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Lynch enron scam { August 8 2002 } Original Source Link: (May no longer be active)
http://www.nytimes.com/2002/08/08/business/08ENRO.htmlhttp://www.nytimes.com/2002/08/08/business/08ENRO.html
August 8, 2002
Ex-Executives Say Sham Deal Helped Enron
By DAVID BARBOZA
HOUSTON, Aug. 7 — Desperate to meet a year-end profit target, the Enron Corporation struck a sham energy deal with Merrill Lynch that let Enron book a $60 million profit in the final days of December 1999, according to former Enron executives involved in the transaction.
The executives said that the energy deal, a complex set of gas and power trades, was intended to inflate Enron's profits and drive up its stock price. Enron and Merrill Lynch, they said, agreed that the deal would be canceled after Enron booked the profits; it later was.
By allowing the company to meet its internal profit targets, the power deal unleashed the payment of millions of dollars in bonuses and restricted stock to high-ranking executives, including Kenneth L. Lay, then the chief executive, and Jeffrey K. Skilling, then Enron's president, former executives said.
"This was absolutely a sham transaction, and it was an 11th hour deal," said one former Enron executive who was briefed on the deal. "We did this deal to get 1999 earnings." This account was confirmed by five other former executives who either worked on the deal or were briefed on it. All the executives insisted on anonymity, concerned either about losing their current jobs or being drawn into the litigation over Enron's collapse.
Merrill Lynch officials said there was nothing improper about the power deal and no prearrangement to cancel it, and one former Enron executive involved in the deal agreed.
"The trades we conducted with Enron were legitimate transactions involving real risk," Merrill said in a statement today. "At no time did Merrill Lynch knowingly assist Enron in misstating revenues."
Yet Merrill executives were so concerned about Enron's accounting for the deal that they obtained a letter signed by Richard A. Causey, Enron's chief accounting officer, stating that Enron did not rely on Merrill Lynch for accounting advice, former executives said. Securities law experts said that such a letter could help Merrill defend itself against any fraud charges that might arise from the transaction.
The deal was five times as big as Enron's sale of a Nigerian power barge to Merrill Lynch the same month, a transaction that a Senate panel denounced last week as evidence that the Wall Street bank helped Enron inflate its profits and cook its books.
Both of the December 1999 deals came as Enron struggled to meet Wall Street's year-end profit expectations. With the profits from the deals, Enron on Jan. 18, 2000, reported a fourth-quarter profit of $259 million, or 31 cents a share, matching analysts' expectations. Without the $60 million profit, the company would have reported earnings of about 24 cents a share, according to Charles Hill, director of research at Thomson First Call, which tracks corporate profits.
"There are times when missing by a penny is huge," Mr. Hill said. "This would have creamed the stock." Instead, by the end of that week, Enron's share price had climbed 27 percent.
For its role in the deal, Merrill Lynch received about $8 million from Enron, people close to the transaction said.
Securities law experts said the transaction, which involved a series of complex gas and power trades, may have violated securities laws by allowing Enron to manipulate its year-end profit statement.
"Not only could this be securities fraud, but you could have a looting of the stock plan," said John C. Coffee Jr., a professor of law at Columbia University. "This could have been a way of fabricating earnings to permit the executives to reap stock bonuses. That's rigging the scoring system."
At the time, moreover, Merrill Lynch's sales force was promoting Enron's stock and the bank's private equity group — touting Enron's stellar performance — was asking investors to contribute over $250 million to one of Enron's off-balance-sheet partnerships.
Lawmakers have criticized Merrill Lynch and other banks that did business with Enron for having been blind to conflicts between the interests of their banking clients and those of investors. Merrill said today that the "Chinese walls" between its various businesses kept information about the power deal away from its sales force.
A spokesman for Enron, now in Chapter 11 bankruptcy protection, declined comment. Arthur Andersen, which as Enron's auditor at the time approved the accounting for the power deal, also had no comment. A spokeswomen for Mr. Lay declined comment and a spokeswoman for Mr. Skilling could not be reached..
The deal originated in Enron North America, the company's trading unit, where executives conceived a plan to take advantage of a group of power plants under construction in the Midwest. Their notion, the former executives said, was that if Enron could sell contracts tied to the output of some of the plant's well in the future, the company could book the long-term profits immediately, even if it did not receive a dime up front.
But when no energy company could be found to participate in such a deal, former executives said, Enron turned to its banker, Merrill Lynch, which operated its own energy trading unit.
The Enron effort was headed up by J. Clifford Baxter, the chairman and chief executive of Enron North America. One of his contacts on the deal at Merrill was Schuyler M. Tilney, the investment banker who last week invoked his Fifth Amendment right against self-incrimination and refused to testify before the Senate Permanent Subcommittee on Investigations. A lawyer for Mr. Tilney declined comment.
The initial plan for the power deal, the executives said, was to create a kind of mirror swap in which Enron would purchase energy contracts from Merrill and Merrill would simultaneously purchase energy contracts from Enron. But Arthur Andersen and Merrill Lynch were troubled by the structure of that deal, former executives said, worried that it amounted to a wash transaction from which no profits could be claimed.
With time winding down on the fourth quarter, Enron put pressure on Merrill and the Andersen accountants to help it complete some kind of deal.
"People were working 14-hour days, and Andersen was working around the clock to get this deal done," said one former Enron executive who was briefed on the transaction. "This deal got done in 10 days."
Enron and Merrill restructured the power deal as a complex series of gas and power contracts over four years. The executives' recollections differ on some accounts. But three executives briefed on the deal said that Enron and Merrill executives discussed canceling it in the first quarter of 2000, months before Merrill's first scheduled payment that September.
To further insulate Merrill, Enron agreed to embed a fee of about $14 million in the power contracts, former executives said.
The former executives said that Andersen accountants opposed elements of the final deal and warned Enron that if no gas was delivered in 2000, they might force the company to restate its 1999 earnings. Andersen officials who asked not to be named said this week that the firm told Enron only that auditors might have to consider the possibility of a restatement.
Tempers flared, some of the former executives said, as end-of-the-quarter pressure mounted on high-level executives including Mr. Baxter. Mr. Causey's letter to Merrill formally sealed the deal on Dec. 30, 1999.
Mr. Baxter committed suicide early this year. A lawyer for Mr. Causey declined to comment.
One Enron executive involved in the transaction disputed that the deal was a sham. Agreeing with Merrill Lynch, he said that there was a real transfer of risk to the investment bank, and he noted that there was no formal sale-buyback agreement.
"You will not see that in the contract," the executive said.
But in April 2000, Enron agreed to pay Merrill $8 million to cancel the deal, months before Merrill was scheduled to make a cash payment to Enron for the physical delivery of gas. Andersen did not press for a restatement of 1999 earnings, the former Enron executives said.
Enron executives benefited tremendously from the deal. Because Enron met its profit targets, dozens of top executives — including Mr. Lay, Mr. Skilling and Mr. Baxter — collected millions in stock and bonuses. Moreover, in the two weeks after the Jan. 18 earnings announcement, 20 Enron executives and directors sold $82.6 million in stock.
The deal was also a boon to Merrill Lynch's energy trading operation, which Merrill sold in January 2001 to Allegheny Energy Inc. for about $500 million.
Two weeks ago, Allegheny said it would shrink the operation because of the turmoil in the energy trading business. For its part, Merrill said in its statement today that it rued its dealings with Enron.
"We relied on representations made by Enron that it and its outside auditors had approved its transactions," Merrill said. "Like many others, we were deceived by Enron, and had we known what we know today, we would not have done business with them."
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