Risk & Compliance

Houston, We Have a Problem, Too

Reliant's financial statements not so reliable; company admits some trades were bogus. Plus: Andersen's Duncan on the stand, burger-backed securiti...
Stephen TaubMay 14, 2002

It almost sounds like a scene from Groundhog Day.

Yesterday, management at another Houston-based energy company admitted it inflated revenues—and then saw its share price plummet on the news.

Reliant Resources Inc., which provides electricity and energy services to wholesale and retail customers, announced that a preliminary review found that the company had engaged in “round-trip” trades. Round-trip trades are power trading transactions involving simultaneous purchases and sales with the same counterparty at the same price.

Reliant management also said that on Friday, it canceled its planned $500 million private placement. Company executives said they scotched the debt deal when they realized that Reliant had probably engaged in the illegal transactions, which boosted revenues by 10 percent since 1999. As CFO.com reported yesterday, the private placement had priced 425 basis points above Treasuries.

“Any round-trip trades impact the company’s total revenues and expenses,” noted Reliant management in a press release Monday. “However, since the ’round-trip trades’ are done at the same price, there is no effect on cash flow or net income.”

Reliant said it did most of these deals with CMS. On Friday, managers at that company said the Securities and Exchange Commission had begun an investigation into similar transactions CMS conducted with Dynegy Inc. As you recall, Dynegy at one time was interested in buying the foundering Enron Corp., but later backed off the deal.

Reliant management said it is currently consulting with its outside auditor, Deloitte & Touche, and intends to consult with the SEC about the company’s financial statements.

“These transactions were inconsistent with our company philosophy,” said Steve Letbetter, Reliant chairman and CEO. “We are about creating value for our shareholders and acting with integrity.” Letbetter went on to place the blame for the round-trip trades on a few Reliant workers. “These transactions resulted from some misguided employees who believed that being higher in the league tables of energy trading was important,” he said. “These types of transactions are no longer occurring at Reliant and will not occur in the future.”

In heavy trading yesterday, shares of Reliant lost 17 percent of their value.

Andersen on Trial

David Duncan, the former Arthur Andersen partner who pleaded guilty to obstruction of justice charges, admitted he ordered employees to shred sensitive documents related to Andersen’s audit of Enron Corp.

“I obstructed justice,” Duncan, the government’s star witness, testified at Andersen’s obstruction of justice trial. “I instructed people in the Enron engagement team to follow the document retention policy, which I knew would result in the destruction of documents.”

Duncan was fired by Andersen in January. Yesterday in a Houston courtroom, he detailed the cozy relationship between Andersen and Enron. Duncan said he was “close to” former Andersen chief accounting officer Richard Causey and former president Jeffrey McMahon.

Duncan testified for only an hour because he took the stand late in the day. He is scheduled to be back on the witness stand today, however. In all likelihood, government prosecutors will ask him whether managers at Andersen’s corporate headquarters knew about the document destruction, or worse, ordered it.

In a meeting in January with investigators from the Energy and Commerce Committee, Duncan reportedly claimed he was merely following the instructions of an Andersen lawyer when he ordered a hurry-up of the destruction of documents related to the Enron audit.

But Duncan refused to testify before Congress, citing his constitutional right not to incriminate himself. On the same day Duncan took the Fifth, however, Andersen managing director Dorsey Baskin Jr. testified that, several days after the SEC began probing Enron, Duncan called a meeting to organize the document destruction. Duncan “directed the purposeful destruction of a very substantial volume of documents just as a government investigation was beginning,” Baskin told lawmakers. “This effort was undertaken without any consultation with others within the firm so far as we know.”

In an exclusive CFO.com poll, 76 percent of respondents said they believed Duncan did not act alone in ordering the destruction of Enron-related audit documents. (To view the results, along with other reader polls about Enron, Andersen, and auditor independence, click here.)

More Andersen Defections

As the Andersen trial rolls on, more companies dumped Andersen as auditor.

The big defector yesterday was USG, a Fortune 500 company that makes gypsum wallboard and related products. USG announced it selected Deloitte & Touche to replace Andersen, ending a relationship that dates back to the Harding Administration.

Management at Caldera International Inc., a developer of software for Linux- and Unix-based computers, said it replaced Andersen with KPMG. And HON Industries hired PricewaterhouseCoopers after ditching Andersen.

Meanwhile, Ernst & Young picked up two new clients from the indicted auditor. Artesyn Technologies, which provides advanced power-conversion equipment and real-time subsystems to the communications industry, replaced Andersen after an 11-year relationship. During fiscal 2001, Artesyn paid Andersen $679,000 in audit fees, $582,000 in fees related to the design and implementation of a financial information system, and $223,000 in other fees, which include the audit of the company’s benefit plan.

Also yesterday: Kaydon Corp. reported it is switching to E&Y after employing Andersen as its auditor since 1984. Kaydon management said the change was made to ensure its shareholders “continue to have the utmost confidence in the integrity of the company’s financial statements.”

Kaydon paid Andersen $379,250 in audit fees and $323,522 in other fees during 2001, according to the company’s most recent proxy.

(To see how the Big Five firms stack up in revenues and practice lines, click on this.)

WBS: Whopper-Backed Securities

Managers at buyout firm Texas Pacific Group and Goldman Sachs Group are considering issuing asset-backed securities to help raise the $2.5 billion they need to buy Burger King, according to Bloomberg.

Under the plan, the two financial giants hope to use revenue generated by the hamburger chain’s 1,200 franchisees as collateral on $1.5 billion to $2 billion of bonds. It would be the largest financing of this type in the United States for a takeover, according to reports.

The reason executives at the two companies are considering the Whopper-backed securities is that rising defaults have dried up the market for junk bonds and bank loans. In the past, buyout firms have typically financed these sorts of takeover deals with highly leveraged funding instruments.

Asset-backed bonds are more restrictive than high-yield debt, but less costly. For example, interest rates on junk bonds are currently 5 percentage points higher than asset-backed debt, according to Bloomberg, citing Moody’s.

J.P. Morgan Chase & Co. and Citigroup Inc. are arranging the financing for Texas Pacific and Goldman. The hopeful buyers also plan to offer about $750 million in equity to complete the deal for the second-largest hamburger chain in the United States.

Short Takes

>> Nortel Networks Corp. announced it will file a shelf registration to offer up to $2.5 billion of securities. The embattled telecom-equipment company said the filings would give it “additional financing flexibility.”

>> Moody’s Investors Service cut its long-term debt rating of Sears, Roebuck and Co. after the embattled retailer announced plans to buy Lands’ End for $1.9 billion in cash. “The downgrade reflects the increased level of operating risk that Sears is undertaking with this acquisition, at a time when it faces challenges to improve the overall profitability of its retail franchise,” said Moody’s in a press release. “In addition, the high cash purchase price relative to the historical earnings of Lands’ End, will likely result in a deterioration of credit protection measures once the debt to finance the acquisition is incurred.”

The credit-rating agency did confirm the Prime-2 commercial paper rating of Sears Roebuck Acceptance Corp.

To read a recent CFO.com interview with Lands’ End CFO Donald Hughes, click here.