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									Questioning of Ken Lay by defense attorney George Secrest, April 24, 2006 Topic: How Enron fell/Biggest mistakes 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 1 2 3 4 5 6 7 8 9 10 11 Q Let me ask you: In your opinion, how did -- a company that big that was doing that type of business on a daily basis, how did it fail and how did it fail so quickly? A A very fair question and a question that, I'm sure, has been asked by just about everybody from time to time. I wish there was a real simple answer. There's not. But I'll give you an answer. Q Please. A A combination of things. And let me say it took some preconditions to even permit this to happen. But in the end, Enron's failure was -- was caused by a classic run on the bank, and we'll come back and talk about that. Probably talk about that in quite a bit of detail. But to get to that run on the bank is really kind of the main reason that Enron failed in my mind. And I think it all begins with the deceit of Andy Fastow and probably not more than one or two other people but the deceit -- when I say "deceit," going back, we know now, to 1997. But in fact, a person that at the very heart of our organization in one of the key positions in our organization, the chief financial officer's position, was, basically, stealing from the company and stealing from the company before there ever became something called an LJM or a Raptors or some of the things that become more famous in recent months -- or at least toward the end of 2001. But he was doing some things and concealing some things and doing a tremendously brilliant job of concealing that and hiding that from not only the board and me and Jeff Skilling and other senior management but, basically, from most -- most, if not all, of the employees except those very few working with him. And that deceit, we know now, not only started two years before we approved a related-party transaction in 1999 but even continued after the summer of 2001 when, in fact, he advised Mr. Skilling -- and of course, I was aware of the fact that he had done this -- that he had sold his interest in those entities he was still involved in them. So, first of all, the deceit and activity of Andy Fastow, our chief financial officer. Secondly, short sellers. And you heard a lot about short sellers. And again, as I think Jeff said, short sellers play a very constructive role in our economy but they also play a very destructive role. But in this case, there were short sellers that were organized and working together and conspiring together, a real conspiracy, going back as far as December of -- certainly -- certainly, January of 2001 with what was referred to as the bears in hibernation meeting down in Florida where a lot of short sellers got together to pick their number one target for 2001 and Enron became that target and from there on they were working together to make sure they did everything they could to erode confidence in the company, destroy confidence in the company, drive down the price of the stock of the company, so forth. Q What -A And finally -- I'm not done yet, Mr. Secrest. I told you this is not simple. Q Okay. Please, continue. A But then, finally, by the cooperation of the most widely read and the most powerful business newspaper in this country, the "Wall Street Journal," where there were a couple of writers

























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that were provided documents as to what Andy Fastow was doing and he was able to -- and they, of course, had information even that we didn't have at that time, I mean, even late 2001. And that, plus the short sellers feeding that information to them and other information to them, a whole series of articles began in mid-October which just went day after day after day, and it didn't take long with everything else going on until a run on the bank occurred. Now, for that to all have happened, it took more than just those three factors. It took some other things to set up the tinder box that allowed the spark created by those three things to strike the match to it that very quickly burned down the company. Q What was that? A Well, that was everything else in the -- in the -- kind of the external environment, starting not the least of which with -- was after one of the largest and longest economic expansions we had had since World War II and after having one of the biggest bull markets we had had since even back in the early '20s. And particularly, in the late '90s when the tech bubble took off, we started -- and of course, in 2000 and through 2001 when that all began to implode. As always happens after excesses, you go through then adjustment periods and recessions and market corrections and the rest of it; and we'll talk about that, I'm sure, before we get through with all this. But that kind of set the stage for a lot of nervousness in the market, a lot of uncertainty in the market; and then other events came along which contributed to that we didn't know at the time. I think Mr. Skilling's resignation certainly created some uncertainty that contributed to that. Didn't predict it at the time, didn't understand it at the time but certainly it did. The market reacted badly to that. Certainly 9/11 contributed a lot to that. I mean, 9/11 really shook consumer investor confidence, and of course, created a lot of uncertainty. And then, of course, shortly after that, that, in fact, we went into mid-October, we did, in fact, announce some big lay -- or some big write-offs in our third quarter report, basically, trying to clean up some problems that we felt needed to be cleaned up. And let me say the day we announced all of that, the stock price for Enron went up; but then the next day, the "Wall Street Journal" articles started and all this other information started tumbling out; and it was an environment very, very ripe to set off what became a bit of an investor panic and, more importantly, a credit market panic and led to a run on the bank and the drain of all the cash out of the company. So it -- just based on liquidity and particularly doing a half a billion dollars of business a day, we finally reached a point where we had to file for bankruptcy protection. Now, that's moving very quickly through a very complicated subject, Mr. Secrest. Q I understand. A I hope we get a chance to talk about that more -Q We will. A -- because it's very difficult to get that all out in a very short period of time. Q We will. But I want to make sure that we're clear here. Are you saying that because Andy Fastow ripped the company off 40, 50, 60 million dollars that that torpedoed this great American enterprise? A It wasn't the 40, 50, 60. You've also seen some numbers in

