Now in Legal Rebels:
Posted Jun 01, 2004 09:50 pm CDT
Once ranked as the seventh-largest corporation in the world, energy trader Enron Corp. was a high-flying success story of the bubble economy of the late 1990s.
The bubble burst in 2001, when Enron revealed it would incur losses of at least $1 billion and would restate its financial results. Soon, Enron’s stock lost nearly all its value, and in December 2001 the company filed for Chapter 11 bankruptcy.
Now the finger-pointing and lawsuits are under way, and among the targets of criticism are some of the lawyers who worked for Enron, both in-house and on retainer. Those looking for new details about their work need look no further than the four reports totaling 4,500 pages produced last fall by court-appointed bankruptcy examiner Neal Batson.
Appointed in May 2002 by the U.S. Bankruptcy Court of the Southern District of New York, Batson outlines possible causes of action against lawyers and law firms for legal malpractice and for aiding and abetting officers’ wrongful conduct. The lawyers and firms provided services and advice relating to Enron’s so-called special purpose entities, known as SPEs, which were allegedly used along with aggressive accounting techniques to manipulate Enron’s financial statements.
Batson was appointed to investigate and report on Enron’s use of SPEs and the roles of Enron’s officers, directors, accountants, attorneys and financial institutions.
Outside law firms named in the reports include two Texas law firms: Austin-based Vinson & Elkins, Enron’s primary law firm; and Houston-based Andrews & Kurth, Enron’s firm of choice for legal work in connection with so-called FAS 140 transactions. Enron used these structured finance transactions to transfer illiquid assets to special purpose entities while retaining control of the assets and assuming liability for the debt incurred.
Among the in-house attorneys mentioned were Enron general counsel James V. Derrick and associate general counsel Rex Rogers, the in-house lawyer primarily responsible for disclosures in Enron’s filings with the Securities and Exchange Commission.
During the 18-month investigation, Batson and roughly 100 cohorts at the Atlanta law firm of Alston & Bird produced more than 40 million pages of documentary evidence and testimony from about 300 witnesses. By Batson’s reckoning, $10 billion in potential claims for the estate has been identified, and $500 million in settlements has already been approved by the court. Alston & Bird billed about $75 million for the reports and incurred roughly $20 million in expenses.
To date, the bankruptcy court has filed no claim against either Enron’s in-house or outside attorneys, but it is supervising Enron’s reorganization under Chapter 11.
Batson does not go so far as to conclude the lawyers committed malpractice, a point emphasized by Vinson & Elkins’ counsel, John Villa of the Washington, D.C., law firm Williams & Connolly.
“In fact, the examiner was careful to make clear that he was not reaching any such conclusion,” Villa says.
“Instead, as the examiner explained, he was merely identifying possible claims for which he found sufficient evidence—ignoring any evidence to the contrary—that the claims would be submitted to a jury for decision, rather than being dismissed before trial on a defense motion for summary judgment … or dismissed by the court as a matter of law at the end of the plaintiff’s case.”
Meanwhile, Vinson & Elkins has been named in a shareholder class action lawsuit filed in U.S. District Court for the Southern District of Texas in Houston on April 8, 2002, by Milberg Weiss Bershad Hynes & Lerach, led by partner Bill Lerach. The complaint alleges that “Vinson & Elkins engaged and participated in … contrivances and manipulations to help inflate Enron’s reported financial results.” The law firm has denied wrongdoing.
Lerach told the ABA Journal that he needed to receive clearance to discuss the case, but he had not called back at deadline.
Derrick was named as a defendant in an action brought by Enron’s unsecured creditor’s committee filed in August 2002 in Texas state court. According to lead counsel Charles Cunningham of the Dallas firm of McKool Smith, the case has been removed to the U.S. District Court in Houston. Cunningham says the case is in discovery, and he expects depositions to begin this month.
The reports by the bankruptcy examiner note that the attorneys and law firms deny knowledge of wrongful conduct by the company’s officers. Lack of knowledge is one of several legal and factual defenses the lawyers could raise, the reports say. They also may argue that Enron’s board approved many of the suspect transactions, and that the company had considered concerns and made an appropriate business decision.
They also could assert that the wrongful acts committed by Enron’s officers should be imputed to the corporation. In that case, they could argue that Enron’s wrongful conduct was greater than their wrongful conduct, and therefore claims by Enron should be barred or reduced under comparative fault rules.
Batson’s extensive reports delve into many complicated financial transactions. According to the reports, the SPE structures were complex, but Enron’s objectives were simple: to borrow money without recording debt, and to record the loan proceeds as cash flow from operating activities.
In many instances, outside law firms provided legal opinions that were used to support Enron’s aggressive accounting techniques. “An attorney’s willingness to provide certain legal opinions was, as a practical matter, crucial to Enron’s ability to complete the FAS 140 transactions,” says one of the reports.
The documents allege that Vinson & Elkins sometimes supplied “true issuance” opinion letters despite questions about whether they could be used to support beneficial accounting treatment. These were used in place of more rigorous “true sale” opinion letters, which verify that the transfer of assets includes a surrender of control that is sufficient to satisfy accounting standards.
The reports cite other Vinson & Elkins activities that could possibly support liability, including its representation of Enron in transactions with names such as “Rhythms” and “Raptors” that had no rational business purpose except to manipulate Enron’s revenue. Other alleged activities include:
• Rendering tax opinions that helped Enron generate accounting income from projections of future tax savings.
