Risk & Compliance

Report: Enron CFO Reaped Millions from Partnership

Also, the debate over Reg FD continues, downgrades outstrip upgrades, and some really important accountants.
Stephen TaubOctober 19, 2001

Talk about the appearance of a conflict of interest.

A limited partnership organized by Andrew Fastow, CFO at Enron Corp. since 1997, racked up millions of dollars in profits from transactions conducted with the energy company, according to The Wall Street Journal, citing an internal partnership document.

The partnership reportedly renegotiated the terms of deals with Enron in ways that boosted its financial positions or reduced its risk of losses.

Fastow and his partnership associates are said to have racked up more than $7 million in management fees and about $4 million in capital increases last year. The huge sums came from their investment of nearly $3 million in the partnership LJM2 Co-Investment LP, the Journal claims.

The limited partnership was set up in December 1999 mainly to do business with Enron, and big-time investors include Wachovia Corp., General Electric Co.’s General Electric Capital Corp., and Credit Suisse First Boston, according to the account in the paper.

The gains from the deals were revealed in a report to partnership investors dated April 30, which was signed by general partner Fastow, says the Journal.

Enron officials had no comments for the Journal in regard to the LJM2 partnership document. However, it would seem there might be some concerns as Fastow, as Enron’s CFO, has fiduciary duties to Enron shareholders.

On Tuesday, Enron stunned investors with the announcement that it had taken a $1.01 billion charge in the third quarter due mostly to write-downs of lousy investments, resulting in a $618 million loss for the three-month period.

Downgrades Up, Upgrades Down

According to Moody’s Investors Service, credit rating downgrades of U.S. corporations far exceeded upgrades in the third quarter. In a press release, Moody’s noted that the ratings of 125 companies were knocked down in the quarter, while only 43 corporations received credit upgrades. This is the 14th consecutive quarter that downgrades have exceeded upgrades.

Among junk credits, 93 issuers were downgraded–versus only 19 upgrades–in the third quarter. The ratings news wasn’t so bad for investment-grade firms, however, which experienced 32 downgrades, versus 24 upgrades.

Recently, Moody’s reported a third-quarter surge in junk defaults. The hardest hit sectors were airlines, telecommunications, motor vehicle parts, and chemical companies, while the strongest sector was oil and gas.

Moody’s senior economist John Puchalla said an increase in risk aversion, a loss of revenues, and the potential changes in demand away from travel and tourism-related industries, have weakened credit quality since the September 11 terrorist strikes.

Moody’s also pointed out that most aggregate measures of corporate debt protection remain stronger now than in the late 1980s and early 1990s. “The much stronger credit position of financial institutions also diminishes the likelihood of a broad-based credit crunch,” noted a Moody’s press release.

The press release also stated that “the lowest short- to intermediate- term borrowing costs and one of the biggest infusions of fiscal stimulus since the mid-1960s, as well as the fastest annual expansion of M2, or financial liquidity, since 1983, signal the return of above-average expenditures growth by 2002’s second half.”

Reg FD: Fair, Yes; Full, No

Another precinct has been heard from on the Reg FD issue.

A majority of financial analysts and portfolio managers said that Regulation Fair Disclosure has succeeded in its first year in providing small investors and investment professionals with the same information, but it also has given many companies an excuse to provide less information to everyone.

This is the finding of a second survey of analysts by the Association for Investment Management and Research (AIMR) about the impact of the one-year old SEC rule. Yesterday, CFO.com reported that the Commission apparently intends to revise Reg FD–even though a recent survey showed that most IR heads and CFOs like the rule the way it is. “Changes to Regulation Fair Disclosure: Why Bother?”

Of course, some observers argue that CFOs and IR managers like Reg FD so much because they don’t have to disseminate nearly as much news to shareholders–particularly bad news. Recent AIMR surveys seem to bear this out. In February, the AIMR survey on Reg FD found that a majority of the responding analysts and portfolio managers said the quality and quantity of substantive information had declined as a result of the new regulation. The current survey shows no statistically significant change in that view, according to AIMR.

“Regulation FD promised fair disclosure, and it seems to have achieved that, but apparently at the expense of full disclosure,” said AIMR’s president and CEO, Thomas A. Bowman, in a press release. “Everyone has access to the same information at the same time, and that’s laudable, but if there is less information in the marketplace, that’s lamentable. Our focus now needs to be to get corporations to be more forthcoming in their public disclosures to provide the level of detailed information investors need to make better-informed investment decisions.”

The specific types of information that respondents still consider to be less available include: earnings guidance, forward-looking information, facts about internal operations, facts about costs and pricing, and facts about sales volume.

The survey is based on 303 responses, 76 percent of whom identified themselves as buy-side professionals, and 24 percent as sell-side professionals.

In Brief

  • Finally, some good news for junk bond issuers. Junk bond mutual funds attracted $470.1 million of net cash this past week, according to AMG Data Services. This was the first week of inflows since the terrorist attacks and the largest in 11 weeks.
  • German business confidence posted the biggest drop in almost 28 years in September, according to a survey of 7,000 companies.
  • Accounting Today published a list of the Top 100 Most Influential People. See list.