Do You Remember JP Morgan Chase & The Enron Scandal?

SEC Settles Enforcement Proceedings against J.P. Morgan Chase and Citigroup

J.P. Morgan Chase Agrees to Pay $135 Million to Settle SEC Allegations that It Helped Enron Commit Fraud

Citigroup Agrees to Pay $120 Million to Settle SEC Allegations that It Helped Enron and Dynegy Commit Fraud

Washington, D.C., July 28, 2003 -- The Securities and Exchange Commission today instituted and settled enforcement proceedings against two major financial institutions, J.P. Morgan Chase & Co. and Citigroup, Inc., for their roles in Enron Corp.'s manipulation of its financial statements. Each institution helped Enron mislead its investors by characterizing what were essentially loan proceeds as cash from operating activities. The proceeding against Citigroup also resolves the Commission's charges stemming from the assistance Citigroup provided Dynegy Inc. in manipulating that company's financial statements through similar conduct.

As to J.P. Morgan Chase, the Commission filed a civil injunctive action in U.S. District Court in Texas. Without admitting or denying the Commission's allegations, J.P. Morgan Chase consented to the entry of a final judgment in that action that would (i) permanently enjoin J.P. Morgan Chase from violating the antifraud provisions of the federal securities laws, and (ii) order J.P. Morgan Chase to pay $135 million as disgorgement, penalty, and interest.

As to Citigroup, the Commission instituted an administrative proceeding and issued an order making findings and imposing sanctions. Without admitting or denying the Commission's findings, Citigroup consented to the issuance of the Commission's Order whereby Citigroup (i) was ordered to cease and desist from committing or causing any violation of the antifraud provisions of the federal securities laws, and (ii) agreed to pay $120 million as disgorgement, interest, and penalty. Of that amount, $101 million pertains to Citigroup's Enron-related conduct and $19 million pertains to the Dynegy conduct.

The Commission intends to direct the money paid by J.P. Morgan Chase and Citigroup to fraud victims ($236 million to Enron fraud victims and $19 million to Dynegy fraud victims) pursuant to the Fair Fund provisions of Section 308(a) of the Sarbanes-Oxley Act of 2002.

"These two cases serve as yet another reminder that you can't turn a blind eye to the consequences of your actions — if you know or have reason to know that you are helping a company mislead its investors, you are in violation of the federal securities laws," said Stephen M. Cutler, Director of SEC's Enforcement Division. His deputy, Linda Chatman Thomsen, added: "As today's actions illustrate, we intend to continue to hold counter-parties responsible for helping companies manipulate their reported results. Financial institutions in particular should know better than to enter into structured transactions where the structure is determined solely by accounting and reporting wishes of a public company."

J.P. Morgan Chase and Citigroup engaged in, and indeed helped their clients design, complex structured finance transactions. The structural complexity of these transactions had no business purpose aside from masking the fact that, in substance, they were loans. As alleged in the charging documents, by engaging in certain structural contortions, these financial institutions helped their clients: (1) inflate reported cash flow from operating activities; (2) underreport cash flow from financing activities; and (3) underreport debt. As a result, Enron and Dynegy presented false and misleading pictures of their financial health and results of operations. Significantly, with respect to Enron, both financial institutions knew that Enron engaged in these transactions specifically to allay investor, analyst, and rating agency concerns about its cash flow from operating activities and outstanding debt. Citigroup knew that Dynegy had similar motives for its structured finance transaction.

As alleged by the Commission, these institutions knew that Enron engaged in the structured finance transactions that are the subject of today's Commission actions to match its so-called mark-to-market earnings (paper earnings based on changes in the market value of certain assets held by Enron) with cash flow from operating activities. As alleged, by matching mark-to-market earnings with cash flow from operating activities, Enron sought to convince analysts and credit rating agencies that its reported mark-to-market earnings were real, i.e., that the value of the underlying assets would ultimately be converted into cash.

The Commission further alleges that these institutions also knew that these structured finance transactions yielded another substantial benefit to Enron: they allowed Enron to hide the true extent of its borrowings from investors and rating agencies because sums borrowed in these structured finance transactions did not appear as "debt" on Enron's balance sheet. Instead they appeared as "price risk management liabilities," "minority interest," or otherwise. In addition, Enron's obligation to repay those sums was not otherwise disclosed.

