Accounting for Enron need now

.as held regarding the related party transac- ions with LJM" (one of Enron's Special Pur- pose Entities). Apparently, several Andersen auditors thought that LJM costs should not be ept off of Enrorr's books. Jones goes on to

say, "The discussion focused on Fastow's con- .cts of in terest in his capacity as CFO and the

:"JM manager, the amount of earnings that Fastow receives for his services and participa- tion in LJM, the disclosures of the transaction in the financial footnotes, and Enrori's BOD's ~oard of Directors] viewsregarding the trans- actions." Enron's activities were described as "intelligent gambling," and Andersen's audi- ors acknowledged "Enrori's reliance on its current credit rating to maintain itself," its "de- pendence" on a supporting audit to meet its fi- nancial objectives, and "the fact that Enron often is creating industries and markets and transactions for which there are no specific rules [and therefore] which requires signifi- cant judgment." Enron was also described as "aggressive" in the way it structured its finan- cial statements.

But the risks of Enron were not the only is- sues discussed at that meeting. Andersen's au- ditors realized that Andersen was also doing significant consulting business with Enron, business that could be jeopardized by an un- favorable audit. "We discussed whether there vould be a perceived independence issue solely considering our level of fees. We dis- cussed that the concerns should not be on the magnitude of the fees but in the nature of the fees. We discussed that it would not be unforeseeable that fees could reach $100 million per year. Such amounts did not trou- ble the participants as long as the- nature of me services was not an issue." In the end, Andersen decided that the risks were worth laking. "Ultimately the conclusion was reached to retain Enron as a client citing that it ap- peared that we had the appropriate people and processes in place to serve Enron and manage our risks."

Ethical Issues in Finance and Accounting 411

Less than a year later, Enrori's third-quarter financial report would reflect Andersen's new and different judgment concerning the SPEs. On October 16,Enron reported a quarterly loss of$618 million and announced mat as a result of Andersen's auditing decisions, they would take a $1.2 billion reduction in shareholder eq- uity.Within one week, the SEC announced that it had opened an investigation into Enron's ac- counting practices. By the end of October, Enron's stock was trading atjust $10 per share, an almost a 90% drop in 18 months.

It is fair to say that Andersen overestimated their ability to manage the risks of Enron. Several decisions made by Andersen's profes- sional staff during October proved to be dis- astrous for the company. On October 12, as Andersen prepared for the public release of the new financial statements, Andersen attor- ney Nancy Temple advised head auditor David Duncan to get "in compliance" with Andersen's document retention policy. Be- cause Andersen's document retention policy included directions to destroy documents that were no longer needed, Duncan inter- preted that advice to mean that he should have Enron-related documents destroyed. Duncan then instructed Andersen employ- ees to shred Enron documents. Duncan has acknowledged that he and others at Andersen were aware of a possible SEC investigation at me time.

Four days later, on October 16, Duncan shared a draft of a press release on Enron with Temple. In her role as Andersen attor- ney, Temple advised changing the press re- lease to delete some language that might suggest that Andersen's audit was not in com- pliance with Generally Accepted Accounting Principles (GAAP), as well as certain refer- ences to discussions within Andersen's legal group concerning Enron. Temple concluded her e-mail by promising to "consult further within the legal group as to whether we should do anything more to protect ourselves

412 Ethical Issues in Finance and Accounting

from potential Section 10 issues" (Section 10 refers to SEC rules that require auditors to report illicit client activity). In early Novem- ber, two weeks after they began shredding documents, Andersen received a federal sub- poena for documents related to Enron. Only at this point did Temple advise Andersen to write a memo advising auditors at Andersen to "keep everything, do not destroy anything." By the end of November, the SEC investiga- tion was officially expanded to include Arthur Andersen.

At one time, Sherron Watkins was an Arthur Andersen auditor who worked on the Enron account. In 1993, she left Andersen to join Enron, working for Andrew Fastow in Enron's finance, international, broadband, and finally, its corporate development divi- sion. Thus, for 18 years she participated in a wide range of Enron's business activities. In August 2001, shortly after Jeffrey Skilling re- signed as Enron's CEO, she wrote a memo to Kenneth Lay.Watkins became widely known as the Enron whistle-blower as a result ofthis memo, despite the fact that she had not ex- pressed concerns earlier and she did not share her concerns with anyone outside of the company. In part, her memo to Lay reads as follows:

Has Enron become a risky place to work? For those of us who didn't get rich over the last few years, can we afford to stay?

Skilling's abrupt departure will raise suspi- cions of accounting improprieties and valuation issues. Enron has been very aggressive in its accounting-most notably the Raptor transac- tions and the Condor vehicle. We do have valu- ation issues with our international assets and possibly some of our EES MTM positions.

The spotlight will be on us, the market just can't accept that Skilling is leaving his dream job. I think that the valuation issues can be fixed and reported with other good willwrite-downs to occur in 2002. How do we fix the Raptor and Condor deals? They unwind in 2002 and 2003, we will have to pony up Enron stock and that won't go unnoticed ....

It sure looks to the layman on the street that we are hiding losses in a related company and will compensate that company with Enron stock in the future. I am incredibly nervous that we will implode in a wave of accounting scandals. My 8 years of Enron work history will be worth nothing on my resume, the business world will consider the past successes as nothing but an elaborate ac- counting hoax. Skilling is resigning now for "per- sonal reasons" but I would think he wasn't having fun, looked down the road and knew this stuff was unfixable and would rather abandon ship now than resign in shame in 2 years ....

Is there a way our accounting gurus can un- wind these deals now? I have thought and thought about a way to do this, but I keep bump- ing into one big problem-we booked the Con- dor and Raptor deals in 1999 and 2000, we enjoyed wonderfully high stock price, many ex- ecutives sold stock, we then try and reverse or fIx the deals in 2001, and it's a bit like robbing the bank in one year and trying to pay it back two years later. Nice try, but investors were hurt, they bought at $70 and $80 a share looking for $120 a share and now they're at $38 or worse. We are under too much scrutiny and there are proba- bly one or two disgruntled "redeployed" em- ployees who know enough about the "funny" accounting to get us in trouble. What do we do? I know this question cannot be addressed in the all-employee meeting, but can you give some assurances that you and Causey will sit down and take a good hard objective look at what is going to happen to Condor and Raptor in 2002 and 2003? ..

I realize that we have had a lot of smart peo- ple looking at this and a lot of accountants in- cluding AA & Co. have blessed the accounting treatment. None of that will protect Enron if these transactions are ever disclosed in the bright light of day. (Please review the late 90s problems of Waste Management where AA paid $130 mil- lion plus in litigation re questionable accounting practices.) ...

I firmly believe that executive management of the company must have a clear and precise knowledge of these transactions and they must have the transactions reviewed by objective ex- perts in the fields of securities law and account- ing. I believe Ken Lay deserves the right to judge for himself what he believes the probabilities of discovery to be and the estimated damages to the company from those discoveries and decide one of two courses of action: