April 30, 2002

As the Enron Inquiry Intensifies, Midlevel Players Face Spotlight

Federal investigators are ratcheting up the pressure on Enron Corp.

In recent weeks, people close to the case say, agents from the Federal Bureau of Investigation have stepped up their interviewing of a group of former and current managers who handled accounting and finance issues at the energy company, which is now in bankruptcy proceedings. Their aim: to squeeze these midlevel players for information that could lead to the indictments of former top brass, including Chairman Kenneth Lay, Chief Executive Jeffrey Skilling and Chief Financial Officer Andrew Fastow.

Although the investigation is still in its early stages, the broad outline of the government's strategy is starting to come into focus. Officials are trying to determine if Enron violated accounting rules when it established several outside ventures to keep debt off the company's books and to hedge against declines in asset values. In addition, authorities are examining whether Enron employees improperly benefited from investments in some of these now-infamous outside ventures at the company's expense.

Justice Department lawyers now believe that two Enron officials, Vice President Rodney Faldyn and senior director Ryan Siurek, are among the midlevel managers who can provide crucial details about some of the outside ventures. People familiar with the matter say the two men are especially important because they have the potential to help prosecutors build a case against Mr. Skilling, who has denied any wrongdoing. Neither Mr. Faldyn nor Mr. Siurek is believed to be a target of the criminal investigation. Their attorney, Michael Levy, declined to comment. Enron's attorney, Robert Bennett, has said the company is cooperating with authorities.

Proving a case against senior Enron executives won't be easy -- even with an army of federal prosecutors and investigators whose ranks have grown so fast that the government has been forced to seek extra office space in Houston. The company's Byzantine financial structure will be difficult to unravel. Another difficulty for prosecutors: Enron executives can point the finger at its auditor Arthur Andersen LLP, which signed off on key transactions. For instance, in early February, Mr. Skilling testified repeatedly at hearings in the Senate and House that he relied on accountants to tell him what was proper. Andersen, which is also the subject of investigations, has denied responsibility.

Here is a look at seven key areas of vulnerability for Enron as prosecutors begin to make their case. It is drawn from interviews with government officials and with current and former Enron executives and lawyers close to the case. It is also drawn from internal company documents, including a report issued in February by a special committee of Enron's board.

The Raptors

Could a felony charge hinge on the difference between the words "on" and "of"?

In the case of four finance vehicles known as the Raptors, it might. The Raptors were set up to hold volatile assets of Enron -- such as high-technology stocks -- as an effort to remove these assets from Enron's balance sheet. But for this arrangement to be legitimate, the Raptors had to be independent from Enron. Under accounting rules, this meant outside investors in the Raptors had to put up equity equal to at least 3% of their total capital. In this case, the so-called outside investor was a private partnership run by Mr. Fastow, Enron's CFO. The partnership provided four different Raptor vehicles with $30 million each.

But every time one of the Raptors received the $30 million, it quickly returned roughly $40 million to the Fastow-led partnership, LJM2 Co-Investment LP. So was this a return on the partnership's investment -- meaning that the Raptor had somehow generated $40 million in profit? Or was this simply a return of the partnership's investment, with $10 million in profit?

If it was the latter, that meant the Fastow-led partnership had essentially already gotten its money back, and therefore no longer had sufficient equity at risk for the Raptors to be considered independent. If they weren't independent, then they should have been included on Enron's balance sheet. In the end, Enron was forced to do this, which hurt the company's earnings.

The payments from the Raptors to the Fastow-led partnership prompted discomfort among some Enron managers. For example, Mr. Faldyn, who worked in Enron's accounting operation, heading a group that at its peak included about 30 people, told special-board investigators that "there were numerous discussions about whether there was sufficient equity at risk" in the Raptors after the Fastow-led partnership had received its payout. Ultimately, according to Mr. Faldyn, Enron consulted with its accountants at Arthur Andersen and decided that it would treat the situation as if the Raptors had not returned the partnership's investment, and therefore were still independent.

But prosecutors could try to use a statement by Mr. Fastow against him. In April 2001, he told his limited partners in LJM2, a group that included giant financial institutions such as Citicorp and J.P. Morgan, that "the return of and return on capital for all four of the Raptor vehicles has already been realized." Therefore, he added in a letter to his investors, LJM2's investment was "not at risk" anymore.

A spokesman for Mr. Fastow declined to comment on the Raptors and all other transactions mentioned in this story. An Andersen spokesman, Patrick Dorton, said: "The Enron board and management hold responsibility for initiating, conceiving and approving these transactions, not the auditors. These deals were structured by Enron employees, their lawyers and investment bankers."

