit Mr. Lay to repay company loans with company stock. 
The Compensation Committee had already given Mr. Lay a $4 
million line of credit which, in August 2001, it increased to 
$7.5 million. During their interviews, the Committee members 
said that they knew of the line of credit, but had been unaware 
that, in 2000, Mr. Lay began using what one Board member called 
an ``ATM approach'' toward that credit line, repeatedly drawing 
down the entire amount available and then repaying the loan 
with Enron stock. Records show that Mr. Lay at first drew down 
the line of credit once per month, then every 2 weeks, and 
then, on some occasions, several days in a row.\169\ In the 1-
year period from October 2000 to October 2001, Mr. Lay used the 
credit line to obtain over $77 million in cash from the company 
and repaid the loans exclusively with Enron stock.\170\ Several 
directors confirmed that Mr. Lay still owed the company about 
$7 million.
---------------------------------------------------------------------------
    \170\ An Enron filing in Federal bankruptcy court in June 2002, 
listing payments to Enron officers during 2001, states that, altogether 
in 2001, the company loaned Mr. Lay over $81 million.
    \169\ Hearing Exhibit 36a, ``Ken Lay's Repayment of Cash Loans by 
Transferring Enron Stock Back to Enron,'' prepared by the Subcommittee 
based upon subpoenaed documents provided by Mr. Lay, an example of 
which appears in Hearing Exhibit 36b.
---------------------------------------------------------------------------
    The interviewed Board members said they had been unaware of 
these transactions at the time and agreed that they could 
fairly be characterized as stock sales. They indicated that 
they had been unaware at the time that, by characterizing the 
stock transfers as loan payments rather than stock sales, Mr. 
Lay bypassed requirements for reporting insider stock sales on 
a quarterly basis and instead delayed reporting the 
transactions to the SEC and investing public until the end of 
the calendar year in which they took place.
    At the hearing, when Dr. LeMaistre, former Compensation 
Committee Chairman, was asked whether his Committee should have 
been monitoring the credit line, he testified that, ``We never 
had any responsibility to monitor this.'' \171\ When asked 
whether he would agree that Mr. Lay had ``abused'' his credit 
line, Dr. LeMaistre testified that ``it was not a term I care 
to use'' and that he would stop short of characterizing Mr. 
Lay's actions as an abuse ``because I do not know the 
circumstances.'' \172\ Mr. Blake, another Compensation 
Committee member, stated, ``I do not want to go close to the 
word `abuse', but I would say that as a CEO, it is not what you 
say, it is what you do. Sale of a stock in the nature that took 
place was inappropriate. . . . I was absolutely shocked by 
this. . . . [I]f we had a chance to have known that occurred, 
we would have taken immediate and corrective action to ensure 
that behavior would not happen again.'' \173\ Both Dr. 
LeMaistre and Mr. Blake seemed to deny responsibility for 
monitoring the CEO's credit line, even though the Board's 
Compensation Committee is charged with overseeing CEO 
compensation and no one other than the Board had the authority 
to monitor or restrict the Chief Executive Officer's actions. 
Mr. Lay used his credit line to withdraw $77 million in cash 
from the company in 1 year, replaced the cash with company 
stock, and never mentioned his borrowings or stock sales to the 
Board or the public. Despite learning of his conduct after the 
fact, the Board members at the hearing were reluctant to 
express strong criticism of Mr. Lay.
---------------------------------------------------------------------------
    \171\ Hearing Record at 90.
    \172\ Id. at 89.
    \173\ Id. at 90.
---------------------------------------------------------------------------
    A second example of the Compensation Committee's poor 
compensation oversight involves the huge annual and special 
bonus plans it approved for Enron executives. During their 
interviews, the Compensation Committee and other Board members 
indicated that they had been unaware of the total amount of 
bonuses paid in early 2001 for work performed in 2000. That 
year, Enron executives received about $430 million in annual 
bonuses under Enron's normal bonus plan. In addition, in 
exchange for meeting certain stock performance targets, a 
special program called the Performance Unit Plan paid bonuses 
to about 65 Enron executives totaling another $320 million. 
Board members indicated that they had been unaware that the 
company had paid out almost $750 million in cash bonuses for a 
year in which the company's entire net income was $975 million. 
Apparently, no one on the Compensation Committee had ever added 
up the numbers.
    The Compensation Committee appeared to have exercised 
little, if any, restraint over Enron's compensation plans, 
instead deferring to the compensation plans suggested by 
management and the company's compensation consultants. During 
their interviews, the Committee members said it had not 
occurred to them that, by giving Enron executives huge stock 
option awards, they might be creating incentives for Enron 
executives to improperly manipulate company earnings to 
increase the company stock price and cash in their options. One 
Board member admitted, however, that Enron was a culture driven 
by compensation. Another said, when asked why Enron executives 
misled the Board and cheated the company, that he ``only can 
assume they did it for the money.''

