The settlement with Enron's bankers came too soon. A critical take on Enron's bankers from the WSJ's Op-Ed page:
The Dismal Science
By Susan Lee
Enron Report
Wall Street Journal, August 11, 2003
Did they or didn’t they? The list of enablers in the Enron collapse is rich in possibilities: Enron’s senior officers, banks, accountants, credit-rating agencies and stock analysts. However, it is the banks that present the most interesting and ticklish issue. Funding was crucial for Enron’s deceptions and the banks provided tons of it. (Indeed, banks are among the biggest creditors now claiming a share of Enron’s assets.) But the fact that the banks shoveled so much money into Enron raises a question: Were the banks fantastically ignorant about Enron’s true condition or were they craftily helping Enron disguise that condition?
Last week’s settlement among regulators and Enron’s largest creditors, Citigroup and J.P. Morgan Chase, sidestepped the answer. Although the banks maintained they were fantastically ignorant, and therefore innocent, the regulators argued in favor of crafty, and therefore demanded $308 million in fines and penalties and a change the way banks do business in the future.
Happily, however, on the same day the settlement was announced, a more satisfying answer came in the public release of a report by the bankruptcy examiner. The examiner, Neal Batson, is by all accounts a respected and conservative bankruptcy lawyer. And despite the fact that the report is a masterpiece of legal understatement, readers will find it difficult to suppress the cry: Guilty! The Batson report is deliciously specific, naming names via internal memos, phone conversations, faxes, sworn testimony and, of course, the white collar equivalent of the smoking gun – e-mails.
Mr. Batson looked into Enron’s relationship with six financial institutions, focusing on the use of special-purpose entities. (SPEs are commercial arrangements with a limited duration and purpose, and are generally held off-balance sheet.) The institutions include Citigroup and J.P. Morgan – the largest creditors – followed by Barclays, Deutsche Bank, Canadian Imperial Bank of Commerce and Merrill Lynch.
The outlines of the story are known: The relationship between Enron and its banks was a you-take-in-my-washing, I’ll-take-in-yours arrangement. As a business enterprise, Enron was failing in a major way. The company needed a way to get cash while maintaining its investment grade credit rating. The banks, especially Citigroup and J.P. Morgan, were tethered to Enron by billions of dollars of deals and needed Enron to stay afloat. The result of these mutual needs as a big bunch of SPEs and breathtakingly aggressive accounting.
After looking at the evidence – the detailing of which makes the report near 1,000 pages – Mr. Batson found that the banks aided an abetted certain senior officers of Enron in a breach of fiduciary responsibility. The breach involved engineering its reported financial statements so that the results were fantasy, given its actual and dire financial condition.
Consider the SPE known as Mahonis that was concocted by Morgan and now constitutes $1.5 billion of its $1.8 billion claim. Mahonia consisted of a corporation chartered in the Jersey Channel Islands using Morgan as its agent (it’s not clear whether the corporation had any employees). Mr. Batson looked at 12 transactions involving Mahonia between 1992 and 2000. The deals were structured like commodity trades in which Enron agreed to deliver oil or gas in the future in exchange for a prepayment with interest. But the trades were on paper only; they were loans.
More than $3.7 billion in financing flowed through Mahonia, allowing Enron to understate debt and overstate cash flow from operating activities. The loans were reported as price risk management liabilities, rather than debt, and the cash was reported as cash flow from operations, so that Enron’s financial statements were, as Mr. Batson observes, “materially misleading and its key credit rations were improperly enchanced.”
The report documents four findings. One, that the banks had “actual knowledge” of wrongful conduct of Enron’s senior officers. The term actual knowledge, by the way, requires a strict standard – it does not mean one “should have known” or “was suspicious.” Two, that these institutions gave “substantial assistance” to Enron’s officers by participating in the structuring, promoting, funding and assisting of the SPE transactions. Assistance also came by entering into undisclosed side agreements and understandings that the banks knew would not get approval from Enron’s accountant, Arthur Andersen.
Three, the magnitude of the money involved makes the accounting misrepresentations “material.” Take the Mahonia case: In 2000, the net cash flow from Morgan to Enron was used to pump up its cash from operating activities by 21% and reduce its debt by 23%. An finally, Mr. Batson argues that the banks, by helping to disguise Enron’s true condition and by causing injury to Enron that “was the direct of reasonably foreseen result of such conduct,: harmed other creditors. Thus, the claims of banks can be equitable subordinated to the claims of other creditors.
When all Mr. Batson’s details of “actual knowledge” and “substantial assistance” are taken together, it’s almost impossible to conclude that there was no intent by the banks to commit fraud. And that begs the next question: Why did the regulators wimp out? A $308 million settlement – and lack of criminal charges – is pale and looks paler next to Mr. Batson’s suggestion that Citigroup and Morgan’s claim of $4.2 billion ought to go to the back of the creditors’ line.
Perhaps the regulators are engaging in a genteel coverup for their own lack of oversight. And perhaps the list of Enron’s enablers ought to be made richer still by adding the Securities and Exchange Commission, the Federal Reserve, the Manhattan District Attorney, the New York State Banking Department and the Comptroller of the Currency.
Ms. Lee is a member of the Journal’s editorial board, |
