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Sherron Watkins Testifies Before House Committee

Aired February 14, 2002 - 12:41   ET

THIS IS A RUSH TRANSCRIPT. THIS COPY MAY NOT BE IN ITS FINAL FORM AND MAY BE UPDATED.

THIS IS A RUSH TRANSCRIPT. THIS COPY MAY NOT BE IN ITS FINAL FORM AND MAY BE UPDATED.
BILL HEMMER, CNN ANCHOR: Up on Capitol Hill, now being sworn in, the Enron executive considered by many to be the whistle-blower on the Enron matter.

(JOINED IN PROGRESS)

REP. JAMES GREENWOOD (R), PENNSYLVANIA: Ms. Watkins, you're aware that this committee is holding an investigative hearing, and when holding an investigative hearing, it is our practice to take testimony under oath. Do you have any objections to giving your testimony under oath today?

SHERRON WATKINS, FORMER VICE PRESIDENT OF CORPORATE DEVELOPMENT AT ENRON: No, I don't.

GREENWOOD: OK. The chair then advises you that, under the rules of this committee and the rules of the House, you are entitled to be advised by counsel. Do you choose to be advised by counsel today?

WATKINS: Yes, I do.

GREENWOOD: And would you identify your counsel for us?

WATKINS: Mr. Philip Hilder.

GREENWOOD: OK. Sir, would you spell your last name, please?

PHILIP HILDER, COUNSEL FOR SHERRON WATKINS: Hilder, sir. H-I-L- D-E-R.

GREENWOOD: Thank you.

In that case, if you would please rise and raise your right hand, I'll give you the oath.

Do you swear that the testimony you are about to give is the truth, the whole truth and nothing but the truth?

WATKINS: I do.

GREENWOOD: You may be seated. You are under oath, and you are recognized for your opening remarks. And you'll probably want to pull that microphone over to you, and it's fairly directional.

WATKINS: OK.

Well, good morning, Mr. Chairman, member of the subcommittee. I am Sherron Watkins, and thank you for the opportunity to address the subcommittee this morning.

I am currently employed at Enron Corporation as a vice president. By way of background, I hold a master's degree in professional accounting from the University of Texas at Austin, and I have been a certified public accountant since 1983.

I began my career in 1982 at Arthur Andersen as an auditor. I spent eight years at Andersen in both the Houston and New York offices. I joined New York-based MG Trade Finance in 1990 to manage their portfolio of commodity-backed finance assets. I held that position until October of 1993.

In October of 1993, I was hired by Mr. Andrew Fastow and moved back to Houston to manage Enron's newly formed partnership with CalPERS, the California Public Employee Retirement System. The partnership was the Joint Energy Development Investments limited partnership, or JEDI. I held the JEDI management portfolio position until the end of 1996.

From 1997 until early 2000, I worked for Enron International, primarily in the Mergers and Acquisitions Group, which is also known as the Corporate Development Group.

In early 2000, I transferred to Enron Broadband Services. I worked there until June of 2000 in a variety of roles.

In mid to late June of 2001, I went to work directly for Mr. Fastow, assisting in the corporate development work that had been put under his supervision after Cliff Baxter resigned in May of 2001. I worked for Mr. Fastow in this new role until late August of 2001.

I have since been reassigned into the Human Resources Group with a variety of assignments.

While working for Mr. Fastow in 2001, I was charged with reviewing all assets that Enron considered for sale and determining the likely economic impact of sale. As part of the sale analysis, I reviewed the estimated book values and market values of each asset.

A number of assets were hedged with an entity called Raptor. Any asset that was hedged should, for the most part, have a locked-in sales value for Enron, meaning that, despite current market prices, Enron should realize the hedged price with Raptor.

It was my understanding that the Raptor special-purpose entities were owned by LJM, the partnership run by Mr. Fastow.

