LATER this month, sometime before Halloween, lawyers for Barclays and Royal Bank of Scotland will be taken to jail to meet one of the most notorious corporate fraudsters of the era. What they hear may be truly frightening.
Andrew Fastow, former chief financial officer of Enron, has just begun a six-year sentence for his role in the Texan energy firm’s spectacular implosion.
Before he was sentenced Fastow gave a 175-page insider account of how he claims the two British banks and others helped to prop up Enron’s house of cards. Fastow’s account, if true, could make the banks liable for $30 billion in losses being sought by Enron’s shareholders. In the coming weeks he will flesh out that account to lawyers representing those shareholders and representatives of the banks.
Leading the shareholders’ suit is Bill Lerach, one of the most colourful and successful lawyers in America. With his mop of white curly hair, Lerach looks like a well-fed Harpo Marx. A Robin Hood to some, a thug to others, Lerach has won billions from companies he has accused of ripping off shareholders. His hard-fighting style has often led to his opposition cutting a deal before going to court.
Armed with Fastow’s deposition, Lerach said the British banks are “doomed to lose”. “If they want to be smart and pay up, we are happy to settle. If they want to go to the gallows in front of a Houston jury, they can be my guest,” said Lerach.
His firm, Lerach Coughlin, has won $8 billion in settlements from Enron’s other banks. In his deposition Fastow described RBS, Barclays and Enron’s other favoured banks as “problem solvers” and claims that in some instances it was they who primarily devised the schemes that helped Enron to inflate its profits figures falsely.
So far Barclays, Royal Bank of Scotland, Credit Suisse and Merrill Lynch have refused to settle. All deny any wrongdoing.
“The plaintiff is using a statement made by Andrew Fastow. This is what plaintiff attorneys in class actions do to try and raise more money. Mr Fastow is a convicted felon who made his statement as part of his effort to reduce his sentence. This is what convicted felons do . . . None of this has anything to do with the legalities or real issues in the case,” said Barclays.
Fastow’s statement could bring further pressure to bear on the “NatWest Three” — the British bankers extradited to the US in July. They are accused by US authorities of pocketing $7.3m in a fraudulent scheme cooked up with Fastow. According to Fastow, Gary Mulgrew, Giles Darby and David Bermingham helped him to structure transactions when they were at Royal Bank of Canada (RBC). Fastow is expected to be the star witness at their trial.
Of the banks still under fire, Barclays holds the strongest position. In July US judge Melinda Harmon dismissed Barclays from the case. She said Enron was mainly responsible for misrepresenting the transactions in its filings and the bank was at most “a culpable aider and abettor”. Lerach is appealing against that decision with the aid of Fastow’s account.
Barclays’ involvement centres on some of the most quintessential deals leading to Enron’s collapse — deals that highlight both the nerdy quality of the energy giant’s executives and their willingness to play fast and loose with the rules.
According to court documents and Fastow’s testimony, in late 1997 Enron’s executives learnt that an outside investor was going to quit a joint-venture investment vehicle the two had set up. Joint Energy Development Incorporated — or Jedi, in homage to Star Wars — generated 40% of Enron’s profits in 1997.
Because it was treated as a separate entity for accounting purposes, Enron did not have to carry its huge debts on its books — $700m. The investor’s exit would force Enron to write off those profits and acknowledge the debts. A new investor was created with the help of Arthur Andersen, Enron’s accountant, Barclays and Vinson & Elkins, Enron’s lawyer. This vehicle was called Chewco, after the sci-fi films’ Chewbacca character.
Barclays lent Chewco $240m and a further $11.4m to two other entities, Little River and Big River, that bought 3% of Chewco. The purchase legitimised Chewco’s claim to be an entity independent of Enron. Fastow alleges that he guaranteed Barclays that its investment would be returned. With no money at risk, Barclays was not really creating a new investment company, just loaning Enron cash, according to Lerach.
The financial jiggery pokery allowed Enron to claim falsely that it had a new “outside” investor and boost its 1997 profits by $45m while keeping the $700m of debt off the books, Lerach claims.
RBS is still a defendant in the case. There have been persistent rumours that the bank, which denies any wrongdoing, is close to cutting a deal with shareholders. The pressure to settle is twofold for RBS. First there are the bank’s own dealings with Enron, then there are the NatWest Three, whose legacy RBS inherited when it bought the British bank in 2000.
Lerach Coughlin has files of embarrassing internal e-mails and documents concerning RBS’s dealings with Enron. According to the lawyers, in one deal RBS was instrumental in the sale of a failing power plant in Brazil that, the legal brief claims, Fastow described as “a piece of shit no-one would buy”. The sale created $84m in “fictitious income for Enron, while hiding $200m in debt”, according to the legal brief.
These and other transactions were structured to provide RBS with “excess economic returns, above what would have been earned in ordinary course of business arm’s-length transactions. These excessive returns were, in fact, a payoff to RBS for engaging in the scheme and taking the legal risks involved in such unlawful conduct”, according to legal briefs submitted to Judge Harmon.
In a spookily prescient memo one RBS manager wrote that “the scale of financial period manipulation is exceedingly worrying”. He was concerned that “any bad news . . . will cut refinance ability dramatically and/or end Enron’s ability to manipulate, thus leading to a horrendous on-balance-sheet position which would further exacerbate the position. The question is when do we stop!” But, said Lerach, they chose not to stop. Neither will he.
