============= Page 1 of 46 ============= ~ AUDIT AND COMPLIANCE ~ COMMITTEE MEETING ~ October 8, 2001 t 1 1 1 y 1 Natural gas. ~ ~ ~ Electricity. 0 Endless possibilities."" 1 1 1 1 ~ CONFIDENTIAL ~ ECO0„y;aa3 E.uowo1ov GOVERNMENT Crim. No. H-04-25 (S-2) ============= Page 2 of 46 ============= E0004397404 EXH004-01035 ============= Page 3 of 46 ============= Dr. Robert K. Jaedicke, Chairman Mr. Ronnie C. Char Dr. Wendy L. Gramm Dr. John Mendelsohn Mr. Paulo V. Ferraz Pereira Lord John Wakeham Agenda Meeting of the Audit and Compliance Committee of the Board of Directors Enron Corp. October 8, 2001 3:00 pm (CDT) Enron Corp. 50th Floor Boardroom Houston, Texas 1. Approve minutes of meeting of the Audit Committee held on August 13, 2001 - Dr. Jaedicke. 2. Third quarter earnings update - Mr. Causey. 3. Third quarter financial reporting observations - Messrs. Duncan and Bauer, Andersen LLP. 4. Review and update on accounting for goodwill - Mr. Causey. 5. Internal control update - Messrs. Causey, Kilchrist and Parsons. 6. Physical security update - Mr. Kean. 7. Audit and Finance Committee roles in monitoring the Risk `Management Policy and procedures for post transaction reviews - Messrs. Causey and Buy. 8. Review of operations under the Enron Risk Management Policy- Mr. Buy. 9. Review of Enron Compliance Report for 2000.- Mr. Derrick. 10. Other business, including executive sessions as deemed necessary - Dr. Jaedicke. 11. Adjournment. E0004397405 =XH004-01036 ============= Page 4 of 46 ============= Audit and Compliance Committee Calendar of 2001 Activities Scheduled Meetings February May August October December I. Audit Committee Composition and Meetings • Assess independence and financial literacy of audit committee, submit written X affirmation to NYSE • Review charter (publish in proxy every 3 years) t X • Audit Committee Chair to approve meeting agenda X X X - X X • Executive session with auditors, internal audit, management, committee X +~-- # • Maintain minutes and report to Board K X X X K II_ Audit Committee Responsibilities and Duties • Recommend appointment of auditors X • Approve audit fees X • Discuss auditor independence, obtain written statement of all relationships X X • Review plans for financial statement audit X • Review annual financial statements prior to release- discuss with mgmt. auditors X • Discuss quality of accounting principles-approve major changes X e • Review adequacy of financial and EDP internal controls ( I X • Review internal control plan X • Discuss results of year-end audit and other matters required by SAS 61 X • Prepare report to shareholders to be included in the annual proxy X ! • Review quarterly results and findings prior to filing X X X X • Review policies and practices for management's communications with analysts X i • Review/Approve for recommendation to the Board policies and procedures X regarding compliance with laws and significant policy • Review credit and market risk with RAC X X X j X X • Review legal matters with general counsel X • Conduct special investigations, studies or tests l • Review director and officer use of aircraft X X =Recommended Timing * = As Needed E0004397406 =XH004-01037 ============= Page 5 of 46 ============= E0004397407 EXH004-01038 ============= Page 6 of 46 ============= DRAFT MINUTES MEETING OF THE AUDIT AND COMPLIANCE COMMITTEE OF THE BOARD OF DIRECTORS EN ROAN CORP. AUGUST 13.2001 Minutes of a meeting of the Audit and Compliance Committee ("Committee") of the Board of Directors of Enron Corp. ("Company"),'noticed to begin at 2:30 p.m., C.D.T., but actually begun at 2:40 p.m.. C.D.T., on August 13. 2001 at the Enron Building, Houston, Texas. All of the Committee members were present as follows: Dr. Robert K. Jaedicke, Chairman Mr. Ronnie C. Chan Dr. Wendv L. Gramm Dr. John MIendelsohn Mr. Paulo V. Ferraz Pereira Lord John Wakeham Director Jeffrey K. Skilling, Messrs. Robert H. Butts, Richard B. Buy. Richard A. Causey, James V. Derrick, Jr.., Shawn Kilchrist, Theodore R. Murphy, D. Andrew Parsons, Rex R. Rogers, and Robert H. Walls.. Jr., and Ms. Rebecca C. Carter, all of the Company or affiliates thereof, and Messrs. Thomas H. Bauer. David B. Duncan. and D. Stephen Goddard, of Arthur Andersen LLP ("AA"). also attended the meeting. h i ded at t e meeting, and the Secretary, The Chairman, Dr. Jaedicke, pres Ms. Carter. recorded the proceedings. Dr. Jaedickc called the meeting to order, noted that a draft of the minutes of the meeting of the Committee held on April 30, 2001 had been distributed to Committee members, and called for comments, additions, or corrections, There being none, upon motion duly made by Dr. Gramm, seconded by Dr. Mendelsohn, and carried, the minutes of the meeting of the Committee held on April 30, 2001 ,vcre approved as distributed. Dr. Jaedicke called upon Messrs. Causey and Duncan to begin the financial reporting and control audit update, a copy of which is filed with the records of the meeting. 1%lr. Duncan presented selected observations related to the Company's second quarter, including the follo.ving: 1) increased attention was focused on the situations in India and California, 2) the \Vholesalc group's continuing evaluation in numerous valuation changes rves related to the situation in C 3) res d lif rni , e a o a an E0004397408 =XH004-01039 ============= Page 7 of 46 ============= the volatility in the energy markets continued to be monitored. and 4) the difficulties in the telecommunications industry had raised the potential for certain exposures. He then noted that AA had no proposed adjusting entries for the second quarter. Mr. Causcy then began a discussion of the Company's reserves. He commented on the prudence- and credit reserve and noted that it was related to the Company's entire portfolio and was reevaluated monthly. He then stated that there was an EES reserve that related to specific transactions currently on the books and he commented on certain transactions and the related reserves. He discussed the allowance for