<PRE>&lt;DOC&gt;
[107 Senate Hearings]
[From the U.S. Government Printing Office via GPO Access]
[DOCID: f:81313.wais]
                                                        S. Hrg. 107-618
  THE ROLE OF THE FINANCIAL INSTITUTIONS IN ENRON'S COLLAPSE--VOLUME 1
=======================================================================
                                HEARINGS
                               before the
                PERMANENT SUBCOMMITTEE OF INVESTIGATIONS
                                 of the
                              COMMITTEE ON
                          GOVERNMENTAL AFFAIRS
                          UNITED STATES SENATE
                      ONE HUNDRED SEVENTH CONGRESS
                             SECOND SESSION
                               __________
                          JULY 23 AND 30, 2002
                               __________
      Printed for the use of the Committee on Governmental Affairs
                           U.S. GOVERNMENT PRINTING OFFICE
81-313                          WASHINGTON : 2002
____________________________________________________________________________
For Sale by the Superintendent of Documents, U.S. Government Printing Office
Internet: bookstore.gpo.gov  Phone: toll free (866) 512-1800; (202) 512-1800
Fax: (202) 512-2250 Mail: Stop SSOP, Washington, DC 20402-0001
                   COMMITTEE ON GOVERNMENTAL AFFAIRS
               JOSEPH I. LIEBERMAN, Connecticut, Chairman
CARL LEVIN, Michigan                 FRED THOMPSON, Tennessee
DANIEL K. AKAKA, Hawaii              TED STEVENS, Alaska
RICHARD J. DURBIN, Illinois          SUSAN M. COLLINS, Maine
ROBERT G. TORRICELLI, New Jersey     GEORGE V. VOINOVICH, Ohio
MAX CLELAND, Georgia                 THAD COCHRAN, Mississippi
THOMAS R. CARPER, Delaware           ROBERT F. BENNETT, Utah
JEAN CARNAHAN, Missouri              JIM BUNNING, Kentucky
MARK DAYTON, Minnesota               PETER G. FITZGERALD, Illinois
           Joyce A. Rechtschaffen, Staff Director and Counsel
              Richard A. Hertling, Minority Staff Director
                     Darla D. Cassell, Chief Clerk
                                 ------
                PERMANENT SUBCOMMITTEE ON INVESTIGATIONS
                     CARL LEVIN, Michigan, Chairman
DANIEL K. AKAKA, Hawaii,             SUSAN M. COLLINS, Maine
RICHARD J. DURBIN, Illinois          TED STEVENS, Alaska
ROBERT G. TORRICELLI, New Jersey     GEORGE V. VOINOVICH, Ohio
MAX CLELAND, Georgia                 THAD COCHRAN, Mississippi
THOMAS R. CARPER, Delaware           ROBERT F. BENNETT, Utah
JEAN CARNAHAN, Missouri              JIM BUNNING, Kentucky
MARK DAYTON, Minnesota               PETER G. FITZGERALD, Illinois
         Elise J. Bean, Acting Staff Director and Chief Counsel
            Robert L. Roach, Counsel and Chief Investigator
                 Kim Corthell, Minority Staff Director
                     Mary D. Robertson, Chief Clerk
                            C O N T E N T S
                                 ------
Opening statements:
                                                                   Page
    Senator Levin................................................1, 161
    Senator Collins..............................................5, 165
    Senator Lieberman (ex officio)...............................9, 167
    Senator Thompson (ex officio)................................    11
    Senator Bunning..............................................    12
    Senator Carper...............................................    23
    Senator Fitzgerald..........................................45, 195
    Senator Cleland..............................................    49
    Senator Dayton...............................................   169
    Senator Durbin...............................................   199
                               WITNESSES
                         Tuesday, July 23, 2002
Robert L. Roach, Counsel and Chief Investigator, Permanent
  Subcommittee on Investigations; accompanied by Gary M. Brown,
  Special Counsel, Committee on Governmental Affairs.............    14
Lynn E. Turner, former Chief Accountant, Securities &amp; Exchange
  Commission, Broomfield, Colorado...............................    26
Pamela M. Stumpp, Managing Director, Chief Credit Officer,
  Corporate Finance Group, Moody's Investors Service, New York,
  New York; accompanied by John C. Diaz, Managing Director, Power
  &amp; Energy Group, Moody's Investors Service, New York, New York..    29
Ronald M. Barone, Managing Director, Utilities, Energy &amp; Project
  Finance Group, Corporate and Government Ratings, Standard &amp;
  Poor's, New York, New York; accompanied by Nik Khakee,
  Director, Structured Finance Group, Standard &amp; Poor's, New
  York, New York.................................................    31
Jeffrey W. Dellapina, Managing Director, JPMorgan Chase Bank, New
  York, New York; accompanied by Donald H. McCree, Managing
  Director, J.P. Morgan Securities, Inc., New York, New York; and
  Robert W. Traband, Vice President, JPMorgan Chase Bank,
  Houston, Texas.................................................    58
David C. Bushnell, Managing Director, Global Risk Management,
  Citigroup/Salomon Smith Barney, New York, New York.............    92
Richard Caplan, Managing Director and Co-Head, Credit Derivatives
  Group, Salomon Smith Barney North American Credit/Citigroup,
  New York, New York.............................................    94
Maureen Hendricks, Senior Advisory Director, Salomon Smith
  Barney/Citigroup, New York, New York...........................    96
James F. Reilly, Jr., Managing Director, Global Power &amp; Energy
  Group, Salomon Smith Barney/Citigroup..........................    97
                         Tuesday, July 30, 2002
Robert Furst, former Managing Director, Merrill Lynch &amp; Co.,
  Dallas, Texas..................................................   171
Schuyler Tilney, Managing Director, Global Energy &amp; Power, Global
  Markets &amp; Investment Banking, Merrill Lynch &amp; Co., Houston,
  Texas..........................................................   172
G. Kelly Martin, Senior Vice President and President of
  International Private Client Division, Merrill Lynch &amp; Co., New
  York, New York.................................................   173
                     Alphabetical List of Witnesses
Barone, Ronald M.:
    Testimony....................................................    31
    Prepared statement with attachments..........................   282
Brown, Gary M.:
    Testimony....................................................    14
Bushnell, David C.:
    Testimony....................................................    92
    Prepared statement...........................................   316
Caplan, Richard:
    Testimony....................................................    94
    Prepared statement...........................................   323
Dellapina, Jeffrey W.:
    Testimony....................................................    58
    Prepared statement...........................................   312
Diaz, John C.:
    Testimony....................................................    29
    Prepared statement with an attachment........................   278
Furst, Robert:
    Testimony....................................................   171
    Prepared statement...........................................   337
Hendricks, Maureen:
    Testimony....................................................    96
    Prepared statement...........................................   330
Khakee, Nik:
    Testimony....................................................    31
    Prepared statement...........................................   282
Martin, G. Kelly:
    Testimony....................................................   173
    Prepared statement...........................................   339
McCree, Donald H.:
    Testimony....................................................    58
    Prepared statement...........................................   312
Reilly, James F., Jr.:
    Testimony....................................................    97
    Prepared statement...........................................   334
Roach, Robert L.:
    Testimony....................................................    14
    Prepared statement with attachments..........................   215
Stumpp, Pamela M.:
    Testimony....................................................    29
    Prepared statement with an attachment........................   278
Tilney, Schuyler:
    Testimony....................................................   172
    Prepared statement...........................................   338
Traband, Robert W.:
    Testimony....................................................    58
    Prepared statement...........................................   312
Turner, Lynn E.:
    Testimony....................................................    26
    Prepared statement...........................................   265
                                EXHIBITS
                                 ------
                                                                   Page
                                VOLUME 1
                       Exhibits for July 23, 2002
101. GEnron Prepays, chart prepared by the Permanent Subcommittee
  on Investigations..............................................   351
102. GFinancial Institution Knowledge of Enron Prepays, chart
  prepared by the Permanent Subcommittee on Investigations.......   352
103. GFinance Related Asset Sales, Prepays and 125 Sales ($MM)
  (Source: August 2001, Enron Corp. Finance Committee
  Presentation.).................................................   353
    GASF--Detail on Prepays, chart prepared by Enron Corp........   354
104. GImpact On Year 2000 Enron Credit Ratios from 1) Adding
  Outstanding Prepays to Debt, and 2) Deducting Prepays from
  ``Funds Flow From Operations,'' chart prepared by the Permanent
  Subcommittee on Investigations.................................   355
    GImpact On October 2001 Enron Valuation from Adding
  Outstanding Prepays to Debt, chart prepared by the Permanent
  Subcommittee on Investigations.................................   356
105. GChase/Mahonia, chart prepared by the Permanent Subcommittee
  on Investigations..............................................   357
106. GChase/Mahonia Collapsed into Loan, chart prepared by the
  Permanent Subcommittee on Investigations.......................   358
107. GYosemite I (Citigroup), chart prepared by the Permanent
  Subcommittee on Investigations.................................   359
108. GYosemite I (Citigroup) Collapsed into Loan, chart prepared
  by the Permanent Subcommittee on Investigations................   360
109. GEnron Corp. Bank Presentation, November 19, 2001, Waldorf
  Astoria, New York, NY, Debt Issues: Commodity Transactions with
  Financial Institutions,........................................   361
110. GProject 10, Due Diligence Findings, November 7, 2001,
  Prepays, prepared by Citigroup.................................   363
111. GWhat Are Prepays? Why Does Enron Enter Into Prepays?,
  presentation charts prepared by Enron Corp.....................   365
112. GPrepaid Transactions Discussion, presentation materials
  prepared by Arthur Andersen....................................   367
113. GPrepay Transaction, memo prepared for Enron Corp. by Arthur
  Andersen, June 1999............................................   375
114. GAndersen email, December 1998, re: Cash vehicles...........   379
115. GWhy Enron Prepays Were Sham Transactions, chart prepared by
  the Permanent Subcommittee on Investigations...................   380
116. GEnron Corp. Credit Conference, Credit Profile, January 29,
  2000, presentation charts prepared by Enron Corp...............   381
117. GThe Ownership of Mahonia Limited, chart provided by
  JPMorgan Chase.................................................   393
118. GCorrespondence between Mourant du Feu &amp; Jeune (``Mourant'')
  and Jersey Financial Regulators, re: establishment of Mahonia;
  and Jersey incorporation documents.............................   394
119. GMourant email, November 2001, re: Mahonia et al--Enron
  trades.........................................................   410
120. GMourant--JPMorgan Chase email, March 2002, re: mahonia
  pipeline imbalances............................................   411
121. GJPMorgan Chase email, July 2002, re: Restructuring existing
  prepays........................................................   412
122. GMourant--JPMorgan Chase email, September 2001, re: Prepay
  Docs...........................................................   413
123. GJPMorgan Chase email, November 1998, re: Pre-pays..........   414
124. GJPMorgan Chase email, June 1998, re: Enron Forward Sale
  Transaction....................................................   415
125. GJPMorgan Chase call memo, June 1999, re: RED ALERT.........   416
126. GJPMorgan Chase email, June 1999, re: Enron (. . . the
  business purpose underpinning the current $500MM prepay
  exercise is simply that of efficiently priced funding.)........   417
127. GJPMorgan Chase email, May 2000, re: Enron (. . . pricing of
  an amortizing swap.)...........................................   418
128. GJPMorgan Chase email, July 1998, attaching copy of Prepay
  pitch presentation.............................................   419
129. GJPMorgan Chase email, December 2000, attaching Description
  of Enron Prepay Transaction....................................   433
130. GEnron Corp. email, September 2001, re: Chase Prepay (We
  need your help to come up with a custom amortization schedule/
  volume schedule that looks like a ``normal commodity swap.'')..   435
131. GEnron Corp.-JPMorgan Chase email, September 2001, re:
  Prepay with copy of Chase $350 Million Prepay diagram..........   436
132. GJPMorgan Chase email, October 2001, re: Enron ($5B in
  prepays!)......................................................   438
133. GJPMorgan Chase email, November 2001, re: Enron Exposure....   439
134. GCorrespondence from JPMorgan Chase to the Permanent
  Subcommittee on Investigations, dated July 18, 2002, regarding
  names of J.P. Morgan Chase &amp; Co. clients and counterparties
  that engaged in commodity prepaid forward transactions with a
  special purpose vehicle........................................   441
135. GSecurity Agreement between Mahonia Limited and The Chase
  Manhattan Bank, December 1997..................................   442
136. GExcerpts of Enron Corp 10K for 2000........................   465
137. GJPMorgan Chase email, November 2000, re: Call Report for
  Enron North America Corporation................................   474
138. GStructuring Summary, Enron Corp.--1996 Prepay..............   476
139. GStructuring Summary, Enron Corp.--1997 Prepay..............   482
140. GStructuring Summary, Enron Corp.--1998 Prepay..............   490
141. GJPMorgan Chase, October 1997, re: Enron Exposure $350MM
  Prepaid........................................................   491
142. GJPMorgan Chase email, December 2000, re: Enron Prepay
  Transaction (. . . need to form Mahonia III . . .).............   492
143. GCorrespondence from JPMorgan Chase to four Members of the
  U.S. House of Representatives, dated March 27, 2002, regarding
  Enron and Mahonia..............................................   493
144. GGlobal Loans Approval Memorandum, December 21, 1998,
  prepared by Citicorp...........................................   513
145. GCitigroup email, September 2000, re: My take on how to
  explain ECLN...................................................   523
146. GCitibank presentation, Enron: Yosemite funded prepaid......   524
147. GEnron Interoffice Memorandum from Tax Planning Department,
  January 10, 2000, re: Yosemite I Withholding...................   529
148. GWalk Through of Prepay, charts prepared by Enron Corp......   537
149. GYosemite Funds Flow Diagram, chart prepared by Enron Corp..   543
150. GFacsimile from Maples and Calder to Citibank, dated
  November 2, 1999, re: Delta Energy Corporation (the
  ``Company'')...................................................   544
151. GNew Account Information, Delta Energy Corporation,
  September 1994, prepared by Citicorp...........................   545
152. GCorrespondence from The Givens Hall Bank to Citibank, N.A.,
  February 1999, re: Delta Energy Corporation and Vega Energy
  Corporation fee notes..........................................   548
153. GDelta Energy Corporation Resolutions, June 26, 2001........   550
154. GCitibank email, May 2001, re: prepaid script between
  Citibank/Enron/Delta...........................................   552
155. GGlobal Loans Approval Memorandum, September 19, 1999,
  prepared by Citibank (Truman)..................................   553
156. GEnron Corp. email, November 2001, re: an investor spoke to
  someone at citi and received info on delta. . . . We need to
  shut this down.................................................   559
157. GYosemite Update; Optional Use as Prepay Funding Vehicle,
  Enron presentation charts......................................   562
158. G``Credit-Linked Notices (`CLNs'),'' May 2001, Derivatives
  Capital Markets,  Citibank/Salomon Smith Barney presentation...   564
159. GYosemite, Issues/Timeline, chart prepared by Enron Corp....   580
160. GCitibank Memorandum to Project Yosemite Working Group,
  February 1999, re: Initial thoughts on structures..............   581
161. GCitigroup, Inc. list of clients or counterparties that
  engaged in pre-paid forward transactions with a special purpose
  vehicle........................................................   582
162. GCitigroup, Inc. email, April 1999, re: Enron/Project
  Roosevelt......................................................   584
163. GCitigroup email, April 1999, re: Enron/Consent to Amendment
  to Roosevelt Transaction.......................................   586
164. GGlobal Loans Short Form Approval Memorandum, April 26,
  1999, prepared by Citibank (Roosevelt).........................   588
165. GCitigroup email, April 1999, re: Enron/Roosevelt Update....   591
166. GSalomon Smith Barney Presentation to Enron on
  Capitalization, September 20, 1999.............................   592
167. GSalomon Smith Barney High Yield Commitment Committee
  Memorandum, April 2001, Enron--$1 Billion--Credit Linked Note..   603
168. GSalomon Smith Barney Investment Grade Commitment
  Committee--New York Memorandum, April 2001, ECLN II............   604
169. GSalomon Smith Barney Investment Grade Commitment
  Committee--Europe Memorandum, November 1999, Yosemite II.......   611
170. GSalomon Smith Barney Investment Grade Commitment
  Committee--New York, October 1999, Yosemite I..................   619
171. GSalomon Smith Barney Investment Grade Commitment
  Committee--New York, August 2000, Yosemite III, CLN I..........   629
172. GCitigroup email, September 2001, re: Enron (. . . better
  breakdown of where they make their money . . .)................   636
173. GYosemite Securities Trust I, Supplement (to Offering
  Memorandum dated November 4, 1999).............................   637
174. GEnron Corp. 10-Q, June 30, 1999............................   644
175. GCiticorp email, October 2001, re: Enron (``relationship'').   651
176. GYosemite Securities Trust I Financing, December 22, 1999-
  2000, chart provided by Enron Corp.............................   653
177. GCitigroup email, June 2001, re: Prepaid Overview, attaching
  chart, Summary of Pre-Paid Accounting and Tax..................   654
178. GCitigroup email, April 2001, re: Enron Credit Approval.....   656
179. GCitigroup email, October 2001, re: Enron (. . . do we have
  incremental debt capacity . . .)...............................   657
180. GCitigroup email, November 1999, re: Yosemite II (Europe) (.
  . . I have been encouraged, from a risk point of view, to try
  to stay in compliance in the near term;).......................   658
181. GCitigroup email, November 1999, re: Yosemite II (Europe) (.
  . . we still have an exposure issue . . . limits are limits . .
  .).............................................................   660
182. GCitigroup email, September 1999, re: Yosemite (. . .
  terminate the price risk . . .)................................   662
183. GCitigroup email, August 2000, re: Citibank and Delta
  relationship (. . . Delta is not controlled by Enron, . . .
  Citi had it set up several years ago.).........................   664
184. GTranscripts of JPMorgan Chase audio tapes:
    a. GTranscripts of JPMorgan Chase audio tapes dated September
  13, September 20, and October 3, 2001..........................   665
    b. GJPMorgan Chase audio tapes dated September 13, September
  20, and October 3, 2001........................................     *
    c. GTranscripts of selected JPMorgan Chase audio tapes.......   668
    d. GTranscripts of selected JPMorgan Chase audio tapes.......     *
185. GAdditional JPMorgan Chase/Enron Corp. Documents in Support
  of July 23, 2002, Testimony (and Appendices) of Robert Roach,
  Chief Investigator, Permanent Subcommittee on Investigations:
    a. GThe Chase Manhattan Bank Facsimile, October 1996, re:
  Enron 96--4 Term Sheets, Draft sheets for prepaid sale options
  2001...........................................................   979
    b. GDocuments related to fees paid Mourant, Mahonia and
  JPMorgan Chase in relation to prepay transactions:
        1. GLetter from Mourant &amp; Co. to Chase Investment Bank
  Limited regarding fees due to Mahonia Limited for its
  participation in the ``Enron V'' (Prepay) transaction, December
  1996...........................................................   984
        2. GFee Letter from JPMorgan Chase to Enron North America
  Corp., September 2001..........................................   985
        3. GMourant &amp; Co. invoice sent to The Chase Manhattan
  Bank for reimbursement of expenses related to Mahonia Limited,
  October 2001...................................................   986
    c. GJPMorgan Chase email, December 1996, re: Enron Natural
  Gas Marketing (Mahonia Limited)................................   987
    d. GJPMorgan Chase email, November 1997, re: Heads-Up memo;
  Upsize to previously approved Enron Prepay.....................   988
    e. GJPMorgan Chase Memorandum, September 1998, re: Enron
  Prepays (1996 &amp; 1997). Includes detail on use of surety bonds
  to provide credit enhancement for prepay structures............   989
    f. GEnron Corp.-JPMorgan Chase email, June 2000, re: June
  2000 gas prepay. Includes detail on pricing methodology for
  prepay transactions............................................   991
    g. GJPMorgan Chase-Mourant email, June 2000, re: Enron-
  Mahonia-Chase Transaction. Includes instructions from JPMorgan
  Chase attorney that documents are acceptable and may be
  executed by Mahonia............................................   992
    h. GMourant-JPMorgan Chase email, September 2000, re: Mahonia
  Limited. Includes detail on fee arrangement for certain prepays   993
    i. GJPMorgan Chase email, November 2000, re: Call Report for
  ENRON NORTH AMERICA CORPORATIO (sic)...........................   999
    j. GJPMorgan Chase email, December 2000, re: Prepay Update #2
  12/18..........................................................  1001
    k. GJPMorgan Chase email, September 2001, re: Enron Prepay (.
  . . clearly they will take any money they can get now . . .)...  1002
    l. GDocuments related to Arthur Andersen's request to Enron
  Corp. for representations as to the nature of the relationship
  between Mahonia and JPMorgan Chase:
        1. GEnron Corp. email, September 2001, re: Rep Letter for
  Mahonia........................................................  1003
        2. GLetter from Enron Corp. to Mahonia Limited, September
  2001...........................................................  1005
        3. GLetter from Mahonia Limited to Arthur Andersen LLP,
  September 2001.................................................  1006
    m. GLetter from Mahonia Limited to The Chase Manhattan Bank,
  September 2001, re: Mahonia's appointment of JPMorgan Chase as
  its agent......................................................  1007
    n. GMourant-JPMorgan Chase email, October 2001, Fwd: Enron
  Swap Transaction. Includes attached Mourant-JPMorgan Chase
  emails from December 2000-September 2001.......................  1009
    o. GAmended Complaint, United States District Court, Southern
  District of New York. JPMorgan Chase Bank, Plaintiff, against
  Liberty Mutual Insurance Company, et al., Defendants, June
  2000, with attachments.........................................  1016
    p. GLetters between JPMorgan Chase and the Permanent
  Subcommittee on Investigations, July 2002, re: details of
  prepay transactions between JPMorgan Chase and Enron Corp......  1087
    q. GLetter from JPMorgan Chase to the Permanent Subcommittee
  on Investigations, July 2002, re: names of JPMorgan Chase's
  clients or counterparties, in addition to Enron, that engaged
  in prepaid forward transactions with a special purpose vehicle
  (``SPV'')......................................................  1099
    r. GLetters between JPMorgan Chase and the Permanent
  Subcommittee on Investigations, July 2002, re: relationship and
  dealings of JPMorgan Chase to Mahonia Limited..................  1100
    s. GFacsimile from JPMorgan Chase to the Permanent
  Subcommittee on Investigations, April 2002, re: JPMorgan Chase/
  Enron transactions and fees....................................  1111
186. GAdditional Citigroup/Enron Corp. Documents in Support of
  July 23, 2002, Testimony (and Appendices) of Robert Roach,
  Chief Investigator, Permanent Subcommittee on Investigations:
    a. GGlobal Loans Approval Memorandum, October 19, 1999,
  prepared by Citibank (Yosemite I)..............................  1122
    b. GEnron Corp. Finance Committee Meeting, August 13, 2001,
  Chief Financial Officer Report, Interest Rate Exposure, Finance
  Related Asset Sales, Outstanding Financings and Debt, ASF-
  Detail on Outstanding Fundings, and ASF-Detail on Prepays......  1131
    c. GEnron presentation charts, Yosemite Update, Evolution, of
  Yosemite, Optional Use as Prepay Funding Vehicle, Yosemite Cost
  Analysis, Yosemite Prepay Analysis, and Conclusions &amp;
  Recommendations................................................  1139
    d. GEnron Corp. documents on details of Yosemite/ECLN
  structures.....................................................  1152
    e. GEnron Corp. charts, What are Prepays, Why Does Enron
  Enter into Prepays, Actual Prepay Synopsis Overview, Actual
  Prepay Synopsis................................................  1166
    f. GCitigroup email, November 1999, re: Yosemite II (Europe).  1170
    g. GFacsimile from Maples and Calder to Schroders, September
  2001, re: Delta Energy Corporation.............................  1182
    h. GFacsimile from Maples and Calder to Milbank Tweed, Hadley
  &amp; McCloy, November 1999, re: Delta Energy Corporation (the
  ``Company'')...................................................  1184
    i. GEnron Corp. email, June 2001, re: Delta Letter, attaching
  . . . sample letter with the representations that Andersen
  would like Delta to confirm....................................  1187
    j. GFacsimile, re: remittance of funds to Bank of Bermuda and
  payment instructions for the account of Schroder Cayman Bank
  and Trust Company Limited, Reference to Delta Energy
  Corporation....................................................  1189
    k. GCorrespondence from The Givens Hall Bank to Citibank,
  N.A., February 1999, re: Delta Energy Corporation and Vega
  Energy Corporation fee notes...................................  1191
    l. GEnron/Delta Swap Confirmation; Enron/Citibank Swap
  Confirmation; and Delta/Citibank Swap Confirmation, all dated
  December 22, 1999..............................................  1194
    m. GEnron/Delta Swap Confirmation and Citibank/EnronSwap
  Confirmation Drafts, dated November 2, 1999....................  1231
    n. GCitigroup email, November 2001, re: Citibank Unwind
  Amounts........................................................  1251
    o. GCitigroup email, December 2001, re: Ene [Enron] (Want to
  make sure swaps are terminated first thing and that delta
  terminates simultaneously so that we don't have any mismatch.).  1253
    p. GCorrespondence from Citigroup to the Permanent
  Subcommittee on Investigations, dated May 2, 2002, regarding
  Citigroup/Enron transactions and fees..........................  1254
    q. GEnron Corp. Project Yosemite, January 1999 presentation..  1263
    r. GReport of Independent Public Accountants, To the
  Trustholders of Yosemite Securities Trust I, April 2001, draft
  financial statements and notes for 2000 and 1999...............  1276
    s. GYosemite Securities Trust Ltd., Notes to Financial
  Statements, December 31, 2000..................................  1284
    t. GArthur Andersen LLP Memorandum, dated August 18, 2000,
  re: $500,000,000 8% Enron Credit Linked Notes due 2005
  Authorization to Sign..........................................  1287
    u. GEnron Corp. letter to Arthur Andersen LLP, dated August
  25, 2000, regarding Andersen's ``comfort'' letter issued in
  connection with the issue and sale of Enron Credit Linked Notes  1288
187. GAdditional Documents Related to JPMorgan Chase Prepays:
    a. GJPMorgan Chase email, August 1996, re: Prepaid Forwards--
  Loans Vs Derivatives (Please arrange to report the prepaid
  forwards as loans effective as of August 31, 1996.)............  1290
    b. GJPMorgan Chase email, September 1996, re: Loans/
  Borrowings Documented as Derivatives...........................  1294
    c. GJPMorgan Chase email, October 1997, re: Loans/Borrowings
  Documented as Derivatives......................................  1299
    d. GJPMorgan Chase email, October 1997, re: Sampoerna Deal (I
  understand the form of the transaction, rather than its
  economic substance, will govern in this case.).................  1300
    e. GJPMorgan Chase email, November 1997, re: Loans/Borrowings
  Documented as Derivatives (Based on our discussions, it was
  concluded that such transactions which are confirmed with the
  counterparty as derivatives should be reported in Trading
  Assets/Liabilities--Risk Management Instruments and marked to
  market.).......................................................  1303
    f. GJPMorgan Chase email, July 1999, re: DISGUISED LOANS (We
  are making disguised loans, usually buried in commodities or
  equities derivatives (and I'm sure in other areas).)...........  1304
    g. GJPMorgan Chase email, June 1999, re: Prepaid Forwards
  (All of us have been grappling for years with the issue of
  determining when a structured transaction is more a kin to a
  loan or a derivative. There are no easy answers.)..............  1306
    h. GJPMorgan Chase Memorandum, August 1999, re: DBF's (Loans
  disguised as derivatives are now known as Derivatives Based
  Funding. (DBF's))..............................................  1312
    i. GJPMorgan Chase email, March 2000, re: Accounting for
  Compound Instruments...........................................  1317
    j. GJPMorgan Chase email, March 2000, re: Prepaid Forwards
  (Pat O'Brien's group has entirely dropped their proposal to
  change the accounting of Prepaid Forwards. This is good news.).  1319
    k. GJPMorgan Chase email, March 2000, re: Prepaid Forwards...  1321
    l. GJPMorgan Chase email, January 1999, re: Enron CLO
  Discussion (Rating agency knowledge of existing deals. Some
  deals that are less know (sic) to the agencies may come to
  light if they are placed in newly formed rated vehicles. This
  could well cause some heartburn for Enron).....................  1323
    m. GJPMorgan Chase email, June 2000, re: Enron prepays.......  1326
    n. GJPMorgan Chase email, July 2000, re: Restructuring
  existing prepays...............................................  1328
    o. GJPMorgan Chase email, March 1998, re: Enron Natural Gas
  Marketing/Mahonia/Parco........................................  1330
    p. GJPMorgan Chase Memorandum, April 2002, re: PARCO Secured
  Loan to Mahonia................................................  1331
    q. GJPMorgan Chase email, November 2000, re: Call Report for
  Enron North America Corporatio (sic)...........................  1332
    r. GJPMorgan Chase email, December 2000, attaching JPMorgan
  Chase Memorandum re: Project Mahonia--$330 Million Forward Sale
  Natural Gas Contract Enron Financing Objectives................  1338
    s. GJPMorgan Chase email, April 1999, re: Mahonia Ltd........  1340
    t. GMourant email, November 1997, re: Mahoniia (sic) /New
  Enron Transaction..............................................  1343
    u. GJPMorgan Chase-Mahonia correspondence, December 1992,
  attempting to identify a Jersey company to serve as SPC in
  prepay.........................................................  1344
    v. GMahonia Limited, Minutes of the First Meeting of Board of
  Directors, December 29, 1992...................................  1347
    w. GMahonia Limited, Certificate of Incorporation (States of
  Jersey), December 1992.........................................  1355
    x. GMourant &amp; Co.-Chase Investment Bank Limited
  correspondence, November 1993, attaching invoices for prepay
  transactions with Chase........................................  1360
    y. GMourant Memorandum, November 1995, re: Chase-Mahonia
  transaction....................................................  1366
    z. GMourant List of The Chase Manhattan Bank SPV Group
  (``Stoneville'' Companies).....................................  1367
    aa. GThe Chase Manhattan Bank description of ownership/
  purpose of The Eastmoss Trust and Mahonia Limited..............  1368
    bb. GThe Chase Manhattan Bank-Mahonia Facsimile, December
  2000, re: Stoneville Aegean Board of Directors Minutes in
  connection with Enron-Mahonia transaction......................  1371
    cc. GMourant &amp; Co. Limited Annual Review on Mahonia Limited,
  ending 22/5/01.................................................  1379
    dd. GJPMorgan Chase-Enron email, September 2001, re: Rep
  Letter for Mahonia.............................................  1384
    ee. GMourant-Enron email, September 2001, re: Mahonia Confirm  1386
    ff. GMahonia Limited letter to Arthur Andersen LLP, September
  2001, re: representing the nature of Mahonia's operations......  1388
    gg. GChase Memorandum, August 1996, re: list of Chase prepays  1389
    hh. GChase-Mahonia-Occidental Petroleum prepay...............  1391
    ii. GChase email, May 1999, re: accounting for Ocean Energy,
  Inc. prepay....................................................  1398
    jj. GChase presentation, December 22, 1999, on Hunt Oil
  Company prepay.................................................  1399
    kk. GJPMorgan Chase email, August 2000, re: Columbia Prepay,
  attaching copy of Columbia Energy Group Structuring Summary....  1414
    ll. GChase correspondence to Michael Kopper, Director, Enron
  Capital and Trade Resources, October 1994, re: Prepaid Crude
  Oil Forward Sale...............................................  1424
    mm. GChase-Enron correspondence, May 1999, regarding Chase
  review of Enron on and off-balance sheet capital structure.....  1431
    nn. GChase presentation, Commodity Prepay Exposure
  Discussion, January 27, 2000...................................  1438
    oo. GChase handwritten note, undated, re: Pre-paids (Mahonia
  lends Enron $ in exchange for a promise that Enron will deliver
  . . . to Mahonia)..............................................  1447
    pp. GChase memorandum, December 2000, re: Project Mahonia--
  $330 Million Forward Sale Natural Gas Contract Enron Financing
  Objectives.....................................................  1448
    qq. GFleet-Chase email, December 2000, re: Mahonia Forward
  Sale...........................................................  1453
    rr. GChase email, February 2001, re: MTM for Prepays.........  1456
    ss. GChase email, October 2001, re: Enron Prepaids...........  1458
                                VOLUME 2
188. GAdditional Citigroup/Enron documents related to Projects
  ``Roosevelt,'' ``Truman,'' and ``Nixon'':
    a. GEnron Corp. Facsimile to Citicorp, December 1998, re:
  Prepay structure...............................................  1461
    b. GCitigroup email, December 1998, re: Call Report--Project
  Roosevelt (Enron)..............................................  1462
    c. GCitigroup Credit Memorandum (Enron), December 1998
  (Roosevelt)....................................................  1466
    d. GCitigroup Facsimile, December 1998, Project Roosevelt,
  Overview of Major Issues.......................................  1473
    e. GCitigroup Facsimile, December 1998, Project Roosevelt,
  Status Report..................................................  1475
    f. GCitigroup Facsimile, December 1998, Enron--Project
  Roosevelt, Issues..............................................  1478
    g. GCMAC Minutes, June 22, 1999, Prepaid Oil Transaction.....  1482
    h. GCitigroup email, September 1999, re: Enron-Roosevelt (. .
  . our expectation was now that the deal would not be repaid
  until December). Our approval to extend deliveries was done
  verbally.).....................................................  1484
    i. GEnron Corp. email, November 1999, re: Truman financial
  prepay diagram, attaching Crude Prepay 9/29/99 (. . . TD
  [Toronto Dominion] provides the commodity swap . . .)..........  1485
    j. GEnron Corp. email, November 1999, re: Y2 [Yosemite II]...  1487
    k. GGlobal Loans Approval Memorandum, December 7, 1999,
  prepared by Citibank (Nixon)...................................  1491
    l. GCitigroup email, December 1999, re: Yosemite 2--Interim
  Solution, attaching Derivative Credit Form.....................  1496
189. GAdditional Documents Related to Yosemite and Enron Credit
  Linked Note (CLN) Transactions:
    a. GYosemite and CLN Payment Structures......................  1500
    b. GProject Yosemite, Enron Corp. presentation...............  1501
    c. GCitigroup Transaction Memorandum, Enron: Project
  Yosemite, April 1999, (This purpose of this memorandum is to
  obtain preliminary approval to seek a mandate to provide
  Enron's top tier banks with $500MM to $1,500MM of Enron default
  protection.)...................................................  1506
    d. GCitigroup email, August 1999, re: Rating Agency
  Discussions....................................................  1511
    e. GCitigroup Transaction Memorandum, Project Yosemite,
  $[1.0] Billion Credit Default Swap Structure Referencing Enron
  Corp., 10-21-99................................................  1513
    f. GSalomon Smith Barney Interoffice Memorandum, October 26,
  1999, re: Follow-up to Yosemite CMAC meeting...................  1519
    g. GCitigroup Memorandum, October 29, 1999, Yosemite
  Securities Trust I, Linked Enron Obligations (LEOs), Frequently
  Asked Questions................................................  1523
    h. GMoody's Investors Service letter to Yosemite Securities
  Trust I, November 18, 1999, re: $750,000,000 8.25% Series 1999-
  A Linked Enron Obligations due 2004............................  1526
    i. GStandard &amp; Poor's letter to Solomon Smith Barney Inc.,
  November 18, 1999, re: Yosemite Securities Trust I,
  $750,000,000 8.25% Series 1999-A Linked Enron Obligations
  (LEOs) due November 15, 2004...................................  1527
    j. GCitigroup email, November 1999, re: Project Yosemite (. .
  . I am afraid that if we ever had to defend this we would
  either (a) embarrass the client or (b) lose the accounting
  argument.).....................................................  1529
    k. GCitigroup email, November 1999, re: Enron--Various
  (Yosemite: . . . A portion of the proceeds will be used to
  repay our Project Roosevelt (Delta).)..........................  1532
    l. GCitigroup email, November 1999, re: Enron Credit (. . . I
  am not willing to approve another incremental exposure on
  Enron, . . .)..................................................  1533
    m. GEnron Debt Security [Series 1999-A], November 18, 1999...  1534
    n. GCitigroup email, November 1999, re: Enron-Yosemite II,
  Citigroup purchase of Yosemite II certificates.................  1541
    o. GCitigroup email, December 1999, re: Enron Failure to Pay
  on Prepaid.....................................................  1543
    p. GCitigroup Chart, Derivative Transactions Associated With
  The Yosemite Structure, January 2000...........................  1545
    q. GCitibank Memorandum, March 29, 2000, re: Project
  Yosemite--Yosemite Co. Structured Credit Derivative Transaction  1546
    r. GCitigroup email, April 2000, re: Project Yosemite--
  Revenue Recognition............................................  1551
    s. GCitigroup email, April 2000, re: Enron...................  1556
    t. GCitigroup Memorandum, August 13, 2000, Enron Credit
  Linked Notes Trust (``Enron CLN''), Frequently Asked Questions.  1560
    u. GCitigroup Script document, undated, detailing Enron
  Credit Linked Notes (CLN) Swaps................................  1564
    v. GCitigroup email, October 2000, re: Enron Follow-up (Royal
  Bank of Canada as holder of $50 million Enron Credit Linked
  Notes).........................................................  1566
    w. GCitigroup email, October 2000, re: Enron Follow-up.......  1569
    x. GCitigroup email, October 2000, re: Enron Follow-up (. . .
  upon a credit event we can legally deliver the prepaid swap to
  be used to pay the noteholders.)...............................  1571
    y. GCitigroup email, October 2000, re: Enron (. . . we ended
  up consolidating the trust . . . and we treated the prepaid
  swaps as a loan . . . for RBC purposes.).......................  1574
    z. GCitigroup email, November 2000, re: Enron CLN
  Transaction--SFAS 133 Accounting for Prepaid Swaps.............  1575
    aa. GCitigroup Memorandum, May 2, 2001, Enron Credit Linked
  Notes Trust II Senior Notes Offering (``Enron CLN II''),
  Frequently Asked Questions.....................................  1579
    bb. GSolomon Smith Barney Memorandum, May 2, 2001, Enron
  Sterling Credit Linked Notes Trust Senior Notes Offering
  (``Enron CLN II''), Frequently Asked Questions.................  1588
    cc. GCitigroup email, June 2001, re: Prepay Diagram,
  attaching chart, $250 Million Prepay...........................  1593
    dd. GCitigroup email, June 2001, re: Enron (. . . there is an
  earnings impact, except that it is neutralized by offsetting
  trades . . .)..................................................  1595
    ee. GEnron Corp. Memorandum, September 20, 2001, re:
  Citibank/Delta Prepay Transactions (. . . some concerns with
  respect to the structure of the prepay transactions . . .).....  1596
    ff. GCitigroup email, November 2001, re: ene [Enron] prepaid
  update (. . . let enron out of paying half of the libor
  breakage (about 250k) on the early termination of the prepaid.
  . . .).........................................................  1597
    gg. GEnron email, December 2001, re: AXA Enron Credit Linked
  Note...........................................................  1598
    hh. GCitigroup email, November 2002, re: Enron II
  Documentation (CLN II).........................................  1599
    ii. GSummary of Enron CLN Accounting Treatment...............  1612
    jj. GEnron Credit Linked Notes Trust Certificates, SFAS 133
  Fair Value Hedge Documentation (Citibank/Royal Bank of Canada
  Total Return Swap).............................................  1613
190. GAdditional Documents Related to Citigroup/Delta
  Relationship:
    a. GMilbank Tweed email, November 1999, re: Delta............  1618
    b. GDelta Energy Corporation letter to Enron Corp., November
  18, 1999, representing the nature of Delta's operations........  1622
    c. GEnron Corp. email, June 2001, re: Sample Swap Co Letter..  1623
    d. GEnron-Citigroup email, June 2001, re: Delta Letter.......  1624
    e. GDelta Energy Corporation letter to Enron Corp., June
  2001, re: Delta Energy Corporation.............................  1626
    f. GCitigroup email, June 2001, re: reps (lydia got on and
  stated that the reps are facts that we believe are true, and
  the rationale for the letter is to confirm that Delta is not a
  spv that needs to be consolidated on the b/s)..................  1627
    g. GCitigroup email, August 2000, re: questions regarding
  Delta..........................................................  1628
    h. GCitigroup email, undated, re: Prepaid Transaction........  1629
191. GAdditional Documents Related to Transfer of Yosemite
  Certificates to Whitewing:
    a. GLJM, December 1999, Benefits to Enron Summary (At year-
  end 1999, Enron sold LJM2 the equity in Yosemite structure.)...  1630
    b. GSE Raptor L.P. Letter of Understanding to LJM2 Co-
  Investment, L.P., Attn: Andrew S. Fastow, December 30, 1999,
  re: . . . proposed acquisition by SE Raptor L.P. . . . of the
  Yosemite Certificates . . .....................................  1631
    c. GLJM Approval Sheet, February 8, 2000, Deal Name: Yosemite  1635
    d. GEnron Corp. Interoffice Memorandum, February 23, 2000,
  re: LJM2 Investment in Certificates of Beneficial Interest in
  Yosemite Securities Trust I....................................  1638
    e. GEnron Global Finance email, February 2000, re:
  calculation (Yosemite Certificates)............................  1639
    f. GEnron Corp. email, undated, re: Yosemite Certificates....  1641
    g. GWire Transfer Requests, February 28, 2000, re: SE
  Acquisition, L.P., LJM2 Co-Investment, L.P., Enron Corp. and
  Whitewing......................................................  1642
    h. GEnron Corp. letter to LJM2 Co-Investment, L.P., Attn:
  Andrew S. Fastow, March 8, 2000, (. . . Enron agrees to pay
  LMJ2 $100,000.)................................................  1645
    i. GGeneral Partner, LJM2 Co-Investment, L.P. draft letter to
  Limited Partners, describing LJM2 purchase and sale of Yosemite
  Trust Certificates.............................................  1646
    j. GEnron Corp., Yosemite Equity Sale Project ``Yes'',
  November 10, 2000..............................................  1649
    k. GEnron Corp. Whitewing Investment Proposal, Yosemite
  Securities Company Ltd, December 12, 2000......................  1659
    l. GDewey Ballantine LLP Memorandum, December 13, 2000, re:
  Osprey Consent-Yosemite (Consent in connection with the
  Whitewing's acquisition of Yosemite Trust Certificates)........  1665
    m. GEnron Corp./Citigroup/Milbank email, February 2001, re:
  Yosemite Securities Company Ltd. (Yosemite Certificate holders)  1673
    n. GEnron Corp. email, November 2001, attaching Yosemite I
  Transaction and Credit and Subordination Agreement between SE
  Acquisition and LJM2...........................................  1677
    o. GCitigroup email, December 2001, re: Ene [Enron]
  settlements....................................................  1680
192. GAdditional Citigroup Documents:
    a. GCitibank/Solomon Smith Barney reprint of a December 6,
  1999, Investment Dealers' Digest regarding Enron/Yosemite......  1681
    b. GCitigroup/GCIB Checkings on Michael Kopper/LJM...........  1682
    c. GCitigroup Internal Memorandum, January 24, 2001, re:
  Review of LJM2 (Enron Fund) and Recommendations for LJM3 (. . .
  LJM2 principals argue that Enron would make the Fund whole
  should it suffer losses because the vehicles that the Fund
  invest in are critically important to Enron's ability to manage
  its earnings.).................................................  1683
    d. GCitigroup, Enron Credit Review, August 2001..............  1684
    e. GPresentation of Enron Corp., Direct and Indirect
  Liability Schedule, October 24, 2001...........................  1692
    f. GSummary of Enron's Capital Market Exposure with
  Citigroup, October 29, 2001....................................  1704
    g. GCitigroup, Project 10, Due Diligence Findings [Enron],
  November 7, 2001...............................................  1706
    h. GLetters between Citigroup and the Permanent Subcommittee
  on Investigations, July 2002, regarding prepay transactions
  between Citigroup and Enron Corp.; names of Citigroup's clients
  or counterparties, in addition to Enron, that engaged in
  prepaid forward transactions with a special purpose vehicle
  (``SPV''); Citigroup's relationship with Delta Energy
  Corporation, etc...............................................  1825
    i. GLetters between Citigroup and the Permanent Subcommittee
  on Investigations, July 2002, regarding Citigroup's
  relationship with Delta Energy Corporation.....................  1841
    j. GCitigroup letter to the Permanent Subcommittee on
  Investigations, August 7, 2002, regarding steps Citigroup is
  taking to ensure that the balance sheet effect of structured
  financing is transparent to investors..........................  1850
193. GAdditional Enron Corp. Documents Related to Prepay
  Transactions:
    a. GEnron Capital &amp; Trade Resources Interoffice Memorandum,
  August 1997, re: Prepaid Hydrocarbon Companies (The purpose of
  the Prepaid Contract is to provide cash flow to Enron Corp. in
  order to meet its cash flow objectives.).......................  1853
    b. GEnron Corp Bank Presentation, November 19, 2001, Waldorf
  Astoria, New York, New York, (selected pages of presentation)..  1858
    c. GEnron prepay guarantee coverage, Off Balance Sheet Debt..  1930
    d. GEnron Surity Bonds Summary, March 10, 2002...............  1931
    e. GEnron Corp. Interoffice Memorandum, re: Enron Annual
  Reviews for Doug McDowell, 1999 and 2000.......................  1932
    f. GEnron email, June 2001, re: Citibank Prepay, attaching
  presentation entitled Enron North America, $250 Million Prepay.  1941
    g. GDraft Enron Letter to Milbank, Tweed, January 2001, re:
  Tax Forms and Administrative Matters for Delta Energy Corp.....  1948
    h. GEnron Corp. Interoffice Memorandum, November 2001, re:
  $750 Million Yosemite Debt--Recourse v. Nonrecourse............  1949
    i. GEnron Corp. Letter to the Permanent Subcommittee on
  Investigations, July 2002, re: accreditation records of Delta
  Energy and Mahonia.............................................  1953
    j. GEnron Risk Assessment and Control Deal Approval Sheet,
  APEA Tax Exempt Prepay, April 29, 1999.........................  1954
    k. GEnron Corp. Memorandum, June 30, 1999, re: Federal Income
  Tax Treatment of Prepayments...................................  1961
    l. GEnron Corp. (Tax Planning Department) Interoffice
  Memorandum, April 2000, re: Yosemite I Withholding for Year
  2000...........................................................  1974
    m. GEnron Corp. (Corporate Tax Planning Department)
  Interoffice Memorandum, April 2001, re: Enron Credit Linked
  Notes Due 2005.................................................  1976
    n. GEnron Corp. (Global Finance Tax Department) Interoffice
  Memorandum, November 2001, re: $750 Million Yosemite Debt--
  Recourse v. Nonrecourse........................................  1981
194. GDocuments Related to Additional Financial Institutions
  Involved in Enron Corp. Prepays:
    a. GCredit Suisse First Boston email, December 2000, re:
  Prepaid Swap (The net effect for ENE [Enron] is raising $150mm
  . . . and not treated as debt. . . .)..........................  1985
    b. GCredit Suisse First Boston email, December 2000, re:
  URGENT/decision required-status on Eneron [sic] oil linked loan
  (I have raised issues to date on reputational risk. . . .).....  1986
    c. GCredit Suisse First Boston email, December 2000, re:
  Enron-Prepaid Oil Swap (Further, I want to clarify the
  reputational risk of this transaction. . . .)..................  1987
    d. GCredit Suisse First Boston email, December 2000, re:
  docs/guarantee approval (. . . DO NOT include any
  representations on accounting driven transactions).............  1988
    e. GCredit Suisse First Boston email, September 2001, re:
  Enron Oil Trade (. . . special request/favor from Ben
  [Glisan].).....................................................  1989
    f. GCredit Suisse First Boston email, September 2001, re:
  PLEASE CALL ME IMMEDIATELY/ENRON-RELATED CREDIT ISSUE (. . .
  emergency request for a $150 million prepaid facility . . . in
  return for the left pole position on a $1B benchmark bond deal.
  . . .).........................................................  1990
    g. GCredit Suisse First Boston letter to the Permanent
  Subcommittee on Investigations, April 24, 2002, regarding
  Enron-related transactions and fees involving Credit Suisse
  First Boston or Donaldson, Lufkin &amp; Jenrette Securities
  Corporation....................................................  1991
    h. GFleet Bank email, December 2000, attaching copy of
  Project Mahonia Memorandum.....................................  2007
    i. GJPMorgan Chase email, December 2000, re: Fee Letter on
  December 2000 Prepay...........................................  2009
    j. GEnron Corp. email, July 2001, attaching copy of Project
  Camelot (Barclays) presentation................................  2013
    k. GEnron Corp., EGM Inventory Financing, August 2001,
  Transaction Structure, (EGM sells inventory to SwapCo (a third
  party entity controlled by but NOT affiliated to Barclays . .
  .).............................................................  2019
    l. GSullivan &amp; Cromwell (on behalf of Barclays Capital)
  letters to the Permanent Subcommittee on Investigations, May
  and November, 2002, attaching list of transactions involving
  Barclays Capital and Enron Corp. and its affiliates............  2023
195. GThe Wall Street Journal Editorial, July 29, 2002, Enron's
  Enablers.......................................................  2043
196. GClarifications for the record of Mr. John C. Diaz and Ms.
  Pamela M. Stumpps, Moody's Investors Service, dated August 15,
  2002...........................................................  2044
                       Exhibits for July 30, 2002
201. GWhat Merrill Knew, chart prepared by the Permanent
  Subcommittee on Investigations.................................  2046
202. GNigerian Barge Chronology, prepared by the Permanent
  Subcommittee on Investigations.................................  2047
203. a. GNigerian Barge Transaction, chart prepared by the
  Permanent Subcommittee on Investigations.......................  2049
    b. GNigerian Barge Transaction, Enron Guarantee/LJM2's
  Purchase, chart prepared by the Permanent Subcommittee on
  Investigations.................................................  2050
204. a. GFactors Leading to Non-Recognition of Revenue in a Sales
  Transaction Under Generally Accepted Accounting Principles,
  chart prepared by the Permanent Subcommittee on Investigations.  2051
    b. GHow Nigerian Barge Deal Failed to Meet Generally Accepted
  Accounting Principles, chart prepared by the Permanent
  Subcommittee on Investigations.................................  2052
205. GMerrill Lynch Analysts' Relationship With Enron And Impact
  On Fees, chart prepared by the Permanent Subcommittee on
  Investigations.................................................  2053
206. a. GTranscript of excepts from a videotaped presentation
  about LJM2 made by Andrew S. Fastow and Michael J. Kopper of
  Enron Corporation on or about September 16, 1999, for Merrill
  Lynch's Private Equity Group representatives...................  2054
    b. GVideotape of excepts from a videotaped presentation about
  LJM2 made by Andrew S. Fastow and Michael J. Kopper of Enron
  Corporation on or about September 16, 1999, for Merrill Lynch's
  Private Equity Group representatives...........................     *
    c. GFull videotaped presentation about LJM2 made by Andrew S.
  Fastow and Michael J. Kopper of Enron Corporation on or about
  September 16, 1999, for Merrill Lynch's Private Equity Group
  representatives................................................     *
207. GMerrill Lynch Appropriation Request Cover Page for Enron
  Nigerian Barge Equity, 1999....................................  2059
208. GMerrill Lynch Interoffice Memorandum, December 1999, re:
  Enron Corp. (Jeff McMahon, EVP and Treasurer of Enron Corp. has
  asked ML to purchase $7MM of equity. . . .), with attached
  Nigeria Barge Project Sell Down................................  2064
209. GMerrill Lynch email, January 2002, attaching Americas
  Credit Flash Report: Week ending 12/23/99 and 12/17/99.........  2068
210. GDraft Merrill Lynch Agreement Letter to Jeff McMahon of
  Enron Corp., December 23, 1999, re: Enron Nigeria Barge Ltd....  2071
211. GMerrill Lynch Agreement Letter to Andrew S. Fastow of Enron
  Corp., December 29, 1999, re: Enron Nigeria Barge Ltd..........  2074
212. GPreliminary Information Memorandum re: Enron Nigeria Barge
  Ltd., December 1999, with handwritten notes, . . . reputational
  risks i.e. aid/abet Enron income stmt. manipulation............  2079
213. GNotes of Paul J. Wood, Director of Corporate Credit,
  Merrill Lynch, re: Nigerian Barge Equity (Brown hates deal)....  2105
214. GLimited Liability Company Agreement of Ebarge, LLC, dated
  December 29, 1999..............................................  2107
215. GShare Transfer Forms from Enron Nigeria Barge Limited to
  Ebarge, LLC, dated December 30, 1999...........................  2114
216. a. GEnron Nigeria Power Holding, Ltd. and Ebarge, LLC, Loan
  Agreement, dated December 29, 1999.............................  2117
    b. GEnron Nigeria Barge Holding Ltd. and Ebarge, LLC and
  Enron Nigeria Barge Ltd., Shareholders' Agreement, dated
  December 29, 1999..............................................  2136
217. GBenefits to Enron Summary, Deal Name: Bargeco, 6/29/00 (. .
  . promising that Merrill would be taken out by sale to another
  investor by June, 2000.).......................................  2157
218. GMerrill Lynch email, June 2000, re: Ebarge LLC (. . .
  getting questions concerning Ebarge, LLC. It was our
  understanding that Merrill Lynch IBK positions would be repaid
  its equity investment as well as a return on its equity by this
  date. Is this on schedule to occur?)...........................  2158
219. GMerrill Lynch email, June 2000, re: Ebarge Letter-Enron,
  attaching draft letter to Enron Corp. from Merrill (Enron has
  agreed to purchase the shares from Ebarge by June 30, 2000)....  2159
220. GMerrill Lynch email, January 2002, re: eBarge (. . . the
  arrangement called from them to pay interest of 15% per annum
  on such investment.)...........................................  2161
221. GMerrill Lynch email, May 2000, re: Ebarge LLC (. . .
  calculation of the income accrual for Ebarge LLC. . . .).......  2163
222. GShare Purchase Agreement between LJM2-Ebarge, LLC and ML
  IBK Positions, Inc., dated June 29, 2000.......................  2164
223. GMerrill Lynch email, January 2002, re: Ebarge LLC
  confirmation of 15% equity return rate. (. . . could not locate
  anything on the 15% equity return.)............................  2173
224. GMerrill Lynch email, January 2002, re: Ebarge (What
  happened is 15% or $525,000 was the equity return. . . .)......  2174
225. GMerrill Lynch email, January 2002, re: Ebarge (the interest
  on the loan was to be paid by Enron. . . .)....................  2175
226. GMerrill Lynch email, January 2002, re: Ebarge LLC (Poor
  poor Kira and Joe!!!!).........................................  2176
227. a. GMerrill Lynch LJM2 Investment Summary (Ebarge LLC), June
  2000...........................................................  2177
    b. GEnron Risk Assessment And Control Deal Approval Sheet on
  Nigeria Power Holding, Ltd. Divestiture, dated November 2000...  2182
228. GNotes of Kevin Jordan, Enron Accountant, re: Nigerian Barge
  transaction....................................................  2191
229. GMerrill Lynch email, June 2000, re: Ebarge and LJM2 (It
  appears that the way we are getting out of the Enron investment
  on MLIBK Positions books ($7.0m + interest) is having LJM2 Co-
  Investment LP buy us out through LP Capital Calls, in which
  MLIBK is also a limited partner.)..............................  2192
230. GTimeline of Pertinent Information, Ebarge, LLC.............  2193
231. GSummary of Merrill Lynch Enron-Related Investment Banking
  Compensation (By Business Segment), chart prepared by Merrill
  Lynch..........................................................  2194
232. GMerrill Lynch email, June 2000, re: LJM2 (The Committee
  (Debt Markets Commitment Committee) is being asked to consider
  $10MM share of a $65MM 364-day liquidity facility for the LJM2
  Co-Investment LP. . . . Please respond with your Yes/No vote at
  your earliest convenience). Follow-up Merrill Lynch email......  2195
233. GMerrill Lynch Interoffice Memorandum, July 2000, re:
  Request for an Exception to Policy for a $10MM Loan commitment
  to LJM II......................................................  2200
234. GMerrill Lynch email, November 2001, re: LJM--updated
  summary (They all committed to this loan, as did we, because of
  the Andy Fastow/Enron relationship. . . .).....................  2201
235. GMerrill Lynch Interoffice Memorandum, February 2001, re:
  Enron (ML recently lost the mandate to underwrite $1.25 billion
  of zero coupon convertible debt because Enron does not believe
  ML is a financial partner. . . . Merrill Lynch has decided to
  help Enron underwrite and syndicate these types of deals.).....  2202
236. GMerrill Lynch email, July 2001, re: Enron--rawhide (I just
  heard back from James and he told me that Enron will definitely
  not tie our loss to new business.).............................  2203
237. GMerrill Lynch email, July 2001, re: LJM2/Enron (. . . we
  took a substantial P/L hit for selling Zephyrus, not something
  we want to repeat. . . .)......................................  2204
238. GMerrill Lynch email, December 2001, re: Structured loan
  transactions (. . . a snapshot of the structured loans in the
  portfolio are as follows. . . .)...............................  2205
239. GMerrill Lynch Interoffice Memorandum, April 1998, re: Enron
  Common Stock Offering, Background, Merrill Lynch's analyst
  relationship with Enron........................................  2206
240. GMerrill Lynch email, January 1999, re: Enron Account Update
  (. . . regarding our difficult relationship in Research . . .
  two significant mandates by Enron.)............................  2209
241. GMerrill Lynch email, February 1999, re: Enron Mandate/Lay
  Letter (. . . it might be appropriate for you to send a note to
  Ken Lay at Enron thanking him for a recent mandate to serve as
  a co-manager on a 12 million share common stock offering
  ($775MM).).....................................................  2210
242. GMerrill Lynch Interoffice Memorandum, December 1998, re:
  Andy Fastow (SVP &amp; CFO of Enron) visit on December 4th)........  2211
243. GMerrill Lynch Calling List for the Enron Corp. common stock
  offering, dated April 28, 30, and May 4, 1998..................  2212
244. GMerrill Lynch Interoffice Memorandum, March 2001, re: $40.0
  million participation request from Enron Corp. . . . in funding
  a five-year Senior Secured Credit Facility for Zephyrus
  Investments, LLC...............................................  2225
245. GCommitment Committee Information, Zephyrus Investments,
  LLC/Enron Corp., March 2001....................................  2233
246. GMerrill Lynch Interoffice Memoranda, October 1999, re:
  Skilling (Enron) Questions on LJM2.............................  2235
247. GMerrill Lynch LMJ2 Co-Investment LP, Fee Calculation.......  2237
248. GMerrill Lynch email, November 2001, re: LMJ2, attaching
  Investor Status Summary, as of 9/30/01.........................  2238
249. GMerrill Lynch LJM2 Co-Investment, L.P., Private Placement
  Memorandum.....................................................  2240
250. GLJM2 Co-Investment, L.P., Limited Partner Groups...........  2289
251. GLJM2 Co-Investment, L.P., Schedule II, Information
  Regarding Limited Partners, As of November 12, 2001............  2292
252. GLJM Investments, Annual Partnership Meeting, October 26,
  2000, presentation.............................................  2293
253. GMerrill Lynch LJM3 Appropriation Request...................  2337
254. GMerrill Lynch email, November 2000, re: ML investment in
  LJM III (. . . there will probably be substantial interest in
  re-doing the employee vehicle early next year.)................  2340
255. GMerrill Lynch email, December 2001, re: ML/LJM2 Co-
  Investment, L.P. Capital Call ($140K Commit) (YOU MUST BE
  JOKING. . . .).................................................  2342
256. GMerrill Lynch Interoffice Memorandum, December 1998, re:
  Enron Corp. Loan Commitment (The loan commitment is required by
  Enron's accountants to insure that the structure receives off-
  balance sheet treatment.)......................................  2344
257. GMerrill Lynch email, May 2000, re: Enron Net Works (. . .
  Enron not worried about debt on the balance sheet, as they can
  structure around it.)..........................................  2346
258. GMerrill Lynch email, May 2000, re: Enron Net Works (Off
  Balance sheet debt--Not a primary driver because Enron believes
  they can structure anything to be off balance sheet.)..........  2348
259. GMerrill Lynch email, April 2001, re: Enron meetings (. . .
  they do a bunch of balance sheet deals similar to your barge
  deal. . . .)...................................................  2349
260. a. GMerrill Lynch email, December 1999, re: New Account
  Opening (Delaware LLC to Cayman Island--Tax Reasons.)..........  2350
    b. GMerrill Lynch email, March 2000, re: Ebarge LLC (. . . we
  have converted the entity to the Cayman Islands . . ...........  2351
261. GList of Merrill Lynch employees investing in LJM2..........  2352
262. GEnron Corp. draft letter/edits on Enron Nigeria Barge Ltd.
  sale...........................................................  2354
263. GBargeco Encomics, LJM2 document............................  2359
264. GEnron Risk Assessment and Control Deal Approval Sheet,
  Nigeria Barges Equity Sell Down, January 13, 2000..............  2360
265. GDan O Boyle, 2000 Deals and Accomplishments................  2364
266. GLJM Investments, Benefit Summaries.........................  2367
267. GLJM2 Co-Investment, L.P. Facsimile, May 2001, to Price
  Waterhouse Coopers, re: Enron Nigeria Barge Ltd................  2374
268. GMerrill Lynch letter to the Permanent Subcommittee on
  Investigations, April 2002, regarding Merrill Lynch
  Transactions with Enron-Related Entities (1997 to Present).....  2379
269. GLetters between Merrill Lynch and the Permanent
  Subcommittee on Investigations, August-November 2002, regarding
  follow-up questions from July 30, 2002 Subcommittee hearing....  2390
* May be found in the files of the Subcommittee
  THE ROLE OF THE FINANCIAL INSTITUTIONS IN ENRON'S COLLAPSE--VOLUME 1
                              ----------
                         TUESDAY, JULY 23, 2002
                                       U.S. Senate,
                Permanent Subcommittee on Investigations,
                  of the Committee on Governmental Affairs,
                                                    Washington, DC.
    The Subcommittee met, pursuant to notice, at 9:34 a.m., in
room SD-106, Dirksen Senate Office Building, Hon. Carl Levin,
Chairman of the Subcommittee, presiding.
    Present: Senators Levin, Cleland, Carper, Lieberman (ex
officio), Collins, Bunning, Fitzgerald, and Thompson (ex
officio).
    Staff Present: Linda J. Gustitus, Chief of Staff, Senator
Levin; Mary D. Robertson, Chief Clerk; Robert L. Roach, Counsel
and Chief Investigator; Stephanie E. Segal, Professional Staff
Member; Ross Kirschner, Deputy Investigator; Jamie Duckman,
Professional Staff Member; Edna Falk Curtin, Detailee/General
Accounting Office; Rosanne Woodroof, Detailee/Department of
Commerce OIG; Lani Cossette; Alex DeMots; David Berick
(Governmental Affairs Committee/Senator Lieberman); Cecily
Cutbill (Senator Carper); Tara Andringa, Kathleen Long, and
Clark Cohen (Senator Levin); Kim Corthell, Republican Staff
Director; Alec Roger, Counsel to the Minority; Claire Barnard,
Investigator to the Minority; Meghan Foley, Staff Assistant;
Jessica Caron, Intern; Gary Brown and Bob Klepp (Governmental
Affairs Committee/Senator Thompson); Holly Schmitt (Senator
Bunning); Jennifer Bonar (Senator Fitzgerald); and Felicia
Knight (Senator Collins).
               OPENING STATEMENT OF SENATOR LEVIN
    Senator Levin. The Subcommittee will come to order.
    Enron was the first in the recent wave of corporate
scandals, but it continues to instruct us on what has gone
wrong in corporate America and what needs to be reformed.
Earlier this month, the Permanent Subcommittee on
Investigations released a report on the role of the Board of
Directors in the collapse of Enron. It found that the Board had
failed in its fiduciary duty to protect Enron shareholders and
that it shares responsibility for Enron's deceptions and its
bankruptcy. Today we will look at financial institutions and
the role that they played in Enron's collapse.
    It is now common knowledge that Enron engaged in accounting
deceptions to convince investors, lenders, analysts, and the
public that the company was in better financial shape than it
really was. In examining the role that financial institutions
played in Enron's demise, we are focusing on one type of so-
called ``structured finance'' transactions that Enron referred
to as ``prepays'' and that they used to obtain billions of
dollars in financing for Enron without showing any additional
debt on its books. I believe that most will conclude, after we
hear today's testimony, that Enron's use of these prepays to
disguise debt was an accounting sham, and to carry out the
deceptions Enron had the help and the knowing assistance of
some of the biggest financial institutions in our country,
including JPMorgan Chase and Citigroup.
    It should be noted that Enron was not the only company
using sham prepays in the way it did. Both Chase and Citicorp
have shopped the prepay structures around, and other banks and
other companies have engaged in similar transactions, which is
also why our investigation of this subject is so important.
    Prepays, in concept, are simple and legitimate. They are
arrangements in which a company is paid in advance to deliver a
service or a product at a later date. But the prepays
constructed by Enron and banks like Chase and Citigroup were
phony prepays. There was an appearance of a product to be
delivered at a later date, but the reality was different. No
product was intended to be delivered; the transaction was in
reality a loan; but it was disguised so no loan would appear on
Enron's books.
    This structured deception had that clear purpose. There is
a big difference in the financial world between cash that comes
from business activity versus cash that comes from a loan, and
there is supposed to be a big difference in the accounting
treatment. Increased business activity can boost a company's
credit rating and stock value. In contrast, greater debt levels
can lower a company's credit rating and stock value.
    In a few minutes, we will hear from the chief investigator
of the Permanent Subcommittee on Investigations Staff, Robert
Roach, who will describe the intricacies of how these phony
prepays worked for Enron. We will then hear from two major
credit agencies, Moody's and Standard &amp; Poor's, who will
testify that despite following Enron quite closely, they were
unaware of the extent and nature of Enron's prepays which, had
they known of them, would have significantly affected Enron's
credit ratings. We will also hear from the former chief
accountant at the Securities and Exchange Commission, Lynn
Turner, about the shady accounting Enron used to hide the
prepay debt and deceptively increase operational cash flow.
    The last two panels will be JPMorgan Chase and Citibank who
were the biggest banking participants in Enron's phony prepay
activities. We will show how the banks arranged for Enron to
carry out these so-called prepays by using offshore shell
companies which the banks controlled, like Mahonia and Delta
Energy--companies which have no employees, no offices, and
operate in secrecy jurisdictions, that make it tough for law
enforcement to uncover or understand their relationships to the
banks behind them.
    The offshore entities were passthroughs, controlled by
banks, and helped disguise the loans so that they wouldn't show
as debt on Enron's financial statements. Those offshore
entities were not the independent entities which they needed to
be in order for the promises of future delivery of commodities
to them to be legitimate prepays. We will also hear how the
banks acted to limit public disclosure of Enron's prepay
obligations.
    Central to the issues today is evidence indicating that
Chase and Citicorp knew what Enron was doing, assisted Enron in
those deceptions, and profited from their actions. Take a look
at this chart which contains excerpts taken from internal
documents at Enron, its auditor Arthur Andersen, and Chase and
Citibank. Each discusses Enron's so-called prepays.
    First is an internal presentation from Enron's own
accounting department. It states: ``Why Does Enron Enter into
Prepays? Off balance sheet financing (i.e., generate cash
without increasing debt load).'' That is Enron's statement of
why it enters into prepays: ``i.e., generate cash without
increasing debt load.''
    Then there is an internal email from Chase which has this
to say about Enron's prepays: ``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 rev[enue] or
(better yet) bury it in their trading liabilities.'' That is
what Chase had to say and what they knew about these prepays.
    A Citigroup email makes a similar point: ``E[nron] gets
money that gives them c[ash]flow but does not show up on books
as big D Debt.''
    And Andersen, of course, knew what was going on. Its
internal email states: ``Enron is continuing to pursue various
structures to get cash in the door without accounting for it as
debt.''
    Now, those are excerpts from just a few of the documents
which our Subcommittee uncovered that show that Enron's prepay
activity was well known to its participants but hidden from
everybody else. Each knew that Enron's prepays were designed to
manipulate its financial statements, not to achieve business
objectives. Each also knew that Enron was booking prepay
proceeds as trading activity instead of loans, even though no
trade or sale was ever intended. Phony prepays produce
misleading financial statements. And that is what happened
here.
    When Enron collapsed and declared bankruptcy in December
2001, it had about $5 billion in outstanding so-called prepays
that were virtually unknown to the company's creditors,
investors, and business associates. And this disguised debt
contributed significantly to the Enron meltdown and the huge
loss to Enron's shareholders, the people who depended on that
stock for their pensions, people who had saved all their life
and who had worked hard for these investments. The debt was
disguised. It contributed to the meltdown and to the huge loss
to those people.
    Today we are going to shine the light in an area where
complexity has been used to hide the truth. Hopefully we will
cut through the darkness and place appropriate levels of
responsibility on those who participated in these schemes.
    [The prepared statement of Senator Levin follows:]
                  PREPARED STATEMENT OF SENATOR LEVIN
    Enron was the first in the recent wave of corporate scandals and
continues to instruct us on what has gone wrong and what needs to be
reformed. Earlier this month the Permanent Subcommittee on
Investigations released a Subcommittee report on the role of the Board
of Directors in the collapse of Enron. It found that the Board had
failed in its fiduciary duty to protect Enron shareholders and shares
responsibility for Enron's deceptions and bankruptcy. Today we are
looking at financial institutions and the role they played in Enron's
collapse.
    It has become common knowledge that Enron engaged in accounting
deceptions to convince investors, lenders, analysts, and the public
that the company was in better financial shape than it really was. In
examining the role that financial institutions played in Enron's
demise, we are focusing on one type of so-called ``structured finance''
transaction Enron referred to as ``prepays'' and used to obtain
billions of dollars in financing for Enron without showing any
additional debt on its books. I think most will conclude after we hear
today's testimony that Enron's use of these prepays to disguise debt
was an accounting sham, and to carry out the deceptions Enron had the
help and knowing assistance of some of the biggest financial
institutions in our country--including JPMorgan Chase and Citigroup. By
the way, Enron was not the only company using sham prepays in the way
it did. Both Chase and Citicorp have shopped the prepay structures
around, and other banks and other companies have engaged in similar
transactions.
    Prepays, in concept, are simple and legitimate. They are
arrangements in which a company is paid in advance to deliver a service
or product at a later date. But they didn't stay legitimate with Enron
and banks like Chase and Citigroup which together began constructing
complex, phony prepays that resulted in Enron obtaining billions of
dollars that were in reality undisclosed loans to Enron. There was an
appearance of a product to be delivered at a later date, but the
reality was different. No product was intended to be delivered; the
transaction was in reality a loan; and it was artfully disguised so no
loan would appear on Enron's books.
    Enron used these so-called prepays to obtain approximately $8
billion in financing over about 6 years. On its financial statements,
Enron reported the prepays as energy trading activity instead of debt,
giving the false impression that the money from the prepays was part of
Enron's ordinary business activities, instead of the loans they really
were.
    The purpose of all the complexity was to hide a loan, so it
wouldn't appear as debt on Enron's books.
    This structural deception had a clear purpose. There's a big
difference in the financial world between cash that comes from business
activity versus cash that comes from a loan, and there is supposed to
be a big difference in the accounting treatment. Increased business
activity can boost a company's credit rating and stock value. In
contrast, greater debt levels can lower a company's credit rating and
stock value.
    In a few minutes we will hear from the Chief Investigator of the
PSI Staff, Robert Roach, who will describe the intricacies of how these
phony prepays worked for Enron. We will then hear from two major credit
agencies, Moody's and Standard and Poor's, who will testify that
despite following Enron quite closely, they were unaware of the extent
and nature of Enron's prepays which, had they known of them, would have
significantly affected Enron's credit ratings. We will also hear from
the former Chief Accountant at the SEC, Lynn Turner, about the shady
accounting Enron used to hide the prepay debt and deceptively increase
operational cash flow.
    Then we will hear from JPMorgan Chase and Citigroup who were the
biggest participants in Enron's phony prepay activities. We will hear
how the banks arranged for Enron to carry out these so-called prepays
by using offshore shell companies the banks controlled, like Mahonia
and Delta Energy, which have no employees and no offices, and operate
in secrecy jurisdictions that make it tough to uncover or understand
their relationships to the banks behind them. We will also hear how the
banks acted to limit public disclosure of Enron's prepay obligations.
    Central to the issues today is evidence indicating that Chase and
Citicorp knew what Enron was doing, assisted Enron in the deceptions,
and profited from their actions. Take a look at this chart which
contains excerpts taken from internal documents at Enron, its auditor,
and Chase and Citibank. Each discusses Enron's so-called prepays.
    First is an internal presentation from Enron's own accounting
department. It states: ``Why Does Enron Enter into Prepays? Off balance
sheet financing (i.e., generate cash without increasing debt load).''
    Next is an internal email from Chase which has this to say about
Enron's prepays: ``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 rev[enue] or (better yet) bury it in their trading
liabilities.''
    A Citigroup email makes a similar point: ``E[nron] gets money that
gives them c[ash] flow but does not show up on books as big D Debt.''
    Andersen of course knew what was going on. Its internal email
states: ``Enron is continuing to pursue various structures to get cash
in the door without accounting for it as debt.''
    These are a few of the documents my Subcommittee uncovered that
show that the Enron's prepay activity was well-known to its
participants, but hidden from everyone else. Each knew that Enron's
prepays were designed to manipulate its financial statements, not to
achieve business objectives. Each also knew that Enron was booking
prepay proceeds as trading activity instead of loans, even though no
trade or sale was ever intended. Phony prepays produce misleading
financial statements. That's what happened here.
    When Enron collapsed and declared bankruptcy on December 2, 2001,
it had about $5 billion in outstanding so called prepays that were
virtually unknown to the company's creditors, investors, and business
associates. This disguised debt contributed significantly to the Enron
meltdown and the huge loss to Enron's shareholder.
    Deception piled on deception. There are many who are responsible
for the massive loss to people relying on pension funds and stock
investments. Today we'll shine the light in an area where complexity
had been used to hide the truth. Hopefully we'll cut through the
darkness and place appropriate level of responsibility on the banks who
participated in these schemes.
    Senator Levin. Senator Collins.
              OPENING STATEMENT OF SENATOR COLLINS
    Senator Collins. Thank you, Mr. Chairman.
    Today is the second in a series of hearings held by the
Permanent Subcommittee on Investigations into the events that
contributed to the collapse of the Enron Corporation. More than
6 months ago, the Subcommittee embarked on a comprehensive
investigation of Enron in an effort to gain understanding and
insight into what appears to have been a colossal failure of
virtually every mechanism that is supposed to provide the
checks and balances on which the integrity of our capital
markets depend.
    I would like to take a moment to praise Senator Levin and
the dedicated Subcommittee staff on both sides of the aisle who
have been tireless in their efforts to unravel the complex
transactions that were purposely designed to confound and
confuse. This undertaking has been enormous, and I greatly
appreciate the diligent work that has gone into this
investigation.
    The Subcommittee's first hearing examined the role of
Enron's Board of Directors in the company's collapse and found
that the Board failed to play its required role as the guardian
of the corporation's shareholders. The Board's failures, of
course, are only part of the story.
    We know now, nearly 8 months after Enron filed for
bankruptcy protection, that a web of conflicts of interest,
accounting improprieties, high-risk transactions, and the
appropriation of corporate assets by Enron executives
contributed to the company's collapse. Today, we will examine
the pivotal role of another set of players in the Enron story:
The financial institutions.
    The Subcommittee's investigation has revealed that certain
financial institutions knowingly participated in, and indeed
facilitated, transactions that Enron officials used to disguise
debt and, thereby, make the company's financial position appear
more robust than it actually was.
