Enron: A Pattern of Abuses?

Kenneth Lay, the embattled chairman, pulled it out in 1987, revamping the company and literally creating a futures market in natural gas, but Enron's survival doesn't look as good in 2002.

Now investigators and lawyers for stockholders are examining how Lay handled that 1987 oil scandal in order to build a case suggesting corporate governance at Enron under Lay may have always been flawed.

In 1985 Houston Natural Gas merged with InterNorth, of Omaha, Neb., to form Enron and Lay was named chief executive officer. But his job and the company's future were precarious.

He presided over a split board of directors -- half of the members were executives of InterNorth and many of them were suspicious of his actions. At the same time, Enron was seriously burdened with debt incurred by the merger.

The company was basically a producer of natural gas and had control over vast reserves throughout the oil belt, but in 1987 the price of natural gas was falling and drastically cutting Enron's income.

At almost the same time, Lay was grappling with a collapsing gas market. In January 1987, a security officer at Apple Bank in New York alerted Enron Corp. auditors to a strange set of transactions by two of the company's oil traders: Louis Borget and Thomas Mastroeni.

Neither Borget nor Mastroeni were well known in Houston. They were officials of an entity called Enron Oil Co. in Valhalla, N.Y., that had become part of Enron in the merger.

David Woytek, at that time a vice president in charge of auditing for Enron, said that Enron Oil at Valhalla, a town in Westchester County, outside of New York City, was a different entity than a later Enron company with the same name. The New York Enron Oil Co. was dissolved in the 1980s.

It did not produce oil, but bought and sold oil futures. It bought oil long if it thought the market would rise and short if it thought oil prices would fall.

Basically, Woytek said, "They were just shooting craps."

The bank security man said that $100,000 transfers were coming from an Enron account at Standard Chartered Bank in Britain's Channel Islands. Channel Island transactions were a red flag to bank security men because the islands were a hotbed of secret offshore bank accounts and often the address of convenience for firms of dubious character.

The transfers, signed by Mastroeni, came from a U.S. Enron account, went to the Channel Islands and then landed in an account opened by Mastroeni at Apple.

"Borget and Mastroeni appear to be writing checks to themselves," Woytek recalls the alert security man telling him.

The suggestion that there were difficulties at Enron Oil presented a sticky problem.

Enron Oil Co., run by Borget and Mastroeni, was one of the few bright spots on Ken Lay's corporate radar screen. The oil trading company was bringing in profits of $30 million a year, one third of the company's earnings and offsetting the grim natural gas picture.

"Ken Lay and all of them (in top management) believed that Borget and Mastroeni had connections to the Saudi Royal family and Kuwaitis," Woytek said, "but later it developed that they did not have either."

"Back then, though, Houston thought they walked on water."

But since the call had come to the chief of audit, it was hard for Enron to ignore. The audit department obtained statements from Apple Bank and found that the account, opened by Mastroeni, appeared to have been altered "using a falsified resolution of the board of directors of Enron Oil," as a lawsuit later charged.

Meanwhile, not knowing the auditors had already determined the account was opened with a fake resolution, Woytek said, Borget and Mastroeni hurried to Washington for a meeting with Lay and top management.

Borget and Mastroeni told Lay that they opened the Apple Bank account to carry their enormous profits from 1986 into 1987 so as to start the year with a positive balance on the company books. Enron had exceeded its budget estimate for 1986, they said, and they created the Apple account to move money to 1987.

"There were a couple of things that bothered us about this story," said Woytek. "First was that this didn't explain why they had to fake a board of directors meeting and minutes to open the account. Secondly, the Tax Reform Act of 1986 had just been passed which meant lower rates for 1987 and we thought it would look to the IRS that Enron Oil was trying to move money out from under higher tax rates."

Another transaction that bothered the auditors was a series of money transfers to an "M. Yass" in Lebanon.

"Borget and Mastroeni said that Yass would only receive cash money delivered on a street in Beirut," recalls Woytek. "They said that the money was to create a series of transactions that would provide a commission to pay a salesman who missed his bonus in 1995.

"This kind of story bothers auditors."

Later investigation would determine, as Enron charged in a March 1990 lawsuit, filed in the U.S. District Court for the Southern District of New York State, "there was no such person (as Yass) and these funds had been diverted to Mastroeni's own personal use and benefit."

"We figured M. Yass stood for My Ass," said Woytek.

Woytek said that even though he and his auditors didn't know this at the time of the first meeting in Washington in Feb. 1987 between Lay and the two traders, they did know that the nearly $5 million in Apple-Channel Island transactions were dubious and they had found "altered bank statements."

"I'd have fired those people on the spot," Woytek said, adding that he made his feelings clear to Lay at the time. United Press International's interviews with two other auditors on the matter confirmed that they agreed with Woytek the two men should have been fired immediately.

