[Senate Hearing 107-618]
[From the U.S. Government Publishing Office]



                                                        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











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                   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 & 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 
  & Energy Group, Moody's Investors Service, New York, New York..    29
Ronald M. Barone, Managing Director, Utilities, Energy & Project 
  Finance Group, Corporate and Government Ratings, Standard & 
  Poor's, New York, New York; accompanied by Nik Khakee, 
  Director, Structured Finance Group, Standard & 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 & Energy 
  Group, Salomon Smith Barney/Citigroup..........................    97

                         Tuesday, July 30, 2002

Robert Furst, former Managing Director, Merrill Lynch & Co., 
  Dallas, Texas..................................................   171
Schuyler Tilney, Managing Director, Global Energy & Power, Global 
  Markets & Investment Banking, Merrill Lynch & Co., Houston, 
  Texas..........................................................   172
G. Kelly Martin, Senior Vice President and President of 
  International Private Client Division, Merrill Lynch & 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 & 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 & 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 & 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 & 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 & 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 & 
  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 
  & 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 & 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 & 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 & 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 & 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 & 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 & 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 & 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 & 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 & 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 & 
Energy from Moody's Investors Service.
    Ronald Barone, Managing Director of Utilities, Energy & 
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 & 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 & 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 & 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.
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    \1\ The prepared statement of Ms. Stumpp and Mr. Diaz with an 
attachment appears in the Appendix on page 278.
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    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 & 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 & 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 & PROJECT FINANCE GROUP, CORPORATE AND GOVERNMENT 
RATINGS, STANDARD & POOR'S, NEW YORK, NEW YORK; ACCOMPANIED BY 
 NIK KHAKEE,\1\ DIRECTOR, STRUCTURED FINANCE GROUP, STANDARD & 
                   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 & Poor's Ratings Services was to serve first as an 
analyst and then as a manager with respect to Enron.
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    \1\ The prepared statement of Mr. Barone and Mr. Khakee with 
attachments appears in the Appendix on page 282.
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    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 & 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 & 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 & 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 & Poor's 
emphasis on objectivity and credibility. There is a 
longstanding and exceptionally strong correlation between the 
ratings initially assigned by Standard & 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 & 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 & 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 & 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 & 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 & 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 & Exchange Commission, 
Standard & 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 & 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.
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    \1\ Exhibit No. 112 appears in the Appendix on page 367.
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    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?
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    \1\ Exhibit No. 104 appears in the Appendix on page 355.
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    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 & 
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 & 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 & 
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 & 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 & 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 & 
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&C. What does that mean?
    Mr. Dellapina. I believe P&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 & 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 & 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 & 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 & 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 & 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 & 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 & 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\
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    \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.''
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    \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.
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    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 & 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 & 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 & 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.
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    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 & 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 & 
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.''
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    \1\ Exhibit No. 157 appears in the Appendix on page 562.
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    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\
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    \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.
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    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.''
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    \1\ Exhibit No. 165 appears in the Appendix on page 591.
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    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----
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    \1\ Exhibit No. 166 appears in the Appendix on page 592.
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    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.
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    \1\ Exhibit No. 166 appears in the Appendix on page 592.
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    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 & Elkins, who is----
    Senator Fitzgerald. Vinson & 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.
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    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 & 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 & 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 & INVESTMENT BANKING, MERRILL 
                  LYNCH & 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 & 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 & 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 & 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.''
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    \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.''
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    \2\ Exhibit No. 244 appears in the Appendix on page 2225.
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    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.''
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    \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\
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    \4\ Exhibit No. 259 appears in the Appendix on page 2349.
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    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.''
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    \5\ Exhibit No. 256 appears in the Appendix on page 2344.
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    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.''
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    \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.
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    \2\ Exhibit No. 204 appears in the Appendix on page 2051.
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    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.
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    \3\ Exhibit No. 207 appears in the Appendix on page 2059.
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    ``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.''
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    \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.''
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    \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.
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    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?
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    \1\ Exhibit No. 216(a) appears in the Appendix on page 2117.
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    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?
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    \1\ Exhibit No. 212 appears in the Appendix on page 2079.
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    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\
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    \1\ Exhibit No. 208 appears in the Appendix on page 2064.
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    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?
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    \2\ Exhibit No. 209 appears in the Appendix on page 2068.
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    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 & 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.
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    \1\ Exhibit No. 239 appears in the Appendix on page 2206.
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    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.''
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    \1\ Exhibit No. 240 appears in the Appendix on page 2209.
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    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?
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    \1\ Exhibit No. 212 appears in the Appendix on page 2079.
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    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&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.''
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    \1\ Exhibit No. 240 appears in the Appendix on page 2209.
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    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.
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    \1\ Exhibit No. 243 appears in the Appendix on page 2212.
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    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?
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    \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.]





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