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© Newswise.
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Keeping Your Balance with Off-Balance Sheet Financing
Newswise — The robber barons of corporate finance at Enron and Worldcom have increased awareness among journalists, investment professionals and the public alike about the dangers and prevalence off-balance sheet activity. AIMR's recent survey focused on corporate communications discovered that off-balance sheet accounting is one of the most important topics of concern to investment professionals, and it's not surprising that both the Securities and Exchange Commission (SEC) and the Financial Accounting Standards Board (FASB) have bolstered their standards. Even so, this doesn't mean that the problem will evaporate on its own, since the new standards primarily indicate where to look for potential trouble. "Off-balance sheet transactions exist because companies want to find ways to control resources without showing debt on their balance sheets. Instead of buying a building, they lease it. Instead of having a mine producing something, they contract with somebody else to buy all the output," said Gerry White, CFA, investment adviser at Grace & White in New York. Because the debt belongs to an outside entity, the company does not have to disclose it on its balance sheet, White explained. Now, companies will have to comply with new standards that lower the threshold for revealing the existence and nature of such arrangements. "Some companies believe that the only things that matter are what's reported on the balance sheet, but I think they're deluding themselves," White said. "To the extent you have disclosure, it allows analysts and rating agencies to figure out the underlying debt," ultimately affecting stock prices and credit ratings. Analysts have been urging improved disclosure on these transactions for years, but only recently have the SEC and FASB acted to tighten the guidelines on off-balance sheet accounting. White added that increased empowerment of auditors resulting from more in-depth auditor oversight boards and new SEC rules as mandated by the Sarbanes-Oxley Act of 2002, also makes a big difference in improving accounting transparencies. White said that regulators were aware of the problem, but it took an "Enron" for them to take the problem seriously and make a move. "Enron and some of the other disasters made the regulators realize how abusive this area could be," he said. The current accounting standards wouldn't necessarily have called the dogs on Enron, which had signs of quirky doings on the books already, but it would probably have revealed more clues. "It's also possible that Enron and some of the other companies wouldn't have done some of the things they did," White said. One major issue that is not adequately covered by the new regulations is joint ventures, which were used by Enron. "Enron used them abusively, but if they had provided more information on joint ventures, you certainly would have had a clue as to what was going on," White said. Being informed is always the best form of empowerment both for investors, as well as journalists. But there are some questions that journalists can ask in order to help investors be informed about a company's finances to help uncover off-balance sheet transactions. White said that reporters need to be sensitive to the strict disclosure guidelines of Sarbanes-Oxley and understand a company's particular situation when asking questions. He suggested four general topics for discussion that can help a journalist look behind the curtain of off-balance sheet financing: 1. Contractual relationships with suppliers -- does the company have any agreements that require it to buy specific goods or services over a long time period? Company officials should be able answer those questions, unless they claim that the information contained in them is confidential or because they would provide insider information, White said. Tamiko Toland is a financial journalist with Thomson Media.
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