doubtful accounts and the reasons the amount had increased from the first quarter. He then noted that a reserve relating to the California tariff risk, that had been present in the first quarter, was no longer in place since the amount had been recorded during the second quarter. Mr. Causey then provided an internal control update and commented on significant current activities, including the following: 1)' the 2001 plan was on schedule and approximately 45% complete, 2) the integration of the retail and broadband portfolios into the existing wholesale structure was continuing, 3) the cash management processes had been strengthened when the new procurement and payment system was implemented, 4) security issues related to the Enron Intelligent Network had been identified and were being addressed, 5) the construction of the enterprise data center and business resumption facility would commence soon, and 6) the Company's risk management policy was being updated to incorporate current "best practices". Dr. Jacdicke called upon Mr. Duncan to begin the independent auditor communication regarding independence. Mr. Duncan stated that AA believed that independence was not only the cornerstone of its profession but the only sound basis to its continued success. He stated that AA belie.ed its policies surrounding independence were compliant with those required and that the scope of its practice was appropriate for the Company. He confirmed that AA was an independent accountant with respect to the Company within the meaning of the Securities Act and the requirements of the Independence Standards Board. Mr. Causcy then began a discussion of the new accounting standard for goodwill. He stated that. effective January 1, 2002, good.. ill would not be amortized but rather tested for impairment annually at the "reporting unit" level. He then discussed the standard's definition of reporting unit and noted that goodwill would be tested for impairment using a two-step approach. He stated that the first step would be to compare the fair value of a reporting unit, utilizing a discounted cash flow or market multiple approach, to its carrying amount. He stated that if the fair value was less than the carrying amount then the implied fair value of the goodwill was compared to its carrying amount and if the carrying amount exceeded the implied fair value then an impairment loss, equal to the E0004397409 =XH004-01040 ============= Page 8 of 46 ============= excess, would be recognized. He commented on the transition and effective date of the new accounting standard. He then presented summaries of the Company's consolidated goodwill excluding equi'ty' method investments, the goodwill related to equity investments, and the unconsolidated goodwill on equity method invcstees' books and discussed areas where the preliminary assessment indicated that the fair value could be less than the carrying amount. He stated that the Company would continue its assessment of the goodwill and would update the Committee at the next meeting. Dr. Jaedicke then called upon Mr. Buy to begin the Market Risk Update, a copy of which is filed with the records of the meeting. Mr. Buy discussed the backtcsting performed on the Company's Value-at-Risk ("VAR") model and stated that per the Kupiec test since the actual occurrences of profits and losses exceeding VAR fell within the acceptable range the VAR model was deemed appropriate. He reviewed the limit violations for the second quarter by portfolio. stated that a significant number of the violations related to the North American Gas portfolio, and noted they were primarily due to price and volatility movement, combined with increased activity via EnronOnline. He reviewed the VAR, maturity: "gap. and net open .position limit Violations for the second quarters of 2000 and 2001. He then presented a chart depicting the VAR limit utilization by portfolio over that last four quarters and noted that the North America Gas and Power portfolios had higher utilization than in previous quarters. Dr. Jaedicke called for an executive session with AA at 3:25 p.m., C.D.T. and Messrs. Butts, Buy, Causey=, Derrick. Kilchrist, Murphy, Parsons'executive' RogersSkilling, and Walls and Ms. Carter left the meeting. Minutes of the session %N ere not recorded for the record. There being no further business to come before the Committee, the meeting was adjourned at 3:40 p.m., C.D.T. Secretary APPROVED: Chairman K--.l of i mc:''.ai I \ I1..:• r _tll:\ doc E0004397410 -XH004-01041 ============= Page 9 of 46 ============= Agenda Item 2 E0004397411 EXH004-01042 ============= Page 10 of 46 ============= 1 Non-Recurring Earnings Third Quarter 2001 ($ in millions) Pre-tax After-tax E.P.S. Recurring Earnings $ 521 $ 396 $0.43 Non-Recurring Items: Azurix Asset Sales 1o p~~ i (310) (310) (0.34) A Broadband (281) (183) (0.20) Loss on Investing Activities* (711) (462) (0.51) Total Non-Recurring Items (1,302) (955) (1.05) Anti-dilution (0.11) Total Earnings ($781) ($559) ($0.73) * Pending New Power market movement E0004397412 EXH004-01043 ============= Page 11 of 46 ============= Third Quarter Recurring Earnings by Segment ($ in millions) Third Quarter Nine Months 2001 2000 2001 2000 Enron Transportation Services $ 83 $83 $293 $ 288 Portland General ® o 3 74 Global Assets ~Y• / k) 16 26 Americas 646 548 Retail Risk Management 43 122 241 34 140 2,567 1,134 (665) - 265 216 171 79 (217) (28) Europe and Other Energy Mkts wm r 67 40 Energy Service )- 71 27 Broadband Services Corporate & Other Interest, M1, & Income Tax Recurring Net Income. (80) (67) (380) $396 (20) (111). (375) $ 292 E0004397413 (206) (1,158) $19206 (170) E (981) $919 j EXH004-01044 ============= Page 12 of 46 ============= Enron Corp. Reserves ($ millions) 9130/01 6130/01 3/31/01 12131100 PGE i Sullivan plant reclamation reserve 20 20 20 20 Allowance for doubtful accounts 25 22 19 10 North America i 1 Allowance for doubtful accounts 355 559 480 106 California A/R reserves at 60% 30: 80% 2Q Credit 450 350 323 288 