[Senate Prints 107-82]
[From the U.S. Government Publishing Office]



107th Congress 
 2d Session                 COMMITTEE PRINT                     S. Prt.
                                                                 107-82
_______________________________________________________________________
 
                   FISHTAIL, BACCHUS, SUNDANCE, AND

                   SLAPSHOT: FOUR ENRON TRANSACTIONS

                       FUNDED AND FACILITATED BY

                      U.S. FINANCIAL INSTITUTIONS


                               __________


                              R E P O R T

                            prepared by the

                       PERMANENT SUBCOMMITTEE ON

                             INVESTIGATIONS

                                 of the

         COMMITTEE ON GOVERNMENTAL AFFAIRS UNITED STATES SENATE



[GRAPHIC IS NOT AVAILABLE IN TIFF FORMAT] 



                            January 2, 2003






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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
MARK DAYTON, Minnesota               JIM BUNNING, Kentucky
                                     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
MARK DAYTON, Minnesota               JIM BUNNING, Kentucky
                                     PETER G. FITZGERALD, Illinois
            Elise J. Bean, Staff Director and Chief Counsel
                 Kim Corthell, Minority Staff Director
                     Mary D. Robertson, Chief Clerk





                            C O N T E N T S

                                 ------                                

                                                                   Page

SUMMARY OF TRANSACTIONS..........................................     3

    Sham Asset Sale..............................................     3

    Sham Loan....................................................     3

FISHTAIL.........................................................     5

    The Facts....................................................     5

    Analysis.....................................................     9

BACCHUS..........................................................    10

    The Facts....................................................    10

    Analysis.....................................................    17

SUNDANCE.........................................................    18

    The Facts....................................................    18

    Analysis.....................................................    25

SLAPSHOT.........................................................    26

    The Facts....................................................    26

    Analysis.....................................................    33

SUBCOMMITTEE HEARING.............................................    34

SUBCOMMITTEE RECOMMENDATIONS.....................................    36


                    FISHTAIL, BACCHUS, SUNDANCE, AND
                   SLAPSHOT: FOUR ENRON TRANSACTIONS
                       FUNDED AND FACILITATED BY
                      U.S. FINANCIAL INSTITUTIONS

                              ----------                              

    On January 2, 2002, Senator Carl Levin, Chairman of the 
U.S. Senate Permanent Subcommittee on Investigations of the 
Committee on Governmental Affairs, and Senator Susan M. 
Collins, the Ranking Minority Member of the Subcommittee, 
announced that the Subcommittee would conduct an in-depth, 
bipartisan investigation into the collapse of the Enron 
Corporation. This investigation was initiated in response to 
Enron's declaration of bankruptcy on December 2, 2001, ending 
Enron's status as a leading energy company and the seventh 
largest corporation in the United States.
    In the year since Enron's declaration of bankruptcy, 
Congressional hearings, including hearings held by this 
Subcommittee and the full Governmental Affairs Committee, have 
disclosed evidence of Enron's participation in accounting 
deceptions, price manipulation, insider abuse, and unfair 
dealing with employees, investors, and creditors. Law 
enforcement agencies have indicted Enron's former chief 
financial officer, Andrew Fastow, for fraud, money laundering, 
and other misconduct. Mr. Fastow's former key assistant, 
Michael Kopper, has pleaded guilty to fraud and money 
laundering. Enron's former top Western energy trader, Timothy 
Belden, has pleaded guilty to fraudulent conduct to manipulate 
prices in the California energy market. Additional criminal and 
civil investigations by the U.S. Department of Justice, 
Securities and Exchange Commission, Federal Energy Regulatory 
Commission, and other Federal, State, and local law enforcement 
agencies are ongoing.
    A key focus of the Subcommittee's investigation has been to 
examine the role of major U.S. financial institutions in 
Enron's collapse.\1\ In July, the Subcommittee held two days of 
hearings examining transactions involving Enron and three 
financial institutions, Citigroup, J.P. Morgan Chase & Co. 
(``Chase''), and Merrill Lynch. Each of the transactions 
examined in these hearings resulted in misleading information 
in Enron's financial statements that made Enron appear to be in 
better financial condition than it was.\2\ The first hearing 
looked at more than $8 billion in deceptive transactions 
referred to as ``prepays,'' which Citigroup and Chase used to 
issue Enron huge loans disguised as energy trades. By 
characterizing the transactions as energy trades rather than 
loans, Citgroup and Chase enabled Enron to claim the loan 
proceeds were cash flow from business operations rather than 
cash flow from financing, thereby misleading investors and 
analysts about the size of Enron's trading operations and the 
nature of its incoming cash flow. The second hearing examined a 
sham asset sale from Enron to Merrill Lynch just before the end 
of the year 2000, which allowed Enron to claim the alleged 
``sale'' revenue on its 2000 financial statements, boosting its 
year-end earnings. The hearing showed that this transaction did 
not qualify as a true sale under accounting rules, because 
Enron had eliminated all risk from the deal by secretly 
promising Merrill Lynch to arrange a resale of the assets 
within six months and guaranteeing a 15 percent return on the 
deal.
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    \1\ The Subcommittee has also examined the conduct of Enron's Board 
of Directors. See ``The Role of the Board of Directors in Enron's 
Collapse,'' S. Prt. 107-70 (July 8, 2002).
    \2\ See Subcommittee hearings, ``The Role of the Financial 
Institutions in Enron's Collapse'' (July 23 and 30, 2002) (hereinafter 
``July 23 hearing'' and ``July 30 hearing'').
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    On December 11, 2002, the Subcommittee held a third hearing 
examining four multi-million dollar structured finance 
transactions known as Fishtail, Bacchus, Sundance, and 
Slapshot, involving Enron, Citigroup, and Chase. These 
transactions, which took place over a six-month period 
beginning in December 2000 and ending in June 2001, are the 
focus of this report. All four transactions related to Enron's 
new business venture in pulp and paper trading. All four were 
financed primarily by the Salomon Smith Barney unit of 
Citigroup or by Chase. The evidence associated with the four 
transactions demonstrates that Citigroup and Chase actively 
aided Enron in executing them, despite knowing the transactions 
utilized deceptive accounting or tax strategies, in return for 
substantial fees or favorable consideration in other business 
dealings. The evidence also indicates that Enron would not have 
been able to complete any of these transactions without the 
direct support and participation of a major financial 
institution.
    The cumulative evidence from the three Subcommittee 
hearings demonstrates that some U.S. financial institutions 
have been designing, participating in, and profiting from 
complex financial transactions explicitly intended to help U.S. 
public companies engage in deceptive accounting or tax 
strategies. This evidence also shows that some U.S. financial 
institutions and public companies have been misusing structured 
finance vehicles, originally designed to lower financing costs 
and spread investment risk, to carry out sham transactions that 
have no legitimate business purpose and mislead investors, 
analysts, and regulators about companies' activities, tax 
obligations, and true financial condition.
    The information and analysis provided in this report are 
based upon a bipartisan investigation conducted jointly by the 
Subcommittee's Democratic and Republican staffs. Overall, the 
Subcommittee has issued more than 75 subpoenas and document 
requests to Enron, Arthur Andersen, and a host of other 
individuals, accounting firms, and financial institutions, 
resulting in over two million pages of documents. The 
Subcommittee has also conducted over 100 interviews.
    To understand the four transactions examined in this 
report, the Subcommittee staff reviewed hundreds of thousands 
of pages of documents produced by Enron, Andersen, Citigroup, 
Chase, and other parties; interviewed key personnel involved in 
the transactions; consulted key Federal agencies including the 
Securities and Exchange Commission, Federal Reserve System, 
Office of the Comptroller of the Currency, the Internal Revenue 
Service, and the Government of Canada; and consulted with a 
number of finance, accounting, and tax experts. This report 
presents the Subcommittee's findings with respect to those four 
transactions, as well as bipartisan recommendations for actions 
that can be taken to stop U.S. financial institutions from 
continuing to design or participate in illegitimate structured 
financial transactions that help U.S. companies engage in 
misleading accounting.

SUMMARY OF TRANSACTIONS

    All four of the transactions at issue in this report 
involve Enron's fledgling electronic trading business in the 
pulp and paper industry, a new business venture which Enron was 
developing with the support of Citigroup, Chase, and others. 
The assets involved in the transactions include Enron's trading 
book of derivatives and forward contracts to deliver pulp and 
paper products, electronic trading software, online trading 
operations dedicated to pulp and paper trading activity, and 
certain paper mills and timberlands in the United States and 
Canada. All four transactions reflect efforts by Enron to keep 
debt off its balance sheet or to manufacture immediate returns 
on its pulp and paper trading business and use these returns to 
report better financial results than the company actually 
produced in 2000 and 2001.
    The four transactions can be summarized as follows.
    Sham Asset Sale. The first three transactions, Fishtail, 
Bacchus, and Sundance, took place within an approximate six-
month period from December 2000 to June 2001. All three 
involved the transfer of assets at inflated values from Enron 
to special purpose entities (SPEs) or joint ventures that Enron 
orchestrated and, among other problems, established with sham 
outside investments that did not have the required independence 
or did not truly place funds at risk. Moreover, when considered 
as a whole, the three transactions resulted in a disguised, 
six-month loan advanced by Citigroup to facilitate Enron's 
deceptive accounting. In effect, Enron transferred its assets 
to a sham joint venture, Fishtail; arranged, in the Bacchus 
transaction, for a shell company to borrow $200 million from 
Citigroup to ``purchase'' Enron's Fishtail interest, without 
disclosing that Enron was guaranteeing the full purchase price; 
used the sham sale revenue to inflate its year-end 2000 
earnings by $112 million; and then quietly returned the $200 
million to Citigroup six months later via another sham joint 
venture, Sundance. The result was that the three transactions 
enabled Enron to produce misleading financial statements that 
made Enron's financial condition appear better than it was. 
Senior Citigroup officials strongly objected to Citigroup's 
participation in one of the transactions, warning: ``The GAAP 
accounting is aggressive and a franchise risk to us if there is 
publicity.'' Citigroup nevertheless proceeded and played a key 
role in advancing this transaction, which could not have been 
completed without the funding and active support of a large 
financial institution.
    Sham Loan. The final transaction, Slapshot, took place on 
June 22, 2001. It involves a sham $1 billion loan and related 
funding transfers and transactions that Chase designed and 
presented to Enron to produce up to $60 million in Canadian tax 
benefits and up to $65 million in financial statement benefits 
for Enron.
    In essence, the Slapshot transaction cloaked a legitimate 
$375 million loan to Enron issued by a consortium of banks 
inside a $1.4 billion sham loan to Enron issued by a Chase-
controlled SPE. Chase provided the extra money for the sham 
loan by approving a $1 billion ``daylight overdraft'' on a 
Chase bank account. To eliminate any risk associated with 
providing the overdraft funds to Enron, Chase required Enron to 
deposit a separate $1 billion in an escrow account at Chase 
prior to Chase's issuing the sham loan to Enron. Enron obtained 
the required escrow funds by drawing on its main corporate bank 
account at Citigroup which issued Enron a separate $1 billion 
daylight overdraft. Chase and Enron then circulated Chase's 
$1.4 billion in ``loan'' proceeds and Enron's $1 billion in 
escrow funds through a maze of U.S. and Canadian bank accounts 
held by Enron and Chase affiliates, ending the transaction when 
both Chase and Enron recovered their respective $1 billion 
overdrafts by the end of the day.
    The end result of the Slapshot transaction was that Enron 
kept the $375 million provided by the bank consortium, and 
Enron directed its Canadian affiliate to repay the $375 million 
loan. But with Chase's assistance, Enron also used the Slapshot 
transaction records to pretend that its affiliate had actually 
received the larger $1.4 billion ``loan'' and to treat its $22 
million loan repayments--each of which was actually a payment 
of principal and interest on the $375 million loan--as pure 
interest payments on the $1.4 billion ``loan.'' Canadian tax 
law, like U.S. tax law, allows companies to deduct from their 
taxable income all interest payments on a loan, but no payments 
of loan principal. By characterizing each $22 million loan 
payment as an interest payment on the $1.4 billion loan, Enron 
claimed to be entitled to deduct the entire $22 million from 
its Canadian taxes, as well as obtain related financial 
statement benefits. Five months later, however, Enron declared 
bankruptcy before all the projected benefits from Slapshot were 
realized.\3\
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    \3\ In response to Subcommittee inquiries, on the day before the 
Subcommittee hearing, Enron's legal counsel provided a letter 
forwarding information prepared by Enron on the current status of the 
Slapshot-related loans, assets and entities. Letter from Skadden, Arps, 
Slate, Meagher & Flom LLP, on behalf of Enron, to the Subcommittee (12/
10/02), included in the hearing record for December 11, 2002, as 
Hearing Exhibit 368. (All exhibits from this hearing are hereinafter 
referred to as ``Hearing Exhibit.'') Enron stated that it had taken 
``[n]o United States federal income tax deductions . . . with respect 
to the Slapshot transaction,'' and ``there were no tax-related benefits 
reported in'' Enron's SEC filings. Enron also stated that its Canadian 
affiliates had actually claimed ``gross interest [tax] deductions'' in 
Canada totaling $124.9 million, but did not anticipate claiming any 
future tax benefits related to the Slapshot transaction.
---------------------------------------------------------------------------
    Chase was paid fees and other remuneration totaling $5.6 
million for allowing Enron to use its ``proprietary'' Slapshot 
structure and for designing, coordinating, and completing the 
complex transactions involved. A written tax opinion provided 
to Enron by a Canadian law firm stated that the transaction 
``clearly involves a degree of risk,'' and advocated proceeding 
only after providing this warning: ``We would further caution 
that in our opinion, it is very likely that Revenue Canada will 
become aware of the proposed transactions . . . [and] will 
challenge them.'' Chase sold similar tax structures to other 
U.S. companies as well.
    Each of the four transactions examined in this report 
involved deceptive financial structures utilizing multiple SPEs 
or joint ventures, asset or stock transfers, and exotic forms 
of financing. All relied on a major financial institution to 
provide funding, complex funds transfers, and intricate 
structured finance deals. In the end, all four transactions 
appear to have had no business purpose other than to enable 
Enron to engage in deceptive accounting and tax strategies to 
inflate its financial results or deceptively reduce its tax 
obligations.

