Enron’s board: oversight, LJM approvals and investigative findings

analysisAccording to the Senate report, Enron’s board had 15 members in 2001, several with 20 years or more on the boards of Enron or its predecessors, organized in five committees. The Executive Committee, chaired by John H. Duncan with Kenneth Lay, Jeffrey Skilling, Robert Belfer, Charles LeMaistre and Herbert Winokur, handled urgent business between meetings. The Finance Committee, chaired by Winokur with Belfer, Norman Blake, Ronnie Chan, Paulo Pereira and Frank Savage, approved transactions of $75 million or more and reviewed those between $25 million and $75 million. Robert Jaedicke chaired the Audit and Compliance Committee, the primary liaison with Andersen, with Chan, Wendy Gramm, John Mendelsohn, Pereira and Lord Wakeham; LeMaistre chaired the Compensation Committee with Blake, Duncan, Jaedicke and Savage; and Wakeham chaired the Nominating Committee with Gramm, Mendelsohn and Jerome Meyer. The Senate report noted that Jaedicke and Wakeham had formal accounting training, while Mendelsohn appeared to have limited familiarity with complex accounting principles. ¹

analysisThe report of the Senate Permanent Subcommittee on Investigations, dated July 8, 2002, also described how the board worked; that description draws largely on director interviews and board records and is not a judicial finding. The board normally met five times a year, and committee and full-board meetings generally lasted one to two hours. Lay and Skilling usually attended Executive, Finance and Audit Committee meetings as well as full board meetings; directors had routine contact with fewer than a dozen senior officers, and the board had no practice of meeting without Enron management present. The report named the senior officers whom the directors said they had trusted: Kenneth L. Lay, chairman and chief executive officer (CEO); Jeffrey K. Skilling, President and Chief Operating Officer and later CEO; Chief Financial Officer Andrew S. Fastow; Chief Accounting Officer Richard A. Causey; Chief Risk Officer Richard Buy; and Treasurer Jeffrey McMahon, later Ben Glisan. It dated Lay’s chairmanship from 1986 until his resignation in 2002 and Skilling’s board service from 1997 until he resigned from Enron in August 2001. ¹

analysisSources date Lay’s offices differently. The Joint Committee on Taxation says he became Chairman and CEO of HNG in June 1984, held both roles at HNG InterNorth and Enron until February 2001, was CEO again from August 2001 and resigned as Chairman and CEO in January 2002 and as a director in February 2002. Enron’s 2001 proxy and the Senate report date his chairmanship from 1986, while a 2003 federal court opinion gives his Enron chairman-and-CEO terms as December 9, 1996 to February 1, 2001 and August 14, 2001 to January 23, 2002, with Lay only Chairman in between; the retained records do not explain the court’s 1996 date. The records agree that Lay ceded the CEO post to Skilling in February 2001 and resumed it in August 2001. A Congressional Research Service chronology records Enron’s January 23, 2002 announcement that Lay had resigned as Chairman and CEO while remaining a director, and his resignation from the board on February 4, 2002. Enron’s 2001 proxy described Skilling as a director since 1997 who had headed Enron North America and its predecessors from August 1990 to December 1996 and was President and Chief Operating Officer from January 1997 and CEO from February 2001; he resigned on August 14, 2001. ^{1 2 3 4 5 6 7}

analysisEnron’s 2001 proxy statement reported that during 2000 the board held five regular and four special meetings, the Executive Committee met seven times, the Audit and Compliance Committee five, the Compensation and Management Development Committee ten, the Finance Committee five and the Nominating and Corporate Governance Committee three; every director attended at least 75% of board and committee meetings except Ronnie Chan. The proxy, unlike the Senate’s 2001 list, placed Jerome Meyer and John Urquhart on the Finance Committee, and it nominated fourteen directors for election at the May 1, 2001 annual meeting. Each non-employee director received an annual service fee of $50,000, committee chairs an additional $10,000, and $1,250 for each board or committee meeting attended. Directors’ fees for 2000, whether paid in cash, deferred or taken as phantom stock units and stock options in lieu of cash, totalled $1,107,492, an average of $79,107 per non-employee director; separately, each non-employee director received 360 phantom stock units and options on 10,775 shares during 2000. ⁴