    Through the use of structured finance vehicles that
included a series of prepaid forward contracts and related
swaps, Enron received billions of dollars in cash. A prepaid
forward contract, or prepay, is essentially a forward sale
agreement in which the buyer receives an up-front payment in
exchange for a commitment to deliver goods or services in the
future. As the Chairman indicated, prepays are perfectly
legitimate when used correctly, and they are common in the
energy industry. When a bona fide prepay is used for a genuine
business transaction, it is a perfectly legitimate means to
provide needed cash to the seller and a desired commodity to
the buyer.
    However, as was the case with much of what went on at
Enron, these transactions were neither simple nor as they
seemed on the surface. Many of the so-called prepays, in fact,
were not prepaid forward contracts at all. They did not
transfer price risk. They did not use independent third
parties. They were not entered into because the purchaser
actually wanted oil or gas, nor were their terms driven by
anything other than a desire to achieve an accounting end.
Instead, they were elaborate circular transactions that were
designed to disguise what were essentially loans totaling
billions of dollars.
    The facade of a prepay enabled Enron to misrepresent the
cash it received as funds obtained from the company's
operations rather than from financing. From an accounting
standpoint, this is a critical distinction. Loans appear on the
company's balance sheet as cash from financing or debt. A
higher debt load raises questions about the company's borrowing
power and ability to generate future profits, and it affects
its credit rating. Cash flow from operations, on the other
hand, enhances the appearance that the company is doing more
business than it actually is and implies that such revenue,
because it is from the company's core operations, is likely to
continue in future periods.
    Enron wanted these deals to be covered in a shroud of
secrecy because they knew that they could not stand up to the
scrutiny of the light of day. Furthermore, they wanted them to
be limited to as few investors as possible in order to maintain
the facade. In fact, an internal Enron document explains that
the continued use of these transactions ``is a sensitive topic
for both the rating agencies and banks and institutional
investors. The ability to continue minimizing disclosure will
likely be compromised if transactions continue to be
syndicated.''
    Maintaining an investment grade rating was vital to Enron.
Had the rating agencies been privy to the circular nature of
these transactions, they would have considered them to be
financing or loans, and they would have factored that fact into
the ratings. Full disclosure of Enron's source of capital might
well have resulted in a downgrade of its rating.
    Although many banks ultimately invested in these
transactions, JPMorgan Chase and Citigroup were two of the
principal banks involved. Their deals enabled Enron to keep
some $8 billion of debt off its balance sheet and, as a result,
misrepresent its financial status to the rating agencies and to
the investing public.
    JPMorgan Chase and Citigroup are two of the Nation's most
prestigious financial institutions. That is why I find their
involvement so shocking. It appears as though they were willing
to risk their reputations to keep an important client--Enron--
happy. They participated in crafting the structure of these
transactions. They used special purpose, offshore vehicles of
their own making as the ``independent'' third parties. They
clearly understood Enron's motivation for wanting to use the
prepay structures to hide the true source of the company's cash
flow. This charade led to Enron's never-ending need for more
cash in order to pay off previous prepays, creating a merry-go-
round of refinancings at the expense of investors.
    While the majority of professionals in corporate America
are ethical people, the public's faith in corporate integrity
and professional judgment has been severely compromised by
recent corporate scandals. The markets have been buffeted by
both Enron and more recent revelations of corporate wrongdoing.
The resulting crisis of confidence is not about the market
system but, rather, the information that underpins its very
validity, the information about the performance of companies
whose shares are traded by investors around the world.
    Some accountants, lawyers, investment bankers, analysts,
and corporate executives, whose integrity and competence are
critical to our system of free markets, have directly
contributed to this crisis. Some have failed in their
professional responsibilities and made it easier for the direct
participants to get away with presenting a misleading picture
to investors. The question now is how to restore trust and
confidence in the markets and corporate America. Tougher laws,
clearer standards, and sure and swift enforcement are part of
the answer.
    Fundamentally, however, restoring faith in America's
capital markets requires that all the players perform their
jobs--not just government regulators and prosecutors, but
lawyers, accountants, investment bankers, market analysts,
corporate management, and boards--in accordance with the spirit
as well as the letter of the law. We all share in the
responsibility for making our markets operate as efficiently,
transparently, and fairly as possible. It is time to stop the
practices that are beneficial to a select few and harmful to
thousands.
    The testimony that we will hear this morning about the role
of financial institutions in the Enron debacle should yield
valuable lessons for strengthening our free market enterprise
system, for restoring public confidence in our capital markets,
and ensuring that small investors, in particular, have access
to complete and accurate information to guide their investment
decisions.
    [The prepared statement of Senator Collins follows:]
             PREPARED OPENING STATEMENT OF SENATOR COLLINS
    Today is the second in a series of hearings held by the Permanent
Subcommittee on Investigations into the events that contributed to the
collapse of the Enron Corporation. More than six months ago, the
Subcommittee embarked on a comprehensive investigation of Enron in an
effort to gain insight and understanding of what appears to be a
colossal failure of virtually every mechanism that is supposed to
provide the checks and balances on which the integrity of our capital
markets depend.
    I would like to take a moment to praise Senator Levin and the
dedicated Subcommittee staff on both sides of the aisle who have been
tireless in their efforts to unravel complex transactions that were
purposefully designed to confound and confuse. The undertaking has been
enormous, and I appreciate all the work that has gone into this
investigation.
    The Subcommittee's first hearing examined the role of Enron's Board
of Directors in the company's collapse and found that the board failed
to play its required role as the guardian of the corporation's
shareholders. The Board's failures, of course, are only part of the
story.
    We know now, nearly eight months after Enron filed for bankruptcy
protection, that a web of conflicts of interest, accounting
improprieties, high risk transactions, and appropriation of corporate
assets by Enron executives contributed to the company's collapse.
Today, we will examine the pivotal role of another set of players in
the Enron story: The financial institutions.
    The Subcommittee's investigation has revealed that certain
financial institutions knowingly participated in, and indeed
facilitated, transactions that Enron officials used to disguise debt
and, thereby, make the company's financial position appear more robust
than it actually was.
    Through the use of structured finance vehicles that included a
series of prepaid forward contracts and related swaps, Enron received
billions of dollars in cash. A prepaid forward contract, or prepay, is
essentially a forward sale agreement in which the buyer receives an up-
front payment in exchange for a commitment to deliver goods or services
in the future. Prepays are commonly used in the energy industry. When
bona fide prepays are used for genuine business transactions, they are
a perfectly legitimate means to provide needed cash to the seller and a
desired commodity to the buyer.
    However, as was the case with much of what went on at Enron, these
transactions were neither simple nor as they seemed on the surface.
Many of the so-called prepays, in fact, were not prepaid forward
contracts at all. They did not transfer price risk. They did not
utilize independent third parties. They were not entered into because
the purchaser actually wanted oil or gas, nor were their terms driven
by anything other than a desire to achieve an accounting end. Instead,
they were elaborate circular transactions that were designed to
disguise what were essentially loans totaling billions of dollars.
    While these transaction were incredibly complicated, they
essentially boil down to the following scenario. Enron entered into a
contract with an offshore entity to deliver oil or gas at a date
certain in the future in exchange for an up-front cash payment. The
offshore entity, created by or at the behest of the bank, made the up-
front payment to Enron with funds provided by the bank. In many cases,
no oil or gas ever really changed hands. The banks understood up-front
what their ultimate return would be because they hedged their risk,
sometimes with Enron itself. The offshore entity supposedly
participating as a trading counterparty, in reality, made nothing but
preset fees, and Enron received an infusion of cash without having to
disclose it as a loan on its balance sheet.
    The facade of a prepay enabled Enron to misrepresent the cash it
received as funds obtained from the company's operations rather than
from financing. From an accounting standpoint, this is a critical
distinction. Loans appear on a company's balance sheet as cash from
financing or debt. A higher debt load raises questions about a
company's borrowing power and ability to generate future profits and
affects its credit rating. Cash flow from operations, however, enhances
the appearance that the company is doing more business that it actually
is and implies that such revenue, because it is from the company's core
operations, is likely to continue in future periods.
    Enron wanted these deals to be covered in a shroud of secrecy
because they knew they could not stand up to scrutiny in the light of
day. Furthermore, they wanted them to be limited to as few investors as
possible in order to maintain the facade. In fact, an internal Enron
document explains that the continued use of these transactions ``is a
sensitive topic for both the rating agencies and banks/institutional
investors. The ability to continue minimizing disclosure will likely be
compromised if transactions continue to be syndicated.''
    Maintaining an investment grade rating was vital to Enron. Had the
rating agencies been privy to the circular nature of the transactions,
they would have considered them to be financing or loans, and they
would have factored that into their ratings. Full disclosure of Enron's
source of capital might well have resulted in a downgrade of its
rating.
    Although many banks ultimately invested in these transactions,
JPMorgan Chase and Citigroup were two of the principal banks involved.
Their deals, known as Mahonia and Yosemite, respectively, enabled Enron
to keep eight billion dollars off its balance sheet and, as a result,
misrepresent its financial status to the rating agencies and the
investing public.
    JPMorgan Chase and Citigroup are two of the nation's most
prestigious financial institutions. Yet, it appears as though they were
willing to risk their reputations to keep Enron, an important client,
happy. They participated in crafting the structure of these
transactions. They used special purpose, off shore vehicles of their
own making as the ``independent'' third parties. They clearly
understood Enron's motivation for wanting to use the prepay structures
to hide the true source of the company's cash flow. This prepay charade
led to Enron's never-ending need for more cash in order to pay off
previous prepays, creating a merry-go-round of refinancings at the
expense of investors.
    While the majority of professionals in corporate America are
ethical people, the public's faith in corporate integrity and
professional judgment has been severely compromised by recent corporate
scandals. The markets have been buffeted by both Enron and more recent
revelations of corporate wrong doing. The resulting crisis of
confidence is not about the market system but rather the information
that underpins its very validity, the information about the performance
of companies whose shares are traded by investors around the world.
    Some accountants, lawyers, investment bankers, analysts, and
corporate executives, whose integrity and competence are critical to
our system of free markets, have directly contributed to this crisis.
Some have failed in their professional responsibilities and made it
easier for the direct participants to get away with presenting a
misleading picture to investors. The question now is how to restore
trust and confidence in the markets and corporate America. Tougher
laws, clearer standards, and swift and sure enforcement are part of the
answer.
    Fundamentally, however, restoring faith in America's capital
markets requires that all the players do their jobs-not just government
regulators and prosecutors but lawyers, accountants, investment
bankers, market analysts, corporate management and boards-in accordance
with the spirit, not merely the letter, of the law. We all share in the
responsibility for making our markets operate as efficiently,
transparently and fairly as possible. It is time to stop practices that
are beneficial to a select few and harmful to thousands.
    The testimony we will hear this morning about the role of financial
institutions should provide some answers, and should yield valuable
lessons for strengthening our free enterprise system, restoring public
confidence in our capital markets, and ensuring that small investors,
in particular, have access to complete and accurate information to
guide their investment decisions.
    Senator Levin. Thank you very much, Senator Collins.
Senator Lieberman.
             OPENING STATEMENT OF SENATOR LIEBERMAN
    Senator Lieberman. Thanks, Mr. Chairman. I thank you and
Senator Collins and your staffs, the staff of the Permanent
Subcommittee on Investigations, for your continuing inquiry
into the workings of the Enron Corporation and specifically for
the meticulous work that you have done in preparing for this
hearing, which I think is some of the most significant work
that this Permanent Subcommittee on Investigations has ever
done, and the history of this Subcommittee is already a proud
one.
    The work that you have done and the opening statements that
you, Senator Levin, and Senator Collins have given amount to a
shocking indictment of the great companies that were involved
here and a profoundly unsettling picture of the way in which
good people at the top of America's economy did some very bad
things that have now brought our economy to a very unsettled
state and greatly diminished the wealth and security of
millions of people, including millions of middle-class
Americans who came into the stock market over the last decade.
    Today, you focus on an aspect of Enron's activities that
has not received much attention, and that is the role of some
of the Nation's--indeed the world's--largest financial
institutions. To feed Enron's need for cash without appearing
to incur debt on its balance sheet, the banks apparently
created complex transactions that disguise their true nature
and ultimately the true nature of Enron's financial condition.
    Enron's lenders apparently even convinced a number of the
Nation's largest insurance companies to provide performance
bonds covering the risk of Enron's default.
    As one judge put it in a case brought against Enron's
insurance companies who were balking at paying off these bonds,
and I quote, ``Taken together, then, these arrangements now
appear to be nothing but a disguised loan,'' end of the quote
from a judge.
    In Connecticut, Enron worked out a strikingly similar deal
with the Connecticut Resources Recovery Authority where a $220
million investment loan to Enron was disguised as a series of
energy transactions in which no energy was actually transferred
to Enron. The result, in a chain of reactions, has been
extraordinary increases in fees for municipalities throughout
the area served by the Connecticut Resources Recovery
Authority.
    Mr. Chairman, all of these transactions are deeply
troubling. They are added evidence that the behavior exhibited
by top Enron officials was not limited to a single company.
Remember in December when Enron declared bankruptcy and
collapsed, we were told that its problems were not systemic. We
were told that Enron was a single bad apple in a barrel of
otherwise good fruit. Now we know better. We know not only that
there were other bad apples in that barrel of corporate
America, but that in order for many of Enron's deceptions to
occur, Enron needed partners, companies that would agree to be
on the other side of questionable trades and transactions.
    So the cancer of corporate greed and deceit spread. In the
case of billions of dollars of disguised loans, Enron's
partners were the world's largest financial institutions--
institutions with proud and respected names.
    Now, I don't know whether disguising loans as commodity
contracts is illegal, but I do know that it allowed Enron to
run roughshod over what is supposed to be the hallmark of our
securities markets, and that is, individual and corporate
investors' access to accurate information about the financial
health of publicly traded companies. Enron and its financial
partners seem to have designed these transactions, that the
Subcommittee has investigated and will illuminate today,
explicitly to thwart that ideal.
    Sadly, millions of average investors are painfully aware of
the consequences of making decisions based on untruthful or
inaccurate information, and today's hearings give us one more
example of how people at the top of America's economy betrayed
the great American middle class which put its hope in the
markets and how important it is for us to act together through
government and through the private sector to restore investor
confidence.
    As Senator Levin and Senator Collins particularly said, we
should, and I believe will, adopt tough new laws to punish and
deter such corporate greed and malfeasance. Business
organizations such as the stock exchanges should and are acting
constructively and progressively to adopt measures of self-
regulation and self-policing. But I must say, Mr. Chairman, as
I prepared for this hearing today and was struck at how, again,
good people were drawn into bad practices, in the end we all
have to acknowledge that the law cannot be everywhere and that
business self-regulation, stock exchange rules cannot be
everywhere; that ultimately, particularly in a democracy, many
of the most critical decisions are made in the privacy of one's
own conscience.
    And if I may veer from where one normally goes at these
hearings, I was thinking, in reading the record for the hearing
today, of something I once learned that was written in the
Talmud, which is that in the hour when our own lives are over
and individuals are brought before the heavenly court, four
questions will be asked, so the rabbis tell us. And the first,
amazingly, is: Did you conduct your business affairs honestly?
Not, did you believe in God? Did you follow all the particular
rituals of your faith? But, did you conduct your business
affairs honestly? Because it is in conduct that we ultimately
reflect the extent to which we have embraced a set of values.
    The other thing I remember having studied once is that of
all the metaphorical crowns that one may earn in life, the most
important is the crown of a good name. And we have here some
corporations that have earned very good names that apparently
by the action of individual people in them have sullied those
good names.
    Senator Levin, Senator Collins, I again commend you and
your staff for conducting this extraordinary investigation, for
bringing to light the facts that will be revealed today, and in
that sense for crying out to those who hold power within
America's economy to remember what the facts of your
investigation show so clearly that too many forgot, which is,
if I may paraphrase from the Bible; Man, people do not live by
quarterly earnings reports alone.
    I thank you, Mr. Chairman.
    Senator Levin. Thank you, Senator Lieberman.
    Senator Thompson, let me call on you, but first let me
thank you and Senator Collins. Your staff has been part of a
truly dedicated team of staffers which has brought us to this
point, and I think it really represents the best in us as
Senators that we and our staffs work this closely together on
such a very complex kind of an investigation involving
literally millions of pages that have to be reviewed. And I
want to thank you both for the staff work that has been so
dedicated.
             OPENING STATEMENT OF SENATOR THOMPSON
    Senator Thompson. Thank you, Mr. Chairman. I could not
agree with you more about the work of the staff. I was very
pleased to see Gary Brown from Nashville, whom I have known
since before he became a lawyer, come up and assist in this,
and he and Mr. Roach have worked very well together.
    This document that these gentlemen have produced is really
remarkable. I would hope that everyone would have the
opportunity to see not only Mr. Roach's statement today but the
document that I believe is attached to it or is an exhibit that
will be a public record. It is indeed detailed and complex.
    As you know, Senator Lieberman, I have been spending a
little time on homeland security and a few other things, but as
I got into this very recently, I was very surprised at what I
saw. I usually like to wait until the evidence is in before I
make too many comments. But I think the comments in this case
are right on, from all you can tell from the record and
actually hearing from both sides.
    And I come away with the feeling that our checks and
balances have let us down. We have checks and balances not only
in government but in our private sector, in our free economy.
And we expect auditors, lawyers, raters, and bankers to deal in
certain ways; otherwise, bad things happen. And we have
certainly seen a lot of bad things happen. But, unfortunately,
the lessons we learned at our mama's knees about the
overwhelming power of money sometime turned out to be true.
These investment bankers are making hundreds of millions of
dollars in fees to set up these deals and pay themselves back
in many cases. They are the ones who receive the money in many
cases.
    So the transactions are very complicated, but the
motivations are not, unfortunately. Apparently what the average
person, anyway, and I assume even the average sophisticated
institutional investor would assume was debt magically turned
out to appear to be cash flow from business. And instead of the
debt-to-capital ratio going up, it went down, the company,
therefore, appearing to be in better shape than it was.
    I understand that we will hear testimony that everybody did
it, that, oh, Enron fooled us again. They have to be the
smartest people in the world because they fool the smartest
people in the world, apparently, consistently over a period of
years, while those smart people were, of course, making many
millions of dollars off of being fooled. But perhaps everybody
did it, perhaps the securities fraud laws tolerate it, but I
venture to say we will have an opportunity to find out. It is
not this body's job, but I venture to say that we will have an
opportunity to find out whether or not the securities fraud
laws encompass these sorts of activities and tolerate it.
    Thank you, Mr. Chairman.
    Senator Levin. Thank you, Senator Thompson. Senator
Bunning.
              OPENING STATEMENT OF SENATOR BUNNING
    Senator Bunning. Thank you, Mr. Chairman. I appreciate you
calling this hearing today and all the work that has gone on by
staff to prepare this unbelievable document that we have in
front of us.
    Enron's collapse earlier this year signaled the beginning
of a crisis in confidence in this country that continues to
have a lasting effect and is still going on. One of the largest
accounting firms is in ruins. Brokerage firms are under
suspicion. And Congress has spent a lot of its time this year
trying to figure out what we can do to prevent another crisis
like this.
    Unfortunately, it is clear that Enron was not alone in the
shady financial dealings. Investors have been burned more than
once this year with companies, including WorldCom and Global
Crossing, using questionable accounting practices in business
transactions. Americans across this country are watching their
savings and their pensions dwindle, and many now question the
validity of financial statements, the independence of financial
advisors, and the ability of boards of directors to provide
proper oversight.
    Personally, I believe it might take a while for average
Americans to feel good about putting their money back into any
part of the stock market, and I can't blame them. Company after
company, over 1,000 to be exact, have restated their earnings,
and all of the major markets reflect that by being in the tank.
We are facing a crisis, and I hope that the accounting bill we
recently passed will restore at least some of the confidence in
the markets.
    There is certainly enough blame to go around from Wall
Street analysts to credit rating agencies to Enron executives.
Too many people dropped the ball or looked the other way when
dealing with Enron, and now we are all paying for it.
    As for today's hearings, I look forward to learning more
about Enron's use of prepays, especially with some of the
companies that helped them in this endeavor. I am particularly
interested in hearing from these companies what they plan to do
in the future to make sure it is not easy for companies like
Citicorp and Chase, JPMorgan Chase, to use and manipulate the
markets by the use of the vehicles that they did to enhance the
cash flow of Enron.
    Thank you, Mr. Chairman. I am looking forward to the
testimony.
    Senator Levin. Thank you.
    I want to also thank and single out Senator Lieberman, who
is the Chairman of the full Committee, for the strong support
that he has personally given to this investigation and helping
us to do what we needed to do to review the massive materials
that we had to review, and also for his very powerful and
eloquent opening statement.
    Let me now introduce our first panel of witnesses this
morning. At the witness table are Robert Roach, a Counsel and
Chief Investigator of the Permanent Subcommittee on
Investigations. Bob has been with the Subcommittee for the last
5 years as a valued member of my staff on the Subcommittee. He
is accompanied by Gary Brown, Special Counsel for Senator
Thompson on the Minority staff of the Committee. That is the
full Committee on Governmental Affairs.
    Gary Brown and Bob Roach represent a very dedicated team of
staffers working together on this Enron investigation for many,
many months. We look forward to hearing their analysis of their
investigation of the role of financial institutions in Enron's
collapse.
    Pursuant to Rule VI, all witnesses who testify before the
Subcommittee are required to be sworn, and at this time I would
ask the witnesses to please stand and raise your right hand. Do
you swear that the testimony that you give before the
Subcommittee this morning will be the truth, the whole truth,
and nothing but the truth, so help you, God?
    Mr. Roach. I do.
    Mr. Brown. I do.
    Senator Levin. We will be using a timing system today, and
about 1 minute before the red light comes on, you will see the
light change from green to yellow, which will then give you an
opportunity to conclude your remarks. And your written
testimony will be printed in the record in its entirety, but we
ask that you limit your oral testimony to no more than 10
minutes.
    Mr. Roach.
      TESTIMONY OF ROBERT L. ROACH,\1\ COUNSEL AND CHIEF
    INVESTIGATOR, PERMANENT SUBCOMMITTEE ON INVESTIGATIONS;
  ACCOMPANIED BY GARY M. BROWN, SPECIAL COUNSEL, COMMITTEE ON
                      GOVERNMENTAL AFFAIRS
    Mr. Roach. Mr. Chairman, Ranking Member Collins, Members of
the Subcommittee, good morning. Earlier this year, Chairman
Levin directed the Subcommittee staff to investigate the role
of financial institutions in Enron's collapse. The Subcommittee
staff--both Democratic and Republican--have worked for the past
7 months on a bipartisan basis to conduct this investigation.
We have worked together to review over a million pages of
documents and interviewed dozens of witnesses from Enron,
Andersen, other accounting firms, credit rating agencies, and a
host of financial institutions.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Roach with attachments appears in
the Appendix on page 215.
---------------------------------------------------------------------------
    Numerous major financial institutions, both here and
abroad, engaged in extensive and complex financial transactions
with Enron. The evidence we reviewed showed that, in some
cases, the financial institutions were aware that Enron was
using questionable accounting. Some financial institutions not
only knew, they actively aided Enron in return for fees and
favorable consideration in other business dealings. 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. The
evidence also indicates that at least in one case these
financial institutions knowingly allowed investors to rely on
Enron financial statements that they knew or should have known
were misleading.
    Our investigation, among other things, focused on one
financing vehicle known as a ``prepay.'' A prepay is commonly
thought of as an arrangement in which one party pays in advance
for a service or product to be delivered at a later date.
Companies use prepays to receive money up front for services to
be rendered in the future.
    Enron constructed elaborate, multiparty commodity trades
that they called prepays in order to book the proceeds from
prepays as cash flow from operations. But when all the bells
and whistles are stripped away, the basic transaction fails as
a prepay, and what remains is a loan to Enron using an
investment bank and an obligation on Enron's part to repay the
principal plus interest. With that being true, the proceeds of
the so-called prepay transaction should have been booked as
debt and not as cash flow from operations.
    Now let me describe in general terms why the prepays came
about and how they worked. Mr. Chairman, with your permission,
one of my colleagues will draw this transaction as I describe
it.
    Now, first of all, Enron needed more cash flow to show that
it could handle its growing debt. One way to address this is
for Enron to go and get a loan from a bank such as Citi or
Chase. But that would add to its debt load, compounding its
problem rather than solving it.
    Now, Enron was a merchant energy company. It could engage
in trades, and the cash from this type of activity would be
accounted for as trading from business operations. However, if
Enron and Chase entered into a trade of a commodity such as gas
or oil, both parties would be at risk of losing money,
depending on the change in value of the oil or gas. And that
would be unacceptable to both Chase and Enron in this situation
because the objective was to get a fixed amount of cash to
Enron, and Chase wanted to be sure it would get its money back
with some interest.
    So to protect themselves from this uncertainty, Chase and
Enron would enter into a second transaction, exactly opposite
to the first, which would mitigate or eliminate that price
risk. And this is a hedge.
    Now, the only problem with this strategy is that these
parallel transactions that you see over there cannot be
accounted for as legitimate trading activity and would be
obvious to auditors. So to help Enron out with its problems,
Chase inserted into the trade one of its shell corporations,
Mahonia, to engage in a series of trades between three
supposedly independent parties.
    Now, the trades between each party in the triangle were
designed to perfectly offset each other so there would be no
price risk. And this is the basic model of what has come to be
called ``the Enron prepay.'' Chase forwards a lump sum of money
to Mahonia. Mahonia forwards the money to Enron. Enron sends
regular deliveries of a commodity, generally oil or gas, back
to Mahonia, and Mahonia sends it on to Chase.
    Now, the advance of cash from Chase and then the advance of
cash from Mahonia to Enron is booked as a trading activity by
Enron rather than a loan, and the proceeds--that is the cash it
receives--is booked as cash flow from operations rather than as
cash flow from financing.
    The transactions are worked out in advance by all the
parties so that they yield a steady and predictable flow of
cash from Enron to Chase, just like a loan repayment. Interest
is embedded in the repayment schedule, and in the
communications we have seen, the payments are referred to as
amortization payments.
    The net result is that on the surface this transaction
appears to be a series of arm's-length trades among independent
entities. However, it is really a set of integrated,
prearranged trades that wash each other out, except for the
movement of funds from Chase to Mahonia to Enron and eventually
back to Chase with some interest payments included.
    Now, this is a simplified version of what really went on.
Actually, the transactions look more like the charts that we
have prepared for the Citi and Chase transactions. I am not
going to go into those right now. I think they will be
discussed a little later, but that is what they look like. And
these transactions fail as legitimate trades for a number of
reasons.
    Senator Levin. Mr. Roach, let me interrupt you just for one
second. I have had a brief consultation here, and you can take
longer than 10 minutes. We are going to withhold many of the
questions so that you will have more time for your
presentation.
    Mr. Roach. Thank you, Mr. Chairman.
    In order for transactions like the ones used by Enron and
the financial institutions to be legitimately booked as cash
flow from operations and not debt, four elements had to be
present: One, the three parties had to be independent; two, the
trades among the three parties could not be linked; three, the
trades had to contain price risk; and, four, there had to be a
legitimate business reason for the trades.
    The Enron-type prepays we examined failed on all accounts:
Two of the three parties in the Enron trades were related--the
banks and their offshore special purpose entities which the
banks established and controlled; the trades among the parties
were linked--contracts associated with the trades were designed
so that a default in one trade affected the other trades; there
was no price risk--except for fees and interest payments, the
final impact of the trades was a wash; neither the banks nor
the banks' special purpose entities had a legitimate business
reason for purchasing the commodities used in these trades.
    Enron used these so-called prepay transactions to obtain
more than $8 billion in financing over approximately 6 years,
including $3.7 billion from 12 transactions with Chase and $4.8
billion from 14 transactions with Citigroup. This $8 billion
figure is a conservative estimate for the 6-year period based
on the documents we were able to review. The full amount since
Enron began using prepays around 1992 may be much larger.
    Now, accounting for prepay proceeds as cash flow from
operations rather than cash from financing gave the impression
that the money from the prepays was part of Enron's ordinary
business activities and not debt. Moreover, the Subcommittee
has learned that Enron was simultaneously treating the prepay
transactions as loans on its tax returns in order to claim the
interest expense as a business deduction.
    Enron's practice of using prepay transactions to understate
debt and overstate cash flow from operations made its financial
statement look much stronger. That, in turn, helped Enron
maintain its investment grade credit rating and support, even
boost, its share price.
    Now, the Subcommittee has done an analysis of what Enron's
financial statements would have looked like had it accurately
recorded the prepay transactions as debt. Please look at this
chart which is marked as Exhibit 104 \1\ in the exhibit books.
The chart shows key figures from Enron's year 2000 financial
statements, the last audited financial statements that the
company filed with the Securities and Exchange Commission. The
financial statements showed that Enron had total debt in 2000
of about $10 billion, and funds flow from operations in the
range of $3.2 billion.
---------------------------------------------------------------------------
    \1\ Exhibit No. 104 appears in the Appendix on page 355.
---------------------------------------------------------------------------
    Now, we know from Enron board presentations that at the end
of 2000, Enron had about $4 billion in outstanding financing
from its so-called prepays. And as you can see from the chart,
if Enron had properly accounted for these transactions, its
total debt would have increased by about 40 percent to $14
billion, and its fund flows from operation would have dropped
by almost 50 percent to $1.7 billion. These are dramatic
changes.
    Now, the impact on Enron's key credit ratios would also
have been significant. These credit ratios are the ratios that
financial analysts typically use to evaluate a company's
financial health. Again, looking at the chart, with the
inclusion of prepays as debt, Enron's debt-to-equity ratio
would have risen from about 69 percent to about 96 percent. Its
debt-to-total-capital ratio would have risen from 40 percent to
49 percent, and its fund flow interest coverage, a key measure
of a company's ability to meet its financing obligations, would
have dropped by almost half, from $4.07 to $2.37 billion. Now,
the credit rating agencies testifying in the next panel will
discuss the significant effect these numbers would have had on
Enron's credit rating.
    Any credit rating downgrade would have had serious
consequences for Enron, including raising its borrowing costs,
limiting the investors who could buy the company's bonds,
weakening its trading status, and possibly triggering certain
demand debt repayments at off-balance sheet entities affiliated
with the company. Enron was acutely aware of the importance of
its credit rating and its financial ratios.
    Now, the Subcommittee staff has additional analysis
regarding the financial impact that would have resulted if
Enron had accurately reflected its prepay proceeds as debt,
including drops in the company's enterprise value and a
significant drop in its implied share price. In the interest of
time, however, I will submit that analysis for the record and
answer any questions you may have about it. I would also ask
that the other appendices to my statement be included in the
Subcommittee's hearing record.
    Senator Levin. They will be made part of the record.
    Mr. Roach. Now, Enron was able to book prepay proceeds as
cash flow from commodity trades rather than cash flow from
loans only with the assistance of the financial institutions.
The banks provided the funding for the prepays, participated in
the required complex commodity trades, and allowed Enron to use
their offshore entities that they controlled as sham trading
partners, for the explicit purpose of allowing Enron to
disguise its multi-million-dollar loans as trading activity.
    Internal communications show that it was common knowledge
among Enron, Chase, and Citigroup employees that the prepays
were designed to achieve accounting, not business, objectives
and that Enron was booking the prepay proceeds as trading
activity rather than debt. The evidence indicates that Chase
and Citigroup not only understood Enron's accounting goal, but
designed and implemented the financial structures to help Enron
achieve its objectives. Moreover, they accepted and followed
Enron's desire to keep the nature of these transactions
confidential.
    By design and intent, the prepays as structured by Enron
and the financial institutions made it impossible for
investors, analysts, and other financial institutions to
uncover the true level of Enron's indebtedness.
    And the financial institutions marketed these structures to
other potential clients. Chase developed a pitch book to sell
other companies on Enron-style prepays. The pitch book
describes the transactions as ``balance sheet `friendly.' '' It
also sets out in general terms Chase's use of Mahonia in
structuring the trades and clearly explains that the trades are
orchestrated to work together. This explanation of the
deliberate packaging of the trades flatly contradicts claims
that the trades are independent and unrelated. Chase apparently
entered into Enron-style prepays with seven companies in
addition to Enron.
    Citigroup also developed a presentation to sell companies
on Enron-style prepays, promoting, in particular, the Yosemite
structure it had developed to raise money for the prepays from
third-party investors without explicitly informing them of the
transactions. And you can see--well, we had a copy of the
Yosemite structure up earlier. The Citi presentation boasts
that the structure ``[e]xpands capability to raise non-debt
financing and . . . improve cash flows from operations'' and
``[e]liminates the need for Capital Market disclosure, keeping
structure mechanics private.'' Citi sold its prepay structure
to two other companies and shopped the Yosemite structure to 14
other companies.
    This shows that Enron is not the only company obtaining
loans disguised as commodity trades and recording cash flows
from operations instead of from financing. Major financial
institutions are knowingly assisting and even promoting such
transactions, which would not be possible without their
willingness to provide the funds, the paperwork, and a sham
offshore trading partner.
    Thank you. Mr. Brown and I would be happy to answer any
questions you may have at this time.
    Senator Levin. Thank you. I do not have any questions. Your
statement is very thorough and clear analysis, and I will see
if any of my colleagues have questions.
    Senator Collins.
    Senator Collins. Thank you, Mr. Chairman. I only have a
couple of questions, but I, too, want to join in complimenting
the staff for its hard work and the excellent presentation as
well as the invaluable assistance that we have received from
Mr. Brown.
    Mr. Roach, as you indicated, one requirement of a
legitimate prepay is that there has to be a legitimate business
purpose for the transaction. During the course of the
investigation, were you ever made aware of a particular need
that either of these banks had for oil or gas, or was the
nature of the commodity involved essentially not relevant from
the banks' perspective?
    Mr. Roach. With respect to these particular trades, it was
irrelevant.
    Senator Collins. So this was not a case where there was a
legitimate need for the commodity by the bank; is that correct?
    Mr. Roach. That is correct.
    Senator Collins. Mr. Brown, you have a great deal of
experience with securities laws and I would like to ask you to
comment on an issue that was not touched on in Mr. Roach's
testimony. Do you believe that securities laws might be
implicated in some of these prepay transactions, and
specifically I would like you to comment on how the term
``fraud on the market'' might apply in the context of what we
are hearing about.
    Mr. Brown. Well, as far as implication of securities laws,
sure, they're implicated in the mere sale of the Yosemite
notes, for example. The sale of the Yosemite notes implicates
the securities laws since those are obviously securities. And
so an issue that naturally arises there is whether or not the
investors who bought those notes received truthful and accurate
information, not misleading information, in terms of the
offering memorandum and any presentations that were made to
them.
    The term ``fraud on the market'' is a term that comes up in
what you see in some of these securities class actions, where,
quite frankly in a situation like Enron, over a period of time
the company's stock price is supported in the marketplace by
what is false and misleading information but the public doesn't
yet know about it. When that becomes known, then the market
price drops, and so people who buy stock during that time
period have been defrauded. How that can be implicated in a
situation like this is whether or not any persons who are
actively engaged in assisting the company in misstating its
public financial statements, whether or not those people can be
determined to be engaged in securities fraud and either
prosecuted or held civilly liable. So that's how those would
operate.
    Senator Collins. Thank you, Mr. Chairman.
    Senator Levin. Thank you, Senator Collins. Senator
Lieberman.
    Senator Lieberman. Thanks, Mr. Chairman.
    And again, thanks to both of you for extraordinary work.
Two quick questions.
    Mr. Roach, this one picks up on what Senator Collins asked.
The charts that you gave us showed a trail of commodity
transactions, in your case, oil. Obviously, no oil actually
changed hands here; is that correct?
    Mr. Roach. Well, Senator, there was at times what they
would call physical transfer, but it was really simply a
transferred title.
    Senator Lieberman. And ultimately, the paper went in a
circle; am I right?
    Mr. Roach. Yes, sir, most of the time it went into a
circle, went through a circle.
    Senator Lieberman. So that it came back to where it
started, without any other immediate effect, at least regarding
the commodity.
    Mr. Roach. That's right. On most occasions that's what
happened.
    Senator Lieberman. Just to the best of your knowledge, are
the financial institutions with which Enron entered into these
trades, generally in the business of buying and selling
commodities?
    Mr. Roach. That gets a little bit beyond my ken. But I can
comment on this, that these are financial institutions which
engage in all kinds of commodity transactions, and so they do
have businesses which do engage in the trading of oil and gas.
But this is a bit different when they sit down and prearrange
it all in advance.
    Senator Lieberman. And prearrange it with the third party
involved being a corporation that they themselves set up. In
other words, Enron, financial institution, and the third party
is of their own creation.
    Mr. Roach. The bank's creation, that's correct.
    Senator Lieberman. Mr. Roach, the financial institutions,
as I have seen the press coverage of this leading up to today,
argue, and I presume they will today, that these prepaid
agreements are often-used financing mechanisms and that there
is nothing inherently wrong with using them, either in general
or in the specific case of Enron. In addition, the financial
institutions argue that it is not their responsibility to make
sure that their clients such as Enron properly account for and
report such transactions.
    I wanted to ask you now whether it is your conclusion,
based on the investigation that you and your colleagues have
done, that the financial institutions involved here did in fact
know how Enron intended to use these transactions, and in that
sense that they aided and abetted Enron's intent to mislead
investors and credit rating agencies?
    Mr. Roach. Unquestionably. The documents that we have
reviewed show that the financial institutions clearly
understood what Enron's objective was in engaging in these
transactions.
    Senator Lieberman. Thank you, gentlemen.
    Thank you, Mr. Chairman.
    Senator Levin. Thank you very much. Senator Thompson.
    Senator Thompson. Thank you very much.
    Gentlemen, thank you very much for the work you have done
here. It is extremely complex for most of us, but I think you
have synthesized it as well as anybody could, and I recommend
these exhibits for those who understand these issues and want
to know more about how these things work.
    As I look through here, it looks like there are two basic
issues or two basic problems. One has to do with the use of
these forward contracts that you have described, which
basically turn liabilities into cash flow and affects the debt
equity ratio. But then there is another set of issues, it seems
to me, where you take issue with the fact that these investment
bankers put out offering memos, prospectuses, to investors in
order to sell these instruments to--I guess they are all
qualified institutional investors. Let us take Yosemite, for
example. There is apparently, from looking at your documents,
the prospectus did not include substantial debt that should
have been included in that prospectus. Was this debt based on
these contracts that we have been talking about? How do those
two issues interrelate?
    Mr. Brown. It is a couple of things. There is an issue
whether there should have been some additional supplemental
disclosure about what had been identified as off-balance sheet
debt and whether or not that would have been important to the
investors purchasing the notes.
    The second aspect of that is whether Enron's overall
financials----
    Senator Thompson. Excuse me. Before you get off that. When
you say ``off-balance sheet debt,'' what are we talking about
there?
    Mr. Brown. Well, there were--well, some things like--we've
all read about and seen--Jedi, Chewco, and then there was an
analysis done by one of the investment banks, and they've
subsequently corrected a portion of it, but what they refer to
as off-balance sheet or non-debt structures, that it would be
very difficult for someone to pick up and know about, which
would affect the debt-to-capital ratio and other key financial
ratios relied upon by the credit rating agencies.
    Senator Thompson. So there was an issue as to how that
category of item should be reported.
    Mr. Brown. Right.
    Senator Thompson. Go ahead.
    Mr. Brown. The second aspect of it is what has been alluded
to I guess in several of the Senators' statements and also in
Mr. Roach's testimony, and that is just the overall effect of
these prepays on Enron's financial condition in general. I
think it is interesting to note that when Enron failed last
fall, the big news at that point was over a 3\1/2\-year period,
approximately $2.5 billion of debt was put back on the books.
    Well, here you are talking about transactions that put $2.5
billion of debt--but not classified as debt--on the books, in a
year.
    Senator Thompson. Are these the prepaid contracts?
    Mr. Brown. Right. And so there is the issue of whether or
not Enron's financial statements, as a whole, which were
incorporated into these offerings, were rendered false or
misleading by the characterization of these transactions as
trading liabilities as opposed to debt, and cash flow from
operations as opposed to cash flow from financing. Now, when
Mr. Turner testifies in a little while, he will be much more
qualified than I to tell you about the implications of those
characterizations.
    But suffice to say that technically you'll hear some
technical compliance with Generally Accepted Accounting
Principles (GAAP) does not mean that the financial statements
or the document is nevertheless not false and misleading, and
there's law to that effect.
    Senator Thompson. So breaking it down in the simplest
terms, when the prospectus went out, it did not include some of
these items that you were talking about that at least arguably
should have been disclosed as Enron debt; is that correct?
    Mr. Brown. Right. And again, whether or not the
characterization of the debt recordation, characterization of
the cash flow, the known use of the proceeds of the transaction
to fund or prepay other items like that, whether or not that
would have been important disclosure in the offering
memorandum.
    Senator Thompson. Well, I think we know what the
institutional investors say about that or are going to say
about that. They clearly say that that would have been
important to them. If that is important to them, it would have
had some impact on their decision to invest.
    Do you know whether or not these mortgage bankers actively
sought to keep from disclosing, keep those items from being
known?
    Mr. Brown. I believe there are some emails which indicate
that when questions started to be raised about what assets are
in the trust, the order comes down, I think, as to shut it
down, or ``Let's shut this down to keep people from asking
about it.''
    Now, inherently, in fairness, there's nothing wrong with
structured finance that includes a blind pool trust. There's
nothing wrong with that. It's just when you combine it with all
these other things that you raise potential questions about
whether or not there would have been appropriate supplemental
disclosure and whatnot.
    Senator Thompson. Such as a three-party deal that was not
at arm's length, an offshore company that had no business
purpose other than to create the booking entry that was
created, that sort of thing?
    Mr. Brown. Yes, sir.
    Senator Thompson. Thank you, Mr. Chairman.
    Senator Levin. Thank you.
    Following the early bird rule, Senator Bunning.
    Senator Bunning. Thank you, Mr. Chairman.
    I would like to ask Mr. Roach, how does Arthur Andersen fit
into how these prepays were structured and accounted for?
    Mr. Roach. Well, Senator, we have seen documents that
Arthur Andersen provided guidance documents to Enron as to what
types of criteria they needed to follow in order to ensure that
these transactions comply with accounting rules, and in fact
the four points that I had mentioned in my statement--and I
think we will see an exhibit on it later--those were actually
taken from an Arthur Andersen presentation that we acquired
under subpoena from Enron, and we had also seen other documents
that discuss that in a similar way.
    So they were clearly providing them guidance on what they
should and should not be doing.
    Senator Bunning. How to set up the prepays?
    Mr. Roach. Yes, and saying this is what you need to do in
order to make sure it falls within the accounting rules.
    We have interviewed some Arthur Andersen accountants who
worked on this, and the one thing that sort of comes across--
it's not clear to us, we're still trying to work this out--it's
not clear whether they really knew everything that was going on
with these deals. I would say that's still an open question,
but from the interviews thus far, there are certainly some
issues that we've discussed with them that they profess that
they didn't know about, and that could have caused further
questions about the way in which these transactions were
accounted for.
    Senator Bunning. In the testimony by JPMorgan Chase that we
will hear later today, they say that neither Chase nor Enron
has an ownership interest in Mahonia and that Mahonia's
officers and directors made the decision to enter into specific
transactions. Do you know who the officers and directors of
Mahonia are, and were they completely separate from Chase?
    Mr. Roach. We know who they are. It is a group over in the
Isle of Jersey called Mourant &amp; Company. It's a firm that
provides administrative and corporate services to corporations.
And those individuals serve as the officers and directors of
Mahonia. Material, which will be discussed later, indicate that
while there is probably a legal separation between Chase and
Mahonia, there certainly are multiple indicia of control over
the entity and the way in which the relationship between Chase
and Mourant and then subsequently Mahonia work.
    Senator Bunning. In other words, Chase controlled Mahonia.
    Mr. Roach. That's our belief. And it was set up
specifically to affect that situation, that the entity would
not----
    Senator Bunning. The transactions----
    Mr. Roach. Well, it was set up so that Chase would not own
it, be able to control it.
    Senator Bunning. I understand. But they did it for that
specific purpose.
    Mr. Roach. To control it, but not own it, yes. And it was
involved in those other transactions other than those engaged
with Enron.
    Senator Bunning. Last question. In your testimony I believe
you said that Enron was treating the prepaid transactions as
loans on its tax returns to get a business deduction, but was
not counting the prepays as loans on its financial statements.
Is that correct?
    Mr. Roach. Yes, sir.
    Senator Bunning. How does that happen if you have an
accountant? If I did that on my own tax returns, I would go to
jail, directly to jail, and do not pass go and not collect
$200, as they say in the game of Monopoly.
    Mr. Roach. Well, Senator, I'm not a tax expert, but what we
have been told in the course of our interviews is that there
are sometimes situations where for purposes of accounting and
financial statements, you can treat cash flow in one way and
then for purposes of taxation treat it as another.
    What we do know is that through interviews of the people in
the tax department of Enron and memos that we have obtained,
that there was a judgment made within Enron that they could,
for tax purposes, treat these--the income from these
transactions--as loans.
    Senator Bunning. And still show them in another manner for
the public to see?
    Mr. Roach. Yes, sir.
    Senator Bunning. Thank you, Mr. Chairman.
    Senator Levin. Thank you, Senator Bunning. Senator Carper.
              OPENING STATEMENT OF SENATOR CARPER
    Senator Carper. Thank, Mr. Chairman.
    To our witnesses, thank you for being here and for your
testimony. I am balancing between a couple of different
hearings, and I missed much of your statement.
    Let me just ask a couple of related questions revolving
around the issue of motivation, and I am interested in your
thoughts on what was the motivation for Enron to enter into
these transactions? What was the motivation for the banks who
were involved in these transactions? What was the motivation
for the investors to invest in these transactions? And finally,
at the end of the day, who gets left holding the bag?
    Mr. Roach. I guess I do because Mr. Brown is drinking
water. [Laughter.]
    I mean it is hard to ascribe motives. What we have seen in
documents clearly indicate that the situation with Enron was
that it was showing incredible amounts of income in its
financial reports due to the accounting mechanisms it employed
to take advantage of these long-term contracts that it had been
signing. The income, that high level of income allowed them to
acquire a lot of debt. The problem is when analysts and credit-
rating agencies began to look at the entire financial
condition, there was a problem because the cash flow that Enron
was bringing in didn't seem to be sufficient enough to support
that level of debt. So the problem Enron had was that it had to
bring in more cash in order to show people that it could carry
the debt load that it had.
    Well, it had some problems. Its assets were not very good,
and in fact, as we've seen in a number of cases, probably being
carried on its books at a much higher value then they really
were, so selling those assets wasn't going to help them much.
There were problems with trading off legitimately part of its
trading book. So they didn't have many options left. If they
went--and as I said earlier in the presentations, if they went
out and got a loan, that wasn't going to help them because that
money would be shown as additional debt. So structuring these
transactions in the way they did solved the problem. They could
take the cash that they received from these transactions, and
count it as cash flow from business activities, and at the same
time not record it as debt. So that is the motivation here with
Enron.
    Senator Carper. I thought that was an excellent
explanation.
    Mr. Roach. Thank you. It's a little more difficult to
understand what the motives of the banks were. I mean, there
are certain communications you can see that allow you to infer
what's going on. I mean clearly Enron was a big player on Wall
Street at that period of time. They were doling out lucrative
contracts for a lot of business to a lot of people. And Enron
was not shy about telling the potential suitors that if you
want our business, you have to belly up to the bar. We want to
see you involved in our activities helping us out. And we do
see memos to the effect that not only the two financial
institutions that are here today, but other financial
institutions were very well aware of that, and were often very
concerned about how what they were and were not doing with
respect to Enron's request affected their ability to get
business in the future. Whether that's the full motivation I
don't know, and as I said, I'm trying to be specific here, that
we've seen this in memos, that's maybe one reason, but I don't
want to say that's fully it or specifically it.
    A little more difficult with the investors, and I think we
ought to let Mr. Brown talk about that.
    Mr. Brown. The investors, particularly in Rule 144A
transactions, there are a series of institutions that are
always looking to park funds and get good rates of return,
which they were getting from what at the time everyone would
say, Fortune 10 company, CEO or CFO, and all the other
management team were being praised as the second coming. They'd
look at it and people could very easily say, good return;
what's the risk here? Let me sign up. And so that's certainly
going to be the motivation from people who were investing in
notes and investing, quite frankly, in the stock.
    Who gets left holding the bag, I guess, at the end of the
day will be determined in bankruptcy court and in litigation,
where there's numerous claims and cross-claims among investors,
investment banks, shareholders, lenders, and the rest. So I
mean it will be a long process determining who ultimately does
hold the bag.
    Senator Carper. Thank you both very, very much.
    Thanks, Mr. Chairman.
    Senator Thompson. Mr. Chairman, could I follow up on
Senator Carper's question a little?
    The documentation you have here seems to indicate that in
terms of the motivation of the bankers, that substantial
amounts of these transactions, the money coming in from these
transactions, were going to pay off the bankers themselves,
from indebtedness that Enron owed to them; is that correct?
    Mr. Roach. Well, yes, sir. What began to happen--and I
think Senator Collins mentioned this in her statement--I mean
it sort of became a merry-go-round. The money brought in in
prepays went to pay off the earlier prepays. This was
particularly true in the Yosemite structure. The first offering
for Yosemite was $800 million. And those funds were provided to
the prepaid transaction, and when Enron received that money it
used the $800 million to pay off two prior prepays, one named
Roosevelt and the other named Truman. I don't pick the names, I
just deliver them.
    And in the second Yosemite a similar thing happened. I
believe there was about 200 million pound sterling raised in
that offering and those went to prepay transactions, and they
were used to repay prepays as well.
    Senator Thompson. So how much of that went to the bankers
though is what I am getting at. Give me the extent of the----
    Mr. Roach. Well, in the end, the banks were the initial
source of the funds for the prepays. So when that would
happen--for example, in Yosemite structure what's really
happening here is Citicorp is transferring the credit risk that
it held out into the capital markets.
    Senator Thompson. For how much? How much credit risk were
they----
    Mr. Roach. Well, they were ultimately on the hook for the
entire amount of the value of the prepay. So, for example, at
the time of Yosemite, I think the remaining value of the Truman
prepay was about $675 million, and the remaining value of the
Roosevelt prepay was about $125 million.
    Senator Thompson. So how much of that were they able to
take care of in the subsequent prepays, all of it?
    Mr. Roach. Well, the entire amount because the entire $800
million raised in Yosemite was used to pay off those previous
prepays.
    Senator Thompson. Thank you, Mr. Chairman.
    Senator Levin. Thank you very much to both of you again.
    And we will now move to our second panel. Let me introduce
you and you can remain standing. This will be very brief. First
at the witness table, we have Lynn Turner, who is a former
Chief Accountant with the Securities and Exchange Commission
from 1998 to 2001.
    From Moody's Investor Service we have Pamela Stumpp. She is
the Managing Director and Chief Credit Officer of the Corporate
Finance Group. And John Diaz, the Managing Director of Power &amp;
Energy from Moody's Investors Service.
    Ronald Barone, Managing Director of Utilities, Energy &amp;
Project Finance Group, Corporate and Government Ratings; and
Nik Khakee, Director of Structured Finance.
    This is a very distinguished panel that we have before us.
We look forward to your testimony. And pursuant to Rule 6, as I
indicated, all witnesses who testify before our Subcommittee
are required to be sworn. I would ask you to raise your right
hands and ask you this question: Whether or not you swear that
the testimony which you give before this Subcommittee will be
the truth, the whole truth and nothing but the truth, so help
you, God.
    Mr. Turner. I do.
    Ms. Stumpp. I do.
    Mr. Diaz. I do.
    Mr. Barone. I do.
    Mr. Khakee. I do.
    Senator Levin. Thank you. We would note again that the
written testimony will be printed in the record in its
entirety. We ask the oral testimony be no more than 10 minutes,
and that green light will disappear after about 9 minutes, at
which point there will be a 1-minute warning before the red
light comes on, which will give you the opportunity to conclude
your remarks.
    Let me start with Mr. Turner.
   TESTIMONY OF LYNN E. TURNER,\1\ FORMER CHIEF ACCOUNTANT,
     SECURITIES &amp; EXCHANGE COMMISSION, BROOMFIELD, COLORADO
    Mr. Turner. Thank you, Chairman Levin, Senator Lieberman,
and Senator Thompson. I testified at the first Senate hearing
that was held by the full Committee with Chairman Levin, and at
that point in time as I recall, both Senator Lieberman and
Senator Thompson said this would be a long road and it would
take a lot of determination to get us to the end of it, and I
commend all of you for the fine work that you and the staff
have done. To that degree, I think the staff have done a
fabulous job in trying to get to the bottom of the issue.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Turner appears in the Appendix on
page 265.
---------------------------------------------------------------------------
    There's no question, what we've already heard today, that
the investors have lost confidence and trust in the markets is
absolutely true. It's evidenced probably best by the downward
spiral that we've seen in the markets that in the last few
weeks have even turned into what some would say is a free fall,
and as a result of that, we've seen investors lose in excess of
$5 to $6 trillion of value which is phenomenal.
    The impact of that on America and now on our economy is
turning out to be very real and in some cases devastating. It
is interesting to note that back in 1929, when we had the
market crash, there were only 1.5 million Americans that were
affected by that. Today there's 85 million Americans. One out
of every two Americans are being impacted--voting Americans are
being impacted--by that today. So it has a much broader impact,
and as a result, we're seeing, I think, the concern, the
frustration, certainly the disgust in some cases on the part of
Americans with that, although I think we have to make sure that
we understand we can't paint all market participants, all
people on Wall Street with the same broad brush. But
notwithstanding that, it is important that all market
participants play a key and important role in making sure that
the financial information that is provided to investors has a
high degree of honesty and integrity, and quality and
transparency behind that.
    In fact, for the people to my left here to be able to do
their job properly, they have to know that the CEO amendment
CFO, the financial executives, have got the numbers done right,
that the auditors have checked that, that the corporate boards
have exercised, like an eagle, their oversight of that process,
so that they then get good quality transparent information from
which they can make judgments. Without that, the credit rating
agencies would be unable to fulfill their responsibility to the
public. And with that as a backdrop, I think the whole
Committee and Subcommittee is to be commended for asking what
role Wall Street has played in these particular transactions,
and in particular these two financial questions.
    There's no question that people need to ask things. What
was their role in this in structuring and engineering and
financing these transactions, and then executing them.
    As Senator Collins said in her opening remarks, perhaps
this is happening all too often. From my vantage point as the
Chief Accountant at the Securities and Exchange Commission, as
a CFO, and as a partner of Coopers &amp; Lybrand, I can tell you
quite frankly it is business as usual. It happens day-in, day-
out, every day on Wall Street. Quite often at the SEC we would
spend a significant amount of time finding these transactions
and then trying to put a lid on them. As the CFO, I was
actually urged by members of Wall Street to undertake
accounting that was woefully inadequate and in violation of the
SEC rules. I might note we didn't do it. I had a great CEO and
a great board, and quite frankly, each one of the Big Five
accounting firms has an on-call group that works very closely
in conjunction with Wall Street in carrying out and designing
and engineering these transactions to ensure that they get
disguised and hid from the investors.
    And with that though, let's get into the accounting for
just briefly for a moment here as we try to summarize this.
There are so many of these transactions because they are being
done day-in and day-out that the Financial Accounting Standards
Board can't write a rule for every single one of them. Not
enough time, not enough resources to do that. But there are
some general guidelines, general principles. And some of those
clearly say, as I outlined in my written statement, that what
we do is we look through to the substance of the transaction,
and there are some rules in black and white that talk about
that. And in my statement I note that the SEC, for example, has
objected, and it's in black and white to transactions going
off-balance sheet when you just came up with a nominally
capitalized SPE like what we have here in Mahonia or Delta, and
just insert that into the transaction, try to get off the
balance sheet.
    Task forces of the FASB have also come out in black and
white and talked about situations where securities are issued
and purchased, and I'll say, ``for the sole purpose of
achieving a desired accounting results, and the transaction
considered individually would serve no valid business purpose
or would not be entered into otherwise.'' In those situations
we look right through the structure to find out what the
substance of it is, and if it's debt, it needs to go on the
balance sheet as debt.
    So as you can see in this particular case, it's not an
issue of being the gray. This is an issue of black and white.
And leaving these liabilities up in the trading credit risk
area, rather than showing them as a true loan to the bank is
just absolutely wrong. Now, some would argue that who cares--
and I think you will hear some arguments as long as it was a
liability on the bank, should we care at all? Or on the balance
sheet, at least it's there. And I think the answer is very much
so. That's why the SEC has promulgated very clear rules that
say each material line time on the balance sheet needs to be
separately broken out. You cannot aggregate them all and just
show them one line item on the balance sheet, and I can
guarantee you that as the CFO at my former employer, if I had
prepared financial statements and had just one line item on my
balance sheet and we're a large international semiconductor,
and I had of gone to either of these institutions and asked
them for financing, just said, liability, hundreds of millions
of dollars, there is no way that their own banking divisions
would have ever given me a loan on that basis.
    There's also a question being raised here about the
reporting for the cash flows. In a statement that the Financial
Accounting Standards Board issued Statement No. 5 on reporting
a cash flow, the FASB decided--and I think appropriately so--by
rule, that you have to break out where the sources of your cash
are coming from so that investors could see is it being
generated by normal business operations or is it coming from
the banks who are providing you financing, or is it coming from
sales of assets, so that investors can currently tell what's
going on with the business and how well management is doing in
achieving their goals.
    When you turn around and put these cash flows from these
financing vehicles up in the statement of cash flow from
operations, then there is no question it misleads investors and
there is no question it will mislead the credit rating
agencies, and the analysts into thinking that the business is
doing much better, it's generating as lot more cash than it
really is, which it can then turn around and use or lacks to
use to pay off the bank debt. And to that degree, I think
investors on this particular case were woefully misled.
    It's also interesting to note that in a court case back in
1969, that the judge in that, on appeal in the U.S. Court of
Appeals for the second court, noted that notwithstanding what
the GAAP rules are, they kind of provide a minimum floor that
if in fact there's material information out there that
investors are entitled to or should know, then you need to get
that information in the filing. The judge turned around and
said that proof of compliance with Generally Accepted Standards
was evidence which may be persuasive, but not necessarily
conclusive, and in that case, that the facts were certified
were not materially false or misleading, so he says you got to
go beyond GAAP if there's material information.
    And interesting enough, he goes on to say that when someone
becomes aware of something that may be in compliance with GAAP,
but more information is needed, the judge said, ``Once he has
reason to believe that this basis assumption is false, an
entirely different situation confronts him. At least this must
be true when the dishonesty he has discovered is not some minor
peccadillo, but a diversion so large as to imperil, if not
destroy, the very solvency of the enterprise,'' which is
exactly what we have in the Enron situation. And so with that I
think it is just a matter of black and white. These numbers
should have gone on the balance sheet as debt without a
question.
    And let me just finish by commending the Senate, the 97
Senators that voted for the Sarbanes Bill. I think the Sarbanes
Bill will help, will go a long ways to solving some of these
problems. Certainly the Auditor Independence Provisions in
there would cease the auditors from being involved in helping
structure these transactions to keep them away from the public,
and certainly I think will bring the confidence of the public
back to the market. So I commend all 97 of you for having taken
that serious undertaking.
    Senator Levin. Thank you very much, Mr. Turner. Ms. Stumpp.
  TESTIMONY OF PAMELA M. STUMPP,\1\ MANAGING DIRECTOR, CHIEF
  CREDIT OFFICER, CORPORATE FINANCE GROUP, MOODY'S INVESTORS
 SERVICE, NEW YORK, NEW YORK, ACCOMPANIED BY JOHN C. DIAZ,\1\
  MANAGING DIRECTOR, POWER &amp; ENERGY GROUP, MOODY'S INVESTORS
                  SERVICE, NEW YORK, NEW YORK
    Ms. Stumpp. Good morning, Mr. Chairman, Senator Collins,
Senator Lieberman and Senator Thompson, and Members of the
Subcommittee.
---------------------------------------------------------------------------
    \1\ The prepared statement of Ms. Stumpp and Mr. Diaz with an
attachment appears in the Appendix on page 278.
---------------------------------------------------------------------------
    My name is Pam Stumpp, and I am Managing Director at
Moody's Investors Service and the Chief Credit Officer for the
Corporate Finance Group. I am joined by my colleague, John
Diaz, who is a Managing Director in our Power &amp; Energy Group.
On behalf of Moody's, we're pleased to appear before you today
at your request regarding your investigation into the role of
the financial institutions in the collapse of Enron.
    For over 100 years Moody's has played an important part in
providing informed and independent credit analysis to
investors. We are proud of our history as the world's oldest
credit rating agency, and we're cognizant of the responsibility
that this legacy confers upon us. It was with this
responsibility in mind that we accepted your invitation to
share our views on the critical issues before you. At a time
when America's faith in the integrity of its corporations and
the stability of its financial markets is badly shaken, we
applaud the efforts of this Subcommittee, the Congress, the
Securities &amp; Exchange Commission, to investigate Enron's
failure, and identify the larger lessons that can be learned
from the company's collapse.
    We are especially interested in these issues because our
ratings depend heavily upon the integrity of the public
financial statements provided by corporations. In our
assessment of a company's creditworthiness, Moody's analysts
begin with the premise that the issuer's SEC filings and
audited financial statements are accurate. We them bring the
benefit of our experience and expertise to our analysis. But as
the Enron situation has demonstrated, where the principle of
transparent public disclosure is abandoned, neither we nor the
regulators can properly fulfill our obligations to the market
and investors globally.
    Before discussing Enron and related issues in more detail,
it is important for me to note that Moody's did not have any
knowledge, prior to Enron's bankruptcy, of the existence of
Enron's prepaid forward and related swap transactions. Even
today our understanding of the specifics of these transactions
is restricted to what we have gleaned from press accounts and
conversations we have had with the Subcommittee staff at their
request. Based on our limited knowledge, these transactions
appear to have been a form of financing. If such transactions
had been accounted for as a loan, Enron's operating cash flow
would have been reduced and its debt would have been greater.
The disclosure of these transactions as loans would have
exerted downward pressure on Enron's credit rating.
    Of course, knowing all that we do know today about the true
nature of Enron's corporate enterprise, it is clear that Enron
had not been an investment grade company for several years. The
compounded impact of these transactions alone on Enron's
financial framework may have resulted in the lower rating and
perhaps an earlier downgrade to below investment grade status.
More fundamentally, however, Moody's would have questioned
management's motivations to have implemented such a structure.
    As Moody's does with all corporate entities, we expressed
to Enron our views regarding its creditworthiness. Specifically
Enron was rated in the Baa category, Moody's lowest investment
grade level. Entities rated Baa contain speculative elements.
We had communicated to Enron that its Baa rating reflected its
high level of debt relative to its operating cash flow.
Consistent with Moody's practice not to recommend that
corporate issuers follow specific courses of action, Moody's
did not instruct or suggest that Enron employee prepaid
transactions or other artificial means to increase operating
cash flow or to understate debt levels.
    Moody's did provide ratings for the notes issued by
Citibank-sponsored Yosemite Trusts I and II, as well as the
several Enron Credit Linked Notes Trusts. We viewed these
transactions to be a means through which Citibank reduced its
level of Enron risk. We have submitted, along with this opening
statement a diagram of the Yosemite structure as presented to
us in the offering memorandum. Yosemite was a structure of the
type that our structured finance group examines and rates
frequently. The purpose of these structures is essentially to
transfer the credit risks associated with a particular company
to third-party note holders.
    In this instance a trust was created that issued notes to
investors. Citibank was obligated to make payments to the
trust, which were then passed to investors. Citibank was not
obligated to make these payments if Enron failed to pay on its
senior note obligations or filed bankruptcy. In exchange for
principle and interest due under the notes, the investors
assumed the risk that Enron might go into bankruptcy or fail to
pay on its obligations. Therefore, the likelihood that the note
holders would receive the promised returns on these notes was
linked directly to Enron's creditworthiness.
    It should be stressed that structured financing is a common
risk management tool available globally to corporations,
financial institutions and State and local governments. It is a
recognized method, for example, of enhancing liquidity and of
transferring credit risk when appropriately implemented. What
might seem to be a complex structure can in fact genuinely
accomplish one or more of these goals. The Yosemite transaction
transferred Enron risks exactly as they intended to. The
problem was that the actual Enron risk was different from that
portrayed by Enron's incomplete and misleading financial
disclosures.
    The securities market can only function efficiently with
transparent and credible financial information. It is critical
to strengthen these elements of our financial infrastructure
and bolster investor confidence. As a major consumer of
publicly-available information, we support rule changes by the
SEC and Congress that enforce transparency and penalize
corporate deception. Furthermore, we endorse a principle-based
approach to accounting, rather than a rules-based approach.
Accounting that promotes adherence to the spirit and the letter
of the rules would strengthen the foundations of our financial
system.
    At this critical juncture, we hope all market participants
step forward to offer confidence-building measures. As far as
Moody's is concerned, we are expanding our knowledge in key
disciplines that have come to influence credit risk. We are
recruiting specialist teams with particular expertise in
credit-related areas such as accounting quality, corporate
governance and off-balance sheet risks. These teams will
supplement the work of our credit generalists in their analysis
of a company's creditworthiness. We hope that our independent
assessment of financial reporting and corporate governance will
improve market transparency and contribute to the restoration
of confidence in our capital markets.
    Finally, as an institution that views its role in the
capital markets with both pride and great seriousness, we
welcome the opportunity to assist this Subcommittee in
examining the shortcomings of the present system and in working
toward effective solutions. Therefore, on behalf of our
colleagues at Moody's, John Diaz and I would like to thank you
for the opportunity to appear today, and we look forward to
answering your questions.
    Senator Collins [presiding]. Ms. Stumpp, thank you so much
for your testimony. We only have about 2 minutes remaining in
the vote that is under way, so Senator Thompson and I are going
to go vote. Senator Levin will be back very shortly, and will
reconvene the hearing, but I will put the hearing in recess
until he returns. Thank you for your testimony.
    [Recess.]
    Senator Levin [presiding]. The Subcommittee will begin
again. And I believe Ms. Stumpp has completed her testimony,
and so we will move to Mr. Barone.
TESTIMONY OF RONALD M. BARONE,\1\ MANAGING DIRECTOR, UTILITIES,
   ENERGY &amp; PROJECT FINANCE GROUP, CORPORATE AND GOVERNMENT
RATINGS, STANDARD &amp; POOR'S, NEW YORK, NEW YORK; ACCOMPANIED BY
 NIK KHAKEE,\1\ DIRECTOR, STRUCTURED FINANCE GROUP, STANDARD &amp;
                   POOR'S, NEW YORK, NEW YORK
    Mr. Barone. Good morning, Mr. Chairman, and Members of the
Subcommittee. I am Ronald M. Barone. From 1994 until Enron
Corporation's bankruptcy in December 2001, one of my roles at
Standard &amp; Poor's Ratings Services was to serve first as an
analyst and then as a manager with respect to Enron.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Barone and Mr. Khakee with
attachments appears in the Appendix on page 282.
---------------------------------------------------------------------------
    I am joined today by Nik Khakee, who was the senior analyst
involved with our work on the Yosemite and Credit Linked Notes
Trusts. The comments I will make a little later regarding those
trusts were prepared by Mr. Khakee.
    On behalf of Standard &amp; Poor's, we welcome the opportunity
to appear at this hearing. Ratings are a key component of the
capital markets, which have functioned effectively for decades
in the United States, and Standard &amp; Poor's is recognized as a
global leader in the field of credit ratings and risk analysis.
While all parties may not agree with our ratings at all times,
Standard &amp; Poor's credit ratings have gained respect and
authority throughout the investing community because they are
widely understood to be based on independent, objective and
credible analysis. The record bears out Standard &amp; Poor's
emphasis on objectivity and credibility. There is a
longstanding and exceptionally strong correlation between the
ratings initially assigned by Standard &amp; Poor's and the
eventual default record. The higher the initial rating, the
lower the probability of default and vice versa.
    Our ratings opinions are based on a company's audited
financial information and qualitative analysis of the company
and its industry sector. We also may have access to certain
confidential information of the company, but only to the extent
that the company's management is willing to provide such
information. We use that information and rely upon it.
    With regard to Enron Corporation, from 1995 until November
1, 2001, Standard &amp; Poor's rating of Enron was BBB +, which
placed Enron at the lower levels of investment grade ratings
and was well below what Enron repeatedly and unsuccessfully
sought from Standard &amp; Poor's.
    It now appears, based on what Mr. Roach and Mr. Brown just
testified to, that in addition to the already well-documented
deceptions regarding its off-balance sheet partnerships, Enron
may have incurred approximately $4 billion in debt-like
obligations structured as prepaid forward transactions and swap
transactions. Our contemporaneous understanding of these types
of transactions was that in the years leading up to its
bankruptcy, Enron was employing them to actively manage its
trading and marketing positions and cash flow. While Enron did
not provide specific details about these particular
transactions, the generalized information it did provide, which
underpinned our analysis, led us to conclude that the funds
from these transactions were more akin to operational cash flow
than new debt-like obligations.
    Despite our repeated requests for complete, timely and
reliable information, Enron did not disclose any information
revealing a link between the prepaid forward transactions and
the swap transactions. Similarly, Enron provided no indication
that these transactions were in any way related to any of the
Yosemite or Credit Linked Note transactions, despite an
explicit inquiry by Standard &amp; Poor's regarding the effect, if
any, of these structured finance transactions on Enron's
financial situation. While our knowledge about the full nature
of these transactions and/or any links between them is still
limited, any lack of disclosure by Enron of their material
aspects would have been yet another flagrant violation of
Enron's duty and responsibility to provide Standard &amp; Poor's
with complete, timely and reliable information.
    In hindsight, and without full information, it is difficult
to assess the effect full disclosure about these transactions
would have had on our ratings analysis; but the sheer volume of
the transactions suggests that it would likely have been
significant.
    It is worth noting as well that on no occasion did we
advise, consult or suggest to Enron that it should employ these
prepaid forward transactions or swap transactions, or any other
means to increase cash flow.
    The Subcommittee has also requested information regarding
our understanding of the structure and operations of the
Yosemite and Credit Linked Notes Trusts. Each of these trusts
was structured as a standard Credit Linked Notes transaction in
which the credit risk of a particular entity, which in these
trusts was Enron, is transferred to the purchaser of notes
issued by the trusts. In such transactions a counter-party
seeks to purchase protection against the default of a
particular issuer. In the first Yosemite transaction, for
example, the protection buyer was Citibank. On the face of it,
by entering into a credit default swap, Citibank protected
itself against a default by Enron. In the event of such a
default, Citibank would receive consideration from the
protection seller. Here the protection seller, the Yosemite I
Trust, obtained the funds needed to pay Citibank in such an
event by selling notes and certificates to qualified
institutional buyers.
    Because our ratings analysis of the notes issued by these
trusts required us only to focus on the structure of the
transactions and whether the default risk of the trusts notes
was a genuine pass through of the default risk of Enron, our
analysis did not include review of the day-to-day operations of
the trusts. As with all such transactions, it was the trustees'
responsibility to ensure that the proceeds of the notes were
invested in accordance with the terms of the indenture and that
all of the trusts' operating requirements were met.
    Enron's demise, along with other recently revealed
corporate accounting problems has damaged the public's
confidence in the marketplace and the economy as a whole.
Because our ratings ultimately depend upon information provided
by the issuer, Standard &amp; Poor's has been a long-time champion
of complete, timely and reliable disclosure of information and
the highest standards of corporate governance.
    To that end, while we applaud the recent proposals and
recommendations made by the Securities &amp; Exchange Commission,
Standard &amp; Poor's has already stated publicly our belief that
such proposals are only a partial solution, as they still leave
wide room for interpretation by companies and their accountants
about whether certain items qualify for additional disclosure.
    We have recently published two articles, which I have
included with my testimony, which focus on the various
proposals in light of Standard &amp; Poor's ratings practices. We
are also in the process of reviewing current accounting and
regulatory requirements with an eye towards making specific
recommendations for improvements aimed at fostering greater
corporate transparency and restoring public confidence in the
markets. Thank you.
    Senator Levin. Thank you very much, Mr. Barone.
    First, Mr. Turner, if you would take a look at Exhibit
112.\1\ This is an Andersen analysis on when a transaction that
is being called a prepay can properly be counted as a trading
contract and as cash flow from operations rather than as debt
and cash from financing. Now, we've put that analysis also on a
board up here to my right. We've put it on one page to make it
easier to use.
---------------------------------------------------------------------------
    \1\ Exhibit No. 112 appears in the Appendix on page 367.
---------------------------------------------------------------------------
    In your testimony you said that you agreed with Arthur
Andersen's four key points for determining when a prepay
transaction can be accounted for as a trading contract, and I
want to ask you about a couple of the four elements.
    First of all, if a transaction fails to meet any of those
criteria, am I correct that it fails the test for being treated
as a trading contract?
    Mr. Turner. Yes. In this case I think that would be true.
    Senator Levin. In other words, if you fail any of the four,
it fails as a trading transaction; is that correct?
    Mr. Turner. Yes, I would agree. I think that was Andersen's
analysis, and I would agree with them.
    Senator Levin. Now, the first criteria is that none of the
agreements in the structured transaction may be linked. In your
judgment were the transactions involving Enron and Chase and
Enron and Citibank linked?
    Mr. Turner. Yes. Your staff has shown me some exhibits. I
don't recall which Bates numbers, but it certainly looked like
they were linked to me.
    Senator Levin. For instance, we understand that Mahonia
entered into a contract in which it assigned to Chase all of
its rights to any payment from Enron. Does that constitute
linkage?
    Mr. Turner. Yes.
    Senator Levin. And what effect does that alone have on the
accounting for this transaction?
    Mr. Turner. When you link all these transactions together,
in essence what you are seeing is that it's really just a
collapsible transaction between Enron and the investment
banker, in this particular case, which would turn it into being
a bank loan on the balance sheet.
    Senator Levin. So that it would destroy that prepay
triangle and just reduce the transaction to a loan between
Enron and Chase?
    Mr. Turner. That's correct.
    Senator Levin. Now, you've seen some of the evidence the
Subcommittee investigation obtained with respect to Mahonia and
Delta and their relationship to Chase and Citibank. That
evidence shows that the banks directed the establishment of
those offshore entities; they controlled the transactions that
the offshore entities entered into; they set up their bank
accounts, and they effectively controlled them since the
offshores were shells with no employees, offices or ongoing
business facilities.
    Under those circumstances, were Mahonia and Delta
independent from Chase and Citigroup?
    Mr. Turner. No. As I think the written testimony points out
in a number of places in the accounting literature, where you
just insert a nominally capitalized SP with no real business
purpose, you collapse it, and again, you get down to just a
transaction between the investment banker and--the bank loan
and Enron.
    Senator Levin. Now, is it important that they be
independent because if they are not independent third entities
out there, this is just simply, in essence, a loan transaction
between the bank and Enron?
    Mr. Turner. That is true. What the accountants are really
looking for is do you have three independent parties each
taking on a legitimate business purpose, legitimate business
risk behind the transaction, or is it really just a sham
transaction designed to try to avoid the accounting rules.
    Senator Levin. Now, another of the Andersen criteria
requires that the parties to the energy trade have an ordinary
business purpose for buying or selling the prepay commodity.
From what you can tell, did either Mahonia or Delta have an
ordinary business reason for engaging in energy trading?
    Mr. Turner. No. I think, in fact, a number of the emails
and memos specifically talk about the purpose was to try to
hide this from the balance sheet of Enron and its investors.
    Senator Levin. Now, Citigroup has said in its prepared
testimony that the ``overall cash flow for Enron would be
exactly the same whether Enron used prepaids or entered into a
bank loan. In the case of prepaids,'' the testimony goes on,
``which are contracts transacted in Enron's trading book, Enron
booked the cash it received on these contracts as cash from
operations, not as cash from financing.''
