Role of BOD in Enron's Collapse: U.S. SubCommitee Investigation July 8, 2002

107th Congress
C O M M I T T E E
Report
2d Session
107 -70
THE ROLE OF
THE BOARD OF DIRECTORS IN
ENRON'S COLLAPSE
__________
R E P O R T
PREPARED BY THE
PERMANENT SUBCOMMITTEE ON INVESTIGATIONS
OF THE
COMMITTEE ON GOVERNMENTAL AFFAIRS
UNITED STATES SENATE
JULY 8, 2002

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C O N T E N T S
____________
SUBCOMMITTEE INVESTIGATION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
SUBCOMMITTEE FINDINGS
(1) Fiduciary Failure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
(2) High Risk Accounting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
(3) Inappropriate Conflicts of Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
(4) Extensive Undisclosed Off-The-Books Activity . . . . . . . . . . . . . . . . . . . . . . . . . 3
(5) Excessive Compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
(6) Lack of Independence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
SUBCOMMITTEE RECOMMENDATIONS
(1) Strengthening Oversight . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
(2) Strengthening Independence. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
BACKGROUND

Fiduciary Obligations of Boards of Directors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Enron Corporation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
Enron Board . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
FACTUAL BASIS FOR FINDINGS
(1) Fiduciary Failure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
(2) High Risk Accounting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
Andersen Briefings on High Risk Areas . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
Other Evidence of Board Awareness of Enron's High Risk Accounting . 20
(3) Inappropriate Conflicts of Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24
Board Approval of LJM With Few Questions Asked . . . . . . . . . . . . . . . . 26
Flawed Controls to Mitigate LJM Conflicts . . . . . . . . . . . . . . . . . . . . . . . . 29
Inadequate Board Oversight of LJM Transactions with Enron . . . . . . . . 32
Inadequate Board Oversight of Fastow's LJM Compensation . . . . . . . . . 35
LJM Profits at the Expense of Enron . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37
(4) Extensive Undisclosed Off-The-Books Activity . . . . . . . . . . . . . . . . . . . . . . . . 39
Whitewing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39
LJM Partnerships . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42
The Raptors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44
Inadequate Public Disclosure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51
(5) Excessive Compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 53
(6) Lack of Independence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55
Board Independence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55
Auditor Independence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 58
CONCLUSION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60

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THE ROLE OF
THE BOARD OF DIRECTORS IN ENRON'S COLLAPSE
_____________________
SUBCOMMITTEE INVESTIGATION
On December 2, 2001, Enron Corporation, then the seventh largest publicly traded
corporation in the United States, declared bankruptcy. That bankruptcy sent shock waves
throughout the country, both on Wall Street and Main Street where over half of American families
now invest directly or indirectly in the stock market. Thousands of Enron employees lost not only
their jobs but a significant part of their retirement savings; Enron shareholders saw the value of their
investments plummet; and hundreds, if not thousands of businesses around the world, were turned
into Enron creditors in bankruptcy court likely to receive only pennies on the dollars owed to them.
On January 2, 2002, Senator Carl Levin, Chairman of the Permanent Subcommittee on
Investigations and Senator Susan M. Collins, the Ranking Minority Member, announced that the
Subcommittee would conduct an in-depth investigation into the collapse of the Enron Corporation.
The following month the Subcommittee issued over 50 subpoenas to Enron Board members, Enron
officers, the Enron Corporation and the Arthur Andersen accounting firm. Over the next few
months, additional subpoenas and document requests were directed to other accounting firms and
financial institutions. By May 2002, the Subcommittee staff had reviewed over 350 boxes of
documents, including the available meeting minutes, presentations and attachments for the full
Board and its Finance and Audit Committees. The Subcommittee staff also spoke with
representatives of Enron Corporation and Andersen, as well as numerous financial institutions and
experts in corporate governance and accounting.
During April 2002, the Subcommittee staff interviewed thirteen past and present Enron
Board members, none of whom had previously been interviewed by the U.S. Department of Justice,
Federal Bureau of Investigation, or the Securities and Exchange Commission. These lengthy
interviews, lasting between three and eight hours, were conducted with the following Enron Board
members: Robert A. Belfer; Norman P. Blake, Jr.; Ronnie C. Chan; John H. Duncan; Dr. Wendy
L. Gramm; Dr. Robert K. Jaedicke; Dr. Charles A. LeMaistre; Dr. John Mendelsohn; Paulo Ferraz
Pereira; Frank Savage; Lord John Wakeham; Charls Walker; and Herbert S. Winokur, Jr. All Board
members appeared voluntarily, and all were represented by the same legal counsel.
On May 7, 2002, the Subcommittee held a hearing on the role and responsibility of the Enron
Board of Directors to safeguard shareholder interests and on its role in Enron's collapse and
bankruptcy. Two panels of witnesses testified under oath. The first panel consisted of five past and
present Enron Board members, including the current Board Chairman and the past Chairmen of the
key Board Committees. The witnesses were as follows:
Norman P. Blake, Jr. (1994 - 2002), Interim Chairman of the Enron Board and former
member of the Enron Finance and Compensation Committees, has extensive corporate,

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Board and investment experience, including past service on the Board of General Electric
and current service as Audit Committee Chairman of the Board of Owens Corning;
John H. Duncan (1985 - 2001), former Chairman of the Enron Executive Committee, has
extensive corporate and Board experience, including helping to found and manage Gulf and
Western Industries;
Herbert S. Winokur, Jr. (1985 - 2002), current Board member, former Chairman of the
Finance Committee, and former member of the Powers Special Committee, holds two
advanced degrees from Harvard University and has extensive corporate, Board and
investment experience;
Dr. Robert K. Jaedicke (1985 - 2001), former Chairman of the Enron Audit and Compliance
Committee, is Dean Emeritus of the Stanford Business School and a former accounting
professor; and
Dr. Charles A. LeMaistre (1985 - 2001), former Chairman of the Enron Compensation
Committee, is former President of the M.D. Anderson Cancer Center, a large, well-respected
and complex medical facility in Texas.1
The second panel consisted of three experts in corporate governance and accounting:
Robert H. Campbell is former Chairman of the Board and Chief Executive Officer of
Sunoco, Inc., and current Board member at Hershey Foods, CIGNA, and the Pew Charitable
Trusts;
Charles M. Elson is Director of the Center for Corporate Governance, University of
Delaware and a former member of the Board of Sunbeam Corporation; and
Michael H. Sutton is the former Chief Accountant of the Securities and Exchange
Commission from 1995 to 1998.
SUBCOMMITTEE FINDINGS
1Two Enron Directors, Mr. Blake and Mr. Winokur, who were members of the Board at the time of the May
7 hearing, resigned from the Enron Board on June 6, 2002.

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Based upon the evidence before it, including over one million pages of subpoenaed
documents, interviews of thirteen Enron Board members, and the Subcommittee hearing on May 7,
2002, the U.S. Senate Permanent Subcommittee on Investigations makes the following findings with
respect to the role of the Enron Board of Directors in Enron's collapse and bankruptcy.
(1) Fiduciary Failure. The Enron Board of Directors failed to safeguard Enron
shareholders and contributed to the collapse of the seventh largest public company in the
United States, by allowing Enron to engage in high risk accounting, inappropriate conflict
of interest transactions, extensive undisclosed off-the-books activities, and excessive
executive compensation. The Board witnessed numerous indications of questionable
practices by Enron management over several years, but chose to ignore them to the detriment
of Enron shareholders, employees and business associates.
(2) High Risk Accounting. The Enron Board of Directors knowingly allowed Enron to
engage in high risk accounting practices.
(3) Inappropriate Conflicts of Interest. Despite clear conflicts of interest, the Enron Board
of Directors approved an unprecedented arrangement allowing Enron's Chief Financial
Officer to establish and operate the LJM private equity funds which transacted business with
Enron and profited at Enron's expense. The Board exercised inadequate oversight of LJM
transaction and compensation controls and failed to protect Enron shareholders from unfair
dealing.
(4) Extensive Undisclosed Off-The-Books Activity. The Enron Board of Directors
knowingly allowed Enron to conduct billions of dollars in off-the-books activity to make its
financial condition appear better than it was and failed to ensure adequate public disclosure
of material off-the-books liabilities that contributed to Enron's collapse.
(5) Excessive Compensation. The Enron Board of Directors approved excessive
compensation for company executives, failed to monitor the cumulative cash drain caused
by Enron's 2000 annual bonus and performance unit plans, and failed to monitor or halt
abuse by Board Chairman and Chief Executive Officer Kenneth Lay of a company-financed,
multi-million dollar, personal credit line.
(6) Lack of Independence. The independence of the Enron Board of Directors was
compromised by financial ties between the company and certain Board members. The Board
also failed to ensure the independence of the company's auditor, allowing Andersen to
provide internal audit and consulting services while serving as Enron's outside auditor.
SUBCOMMITTEE RECOMMENDATIONS

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Based upon the evidence before it and the findings made in this report, the U.S. Senate
Permanent Subcommittee on Investigations makes the following recommendations.
(1) Strengthening Oversight. Directors of publicly traded companies should take steps to:
(a) prohibit accounting practices and transactions that put the company at high risk of
non-compliance with generally accepted accounting principles and result in misleading
and inaccurate financial statements;
(b) prohibit conflict of interest arrangements that allow company transactions with a
business owned or operated by senior company personnel;
(c) prohibit off-the-books activity used to make the company's financial condition appear
better than it is, and require full public disclosure of all assets, liabilities and activities
that materially affect the company's financial condition;
(d) prevent excessive executive compensation, including by --
(i) exercising ongoing oversight of compensation plans and payments;
(ii) barring the issuance of company-financed loans to directors and senior officers
of the company; and
(iii) preventing stock-based compensation plans that encourage company personnel
to use improper accounting or other measures to improperly increase the company
stock price for personal gain; and
(e) prohibit the company's outside auditor from also providing internal auditing or
consulting services to the company and from auditing its own work for the company.
(2) Strengthening Independence. The Securities and Exchange Commission and the self-
regulatory organizations, including the national stock exchanges, should:
(a) strengthen requirements for Director independence at publicly traded companies,
including by requiring a majority of the outside Directors to be free of material financial
ties to the company other than through Director compensation;
(b) strengthen requirements for Audit Committees at publicly traded companies,
including by requiring the Audit Committee Chair to possess financial management or
accounting expertise, and by requiring a written Audit Committee charter that obligates
the Committee to oversee the company's financial statements and accounting practices
and to hire and fire the outside auditor; and
(c) strengthen requirements for auditor independence, including by prohibiting the
company's outside auditor from simultaneously providing the company with internal
auditing or consulting services and from auditing its own work for the company.

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BACKGROUND

Fiduciary Obligations of Boards of Directors. In the United States, the Board of Directors
sits at the apex of a company's governing structure. A typical Board's duties include reviewing the
company's overall business strategy; selecting and compensating the company's senior executives;
evaluating the company's outside auditor; overseeing the company's financial statements; and
monitoring overall company performance. According to the Business Roundtable, the Board's
"paramount duty" is to safeguard the interests of the company's shareholders.2
Directors operate under state laws which impose fiduciary duties on them to act in good
faith, with reasonable care, and in the best interest of the corporation and its shareholders. Courts
generally discuss three types of fiduciary obligations. As one court put it:
"Three broad duties stem from the fiduciary status of corporate directors: namely, the duties
of obedience, loyalty, and due care. The duty of obedience requires a director to avoid
committing ... acts beyond the scope of the powers of a corporation as defined by its charter
or the laws of the state of incorporation. ... The duty of loyalty dictates that a director must
act in good faith and must not allow his personal interest to prevail over the interests of the
corporation. ... [T]he duty of care requires a director to be diligent and prudent in managing
the corporation's affairs.3
In most states, directors also operate under a legal doctrine called the "business judgment
rule," which generally provides directors with broad discretion, absent evidence of fraud, gross
negligence or other misconduct, to make good faith business decisions. Most states permit
corporations to indemnify their directors from liabilities associated with civil, criminal or
administrative proceedings against the company. In addition, most U.S. publicly traded
corporations, including Enron, purchase directors' liability insurance that pays for a director's legal
expenses and other costs in the event of such proceedings.
Among the most important of Board duties is the responsibility the Board shares with the
company's management and auditors to ensure that the financial statements provided by the
company to its shareholders and the investing public fairly present the financial condition of the
company. This responsibility requires more than ensuring the company's technical compliance with
generally accepted accounting principles. According to the Second Circuit Court of Appeals, this
technical compliance may be evidence that a company is acting in good faith, but it is not
2"Statement on Corporate Governance," The Business Roundtable (9/97) at 3.
3Gearheart Industries v. Smith International, 741 F.2d 707, 719 (5th Cir. 1984).

