Raptor Special Purpose Entities

The Raptor structures were a series of four special purpose entities created by Enron between April and December 2000 to hedge losses on the company’s merchant investment portfolio. Engineered by Andrew Fastow’s Global Finance group in partnership with his LJM2 private equity fund, the Raptors were designed to allow Enron to avoid reflecting investment losses on its balance sheet through off-balance-sheet hedging arrangements. The fatal flaw at the heart of these structures was that the hedges were backed primarily by Enron’s own stock, creating a circular arrangement that provided no true economic protection against loss.

When Enron’s stock price declined in 2001, the Raptors became insolvent, forcing the company to unwind the structures in September 2001 and recognize approximately $710 million in losses. This unwinding contributed substantially to Enron’s third quarter $1.2 billion equity reduction and accelerated the crisis of confidence that destroyed the company. The Department of Justice later characterized the Raptor structures as being “of crucial significance to Enron in hiding its failing financial picture from the public.”

Structure and Purpose

The Four Raptor Vehicles

Each of the four Raptor entities consisted of a two-tier structure with an upper-tier and lower-tier entity, created through Enron’s partnership with LJM2 Co-Investment L.P.:

Raptor I, known internally as “Project Raptor,” served as the prototype for the subsequent three vehicles. LJM2 made an initial investment of $30 million into each structure, while Enron contributed contingent obligations backed primarily by its own stock. The entities then entered into total return swap agreements with Enron to hedge the company’s merchant investment positions.

How the Hedges Worked

The Raptors used equity derivative swaps to provide Enron with protection against declines in the value of its merchant investments. These investments included both publicly traded securities and private equity positions. When Enron entered into a hedge with one of the Raptor vehicles, the SPE would be obligated to pay Enron if the hedged investment declined in value, effectively insulating Enron’s income statement from investment losses.

The transactions required detailed documentation. As Gordon McKillop explained in an August 2000 email: “The Raptor I structure requires that certain information be included with the confirmation of derivative transactions with Talon. Please fill out the attached form for the Avici swap on August 3.” The legal team, including Sara Shackleton and Carol St. Clair, worked extensively on ISDA master agreements and swap confirmations to formalize each hedge.

The hedged portfolio was diverse. A September 2000 email cataloging the pending transactions noted: “We are missing 4 valuations; Amerada Hess, LSI Preferred (We have the warrants), Merlin Credit Derivative and Chewco SLP. Of the 31 privates plus Chewco SLP, we have proposal sheets and confirms for only 7. The publics have all been received.” Public equity hedges included positions in companies such as Avici and Hanover Compressor.

The Circular Hedging Problem

The fundamental flaw in the Raptor structures was that Enron was essentially hedging itself. The credit capacity of the Raptor entities to pay Enron on declining investments depended primarily on the value of Enron stock that Enron itself had contributed to the structures. As one academic analysis of the Powers Report explained: “The economic underpinning of the hedge was based on Enron’s shares—in effect, Enron’s profit was being hedged by Enron’s own shares, and ultimately, hedging yourself against loss provides no economic security against loss at all.”

This meant that if Enron’s stock price fell at the same time as its merchant investments declined in value, the Raptor entities would lack the resources to pay on the hedges precisely when Enron needed them most. The correlation between Enron’s stock price and market conditions affecting its merchant investments made this scenario not merely possible but likely.

Internal awareness of this limitation is documented in the email record. When David Delainey, head of Enron Energy Services, learned about the Raptor structures in May 2000, he immediately questioned their economic substance. He asked colleagues: “How do we immunize ourselves from the workouts being shed into Raptor?” In a follow-up message the same day, he acknowledged the structures’ true nature: “That may work - I don’t want to end up with an equity position I just worked hard to eliminate. Further, raptor may be a good accounting hedge but if we took back JEDI’s share at existing marks we would be destroying significant real value.”

This distinction between “a good accounting hedge” and actual economic protection goes to the heart of what made the Raptors fraudulent. They allowed Enron to record favorable accounting results while providing no genuine protection against loss.

Internal Warnings and Resistance

Risk Assessment Group Concerns

Vince Kaminski, head of Enron’s Research group within the Risk Assessment and Control function, and his team were deeply involved in analyzing and valuing the Raptor structures. Beginning in early 2000, Kaminski’s group provided Monte Carlo simulation models for the Raptor valuations. In April 2000, Paulo Issler emailed Kaminski: “Find attached the MC model for Talon. A copy of this spreadsheet may be found on o:\research\custom\projects\talon.”

By early 2001, as the Raptor structures grew in complexity and the merchant investment portfolio deteriorated, Kaminski’s team intensified their analysis. In February 2001, Rakesh Bharati, a quantitative analyst on Kaminski’s team, began producing detailed spreadsheets examining the Raptor positions. The group also provided valuation analysis to Arthur Andersen, Enron’s external auditor. An April 2001 email noted: “Here is the copy of the spreadsheet for your review. This will form the basis for the discussion with AA today. The arguments are provided in the sheet named ‘Simulation.’”

David Port’s Ethical Concerns

In March 2001, David Port, a senior member of Kaminski’s research group who received daily Raptor position reports, raised explicit concerns about the ethical dimensions of the structures. On March 23, 2001, Port forwarded information to Kaminski with a pointed question: “Vince, How do we cope with the ethical issues this presents? Rgds, DP”

The position reports that prompted this concern were distributed widely to senior management. Recipients of the March 9, 2001 Raptor Position Reports included Ben Glisan (Treasurer), Andrew Fastow (CFO), Richard Causey (Chief Accounting Officer), Rick Buy (Chief Risk Officer), and Greg Whalley (President and COO). Port told Kaminski: “I get this every day - the summary is the important piece.”

