Enron Corp.’s questionable use of off-balance-sheet transactions to hide debt appears to have begun years earlier than previously believed, raising new uncertainties about the company’s financial statements going back to the early 1990s, Monday’s Wall Street Journal reported.
It also raises additional questions about the roles played by former Chief Executive Jeffrey Skilling and former Chief Financial Officer Andrew Fastow in setting up such structures.
During the early 1990s, the Enron unit run by Mr. Skilling set up a group of partnerships and trusts operating under the rubric “Cactus” to buy and sell large amounts of natural gas. Company documents indicate some of these were structured as “special purpose entities,” which could serve as a repository for assets and debts that otherwise would have shown up on Enron’s balance sheet. In order to be treated as separate, though, an SPE has to have at least 3% of its total capital in the form of equity from an outside venture, according to accounting rules put into place in 1991.
One of the Cactus entities, known as the Cactus Hydrocarbon III Production Payment Trust, was structured as an SPE and was part of a complex structure that appears to have held several hundred million dollars of off-balance-sheet debt. The documents describe Cactus III as a “$500+ million `permanent funding facility.'”
The Cactus III trust was created with two classes of “certificates”: Class A, which comprised 97% of the capital, and Class B, which comprised the remaining 3%. While the structure clearly seems set up to meet the 3% equity requirement, the Enron documents show that the Class B certificates had several features commonly associated with debt. They carried an interest rate and holders received payments on a monthly basis, presuming there were sufficient funds available after paying the Class A certificate holders. The documents describe the Class B certificates as having an “outstanding principal component plus accrued and unpaid interest” and as being “trust liabilities.” The documents also envisioned obtaining a credit rating on the certificates.
After looking over copies of some Cactus documents, Charles Mulford, an accounting professor at the Georgia Institute of Technology, questioned whether the structure would meet SPE accounting rules. Enron appeared to be “very much pushing the envelope on this Cactus deal,” he said.
The General Electric Capital unit of General Electric Co. made a small investment of several million dollars in the Class B certificates. GE viewed the certificates as debt instruments, company spokesman John Oliver said. “We booked the investment as debt,” he said, adding that GE doesn’t know how Enron treated the Class B certificates.
An Enron spokesman said the company didn’t have any comment on the Cactus program. One former Enron official who worked on the Cactus deals conceded that the certificates had “debt-like characteristics” and were “on the edge of the gray area” of what was acceptable from an accounting point of view. But, this person added, the Cactus transactions were thoroughly vetted by company lawyers and its outside auditor, Arthur Andersen LLP. “I would challenge anyone to say that these were a sham,” this person said.
An Andersen spokesman said the firm “would never have approved the accounting for an SPE that didn’t meet the accounting rules.” Asked about the Class B certificates, he said “all the information we have indicates that this is an outside equity investment.”
A spokesman for Mr. Fastow declined to comment.