FISHTAIL

    The Facts. The first transaction in the four-part series, 
Fishtail, \4\ took place in December 2000. This transaction was 
the first step in a larger plan by Enron to move its pulp and 
paper trading business off its balance sheet into a separate 
joint venture, sell its ownership interests in that venture, 
and then declare the income from the sale on its 2000 financial 
statements. The first step, Fishtail, called for Enron to 
contribute its existing pulp and paper trading business--that 
is, its electronic trading software, pulp and paper online 
trading operation and personnel, and existing pulp and paper 
trading book--to a joint venture with another investor in order 
to convert the business into an equity investment and establish 
its value.
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    \4\ This report refers to transactions by the project names that 
Enron chose. In some instances, the participating financial 
institutions used different nomenclature. Fishtail, for example, was 
known internally at Chase as project ``Grinch.''
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    Enron, LJM2 Co-Investment, LP (``LJM2''), \5\ and Chase 
participated in the Fishtail joint venture which was 
established on December 19, 2000. To participate in Fishtail, 
LJM2 (acting through an affiliate LJM2-Ampato LLC) formed a new 
SPE called Annapurna LLC. Enron (acting through Enron North 
America) and Annapurna each held 50 percent of Fishtail's 
voting shares.\6\ Figure 1 illustrates the final structure of 
the Fishtail joint venture.
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    \5\ LJM2 is a Delaware limited partnership which was formed and 
managed by Enron's chief financial officer, Andrew Fastow, and which 
functioned as a private equity fund that dealt almost exclusively with 
Enron. For more information on LJM2, its dealings with Enron, and the 
conflicts of interest inherent in its relationship with Enron, see the 
Subcommittee's report, ``The Role of the Board of Directors in Enron's 
Collapse,'' S. Prt. 107-70 (July 8, 2002), at 23-35.
    \6\ See ``Fishtail LLC Formation/Securitization,'' Andersen 
memorandum by Thomas Bauer and Kate Agnew (12/29/00), Bates AASCGA 
008673.1-4, Hearing Exhibit 324. Under generally accepted accounting 
principles (GAAP), companies typically do not consolidate entities in 
which they own 50 percent or less of the total outstanding voting 
shares. Accounting Principles Board Opinion No. 18, ``The Equity Method 
of Accounting for Investments in Common Stock'' (1971). Because the two 
parties in Fishtail each owned 50 percent of the voting shares, the 
joint venture did not appear on either Enron or Annapurna's financial 
statements.
[GRAPHIC] [TIFF OMITTED] T3559.001

    Arthur Andersen was Enron's auditor and evaluated the 
Fishtail transaction to determine whether it complied with GAAP 
accounting rules. The key Andersen guidelines for capitalizing 
joint ventures stated that, in a 50-50 joint venture involving 
two parties, the ratio of investment by the two parties may not 
exceed a ratio of four to one.\7\ In other words, under the 
Andersen 4:1 rule, a 50-50 joint venture may remain 
unconsolidated only if the minority party to the joint venture 
contributes a minimum of 20 percent of the total 
capitalization. In addition, the Andersen guidelines require 
that the contribution provided by the second investor must 
include capital-at-risk equal to at least 3 percent of the 
total capitalization. This 3 percent ``equity investment'' must 
be funded at the time the joint venture is formed and remain at 
risk throughout the venture.\8\
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    \7\ See Andersen email, plus attachments, from Kate Agnew to 
Andersen employees John Stewart and others (8/21/00), Bates AASCGA 
007193.1-007195.11, Hearing Exhibit 336. Since authoritative accounting 
literature on establishing, capitalizing and consolidating joint 
ventures and distinguishing them from special purpose entities is 
limited, Andersen developed internal policies and guidelines on how to 
structure joint ventures to ensure their GAAP compliance and prevent 
abuses such as deconsolidating a joint venture that was really funded 
and controlled by a single party. The 4:1 rule, which was unique to 
Andersen, was one of its key requirements for capitalizing 50-50 joint 
ventures. The traditional approach to capitalizing 50-50 joint ventures 
is to require each investor to provide 50 percent of the total 
capitalization.
    \8\ See ``Fishtail LLC Formation/Securitization,'' Andersen 
memorandum by Thomas Bauer and Kate Agnew (12/29/00), Bates AASCGA 
008673.1-4, Hearing Exhibit 324. When analyzing the minimum substantive 
investment required for an unconsolidated joint venture like Fishtail, 
Andersen analogized to the minimum 3 percent equity at risk requirement 
already in place for SPEs. (``Specific authoritative guidance 
surrounding the necessary amount of capital-at-risk to be considered a 
substantive investment is available only in literature surrounding 
SPE's. Although [Fishtail] appears to be a business/strategic joint 
venture, and is not by definition an SPE, we believe the SPE guidance 
(EITF 90-15) establishes a good reference point as a minimum standard 
for our consideration.'')
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    Enron's capital contribution to Fishtail was its pulp and 
paper trading business. In order to place a dollar value on 
this contribution, Chase and Enron relied on a November 2000 
valuation analysis provided by Chase Securities, Inc. in 
connection with an earlier effort by Enron and a third party to 
form a joint venture that was not completed. The Chase 
Securities analysis had concluded that the pulp and paper 
trading business was worth $200 million.\9\ Chase Securities 
issued this valuation, even though the key asset at the time, 
Enron's pulp and paper trading book, was being carried on 
Enron's books at less than half that amount, approximately $85 
million.\10\ According to Enron and Chase officials interviewed 
by the Subcommittee, the remaining $115 million in value came 
from intangible or ``soft'' assets associated with the pulp and 
paper trading business.\11\ Enron's own internal accounting 
guidance, however, suggests that the most appropriate valuation 
for such intangible or soft assets may be ``zero.'' \12\ To 
justify the significant value assigned to Enron's soft assets 
in Fishtail, Enron and Chase contend that the $115 million 
figure is the product of an unbiased third-party analysis, but 
this valuation is, in fact, the product of a Chase affiliate 
supporting an Enron assessment of its own soft assets.\13\
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    \9\ See ``Enron Network Partners: Valuation Analysis of Contributed 
Assets,'' by Chase Securities, Inc. (11/20/00), Bates CITI-SPSI 
0015996-0016017.
    \10\ See ``Fishtail LLC,'' an Enron document summarizing the 
Fishtail transaction (undated), Bates ECa000015282.
    \11\ Subcommittee interview with Michael K. Patrick of Enron (11/
14/02) (hereinafter ``Patrick interview'') and Robert Traband of Chase 
(11/19/02) (hereinafter ``Traband interview''). See also ``Enron 
Network Partners: Valuation Analysis of Contributed Assets,'' by Chase 
Securities, Inc., Bates CITI-SPSI 0016012. In the section entitled, 
``Soft Assets,'' the Chase Securities analysis states: ``In addition to 
`hard dollar' assets, Enron will contribute credit support, management 
talent, a technology platform, internet experience (EOL), risk 
management, and other assets to the partnership. . . . Enron believes 
these assets add significant value to the partnership.'' EOL refers to 
Enron Online, the electronic trading system Enron used to trade energy-
related contracts and derivatives. The Chase Securities analysis of 
Enron's pulp and paper trading system apparently agreed with Enron's 
valuation of its associated ``soft assets'' as worth another $115 
million.
    \12\ See ``Accounting for Investments in Limited Partnerships and 
other Joint Ownership Entities,'' Enron accounting policy and guidance 
(6/26/01), Bates AAHEC(2) 03172.6, Hearing Exhibit 335 (``[I]n all 
cases the fair value of the contributions must be objectively 
determined and verifiable. Certain contributed intangibles may be 
difficult to objectively measure and therefore maybe [sic] deemed to be 
valued at zero for the purposes of the economic assessment. The intent 
is that the third party should not necessarily get `equity credit' for 
`soft' contributions.'' (Emphasis in original.)). Evidence indicates 
that Enron had vetted the policy statements in this memorandum with 
Andersen, and they were consistent with Enron valuation principles in 
place at the time of the Fishtail transaction.
    \13\ When Enron ``sold'' its Fishtail ownership interests one week 
later in the Bacchus transaction, Enron claimed a profit of $112 
million on the ``sale.'' This outsized profit margin raises obvious 
questions about whether Enron engineered an inflated asset valuation 
and sales price to enable it to report a large sales gain on its 2000 
financial statements. In addition, one year later, an internal, 
preliminary asset inventory compiled by Enron in anticipation of 
declaring bankruptcy estimated the total market value of its pulp and 
paper trading business as of September 30, 2001, at $50 million. 
``Enron Corporate Development Asset Inventory'' (11/25/01), Bates EC 
001521856-57, Hearing Exhibit 313. This $50 million internal valuation 
is dramatically less than the $200 million valuation Enron claimed in 
the Fishtail transaction nine months earlier, and the $228.5 million 
valuation claimed in the Sundance transaction just four months earlier. 
See ``Sundance Structure,'' Citigroup document (undated), Bates CITI-
SPSI 0044992, Hearing Exhibit 331.
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    In light of Enron's alleged $200 million contribution, 
Annapurna was required to contribute at least $50 million to 
Fishtail to meet the Andersen 4:1 guideline for capitalizing 
joint ventures. In addition, Annapurna had to contribute at 
least 3 percent of the total capitalization at the time the 
joint venture was formed and ensure it remained at risk.\14\ To 
provide the required contribution to Fishtail, Annapurna turned 
to LJM2 and Chase. For its part, LJM2 transferred $8 million in 
cash to Annapurna which, in turn, passed the funds to Fishtail. 
Chase provided Annapurna with a $42 million ``commitment,'' set 
out in a letter of credit, to fund Annapurna if called upon to 
do so. Annapurna then passed on this funding commitment to 
Fishtail. The parties referred to Chase's commitment as an 
``unfunded capital'' investment.\15\ One Enron employee 
referred to this novel approach of capitalizing a joint venture 
with an ``unfunded capital'' commitment as a ``new accounting 
technology'' developed by Enron.\16\
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    \14\ See ``Fishtail LLC Formation/Securitization,'' Andersen 
memorandum by Thomas Bauer and Kate Agnew (12/29/00), Bates AASCGA 
008673.1-4, Hearing Exhibit 324. In addition to the joint venture 
capitalization rules, under applicable accounting rules for SPEs, 
Annapurna qualified as an independent entity, unconsolidated with any 
party, only if, among other requirements, at least 3 percent of its 
capital came from an independent equity investor and remained genuinely 
at risk. See In Re The PNC Financial Services Group, Inc., SEC 
Administrative Proceedings File No. 3-10838 (Order Making Findings and 
Imposing Cease and Desist Order, 7/18/02); EITF Abstracts, Topic D-14, 
``Transactions Involving Special Purpose Entities''; EITF Issue No. 90-
15, ``Impact of Nonsubstantive Lessors, Residual Value Guarantees, and 
Other Provisions in Leasing Transactions,'' Response to Question No. 3.
    \15\ Email by Enron employee Michael Patrick to Wes Colwell, (1/4/
01), Enron disk produced to the Subcommittee.
    \16\ Id. Several finance and accounting experts told the 
Subcommittee staff they had never heard of an ``unfunded capital'' 
commitment being used to capitalize a joint venture and expressed 
skepticism over whether it qualified under current accounting rules as 
a valid joint venture contribution. One expert also said that the 
arrangement cast doubt on the arms-length nature of the transaction, 
since it permitted one of the two parties to the joint venture to defer 
any actual investment in the venture until a later time.
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    According to the same Enron employee, the Fishtail 
transaction was ``primarily accounting driven and the structure 
was heavily negotiated with Arthur Andersen.'' \17\ Andersen 
apparently approved ``the unfunded nature of the commitment'' 
made by Chase only after a clause was added to the joint 
venture agreement giving Fishtail unilateral power to draw down 
the Annapurna-Chase commitment in certain circumstances.\18\ 
Another aspect of the agreement, however, specified that the 
first $200 million dollars of any loss experienced by Fishtail 
would be allocated to Enron, thereby making it highly unlikely 
that the Chase commitment would ever actually be drawn.\19\ 
Andersen nevertheless approved the transaction.
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    \17\ Id. Mr. Patrick reaffirmed this information in his 
Subcommittee interview. The key Andersen employee involved in the 
Fishtail and Sundance transactions, Thomas Bauer, refused to be 
interviewed by the Subcommittee prior to the hearing to explain either 
his role or Andersen's understanding of the two transactions. His legal 
counsel has since indicated, however, that Mr. Bauer has decided to 
cooperate and submit to a Subcommittee interview in the near future.
    \18\ ``Amended and Restated Limited Liability Company Agreement of 
Fishtail LLC'' (12/19/00), Clause 4.02, Bates SENATE ANNA 00081. See 
also ``Fishtail LLC Formation/Securitization,'' Andersen memorandum by 
Tom Bauer and Kate Agnew (12/29/00), Bates AASCGA 008673.1, Hearing 
Exhibit 324 (``Our preference would be to have the amount computed 
pursuant to the 4 to 1 test to be fully funded upon formation but would 
not insist since the 4 to 1 test is not mandatory in the 
literature.''). Mr. Patrick substantiated this account in his 
Subcommittee interview.
    \19\ ``Amended and Restated Limited Liability Company Agreement of 
Fishtail LLC'' (12/19/00), Clause 4.02, Bates SENATE ANNA 00081. See 
also ``Project Grinch,'' summary memorandum by Chase (12/16/00), Bates 
SENATE ANNA 00397-99, Hearing Exhibit 312 (The first paragraph of this 
memorandum states in bold type: ``It is expected that the commitment 
will be unfunded.'').
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    Chase was paid $500,000 in fees for participating in the 
Fishtail transaction.\20\ Its $42 million unfunded commitment 
to the joint venture was never used, and Chase never actually 
contributed any funds to Fishtail. LJM2 was paid an up-front 
fee of $350,000 for participating in Fishtail. Approximately 
six months later, LJM2 was paid $8.5 million to ``sell'' its 
Annapurna ownership interest to Sundance. This payment meant 
that LJM2 not only recouped its initial capital investment of 
$8 million, but also, when combined with its earlier $350,000 
fee, earned an overall 15 percent return on its Fishtail 
investment.\21\
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    \20\ See Chase Securities letter to Enron (12/20/00), Bates SENATE 
ANNA 00360-61, Hearing Exhibit 315. This information was also confirmed 
in the Traband interview and Subcommittee interview with Eric Peiffer 
(12/4/02) (hereinafter ``Peiffer interview'').
    \21\ LJM2 documents show that LJM2 had expected to receive a 15 
percent return on its Annapurna investment and to be taken out of the 
Fishtail transaction within six months. See, for example, ``LJM2 
Investment Summary'' (12/20/00), Bates LJM 029881-4, Hearing Exhibit 
306. While one Enron employee maintained in a Subcommittee interview 
that the 15 percent return was the maximum that LJM2 was entitled to 
receive on the joint venture, and not a guaranteed minimum return, the 
LJM2 documentation and similar minimum fee arrangements between Enron 
and LJM2 in other investments, suggest the final amount paid to LJM2 
was more than coincidence. See, for example, 15 percent fee arrangement 
in the Nigerian barge transaction examined at the Subcommittee's July 
30 hearing; Patrick interview.
---------------------------------------------------------------------------
    Analysis. The Fishtail transaction was, at its core, a sham 
joint venture which pretended to have more than one investor, 
but, in fact, relied solely on Enron. The primary goal of the 
transaction was to create an appearance of Enron's moving its 
pulp and paper trading business from an in-house operation to a 
separate joint venture so that Enron could eliminate the assets 
from its balance sheet. A secondary goal was to fix a market 
value to the transferred assets in preparation for their 
``sale'' a week later.
    The evidence shows that Fishtail did not qualify for off-
balance sheet treatment and should have been consolidated with 
Enron. Enron's counter party in the joint venture, Annapurna, 
functioned as a shell operation designed to create the 
appearance but not the reality of a second investor. Annapurna 
had no employees, no bank account, and no purpose or activities 
apart from its passive investment in Fishtail.
    Annapurna was allegedly capitalized by LJM2 and Chase. But 
LJM2's related party status, due to its close Enron ties and 
the ownership and control exercised by Enron's chief financial 
officer, Andrew Fastow, \22\ disqualified LJM2 from providing 
the ``independent'' equity investment necessary to an 
unconsolidated SPE or joint venture.\23\ In addition, Mr. 
Fastow's pending criminal indictment alleges that Enron, on 
more than one occasion, used LJM2 ``to manufacture earnings 
through sham transactions'' and that Enron had an ``undisclosed 
agreement'' with Mr. Fastow to ensure that LJM2 did ``not lose 
money in its dealings with Enron.'' \24\ This undisclosed 
agreement, if it existed, meant that LJM2's investment in 
Annapurna was never truly at risk since, in essence, Enron had 
guaranteed it would not suffer any loss from an Enron venture. 
Chase's $42 million commitment also failed to place any funds 
at risk, since it was never funded or drawn upon and functioned 
under arrangements which made its use highly unlikely. As one 
finance expert put it, ``Chase never really had any skin in the 
game.''
---------------------------------------------------------------------------
    \22\ See Subcommittee report, ``The Role of the Board of Directors 
in Enron's Collapse,'' S. Prt. 107-70 (July 8, 2002), at 23-35.
    \23\ See EITF Abstracts, Topic D-14, ``Transactions Involving 
Special Purpose Entities.''
    \24\ United States v. Fastow, (USDC SDTX, Cr. No. H-02-0665), 
Indictment (10/31/02) at paragraphs 19 and 22.
---------------------------------------------------------------------------
    If Chase's unfunded commitment were disregarded, then 
Annapurna's capitalization and contribution to Fishtail totals 
$8 million in cash, well short of the Andersen 4:1 
capitalization guidelines for unconsolidated joint ventures. In 
addition, if the $8 million was neither independent nor at risk 
due to LJM2's related party status and undisclosed agreement 
with Enron, Annapurna collapses as a SPE, and Fishtail fails to 
meet its requirement for a minimum 3 percent at-risk 
investment. In either situation, Fishtail should have been 
consolidated with Enron.
    Additional issues are raised by the $200 million valuation 
placed on Enron's pulp and paper trading business when it was 
contributed to Fishtail. This $200 million figure was more than 
double the market value of the one ``hard asset'' carried on 
Enron's own books, the remaining assets were ``soft assets'' 
that Enron itself was cautious about using to establish the 
value of a joint venture contribution, and the only 
``independent'' asset valuation was performed by a Chase 
affiliate.
    By participating in Fishtail, Chase helped Enron move its 
pulp and paper trading business off-balance sheet and establish 
a generous market value for the transferred assets. Chase never 
actually invested any funds in Fishtail or took any active role 
in the business, yet was paid half a million dollars for 
pretending to provide the bulk of financing for this so-called 
joint venture.

