Risk Management

SEC Charges Three Enron Executives

A former accountant and two executives are accused of involvement in a fraudulent deal to manipulate Enron's publicly reported earnings.
Sarah JohnsonOctober 16, 2006

The Securities and Exchange Commission has charged a former Enron accountant/executive and two former executives with fraud and aiding and abetting Enron’s violations of the reporting, record-keeping, and internal controls provisions of securities laws.

The three ex-officials, former accountant and executive Jerry Kent Castleman and former executives Cheryl Lipshutz and Kathleen Lynn,
were allegedly involved a fraudulent deal to manipulate Enron’s publicly reported earnings. The result, the SEC said Friday, was that the company filed materially false and misleading information in its 1999 and 2000 annual reports; in its 1999 third-quarter report; in its 2000 reports for the first three quarters; and in the first two 2001 quarterly reports.

Without admitting or denying the commission’s allegations, Lipshutz agreed to disgorge $20,000 and pay prejudgment interest of $7,150 and a penalty of $25,000.

Eric Reed, Castleman’s attorney at Lyons Rhodes Vela in Houston, told CFO.com that “no decision has been made” about his client’s response to the charges. “We are examing the situation very carefully and deliberately. He’s a good person, a good professional with a great track record…these allegations are obviously a setback.”

CFO.com also attempted to call Lynn’s residence in Texas, but no one answered the phone.

The commission alleges that Enron sold an interest in a troubled power project in Cuiaba, Brazil, to LJM Cayman, LP, which was controlled by former Enron CFO Andrew Fastow. Enron South America, an Enron subsidiary, deconsolidated its interest in the project and Enron recognized earnings from related gas supply contracts. Enron and ESA needed these earnings to meet earnings estimates for the third and fourth quarters of 1999, the SEC says in its complaint.

The SEC says that deconsolidation and recognition weren’t the appropriate accounting routes to take because the seller (Enron) did not transfer to the buyer (LJM) the usual risks and rewards of ownership. The selldown allegedly included an oral side agreement that LJM would not lose money on its Cuiaba investment. The side agreement was neither written down in the deal documents nor disclosed to Enron’s auditor, according to the SEC.

The SEC also says that in 2001, to satisfy the side agreement, Enron bought back LJM’s interest without reversing the previously recognized earnings (the buyback). Further, Enron paid LJM a profit despite the poor economics of the project, according to the commission.

The SEC claims that Castleman, then an Enron accountant, and Lipshutz negotiated and documented the selldown, and Castleman and Lynn negotiated and documented the buyback. The complaint alleges that the defendants knew or should have been aware of the existence of the side agreement and that it was not included in the deal documents. They also knew, according to the complaint, that the Cuiaba project was troubled and that Enron was incurring significant costs to keep it going.

The complaint also alleges that the defendants knew or should have known that the selldown was aimed at improperly deconsolidating the project and manufacturing earnings from related gas supply contracts.

In early drafts of the deal documents, rejected by Enron’s independent auditor, Castleman and Lipshutz tried to structure the selldown so that LJM would assume no transactional risk, according to the SEC.

Castleman and Lynn allegedly negotiated and documented the buyback in which Enron paid LJM a profit of over 13 percent for temporarily parking the interest, even though the value of the interest had decreased significantly over time due to the problems with the project, the SEC says.

The complaint charges that Castleman, Lipshutz, and Lynn knew or should have known that the side agreement violated Enron’s “desired” accounting treatment. According to the complaint, Castleman also hid the undocumented side agreement from Enron’s independent auditor and knew that Enron didn’t reverse the previously recognized earnings at the time of the repurchase.

The SEC also alleges that the former Enron executives violated various sections of the Securities Act of 1933. The complaint seeks permanent injunctions, disgorgement with prejudgment interest and penalties from each of the defendants, as well as an order barring Castleman from serving as an officer or director of a publicly traded company.