Enron and the Special Purpose Entities-Use or Abuse? -- The Real Problem -- The Real Focus

In December of 2001, Enron Corporation, one of the nation's largest energy and gas providers, filed for bankruptcy under chapter 11 of the U.S. Bankruptcy Code, one of the largest corporate bankruptcy filings at that time. A myriad of scholarship, books, and articles have been written on Enron's meteoric rise and fall. The failure in oversight that permeated Enron's corporate gatekeepers, such as Enron's Board of Directors and upper management, its public accountants Arthur Andersen, the Securities and Exchange Commission (SEC), and other professionals who were tasked to navigate the Enron empire, was disturbing and disconcerting on a number of levels-not the least of which being the blow to investor confidence, the foundation that the capital markets are built on.On the heels of Enron's debacle came the Sarbanes-Oxley Act of 2002, the far reaching legislative reform that was designed to shore-up the accounting and corporate governance shortfalls that the legislature and the investing public believed allowed Enron to do what it did unabated. Supplementing the reforms set forth in the Sarbanes-Oxley Act are a number of accounting rules, guidelines, and interpretations that are designed to curtail the type of accounting fraud Enron perpetrated through its use (or more accurately abuse) of what are referred to as special purpose entities (SPEs). Although much has been written chronicling and analyzing the various aspects of the Sarbanes-Oxley Act, little has been written analyzing the accounting guidance related to SPEs.Since the Enron debacle, a dark cloud has been cast over the SPE by the investment and financial community. The line between SPE use and abuse has been blurred to the point where the two are considered one in the same, i.e., that SPEs by their very nature are these ominous, nefarious, inherently evil entities whose only purpose is to defraud, obfuscate, and manipulate financial statements. The purpose of this piece, among other things, is to challenge this assumption and conclusion. The focus for this paper is to take a look at both the new accounting rules in the post-Enron era that have been enacted, in significant part, due to what happened with Enron and its SPE use, as well as the accounting rules related to SPEs that were in effect during both the pre and post-Enron eras. This article examines the accounting reforms and legislative approaches currently being taken regarding the accounting for and disclosures of SPEs. This piece questions whether or not those approaches are, in fact, the correct ones.The article will examine closely the method and manner that Enron perpetrated such fraud, with the goal of demonstrating that it was not a lack of accounting rules or deficient interpretive accounting guidance that resulted in Enron's SPE improprieties. Instead, dishonest and fraudulent behavior by Enron management was the real problem. The next part of the piece will cite and critique current rules and some proposed accounting reforms being considered, analyzing their current and potential effectiveness, with the goal of highlighting reasons why the proposed reforms may not meet their desired or stated objectives. Finally, the piece will explore and suggest some alternative approaches once the issue has been reframed. In the alternative, this piece, in essence, suggests that enforcement efforts should be focused on the SPE abusers instead of the SPEs themselves.The overall goal of this piece is to question whether we should be taking a different approach to financial fraud in the area of SPEs than the path currently being taken; the end result being that we will ultimately be making it more difficult and more costly for the myriad of legitimate SPE use that may or may not be able to continue in light of the accounting and disclosure requirements currently in place and that have been enacted to a large degree in response to what occurred with Enron.