updated 4/5/2006 6:36:52 PM ET 2006-04-05T22:36:52

Enron Corp.’s outside law firm conducted a cursory probe in the fall of 2001 of accounting complaints raised by former finance executive Sherron Watkins that asked executives and accountants who had already approved financial structures if they were proper, a lawyer with the firm testified Wednesday.

And Max Hendrick III, a partner with the Houston law firm Vinson & Elkins LLC who helped conduct the investigation, testified during the criminal fraud and conspiracy trial of Enron founder Kenneth Lay and former chief executive Jeffrey Skilling that the firm would have had to bow out if a more extensive probe were required because of its relationship with Enron.

The law firm, which once collected up to $40 million in fees annually from Enron, would “not be considered independent for the purpose of doing a special or full-blown investigation,” Hendrick, a defense witness, told Lay lawyer Bruce Collins.

Asked by Collins if he was “prepared to throw away 30 years of professional integrity to conduct a whitewash,” Hendrick replied: “I certainly was not.”

Skilling’s much-anticipated testimony was expected to begin Thursday afternoon. The exact time depends on how long attorneys question Jim Derrick, Enron’s former general counsel. Lay aims to testify in the trial as well, but at least three character witnesses for Skilling will immediately follow the ex-CEO on the witness stand.

Watkins, a former Enron vice president, met with Lay in August 2001 days after Skilling had abruptly resigned to tell him the company needed to come clean about potentially disastrous accounting tricks she had found.

Her prosecution testimony last month about that meeting was intended to bolster government allegations that Lay knew the energy trading company was in financial turmoil when he claimed publicly the company was strong in the fall of 2001. The government contends Skilling also lied about Enron’s financial condition before he resigned.

Both men counter that there was no fraud at Enron except that committed by a few executives who skimmed money from secret deals, and the company failed because of bad publicity coupled with lost market confidence.

The company collapsed into bankruptcy proceedings in December 2001, just over three months after Watkins met with Lay. Congress anointed her a hero in 2002 for her warnings, which included her statement in a famed memo, “I am incredibly nervous that we will implode in a wave of accounting scandals.”

Hendrick testified Wednesday that he and firm partner Joe Dilg agreed in discussions with Lay and Derrick to limit the scope of the investigation.

Hendrick said he and Dilg sought only to find out if senior Enron management and Enron’s outside auditors at Arthur Andersen LLP were familiar with issues raised by Watkins and whether a more detailed probe was necessary.

They didn’t dig into accounting propriety or whether executives they interviewed told them the truth.

“What we did, we carried out and took our job seriously,” Hendrick said. “We carried out our investigation in a professional way. I approached it just as I would an engagement for anyone else.”

Watkins had suggested Lay enlist other law and accounting firms without Enron ties to investigate, and she criticized what she considered Vinson & Elkins’ flimsy approach.

But Hendrick told Collins outsiders would have needed more time to get familiar with the issues Watkins raised, and Lay and Derrick wanted a fast conclusion.

“Is it a fair statement that Enron knew no accountants would help with the investigation?” prosecutor John Hueston asked.

“As a result of the decision not to bring in independent auditors, yes, that’s fair,” Hendrick replied.

Specifically, Watkins told Lay she had examined a list of weak assets Enron wanted to sell that had been tucked into off-balance-sheet financial structures intended to lock in their values.

The structures, known as Raptors, were backed by Enron stock and intertwined with partnerships run by then-Chief Financial Officer Andrew Fastow that conducted deals with Enron. Watkins said the Raptors owed the energy company hundreds of millions of dollars and the falling Enron shares they contained couldn’t cover the debt.

Hendrick and Dilg spoke to Fastow, former Enron Chief Accounting Officer Richard Causey, other Enron executives and Andersen auditors who oversaw the energy company’s books — all of whom said the Raptors were appropriate and the accounting was proper.

Hendrick and Dilg concluded that no further investigation was necessary. They determined many of Watkins’ concerns were fueled by office gossip, and concluded the only potential problem Enron faced was “a risk of adverse publicity and litigation,” Hendrick said.

Their conclusion came as Enron announced massive third-quarter losses in mid-October 2001, many of which stemmed from shutting down the Raptors.

Fastow, who pleaded guilty in January 2004 to two counts of conspiracy, testified last month that Enron used the Raptors to help it manufacture earnings and hide losses. Causey pleaded guilty last December to securities fraud, and may testify during the trial.

Derrick, who succeeded Hendrick on the stand, didn’t discuss the Watkins complaints Wednesday. He said he believed Fastow’s partnerships could benefit Enron by doing deals quicker than other asset buyers, but was “astonished” to learn after the company failed that Fastow had stolen money from it through other schemes. His testimony was to continue Thursday, followed by Skilling.

Skilling faces 28 counts of fraud, conspiracy, insider trading and lying to auditors, while Lay faces six counts of fraud and conspiracy.

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