Enron Corp. tried to dodge accounting rules by dropping a plan to sell assets in a failed water business, a former Arthur Andersen LLP accountant said on Monday.
John R. Sult, who oversaw the books on Enron’s Azurix water venture for Andersen, told jurors the energy trading company could avoid a writedown of hundreds of millions of dollars by promoting, instead, a $1 billion growth strategy for the unit.
“By merely standing up and making the assertion that the strategy exists somehow makes the problem go away,” he testified, explaining his view of Enron’s plan.
Enron founder Kenneth Lay is accused of improperly avoiding writedowns and former Chief Executive Officer Jeffrey Skilling is accused of misusing reserves. The two men are beginning the eighth week of their federal fraud and conspiracy trial.
Another former Andersen accountant, Thomas Bauer, corroborated earlier testimony from former senior Enron accountant Wesley Colwell that the energy company wrongly dipped into reserves to pad earnings. Bauer said he and Colwell now work at a Houston consulting firm, but that on advice from his lawyer, he hasn’t discussed trial-related issues with Colwell.
Bauer, who oversaw the books of Enron’s profitable trading operation, said companies can establish reserves for costs related to assets or liabilities — such as lawsuits — but cannot set aside income in good times to pad earnings in bad.
“It is not discretionary to pick a number that helps with an earnings target,” Bauer said.
Skilling lawyer Randy Oppenheimer sought to show, as he cross-examined Bauer, that companies routinely consider levels of reserves when finalizing their books to prepare quarterly earnings reports. He asked Bauer whether there was anything “illegal or nefarious” about checking reserves when ascertaining whether a certain earnings target can be met.
“If you can do it legitimately, I would agree with that,” Bauer said, but added later: “I don’t think you should be looking at your reserves with a mind toward meeting your earnings target.”
Allegations against Skilling include that he signed letters to outside auditors vouching for Enron’s financial statements, which were allegedly misleading. Lay is accused, too, of lying to outside auditors in October 2001 when he said Enron planned to invest in Wessex Water Ltd., Azurix’s cornerstone asset, allowing Enron to avoid a writedown of $700 million or more.
Lay told analysts in a late October 2001 conference call — weeks before the company sought bankruptcy protection — that Andersen had examined the issue and determined no writedown was necessary.
Had Enron maintained its plan to sell Wessex and other Azurix assets, an accounting rule that took effect in January 2002 would have required the energy company to take that writedown and book it as a loss to reconcile the utility’s book value with its true fair market value. A growth strategy would let Enron avoid the writedown, Sult said.
Sult said that until the fall of 2001, Enron’s financial statements consistently said the company planned no new growth for its water business.
“Trying to avoid a (writedown) within the accounting rules is absolutely OK, isn’t it?” asked Lay lawyer Shawn Cleveland.
“Provided it’s within the accounting rules,” Sult replied.
Sult also said on cross-examination that he and Lay never discussed Azurix or Wessex. Nor was Lay involved in accounting analyses related to a possible writedown, he said.
The government’s indictment alleges that such a writedown could have prompted credit rating agencies to cut Enron’s ranking, which could have jeopardized the company’s ability to borrow millions to support its trading operation.
Enron bought Wessex for $2.2 billion in 1998. In 2002, a subsidiary of Malaysian energy group YTL Power International bought Wessex from Enron for $777 million and almost $1 billion in assumed debt.
Bauer invoked his Fifth Amendment right not to testify during Andersen’s 2002 obstruction of justice trial. The firm’s conviction of obstruction for destroying Enron-related audit documents in late 2001 was overturned by the U.S. Supreme Court last year, which cited vague jury instructions that allowed jurors to convict without finding criminal intent.
Bauer’s testimony was to continue Tuesday. On deck to follow him is Standard & Poor’s credit analyst Ron Barone, and then former Enron Treasurer Ben Glisan Jr., who is serving a five-year prison term for conspiracy.
Prosecutor Kathryn Ruemmler said Glisan will be released from prison on furlough during his testimony. FBI agents would transport him to and from his home to the courthouse until his testimony wraps up, and then he’d be transported back to prison, she said.
Skilling faces 31 counts of fraud, conspiracy, insider trading and lying to auditors, while Lay faces seven counts of fraud and conspiracy. Both men say there was no fraud at Enron and negative publicity coupled with diminished market confidence fueled the company’s swift descent into bankruptcy protection in December 2001.