Identify as many financial and non-financial red flags from the letter as you can. According to my analysis, there are at least 20 red flags mentioned in Watkins' letter.

Each red flag description should not exceed two sentences.

Has Enron become a risky place to work? For those of us. How do we fix the Raptor and Condor deals? They who didn't get fich over the last few years, can we afford unwind in 2002 and 2003 , we will have to pony up to stay? Skilling's abrupt departure will relse suspicions Enron stock and that won't go unnoticed. of accounting improprinties and valuation issues. Enron. To the layman on the street, it will look like we recoghas been very aggressive in its accounting - most note- nized funds flow of $800 million from merchant asset bly the Raptor transactions and the Condor vohicle. We sales in 1999 by selling to a vehicle (Conder) that we copdo have valuation issues with our international assets italized with a promise of Enren stock in later years, is and possibly some of our EES MTM positions. Ithat really funde flow or is it cash from equity issuance? The spotlight will be on us, the market just can't We have recognized over sseo mitlion of fair value accept that Skilling is leaving his dream job. I think gains on stocks via our swaps with Raptor, Much of thot that the valuation issues can be fixed and reported stock has declined significanty=Avici by 96 percent from with other goodwill write-downs to occur in 2002. $178 million, to 56 million the Now Powar Company by (continued) 80 percent from $40 a share, to $6 a share. The value in This year, with the value of our stock declining. the the swaps won't be there for Raptor, so once again underlying capitalization of the Raptor entities is declinEnron will issue stock to offset these losses. Raptor is ing and credit is pushing for reserves against our MTM an LJM entity. It sure looks to the fayman on the street positions. that we are hiding losses in a related company and will To avoid such a write-down or reserve in quarter one compensate that company with Enron stock in the 2001, we "enhanced" the capital structure of the Flaptor future. 1 am incredibly nervous that we will implode in vehicles, committing more ENE shares. a wave of accounting scandels. My eight years of Enron My understanding of the third-quarter problem is work history will be worth hothing on my resume, the that we must "enhance" the vehicles by $250 million. business world will consider the past successes as noth-_ I realize that we have had a lot of smart people looking but an elaborate accounting hoax. Skilling is resign- ing at this and a lot of accountants including A & Co. ing now for "personal reasons" but I would think he. have blessed the accounting treatment. None of that Wasn't having fun, looked down the road and knew will protect Enron if these transactions are ever disthis stuff was unfixable and would rather abandon ship closed in the bright light of day. Please review the late now than resign in shame in two years. Sors problems of Waste Management inews'quote)Is there a way our accounting gurus can unwind where AA paid 5130 million plus in litigation re questhese deals now? I have thought and theught about a tionable accounting practices.) way to do this, but I keep bumping into one big The overriding basic principle of accounting is that if problem-we booked the Condor and Raptor deals in you explain the "accounting treatment" to a man in the 1999 and 2000, we tenjoyed wonderfully high stock street, would you influence his investing decisions? price, many executives sold stock, we then try and Would he sell or buy the stock based on a thorough reverse or fix the deals in 2001, and it's a bit like robbing understanding of the facts? If so, you best present it corthe bank in one yeor and trying to pay it back two yeors rectly andlor change the accounting. later. Nice try, but investors were hurt, they bought at My concern is that the footnotes don't adequately $70 and $90 a share looking for $120 a share and now explain the transactions. If adequately explained, the they're at $38 or worse. We are under too much scrutiny investor would know that the "entities" described in our and there are probably one of two disgruntled "rede- related party footnote are thinly capitalised, the equify. ployed" employees who know enough about the holders have no skin in the game, and all the value in "funmy" accounting to get us in trouble. the entaies comes from the underfying value of the deriWhat do we do? I know this question cannot be vatives (unfortunately in this case, a big loss) AND Enron addressed in the all-employee meeting, but can you