In completing my work, certain Enron business units provided me with analyses that showed certain of the hedged losses that had been incurred by Raptor were actually coming back to Enron. The general explanation was that the Enron stock, backstopping the Raptor hedge, had declined in value such that Raptor would have a shortfall and would be unable to fully cover the hedge price that it owed to Enron.

I was highly alarmed by the information I was receiving. My understanding as an accountant is that a company could never use its own stock to generate a gain or avoid a loss on its income statement.

I continued to ask questions and seek answers, primarily from former coworkers in the Global Finance Group or in the business units that had hedged assets with Raptor. I never heard reassuring explanations.

I was not comfortable confronting either Mr. Skilling or Mr. Fastow with my concerns. To do so, I believe, would have been a job- terminating move.

On August 14, 2001, I was informed of Mr. Skilling's sudden resignation and felt compelled to inform Mr. Lay of the accounting problems that faced Enron. I sent Mr. Lay an anonymous letter on August 14, 2001, in response to a request for questions for an upcoming all-employee meeting to be held August 16 to address Mr. Skilling's departure.

At the all-employee meeting, Mr. Lay commented that our visions and values had slipped and that, if any employee was truly troubled by anything at Enron, please bring those concerns to him or any number of the top management, including Cindy Olson, Steve Kane and others.

On August 16 I met with Ms. Olson to show her a copy of the letter and discuss it with her. She encouraged me to meet with Mr. Lay personally. Since Mr. Lay was travelling through the rest of the week, she said the meeting would probably take place the week of August 20.

I was concerned that Mr. Lay was planning to fill the office of the chair over the weekend and that he might choose Mr. Fastow or Rick Causey, the chief accounting officer. To voice my concerns, I met with Rex Rogers, Enron's associate general counsel, on Friday, August 17, 2001.

I provided Mr. Rogers with a version of the anonymous letter, as well as two additional memos, all of which are part of the seven pages that this committee discovered in mid-January 2002.

On Monday, August 20, 2001, Mr. Lay's assistant scheduled a meeting for me to meet with Mr. Lay that following Wednesday, August 22, 2001.

I subsequently held discussions with a former mentor at Andersen, James Hecker, and a longtime friend and coworker, Jeffrey McMahon, to vet my concerns before my meeting with Mr. Lay.

I met with Mr. Lay on the afternoon of Wednesday, August 22, 2001. The meeting lasted just over one-half hour.

I provided him with five memos I had drafted to help explain the problems facing the company. These five memos constitute the seven pages this committee discovered and subsequently disclosed on January 14, 2002.

Additionally, I provided Mr. Lay an analysis of the Raptor entity economics and a presentation prepared by Enron's Risk Assessment and Control Group.

I primarily used the memo titled, "Summary of Raptor Oddities," as talking points with Mr. Lay.

My main point to Mr. Lay was that, by this time, Raptor owed Enron in excess of $700 million under certain hedging agreements. My understanding was that the Raptor entities basically had no other business aside from these hedges, therefore they had collectively lost over $700 million. I urged Mr. Lay to find out who lost that money.

If he discovered that this loss would be borne by Enron shareholders, be (ph) an issuance of stock in the future, then I thought we had a very large problem on our hands.

I gave Mr. Lay my opinion that it is never appropriate for a company to use its stock to affect its income statement.

At the conclusion of the meeting, Mr. Lay assured me that he would look into my concerns.

I also requested a transfer, as I was uncomfortable remaining as a direct report to Mr. Fastow. I intend to fully cooperate with the subcommittee, and I now welcome the opportunity to answer any questions the members may have at this time.

GREENWOOD: Thank you very much for your testimony, Ms. Watkins. And we all thank you again for being here.

The chair recognizes himself for 10 minutes for inquiry.

Ms. Watkins, when we spoke yesterday, you described that, in your earlier days working for Mr. Fastow, the special-purpose entities were basically legitimate. They seemed to be garden-variety, securitized entities that were designed to do legitimate financial purposes with which you had no qualms. And as you described -- and I think Condor was one of those early SPEs that fit that category.

