Enron - Special Purpose Entities

Special Purpose Entities (SPE) are legal. Enron violated both the 3% equity and transfer of risk requirements. Is Enron’s use of the SPE not only illegal, but also unethical? In what respects? What makes the SPE ethical in certain circumstances, and not others? Is there ever a case where you would consider and SPE ethical? What, is anything, differentiate that circumstances from those in the case?

After the Enron collapse, the word SPE has acquired an unpleasant connotation in public mind. A SPE, as the name suggests, is formed for a special purpose: therefore its powers are limited to what might be required to attain that purpose and its life is destined to end when the purpose is attained.

When a corporation, call it the sponsor of the SPV, wants to achieve a particular purpose, for example, funding, by isolating an activity, asset or operation from the rest of the sponsor's business, it hives off such asset, activity or operation into the vehicle by forming it as a special purpose vehicle. This isolation is important for external investors whose interest is backed by such hived-off assets, etc., but who are not affected by the generic business risks of the entity of the originating entity. Thus SPEs are housing devices - they house the assets etc transferred by the originating entity in a legal outfit, which is legally distanced from the originator, and yet self-substained as not to be treated as the baby of the originator.

By its very nature, an SPV must be distanced from the sponsor both in terms of management and ownership, because if the SPV were to be owned or controlled by the sponsor, there is no difference between a subsidiary and an SPV.

In Enron’s case using SPE was not only illegal but also unethical because Enron’ executives intended to cheat from the beginning and thus used their friends to satisfy 3% outside equity rule.

A SPE can be used ethically if such a SPE is independent, responsible for its own funding, risk capital and management decisions. Most SPEs, for example, securitization SPEs, run on a pre-punched program and do not have to take any management decision: they are almost "brain dead".

The key issue in examining an SPV is distancing of the SPV as far as management, control and shareholding is concerned. If the SPV stands on its own feet in terms of ownership, funding and management, it achieves an arms length relation with its sponsor and therefore becomes just like any other relationship.

But the real issue is that most SPEs are figments floated by the originator and are hardly independent in any sense, as was the case with Enron. The mechanical rules that define SPEs are largely responsible because these rules, based on a certain amount of risk capital in the SPE are easy to circumvent.

Enron’s board of directors attempted to put control in place, but it seems Enron senior management was unwilling to take control issue seriously. Was Enron’s Board serious about the controls or was it negligent? Should Enron’s board have done more, or would that become micromanaging?

Enron’s board’s attempts to put control in place were highly flawed and lacked any will power. They had some controls but there was no one to ensure that executives are doing what they are supposed to do. Enron’s board could definitely have done more without labeled as micromanaging.

Enron was really building markets where none existed. Should they be faulted for testing the market structures? They, among other companies, were responsible for one of the greatest market booms in recent history, cannot be solely faulted for the collapse of the market. Should they not be rewarded for their economic contribution?

The damage Enron did by indulging in unethical and illegal practices was much greater than their contribution to the market. Enron abused SPEs to create an illusion of liquidity. Without this illusion, Enron’s business would have migrated to other firms that were increasingly figuring out other ways of participating in the commodities that the Enron