That flair led Watkins last summer to conclude there was something rotten at Enron. The numbers didn't add up. A pair of letters that she wrote to Chairman Kenneth Lay exposed top officials--perhaps including Lay himself--who for months had been trying to hide a mountain of debt, and started a chain reaction of events that brought down the company. Watkins' letters, along with thousands of other documents, are now in the hands of congressional and criminal investigators who are probing how Enron, its pet-rock auditors at Andersen and a host of other supporting actors allowed the country's seventh largest company to suddenly go bankrupt in December. "I am incredibly nervous that we will implode in a wave of accounting scandals," Watkins wrote of Enron's financial health. "I have heard one manager-level employee from the principal investments group say, 'I know it would be devastating to all of us, but I wish we would get caught. We're such a crooked company.'"
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Maybe you can only glimpse the soul of a company when it breaks open right before your eyes. But we know now, thanks to Watkins, that Enron hid billions of dollars in debts and operating losses inside private partnerships and dizzyingly complex accounting schemes that were intended to pump up the buzz about the company and support its inflated stock price. We also learned last week that executives at Andersen, the accounting giant that enabled Enron's every move, fretted about the arrangement but saw the chance to double their fees if they just kept their heads down. And now that the party's over and the damage control is in full swing from Houston to Chicago to Washington, just about everyone who helped create this mess is busy pointing fingers, scapegoating the other guys, firing the lower-downs and diming out the higher-ups. Last week what was once envisioned as a new kind of company resembled little more than a circular firing squad of executives, accountants, consultants and lawyers, all fighting to stay in business or, at least, out of jail.
As these characters tell their self-serving stories, the fall of Enron is the most revealing sort of failure. It is a failure of the old-fashioned idea that auditors, directors and stock analysts are supposed to put the interests of shareholders above their own thirst for fees. It is a failure of government: having greased nearly every campaigner's palm in Washington, Enron worked overtime to keep the regulators from looking too closely at a balance sheet gone bad. And it is a failure of character, especially inside Enron, where managers who knew something was badly wrong did not say anything publicly until the subpoenas began to arrive.
About the only thing that didn't fail was Sherron Watkins' flair for numbers. In the sad tale of Enron's collapse, Watkins is the closest thing to a hero in sight. When she goes out for coffee, strangers stop to give her "attagirls" and ask for her autograph. She still goes to work each day at the company's headquarters in downtown Houston, where the tilted logo out front has yielded Enron a new nickname: the Crooked E.
Normally when public companies flame out in scandal, top executives can be seen running from headquarters mumbling that they are shocked to learn that there was gambling going on in the casino. But there's not much of that here. Enron and Andersen officials hardly deny the dubious deals, the 881 offshore tax havens or the stupid accounting tricks. That's partly because nobody can be sure that those dodges were inherently illegal. Many companies maintain similar arrangements, usually intended to avoid taxes--a benefit of interest to Enron too.
Enron avoided paying federal income tax for four out of the last five years and instead received millions of dollars in federal-tax refunds. For now, the House Energy and Commerce Committee and federal agents probing Enron's fall are skipping over the accounting schemes and other questionable business practices--including a bizarre sex angle: a scheme to offer pornography via the Internet. The investigators instead have zeroed in on what officials from Enron and Andersen did and did not do once they realized that the debts were mounting, that the stock price was falling and that the last people to learn of the looming reckoning were going to be millions of Enron shareholders. Watkins' two letters provide the road map for their inquiry.
It took Watkins weeks to work up the nerve to write her first letter to Lay. She had been working for chief financial officer Andrew Fastow last summer, looking for assets to sell as Enron ran into financial trouble while transforming itself into a company that traded energy, water, weather derivatives and anything else it could turn into a commodity. Watkins wanted to help, but everywhere she looked she ran into off-the-books arrangements that no one could explain or seemed to want to investigate. She knew that others who had pressed then ceo Jeffrey Skilling about the investments had run into trouble. One of her friends, then company treasurer Jeff McMahon, had been transferred when he "complained mightily" to Skilling about the "veil of secrecy" surrounding the outside deals.
