WASHINGTON -- The head of the Arthur Andersen accounting firm told a congressional panel Wednesday that his firm warned Enron Corp. directors early last month that the company might be guilty of "possible illegal acts" for withholding critical financial information from Andersen auditors.
The testimony by Andersen Chief Executive Joseph F. Berardino came during the opening round of an expanding probe on Capitol Hill of the largest bankruptcy in U.S. history -- one that has left tens of thousands of investors -- including mutual and pension funds -- with nearly worthless stock.
The allegations raised in the House hearing marked the first time that an individual with inside knowledge of Enron's practices has alleged illegal behavior. It also opens a serious public breech between the collapsed energy trading company and its auditors, who are also under investigation.
Berardino disclosed that Enron officials had committed a possible violation of corporate disclosure laws by arranging a secret deal with an unnamed bank to mislead Andersen auditors.
Enron persuaded the auditors that debts held by an internal partnership did not have to be included on its financial statements because the bank had made a "substantive" investment of its own in the partnership, he said.
If that were true, securities law would have allowed the partnership debts to be kept off the books. But Enron failed to tell Andersen that it had provided the bank with half the cash necessary to make the investment, Berardino said.
"It is not clear why the relevant information was not provided to us," Berardino testified.
Enron officials disputed the allegation, saying the company had always been open with its accountants. It claimed that it was company management, not Arthur Andersen, that discovered the arrangement and reported it to Andersen within 24 hours.
Meanwhile, one of the key players in the Enron meltdown failed to comply with a Securities and Exchange Commission subpoena Wednesday. The SEC wanted to interview Andrew Fastow, the former chief financial officer and one the key architects of Enron's partnership strategy. Fastow earned $30 million from his management of the partnerships.
The accounting treatment of the Enron partnerships has played a key role in the company's collapse. When Andersen belatedly learned of the transaction, Berardino said, it issued its warning to the audit committee of Enron's board of directors. That triggered a restatement of Enron's earnings on Nov. 8 in which the company admitted overstating profits by $569 million over the previous four years.
That confession was one of the key events that shook the investment community's confidence in Enron, sending its stock into a death spiral and causing its former trading partners to shun the world's biggest energy trader.
An 11th-hour takeover bid by Houston neighbor and rival Dynegy Inc. was announced Nov. 9, but that deal was scuttled Nov. 28 after yet more disclosures about Enron's questionable finances. With the Dynegy rescue off the table and Enron's stock price at less than $1 , Enron last week filed for Chapt. 11 bankruptcy protection.
The Enron debacle and the resulting congressional investigations could produce legislation on a number of fronts: stronger requirements for disclosure of financial information by corporations, limits on how much of an employee's pension funds can be invested in their company's stock, and new conflict-of-interest rules for accountants and stock analysts.
Opening Wednesday's hearing, Rep. Richard H. Baker, R-La., chairman of the House Financial Services subcommittee on capital markets, said the Enron case has "far-reaching implications. We must make the careful determination of whether we are dealing with a case of outright fraud and violation of existing securities laws. Or whether investors failed to receive an accurate picture of Enron's financial condition as a result of existing disclosures and accounting standards that are insufficient and require revision."
The hearing before the two House Financial Services subcommittees -- the first of a string of planned congressional hearings in the coming months -- was held without its star witness, Enron Chairman and Chief Executive Kenneth L. Lay, a big campaign contributor and friend of President Bush.
The congressional probe puts lawmakers in a politically awkward position. Enron contributed more than $1.6 million in the last election cycle, most of it to Republicans. GOP House leaders have pledged to grill Enron and its executives and joined Democrats Wednesday in assailing Enron bosses for cashing out more than $1 billion in stock while employees were barred from selling stock in their retirement accounts.
Wednesday's hearing was held in the room used by Republicans to investigate President Clinton's Whitewater real estate venture. Some Democrats are relishing the opportunity to look into Enron executives' ties to Bush and its private meetings with Vice President Dick Cheney that produced the administration's energy policy.
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