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January 16, 2002

Politics & Policy
Vinson & Elkins Discounted Warnings
By Employee About Dubious Accounting

A venerable and politically connected law firm advised Enron Corp. officials not to worry about a company employee's warnings of questionable accounting, based on an inquiry that only canvassed Enron executives and its accountants at Arthur Andersen LLP.

The report by Vinson & Elkins partner Max Hendricks III, a copy of which was obtained by The Wall Street Journal, concluded that Enron's practice of forming special-purpose entities to keep debt off its books was "creative and aggressive," but that "no one has reason to believe that it is inappropriate from a technical standpoint."

In fact, the subsequent widespread disclosure of those partnerships last fall fueled Enron's downward spiral toward a bankruptcy filing, lawsuits and now government inquiries -- including a federal criminal investigation. The Enron executive whose complaints prompted the Vinson & Elkins review also warned, in an August letter to Enron's chairman, against using Vinson & Elkins to vet her concerns because she believed there was a conflict of interest.

Vinson partner Ronald Astin also was involved in structuring some of the partnerships, according to an Enron source.

The expanding Enron scandal also is putting political heat on President Bush and his inner circle. Along with Enron, Houston's Vinson & Elkins has been among the big Texas businesses that have been his biggest political patrons. Of the firm's 341 partners, 165 contributed about $204,000 to Mr. Bush's 2000 campaign, according to Thomas Marinis Jr., a firm partner and boyhood friend of the president's.

The web of friendships and money threatens to raise additional questions about possible conflicts of interest. For instance, after Commerce Secretary Donald Evans received a call for help from Enron Chairman Kenneth Lay, among those he turned to for advice was his department counsel, Theodore Kassinger. Mr. Kassinger is a former Vinson & Elkins attorney who had done work for Enron on international trade and project-financing matters, according to his public resume. Mr. Kassinger declined a request for an interview. But a Commerce Department spokesman said Mr. Kassinger worked in Washington and knew nothing about Enron partnerships. He also said Mr. Kassinger hadn't been asked for help by any former law firm colleagues.

White House counsel Alberto R. Gonzales also is an alumnus of Vinson & Elkins -- or V&E, as the Texas legal and political powerhouse is commonly known. Mr. Gonzales left there in 1994, when Mr. Bush, newly elected as Texas governor, picked him to serve as his attorney. White House spokesman Dan Bartlett says he is unaware of any contacts between Vinson & Elkins attorneys and administration officials about Enron. "One thing is clear," he adds. "This administration has taken no action to benefit or to attempt to help the Enron company."

Vinson & Elkins's internal inquiry that ended up reassuring Enron was spurred by an August letter from Enron Global Finance executive Sherron Watkins to Mr. Lay. In it, she raised alarms about the energy firm's unorthodox partnerships and their potential danger to the company's finances and public image.

"I am incredibly nervous that we will implode in a wave of accounting scandals," Ms. Watkins wrote, according to a copy of the letter obtained by the Journal. "My eight years of Enron work history will be worth nothing on my resume, the business world will consider the past successes as nothing but an elaborate accounting hoax," she added.

In her letter, Ms. Watkins specifically points to Enron's creation of a partnership called Raptor to help protect it from falling share prices in companies in which it owned stock. As she described the situation, Raptor had to pay Enron if the company stock prices fell. In return, Enron had promised to make up Raptor's losses with shares of Enron stock. When Enron's stock declined throughout the year, the amount needed to make Raptor whole grew significantly.

Ms. Watkins also raised concerns about whether Enron had properly disclosed the transactions with the partnerships to investors. And she questioned whether Enron Chief Financial Officer Andrew S. Fastow had a conflict of interest in forming them.

She also specifically cautioned Mr. Lay against using Vinson & Elkins "due to conflict." Despite that, Mr. Lay did turn to his longtime allies at the firm. The ties between Enron and Vinson & Elkins date to the early 1980s, prior to when Enron's predecessors, Houston Natural Gas and Internorth, merged. Enron was the law firm's biggest client, though it only accounted for about 7% of its work.