BACCHUS

    The Facts. The second transaction, Bacchus, took place one 
week after Fishtail, on or about December 26, 2000. Enron used 
the Bacchus transaction to declare that a $200 million asset 
``sale'' had taken place and record a $112 million ``gain'' on 
its 2000 financial statements.
    Enron's primary goal in Bacchus was to ``monetize'' its 
interest in its pulp and paper trading business so that it 
could record additional income and cash flow from the ``sale'' 
of this business venture on its financial statements.\25\ The 
Fishtail transaction took the first step by purporting to move 
Enron's pulp and paper trading business to a separate joint 
venture off Enron's books. Once Fishtail was complete, Enron 
took the next step, in Bacchus, to ``sell'' its Fishtail 
investment to an allegedly independent third party so that it 
could record the cash flow and income on its books.
---------------------------------------------------------------------------
    \25\ See ``Transaction Descriptions,'' Enron document (undated), 
Bates EC2 000009786-87, Hearing Exhibit 317; Patrick interview; 
``Fishtail LLC Formation/Securitization,'' Andersen memorandum by 
Thomas Bauer and Kate Agnew (12/29/00), Bates AASCGA 008673.1-4, 
Hearing Exhibit 324.
---------------------------------------------------------------------------
    Enron reasoned that its ownership interests in Fishtail 
\26\ qualified as a ``financial asset'' that could be sold and 
accounted for under Statement of Financial Accounting Standards 
(SFAS) 140.\27\ SFAS 140 has typically been applied to the sale 
of financial assets such as pools of mortgages or receivables 
that have been securitized and transferred to an SPE.\28\ To 
avoid consolidation, the SPE purchasing the financial assets 
must have a minimum outside equity investment which represents 
at least 3 percent of the SPE's total capital and which must 
remain genuinely at risk.\29\
---------------------------------------------------------------------------
    \26\ Enron and LJM2 had agreed on three classes of ownership 
interests in the Fishtail joint venture. Class A interests, owned by 
Enron, conveyed the right to exercise management control over the joint 
venture and the right to 0.1 percent of the ``economic interests'' in 
Fishtail. Class B interests, owned by Annapurna, conveyed the right to 
20 percent of the ``economic interests'' in Fishtail. Class C 
interests, owned by Enron, conveyed the right to 79.9 percent of the 
``economic interests'' in Fishtail. See ``Fishtail,'' a summary of the 
Fishtail transaction by Deloitte & Touche, LLP, executed in conjunction 
with the Powers Report, Bates DT 000376-000403, Hearing Exhibit 305. 
Presumably, by ``economic interests'' the parties meant the profits or 
losses sustained by the joint venture.
    \27\ SFAS 140, ``Accounting for Transfers and Servicing of 
Financial Assets and Extinguishment of Liabilities,'' is a statement of 
accounting standards issued by the Financial Accounting Standards Board 
(FASB), an organization designated by the Securities and Exchange 
Commission (SEC) to develop, promulgate, and interpret generally 
accepted accounting principles for U.S. business. SFAS 140 superceded 
and replaced SFAS 125. Enron's reliance on SFAS 140 in this transaction 
is documented, for example, in a Citigroup draft analysis of the 
transaction, ``Capital Markets Approval Committee: Enron Corp. Project 
Bacchus FAS 125 Transaction'' (12/1/00), Bates CITI-SPSI 012895. Enron 
engaged in numerous transactions under SFAS 140 and its predecessor 
SFAS 125, collectively involving more than $1 billion. See ``Finance 
Related Asset Sales: Prepays and 125 Sales'' (presentation to the 
Finance Committee of the Enron Board of Directors, August 2001), 
Exhibit 42 in the Subcommittee hearing, ``The Role of the Board of 
Directors in Enron's Collapse'' (May 7, 2002). See also ``First Interim 
Report of Neal Batson, Court-Appointed Examiner,'' In Re Enron Corp., 
Case No. 01-16034(AJG) (Bankr. SDNY, 9/21/02).
    \28\ Unlike other asset sales, SFAS 140 has been interpreted to 
allow the seller of the financial asset to retain a significant degree 
of control over the asset, even after its securitization and transfer 
to the SPE. For example, a financing company that routinely issues and 
acquires car loans may continue to manage and collect payments on these 
car loans even after pooling them and selling the rights to the cash 
flow to an SPE in an SFAS 140 transaction. Enron analogized that, in an 
SFAS 140 transaction, it could sell its Fishtail interests to an SPE, 
while continuing to exercise control over its pulp and paper trading 
business even after the sale.
    \29\ See footnote 14. FASB is currently in the process of revising 
certain SPE accounting standards and, among other changes, may increase 
the required minimum outside equity for an unconsolidated SPE from 3 to 
10 percent. See FASB Exposure Draft, ``Consolidation of Certain 
Special-Purpose Entities'' (June 28, 2002).
---------------------------------------------------------------------------
    Within one week of forming Fishtail, Enron ``sold'' its 
Class C ownership interest in Fishtail for $200 million to an 
SPE it had formed called the Caymus Trust. This transaction, 
which Enron called Bacchus, is illustrated in the following 
Figure 2.
[GRAPHIC] [TIFF OMITTED] T3559.002

    The Caymus Trust was established by Enron as a Delaware 
business trust.\30\ The Caymus Trust was capitalized with a 
$194 million loan from Citigroup and a $6 million equity 
``investment'' from FleetBoston Financial provided through an 
off-balance sheet entity it had established called Long Lane 
Master Trust IV.\31\ The $194 million represented 97 percent of 
the Trust's total capitalization, while the $6 million 
represented the required minimum 3 percent outside equity 
investment. Although FleetBoston appeared to carry the risk 
associated with the $6 million equity investment, in fact, the 
risk had been conveyed to Citigroup through a total return 
swap.\32\ This arrangement meant that Citigroup was responsible 
not only for the $194 million loan it had issued to the Caymus 
Trust, but also for the $6 million cash investment ostensibly 
made by FleetBoston.\33\
---------------------------------------------------------------------------
    \30\ See ``Data Sheet Reprint . . . Caymus Trust (c/o Wilmington 
Trust)'' (2/22/02), Bates ECa 000009793.
    \31\ Citigroup and FleetBoston worked together on at least one 
other set of Enron transactions, the Yosemite prepays, which also made 
use of Long Lane Master Trust IV. For more information, see the July 23 
hearing, ``Testimony of Robert Roach, Chief Investigator, Permanent 
Subcommittee on Investigations,'' Appendix D, at pages D-10 and D-11.
    \32\ Email by Citigroup employee James Reilly (11/28/00), Bates 
CITI-SPSI 0118432, Hearing Exhibit 322c; Subcommittee interview with 
Citigroup employees Richard Caplan (11/21/02) and William Fox (11/22/
02). A total return swap is a derivative transaction in which one party 
conveys to the other party all of the risks and rewards of owning an 
asset without transferring actual legal ownership of that asset.
    \33\ According to explanations provided by Citigroup employees 
during their Subcommittee interviews, Citigroup used FleetBoston in the 
Bacchus transaction because its initial analysis led it to believe that 
owning both the debt and equity in Caymust Trust would raise regulatory 
issues. By the time Citigroup realized that these issues would not 
arise, the transaction was nearly completed and Citigroup decided not 
to change the structure.
---------------------------------------------------------------------------
    Enron, in turn, reduced Citigroup's risk in the Bacchus 
transaction by entering into a total return swap with Citigroup 
to provide credit support for the $194 million loan.\34\ Under 
this total return swap, Enron effectively pledged to make 
Citigroup whole for any decline in value of the Fishtail assets 
should those assets be needed to repay the loan.\35\ In effect, 
Enron had guaranteed the $194 million loan.\36\ In an 
interview, Enron personnel explained to the Subcommittee that 
Andersen had approved its interpreting SFAS 140 as allowing 
Enron to guarantee the debt financing associated with the 
Caymus Trust.\37\ Andersen instructed that similar credit 
support could not be provided by Enron for the $6 million 
outside equity investment, \38\ essentially because that 
support would mean that Enron would, in effect, be guaranteeing 
the entire purchase price, the purchaser of the assets would 
assume no risk from participating in the transaction, and the 
asset transfer would, therefore, no longer qualify as a 
``sale'' under SFAS 140.
---------------------------------------------------------------------------
    \34\ See ``Project Bacchus,'' diagram of Bacchus transaction 
(undated), Bates ECa 000196027, Hearing Exhibit 316; ``Global Loans 
Approval Memorandum,'' (12/11/00), Bates CITI-SPSI 0015991-95, Hearing 
Exhibit 318.
    \35\ Conversely, the total return swap also entitled Enron, in 
effect, to retain any increase in value of the Fishtail assets, should 
that occur.
    \36\ By using a total return swap instead of a loan guarantee, 
Enron avoided having to disclose the guarantee in its financial 
statement footnotes.
    \37\ Patrick interview.
    \38\ See series of Andersen emails, (11/30/99), Bates AASCGA 
001133.1-3, Hearing Exhibit 325.
---------------------------------------------------------------------------
    Although Enron was barred by accounting standards from 
doing so, the Subcommittee uncovered documentary evidence 
indicating that Enron had also guaranteed the $6 million equity 
``investment'' in the Caymus Trust. Enron provided this 
guarantee by making an undisclosed oral agreement with 
Citigroup to ensure repayment of the $6 million. The key 
internal Citigroup memorandum seeking final approval of the 
Bacchus transaction from the Citigroup Credit Committee makes 
multiple references to the existence of this oral 
agreement.\39\ The memorandum describes the Bacchus credit 
``facility'' being requested as consisting of two parts: a 
``loan'' and an ``equity'' contribution. The memorandum states: 
``The equity component we provide will be based on verbal 
support as committed by Andrew S. Fastow . . . to Bill Fox [of 
Citigroup].'' It also states that the ``equity portion of the 
facility'' involves ``a large element of trust and relationship 
rationale'' but ``this equity risk is largely mitigated by 
verbal support received from Enron Corp. as per its CFO, Andrew 
S. Fastow.'' At another point, the memorandum states: ``Enron 
Corp. will essentially support the entire facility, whether 
through a guaranty or verbal support.'' \40\
---------------------------------------------------------------------------
    \39\ ``Global Loans Approval Memorandum,'' (12/11/00), Bates CITI-
SPSI 0015991-95, Hearing Exhibit 318.
    \40\ See also ``Executive Summary'' of certain Citigroup 
transactions with Enron (undated), Bates CITI-SPSI 0128937, Hearing 
Exhibit 320 (``Bacchus/Caymus Trust Facility--Citibank has been asked 
to approve and hold this $250MM facility consisting of Notes and 
Certificates. . . . The Notes ($242.5MM) will be supported by a total 
return swap with Enron Corp as the credit risk. The Certificates are 
supported by verbal support obtained by Bill Fox from Andy Fastow, 
Enron Corp's Chief Financial Officer.'')
---------------------------------------------------------------------------
    During an interview with Subcommittee staff, one senior 
Citigroup official who played a key role in securing final 
approval of the deal denied that Enron had verbally guaranteed 
the equity ``investment.'' \41\ Yet he confirmed that, prior to 
the closing of the deal, he traveled to Enron in Houston and 
met with Mr. Fastow to obtain Enron's ``verbal support'' for 
the equity investment. He also told the Subcommittee that Mr. 
Fastow assured him that Enron would take ``whatever steps 
necessary'' to ensure Citigroup would not suffer any loss 
related to the $6 million.\42\ Later, the same senior official 
sent an email to Citigroup's risk management team stating that 
Citigroup had obtained a ``total return swap from Enron'' for 
the debt financing and ``verbal support for the balance,'' 
meaning the $6 million.'' \43\
---------------------------------------------------------------------------
    \41\ Fox interview.
    \42\ Id. At the December 11 hearing, Mr. Fox testified that Mr. 
Fastow promised to take ``all steps necessary'' to protect Citigroup 
from any loss related to the $6 million.
    \43\ Email from Mr. Fox to Citigroup employee Thomas Stott (4/18/
01), Bates CITI-SPSI 0085843, Hearing Exhibit 319. Still another 
Citigroup email, written two days after the Bacchus deal closed, 
stated: ``The equity component has been approved on the basis of verbal 
support verified by Enron CFO, Andy Fastow.'' Email from Citigroup 
employee Lydia Junek to Mr. Fox (12/21/00), Bates CITI-SPSI 0128944-45, 
Hearing Exhibit 322h.
---------------------------------------------------------------------------
    In addition, a key Citigroup document seeking approval of 
multiple new credit facilities for Enron explicitly stated at 
the time that, with respect to the Bacchus transaction, 
Citigroup had obtained ``verbal guarantees'' from Enron for the 
equity ``investment'' in the Caymus Trust.\44\ This document, a 
Citigroup credit approval report signed by senior Citigroup 
employees, listed 14 ``credit facilities'' Citigroup was 
considering establishing for the benefit of Enron. Two 
identified the Caymus Trust as the ``borrower.'' One of these 
two described a proposed $7.5 million ``facility'' (later 
reduced to $6 million) for the Caymus Trust, which represented 
the required 3 percent outside equity ``investment'' in that 
entity.\45\ The credit approval report states that Citigroup 
had obtained the following ``Support'' for this equity 
component:
---------------------------------------------------------------------------
    \44\ Citibank Credit Approval (12/8/00), Bates CITI-SPSI 0128921, 
Hearing Exhibit 320.
    \45\ At the time the credit approval report was completed in early 
December 2000, Enron and Citigroup expected the total purchase price in 
the Bacchus transaction would be $250 million, instead of the $200 
million amount ultimately decided upon; the credit approval report 
reflected the initial, larger total. See email from Citigroup employee 
Steve Baillie to other Citigroup employees (11/24/00), Bates CITI-SPSI 
0119040, Hearing Exhibit 322a.