Reevaluated monthly Valuation - gas and power 87 277 401 435 EES Specific Deal Reserves 415 248 PG&E Credit Claims 50 111 - - Other specific transactions 87 98 143 58 California and N. West, political risk 21 47 47 47 9ammel monetization reserve 35 35 35 California tariff risk - 319 - Reserve used in second quarter TVA settlement - - - 253 Settled first quarter 2001 ~ A 1,465 1,725 1,748 1,222 Gtr G ' ~; p~q([fy ~,j Europe tO :50 e- A Credit 104 114 117 131 Reevaluated monthly Global Exploration and Production - Allowance for doubtful accounts 11 11 17 17 ~ y South America Credit - - 33 s, o C Reevaluated monthly C- CALME Dom Rep hotel litigation & AIR reserve - - - 3 A/R written off following renegotiation of PPA Madosa sale - deferred revenue 13 13 13 Amortization of call option EIM Credit 25 14 - - Corporate Tax reserve related to years under audit (a) 285 285 285 285 / n Qj( a 001~L (a) Tax years under audit are 1996 forward. E0004397414 =XH004-01045 ============= Page 13 of 46 ============= iL E0004397415 EXH004-01046 ============= Page 14 of 46 ============= This agenda item will be distributed at the meeting. 16 EXH004-01047 E0004397416 ============= Page 15 of 46 ============= E0004397417 EXH004-01048 ============= Page 16 of 46 ============= Statement of Financial Accounting Standards No. 142 Goodwill and Other Intangible Assets Adoption required as of January 1, 2002 as a cumulative effect of an accounting change. Disclosure of expected impact (if material) should be included in the third quarter form 10-Q. Evaluating $4.3 billion of consolidated goodwill and $1.5 billion of unconsolidated goodwill as of June 30, 2001. Expect to assign the following goodwill to the Americas reporting unit: •Portland General - $750 $900 million •Elektro $583 million •EGPP - $165 million •Expect impairment of approximately $213 million of goodwill relating to Azurix assets to be held for sale in third quarter. Expect additional disclosure for cumulative effect of accounting change of approximately $144 million. Evaluation of Wessex goodwill ($697 million) is ongoing. E0004397418 EXH004-01049 ============= Page 17 of 46 ============= Enron Goodwill Analysis Summary by Operating Segment Cumulative Effect of Accounting Change As of June 30, 2001 Non-Recurrua4l Charge (in millions) Allocated $750MM to S900MM to Americas Allocated to Americas Evaluation ongoing Consolidated Goodwill Transportation (excluding equity method and Global Industrial Global TOTAL investments); Distribution Americas Markets Markets Europe Assets EES EBS Wind ENRON Portland General S 1,468 $ 1,408 Elektro $ 583 583 Form Corp (related to FES MI Buytatck) $ 434 434 Fnron Europe (M(' , Metals) $ 304 364 Fnron Enertly Services 193 193 Wind $ 187 181 Lnron Global Power & Pipelines I LC 165 1St, Lnron Internacional Panama S A (BLM) 64 64 Enron Brnadband Services $ 55 55 36 HNG $ 36 13 13 Induslrias Etoctricas do Ventane Ltd. Global Markets $ r1 12 a) 12 Other Subtotals $ 1,408 $ 36 $ 9 $ - $ 364 5 837 $ 627 S 55 $ 187 $ 3,523 Goodwill Relating to Equity Method Investments: TGS $ 248 $ 2488 Ecocloctrnca 165 165 CEG/Riogas 102 102 Gaspart 127 127 Northern Plains $ 77 12 Sri Ottu:r 35 Subtotals S 72 S $ S - $ - $ 677 $ - $ $ - S 749 Total Consolidated Goodwill $ 480 1 S 36 5 9 S $ 364 $1,514 $ 627 S 55 $ 187 5 4,272 , oodwill: Unconsolidated Goodwill: S 697 AzurixNVess(,x Z13 Azunx/Other 213 149 Stadacona $ 149 SK Enron $ 117 ill Pulp & Paper iFishl:.ail) 223 223 Transredes 31 31 Other 24 1 25 Total Unconsolidated Goodwill $ t)34 $ - S - $ 372 5 - $ 149 S - S - $ - $ 1,455 E0004397419 EXH004-01050 ============= Page 18 of 46 ============= E0004397420 =XH004-01051 ============= Page 19 of 46 ============= Internal Control Update 414 2001 Plan Status • Approximately 80% complete Activity Related to Issues Identified in Control Audits - EES/EWS integration Project Management Office has been created to provide coordination and oversight for all EES transition projects. Systems integration requirements and timelines have also been developed; execution has begun • Enron Intelligent Network security enhancements progressing on schedule and estimated for completion by fourth quarter 2001 • Construction has begun on the West Houston data center which will also serve as the cornerstone to Enron's business continuity plans; estimated for completion by second quarter 2002 Recently completed audit of EnronOnline was positive and resulted in no findings categorized as significant "~ • Re-engineering of processes and systems to strengthen supporting infrastructure for Metals business scheduled for completion by first quarter 2002 • Curve validation processes being re-examined to address issues raised with respect to functional responsibilities and consistency across business units and/or product portfolios `* Other Significant Control Related Activities • RAC operational issues team formed to focus on operational risk exposures and techniques to identify, access, categorize, quantify and manage these exposures in all business units • Monitoring and enforcement activities are being adjusted for newly revised Risk Management Policy '• Recently identified E0004397421 =XH004-01052 ============= Page 20 of 46 ============= E0004397422 EXH004-01053 ============= Page 21 of 46 ============= i Corporate -Security Update ~ i E0004397423 EXH004-01054 ============= Page 22 of 46 ============= Objectives • Deter attack Protect in the event of attack • Increase sense of security E0004397424 =XH004-01055 ============= Page 23 of 46 ============= Approach identify threats Prioritize remediation: near term v. long term - facilities EC004397425 EXH004-01056 ============= Page 24 of 46 ============= Summary • Enron center - surveillance - vehicle barriers - access control increase security personnel Personnel - background checks Domestic facilities International facilities survey/audit EO004397426 F(Nnna_nlnn7 ============= Page 25 of 46 ============= E0004397427 =XH004-01058 ============= Page 26 of 46 ============= Roles For Monitoring The Risk Management Policy Audit and Compliance Committee Finance Committee Review internal controls as it relates to the operation of the Risk Management Policy Review limit violations and determine that actions taken by management are consistent with the Policy (e*&,O Approve risk management framework and review policy issues .