July 28, 2003
J.P. Morgan and Citigroup Settle Inquiries on Enron's Fraud
The Securities and Exchange Commission said that J.P. Morgan Chase would pay $135 million and Citigroup would pay $120 million to settle the S.E.C.'s allegations against the companies. The Citigroup payment includes $19 million to settle allegations that it helped Dynegy Inc., an independent power producer, manipulate its financial statements.
In addition, the Manhattan district attorney's office said the two banking companies had agreed to pay a total of $50 million, half to New York State and half to New York City, to settle similar allegations.
"These two cases serve as yet another reminder that you can't turn a blind eye to the consequences of your actions," Stephen M. Cutler, director of the S.E.C.'s enforcement division, said in a statement. "If you know or have reason to know that you are helping a company mislead its investors, you are in violation of the federal securities laws."
The S.E.C. asserted that both banking companies helped Enron set up complex financial transactions through a group of so-called special purpose entities that enabled Enron to mask the true condition of its finances. It said Citigroup had provided Dynegy with similar assistance.
These financial transactions, the S.E.C. said, enabled Enron and Dynegy to inflate reported cash flow from their operating activities, underreport cash flow from financing activities, and underreport debt.
"Both financial institutions knew that Enron engaged in these transactions specifically to allay investor, analyst and rating agency concerns about its cash flow from operating activities and outstanding debt," the S.E.C. said in its statement. "Citigroup knew that Dynegy had similar motives for its structured financial transaction.
The S.E.C. said $236 million of the money would go to Enron investors who experienced losses because of the fraudulent finances, while $19 million would go to Dynegy investors.
The two banking companies also reached agreements with the Federal Reserve Bank of New York to strengthen their risk-management practices, particularly those associated with complex structured-finance transactions, the Fed said.
The Manhattan district attorney's office said that as a result of the settlements, it would not prosecute J.P. Morgan Chase or Citigroup or their employees for their Enron-related conduct.
With the announcement of the settlement, the district attorney, Robert M. Morgenthau, released copies of statements from the banking companies pledging reforms, as well as copies of a letter he sent to federal and state banking regulators.
In part, Mr. Morgenthau said bankers, as well as the lawyers and accountants who work for them, "must evaluate complex transactions as a whole, not as if they were a series of unrelated parts, and must take into account the use â€” or misuse â€” that their clients intend to make of transactions, as structured."
Under the agreement with the Manhattan district attorney's office, J.P. Morgan Chase and Citigroup will each pay $12.5 million to New York State and $12.5 million to New York City, as well as the costs of the investigation.
Citigroup and J.P. Morgan Chase agreed to make the payments to settle the cases without admitting or denying wrongdoing.
"We are pleased that these matters have been resolved," said Kristin Lemkau a spokeswoman from J.P. Morgan Chase.
Ms. Lemkau added that the company would not be taking any additional charges against its earnings in connection with these settlements.
Over the course of the last year, J.P. Morgan Chase has set aside $700 million in reserves to cover potential penalties for its Enron-related activities.
A telephone call to Citigroup seeking comment had not been returned.
John C. Coffee, a professor of securities law at Columbia University, said the settlement was "an easy decision" for the banking companies to make.
"If you are a bank, you don't want to be in fights with the S.E.C., the Federal Reserve or the New York district attorney's office," he said.
Moreover, Mr. Coffee said the fines paid could serve a dual purpose. "Since most of this money will eventually go to the injured investors in Enron, it is a kind of down payment the banks will make with class-action plaintiffs' lawyers," he said.
Michael A. Perino, a professor of securities and corporate law at St. John's University, said the settlement represented two important trends in S.E.C. enforcement actions.
"First, they are going after the intermediaries who help these complex transactions," he said.
"Second, it is clear the S.E.C. is trying to deter future misconduct in this area, and they are doing that by requesting ever-larger settlements."
Earlier this month, Enron filed a Chapter 11 bankruptcy reorganization plan that would pay most creditors less than one-fifth of the estimated $67 billion they are owed. Citigroup, J.P. Morgan and other unsecured creditors would get cash, potential proceeds from fraud lawsuits and shares of Enron's remaining businesses if the plan receives court approval.
Enron filed what at the time was the biggest-ever Chapter 11 bankruptcy in December 2001.
On Jan. 16, 2002, J.P. Morgan Chase said it had written off $456 million in trading losses and loans to Enron. At that time, the bank said it had exposure to potential losses of more than $2 billion.
The next day, Citigroup said it had written off $228 million in loans and trading positions in the fourth quarter of 2001 to cover Enron's collapse.
Today's settlement is the latest effort by J.P. Morgan Chase and Citigroup to resolve legal liabilities involving allegations of bank fraud.
In January, J.P. Morgan Chase settled a lawsuit it filed against 11 insurance companies that had issued roughly $1 billion in surety bonds backing Enron transactions processed through Mahonia, an offshore entity based in the Channel Islands off the coast of Britain. Under the terms of the settlement, the bank received $654 million from the insurers.
Both J.P. Morgan and Chase still face Enron-related lawsuits filed by investors. Today's settlements and the information acquired in the investigations may prove useful in those lawsuits.
News of the settlement had little impact on Wall Street. Citigroup's stock rose 7 cents to close at $45.80, on the New York Stock Exchange. J.P. Morgan Chase's shares edged up 2 cents, to $35.49.