---------------------------------------------------------------------------
      ``Type: VERBAL GUARANTEES Percentage: 100.00''

The report lists the ``Support Provider'' as ``Enron Corp.'' 
\46\
---------------------------------------------------------------------------
    \46\ Citibank Credit Approval (12/8/00), Bates CITI-SPSI 0128921, 
Hearing Exhibit 320.

    Together, the evidence establishes that Enron guaranteed 
100 percent of the debt and equity ``investment'' in the Caymus 
Trust, and both Enron and Citigroup knew it. Enron's 100 
percent guarantee of the Caymus Trust investments meant that 
the Caymus Trust had incurred no risk in transferring the $200 
million to Enron to ``purchase'' the Fishtail assets, because 
Enron itself had guaranteed repayment of the full amount. The 
absence of risk meant the asset transfer did not qualify as a 
``sale'' under SFAS 140, and Enron should not have booked 
either cash flow from operations or a reportable gain from this 
transaction. Instead, Enron should have treated the $200 
million as a loan from Citigroup and booked the funds as debt 
and cash flow from financing.
    Nevertheless, immediately upon completing the December 
``sale'' of its Class C Fishtail interests to the Caymus Trust, 
Enron declared an additional $200 million in cash flow from 
operations as well as a $112 million gain in income on its 
year-end 2000 financial statements.\47\
---------------------------------------------------------------------------
    \47\ See Enron's 10-K SEC filing for 2000. Enron apparently 
calculated the $112 million gain by subtracting $88 million from the 
$200 million ``sale'' price. This $88 million was apparently the 
``basis'' Enron claimed for its Class C ownership interest in Fishtail. 
See ``3% Test and Gain Calculation,'' Andersen document (11/17/01), 
Bates AASCGA 002454.6, Hearing Exhibit 321. See also footnote 11.
---------------------------------------------------------------------------
    Citigroup internal documentation shows that Citigroup 
participated in the Bacchus transaction in part as an 
accommodation to Enron. One email from November 2000 describes 
the Bacchus transaction as follows: ``For Enron, this 
transaction is `mission critical' (their label not mine) for 
[year-end] and a `must' for us.'' \48\ Another email dated a 
week after the deal closed states with respect to Bacchus: 
``Sounds like we made a lot of exceptions to our standard 
policies, I am sure we have gone out of our way to let them 
know that we are bending over backwards for them. . . let's 
remember to collect this iou when it really counts.'' \49\ 
Another document advocating participating in several Enron 
transactions states: ``Given the breadth of our relationship 
with the company we have been told by Enron that it is 
important that we participate in these strategic initiatives,'' 
including Bacchus.\50\ Another email a few months later 
discussing Bacchus and other pending deals observes: ``Enron 
generates substantial GCIB revenue ($50mm in 2000); any 
decision to limit/reduce credit availability will significantly 
reduce revenues going forward both at Cit and SSB and 
permanently impair the relationship.'' \51\
---------------------------------------------------------------------------
    \48\ Email from Citigroup employee James Reilly to other Citigroup 
employees (11/28/00), Bates CITI-SPSI 0129017.
    \49\ Email from Citigroup employee Steve Wagman to Citigroup 
employee Amanda Angelini, with copies to Mr. Caplan and others (12/27/
00), Bates CITI-SPSI 0119009, Hearing Exhibit 322i.
    \50\ ``Executive Summary,'' Citigroup document (undated), Bates 
CITI-SPSI 0128937, Hearing Exhibit 320.
    \51\ Email from Mr. Fox to Citigroup employee Thomas Stott (4/18/
01), Bates CITI-SPSI 0085843, Hearing Exhibit 319. GCIB refers to 
Global Corporate & Investment Bank. Cit refers to Citigroup. SSB refers 
to Salomon Smith Barney.
---------------------------------------------------------------------------
    The evidence also indicates that, early on, Citigroup 
became aware that Enron might use the Bacchus transaction to 
improve its financial statements. Emails over time show 
Citigroup personnel were aware, for example, that Enron might 
use Bacchus to reduce debt and generate cash flow from 
operations on its financial statements, but Citigroup asserts 
its personnel were unaware that Bacchus would generate material 
earnings for Enron. One Citigroup email in November 2000, 
states that ``Enron's motivation'' in Bacchus ``now appears to 
be writing up the asset in question from a [cost] basis of 
about $100 [million] to as high as $250 [million], thereby 
creating earnings.'' \52\ This email also states a ``concern'' 
about ``appropriateness since there is now an earnings 
dimension to this deal, which was not there before.''
---------------------------------------------------------------------------
    \52\ Email from Citigroup employee Steve Baillie to Mr. Fox (11/24/
00), Bates CITI-SPSI 0119040, Hearing Exhibit 322a.
---------------------------------------------------------------------------
    Another Citigroup email a month later states that the 
Bacchus transaction was ``designed'' in part to ``ensure that 
Enron will meet its [year-end] debt/cap[iptalization] 
targets''; it was ``probable'' the transaction would ``add to 
[funds flow from operations]'' on Enron's financial statements; 
and ``possible, but not certain, that there will be an earnings 
impact.'' \53\ An email two days later calculates that the $200 
million would represent more than ten percent of the cash flow 
and net income Enron had reported in 1999 and was likely to 
report in 2000.\54\ An email in response states: ``Based on 
1999 numbers would appear that Enron significantly dresses up 
its balance sheet for year end; suspect we can expect the same 
this year.'' \55\ While two of the December emails predict any 
earnings from the Bacchus transaction were likely to be 
immaterial, Citigroup personnel agreed in Subcommittee 
interviews that the $112 million in extra earnings finally 
reported was material even to a company as large as Enron.\56\ 
Citigroup denied knowing at the time, however, that Enron had 
actually recorded these additional earnings in its 2000 
financial statements.
---------------------------------------------------------------------------
    \53\ Email from Citigroup employee James Reilly to Mr. Caplan, Mr. 
Fox, and others (12/6/00), Bates CITI-SPSI 0119046, Hearing Exhibit 
322d.
    \54\ Email from Citigroup employee Shirley Elliott to Mr. Fox (12/
13/00), Bates CITI-SPSI 011906, Hearing Exhibit 322f (``In terms of 
total balance sheet size, it appears that Bacchus is immaterial; 
however, the $200 million represents 16.3% and 22.4% of operating cash 
flow and net income, respectively [for 1999, and] . . . 11.6% of cash 
EBITDA . . . [for 2000].'') This analysis assumes a zero basis.
    \55\ Email from Mr. Fox to Shirley Elliott (12/13/00), Bates CITI-
SPSI 0128912, Hearing Exhibit 322g.
    \56\ Caplan interview; Fox interview.
---------------------------------------------------------------------------
    In interviews with the Subcommittee staff, Citigroup 
executives involved in the Bacchus transaction stated that when 
a structured finance transaction has features suggesting that a 
client might be using the transaction to manufacture earnings 
on its financial statements, it creates an ``appropriateness 
issue'' which generally requires a greater degree of review and 
due diligence within the investment bank.\57\ When asked 
whether the necessary appropriateness review took place in 
Bacchus, one Citigroup official stated that ``further 
investigation'' was warranted since the emails indicated that 
Citigroup had not clarified whether Enron was, in fact, going 
to claim earnings from the transaction and, if so, how much. He 
also indicated that he was unaware of any additional action 
taken to examine the earnings or other financial statement 
implications of the transaction. The Subcommittee has not 
found, and Citigroup has not provided, any evidence 
establishing that Citigroup undertook any additional 
appropriateness review to gauge Enron's potential use of 
Bacchus to generate earnings.
---------------------------------------------------------------------------
    \57\ Id. These Citigroup executives also indicated that Citigroup 
typically does not get involved in structured transactions that have an 
earnings impact, with the exception of transactions generating tax 
benefits.
---------------------------------------------------------------------------
    In fact, the Bacchus figures significantly improved Enron's 
2000 financial statements. The $112 million gain represented 
more than 11 percent of Enron's total net income for the fiscal 
year, while the $200 million in cash flow represented about 6 
percent of Enron's total cash flow from operations for the 
year.\58\ These figures suggest that, had the Fishtail and 
Bacchus transactions failed to close, Enron would likely have 
failed to meet Wall Street's earnings projections for the year, 
and the company's share price would have suffered.
---------------------------------------------------------------------------
    \58\ According to its 10-K filing with the SEC, Enron's total net 
income for 2000 was $979 million. Using this filing and other 
information, the Subcommittee estimated Enron's total funds flow from 
operations in 2000 at about $3.248 billion. See July 23 hearing, 
``Testimony of Robert Roach, Chief Investigator, Permanent Subcommittee 
on Investigations,'' Appendix A, at page A-4.
---------------------------------------------------------------------------
    Citigroup was paid a $500,000 fee for its participation in 
Bacchus, earned about $5 million in interest payments related 
to the $200 million debt, and obtained another $450,000 yield 
related to the $6 million ``equity investment.'' \59\
---------------------------------------------------------------------------
    \59\ ``Global Loans Approval Memorandum,'' (12/11/00), Bates CITI-
SPSI 0015991-95, Hearing Exhibit 318; information supplied by Citigroup 
to the Subcommittee.
---------------------------------------------------------------------------
    Analysis. Even more than Fishtail, the Bacchus transaction 
was steeped in deceptive accounting, if not outright accounting 
fraud. The evidence shows that Enron guaranteed both the debt 
and equity ``investment'' in the Caymus Trust, thereby 
eliminating all risk associated with the ``sale'' of the 
Fishtail assets to the Trust. Without risk, the transaction 
fails to qualify as a sale under SFAS 140. The fact that 
Enron's guarantee of the $6 million equity ``investment'' was 
never placed in writing, but was kept as an oral side agreement 
with Citigroup, demonstrates that both parties understood its 
significance and potential for invalidating the entire 
transaction. Citigroup nevertheless proceeded with the deal, 
knowing that a key component, Enron's guarantee of the $6 
million, rested on an unwritten and undisclosed oral agreement.
    Citigroup was also aware that Enron was likely to use the 
Bacchus transaction to improve its financial statements through 
added cash flow and perhaps added earnings, but did not 
sufficiently confront this issue either internally or by asking 
Enron for more information. In the end, Citigroup not only 
participated in the Bacchus deal, it supplied the funds needed 
for Enron to book the $200 million in extra cash flow from 
operations and $112 million in extra net income on its 2000 
financial statements. Without Citigroup's complicity and 
financial resources, Enron would not have been able to complete 
the deal and manipulate its financial statements to meet Wall 
Street expectations for its 2000 earnings.

SUNDANCE

    The Facts. The third transaction, Sundance, took place six 
months after Bacchus. Fishtail and Bacchus had been constructed 
as short term arrangements \60\ intended to enable Enron to 
move its pulp and paper trading business off-balance sheet and 
recognize income and cash flow from this business venture prior 
to the end of the fiscal year. Sundance Industrial Partners 
(``Sundance'') was allegedly established to create a more long-
term off-balance sheet entity which Enron could use to hold and 
manage all of its pulp and paper business assets. Like 
Fishtail, however, Sundance provided the appearance but not the 
reality of having more than one investor, and should have been 
consolidated on Enron's balance sheet.
---------------------------------------------------------------------------
    \60\ The $194 million loan in Bacchus, for example, had a one-year 
maturity date. See ``Global Loans Approval Memorandum,'' (12/11/00), 
Bates CITI-SPSI 0015991-95, Hearing Exhibit 318. LJM2's investment in 
Fishtail was intended to end after six months or trigger higher costs. 
``LJM2 Investment Summary'' (12/20/00), Bates LJM 029881-4, Hearing 
Exhibit 306.
---------------------------------------------------------------------------
    Sundance was constructed as a 50-50 joint venture between 
Enron and Citigroup, to be capitalized at a 4:1 ratio in 
accordance with Anderson's joint venture guidelines. Figure 3 
is a diagram of the Sundance structure.
[GRAPHIC] [TIFF OMITTED] T3559.003

