J.P. Morgan Chase & Co. and a group of insurance companies reached a settlement yesterday on a $1 billion dispute over a series of failed energy trades that Enron Corp. allegedly used to hide its mounting debts from investors before its 2001 collapse.
The 11 insurance companies, which promised to cover the bank against loss if Enron failed to make good on the deals, agreed to pay 60 percent of the $965 million guarantee. The amount will be reduced by an $85 million payment from the bank to the insurance companies, giving J.P. Morgan about half of its original guarantee, the insurance companies said.
The settlement, signed just before a federal court jury in New York was to begin deliberations in the case, removed the risk of a verdict against the bank. That outcome could have been a powerful legal weapon, lawyers said, in a massive lawsuit by former Enron shareholders seeking billions of dollars in damages from J.P. Morgan and other Enron bankers. The shareholders suit, still in its initial phase, claims that banks and the energy trader's law firms helped Enron create a labyrinth of deceptive financial deals -- charges that the firms deny.
The evidence and testimony in the insurance case will be part of the shareholder suit, if it goes forward, attorneys said
"We believe our firm acted appropriately" in all the Enron transactions, J.P. Morgan chairman and chief executive William B. Harrison Jr. said in a conference call with financial analysts. "Given the environment we are in," and the uncertainty of jury verdicts, "we believe it was prudent to accept a reasonable settlement," he added.
The bank also noted in a statement that accusations that it had joined Enron in a fraud against the insurance companies were dismissed before the settlement.
"We are very satisfied with this result," Alan Levine, lead attorney for the insurers, said yesterday. "We think the economics of the settlement agreement speaks for itself." The largest payments will be made by Travelers Property Casualty Corp., Federal Insurance Co., Lumbermens Mutual Casualty Co. and Fireman's Fund Insurance Co.
J.P. Morgan also announced it has set up a pretax reserve of $900 million to cover judgments and fines resulting from investigations of Enron and other financial scandals. The bank has already agreed to pay $80 million to regulators as part of a $1.43 billion settlement by Wall Street firms accused of promoting companies' stocks to win investment-banking business.
The reserve and settlement will reduce the bank's fourth-quarter earnings by about 43 cents per share, creating a loss, the company said. News of the settlement helped lift J.P. Morgan shares $1.44, or 6 percent, to $25.44 yesterday. The bank's stock has lost 22 percent of its value since July, but it has staged a comeback since hitting a low of $15.45 a share in October.
During the three-week civil trial that ended Tuesday, the insurers contended that they had been tricked by Enron and J.P. Morgan into providing guarantees on energy trades that were, in fact, disguised loans.
The bank had made $1.9 billion in upfront payments to an offshore company sponsored by the bank, named Mahonia Ltd., to finance Mahonia's purchase of oil and gas from Enron. In many cases, Mahonia sold the energy back to Enron, insurance companies said, creating "circular" transactions that were really loans, not energy trades. Insurance companies are barred from guaranteeing loans.
When the insurers refused to pay the guarantee after Enron's bankruptcy, the bank sued to compel payment.
"J.P. Morgan and the insurers were getting a little cold feet about the hit they might have to take, and they found something close to a middle ground" in the settlement, said Craig Woker, a financial analyst with Morningstar Inc. in Chicago.
"Unlike the investor on the street who's buying stock, or note holders, there was at least some hint that the insurance companies knew exactly what they were getting into," said Gary Brown, a Nashville lawyer who investigated the Mahonia transactions as a staff member for the Senate Permanent Subcommittee on Investigations.
J.P. Morgan had to face the impact of its own internal memos and e-mails that convinced Democratic and Republican subcommittee members that the Mahonia transactions with Enron were shams, he said.
In one memo introduced in the insurance-company trial, then-Chase executive George Serice said, "Enron loves these deals as they are able to hide funded debt . . . book it as deferred [revenue], or better yet bury it in their trading liabilities."
In a report issued yesterday, Sen. Carl M. Levin (D-Mich.), outgoing chairman of the subcommittee investigating Enron's deals with its bankers, reiterated the conclusion that Enron would not have been able to complete suspect transactions, such as the ones with J.P. Morgan and Mahonia, "without the direct support and participation of a major financial institution."
Brown said of the settlement: "Did these investment banks actively participate in presenting a false picture of Enron to shareholders? A jury could very easily conclude yes. They could say no. But the company has to ask, when is the time to settle" and limit the risk?