Watkins learned Enron was losing money on two equity investments: network-equipment supplier Avici lost 98% of its value, and another, New Power, an energy retailer that had Ken Lay on the board, dropped more than 80%. Because both firms were backed by Enron stock, Watkins knew their downfall was dragging down Enron too. None of that was being reflected in the company's public filings, as far as she could tell. As her lawyer Philip Hilder explains, "The numbers just didn't add up."
Already known as outspoken, Watkins didn't want to approach Skilling directly for fear of losing her job, Hilder says. "She thought it would be fruitless while he was there." When Skilling suddenly quit on Aug. 14, Lay called an all-employees meeting two days later and asked for comments from workers beforehand. That's when Watkins finally sat down to write a one-page anonymous letter on her computer at work. She dropped it in the box at headquarters the next day.
The letter laid out what many executives knew but no one had the courage to say. Watkins homed in on two sets of transactions called Condor and Raptor (Enron had a penchant for names inspired by Jurassic Park and Star Wars) and argued that the accounting treatment was unsound, if not dishonest. Enron had booked huge profits from these entities while its stock price soared in 2000, despite the fact that neither Condor nor Raptor had any hard assets. But now that Enron's price was dropping, the company had to note these devaluations or pour more money into the companies when cash was short. "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."
But what gave the brief letter its power was its overwhelming sense of doom. "Skilling is resigning now for 'personal 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 two years."
At the Aug. 16 companywide meeting, Lay invited anyone troubled by Skilling's departure to meet with him. Four days later Watkins called a friend at Andersen and asked for advice. On Aug. 21 the friend drafted a memo detailing Watkins' concerns for Andersen auditors on the Enron account. Meanwhile, Watkins went to Lay seeking a meeting. The next day she met with the chairman.
The session was businesslike, and Lay seemed genuinely concerned. Watkins brought along a six-page letter detailing her worries, and Lay promised to have a team of lawyers review the controversial deals. But he decided to use Enron's law firm, Vinson & Elkins, despite Watkins' unease about a conflict of interest. Vinson & Elkins had been paid for work on Condor and Raptor transactions. But Lay went ahead with the review--whose scope he kept strictly limited.
By then, Lay was in the middle of a personal stock sell-off. On Aug. 20 he exercised options to buy 25,000 shares at $20.78 a share. The next day he exercised an additional 68,000 shares at $21.56. On both days, the stock closed around $36, which meant Lay netted nearly $1.5 million before taxes. He continued to be a huge booster for the stock for another month. As late as Sept. 26, Lay would try to reassure Enron employees that "our financial liquidity has never been stronger." But as the stock fell last fall, company employees were told that they would be unable to move any assets held in Enron stock into other securities in their 401(k) plan while the company switched plan administrators.
The end was near. On Oct. 15 Vinson & Elkins issued a nine-page report stating that Andersen approved of the Condor and Raptor deals and that Enron had done nothing wrong. On Oct. 16 the company announced a $618 million third-quarter loss and a $1.2 billion reduction in shareholder equity. On Oct. 31 the sec opened a formal inquiry into Enron. Last week, a Vinson & Elkins spokesman said the law firm was "not in a position to talk about our engagement with Enron or any other client."
Enron too said as little as possible last week as the company tried to reorganize itself and as Lay and other top executives tried to fend off lawsuits filed by angry employees and other investors. The law makes it extremely difficult to confiscate the personal assets of corporate officers in punishment for actions on behalf of the company, but if there were ever a chairman who courted that fate, it is Lay. Last week he put three properties in Aspen up for sale, for $16 million, and huddled with his lawyers in preparation for congressional hearings next month. Few in business have ever fallen so far so fast: the man who once could raise Cabinet officials with a single telephone call and rated the only one-on-one meeting with the Vice President on energy policy last year can't show his face in Houston for fear of reprisals.
While Enron suffered in silence last week, Andersen was tripping over its own attempts at damage control. Andersen has the most to gain by coming clean because if it doesn't, it stands to lose a lot of business. So with help from an army of just-hired p.r. agents, the Chicago company worked overtime to show that in its work for Enron, it was merely trying to serve a secretive and aggressive client who was pushing the envelope on accounting rules that aren't very clear anyway. Last week, two days after Time reported that Andersen ordered the destruction of documents in October, the company sent ceo Joe Berardino out in public to strike a contrite tone. Andersen placed three auditors in its Houston office on leave and took out full-page ads in the newspapers promising to "deal with these issues, candidly and directly ... Without question, this is the most difficult and challenging episode in our firm's history."
