FW: Enron II

-----Original Message-----
From: Monley, John M
Sent: Tuesday, October 30, 2001 11:02 AM
To: Immer, Ingrid
Subject: Enron II
October 28, 2001
Plumbing Mystery of Deals by Enron
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T the heart of the sudden collapse in investor confidence in the Enron Corporation (news/quote </redirect/marketwatch/redirect.ctx?MW=http://custom.marketwatch.com/custom/nyt-com/html-companyprofile.asp&symb=ENE <) are unusual trades it entered into with partnerships led by its chief financial officer, Andrew S. Fastow, beginning in the summer of 1999. Because they were transactions among related parties, the company was required to disclose them, but the disclosures raised as many questions as they answered. Following are some questions that investors are asking, and the currently available answers.
Q. Why did Enron enter into the deals?
A. Enron's first disclosures, in 1999, gave no reason. In later reports, it said it was seeking to "hedge certain merchant investments and other assets," by which it apparently meant investments in technology and telecommunications companies.
Q. How did those investments do?
A. It looks as if they plunged in value, although there is no clear disclosure on that.
Q. Why can't that be discerned?
A. The company never said just what the investments were. And the transactions with the partnerships were complicated, involving a variety of derivative securities, Enron stock and various promissory notes. Enron's financial disclosures do not provide enough information to understand the arrangements completely.
Q. Why were they so complicated?
A. One reason may have been to use accounting rules to its advantage. One accounting rule dictates that companies may not record profits or losses on transactions in their own stock. If a company sells its shares at $10 each and then buys them back - whether for $1 or $50 - there is no gain or loss. But shareholder equity does go up or down on the balance sheet - in that case reflecting how much extra cash the company took in, or paid out, on the transactions. Enron's transactions appear to have been structured to fall under that rule.
Q. Who made money from these transactions?
A. Enron reported some profits along the way from the deals, although not all of the profits were spelled out in its quarterly filings. And it appears that the partnerships distributed money to investors.
Q. If the deals began in 1999, why all the uproar now?
A. Many investors and analysts were not curious about them when everything seemed to be going well. As long as Enron was exceeding its forecasted profits each quarter, they were willing to assume that what was not being disclosed was not really important.
Q. When were concerns raised with Enron?
A. The complaints grew as Enron's share price fell earlier this year. By this summer, Enron decided that Mr. Fastow would sell his stake in the partnerships. Then, because the partnerships would no longer be considered related to Enron, the company would no longer have to disclose anything about the transactions. But investors were still worried, and Enron later closed out its deals with the partnerships.
Q. How did Enron do?
A. Badly. It took a $35 million loss, which, given the size of the transactions involved and the previous profits taken, was not very much. But it also reduced shareholder equity by $1.2 billion.
Q. How did that happen?
A. That, like so much else, is not clear. But it looks as if the partnership owed Enron that much money, could not pay and was let off the hook by Enron. In return, Enron terminated "previously recorded contractual obligations to deliver Enron shares in future periods." Enron treated that like a share buyback, even though the shares in question had not been issued, and determined that there was no need to treat it as a loss that would reduce reported earnings.
Q. Is that legal under the accounting rules?
A. Presumably it is. But Enron's limited disclosures make it impossible to say for sure. Enron may have discovered ways to use the accounting rules to enable it to keep losses off income statements, while leaving profits on them. That may become clearer when the Securities and Exchange Commission, which has begun preliminary inquiries, completes its work. FLOYD NORRIS