Enron’s Raptors: a hedge backed by its own risk

attributedRaptor I was Talon I LLC. Enron participated through its wholly owned Harrier I LLC, contributing a $50 million note and $537 million of Enron stock and contracts in exchange for a $400 million note and membership interests. LJM2 contributed $30 million and managed the vehicle. ¹

qualification

The transaction was effective 18 April 2000. A nominal outside contribution did not establish independence where its return was protected and Enron supplied most of the credit capacity.

attributedThe Raptor I arrangements gave LJM2 priority over Enron’s hedging activity: the vehicle was not to enter the derivatives until LJM2 had received a $41 million distribution. An Enron put-option transaction produced that payment in August 2000, leaving little outside money exposed before the hedges began. ¹

qualification

The $41 million distribution included return of capital and profit; it was not a $41 million profit on top of the $30 million investment. The option transaction also returned $4 million to Enron.

attributedRaptor I recorded $734 million notional derivatives, all dated 3 August 2000 although many were negotiated in September. A hedge of Avici stock at an earlier, higher valuation offset about $75 million of decline. The committee said the earlier date did not reflect when the transactions were actually entered. ¹

qualification

The committee found no direct evidence of why 3 August was selected. The board approved Raptor I on 2 May, after its effective date; internal approval signatures followed later, with Skilling’s line blank. Notional derivative value is not equivalent to cash investment.

response

Internal lawyer Jordan Zisman raised concerns about transactions involving impaired assets; he later qualified his account and did not say all relevant assets were known to be impaired. Senior lawyers disagreed with his legal assessment.

attributedThe four Raptor vehicles were Talon I, Timberwolf I, Porcupine I and Bobcat I. The retained subsidiary schedule places them respectively beneath Harrier I, Grizzly I, Pronghorn I and Roadrunner I. Raptor II was created in June 2000, Raptor III in September and Raptor IV also in September. ^{1 2}

qualification

The report warns that some board materials called the fourth structure Raptor III. The sequence here follows its reconciled naming; an exhibit listing is not a complete contemporaneous percentage-ownership table.

attributedRaptor III, Porcupine, was designed to hedge Enron’s investment in The New Power Company using New Power shares themselves. Enron transferred warrants on 24 million shares, through Pronghorn, for a $259 million note; LJM2 contributed $30 million and received $39.5 million about a week later. Enron then used a swap on 18 million New Power shares to support a gain of approximately $370 million. ¹

qualification

The warrants had been carried at zero by Enron. The report says the $259 million note was not recorded or deducted from Porcupine’s credit capacity, and found no board approval record. This was a circular exposure to the same investment, not independent insurance.

attributedA December 2000 cross-guarantee temporarily shared credit capacity among the four Raptors. In the first quarter of 2001 the shortfall reached approximately $504 million. Enron then cross-collateralised the vehicles and supplied further share commitments in a restructuring documented in April but effective 26 March. ¹

qualification

The committee questioned whether the restructuring could erase an existing impairment, and noted the inconsistency of a restricted-share discount with price protection. It is not treated here as an independently validated hedge.

response

Skilling disputed accounts that he had significant involvement in the December restructuring. Andersen’s initial memorandum supported the temporary cross-guarantee; an amended memorandum in October 2001 recorded objections from its Chicago specialists.

attributedEnron terminated the Raptors on 28 September 2001 and paid LJM2 $35 million to unwind its interests. The termination generated a $710 million pre-tax charge, $544 million after tax. The related $1.2 billion equity reduction comprised about $1 billion of previously overstated equity and about $200 million associated with termination. ¹

qualification

The charge to earnings and correction to equity measure different accounting effects and must not be added as two cash losses. Fastow negotiated for Enron while Kopper, who had acquired Fastow’s LJM2 interest in July, represented LJM2.

response

Enron personnel followed Andersen advice at inception, restructuring and termination according to the committee. The inquiry criticised that advice but could inspect only the workpapers made available to it.

attributedThe Powers inquiry concluded that Enron retained the economic risk behind the Raptor hedges: the vehicles were capitalised substantially with Enron shares and share contracts. Falling merchant investments and a falling Enron share price could therefore defeat both sides of the supposed protection. ¹

qualification

The report calculates $1.077 billion of pre-tax earnings contributions from the third quarter of 2000 through the third quarter of 2001, excluding the separate $710 million termination charge. This is an accounting comparison, not a sum of cash stolen.

attributedThe Powers investigation was a private internal inquiry by William Powers, Raymond Troubh and Herbert Winokur, assisted by legal and accounting advisers. It lacked compulsory powers and did not obtain all relevant emails, Andersen workpapers or cooperation from the LJM partnerships and several central participants. ¹

qualification

Board and committee assessments were solely Powers and Troubh’s views; assessments of Vinson & Elkins were solely Troubh and Winokur’s. Multiple retained copies reproduce one report, not independent corroboration.