The Enron Nine
Enron's "partnerships" essentially allowed the company to sell assets to itself--a Brazilian utility, commodity trading contracts, broadband capacity--and to rig the prices and profits on both sides of the transaction, then book the sale as rising revenues for Enron and thus send the share price higher. "In order for Enron's accounting scheme to work, the parties involved had to be controlled by Enron," the lawsuit explains. "But this control and affiliation had to be concealed." The selected private investors, who received lucrative rewards for putting up front money for Jedi or Chewco or the others, understood this reality because they were assured by Enron execs managing the schemes of exclusive access to the company's charmed opportunities. If they knew, the bankers who arranged the SPEs must also have known.
Keeping Enron's stock price aloft was the crucial imperative for all these parties. The company was borrowing billions in the short-term money market to finance its expansions but had to issue long-term debt securities to pay off the short-term paper. If the share price faltered, Enron could lose its investment-grade credit rating and access to long-term credit. The banks would lose their ability to sell more debt and their own commercial loans to Enron might even be imperiled.
With its distinctive circular logic, Enron was in effect creating "profits" from its own soaring share price--and vice versa. The fatal flaw, however, was embedded in the deals themselves. To reassure outside investors and presumably the bankers, these special entities included a promise that if things went poorly and the share price fell, the entities would be made whole again with--guess what?--new issues of Enron stock, a consequence sure to drive the share price still lower. This bind gave insiders a strong motive to maintain the deception. If they stopped pedaling, the bicycle would fall over.
So, as the lawsuit describes, the financiers and Enron executed an accelerating series of concealed transactions--new "entities" created to offload more debt from Enron and gull more shareholders. These deals typically occurred at year's end or the close of a quarter when a very bad financial report was bearing down on the company or when old investors were withdrawing from the existing partnerships. The bankers had to find new money and invent new entities to cover the looming discrepancies of older ones. Law firms had to vet the documenting papers for legality. Arthur Andersen auditors had to approve the accounting. Or else all of them would have a lot of explaining to do.
One of the most egregious episodes occurred in December 1999 when Merrill Lynch was managing the creation of LJM2 but couldn't find sufficient outside capital to make the partnership look like a bona fide "independent" entity. Enron had just executed one of its most brazen fictions--announcing that its new trading of fiber-optic broadband capacity was off to a tremendous start and promised unprecedented profit levels (in fact, the broadband market was drowning in too much capacity, and Enron trading partners like Global Crossing were on the brink of their own meltdowns). As Christmas approached, Enron's banks announced an early gift for high-level collaborators at the other banks--all of them would put up virtually 100 percent of the LJM2 financing and thus reap the bonanza for their banks and for themselves as personal investors. For six months Enron stock had been trading at around $40, but thanks to corporate lies and this new infusion of phony financing, the share price shot up to above $70. And a very Happy New Year was had by all.
The Enron Nine, having already announced their innocence, will get their turn when they file their rebuttals in the next month or two. One line of defense is likely to be that while these deals may sound fictitious and fraudulent to unsophisticated outsiders, they are actually standard transactions in high finance. The scariest implication of Enron is that maybe they are right, at least in a narrow legal sense. The terms of finance, the meaning of profit and loss, capital and ownership, have been so pushed out of shape by a generation of "market reform" politics, that it is possible that Enron, except for the scale of its fraud, does resemble Wall Street routine far more than anyone is ready to admit.
The daunting task of reform, already facing growing timidity in Congress, may require letting the lawyers dig to the bottom of this mess--aggressive trial lawyers like Milberg Weiss and courageous public prosecutors. In that regard, New York Attorney General Elliot Spitzer has bravely stared down Merrill Lynch on the duplicity of its stock analysts and may win important structural reforms from it and other Wall Street firms. Michael Chertoff, the tough Republican prosecutor who is US assistant attorney general, stood his ground against enormous pressure to let Arthur Andersen off the hook on its criminal indictment.
William Lerach, the trial lawyer who has taken on Wall Street banking, is gutsy enough but might, of course, settle the shareholders' case for the right money--big money. But if the banks refuse to deal and the Enron Nine go to public trial, it could become an educational spectacle that turns them into the O.J. Simpson of modern American capitalism.