As you described your time with the company, it seemed to me that it was like the story of the frog in the pot on the stove; that gradually, largely directed by Mr. Fastow, I understand, the rules of the game began to change and the legitimacy of these entities and partnerships began to be stretched until finally we end up with something like the Raptors, which seem to serve no legitimate, and perhaps not even a legal, purpose.

GREENWOOD: And it seemed to me that the difficulty was that the corporate culture was slowly acclimated to this transition from what was quite legitimate to what was clearly not legitimate.

Let me ask you this specific question: Is it your opinion that the Raptor transactions, then, were nothing more than sheer income statement manipulation? And if you do think that, why do you say so? WATKINS: That is my opinion. And it is my opinion because true economic risk was not passed to a third party. Raptor owed Enron in excess of $700 million, and there was not an outside third party that bore than loss. It was going to be borne by Enron's shareholders by an issuance of stock in the future.

GREENWOOD: Explain how that affected the income statements.

WATKINS: Well, the Raptor hedges were locking in, supposedly, sales value that Enron had on equity investments that it had made. The investments that were probably the more volatile was a tech investment in Avici and the new power company, a start-up that Enron had done. Those investments were hedged with Raptor. They had dropped significantly in value.

And in the related-party footnote in 2000, it mentions that Enron had recognized $500 million of revenue from the special entities, offsetting a corresponding write-down in the equity investment portfolio of Enron.

I think that tended to make readers think that it was a $500 million gain offset by a $500 million loss, therefore zero impact on the income statement. However, without the Raptor transactions, Enron would have had a $500 million loss, not covered by any gains, running through the 2000 income statement.

GREENWOOD: As you came to understand this, prior to your first meeting with Mr. Lay, did you discuss these concerns with other employees at Enron?

WATKINS: As I was doing my work and looking at these assets hedged by Raptor, my concern was that it seemed to be just common knowledge that the Raptor losses were backstopped by Enron stock. And an analysis was always looked at: What's the value of Enron stock compared to the money Raptor owes us?

And I was shocked that people could explain this to me with no concern in their voice, like there was some magic structure that Enron and Andersen had come up with to make this work.

GREENWOOD: And did it seem to be -- did you get the impression, or what it said to you by others, that they thought that this was perfectly legitimate, or that it was shaky but everyone's going along with the deal?

WATKINS: There were people like Mr. McMahon and others that had expressed concerns about LJM and the transactions Enron was doing with LJM. But for the most part, people seemed to think there was some accounting rule that was allowing this to be acceptable. It was very common knowledge; it wasn't hidden.

GREENWOOD: Did you watch Mr. Skilling's testimony before this subcommittee last week?

WATKINS: Yes, I did. GREENWOOD: Would you care to comment on how you reacted as you heard Mr. Skilling describe his awareness or lack or awareness or understanding of these transactions?

WATKINS: Well, I would like to use Mr. Skilling's own words to describe what I thought about his testimony. He was interviewed by Enron's in-house newsletter in 2001. In the interview, Mr. Skilling was asked, "What's the best advice you ever received?" And his reply was, "If it doesn't make any sense, don't believe it."

(LAUGHTER)

GREENWOOD: Did you confront Mr. Skilling himself with this concern?

WATKINS: No, sir, I did not.

GREENWOOD: And why did you not?

WATKINS: I did not want to do that without the safety net of a job in hand. I felt like it would be an immediate job-terminating move. Frankly, I thought it would be fruitless, that nothing would happen.

GREENWOOD: And what led you to -- did you have other experiences, or the experiences of others, that led you to believe that might be -- that you might be putting your job on the line if you were to confront Mr. Skilling, or Mr. Fastow for that matter, with these concerns?

