FW: E memo

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-----Original Message-----
From: Stephens, Jeffery
Sent: Wednesday, January 16, 2002 2:26 PM
To: gregory.schockling@bhlp.com
Subject: FW: E memo

-----Original Message-----
From: John_Carmody@transalta.com [mailto:John_Carmody@transalta.com]
Sent: Wednesday, January 16, 2002 2:23 PM
To: Stephens, Jeffery
Subject: FW:E memo

----- Forwarded by John Carmody on 01/16/2002 03:21 PM -----

"Carmody, Tom"
<TCarmody@util To: "'john_carmody@transalta.com'" <john_carmody@transalta.com<
icorp.com< cc:
Subject: FW:
01/16/2002
10:57 AM

< -----Original Message-----
<
<
< Text of Letter to Enron's Chairman After Departure of Chief Executive
< ollowing is the text of an unsigned letter written in August to Kenneth
L.
< Lay, the chairman of the Enron Corporation (news/quote
<
</redirect/marketwatch/redirect.ctx?MW=http://custom.marketwatch.com/custo
< m/nyt-com/html-companyprofile.asp&symb=ENRNQ<), after Jeffrey K. Skilling
< resigned unexpectedly as chief executive on Aug. 14. Its author was later
< identified as Sherron S. Watkins, a vice president for corporate
< development at Enron. The House Energy and Commerce Committee released
< excerpts of the letter on Monday and the full letter yesterday:

< Has Enron become a risky place to work? For those of us who didn't get
< rich over the last few years, can we afford to stay?
< Skilling's abrupt departure will raise suspicions of accounting
< improprieties and valuation issues. Enron has been very aggressive in its
< accounting - most notably the Raptor transactions and the Condor vehicle.
< We do have valuation issues with our international assets and possibly
< some of our EES MTM positions.
< The spotlight will be on us, the market just can't accept that Skilling
is
< leaving his dream job. I think that the valuation issues can be fixed and
< reported with other good will write-downs to occur in 2002. How do we fix
< the Raptor and Condor deals? They unwind in 2002 and 2003, we will have
to
< pony up Enron stock and that won't go unnoticed.
< To the layman on the street, it will look like we recognized funds flow
of
< $800 million from merchant asset sales in 1999 by selling to a vehicle
< (Condor) that we capitalized with a promise of Enron stock in later
years.
< Is that really funds flow or is it cash from equity issuance?
< We have recognized over $550 million of fair value gains on stocks via
our
< swaps with Raptor. Much of that stock has declined significantly - Avici
< by 98 percent from $178 million, to $5 million; the New Power Company by
< 80 percent from $40 a share, to $6 a share. The value in the swaps won't
< be there for Raptor, so once again Enron will issue stock to offset these
< losses. Raptor is an LJM entity. It sure looks to the layman on the
street
< that we are hiding losses in a related company and will compensate that
< company with Enron stock in the future.
< I am incredibly nervous that we will implode in a wave of accounting
< scandals. My eight years of Enron work history will be worth nothing on
my
< r?sum?, the business world will consider the past successes as nothing
but
< an elaborate accounting hoax. Skilling is resigning now for "personal
< reasons" but I would think he wasn't having fun, looked down the road and
< knew this stuff was unfixable and would rather abandon ship now than
< resign in shame in two years.
< Is there a way our accounting guru's can unwind these deals now? I have
< thought and thought about a way to do this, but I keep bumping into one
< big problem - we booked the Condor and Raptor deals in 1999 and 2000, we
< enjoyed wonderfully high stock price, many executives sold stock, we then
< try and reverse or fix the deals in 2001, and it's a bit like robbing the
< bank in one year and trying to pay it back two years later. Nice try, but
< investors were hurt, they bought at $70 and $80 a share looking for $120
a
< share and now they're at $38 or worse. We are under too much scrutiny and
< there are probably one or two disgruntled "redeployed" employees who know
< enough about the "funny" accounting to get us in trouble.
< What do we do? I know this question cannot be addressed in the
< all-employee meeting, but can you give some assurances that you and
Causey
< will sit down and take a good hard objective look at what is going to
< happen to Condor and Raptor in 2002 and 2003?
< Summary of Alleged Issues:
<
< RAPTOR Entity was capitalized with LJM equity. That equity is at risk;
< however, the investment was completely offset by a cash fee paid to LJM.
< If the Raptor entities go bankrupt LJM is not affected, there is no
< commitment to contribute more equity.
< The majority of the capitalization of the Raptor entities is some form of
< Enron N/P, restricted stock and stock rights.
< Enron entered into several equity derivative transactions with the Raptor
< entities locking in our values for various equity investments we hold.
< As disclosed in 2000, we recognized $500 million of revenue from the
< equity derivatives offset by market value changes in the underlying
< securities.
< This year, with the value of our stock declining, the underlying
< capitalization of the Raptor entities is declining and credit is pushing
< for reserves against our MTM positions.
< To avoid such a write-down or reserve in quarter one 2001, we "enhanced"
< the capital structure of the Raptor vehicles, committing more ENE shares.
< My understanding of the third-quarter problem is that we must "enhance"
< the vehicles by $250 million.
< I realize that we have had a lot of smart people looking at this and a
lot
< of accountants including AA & Co. have blessed the accounting treatment.
< None of that will protect Enron if these transactions are ever disclosed
< in the bright light of day. (Please review the late 90's problems of
Waste
< Management (news/quote
<
</redirect/marketwatch/redirect.ctx?MW=http://custom.marketwatch.com/custo
< m/nyt-com/html-companyprofile.asp&symb=WMI<) - where AA paid $130 million
< plus in litigation re questionable accounting practices.)
< The overriding basic principle of accounting is that if you explain the
< "accounting treatment" to a man in the street, would you influence his
< investing decisions? Would he sell or buy the stock based on a thorough
< understanding of the facts? If so, you best present it correctly and/or
< change the accounting.
< My concern is that the footnotes don't adequately explain the
< transactions. If adequately explained, the investor would know that the
< "entities" described in our related party footnote are thinly
capitalized,
< the equity holders have no skin in the game, and all the value in the
< entities comes from the underlying value of the derivatives
(unfortunately
< in this case, a big loss) AND Enron stock and N/P. Looking at the stock
we
< swapped, I also don't believe any other company would have entered into
< the equity derivative transactions with us at the same prices or without
< substantial premiums from Enron. In other words, the $500 million in
< revenue in 2000 would have been much lower. How much lower?
< Raptor looks to be a big bet if the underlying stocks did well, then no
< one would be the wiser. If Enron stock did well, the stock issuance to
< these entities would decline and the transactions would be less
< noticeable. All has gone against us. The stocks, most notably Hanover,
the
< New Power Company and Avici are underwater to great or lesser degrees.
< I firmly believe that executive management of the company must have a
< clear and precise knowledge of these transactions and they must have the
< transactions reviewed by objective experts in the fields of securities
law
< and accounting. I believe Ken Lay deserves the right to judge for himself
< what he believes the probabilities of discovery to be and the estimated
< damages to the company from those discoveries and decide one of two
< courses of action:
< 1. The probability of discovery is low enough and the estimated damage
too
< great; therefore we find a way to quietly and quickly reverse, unwind,
< write down these positions/transactions.
< 2. The probability of discovery is too great, the estimated damages to
the
< company too great; therefore, we must quantify, develop damage
containment
< plans and disclose.
< I firmly believe that the probability of discovery significantly
increased
< with Skilling's shocking departure. Too many people are looking for a
< smoking gun.
