The Sociology of the Grand Bust-Up

William Krehm

Faith can be as elastic as a lady-of-the night's garters. And there is no lack of resourcefulness as the official profits of the

New Economy avoid any too disturbing conclusions from the endless series of major bankruptcies. On the oped page of The Wall Street Journal (11/0 1, "A Corporate Crime Wave?"), George Gilder provides as usual a brilliant example: "Politicians must stop tinkering with the structure of law and regulation under which entrepreneurial plans play out. Businesses find themselves operating amid the turbulence of constant legal and monetary change. In extremis, caught in a baffling web of often conflicting bankruptcy, tax, regulatory, and securities laws, many executives make decisions that in retrospect can be interpreted as in-criminating.

"Bankruptcy, however, is not a crime but a punishment. Virtually no one plans for its concussive effects or expects them at all. The real source of the `crime wave' is the undulation of policy and the babel of alibis from politicians and bureaucrats searching for scapegoats."

But for a more earthbound summary of the facts let's retreat to the reporting pages of the same publication (21/01/02, "Murky Waters: A Primer on Enron Partnerships" by John R. Emshwiller and Rebecca Smith):

"With names such as Martin and Raw-hide, Braveheart and Raptor, [the Enron partnerships] sound like fancy bar drinks or maybe top-secret military missions.

"They are, in fact, a few of the myriad entities that Enron Corp. helped set up over the past decade and that now find them-selves at the heart of one of the biggest corporate scandals in history. Government investigators are sifting through the complex financial structures of these partner-ships, limited-liability companies and other affiliates to determine what, if any, accounting rules and laws have been violated.

"The partnerships - which Enron told investors little or nothing about - hid hundreds of millions of dollars of losses and debt from public view.

"Why did Enron create the limited partnerships? By setting them up, Enron could draw in capital from outside investors, such as banks, insurance companies, pension funds and even wealthy individuals. If structured properly, including at least 3% of their equity from outside investors, the partnerships could be kept off the company's balance sheet. This was an important consideration for a fast-growing energy-trading company that feared that much debt would damage its credit rating. Another, more personal incentive arose over time as Enron executives headed and partly owned some of the partnerships, they provided a lucrative source of outside income for those involved. Enron's former chief financial officer, Andrew Fastow, made more than $30 million from partnerships he ran.

"In all Enron had about 3,500 subsidiaries and affiliates, many of them limited partnerships and limited-liability companies. In the partnerships' simplest form, Enron and outside partners would each put up money to invest in specific projects, such as a pipe-lines or a power plant, and then split any profits when the partnership ended. In some of these Enron parked assets that were troubled and falling in value, such as certain overseas energy facilities or stock in companies that had been spun off to the public by Enron. That hid losses that Enron would have had to report. In some cases Enron promised to compensate partnership investors, often by issuing Enron stock to them. Compounding the problem was the stock-market retreat of last year.

"The company says that it set up safe-guards that required top company officers and the board to review and approve deals between Enron and the partnerships. But there are some questions as to whether the executive-run partnerships received favored treatment. For example, internal documents from the LJM2 partnership indicate that at least on one occasion, the partnership renegotiated a deal that saved it millions of dollars, seemingly at Enron's expense. Public attention started focussing on these partner-ships in October, it opened concerns about a raft of problems buried in their complex web. With all this attention, investor confidence in Enron collapsed, and by December it was forced to file for bankruptcy-court protection.