- Congressional probers are now examining whether the
used complex but legal securities to mask the true size of its debt
- In recent weeks, the scandal enveloping Enron has been
focused on a flock of independent limited partnerships that the company
apparently used to conceal billions of dollars in debt from investors and
analysts. But the alleged sleight-of-hand may not have ended there. A
of Enron's finances shows it was using other complex financial instruments
-- this time with its own subsidiaries -- that understated between $1.5
billion and $3 billion in additional debt. The difference: These
were on its balance sheet.
- The complex securities, which masked as much as 20% of
the Enron's liabilities, are perfectly legal, tax and accounting experts
say. However, congressional committees are now reviewing whether the
were used to mislead investors. And Hill Democrats are considering
that would prohibit their future use, BusinessWeek Online has learned.
An Enron spokesperson was not immediately available to comment on this
- EXPENSIVE LOANS
- Though it was legal, the arrangement may have shielded
from investors the true extent of the energy giant's outstanding debt.
And because credit-rating agencies treated the obligations as equity, the
scheme made it easier for the company to retain a strong credit rating
and, thus, raise additional funds -- even though it was already deeply
- "There was no reason to do this transaction other
than to avoid taxes and keep the debt off the balance sheet," asserts
one congressional tax expert, who added that no company would have done
such transactions if it were just looking to borrow money.
- Indeed, the securities did not come cheap. Wall Street
firms charged 1% to 1.2% to structure the deals, far more than what a
such as Enron would have paid simply to borrow the funds. And Enron paid
interest rates of 8% to 9% for the securities. That rate was a full
point or more above what it was paying for ordinary debt at roughly the
- DEBT BY ANOTHER NAME
- Enron appears to have been willing to pay the higher
rates and pricey fees because the securities were treated as shareholder
equity for the purposes of financial disclosure, but considered debt for
tax purposes. As a result, Enron could not only conceal large amounts of
liabilities but it could also benefit from big tax deductions for the
it paid on the securities.
- Known as "trust preferred securities," the
instruments were marketed by Wall Street firms under such names as Monthly
Income Preferred Shares (MIPS) or Trust Originated Preferred Securities
(TOPS). Enron was among the biggest and earliest users of the arrangements,
although they became widespread in the '90s. Nowadays, corporations are
still using similar arrangements, though rarely as extensively as
- Unlike the off-balance-sheet partnerships that are now
the focus of a criminal probe, these transactions did appear on Enron's
balance sheet. But because the debt was treated merely as borrowing among
subsidiaries, it did not have to be reported as indebtedness. Rather, it
was listed as "minority interests" and "company-obligated
preferred securities of subsidiaries."
- NEW POLICY QUESTIONS
- And the ability to account for the securities in that
manner was critically important to the ability of the cash-hungry and
indebted company to sell additional bonds. Enron's 2000 annual report
$8.5 billion in long-term debt, not counting the MIPs-type deals, which
may have totaled up to an additional $3 billion.
- Government officials have known about the transactions
for at least six years. In 1996, they attracted the attention of the
Revenue Service, which disallowed almost $24 million in tax deductions.
But Enron appealed, and two years later, the IRS dropped its dispute. At
about the same time, the Clinton Administration proposed legislation to
bar the practice, but it was rebuffed by Congress in the face of strong
opposition from both the securities and accounting industries.
- Enron's off-balance-sheet partnerships are the focus
of most of the allegations now plaguing the company. But the arcane
that it used to turn debt into equity are raising new policy questions
that both Congress and the White House may have to tackle in the coming
- Gleckman covers economic policy for BusinessWeek in
- Washington bureau
- Edited by Beth Belton