WATKINS: Basically, it appeared that the Raptor transactions had been going on for a number of years. My understanding was that Mr. Skilling was fully aware of them. He is a very hands-on manager. I had also heard rumors that people as close to him as Mr. Baxter had complained to him and he had done nothing. So I really felt it was fruitless to go to Mr. Skilling.

GREENWOOD: Do you think it's possible that Mr. Skilling was unaware of the nature of these transactions?

WATKINS: No, I do not.

GREENWOOD: Could you tell us why you think that's not possible? He seemed to have forgotten about them.

WATKINS: He is a very much intense, hands-on manager. He was very involved in Mr. Fastow's endeavors, and I find it very hard to believe that he was not fully aware of transactions with Mr. Fastow's partnerships.

GREENWOOD: Now, did Mr. Fastow learn that you had communicated your concerns to Mr. Lay?

WATKINS: I did find out that he found out I was the writer of the anonymous letter and that I had also met with Mr. Lay. I found that out August 30, 2001. GREENWOOD: And how did he respond? Did he name you employee of the month?

(LAUGHTER)

WATKINS: Well, Ms. Olson told me that she and Ken Lay were both highly alarmed by Mr. Fastow's reaction. He wanted to have me fired. He wanted to seize my computer.

GREENWOOD: He wanted to have you fired? He told people he wanted to have you fired?

WATKINS: That's what Ms. Olson told me.

GREENWOOD: OK. And he wanted your computer?

WATKINS: Yes.

GREENWOOD: And did he obtain your computer?

WATKINS: He did, but Ms. Olson basically said, "Let me send you to your office with an IT person. Here's a new laptop. Transfer whatever files you want to on the new one. Delete whatever ones you want to on the old one. We'll just hand him the hardware." She said, "You don't mind doing that, do you?" And I said, "No, I don't."

(LAUGHTER)

GREENWOOD: So you pulled a fast one on Andy.

(LAUGHTER)

Let's get to your face-to-face meeting with Mr. Lay. Could you describe for the committee how he reacted and what your impression of his reaction is, particularly with regard to what extent it seemed to you, based on his comments, his reactions, that the news that you were bringing to him was surprising or not surprising? Was alarming or not alarming? And to what extent it seemed to you that he had an appropriate response that would have convinced of given you some comfort that he was in fact going to deal with this?

WATKINS: Well, he tried to put me at ease. He knew this was probably difficult for me to do, and he recognized that. I handed him my set of documents and directed him to the "Summary of Raptor Oddities" document as a talking point.

He seemed to take it very seriously. In fact, when he read the quote that I put in that memo about the manager-level employee saying "We're such a crooked company," he winced. You know, that seemed a painful comment to him.

He was aware that these Raptor transactions had been presented to the board, but I said my understanding of the way these things are generally presented, it's high-level summaries. And I'm not so certain that the true nature was fully disclosed. And he contended that I might be right. And by the end of the discussion, he certainly said he would look into it and order an investigation, and asked me what could he do for me, which is when I requested the transfer out of Mr. Fastow's group.

GREENWOOD: OK. My time is expired.

The chair recognizes the gentleman, Mr. Dingell, for 10 minutes for purposes of inquiry.

REP. JOHN D. DINGELL (D), MICHIGAN: Mr. Chairman, I thank you. Again, I commend you.

Ms. Watkins, I want to commend you also. I hope you understand these questions are friendly, but our time is limited, and so I therefore have to ask them in a way that gives you an opportunity to answer, where possible, yes or no.

I'll be working from a document which is entitled, "Outlines of points to discuss with Ken Lay and Jim Derrick."

Ms. Watkins, you specifically asked that Vinson & Elkins not do this investigation. That was because they had approved many of the LJM deals as attorney for Enron, is that correct?

WATKINS: Yes, sir, it is.

DINGELL: Now, I want to refer you to the document that I have just mentioned. This is a document which was prepared by Vinson & Elkins on the result of their investigation. And Jim Derrick is Enron's general counsel, is he not?

