Enron Allegation Details - J.P. Morgan Chase The following information is drawn from the First Consolidated and Amended Complaint filed April 8th in US District Court for the Southern District of Texas, Houston Division. For more information, view the entire complaint. According to the complaint, J.P. Morgan conceived, launched and operated Mahonia Ltd. and Mahonia Natural Gas Ltd. for Enron.  Prior to its merger with J.P. Morgan & Co., Chase Manhattan Bank set up an energy trading business in the British Channel Islands named Mahonia, Ltd. The business, based in New Jersey, conducted billions of dollars of natural gas trading with other energy companies. Many of its transactions took place just before year-end. Often, the deliveries of natural gas and oil were sold right back to those who delivered them through complex derivative transactions. Approximately 60 percent of Mahonia’s trades were with Enron Corp.  Unlike the hundreds of partnerships Enron constructed, designed to manipulate its financial statements, Mahonia was conceived, launched and operated by J.P. Morgan. In reality, the Mahonia transactions with Enron were nothing more than a sham designed to allow Enron to disguise massive borrowing as commodity trades, thus allowing it to manipulate its income and hide house liabilities from its financial statements. According to the complaint, J.P. Morgan would pay Enron between $150 and $200 million for the future delivery of natural gas or crude oil. The transaction was constructed as a trade rather than as a loan to Enron, allowing Enron to show trading income on its financial statements that would help to cancel out losses that would have otherwise been reported. Additionally, a loan would have to be accounted for as a liability on Enron’s financial statements. Because these transactions were structured as a trade rather than a loan, Enron would eventually have to deliver the oil or gas, usually in $10 to $20 million installments.  With each delivery, losses related to the contracts would appear on Enron’s general ledger.  Because the contracts were structured for delivery to begin in the following year, losses would be carried from one year to the next without showing up on Enron’s reported financial statements. In reality, however, neither party to the contract anticipated that Enron would actually deliver the commodity – each party would arrange complicated derivative transactions to negate the liability to deliver the oil and gas. By structuring the loans as commodity trades, Enron was able to keep losses in reserve in case it had an unusually profitable year and wished to smooth its earnings to lower its tax liability. If it didn’t need the tax protection, Enron could just “roll the losses forward” by entering into a similar transaction that would generate income to offset the trading losses recognized at delivery.  Essentially, this was a Ponzi Scheme in which losses could be hidden indefinitely by obtaining bigger and bigger “trade” contracts every year with J.P. Morgan. With significant losses carried forward by Enron from year to year, it was virtually guaranteed that Enron would have to come back to Mahonia the following year for another “trade,” or its losses would become public knowledge. In effect, the Mahonia trades were also a source of off-balance-sheet financing that allowed Enron to essentially borrow money without the debt being reflected in their financial statements. Enron was having difficulty raising money in the stock and bond markets, and by mid-1999, this source of funding was vital to Enron’s very survival. Starting in the summer of 1999, Enron officials contacted J.P. Morgan with requests for increasingly large trades, including a request for a $650 million trade, up from the previous standard of $150 million per trade.  Because these trades were, in reality, just dressed-up bank loans to Enron, J.P. Morgan needed security for these loans. J.P. Morgan had been shifting some of this risk to other banks by paying them some of the transaction fees garnered from Enron in exchange for the other banks guaranteeing part of the loan.  Over time, J.P. Morgan could no longer shoulder the risk itself or find enough banking partners willing to assume the risk of default by Enron. Enron then sought and obtained “surety bonds” from eleven insurance companies guaranteeing that Enron would not default on the payment portion of its trades with Mahonia. These surety bonds reduced J.P. Morgan’s risks in upping the trade amounts, and allowed J.P. Morgan to finance larger and larger trades for Enron. For example, on December 28, 2000, Enron and Mahonia entered into a commodity trade and on that very same day, Enron entered into an agreement with an entity called Stoneville Aegean Limited to purchase from Stoneville the identical quantities of gas that Enron was that same day agreeing to sell to Mahonia, to be delivered to Enron on the very same future dates as Enron was supposed to deliver the same quantities of gas to Mahonia.  The fact that Enron would be simultaneously buying from Stoneville the very gas it was selling to Mahonia becomes even more suspicious when considered in light of the further evidence adduced by Defendants to the effect that both Mahonia and Stoneville – offshore corporations set up by the same company, Mourant & Company – have the same director, Ian James, and the same shareholders.  From 1997 to 2000, J.P. Morgan used Mahonia Ltd. and its related companies to provide for or arrange more than $2.2 billion of these “back-to-back” transactions.  The suit contends that Enron and J.P. Morgan disguised bank loans as commodity trades to allow Enron to misrepresent its financial condition to plan participants. The operation and the tangled Mahonia transactions were intended by the Enron defendants to inflate Enron’s financial statements. J.P. Morgan aided and facilitated this manipulation of Enron’s financial statements.