Ex-Enron attorney: Allegations were 'gossip'
Witness: Accountants found energy giant's special purpose entities were legitimate.
By Shaheen Pasha, CNNMoney.com staff writer

HOUSTON (CNNMoney.com) - Enron investigated allegations made by then-vice president Sherron Watkins in 2001, but found some of her concerns were based on office gossip and found no evidence the company's accounting was inappropriate, a witness for the defense of the company's two former CEOs testified Wednesday.

The testimony came a day before one of the defendants, ex-CEO Jeffrey Skilling, was expected totake the stand.

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Max Hendrick, a partner at Vinson & Elkins, the law firm retained by Enron to look into Watkins' concern, testified at the trial of Skilling and Kenneth Lay that he and another attorney interviewed Enron executives -- including former accounting chief Richard Causey and former financial chief Andrew Fastow -- as well as the lead Enron accountants at Arthur Andersen.

Hendrick said he told Enron founder Lay and General Counsel James Derrick that the preliminary investigation didn't turn up any evidence to warrant a further investigation by an independent counsel.

In his report to Lay and to Enron's board of directors' audit committee, Hendrick conceded while there were "bad cosmetics" related to the company's special purpose entities, LJM and Raptors, that could give rise to litigation down the road if market conditions turned sour, he and Vinson attorney Joe Dilg found that Enron's accounting may have been aggressive but not technically inappropriate.

Upon cross-examination, however, government prosecutor John Hueston questioned the narrow scope of Hendrick's investigation, adding that neither he or Dilg had any accounting expertise and had to rely on the assurances of management and Arthur Andersen. Hendrick agreed that his only mission in the probe was to question senior management about the allegations made by Watkins in an anonymous letter to Lay but didn't involve embarking on a larger investigation of the accounting propriety of each transaction.

Watkins testified last month that she approached Enron founder Lay after former CEO Skilling resigned, and warned Lay that the company would "implode in a wave of accounting scandals." She said she requested that Enron hire independent auditors and attorneys to address the matter and was shocked to learn that Enron relied on Arthur Andersen and Vinson & Elkins to investigate their own work.

Hendrick testified that he and Dilg decided to keep their investigation within a narrow scope. They said they didn't interview a wide swathe of individuals within the company, aside from those that Watkins suggested in her memo and other senior executives, and didn't delve into any LJM documents to determine whether there were side deals after Fastow denied the allegation.

"It wouldn't be the first time someone accused of fraud would lie?" Hueston asked. "It wouldn't be the first time," Hendrick conceded.

E-mails never seen

Amid objections from the defense, Hueston presented e-mails and memos from former employees in which the employees raised concerns to Lay that Watkins allegations of aggressive accounting were plausible. Hendrick testified that he was never provided with the e-mails during his investigation.

Earlier Wednesday, Hendrick testified that Enron decided that hiring an outside auditor to oversee Arthur Andersen's work would have delayed the investigation by months and the company was intent on conducting a preliminary probe quickly with little media attention until a finding was reached. He said there was already media speculation in the wake of Skilling's sudden departure.

Hueston showed Hendrick an e-mail during cross that depicted a $500 million loss within Enron Energy Services while Enron was reporting earnings.

"Would this e-mail have caused you to question the competency and integrity of Enron's auditors?" Hueston asked. "It would have prompted some question,' Hendrick replied.

Upon redirect, however, defense attorney Bruce Collins revealed that the writer of the e-mail was a disgruntled ex-employee who had been referred to as "a nut job" by her boss at Enron -- a factor Hendrick conceded he would have taken into consideration in determining its validity.

Hendrick added that he had never been restricted by Lay from investigating any issue but he believed that he had conducted the job he was asked to do in a professional manner, adding "I approached it just as I would an engagement for anyone else."

"Would you throw away 30 years of professional integrity to prepare a whitewash for Enron?" Collins asked. "No absolutely not," Hendrick replied.

And Hendrick also refuted Watkins' previous testimony that his partner in the investigation, Dilg, seemed upset and nervous when he told Watkins the preliminary findings of the probe -- the reaction, Watkins said, convinced her that Vinson & Elkins knew something was wrong.

"I didn't notice anything out of the ordinary in Mr. Dilg's demeanor," Hendrick testified.

Still, under Hueston's questioning, Hendrick said Vinson & Elkins did too much work for Enron, including some legal issues tied to the Raptors transactions in question, to have legitimately been able to lead an independent investigation.

Defense attorneys representing Skilling and Lay have maintained that not only are the defendants innocent of any crimes, but that there were no crimes committed at Enron, aside from the actions of former financial chief Andrew Fastow and a handful of associates.

At the heart of Enron's defense is the notion that the financial transactions at the company were so complex that both Lay and Skilling had to rely on the counsel of accountants and some of the top legal minds at firms such as Vinson & Elkins, considered the premier law firm representing the power industry.

Skilling set to take stand

After Hendrick, the defense called Derrick, who served as general counsel at Enron. Derrick testified that the company had a strict policy that any financial transaction had to be approved by an Enron attorney and a number of controls would be put in place to avoid any hidden risk an initiative he said was spearheaded by Skilling.

He added that he spoke to Fastow about his fiduciary duties to Enron as Fastow planned to take over LJM and advised him that the company wouldn't tolerate any violation of his duties to Enron. He said he, like the board of directors, believed that the creation of LJM benefited Enron by giving the company an additional source of capital necessary to make deals quickly and he had no concerns that there were any side agreements at play.

The defense will continue to question Derrick Thursday morning and Skilling is expected to take the stand by the afternoon and through next week. But Daniel Petrocelli, Skilling's lead attorney said Skilling's testimony will be followed by that of three character witnesses, rather than Lay, as originally anticipated.

It's still unclear whether Lay attorney Michael Ramsey will take the lead when Lay takes the stand. Ramsey was in the hospital Tuesday undergoing invasive tests due to complications from a stent that was placed in his heart late last month. He will undergo another surgery Thursday, defense attorneys said, to clear a blockage in a carotid artery.

A Lay spokeswoman said the team is hopeful that Ramsey will rejoin the trial, but that it's still too early to tell. The defense team said Ramsey's illness isn't expected to cause any delays or complications within the trial, although for Lay, the timing couldn't be worse.

Lay and Skilling combined face almost three dozen fraud and conspiracy charges. They are accused of lying to investors about the company's financial state while they enriched themselves by selling millions of dollars in stock.

Enron was once the seventh-largest corporation in the U.S. It declared bankruptcy in December 2001, costing 4,000 employees their jobs and resulting in millions of dollars in losses for investors.

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Click here for CNNMoney.com's special report 'Enron on Trial.' Top of page

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Market indexes are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer LIBOR Warning: Neither BBA Enterprises Limited, nor the BBA LIBOR Contributor Banks, nor Reuters, can be held liable for any irregularity or inaccuracy of BBA LIBOR. Disclaimer. Morningstar: © 2014 Morningstar, Inc. All Rights Reserved. Disclaimer The Dow Jones IndexesSM are proprietary to and distributed by Dow Jones & Company, Inc. and have been licensed for use. All content of the Dow Jones IndexesSM © 2014 is proprietary to Dow Jones & Company, Inc. Chicago Mercantile Association. The market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. FactSet Research Systems Inc. 2014. All rights reserved. Most stock quote data provided by BATS.