Statements by another executive may also help prosecutors in connection with the Raptors. In May 2000, according to the special board investigation, the directors on Enron's Finance Committee were told by corporate Treasurer Ben Glisan Jr., a Fastow protege, that the maximum LJM2 would receive from its investment in the Raptors was 30% a year. The board approved that level of return. But Mr. Fastow's partnership made many, many times that amount. He told LJM2's investors in October 2000 that returns on the Raptors ranged from more than 150% to nearly 2,500%.

INSIDE THE PROBE Under scrutiny • Enron transactions with related partnerships   Possible key witnesses for prosecutors   • David Duncan, lead Arthur Andersen accountant   • Shirley Hudler, former senior director   • Ryan Siurek, a senior director   • Rodney Faldyn, a vice president in accounting   Department of Justice, Enron task force   • Leslie Caldwell, director   • Andrew Weissmann, special attorney   • Samuel Buell, special attorney

For prosecutors, the disparity could be useful in showing that the Raptors were used to defraud Enron and its shareholders to the advantage of LJM2.

Last December, Mr. Glisan gave federal investigators a proffer, a statement outlining his knowledge that authorities could pursue in exchange for immunity from prosecution or a possible plea-bargain arrangement. But people familiar with the matter say that the government never responded -- a sign that it's still assessing whether to seek Mr. Glisan's cooperation or make him a target of the investigation. Mr. Glisan's attorney, Henry Schuelke, didn't return numerous phone calls seeking comment.

Raptors Restructuring

By early 2001, the underlying investments in the Raptors had deteriorated so severely that a team of Enron executives began working on a major restructuring.

Their gambit was successful -- at least for a time. By shoring up the Raptors with millions of shares of Enron stock, whose value could be used to offset the investment declines, they managed to stave off reporting more than $500 million in losses for about six months.

In his testimony before Congress, Mr. Skilling tried to distance himself from the Raptors restructuring. "I can state here today that I did not have any knowledge that the transaction was designed to conceal losses," Mr. Skilling testified on Feb. 7 before a House subcommittee.

But in their interviews for the special board investigation, Messrs. Faldyn and Siurek suggested that Mr. Skilling knew much more than he has let on, raising the possibility that prosecutors could lodge a perjury charge against him.

Mr. Faldyn said he understood from Richard Causey, Enron's chief accounting officer, that Mr. Skilling had made the restructuring of the Raptors a "top priority."

Mr. Siurek, who came to Enron in 1999 from Arthur Andersen and was put to work on creating the Raptors in early 2000, said that he, too, "has no doubts" that Mr. Skilling knew about the Raptors' troubles. After helping out on the restructuring, he received a call from Mr. Skilling congratulating him. "It was Siurek's understanding that Skilling was the ultimate decision-maker concerning the restructuring," the interview notes with him state.

A spokeswoman for Mr. Skilling declined to comment beyond testimony given before Congress. Mr. Causey's attorney, Reid Weingarten, declined to comment.

As rich a vein as the Raptors may be for prosecutors, they also underscore some of the challenges that the government faces in assembling its case. Much of what Messrs. Siurek and Faldyn say they believe Mr. Skilling knew is based on second-hand information from Mr. Causey. Other potential witnesses from Enron's accounting and legal department, meanwhile, were asked to sign off on narrow aspects of a given transaction, meaning the government might have to call dozens of people to piece together the story.

Chewco

When did top executives find out about a secret loan agreement?

For prosecutors, this is the key question when it comes to Chewco, a venture that Enron helped set up in late 1997 and that was used to keep more than $700 million in debt, related to various energy investments, off its books. To meet this aim, it was essential that Chewco be considered a separate entity from Enron, with outside investors putting up the 3% equity requirement -- just like with the Raptors.

Michael Kopper, an Enron executive who was put in charge of Chewco, raised this money by getting a loan from Barclays PLC, the British bank, for two paper vehicles that he had helped create. Known as Big River LLC and Little River LLC, they were to act as the independent investors in Chewco. But there was a catch: Barclays would only lend the money -- $11.5 million in total -- if an Enron affiliate turned around and deposited more than half that amount into two accounts at Barclays, helping ensure repayment of the loan. The Enron affiliate complied.

The upshot: Enron was secretly backing the loan. Little River and Big River never had enough of their own money truly at risk in Chewco to satisfy the 3% rule. Yet for the next four years, Enron treated Chewco as if it did meet the 3% standard, allowing the company to tamp down its debt and bolster its earnings.

