Investigative Report
Who Cleared That Enron Exemption?
Posted Feb. 11, 2002
By John Berlau
Media Credit: KEVIN LAMARQUE/REUTERS
Portrayed by some as the white knight of the Enron scandal, Levitt instead may have contributed to the downfall of the energy giant.
Former Securities and Exchange Commission (SEC) chairman Arthur Levitt fast is emerging in the national media as the white knight of the Enron Corp. scandal. If only Congress hadn't stopped the proposed "reforms" of Levitt, who was appointed by President Bill Clinton in 1993 and served until early 2001, pundits have been saying, the Enron debacle might have been avoided. Now Levitt is making the rounds of TV talk shows such as ABC's This Week and PBS' Charlie Rose, and media liberals are nodding their heads sagely.
On Jan. 24, the day he was to testify before the Senate Governmental Affairs Committee, a Washington Post editorial praised the Senate for "starting off on the right foot by hearing from Arthur Levitt." The Post then lectured the senators to "listen carefully" to Levitt "and frame reform accordingly." For the most part, the senators took the Post's advice. Republicans and Democrats praised Levitt's public service and the proposal he pushed at the SEC to ban auditing firms from providing consulting services to the corporations they also audit.
No one asked Levitt about a New York Times story that appeared the day before, reporting matter of factly that the SEC had, on Levitt's watch, given Enron huge exemptions from securities laws intended to protect investors. In particular, an exemption in 1997 from the Investment Company Act of 1940 "cleared the path for the company to both expand overseas and make use of the special partnerships that have caused the company so much turmoil," the Times stated. These partnerships allowed Enron to hide hundreds of millions of dollars of debt.
Media outlets, including the Times itself, have not followed up on this story. TV journalists interviewing Levitt have not asked him how much he knew or why he should have credibility when his agency may have opened the door for Enron business practices that resulted in so many people losing their jobs and savings. The congressional committees do not appear to be looking into the actions of the Clinton-Levitt SEC, although a staffer for the Republican minority on the Senate Governmental Affairs Committee tells Insight that "it is possible" this will be one of the questions the committee sends to regulatory agencies that governed Enron.
Meanwhile, independent observers are asking why Republican lawmakers are not doing more to highlight the special breaks Enron received from Levitt, a major Democratic fund-raiser before Clinton named him SEC chairman, and from the Clinton administration, in which Levitt was a major figure. "The conflict [of interest] between consulting functions performed by accounting firms and auditing functions (which Levitt criticized) is a valid point, but that's really a general matter that applies to everyone," says former congressman Dan Frisa (R-N.Y.), now a columnist for Newsmax.com. "I'm not sure if that alone would have caused the Enron fiasco were it not for the SEC exemption. … For all of the talk about the Bush administration's vast contacts with Enron, I think most of what Enron got was during the Clinton administration and at the hands of Clinton appointees."
Paul Sperry, Washington bureau chief for WorldNetDaily.com, agrees that so far it looks like Enron got far more from the Clintons than from Bush. "Until the [Bush energy] task-force minutes are released, we won't know definitively how much favoritism they got out of the Bush administration. But there's no doubt that, in terms of palpable return on [Enron's] political campaign-donation investment to the Clinton campaigns, [former Enron chief] Ken Lay got a much better return out of the Clinton administration," says Sperry, a former deputy editor of Investor's Business Daily. "They had palpable results. So far there hasn't been anything palpable [out of the Bush administration]. Some are saying [Lay] helped write the energy policy, but that energy policy was never passed into law. Maybe they got people appointed to certain positions, [but] if there was all this cronyism going on with Bush, it just didn't pan out the way it did for Enron with Clinton."
And that exemption from Levitt's SEC is closely related to other help the Clinton administration gave Enron with its foreign projects, Insight has learned. Sperry reported on WorldNetDaily.com that Enron executives got seats on at least 11 overseas trade missions of the Clinton-era Commerce and Energy departments. Memos obtained by congressional committees, the public-interest law firm Judicial Watch and by Insight show that officials in the Clinton White House picked members of trade missions based on their contributions to the Democratic Party.
