How Wall Street Greased Enron's Money Machine
The Wall Street Journal
Monday, January 14, 2002
JOHN R. EMSHWILLER, ANITA RAGHAVAN and JATHON SAPSFORD
interactive.wsj.com
In March 1995, Enron Corp. executive Andrew Fastow approached Philip Pool, a banker at Donaldson, Lufkin & Jenrette Inc. with a tantalizing offer.
As an official of a prized DLJ corporate client, Mr. Fastow wanted DLJ's help to raise money for a partnership the Houston energy company was putting together. The partnership, Mr. Fastow said, would help Enron by buying assets from the company and keeping debt off its balance sheet. Too much balance-sheet debt would lower Enron's credit rating and hinder growth.
But the proposal had an unusual feature. While remaining an Enron official, Mr. Fastow would head the independent partnership, which would have outside investors and do business with Enron. DLJ said no. "There are too many conflicts here," Mr. Pool told Mr. Fastow, according to people familiar with the conversation.
A spokesman for Mr. Fastow confirmed that the 1995 meeting took place. But he said that by 1999 DLJ was expressing interest in doing private placement work for a similar partnership, known as LJM2 Co-Investment LP, which would eventually do hundreds of millions of dollars of business with Enron. Mr. Fastow, who by 1999 was Enron's chief financial officer, ran LJM2 and was a part owner until he severed ties with it last summer.
Mr. Pool, who is no longer with DLJ, says he talked with Enron in 1999 but says the private fund group that he co-headed decided that the conflict-of-interest concern was still too great. A spokesman for Credit Suisse First Boston, which acquired DLJ in 2000, declined to comment.
In the end, Merrill Lynch & Co., the nation's largest securities firm, took on the task of helping to market LJM2. Merrill committed $22 million from the firm and its officials to the partnership as part of helping to raise nearly $400 million from more than three dozen institutional and individual investors, according to partnership records.
A gaggle of other financial firms joined Merrill in investing in LJM2, apparently in hopes of further cultivating ties with Enron, which at the time was one of Wall Street's hottest clients. J.P. Morgan Chase, Citigroup Inc., Credit Suisse First Boston, Wachovia Corp. and others poured between $10 million and $25 million into the Enron partnership. A DLJ-related limited partnership even kicked in $5 million.
A Merrill spokesman says "we believe that our relatively limited dealings with Enron and our involvement with LJM2 were entirely proper. We believe the potential conflicts involved in LJM2 were fully disclosed to partnership investors."
Representatives for J.P. Morgan, Citigroup and Wachovia declined to comment on the investments.
The upshot: Some of the world's leading banks and brokerage firms provided Enron with crucial help in creating the intricate -- and, in crucial ways, misleading -- financial structure that fueled the energy trader's impressive rise but ultimately led to its spectacular downfall. Indeed, without the financial grease from Wall Street, Enron wouldn't have grown into the nation's biggest energy trader and seventh-biggest company. In return, Wall Street firms earned hundreds of millions of dollars in fees -- $214 million in underwriting alone, and much more in lending, derivatives trading and merger advice.
Now the banks are scrambling to recover what they can in the wake of Enron's bankruptcy filing, the largest in U.S. history, last month. The debts include $4 billion in loans and billions of dollars more in other obligations owed to banks, which could erase at least some of the considerable profits financial institutions made in financing Enron on the way up. When all is said and done, the question that ultimately will be raised is: Did the banks lower their lending standards to get all the other business from Enron? The banks vehemently say no.
"Enron was a cash cow for the banks," says Frank Partnoy, a former Morgan Stanley derivatives salesman who wrote a book on Wall Street's high-pressure sales tactics. "You can't do sophisticated limited partnerships and credit derivatives without the participation of the major banks." Mr. Partnoy, now a professor at the University of San Diego School of Law, likens the role of banks in the Enron debacle to a "casino claiming hardship when a high roller playing on credit can't pay his marker. It's difficult to feel too sorry for the banks trying to recover debts owed by Enron, given that the same banks set up the game and were intimately involved in the Enron partnerships."
Enron's demise already has produced dozens of shareholder lawsuits. The deep involvement -- and deep pockets -- of big banks and Wall Street firms raises the possibility that they will get sucked into the litigation maelstrom.
Wall Street's role in the Enron saga throws the spotlight on the 1999 repeal of Depression-era legislation called the Glass-Steagall Act. The law was meant to separate the business of lending from underwriting, largely because many blamed the financial turmoil of 1929, and the depression that followed, on speculation in the stock market by the nation's banks, which also are supposed to be the guardians of deposits.
Bankers lobbied successfully for Glass-Steagall's repeal in hopes of creating huge financial supermarkets such as Citigroup and J.P. Morgan. These institutions now can offer credit cards and loans alongside mutual funds. On the corporate side, they can lend and arrange credit lines while also filling out such financings with other lucrative services once limited to investment banks, such as stock or bond offerings or mergers advisory.
