ENRON'S SECOND HOME
Enron utilized tax loopholes in Caymans haven
Enron utilized tax loopholes in Caymans haven
GEORGE TOWN, Grand Cayman - This island, where scoundrels from Blackbeard to cocaine cowboys have landed looking to launder lucre, was Enron's second home.
The Houston-based energy giant, like thousands of other corporations, set up subsidiaries in Grand Cayman. But while fellow Fortune 500 companies such as Philip Morris and BellSouth created one subsidiary each, Enron set up nearly 700.
Enron also found a tax-free laboratory in the British colony in the Caribbean for testing some unorthodox accounting practices through partnerships formed there. Those partnerships eventually helped bring down the company.
Lawyers on the three Cayman Islands about 500 miles south of Miami said they were concerned about conflicts inherent in the partnerships, which were billed as independent from Enron but managed by the energy company's chief financial officer.
Cayman attorneys said they sought proof that Enron's board approved the partnerships and traveled to Houston several times to meet with Enron officials, including Vinson & Elkins, Enron's outside law firm.
The response: The board's on board. The Cayman attorneys said they were told that U.S. laws and accounting standards were being met.
Locals said the regulatory failure was in Washington, not in George Town, the capital of Grand Cayman.
"Our assessment is, this is largely a U.S.-based issue," said Debra Drummond, the government's assistant financial secretary.
Enron landed in the Caymans during the 1980s, when locals acknowledge that cash pouches and see-no-evil banking weren't unknown.
The notorious Bank of Credit and Commerce International, BCCI, used the Caymans to launder drug money. During the 1990s, an institution named Guardian Bank was revealed as a front for tax evaders.
The islands' banking secrecy laws also helped to attract $800 billion in deposits, making it the world's fifth-largest financial center. The financial industry continues to have its critics but has lately won plaudits for fighting economic crimes.
Enron avoided paying federal income taxes for several years during the '90s thanks partly to its offshore subsidiaries, according to a study by the watchdog group Citizens for Tax Justice. But the company was never enmeshed in scandal in the Caymans until last fall.
"They were our biggest client," said Bruce Putterill, an attorney with Hunter & Hunter, one of the islands' most prestigious law firms. Setting up subsidiaries is Hunter & Hunter's leading business.
Enron's subsidiaries ranged from South American water companies to Asian power firms. The units are registered in the Caymans but don't have local operations, employees or offices.
Putterill said his firm still works for Enron and is negotiating the sale of Enron's interest in a power plant in India.
His firm did nothing wrong or even secretive, he added; all the subsidiaries are listed in Enron's annual report.
U.S. firms such as General Motors, BellSouth and Philip Morris are among those that incorporate units in the Caymans, drawn primarily by the freedom from taxes. Legend says that British King George III rewarded the Caymans with permanent status as a tax haven after locals saved victims of a shipwreck during the late 1700s.
The Caymans also offers freedom from U.S. government oversight and regulation, as well as a financial services system that caters to businesses, with 600 banks and innumerable investment houses.
Putterill said his trips to Enron's Houston headquarters were part of his routine checks on its business practices. He declined to elaborate on the discussions, citing attorney-client privilege.
At some point, Putterill said, he suspected that Enron's subsidiaries weren't doing well. "Over the last two years they've actually been selling assets," he said.
In 1999, about the time Enron's Cayman units began selling assets, company representatives approached another George Town law firm.
This time, they wanted to erect a complex corporate structure: an independent partnership that would do business with Enron.
LJM Cayman was like hundreds of other partnerships that Henry Harford had helped set up.
"It'd be easy to say the Cayman Islands is at the center of some intergalactic plot," said Harford, an attorney with Maples and Calder, the island's largest law firm.
The truth, he said, "is ... more mundane."
Harford said he set up the LJM Cayman partnership in June 1999 at the request of a U.S. law firm working for Enron. He declined to name the firm.
LJM are the initials of the children of Andrew Fastow, Enron's chief financial officer, who would run the partnership. The partnership would house ventures for Enron and some European investors, who put in $16 million, Harford said he was told.
Harford said he was concerned about the potential conflicts inherent in Fastow's dual roles as Enron's chief financial officer and the manager of what was billed as an independent partnership.
"We said, 'We must make sure Enron knows about it.' Otherwise, it wouldn't be quite right," he said.
Enron knew. The board had waived its conflict-of-interest policy for Fastow.
Harford said he was told that LJM Cayman was a vehicle for bringing foreign investors into Enron ventures, such as a Brazilian power project.
But that played only a minor role, according to an internal investigation led by former Enron board member William Powers Jr., dean of the University of Texas law school. LJM Cayman's main purpose was to protect, or hedge, the value of an investment that Enron had in the Internet firm Rhythms NetConnections.
But in a true hedge, an unrelated party is paid to assume the risk of a volatile investment. In the case of LJM, Enron was using its own stock as leverage, which could be disastrous if the stock price fell.
In addition, the partnership terms were skewed toward LJM and enriched Fastow and other investors, the internal investigation found. Those investors included several Enron employees who were secretly offered financial interests by Fastow, the report says.
The Fastow Family Foundation, for example, invested $25,000 and received $4.5 million within months when Enron bought out the partnership. Two other Enron executives invested $5,800 and received about $1 million in one or two months.
Harford said he was unaware that Fastow and other Enron insiders made millions of dollars from the Cayman partnerships. "I don't know if that's true or not," he said.
Although Harford questioned the ethics of the partnerships, he said the U.S. legal standards are not hard to meet.
The LJM Cayman unit was designed to be legally independent from Enron so that Enron could keep the partnership's losses and debts off its corporate books. That requires only that a 3 percent stake be held by an outsider.
"That 3 percent rule always struck me as complete nonsense," Harford said.
But the internal investigation of Enron indicated that the partnership never had the required outside investment. Shortly before filing for bankruptcy, Enron acknowledged that the Cayman partnerships and others didn't meet the 3 percent rule. As a result, Enron had to write down its assets by $1 billion.
"Having something off-balance sheet is not a problem," Harford said. "Thinking it's off-balance sheet, and it isn't, is the problem."
Harford said that he was shocked that the partnerships were the cover for such dealings, but that it wasn't his job to oversee them.
"An analogy is, Ford makes a car and someone uses it in a getaway," he said. "We don't check in every day. That's not our business."
Putterill said the Enron debacle has little to do with the Cayman Islands.
"If anything is going to be done to prevent incidents like this in the future," he said, "it will have to come from the U.S."
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