Posted on 01/11/2002 7:45:03 PM PST by ken5050
There are two distinct aspects to the Enron mess; the political mudslinging, and the criminal fraud aspects of the case as pertains to the company and its auditors, Arthur Anderson. Oddly, in all the verbiage that has been written to date, very little has been written that begins to explain the TRUE nature of the financial fraud at Enron. More oddly, it is not that difficult to understand. For those who would like some insight, I will attempt to clarify, in lay terms, three points which, I believe, will ultimately be crucial as the investigations commence. So, if you'd like to learn, and understand a few things, read on.....
And, as in all financial transactions, it's about leverage, which can be powerful on the way up, and destructive on the way down....and it is no different from an individual who overextends himself on credit cards...
Here's how it worked. Enron needed money, lots of money, for its energy trading businesses. To borrow money in the capital markets, you have to put up some equity, anywhere from 2% to 20%, depending on the transaction. It's no different than when you're buying a house. You may need 5%, 10%, or 30% of the purchase price for a down payment.
Now, Enron had two things it could put up as equity in these partnerships...its stock, which was fine as long as the stock price stayed level or kept rising, and other assets. And here's where the fraud came in. Let's say that Enron owned a pipeline, or a plant, or anything, and let's say that Enron had paid $10 million for it years ago. Enron decided, presto, like magic, that the plant, or pipeline, or whatever, is now worth $110 million. So it assign the plant to the partnership at a value of $110 million, which then allows the partnership to go out and borrow, say ONE BILLION dollars more from various banks. The game's afoot. But what Enron now did was far worse. It booked the gain on the transfer of the asset to the SPE, the difference between the "cost" basis of $10 million and the "sale" price of $110 million, as $100 millon of PROFIT. Indeed, as much as 40-50% of Enron's "profits" over the last 5 years may be fictional, er, fraudulent of this type, and Enron is restating those earnings now.
Look, it's as if you bought a house for $10,000, sold it "on paper" to your second cousin for $110,000, and then he asked a bank to loan him $100,000 based on the resale price. The bank would get an appraisal to determine the true value of the house ( well, except if you're Andy Cuomo and you're running HUD..)and the jig would be up. Well, it's the auditors job to determine that transactions, especially sales and transfers among related entities, are legitimate transactions and are done at fair market valuations. It's a basic audit function, easy to do, and there is absolutely no excuse for Anderson blowing it, not picking it up. That's why Anderson is finished. They can't explain this one away, no matter how hard they try.
The pattern and practice of artificially inflated prices, and thus inflated profits, appears to have gone on for several years.
2. The inability of Enron employees to sell the stock n their 401k while top executives made billons selling stock options......This one takes a little unravelling, and is being used to portray the tremendous financial hardships some Enron employees are suffering. So, first, a little free-market philosophy, then, some key technical knowledge.
There's no guarantee in the markets. Enron lost 95% of it's market value, but so has Lucent. Where's the bleating for the Lucent employees?. Lucent spent millions on a golf course for its top officers, for example.
Stock options are non qualified employee compensation, that is they are not governed by ERISA, and are given mainly to top managers. The 401k plan is a qualified employer sponsored pension plan, and as such, has to conform to certain minimal standards. Employees must be given a choice of investment options, the ability to reallocate their existing funds, and to change future inverstment allocation, as well as basic financial and investment information. A companycan either choose to self - administer its own plan, or to contract out to a TPAS ( third party administrator) the financial, accounting, and regulatory and reporting requirements for the plan, which are considerable because of all the existing federal regulations. Most companies choose to hire outside TPA's for their expertise. Companies will competitively bid for the business. It is a huge market, with many players.
FYI, under present standards, all a company is required to do is offer FOUR investment choices, ususally a stock fund, bond fund, money market fund, and a fixed account. Employeer must be allowed to move thier existing funds,a s well as change future allocations..only once a year. And, they must be provided with basic plan and investment knowledge, either through seminars, or written reports, or computer programs.
