More than one Enron official warned company about growing crisis

One staff lawyer grew so worried, he secretly hired an outside law firm to review the company's murky business partnerships. Another executive was reassigned after raising alarms.

Published January 18, 2002 8:41PM (EST)

In recent weeks, Enron executives have insisted that their controversial -- and ultimately disastrous -- accounting strategies were legally vetted. But Salon has learned that a law firm hired secretly by one of Enron's own attorneys last year recommended that the huge energy trader stop setting up the financial instruments whose exposure later drove the company into bankruptcy.

At the heart of the Enron scandal are a series of complex partnerships that Enron employed to keep billions of dollars of debt off its books -- thus boosting both its quarterly profits and its credit level. Enron executives participated in these partnerships, earning millions of dollars in management fees and raising major conflict-of-interest issues.

Embattled Enron CEO Ken Lay has attempted to justify the partnerships by noting that Enron's own staff attorneys as well as those at Vinson & Elkins, its powerful outside law firm, signed off on them. Despite this legal advice, it was reported earlier this week that one Enron executive, Sherron S. Watkins, raised serious questions about the propriety of the partnerships in a memo sent to Lay in late August. Salon has now learned of two other major instances in which Enron executives were told by company colleagues that the partnerships were deeply troubling and possibly illegal.

In one case, an Enron staff attorney took the extraordinarily unusual step of secretly retaining another outside law firm to evaluate the legality of the partnerships set up by then-chief financial officer Andrew Fastow.

Last summer, before Enron was forced to reveal the actual state of its finances, Fastow moved to set up more of these partnerships. But Fastow's plan was blocked when an Enron attorney named Jordan Mintz took matters into his own hands. According to sources inside Enron, Mintz, who had just moved from the company's tax department to its finance department, was so concerned about the questionable nature of the partnerships -- and apparently so worried that Enron's attorneys were too close to the business schemes to judge them correctly -- that he sought a second legal opinion.

Without the knowledge of his boss, Enron chief counsel James Derrick Jr., Mintz hired an outside firm far removed from Enron and its Houston-based firm, Vinson & Elkins, to take a fresh look at the questionable deals. After reviewing the partnerships, the respected New York firm hired by Mintz -- Fried Frank Harris Shriver & Jacobson -- recommended to him that Enron stop setting up the shell partnerships. The New York firm's opinion prompted Mintz to write internal memos to company executives urging Enron to halt the practice -- which they apparently did. In October, Enron fired Fastow. Last month, he hired celebrated attorney David Boies, who represented Vice President Al Gore during his Florida recount battles.

Contacted Wednesday night, Mintz declined to comment, citing attorney-client privilege. When asked about the Mintz retention of outside counsel, Mark Palmer, an Enron spokesman, said "this is the first I've heard of that" and declined to comment further. A spokesman for Fried Frank did not return a call for comment.

Without specifically confirming the Mintz episode, House Energy & Commerce Committee spokesman Ken Johnson said that worried Enron executives did go outside the company for legal advice: "(This) happened in a couple instances. There was more than one person who was spooked by these partnerships."

It is unusual for a corporate lawyer to go behind the back of his boss, the chief counsel, and retain an outside firm to do work for a company. And it was against standard operating procedure at Enron, where chief counsel Derrick had to approve of any outside legal work. But Mintz apparently thought that Derrick, who had worked at Vinson & Elkins before joining Enron, was too much a part of the company's closed culture, in which dubious business practices had become the norm.

No less than 10 congressional committees are investigating the collapse of Enron, an energy trading company with close ties to politicians in general and the Bush administration in particular. On Wednesday the Senate Finance Committee joined the ranks of nine other House and Senate bodies -- as well as the Departments of Labor and Justice, the Securities and Exchange Commission and the Internal Revenue Service -- by announcing that it, too, would look into the largest bankruptcy in American history.

On Wednesday, investigators with the House Energy & Commerce Committee interviewed David Duncan, the former Enron auditor with Arthur Andersen who had been fired the day before.

One of the primary questions under investigation is why Fastow and other Enron executives were permitted to establish complex and secretive partnerships with odd, obscure names -- LJM1, LJM2, JEDI, Chewco, the Raptor entities, Osprey, Big Doe -- that allegedly reaped these partners windfall profits while hiding Enron debt. In November, Enron had to revise its finance statements for the past four and a half years, acknowledging that the company was $600 million in net income poorer than it had led the government and its investors to believe. The Houston company also had to acknowledge an additional $2.5 billion in debt -- much of which came from these murky "partnerships." Recent revelations tied to the Watkins memo may result in billions more debt added to the Enron ledger.

"Someone should have stepped up and said, 'No, you can't do these sort of things!'" said a knowledgeable former Enron employee. But for too long no one did, the employee added. And then when someone finally spoke up, it was too late.

Currently, much is being made in the media of Watkins' August letter to CEO Kenneth Lay, released on Tuesday by investigators with the House Energy and Commerce Committee. "I am incredibly nervous that we will implode in a wave of accounting scandals," Watkins wrote. "The business world will consider the past successes as nothing but an elaborate accounting hoax."

But Watkins' letter, said one source, was not the only alarm being sounded within the company before it imploded. In addition to the flags raised by Watkins and Mintz, then-treasurer Jeff McMahon also aired his own growing concern. In her memo, Watkins alluded to McMahon's tribulation, writing that he "was highly vexed over the inherent conflicts of [the] LJM [partnership]. He complained mightily to [chief executive] Jeff Skilling and laid out five steps he thought should be taken if he was to remain as treasurer. Three days later, Skilling offered him the CEO spot at Enron Industrial Markets and never addressed the five steps with him."

In the eyes of many Enron executives at the time, McMahon's new assignment was meant to silence him. McMahon "learned about these partnerships and he thought they were wrong," said a knowledgeable former Enron employee. "He thought they were a huge conflict of interest." McMahon, according to this source, went to Skilling and said, "'We have this problem, and I think there's a conflict.' Skilling says, 'I'll take a look at it; I'll take care of it.' And the next thing you know, he's reassigned. And it was not a promotion." To other executives it looked like retaliation against a whistleblower, an Enron source said.

McMahon "did go to Jeff Skilling and tell him he was uncomfortable with the internal and external conflicts the LJM partnerships were creating," confirmed Enron spokesman Palmer. "And he told him he could no longer serve as treasurer with those conflicts in place." As for whether the reassignment was a demotion of any sort, Palmer said, "It's probably open to interpretation by a lot of people."

In August, the same month Watkins wrote her memo, Skilling himself resigned from Enron under mysterious circumstances. McMahon, who replaced Fastow as Enron's chief financial officer in October, did not return a call for comment.

"We hope in the very near future to be interviewing Mr. McMahon," House Energy & Commerce Committee spokesman Johnson said. "We feel he has a lot to offer." Johnson's committee has uncovered a number of incriminating details in the Enron investigation, including the shredding of documents and the Watkins memo.

A congressional source also reports that such matters may be just the tip of the iceberg, that much more damaging information will be coming out in the next few weeks dealing with the Enron partnerships.

By Jake Tapper

Jake Tapper is the senior White House correspondent for ABC News.

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