WATKINS: Yes, he is.

DINGELL: Ms. Watkins, in this document, it says that Jim Derrick decided not to engage an independent accountant as you had recommended. Is that correct?

WATKINS: Yes.

DINGELL: The caveat on that investigation was that they should not second-guess the accounting treatment, they would not do a detailed transactions analysis, and there would be no discovery-style investigation. Did you know that at this particular time or at some later time?

WATKINS: I was not aware that the investigation was being limited. I met with Vinson & Elkins on September 10 for roughly three hours and had no indication that it was a limited investigation. I only discovered that it was limited when I read their October 15 response, which was not provided to me. I read it off of this committee's webpage.

DINGELL: It is fair to say that this, then, was not much of an investigation, was it?

WATKINS: I don't think so. DINGELL: Vinson & Elkins said that, with all these caveats, there was no problem except a cosmetic one, is that correct?

WATKINS: That is what they concluded.

DINGELL: And on page seven, Vinson & Elkins tells Ken Lay that Enron stock is being used to support transactions with Condor and Raptor. Enron was getting earnings through derivatives transactions with Raptor when it could be argued that there was no third party involved. And because of the falling value of both Enron's stock and asset value, that question was raised as to who bears the loss.

These are exactly the same questions you had asked earlier, isn't that so?

WATKINS: Yes, sir.

DINGELL: Now, then Vinson & Elkins says on page eight of the document, notwithstanding these bad cosmetics, Enron representatives uniformly stated that Condor and Raptor vehicles were clever, useful vehicles that benefited Enron.

What this says to me, that everyone -- Vinson & Elkins, Ken Lay, Jim Derrick and all the people they interviewed -- knew that these were not special-purpose vehicles that bore risk, is that correct?

WATKINS: It would appear to be so, yes.

DINGELL: And they knew that they were in bad financial shape, did they not?

WATKINS: Yes.

DINGELL: And they had approved them, had they not?

WATKINS: Yes.

DINGELL: So when high-level officials say they didn't know about these vehicles, can that be true?

WATKINS: No, they knew about the vehicles.

DINGELL: Now, what do you think all these people expected to happen at this point in September 2001?

WATKINS: I think what's interesting to note is that it says here the Raptor vehicles were clever, useful vehicles that benefited Enron.

I think that there was an understanding that Andersen and Vinson & Elkins had blessed these things, that, you know -- when I met with Rex Rogers on August 17, he said, "Sherron, how could you possibly be right? I mean, Andersen and Vinson & Elkins would not risk their firms, giving us wrong advice. They blessed these structures." And so I think that certain people at Enron thought that these were complex but clever and that they were legitimate. DINGELL: So here we have a situation where Vinson & Elkins does -- I think they had to -- some kind of due diligence or gave legal advice to Enron on these matters. Is that not so?

WATKINS: Yes, sir.

DINGELL: The accountant was in a similar position, both as accountant and as consultant. Is that not so?

WATKINS: Yes, that's right.

DINGELL: So am I fair in inferring from this that their statements about the character of these devices, as being a benefit to Enron, was in error?

WATKINS: Well, a benefit to Enron, if you consider that we were meeting financial statement targets that we had told investor analysts. But you can't meet those targets falsely.

DINGELL: So they were essentially representing them as being a benefit in the meeting of targets which could not be met.

WATKINS: Yes, sir.

DINGELL: Mr. Chairman, in the interest of time, I would like to just ask unanimous consent to introduce the document to which I have referred.

And again, Ms. Watkins, you're a woman of extraordinary courage. We thank you for your assistance.

GREENWOOD: Without objection, the document to which the gentleman from Michigan refers, and all of the other documents in the binder, will be made a part of the record.

The chair recognizes the gentleman, Mr. Tauzin, for 10 minutes.

