Andrew Fastow and the LJM partnerships

analysisEnron’s Form 8-K of November 8, 2001 described LJM Cayman, L.P. (LJM1) and LJM2 Co-Investment, L.P. (LJM2) as private investment limited partnerships formed in 1999. Andrew S. Fastow, then Enron’s Executive Vice President and Chief Financial Officer, was the managing member of the general partners of both from their inception through July 2001. Enron stated that it believed the initial capital commitments to LJM1 were $16 million and the aggregate capital commitments to LJM2 $394 million; that the general partners were entitled to annual management fees and to a share of profits above their portion of contributed capital; and that the limited partners included a significant number of institutions and other investors that were not related parties to Enron. According to the July 8, 2002 report of the Senate Permanent Subcommittee on Investigations, which drew on the Powers Committee report, LJM1 was organized as a Cayman Islands limited partnership and LJM2 as a Delaware limited partnership. In each, the general partner that ran the fund day to day was wholly owned by Fastow through a complex set of intermediaries, while most limited partners were third-party investors such as banks, pension funds and insurance companies. LJM3, a third entity approved by Enron’s Board, never became active. ^{1 2}

analysisThe SEC alleged in its August 2002 complaint against Michael Kopper, which Kopper settled without admitting or denying the allegations, that Enron’s Chief Financial Officer invested $1 million in LJM Cayman and was granted a limited waiver of Enron’s conflict-of-interest rules so that he could run it as general partner. LJM Cayman had two limited partners, an entity owned by Credit Suisse First Boston and an entity owned by National Westminster Bank (NatWest), each of which invested $7.5 million. Enron’s November 2001 Form 8-K stated that, before approving Fastow’s affiliation with LJM1 and LJM2, the Board determined that his participation would not adversely affect Enron’s interests and approved the initial LJM1 transaction. The Board required each transaction to be reviewed and approved by the Office of the Chairman, the Chief Accounting Officer and the Chief Risk Officer, recognized the Chairman’s ability to require Fastow to resign from the partnerships, and directed annual Audit and Compliance Committee reviews. The 8-K noted that whether these controls were properly implemented was under investigation by the Board’s Special Committee; the Powers Committee later concluded that the controls as designed were not rigorous enough and that their implementation and oversight were inadequate at both management and Board levels. ^{3 4 1 5}

analysisThe Senate Permanent Subcommittee on Investigations found in its report of July 8, 2002 that Enron’s Board, with little debate or independent inquiry, approved three code-of-conduct waivers allowing Fastow to establish the LJM1, LJM2 and LJM3 private equity funds in 1999 and 2000, the last in October 2000 with even less debate. It concluded that the Board knew the partnerships were designed to do business primarily with Enron but failed to make the controls effective, and that the partnerships realized hundreds of millions of dollars in profits at Enron’s expense. These are congressional findings, not judicial ones. At the Subcommittee’s hearing, directors Herbert Winokur and Robert Jaedicke contended that the Board had not actually waived the code of conduct but had applied it in the LJM matters. ²

analysisAccording to the Senate Permanent Subcommittee on Investigations, the Finance Committee approved LJM2 at a 90-minute meeting on October 11, 1999 and the full Board approved it on October 12, 1999. By then Fastow had already completed negotiations with Merrill Lynch on an LJM2 marketing strategy and had approved an LJM2 private placement memorandum, which Merrill Lynch released on October 13, 1999, one day after the Board meeting. According to the Subcommittee, no Board member recalled reviewing the memorandum; had they done so, directors would have learned that it named as LJM2 principals not only Fastow but also two other senior Enron financial officers working for him, Michael Kopper and Ben Glisan, neither of whom had obtained a code-of-conduct waiver, and that it promoted the officers’ inside access to Enron information and deal flow. These are congressional findings, not judicial ones. Winokur testified at the Subcommittee’s hearing that the Finance Committee had been told that Enron’s legal counsel, Vinson & Elkins, had reviewed the memorandum and that it relied on the firm to alert the Board to any problems; he indicated that the firm never told the Board anything was amiss. ²

