December 28, 2003

Enron and Former Army Secretary Tom White

There was some discussion over the past several years about the qualifications of former Enron executive Thomas White to be Bush's Secretary of the Army. Rumsfeld fired him at the start of May 2003.

Reading Bethany McLean and Peter Elkind (2003), The Smartest Guys in the Room: The Amazing Rise and Fall of ENRON (New York: Penguin: 1591840082) makes it clear that Tom White's appointment--and his survival for more than two years--was even more astonishing than I had previously imagined. From the summer of 1997 until the winter of 2001 Tom White was the number two executive at Enron Energy Services [EES], and here's what McLean and Elkind have to say about EES:

p. 175 ff: ...In March 1997, two months after becoming president, Skilling... broke out retail as a separate business, named it Enron Energy Services, and designated Lou Pai as its chairman and CEO.... A few months later Tom White, the retired general who had managed the construction of Teesside, was named Pai's number two.... But how was this new team going to turn things around? Enron had lost $35 million on the retail [power sales] business in 1996. The following year... a hiring binge... advertising costs, EES appeared headed for a $100 million loss. Wall Street had become agitated....

Andy Fastow's finance group began working on a plan.... [T]wo investors [the Ontario Teachers' Pension Plan and JEDI II, Enron's 50/50 partnership with CalPERS] agreed to take a 7 percent stake in EES for $130 million.... [T]he deal allowed Enron to book a $61 million profit in 1997... 58% of the company's net earnings that year.... Enron booked the entire gain from the deal, even though EES received its money in three annual installments (and an Arthur Anderson in-house expert had advised the Enron audit team that only one-third of the gain should have been recorded in 1997)....

Only a few months after Enron booked this gain from selling part of EES, the company finally threw in the towel on its residential energy campaign.... Instead of targeting homes, it would target businesses.... And instead of just selling them power, it would subcontract to take care of all their energy needs....

"That was the pitch," recalls an early EES executive: "'You go focus on building your widget, and we'll worry about the energy side of the business. We're the energy experts.'"... EES was promising savings of anywhere between 5 to 15 percent.

The more perplexing question is why this would be an alluring idea for Enron.... [M]ost states were still refusing to deregulate retail energy. That meant the only way Enron could cut the cost of energy for a customer was to buy electricity from a local utility and resell it at a loss.... Enron was willing to do this because it remained convinced--despite much evidence to the contrary--that the states would soon open up their markets and the company would begin making money at the tail end of their contracts.... [T]his new thrust by EES was taking Enron somewhere it didn't belong.... Enron was promising, for instance, to make energy-efficiency improvements, many of which would require big up-front expenditures. But what did Enron executives know about energy efficiency? Nothing.... pricing energy costs for customers was especially tricky....

One thing Enron was good at quickly came into play, though: cutting deals.... Offering big customers millions in guaranteed savings, EES began rapidly signing up high-profile clients.... EES was still reporting losses: $119 million in... 1998, another $68 million in 1999....

Back in January 1998... Enron invited the analysts who covered [EES] to Houston.... The group was escorted to the sixth floor... where they were shown what was described as the EES war room... a big open room, bustling with people, all busily working the telephones and hunched over computer terminals.... It was also a veritable sham... secretaries, EES staff from other locations, and non EES employees who had been drafted for the occasion and coahed on the importance of appearing busy.... After getting the all-clear signal... [they] returned to [their] real desk[s].... The analysts had no clue they'd been hoodwinked....

[I]f you tell all your highly aggressive deal makers that the only thing that matters is total contract value and add to that horrible ontrols and an extreme urgency to get deals done quickly and a compensation system based on the projected profitability of long-term deals, you're inevitably going to get an awful lot of bad contrasts.... EES executives used all the standard tricks to make their deals look better than they were.... They singed fifteen-year contracts that even they acknowledged would lose money for the first ten years--but included a wildly optimistic price curve that showed steep profits at the end.... They underestimated the cost of and overstated the savings from efficiency improvements. They stomped all over Rick Buy's risk assessors.... Even after it started reporting quarterly accounting profits, EEs was hemorrhaging cash.... [I]ts operating expenses were huge... it was writing multimillion-dollar checks to win contracts. Then there was the matter of making energy improvements, a huge capital expense....

[T]he biggest problem of all: once Enron had the contracts, it had to start fulfilling the terms.... Take the California public universities' contracts, which required EEs to bill the university system for energy use on each of their 31 campuses. According to David DeMauro, a Cal STate administrator... from the very first month that the contract went into effect... "There were no situations... where the bills were eithe ron time or correct. People either didn't get the bills or they got incorrect bills. We went four years without receiving timely or accurate bills. We figured a company like thi scould do something as easy as turning out timely, accurate bills. They were never able to do so."

"The problem was so widespread... we decided that our strategy would be tha twe would not pay Enron until they could deliver us an accurate bill. We probably went five or six months without paying Enron at all. I would guess our accounts payable was approaching $40 million or so."

Enron never delivered the energy-efficiency projects it had promised, either, says DeMauro. The one constant in dealing with Enron, he says: "People we worked with were always making promises that weren't kept."...

Posted by DeLong at December 28, 2003 08:28 PM | TrackBack

Comments

I wonder what "the energy efficieny" rate of US economy these days is. I think that is something like "GDP per unit energy consumed", or it is computed on that basis. And I understand certain communities don't like to talk about it. For example it became obvious to me, though I might be wrong, that CNN didn't like to make a mention of it even during Clinton administration.

Why is this relevant?

Transparency of issues is as important as transparency of transactions in the way of reducing corruption. One of contributors to this blog Stephen J Fromm might want to testify to that, just might.

But where even "CNN during Clinton administration" shys away from even making a mention of a term like "energy efficiency of US economy" for what reason God knows, well, then expect more cases of Enron.... and expect more wars without a clear and good reason...

Posted by: Bulent Sayin on December 28, 2003 09:51 PM

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The reason for Enron scam accounting is simple: look bigger and more profitable - your real revenue comes from leveraging the capitalization anyway.
And the reason for that is simple: your capitalization has little to do with your business' revenues (personally, my favorite is P/E 100 - it means whatever you earn on the stock has nothing to do with what the company earns).
In other words, if US stock market was not a pyramid scheme, there would be no Enron. Maybe Ken Lay deserves a break?

Posted by: Leopold on December 28, 2003 11:14 PM

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Are we sure White is working for DoD and not the OMB? But notice Andersen had to know there were issues as early as 1997. Too bad they did not pull the plug on the relationship four years earlier.

Posted by: Harold McClure on December 29, 2003 05:55 AM

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Re Andersen: Who needs accountability when you have those $1,000 "new economy" Aeron chairs?

Posted by: Chris on December 29, 2003 06:40 AM

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Conspicuous by its absence in the quoted material is ANY mention at all of Thomas White's role.

As I've written here several times before, White was not a finance or accounting type, but an operations guy. He was an expert on military logistics, and apparently used that expertise to good effect in helping to build Enron from a small pipeline operation to the world's largest energy company. But there is no evidence at all, that I'm aware of, that White had ANYTHING to do with the financing of that build-up.

Posted by: Patrick R. Sullivan on December 29, 2003 07:38 AM

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Hm. Sullivan didn't say anything about Krugman. The Lord be praised!

Posted by: Zizka on December 29, 2003 08:14 AM

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"But there is no evidence at all, that I'm aware of, that White had ANYTHING to do with the financing of that build-up"

In other words, White wasn't a criminal himself--he just lent his name and reputation to criminals, never taking even the cursory look at his company's dealings that would have made its nature clear to him. All these accounting issues doubtless went right over his head. Shorter Patrick Sullivan--White wasn't a crook--just a clueless dupe.

Forgive me if I don't find "clueless dupe" high on the list of characteristics I want in a Secretary of the Army.

Posted by: rea on December 29, 2003 08:33 AM

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"[I]f you tell all your highly aggressive deal makers that the only thing that matters is total contract value and add to that horrible ontrols and an extreme urgency to get deals done quickly and a compensation system based on the projected profitability of long-term deals, you're inevitably going to get an awful lot of bad contrasts"

Boy, this is sums up my experience in the wireless telecom business. In fact, I think its fairly common in any American industry where the players are just counting the days until the stock options vest. Enron is only notorious because it blew so many zeroes.

Posted by: Carlos Mucha on December 29, 2003 09:17 AM

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"Hm. Sullivan didn't say anything about Krugman. The Lord be praised!"

Doh!

Posted by: jd on December 29, 2003 09:56 AM

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I see the Christmas spirit hasn't dulled the usual suspects' taste for casual slander of people they don't even know. On the basis of exactly zero evidence.

Posted by: Patrick R. Sullivan on December 29, 2003 02:38 PM

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Patrick,are you projecting again?

Posted by: Barry on December 29, 2003 03:09 PM

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Casual slander? I intended that to be a snarky remark. Quite a different kettle of fish.

"Zero evidence?" Evidence is required for snarky remarks?

I don't know anyone in the blogosphere. But if I knew them, then it would be OK to slander them casually? What about a nice formal slander? OK too?

Patrick, were you not part of the Krugman-bashing chorus on this site some time back? That's the way I remember it. That was my point.

Posted by: Zizka on December 29, 2003 04:06 PM

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Patrick Sullivan may not know it, but he is infamous here on Brad's blog for his fanatical defenses of the conservatarian viewpoint. However, maybe he has a point, we should give him a break. Maybe Pat's Scrooge had a dickensian moment this holiday season, and he may just try to help out the tiny tims of the world instead of hoarding all his gold. So let's give him a chance!

Posted by: non economist on December 29, 2003 06:57 PM

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"casual slander of people they don't even know. On the basis of exactly zero evidence."

Surely you don't mean ME, Patrick. After all, when I called White a "clueless dupe," I was merely summarizing YOUR defense of the guy. If it makes you feel better, I don't think White was really a clueless dupe at all. :)

Posted by: rea on December 30, 2003 05:28 AM

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I see the usual suspects are unusually self-unaware today. No one has been able to produce a shred of evidence that White had any knowldedge of the accounting shenanigans at Enron. Nor even any evidence that he had the education to understand such even if they were staring him in the face.

But that doesn't stop them from spouting off.

Posted by: Patrick R. Sullivan on December 30, 2003 07:35 AM

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Patrick Sullivan tamps down the hatch on the memory hole: "No one has been able to produce a shred of evidence that White had any knowledge of the accounting shenanigans at Enron."

Unfortunately for Patick there are a bunch of documents over at http://www.scoop.co.nz/mason/stories/HL0211/S00018.htm
which show that White was a wizz at hiding losses and much much more.

Posted by: Josh Halpern on December 30, 2003 08:17 AM

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On a not very closely related matter, Ashcroft has recused himself from the Plame investigation. Wonder if he'll recuse himself from the Missouri campaign funding case, should it get to him?

Posted by: K Harris on December 30, 2003 10:12 AM

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Josh, that's a New Zealand address. It might as well be a Freedom ^H^H^H^H^H^H^H French address.
It is probably a Saddamite Islamofascistsymp Idiotarian hoax, like when they hid all of Saddam's nuclear weapons.

Posted by: Barry on December 30, 2003 11:27 AM

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Oh boy, Jason Leopold's infamous story--which even the editors of Salon ran away from as fast as they could--is still being cited. For an example of the stupidity of Leopold:

" At a time when Enron executives were publicly assuring employees and stock holders that their investments and pensions were safe- from June 2001 through to February 2002 - Thomas White was one of many Enron executives who was busy cashing in his own investments.

" A Graph at The Memory Hole (link) details these sales. In all White received $12.1 million from his sales of Enron stock over this period. "

We've been all over this before here. White HAD TO SELL his shares, under an agreement with congress in order to be confirmed as Sec'y of the Army. As it happened he couldn't sell all he owned by the deadline, and ended up losing several million dollars. Quite the master criminal!

I believe Leopold himself was told this by me on this very blog last year, but this is still up there for the illinformed to be duped.

Posted by: Patrick R. Sullivan on December 30, 2003 02:29 PM

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Patrick ol fella, you did notice that Email from Tommy boy about the middle of the page, after one of his underlings told him that they had a big loss:
"Close a bigger deal, hide the loss before the 1Q"

As to Tommy's timing, Martha didn't do nearly as well and she has a court date.

