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Enron's LJM Special Purpose Entity question...?

Enron had a special purpose entity called LJM which it used to hide enrons debt off the balance sheet by buying its poorly performing stocks i understand this part because it is pretty simple the part i am having trouble with is how they used Enron's stock as collateral, this is an excerpt about LJM taken from Wikipedia that i dont understand can someone explain this to me In March 1998, Enron invested $10 million for 5.4 million shares of Rhythms NetConnections, a then private broadband provider. After Rhythm went public, shares skyrocketed and Enron found itself with $300 million worth of Rhythm stock in May 1999. However, a lock-up agreement forced Enron to hold its shares until the end of 1999. Owing to Enron's mark-to-market policy, Skilling's worries about Rhythm's volatility led to LJM1 carrying forth a convoluted transaction. First, Enron transferred with severe locking restrictions 3.4 million shares of Enron stock worth $276 million at the time to LJM1 at a reduced price of $168 million. Then, LJM1 capitalized one of its subsidiaries, LJM Swap-Sub, with $80 million of its restricted shares and $3.75 million in cash. Finally, Swap-Sub placed a put option on 5.4 million shares of Rhythms stock owned by Enron. Under the option, Enron could require Swap-Sub to purchase the shares in June 2004 at $56 a share. Hence, Enron's stock price was now tied to Rhythms' stock price. If Enron's stock did well and Rhythms' sank, then Swap-Sub could reimburse Enron using its Enron shares and provide Enron a profit. More importantly, the deal allowed Enron to use this "trapped" value of the Rhythm put option to bolster its income statement and keep its stock price inflated.

Public Comments

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