        Finding (6): The independence of the Enron Board of 
        Directors was compromised by financial ties between the 
        company and certain Board members. The Board also 
        failed to ensure the independence of the company's 
        auditor, allowing Andersen to provide internal audit 
        and consulting services while serving as Enron's 
        outside auditor.

    Board Independence. At the May 7 hearing, the expert 
witnesses testified that the independence and objectivity of 
the Enron Board had been weakened by financial ties between 
Enron and certain directors. These financial ties, which 
affected a majority of the outside Board members, included the 
following.\174\
---------------------------------------------------------------------------
    \174\ Hearing Exhibit 43, ``Enron Board of Directors--Financial 
Ties to Enron,'' prepared by the Subcommittee.

        --LSince 1996, Enron paid a monthly retainer of $6,000 
        to Lord John Wakeham for consulting services, in 
        addition to his Board compensation. In 2000, Enron paid 
        him $72,000 for his consulting work alone.\175\
---------------------------------------------------------------------------
    \175\ Enron 2001 Proxy.

        --LSince 1991, Enron paid Board member John A. Urquhart 
        for consulting services, in addition to his Board 
        compensation. In 2000, Enron paid Mr. Urquhart $493,914 
        for his consulting work alone.\176\
---------------------------------------------------------------------------
    \176\ Id.

        --LEnron Board member Herbert Winokur also served on 
        the Board of the National Tank Company. In 1997, 1998, 
        1999, and 2000, the National Tank Company recorded 
        revenues of $1,035,000, $643,793, $535,682 and $370,294 
        from sales to Enron subsidiaries of oilfield equipment 
        and services.\177\
---------------------------------------------------------------------------
    \177\ Enron 2000 and 2001 Proxy.

        --LIn the past 5 years Enron and Kenneth Lay donated 
        nearly $600,000 to the M.D. Anderson Cancer Center in 
        Texas. In 1993, the Enron Foundation pledged $1.5 
        million to the Cancer Center. Two Enron Board members, 
        Dr. LeMaistre and Dr. Mendelsohn, have served as 
        president of the Cancer Center.\178\
---------------------------------------------------------------------------
    \178\ M.D. Anderson Cancer Center records.

        --LSince 1996, Enron and the Lay Foundation have 
        donated more than $50,000 to the George Mason 
        University and its Mercatus Center in Virgina.\179\ 
        Enron Board member Dr. Wendy Gramm is employed by the 
        Mercatus Center.
---------------------------------------------------------------------------
    \179\ New York Times, 11/30/01.

        --LSince 1996, Enron and Belco Oil and Gas have engaged 
        in hedging arrangements worth tens of millions of 
        dollars.\180\ In 1997, Belco bought Enron affiliate 
        Coda Energy.\181\ Enron Board member Robert Belfer is 
        former Chairman of the Board and CEO of Belco.
---------------------------------------------------------------------------
    \180\ Enron 2001 Proxy.
    \181\ Enron 1998 Proxy.

        --LCharls Walker, a noted tax lobbyist, was an Enron 
        Board member from 1985 until 1999. In 1993-1994, Enron 
        paid more than $70,000 to two firms, Walker/Free and 
        Walker/Potter that were partly owned by Mr. Walker, for 
        governmental relations and tax consulting services. 
        This sum was in addition to Mr. Walker's Board 
        compensation.\182\ Enron was also, for more than 10 
        years ending in 2001, a major contributor of up to 
        $50,000 annually to the American Council for Capital 
        Formation, a non-profit corporation that lobbies on tax 
        issues and is chaired by Mr. Walker.\183\
---------------------------------------------------------------------------
    \182\ Enron 1994 and1995 Proxy.
    \183\ Subcommittee staff interview of Mr. Walker.

