Enron's scandal, the companies activities between 1999 and 2001, was facilitated by the repeal of Glass Steagall and the
Commodity Futures Modernization Act of 2000Whitewing
The White-winged Dove is native to Texas, and was also the name of a special purpose entity used as financing vehicle by Enron.<30> In December 1997, with funding of $579 million provided by Enron and $500 million by an outside investor, Whitewing Associates L.P. was formed. Two years later, the entity's arrangement was changed so that it would no longer be consolidated with Enron and be counted on the company's balance sheet. Whitewing was used to purchase Enron assets, including stakes in power plants, pipelines, stocks, and other investments.<31> Between 1999 and 2001, Whitewing bought assets from Enron worth $2 billion, using Enron stock as collateral. Although the transactions were approved by the Enron board, the assets transfers were not true sales and should have been treated instead as loans.<32>
LJM and Raptors
Main article: LJM (Lea Jeffrey Michael)
In 1999 Fastow formulated two limited partnerships: LJM Cayman. L.P. (LJM1) and LJM2 Co-Investment L.P. (LJM2), for the purpose of buying Enron's poorly performing stocks and stakes to improve its financial statements. Each of the partnerships were created solely to serve as the outside equity investor needed for the special purpose entities that were being used by Enron. Fastow had to go before the board of directors to receive an exemption from Enron's code of ethics (since he was serving as CFO) in order to run the companies.<33> LJM 1 and 2 were funded with around $390 million of outside equity contributed by J.P. Morgan Chase, Citigroup, Credit Suisse First Boston, and Wachovia. Merrill Lynch, which marketed the equity, also contributed $22 million.<29>
Enron transferred to "Raptor I-IV", four LJM-related special purpose entities named after the velociraptors in Jurassic Park, more than "$1.2 billion in assets, including millions of shares of Enron common stock and long term rights to purchase millions more shares, plus $150 million of Enron notes payable."<34><35><36> The special purpose entities had been used to pay for all of this using the entities' debt instruments. The instruments' face amount totaled $1.5 billion, and the entities had been used to enter into derivative contracts with Enron for a notional amount of $2.1 billion.<35>
Enron capitalized the Raptors, and, in a similar matter to when a company issues stock at a public offering, then booked the notes payable issued as assets on its balance sheet and increased its shareholders' equity for the same amount.<37> This treatment later became an issue for Enron and its auditor Arthur Andersen as removing it from the balance sheet resulted in a $1.2 billion decrease in net shareholder equity.<38>
The derivative contracts of $2.1 billion did lose value. Enron had set up the swaps just as the stock prices had hit their high points. Over five fiscal quarters, the value of the portfolio under the swaps fell by $1.1 billion as the stock prices fell (the special purpose entities now owed Enron $1.1 billion under the contracts). Enron, using "fair value" accounting, was able to show a $500 million gain on the swap contracts in its 2000 annual report, which exactly offset its loss on the stock portfolio. This gain was attributed to one third of Enron's earnings for 2000 (before it was properly restated in 2001).<39>
linkThe “Enron Loophole”
The section 2(h) “loophole”
The first provision of the CFMA to receive widespread popular attention was the “Enron Loophole.” In most accounts, this “loophole” was the CEA’s new section 2(h). Section 2(h) created two exemptions from the CEA for “exempt commodities” such as oil and other “energy” products.<71>
First, any transaction in exempt commodities between “eligible contract participants” (acting as “principals”) not executed on a “trading facility” was exempted from most CEA provisions (other than fraud and anti-manipulation provisions). Even the fraud provisions were excluded for transactions between “eligible commercial entities.” This exemption in Section 2(h)(1) of the CEA covered the “bilateral swaps market” for exempt commodities.<72>
Second, any transaction in exempt commodities executed on an “electronic trading facility” between “eligible commercial entities” (acting as principals) was also exempted from most CEA provisions (other than those dealing with fraud and manipulation). The “trading facility”, however, was required to file with the CFTC certain information and certifications and to provide trading and other information to the CFTC upon any “special call.” This exemption in Section 2(h)(3) of the CEA covered the “exempt commercial market” for “electronic trading facilities.”<73>
While the language of Section 2(h) was in H.R. 4541 as passed by the House, the portion of Section 2(h) dealing with the exempt commercial market had been deleted from S. 2697 when the Senate Agriculture Committee reported out an amended version of that bill. H.R. 4541 served as the basis for Titles I and II of the CFMA. The Senate Agriculture Committee’s removal of the Section 2(h) language from S. 2697, however, served as the basis for later Senate concern over the origins of Section 2(h).<74>
In 2008 Congress enacted into law over President Bush’s veto an Omnibus Farm Bill that contained the “Close the Enron Loophole Act.” This added to CEA Section 2(h) a new definition of “energy trading facility” and imposed on such facilities requirements applicable to fully regulated exchanges (i.e. “designated contract markets”) such as the NYMEX. The legislation did not change Section 2(h)’s exemption for the “bilateral swaps market” in energy commodities.<75>
The section 2(g) “loophole”
Section 2(g) of the CEA is also sometimes called the “Enron Loophole”. It is a broader exclusion from the CEA than the Section 2(h) exemption for the “bilateral swaps market” in exempt commodities. It excludes from even the fraud and manipulation provisions of the CEA any “individually negotiated” transaction in a non-agricultural commodity between “eligible contract participants” not executed on a “trading facility.” Thus, the exclusion from provisions of the CEA for “eligible contract participants” is broader than the Section 2(h)(1) exemption for “bilateral swaps” of energy commodities. The criteria for this exclusion, however, are narrower in requiring “individual negotiation.”<76>
This exclusion was not contained in either H.R. 4541 or S. 2697 as introduced in Congress. The House Banking and Financial Services Committee added this provision to the amended H.R. 4541 it reported to the House. That language was included in H.R. 4541 as passed by the House. Its final version was modified to conform to the Gramm-Leach-Bliley Act definition of “swap agreement.” That definition requires that the swap be “individually negotiated.” H.R. 4541 had required that each “material economic term” be individually negotiated.<77>
2002 Senate hearings indicated CEA Section 2(h)(3) was not the“Enron Loophole” used by EnronOnline. That facility was not required to qualify as an “electronic trading facility” under Section 2(h)(3) of the CEA because Enron Online was only used to enter into transactions with Enron affiliates. There were not “multiple participants” on both the buy and sell sides of the trades. Whether such Enron-only trades were covered by the Section 2(h)(1) “bilateral swaps market” exemption for energy products or the broader Section 2(g) exclusion for swaps generally depended whether there was “individual negotiation.”<78>
Credit default swaps
With the 2008 emergence of widespread concerns about credit default swaps, the CFMA’s treatment of those instruments has become controversial. Title I of the CFMA broadly excludes from the CEA financial derivatives, including specifically any index or measure tied to a “credit risk or measure.” In 2000, Title I’s exclusion of financial derivatives from the CEA was not controversial in Congress. Instead, it was widely hailed for bringing “legal certainty” to this “important market” permitting “the United States to retain its leadership in the financial markets”, as recommended by the PWG Report.<79>
link