Posted by: Josh Halpern on December 30, 2003 06:15 PM

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" Patrick ol fella, you did notice that Email from Tommy boy about the middle of the page, after one of his underlings told him that they had a big loss:
" 'Close a bigger deal, hide the loss before the 1Q' "

Josh, ol fella, Jason Leopold his ownself, right here on Semi-Daily Journal, was asked TWICE by me to produce the actual e-mail from White from which the above line is supposedly lifted. He couldn't do it.

And no one else has been able to do it either. After all this time.

Posted by: Patrick R. Sullivan on December 31, 2003 09:34 AM

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Actually, Patrick, White isn't really my issue nowadays. It was initially your historic Krugman-bashing (my first comment, to which you overreacted). What really steams me is the way that apparently none of Enron's political enablers will suffer any consequences. Primarily Bush, but including whichever Democrats were involved, starting with Lieberman.

The big issue here and in other similiar cases isn't what was done that was illegal, but the fact that too much was legal.

The White / Leopold controversy was about how much evidence Leopold had against White. I don't follow it, but apparently Leopold lost. My guess is that either White got away with it for lack of evidence, or else that he did something which shouldn't have been legal but was.

I don't spend a lot of time on the guy any more, and it seems certain that he'll never be prosecuted. That doesn't stop us from suspecting that he probably should have been prosecuted. I suspect that OJ was guilty too -- in the colloquial sense of the word, meaning that "he did what he was accused of".

Crimes within the old-boy-network don't ever seem to be punished very severely, or even at all. Big surprise there. The same seems to have been the outcome with the Savings and Loan fraud and the BCCI fraud. Insofar as these frauds had a partisan slant I think that the Republicans were measurably worse, but I'd be happy to see every politician and crook in the lot be ruined and jailed. It won't happen, though.

Posted by: Zizka on December 31, 2003 11:52 AM

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" Actually, Patrick, White isn't really my issue nowadays. It was initially your historic Krugman-bashing (my first comment, to which you overreacted)."

I really really hate to dent your self-esteem, ziska, but I didn't respond to you at all. Guilty conscience?

Posted by: Patrick R. Sullivan on December 31, 2003 03:15 PM

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So I'm not one of "the usual suspects"? May joy be unconfined.

You didn't respond to me again this time.

Posted by: Zizka on December 31, 2003 03:25 PM

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Read this Patrick you dick smoking sonofabitch nazi. It's exactly what McLean and Biskind wrote in their book. How do you explain the other documents that show White hiding losses?

Tom White played key role in covering up Enron losses
As Enron neared the end, the Army secretary used highly dubious accounting methods to inflate its revenue.
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By Jason Leopold
Salon.com
Aug. 29, 2002 | Three months before he was nominated as secretary of the Army by President Bush, Thomas White faced what surely was the most difficult task in his 10-year career as an Enron executive: Helping hide the hundreds of millions of dollars in losses from Enron Energy Services, the retail division he had headed since 1998.
It was February 2001 and for White and others in charge of EES, it was imperative that the division find ways to inflate its first-quarter earnings and hide what was becoming a black hole of losses.
But after White had left to pursue his Army post, the company was boasting a record quarter for EES, with a remarkable 18-percent increase in earnings over the previous year and new contracts with Eli Lilly, Owens-Corning, Quaker Oats, J.C. Penney and Saks. EES reported a 59-percent increase in new retail energy services contracts totaling $5.9 billion. But those figures were based on highly questionable accounting practices. According to documents obtained by Salon, EES helped Enron keep its illusion of profitability by grossly inflating the value of contracts it signed in February and April 2001, showing EES turning a profit when it was not.
Presiding over and even encouraging EES's accounting was Tom White.
When White testified July 18 before the Senate Commerce Committee about his role at Enron, questions focused primarily on his relationship to the various Enron schemes already familiar to the public, such as the alleged price-fixing schemes that contributed to the energy crises of many Western states in 2001. They also explored, to a limited degree, how Enron managed to hide some of EES's problems by transferring more than $500 million in losses into the company's wholesale services division.
White explained how, unlike Enron's wholesale division, the energy crisis caused grave cash-flow problems for EES. "I can say categorically that it was not ever in the interest of Enron Energy Services to have wholesale energy prices escalate," White testified.
But when asked about the troubled accounting of his own division, he offered an adamant -- but curiously qualified -- statement: "The deals that we put together within the accounting structure that was accepted and was the standard in the industry -- I stand behind that -- were signed and the right deals to do and were properly accounted for at the point that we signed those up."
What he did not explain was how these multibillion-dollar deals were able to create such a false picture of prosperity. Two off-the-books partnerships set up by White and Pai in February 2001 shed some light on EES's illusory profits and how the division was willing to go to great lengths to fool Wall Street.
On Feb. 20, 2001, Enron announced that EES had entered into a $1.3 billion, 15-year contract with Eli Lilly, the Indianapolis-based pharmaceutical company. Following in the Enron tradition of nicknames (like the price-setting "Fat Boy" scheme, or the famous off-budget shell companies named "Jedi" after "Star Wars") EES coined the deal "Heston" after the actor Charlton Heston, according to a former EES sales manager. According to a news release at the time, Enron was to "manage the supply of electricity and natural gas for Lilly facilities in Indiana, as well as perform operations and maintenance on energy assets and related energy infrastructure upgrades that will increase energy efficiency at Lilly facilities."
It helped EES that Kenneth Lay, former chairman and chief executive of Enron, was a member of Eli Lilly's board of directors and used his influence in getting the drug manufacturer to agree to the deal, according to one of the sales executives who worked on the contract. This former employee also said Lay discussed the contract at a meeting of Eli Lilly's board of directors, saying Enron would offer the pharmaceutical company cash if it signed the contract.
The problem with the deal, however, was that Indiana had not yet deregulated its wholesale electricity market. EES, therefore, could not yet provide Lilly with electricity. So, according to the source, White and Pai instructed the salesmen to predict when Indiana would deregulate and then predict how much Enron would earn during the projected 10 years of the contract. Ultimately, the deal was valued at around $600 million, even though it was based on two unreliable factors: When Indiana would deregulate, and the wholesale prices in the wildly erratic energy market.
This accounting method -- forecasting a future profit and counting it as revenue -- is called "mark-to-market" accounting, and is required under rules adopted in recent years by the Financial Accounting Standards Board. Mark-to-market involves recording the value of deals based on forward prices, allowing a company that agreed to supply gas or power at a fixed price to optimistically project future energy prices below the contract price. A company can then record the difference as profit as soon as a deal is signed, even though fluctuating prices change the value of the deal over time. The Securities and Exchange Commission has urged trading firms and other corporations to begin immediately, in 2001 financial reports, to boost disclosure in several areas, including valuation of energy trading contracts and the impacts of mark-to-market practices on earnings.
But back then, mark-to-market accounting was a loophole to exploit. Every quarter, prior to Enron's earnings release, an elite EES group that included White and that referred to itself as "G5," and then later (just like the United States and its economic allies) "G7," would meet to discuss, among other things, how EES would use mark-to-market accounting to boost Enron's earnings and standing on Wall Street. One former EES employee who attended the meetings said it was White and Pai who were responsible for implementing the mark-to-market approach to EES's earnings.
The employee explained how, under their guidance, energy contracts EES would sign over a 10-year period were booked as immediate gains for the company and helped inflate Enron's earnings when, in fact, the contract would cause EES to hemorrhage cash. According to the documents, White and Pai signed off on all of the long-term energy contracts EES entered into.
"Mark-to-market accounting allowed Enron to show a false profit and delay taking the loss," the former EES employee said. "It is not mark-to-market accounting that caused that, but instead the misuse of the method."
As a result, the method has its critics. "Because mark-to-market accounting allows for a considerable degree of discretion on how companies value their energy trading portfolios, there always is the potential that some companies may succumb to the temptation to use more favorable methods or techniques to increase the value or earnings associated with their portfolio when no independent market exists to verify that," said Paul Patterson, an independent energy consultant based in New York, who has been a leading critic of mark-to-market murkiness. "If this method is misused it's very possible that a company's earnings growth may prove illusory.
"Giving companies such wide latitude in reporting their results can become a prescription for disaster," Patterson said.
Said one former EES executive who worked on one of three off-the-books energy contracts: "Where Enron pushed the envelope is that many of these contracts are ones that usually would have been signed for one to three years, whereas EES would sign deals lasting 10 years and immediately book the projected revenue as profit. But there isn't a market that exists that far out that could accurately predict the revenue stream EES said it would be getting."
White has been portrayed as an EES "cheerleader" who was in the dark about Enron's financial machinations and questionable accounting practices. "White was the guy who shook hands with people and motivated the sales staff," said Lance Dohman, a former sales manager for the division. "He would just try and get everyone all fired up to go out and sign contracts." When sought for comment for this story, White's spokesman, Maj. Mike Halbig, said White had answered all questions about his tenure at Enron and has put the issue behind him to focus on his job running the Army.
But White, the only Enron executive who seemed liked by almost everyone who knew him, played a much more crucial role in the day-to-day operations at Enron, according to the documents, which include EES memos and interoffice e-mails.
In one February 2001 e-mail, as panic about EES's mounting losses began to spread among White's employees, an EES employee reported to ESS chairman Lou Pai and to White that the division was losing more than $3 million a month on other contracts signed because of rising wholesale energy costs.
"Close a bigger deal to hide the loss," White responded in the e-mail.
White's word choice is illuminating, because at that point, EES's primary concern became how to "hide" growing losses behind new contracts that, through a questionable use of an accounting loophole, allowed it to claim profits that were wildly speculative in order to give the appearance that the company was actually making money. That false image, of course, would be shattered in the fall, when Enron became the country's biggest bankruptcy ever and 4,500 employees lost their jobs.
But White's employees saw ominous signs long before that.
In February 2001, it was widely known among the EES staff on the seventh floor of Enron's Houston towers that some of the contracts the division had signed in 1999 and 2000 were causing EES to hemorrhage money, according to former EES sales manager Margaret Ceconi, and rumors were spreading that White and Pai might be forced out as a result. The growing energy crisis was causing the wholesale costs of electricity and natural gas to skyrocket, and EES, Enron's retail division, was paying a steep price.
Intensifying the pressure, Pai and White had set the bar dizzyingly high for their division just weeks earlier. At a conference for Wall Street analysts on Jan. 25, 2001, in Houston, Pai and White made the bold prediction that Enron Energy Services' revenues would jump to $10 billion that year, up from $4.6 billion the year before. Earnings, White and Pai said, would reach $225 million in 2001, up from $103 million in 2000. Those were the numbers Jeff Skilling, appointed that month as Enron's chairman, and Andrew Fastow, the company's former chief financial officer, told White and Pai they would have to meet in order for Enron to keep its standing on Wall Street, according to a former EES sales manager who worked on six of EES's large contracts and attended the analysts meeting in Houston.
But within weeks, White and Pai tried to cancel an electricity contract with two University of California campuses. EES was spending as much as $300 a megawatt-hour for the power it delivered to the colleges, but was only charging the universities around $32 a megawatt-hour, based on its 1998 contract. EES executives said the unit could lose as much as $1 billion annually on the U.C. contract alone. But the U.C. system sued Enron, and a judge later ruled in April 2001 that EES must continue to supply the college campuses with power.
Pressure began to grow to land new deals, and make them look as big, and as profitable, as possible. Even if it wasn't entirely true.
The Lilly contract, however, also included a perk to Lilly hidden from the public, Enron shareholders and the budget sheets. According to a copy of the Eli Lilly contract (which, according to an EES source, was ultimately signed by White, Pai, Skilling and Fastow) Enron and Lilly established a limited liability company, made up of Enron and Lilly executives, in order to facilitate the contract. Being a part of the LLC gave Eli Lilly and Enron huge tax incentives. Enron also, through the LLC, would pay Lilly $50 million in cash upfront to win the partnership; Lilly would have to pay back the money over time.
According to John Couch, a Houston tax attorney with Bracewell and Patterson who looked at the contract for Salon, the shares appeared to be the primary attraction for Lilly to sign. "The reason Eli Lilly signed this is because they got $50 million in cash from Enron that the company was able to use to accelerate income and to absorb other losses the company incurred," Couch said. "It says it would provide a legitimate service to Eli Lilly, which an LLC needs to do. But what makes this deal a better deal is it was structured through an LLC and it gave a Eli Lilly a tax advantage."
Once EES formed a limited liability corporation to handle the partnership, the company would then sell its stake at a profit to a third party, such as a bank, which is exactly what EES did in the case of Quaker Oats and Owens Corning, two other deals that were set up in the form of LLCs, according to the former EES sales executive.
And, perhaps most startlingly, the contract stipulated that any earnings Enron made off the contract would be split between Enron and Lilly 30 percent to 70 percent. That means the $600 million that Enron projected as revenue would have been, at best, only $180 million.
So the Lilly deal, listed in the company quarterly reports as worth $600 million, would only mean, optimistically, profits of $130 million. And that was based on a rosy, best-case scenario market report.
Nonetheless, White and Pai were a step closer to reaching their earnings goal.
The Lilly contract says Enron will "develop, design, construct and implement demand-side energy management projects" but all that entailed was removing and replacing a chiller, projecting the revenues over 20 years, and booking the revenues as a mark-to-market profit.
The Eli Lilly deal, which was handled by EES executives Jeff Forbis, Michael Mann and Richard Zdunkewicz, earned White, Pai and others a sizable bonus, according to sources within EES.
But according to Joan Todd, a spokeswoman for Eli Lilly, the deal never actually commenced. "The contract was structured in a manner that allowed the partnership to enter into routine leases for assets," Todd said. "We barely got into the contract with Enron before the company got into its problems."
Todd said the contract was unwound last month and Lilly resumed control over its own energy management. Todd also said that Lilly never accounted for the $50 million payment from Enron on its balance sheet and that the money was not booked as income. Todd did not know whether Lilly received tax incentives from the partnership but she said the company is negotiating with Enron's creditors on whether to pay the $50 million back to the company.
The deal, though, allowed Lilly to keep the transaction off its balance sheet. If Lilly did receive tax incentives from the deal, it's likely the company would have to restate its earnings after the deal was unwound, Couch said.
To fully understand the Enron/Eli Lilly deal, said one of the three sales executives who worked on the contract, "you have to understand why we needed to sign the contract in the first place."
"We were scrambling," the EES sales executive said. "We needed to sign as many large deals as we could between February and April to keep EES from collapsing. If we didn't sign these contracts it's likely that Enron would have imploded right then."
Ceconi, the former EES sales manager, said the Lilly contract allowed EES to claim revenue and margins in the current quarter that were not coming in. "That's what created the cash-flow crisis," she said. "It gave the appearance that EES was a cash machine. In that kind of environment the only way to continue -- and this gets to the issue of the house of cards -- was to continue and generate more business.
"Pai and White told us we had to keep feeding the fire," she said. "That's where the nervousness started to set in."
Also, some of the profits EES booked from the Eli Lilly deal don't appear to make sense. EES projected earnings on equipment it would install for Eli Lilly and maintenance, but no forward market exists for that. EES would do the same thing on Feb. 21, 2001, a day after it announced the Eli Lilly deal. On that day, EES announced in a press release another multibillion-dollar contract, this time with Quaker Oats, the second off-the-books partnership set up under White and Pai that brought them closer to reaching earnings. This deal was set up as a "special purpose entity" in order to provide both companies with tax incentives, according to the contract.
Tom White played key role in covering up Enron losses | 1, 2, 3, 4
EES agreed to supply 15 Quaker plants with energy management, from supplying natural gas and electricity to a staff of EES employees who would maintain boilers and pipes and procure spare parts. Enron, according to a copy of the contract obtained by Salon, guaranteed Quaker it could save $4.4 million from its 1999 energy bill. Enron forecast a $36.8 million profit over the 10-year deal and used mark-to-market accounting to book $23.4 million of that -- before it had even consummated the Quaker deal.
Under accounting rules, such treatment is permitted for commodities, such as natural gas and electricity. But the rules are more restrictive when it comes to services, such as boiler maintenance and parts procurement, for which no forward markets exist. Profits from these activities are supposed to be, according to the FASB, booked on a more conservative "accrual" basis, whereby a fraction of the profit is realized each year as it comes in.
According to a report earlier this year in the Financial Times, Enron's problem was that almost all the profits projected for the Quaker deal were derived from services, not commodities. How did it manage to book them upfront? The company used a questionable method called "revenue allocation." The net effect of this highly complex treatment was to redefine as commodities some of the money Quaker was paying for services and thereby create more profits that Enron could book upfront.
Under the system, Enron's internal accountants created a new category called "allocated revenues." These were based not on what Quaker had historically paid for energy commodities and its service contracts, but on figures that Enron claimed reflected the open market value of the commodities and services.
This revaluation made a significant difference to the reported worth of the contract. Enron would have earned only a small margin supplying gas and power to Quaker based on the original revenue figures it used to calculate the deal. Instead, revenue allocation allowed the company to claim an immediate hefty profit on the deal. Asked if such a move is illegal, a former Enron accountant told the Financial Times: "It's certainly skirting the edge. It's very, very aggressive."
The former EES sales executives claim the division, under White and Pai, managed to list as mark-to-market $85 million in energy services profits from 12 deals, including the Quaker contract, that should have been listed as accrued. In some instances, the sales executives said, the profits came from changing light bulbs and air-conditioning filters.
Former employees say it was easy for White and Pai to get their sales staff to inflate services margins, because no one could accurately predict them. Perhaps Enron's boldest assumptions had to do with something called "efficiency projects." No one will ever know how accurate EES's projections were for the Quaker deal. Enron collapsed just months into the deal. Quaker says it has since made "other arrangements."
During White's contentious hearing before the Senate, one issue that came up repeatedly was how White weighed the importance of his division against the competing divisions, particularly Enron's wholesale division, which profited heavily from the energy price spikes in 2001, and also Enron, the company. White continually tried to paint his role as that of a captain of his own ship, autonomous with respect to the rest of the company.
"Well, when the difference was between the interests of the company, the Enron Corporation, or your divisions, which interest wins?" Democratic Sen. Byron Dorgan of North Dakota asked during the testimony.
"The division," responded White.
But according to key documents and sales reports obtained by Salon, known within Enron as "The Lou and Tom Report" (after Pai and White), their loyalties are clearly to the company -- and the company's bottom line. They detail, for example, how EES shifted more than $500 million in losses to Enron North America and listed the losses as debt. This made EES look like it was turning a profit -- because the division wiped out the losses and only showed profits -- and made Enron's wholesale division look like it was entering into lucrative electricity deals.
They also, in plotting the division's course, were heavily influenced in their actions by a keen concern for the company's overall health. "We need to push Tyco to take this deal or ENA [Enron North America, the parent company] isn't going to make the quarter," White and Pai said in their report, referring to a pending outsourcing energy management deal with Tyco Healthcare Group LP, a unit of Tyco International Ltd., in 1999. "You guys need to close the books a month before earnings."
On many occasions, the documents show, EES would be forced to renegotiate long-term energy contracts it signed with large corporations as many as three or four times, often resulting in the contract losing its original value (which itself was based on a bogus curve) by hundreds of millions of dollars. One example of this is a contract EES signed with Tyco in 1999 that was renegotiated four times.
Analysts said Enron should have disclosed this information or restated its quarterly earnings. "If the contract was amended or changed, that would lower your earnings for the period in which the value of the contract fell," Patterson said. "If the contract has fallen because of price changes or because it was renegotiated, then theoretically the value of the contract has fallen; then one would expect that the earnings from that contract would go down in the period in which the value fell."
But such disclosures, including in the Tyco case, were never made. And as EES's fortunes were slowly dwindling away, officials, including White, remained silent.
salon.com


Posted by: jed grossman on January 3, 2004 11:56 PM

____

Read this Patrick you dick smoking sonofabitch nazi. It's exactly what McLean and Biskind wrote in their book. How do you explain the other documents that show White hiding losses?

Tom White played key role in covering up Enron losses
As Enron neared the end, the Army secretary used highly dubious accounting methods to inflate its revenue.
- - - - - - - - - - - -
By Jason Leopold
Salon.com
Aug. 29, 2002 | Three months before he was nominated as secretary of the Army by President Bush, Thomas White faced what surely was the most difficult task in his 10-year career as an Enron executive: Helping hide the hundreds of millions of dollars in losses from Enron Energy Services, the retail division he had headed since 1998.
It was February 2001 and for White and others in charge of EES, it was imperative that the division find ways to inflate its first-quarter earnings and hide what was becoming a black hole of losses.
But after White had left to pursue his Army post, the company was boasting a record quarter for EES, with a remarkable 18-percent increase in earnings over the previous year and new contracts with Eli Lilly, Owens-Corning, Quaker Oats, J.C. Penney and Saks. EES reported a 59-percent increase in new retail energy services contracts totaling $5.9 billion. But those figures were based on highly questionable accounting practices. According to documents obtained by Salon, EES helped Enron keep its illusion of profitability by grossly inflating the value of contracts it signed in February and April 2001, showing EES turning a profit when it was not.
Presiding over and even encouraging EES's accounting was Tom White.
When White testified July 18 before the Senate Commerce Committee about his role at Enron, questions focused primarily on his relationship to the various Enron schemes already familiar to the public, such as the alleged price-fixing schemes that contributed to the energy crises of many Western states in 2001. They also explored, to a limited degree, how Enron managed to hide some of EES's problems by transferring more than $500 million in losses into the company's wholesale services division.
White explained how, unlike Enron's wholesale division, the energy crisis caused grave cash-flow problems for EES. "I can say categorically that it was not ever in the interest of Enron Energy Services to have wholesale energy prices escalate," White testified.
But when asked about the troubled accounting of his own division, he offered an adamant -- but curiously qualified -- statement: "The deals that we put together within the accounting structure that was accepted and was the standard in the industry -- I stand behind that -- were signed and the right deals to do and were properly accounted for at the point that we signed those up."
What he did not explain was how these multibillion-dollar deals were able to create such a false picture of prosperity. Two off-the-books partnerships set up by White and Pai in February 2001 shed some light on EES's illusory profits and how the division was willing to go to great lengths to fool Wall Street.
On Feb. 20, 2001, Enron announced that EES had entered into a $1.3 billion, 15-year contract with Eli Lilly, the Indianapolis-based pharmaceutical company. Following in the Enron tradition of nicknames (like the price-setting "Fat Boy" scheme, or the famous off-budget shell companies named "Jedi" after "Star Wars") EES coined the deal "Heston" after the actor Charlton Heston, according to a former EES sales manager. According to a news release at the time, Enron was to "manage the supply of electricity and natural gas for Lilly facilities in Indiana, as well as perform operations and maintenance on energy assets and related energy infrastructure upgrades that will increase energy efficiency at Lilly facilities."
It helped EES that Kenneth Lay, former chairman and chief executive of Enron, was a member of Eli Lilly's board of directors and used his influence in getting the drug manufacturer to agree to the deal, according to one of the sales executives who worked on the contract. This former employee also said Lay discussed the contract at a meeting of Eli Lilly's board of directors, saying Enron would offer the pharmaceutical company cash if it signed the contract.
The problem with the deal, however, was that Indiana had not yet deregulated its wholesale electricity market. EES, therefore, could not yet provide Lilly with electricity. So, according to the source, White and Pai instructed the salesmen to predict when Indiana would deregulate and then predict how much Enron would earn during the projected 10 years of the contract. Ultimately, the deal was valued at around $600 million, even though it was based on two unreliable factors: When Indiana would deregulate, and the wholesale prices in the wildly erratic energy market.
This accounting method -- forecasting a future profit and counting it as revenue -- is called "mark-to-market" accounting, and is required under rules adopted in recent years by the Financial Accounting Standards Board. Mark-to-market involves recording the value of deals based on forward prices, allowing a company that agreed to supply gas or power at a fixed price to optimistically project future energy prices below the contract price. A company can then record the difference as profit as soon as a deal is signed, even though fluctuating prices change the value of the deal over time. The Securities and Exchange Commission has urged trading firms and other corporations to begin immediately, in 2001 financial reports, to boost disclosure in several areas, including valuation of energy trading contracts and the impacts of mark-to-market practices on earnings.
But back then, mark-to-market accounting was a loophole to exploit. Every quarter, prior to Enron's earnings release, an elite EES group that included White and that referred to itself as "G5," and then later (just like the United States and its economic allies) "G7," would meet to discuss, among other things, how EES would use mark-to-market accounting to boost Enron's earnings and standing on Wall Street. One former EES employee who attended the meetings said it was White and Pai who were responsible for implementing the mark-to-market approach to EES's earnings.
The employee explained how, under their guidance, energy contracts EES would sign over a 10-year period were booked as immediate gains for the company and helped inflate Enron's earnings when, in fact, the contract would cause EES to hemorrhage cash. According to the documents, White and Pai signed off on all of the long-term energy contracts EES entered into.
"Mark-to-market accounting allowed Enron to show a false profit and delay taking the loss," the former EES employee said. "It is not mark-to-market accounting that caused that, but instead the misuse of the method."
As a result, the method has its critics. "Because mark-to-market accounting allows for a considerable degree of discretion on how companies value their energy trading portfolios, there always is the potential that some companies may succumb to the temptation to use more favorable methods or techniques to increase the value or earnings associated with their portfolio when no independent market exists to verify that," said Paul Patterson, an independent energy consultant based in New York, who has been a leading critic of mark-to-market murkiness. "If this method is misused it's very possible that a company's earnings growth may prove illusory.
"Giving companies such wide latitude in reporting their results can become a prescription for disaster," Patterson said.
Said one former EES executive who worked on one of three off-the-books energy contracts: "Where Enron pushed the envelope is that many of these contracts are ones that usually would have been signed for one to three years, whereas EES would sign deals lasting 10 years and immediately book the projected revenue as profit. But there isn't a market that exists that far out that could accurately predict the revenue stream EES said it would be getting."
White has been portrayed as an EES "cheerleader" who was in the dark about Enron's financial machinations and questionable accounting practices. "White was the guy who shook hands with people and motivated the sales staff," said Lance Dohman, a former sales manager for the division. "He would just try and get everyone all fired up to go out and sign contracts." When sought for comment for this story, White's spokesman, Maj. Mike Halbig, said White had answered all questions about his tenure at Enron and has put the issue behind him to focus on his job running the Army.
But White, the only Enron executive who seemed liked by almost everyone who knew him, played a much more crucial role in the day-to-day operations at Enron, according to the documents, which include EES memos and interoffice e-mails.
In one February 2001 e-mail, as panic about EES's mounting losses began to spread among White's employees, an EES employee reported to ESS chairman Lou Pai and to White that the division was losing more than $3 million a month on other contracts signed because of rising wholesale energy costs.
"Close a bigger deal to hide the loss," White responded in the e-mail.
White's word choice is illuminating, because at that point, EES's primary concern became how to "hide" growing losses behind new contracts that, through a questionable use of an accounting loophole, allowed it to claim profits that were wildly speculative in order to give the appearance that the company was actually making money. That false image, of course, would be shattered in the fall, when Enron became the country's biggest bankruptcy ever and 4,500 employees lost their jobs.
But White's employees saw ominous signs long before that.
In February 2001, it was widely known among the EES staff on the seventh floor of Enron's Houston towers that some of the contracts the division had signed in 1999 and 2000 were causing EES to hemorrhage money, according to former EES sales manager Margaret Ceconi, and rumors were spreading that White and Pai might be forced out as a result. The growing energy crisis was causing the wholesale costs of electricity and natural gas to skyrocket, and EES, Enron's retail division, was paying a steep price.
Intensifying the pressure, Pai and White had set the bar dizzyingly high for their division just weeks earlier. At a conference for Wall Street analysts on Jan. 25, 2001, in Houston, Pai and White made the bold prediction that Enron Energy Services' revenues would jump to $10 billion that year, up from $4.6 billion the year before. Earnings, White and Pai said, would reach $225 million in 2001, up from $103 million in 2000. Those were the numbers Jeff Skilling, appointed that month as Enron's chairman, and Andrew Fastow, the company's former chief financial officer, told White and Pai they would have to meet in order for Enron to keep its standing on Wall Street, according to a former EES sales manager who worked on six of EES's large contracts and attended the analysts meeting in Houston.
But within weeks, White and Pai tried to cancel an electricity contract with two University of California campuses. EES was spending as much as $300 a megawatt-hour for the power it delivered to the colleges, but was only charging the universities around $32 a megawatt-hour, based on its 1998 contract. EES executives said the unit could lose as much as $1 billion annually on the U.C. contract alone. But the U.C. system sued Enron, and a judge later ruled in April 2001 that EES must continue to supply the college campuses with power.
Pressure began to grow to land new deals, and make them look as big, and as profitable, as possible. Even if it wasn't entirely true.
The Lilly contract, however, also included a perk to Lilly hidden from the public, Enron shareholders and the budget sheets. According to a copy of the Eli Lilly contract (which, according to an EES source, was ultimately signed by White, Pai, Skilling and Fastow) Enron and Lilly established a limited liability company, made up of Enron and Lilly executives, in order to facilitate the contract. Being a part of the LLC gave Eli Lilly and Enron huge tax incentives. Enron also, through the LLC, would pay Lilly $50 million in cash upfront to win the partnership; Lilly would have to pay back the money over time.
According to John Couch, a Houston tax attorney with Bracewell and Patterson who looked at the contract for Salon, the shares appeared to be the primary attraction for Lilly to sign. "The reason Eli Lilly signed this is because they got $50 million in cash from Enron that the company was able to use to accelerate income and to absorb other losses the company incurred," Couch said. "It says it would provide a legitimate service to Eli Lilly, which an LLC needs to do. But what makes this deal a better deal is it was structured through an LLC and it gave a Eli Lilly a tax advantage."
Once EES formed a limited liability corporation to handle the partnership, the company would then sell its stake at a profit to a third party, such as a bank, which is exactly what EES did in the case of Quaker Oats and Owens Corning, two other deals that were set up in the form of LLCs, according to the former EES sales executive.
And, perhaps most startlingly, the contract stipulated that any earnings Enron made off the contract would be split between Enron and Lilly 30 percent to 70 percent. That means the $600 million that Enron projected as revenue would have been, at best, only $180 million.
So the Lilly deal, listed in the company quarterly reports as worth $600 million, would only mean, optimistically, profits of $130 million. And that was based on a rosy, best-case scenario market report.
Nonetheless, White and Pai were a step closer to reaching their earnings goal.
The Lilly contract says Enron will "develop, design, construct and implement demand-side energy management projects" but all that entailed was removing and replacing a chiller, projecting the revenues over 20 years, and booking the revenues as a mark-to-market profit.
The Eli Lilly deal, which was handled by EES executives Jeff Forbis, Michael Mann and Richard Zdunkewicz, earned White, Pai and others a sizable bonus, according to sources within EES.
But according to Joan Todd, a spokeswoman for Eli Lilly, the deal never actually commenced. "The contract was structured in a manner that allowed the partnership to enter into routine leases for assets," Todd said. "We barely got into the contract with Enron before the company got into its problems."
Todd said the contract was unwound last month and Lilly resumed control over its own energy management. Todd also said that Lilly never accounted for the $50 million payment from Enron on its balance sheet and that the money was not booked as income. Todd did not know whether Lilly received tax incentives from the partnership but she said the company is negotiating with Enron's creditors on whether to pay the $50 million back to the company.
The deal, though, allowed Lilly to keep the transaction off its balance sheet. If Lilly did receive tax incentives from the deal, it's likely the company would have to restate its earnings after the deal was unwound, Couch said.
To fully understand the Enron/Eli Lilly deal, said one of the three sales executives who worked on the contract, "you have to understand why we needed to sign the contract in the first place."
"We were scrambling," the EES sales executive said. "We needed to sign as many large deals as we could between February and April to keep EES from collapsing. If we didn't sign these contracts it's likely that Enron would have imploded right then."
Ceconi, the former EES sales manager, said the Lilly contract allowed EES to claim revenue and margins in the current quarter that were not coming in. "That's what created the cash-flow crisis," she said. "It gave the appearance that EES was a cash machine. In that kind of environment the only way to continue -- and this gets to the issue of the house of cards -- was to continue and generate more business.
"Pai and White told us we had to keep feeding the fire," she said. "That's where the nervousness started to set in."
Also, some of the profits EES booked from the Eli Lilly deal don't appear to make sense. EES projected earnings on equipment it would install for Eli Lilly and maintenance, but no forward market exists for that. EES would do the same thing on Feb. 21, 2001, a day after it announced the Eli Lilly deal. On that day, EES announced in a press release another multibillion-dollar contract, this time with Quaker Oats, the second off-the-books partnership set up under White and Pai that brought them closer to reaching earnings. This deal was set up as a "special purpose entity" in order to provide both companies with tax incentives, according to the contract.
Tom White played key role in covering up Enron losses | 1, 2, 3, 4
EES agreed to supply 15 Quaker plants with energy management, from supplying natural gas and electricity to a staff of EES employees who would maintain boilers and pipes and procure spare parts. Enron, according to a copy of the contract obtained by Salon, guaranteed Quaker it could save $4.4 million from its 1999 energy bill. Enron forecast a $36.8 million profit over the 10-year deal and used mark-to-market accounting to book $23.4 million of that -- before it had even consummated the Quaker deal.
Under accounting rules, such treatment is permitted for commodities, such as natural gas and electricity. But the rules are more restrictive when it comes to services, such as boiler maintenance and parts procurement, for which no forward markets exist. Profits from these activities are supposed to be, according to the FASB, booked on a more conservative "accrual" basis, whereby a fraction of the profit is realized each year as it comes in.
According to a report earlier this year in the Financial Times, Enron's problem was that almost all the profits projected for the Quaker deal were derived from services, not commodities. How did it manage to book them upfront? The company used a questionable method called "revenue allocation." The net effect of this highly complex treatment was to redefine as commodities some of the money Quaker was paying for services and thereby create more profits that Enron could book upfront.
Under the system, Enron's internal accountants created a new category called "allocated revenues." These were based not on what Quaker had historically paid for energy commodities and its service contracts, but on figures that Enron claimed reflected the open market value of the commodities and services.
This revaluation made a significant difference to the reported worth of the contract. Enron would have earned only a small margin supplying gas and power to Quaker based on the original revenue figures it used to calculate the deal. Instead, revenue allocation allowed the company to claim an immediate hefty profit on the deal. Asked if such a move is illegal, a former Enron accountant told the Financial Times: "It's certainly skirting the edge. It's very, very aggressive."
The former EES sales executives claim the division, under White and Pai, managed to list as mark-to-market $85 million in energy services profits from 12 deals, including the Quaker contract, that should have been listed as accrued. In some instances, the sales executives said, the profits came from changing light bulbs and air-conditioning filters.
Former employees say it was easy for White and Pai to get their sales staff to inflate services margins, because no one could accurately predict them. Perhaps Enron's boldest assumptions had to do with something called "efficiency projects." No one will ever know how accurate EES's projections were for the Quaker deal. Enron collapsed just months into the deal. Quaker says it has since made "other arrangements."
During White's contentious hearing before the Senate, one issue that came up repeatedly was how White weighed the importance of his division against the competing divisions, particularly Enron's wholesale division, which profited heavily from the energy price spikes in 2001, and also Enron, the company. White continually tried to paint his role as that of a captain of his own ship, autonomous with respect to the rest of the company.
"Well, when the difference was between the interests of the company, the Enron Corporation, or your divisions, which interest wins?" Democratic Sen. Byron Dorgan of North Dakota asked during the testimony.
"The division," responded White.
But according to key documents and sales reports obtained by Salon, known within Enron as "The Lou and Tom Report" (after Pai and White), their loyalties are clearly to the company -- and the company's bottom line. They detail, for example, how EES shifted more than $500 million in losses to Enron North America and listed the losses as debt. This made EES look like it was turning a profit -- because the division wiped out the losses and only showed profits -- and made Enron's wholesale division look like it was entering into lucrative electricity deals.
They also, in plotting the division's course, were heavily influenced in their actions by a keen concern for the company's overall health. "We need to push Tyco to take this deal or ENA [Enron North America, the parent company] isn't going to make the quarter," White and Pai said in their report, referring to a pending outsourcing energy management deal with Tyco Healthcare Group LP, a unit of Tyco International Ltd., in 1999. "You guys need to close the books a month before earnings."
On many occasions, the documents show, EES would be forced to renegotiate long-term energy contracts it signed with large corporations as many as three or four times, often resulting in the contract losing its original value (which itself was based on a bogus curve) by hundreds of millions of dollars. One example of this is a contract EES signed with Tyco in 1999 that was renegotiated four times.
Analysts said Enron should have disclosed this information or restated its quarterly earnings. "If the contract was amended or changed, that would lower your earnings for the period in which the value of the contract fell," Patterson said. "If the contract has fallen because of price changes or because it was renegotiated, then theoretically the value of the contract has fallen; then one would expect that the earnings from that contract would go down in the period in which the value fell."
But such disclosures, including in the Tyco case, were never made. And as EES's fortunes were slowly dwindling away, officials, including White, remained silent.
salon.com


Posted by: jed grossman on January 3, 2004 11:59 PM

____

Read this Patrick you dick smoking sonofabitch nazi. It's exactly what McLean and Biskind wrote in their book. How do you explain the other documents that show White hiding losses?

Tom White played key role in covering up Enron losses
As Enron neared the end, the Army secretary used highly dubious accounting methods to inflate its revenue.
- - - - - - - - - - - -
By Jason Leopold
Salon.com
Aug. 29, 2002 | Three months before he was nominated as secretary of the Army by President Bush, Thomas White faced what surely was the most difficult task in his 10-year career as an Enron executive: Helping hide the hundreds of millions of dollars in losses from Enron Energy Services, the retail division he had headed since 1998.
It was February 2001 and for White and others in charge of EES, it was imperative that the division find ways to inflate its first-quarter earnings and hide what was becoming a black hole of losses.
But after White had left to pursue his Army post, the company was boasting a record quarter for EES, with a remarkable 18-percent increase in earnings over the previous year and new contracts with Eli Lilly, Owens-Corning, Quaker Oats, J.C. Penney and Saks. EES reported a 59-percent increase in new retail energy services contracts totaling $5.9 billion. But those figures were based on highly questionable accounting practices. According to documents obtained by Salon, EES helped Enron keep its illusion of profitability by grossly inflating the value of contracts it signed in February and April 2001, showing EES turning a profit when it was not.
Presiding over and even encouraging EES's accounting was Tom White.
When White testified July 18 before the Senate Commerce Committee about his role at Enron, questions focused primarily on his relationship to the various Enron schemes already familiar to the public, such as the alleged price-fixing schemes that contributed to the energy crises of many Western states in 2001. They also explored, to a limited degree, how Enron managed to hide some of EES's problems by transferring more than $500 million in losses into the company's wholesale services division.
White explained how, unlike Enron's wholesale division, the energy crisis caused grave cash-flow problems for EES. "I can say categorically that it was not ever in the interest of Enron Energy Services to have wholesale energy prices escalate," White testified.
But when asked about the troubled accounting of his own division, he offered an adamant -- but curiously qualified -- statement: "The deals that we put together within the accounting structure that was accepted and was the standard in the industry -- I stand behind that -- were signed and the right deals to do and were properly accounted for at the point that we signed those up."
What he did not explain was how these multibillion-dollar deals were able to create such a false picture of prosperity. Two off-the-books partnerships set up by White and Pai in February 2001 shed some light on EES's illusory profits and how the division was willing to go to great lengths to fool Wall Street.
On Feb. 20, 2001, Enron announced that EES had entered into a $1.3 billion, 15-year contract with Eli Lilly, the Indianapolis-based pharmaceutical company. Following in the Enron tradition of nicknames (like the price-setting "Fat Boy" scheme, or the famous off-budget shell companies named "Jedi" after "Star Wars") EES coined the deal "Heston" after the actor Charlton Heston, according to a former EES sales manager. According to a news release at the time, Enron was to "manage the supply of electricity and natural gas for Lilly facilities in Indiana, as well as perform operations and maintenance on energy assets and related energy infrastructure upgrades that will increase energy efficiency at Lilly facilities."
It helped EES that Kenneth Lay, former chairman and chief executive of Enron, was a member of Eli Lilly's board of directors and used his influence in getting the drug manufacturer to agree to the deal, according to one of the sales executives who worked on the contract. This former employee also said Lay discussed the contract at a meeting of Eli Lilly's board of directors, saying Enron would offer the pharmaceutical company cash if it signed the contract.
The problem with the deal, however, was that Indiana had not yet deregulated its wholesale electricity market. EES, therefore, could not yet provide Lilly with electricity. So, according to the source, White and Pai instructed the salesmen to predict when Indiana would deregulate and then predict how much Enron would earn during the projected 10 years of the contract. Ultimately, the deal was valued at around $600 million, even though it was based on two unreliable factors: When Indiana would deregulate, and the wholesale prices in the wildly erratic energy market.
This accounting method -- forecasting a future profit and counting it as revenue -- is called "mark-to-market" accounting, and is required under rules adopted in recent years by the Financial Accounting Standards Board. Mark-to-market involves recording the value of deals based on forward prices, allowing a company that agreed to supply gas or power at a fixed price to optimistically project future energy prices below the contract price. A company can then record the difference as profit as soon as a deal is signed, even though fluctuating prices change the value of the deal over time. The Securities and Exchange Commission has urged trading firms and other corporations to begin immediately, in 2001 financial reports, to boost disclosure in several areas, including valuation of energy trading contracts and the impacts of mark-to-market practices on earnings.
But back then, mark-to-market accounting was a loophole to exploit. Every quarter, prior to Enron's earnings release, an elite EES group that included White and that referred to itself as "G5," and then later (just like the United States and its economic allies) "G7," would meet to discuss, among other things, how EES would use mark-to-market accounting to boost Enron's earnings and standing on Wall Street. One former EES employee who attended the meetings said it was White and Pai who were responsible for implementing the mark-to-market approach to EES's earnings.
The employee explained how, under their guidance, energy contracts EES would sign over a 10-year period were booked as immediate gains for the company and helped inflate Enron's earnings when, in fact, the contract would cause EES to hemorrhage cash. According to the documents, White and Pai signed off on all of the long-term energy contracts EES entered into.
"Mark-to-market accounting allowed Enron to show a false profit and delay taking the loss," the former EES employee said. "It is not mark-to-market accounting that caused that, but instead the misuse of the method."
As a result, the method has its critics. "Because mark-to-market accounting allows for a considerable degree of discretion on how companies value their energy trading portfolios, there always is the potential that some companies may succumb to the temptation to use more favorable methods or techniques to increase the value or earnings associated with their portfolio when no independent market exists to verify that," said Paul Patterson, an independent energy consultant based in New York, who has been a leading critic of mark-to-market murkiness. "If this method is misused it's very possible that a company's earnings growth may prove illusory.
"Giving companies such wide latitude in reporting their results can become a prescription for disaster," Patterson said.
Said one former EES executive who worked on one of three off-the-books energy contracts: "Where Enron pushed the envelope is that many of these contracts are ones that usually would have been signed for one to three years, whereas EES would sign deals lasting 10 years and immediately book the projected revenue as profit. But there isn't a market that exists that far out that could accurately predict the revenue stream EES said it would be getting."
White has been portrayed as an EES "cheerleader" who was in the dark about Enron's financial machinations and questionable accounting practices. "White was the guy who shook hands with people and motivated the sales staff," said Lance Dohman, a former sales manager for the division. "He would just try and get everyone all fired up to go out and sign contracts." When sought for comment for this story, White's spokesman, Maj. Mike Halbig, said White had answered all questions about his tenure at Enron and has put the issue behind him to focus on his job running the Army.
But White, the only Enron executive who seemed liked by almost everyone who knew him, played a much more crucial role in the day-to-day operations at Enron, according to the documents, which include EES memos and interoffice e-mails.
In one February 2001 e-mail, as panic about EES's mounting losses began to spread among White's employees, an EES employee reported to ESS chairman Lou Pai and to White that the division was losing more than $3 million a month on other contracts signed because of rising wholesale energy costs.
"Close a bigger deal to hide the loss," White responded in the e-mail.
White's word choice is illuminating, because at that point, EES's primary concern became how to "hide" growing losses behind new contracts that, through a questionable use of an accounting loophole, allowed it to claim profits that were wildly speculative in order to give the appearance that the company was actually making money. That false image, of course, would be shattered in the fall, when Enron became the country's biggest bankruptcy ever and 4,500 employees lost their jobs.
But White's employees saw ominous signs long before that.
In February 2001, it was widely known among the EES staff on the seventh floor of Enron's Houston towers that some of the contracts the division had signed in 1999 and 2000 were causing EES to hemorrhage money, according to former EES sales manager Margaret Ceconi, and rumors were spreading that White and Pai might be forced out as a result. The growing energy crisis was causing the wholesale costs of electricity and natural gas to skyrocket, and EES, Enron's retail division, was paying a steep price.
Intensifying the pressure, Pai and White had set the bar dizzyingly high for their division just weeks earlier. At a conference for Wall Street analysts on Jan. 25, 2001, in Houston, Pai and White made the bold prediction that Enron Energy Services' revenues would jump to $10 billion that year, up from $4.6 billion the year before. Earnings, White and Pai said, would reach $225 million in 2001, up from $103 million in 2000. Those were the numbers Jeff Skilling, appointed that month as Enron's chairman, and Andrew Fastow, the company's former chief financial officer, told White and Pai they would have to meet in order for Enron to keep its standing on Wall Street, according to a former EES sales manager who worked on six of EES's large contracts and attended the analysts meeting in Houston.
But within weeks, White and Pai tried to cancel an electricity contract with two University of California campuses. EES was spending as much as $300 a megawatt-hour for the power it delivered to the colleges, but was only charging the universities around $32 a megawatt-hour, based on its 1998 contract. EES executives said the unit could lose as much as $1 billion annually on the U.C. contract alone. But the U.C. system sued Enron, and a judge later ruled in April 2001 that EES must continue to supply the college campuses with power.
Pressure began to grow to land new deals, and make them look as big, and as profitable, as possible. Even if it wasn't entirely true.
The Lilly contract, however, also included a perk to Lilly hidden from the public, Enron shareholders and the budget sheets. According to a copy of the Eli Lilly contract (which, according to an EES source, was ultimately signed by White, Pai, Skilling and Fastow) Enron and Lilly established a limited liability company, made up of Enron and Lilly executives, in order to facilitate the contract. Being a part of the LLC gave Eli Lilly and Enron huge tax incentives. Enron also, through the LLC, would pay Lilly $50 million in cash upfront to win the partnership; Lilly would have to pay back the money over time.
According to John Couch, a Houston tax attorney with Bracewell and Patterson who looked at the contract for Salon, the shares appeared to be the primary attraction for Lilly to sign. "The reason Eli Lilly signed this is because they got $50 million in cash from Enron that the company was able to use to accelerate income and to absorb other losses the company incurred," Couch said. "It says it would provide a legitimate service to Eli Lilly, which an LLC needs to do. But what makes this deal a better deal is it was structured through an LLC and it gave a Eli Lilly a tax advantage."
Once EES formed a limited liability corporation to handle the partnership, the company would then sell its stake at a profit to a third party, such as a bank, which is exactly what EES did in the case of Quaker Oats and Owens Corning, two other deals that were set up in the form of LLCs, according to the former EES sales executive.
And, perhaps most startlingly, the contract stipulated that any earnings Enron made off the contract would be split between Enron and Lilly 30 percent to 70 percent. That means the $600 million that Enron projected as revenue would have been, at best, only $180 million.
So the Lilly deal, listed in the company quarterly reports as worth $600 million, would only mean, optimistically, profits of $130 million. And that was based on a rosy, best-case scenario market report.
Nonetheless, White and Pai were a step closer to reaching their earnings goal.
The Lilly contract says Enron will "develop, design, construct and implement demand-side energy management projects" but all that entailed was removing and replacing a chiller, projecting the revenues over 20 years, and booking the revenues as a mark-to-market profit.
The Eli Lilly deal, which was handled by EES executives Jeff Forbis, Michael Mann and Richard Zdunkewicz, earned White, Pai and others a sizable bonus, according to sources within EES.
But according to Joan Todd, a spokeswoman for Eli Lilly, the deal never actually commenced. "The contract was structured in a manner that allowed the partnership to enter into routine leases for assets," Todd said. "We barely got into the contract with Enron before the company got into its problems."
Todd said the contract was unwound last month and Lilly resumed control over its own energy management. Todd also said that Lilly never accounted for the $50 million payment from Enron on its balance sheet and that the money was not booked as income. Todd did not know whether Lilly received tax incentives from the partnership but she said the company is negotiating with Enron's creditors on whether to pay the $50 million back to the company.
The deal, though, allowed Lilly to keep the transaction off its balance sheet. If Lilly did receive tax incentives from the deal, it's likely the company would have to restate its earnings after the deal was unwound, Couch said.
To fully understand the Enron/Eli Lilly deal, said one of the three sales executives who worked on the contract, "you have to understand why we needed to sign the contract in the first place."
"We were scrambling," the EES sales executive said. "We needed to sign as many large deals as we could between February and April to keep EES from collapsing. If we didn't sign these contracts it's likely that Enron would have imploded right then."
Ceconi, the former EES sales manager, said the Lilly contract allowed EES to claim revenue and margins in the current quarter that were not coming in. "That's what created the cash-flow crisis," she said. "It gave the appearance that EES was a cash machine. In that kind of environment the only way to continue -- and this gets to the issue of the house of cards -- was to continue and generate more business.
"Pai and White told us we had to keep feeding the fire," she said. "That's where the nervousness started to set in."
Also, some of the profits EES booked from the Eli Lilly deal don't appear to make sense. EES projected earnings on equipment it would install for Eli Lilly and maintenance, but no forward market exists for that. EES would do the same thing on Feb. 21, 2001, a day after it announced the Eli Lilly deal. On that day, EES announced in a press release another multibillion-dollar contract, this time with Quaker Oats, the second off-the-books partnership set up under White and Pai that brought them closer to reaching earnings. This deal was set up as a "special purpose entity" in order to provide both companies with tax incentives, according to the contract.
Tom White played key role in covering up Enron losses | 1, 2, 3, 4
EES agreed to supply 15 Quaker plants with energy management, from supplying natural gas and electricity to a staff of EES employees who would maintain boilers and pipes and procure spare parts. Enron, according to a copy of the contract obtained by Salon, guaranteed Quaker it could save $4.4 million from its 1999 energy bill. Enron forecast a $36.8 million profit over the 10-year deal and used mark-to-market accounting to book $23.4 million of that -- before it had even consummated the Quaker deal.
Under accounting rules, such treatment is permitted for commodities, such as natural gas and electricity. But the rules are more restrictive when it comes to services, such as boiler maintenance and parts procurement, for which no forward markets exist. Profits from these activities are supposed to be, according to the FASB, booked on a more conservative "accrual" basis, whereby a fraction of the profit is realized each year as it comes in.
According to a report earlier this year in the Financial Times, Enron's problem was that almost all the profits projected for the Quaker deal were derived from services, not commodities. How did it manage to book them upfront? The company used a questionable method called "revenue allocation." The net effect of this highly complex treatment was to redefine as commodities some of the money Quaker was paying for services and thereby create more profits that Enron could book upfront.
Under the system, Enron's internal accountants created a new category called "allocated revenues." These were based not on what Quaker had historically paid for energy commodities and its service contracts, but on figures that Enron claimed reflected the open market value of the commodities and services.
This revaluation made a significant difference to the reported worth of the contract. Enron would have earned only a small margin supplying gas and power to Quaker based on the original revenue figures it used to calculate the deal. Instead, revenue allocation allowed the company to claim an immediate hefty profit on the deal. Asked if such a move is illegal, a former Enron accountant told the Financial Times: "It's certainly skirting the edge. It's very, very aggressive."
The former EES sales executives claim the division, under White and Pai, managed to list as mark-to-market $85 million in energy services profits from 12 deals, including the Quaker contract, that should have been listed as accrued. In some instances, the sales executives said, the profits came from changing light bulbs and air-conditioning filters.
Former employees say it was easy for White and Pai to get their sales staff to inflate services margins, because no one could accurately predict them. Perhaps Enron's boldest assumptions had to do with something called "efficiency projects." No one will ever know how accurate EES's projections were for the Quaker deal. Enron collapsed just months into the deal. Quaker says it has since made "other arrangements."
During White's contentious hearing before the Senate, one issue that came up repeatedly was how White weighed the importance of his division against the competing divisions, particularly Enron's wholesale division, which profited heavily from the energy price spikes in 2001, and also Enron, the company. White continually tried to paint his role as that of a captain of his own ship, autonomous with respect to the rest of the company.
"Well, when the difference was between the interests of the company, the Enron Corporation, or your divisions, which interest wins?" Democratic Sen. Byron Dorgan of North Dakota asked during the testimony.
"The division," responded White.
But according to key documents and sales reports obtained by Salon, known within Enron as "The Lou and Tom Report" (after Pai and White), their loyalties are clearly to the company -- and the company's bottom line. They detail, for example, how EES shifted more than $500 million in losses to Enron North America and listed the losses as debt. This made EES look like it was turning a profit -- because the division wiped out the losses and only showed profits -- and made Enron's wholesale division look like it was entering into lucrative electricity deals.
They also, in plotting the division's course, were heavily influenced in their actions by a keen concern for the company's overall health. "We need to push Tyco to take this deal or ENA [Enron North America, the parent company] isn't going to make the quarter," White and Pai said in their report, referring to a pending outsourcing energy management deal with Tyco Healthcare Group LP, a unit of Tyco International Ltd., in 1999. "You guys need to close the books a month before earnings."
On many occasions, the documents show, EES would be forced to renegotiate long-term energy contracts it signed with large corporations as many as three or four times, often resulting in the contract losing its original value (which itself was based on a bogus curve) by hundreds of millions of dollars. One example of this is a contract EES signed with Tyco in 1999 that was renegotiated four times.
Analysts said Enron should have disclosed this information or restated its quarterly earnings. "If the contract was amended or changed, that would lower your earnings for the period in which the value of the contract fell," Patterson said. "If the contract has fallen because of price changes or because it was renegotiated, then theoretically the value of the contract has fallen; then one would expect that the earnings from that contract would go down in the period in which the value fell."
But such disclosures, including in the Tyco case, were never made. And as EES's fortunes were slowly dwindling away, officials, including White, remained silent.
salon.com


Posted by: jed grossman on January 3, 2004 11:59 PM

____

Read this Patrick you dick smoking sonofabitch nazi. It's exactly what McLean and Biskind wrote in their book. How do you explain the other documents that show White hiding losses?

Tom White played key role in covering up Enron losses
As Enron neared the end, the Army secretary used highly dubious accounting methods to inflate its revenue.
- - - - - - - - - - - -
By Jason Leopold
Salon.com
Aug. 29, 2002 | Three months before he was nominated as secretary of the Army by President Bush, Thomas White faced what surely was the most difficult task in his 10-year career as an Enron executive: Helping hide the hundreds of millions of dollars in losses from Enron Energy Services, the retail division he had headed since 1998.
It was February 2001 and for White and others in charge of EES, it was imperative that the division find ways to inflate its first-quarter earnings and hide what was becoming a black hole of losses.
But after White had left to pursue his Army post, the company was boasting a record quarter for EES, with a remarkable 18-percent increase in earnings over the previous year and new contracts with Eli Lilly, Owens-Corning, Quaker Oats, J.C. Penney and Saks. EES reported a 59-percent increase in new retail energy services contracts totaling $5.9 billion. But those figures were based on highly questionable accounting practices. According to documents obtained by Salon, EES helped Enron keep its illusion of profitability by grossly inflating the value of contracts it signed in February and April 2001, showing EES turning a profit when it was not.
Presiding over and even encouraging EES's accounting was Tom White.
When White testified July 18 before the Senate Commerce Committee about his role at Enron, questions focused primarily on his relationship to the various Enron schemes already familiar to the public, such as the alleged price-fixing schemes that contributed to the energy crises of many Western states in 2001. They also explored, to a limited degree, how Enron managed to hide some of EES's problems by transferring more than $500 million in losses into the company's wholesale services division.
White explained how, unlike Enron's wholesale division, the energy crisis caused grave cash-flow problems for EES. "I can say categorically that it was not ever in the interest of Enron Energy Services to have wholesale energy prices escalate," White testified.
But when asked about the troubled accounting of his own division, he offered an adamant -- but curiously qualified -- statement: "The deals that we put together within the accounting structure that was accepted and was the standard in the industry -- I stand behind that -- were signed and the right deals to do and were properly accounted for at the point that we signed those up."
What he did not explain was how these multibillion-dollar deals were able to create such a false picture of prosperity. Two off-the-books partnerships set up by White and Pai in February 2001 shed some light on EES's illusory profits and how the division was willing to go to great lengths to fool Wall Street.
On Feb. 20, 2001, Enron announced that EES had entered into a $1.3 billion, 15-year contract with Eli Lilly, the Indianapolis-based pharmaceutical company. Following in the Enron tradition of nicknames (like the price-setting "Fat Boy" scheme, or the famous off-budget shell companies named "Jedi" after "Star Wars") EES coined the deal "Heston" after the actor Charlton Heston, according to a former EES sales manager. According to a news release at the time, Enron was to "manage the supply of electricity and natural gas for Lilly facilities in Indiana, as well as perform operations and maintenance on energy assets and related energy infrastructure upgrades that will increase energy efficiency at Lilly facilities."
It helped EES that Kenneth Lay, former chairman and chief executive of Enron, was a member of Eli Lilly's board of directors and used his influence in getting the drug manufacturer to agree to the deal, according to one of the sales executives who worked on the contract. This former employee also said Lay discussed the contract at a meeting of Eli Lilly's board of directors, saying Enron would offer the pharmaceutical company cash if it signed the contract.
The problem with the deal, however, was that Indiana had not yet deregulated its wholesale electricity market. EES, therefore, could not yet provide Lilly with electricity. So, according to the source, White and Pai instructed the salesmen to predict when Indiana would deregulate and then predict how much Enron would earn during the projected 10 years of the contract. Ultimately, the deal was valued at around $600 million, even though it was based on two unreliable factors: When Indiana would deregulate, and the wholesale prices in the wildly erratic energy market.
This accounting method -- forecasting a future profit and counting it as revenue -- is called "mark-to-market" accounting, and is required under rules adopted in recent years by the Financial Accounting Standards Board. Mark-to-market involves recording the value of deals based on forward prices, allowing a company that agreed to supply gas or power at a fixed price to optimistically project future energy prices below the contract price. A company can then record the difference as profit as soon as a deal is signed, even though fluctuating prices change the value of the deal over time. The Securities and Exchange Commission has urged trading firms and other corporations to begin immediately, in 2001 financial reports, to boost disclosure in several areas, including valuation of energy trading contracts and the impacts of mark-to-market practices on earnings.
But back then, mark-to-market accounting was a loophole to exploit. Every quarter, prior to Enron's earnings release, an elite EES group that included White and that referred to itself as "G5," and then later (just like the United States and its economic allies) "G7," would meet to discuss, among other things, how EES would use mark-to-market accounting to boost Enron's earnings and standing on Wall Street. One former EES employee who attended the meetings said it was White and Pai who were responsible for implementing the mark-to-market approach to EES's earnings.
The employee explained how, under their guidance, energy contracts EES would sign over a 10-year period were booked as immediate gains for the company and helped inflate Enron's earnings when, in fact, the contract would cause EES to hemorrhage cash. According to the documents, White and Pai signed off on all of the long-term energy contracts EES entered into.
"Mark-to-market accounting allowed Enron to show a false profit and delay taking the loss," the former EES employee said. "It is not mark-to-market accounting that caused that, but instead the misuse of the method."
As a result, the method has its critics. "Because mark-to-market accounting allows for a considerable degree of discretion on how companies value their energy trading portfolios, there always is the potential that some companies may succumb to the temptation to use more favorable methods or techniques to increase the value or earnings associated with their portfolio when no independent market exists to verify that," said Paul Patterson, an independent energy consultant based in New York, who has been a leading critic of mark-to-market murkiness. "If this method is misused it's very possible that a company's earnings growth may prove illusory.
"Giving companies such wide latitude in reporting their results can become a prescription for disaster," Patterson said.
Said one former EES executive who worked on one of three off-the-books energy contracts: "Where Enron pushed the envelope is that many of these contracts are ones that usually would have been signed for one to three years, whereas EES would sign deals lasting 10 years and immediately book the projected revenue as profit. But there isn't a market that exists that far out that could accurately predict the revenue stream EES said it would be getting."
White has been portrayed as an EES "cheerleader" who was in the dark about Enron's financial machinations and questionable accounting practices. "White was the guy who shook hands with people and motivated the sales staff," said Lance Dohman, a former sales manager for the division. "He would just try and get everyone all fired up to go out and sign contracts." When sought for comment for this story, White's spokesman, Maj. Mike Halbig, said White had answered all questions about his tenure at Enron and has put the issue behind him to focus on his job running the Army.
But White, the only Enron executive who seemed liked by almost everyone who knew him, played a much more crucial role in the day-to-day operations at Enron, according to the documents, which include EES memos and interoffice e-mails.
In one February 2001 e-mail, as panic about EES's mounting losses began to spread among White's employees, an EES employee reported to ESS chairman Lou Pai and to White that the division was losing more than $3 million a month on other contracts signed because of rising wholesale energy costs.
"Close a bigger deal to hide the loss," White responded in the e-mail.
White's word choice is illuminating, because at that point, EES's primary concern became how to "hide" growing losses behind new contracts that, through a questionable use of an accounting loophole, allowed it to claim profits that were wildly speculative in order to give the appearance that the company was actually making money. That false image, of course, would be shattered in the fall, when Enron became the country's biggest bankruptcy ever and 4,500 employees lost their jobs.
But White's employees saw ominous signs long before that.
In February 2001, it was widely known among the EES staff on the seventh floor of Enron's Houston towers that some of the contracts the division had signed in 1999 and 2000 were causing EES to hemorrhage money, according to former EES sales manager Margaret Ceconi, and rumors were spreading that White and Pai might be forced out as a result. The growing energy crisis was causing the wholesale costs of electricity and natural gas to skyrocket, and EES, Enron's retail division, was paying a steep price.
Intensifying the pressure, Pai and White had set the bar dizzyingly high for their division just weeks earlier. At a conference for Wall Street analysts on Jan. 25, 2001, in Houston, Pai and White made the bold prediction that Enron Energy Services' revenues would jump to $10 billion that year, up from $4.6 billion the year before. Earnings, White and Pai said, would reach $225 million in 2001, up from $103 million in 2000. Those were the numbers Jeff Skilling, appointed that month as Enron's chairman, and Andrew Fastow, the company's former chief financial officer, told White and Pai they would have to meet in order for Enron to keep its standing on Wall Street, according to a former EES sales manager who worked on six of EES's large contracts and attended the analysts meeting in Houston.
But within weeks, White and Pai tried to cancel an electricity contract with two University of California campuses. EES was spending as much as $300 a megawatt-hour for the power it delivered to the colleges, but was only charging the universities around $32 a megawatt-hour, based on its 1998 contract. EES executives said the unit could lose as much as $1 billion annually on the U.C. contract alone. But the U.C. system sued Enron, and a judge later ruled in April 2001 that EES must continue to supply the college campuses with power.
Pressure began to grow to land new deals, and make them look as big, and as profitable, as possible. Even if it wasn't entirely true.
The Lilly contract, however, also included a perk to Lilly hidden from the public, Enron shareholders and the budget sheets. According to a copy of the Eli Lilly contract (which, according to an EES source, was ultimately signed by White, Pai, Skilling and Fastow) Enron and Lilly established a limited liability company, made up of Enron and Lilly executives, in order to facilitate the contract. Being a part of the LLC gave Eli Lilly and Enron huge tax incentives. Enron also, through the LLC, would pay Lilly $50 million in cash upfront to win the partnership; Lilly would have to pay back the money over time.
According to John Couch, a Houston tax attorney with Bracewell and Patterson who looked at the contract for Salon, the shares appeared to be the primary attraction for Lilly to sign. "The reason Eli Lilly signed this is because they got $50 million in cash from Enron that the company was able to use to accelerate income and to absorb other losses the company incurred," Couch said. "It says it would provide a legitimate service to Eli Lilly, which an LLC needs to do. But what makes this deal a better deal is it was structured through an LLC and it gave a Eli Lilly a tax advantage."
Once EES formed a limited liability corporation to handle the partnership, the company would then sell its stake at a profit to a third party, such as a bank, which is exactly what EES did in the case of Quaker Oats and Owens Corning, two other deals that were set up in the form of LLCs, according to the former EES sales executive.
And, perhaps most startlingly, the contract stipulated that any earnings Enron made off the contract would be split between Enron and Lilly 30 percent to 70 percent. That means the $600 million that Enron projected as revenue would have been, at best, only $180 million.
So the Lilly deal, listed in the company quarterly reports as worth $600 million, would only mean, optimistically, profits of $130 million. And that was based on a rosy, best-case scenario market report.
Nonetheless, White and Pai were a step closer to reaching their earnings goal.
The Lilly contract says Enron will "develop, design, construct and implement demand-side energy management projects" but all that entailed was removing and replacing a chiller, projecting the revenues over 20 years, and booking the revenues as a mark-to-market profit.
The Eli Lilly deal, which was handled by EES executives Jeff Forbis, Michael Mann and Richard Zdunkewicz, earned White, Pai and others a sizable bonus, according to sources within EES.
But according to Joan Todd, a spokeswoman for Eli Lilly, the deal never actually commenced. "The contract was structured in a manner that allowed the partnership to enter into routine leases for assets," Todd said. "We barely got into the contract with Enron before the company got into its problems."
Todd said the contract was unwound last month and Lilly resumed control over its own energy management. Todd also said that Lilly never accounted for the $50 million payment from Enron on its balance sheet and that the money was not booked as income. Todd did not know whether Lilly received tax incentives from the partnership but she said the company is negotiating with Enron's creditors on whether to pay the $50 million back to the company.
The deal, though, allowed Lilly to keep the transaction off its balance sheet. If Lilly did receive tax incentives from the deal, it's likely the company would have to restate its earnings after the deal was unwound, Couch said.
To fully understand the Enron/Eli Lilly deal, said one of the three sales executives who worked on the contract, "you have to understand why we needed to sign the contract in the first place."
"We were scrambling," the EES sales executive said. "We needed to sign as many large deals as we could between February and April to keep EES from collapsing. If we didn't sign these contracts it's likely that Enron would have imploded right then."
Ceconi, the former EES sales manager, said the Lilly contract allowed EES to claim revenue and margins in the current quarter that were not coming in. "That's what created the cash-flow crisis," she said. "It gave the appearance that EES was a cash machine. In that kind of environment the only way to continue -- and this gets to the issue of the house of cards -- was to continue and generate more business.
"Pai and White told us we had to keep feeding the fire," she said. "That's where the nervousness started to set in."
Also, some of the profits EES booked from the Eli Lilly deal don't appear to make sense. EES projected earnings on equipment it would install for Eli Lilly and maintenance, but no forward market exists for that. EES would do the same thing on Feb. 21, 2001, a day after it announced the Eli Lilly deal. On that day, EES announced in a press release another multibillion-dollar contract, this time with Quaker Oats, the second off-the-books partnership set up under White and Pai that brought them closer to reaching earnings. This deal was set up as a "special purpose entity" in order to provide both companies with tax incentives, according to the contract.
Tom White played key role in covering up Enron losses | 1, 2, 3, 4
EES agreed to supply 15 Quaker plants with energy management, from supplying natural gas and electricity to a staff of EES employees who would maintain boilers and pipes and procure spare parts. Enron, according to a copy of the contract obtained by Salon, guaranteed Quaker it could save $4.4 million from its 1999 energy bill. Enron forecast a $36.8 million profit over the 10-year deal and used mark-to-market accounting to book $23.4 million of that -- before it had even consummated the Quaker deal.
Under accounting rules, such treatment is permitted for commodities, such as natural gas and electricity. But the rules are more restrictive when it comes to services, such as boiler maintenance and parts procurement, for which no forward markets exist. Profits from these activities are supposed to be, according to the FASB, booked on a more conservative "accrual" basis, whereby a fraction of the profit is realized each year as it comes in.
According to a report earlier this year in the Financial Times, Enron's problem was that almost all the profits projected for the Quaker deal were derived from services, not commodities. How did it manage to book them upfront? The company used a questionable method called "revenue allocation." The net effect of this highly complex treatment was to redefine as commodities some of the money Quaker was paying for services and thereby create more profits that Enron could book upfront.
Under the system, Enron's internal accountants created a new category called "allocated revenues." These were based not on what Quaker had historically paid for energy commodities and its service contracts, but on figures that Enron claimed reflected the open market value of the commodities and services.
This revaluation made a significant difference to the reported worth of the contract. Enron would have earned only a small margin supplying gas and power to Quaker based on the original revenue figures it used to calculate the deal. Instead, revenue allocation allowed the company to claim an immediate hefty profit on the deal. Asked if such a move is illegal, a former Enron accountant told the Financial Times: "It's certainly skirting the edge. It's very, very aggressive."
The former EES sales executives claim the division, under White and Pai, managed to list as mark-to-market $85 million in energy services profits from 12 deals, including the Quaker contract, that should have been listed as accrued. In some instances, the sales executives said, the profits came from changing light bulbs and air-conditioning filters.
Former employees say it was easy for White and Pai to get their sales staff to inflate services margins, because no one could accurately predict them. Perhaps Enron's boldest assumptions had to do with something called "efficiency projects."


Posted by: jed grossman on January 4, 2004 12:01 AM

____

Read this Patrick you dick smoking sonofabitch nazi. It's exactly what McLean and Biskind wrote in their book. How do you explain the other documents that show White hiding losses?

Tom White played key role in covering up Enron losses
As Enron neared the end, the Army secretary used highly dubious accounting methods to inflate its revenue.
- - - - - - - - - - - -
By Jason Leopold
Salon.com
Aug. 29, 2002 | Three months before he was nominated as secretary of the Army by President Bush, Thomas White faced what surely was the most difficult task in his 10-year career as an Enron executive: Helping hide the hundreds of millions of dollars in losses from Enron Energy Services, the retail division he had headed since 1998.
It was February 2001 and for White and others in charge of EES, it was imperative that the division find ways to inflate its first-quarter earnings and hide what was becoming a black hole of losses.
But after White had left to pursue his Army post, the company was boasting a record quarter for EES, with a remarkable 18-percent increase in earnings over the previous year and new contracts with Eli Lilly, Owens-Corning, Quaker Oats, J.C. Penney and Saks. EES reported a 59-percent increase in new retail energy services contracts totaling $5.9 billion. But those figures were based on highly questionable accounting practices. According to documents obtained by Salon, EES helped Enron keep its illusion of profitability by grossly inflating the value of contracts it signed in February and April 2001, showing EES turning a profit when it was not.
Presiding over and even encouraging EES's accounting was Tom White.
When White testified July 18 before the Senate Commerce Committee about his role at Enron, questions focused primarily on his relationship to the various Enron schemes already familiar to the public, such as the alleged price-fixing schemes that contributed to the energy crises of many Western states in 2001. They also explored, to a limited degree, how Enron managed to hide some of EES's problems by transferring more than $500 million in losses into the company's wholesale services division.
White explained how, unlike Enron's wholesale division, the energy crisis caused grave cash-flow problems for EES. "I can say categorically that it was not ever in the interest of Enron Energy Services to have wholesale energy prices escalate," White testified.
But when asked about the troubled accounting of his own division, he offered an adamant -- but curiously qualified -- statement: "The deals that we put together within the accounting structure that was accepted and was the standard in the industry -- I stand behind that -- were signed and the right deals to do and were properly accounted for at the point that we signed those up."
What he did not explain was how these multibillion-dollar deals were able to create such a false picture of prosperity. Two off-the-books partnerships set up by White and Pai in February 2001 shed some light on EES's illusory profits and how the division was willing to go to great lengths to fool Wall Street.
On Feb. 20, 2001, Enron announced that EES had entered into a $1.3 billion, 15-year contract with Eli Lilly, the Indianapolis-based pharmaceutical company. Following in the Enron tradition of nicknames (like the price-setting "Fat Boy" scheme, or the famous off-budget shell companies named "Jedi" after "Star Wars") EES coined the deal "Heston" after the actor Charlton Heston, according to a former EES sales manager. According to a news release at the time, Enron was to "manage the supply of electricity and natural gas for Lilly facilities in Indiana, as well as perform operations and maintenance on energy assets and related energy infrastructure upgrades that will increase energy efficiency at Lilly facilities."
It helped EES that Kenneth Lay, former chairman and chief executive of Enron, was a member of Eli Lilly's board of directors and used his influence in getting the drug manufacturer to agree to the deal, according to one of the sales executives who worked on the contract. This former employee also said Lay discussed the contract at a meeting of Eli Lilly's board of directors, saying Enron would offer the pharmaceutical company cash if it signed the contract.
The problem with the deal, however, was that Indiana had not yet deregulated its wholesale electricity market. EES, therefore, could not yet provide Lilly with electricity. So, according to the source, White and Pai instructed the salesmen to predict when Indiana would deregulate and then predict how much Enron would earn during the projected 10 years of the contract. Ultimately, the deal was valued at around $600 million, even though it was based on two unreliable factors: When Indiana would deregulate, and the wholesale prices in the wildly erratic energy market.
This accounting method -- forecasting a future profit and counting it as revenue -- is called "mark-to-market" accounting, and is required under rules adopted in recent years by the Financial Accounting Standards Board. Mark-to-market involves recording the value of deals based on forward prices, allowing a company that agreed to supply gas or power at a fixed price to optimistically project future energy prices below the contract price. A company can then record the difference as profit as soon as a deal is signed, even though fluctuating prices change the value of the deal over time. The Securities and Exchange Commission has urged trading firms and other corporations to begin immediately, in 2001 financial reports, to boost disclosure in several areas, including valuation of energy trading contracts and the impacts of mark-to-market practices on earnings.
But back then, mark-to-market accounting was a loophole to exploit. Every quarter, prior to Enron's earnings release, an elite EES group that included White and that referred to itself as "G5," and then later (just like the United States and its economic allies) "G7," would meet to discuss, among other things, how EES would use mark-to-market accounting to boost Enron's earnings and standing on Wall Street. One former EES employee who attended the meetings said it was White and Pai who were responsible for implementing the mark-to-market approach to EES's earnings.
The employee explained how, under their guidance, energy contracts EES would sign over a 10-year period were booked as immediate gains for the company and helped inflate Enron's earnings when, in fact, the contract would cause EES to hemorrhage cash. According to the documents, White and Pai signed off on all of the long-term energy contracts EES entered into.
"Mark-to-market accounting allowed Enron to show a false profit and delay taking the loss," the former EES employee said. "It is not mark-to-market accounting that caused that, but instead the misuse of the method."
As a result, the method has its critics. "Because mark-to-market accounting allows for a considerable degree of discretion on how companies value their energy trading portfolios, there always is the potential that some companies may succumb to the temptation to use more favorable methods or techniques to increase the value or earnings associated with their portfolio when no independent market exists to verify that," said Paul Patterson, an independent energy consultant based in New York, who has been a leading critic of mark-to-market murkiness. "If this method is misused it's very possible that a company's earnings growth may prove illusory.
"Giving companies such wide latitude in reporting their results can become a prescription for disaster," Patterson said.
Said one former EES executive who worked on one of three off-the-books energy contracts: "Where Enron pushed the envelope is that many of these contracts are ones that usually would have been signed for one to three years, whereas EES would sign deals lasting 10 years and immediately book the projected revenue as profit. But there isn't a market that exists that far out that could accurately predict the revenue stream EES said it would be getting."
White has been portrayed as an EES "cheerleader" who was in the dark about Enron's financial machinations and questionable accounting practices. "White was the guy who shook hands with people and motivated the sales staff," said Lance Dohman, a former sales manager for the division. "He would just try and get everyone all fired up to go out and sign contracts." When sought for comment for this story, White's spokesman, Maj. Mike Halbig, said White had answered all questions about his tenure at Enron and has put the issue behind him to focus on his job running the Army.
But White, the only Enron executive who seemed liked by almost everyone who knew him, played a much more crucial role in the day-to-day operations at Enron, according to the documents, which include EES memos and interoffice e-mails.
In one February 2001 e-mail, as panic about EES's mounting losses began to spread among White's employees, an EES employee reported to ESS chairman Lou Pai and to White that the division was losing more than $3 million a month on other contracts signed because of rising wholesale energy costs.
"Close a bigger deal to hide the loss," White responded in the e-mail.
White's word choice is illuminating, because at that point, EES's primary concern became how to "hide" growing losses behind new contracts that, through a questionable use of an accounting loophole, allowed it to claim profits that were wildly speculative in order to give the appearance that the company was actually making money. That false image, of course, would be shattered in the fall, when Enron became the country's biggest bankruptcy ever and 4,500 employees lost their jobs.
But White's employees saw ominous signs long before that.
In February 2001, it was widely known among the EES staff on the seventh floor of Enron's Houston towers that some of the contracts the division had signed in 1999 and 2000 were causing EES to hemorrhage money, according to former EES sales manager Margaret Ceconi, and rumors were spreading that White and Pai might be forced out as a result. The growing energy crisis was causing the wholesale costs of electricity and natural gas to skyrocket, and EES, Enron's retail division, was paying a steep price.
Intensifying the pressure, Pai and White had set the bar dizzyingly high for their division just weeks earlier. At a conference for Wall Street analysts on Jan. 25, 2001, in Houston, Pai and White made the bold prediction that Enron Energy Services' revenues would jump to $10 billion that year, up from $4.6 billion the year before. Earnings, White and Pai said, would reach $225 million in 2001, up from $103 million in 2000. Those were the numbers Jeff Skilling, appointed that month as Enron's chairman, and Andrew Fastow, the company's former chief financial officer, told White and Pai they would have to meet in order for Enron to keep its standing on Wall Street, according to a former EES sales manager who worked on six of EES's large contracts and attended the analysts meeting in Houston.
But within weeks, White and Pai tried to cancel an electricity contract with two University of California campuses. EES was spending as much as $300 a megawatt-hour for the power it delivered to the colleges, but was only charging the universities around $32 a megawatt-hour, based on its 1998 contract. EES executives said the unit could lose as much as $1 billion annually on the U.C. contract alone. But the U.C. system sued Enron, and a judge later ruled in April 2001 that EES must continue to supply the college campuses with power.
Pressure began to grow to land new deals, and make them look as big, and as profitable, as possible. Even if it wasn't entirely true.
The Lilly contract, however, also included a perk to Lilly hidden from the public, Enron shareholders and the budget sheets. According to a copy of the Eli Lilly contract (which, according to an EES source, was ultimately signed by White, Pai, Skilling and Fastow) Enron and Lilly established a limited liability company, made up of Enron and Lilly executives, in order to facilitate the contract. Being a part of the LLC gave Eli Lilly and Enron huge tax incentives. Enron also, through the LLC, would pay Lilly $50 million in cash upfront to win the partnership; Lilly would have to pay back the money over time.
According to John Couch, a Houston tax attorney with Bracewell and Patterson who looked at the contract for Salon, the shares appeared to be the primary attraction for Lilly to sign. "The reason Eli Lilly signed this is because they got $50 million in cash from Enron that the company was able to use to accelerate income and to absorb other losses the company incurred," Couch said. "It says it would provide a legitimate service to Eli Lilly, which an LLC needs to do. But what makes this deal a better deal is it was structured through an LLC and it gave a Eli Lilly a tax advantage."
Once EES formed a limited liability corporation to handle the partnership, the company would then sell its stake at a profit to a third party, such as a bank, which is exactly what EES did in the case of Quaker Oats and Owens Corning, two other deals that were set up in the form of LLCs, according to the former EES sales executive.
And, perhaps most startlingly, the contract stipulated that any earnings Enron made off the contract would be split between Enron and Lilly 30 percent to 70 percent. That means the $600 million that Enron projected as revenue would have been, at best, only $180 million.
So the Lilly deal, listed in the company quarterly reports as worth $600 million, would only mean, optimistically, profits of $130 million. And that was based on a rosy, best-case scenario market report.

Posted by: jed grossman on January 4, 2004 12:02 AM

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Read this Patrick you dick smoking sonofabitch nazi. It's exactly what McLean and Biskind wrote in their book. How do you explain the other documents that show White hiding losses?

Tom White played key role in covering up Enron losses
As Enron neared the end, the Army secretary used highly dubious accounting methods to inflate its revenue.
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By Jason Leopold
Salon.com
Aug. 29, 2002 | Three months before he was nominated as secretary of the Army by President Bush, Thomas White faced what surely was the most difficult task in his 10-year career as an Enron executive: Helping hide the hundreds of millions of dollars in losses from Enron Energy Services, the retail division he had headed since 1998.
It was February 2001 and for White and others in charge of EES, it was imperative that the division find ways to inflate its first-quarter earnings and hide what was becoming a black hole of losses.
But after White had left to pursue his Army post, the company was boasting a record quarter for EES, with a remarkable 18-percent increase in earnings over the previous year and new contracts with Eli Lilly, Owens-Corning, Quaker Oats, J.C. Penney and Saks. EES reported a 59-percent increase in new retail energy services contracts totaling $5.9 billion. But those figures were based on highly questionable accounting practices. According to documents obtained by Salon, EES helped Enron keep its illusion of profitability by grossly inflating the value of contracts it signed in February and April 2001, showing EES turning a profit when it was not.
Presiding over and even encouraging EES's accounting was Tom White.
When White testified July 18 before the Senate Commerce Committee about his role at Enron, questions focused primarily on his relationship to the various Enron schemes already familiar to the public, such as the alleged price-fixing schemes that contributed to the energy crises of many Western states in 2001. They also explored, to a limited degree, how Enron managed to hide some of EES's problems by transferring more than $500 million in losses into the company's wholesale services division.
White explained how, unlike Enron's wholesale division, the energy crisis caused grave cash-flow problems for EES. "I can say categorically that it was not ever in the interest of Enron Energy Services to have wholesale energy prices escalate," White testified.
But when asked about the troubled accounting of his own division, he offered an adamant -- but curiously qualified -- statement: "The deals that we put together within the accounting structure that was accepted and was the standard in the industry -- I stand behind that -- were signed and the right deals to do and were properly accounted for at the point that we signed those up."
What he did not explain was how these multibillion-dollar deals were able to create such a false picture of prosperity. Two off-the-books partnerships set up by White and Pai in February 2001 shed some light on EES's illusory profits and how the division was willing to go to great lengths to fool Wall Street.
On Feb. 20, 2001, Enron announced that EES had entered into a $1.3 billion, 15-year contract with Eli Lilly, the Indianapolis-based pharmaceutical company. Following in the Enron tradition of nicknames (like the price-setting "Fat Boy" scheme, or the famous off-budget shell companies named "Jedi" after "Star Wars") EES coined the deal "Heston" after the actor Charlton Heston, according to a former EES sales manager. According to a news release at the time, Enron was to "manage the supply of electricity and natural gas for Lilly facilities in Indiana, as well as perform operations and maintenance on energy assets and related energy infrastructure upgrades that will increase energy efficiency at Lilly facilities."
It helped EES that Kenneth Lay, former chairman and chief executive of Enron, was a member of Eli Lilly's board of directors and used his influence in getting the drug manufacturer to agree to the deal, according to one of the sales executives who worked on the contract. This former employee also said Lay discussed the contract at a meeting of Eli Lilly's board of directors, saying Enron would offer the pharmaceutical company cash if it signed the contract.


Posted by: jed grossman on January 4, 2004 12:04 AM

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Read this Patrick you dick smoking sonofabitch nazi. It's exactly what McLean and Biskind wrote in their book. How do you explain the other documents that show White hiding losses?

Posted by: jed grossman on January 4, 2004 12:06 AM

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Read this Patrick you dick smoking sonofabitch nazi. It's exactly what McLean and Biskind wrote in their book. How do you explain the other documents that show White hiding losses?

Posted by: jed grossman on January 4, 2004 12:11 AM

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