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necessarily conclusive. The "critical test," the Court said, is "whether the financial statements as
a whole fairly present the financial position" of the company.4
Over the years, blue ribbon commissions, corporate organizations, and academic scholars
have addressed the fiduciary obligations of Boards of Directors of publicly traded companies,
including their role in ensuring accurate financial statements. In 1999, the Committee of Sponsoring
Organizations of the Treadway Commission issued a report on "Fraudulent Financial Reporting
1987-1997; An Analysis of U.S. Public Companies," evaluating 200 cases of publicly traded
companies involved in financial statement fraud. Among other findings, the report stated that
companies with fraudulent financial statements appeared to have boards "dominated by insiders"
and "weak" audit committees that rarely met. The report stated that its results "highlight the need
for an effective control environment, or `tone at the top'" and urged improvements in companies'
internal controls, governance and ethics.
In 2000, the Blue Ribbon Commission on Improving the Effectiveness of Corporate Audit
Committees issued 10 recommendations identifying best Committee practices at publicly traded
companies. The Commission recommended that all publicly traded companies establish an audit
committee with a formal charter and members who are independent and "financially literate," at
least one of whom has accounting or financial management expertise. The Commission
recommended that audit committees: (1) evaluate the objectivity and independence of the company
auditor; (2) discuss the "auditor's judgements about the quality, not just the acceptability, of the
company's accounting principles as applied in its financial reporting," including the "clarity of the
company's financial disclosures and degree of aggressiveness or conservatism of the company's
accounting principles ..."; (3) determine that the company's financial statements are "fairly presented
in conformity with generally accepted accounting principles in all material respects"; and (4) discuss
with the auditor "significant [accounting] adjustments, management judgement and accounting
estimates, significant new accounting policies, and disagreements with management."
The Commission report states: "Board membership is no longer just a reward for `making
it' in corporate America; being a director today requires the appropriate attitude and capabilities, and
it demands time and attention." The report urged boards of directors to "understand and adopt the
attitude of the modern board which recognizes that the board must perform active and independent
oversight to be, as the law requires, a fiduciary for those who invest in the corporation."
Enron Corporation. At the time of Enron's collapse in December 2001, Enron Corporation
was listed as the seventh largest company in the United States, with over $100 billion in gross
revenues and more than 20,000 employees worldwide. It had received widespread recognition for
its transition from an old-line energy company with pipelines and power plants, to a high tech global
enterprise that traded energy contracts like commodities, launched into new industries like
broadband communications, and oversaw a multi-billion-dollar international investment portfolio.
4U.S. v. Simon, 425 F. 2d 796, 805-6 (2nd Cir. 1969), cert. denied, 397 U.S. 1006 (1970)(quoting, in part,
the trial judge). See also 15 USC 77s and 78m ("Every issuer ... shall ... keep books, records, and accounts, which,
in reasonable detail, accurately and fairly reflect the transactions and disposition of the assets of the issuer.")