REP. BILLY TAUZIN (R), LOUISIANA: First, Ms. Watkins, I apologize that we scheduled this hearing on Valentine's Day. I want to wish you a Happy Valentine's.

WATKINS: Thanks.

TAUZIN: I want to refer specifically to the document which you handed Ken Lay on October the 30th. That document has been widely publicized in the last several days. Some have characterized it as an attempt to describe a public relations effort to help the company through this problem.

I want you to tell me whether the facts outlined in that document are, to your best knowledge and belief, true.

WATKINS: Yes, sir. I was providing this to Mr. Lay as a concept on public relations. However, I felt that it was a truthful public relations strategy, and it was something I felt should be said.

TAUZIN: So the things you recommended that Mr. Lay say and do are based upon facts in this document that you believed to be true?

WATKINS: Yes, I do believe that Mr. Skilling and Mr. Fastow, along with two very well respected firms, did dupe Ken Lay and the board.

TAUZIN: Well, specifically you say that. You say that, as CEO, Mr. lay relied about his COO, Mr. Skilling, as well as CFO Fastow and CAO Causey, to manage the details. Is that correct?

WATKINS: Yes.

TAUZIN: Is that accurate? Was Mr. Skilling expected to manage the details of these transactions?

WATKINS: From all the records and presentations that I ever viewed, Mr. Skilling was supposed to be an integral part of the controls and the review process with the LJM transactions.

TAUZIN: Now, did you see Mr. Skilling's testimony last week before this committee?

WATKINS: Yes, sir, I did.

TAUZIN: Did you specifically hear his testimony regarding the LJM approval sheets?

WATKINS: Yes, I did.

TAUZIN: Now, he basically testified that he never saw these sheets and he was not required to sign them; that's why he didn't sign them. Is it your testimony that he, in fact, knew about these sheets?

WATKINS: Well, all I can say -- all I can speak to is that it was Enron's very strict policy, when completing transactions and deals, to have deal sheets, deal approval sheets, and there was never a name put on the approval block that was not required. And I don't ever remember an instance where signatures were not obtained for every person listed.

TAUZIN: So that if Mr. Skilling's name consistently appears on the sheets, but it remains unsigned, it was not because he was not obligated to sign it; it was because he just didn't sign it.

WATKINS: That's correct.

TAUZIN: Is that correct?

WATKINS: That would be my understanding of our very strict procedures, yes.

TAUZIN: Were those procedures that Mr. Skilling would have understood?

WATKINS: Yes.

TAUZIN: You say, also in the memo, that Mr. Lay should admit that he trusted the wrong people. Are you saying that Mr. Lay was wrong to trust Mr. Skilling and Mr. Fastow and Mr. Causey with these details?

WATKINS: Yes, sir, I do believe they misserved Mr. Lay, the board, Enron and its shareholders.

TAUZIN: In fact, you go on to say that Ken Lay and his board were duped by his COO who wanted the targets met no matter what the consequences; a CFO motivated by personal greed; and two of the most respect firms, Arthur Andersen and Company and Vinson & Elkins, who had both grown too wealthy off Enron's yearly business and no longer performed their roles as Ken Lay, the board and just about everybody on the street would expect as a minimum standard for CPAs and attorneys.

Do you believe that statement?

WATKINS: I do.

TAUZIN: You say, further on, the culprits are Skilling, Fastow, Glisan, Causey, as well as Arthur Andersen and Vinson & Elkins. Do you believe that statement to be true?

WATKINS: Yes, sir, I do.

TAUZIN: Now, in Mr. Skilling's testimony, he very specifically denied any knowledge that, in these transactions, Enron Corporation had not properly transferred the risk to cover the losses. Do you believe that statement to be true?

WATKINS: No, I do not. Mr. Skilling was a great proponent of looking to the markets to make sense of a transactions. And I doubt we could have hedged these volatile stocks with any true unrelated third party at the prices that we were actually able to obtain from Raptor.

