Exemption Won in 1997 Set Stage for Enron Woes
The New York Times
January 23, 2002
By STEPHEN LABATON
WASHINGTON, Jan. 22 — As
it expanded aggressively
overseas in the 1990's, the Enron
Corporation won an
exemption from a Depression-era
law that would have prevented its
foreign operations from shifting
debt off their books and that
barred executives from investing
in partnerships affiliated with the
company.
The exemption enabled Enron's
foreign operations to engage in
the kind of financial engineering
that experts now say was
reminiscent of some of the
corporate excesses of the 1920's
that led to the 1940 law and that
were an important element of the
company's meteoric rise and
startling collapse.
Had Enron not been granted the
exemption, some of its operations
in South America and in Europe
would not have been able to
structure financial operations to
both conceal them from investors
and shift debt off their books.
Enron's initial efforts in 1996 to
persuade Congress to change the
law were thwarted by opposition
from a powerful trade group and
some federal regulators. The
company responded by hiring the
former boss of a leading staff
official at the Securities and
Exchange Commission to
represent it in negotiations with
the agency. In an unheralded
five-paragraph order in March
1997, the S.E.C. official, Barry P.
Barbash, gave Enron's foreign
operations a broad exemption
from the law — the Investment
Company Act of 1940.
How Enron came to get its
exemption from the severe
restrictions of the law clearly
illustrates the ways the company lobbied Washington and
the response by the regulatory system. That system was
devised during the Depression to protect investors and
customers of utilities from a wide range of corporate
abuses that investigators think ultimately took place at
Enron.
Both Congress and the S.E.C. are reviewing the
exemption to the Investment Company Act and earlier
exemptions that were given to the company by the
agency, including a 1993 exemption from the tough
restrictions imposed by the Public Utility Holding
Company Act of 1935.
Experts say that the S.E.C. rulings unshackled the
company from significant accounting restraints and
business dealings between the Enron companies and
their executives. The 1997 exemption, in particular,
cleared the path for the company to both expand overseas
and make greater use of the special partnerships that
have caused the company so much turmoil.
"From a regulatory standpoint, this raises a flag," said
Joseph V. Del Raso, a former official at the S.E.C. in the
1980's and an expert on the Investment Company Act. "It
gave them carte blanche to go all over the world and set
up subsidiaries and affiliated entities that would have
been prohibited under the act."
Another expert on the act, Mark A. Sargent, the dean of
the Villanova law school, agreed.
"The Enron structure was not a single company with
stockholders engaged in operations like an ordinary
corporation," he said. "It was similar to an investment
company with investments in a bunch of different
companies. The decision to exempt those from the kind of
protections to investors is now coming home to roost."
Arthur Levitt, who was the chairman of the S.E.C. when
the 1997 exemption was granted, said today that he had
no recollection of it. But he said it could be a potentially
significant part of the agency's role in failing to oversee
Enron.
"It may be one of those cases of the nail in the shoe of the
horse," he said. "It may be one of those things that
seemed insignificant at the time but can wind up being
determinative."
Mr. Barbash, the lawyer at the S.E.C. who approved the
exemption, said in an interview this week that he viewed
the exemption as narrow because it applied only to the
foreign operations of Enron and some of its subsidiaries.
He said that it was successful in that it managed to head
off Enron's efforts to have a broadly worded exemption
written into the law "that companies could have then
driven trucks through."
"Enron knew the regulatory boxes, and they tried to
fashion their businesses to fall outside of those boxes,"
Mr. Barbash said. "Much of what's been written so far
about the company is that it turned itself inside out like a
pretzel to fall outside of restrictions — accounting
restrictions, taxpayer restrictions and regulatory
restrictions."
Another former S.E.C. official who is an authority on the
Investment Company Act, was more critical.
"This was a case of giving Enron an inch and they took
miles," said the former official, who spoke on the condition
of anonymity. "They were given a significant new
opportunity, and they took it and flew it smasho into the
ground."
Mark Palmer, an Enron spokesman, did not return a call
seeking comment.
Mr. Barbash, who at the time was director of the
investment management division at the S.E.C., said that
Enron's lawyers came to him in 1996 after the company
had failed to persuade Congress to grant the company
broad exemption to the 1940 law.
Enron and several of its subsidiaries said they needed the
exemption because their foreign operations were quickly
taking on the characteristics of investment companies.
The act, which regulates mutual funds and other kinds of
investment companies, generally applies to companies
that hold at least 40 percent of their assets in securities
that are passive investments and not controlling interests.
A lawyer who represented Enron said that although the
company and its foreign subsidiaries had actually
controlled many of their overseas ventures, like power
plants, they were unable to have a 51 percent stake in
them because of local rules and political constraints.
In 1996, Congress rewrote parts of the act but refused to
grant an exemption to Enron because of significant
opposition from both the S.E.C. and the Investment
Company Institute, the main trade organization for the
mutual fund industry and a strong supporter of the law.
Mr. Barbash said that in 1996, Congressional aides
advised Enron's lawyers to seek an exemption directly
from the agency.
The company decided to retain Joel H. Goldberg, a former
director of the investment management division at the
S.E.C., who said today that he did not know how the
company came to hire him.
An Enron official said the company had retained Mr.
Goldberg knowing that he had previously been Mr.
Barbash's boss and was his predecessor at the S.E.C. Mr.
Goldberg had been Mr. Barbash's supervisor at the S.E.C.
in the 1980's and the Labor Department in the 1970's.
The two lawyers are now partners at the international law
firm of Shearman & Sterling.
Mr. Goldberg said he viewed the exemption as a narrowly
tailored one intended to permit the company to continue
its overseas projects. But he acknowledged that had the
company not been granted the exemption, it would have
been constrained from using any partnerships or shifting
debt off the books in its foreign operations.
"I guess on the one hand, if they had been subject to the
Investment Company Act, they probably could not have
done these transactions," he said. "The subsidiaries would
not have existed, and they would have had to make
another plan."
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