- Determine appropriateness of limits, correlations, profitability and liquidity based on the company's risk appetite as ratified by the Board Review corporate liquidity and funding plans Review investment returns achieved " relative to expectations ECO04397428 EXH004-01059 ============= Page 27 of 46 ============= Procedure: Post Transaction Reviews •Pilst transaction reviews toCtransi.lCtl()I1ti o ci $200 Million will b( p('rti}rrllcd at a 1i11nila1l1I11 of lx and 36 month intervals alter closing. Additional transaction reviews will occur as directed by the Chiel' Risk O11-icer or in response to Board questions. "Merchant" investments will continue to be monitored by RAC and quarterly portfolio performance reported to the Finance Committee at regularly scheduled meetings. -Compliance related issues resulting from transaction reviews will he evaluatei:l and discussed with the Audit and C:•ompliance Committee. All other issues resulting from transaction reviews will be discussed with the Finance Coin m ittee. -Major strategic implications resulting fro111 tl'a11sactio11 reviews will be presented to the ti.lll Board. &.9 E0004397429 EXH004-01060 ============= Page 28 of 46 ============= Agenda Item 8 E0004397430 EXH004-01061 ============= Page 29 of 46 ============= Market Risk Update Table of Contents Risk Profile Risk Profile by Market Concentration Risk Profile by Business Unit Backtesting of Enron Corp. Aggregate VaR 10 Utilization of VaR Limits Market Risk Limit Violations Scenario Analysis Liquidity Risk Ratio Analysis 0 Brazilian Foreign Exchange Exposure Update E0004397431 =XH004-01062 ============= Page 30 of 46 ============= Risk Profile Eight Months Ended August 31, 2001 and 2000 Market Concentration(1) Trading P&L YTD 8/31/01 P&L = $2.2 B ( YTD 8/31/00 P&L = $1.8 B 1,2000 0 1,006 800 807 677 526 400 i 326 291 Business Unit Comparison Trading P&L YTD Trading P&L ='$2.2 B ' 1.655 8 5 2 28 55 58 M1 Americas Americas European Products Financials Emerging (40) Gas Power Gas & Businesses Americas Europe Global Industrial Power Markets Markets Average VaR YT®.._: . ..rt..._.. _ ........ 8131/01 Avg VaR = $79 MM Average VaR YTD Average VaR $79 MM ($MM) ($MM) YTD 8/31/00 Avg VaR = $38 MM (6) (3) (3) (4) (7( (20) i10 {?Oj J (40) (29) (0) F X50 3 ($0( (60) Americas Americas European Products Financials Emerging (80) f,0 k) Gas Power Gas & Businesses Americas Europe Global Industrial Power Markets Markets Return on VaR - Eight Months Ended August 31 Enron ` Return on VaR -Eight Months Ended August 31 Enron ': 2001 128% 140% 141% 21% 158% 210% 214% 2001 191% 168% 78% 201% 214% '` 2000 210% 189% 192% 72% 157% 49% 352% 2000 281% 176% 139% 114% 352% (1) Commodities aggregated per Concentration Limit categories E0004397432 EXH004-01063 ============= Page 31 of 46 ============= Risk Profile by Market Concentration Eight Months Ended August 31, 2001 and 2000 Americas Americas European Gas Emerging ($MM) Gas Power & Power Products Financials Businesses 1,003 975 YTD 8/31/01 P&L ' $2.2 B 795 Trading P&L 725 672 YTD 8/31/00 P&L $1.8 B 528 475 247 269 225 72 29 27 a 4 46 7 , 411 24 2 34 57 37 36 11 21 12 18 21 =r ; (9) "a 3 12 5 (2 . MWI= ®2 NA Gas Americas NA Power Americas UK Power European Continental Nordic Coal Global Credit Financials Steel Metals Weather Emerging Products Trading Other Businesses r Po P ($MM) Gas Other Power Other wer owe Gas Other O i k (16) r , (32) E0004397433 (64) Return on VaR - Eight Months Ended August 31 2001 129% 85% 141% 32% 2000 207% 295% 190% (8%) Total Enron RoVal EXH004-01064 115% 99% 107% t75% 175% 98% 127% • 244% 82% 135% 86% 187% (22%) 161% • 30% 53% 63% 11% 166% NA 43% 53% 105% I YTD 8/31/01 = 214% Total Enron RoVaR YTD 8/31/00 = 352% ============= Page 32 of 46 ============= Risk Profile by Business Unit Eight Months Ended August 31, 2001 and 2000 ($MM) Americas Europe Global Industrial 923 Markets Markets 875; 795 ._...._ 730 Trading P&L YTD 8/31/01 P&L=$2.2B 650 YTD 8/31/00 P&L = $1.8 B 527 425 247 269 200 72 36 29 27 24 11 4 46 7 42 54 21 12 4 48 37 5 21 ~9~ 210 = L2 11 4 (22) NA Gas NA Power Americas UK Power European Metals Continenltal Credit Australian/ Nordic Coal Global Weather Global Steel Pr ducts Pulp, Paper & Other Gas Power Trading Japanese Power Markets Other o Lumber ($MM) Power 0 .~_., w __ _ (3 YTD 8/31/01 Avg VaR = $79 MM 8E0004397434 Average VaR YTD 8/31/00 Avg VaR = $38 MM (64)] Return on VaR - Eight Months Ended August 31 2001 104% 187% 12% 115% 99% 82% 107% 98% 135% ( % 166% 122% 135% 3% 244% 36% 2000 207% 190% 227% 187% (22%) 43% 161% 11% 59% 30% 53% 154% 53% 63% NA 114% Total Enron RoVaR YTD 8/31/01 = 214% Total Enron RoVaR YTD 8/31/00 = 352% EXH004-01065 ============= Page 33 of 46 ============= ($MM) 600 200 100 0 (100) TIII /i j'A . , r", ~. ($150 MM) (200 .^ . ' _._ , ....__., _. ......n_. __..., _ .:. __._~... ...._.,. Loss Notifications >VaR L imit (MM) Conclusion: ($ 87) ($105) 09/01/00 11/16/00 ($215) 12/13/00 ($194) 04/09/01 Kupiec Test sets out acceptable range of instances where curveshift profit and loss exceeds VaR. At 95% ($136) 12/07/00 ($139) 06/11/01 confidence and for the 251 trading days shown, the Actual acce table ran e is between 6 and Mimes ($630) 12/12/00 ($ 65) 07/25/01 g . p occurrences are 17, indicating that the VaR model is acceptable. (400 _, T12/12/00 - ($551 MM) ($520 MM) (600) 0 0 0 0 0 0 O 0 0 0 0 0 0 r 2 2 O O 0 0 0 0 0 0 0 0 0 0 0 0 O O 2 O Q O O- O O O O O O O O O O O O O O +7 0 C7 C) N) O C') C') N N N C~ N N r r- N r p O N N r -- r +-- r -- O O Nd N N C`] N O O Q O C= N C') - Q) 6) r O r C9 1 ` N Cs 0) r N r O Q r N C ` N ` N r N N r r \ ` \ N () ` N N N C) C~1 ~T d LO LO LO (~ CO ` 60 I' 1 P OD CO CO 12 Month Corp. Limit Evolution: 06/01/00 10/07/00 12/07/00 12/28/00 02/13/01 08/14/01 (MM) $75 $100 $140 $100 $125 $150 E0004397435 =XH004-01066 ============= Page 34 of 46 ============= Percentage of VaR Limit 100% 75% 50% Utilization of VaR Limits Quarterly Comparison ~" Average VaR 25% Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 02 Q3 Q4 Q1 Q2 03 Q4 Q1 Q2 Q3 04 Q1 Q2 Q3 Q4 Q1 Q2 Q3 2000 2001 2000 2001 2000 2001 2000 2001. 