DoJ forces Merrill to disclose future structured product deals

In a deal struck with the US Department of Justice (DoJ) over charges of conspiracy with Enron, Merrill Lynch has agreed sweeping reforms that will require all complex structured finance transactions effected by a third party with the bank to be authorised by a new Special and Structured Products Committee (SSPC).

In addition, the bank has agreed for the SSPC to be monitored for 18 months by an independent auditing firm. At the same time, a DoJ-selected attorney will review and oversee the work of the auditing firm. Merrill Lynch has declined to comment on any aspect of the deal.

The co-operation agreement arose after three former Merrill executives were indicted today by a federal grand jury on charges of conspiracy to commit wire fraud and falsify books and records. Merrill Lynch has accepted responsibility for the conduct of the three defendants – Daniel Bayly, former head of global investment banking; James Brown, head of Merrill’s strategic asset lease and finance Group; and Robert Furst, the Enron relationship manager for Merrill Lynch in the investment banking division. All three surrendered to the FBI in Houston today.

According to the indictments, Enron attempted unsuccessfully in 1999 to sell an interest in electricity-generating power barges moored off the coast of Nigeria. Enron then arranged for Merrill Lynch to serve as a temporary buyer so Enron could record earnings and cashflow in 1999, making Enron appear more profitable than it was. Merrill’s purchase of the Nigerian barges allowed Enron to improperly boost its reported earnings by $12 million in earnings and its funds flow by $28 million in the fourth quarter of 1999.

The indictment alleges Enron promised Merrill Lynch that it would receive a return of its investment plus an agreed-upon profit within six months - a verbal agreement that was not disclosed in the written contact used by Enron’s internal and external accountants to determine the accounting treatment of the deal. Specifically, Enron promised in a verbal “handshake” side deal that Merrill would receive a rate of return of approximately 22% and that Enron would sell the barges to a third party or repurchase the barges within six months. That agreement meant Merrill Lynch’s supposed equity investment in the barges was not truly “at risk” and did not qualify as a sale from which earnings and cashflow could be recorded.

On June 29, 2000, having found no true third-party purchaser to buy Merrill Lynch’s interest in the barges, Enron arranged for a special-purpose entity known as LJM2, owned and operated by Andrew Fastow, to purchase Merrill Lynch’s interest for $7,525,000 - fulfilling the side agreement.