FASB Tightens Rules on Special Purpose Entities

The board that writes U.S. accounting rules issued new guidelines today aimed at preventing the kind of abuse of financing partnerships that helped trigger Enron Corp.'s collapse.

The Financial Accounting Standards Board's rule on so-called special purpose entities, which Enron used to hide massive amounts of debt, requires that outside investors provide at least 10 percent of the SPE's capital or that they have to be included on a company's balance sheet.

Previous accounting practice required only a 3 percent investment by outsiders. When accountants determined that Enron didn't even meet that standard on a key SPE, it was forced to move large debts back onto its books and report a loss that led to its bankruptcy filing.

“FASB has certainly gone a long way toward curing the problems of Enron, especially with increasing the 3 percent to the 10 percent equity,” said Steven L. Schwarcz, a business and law professor at Duke University.

The financing vehicles, which the FASB now refers to as “variable interest entities,” are broadly used as a way for companies to isolate a business operation and attract investors to it. They are used, for instance, for leasing airlines and commercial buildings, and to turn credit card billings into bonds. Thus, the standards board faced intense lobbying pressure from groups concerned the new guidelines would hurt their business.

It is not clear what the exact effect of the new rules will be because companies generally have not had to disclose information about their use of SPEs before, although the Securities and Exchange Commission did begin requiring some added disclosures last year.

Some accounting experts estimate that billions of dollars in debt will have to be consolidated as a result of the new rules unless companies can raise outside capital.

“I don't know but I suspect there's going to be a heck of a lot of assets and liabilities added to balance sheets,” said Jeffrey P. Mahoney, a FASB project manager based in Washington.

The new standards also require companies to disclose their involvement with an SPE, including the nature and amount of their risk. That information must be included in the footnotes of a company's annual report.

SPEs created after Jan. 31 will have to conform to the new standards immediately. Existing ones would have to follow the new guidelines for consolidation after June 15.

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