2000 2001 2000 2001 2000 2001 Americas Americas European Products Financials Emerging TOTAL ENRON Gas Power Gas & Power Businesses TRADING Note 1: 03 2001 represented by July I - August 31. Note 2: Utilization calculations were based on Commodity Group Limits, Trot Concentration Limits. Concentration Limits were not established until- 6u14101. E0004397436 :XH004-01067 ============= Page 35 of 46 ============= 0 0 0 0 Market Risk Limit Violations July 1 to September 26, 2001 No Violations of Board Approved Portfolio Limits No Violations of Board Approved Concentration Limits No Violations of Business Unit Limits Commodity Group Limits are established conservatively to act not as traditional "limits", but as triggers for management decision making, thereby ensuring compliance with Concentration Limits. Commodity Group Limits may be adjusted frequently in response to business needs and market dynamics. Commodity Group Limit Violations 0 VaR ® Maturity/Gap Net Open Position 50 40 Lim _ 0 EOL Crude North Global Regulated UK Power wer Metals",T European. Steel Lumber American Products Portfolio Gas Gas (POE) (1) Violations were the result of booking errors. E0004397437 =XH004-01068 ============= Page 36 of 46 ============= What if... War in the Middle East Breaks Out • Most militant Middle Eastern countries declare an oil embargo; crude prices rise to $42 for the next four months • A majority of the Middle Eastern countries declare an oil embargo; price of crude spikes to $75 for the next four months • Terrorists destroy a gas pipeline in the Gulf; gas prices increase an average of $1 per month for the next 12 months Recession Recession and war fears cause a credit crunch, reduction in volumes and foregone profits In addition to above, Enron realizes losses from an increase in bankruptcies Prolonged and Unexpected Winter Freeze in the U.S. • Gas and power prices rise due to an increased demand as a result of colder weather * Worst case, assumes instantaneous impact on current positions. ** Losses incurred or income foregone over a 3 month period. E0004397438 ($MM) (`t 0 (300) (400'i ($82)* ( 7u k 0:k Crude Natural Gas Loss in Potential Profits Credit Losses Power =XH004-01069 ============= Page 37 of 46 ============= Liquidity Risk Ratio Analysis Ten Day Forward Time Horizon Future Available Cash + Borrowing Capacity Liquidity Ratio= fi Trading Portfolio's Potential Future Cash Requirements Liquidity Ratio - P99 Potential Margin Exposure 1 5_0 13.5 P99 Advisory Limit = 1.5 12.0 Liquidity Ratio 1 0_5 6_O 4.5 . 3.0 0_O 08/'13/01 08/20/01 08/27/0-1 09/03/01 09/10/01 09/17/01 09/24/01 Liquidity Ratio - P50(1) Potential Margin Exposure 48_0 - . ._.. _.., a m _0 45 42.0 . .,® m P50 Advisory Limit = 3.0 Liquidity Ratio 36.0 33_0 30_0 27_0 F 24_0 21 _0 - ;a.~. .~.. 10-0 -IS-0 2_0 9_Q O -Q 0_0 C D43/ 1 3/01 0 8/2 0/01 0 8/2 7/01 0 9/0 3/01. 09/1 0/01 0 9/1 7/01 U9/P--a/0-1 (1) Includes Net Accounts Receivable and Debt and Equity Shelf Registrations. - - E0004397439 EXH004-01070 ============= Page 38 of 46 ============= Brazilian Foreign Exchange Exposure Update Brazilian Reais ("BRL") Cumulative Translation Adjustment, (CTA) Current and Forecasted Balances Historical CTA Balance Forecasted CTA Balance BRL Historical Rate 1 7600 BRL Forward Rate 1 547 4.50 1,400 1,420 15224 4.00 1,200 1164 Z 1,004 50 3 1,000 899 . S00 3.00 600 2.50 E 4 400 200 2.00 Mar-01 Jun-01 Sep-01 Dec-01 Dec-02 Dec-03 Dec-04 E0004397440 =XH004-01071 ============= Page 39 of 46 ============= m n 0 0 .A w .p EXH004-01072 ============= Page 40 of 46 ============= Vinson &Elkins ATTORNEYS AT LAW VINSON & ELKINS L.L.P. 2300 FIRST CITY TOWER 1001 FANNIN STREET HOUSTON, TEXAS 77002-6760 Writer's Phone: 713-758-2117 TELEPHONE (713) 758-2222 Writer's Fax: 713-615-5516 --- FAX (713) 758-2346 September 28, 2001 PRIVILEGED AND CONFIDENTIAL Enron Corp. 1400 Smith Street Houston, Texas 77002 Attention: Mr. James V. Derrick, Jr., General Counsel Re: Enron Corp. Compliance Program E-mail' csandvickPvelaw.com Web: www.velaw.com Reference is hereby made to the United States Sentencing Guidelines set forth in the United States Sentencing Commission, Guidelines Manual, Chapter 8 (1998) (the "Guidelines"). This written opinion is being furnished to you in connection with our involvement in the review of, and revisions to, Enron Corp.'s corporate compliance program to comply with the Guidelines. In connection with the opinion set forth below, we have examined copies of the following documents: (i) Code of Business Conduct: General Policy Regarding Laws and Business Conduct, Policy No. 1.01 (the "General Policy"), adopted by the Board of Directors of Enron Corp. on August 10, 1993, as revised in September 2001 (capitalized terms used in this letter and not otherwise defined herein shall have the respective meanings given them in the General Policy, which is attached as Schedule 1 hereto); (ii) Enron Corp. Code of Ethics booklet (the "Ethics Booklet") dated July, 2000, which includes general standards and procedures regarding compliance with applicable laws by the employees of Enron Corp. and its affiliates (the "Company"); (iii) Form of Acknowledgement of the Ethics Booklet and Compliance Statement attached as Schedule 2 hereto (the "Acknowledgement"); (iv) Form of Enron Corp. Compliance Program Procedures (the "Procedures") adopted by the Enron Compliance Officer as of August 4, 1994; E0004397442 HOUSTON AUSTIN BEIJING DALLAS LONDON MOSCOW NEW YORK SINGAPORE WASHINGTON, D.C. - ----- u _-a Cmmnliance Letter- 2001 (H004-01073 ============= Page 41 of 46 ============= Enron Corp. Page 2 September 28, 2001 (v) 2000 Compliance Reports for Enron Corp. and the Operating Groups (the "2000 Compliance Reports"); (vi) Time line for submission of 2001 Compliance Reports, attached as Schedule 3 hereto (the "2002 Time Schedule"); and (vii) Incident log for alleged compliance-related events from Enron Corp. and the Operating Groups, Environmental Incident Log, and Summary of Incidents from Building Security and Corporate Security (collectively, the "Tracking Log"). Based upon the foregoing and subject to the qualifications set forth below, we are of the opinion that the Enron Corp. corporate compliance program generally has been designed in a manner to constitute an "effective program to prevent and detect violations of law", Guidelines § 8A1.2, cmt.