How Enron Used Accounting for Prepaid Commodity Swaps to Delay Bankruptcy for One Decade: The Shadowy Relationships With Big Banks

Abstract

Accounting standards for prepaid commodity swaps did not exist until 2003. This absence of regulation gave Enron the opportunity to have its own homemade accounting. Two actions facilitated this task for Enron: (a) The Securities and Exchange Commission granted Enron in January 1992 a unilateral privilege to use mark-to-market valuation for energy contracts. This private communication was made at a time when viable markets did not exist. (b) Big banks colluded with Enron’s top executives to design structured finance contracts that allowed Enron to report at least US$8.7 billion of loans as cash flow from operations. Seventy-one percent of the cash flow from operations reported in the last 5 years of Enron’s existence came from these loans. JPMorgan Chase and Citigroup effectively made it easy for Enron to carry out this fraud. The two banks established their own special purpose entities to give these loans the appearance of legitimate trade transactions using prepaid commodity forwards and swaps. This article outlines some of the schemes that the two banks devised to help Enron appear financially healthy when in reality it was near bankruptcy for years.