Lawyers finally called to account in Enron debacle
16 September 2002
30 September 2013
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Accountants have often felt the finger of blame in corporate accounting scandals. Maxwell, BCCI and last year's Waste Management scandal are just a few instances that spring to mind. The legal advisers have usually managed to avoid the spotlight, but after Enron that may be about to change.
In a class action brought by Enron shareholders in the US, Vinson & Elkins and Kirkland & Ellis are, along with Enron executives, the accountants and a number of banks, named as co-defendants.
Vinson, as primary adviser to Enron, is most hard hit. Enron has been a client of the firm since the 1970s, and by the 1990s the energy giant had become Vinson's largest client, providing around 7 per cent of the firm's annual turnover - around $450m (£289.8m) last year.
The Powers Report, prepared by Wilmer Cutler & Pickering partner William McLucas for a special committee of the Enron board, concluded that Vinson was involved in many of Enron's most controversial deals and in decisions about how to disclose those deals to the public.
"There was an absence of forceful and effective oversight by senior Enron management and in-house counsel, and objective and critical professional advice by outside counsel at Vinson & Elkins and auditors Andersen," stated the Powers Report.
The suit claimed that Vinson's involvement in, and knowledge of, Enron's manipulative off-balance-sheet transactions was extraordinarily extensive. It claimed: "Vinson & Elkins knew that these partnerships were not independent of Enron and were not valid SPEs [special purpose entities], but rather, were manipulative contrivances being utilised to artificially inflate Enron's reported financial results."
A large proportion of the suit against the law firms revolves around the way Enron structures its now notorious SPEs or special purpose vehicles (SPVs). The suit alleged that Vinson provided advice in structuring virtually every one of these transactions. The formation of an SPV named Chewco is a classic example of how this worked.
In late 1997, Enron learnt that one of the outside investors in an Enron subsidiary named Jedi was going to withdraw, and that Jedi would therefore have to be restructured. Because of the involvement of an outside investor, Jedi had been treated as independent of Enron, which meant that the company could engage in transactions with Jedi as a third party, recognising revenue and profits from transactions, while not carrying its debt on the books. However, when the outside investor withdrew, the company was left with two options: either it found another investor or it would have to wipe out the profitable transactions it had done with Jedi, which equalled 40 per cent of that year's revenue, and put Jedi's debt on Enron's balance sheet.
An outside investor could not be found, the suit then alleged that Enron, with the help of Vinson quickly formed a new entity called Chewco, which Enron and an Enron executive controlled. But Chewco did not have an outside investor with a 3 per cent stake, which was the required amount for either Chewco or Jedi to be treated as independent.
"By forming Chewco at the end of 1997, Enron avoided a disaster by keeping Enron's previously recorded profits from transactions with Jedi in place, and thus inflating Enron's  97 reported profits," the suit alleges.
And this is just one example of many cited in the suit to demonstrate the involvement of Vinson.
But does involvement of this kind by legal advisers really leave them open to claims by shareholders?
It is not the first time that firms have faced action of this kind. In 1998, shareholders in the First Pensions case brought a suit against Rogers & Wells (now Clifford Chance Rogers & Wells) for its role in the collapse of the US pensions company. Eventually, the claim was settled in 2000 for an undisclosed amount without the firm accepting any liability.
"But cases where the law firms have faced civil action are not actually that common," said Mike Aguirre, the lawyer acting on behalf of the investors in the First Pensions case.
A source close to the Enron case agreed: "In the past, it has been very difficult to successfully bring a case in these sort of circumstances. And people have usually gone for the accountants, because it's much easier to prove they're at fault."
In their defence, Vinson and Kirkland, along with the other co-defendants, cited a 1994 Supreme Court case that limited the liability of firms found to have aided and abetted in securities fraud. In that case, the court ruled that aiding and abetting were not mentioned in the relevant statute and so the banks concerned could not be held liable.
Investors and their lawyers are fighting to see this changed. "The Enron civil litigation has turned into an effort to somehow prove that these institutions that are aiders and abettors are also direct actors. Their defence has essentially been: 'We might have aided and abetted, but we're immune','" said Daom Silvers, associate general counsel of the American Federation of Labour-Congress of Industrial Organisations.
However, those involved predict that it is unlikely the civil case will reach court. "I'd say that there's a very high chance this case will settle," one source said. "The firms and banks involved don't want their names dragged through the mud, and settlement is the easiest way around that."