analysisEnron’s code of conduct barred full-time officers and employees from sharing in the profits of an entity doing business with Enron unless the interest was disclosed in writing to the Chairman and CEO and he found that it did not harm the company’s best interests. According to the Senate report, Kenneth Lay approved waiving this rule for Andrew Fastow’s LJM partnerships and asked the board to ratify his decision, although company rules did not explicitly require board concurrence; all three LJM presentations to the board, for LJM1, LJM2 and LJM3, expressly requested approval of a waiver. At the Senate hearing of May 7, 2002, directors Herbert Winokur and Robert Jaedicke contended that the board had not waived the code but had ‘applied’ it in the LJM matters. ¹

analysisThe Senate report found, in a congressional rather than judicial finding, that the board ratified Fastow’s waiver and approved LJM1 and its first transaction, a hedge of Enron’s Rhythms NetConnections stock, with little study or debate at a special board meeting held by teleconference on June 28, 1999. Contrary to usual practice the proposal had not gone to the Finance Committee; directors received the written materials by fax three days earlier, and the one-hour meeting also covered a stock split, more stock-plan shares, a new corporate jet and a Middle Eastern power plant. Directors told the Subcommittee that they had seen LJM1 as a single low-risk transaction backed by an outside fairness opinion; the report noted that the opinion was not mentioned in the board presentation and was delivered about two months later. ¹

analysisLJM2 took a different route. The Senate report found, again as a congressional rather than judicial finding, that the LJM2 proposal went first to the Finance Committee, which approved it on October 11, 1999 after what its chairman Herbert Winokur called ‘a vigorous discussion’, and that the board approved it the next day. No director asked to see the LJM2 private placement memorandum: Winokur testified that the committee relied on Vinson & Elkins having reviewed it, and Robert Belfer said he received a copy in the mail offering him an investment and threw it away unread. ¹

analysisThe Senate report found that the LJM controls presented to the board grew over time: the June 1999 LJM1 presentation specified none; the October 1999 LJM2 presentation specified one, approval of all Enron-LJM transactions by Chief Accounting Officer Richard Causey; and the October 2000 LJM3 presentation added approval by Richard Buy and Jeffrey Skilling, an annual Audit Committee review each February and a Skilling review of Fastow’s economic interest; at that October 2000 meeting the Finance Committee added quarterly LJM reviews and a one-time Compensation Committee review of Fastow’s LJM compensation. Skilling testified at a House hearing that he had been unaware of any obligation to review the LJM transactions, and Causey and Buy said they reviewed them only for narrow procedural or risk issues, not overall fairness to Enron. The Senate subcommittee’s account is a congressional finding, not a judicial one. ¹

analysisIn its February 1, 2002 report, an internal board committee’s conclusion rather than a judicial finding, the Special Investigative Committee of Enron’s board, known as the Powers Committee, found that the related-party controls the board required were not rigorous enough and were poorly implemented and overseen. Those controls were chiefly approval of all LJM transactions by Causey, Buy and later Skilling, plus annual Audit and Compliance Committee reviews. Causey and Buy read their roles very narrowly, Skilling was almost entirely uninvolved despite representations to the board, and no one asked Fastow the amount of his LJM compensation until October 2001. The Senate report added, from the Powers findings, that in at least 13 instances both negotiators reported to Fastow. ^{2 1}

analysisThe Senate report found that the Audit Committee’s annual LJM reviews in February 2000 and February 2001 were superficial and relied entirely on management. Each time the committee spent 15 to 30 minutes with Causey on a short list, eight 1999 transactions on one sheet and twelve 2000 transactions on two pages, giving only a name, value and brief description, and no member ever requested or reviewed a Deal Approval Sheet or LJM Approval Sheet. The report noted the Powers report’s account that the reviews lasted 10 to 15 minutes. These are congressional findings, not judicial ones. ¹

analysisAndersen had also briefed the Audit Committee on Enron’s accounting. The Senate report found that at a February 7, 1999 Audit Committee meeting in London, chaired by Robert Jaedicke and attended by Lay and Skilling, Andersen’s engagement partner David Duncan presented a risk profile of Enron’s accounting and told members its practices ‘push limits’ or were ‘at the edge’ of acceptable practice; no director objected, sought a second opinion or asked for a more prudent approach. Similar Andersen briefings on high-risk areas, including structured and related-party transactions, followed once or twice a year through 2001. At the May 7, 2002 hearing Jaedicke said the directors knew Enron was engaged in ‘high-risk and innovative transactions’ but did not recall being told that its accounting practices ‘push limits’, and most directors interviewed declined to characterize Enron’s accounting as high-risk or aggressive. The Senate subcommittee’s account is a congressional finding, not a judicial one. ¹

