The Enron Nine
For those already exhausted by the torrent of Enron disclosures, I would not recommend reading the "Consolidated Complaint" filed by defrauded investors for a literary experience. The class-action lawsuit is 500 pages long, not counting appendixes, and dense with tedious legal repetitions and the mind-numbing complexities of Enron's financial transactions, most already known. On the other hand, this document tells an eye-popping story of how the Wall Street system really works, and it resonates with political significance because the plaintiffs' lawyers are redirecting public outrage--and multibillion-dollar damage claims--at the best and most powerful names in American finance. Nine leading banks and financial houses have been added as defendants and depicted as intimate insiders in what the lawsuit calls the "Enron Ponzi scheme." They were the engineers, it is asserted, who devised manipulative deals concealing the truth. They were also principal beneficiaries of this massive scam.
The "Enron Nine" (if we may call them that) are J.P. Morgan Chase, Citigroup, Credit Suisse First Boston, Canadian Imperial Bank of Commerce, Bank of America, Merrill Lynch, Barclays, Deutsche Bank and Lehman Brothers. These financial institutions collaborated with the now-bankrupt energy company in its financial sleight of hand--the deals that enabled Enron to inflate its profits, conceal its burgeoning debts and push its stock price higher and higher. Together and individually, the banks and brokerages raised at least $6 billion for Enron through the debt or stock issues sold to unsuspecting investors from 1996 through 2001, when the Enron illusion finally expired. Another $4 billion or more was channeled into Enron's "partnerships" like Jedi, Chewco and LJM1 and LJM2, which became the principal mechanism for hoodwinking shareholders. These deals were often hurriedly arranged at year's end to paper over the company's true condition and keep the fraud from collapsing.
Enron was "the golden goose of Wall Street," according to the investors' complaint. The banks "earned" hundreds of millions, billions altogether, in securities commissions and consulting fees as well as from the inflated interest rates they charged Enron on disguised loans. In fact, selected senior managers at Morgan, Citigroup, Merrill and others even invested millions of their own money in Enron's secretive "special entities," promised extraordinary returns of 1,000 percent or more. As one reads through these financial intricacies, the gut question is the same one asked about Richard Nixon during the Watergate scandal: What did the bankers know and when did they know it? If they were not ringleaders, then they must be as gullible as the shareholders who were bilked. And, if these allegations are true, why isn't there also a federal grand jury looking into the possibility of criminal fraud?
At this point, these are only allegations. Though most of the supporting facts are already established, the legal risk of launching this bold foray against the financial establishment is considerable. It might lose, because the plaintiffs must prove not simply that the banks aided and abetted Enron's deceptions but that they were also principal authors. The banks are somewhat shielded from liability by Supreme Court rulings and the "tort reform" law that Congress enacted for the financial industry back in 1995 [see Greider, "Enron Democrats," April 8 and "Enron: Crime in the Suites," February 4]. They also have deep pockets. As a practical matter, Enron itself is not going to have much left for compensating shareholders after the bankruptcy court gets through with it. Indeed, in bankruptcy proceedings, the creditors standing first in line with claims on the carcass are the same banks--led by J.P. Morgan and Citigroup--accused by this lawsuit of fueling the fraud. Other, less privileged creditors may decide to challenge the legitimacy of the banks' claims, using a similar argument that Morgan, Citigroup and others were actually Enron insiders, not arms-length lenders.
"The Enron fiasco represents a massive wealth transfer from public investors...to corporate insiders, Wall Street bankers and the accounting and legal professionals who perpetrated the fraud," the lawsuit declares. Nearly $25 billion was lost by people, pension funds and other institutional investors who purchased Enron shares at fraudulently inflated stock prices, peaking above $90, only to see the stock price collapse, eventually to pennies. This vast class of injured parties is led by the University of California's Board of Regents on behalf of its pension fund, which lost $145 million. The lawsuit was crafted by William Lerach and a squad of lawyers from Milberg Weiss Bershad Hynes & Lerach, the West Coast firm that has successfully pursued scores of investor-fraud lawsuits. Arthur Andersen and two premier law firms, Vinson & Elkins of Houston and Kirkland & Ellis of Chicago, are included among the co-defendants (led by Enron and thirty-eight of its executives and directors) because they blessed the legality of the fraud. Lerach is currently trying to negotiate a separate settlement with Andersen that could bolster his case enormously if the firm agrees to turn over its internal documents. The Wall Street Journal editorial page is already attacking Milberg Weiss and the California regents, a sure sign the citadel of finance is rattled.
