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Banks hide loans { July 24 2002 } Original Source Link: (May no longer be active)
http://www.washingtonpost.com/wp-dyn/articles/A53153-2002Jul23.htmlhttp://www.washingtonpost.com/wp-dyn/articles/A53153-2002Jul23.html
Senate Panel Says 2 Banks Helped Enron Hide Loans
J.P. Morgan, Citigroup Arranged 'Prepays'
By Carrie Johnson
Washington Post Staff Writer
Wednesday, July 24, 2002; Page E01
J.P. Morgan Chase & Co. and Citigroup Inc., two of the world's largest banks, helped Enron Corp. arrange billions of dollars in loans that disguised its deteriorating financial condition, and worked to hide the details of some deals from investors, Senate investigators said yesterday.
The transactions, known as prepays, brought Enron more than $8.5 billion in the six years before it collapsed last fall. Had Enron properly accounted for the loans, its debt obligations would have increased by more than 40 percent, to $14 billion in 2000, according to an analysis by the staff of the Senate Governmental Affairs Committee's investigations subcommittee.
That would have led to lower credit ratings, officials of debt-rating agencies testified.
Subcommittee Chairman Carl M. Levin (D-Mich.) called Enron's use of the prepays to disguise debt "an accounting sham" and said the company had "the help and knowing assistance of some of the biggest financial institutions in our country."
"Chase and Citicorp knew what Enron was doing, assisted in the deceptions, and profited from their actions," he said.
The banks collected large fees and earned consideration for more deals with Enron, in addition to interest payments, for structuring the deals, senators said. Enron, for example, paid $167 million to Citigroup from 1997 to 2001.
Chase and Citigroup also sold the prepay structures to at least 10 other clients.
"J.P. Morgan Chase and Citigroup are two of the nation's most prestigious financial institutions," said Sen. Susan Collins (R-Maine), ranking minority member of the subcommittee. "That's why I find their involvement so shocking. It appears as though they were willing to risk their reputation to keep an important client, Enron, happy."
J.P. Morgan Chase officials testified that Enron, not the bank, is responsible for how Enron treated the prepays on its books. They said the bank has suffered mightily from its relationship with Enron, which owes the bank $2.6 billion, including $600 million in unsecured debt.
Citigroup officials said they believed the prepay transactions were appropriate and that they relied on Enron's outside accountants from Arthur Andersen LLP.
"We believed that Enron was making good-faith accounting judgments that were reviewed by Arthur Andersen, which was then the world's premier auditing firm in this sector, and that the audit committee of Enron's board exercised meaningful supervision over the company's accounting policies and procedures," said David Bushnell, a risk-management official for Citigroup.
The banks' stocks have been battered in recent days. Citigroup closed at $27 a share yesterday, down $5.04. J.P. Morgan Chase closed at $20.08 a share, down $4.44.
Prepays are arrangements in which companies are paid to deliver a product -- in Enron's case, oil and natural gas -- at a later date. But Enron and several large banks structured the deals in ways that compromised the independence of the transactions, making them loans rather than sales for accounting purposes, the Senate investigation found.
Enron did not reveal that to its shareholders, investigators said, and instead booked the deals as cash from operations, making its finances look better than they were.
Chase and Citigroup engaged in the deals by using secretive offshore entities called Mahonia, Delta and Yosemite. Senate investigators said the groups, based on the Isle of Jersey, in the English Channel, and in the Cayman Islands, are not legally tied to the banks, but are, in essence, controlled by them through lawyers and charitable trusts.
The banks deny that they control the offshore firms.
Senate investigators testified that the banks took pains not to use "requirements or descriptive language in the prepay documentation that would disclose the true nature of the transaction," according to a report prepared by Senate investigator Robert Roach.
An April 1999 Citigroup memo said the documentation for a deal known as Roosevelt could not reflect an agreement under which Enron would repay $190 million, "as it would unfavorably alter the accounting."
James Reilly, the Houston-based employee who wrote the e-mail message, testified that the agreement was "not in any way binding," and that he did not intend to hide information or to keep it secret.
In November 2001, when an institutional investor asked questions about another entity Citigroup created for use in the prepay transactions, an Enron staffer responded by sending an e-mail to Citigroup saying "we need to shut this down."
So few people knew about the extent of the prepays that when one Chase employee found out last October, he expressed shock. "$5B in prepays!!!!!!!!!" he wrote.
Another Chase worker involved in the deal replied: "shutup and delete this email."
Chase officials said the company preserves its e-mail messages for a long period of time and that the reply must have been a joke.
The prepay deals are under scrutiny by the Manhattan district attorney's office and the Securities and Exchange Commission. J.P. Morgan Chase and Citigroup have been sued by Enron shareholders. Separately, J.P. Morgan Chase is fighting in court a group of insurance companies that refuse to pay for the failed prepay deals because, they say, they were deceived about the nature of the transactions.
Gary Brown, a lawyer for the full Governmental Affairs Committee, testified that participants in the prepay deals could have violated securities laws if investors were not properly warned about the risks. For example, he said, investors may have been given misleading information about Enron's health in the sale of notes via the Yosemite investment trust formed by Citigroup.
Citigroup raised more than $2.4 billion for Enron in six Yosemite bond offerings between 1999 and 2001, investigators said.
Sen. Peter Fitzgerald (R-Ill.) pressed Citigroup officials about the risks the bank passed to investors by selling Yosemite notes and certificates. He asked whether the repeal of laws preventing banks from selling securities heightened the risk that banks could move bad loans off their books by issuing securities to the public.
"Do you feel Citi contributed to misleading people who bought their securities?" Fitzgerald asked.
Maureen Hendricks, a Citigroup employee who had management responsibility for the investment banking relationship with Enron, said: "We disclosed what we knew to be correct. The purpose of Yosemite was to deliver senior unsecured credit to the public markets. It was disclosed throughout the prospectus."
Richard Caplan, a Citibank managing director, maintained that Yosemite had been fully vetted and was sold only to large and sophisticated institutional investors. The sales were "entirely appropriate," he said, and the fact that the money was used to fund other prepays was "absolutely" understood by Enron Treasurer Jeff McMahon.
"He's told us something very different," Levin said.
© 2002 The Washington Post Company
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