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this case -- or in this trial that might put that number over a hundred million or whatever it was. But no, a company the size of Enron, it's -- like it is so often, it wasn't the amount of money that Andy and Michael Kopper and maybe one or two others stole from the company. That's bad enough. It was more a matter of -- of what they did to steal that money and then to conceal and hide what they did to steal that money and then how that all came out in late 2001 in such a way to just totally erode confidence in Enron to such extent in a very fragile market and let me say very definitely a market where the glass was always half empty, never half full, which always happens as you move into more of a bear market and corrections and so forth; and particularly after 9/11 with all the trauma created by that event, it was just an environment in which what Andy did and hid and what the "Wall Street Journal," with the help of the short sellers, exposed, it kicked off a shockwave among investors that just very quickly people started pulling out of the market, pulling the cash out of the company, our counterparties -- our trading counterparties. And it led to a run on the bank that we just couldn't stop. Q Let me ask you this. We got to go over this in, I hate to report, excruciating detail later on. But this case has a lot to do and maybe it's all about things that you said or things that you didn't say that formed the basis of the -- of the charges lodged against you both in the conspiracy and in the securities fraud and wire fraud counts. But let me ask you: Do you honestly think that anything that you said in these analyst calls or these conference calls or online forums or e-speaks, any of that kind of situation, do you think anything that you said or anything that you didn't say led to this run on the bank? A That's a very complicated question. But I mean, let me answer that a little differently, Mr. Secrest. The answer to your question is no. But like so many simple answers, I need to qualify it -Q Sure. A -- not qualify, I need to expand on that a little bit. From my standpoint, going into the fourth quarter of 2001, going into the second half of October, 2001, and the fundamentals of the company -- the fundamentals of Enron were incredibly strong. Our wholesale business, which was making up over 90 percent of our net income and our cash flows at that time, was having some of the strongest performance it had ever had. And it was growing dramatically, all the way through the third quarter and into the fourth quarter of 2001. Our pipelines, which were our second largest profit center, continued and -- which delivered 15 percent of all the natural gas consumed in the United States were continuing to perform very strongly. The retail business, as far as its fundamentals, as far as its basic business plan, its basic business purpose, was doing extremely well. So the fundamentals of the company remained strong. And as far as the problems of the company, which I've already pretty much itemized, I think that I and, before me, Jeff and others were being very, very candid about those problems, and we were addressing those problems and we were solving those problems. So even though there were problems, I don't think those problems are what caused this run on the bank. I think it was just this loss of confidence and this uncertainty, and again, in an environment where the glass is always half empty and maybe less than that, and particularly, dealing with a business like ours which was increasingly -- because of the size