According to Woytek, who was at the meeting, Lay largely accepted Borget and Mastroeni's story and sent them back to New York.

Lay then agreed to send a four-person audit team to New York to look into the situation, but the team was warned not to upset the profitable oil trade operations in Valhalla. Herb Perry, one of the audit team told UPI that their orders were to "go up and get the ($5 million) back."

Woytek said the team, which included Woytek, Perry, John Beard and Carolyn Key, were stymied from the moment they got to New York.

"Borget knew we were onto him. He had us picked up a limousine and we couldn't enter the Valhalla offices without being announced," he said.

After three days the team was called back to Washington. Later an Arthur Andersen audit team was sent to Enron Oil to take a longer look.

Even then, the material from the bank and some company records were sufficient for Woytek to prepare a report recommending in April 1987 that the two Enron oil executives be fired.

"Everyone concurred," Woytek said. "Carolyn Key told me 'these guys are as crooked as a dog's hind leg.'"

In April, the team met with Lay and the audit committee of the board of directors. Woytek presented his recommendation that Borget and Mastroeni be fired. Woytek said that several members of the board concurred, but in the end Ken Lay ordered that the two men be retained, but stripped of the power to open bank accounts and make money transfers.

"What could I do? He was the chief executive officer of the company," said Woytek. "He had a bigger picture."

But Borget and Mastroeni still had the authority to commit the company to multi-million dollar oil contracts. According to Woytek, they used that power to its full extent. "They went wild," he said, alleging that in the six months from April to Oct. 1987, they made oil commitments totaling $1.2 billion. Many of these were fictitious -- designed to enrich the two traders -- others would cause Enron grievous losses.

"Enron was close to bankruptcy," when the trades were discovered in October 1987, said Woytek. The problem for the company was that Borget and Mastroeni had made trades well over their trading limits, primarily buying long, and as the market worsened, the company was liable for the losses.

Through a concerted effort at contract management -- including selling on many of the losing contracts to other traders -- Enron was able to reduce its exposure to $142 million.

Borget and Mastroeni were fired in October 1987 and later pleaded guilty to conspiracy to defraud and to filing false returns. Borget served five months in prison and Mastroeni was given a suspended sentence. Borget, who now lives in Croton-on-the-Hudson and was reached by telephone, told UPI, "That's too long ago and my memory isn't good. I don't care to discuss it."

Mastroeni could not be located for comment.

Enron's crisis became public the same month as the 1987 stock market crashed and though there were news stories about it, the Wall Street slump obscured the critical problems at Enron.

Enron later retained a prominent Washington criminal lawyer, Judah Best of Debevoice & Plimpton, to file a civil suit against the two men and a series of other firms and individuals that it said had conspired with them.

In a 50-page complaint filed at the United States District Court for the Southern District of New York State on March 26, 1990, Enron sketched three years in which Borget and Mastroeni had embezzled millions of dollars by paying themselves fees and bonuses based on often-fictitious transactions, conspiring with a series individuals in the Channel Islands, Japan, London and Panama to bilk Enron.

The complaint charged the two Enron Oil executives with many of the kind of deceptions now under investigation at Enron itself, including record destruction, back dating transactions and misleading superiors.

The civil case was settled out of court.

Woytek's internal audit function was done away with shortly thereafter and they were all transferred to work for Arthur Andersen, which had a contract for internal and external auditing.

He and Perry believe that move paved the way for last year's scandal.

"You cannot have both internal audit and external by the same firm," Perry said. "Internal auditors work within a company, form relationships with the people in the company and know more about what's really going on." Several congressional proposals for reform have made the same point.

Woytek said he and the other auditors feared they might be made scapegoats for Enron Oil and he kept copies of his files on the case.

Woytek said that when he was interviewed by Marie Brenner for an article in Vanity Fair magazine, she had suggested that the incident smacked of a corporate culture pattern of Lay being duped by underlings like Jeffrey Skilling or Louis Borget and then saying that he didn't know what they were doing.

Woytek agreed that was certainly what happened in the Borget matter. "When the whole thing blew up in October 1987, he told a meeting of the employees that he hadn't known about the problems before," Woytek said.

Kelly Kimberly who handles public affairs for Lay told UPI that the charges against the former chairman were "absurd." She said that when higher management learned of illegal activities by two traders "they were fired and prosecuted." She said that the oil operation had been "inherited" in the merger and that as Lay learned of the unauthorized bank account, it was "audited repeatedly."

Woytek, Perry and Beard told UPI that they have been interviewed by Paul Howes, a partner at Milberg, Weiss, which is representing stockholders trying to recover losses incurred by the sudden drop in stock value last fall. Howes grilled them on how Lay handled the matter. Howes would not comment to UPI, but acknowledged that he is in charge of the firm's investigation of Enron.

A spokesman for Enron, Eric Thode, said the company had no comment on the issue and was no longer representing Lay who stepped down as chairman.