In January 1995, Lay was a guest of the late commerce secretary Ron Brown on a trade mission to India. During the mission the Export-Import Bank (Ex-Im) and the Overseas Private Investment Corp. (OPIC), two federal export-finance agencies stacked with Clinton appointees, announced they were lending $400 million to an Enron-led consortium to build an electric power plant in Dabhoi, India. Ironically the project became a factor in Enron's downfall, experts say, when there was a dispute with the Indian government about payment.
According to a 1997 story in Time magazine, Clinton took a personal interest in that Indian power plant, writing memos to his chief of staff, Thomas "Mack" McLarty, to monitor the agencies and push through the loans to Enron. McLarty later became a paid adviser to Enron.
After lobbying by the Clinton administration, the Indian government gave final approval to the Enron project in June 1996. Four days earlier, Enron had given $100,000 to the Democratic National Committee. Frank Wisner, Clinton's ambassador to India, helped push for the project and got a seat on the board of an Enron subsidiary when he stepped down in 1997.
Under Clinton, OPIC and Ex-Im loaned $1.7 billion to Enron for foreign projects in countries including the Philippines, Argentina, Colombia and Turkey that taxpayers now may have to bail out, according to Sperry. Karen Kerrigan, chairwoman of the Small Business Survival Committee, notes that the private sector probably never would fully have financed many of these risky projects. "American taxpayers … loaned the company loads of money to fund undertakings that private-sector investors probably would not touch," she states.
But Enron still had a problem: the Investment Company Act of 1940. The law bans companies from investing more than 40 percent of their assets in subsidiaries or partnerships in which the companies do not have a controlling interest unless they go through the same registration process as a mutual fund. Because Enron had only a minority interest in many of its foreign partnerships, it feared it could find itself subjected to the rigid provisions of the act. In 1996, when Congress was modernizing the Investment Company Act, Enron lobbied hard to get an exemption for its projects written into the law.
The Republican-controlled Congress, which Democratic partisans claim was corrupted by the company's campaign contributions, told Enron: No dice! "We didn't give it an awful lot of consideration because it just didn't seem to make any sense, and it didn't seem to be justified," recalls Frisa, who served on the House Commerce subcommittee on Telecommunications and Finance in 1995 and 1996. "We just passed on it and didn't include it."
But Enron didn't give up. It went to the Democrat-controlled SEC under Levitt to get the exemption the Republican-controlled Congress had refused. The company admitted in its application, a copy of which Insight obtained, that it was "aware of no direct precedent for the exemptive order requested in this application." Nevertheless, without mentioning directly the government loans it had received at the hands of the Clinton administration, Enron argued that to deny the exemption would go against government export policy. "National policies to encourage exportation of goods and services, as expressed in Ex-Im Bank rules and the Overseas Private Investment Corp. guidelines, indicate [an] intention to encourage foreign infrastructure activities of the type conducted by covered entities," Enron wrote. "It is in the public interest for the covered entities to be permitted to engage in these activities without unintended restrictions imposed by the act."
This certainly made it clear that Enron's effort was blessed by the White House. It worked, and the SEC gave Enron the relief it could not get from Congress, announcing on March 13, 1997: "It is ordered that the requested exemption from all [emphasis added] provisions of the act is hereby granted."
The SEC earlier had given Enron an exemption from the Depression-era Public Utility Holding Company Act in 1993, just after Levitt came onboard as chairman. Although that exemption has its critics, who say it allowed Enron to get into different types of businesses, many experts say the exemption was appropriate given the changes in the electricity market since the 1930s. But experts on the Investment Company Act say that while an exemption from some of the law's provisions on certain projects may have been justified, the unusual blanket nature of the 1997 exemption — for present and future projects — allowed Enron to escape accountability.
"I think it's one of the factors that might be considered in some of the concerns people have now about what really went on behind the scenes at Enron," says Joseph Del Raso, a partner in the Philadelphia law firm Pepper Hamilton, who worked at the SEC's Division of Investment Management in the 1980s. Del Raso, who also is coeditor of the Villanova Journal of Law and Investment Management, tells Insight that without the exemption the law would have made a number of things that led to Enron's demise more difficult to do. For instance:
Had Enron been covered by the law, its executives could not have invested in its partnerships, thereby eliminating potential conflicts with shareholders' interests. "If they were subjected to the act, then the officers and directors would not have been able to invest in the offshore partnerships, because under the act they would have been affiliated transactions," Del Raso says.