    Let me correct my question. Citigroup's testimony said that
the overall cash flow for Enron would be exactly the same
whether Enron used prepaids or entered into a bank loan. My
question to you is: Is it, in fact, the same?
    Mr. Turner. No. Without a doubt, both the accounting rules,
GAAP, as well as the SEC regulations and SEC disclosure
regulations make it very clear that you have to separate out
the three different components of cash flows and report them
properly. Those you generate from normal, ongoing, legitimate
business operations, which is cash that you then might be using
in the second category, and that is financing to pay back
loans, so you have to show financing separate, distinct, those
funds that came in from a bank loan separate and distinct from
those that you generate from just selling normal products and
goods in the normal course of business.
    So they are not the same, and what is so interesting in
that testimony is while people say it is the same and it really
doesn't matter, people don't go to such great lengths and
engage auditors, attorneys, accountants, and do all this
paperwork and incur all these costs and time if it doesn't
matter. If it doesn't matter, you just follow the GAAP rules.
But in this case, that is not what happened. There was a reason
that they did this, and that was to hide and disguise it from
investors.
    Senator Levin. What difference does it make to investors?
    Mr. Turner. Investors need to know what the liquidity of
the business is going to be. Are you going to have the
resources to meet your different type of obligations? Is it an
account payable that you may need to pay off in the next 30
days? Or is this going to be a big debt payment going to come
due? It is like you, perhaps, Senator, going and asking a bank
for a loan and putting your credit card receivables, your
mortgage on your house, your loan on your car all on one line
and going into the bank and saying, Don't worry about it, it's
all one line liability, you don't need to know any more
information about it. I don't know of a bank that would make
you a loan on that basis.
    Senator Levin. This is the way they summarize their
argument in their testimony that is prepared: ``Price risk
management liability is a liability, plain and simple. It must
be satisfied every bit as much as debt. Thus, while not
recorded as debt, prepaid liabilities were clearly obligations
of the company and visible as such to investors.''
    Do you agree with that?
    Mr. Turner. I couldn't be in more disagreement with that
than you could get. It is absolutely false. It is wrong. It is
counter to the SEC rules. It is counter to GAAP. And, quite
frankly, again, if I was the CFO at Symbios and approaching
either of these banks' lending group with a set of financial
statements where you treated your liabilities all on one line
like that, I can guarantee you--in fact, I think one of the
banks might have even been in the consortium of banks that
loaned to me at Symbios--they would have never, ever accepted
those financial statements or given me a loan on that basis.
    Senator Levin. Ms. Stumpp, do you agree with that quoted
statement of their testimony?
    Ms. Stumpp. I don't agree with their quoted statement. In
fact, I agree with Mr. Turner.
    Mr. Diaz. I would add that from our point of view as a
rating agency, that is definitely misleading because we rely
very much on cash flow to debt as a key measure, on cash flow
coverage of interest, and what it's doing, it's inflating the
cash flow and reducing the debt. So from our point of view, it
has a major impact.
    Senator Levin. Mr. Barone, do you agree with that quoted
statement from Citigroup's testimony that price risk management
is a liability, plain and simple, that it must be satisfied
every bit as much as debt, thus, while not recorded as debt,
prepaid liabilities were clearly obligations of the company and
visible as such to investors? Do you agree with that?
    Mr. Barone. No, not necessarily, Senator. While they may
have appeared as liabilities on the balance sheet under price
risk management liabilities, our determination of the credit
protection ratios of Enron would have looked more towards true
obligations and not the short-term nature of what the price
risk management liability may have proved, because it is often
offset by assets from price risk management. And that is how
the company had always explained that their trading books were
generally in balance. So, no, it's definitely concealing an
obligation.
    Senator Levin. And that is highly relevant to you?
    Mr. Barone. Absolutely.
    Senator Levin. Because it is relevant to investors.
    Mr. Barone. I would say sure. I'm not an investor, but as
someone who evaluates a company's credit and bonds that are
ultimately bought by investors, it trickles downhill there.
    Senator Levin. Mr. Khakee, did you want to add anything to
that?
    Mr. Khakee. No. I echo my colleague's comments.
    Senator Levin. Thank you.
    Now, Chase and Citibank didn't just go along with Enron and
what Enron wanted to do with its prepays--these so-called
prepays, these phony prepays, these fake prepays. Both banks
went further. They tried to sell these Enron-style prepays to
other companies. Before doing that, should each bank have done
its own accounting analysis of the structure, consult with its
own accountants to determine that the suggested accounting
complies with generally accepted accounting principles? Could
the banks reasonably rely solely on the accounting judgment of
a client and say that our client's auditor said these
transactions could be accounted for this way so that is good
enough for us? Shouldn't they have done their own analysis, Mr.
Turner?
    Mr. Turner. Yes. I actually agree with you on that,
Senator, and I think that is where Judge Friendly was going in
the court case that I mentioned to you before.
    If you become aware of evidence, which clearly they were,
as it is cited and referred to in a number of these memos, that
there is something improper going on with the financial
statements, then you have got to--you can't just stick your
head in the sand like an ostrich. You have got to follow it
through and make sure that it is okay and it is done right. In
fact, at times when I was at the Commission, when we were aware
of the fact that professionals outside the company who operate
as gatekeepers to make sure the markets maintain their
integrity, when they became aware of things and did stick their
head in the sand and didn't follow through, then we did take
enforcement actions and did investigate the matters, which I
hope will happen here.
    Senator Levin. Two final questions from me. Ms. Stumpp, you
say in your prepared testimony--and perhaps I missed it in your
oral testimony--that Moody's did not have any knowledge prior
to Enron's bankruptcy of the existence of Enron's prepaid
forward and related swap transactions. Is that accurate?
    Ms. Stumpp. That's accurate.
    Senator Levin. Finally, my last question to Mr. Barone. You
have seen the staff analysis. If you look at Exhibit 104,\1\
this is an analysis of the impact on Enron's debt of these sham
prepays. I think it is in the book in front of you also. Do you
agree with that analysis?
---------------------------------------------------------------------------
    \1\ Exhibit No. 104 appears in the Appendix on page 355.
---------------------------------------------------------------------------
    Mr. Barone. Senator, I would agree that treated as a loan,
you would add additional items to the debt line. You would
reduce cash flow, as it states, and you would record a
particular amount of implied interest associated with the
additional debt. If you are going to add debt, you must add
interest. So in that regard, yes, I agree. The mathematics of
the calculation of the funds flow interest coverage I'm not
doing here, but it does not look all that out of bounds. It
looks pretty accurate.
    Senator Levin. And so their treating this as business
income rather than as a loan, has that significant effect on
its credit rating?
    Mr. Barone. As presented here, yes. Going from 4 times
interest coverage to 2.25 times interest coverage, all things
being the same, no change in business risk, no change in
strategy, and so forth, yes, that is significant.
    Senator Levin. And should this have been treated as a loan
in your judgment?
    Mr. Barone. Not having immediate firsthand knowledge of how
the transaction went down, but based upon the testimony I
listened to today, yes, sir, it should have been treated as an
obligation, as a loan.
    Senator Levin. And shown as debt?
    Mr. Barone. And shown as debt.
    Senator Levin. Thank you. Senator Collins.
    Senator Collins. Thank you, Mr. Chairman.
    Mr. Turner, I want to thank you for your usual
straightforward testimony. It is very helpful to us in sifting
through the conflicting messages and testimony that we are
getting.
    You testified that there is no question that the accounting
treatment misled investors. The banks essentially are
responding with two, in my view, contradictory arguments. On
the one hand, they are saying that there were no red flags, an
assertion that clearly is contradicted by all of the internal
documents that we have. But their second argument is, ``it is
not our responsibility to make sure that Enron is reporting the
debt correctly; it is not our job.''
    In your opinion, if a financial institution is involved in
helping to create and finance this type of transaction and
understands that they are going to be used by their client to
misrepresent the company's financial position, what obligation
does the financial institution have?
    Mr. Turner. Senator, in this particular case I think what
concerns me, certainly what had concerned me from my role as an
SEC chief accountant, was the fact that in some of these
transactions they were actually going out and raising money
from the public to fund these vehicles. And they had firsthand
knowledge of exactly what was going on, but there was not full
and fair disclosure to investors. So they, in essence, withdrew
from the investors their ability to make an informed decision
as they were buying these securities because they didn't see a
clear and transparent picture.
    At the Commission and in the markets, you have to rely upon
these gatekeepers to make sure all the material information is
provided to investors. When a professional gatekeeper knowingly
withholds that information, I think it raises not only the
question that Senator Levin raised in an earlier question about
whether or not they aided and abetted in what happened here,
which I certainly think they did, but I think if I was still at
the SEC, we'd certainly look at whether or not they had a
primary obligation under the securities laws since there
appears to have been willful knowledge here of a lack of
disclosure to investors that they were raising money from to
make that disclosure to them. And I would suppose that's
certainly one thing that the Commission will turn around and
take a look at.
    Senator Collins. Let me follow up on that very point. Have
you had the opportunity to review the prospectus that Citigroup
created for the Yosemite Trust?
    Mr. Turner. Yes, I have read--I haven't read every word,
but I've scanned through the Yosemite Trust offering.
    Senator Collins. And what are your preliminary conclusions
regarding the accuracy of the representations made of Enron's
financial picture in that prospectus?
    Mr. Turner. One, it refers back to some of the Enron
filings that clearly don't have this financial information
presented as a loan to it and is telling investors go look at
that, notwithstanding the fact that they clearly knew, as
evidenced by their own internal memos, that it had been kept
off those balance sheets as debt. And so I think there's a
legitimate question here based upon what I've been provided so
far to date, that raises the question about whether or not
there were disclosures that the investment bankers were aware
of and should have been aware of based upon their due diligence
that were missing.
    Senator Collins. It seems to me based on the review of the
documents in this case that in the specific instance of
structuring the prepays, that Andersen gave accurate guidance
in this instance to Enron on the criteria that must be
satisfied in order for this to be a legitimate prepay. Would
you agree with that?
    Mr. Turner. Yes, I think Andersen did give some good
guidance to the people involved with it, and it's guidance
certainly I would have used myself if I was still a partner out
there in evaluating whether these would be treated as prepaid
trading assets and liabilities or as debt financing. So I think
their conclusion, and conclusion as to how to apply it to these
transactions were correct.
    Senator Collins. But the criteria they set out clearly were
not followed.
    Mr. Turner. I would agree with that. In fact, Senator I
would turn around and tell you that some emails or
correspondence makes it appear like people almost attempted to
mislead Andersen, which is highly unfortunate. Again, one of
the fine things that the Senate dealt with in the Sarbanes
bill.
    Senator Collins. Mr. Turner, some people have told us and
continue to maintain--and this follows up on a question that
the Chairman asked you--that the technical manner in which
Enron accounted for its obligations under these transactions
was really irrelevant because the trading liability or debt
would be viewed similarly by the markets.
    Could you explain for us further why it does, in fact,
matter how Enron chose to report this cash, whether it reported
it as cash from its trading operations or as a loan?
    Mr. Turner. Yes. In particular on this balance sheet, this
balance sheet has a significant amount, billions of trading
assets, billions of trading liabilities, and I think a normal
reader of these financial settlements would understand that
companies' traders try to match those assets and liabilities to
where they come due at the same time and offset one another.
And as a result, you're not going to have to be generating a
bunch of additional cash flow to be paying down bank debt or
meet the interest and principal payments.
    But, in fact, that wasn't the case here. These really
weren't trading assets and liabilities that were going to be
offset. They were bank loans who had debt and principal
payments, interest payments that had to be met, and the company
wasn't generating sufficient cash flow to meet those, as we all
know now, because it ended up in bankruptcy.
    By being able to pump up the cash flows to make it look
like they were generating a lot of cash and then hide the bank
debt so it looked like they didn't have a lot of bank debt
payments coming due, it disguised the true nature of what the
real liquidity of this institution looked like. We can tell,
quite frankly, we all found out the day it filed for bankruptcy
that it really didn't have the cash, didn't have the liquidity.
The only thing it did have was a lot of bank debt that we found
out for the first time was off-balance sheet.
    Senator Collins. Ms. Stumpp, many analysts have described
Enron's finances as ``verging on the impenetrable,'' and, in
fact, one stock analyst described it as a ``black box.'' Did
your rating agency have difficulty in ascertaining the true
picture of Enron's finances?
    Ms. Stumpp. Well, in retrospect, knowing what we all know
now----
    Senator Collins. I don't want you to answer in retrospect.
I mean, when you were going through the process, did you find
it difficult to analyze and rate Enron because of the
complicated and unusual nature of many of its transactions?
    Mr. Diaz. Maybe I can answer that, because I was
responsible for Enron. We certainly looked at Enron as being a
very complex company, mainly because of its trading operations,
so we spent a lot of time trying to understand the risks around
the trading and, as Mr. Turner said, trying to understand the
matching of the assets and liabilities.
    I think we also spent a lot of time trying to understand
the nature of some of the financing that was taking place off-
balance sheet in terms of their investments in international
projects.
    But the fundamental problem was that we did not see what
they were really doing in terms of the prepaids, which is part
of the picture. We also were not able to see the existence of
some of the other off-balance sheet vehicles like LJM and
Braveheart and all those other vehicles that were kept out of
the limelight.
    So, what looked like a complex but understandable company
really was not. There was a lot of misleading--there was a lot
of deception in the way that they presented the financial
statements.
    Senator Collins. But you felt that you had adequate
information on which to base a rating decision?
    Mr. Diaz. At the time we did because--if we had felt that
we didn't--we would have either withdrawn--we probably would
have withdrawn the rating. So at the time, based on the
information we had, we did believe that we had adequate
information.
    Senator Collins. Mr. Barone, I am going to ask you the same
question.
    Mr. Barone. Yes, I echo my colleagues' remarks. While Enron
was certainly a little more complex than some of the other
energy credits that we evaluated--we spent a considerable
amount of time trying to delve in and do the analysis, and we
believed that we had--given the information that was provided
to us--that it was full and adequate and enough for us to do
the evaluation, certainly. What we've learned in retrospect,
obviously is that that was not necessarily the case.
    Senator Collins. Mr. Turner, I am going to put you on the
spot here. Did the rating agencies do a good job?
    Mr. Turner. You're right, you are putting me on the spot.
Let me say this, Senator: I remember back around the middle of
October, as this whole thing was imploding on itself, one of
the newspaper reporters calling me up and asking me if I would
review and read the Enron financial statements.
    I went through and read them in depth at that point in
time, and to be quite honest with you, they raised more
questions in my mind than they answered. They raised a lot of
questions because there were tantalizing little bits of
information, but certainly not enough to analyze the full set
of financials from. And the question is: Did people who were
analyzing them, not only the rating agencies but the stock
analysts as well, were they able to go back into Enron--because
certainly they get a mosaic of information we don't get out in
the public. Were they able to go in and get the answers to
those questions? Quite frankly, many of those questions, if
answered, would have told you that those financial statements
had been cooked. And so I think the real question was: Did they
go through, did they ask those questions, did they get the
answers to those questions? Because the financials themselves
clearly tee up a lot of serious questions that we now have the
answers to and we know they're cooked.
    Senator Collins. Thank you, Mr. Chairman.
    Senator Levin. Thank you very much, Senator Collins.
Senator Lieberman.
    Senator Lieberman. Thanks, Mr. Chairman. Thank you all for
your testimony.
    Mr. Turner, during your oral testimony today, I believe I
heard you say that the kinds of transactions that we are
focusing on today occur day in and day out on Wall Street and
in the economy. Could you expand on that a bit? What do you
mean?
    Mr. Turner. Wall Street designs and engineers transactions,
not on their own but with the help of the accounting firms as
well as the law profession, quite frankly, that are intended to
obfuscate or keep information from investors. Off-balance sheet
types of financings, financings that will make things look like
equity rather than debt on the balance sheet, not just the
issue of what type of liability, but whether it's debt or
equity. At the SEC, quite frankly, they're very tough to find
because they design them with the notion of keeping them out of
the filings, but we would find them from time to time and then
basically have to go through a battle, major battles, to try to
keep--or to try to get investors the information they needed
disclose.
    The Financial Accounting Standards Board, out from your
State, Senator, actually has a list of publications that is
probably about four inches thick now and about--there's
thousands of answers in that on these transactions, and I would
guess maybe 70 percent, maybe more of those answers are just
for these type of structured transactions coming out of Wall
Street, where they've structured the transaction, tried to get
around the FASB rules. We would find out about them at the SEC,
and then asked the FASB to try to deal with it. I think it's
probably the best indication of just how much time and effort
goes into not only structuring but then trying to fix the
problem and get clear disclosure for investors.
    Senator Lieberman. Seventy percent of what was the number
you gave?
    Mr. Turner. There is what's known as the Emerging Issues
Task Force of the Financial Accounting Standards Board. It's a
group of people who deal with emerging accounting issues as
they arise. Quite often they arise because the investment
bankers have designed these transactions. People have found out
about them, and so then we have to come up with an answer to
try to make them transparent to investors.
    Quite frankly, I would say that on a number of occasions
even the accounting firms themselves were appalled by the
accounting that the investment bankers were proposing or the
companies were proposing to use. And to their great credit, we
would have the accounting firms call us up, tell us about the
transaction, and then ask us to try to shut it down.
    I will tell you I do recall one situation where even the
investment banker was asking everyone to sign a non-disclosure
agreement as they shopped it around so that no one could come
and tell the SEC about it.
    Senator Lieberman. And in that case, to use language that
you used, the proposal had the intention to hide and disguise
the true condition of the transaction from investors?
    Mr. Turner. Without a doubt.
    Senator Lieberman. I want to go back just real briefly.
Seventy percent of what, in your first answer, were you talking
about?
    Mr. Turner. It's 70 percent of these emerging accounting
issues that this task force has dealt with.
    Senator Lieberman. Had to do with these so-called
structured transactions?
    Mr. Turner. Some of them are structured transactions. Some
of them are just pure off-balance sheet type transactions that
are--there's more than just structured transactions that Wall
Street has used to disguise the real true nature----
    Senator Lieberman. Again, with this 70 percent of the
emerging issues, OK.
    Mr. Turner. OK.
    Senator Lieberman. Where the intention was to hide and
disguise the true condition of the transaction--and, therefore,
the company--from investors? And you are not here just talking
about the kind of prepays that Enron was involved in with the
financial institutions we are talking about, but other
structured transactions?
    Mr. Turner. That's true. And on some of these, there's very
legitimate good business reasons for them to do what they want
to do because of tax reasons or to protect themselves in
bankruptcy court or whatever. But that doesn't prevent you from
turning around and really reflecting the true economic
substance on the balance sheet in the way it should be.
    Senator Lieberman. Which, by and large, they were not
doing.
    Mr. Turner. Correct.
    Senator Lieberman. Would you say that this widespread use
of these structured transactions to conceal the true nature of
the transactions in the company from investors is still going
on today?
    Mr. Turner. Yes.
    Senator Lieberman. Notwithstanding Enron, WorldCom, Tyco,
ImClone, etc., still going on?
    Mr. Turner. Yes. I would guess that--and it would be
speculation, but I would guess that, yes, that's still true.
We're still seeing these type of issues come up at the Emerging
Issues Task Force.
    Senator Lieberman. Let me go on to the credit rating
agencies and pick up on a note, that all of you were before the
full Committee earlier, as part of a series of hearings in
which we asked essentially why didn't the watchdogs bark so
that we had warning about what was happening at Enron in this
particular case. Credit rating agencies are institutions that
investors rely on because they presumably have more information
than most investors do to guide where money should go, and we
had very interesting testimony about the history of the
agencies and they played a very important role in the
development of our economy, etc.
    Ms. Stumpp, you said in your testimony, ``It is important
for me to note that Moody's did not have any knowledge prior to
Enron's bankruptcy of the existence of Enron's prepaid forward
and related swap transactions.'' And the folks from Standard &amp;
Poor's had a similar comment, although not in as crisp a
sentence as you did.
    So the question that I want to ask, both looking back and
looking forward, is: Why didn't the credit rating agencies
know? Let me put it another way. We just heard from Mr. Turner,
and we are going to hear later in the hearing from two of the
largest financial institutions in the world who are going to
testify that the kinds of structured transactions that they
entered into with Enron were and are common practice in the
world of finance.
    So if these sorts of prepays are so common, I have got to
ask you: Why didn't Moody's and Standard &amp; Poor's detect them
and their impact on Enron's true financial condition?
    Ms. Stumpp. Well, again, it's a two-part question, looking
back and looking forward.
    Senator Lieberman. Right.
    Ms. Stumpp. Looking back, we did ask questions of these
companies, but candidly, these transactions were disguised
loans, and it was very difficult, and it would be very
difficult from a simple examination of a company's financial
statements to detect them. The financial statements were
deliberately misleading, and it was intended to hide this type
of transaction from specifically parties such as the rating
agencies or investors.
    What I would say in terms of looking forward is that we are
asking more and tougher questions, specifically as it relates
to companies in the energy industry. For example, we are asking
them if they have engaged in these types of transactions. There
was a company that did disclose as a result of certain
prompting that it restated its financials as a result of
prepaid transactions. We reviewed that situation and took a
rating action and downgraded that rating in part because of the
effects of this.
    We're setting up specialist teams at Moody's. We are
basically setting up specialist teams to review accounting and
corporate governance. In fact, we're looking to factor that
very closely into our ratings. And we also sent a survey to
every single corporate issuer of rated debt, as well as in
other areas of Moody's, to ask them about matters such as
triggers and off-balance sheet obligations.
    Senator Lieberman. So looking back now, are you saying, by
describing a commendable and encouraging series of steps you
are taking now and on into the future, that Moody's was not
aggressive enough in pursuing Enron and trying to obtain
information about the true nature of these transactions?
    Ms. Stumpp. I think we were aggressive. I think we asked
direct and difficult questions of Enron, but there was----
    Senator Lieberman. They were not telling you the truth?
    Mr. Diaz. Yes.
    Ms. Stumpp. Correct.
    Mr. Diaz. Basically, they--for example, we asked them at
one point, to try to understand the scope of their off-balance
sheet obligations, to tell us everything they had--whether it
was on-balance sheet or off-balance sheet so that we could make
a judgment as to how we would treat it. So forgetting about the
accounting treatment, forgetting about the structuring of
transaction, what is the economic value transaction, and they
gave us what they termed to be the kitchen sink of everything
they had, but there was a lot of information there that was
just not given to us. So even when we were asking directly for
information, they were just withholding it.
    So in the case of these prepaids, Senator, I think you are
alluding to the fact that they are common as long as they are
real, legitimate transactions where a commodity is delivered.
But in this case, it was a clear effort at hiding what was
really debt from ourselves as well as other investors.
    Senator Lieberman. Mr. Barone, from Standard and Poor's
part, I presume the answer is somewhat the same. I believe
that, am I right, that you as well as Moody's did rate the
Citibank sponsored Yosemite Trust, is that right?
    Mr. Barone. Yes, that is correct.
    Senator Lieberman. So if you did, both of you rated the
Yosemite Trust, therefore, you had some firsthand knowledge of
these specific transactions, why did that not lead the credit
rating agencies to see what was going on and ring the bell to
alert everyone?
    Mr. Barone. There was limited information provided specific
to the portion of the trust that we were asked to rate. I am
going to defer to my colleague, Mr. Khakee, to explain exactly
why we saw page one, if you will, but never saw page two and
page three.
    Mr. Khakee. Yes. I should distinguish that from the
perspective of performing the analysis, in terms of placing a
rating on the notes that were issued by the Yosemite Trust the
focus of the analysis is to make sure that the rating on the
notes is consistent with the underlying company. That was, in
this case, Enron. And so the analysis really focuses on
reviewing the documentation to make sure that the rating is, in
effect, a pass-through of the Enron rating.
    So when you look at the eligible investments criteria, when
you look at any of the dependencies from a credit perspective,
our analysis showed that it was very consistent, that investors
who purchased a Yosemite note were, in fact, buying the default
risk of Enron. So that was completely consistent.
    Senator Lieberman. Yes.
    Mr. Khakee. What we were never presented with was all of
the other aspects of what Yosemite was tied to.
    Mr. Barone. The issue of the Delta entity and how the swap
moved and so forth was never presented to us when we were asked
to evaluate the Yosemite transaction. It was not, indeed, part
of the credit evaluation of Yosemite. The bankers did not
present that portion of the transaction to us.
    Senator Lieberman. My time is up, but that appears to me to
be very focused vision. In other words, you were right in the
middle in looking at Yosemite of the kinds of transactions that
infuriate us today, and you are much more expert at this than I
am, but it bothers me that it did not open the door for you to
see what was happening.
    Mr. Barone. I know you are out of time, Senator, but there
was nothing there to even elicit the second question as to what
is beyond all this. There was nothing that sort of hinted at--
oh, there is Delta and there is this swap with the prepay.
There was nothing revealed that prompted us to ask more
pointed, more direct, or specific questions regarding the
transactions. These credit linked notes are very common, as I
understand, in the structured finance group.
    Senator Lieberman. Mr. Diaz, a final question, a very brief
answer I am going to ask of you. You indicated that, and I
presume folks at Standard and Poor's would say the same, the
people at Enron did not tell you the truth, they were not
disclosing what they were doing. Who did not tell you the
truth?
    Mr. Diaz. The people that we dealt with in the financial
area, the CFO----
    Senator Lieberman. Whose name was?
    Mr. Diaz. Andy Fastow.
    Senator Lieberman. All right. Anyone else?
    Mr. Diaz. It would have been Ben Glisan, and Jeff McMahon
at times.
    Senator Lieberman. Thank you. Thanks, Mr. Chairman.
    Senator Levin. Familiar names, I am afraid. Senator
Fitzgerald.
            OPENING STATEMENT OF SENATOR FITZGERALD
    Senator Fitzgerald. Thank you very much, Mr. Chairman, and
all of you, thank you for being here.
    After hearing the testimony this morning, I really think
that the transactions we are describing today are along the
lines of the ones that we had hearings on earlier in the year,
at least in the Commerce Committee. Enron was borrowing money
and booking it as revenue from operations and going to
elaborate steps to keep the actual liability incurred by virtue
of the borrowing off their income statements.
    And whether it is all the off-the-books partnerships, which
they would cause to go out and borrow money and figure out a
way to have the borrowed money then paid to Enron itself, which
they would book as income or revenue. They would manage to keep
the indebtedness of the partnership off the books--they did
that with the Blockbuster Video transaction, where they created
Braveheart. They had Braveheart go borrow $115 million from the
Canadian Imperial Bank of Commerce.
    Then they sold the worthless asset to the partnership. The
partnership paid Enron with the borrowed money. Meanwhile,
there had been some form of credit support from Enron itself
over to Braveheart the partnership, but that was not disclosed
to investors.
    And at the end of the day, Enron, I think, incurred about
$20 billion worth of obligations that they managed not to
report as indebtedness on their balance sheet, and when they
filed for bankruptcy last December, it was because they had $4
billion in debt coming due that they had to pay and they did
not have the cash to pay it.
    These prepaid transactions, as you have eloquently
testified, were just another means of really borrowing money
and getting the proceeds of the borrowings in a way that they
could book it as cash from operations and keep the liability
off their books. So they were very creative in borrowing money
and booking it as income.
    I do want to follow up on a few things that have been said.
Mr. Turner, you said that you were very troubled by the sale of
the securities to the public, and I guess in the case of
Citibank, I have to say I was much chagrined to learn that
Citibank had lent $1.5 billion to Enron and then they had
managed to sell securities to the public to hedge their own
position, and I believe when Enron went bankrupt, then they did
not have to pay back the securities and they wound up, in
effect, not losing any money even though they lent Enron $1.5
billion.
    Morgan is in a different position because instead of
selling securities to the public to hedge their risk, they got
surety contracts and now the insurers will not pay them on that
and they are in court over that.
    But Mr. Turner, your citing your concern actually brings up
the whole issue of the Glass-Steagall Act, which had been in
place a long time. Congress undid it a couple of years ago, but
the reason Glass-Steagall was put into effect back in the early
part of the depression was because prior to the stock market
crash in the 1920's, there had been a pattern of commercial
banks/investment banks unloading bad loans off on the public by
selling securities.
    I would like you, Mr. Turner, to flush out your concerns
here. When we repealed Glass-Steagall and did away with all
remnants of the law between commercial banking and investment
banking, do you think we made a mistake?
    Mr. Turner. You guys ask tough questions. At the time that
Glass-Steagall was repealed and GLB was put in place, I do know
I had a concern as to whether or not you had legitimate and
real firewalls, and, in fact, I was not the only one. I recall
that Chairman Greenspan on more than one occasion was up here
testifying that, in fact, if you went that route, you had to
make sure that you had honest-to-goodness firewalls in between
and different subsidiaries set up for securities versus banks,
all under his supervision as overseen from a bank holding
company.
    To that extent, I do agree with Chairman Greenspan that if
you are going to break down the restrictions between the
securities firms and the banking firms, a point I do not
necessarily disagree with in light of the competitive banking
and the global international market, I do agree with Greenspan
that the securities firms, you have got to have functional
regulation and the securities firms and banking firms cannot be
working together, entering into transactions together and using
the securities arm to try to get banking business. I think
there does need to be some restrictions put on that and avoided
or we will have some problems.
    Senator Fitzgerald. Citibank sold these securities to
sophisticated investors and did not have to make any
disclosures except those required for sophisticated investors,
right?
    Mr. Turner. Right. I think one of the things that really
concern me about the Yosemite thing is you do not see
disclosures in there talking about the fact that Citibank is
trying to reduce its exposure to Enron, either because of its
own internal lending caps or perhaps because they really felt
that there was risk there. They are trying to reduce their
exposure at the same time they are trying to increase exposure
to outside investors through offering these notes, and I think
it would have been--investors would have wanted, and I think,
in fact, some--I was told some investors did drop out of later
deals because they could not get adequate disclosures and had
concerns about that.
    And I think investors will come back and say, why did
Citibank not tell us at the same time that they are placing, in
essence, Enron paper with us, because that is where the debt
payments and resources are going to have to come from to repay
it, why was Citibank getting out of their exposure to Enron
while they are turning around and selling these very same type
of liabilities off to investors?
    Senator Fitzgerald. We have talked a lot about how Enron
took their debt off the balance sheets and we have uncovered a
lot of ways in which they did it here, which they probably
violated technical accounting rules. You did not really have
three independent parties with this Delta-Yosemite transaction,
and so forth.
    But from the testimony of many of you, I guess you are very
concerned about how companies in America are taking debt off
their balance sheet and I am wondering, should we in Washington
try to close down loopholes in the law which were in the
accounting regulations which allow companies to do this?
    There are some well-established and legal ways of taking
debt off the balance sheet. A simple one is if you have a
building, do a sale-lease back and you get rid of your
mortgage. A lot of companies do that. However, you are not
really fooling anybody by doing that. Airlines take debt off
their balance sheet by selling aircraft and then leasing them
back. I suppose you guys are not fooled by that because you
look for things like that. But now, you really have to look for
a lot more sophisticated ways of taking debt off the balance
sheet.
    Would it be helpful if Congress tried to shut down some of
those means by which companies are able to take debt off the
balance sheet? That is to anybody on the panel who would want
to address that.
    Mr. Barone. Senator, I do not know if it is helpful to the
financial markets to necessarily do away with the use of off-
balance sheet financing. I think the issue is one of greater
disclosure and penalties for those that do not. The airplane
leasing, as you noted, often appears in footnotes and is an
integral part of a company's financial reporting.
    Senator Fitzgerald. Would you like to see tighter
requirements in SEC disclosure laws about the use of off-
balance sheet financing?
    Mr. Barone. Yes, sir. Senator, we actually have a position
paper on that that is included in my testimony.
    Senator Fitzgerald. Mr. Turner, what do you think about
that?
    Mr. Turner. Senator, I would turn around and tell you that
I believe, as a businessman, as a former businessman, that
those financial statements, not only for investors but for
management purposes, really need to reflect what is going on
with the business. If you are structuring off-balance sheet
financing because of tax purposes or others, so be it. I have
got no problem with that. But at least show them in the
financial statements for what they really are. Show them as
debt. To the extent that we have things that are really debt
that are off the balance sheet, it just does not ring true with
the average investor out there and it is what has caused us a
loss in the confidence.
    So I do believe Congress or the financial accounting
standard setters ought to turn around and do something that, in
essence, says we are going to put debt on your balance sheet if
you have to use your own resources or cash to pay it. Just
putting it in the footnote, quite frankly, is like just putting
stock options in the footnote, and that does not get the job
done, either.
    I think if we are going to tell the rest of the world we
have got the most transparent markets in the world, which we
do, clearly do have today, then we have got to uphold that
leadership and make these financial statements real and real to
the investors and put the debt on the balance sheet.
    Senator Fitzgerald. One final question, if I could. It has
been reported in the Wall Street Journal on February 11, 2002,
that Bob Rubin of Citibank called Peter Fisher, Undersecretary
of the Treasury for Domestic Financial Markets, to ask that ``a
Treasury official ask credit rating agencies to give Enron a
break.'' We know that Mr. Fisher, from other reports, declined
to do that. Did anybody from Citibank call any of your agencies
to lobby you to give Enron a break?
    Mr. Barone. No.
    Ms. Stumpp. No.
    Senator Fitzgerald. No? Did you have any banks call you to
lobby you to give Enron a break?
    Ms. Stumpp. [Nodding affirmatively.]
    Mr. Barone. No.
    Senator Fitzgerald. OK. That probably would be a warning
sign to you, if a bank called you directly and asked you to
give a break to somebody.
    Senator Levin. Senator Fitzgerald, did someone shake their
head no? I am sorry. You said no?
    Senator Fitzgerald. Were you all saying no?
    Senator Levin. Were the answers on the record as being no?
    Mr. Diaz. I have testified before, during the events of the
week of November 5, when the Dynegy deal was in progress, we
did have discussions with banks at the time, but we were not
lobbied--I mean, they were looking for us to give the deal a
chance to work out, and I have testified that we held off
action because we thought the probability of the Dynegy deal
going through was high and that the ultimate----
    Senator Fitzgerald. The Dynegy deal?
    Mr. Diaz. Dynegy, when Dynegy was trying to buy Enron. I
think that is what you are referring to, at that time, during
that time frame.
    Senator Fitzgerald. And you were having calls from banks
asking you to hold off on your downgrading of Enron's debt at
that time?
    Ms. Stumpp. We received a call from a bank requesting a
meeting following a time when we were going to downgrade
Enron's rating. We had that meeting. I would not characterize
the call as ``give Enron a break.'' It was, ``could we have a
discussion in recognition of the fact that this is an important
issue'' and that there was basically new and material
information that the banks wanted to convey to us.
    Senator Levin. Thank you. I am going to call on Senator
Cleland. I just want to note for the record that the Sarbanes
bill does contain a provision, I think, along the lines that
Senator Fitzgerald was referring to, which would significantly
tighten the rules for the display and disclosure of off-balance
sheet financing, so there is at least some movement in that
direction. I think that is a very important area that Senator
Fitzgerald got into, but I do believe that significant
provision is part of the Sarbanes bill.
    Senator Cleland, I think I am going to call on you.
Technically, you have not had an opportunity yet. Senator
Cleland.
              OPENING STATEMENT OF SENATOR CLELAND
    Senator Cleland. Thank you very much, Mr. Chairman.
    Mr. Turner, I would say that I am on three committees that
have been investigating Enron, the Commerce Committee, the
Governmental Affairs Committee, and this Permanent Subcommittee
on Investigations, and each hearing increases the ``Alice in
Wonderland'' quality of this incredible investigation. It gets
curiouser and curiouser.
    We started off basically by looking at Enron officers. I
indicated that in combat, officers eat last, but in this
combat, Enron officers ate first. Then we looked at the
accountants and found out the accountants were not accounting
and the auditors were not auditing.
    And now we find that the lending institutions, the great
financial services institutions, JPMorgan, Citigroup, Bankers
Trust, Barclays, Connecticut Resource Recovery Authority,
Credit Suisse, First Boston, Fleet Boston, Morgan Stanley,
Royal Bank of Canada, Royal Bank of Scotland, Toronto Dominion
were involved and $8 billion of loans that on any balance sheet
in America, kept by any little accountant in any little
hometown in Georgia would have been listed as a liability and
not an asset.
    What I would like to know from you is, how in the world can
some of the finest minds in finance in the world with these
great institutions participate in something like this? It seems
like it would be more difficult to sneak sunrise by a rooster
than to sneak $8 billion of liabilities and transform them into
assets with these great financial institutions looking on. What
happened?
    Mr. Turner. Oh, I think people are running down the yellow
brick road in Oz-land.
    Senator Cleland. Well, we are not in Kansas anymore.
    Mr. Turner. Yes, we are not in Kansas anymore. [Laughter.]
    When you would see these meetings occur between the
investment bankers and the attorneys and the accountants as
they designed these type of transactions, it became a
combination of a game, a herd mentality, if you will, a very
competitive, let us beat the other banker out and try to come
out with another vehicle that we can sell some and raise fees
off of. They really lost their compass and lost sight of the
fact that, really, what makes those investment banking firms
are the investing public and the markets, but instead became
much more focused on making fees.
    And as the industry changed from a commission-based,
profit-oriented organization 30, 40 years ago to one that is
driven by investment banking fees and that is where their
compensation is, I think that change in profits, that change in
compensation, that change in structure and what really made the
investment banking firms and Wall Street changed their behavior
to one of looking out for investors to one of let us make a
buck and let us see what we can go around the rules----
    Senator Cleland. Would you say that was infectious greed?
    Mr. Turner. It was infectious greed----
    Senator Cleland. Mr. Greenspan was suggesting----
    Mr. Turner [continuing]. Like a bad case of cancer.
    Senator Cleland. Ms. Stumpp, what happened?
    Ms. Stumpp. Well, I would say that in this regard,
financial institutions do engage in structured transactions and
in financial engineering as part of their history. In this
case, it is perhaps not, again, the structure, although we
recognize the outcome of the structure was to boost cash flow
and to not show appropriate debt or the actual level of debt
that was on the books, but it was the disclosure. It was the
treatment of this transaction. The disclosure and the treatment
were not clear so that people could not really see the true
picture of the financial health of Enron. So what I would say
is that perhaps it was financial engineering going a little too
far, but the disclosure element was particularly problematic.
    Senator Cleland. Mr. Barone, what happened?
    Mr. Barone. I think you hit it on the head, Senator, about
the greed issue. I mean, it is obviously a blatant attempt to
hide and disguise various transactions to make a company look
better. I believe we were defrauded. I believe we did a fine
job in our attempt to try to uncover various additional debt,
liabilities, and so forth, but you do not know what you do not
know, and that which was concealed made it extremely difficult
to paint a true picture of Enron's creditworthiness. I think it
may have started out with one intent, but it clearly was a
snowball rolling down the hill and it just kept building.
    Senator Cleland. I think it is the ultimate in fuzzy math
and it has cost the teachers' and employees' retirement pension
funds in my State almost $127 million in losses.
    Thank you, Mr. Chairman.
    Senator Levin. Thank you, Senator Cleland. Senator Carper.
    Senator Carper. Thanks, Mr. Chairman, and to our witnesses,
welcome and thank you for being here today.
    I would ask, Mr. Turner, I do not think anyone has asked
you any questions today, so maybe I will throw one your way.
How does the--I will call it the Sarbanes legislation that we
have been in conference on now--how does that legislation
reduce, if at all, the likelihood that other companies like
Enron will try to use prepaid forward transactions or a device
like that to deceive?
    Mr. Turner. I think there are actually some excellent
provisions in the Sarbanes bill. I do not think it is an end-
all for this problem and you should be careful about that, but
there is a very important provision in there that says that the
executives are going to have to sign off on the financial
statements, not just based upon whether they are GAAP, but
whether or not they fairly present the real true economic
picture of the balance sheet and the income statement of these
companies, and I think that provision is going to make the
executives think twice. They can no longer hide behind GAAP as
a result of that provision in that legislation. They are going
to have to turn around and make sure it presents a true
economic picture.
    In the list of prohibited services that has been,
unfortunately, severely opposed by some members of the House,
it has a prohibition on some services, the nature of which the
auditors would typically do in these type of situations, so it
will cut off the ability of the investment bankers to go get
the assistance from auditors in turning around and trying to
structure these things. As long as we can hang on to that list
of nine provisions, I think it will go a long ways and I really
hope we do not lose those things in conference.
    I think the additional legal provisions, including some
strengthening of what the SEC regulations are and who they can
go out and reach, give them reach that will allow them to go
after these type of situations and professionals who were not
at the company but nonetheless aided and abetted in this type
of false and misleading financial reporting.
    I think all of those components of the Sarbanes bill are
just very good, very excellent, very outstanding, are going to
ensure that we have some independent gatekeepers as well as
some people inside who can no longer just try to get around the
rules.
    Senator Carper. Let me ask our other witnesses, do you want
to comment on the same question? If not, I can ask another
question.
    Before coming to the Senate, I was privileged to be
Governor of Delaware for 8 years and well before that to be
Treasurer of the State for 6 years. I remember when Delaware
had the worst credit rating of all 50 States. We were tied for
dead last with Puerto Rico, and they were embarrassed. That is
how bad it was. We were closed out of credit markets, literally
could not sell bonds, notes. It was a bad time. You folks were
all over us, Moody's and Standard and Poor's, all over us in
the bad old days back in the 1970's and did not let us get away
with anything.
    When I see what Enron got away with, the question comes to
mind. I know others have probably asked this question, but how
did they get away with it without you folks knowing what was
going on?
    Mr. Barone. Well, Senator, I would assume that in Delaware,
you did not defraud the agencies by not presenting a full,
clear, and accurate picture of the financial well-being or lack
thereof of the State.
    No, I think they got away with it through deception,
through fraudulent disclosure, lack of disclosure, insufficient
disclosure, and not for a lack of asking by us. My colleague
pointed to the kitchen sink document that we all were privy to.
We asked what obligations do you have that were not on-balance
sheet. We always had a tug of war with Enron as to what off-
balance sheet obligations we should effectively put back on
their balance sheet. They clearly disclosed many things that
were not on-balance sheet and even came to some agreement with
us that, yes, certain things probably should be added back.
    What we did not know is that there was another book full of
things that should have been added back to the balance sheet
and considered obligations. That is how they got away with it.
    Senator Carper. Anyone from Moody's?
    Mr. Diaz. Yes. I think, fundamentally, I agree with Mr.
Barone. It is a lot of use of financial engineering, lack of
disclosure, lack of transparency, and basically never refusing
to answer a question when we probed, but giving us misleading
answers and withholding information. I spoke about the kitchen
sink, where we asked them to give us a list of all their
financial obligations, and they--clearly, a lot of the
partnerships were not included in that information. We are not
auditors, so we do not go and look at the books, but it is
basically a--I think they got away with it for a while, but
ultimately, that kind of situation is not sustainable, and that
is what happened.
    Senator Carper. What are you doing different today at
Standard and Poor's or at Moody's to ensure that companies like
Enron do not get away with this sort of thing in the future?
    Mr. Barone. I think we have a degree of healthy skepticism
when probing companies for information. I think history is a
great teacher. You learn a lot from looking back. For many of
the energy firms, we are asking about prepaid deals: If they
did them, to describe them and disclose them. We are also
asking about trading activity as well, not that we had not
asked similar questions before, but I think we just have a
greater skepticism. We are a little bit more critical. Our
skills are honed even further. I mean, time is a great
educator.
    Senator Carper. Thank you.
    Ms. Stumpp. I would say, for Moody's, I mentioned this a
few moments ago, but we are asking more and tougher questions.
With respect to the energy merchants themselves, we have asked
them about their engagement in prepaid forward transactions,
particularly as a result of the disclosure of Project Alpha in
connection with Dynegy. Some companies have told us that they
have, again, been approached to do these deals. Some of them
have told us they declined to do some of these deals. At this
point, few have indicated that they have done any of these
deals.
    We plan, as a result of the information that we understand
today and from what we have read in the papers, to follow up
and have written correspondence with these companies, asking
them to affirm to us that they are not engaged in these prepaid
forward transactions, or if they are, to disclose it to us and
the level of such activity.
    We are setting up at Moody's specialist teams in connection
with experts who can help us with accounting and corporate
governance matters. We have gone out to the entire corporate
finance rated universe and asked them information on off-
balance sheet obligations and on ratings triggers and we
produced a report last week on our survey of ratings triggers.
    Senator Carper. Thank you very much. I might add, Mr.
Chairman, just as a postscript, the State that used to have the
worst credit rating of any State in the Nation ended up, I
think about 2 or 3 years ago, thanks to companies here plus one
that is not, Delaware ended up with a AAA credit rating. So,
miracles do happen. Thank you.
    Senator Levin. Well, one of the reasons for its dramatic
improvement is one of our colleagues who is sitting right to my
right. Senator Carper was then Governor of the State, and he is
much too modest to take credit for it, but he deserves a great
deal of that credit for his State's improvement.
    Talking about credit ratings, let me ask you just one final
question. You have all indicated that the prepays here should
have been booked as loans. They were disguised loans. Instead
they were booked as cash coming in from business operations.
And my question is this. If they had been properly booked, how
would that have affected your ratings? First let me ask you,
Ms. Stumpp.
    Ms. Stumpp. Unequivocably it would have resulted in a lower
rating. And the magnitude today--it is quite dramatic, the
magnitude of the reduction in cash operations and the increase
in debt, and we would have had a lower rating on Enron.
    Senator Levin. Mr. Barone.
    Mr. Barone. The same here, Senator. We would have had a
lower rating on Enron for certain--significantly. How far? How
much? I couldn't necessarily pass that judgment right now, but
it could have easily been non-investment grade, two notches
below or three notches below where it was before its demise.
    Senator Levin. Senator Fitzgerald.
    Senator Fitzgerald. If I could just ask a final question. I
think we are probably going to break for lunch here.
    Senator Levin. No, we have decided that we are going to go
right through lunch, I am afraid. This is becoming a very
unhappy tradition of this Subcommittee.
    Senator Fitzgerald. So I don't get lunch?
    Senator Levin. Well, I don't want to go that far. In the
back room maybe we will give you a sandwich.
    Senator Fitzgerald. All right. Well, let me--if I could--
there has been a vast increase in the level and amount of
securitizations in this country in the last maybe 20 years. A
lot of financial institutions take their credit card
receivables, securitize them, and later--and then they book all
the revenue after they sell the receivables, they book that as
revenues.
    Presumably they are setting aside some kind of reserves in
case they have--they have to set aside reserves for the
purchaser, I think, in most cases, but sometimes there is not
really good disclosure of whether the securitizations are with
recourse to the issuer. And this comes up in Enron because it
appears that some of the monetization transactions that Enron
did, they led the ratings agencies to believe were non-recourse
to Enron and it turned out they were recourse.
    I am wondering if you from the rating agencies have any
general thoughts on the level and amount of securitizations out
there. A lot of companies have accelerated their earnings by
securitizing assets, and I wonder to what extent investors are
aware of lurking liabilities out there. Quite often I read that
some company had to take a charge-off because all of a sudden
somebody was going after them to make good on a portfolio of
securities that they securitized.
    Would any of you care to comment on that? Mr. Khakee, you
are a Director of Structured Finance Group at Standard &amp;
Poor's, would you care to comment on that?
    Mr. Khakee. Yes, I would, actually, Senator. I think there
is nothing fundamentally or inherently wrong with structured
finance. I think that it is important to try and understand the
differences between the types of transactions that you are
alluding to. In a typical asset-backed structured financing,
what is being securitized are receivables. The credit risk of
those receivables is based on the underlying payments or cash
flow streams that are coming in. You mentioned credit card
transactions. You could also look at mortgages that are being
securitized.
    I think it is clear that securitization has benefited the
vast number of consumers. It has brought down, most likely, the
overall cost of financing, and mortgage financing is a very
important part of the overall economy. So I think structured
finance, when used properly and when explained properly, is an
important tool.
    When you refer to credit-linked notes, which in this case
are the Yosemite transactions, that is not so much a
securitization per se. The investors are investing in a
different type of risk. It is directly linked to Enron, and it
is quite clearly stated as such. When one is investing in a
securitization, one is investing in a capital structure. The
rating, if you will, when we issue a rating, reflects the risk
that they are taking, given the place in the capital structure
that they are investing.
    So I think it is important to try and differentiate across
the various products inside of structured finance. But if you
want to aggregate and just make a comment on structured
finance, I think it is a very important part of the overall
ability of businesses----
    Senator Fitzgerald. Are you seeing more companies, though,
pushing the envelope on securitizing products and not fully
reporting the amount of recourse that is still available to the
issuer of the securities?
    Mr. Khakee. One of the fundamental parts of our criteria
when we review structured financings is non-recourse and non-
consolidation. To the extent that we are able to de-link the
rating on a structured finance from the origination company--
the bank that securitizes the credit card receivables or the
bank that securitizes the mortgages--non-consolidation and non-
recourse are a very fundamental part of that analysis.
    To the extent that we can receive the appropriate opinions
and comfort that is being achieved, that gives us the comfort
to issue ratings that de-link from the source of the original
receivables. To the extent that is not achieved, you have not
achieved certain elements of structured finance, which is to
de-link from the origination company.
    Senator Fitzgerald. So you are very careful to look at
whether all those elements have been met to justify calling it
a securitization transaction and that the company is justified
in taking the securitizations revenues into earnings when they
do? I mean, you carefully look at that?
    Mr. Khakee. Yes, those aspects of criteria are fundamental
parts of the analysis that any analyst would execute with
regard to reviewing a structured financing.
    Senator Fitzgerald. But in the case of Enron, they were
able to persuade the rating agencies that a lot of their
monetization contracts, I won't call them securitizations, were
non-recourse, were they not, when in fact they were recourse?
    Mr. Khakee. Well, I can't comment on the----
    Mr. Barone. I can handle that. No, in many cases, we would
put back certain obligations that, while legally may have been
non-recourse to Enron, there was an economic incentive, a moral
incentive, or some other incentive and reason to include non-
recourse debt in determining its credit rating. I would say
there are many cases where they just never told us these
obligations existed that had recourse, real or otherwise, to
Enron. And I think that should be distinct.
    Mr. Diaz. In our case, that was the reason we were trying
to get a hold of all the off-balance sheet debt, so we can take
a good look at what the underlying economic benefits were and
what the underlying recourse was. If we can make up our own
minds, even if it was legally--in some cases, we can have
project financings that are legally non-recourse and you can
actually have a structure that says that. But if we think that
the asset is an integral part of the company's strategy, we
would actually count that as part of the credit ratios.
    Mr. Turner. Senator Fitzgerald, if I could address that for
just a moment. At the Commission, I think we were concerned
about the point you raise, and I think it is a very--it is an
excellent, valid question. There have been trillions of dollars
done in securitization and the monetization of assets, and
there is no question that while originally we were monetizing
high-quality credit card portfolios, now we are down to
monetizing much more risky assets. And I think it is exposing
the markets to some additional risk, and I am very concerned
about that.
    And we were seeing not only monetization of assets, but we
were also seeing financial instruments going out with triggers
in them, that if troubles happened with the company, that if it
didn't pan out, all of a sudden that trigger would turn these
companies into a death spiral. In fact, you would often hear
that these financial instruments did have a death spiral.
    Senator Fitzgerald. We had such triggers in the case of
Enron.
    Mr. Turner. And those have not been adequately disclosed.
There is no question about it. And I think there does need to
be greater disclosure of that. We need to get greater
disclosure of any financial instruments or off-balance sheet
financings that might result in the risk of those coming back
to the issuer. In particular, if the issuer is going to have to
use cash or other resources that it might have to pay those,
then that risk needs to be disclosed. And today, it is not
being disclosed.
    Ms. Stumpp. Senator, if I could just add on to that. Last
week, Moody's released a report, Moody's Analysis of Ratings
Triggers. And what we found in looking at all ratings triggers
was that less than a quarter of the rating triggers--and this
is based on company-supplied information--are disclosed in
companies' SEC filings. So less than half--and less than,
actually, 25 percent, according to the data compiled on issuer
feedback to us--is disclosed in the SEC filings. Now, this is
based on all types of triggers, including some that are
relatively benign.
    Senator Fitzgerald. Are they supposed to disclose it, those
triggers? Or is it just some of them are voluntarily doing it
and they are under no obligation?
    Ms. Stumpp. Well, what we found in reviewing the data was
that the less-risky type triggers--those dealing with pricing
grids--were the ones that were typically disclosed, whereas the
ones that basically revolved around the riskier types of
triggers--puts, acceleration, default--were the ones that were
not always typically disclosed.
    So in answer to your question, we would certainly support
heightened disclosure, particularly as it relates to off-
balance sheet with recourse, and what are the types triggers or
factors that would cause the debt to come back on to the
balance sheet. This needs to be emphasized and the disclosure
needs to be improved.
    Mr. Turner. This is a point where I couldn't agree more
with Ms. Stumpp. And in fact, in the rule proposals that have
been put out by the Commission, this is a big hole that are in
those rule proposals, because this type of disclosure would not
be required even under the new rule proposals.
    So I think those need to be enhanced significantly for this
reason. And certainly my experience was just like Ms. Stumpp's
in finding that companies weren't disclosing them
notwithstanding the fact that there are some SEC rules that say
if you have something that could significantly impact the
liquidity of the company, unless you are certain it is never
going to happen, unless you are certain it is remote, even if
you don't know whether it is going to happen or not, you have
to disclose it. And we are just not seeing those type of
disclosures being made today.
    Mr. Barone. Senator, in a similar vein, as Ms. Stumpp
noted, we had also published a white paper on ratings triggers.
We even listed the companies we thought had serious exposure--
which did not necessarily produce a rating change, but meant
that should a rating change occur, the company's
creditworthiness could spiral out of control.
    And just going to your other line of questioning, I don't
know if you were here before, but I pointed out that--in my
testimony--we have a white paper that was titled ``Accounting
Abuses and Proposed Countermeasures,'' where we support many of
the items the SEC is proposing and information that is in the
Sarbanes Bill as well.
    Senator Fitzgerald. If the Chairman would indulge me, could
I ask about their opinion on the accounting matter you and I
discussed?
    Senator Levin. We can, but we are going to have to move on
to our third panel. So if you want to just briefly get their
opinion on that.
    Senator Fitzgerald. Real quick. I mean, one of my theories
here is that the reason we have seen such a rash of
overstatements of earnings in the last year or so is that
managers have a motivation, a powerful motivation, to at all
times keep their earnings per share high and their stock price
high. And that is the vast increase in--exponential increase in
the issuance of stock options in the last few years, which
aren't accounted for on the income statement. They are treated
like manna from heaven. In the case of Enron, the top 29
executives cashed in $1.1 billion worth of stock options in the
last 3 years before they put the company in bankruptcy. When
you have executives who can make tens or hundreds of millions
of dollars by keeping their stock price high by doing whatever
possible to report higher per share earnings, at a certain
point you have a powerful motivating force to bend the rules.
    What do the rating agencies think about my and Senator
Levin's proposal to encourage companies to account for stock
option compensation expense, instead of the current system
where they just ignore it except in a footnote.
    Mr. Barone. We would support greater disclosure of stock
options in the financial statement reporting.
    Mr. Diaz. I would support that. I would say that stock
option is a form of compensation, it should be taken into
account as such when you are looking at a company's net income
and earnings potential.
    Senator Levin. Mr. Turner--I am sorry. Ms Stumpp.
    Ms. Stumpp. Yes, I would agree. And it should be done on a
basis that is consistent so that companies can be evaluated on
the same accounting-standard basis.
    Senator Fitzgerald. Right now, a company that pays its
managers in cash has to report an expense. But if they pay the
managers in options, there is no expense there. So it has to
make it hard for you to get an apples-to-apples comparison. Is
that correct?
    Mr. Barone. That is correct, yes.
    Mr. Diaz. You have to make certain assumptions as to how
much those are worth. And yes, you could be off. So, yes.
    Senator Levin. Well, we are doing our best to end the
misuse of accounting relative to this stealth compensation. Mr.
Turner, do you have any comment on the stock option issue?
Should they be treated as compensation?
    Mr. Turner. Unquestionably they should be treated as
compensation. As the former Vice President, Chief Financial
Officer of a major high-tech company in this country, I can
tell you that I participated with many of the leading high-tech
companies in surveys in which we all characterized the options
as expense. I would be more than willing to share that with the
Subcommittee. We even had our standard methodology for
measuring those. These executives that say they can't measure
the value of an option, we all knew what the value was that we
were giving employees. And if a manager, if an executive can't
figure out what he is paying employees in the form of paper
versus cash, then quite frankly, probably he shouldn't be
sitting in that company as an executive.
    Senator Fitzgerald. What about a company that pays, like, a
law firm bill or some vendor's bill in stock options? High-tech
companies do that all the time. They will pay a law firm in
stock options.
    Mr. Turner. We would record that as expense. And I will
tell you, Senator, I recorded compensation expense for options
in my financial statements and it never caused me a problem. It
made it much more transparent.
    Senator Levin. The temptation is great to pursue that issue
because we put a lot of time in on it, and I hope we can still
obtain that reform, this Congress, but we are going to have to
move on. We thank this panel for your appearance here, and we
will now move to our third panel.
    Donald H. McCree, the Managing Director of Morgan Chase;
Robert Traband, the Vice President of Morgan Chase Bank in
Houston; and Jeffrey Dellapina, who is Managing Director of
Morgan Chase Bank in New York. And I would ask you to please
stand and raise your right hands.
    Do you swear that the testimony that you will give before
this Subcommittee will be the truth, the whole truth, and
nothing but the truth, so help you, God?
    Mr. McCree. I do.
    Mr. Traband. I do.
    Mr. Dellapina. I do.
    Senator Levin. Thank you for appearing here today. And we
will again use that same timing system, which we have
announced. And I believe that Mr. Traband is going to begin, is
that correct?
    Mr. Traband. I hand it off to my colleague.
    Senator Levin. Mr. Dellapina first?
    Mr. Dellapina. Yes, sir.
    Senator Levin. Fine. Please proceed.
TESTIMONY OF JEFFREY DELLAPINA,\1\ MANAGING DIRECTOR, JPMORGAN
   CHASE BANK, NEW YORK, NEW YORK, ACCOMPANIED BY DONALD H.
  McCREE, MANAGING DIRECTOR J.P. MORGAN SECURITIES, INC., NEW
YORK, NEW YORK; AND ROBERT W. TRABAND, VICE PRESIDENT, JPMORGAN
                   CHASE BANK, HOUSTON, TEXAS
    Mr. Dellapina. Mr. Chairman and Members of the
Subcommittee, my name is Jeffrey Dellapina. I am a Managing
Director in the Credit and Rates Group of JPMorgan Chase &amp; Co.
I am accompanied by my colleagues Don McCree, a Managing
Director, and Robert Traband, a Vice President. I was involved
in the Enron prepay transactions beginning in 1997. Mr. Traband
is based in Texas, and worked on the Enron account beginning in
1999. Mr. McCree currently serves as senior credit officer for
the JPMorgan Chase Bank. He was not involved in the
transactions that are being discussed today. He is here because
the Subcommittee requested a senior banker who could address
broad policy issues. I am presenting this oral statement on
behalf of the three of us.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Dellapina appears in the Appendix
on page 312.
---------------------------------------------------------------------------
    JPMorgan Chase &amp; Co. is a holding company. Through our
subsidiaries and affiliated companies we offer global financial
services, have operations in more than 50 countries, and serve
more than 30 million consumers and the world's most prominent
corporate, institutional, and government clients, including
over 90 percent of the Fortune 1000 companies. JPMorgan Chase &amp;
Co. and its subsidiaries and affiliated companies employ nearly
100,000 people throughout the United States and worldwide.
    Our institution has an established reputation for
integrity, and we welcome the opportunity to appear today at
the invitation of the Subcommittee. In accordance with the
Subcommittee's request, this statement will focus on and
provide background information with respect to the prepaid
natural gas and oil forward contracts involving JPMorgan Chase
and Enron.
    At the outset, we wish to emphasize two significant points.
First, prepaid forward contracts have been used for many years
and are widely recognized as an entirely proper tool to enable
businesses to increase their liquidity and diversify their
sources of funding. Second, we do not provide accounting
services to our clients. In the U.S. financial system, those
are responsibilities that are properly assigned to the client's
management, advised by its auditors, both internal and
external, guided by generally accepted accounting principles.
    Before we turn to the Enron prepaid forward transactions,
we would like to talk generally about corporate finance and
prepaid forward commodity contracts in order to place these
specific transactions in their proper context.
    Senior financial officers of major corporations are
continuously working to ensure that their companies' ongoing
access to capital will enable asset growth and business
prosperity. The management process includes taking actions to
maintain liquidity and diversify the corporation's source of
funds. In support of these objectives, lawyers, accountants,
commercial bankers, and investment bankers all work with
clients to structure financial transactions that have favorable
characteristics within the parameters of existing accounting,
tax, and legal requirements.
    Financing can be obtained in a multitude of ways,
including, for example, common equity, preferred stock, loans,
commercial paper, and other debt securities and, in the case of
financial trading firms, repurchase and forward agreements.
These are other forms of transactions that are designed to meet
particular financing needs, commonly referred to as
``structured finance'' transactions. The structured finance
market is very large, and is participated in by the world's
major financial firms. Examples of structured finance
transactions include collateralized debt obligations, such as
mortgage-backed securities and credit card securitizations,
debt-equity hybrid securities, leases of all varieties,
convertible bonds and convertible preferred stock.
    Prepaid forward commodity transactions are also a form of
structured finance. In forward commodity transactions, which
are common in many industries, the parties enter into a
contract for sales and deliveries of the commodity at future
dates. A prepaid forward provides for payment to be made at the
inception of that contract.
    The specifics of structured finance transactions may differ
significantly from client to client as we and other financial
firms participate in transactions to meet the specific needs of
each client. What these transactions have in common is
increased liquidity and the diversification of funding sources.
Diversification of funding sources is a matter of prudence.
Throughout recent history, there have been numerous events that
have had an adverse impact on the ability to access one or more
funding sources and on the cost of doing so. Diversifying
sources of financing mitigates a corporation's exposure to such
events and enables it to maintain and expand its core business.
    Let me now turn to the specifics of the Enron transactions
themselves. Let me first emphasize that the more than 20
transactions before you were not all identical.
    In 1992, Enron approached the Chase Manhattan Bank, one of
the four predecessor banks that have now all been merged into
JPMorgan Chase, with a request that it enter into a prepaid
forward transaction. At that time, there was some uncertainty
as to whether Chase, as a national bank, was authorized to
accept physical delivery of a commodity. Therefore, the 1992
transaction was accomplished by having a special purpose
entity, or SPE, take delivery of the commodity. SPEs are
companies that are established for a particular purpose. They
are widely used in structured finance transactions. As the
people working on the transaction were located in London, a
Jersey SPE was used.
    From 1993 through 2001, Enron entered into a total of 11
more prepaid transactions involving Chase. Ten of the
transactions were with Mahonia Limited and one was with Mahonia
Natural Gas Limited, both Jersey Channel Islands SPEs. All but
one of these transactions were physically settled transactions,
meaning that they were settled with deliveries of gas and oil.
The last transaction was financially settled, meaning no
commodity was delivered, although the cash payment was to be
determined by the price of natural gas.
    Prior to continuing with the chronology, we would like to
address Mahonia. Mahonia is beneficially owned by a charitable
trust. Neither Chase nor Enron has any ownership interest in
Mahonia. No employee or officer of Chase or Enron served as an
officer or director or held shares in Mahonia. The directors
and officers of Mahonia make the ultimate determination as to
whether or not to enter into a transaction. Those directors and
officers are neither appointed nor controlled by Chase or
Enron. The use of entities like Mahonia is standard activity in
structured finance.
    In the Enron prepaid forwards. the SPE entered into a
prepaid forward contract with an Enron subsidiary using funds
provided by Chase. The prepaid forward transaction created not
only credit risks for Chase, but performance, delivery, and
commodity price risks as well. As mitigants for these
transactions--as mitigants for these risks, the transactions
included an Enron Corp. guarantee, a performance letter of
credit or a surety bond, and either exchange-traded futures
contracts or over-the-counter derivative contracts with Enron
Corp. Although the last prepaid transaction was financially
settled, similar risks and mitigants were present in that
transaction, the sole difference being that no physical
delivery was required. Originally, the commodity purchased from
Enron was sold into the broader market. After Chase was capable
of taking physical delivery of gas or oil, Chase purchased the
commodity from Mahonia and in turn sold physical gas or oil
into the market. Beginning in the late 1990's, Chase entered
into contracts to sell its gas or oil positions to Enron, which
was by far the largest market participant.
    All of the prepaid transactions in which the Subcommittee
has an interest were undertaken at the initiative of Enron.
Chase understood that the transactions originally had tax
benefits for Enron. Later, Chase learned, Enron no longer
received tax benefits from the transactions but chose to
continue to engage in prepaid forward transactions for other
corporate purposes. Enron management informed Chase that the
prepaid forwards served to monetize the unrealized profit in
its trading book. Enron also advised Chase that the rating
agencies wished to see more cash generated from its growing
trading activities.
    There have been allegations in the media that the prepaid
forward transactions were disguised debt or a disguised loan.
The prepaid forwards were undoubtedly financing, as all
contracts are that involve prepayment features, but every
financing is not a loan. These transactions had different
features, benefits, and risks than loans.
    These prepaid transactions were accounted for on the books
of JPMorgan Chase consistent with GAAP. It is our understanding
that Enron reported these transactions as liabilities on its
balance sheet in accordance with GAAP; in other words, they
were not off-balance sheet transactions. As I stated earlier,
however, the manner in which Enron accounted for these
transactions on its books and in its financial statements was a
matter for Enron and its management and auditors.
    As the Subcommittee is aware, JPMorgan Chase was one of
several financial firms that provided financial services to
Enron. We have been one of the parties substantially harmed by
its failure, incurring hundreds of millions of dollars in
losses. JPMorgan Chase welcomes this opportunity to answer the
Subcommittee's questions today and will continue to cooperate
with the Subcommittee's inquiry. This concludes our oral
presentation, and we would be pleased to respond to your
questions.
    Senator Levin. Thank you, Mr. Dellapina. Mr. Traband.
    Mr. Traband. He was representing all three of us.
    Senator Levin. It is very clear that Enron saw prepays as a
way to get cash without reporting it as debt. If you will look
in your books at Exhibit 111,\1\ exhibit books in front of you,
there is a page from an Enron document on prepays. ``Why does
Enron enter into prepays?'' ``Off-balance sheet''--the first
bullet. ``Off-balance sheet financing.'' That is, it generates
cash without increasing debt load.
---------------------------------------------------------------------------
    \1\ Exhibit No. 111 appears in the Appendix on page 365.
---------------------------------------------------------------------------
    Now let us see how Chase saw the prepays. Take a look, if
you would, at Exhibit 139.\2\ This is one of Chase's
structuring summaries, the documents which are used to gain
credit approval for a financial transaction. It echoes that
same thing.
---------------------------------------------------------------------------
    \2\ Exhibit No. 139 appears in the Appendix on page 482.
---------------------------------------------------------------------------
    In the past 3 years--if you look at--near the bottom of the
front page there--in the past 3 years Enron has utilized the
prepaid sale as a mechanism to address a number of needs,
including refreshment of Section 29 credits and sourcing funds
classified as liabilities from price risk management as opposed
to long-term debt.
    So Chase is clearly aware that that is one of Enron's
motives, to classify that income as price risk management
rather than long-term debt.
    Now, I also want to refer you now to Exhibit 123.\2\ This
is an email from George Serice--I believe that is how he
pronounces his name--who is an investment banker with Chase.
And the third paragraph reads as follows:
---------------------------------------------------------------------------
    \2\ Exhibit No. 123 appears in the Appendix on page 414.
---------------------------------------------------------------------------
    ``Enron loves these deals, as they are able to hide funded
debt from their equity analysts, because they, at the very
least, book at as deferred revenue or, better yet, bury it in
their trading liabilities.''
    That is what Chase knew.
    Now, does this email not provide some pretty compelling
evidence as to what Chase knew? ``Enron loves these deals''?
This is 1998, November. ``Enron loves these deals, as they are
able to hide funded debt from their equity analysts . . .''
better yet--even better than deferred revenue--they ``bury it
in their trading liabilities.''
    Do you have any comment on that email?
    Mr. Traband. Yes. This email predates my involvement with
Enron, but I can tell you my own understanding of the purpose
of the prepays and how I viewed them.
    Senator Levin. I am not asking you that question. You could
have testified to that. My question is do you have any comment
on that email? This is a Chase person here, now, acknowledging
what Enron is doing--acknowledging. They love these deals. It
allows them to hide funded debt. They can bury this in their
trading liabilities--which is exactly what happened, and Chase
knew it in 1998. Do you have any comment on this email, Mr.
McCree?
    Mr. Cree. I think I would view that as a casual commentary
by an employee that, frankly, was not informed as to the
completeness of the entirety of the transactions.
    Senator Levin. Would you agree it is a devastating
commentary?
    Mr. McCree. Well, I don't know, devastating. I don't think
he was fully informed as to Enron's intention or the full
structure of the Mahonia as they were put together.
    Senator Levin. Are you embarrassed by that?
    Mr. McCree. I am confused by it.
    Senator Levin. You are not embarrassed by this?
    Mr. McCree. I think it is an unfortunate statement. I don't
think it bears resemblance to how we as an institution view the
transactions that were undertaken here.
    Senator Levin. OK, Mr. Dellapina. You are in this email.
    Mr. Dellapina. I don't----
    Senator Levin. Do you have any comment on that?
    Mr. Dellapina. Yes, I don't recall receiving it or
responding to it. But I certainly have had a chance to look at
it recently, and I believe that it is inaccurate. I believe
that prepaid forwards are fundamentally different than funded
debt.
    Senator Levin. When you say it is inaccurate, are you
saying that Enron did not love those deals?
    Mr. Dellapina. I am unfamiliar with why that comment was
raised.
    Senator Levin. But you are not saying that is inaccurate?
    Mr. Dellapina. I am saying the reference to funded debt,
which is throughout this document, I believe to be inaccurate.
    Senator Levin. But I want to get back to this question.
Here you got a Chase email that you received, or at least you
are referred to in the email, that says Jeff Dellapina and Bob
Mertensotto worked on a deal this summer where they took out a
couple of older prepaid PLCs with these surety bonds. Jeff is
also working on another prepay for Enron now.
    That is you. It is the only ``Jeff'' in here.
    And then it says something, and I want to ask you whether
or not you deny its accuracy. ``Enron loves these deals, as
they are able to hide funded debt from their equity
analysts''--do you deny that, first of all, that Enron loved
those deals for that reason?
    Mr. Dellapina. Mr. Chairman, I have no reason to believe
why they would love them or why they would not love them, and
its impact on equity analysts.
    Senator Levin. All right. Do you deny that Enron loved
these deals not just because they could hide it, but because
they could bury it in their trading liabilities? You are not
able to deny that either, are you?
    Mr. Dellapina. I know that the transactions, or at least it
was represented to the bank that the transactions were
reflected in their trading liabilities. The references to
``bury''----
    Senator Levin. The word here in the Chase memo is ``bury.''
Does that embarrass you?
    Mr. Dellapina. It confuses me as well. I believe it to be
inaccurate.
    Senator Levin. Now, here is Chase's--well, let me just say
this. If I were Chase, I would be embarrassed. I would be
ashamed of that email. Let me just get that on the record. But
I am not sure what will embarrass or shame you, so let me go on
to Exhibit 128.\1\
---------------------------------------------------------------------------
    \1\ Exhibit No. 128 appears in the Appendix on page 419.
---------------------------------------------------------------------------
    Here is your prepay pitch. Now, you are making a pitch for
prepays. And the introduction says the following about prepays.
And this is--I think it is page 3 of this Exhibit, where it
says ``Introduction.'' Let me just--so that I connect both Mr.
Traband and Mr. Dellapina to this particular document. There is
an email, which is the front page of Exhibit 128, which shows a
copy of this going to Mr. Dellapina, and it is to Mr. Traband,
and it says, this is P&amp;C. What does that mean?
    Mr. Dellapina. I believe P&amp;C means private and
confidential.
    Senator Levin. And not for distribution? So only use this
for your own education. OK?
    Now, on, I think it is page 3, but in any event, it is the
page which is headed by ``Introduction.'' It says: ``Prepayment
received for a forward sale of inventory: Fixed quantity;
specific delivery location(s).'' It is an ``Alternative source
of finance,'' and its ``Balance sheet `friendly'.''
    And then on page 5, it says the following: ``Attractive
accounting impact by converting funded debt to `deferred
revenue,' or long-term trade payable.''
    Isn't the ``balance-sheet friendly'' aspect of prepays a
selling point which Chase stressed when it pitched this product
to other companies? Is that an accurate statement?
    Mr. Traband. In the course of our dialog with our clients
we certainly discuss the merits of transactions, and among
those are accounting or tax issues. At the end of the day, we
are not--we do not advise them on those issues and they go back
and talk to their own accountants and attorneys.
    Senator Levin. Part of your pitch, is it accurate to say,
is that these prepays have an attractive accounting impact by
converting funded debt to deferred revenue or long-term trade
payable? Isn't that what you represent to people who are
hearing that pitch?
    Mr. Traband. That is certainly in the pitch. And there are
different forms of liabilities that appear differently on the
balance sheet. Ultimately all are liabilities. And for
different types of financing transactions, one may more
accurately reflect the transaction.
    Senator Levin. At least this is part of your pitch that you
made?
    Mr. Traband. That is part of the pitch.
    Senator Levin. So on the next page of the pitch book is the
phrase ``attendant tax benefits.'' Now, is it not the case that
the funds that Enron received from these prepays could be
considered by them as a loan for tax purposes?
    Mr. Traband. I can't speak to the tax treatment of these
transactions.
    Senator Levin. What are the attendant tax benefits? Can
that not be treated as a loan? Is that not one of them?
    Mr. Traband. I don't know what the attendant tax benefits
are.
    Senator Levin. Well, who was making the pitch?
    Mr. Dellapina. I may have----
    Senator Levin. Dellapina made the pitch. So what did----
    Mr. Dellapina. I may have contributed to the pitch as well.
I am not a tax professional and do not understand tax. What I
believe it refers to, and again, this is not an expert opinion,
but that the use of a prepaid forward could be used either as
current income or possibly treated as taxable income on a
deferred basis. That is current taxable income. That is about
the extent of the tax knowledge that I have.
    Senator Levin. Is the interest paid deductible, do you
know?
    Mr. Dellapina. There is no interest paid on a prepaid
forward.
    Senator Levin. Are the fees or the payments deductible?
    Mr. Dellapina. I am not familiar with the accounting.
    Senator Levin. Are any of you familiar with the tax
benefits which you pitched to companies?
    Mr. McCree. No, I think what we would likely say in a
situation like that is the tax attributions of any deal,
structured finance, prepaid, will be dependent upon the tax
characteristics of the individual company. And that would be a
matter between their tax advisors and themselves. But in our
experience, prepaids had certain tax attributes which were
attractive to a variety of our clients.
    Senator Levin. Would you agree, Mr. McCree that one of the
tax attributes--one of the attributes--was the attractive
accounting impact by converting funded debt to long-term trade
payable? Would you agree that is something which is attractive,
that you made a pitch to----
    Mr. McCree. I don't know about----
    Senator Levin [continuing]. Potential clients?
    Mr. McCree. I think the ability for, certainly in Enron's
case, the company to treat this as a trading liability, which
is how they treated it based on advice from Andersen, was an
attractive feature to the prepaids.
    Senator Levin. And you pitched you could convert funded
debt to deferred revenue or long-term trade payable?
    Mr. McCree. I don't know the answer to that. I don't know
if that was----
    Senator Levin. You don't know if your company made----
    Mr. McCree. That is what it says.
    Senator Levin. Well, this is your company.
    Mr. McCree. Yes, it is.
    Senator Levin. Are you familiar with that document?
    Mr. McCree. I have never seen it.
    Senator Levin. Are you familiar with that document, Mr.
