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Teaching Enron Georgetown University Law Center Scholarship @ GEORGETOWN LAW 2005 Teaching Enron Milton C. Regan Georgetown University Law Center, [email protected] This paper can be downloaded free of charge from: https://scholarship.law.georgetown.edu/facpub/313 74 Fordham L. Rev. 1139-1249 (2005) This open-access article is brought to you by the Georgetown Law Library. Posted with permission of the author. Follow this and additional works at: https://scholarship.law.georgetown.edu/facpub Part of the Business Organizations Law Commons, and the Legal Education Commons GEORGETOWN LAW Faculty Publications March 2010 Teaching Enron 74 Fordham L. Rev. 1139-1249 (2005) Milton C. Regan Professor of Law Georgetown University Law Center [email protected] This paper can be downloaded without charge from: Scholarly Commons: http://scholarship.law.georgetown.edu/facpub/313/ SSRN: http://ssrn.com/abstract=844191 Posted with permission of the author TEACHING ENRON Milton C. Regan, Jr.* INTRODUCTION ........................................................................................ 1140 I. ENRON ..........................................................................................1143 II. ENRON'S ATTORNEYS .................................................................. 1154 A. Inside Counsel ....................................................................... 1154 B. Outside Counsel .................................................................... 1155 III. STRUCTURED FINANCE TRANSACTIONS ....................................... 1156 A. Background ........................................................................... 1156 B. Enron's FinancialAssets ...................................................... 1157 C. The "Sales" that Weren't...................................................... 1158 D. Issue One: True Sale Versus True Issuance Opinions ......... 1162 Questions and Discussion ..................................................... 1166 E. Issue Two: Andrews & Kurth Opinions ............................... 1172 Questions and Discussion ..................................................... 1176 IV. PROJECT NAHANNI ....................................................................... 1180 A. Background ........................................................................... 1180 B. The Structure of ProjectNahanni ....................... 1182 C. Enron's Attorneys ................................................................. 1186 D. Questions and Discussion..................................................... 1188 V. SUNDANCE INDUSTRIAL TRANSACTION ....................................... 1191 A. Background ...........................................................................1191 B. ENA Sale of Sonoma Class A Interest to Salomon................ 1194 C. Enron's Lawyers ...................................................................1195 D. Questions and Discussion..................................................... 1199 VI. RELATED PARTY TRANSACTIONS ................................................ 1202 A. Background ........................................................................... 1202 B. Issue One: The "Hedges" that Weren't ............................... 1203 C. RhythmsNet ........................................................................... 1205 Questions and Discussion ..................................................... 1210 D. Raptors .................................................................................. 1213 * Professor of Law, Georgetown University Law Center. My thanks to Vic Fleischer for comments on a draft of this article, and to Bill Bratton for his review of the description of selected transactions. I am also grateful to Jeff Bauman for comments and advice as I have taught classes based on the events surrounding Enron, as well as for countless conversations about ethics issues that arise in corporate law practice. A short discussion of some of the transactions that I analyze in this article is contained in Chapter 20 of our casebook, Legal Ethics and Corporate Practice (Milton C. Regan, Jr. & Jeffrey D. Bauman eds., 2005). 1139 HeinOnline -- 74 Fordham L. Rev. 1139 2005-2006 1140 FORDHAM LAW REVIEW [Vol. 74 Q uestions and D iscussion .....................................................1217 E. Issue Two: Disclosure of Fastow'sLJM Compensation...... 1220 Q uestions and D iscussion .....................................................1225 F. Issue Three: Three Percent Outside Equity in Raptors .......1230 Q uestions and D iscussion .....................................................1231 G. Issue Four: Cuiaba Transaction........................................... 1232 Questions and D iscussion .....................................................1237 V II. C H EW CO .......................................................................................1238 A . B ackground ...........................................................................1238 B. Issue One: Enron Officer Involvement in Chewco ...............1238 Q uestions and Discussion .....................................................1239 C. Issue Two: Three Percent Outside Equity ............................1240 Questions and D iscussion .....................................................1243 C O N CLU SIO N ...........................................................................................1243 INTRODUCTION The word "Enron" has become a shorthand reference for corporate wrongdoing in the first years of the twenty-first century. Aside from the dizzying heights from which it fell, Enron was notable for the intricacy of the misbehavior in which it engaged. "'Every other white-collar case in history is arithmetic,"' commented one investigator, while "'Enron is calculus.' 1 The company created elaborate organizational structures, often with multiple layers of control, that were intended to use legal form to disguise economic substance. Such manipulation of form obviously required the services of many lawyers. Transactional lawyers in particular have expertise in fashioning elaborate permutations of form that the law will honor, even if the result is not entirely congruent with underlying economic substance. 2 It is reasonable therefore to assume that lawyers' fingerprints were on Enron's arrangements perhaps more than in any other recent corporate scandal. Enron thus would seem to have especially valuable potential as an instructive case study for lawyers and law students. In particular, it promises to offer insights into the kinds of judgments that transactional lawyers must make-a group largely neglected in ethics rules and whose 1. Jeffrey Toobin, End Run at Enron, The New Yorker, Oct. 27, 2003, at 48, 50. 2. A "triangular" merger, for instance, is an arrangement in which an acquiring company creates a new subsidiary to which it transfers its assets in return for all of the subsidiary's stock. The boards and shareholders of the subsidiary and the acquired company then approve the merger of the two entities, thereby avoiding what otherwise would be the requirement that the merger be approved by the original acquiring company's shareholders. Similarly, corporate subsidiaries may be substantively controlled by a parent company, but still treated formally as separate entities for certain purposes. A "synthetic lease" enables a company to sell and then lease back its assets, continue to operate exactly as before, but remove the debt associated with those assets from its books. The list is limited only by the imaginations of corporate lawyers and business professionals. HeinOnline -- 74 Fordham L. Rev. 1140 2005-2006 2005] TEACHING ENRON 1141 activities generally are shielded from public view. Much of the commentary on Enron's attorneys has focused on whether these lawyers violated ethical rules or other legal provisions, and on how the law governing attorney conduct might be strengthened to prevent future 3 transgressions. This commentary generally has been thoughtful and valuable as far as it goes. The application of legal rules, however, is triggered by the existence of certain facts-and the perception that these facts exist is the result of a complicated process. As Geoffrey Hazard has observed, "The difficult ethical problem . is not ... what the rule says but whether the factual conditions have arisen that call the rule into operation." 4 This suggests that we may gain particularly rich insights into the complexity of ethical judgment by trying to understand circumstances as lawyers themselves may have seen them. Proposed transactions do not come labeled as problematic and intricate legal structures are rarely obviously fraudulent. Those characterizations are conclusions that are the product of a complex process of perception that organizes information in particular ways, based on factors such as situational cues and personal predilections. Behaving ethically requires cultivating powers of perception that are sensitive to and recognize events that carry ethical significance. Gaining an appreciation of the circumstances in which a given set of lawyers operated can be difficult, because it requires access to details about the texture of practice that often are unavailable. In the case of Enron, however, the bankruptcy court appointed an Examiner to review many of Enron's transactions for the purposes of determining what assets might be recovered by the company's estate and whether Enron might have causes of action against any individuals or entities.5 In response, over the course
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