Gathered some info on those "SPV's"....
and don't you think the last sentence of the article is a master of understatement?
>>>>>>>> "Something is wrong with the rules," he said <<<<<<<<<<<<<<
chron.com
Pop up of Special Purpose Vehicles
chron.com
How SPV's worked
HoustonChronicle.com -- houstonchronicle.com | Section: Business
Jan. 28, 2002, 6:31AM
Special-purpose vehicles used to control market, credit rating
By DAN FELDSTEIN
Copyright 2002 Houston Chronicle
As accountants, stockbrokers and others study Enron's collapse, they focus on the company's now-infamous "special-purpose vehicles" -- independent companies that propped up Enron's income and hid its debt.
They want to know whether the vehicles' goosing of Enron's financial statements was a side effect or their sole purpose.
One good clue is the list.
In the last year at Enron Global Finance group, managers were sometimes handed a list of Enron assets and instructed to go out and sell some to the vehicles, said an employee with direct knowledge of the procedure.
"Knowing what I do now, I know that was used directly to manipulate the (stock) market," the employee said.
A manager would pick something, from a plant to stock to a piece of a start-up company. Then he would walk the deal through a team of internal lawyers and auditors.
The bigger the "sale," the bigger his bonus.
What actually happened was that a bank or other investor lent money to the newly created company to finance the purchase. The new company, in turn, paid the money to Enron.
Why didn't Enron just get a loan itself without going through a middleman? Because the loan now belonged to the new company, not Enron, and thus didn't count as a debt on Enron's financial statement.
Instead, it counted as income to Enron when the new company passed on the proceeds.
Less debt and more income do wonders for a quarterly report. The procedure assured Enron would keep its high credit rating, saving big bucks, and would keep the stock price up.
After a while, the employee said, employees joked that there would be no assets left to deal.
"Every associate on up knew. We used to joke about, `I want this thing to stand up until I get my money and go,' " he said.
Two former Enron employees who worked on the special-purpose vehicles spoke at length to the Chronicle about what they did for a living. One met with a reporter in the offices of a Rice University accounting professor.
The employees, graduates of top schools, spoke on the condition that they not be identified.
Both said there were many uses for the vehicles that they considered legitimate, such as bringing in outside partners to share the risks of a particular venture. But there was little question, especially toward the end in the finance group, that many had no real "business purpose" other than improving financial appearances.
"They are created merely to make the income statement look better. An average person would say there's something wrong," said Michael Granof, a University of Texas accounting professor.
The employee with direct knowledge of the process didn't disagree. It's just sort of what they did, he said, and he never realized the extent of the company's debt.
The anatomy of the deal was simple, he said.
Say the asset was 100 shares of IBM stock. Enron would divide each share into two parts, one called a "control interest" and one called an "economic interest." Then it would sell the economic interest to a newly created special-purpose vehicle.
The asset was rarely as simple as 100 shares of another company's stock. So Enron had to put a value on it. Because there wasn't really an outside buyer, it decided the price itself and had that number blessed by its auditor, Arthur Andersen.
The deal was placed with a bank, insurance company or other major lender, which put up 97 percent of the money. Sometimes the promise of Enron stock would be put up to guarantee the loan, as a sort of collateral, although Enron stockholders were never told of the risk that their shares could be diluted if such new shares had to be issued, the employee said.
To qualify as "independent" from Enron for accounting purposes, an SPV had to be owned by someone else. So an outside entity would be brought in to make the required investment, which was just 3 percent of the SPV's total start-up cash.
In some cases, Enron is alleged to have lent that money to the outside equity partners, though the employee said he had no direct knowledge of that.
Enron no longer owned the economic interest in the asset, but it did own control over it. In the sales contract with the vehicle, Enron promised always to act in the interest of the SPV. Lawyers and auditors said all this was OK.
As the asset made money for the SPV -- if it did, and many didn't -- it made principal and interest payments to the lender and issued dividends to the outside equity partners, just like in a normal company.
So what was left for Enron? Unlike a normal company, the yield to the equity partners was capped. If the partner's yield cap was 15 percent and the asset made 20 percent, Enron got 5 percent.
Most important, Enron got to report the proceeds of the sale of the asset as earnings. It had to repay the loan, of course, but the debt didn't show up on Enron's financial statements.
A basic question is why Enron didn't just sell the assets normally to raise money. The answer is control, the employee said. If the asset were a plant, perhaps Enron would give itself the operating and maintenance contract. If it were private shares of another company, maybe Enron was technically forbidden to sell, or it could make another deal later.
By keeping its visible debt low, Enron retained a higher credit rating and thus paid a lower interest rate on money it borrowed and money borrowed by the SPVs, the employee said.
When Enron was forced to restate its earnings last year to include some of that debt, and as debt from other sources also surfaced, Moody's Investor Services downgraded Enron's bond rating. With a trading company such as Enron, where the ability to borrow vast sums at favorable interest rates is key, that was fatal. Bankruptcy quickly followed.
Such accounting practices were a factor in the company's fall, but the real problem was that many of Enron's recent major investments -- broadband and water divisions, New Power and an Indian power plant -- did not work out, said the employee and Rice University accounting professor Bala Dharan, who also questioned the employee.
"Investors don't like to hear you say, `Oh, I was wrong.' So you start having a yard sale to boost CFO (cash flow from operations) and net income," the employee said.
The second employee said many SPVs were easier to justify. Sometimes they were created to bring two other parties together, with Enron merely providing the expertise. Both said investors were happy to get involved in the deals.
But in recent years, the first employee said, their use became more questionable.
"Is any of that illegal? No, but it's shady. The investor couldn't truly know what Enron owned or what Enron owed. People don't pay attention to the footnotes," he said.
And the footnotes in Enron's required financial statements also weren't much help. Granof, an author of accounting textbooks with an MBA and doctorate, said he found them "unintelligible."
"That was conscious. No two ways about it," the employee responded.
Granof said he still couldn't quite understand why SPVs are considered legitimate. While expressing disappointment with Andersen for "deceiving" investors while meeting the letter of the law, he said, "there but for the grace of God go four other major accounting firms" of the Big Five that could have been similarly ensnared in the Enron fiasco.
"Something is wrong with the rules," he said. |