Last October, at a meeting with fellow Enron officials and Andersen accountants, a mid-level company executive named Shirley Hudler pulled the funding-agreement documents for the Barclays accounts from her files, according to interview notes taken by the outside lawyers conducting the special board investigation. The document, dated Dec. 30, 1997, laid bare for all a devastating fact: Enron had wrongly accounted for Chewco for four years -- an arrangement that had led the company to improperly inflate its earnings by some $400 million.

Another Enron employee told the special board investigators that, when Mr. Glisan saw a document about the Barclays accounts, the Enron treasurer, reacted strongly. "We're toast!" Mr. Glisan said, according to this employee.

The employee told the special board that he interpreted Mr. Glisan's response as one of utter surprise. But others at Enron say they believe Mr. Glisan and some of his superiors were aware of the troubling nature of Chewco from the outset. If that's true -- and federal prosecutors can prove it -- the Chewco transaction could trigger charges of securities fraud against the company or individuals or both, lawyers following the investigation say. Related charges of mail or wire fraud are also possible.

One key witness will surely be Ms. Hudler, who handled some transactions involving Chewco. The FBI has expressed its interest in speaking with her, according to people familiar with the situation; Ms. Hudler is considered a potential witness, not a target, these people say. In her interview for the special board investigation, she noted that Mr. Glisan "oversaw the transaction" that had set up Chewco. She added that Mr. Glisan and other Enron executives shouldn't have been "surprised" last fall about the 3% equity violation because the reserve accounts had been "mentioned in the closing binder" four years earlier -- a document that higher-ups typically would have seen.

Kopper Payment

When Chewco was launched in 1997, some Enron executives received a life-size head of the Star Wars character Chewbacca to commemorate the deal. Last year, when Enron decided to buy out Chewco, Mr. Kopper and his domestic partner, William Dodson, received something much more substantial: $12.6 million.

A big question for prosecutors is whether Mr. Fastow, the CFO, also profited circuitously from the Chewco closeout -- and, if so, whether that constituted a breach of his fiduciary duty to Enron.

The size of the payment to Messrs. Kopper and Dodson was a concern to some inside Enron from the time it had first been contemplated a year earlier, in 2000. Then-Treasurer Jeff McMahon, for one, believed a much smaller payment from Enron -- $1 million -- was fair, given that Messrs. Kopper and Dodson had invested only $125,000 in Chewco to begin with, and they already had received hundreds of thousands of dollars in fees over the years.

But Mr. Fastow struck a much more favorable deal for Mr. Kopper -- and a much less favorable one for Enron. In his interview for the special board investigation, Mr. McMahon said that Mr. Fastow told him that he himself had negotiated a $10 million figure with Mr. Kopper, and that "Skilling was okay with buying out Chewco at that price."

Mr. Fastow also saw to it that Messrs. Kopper and Dodson received another $2.6 million to cover their tax bill. One of Enron's senior attorneys, Jordan Mintz, was upset at the notion of forking over this additional sum. He argued that Enron had absolutely no obligation to make such a payment. But Mr. Mintz told the special board investigation that Mr. Fastow, once again, claimed to have called Mr. Skilling and received his approval. The $2.6 million was a go.

Notably, business between Mr. Fastow and Mr. Kopper didn't end with Chewco. Around the same period that Enron bought out Mr. Kopper, he personally acquired Mr. Fastow's position in LJM for an undisclosed sum.

The timing has created suspicions. The lawyers for the special board investigation asked Enron's former general counsel, James Derrick, whether the $12.6 million "was used by Kopper to pay Fastow for his share" of LJM. If the government concludes that this is what happened, Messrs. Fastow and Kopper could be charged with breach of fiduciary duty on the grounds that they intended all along for Enron's money to wind up in Mr. Fastow's pocket.

Mr. Kopper's attorney, Wallace Timmeny, declined to comment. Mr. Dodson couldn't be reached.

Southampton Place

For some at Enron, Southampton Place LP seemed the investment of a lifetime; they plunked down $5,800 each, and a couple of months later $1 million was wired into each of their checking accounts.

But those who made such a killing -- including Mr. Glisan and an Enron lawyer named Kristina Mordaunt -- are now likely to be confronted by federal prosecutors who want to know: Was it all just a fraud to rip off the company?

In early 2000, Mr. Fastow and Mr. Kopper offered a handful of their colleagues at Enron an opportunity to invest in Southampton. Mr. Kopper told Ms. Mordaunt that Southampton was being created to buy out an interest in another limited partnership, LJM Cayman LP, that was initially set up by Mr. Fastow with some outside investors to do a hedging transaction with Enron. In this case, Enron had wanted to avoid losses in the event of a decline in the value of shares it held in a publicly traded Internet service provider called Rhythms NetConnections Inc.