Obviously, Enron's plan far exceeded those minimum requirements. The employees were happy, both in their investment options, and in the performance of Enron's stock.Now here's where it gets interesting...
Last fall, as Enron's stock price was collapsing, and the top people were selling hundreds of millions in Enron stock, most Enron employees were unable to sell their shares held in the 401k plan for several months, becuase all assets were "frozen" while the plan changed administrators. In itself, this is not unusual..it happens all the time. Before the new administrator accepts responsibility, it has to reveiw the books, so to speak, to reconcile all the accounts, and each employee's accout balances. It can take from one to three months to complete.
Look, consider that you decide to sell you house. You put a FOR SALE sign outside, 5 minutes later, a person drives by and agrees to your price, and gives you a check for a deposit. he wants to move in as fast as possible. Even so, it may take two months until you can close..there are little details like a property inspection, title search, mortgage approval, etc.....It takes time. Changing 40lk plan administrators is a thousand times more complicated. OK, so far, bad luck, lousy timing, for Enron's employees, but no foul, right? Well...
Now, stay with me, becuase what follows is pure speculation on my part, but I believe, highly credible. Why, with everything going on with Enron at the time ( and the top people knew then that the company was already in big trouble, would Enron executives decide to start mucking about with the pension plan. Well, if they knew that it would have the effect of "freezing" the plan for several months, thus prohibiting Enron employees from dumping the stock, (and the employees held a lot of the stock in the plan), that might help to stabilize the stock price, let alone avoid the embarrasing disclosure of Enron employees deserting the stock en masse.
Look for the obvious. If the roof of your house is leaking badly, you don't decide to paint the inside first.The top Enron people had been cooking the books for years, this was just another easy way to try and prop up the stock. And it should be easy to prove, there has to be records, memos, as to when the initial discussions were held regarding the plan changes. You normally don't decide to do this overnight..you'll interview several TPA's, receive bids and presentations......the time line should be easily established. I may be wrong on this, but a little bird tells me I'm not...we shall see...
3. The auditor's ( Arthur Anderson) decision to start destroying workpapers and other data...
Anderson is finished as a firm, no one is yet publicly saying so. The problem with this cover up will be that AA will NOT be able to demonstrate that it followed the same procedures, and timelines, in destroying data for its other clients...If it didn't, it's prima facie destruction of evidence, with criminal penalties. If it acts the same with all its other clients, and tries to maintain the fiction that this is it's normal pattern and practice of maintaining and safe-keeping client files and records, then you'll soon see every major client heading out the door. If you heard that your pediatrician was suspected of child abuse, would you take your kid back for the next check-up? I think not.
BTW, I think this will end with Enron pushed to dissolution, forced into a chapter 7 filing.....the company wil NOT come out of bankruptcy. Why shoiuld it survive? There's nothig left. Several of the top people will receive lenghty prison sentences, and there will be disgorgement of hundreds of millions of profits from stock sales by these folks, in an attempt to mitigiate jail time. Anderson will dissolve in a bankruptcy filing also, after being sued by everyone. The partners will lose everything, plus, and over half of them will never work for a major accounting firm again.
I hope those of you intereested in the Enron matter find this discussion of interest. I tried to be as brief and as non-technical as possible, I trust I was successful. if you have any questions, I'll be pleased to respond to them over the weekend. Regards...
BTW, I trust that Front Page is OK for this..I was trying to make it as accessible as possible....
I don't think that's speculation, but a no-brainer. Crooks, whether in tattered Levi's or $2000 suits, are dumb and always leave a trail.
This is the kind of stuff that Whitewater was about and the folks a certain current US Senator was hooked up with were up to the same thing.
I have to think Senator Gramm's retirement is tied to all this. I bet Wendy has already received her supoena.
Then you go ahead and do it. Go ahead!
Your neighbor down the street, the junior senatrix, may well have served as an expert advisor to Enron management concerning this practice.
Disclaimer: Opinions posted on Free Republic are those of the individual posters and do not necessarily represent the opinion of Free Republic or its management. All materials posted herein are protected by copyright law and the exemption for fair use of copyrighted works.