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

Abstract

This study addresses two important, but less known, factors that contributed to Enron’s collapse. (a) The SEC’s granting Enron in January 1992 a unilateral privilege to use mark-to-market for energy contracts. Enron had a full discretion to estimate the market values of its contracts and reported the changes in these values as a steady increase in profits without disclosing the source. (b) The role of big banks in conspiring with Enron’s top executives to design structured finance contracts that allowed Enron to loans as cash flow from operations for nearly one decade. More than 24 contracts of prepaid commodity swaps and prepaid commodity forward contracts were executed on paper through special purpose entities established by JPMorgan Chase and Citigroup. Enron borrowed a total of ($8.7 Billion between 1992 and 2000 using these structured finance contracts disguised as commodity swaps. The absence of accounting guidance for prepaid commodity swaps gave Enron the way to manipulate its financial statements with impunity to satisfy management goals at the expense of investors.