    Enron contributed the following assets to the Sundance 
joint venture: a Canadian paper mill known as Stadacona; a New 
Jersey paper mill known as Garden State Paper; timberland 
located in Maine and known as SATCO; a $25 million liquidity 
reserve for ongoing administrative expenses; a $65 million 
commitment to service debt and capital expenditures; and $208 
million in cash.\61\ The total value of Enron's contribution 
was approximately $750 million.
---------------------------------------------------------------------------
    \61\ See ``Sundance Steps'' (6/1/01), Bates CITI-SPSI 0128886.
---------------------------------------------------------------------------
    Citigroup, in turn, appeared to contribute $8.5 million in 
cash, \62\ certain shares valued at $20 million, \63\ and $160 
million in an ``unfunded capital commitment.'' Citigroup, thus, 
appeared to contribute assets totaling approximately $188.5 
million to meet the Andersen joint venture capitalization 
guidelines.\64\
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    \62\ The $8.5 million was immediately used by Sundance to purchase 
Annapurna's Class B 20-percent economic interest in Fishtail. All of 
these monies were apparently paid to LJM2, enabling LJM2 to recoup its 
$8 million capital contribution to Annapurna and, when combined with an 
earlier $350,000 fee, earn an overall return of 15 percent on its 
Fishtail investment. See ``Sundance Steps,'' Enron document (5/16/01), 
Bates ECa 000022315, Hearing Exhibit 328a; ``Structuring Summary: 
Project Grinch,'' Chase document (12/16/00), Bates JPM-1-00437, Hearing 
Exhibit 311.
    \63\ The shares conveyed ownership of an SPE called Sonoma, LLC 
whose sole asset consisted of Enron's Class A interest in Fishtail, 
which Enron had retained during the Bacchus transaction. The Class A 
interest essentially conveyed management control over Enron's pulp and 
paper trading business. Just prior to contributing the shares to 
Sundance, Citigroup purchased them from Enron for $20 million. Enron 
immediately reported the $20 million in ``sales'' revenue on its second 
quarter 2001 financial statements. The evidence suggests that the $20 
million transaction was executed solely to allow Enron to book the 
additional $20 million. Initially, Enron's outside counsel, Vinson and 
Elkins, had declined to issue a legal opinion characterizing the Sonoma 
stock transfer to Citigroup as a ``true sale,'' since Citigroup had 
avoided all risk associated with the shares by immediately contributing 
them to Sundance. To satisfy Vinson and Elkins, Citigroup entered into 
a derivative transaction with Sundance which, in part, allowed Sundance 
to sell the shares back to Citigroup within a certain period of time. 
After this derivative was put in place, Vinson and Elkins issued a 
``last minute true sale opinion'' allowing Enron to book the sale. See 
``Enron Industrial Markets Finance Presentation of Sundance Industrial 
Partners,'' Enron document, (6/1/01), Bates ECa000169835, Hearing 
Exhibit 329. An internal Citigroup email indicates that Citigroup 
itself did not intend to take on any real risk by participating in the 
derivative transaction: ``Spoke with the client. They intend and expect 
to close tomorrow whether the put issue is resolved or not. They fully 
understand that we will blow the deal up if we are at risk for the put. 
. . .'' Email from Citigroup employee Doug Warren to Mr. Caplan (5/29/
01), Bates CITI-SPSI 0123901, Hearing Exhibit 333l.
    \64\ The $188.5 million was intended to provide the minimum 20 
percent capital contribution required by the Andersen 4:1 
capitalization guidelines for 50-50 unconsolidated joint ventures. The 
$28.5 million in cash and stock was intended to provide the minimum 3 
percent capital-at-risk required by the Andersen guidelines.
---------------------------------------------------------------------------
    Although Vinson and Elkins viewed the derivative 
transaction as sufficient to put Citigroup at risk for the 
Sonoma shares, other terms in the Sundance partnership 
agreement--which Vinson and Elkins helped draft--explicitly 
authorized Citigroup to unilaterally dissolve the partnership 
at any time, prior to incurring any loss. See email by Mr. 
Caplan to Mr. Fox, with attachments (10/29/01), Bates CITI-SPSI 
0127648, Hearing Exhibit 333t. Vinson and Elkins knew or should 
have known that this partnership language insulated Citigroup 
from any true risk of loss in its Sundance investments. Vinson 
and Elkins nevertheless issued the true sale opinion allowing 
Enron to record the $20 million gain from the Sonoma share 
transfer.
    Upon receiving the contributions from Enron and Citigroup, 
Sundance immediately used the $208 million cash provided by 
Enron to buy Enron's prior Fishtail interests from the Caymus 
Trust.\65\ The Caymus Trust then used these funds to pay off 
its $194 million loan from Citigroup and return the outstanding 
$6 million equity ``investment,'' thereby eliminating all 
remaining risk for Citigroup associated with the Bacchus 
transaction.\66\ The $208 million payment also included a $1.5 
million payment to the Caymus Trust that was apparently passed 
along to Citigroup for alleged ``breakage costs,'' presumably 
due to early repayment of the $194 million loan.\67\ In 
essence, then, six months after receiving $200 million from the 
Caymus Trust--all of which had been financed by Citigroup--and 
using the money to book cash flow and earnings on its 2000 
financial statements, Enron returned $200 million to Citigroup 
via the Sundance joint venture.
---------------------------------------------------------------------------
    \65\ This $208 million ``purchase'' of the Class C Fishtail 
interests, when considered in conjunction with Sundance's ``purchase'' 
of the Class B Fishtail interests for $8.5 million and Class A Fishtail 
interests for $20 million, appears to mean that, as of June 2001, Enron 
and Citigroup paid a total of $236.5 million for Enron's pulp and paper 
trading business. But see ``Sundance Structure,'' Citigroup document 
(undated), Bates CITI-SPSI 0044992, Hearing Exhibit 331 (valuing 
Fishtail at $228.5 million). Both figures represent a significant 
increase over the $200 million value assigned to this business just six 
months earlier. This increased value was assigned to Enron's trading 
business during a period in which many internet-based businesses were 
falling in value.
    \66\ ``Sundance Steps,'' Enron document (5/16/01), Bates 
ECa000022315, Hearing Exhibit 328a.
    \67\ Id.
---------------------------------------------------------------------------
    The evidence suggests that Citigroup agreed to participated 
in Sundance only after, contrary to accounting principles, the 
joint venture was structured to ensure that none of Citigroup's 
funds was actually at risk and none of its expected returns 
depended upon the risks and rewards of the joint venture. 
Citigroup protected its ``investments'' from loss in several 
ways. First, under the partnership agreement, Citigroup 
obtained unilateral authority to dissolve the Sundance 
partnership at any time and force its liquidation before Enron 
could draw upon any Citigroup funds.\68\ This unilateral 
authority meant, in effect, that as long as Citigroup monitored 
the Sundance transaction and acted promptly to dissolve the 
partnership, it could protect itself against any loss.
---------------------------------------------------------------------------
    \68\ The Sundance partnership agreement authorized Citigroup, at 
its discretion, to invoke the creation of a board of directors and 
appoint two of the four members. ``Sundance Partnership Agreement'' 
(06/01/01), at 52-53, Bates CITI-SPSI 0016044. If this board were to 
``Deadlock,'' it would be considered a ``dissolution event'' and the 
partnership would automatically dissolve. Id. at 6, 61; see also 
``Description of the Sundance Transaction,'' Citigroup document, (10/
29/01), Bates CITI-SPSI 0127648, Hearing Exhibit 333t.
---------------------------------------------------------------------------
    In addition, the partnership agreement required Sundance to 
maintain at all times $28.5 million in Enron notes or other 
high quality, liquid financial instruments to which Citigroup 
was given preferred access.\69\ These liquid financial 
instruments were explicitly segregated and set aside to ensure 
repayment, with a specified return, of Citigroup's $8.5 million 
cash contribution and $20 million share contribution to the 
partnership. In addition, the partnership agreement provided 
that Enron had to exhaust its Sundance investments before any 
of Citigroup's $28.5 million in cash and stock could be used.
---------------------------------------------------------------------------
    \69\ See ``Description of the Sundance Transaction,'' Citigroup 
document (10/29/01), Bates CITI-SPSI 0127648, Hearing Exhibit 333t.
---------------------------------------------------------------------------
    Citigroup's $160 million ``unfunded'' capital commitment 
also operated under multiple protections making it unlikely 
ever to be used. Under the partnership agreement, Citigroup's 
funding commitment could be called on only after the 
partnership incurred GAAP losses in excess of $657 million, 
Enron exhausted its $65 million debt and capital reserve and 
$25 million liquidity reserve, and the $28.5 million in liquid 
financial instruments were cashed in. Again, these arrangements 
meant that Sundance would have to lose almost $750 million--
Enron's entire investment--before any loss could be repaid from 
Citigroup's ``contributions.'' Enron highlighted these features 
of the Sundance agreement in a September 2001 presentation to 
Citigroup, describing it as ``SBHC's Cushion.'' \70\ Citigroup 
was told that it could wait until the entire ``cushion'' was 
absorbed before dissolving Sundance to avert any losses.
---------------------------------------------------------------------------
    \70\ ``Enron Industrial Markets Finance Presentation of Sundance 
Industrial Partners to Salomon Smith Barney,'' (September 2001), Bates 
CITI-SPSI 0044993, Hearing Exhibit 331. SBHC refers to Salomon Brothers 
Holding Company. The presentation lists the risk mitigation mechanisms 
point by point, including: ``Enron takes the first $747m in US GAAP 
losses. . . . SBHC has the power to dissolve the partnership at will. . 
. . SBHC has adequate information to assess ongoing risk. . . . Daily 
trading loss cannot exceed $5.5mm (6.7 months to erode cushion through 
trading losses). . . . Sundance has enough liquidity to repay SBHC 
anytime.''
---------------------------------------------------------------------------
    Citigroup internal documents repeatedly described its 
Sundance investment as protected from risk. One of Citigroup's 
primary negotiators of Sundance put it this way:

        ``The transaction is structured to safeguard against 
        the possibility that we need to contribute our 
        contingency fund and to ensure that there is sufficient 
        liquidity at all times to repay our $28.5 million 
        investment.'' \71\
---------------------------------------------------------------------------
    \71\ Email from Mr. Caplan to Mr. Fox with attached Citigroup 
memorandum, ``Description of the Sundance Transaction'' (10/29/01), 
Bates CITI-SPSI 0127647-49, Hearing Exhibit 333t.

    Another Citigroup email stated, ``our invest[ment] is so 
subordinated and controlled that it is `unimaginable' how our 
principal is not returned.'' \72\ In addition, Citigroup 
arranged to receive fees and a specified return on its Sundance 
``contributions,'' rather than share in any profits or 
increased value in the partnership, which means that its 
expected return was structured more like a return on debt than 
on an equity investment. In fact, although Citigroup internally 
classified its Sundance contribution as an ``equity 
investment,'' minutes of a meeting of the Citigroup Capital 
Markets Approval Committee (CMAC) considering the Sundance 
structure noted that, ``based on the way the deal is 
structured, it is more like debt rather than equity.'' \73\ The 
final CMAC approval memorandum stated: ``The investment has 
been structured to act like debt in form and substance.'' \74\
---------------------------------------------------------------------------
    \72\ Email between Citigroup employees Timothy Leroux and Andrew 
Lee (5/25/01), Bates CITI-SPSI 0044874, Hearing Exhibit 333i. According 
to a Subcommittee interview with Mr. Caplan, Citigroup was so convinced 
of the security of its investment and the lack of any real risk, that 
Citigroup decided not to purchase any default protection related to the 
Sundance transaction.
    \73\ ``Capital Markets Approval Committee (CMAC) Minutes to 
Meeting'' (5/16/01), Bates CITI-SPSI 0016030-31, Hearing Exhibit 327. 
See also email between Citigroup employees Amanda Angelini and Timothy 
Leroux (4/27/01), Bates CITI-SPSI 0044852, Hearing Exhibit 333a 
(listing reasons why Sundance ``is more like debt than equity'').
    \74\ ``Capital Markets Approval Committee New Product/Complex 
Transaction Description Guidelines Enron Corp. Project Sundance 
Transaction'' (5/15/01), Bates CITI-SPSI 0044830, Hearing Exhibit 333c. 
See also email from Citigroup employee Paul Gregg, ``Subject: Enron 
Exposure on NA Credit Derivs,'' (10/22/01), Bates CITI-SPSI 0123218, 
Hearing Exhibit 333u (``Note that these equity partnerships, are 
designed to act as debt exposure due to numerous triggers built in 
which allow us to terminate.'').
---------------------------------------------------------------------------
    Given the lack of risk associated with Citigroup's Sundance 
``investment,'' Citigroup personnel repeatedly questioned 
Sundance's proposed off-balance sheet accounting. One Citigroup 
e-mail two weeks before the deal's closing noted: ``[A 
Citigroup tax attorney] wanted to say that this is a funky deal 
(accounting-wise). He is amazed that they can get it off 
balance sheet.'' \75\ Another email from Citigroup's Global 
Energy and Mining group head in the Global Relationship Bank 
questioning several aspects of the transaction stated: ``Also 
not clear to me how this structure achieves Enron's off balance 
sheet objectives. Do we have a full understanding of this 
aspect of the transaction?'' A Citigroup official responded by 
writing: ``On the accounting: [Andersen] has agreed that by 
maintaining an 80/20 split on ownership with equal voting they 
can achieve off b/s treatment. We have not advised nor opined 
on the accuracy of that. However, according to Rick Caplan, it 
is identical to what Dynegy did in the gas deal for abg gas.'' 
\76\
---------------------------------------------------------------------------
    \75\ Email from Citigroup employee Lynn Feintech to Mr. Caplan, 
``RE: cmac memo'' (5/15/01), Bates CITI-SPSI 0122412, Hearing Exhibit 
333d.
    \76\ Email exchange between Citigroup employees Mr. Fox and Ms. 
Feintech, ``RE: Sundance,'' (5/16/01), Bates CITI-SPSI 0119011, Hearing 
Exhibit 333f. This email exchange may contain a reference to Dynegy and 
an SPE it sponsored, ABS Gas Supply LLC. If so, the SEC has recently 
determined that Dynegy violated certain securities laws and accounting 
rules by failing to consolidate ABS Gas on its balance sheet. While not 
admitting any of the SEC findings on this or other unrelated matters, 
Dynegy agreed to entry of a cease and desist order in the case and paid 
a $3 million penalty. See SEC v. Dynegy Inc., Civil Action No. H-02-
3623 (USDC SDTX), Complaint (9/23/02), paragraphs 42-53.
---------------------------------------------------------------------------
    Just prior to the closing for the Sundance transaction, 
three senior Citigroup officials strongly warned against 
proceeding with the deal, in part due to its ``aggressive'' 
accounting. The head of Citigroup's Risk Management team for 
the Global Corporate and Investment Bank stated in a memorandum 
sent to the head of the investment bank:

        ``This is a follow-up to our lunch conversation on the 
        transaction for Enron. If you recall, this is a complex 
        structured transaction, which I have refused to sign 
        off on.--Risk Management has not approved this 
        transaction for the following reasons: . . . The GAAP 
        accounting is aggressive and a franchise risk to us if 
        there is publicity (a la Xerox).'' \77\
---------------------------------------------------------------------------
    \77\ Citigroup memorandum by Mr. Bushnell, ``Enron--Project 
Sundance Transaction,'' (5/30/01), Bates CITI-SPSI 0124615, Hearing 
Exhibit 333n. The concerns expressed in the memorandum were raised 
internally five days earlier in draft form. See email from Citigroup 
employee Eleanor Wagner to Mr. Bushnell (5/25/01), Bates CITI-SPSI 
0044872, Hearing Exhibit 333k.

In an accompanying email, the head of Citigroup's Global 
---------------------------------------------------------------------------
Relationship Bank wrote:

        ``We ([the Global Energy and Mining group head] and I) 
        share Risk's view and if anything, feel more strongly 
        that suitability issues and related risks when coupled 
        with the returns, make it unattractive. It would be an 
        unfortunate precedent if both GRB relationship 
        management and Risk's views were ignored.'' \78\
---------------------------------------------------------------------------
    \78\ Email from Alan MacDonald, head of Citigroup's Global 
Relationship Bank, to Michael Carpenter, head of Citigroup's Global 
Corporate & Investment Bank, ``FW: Memo on Enron--Project Sundance'' 
(5/31/01), Bates CITI-SPSI 0124614, Hearing Exhibit 333n.

