Posted on 07/22/2002 11:28:33 AM PDT by MamaLucci
Citigroup deals helped Enron to hide its debts
Senate investigators charge that two Wall Street firms helped obscure billions in loans
By Jathon Sapsford and Paul Beckett
THE WALL STREET JOURNAL
July 22 — Citigroup Inc. arranged an unusual financing technique for Enron Corp. that enabled the energy trader to appear rich in cash rather than saddled with debt, according to internal documents of both companies.
DETAILS OF the controversial arrangement are only now coming to light as Congress turns to probing the role played by Enron’s banks in enabling its illusory growth.
In a series of deals known as Yosemite, the documents show, Citigroup’s complex scheme helped Enron borrow money over the past three years that was booked as coming from trades instead of loans. The deals, involving bond offerings and trades with an offshore entity, helped boost the company’s weak cash flow to match its growth in paper profits, at a time when the gap between the two had grown to as much as $1 billion a year, according to one Enron memo.
Investigators want to determine whether Enron would have been able to defraud investors if not for the willing participation of Wall Street. The documents amount to the most in-depth evidence yet of the extent to which Citigroup, the nation’s largest financial institution, helped Enron disguise debt on its balance sheet through some of the most complex financial accounting arrangements at the Houston energy company.
Although Citigroup’s actions technically may have been in accordance with accounting principles, they raise questions over whether Citigroup helped shield important information from Enron investors. Citigroup says it has done nothing wrong, noting that lenders shouldn’t be held responsible for how a client such as Enron accounted for the financing arranged by its bankers. Citigroup said in a statement, “The transactions we entered into with Enron were entirely appropriate at the time based on what we knew and what we were told by Enron. We were assured that Enron’s auditors had approved them, and we believed they were consistent with accounting rules in place at the time.” Enron officials didn’t return calls seeking comment.
The deals will be scrutinized in new detail as part of hearings the Senate’s Permanent Subcommittee on Investigations will launch Tuesday, examining to what extent Enron’s banks helped disguise the true nature of its finances until its spectacular flameout and filing for bankruptcy protection last December.
“It has become common knowledge that Enron engaged in accounting deceptions to convince lenders, investors and analysts that the company was in better financial shape than it was,” said Senator Carl Levin, the Michigan Democrat who will act as co-chairman of the hearings. “The question the Subcommittee will examine is the extent to which major financial institutions knew of and aided Enron’s accounting deceptions.”
Citigroup rival J.P. Morgan Chase & Co. also will face scrutiny in the hearings this week for similar deals through a vehicle known as Mahonia, which was the subject of a page one story in The Wall Street Journal in January. Mahonia has drawn wide scrutiny following a lawsuit with insurers who guaranteed the transactions through surety bonds.
The insurers refuse to pay Morgan, arguing that prepaid transactions effectively generated loans, not trades. Their viewpoint struck a chord with the judge overseeing the case, U.S. District Judge Jed S. Rakoff, who said in a March opinion that the Mahonia transactions “now appear to be nothing but a disguised loan.”
The Securities and Exchange Commission is investigating both Citigroup and J.P. Morgan over whether the banks helped Enron hide debt and artificially boost cash flow, and the office of Manhattan District Attorney Robert Morgenthau also has been examining the deals, people familiar with the matter say.
A spokesman for J.P. Morgan said the company believes “the prepaid transactions were properly accounted for by our firm and Enron.”
Enron, which had a reputation of brow-beating its bankers, appeared to put some pressure on Citigroup to carry out elements of the deals. For example, according to one e-mail account, on May 14, 2001, Enron Treasurer Ben Glisan scolded bankers at Citigroup’s Salomon Smith Barney investment-banking unit for not pushing aggressively Citigroup’s portion of a Yosemite-related bond offering the securities firm had proposed selling to European investors.
• Companies under the microscope
“If possible, I am even more p — d today than I was last Thursday,” Mr. Glisan told Maureen Hendricks, a senior Salomon investment banker, according to the account of the call she later e-mailed to colleagues. The bottom line, Mr. Glisan told Ms. Hendricks: “Enron is going to raise hell over this deal.” Salomon eventually sold the bonds. Mr. Glisan declined comment.
Like the Mahonia arrangement, Citigroup’s Yosemite transactions involved what are known as commodity “prepay” transactions, in which money is paid up front for commodities such as natural gas or oil to be delivered at a future date. Those are common in the energy industry. But documents expected to be released in this week’s Senate hearings will show that the Yosemite transactions were intensely complex and made debt appear on Enron’s public disclosures as trades through a series of “round trip” prepaid transactions.
