Here's a better link to the memo from which you can actually copy text: http://www.itmweb.com/f012002.htm
Luke T - if that is genuine it is pretty damning however something caught my eye. The letter/memo is address to "Mr Lay" but later on says "I believe Ken Lay deserves the right to judge for himself....." that seems a strange way to address someone you are writing to?
specious_reasons
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The memo is supposed to be real - both books I read reference it. At the least, the first page which is addressed to Lay is Watkin's memo. I don't know if Watkins wrote up the rest of the pages. It may have been a follow up, written at the request of the Lay.
The books don't agree with LukeT's opinion on what the memo meant. Not that it paints her in an entirely good light. (She's already been lauded in the media back in 2001-2002 as the "whistleblower" at Enron.) This was basically a politcal letter. She was at odds with Fastow's group, and was fairly certain that there were shady deals going on. Of course, Lay hardly followed up.
The books don't agree with LukeT's opinion on what the memo meant. Not that it paints her in an entirely good light. (She's already been lauded in the media back in 2001-2002 as the "whistleblower" at Enron.) This was basically a politcal letter. She was at odds with Fastow's group, and was fairly certain that there were shady deals going on. Of course, Lay hardly followed up.
I'm going to take a stab at this SPE thing and see if I have it right.
Say Enron wants to get into the broadband internet business. This requires a large investment. And during a start-up of a new business, there will be losses until that investment starts to pay off. These losses would have to be reported to Enron's investors.
So Enron creates a Special Purpose Vehicle/Entity. This is a company which is legally separate from Enron (even though Enron can own up to 97 percent of it), and so any losses it suffers doesn't have to be reported to Enron stockholders. It is not considered a "subsidiary" of Enron as long as Enron's share of the SPE is under 97 percent. Yeah, you read that right. 97 percent.
Okay. So this SPE is a separate entity all to itself, even though Fastow (Enron guy) owns it, say.
So now this SPE needs money to start up its broadband internet business. Enron has not given it money. Instead it has "invested" X number of shares to be used as collateral so the SPE can borrow money.
The whole purpose of creating an SPE is because whatever it is that is being invested in is high risk and might lose money in the beginning, and the company which created the SPE doesn't want to have to report the losses and thereby shake its investors' confidence. The company that created the SPE is counting heavily on the SPE eventually becoming a profit machine and therefore not having to lose whatever was offered as collateral.
So the people who loaned money to the SPE figure that if the SPE is unable to pay its loan off, they will at least get Enron stock that is being offered as collateral. And Enron stock is climbing like a rocket.
Enron creates THOUSANDS of SPEs.
Then the market begins to tank. Hey, we all remember that. 2000-2001.
Enron has millions and millions and millions of stocks hanging out there as collateral.
Top execs at Enron begin bailing out. Selling their stock, making milllions.
People begin to get nervous. Panic.
Right then, Enron tells its employees it has switched to a new managing company for their 401(k) program. By law, this means they can't sell their stocks for six months.
Coincidence?
Enron peaked at 90 bucks a share and dropped down to a grain of sand per share while the employees were left holding the empty bag.
Say Enron wants to get into the broadband internet business. This requires a large investment. And during a start-up of a new business, there will be losses until that investment starts to pay off. These losses would have to be reported to Enron's investors.
So Enron creates a Special Purpose Vehicle/Entity. This is a company which is legally separate from Enron (even though Enron can own up to 97 percent of it), and so any losses it suffers doesn't have to be reported to Enron stockholders. It is not considered a "subsidiary" of Enron as long as Enron's share of the SPE is under 97 percent. Yeah, you read that right. 97 percent.
Okay. So this SPE is a separate entity all to itself, even though Fastow (Enron guy) owns it, say.
So now this SPE needs money to start up its broadband internet business. Enron has not given it money. Instead it has "invested" X number of shares to be used as collateral so the SPE can borrow money.
The whole purpose of creating an SPE is because whatever it is that is being invested in is high risk and might lose money in the beginning, and the company which created the SPE doesn't want to have to report the losses and thereby shake its investors' confidence. The company that created the SPE is counting heavily on the SPE eventually becoming a profit machine and therefore not having to lose whatever was offered as collateral.
