Enron Kept Crucial Information From Auditors, Memo Discloses
Enron Corp. executives withheld several crucial financial documents from its auditors at Andersen for four years, misleading the accounting firm into approving inaccurate financial reports, according to an internal Andersen memo acquired by The Times.
Soon after the auditors discovered the documents, according to the memo, they advised Enron that it would have to restate its earnings from 1997 through 2001.
Even after Andersen officials finally learned the contents of the documents, Enron attorneys made a last-ditch attempt in meetings with their auditors to head off the financial reckoning.
The restatement, announced Nov. 8, reduced the company’s reported earnings over the period by more than $500 million--a step that ultimately led to the energy company’s Chapter 11 bankruptcy filing Dec. 2.
The internal memo, written Nov. 2 by Thomas H. Bauer, an Andersen auditor assigned to Enron, covers the accounting treatment of two Enron subsidiaries known as JEDI and Chewco. It hints at the lengths to which Enron officials went to conceal important financial information about the subsidiaries from its auditors and, by extension, its investors.
After the auditors saw the documents for the first time in November, the memo reveals, Enron lawyers spent two days meeting with them in an attempt to minimize their significance, at one point proposing an argument so elaborate that Bauer “could not comprehend” it.
The memo by Bauer is one of the few pieces of evidence yet to emerge that supports the auditing firm’s contention that it was misled by its client.
Patrick Dorton, a spokesman for Andersen, on Wednesday called the memo “just another chunk of evidence that demonstrates Enron withheld critical information from Andersen regarding Chewco.” He declined to comment further.
Still, the memo falls well short of absolving Andersen from the raft of accusations of errors and lapses of judgment laid against the firm by congressional investigators, professional observers and, most recently, a special investigative committee of Enron’s board, which issued its highly critical report on Saturday.
The memo covers only one of countless suspect transactions on which Andersen consulted for Enron. It also fails to resolve whether Andersen overlooked any other indications of the real relationship tying JEDI and Chewco to Enron over the years.
Bauer will testify today before the House Commerce Committee, which is investigating the Enron collapse. “He’s cooperating with the committee, he’s met with the committee,” said his attorney, Scott Schreiber of the Washington law firm Arnold & Porter. Bauer remains an Andersen partner but has been placed on administrative leave.
JEDI, which stands for Joint Energy Development Investments, was formed in 1993 as a $500-million joint venture between Enron and the California Public Employee Retirement System. Thanks to an accounting technicality, JEDI was treated as an unconsolidated subsidiary of Enron, meaning its assets and liabilities were not reported as part of Enron’s financial results. Debt JEDI incurred on Enron’s behalf stayed off the Enron books, allowing Enron to maintain a higher credit rating than it might otherwise have deserved. JEDI’s earnings, however, were reported in Enron’s results.
In late 1997, when CalPERS sought to withdraw from the partnership, Enron formed Chewco to purchase the CalPERS interest. The new entity was placed under the management of Michael Kopper, an Enron employee reporting to Andrew S. Fastow, Enron’s chief financial officer. As the special board committee later contended, Kopper and his domestic partner invested $125,000 in the partnership and reaped a windfall of $10.5 million in fees and investment returns.
Under accounting rules, at least 3% of Chewco’s capital had to be owned by an independent investor in order to continue to keep Chewco and JEDI off Enron’s books. That investor had to have equity at risk--meaning that if Chewco had $100 million in capital, an outside investor had to own at least $3 million of its equity.
Because Enron could not find an equity investor to take that role, according to the special committee, it resorted to financial subterfuge. Chewco borrowed $11.4 million from Barclays Bank in a way that made the loans appear to be equity investments, thus satisfying the 3% rule. In fact, Chewco guaranteed $6.6 million of the loans with a cash reserve, meaning that less than $5 million was truly at risk. As the special committee observed in its report, the $6.6-million collateral “was fatal to Chewco’s compliance with the 3% equity requirement.” The key evidence of its existence was a Dec. 30, 1997, letter from JEDI to Chewco documenting the $6.6-million transfer.
An Enron spokeswoman declined to comment on the Bauer memo, noting the matter had been covered in the special committee’s report. That report noted that many Enron executives involved in Chewco and JEDI, including Kopper, whose signature appears on the transfer letter, “profess no recollection of the Barclays funding.”
The report also said it found evidence that Andersen was aware at least that the transfer had taken place. Bauer’s memo indicates that even if that were so, the auditors did not realize until later that the transfer was collateral for the Barclays loan. Bauer’s memo indicates that Andersen auditors remained unaware of the letter until Nov. 2, when they received it and several other documents from the law firm assisting the special committee.
By then the Enron board was aware of the letter and its implications. On Oct. 26, Bauer reported, he received a call from two Enron executives asking for a clarification of the 3% rule and hinting that Chewco might have failed to meet it.
Only after the special committee’s lawyers provided the letter to the auditors Nov. 2, however, did Bauer and his colleagues understand the scope of the problem. At a meeting with Enron executives that night, the Andersen team hinted they believed the Chewco accounting was flawed. If Enron disagreed, Bauer told them, “we would like to have a discussion as to the basis of their conclusions.”
At a second meeting the next day, Bauer’s memo relates, Andersen laid out several problems with the Chewco accounting, including the investment by Barclays and Kopper. Because Kopper was an Enron employee, Bauer noted, his $125,000 investment could not be counted as part of the 3% threshold.
Several Enron attorneys and executives tried strenuously to assuage auditors’ concerns. They also insisted they never had the Dec. 30, 1997, letter in their possession. Andersen “assisted the group with a search of the documents in the room” and promptly turned it up.
Meanwhile, the Enron team also observed that Koppers’ interest had been transferred to William Dodson. Dodson was Koppers’ domestic partner, but Enron contended that he should be considered an outside investor because Texas law did not recognize same-sex relationships. Bauer found that a dubious argument, noting that the “legal factor” was only one of several factors to be considered.
Before the day was out the Enron team acknowledged the document made a critical difference. Within days, Enron disclosed publicly it had improperly accounted for JEDI and Chewco and dramatically restated its earnings.