    Despite these strongly worded warnings from senior 
personnel the transaction went forward on June 1, 2001. The 
final go-ahead came on the day after a key Citigroup employee 
working on the deal sent an email at 6 p.m. stating: ``Any 
word? Am getting a significant amount of pressure from [E]nron 
to execute.'' \79\ Another Citigroup email dated one month 
later reported: ``[The head of the investment bank] was out of 
the country the day that transaction closed. The approval memo 
was . . . faxed to him. [He] then had a conversation with [the 
Risk Management head], who shared with us [his] feedback. We 
proceeded to close the transaction that day, given the absence 
of in[s]tructions [from either person] to the contrary.'' \80\
---------------------------------------------------------------------------
    \79\ Email from Mr. Caplan to Shawn Feeny (5/31/01), Bates CITI-
SPSI 012894, Hearing Exhibit 333o.
    \80\ Email from Shawn Feeney to Citigroup employee Andrew Lee (6/
29/01), Bates CITI-SPSI 0122944, Hearing Exhibit 333r.
---------------------------------------------------------------------------
    Citigroup has been unable to tell the Subcommittee who 
provided the final approval of the Sundance transaction. 
Although Citigroup internal policy requires signed management 
transaction approvals for transactions as large as Sundance, 
Citigroup could not locate any of the normal signed 
approvals.\81\ In his interview, Citigroup's Risk Management 
head for the investment bank, who composed the strongly worded 
memorandum warning against proceeding with Sundance, stated 
that he was unable to recall virtually anything about his 
objections to the transaction, how his concerns were resolved, 
or who actually gave the final approval for the transaction. 
For example, he stated that he could not recall the specifics 
of his accounting concerns; whether he discussed his accounting 
concerns with the investment bank head, although he assumes he 
did; the reassurances he received on the accounting issues, 
although he assumes he received reassurances; whether he ever 
signed off on the transaction, although he assumes he did; or 
whether the investment bank head ultimately approved the 
project.\82\ At the hearing held one week after his interview, 
this Citigroup official testified that his memory of the 
transaction had been refreshed by reviewing certain emails and 
recalled giving his approval to the Sundance transaction, 
although he testified that he continued to be unable to recall 
other specific information about the final approval process, 
including whether the investment bank head finally approved the 
deal.\83\
---------------------------------------------------------------------------
    \81\ See email exchange between Citigroup employees Timothy Leroux 
and Andrew Lee, ``RE: Sundance Approvals,'' (6/6/01), Bates CITI-SPSI 
0123806, Hearing Exhibit 333q (``Would you happen to have a copy of the 
management approvals for the sundance trade (The Firm Investments group 
needs it for their files.)'' Response: ``No . . . was given a verbal go 
ahead. . . . Understand signed is to follow''). See also email from Mr. 
Fox to Mr. MacDonald (6/04/01), Bates CITI-SPSI 0124617 (``[A]ny feed 
back from Carpenter on Sundance; apparently the deal closed.'')
    \82\ Bushnell interview (12/03/02).
    \83\ Bushnell testimony at the Subcommittee hearing held on 
December 11, 2002.
---------------------------------------------------------------------------
    In any event, the Sundance transaction did close. When 
negative information about Enron began to emerge a few months 
later and questions began to arise about Enron's solvency, 
Citigroup invoked the Sundance agreement provisions protecting 
it from loss and actually terminated the Sundance partnership 
on or about November 30, 2001, five months after it was 
established and two days before Enron filed for bankruptcy.\84\ 
At that time, Citigroup demanded that Enron buy out its 
Sundance interest for the $28.5 million Citigroup had 
``contributed'' in cash and stock, and recovered this entire 
amount plus a return.\85\ Citigroup also terminated its $160 
million funding commitment. Citigroup's actions showed that the 
partnership features had worked as intended to insulate its 
entire Sundance ``investment'' from loss.
---------------------------------------------------------------------------
    \84\ Caplan interview.
    \85\ Id. See also email from Mr. Caplan (11/30/01), Bates CITI-SPSI 
0125273, Hearing Exhibit 333y. Although the Sonoma shares Citigroup had 
contributed to Sundance had likely lost value in light of Enron's 
bankruptcy and Citigroup had allegedly assumed any risk of loss, 
Citigroup secured the full $20 million that the shares had supposedly 
been worth when contributed five months earlier.
---------------------------------------------------------------------------
    For participating in Sundance, Citigroup was apparently 
paid upfront fees of $725,000 as well as another $1.1 million 
return on its $28.5 million ``investment.'' \86\ When Sundance 
facilitated pre-payment of the $194 million loan in Bacchus, 
Citigroup received another $1.5 million in ``breakage costs.''
---------------------------------------------------------------------------
    \86\ Information provided to the Subcommittee by Citigroup.
---------------------------------------------------------------------------
    Analysis. Like Fishtail and Bacchus, the Sundance 
transaction involves deceptive accounting and sham investments. 
One key objective of the Sundance transaction was to keep 
Enron's pulp and paper assets off its balance sheet by placing 
them in a separate joint venture. But the lack of risk 
associated with Citigroup's so-called ``investment'' in 
Sundance indicates that this joint venture did not qualify for 
off-balance sheet treatment and should have been consolidated 
with Enron.
    To qualify as an unconsolidated 50-50 joint venture, 
Sundance needed two investors contributing capital in 
accordance with the Andersen 4:1 joint venture capitalization 
guidelines. In addition, a minimum three percent of the total 
capitalization had to be an independent equity investment at 
risk for the duration of the joint venture. The evidence 
indicates, however, that none of Citigroup's Sundance 
investment was ever truly at risk in light of Citigroup's right 
to dissolve the partnership at will prior to any loss, and the 
additional safeguards provided for each of its ``investments.'' 
In the case of its $160 million ``unfunded commitment,'' 
Citigroup funds could be used only after Enron's entire $750 
million investment was exhausted. In the case of its $28.5 
million contribution of cash and stock, Enron's investment not 
only had to be exhausted beforehand, but the $28.5 million also 
had to be kept in segregated, liquid financial instruments to 
which Citigroup had preferred access. In the end, none of 
Citigroup's funding commitment was actually used and all of its 
cash and stock contributions were returned on short notice, in 
cash, with interest. Without Citigroup's sham investment in 
Sundance, Enron would have had to consolidate this partnership 
on its balance sheet, include in its financial results all of 
the Sundance pulp and paper assets, and disclose to investors 
and financial analysts all of the debt associated with this 
business venture.
    Senior Citigroup officials opposed participating in 
Sundance, calling its accounting ``aggressive'' and a 
``franchise risk.'' Just prior to the transaction's closing, 
three senior Citigroup officials warned against proceeding with 
it. The final go-ahead on the transaction was provided verbally 
by an unidentified Citigroup official. The final approval 
documents cannot be located.
    Sundance's aggressive accounting troubled senior Citigroup 
officials who were analyzing the transaction on its own terms. 
But its aggressive nature deepens when Sundance, Bacchus, and 
Fishtail are analyzed as a whole. When viewed together, the 
three transactions result in a disguised six-month loan 
advanced by Citigroup to facilitate Enron's deceptive 
accounting. In effect, Enron borrowed $200 million from 
Citigroup in December 2000; arranged for a shell company, the 
Caymus Trust, to use the funds to ``purchase'' the Fishtail 
assets for $200 million, without disclosing that Enron was 
guaranteeing the full purchase price; used this sham sale to 
inflate its 2000 cash flow from operations by $200 million and 
its earnings by $112 million; and then quietly returned the 
$200 million to Citigroup six months later via Sundance.\87\ 
This view of the three transactions as a disguised $200 million 
loan is further strengthened by evidence indicating that 
Citigroup never truly placed any money at risk in the Bacchus 
or Sundance transactions, it profited from the transactions by 
obtaining fees and interest charges rather than equity rewards, 
and the $200 million seems, in the end, to have been cycled 
through all three transactions for the sole business purpose of 
facilitating Enron's financial statement manipulation.
---------------------------------------------------------------------------
    \87\ In fact, when setting up the mechanics of the Sundance 
transaction, Enron personnel cautioned Enron against muddying the 
timing by reacquiring its old Fishtail assets too soon. One internal 
Enron email instructed: ``Fishtail CANNOT touch Enron's Balance Sheet 
before Sundance is deconsolidated.'' ``Sundance Steps,'' Enron document 
(5/16/01), Bates ECa000022315, Hearing Exhibit 328a.
---------------------------------------------------------------------------

SLAPSHOT

    The Facts. The fourth and final transaction, Slapshot, took 
place on June 22, 2001, soon after creation of the Sundance 
joint venture. Undertaken in connection with a loan to 
refinance a Canadian paper mill associated with Sundance, 
Slapshot was designed as a tax avoidance scheme that centered 
on utilizing a one-day, $1 billion ``loan'' from Chase to 
generate approximately $60 million (U.S.) in Canadian tax 
benefits, as well as $65 million in financial statement 
benefits for Enron.\88\
---------------------------------------------------------------------------
    \88\ When Chase first presented the Slapshot structure to Enron, it 
projected Canadian tax benefits totaling $125 million in U.S. dollars. 
``Results and Cash Flows,'' Chase document (undated), Bates SENATE FL-
00939. When Enron performed its own analysis of potential tax savings 
using more conservative assumptions, it calculated that, over five 
years, Enron would obtain ``a tax savings NPV of US$60 million'' and 
``net income improvement over the next five years of NPV US$65 
million.'' ``Slapshot Savings,'' Enron document (undated), Bates 
ECa000195947. NPV means net present value. Another Enron document 
estimated that Slapshot would benefit Enron's Corp's ``earnings per 
share computation'' by $120 million over the five-year life of the 
project. Email from Enron tax expert Morris Clark to Enron North 
America's chief financial officer Joseph Deffner (undated), Bates EC 
003005056.
---------------------------------------------------------------------------
    Enron first purchased the Canadian paper mill in March 2001 
for about $350 million.\89\ Three months later, in June, Enron 
contributed the paper mill to the Sundance joint venture with 
the explicit understanding that Enron would soon be refinancing 
the purchase price.\90\
---------------------------------------------------------------------------
    \89\ Enron bought the mill, located in Quebec City, Canada, from 
Daishowa, Inc. and provided the initial financing. When purchased by 
Enron, the mill was named the Daishowa Forest Products paper mill; 
Enron renamed it Stadacona. Enron also established a new company, 
Campagnie Papiers Stadacona (``CPS''), as the immediate owner of the 
mill. According to a tax opinion letter, CPS had originally borrowed 
approximately $346 million from Enron to purchase the Stadacona paper 
mill. The larger $375 million loan amount in the Slapshot transaction 
was apparently provided not only to refinance the mill's purchase 
price, but also to pay Enron a $29 million ``structuring fee.'' See tax 
opinion letter from Skadden, Arps, Slate, Meagher & Flom LLP And 
Affiliates (``Skadden Arps'') to Enron Wholesale Services, (8/15/01), 
Bates EC2 000047056, Hearing Exhibit 352.
    \90\ Since Stadacona was a key joint venture asset, Citigroup 
demanded and was given the right to approve any refinancing arrangement 
to ensure that Enron did not encumber the asset. Enron accordingly 
informed Citigroup about the Slapshot structure, and Citicorp 
apparently registered no objection to Enron's participation in it. 
Enron also paid Citigroup a fee to reimburse it for the costs 
associated with Citicorp's analyzing the Slapshot structure.
---------------------------------------------------------------------------
    Chase presented Enron with a refinancing proposal that 
would not only provide Enron with a loan from a consortium of 
banks to pay for the paper mill but also, at the same time, 
provide an Enron affiliate with significant Canadian tax 
benefits.\91\ In exchange for about $5.6 million in fees and 
other remuneration, Chase provided Enron with access to its 
``proprietary'' structured finance arrangement \92\ utilizing a 
sham $1 billion ``loan'' intended to be issued and repaid 
within a matter of hours. Although the $1 billion ``loan'' was 
to be issued and repaid on the same day, the Slapshot structure 
was designed to enable Enron's Canadian affiliate to claim tax 
deductions and reap other Canadian tax benefits as if a real $1 
billion loan had been issued and remained outstanding. See 
Figure 4 for a diagram of the Slapshot structure.
---------------------------------------------------------------------------
    \91\ Since 2000, Enron had been working to design a tax structure 
that would enable it to use Canadian tax laws to generate tax 
deductions. Enron halted that effort when it decided to use the Chase 
structure. See email, with attachments, between Enron employees Stephen 
Douglas and Davis Maxey (12/11/00) (no Bates number), Hearing Exhibit 
362, Enron disk produced to the Subcommittee; and Subcommittee 
interview with Stephen Douglas (12/3/02).
    \92\ A key Chase employee involved in Slapshot, Eric Peiffer, 
referred to it as a new ``tax technology.'' Peiffer interview.
---------------------------------------------------------------------------
    Chase provided Enron with a step-by-step description of how 
the Slapshot transaction was to be executed.\93\ These 
instructions described a complex series of structured finance 
arrangements using shell corporations, fake loans, and complex 
funding transfers across international lines. They also showed 
how the $1 billion in supposed loan proceeds would be repaid 
later the same day. Chase personnel actively assisted in 
planning and completing the specified steps in the Slapshot 
deal. The transaction itself actually took place on June 22, 
2001.
---------------------------------------------------------------------------
    \93\ See, for example, ``Structured Canadian Financing Transaction 
Organizational Meeting,'' (2/8/01), Bates SENATE FL-00887, Hearing 
Exhibit 344 (providing six-step description of Slapshot transaction); 
``Transaction Summary,'' Chase document (undated), Bates SENATE FL-
00909-14, Hearing Exhibit 338 (providing seven-step description).
---------------------------------------------------------------------------
    The transaction involved multiple Chase and Enron 
affiliates and SPEs, a number of which were established 
specifically to facilitate the Slapshot deal. Chase established 
its key entity in the transaction, Flagstaff Capital 
Corporation (``Flagstaff''), as a wholly-owned SPE in Delaware. 
Chase also organized a bank consortium made up of itself and 
three other large banks to issue the $375 million loan to 
refinance the paper mill.\94\ Enron established Compagnie 
Papiers Stadacona (``CPS'') in Canada as the direct owner and 
operator of the Stadacona paper mill.\95\
---------------------------------------------------------------------------
    \94\ The bank consortium members were Chase, Royal Bank of 
Scotland, Industrial Bank of Japan, and Bank of Tokyo-Mitsubishi, each 
of which was responsible for an equal share of the $375 million loan.
    \95\ Enron then contributed CPS to the Sundance joint venture. 
Enron established CPS as a Nova Scotia Unlimited Liability Company 
(``NSULC''), which is a particular type of corporation in Canada. Enron 
did not own CPS directly, but created a longer ownership chain which 
included two Dutch corporations it had established, BV-1 and BV-2. As 
indicated in the diagram, Sundance owned BV-1 which owned BV-2 which 
directly owned CPS. Enron also created two additional NSULCs, Hansen 
and Newman, that were both wholly-owned by CPS. Enron created this 
complex maze of companies, CPS, BV-1, BV-2, Hansen, and Newman, as part 
of the Slapshot tax avoidance structure in order to take advantage of 
differences between U.S. and Canadian tax laws. For example, since 
Hansen, Newman, and CPS were NSULCs, U.S. tax law would allow Enron to 
treat them as pass-through entities for U.S. Federal income tax 
purposes. Similarly, under U.S. tax law, BV-1 was a controlled foreign 
corporation, while BV-2 could be treated as a disregarded entity for 
tax purposes. A tax opinion letter issued to Enron by Skadden Arps 
supporting the proposed structure explained, in part, that ``since CPS 
itself [will be] treated as a branch of BV-2, which in turn [will be] 
treated as branch of BV-1, Newman and Hansen will both be treated as 
disregarded entities all of the assets and liabilities of which [will 
be] owned by BV-1 for United States federal income tax purposes.'' At 
the same time, Canadian law viewed CPS, Hansen, and Newman as separate 
companies which would increase the amount of potential Canadian tax 
benefits.
[GRAPHIC] [TIFF OMITTED] T3559.004