TAUZIN: Is it your testimony, then, that Mr. Skilling must have known about the details about the Raptor transaction to know that risk had not transferred?

WATKINS: It is my opinion that he was probably aware that we could not have transacted at those prices with an unrelated third party, and the only reason Mr. Fastow was transacting with Enron through the Raptor transactions at those prices for volatile for stocks was that Mr. Fastow could not lose money and he was backstopped by Enron stock.

TAUZIN: Now, Ms. Watkins, you made it as clear as I've ever seen anybody make it. You basically outlined for Mr. Lay what would happen if he did the right thing -- if he cleaned up this mess, reported correctly to his stockholders and investors, if he got rid of the culprits, and if he made these public statements on behalf of the corporation that he, in fact, was going to do everything to save his company. And that, if he didn't take that advice, you told him the worst is going to happen. It's going to happen anyhow, and Mr. Lay will be more implicated in this than is deserved. What did you mean by that?

WATKINS: Mr. Lay was back at the helm as CEO, and it was my humble opinion that he did not understand the gravity of the situation the company was in.

TAUZIN: Now, you explained to him, as the chairman has outlined, in rather detailed form what you thought was wrong with Raptor, what you thought was wrong with these transactions. Did he understand the gravity, the implications of what you were telling him, in your opinion?

WATKINS: In my opinion, I don't think he did. And I have that opinion because at an October 23 all-employee meeting to discuss the write-downs that had occurred in the third quarter, there were several questions about Raptor and about the LJM transactions. And Mr. Lay likened the problem that the company was now facing to a 1980s problem when the Peruvian government nationalized an oil company Enron had, to the J-Block Enron had in 1997. And I don't think an accounting manipulation problem is in any way related to a poor investment.

TAUZIN: You're saying he didn't get it.

WATKINS: No...

TAUZIN: He didn't get it.

Now, as I understand your memo to him, you're basically telling him that these officials of his corporation were engaging in these essentially improper activities, were doing it in a way that he and his board were being duped, kept in the dark.

Who had the power to protect those people from discovery from Mr. Lay and his board? Who had the power to allow these activities to go forward by all of these employees, including investment themselves in some of these outside partnerships and entities at great profit? Who had the power to let all that happen and keep that information from the board and Mr. Lay all that while?

WATKINS: Well, my opinion would be that would be Mr. Skilling.

TAUZIN: And finally, Ms. Watkins, I refer you to the document entitled, "Lessons Learned," tab eight. In that document, there are three points: recognize the effect of an accounting hedge versus an economic hedge; the corporation should consider hedging assets in Raptor to minimize credit capability volatility; the new Raptor structure transferred risk in the form of stock dilution.

Did you show this document to Mr. Lay?

WATKINS: Yes, I did.

TAUZIN: Now, it contains some handwriting. Whose handwriting is that?

WATKINS: That's my handwriting. TAUZIN: The handwriting basically says, to the final point, there it is, that is a smoking gun, you cannot do this. What did this mean?

WATKINS: Well, my concern was that this was a document Enron had produced, it was well-known. And what that bullet point is trying to say in plain English is that the new Raptor structure transferred income statement equity investment risk in the form of stock dilution. And you can never use your stock to affect the income statement, you can't do this.

TAUZIN: You just can't do that legitimately, legally.

WATKINS: That's correct.

TAUZIN: Where did you get this document?

WATKINS: From the Risk Assessment and Control Group run by Mr. Richard Buy.

TAUZIN: And if I may, what was Mr. Lay's reaction to this document when you showed it to him?

WATKINS: He was concerned. He was concerned with everything I was telling him.

TAUZIN: There's another note you wrote on the second point: "The corporation isn't Raptor. How could corporation consider anything at Raptor?" What did you mean by that?