analysisEnron’s Form 8-K of November 8, 2001 stated that from June 1999 through September 2001 Enron and Enron-related entities entered into 24 business relationships in which LJM1 or LJM2 participated. They included asset sales between Enron and LJM2, LJM purchases of debt or equity in Enron-sponsored special purpose entities (SPEs) and Enron affiliates, LJM equity investments in SPEs designed to mitigate market risk in Enron’s investments, a call and a put option sold by LJM2, and a subordinated loan to LJM2 from an Enron affiliate. For the period from June 1999 through June 2001 the Powers Committee counted more than 20 distinct transactions with the LJM partnerships, and the staff of the Joint Committee on Taxation (JCT) approximately 20 purported asset sales or hedging transactions in the same period. The JCT staff described the partnerships as off-balance-sheet SPEs established by Enron employees to transact business with Enron and improve its financial statements, and said the LJM hedges were accounting hedges rather than economic hedges. These are descriptions in the two reports, not judicial findings. ^{1 2 3}

analysisThe Senate Permanent Subcommittee on Investigations reported that over two years Enron entered into more than two dozen transactions with LJM1 and LJM2: sales of turbines, Nigerian barges and dark fiber to LJM2; LJM participation in Whitewing and the Osprey debt certificates; purchases of interests in Enron power plants in Brazil, Poland and elsewhere; LJM2’s purchase of two tranches of Enron North America credit-linked obligations; two prepay transactions; and the four Raptors. It found that the first seven LJM2 deals, all in 1999, were sales of poorly performing Enron assets; that is a congressional finding, not a judicial one. Enron’s November 2001 Form 8-K described the dark fiber sale: in June 2000 LJM2 bought dark fiber optic cable from Enron for $100 million, paying $30 million in cash and a $70 million interest-bearing note, and Enron recognized $67 million of pre-tax earnings in 2000 on the sale. LJM2 resold part of the fiber for $40 million and the rest for $113 million in December 2000 to an SPE, repaid the note and earned $2.4 million; an Enron credit-support derivative left Enron with $61 million of remaining exposure. ^{4 5 1}

analysisLJM1’s first transaction, approved by the Board in June 1999 together with Fastow’s participation in LJM1, was described by the Powers Committee and the JCT staff as a purported hedge of Enron’s stake in Rhythms NetConnections, bought at the initial public offering for $10 million and later worth over $300 million. Enron transferred its own stock to an SPE in exchange for a note, with LJM1 supplying the outside equity, and recognized after-tax income of $95 million from the Rhythms investment in 1999. Andersen, which had approved the transaction, admitted that it erred in concluding that the Rhythms transaction was structured properly under the SPE non-consolidation rules; according to the Powers Committee, Andersen’s CEO told Congress that the firm had simply been wrong in 1999. In 2001 Enron and Andersen concluded that the LJM1 SPE failed the outside-equity requirement. In its November 8, 2001 Form 8-K Enron stated that the wholly owned LJM1 subsidiary that had entered into derivative transactions to hedge Enron’s Rhythms investment, identified in the SEC’s complaint against Kopper as LJM Swap Sub, did not qualify for non-consolidation because of inadequate capitalization and should have been consolidated from 1999; the restatement reduced Enron’s net income by $95 million for 1999 and $8 million for 2000. ^{2 3 1}

analysisAccording to the SEC’s complaint against Kopper, in June 1999 LJM Cayman’s subsidiary LJM Swap Sub, L.P. issued Enron a put option on its Rhythms NetConnections shares. Because Swap Sub was capitalized primarily with Enron shares, it could not have paid on the option if Enron’s stock fell below a certain price. In 2000 Enron paid $30 million to unwind the banks’ interests in Swap Sub, purportedly allocated $20 million to NatWest and $10 million to CSFB. These are allegations, which Kopper settled without admitting or denying. Enron’s November 8, 2001 Form 8-K stated that Kopper was the controlling partner of a limited partnership that, through another limited partnership, bought interests in affiliated subsidiaries of LJM1 in March 2000; the Senate Subcommittee later identified the buyer as Southampton. Four of its six limited partners were then Enron officers or employees, including Treasurer Ben Glisan, and a fifth was an entity associated with Fastow. Enron said it was terminating the employment of Glisan and of another of them, a division general counsel. ^{6 7 1 4}

