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Merrill reaches deal with enron affair { September 18 2003 } Original Source Link: (May no longer be active)
http://www.nytimes.com/2003/09/18/business/18ENRO.htmlhttp://www.nytimes.com/2003/09/18/business/18ENRO.html
September 18, 2003
Merrill Reaches Deal With U.S. in Enron Affair
By KURT EICHENWALD
HOUSTON, Sept. 17 — Merrill Lynch & Company, in an agreement with prosecutors that let it avoid criminal charges over its role in the Enron debacle, promised today not to engage in business deals — even ones that appear legal — that it believes might be used to mislead investors about a company's financial condition.
The Wall Street firm also agreed to allow the government to monitor portions of its business for the next 18 months.
The settlement involved deals late in 1999 that let Enron increase its reported profits when its business was falling short of Wall Street's expectations. Merrill acknowledged that the government had obtained evidence that some of its employees might have committed crimes in the transactions, and it accepted responsibility for those employees' actions. Three former senior executives were charged today in connection with their roles in one deal.
Prosecutors — whose decision last year to prosecute Enron's accountants, Arthur Andersen, contributed to that firm's collapse — said that they hoped the Merrill settlement would be seen by other companies as a model for appropriate behavior in the financial world.
Legal experts, meanwhile, said the deal could serve as a strong deterrent to abuses in Wall Street's marketing of the complex deals known as structured finance, which critics say can obscure companies' true financial conditions, even if they arguably meet accounting rules.
The Merrill settlement — under what is known as a deferred-prosecution agreement — is a result of negotiations that began this summer with a meeting of federal prosecutors and E. Stanley O'Neal, the firm's chairman and chief executive.
Information provided by prosecutors helped convince Mr. O'Neal that Merrill's culture had become too reckless and its procedures too lax, a Merrill official and other people close to the firm said. Within days, they said, he began moving to change that, ousting a number of the firm's senior officers.
A spokesman for Merrill Lynch declined to comment on the case's role in Mr. O'Neal's personnel moves. At the time, Mr. O'Neal was involved in a broad effort to consolidate his power in the firm and to enhance profits by cutting costs.
Like many of its Wall Street peers, Merrill has had its reputation battered by scandals over the last two years — not only the Enron affair, but abuses involving stock analysts and the distribution of shares in hot new companies. But prosecutors today praised the firm for its willingness to embrace internal reforms.
"The whole idea is to be the gold standard that other financial institutions will follow," said Andrew Weissmann, a federal prosecutor on the case. Merrill's approach to the settlement, he added, "demonstrates that its current leadership is committed to being a responsible citizen and ensuring that the illegal activities that occurred will not be repeated."
The resolution in the corporate case came as three former senior Merrill executives were indicted on charges of conspiracy, obstruction of justice and perjury for their roles in one transaction, what was supposed to be a sale by Enron to Merrill of an interest in power barges moored off the coast of Nigeria.
Each of those executives — Daniel Bayly, the former head of global investment banking; James A. Brown, the former head of Merrill's strategic asset lease and finance group; and Robert S. Furst, who was in charge of managing Merrill's relationship with Enron — pleaded not guilty at an arraignment today in federal district court here. They were each released on a $100,000 bond, secured with $50,000 in cash.
At issue in the barge deal is whether Merrill genuinely purchased an interest in the assets, or whether the transaction was a sham intended to allow Enron to book bogus profits.
According to the indictment, Enron was trying desperately late in 1999 to sell a stake in the barge. When no buyer emerged by December, Andrew S. Fastow, the company's chief financial officer at the time, and others approached Merrill about becoming the buyer.
But the indictment says that the sale to Merrill was nothing of the kind. While Merrill agreed to pay $28 million for the barges, 75 percent of that money was provided by Enron itself. And in a secret side deal, the indictment says, Enron executives pledged that Merrill would receive back its investment plus an agreed- upon profit within six months.
Consequently, the indictment says, Merrill never had any risk in the deal, and so never actually purchased anything; Enron, meanwhile, booked $12 million in bogus profits.
Besides the barge deal, today's settlement encompasses a second 1999 transaction in which Merrill and Enron engaged in back-to-back energy trades. Though the trades effectively canceled each other out, Enron was able to book income from them because of the way they were treated under accounting rules.
Under the settlement, Merrill is required to establish a Special and Structured Products Committee that will be responsible for reviewing all of its structured finance transactions with any third party.
In addition, for 18 months, Merrill must retain an independent auditing firm to review the committee's procedures. And the company will have to hire a lawyer — selected by the Justice Department — to oversee the work of the auditing firm. The lawyer will issue periodic reports to the government about Merrill's compliance with the settlement.
The committee will be required to reject any transaction with a third party that it believes is intended to create a misleading effect on a company's earnings, revenues or balance sheet. Undocumented side agreements like the one described in the Nigerian barge indictment will be specifically prohibited. Any transactions, like the 1999 energy trades, that cancel out any real economic effect will also be prohibited.
The committee must also review any year-end transaction with a third party "where Merrill Lynch knows or believes that the third party's primary motive is to achieve" accounting outcomes that would affect reported financial results.
Such transactions were widely used in corporate America before the Enron debacle, and while some accounting rules have been tightened in Enron's wake, many deals that could serve to cloud financial reports can still be done legally.
But financial and legal experts said that the limits imposed on Merrill — and the model they offer for other firms — could go a long way in slowing the use of deals that have no purpose other than to make a company's financial reports look better.
"This says that Merrill Lynch can't participate in any transaction that is designed just to create window-dressing for a financial statement," said Gordon Yale, a principal with Yale & Company, a Denver-based forensic accounting firm. "I think that will have a chilling effect on transactions with no economic substance but profound financial reporting impact. Any other company will be able to look at how Merrill got to this place and know what they need to avoid."
John C. Coffee Jr., a professor at Columbia Law School, said that transactions that create a misleading financial outcome, even if they are arguably legal, "are going to be a vanishing species."
Besides the model offered by the settlement, he said: "We have mid-level executives seeing that they can go to prison for these types of deals. That is a deterrent."
Other legal experts said competing firms might see an opportunity, in the wake of the settlement, to snap up deals that otherwise might have been done by Merrill.
"This is very unusual, and not an off-the-shelf settlement," said Stephen Ryan, a former federal prosecutor who is now a partner at Manatt Phelps & Phillips in Washington. "There are some people in the marketplace who might see it as a business opportunity. But I think there is a signal that conduct that is unattractive to the regulators will be addressed in unprecedented ways like this."
Earlier this year, the S.E.C. filed charges against four former Merrill executives, including Mr. Bayly and Mr. Furst, largely involving the Nigerian barge deal that figured in today's indictments and settlement.
The other former Merrill executives named in that case — Thomas W. Davis, former vice chairman for private equity and research, and Schuyler M. Tilney, who was head of energy investment banking at the firm's Houston office — were not charged today. Both men were fired by Merrill after refusing to testify before the S.E.C. about their dealings with Enron.
Merrill itself paid $80 million in February to settle civil charges against the firm itself. No additional financial penalties were imposed on Merrill in today's settlement of the government's criminal case.
Copyright 2003 The New York Times Company
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