So the people who loaned money to the SPE figure that if the SPE is unable to pay its loan off, they will at least get Enron stock that is being offered as collateral. And Enron stock is climbing like a rocket.
Enron creates THOUSANDS of SPEs.
Then the market begins to tank. Hey, we all remember that. 2000-2001.
Enron has millions and millions and millions of stocks hanging out there as collateral.
Top execs at Enron begin bailing out. Selling their stock, making milllions.
People begin to get nervous. Panic.
Right then, Enron tells its employees it has switched to a new managing company for their 401(k) program. By law, this means they can't sell their stocks for six months.
Coincidence?
Enron peaked at 90 bucks a share and dropped down to a grain of sand per share while the employees were left holding the empty bag.
headscratcher4
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Luke: that seems like a pretty good explaination...at least from what I've read of the whole affair.
It also sounds like an elaborate Ponzi scheme...moving money around in such away as it looks like a profit is being made at the same time that huge losses keep building. Very clever really, I can't believe (though it may come out in the trial) that these are legitimate accounting techniques...I mean you would have to hide the fact that you do this from investors, because no self-respecting outside investor is going to let a company get around shuffling off loss like this IF it can come back on the company...which it did. The whole scheme depends on the stock price, as I understand things, not falling and thus undermining the value of the stock provided to the SPC, but that is exactly what happened to Enron, as I understand it, when the collapse came...the stock started to fall and the whole value structure of the SPC shell-game fell apart.
It also sounds like an elaborate Ponzi scheme...moving money around in such away as it looks like a profit is being made at the same time that huge losses keep building. Very clever really, I can't believe (though it may come out in the trial) that these are legitimate accounting techniques...I mean you would have to hide the fact that you do this from investors, because no self-respecting outside investor is going to let a company get around shuffling off loss like this IF it can come back on the company...which it did. The whole scheme depends on the stock price, as I understand things, not falling and thus undermining the value of the stock provided to the SPC, but that is exactly what happened to Enron, as I understand it, when the collapse came...the stock started to fall and the whole value structure of the SPC shell-game fell apart.
I'm just guessing, having never read a book on the matter or taken a business course of any kind, at what it is Enron did. So if I'm wrong, someone please straighten me out.
So here's what else I gather from surfing the net.
Enron was a middle man for natural gas, in the beginning. They would buy natural gas from a supplier and then sell it to a customer. For a tidy profit.
This would supposedly save the customer having to buy their supplies from multiple suppliers to meet their needs and all the hassle/haggling that would entail. Enron was a one stop shop for the customer.
Enron eventually controlled the entire natural gas market, for all intents and purposes. Which meant they could mark up the price of natural gas as high as they wanted with the customer not having much choice.
Enron then realized they could do this with just about any commodity. Like electricity. And that's when things got ugly in California.
Don't want to pay our price? Fine. No electricity for you. One year!
Say. We could do this with anything. Like broadband video on demand!
Thus, SPE's were born.
But other companies began to see the opportunity to do the same thing in the energy market.
Dammit! Competition!
So the prices began to drop, and Enron's stock began to fall.
Say. That stock you promised as collateral isn't worth as much any more. You better print some more.
Crash!
So here's what else I gather from surfing the net.
Enron was a middle man for natural gas, in the beginning. They would buy natural gas from a supplier and then sell it to a customer. For a tidy profit.
This would supposedly save the customer having to buy their supplies from multiple suppliers to meet their needs and all the hassle/haggling that would entail. Enron was a one stop shop for the customer.
Enron eventually controlled the entire natural gas market, for all intents and purposes. Which meant they could mark up the price of natural gas as high as they wanted with the customer not having much choice.
Enron then realized they could do this with just about any commodity. Like electricity. And that's when things got ugly in California.
Don't want to pay our price? Fine. No electricity for you. One year!
Say. We could do this with anything. Like broadband video on demand!
Thus, SPE's were born.
