Merrill Top Managers Invested in Enron Partnership
(Update3)
By Mark Lake and Stephen Cohen
New York, Jan. 29 (Bloomberg) -- Merrill Lynch & Co. executives invested in a limited partnership Enron Corp. used to inflate earnings and hide debt from shareholders, according to people familiar with the situation.
Merrill invited executives, including some managing directors and other senior officials, to invest after helping the Houston- based energy trader raise $349 million for the partnership, known as LJM2, from pension funds and other institutional investors.
The investments may come under congressional scrutiny. The House Energy and Commerce Committee has subpoenaed Enron's partnership records, including the identities of investors. Enron's disclosure on Nov. 8 that Chief Financial Officer Andrew Fastow made $30 million managing two partnerships, including LJM2, hastened the company's collapse.
``It raises questions about conflicts of interest and how objective Merrill could be about Enron,'' said Joel Seligman, the dean of the Washington University law school in St. Louis.
In an internal e-mail, Merrill said that LJM2 was expected to return more than 30 percent a year. That's triple the average return on the Standard & Poor's 500 Index, the benchmark for U.S. stocks, over the past 75 years. Members of the investment banking executive committee were encouraged to invest by Daniel Bayly, then head of the group, said one investor.
``The investment partnership was reviewed and deemed appropriate by parties on all sides of the transaction,'' said Merrill spokesman Joe Cohen. ``Consistent with common industry practice, it was offered to qualified external as well as internal investors, and this is not a conflict of interest.''
Bayly, who is now the chairman of investment banking, declined to comment. Merrill's shares fell $1.50, or 2.8 percent, to $51.46, outpacing today's 2.4 percent decline by the Bloomberg Wall Street Index.
The investments by senior Merrill executives shows the conflicting roles that may have made investment banks less skeptical of Enron, said Seligman. At the same time that the firm was doing business with the company, Merrill officials had a vested interest in Enron's performance, he said.
Merrill's Role
LJM2 was one of dozens of partnerships Enron officials set up to move as much as $3 billion in debt off the company's balance sheet and by doing so make the company appear more profitable. Enron also exaggerated profit by recording sales of assets to the partnerships as gains. The company in November restated earnings for the three full years between 1997 and 2000, reducing profit by $586 million because of losses from the partnerships. It also reduced its reported earnings for the first three quarters of 2001 by $1.2 billion.
Enron created LJM2 in October 1999 to hold or sell Enron assets, including fiber-optic cable that it bought at a premium from Enron in June 2000 and resold six months later to another partnership controlled by Fastow.
The company sought to attract some pension funds by promising outsized returns. Danny Bowers, chief investment officer for the Houston Firefighters Relief and Retirement Fund, which manages about $1.7 billion, said Fastow indicated an investor could expect to double their money.
Arranged Business
Enron chose Merrill to raise the money for LJM2 in part because the firm arranged bond sales for Enron, the people said. According to Bloomberg data, Merrill arranged more than one third of the 29 bonds Enron has outstanding. The firm also has one of the biggest private equity operations on Wall Street. Kevin Albert, head of that business, didn't return calls for comment.
Merrill, the largest securities firm by capital, rounded up investors for LJM2 by touting Fastow's participation, according to a 42-page presentation sent to pension funds. ``A. Fastow's dual role creates advantages for the fund and Enron,'' the prospectus said, adding that Fastow had invested $2 million of his own money in the venture, giving him an interest in helping it succeed.
The partnership attracted investors, including American International Group Inc., Citigroup Inc. units Citicorp and Travelers Insurance Co., Canadian Imperial Bank of Commerce and General Electric Co. unit GE Capital Services, among other firms.
Pension Funds Skeptical
Some pension fund managers declined to invest because they saw a conflict. David L. Long, who manages $1.3 billion on behalf of 20,000 members of the Houston Municipal Employees Pension System, said he declined to invest in LJM2 after Merrill salesman Mark Murphy arranged a meeting for him with Enron about the partnership.
``We had a lot of discussion about potential conflicts of interest,'' said Long, who, along with the pension fund's chief investment officer, investment manager and a consultant, met Fastow in his office at Enron headquarters. ``You had the CFO of Enron who's an employee of Enron acting as general partner of a partnership which for the most part could be construed to be adversarial to Enron.''
Lawmakers such as Representative Billy Tauzin, a Louisiana Republican who chairs the House Energy and Commerce Committee, have demanded Enron release the names of the investors in its partnerships. Congress is probing for any inappropriate business relationships investors had with the company.
Perk for Executives
Many securities firms allow senior executives to invest in venture capital funds set up for clients as a perk. The former Donaldson, Lufkin & Jenrette Inc., now part of Credit Suisse First Boston, was among the firms on Wall Street that extended the opportunity to many of its managing directors.
LJM2 was one of only a handful of private placements Merrill has offered its employees. One previous example was Merrill's sale of $22 million of its investment in failed hedge fund Long Term Capital Management LP to its own executives, including Chairman David Komansky. Merrill helped Long Term Capital collect about half its initial capital when it was established in 1994.
In March 2000, Merrill offered stakes in LJM2 to some of its senior managing directors and top executives. One former Merrill managing director who invested said the prospectus didn't provide details of what the partnership would own.
Cash Distributions
Since it was created, the partnership has made three cash payouts to its investors, including one in 2000 and two last year, the people said. The partnership produced returns of almost 50 percent for the first year, according to one investor.
After Enron restated more than four years of earnings in early November, investors in LJM2 received a request for additional capital. Merrill complained and the executives weren't required to invest more, people familiar with the situation said.
After Enron filed for bankruptcy protection on Dec. 2, the biggest such filing ever, Merrill set up an internal committee to oversee requests for information from employees who invested, one of the people said. |