give stock and N.P. Looking at the stock we swapped, I alse some assurances that you and Causey will sit down and don't believe any other company would have entered take a good hard objective look at what is going to hap- into the equity derivative transactions with us at the pen to Condor and Raptor in 2002 and 2003? same prices or without substantial premiums from Summary of Alleged Issues: Enron. In other words. the $500 million in reverue in 2000 would have been much lower. How much lower? RAPTOR Entity was capitalized with LWM equity. That. Raptor looks to be a big bet if the underlying stocks equiry is at risk; however, the imvestment was did well, then no one would be the wiser, If Enron stock completely offset by a cash fee paid to LJM. If the did well, the stock issuance to these entities would Raptor entities go bankrupt LJM is not affected, there decline and the transactions would be less noticeable. is no commitment to contribute more equity. All has gone against us. The stocks, most notably The majority of the capitalization of the Raptor Hanover, the New Power Company and Avici are underentities is some torm of Enron N. restricted stock and water to great or lesser degrees. stock rights. I firmly believe that executive management of the Enron entered into several equity derivative iransac- company must have a clear and precise knowledge of tions with the faptor entities locking in our values for these transactions and they mest hove the transactions various equity investments we hold. reviewed by objective experts in the fields of securities As disclosed in 2000, we recognized $500 million of I law and accounting. I believe Ken Lay deserves the right rovenue from the equity derivatives offset by market to judge for himself what he believes the probabilities value changes in the underlying socurities. of discovery to be and the estimated damages to the company from those discoveries and decide one of two spot at Enron Industrial Markets and never courses of action: addressed the five steps with him. 1. The probability of discovery is low enough and the b. Cliff Baxter complained mightily to Skilling and estimated damage too great; therefore we find a all who would listen about the inappropriateness way to quietly and quickly roverse, unwind, write of our transactions with LJM. down these positions/ransactions. c. I have heard one manager-level employee from 2. The probability of discovery is too great, the the principal investments group say, "1 know estimated damages to the company too great: it would be devastating to all of us, but I wish therefore, we must quantily, develop damage conwe would get caught. We're such a crooknd tainment plans and disclose. company," The principal imvestments group hedged a large number of their investments I firmly believe that the probability of discovery sigwith Raptor. These people know and see a lot. nificantly increased with Skilling's shocking departure. Many similar comments are made when you Too many people are looking for a smoking gun, ask about these deals. Employees quote our Summary of Raptor Oddities: C.F,O. as saying that he has a handshake doal with Skilling that LJM will never lose money. 1. The accounting treatment looks questionable. 4. Can the general counsel of Enron audit the deal trail a. Enron booked a 5500 million gain from equity and the money trail between Enron and LJM.Raptor derivatives from a related party. the C.F.O. says no, isn't that a prablem? b. That related party is thinly capitalized with no party ot risk except Enron. c. It appears Enron has supported an income stateCondor and Raptor Work: ment gain by a contribution of its own shares. 1. Postpone decision on filling office of the chair, if the One basic question: The related party entity has current decision includes C.F.O. andior C. A.O. lost $500 million in its equity derivative transac- 2. Involve Jim Dorrick and Rex. Rogers to hire a law tions with Enron. Who bears that loss? I can't firm to investigate the Condor and Raptor transacfind an equity or debt hoider that bears that tions to give Enron attorney-client privilege on the loss. Find out who will lose this money. Who work product. ICar't use V \& E due to conflict-they will pay for this loss at the related party entity? provided some true sale opinions on some of the If it's Enron, from our shares, then I think we deals.) do not have a fact pattern that would look good 3. Law firm to hire one of the big 6, but not Arthur to the S.E.Ci or investors. Andersen or PricowaterhouseCoopers due to their 2. The equity derivative transactions do not appear to conflicts of interest: AA \& Co. (Enron); PWC (LJM). be at afms length. a. Enron hedged New Power, Hanover and Avici 4. Investigate the transoctions, our accounting treatNent and our future commitments to these vohicles with the related party at what now appears to _ in the form of stock, NP, etc., For instance: In the be the peak of the market. New Power and Avici _ third quarter we have a 5250 million problem with have fallen away significantly since. The related Raptor 3 (NPW) if we don't "enhance" the copital party was unable to lay off this risk. This fact pat- structure of Raptor 3 to commit more ENE sharea. tern is once again very negative for Enron. By the woy: in Q, 1 we enhanced the Raptor 3 deal, b. I don't think any other unrelated company would committing more ENE shares to avoid a write down. have entered into these transactions at these 5. Develop cleanup plan: prices. What else is going on here? What was a. Best case: Clean up quietly if possible. the compensation to the related parfy to induce b. Worst case: Quantify, develop P.A. and L.F. camit to enter into such transactions? paigns, customer assurance plans (don't want to 3. There is a veil of secrecy around WM and Rapter. go the way of Salomen's trading shopl, legal Employees question our accounting propriety consieactions, severance actions, disclosure. tently and constantly. This alone is cause for concern. 6. Personnel to quit confidentially to determine if I'm a. Jetf McMahon was highly vexed over the inherall wet: ent conflicts of LJM. He complained mightily to a. Jeff MeMahon Jeff Skilling and laid out five steps he thought b. Mark Koenig should be taken if he was to remain as treasurer. c. Rick Buy Three days later, Skilling offered him the C.E.O. d. Greg Walley To put the accounting treatment in perspective I offer did the 5500 million in value come from? it came the following: from Enron shares. Why haven't we booked the 1. We've contributed contingent Enron equity to the transaction as $500 million in a promise of shares Raptor entities. Since it's contingent, we have the to the Raptor entity and $500 million of value in consideration given and received at zero. We do, as our "economic interests" in these entities? Then Causey points out, include the shares in our fully we would have a wtite-down of our value in the diluted computations of shares outstanding if the Raptor entities. We have not booked the latter, current economics of the deal imply that Enron will because we do not have to yet. Technically we can have to issue the shares in the future. This impacts wait and face the music in 2002-2004. 2002-2004 earnings-per-share projections only. 6. The related party footnote tries to explain these 2. We lost value in soveral equity investments in 2000 . transactions. Don't you think that several interested $500 million of lost value. These were fair-value companies. be they stock analysts. journalists. investments; we wrote them down. However, we hedge fund managers, etc., are busy trying to disalso booked gains from our price risk management cover the reason Skilling left? Don't you think their transactions with Paptor, recording a correspondsmartest people are poring over that footnote discloing PRM account receivable from the Raptor entisure right now? I can just hear the discussions-"it ties. That's a $500 million related party trensactionlooks like they booked a $500 milion gain from this it's 20 percont of 2000 isiT, 51 percant of NI pretax, ___ related party company and i think, from all the unde33 percent of NI after tax. cipherable half-page on Enron's contingent contribu- 3. Credit reviews the underlying capitalization of tions to this related party entity, I think the related Raptor, reviows the contingent shares and deter-_ party entity is capitalized with Enron stock." .. "No, mines whether the Roptor entities will have enough _ no, no, you must have it all wrong, it can't be that, capital to pay Enron its $500 million when the that's just too bad, too fraudulent, surely AA \& Co. equity derivatives expire. wouldn't let them get away with that?" "Go back to 4. The Raptor entities are technically bankrupt, the the drawing board, it's got to be something else. But value of the contingent Enron shares equals or is _.. find itl" .. "Hey, just in case you might be right, try just below the PFM account payable that Raptor and find some insiders or 'redeployed' former owves Enron. Raptor's inception'to-date income statement is a $500 million loss. 5. Where are the equity and debt investors that lost Somm: htips;/iwww,jusice.gov/archiveienaron'exhibito3-15 out? LJM is whole on a cash-on-cash basis. Where BBBC-0001/lmagss.98/1.001.PDF, accessed June I. 2004