A Revisionist View of Enron and the Sudden Death of 'May'
University of San Diego School of Law
Villanova Law Review, Vol. 48, No. 4, p. 1245, 2003
This article makes two points about the academic and regulatory reaction to Enron's collapse. First, it argues that what seems to be emerging as the conventional story of Enron, involving alleged fraud related to Special Purpose Entities, is incorrect. Instead, this article claims that Enron is largely a story about derivatives - financial instruments such as options, futures, and other contracts whose value is linked to some underlying financial instrument or index. A close analysis of the facts shows that the most prominent SPE transactions were largely irrelevant to Enron's collapse, and that most of Enron's deals with SPEs were arguably legal, even though disclosure of those deals did not comport with economic reality. This first point about derivatives is important to the literature studying the relationship between finance and law: legal rules create incentives for parties to engage in economically equivalent unregulated transactions and financial innovation creates incentives for parties to increase risks (to increase expected return) outside the scope of legal rules requiring disclosure. Second, this article argues that the regulatory response to Enron was misguided, in part because it focused too much on the conventional story. Congress - in a little noticed provision of the Sarbanes-Oxley Act of 2002, Section 401(a) - directed the Securities and Exchange Commission to adopt new regulations requiring that periodic filings disclose off-balance sheet transactions that may have a material effect on a company's financial condition. The SEC originally proposed disclosure regulations based on this heightened may standard, but in its final release reverted to a lower reasonably likely standard. Surprisingly, the SEC promulgated these reasonably likely regulations even though Congress, in debating Sarbanes-Oxley, already had considered - and rejected - this approach. This second point about regulatory response is important to the literatures studying both mandatory disclosure and the relationship between Congress and administrative agencies: not only did interested private actors quickly capture the agency rule-making process, but they were able to persuade the agency to revive an interpretation the legislature already had considered and rejected.
Number of Pages in PDF File: 37
JEL Classification: K22
Date posted: June 17, 2003