(k) (an "Effective Program"). The opinion set forth above is subject to the following qualifications: a. The Guidelines provide that whether a compliance program constitutes an Effective Program depends on a number of factors, not all of which are specified and many of which are fact specific and relate to future facts; thus, no absolute assurance can be given regarding whether a court or prosecutor would find that a particular corporate compliance program constitutes an Effective Program. Guidelines § 8A1.2, cmt.(k). The official commentary to the Guidelines lists a number of factors as being relevant as to whether a program constitutes an Effective Program. The following is„a list of such factors and our analysis of how the Enron compliance program addresses such factors: (1) Size of organization. The requisite degree of formality of an Effective Program will vary with the size of the organization; the larger the organization is, the more formal the compliance program should be. Guidelines § 8A1.2, cmt.(k)(i). For example, a larger organization should have established written policies defining the standards and procedures to be followed by its employees and other agents. Id. Enron Corp. has such written standards and procedures, including without limitation the standards and procedures set forth in the Code of Business Conduct, the Ethics Booklet and the Procedures; the Operating Groups have additional written standards and procedures. (2) Likelihood that certain offenses may occur because of the nature of its business. If because of the nature of an organization's business there is a substantial risk that certain types of offenses may occur, management must have taken reasonable steps to prevent those types of offenses. Guidelines § 8A1.2, cmt.(k)(ii). Each of Enron Corp. and its Operating Groups prepared summaries of areas of law applicable to it based on the nature of its business (the "Summaries"). Enron Corp. and the Operating Groups have updated the Summaries through the 2000 Compliance Reports and are scheduled to produce the 2001 Compliance Reports E0004397443 H004-01074 ============= Page 42 of 46 ============= Enron Corp. Page 3 September 28, 2001 as updates for the compliance calendar year 2001 generally according to the 2002 Time Schedule. We have been advised that the Code of Business Conduct, the Ethics Booklet and the other written standards and procedures adopted by Enron Corp. and the various Operating Groups address the material areas relevant to each of them. (3) Prior history of the organization. An organization's prior history may indicate types of offenses that it should have taken actions to prevent. Guidelines § 8A1.2, cmt.(k)(iii). Recurrence of misconduct similar to that which an organization has previously committed casts doubt on whether it took all reasonable steps to prevent such misconduct. Id. We regularly remind Enron Corp. and the Operating Groups to continue to consider any past misconduct, including without limitation, any criminal, civil or administrative proceedings or investigations, in formulating and communicating compliance standards and procedures, and in auditing and monitoring compliance with such standards and procedures. (4) Industry Practice; governmental regulations. An organization's failure to incorporate and follow applicable industry practices or the standards called for by any applicable governmental regulation weighs against a finding of an Effective Program. Guidelines § 8Al.2, cmt.(k). We have consulted with Enron Corp. and the Operating Groups about the need to take industry practice (which cannot be precisely defined) into account in formulating their programs and procedures. Enron Corp. and the Operating Groups will need to continue monitoring industry practice and applicable governmental regulations and make appropriate changes to their corporate compliance programs. b. Although the Guidelines state that the precise actions necessary for an Effective Program will depend upon a number of factors, the Guidelines provide that an Effective Program is one "that has been reasonably designed, implemented, and enforced so that it generally will be effective in preventing and detecting criminal conduct" by its employees and other agents. Guidelines § 8A1.2, cmt.(k), introduction. The Guidelines further state that the hallmark of an Effective Program is the organization's "due diligence in seeking to prevent and detect criminal conduct by its employees and other agents." Id. Due diligence requires at a minimum that the organization must have taken the following steps: (1) The organization must have established compliance standards and procedures to be followed by its employees and other agents that are reasonably capable of reducing the prospect of criminal conduct. Guidelines § 8A1.2, cmt. (k)(1). As discussed above, Enron Corp. and each Operating Group prepared the Summaries and the 2000 Compliance Reports, which include a list of written standards and procedures to be followed by its employees. In connection with preparing the Summaries and the 2000 Compliance Reports, Enron Corp. and the Operating Groups were requested to review the laws applicable to their business and consider whether their standards and procedures