Footnote 8

eported the repayment obligation as price risk management liabilities. The difference in treatmentwas important because balance sheet debt is a component of several of the key financial ratios therating agencies continuously monitored.189. The difference in accounting treatment also was important to Enron’s cash flowstatements. Had the cash flow to Enron been properly recognized as loan proceeds, those fundswould have been recorded as cash flow from financing activity. Instead, by misclassifying the fundsflow as emanating from a commodity contract, the Insiders ensured that the funds were reported ascash flow from operating activities. Again, cash categorized as funds flow from operations helpedthe Insiders “manage” the “quality of earnings” problem that the rating agencies perceived couldarise from the use of MTM accounting.190. Accounting for the Enron prepay transactions as if they were commodities contractsrather than debt violated GAAP – among other provisions, FAS133 and Emerging Issues Task ForceAbstract 98-15 (“EITF 98-15"), titled “Structured Notes Acquired for a Specified InvestmentStrategy.”191. Every independent entity to investigate the Enron prepay transactions agrees that theyviolated GAAP. The Senate Permanent Committee on Investigations investigated and reported onthe Enron prepay transactions. At the conclusion of the investigation, the Committee’s ChiefInvestigator characterized the prepays as a “sham” and described succinctly the GAAP rules forprepays and how the Enron prepays deviated from those rules:In order for [prepay] transactions like the ones used by Enron and the banks to belegitimately booked as a trading liability and not debt, four elements had to bepresent: One, the three parties had to be independent; two, the trades among the threeparties could not be linked; three, the trades had to contain price risk; and, four, therehad to be a legitimate business reason for the trades.The Enron type prepays we examined failed on all accounts: Two of the threeparties in the Enron trades were related – the banks and their offshore specialpurpose entities which the banks established and controlled; the trades among the604041v1/007457-51-