by Glenn Cheney
Norwalk, Conn. - Enron and its gaggle of special purpose entities have been the rage of the nation, but when it came time to comment on a Financial Accounting Standards Board proposal that might help prevent future SPE shams, the board had received only one comment letter a week before its July 31 deadline.
It was a big letter, however, coming from Sen. Carl Levin, D-Mich., the ranking Democrat on the Senate Permanent Subcommittee on Investigations and the chair of the investigation into the collapse of Enron. He generally praised the proposal, but had a problem with two big words that aren’t in the clause where it counts.
The words in question: “decision-making authority.”
The proposal is an amendment to, and clarification of, FASB’s Statement 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. If adopted, the proposal would prohibit an entity from being a qualifying special purpose entity if it engages in certain activities or obligations. A QSPE, for example, could not enter into an agreement that obligates a transferor to deliver extra assets to fulfill the SPE’s obligations. QSPEs would also be prohibited from holding equity instruments.
Levin is adamant about the connection between solid accounting standards and honest financial reports.
“FASB has issued several proposals to curb the accounting deceptions of Enron and others, including new standards for special purpose entities, and it is planning others, such as honest accounting standards for stock options,” Levin told Accounting Today. “But FASB can’t do it alone. Better accounting standards alone are not enough. The new Public Company Accounting Oversight Board, the Securities and Exchange Commission, the American Institute of CPAs, accounting firms, corporate board-rooms and senior management all have to accept responsibility to improve U.S. accounting practices if investor confidence is to be restored in our financial reporting systems and markets.”
FASB senior project manager Ronald Lott - who said that he appreciated, but could not comment on, Sen. Levin’s letter - said that a “qualifying” SPE is one that allows another entity to de-recognize assets that are transferred to an SPE that is not allowed to sell, pledge or otherwise transfer the asset. Lott added that Levin had apparently “done a thorough job of going through the proposal and trying to understand it.”
The senator’s letter generally praised the proposal, noting that it “appears to strike the right balance between limiting sham QSPE transactions undertaken to conceal debt or contingent liabilities, while allowing legitimate, risk-dispersing securitizations to continue.”
Levin’s investigations found that the debt concealed at Enron a few months before its collapse exceeded $5 billion. The debt never appeared in the company’s balance sheet because it was transferred to unconsolidated SPEs and accounted for under Statement 140 or its predecessor, Statement 125. Those rules were also used to allow Enron to recognize $350 million of gain.
By prohibiting QSPEs from holding equity instruments, the proposal would prevent a practice paralleling Enron’s securitization of equities by transferring interest in them through an SPE financed with debt and equity supplied by financial institutions. The proposal makes it clear that companies cannot use SPEs to transform equities into instant earnings.
Sen. Levin found fault with the proposal’s attempt to force companies to surrender control of assets transferred to a QSPE. The proposal specifies the factors that determine that control has been surrendered. Levin expressed concern that the list does not deal with effective control over a QSPE’s decision-making process. He cited a shifty triangle of accounting among Enron, J.P. Morgan and an SPE known as Mahonia. Though no document indicated that J.P. Morgan owned Mahonia, the SPE had no employees and was dependent on the bank for its finances, legal advice and execution of its business interests.
“[None] of the listed factors appears to address the situation in which a transferor maintains effective control over the transferred assets by dominating the SPE’s decision-making process,” Levin’s letter said. He suggested firm but simple wording that would prohibit “an arrangement that allows the transferor to exercise decision-making authority, either directly or indirectly, over the QSPE.”
Earlier this year, when the subcommittee issued a report on the involvement of financial institutions in Enron’s SPE deals, Levin slammed banks and brokers for contributing to the use of deceptive accounting practices. The report identified a gap where the SEC fails to regulate banks, and banking regulators fail to oversee accounting practices.
“Enron’s deceptions were shocking, and equally shocking was the extent to which respected U.S. financial institutions like Chase, Citigroup and Merrill Lynch helped Enron carry out its deceptions and mislead investors and analysts about the company’s finances,” Levin said. “These financial institutions weren’t victims of Enron; they helped plan and carry out Enron’s deceptions in exchange for large fees or favorable consideration in business deals.”
At press time, Lott said that he expected more comment letters, which typically arrive just at or even after the deadline. All letters, he said, would receive as much attention as Levin’s.
FASB has no other SPE-related projects on its agenda. It recently put aside the possibility of a project on accounting for interest held in certain unconsolidated SPEs and whether such interest should be considered a derivative. Lott said that the marketplace appears to be handling such situations appropriately, so the issue was not given priority.
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