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By Howard Gleckman 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 review 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 transactions 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 securities were used to mislead investors. And Hill Democrats are considering legislation that would prohibit their future use, BusinessWeek Online has learned. An Enron spokesperson was not immediately available to comment on this story.
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 in debt.
"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 company 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 percentage point or more above what it was paying for ordinary debt at roughly the same time.
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 interest 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 Enron.
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 heavily indebted company to sell additional bonds. Enron's 2000 annual report disclosed $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 Internal 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 arrangements 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 months. Gleckman covers economic policy for BusinessWeek in the Washington bureau