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Non-Tech : The ENRON Scandal -- Ignore unavailable to you. Want to Upgrade?

To: Mephisto who wrote (3780)	4/1/2002 7:58:42 PM
From: Mephisto	Respond to of 5185

Boards first line of defence against off-book abuses globeandmail.ca By JANET MCFARLAND Saturday, March 30, 2002 - Print Edition, Page B6 Thanks to Enron's collapse, the words "off-balance-sheet debt" have become synonymous with "elaborate accounting fraud" in the minds of most investors. Enron's off-balance-sheet debt was a key factor in the largest corporate failure in U.S. history, so there is no surprise that the accounting structure is now viewed with suspicion. By the time it failed in early December, Enron had shifted billions of dollars of debt off its books. A recent review by a special committee of Enron's board concluded the company reported almost $1-billion (U.S.) too much in earnings in the 12 months between the third quarter of 2000 and the third quarter of 2001. That's because it used special-purpose entities (SPEs) to hide losses. As a result of Enron's abuse of SPEs, U.S. and Canadian regulators have recently announced plans to bring in tougher rules for these commonly used accounting vehicles. The challenge now is how to make changes that are meaningful and difficult to evade, without putting an end to a valuable accounting tool. Because as heretical as it sounds in an Enron-obsessed age, off-balance-sheet debt is not just a tool of evil. In a recent presentation at a conference on Enron, Irene Wiecek, a finance professor from the Rotman School of Management at the University of Toronto, said SPEs are supposed to be separate, outside entities with outside minority investors and their own management. She said they are widely used, because they allow companies to put assets into a separate company to raise cash and let other people share their ownership -- and risk. SPEs are formed to sell a stake in a wide array of assets, even accounts receivable. SPEs are especially used by banks and financial institutions to securitize loans or pool ownership in other financial vehicles. But wrong uses of SPEs abound. Companies abuse SPEs to simply get debt off the balance sheet, to hide losses, to hide risk, or to manipulate financial statements. Enron's Chewco division illustrates everything an SPE was never intended to be. Chewco was created in 1997 to -- of all things -- invest in another Enron SPE, called Jedi. Chewco had to have an outside investor, but Enron couldn't quickly find a minority partner. So an Enron employee, Michael Kopper, became the investor and managing partner of Chewco. He ended up earning more than $10-million for his trouble. Enron's former chief financial officer, Andrew Fastow, made at least $30-million from heading and partly owning two other SPEs, which did dozens of transactions to absorb money-losing assets, allowing Enron to book gains on these sales. Ms. Wiecek said accountants have to look beyond a company's legal boundaries to decide whether its SPEs are part of its broader economic entity. If they are not truly independent, the debt must be included on its balance sheet. "The question to ask is, do they have control of the assets and are they exposed to the risk?" she said. She adds that a red flag should be raised when a company is creating an SPE to achieve an accounting objective, rather than a business or economic objective. "Are you trying to create economic value of just trying to hide something?" This question is at the centre of new rules being developed in the United States by the Financial Accounting Standards Board. It says it will publish new SPE rules for public comment by the end of April. The standards board will require SPEs to have at least a 10-per-cent outside investment by other partners, up from 3 per cent currently. (Canada already has a 10-per-cent limit.) And even if they exceed the 10-per-cent limit for outside ownership, SPEs will also have to meet a new test of true independence. Companies will have to ensure that risk has been transferred to the new company and does not revert to the parent. And, unlike Enron, the parent company cannot guarantee returns to investors in an SPE. David Smith, president of the Canadian Institute of Chartered Accountants, said this week that the standards board will introduce new SPE rules for Canada in August. The institute hasn't revealed the rules yet, but it will likely follow the U.S. lead in requiring substantive independence beyond a simple ownership test. Such an open rule is necessary, but it will also end up being endlessly debated. Companies will surely compose elaborate justifications for a suspect SPE, arguing it is technically at arm's length, and is being created for a valid economic purpose. Prior to its collapse, Enron did just this. This means that as much as accountants and regulators will supervise, the first line of defence will be corporate directors who are asked to approve SPEs. They are in the best position to carefully review whether an SPE is really independent, or is little more than a contrived subsidiary. With the investment community rightly nervous about the risks of off-balance-sheet debt, boards have a strong incentive to become the vigilant arbiters of accounting vehicles to ensure there are no Enron-like risks lurking off the books. jmcfarland@globeandmail.ca globeandmail.ca