Former Officials Say Enron Hid Gains During Crisis

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Former Officials Say Enron Hid Gains During Crisis in California

By DAVID BARBOZA

OUSTON, June 22 — The Enron Corporation used undisclosed reserves to keep as much as $1.5 billion in trading profits off its books during the California energy crisis, according to six former managers and executives who handled or reviewed the accounts.

The enormous reserves, which would have doubled the company's reported profits, were hidden in late 2000 and early 2001, as energy prices soared in California and politicians accused trading companies like Enron of price gouging. The former Enron officials said that the company swelled the reserves in hopes of damping the political firestorm.

Further, some former executives said, Enron manipulated the reserves to help it report steady profit growth to Wall Street and credit rating agencies. Investors generally are not willing to pay as much for the stock of a volatile trading operation as they would for companies — like Enron before its collapse — that report steady quarter-by-quarter growth.

The Securities and Exchange Commission and investigators from the Justice Department have interviewed witnesses to determine whether the practices violated securities laws by creating "cookie jar reserves" or a kind of corporate slush fund to doctor quarterly earnings reports, according to people who have been interviewed by investigators.

The existence of the huge reserves adds a strange twist to the Enron story. The company filed for bankruptcy protection last December amid reports that executives inflated profits and hid losses with off-balance-sheet partnerships. But interviews with more than a dozen former executives and managers suggest that the company at times also held back trading profits to serve its political and financial ends.

The majority of these gains were "paper" profits on long-term contracts, rather than cash that could have helped Enron stave off the liquidity crisis that led to its collapse last fall. In any event, one former executive said, the reserves were depleted in the months before Enron's bankruptcy.

The use of reserves to manage profits is outlawed, but it is not uncommon. This month, the Microsoft Corporation agreed to settle an enforcement action in which the S.E.C. charged it with maintaining huge reserves in the late 1990's that could have been used to enhance profits when the company's earnings growth began to wane.

Former top executives at Enron, including Kenneth L. Lay, the longtime chairman, and Jeffrey K. Skilling, the company's president and later chief executive, said last week through their spokeswomen that they were aware of the reserves but considered them proper.

Judy Leon, Mr. Skilling's spokeswoman, said that money was set aside mainly in credit reserves to insulate Enron from the risk that California's utilities could be bankrupted by the crisis and left unable to pay their debts. "At no time did Mr. Skilling have any knowledge of inappropriate or illegal activity in the reserve account," she said. The S.E.C. questioned Mr. Skilling about the reserves late last year, according to a person who has reviewed his testimony.

Accounting rules allow for credit reserves — and, indeed, California's biggest investor-owned utility, Pacific Gas and Electric, sought bankruptcy protection in April 2001, owing Enron $500 million. The rules also permit companies to reserve against specific contingencies, like litigation. And trading companies can use so-called prudency reserves to protect against market risks, like the inability to exit a trading position at a good price.

But six former Enron officials who handled or reviewed the accounts said that Enron used prudency reserves to manipulate the reported profits of its energy trading operations.

The economic value of energy trades — particularly deals providing for the delivery of electricity long in the future — is highly subjective. As the dominant trader, analysts say, Enron had great leeway to establish market prices. Likewise, when profits seemed bloated during the California crisis, executives said, it became common to give trades a "haircut," shifting a portion of the profits into a reserve that could later be drawn down.

One former executive recounted how Enron traders made close to $500 million on a single day in the summer of 2000, after a natural gas pipeline burst near Carlsbad, N.M., and market prices spiked.

"We made such an incredible amount of money we didn't want to recognize it all into earnings," said the executive, who like others interviewed requested anonymity because of concern about being drawn into litigation. "We were supposed to make $500 million in a quarter and we were doing it in a day." Two other former Enron officials confirmed details of the episode.

Accounting experts said that the subjectivity of prudency reserves makes them susceptible to abuse.

"If you're using trading reserves as a mechanism for understating your positions in good times — and therefore not reporting profits — and later reporting the old profits in times that aren't as good, that would clearly be an abuse of the accounting rules," said Lynn Turner, a professor at Colorado State University and the former chief accountant for the S.E.C.

During the energy crisis, power shortages led to rolling blackouts and price spikes in California. Elected officials railed at power merchants, with Gov. Gray Davis accusing them of profiteering and market manipulation.

At the time, Enron executives denied the charges, blaming a poorly designed energy market for California's problems. And while the company reported profits of $350 million for the last three months of 2000 — 34 percent more than a year earlier — executives minimized the impact of the crisis on Enron's bottom line.

"Now for Enron, the situation in California had little impact on fourth-quarter results," Mr. Skilling told Wall Street analysts on a Jan. 22, 2001, conference call. "Let me repeat that. For Enron, the situation in California had little impact on fourth-quarter results." He explained that because Enron did not own power plants in California, the company did "not invite the same accusations the generators have faced regarding excessive profits."

The disclosure of internal documents last month describing ways that Enron's traders operated in California's market prompted officials to renew their demand for billions in refunds from energy companies. Told about the reserves, Gov. Davis expressed fresh outrage.

"Enron's made such a killing off this state, they were embarrassed to disclose it to their shareholders," the governor said on Friday in a statement. "Unfortunately, Enron will live on as a symbol for everything that has gone wrong with electricity deregulation."

Several high-ranking Enron executives said that the company began using reserves to "smooth" or "manage" earnings growth as early as 1998, when energy price spikes in the Midwest brought traders unwanted scrutiny.

Enron's disclosures about its reserves were limited, and, according to former executives, incomplete. In its year-end report for 2000, it listed $452 million in "credit and other reserves." There was nothing disclosed about prudency reserves.

Enron's use of the reserves was approved by Arthur Andersen, the company's longtime auditor, and by Richard A. Causey, the company's chief accounting officer. His lawyer, J. C. Nickens, said that Mr. Causey — who left the company after its collapse — told Enron's board that the company was using a combination of credit and prudency reserves.

W. Neil Eggleston, an attorney for the independent directors who have left the board since Enron's collapse, said, "If the management of Enron was using reserves to manipulate the profits of the company, the board was completely unaware of it."

Kelly Kimberly, the spokeswoman for Mr. Lay, Enron's former chairman, said that both the growth of the prudency reserves and their subsequent release into the company's profit stream were appropriate.

"It is a common practice and in fact a responsible practice to increase prudency reserves when volatility is high and when prices are rising," she said. "In 2000, volatility was high and natural gas and electricity prices rose at least fivefold over the course of the year. In 2001, when prices and volumes declined, the prudency reserve would also have been adjusted downward."

Patrick Dorton, a spokesman for Andersen, said the firm did not engage in any wrongdoing. "Andersen auditors would never, under any circumstances, tolerate an arrangement intended to manage earnings," he said. "Not in this situation, or any other, did that happen."

Former managers and executives said there were at least three types of reserve funds and that they totaled between $800 million and $2 billion at various times in 2000 and 2001.

During the California energy crisis, the reserves skyrocketed, former managers and executives said. Enron's traders were making more than enough to meet profit targets. And there were concerns that the big gains would not last.

"There were days when we were making $100 million," said another former Enron manager with access to the trading records. "When you're making that kind of money you have to ask yourself, `Are we the market?' Your earnings are unfathomable, so you say, `Maybe we're too large. Maybe we ought to reserve something.' "