    A number of corporate governance experts contacted by the 
Subcommittee staff identified these financial ties as 
contributing to the Enron Board's lack of independence and 
reluctance to challenge Enron management. At the May 7 hearing, 
Charles Elson, Director of the Center for Corporate Governance 
at the University of Delaware, testified that public company 
directors should have ``no financial connection to the company 
whatsoever'' other than their Board compensation, but the Enron 
Board was ``problematic'' because a number of directors ``were 
service providers or recipients of corporate largess in some 
way, shape, or form.'' \184\ He testified:
---------------------------------------------------------------------------
    \184\ Hearing Record at 94-95.

        ``By taking those fees, you are effectively becoming 
        part of the management team, and I think there is a 
        real problem with exercising independent judgement vis-
        a-vis what the management has done if you feel part of 
        that team, either through participating in the 
        development of management plans and strategies or the 
        fear that if one objects too strenuously, those 
        consulting fees may disappear. . . . You may take what 
        they are telling you at face value without being more 
        probative because of the relationship. . . . [I]f a 
        director's role is as a consultant, hire the director 
        as a consultant. If the director's role is to be a 
        director, hire them as a director. You cannot blend the 
        two.'' \185\
---------------------------------------------------------------------------
    \185\ Hearing Record at 106-107.

    Robert H. Campbell, retired Chairman and CEO of Sunoco, 
Inc., who presently sits on the Boards of several large 
corporations, testified that ``consulting arrangements with 
directors is absolutely incorrect, absolutely wrong'' because 
directors are already paid a substantial fee to be available to 
management and provide their perspective on company 
issues.\186\
---------------------------------------------------------------------------
    \186\ Hearing Record at 107.
---------------------------------------------------------------------------
    The three experts at the May 7 hearing also criticized the 
compensation paid to the Board members, noting that $350,000 
per year \187\ was significantly above the norm and that much 
of the compensation was in the form of stock options which 
enabled Board members to benefit from stock gains, without 
risking any investment loss.\188\ Mr. Elson criticized stock 
options because ``[t]here is no real downside. The worst you 
can lose is the expectancy of great riches.'' \189\ All three 
experts urged companies to reconsider awarding excessive Board 
compensation and urged them to award compensation in the form 
of stock rather than stock options.
---------------------------------------------------------------------------
    \187\ See Hearing Exhibits 35a and 35b, on Enron Board Member 
compensation, prepared by the Subcommittee.
    \188\ Hearing Record at 110-112.
    \189\ Id. at 111.
---------------------------------------------------------------------------
    Auditor Independence. The hearing experts also criticized 
the Enron Board and its Audit Committee for inadequate 
oversight to ensure the independence and objectivity of 
Andersen in its role as the company's outside auditor. The 
Audit Committee formally reviewed Andersen's independence 
annually, and Committee members told the Subcommittee staff 
there had never been any sign of a problem. The evidence 
suggests, however, that the Audit Committee did not probe the 
independence issue, nor did it initiate the type of 
communications with Andersen personnel that would have led to 
its discovering Andersen concerns with Enron accounting 
practices.
    The Audit Committee had very limited contact with Andersen, 
essentially communicating with Andersen personnel only at Board 
meetings. The Audit Committee Chairman for more than 10 years 
was Dr. Jaedicke. Despite his long tenure on the Audit 
Committee, the interviews disclosed that Dr. Jaedicke had 
``rarely'' had any contact with Andersen outside of an official 
Audit Committee or Board meeting. None of the other interviewed 
Audit Committee members had ever contacted anyone from Andersen 
regarding Enron outside of an official Enron Committee or Board 
meeting. None had ever telephoned Andersen directly.
    The Audit Committee members indicated that they had thought 
Andersen and Enron had a good working relationship, and taken 
great comfort in knowing that Andersen was more than Enron's 
outside auditor, but also provided Enron with extensive 
internal auditing and consulting services, combining its roles 
into what Enron called ``an integrated audit.'' Dr. Jaedicke 
maintained that it was a significant benefit to Enron for 
Andersen to be involved with Enron's activities on a day-to-day 
basis and to help the company design its most complex 
transactions from the start. Although one Board member, Lord 
Wakeham, indicated that he had been concerned that this high 
level of involvement meant Andersen might be too close to Enron 
management, most Board members indicated that issue had not 
been a concern. No Board member expressed any concern that 
Andersen might be auditing its own work, or that Andersen 
auditors might be reluctant to criticize Andersen consultants 
for the LJM or Raptor structures that Andersen had been paid 
millions of dollars to help design.\190\
---------------------------------------------------------------------------
    \190\ See, for example, Powers Report at 5 (``Andersen billed Enron 
$5.7 million for advice in connection with the LJM and Chewco 
transactions alone, above and beyond its regular audit fees.'') and 132 
(``Andersen's total bill for Raptor-related work came to approximately 
$1.3 million. Indeed, there is abundant evidence that Andersen in fact 
offered Enron advice at every step, from inception through 
restructuring and ultimately to terminating the Raptors.'').
---------------------------------------------------------------------------
    In contrast, the accounting and corporate governance 
experts at the May 7 hearing condemned the very concept of an 
integrated audit, not only for diluting the outside auditor's 
independence, but also for reducing the effectiveness of an 
outside audit by allowing the auditor to audit its own work at 
the company. Mr. Sutton called it a ``terrible idea,'' while 
Mr. Campbell called it a ``horrible practice and I do not think 
it should be permitted.'' \191\
---------------------------------------------------------------------------
    \191\ Hearing Record at 105 and 106.
---------------------------------------------------------------------------
    Enron Board members told the Subcommittee staff that they 
had been unaware of any tensions between Andersen and Enron and 
unaware of the many concerns Andersen had with Enron's 
accounting practices. The interviewed Board members said that 
they had not been informed and were unaware of a February 2001 
visit paid by the head of Andersen, Joseph Berardino, to 
Enron's headquarters and did not know why the meeting took 
place or what was discussed. They also said they were unaware 
that, shortly after the visit, in March 2001, a senior Andersen 
partner, Carl Bass, was removed from his Enron oversight role 
at Enron's request. The Board members observed that they had 
given Andersen regular opportunities outside the presence of 
Enron management to communicate any concerns about the company, 
including whether company officials were pressuring Andersen 
accountants who raised objections to company proposals. They 
expressed shock and dismay that Andersen had never conveyed its 
many concerns about Enron's accounting and transactions to the 
Enron Board.
    The interviewed Board members indicated that they had not 
considered whether Andersen might be reluctant to express 
serious concerns about Enron accounting practices out of an 
unwillingness to upset Enron management or endanger its fees. A 
number of the interviewed directors discounted the importance 
of Andersen's fees, even though Enron was one of Andersen's 
largest clients and, during 2000, paid Andersen about $52 
million or $1 million per week for its work. Andersen's 
consulting fees at Enron exceeded its auditing fees for the 
first time in 1999, and, in 2000, totaled about $27 million 
compared to auditing fees of about $25 million.\192\
---------------------------------------------------------------------------
    \192\ Hearing Exhibit 7b, ``Summary of Fees--Activity Overview'' 
(Audit Committee presentation, 5/1/00).
---------------------------------------------------------------------------
    When asked by Senator Collins at the hearing if he had 
``ever known an auditor to come in and say, we are not 
independent, we are too close to management,'' Dr. Jaedicke 
said no, ``[t]hey would not last very long if they did that.'' 
Senator Collins responded:

