Enron Corp. - University of California | Office of The President

the hedge, which would also be recorded on Enron's income statement. Like the Rhythms hedge,
these transactions were not real hedges – they were not with a creditworthy, independent outside
party and there was no transfer of the economic risk of a decline in the investments. Enron still bore
virtually all of the economic risk and, in effect, Enron was hedging risk with itself. This practice of
using Enron's own stock to offset losses was contrary to a basic principle of financial reporting that,
except under limited circumstances which Enron did not meet, a business may not recognize gains
due to the increase in the value of its own capital stock on its income statement. See APB No. 9, 28
and ARB No. 43, Chapter 1.
463. When the value of many of Enron's merchant investments fell in late 2000 and early
2001, the Raptors' hedging obligations to Enron grew. At the same time, however, the value of
Enron's stock declined, decreasing the ability of the Raptors to meet those obligations. These two
factors combined to create in 1stQ 01 a $500 million impairment for Enron of the Raptors'
obligations to it. In order to avoid recording a massive reserve, the Enron Defendants restructured
the vehicles in the first quarter of 2001.
464. Ultimately, in the 3rdQ 01, Enron finally recorded an after-tax charge of $544 million
($710 million pre-tax) and also reported a reduction in shareholder equity by $1.2 billion. However,
even this restatement did not correct the improperly reported income derived from the Raptors of $1
billion in 1999-2000. Transactions with the Raptors from the 3rdQ 00 through the 3rdQ 01 allowed
Enron to improperly avoid reflecting almost $1 billion merchant investments losses on its income
statement, such that pre-tax earnings were overstated by 240%.
465. Skilling was behind the decision to create the Raptors as he wanted to protect the
value of merchant investments and avoid excessive quarter-to-quarter volatility in Enron's reported
earnings. Due to the size and illiquidity of many of these investments, they could not practicably be
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