Man Without Qualities

Tuesday, August 03, 2004

Again, Enron

When Enron collapsed there were widespread accusations that the "special purpose corporations" and "structured finance" transactions that Enron had employed were obviously fraudulent. In particular, the so-called Mahonia transaction, which the New York Times and others alleged fraudulently allowed Enron to claim as revenue what were "obviously" loans, was singled out for especially fierce criticism.

This blog did not agree and does not agree with what the Man Without Qualities continues to regard as overly-broad and hysterical criticism of the Enron financial structure. Indeed, although a number of people have pled guilty to various types of fraud, not one of these supposedly "obviously" fraudulent structured finance transactions has been shown to have actually been fraudulent. While some guilty pleas - such as Mr. Fastow's - have been obtained from defendants essentially confessing to the fraudulence of those transactions, those pleas have been obtained under (legally permitted) duress, in Mr. Fastow's case under the threat of imprisoning his wife and depriving their young children of any parental contact for many years. But neither the government nor private litigants have been notably successful in proving the fraudulence of these structured finance transactions where anyone else has bothered to contest the issue. Now we have this:

U.S. bank J.P. Morgan Chase & Co. said it won a lawsuit against WestLB AG related to Morgan's Enron financing. .... The case centered on J.P. Morgan Chase's involvement with an offshore financing vehicle called Mahonia Ltd. In a complex trading arrangement that later drew extensive scrutiny from U.S. regulators, Morgan channeled money to Enron, which then returned the payments in the form of contracts for the future delivery of gas. Those gas-related payments, known as gas prepay contracts, were paid through an offshore vehicle, Mahonia.

When Enron melted down, J.P. Morgan was thrown into litigation as it sought to call in guarantees underpinning its Enron-related financing. One of those litigants was WestLB. WestLB was the lead arranger among a syndicate of banks that had provided a $165 million letter of credit, a common form of risk underwriting in the event that Enron defaulted on the gas prepays.

After Enron's collapse, WestLB refused to honor the letter of credit, alleging that the transactions were part of a "fraudulent scheme" that essentially disguised loans to the energy company. J.P. Morgan sued WestLB; WestLB countersued and the trial began in London's High Court of Justice in January.

Yesterday, Justice Jeremy Cooke ruled in favor of J.P. Morgan and Mahonia, saying that how Enron accounted for them didn't breach U.S. accounting and securities rules. ... "Enron's accounting for the prepays was not in breach of U.S. Generally Accepted Accounting Principles," he wrote in his opinion. He added that its "accounting for these transactions did not constitute a breach of U.S. securities law." ....

The Mahonia-related trading arrangement has been the subject of extensive scrutiny in the wake of Enron's filing for bankruptcy protection in December 2001 as regulators sought to untangle how the energy trader had financed its extensive dealings. ....

The English court seems to have got the case exactly right. It is interesting to note how separation of that court from the often hysterical rantings and US domestic political considerations over the Enron failure which are so common - and so self-destructive - in the United States seems to have helped to clarify matters for the London judge. Perhaps the passage of time will have some of the same stabilizing effects on courts in this country.

In the mean time, a glimpse of the outcome of the prosecution of Kenneth Lay, for example, can be glimpsed in this not-too-distant London mirror.

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