The law also has strict record-keeping requirements for the entities an investment company owns. This would have made it harder for Enron to put its overseas partnerships off the balance sheets and bury them in footnotes, according to Del Raso.
Del Raso says the law's strict accounting rules would have made it harder to hide debt through offshore partnerships. "Investment companies have to have what we call 'fair-value' accounting, and the board would have to determine what the real value is of illiquid investments," he says. "[With] a lot of these offshore partnerships, people are still trying to figure out what was worth what. [Under the law from which Enron arranged an exemption] the board would have had an obligation to make sure the management was properly valuing the investments."
Del Raso believes Enron used the exemption not just for the government-backed projects but also for offshore partnerships to hide debt (see "Buried Treasure," Feb. 11). Jeffrey Haas, a professor at New York Law School who specializes in securities law, agrees that the exemption was essential to Enron's schemes. Without the exemption, he says, "there's a possibility [more] disclosure would have been made, and it could have blown the whistle."
Another thing raising eyebrows about the special exemption for Enron is the connection between Barry Barbash, the regulator who, as head of the SEC's investment-management division in 1997, signed off on the agreement, and Joel Goldberg, the Enron lobbyist pushing it. Goldberg had been a boss of Barbash when both worked at the SEC in the 1980s. Now both are out of government and are partners at the Washington office of the law firm Shearman & Sterling. "It looks bad," Haas says, "but it doesn't necessarily imply that there's any wrongdoing."
In an interview with Insight, Barbash calls the suggestion that his relationship with Goldberg influenced the decision "totally without foundation." He says he had only one meeting with Goldberg during the process, and that Goldberg met mostly with his staff. Barbash says the exemption had nothing to do with many of the off-balance-sheet partnerships. He still believes the exemption was justified because Enron didn't present itself as a mutual fund or other type of investment company. "Enron projected itself as a company that had a business that wasn't like a mutual fund," Barbash says. "To emphasize that, when the SEC granted the order, we conditioned it [so that Enron] agreed that none of these subsidiaries will hold itself out as an investment company."
But Del Raso counters that the law doesn't just apply to mutual funds, and Enron's partnerships were just the type of abuses lawmakers in 1940 were trying to prevent. "In the public-utility business, they'd set up holding companies, and basically they would pyramid the investments so the insiders would continue to dilute the public shareholders with the way they would patch together all these underlying utility companies that the holding company owned," Barbash says. "Even though we're talking about something that may have happened 75 years ago, it may be not a lot different from the Enron situation now."
Levitt told the New York Times he had no recollection of Enron's exemption. "It may be one of those things that seemed insignificant at the time but can wind up being determinative," he said. He did not respond to Insight's request for further comment.
But Barbash, who Levitt brought out of private practice to head the investment-management division at the SEC in 1993, says he sent memos to Levitt and the commissioners about the proposed exemption, and that they were well-aware of the issue. "That exemptive order was probably one of the most well-vetted things in Washington of its day," Barbash tells Insight. "Everybody who mattered in the SEC knew of the order at the time." When asked if he ever discussed the exemption with Levitt, Barbash replies, "I don't have a clear recollection."
A securities lawyer with knowledge of the Enron exemption tells Insight that, because of Enron's status in the Clinton administration and his background as a Democratic fund-raiser, Levitt likely was involved in the decision. Levitt "was very tuned in to political developments," says the securities lawyer, who requested anonymity. As journalist Michael Lewis has noted, Levitt "landed his job at the SEC in part because he raised a lot of money on [Wall] Street for Bill Clinton."
Whatever former SEC chairman Levitt's role in Enron's exemption, some find it ironic that the Clinton-Levitt SEC repealed Reagan-era exemptions for small companies under the justification of preventing investor fraud (see "Recession Shock," Dec. 31, 2001), yet gave special breaks to this large, well-connected corporation that may have committed the biggest fraud in U.S. history. "Enron just caused more investor fraud than all the violations of penny stocks and small caps, rolled up, for probably the last two decades," says James Steinkirchner, cochairman of the National Small Public Company Leadership Council.
John Berlau is a writer for Insight.
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