require revisions or additions to reduce the prospect of violating such laws. We have been advised that E0004397444 H004-01075 ============= Page 43 of 46 ============= Enron Corp. Page 4 September 28, 2001 substantive corporate legal policies are distributed to those employees of Enron Corp. and the Operating Groups who have a need to know such policies in the course of the performance of their duties or the supervision of other employees. Each Operating Group is responsible for ensuring that such distribution occurs on an appropriate periodic basis and that employees know the location of each such policy that is applicable to them or employees supervised by them. We also understand that English (Spanish or Portuguese) versions of the Ethics Booklet have been and will be distributed annually to all personnel of Enron Corp. and the Operating Groups and that all personnel are requested to acknowledge the receipt and review thereof annually in the Acknowledgement in substantially the form of Schedule 2. (2) A specific individual or individuals within High-Level Personnel of the Company must have been assigned overall responsibility to oversee compliance with such standards and procedures. Guidelines § 8A1.2, cmt.(k)(2). High-Level Personnel is defined by the Guidelines as an individual who has substantial control over the organization or who has a substantial role in policy making within the organization; the term includes a director, an executive officer, and an individual in charge of a major business unit or functional unit of the organization. Guidelines § 8A1.2, cmt.(3)(b). We have been advised that Enron Corp. and each of the Operating Groups has assigned responsibility for their respective corporate compliance programs to High-Level Personnel and that such personnel are performing (or have delegated, but have maintained overall responsibility for performing) the duties listed in the General Policy and the Procedures. We understand that Enron Corp. periodically reviews the performance of such duties and makes appropriate changes (if any) in the designated personnel if indicated based on such review. (3) The organization must have used due care not to delegate substantial discretionary authority to individuals whom the organization knew, or should have known through the exercise of due diligence, had a propensity to engage in illegal activities. Guidelines § 8A1.2, cmt.(k)(3). The Procedures provide that (i) Enron Corp. will require the Acknowledgement in substantially the form of Schedule 2 to be completed on an annual basis by management employees of Enron Corp. and the Operating Groups, and (ii) if any employee is discovered to have such a propensity, such employee shall be divested of substantial discretionary authority. We have been advised that, in addition to the foregoing, Enron Corp. and the Operating Groups selectively have been conducting appropriate background checks (by reviewing criminal records, credit records and employment records) on management personnel who will be exercising substantial discretionary authority prior to hiring them. We also understand that a written policy governing the utilization of background checks for the hiring, retention, promotion and reassignment of personnel has been implemented. E0004397445 :H004-01076 ============= Page 44 of 46 ============= Enron Corp. Page 5 September 28, 2001 (4) The organization must have taken steps to communicate regularly and effectively its standards and procedures to all employees and other agents, e.g., by requiring participation in training programs or by disseminating publications that explain in a practical manner what is required. Guidelines § 8A1.2, cmt.(k)(4). In the Summaries and the 2000 Compliance Reports, Enron Corp. and each of the Operating Groups have listed the written and other means of communicating their respective standards and procedures, and in connection with preparing and reviewing the Summaries and the 2000 Compliance Reports, have considered whether such means should be revised or supplemented. We have been advised that Enron Corp. and the Operating Groups have established additional means of such communication based on such review, as appropriate. We understand that the Ethics Booklet, certain other standards and procedures as well as all appropriate compliance policies applicable to Enron Corp. and the various Operating Groups are available to employees via computer. Further, we understand that all compliance policies are located at one home web page site that is available to all employees. In addition, we understand that Enron Corp. and the Operating Groups are utilizing its electronic communication system, including ethink and espeak, eHRonline, etv and ccMail or PhoneMail or other medium, where appropriate, to update and remind its employees with respect to important policies. (5) The organization must have taken reasonable steps to achieve compliance with its standards, e .g., by utilizing monitoring and auditing systems reasonably designed to detect criminal conduct by its employees and other agents and by having in place and publicizing a reporting system whereby employees and other agents can report criminal conduct by others within the organization without fear of retribution. Guidelines § 8A1.2, cmt.