    On June 22, Chase advanced the bank consortium's $375 
million loan to Flagstaff to be repaid in five years and one 
day.\96\ On the same day, Enron entered into a complex series 
of derivatives with Flagstaff, in essence, to guarantee 
repayment of the $375 million.\97\ According to one internal 
Chase document, these derivatives gave Chase and the bank 
consortium ``credit support equivalent to a guarantee . . . 
that does not constitute a guarantee for GAAP accounting for 
Enron's purposes, thus providing an accounting benefit to 
Enron.'' \98\ In addition, by authorizing a ``daylight 
overdraft'' on the Flagstaff account, Chase ``loaned'' its 
affiliate, Flagstaff, another $1.039 billion.\99\
---------------------------------------------------------------------------
    \96\ The loan was structured to be in excess of five years in order 
to qualify for certain withholding tax benefits under Canadian tax law.
    \97\ Rather than a simple loan guarantee, Chase and Enron devised a 
complex set of derivatives involving a warrant, put option, and total 
return swap, which functioned together to support repayment of the $375 
million loan. See email by Eric Peiffer (10/16/01), Bates SENATE FL 
004540, Hearing Exhibit 357k.
    \98\ ``(Flagstaff) Transaction Summary,'' Chase document (undated), 
Bates FL-00910, Hearing Exhibit 375. An Enron employee indicated that 
this transaction was structured so that Enron could avoid disclosure of 
the guarantee in its financial statement footnotes. A Chase 
representative indicated that Enron told Chase it wanted to structure 
the transaction as a swap because it was concerned that a guarantee 
would require Enron to carry the mill on its books.
    \99\ According to a Skadden Arps opinion letter, despite the amount 
involved, ``[n]o instrument was prepared to evidence the Day-Light 
Loan'' from Chase to Flagstaff. Tax opinion letter from Skadden Arps to 
Enron Wholesale Services, (8/15/01), Bates EC2 000047058, Hearing 
Exhibit 354.
---------------------------------------------------------------------------
    At the conclusion of these initial steps, Flagstaff held 
two loans totaling approximately $1.4 billion ($375 million 
from the bank consortium and $1.039 billion from Chase).\100\ 
Flagstaff immediately loaned the entire amount to an Enron 
affiliate, Hansen, in exchange for a note.\101\
---------------------------------------------------------------------------
    \100\ The total loan amount was $1,414,504,347, however, for ease 
of reference, the figure $1.4 billion will be used in the following 
analysis.
    \101\ Hansen is a NSULC shell company established by Enron and 
wholly owned by CPS. The Hansen note set up a so-called ``bullet loan'' 
of five years and one day, which required Hansen to pay only interest 
on the loan for five years and then, on the last day of the loan, repay 
the principal in its entirety.
---------------------------------------------------------------------------
    Upon receiving the $1.4 billion from Flagstaff, Hansen 
immediately ``loaned'' the money to its parent, CPS, another 
Enron affiliate.\102\ CPS then directed $375 million of the 
$1.4 billion to Enron. CPS ``loaned'' the remaining $1.039 
billion to an Enron subsidiary in Canada called Enron Canadian 
Power Company (``ECPC'').
---------------------------------------------------------------------------
    \102\ Hansen ``loaned'' the funds to CPS on essentially the same 
terms as the ``loan'' between Hansen and Flagstaff. Apparently in an 
effort to make the two loans between Flagstaff and Hansen and between 
Hansen and CPS technically different and to allow Hansen to assert that 
its ``business purpose'' in entering into the transactions was to make 
money off its loan to its parent CPS, the former loan had an interest 
rate of 6.12 percent, and the latter an interest rate of 6.13 percent.
---------------------------------------------------------------------------
    At the same time this loan activity was occurring, Hansen 
entered into an agreement with its fellow subsidiary, 
Newman.\103\ This agreement obligated Newman to purchase 99.99 
percent of Hansen's shares in five years and one day for $1.4 
billion, the same amount Hansen already ``owed'' to Flagstaff.
---------------------------------------------------------------------------
    \103\ Newman is another NSULC shell company established by Enron 
and, like Hansen, wholly owned by CPS.
---------------------------------------------------------------------------
    Newman and Flagstaff then entered into an agreement whereby 
Newman immediately paid Flagstaff $1.039 billion in exchange 
for Flagstaff's agreeing to assume Newman's obligation to pay 
for Hansen's shares in five years and one day.\104\ The $1.039 
billion Newman paid to Flagstaff had been provided to Newman by 
Enron for placement in an escrow account.\105\ Chase had been 
unwilling to release its $1.039 billion daylight overdraft 
``loan'' to Enron until it was sure that there was $1.039 
billion in an escrow account available to ensure Chase would 
recover its money within the same day. To accommodate Chase, 
Enron had secured its own $1.039 billion daylight overdraft 
authorization on an account it held at Citibank. Once these 
funds were wired from Citibank to an escrow account at Chase, 
Chase released the $1.4 billion in Flagstaff that would go up 
the chain to Hansen and CPS. Flagstaff also took possession of 
the Enron escrow funds and forwarded the money to Chase which 
used it to pay off the daylight overdraft it had issued at the 
beginning of the day.
---------------------------------------------------------------------------
    \104\ The parties calculated that $1.039 billion was the net 
present value of the $1.4 billion owed by Newman to Hansen in five 
years and one day.
    \105\ Enron sent the $1.039 billion to Newman in accordance with a 
series of transactions involving ECPC and other Enron affiliates. 
Enron's corporate bank account at Citigroup was, thus, both the 
origination point and termination point for the two different chains of 
transfers involving two separate amounts of $1.039 billion--Enron's 
$1.039 billion in escrow funds and Chase's $1.039 billion in ``loan'' 
proceeds.
      In the Newman-ECPC transaction, ECPC obtained Newman debenture 
shares. These debenture shares were designed to provide monetary 
distributions which exactly mirrored the interest payable to CPS under 
the CPS-ECPC note. That meant ECPC was to pay interest on the note to 
CPS in an amount exactly equal to the distributions that ECPC was to 
receive from Newman, an entity wholly-owned by CPS. According to Enron, 
Canadian tax lawyers advised it that the expected interest and 
distributions needed to actually change hands among the parties, 
notwithstanding the fact that from ECPC's perspective the net result 
was a wash.
---------------------------------------------------------------------------
    The net result of the Slapshot transaction is as follows.

         LIn two offsetting transfers of funds that 
        moved through multiple bank accounts of Chase, Enron, 
        and their affiliates, Chase issued a sham loan of 
        $1.039 billion to Enron and, on the same day, had Enron 
        send $1.039 billion in escrow funds to Chase which used 
        the escrow funds to satisfy the sham loan. Chase's 
        alleged ``loan'' was never at risk, however, since 
        Chase had required Enron to transfer the funds to an 
        escrow account at a Chase bank, before Chase released 
        any of the ``loan'' proceeds to Enron.

         LHansen and Flagstaff exchanged obligations to 
        pay each other an identical amount, $1.4 billion, in 
        five years and one day. The legal documents explicitly 
        authorized them to set off the funds owed to each 
        other.\106\
---------------------------------------------------------------------------
    \106\ See ``Credit Agreement,'' (6/22/01), Bates JPM-14-00475, 
Hearing Exhibit 350, Section 10.08 (``Right of Setoff'') at Bates JPM-
14-00512.

         LCPS was left with a net outstanding loan of 
        $375 million, to be repaid with interest, to the bank 
        consortium through Hansen and Flagstaff over five years 
        and one day. The loan was guaranteed by Enron through a 
        complex set of derivatives that did not show up as a 
        loan guarantee on Enron's books.\107\
---------------------------------------------------------------------------
    \107\ The transaction was also structured to allow CPS to account 
for the loan on its books by showing a net debt of $375 million, not 
$1.4 billion. See, for example, ``Transaction Summary,'' (undated), 
Bates SENATE FL-00912, Hearing Exhibit 338.

    Notwithstanding the reality that only $375 million was 
actually loaned to CPS, the transaction was structured in such 
a way as to allow CPS, for tax purposes, to act as if it were 
subject to a $1.4 billion ``loan'' obligation that remained 
outstanding. The purpose was to circumvent the general 
principle in U.S. and Canadian tax law which allows companies 
to deduct only their loan interest payments, but not their loan 
principal payments. The Chase structure was intended to enable 
CPS to claim to be entitled to a Canadian tax deduction for its 
entire amount of its payments on the $375 million loan.
    The Chase-designed structure worked as follows. The 
transaction documents required CPS to make quarterly loan 
payments to Hansen in the amount of approximately $22 million. 
Hansen was then to pay Flagstaff an identical amount, and 
Flagstaff was to pay the same amount to the bank consortium. 
The $22 million was equivalent to a payment of principal and 
interest, using a fixed 6.12 percent interest rate, on the 
existing $375 million loan. In five years and one day, these 
payments would reduce the $375 million loan to zero.
    At the same time, Chase and Enron had manipulated the size 
of the loans between Flagstaff and Hansen and between Hansen 
and CPS, as well as the interest rates on those loans, in such 
a way that the $22 million quarterly payment was also 
equivalent to an interest-only payment, using a fixed 6.13 
percent interest rate, on the $1.4 billion loan. Under Canadian 
tax law, if CPS were to characterize the $22 million as an 
interest-only payment on an outstanding loan, it could deduct 
the full $22 million from its Canadian taxes. Assuming 
repayment of the loan in full, Enron calculated the total 
deductions and related Canadian tax benefits from the Slapshot 
transaction over five years to be in the range of $60 
million.\108\ These Canadian tax benefits were also calculated 
to convey additional financial statement benefits for Enron 
totaling about $65 million.\109\ Another Enron document 
calculated that Slapshot was going to ``positively [impact] 
Enron's earnings per share computation by approximately $120 
[million]'' over the life of the transaction.\110\
---------------------------------------------------------------------------
    \108\ ``Slapshot Savings,'' Enron document (undated), Bates 
ECa000195947, Hearing Exhibit 339. Enron indicated that this $60 
million represented the net present value of the total tax savings over 
five years. See also Chase projection of tax and financial statement 
benefits, ``Results and Cash Flows,'' Chase document (undated), Bates 
SENATE FL-00939, Hearing Exhibit 343. In response to Subcommittee 
inquiries, Enron stated that its Canadian affiliates actually claimed 
``gross interest [tax] deductions'' in Canada related to Slapshot 
totaling $124.9 million, but have since decided not to claim any 
additional Slapshot tax benefits in the future. Letter from Enron legal 
counsel, Skadden, Arps, Slate, Meagher & Flom LLP, to the Subcommittee 
(12/10/02), Hearing Exhibit 368.
    \109\ Id. Enron stated that a ``tax depreciation delay'' over five 
years would create a ``deferred tax benefit, resulting in net income 
improvement over the next five years of NPV US$65 million.'' (Emphasis 
omitted.)
    \110\ Email from Enron tax expert Morris Clark to Enron North 
America's chief financial officer Joseph Deffner (undated), Bates EC 
003005056.
---------------------------------------------------------------------------
    Prior to participating in Slapshot, Chase obtained a legal 
opinion from a Canadian law firm, Blake, Cassels & Graydon, LLP 
(``Blake Cassels''), supporting the Slapshot structure. Enron 
apparently relied on that opinion and ultimately obtained its 
own opinion from the same law firm.\111\ The opinion provided 
to Enron, which included caveats and warnings that did not 
appear in the law firm's earlier opinion to Chase, noted that 
the Slapshot structure ``clearly involves a degree of risk'' 
and advocated proceeding only after providing this warning:
---------------------------------------------------------------------------
    \111\ See tax opinion letters from Blake Cassels to Chase 
Securities Inc. (11/7/00) (no Bates number), Hearing Exhibit 353, and 
from Blake Cassels to Enron North America Corp. (6/23/01), Bates EC2 
000047037, Hearing Exhibit 352. The tax opinion Enron received from 
Blake Cassels is dated one day after the transaction closed; Enron told 
the Subcommittee it was informed orally of its substance prior to the 
closing. Subcommittee interview of Stephen Douglas (12/3/02).

        ``We would further caution that in our opinion it is 
        very likely that Revenue Canada will become aware of 
        [the Slapshot transactions] and, upon becoming aware of 
        them, will challenge them under [the Canadian anti-tax 
        avoidance statute]. It is also, in our view, likely 
        that such a Revenue Canada challenge would not be 
        resolved in the Courts at a level below that of the 
        Federal Court of Appeal. It is therefore likely that 
        Enron will be faced with the decision as to whether to 
        pursue the matter through the Courts or to attempt to 
        reach a settlement with Revenue Canada pursuant to 
        which it would receive a reduced Canadian tax 
---------------------------------------------------------------------------
        benefit.''

In short, Enron's own tax counsel warned that Slapshot would 
likely result in litigation over Enron's tax liability and 
Enron would have to determine whether to settle the expected 
dispute with Revenue Canada.
    Internal documentation indicates that both Enron and Chase 
were concerned about the Canadian tax authorities disallowing 
the Slapshot structure and so took steps to keep information 
that would provide insights about the transaction to a minimum. 
For example, in analyzing how to structure an interest rate 
swap, Chase and Enron jointly considered three alternatives, 
two of which were described as disadvantageous, in part, 
because they would produce a ``potential road map'' of the 
transaction for Revenue Canada. Chase and Enron chose the third 
alternative which was explicitly described as advantageous, in 
part, because it provided ``no road map'' for Revenue 
Canada.\112\
---------------------------------------------------------------------------
    \112\ ``Structured Canadian Financing Transaction Organizational 
Meeting,'' (2/8/01), Bates SENATE FL-00897, Hearing Exhibit 344.
---------------------------------------------------------------------------
    In another document, an Enron tax attorney cautioned 
against Enron's repatriating into the United States in 2001, 
certain funds associated with certain ``preferred shares'' that 
had been exchanged in the Slapshot transaction in 2001, because 
this same-year transaction would undermine Slapshot's alleged 
business purpose. An email written by the Enron tax attorney 
states that the Slapshot tax analysis ``is predicated on two 
significant factors'': (1) demonstrating a business purpose for 
why Enron's Canadian affiliates received $1 billion from Enron 
and CPS; and (2) demonstrating that ``Enron Canada did not have 
a tax-avoidance motive for entering into Project Slapshot.'' 
\113\ The email goes on to state:
---------------------------------------------------------------------------
    \113\ Email from Enron tax expert Morris Clark to Enron North 
America's chief financial officer Joseph Deffner (undated), Bates EC 
003005056.

