ENRONITIS – A COMMUNICABLE DISEASE
By Jim Rarey
February 27, 2002
What at first was thought to be just the outrageous illegal excesses of one
company (Enron) is now found to be an outbreak threatening to become an
epidemic. In the Enron case, over $80 billion in value has disappeared from
investment portfolios including pension funds, private 401K’s, IRA’s and
other institutional and private investors. And that’s just the stock effect.
Still to come are disclosures of the impact of loans from investment banks
and bonds issued by Enron subsidiaries and "partnerships" which will be in
the billions of dollars.
Before tracing the contagion of the "Enron Syndrome" we should try to
clarify just exactly what Enron was doing. About the only consistent
explanation in most of the media is that the company was hiding its true
debt on the balance sheets of the partnerships. It was doing much more than
that.
Enron set up more than 3,000 private "partnerships" with the aid of
investment bankers who rounded up the investors to give the appearance of
independent companies. With the connivance of the bankers, bond rating
services and Wall Street analysts, bonds were then issued by the
partnerships. The bonds were backed, not by the (non-existent) assets of the
partnerships, but by Enron stock. Enron stock at that time was the darling
of Wall Street trading in $60-$80 dollar range. Given investment grade
ratings by the ratings services and buy recommendations from Wall Street
analysts, the bankers had no problem touting the investments to unsuspecting
investors. Of course Enron is now a penny stock and the bonds have virtually
no backing.
This stratagem worked so well the bankers began to recommend the structure
to other clients. Chief among the investment houses were CitiGroup, Credit
Suisse First Boston and Deutche Bank Alex Brown according to a 2/14/02 New
York Times article. The practice became so lucrative that some of the banks
began buying the bonds themselves and then peddled them to investors.
Two of the companies named in the Times article as adopting the Enron model
are the Williams Companies and the El Paso Corporation. Both are also big
players in the energy (oil and gas) markets. The major selling point of the
model was that it would shield the bond liabilities from 'investors view by
keeping them on the partnerships' balance sheets.
J.P Morgan Chase also had a "arrangement" with Enron where large sums of
money were prepaid to Enron supposedly for future delivery of oil and gas
commodities. These transactions were run through one of the partnerships and
an entity called Mahonia Ltd., a subsidiary of Morgan Chase set up in Jersey
in the (English) Channel Islands.
No commodities were ever delivered and the prepayment was returned to Morgan
Chase plus about 3.4% of the contract. The transactions are being
investigated, as they appear to be nothing but private loans to Enron
outside of normal reporting requirements.
Morgan Chase required Enron to obtain performance bonds from insurance
companies for the transactions with themselves as the beneficiary. Since the
bankrupt Enron now cannot make good on the repayments, Morgan Chase has
claimed payment from the insurance companies. The insurance companies are
refusing to pay saying the transactions were misrepresented as commodity
trades.
Morgan Chase has sued and, according to Standard & Poors, stands to lose
over $5 billion if unsuccessful. One of the companies involved is Travelers
Insurance, a subsidiary of CitiGroup. Ironically, and perhaps even
poetically, this has the effect of the Rockerfellers suing themselves since
they control both Morgan Chase and CitiGroup.
Are all these goings on legal? Where were the accountants and lawyers while
this was happening? There is some confusion as to whether the partnership
scheme was the brainchild of Enron management or of the consulting arm of
Enron’s auditors, Arthur Anderson. It may be irrelevant since both embraced
the concept wholeheartedly. Arthur Anderson is said to have passed the model
on to some of its other big clients of which Global Crossings is one of the
more notable.
Global Crossings, of course, is much in the new as it tries to sell its core
business (a strategic fiber optic network) to a company with close ties to
the government of Communist China. It also has gained notoriety for its
chairman's reaping of over $700 million in stock sales before the company
went into Chapter 11 bankruptcy. (This dwarfs Enron CEO Ken Lay’s sales of
$100 million.) Also Democratic National Committee chair Terry McAuliffe, who
had a close relationship with the company, realized an $18 million profit
from a $100,000 investment in Global Crossings.
Enron’s law firm, Vinson & Elkins evidently had no reservations about Enron
securities earning fees in 1999 for advising on $3.4 billion in Enron
offerings. The firm is also said to have given Enron (unknown) advice on
document shredding by Enron and Arthur Anderson.