Here’s how the trades worked: In each of the four Yosemite deals, Citigroup set up a trust that raised money from investors in Europe or the U.S. Then the money moved to a Citigroup-sponsored special purpose vehicle in the Cayman Islands known as Delta. Delta then sent the money in a circle through a series of oil trades, first to Enron then to Citigroup, and then back to Delta, each time moving the money through oil prepay contracts.
Oil never actually changed hands, and the trades effectively canceled each other out. Cash settlement is common in commodity transactions, but the round-trip nature of the trades is one uncommon aspect that has drawn the scrutiny of congressional investigators. So has the accounting effect of the circular trades, which allows Enron to borrow money from the Yosemite investors but record it as cash generated from its operations — because prepay contracts are booked as trades rather than loans. The distinction was important because the company’s burgeoning debt levels were starting to raise a few red flags among shareholders well in advance of Enron’s collapse.
“The use of prepays as a monetization tool is a sensitive topic for both ratings agencies and institutional investors,” said an undated Enron document now in the hands of congressional investigators. Documents show that Enron commonly referred to the Yosemite transactions as keeping details in a “black box.” Only two parties would know the precise details: Enron and Citigroup, according to the documents.
Enron, meantime, put into Yosemite an extra payment called a “magic note,” according to internal documents, that assured that Yosemite’s investors received interest on their investments. Those investors were led to believe they were buying assets from Enron that produced revenue. In fact, Enron simply was paying — out if its own revenues — interest on its magic note, a bond with a yield of as much as 49% in one instance. The return was spread out among Yosemite investors to make sure they got interest on their investment in the trust.
All of this is a concern to regulators because the debt doesn’t appear as such on Enron’s public filings. Citigroup puts the blame squarely on Enron and its then-auditors at Arthur Andersen LLP.
“If what has been reported turns out to be the case — large-scale self-dealing, inflated assets, management that was inattentive or worse, a subservient board and a failure of auditing controls — we would not have done the business we did with Enron,” the bank said in its statement.
“I wish I’d never heard of Enron,” Citigroup Chairman Sanford I. Weill said in an interview last week.
Citigroup says that while the Yosemite deals were complicated, they were merely a refinancing of an existing arrangement whereby Citigroup had extended money to Enron for the future delivery of gas.
Other banks such as FleetBoston Financial Corp. and Credit Suisse First Boston arranged Enron prepay transactions totaling a little more than $1 billion in the past decade, according to Congressional investigators. J.P. Morgan alone during roughly the same period arranged $3.7 billion, they say.
But Citigroup outdid them all, providing Enron with $4.8 billion in 14 separate transactions through prepays in just the last three years before Enron filed for bankruptcy protection in December.
Despite the banks’ denials of any wrongdoing, many investors say the banks had or should have had knowledge about the true state of Enron’s finances. The two banks, as well as other Wall Street firms involved in Enron, face lawsuits accusing them of pushing Enron securities on the public, when, as lenders, they should have had insights that Enron’s finances were dodgy.
This week’s Congressional hearings, moreover, are likely to examine Citigroup marketing similar structures to other energy companies, including Dynegy Inc., through a transaction known as Project Alpha, people familiar with the investigations into Citigroup say.
Enron’s use of prepays arranged by banks was so extensive that Arthur Andersen created guidelines it gave to banks about what was needed for these structures to appear on Enron’s books as trades rather than debt. “For prepays to be treated as trading contracts, the following attributes must exist,” the brochure said, citing, among other things, that “the purchaser of the gas must have an ordinary reason for purchasing the gas.” A Houston federal jury convicted Andersen in June of obstructing justice after the government accused the accounting firm of destroying documents related to Enron.
Selling securities involved in the Yosemite transactions became the product of intense rivalry between banks. “Our co-managers are having a lot of fun trying to ‘out-sell’ us,” said Ms. Hendricks, the Citigroup investment banker, in her e-mail to colleagues in May 2001.
Yet even as the banks helped Enron to generate trades rather than loans for the purposes of its financial results, it was a different story when it came to paying taxes. Enron’s tax specialists advised the company to treat the Yosemite transactions as loans. Noted a Jan. 10, 2000, interoffice memorandum prepared by Enron’s tax department: “The most advantageous position for [Enron] to take is that the prepay is a loan for tax purposes.”
Paging Mr. Lieberman.
You nailed old pious Joe. ROFLMAO
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