Re: Model Development Report

---------------------- Forwarded by Vince J Kaminski/HOU/ECT on 12/30/99
04:31 PM ---------------------------

Vince J Kaminski
10/04/99 07:30 AM
To: Andrew Schuleman/AA/Corp/Enron@ENRON
cc: Thomas Bauer/AA/Corp/Enron@Enron, Richard Causey/Corp/Enron@Enron, Ted
Murphy/HOU/ECT@ECT, Stinson Gibner/HOU/ECT@ECT, Vince J Kaminski/HOU/ECT@ECT,
Patty Grutzmacher/AA/Corp/Enron@Enron, John Sorrells/AA/Corp/Enron@Enron,
Derek Claybrook/AA/Corp/Enron@Enron
Subject: Re: Model Development Report

Andy,

Thanks for your message regarding the Model Risk project. I think it's a very
important issue and really critical to Enron. The model risk represents a
very significant exposure to the company: a wrong model results in bad
decisions and eventually leads to accounting errors and incorrect financial
statements.

Here are my comments.

1. Reasons of model risk. The main source of model risk in Enron is omitted
in your list. I think it's due to the fact that the responsibility for the
final model approval and validation is dispersed in the organization and
there no single unit/person that is vested with the authority to audit,
approve and monitor valuation models. The popular perception is that this is
done by the Research Group, but this could not be further form the truth.
Given the way the organization evolved over the last few years, we became a
group of internal consultants, working on highly specialized, partial
problems (sometimes, we work on a project from A to Z, but it's an exception
to the rule).

It's imperative that this is communicated to the senior management in a
precise, non-ambiguous way. I think that this is the main source of potential
problems and the first shortcoming of the modeling process to be corrected.

2. Inappropriate application of models. I would expand point 3 in your
draft (inappropriate application of models)
and add two lower level points: a) wrong inputs b) incorrect model used for a
given transaction. TVA is an example of point a: a transaction in case of
which the inputs have not been being updated for an extended period of time
in the past.

3. Control Strength. Under Control Strength you can mention that several
audits
of the Research Group model by Arthur Andersen and Darrell Duffie have been
initiated at our insistence.

4. Audit scope. I don't think you can address the issue of the model risk if
you exclude
from your review Risk Analytics and IT. The model development
activity cannot be divided into separate, independent processes.
I am afraid your recommendations will be highly inaccurate if your audit
scope will
remain as is.

Vince Kaminski

Andrew Schuleman@ENRON
09/29/99 06:00 PM
To: Wanda Curry/HOU/ECT@ECT, Vince J Kaminski/HOU/ECT@ECT
cc:
Subject: Model Development Report

Attached is a draft of the Model Development Report that will be presented at
the Controller's Meeting on Friday, October 1, 1999. I would appreciate if
you could please review the report and respond with any comments prior to the
meeting. I appreciate all your help and cooperation throughout our review.

Thanks,
Andy