The Findings Against Enron
The New York Times
September 23, 2002
By KURT EICHENWALD
With its preliminary findings that Enron violated public disclosure rules in its dealings
with banks, a bankruptcy examiner's report
highlights numerous avenues for criminal investigators seeking
to bring a case that the company's deluge of deals with off-the-books
partnerships involved potential fraud.
Throughout the report filed on Friday, the court-appointed examiner
in the Enron case, Neal Batson, is careful to caution that his conclusions
could change as he continues his investigation. But based on the report,
there can be little dispute that some executives at Enron worked to
disguise the company's true condition in filings with the Securities and
Exchange Commission through complex financing deals involving the
partnerships and banks.
All told, the report concluded, the transactions studied by the examiner
provided Enron with almost $1.4 billion in cash from 1997 to 2001.
This huge influx of money - all reported as revenue from operations
or investing - originated as loans from the banks to partnerships set up
by Enron. The partnerships then used the money to purportedly buy
assets from the company, which, the report concluded, otherwise would
have been difficult to sell.
But these were sales in name only. Through a complex financial
arrangement known as a total return swap, Enron retained all rights to any
profits produced by the asset that was purportedly sold, and also
assumed responsibility for paying the banks cash that equaled the total
amount loaned to the partnership, plus a fixed interest rate. It would be
as if an individual claimed to have sold his own house while
remaining responsible for the mortgage, retaining the profit from
any increase in value in a future sale, and continuing to live in the place to
boot.
What will be of interest to criminal investigators, however, is how often
participants in the transactions failed to take actions that would be
required if the deals were true sales. For example, to obtain approval from
accountants that such a transaction can be treated as a sale, Enron
would have had to obtain two written findings from its lawyers, known
as a true sale opinion and a nonconsolidation opinion.
According to a footnote in the report, however, Enron did not consistently
obtain such opinions before entering into the transactions.
Moreover, banks did not always demand to see evidence that the deal
could be treated as a sale; instead, as they would with a loan, they
simply relied upon the creditworthiness of Enron to back the
deal - something that would be necessary for a loan but irrelevant in an
unrelated sale. The poor value of the assets in the partnerships that were
purportedly receiving the loan would have dictated a far higher
interest rate than was given in the transaction, the report says - another sign
that the true recipient of the loan was Enron.
Such distinctions obviously involve arcane areas of finance that are little
understood by investors. And indeed, the report says, Enron's
disclosures of the transactions - which at times brought in as much
as a third of its profits before taxes and interest - were virtually
nonexistent, and only had the potential of being understood by
investors with deep knowledge of advanced accounting. Ultimately, the report
concludes, the disclosures were in violation of generally accepted
accounting principles.
These types of facts are important, because of the challenges facing
criminal investigators in bringing an accounting fraud case against Enron.
Most of the transactions that have raised widespread criticism in Congress
and among regulators were approved by both Arthur Andersen,
Enron's auditors, and by outside lawyers. Because fraud cases require
proof the defendant intended to commit a crime, such approval creates
what is known as a reliance defense. In other words, the defendant could
not have meant to commit a crime, because professionals said the
transaction was appropriate.
That is why a potential Enron accounting case is so difficult, and why
the investigation has split into two distinct areas. In the first, Enron is
the victim, with the partnerships used by executives - including Michael J. Kopper,
who recently pleaded guilty to felonies - to steal money
that rightfully belonged to the company. That investigation, involving
partnerships with names like Southampton and Chewco, has been
active, with numerous witnesses reporting to have been contacted recently
by investigators. Lawyers in the case anticipate that Andrew S.
Fastow, Enron's former chief financial officer who was identified by Mr. Kopper
as a co-conspirator, will be indicted soon.
The second area of investigation involves Enron as culprit, misrepresenting its
financial performance to investors through its dealings with the
partnerships. It is there that the reliance defense comes into play, making
any criminal case where accountants were fully informed far more
difficult.
According to people who have spoken to government investigators, prosecutors
in the Enron case recognize the complexity presented by the
reliance on accountants and lawyers, but nevertheless are actively exploring
bringing accounting fraud charges. In such a case, the
government could potentially argue that the accountants and lawyers were
so compromised by Enron's money and pressure that their
opinions were meaningless. Moreover, while each individual transaction may
have had approval, the total result was deceptive - a fact that
could only have been fully understood by the executives at
the highest reaches of Enron.
This is where Mr. Batson's report provides possible signals for the criminal case.
With evidence scattered throughout the report that
accountants, executives and bankers failed to take actions that they
otherwise would have for transactions that were actual sales, the deals
provide certain levels of proof that participants may have been acting
with a wink and a nod when providing loans disguised as sales. In
essence, the credibility of the accountants, lawyers and bankers
could be challenged by their failure to obtain certain necessary
documentation or to price loans at an appropriate rate.
There are strong reasons for the government to crack down on the
types of financial finagling that took place at Enron. Ultimately, by using
legitimate rules to disguise the true nature of its finances, the company
undermined the disclosure rules that lie at the foundation of the
American capital markets. By engaging in transaction after transaction
that pushed close to - and in some cases over - the literal
requirements of the accounting rules, Enron was able to create an image
in its financial disclosures of a company that simply did not exist.
nytimes.com
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