Memo: Enron Lied to Auditor

LOS ANGELES -- Enron officials withheld several crucial financial documents from auditors at Andersen for four years, misleading the accounting firm into approving inaccurate financial reports, according to an internal Andersen memo.

Soon after the auditors discovered the documents, the memo says, they advised Enron that it would have to restate its earnings from 1997 through 2001.

Even after Andersen officials learned the contents of the documents, Enron attorneys made a last-ditch attempt in meetings with their auditors to head off the inevitable financial reckoning.

The restatement, announced Nov. 8, reduced the company's reported earnings over the period by more than $500 million -- a step that led ultimately to the energy company's Chapter 11 bankruptcy filing Dec. 2.

The memo, written last Nov. 2 by Thomas 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 a desperate attempt to minimize their significance.

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.

Bauer is scheduled to testify Thursday before the U.S. House Commerce Committee.

"He's cooperating with the committee, he's met with the committee," said his attorney, Scott Schreiber of the Washington law firm Arnold & Porter. Schreiber said Bauer, who remains an Andersen partner but has been placed on administrative leave, would read a written statement and answer questions at Thursday's hearing.

Former Enron president and chief executive officer Jeffrey Skilling was also scheduled to appear Thursday before a House committee.

JEDI, or Joint Energy Development Investments, was formed in 1993 as a $500 million joint venture between Enron and the California Public Employee Retirement System, or Calpers.

JEDI was treated as an unconsolidated subsidiary of Enron, meaning that its assets and liabilities were not reported as part of Enron's financial results. This was a boon to Enron, for it meant that debt JEDI incurred on Enron's behalf stayed off the Enron books, allowing the company to maintain a higher credit rating than it might otherwise have deserved. JEDI's earnings, however, were reported in Enron's results, making them look better than they were.

In late 1997, when Calpers sought to withdraw from the partnership, Enron formed Chewco to purchase the Calpers interest. The entity was placed under the management of Michael Kopper, an Enron employee reporting to Andrew 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 percent 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. Moreover, 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's report, it resorted to financial subterfuge. Chewco borrowed $11.4 million from Barclays Bank in a way that made the loans appear, on the surface, to be equity investments, thus satisfying the 3 percent 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 percent equity requirement." The key evidence of its existence was a Dec. 30, 1997 letter from JEDI to Chewco setting forth its terms.

Bauer's memo indicates that Andersen auditors remained unaware of the letter until Nov. 2.

By then the Enron board had itself become 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 percent rule and hinting that Chewco might have failed to meet it.

Only after the special committee's lawyers provided the letter to the auditors on Nov. 2, however, did Bauer and his colleagues understand the scope of the problem. At a meeting with Enron officials that night, the Andersen team hinted that they believed the Chewco accounting was flawed.

At a second meeting the next day, Bauer's memo relates, Andersen laid out several problems with the Chewco accounting.

Before the day was out, the Enron team reluctantly acknowledged the problem. Within days, Enron disclosed publicly that it had improperly accounted for the JEDI and Chewco subsidiaries and dramatically restated its earnings.