Traband?
    Mr. Traband. I recall distantly that document.
    Senator Levin. Mr. Dellapina.
    Mr. Dellapina. I am familiar with, yes, components of the
document.
    Senator Levin. All right. So that is one of the attractive
attributes of this particular approach, is that not correct?
And you made that pitch to companies, right?
    Mr. Dellapina. Yes, I don't recall the specific details of
the pitch. One of the parties that would do a transaction like
a prepaid forward would be a producer of a commodity, and it--
it would probably be a pretty accurate way of portraying a
forward sale, and the actual forward sale of the commodity as a
deferred revenue item. And actually raising finance in that
manner.
    Senator Levin. What companies did Chase sell this product
to? Can you give us the list?
    Mr. McCree. Mr. Chairman, if possible, and as a general
matter, we at JPMorgan, both from an individual standpoint and
a corporate standpoint, guard the confidentiality of our
clients closely and believe in keeping their information
private. So if it would be possible not to go into specific
company names, that would be important to us as a policy
matter. If you insist we do it, we are happy to do it.
    Senator Levin. Is it accurate to say that one, two, three,
four, five, six, at least seven companies bought that pitch?
    Mr. McCree. I don't know--do you know?
    Mr. Dellapina. I do not know whether all seven of those
companies were actually pitched.
    Senator Levin. Can you give us the number of companies
which bought this approach from Chase?
    Mr. Dellapina. Well, I can tell you there were seven
companies that entered into transactions, as we supplied to the
Subcommittee, with Mahonia. I cannot confirm that they were
pitched. The prepaid forward transactions were fairly well
known in the market, and I can't confirm that I pitched this to
all seven of those.
    Senator Levin. Can you tell us how many you did pitch it
to?
    Mr. Dellapina. I cannot tell you what number of companies I
pitched it to.
    Senator Levin. Now, Mr. Turner on the previous panel said
there are a number of criteria that prepaid transactions must
meet before they can be considered real trades and accounted
for as such. They have to be independent trades among
independent parties, there must be price risk, among other
criteria.
    Mr. Dellapina, were the trades that made up the Chase
prepaid transactions with Enron independent trades between
independent parties?
    Mr. Dellapina. Yes, I believe they were.
    Senator Levin. Let us look at Mahonia now, just to see how
independent Mahonia was. If you look at Exhibit 118.\1\ First,
this is from a firm, a law firm in the Channel Islands, are
these offshore folks that you work with? Mourant? It says,
``our clients, Chase Bank &amp; Trust Company Limited.'' So, now,
Chase is the client of Mourant, this offshore Channel Island
firm--so it represents Chase. And here is the letter that goes
to the Registrar of New Corporations and Trusts in Jersey. And
the letter says the following:
---------------------------------------------------------------------------
    \1\ Exhibit No. 118 appears in the Appendix on page 394.
---------------------------------------------------------------------------
    ``Our clients, Chase Bank &amp; Trust Company Limited . . . are
considering promoting from time to time specific purpose
vehicles for use in particular banking transactions. The
possible areas in which the SPV's could be used are numerous,
but at this stage it can be foreseen that the likely use for
them would be:''--and then the letter lists one of the reasons
as ``where a company wishes to raise finances not by way of
borrowing but by way of a related transaction.'' That is number
one.
    Now, the letter goes on to say, if you look at the top of
page 2: ``For obvious reasons, it is important that the SPV''--
the special purpose vehicles--``are controlled by Chase.''
    ``. . . It is important that the SPV's are controlled by
Chase.'' And I want you to remember those words.
    But for accounting and other requirements it is not
desirable that they are wholly owned by Chase. Accordingly,
Chase is considering establishing a charitable trust which
would own all the shares of a holding company, which in turn
would wholly own the various SPVs.
    Are you familiar with that letter?
    Mr. Dellapina. I have never seen that letter from 1986,
so----
    Senator Levin. Do you have any reason to doubt its
authenticity? You, Mr. McCree, are you familiar with this
letter?
    Mr. McCree. No, never seen it.
    Senator Levin. Your lawyers haven't gone over this with
you, this letter?
    Mr. McCree. No.
    Senator Levin. This is the first time you are seeing it,
all of you?
    Mr. McCree. Yes.
    Mr. Traband. Yes.
    Mr. Dellapina. The first time.
    Senator Levin. OK. So here goes. Your lawyer says it is
important SPVs are controlled by Chase, but for accounting and
other requirements it is not desirable that they be wholly
owned by Chase: ``Accordingly, Chase is considering
establishing a charitable trust''--Chase is considering
establishing a charitable trust--``which would own all the
shares of a holding company which in turn would wholly own the
various SPVs.''
    And there is a second letter in this packet here, April 29,
from the Jersey office, telling the incorporating law firm that
such an entity would not be a problem.
    Next document, then, is May 13. It shows that--excuse me,
the next document is May 12, received on May 13, showing that
East Moss Limited has in fact been formed.
    Then if you will skip to the letter after next, which is
the one that Chase's attorney, James Mourant, wrote to the
Jersey agency on May 29, 1986, to explain a financial
transaction that involved Chase and East Moss Limited. And this
is what he wrote--if you will look at the middle of page 2:
    ``In order that the U.S. authorities could be entirely
satisfied with the arrangements it was considered preferable
that my firm's trust company act as trustee of the charitable
trust and administer East Moss rather than Chase Jersey.''
    So now we have Chase's agent, a trust company of Chase's
agent, Mourant, acting as trustee of the trust. OK?
    Now, the next document is Mahonia's registration form to
the Jersey Commercial Relations Department. And we can see
there that when Mahonia was formed in 1992, Chase's agent,
Mourant, was listed as the owner. Do you see that, down--number
7, beneficial owner? It is your agent, Mourant.
    So, any doubt in your mind that Chase controlled Mahonia?
    Mr. McCree. Well, I would say that Chase did not control
Mahonia and Chase did not own Mahonia. It was set up as a
separate special purpose----
    Senator Levin. Who did own Mahonia?
    Mr. McCree. A charitable trust.
    Senator Levin. And who owned the charitable--who
established the charitable trust?
    Mr. McCree. I don't know the answer to that.
    Senator Levin. Well, it is in this letter. Chase
established the charitable trust.
    Mr. McCree. I am just looking at this letter--the 1986
letters referred to a bid by Dixon's for Woolworth's. It looks
to me like a completely unrelated transaction. I have never
seen the letters before, so I don't know the specifics as to
the transactions that are referenced to in the 1986 letters and
the linkages between Mahonia. I just don't know the answer to
that, Senator.
    Senator Levin. Well, take a look again at that May 19,
1986, letter.
    ``Further to our application to incorporate an investment
holding company to be called East Moss Limited, I am writing to
give you further details.''
    This is your agent writing the registrar, now, in Jersey.
And right in the middle:
    ``I should begin by mentioning that although this
particular transaction is part of a Chase scheme''--that is
your agent's words--``for various reasons, one of my firm's
trust companies will in fact be acting as trustee of the
charitable trust.''
    Your agent's trust company--are you with me so far--is
going to be the trustee and administering East Moss Limited.
Any problems so far?
    Mr. Dellapina. Mr. Chairman, may I just make a comment?
    Senator Levin. Sure.
    Mr. Dellapina. None of us have seen this email before--this
letter before. And the suggestion that Ian James was our agent
or our attorney, I do not understand that. For the period of
time----
    Senator Levin. The suggestion by whom?
    Mr. Dellapina. That he was our attorney.
    Senator Levin. Whose suggestion?
    Mr. Dellapina. I think the suggestion--at this hearing.
    Senator Levin. No, the suggestion by your attorney. ``Our
clients''--do you see that? Exhibit 118?\1\ Our clients, Chase?
It is not the suggestion here; it is your lawyer's statement
that he represents you. Now, who pays his fees? Who pays
Mourant's fees?
---------------------------------------------------------------------------
    \1\ Exhibit 118 appears in the Appendix on page 394.
---------------------------------------------------------------------------
    Mr. Dellapina. On the transactions that I have been
involved with, we have--the Chase Manhattan Bank has paid the
fees for Mourant.
    Senator Levin. There you go. Mourant writes the letter,
says he is your lawyer. You are paying his fees. Mourant's
trustee is running the charitable trust that owns the holding
company that owns Mahonia. You can put as many layers on this
as you want, but it comes right back to it. Your agent has a
trust which is the trustee of a charitable trust which owns a
holding company which owns Mahonia.
    Folks, is there any doubt about what I am saying, in your
mind? This may be the first time that you are seeing it, but
you are seeing it. It is right in front of you. Do you have any
reason to doubt that?
    Mr. McCree. I just--my understanding is that we do not own
Mahonia, we do not control Mahonia.
    Senator Levin. Who gave you the understanding you don't
control Mahonia? Who told you that?
    Mr. McCree. It might have been Jeff.
    Senator Levin. Jeff, who told you you don't own Mahonia?
    Mr. Dellapina. When I started doing the transactions, I
understood this to be an independent SPE, from our attorneys. I
don't recall specifically who would have conveyed that
information. We have always known Ian James to be the attorney
for Mahonia. And yes, Ian James with Mourant's fees have been
paid by the Chase Manhattan Bank. We don't view this as
entirely uncommon. It is not uncommon, for example, in a
closing of a home mortgage that a client would pay a bank's
attorney's fees. But we have always known--I have always known
Ian James to be the attorney for Mahonia.
    Senator Levin. You pay their fees.
    Mr. Dellapina. We do pay their fees.
    Senator Levin. And this is the first you ever heard that
you folks established Mahonia? This is the first you have ever
heard of that?
    Mr. Dellapina. Mr. Chairman, when Enron approached JPMorgan
Chase to do a prepaid forward transaction, as we described in
the statement, Chase--we were not sure as to whether Chase
could take physical commodities at that point. Chase did at the
time approach Mourant and ask if there was an SPE that would be
interested in entering into the transaction. That is to the
best of my information. I was not in the group at the time.
    Senator Levin. Who pays all the costs associated with the
administration of Mahonia.
    Mr. Dellapina. Those costs are paid by Chase.
    Senator Levin. Not just the legal fee?
    Mr. Dellapina. Not just the legal fees.
    Senator Levin. And who pays Mahonia's annual Jersey
statutory charge?
    Mr. Dellapina. I am not sure of the answer.
    Senator Levin. Do either of you know? Well, let me tell
you: Chase does. You pay the annual charge, you pay the legal
fees, you pay the administrative costs, you established
Mahonia. Your lawyer is the agent for it. And you are telling
me you don't have any control over Mahonia? You are under oath.
You are telling me Chase has no control over Mahonia?
    Mr. McCree. I don't believe we control the individual
decisions of Mahonia.
    Senator Levin. Do you have any control over Mahonia at all,
Mr. McCree?
    Mr. McCree. Not to my knowledge.
    Senator Levin. Mr. Traband.
    Mr. Traband. Not to my knowledge.
    Senator Levin. Mr. Dellapina.
    Mr. Dellapina. To the best of my knowledge, Mahonia and its
attorneys----
    Senator Levin. Despite all that.
    Mr. Dellapina. I do not believe we control Mahonia.
    Senator Levin. You have no control over it. Does your agent
control it, Mr. McCree?
    Mr. McCree. I don't believe so.
    Senator Levin. Is Mourant----
    Mr. McCree. I don't know who the board of directors of
Mahonia is, but I believe the board of directors of Mahonia
controls the decisions of that company.
    Senator Levin. Do you know who is on that board?
    Mr. McCree. I do not off the top of my head.
    Senator Levin. Do you know who is on that board, Mr.
Traband?
    Mr. Traband. I don't know who is on the board.
    Senator Levin. Mr. Dellapina.
    Mr. Dellapina. I believe I know at least one individual who
is on the board.
    Senator Levin. Who is that?
    Mr. Dellapina. I believe Ian James. He is a director of
Mahonia. Ian James is an attorney at Mourant.
    Senator Levin. And that is the law firm that you pay the
fees to, right?
    Mr. Dellapina. That is the law firm that represents
Mahonia.
    Senator Levin. And you pay the fees to.
    Mr. Dellapina. And we paid their fees on these structured
transactions.
    Senator Levin. Do you know whether Mahonia has ever entered
into a commercial transaction in which Chase was not involved?
    Mr. Dellapina. I do not believe so.
    Senator Levin. Mr. Traband.
    Mr. Traband. I am not aware of any.
    Senator Levin. Mr. McCree.
    Mr. McCree. I do not know.
    Senator Levin. Did Chase serve as Mahonia's agent in the
prepays, Mr. Dellapina?
    Mr. Dellapina. I believe that we served as an agent for
commercial transactions.
    Senator Levin. Did Chase serve as Mahonia's agent in the
prepays?
    Mr. Dellapina. I believe that is correct.
    Senator Levin. Mr. Traband.
    Mr. Traband. I don't know the answer.
    Senator Levin. Mr. McCree.
    Mr. McCree. I am sorry, I don't know.
    Senator Levin. You don't know.
    Now, Exhibit 184(a) \1\ is a transcript of part of a phone
conversation which was recorded apparently by Chase.
---------------------------------------------------------------------------
    \1\ Exhibit No. 184(a) appears in the Appendix on page 665.
---------------------------------------------------------------------------
    Mr. Dellapina, let me address this to you. This is a
transcript of part of a phone conversation that you had with
Mr. Traband here, Mr. Serice, who wrote that honest letter
about what the motives here were of Enron, and Joe Deffner and
Lisa Bills of Enron, and it was on September 13, 2001, and if
we can play that conversation, do we have that? Do you see the
transcript in front of you at the bottom of page 7--I am sorry,
at the bottom--it is in Exhibit 184.
    [Audio tape played.]
    Senator Levin. Let's go back now in the transcript. Ms.
Bills--this is the best that we understand. We need to have--
excuse me, Mr. Garberding, I guess, is speaking here first.
``We need to have a specific rep letter that a representative
of Mahonia signed that reference a certain point.'' Ms. Bills:
``Which is, yes, separate from Chase. It doesn't have Chase
showing up anywhere on the fax letterhead or anything along
those lines, a separate fax number, etc.'' Mr. Dellapina. ``Oh,
talk about it, yes.'' Mr. Deffner. ``That goes to the same
point you were raising''--you were raising--``earlier, Jeff,
that from your side you also want to make sure that Mahonia
seems independent.'' ``Seems independent.''
    Mr. Dellapina, if Mahonia is independent, you don't need to
make it seem independent.
    Mr. Dellapina. I entirely agree with that statement. To the
best of my understanding----
    Senator Levin. Why do you want to make it seem independent?
    Mr. Dellapina. I don't believe I would have wanted it to
seem independent.
    Senator Levin. It says right here though----
    Mr. Dellapina. I believe it is independent.
    Senator Levin. ``That goes to the same point you were
raising earlier, Jeff, that from your side you also want to
make sure that Mahonia seems independent.'' That's the point
you were making, Jeff.
    Mr. Dellapina. Mr. Chairman, that's a statement by another
individual.
    Senator Levin. Did you disagree with that?
    Mr. Dellapina. I disagree that I----
    Senator Levin. No. Did you disagree with it on the phone
conversation, Mr. Dellapina?
    Mr. Dellapina. I did not challenge that point on that phone
conversation.
    Senator Levin. No, you didn't challenge the fact that you
had made that point earlier. The representation that was made
here by Deffner that ``That goes to the same point you were
raising earlier, Jeff, that from your side you also want to
make sure that Mahonia seems independent.'' Do you deny ever
making that point?
    Mr. Dellapina. I do not believe that Mahonia is not
independent. I believe it is independent.
    Senator Levin. Do you deny under oath that you stated
earlier in this conversation or sometime before that you also
wanted to make sure that Mahonia seems independent or words to
that effect? Do you deny having said that?
    Mr. Dellapina. Mr. Chairman, I don't recall what I said in
that conversation or in an earlier conversation.
    Senator Levin. OK. Now take a look at Exhibit 142.\1\ This
is an email from an attorney at Chase to Mourant. Your lawyer,
your agent. You pay him.
---------------------------------------------------------------------------
    \1\ Exhibit No. 142 appears in the Appendix on page 492.
---------------------------------------------------------------------------
    The second line down there, it says--so this is now from an
attorney at Chase to the attorney in the islands there, the
Jersey Islands. ``At this point, while not a certainty, it
looks like we will need to form Mahonia 3.''
    ``We will need to form Mahonia 3.''
    ``In addition to entering into the prepay with Enron North
America, this entity will be entering into a contract to sell
its rights to receive gas under the prepay agreement to a group
of purchasers, including Chase. In this connection, the
purchasers will appoint Mahonia 3 to act as its agent in
handling the sale of the natural gas delivered under the Enron
contract. The purchaser of the gas in this contract will be
Chase. Chase will then sell the gas pursuant to a fixed price
forward contract to Stoneville Aegean, an SPV that entered into
transactions introduced by Chase in the early to mid-1990's.
Stoneville will then sell the gas pursuant to a fixed price
forward contract to Enron.''
    Great specificity as to what Mahonia 3 is going to be doing
during the next so-called prepay.
    So Mahonia 3 was created and it did engage in so-called
prepay with Chase and with Enron. Now, Mr. Dellapina, Mahonia
is an independent entity. Why is a lawyer from Chase telling
Mahonia's administrators that ``we will need to form Mahonia
3''? If Mahonia is independent, why is Chase telling Mahonia's
administrators that?
    Mr. Dellapina. In this structured transaction, I believe as
is common in other structured transactions, the bank introduces
the idea of a transaction to a party, in this case the law firm
that had, in fact, formed or identified Mahonia for the first
transaction. So raising this as a new opportunity for this
attorney seems consistent with what would be done in a
structured transaction, to the best of my knowledge.
    Senator Levin. So now your attorney--or, excuse me, Chase's
is describing in great detail what contractual arrangements
this supposedly independent entity you are going to decide to
enter into when it hasn't even been formed yet? You are laying
out all the specifics of contractual arrangements that an
independent entity is supposed to apparently make decisions on,
and that entity hasn't even been formed yet. In fact, you are
telling someone to form that entity. You call that
independence? Is that your definition of independence?
    Mr. Dellapina. The use of SPVs in these transactions are
designed to create independent legal agreements, an independent
legality in the transactions. Ultimately we will explain to you
later that that legal independence did, in fact, create
financial--additional financial risk to us and additional
financial harm.
    Senator Levin. Exhibit 120,\1\ if you will take a look at
it, February 28, 2002. This is an email between two employees
of your agent, Mourant &amp; Company, administrator of Mahonia. In
this email, one employee reports that Chase has just informed
her that it discovered that Mahonia was inadvertently omitted
from the gas delivery agreements related to one of the 1998
prepay transactions. Four years, nobody was even aware of the
fact that Mahonia was omitted from the agreement, so title to
the gas was never transferred to Mahonia.
---------------------------------------------------------------------------
    \1\ Exhibit No. 120 appears in the Appendix on page 411.
---------------------------------------------------------------------------
    Then she writes the following: ``Accordingly, new pipeline
agreements need to be completed, reflecting the providers
delivering to Mahonia, who in turn deliver to JPMorgan.''
    ``New pipeline agreements need to be completed. He will
forward the paperwork to me by fax and would be grateful if the
directors would consider execution as soon as possible.''
    Were those papers delivered, do you know, Mr. Dellapina?
    Mr. Dellapina. I do not know.
    Senator Levin. You are not familiar with this?
    Mr. Dellapina. I'm not familiar with this email.
    Senator Levin. No. Are you familiar with the problem?
    Mr. Dellapina. Generally. Not specifically.
    Senator Levin. Generally, were you familiar that Mahonia
was left out of one of these transactions and you had to go
back and create new papers to include it?
    Mr. Dellapina. I don't know that Mahonia was left out of
the transaction. I don't--what I generally understand is that
there was an operational issue--it wasn't appropriately booked
on an operational basis with the pipeline. But I don't know
much more than that.
    Senator Levin. You're not familiar with the fact that there
was a discovery of an anomaly that it was left out of a
transaction? This is the first time you are hearing about that?
    Mr. Dellapina. No. I am generally aware that there was an
operational issue that it was not actually booked properly.
    Senator Levin. Not booked properly. Mahonia was left out,
right?
    Mr. Dellapina. I don't understand ``left out.''
    Senator Levin. You don't understand what?
    Mr. Dellapina. ``Left out.''
    Senator Levin. Omitted. Wasn't included.
    Mr. Dellapina. All of the legal paperwork was executed. I
understand that the issue was relating to the actual
communication with the pipeline company and the actual
recording by the pipeline company.
    Senator Levin. Was there a new pipeline agreement that was
completed reflecting the providers delivering to Mahonia, who
then in turn delivered to JPMorgan?
    Mr. Dellapina. That I am not aware of.
    Senator Levin. Let me read you one line from this memo.
``Greg has just called to advise that JPMorgan's agents have
arranged to settle the invoice and that they do not need our
instruction. Have also advised that they have just discovered
anomalies in the Texas Eastern Pipeline agreements in respect
to certain trades, whereby the pipeline agreements are made
directly between the providers and JPMorgan, effectively
bypassing Mahonia.''
    How's that for a definition of ``left out''? Is that
better? Were you familiar with--are you familiar with the fact
that Mahonia was bypassed inadvertently?
    Mr. Dellapina. Inadvertently, I am familiar that on the
pipeline records, the gas does not note Mahonia in the title
chain.
    Senator Levin. Are you aware of the fact that this was
described as an inadvertent bypassing?
    Mr. Dellapina. That it was described as that?
    Senator Levin. Yes.
    Mr. Dellapina. No. I have not seen this email before, and
I'm not familiar with that.
    Senator Levin. All right. But you are generally aware of
the fact that Mahonia was inadvertently bypassed in one of
these deals in the booking?
    Mr. Dellapina. Yes.
    Senator Levin. All right. Now, if Mahonia is an independent
company and it was bypassed for 4 years, would you say that it
is particularly an independent company? If someone discovers 4
years later that Mahonia was bypassed in a booking, no one
discovered it for 4 years, is that your definition of
independent company?
    Mr. Dellapina. Mr. Chairman, we have transacted prepaid
forward physical transactions with Enron and Mahonia since
1992, and there was a discovery made that in one transaction
there was inappropriate communication to the pipeline which
didn't specify exactly how the volumes were flowing.
    With SPVs, we are not suggesting that this SPV had a vast
operation and that it was designed to get into a vastly
detailed commercial activity. The SPV was designed in the
structured transaction or served the role in the structured
transaction to create legal independence among contracts.
    Senator Levin. You said ``legal independence.'' Are you
distinguished that from actual independence?
    Mr. Dellapina. I don't know the definition of ``actual
independence.'' The history----
    Senator Levin. Real.
    Mr. Dellapina [continuing]. Of the transactions----
    Senator Levin. Real-world independence.
    Mr. Dellapina. Legal independence.
    Senator Levin. Does that distinguish from real-world
independence?
    Mr. Dellapina. I don't know the answer to that.
    Senator Levin. OK.
    Mr. Dellapina. We began these transactions in 1992 for the
reasons we described, that is, Chase's--the lack of clarity as
to our ability to take physical oil and gas back in 1992. The
purpose of Mahonia at that point was to enable that physical
delivery, and throughout the period in which we've been
involved with Mahonia, we've always recognized it as a legally
independent entity.
    Senator Levin. Which didn't have a vast operation, in your
words, right?
    Mr. Dellapina. No, it did not.
    Senator Levin. As a matter of fact, it was a shell. It was
created by Chase, wasn't it, solely for your transactions? That
is its registration statement. Is that correct? I went through
the registration statement with you. That is the purpose of
Mahonia, to assist you in transactions. There is no operations,
except to assist you.
    Mr. Dellapina. That is correct. They work on structured
transactions with us. That is correct.
    Senator Levin. All right. So when you say they didn't have
vast operations, don't try to sell us on the concept that they
were anything other than a shell corporation created by you to
assist Chase, run by your agent, Mourant--who you paid, whose
fees, Mahonia's fees you paid, and you are going to try to
leave it with this Subcommittee that in your judgment you
honestly believe that this Mahonia was not under the effective
control of Chase? Is that your testimony, Mr. Dellapina?
    Mr. Dellapina. To the best of my knowledge, when I worked
on these transactions I did not understand that we controlled
this company. We did not own it, and we did not enter into
documentation on their behalf.
    Senator Levin. You were aware of the fact that it was
created to assist Chase, was owned by a trust, which was in
turn owned by your agent, was created for you, you paid all of
its registration fees, you paid all of its administrative fees,
you paid its legal fees. And are you telling this Subcommittee
that in your honest judgment Chase did not effectively control
Mahonia?
    Mr. Dellapina. Mr. Chairman, I am not sure that I have the
legal knowledge to define----
    Senator Levin. I am just asking you for your honest
judgment. I am not asking you for a legal opinion. I am asking
you from what you know.
    Mr. Dellapina. I understand--I think I understand the
question. And I will again say that we--I fully recognize that
this is an SPV that was working on these transactions for a
purpose. Originally it was to accommodate the physical transfer
of oil, which the bank at that time did not do. And continuing
throughout the evolution of these transactions, which occurred
over 10 years and changed form over time, the transaction--the
company was recognized independently as a legal entity.
    Senator Levin. I am going to go back to my question,
because you say you understand it.
    Mr. Dellapina. I did understand the question----
    Senator Levin. I am asking you for your honest judgment.
Did Chase effectively control Mahonia?
    Mr. Dellapina. I don't believe that we controlled Mahonia.
    Senator Levin. Mr. McCree, do you want Chase to stand by
that answer?
    Mr. McCree. Yes.
    Senator Levin. In your judgment, Mr. McCree, do you believe
that Chase did not effectively control Mahonia, given all the
facts we have laid out here--it was created for you, owned and
operated by your agent, you paid all of its fees, you paid its
legal fees, you don't know of any example where it did anything
for any other company from Chase, and you want as a
representative of Chase to tell this Subcommittee that in your
honest judgment Chase did not effectively control Mahonia?
    Mr. McCree. My understanding, Mr. Chairman, is that Mahonia
was controlled by a charitable trust, which was governed by a
board of directors which made independent decisions on the
individual transactions that were forwarded to them for
consideration.
    Senator Levin. Are you aware of the fact that Mahonia was
owned by your agent, operated by your agent, that Chase paid
all of its legal fees, registration fees, and administrative
fees, and that there was no--its sole purpose for coming into
existence was to assist Chase? Are you aware of all those
facts?
    Mr. McCree. My understanding is it was owned by a
charitable trust, not by our agent.
    Senator Levin. Who owns the charitable trust?
    Mr. McCree. I don't know the answer to that.
    Senator Levin. Well, we went through the letter.
    Mr. McCree. I'm not sure who owns the charitable trust. I
believe a charitable that was established, but I'm not--I am
not fluent in the entirety of the legal structure of the
ownership structure of Mahonia--or the charitable trust, sorry.
    Senator Levin. Well, do you want to read your agent's
letter again? April 24, first letter in Exhibit 118,\1\ page 2.
You see, when you use offshore jurisdictions this way, it is
kind of hard for us to subpoena them, by the way. But let's
read what they say. This is 1986. Page 1 of the letter, it
says, ``Our clients, Chase.'' Here's page 2. ``For obvious
reasons, it is important that the SPVs are controlled by
Chase.'' He's lying? Is your lawyer lying?
---------------------------------------------------------------------------
    \1\ Exhibit No. 118 appears in the Appendix on page 394.
---------------------------------------------------------------------------
    Mr. McCree. Well, I don't--this is a 1986 letter.
    Senator Levin. Which created Mahonia.
    Mr. McCree. Did it create Mahonia?
    Senator Levin. Led to it.
    Mr. McCree. I do not know----
    Senator Levin. Well, let's just keep reading it. ``For
obvious reasons, it is important that the SPVs are controlled
by Chase.'' Was it important that the SPVs be controlled by
Chase?
    Mr. McCree. I have no idea what SPVs----
    Senator Levin. Is it important that the SPVs that you used,
that they created, are controlled by you?
    Mr. McCree. No, I don't believe so, but I don't know the
specifics of this individual transaction. I really have no
knowledge of a 1986 transaction.
    Senator Levin. Well, we are going to have to get the answer
from Chase then. If you don't know the answers to this, we are
going to need to get the answer. And if we have to get your
president here to do it, we are going to get it, because this
is shameful. This is shameful that you are not owning up to
something that your lawyer did in 1986 on your behalf, creating
an entity on your behalf, saying here, ``For obvious reasons,
it's important the SPVs are controlled by Chase. But for
accounting and other requirements, it's not desirable that they
be wholly owned by Chase. Accordingly''--what does your lawyer,
your agent say? ``Chase is considering establishing a
charitable trust which would own all the shares of the holding
company, which in turn would wholly own the various SPVs.''
    Did Chase establish a charitable trust? Yes or no.
    Mr. McCree. I just--Mr. Chairman, I do not know the
entirety of the context of this letter, the time frame, or
anything. So I feel uncomfortable describing what was being
described in this letter. I don't know the answer to that.
    Senator Levin. We thought you would be prepared to answer
questions here for Chase today, and I guess you are not.
    Mr. McCree. Not this one. I apologize.
    Senator Levin. This goes to the heart of the matter here.
This goes to the heart of a deception as to whether Mahonia was
an independent entity. Because if it is not, it is a loan.
Everyone acknowledges that. If Mahonia is not independent, it
is a loan. It has got to meet three other criteria, too, which
we haven't gotten to. But this isn't just a question.
    Mr. McCree. I would say I would be happy--or we would be
happy to provide additional information on this matter. I don't
have the full context. My understanding is Mahonia is an
independent entity.
    Senator Levin. Yes. Well----
    Mr. McCree. And I apologize for that.
    Senator Levin. When we sent Chase a letter, we expected
that they would send somebody that could answer questions about
control.
    All right. Keep going now. ``It is not desirable that they
be wholly owned by Chase. Accordingly, Chase is considering
establishing a charitable trust''--you don't know if they did
or not, right?
    Mr. McCree. I have no idea.
    Senator Levin. ``. . . which would own all the shares of
the holding company which in turn would wholly own the various
SPVs.''
    It is a shell, and it is a shell game, and Chase should own
up to it, be honest about it, and it is not. And this
Subcommittee is going to get the answers from Chase to that
question. Who do you suggest we call here as a witness who can
answer the question?
    Mr. McCree. I don't know. I will have to find out who was
involved in the transactions at the time.
    Senator Levin. Turn, if you would, to Exhibit 131.\1\ Now,
Exhibit 131 is a diagram that was sent to you by email by an
Enron employee, and I believe it is addressed to you, Mr.
Dellapina. This diagram works on the details of the prepay
transactions, and it was sent to you less than 2 days before
the $350 million prepay between Chase, Mahonia, and Enron was
signed. The diagram shows all three legs of the transaction,
the expected price, and the general terms of the arrangements
between the three parties. That is on page 2. Do you follow me
so far?
---------------------------------------------------------------------------
    \1\ Exhibit No. 131 appears in the Appendix on page 436.
---------------------------------------------------------------------------
    Mr. Dellapina. Yes.
    Senator Levin. So these trades were developed as a package
deal, is that true?
    Mr. Dellapina. Yes.
    Senator Levin. Now, in these transactions, the contract
between Mahonia and Enron and the contract between Mahonia and
Chase were identical in terms of volumes and delivery dates,
and the financial terms were only slightly different to reflect
the fees that Mahonia would receive for participating as a
party in the transaction. Is that correct?
    Mr. Dellapina. I believe that's correct.
    Senator Levin. So Mahonia essentially received a fee for
participating in these transactions. Is that correct?
    Mr. Dellapina. That is correct.
    Senator Levin. But one of the four criteria for a
legitimate prepay was not met here by your own testimony,
because there cannot be this kind of linkage. They are all part
of--this was a package deal. You have just testified to us
under oath.
    Mr. Dellapina. Mr. Chairman.
    Senator Levin. Yes.
    Mr. Dellapina. I am not familiar with the four criteria for
a prepay.
    Senator Levin. They have been testified----
    Mr. Dellapina. I saw this earlier, and I was--I don't
believe that I was ever asked to review that. That would have
been out of my scope, and I'm not familiar with----
    Senator Levin. According to the testimony this morning, for
there to be a legitimate prepay you need a number of things.
One of them has got to be independent parties which are not
involved in a package deal transaction which is linked
together.
    When you look at the diagram that was showing the last
prepay, it was signed in 2001. All the transactions are
financially settled. All the legs use the same amount of gas,
pegged to the exact same price. All of the payments are fixed.
The same amount of funds go in and out of Mahonia and into
Enron. The only difference is that Chase picks up an extra $6
million, and now there is risk that one party may not pay, but
that is true in any loan. That is not price risk.
    Is there any price risk in this transaction, Mr. Dellapina?
    Mr. Dellapina. The price risk in this transaction initiates
with the transaction between Enron and Mahonia, and then the
transaction between Mahonia and Chase. That price risk is being
hedged with a swap between Enron and Chase.
    Senator Levin. So there is no price risk at the end of the
game when you put it all together; is that not correct?
    Mr. Dellapina. Provided that all parties, in fact, perform
on the contracts, there is no speculative price risk, the price
risk materializes in the form of a pretty large counterparty
credit exposure.
    Senator Levin. But there is a credit risk. So there is a
credit risk here, but not a price risk. Is that correct?
    Mr. Dellapina. The price risk will only materialize if the
credit--the counterpart does not perform.
    Senator Levin. Why don't we just get a straight answer to
this question? In other words, there is a credit risk here, but
not a price risk; is that not correct?
    Mr. Dellapina. There is a credit risk.
    Senator Levin. You are not willing to say there was no
price risk. Even though every party was perfectly hedged and
guaranteed here, you are not willing to answer the question was
there a price risk before this Subcommittee?
    Mr. Dellapina. There was not a speculative price risk in
the transaction. There was not when the transaction was
concluded. We certainly look at prices, and the movement in
prices will, in fact, affect our credit exposure.
    Senator Levin. Mr. McCree, do you want to comment on that?
Do you agree with that? Was there a price risk here?
    Mr. McCree. There's certainly a credit risk. The magnitude
of the credit risk moves in a scenario that we have to now
based on market prices, I believe.
    Senator Levin. Try my question. Was there a price risk
here?
    Mr. McCree. Not at the outset of the transaction. There
was, but it was hedged.
    Senator Levin. Now, in Exhibit 138--and, by the way, price
risk is another criteria which has been testified to as
absolutely essential for there to be a legitimate transaction
here. It would not count as debt.
    Let me point you to Exhibit 138.\1\ This is Chase's own
description of one of these transactions, and it comes right
out and it clearly states the objective. It is in the middle
of--let me see if I can get you the right page here. It is
right under that--see the black bar? ``The transaction calls
for Chase to advance funds to a special purpose corporation
formed by Chase in the Channel Islands, Mahonia, Limited.''
Does that sound familiar? Do you agree at least that you formed
Mahonia? Mr. McCree, did you form Mahonia?
---------------------------------------------------------------------------
    \1\ Exhibit No. 138 appears in the Appendix on page 476.
---------------------------------------------------------------------------
    Mr. McCree. I think we asked Mourant &amp; Co. to consider
forming Mahonia.
    Senator Levin. I see. To consider forming Mahonia, not even
to form it. This is your document.
    Mr. Traband. I think the language used in this document is
loose and inaccurate.
    Senator Levin. That is a problem with a lot of Chase
documents. Let me tell you, that is exactly the problem. So
your document here, which says that this special purpose
corporation which was formed by Chase in the Channel Islands,
Mahonia Limited, that is not true; is that what you are saying?
This isn't 1986, folks.
    Mr. Traband. I think what we would say is----
    Senator Levin. This is 1996.
    Mr. McCree. Mr. Chairman, I think what we would say is
Chase arranged for the establishment of Mahonia.
    Senator Levin. I see.
    Mr. McCree. But once it was established, it was controlled
by its board of directors----
    Senator Levin. Which were controlled by your agent.
    Mr. McCree. No, by its board of directors. And we believe
it was all done in accordance with law.
    Senator Levin. So this is not an accurate statement in this
Chase document. Is that the bottom line? You didn't form it?
    Mr. McCree. We arranged for the formation----
    Senator Levin. You just caused it to be formed.
    Mr. McCree. We arranged for the----
    Senator Levin. You arranged for it to be formed, but you
are not willing to say you--that this is formed by you. You
just paid somebody else to form it.
    Mr. McCree. Correct.
    Senator Levin. So if I go and tell somebody, hey, I am
building a new house, you are just saying literally that means
I have got to go out and build it myself rather than paying to
build it; is that correct? That is the way you use language at
Chase?
    Mr. McCree. No. I think it's--I think----
    Senator Levin. Come on, you formed Mahonia. That is the
common-sense version. You formed it. You paid for it to be
formed. You caused it to be formed. You formed it. You created
it. You brought it into existence.
    Mr. McCree. We asked our attorney and Mourant &amp; Co. to
establish a special purpose entity for the----
    Senator Levin. And they did it.
    Mr. McCree [continuing]. Purpose of doing this--yes.
    Senator Levin. And they did what you paid them to do,
didn't they? Right?
    Mr. McCree. Yes.
    Senator Levin. OK. Let's keep going beyond that. ``Mahonia
in turn enters into a forward gas sales contract, referred to
as a prepay, with an Enron subsidiary, Enron Natural Gas
Marketing. An integral part of the prepay is the execution of a
series of commodity and interest rate swaps which result in a
known cash flow stream.'' ``Known cash flow stream.'' That is a
pretty good definition of eliminating price risk, wouldn't you
say, steady repayment of funds? Mr. Dellapina.
    Mr. Dellapina. Yes, we were trying to eliminate price risk.
    Senator Levin. Mr. Dellapina, isn't it the case when you
look at these so-called prepays that they are nothing more than
a big circle designed to get Chase loans to Enron and back to
Chase? Just a circle, isn't that true?
    Mr. Dellapina. Mr. Chairman, these transactions were
started in 1992, the form of which changed over the ensuing 11
years or so that the transactions were being done with Enron.
There were elements of the transaction that were designed to
mitigate price risk. Towards the end of the transactions, there
were elements of it that were designed to also mitigate the
physical delivery risk. But there are structural differences
which we believe make these fundamentally different than loans.
And if you have a moment, I'd like to go through the
differences with you.
    Senator Levin. Well, why don't we just address my
questions, if you would.
    Mr. Dellapina. Excuse me, Mr. Chairman?
    Senator Levin. I would rather you just respond to my
questions, if you would. I want to talk to you about the way
you characterized the last prepay, the $350 million prepay.
Wasn't that characterized as a circular deal, Mr. Traband?
    Mr. Traband. Characterized as a circular deal?
    Senator Levin. One that went in a circle.
    Mr. Traband. Well, I mean, my understanding is that----
    Senator Levin. Like that triangle you just saw there.
    Mr. Traband. My understanding is that there was a prepaid
swap and a separate commodity swap.
    Senator Levin. Would you call that a circular deal?
    Mr. Traband. I don't know if I'd call that a circular deal.
    Senator Levin. You did. Do you want to hear yourself, a
telephone conversation that Chase recorded?
    Mr. Traband. I have no doubt to question you there.
    Senator Levin. You described it as a circular deal. What
did you mean by that?
    Mr. Traband. I don't recall.
    Senator Levin. You don't recall what you meant, 2001,
September----
    Mr. Traband. I'm sure I was addressing the fact that we
were trying to mitigate our price risk.
    Senator Levin. Let's listen to the tape, Exhibit 184(a),\1\
so you can follow it. This is Mr. Ballentine. Can we start
over? Is it possible? The first voice we think is Mr.
Ballentine who is saying, ``Jeff, why do they want to hedge
with gas where it is now?'' Then Mr. Dellapina, then Mr.
Traband.
---------------------------------------------------------------------------
    \1\ Exhibit No. 184(a) appears in the Appendix on page 665.
---------------------------------------------------------------------------
    [Audio tape played.]
    Senator Levin. Did you hear that, ``it's amortizing debt''?
Did you hear Mr. Ballentine say that?
    Mr. Traband. I heard him say that.
    Senator Levin. Is that accurate?
    Mr. Traband. I think he was using the term ``debt''
interchangeably with the term ``credit''?
    Senator Levin. He was using the term ``debt''
interchangeably with the term ``credit.''
    Mr. Traband. There was credit risk in the transaction that
would be apparent in a debt transaction as well, they have
common characteristics.
    Senator Levin. OK. What do you mean by ``back-to-back
swap''? That term is used, ``back-to-back swap.'' What does
that mean?
    Mr. Traband. I think we were referring to the fact that we
were entering into the prepaid swap and the subsequent
commodity swap to hedge the price risk.
    Senator Levin. What did you mean when you said this is a
circular deal that goes right back to them?
    Mr. Traband. I think we were reflecting that this is a
structured financing.
    Senator Levin. Is that a term you use a lot, ``circular
deal''?
    Mr. Traband. I don't believe so.
    Senator Levin. Let me just conclude with a couple questions
here. First, Mr. Traband, Mr. Dellapina, who are the people at
Enron whom you dealt with on the prepays? Let me start with
you, Mr. Dellapina.
    Mr. Dellapina. The principal individual I dealt with was
Joseph Deffner.
    Senator Levin. The one who we talked about before?
    Mr. Dellapina. Yes.
    Senator Levin. And who else?
    Mr. Dellapina. The only other individuals I would have
dealt with would have worked for Joseph, and their names, I
believe, were Lisa Bills and Michael Garberding. Those are the
two names I recall.
    Senator Levin. Mr. Traband, who did you work with at Enron
on the prepays?
    Mr. Traband. On the actual prepay transactions, I worked
with Joe Deffner and Lisa Bills and had reason to discuss the
prepays with others.
    Senator Levin. OK. One exhibit I want you to look at, we
haven't looked at it yet but it has been referred to this
morning is Exhibit 131.\1\
---------------------------------------------------------------------------
    \1\ Exhibit No. 131 appears in the Appendix on page 436.
---------------------------------------------------------------------------
    Before you look at that, have any of you ever spoken with
Jeff McMahon at Enron? Mr. Dellapina.
    Mr. Dellapina. I have not spoken directly to Jeff McMahon.
    Senator Levin. Mr. Traband.
    Mr. Traband. Yes, I had occasion to speak with Jeff
McMahon.
    Senator Levin. On prepays?
    Mr. Traband. Generally, yes.
    Senator Levin. On prepays?
    Mr. Traband. Yes.
    Senator Levin. Mr. McCree.
    Mr. McCree. No.
    Senator Levin. Now, on Exhibit 131, this is an October 2001
exchange of emails at Chase, and here is one person--when the
bank is learning that, to its surprise, Enron had $5 billion in
prepays outstanding, an amount which was greater than Chase
even had expected. And here's the conversation: One employee of
Chase says, ``$5 billion in prepays!'' The other one says,
``Shut up and delete this email.''
    Any of you involved in this conversation? Mr. McCree.
    Mr. McCree. No.
    Senator Levin. Are you familiar with it?
    Mr. McCree. No, not to my knowledge.
    Senator Levin. Mr. Traband, are you familiar with it?
    Mr. Traband. I was not part of this conversation. I've
subsequently seen the email.
    Senator Levin. You have seen the email?
    Mr. Traband. Just in preparation for this meeting.
    Senator Levin. It was not deleted.
    Mr. Traband. I'm sorry?
    Senator Levin. Was the email not deleted?
    Mr. Traband. We are all aware that our email does not get
deleted. It's archived for a period of time.
    Senator Levin. I gave you the wrong exhibit number. It is
Exhibit 132.\1\
---------------------------------------------------------------------------
    \1\ Exhibit No. 132 appears in the Appendix on page 438.
---------------------------------------------------------------------------
    OK. Mr. Dellapina, do you know who participated in this
conversation?
    Mr. Dellapina. I'm just turning to this now. I am not
familiar with that.
    Senator Levin. Here we have got one Chase employee telling
the other to shut up and delete the email. Does that trouble
you, Mr. McCree? Are you embarrassed by that?
    Mr. McCree. Yes. But I'm not sure what it means.
    Senator Levin. It means delete the email.
    Mr. McCree. No, I know. But it's--I don't know the context,
but yes.
    Mr. Traband. If I could just say something?
    Senator Levin. Yes.
    Mr. Traband. We are all aware that our emails are archived
for a period of time and that it's not possible to delete an
email. So I think that was said in jest and not meant to be
taken seriously.
    Senator Levin. Mr. McCree, let me just ask you the final
question. You represent one of the most important financial
institutions in the country, and you have a reputation to
maintain. Yet you use entities and secrecy jurisdictions,
arguing that you don't control them, when I think it is obvious
to any reasonable person looking at this that you created it
and you control it. You maintain the fiction here that you
don't control it, ignoring all of the evidence, producing none,
by the way, to counter it other than the fact that your
understanding is that it is independent. But I went through all
of the control mechanisms, all of the indicators of control, so
you maintain that you don't effectively know Mahonia even
though it was created for you, run by your agent, paid for by
you.
    You then helped to create a situation here where you have
got prepays that, according to the experts that we have had, do
not meet the criteria for prepays. They are linked
transactions, for one thing. The parties are not independent,
at least if you can accept all of the evidence that says
Mahonia is really controlled by Chase, and they are treated as
loans. There are many indicators we have that they are treated
as loans.
    So you are now, as Chase, participating in this entire
picture where billions of dollars of cash coming into Enron,
which should have been treated as loans, if it had been treated
as loans, would have affected their credit rating and a lot
fewer people would have been stung by Enron. And they produce
documents which are misleading, documents which bury it. Your
own employees says Enron loves these kinds of transactions
because they can hide debt and they can bury it.
    Is Chase at all troubled by this? Do you find this
troubling at all? I don't mean the fact that you are here. I
hope you find that troubling.
    Mr. McCree. Yes.
    Senator Levin. But I mean the fact--are these facts at all
troubling to Chase?
    Mr. McCree. Let me answer it this way: In establishing the
transactions with Mahonia, we believed that we were in
compliance with all relevant laws, all accounting standards,
all tax standards. We had no reason to believe then that we
were not, and we have no reason to believe now that we are not.
    We also believed that Enron at the time was in compliance,
and particularly with its accounting regulations, and was
reflecting these transactions in accordance with GAAP on their
balance sheet.
    I find it personally troubling and hard to understand in
terms of Chase doing something wrong here how that would jibe
with the financial loss that we suffered as a firm in the
entirety of the Enron transactions and, frankly, in many of
these prepay transactions. So as to the difference between a
loan and a prepaid contract, aside from whether the accounting
was appropriate at the time or not, we suffered multiple legs
of loss due to the structure of these transactions, some on the
commodity risk, some on delivery risk, and we are in litigation
on some with the sureties.
    We do find it troubling. We find what is happening in the
financial system in general troubling right now. I'll echo what
a few people said up here earlier. We applaud the efforts that
the Congress is going about in terms of reform and transparency
of the financial accounting system and financial system in
general. We believe we have as high an interest as a major
principal lender across corporate America in this transparency.
    As it relates to JPMorgan, we have significantly increased
our attention to diligence, to probing questions around our
clients' financial statements, to purpose of transactions, and
we are rethinking the way we conduct business on a going-
forward basis in the new environment that we operate in today.
    Senator Levin. Well, you have plenty of reason to believe
that your company controls Mahonia. You were given reason to
believe today. Would you agree with that, that you now have
reason to believe that your company controls Mahonia?
    Mr. McCree. I continue to repeat what I said before----
    Senator Levin. Yes, I know that, but----
    Mr. McCree [continuing]. Which is I----
    Senator Levin. But you heard reasons here today that are
reasons to believe that Chase controls Mahonia.
    Mr. McCree. I believe Mahonia was controlled by its board
of directors. They made the decisions.
    Senator Levin. You didn't hear anything today which gives
you any reason to believe that Chase controlled Mahonia?
    Mr. McCree. No.
    Senator Levin. OK. Well, let me tell you, both the board of
directors of Mahonia--we think all the board of directors of
Mahonia work for your agent. They are all working for that law
firm. You can try to avoid it, but you can't. Responsibility
comes right back to you. You can sit here repeating that you
believed it was independent despite overwhelming evidence that
you control it. You use an offshore jurisdiction in a secrecy
jurisdiction. The evidence that we were able to obtain
nonetheless dramatically demonstrates that Mahonia was created
for Chase, created by Chase, paid for by Chase, controlled by
Chase, run by Chase's agents, fees paid for by Chase, and yet
you sit here and just repeat the mantra that you believe it was
independent. That does not satisfy the responsibility of a
major bank. You have got a greater responsibility than to do
that. And I must tell you that I think that this is just one
example of why the American people have lost confidence in Wall
Street, that we have a bank that is participating in Enron's
effort, known to the bank--we have those emails--to turn debt
into operating income. Your people knew that. That is in those
emails. They knew that this is what Enron was up to. They love
to do it. They love to hide it. And to just sit here and to try
to tell this Subcommittee that you believe Mahonia is
independent and you believe that this transaction was not, in
fact, a phony prepay, even though, by the way, your own
testimony here today indicates quite clearly that these
transactions were linked, those three legs were linked
together, you acknowledge that here today, which by expert
testimony means it was not, in fact, a transaction which could
qualify as a legitimate prepay.
    We are going to have to hear from folks at Citibank to
answer questions that you could not answer or would not answer
here today, but your testimony today here just seems to me is
part of a picture which I find mighty disturbing. I would like
to see that picture change. I hope we are going to do our share
here in Congress in a constructive and positive way. But it is
going to take some recognition on the part of our financial
institutions that things have got to change. You can't have
people writing emails back and forth to each other saying, hey,
these kind of transactions are just what Enron loves, they can
hide debt, and just ignore it as though that is not going on
inside of your own bank.
    So we will ask your folks to answer the questions that you
could not or would not answer relative to the control of
Mahonia. We will refer all of this testimony and the exhibits
to this Securities and Exchange Commission and to the
Department of Justice. And I will call upon Senator Fitzgerald
in case he has questions of this panel.
    Senator Fitzgerald. Thank you, Mr. Chairman.
    I just wanted to go back and be very clear in my own mind
about the extent of JPMorgan Chase's understanding of the
nature of the prepay transactions.
    Now, as I understand it, JPMorgan is trying to force
certain insurers to pay an obligation pursuant to surety bonds
that were backing Enron's performance on some of these prepays.
Is that correct, Mr. Dellapina?
    Mr. Dellapina. Yes, Senator, several of the prepay
transactions that were done beginning in 1998 had a credit
diversification benefit to those transactions which were surety
bonds from major insurance companies in the United States.
Those insurance bonds, those insurance companies worked with
Enron and came to us and asked us to participate in the
transactions----
    Senator Fitzgerald. So Enron got those insurance companies
to offer the surety bonds. It wasn't JPMorgan Chase that went
out and got the insurance policies?
    Mr. Dellapina. That is correct, Senator.
    Senator Fitzgerald. OK. Now, you are suing certain insurers
asking them to perform under their surety bonds. That is
correct? Do you know the names of the insurers that you are
suing?
    Mr. Dellapina. I know several of the names, sir.
    Senator Fitzgerald. Can you give us a few of those? It is
in a public record----
    Mr. Dellapina. The Traveler's Insurance Company, Chubb, St.
Paul.
    Senator Fitzgerald. Traveler's is owned by--who are they
owned by?
    Mr. Dellapina. I believe Citigroup.
    Senator Fitzgerald. OK. That will be interesting. This is
very--a lot of connections here. So you are suing Traveler's,
Chubb, and other insurers, asking them to pay.
    Now, according to published reports, the insurance
companies are saying we are not going to pay because these
weren't real prepay transactions, these were just loans. Is
that correct that that is the defense of the--in essence, that
is the defense of the insurance companies?
    Mr. Dellapina. Senator, I am not familiar with all of the
defenses raised by the insurance companies. I disagree with
that characterization that they're loans, if that's, in fact,
what they're making as a characterization.
    Senator Fitzgerald. My understanding from published reports
is that they are saying these aren't--these were just loans and
that they were misled. For the record, I guess the case is
styled JPMorgan Chase Bank v. Liberty Mutual Insurance Company,
Traveler's, St. Paul, Continental Casualty, National Fire
Insurance Company of Hartford, Firemen's Fund, Safeco, another
Traveler's indemnity company, Federal Insurance Company,
Hartford Fire Insurance Company, and Lumbermen's. Those are the
defendants.
    My understanding is that those insurance companies are
maintaining that this was just a loan and that they were misled
on the nature of the transaction. Your position is they weren't
loans. Is that correct?
    Mr. Dellapina. I'd prefer not to speak in context of that
outstanding litigation, but if you are asking me with respect
to the prepays outside of the litigation and not taking into
account what their defense might be, I do believe that the
characteristics of these transactions are fundamentally
different from a loan and have different risks associated with
them.
    Senator Fitzgerald. So your personal opinion is that these
are different than loans, but earlier Senator Levin produced
Exhibit 123,\1\ which was an email to Karen Simon that was cc'd
to you, Jeffrey W. Dellapina, on 11/25/98, and this is the
email. Is it written by George Serice? George Serice I believe
wrote this. That is where it was said that ``Enron loves these
deals.'' He is talking about prepays. He says, ``Jeff is also
working on another prepay for Enron now.'' That is you, I
presume. He said, ``Enron loves these deals as they are able to
hide funded debt from their equity analyst.''
---------------------------------------------------------------------------
    \1\ Exhibit No. 123 appears in the Appendix on page 414.
---------------------------------------------------------------------------
    Well, it would seem to me that whoever wrote this email
knew that these prepays were a way of hiding what was
essentially a loan, doesn't it?
    Mr. Dellapina. Senator, as I mentioned to the Chairman, I
do not believe that that email is accurate, and prepaid
forwards are, in fact, a form of financing, but not all forms
of financing are loans. I'm not an accountant, but I believe
there are very different characteristics of the prepaid forward
transaction and the loan. Some of those characteristics are as
follows: This is a commercial contract between a buyer and
seller that is not satisfied in dollars. It is satisfied in
goods and/or services. With the prepaid forward, the final
market value of this contract and the actual goods that are
being delivered will only be known at the delivery, and as
opposed to a loan where it is a set dollar amount that is going
to be paid at maturity.
    There are very--there are probably three or four additional
risks in prepaid forward transactions that are not present in a
loan and that, regrettably, have caused us to suffer additional
losses in these transactions, losses that are incremental to
any losses we would have suffered if it was just a loan.
    Those risks are commodity price risks, account receivable
collection risk, and these transactions, through the first 5 or
6 years of these transactions, the physical commodities were
delivered into the market. Over the last several years, the
physical commodities and the natural gas was actually delivered
to Enron. That was not an essential part of the transaction and
was not part of the transaction for the first 6 years. The
decision to sell the commodity to Enron, which has been
characterized as a circle, actually introduced an entirely new
credit risk for us. We could have sold that gas, as we had in
the past, prior to the time I was there, to other market
participants, and we would have taken the risks that those
participants would have paid for that commodity.
    When Enron bought the natural gas in the latter
transactions, we assumed an entirely new credit risk. And to
summarize that, when Enron went bankrupt, they owed us an
additional $32 to $35 million for natural gas that had been
delivered to them, and they did not pay that.
    Senator Fitzgerald. How much does Enron owe you now?
    Mr. McCree. In total?
    Senator Fitzgerald. Yes.
    Mr. McCree. I'm not sure. Right now, as of----
    Senator Fitzgerald. As of the bankruptcy----
    Mr. McCree. December 19, which is when we announced, I
think. Have to look at my notes--$2.6 billion.
    Senator Fitzgerald. $2.6 billion? At about the time of
their bankruptcy, and that's when you last calculated it?
    Mr. McCree. I'm not sure. I just haven't seen the figure
lately.
    Senator Fitzgerald. Now, would you know, Mr. McCree, how
much they owed you back in, say, May 2001?
    Mr. McCree. No, but Mr. Traband may.
    Mr. Traband. I don't recall specifically how much they owed
us, but it, I would imagine was, something greater than $2
billion.
    Senator Fitzgerald. Over $2 billion in May 2001
    Mr. McCree. In the latter--I don't know the question, but
we actually increased our credit exposure in a number of
different ways through the fall of 2001, prior to the
bankruptcy.
    Senator Fitzgerald. Can you give me in rough terms--it
started apparently in 1992, Mr. Dellapina was saying, with this
structured financing. Was that when your relationship with
Enron started?
    Mr. Dellapina. I do not believe any of us were involved
with Enron in 1992. I do not believe it was the only
transaction or the only relationship with Enron back then.
    Senator Fitzgerald. But in rough terms would you know how
much was owed to JPMorgan back in 1997, 1998, 1999, 2000, or
2001?
    Mr. McCree. No, but we can certainly provide that
information. We would be happy to do that.
    Senator Fitzgerald. If you could provide that later, we
would appreciate that.
    Now, I want to call your attention to--I don't know if this
is an exhibit. This is an analyst report by Anatol Feygin,
dated May 18, 2001. The headline is: ``Enron Corp, Enron
Weakness Not Explainable Fundamentally.''
    In this report, your firm, J.P. Morgan Securities, Inc.--
and I guess that is your company, Mr. McCree--via its analyst,
Anatol Feygin, is rating Enron as a buy and setting a 12-month
price target at $120 a share, even though Enron was then
trading at $52.20. I am wondering how much exposure
specifically you had to Enron at the time this report was put
out, and so I would ask if for the record, Mr. McCree, you
could provide exactly how much indebtedness was owed your
company.
    One of the concerns I have is that analysts do not always
have to disclose to the people that they are offering their
research reports to the full gamut of potential conflicts that
they have, and in the case of Enron owing large amounts of
money, over $2 billion, to JPMorgan Chase, I am concerned
whether that would have influenced in any way the research
reports.
    Now, Mr. Feygin testified before this Subcommittee in
February about his coverage of the Enron Corporation and
explained why he made the recommendations that he did. Do you
think that this potential liability of your firm to the
fortunes of Enron would have had any impact at all on the
ratings that Mr. Feygin or other JPMorgan analysts would give
to Enron?
    Mr. McCree. No. I believe we have very stringent and very
thorough Chinese Wall policies which would segregate any public
research professional from any kind of relationship material,
size of exposure whatsoever that we would have on the banking
side of the firm. And we, as a general matter, lend material
amounts of money to virtually all of the Fortune 1,000
companies and we hold our responsibilities around
confidentiality and wall issues very, very seriously.
    Senator Fitzgerald. Do you believe Mr. Feygin would have
known that Enron owed your firm over $2 billion?
    Mr. McCree. I don't know how he would know that.
    Senator Fitzgerald. Because that is done over on the bank
side; is that correct, the loans or the prepay transactions
were done over there on the bank side and you are over at J.P.
Morgan Securities? You say you have a firewall there.
    Do either of the other of you want to comment on that issue
as to whether Mr. Feygin could have been in any way influenced
by the debt owed to your bank by Enron?
    Mr. Traband. I'm not aware of how Anatol could have been
aware of our exposure. I would--I certainly never had any
conversation with him about that, and would not have had any.
    Senator Fitzgerald. Do you know Anatol?
    Mr. Traband. Only by reputation.
    Senator Fitzgerald. Have you ever talked to him?
    Mr. Traband. I requested information from him once, and the
firewalls work that public information can be shared to
private, but private cannot go to public.
    Senator Fitzgerald. Did you ever have any conversations
with him about Enron?
    Mr. Traband. Not that I recall.
    Senator Fitzgerald. Mr. Dellapina, did you ever have any--
--
    Mr. Dellapina. I have never met Anatol and have never
spoken with him to the best of my knowledge.
    Senator Fitzgerald. You don't know him?
    Mr. Dellapina. I don't.
    Senator Fitzgerald. Mr. McCree.
    Mr. McCree. Never met him.
    Senator Fitzgerald. You have never met him, even though he
works within J.P. Morgan Securities, so you never talked to
him.
    Well, with that, Mr. Chairman, let me ask one final
question. All of the approximately $2.6 billion now owed to
JPMorgan Chase, how much of that is covered by surety bonds,
and they may be disputed whether the surety bonds are good, but
assuming they are good, how much of that is covered by surety
bonds?
    Mr. Dellapina. I believe that the amount is slightly over
$900 million.
    Senator Fitzgerald. So even if you could collect on the
surety bonds, you would be out approximately another $1.6 or
$1.7 billion; is that correct?
    Mr. Traband. Our total exposure at the time of the
bankruptcy was $2.6 billion. Not all of that was unsecured
exposure to Enron.
    Senator Fitzgerald. How much of it was secured?
    Mr. Traband. I think--and I am trying to recall the
numbers. I think that unsecured exposure was roughly $600 or
$700 million dollars.
    Senator Fitzgerald. Now, are you terming the loans for
which you had, or the prepaid transactions for which you had--
--
    Mr. Traband. Yes.
    Senator Fitzgerald. Now, it's interesting, these prepaid
transactions show up basically as debt in Enron's bankruptcy
filing, right, that you are just another creditor that they are
going to blow out just like they would blow out somebody who
had given them a straight-up loan?
    Mr. Traband. Well, all of their creditors appear in their
bankruptcy filing including accounts payable creditors.
    Senator Fitzgerald. Right. But we have gone along with not
calling these prepaid transactions loans. Mr. Dellapina was
explaining why it is not necessarily a loan, but we see that at
the end of the day when there is a bankruptcy filing the debtor
is just treating you like a bank that had given it an extension
of credit pursuant to a promissory note and they are going to
blow you out in bankruptcy court in their reorganization or
their liquidation. Of that $2.6 billion you said approximately
$600 million was unsecured, the rest of it was secured. Are you
describing the liability that is owed to you that is covered or
potentially covered by surety bonds as secured?
    Mr. Traband. Certainly prior to the bankruptcy we viewed it
that way.
    Senator Fitzgerald. OK.
    Mr. Traband. We obviously have not successfully collected.
    Senator Fitzgerald. But that is not really security. That
is a credit enhancement. That is a credit guarantee. It is not
the collateral.
    Mr. Traband. Yes, that's correct. I used ``secured''
broadly. Credit enhanced or secured.
    Senator Fitzgerald. So of the $2.6 billion, if you cannot
recover from the surety bonds, you will lose $900 million and
then another $600 million is unsecured. So you might have about
$1.5 billion that is actually secured and you think you could
get repaid on? What is your collateral for the $1.5 billion
that you think is secured?
    Mr. Traband. That varies. For example, $400 million would
be related to the pipeline loans that were entered into in
November prior to their bankruptcy.
    Senator Fitzgerald. And you got good security for that?
    Mr. Traband. We got good security for that. And there are
other transactions. At the time of the bankruptcy we had credit
exposure to their Florida Gas Transmission affiliate, which was
subsidiary-level financing. It was not technically secured, but
it was not to Enron Corp. So we were--the $2.6 billion is
aggregate exposure to Enron and Enron-related entities.
    Senator Fitzgerald. Now, is the bank carrying--what
percentage of the $2.6 billion had the bank reserved for and
what percentage are you carrying as nonaccrual?
    Mr. McCree. I do not know the nonaccrual or reserve. I
believe we have written off roughly $450 million of that
exposure.
    Senator Fitzgerald. You have written off $450 million----
    Mr. McCree. In the fourth quarter of this year, last year.
    Senator Fitzgerald. Presumably you have set aside
reserves----
    Mr. McCree. Yes. I just don't know what the number is.
    Senator Fitzgerald. You do not know the number.
    Mr. McCree. I think the general--just to finish, the
general comment I would make on this is, we have the largest
exposure we believe of any institution in the world to Enron.
We feel as--I'll use the word--defrauded as anybody else in
connection with the broad happenings at Enron. We believe that
we acted in accordance with law, in accordance with GAAP, and
from a reputational standpoint, which, Mr. Chairman, you
referenced, that we upheld our general reputation and tried to
do things as the rules were written. That is not saying the
rules were right or the rules were wrong. I think as we go
forward, as I said before, transparency is a fantastic
development and we applaud that. I would--or we would caution
about throwing the whole structured finance industry out based
on the effects of what Enron did. We think that the
fundamentals of structured finance, the legal basis on which
structured finance is done, and the constructs supporting the
industry need to have--need to be looked at, but once the rules
are looked at and well articulated, they are a fundamental
diversification of funding sources and a powerful tool for
corporations around the world, specifically in the United
States, if used responsibly.
    Senator Fitzgerald. So even though you may have lost an
awful lot of money by engaging as a banker for an entity that
was heavily engaged in monetization transactions, you are not
at all less enthusiastic to do more securitization transactions
in the future?
    Mr. McCree. I would say we are much more diligent in terms
of how the transactions are put together, the extent of
questions that are asked around the transactions and the
underlying broad financial condition of the companies that we
interact with.
    Senator Fitzgerald. Do you know if any banks declined to do
the transactions that you did for Enron before they came to
you; are you aware of that?
    Mr. McCree. I don't know the answer to that.
    Mr. Traband. Don't know.
    Senator Fitzgerald. OK. Mr. Chairman, I yield the floor
back to you.
    And thank you, gentlemen for being here. I think it took a
lot of courage to come before this Subcommittee and answer our
questions. Thank you.
    Senator Levin. Well, I do not think they had a heck of a
lot of choice, but nonetheless, we are glad that you were here,
and structured transactions and arrangements clearly do have a
purpose, Mr. McCree, if they are legitimate. And if they are
illegitimate and if they are deception, they not only do not
have a purpose that is acceptable, they have indeed a very
deleterious and a very negative effect on people who have
invested their savings and on the economy as a whole.
    When you say in your final comment, Mr. McCree, that the
move to transparency that is going on now is fantastic or words
to that effect, the whole purpose of these prepays, as used by
Enron, and in which you participated, was to hide the nature of
the transaction. So we are glad that you testify that you
welcome a move to transparency. I must tell you that is one of
the things that was missing here, that it was an effort here to
hide, in the words of that email, that Chase email, that were
so devastating here, which caused losses, huge losses to so
many people. Chase may have been stung by Enron. Apparently it
was. You are going to take some losses too. But that in no way
can justify any participation of Chase in the losses of others.
The fact that you yourself may have lost isn't in any way going
to excuse your participation in the deceptive practices that
Enron perpetrated.
    And that is going to be for others to judge. It is going to
be for the SEC and the Department of Justice, and I guess in
civil court where you are right now. You have got cases that
are existing in court that are brought by a number of people,
and you, yourself apparently are bringing suit on some surety
arrangement. So some of those issues will be resolved
elsewhere.
    But we will close your panel here by thanking you for
coming today. We will be calling upon people at Chase to give
us the answers to those questions relative to Mahonia, and we
will now stand adjourned because--excuse me one minute.
    Do we have votes?
    We will excuse you, and we will hold off calling our next
panel until after we return, which will be perhaps as long as
20 minutes because we have two roll calls I believe back to
back. Thank you.
    We will recess for about 20 minutes.
    [Recess.]
    Senator Levin. The Subcommittee will come back to order,
and I now would like to call our final panel of witnesses for
today.
    David Bushnell, the Managing Director of Global Risk
Management at Citigroup; James Reilly, Jr., the Managing
Director of Salomon Smith Barney, which is a member of
Citigroup; Richard Caplan, the Managing Director and Co-Head of
the Credit Derivatives Group at Salomon Smith Barney North
American; and finally, Maureen Hendricks, Senior Advisory
Director of Salomon Smith Barney. And I would ask you to please
rise and raise your right hands.
    Do you solemnly swear that the testimony that you will give
to the Subcommittee today will be the truth, the whole truth
and nothing but the truth, so help you, God?
    Ms. Hendricks. I do.
    Mr. Bushnell. I do.
    Mr. Reilly. I do.
    Mr. Caplan. I do.
    Senator Levin. Thank you. We will use the same timing
system as we did this morning for your statements, so please
keep your oral testimony to no more than 10 minutes, but we
will print any written testimony in the record in its entirety,
and the red light will come on after 10 minutes, but the green
will change to yellow after about 9 minutes to give you a
chance to conclude your remarks.
    And according to this, Mr. Reilly, you are to start I
believe; is that correct?
    Mr. Bushnell. Actually, Mr. Chairman, I am going to start.
    Senator Levin. OK. Mr. Bushnell.
 TESTIMONY OF DAVID C. BUSHNELL,\1\ MANAGING DIRECTOR, GLOBAL
RISK MANAGEMENT, CITIGROUP/SALOMON SMITH BARNEY, NEW YORK, NEW
                              YORK
    Mr. Bushnell. Good afternoon, and thank you for the
opportunity to come to speak with you today.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Bushnell appears in the Appendix
on page 316.
---------------------------------------------------------------------------
    My name is David Bushnell, and I'm a Managing Director at
Citigroup's Global Corporate and Investment Bank. I am head of
its Risk Management Division. That division functions as an
independent control unit over our operating businesses.
    Our institution recognizes the importance of the work that
this Subcommittee is doing with respect to its examination of
Enron's collapse. Enron's failure was a pivotal event in
American business. In the space of a few short months, Enron
went from an investment grade credit, ranked seventh in the
Fortune 500, to bankruptcy. Like many others, Citigroup lost
money as an Enron lender. More importantly, investors have lost
money, employees have lost jobs, and the public has lost
confidence in our financial markets.
    The integrity of our markets and the integrity of our
borrowers and their financial statements is of utmost
importance to us. We therefore commend the Subcommittee's
efforts to understand the factors that caused or permitted
Enron's stunning collapse, and we encourage changes in our
accounting or other rules that will protect against what
happened here.
    During our business relationship with Enron we thought we
were dealing with honest managers who had legitimate business
purposes for the transactions we did with them. We believe that
Enron was making good faith accounting judgments that were
reviewed by Arthur Andersen, which was then the world's premier
auditing firm in its sector. We believe that the Audit
Committee of Enron's board exercised meaningful supervision
over the company's accounting policies and procedures.
    The emerging facts suggest that Enron was not the company
that we thought it was. If what has been reported out turns out
to be the case, large-scale self dealing, inflated assets,
management that was inattentive or worse, a subservient board,
and a failure of accounting controls, we would not have done
the business we did with Enron.
    But let me be clear. While we regret our relationship with
Enron, we acted in good faith at all times. Our employees,
including the bankers who are here today, are honest people
doing honest business. They did transactions that were common
throughout the financial markets and they believe those
transactions were entirely appropriate.
    The focus of this hearing is structured finance and the
accounting rules that apply to the types of structured
transactions that Enron used. My colleagues will talk to you
about some of the specifics, but I want to emphasize that like
every other institution in the financial services industry, we
design financing structures for a diverse set of clients
against a background of accounting, tax, and legal rules. Some
of those accounting rules are complicated and subject to
interpretation by accounting experts. If specific rules do not
work the way they should, then they should be fixed. Moreover,
changes are needed to increase accounting oversight and the
reliability of companies' financials.
    I must stress, however, that we do not dictate our clients'
accounting practices. Once we are satisfied that a client's
proposed tax and accounting treatment seem reasonable, the
accounting judgments are left to the client and its accounting
professionals who have complete access to all of the
information. And this, I would submit, is as it should be. It
has always been the law and accepted practice that companies
are permitted to rely on the certified financial statements of
the party on the other side of the transaction. The auditors
are experts in understanding the accounting rules, and the
auditors are in possession of detailed information about the
companies' entire financial picture.
    Recent regulatory initiatives appreciate that
responsibility for the accuracy of financial statements, that
it must rest with the companies' management and auditors as
evidenced by the recent SEC rule requiring CEOs and CFOs to
certify the accuracy of their financial statements, and the
legislative proposal strengthening the independence and
oversight of the accounting function.
    At Citigroup I oversee a comprehensive process for
reviewing structured finance transactions. Our Commitment
Committee is responsible for reviewing equity and fixed income
securities underwritings to ensure that we are comfortable with
the transactions and so that we protect our reputation for
high-quality financings and retain investor confidence.
    Our Capital Markets Approval Committee--you'll hear us call
it CMAC here--reviews structured financing products and
approves only those transactions that it concludes are
appropriate. For example, the Enron--the Yosemite transactions,
about which this Subcommittee has expressed interest, were
reviewed and approved by our CMAC. We pride ourselves on our
reputation for being an institution with integrity. If a
transaction raises potential accounting, tax, legal compliance,
regulatory, or appropriateness issues for us or our clients, or
otherwise exposes us to reputational risk, the CMAC evaluates
those risks to ensure that our institution is comfortable in
completing the transaction. This is not to say that we
substitute our judgment for that of our clients, or their tax,
accounting or legal advisers. Responsibility for those
judgments remains with them.
    Thus, when we agreed to structure prepaid transactions for
Enron, we relied heavily on the assurances that its outside
auditor, Arthur Andersen, had reviewed these transactions.
Enron told us that Andersen believed the proposed accounting
treatment for the prepaids was appropriate. And while I'm not
an accounting expert and no one on this panel is, the
accounting treatment seemed reasonable to the members of our
CMAC.
    I am sure that the Subcommittee understands that at the
time these transactions were done, Arthur Andersen was
considered the preeminent accounting firm whose word carried
weight and gave comfort. Certainly now, with all of the
information that's come to light, it's easy to question
Andersen's review. And indeed, the information contained in
your Subcommittee's recent report on Enron's board is striking
for what it reveals about Andersen's own concerns about the
risk of Enron's accounting methodologies, but we learned about
these reservations only after the fact.
    The sobering facts about Enron set forth in this
Subcommittee's recent report make clear that much stronger
oversight of the accounting profession is needed. The report
also suggests that a rule-based accounting system such as
American GAAP may be too susceptible to abuse. It perhaps
should be supplemented by more of a principle-based system. We
would also support rules requiring greater management
accountability, more stringent board oversight and greater
board independence. These rule changes are essential if we are
going to re-establish the trust that is necessary to the
efficient functioning of our economy.
    Thank you, and I look forward to answering your questions.
    Senator Levin. Thank you very much, Mr. Bushnell.
    Mr. Caplan, are you next?
    Mr. Caplan. Yes.
TESTIMONY OF RICHARD CAPLAN,\1\ MANAGING DIRECTOR AND CO-HEAD,
 CREDIT DERIVATIVES GROUP, SALOMON SMITH BARNEY NORTH AMERICAN
              CREDIT/CITIGROUP, NEW YORK, NEW YORK
    Mr. Caplan. My name is Rick Caplan. I am a Managing
Director of Citigroup's Corporate and Investment Bank, and Co-
Head of the North American Credit Derivatives Group, one of
several groups at Citi that structure financings for
sophisticated corporate clients.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Caplan appears in the Appendix on
page 323.
---------------------------------------------------------------------------
    A prepaid swap transaction, the transaction you have
invited us to talk about today, is a form of structured
finance. Structured financings have been used over the past
several decades by virtually all sophisticated companies as a
way of raising money. While many structured financings have the
same impact as a loan, they often are treated differently for
accounting purposes. There are many examples of loan-like
transactions that have different accounting treatments,
including financing tools that support much of this Nation's
trading and fixed income securities, such as repurchase
agreements or repos and reverse repos, widely-used insurance
products such as guaranteed investment contracts and finite
insurance, equipment trust certificates widely used in the
airline industry and common project finance strategies such as
synthetic leases.
    As this Subcommittee is aware, Enron made extensive use of
structured finance. Indeed, from 1995 through 2001 Fortune
Magazine selected Enron as the most innovative company in
America. And in 1999, Enron's CFO, Andrew Fastow, was awarded
CFO Magazine's Excellence Award for Capital Structure
Management, based on the unique financing techniques he
pioneered.
    For all of Enron's innovation and sophistication, the
prepaid swap transactions we are discussing today, were hardly
a unique financing technique. Prepaid swap transactions and
similarly commodity-based financings have been widely used in
the power and energy industry since the 1970's. In essence a
prepaid swap contract involves an up front cash payment by one
party in return for an obligation by another party to deliver a
commodity for the cash value of that commodity at some point in
the future. In the prepaid engaged in by Citibank with Enron,
Enron received cash up front in exchange for Enron's obligation
to deliver at some point in the future a specific quantity of
gas or oil or its financial equivalent.
