In addition to maintaining the Wall Street Journal’s essential Law Blog, Peter Lattman continues to contribute interesting news articles for the WSJ, including this one from yesterday that he co-authored with Jesse Eisinger about something that is close to the heart of the Enron scandal — a company’s alleged use of special purpose entities to dump low-performing assets that would otherwise depress earnings if the company were to hold on to them (thus, the characterization of an SPE as a “nuclear waste dump”).
Public revelations of former Enron CFO Andy Fastow’s shenanigans with certain of Enron’s SPE’s in October, 2001 triggered the collapse of Enron into bankruptcy, and the same thing almost happened to Omnicon — the world’s largest ad holding company — back in June 2002. At that time, the WSJ reported that an Omnicon SPE called Seneca Investments appeared to have been used by Omnicom to avoid an earnings charge of about $90 million in connection with its reporting of $246 million of earnings for the first half of 2001. Given the nearness of similar disclosures relating to Enron and Enron’s subsequent December, 2001 bankruptcy, Omnicom’s stock price dropped like a rock before stabilizing at about half of its pre-SPE disclosure price. Nevertheless, the company was able to stem an Enronesque collapse into bankruptcy.

But that happy story still does not resolve the knotty and inevitable civil securities fraud lawsuit over the matter, and discovery in that lawsuit is revealing precisely how Omnicon handled the favorable transaction with its SPE. The product of that discovery indicates that Omnicon set up Seneca in May 2001 with private equity firm Pegasus Capital for the purported purpose of reorganizing some struggling dot-com businesses. In return for the contribution of stakes in three public companies — Agency.com, Organic and Razorfish — along with interests in 13 nonpublic companies and some cash, Omnicom received preferred Seneca shares and accounted for the deal as an asset sale without reporting a gain or loss. Arthur Andersen orginally signed off on the accounting for Omnicon and then, after Andersen was prosecuted out of business partly for approving similar deals in regard to Enron, KPMG also approved the accounting for the transaction.
The kicker? Omnicon paid about $128.1 million for its interest in Agency.com, Organic and Razorfish, but the value of those interests at the time Omnicon contributed them to the Seneca SPE had dropped $89.5 million to $38.6 million.
In the meantime, Omnicon’s stock has recovered and now trades at a higher price than it did before the revelation of the Seneca SPE. No Omnicon executives or auditors were charged with a crime. But in Houston, former Enron executives Ken Lay and Jeff Skilling await a jury’s determination of whether they will spend most of the rest of their lives in jail in large part because of Enron’s similar use of SPE’s, which were also approved by outside auditors and attorneys.
Thus, as noted here, Enron’s use of SPE’s is criminal because Enron landed in bankruptcy. On the other hand, Omnicon’s use of SPE’s is not because it was able to avoid that fate. Meanwhile, other executives skate because of good timing in going bust. So it goes in the never-ending lottery of criminalizing corporate agency costs.
Peter Henning has more on the crime-fraud implications of the matter here, and Peter Lattman updates the story in this post on his blog.