Academic journal article Texas Law Review

Filling the "GAAP": Why Generally Accepted Accounting Principles Should Inform U.C.C. Article 9 Decisions*

Academic journal article Texas Law Review

Filling the "GAAP": Why Generally Accepted Accounting Principles Should Inform U.C.C. Article 9 Decisions*

Article excerpt

I. Introduction: The "Perfect Circle of Lack of Responsibility"

In the 1992 comedy blockbuster White Men Can't Jump,1 actors Wesley Snipes and Woody Harrelson are two basketball hustlers who team up to take on other streetball duos in Southern California. Though working together, they are constantly attempting to upstage each other, and their personal differences threaten to break up the successful team. It is only after the two settle their differences and learn to trust each other that they are able to elevate their performance as a team and become better individuals in the process.

Such is the relationship between attorneys and accountants. Though readily acknowledged as being "allied professions,"2 attorneys and accountants are too often seen as discretely in charge of separate aspects of a transaction.3 But this should not be the case. Such an attitude contributes to what Professor William Simon describes as a "perfect circle of lack of responsibility."4 Professor Lawrence Cunningham describes this circle with an anecdote: "A familiar pass-the-buck pas de deux in deal meetings and conference calls occurs when the accountant says, after an impasse, 'that's a legal problem' while the lawyer says 'that's an accounting problem.'"5

There is no better illustration of this circle than the collapse of Enron. One of the most famous scandals in corporate America6 put the deficient relationship between accountants and attorneys on center stage. Though Enron was guilty of numerous schemes,7 at the heart of the fraud was the company's legal and accounting treatment of special purpose entities (SPEs).8 These SPEs were set up as outside companies of Enron in order to house liabilities that could be kept off the company's balance sheet.9 By keeping large amounts of debt off the balance sheet, Enron was able to fool investors into believing the company was in better financial condition than it was, resulting in higher stock prices.10 When the fraud was discovered, sorting out liability became a mess.11

In keeping with the circle, Enron's attorneys denied any responsibility, pointing the finger at accountants.12 However, this was not a credible argument because the accounting decision for SPE transactions was based in part on legal opinions issued by attorneys.13 And what was the legal opinion required? It was a determination that is critical under Article 9 of the Uniform Commercial Code (U.C.C.), which governs secured lending: Did transfers from Enron to these SPEs constitute a "true sale"?14 This is a critical determination because if these transfers were not true sales, but rather disguised loans, the parties to these transactions would be vulnerable in bankruptcy proceedings absent any proof of a "backup" security interest.15

Enron's fraudulent transfers provide the perfect example of the connection between the U.C.C. secured lending provisions and Generally Accepted Accounting Principles (GAAP). At any point, either accountants or attorneys could have pulled the plug on these fraudulent transfers simply by adhering to their respective standards. Additionally, the Enron case demonstrates why it is critical that the U.C.C. and GAAP inform each other in complex transactions. As transactions become more complex, there is an increasing overlap of work performed by attorneys and accountants.16 This complexity often makes attorneys and accountants legally responsible for one another.17 Certain accounting decisions require a legal opinion before the accountant can move forward.18 Moreover, some legal decisions first require an accounting decision.19 As a result, attorneys can be held responsible for misrepresentations within financial statements.20

In order to transcend the perfect circle of lack of responsibility, the legal community must attempt to incorporate elements of GAAP into commercial law. In describing this incorporation, this Note proceeds in five parts. Part II describes conceptual issues with incorporating GAAP into U. …

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