    The prepaids provided Enron with an ability to raise cash
against certain long-term assets, which as we understood it,
helped Enron address a disconnect between the revenue and cash
flow in its trading book. Enron told Citibank that because of
the way auditors, including its auditors, Arthur Andersen,
accounted for prepaids, Enron could use prepaids to bring its
cash flow in line with its revenues. As Enron explained,
because prepaids were comprised of commodity trades, executed
in Enron's trading book, Enron's financial obligations on these
trades, were recorded in its trading book as a trading
liability, termed price risk management liability, and the cash
generated by these trades would be disclosed in its cash flow
statement as cash flow from operations.
    Enron assured Citibank that its accounting treatment of
prepaids had been fully vetted by Arthur Andersen, which at the
time was one of the Nation's leading accounting firms. The
accounting position we understood Enron was taking seemed
reasonable based on our understanding of the then-existing
accounting rules and guidelines. I should add that Citibank did
not advise Enron, nor would it advise any client as to the
appropriate accounting treatment of any transaction. Some have
suggested that prepaids are off-balance sheet or that the
liabilities that Enron incurred as a result of these financings
somehow were disguised or hidden. That simply is not true.
Enron's obligations on these financings were clearly reflected
as liabilities on Enron's balance sheet, and denominated as I
said before, as a price risk management liability.
    A price risk management liability is a liability, plain and
simple, that must be satisfied every bit as much as debt. Thus,
while not recorded as debt, prepaid liabilities were clearly
obligations of the company, and visible as such to investors.
    There also has been a suggestion that Enron somehow was
able to generate extra cash flow by using prepaids instead of
loans. That also is not accurate. The overall cash flow for
Enron would be exactly the same whether Enron used prepaids or
entered into a bank loan. In the case of prepaids, Enron booked
the funds it received on these contracts in its cash flow
statement as cash from operations, not as cash from financing.
We understood that Arthur Andersen has fully vetted this
accounting treatment as well. Another point I would like to
address is the confusion that has arisen between prepaids and
Credit Linked Notes. There is no necessary linkage between the
two. Prepaids exist without Credit Linked Notes. Credit Linked
Notes exist without prepaids.
    A Credit Linked Note is simply a security through which an
investor takes on the credit risk of a particular company
without actually purchasing a bond issued by that company.
Credit Linked Notes are well recognized financial instruments.
Citi structured Enron Credit Linked Notes called Yosemite and
the ECLNs. These instruments were sold to the largest and most
sophisticated institutional investors in several Rule 144A
offerings. As with every offering that Salomon Smith Barney
brings to market, the Enron Credit Linked Notes and the
underlying prepaid financings that the notes funded were fully
vetted and reviewed. The firm's stringent internal control
processes are designed to safeguard Citi's reputation through
careful screening of potential transactions. The Credit Linked
Notes and the underlying prepaid financings were approved only
after undergoing this screening process. I believe that our
conduct in arranging the prepaids and in selling Enron Credit
Linked Notes was entirely appropriate. We arranged these
financings for what appeared at the time to be one of America's
best and most admired companies. We used the financing
structure that had been commonly employed in the energy and
power industry for many years, and we relied on the fact that
Enron's accounting treatment of these transactions was blessed
by one of the Nation's leading accounting firms and seemed
reasonable under the then-existing accounting rules and
guidelines.
    Thank you, and I look forward to answering your questions.
    Senator Levin. Thank you, Mr. Caplan. Ms. Hendricks.
 TESTIMONY OF MAUREEN HENDRICKS,\1\ SENIOR ADVISORY DIRECTOR,
       SALOMON SMITH BARNEY/CITIGROUP, NEW YORK, NEW YORK
    Ms. Hendricks. Thank you, Mr. Chairman, and Members of the
Subcommittee. My name is Maureen Hendricks, and I am currently
a Senior Advisory Director at Salomon Smith Barney. From 1999
until May 2001 I was the head of Salomon Smith Barney's Global
Energy &amp; Power Group, with the responsibility for the Enron
account.
---------------------------------------------------------------------------
    \1\ The prepared statement of Ms. Hendricks appears in the Appendix
on page 330.
---------------------------------------------------------------------------
    As you have heard quite often Enron was a significant user
of structured finance, which is simply a way of providing cash
to a company through means other than traditional bank loans.
And far from being faulted for it, at the time, Enron was
celebrated for its innovative financing techniques.
    One project that I worked on for Enron was the Yosemite
structure, which was designed as a way for Enron to do
structured finance in the capital markets. As it happened, the
structured financing underlying the Yosemite offerings was a
prepaid. Prepaid are a commodity-base structured financings
that were widely used in the energy sector. Production
payments, which I structured back in the 1970's, are precursors
of the prepaids at issue here today. And like prepaids, they
originally had certain accounting advantages over straight
loans.
    At the time that we structured the Yosemite deals, I had
absolutely no reason to believe that there was anything wrong
with prepaids or with Enron's proposed accounting treatment for
them. Indeed, it appeared very familiar. Moreover, we
understood from Enron that Arthur Andersen had fully vetted the
accounting treatment. In shepherding the Yosemite offering, I
oversaw the due diligence that we conducted of Enron in close
cooperation with our outside counsel. I believe that we asked
the company to answer questions. I regret to say that it
appears from all that has recently been disclosed that we were
not provided with the right answers by Enron management. It
also appears that the audited financial statements upon which
we relied were not accurate and did not present fairly Enron's
financial condition. I believe the decision to approve these
transactions was an appropriate one based on the information
that had been provided to me and my team. I continue to believe
that structured finance, if used by honest companies, whose
books are reviewed by responsible auditors, serves a valuable
function in our Nation's economy. However, with the benefit of
hindsight and the raft of recent disclosures about Enron, I
deeply regret that our firm ever entered into transactions with
this company.
    Thank you.
    Senator Levin. Thank you very much. Mr. Reilly.
TESTIMONY OF JAMES F. REILLY, JR.,\1\ MANAGING DIRECTOR, GLOBAL
      POWER &amp; ENERGY GROUP, SALOMON SMITH BARNEY/CITIGROUP
    Mr. Reilly. Thank you, Mr. Chairman and Members of the
Subcommittee. My name is Jim Reilly. I am a Managing Director
of the Global Power and Energy Group at Salomon Smith Barney. I
have spent more than 25 years as a banker covering the energy
industry, and I have spent virtually my entire banking career
in the city of Houston.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Reilly appears in the Appendix on
page 334.
---------------------------------------------------------------------------
    I was a relationship manager for Enron and its predecessor
companies since the 1980's, first at Bankers Trust, later at
Citibank, and finally at Salomon Smith Barney. Relationship
managers work closely with a particular group of clients in
order to understand best their needs. We help them access the
full range of resources and expertise available at the firm.
Thus, if a client came to me with a particular financing
objective, I would put it in touch with the appropriate group
at Citibank or Salomon Smith Barney that was best positioned to
help accomplish its goals. While in most cases I have a general
familiarity with the transactions that my firm arranges for the
clients, I do not structure these transactions and typically am
not close to the details.
    I am aware that questions have now been raised about my
references in certain emails to what the New York Times
reported were ``secret oral agreements.'' There were no
``secret deals.'' The facts are these. In December 1998
Citibank and Enron entered into a $500 million 3-year prepaid
swap transaction for the delivery of oil and natural gas.
Agreements were entered into with insurance companies to
guarantee the delivery of the oil and natural gas. It was
understood that Enron would likely settle this contract early
within several months, but that informal expectation did not
affect the basic 3-year agreement between the parties. In April
1999 Citibank was prepared to syndicate the deal to other banks
to spread its risk. Enron preferred that Citibank not do that
for reasons having to do with other unrelated credit needs of
Enron. Enron paid down a $375 million portion of the contract
around that time and expressed its intention to settle the rest
of the contract several months later in September, an informal
expression of intent not unlike its original December 1998
indication that it expected to settle the contract early.
    There was no binding agreement between Enron and Citibank
that Enron would in fact settle the contract at that time.
There was still a 3-year derivative contract covered by 3-year
insurance contracts. Indeed September 1999 came and went
without Enron settling the contract. No one took action or
considered taking action against Enron because there had been
no binding or enforceable agreement that Enron had broken. In
short my emails about the paperwork not reflecting Enron's
intention to settle the contract ahead of time were meant only
to alert my coworkers that Enron was intending to take
Citigroup out of the transaction. No one read that language to
refer to a binding or enforceable agreement, and that's not the
way it was intended.
    On a more personal note, I have lived in Houston for
virtually all of my working life. Every day I see the tragedy
that Enron's demise has wrought on my home town, and it saddens
me greatly. It is for that reason that I want to thank this
Subcommittee for the thorough and detailed investigation it is
conducting.
    I look forward to answering your question.
    Senator Levin. Thank you very much, Mr. Reilly.
    First though let me ask you a question, Mr. Caplan. Do you
agree that there was an objective on the part of Enron to
structure these transactions so that the cash obtained by Enron
would be reported in the cash flow statement as funds flow from
operations, rather than as funds flow from financing or debt?
    Mr. Caplan. I would say, Mr. Chairman, that was the
express--one of the express objectives of the company in
entering the financings.
    Senator Levin. And that you were aware of that objective?
    Mr. Caplan. Absolutely.
    Senator Levin. Exhibit 144,\1\ if you would have a look at
that. This is a loan approval memo. The exhibits are in the
books in front of you there.
---------------------------------------------------------------------------
    \1\ Exhibit No. 144 appears in the Appendix on page 513.
---------------------------------------------------------------------------
    On page--it is under No. 7, Key Success Factors under the
word ``story'' in the middle. It said there--and this is a
Citicorp document--that the prepaid forward structure will
allow Enron to raise funds without classifying the proceeds
from this transaction as debt. Is that correct?
    Mr. Caplan. That is correct.
    Senator Levin. That was clearly known to you. Now, Exhibit
145,\2\ this is a September 2000 email in which a Citicorp
employee discusses how to present the Yosemite transaction to
potential investors. In it he demonstrated he understood that
the purpose and the benefits of prepaid transactions included
allowing Enron to generate cash flow without increasing the
company's reported debt, and right in the--at the beginning
where it says, ``First, I would go through the prepaid on a
stand-alone basis, and get into why a company does it, gets
cash flow, shows up as other liability not debt.'' And then in
the middle where it says, that ``Enron pays back a fixed stream
over time, net net, economically like a loan.'' Then near the
bottom, about 5 lines up, it says, ``E'', Enron, ``gets money
that gives them [cash flow] but does not show up on books as
Debt.'' So that was very clearly understood, that they were
trying to have cash flow come from business transactions and
not appear as debt on their books; is that correct?
---------------------------------------------------------------------------
    \2\ Exhibit No. 145 appears in the Appendix on page 523.
---------------------------------------------------------------------------
    Mr. Caplan. Yes, sir, I would say it's very correct because
this transaction that's described here and we're discussing
today is a form of structured financing, and there are many
forms of structured financing out there that have loan-like
characteristics that people don't call loans. So none of this
would be unusual in this kind of--in speaking about something
like this, even saying something like ``net net, economically
like a loan,'' I think that's a true statement, but that you
could say about a lot of different products that companies
enter into.
    I think a good example is a synthetic lease, where a
company wants to buy a building, and they can kind of do it one
of two ways. One way they can do it is go to the bank and
borrow the money to buy the building and record that borrowing
as a loan on its books. Alternatively, what the company can do
is go to the bank and say, ``You bank, buy the building and
lease the building to us for the economic life of the building,
and we'll call that a lease, and we won't record that on our
books as debt, we'll record it as lease payments.'' And I think
the point of this is that there are many different ways to
structure financings, and they're all based on interpretations
of accounting rules by internal accountants and by outside
auditors that are within the companies own purview and not the
responsibility of the banks.
    Senator Levin. Well, maybe we will look at synthetic leases
next year, but we are looking at prepays at the moment.
    If you look at a memo on Yosemite I, this is----
    Mr. Bushnell. Excuse me, Senator. What number exhibit is
that?
    Senator Levin. I was just going to get to that. Exhibit
146.\1\ This is a chart prepared by Citibank. Now, this chart
was prepared by Citibank and completed prior to the Yosemite I
offering. The numbers do not correspond to the numbers involved
in the Yosemite I prepay, but it is illustrative of how various
features of the transaction are calculated. Is it not true that
the amount of oil or the gas used in the Enron Citi prepays was
determined by the amount of money that Enron was getting? In
other words, you back into the amount of oil and gas that is
the basis of the transaction; is that correct?
---------------------------------------------------------------------------
    \1\ Exhibit No. 146 appears in the Appendix on page 524.
---------------------------------------------------------------------------
    Mr. Caplan. The ways the transactions were structured is
that--again, like in other alternative forms of financing, the
company came and said they wanted to receive funds of a certain
amount, and then the transactions were structured so that you
created a barrel equivalent or a gas equivalent of that amount
of funds and attached a price to it. So I think that, yes.
    Senator Levin. So they did not decide first how many
barrels of oil they wanted to sell in advance; they decided
first about how much money was needed, and then they translated
that into the current or predicted future price of oil; is that
correct?
    Mr. Caplan. I think that is a fair way to say it.
    Senator Levin. Now, a memo on Yosemite I which was prepared
by the Enron Tax Department described the prepay transaction
funded by Yosemite I as a prearranged integrated transaction.
That was a memo on Yosemite I prepared by the Enron Tax
Department. Would you agree with that description of the prepay
transaction, a prearranged integrated transaction?
    Mr. Caplan. I'm actually not clear what that means. That
sounds like a tax term for describing the transaction, and we
weren't privy to their internal tax memos or what their tax
treatment of the transactions were, so I feel like I can't
really comment on the use of that term.
    Senator Levin. That term appears at the bottom of page 1 of
Exhibit 147.\1\ You see it down there?
---------------------------------------------------------------------------
    \1\ Exhibit No. 147 appears in the Appendix on page 529.
---------------------------------------------------------------------------
    Mr. Caplan. I'm sorry. Where is it?
    Senator Levin. See at the last line, where it says
``prearranged integrated transaction?''
    Mr. Caplan. Yes.
    Senator Levin. That is an Enron document, but my question
to you is do you think that is an accurate description of the
prepay transaction that Citibank, Delta and Enron were engaged
in?
    Mr. Caplan. I would say that the legs of the transaction
were certainly arranged at the closing of transaction. I'm not
sure--again, I'm not sure if that's a tax term, integrated
transaction. So I don't really know how to comment on that. The
legs of the transaction were all executed on the same day.
    Senator Levin. Simultaneously?
    Mr. Caplan. On the same day at the same time, yes.
    Senator Levin. Now, Exhibit 148 is your chart.\2\
---------------------------------------------------------------------------
    \2\ Exhibit No. 148 appears in the Appendix on page 537.
---------------------------------------------------------------------------
    Mr. Caplan. I think this might be an Enron chart.
    Senator Levin. Is that an Enron chart? Yes, you are right,
it is an Enron chart. It is called a Prepay Walk Through. This
is a prepay walk through. It reviews a Citibank, Delta and
Enron prepay, and it is a little difficult here to read, but it
reports one important point in a box next to the name of each
entity in the transaction, and that is that each entity in that
triangle is completely hedged. In other words, there is no
price risk. Can you read that? Are you able to read that?
    Mr. Caplan. Yes, I am.
    Senator Levin. The top box, it is kind of hard to read, but
it says ``Delta'' at the top and then it says ``Debt is now
completely hedged,'' underneath the word ``through.'' Do you
see that?
    Mr. Caplan. Yes, I can read it.
    Senator Levin. And then down at the right it says Citibank
or ``Citi is now completely hedged.'' See that?
    Mr. Caplan. Yes.
    Senator Levin. And then on the left it says ``Enron'' and
then it is kind of hard to read because it has got black ink
over it, but it says, ``Enron is now completely hedged and has
only limited exposure to Delta.''
    Mr. Caplan. Yes, I can read that.
    Senator Levin. So at that point there is no price risk; is
that correct?
    Mr. Caplan. I think on the beginning of the transaction, in
the first leg of it, the price risk is created, and then that
price risk is hedged away by entering into the next two legs.
So when all the legs are executed, the price risk, the intent
is to eliminate the price risk.
    Senator Levin. And that was done all at the same time?
    Mr. Caplan. It was done all at the same time.
    Senator Levin. When those three legs were put together,
there was no price risk?
    Mr. Caplan. When the transaction was--when all the legs
were executed, the price risk was eliminated, which I think
this is an interesting piece of paper to look at because it
clearly indicates that Enron, and I would think therefore their
accountants, understood the nature of the transaction and the
way that the legs worked together.
    Senator Levin. And so did Citibank.
    Mr. Caplan. And absolutely, so did Citibank.
    Senator Levin. And the parties worked together to arrange
that?
    Mr. Caplan. We worked with Enron to structure the
transaction so that our risks were hedged and that it met their
requirements. Enron worked with their accountants to set the
transaction up so that they could book the transaction as they
saw fit, but we did not get involved in their accounting
decision, nor do we get involved in any company's accounting
decisions.
    Senator Levin. Who represented Delta?
    Mr. Caplan. Delta was represented by a firm in the Cayman
Islands called Maples and Calder.
    Senator Levin. But in that particular transaction who
represented them?
    Mr. Caplan. In this particular----
    Senator Levin. Yes. When you were putting together that
triangle, who represented Delta?
    Mr. Caplan. Maybe we should spend a couple minutes----
    Senator Levin. Not quite yet. Who represented Delta when
you put together--you said the same day they were all----
    Mr. Caplan. Well, the way the transactions were documented
is--in these kinds of structured financings, usually the
investment bank prepares the documentation, so our counsel,
Milbank Tweed, prepared all of the documentation. Delta had its
own counsel, but that counsel's role was somewhat limited in
the transaction.
    Senator Levin. Well, was it there at all?
    Mr. Caplan. Yes, it was definitely there because they
reviewed the documents and had to prepare board resolutions and
do all the things that make Delta an independent entity for
accounting purposes, which is what's relevant here.
    Senator Levin. Who paid Milbank Tweed?
    Mr. Caplan. Mainly in these transactions Enron paid Milbank
Tweed.
    Senator Levin. So Delta's lawyer was paid by Enron?
    Mr. Caplan. Delta's lawyer--it depended on the
transaction--honestly, I don't remember exactly, but Delta,
some of the fees for Delta's lawyers were paid by us, some were
paid by Enron, some were paid by spreads in the transaction
where amounts were--where when you netted out the three legs of
the transaction, there was a spread left at Delta, and that
paid some of the fees to their lawyers and their management and
that sort of thing. It's a very typical kind of arrangement for
the bank to make those payments or----
    Senator Levin. So what did Delta pay?
    Mr. Caplan. What did Delta make?
    Senator Levin. Pay.
    Mr. Caplan. Pay?
    Senator Levin. You paid part of it, Enron paid part of the
Milbank fee. What did Delta pay? What part of the fee did Delta
pay?
    Mr. Caplan. To its lawyers?
    Senator Levin. Yes.
    Mr. Caplan. I'm not clear that they paid any of their fees
to their lawyers. Only if there was spread left in the
transaction that was there to pay lawyers, but it was never
intended that Delta was going to have huge sums of money to
pay--to pay its lawyers or anyone else.
    Senator Levin. How about any sums of money?
    Mr. Caplan. It was intended to have sums of money, yes.
    Senator Levin. Have a spread?
    Mr. Caplan. To have--yes, there were always earnings at
Delta in these transactions, because there were transaction
costs associated with using Delta as the special purpose entity
in the deal.
    Senator Levin. But you do not think they paid Milbank on
this one; you think it was either you or Enron?
    Mr. Caplan. Yes. It was either us or Enron. Enron paid all
of the--until they went into bankruptcy, they paid all of the
Milbank bills. Some remained outstanding.
    Senator Levin. Now, in the prepays involving, or most of
the prepays involving Enron, Citibank, and Delta, did
commodities ever change hands?
    Mr. Caplan. All of the prepaid transactions that I worked
on were financially settled, which means that there is no
change of commodities between parties. In the commodities
market you can do transactions that are either physically
settled by delivery of the commodity, or you can financially
settle the contract by just exchanging payments based on the
price of whatever the commodity reference is.
    Senator Levin. And can you tell in advance in this
particular one whether it was intended that commodities
actually be transferred?
    Mr. Caplan. Absolutely not, because these were financially
settled arrangements.
    Senator Levin. It was never intended that the commodities--
--
    Mr. Caplan. I think in some of the earlier prepaids that
predate my time at Citibank, and I think a large part of the
reason Delta was set up in the first place was because there
was going to be a physical delivery of commodities, and
Citibank, as a bank, under its regulatory regime, wasn't able
to take physical deliveries of commodities, so I think the
intent was there, but when I got involved, financial settlement
was the way--was the method of settlement of choice.
    Senator Levin. Looking again at that Exhibit 148, would you
agree that the point here was to eliminate price risk, ensure
that the funding source get its money; in other words, to
perfectly hedge the transaction; would you agree with that,
that was the intent?
    Mr. Caplan. I'm sorry. Where are you reading that?
    Senator Levin. Exhibit 148, that transaction that is
described there with that triangle, the intent of that was to
ensure that the funding source get its money, price risk be
eliminated, and that it be a perfectly hedged transaction.
    Mr. Caplan. Absolutely, because as a bank, we don't look to
take on commodity risk. We look to take on credit risk. So any
time we enter into a transaction that creates some commodity
risk, the first thing we do as a prudent risk management
exercise is to go and hedge that commodity risk. So that was
absolutely the intent.
    Senator Levin. All of the parties were hedged in that one?
    Mr. Caplan. All of the parties were hedged in this one,
yes.
    Senator Levin. Now, as we learned earlier today, it is
important that the third party be independent of the first two
parties or the other two parties. So we are now going to talk a
bit about Delta.
    Delta, as we understand it, was formed in the Cayman
Islands in 1993. Do you know who formed Delta?
    Mr. Caplan. Yes, absolutely. It was formed by Citibank,
much as Citibank forms special purpose entities to do lots of
structure finance transactions, much as other institutions in
the market form special purpose entities.
    Why they're called special purpose entities is they are
formed to do a specific purpose, and we formed it--we were
involved in setting it up and identifying a law firm that could
draft the papers, and paying that law firm in the Cayman
Islands.
    Senator Levin. You paid the law firm?
    Mr. Caplan. Absolutely.
    Senator Levin. To set up Delta?
    Mr. Caplan. We paid the law firm to set up Delta. We--much
as we do in many of these--whether it's a credit card
receivables transaction, mortgage securitization, we set Delta
up for accounting and legal purposes as an independent entity.
We were trying to satisfy accounting tests then in existence
which still apply today, and Delta's been--as you just noted,
Delta's been around since 1993. It's been vetted through our
accounting system over that period of time, and it remains for
accounting purposes an independent entity.
    Senator Levin. And who effectively controls Delta? Putting
aside the accounting purpose, who effectively controls Delta?
    Mr. Caplan. I'm not sure----
    Senator Levin. Common sense terms.
    Mr. Caplan. Common sense terms, when you're talking about
SPVs, I don't think they're that relevant.
    Senator Levin. Just in conversation here, I am asking you a
simple question. Who has effective control of Delta?
    Mr. Caplan. I'm not certain what--regardless of who has
effective control of Delta, I'm not certain why that's a
relevant aspect of any of this.
    Senator Levin. We will decide the relevance of it. But why
don't you try to answer the question. Who has effective control
of Delta?
    Mr. Caplan. I would say the directors of Delta, because
it's, as a legal matter and as an accounting matter, and I know
that you're saying not to look at this as an accounting matter,
but I think the only way you can look at Delta is from an
accounting perspective, because the only reason it's there is
to satisfy the rule-based system of accounting that we have.
It's very similar to--I mean ``control'' is a tough word for me
to work with. It's very similar to the word ``gain'' in the tax
code. There are multiple definitions of ``gain'' depending on
the circumstance you're talking about at the moment, and
``control'' has that same connotation, and I think the
relevance of ``control'' here----
    Senator Levin. It has nothing to do with gain. It has to do
with who controls the entity, that is all. But in any event,
has Delta ever entered into a prepay transaction in which
Citibank was not involved?
    Mr. Caplan. No, it has not.
    Senator Levin. Was it created to assist Citibank?
    Mr. Caplan. It was absolutely created to assist Citibank.
    Senator Levin. And is it owned by a charitable trust?
    Mr. Caplan. It is.
    Senator Levin. Called Grand Commodities Corporation?
    Mr. Caplan. That's my understanding.
    Senator Levin. And who has control of that trust?
    Mr. Caplan. I'm not certain of who controls that trust.
    Senator Levin. Do you know, Mr. Bushnell?
    Mr. Bushnell. No, I don't, Senator.
    Senator Levin. Do you know, Ms. Hendricks?
    Ms. Hendricks. No, sir.
    Senator Levin. Do you know, Mr. Reilly?
    Mr. Reilly. I don't, Senator.
    Senator Levin. Could Citibank control that trust?
    Mr. Caplan. Not to my knowledge.
    Senator Levin. Could it?
    Mr. Caplan. It would be pure conjecture to answer that,
but----
    Senator Levin. As far as you know, who--when you want Delta
to do something, you notify some lawyer down there in the
Caymans?
    Mr. Caplan. Yes, absolutely. Again, this----
    Senator Levin. And you pay that lawyer's fees or Enron
does, right?
    Mr. Caplan. It depends on the transaction. It's been
different in every one. But, again, I don't find any of that
unusual for structured----
    Senator Levin. I am not arguing usual or unusual. In fact,
it is probably mighty discouraging that it is very usual. The
fact that it is common doesn't mean that it is not deceptive.
The question is whether or not a common practice was put here
to a deceptive purpose. That is the issue here. You have got a
lawyer down in the Cayman Islands. It is a secrecy
jurisdiction. You can't pierce that veil. Some trust is
created, just the way it was--we just went through that with
Chase. Some trust is created. In the case of Chase, Chase's
lawyers created the trust. We don't know who created this
trust. You don't know who created this trust. We are going to
try to find out, if you will be cooperative.
    Along that line, by the way, will you agree to authorize
Maples and Calder in the Cayman Islands to give the
Subcommittee all documents relating to the formation,
ownership, and activities of these entities? Will you give us
that authority?
    Mr. Caplan. I think we'd have to defer to counsel to answer
that question.
    Senator Levin. Will you let the Subcommittee know whether
you will give us that authority?
    Mr. Caplan. Absolutely.
    Senator Levin. Why do you do this in the Caymans, a secrecy
jurisdiction? Why aren't you just open about these kind of
things? You are forming an entity. The operations of that
entity are hidden. It has got to be independent or else this
whole thing doesn't work. It doesn't work for other reasons, by
the way, which it seems to me you have already pretty well
cleared. It was all done at one time. There is linkage between
the transactions. According to our experts here, this doesn't
even qualify in any event, no matter who owns Delta.
    But putting that aside just for a moment, why are you
forming this kind of entity in the Cayman Islands, in a secrecy
jurisdiction? And why do you hesitate to say that you will give
us authority to try to pierce that secrecy to find out who owns
that trust which holds the stock in Delta? That is troubling
and I want to know your answers, either you or Mr. Bushnell.
    Mr. Bushnell. I think I would answer in a couple of ways,
Senator. I think the reason why we want to check with counsel
is we don't know if we are able to enforce anything on----
    Senator Levin. I didn't say that. I said authorize.
    Mr. Bushnell. Authorize to ask. We certainly could ask.
Whether they'll respond to that or not, I don't know what their
terms and bylaws and conditions are.
    Senator Levin. Are you then saying that you will--that
Citibank will authorize us to--that you will authorize them to
turn over any documents that they have to this Subcommittee?
    Mr. Bushnell. Again, Senator, that is something that I want
to discuss with counsel.
    Senator Levin. OK. Then let's go back to the Caymans. Why
do you do this in secrecy jurisdictions? Why not do it in
daylight?
    Mr. Bushnell. Do you want to answer that, Mr. Caplan?
    Mr. Caplan. Yes, I don't think that there's anything really
nefarious about doing it in the Caymans. Again, you have to
step back and put this in perspective of what this business is.
And the structured finance business has developed over the last
30 years, and a lot of it is around using these special purpose
entities, and you often set them up in different jurisdictions.
And I think the main reason you use the Caymans is there's tax
neutrality in the Caymans. It's not because we are trying to
hide something. All the transactions that we've done with Delta
you see in these papers. We have fully disclosed what we have
done with Delta. I don't think we're trying to in any way----
    Senator Levin. We don't know who Delta is. We can't find
out from the Caymans----
    Mr. Caplan. I think the reason for that is there's not much
to know about Delta. It's a special purpose entity----
    Senator Levin. I think you are right. It is a shell.
    Mr. Caplan. It satisfies accounting requirements to be an
independent entity, and that was the sole purpose for setting
it up. That was the sole purpose for its use. And I think that
if you would examine other special purpose entities used by
Citibank and other banks and other corporations in receivables
financings or mortgage financings, you will find that they have
very similar characteristics to Delta. And if the Subcommittee
thinks that that's an appropriate thing to spend its time on,
we would applaud anything that makes things clearer to people
in the market.
    Senator Levin. You would applaud making things clearer to
the market including----
    Mr. Caplan. Yes.
    Senator Levin [continuing]. The nature of Delta. And yet
you are reluctant to authorize us to find out everything that
we can from Delta. You have to check with counsel.
    OK. But, at any rate, let me go back to one of the criteria
for this to be a true trading--for a prepay to be a trading
contract, according to the experts before us, the purchaser of
the gas must have an ordinary business reason for purchasing
the gas, not in substance be a special purpose entity
established just to get a secured investment in a dead
instrument from a gas supplier.
    Now, that is what our experts say a legitimate prepay has
got to meet, and you have just told us twice this entity was
created purely for accounting purposes, no intention whatsoever
that that purchaser of the gas have an ordinary business reason
for purchasing it. So, whether or not we pierce that veil
around Delta--and we are going to keep trying--according to the
experts here, this is not a legitimate prepay by your own
testimony because Delta was created solely for accounting
purposes, you have told us twice. It does not have an ordinary
business reason, which it must have, for purchasing the gas. It
cannot in substance be a special purpose entity. You just told
us that is all it is, is a special purpose entity.
    Do you want to respond to that? Because you have just, it
seems to me, proven what we have, what our staff has, I think,
very thoroughly proven in not only that way but in a lot of
other ways as well. But do you want to comment on that?
    Mr. Caplan. Well, might I ask what that document you're
referring to is?
    Senator Levin. This is the document which the experts
here--which we had this morning. It is not a document. These
are the criteria for a legitimate prepay.
    Mr. Caplan. Is it in the exhibit book?
    Senator Levin. It is not in the exhibit book. It is--what
is the exhibit number? Exhibit 112?\1\
---------------------------------------------------------------------------
    \1\ Exhibit No. 112 appears in the Appendix on page 367.
---------------------------------------------------------------------------
    We asked the experts that we had this morning about the
document which Arthur Andersen prepared for its customers
saying that for prepays to be treated as trading contracts, the
following attributes must exist, and then if you will look at
page 4, the purchaser of the gas must have an ordinary business
reason for purchasing the gas, not in substance be a special
purpose entity established just to affect a secured investment
in the debt instrument from the gas supplier. We asked them,
our experts, whether or not those criteria, in fact, must be
met in order for there to be a legitimate prepay transaction
that would appear as a business expense or a business operation
on the books rather than a debt. They all said yes this
morning. Do you have any reason to doubt that that is accurate?
    Mr. Caplan. Just briefly looking through this, I think this
is a very interesting document because it's a document prepared
by Enron's auditors. So, clearly, Enron's auditors had to----
    Senator Levin. It is by Arthur Andersen.
    Mr. Caplan. Right, which is----
    Senator Levin. Arthur Andersen, at least at that moment,
was known as a legitimate firm which----
    Mr. Caplan. Absolutely.
    Senator Levin [continuing]. Set up the caution. Here Arthur
Andersen is being cautionary here. They are telling their
client, if you are going to have a legitimate prepay, you have
got to follow certain rules. It is certainly nice to hear
Arthur Andersen laying down certain rules for Enron. They told
Enron for prepays to be treated as trading contracts, in other
words, not as debt, the following attributes must exist, and
then they listed here--this attribute doesn't exist in the
contract that you just mentioned.
    Mr. Caplan. Well, what's interesting to me about this
exhibit is that if truly that is Arthur Andersen's opinion and
Arthur Andersen knew of the entire transaction as described in
the Enron documents you've just shown me, I would say either
one of two things happened: Arthur Andersen concluded that
these criteria were met because they gave a clean audit opinion
for Enron through all the periods--and I see this document has
a 1997 reference in it, so it's clear that this was in
existence for a while; and if our transactions didn't meet
these criteria, which I'm seeing for the first time, frankly,
and Arthur Andersen still gave a clean opinion, then what does
that say about what Arthur Andersen was doing?
    Senator Levin. But they didn't know who Delta was. And you
do.
    Mr. Caplan. Why, then----
    Senator Levin. They are just telling their client Delta has
got to be--they just lay it out here. Delta has to have an
ordinary business reason for purchasing the gas. They are
notifying their client of that.
    Mr. Caplan. But then I----
    Senator Levin. They don't know who Delta is. You do.
    Mr. Caplan. Absolutely.
    Senator Levin. You just told me that Delta must have an
ordinary business purpose for purchasing the gas, not in
substance be a special purpose entity. You knew they were a
special purpose entity. You said twice, of course, that is all
they are. So unless you disagree with that criteria for what is
a legitimate prepay, you have demonstrated why this was not a
legitimate prepay. And yet it appeared on the books as a
legitimate prepay.
    Mr. Caplan. Senator, could I----
    Senator Levin. You referred investors to those books, by
the way.
    Mr. Caplan. I would actually disagree with the statement
that Arthur Andersen had no knowledge of Delta.
    Senator Levin. Forget that. If they had knowledge of Delta
and knew then that it violated their own criteria, then they
are culpable. I am not talking about Arthur Andersen. We have
had them here. We will have them again. I am talking about you
folks. You folks knew by your own testimony that Delta did not
have an ordinary business purpose for purchasing the gas. It
was a special purpose entity. You have told us that twice. So
unless that criteria is wrong--and we had an expert here this
morning that said it is not wrong, by the way--you folks
knowingly participated in a transaction characterized as a
prepay which, in fact, was not a prepay.
    Now, do you disagree with this criteria as being accurate?
    Mr. Caplan. I disagree with--I have no basis for--I mean,
this is an accounting interpretation, so I have no--I'm not an
accountant. I have no basis for determining what the right
criteria are for a prepay to be treated as a prepay on a
company's books. That is between the company and its auditors.
    We were of the belief that Enron in connection with its
accountants had done whatever disclosure to its accountants,
had reached whatever conclusions, we were fully of the belief
that Andersen was fully aware of every aspect of this
transaction. So if these are the requirements that Andersen was
setting out, which we had no knowledge of prior to this point,
then clearly Andersen must have thought they were met. Why else
would they give an unqualified opinion to the financials?
    Senator Levin. Let's come back to you. You have an
accountant, don't you, Citibank?
    Mr. Caplan. Absolutely.
    Mr. Bushnell. Yes, sir.
    Senator Levin. Doesn't Citibank tell you the same thing,
that in order for a prepay to be treated as a trading contract,
that the purchaser must have an ordinary business purpose and
not be a special purpose entity? Isn't that what your
accountant tells you?
    Mr. Bushnell. The accountants in this transaction for
Citibank, we classified this as a trading asset, Senator.
    Senator Levin. Did your accountant----
    Mr. Bushnell. For purposes----
    Senator Levin. Has your accountant notified you or ever
told you that the purchaser of gas must have an ordinary
business purpose for purchasing gas and not be a special
purpose entity? Have you ever been told that?
    Mr. Bushnell. I don't know what their interpretation----
    Senator Levin. Not interpretation. Have you ever been
informed of that by your accountant?
    Mr. Bushnell. No.
    Senator Levin. Who is your accountant?
    Mr. Bushnell. Our accountant at this time is KPMG.
    Senator Levin. And who was it then?
    Mr. Bushnell. It was KPMG.
    Senator Levin. If there is no third party here that is
independent that has the characteristics of not just being
created for the purpose and being a special purpose entity,
then it is a loan. Now, unless you disagree with that, that is
what you end up with here, is that you have a loan and that has
got some huge implications because it wasn't treated as a loan
on the books. Andersen--I am informed that Andersen asked for a
representation that Delta was independent. Enron wrote Citibank
and worked on the letter saying that Delta was independent. Is
that accurate?
    Mr. Caplan. There was a representation----
    Senator Levin. Did Citibank ever work on a letter----
    Mr. Caplan. Yes.
    Senator Levin [continuing]. Which represented that?
    Mr. Caplan. I think this is the point that I'm trying to
make, is that Andersen knew fully well about Delta and
requested certain representations be made by Delta saying--
effectively certifying its status as a special purpose entity
that was separate from Citibank. So Andersen fully knew exactly
what Delta was and still came to the conclusion that these
transactions should not be treated as loans but should be
treated as trading assets.
    Senator Levin. You are saying Andersen knew that this was a
special purpose entity established just for that purpose, not
because it was interested in buying gas, you think Andersen
knew that?
    Mr. Caplan. I think they knew that.
    Senator Levin. And did you join in the analysis of this
letter that represented that--with Enron representing that
Delta was independent?
    Mr. Caplan. I was involved in the creation of that letter,
yes.
    Senator Levin. Now, we have an Exhibit 150,\1\ a fax from
the law firm in the Cayman Islands. This is Maples and Calder,
a firm that represents Delta that is paid for by other folks
like you. Maples and Calder wrote Citibank about a request for
information regarding Delta. If you could take a look at
Exhibit 150, the Delta attorneys asked Citibank for permission
to respond to the request. At least that is what it looks like
to me, Exhibit 150 in the middle: ``I noted that this
information could not be disclosed until we had received
authorization from our client.''
---------------------------------------------------------------------------
    \1\ Exhibit No. 150 appears in the Appendix on page 544.
---------------------------------------------------------------------------
    Maybe I best go back a little bit here. ``Regarding Delta
Energy Corporation (the `Company')''--here's the email. We've
``been contacted . . . Milbank Tweed in relation to this
Company.'' That's Delta. ``They've requested the information
outlined in the attached email. I noted that this information
could not be disclosed until we had received authorization from
our client. In connection therewith, I should be grateful if
you would kindly confirm whether it is acceptable to you for
this information to be provided.''
    Are you familiar with that?
    Mr. Caplan. Yes.
    Senator Levin. Now, you have no control over Delta. Why
would Maples and Calder be seeking permission from Citibank?
    Mr. Caplan. Again, I think it goes to the reason you set
these special purpose entities up, and it is not a question of
control. We were the person that sponsored it. We were the
person that used it. I don't think it's unusual that Maples and
Calder, who we used to set up Delta, would contact us asking if
this was OK to talk about with another law firm. The point,
again, with the SPVs is that they're separate, independent for
accounting and legal purposes, but that doesn't mean that
Citibank doesn't have a continuing role in the way they
operate.
    Senator Levin. Well, it looks like you gave permission to
Milbank Tweed to get information on Delta, and I am just
wondering why you can't do the same for us.
    Mr. Caplan. I just have to defer that question.
    Senator Levin. The exhibit, if you would, take a look at
Exhibit 151.\1\ And this is page 2 of the exhibit, and it is
part of account-opening documentation for Delta Energy at
Citibank. And given the Subcommittee's attention to money-
laundering issues, we checked to see what due diligence was
performed by Citibank on Delta before the account was
established, and the document contains the following notation:
``We will not be''--this is page 2. ``We will not be obtaining
any documentation because of the internal nature of the
account.''
---------------------------------------------------------------------------
    \1\ Exhibit No. 151 appears in the Appendix on page 545.
---------------------------------------------------------------------------
    Why would Citibank consider the Delta account to be an
internal account if you did not have some control over Delta?
    Mr. Caplan. I think it just goes back to why we set Delta
up. I mean, obviously I'm just in the past few days familiar
with this document. But if you subscribe to the theory that in
these kind of transactions the bank sets up special purpose
entities to perform specific roles, then setting up a bank
account for that entity would be part of the overall
structuring of the deal and would not be unusual. And I would
bet that if you were to examine our records on other SPVs or
other banks' records on SPVs that you would find similar
documentation in pretty much every transaction out there.
    Senator Levin. It goes on to say, ``It will be
controlled''--and they are referring here to the account. ``It
will be controlled exclusively by the Houston office until it
is transferred to Citibank, New York, at which time it''--that
is, Delta's account--``will be controlled exclusively by New
York.'' So you are controlling Delta's account?
    Mr. Caplan. I think that's, again, a typical thing in
structured financing. You don't allow funds out of accounts in
the entire structure because this is one of the control
mechanisms you put in place that is a prudent risk management
technique so your SPV--because your SPV, Delta in this
instance, could theoretically go off and do business with other
parties. So one of the ways----
    Senator Levin. One of the control mechanisms you put in
place, you finally got there.
    Mr. Caplan. I would call it more of a risk management
mechanism.
    Senator Levin. It slipped. The word ``control'' slipped
from your lips. One of the control mechanisms which you put in
place.
    Mr. Caplan. Control of a bank account means that you don't
allow disbursement of funds without a sign-off, effectively,
which we would call a risk management practice that is prudent
so that if the SPV--if the management of the SPV turned--
decided to go off on some jaunt and enter into some transaction
with another bank, for instance, our funds would not be at
risk.
    Senator Levin. Well, it slipped out there. That was just
one of the control mechanisms. But you are going to help us
find out all the rest of them.
    Exhibit 152,\1\ this is the bill sent by Citibank by Givens
Hall Bank and Trust Company of the Cayman Islands, the company
that provided administrative services for Delta. The bill for
services related to the management and administration of Delta
Energy, and you can see Givens Hall bills Citibank. Why? For
supplying the board of directors, shareholders, etc., to the
company and its parent company and administering the overlying
trust for the year ending December 31, 1999. So Citibank is
paying for the administrative costs relating to Delta. Is that
correct?
---------------------------------------------------------------------------
    \1\ Exhibit No. 152 appears in the Appendix on page 548.
---------------------------------------------------------------------------
    Mr. Caplan. Again, very typical in these kind of
transactions. Yes, it's correct.
    Senator Levin. You can repeat the word ``typical,'' but the
answer comes out the same way. You were paying----
    Mr. Caplan. Yes, absolutely.
    Senator Levin [continuing]. For these administrative costs.
    Mr. Caplan. Absolutely.
    Senator Levin. It is very typical for you to control the
entity that you create. That is typical. That is essential. In
fact, you want to control its bank account, you say, because
just on some theory that some day this creation of yours might
somehow or other decide to go off in some different direction
for some unexplained reason.
    Mr. Caplan. That's correct.
    Senator Levin. Now, Givens Hall has been replaced by
Schroder Cayman Bank and Trust Company as the administrator of
Delta. Who owns Schroder, do you know?
    Mr. Caplan. It's an independent, Schroder.
    Senator Levin. Wasn't this acquired by Salomon Smith Barney
in the year 2000?
    Mr. Bushnell. Mr. Chairman, perhaps I could answer that. In
2000, we acquired a part of the Schroder's organization.
    Senator Levin. I am sorry. ``Part'' was the word?
    Mr. Bushnell. A part of the Schroder's organization. It did
not have to do with funds administration. That remains an
independent company that is not under the Citibank umbrella.
    Senator Levin. Let me yield here to Senator Fitzgerald.
    Senator Fitzgerald. Thank you, Mr. Chairman. And I thank
all of you for being here.
    I want to shift gears just a little bit. How much money
does Enron owe Citibank and its--your holding company is
Citicorp, right, and all of you work for----
    Mr. Bushnell. Mr. Fitzgerald, it's Citigroup.
    Senator Fitzgerald. Citigroup, OK. That is the bank holding
company. It owns Citibank, it owns Salomon Smith Barney, and it
owns Traveler's.
    Mr. Bushnell. That's correct.
    Senator Fitzgerald. How much money is owed to Citigroup and
its subsidiaries by Enron, say the last time you looked at that
time question? I imagine you looked at it at the time of their
bankruptcy filing.
    Mr. Bushnell. Yes, we did, Mr. Fitzgerald, Senator. We
could get the Subcommittee the exact number, so this is from my
recollection, but at time of bankruptcy filing, the total
exposure to Citigroup was about $1.2 billion. That was
comprising three major components that you've discussed in the
organizational structure of Citigroup. There were bonds, Enron
bonds, and indeed----
    Senator Fitzgerald. How much were the bonds?
    Mr. Bushnell. To my recollection, the bonds were--had an
amount of about $150 million face. That's what they were
purchased for. At the Traveler's Insurance Company there was--
--
    Senator Fitzgerald. Direct bonds of Enron Corporation.
    Mr. Bushnell. Those were corporate bonds, that's correct.
Not only Enron but Enron subsidiaries that went under different
names. But that's correct.
    Senator Fitzgerald. OK.
    Mr. Bushnell. Then there was about $300 million of the
indemnity company's indemnification risk in the Mahonia
transactions. So when we look at overall exposure, we looked at
that as a risk.
    Senator Fitzgerald. Is that Traveler's?
    Mr. Bushnell. That's a Traveler's Indemnity Company.
    Senator Fitzgerald. But you are contesting that you owe
anything----
    Mr. Bushnell. We are contesting that we owe anything on
that.
    Senator Fitzgerald. And why are you contesting that? Aren't
you saying that JPMorgan Chase knew that its prepay
transactions were really loans?
    Mr. Bushnell. No. What we're contesting is that under New
York State law, indemnity companies are not allowed to
guarantee financing transactions of any type.
    Senator Fitzgerald. When you offered the guarantee, you
didn't recognize it was a financing transaction?
    Mr. Bushnell. We did not recognize it, and that's, in
essence, what the documents that were disclosed to us at the
Traveler's----
    Senator Fitzgerald. And you are saying it was a financing
transaction. You believe it--you are now saying it was a
financing transaction.
    Mr. Bushnell. What was issued, in essence, was--the
indemnification bonds are for performance bonds. That is what
the indemnity companies are authorized to do under insurance
law. If this was a financially settled transaction, they're not
allowed to indemnify financial settlements, only commodities
and other services settlements.
    Senator Fitzgerald. Do you think JPMorgan--are you
contending that JPMorgan Chase knew it was a financing
transaction or didn't know?
    Mr. Bushnell. I don't know--I'm not--I don't know what
JPMorgan Chase thought they----
    Senator Fitzgerald. You don't know what they knew, so you
don't--it's not your position at Citibank that--or at
Traveler's that JPMorgan Chase knew it was a financing
transaction that they were getting a surety contract for?
    Mr. Bushnell. I am not aware of what our position is in
that litigation, Senator. I know the basics of the outlined
litigation between the indemnity company and JPMorgan Chase.
    Senator Fitzgerald. OK. Back to this $1.2 billion in
indebtedness: $150 million in Enron Corporation or corporate
subsidiary bonds; $300 million in indemnity.
    Mr. Bushnell. Exposure, as potential.
    Senator Fitzgerald. Indemnity exposure?
    Mr. Bushnell. Correct. And we had about $650 million at
time of filing of secured exposure, secured by assets within
the Enron group.
    Senator Fitzgerald. Is that a loan, a direct----
    Mr. Bushnell. That was a loan.
    Senator Fitzgerald. A $600 million loan.
    Mr. Bushnell. Yes.
    Senator Fitzgerald. Secured by collateral of Enron. What
was the collateral?
    Mr. Bushnell. Pipelines.
    Senator Fitzgerald. OK. Was that----
    Mr. Bushnell. Two pipeline systems.
    Senator Fitzgerald. Was that financing you did after the
bankruptcy?
    Mr. Bushnell. No. We did that before the bankruptcy.
    Senator Fitzgerald. OK. You are secured on that.
    Mr. Bushnell. And we----
    Senator Fitzgerald. And so that is the total of your
exposure, $650 million in secured lending, $300 million in
indemnity exposure, and $150 million in bonds.
    Mr. Bushnell. No, we need a little bit more to get to $1.2
billion, if my math is correct. We had about $150 million of
unsecured exposure. Some of that was loan exposure, and some of
that was contractual exposures in trading with them for foreign
exchange, for interest rate swaps, for commodity trades. So we
had those unsecured exposures added up.
    Senator Fitzgerald. OK. I want to ask you about the off-
the-books partnerships that Congress--at least in the Commerce
Committee we were examining these heavily last winter. Enron,
as you know, created apparently a couple thousand off-the-books
partnerships. Many of them were borrowing money. Enron would
sell assets to the partnerships and book revenue from the sale
of assets. They would kind of do it in the way to encourage the
perception that these were revenues from recurring operations
rather than one-time sales.
    It was reported on page 73 of the Powers report that
Citigroup invested bank funds--I imagine Citibank funds--in at
least one of these partnerships, LJM2. Is that true?
    Mr. Bushnell. Yes, it is, Senator. A point of
clarification. When I discussed the $150 million of corporate
bond exposure, we would have included the $15 million--I
believe the number was $15 million, but, again, we can get the
Subcommittee the exact number--as investment exposure, maybe is
a better way to term it, in that. And, again, I can get you the
exact entity within the Citigroup family which had that. I
doubt that it was Citibank NA, but instead a different
structure that would have made that investment.
    Senator Fitzgerald. Could be Salomon Smith Barney?
    Mr. Bushnell. No, not Salomon Smith Barney either. Perhaps
a holding company at Citigroup or a different investment
vehicle.
    Senator Fitzgerald. That invested the $15 million, but they
invested in it in LJM2. That money isn't owed by Enron to
Citibank or whoever invested that money. In fact, that is not a
loan. That was an investment, right, an equity investment?
    Mr. Bushnell. That's correct.
    Senator Fitzgerald. So they lost that.
    Mr. Bushnell. That's correct.
    Senator Fitzgerald. Do you know who at Citigroup was
responsible for managing the Citigroup investments in these
partnerships?
    Mr. Bushnell. I know at the senior level. I don't know who
would have--that would have been Todd Thompson who runs the
investment group.
    Senator Fitzgerald. Todd Thompson.
    Mr. Bushnell. Todd Thompson.
    Senator Fitzgerald. Would he have been the one to sign off
on the investment in LJM2?
    Mr. Bushnell. I'm not aware of what their sign-off
procedure is, Senator, for that portion of Citigroup, how they
handle----
    Senator Fitzgerald. But in his office or his group?
    Mr. Bushnell. Somewhere within his division there must have
been, since we made the investment, some sort of vetting
process and approval process to take that in.
    Senator Fitzgerald. Now, some of the class action lawsuits
that have been filed that named JPMorgan and Citigroup allege
that JPMorgan Chase and Citigroup administered the financial
affairs, such as profit distribution and capital calls, of
LJM2. Is that correct?
    Mr. Bushnell. Senator, I don't know what the structure was,
who the administrative agent might have been from the bank for
LJM2.
    Senator Fitzgerald. Was the bank an administrator or----
    Mr. Bushnell. Again, I don't know.
    Senator Fitzgerald. Does anybody know? You don't know the
answer to that?
    Mr. Bushnell. No, sir.
    Senator Fitzgerald. Is it possible that any of the
employees, executives, or director of Citigroup personally
invested in any of the Enron partnerships such as LJM2?
    Mr. Bushnell. I don't know, Senator, the answer to that
question, if any did. We have a fairly stringent policy in
Citigroup regarding investments by any individuals that would
have been vetted through our compliance and responsibility
function, but----
    Senator Fitzgerald. Does anybody know if any----
    Mr. Bushnell. No, sir.
    Senator Fitzgerald. OK. Then can you answer that question
in writing and give it to us and tell us, survey the office,
find out if any employees, executives, or directors of Citibank
invested in any of the Enron partnerships?
    Mr. Bushnell. Yes, we will, Senator, and put that in
writing. I've been informed by our counsel behind me that no
individuals did invest, no Citigroup individuals did invest in
LJM2.
    Senator Fitzgerald. So your testimony is that no employees,
no executives, and no directors of Citigroup invested as
individuals in any of the Enron partnerships, any of the 2,000
partnerships?
    Mr. Bushnell. The only one, again, that I've just been
passed a note from counsel refers to LJM2. But we could get
that information for you, Senator, if that----
    Senator Fitzgerald. I would appreciate a written response
to that survey.
    Now, it has been reported that Mr. Rubin, currently the
vice chairman of Citigroup, made calls to the Undersecretary of
the Treasury and to Moody's Investor Services in an attempt to
assist Enron days before they filed for bankruptcy. Do you know
if that is true?
    Mr. Bushnell. I don't know if that's true, Senator.
    Senator Fitzgerald. Does anybody know if that is true?
    Ms. Hendricks. I have no knowledge.
    Mr. Caplan. I don't know.
    Senator Fitzgerald. Has any of you ever talked to Mr. Rubin
about Enron?
    Mr. Bushnell. No.
    Mr. Caplan. No.
    Senator Fitzgerald. None of you have?
    Mr. Bushnell. I have talked to Mr. Rubin about Enron in a
general discussion when it was going into bankruptcy. We had
several high-level meetings, as you could attest to a
situation, and he was in attendance at those, but not about
anything having to do with----
    Senator Fitzgerald. So the New York Times reported on
February 21, 2002, that Mr. Rubin made those calls to the
Undersecretary of Treasury and to Moody's Investor Service, and
you are saying you are not sure if that New York Times report
is accurate?
    Mr. Bushnell. I have no knowledge of accuracy or
inaccuracy.
    Senator Fitzgerald. Does anybody? Can you find out an
answer to that and clarify that in writing what Mr. Rubin's
contacts were with the administration and provide that to the
Subcommittee? I find that fairly incredible that something like
that is reported in the New York Times and you don't know
whether that is true, there is no investigation to find out
whether that is true, nobody cares whether your vice chairman
called the Undersecretary of the Treasury?
    Did you ask Mr. Rubin to get involved, Mr. Bushnell?
    Mr. Bushnell. No, I did not.
    Senator Fitzgerald. Are you aware of anybody who may have
asked Mr. Rubin to get involved?
    Mr. Bushnell. No, I'm not.
    Senator Fitzgerald. Do you think he just came into work 1
day and it popped into his head, I'm going to pick up the phone
and call the Undersecretary of the Treasury and ask them to see
what they can do to help Enron out?
    Mr. Bushnell. I don't know what was going on in his head.
Senator, we'd be happy to respond to the question in writing
for you, if that helps.
    Senator Fitzgerald. Mr. Caplan, do you have no knowledge,
too?
    Mr. Caplan. No, sir, I'm not at that level of the
organization, unfortunately.
    Senator Fitzgerald. Are you, Mr. Bushnell? You talk to Mr.
Rubin.
    Mr. Bushnell. I do talk with Mr. Rubin. But I did not
question him about his phone calls or involvement with either
Moody's or governmental officials.
    Senator Fitzgerald. Either of you talk to Sandy Weill about
Enron Corporation?
    Mr. Bushnell. I did.
    Senator Fitzgerald. And what was the nature of that
conversation?
    Mr. Bushnell. The nature of that conversation was many
conversations about our exposures across Citigroup--how we were
going to deal with them, what was likely to happen in terms of
financing, debtor in possession financing after they filed for
bankruptcy, and----
    Senator Fitzgerald. Is it possible Mr. Weill asked Mr.
Rubin to call the Undersecretary of the Treasury?
    Mr. Bushnell. I wouldn't know, Senator.
    Senator Fitzgerald. Did you ask him for help?
    Mr. Bushnell. I did not ask Mr. Weill or Mr. Rubin for
help.
    Senator Fitzgerald. Ms. Hendricks.
    Ms. Hendricks. Yes, sir?
    Senator Fitzgerald. Have you talked to Mr. Rubin or Mr.
Weill----
    Ms. Hendricks. No, sir, I have not.
    Senator Fitzgerald [continuing]. About Enron?
    Ms. Hendricks. No, sir.
    Senator Fitzgerald. Mr. Reilly.
    Mr. Reilly. No, I have not, Senator.
    Senator Fitzgerald. Salomon Smith Barney, were they going
to be an advisor or were they hoping to get the business to
advise Enron on their merger with Dynegy? Any of you aware?
    Mr. Reilly. Yes, Senator, we were--Salomon Smith Barney was
the co-advisor with JPMorgan.
    Senator Fitzgerald. You were.
    Mr. Reilly. Yes.
    Senator Fitzgerald. And so you hoped that that merger would
go through at the time? I mean, you were trying to put it
together; is that correct?
    Mr. Reilly. We were, again, one of the advisors.
    Senator Fitzgerald. Moody's or Standard &amp; Poor's--I can't
remember which one of the credit agencies--said that they were
getting calls from banks urging them to not lower Enron's
credit rating, to give it some time because they wanted this
merger to go through. Are you aware of anyone at Citibank
calling Moody's, Standard &amp; Poor's, or any other credit agency
urging them not to lower the credit rating of Enron prior to
this merger?
    Mr. Bushnell. Senator, I'm not aware of the people
involved. I know that there were conversations between the
rating agencies and Enron during this time when the possibility
of a merger existed and that as advisors we would have been
involved in those meetings as to the possibility of the merger
happening or not and what its influence on the business and
ratings might have been.
    Senator Fitzgerald. Any of the others care to comment on
that? Mr. Reilly, do you have any knowledge of attempts by
anyone within the Citigroup holding company to contact the
rating agencies around the time of the Dynegy transaction?
    Mr. Reilly. Senator, I would echo what Mr. Bushnell said.
    Senator Fitzgerald. Mr. Reilly, do you know how much money
in fees Citigroup or Salomon Smith Barney would have realized
had the Dynegy-Enron deal gone through?
    Mr. Reilly. Not precisely, Senator.
    Senator Fitzgerald. Roughly?
    Mr. Reilly. It was in the tens of millions.
    Senator Fitzgerald. Forty-five million sound about right?
    Mr. Reilly. I don't recall the exact figure, but that
number wouldn't surprise me.
    Senator Fitzgerald. I would like to go to your analyst
Raymond Niles at Salomon Smith Barney. I gather that he tracked
Enron for you, and on October 26, 2001, he downgraded Enron
from a speculative buy to a speculative neutral. This followed
the October 16 restatement, I think, that caused Enron to
report a $618 million third quarter loss and disclosed a $1.2
billion reduction in shareholder equity.
    Now, Mr. Niles, like Mr. Fagin from JPMorgan Chase,
testified before this Subcommittee earlier this year and gave
his reasons for making the recommendations he did make.
    Do you think that the indebtedness of Enron to Citibank in
any way, shape, or form had any influence on the analyst
ratings, on Mr. Niles' ratings?
    Mr. Bushnell. No, I don't, Senator. We have stringent
internal controls, even if there was a desire to retain private
side information from public side information, Mr. Niles is a
public side analyst. He has access to public information.
Clearly, as bankers and as advisors, we had a lot of private
side information, and we have a strict internal compliance
process known in the industry as a Chinese wall, but a firewall
that prevents information from flowing between those private
side information to the public side.
    Senator Fitzgerald. But Salomon Smith Barney was owed
money, not just Citibank but Salomon Smith Barney----
    Mr. Bushnell. Salomon Smith Barney, the legal entity, had
trading exposures--contracts--which caused us to end up as we
are--an unsecured creditor.
    Senator Fitzgerald. You are an unsecured creditor in the
bankruptcy, and you are telling me that Mr. Niles--there is no
way that he could have known that, that the company he worked
for was owed money by Enron.
    Mr. Bushnell. That's--he did not know the amount that we
would have had--or if he had----
    Senator Fitzgerald. Did he know that money was owed?
    Mr. Bushnell. Don't even know if he--he would not have had
access to that information.
    Senator Fitzgerald. Would anybody who did know that Enron
owed Salomon Smith Barney money have been in a position to
influence Mr. Niles in any way?
    Mr. Bushnell. Again, Senator, that would definitely be
against our internal compliance rules as well as lots of
others. So we don't feel that that would have happened.
    Senator Fitzgerald. If I could ask you a few questions
about the Delta transactions, we have established that
Citigroup has a subsidiary in the Cayman Islands known as
Delta.
    Mr. Caplan. I would not term them a ``subsidiary.''
    Senator Fitzgerald. OK. What would you term it?
    Mr. Caplan. They are an independent special purpose entity
that we've used in these transactions, but it is definitely not
a subsidiary of Citigroup.
    Senator Fitzgerald. And it is out of your control?
    Mr. Caplan. For accounting purposes, which I think is the
relevant regime, it's out of our control.
    Senator Fitzgerald. Who owns it?
    Mr. Caplan. A charitable trust.
    Senator Fitzgerald. OK. And we had some discussion about
this before. And what is the name of the charitable trust?
    Mr. Caplan. I think it's something called Grand Cayman
Commodities Corp.
    Senator Fitzgerald. Who established that trust?
    Mr. Caplan. I'm not sure. Delta predates my time at
Citibank.
    Senator Fitzgerald. And what is the charitable business of
the charitable trust?
    Mr. Caplan. I'm not sure of that either. But, again, the
purpose of Delta, it was established by us. We had the entire--
--
    Senator Fitzgerald. I thought it was established by a
charitable trust.
    Mr. Caplan. It was established by Citibank, it was
sponsored by Citibank, and a charitable trust----
    Senator Fitzgerald. I thought you just said that Delta was
established by a charitable trust.
    Mr. Caplan. Delta is owned--I'm sorry for using the wrong
word. Delta is owned by a charitable trust, but it was
sponsored and put together by Citibank to use in these
particular type of structured financing transactions, and,
again, it's very similar to special purpose entities we
create----
    Senator Fitzgerald. Who is the trustee of the charitable
trust?
    Mr. Caplan. I'm not certain of that.
    Senator Fitzgerald. Can you find that out and put that in
writing to our Subcommittee, please?
    Mr. Caplan. Certainly.
    Senator Fitzgerald. Who is in control of the--does this
charitable trust do whatever Citibank tells it to do?
    Mr. Caplan. The charitable trust?
    Senator Fitzgerald. Yes. You told them to establish Delta,
and they just go ahead and do that?
    Mr. Caplan. The charitable--all the charitable trust did
was buy the shares of Delta.
    Senator Fitzgerald. So is Delta a corporation?
    Mr. Caplan. Delta is a corporation.
    Senator Fitzgerald. And the charitable trust----
    Mr. Caplan. Is the owner.
    Senator Fitzgerald [continuing]. Bought the shares?
    Mr. Caplan. Correct.
    Senator Fitzgerald. Did you ask the trustees of the trust
to buy the shares?
    Mr. Caplan. Of the--yes.
    Senator Fitzgerald. What year was this?
    Mr. Caplan. Nineteen-ninety-three.
    Senator Fitzgerald. How much did the charitable trust pay
for the shares?
    Mr. Caplan. I'm not even sure that they paid for them. They
own the shares. They may have been contributed to the
charitable trust. That's typically--when you set up a special
purpose vehicle to act in a role in one of these structured
financings, you typically take the ownership interest and
contribute it to a charitable trust. So I don't think there was
any payment by the--I mean, the purpose of the charitable trust
is that it's supposed to hold the shares. Again, it's a very
generic concept in structured finance.
    Senator Fitzgerald. Well, now I think whoever the trustees
of this charitable trust that are holding shares in Delta might
regret that they are holding them because there could be some
liability attached to that, couldn't there, with all the
lawsuits that have been filed regarding ways in which Enron's
debts were concealed from the public? I would like to know who
the trustees of this charitable trust were, and I would
appreciate it if you could provide that to the Subcommittee.
    Mr. Caplan. Yes, Senator.
    Senator Fitzgerald. Any information. Is this charitable
trust directly or indirectly controlled by Citibank?
    Mr. Caplan. Not to my knowledge.
    Senator Fitzgerald. It is independent of Citibank?
    Mr. Caplan. That's my understanding.
    Senator Fitzgerald. Is it a U.S.-based charitable trust?
    Mr. Caplan. I don't think so. I think it's a Cayman
Islands-based charitable trust.
    Senator Fitzgerald. OK. Delta was established in 1993. Has
it had any business transactions that were not related to
Enron?
    Mr. Caplan. Yes, it has. With, I think, Arcla Energy
Corporation, and I think the other one was Hess.
    Senator Fitzgerald. With two other energy----
    Mr. Caplan. Yes.
    Senator Fitzgerald. Only with energy corporations.
    Mr. Caplan. Well, I think that is because of the reason
why--again, when you establish these special purpose entities,
they are established for a special purpose. That's kind of
where the name comes from. And in this case, Delta was
established to do commodity swap transactions, and those
commodity swap--and where that business--my understanding of
where that business started was, again, in the oil--in the
energy and power industry, these prepay transactions were
fairly typical. And they started to come to banks to do them,
but banks, at least at that time, weren't able to hold physical
commodities such as oil. So Delta was established for the
special purpose of being able to hold physical commodities of
oil.
    Senator Fitzgerald. Who first suggested setting up Delta?
Whose idea was that?
    Mr. Caplan. I'm not sure of the answer to that.
    Senator Fitzgerald. Were you around in 1993, Mr. Caplan?
    Mr. Caplan. No. I didn't join the bank until 1997.
    Senator Fitzgerald. So it was already up and running?
    Mr. Caplan. It was up and running, had been used multiple
times for these kind of transactions.
    Senator Fitzgerald. How many times do you think it has been
used for these types of transactions?
    Mr. Caplan. I think it's about--well, it's all the Enron
transactions and the Hess one, and I just want to correct one
thing which I think we need to straighten out. We're not sure
whether it was used by Arcla. I was led to believe that, but
I'm just handed a note saying it may not have been. So we'll
find out the answer to that.
    Senator Fitzgerald. OK.
    Mr. Caplan. But it's been used probably ten--about ten
times.
    Senator Fitzgerald. Do you think it was Citigroup that came
up with the idea establishing this company, Delta, or do you
think it was Enron or some other energy company?
    Mr. Caplan. I mean, again, we've done these transactions
with counterparties such as other banks, so, for example, we
did a transaction with Enron where Toronto Dominion was--it was
either Toronto Dominion or Barclay's was in the place that
Delta is in in these deals. So I'm not sure whether it was
something that Citibank decided to establish or was established
in connection with here's a transaction, we need a party to
hedge commodity risk with, let's--is there someone in the
market we can use, or is there a more efficient way to do it.
    Senator Fitzgerald. If you could find out who incorporated
Delta and provide that----
    Mr. Caplan. There's a law firm in the Cayman Islands called
Maples and Calder who we hired to incorporate Delta.
    Senator Fitzgerald. You hired them to----
    Mr. Caplan. Yes.
    Senator Fitzgerald. OK. So Citibank really hired the law
firm to incorporate Delta.
    Mr. Caplan. Yes, which is what--again, we do this all the
time. This is standard operating procedure in the structured
finance industry. If you go to any other bank out there that
engages in these kind of transactions or any corporation that
does receivable sales or anything--or mortgage sales, any of
those things, you will find that special purpose entities are
created in the middle of these transactions to serve different
purposes, but they're all kind of formed the same way. The bank
involved pays the costs of setting it up, makes sure that it's
set up in a way that for accounting purposes it is an
independent entity. And then it goes on to serve whatever
purpose it's been created for, but, again, it's a very standard
concept in structured finance.
    Senator Fitzgerald. Now, Citibank, isn't it true that
Citibank attempted to lay off some of its position in Enron,
Enron owed it a lot of money and Citibank attempted to lay off
some of that risk by selling Enron-linked securities, including
the Delta loans as notes? Is that correct?
    Mr. Caplan. The whole purpose of the Yosemite transactions
was to take credit risk that was resident in the bank market
and move it to the bond market, because the bond market is able
to accept longer----
    Senator Fitzgerald. OK, credit risk that was a risk that
Citibank was absorbing----
    Mr. Caplan. Citibank or other banks.
    Senator Fitzgerald. Citibank and other banks.
    Mr. Caplan. Yes.
    Senator Fitzgerald. You were maybe the lead lender? How
many other banks were involved?
    Mr. Caplan. The way the transactions worked is the money--
Enron would refinance transactions with the proceeds it
received in the transactions we entered into. So I'm not
certain exactly how many other banks they used, but that was
the stated purpose of the transaction.
    Senator Fitzgerald. How much money did Enron owe to
Citibank that Citibank was able to offset by selling bonds?
    Mr. Caplan. In the first transaction that we did?
    Senator Fitzgerald. Yes.
    Mr. Caplan. I think it was $125 million.
    Senator Fitzgerald. And how many more transactions did you
do?
    Mr. Caplan. We did, I guess, four transactions in total.
    Senator Fitzgerald. Laying off a total of how much?
    Mr. Caplan. $2.4 billion.
    Senator Fitzgerald. You laid off $2.4 billion----
    Mr. Caplan. But it's not--again, that's not all of our
exposure. It was exposure----
    Senator Fitzgerald. How much of it was yours?
    Mr. Bushnell. Senator, in the first transaction, I think
the transaction you were referring to was the $800 million
issuance, of which $125 million was repaid to Citibank and $675
million, if my math is correct, would then have been repaid to
other banks. And I don't know in each of the separate----
    Senator Fitzgerald. Ms. Hendricks, you were actually in
charge of the----
    Ms. Hendricks. Yes, Senator.
    Senator Fitzgerald [continuing]. Yosemite investments; is
that right?
    Ms. Hendricks. I was the senior investment banker at
Salomon Smith Barney at the point at which Enron first
approached us to discuss the concept of using the public
capital markets in a structured finance way to enable them to
raise capital which would allow them to repay bank structured
financings.
    Senator Fitzgerald. Money that they owed to you.
    Ms. Hendricks. And others.
    Senator Fitzgerald. So they got the proceeds from----
    Ms. Hendricks. Absolutely.
    Senator Fitzgerald. From the bonds that they issued----
    Ms. Hendricks. Absolutely.
    Senator Fitzgerald [continuing]. And used it to repay to
you.
    Ms. Hendricks. Absolutely. And the purpose for that was so
that they could continue to get new capital from us, which they
subsequently did in a series of transactions, which was all
part of their original purpose for structuring the Yosemite
deals.
    Mr. Caplan. And if I could add something to that, when we
marketed the Yosemite deals, the purpose that we used in the
marketing, that we told investors why we were doing the deals,
was to shift credit risk from the bank market to the bond
market, which is a deeper market, which--one of the main
purposes of this transaction was the bank market is typically a
short-term market, and Enron had a lot of long-term assets and
wanted to extend its liabilities.
    Senator Fitzgerald. You are saying Enron came to you and
asked you to do this. It was not any concern that you had at
all with Enron's ability to repay the money it owed to
Citibank.
    Ms. Hendricks. No, Senator, perhaps I could answer that.
When Enron came to us, the presentation that they made was that
they were at a point----
    Senator Fitzgerald. When did they come to you with this?
    Ms. Hendricks. Well, I started covering the account in
1999, early 1999, so this is really about then. And the
discussions were 100 percent around that they were beginning to
feel constrained in terms of the use of the bank debt markets,
constrained relative to not a concern that we had about the
credit quality of the company, but constrained in terms of the
opportunities that they saw to grow their company.
    Putting ourselves back, I mean, it's hard to do today, but
going back into the psyche of 1999, Enron was a firm proponent
that they had a very novel and different business model which
could be applied to a variety of different industries.
    Senator Fitzgerald. They sure did.
    Ms. Hendricks. Yes, Senator, they did. But at the time,
virtually everyone----
    Senator Fitzgerald. OK, let me ask you this: Enron wants to
switch away from borrowing from banks to borrow from the
public. So why doesn't Enron--why don't you at Salomon Smith
Barney help them issue corporate bonds of the Enron
Corporation? What is wrong with that? Why couldn't you have
just issued corporate bonds and repaid the indebtedness to you?
    Ms. Hendricks. We absolutely could have done that. The
request of the company was to help them resolve something that
had been widely discussed in all of the public market
information on the company, which was that as a result of mark-
to-market accounting, they were required to recognize as
revenue mark-to-market--they were required to recognize as
revenue their price risk management book. And, unfortunately,
there was no attendant cash flow associated with that.
    When they came to us, their comment was that what they
wanted to do--and they'd had these discussions with the rating
agencies----
    Senator Fitzgerald. Well, what difference does it make if
there was no attendant cash flow with that?
    Ms. Hendricks. They needed----
    Senator Fitzgerald. The banks had to start doing mark-to-
market. When Citibank used to just report your bonds at what
you paid for them, and when they changed to mark-to-market,
banks started to account for their bond portfolio every day.
And, yes, there was no cash flow associated with that.
    Ms. Hendricks. Yes, but----
    Senator Fitzgerald. So what?
    Mr. Bushnell. Maybe I could answer that, Senator, with,
again, the complexities that we deal with. We have bonds in
Citigroup that are mark-to-market. We have bonds in Citigroup
that are historical cost basis. It depends on the----
    Senator Fitzgerald. Then whether they are held for trading
or for long-term investment.
    Mr. Bushnell. Correct. But the intent of it is they're
trading, they're mark-to-market. If they're held for
investment, they're usually held at an accrual-based process.
If I could also, Senator--I misstated some information. On the
first Yosemite I transaction, the $800 million, we were repaid
$350 million of the $800 million, not $125 million. That is the
information that I have.
    Senator Fitzgerald. Go back, Ms. Hendricks, explaining why
Enron Corporation did not issue bonds, why they instead, you
did this Yosemite transaction.
    Ms. Hendricks. Their objective was to monetize their future
cash flows, and the proceeds from those monetizations were
going to be used----
    Senator Fitzgerald. That is another way of saying borrow,
is it not?
    Ms. Hendricks. Senator, we have had a lot of discussion
today with respect to the use of structured financing. There is
no question is it a financing. There is no question it is the
economic equivalent of a financing. It is structured in such a
way so that we'll achieve certain accounting or tax or
regulatory issues. In this case, it was an accounting issue,
but it was an accounting issue that was represented to us that
had been created as a result of the tremendous growth in their
trading book and the advent of mark-to-market accounting.
    The conjunction of those two, at a time when they believed
there was phenomenal additional investment opportunities,
resulted in, and this is frankly widely discussed in a number
of the public-market documents, including reports from Moody's
and Standard &amp; Poor's, at a time when they thought that there
were significant investment opportunities that would not
generate cash for a 3-year period. So what they were trying to
do is to monetize the cash from an existing asset base that
they had, which was their trading portfolio and reinvest that
in assets which were publicly disclosed----
    Senator Fitzgerald. They could have done that by issuing
bonds and pledging the assets that you referred to as
collateral for the bonds.
    Ms. Hendricks. Yes.
    Senator Fitzgerald. What I am asking you is why do the
Yosemite transaction instead of issuing bonds? You can monetize
anything by issuing bonds, and what I am asking you is why did
you work with Enron, not to help them issue corporate bonds, if
they wanted to go to the public markets, as opposed to the bank
markets to borrow from, but why did you help them do Yosemite?
    Mr. Caplan. Maybe I could help on that answer. The purpose
of Yosemite was to allow Enron to continue to do structured
finance in the bank market because they thought there was a lot
of value to the way they structured their balance sheet, and
they felt that banks were the most capable or the best clearing
house to do structured finance through. So that the idea with
Yosemite was to create a mechanism where we, as a bank, could
move credit risk from the bank market to the capital markets
and extend the tenor of bank-type financing.
    Senator Fitzgerald. So explain to me how Yosemite worked.
Explain exactly how that worked.
    Mr. Caplan. Yosemite is actually a relatively--I know that
it has been perceived as something very complex, but at the end
of the day, it is a relatively simple idea. We went to the
market and raised money, and the note-holders in Yosemite took
the credit risk of Enron, and the way they took that credit----
    Senator Fitzgerald. You sold them notes?
    Mr. Caplan. We sold them notes of a trust.
    Senator Fitzgerald. Of a trust.
    Mr. Caplan. That they were credit-linked notes, and they
were linked to the reference credit of Enron. So, if Enron went
bankrupt, note-holders would take Enron risk, and they were
paid a spread that was above Enron straight bond spreads for
taking that risk because of the more complex nature of the
transaction.
    Senator Fitzgerald. They got a higher return than they
would have gotten from Enron bonds.
