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The Surety Thing

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Memos between reinsurer General Re and Chubb & Son Inc., for instance, suggest that at least some insurers were aware that transactions of the kind underwritten for Enron and Morgan Chase served primarily "to raise low-cost capital that does not show up as a loan on the borrower's balance sheet."

Moreover, an internal memo from Kemper Insurance dated April 26, 2001 (and later obtained by J.P. Morgan Chase) seems to show that Kemper employee James Crinnion considered the outstanding surety bonds to be quite risky.

Farther down in the note, however, Crinnion concedes that Enron's stature makes it a risk worth taking. "From all accounts Enron is a large enough account with a strong balance sheet, cash flow and available credit facilities to warrant Kemper to issue such onerous bonds," Crinnion wrote. "Based on Enron's financial strength I would recommend these long-tail financial guarantees as an acceptable risk on a going forward basis."

But, Crinnion added, "I would not recommend we write these types of obligations in the future."

According to Robert Roach, chief investigator for the Senate subcommittee, Enron received a total of approximately $8 billion in pre-paid financing over six years from J.P. Morgan Chase and Citigroup. "Enron's practice of using prepay transactions to understate debt and overstate cash flow from operations made its financial statement look much stronger," Roach noted in his testimony on Tuesday.

But a Salomon Smith Barney banker who helped set up the structure and issue the bonds which Citigroup used to extend trade-related financing to Enron, says the deals did not seem unusual to her. In testimony on Tuesday, Maureen Hendricks, a senior advisor from Salomon Smith Barney, said she "had absolutely no reason to believe that there was anything wrong with… Enron's accounting treatment [of the transactions]." Although she says she knew that Enron's obligations would not be recorded as debt, and the cash would be treated as coming from operations and not from finanancing, she accepted the fact that "Arthur Andersen had fully vetted the accounting treatment."

Hendricks went on to intimate that Citigroup bankers had been taken in by the accounting at Enron. "It appears that the audited financial statements, upon which we relied, were not accurate and did not fairly present Enron's financial condition," she told lawmakers.

But some observers found that comment puzzling. As Roach noted, in 2000 (the last year Enron submitted a 10-K to the SEC), the Houston-based trading company's numbers would have looked substantially worse -- without help from the transactions set up by Salomon Smith Barney, Citigroup, and JP MorganChase.

"If Enron had properly accounted for these transactions," Roach testified, "its total debt would have increased by about 40 percent to about $14 billion, and its funds flow from operations would have dropped by almost 50 percent, to about $1.7 billion." He added: "These are dramatic changes."

Editor's note: To read more about the role of banks in Enron's prepaid transactions, click here.