Specifically as to J.P. Morgan Chase, the Commission's allegations stem from J.P. Morgan Chase's participation in so-called prepay transactions with Enron which were loans disguised as commodity trades to achieve Enron's reporting and accounting objectives. These prepays were in substance loans because their structure eliminated all commodity price risk that would normally exist in commodity trades. This was accomplished through a series of trades whereby Enron passed the commodity price risk to a J.P. Morgan Chase-sponsored special purpose vehicle, which passed the risk to J.P. Morgan Chase, which, in turn, passed the risk back to Enron. While each step of this structure appeared to be a commodity trade, with all elements of the structure taken together, Enron received cash upfront and agreed to future repayment of that cash with negotiated interest. The interest amount was set at the time of the contract, was calculated with reference to LIBOR, and was independent of any changes in the price of the underlying commodity. The only risk in the transactions was J.P. Morgan Chase's risk that Enron would not make its payments when due, i.e., credit risk.

The Commission's action with respect to Citigroup also stems from certain prepay transactions with Enron that, while structured somewhat differently than the Chase transactions, had the same overall purpose and effect. Like the J.P. Morgan Chase prepays, the Citigroup prepays passed the commodity price risk from Enron to a Citigroup-sponsored special purpose vehicle to Citigroup and back to Enron. As in the J.P. Morgan Chase prepays, Enron's future obligations under the Citigroup prepays consisted of repayments of principal and interest that were independent of any changes in the price of the underlying commodity.

Additionally, the Commission's action against Citigroup is based on two other transactions with Enron, Project Nahanni and Project Bacchus, each of which was also a structure that transformed cash from financing into cash from operations. As the Commission found, in project Nahanni, Citigroup knowingly helped Enron structure a transaction, that allowed Enron to generate cash from operating activities by selling Treasury bills bought with the proceeds of a loan. Project Bacchus was structured by Enron as a sale of an interest in certain of its pulp and paper businesses to a special purpose entity capitalized by Citigroup with a $194 million loan and $6 million in equity. According to the Commission, however, in substance, Project Bacchus was a $200 million financing from Citigroup, because Citigroup was not at risk for its equity investment in the project.

The Citigroup action also contains findings relating to a transaction with Dynegy — Project Alpha — which was a complex financing that Dynegy used to borrow $300 million. According to the Commission's findings, Citigroup knew that Dynegy implemented Alpha to address the mismatch between its mark-to-market earnings and operating cash flow, and that it characterized as cash from operations what was essentially a loan transaction. As Citigroup knew, Dynegy, too, was concerned that the mismatch between earnings and cash flow from operations would raise questions about the quality of Dynegy's earnings and its ability to sustain those earnings.

In determining to settle its action against Citigroup, the Commission took into account Citigroup's cooperation with the Commission's investigation, as well as its timely efforts to resolve the matter.

The Commission brought its Enron-related actions in coordination with the New York County District Attorney's Office, which, also today, entered into settlement agreements with J.P. Morgan Chase and Citigroup.

The Commission also acknowledges the assistance of the Federal Reserve Bank of New York, the Office of the Comptroller of the Currency, and the New York State Banking Department in connection with today's Enron-related actions. Today, the Federal Reserve Bank of New York and the Office of the Comptroller of the Currency entered into separate written agreements with Citigroup. The Federal Reserve Bank of New York and the New York State Banking Department entered into a written agreement with J.P. Morgan Chase. These agreements, between the institutions and their primary banking regulators, obligate them to enhance their risk management programs and internal controls so as to reduce the risk of similar misconduct.

With these two actions, the Securities and Exchange Commission has raised to six the total number of separate actions it has brought in connection with the Enron matter in the twenty months since Enron declared bankruptcy. The various defendants and respondents include three major financial institutions, Enron's former Chief Financial Officer, and eight other former senior Enron executives. The commission has so far garnered $324 million for the benefit of the victims of the Enron fraud.

The Commission's investigations relating to Enron and Dynegy are continuing.

For further information contact:

Linda Chatman Thomsen, Deputy Director, Division of Enforcement — (202) 942-4501
Harold F. Degenhardt, District Administrator, Fort Worth District Office — (817) 978-6469
Charles J. Clark, Assistant Director, Division of Enforcement — (202) 942-4731

Additional Materials Available at

See Also: SEC v. J.P. Morgan Chase (Litigation Release No. 18252); In the Matter of Citigroup, Inc. (Securities Exchange Act of 1934 Release No. 34-48230; Accounting and Auditing Enforcement Release No. 1821; Administrative Proceeding File No. 3-11192)