Updated from 4:36 p.m. EST

On the eve of former CEO Kenneth Lay's scheduled testimony before congressional committees, a report by three independent members of Enron's ( ENRNQ) board paints a dark picture of corporate deceit, a culture of arrogance and a tangled web of executives who sought personal riches at investors' expense.

But Lay won't be letting Congress in on what he knows just yet, as he indicated through his attorney Sunday night that he wouldn't be testifying Monday as previously agreed. Through his attorney, Earl Silbert, Lay informed key congressmen that he'd be absent from Monday's hearings. The letter from Silbert indicated his client would "withdraw his prior acceptance of your invitation" in light of "inflammatory statements" from certain members of Congress. It also claimed it would be unfair for Lay to testify as "conclusions have been reached before Mr. Lay has been given an opportunity to be heard."

However, the internal investigative report, released Saturday, makes accusations that are much more troubling than previously revealed.

"Our investigation identified significant problems beyond those Enron has already disclosed," reads the report prepared by William C. Powers Jr., dean of the University of Texas School of Law, and two other outside directors, Raymond S. Troubh and Herbert S. Winokur.

Their report concludes that most of Enron's troubles were brought about by self-serving deceit. "The tragic consequences of the related-party transactions and accounting errors were the result of failures at many levels and by many people," the report states. It was caused by "a flawed idea, self-enrichment by employees, inadequately designed controls, poor implementation, inattentive oversight, simple (and not-so-simple) accounting mistakes and overreaching in a culture that appears to have encouraged pushing the limits. Our review indicates that many of those consequences could and should have been avoided."

Who Benefited?

The investigation's most damning finding is that these tactics appear intended to enrich a group of high-rolling insiders at the expense of employees and shareholders.

"Enron employees involved in the partnerships were enriched, in the aggregate, by tens of millions of dollars they should have never received -- former CFO Andrew Fastow by at least $30 million, another executive, Michael J. Kopper by at least $10 million, two others by $1 million each, and still two more by amounts we believe were at least in the hundreds of thousands of dollars," the report notes. "These benefits came at Enron's expense."

The report details a plethora of self-dealing that involved Fastow and other senior managers. In fact, the report outlines how Fastow apparently created a partnership to reward Enron employees for their involvement in previous misdeeds.

"These investments, in a partnership called 'Southampton Place,' provided spectacular returns," the report notes. "In exchange for a $25,000 investment, Fastow received ... $4.5 million in approximately two months. Two other employees, who each invested $5,800, each received $1 million in the same time period. We have seen no evidence that Fastow or any of these employees obtained clearance for those investments, as required by Enron's Code of Conduct."

The report largely blames the former CFO. "What Fastow presented as an arrangement intended to benefit Enron became, over time, a means of both enriching himself personally and facilitating manipulation of Enron's financial statements," the report concludes. "The evidence suggests that he placed his own personal interests ... ahead of Enron's interests."

Yet the investigation places plenty of blame on Lay and former CEO Jeff Skilling for their knowledge and actions and, in Lay's case, his apparent uninterest or ignorance.

Authors of the report refer to Lay as "captain of the ship," noting that he should have known about Fastow's chicanery and used his authority to extinguish it. "As CEO, Lay had the ultimate responsibility for taking reasonable steps to ensure that the officers reporting to him performed their oversight duties properly," the report states. "He does not appear to have directed their attention, or his own, to the oversight of the LJM partnerships. Ultimately, a large measure of the responsibility rests with the CEO."

While the report notes that Lay delegated much of the day-to-day operations to Skilling during the LJM transactions, it concludes that he was familiar with Fastow's antics, something Lay disputes. "Lay approved the arrangements under which Enron permitted Fastow to engage in related-party transactions with Enron," the report states. "He bears significant responsibility for those flawed decisions as well as for Enron's failure to implement sufficiently rigorous procedural controls to prevent the abuses that flowed from this inherent conflict of interest."

As for Skilling, who abruptly resigned as Enron's CEO in August, the investigation suggests he encouraged Fastow's actions, which is ironic given Skilling's image as a procedure fanatic.

"Skilling, who prides himself on the controls he put in place in many areas at Enron, bears substantial responsibility for the failure of the system of internal controls put in place to mitigate the risk inherent in the relationship between Enron and the LJM partnerships," the report notes. "Although Skilling denies it, if the account of other Enron employees is accurate, Skilling both approved a transaction that was designed to conceal substantial losses in Enron's merchant investments and withheld from the Board important information about that transaction."

All of this occurred as Skilling, Lay, Fastow and other insiders benefited from the sale of tens of thousands of shares of Enron common stock each month.

But the board also pointed a finger at itself: " T he Board of Directors failed, in our judgment, in its oversight duties. This had serious consequences for Enron, its employees and its shareholders." The report is especially critical of the audit and compliance committees, which should have been "more aggressive and vigilant" in their oversight. Winokur, a member of Enron's board and its finance committee during the period in question, did not participate in writing that portion of the investigative report.

Accounting for Outside Advice

While this latest report focuses primarily on how Enron crumbled from the inside, it also takes critical shots at outsiders: accountants, attorneys and consultants. It reserves its harshest critique for Arthur Andersen, the embattled accounting firm that served as Enron's auditor.

The report details financial transactions -- from partnerships to questionable accounting decisions -- that grossly misled investors. "We believe these transactions resulted in Enron reporting earnings from the third quarter of 2000 through the third quarter of 2001 that were almost $1 billion higher than should have been reported," the report states.

It concludes that Andersen could be linked to almost every misdeed. "In virtually all of the transactions, Enron's accounting treatment was determined with extensive participation and structuring advice from Andersen," the report notes. Andersen received $5.7 million for consulting work related to two partnerships, beyond standard auditing fees.

"The Board appears to have reasonably relied upon the professional judgment of Andersen concerning Enron's financial statements and the adequacy of controls for the related-party transactions," the report says. "Our review indicates that Andersen failed to meet its responsibilities in both respects."

Andersen issued a statement denying the allegations, claiming that the internal investigation's attempt to shift blame to outsiders is self-serving rhetoric.

The report is also critical of Enron's Houston law firm, Vinson & Elkins, for not bringing a "stronger, more objective and more critical voice to the disclosure process."

Inquiring Minds

It could take years to untangle the complex web once known as Enron. Congress will take another step in that direction this week as Skilling, Fastow and Kopper all trek to Capitol Hill to testify. A spokesperson for Skilling said he still plans to testify, is not seeking immunity and will not refuse to answer questions on Fifth Amendment grounds.

Fastow and Kopper have informed House Energy and Commerce Committee Chairman Bill Tauzin they will refuse to answer the committee's questions, asserting their Fifth Amendment rights, when called to testify Thursday.

To chronicle the events and what they mean to investors, I'll be writing the Enron Journal on RealMoney.com. Beginning Monday, I'll pen a series of shorter, more spontaneous missives as congressional hearings continue and other investigations search for the truth. Stay tuned. If you don't have a subscription to RealMoney.com, sign up for a free trial today.

This saga is only beginning to unfold.
Christopher S. Edmonds is president of Resource Dynamics, a private financial consulting firm based in Atlanta. At time of publication, neither Edmonds nor his firm held positions in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While Edmonds cannot provide investment advice or recommendations, he welcomes your feedback and invites you to send it to Chris Edmonds.

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