But other companies began to see the opportunity to do the same thing in the energy market.
Dammit! Competition!
So the prices began to drop, and Enron's stock began to fall.
Say. That stock you promised as collateral isn't worth as much any more. You better print some more.
Crash!
Another thing they did. I think.
Let's say it is time to report how much money you have hanging out there. I think they have to do this quarterly.
ENRON: Well, we promised to buy umpteen megawatts of electricity from Supplier A. And we promised Customer B that we would sell those umpteen megawatts to them. So how much do we owe to Supplier A, and how much can we get from Customer B?
This may cover a period of years in the future.
Talk about "your mileage may vary". Enron inflated their guesstimates of how much they would be able to sell their commodities for in the future.
This caused investors to believe Enron was really going to be raking in the cash. Investor confidence: high.
Introduce a few competitors who undercut the prices, or if Customer B balks at paying those prices...
ENRON: Um. Sorry. Those profit guesstimates we made a couple years ago? We were, like, WAY OFF!!!
Investor confidence: low.
Let's say it is time to report how much money you have hanging out there. I think they have to do this quarterly.
ENRON: Well, we promised to buy umpteen megawatts of electricity from Supplier A. And we promised Customer B that we would sell those umpteen megawatts to them. So how much do we owe to Supplier A, and how much can we get from Customer B?
This may cover a period of years in the future.
Talk about "your mileage may vary". Enron inflated their guesstimates of how much they would be able to sell their commodities for in the future.
This caused investors to believe Enron was really going to be raking in the cash. Investor confidence: high.
Introduce a few competitors who undercut the prices, or if Customer B balks at paying those prices...
ENRON: Um. Sorry. Those profit guesstimates we made a couple years ago? We were, like, WAY OFF!!!
Investor confidence: low.
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Without commenting on Enron specifically, it's important to note that there are perfectly legitimate uses for SPEs. Let's say that Amalgamated Widget is a company at high risk of failure -- business is declining, debt is up, etc. And they want to get some financing. It'll be tough for them to get a loan because even if it's overcollateralized lenders are wary of the risks and expense of bankruptcy. Let's further say that AW's customers are first rate -- they supply GE, United Technologies, guys like that. Well, AW can bundle up its receivables to those top-notch companies into an SPE. One of the purposes of an SPE is to make it bankruptcy remote -- it's failure won't bankrupt the company and the company's failure won't bankrupt it. Lenders will make a loan against GE making its payments timely -- as bets go, only a T-Bill is lower risk than that. So AW dumps, say, $230 MM of receivables from those top-notch companies, the lender lends $200 against it and AW gets not only the $200 MM in cash but the residual $30 MM (less interest) in the SPE as an equity investment. Someone else puts in $900 M to take it off AW's balance sheet completely and give the lenders comfort that there's a third party who cares what happens to the thing, and everyone is happy.
The keys are a) keeping things at arms' length (Enron had employees or funded cronies take the 3% part), b) keeping contingent liabilities from the issuing company to the SPE to an absolute minimum (which, as Luke pointed out, Enron allegedly didn't do -- they owed these things gobs of stock under some circumstances) and c) disclosure, disclosure disclosure, which again, Enron was allegedly deficient at.
The keys are a) keeping things at arms' length (Enron had employees or funded cronies take the 3% part), b) keeping contingent liabilities from the issuing company to the SPE to an absolute minimum (which, as Luke pointed out, Enron allegedly didn't do -- they owed these things gobs of stock under some circumstances) and c) disclosure, disclosure disclosure, which again, Enron was allegedly deficient at.
specious_reasons
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You got the basics of SPEs correct, as I understand it.
You have the motivation wrong, though. Enron practiced Mark-to-Market accounting. This means that if Enron signed a contract for 20 years, it could book the whole value of that contract in the year it made the deal. How Mark-to-Market is supposed to work, though, is that if the profits fall short of the contract value, then that is supposed to be reported as a loss.
Enron had assets that were going to start taking losses, so when Fastow came up with the SPEs, it looked like a really sweet deal:
- The Raptor/ChewCo/etc. SPEs could buy the assets at above-market prices, since the 3% of "independent" investors were really Enron executives.