analysisThe Powers Committee found that the 2000 termination of the Rhythms hedge, negotiated between Enron and LJM1 through Fastow, was extraordinarily generous to LJM1’s investors, and that Fastow had offered interests in it to Kopper and four other Enron employees through a partnership called Southampton Place. For a $25,000 investment Fastow received, through a family foundation, $4.5 million in about two months; two employees who each invested $5,800 received $1 million each. The Committee saw no evidence of the clearance required by Enron’s Code of Conduct. These are a board committee’s conclusions, not court findings, and Fastow and Kopper declined to be interviewed by the Committee, entirely or on most issues. ³

analysisThe SEC alleged in its August 2002 complaint against Kopper that in about February 2000 Kopper, three NatWest bankers and others caused Enron to pay $20 million for NatWest’s interest in the LJM Cayman partnership assets while paying NatWest only $1 million. The three bankers allegedly received about $7.3 million; the balance went to investors in Southampton, which Kopper created: Kopper ($4.5 million), a purported charitable foundation in the name of the CFO’s family ($4.5 million) and five other individuals, four of them Enron employees, who received between about $400,000 and $1 million each. Kopper settled the SEC action without admitting or denying the allegations, agreeing to disgorge and forfeit about $12 million, and pleaded guilty in August 2002 to conspiracy to commit wire fraud and money laundering; at his plea, according to the Deputy Attorney General, he accepted responsibility for his role in the offenses. In September 2002 a federal grand jury in Houston indicted three former British bankers for wire fraud in a scheme involving the Southampton entity. ^{7 8 6 9}

analysisThe SEC made a parallel allegation against Fastow in its complaint of October 2, 2002: that in about February 2000 Fastow and others caused Enron to buy out the interests of LJM1’s two limited partners, Credit Suisse First Boston and NatWest, telling Enron that NatWest wanted $20 million for its interest in the partnership assets but paying NatWest only $1 million and keeping the rest, and that a purported charitable foundation in the name of Fastow’s family received $4.5 million. The allegation was not adjudicated: Fastow settled the SEC action on January 14, 2004 without admitting or denying the allegations and the same day pleaded guilty to two counts of conspiracy to commit securities and wire fraud. In his plea agreement he admitted that he and other members of Enron’s senior management conspired to manipulate Enron’s reported financial results and to cause Enron to enter into improper transactions with the LJM entities, which he controlled, and he admitted self-dealing in the so-called Southampton transaction, Enron’s $30 million buyout of LJM Swap Sub, LP, an entity he controlled, in violation of his duty of loyalty and honest services to shareholders. He was sentenced to six years in prison on September 26, 2006. ^{10 11 12 13}

analysisThe SEC’s complaint against Fastow also challenged two sales of Enron interests. It alleged that, to avoid consolidating debt of a power-plant project in Cuiaba, Brazil, and to recognize earnings, Enron entered into a sham sale of an interest in the plant to LJM1 after failing to find an independent buyer, and that Fastow had an unwritten side agreement, later honored by Enron, requiring Enron to buy the interest back at a guaranteed profit; the Senate Permanent Subcommittee on Investigations reported that Enron repurchased LJM’s interest in 2001 at a much higher price. The SEC further alleged that in December 1999 Enron booked about $12 million of 1999 earnings from a sham sale of an interest in Nigerian power barges to a financial institution, identified in the SEC’s 2004 settlement announcement as Merrill Lynch, on Fastow’s oral promise that Enron would take the institution out within six months; six months later Fastow arranged for LJM2, a partnership he controlled, to buy the institution’s interest on the previously agreed terms. These allegations were not adjudicated: Fastow settled without admitting or denying them, pleaded guilty to two conspiracy counts on January 14, 2004, and was sentenced to six years in prison in September 2006. ^{10 11 12 13 4}

