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

To: Baldur Fjvlnisson who wrote (3792)	4/2/2002 5:55:05 AM
From: Baldur Fjvlnisson	Read Replies (1) \| Respond to of 5185

D. The "Gatekeepers" These are but three examples of how Enron's derivatives dealings with outside parties resulted in material information not being reflected in market prices. There are others, many within JEDI alone. I have attempted to summarize this information for the Committee. Clearly it is important that investigators question the Enron employees who were directly involved in these transactions to get a sense of whether my summaries are complete. Moreover, a thorough inquiry into these dealings also should include the major financial market "gatekeepers" involved with Enron: accounting firms, banks, law firms, and credit rating agencies. Employees of these firms are likely to have knowledge of these transactions. Moreover, these firms have a responsibility to come forward with information relevant to these transactions. They benefit directly and indirectly from the existence of U.S. securities regulation, which in many instances both forces companies to use the services of gatekeepers and protects gatekeepers from liability. Recent cases against accounting firms - including Arthur Andersen - are eroding that protection, but the other gatekeepers remain well insulated. Gatekeepers are kept honest - at least in theory - by the threat of legal liability, which is virtually non-existent for some gatekeepers. The capital markets would be more efficient if companies were not required by law to use particular gatekeepers (which only gives those firms market power), and if gatekeepers were subject to a credible threat of liability for their involvement in fraudulent transactions. Congress should consider expanding the scope of securities fraud liability by making it clear that these gatekeepers will be liable for assisting companies in transactions designed to distort the economic reality of financial statements. With respect to Enron, all of these gatekeepers have questions to answer about the money they received, the quality of their work, and the extent of their conflicts of interest. It has been reported widely that Enron paid $52 million in 2000 to its audit firm, Arthur Andersen, the majority of which was for non-audit related consulting services, yet Arthur Andersen failed to spot many of Enron's losses. It also seems likely that at least one of the other "Big 5" accounting firms was involved at least one of Enron's special purpose entities. Enron also paid several hundred million dollars in fees to investment and commercial banks for work on various financial aspects of its business, including fees for derivatives transactions, and yet none of those firms pointed out to investors any of the derivatives problems at Enron. Instead, as late as October 2001 sixteen of seventeen the securities analysts covering Enron rated it a "strong buy" or "buy." Enron paid substantial fees to its outside law firm, which previously had employed Enron's general counsel, yet that firm failed to correct or disclose the problems related to derivatives and special purpose entities. Other law firms also may have been involved in these transactions; if so, they should be questioned, too. Finally, and perhaps most importantly, the three major credit rating agencies - Moody's, Standard & Poor's, and Fitch/IBCA - received substantial, but as yet undisclosed, fees from Enron. Yet just weeks prior to Enron's bankruptcy filing - after most of the negative news was out and Enron's stock was trading at just $3 per share - all three agencies still gave investment grade ratings to Enron's debt. The credit rating agencies in particular have benefited greatly from a web of legal rules that essentially require securities issuers to obtain ratings from them (and them only), and at the same time protect those agencies from outside competition and liability under the securities laws. They are at least partially to blame for the Enron mess. An investment-grade credit rating was necessary to make Enron's special purpose entities work, and Enron lived on the cusp of investment grade. During 2001, it was rated just above the lowest investment-grade rating by all three agencies: BBB+ by Standard & Poor's and Fitch IBCA, and Baa1 by Moody's. Just before Enron's bankruptcy, all three rating agencies lowered Enron's rating two notches, to the lowest investment grade rating. Enron noted in its most recent annual report that its "continued investment grade status is critical to the success of its wholesale business as well as its ability to maintain adequate liquidity." Many of Enron's debt obligations were triggered by a credit ratings downgrade; some of those obligations had been scheduled to mature December 2001. The importance of credit ratings at Enron and the timing of Enron's bankruptcy filing are not coincidences; the credit rating agencies have some explaining to do. Derivatives based on credit ratings - called "credit derivatives" - are a booming business and they raise serious systemic concerns. The rating agencies seem to know this. Even Moody's appears worried, and recently asked several securities firms for more detail about their dealings in these instruments. It is particularly chilling that not even Moody's - the most sophisticated of the three credit rating agencies - knows much about these derivatives deals.