And it abruptly fired David Duncan, who managed the Enron account in Houston, saying he had "without any consultation with others in the firm" organized the destruction of documents as Enron's losses mounted in October. Seeking to put as much distance as possible between the home office and a wayward Houston branch, the company pointed out that all shredding had ceased once the sec issued a subpoena in the Enron matter. As a former Andersen partner in Chicago told Time, "The issue of document deletion is entirely dependent on when the organization was aware that there might be a liability issue. Liability begins once there is knowledge."
Which explains why things got worse--much worse--for Andersen a few days later, when it was revealed that officials at the company's headquarters in Chicago had discussed the questionable Enron accounting very early in the game--in a conference call last Feb. 5. Enron was no longer a problem that Andersen's Houston office had kept to itself. Nor were the top Andersen officials worrying about the actions of some low-level, rogue Enron trader back on Feb. 5. What concerned the auditors that morning was how to account for losses piling up in an off-the-books partnership between the company and a firm called LJM. The manager of LJM was none other than Enron's chief financial officer, Fastow. Putting aside the Texas-size conflict of interest for Fastow--whose day job involved vouching for Enron's financial health--Andersen knew that Enron's debts to LJM were rising to a level that required public disclosure no matter who was in charge. Such a disclosure would have sent Enron's stock into a dive. But no disclosure was made in the company's next quarterly report. Why not? One memo of the Feb. 5 conference call noted that Enron "often is creating industries and markets and transactions for which there are no specific rules."
And yet Andersen's understanding of Enron's strange business practices was extensive enough that Andersen executives, during the same conference call, contemplated dropping Enron as a client. That would have been a kick in the teeth for the auditing firm: Enron was paying Andersen some $50 million a year in auditing and "consulting" fees--and officials said in the conference call that they envisioned billings doubling in the coming years. Ultimately, Andersen decided to stick with Enron because, according to an e-mail record of the call, "we had the appropriate people and processes in place to serve Enron and manage our engagement risks." That engagement ended late last week when, in a largely symbolic move, Enron fired Andersen instead.
In Washington, of course, the politicians weren't just firing Enron and Andersen; they were plucking them from their Rolodexes and sending back their gifts. Lawmakers of both parties--led by those in close contests this November--scrambled to give back hundreds of thousands of dollars in campaign contributions Enron employees had sprinkled across the political landscape last year. Just for good measure, lawmakers have launched seven separate Enron probes.
The Republican White House, which received the vast majority of the Enron money, struck an unbothered pose, relieved that neither Treasury Secretary Paul O'Neill nor Commerce Secretary Don Evans had lifted a finger when Enron came calling for help last fall. Still, the Bush team made one tiny bow to the explosive potential of the Enron scandal, hinting for the first time that it might fork over the details of Vice President Cheney's closed-door meetings with energy-industry officials last spring if a congressional committee requested them. Bush spokesman Dan Bartlett predicted that those papers, if released, would provide no evidence of a smoking quid pro quo between the Administration and Enron. "News flash," dry-quipped Bartlett. "We want to increase domestic natural-gas production. Tell me what Democrat doesn't."
If anyone was having trouble making Enron go away, it was Harvey Pitt, a lawyer who represented the Big Five accounting firms before Bush named him to chair the Securities and Exchange Commission last year. Until the Enron scandal broke, Pitt had waved away demands for stronger regulation of corporate accounting and auditing. There were calls from lawmakers for Pitt to recuse himself from the sec probe of Enron, but Pitt refused--after a fashion, anyway--saying that such a step would hurt the agency's standing. He added, however, that director of enforcement Stephen Cutler would run the probe anyway. Bush last month named two other accounting executives to empty seats on the sec: Paul Atkins, a partner with Pricewaterhouse Coopers, and Cynthia Glassman of Ernst & Young. These rookies, like Pitt, face a rough season. "There could be other Enron-like situations out there," says Arthur Levitt, the activist former sec chairman. "Financial legerdemain from seduced audit committees, compromised accountants and inadequate standards could certainly crop up again at other U.S. companies." At the moment, the public's best protection against that sort of surprise is other brave whistle-blowers like Sherron Watkins.