Beyond Enron

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

Prior to its earnings restatement last November, Enron explained to CFO and anyone else who cared to inquire that the assets and liabilities of those subsidiaries — along with their costs — needn’t be consolidated, even if FASB went ahead with its proposal to eliminate the simple 51 percent of voting rights threshold, as the rulemakers periodically threatened to do. Without control, as currently defined, Enron was fully observing U.S. GAAP by accounting for such affiliates through the equity method.

But in the Form 8-K Enron filed to restate its results for 1997 through 2000, the company admitted that three of its affiliated partnerships should have been consolidated after all. The document itself doesn’t make clear why, though analysts suggest that it’s because the other investors in the partnerships might have been Enron employees. Enron’s auditor, Arthur Andersen LLP, contends that Enron did not make available to it a side agreement concerning one of the three partnerships, called Chewco, and that its disclosure would have required that Chewco be consolidated — as well as the other two, because they invested in each other. There, in any case, went $680 million, or 20 percent of Enron’s earnings during that four-year period.

Granted, Enron was absolutely correct in insisting that the restatement didn’t reflect any change in its fundamental financial condition. Yet the argument often advanced in cases of earnings management — that accounting tricks don’t fool investors so long as enough information is disclosed — doesn’t apply here, because Enron simply didn’t provide enough information. Analysts who normally ignore off-balance-sheet treatment of assets and liabilities by adding them back to the balance sheet found that difficult, if not impossible, to do with Enron.

Credit-rating firms are often in a position to demand more information. In fact, credit analysts such as John O’Connor of Duff & Phelps (now part of Fitch) told CFO in June 1999 that he was able to “look through” Enron’s accounting treatment of its unconsolidated affiliates. So, to some extent, did Ron Barone, his counterpart at Standard & Poor’s. As a result, Barone added back into Enron’s debt anywhere from $3 billion to $5 billion of what he understood its off-balance-sheet liabilities to be. But, to say the least, the numbers alone did not tell the whole story. And Enron’s footnote disclosures weren’t nearly enough for other analysts. Even today, Enron’s financial condition “is all Greek to us,” says Carol Levenson, a Chicago-based credit analyst for Gimme Credit research service.

As a result of the fiasco, Fitch, Moody’s, and S&P have all announced that, going forward, they will look more closely at credit “triggers” embedded in equity-backed, off-balance-sheet notes.

What about Enron’s auditor? Andersen CEO Joe Berardino testified before Congress in mid-December that Enron failed to make available critical information while Andersen employees were examining its results for 1997. In January, however, Andersen conceded it had destroyed some information concerning the case. As for Enron’s audit committee, it included Wendy Gramm, who was widely considered a lax regulator when she served as head of the Commodity Futures Trading Commission in the early 1990s. She is also married to Texas Senator Phil Gramm, another regulatory minimalist.

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