analysisThe Senate Permanent Subcommittee on Investigations reported that LJM’s 2000 annual partnership meeting report claimed 23 investments with Enron and a 69 percent rate of return in its first year, and that LJM did business with essentially one company, Enron. When Enron unwound the Rhythms transaction it paid LJM1 a $30 million termination fee, and when it unwound the Raptors it paid LJM2 $35 million, although in both cases, the Subcommittee said, the hedges’ performance should have required payments to Enron. This is a congressional finding drawing on LJM’s investor report and the Powers Committee report, not a judicial one. Enron’s proxy statement of March 27, 2001 had stated that its 2000 transactions with LJM2 were negotiated on an arm’s length basis with senior Enron officers other than Fastow and that management believed their terms were reasonable and no less favorable than those of similar arrangements with unrelated third parties. ^{1 2}

analysisAccording to the Senate Permanent Subcommittee on Investigations, drawing on director Charles LeMaistre’s notes and interviews, Fastow acknowledged in an October 23, 2001 telephone call with LeMaistre and John Duncan LJM compensation totalling $45 million, $23 million from LJM1 and $22 million from LJM2, but declined to give his investment returns; the $45 million is his own statement as recorded, while Enron’s November 2001 Form 8-K estimated the amount at in excess of $30 million. When LeMaistre asked whether any Enron employee other than Fastow and Kopper had an economic interest in or benefit from the partnerships, Fastow said no, which the Board later found to be untrue; directors said they first learned during the Powers investigation of Southampton, which Fastow had set up with five other Enron employees to invest in LJM1. Board members told the Subcommittee they had been misled or misinformed about key aspects of the partnerships, and the Subcommittee said the evidence seemed to bear out that the Board did not have complete information about LJM’s owners, employees, transactions and profits. Fastow was placed on leave on October 24, 2001, and on October 28 the Board established a Special Committee of three directors who were not Enron employees to investigate the related-party transactions that were the subject of the SEC inquiry. ^{1 3}

analysisEnron reported in its November 8, 2001 Form 8-K that it believed Fastow had sold his interests in LJM1 and LJM2 to Michael J. Kopper as of July 31, 2001. Kopper had reported to Fastow as a non-executive officer of an Enron division and, according to Enron, resigned immediately before buying Fastow’s interests in LJM2. The SEC alleged in its August 2002 complaint, which Kopper settled without admitting or denying the allegations, that Kopper had also been a managing director of LJM2 Capital Management from January 2000 to July 2001 and that in late July 2001 he left Enron to run LJM2 Co-Investment, an affiliate of entities he had bought from Enron’s CFO for approximately $16.5 million. The Senate Permanent Subcommittee on Investigations found that Finance Committee chairman Herbert Winokur was told in August 2001 that Fastow had sold his LJM interest (in June, he was told, although the report notes that the sale actually took place in July 2001) and that further reviews were unnecessary, and that no interviewed director asked who had bought it; had anyone asked, they would have learned that the new owner was Kopper, whose close association with Fastow raised similar conflict-of-interest concerns. Winokur testified that, had he known of Kopper’s role, he “would have wanted to continue the reviews”. ^{4 5 6 1}

analysisA February 5, 2002 press report based on records of the California Public Employees’ Retirement System (CalPERS) stated that in October 2000 two senior CalPERS investment officers introduced Fastow to members of the fund’s board and briefed them on the fund’s earlier private investments with Enron; one of them called Fastow “the architect of our partnership over the last six years”. The same report stated that in December 2000 CalPERS’ outside private-equity adviser, in a draft memorandum on LJM 3 Co-Investment LP, the latest partnership Fastow was offering the fund, outlined conflicts of interest because Fastow and Kopper “owe fiduciary duties” to Enron. CalPERS declined to invest in LJM3 and explained its objections privately to Fastow, but did not confront Enron’s board or make its concerns public. The fund’s spokeswoman said that at the time the matter “did not sound like it would be something that would bring down the entire company”, and that the fund was also worried about conflicts with its earlier JEDI partnerships. This is a press account of the fund’s records, not an official finding. LJM3 never became active: the Senate Permanent Subcommittee on Investigations reported that of the three LJM entities approved by Enron’s Board only LJM1 and LJM2 did. ^{1 2}

