T
he first detailed allegations that Enron
abused mark-to-market accounting to
hide wholesale trading losses have
emerged in congressional testimony pro-vided
by a professor and former deriva-tives
trader who reviewed the Enron case
for Senate Governmental Affairs Com-mittee.
Those charges, along with allega-tions
that have surfaced that mark-to-market
accounting was misused by Enron
Energy Services, the company's retail
energy and services unit, are expected to
support the push by accounting rulemak-ers
for much more disclosure on mark-to-market
accounting practices and the
impact of mark-to-market accounting on
earnings trading firms' earnings.
In testimony Thursday before the
Senate Governmental Affairs Committee
last week, Frank Partnoy of the Universi-ty
of San Diego Law School, said it
appears that Enron traders mismarked
forward curves and manipulated the
amount of profits and losses that would
be reported in financial statements.
"In a nutshell, it appears that some
Enron employees used dummy accounts
and rigged valuation methodologies to cre-ate
false profit-and-loss entries for the deriv-atives
Enron traded," said Partnoy, who
reviewed the case over several weeks at the
committee's request. "It appears that Enron
traders selectively mismarked their forward
curves, typically in order to hide losses."
"Traders are compensated based on
their profits," he observed, "so if a trader
can hide losses by mismarking forward
curves, he or she is likely to receive a
larger bonus."
Partnoy said mismarking forward
curves was not the only problem.
"For each trade," he testified, "a
trader would report either a profit or loss,
typically in spreadsheet format. These
profit-and-loss reports were designed to
reflect economic reality. Frequently they
did not. Instead of recording the entire
profit for a trade in one column, some
traders reportedly split the profit from a
trade into two columns. The first column
reflected the portion of the actual profits
the trader intended to add to Enron's cur-rent
financial statements. The second col-umn,
ironically labeled the 'prudency'
reserve, included the remainder."
Partnoy told the committee that in
his estimation, "Enron's 'prudency'
reserves did not depict economic reality,
nor could they have been intended to do
so. Instead, 'prudency' was a slush fund
that could be used to smooth out profits
and losses over time. The portion of prof-its
recorded as 'prudency' could be used
to offset any future losses," he said.
He recommended that investigators
question Enron employees who were
involved in these transactions "to get a sense
of whether my summaries are complete."
Alleged Enron abuses of mark-to-market accounting emerge