What Did Ken Lay Know on Aug. 20?
On Aug. 20, 2001, Kenneth L. Lay was absolutely upbeat about Enron's prospects. Although Jeffrey K. Skilling had abruptly resigned as Enron's president and CEO less than a week before, Lay insisted that the company's slate was clean. "There are absolutely no problems that had anything to do with Jeff's departure," Lay, who had just reassumed the CEO job, told BusinessWeek Dallas Correspondent Stephanie Anderson Forest that day. "There are no accounting issues, no trading issues, no reserve issues, no previously unknown problem issues.... There is no other shoe to fall."
Two months later, Enron's finances began to unravel. By December, the company was in bankruptcy, and on Jan. 23, Lay resigned under pressure from Enron's creditors. But what federal investigators want to know is: Did Lay know more than he was admitting on Aug. 20 -- and were his statements to BusinessWeek Online an act of securities fraud?
THE FAMOUS MEMO.
Investigators in Congress and at the Securities & Exchange Commission have uncovered a chronology they believe suggests Lay should have known of Enron's massive accounting problems before that interview. Enron Vice-President Sherron S. Watkins' now-famous memo to Lay -- asking, "Has Enron become a risky place to work?" and pointing out that "Enron has been very aggressive in its accounting" -- was written and dropped off for Lay to review on Aug. 15, according to congressional investigators and Watkins' lawyer. By Aug. 20, Lay had scheduled a meeting with Watkins to discuss her concerns, according to her lawyer, Philip Hilder of Houston. Documents obtained by congressional investigators back up that date.
If Lay knew of the problems and had good reason to view them as substantial, any public statements denying those problems could be deemed false and misleading corporate disclosures. That would be a potential civil or even criminal violation of federal securities laws. "If it appears in BusinessWeek or on its Web site, he's as vulnerable for that as if he put it out in a company news release," says a former top SEC lawyer. The interview with Lay was posted on the Web site on Aug. 24, 2001.
Lay's statements are now a matter of interest to the SEC, which has acknowledged it is investigating the company. BusinessWeek has provided the agency with the published transcript of the interview from its Web site. Enron is also under investigation by the Justice Dept., the Internal Revenue Service, the Labor Dept., two Cabinet-level task forces, and 10 congressional committees.
Lay's attorney, Earl J. Silbert of the Washington firm Piper Marbury Rudnick & Wolfe, declined to speak on the record about Lay's knowledge of Watkins' allegations at the time of the interview.
A MATTER OF TIMING.
The evidence starts with Watkins' memo, in which she told Lay: "I am incredibly nervous that we will implode in a wave of accounting scandals." Although Watkins' letter was unsigned, she soon identified herself and met with Lay for one hour on Aug. 22.
The question for investigators is: Had Lay read Watkins' memo detailing questionable transactions and aggressive accounting in Enron's now-controversial trading partnerships by the time he got on the phone with BusinessWeek's Forest -- between noon and 1 p.m. on Aug. 20 -- and issued his "no other shoe" statements?
Watkins says her meeting with Lay was scheduled by Aug. 20, according to Hilder, her lawyer. Further, on the 20th, Watkins told a friend at Enron's auditing firm, Arthur Andersen, about the coming meeting. According to an Aug. 21 memo by James A. Hecker, a Houston-based Andersen partner, Watkins called Hecker on Aug. 20 to discuss her concerns about Enron's accounting. In a memo he wrote about the conversation, Hecker said: "Sherron told me she was concerned enough about these issues that she was going to discuss them with Ken Lay, Enron's Chairman, on Wednesday, August 22, 2001."
ANONYMOUS DROP BOX.
What's unclear is how much Lay knew of Watkins' concerns when he spoke to BusinessWeek Online. Hilder, the lawyer, says Watkins had delivered only the first page of what became a seven-page memo at that point. That page contains Watkins' most explosive allegations, while the ensuing six pages are detailed backup. Further, she delivered the memo to a "drop box" Lay had provided for employees to express their concerns anonymously in the wake of CEO Skilling's resignation. Hilder could not say whether Watkins called her memo to Lay's or his staff's attention when she scheduled her meeting with him.
A bigger question may be whether Lay had sufficient reason to believe Watkins' charges were credible. He's likely to argue that the charges were unsubstantiated and that his knowledge of the company supported his statement that Enron "is probably in the strongest and best shape that it has ever been in."
But Lay's later actions indicate he did take Watkins' concerns seriously: He sent her memo to Enron's general counsel, who asked Enron's Houston law firm, Vinson & Elkins, to review the partnership transactions. That review was carefully circumscribed: V&E's report said Enron and the law firm "decided that our initial approach would not involve the second guessing of [Andersen's] accounting advice...there would be no detailed analysis of each and every transaction."
"IN HIS HEAD"?
And V&E itself had previously issued legal clearance for many of the Enron partnerships. Under those conditions, V&E concluded on Oct. 15 that Watkins' allegations "do not, in our judgment, warrant a further widespread investigation by independent counsel and auditors."
That sequence of events may strengthen the investigators' case. The BusinessWeek Online interview was conducted after Watkins had delivered her memo but before V&E's report. If Lay had read the memo, "The knowledge was in his head, but he didn't have the benefit of someone having assured him [the Watkins charges] didn't matter," says a source familiar with the federal investigations.
And Lay's categorical statement to BusinessWeek Online -- "no accounting issues, no trading issues, no reserve issues, no previously unknown problem issues" -- may have dug the legal hole a little deeper. That statement hits on most of the areas that have since tripped Enron into massive earnings restatements and bankruptcy.
By speaking so strongly, Lay himself appeared to be aware of those risks. "If there's anything material and we're not reporting it, we'd be breaking the law," he told BusinessWeek's Forest. "We don't break the law." Now, SEC and Justice Dept. investigators will be probing these statements.
By Mike McNamee, with Wendy Zellner and Stephanie Anderson Forest in Dallas, and Laura Cohn in Washington
Edited by Douglas Harbrecht