(k)(5). In connection with preparing the Summaries and the 2000 Compliance Reports, Enron Corp. and each Operating Group have described their means of monitoring and auditing and have considered whether any additional means should be established. We have been advised that Enron Corp. and the Operating Groups have established additional means of monitoring and auditing based on such review, where appropriate. In that regard, we understand that a Risk Assurance Group has been formed to perform a review of the internal accounting, financial and compliance controls in Enron Corp, and each of the Operating Groups. In addition, Enron Corp. has established a confidential post office box to allow employees and agents of the Company to report violations of law without fear of retribution and has informed all Company employees of the existence and manner of utilizing such post office box. Enron Corp. has also established an Office of the Chairman ccMail Box and PhoneMail Box for questions, messages, comments or suggestions by the Company's employees. The 2000 version of the Ethics Booklet, which we understand was distributed in the second quarter of 2000, lists the confidential post office box, the Office of the Chairman ccMail Box and PhoneMail Box as facilities through which employees may report suspected violations of the law without fear of retribution by those not involved in wrongdoing. We understand ECO04397446 304-01077 ============= Page 45 of 46 ============= Enron Corp. Page 6 September 28, 2001 that you further publicize the confidential post office box and the Office of the Chairman ccMail Box and PhoneMail Box, via memorandum and computer on a quarterly basis, in order to increase employee awareness of these reporting facilities. Because we understand that reports of alleged violations of Enron's policies commonly are made to management personnel as opposed to the confidential reporting facilities, we advise that you continue to conduct interviews of appropriate management personnel to enhance reporting of alleged compliance related incidents. (6) The standards must have been consistently enforced through appropriate disciplinary mechanisms, including, as appropriate, discipline of individuals responsible for the failure to detect an offense. Guidelines § 8A1.2, cmt.(k)(6). Adequate discipline of individuals responsible for the offense is a necessary component of enforcement; however, the formm of discipline that will be appropriate will be case specific. Id. The General Policy and the Procedures require that consistent discipline be imposed on individuals violating the Code of Business Conduct. We have been advised that discipline is generally handled at the Operating Group level, and the Tracking Log is intended for use in reporting the resolution (and related discipline, if appropriate) of alleged compliance-related incidents. We understand that investigation of potential violations is generally handled by the legal department. (7) After an offense has been detected, the organization must have taken all reasonable steps to respond appropriately to the offense and to prevent further similar offenses -- including any necessary modifications to its program to prevent and detect violations of law. Guidelines § 8A1.2, cmt.(k)(7). The General Policy and the Procedures require that the Code of Business Conduct and related means of communicating, auditing and monitoring compliance therewith be reviewed and revised on a periodic basis, including upon the detection of an offense. The Tracking Log is designed to report additional controls implemented as a result of alleged compliance-related incidents. c. You should be aware that the decrease in fines and other benefits resulting from an Effective Program under the Guidelines (i) will not apply if any High-Level Personnel within an organization (or under certain circumstances, within a subsidiary, division or unit of an organization) or any individual responsible for the administration or enforcement of the corporate compliance program participated in, condoned, or was willfully ignorant of the offense, (ii) may not apply if any individual who, within the scope of his or her authority, exercises a substantial measure of discretion in acting on behalf of an organization, participated in the offense, and (iii) will not apply if, after becoming aware of an offense, an organization unreasonably delays in reporting the offense to appropriate governmental authorities. Guidelines § 8C2.5(f). E0004397447 1004-01078 ============= Page 46 of 46 ============= Enron Corp. Page ? September 28, 2001 d. It has been represented to us by you that the Operating Groups and the entities which they include encompass all of Enron Corp. and its Affiliates, and that the compliance program of each Operating Group covers each entity within such group. We understand that the Operating Groups have adopted their own Related Codes and have either adopted their own related procedures for the administration of their respective compliance programs or have elected to utilize Enron Corp.'s procedures. e. Each of the steps outlined in the General Policy and the Procedures needs to be implemented, maintained and revised as appropriate from time to time as described therein. f. We have assumed that (i) the written standards and procedures applicable to Enron Corp. or any Operating Group may be easily located by employees to which such standards and procedures apply and (ii) such employees are aware of which of such standards and procedures are applicable to them and employees for whom they are responsible. g. We have assumed that Enron Corp. and the Operating Groups will substantively review their compliance programs on a periodic basis and at least once a year to determine whether they are adequate, based on the materials attached hereto, as well as on "Tips on Review/Revision of Compliance Programs" furnished to them, the form of which is attached as Schedule 4 hereto (the "Tips"), and that appropriate revisions will be made from time to time based on such review and on the answers to the questions posed in the Tips. h. Enron Corp. and its Operating Groups need to continue to identify the agents to be included in their respective corporate compliance programs and take steps to include such agents to the extent, if any, they are not already so included. i. The Guidelines are still relatively new and there are few court decisions interpreting what constitutes an Effective Program. Obviously, as courts interpret the Guidelines, the components of an Effective Program may change. If you have any questions or comments with respect to the foregoing, please do not hesitate to contact us. Very truly yours, VINSON & ELKINS L.L.P. E0004397448 =XH004-01079