Former Enron Corp. Chairman Kenneth L. Lay went on possibly the biggest emotional roller-coaster ride of his life last week, first being subjected to what amounted to a public verbal flogging at the hands of a Senate committee on Tuesday — one senator called him “perhaps the most accomplished confidence man since Charles Ponzi” — only to be somewhat rehabilitated later in the week when a high-level Enron executive testified that Lay had been “duped” by his closest associates.

Lay protege and former CEO Jeffrey K. Skilling and ex-CFO Andrew S. Fastow were the “culprits” behind the questionable off-the-book partnerships that concealed more than $1 billion in debt and led to Enron’s swift collapse last fall, but Lay didn’t grasp the enormity of what was going on, said Sherron Watkins, who warned the then-chairman last August in a now-famous memo that the company was about to “implode” in a wave of accounting irregularities.

“It is my…opinion he [Lay] did not understand the gravity of the situation that the company was in.” She described Lay as “a man of integrity.”

Skilling and Fastow, however, were like the “swindlers” in “The Emperor’s New Clothes,” who had fooled the emperor about “the fine material that they were weaving,” she told the House Energy and Commerce Committee’s oversight and investigations subcommittee, in her first public appearance on Capitol Hill last Thursday.

Both men “did dupe Ken Lay and the board,” according to the 42-year old vice president for corporate development. Fastow and Skilling “are highly intimidating,” she testified. “I think they intimidated a number of people into accepting” the otherwise questionable partnerships, which, in addition to hiding debt, inflated corporate earnings and made several Enron executives wealthy.

Barring any other major disclosures about Lay, Watkins’ testimony may be enough to spare Lay from being charged with criminal securities fraud. The law requires prosecutors to show that Lay knowingly and willingly intended to commit criminal fraud, but Watkins’ testimony clearly raises serious doubts about whether such intent existed on Lay’s part.

However, a number of troubling questions still remain: Why didn’t Lay act more decisively and aggressively to investigate the problems with the partnerships when Watkins first brought them to his attention last August? How could Lay, whose job as chairman was to approve these partnerships, be so bamboozled by Skilling and Fastow? If he was unaware of the problems facing the company, then why did Lay sell so much of his Enron stock?

When asked who at Enron had the power to withhold details about the partnerships from the board of directors and other top company officials, Watkins told the House subcommittee, “in my opinion, that would be Mr. Skilling.”

Skilling resigned in August 2001, she said, because “in my opinion, he could foresee these problems [with the partnerships], and he wanted to get as far away as possible.” This directly contradicted Skilling’s congressional testimony in which he disavowed knowing that the partnerships were intended to hide debt and inflate earnings, or that Enron was facing financial collapse.

Watkins further disputed Skilling’s claim that he had not signed off on partnership deals. “Skilling was an intense hands-on manager,” she said, adding that a deal wasn’t considered done until it had the requisite signatures. “There was never an instance where approvals were not obtained. While a transaction might be agreed to over the phone, it had to be followed up with an approval sheet. No deal could be done without those approvals.”

An energy industry source called Watkins a “very credible” witness. Skilling “had a reputation for years of being very aggressive, abusive, short with people and arrogant. He was a bad dude…one of these guys you learn never to cross,” he said. Fastow “facilitated that type of behavior.” Lay, on the other hand, was “40,000 feet above this,” involved in philanthropic and civic activities, he noted. “He was Mr. Houston. He was kind of like a president emeritus. I think he was really ready to retire.”

Subcommittee Chairman James Greenwood (R-PA) said Watkins’ testimony was an “unvarnished assessment” of what went on inside Enron. While he called her the “lone voice” of doom at Enron, he said Watkins was “not a whistle blower in the conventional sense.” Rather, he called her a “loyal employee” of Enron, who appeared before Congress only after being subpoenaed.

Despite the glowing reviews by Greenwood and others, Watkins came under some attack for her failure to alert outside authorities to the improprieties and possible illegal acts within Enron. In addition,Watkins told House lawmakers that she sold $31,000 in stock and another $17,000 in options after she warned Lay last August.

When asked why she hadn’t reported her concerns to the Securities and Exchange Commission, the Federal Bureau of Investigation or the Treasury Department, Watkins said she was afraid that going public “would hasten our demise. I was concerned about Enron’s 20,000 employees, that they might think it was something I had caused.” She said she believed if company executives addressed the problem internally, they “could come clean, but with some contingency plans,” so that the damage would be contained. “I wasn’t thinking legally.”

Under questioning Watkins said she had placed a copy of her August memo to Lay (identifying the problem areas) in a safe deposit box out of concern for her personal safety. Because she had in some measure been responsible for Fastow being fired, “I was concerned he might be vindictive.” House Energy and Commerce Chairman W.J. “Billy” Tauzin (R-LA) advised Watkins to notify the committee if there are any reprisals as a result of her testimony.

In her last meeting (in January) with former Enron Vice Chairman J. Clifford Baxter, Watkins said he indicated that he had spoken to Skilling “quite often” about the inappropriateness of the partnerships. He particularly complained about the impropriety of Enron’s involvement in Fastow’s Raptor partnership transactions, she noted. During a March 2001 meeting, Baxter told Skilling that Enron was “headed for a train wreck, and it is your job to get out in front of the train [to] try to stop it,” Watkins said. Baxter was found dead last month from a self-inflicted gunshot wound in Houston.

She estimated that Fastow walked away with about $30-$35 million as a result of his dual roles — manager and investor — in the Raptors’ transactions. “The saying around Enron was ‘heads Mr. Fastow wins, tails Enron loses.'”