• Giving a true sale opinion that enabled Enron to book a $20 million gain in a transaction involving the company’s forest products business, even though there was no valid business purpose for the transaction.
• Investigating allegations by Enron whistle-blower Sherron Watkins without making full disclosure about its role in some of the transactions being investigated.
Andrews & Kurth rendered at least 24 opinions regarding the FAS 140 transactions. The reports say a fact-finder could possibly determine the law firm knew that Enron as a practical matter retained control of assets transferred in many of the transactions, and that Enron was engaging in the transfers to produce misleading financial statements.
Andrews & Kurth’s attorney, Paul Coggins, a principal at Fish & Richardson in Dallas, defends his client’s work. “A fact-finder will find that the work Andrews & Kurth performed for Enron was exceptional work performed by nationally recognized lawyers,” he says. “Andrews & Kurth cooperated fully with the examiner. The examiner’s criticisms are unfounded and fall well short of proof.”
The reports also say Derrick, the general counsel, apparently failed to educate himself and Enron’s board about suspect transactions. According to the reports, Derrick viewed his principal role as that of administrator of the law department, relying on the general counsel of each business unit to manage transactions.
“Few issues relating to the SPE transactions appear to have been [elevated] to him,” says one of the reports. “In those instances when issues came to his attention, however, the evidence suggests that Derrick did not fully analyze the issue but rather accepted the conclusions of others without probing or testing them.”
In an e-mail statement, Derrick’s lawyer, Cliff Gunter of the Houston-based firm of Bracewell & Patterson, says, “The evidence is clear that Mr. Derrick fulfilled his duties to Enron and the board of directors. … We are pleased that the examiner found no grounds to attribute any intentional wrongdoing to Mr. Derrick and believe that the evidence, considered as a whole, will clear Mr. Derrick of any criticism.”
The reports also suggest that Rogers, Enron’s chief securities counsel, may have failed to inform himself properly. “A fact-finder could conclude that Rogers failed to discharge his responsibilities to advise Enron with respect to the disclosure issues surrounding the SPE transactions. Although Rogers testified that he took some steps to understand several of Enron’s most frequently used SPE transactions, … he said he found them ‘complex.’
“While it is true that many of the transactions were exceedingly complicated in their structure, the reason that certain Enron officers used them —to manipulate Enron’s financial statements—was not. If in fact Rogers was unable to understand these transactions, he could not properly advise Enron regarding the necessary disclosures.”
Rogers’ lawyer, Michael Rauh of the Washington, D.C., law firm of Manatt, Phelps & Phillips, disputes the reports’ conclusions. “Mr. Rogers would strenuously contend that Mr. Batson is just plain, flat-out wrong.” He declines to elaborate.
Bankruptcy examiners in the Enron scandal have a lesson for lawyers: Look beyond your own work assignments on complex projects to see the big picture and understand the ramifications.
That’s the verdict of experts and legal scholars in the wake of the 18-month examination of the former energy giant’s tangled web of suspect transactions and inflated assets.
Court-appointed examiner Neal Batson of the Atlanta law firm Alston & Bird, who led the investigation, advises corporate lawyers who encounter wrongdoing to recognize who their client is. “In most instances you’re representing the corporation, not the officers,” he says. “Individuals hire and fire you and make decisions about how you will be compensated, but you’re not representing those individuals.”
Batson says lawyers in such situations “need to have their antennae up and be prepared to go up the ladder to the general counsel or all the way to the board of directors.”
Steven Collins, general counsel for Alston & Bird, says lawyers working on legal aspects of transactions need to keep sight of “the bigger picture, the way in which what they’re doing fits into the overall transaction.
“In many instances, that may not be problematic, but in Enron the transactions were being documented differently than the underlying economic substance. That is a situation in which the lawyer needs to be aware of the context in which he’s operating. If the lawyer becomes aware of accounting or disclosure issues that are problematic, the lawyer cannot simply continue what he’s doing and ignore it.”
“Lawyers need to be on the lookout for red flags,” adds Rebecca Lamberth, a partner at Alston & Bird. “If you’ve never seen a deal like this before and something about it bothers you, pay attention to that. Common sense should never be underrated.”
That’s easier said than done, legal scholars say. Properly fulfilling the lawyer’s role in an Enron-style situation may include admitting that one doesn’t understand the workings of a transaction, questioning its purpose, becoming a whistle-blower and potentially alienating colleagues.
“The tendency is to say, ‘Smart people must have blessed these transactions,’ ” says Robert Rasmussen, a Vanderbilt University law professor and bankruptcy specialist. Lawyers come to believe that “the accountants blessed it so it must be all right. The accountants get to say, ‘The lawyers blessed it so it must be OK.’ Always thinking someone else is going to handle it is a danger.”
“There’s a big temptation not to ask a million questions because you don’t want to look stupid,” says Shaun Martin, a legal ethics professor at the University of San Diego. “It’s not that people did not understand their little part of it. They knew they were supposed to draft something, but they may have had no idea why they were doing it.”
Lawyers have a duty to make sure they’re not a party to “someone else’s shenanigans,” Martin says. “If a lawyer can’t come up with a good business reason for what she is doing, the lesson is to think twice about it.”