Adapting to a Rapidly Changing Regulatory

and Financial Environment


Isam Salah
King & Spalding LLP
New York City


ENRON – December 2001 Bankruptcy Filing Largest in U.S. Corporate History

WORLDCOM – July 2002 Bankruptcy Filing Overtakes Enron as largest in U.S. Corporate History


Enron’s Abuses

Legal Response to Enron’s Abuses


Enron’s Abuses

•         Not fully disclosing the extent and nature of transactions with related parties

•         Improperly excluding the debt of SPEs from its balance sheet

•         Treating certain transactions as asset sales without actually transferring the risks of ownership

•         Engaging in commodities transactions that were in fact disguised loans

•         Engaging in transactions that purported to hedge risk but in fact were designed to keep losses off its books


Legal Response to Enron’s Abuses

Passage of the Sarbanes-Oxley Act in July 2002


Sarbanes-Oxley – Sweeping reform that affects relationships between public companies, their directors and officers and their auditors.

•         Certification of financial statements by CEOs and CFOs of public companies

•         Restrictions on personal loans to directors and officers

•         Forfeiture of bonuses and profits from sales of securities during 12 month period following publication of financial statements that are later restated

•         Audit committees to adopt procedures for the processing of complaints about accounting practices and to protect whistleblowers


Additional Features of Sarbanes-Oxley

•         Securities and Exchange Commission (SEC) to review public company reports periodically

•         Prohibitions on auditing firms performing certain non-audit functions

•         Accounting firms to be regulated by Public Company Accounting Oversight Board

•         Securities analysts subjected to formal conflict of interest rules

•         Increases in fines and penalties for violations

Board of Directors – A majority must be independent, Must hold regular meetings of
non-management directors, Financial experts – Audit Committee , must have at least one,

New Restrictions on Auditors to Enhance Independence

•         Limitation on services provided by auditors

•         Audit committee must pre-approve all non-audit services


Other Auditor Requirements

•         Rotation of lead audit partner every five years

•         Report critical accounting policies to audit committee, including alternative treatment


Public Company Accounting Oversight Board

•         Five members appointed by SEC

•         Not a U.S. government agency

•         All public accounting firms must register if they participate in audit of a public company


Public Company Accounting Oversight Board

•         Required to establish auditing standards, quality control standards, ethics standards and independence standards

•         SEC to inspect registered accounting firms every one year or three years, depending on size of firm

•         Power to conduct investigations and disciplinary proceedings and to suspend


Lessons to be Learned

•         Islamic finance sector is young and the effects of its own “Enron” would be severe

•         Islamic finance sector has a strong interest in having safeguards in place to avoid an “Enron”


Use of Special Purpose Entities (SPEs)

•         Widely used by Enron to facilitate abusive practices

•         Regularly used in Shari’ah compliant transactions, especially in the U.S. to address regulatory issues

•         Must make clear the reasons why SPEs are used


Disguised Transactions

•         Enron used financing disguised as commodities trades

•         Commodities trades are often used in Shari’ah compliant transactions

•         Must make clear that commodities transactions are not used to perpetrate misleading financial statements


•         Importance of strong private and public gatekeepers

•         Importance of strong and independent board of directors and audit committee

•         Importance of preserving the independence and integrity of auditors

•         Crucial role of the regulators

•         Distinguish use of SPEs and commodity transactions to avoid taint

•         Continue the development of improved and streamlined financing structures