She described Enron as a “very arrogant place [to work], with a feeling of invincibility.” Watkins said she “never heard any discussions” from top Enron executives about how the partnerships might negatively affect the company’s shareholders. Enron investors and employees lost billions of dollars when the value of Enron stock plunged to just pennies per share, as the company collapsed and slid into bankruptcy in December.

Watkins also faulted Enron’s ex-auditor Arthur Andersen LLP and former outside corporate counsel, Houston-based Vinson & Elkins (V&E), for failing to aggressively pursue and report the problems associated with the controversial partnerships. “I think they [partnership problems] were very easy to discover,” she said, but the experts were blind to them. Watkins, who had previously worked at Arthur Andersen, noted that she identified the problems fairly quick.

Following her meeting with Lay last August, during which he vowed to “try to get to the bottom” of Watkins’ concerns, Lay directed Vinson & Elkins to conduct an investigation of the partnerships that was “very limited [in] scope,” according to Watkins. As part of the effort, Vinson and Elkins turned to Arthur Andersen to do a review of the accounting treatment.

“I was more than slightly disappointed” by Lay’s decision, she said, especially since she noted Andersen in the past had signed off on improper things that it should not have.

Watkins met again with Lay in late October, at which time he told her that he planned to fire both Vinson & Elkins and Andersen, and would establish an internal special investigative committee to look into the partnerships. Watkins told House lawmakers that she thought someone else within the company had made these decisions.

Her testimony paralleled the comments she made in a key Oct. 30 e-mail to Lay in which she provided him a step-by-step blueprint for minimizing the damage to himself and the company. Watkins urged him to inform the SEC that he and Enron’s board “were duped by a COO [Skilling] who wanted the targets met no matter what the consequences, a CFO [Fastow] motivated by personal greed and two of the most respected firms, AA&Co. and V&E, who had both grown too wealthy off Enron’s yearly business and no longer performed their roles” in compliance with the minimum standards for accountants and attorneys. Skilling was COO before being named CEO.

In addition, Watkins advised Lay to be “open about his involvement or more [importantly] his lack thereof” in the partnerships, “admit that he trusted the wrong people” at the company, “admit that as soon as Skilling resigned employees reported to him their opinions as to the inappropriate LJM transactions,” say that he “appropriately took the matter seriously,” but mistakenly “relied on V&E and Arthur Andersen to [review]…their own work.”

Watkins further suggested in the e-mail that Lay fire Andersen and V&E, restate the company’s 2000 financials and committ to “staying at Enron and returning the company to its former glory.” Last October, the former chairman adjusted Enron’s earnings by $577 million. This subsequently led to a writedown in shareholder equity of more than $1.2 billion.

If Lay failed to follow her advice, she warned him he “will be more implicated in this than is deserved and he won’t get the chance to restore the company to its former stature,” according to the e-mail, which was released by the House Energy and Commerce Committee. “Nobody wants Ken Lay’s head. He’s very well respected in business and the community. The culprits are Skilling, Fastow, [Ben] Glisan and [Richard] Causey, as well as Arthur Andersen and V&E,” Watkins wrote. Glisan, Enron’s former treasurer, was fired in October, and Causey, the company’s chief accounting officer, was fired last Thursday.

Watkins portrait of Lay as a victim was in stark contrast to the “con man” image painted by members of the Senate Commerce Committee, who vilified Lay for more than an hour last Tuesday for asserting his right under the Fifth Amendment of the Constitution to not testify.

Lay appealed to the senators to “not draw a negative inference” from his decision to assert his constitutional right to avoid self-incrimination.

“I am deeply troubled by asserting these rights because it may be perceived by some that I have something to hide. But after agonizing consideration I cannot disregard my counsel’s instruction,” he told the Senate panel, which subpoenaed Lay to appear. The Supreme Court ruled less than a year ago that “one of the Fifth Amendment’s basic functions is to protect innocent men,” a very haggard-looking Lay said.

“Therefore, I must respectfully decline to answer on the Fifth Amendment grounds all [of] the questions of this committee and subcommittee, and those of any other congressional committee and subcommittee,” Lay said. He also had been subpoenaed to appear before a subcommittee of the House Financial Services Committee last Thursday, but the hearing was canceled due to Lay’s refusal to testify.

He said, “I come here today with a profound sadness about what has happened to Enron, its current and former employees, retirees, shareholders and other stakeholders,” said Lay, who added that he “wanted to respond…to the questions” of the Senate committee about Enron’s collapse, but could not ignore the advice of his attorney.

Under the Fifth Amendment, accused individuals cannot be forced to testify against themselves or submit to cross examination, even in a court trial. Testifying before a congressional committee would, in effect, be agreeing to undergo cross examination by numerous “prosecutors,” many of whom are up for re-election this year.

Lay was dismissed but not before being publicly berated by members of the Senate panel, who appeared to have pre-judged the long-time Enron chairman and stretched their immunity from defamation laws to the limit. Under the “speech and debate clause” of the Constitution, lawmakers can pretty much say anything they want to about a person (even without proof) and not be sued, so long as Congress is in session.

Sen. Peter Fitzgerald (R-IL) called Lay “perhaps the most accomplished confidence man since Charles Ponzi,” the creator of the infamous Ponzi scam.

“Mr. Lay, we are all stunned and confused by your behavior,” said Sen. Jean Carnahan (D-M), who added that she couldn’t buy “ignorance” as a defense for either Lay or Skilling, whose duties were to “approve or disapprove” of the company’s course. “I find ignorance a difficult defense.”

Lay last week joined four other top Enron executives — excluding Skilling — who have asserted their Fifth Amendment rights not to testify before Congress.

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