Enron's decline shows how these multi-faceted institutions are often on many sides of big deals in arrangements bristling with potential conflicts. Consider the many hats worn by J.P. Morgan as one of Enron's main lenders. (J.P. Morgan says its lending exposure to Enron is more than $2.6 billion.) It has arranged billions of dollars in loans to Enron, keeping chunks of that financing on its own books. It also has underwritten bonds for Enron.
Less visible are other roles. J.P. Morgan trades currencies, bonds and derivative contracts, both with Enron and with other institutions that trade the debts and obligations issued by Enron. It has a research analyst covering Enron who until last fall had recommended investors buy Enron stock. J.P. Morgan also sold Enron credit derivatives, among other things, even as its asset-management arm managed a stock fund for the Employee Retirement System of Texas that held Enron stock. (The Enron stock was liquidated from the portfolio at the end of November, a spokeswoman for the Texas system says -- more than a month after Enron's troubles were well known.)
A spokeswoman at J.P. Morgan says the asset-management arm is likely to join some of the shareholder suits against Enron even though teams from other areas of the bank were advising Enron on the same decisions that are now being called into question by lawsuits.
J.P. Morgan officials say they have strict "Chinese walls" separating these businesses to keep conflicts from compromising the bank's activities. But "it's very difficult to keep the Chinese walls in place," says David Hendler, an analyst at CreditSights, a debt market research firm.
J.P. Morgan says its many ties to Enron reflect diversification into a slew of different business lines that insulate it from the risks of lending. Such diversification reduces risk to the financial system as a whole, the bank argues, a view shared by the many big institutions with ties to Enron. And Enron's failure has yet to show any sign of bringing down a major financial institution.
Meanwhile, J.P. Morgan already is suing one of Enron's other big lenders, Citigroup, in New York federal court. The suit alleges that a group of insurers, including a Citigroup unit, are improperly refusing to pay about $1 billion on surety-bond policies for Enron-related oil and natural gas delivery contracts.
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Doing Deals With Enron
Some of the investment banks that were underwriters, agents and/or advisers for Enron, 1999-2001Investment bank Stocks & convertibles Debt Syndicated loans Mergers & acquisitions
Citibank/Salomon Smith Barney 4 - 4 4
J.P. Morgan Chase - - 4 4
Credit Suisse First Boston 4 4 4 4
BNP-Paribas - 4 4
Deutsche Bank - - 4
Merrill Lynch & Co. 4 4 - 4
Goldman Sachs Group 4 - - 4
Banc of America Securities 4 4 - 4
Lehman Brothers 4 - 4
Source: Thomson Financial
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In court papers, St. Paul Fire & Marine Insurance Co. says it can't find evidence of actual oil and gas deliveries and contends the entire arrangement was designed to obtain guarantees for J.P. Morgan on loans to Enron "in the guise" of insuring product-supply contracts. J.P. Morgan denies that allegation. Citigroup declines to comment, citing pending litigation.
It wasn't long ago that Enron was among the ripest of Wall Street's plum clients. It had a voracious appetite for capital and was constantly pioneering new businesses trading everything from electricity futures to hedges against bad weather. Its online trading operation, called EnronOnline, handled nearly $1 trillion in transactions in the two years following its November 1999 opening.
Enron expected lots of help from Wall Street as it hacked out new trails in the wilderness of commerce. None of its exploits were wilder than the private partnerships run by company executives. While many big businesses had long done business with outside partnerships as a way to keep debt off the books, none had ever set up a structure like the one Enron created. For one thing, the partnerships seemed designed to make some Enron officials far more money working part time on the partnerships than they did working full time for Enron. The company recently estimated that Mr. Fastow -- whom Enron replaced as chief financial officer last October as controversy around him mounted -- made more than $30 million since 1999 running LJM2 and a smaller partnership, called LJM Cayman LP.
Not all prospective investors were immediately dazzled by the ample returns being dangled by those pitching the LJM2 partnership. Miami-area businessman Eugene Conese recalls that when his Merrill broker first described the LJM2 partnership, "I said I thought there was a conflict of interest … that it didn't seem proper."
After assurances from Merrill and Enron officials that everything was proper, Mr. Conese relented. He committed $3 million personally and through a family partnership, LJM2 records show. Last year, after the surprise resignation in August of Enron President and Chief Executive Jeffrey Skilling, Mr. Conese tried to sell back his partnership interest and contacted LJM2, then being run by a former Enron executive and Fastow associate named Michael Kopper. LJM2 never acted on the request, says Mr. Conese. Recently, some of the limited partners hired a lawyer to explore their legal options in the face of a request by LJM2 management to put more money into the partnership.
Mr. Kopper has in the past declined to be interviewed. A call to LJM2's Houston office across the street from Enron headquarters was answered by a recording that said, "You've reached a nonworking number at Enron." |
