Speech by SEC Staff:
Remarks To Announce the Filing of
SEC v. Merrill Lynch, et al.
Stephen M. Cutler
Director, Division of Enforcement
U.S. Securities & Exchange Commission
March 17, 2003
As alleged in our complaint, at the end of 1999, Merrill Lynch and four of Merrill's senior executives aided and abetted the fraudulent manipulation of Enron's financial statements. They did so through two transactions designed to make Enron's performance look better than it actually was. Merrill Lynch has agreed to a settlement calling for the entry of a permanent anti-fraud injunction against the firm and a payment totaling $80 million -- $37.5 million in disgorgement, $37.5 million in penalties, and $5 million in pre-judgment interest. The $37.5 million penalty is one of the largest ever imposed in a Commission action. Pursuant to the Sarbanes-Oxley Act, we intend to add this penalty amount to the disgorgement and interest amounts for a distribution fund for the benefit of the victims of Enron's fraud. The Commission is litigating the case against the four individuals.
The first of the two transactions at issue involved what was in essence an "asset parking" arrangement. Merrill Lynch agreed to take off of Enron's hands - and allow Enron to record $12 million in profits from the "sale" of - Enron's interest in some Nigerian barges. In reality, the risk of ownership on these barges never left Enron's hands at all. The sale of the barges was a sham. Here's how it worked: On December 29, 1999, Merrill Lynch bought an interest in the barges from Enron with an express understanding that Enron would arrange for the sale of this interest by Merrill Lynch within six months at a specified rate of return - if not to a third-party, then back to Enron itself. As an email between two Enron executives put it: "Should a strategic buyer not materialize by June 30, 2000, [Enron] will have to take out ML." The email went on to say: "As you know, ML's decision to purchase the equity was based solely on personal assurances by Enron senior management to ML's Vice Chairman that the transaction would not go beyond June 30, 2000." The same understanding was memorialized in Merrill's own internal documents. One such document noted that Enron "assured us that we will be taken out of our investment within six months" and added that Merrill's Vice Chairman would be calling Enron's senior management to "confirm this commitment to guarant[ee] the ML takeout within six months." Merrill Lynch entered into this transaction solely to accommodate Enron and protect the firm's lucrative financial relationship with its client. Merrill didn't have any use for the barges themselves. The group at Merrill that handled the transaction had no experience in dealing with Nigeria or, for that matter, Africa, and did no due diligence on the barges. Given all this, some within Merrill actually expressed concern about Enron's proposed treatment of the transaction as a sale, and more pointedly, concern that Merrill Lynch could appear to be aiding and abetting Enron's earnings manipulation. Nevertheless, Merrill went forward with the transaction. Six months later, consistent with the understanding reached back in December 1999, Enron arranged to take Merrill Lynch out of the barge deal at the agreed-upon rate of return.
The second of the two transactions involved an exchange of offsetting energy options. On December 29, 1999, Enron sold to Merrill Lynch a physically settled call option. Simultaneously, Merrill Lynch sold to Enron a financially settled call option. The terms of the options were virtually identical. As one contemporaneous Merrill Lynch memorandum put it: "The quantities, pricing points, market locations and term are 'mirror image.'" Or as another internal Merrill memo put it, the proposed transaction was "delta neutral." The purpose and effect of these two transactions for Enron -- and Merrill understood this -- was to allow Enron to report an additional $50 million of income and achieve its year-end earnings target. Because of its importance in this regard, Enron was willing to pay Merrill Lynch $17 million to enter into the transaction. Merrill Lynch, in essence, was to be paid a $17 million fee for helping Enron cook its books. Only two months later, Enron agreed to unwind the transaction and ended up paying Merrill half of the $17 million fee. In connection with the unwinding of the transaction, a Merrill Lynch email, written by defendant Schuyler Tilney, stated that Enron's desire to unwind the transaction was not surprising and acknowledged: "We were clearly helping them make earnings for the quarter and year (which had great value in their stock price, not to mention personal compensation)."
The four former executives named in the Commission's complaint are Schuyler Tilney, the former Global Head of the Energy and Power Group, Robert Furst a former Managing Director, Daniel Bayly, the former Chairman of Investment Banking, and Thomas Davis, the former Vice Chairman of Private Equity and Research. The complaint alleges specific conduct by each of the defendants with respect to the parking transaction and by Messrs. Furst and Tilney with respect to the sham energy transaction. With respect to all four individuals, the Commission is seeking permanent injunctions against future violations of the federal securities laws, officer and director bars, and penalties.
I would like to recognize the staff of the Federal Energy Regulatory Commission for its assistance in the Commission's investigation.
I would also like to commend and thank the Justice Department Enron Task Force for its close cooperation with the Commission's Enforcement Division on this matter and on the continuing Enron investigation. This cooperation is a perfect example of different government agencies working together to restore investors' confidence in our financial markets.
I want to thank the Commission and Chairman Donaldson for their leadership and commitment to aggressive enforcement.
I want to thank our entire enforcement Enron team, and especially those responsible for today's action, Deputy Director Linda Thomsen, Assistant Director Charles Clark, Associate Chief Accountant Regina Barrett, Assistant Chief Litigation Counsel Lou Mejia, Branch Chief Alex Lipman, Branch Chief Doug Paul, and Senior Counsel Kevin Loftus, for their hard work and dedication.
Finally, in case there is any doubt, our investigation is continuing.