Beyond Enron

The fate of Andrew Fastow and company casts a harsh light on off-balance-sheet financing.

Asset monetization, off-balance-sheet financing, financial engineering, call it what you will.

When all is said and done, accounting wizardry of this ilk amounts to hiding information from investors. But as Abraham Lincoln knew, you can’t fool all of the people all of the time — not even if you’re a company as lionized as Enron Corp. was. And when it was revealed last October that Enron was responsible for the debt of partnerships managed by its soon-to-be-cashiered CFO, Andrew S. Fastow, investors swiftly punished the company for its deceit, ultimately sending the nation’s seventh-largest company into bankruptcy.

Other companies have flagrantly violated accounting standards to meet Wall Street’s expectations. Sunbeam, Waste Management, and Cendant notably engaged in clear-cut fraud. But none of those companies ceased to be a going concern when their shenanigans came to light. Then again, Enron wasn’t simply managing earnings. The energy giant was seeking to hide from investors billions of dollars of debt, and that is about as fundamental to a company’s financial condition as anything can be.

By now it’s well known that Enron incurred that debt because it needed capital to realize the vision of its famously farsighted leaders — first Kenneth L. Lay, then Jeffrey K. Skilling. And it succeeded, morphing practically overnight from an old-fashioned pipeline operator to an asset-light energy trader. By the end, 90 percent of Enron’s revenues flowed from its energy-trading business — not just in traditional commodities such as oil, gas, coal, and electricity, but also in newfangled markets such as bandwidth and pollution-emission credits.

By now it’s also well known how swiftly Lay and Skilling’s vision evaporated, starting last fall with a flood of bad news: huge write-downs for failed investments in the telecom and water businesses, a reduction of shareholder equity by $1.2 billion, a restatement of earnings for the past five years, a crippling downgrade from the rating agencies. Fastow’s involvement in the limited partnerships came to light, and Enron’s off-balance-sheet chickens came home to roost.

Today, investigators are still trying to ascertain exactly what was going on in Fastow’s financial black box. But the market isn’t waiting for Congress to close up regulatory loopholes, or for the Securities and Exchange Commission to revise its disclosure requirements, or for the Financial Accounting Standards Board to reconsider its rules on consolidations and equity-based transactions. No, the market is punishing the stock of other companies that have lots of off-balance-sheet debt and even a whiff of tricky accounting. “Anybody that is seen to be playing games” is likely to be penalized by investors, says David Tice, a Dallas-based investment manager and short-seller who derisively calls Enron “a hedge fund in drag.”

The bottom line: Enron-bitten investors are in no mood to indulge companies that engage in complicated financial engineering — at least for now.

Back on the Balance Sheet

A growing number of companies that have apparently gone nowhere near as far as Enron did with off-balance-sheet activities are now reeling those activities in, or fending off calls to do so. One, El Paso Corp., a Houston company that owns the country’s largest gas pipeline, has even seen fit to consolidate $2 billion in off-balance-sheet financings in the wake of the Enron debacle. As El Paso explained in a press release accompanying the announcement, “It has become clear in the last month that the market now expects energy companies to maintain lower leverage and more simplified balance sheets.”


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