Arthur Anderson is no stranger to controversial accounting methods. It has
lost several large class action civil law suits over its actions (or lack
thereof) and at least two multi-million dollar fines for criminal complicity.
However, accountants, lawyers, investment bankers and Wall Street analysts
have been emboldened by congressional legislation effectively giving them a
"safe harbor" in relying on the statements of clients. In 1995, the Private
Securities Litigation Reform Act (H.R. 1058) forbid private class action
suits against such "professionals" in federal courts.
The bill was bitterly opposed by trial lawyers and severely conflicted the
Democrat Party. It was essentially a confrontation between the lawyers on
one hand and the investment community on the other. The bill was passed and
sent to President Clinton who promptly vetoed it. Some say this was merely a
symbolic gesture on his part since he must have known the votes were there
to override his veto, which happened in short order. The vote to override
was 319 to 100 in the House and 68 to 30 in the Senate. Thus the
confrontation between the two special interest groups turned out to be
strictly no contest with the bankers and their allies winning hands down.
But the bill left some loopholes. Trial lawyers shifted their private class
action suits to state courts where the "safe harbor" provisions did not
apply. Consequently, in 1998, the congress moved to remedy that oversight.
Senator Phil Gramm, Chair of the Senate Banking Committee (whose wife sits
on the Enron Board of Directors Audit Committee) introduced S.1260 "to limit
the conduct of securities class actions under State law." While affirming
the right for such lawsuits to be filed in state courts, it contained a
provision for transferring such suits to federal court for dismissal. It
also severely limited the amount of information that plaintiffs could obtain
in the discovery process.
The bill passed by even larger margins than the 1995 bill with a 319 to 82
vote in the House and 79 to 21 in the Senate In the face of such
overwhelming votes, Clinton meekly signed the bill into law. In the house
the lone dissenting Republican vote was cast by Rep. Ron Paul of Texas (not
one of Enron’s favorite congressmen). Paul was not in the congress during
the 1995 vote.
In 1996 Enron had lobbied vigorously, but unsuccessfully, to get an
exemption for its projects put into an update of the 1940 Investment Company
Act. Failing that, its next step was to approach the Securities and Exchange
Commission (SEC) for an exemption. Congress, in its wisdom, had given the
SEC the power to exempt individuals and/or companies from the requirements
of the 1940 Investment Company Act. This supposedly was to relieve small
businesses from onerous reporting requirements.
As reported by Insight Magazine, Enron lobbyist Joel Goldberg approached
Barry Barbash, SEC head of the Investment-Management Division about getting
an exemption. In March of 1997 Barbash authorized the exemption writing, "It
is ordered that the requested exemption from all provisions of the act is
hereby granted."
According to Insight, Goldberg had been Barbash’s boss when both worked at
the SEC in the 1980’s. The two are now partners in the Washington office of
the Shearman and Sterling law firm.
Clinton appointed head of the SEC Arthur Levitt told the New York Times he
has no recollection of the Enron exemption. However, Barbash told Insight he
sent memos to Levitt and the commissioners and that the exemption was, "one
of the most well-vetted things in Washington in its day."
With the exemption in hand and the accountants, lawyers and bankers
protected from private class action lawsuits, it was full steam ahead with
the results we see today.
Without the exemption, Enron officials could not legally have been on the
boards of the partnerships. Also the reporting requirements would have made
it difficult if not impossible to keep the liabilities off of Enron’s
balance sheet.
However, the "safe harbor" may not be as safe as some thought. It does not
protect against criminal activity or willful fraud if it can be proved.
Although the Fifth Amendment protects the players from giving evidence
against themselves, investigators seem to be turning up enough for a number
of criminal convictions.
The ultimate effect on the stock market and the county’s financial structure
is yet to be determined. If the Enron practices are as widespread in other
companies, as some believe, we may be seeing a domino effect with Enron and
Global Crossing only the beginning. There may never be a full accounting as
to how much money Enron and others raised through these practices.
One aspect of the problem the media is avoiding like the plague is the
possibility of money laundering for nefarious purposes other that personal
enrichment. The labyrinth of several thousand companies scattered around the
globe is a money launderer’s dream and a law enforcement nightmare.
Permission is granted to reproduce this article in its entirety.
The author is a free lance writer based in Romulus, Michigan. He is a former
newspaper editor and investigative reporter, a retired customs administrator
and accountant, and a student of history and the U.S. Constitution.
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