analysisEnron’s proxy statement dated March 27, 2001 disclosed that in 2000 Enron entered into transactions with LJM2, whose general partner’s managing member was Fastow: eleven asset sales to LJM2 for about $213 million, purchases from LJM2 of about $76 million, and LJM2 equity of about $127 million in four structured finance vehicles used for derivatives with a combined notional amount of about $2.1 billion. It stated that the deals were negotiated at arm’s length with officers other than Fastow on terms no less favorable than with unrelated parties. Note 16 of Enron’s 2000 Form 10-K described 1999 and 2000 transactions with limited partnerships, the Related Party, whose general partner’s managing member was a senior Enron officer, without naming him; it stated that their limited partners were unrelated to Enron and that the terms were reasonable compared with those obtainable from unrelated parties. The Powers Committee later found that this reasonableness assertion apparently had no factual basis and that Enron’s disclosures did not convey Fastow’s financial interest; the Senate subcommittee concluded that the partnerships realized hundreds of millions of dollars in profits at Enron’s expense; and in November 2001 Enron announced that it would restate its financial statements for 1997 through 2000. ^{1 2 3}

analysisThe Powers Committee found that Enron’s filings disclosed the LJM partnerships but that the disclosures were obtuse, failed to convey the substance of the transactions or the extent of Fastow’s financial interest, and reflected an effort to avoid disclosing that interest and to downplay the transactions. It said they asserted, apparently without factual basis, that the terms were reasonable compared with third-party deals, and that the process was substantially influenced by Enron Global Finance, Fastow’s group, without effective oversight by management, in-house counsel, Vinson & Elkins or Andersen. These are a board committee’s conclusions, not a court finding. ⁴

analysisThe Powers Committee found that Vinson & Elkins, Enron’s longstanding outside counsel, advised on and documented many of the related-party transactions and helped prepare their disclosure in proxy statements and financial statement footnotes, and that management and the Board relied heavily on its perceived approval. While declining to fault the firm on accounting matters, it concluded that Vinson & Elkins should have brought a stronger, more objective and more critical voice to the disclosure process. The portions of the report on Vinson & Elkins are solely the views of committee members Raymond Troubh and Herbert Winokur, because of the firm’s relationship with the University of Texas School of Law, whose dean chaired the committee; they are not a court finding. According to a press account summarized by a class-action case database, in January 2007 the court in the Newby securities class action granted the lead plaintiffs’ request to drop Vinson & Elkins, among others, from the suit; a spokesman for the lead plaintiffs said it was unlikely investors would be able to recoup money from those dismissed. ^{4 5}

analysisAccording to the staff of the Joint Committee on Taxation, an Enron vice president for corporate development sent Kenneth Lay a memorandum in August 2001 raising accounting and disclosure concerns about the Raptor, LJM and Condor transactions and suggesting that a law firm other than Vinson & Elkins and an accounting firm other than Andersen investigate them. In October 2001, at Enron’s request, Vinson & Elkins reviewed the issues, including Fastow’s conflict of interest and the Condor (Whitewing) and Raptor vehicles, and concluded that the facts did not warrant a further widespread investigation by independent counsel and auditors. When the employee’s concerns were discussed at Audit Committee and Board meetings in October 2001, Vinson & Elkins made the primary presentations and indicated that its preliminary investigation had found nothing worth further investigation, according to the Senate Permanent Subcommittee on Investigations. These are descriptions in congressional reports, not judicial findings. ^{6 7}

analysisThe Powers Committee concluded that Fastow, as Chief Financial Officer, stood on both sides of the related-party transactions, and that the transactions became a means both of enriching him and of facilitating manipulation of Enron’s financial statements. In its report of February 1, 2002 the committee found that Fastow placed his own and the LJM partnerships’ interests ahead of Enron’s and sought to influence the Enron employees who negotiated with LJM, and that he did not tell the Board about Kopper’s role in Chewco or LJM2 or about the partnerships’ profitability. It estimated that Fastow was enriched by at least $30 million and Kopper by at least $10 million. Fastow declined to be interviewed, entirely or on most issues, and these remain a board committee’s conclusions rather than a court finding; on January 14, 2004 he pleaded guilty to two counts of conspiracy to commit securities and wire fraud. ^{1 2}

