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http://www.insurancejournal.com/magazines/west/2002/01/28/features/18788.htm
Insurance
Journal
Enron's Crash Radiates in All Directions,
Implications for Insurers
By Charles E. Boyle
January
28, 2002
"Bankruptcy" and "Chapter 11"
are inadequate terms to describe the carnage left in the wake
of Enron's collapse, which affected the lives of thousands of
people, numerous banks and dozens of insurance companies. The
tremors reverberate from the U.S. through Europe, Japan,
Australia and on around the world. The allegations of insider
trading, influence peddling, destroyed documents, coverups and
fraud now go all the way to the White House.
No day
seems to pass without some new revelation concerning the
extent of the energy giant's involvement in the world's
financial system. At least three agencies are conducting
investigations—the SEC, the Labor Department and, most
recently, the Justice Department, which announced it was
seeking to determine if there had been any criminal
violations. Five Congressional committees are also looking
into the company's affairs.
Enron rose from a
medium-sized utility, formed in 1985 by the merger of Houston
Natural Gas with Internorth, to become one of the biggest
energy providers in the world. It compounded its position by
capitalizing on the revolution in technology to pioneer
trading energy products online. The system became fully
operational in November 1999, and helped make Enron a
household name, many shareholders very rich, and its officers
and directors even richer. The site expanded its trading
activity well beyond gas and electricity. At its height, daily
transactions averaged $2.5 billion. In two years, it recorded
$880 billion worth of trades.
Everyone now sees the
flaws, but this wasn't apparent less than six months ago, when
shares of Enron traded in the $80 range. The company was
winning all sorts of awards for its shrewd business
innovations, and Wall Street analysts were touting its "growth
potential." Apparently, however, it went one step too
far. Unlike e-bay, or the Commodities exchanges, Enron
remained a party to the trades it conducted.
As energy
prices dropped along with other commodities in a worldwide
business slowdown, Enron's participation virtually insured
that it was losing money. But the company refused to publicly
address the issue. It was finally forced to do so when its
accountants, Arthur Andersen, rather belatedly raised
questions about its earnings statements. In October, Enron
finally revealed loss exposures of close to $1 billion for
2001, and restated its earnings for 1997 through the first
half of 2001, lowering its reported results by $591
million.
A last minute merger with Dynegy Inc., another
energy company controlled by Chevron, fell apart in November
and a week later Enron filed for Chapter 11 protection listing
outstanding debts of more than $13 billion —the biggest
bankruptcy in U.S. history.
The creditors read like a
"who's who" of global finance led by J.P. Morgan
Chase, Enron's principal financial partner with $965 million
in secured debt, and around $500 million unsecured. However,
its exposures may go as high as $2.6 billion. It's managed to
be appointed as a "debtor in possession" on many of
Enron's energy contracts, which it backed, and has filed suits
against the insurance companies seeking to recover on a number
of Enron's surety bonds, so it might end up losing a good deal
less.
Many other banks also have significant
exposures.
The insurance industry is involved on three
fronts. Life insurers and asset management companies that held
debt or equity positions in Enron securities have to face the
fact that most of their investments are virtually
worthless.
The second potential liability area is
surety bonds and/or financial guarantees. Don Watson of
Standard & Poor's in New York explained that, "one of
the main questions the insurance companies are asking is
whether the policies they wrote were in reality financial
guarantees, or were they insurance polices." In the first
case, Watson indicated that U.S. law generally requires that
payment be made even if there has been fraud or
misrepresentation. This protects investors, but allows the
companies to try to recover the funds from those
responsible.
"The problem with Enron," Watson
continued, "is that there are substantial questions as to
whether the policies were really financial guarantees, and
what they actually covered." S&P hasn't "gotten
to the point that we can make a statement on this" due to
the litigation and the claims by many insurers that there were
misrepresentations made concerning the nature of the policies.
S&P's Fred Sklow confirmed that so far they had talked to
nine of the 11 companies involved concerning these claims, and
that, although they would continue to monitor the situation,
it seemed unlikely that there would be any rating actions at
this time.
Chubb Corp with an estimated $220 million
and CNA Financial with around $50 million are the most
severely impacted, but more than $1 billion in payments are
currently the subject of the lawsuit with J.P. Morgan. Filed
before the bankruptcy petition, it was the first official
dispute to raise the question of fraud at Enron.
Other
parties include Citigroup's Travelers, Kemper's Lumbermens
Mutual Casualty, Allianz AG's Firemen's Fund, Hartford,
Safeco, The St. Paul and Liberty Mutual. All refused to pay
Morgan's claims unless they can examine and verify the
existence of the underlying contracts their various units
insured, and all of them, except Travelers, have asked the
bankruptcy court judge to void the obligations if they can't
be substantiated. Neither Morgan nor Enron has so far produced
any contracts, calling the insurers' claims a "fishing
expedition," but as the cloud of suspicion over Enron's
finances grows, it's quite likely that more fishing boats will
be casting their nets.
Finally there remains the
potential impact of civil actions, which could trigger demands
for coverage and defense under corporate indemnity and
Directors and Officers liability policies.
The national
law firm of Milberg Weiss Bershad Hynes & Lerach filed
class action suits on behalf of both investors and employees
the same week Enron filed for Chapter 11.
Their website
explains the nature of the claims and seeks more participants,
stating: "If you purchased shares of Enron Corp. publicly
traded securities between October 19, 1998 and November 27,
2001 and would like to join the securities class action,
please click here. If you are a current or former Enron
employee and wish to inquire about the 401(k) and other
benefits litigation, please click here." One assumes that
a chorus of crickets on a summer night wouldn't be clicking
any louder.
Bill Lerach stated, "This appears to
be one of the worst instances of illegal insider trading we've
ever encountered." That opinion, coming from a partner in
a firm that's specialized in this type of litigation for over
30 years, gives an idea of the scope of the alleged violations
of securities law.
Ironically the Justice Department
investigation (from which Attorney General John Ashcroft, who
received $50,000 from Enron related sources for a failed
senatorial bid, has recused himself) might be a positive
development for the insurance industry.
Gary Grasso, a
Chicago-based attorney who specializes in Directors and
Officers liability coverage, said that, "It [Enron] is
clearly a situation with obvious defenses, if those indicted
or peripherally involved operated outside of the scope of
their employment." He pointed out that an executive's
actions don't necessarily have to be criminal to still be
considered outside of his employment, but in situations where
criminality is involved the classic defense is even more clear
cut.
"If they're convicted, or if they [Enron's
officers and/or directors] plead [guilty, even to a lesser
charge], it's admissible in civil cases; you've got good
grounds for a summary judgment," said Grasso. It's an
established fact that D&O coverage doesn't require an
insurer to step in and defend, or reimburse the losses of, an
executive who's committed a crime. It's very much against
public policy in the same sense that insurance can't (or at
least isn't supposed to) cover punitive damage awards.
Grasso
also pointed out that Enron could well pursue officers and
directors who may have acted against the company's interests,
as well as its accountants Arthur Andersen. The firm's
certification of the company's balance sheet without
challenging numerous irregularities, particularly a number of
"off balancesheet" items, was already being called
into question even before it was revealed that some of its
employees had apparently destroyed a number of Enron-related
documents.
The investigations will certainly reveal
more about Enron in the future, and the losses, even if the
p/c insurers are able to avoid the worst of them, will be
substantial. It's clear that a number of persons connected
with the company may have breached their trust, even if
they're never convicted of criminal offenses.
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