February 5, 2002   (also see Robert A. Belfer)

Legal Liability in Enron Fiasco May Depend on Two-Page Memo

Legal liability in the Enron Corp. debacle could depend, in part, on who knew about an innocuous-looking, two-page memorandum dated Dec. 30, 1997, involving one of the now-controversial outside partnerships run by company executives.

Enron's collapse into bankruptcy proceedings late last year, caused in large part by the existence of those partnerships, is now the focus of congressional hearings and criminal and civil investigations. The company's downfall also has subjected the nation's corporate-accounting practices to unprecedented scrutiny.

The memo was signed by two Enron executives at the time, Jeremy Blachman and Michael Kopper. It included plans for how to distribute about $6.6 million from one limited partnership, known as JEDI, to another limited partnership, known as Chewco Investments. Chewco has received widespread attention recently as one of the partnerships whose questionable accounting treatment helped bring Enron down. Chewco was run and partly owned by Mr. Kopper, who resigned last year as a managing director of the Houston energy-trading giant.

The memo shows Mr. Blachman was signing on behalf of an Enron unit that was serving as general partner of JEDI, and Mr. Kopper was signing on behalf of Chewco. The memo was on JEDI letterhead and addressed to Chewco Investments.

The final destination and purpose of these funds has become the center of a controversy between Enron and its longtime auditor Arthur Andersen LLP, as well as a focus of inquiries by federal investigators probing the Enron collapse. Late last year, Enron and Andersen officials said their discovery of the use of that money in relation to Chewco had required Enron to retroactively reduce reported earnings back to 1997 by nearly $400 million, or more than 10%. This reduction produced the lion's share of a broader financial restatement that helped force Enron to seek bankruptcy-court protection on Dec. 2.

In Dec. 12 congressional testimony, Andersen's chief executive, Joseph Berardino, said the 1997 handling of the Chewco/JEDI financial arrangements involved "possible illegal acts." He said that in 1997, crucial information about the financial arrangements had been withheld from Andersen by Enron officials.

Monday, an attorney for Mr. Kopper declined to comment. Mr. Blachman, who is currently a managing director at an Enron unit, didn't return phone calls seeking comment. It isn't clear whether Mr. Blachman played anything more than just a minor role in the Chewco matter. A report issued over the weekend by Enron's board of directors investigating Enron's executive-run partnerships indicates that Mr. Blachman, when interviewed recently, couldn't recall details of the Dec. 30 document.

Mr. Berardino's testimony added to questions of who knew what and when in regard to Chewco. The partnership was created in 1997 to purchase from Enron for $383 million an interest in JEDI, which is an acronym for Joint Energy Development Investments. Enron had helped form JEDI in 1993 and operated it as a separate entity to invest in energy projects. By selling Chewco an interest, Enron was able to keep treating JEDI as independent, which meant keeping more than $700 million in JEDI-related debt off Enron's balance sheet.

Enron was only able to do this transaction because Chewco was considered an independent entity under accounting rules, which required that the entity have outside equity equal to at least $11.5 million, or 3%, of its $383 million in assets. Andersen has acknowledged that it reviewed Chewco in 1997 and found that two small limited liability companies, known as Big River Funding and Little River Funding, had put in enough outside equity to meet that requirement. Mr. Kopper, besides his connection to Chewco, also shows up as signatory for Big River and Little River on its bank-loan documents.

As it turned out, however, more than half the outside equity investment was in effect guaranteed by the $6.6 million due from JEDI to Chewco being deposited in accounts as collateral against bank loans, which Big River and Little River had taken out to invest in Chewco. This collateral deposit meant Chewco never had enough true outside equity to be treated as independent. Thus it should have been folded into Enron, along with JEDI, in 1997. Andersen has said it wasn't told in 1997 about the collateral arrangement.

The 1997 memo talks of sending the $6.6 million to reserve accounts on behalf of Little River and Big River. Monday, an Andersen spokesman said "this is more confirmation of the fact that Enron didn't provide critical information regarding Chewco to Andersen." An Enron spokesman declined to comment. One person familiar with the matter said that in 1997 Enron officials were telling bankers involved in the Chewco-related loans that Andersen had reviewed and approved of the now-suspect collateral transaction. The board report released over the weekend said that Andersen work papers indicated that the accounting firm had access to cash-flow records from JEDI including the now-suspect $6.6 million distribution. However, the report added, it didn't know if Andersen had done anything to trace the disbursements from JEDI.

And it still isn't known who at Enron or Andersen saw or had access to this 1997 memo over the past four years. If individuals knew about the arrangement and its potential financial impact on Enron, they could be guilty of violations of the law, says one federal investigator looking into the matter.

A Nov. 2, 2001, memorandum prepared by an Andersen official said that the accounting firm was called on Oct. 26 by an Enron official named Rodney Faldyn who "advised that he had learned that Chewco may not have the requisite equity" and asked about the possible accounting impact of that situation. That was the same day that The Wall Street Journal disclosed the existence of Chewco and its connection to Mr. Kopper. Mr. Faldyn declined to comment Monday.

Over the next several days, Enron and Andersen began reviewing Chewco, according to the Andersen memo. On Nov. 2, Andersen received a set of Chewco-related documents from the law firm of Wilmer, Cutler & Pickering, which had just been hired to help Enron's board of directors do its investigation of the partnership arrangements. That investigative report, released over the weekend, was extremely critical of Chewco and similar partnerships as well as of top Enron officials.

The Dec. 30, 1997, memo was part of the Wilmer Cutler packet of documents, said the Andersen memo. It isn't clear where the law firm obtained the Chewco-related documents. William McLucas, the firm's lead attorney on the Enron investigation, couldn't be reached for comment Monday.

Write to John R. Emshwiller at john.emshwiller@wsj.com²

Updated February 5, 2002 12:15 p.m. EST