Ms. Mordaunt cut her $5,800 check in March 2000. "The next time she heard about the investment was when Kopper called her in May or June asking for wire transfer instructions," according to the special board investigation. The other $1 million windfall recipient, Mr. Glisan, told the special board investigation that Mr. Fastow was the one who had invited him into Southampton. Meantime, Mr. Fastow's family foundation collected $4.5 million on a $25,000 investment, while Mr. Kopper and two other lower-level employees made unknown sums on Southampton.

In her interview with the special board investigation, Ms. Mordaunt said that she didn't ask any questions about how she reaped such an extraordinary return. The special board report makes it clear that the investigators believe the transaction was done at Enron's expense. Ms. Mordaunt and her attorney didn't return calls seeking comment.

The report states that Enron paid a Southampton-owned entity some $17 million as part of a complex deal to buy back some of its own shares. The entity had come to own the stock through a series of transactions involving Enron and LJM Cayman.

Mr. Fastow signed for Southampton. Mr. Causey, the Enron chief accounting officer, signed for the company. The special board report concludes that Enron in effect overpaid to buy back its own stock, giving a "huge windfall" to Southampton. "It is difficult to understand why Enron's accounting personnel" let the deal proceed, the report says.

In all, it adds, Southampton and the other LJM Cayman investors "walked away with tens of millions of dollars in value that, in an arm's length context, Enron would never have given away."

When lawyers conducting the special board investigation showed Ms. Mordaunt the letter laying out details of the Southampton-Enron deal, she "was visibly shaken and on the verge of tears," according to notes taken during her interview.

Of particular concern to the board investigators was that Mr. Fastow brought Mr. Glisan into Southampton around the same time that Mr. Glisan was negotiating on Enron's behalf with another LJM partnership. On the other side of that deal was none other than Mr. Fastow. Likewise, Ms. Mordaunt represented Enron as a lawyer in at least one transaction with an LJM entity run by Mr. Fastow.

Both Ms. Mordaunt and Mr. Glisan told the special board investigation that they never undermined Enron in favor of LJM -- and never were asked to -- in return for a piece of Southampton. Still, defense lawyers say that they expect the government to lean on some of the Southampton investors, seeing if they can get them to provide damning information on Enron higher-ups in exchange for immunity or a lesser charge.

Braveheart

Of all the creative accounting that Enron engaged in, its treatment of a project called Braveheart stands out.

In mid-2000, Enron joined with Viacom Inc.'s Blockbuster unit to roll out an exciting-sounding new service: Customers across the U.S. would be able to choose from among thousands of movies, including hot new features, sent via telephone lines to their televisions at home.

But the business foundered. At its peak, in March 2001, Braveheart provided only about 1,000 test customers with movies in four U.S. cities -- many of whom didn't even pay. Blockbuster, for its part, never accounted for any financial gain or loss from the venture, which it termed a "pilot project."

Not Enron. Enron claimed $110.9 million in profits from Braveheart in the fourth quarter of 2000 and the first quarter of 2001, a calculation company officials have declined to explain. This was clearly aggressive accounting. Prosecutors want to know if it went so far as to constitute fraud.

Insider Trading

Did Enron executives use inside information to time sales of company stock and put millions of dollars into their pockets?

With that possibility in mind, FBI agents have been asking questions of associates of Army Secretary Thomas White, vice chairman of Enron's energy services unit before he came to the Pentagon. Mr. White sold $3.08 million, or half of his holdings, last October as Enron started to crumble and he was making calls to former colleagues and friends at the company. Mr. White has denied any wrongdoing. "I never sold any stock based on what anyone told me at Enron," he told reporters last month.

Other Enron executives may also face scrutiny. Mr. Lay, the former chairman, sold close to $175 million in Enron stock between 1999 and 2001, according to trading records. Mr. Lay's spokeswoman says he "firmly denies any allegations of wrongdoing including insider trading." He also has denied knowing anything about the underlying financial problems that led to Enron's collapse.

However, if prosecutors can establish that Mr. Lay knew of Enron's financial problems and continued to sell his shares at a time when Enron's stock price was artificially inflated by misleading information disseminated by the company, he could face charges of insider trading. The same thing holds true for several other top Enron executives.

-- John R. Emshwiller contributed to this article.

Write to Kathryn Kranhold at kathryn.kranhold@wsj.com⁶, Rick Wartzman at rick.wartzman@wsj.com⁷ and John R. Wilke at john.wilke@wsj.com⁸

Updated April 30, 2002