Kaminski’s October 2001 Refusal

As Enron’s stock price declined through the summer of 2001, Kaminski’s team began modeling liquidation scenarios for the Raptor structures. In August 2001, Rakesh Bharati reported on deteriorating positions: “R2 was long swap @ $44.875 (about 5.5 MM shares) [Hanover Compressor] with a collar ($34.875 and $94.68), according to my information. It is presently trading around $30.” Another analyst, Ding Yuan, prepared notes on “the impact of current Enron stock price on the Raptor structures.”

On October 4, 2001, shortly after the Raptor unwind but before the full scope of Enron’s problems became public, Kaminski sent an email to Ryan Siurek, copying Rick Buy and David Port, in which he formally refused to support the Raptor valuations his group had produced:

“Ryan, In the follow up to the meeting we had on Wednesday I would like to reinforce one point I made. I feel strongly that I cannot support the valuations my group has produced so far for the LJM/Raptor related transactions without examination of all the related legal documents. I feel that we did solid work based on verbal information, but I cannot guarantee the quality of the final product without looking at the contracts. These transactions are too complex and controversial to bypass this step.”

This refusal to certify the valuations was significant. Kaminski later documented that his original email “disappeared from my mailbox on the Enron system,” prompting him to forward copies to his personal AOL account and to Enron’s LJM litigation team for preservation.

Collapse and Unwinding

The September 2001 Unwind

By September 2001, the combination of declining Enron stock prices and deteriorating merchant investment values had rendered the Raptor structures insolvent. The company moved to unwind the structures before the end of the third quarter. On September 21, 2001, Sara Shackleton circulated draft documentation for the unwinding process, explaining: “The plan is to dissolve each Raptor entity [except for the entities involved in Raptor 3, namely Pronghorn I LLC and Porcupine, LLC] the day following the LJM buyout—in other words, prior to the end of the quarter.”

Raptor III’s entities remained temporarily active due to a related transaction known as the Hawaii monetization, which needed to remain in place for a period following the unwinding of the other structures.

The unwinding transactions closed on September 28, 2001. Ron Baker, from Global Finance, offered to brief Chief Risk Officer Rick Buy: “Let me know if you would like to get together to discuss how the Raptor unwind is accomplished from a mechanical standpoint, as well as, what comes back to Enron in the transaction.”

The $710 Million Loss

The unwinding of the Raptor structures crystallized approximately $710 million in losses. Mary Fischer, working on the tax accounting for the transactions, documented the magnitude in October 2001 emails: “I just checked the SAP reports on Harrier I LLC, Grizzly I LLC, Pronghorn I LLC, Roadrunner I LLC that the total losses of $710,594,336 have not been booked in SAP for September.”

On October 24, 2001, Fischer distributed notice that the Raptor entities were being dissolved: “The messages below advises of the Raptor entities are being dissolved, Harrier, Talon, Roadrunner, Bobcat, Grizzley, Timberwolf. Additionally, the expectation is that there should be little or no activity in these companies post September close.”

These losses contributed to Enron’s disastrous third quarter 2001 announcement in October, which included a $1.2 billion reduction in shareholders’ equity. The disclosure triggered the cascade of events that would lead to Enron’s bankruptcy filing on December 2, 2001.

Accounting Violations and Legal Aftermath

Arthur Andersen’s Role

Arthur Andersen, Enron’s external auditor, was deeply involved in the Raptor transactions. According to the Powers Report, “Andersen participated in the structuring and accounting treatment of the Raptor transactions and charged over $1 million for its services, yet it apparently failed to provide the objective accounting judgment that should have prevented these transactions from going forward.”

The Department of Justice later documented that Andersen’s own Professional Standards Group had deemed the aggregation technique used for the Raptors “a black and white violation of GAAP.” Specifically, “Enron’s engagement team had approved the use of an improper accounting technique for four ‘Raptors,’ and to conceal the fact that some of the Raptors had suffered severe losses, the Enron engagement team had allowed Enron to aggregate the four Raptors for accounting purposes.”

Criminal Prosecutions

The Raptor structures figured prominently in the criminal cases brought against Enron executives. Ben Glisan, Enron’s Treasurer who received regular Raptor position reports, pleaded guilty on September 10, 2003 to conspiracy to commit wire and securities fraud. The Department of Justice noted that “the Raptor vehicles’ insolvency in the fall of 2001 played a substantial part in the ultimate collapse of Enron.”

Andrew Fastow, who created and controlled the LJM2 fund that partnered with Enron on the Raptor structures, also faced criminal prosecution for his role in the transactions. The Raptors were among the most significant examples of the self-dealing arrangements that allowed Fastow to personally profit from transactions that harmed Enron shareholders.

Timeline

See Also

• Andrew Fastow — CFO who created LJM funds and engineered Raptor structures
• Vince Kaminski — Head of Research who raised concerns and refused to certify valuations
• Risk Management — Enron’s risk assessment function and its failure to prevent the Raptor transactions
• LJM Partnerships — The private equity funds that partnered with Enron on structured finance transactions

References

This article draws on email evidence from the Enron corpus spanning May 2000 through January 2002, including correspondence from Sara Shackleton, Carol St. Clair, Gordon McKillop, Vince Kaminski, David Port, Rakesh Bharati, Mary Fischer, and David Delainey. Secondary sources include Department of Justice prosecution documents, Congressional testimony, and academic analysis of the Powers Report findings.