        ``It should be noted that repaying the Preferred Shares 
        within the same year as entering into Project Slapshot 
        puts pressure on both of the above factors and, as 
        such, puts the integrity of the transaction at risk. . 
        . . [I]t is certainly our position that the greater 
        period of time that we can interpose before repaying 
        any of the Preferred Shares, the greater the likelihood 
        of withstanding an attack by Revenue Canada on audit.'' 
        \114\
---------------------------------------------------------------------------
    \114\ Id.

This analysis shows, again, Enron's ongoing concerns that 
Revenue Canada would ``attack'' Slapshot and that the Slapshot 
structure itself would not withstand legal challenge.
    Chase and Enron also included in the Slapshot legal 
documents a ``recharacterization rider'' to take effect only if 
Canadian tax authorities successfully challenged the underlying 
tax structure and reclassified the payments from Hansen to 
Flagstaff as payments of principal and interest on the $375 
million loan. Should such an event occur, Chase and Enron 
agreed to ``recast any principal paid in excess of 25% of the 
recharacterized loan as instead being a loan from [Hansen] to 
Flagstaff.'' \115\ This rider was designed to avoid payment of 
certain Canadian withholding taxes that would be triggered if 
Hansen's loan principal payments were to exceed a specified 25 
percent limit. The rider's solution was to reclassify the 
Hansen loan payments to Flagstaff as the reverse--as the 
extension of loans by Hansen to Flagstaff--the exact opposite 
of what was intended under the Slapshot structure. This rider's 
existence is additional evidence, not only that Chase and Enron 
had real concerns that Revenue Canada would overturn Slapshot, 
but also that both were willing to continue to use deceptive 
strategies to avoid payment of Canadian taxes.
---------------------------------------------------------------------------
    \115\ ``5/25 Recharacterization Rider,'' (undated), Bates SENATE 
FL-00075, Hearing Exhibit 351.
---------------------------------------------------------------------------
    Analysis. Chase constructed and sold Slapshot as a tax 
avoidance structure whose core transaction was a deception--a 
sham $1 billion loan that had no economic rationale or business 
purpose apart from generating deceptively large tax 
deductions.\116\ The funds never performed any function other 
than to transverse multiple bank accounts in a single day to 
create the appearance of a loan that was, in fact, an illusion. 
The funds were issued without the paperwork that normally 
accompanies a billion-dollar borrowing. Chase's $1 billion was 
never even truly at risk since Chase had required Enron to 
place the same amount in a Chase escrow account before Chase 
issued the original ``loan'' to Enron.
---------------------------------------------------------------------------
    \116\ In one interview, Enron contended that one of the purported 
business purposes of the transactions was that the various Chase and 
Enron affiliates were profiting from the loans they exchanged. Douglas 
interview. However, the interest rate difference in the loans between 
Flagstaff and Hansen and between Hansen and CPS differed by only 0.01 
percent. In addition, Hansen and CPS were both Enron affiliates, 
contradicting any business rational for them to profit from each other. 
Moreover, the loan activity among these entities had no function apart 
from the $1.039 billion loan. All of the loans and related transactions 
were engineered by Chase and Enron to function together.
---------------------------------------------------------------------------
    The deceptive nature of the Slapshot transaction is clear 
from its component parts. Serial billion-dollar-plus loans were 
issued to newly created shell companies such as Flagstaff and 
Hansen which had virtually no capitalization, assets, or 
business operations to justify the lending. Another key 
transaction was a complex stock agreement between Hansen and 
Newman, two companies that were incapable of negotiating at 
arms-length because both were Enron-sponsored SPEs, wholly 
owned by the same Enron affiliate, CPS, with identical company 
officers. With respect to another key series of transactions, 
Flagstaff and Hansen clearly intended to set-off their 
identical $1.4 billion obligations to each other, but this 
intent to set-off is never mentioned in the transaction 
documents due to legal advice that it would undercut the 
supposed arms-length nature of the transaction.\117\ Still 
another decision on interest rates appears to have been made 
not to rationalize or maximize the benefits to any one party 
but to avoid providing Revenue Canada with a useful ``road 
map'' to the transaction. Chase and Enron even agreed to recast 
the very nature of key transactions to salvage limited Canadian 
tax benefits in the event Canadian tax authorities refused to 
recognize Hansen as paying off a $1.4 billion ``loan.''
---------------------------------------------------------------------------
    \117\ A Chase email stated: ``As Flagstaff's payment to [Hansen] is 
conditional on [Hansen's] repaying, Chase can just choose to invoke 
set-off which is Chase's full intention--to direct [Hansen] to keep its 
money rather than repay the loan, in return for Flagstaff not having to 
pay cash for the [Hansen] shares. Clearly there is no benefit to Chase/
Flagstaff to have the money move. As discussed, the lawyers (especially 
the tax lawyers) are hesitant to state explicitly Chase's intent to 
set-off or to require this set off, as they wish to keep the documents 
as `arm's length' as possible rather than tie them together (which 
additional `intent to set-off' language would do).'' Email between 
Chase employees Eric Peiffer and Kathryn Ryan (date illegible but 
possibly 2/28/01), Bates SENATE FL-02335, Hearing Exhibit 357c.
---------------------------------------------------------------------------
    Many features of Slapshot--the sham billion-dollar loan 
that had no business purpose apart from generating tax 
benefits, the contrived set offs between key parties, and the 
involvement of multiple shell companies lacking ongoing 
business operations--raised the possibility that the entire 
Slapshot transaction would be invalidated under Canada's 
statutory general anti-avoidance rule. Despite the legal risks 
associated with Slapshot, Chase and Enron proceeded with the 
transaction.\118\ If Enron had not gone bankrupt, the large tax 
deductions generated by Slapshot would likely have been used to 
shelter the paper mill's income from the payment of Canadian 
corporate income tax. Lower tax liabilities would have then 
translated into stronger Enron financial statements. Enron's 
bankruptcy, however, interrupted Slapshot just five months 
after it began producing the promised benefits.
---------------------------------------------------------------------------
    \118\ In fact, one Chase employee informed the Subcommittee that it 
has marketed the Slapshot structure to at least 15 to 20 other 
companies in addition to Enron.
---------------------------------------------------------------------------
    Chase was paid more than $5 million for designing and 
orchestrating Slapshot. Enron could not have completed this 
transaction without the initiative and enthusiastic backing of 
a major financial institution with the resources to issue and 
move a $1 billion daylight overdraft through multiple bank 
accounts across international lines in a single day. Without 
Chase's willing efforts to design, fund, and execute the 
incredibly complex transactions involved, whose details had to 
be carefully planned and coordinated, Enron would not have been 
able to make use of this deceptive tax strategy.

SUBCOMMITTEE HEARING

    On December 11, 2002, the Subcommittee held a hearing 
examining Fishtail, Bacchus, Sundance, and Slapshot. The 
Subcommittee heard from four panels of witnesses, including 
Citigroup and Chase officials, a banking and securities expert, 
and key Federal agencies.
    The first panel consisted of Citigroup officials who were 
directly involved in the Bacchus and Sundance transactions, as 
well as a senior Citigroup official responsible for setting 
corporate policy. The Citigroup witnesses were Charles O. 
Prince III, Chairman and Chief Executive Officer of Citigroup's 
Global Corporate and Investment Bank; David C. Bushnell, 
Managing Director and head of Global Risk Management for the 
Global Corporate and Investment Bank; Richard Caplan, Managing 
Director and Co-Head of the Credit Derivatives Group at Salomon 
Smith Barney North American Credit; and William T. Fox III, 
Managing Director of the Global Power & Energy Group at 
Citibank. Mr. Caplan participated directly in both the Bacchus 
and Sundance transactions. Mr. Fox was directly involved in the 
Bacchus transaction and was the key Citigroup official who 
communicated with Mr. Fastow regarding the verbal guarantee of 
the ``equity investment'' in the Caymus Trust. Mr. Bushnell, as 
head of risk management, was directly involved in the Sundance 
transaction. At the hearing, Mr. Bushnell disclosed that, 
although he had strongly urged Citigroup not to participate in 
Sundance, he may have provided the final oral approval that 
allowed this project to proceed. Mr. Prince, who was not 
directly involved in either transaction, described a number of 
Citigroup's post-Enron reforms, including a new corporate 
policy to prevent Citigroup's participation in any transaction 
in which the transaction's net effect is not accurately 
disclosed to a company's investors and analysts.
    The second panel consisted of Chase officials who were 
directly involved in the Slapshot transaction, as well as 
senior officials responsible for setting Chase's corporate 
policy. The Chase officials were Michael E. Patterson, Vice 
Chairman of J.P. Morgan Chase & Co.; Andrew T. Feldstein, 
Managing Director and Co-Head of Structured Products and 
Derivatives Marketing at J.P. Morgan Chase & Co.; Robert W. 
Traband, Vice President of Chase in Houston; and Eric N. 
Peiffer, Vice President of Chase in New York. Mr. Peiffer 
played a key role in developing and marketing the Slapshot tax 
structure. Mr. Peiffer and Mr. Traband dealt directly with 
Enron to design and carry out the Slapshot transaction examined 
in this report. Mr. Feldstein, who was not directly involved in 
Slapshot and is the new head of the Chase division carrying out 
structured finance and derivatives transactions, described 
Chase's renewed commitment to the principles of integrity and 
transparency in its structured finance and derivative 
transactions. Mr. Patterson, who was also not directly involved 
in Slapshot, described a number of Chase's post-Enron reforms, 
including a new transaction review committee, which he heads, 
to prevent Chase's participation in transactions that 
facilitate deceptive accounting or carry other reputational 
risks. The Chase witnesses also testified at the hearing that 
Chase would no longer market the Slapshot tax structure or 
participate in transactions similar to Slapshot.
    The third panel at the hearing consisted of testimony from 
Muriel Siebert, who was the first woman member of the New York 
Stock Exchange, the first woman Supervisor of Banking for the 
State of New York, and the current owner and president of a 
brokerage house. Ms. Siebert testified that, since Enron's 
collapse, her business had seen individual investors leave the 
stock market altogether because ``they did not trust the 
system.'' She expressed great concern about the deceptive 
transactions discussed in the hearing and the need to initiate 
reforms to prevent U.S. financial institutions from 
facilitating deceptive accounting or tax transactions.
    The fourth and final panel consisted of top Federal 
regulators at the Federal Reserve, Securities and Exchange 
Commission (``SEC''), and Office of the Comptroller of the 
Currency (``OCC''). The witnesses were Richard Spillenkothen, 
Director of the Division of Banking Supervision and Regulation 
at the Federal Reserve; Annette Nazareth, Director of the 
Division of Market Regulation at the SEC; and Douglas W. 
Roeder, Senior Deputy Comptroller for Large Bank Supervision at 
the OCC. These witnesses indicated that a relatively small 
universe of financial institutions--for example, less than ten 
of the national banks overseen by the OCC--engage in the type 
of complex structured finance transactions examined in this 
report. They also acknowledged a regulatory gap that now exists 
in overseeing these transactions, since the SEC does not 
generally regulate banks, and the bank regulators do not 
generally oversee accounting practices. All three witnesses 
agreed with the testimony of the Federal Reserve that banks 
should not ``engage in borderline transactions that are likely 
to result in significant reputational or operational risks to 
the banks.'' The witnesses also described their existing 
regulatory efforts to address the issues raised in the hearing 
and their plans for additional actions in the future. Among 
other measures, the Federal Reserve has begun a review of 
structured finance products which it plans to complete within a 
few months. All three witnesses expressed a readiness to 
consider joint efforts to prevent U.S. financial institutions 
from aiding or abetting accounting fraud by their clients.

SUBCOMMITTEE RECOMMENDATIONS

    The four transactions discussed in this report, Fishtail, 
Bacchus, Sundance, and Slapshot, are examples of the complex, 
deceptive transactions that have become Enron's signature. None 
of the four could have been completed without the backing and 
active participation of a major financial institution willing 
to facilitate a client's deceptive accounting or tax 
transactions. The evidence compiled in this report and the 
December hearing, as well as in the two earlier Subcommittee 
hearings in July, show that some major U.S. financial 
institutions deliberately misused structured finance techniques 
to help Enron engage in deceptive accounting or tax strategies, 
and were rewarded with millions of dollars in fees or favorable 
consideration in other business dealings. The resulting loss of 
investor confidence in the honesty and integrity of U.S. 
companies and financial institutions is an ongoing problem that 
requires additional attention and action.
    Based upon the evidence before it, including more than two 
million pages of subpoenaed documents; numerous interviews with 
Enron, Andersen, Citigroup, Chase, Merrill Lynch, and other 
parties; consultations with multiple finance, accounting, and 
tax experts; and the records associated with the Subcommittee 
hearings on July 23, July 30, and December 11, 2002, the U.S. 
Senate Permanent Subcommittee on Investigations makes the 
following recommendations.

    L(1) Joint Review of Structured Finance Products and 
Transactions. The Federal Reserve, OCC, and SEC should 
immediately initiate a one-time, joint review of banks and 
securities firms participating in complex structured finance 
products with U.S. public companies to identify those 
structured finance products, transactions, or practices which 
facilitate a U.S. public company's use of deceptive accounting 
in its financial statements or reports. By June 2003, these 
agencies should issue joint guidance on acceptable and 
unacceptable structured finance products, transactions and 
practices. By the end of 2003, the Federal Reserve, OCC and SEC 
should each take all necessary steps to ensure the financial 
institutions they oversee have stopped participating in 
unacceptable structured finance products, transactions, or 
practices.

    L(2) SEC Policy Statement: The SEC should issue a 
regulation, guidance, or other policy document stating that it 
is the SEC's policy to take enforcement action against a 
financial institution that offers a deceptive financial product 
to, or participates in a deceptive financial transaction with, 
a U.S. publicly traded company, thereby aiding or abetting that 
company's inclusion of material false or misleading information 
in its financial statements or reports.

    L(3) Unsafe and Unsound Practice: Upon issuance of an SEC 
regulation, guidance or other policy statement under 
Recommendation (2), the Federal Reserve and OCC should promptly 
instruct their bank examiners, as part of their routine bank 
examinations, to evaluate a bank's structured finance 
activities to determine whether such activity appears to 
constitute a violation of the SEC policy and, if so, to declare 
that activity also constitutes an unsafe and unsound banking 
practice. In addition, the Federal Reserve and OCC should 
instruct their bank examiners to utilize the agency's full 
panoply of regulatory and enforcement tools to require any such 
bank to cease engaging in any such unsafe and unsound practice. 
In this way, for the first time, Federal bank regulators will 
be able to exercise regulatory authority within their 
jurisdiction to deter banks from aiding or abetting deceptive 
accounting, because such activities will constitute an unsafe 
and unsound banking practice. In addition, such Federal Reserve 
and OCC actions will help ensure that a meaningful mechanism is 
introduced into routine Federal bank examinations to deter 
banks' future misuse of structured finance transactions that 
aid or abet deceptive accounting.
      

                                   - 
