Enron’s RhythmsNet Hedge and the Accounting Motive for an Overpriced Put

Summary

The document examines a transaction described in a book about Enron. It says Enron held futures on its own stock whose gains could not be recognized as profit under accounting restrictions, while it had recorded a mark-to-market gain on RhythmsNet shares. The writer understands the proposed hedge as buying a put against the RhythmsNet exposure and describes an off-balance-sheet entity that acquired forwards at book value and could sell the put to fund a liability linked to that exposure.

The central question is why Enron would accept an overpriced put when the difference from fair value might eventually affect earnings. The document offers the transaction’s setup and the writer’s interpretation, but not an answer or independent evidence establishing the accounting rationale. Its account is therefore a prompt to consider how structuring, recognition timing, and reported earnings may interact; it does not establish that the hedge was economically sound or that the stated interpretation captures all transaction details.

Key ideas

• The account links a RhythmsNet mark-to-market gain with a proposed put hedge.
• An off-balance-sheet entity is described as holding forwards and selling the put.
• The writer questions why Enron would pay more than fair value for the put.
• The document poses an accounting and structuring puzzle but provides no resolution or independent verification.

Tags

# Enron - RhythmsNet hedge


# Enron - RhythmsNet hedge












I am reading "Power Failure: The Inside Story of The Collapse of Enron" By Mimi Swartz, Sherron Watkins.

In the book, the following transaction is described:

Enron had USD200mn worth of futures on its own stock. The gain could not be booked as profit due to accounting restrictions. Enron had booked a USD300mn profit booking as mark-to-market some shares in a company called RhythmsNet.

As I understand, their goal was to hedge their profit gain on RhythmsNet. Therefore they decided to buy a put on the RhythmsNet exposure.

They set up a separate, off balance sheet, entity where they parked the forwards (by selling the forwards to the SPV at book value). The entity would have sold the put for "as much as possible" so that the SPV assets would have matched as close as possible the USD300mn liability without the need of additional capital injections in the SPV.

I still fail to understand why it would have made sense for Enron, however, to buy an overpriced put. My point is that the difference between the price and the fair value would have hit anyway the bottom line at some point in time.

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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.