Every quarter, Enron's internal accountants recalculated Mariner's value, and nearly every quarter it went up. By November, 2001, Enron estimated that the value of its 75% stake had risen to about $350 million, nearly double the original investment. As those gains accumulated, they were applied straight to Enron's operating income--helping to ignite its seemingly explosive financial performance.
But like much else at Enron, the Mariner investment may not have been what it seemed. Executives inside a key internal control unit, the Risk Assessment & Control Group, felt its soaring book value was overstated, according to several ex-employees. They waged an unsuccessful war to have Mariner's value marked down. In November, says one member of the unit, an informal RAC study valued Enron's Mariner investment at about $150 million. "There were endless meetings fighting about how this deal should be valued," says another former RAC employee, Ogan Kose.
If it seems as though all of Enron's accounting tricks have already been exposed, guess again. Ex-employees say Mariner is part of a larger story that still hasn't fully come to light: They allege the company overstated the values of its investments in several private domestic companies in order to bolster Enron's overall financial performance. At a time when former leaders Kenneth L. Lay and Jeffrey K. Skilling are trying to blame the company's problems on a small group of rogue financial execs, the details of Enron's investment portfolio indicate the company's problems went well beyond the CFO's office--and well beyond its controversial off-balance-sheet partnerships. "The investments were the responsibility of a fairly large number of people throughout the organization," says Bala G. Dharan, a professor of accounting at Rice University's School of Management, who has studied Enron's portfolio. The possibility that games were played with the investments, he says, "gives the impression that the accounting problems were symptoms of wider cultural problems [within Enron]."
Enron and Mariner both declined to comment. "We'll let the process of investigation currently under way take its course," says Enron spokesman Mark Palmer. And one high-ranking Enron executive argues that Mariner is a profitable company with good prospects. In 2000, it earned $21 million on revenues of $121 million. He added that with Mariner, as well as many of the company's other private investments, "there's room for disagreement as to what the carrying value should be."
Enron began building a portfolio of investments in public and private companies in the early 1990s. The majority of the deals were engineered by Enron Capital & Trade Resources, the dynamic unit then run by future CEO Skilling. He intended the investments to bolster the company's efforts to develop a broad, diversified commodities-trading business. In order to assure a reliable supply of the assets being traded, Enron took stakes in Mariner, paper manufacturer Kafus, steelmaker Qualitech, and the publicly traded Internet service Rhythms NetConnections, among others.
The exact performance of the company's investments is impossible to track because Enron is not required to report it separately. But one high-ranking executive says that at its peak, in late 1998, the domestic portfolio of public and private investments in Enron North America, ECT's successor, was valued at about $1.5 billion. These holdings included a shifting array of 25 to 50 private companies. According to one former RAC employee, the private companies in this portfolio other than Mariner were overvalued by $50 million to $75 million.
While the company boasted about the performance of its investments externally, a different picture was painted internally. According to Kose, executives at an RAC meeting told other members of the unit in the summer of 2001 that 70% of Enron's investments had failed to meet their internal performance targets. The summer meeting "was supposed to be secret," says Kose. "They purposely did not distribute any documents."
Of all of Enron's private investments, Mariner was the most overvalued, according to several inside sources. Because it was one of Enron's biggest stakes and because of the innate unpredictability of deepwater drilling returns, it turned into "a pretty decent tool for earnings management," alleges one RAC source. Noting that the valuation model for Mariner was "highly tweakable," another RAC employee says it was easy to inflate the investment by changing assumptions about the productivity of deep-sea acreage or the long-term price of oil and gas.
How did the manipulation occur? In theory, ex-employees say, the business unit that managed the Mariner investment (which was shuffled among divisions as Enron restructured) would first submit a proposed valuation for Mariner to RAC at the end of each quarter. Then the RAC unit was supposed to have the power to modify the numbers if it felt that the valuation was too high. But in reality, RAC staffers say, the system didn't work. Enron's performance-review system gave dealmakers the ability to evaluate the RAC personnel who were reviewing their deals--a practice that made it risky to challenge aggressive investment valuations. What's more, two RAC employees say that when they complained about investment valuations, the head of their unit, Chief Risk Officer Richard B. Buy, rarely backed them up. Buy is also a board member at Mariner. He and his attorney both declined to comment.
Unlike Enron's dealmakers, RAC employees would not directly benefit if the value of the company's investments were inflated. Many say that they frequently complained about how their sophisticated financial analyses were discarded. So, out of frustration, they decided to take a different approach to valuing the company's outside stakes starting in early 2000. Rather than simply rubber-stamping the investment valuations proposed by the company's business units, as they had been pressured to do in the past, they decided to start offering valuation "ranges" for the company's investments. The range for Mariner, for instance, was $80 million to $350 million, according to one RAC source.
Little changed, though, as the company almost always took the highest possible valuation. But the RAC group believed it was making a point. "If they were marking [the valuation] to whatever number they wanted for book purposes, we didn't want to be responsible for that number," says another former RAC manager. In retrospect, it seems a hollow victory. The public never benefited from accurate valuations, and the larger battle--to ensure that Enron properly reported the performance of its investments--was clearly lost. By Mike France in New York, with Wendy Zellner in Dallas