Win or lose, the lawsuit poses numerous embarrassments for Washington politics, and Congressional reformers should study it for a summary of the corrupted laws that need to be re-examined. Perhaps the most important one is this: The merger of commercial banks and Wall Street investment houses, ratified by Congress in 1999 and legalizing the new financial conglomerates like Citigroup and J.P. Morgan Chase, has already reproduced the very scandals of self-dealing and swindled investors that led to the legal separation of these two realms seventy years ago in the Glass-Steagall Act. Morgan and Citigroup senior executives, for example, consulted Enron's top executives almost daily on how to solve the company's deepening financial problems, but that knowledge was never shared with investors to whom the banks sold Enron shares and debt securities or, for that matter, with other banks who took a share of syndicated loans. The banks' stockbrokers maintained "strong buy" recommendations even as Enron entered its "death spiral," as the lawsuit calls it.
Meanwhile, Morgan and Citigroup executives, evidently nervous about the looming meltdown, were arranging insurance to hedge their own commercial-lending exposure to Enron. Morgan's insurance company subsequently refused to pay up on the grounds that the bank had concealed the fraudulent nature of its Enron transactions. Morgan sued to collect; a federal judge ruled for the insurer. Likewise, Citibank's supposed commodity swap with Enron was in fact a disguised loan, the suit claims. "In interacting with Enron, Citigroup functioned as a consolidated and unified entity," the lawsuit charges. "There was no so-called Chinese wall." But when Congress repealed Glass-Steagall, it was assured that the new mega-banks would keep their conflicting obligations separated by "firewalls" within the organizations. That promise, always improbable sounding, now appears to be a hoax. When you think about it, how could a bank's senior managers compartmentalize what they knew about Enron's internal troubles as investment counselors and separate it from their fiduciary obligations as bankers to the people who park their savings with the bank? Especially when some of the bankers were personally invested in schemes set up to conceal the truth?
The lawsuit also documents the duplicitous uses of freewheeling stock options. Even as company officials worked with the bankers to keep the game going, Enron insiders were cashing stock options and selling off $1.2 billion of their own shares. The lawsuit provides a narrative in five-color charts that depict the timeline of how Enron execs pumped up profit and the stock price with repeated gimmicks devised by their bankers, but meanwhile sold their own stakes on the "good news."
The theory of the case goes like this: Enron's glory days were actually quite brief. Its trading business was launched in 1990, but big flaws in the business plan were already apparent to insiders by 1995. The venture was simply not as profitable as its founders had imagined or the expanding marketplace of energy deregulation was not keeping up with their expansive promises to investors. Either way, the company started cooking its books, inflating profits from legitimate long-term energy contracts by booking future-year returns upfront (an accepted practice that requires a company to downgrade its profits in subsequent years when initial claims prove wrong). Instead of acknowledging error, Enron began its ventures in self-dealing--setting up the "special purpose entities" (SPEs) with Star Wars names to pretty up its balance sheet. These transactions evolved into Super Ponzi.
The essential element of a Ponzi scheme is the promise of quick, extravagant returns paid to initial investors, financed with the stream of money raised from subsequent investors. (Charles Ponzi's 1920s fraud, the Security Exchange Company, looks quite moderate alongside Enron.) The illusion always collapses eventually because, despite what you might think, there is not an infinite supply of gullible fools. Enron's run-up, like Ponzi's, required a willing suspension of disbelief among otherwise astute investors, and that is why the prestigious banks (not to mention auditors and law firms) were so vital to the scheme. If J.P. Morgan or Citibank or Merrill Lynch was managing the new security issue and itself lending to Enron, who could doubt its soundness? The cumulative impression, as one reads through the labyrinth of deal-making, is that of a deranged bookkeeper concocting a paper castle in the air. Only these bankers were doing the construction, as the legal complaint repeatedly reminds. Did they too get caught up in the illusion? Or were they just trying to protect their golden goose?