- These sales could booked as profit for Enron.
Fastow thought it was a sweet deal, too, because:
- He was on both sides of the negotiating table, so he could structure the deal however he needed to.
- He received large "management fees" from LJM. $60 million in total, I think...
- He could use these investment funds to pressure investment banks and brokerage houses to treat Enron (and the LJM funds) favorably.
The broadband deal was a bit interesting. They decided to "sell" the business first, in order to book the profits right away, rather than the other deals, which were to avoid booking losses.
And HS4 is right, all of these investments were basically double-or nothing bets that the stock price would rise, because the majority of the money for the sale would come from Enron, and the hedge against the investment failing was - Enron stock.
When I get home and have access to books, I'll see if I can produce a coherent version of the Enron SPE deals.
You have the motivation wrong, though. Enron practiced Mark-to-Market accounting. This means that if Enron signed a contract for 20 years, it could book the whole value of that contract in the year it made the deal. How Mark-to-Market is supposed to work, though, is that if the profits fall short of the contract value, then that is supposed to be reported as a loss.
Enron had assets that were going to start taking losses, so when Fastow came up with the SPEs, it looked like a really sweet deal:
- The Raptor/ChewCo/etc. SPEs could buy the assets at above-market prices, since the 3% of "independent" investors were really Enron executives.
- These sales could booked as profit for Enron.
Fastow thought it was a sweet deal, too, because:
- He was on both sides of the negotiating table, so he could structure the deal however he needed to.
- He received large "management fees" from LJM. $60 million in total, I think...
- He could use these investment funds to pressure investment banks and brokerage houses to treat Enron (and the LJM funds) favorably.
The broadband deal was a bit interesting. They decided to "sell" the business first, in order to book the profits right away, rather than the other deals, which were to avoid booking losses.
And HS4 is right, all of these investments were basically double-or nothing bets that the stock price would rise, because the majority of the money for the sale would come from Enron, and the hedge against the investment failing was - Enron stock.
When I get home and have access to books, I'll see if I can produce a coherent version of the Enron SPE deals.
This was why I was very curious as to what he had been charged with - from my limited knowledge of the debacle (from before this thread) I couldn't understand how he could plead ignorance.
Thanks to this thread I have a slightly better idea - I presume he is hoping to be able to prove that people deliberately deceived him and somehow kept him in the dark and they could do that because he was stupid!
How long are they anticipating the trial will run for?
Couple of things. First, I was under the impression that 14% ownership of an entity was the magic number for reporting to the FTC.
Second thing is that if these SPEs were owned by employees (even if Enron put up the cash) they, in effect, were getting a business funded by Enron. That sounds pretty shady even though there could be some hocus pocus with options and grants and the like.
I cannot imagine a jury looking very kindly on this stuff, particularly given the outcome.
It shouldn't take terribly long (a week or two, tops) except that the feds have a way of overdoing it and thus confusing the bejesus out of a jury.
In the UK we seem to have got into a habit of these trials taking around 2 years and then the judge dismissing the jury "because it's all a bit complicated" oh and with costs to the taxpayer of £60 million or so - I kid you not: http://news.bbc.co.uk/1/hi/england/london/4373461.stm .
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Happens here too. I should have said "months" not weeks but it really depends on the feds. If they pull out every document and go over it with a fine tooth comb it could take a year. The defense might actually like that.
specious_reasons
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(Salacious detail alert!)
The initial investments were made by Michael Kopper's gay lover. Kopper wasn't an executive officer, and since he had no legal relationship with the person in question, that satified the "arms length" legal requirement.
Except for the fact that the money he used was laundered from Fastow and Kopper.
One of the internal complaints about Fastow's SPE is that Kopper was both an Enron and LJM employee. At some point in time, Fastow defused this by assigning Kopper (and the LJM team) full-time to LJM. However, he didn't move them out of Enron's office, and Fastow himself sat on both sides of the deal. He was supposed to move the LJM people out of Enron entirely, but that never really seemed to happen....