So close were the firms that, at times, Mr. Lay would pick a local charity, and Vinson & Elkins partners were expected to pony up donations along with Enron, say people familiar with the firm. And just as Mr. Lay and Enron were early givers to the Bush presidential campaign, so, too, was Vinson & Elkins. In early 1999, 140 of its lawyers wrote $1,000 checks in the span of a few days, and bundled them for delivery to Bush headquarters, according to an analysis by the Center for Responsive Politics. Both outfits' executives are among the Bush "Pioneers," supporters who raised at least $100,000 for the candidate.

Over the years, lawyers at the firm would move in and out of jobs as Enron's in-house attorneys. Enron's general counsel, James Derrick Jr., was a partner at the firm until he joined the energy company in 1991. It was Mr. Derrick, one of the Enron contributors to Mr. Bush, who requested the internal study of Ms. Watkins's concerns. But he imposed two restraints: Don't second-guess the Andersen accountants, and don't analyze every transaction.

Washington defense attorney Robert Bennett, who is representing Enron, says the limits were imposed because "they wanted an answer to this if they could get one soon." But in hindsight, he concedes, "They probably should have done some other things," such as seeking outside expertise on the accounting questions.

Vinson & Elkins investigators zeroed in on four areas -- conflicts of interests, the accounting treatment of the partnerships in Enron's financial statement, public disclosures of the partnership transactions and the potential impact on Enron's financial statements because of stock-price declines.

In each case, they dismissed Ms. Watkins's worries primarily by relying on assurances from Arthur Andersen that the accounting practices were appropriate, according to the report. "In summary, none of the individuals interviewed could identify any transaction between Enron [and the outside partnership] that was not reasonable from Enron's standpoint or that was contrary to Enron's best interests," Mr. Hendrick noted.

The company believed the conflict of interest largely was resolved when Mr. Fastow severed his connection with the controversial partnerships, but Mr. Hendrick noted that Enron's board twice waived the company's ethics code to allow transactions to go forward.

The one area where the investigators saw Enron as vulnerable was in its public relations: The transactions could "be portrayed very poorly if subjected to a Wall Street Journal expose or class action lawsuit," they noted in the report.

The report is dated Oct. 15, 2001. The next day, Mr. Lay disclosed that his company had a loss of $618 million in the third quarter. Shortly later, the complex partnership arrangements were exposed, along with the fact that Enron had used them to conceal billions of dollars in losses. The revelations rocked the company, and led to its Dec. 2 bankruptcy filing.

Mr. Bennett argues that Mr. Lay would have conducted a more thorough investigation of the partnerships if his attorneys had recommended it. "I think this shows Ken Lay's good faith in the matter," he says of the report.

Joseph Dilg, Vinson & Elkins's new managing partner, who has worked closely with Enron since the early 1990s, declined to comment on the specifics of the firm's investigation of Enron's partnerships and auditing practices.

"We remain very comfortable with everything we did," he says.

But Mr. Dilg says that while the firm could offer legal opinions on certain Enron transactions, it couldn't conduct a review of its accounting practices because it doesn't have expertise.

"We are not competent to render accounting advice," he says.

An Andersen spokesmen Tuesday declined to comment on the report, referring only to Andersen Chief Executive Joseph Berardino's recent congressional testimony. In that appearance, Mr. Berardino said Andersen made a mistake in accepting Enron's accounting for one of the partnerships, and wouldn't have approved of another if it had known all the details.

Mr. Dilg says the Securities and Exchange Commission and congressional committees haven't yet contacted him or his partners. But, he adds, the firm has retained Washington's Williams & Connolly as its outside counsel. The firm also has hired well-known Houston lawyer Joe Jamail to handle civil litigation. The firm was named in two Enron-related lawsuits, but those have been withdrawn.

Write to Jeanne Cummings at jeanne.cummings@wsj.com, Tom Hamburger at tom.hamburger@wsj.com and Kathryn Kranhold at kathryn.kranhold@wsj.com