    Mr. Caplan. Right, because Enron bonds are publicly
offered. They were very generic in a way, and these were Rule
144A offerings. You were buying----
    Senator Fitzgerald. What was the return? What was the
interest rate on the----
    Mr. Caplan. To give you an example, in the first
transaction, the return relative to Enron, to straight Enron
debt, was about 1 percent above, the annual return was about 1
percent above straight Enron debt. So investors were getting
paid that extra return for not only taking the credit risk, but
understanding the structure that we devised.
    Senator Fitzgerald. Was the indebtedness that Enron
indirectly incurred by virtue of this Yosemite transaction, was
that indebtedness reflected on their balance sheet?
    Mr. Caplan. Well, the Yosemite transaction did not create
indebtedness for Enron. All the Yosemite transaction did was
create a credit transfer mechanism for Citibank, but then
Citibank turned around and did the prepaid transactions with
Enron, which showed up as liabilities on their balance sheet.
So what we told investors when we marketed the deal is that any
credit risk that Citibank is effectively hedging using this
structure, that credit risk starts with Enron and is disclosed
in their financial statements.
    Senator Fitzgerald. Your testimony here is that there was
no desire on the part of Citibank to limit their exposure to
Enron that caused you to engage in this Yosemite transaction,
that it was all Enron's idea. You didn't hit your lending
limits with Enron. You liked Enron as a credit. You would have
kept loaning to Enron. It was Enron that came to you and said
let us get rid of this loan, this money we owe to Citibank, and
let us change it this transaction with Yosemite and have
Salomon Smith Barney basically sell this indebtedness off to
public investors who will own these notes.
    Mr. Bushnell. Maybe I can address that, Senator, to help a
little bit.
    We have, in terms of our own exposures to any corporation,
we have internal limits that we set against individual obligors
or companies that is in accord with our perceived riskiness of
them. Obviously, the higher rated credit, not only by the
rating agencies, but done independently by us, we would be
willing to extend more money to a higher rate of credit. Those
limits are well beneath our legal lending limit. We are strong
believers in----
    Senator Fitzgerald. What is your legal lending limit?
    Mr. Bushnell. I believe right now our legal lending limit
for Citibank N.A., the largest bank in our chain, I think it is
upwards of $5.5 or $6 billion. So the limits----
    Senator Fitzgerald. What is your internal lending limit?
    Mr. Bushnell. Again, generally, you would have to refer to
that via both the rating of the company and the maturity or
duration of the risk that we were taking on. So the shorter the
time frame you might be willing to take more risk, it was only
for a 6-month or a 9-month transaction versus something that
has 7 years' worth of credit risk. But to give you an
indication for a BBB-rated company, our 2 to 5 year maturity
side would be on the order of about $400 to $425 million that
we would, in general, not want to have any more exposure. This
is prudent risk diversification.
    Senator Fitzgerald. Four hundred and?
    Mr. Bushnell. Of equivalent, unsecured credit.
    Senator Fitzgerald. This----
    Mr. Bushnell. This internal guideline.
    Senator Fitzgerald. That is your internal guideline.
    Mr. Bushnell. Yes, Senator.
    Senator Fitzgerald. Four hundred and fifty million dollars,
but at one time, Enron owed you as much as $2.4 billion.
    Mr. Bushnell. I am not sure it got quite that high, but we
had larger exposure than that. It was over our internal
guidelines, and we had an active desire, not because we were
concerned about credit quality, but from a portfolio management
process, we do not believe in putting too many eggs in any one
basket.
    Senator Fitzgerald. So you did have a desire to get rid of
some of this exposure; is that not correct?
    Mr. Bushnell. That is correct.
    Senator Fitzgerald. Ms. Hendricks, you had said it was just
Enron coming to you wanting to do this Yosemite transaction.
Now Mr. Bushnell is saying that you had an internal desire at
Citibank to get rid of some of this exposure of this one
company.
    Mr. Bushnell. Senator, I think the understanding is my bank
is not unique in that, and what was happening, and what the
company was expressing, and what this entire transaction was
set up to do was a lot of the banks were getting to their
limit. Enron was a very fast-growing company, and so there were
lots of capital needs, and the banks were providing it, but
even though they liked the credit, they obviously continued to
extend money, etc.
    They were starting to reach their internal prudency
thresholds, if you will, and the purpose of the Yosemite
transaction was to provide relief, if you will, on those banks
so that by accessing the public capital markets so that the
banks could continue in their activities in Enron.
    Mr. Caplan. I would just add to that, one of the reasons I
am personally involved in this deal, is I run the credit
derivatives business at Citibank, and what we do with credit
derivatives is move risk off of our books through swap
contracts, which is effectively what we did here, and we do it
for prudent risk-management purposes, so that we maintain a
diversified lending book and that we do not have too much
exposure to any one obligor. It is not necessarily the
financial health of that obligor.
    Senator Fitzgerald. Oftentimes you lay off that risk with
other big banks, though, do you not?
    Mr. Caplan. We lay it off all different ways. We have done
other Rule 144A offerings, where we have laid off risk in a
very similar manner to this transaction.
    Senator Fitzgerald. Were you doing that prior to the
legislation that passed a couple of years ago to repeal Glass-
Steagall? Have you been doing that a long time?
    Mr. Bushnell. Yes, Senator. We have been using various
means of credit mitigation, including insurance contracts from
insurance companies, including other banks, and that was prior
to the passage of Gramm-Leach.
    Mr. Caplan. The credit derivatives business has been
evolving over time, been around since 1996, I would say.
    Senator Fitzgerald. The credit derivatives business has
only been around since 1996?
    Mr. Caplan. In any large-scale way. I mean, I think there
were small transactions done prior to that, but nothing like it
is today.
    Senator Fitzgerald. Is that the first time you started
laying them off in Rule 144A offerings?
    Mr. Caplan. I think the first--some of that predates me. I
know of one Rule 144A offering that we did in 1998 where we
laid off several million dollars of a diversified basket of
names.
    Senator Fitzgerald. I do not know if the Chairman has
called your attention to Exhibit 181.\1\ This is an email from
William Fox, dated November 10, 1999, to, among others, James
F. Reilly, Niels Kirk and also to William Fox--William Fox
sending an email to himself, I guess. But Mr. Fox in this email
said, ``In spite of all of the repayments that we have or will
receive from Condor and Yosemite, we still have an exposure
issue as it relates to obligor limits; there is a developing
view that limits are limits and not to be exceed--'' he must
have meant not to be exceeded. ``This is something we will have
to deal with. Also, we do not have room for incremental assets
of $200 to $300 million over year end. I will discuss with
Reilly later today for current status and review of options.''
---------------------------------------------------------------------------
    \1\ Exhibit No. 181 appears in the Appendix on page 660.
---------------------------------------------------------------------------
    Mr. Reilly, do you remember this email?
    Mr. Reilly. I do, Senator.
    Senator Fitzgerald. Did you subsequently discuss with Mr.
Fox this email or the issues raised therein?
    Mr. Reilly. Certainly the issues raised there.
    Senator Fitzgerald. Who is Mr. Fox?
    Mr. Reilly. He was then, and is currently, the head of
Citibank's Global Energy &amp; Mining Group.
    Senator Fitzgerald. What was Mr. Fox's message to you? It
sounds to me like he was concerned that you had too much
exposure to Enron, and he is referring to Yosemite, and was he
encouraging you to hurry up and get the Yosemite transactions
done?
    Mr. Reilly. No, that is not the intent of this email. There
was, by date--I do not remember the precise date in which
Yosemite I actually closed, but there were discussions about
looking at what became Yosemite II in Europe and what this
bridge, I believe what this bridge was dealing with was whether
or not, if we could not get Yosemite II closed by the end of
the year, would we consider making another loan on our books.
    Senator Fitzgerald. Did you have a position on that issue?
Did you favor making more loans to Enron at the time?
    Mr. Reilly. What was happening was going back to Mr. Fox's
comment is that, and as Mr. Bushnell said earlier, there is in
place a framework called the obligor limits, and we were, I
think, over time--this is my characterization--over time we
would try to manage all clients down and into that obligor
limit range. That does not mean that there are not exceptions
from time-to-time, and so we were moving in that direction, and
so the question here was were we prepared to put on an
additional amount of credit exposure in light of those obligor
limits.
    Senator Fitzgerald. Would you have favored it, taking on an
additional amount?
    Mr. Reilly. In fact, we did take on the additional amount,
Senator.
    Senator Fitzgerald. You did, and did you favor taking on
the additional amounts?
    Mr. Reilly. Yes, I did.
    Senator Fitzgerald. You did.
    Now, Ms. Hendricks, why do you not finish up with what you
started. I interrupted you, and we went to others. You started
to explain how the Yosemite transactions worked. You said that
Enron came to you and wanted to switch from tapping bank debt
to tapping public debt.
    Ms. Hendricks. Yes, sir.
    Senator Fitzgerald. So who came in to ask you for help? Did
Mr. Fastow come to you?
    Ms. Hendricks. No. Actually----
    Senator Fitzgerald. Mr. Glisan.
    Ms. Hendricks. No, Mr. Glisan was not in charge of the
company. I think it would have been Jeff McMahon.
    Senator Fitzgerald. Jeff McMahon came to you.
    Ms. Hendricks. Yes.
    Senator Fitzgerald. And he asked you to put this together.
    Ms. Hendricks. He or members of his team. It was a
collective conversation.
    Senator Fitzgerald. Did you know roughly when that was?
    Ms. Hendricks. Well, in early 1999.
    Senator Fitzgerald. Early 1999, and explain to me what you
did with Yosemite. You said that you created a trust. Was
Yosemite a trust?
    Ms. Hendricks. Senator, the first thing I would have done
on the investment banking side is, first, make sure that Jim
Reilly, who was my colleague on the commercial banking side,
was aware, and he would have done the same with me. And then
the second thing we would have done is created a team of
product specialists who would have sat down with us with the
company and attempted to brainstorm solutions to the problem
that the company was presenting to us.
    Senator Fitzgerald. Did you sit down with Mr. Reilly at
that time?
    Ms. Hendricks. Yes, sir.
    Senator Fitzgerald. You two collaborated on this?
    Ms. Hendricks. Yes, sir.
    Senator Fitzgerald. And you came up with the idea of
Yosemite?
    Ms. Hendricks. No, sir. I am not smart enough.
    Senator Fitzgerald. Who came up with that idea?
    Ms. Hendricks. Mr. Caplan and colleagues of his in the
Credit Derivatives Group.
    Senator Fitzgerald. These are the credit derivatives guys.
    Ms. Hendricks. Yes, sir.
    Senator Fitzgerald. They were the only ones smart enough
for that. Again, go back and walk me through this transaction
slowly, how this worked. You started to explain about the trust
and the notes.
    Mr. Caplan. The place to really start is the financings
that Enron was doing in the bank market, and there were a
variety of financings. So the real premise was Enron came to us
and said we do a lot of financing in the bank market, we like
doing our financing in the bank market----
    Senator Fitzgerald. Not just at Citibank, but all other
banks.
    Mr. Caplan. All over the place.
    Senator Fitzgerald. Did they take all of their bank
borrowings from all over the world and come to you and ask you
to----
    Mr. Caplan. And they said one of the problems we have with
bank financing is that it is short term, for the reasons that
Mr. Bushnell just explained.
    Senator Fitzgerald. Right.
    Mr. Caplan. So we would like--but the rest of our balance
sheet, we have a lot of long-term assets, so we have got long-
term assets and short-term liabilities. That seems like a
recipe for disaster at some point, if you do not manage those
things.
    So what their premise was is we are a growing company. We
have to be careful thinking about our liquidity plans for the
future, and one of the tenets of a carefully thought-out
liquidity plan is to better match your assets and your
liability maturities.
    So the thought was where can you get longer term debt,
effectively or where can you place your credit risk in the
longer term market? The logical place is the bond market
because investors will invest for longer terms there.
    So, understanding that they wanted to have the flexibility
to continue to finance in a sophisticated way in the bank
market, but wanted to move the credit risk out into the capital
markets, we developed Yosemite, which basically the idea behind
Yosemite is Yosemite is just a credit default swap written from
the bond market----
    Senator Fitzgerald. Yosemite is a what?
    Mr. Caplan. It is basically a credit default swap, and I
will explain what that means.
    Senator Fitzgerald. What is Yosemite from a legal
standpoint?
    Mr. Caplan. From a legal standpoint, the first deal was a
trust; the second deal was a Channel Island Corporation; and
the other deals were trusts.
    Senator Fitzgerald. Yosemite I was a trust.
    Mr. Caplan. Yes.
    Senator Fitzgerald. Was a Cayman Islands trust?
    Mr. Caplan. A Delaware business trust.
    Senator Fitzgerald. A Delaware business trust.
    Mr. Caplan. So we set up Yosemite. Yosemite issued notes
and certificates and held the proceeds of those notes and
certificates and invested them--it basically had the ability to
invest in several different things, which were not disclosed
to----
    Senator Fitzgerald. How much did Yosemite I raise?
    Mr. Caplan. It raised $750 million of notes and $75 million
of equity or certificates--equity for tax purposes.
    Senator Fitzgerald. Who gave the equity?
    Mr. Caplan. It was a combination of Citibank and Enron.
    Senator Fitzgerald. So Citibank invested its own bank
funds?
    Mr. Caplan. Not directly. It is a little complicated.
Actually, a Fleet Boston, Fleet Bank's conduit, which is
something called Long Lane Master Trust, I mean this is the
essence of structured finance, right? Fleet Boston's conduit
called Long Lane Master Trust actually bought the Citibank half
of the equity, and then that entity, Long Lane Master Trust
entered into a swap with Citibank, where we took the risk on
the equity, and we effectively paid them a financing cost for
buying the equity, plus a spread for their----
    Senator Fitzgerald. That sounds like really you were behind
all of the equity then.
    Mr. Caplan. Well, no, that was only on half of the equity
and then Enron, through some entity, bought the other half.
    Senator Fitzgerald. Yes, but if you are paying somebody
else to invest their half, to take half the equity, you are
really putting together all of the equity.
    Mr. Caplan. The only purpose of having the equity in the
transaction was a tax reason, which was to get the notes
treated as debt for tax purposes. So the equity had----
    Senator Fitzgerald. Are these notes Yosemite issues, are
they so-called NIPs?
    Mr. Caplan. No.
    Senator Fitzgerald. No.
    Mr. Caplan. No, they are credit-linked notes.
    Senator Fitzgerald. And they are strictly debt.
    Mr. Caplan. For tax purposes, they are debt.
    Senator Fitzgerald. For other purposes, are they equity?
    Mr. Caplan. No, they are not equity for any purposes. They
are strictly debt. They offer it under an indentured----
    Senator Fitzgerald. It is not the new-fangled combination
debt----
    Mr. Caplan. There is no special----
    Senator Fitzgerald. So you issued notes and certificates.
Are the certificates the equity certificates?
    Mr. Caplan. Yes, exactly.
    Senator Fitzgerald. So you raised $750 million in notes and
$75 million in equity. You raised that $750 million in notes,
is that promissory notes?
    Mr. Caplan. No. The trust would issue notes to the market
through an indenture----
    Senator Fitzgerald. What is the note, a promissory note?
    Mr. Caplan. It is more like a bond. I guess you could call
it a promissory note.
    Senator Fitzgerald. Well, a bond is a note.
    Mr. Caplan. Yes.
    Senator Fitzgerald. So a bond or a note----
    Mr. Caplan. So there was an indenture under which----
    Senator Fitzgerald. But there is a promise to repay, right?
    Mr. Caplan. Yes, by the trust.
    Senator Fitzgerald. Yosemite was obligated to repay----
    Mr. Caplan. Exactly.
    Senator Fitzgerald [continuing]. The purchaser of the note.
What increments were those notes in? You sold $750 million in
notes. Did you sell them in $75-million chunks or $5-million
chunks?
    Mr. Caplan. I think the minimum denomination was a million
dollars.
    Senator Fitzgerald. Do you know how many investors you got?
    Mr. Caplan. I think in the first deal it was less than 100.
    Senator Fitzgerald. So you had 100 people invested----
    Mr. Caplan. All in the Rule 144A market, which is qualified
institutional buyers.
    Senator Fitzgerald. Could you give me examples of some of
the Rule 144A market buyers?
    Mr. Caplan. It is kind of all of the major--it is other
banks, it is pension funds, it is insurance companies. To be a
qualified institutional buyer, you have to have at least $100
million in investable assets. So it is large institutions.
    Senator Fitzgerald. So pension funds, the State pension
funds and so forth could have bought those.
    Mr. Caplan. If they met the requirements for buying the
notes, they could, if they had a qualified asset manager and
that sort of thing.
    Senator Fitzgerald. Do you see any risk with the new
breakdown of Glass-Steagall, where a bank could have, and I am
not saying this is what happened, but say you have a bad loan,
a bank is enabled to sell securities to the public to take that
bad loan off their books, do any of you see any risk in that,
in the new rules we have created by repealing Glass-Steagall in
the last couple of years? Do any of you care to comment on
that? Then I will turn this back to the Chairman.
    Mr. Bushnell. Senator, I think raising funds in the capital
markets, in the public markets, and where those proceeds go is
something that has been quite common. When you do a bond
offering in the public markets, the proceeds are fungible, and
what the issuer does with those monies, they may pay down
banks, they may pay down certain banks and not other banks.
They may pay down payables that they owe. They may do lots of
different things with that. It generally flows into that.
    So we have stringent rules that I have discussed internally
that would not let the public side know what our own exposures
were as a means to manage risk. So I think that, at this point
in time, we are comfortable with those internal controls.
    Senator Fitzgerald. Does Citibank feel, in any way, misled
by Enron, Mr. Reilly?
    Mr. Reilly. Certainly. Do you mean, with respect, just
broadly, Senator?
    Senator Fitzgerald. Yes. You were a lending officer at
Citibank for them. Do you feel you were misled by them in any
way?
    Mr. Reilly. I think, Senator, in the 8 or 9 months since
Enron declared bankruptcy, an awful lot of stuff has been in
the press and has come out through committees and other
reports, and I would say that if all of that turns out to be
true, then, yes, we would feel very misled.
    Senator Fitzgerald. Do you feel that selling the Yosemite
securities to the public, that in doing so, Citibank
contributed to misleading the people who bought those
securities in any way?
    Ms. Hendricks. No, sir.
    Senator Fitzgerald. You do not?
    Ms. Hendricks. No, sir.
    Senator Fitzgerald. Why do you say that?
    Ms. Hendricks. Because on the basis of the information that
we had at the time and the publicly audited financial
statements that we had and on which we had every reason to
rely, and I would echo, and perhaps state more strongly, Mr.
Reilly's conclusion. I do feel misled, and I would say that we
disclosed what we knew to be correct. And in accordance with
generally accepted accounting principles, the purpose of
Yosemite was to deliver senior unsecured credit of Enron to the
public markets, which is, in fact, as the structure worked, and
it was disclosed, throughout the prospectus, that that is what
we were going to be doing.
    Senator Fitzgerald. Maybe the Subcommittee has it, but I
would love to have a prospectus for Yosemite.
    Ms. Hendricks. Absolutely.
    Senator Fitzgerald. If you could provide that for me. I
want to thank you. All of you have been very good. You have
been good at explaining some of these transactions. I used to
be a general counsel for a bank holding company, but we were
much smaller, and we were not this fancy. We stayed away from
things that got too complex. We were very simple. We liked the
collateral, in the bank vault, in the basement.
    This has been a real learning experience, and you have been
very helpful, and I appreciate the indulgence of the Chairman
of the Subcommittee. You have been very kind to this non-
ranking Member to let me go on for quite some time.
    So thank all of you for being here.
    Senator Levin. Mr. Caplan, one of your colleagues
apparently thought that there was a need to put a little more
window dressing on some of these transactions, and I would ask
you to look at Exhibit 154.\1\ Exhibit 154 is a May 9, 2001,
memo to you from a colleague named Timothy Swanson. He added a
minimal charge of one penny to the price spread between the
purchase and sale price of the oil involved in this prepay to
make it seem a little more like a true trade.
---------------------------------------------------------------------------
    \1\ Exhibit No. 154 appears in the Appendix on page 552.
---------------------------------------------------------------------------
    He reports to you that he told another Citi employee that,
``The charge makes the prepaid structure a little more like a
true trade.'' That is a pretty good example, is it not, of
where Citi employees felt the transactions were not real
trades? They had to do something like a penny, which is totally
nominal, as he points out, just to make him look like real
trades.
    Do you remember this memo?
    Mr. Caplan. I do, in fact.
    Senator Levin. Did you call him up and say, Hey, wait a
minute. These are real trades. We do not----
    Mr. Caplan. Actually, yes.
    Senator Levin. You called him right back and said these are
real?
    Mr. Caplan. What I would say is that the economics of the
trade, what the various parties were going to receive, were
negotiated into the transaction already and what all of this
represents is, frankly, another group who started working on
these trades late in the day, trying to put some more revenues
through. In fact, the one basis point per annum on the whole
transaction, this additional revenue that Mr. Swanson was
attempting to----
    Senator Levin. Which is totally nominal, you would agree?
It is one penny. It is a totally----
    Mr. Caplan. It is $315,000.
    Senator Levin. But its purpose is to make----
    Mr. Caplan. Its purpose was to make more money.
    Senator Levin. No, the purpose, it says right here, is to
make the prepaid structure more like a true trade. That is what
it says here. Did you call back and say----
    Mr. Caplan. I did, and I said I do not think that that is
necessary to make this trade work. And, in fact, the Kelly that
is referenced, the Kelly McIntyre referenced in this email, is
not a Citibank employee. She is an Enron employee, and Enron
came----
    Senator Levin. Who is an Enron employee?
    Mr. Caplan. Kelly McIntyre, who----
    Senator Levin. Is Timothy Swanson?
    Mr. Caplan. Timothy Swanson is a Citibank employee. Kelly
McIntyre, who this email is referring to, is an Enron, was an
Enron employee. What ended up happening in this transaction is
we executed the transaction without this additional one-basis-
point spread because Enron thought the transaction was a real
transaction, had vetted it again with their auditors, and felt
that this was just Citibank trying to make more money, and they
were unwilling to pay the additional amount that we had asked
for.
    So they said that is very nice that you would like to make
more money, but, sorry, we think this transaction works as is,
and we are not going to pay you additional fees to do something
we think already works.
    Senator Levin. But the stated purpose in the memo was not
to make more money. The stated purpose was that it would make
the spread a more real transaction. That is what was stated
here, twice.
    Mr. Caplan. I think that that's--I'm sorry.
    Senator Levin. ``I told her the change makes the prepay
structure more like a true trade.'' My question to you is: Are
you testifying then you called Timothy Swanson and said you
don't have to make this look like a true trade, it is a true
trade?
    Mr. Caplan. Yes.
    Senator Levin. You called Mr. Swanson.
    Mr. Caplan. Absolutely. I called--in fact----
    Senator Levin. That is fine. That is good enough.
    Mr. Caplan. Yes.
    Senator Levin. You called him back and said----
    Mr. Caplan. Yes.
    Senator Levin [continuing]. No need to add a penny----
    Mr. Caplan. In fact, what I said was Enron won't agree to
this because they think it's a true trade already.
    Senator Levin. The penny is, in fact, diminutive. You would
agree to that, right?
    Mr. Caplan. No, I would not----
    Senator Levin. You would not agree with that?
    Mr. Caplan. It's $315,000 additional revenue to Citibank.
    Senator Levin. I understand, but you would agree----
    Mr. Caplan. Present value.
    Senator Levin. You disagree that the penny is, in fact,
diminutive, then. You think that's false.
    Mr. Caplan. It's figured to be an incremental one basis
point on the whole transaction. I don't think $315,000 is a
diminutive amount of money.
    Senator Levin. You disagree with that, too.
    Mr. Caplan. I would disagree with that as well, yes.
    Senator Levin. And that its purpose was to make this look
like a true trade.
    Mr. Caplan. Yes.
    Senator Levin. Was that the reason for his recommendation?
Would you agree to that?
    Mr. Caplan. No. The reason for his recommendation was to
make more money on the trade, plain and simple.
    Senator Levin. That is not what he says here, though, is
it?
    Mr. Caplan. I understand----
    Senator Levin. So now I am asking you, he in this memo said
that the purpose of the incremental penny was to make it look
like a true trade. Is that not true?
    Mr. Caplan. That is true. That is what the memo says.
    Senator Levin. I want to get to the Yosemite structure now.
Investors here were told, as I understand it, only that the
trust would invest in Enron-related investments. They did not
know specifically what the money was invested in.
    Mr. Caplan. Yes, that is correct.
    Senator Levin. So nobody was supposed to know specifically
what the $800 million was going to be invested in.
    By the way, Ms. Hendricks, did Mr. McMahon know that the
funds from the Yosemite trusts were going to be used to finance
the Enron prepays?
    Ms. Hendricks. Senator, I believe that when we first
started the conversation on this, there was discussion of a
number of different assets that were considered before it was
determined that it would be prepaids that were used. So I'm not
sure that at the first conversation with Mr. McMahon that it
was expressly stated that it would be used for prepaids,
although clearly that was one of the alternatives.
    Mr. Caplan. If I might, when the transaction was executed
in November 1999, Mr. McMahon absolutely knew what the bank
financing was going to be, that it was going to be a prepay
transaction. I mean, it's a $750 million transaction. The
treasurer of the company would want to know where the money is
going and how it's coming in, and he was absolutely involved in
that process.
    Senator Levin. Did he know that the funds from the Yosemite
trusts were going to be used to finance Enron prepays?
    Mr. Caplan. Absolutely. He himself was on the road show for
the first deal, so he was intimately aware of the details of
the transaction and its intended uses.
    Senator Levin. He told us something very different, by the
way.
    In Exhibit 156,\1\ if you would take a look at that now,
this is a memo from Doug McDowell, an Enron employee who was
heavily involved in working with you on the Yosemite structure,
I believe. Is that correct?
---------------------------------------------------------------------------
    \1\ Exhibit No. 156 appears in the Appendix on page 559.
---------------------------------------------------------------------------
    Mr. Caplan. That is correct.
    Senator Levin. And this is what he wrote, that ``Apparently
an investor spoke to someone at Citi and received info on
Delta. This person at Sumitomo is now calling us asking about
Delta now. We need to shut this down.''
    Did you shut it down?
    Mr. Caplan. This is a very interesting email.
    Senator Levin. Did you shut it down?
    Mr. Caplan. It turned out that the information on Delta had
come not from Citibank but from Enron. And we had agreed--
again, we've talked about the purpose of the transaction to
maintain flexibility and that the investments in Yosemite would
not be disclosed to investors. So we had agreed with Enron that
we would not tell investors about Delta, and it turned out in
this instance that it wasn't Citibank telling Enron about
Delta. It was--sorry, the investor. It was Enron telling the
investor.
    Senator Levin. Whoever it was who told the investor, you
agreed that information should not go to the investors?
    Mr. Caplan. Our agreement with Enron was not to disclose
the details of the Delta deal. It was a confidential deal from
their perspective.
    Senator Levin. Do you think it is appropriate for an
investment bank to shut down the flow of information when an
investor requests that information?
    Mr. Caplan. I think it's appropriate to meet our
obligations under whatever contractual arrangement we have, and
it was extremely clear in the disclosure document for Yosemite
that investors would not learn the trust investments. So
investors had no right to know what was in the trust until
Enron filed bankruptcy.
    Senator Levin. My question, though, is: Do you think it is
appropriate for an investment bank not to respond to a request
for information, to agree to that?
    Mr. Caplan. I think it's appropriate--I think
``appropriate'' is not the right--respectfully----
    Senator Levin. That is my word. But, no, I----
    Mr. Caplan. I understand that's----
    Senator Levin. That is my question. Do you think it is
appropriate for an investment bank to agree to deny information
to a prospective investor who seeks information?
    Mr. Caplan. I think unless the investment bank has a legal
obligation in a transaction such as this to disclose the
information, the investment bank is completely within its
rights not to disclose the information. And, in fact, in some
of the transactions I was talking about earlier where we did
similar Rule 144A offerings and used credit default swaps, we
have the same blind trust concept, and investors have asked for
information in those transactions as well, and we have again
declined to provide the information on the same theory.
    Senator Levin. I think then that your answer is yes.
    Mr. Caplan. I think my answer is a little different than
yes.
    Senator Levin. It is appropriate to agree to refuse to
provide information on request to a prospective investor. Is
that correct?
    Mr. Caplan. As long as we don't have a legal obligation.
    Mr. Bushnell. If I could add to that, Senator.
    Senator Levin. Sure.
    Mr. Bushnell. In many instances--and we've discussed with
Senator Fitzgerald that we are in possession of material, non-
public information, and should an investor ask that of an
investment bank, it is entirely inappropriate for us and would
be indeed a violation of securities law to give that
information up.
    Ms. Hendricks. Senator, if I might?
    Senator Levin. Sure.
    Ms. Hendricks. It is specifically stated in the offering
document for Yosemite I that we would not tell investors what
was in the trust. And I think that's the point that Mr.
Caplan--the distinction that Mr. Caplan is trying to draw, is
that the fundamental underlying credit of the investor--that
the investor was purchasing was Enron senior unsecured, and
that was unrelated to the assets that were held in the trust.
And because we were not going to disclose at the outset what
was in the trust and were not going to disclose on an ongoing
basis what was in the trust, it was inappropriate for us to be
discussing that after we had specifically stated that we were
not going to.
    Senator Levin. Do you know why Enron wanted to keep the
Delta prepay secret?
    Mr. Caplan. As in many of their structured financings, they
required confidentiality as part of the transaction, and that's
true, again, in many structured finance transactions. You don't
disclose the details of it. There are often proprietary aspects
of it that you don't wish your competitors to get a hold of.
    Senator Levin. But you know that they were also trying to
avoid showing debt. You have already testified to that. Is that
correct?
    Mr. Caplan. It's not that they were trying to avoid showing
debt. They were trying to classify this as a price risk
management liability----
    Senator Levin. Instead of----
    Mr. Caplan. Which is a liability.
    Senator Levin. Instead of debt.
    Mr. Caplan. Instead of a loan, yes.
    Senator Levin. Try not to show it as debt. Why do you avoid
that word? You say they don't want to show it as a loan.
    Mr. Caplan. Actually, no reason.
    Senator Levin. I say they don't want to show it as debt.
    Mr. Caplan. That's fine. Debt----
    Senator Levin. Why do you----
    Mr. Caplan. They do not--they wanted to show it as price
risk management liability and not as debt.
    Ms. Hendricks. Not as funded debt, correct.
    Mr. Caplan. Not as funded debt.
    Senator Levin. Now, you say in your testimony today that
price risk management liability is a liability, plain and
simple. It must be satisfied every bit as much as debt. And
thus, while not recorded as debt, prepaid liabilities were
clearly obligations of the company and visible as such to
investors.
    Every witness on our second panel--Moody's, Standard &amp;
Poor's, Mr. Turner--disagreed with your statement. Were you
here when they disagreed with that?
    Mr. Caplan. I was not.
    Senator Levin. Did you hear that? Were you watching or do
you----
    Mr. Caplan. Yes, some of it.
    Senator Levin. Mr. Turner, former chief accountant at SEC,
said it was clearly wrong, your statement, that there is a huge
difference between showing something as debt and showing
something as price risk management liability.
    Who supports your position? Has your accountant told you
that there is no difference between showing something as price
risk management liability and showing it as debt? Have you been
informed of that by somebody?
    Mr. Caplan. Well, again, I think this is a--it's an
accounting question and----
    Senator Levin. Has your accountant told you there is no
difference?
    Mr. Caplan. Well, I think that a liability is a--it's an
obligation to repay. I think that's a legal definition, not an
accounting concept. But the accounting concept here was--if the
books of Enron didn't properly reflect what their true debt
was, then I think that's a matter you have to take up with
their accountants and not with their bankers. We don't have
control----
    Senator Levin. But you are the one who said there is no
difference whether it is shown as debt or whether it is shown
as price risk management. You are making that statement.
    Mr. Caplan. Yes.
    Senator Levin. Now you are telling me take that up with
their auditors, with Enron's auditors.
    Mr. Caplan. I'm making the statement that a liability is a
legal obligation. I'm not making a qualitative statement as to
where something should appear on a company's balance sheet.
That is not within the purview or the role or the
responsibility of a bank. That is between a company and its
auditors.
    Senator Levin. Mr. Bushnell, do you agree that it makes no
difference if an obligation is shown as price risk management
liability or as debt, that a liability is a liability?
    Mr. Bushnell. I think----
    Senator Levin. Do you agree with that statement?
    Mr. Bushnell. I think that in the bankruptcy situation that
Enron is now in, there are many people that are in the same
position----
    Senator Levin. I am not talking about a--I am not talking
about that. I am talking about before the bankruptcy, before
that happened. Do you agree that a liability is a liability, it
doesn't make any difference, it has to be satisfied whether it
is debt or price risk management? Do you agree with that? Is
that Chase's position? Excuse me. Is that Citibank's position?
    Mr. Bushnell. Citibank's position is--from a credit aspect
is there are many different types of liabilities, and the
correct accounting classification is important for us to
understand the nature of the credit.
    Senator Levin. So it does make a difference where it shows?
    Mr. Bushnell. What the correct accounting aspect is, yes.
    Senator Levin. Right. So the issue then is not--as Mr.
Caplan has said, look, it was shown in their books--that is his
testimony here--that it was reflected in their books, that it
was disclosed in Enron's books, and a liability is a liability,
plain and simple, that has to be satisfied. Price risk
management liability has to be satisfied every bit as much as
debt. While not recorded as debt, prepay liabilities were
clearly obligations of the company and visible as such to
investors. We had the former chief accountant of the SEC saying
he couldn't disagree with the statement more. Mr. Caplan,
representing Citibank, has made that statement.
    Mr. Bushnell. I don't think Mr. Caplan's statement is
inconsistent at all. I think what he was trying to----
    Senator Levin. Inconsistent with what?
    Mr. Bushnell. Inconsistent with what I just said, Senator.
    Senator Levin. Is it Citibank's position?
    Mr. Bushnell. Is that the correct classification of a
liability is an accounting concern, and that classification
differential is important.
    Senator Levin. And it matters.
    Mr. Bushnell. And it matters.
    Senator Levin. And if it is buried somewhere in the
financial statement under a false label, that matters?
    Mr. Bushnell. If the accounting for it was certified by its
board of directors, its chief financial officer, and its
independent accounting firm, that would make a difference.
    Senator Levin. But if it is buried somewhere under a false
label, that would matter, wouldn't it?
    Mr. Bushnell. It would matter what the classification of
that is, yes.
    Senator Levin. It would make a difference. It would be
significant. It is important, then, as to whether or not it is
put in the proper category, that an obligation isn't an
obligation, that there are----
    Mr. Bushnell. That all----
    Senator Levin [continuing]. Different obligations----
    Mr. Bushnell [continuing]. Items on the balance sheet,
Senator, both the assets and liability, are put in their
correct accounting structure is important for fundamental
analysis, yes. We rely on accounting firms and boards of
directors and the management of companies to put those assets
and liabilities in the correct positions in the balance sheet,
both on the asset side and the liability side. That is their
responsibility.
    Senator Levin. It is also your responsibility, it seems to
me, not to participate in a deception. Would you agree that
that is the bank's responsibility? I know you are not going to
agree you did participate in a deception. I am sure you are not
going to agree with that.
    Mr. Bushnell. That's correct.
    Senator Levin. But would you agree that you have a
responsibility not to participate in a deception?
    Mr. Bushnell. We have a responsibility to our clients, both
investors and to the customers who need capital, to do things
in accordance with the rules as they're established. And the
rules that were established, whether they are tax rules,
whether they are accounting rules, whether they're regulations
for commodity trading or banking, yes, we have an obligation to
stay within those rules. And we let the experts who determine
what those rules should be as well as interpret exactly what
they are do that.
    Senator Levin. I am really surprised that you can't answer
that question with a yes, that you have an obligation not to
participate in a deception. It seems to me that is an easy one,
that that one doesn't have to be hedged.
    Mr. Bushnell. I thought that's what I answered, Senator. I
think the answer is yes in a more English verbiage or--it
depends on what the definition of a deception is.
    Senator Levin. Any way you want to define it. You can
define it any way you want. Don't you think that the bank has
an obligation not to participate in a deception? You define
deception.
    Mr. Bushnell. Yes.
    Ms. Hendricks. Senator, might I add something to that
discussion?
    Senator Levin. Sure.
    Ms. Hendricks. I did listen this morning to the
presentation on the expert panel, and I for one was a little
surprised at the testimony in the context that I have in front
of me--a report that was written by Moody's in 1998 that refers
to under risks and weaknesses of the credit, significant off-
balance sheet liabilities, including $1.3 billion in
guarantees, $1.4 billion in transportation agreements, and $4.4
billion invested in projects of unconsolidated subsidiaries
globally add significant leverage to Enron's capital position.
    This is a direct lift from footnotes of Enron's financial
statements, and had Lynn Turner read the financial statements
which he said he did, he would obviously have seen this. And I
would posit that $1.3 billion in guarantees, while not listed
as funded debt, certainly is a liability of the company that
one would take into consideration in thinking about its overall
financial obligations. And I think that's the distinction that
we're trying to draw, is that as specifically determined under
accounting that it is not listed, in fact, unlike price risk
management assets and liabilities, it's not on the balance
sheet. It's in the footnotes, which arguably are an integral
part of the balance sheet.
    But I do think that there is perhaps--there was perhaps
some overstatement with respect to the issues this morning.
    Senator Levin. Take a look at Exhibit 157,\1\ if you would
please. This is an Enron document. In the middle of it, it
says, ``The Citibank swap combined with the Enron credit link
notes provides for a unique black box feature which provides
considerable flexibility for substitution.'' Two dots down,
``Black box allows Enron the ability to provide a permanent
takeout feature for highly structured transactions in the
capital markets while limiting disclosure of prepay to
Citibank.''
---------------------------------------------------------------------------
    \1\ Exhibit No. 157 appears in the Appendix on page 562.
---------------------------------------------------------------------------
    And then on the next page, at the bottom, ``The use of
prepays as a monetization tool is a sensitive topic for both
the rating agencies and bank institutional investors. The
ability to continue minimizing disclosure will be compromised
if transactions continue to be syndicated.''
    Do you believe that is a legitimate purpose--to minimize
disclosure? Were you aware that that was Enron's purpose?
Anyone.
    Ms. Hendricks. I'll take that. I think I would say a couple
of things. One, this is obviously not a document that we
prepared and prior to the preparation for this meeting had not
seen, or at least I have not seen.
    This is the first that I've heard about use of prepays as a
monetization tool being a sensitive topic. Quite the contrary,
again, in that report that I just referenced by Moody's in
December 1998, there is, if not a specific reference to
prepays, a definition of prepays in there and an acknowledgment
that the company was doing that.
    Further, we had been told by Enron that the agencies were
supportive of their monetization of their price risk trading
book, provided that the book was either in balance or in a net
asset long position and, therefore, were not aware of this
comment about it being a sensitive topic, etc.
    Senator Levin. Were you aware--I would like to just move on
a little more quickly. Were you aware of the fact that Enron
did not wish to have to explain the details of any of the
assets to investors or rating agencies?
    Ms. Hendricks. The assets of the trust?
    Senator Levin. Yes.
    Mr. Caplan. That was the primary purpose of the
transaction.
    Ms. Hendricks. Yes, absolutely.
    Senator Levin. So you were aware of that.
    Mr. Caplan. Yes.
    Ms. Hendricks. Absolutely.
    Senator Levin. And Citi was aware that that lack of
disclosure was a fundamental goal of the Yosemite structure?
    Ms. Hendricks. Absolutely.
    Mr. Caplan. It wasn't--let me just correct----
    Senator Levin. I am not saying you are agreeing that it was
improper. I am just saying you agree that that was a purpose of
that structure.
    Mr. Caplan. Right. The disclosure in Yosemite made clear
that investors would not learn about the credit risks that were
being hedged through the transaction.
    Senator Levin. You then began to tout the black box
feature, did you not, Exhibit 158? \1\ Take a look at it. This
is, I believe, is page 33. This is a Citibank document where
you are now trying to sell the feature of this kind of
structure, SPV investments purchased by the SPV are unknown to
the investors and the rating agencies.
---------------------------------------------------------------------------
    \1\ Exhibit No. 158 appears in the Appendix on page 564.
---------------------------------------------------------------------------
    Mr. Caplan. We were very successful in marketing the
Yosemite deal to investors, so we tried to duplicate the
concept with other capital-intensive borrowers such as Enron,
because we thought the concept had a lot of merit, the concept
of moving credit risk, but leaving other risks in the bank
market, so yes.
    Senator Levin. All right. But also selling--that one of the
benefits of the structure is to mask what was being done with
the funds. You touted that as one of the benefits.
    Mr. Caplan. It wasn't so much mask. It was provide
flexibility in the bank market, effectively.
    Senator Levin. Unknown to the investors, right?
    Mr. Caplan. Yes, but that's consistent with the
disclosure----
    Senator Levin. I am not saying it is not consistent. That
is what masking means. You keep it hidden.
    Mr. Caplan. It's consistent with the disclosure in the
Yosemite offering document that investors would not know the
trust investments. We were effectively just duplicating that
concept for other borrowers.
    Senator Levin. How many companies used this same structure
after you made a pitch to them? Do you know?
    Mr. Caplan. We did one structure like this with one
company, but it was primarily done in the bank market.
    Senator Levin. So you didn't sell any structures similar to
Yosemite?
    Mr. Caplan. In the Rule 144A market we did not.
    Senator Levin. OK. Let me check with Mr. Reilly on Project
Roosevelt. You talked about this before. This consisted of two
prepays, $310 million natural gas prepay and $190 million oil
prepay. The purpose was to supply Enron with $500 million in
cash at year end because another financing deal fell through.
According to the memos that you wrote, although this
transaction was written up as a 3-year deal, it was Enron's
intention to repay the $500 million by May 1, 1999, Citibank
held off syndicating the $500 million loan that it made to
Enron with the expectation that it would be repaid by May 1,
and the prepaid oil and gas deliveries were also delayed until
after the expected repayment date.
    Now I would like you to look at Exhibit 162.\1\ It is a
memo you wrote on April 19, 1999, reporting that Enron
indicated it could not repay all the $500 million by May 1. It
asked if it could pay off the $310 million gas prepay by May 1
and delay repayment of the $190 million oil prepay until
November or December. It asked you to hold off syndicating the
$190 million until after the new repayment date and
characterized it as a favor.
---------------------------------------------------------------------------
    \1\ Exhibit No. 162 appears in the Appendix on page 584.
---------------------------------------------------------------------------
    You allowed Enron to defer repayment of $125 million until
September 30, and you delayed syndication of the loan and
deliveries of the oil until after the September 30 repayment
date.
    So now Project Roosevelt is billed as to commodity prepays.
Enron promised that it would repay the money within 5 months.
You held off syndicating the loan and scheduling deliveries
until after the expected repayment. Enron asks to delay the
repayment of some of the funds. You push back the syndication
and delivery dates.
    So far am I OK?
    Mr. Reilly. Generally, yes, Senator.
    Senator Levin. OK. Now, it sounds to me more like a short-
term loan than a commodity deal. You keep pushing back the
delivery date until after full repayment is scheduled to be
made, and let's take a look here. I quoted from Exhibit 162, so
we will move on to Exhibit 144.\2\
---------------------------------------------------------------------------
    \2\ Exhibit No. 144 appears in the Appendix on page 513.
---------------------------------------------------------------------------
    OK. We are on Exhibit 144. This is the initial loan
approval memo for this transaction, and it gives us some
insight as to what is really going on.
    Under the subheading ``Story'' on page 7--or it is not page
7, but it is Item 7--it reads the following: ``The prepaid
forward structure will allow Enron to raise funds without
classifying the proceeds from this transaction as debt (it is
accounted for as `deferred income'). This is a common method of
raising non-debt financing among energy companies.'' So it was
very clear to you that this prepay forward structure will allow
Enron to raise funds without classifying the proceeds from this
transaction as debt. Right?
    Mr. Reilly. That is correct, Senator.
    Senator Levin. OK. Now, Exhibit 164,\3\ the loan approval
memo for the extension notes,``The company has verbally agreed
to repay the remaining $125 million by September 30, 1999.''
However, in another memo, which is Exhibit 163,\4\ you write
the following: ``Although they have agreed to prepay by 9/30,
the papers cannot stipulate that as it would require
recategorizing the prepaid as simple debt.'' Our records cannot
reflect what they've agreed to. That is very clear. Your
records cannot stipulate that they have agreed to prepay by 9/
30.
---------------------------------------------------------------------------
    \3\ Exhibit No. 164 appears in the Appendix on page 588.
    \4\ Exhibit No. 163 appears in the Appendix on page 586.
---------------------------------------------------------------------------
    Mr. Reilly. Senator, I----
    Senator Levin. That's your words, isn't it?
    Mr. Reilly. Yes, those are the words, but if I might, I
think as I referred to in the opening, my opening statement,
that ``agreement'' is probably--is a word that could mean
different things, but in this particular case, there had been
discussions with the client about the likelihood that they
would repay the transaction or prepay the transaction before it
ran the full term.
    Having said that, the transaction was structured to go to
full term, and in the intervening period between the initial
closing of the Roosevelt transaction and when we were getting
to the point of dealing with the syndication, potential
syndication of the transaction, Enron had also begun the
process that ultimately became the Yosemite transaction, which
then gave other opportunities, other ways that structured
transactions--may or may not have been a prepay, but structured
transactions might have been funded.
    So I think what we had was a statement of intention on the
part of the company, but not in any way a binding agreement on
the part of the company, and I think, as evidence of that, they
did not prepay the transaction along those schedules.
    Senator Levin. Twice you used the term ``agreement.'' You
are saying both times you were inaccurate.
    Mr. Reilly. I would say that no one that read that--I did
not intend that to mean that it was a binding agreement, and no
one in my institution felt that a binding agreement had been
made.
    Senator Levin. That is not the issue. They agreed to
something. But you said you cannot be much more explicit than
this. This is contemporaneous. The papers cannot stipulate
that. That is very explicit. This is not some casual comment.
You write down here, ``They've agreed to prepay by 9/30, but
the papers cannot stipulate that.'' How much more precise can
you be here, folks? You are saying those papers have got to
keep that oral. It is an oral agreement. For God's sake, you
cannot make a record of that. Why? It would require
recategorizing the prepaid as simple debt. Now we talk about
participation of the bank.
    Mr. Reilly. No, I----
    Senator Levin. Oh, yes. Now we are talking about your role
because your papers--the papers here cannot reflect the
reality, which was an agreement. It has got to be kept oral. It
cannot show in the papers why that would be debt. That is what
Enron did not want, debt reflected on their books. You cannot
tell me it makes no difference how obligations are described in
books. There is no way you can persuade anybody of that. They
were fighting, struggling to make sure debt did not appear on
their books. They went through all kinds of contortions and
other companies went along with them, using offshore items,
companies' entities to filter through money that were not real
entities at all, controlled by, you do not know if you did or
not. The record is pretty clear. But you go through all these
contortions. They went through all these contortions to avoid
debt being shown on their books for one very clear reason, it
would hurt their credit rating, hurt their stock price, and now
your bank, in a very specific clear way, in your words, the
papers cannot stipulate that they have agreed to what they have
agreed to orally. Why? It would require recategorizing the
prepaid as simple debt.
    What can be clearer than that?
    Mr. Reilly. Senator, I think if you took all of the papers,
emails, approval memos throughout the life of the Roosevelt
transaction, which was really from December 1998 until near the
end of the year in 1999, I think that there are--when that is
discussed, it is discussed in some cases as an intention, in
some cases as an expectation. In the two references you've made
to what I've said, it does say agreement. There was no--I am
telling you again, there was no agreement in any----
    Senator Levin. No oral agreement?
    Mr. Reilly. No contractual sense, no agreement, no----
    Senator Levin. No oral agreement?
    Mr. Reilly. No, there was no commitment on the part of the
company to repay those loans, none.
    Senator Levin. Was there an oral agreement?
    Mr. Reilly. No, there was not.
    Senator Levin. You said there was.
    Mr. Reilly. I understand that.
    Senator Levin. You lied in this memo.
    Mr. Reilly. No, I don't believe I did. I believe that--I
believe that----
    Senator Levin. Says there was an oral agreement.
    Mr. Reilly. I believe what I said in the agreement, which
was understood by the individuals who are the recipients of
that agreement, was telling them that they would--that it was
likely that the transaction would be repaid.
    Senator Levin. It did not say ``likely.'' I want to read
you your words. These are your words at the time. ``The company
has verbally agreed to repay the remaining $125 million by
September 30.'' They verbally agreed. I said, ``Did they orally
agree?'' You said, ``No.'' Your memo says they did. Which is
true?
    Mr. Reilly. They did not.
    Senator Levin. The memo is wrong?
    Mr. Reilly. The memo was wrong.
    Senator Levin. A contemporaneous memo that you wrote at
that time was in error, and then the second memo, 4/28/99, is
also in error; is that correct, that they have agreed to prepay
by 9/30; that is wrong?
    Mr. Reilly. It is the same situation. What they have said
is that they would--their intention was to repay, prepay.
Sorry.
    Senator Levin. Who are you telling that they made this
agreement? Who are you representing that to in the bank?
    Mr. Reilly. That list of people that are on this.
    Senator Levin. Why would you tell them that there was an
agreement if there was not?
    Mr. Reilly. Again, Senator, I believe that those
individuals do not--did not believe that that was a binding
contract on the part of the company to make prepayments.
    Senator Levin. If you would take a look at Exhibit 165.\1\
OK, about the fifth line down. We have--let us start at the
top. It is from you. ``We have agreed the following with Enron:
On 5/1 Enron will prepay the $310 million natural gas portion.
The $190 million oil portion will remain outstanding.
Deliveries scheduled for May/June/July/August/September will be
rescheduled to sometime after 10/1--there will, therefore, be
no amortization until after 9-30. They have agreed to prepay
that amount no later than 9/30. The paperwork cannot reflect
their agreement to repay the $190 million as it would
unfavorably alter the accounting.''
---------------------------------------------------------------------------
    \1\ Exhibit No. 165 appears in the Appendix on page 591.
---------------------------------------------------------------------------
    What can be clearer? How many more times do I have to read
your own words to you in different memos?
    Mr. Reilly. Senator, I will say the same thing again.
    Senator Levin. I expect you would.
    Mr. Reilly. And that----
    Senator Levin. ``The paperwork cannot reflect their
agreement to repay the $190 million as it would unfavorably
alter the accounting.'' Whose accounting?
    Mr. Reilly. Enron's.
    Senator Levin. It would have to show as a debt, would it
not?
    Mr. Reilly. Well, Senator, this--the Roosevelt----
    Senator Levin. If there was an agreement, it would have to
show as a debt, would it not?
    Mr. Reilly. Senator, if the--I think we've acknowledged
here both generically structured finance and Enron specifically
did in fact undertake transactions in which they could
categorize capital raising as non-debt, whether it be prepaids
or the like. So there's no reason to back away from that.
    It's also mentioned in other emails that their intention,
should they prepay, was to refinance it with other commodity-
based transactions, which I think sticks with the same line of
intent that they had when they closed this deal in December
1998.
    Senator Levin. Now, let me ask my question again. If there
were an agreement to repay to $190 million, it would result in
their being required to list this as a debt, would it not?
    Mr. Reilly. I believe that if we had redone the documents
and required it to be paid on a given day, because it was a
physical delivery prepay, that you simply couldn't meet that
physical delivery schedule on any 1 day.
    Mr. Caplan. Senator, I would add----
    Senator Levin. That is not responsive.
    Mr. Reilly. I'm sorry. I'll try----
    Senator Levin. I am asking a fairly direct question. If
there was an agreement to pay that money to you by that fixed
date of September 30, that would have required them to account
for this as a loan, would it not?
    Mr. Reilly. If there had been an amendment to the document
so that there was a binding contractual agreement, I understood
from the company that that could recategorize the transaction.
    Senator Levin. As a----
    Mr. Reilly. As debt.
    Senator Levin. Debt. Hard to get that word out of your
testimony here, but we are going to keep getting it. You can
fuzz it up. You can put words around it, but my question is so
direct, and your answer tends to be so indirect. And I do not
know--I think I know why, but you ought to be straightforward
here. You have said it in your own words. If this is shown as a
specific date to repay this, then it would change their
accounting and they would have to show it as a debt. And you
knew that. Is that correct? If the documents were rechanged----
    Mr. Reilly. Senator----
    Senator Levin. I got all that.
    Mr. Reilly. Can I go back and just read----
    Senator Levin. No, I do not think so. I want to go on to
the next question. I do not want to go backward. I want to go
forward here. I am going to just try one more time, because it
seems to me it is so clear what I am asking.
    If the documents reflected an agreement on the part of
Enron to pay that money back to Citibank by that specific date,
Enron would have been required to show that as a debt on their
books; is that not true?
    Mr. Reilly. I believe that is true, although that
particular accounting judgment was not mine. That was what I
understood from the----
    Senator Levin. And that is what you wrote in this memo,
this email, did you not?
    Mr. Reilly. Yes.
    Senator Levin. That is something that you worked with them
to avoid, did you not? You left that agreement out of those
documents, did you not?
    Mr. Reilly. Senator, again, there was no agreement.
    Senator Levin. I understand.
    Mr. Caplan. Senator, could I add something to clarify this
maybe a little bit?
    Senator Levin. Yes. Well, yes, try to clarify it. Not if it
is going to ``fuzzify'' it.
    Mr. Caplan. I'll try not to ``fuzzify'' it. September 30
comes along, there is no repayment of this transaction. So,
one, if there was a real agreement to repay it, then they
breached that agreement, and we did not do anything about that.
And usually on multimillion dollar transactions, if companies
breach their agreement, we tend to do something about it.
    Also I would add that there are other discussions of other
types of agreement around this transaction such as syndication
strategy and what the ``agreement'' with the company is on
that. But you won't find anything in the documents on a
syndication strategy, because I think the word ``agreement'' is
being used very loosely here, and I think why my colleague, Mr.
Reilly, is struggling, is that there wasn't--if you went to the
company, they would tell you they were not agreeing to do
anything. They were telling--they were expressing an intention
which got us comfortable in making a credit decision, but that
intention was not--did not rise to the level of an obligation.
And I think that is kind of the basic difference, and I think
it is unfortunate that Mr. Reilly used the word ``agreement,''
but I don't think that's supported by the facts surrounding the
transaction.
    Senator Levin. When they did not pay by that fixed date,
was there a understanding that they could pay by a later date?
Was there any conversation about them paying at a----
    Mr. Caplan. I was not privy to those conversations.
    Senator Levin. Who is? Mr. Reilly, are you privy as to what
happened when they did not pay by the date they said they would
pay it by?
    Mr. Reilly. They did not.
    Senator Levin. And then there was an understanding,
representation, whatever word you want?
    Mr. Reilly. Ultimately that--ultimately.
    Senator Levin. But they said they would pay it by another
time, right, in another way?
    Mr. Reilly. Well, I think--I'm not sure exactly what you're
referring to, but I believe----
    Senator Levin. What happened on that date when they did not
pay it? Was there not an understanding at that point as to how
and when they would pay it?
    Mr. Reilly. Well, we kept the existing transaction
documents in place. We did change the amortization schedule,
and it was the understanding of the parties that Roosevelt
transaction would likely be retired to the proceeds from the
first Yosemite transaction.
    Senator Levin. That was the understanding, not the
agreement, the understanding?
    Mr. Reilly. That's correct, Senator.
    Mr. Caplan. I think our credit approval----
    Senator Levin. There is no difference between----
    Mr. Caplan. Our credit approval indicates that we had
approved the transaction for the full tenor of the transaction
which is very typical in derivative transactions, and in many
instances counter-parties early terminate those kind of
transactions. So our credit approval didn't indicate that this
was a shorter transaction in any way based on Mr. Reilly's
communications.
    Senator Levin. Did Citibank represent to the sureties that
it expected real commodity deliveries?
    Mr. Reilly. I never had a conversation with the sureties.
    Senator Levin. Who would know most about that? Who had
conversation with the sureties, anybody here?
    Mr. Caplan. I was not involved in that transaction.
    Senator Levin. Mr. Bushnell.
    Mr. Bushnell. I did not.
    Senator Levin. Ms. Hendricks.
    Ms. Hendricks. No, sir.
    Senator Levin. Let us see. Why do I not yield to my
colleague, Senator Fitzgerald? I have more questions, but let
us go back and forth.
    Senator Fitzgerald. All right. Thank you very much.
    Ms. Hendricks, my understanding is that you were the
Citibank/Salomon Smith Barney investment banker that was in
charge of the Yosemite transactions; is that correct?
    Ms. Hendricks. Yes, I was the Salomon Smith Barney
investment banker, sir.
    Senator Fitzgerald. And is it correct that on September 9,
1999, you had to make a presentation to the Investment Grade
Commitment Committee of the bank in New York regarding some of
Enron's obligations, specifically regarding Project Condor; is
that correct?
    Ms. Hendricks. Yes, sir.
    Senator Fitzgerald. Now, you made the presentation on
September 8. Robert Rubin was present for that presentation; is
that not correct, according to the minutes of the meeting?
    Mr. Bushnell. Excuse me, Senator, if I could clarify. We
have two Robert Rubins at Citigroup. The Robert Rubin that this
was referring to was a Senior Managing Director in the Salomon
Smith Barney entity. He had come from Shearson Lehman. He sat
on our Capital Commitments Committee. That's not the Robert
Rubin that was Treasury Secretary.
    Senator Fitzgerald. So that is not the Mr. Rubin we were
talking about before?
    Ms. Hendricks. No, Senator.
    Senator Fitzgerald. It is another Robert Rubin. You made a
presentation to that Investment Grade Commitment Committee, is
that correct, on September 8, 1999?
    Ms. Hendricks. Yes, sir.
    Senator Fitzgerald. Did they ask you to do a follow-up
report to them?
    Ms. Hendricks. Yes, sir.
    Senator Fitzgerald. And why did they ask you to do a
follow-up report?
    Ms. Hendricks. As part and parcel of the discussion that we
had related to this transaction, there were a number of
questions from the Subcommittee, which is an extremely rigorous
investigative body prior to any transaction that we do, about
the amount of disclosure in Enron's public financial
statements. And I was specifically asked that if one included--
and I believe the question that was asked of me was off-balance
sheet debt, but that was a catch-all term for basically all of
the liabilities that we could think of.
    Senator Fitzgerald. That were off-balance sheet, that were
not in their public financials; is that----
    Ms. Hendricks. Well, frankly, that were in footnotes, OK?
So whether or not you categorize that as off-balance sheet,
whether or not you categorize certain things that might be
listed as non-debt, as debt items, etc., the question that was
asked of me is if you included all of those items, is this
still an investment grade company?
    Senator Fitzgerald. And what is the debt to equity ratio?
    Ms. Hendricks. No. I was not asked that question. I was
asked the question, is this still an investment grade company?
    Senator Fitzgerald. And how do you determine if it is?
    Ms. Hendricks. My approach was to go back with my team and
say, all right, we don't have a lot of time here. Let's do the
most rigorous, most punitive, in terms of including everything
we can think of, analysis that we possibly can of the company's
overall leverage.
    Senator Fitzgerald. And what did you come up with? Is that
not the exhibit that is Exhibit 166?\1\ Is that not the report
that you prepared in response to----
---------------------------------------------------------------------------
    \1\ Exhibit No. 166 appears in the Appendix on page 592.
---------------------------------------------------------------------------
    Ms. Hendricks. That is correct, Senator.
    Senator Fitzgerald [continuing]. The Investment Grade
Commitment Committee's request?
    Ms. Hendricks. That is correct, Senator.
    Senator Fitzgerald. And you found that Enron, on a GAAP
basis, what they totally reported was total debt of
$12,056,000,000; is that correct? That would be on the second
page of your report dated September 20, 1999; is that correct?
    Ms. Hendricks. Yes, sir.
    Senator Fitzgerald. And then you found that Moody's was
aware of additional off-balance sheet items, such as $4.4
billion in investments in unconsolidated subsidiaries, off-
balance sheet guarantees of $1.3 billion, transportation
commitments of $1.4 billion for a total of $5.7 billion?
    Ms. Hendricks. Yes, and that's a mathematical mistake. That
should be $7.7 billion, I believe.
    Senator Fitzgerald. That should be $7.7 billion, OK. And
then beneath, where you put that----
    Ms. Hendricks. Yes, sir.
    Senator Fitzgerald. Seven point one billion dollars in
additional off-balance sheet liabilities----
    Ms. Hendricks. Disclosed in their footnotes, yes, sir.
    Senator Fitzgerald. And that Moody's was aware of?
    Ms. Hendricks. Correct, in the report that I mentioned
earlier.
    Senator Fitzgerald. And while the publicly-reported
financials show a GAAP debt to capitalization ratio of 49
percent, you calculate that the GAAP debt plus Moody's off-
balance sheet liabilities was 56 percent; is that correct?
    Ms. Hendricks. Yes, and that's an error. Using the $7.1
billion, it should be 60 percent.
    Senator Fitzgerald. Sixty percent, OK. Then you came up--if
you have this document here, on this next page--I want to hold
this up so we are carefully talking about the same document
here. There is a document that says, ``SSB.'' I suppose that is
Salomon Smith Barney--``Additional Known Structures''--so these
are additional structures you knew of--``other off-balance
sheet items,'' and you come up with an additional $6 billion in
off-balance sheet liabilities; is that correct?
    Ms. Hendricks. That's what's on this page, yes, sir.
    Senator Fitzgerald. Is the math on this page correct?
    Ms. Hendricks. The math on this page is correct.
    Senator Fitzgerald. And then you have a little line here of
GAAP debt plus Moody's liabilities, plus the Salomon Smith
Barney known structures, brings the debt to equity ratio to 65
percent; is that correct?
    Ms. Hendricks. That is correct.
    Senator Fitzgerald. So you were aware that really their
debt level was higher than would appear in their publicly-
available financial reports as of the date of this report,
September 20; is that correct?
    Ms. Hendricks. Well, Senator, if I might, on that sheet
that you just held up, if you look further in your materials,
you'll see that we provided the Subcommittee with a list of
those assets that we feared at the time, but could not--were
not absolutely certain, we were double counting. We threw them
in because we wanted to be as punitive as possible, but we
recognized that we were being negatively sloppy in our
analysis. And so a number of those items--and frankly, we were
sloppy not only in the calculation that I've just admitted to,
but also in our terminology, when we call that SSB additional
known structures.
    Senator Fitzgerald. But you were aware that there were
significant substantial off-balance sheet liabilities that were
out there that Moody's did not necessarily know about and that
were not necessarily self-evident from the publicly available
financial statements filed by Enron; is that correct?
    Ms. Hendricks. Senator, the answer to that question is no,
because I did this calculation to be as negative as I could,
not to demonstrate that I knew things that weren't in the
information. As a consequence of that, I knew we were double
counting, and I subsequently then----
    Senator Fitzgerald. Were you double counting--was
everything double counted or just a few items on there double
counted?
    Ms. Hendricks. Most of the items were double counted. I
think if you look in your exhibits at--if you continue on in
that same exhibit, Exhibit 165.\1\ If you keep turning pages,
you'll get to the part--that same chart, where it lists the
double-count.
---------------------------------------------------------------------------
    \1\ Exhibit No. 166 appears in the Appendix on page 592.
---------------------------------------------------------------------------
    Senator Fitzgerald. I, maybe, see that you are saying about
$3 billion of the additional $6 billion is double counted.
    Ms. Hendricks. It turns out that leases as well are on the
balance sheet, or actually picked up in the Moody's report I
believe. So there were a number of items here. I think the
principal item that is on the balance sheet is the----
    Senator Fitzgerald. When did you realize you had double
counted?
    Ms. Hendricks. I knew it when I was doing the calculation,
but I couldn't be certain, and so after we prepared this
analysis and I was able to demonstrate that this was still an
investment grade company, which is the next page of this
presentation, which was the whole purpose of doing the
presentation, was to get to this final page, and to be able to
demonstrate that even throwing in things that I knew to be
double counting, even though I couldn't precisely give you the
numbers, which I subsequently did. I subsequently went back and
said, OK, the Marlin financing is in Note 9, and the Firefly
financing is electro and that's Note 9, and the Sutton Bridge
financing is a Rule 144A Euro bond and that is in the public
domain.
    When I was subsequently able to go back and get that
specific data, we absolutely corrected the information. But at
the time my objective was not to be accurate. My objective was
to be as conservative as I conceivably could be, and to
demonstrate first to my own satisfaction and second to the
Subcommittee's satisfaction, that this was still an investment
grade company. And that is what the final page of this
presentation demonstrates to me and to my satisfaction at the
time.
    When I subsequently was able to go back----
    Senator Levin. What page are you looking at?
    Ms. Hendricks. I'm sorry, sir. If you go to the last page--
--
    Senator Levin. Just the number at the bottom.
    Ms. Hendricks. Down at the bottom, page 4, comparable
companies, the last page of that exhibit.
    Senator Levin. OK, thank you.
    Ms. Hendricks. What we did was to say here are companies
that are in the same industry that are subjected--financing
themselves in the same way. And, Senator, the reason I derive
so much comfort from this presentation was because I did not
adjust these other companies's numbers of any form of off-
balance sheet activity.
    Senator Fitzgerald. I am looking at comparable companies.
This is document CITISPSI 0031098.
    Ms. Hendricks. Yes, sir.
    Senator Fitzgerald. Here you are just disclosing the GAAP
indebtedness. It says, ``The following is a review of the GAAP
debt capital ratio of certain comparable companies.'' And then
you have Enron listed, and it seems like here you have backed
out the off-balance sheet liabilities.
    Ms. Hendricks. No, sir. This is the----
    Senator Fitzgerald. Well, how do you come up with a debt to
equity ratio of 48.7 percent here?
    Ms. Hendricks. Because all of these are debt-to-cap. When
you look at AES Corp, when you look at Sonat, for this to be
apples to apples on this page, I showed Enron's number. But on
the prior page and on the previous page----
    Senator Fitzgerald. Yes, but you are aware of substantial
off-balance sheet liabilities of Enron, which you have just
demonstrated in the prior pages.
    Ms. Hendricks. They were disclosed in the footnotes to the
financial statements.
    Senator Fitzgerald. All of those liabilities?
    Ms. Hendricks. No. Maybe, I'm obviously not being clear.
    Senator Fitzgerald. I see what you are saying, that you
know that the publicly reported GAAP debt to capital ratio of
AES Corp was 78 percent.
    Ms. Hendricks. Yes, sir.
    Senator Fitzgerald. And that does not make reference to any
off-balance sheet liabilities that company may have.
    Ms. Hendricks. Correct.
    Senator Fitzgerald. I understand that. But are you saying
the only thing that is relevant to determine whether a company
is investment grade are its GAAP basis liabilities, and that
all of those off-balance sheet obligations are irrelevant in
deciding whether it is investment grade?
    Ms. Hendricks. Senator, what I'm saying is the question
that you asked me first was do I recall this presentation and
what was I asked in the presentation, and what was the purpose
of my response presentation. I was asked if including the off-
balance sheet--loose language--liabilities of this company
would still--if we included those, would the company still be
an investment grade credit.
    This is the analysis that I did and this is the analysis
that I sent to the Chairman of the Subcommittee, and
subsequently had either a telephone or over-lunch conversation.
I mean I don't think it was an actual presentation where I went
back to the committee with the material, but it was a
discussion in which I said we have done an incredible stress
testing.
    Senator Fitzgerald. So you persuaded the committee that
this was an investment grade company, that Enron was, and you
should go forward with the public offering or the Rule 144A
sale of securities?
    Ms. Hendricks. Yes, Senator.
    Senator Fitzgerald. Did anybody question you on that?
    Ms. Hendricks. No, Senator, and what I represented was that
we would, from this point forward, do a thoroughly rigorous
analysis, which we did in each subsequent Commitment Committee
presentation.
    Senator Fitzgerald. Was your compensation in any way tied
to how many deals you brought in and persuaded the company to
underwrite?
    Ms. Hendricks. No. In any direct way, no. We're not paid on
a commission basis. My compensation, as the global head of the
group, was primarily a function of the global revenues of the
firm of which Enron was less than 10 percent.
    Senator Fitzgerald. So if you did not generate any business
all year, it would not really affect your compensation?
    Ms. Hendricks. No, I wouldn't say that. I would think they
might question whether or not I should still be the head of the
group.
    Senator Fitzgerald. Can it not be said that they expect you
to generate some deals?
    Ms. Hendricks. Absolutely, sir.
    Senator Fitzgerald. You try to generate deals for the bank,
right?
    Ms. Hendricks. Yes, sir.
    Senator Fitzgerald. But at the same time you do not want
your firm to underwrite something it should not.
    Ms. Hendricks. Senator, in my belief, there is no level of
fee compensation that justifies risking the firm's reputation,
and there is absolutely no way that we would have done this
transaction to do this transaction if we thought there was an
issue.
    Senator Fitzgerald. Are bankers at Salomon Smith Barney
penalized if they sell bad securities to the public that do not
get repaid?
    Ms. Hendricks. In my opinion, absolutely.
    Senator Fitzgerald. In your opinion. Is that any part of a
written compensation policy for the bankers there?
    Ms. Hendricks. No, because we do not have written
compensation policies, sir.
    Senator Fitzgerald. There is nothing written, it is all
just--who decides what your compensation is?
    Ms. Hendricks. My boss.
    Senator Fitzgerald. Who is your boss?
    Ms. Hendricks. At the time, the Global head of the
investment bank.
    Senator Fitzgerald. And you do not know on what criteria he
bases your compensation?
    Ms. Hendricks. No, sir, I think I have a general idea of
the criteria----
    Senator Fitzgerald. What are they?
    Ms. Hendricks. But there is no contractual arrangement.
    Senator Fitzgerald. Do you think that they look favorably,
when it comes to compensating you, on how many deals you
generate?
    Ms. Hendricks. Yes, and I think they would look very
favorably, very unfavorably on me for doing transactions that
resulted in either a loss of prestige for the firm or an
economic loss.
    Senator Fitzgerald. Would you not think this transaction
resulted in somewhat of a loss of prestige?
    Ms. Hendricks. Absolutely.
    Senator Fitzgerald. Were you penalized at all in your
compensation?
    Ms. Hendricks. I believe I was, sir, yes.
    Senator Fitzgerald. You were. OK. Now, on November 4, this
is a supplement to the offering memorandum, dated November 4,
1999, for Yosemite Securities Trust I. When did you actually
sell?
    Ms. Hendricks. I am sorry, Senator. Could you say that one
more time for me. I am sorry.
    Senator Fitzgerald. This is the prospectus for Yosemite
Securities Trust I.
    Ms. Hendricks. Yes, sir.
    Senator Fitzgerald. For the notes, and I asked you for that
before, and lo and behold my staff had one. What was the date
that you sold the Yosemite securities, that you actually closed
the sale of those notes?
    Ms. Hendricks. I do not know.
    Mr. Caplan. It is November 4, 1999.
    Senator Fitzgerald. That is the date of this supplement. It
says, initially, ``Purchasers expect to deliver the securities
on or about November 18.''
    Mr. Caplan. Oh, I am sorry.
    Senator Fitzgerald. So somewhere around November 18.
    Mr. Caplan. Sorry. It was November 18th.
    Senator Fitzgerald. In this prospectus, you do disclose
certain risk factors that you knew of. The underwriter is
Salomon Smith Barney; is that correct?
    Ms. Hendricks. Yes.
    Senator Fitzgerald. That is the company you work for,
right?
    Ms. Hendricks. Yes, sir.
    Senator Fitzgerald. We have established that Salomon Smith
Barney knew of some of the off-balance sheet liabilities by
September 1999 of Enron. Did you disclose any of those off-
balance sheet liabilities in this offering prospectus?
    Ms. Hendricks. Senator, I do not mean to quibble with
terminology, but it is relevant I think to this discussion. I
do not agree that these are off-balance sheet liabilities. That
was a sloppy term that we used in our presentation material,
but virtually all of the transactions----
    Senator Fitzgerald. Was it material information--let me put
it that way--what you prepared for the Investment Grade
Committee? It was apparently material enough for you to tell
your committee before they went forward with it. Was it
material----
    Ms. Hendricks. No, sir, I did not believe that was material
nonpublic information for us to disclose to the committee--I
mean, to the public.
    Senator Fitzgerald. Why were you disclosing it to the
committee? If it is not material, why are you wasting their
time?
    Ms. Hendricks. One, because they asked me to, but, two,
most importantly, this was a flawed analysis that anyone could
have done in reading the financial statements and which I think
Lynn Turner referred to this morning in terms of when you read
through these financial statements, there are a number of
questions that are asked. At the point at which I did the
analysis, it was inaccurate, and had we disclosed it, it would
have been misleading. Having said that----
    Senator Fitzgerald. It was overly conservative.
    Ms. Hendricks. There was no legal requirement to disclose
it, and what we disclosed is what we believe is the legal
requirement. As I am sure you know, our underwriting activities
are extremely carefully monitored, and we do exactly what it is
appropriate for us to do, recognizing that to step outside of
those boundaries is to subject both investors and ourselves to
risk.
    Mr. Caplan. And we relied upon experts in determining what
the appropriate disclosure in this instance was and received
legal opinions consistent with that----
    Senator Fitzgerald. Who is your law firm?
    Mr. Caplan. In this transaction, we actually received two
different legal opinions on the securities law issues. One was
from Millbank Tweed basically on the Yosemite structure, and
then Vinson &amp; Elkins, who is----
    Senator Fitzgerald. Vinson &amp; Elkins?
    Mr. Caplan [continuing]. Who is Enron's legal counsel, as
you know, gave a 10b-5 opinion----
    Senator Fitzgerald. They opined that your disclosures were
sufficient.
    Mr. Caplan. That the disclosure, the Enron-related
disclosure, in particular, was sufficient, as well as received
a comfort letter from Enron's accountants that the information
incorporated by reference and included in the document was
proper.
    Senator Fitzgerald. So let me just get this straight. You,
Ms. Hendricks, that whole analysis you did for your Investment
Commitment Committee, the presentation, dated September 20,
where you itemized the off-balance sheet liabilities of Enron
Corporation, you do not believe that was material information
that someone who might want to invest directly or indirectly in
Enron needed to be aware of?
    Ms. Hendricks. I believe that all of that information was
public information, that anyone could have done the analysis
that I did, that the liabilities were not off-balance sheet,
and that, no, I did not need to disclose it.
    Mr. Caplan. Which was verified by our experts, effectively.
    Senator Fitzgerald. All of that information was disclosed,
and so you did not believe it needed to be detailed in any
risk-factor statement in your offering memorandum?
    Ms. Hendricks. No, sir. I know that in this morning's
presentation, there was discussion by the staff with respect to
requirements for supplemental disclosure, but we did not
believe that that was appropriate or necessary.
    Senator Fitzgerald. So is your position that if it is
disclosed in publicly available documents, even if the
disclosure is obtuse, you would admit that the disclosure in
the footnotes is fairly obtuse with respect to these off-
balance sheet liabilities, would you not? Your position is that
if it is somewhere in the publicly available reports, even if
it is buried in an obscure footnote, that you do not have to
further disclose it or highlight it.
    Ms. Hendricks. Senator, my position is that this was a Rule
144A transaction that was being sold to QIBs, which are the
largest, most sophisticated institutional investors in the
world and that our obligation here was to incorporate, by
reference, which we did, the financial statements of Enron
which were audited by a reputable accounting firm at the time
and that that was the standard of required disclosure, which we
met.
    Senator Fitzgerald. Well, I appreciate that. Mr. Chairman,
if you want to----
    Senator Levin. We are going to take a 10-minute recess for
the sake of our witnesses, and our staff, and I think
ourselves. We will recess for 10 minutes.
    [Recess.]
    Senator Levin. We will come back to order.
