NEW YORK (CNN/Money) -
Congressional investigators testified Tuesday that Citigroup and J.P. Morgan Chase helped not only Enron Corp. but several other companies set up sham transactions to alter their finances.
Investigators with the Senate's Permanent Subcommittee on Investigations said the banks helped the now-bankrupt energy trader with more than $8 billion in complex financing arrangements that made it look rich in cash rather than heavily indebted.
"The evidence indicates that Enron would not have been able to engage in the extent of the accounting deceptions it did, involving billions of dollars, were it not for the active participation of major financial institutions willing to go along with and even expand upon Enron's activities," chief congressional investigator Bob Roach testified at a panel hearing Tuesday.
Roach said that third-party "shell" corporations were used to transfer money back and forth between Enron and the banks to make loans look like trading activity and that both banks actively sold other clients on their ability to alter finances in this way.
Roach said J.P. Morgan Chase had even developed a "pitch book" to tell clients about such deals and had made such arrangements with seven other clients. Citigroup made similar deals with at least three other clients after soliciting business from as many as 14, Roach said.
More ominously, investigators said they still were studying whether Citigroup may have violated securities laws in issuing a prospectus to entice investors to buy the debt of one such "shell" corporation, called Yosemite. The investors in that transaction may have unwittingly placed themselves in the middle of a trade that sent money back and forth between Enron and Citigroup, making a loan look like a cash transaction.
"I don't see disclosures that Citigroup was trying to reduce its exposure to Enron -- trying to reduce its exposure at the same time it was trying to increase that exposure to outside investors by issuing notes," Lynn Turner, former chief accountant at the Securities and Exchange Commission, testified.
Citigroup officials said the exposure to Enron debt was disclosed throughout its prospectus for an offering of about $800 million in Yosemite debt -- though they did not disclose that the proceeds were used to fund another "shell" corporation deal between Enron and Citigroup.
Shares of J.P. Morgan (JPM: down $4.44 to $20.08, Research, Estimates) and Citigroup (C: down $5.04 to $27.00, Research, Estimates) both fell sharply Tuesday.
Chase officials defend transactions
J.P. Morgan officials testified that the transactions they set up were commonly used forms of structured financing and were appropriate. They also said they thought Enron had reported the transactions as liabilities and that, in any event, they were not responsible for how Enron reported them.
The officials also refuted investigators' claims that the schemes -- called "pre-pays" because they involved third-party entities paying in advance for the delivery of oil and natural gas -- were used simply to cover up debt.
"Pre-paid forward contracts have been used for many years and are widely recognized as an entirely proper tool to increase liquidity and diversify sources of funding," J.P. Morgan official Jeffrey Dellapina testified.
Dellapina and other officials also denied that Mahonia Ltd., the third-party entity involved in all 11 of the pre-paid deals between Morgan and Enron between 1993 and 2001, was merely a puppet of Morgan -- though they also admitted that Morgan's attorneys had established the company and that it did no business with anybody but Morgan.
Subcommittee Chairman Sen. Carl Levine, D-Mich., also introduced a J.P. Morgan e-mail, dated Nov. 25, 1998, that dramatically contradicted the officials' testimony.
"Enron loves these deals, as they are able to hide funded debt from their equity analysts because they (at the very least) book it as deferred [revenue] or (better yet) bury it in their trading liabilities," the e-mail said.
Though the Morgan officials said they had never seen the e-mail and that its author was simply mistaken, Levin was unconvinced.
"[Mahonia] is a shell, [and] this is a shell game," Levin said. "[J.P. Morgan] Chase should own up to it and be honest about it, but it's not."
'No secret deals'
Citigroup officials also called its arrangements with Enron appropriate and in compliance with accounting standards -- though they admitted that, economically, they were a way for Enron to reclassify debt as a different kind of liability.
"Enron assured us these had been fully vetted by [Enron auditor Arthur] Andersen," Citigroup official Rick Caplan testified. "We should add that we did not advise Enron or anybody else as to the appropriate accounting treatment of any transaction."
Other Citigroup officials testified that they may have been misled by Enron, and congressional investigator Roach earlier testified that Andersen may not have been aware of the exact nature of all the transactions.
But an internal e-mail, sent by James Reilly, an official in Citigroup's Houston office, said that documents in a 1999 deal called "Roosevelt" could not reflect Enron's agreement that it would pay back millions to Citigroup by a certain time, "as it would unfavorably alter the accounting" and force Enron to report the deal as a loan.
In the Roosevelt deal, Enron got $500 million in cash from Citigroup and agreed to deliver oil and gas in a period of three years. It paid back $375 million of that by May and verbally agreed to pay the rest back by Sept. 30 rather than delivering commodities. Reilly's e-mail appeared to warn that documenting that agreement to repay would force Enron to list the transaction as a loan.
Reilly, however, testified that his e-mail had been misinterpreted and that Enron had not verbally or in any other way committed to paying back the money; instead, his e-mail had simply reflected Enron's hope to pay back money by a certain period of time.
"There were no secret deals," Reilly said.
In the Roosevelt, Yosemite, Mahonia and other deals, investigators said, Enron "sold" energy to a phony corporation set up, controlled and financed by the banks.
Enron then would "buy" the energy back from the shell at a preset price, which amounted to paying back principal plus interest. These transactions were essentially loans to Enron -- and Roach said they were called that in Enron's income-tax returns. In their financial reporting, however, they were booked as cash flow.
In return, the banks received fees and favorable consideration in other business dealings, Roach said.
Investigators believe the deals with both banks helped Enron understate its debt in 2000 by $4 billion, or 40 percent, and overstate its cash flow by about $1.7 billion, or about 50 percent, Roach said.
Enron filed for bankruptcy last December after disclosing it had overstated profits by hiding debt in a number of ways.
At Tuesday's hearing, representatives of Standard & Poor's and Moody's testified that the credit-rating agencies would have significantly altered their view of Enron, and Moody's said it might have cut Enron's debt rating to junk status far earlier than it did if the agencies knew about the financing maneuvers.
The rating agency representatives also said they had not been contacted by any banks seeking a "break" for Enron during the period last year when Enron's accounting schemes began to unravel and its stock began to fall.
Former Treasury Secretary Robert Rubin, then an official with Citigroup, called Treasury to ask if it might be appropriate to appeal to rating agencies to delay cutting Enron's credit rating. The Treasury Department refused, and Rubin dropped the matter.
The Justice Department is investigating what others, including Merrill Lynch & Co. (MER: Research, Estimates) and National Westminster Bank, a unit of Royal Bank of Scotland PLC, may have done to help Enron hide debt, according to a Wall Street Journal report Tuesday.
Other energy companies, including CMS Energy (CMS: Research, Estimates) and Duke Energy (DUK: Research, Estimates), are under investigation for conducting what are called "round-trip" energy trades, transactions that essentially canceled each other out while creating the appearance of heavier trading volume -- though they did not appear to be a means to hide debt.