1 107th Congress "!S. PRT. 2d Session COMMITTEE PRINT 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 JULY 8, 2002 U.S. GOVERNMENT PRINTING OFFICE 80–393 PDF WASHINGTON : 2002 For sale by the Superintendent of Documents, U.S. Government Printing Office Internet: bookstore.gpo.gov Phone: toll free (866) 512–1800; DC area (202) 512–1800 Fax: (202) 512–2250 Mail: Stop SSOP, Washington, DC 20402–0001 VerDate 11-MAY-2000 12:07 Sep 12, 2002 Jkt 000000 PO 00000 Frm 00001 Fmt 5012 Sfmt 5012 80393.TXT SAFFAIRS PsN: SAFFAIRS 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 (II) VerDate 11-MAY-2000 12:07 Sep 12, 2002 Jkt 000000 PO 00000 Frm 00002 Fmt 5904 Sfmt 5904 80393.TXT SAFFAIRS PsN: SAFFAIRS 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 (III) VerDate 11-MAY-2000 12:07 Sep 12, 2002 Jkt 000000 PO 00000 Frm 00003 Fmt 5904 Sfmt 5904 80393.TXT SAFFAIRS PsN: SAFFAIRS VerDate 11-MAY-2000 12:07 Sep 12, 2002 Jkt 000000 PO 00000 Frm 00004 Fmt 5904 Sfmt 5904 80393.TXT SAFFAIRS PsN: SAFFAIRS THE ROLE OF THE BOARD OF DIRECTORS IN ENRON’S COLLAPSE SUBCOMMITTEE INVESTIGATION On December 2, 2001, Enron Corporation, then the seventh larg- est publicly traded corporation in the United States, declared bank- ruptcy. 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. Thou- sands 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 Sub- committee would conduct an in-depth investigation into the col- lapse of the Enron Corporation. The following month the Sub- committee issued over 50 subpoenas to Enron Board members, Enron officers, the Enron Corporation, and the Andersen account- ing firm. Over the next few months, additional subpoenas and document requests were directed to other accounting firms and fi- nancial institutions. By May 2002, the Subcommittee staff had re- viewed over 350 boxes of documents, including the available meet- ing 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 Bu- reau of Investigation, or the Securities and Exchange Commission. These lengthy interviews, lasting between 3 and 8 hours, were con- ducted 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. Le- Maistre, Dr. John Mendelsohn, Paulo Ferraz Pereira, Frank Sav- age, Lord John Wakeham, Charls Walker, and Herbert S. Winokur, Jr. All Board members appeared voluntarily, and all were rep- resented by the same legal counsel. (1) VerDate 11-MAY-2000 12:07 Sep 12, 2002 Jkt 000000 PO 00000 Frm 00005 Fmt 6633 Sfmt 6633 80393.TXT SAFFAIRS PsN: SAFFAIRS 2 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 bank- ruptcy. Two panels of witnesses testified under oath. The first panel consisted of five past and present Enron Board members, in- cluding 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 Cor- ning; John H. Duncan (1985–2001), former Chairman of the Enron Executive Committee, has extensive corporate and Board experience,