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of the wholesale business was increasingly based upon confidence, confidence of the counterparties doing business with us and confidence of the financial market. And we were totally dependent on that confidence; and because of the events I've talked about, starting again in mid-October and the information that was beginning to come out about Andy Fastow and some of the things he was doing, and like I say, with a little bit of help on the side by the short sellers and by a publication that decided to campaign or make a series of articles out of this, all of that fed into a fire storm that we couldn't stop. Q I'm going to ask you this. And again, we're going to cover it in detail later. But as you sit there on the witness stand under oath, was there anything that you said in these various analyst calls or conference calls, all-employees meeting, et cetera, that was intentionally misleading or intentionally false? A Absolutely not. Absolutely not. As I -- certainly, at the time, I thought all of those things were accurate. As I've now had to go back painstakingly and go through all of those time after time after time, I still believe, based on the information we had at the time, those were all accurate. Q Are you naturally an optimistic person? A Absolutely. Don't run for that -- from that one. I've always been an optimistic person. And for the most part, that optimism has been well rewarded. And Mr. Secrest, I might say, I mean, indeed, if you would look at surveys of leaders, if you look at survey of leaders not just in business but in most other fields, most leaders are optimistic. Most people don't like to follow pessimistic leaders. Q I guess here's the bottom line, Mr. Lay: You were on watch on December 2nd, 2001, when the company filed bankruptcy. Do you accept any responsibility for that? A I said before I accept full responsibility for everything that happened at Enron. Having said that, I can't take responsibility for illegal activity that there is no way I could have had any knowledge of. But I take full responsibility for what happened at Enron. I can't take full responsibility for the individual conduct of all 30,000 employees at Enron and, particularly, those that, in fact, appear to have been engaged in criminal activity. Let me ask you, Mr. Lay: Looking back in your tenure as chief executive officer and chairman of the board, what, in your opinion, was the biggest mistake you ever made while serving Enron? A Well, I suppose with hindsight that's pretty -- pretty easy; and that was hiring Andy Fastow. Q How was it that he was hired in the first place? A Back in the early '90s when Mr. Skilling was beginning to get the wholesale business going and, particularly, was involved in this gas bank activity and this financing of independent producers and some other things that we were doing, he was looking for a structured finance expert. And I was, generally, aware of this. I mean, Jeff was the one that, in fact, of course, was doing the -- was putting it together and pursuing the search. But -- but apparently, a nationwide search was done for this -- for an individual that met the specifications that Jeff had laid out as to the kind of person he thought we needed to even further accelerate the development of this business. And I think it was Spencer Stuart here in town













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that led that. I mean, Spencer Stuart is a nationwide search firm, a very highly recognized search firm. And probably the office here in Houston is one of the most highly recognized groups in the country on searching for talent for the energy business, as you would expect being in Houston, Texas; but they undertook the search, as I understood it. And after reviewing a lot of possible candidates -- and they may have even brought some candidates to Jeff's attention. I'm not sure of that. But certainly, the one candidate that ended up being seriously considered and even brought to -- being brought to Houston to be interviewed and so forth was Andy Fastow. Q Hiring Andy Fastow being your biggest mistake, what's your second biggest mistake? A I think even that one is pretty easy to and that was promoting him to chief financial officer. Q Why do you say that? A Well, I think that put him in a position of -- of power, authority, influence where he could, in fact, do the kind of damage that he ended up doing. I mean, I -- but like I say, those are kind of one in the same. I mean, if we hadn't hired him, he never would have been promoted. But he was promoted to chief financial officer after we, again, had attempted a nationwide search to find a new chief financial officer. And basically, after -- I think it had probably been -- it had been several months, maybe a year or so, we finally were not able to find a satisfactory candidate so we decided to give him a chance. Q You hired Andy Fastow. He made the CFO. What part, if any, in the demise of Enron can we attribute to that swell idea known as LJM? A Well, that had to be pretty high on that list, too. And like I say, certainly, it was a deadly combination having an untrustworthy person as our CFO. But -- and at the time we all looked at LJM, had some questions about it: the related-party transactions, of course, the inherent conflict of interest, and so forth. The board looked at it. The board had a lot of questions. But certainly, after a fairly lively discussion of that in a board meeting, it was decided to proceed ahead and then, of course, it was expanded into other -- you know, other activities than just that original approval which had to do with hedging one particular vehicle but -- and we put in place a lot of what we thought were controls, procedures, controls, oversight, whatever, that would make sure that the company's interest was totally protected. But of course, what you can never protect against is somebody that turns out to be a liar and a thief on the other side. Q Well, would it be fair to say that not only is there a liar and a thief on the other side but there also was a waiver of the code of conduct or the conflict provisions? A Oh, very much so. Like I say, we put in controls and procedures to try to prevent that from being a problem for us. But clearly, it was a mistake. I mean, looking back, we can always look at things that we've done that were mistakes. That was clearly a mistake. I mean, at the time it looked like a prudent risk, and certainly, even for, you know, the year and a half or so after that, it looked like it was -- it was something that was -- a risk that was well worth taking. And the process, certainly from day one all the way through, I mean, there were dozens and dozens and dozens of lawyers and accountants inside

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and, of course, Arthur Andersen and Vinson & Elkins outside and, of course, our risk management group and all kinds of other people that kept scrubbing it and controlling it or looking at ways to put controls on it. So it wasn't a matter -- it wasn't kind of put together in a secret corner somewhere and nobody knew about it. Everybody knew about it. And it looked like it was being well supervised, overseen, reviewed certainly on a quarterly basis throughout. But indeed, like I say, looking back, it was a mistake. Q Pretty big one? A A big one.

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