Ken Silverstein EnergyBiz Insider Editor-in-Chief

Federal regulators, lawmakers and investors are taking active steps to remedy the situation, which has resulted in multi-billion dollar fines and a host of regulatory changes. Banks are not responsible for their clients' accounting techniques; however, those institutions cannot knowingly misstate financials. And, their analysts can't hype stock purchases if they believe those shares to be losers.

That has all been alleged by litigants. Now a federal judge in Houston has given her early approval of a $6.6 billion settlement in a case involving Canadian Imperial Bank of Commerce, JP Morgan Chase and Citigroup, which includes interest on a proposed $6.4 billion settlement announced last year.

So far, banks have been held liable for $7.2 billion in damages and all for helping Enron hide debt and inflate earnings before it went bankrupt in December 2001. Lehman Brothers and Bank of America have already settled, along with Andersen Worldwide and several former Enron board members. Investors will only recover a fraction of the estimated $47 billion that was lost.

"It is the largest recovery for fraud in history and, believe me, we are not done," says lead plaintiff attorney William Lerach, outside the Houston courthouse. "There's more to come. Those that haven't settled are going to go to trial and be held liable, and that's why they're paying these huge amounts of money to settle."

The banks that have not settled with shareholders include Merrill Lynch, Barclays, Credit Suisse First Boston, Toronto Dominion Bank, Royal Bank of Canada and Royal Bank of Scotland. Multiple suits have been filed, although the University of California has been named the lead plaintiff in the case where U.S. District Judge Melinda Harmon presides.

Traditional Roles

Investment banks are an important means of allocating capital. In their traditional role of underwriting corporate securities -- financial intermediaries that verify data, facilitate pricing and perform due diligence -- they arranged for more than half of the total financing provided to U.S. non-financial businesses in 2001, says General Accountability Office (GAO.) They also provide analytical services and recommend issuances.

The accusations against banks by shareholders and government investiators alike are two-fold: using accounting trickery to help Enron misstate financials and confusing the divide that should separate the underwriting side of the business from the advisory side.

Investment banks are alleged to have helped Enron rig its financial statements through complicated "structured financing" arrangements. Banks use loopholes in tax and accounting law to assist corporate clients so that they keep more of what they earn. When properly carried out, it can provide needed liquidity and funding sources.

But it has been widely criticized for its misuse in helping to hide losses and avoid taxes. Members of the U.S. Senate Permanent Subcommittee on Investigations, for example, say Citigroup and J.P. Morgan actively abetted Enron in inflating its earnings by 11 percent in 2000 by disguising loan transactions to look like legitimate business deals.

The banks are also alleged to have pressured their research departments to issue favorable "buy ratings" so that their institutions could win companies' underwriting business. The inherent conflicts have forced the Securities and Exchange Commission to formally separate the two disciplines and to require certification from research analysts that their views are independent.

As a result, the SEC now limits the manner in which analysts issue opinions on stocks. It will also restrict their personal investments and make them disclose any relationships that they have to the companies that they are researching and about which they are supposedly giving unbiased information to the investing public. The new rules are in compliance with the Sarbanes-Oxley Act.

Through this ordeal, investors learned that analysts are pressured to promote the stocks of the corporations in which their employers do business, as well as from the investment banking operations that allegedly give them a slice of the revenues from stock sales. One analyst, Henry Blodget, got caught giving advice in which he did not really believe. The endeavor earned $115 million for his firm from 52 separate investment-banking transactions, according to New York Attorney General Elliot Spitzer.

"Since investment banks may be tempted to participate in profitable but questionable transactions, it is especially important that regulators be alerted to this and be ready to use their enforcement tools to deter such action," the GAO wrote in an earlier report.

Encouraging Signs

That government watchdog agency adds that it is "encouraged" that both investment banks and regulators have strengthened their practices. Banks are rising to the challenge by making managerial changes, establishing oversight committees and strengthening their internal reviews.

But the overarching question is how the banks found themselves in this position to begin with. In the 1990s, Enron was the quintessential American company that could do no wrong. And as long as it was ostensibly making money and spreading the wealth, it was an idol among analysts and investors.

Still, not every analyst -- or every reporter -- knelt before Enron. In a piece that appeared in Fortune in March 2001 -- about 10 months before Enron's bankruptcy -- writer Bethany McLean asked a fundamental question: How does Enron make money? Todd Shipman at Standard & Poor's responded by asking the reporter to let him know if she finds out -- the kind of skepticism that should have raised red flags from the start.

"Enron has an even higher opinion of itself," wrote McLean, in the March 2001 story. "At a late-January (2001) meeting with analysts in Houston, the company declared that it should be valued at $126 a share, more than 50 percent above current levels. Indeed, First Call says that 13 of Enron's 18 analysts rate the stock a buy."

Enron's cunning ways along with the largess it tossed around led to an un-ending hype of its stock as well as its business processes and methodologies. Unfortunately, it was all a mirage and the investment banks that helped perpetuate the myth now have to pay. While the regulatory and judicial systems are attempting to fix the shortcomings, investors and banks alike have already paid a high price.

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