        ``Exactly my point. . . . When you are making over $40 
        million a year, the auditor is not likely to come to 
        the Audit Committee and say anything other than that 
        they are independent. Is it not the job of the Audit 
        Committee to make sure that the auditor truly is giving 
        full, accurate, and appropriate advice to the Board?''

The facts suggest that the Enron Audit Committee went through 
the motions of asking Andersen about its independence, relied 
on what it was told, and did little more to evaluate the 
relationship between the auditor and the company. Had it dug 
deeper, the Enron Audit Committee might have uncovered the 
ongoing tensions between the company and its auditor and the 
many misgivings Andersen expressed internally while going along 
with Enron's high risk accounting.

                               CONCLUSION

    Enron's Directors protest that they cannot be held 
accountable for misconduct that was concealed from them. But 
much that was wrong with Enron was known to the Board, from 
high risk accounting practices and inappropriate conflict of 
interest transactions, to extensive undisclosed off-the-books 
activity and excessive executive compensation.
    At the hearing, the Subcommittee identified more than a 
dozen red flags that should have caused the Enron Board to ask 
hard questions, examine Enron policies, and consider changing 
course. Those red flags were not heeded. In too many instances, 
by going along with questionable practices and relying on 
management and auditor representations, the Enron Board failed 
to provide the prudent oversight and checks and balances that 
its fiduciary obligations required and a company like Enron 
needed. By failing to provide sufficient oversight and 
restraint to stop management excess, the Enron Board 
contributed to the company's collapse and bears a share of the 
responsibility for it.
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