analysisThe Senate report found that the Finance Committee, having decided in October 2000 to review LJM transactions quarterly, held only one such review, in February 2001. Its chairman Herbert Winokur said no review was held in May 2001 because he had received no quarterly report and assumed there were no transactions, and that in August 2001 he was told Fastow had sold his LJM interest, so reviews were unnecessary; no director asked who had bought it. Winokur testified that, had he known that the new owner of LJM2 was Fastow’s former top staffer Michael Kopper, he ‘would have wanted to continue the reviews’. The finding is a congressional committee’s conclusion, not a judicial one. ¹

analysisThe Senate report also found that after the Finance Committee asked in October 2000 for a review of Fastow’s LJM compensation, Compensation Committee chairman Charles LeMaistre twice asked Enron’s senior compensation officer for the outside income of all senior officers without naming Fastow, received nothing and let the matter drop. After an October 2001 press report, LeMaistre and John Duncan telephoned Fastow, who on October 23 said he had received $45 million from LJM, $23 million from LJM1 and $22 million from LJM2; the board placed him on leave on October 24, 2001. This account is a congressional committee’s finding, not a judicial one. ¹

analysisThe Senate report stated that Enron valued the total cash and equity compensation of its board members in 2000 at about $350,000 each, more than twice the national average (it cited $138,747 at the top 200 U.S. public companies), and experts at the Subcommittee’s hearing called it significantly above the norm. The figure is broader than the $79,107 average in Enron’s 2001 proxy, which covered directors’ fees only: the Senate valuation also counted restricted stock, phantom stock units and stock options, including the annual equity grants the proxy lists separately. The valuation appears in a congressional finding, not a judicial one. ^{1 2}

analysisThe Senate report found, as a congressional rather than judicial conclusion, that Enron paid its executives lavish compensation that the Compensation Committee approved with little debate or restraint. Kenneth Lay’s total compensation in 2000 exceeded $140 million, including $123 million from exercising stock options, and he had accumulated more than 6.5 million options. The report said executive Lou Pai left the company in 2000 with more than $265 million in cash after exercising options and selling the stock; the Securities and Exchange Commission’s (SEC) 2008 complaint against Pai places his share sales of May 18 to June 7, 2001 shortly before his departure. Compensation Committee chairman Charles LeMaistre testified that he ‘did not worry’ about the level of pay because the board’s compensation consultant told him Enron’s practices were on target. In July 2008 Pai settled SEC insider-trading charges over his 2001 share sales without admitting or denying them, agreeing to pay $30 million in disgorgement and prejudgment interest (subject to a $6 million offset) and a $1.5 million civil penalty; a class-action database reports that in January 2007 the court granted the lead plaintiffs’ request to drop Pai and Lay’s estate from the investors’ class action. ^{1 3 4}

analysisAccording to the Subcommittee, Enron executives received about $430 million in annual bonuses for 2000 under the normal bonus plan, and the Performance Unit Plan paid about 65 executives another $320 million. Directors said they had been unaware that almost $750 million in cash bonuses was paid for a year in which net income was $975 million, and the report, a congressional finding rather than a judicial one, concluded that no one on the Compensation Committee had added up the numbers. In a separate account, the Joint Committee on Taxation reported that Enron’s Statement of Financial Affairs in its bankruptcy case listed $309.9 million paid by Enron and its affiliates to senior management in salary, bonuses, long-term incentives, deferred payments, loan advances, expense reimbursements, directors’ fees and other payments during the year before the bankruptcy filing; the same insiders also received $434.5 million of compensatory stock value from option exercises and restricted stock in that period. ^{1 5}

analysisEnron’s 2001 proxy statement also disclosed that Enron Supply Corp., an Enron subsidiary, had an agreement, expiring on December 31, 2003, under which Lay/Wittenberg Travel Agency in the Park, Inc. (TAP) arranged travel for employees of Enron and its affiliates. TAP was 50% owned by a sister of Chairman Kenneth L. Lay and received net revenue of $517,200 from Enron employee travel in 2000. ²