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One of Enron's key corporate achievements during the 1990s was creation of an online
energy trading business that bought and sold contracts to deliver energy products like natural gas,
oil or electricity. Enron treated these contracts as marketable commodities comparable to securities
or commodity futures, but was able to develop and run the business outside of existing controls on
investment companies and commodity brokers. The nature of the new business required Enron's
access to significant lines of credit to ensure that the company had the funds at the end of each
business day to settle the energy contracts traded on its online system. This new business also
caused Enron to experience large earnings fluctuations from quarter to quarter. Those large
fluctuations potentially affected the credit rating Enron received, and its credit rating affected
Enron's ability to obtain low-cost financing and attract investment. In order to ensure an
investment-grade credit rating, Enron began to emphasize increasing its cash flow, lowering its debt,
and smoothing its earnings on its financial statements to meet the criteria set by credit rating
agencies like Moody's and Standard & Poor's.
Enron developed a number of new strategies to accomplish its financial statement objectives.
They included developing energy contracts Enron called "prepays" in which Enron was paid a large
sum in advance to deliver natural gas or other energy products over a period of years; designing
hedges to reduce the risk of long-term energy delivery contracts; and pooling energy contracts and
securitizing them through bonds or other financial instruments sold to investors. Another high
profile strategy, referred to as making the company "asset light," was aimed at shedding, or
increasing immediate returns on, the company's capital-intensive energy projects like power plants
that had traditionally been associated with low returns and persistent debt on the company's books.
The goal was either to sell these assets outright or to sell interests in them to investors, and record
the income as earnings which top Enron officials called "monetizing" or "syndicating" the assets.
A presentation made to the Finance Committee in October 2000, summarized this strategy as
follows.5 It stated that Enron's "[e]nergy and communications investments typically do not generate
significant cashflow and earnings for 1-3 years." It stated that Enron had "[l]imited cash flow to
service additional debt" and "[l]imited earnings to cover dilution of additional equity." It concluded
that "Ernon must syndicate" or share its investment costs "in order to grow."
One of the problems with Enron's new strategies, however, was finding counterparties
willing to invest in Enron assets or share the significant risks associated with long-term energy
production facilities and delivery contracts.6 The October 2000 presentation to the Finance
Committee showed that one solution Enron had devised was to sell or syndicate its assets, not to
independent third parties, but to "unconsolidated affiliates" - businesses like Whitewing, LJM,
JEDI, the Hawaii125-0 Trust and others that were not included in Enron's financial statements but
were so closely associated with the company that Enron considered their assets to be part of Enron's
5Hearing Exhibit 39, "Private Equity Strategy" (Finance Committee presentation, 10/00).
6As part of its asset light strategy, during the summer of 2000, Enron worked on a transaction called
"Project Summer" to sell $6 billion of its international assets to a single purchaser in the Middle East. Enron's
Directors indicated during their interviews that this deal fell through when the purchaser's key decisionmaker
became ill. Enron then pursued the asset sales on a piecemeal basis, using Whitewing, LJM and others.

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own holdings. The October 2000 presentation, for example, informed the Finance Committee that
Enron had a total of $60 billion in assets, of which about $27 billion, or nearly 50 percent, were
lodged with Enron's "unconsolidated affiliates."
All of the Board members interviewed by the Subcommittee were well aware of and
supported Enron's intense focus on its credit rating, cash flow, and debt burden. All were familiar
with the company's "asset light" strategy and actions taken by Enron to move billions of dollars in
assets off its balance sheet to separate but affiliated companies. All knew that, to accomplish its
objectives, Enron had been relying increasingly on complicated transactions with convoluted
financing and accounting structures, including transactions with multiple special purpose entities,
hedges, derivatives, swaps, forward contracts, prepaid contracts, and other forms of structured
finance. While there is no empirical data on the extent to which U.S. public companies use these
devices, it appears that few companies outside of investment banks use them as extensively as
Enron. At Enron, they became dominant; at its peak, the company apparently had between $15 and
$20 billion involved in hundreds of structured finance transactions.

Enron Board. In 2001, Enron's Board of Directors had 15 members, several of whom had
20 years or more experience on the Board of Enron or its predecessor companies. Many of Enron's
Directors served on the boards of other companies as well. At the hearing, John Duncan, former
Chairman of the Executive Committee, described his fellow Board members as well educated,
"experienced, successful businessmen and women," and "experts in areas of finance and
accounting."7 The Subcommittee interviews found the Directors to have a wealth of sophisticated
business and investment experience and considerable expertise in accounting, derivatives, and
structured finance.
Enron Board members uniformly described internal Board relations as harmonious. They
said that Board votes were generally unanimous and could recall only two instances over the course
of many years involving dissenting votes. The Directors also described a good working relationship
with Enron management. Several had close personal relationships with Board Chairman and Chief
Executive Officer (CEO) Kenneth L. Lay. All indicated they had possessed great respect for senior
Enron officers, trusting the integrity and competence of Mr. Lay; President and Chief Operating
Officer (and later CEO) Jeffrey K. Skilling; Chief Financial Officer Andrew S. Fastow; Chief
Accounting Officer Richard A. Causey; Chief Risk Officer Richard Buy; and the Treasurer Jeffrey
McMahon and later Ben Glisan. Mr. Lay served as Chairman of the Board from 1986 until he
resigned in 2002. Mr. Skilling was a Board member from 1997 until August 2001, when he resigned
from Enron.
The Enron Board was organized into five committees.
7Hearing Record at 34.

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