Investors Lured to Enron Deals by Inside Data
The New York Times
January 25, 2002
By KURT EICHENWALD
Enron executives
enticed wealthy individuals
and institutions to invest in one
of the partnerships that helped
wreck the company by dangling
the prospect that inside
knowledge could potentially help
them double their money in a
matter of months, according to
partnership records and
prospective investors.
In dozens of pages, the
confidential records of a
partnership called LJM2 describe
the inner workings of an entity at
the heart of the Enron debacle.
The records show company
executives wearing two hats,
offering banks, insurance
companies, Wall Street firms and
wealthy investors inside
knowledge about Enron and its
off-the-books holdings —
information that they denied
company shareholders.
The Securities and Exchange
Commission is investigating
whether Enron's accounting for
its partnerships violated the law,
though details of its inquiry have
not been disclosed.
Under pressure from the S.E.C.
investigation, Enron began
disclosing details of its
partnerships last fall and started
down what turned out to be the
road to collapse.
The records show that Enron
disclosed to potential investors
the conflicts of interest posed by
Enron executives' playing a dual
role, but sought to allay concern
over them.
The LJM2 partnership was run
by Andrew S. Fastow, who at the
same time was Enron's chief
financial officer. It was set up, in
part, to invest in entities that
Enron controlled and to purchase
investments that Enron did not
want on its books.
Mr. Fastow and other Enron
executives who managed the
partnership had a duty to
maximize returns for Enron
shareholders, the documents
note, even as they were offering a
separate set of lucrative deals to
banks, Wall Street firms and
wealthy individuals who owned
stakes in the partnerships.
According to the documents, the
spectacular returns were possible
because the partnerships would
be investing in deals originated
by Enron, then in its heyday as a
swashbuckling global pioneer of
energy deregulation. The
investments would draw on
confidential, nonpublic
information developed by the
energy company, the documents
explained.
"Enron frequently has access to
investment opportunities that are
not available to other investors," the private placement
memorandum for LJM2 said.
Securities experts say that knowledge of the investment
plans and strategies of hot companies, like Enron was at
the time, is a coveted commodity on Wall Street because it
can provide investors a leg up.
The records show that investors in LJM2, which set out to
raise $200 million and ultimately took in $349 million,
were given more information about Enron's financial
situation than the company's shareholders.
For example, documents sent to potential investors in
2000 revealed that Enron controlled about 50 percent
more assets than disclosed in Enron's securities filings.
The difference — $34 billion versus $51 billion, as of June
30, 1999 — was the value of assets moved off Enron's
books through various partnership deals.
The disclosures created conflicts for Wall Street firms, as
well. For example, the investment banking arm of Merrill
Lynch (news/quote) & Company, which underwrote the
LJM2 offering, was aware of the off-balance-sheet figures
for Enron; indeed, Merrill's NAME is on the cover page of
the offering containing the data.
But because the numbers were confidential, that
information could not be shared with Merrill brokerage
clients who were investing in Enron stock. Joe Cohen, a
Merrill spokesman, declined to comment.
Merrill was not alone. Dozens of other banks, brokerage
firms, pension funds and other institutional investors
were approached to invest in LJM2 just over two years
ago, and all were provided with the confidential data about
the extent of Enron's off-balance-sheet dealings.
Enron's shareholders learned little of these deals until the
company restated its financial results last fall, erasing
nearly $600 million in profits over five years, and provided
additional, but still fragmentary, details.
Wall Street firms are supposed to maintain a so-called
Chinese wall to ensure that customers of their brokerage
operations are not made privy to inside information
gleaned by their investment bankers. In this case,
securities experts said, the intent of those laws was
undermined.
The transactions "followed the legal norms to produce a
perverse result," said John C. Coffee Jr., a securities law
expert at Columbia University. "It's a case where the
Chinese wall is working to injure public investors, rather
than benefit them."
At the same time, analysts of the Enron stock were
provided little information about the partnerships.
John Olson, an analyst with Sanders Morris Harris in
Houston who was long a skeptic on Enron stock, recalled
that he once questioned company executives about their
partnerships.
"They told us, `We can't discuss it, it's confidential, and we
are enjoined from disclosing anything about it,' " Mr.
Olson said.
Among the investors in LJM2, according to court records,
are Citicorp (news/quote), the American Home Assurance
Company, the Travelers Insurance Company, and an
investment partnership affiliated with Morgan Stanley.
The partnership documents made clear to potential
investors the magnitude of the conflicts of interest created
by the dual roles of the executives. "One of the most
challenging due diligence issues for the partnership is the
potential for conflict as a result of the principals' dual
positions as Enron employees and principals of the
partnership," the offering memorandum said.
A separate document disclosed last week by
Congressional investigators said that Enron's board
waived the company's code of ethics to allow Mr. Fastow to
serve as LJM2's general partner. Investors were told that
Richard A. Causey, who is still Enron's chief accounting
officer, was assigned responsibility for monitoring the
partnership and mediating conflicts of interest.
The partnership documents — including sales
presentations made by Mr. Fastow to potential
institutional investors in LJM2 — describe in detail the
workings and performance of several partnerships that
have gotten the most attention since the Enron scandal
began to unfold.
Among them are limited partnerships known as JEDI I
and JEDI II, an acronym with a "Star Wars" glint that
stood for Joint Energy Development Investments.
The records said that investors in those partnerships
initially were promised returns of 15 percent and 20
percent, respectively. By the time LJM2 was being
marketed, JEDI I had returned 23 percent annually for its
life, and JEDI II — which was still in operation — was
expected to return 194 percent annually.
For the LJM2 partnership, according to internal records
and marketing materials, the Enron executives were
expecting a minimum annualized return of 30 percent.
But sales agents also emphasized the earlier partnerships'
results.
"The implication of their pitch was very clear," said one
person who heard it. "At least 30 percent could mean well
over 100 percent or more."
As of last March 31, according to confidential partnership
records, three of the four largest investments in LJM2
brought in returns of more than 100 percent. The lowest
return, from an investment in another Enron entity called
Raptor I, was 58 percent over four months; the highest, in
Raptor II, was 212 percent in just over three months.
In the first quarter of last year, the partnership
distributed $75 million to investors — or about 44 percent
of the total of $171 million that was invested in the
partnership by the end of 2000.
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