analysisAccording to the Senate report, whose account of these meetings draws largely on director interviews and board records and is not a judicial finding, directors first learned at the October 8, 2001 Audit Committee and board meetings of the planned Raptor termination with an $800 million earnings charge and of an employee’s warning letter, which officers described as anonymous. Vinson & Elkins said its preliminary review had found nothing warranting further investigation; the concerns were presented as relating to LJM and related-party transactions without mention of the Raptors, and Kenneth Lay, who had received the letter, apparently did not disclose its Raptor and accounting warnings. On October 31, 2001 the board elected a new director to chair a newly formed Special Committee to investigate transactions with related parties, and Enron’s Form 8-K of November 8, 2001 announced the restatement of its 1997–2000 financial statements. ^{1 2 3}

analysisEnron’s directors told the Senate subcommittee unanimously that management did not disclose at the October 8 meeting that the Raptor termination also required a $1.2 billion reduction in shareholders’ equity; most said they learned of it from a press report after Lay disclosed the figure on an analyst call, which the Senate report dates to October 17, and several said it was the first event that made them realize Enron was in trouble. The Powers Committee report places Lay’s disclosure on the October 16, 2001 analyst call. The directors’ account comes from the Senate report’s interviews and board records, not from a judicial finding. ^{1 3}

analysisEnron’s Form 8-K of November 8, 2001, which also gave details of transactions with the LJM partnerships, was signed for Enron Corp. by Richard A. Causey as Executive Vice President and Chief Accounting Officer. It reported that the new director was William Powers, Dean of the University of Texas School of Law, and that the Special Committee was to investigate transactions between Enron and certain related parties, take disciplinary action, communicate with the SEC, which had opened a formal investigation, and recommend further action. The other members were independent directors Frank Savage, Paulo Ferraz Pereira and Herbert S. Winokur, Jr.; counsel was Wilmer, Cutler & Pickering, which retained Deloitte & Touche for accounting advice. The Powers Committee report states that William C. Powers, Jr. and Raymond S. Troubh, neither a director when the transactions under investigation took place, joined the board and the committee, and two previously appointed members stepped down so that the new directors formed a majority, leaving Powers, Troubh and Winokur. Because Winokur had chaired the Finance Committee and taken part in the decisions reviewed, the report’s evaluation of the board and its committees reflects only Powers’s and Troubh’s views. ^{2 3}

analysisIn the part of its February 1, 2002 report that reflects only the views of members Powers and Troubh, the Powers Committee concluded that Enron’s board had failed in its oversight duties, with serious consequences; it is an internal board committee’s conclusion, not a judicial finding. The board approved arrangements letting the chief financial officer act as general partner of partnerships doing significant business with Enron, a decision the two reviewing members called fundamentally flawed; it underestimated the conflict and overestimated the controls, authorized the Rhythms transaction and three Raptor transactions that many members did not understand, and failed to demand more information. Committee reviews of LJM were too brief and superficial, and the Compensation Committee never reviewed Fastow’s LJM pay. All 13 directors interviewed by the Senate Subcommittee strongly disagreed with the conclusion that the board had failed in its oversight duties, saying they had reasonably relied on management, Andersen and Vinson & Elkins. ^{1 2}

analysisThe Powers Committee also assessed the senior officers, again as an internal committee’s conclusions rather than judicial findings. It found that Kenneth Lay, as CEO for much of the period, had ultimate responsibility for ensuring that the officers reporting to him performed their oversight duties, did not appear to have directed attention to oversight of the LJM partnerships, and approved the arrangements allowing Fastow’s related-party transactions as well as the Rhythms transaction and three Raptor vehicles; it concluded that ‘a large measure of the responsibility rests with the CEO’. Lay was indicted on July 7, 2004; after his death on July 5, 2006 his conviction was voided by a federal judge. ^{1 3 4}

analysisThe Powers Committee found, as an internal committee’s conclusion and not a judicial finding, that Jeffrey Skilling, president and chief operating officer and later CEO until August 2001, personally supported the board’s decision to let Fastow proceed with LJM despite the conflict, gave little attention to his oversight duties and bore substantial responsibility for the failure of the internal controls over the LJM relationship. It cited conflicting evidence that, if other employees’ accounts are accurate, Skilling approved the March 2001 Raptor restructuring designed to conceal losses and withheld important information about it from the board. Skilling denied approving the restructuring, described his assigned oversight role as minimal and told a House subcommittee that he ‘was not required to approve those transactions’. He was indicted on July 7, 2004 and convicted on 19 counts; on June 24, 2010 the U.S. Supreme Court affirmed in part and vacated in part. ^{1 2 3}