    I want to pick up where Senator Fitzgerald left off and
refer you to Exhibit 168,\1\ Page 21. Now this was prepared, as
I understand, Ms. Hendricks, by the time you have gotten to
Yosemite IV, through all of these transactions involving
Yosemite; is that correct?
---------------------------------------------------------------------------
    \1\ Exhibit No. 168 appears in the Appendix on page 604.
---------------------------------------------------------------------------
    Ms. Hendricks. Is this Yosemite IV, Senator? I am sorry. I
just turned right to----
    Senator Levin. That is OK. If you go back to Exhibit 168.
    Ms. Hendricks. April 16.
    Senator Levin. All right.
    Ms. Hendricks. Yes, sir.
    Senator Levin. What is this document?
    Ms. Hendricks. This is the Commitment Committee memorandum
that would have been prepared for the Investment Grade
Commitment Committee.
    Senator Levin. This is after Yosemite IV?
    Ms. Hendricks. No, this would have been----
    Senator Levin. Just before Yosemite IV?
    Ms. Hendricks. Prior to, yes. This would have been the
approval for Yosemite IV, sir.
    Senator Levin. So, by now, you have gone through this kind
of an assessment as to what the appropriate amount of what
previously had been called additional known structures, off-
balance sheet items, etc. You have now got to the point where
you are about to take up Yosemite IV, right? You have done it
for Yosemite I, you have done it for Yosemite II, you have done
it for ECLN I, haven't you?
    Ms. Hendricks. Yes, and this is actually ECLN II. I know
that the staff refers to it as Yosemite IV, but----
    Senator Levin. OK. We will call it either ECLN II or
Yosemite IV interchangeably, correct?
    Ms. Hendricks. Yes, sir.
    Senator Levin. Now what you have testified to is that these
figures appeared in the Enron financial statement; is that
correct?
    Ms. Hendricks. Yes, Senator.
    Senator Levin. As a matter of fact, and this is the
critical question, these items are financings, are they not?
    Ms. Hendricks. Yes, Senator.
    Senator Levin. They are.
    Ms. Hendricks. Yes, Senator.
    Senator Levin. They appear as financings in the financial
statements of Enron?
    Ms. Hendricks. No, Senator. It would depend on the
structure as to how they are accounted for.
    Senator Levin. My question is did they appear as financing
in the financial statements of Enron?
    Ms. Hendricks. They would have been listed on the balance
sheet or in the footnotes as obligations of the company. I am
not trying to be difficult, Senator. I am trying to make sure I
understand what you are asking.
    Senator Levin. I thought that they were listed in that big
item called price risk management liabilities, were they not?
    Ms. Hendricks. The prepaids are, yes, sir. Receivable
financing, for example, would not have been.
    Senator Levin. Let us just talk about the prepaids.
    Ms. Hendricks. OK.
    Senator Levin. Prepaids were listed in price risk
management liabilities; is that correct?
    Ms. Hendricks. They were included, yes, Senator.
    Senator Levin. In the Enron financial statements.
    Ms. Hendricks. In the Enron audited financial statements,
yes, Senator.
    Senator Levin. But you know that they are financings, do
you not?
    Ms. Hendricks. Senator, I know that they have monetized the
future cash flows, yes, sir.
    Senator Levin. You know they are financings, do you not?
    Ms. Hendricks. Yes, sir.
    Senator Levin. You use that term all of the time.
    Ms. Hendricks. Yes, Senator.
    Senator Levin. They do not appear as financings, do they,
in the Enron financial statement?
    Ms. Hendricks. They appear as liabilities, Senator.
    Senator Levin. Not as financing.
    Ms. Hendricks. Senator, I----
    Senator Levin. Is that not correct? They do not appear as
financings in the Enron financial statement; is that correct?
    Ms. Hendricks. I believe that the generally accepted
accounting principles required them to be disclosed, as their
auditors told them they had to disclose them; that these are
price risk management liabilities of the firm that what----
    Senator Levin. I am talking here about the prepays.
    Ms. Hendricks. Yes, of Enron.
    Senator Levin. They are not financings.
    Ms. Hendricks. They were structured financings. I mean,
they were loans, they were structured financings. You have used
different terms----
    Senator Levin. No, I have not. You told your board that
they are financings.
    Ms. Hendricks. Well, we called them off-balance sheet
financings, Senator, and they are not off-balance sheet either.
    Senator Levin. But they are financings.
    Ms. Hendricks. Well----
    Senator Levin. You treat them as financings to your board.
You tell them your financings. We have been told all day long
by the folks who were trying to defend this stuff that the oil
prepaids are financings. That is the argument you have all been
using.
    Ms. Hendricks. Correct.
    Senator Levin. OK, if they are financings, they do not show
up as financings on the Enron financial statement as
financings. Do they?
    Now that is a very precise question. Do they show up on the
Enron financial statement as financings?
    Ms. Hendricks. Nowhere on the Enron financial statement,
that I am aware of, does anything show up as financings.
    Senator Levin. They show up----
    Ms. Hendricks. They show up as long-term debt, but not
financings.
    Senator Levin. They do not show up at all as debt or
financings, do they?
    Ms. Hendricks. I am not aware of anything that shows up as
financings.
    Senator Levin. Including oil prepaids.
    Ms. Hendricks. Including oil prepaids.
    Senator Levin. So now you believe the oil prepaids are
financings. They do not show up on the Enron financial
statement as financings; are you with me so far?
    Ms. Hendricks. I am with you, sir.
    Senator Levin. But you tell investors that they can rely on
the financial statements of Enron which you incorporate by
reference in your offering----
    Ms. Hendricks. Yes, Senator.
    Senator Levin [continuing]. Even though that financial
statement, which you incorporate by reference, leaves off the
fact that there are this many prepaids that you treat as
financings when you deal with your own board; is that factually
correct, what I just said?
    Ms. Hendricks. No, this is not our board. I am sorry.
    Senator Levin. Excuse me, to the committee.
    Ms. Hendricks. OK.
    Senator Levin. You are right.
    Ms. Hendricks. There is a difference.
    Senator Levin. You are right. I am sorry. To the committee
that you presented this to, you presented this as a financing;
is that correct?
    Ms. Hendricks. Yes, sir, I presented this as off-balance
sheet financings, which is incorrect, but it definitely is
presented as specific things that we were aware of, yes.
    Senator Levin. And you believe it is a financing, do you
not, the prepaids?
    Ms. Hendricks. I believe that it is a structured financing,
yes, sir.
    Senator Levin. You do, the prepaids.
    Ms. Hendricks. Yes, sir.
    Senator Levin. But they do not appear on the financial
statement of Enron as a financing, do they?
    Ms. Hendricks. No, sir, they do not. They appear as price
risk management liabilities.
    Senator Levin. And you incorporate that financial
statement, by reference, in your offering, do you not?
    Ms. Hendricks. Yes, sir, we do.
    Senator Levin. Therefore, you are incorporating something
which is not accurate.
    Ms. Hendricks. I disagree with that, Senator.
    Senator Levin. You present to your Capital Committee this
is a financing. It does not show as a financing on the
financial statement that you incorporate, by reference. It
shows as something else, something very different, which
everyone here has finally acknowledged, which is a risk
management liability.
    Ms. Hendricks. Senator, we disclose, throughout this
memorandum to our Commitment Committee, that these transactions
are accounted for under generally accepted accounting
principles under price risk management and asset liabilities.
And when we are asked by them what the business purpose is of
engaging in these transactions, we gave the same response that
we gave to your Subcommittee earlier this morning with respect
to our belief that this was a legitimate business purpose as an
attempt to monetize future cash flows.
    I also further believe that this type of transaction was
described in the report by Moody's in 1998. I think there are
references that are made to it in other transactions, but if
you are asking me if, specifically----
    Senator Levin. That is my question, very specifically.
    Ms. Hendricks. And I gave the answer, no, these are not
listed as financings and, no, it would not have been
appropriate for us to include them because, under generally
accepted accounting principles, they are not financings, and it
would have been inappropriate----
    Senator Levin. Prepaids are not financings.
    Ms. Hendricks. Under generally acceptable accounting
principles----
    Mr. Caplan. But again, I think that is not even our
decision.
    Senator Levin. I thought that you have been arguing all
afternoon that they are financings.
    Mr. Caplan. We consider them financings because we take
credit risk in them.
    Senator Levin. Good. So that is--yes.
    Mr. Caplan. However, the accountants are the ones that are
charged with disclosing them where they should be disclosed in
the financial statements. So you are asking us to indicate
whether we think an accounting principle is right or wrong, and
I do not think we are in a position to do that.
    Senator Levin. No, I am not. I am asking you a simple
question. You presented to your committee here these prepays as
financing, which you have been arguing they are all afternoon,
and they are not shown as financings on the financial statement
of Enron, which you incorporate by reference in your offering.
Those are factual statements.
    Ms. Hendricks. Correct.
    Senator Levin. Mr. Caplan, who were the people at Enron
whom you dealt with on the prepays and on the Yosemite
structure?
    Mr. Caplan. Starting, I guess, from the top of the
organization, I know that Andy Fastow was aware of them, but I
did not have direct dealings with him--Jeff McMahon, Bill
Brown, Doug McDowell, Jody Coulter, Barry Schnapper, George
McKean, Dan Boyle, I would say those are kind of the primary
people--I am sorry, Ben Glisan, a couple of people in Europe,
Trease Kirby, and Simon Crowe and Paul Chivers, and one other
person in Europe, a woman named Anne Edgley, I would say that
is probably the core group of people.
    Senator Levin. Mr. Bushnell, this is a question for you.
    Chase supplied us with tapes of phone conversations related
to the prepay transactions. They supplied them because all of
the traders calls are taped, and they were under subpoena to
produce all documents, including tapes that addressed Enron
transactions.
    Now Citigroup received a similar subpoena. Your traders
apparently are also taped, their phone conversations. Why has
Citigroup not produced any tapes to the Subcommittee?
    Mr. Bushnell. I cannot answer that question in terms of why
we might not have responded to that. I believe, Senator, that
some of our traders are taped and others are not, but I am not
aware of the existence of any tape recordings.
    Senator Levin. Have you inquired?
    Mr. Bushnell. I have not.
    Senator Levin. How would you be aware of them if you have
not inquired?
    Mr. Bushnell. I said I am not aware of the existence of any
of the tapes. I have not asked the question, Senator.
    Senator Levin. Would you do that?
    Mr. Bushnell. Yes, sir.
    Senator Levin. We have asked a number of questions which we
are going to need answers for, for the record, from both of our
last panels. The testimony today and the documents surely paint
a very disturbing picture. Enron came to the banks. It had a
clear desire to get cash, but to show it not as debt, but as
something else--cash flow from operations. The financial
institutions provided the structure and the vehicle to create
these fake prepaid trades. It attempted to turn debt into cash
flow from operations.
    The critical third party that was provided were off-shore
shell corporations that existed in secrecy jurisdictions solely
for, and as the creation of, the investment bank.
    Just a little bit like the ``Wizard of Oz,'' when Toto
pulls back the curtain to show the great Oz is no more than
just an old man rapidly manipulating pyrotechnic devices, when
you pull back the curtain of off-shore shell companies, it
reveals that the banks were calling the shots and pulling the
strings. There is no other conclusion that any reasonable
person can reach, I believe, that effective control of those
two off-shore entities were in the hands of the banks.
    This deception was taken a step further when investments
were, in the Yosemite Trust, sold to persons relying on an
Enron financial statement which did not disclose these prepays
and which Citibank incorporated by reference in its offering.
    Enron desperately wanted the cash to be booked as prepays,
real prepays, they hoped people would believe, but in order for
them to be legitimate prepays, there had to be independent
parties, the third-party entities could not be controlled by
the banks, the trades could not be linked, and the testimony--
it is very obvious here today--shows that they were linked.
There had to be price risk. Plenty of testimony was that they
were all hedged, and there was no price risk. The purchaser of
the commodity had to have an ordinary business reason for
purchasing it. That surely did not appear with either of these
off-shore entities.
    So the reality was hidden from credit rating agencies, from
the public, from outside investors. I do not believe that Enron
could have done what it did in hiding debt and disguising it as
cash flow from operations without the assistance and
participation of the banks.
    All of the documents in the record here are going to be
referred, as I indicated, to the SEC and the Department of
Justice. We hope that the Sarbanes bill will cure some of the
problems here, but I think the problem ultimately has got to be
addressed internally by our major institutions. It is a sad day
for me, believe me, when two institutions like Citigroup and
Chase, come before us and, instead of shedding light on what
clearly was the intent here of Enron to turn debt into
operational cash coming in, we find the continuation basically
of an insistence that nothing was done wrong here, that nobody
knew that this was intended to be shown as debt, even though
there is no jurisdiction for it--excuse me--it was intended to
be shown as operational income, even though there is no
jurisdiction for it according to the criteria which we had set
out to be shown as anything other than debt.
    The answer has got to come not just from additional
regulation and laws, although I think they are appropriate, if
done sensibly, but the ultimate answer here has got to be given
at least significantly by our institutions, our banks, our
boards of directors, our corporations. This is a pretty sad
story, in my judgment. I know we have not heard the end of it,
but we have reached the end of the hearing. We thank our
witnesses for coming forward. It has been a long day, I hope an
illuminating day. That has been our intention.
    We will stand adjourned.
    [Whereupon, at 7:25 p.m., the Subcommittee was adjourned.]
       THE ROLE OF THE FINANCIAL INSTITUTIONS IN ENRON'S COLLAPSE
                              ----------
                         TUESDAY, JULY 30, 2002
                                       U.S. Senate,
                Permanent Subcommittee on Investigations,
                  of the Committee on Governmental Affairs,
                                                    Washington, DC.
    The Subcommittee met, pursuant to notice, at 9:36 a.m., in
room SD-342, Dirksen Senate Office Building, Hon. Carl Levin,
Chairman of the Subcommittee, presiding.
    Present: Senators Levin, Durbin, Carper, Dayton, Lieberman
(ex officio), Collins, and Fitzgerald.
    Staff Present: Linda J. Gustitus, Chief of Staff, Senator
Levin; Elise J. Bean, Acting Chief Counsel; Mary D. Robertson,
Chief Clerk; Robert L. Roach, Counsel and Chief Investigator;
Stephanie E. Segal, Professional Staff Member; Ross Kirschner,
Deputy Investigator; Jamie Duckman, Professional Staff Member;
Edna Falk Curtin, Detailee/General Accounting Office; Rosanne
Woodroof, Detailee/Department of Commerce OIG; Lani Cossette,
Intern; Alex DeMots, Intern; Kim Corthell, Republican Staff
Director; Alec Roger, Counsel to the Minority; Claire Barnard,
Investigator to the Minority; Jim Pittrizzi, Detailee/General
Accounting Office; Meghan Foley, Staff Assistant; Jessica
Caron, Intern; Victor Marsh, Intern; Tim Henseler (Senator
Levin); David Berick (Senator Lieberman); Bill Weber (Senator
Durbin); Gary Brown and Bob Klepp (Government Affairs
Committee/Senator Thompson); Holly Schmitt (Senator Bunning);
and Jennifer Bonar (Senator Fitzgerald).
               OPENING STATEMENT OF SENATOR LEVIN
    Senator Levin. Good morning, everybody.
    Last week, the Subcommittee looked at the sham transactions
that Enron used to obtain billions in loans from major
financial institutions without showing any debt on Enron's
books. The hearing revealed that the financial institutions not
only were aware that Enron was engaged in misleading accounting
but actively assisted Enron in its deceptions.
    The documentation included an internal email from a Chase
banker reporting how ``Enron loves these transactions because
it can hide debt from its equity analysts.'' We saw how Chase
and Citigroup helped Enron construct false energy trades by
providing offshore entities, effectively controlled by the
banks, to participate as sham trading partners, the banks that
then helped orchestrate multi-party trades with no price risk
that canceled each other out except for the equivalent of
interest payments by Enron on loans Enron was trying to hide,
and the phony cash flow from operations Enron was trying to
magically create.
    Chase and Citigroup did more than just help Enron carry out
its deceptions. They also pitched Enron-style phony prepays to
other companies, further spreading into the U.S. business
community the poisonous practice of misleading accounting.
    At the hearing, through the witnesses, and after the
hearing, through statements by their CEOs, the two banks
claimed this was all business as usual, reflecting industry
practices, and that their companies acted properly and with
integrity, to use their words. William Harrison, the CEO from
Chase, even lauded Chase's witnesses because, in his words,
they ``stood tall'' in the face of Subcommittee questioning.
Neither company has admitted responsibility for helping Enron
doctor its financial statements, much less admit to any
misjudgment or wrongdoing.
    The evidence presented at the hearing last week, however,
was clear and convincing. And when the banks' witnesses were
confronted with the documentary evidence that showed the banks
knew that the phony prepays were being used by Enron to book
loans as cash flow from operations in order to keep their
credit rating and stock prices up, the witnesses worked hard to
obfuscate the plain meaning of their own words.
    Look at the testimony last week of Jeffrey Dellapina of
Chase when confronted with a recording and transcript of a
phone conversation in which he participated where an Enron
employee said to Mr. Dellapina, ``That goes to the same point
you were raising, Jeff, that from your side you also want to
make sure that Mahonia seems independent.'' When questioned
about the use of the phrase ``seems independent,'' Mr.
Dellapina challenged the taped conversation. ``I don't believe
I would have wanted it to seem independent,'' he said.
    When asked about an internal Chase document describing
Mahonia as a special purpose entity used in the Enron prepays
as ``formed by Chase,'' Donald McCree, a senior Chase official,
testified that the words ``formed by Chase'' were loose and
inaccurate.
    When Robert Traband of Chase was asked if he would call the
Enron prepays with Chase a circular deal, Mr. Traband testified
he didn't know. The Subcommittee then played a tape of a
conversation involving Mr. Traband where he specifically
described the prepays as ``circular.'' When asked what he meant
by that term, Mr. Traband said, ``I don't recall.''
    Citigroup often took the same tack of saying its documents
didn't mean what they said. When asked about a memo in which a
Citigroup employee suggested adding a penny to the price spread
in an Enron prepay to make the prepaid structure a little more
like a trade, Richard Caplan of Citigroup denied that the memo
actually meant what it said.
    A similar response was given by James Reilly of Citigroup
when he was asked about three different memos regarding the so-
called Roosevelt prepay. In those memos, Mr. Reilly refers to
Enron's undisclosed agreement to repay $125 million by
September 30, 1999, an arrangement that, if known, would have
forced recategorization of the so-called prepay as Enron debt.
    At the hearing Mr. Reilly said, `` `Agreement' is a word
that could mean different things, and I did not intend to mean
that it was a binding agreement.''
    In one exchange, when confronted with the discrepancy
between what the memo said and what he was testifying to at the
hearing, Mr. Reilly said, ``The memo is wrong.'' He was, in
effect, disputing the plain words of three contemporaneously
written memos.
    And, finally, when David Bushnell was asked whether he
agreed that it is the responsibility of a financial institution
like Citigroup not to participate in a deception, believe it or
not, Mr. Bushnell said, ``It depends upon what the definition
of a `deception' is.''
    I guess that is what is meant by ``standing tall.''
    So last week, Chase and Citigroup denied the plain meaning
of words in their own contemporaneous documents. Today, looking
at the prepared statement of Merrill Lynch, it is more of that
same approach: Deny the plain meaning of words in your own
documents.
    Merrill Lynch will say commitment doesn't mean commitment,
guarantee doesn't mean guarantee. They mean something else,
maybe best efforts. And loan doesn't mean loan. It means
purchase.
    Last week, we showed how two major financial institutions
helped Enron hide debt. This week, we will see how a major
financial institution, Merrill Lynch, helped Enron artificially
and deceptively create revenue.
    But the underlying truth is the same as last week. Enron
couldn't have engaged in the deceptions it did without the help
of a major financial institution. Merrill Lynch assisted Enron
in cooking its books by pretending to purchase an existing
Enron asset when it was really engaged in a loan.
    The accounting sham involved the sale of an interest in
three Nigerian barges that operated as floating power stations.
Enron wanted to sell these barges before the end of calendar
year 1999 so it could report the sales income as earnings in
its 1999 financial statements. But Enron was unable to find a
buyer willing to complete the sale before the end of the year.
    In mid-December 1999, Enron asked Merrill Lynch as a favor
to set up a special purpose vehicle, subsequently called
Ebarge, to take an Enron asset--barges, or the income that they
might particularly create--for a short period of time for a $28
million purchase price consisting of a $7 million cash payment
from Merrill Lynch and a purported loan of $21 million from
Enron to Ebarge. This transaction would allow Enron's African
Division to book sales income of $12.5 million. Merrill Lynch
agreed, but this is the key: Only after receiving Enron's
commitment that it would find a buyer for Merrill Lynch's
interest in the barges within 6 months.
    Merrill Lynch also received assurances of a 15-percent
return on its $7 million, plus an immediate payment of
$250,000. This so-called sale arrangement violated elemental
accounting rules which allow a seller to book sales income only
for a transaction that is a real sale. Enron's guarantee to
Merrill functioned as an ongoing obligation that kept Merrill
from assuming the risks of company ownership. In a real sale,
the risks and rewards of the asset are completely transferred
from the seller.
    The evidence is clear that Enron and Merrill were aware of
this accounting problem, and in order to facilitate Enron
booking the transaction as a sale, it had to keep Enron's oral
guarantees a secret, omitting it from the documentation and
leaving it as an oral understanding.
    As the 6-month deadline approached on June 30, 2000,
Merrill Lynch became concerned that Enron would not fulfill its
promise. On the day before the deadline, LJM2, an investment
vehicle run by Enron's chief financial officer Andy Fastow,
stepped in and took over an interest in the barges from Merrill
Lynch at the previously agreed upon terms. It paid Merrill
Lynch the $7.525 million that had been assured to Merrill by
Enron at the beginning of the transaction, the $7 million
principal and 15-percent interest over 6 months, and it assumed
the $21 million note that Enron initially loaned to Ebarge.
    By the way, Ebarge never paid any interest on that note,
notwithstanding loan documents that required it to do so. Three
months later, in September 2000, Enron and LJM2 sold the barge
interest to a third party.
    When you look at the elements of this transaction, it is
obvious that it is not a real sale. Through an unwritten side
agreement, Enron provided a guarantee to take Merrill Lynch out
of the deal within 6 months. Merrill Lynch was guaranteed and
received a specified 15-percent return on its $7 million
investment. Merrill Lynch never received the periodic cash flow
payments from the operation of the barges as promised under the
agreement and never complained about it to Enron. Ebarge, the
Merrill Lynch special purpose vehicle, didn't pay any interest
on the $21 million loan advanced by Enron. Enron paid all the
costs associated with the formation, operation, and management
of Ebarge. In other words, the risks of owning Ebarge weren't
transferred to Merrill Lynch.
    This wasn't the only troubling transaction that Merrill
Lynch had with Enron. In an April 1998 memorandum, two high-
ranking Merrill Lynch employees informed Merrill Lynch's
president, Herb Allison, that Merrill had lost a chance to co-
manage a large Enron stock offer solely because Enron objected
to what Enron saw as a lack of support by Merrill Lynch's Enron
analyst John Olson. The memorandum stated that Enron's decision
to deny Merrill's participation in the offering was ``based
solely on the research issue and was intended to send a strong
message as to how viscerally Enron's senior management team
feels about our research effort.''
    A few months later, Mr. Olson was gone from Merrill. The
new Merrill analyst assigned to Enron then upgraded the Enron
stock from the equivalent of a neutral to a buy rating. A
January 1999 memorandum thanked Mr. Allison for telephoning
Kenneth Lay at Enron about Merrill's ``difficult relationship
in research,'' and it projected additional fees from Enron now
in the range of $45 million.
    Earlier this year, Merrill paid $100 million to the New
York State Attorney General for compromising the independence
of its financial analysts in a case not involving Enron.
    Among the additional business that Merrill Lynch picked up
that year and the next was handling the private placement
offerings for Enron's off-balance sheet partnerships LJM2 and
LJM3. Merrill Lynch was not blind to the conflicts of interest
raised by these partnerships, but Merrill Lynch decided to go
ahead, and it helped raise some $390 million for LJM2. The
money that Merrill raised for LJM2 helped Enron inflate its
earnings and mislead investors and analysts in the way that it
did.
    Merrill described Enron internally as ``one of its biggest
clients'' and ``the key to its Houston office.'' In 5 years,
from 1997 until 2001, Merrill Lynch received approximately $43
million in fees from Enron. There is nothing wrong with making
money honestly. It is part of the American dream. But making
money by assisting a company like Enron to engage in misleading
accounting or by discouraging analysts to provide honest
ratings or by touting a questionable investment is more like a
nightmare than a dream. It misleads investors, rewards the
wrong companies for the wrong reasons, and produces the
situation we are in today with the crisis of investor
confidence.
    Today, we will inquire why a company like Merrill Lynch
would risk its reputation to do what it did. Hopefully, when
the details come to light, Merrill Lynch will take action
against those who participated in deceptions with Enron and
will set a firmer, straighter course for the future.
    Senator Collins.
              OPENING STATEMENT OF SENATOR COLLINS
    Senator Collins. Thank you, Mr. Chairman. Today is the
second hearing held by the Permanent Subcommittee on
Investigations examining the role played by some of America's
leading financial institutions in the collapse of Enron. Our
investigation has revealed that certain financial institutions
knowingly participated in and, indeed, facilitated transactions
that Enron officials used to make the company's financial
position appear more robust than it actually was, thereby
deceiving shareholders, customers, and employees.
    Last week, the Subcommittee examined one such type of
transaction. Enron and its bankers, JPMorgan Chase and
Citigroup, call them ``prepays.'' The evidence, however,
revealed them to be nothing more than sham transactions
designed to obtain, as one of the banks continued to tout on
its website, ``financial statement-friendly financing.''
    Like so many of the other deals at Enron, the apparent
motive was to portray a false image of the company's financial
health. As NYU law professor and former judge William Allen
noted recently in a speech, banks such as JPMorgan Chase and
Citigroup are supposed to play a valuable role in our system of
corporate checks and balances because they monitor debtors more
closely than other providers of risk capital. ``Did the lenders
not understand that they were enabling deception?'' Professor
Allen asked. Much to my dismay, last week's hearing made clear
that they did understand but chose to proceed anyway.
    Our focus this morning is whether Merrill Lynch also
participated in enabling Enron to deceive the public. There are
four aspects of the Merrill Lynch-Enron relationship that we
will examine. The first involves Merrill's purchase of Nigerian
barges with electricity-generating equipment from an Enron-
related entity in late 1999. This transaction allowed Enron's
African Division to meet its quarterly reporting target and
announce to the financial world that Enron had sold a $12
million asset.
    As with much at Enron, though, the reality was a different
story. Merrill's purchase of the barges was predicated on
Enron's agreement that it would find another buyer for them
within 6 months. Under a Securities and Exchange Commission
accounting bulletin published that very month, such an
arrangement clearly did not allow the seller to recognize the
revenue. Handwritten notes by a Merrill employee warned that
there was a ``reputational risk, i.e., aiding and abetting
Enron income statement manipulation,'' but, nevertheless,
Merrill went ahead with the deal.
    Second, the Subcommittee will examine actions taken by
Merrill management in response to Enron's complaints that
Merrill's financial analyst had rated the company less
favorably than Enron would have liked. Enron informed Merrill
that it would not be selected as a manager or co-manager of a
large Enron stock offering solely because Enron objected to the
rating of its equity research analyst. Merrill appears to have
gone to extraordinary lengths to placate Enron, and
subsequently Merrill was indeed added as a co-manager of the
offering. After the offer went public, Merrill executives kept
Enron's CFO updated on the activities of the research analyst.
On at least three occasions, Merrill actually sent the CFO
copies of the analyst's internal list of calls that he made to
clients touting the offering. The analyst in question
subsequently left Merrill, and his replacement immediately
upgraded Enron. This case raises troubling questions about
conflicts of interest compromising the integrity of the ratings
on which investors rely.
    Third, the Subcommittee will pursue Merrill's decision to
participate in an Enron loan syndication. Enron sought
Merrill's participation in a deal that had been arranged by
JPMorgan Chase, but had failed to raise the needed $482 million
for an Enron-related company. Prior to the request, Enron had
made clear to Merrill that it was at ``a distinct
disadvantage'' for obtaining future business from Enron because
of its reluctance to use its balance sheet to support Enron's
business activities. Subsequently, Merrill agreed to
participate in the loan syndication despite indications that
the investment would result in a financial loss. Ultimately,
Merrill did indeed lose approximately $1.6 million in the deal.
    Finally, the Subcommittee will closely look at Merrill's
dealings with an off-the-books partnership headed by Enron's
CFO Andrew Fastow. His investment company, LJM2, asked Merrill
to provide a $10 million line of credit in connection with a
$65 million revolving credit facility. An internal Merrill
document advocating the credit request states, ``Committing to
this LJM2 facility will build Merrill Lynch's relationship with
Andy Fastow and assist Merrill Lynch in securing future
investment banking opportunities with Enron.''
    Other Merrill emails warned against it, citing the lack of
a rating and the nature of the credit risk. Nevertheless, two
of the witnesses scheduled to testify before the Subcommittee
this morning requested an exception to bank policy for the loan
for the following reasons: ``Enron is an excellent client, $40
million in revenue in 1999, $20 million in revenue for 2000
year to date. Andy Fastow is in an influential position to
direct business to Merrill.'' In the end, the prospect of more
lucrative business from Enron trumped those at Merrill who
urged caution.
    As we learn more about how prestigious financial
institutions participated in transactions that allowed Enron to
deceive investors, I am reminded of a congressional hearing
almost a century ago with another banker. In 1912, J.P. Morgan
appeared before a House Subcommittee to be questioned about his
firm's banking practices. He was asked whether it was true that
his bank had no legal responsibility for the value of bonds it
sold to clients. He responded that the banks assumed something
even more than legal responsibility--moral responsibility.
    Yet, incredibly, last week, when asked by Senator Levin
whether it was appropriate for a financial institution to act
in a manner it knew was deceptive, one banker responded, ``It
depends on what the definition of a `deception' is.''
    It is this sad and telling quote that sums up the attitude
of some professionals on what their duty is in today's market.
This attitude must change. The day of the deal that serves no
purpose other than to exploit an accounting loophole and the
day when the law serves as the ceiling rather than the floor on
the conduct of Wall Street professionals and corporate
executives must come to an end.
    It is important to remember that the Enron debacle is more
than just a tale of one company's greed. As a result of Enron's
downward spiral and ultimate bankruptcy, shareholders, large
and small, individual and institutional, lost an estimate $60
billion. The collapse of Enron caused thousands of Americans to
lose jobs, to lose their retirement savings, and to lose
confidence in corporate America. It is time to halt the
practices that are beneficial to a select few and harmful to
thousands.
    I want to once again commend Chairman Levin for his
leadership in this important and thorough investigation. It is
my expectation that these hearings will yield valuable lessons
for strengthening our free enterprise system, restoring public
confidence in our capital markets, and ensuring that small
investors in particular have access to complete and accurate
information to guide their investment decisions.
    Senator Levin. Thank you, Senator Collins, and thank you
very much for your words and also for your and your staff's
participation and support in this investigation.
    Senator Lieberman.
             OPENING STATEMENT OF SENATOR LIEBERMAN
    Senator Lieberman. Thank you, Mr. Chairman. I want to again
commend you, Senator Levin, and you, Senator Collins, and your
staffs for continuing the very important and very insightful
work that this Permanent Subcommittee on Investigations is
doing into the role of financial institutions in Enron's
collapse. As Chairman of the full Senate Committee on
Governmental Affairs, I am proud of and grateful for the work
that you are doing.
    Today, we will examine another set of very troubling
transactions between Enron and one of the Nation's leading
financial institutions, Merrill Lynch. We are going to be
talking about a number of technical issues today, about highly
complex agreements and partnerships that improved the
appearance of Enron's financial statements but kept investors
in the dark about what was really happening at that company
before it was too late for most of them to save their security.
But there are, of course, beyond these details, much larger
questions at stake here, and I would like to just speak for a
moment or two about them.
    For weeks now, our capital markets have seemed like a
mountain climber sliding down a hill, drawn by the forces of
gravity, trying to find a ledge to break the fall. In the last
several days, it appears that the markets have grabbed onto a
ledge, but it is too early to determine whether that ground
will hold and the confidence that is the precondition of growth
in the markets has fully returned.
    Obviously, one of the main causes of the fall down the
mountain of our markets has been the collapse of investor
confidence, which is to say the inability of average investors
to know who or what to believe.
    We Americans are great risk takers. That is what gives our
free enterprise system its vitality, its seemingly endless
supply of new ideas and ambitious people to turn those ideas
into opportunities and wealth, to grow the middle class. But
Americans are also great pragmatists. We don't part carelessly
with our money. We work hard to understand the difference
between intelligent investing and reckless gambling. And that
practicality is aided and based, in the case of investments, on
the honesty and transparency of our markets.
    It is that critical blend of hard-charging risk and hard-
won trust that gives our unique brand of capitalism its
strength and its stability. Without risk, our economy couldn't
accelerate. But without trust, it couldn't stay on the road.
    That delicate balance has clearly been upended since
December 2 when Enron declared bankruptcy. Enron and its
progeny, WorldCom, etc., have had a terrible effect on that
transparency and sense of trust. It is now equally troubling,
of course, to see truly venerable firms like Merrill Lynch
drawn into this web of actions that have undermined trust in
our markets in the long term for profit in the short term.
    Today's hearing echoes, in fact, several of the concerns
raised during the full Senate Governmental Affairs Committee's
hearing on February 27 when we examined particularly that day
the role of Wall Street analysts. Today we are going to be
examining the interrelationship between investment firms and
research analysts, and we are also going to hear evidence, as
my colleagues have indicated, that strongly suggests a quid pro
quo between Merrill and Enron regarding the analysis that was
given by Merrill Lynch regarding Enron's stock.
    The findings presented by the Subcommittee today regarding
this distortion of the analyst ratings process are totally
consistent with the findings of New York Attorney General Eliot
Spitzer's first-rate investigation into Merrill's equity
research practices. As a result of that investigation, Merrill
Lynch agreed to a $100 million penalty and promised to reform
its practices.
    Hopefully, such conduct will now end, not just at Merrill
but at all the other firms involved, as a result of the very
strong bill sponsored and written by Senator Sarbanes that has
passed the Senate and is on its way to becoming law, which
contains tough mandates that should enhance the independence of
the Wall Street analysts that millions of average investors
depend on as they decide where and how to put their money into
the market.
    Finally, Mr. Chairman, I think it is important to remember
again that today, as the result of a remarkable revolution that
has occurred in our country over the last two decades in which
capitalism has truly been democratized, more than half of the
American people have a stake in our capital markets, or at
least they did before the recent crisis in confidence among
investors. My guess is they still do. That money is
underpinning people's hopes for funding a secure retirement,
for sending a child to college, or for buying a house or
starting a new business. Just talk to your friends and
neighbors and coworkers, as I have been over the last several
weeks, and you will be able to measure the very personal impact
on millions of Americans that has resulted from the topics that
this Subcommittee is investigating today.
    So while the talk may get technical today, the stakes here
could not be more real for millions of American families. And
that is why, Mr. Chairman and Senator Collins, I want to thank
you and your staffs again for your outstanding work in these
investigations which have told and will continue to tell such
riveting stories of corporate fraud and negligence that I am
confident that they will help bring about not just the
corrective legislation, but the business self-regulation that
will restore confidence in our markets and help those millions
of Americans I have spoken of realize those dreams regarding
their retirement, their children's education, and their hopes
in general for a better life.
    For that I thank you, and I think that the people of this
country are and will be thankful for the work that you are
doing here.
    Senator Levin. Senator Lieberman, thank you, and thank you
for the support which you have constantly given to this
investigation.
    Senator Dayton.
              OPENING STATEMENT OF SENATOR DAYTON
    Senator Dayton. Thank you, Mr. Chairman. I certainly would
echo the comments of Senator Lieberman to both you and Senator
Collins and your staffs. I think you have done an extraordinary
job in delving into these matters. I think you have uncovered
more information that explains the full scope of Enron's
nefarious schemes than any other entity in the Congress and, to
my knowledge, anywhere in the country. I think you have
performed, as Senator Lieberman has said, an invaluable service
to our Nation. You have helped this Subcommittee and Congress
attempt to come to a full understanding of what has occurred
here so that we can prevent it from happening ever again in
this country. You have given the victims, employees, investors,
and the public confidence in our financial institutions.
    I note that in the beginning many wondered how it was that
this company could have gone so far and concealed so much and
built such a web of financial transactions that proved to be
unreliable and ultimately worthless. It was clear from your
previous hearing that they did not engage in these transactions
alone. In fact, they could not have carried out this web of
deceit and this scope of financial transactions and deceived so
many other parties for so long without willing collaborators;
collaborators who saw it in their financial interest to do so,
even at the deception of their own investors, their own other
clients, and certainly at the expense of their own corporate
integrity.
    The Wall Street Journal yesterday said, and they are not
the type to easily bash business, but they said that with the
evidence they have looked at, the banks, referring to Citigroup
and Morgan, deserve the beating that they are now getting. And
I would ask unanimous consent that this editorial be included
in the record, Mr. Chairman. I think it is unusual and well-
deserved support of the work of the Subcommittee.\1\
---------------------------------------------------------------------------
    \1\ Exhibit No. 195 which appears in the Appendix on page 2043.
---------------------------------------------------------------------------
    I think it also bears putting it into the record now so
that it helps sets the context that the victims of these
schemes that go beyond the corporations involved. As they said
here, the investors who bought into these, the insurance
companies, investors in Enron, the banks' investors and
shareholders, and of course, the employees of these companies,
have suffered from these transactions. Those who put their
faith and trust in these institutions and suffered the
consequences were a lot of real, regular Americans. They were
not the ones with deep pockets, not the ones who walk up and
down Wall Street, not the ones who have limousine service and
show up every day with three-piece suits. These are people who
work for a living. These are people whose retirements depended
upon these investments. These are people in many cases whose
life savings were wrapped up in these investments. They are
people who had every reason to believe that they were being led
not only to make good investments, but they were being given
accurate and appropriate information by those who were
counseling them, including their brokers.
    This hearing today, Mr. Chairman and Ranking Member, gets
into, I think, a very important area. Were people who were
induced to invest in Enron and its subsidiaries given accurate
information by those in the know, or was that information
compromised by the very institution that they were relying upon
to provide that information?
    Both of you have noted in your opening remarks--and we will
delve into it further--the scope of the financial relationship
that Merrill Lynch has evidently had with Enron and its other
operations. I note that in its July 26 public statement, the
company seems to take a somewhat different tack in that regard.
It notes that a couple of its employees have been notified that
they are subject to a Department of Justice investigation. It
says here that Merrill Lynch, however, has been advised that it
is not a target or a subject of the Department of Justice's
investigation, and is cooperating fully with this Subcommittee.
It goes on to say Merrill Lynch's dealings with Enron were
limited. As has been reported previously, they included a $7
million equity investment in a company established to operate
energy generation barges and Merrill Lynch's role as a private
placement agent for the LJM2 partnership. Merrill Lynch
strongly believes its dealings with Enron and LJM2 were
appropriate and proper based upon what it knew at the time.
Merrill Lynch also believes that based on the information
currently available to its employees, its employees also
behaved properly in the Enron transactions.
    I think it will be particularly interesting today, Mr.
Chairman, to see how those statements reconcile with the
evidence that this Subcommittee has uncovered.
    Thank you.
    Senator Levin. Thank you so much, Senator Dayton. As
always, you have put your finger on some very, very significant
points.
    I now call as witnesses Robert Furst and Schuyler Tilney.
Mr. Furst was a former Managing Director for Merrill Lynch at
Dallas. Mr. Tilney is Managing Director of Global Energy and
Power, Global Markets &amp; Investment Banking for Merrill Lynch in
Houston, Texas.
    The first order of business today is to swear you both in
as witnesses, and I would ask you to please stand and to raise
your right hands. Do you swear that the testimony that you will
give to this Subcommittee today is the truth, the whole truth,
and nothing but the truth, so help you, God?
    Mr. Furst. I do.
    Mr. Tilney. I do.
    Senator Levin. You have prepared statements for today
informing the Subcommittee that you both are invoking your
Fifth Amendment right against self-incrimination and that you
both, therefore, will refuse to testify today. You may proceed
with your written statements now, and then we will clarify that
issue.
    First, Mr. Furst.
TESTIMONY OF ROBERT FURST,\1\ FORMER MANAGING DIRECTOR, MERRILL
                   LYNCH &amp; CO., DALLAS, TEXAS
    Mr. Furst. Thank you, Mr. Chairman, Madam Ranking Member,
and members of the Subcommittee. My name is Robert Furst, and I
appear here today voluntarily. In anticipation of testifying
before you today, I met voluntarily with the Subcommittee's
staff 2 weeks ago for nearly the entire day. As your staff has
no doubt informed you, I cooperated fully with them, answering
all of their questions to the best of my ability, reviewing a
number of documents and providing information that I believed--
and still believe--will assist the Subcommittee in
understanding the investment banking transactions at issue here
today. At the time I met with the staff, I intended to appear
today and testify truthfully, fully, and to the best of my
ability.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Furst appears in the Appendix on
page 337.
---------------------------------------------------------------------------
    Since I met with the staff, however, I have learned that
the matter in which the Subcommittee is interested is also the
subject of an investigation by the U.S. Department of Justice.
As much as I would like to advise the Subcommittee of my view
as to whether there was anything questionable concerning one of
the investment banking transactions my colleagues and I worked
on at Merrill Lynch, my lawyers have advised me that any such
statement may constitute a waiver of my constitutional rights
under the Fifth Amendment. As I am sure the Subcommittee knows,
and as my lawyers have informed me, the U.S. Supreme Court last
year reaffirmed the principle that because, ``truthful
responses of an innocent witness . . . may provide the
government with incriminating evidence from the speaker's own
mouth,'' even innocent witnesses may assert their Fifth
Amendment right not to answer questions. I, therefore,
respectfully advise the Subcommittee that I intend to assert my
constitutional privilege under the Fifth Amendment in response
to the Subcommittee's questions today.
    Thank you.
    Senator Levin. Mr. Tilney.
  TESTIMONY OF SCHUYLER TILNEY,\1\ MANAGING DIRECTOR, GLOBAL
ENERGY AND POWER, GLOBAL MARKETS &amp; INVESTMENT BANKING, MERRILL
                  LYNCH &amp; CO., HOUSTON, TEXAS
    Mr. Tilney. Mr. Chairman, Ranking Member, Members of the
Subcommittee, my name is Schuyler Tilney, and I am a Managing
Director at Merrill Lynch. As you may know, 2 weeks ago, I met
with Robert Roach, special counsel--excuse me--the majority
counsel and chief investigator of the Subcommittee; Gary Brown,
special counsel, as well as other members of the Subcommittee
staff. I answered all of the questions they asked me concerning
the subjects of today's hearings. I believe they would agree
that I was fully cooperative and forthcoming about the facts
that I knew, and that I did my best to answer every one of
their questions. I met with the Subcommittee staff voluntarily,
and I fully anticipated that I would appear before you today to
answer your questions.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Tilney appears in the Appendix on
page 338.
---------------------------------------------------------------------------
    Unfortunately, since that time, I have been advised that
one of the transactions to be covered today is the subject of
an investigation by the Department of Justice. Therefore, I
have reluctantly accepted my lawyer's advice to decline to
answer questions at this time based upon my constitutional
right not to do so. I am profoundly saddened that I must make
this decision, and I am mindful of the significant personal and
professional consequences that follow from my decision not to
give testimony at this time. I look forward to the day that I
can satisfy all of the concerns the Subcommittee may have on
these matters.
    Thank you.
    Senator Levin. Mr. Furst, is it your intention to refuse to
answer any and all questions directed to you by the
Subcommittee today?
    Mr. Furst. Yes, it is.
    Senator Levin. Mr. Tilney, is it your intention to refuse
to answer any and all questions directed to you by the
Subcommittee today?
    Mr. Tilney. On the advice of my lawyer, it is.
    Senator Levin. With that understanding, you having invoked
your right to assert your constitutional privilege, you are
both now dismissed.
    I will now call Kelly Martin, Senior Vice President and
President of International Private Clients for Merrill Lynch in
New York.
    Before I administer the oath to Mr. Martin, I will just
make one other comment about witnesses today. We have one other
witness, Dan Bayly, who we invited to testify today who is a
current Merrill Lynch employee and who is familiar with a
number of issues being discussed today. Despite our earlier
efforts, his counsel did not offer to make him available to the
Subcommittee staff for a prehearing interview until
approximately 9 p.m. last night, and then for a very limited
period of time, which was not an acceptable proposal.
Consequently, the Subcommittee staff will be taking his
deposition immediately following the close of today's hearing.
    Mr. Martin, would you please stand and raise your right
hand? Do you swear that the testimony you are about to give to
this Subcommittee will be the truth, the whole truth, and
nothing but the truth, so help you, God?
    Mr. Martin. I do.
    Senator Levin. You may proceed now with your statement.
  TESTIMONY OF G. KELLY MARTIN,\1\ SENIOR VICE PRESIDENT AND
  PRESIDENT OF INTERNATIONAL PRIVATE CLIENT DIVISION, MERRILL
                LYNCH &amp; CO., NEW YORK, NEW YORK
    Mr. Martin. Thank you, Mr. Chairman.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Martin appears in the Appendix on
page 339.
---------------------------------------------------------------------------
    Mr. Chairman and Members of the Subcommittee, thank you for
the opportunity for me to speak with you today. My name's Kelly
Martin. I'm a senior vice president at Merrill Lynch and
president of the International Private Client Division. During
most of the relevant time period, I was head of Merrill Lynch's
Global Debt Markets Division.
    As the Subcommittee has requested, I am here to speak about
Merrill Lynch's policies and practices relating to its
relationships with publicly traded companies. I was not
personally involved in any of these transactions which will be
reviewed today.
    As the Chairman said, another Merrill Lynch executive, Dan
Bayly, chairman of Investment Banking, will be available--was
available to testify today and will be interviewed by the
Subcommittee subsequently.
    I will do my best to answer your questions accurately and
from an overall Merrill Lynch perspective. However, please be
advised that Mr. Tilney and Mr. Furst had primary relationship
responsibility with Enron at the time of the transactions in
question. We have addressed in our written statement all the
transactions that the Subcommittee has asked about. For purpose
of this oral statement, we will discuss our relationship with
Enron, the December 1999 purchase of an equity interest in
certain barges, and our overall research coverage.
    By way of background, Merrill Lynch believes that our
limited dealings with Enron were appropriate----
    Senator Levin. Mr. Martin, let me interrupt you just for a
minute. Could you bring that mike as close as possible to your
mouth? A little more.
    Mr. Martin. How's that?
    Senator Levin. Better. Thanks. You are getting there.
    Mr. Martin. By way of background, Merrill Lynch strongly
believes that our limited dealings with Enron were appropriate
and proper based on what we knew at the time. At no time did we
engage in transactions that we thought were improper. We
welcome the opportunity to discuss them with you.
    At the outset, all of us in this room recognize the
enormous harm caused by the collapse of Enron. The facts that
now have come to light about Enron, however, were not known at
the time of the transactions discussed below. All of us now
have the significant benefit of hindsight. Our decisions,
however, had to be made with the facts--based on the facts that
we knew at the time.
    At the time we conducted business with Enron, it was not a
discredited, bankrupt company as it is today. It was instead
the world's leading integrated electricity and natural gas
company--a company of enormous stature and prestige.
    In 1999, Enron reported revenues of $40 billion. It was
ranked as the most innovative company in the world for 5
straight years by Fortune 500 company CEOs, board members, and
senior management who participated in this survey. In addition,
it was ranked as the top company for ``Quality of Management.''
It was literally the textbook example of a modern American
success story.
    Moreover, at the time we dealt with Enron, it was known to
have extensive in-house and outside expertise. Enron's CFO,
Andrew Fastow, had been awarded CFO Magazine's ``Excellent
Award for Capital Structure Management.'' Its CEO, Jeffrey
Skilling, had been a partner at McKinsey &amp; Company, a leading
management consulting firm in the world. Enron had one of the
most widely respected boards in the country. Arthur Andersen
was viewed throughout the world as a leader among independent
auditing firms. Vinson &amp; Elkins, Enron's principal outside
counsel, was one of the leading law firms in Texas.
    Our firm dealt with Enron at an arm's-length relationship
and made business decisions based on information that was then
available. We relied on Enron's accountant's opinions, its
board approvals, its lawyers' opinions, its audit committee
oversight, and other governance processes, and felt justified
at the time in believing Enron's financial representations. In
addition, the transactions were subject to a significant amount
of Merrill Lynch internal approval processes and included
review with business, legal, and other personnel who had no
personal stake in the specific outcomes. At no time did we
engage in transactions that we thought improper.
    Merrill Lynch's relationship with Enron. Merrill Lynch is
one of the leading, world's largest diversified financial
institutions. At the time of 1999, we had revenues of
approximately $22 billion. Our investment banking revenues for
that year were some $3.7 billion. Enron was not a significant
contributor to Merrill Lynch's revenues or earnings. It
represented two-tenths of 1 percent of the total average annual
investment banking fees for the firm--two-tenths of 1 percent.
    Between 1997 and 2001, Enron retained advisers to assist it
in 43 strategic transactions. Enron retained Merrill Lynch to
act as adviser on one transaction during the 5-year period of
time. At least 10 other firms performed more advisory
assignments for Enron during this period, including two firms
that, added together, performed a total of 23 such assignments.
    Although Merrill Lynch participated in debt and equity
offerings for Enron, the relationship was modest. From time to
time, Merrill Lynch also participated in credit lines for
Enron. Here, too, however, we had a minimal role. We did not
participate in most of the credit lines, and our commitments to
Enron represented less than 3 percent of those deals that we
participated in with them. We were never a lead lender in any
loan syndicate. We did not participate in any of the billions
of dollars of prepay financing transactions that the
Subcommittee examined last week. We discuss below the
transactions that the Subcommittee has asked us to address.
    The barge transaction. Questions have been raised whether
it was appropriate for Enron to record a December 1999
transaction with Merrill Lynch as a sale. In that transaction,
a Merrill Lynch entity--Ebarge, LLC bought shares of a company
that entitled Ebarge to be part of the cash flows from the sale
of energy to be produced by generators on three barges. Merrill
Lynch's investment exposure in the transaction was $7 million.
Merrill Lynch agreed to the transaction largely to build a
relationship with Enron and believed that it was likely,
although not certain, that a third party unaffiliated with
Enron would ultimately purchase Merrill Lynch's shares in that
company.
    Merrill Lynch does not know, even today, whether Enron's
accounting treatment for this transaction was correct. We were
not advising Enron on the appropriate accounting treatment for
this transaction. In general, when we act as a purchaser or a
seller, we are not asked for and do not provide advice on the
other party's accounting treatment; rather, we expect them and
their experts to determine the appropriate accounting treatment
unto themselves. This is a market practice and fully in accord
with all legal standards. Furthermore, there was no
understanding by Merrill Lynch that Enron or any entity related
to Enron would buy back Merrill Lynch's shares. In fact,
Merrill Lynch had a contrary understanding--that an independent
third party was likely to buy Merrill Lynch's interest.
    There was no guarantee, hidden or otherwise, that Merrill
Lynch would receive a certain rate of return. The purpose of
not including a reference to any questions--to any guarantee in
the written agreement was not to hide it; it was because there
was no guarantee and Merrill Lynch was at risk. The written
purchase and sale agreement expressly provided that it was the
entire agreement of the parties, and that it superseded any
other understanding related to the purchase and sale. Had Enron
not succeeded in finding a buyer for our interest, our only
recourse would have been to try to find a buyer ourselves.
    Three, we did anticipate that an independent third party--
an Asian trading company, which we understood was close to
agreeing to the principal terms of the purchase of the shares--
would potentially buy Merrill Lynch's interest, but Merrill
Lynch knew that it was at risk and knew that it had no remedy
if the company failed to go forward and Enron and Merrill Lynch
failed to find a purchaser.
    Four, the transaction was, in fact, a purchase of equity
interest rather than a loan. Merrill Lynch owned the shares and
was at risk until it was able to sell or re-sell those shares.
Though it hoped and expected to be able to re-sell those shares
at a profit, it had no guarantee that would happen.
    Five, Merrill Lynch played no role whatsoever in
determining Enron's own accounting for the transaction.
    Six, nevertheless, we considered a number of issues
presented by the transaction. Consistent with Merrill Lynch's
internal procedures, the transaction was considered by a
committee of individuals that included credit, legal, and other
personnel who had no personal stake in the proposed
transactions and who are expected to consider a wide range of
issues and risks raised by a given transaction. Before deciding
to proceed with this transaction, the committee did what it was
supposed to do: It considered the issues, including whether the
transaction could be used to manipulate Enron's income
statements, and concluded that Merrill Lynch's participation in
the transaction was appropriate.
    Among the factors considered: Merrill Lynch was, in fact,
at risk in the transaction; Enron's accounting for the
transaction had been vetted with and approved by Enron's
outside auditors; Enron and its experts were among the most
knowledgeable in the world on structured finance; the
transaction itself was so small relative to Enron, which had
$40 billion in revenues in 1999, that it seemed inconceivable
that the transaction could be used to manipulate Enron's
earning statements.
    Research coverage. The Subcommittee has asked about Enron's
complaint in 1998 concerning Merrill Lynch's research coverage
of Enron and whether as a result Merrill Lynch's research
ratings were compromised.
    The facts are: In 1998, an internal memorandum indicated
that Enron was not going to invite Merrill Lynch to participate
in an underwriting of Enron's common stock because Enron was
disappointed with our research coverage. The memorandum asked
senior executives to place a call to Enron executives for the
purpose of reconsidering their decision, citing our
longstanding relationship with the company and leadership
position in the natural gas industry.
    We understand that such a call was made, and ultimately
Merrill Lynch participated as a co-manager in the transaction,
which occurred in May 1998.
    At no time was Merrill Lynch's research compromised. In
fact, our analyst retained his intermediate neutral rating
throughout the entire time in question. His neutral rating
extended from at least July 1997 through August 1998, at which
time he left the firm.
    In October 1998, after this analyst joined a new firm--
after he joined his new firm, this former analyst initiated
Enron coverage with a rating of accumulate.
    In 1998, the Merrill Lynch analyst who assumed coverage of
Enron, along with continuing his coverage of other companies in
the sector, also initiated his coverage of Enron with
accumulate.
    In 2001, our analyst was one of the first to downgrade
Enron.
    In conclusion, we thank the Members of the Subcommittee for
this opportunity to come before you today and present
information that may be helpful in your investigation into
Enron's collapse. We fully support your efforts and want to
assist in restoring investor confidence in capital markets.
Merrill Lynch intends to be an industry leader in helping to
ensure that America's capital markets are governed by the
highest ethical standards.
    Had we known at the time what we know today, we would not
have conducted business with Enron. Without the benefit of
hindsight, however, and based on the information available to
us at the time, we strongly believe that our actions were
appropriate and proper.
    Thank you, Mr. Chairman.
    Senator Levin. Thank you, Mr. Martin.
    Our questioning today will proceed as follows. Senator
Collins and I will each take 20 minutes for questioning. We
will then turn to our colleagues based on the early-bird
approach for 10 minute rounds of questions.
    Enron was one of the most aggressive companies asking
Merrill Lynch to put its money to work on behalf of Enron.
Enron's CFO, Andrew Fastow, made it very clear to Merrill Lynch
that investment in Enron ventures was an important part of the
relationship building process. The message from Enron was
unambiguous. ``We give business to people who lend us money and
put their balance sheet to work for us.'' Merrill Lynch wanted
to respond to Enron's demands.
    Exhibit 208 \1\--and these exhibits are all in front of
you, Mr. Martin--is a December 1999 memo on the Nigerian barge
deal. It stated that ``Enron views the ability to participate
in transactions like this as a way to differentiate Merrill
Lynch from the pack and add significant value.''
---------------------------------------------------------------------------
    \1\ Exhibit No. 208 appears in the Appendix on page 2064.
---------------------------------------------------------------------------
    Exhibit 244 \2\ is a 2001 memo to senior Merrill officials,
reporting that Merrill Lynch was going to try to put its money
to work for Enron. ``Merrill Lynch agreed to seek ways to
commit its balance sheet to selected situations that were
uniquely value added to the company.'' Commit its balance
sheet. Now, that was simply because Enron had informed Merrill
Lynch of the following. That ``Merrill Lynch is at a distinct
disadvantage because of Merrill's reluctance to use its balance
sheet to support Enron's activities.''
---------------------------------------------------------------------------
    \2\ Exhibit No. 244 appears in the Appendix on page 2225.
---------------------------------------------------------------------------
    At the same time Merrill Lynch was fully aware of what
Enron was trying to do, structure deals so that debt was hidden
off-balance sheet and cash flow was manufactured. Look at what
Merrill Lynch said about Enron deals in discussing a planned $3
billion public offering. An internal Merrill Lynch memo,
Exhibit 258 \3\ said the following: ``Enron believes they can
structure anything to be off balance sheet.''
---------------------------------------------------------------------------
    \3\ Exhibit No. 258 appears in the Appendix on page 2348.
---------------------------------------------------------------------------
    The Nigerian barge transaction was referred to as a
``balance sheet deal.'' That is Exhibit 259.\4\
---------------------------------------------------------------------------
    \4\ Exhibit No. 259 appears in the Appendix on page 2349.
---------------------------------------------------------------------------
    In another transaction, Exhibit 256,\5\ Enron asked Merrill
Lynch to give a special purpose entity a loan that would never
be used ``to ensure that the structure receives off balance
sheet treatment.''
---------------------------------------------------------------------------
    \5\ Exhibit No. 256 appears in the Appendix on page 2344.
---------------------------------------------------------------------------
    So Merrill Lynch knew full well that Enron was trying to
structure deals so that debt was hidden off-balance sheet and
cash flow was manufactured. And yet it still participated in
Enron deals.
    The first question. Mr. Martin, would you agree that it is
Merrill Lynch's responsibility not to participate in a
financial deception?
    Mr. Martin. Absolutely.
    Senator Levin. Now, on the Nigerian barge deal, a
subsidiary of Enron was trying to see projected future cash
revenues from 3 barges that it owned in Nigeria. When the sale
of that interest fell through, Enron sought Merrill Lynch's
help in completing a transaction by the end of the year to meet
Enron's revenue targets. If you look at Exhibit 208,\1\ this is
a memo describing the Enron proposal. ``Jeff McMahon, Enron
Vice President, Treasurer of Enron, has asked Merrill Lynch to
purchase $7 million of equity in a special purpose vehicle that
will allow Enron Corporation to book $10 million of earnings.
The transaction must close by 12-31-99. Enron is viewing this
transaction as a bridge to permanent equity, and they believe
our hold will be for less than 6 months. The investment would
have a 22.5 percent return.''
---------------------------------------------------------------------------
    \1\ Exhibit No. 208 appears in the Appendix on page 2064.
---------------------------------------------------------------------------
    So Merrill knew that Enron wanted to complete a transaction
by the end of 1999 so it could book the $12 million in earnings
or $10 million in earnings to assist Enron. A special purpose
vehicle was created called Ebarge to hold the interest in the
barges. It is our understanding that Enron paid all the costs
of creating that special purpose vehicle. Ebarge was funded by
a $7 million cash contribution from Merrill Lynch and a $21
million seller-financed loan from Enron. Ebarge then
transferred $28 million to the Enron subsidiary. The issue is
whether accounting rules allowed Enron to show the proceeds
from this transaction as income on their financial statement.
    Exhibit 204 is a chart.\2\ According to the first chart
which covers the relevant accounting rules, Enron was
prohibited from taking credit in its books for the barge sale
if any one of the following happens: If Enron had significant
obligations for future performance to directly bring about the
resale of the Nigerian barge interest by Merrill Lynch; or if
the risks of ownership did not transfer from Enron to Merrill
Lynch; or another factor that can prohibit recognition of a
sale is if Merrill Lynch paid no interest on the financing
provided by Enron.
---------------------------------------------------------------------------
    \2\ Exhibit No. 204 appears in the Appendix on page 2051.
---------------------------------------------------------------------------
    Now, let us just look at the first two points, that Enron
guaranteed a resale, and that Merrill Lynch was promised by
Enron that it would receive back its equity investment plus a
rate of return. The documents clearly show a commitment to
Merrill Lynch that it would be bought out within 6 months.
Exhibit 207 \3\ is the internal Merrill Lynch document written
by Robert Furst, who was before us earlier today, requesting
funds for the barge transaction.
---------------------------------------------------------------------------
    \3\ Exhibit No. 207 appears in the Appendix on page 2059.
---------------------------------------------------------------------------
    ``Enron is viewing this transaction as a bridge to
permanent equity, and''--and here are the key words--``they
have assured us that we will be taken out of our investment
within 6 months.''
    Further down on that page. ``Enron will facilitate our exit
from the transaction with third party investors. Dan Bayly will
have a conference call with senior management of Enron
confirming this commitment to guarantee the Merrill Lynch take
out within 6 months,'' confirming this commitment to guarantee
the Merrill Lynch take out within 6 months.
    The conference call did take place, and according to Mr.
Furst and Mr. Tilney, who participated in that call, and who
were interviewed by our staff, Mr. Fastow represented during
that call that Enron would get Merrill Lynch out of the deal
within 6 months. That is what Mr. Furst and Mr. Tilney told our
staff.
    Now, Merrill Lynch continued to represent its understanding
that it had a commitment from Enron. If you will look at
Exhibit 209,\1\ this is a December 23, 1999 weekly Merrill
Lynch report memo. Now, this is a Merrill Lynch document, and
here is what it says. ``Most unusual transaction of the week
was IBK''--and that is Merrill Lynch's investment bank
division--``was IBK request to approve Enron Corporation
relationship loan.'' That is Merrill Lynch's word, loan.
Merrill Lynch asked to invest $7 million in a Nigerian power
project relationship loan.
---------------------------------------------------------------------------
    \1\ Exhibit No. 209 appears in the Appendix on page 2068.
---------------------------------------------------------------------------
    Within that same internal Merrill Lynch weekly report it
said the following: ``This transaction will allow Enron to move
assets off balance sheet and book future cash flows currently
as 1999 earnings, approximately $12 million. IBK was supportive
based on Enron relationship, approximately $40 million in
annual revenues and assurances from Enron management that we
will be taken out of our $7 million investment within the next
3 to 6 months.'' In writing, contemporaneously, the word
``assurances.''
    Mr. Furst and Mr. Tilney told our staff that the deal would
not have gone forward without that assurance from Enron.
    After negotiations over the arrangement, Enron agreed to
repay Merrill Lynch's money plus a 15 percent rate of interest
and an up-front $250,000 fee, making the effective interest
rate 22\1/2\ percent. This understanding on Merrill Lynch's
part continued throughout the next 6 months. And then as the 6-
month deadline approached, Merrill Lynch's officials, including
those at high levels, raised the issue of this guarantee.
    In a June 13 email, Exhibit 218,\2\ one Merrill Lynch
employee, who also served as the Vice President, Assistant
Secretary and Assistant Treasurer of Ebarge wrote the
following: ``As we approach June 30, I am getting questions
concerning Ebarge, LLC. It was our understanding''--
understanding--``that Merrill Lynch IBK positions would be
repaid its equity investment as well as a return on its equity
by this date. Is this on schedule to occur?'' Note the
contemporaneous word ``our understanding.''
---------------------------------------------------------------------------
    \2\ Exhibit No. 218 appears in the Appendix on page 2158.
---------------------------------------------------------------------------
    On June 14, just the next day, a Merrill Lynch employee
drafted a letter, reminding Enron of the agreement regarding
Ebarge. This is Exhibit 219.\3\ It stated, by Merrill Lynch
employee contemporaneously: ``Enron has agreed to purchase the
shares from Ebarge by June 30 for a purchase price net of the
balance on the loan from Enron Nigeria Power of $7,510,976.''
Note the word ``agreed.''
---------------------------------------------------------------------------
    \3\ Exhibit No. 219 appears in the Appendix on page 2159.
---------------------------------------------------------------------------
    Now, before that letter was actually sent, Enron called and
informed Merrill Lynch that a buyer had been identified. This
was LJM2. But the situation has repeatedly been made clear.
Enron had made a commitment to get Merrill Lynch out of the
barge deal, and pay Merrill the $7 million and its promised
rate of return.
    And as the share purchase agreement, Exhibit 222,\1\
between Ebarge and LJM2 shows the price paid by LJM2 was
$7,525,000, which is exactly equal to what Merrill Lynch was
promised by Enron, at 7 million in equity, plus a 15 percent
rate of return for the 6 months.
---------------------------------------------------------------------------
    \1\ Exhibit No. 222 appears in the Appendix on page 2164.
---------------------------------------------------------------------------
    Now, given that, all that, contemporaneous and in writing,
and these are on Merrill Lynch's own documents. I am not even
going to take the time now to go to the LJM documents which
make specific reference to the promise to Merrill that it would
be taken out using the same words by another investor by June.
But given all that, how can you possibly say that there was no
understanding by Merrill Lynch that Enron or any entity related
to Enron would buy back Merrill Lynch's shares. Do you have
personal knowledge, by the way, of any of this, or are you just
giving the statement here for Merrill Lynch?
    Mr. Martin. Mr. Chairman, I was not involved in any of
these transactions in any detail whatsoever.
    Senator Levin. So when you gave the statement earlier, you
are just giving the statement, position of Merrill Lynch, not
your own personal information; is that correct?
    Mr. Martin. Yes. I'm here--I believe the request of the
Subcommittee was to have a senior Merrill Lynch person who
could comment on policy. That was my original role. But I'll
play that role and any other role----
    Senator Levin. We of course expected that we would have the
direct testimony, which we did not get, but we have the
statements made by the two witnesses who used their Fifth
Amendment privilege, the statements to our staff, which I have
now reflected, but I also, in addition to that, have now gone
through all kinds of contemporaneous documents which show that
there was a commitment, a promise, an assurance, over and over
again. Yet it is Merrill Lynch's position that those words were
not true.
    Mr. Martin. Let me try, in the position that I'm in, to
frame that out from a Merrill Lynch perspective and try to shed
some light on our view, first and foremost of this as an equity
investment. And again, this is from an overall Merrill Lynch
point of view. And the documents that you went through, I have
seen some over the last few days, and in and of themselves each
of these documents have sort of multiple words on them, some
with, on the same page, ``loan'' and ``equity'', ``equity'' and
``loan.'' So I can't comment on each and every one of the
documents.
    But this is what I can shed some light on, again from a
Merrill Lynch perspective. The process internally that we used
to make this decision on the barge was as follows.
    Senator Levin. Could you pull the mike a little closer,
please?
    Mr. Martin. OK. And again, I think this was instructive how
we looked at things. First and foremost, this transaction went
to a committee internally at Merrill Lynch called the Debt
Markets Commitment Committee, otherwise known as the DMCC. It
went there to be vetted, and it went there for a decision in
December. That committee did talk about this transaction, but
they could not make a decision on the transaction. The reason
they could not make a decision on the transaction is the
Merrill Lynch Debt Markets Commitment Committee has no
authority to make equity decisions. So it was kicked to--up to
Tom Davis, who is President of the Capital Market Group. And
the reason it was kicked up to Tom Davis in the Cap Market
Group is he is the only person--he was the only person in the
investment banking world who can make an equity decision. So he
had to get involved.
    Third, where this transaction was booked internally was an
area called IBK Positions, which if you've read through this
multitude of documents, was in there in various places. And the
only thing in IBK positions, the only things that can be put in
IBK positions are equity investments. So the decisionmaking
process on this transaction internally at Merrill Lynch, the
vetting process internally at Merrill Lynch, the governance
process internally at Merrill Lynch, and last but not least,
how this transaction was booked and where it was booked was
equity, equity, equity. With regard to conversations that took
place between individuals at Merrill Lynch and Enron, between
various documentation and Enron about guarantees, this is my
understanding of the discussions. My understanding of the
discussions are that we of course, Merrill Lynch, are not in
the business of buying barges. We are in the business of making
private equity decisions, and we do that, and we do that in a
multitude of things.
    The discussions with Enron were we do not want to be in
this investment long term but as a relationship with you, a
growing relationship with you, this is something that we will
do from an accommodation point of view. From where I sit in the
seat I sit in and the background I have involved with all of
these transactions, I can't comment specifically on
conversations that may or may not have taken place between
various individuals. Thank you.
    Senator Levin. All the expenses of this special purpose
entity were paid for by Enron; is that correct?
    Mr. Martin. That's my understanding.
    Senator Levin. Is it common for a special purpose entity
which is used by Merrill Lynch to have all of its associated
costs paid for by another entity?
    Mr. Martin. It is not unusual.
    Senator Levin. Exhibit 216(a) \1\ is the loan agreement
between Enron and Ebarge related to the $21 million so-called
loan from Enron Nigeria Power Holding, Limited. The loan to
Ebarge had an interest rate of 12 percent per year. The first
repayment of principal and interest, $773,000, was due April
30. Was that payment received?
---------------------------------------------------------------------------
    \1\ Exhibit No. 216(a) appears in the Appendix on page 2117.
---------------------------------------------------------------------------
    Mr. Martin. I don't believe so, no.
    Senator Levin. If this were a true equity investment and
that interest were due, would not Merrill Lynch have written to
the person owing it the money, saying, hey, where is the
$773,000?
    Mr. Martin. Ultimately, yes.
    Senator Levin. Not ultimately. I am talking about on April
30 when it was due.
    Mr. Martin. Mr. Chairman, I mean ultimately. Merrill Lynch
has hundreds and thousands and tens of thousands of these
arrangements, so ultimately from the financial accounting
department somewhere, they would be sending out a notice.
    Senator Levin. So if this were a true equity position, that
notice would have gone out, would it not have?
    Mr. Martin. At some point in time it would have gotten out.
    Senator Levin. Did it?
    Mr. Martin. I do not know.
    Senator Levin. Pardon?
    Mr. Martin. I don't know if it went out.
    Senator Levin. We have been informed it did not go out.
    Mr. Martin. OK.
    Senator Levin. Ebarge never made a single one of those
payments, neither the principal nor the interest.
    Merrill Lynch not only, or Ebarge not only, borrowed the
money from Enron, the $21 million, but to perhaps clarify a
point I was just making, Merrill Lynch did not receive the
scheduled cash flow payments from the operations of the barges
as you were supposed to receive under the terms of the
agreement. Is that correct?
    Mr. Martin. That's my understanding, yes.
    Senator Levin. And you never complained about that; is that
correct?
    Mr. Martin. That's also my understanding.
    Senator Levin. So this so-called loan to Ebarge from Enron
on which interest was due, Ebarge never received a notice of
that, and the amount of money owed Merrill Lynch, scheduled
cash flow payment from the operation of the barges that they
were supposed to receive under the terms of the agreement, they
were never received and there was never a complaint about that
as well.
    My last question, because my time is up. Ebarge did not
have a bank account, as we understand it, and in February or
March 2000, Ebarge was re-domiciled from Delaware to the Cayman
Islands at the request of Enron.
    Now, if this was a Merrill Lynch company, why did Merrill
Lynch re-domicile it at the request of Enron, and why did Enron
want it domiciled in the Caymans?
    Mr. Martin. Mr. Chairman, I'm not the--I'm not sure
specifically with regard to this transaction why the special
purpose vehicle may have been moved from one domicile to
another.
    I know overall that using the Cayman Islands as a domicile
often has tax advantages for offshore entities, and that is
often why things are moved to the Cayman Islands.
    Senator Levin. Well, do you know whether or not Ebarge ever
paid U.S. taxes?
    Mr. Martin. I do not know.
    Senator Levin. So here in summary appears to be what
happened. There is an unwritten side agreement that you have no
evidence did not occur, and there is a huge amount of
contemporaneous written evidence that it did occur, that Enron
provided a guarantee to take Merrill Lynch out of the deal
within 6 months. Merrill Lynch was guaranteed and received a 15
percent return on its $7 million payment. Merrill Lynch never
received the periodic cash flow payments from the operation of
the barges as promised under the agreement, never complained
about it to Enron. Ebarge did not pay any interest on the $21
million loan advanced by Enron. Enron paid all the costs
associated with the formation, operation and management of
Ebarge, the Merrill Lynch special purpose vehicle. It is very
clear, it seems to me overwhelmingly clear, that in fact the
risks of owning Ebarge were not transferred to Merrill Lynch
and indeed there was never a real sale by any of the accounting
standards which have to be applied before the term ``sale'' can
be applied to a transaction.
    And so the December 23, 1999 weekly report of Merrill
Lynch, its own internal report, had it exactly right. This was
a relationship loan. The accounting rules indicate it was not a
real sale. Merrill Lynch knew it, Enron knew it, and yet Enron
booked $12 million in income from the proposed sale or supposed
sale, and that was a deception in its financial statement, and
Merrill Lynch was a participant in that deception.
    Senator Collins.
    Senator Collins. Thank you very much, Mr. Chairman.
    Mr. Martin, I realize that you have no direct knowledge of
these transactions, you were not personally involved, and in
some ways I feel that you must have drawn the short straw to be
here today.
    Mr. Martin. I volunteered actually.
    Senator Collins. But nevertheless the testimony that you
presented on behalf of Merrill Lynch raises so many troubling
questions, particularly since much of what you've presented
appears to be directly contradicted by interviews conducted by
the Subcommittee, and by documents from your company.
    You started out by saying ``at no time did we engage in
transactions that we thought were improper.'' Are you saying
that there were no red flags that made you think that something
troubling or unusual or deceptive was going on?
    Mr. Martin. No. We, as is in many of these pages,
transactions all the time have issues, have questions, have
risks. So our processes are designed internally to actually vet
those before we do the transaction, and only if--and I want to
underscore that--only if we feel comfortable with all the risks
will we go ahead with the transaction from our point of view.
    Senator Collins. But I do not see how you could possibly
feel comfortable with these transactions given the information
that is provided within your firm's documents. For example, Mr.
Furst told the Subcommittee that Merrill was very much aware
that Enron needed to try to inflate it earnings and to have a
better return for its African division. There is ample evidence
that Enron had significant obligations for future performance
to bring about the resale of the Nigerian barges. And so that
raises questions of whether the risk of ownership ever really
transferred from Enron to Merrill.
    There is a very persuasive question raised by one of
Merrill's high-ranking employees, Jim Brown, in Exhibit 212,\1\
in which he specifically raises reputational risk of aiding and
abetting Enron's income statement manipulation. Is that not a
huge red flag?
---------------------------------------------------------------------------
    \1\ Exhibit No. 212 appears in the Appendix on page 2079.
---------------------------------------------------------------------------
    Mr. Martin. These are all--Senator, these are all red
flags. Jim Brown's notes here talk about questions that he had
going into this committee meeting, the DMCC which I mentioned
previously. Foreign tax, environmental, operating performance,
failure to complete, foreign ownership, reputational risk,
these are all things that Jim Brown, in his capacity as a
senior member of the Merrill Lynch committee, would have talked
and raised about at that committee meeting.
    Senator Collins. But he specifically raises the issue of
financial statement manipulation.
    Mr. Martin. Correct.
    Senator Collins. Did that not put you on guard that Enron
might be cooking its books through this transaction?
    Mr. Martin. Again, I wasn't, ``A'', in this meeting, and
``B'' in this transaction, but the way our processes work--and
we Merrill Lynchers spend a lot of time making sure that of the
millions of transactions that we do on a yearly basis, that
they are vetted as thoroughly as possible.
    So my assumption is that this was discussed and the various
people sitting around the table, which included legal and
credit, relationship management, bankers, corporate finance,
that they went through all of this and they got assurances,
either from Enron or from Enron's advisers, that these things
could be satisfied from our point of view, Merrill Lynch's
point of view.
    Again, we can't--we can't impose--we cannot look through
our clients and know everything that they're going to do with
all parts of their transactions, but we do the best we can to
make sure that transaction at hand for us is vetted properly
and as fully as possible.
