Tougher Rules on Enron-type Deals Approved
By Deepa Babington
01/15/2003
Reuters English News Service
NEW YORK, Jan 15 (Reuters) - U.S. accounting rule makers on Wednesday approved new standards that clamp down on the abuse of creative financing deals that allowed companies such as Enron Corp. (ENRNQ.PK) to shift debt off their books.
The new standard represents one of the most significant changes in accounting rules inspired directly by Enron's collapse.
At its board meeting on Wednesday, the Financial Accounting Standards Board, which sets accounting standards in the United States, signed off on stiffer rules surrounding so-called special purpose entities and when they can be excluded from a parent company's books.
The now infamous special purpose entities (SPEs) typically are partnerships or joint ventures that are often used by companies to move debt off their balance sheet. Many have legitimate uses, but others are structured specifically with the intent of concealing debt from investors.
They came into the spotlight after the collapse of energy trader Enron, which used sophisticated partnerships it controlled to move debt off its balance sheet. The murky deals were instrumental in Enron's demise and the company is accused of using them to fool investors about the true state of its finances.
Analysts say it is too early to gauge the full impact of the new rules, but expect several companies to face the threat of moving debt from special purpose entities they invest in back onto their books. That, in turn could sharply skew key debt and equity ratios watched by investors and analysts.
"I think what it will do is cause people to think very carefully for a while about their involvement with financing entities," said Raymond Check, a partner at law firm Cleary Gottlieb who works closely with structured finance transactions.
"There will be a lot of caution until it becomes clear how the nitty gritty (of applying the rules and calculations involved affect corporate balance sheets)," Check said.
ANOTHER TOOL
Criticized by many for the lax accounting rules surrounding them, the FASB has rushed to improve accounting standards and disclosure rules relating to these entities, which it now calls variable interest entities.
Earlier, companies with a controlling interest - usually more than 50 percent of equity - in a special purpose entity were required to combine that entity's assets and liabilities into its own books.
Under the new rules, companies that bear the majority - or more than 50 percent - of risk of expected losses or gains from a special purpose entity must also reflect that SPE's assets and liabilities in their balance sheet.
"You have another tool in your toolbox when you're looking at these things," Cathy Coburn, a research associate at FASB said about the change in rules. "They can make a better determination as to whether they need to consolidate or not."
The new rules also require companies to disclose the nature, purpose, size, activities and maximum exposure to special purpose entities. For companies with existing SPEs, the new rules go into effect for fiscal periods after June 15. Any new special purpose entities must comply with the rules beginning in fiscal periods after Jan. 31.
To be sure, accountants and lawyers structuring such deals are likely to find ways to sidestep the consolidation requirement, analysts say.
For example, other parties can take on more of the risk, to make sure that no party bears more than 50 percent of the risk, said Stephen Ryan, associate professor of accounting at New York University's Stern School of Business.
The impact of the new rules is not limited to corporations alone.
Asset managers like mutual funds that run securitized portfolios of debt called collateralized debt obligations might have to move them onto their balance sheets, even though that prospect seemed unlikely a few months ago, said Jim Mountain, a partner at accounting firm Deloitte & Touche LLP.
CDOs are a small but growing corner of the bond market. As of the third quarter, there were some $232.4 billion of collateralized debt obligations outstanding in the United States, according to the Bond Market Association. But that remains a small part of the $19.8 trillion U.S. bond market.
The Securities and Exchange Commission also is expected to finalize rules requiring corporations to disclose more information about off balance sheet deals as early as next week. (Additional reporting by Dan Wilchins).