WATKINS: Well, the bullet point just says corp should consider hedging assets in Raptor to minimize, you know, some problems. And if Raptor is supposed to be Mr. Fastow's company, then it's Mr. Fastow's problem.

TAUZIN: Not the corporation's.

WATKINS: Why should Enron Corporation should consider anything there? Exactly.

TAUZIN: Even with this you still say he didn't get it?

WATKINS: I don't think so.

TAUZIN: Thank you, ma'am.

GREENWOOD: The chair thanks the gentleman and recognizes the gentleman from Florida, Mr. Deutsch, for 10 minutes.

HEMMER: While we get this little shift there in the subcommittee, we want to bring in Mark Hosenball for "Newsweek" magazine, who is riding shotgun along with us as we watch this hearing today.

Mark, good afternoon to you, and it's quite evident here that many members of this committee are trying to attach this to Ken Lay. But apparently, at this point, there's a bit of teflon layer put over the testimony of Sherron Watkins, saying Ken Lay is the one who may have been duped along with the board.

Do you read the same way?

MARK HOSENBALL, "NEWSWEEK": She is certainly saying that very clearly. She's really sticking to Skilling and Fastow, the chief financial officer and the chief operating officer, but seems to be, you know, keep saying again and again and again, well, Ken Lay must have been duped by these characters, he never really got it. Maybe that's true. It's pretty clear that she, you know, some months before this thing collapsed warned him, but he still continued to behave in public and apparently within the corporation as if there's nothing wrong. Does this mean denial on his part or means he didn't get it? She says he believes he didn't get it.

HEMMER: She says Ken Lay "possible" in her words that he did not know about the transactions. Clearly, somewhat incredulous on behalf of House members there. Are they buying this?

HOSENBALL: She's not saying he didn't know about the transactions. She's saying he didn't understand the import of the transactions, which is a little bit different.

HEMMER: A lot of talk about raptor. Put it in econ 101 or finance 101 for us. What is it?

HOSENBALL: Well, as I understand it, raptor one of these partnerships that they allegedly set up to, you know, carry that company's financial risk, but the partnerships were not carrying the company's financial risk, just sort of being manipulated by Fastow to enrich himself, and apparently to clean up Enron's own profit and loss statement.

HEMMER: Many people think she might be the star witness in all this. Can she be impugned in any way that you see, Mark?

HOSENBALL: Not that I can see yet. But I haven't investigated her background up and down. She is a former accountant for Arthur Andersen, who I think joined the company. Her credentials seems to be pretty impeccable. Her testimony seems to be credible. She seems to know what she's talking about.

HEMMER: The story I refer to in "The Washington Post" this morning was there was another memo released where she says she shows where you can essentially hide these transactions. I'm sure you saw the story. Your reaction to it?

HOSENBALL: Again, that's not exactly what she's saying. What she is saying to Lay in this memo, according to "The Washington Post," and according to what she testified, is that Lay could put out story if he wanted to. He could solve these problems, or cleanup the problem by saying that there are these bad things going on, but other people did it, it wasn't him.

Now unfortunately, this is same line that everybody involved in this, including Skilling, Fastow. Well, Fastow hasn't said anything public. But Skilling, the accountants, the lawyers, Ken Lay, this is the story that they're all saying that nobody knew anything, it's all somebody else's fault. She saying that she really believes that in the case of Ken Lay. You know, the investigation will show.

HEMMER: Mark, thanks for hanging out with us. I know you've got to run here, but quickly, where will she move the ball after today, Sherron Watkins?

HOSENBALL: I don't know. I mean, she's basically pointing the finger stronger at Skilling and kind of suggesting that his testimony last week wasn't credible. She's reiterating stuff that we already knew. I don't know that this moves the ball further, except that it gives you an actual body who knows this stuff, who is sitting there saying, I don't believe Skilling, but I do believe Ken Lay.

Mark Hosenball, "Newsweek" magazine. Get back to work, OK. Thanks for hanging out.

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