Related Party Transactions first gained attention of regulators after the collapse of Enron. At the time of its bankruptcy, it was the 7th largest company in the world. Investigations first by its own employees and then by regulators uncovered a web of related party transactions which I will describe.
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Enron had a policy of booking the Present Value of Future cash flow of a contract as Income once the contract was signed. This boosted Revenue and thus earnings and EPS went through the roof and stock price went through the roof. They would put up a gas pipeline in Porto Rico and estimate the life of the pipeline as 25 years, estimate the revenue PV it and book it as revenue. There was one catch. There was no cash to show.<\/p>\n\n\n\n
This is when their CFO Andy Fastow hit upon a plan. He incorporated 2 SPVs in Cayman Islands backstopped by Enron\u2019s Stock. They would borrow from Banks and buy Enron\u2019s receivables thus Enron would get cash and sell the future receivables to these two SPVs who would collect the receivables. The banks lent SPVs money in the hope to get investment banking mandates.
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Their Management Consultants Arthur Anderson suggested large parts of this scheme. Auditors from Arthur Andersen found nothing wrong in this Future Value Accounting. This scheme got uncovered when one CPA within Enron flagged these transactions and said this involved conflict of interest and they were related party transactions tainted by extra commercial considerations and were not at arm\u2019s length.<\/p>\n\n\n\n
The stock Price collapsed and because Enron had offered its stock as collateral to the banks to lend to the 2 SPV\u2019s the banks called for additional collateral to be posted, Enron Could not and the banks pulled the plug on the loans. This led to an even greater drop in the value of the shares and regulators stepped in while Enron declared Bankruptcy.<\/p>\n\n\n\n