    Senator Collins. You seem to imply in your statement that
the answer to the issue of financial statement manipulation
was, ``that the transaction was so small relative to Enron that
it seemed inconceivable that the transaction could be used to
manipulate Enron's income statements.'' On the one hand that
sounds to me like you are saying it is OK if they cheat a
little, but aside from that issue which is troubling to me, did
it not occur to Merrill that Enron might be engaging in similar
transactions with other partners, and therefore, there might be
significant implications for the accuracy of its financial
statements? If Enron was pushing so hard for Merrill to
complete this transaction that one of your high-level employees
raised a red flag about the risk to Merrill Lynch's reputation,
why was that not pursued more? Why did it not occur to Merrill
Lynch that this might be the tip of the iceberg?
    Mr. Martin. A few things in response, Senator. One thing is
the reference to the size of the transaction is--to put it in
perspective, from a Merrill Lynch point of view, and from an
Enron point of view, I suspect, what the singular transaction
was, we, in our written and opening statement, were also trying
to respond to the Subcommittee's questions about our, Merrill
Lynch's knowledge and active involvement with Enron in their
own manipulations, which is clearly not true.
    Red flags, to your question on red flags. Enron was a very
aggressive client. Enron was, as I said in the opening
statement, recognized by everybody in the United States and
perhaps globally, from Wall Street to government to consulting
to academia as the future way that American companies could
potentially be run. It was $40 billion in revenue. It was an
aggressive company. Their whole thesis, as stated publicly in
multiple situations, was physical assets aren't needed;
financial assets and off-balance sheet assets are the way to
go. That was stated everywhere in every article about Enron and
their philosophy about how to build their business.
    So clearly, we were focused on working with them as a
growth company, as a big company, as a seeming industry leader,
certainly in their industry and corporate America. We, however,
had never--never at any one point in time would we do something
that we thought would be wrong, but there would be no way that
we could possibly know, with a $40 billion company, all the
various transactions that they were doing.
    Senator Collins. Let me tell you of another red flag that
was raised by Merrill Lynch. Mr. Furst raised the issue of how
a $7 million sale of these barges could be booked as $10
million or earnings. Could you explain why that did not cause
concern?
    Mr. Martin. No. Again, I think--I do not know where that
comes from but----
    Senator Collins. It is Exhibit 208.\1\
---------------------------------------------------------------------------
    \1\ Exhibit No. 208 appears in the Appendix on page 2064.
---------------------------------------------------------------------------
    Mr. Martin. We knew--Exhibit 208?
    Senator Collins. Yes.
    Mr. Martin. What we are most concerned about at Merrill
Lynch is the $7 million of risk, which is why I went through,
somewhat painstakingly, where we booked the transaction. You
know, once again, I don't have a comment on what Enron would
book in their financial statements on their books and records
based on either this transaction or any other transaction.
    Senator Collins. On page 7 of your testimony you state that
the transaction was in fact a purchase of an equity interest
rather than a loan, correct? That was your testimony today?
    Mr. Martin. Yes, Senator.
    Senator Collins. I would like you to look at Exhibit
209,\2\ the second page. It is a Merrill Credit Flash Report,
and there is a summary that clearly describes the Nigerian
barge transaction as a loan. It says, ``The most unusual
transaction of the week''--I guess we should take some comfort
that it was unusual--``the most unusual transaction of the week
is the IBK request to approve Enron Corporation relationship
loan.'' How is it that Merrill Lynch is maintaining this
morning that this was the purchase of an equity interest, when
the credit flash report put out by Merrill Lynch describes it
as a loan?
---------------------------------------------------------------------------
    \2\ Exhibit No. 209 appears in the Appendix on page 2068.
---------------------------------------------------------------------------
    Mr. Martin. Senator, if you'll look down on that page in
the first sentence, the same page, it says: ``Requested by
Enron Corporation to make a $7 million equity investment.''
There are other documents that have both--as I said to Mr.
Chairman, there are documents that use the words ``equity'' and
``loan'' and ``commitments'' quite interchangeably, which is
why I, from my seat, and what I can help you with from an
understanding point of view, is if you follow how we made the
decision to do this transaction, who can make a decision how
the decision was made and where the decision ultimately--where
the transaction was ultimately placed within Merrill Lynch, it
was all equity. So the language on all of these various pages
is actually somewhat contradictory almost on each and every one
of these pages. So on the same page, after they talk about a
relationship loan, they talk about a $7 million equity
investment.
    Senator Collins. I want to follow up on the question that
Senator Levin asked you about the understanding that Merrill
Lynch had that there would be a resale of the barges within 6
months time. You testified that there was no understanding by
Merrill Lynch that Enron or any entity related to Enron would
buy back Merrill Lynch's shares. And you go on to say that, in
fact, Merrill Lynch had a contrary understanding that an
independent third party would likely buy Merrill Lynch's
interest.
    My first question is then, regardless of whom you thought
the ultimate purchaser was going to be, the clear understanding
was that you were going to be stuck with these barges for only
6 months; is that correct?
    Mr. Martin. Again, I wasn't involved specifically in this
transaction, but the--it is my understanding that the
discussions with Enron went along the lines of initially
continued to increase the business relationship. They needed us
to do something with regard to these barges. We are not in the
business of buying barges. We can do equity investments. We
obviously had discussions with Enron that we would like their
help in getting out of this investment, and it's their business
and they know the industry, and as a leading corporation in
this sector, they would be most likely to help us. But we were
fully prepared, again, fully prepared as a corporation to take
that $7 million investment, and potentially over time, write it
down if we still had to carry it.
    So there was a hope, and there was an anticipation that we
could get out of this investment over the course of 6 to 12
months, but again, I--from all of the things that I understand,
there were not very specific timelines with regard to specific
dates.
    Senator Collins. In fact, was there not an understanding
that Enron was responsible for finding a buyer?
    Mr. Martin. Again, I believe the understanding was that
Enron would go to great lengths to help us seek a potential
other buyer for this asset. They had been working very closely
with, as I said in the opening statement, an Asian corporation
who was a potential buyer of these barges, and got very close,
apparently, to being able to make the purchase. So we were
relying on Enron's expertise in their own industry to help us
find potential other buyers over time, which is correct.
    Senator Collins. Mr. Furst told the Subcommittee that
without the guarantee or assurances that Enron would find a
buyer for the barges within that set time, Merrill would not
have gone through with the deal. Do you contest the accuracy of
that?
    Mr. Martin. I don't actually know Mr. Furst, so I don't
know exactly what he said or didn't say. I suspect, again, from
a point of view of process, what would have been asked of the
investment bankers is if we have to make an investment, a
private equity investment to enhance a client relationship, how
over time are we going to get out of this? So from his point of
view as an investment banker trying to do a transaction, he may
have had that view. I don't think necessarily that would have
been the Merrill Lynch &amp; Co. view.
    Senator Collins. Are you aware that other Enron employees
were becoming concerned as time went on that Merrill Lynch was
still stuck with the barges and, in fact had drafted a letter
about the possible resale of the barges back to Enron or some
other party?
    Mr. Martin. I was not aware, no. These are Enron concerns.
    Senator Collins. These are Merrill Lynch concerns to Enron.
    Mr. Martin. Some of the----
    Senator Collins. Expressed to Enron, that there still had
not been a buyer.
    Mr. Martin. Some of the documentation that the Chairman
walked us through were from different parts of Merrill Lynch,
some accounting, some finance, some banking, and it is not
unusual, particularly in finance and accounting, that they have
certain things that they are supposed to track. So their
concern would be--they would be doing their job based on what
they were told as far as expected returns and expected exit of
the investment.
    Senator Collins. The reason this issue is so important is
that if this is not a true sale, then it violates the Generally
Accepted Accounting Principles for Enron to represent it as
such, and it also violates the SEC bulletin on revenue
recognition and financial statements. It seems to me that the
deal had four characteristics that suggest that this was not a
true sale. First, Enron did have significant obligations for
future performance to directly bring about the resale of the
barges. Second, the risks of ownership do not, in my judgment,
seem to have truly been transferred from Enron to Merrill,
given that agreement. Third, Merrill did not pay interest on
the financing provided by Enron. And fourth, Enron appears to
have paid all of Merrill's costs of the transaction. Do you
disagree with any of those facts?
    Mr. Martin. Well, I think, Senator, the question you are
asking me is from Enron's point of view, and Enron and their
advisers, accounting advisers, was this a true sale from their
point of view, is not something that we, Merrill Lynch, spent a
lot of time on. What we spent our time on was, again, we--it
was our understanding that we had an equity investment, that we
had to book it in the right place, that we had to have an exit
strategy, that we needed help on the exit strategy. And that
was our concern. Our concern was for Merrill Lynch
shareholders, that $7 million, and make sure that the $7
million was booked the right way and that there was some
rational strategy to get out of it.
    Whether that was from an Enron point of view proper GAAP
accounting, is it's an Enron and Enron adviser topic.
    Senator Collins. I just cannot accept that answer when one
of your employees raised the issue of whether Enron was using
this transaction to manipulate its financial statement.
    Mr. Martin. Correct. That was one of--in Jim Brown's
statements of the questions he had, I'm sure--again, I wasn't
in that meeting and I wasn't listening to all the dialogue
around his concerns, but there must have been conversation
around that specific topic, that he got comfort that that
actually couldn't happen from our standpoint.
    Senator Collins. Thank you, Mr. Chairman.
    Mr. Martin. Thank you.
    Senator Levin. Thank you, Senator Collins. Senator
Lieberman.
    Senator Lieberman. Thanks, Mr. Chairman.
    Mr. Martin, thanks for your testimony. I must say that in
the testimony today, which I gather is on behalf of Merrill,
that people at Merrill essentially had no idea at the time that
any of the interactions between your firm and Enron were
questionable or that Enron might be engaged in deceptive and
improper activities. After reviewing the Subcommittee's
findings and listening this morning to your testimony and
answers to the questions Senator Levin and Senator Collins have
posed, I must tell you that it is hard to see how an
experienced, respected, sophisticated company like Merrill
Lynch missed what was going on here.
    Let me just take this LJM2 agreement interaction, for
instance, that people at Merrill knew because the firm was the
private placement agent, because Merrill was itself an
investor, and because almost 100 of Merrill's employees were
investors in LJM2, that Mr. Fastow was on both sides of LJM's
transactions with Enron. In fact, Merrill apparently advertised
that fact in its private placement memorandum. And Merrill also
said in the memorandum that two other gentlemen, also Enron
finance insiders, Mr. Kopper and Mr. Glisan, would also be
managing LJM. Later, when Merrill was trying to sell the
Nigerian barges that it temporarily bought from Enron, it was
LJM2 that bought the barges from Merrill, so there was
awareness there as well.
    So I must say it is hard for me to understand how Merrill
Lynch did not understand that LJM, in its transactions, for
which Merrill provided hundreds of millions of dollars in
financing, represented a very risky and questionable corporate
strategy for Enron, or is the point here really--and again,
this is hindsight--that that did not matter to Merrill Lynch?
In other words, as you said at one point, that Merrill Lynch
was evaluating risk to Merrill Lynch in this series of
transactions with Enron and its spinoffs, and not risk to the
investors in Enron as a result?
    Mr. Martin. Senator, thank you for the questions. Broad
topic of LJM2, it's quite a broad topic. First and foremost we
were the placement agent, which means we found people who were
interested in this concept with these people for these type of
investments in primarily the institutional market, some fairly
sophisticated investors. We, again, in our own corporate due
diligence, we raised the flags significantly about how Mr.
Fastow, how are we to be--how was it going to be made clear,
and how was Enron going to ensure that there was in fact no
conflict, and how could they govern that? How could they
actually govern the fact that they had a CFO who was in Enron
and also was the managing partner for what in and of itself was
a private equity alternative investment fund? We debated that
internally, and again, in some of these records here that I've
become familiar with, we even had a call with Jeffrey Skilling,
the President of Enron, to say, ``How are you, Mr. Skilling,
going to make sure? Are you comfortable with this? Are you
comfortable that there is a Chinese wall, that decisions will
not be compromised, that it will not be to Enron's detriment or
benefit and vice versa for LJM2?''
    His answer, again--and this is my understanding, having not
been involved in all these conversations--his answers were very
clear, that he knew all about how this was set up; he was
extremely comfortable and had a lot of confidence with Mr.
Fastow and the dual roles he was going to play; that it was
vetted and approved by their own board of directors and it was
vetted and approved by all their various advisers.
    So I agree with your question/statement that we, Merrill
Lynch, should have had red flags on the LJM2 contract. We did
have them. We vetted them as far as we possibly could.
    With regard to the complication within LJM2 and what
exactly was going on in LJM2, the type of constructs, the type
of financing, the type of assets, I would offer up that we
didn't understand actually what was going on in LJM2, we,
Merrill Lynch, but I would also offer up that nobody did,
because there were other people who invested in LJM2 who were
at least as sophisticated as Merrill Lynch. We all got the
statements about their investments. We all got the updates with
regard to what kinds of transactions they were doing or not
doing. None of us spotted, or none of us connected the dots
from activity in LJM2 and the potential consequences on both
LJM2 and Enron. We just didn't--we either didn't connect the
dots or we didn't necessarily know all the connections, but we
didn't, and none of the other investors in LJM2 did either.
    Senator Lieberman. Here is my concern about that. The more
I hear about this case, the more it seems to me that Enron,
perhaps not uniquely, but Enron was like a poisonous spider
spinning a web for its own benefit, in which it was engaging
and entrapping a whole host of very reputable financial
institutions, including your own, but your entrapment was not
unknowing, or in some sense, unwilling, because the web that--
the poisonous web that Enron was spinning, nonetheless had some
attractive qualities to it for you. It had a business
relationship, it had fees. And that ultimately what Merrill was
doing was what at the base level one expects a business to do,
which is to protect itself from undue risk.
    But the question is, because it just does seem to me that
you had an access to so much inside information as a result of
your participation in these deals--and I do not mean improper
inside information--I mean the kind of information, you know,
the poor suckers as they turned out to be who were investing
their 401(k) plans or institutional investors who were
investing hundreds of millions of dollars in Enron did not
have, and the information that the board of directors of Enron
and the auditors and all we now know were not aggressively,
independently trying to get out to the public, that one of the
breakdowns in the system here was that great companies like
Merrill Lynch did not blow the whistle, did not accept that
extra measure of responsibility and say, ``Hey, we are
protecting our risk in this deal with Enron and LJM and LJM2,
but this thing stinks, and maybe we do not see the whole
picture.'' We could not see the whole picture of what Enron was
up to; you could not see the whole picture.
    But should not folks at Merrill have seen enough to have
said, ``Hey, we do not want to be part of this,'' because in
the end maybe you ended up aiding and abetting the improper,
perhaps illegal behavior of the executives of Enron?
    Mr. Martin. I think, Senator, that again trying to go back,
it is hard to go back in time, very hard. I take your point and
that is a level and a role that Merrill Lynch frankly aspires
to play which is over and above the next transaction or the
next 10 transactions. What is in the long-term best interest
of--at Merrill Lynch, our clients and frankly the markets
themselves, and we have tried to play that role, not just in
the United States, but around the world.
    Speaking purely personally--and my dealings with Enron were
quite limited--it was a very complicated company. We, for a
living, are financial experts or parts of financial experts.
Clearly in hindsight, it would have been great to put this
whole puzzle together and blow the whistle. It was a very hard
puzzle. It was almost a multidimensional puzzle. It is a role
that we aspire to play. It is a role that we try to play,
frankly. And for the snippets of information that we had--and I
hear what you say about inside information, legal inside
information--the balance sheets, the tax structures, the
operating complexity of these type of companies are geometric,
no one counterpart, be it commercial bank or investment bank,
for a company like Enron was, frankly could ever see enough to
actually know that whole dimensional puzzle.
    Senator Lieberman. Let me interrupt you because my time is
up. But I want to ask you--my colleagues will come, I am sure,
to the question of the relationship between Enron and the
analyst at Merrill who was giving the adverse ratings on Enron,
and what Merrill's executives' conduct toward them said about
what you knew about what was happening there.
    But my final question, and I ask for a brief answer. This
is one of those knowing all we know now, and having been
through the torment the market and the economy has been through
as a result of Enron and its progeny, has anything changed at
Merrill Lynch? In other words, if you saw what you saw, if
today this deal came in, would it raise enough red flags so
somebody at Merrill would have said, ``We can protect our risk.
Merrill's going to be all right in this deal, but this thing
smells and we should not be part of it?''
    Mr. Martin. Senator, we are continuously changing and
trying to improve all of our processes. The processes that we
went through on all of these transactions were as complete as
we could make them at the time with the information we had at
the time. Again, in perfect 20/20 hindsight, we would have the
same processes and spend more time on them and have more
discussion on them, and hope to get the answers that were more
complete in this multidimensional puzzle called Enron.
    Senator Lieberman. Well, I hope that if one like this came
through the door today, that the folks at the top would make
sure the folks who were dealing with it would blow the whistle.
Thank you.
    Mr. Martin. Thank you.
    Senator Levin. Senators Dayton, Fitzgerald, Durbin, and
Carper, in that order.
    Senator Dayton. Thank you, Mr. Chairman.
    Mr. Martin, I do not agree with the view that you drew the
short straw to be here. It seems to me, based on your comments
and lack of direct knowledge about these events so far, that
you were selected very carefully to represent the company. They
selected you because of your minimal knowledge of the events
and incidents about which you were going to be asked today so
that the company could issue a press statement saying it was
cooperating fully with the Subcommittee, when it was in fact
providing as little information and confirmation or informed a
denial as possible. I just want to say for the record, I do not
consider that to be cooperating with the Subcommittee at all.
    Since you do not really have any of the answers based on
your lack of involvement, I am not going to ask you many
questions. I would like to put into the record and at the end
get your overall observation on this matter regarding the
analyst who did not give Enron the rating which they thought
they were deserving, going back to 1998. I also note, just to
set the context, you refer to how little the financial
relationship was with Enron for Merrill Lynch. You, throughout
your testimony on behalf of the company, minimized that
relationship, but yet these memoranda and that subsequently
stressed some of these deals which others have referred to and
others which are questionable on their nature, questionable on
their value as stand-alone transactions, refers to Enron, for
example, one memorandum has one of the most critical
relationships in the Houston office, also in another matter
refers to Enron as providing $40 million in revenues for
Merrill Lynch in 1999 and $20 million to be expected in the
year 2000. These are not insignificant amounts of money. It
seems clear that one of the reasons to engage in some of these
transactions on Merrill Lynch's account was in the hopes of
obtaining additional financial relationships with the company
in subsequent years. There is nothing wrong with that unless
the transactions themselves are wrong.
    But this particular matter is a memo from Rick Gordon and
Schuyler Tilney to Herb Allison. It is dated April 18, 1998. It
is Exhibit 239.\1\ It is on Merrill Lynch stationery and it is
an interoffice memorandum, so I assume it is an accurate or
valid document. It is asking Mr. Allison to call two senior
executives of Enron, Ken Lay, the Chairman and Chief Executive
Officer, and Jeff Skilling, President and Chief Operating
Officer, regarding Merrill Lynch's participation in Enron's
contemplated $750 million common stock offering.
---------------------------------------------------------------------------
    \1\ Exhibit No. 239 appears in the Appendix on page 2206.
---------------------------------------------------------------------------
    It goes on to say, ``Enron was notified approximately 6
weeks ago''--this is April 1998--``by Moody's Investor Service,
that it is considering downgrading Enron's debt due to the
increase in the company's leverage over the past few years.
After several meetings with Moody's to better understand its
concerns, Enron determined that it needed to undertake a large
common stock offering to avoid a credit rating downgrade. The
company is extremely sensitive with regard to the
confidentiality concerning this transaction. Past equity
offerings undertaken by the company have been leaked in advance
of the offerings with negative consequences to the stock price.
Therefore, Enron solicited advice from only Merrill Lynch
regarding the size and terms of and market receptivity to the
offering. We were obviously apprised of the transaction in the
strictest confidence and were informed that no other investment
banks would be contacted in order to lessen the likelihood of a
leak.''
    It goes on to say that ``the expectation at Merrill Lynch,
which is certainly understandable, is that they would be
selected by Enron to serve as the lead manager.'' Given that
they were the only investment bank to be contacted for advice
on the transaction, that would be my knowledge and experience,
a very reasonable expectation.
    ``However,'' it goes on to say, ``our research relationship
with Enron has been strained for a long period of time. Our
equity research analyst at Enron is John Olson. He has a poor
relationship with Jeff, and particularly Ken for several
reasons.'' This being Ken Lay, the Chairman and Chief Executive
Officer, and Jeff Skilling, President and Chief Operating
Officer. Those are pretty high-level people in this $40 billion
Enron company to have a poor relationship with.
    It goes on to say, ``Enron's Chief Financial Officer, Andy
Fastow, called last night to inform us that Merrill Lynch would
not be selected as lead manager of the offering, and further,
that we would not even be included as a co-manager. He stated
that the decision was based solely on the research issue and
was intended to send a strong message as to how `viscerally'
Enron's senior management feels about our research effort.''
    Now, this was pretty apparent that Enron plays hardball or
played hardball. Here is the Chief Financial Officer calling to
inform your associates that after all this work, after all this
advice on a very confidential basis, you are not going to be
the lead manager. You are not even going to be a co-manager
because they are just unhappy with the rating that the analyst
has been giving the company. It is a rating which would seem to
be warranted by the very transaction here. You had been asked
to advise and were rejected from participation, mainly to issue
a large common stock offering in order to avoid a credit rating
downgrade by Moody's, which would certainly have a major impact
on the price and value of the stock.
    So all of this seems to be, quite understandably, troubling
to Merrill Lynch and to others. Mr. Olson, as you note in your
testimony, then, without changing his rating, leaves in August.
It may be a coincidental event, but it does raise some
questions as to exactly why he departed from Merrill. Then his
successor, who your testimony notes did not issue a revised
rating or an upgrade until November. It is surprising that you
would leave such a major company without someone following it
on an active basis or issuing an immediate revision to the
rating. There is a gap there from August to November, and maybe
you can fill in that gap.
    But the fact is that the rating was increased by your
successor analyst, is an institutional rating, and is backed by
Merrill Lynch. It is not Mr. Olson or his successor as an
individual. It has all the backing, all of the prestige and all
of the credibility of Merrill Lynch in terms of its clients and
others who are aware of those recommendations.
    It certainly seemed to have had a beneficial result with
regard to the relationship with Enron. There is a memo from Mr.
Tilney to Mr. Allison, Exhibit 240,\1\ on January 15, 1999;
after these various personnel shifts have taken place. It says,
``On a positive note, I want to update you on recent
developments in our relationship with Enron, since you spoke to
their CEO, Ken Lay, last spring regarding our difficult
relationship and research. It is clear that your responsive
message was appreciated by the company, and any animosity seems
to have dissipated in the ensuing months. To that end, we have
recently been awarded two significant mandates by Enron; the
first to lead-manage the $1.5-billion IPO of their water
company, which is expected to file in late February, and the
second to raise a $1-billion private equity fund on behalf of
the parent, which is expected to kick off in early March. Total
fees to Merrill Lynch for these two transactions alone should
be $45 to $50 million.''
---------------------------------------------------------------------------
    \1\ Exhibit No. 240 appears in the Appendix on page 2209.
---------------------------------------------------------------------------
    These are pretty high-stakes evaluations then that your
research analysts make. Does this happen on a regular basis
that the chief financial officers of companies call to inform
your one side that they are not going to be invited to be a
lead manager because they are dissatisfied with a rating that
has been given by your research analyst? Does that typically
result then in the departure of the research analyst a couple
months later and a subsequent upgrade in the rating? Is that a
common occurrence at Merrill Lynch or is this unusual? Do you
have any knowledge of that aspect of the company?
    Mr. Martin. Senator, let me answer a few of your initial
concerns, and I will get to that. First of all, Merrill Lynch
cooperates----
    Senator Dayton. I would like you to answer the question I
just asked. Is this a typical occurrence or not?
    Mr. Martin. It is a typical occurrence for a CFO of a
corporation to follow extremely closely what all of the
analysts are saying.
    Senator Dayton. That was not my question, sir. My first
question is, is it a typical occurrence for the CFO to call and
inform your investment bankers that they will not be selected
to be the lead manager because they are viscerally dissatisfied
with the rating that the company has provided?
    Second, is it typical then that the analyst involved, who
did not change his rating, departs within a couple of months
after that matter?
    Third, is it typical that the successor analyst raises the
rating?
    Fourth, is it typical then that it is followed by these
kinds of awards by the company? Those are the four questions.
    Mr. Martin. It is not atypical to get investment banking
business with research being part of that decisionmaking
process.
    Senator Dayton. If your rating of the company is good
enough, then you get the investment banking business? If your
rating of the company is not good enough, then you do not get
the investment banking business?
    Mr. Martin. If your following of the company is complete,
if your following of the company is consistent, if your
following of the company is reflective of what the company
thinks of their story, it is part of their decisionmaking
process who then would get investment banking business. That is
absolutely true.
    Senator Dayton. Is that practice typical in your company
and in the industry, as you know it?
    Mr. Martin. It is typical that the research topic is part
of the investment banking process. That is typical both at
Merrill Lynch, and I assume for the rest of the industry.
    Senator Dayton. So you and the company are typically then
placed under enormous pressure, if you want these very
lucrative investment banking awards, to have your rating of the
companies reflect the positive regard with which the executives
or the management of that company wants to be evaluated.
    Mr. Martin. I think the investment banking clients want the
research analysts to understand their company and reflect that
accurately, as opposed to the ratings.
    Your second question, I believe, Senator, was or one of the
questions was, in research coverage, the gap August to
November. What happens at Merrill Lynch--I can't speak for the
rest of the Street--is when a new analyst takes over a company,
they need time to analyze the company, which is what happened
and is very typical.
    Senator Dayton. I accept that that is the case.
    Do you know any of the circumstances concerning the
departure of Mr. Olson?
    Mr. Martin. I know some of them. I believe what occurred
within the Research Department was, because of the way the
energy industry itself was starting to segment, you had trading
companies, you had physical companies, you had financial
companies, that we reorganized our research group, and we put
under one analyst four or five companies that were similar. So
we had Enron, and Coastal, and Williams and several other
companies that, to us and to the analyst community, looked
similar, as far as activity goes.
    Senator Dayton. I have one other question regarding a
transaction in April. Mr. Tilney sent copies of Mr. Olson's
Enron call list to Mr. Fastow when Mr. Olson was under some
scrutiny, and this transaction, the sale of the additional
stock was going through. These are, I assume, clients of his or
Merrill Lynch's that he is calling to pitch or at least make
aware of this offering, but he is also the analyst who is
providing the rating at this point, which is, unless he has
changed it, really, not a neutral, not a buy.
    Is this typical also that the call sheets are sent to the--
--
    Mr. Martin. Yes.
    Senator Dayton. So that they are aware that he is on board
sufficiently enough that he is pitching the company and the
stock sale, even though he does not approve of it?
    Mr. Martin. His rating, actually, specifically was neutral
short term, and positive long term. So he had a one rating as
far as a long-term investment. It is typical and accepted
practice that in an offering, whether it is equity or debt,
that our marketing effort and who we talk to would be shared
with particularly the CFO, who is particularly interested in
who is buying the stock or who isn't buying the stock, and why
not.
    Senator Dayton. So he is rating the company, and that is
the official Merrill Lynch rating of the company. He is also
pitching the sale of the stock. Is he aware then that the sale
of this or the issuance of this stock is for the purpose of
satisfying Moody's and bringing down the debt-to-equity ratio
of the company? Is he aware of that when he makes these
pitches?
    Mr. Martin. I am not sure what he would or would not have
been aware of, but clearly----
    Senator Dayton. The others were aware. The people in the
investment banking side were aware.
    Mr. Martin. There would be a Chinese wall between certain
information that he would or would not have. He clearly would
know there would be an equity issuance coming.
    Senator Dayton. There was not a Chinese wall, though, when
Mr. Fastow called to basically tell you that he was
dissatisfied with the rating; therefore, he was not going to
give you the business. I mean, he is effectively bridging that
wall.
    Mr. Martin. The Chinese wall is an information wall.
    Senator Dayton. I find your comments, then, and I take you
at your word, sir, about the commonality of this matter to be
extremely disturbing. My time has, I guess, expired, so I will
relinquish the microphone, but I think if this is the case, Mr.
Chairman, that this is typical, then I think it raises a
serious question whether the ratings that investors are
depending on have any credibility whatsoever. It seems like it
is a free-for-all and a very intense competition to get the
very lucrative investment banking relationships and to increase
the profits from them. Therefore, the analysts or the companies
are evidently under severe pressure from the companies that
they are rating to make those ratings conform to the company's
desires or they are going to lose the business, and I think
that is very alarming.
    Mr. Martin. Senator, let me just follow on that the
ratings, and who can change ratings, and when to change ratings
is completely controlled by Compliance. As and when there are
activities going on, the ratings get frozen. There is a black-
out period where ratings cannot be changed up or down if there
is an activity, if there is a capital market activity going on.
    Senator Dayton. But the fact is, your subsequent analyst
raised the rating of the company, and Merrill Lynch was
rewarded, as the January 1999 memo indicates, with a couple of
very lucrative investment banking relationships with Enron. So
there was definitely a very direct reward immediately following
that change.
    Thank you, Mr. Chairman.
    Senator Levin. Thank you. These are disturbing questions,
indeed, that you have raised. Senator Fitzgerald.
    Senator Fitzgerald. Mr. Martin, thank you very much for
testifying today.
    Mr. Martin. Thank you.
            OPENING STATEMENT OF SENATOR FITZGERALD
    Senator Fitzgerald. I would like to turn your attention to
Exhibit 212 in your book.\1\ Exhibit 212 is a fax from Rob
Furst, who was in your Dallas office, to Jim Brown at Merrill
Lynch. Can you tell me who Jim Brown is? Do you know?
---------------------------------------------------------------------------
    \1\ Exhibit No. 212 appears in the Appendix on page 2079.
---------------------------------------------------------------------------
    Mr. Martin. Senator, Jim Brown, I believe, has been or is
the senior person in charge of Structured Finance.
    Mr. Fitzgerald. Senior person in charge of Structured
Finance?
    Mr. Martin. Structured Finance.
    Mr. Fitzgerald. Where is he located?
    Mr. Martin. Physically? He is in New York. I believe he is
located in the Investment Banking group.
    Mr. Fitzgerald. So this fax is from Rob Furst to Jim Brown
in Structured Finance in New York.
    The cover page of the fax, it says, ``Twenty-six pages are
being faxed,'' and it includes some handwritten notes that
appear to outline some of the risks of the Nigerian barge
transaction for Merrill Lynch. It says, ``foreign tax,
environmental, operating performance, failure to complete.'' It
says, ``No repurchase obligation from Enron.''
    Do you know whether those notes were written by Mr. Brown
or by Mr. Furst?
    Mr. Martin. It is my understanding they were Mr. Brown's
notes to go into a meeting.
    Mr. Fitzgerald. So this is Mr. Brown in Structured Finance,
and he wrote the last risk at the bottom which says, the
handwritten note of Mr. Brown says, ``Reputation risk; i.e.,
aid and abet Enron income statement manipulation.''
    Does that suggest to you that Mr. Brown, in charge of
Structured Finance, feared that this whole Nigerian barge
transaction was designed to assist Enron in manipulating their
income statement?
    Mr. Martin. Senator, what this list would indicate to me is
that Mr. Brown, first of all, was doing a very thorough job. He
was, to himself, writing down all of the potential risks, and
again, having not been at that specific meeting, had each and
every one of these vetted to his satisfaction.
    Mr. Fitzgerald. So he must have discussed the reputational
risk; i.e., aiding and abetting Enron income statement
manipulation, he must have discussed that at a meeting with
other people in the Structured Finance office in New York?
    Mr. Martin. He would have discussed it, again, I assume he
discussed it, he would have discussed it at a meeting that had
people from Legal, and Credit, and Product, and Banking all
together. He would have gone through a list and wanted to get
comfort from his seat that these things were not a problem.
    Mr. Fitzgerald. So there would have been a whole group of
people at Merrill Lynch who would have been made aware of that
risk that this transaction was designed to manipulate Enron's
income statement, but they nonetheless went forward with this?
    Mr. Martin. No, I think that this was a question, these are
a series of questions and risks. So there would have been a
group of people--again, having not been at the meeting, it is
hard to be exact--but I would surmise there would have been a
group of people, and each and every one of these risks would
have been discussed from different points.
    Mr. Fitzgerald. Let me ask you this. You are here, you have
no firsthand knowledge of the Enron transactions, but you do
speak for Merrill Lynch to answer questions about their
policies.
    Mr. Martin. Sure.
    Mr. Fitzgerald. What is the policy, within Merrill Lynch,
when it comes to assisting with transactions that are designed
to manipulate your clients' income statement?
    Mr. Martin. The policy is unequivocally not to do them.
    Mr. Fitzgerald. Not to do it.
    Mr. Martin. Absolutely.
    Mr. Fitzgerald. What if a transaction comports with GAAP,
and it is legal, but really it has no economic purpose, and the
only reason to do it is to gin up the earnings, the reported
earnings of the company? It seems to me that Enron engaged in
thousands of those types of transactions, many of which do seem
to have comported with GAAP.
    If the sole purpose of a transaction was to manipulate the
income statement, but it is legal, and it comports with GAAP,
would Merrill Lynch do the deal?
    Mr. Martin. If the transaction was legal, and if it had
sign-off from Enron's advisers, our judgment, we would have a
discussion, we would have a discussion about, if it was in a
gray area, whether we reputationally wanted to do that or not.
    Mr. Fitzgerald. And that is apparently what went on here.
    From my standpoint, I think it is very apparent that
Merrill Lynch, whether wittingly or unwittingly, became the
investment banker to a big Ponzi scheme at Enron, along with
other investment banks. You were very involved in setting up
LJM2, the purpose of which, as far as I can tell, was to help
Enron book fictitious earnings. You were involved in the
Nigerian barge situation.
    I guess, rather than beating you up by going through
individual transactions, and I think the Subcommittee has many
documents they are going to want to continue to ask you about
today, I would want to ask you a broader question. I feel that
Congress is actually ignoring the root cause of why companies
are manipulating their earnings.
    Just today in The New York Times, on the front page of the
Business Section, it was disclosed that top managers at Qwest
Communications cashed in $500 million worth of stock options in
the last couple of years. They have all since left the company.
There is a new CEO, Dick Notebaert, who happens to be from my
State of Illinois, and now he is restating the earnings. But
those previous managers have gotten very rich on their stock
options, and the long-term investors are left holding the bag.
    I actually think it is Congress's fault that we have
created this situation, because back in 1993-1994, Congress put
a gun to the head of the Financial Accounting Standards Board
and made them back down from their Rule 123, which was going to
require companies to expense stock option compensation on their
income statements. I think that would have at least been some
discipline on corporate America.
    In the case of Enron, the top 29 managers cashed in $1.1
billion worth of stock options. Most of those managers left the
company by the time it hit the wall. Unfortunately for Ken Lay,
he had to come back because Jeff Skilling left. He had lined
up, himself, had lined up a job with another company. My
suspicion is they all knew it was a house of cards.
    My guess is tons of Enrons are out there goosing their
earnings, trying to keep their earnings per share high to keep
the options in the money so the senior managers can cash in
those options. You are seeing cases of companies actually
accelerating their earnings and deferring their expenses, like
WorldCom did. They just capitalized expenses.
    What is Merrill's perspective, as an investment banker who
sees a lot of companies on a day-to-day basis? Do you think
this is a worry out there that Congress has given executives in
corporate America, 90 percent of their compensations now coming
from stock options, some of the executives are in a position to
make tens or hundreds of millions of dollars by fictitiously
posting earnings? Do you think that those stock options are a
potential motivating factor in causing corporate America to
fictitiously goose their earnings?
    Mr. Martin. I think stock options, in addition to other
things, would be a contributing factor to behavior, which may
not be perhaps in the long-term best interests of shareholders.
It may be a contributing factor. I think the short-termism and
the pressure to perform, as viewed by all of the analysts,
which we just previously spoke about, by shareholders, by
boards is intense and seems to be getting more intense.
    I think the true alignment, particularly of the officers of
a company, with the long-term success and value creation of a
company, would be a very worthwhile thing and something that,
although I have never spoken to Merrill Lynch directly about
it, I assume that Merrill Lynch would be very supportive of
that.
    The alignment of risk, the proper risks and rewards for the
people at corporations making these decisions--we all make a
lot of decisions. The big decisions take years, and years and
years to unfold, whether they are right or they are wrong. So
linking those together and alignment of responsibility,
accountability, and rewards would be something that we would be
supportive of.
    Mr. Fitzgerald. Now Merrill Lynch itself uses stock
options, do they not, in their employee compensation?
    Mr. Martin. Yes, we do.
    Mr. Fitzgerald. And you, yourself, have stock options; is
that correct?
    Mr. Martin. I have a few, yes.
    Mr. Fitzgerald. You have a few. Now does that give your
investment bankers the incentive to help drive up business
however possible to keep the earnings flowing so that their
individual stock options can stay in the money, and they can
cash them in before they expire? Do you think that that is
itself an incentive within Merrill Lynch to ignore the
reputational risk to Merrill Lynch to go ahead, get those extra
fees, keep Enron as a client? What do you think?
    Mr. Martin. I think that we have a saying, at least at
Merrill Lynch, that no transaction or no one person's bottom-
line P&amp;L, one person being a business unit, is more important
than the reputation of Merrill Lynch. That is the way we behave
and act.
    Mr. Fitzgerald. Do you know whether Mr. Furst got any stock
options and whether he has cashed them in? And now my guess is
he's leaving the company; is that correct?
    Mr. Martin. I believe he is no longer with us.
    Mr. Fitzgerald. Can you look into that and tell us what
stock options he has exercised, and maybe he has already
profited from that.
    Mr. Martin. OK.
    Mr. Fitzgerald. Well, with that, I suppose we will have
further opportunities to get into more specifics this
afternoon.
    Incidently, Senator Levin and I have a bill that would kind
of undo some of the ill effects from Congress's actions in
1993-1994. I am pleased that some companies are voluntarily
expensing their stock option compensation expense. I am very
fearful that there are many more Enrons out there and that the
root cause of it is powerful motivation in the hands of
managers to book current earnings, cash in their stock options.
They can leave the company before the restatements. Their
fortune is assured, but the long-term investors are left
holding the bag.
    I wish that Congress would have the courage to address
this. It seems to me that almost every executive in America who
has stock options is dead set against having to record them as
a compensation expense on their income statements, and the
earnings of almost every company in America are grossly
overstated because the compensation expense is just ignored on
the income statement.
    But thank you very much, Mr. Martin.
    Mr. Martin. Thank you.
    Senator Levin. Thank you, Senator Fitzgerald. Senator
Durbin.
    Senator Durbin. Thank you, Mr. Chairman.
    Mr. Martin, thank you for being here.
    Mr. Martin. Thank you.
              OPENING STATEMENT OF SENATOR DURBIN
    Senator Durbin. For the record, before joining this inquiry
into the corporate culture of America, I would like to take a
moment and make an observation about the notion of justice in
America. If you follow the morning papers, you realize that a
professional basketball player is in the news for misdemeanor
charges that he engaged in threatening conduct, and because of
that threatening conduct, he faces a maximum jail term of 5
years.
    I want to make a point of that for the record because all
that we have heard and described about the conduct of the Enron
Corporation. As we sit here today, there is still not a single
officer of Enron who has been charged by this government for
any wrongdoing. That professional basketball player faces more
jail time than any officer of Enron today as we enter into this
discussion.
    Second, I would like to note that there is a Hollywood
actress who has been accused of shoplifting, and I would like
to make a point that whatever the amount that she shoplifted,
she is facing the prospect of more jail time than any of the
employees of Merrill Lynch who were involved in what led to the
agreement between the State of New York and Merrill Lynch,
because of conflicts of interest and deception by the employees
of Merrill Lynch when it came to the selection of stocks. I am
going to ask Mr. Martin for some detail on that in a moment,
but what I have read in press accounts suggests that analysts
at Merrill Lynch were intentionally deceiving the clients of
that company about their true feelings concerning the value of
companies, compromising in the process the savings, the
investments, the retirements, and sometimes the lives and
futures of a lot of innocent people.
    The net result of that misconduct was a fine on Merrill
Lynch in the amount of $100 million, a substantial amount of
money for the average person. But according to the New York
Times, that fine represented less than one-third of what
Merrill Lynch paid for office supplies and postage in the
previous year.
    As I said, I hope that we will keep in perspective the
notion of justice in America when we are talking about
misdemeanor charges and jail time for shoplifting and
threatening conduct that far exceed any of the penalties which
we are imposing on wrongdoers in this corporate corruption
scandal.
    Mr. Martin, tell me, if you will, why Merrill Lynch agreed
to pay the $100 million to New York and other States.
    Mr. Martin. Senator, I am not in a position to answer that.
I was not involved in those discussions, the dialogue, the
decisionmaking process. Unfortunately, I am just not in a
position to answer that question.
    Senator Durbin. Well, do you know? I mean, what is your
position at Merrill Lynch?
    Mr. Martin. I run the International Private Client
business.
    Senator Durbin. Are you aware of the nature of the charges
against Merrill Lynch which led to the payment of this fine?
    Mr. Martin. Only broadly.
    Senator Durbin. Can you tell me, broadly, what they were?
    Mr. Martin. I think there was an allegation that there was
undo influence by certain parts of the firm on our research
process.
    Senator Durbin. How was that manifest? Was it not manifest
in emails that were brought to the attention of the attorney
general of New York, where analysts at Merrill Lynch were, in
fact, advising clients to buy certain stock which they had
personally said in email was not valuable or not of great
worth; is that not the nature of this charge?
    Mr. Martin. Senator, I am just not prepared to have a
dialogue on that.
    Senator Durbin. Mr. Martin, I am glad you are here today,
but you are of very little value to us, and perhaps that is why
you are here today.
    Mr. Martin. Thank you.
    Senator Durbin. You were able to suggest that you are
carrying the banner for Merrill Lynch, but just have plausible
deniability on every single thing that we ask. Thanks for
joining us, nevertheless.
    Let me ask you about your testimony because I am curious.
There are two things that come out of your testimony that do
not square. One is, early in the testimony, on page 4, where
you go to great lengths to suggest that the relationship
between Merrill Lynch and Enron was modest and minimal. Those
are your words. Do you recall that part of your testimony?
    Mr. Martin. Yes, Senator.
    Senator Durbin. And then on page 10, when you talk about
the problems dealing with research in your testimony and the
lengths to which your company went, to try to win back the
confidence of your buddies, your friends and colleagues at
Enron, you refer to this as a longstanding relationship worthy
of these extraordinary efforts. That seems to be in contrast.
At one point, this is a client of very little importance, and
then by page 10, it is a client that, when it expresses
misgivings about your ratings by Merrill Lynch of Enron, is
worth all of this extra effort to win back their friendship.
Can you explain the difference?
    Mr. Martin. Senator, there is a difference between
relationship--the importance of the Enron relationship, again,
going back in time, was accurately stated; large, important
relationship. Again, $40 billion in revenue, growth company,
leader in the industry, leader in technology, leader in the
thought processes of corporate America, so it was a critical
relationship for us, no doubt.
    The facts are, from a business point of view, it was a
small account. Again, our investment banking revenues, which I
went through on page 4, $3.5 to $3.7 billion of investment
banking revenues on an annual basis, and the Enron investment
banking fees to us were two-tenths of 1 percent of that number.
So it was a small account as far as activity, a very important
account as far as both current relationship and potential
relationship.
    Senator Durbin. Mr. Martin, I could dwell on that
particular comment because, in a memo on January 18, 1999,
someone from the Investment Banking Division notified your
president on an update on Merrill's relationship with Enron,
since your president spoke to Mr. Lay concerning ``our
difficult relationship in Research,'' and went on to say, in so
many words, things are back on track between Enron and Merrill
Lynch now, since we have got some new ratings out. And he
concluded by saying, ``Total fees to Merrill Lynch for two
transactions,'' which are referred to here, significant
mandates by Enron alone would be worth \1\ ``$40 to $50
million.''
---------------------------------------------------------------------------
    \1\ Exhibit No. 240 appears in the Appendix on page 2209.
---------------------------------------------------------------------------
    So, when you talk about a million dollars, and $2 million
and $8 million, it appears that this email raises a question as
to whether it was a much larger relationship, but I do not want
to dwell on the difference in dollars and how big it was to
your bottom line. I guess it really comes down to a more
fundamental question.
    For the individual investor relying on Merrill Lynch's
recommendations and analysis to make important life decisions
about their savings and their pensions, whether Enron
represented 1 percent or 10 percent of your bottom line is
insignificant. They trusted you. They believed that you were
the cop on the beat; that Merrill Lynch was giving them good,
solid information. But instead of being the cop on the beat,
you were the dog in the lap.
    It appears that what occurred here is that once pressure
was put on Merrill Lynch, because this seventh largest
corporation in America disapproved of being rated neutral, that
your officers, including your president, scrambled, hat in
hand, to try to win back the love and affection of Enron. I
mean, by every indication, that is what occurred. How does
that, in any way, enhance Merrill Lynch's reputation for
trustworthiness?
    Mr. Martin. The research process that we have at Merrill
Lynch is extremely rigorous. It is separate from the rest of
the firm. We probably cover more stocks, and more locations,
and more countries in the world than any other institution.
    If you look at the facts about our research and the
performance of the stocks that the research recommends, it is,
year in and year out, if not the leader amongst the top two or
three leaders as far as providing accurate, concise, balanced
research on companies.
    Enron, in question, the various analysts that we had, the
two different analysts, each came up with the conclusion that,
from a long-term perspective, that Enron was a company to buy.
They were not alone in that. There were 40 or 45 other analysts
on Wall Street who also covered Enron, almost all of them as
positive. We try very hard and work very hard, as a research
provider, to give unbiased, consistent, long-term research to
our individual investors and our institutional investors, and
we do not get everything right as human beings, but we very
much take seriously the responsibility we have.
    Senator Durbin. Mr. Martin, I think there are enough
disclaimers on everything that the stock analysts do to give
their recommendations and say past performance will not
necessarily predict future results and so forth. I know that. I
own stock. Most people do in this country. I understand those
disclaimers, and I understand people can miscalculate and guess
something big is going to happen or something bad is going to
happen, neither of which occurs.
    But what has been raised here is a question of conflict of
interest and deception, and that is much different. To make an
honest mistake in analyzing the future performance of a company
is one thing, to be so intricately enmeshed in the business
dealings of Enron that your company is not playing it straight
is another thing.
    The point I would like to close with is this. You have
repeatedly made reference to a Chinese wall. I might just say,
as far as that analogy is concerned, that a Chinese wall may
have been a great challenge to breach a thousand years ago, but
it is not today, and I happen to believe that without strong
laws and meaningful penalties, the Chinese walls built by
corporations are not enough to restore the confidence of the
average person in this process. If that confidence is not
restored, not only will your company suffer, but this economy
will suffer.
    Thank you, Mr. Chairman.
    Mr. Martin. Thank you.
    Senator Levin. Thank you, Senator Durbin.
    You just told Senator Durbin that ``Research is separate
from the rest of the firm.'' Why was Olson then peddling the
Enron stock offering?
    Mr. Martin. Organizationally, the way it is structured in
Merrill Lynch is Research reports to Research who reports to
somebody who is executive vice president on the Executive
Committee who reports to the president. So Research is not
imbedded in the investment bank or the consumer business. It is
a separate entity. It is a separate function. It obviously has
dealings with the different parts of the firm, but it is run as
a separate function with checks and balances.
    Senator Levin. Which reinforces my question. Why was he
peddling stock then?
    Mr. Martin. He was not--I do not know what he was doing. I
do not necessarily think he was peddling stock.
    Senator Levin. Have you not seen the notes that you made
reference to before? You said it was ordinary that notes of
conversations that somebody like he would have in offering
stock would be made available to the company whose stock
offering it was. You said that was very common.
    Mr. Martin. It is not unusual.
    Senator Levin. My question is why was he peddling Enron
stock if he is an analyst, when you said the Research Division
is separate from the rest of the firm? It is a very fundamental
question.
    Mr. Martin. The role of the analyst, in a capital market
transaction, is usually to provide content and depth of a
topic. So the role he most likely played was talking to
accounts with the sales people, and the accounts asking him in-
depth questions that only an analyst can answer about Enron.
    Senator Levin. Enron seemed to have so much trouble with
his analysis that they wanted him removed from the scene. So it
is not just making phone calls and getting responses, he was
analyzing Enron; is that not correct?
    Mr. Martin. He is the analyst for Enron.
    Senator Levin. My question is what is he doing then
peddling Enron stock if there is a Chinese wall.
    Mr. Martin. In that process----
    Senator Levin. There is not even a wall.
    Mr. Martin. In that process, in the distribution process,
the analyst would provide, the analyst would be the content
expert for both the industry and that company, and they would
provide that expertise to the account base and to the sales
force to give them answers to questions that they were going to
have.
    Senator Levin. So you are saying he did not initiate calls?
    Mr. Martin. No, he is going to be making----
    Senator Levin. Let me ask that clearly. Are you saying he
did not initiate calls; he only was responding to calls?
    Mr. Martin. No. With regard to what he was doing
specifically, I do not know. What I am trying to respond to and
give you a frame of reference on is that an analyst can be
involved, and will often be involved, if there is an equity
issuance, to provide what an analyst has spent a lot of time
doing, which is depth of coverage and content.
    Senator Levin. Can you take a look at Exhibit 243.\1\ These
are calling lists from John Olson for the Enron Corporation
common stock offering as of today. It says call list. He goes
through all of the calls.
---------------------------------------------------------------------------
    \1\ Exhibit No. 243 appears in the Appendix on page 2212.
---------------------------------------------------------------------------
    No. 2, likes the story; No. 5, likes the story; left voice
mail, Enron story, No. 7; No. 8, Enron story; No. 9, Enron
story; No. 12, Enron story. He is telling the Enron story. No.
13, will probably pass.
    He is not responding to questions here. He is pitching. In
fact, in your own words, I think he said he was pitching.
    Will consider it. He is leaving all of these voice mails.
He is not responding to inquiries here. He is leaving voice
mails with the Enron story. He is pitching. Day after day after
day he is pitching. There are three different days of call
sheets here. That is not a Chinese wall. There is no wall. You
have got your Research people, who are supposed to be making a
pitch for the stock that you are selling, and that is one of
the most disturbing features of this matter.
    Do you have any further comment on this?
    Mr. Martin. Again, Mr. Chairman, it is--I see this list of
clients, it is not unusual for a Research person to work with
the institutional sales group, because these are all
institutional sales people, about trying to provide insight
into the company that they are analyzing, but I cannot speak
for all of these various calls and things.
    Senator Levin. Do you want to qualify or rethink your
statement about Research being separate from the rest of the
firm?
    Mr. Martin. Well, I will qualify it. The organizational
construct of Research is designed at Merrill Lynch to provide
an organizational distinctiveness to that function.
    Senator Levin. Well, it may be created for that purpose,
but it sure as heck is not functioning in that way, by your own
evidence. You have got a pitch man here in your Research
Department.
    Mr. Martin, let me ask you about another document. You told
me earlier that the Debt Management Commitment Committee bumped
the decision on the barge transaction upstairs. I want to go
back now to the barge transaction, and you mentioned, I think,
that it may have gone to Tom Davis.
    Now the Subcommittee staff has been informed that the
decision was sent to either Mr. Davis or Mr. Bayly. So is it
possible that Mr. Bayly, instead of Mr. Davis, made the
decision on this?
    Mr. Martin. Again, I do not have the direct knowledge or
involvement, but from a process point of view, the person who
should have made the decision is Tom Davis.
    Senator Levin. Will you take a look at Exhibit 207,\1\
because Mr. Bayly, I take it, was one of the--can you give us
his title?
---------------------------------------------------------------------------
    \1\ Exhibit No. 207 appears in the Appendix on page 2059.
---------------------------------------------------------------------------
    Mr. Martin. He is chairman of Investment Banking.
    Senator Levin. Chairman of Investment Banking?
    Mr. Martin. The Investment Banking team.
    Senator Levin. Now this, if you look at Exhibit 207, this
is what the chairman of Investment Banking is going to do,
according to the notes of Mr. Furst. If you look at the bottom
now, here is the chairman of the Investment Banking Committee.
    ``Dan Bayly will have a conference call with senior
management of Enron confirming this commitment to guaranty the
ML takeout within 6 months.'' That is what Mr. Furst's memo
says. That is what the head of this Subcommittee is going to
do. He is going to confirm a commitment to guarantee the
takeout.
    Now do you know whether that conference call, in fact, took
place?
    Mr. Martin. I believe it did take place.
    Senator Levin. Do you have the notes of that or a tape of
that call?
    Mr. Martin. I do not, no.
    Senator Levin. Have you done an investigation as to what he
said in that call?
    Mr. Martin. I have not, no.
    Senator Levin. Has Merrill?
    Mr. Martin. I do not know if Merrill has.
    Senator Levin. This is the most critical issue on this
matter that the Subcommittee is looking at this morning, is
whether or not that guarantee was made the way all of the
evidence, contemporaneous and in writing, says it was made.
This is directly on point. ``Dan Bayly will have a conference
call with senior management of Enron confirming the commitment
to guaranty the takeout,'' and you are coming before this
Subcommittee and telling us that you do not even know if
Merrill Lynch has asked Mr. Bayly whether or not that call, in
fact, contained that kind of----
    Mr. Martin. I assume they either have or are, but I do not
know, in fact, whether that has occurred.
    Senator Levin. I do not assume either. I wish I could.
    Would you get us the notes of any conversations that
Merrill Lynch has had with Mr. Bayly about that call?
    Mr. Martin. Yes.
    Senator Levin. Why did you not inquire about that before
you go there today, since it is such a central matter?
    Mr. Martin. The original role I was asked to play was to
provide a Merrill Lynch perspective, a policy perspective, and
a broad perspective on ML and Co, and how it, particularly from
a process point of view, would have been involved in all of
these, which is what I spent the last several days doing. So
the role I was expected to play is the role I am trying to
play. I was not going to get prepared to discuss each and every
one of these transactions, having not been in them.
    Senator Levin. Mr. Martin, you have testified here today
that there was no guarantee, and you have said that under oath.
Here is a document which says that Mr. Bayly will have a
conference call with the management of Enron confirming this
commitment to guarantee, and you are appearing in front of this
Subcommittee, under oath, saying you have made no inquiry, you
do not know whether or not Merrill Lynch has made any inquiry
as to the content of that call, as to whether Mr. Bayly, in
fact, said that.
    I find that totally impossible, frankly, to accept because
you are representing a firm. You made the statement today there
was no guarantee, and yet, and no understanding by Merrill
Lynch that Enron or any entity related to Enron would buy back
Merrill Lynch's shares. How can you make that statement without
having made the inquiry or knowing about whether or not Merrill
Lynch has even inquired of Bayly, who is the head of your
Credit Division there, about the content of that conference
call? I do not even know how you could come before this
Subcommittee and make the statement that there was no
understanding, in the face of this document saying that the
head of your whole division here was going to confirm that
understanding.
    Mr. Martin. Again, Mr. Chairman, it is, in my preparation
for my role here, I knew that there was--had been made aware
that there was a conference call. I am not aware of what the
content of that conference call was, having not been on it.
Again, I know it is easy to assume, but my assumption is that
Merrill Lynch has spoken with Mr. Bayly at some length about
this topic and we would be happy to send you all of the notes
and information on that.
    Senator Levin. Mr. Martin, let me wind up this segment by
just, on this particular issue, and I am going to be moving on
to the other aspects, after I call upon Senator Collins, but
basically the claim that the barge deal was a purchase by
Merrill Lynch and that there was a real sale by Enron is just
simply unbelievable, and the documents of Merrill Lynch are
just so full of references to a guarantee, and a commitment,
and an assurance that is contemporaneous, that it is incredible
to believe that this was a real purchase.
    The fact that it was booked as a purchase by Merrill Lynch
is not evidence of the fact that it was a real purchase; in
fact, quite the opposite. The question is why would Merrill
Lynch book this as a purchase, in the face of all of the
contemporaneous evidence that, in fact, it was a ``relationship
loan,'' to use the words of a Merrill Lynch employee. That is
the issue. It is not evidence that it was a purchase. It raises
the question very dramatically as to how could it be booked as
a purchase in the face of all of that contemporaneous,
documented evidence.
    There is also, in addition to that contemporaneous
evidence, the statements of employees of Merrill Lynch to the
staff of this Subcommittee that Merrill Lynch would not have
entered into the transaction, but for the pledge by Enron to
take out Merrill Lynch from the barge transaction within 6
months. Enron, in fact, found a buyer on the date that it had
promised, and it had to do so by using its own entity of last
resort, LJM2. The agreement up front that you were going to get
the $250,000, and then 15-percent interest on the $7 million
was very clear. It is exactly what you got when LJM2
transferred the $7 million on the scheduled date.
    So the claims of Merrill Lynch here are too thin, and we
are not that naive. There was all of the motivation in the
world to book this as a sale to please Enron and to make sure
that Enron's own financial treatment and deception was not
countered by the way in which Merrill Lynch treated it in its
own books. You tried to stuff a loan into what was supposed to
be the skin of a sale, but the skin is just too thin, and I
think we can see right through it, and hopefully you can, too,
at Merrill Lynch.
    Senator Collins.
    Senator Collins. Thank you, Mr. Chairman.
    Mr. Martin, I want to go back to the issue of John Olson's
calls, because like the Chairman, I am convinced that these
were calls where he is trying to sell the stock, as opposed to
your explanation of answering questions from institutional
investors. By my quick count, it looks like Mr. Olson made at
least 110 calls. Let me give you some of the comments, just
taking three of the calls, one of them Mr. Olson noted.
    One records his conversation with a Rod Mitchell at the
Mitchell Group. He says, ``Wants to buy cheaper. He is a
bargain hunter.''
    Another one is with Barbara Friedman from John Hancock.
``Likes the idea. Will consider it. Does not own now.''
    A third, Barry Allan at Putnam. ``Thinks the price is too
high. Might buy at $44 to $45.''
    Would you agree that these are calls where Mr. Olson was
trying to sell the stock?
    Mr. Martin. Senator, as we went through the information
before, having not been there and having not listened to phone
calls, and who was there, and who was not there, it is hard for
me to answer. The answer is I do not know.
    Senator Collins. If you look at the comments that Mr. Olson
recorded, and it is clear that he initiated the call because in
many cases his comment is ``left voice mail/Enron story,'' what
other conclusion could one reach?
    Mr. Martin. Again, the role of an analyst in these
discussions can be multiple, but the one, I do not know what he
was speaking about, I do not know if he was the only person on
the phone call, I do not know if there were other sales people,
I do not know if he was playing a role that was supportive. I
just do not know.
    Senator Collins. Mr. Martin, on three occasions Merrill
sent Enron executives copies of these call sheets listing Mr.
Olson's calls. Is it common for Merrill to provide companies
like Enron with copies of analysts' internal call sheets to
clients?
    Mr. Martin. During a deal, during a capital market deal, it
is not uncommon to, particularly with CFOs of corporations, to
share with them feedback on specific, for specific clients. It
is not uncommon.
    Senator Collins. If Mr. Olson was making calls touting the
stock, as I believe is evident from the call sheets, and he was
a research analyst responsible for rating the stock, is Merrill
precluded from having a research analyst make such calls as a
result of its settlement with the New York State attorney
general?
    Mr. Martin. That, Senator, I do not know, specifically. I
would be happy to follow up on that.
    Senator Collins. Are you unfamiliar with the attorney
general's settlement?
    Mr. Martin. I am familiar with it in broad terms.
    Senator Collins. Do you think Enron's complaints about how
it was rated by this research analyst would have been handled
differently now that Merrill Lynch has entered into a
settlement with the attorney general?
    Mr. Martin. Again, I do not know the specifics of the
agreement--agreement and agreements--that we have in the
settlement with the New York attorney general. I can say with
regard to Enron and its ratings, again, both Olson and the new
analyst had the same exact rating as far as long term. And, in
fact, when Olson moved from Merrill Lynch to another firm, even
before our analyst came out, he came out with a short-term buy
and a long-term buy.
    So, with regard to our behavior and change specific to the
New York attorney general, I just--I'm not in a position to
answer that.
    Senator Collins. Was Mr. Olson forced to leave or
encouraged to leave because Enron complained to Merrill about
his ratings?
    Mr. Martin. It is my understanding it was not specifically
tied just to Enron; it was tied to----
    Senator Collins. Was that one of the factors?
    Mr. Martin. I believe not. What we were doing in the
Research group at the time was there was a whole host of these
companies that seemed to look like--looked different. So,
specifically, Williams Company, and Coastal and a few others,
we wanted to group together under one analyst. So there was a
restructuring of analyst coverage. And so a bunch of companies
that heretofore been covered by different people were put under
one analyst. So his job, his specific job was eliminated as the
restructuring occurred.
    Senator Collins. Is it your testimony that Mr. Olson's
departure was not, in any way, connected to the criticism that
Merrill executives received from Enron?
    Mr. Martin. That is my testimony.
    Senator Collins. Thank you, Mr. Chairman.
    Mr. Martin. Thank you.
    Senator Levin. Just an additional question or two relative
to the Olson matter. Has Merrill Lynch made an investigation as
to whether or not there were conversations with Mr. Olson about
his analysis of Enron stock?
    Mr. Martin. I am sorry, Mr. Chairman. Was there an
investigation by Merrill Lynch on his analysis of Enron?
    Senator Levin. Has Merrill Lynch asked--have they
investigated whether there were discussions with Mr. Olson
about his analysis of Enron stock?
    Mr. Martin. I do not know.
    Senator Levin. That is a very important issue before the
Subcommittee, obviously, today, and would you make inquiry as
to that and send us a copy of those notes of conversations
relative to that subject and any investigation into that?
    I would think that Merrill Lynch would want to investigate
that. Since it has made the claim that there is a wall, one
would think that it would want to see whether or not, in fact,
there was such a wall or whether it functioned in any semblance
of way during this process. It sure did not look like a wall to
me, it looked like a ditch.
    But if you would furnish that, for the record.
    Mr. Martin. Yes, I will do that.
    Senator Levin. Thank you. You do know that Mr. Allison did
call Ken Lay and Jeff Skilling in an attempt to have Merrill
Lynch inserted as a co-manager, those calls were made?
    Mr. Martin. That is my understanding, yes, sir.
    Senator Levin. Do you know what Mr. Allison told Mr. Lay
and Mr. Skilling in those calls?
    Mr. Martin. No, I do not.
    Senator Levin. Would you make inquiry--I would think that
that would be a fairly important issue to Merrill Lynch; it is
to us--and let us have a copy of that inquiry when you make it?
    Mr. Martin. Yes. We'll have that done.
    Senator Levin. Exhibit 242 \1\ has been referred to in some
detail. I am not going to go over the material that Senator
Dayton and others have gone over in this regard, except to
point out in the middle line there called ``Background'' that
this is to Dan Bayly from Schuyler Tilney, and it says, ``As
you know, Merrill Lynch was nearly excluded from Enron's $750
million common stock offering earlier this year. So this
mandate is critical to reigniting our relationship with
Enron.'' That is how important it was to Merrill Lynch.
---------------------------------------------------------------------------
    \1\ Exhibit No. 242 appears in the Appendix on page 2211.
---------------------------------------------------------------------------
    Do you know whether or not any supervisor or anybody above
the analysts in the chain of command at Merrill Lynch ever
discussed with Mr. Olson the fact that Merrill Lynch lost a
lucrative deal solely because of his or, in part, because of
his research activity? Do you know whether or not any
supervisor or anyone above him----
    Mr. Martin. Mr. Chairman, I do not know.
    Senator Levin. Would you make inquiry and let us know?
    Mr. Martin. Yes.
    Senator Levin. And, if so, what the result of that inquiry
was.
    Mr. Martin, you said a moment ago that it is your testimony
that Mr. Olson's departure was ``not in any way related to his
Enron rating.'' That is not our understanding, and I am
wondering whether you wish to qualify your statement.
    Mr. Martin. I thank you for the opportunity to qualify, but
I am comfortable with the statement, Mr. Chairman.
    Senator Levin. You what?
    Mr. Martin. I am comfortable with the original statement.
    Senator Levin. Thank you.
    Let me turn now to LJM2. In September 1999, Andrew Fastow,
Enron's chief financial officer, and Michael Kopper, his right-
hand man, made a presentation to a Merrill Lynch investment
team to pitch a proposal for LJM2, which is a private
investment fund established to make its money primarily from
transacting business with Enron.
    Mr. Fastow was to be the general manager and then equity
holder of LJM2 at the same time he continued his job as Enron
CFO. Three others--Mr. Kopper, Ben Glisan, and Anne Yaeger--
would also work at LJM2, while maintaining their full-time jobs
at Enron.
    In September, Mr. Fastow was looking for help in raising
about $200 million in capital for LJM2. Without that money,
LJM2 could not do anything. It was the fuel that LJM needed to
act. Mr. Fastow made his pitch to Merrill Lynch on September
16, 1999, at its offices in New York.
    During the course of the Subcommittee investigation,
Merrill Lynch provided a 50-minute videotape that captured some
of Mr. Fastow's pitch to the Merrill Lynch team, and we have
edited that tape down to about 7 minutes. And I would ask that
it run now, but before it starts running, there is a transcript
which is available. I think this is Exhibit 206(a).\1\
---------------------------------------------------------------------------
    \1\ Exhibit No. 206(a) appears in the Appendix on page 2054.
---------------------------------------------------------------------------
    I wonder if we could just play these excerpts.
    [Videotape played.]
    Senator Levin. We will come back to that chart in a minute,
why LJM2 is unique.
    [Videotape played.]
    Senator Levin. Mr. Martin, were you at that briefing?
    Mr. Martin. No, Mr. Chairman.
    Senator Levin. This Subcommittee has already looked at the
LJM2 transaction in some depth at earlier hearings, and what we
found after interviewing 13 Enron board members and a number of
corporate governance and accounting experts is that, as far as
any of them knew, it was unprecedented for a publicly traded
company to allow its CFO, the person with the greatest access
to the company's money flows and profit margins to set up his
own investment fund to do business directly with the company.
    Now Merrill was obviously aware of the conflicts of
interest. If you look at Exhibit 246,\1\ this is from Schuyler
Tilney and Robert Furst, the two people who were before us
early this morning, briefly. The subject is, ``Skilling
Questions on LJM2.''
---------------------------------------------------------------------------
    \1\ Exhibit No. 246 appears in the Appendix on page 2235.
---------------------------------------------------------------------------
    ``We would like to have a conversation with Jeff about
LJM2. Our questions are as follows:''
    And then No. 3, ``Are you comfortable with the internal
mechanics put in place to resolve the conflict-of-interest
issue? Have these internal policies been reviewed with internal
and external counsel and the board?''
    Now that is the question which Merrill Lynch is asking
Fastow, who is involved in the conflict. Of course, his answer
comes back, if you will see the next document, where it says
that on October 11, which is 4 days after that first memo, Mr.
Tilney first spoke with Jeff Skilling, president and COO of
Enron Corporation. ``We asked Jeff the questions listed on the
memo. It was apparent he has spent a great deal of time on LJM2
matters, and he is comfortable,'' it says here, ``with the
conflict-of-interest issue for the following reasons,'' and
then gives the reasons that he, the person who is involved in
the conflict or who, on behalf of Enron, approved the conflict
is saying why he approved it on behalf of the corporation.
    But that does not, it should not satisfy Merrill Lynch.
Merrill Lynch now has the problem, the dilemma, which was
raised by your own people as to whether or not you want to
participate in a transaction where there seems to be a
conflict. Instead of asking the company that is involved, it
would seem to me you would ask your own legal counsel as to
whether or not it would be appropriate to participate in that
transaction and to sell that LJM2 stock.
    My question to you is did you get a legal opinion about the
ethics issue from your own counsel?
    Mr. Martin. Mr. Chairman, I do not know the answer to that
question.
    Senator Levin. If you would find out if you did, would you
send us a copy; and if you did not, would you let us know, for
the record----
    Mr. Martin. And that is a legal opinion on the conflict
topic.
    Senator Levin. On that conflict question.
    Mr. Martin. OK.
    Senator Levin. As to why, since there was a question raised
as to whether or not there was not a clear conflict, which
there was, and it was waived by the Enron board, but
nonetheless it was a clear conflict, to have their CFO deal
with them from an outside investment firm with inside
information that he had.
    So now if you look at Exhibit 249,\1\ which is the private
placement memorandum that Merrill put together to convince
qualified investors, like pension funds, insurance companies
and banks, to invest in LJM2, and here is what it says. It says
that ``Under Mr. Fastow's management, the partnership expects
to have the opportunity to co-invest with Enron in many of
Enron's new investment activities and the opportunity to
acquire existing Enron assets on a highly selective basis, and
the access to deal flow should provide the partnership with
unusually attractive investment opportunities. The partnership
will be managed on a day-to-day basis by a team of three
investment professionals who all currently have senior-level
finance positions with Enron--Fastow, Kopper and Glisan--who
will continue their current responsibilities with Enron, while
managing the day-to-day operations of the partnership.''
---------------------------------------------------------------------------
    \1\ Exhibit No. 249 appears in the Appendix on page 2240.
---------------------------------------------------------------------------
    So that is repeating the pitch that Mr. Fastow made to you.
If you take a look at the chart on page 2 of this transcript,
this is what Mr. Fastow was telling you at Merrill Lynch why
LJM2 is unique. Preferred access to proprietary deal flow is
No. one; four, ability for LJM2 to evaluate investments with
full knowledge; five, LJM2 speed and knowledge advantage--
knowledge, knowledge, knowledge. Inside, by the way, inside
information because of Fastow's dual role.
    Do you know whether or not anyone from Merrill contacted
the Enron board about LJM2?
    Mr. Martin. Mr. Chairman, I do not know specifically, no.
    Senator Levin. Would you inquire of that?
    Mr. Martin. Yes.
    Senator Levin. Had anyone from Merrill spoken to the board,
by the way, they would have learned that the board had not
authorized anyone and did not waive the conflict of interest
rules relative to anyone but Fastow to participate in LJM2.
Glisan and Kopper, both listed in your placement memo, were
violating Enron's ethics rules, because they did not get a
waiver, by working at LJM2 in addition to their inside position
at Enron.
    Were you aware of that at Merrill?
    Mr. Martin. No, I was not.
    Senator Levin. The Subcommittee report on the Enron board
concluded that ``No company ought to set up a fund like LJM2
because the conflicts of interest overwhelm any internal
controls that are set up to supposedly keep the fund fair.'' We
also know now that LJM2 was one of the primary devices that
Enron used to cook its books through phony asset sales and
other transactions that produced about $2 billion in funds flow
in a 6-month period and through accounting shams, such as the
so-called Raptor hedges that Enron used to hide a billion
dollars in stock losses at the same time that Mr. Fastow and
LJM2 investors lined their pockets with millions of dollars in
profits in just 2 years at the expense of Enron's shareholders.
    Looking back at this, do you believe that Merrill should
have gotten outside advice before agreeing to underwrite the
private offering of LJM2, given the fact that Merrill was aware
of a conflict-of-interest situation?
    Mr. Martin. Mr. Chairman, I believe that, from a due-
diligence point of view, that we should have done everything
possible to ensure that we got comfortable with the conflict.
    Senator Levin. Let me conclude by saying just a few words
about today's hearing and last Tuesday's hearing, because we
have been looking at, and we continue to look at the role of
financial institutions and Enron's collapse.
    Last week's hearing looked at Citibank and Chase and their
role in $8 billion of financing that Enron never reported on
its books as debt.
    Today we looked at Merrill Lynch and its willingness to put
its ``balance sheet to work'' for Enron in order to position
itself to get Enron's business.
    We have looked at a number of troubling interactions
between Merrill and Enron. First, the Nigerian barges. We
looked at a $28-million transaction involving Nigerian barges
that Enron used to improperly inflate its 1999 earnings by
$12.5 million, after claiming an end-of-the-year sale to
Merrill, but the sale to Merrill was conditioned on a
guarantee, a guarantee that Enron would take Merrill out of the
deal within 6 months and pay Merrill not only a $250,000-up-
front fee, but also a 15-percent return on Merrill's cash
investment of $7 million. That guarantee meant there was no
real sale at all.
    Merrill has contradicted, in its testimony, the
contemporaneous documents, saying that those documents do not
really mean what they say. Well, that is what last week's
inadequate, and may I say feeble, explanation was as well.
    The facts are that the documents show that Merrill got a
promise from Enron to take them out of the deal within 6 months
at a specified profit and that LJM2 met that promise by buying
Merrill's interest in the barges by the end of June for $7.25
million. Nothing says it more eloquently than the internal
document at Merrill Lynch that says that the most unusual
transaction of the week was the request to approve Enron's
relationship loan.
    The second transaction we looked at had to do with a $750-
million Enron stock offering, from which Merrill was initially
excluded by Enron due to Merrill's analyst's visceral
reaction--excuse me--due to Enron's visceral reaction to
Merrill's investment research on the company.
    Within months of Enron's complaint, the analyst who had
given Enron the equivalent of a neutral rating had left
Merrill, a new analyst was assigned to the company, and by
November 1998, Enron's investment rating was upgraded to the
equivalent of a buy.
    The third one was the LJM2 offering. We looked at Merrill's
lead role in underwriting the $390-million private offering of
LJM2, the off-the-books partnership which was run by Enron's
CFO, who had clear conflicts of interest, and that was a major
contributor to Enron's accounting deceptions and downfall.
Merrill was aware of the potential conflicts involved in LJM2,
but did not seek, apparently, outside legal counsel or other
advice on whether it should participate in that underwriting.
In the end, it helped raise the money which LJM2 used to help
Enron cook its books.
    Our investigation indicates that Enron could not have
engaged in the extent, and to the extent, of the deceptions
that it did without the knowing assistance and participation of
major financial institutions.
    The purpose of these hearings has been, and will continue
to be, to set out what happened, to provide a record for
possible legislative action. Of course, it is not our job to
determine whether the facts that we have laid out constitute
violations of securities laws or other laws prohibiting
corporate misconduct. We will turn over the findings, and the
information and the evidence, to the Securities and Exchange
Commission, the Department of Justice, and other law-
enforcement agencies who have the responsibility to make those
determinations. But it is our job to build a legislative record
to show what needs to change to help prevent financial
institutions from participating in or contributing to
accounting deceptions, to alter investment research or to
finance questionable transactions.
    Important advances were made by the Sarbanes accounting
reform bill, which I strongly supported, which has now passed
both Houses of Congress and which is awaiting the signature of
President Bush. Additional steps are being taken by the SEC,
the New York Stock Exchange and other bodies. The key to the
success, however, of the changes which need to be made is
whether the financial institutions themselves will address the
problem that needs correction.
    So far, the institutions which have appeared before us--
Citibank, Chase and Merrill--have not acknowledged any problem
in the way in which they handled Enron. And while the case
histories presented during these hearings of the problems that
indeed were in existence and did exist with the way in which
financial institutions handled Enron, these three financial
institutions are not the only ones that dealt improperly with
Enron.
    So the question that now needs to be asked and which we
will leave this hearing with is whether the financial
institutions in this country are going to acknowledge the
problems, step up and make the changes that need to be made
internally as a result of the events that have been so
tragically unfolding in the fall of Enron and since.
    I can only hope that the financial institutions will carry
out their responsibility, and I know that each of us on this
Subcommittee are determined that we will carry out our
responsibility.
    We thank you for coming forward today, Mr. Martin, and we
will stand adjourned.
    Mr. Martin. Thank you, Mr. Chairman.
    [Whereupon, at 1:03 p.m., the Subcommittee was adjourned.]
                            A P P E N D I X
                              ----------
[GRAPHICS] [TIFF OMITTED]