analysisThe Powers Committee found that Michael Kopper, who worked for Fastow in the finance area, enriched himself substantially at Enron’s expense through his roles in Chewco, Southampton Place and possibly LJM2; in a transaction he negotiated with Fastow, Kopper and his Chewco co-investor received more than $10 million from Enron for a $125,000 investment. It said the Board was apparently unaware of his Chewco activities and that he violated Enron’s Code of Conduct, including by secretly offering a Southampton interest to another employee. These are a board committee’s conclusions, not a court finding; Kopper declined to be interviewed by the Committee, entirely or on most issues. Kopper pleaded guilty in August 2002 to conspiracy to commit wire fraud and money laundering; a later press report stated that he was sentenced to 37 months in prison. ^{1 3}

analysisThe Powers Committee found that Ben Glisan, an accountant who succeeded Jeffrey McMahon as Treasurer, was a principal hands-on Enron participant in Chewco and the Raptors, both of which later required restatements. It cited substantial evidence that he knew facts showing Chewco failed the non-consolidation requirement, said he shared responsibility for Raptor accounting judgments that went well beyond the aggressive, and found that he violated the Code of Conduct by taking a Southampton Place interest while working for Enron on LJM2 transactions. These are a board committee’s conclusions, not a court finding; Glisan declined to be interviewed by the Committee on Chewco. On September 10, 2003 Glisan pleaded guilty to conspiracy to commit wire and securities fraud and was sentenced to 60 months in prison. ^{1 3}

analysisLJM2 Co-Investment, L.P. filed for Chapter 11 bankruptcy protection in Dallas on September 25, 2002, according to a Congressional Research Service chronology; the case (No. 02-38335) was heard by the U.S. Bankruptcy Court for the Northern District of Texas, Dallas Division. Under the confirmed plan LJM2’s assets were transferred to trusts, and the LJM2 Creditors Liquidation Trust acted as its successor in pursuing claims for distribution to LJM2’s creditors. On September 23, 2004 LJM2 sued Andrew Fastow and Michael Kopper in the bankruptcy court, alleging misconduct and mismanagement of LJM2, including distributions and payments from the partnership, and asserting breach of fiduciary duty, fraud, conspiracy, defalcation, conversion and unjust enrichment; these are allegations described by the court, not findings. On April 19, 2005 the Judicial Panel on Multidistrict Litigation transferred the case to the Enron multidistrict litigation in the Southern District of Texas, and its outcome is not in the retained record. Lead plaintiffs’ counsel in the Enron securities class action announced on September 27, 2005 that the lead plaintiff would also secure a distribution of approximately $32 million for investors through the LJM2 bankruptcy proceeding; that is a party’s statement, not a court record. ^{1 2 3}

analysisOn March 31, 2005, after obtaining a judgment in Delaware against its former general partner LJM2 Capital Management, L.P., which it put at $30 million, LJM2’s liquidation trust sued William Dodson, Michael Kopper, Citibank N.A., Andrew and Lea Fastow and another entity to recover about $13 million of transfers by Capital Management. LJM2 alleged that Capital Management was its general partner from 1999 to January 4, 2002 and was controlled by Kopper, and contended that Dodson was Kopper’s domestic partner. These are LJM2’s allegations as summarized by the bankruptcy court in its opinion of July 25, 2005, which recorded the Delaware judgment. Dodson moved to dismiss, contending that the complaint failed to state a claim and was barred by judicial estoppel, res judicata and the trust’s lack of standing; Andrew Fastow moved to dismiss under the first-to-file rule or for abstention and Lea Fastow for improper service; Kopper and the Fastows asked for a stay pending their criminal proceedings to preserve their Fifth Amendment privilege. The court denied the motions of Dodson and Lea Fastow, transferred the proceeding to the Enron multidistrict litigation court in the Southern District of Texas and stayed it as to Kopper and Andrew Fastow until June 13, 2006; the outcome is not in the retained record. ²