< Summary of Raptor Oddities:
< 1. The accounting treatment looks questionable.
< a. Enron booked a $500 million gain from equity derivatives from a
related
< party.
< b. That related party is thinly capitalized with no party at risk except
< Enron.
< c. It appears Enron has supported an income statement gain by a
< contribution of its own shares.
< One basic question: The related party entity has lost $500 million in its
< equity derivative transactions with Enron. Who bears that loss? I can't
< find an equity or debt holder that bears that loss. Find out who will
lose
< this money. Who will pay for this loss at the related party entity?
< If it's Enron, from our shares, then I think we do not have a fact
pattern
< that would look good to the S.E.C. or investors.
< 2. The equity derivative transactions do not appear to be at arms length.
< a. Enron hedged New Power, Hanover and Avici with the related party at
< what now appears to be the peak of the market. New Power and Avici have
< fallen away significantly since. The related party was unable to lay off
< this risk. This fact pattern is once again very negative for Enron.
< b. I don't think any other unrelated company would have entered into
these
< transactions at these prices. What else is going on here? What was the
< compensation to the related party to induce it to enter into such
< transactions?
< 3. There is a veil of secrecy around LJM and Raptor. Employees question
< our accounting propriety consistently and constantly. This alone is cause
< for concern.
< a. Jeff McMahon was highly vexed over the inherent conflicts of LJM. He
< complained mightily to 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 C.E.O. spot at Enron Industrial Markets and
never
< addressed the five steps with him.
< b. Cliff Baxter complained mightily to Skilling and all who would listen
< about the inappropriateness of our transactions with LJM.
< c. I have heard one manager-level employee from the principal investments
< group say, "I know it would be devastating to all of us, but I wish we
< would get caught. We're such a crooked company." The principal
investments
< group hedged a large number of their investments with Raptor. These
people
< know and see a lot. Many similar comments are made when you ask about
< these deals. Employees quote our C.F.O. as saying that he has a handshake
< deal with Skilling that LJM will never lose money.
< 4. Can the general counsel of Enron audit the deal trail and the money
< trail between Enron and LJM/Raptor and its principals? Can he look at
LJM?
< At Raptor? If the C.F.O. says no, isn't that a problem?
< Condor and Raptor Work:
< 1. Postpone decision on filling office of the chair, if the current
< decision includes C.F.O. and/or C.A.O.
< 2. Involve Jim Derrick and Rex Rogers to hire a law firm to investigate
< the Condor and Raptor transactions to give Enron attorney-client
privilege
< on the work product. (Can't use V & E due to conflict - they provided
some
< true sale opinions on some of the deals).
< 3. Law firm to hire one of the big 6, but not Arthur Andersen or
< PricewaterhouseCoopers due to their conflicts of interest: AA & Co.
< (Enron); PWC (LJM).
< 4. Investigate the transactions, our accounting treatment and our future
< commitments to these vehicles in the form of stock, NP, etc., For
< instance: In the third quarter we have a $250 million problem with Raptor
< 3 (NPW) if we don't "enhance" the capital structure of Raptor 3 to commit
< more ENE shares. By the way: in Q. 1 we enhanced the Raptor 3 deal,
< committing more ENE shares to avoid a write-down.
< 5. Develop cleanup plan:
< a. Best case: Clean up quietly if possible.
< b. Worst case: Quantify, develop P.R. and I.R. campaigns, customer
< assurance plans (don't want to go the way of Salomon's trading shop),
< legal actions, severance actions, disclosure.
< 6. Personnel to quiz confidentially to determine if I'm all wet:
< a. Jeff McMahon
< b. Mark Koenig
< c. Rick Buy
< d. Greg Walley
< To put the accounting treatment in perspective I offer the following:
< 1. We've contributed contingent Enron equity to the Raptor entities.
Since
< it's contingent, we have the consideration given and received at zero. We
< do, as Causey points out, include the shares in our fully diluted
< computations of shares outstanding if the current economics of the deal
< imply that Enron will have to issue the shares in the future. This
impacts
< 2002-2004 earnings-per- share projections only.
< 2. We lost value in several equity investments in 2000, $500 million of
< lost value. These were fair-value investments; we wrote them down.
< However, we also booked gains from our price risk management transactions
< with Raptor, recording a corresponding PRM account receivable from the
< Raptor entities. That's a $500 million related party transaction - it's
20
< percent of 2000 IBIT, 51 percent of NI pretax, 33 percent of NI after
tax.
< 3. Credit reviews the underlying capitalization of Raptor, reviews the
< contingent shares and determines whether the Raptor entities will have
< enough capital to pay Enron its $500 million when the equity derivatives
< expire.
< 4. The Raptor entities are technically bankrupt; the value of the
< contingent Enron shares equals or is just below the PRM account payable
< that Raptor owes Enron. Raptor's inception-to-date income statement is a
< $500 million loss.
< 5. Where are the equity and debt investors that lost out? LJM is whole on
< a cash-on- cash basis. Where did the $500 million in value come from? It
< came from Enron shares. Why haven't we booked the transaction as $500
< million in a promise of shares to the Raptor entity and $500 million of
< value in our "economic interests" in these entities? Then we would have a
< write-down of our value in the Raptor entities. We have not booked the
< latter, because we do not have to yet. Technically we can wait and face
< the music in 2002-2004.
< 6. The related party footnote tries to explain these transactions. Don't
< you think that several interested companies, be they stock analysts,
< journalists, hedge fund managers, etc., are busy trying to discover the
< reason Skilling left? Don't you think their smartest people are poring
< over that footnote disclosure right now? I can just hear the discussions
-
< "it looks like they booked a $500 million gain from this related party
< company and I think, from all the undecipherable half-page on Enron's
< contingent contributions to this related party entity, I think the
related
< party entity is capitalized with Enron stock." . . . . "No, no, no, you
< must have it all wrong, it can't be that, that's just too bad, too
< fraudulent, surely AA & Co. wouldn't let them get away with that?" "Go
< back to the drawing board, it's got to be something else. But find it!" .
< . . . "Hey, just in case you might be right, try and find some insiders
or
< `redeployed' former employees to validate your theory."
< <<Previous </2002/01/16/business/16TEXT.html?pagewanted=1< |
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<
<
<
< Matt Haverty
< Director
< Strategic Investments
< Aquila Energy Capital Corporation
< Tel: 816-527-1971
< Fax: 816-527-4971
< www.aquila.com
<
<
<