Fed Probes Trade Accounting Of Morgan in Enron Dealings
By GREG IP, SUSAN PULLIAM and HENNY SENDER
Staff Reporters of THE WALL STREET JOURNAL
The Federal Reserve Bank of New York is examining J.P. Morgan Chase & Co.'s accounting for commodity-related trades with Enron Corp., according to internal central-bank documents reviewed by The Wall Street Journal.
The trades being reviewed by the Federal Reserve appear to relate to an offshore entity set up by the old Chase Manhattan Bank a decade ago through which it came to do substantial business with the once-mighty energy company. The big volume of trades between the offshore operation, called Mahonia Ltd., and Enron surfaced weeks ago in litigation connected with Enron's bankruptcy-court filing, raising questions as to whether Mahonia was a vehicle for loans disguised as trades that helped Enron draw a misleading financial picture for investors.
See full coverage of the Enron saga.
Specifically, the trades being reviewed by the Federal Reserve appear to relate to transactions between Mahonia and Enron known as "prepaid forward transactions," under which J.P. Morgan would pay Mahonia, and ultimately Enron, upfront for the future delivery of natural gas or crude oil. As previously reported, Enron accounted for the transactions as trades, rather than loans; often, the deliveries of natural gas and oil were sold right back to those who delivered them through complex derivative transactions. The Fed appears to be reviewing how J.P. Morgan accounted for the transactions.
In a memo dated Jan. 24, 2002, made available under the Freedom of Information Act, two Federal Reserve Bank of New York staffers referred to their review of "two prototypical prepaid forward transactions" and interviews with J.P. Morgan lawyers on the subject. Details of the Fed's examination were withheld from the material provided to the Journal. The same memo later refers to the authors' "discussions with PricewaterhouseCoopers (JPMC's external accountant) and the FRBNY Statistics Function."
Joseph Evangelisti, a spokesman for J.P. Morgan said, "It is perfectly normal for the Fed, in the course of its ongoing and continuing review of the banks it supervises, to seek information on high-visibility issues or transactions. In all our dealings with the Fed, we cooperate fully."
A spokeswoman for the Fed in Washington said it couldn't comment on supervisory matters involving particular banks. "But as part of our normal banking supervisory role, we need to understand what is happening at the institutions we supervise. Under the current circumstances, of course, we would be asking questions of institutions with exposures so that we could understand the nature of those exposures and their accounting treatment." The spokeswoman added, "As a general matter, banks are permitted to engage in prepaid forward transactions."
The documents give no indication that J.P. Morgan is the subject of a formal investigation; the January memo's co-author, Arthur Angulo, is a frontline Fed staffer who keeps a permanent office at J.P. Morgan, a common arrangement between Fed staff and banks under their supervision.
Still, it's the first sign that the central bank has taken an interest in the transactions. The revelation also comes amid heightened sensitivity to how corporations have accounted for complex financial transactions. Two weeks ago, PNC Financial Services Group Inc. restated its 2001 results after the Fed raised questions about how PNC accounted for three companies it set up in 2001 with insurance company American International Group Inc.
The Fed's interest reflects a widening of the government's interest in how Enron could have appeared as financially strong as long as it did, only to collapse so rapidly, filing for bankruptcy-court protection in early December. Congress is poised to begin hearings next week on Wall Street's involvement with Enron, looking at both commercial banks and securities firms as it continues to probe the role of Enron's auditing firm, Arthur Andersen LLP.
Shareholders of J.P. Morgan have been nervously waiting for another shoe to drop as a result of J.P. Morgan's close ties to Enron. The bank's stock has been on a steady slide in recent weeks, dropping from $39 a share on Jan. 10 to $29.14 Thursday, down 27 cents, at 4 p.m. in New York Stock Exchange composite trading. In recent days, worries have grown that the firm might cut its dividend or seek to raise additional capital because of its exposure not only to Enron but other companies that have recently filed for bankruptcy protection, including Global Crossing Ltd., a once-high-flying telecommunications company.
Already, the bank is in litigation over the refusal of several insurance companies to honor $1.1 billion in guarantees made to J.P. Morgan against Enron's default on the Mahonia transactions; those insurers argue that the trades were actually loans in disguise. J.P. Morgan maintains those claims are without merit. As previously reported, the Securities and Exchange Commission is also scrutinizing J.P. Morgan's role in the Mahonia transactions.
"They could be faced with a choice between maintaining their credit rating or maintaining their dividend," said Michael Mayo, bank analyst with Prudential Securities in New York.
A number of analysts concluded that Chase's dividend wouldn't be cut after a conference call on the subject last week by a Merrill Lynch analyst. J.P. Morgan has said that all of its Enron exposure has been disclosed, and the bank's chief financial officer insisted during the conference call that the firm has "large excess capital."
But the jitters have persisted, and the bond market is anticipating more bad news from J.P. Morgan as well. Standard & Poor's Ratings Group put the bank's debt on negative outlook Jan. 10, while Moody's Investors Service last week affirmed its double-A rating. But the bonds are trading at levels that suggest credit analysts believe the bank should be trading three notches below its present rating.
The new documents also show that, as Enron spiraled toward collapse, regulators were trying to gauge what, if any, damage such a collapse could wreak on the financial system. The Fed's documents disclose its keen interest in banks' exposure in general to the troubled company, in particular through a sophisticated financial instrument called credit derivatives. J.P. Morgan's credit-derivatives exposure is among the largest in the $1 trillion market. Big financial players trade credit derivatives as a way of buying or selling insurance against default by an underlying company. In a series of e-mails in late November and early December, Fed staffers make references to their analysis of J.P. Morgan's credit-derivatives exposure, though details were withheld in the released versions.
A Nov. 8 memo to Federal Reserve Board governors from Richard Spillenkothen, director of the board's bank supervision and regulation section, relates to concerns about overall exposure by banks as Enron's plunge toward its bankruptcy filing intensified. It states: "Attached is a note by Mike Martinson regarding Enron, which appears, at this point, likely to go into bankruptcy. The note includes some information on bank exposures, which in some cases are large, but manageable out of earnings."
The documents also provide added evidence of former Enron Chief Executive Officer Ken Lay's familiarity with top Washington regulators, including Fed Chairman Alan Greenspan. On Jan. 29, Mr. Lay wrote Mr. Greenspan to invite him to address the Business Council, an association of CEOs of the country's biggest companies. Mr. Lay was vice chairman of the association. On Feb. 27, he wrote to thank Mr. Greenspan for appearing: "Your remarks struck a real chord with our members and provided us with insightful observations about the new administration's priorities."
Asked if Mr. Greenspan's appearance was different from what he would do in the normal course of his job, the Fed spokeswoman said no.
As previously reported, Mr. Lay later called Mr. Greenspan on Oct. 26 to talk about the company's difficulties.
Write to Greg Ip at greg.ip@wsj.com, Susan Pulliam at susan.pulliam@wsj.com and Henny Sender at henny.sender@wsj.com
Updated February 22, 2002 |