analysisIn further internal-committee conclusions, not judicial findings, the Powers Committee found that Chief Accounting Officer Richard Causey presided over accounting judgments that ‘went well beyond the aggressive’, in most cases with Andersen’s concurrence; that, though charged by the board with approving all LJM transactions and reviewing them annually with the Audit and Compliance Committee, he did not implement a procedure to identify all LJM1 and LJM2 transactions or scrutinize them as expected; and that he did not give the committee full information on the Raptor III and Raptor restructuring transactions. Causey was indicted on July 7, 2004, pleaded guilty to one count of securities fraud on December 28, 2005 and was sentenced to 66 months in prison. Senior Risk Officer Richard Buy, also charged with reviewing and approving all Enron-LJM transactions, did not implement a procedure for identifying all LJM1 and LJM2 transactions, apparently saw his role more narrowly than the board had reason to believe, and did not ensure a careful review of their economic terms; according to the Senate report, Buy said he reviewed and signed the LJM documents but considered only narrow procedural or risk issues, not overall fairness to Enron. ^{1 3 5 2}

analysisIn its July 8, 2002 staff report, based on subpoenaed documents, director interviews and a hearing, the Senate Permanent Subcommittee on Investigations made six findings on the board’s role: fiduciary failure; knowingly allowing high-risk accounting; approving inappropriate conflicts of interest by letting the chief financial officer run the LJM funds; knowingly allowing billions of dollars of undisclosed off-the-books activity; approving excessive executive compensation and failing to halt Kenneth Lay’s abuse of a company-financed personal credit line; and lack of independence of the board and of the outside auditor Andersen. These are a congressional committee’s conclusions, not judicial findings. At the May 7, 2002 hearing all five director witnesses rejected any share of responsibility for the collapse; John Duncan testified that management did not ‘tell the truth’ and Herbert Winokur that directors could not be criticized for problems concealed from them. Winokur, one of the two hearing witnesses still on the board, resigned on June 6, 2002, when the board accepted the resignations of its four remaining long-standing directors, and a securities class-action database reports that in January 2005 a group of former outside directors settled investors’ claims for $168 million without admitting wrongdoing, $13 million of it to be paid by the directors personally. ^{2 6 7}

analysisEnron’s long-serving directors left the board in mid-2002. According to a Congressional Research Service chronology, the board announced on May 22, 2002 the election of John W. Ballantine and Corbin A. McNeill, Jr. as directors of the bankrupt company; John Mendelsohn and Frank Savage resigned on May 30, 2002; and on June 6, 2002 the board accepted the resignations of the four remaining long-standing directors, Robert A. Belfer, Norman P. Blake, Jr., Wendy L. Gramm and Herbert S. Winokur, Jr. The Senate report confirms that Blake, then interim chairman, and Winokur resigned on June 6, 2002, after appearing at its May 7 hearing. ^{1 2}

analysisIn his final report of November 4, 2003, court-appointed bankruptcy examiner Neal Batson concluded that, although the oversight of special purpose entity (SPE) transactions by the board and its Audit and Finance Committees may be criticized, he had not found sufficient evidence from which a fact-finder could conclude that the outside directors (those serving from 1997 to the petition date other than Lay and Skilling) abdicated their monitoring duties or consciously disregarded red flags; he did find sufficient evidence from which a fact-finder could conclude that certain of them breached their duty of good faith in approving the LJM1/Rhythms hedge and certain LJM2/Raptor hedges, having facts showing these lacked any rational business purpose. These are an examiner’s assessments, not a court judgment, and the retained records show no estate action on them. A securities class-action database’s case summary, compiled from press reports, states that in January 2005 a group of former outside directors, whom it does not name, settled investors’ claims for $168 million without admitting wrongdoing, insurance to cover most of the cost and the directors to pay $13 million personally; plaintiffs had accused them of selling Enron shares after the company began giving false financial information, although a federal judge in Houston had dismissed insider-trading and fraud charges against them in 2003. The settlement agreement and any court approval are not in the retained records. ^{3 4}