Merrill Lynch & Co and Enron Corp touted profitable investments with the California Public Employees' Retirement System to draw investors into a private partnership the energy trader used to inflate earnings.
Calpers, the largest US public pension fund, had already decided against putting money in the LJM2 Co-investment partnership when Merrill distributed a prospectus highlighting investments the pension fund made with Enron. Former Enron financial chief Andrew Fastow and other company executives also cited Calpers as part of their pitch to raise US$394 million for LJM2, according to money managers.
Enron's relationship with Calpers "carried a very positive connotation," said Richard Holbein, president of a Dallas-based consulting firm approached by Merrill about LJM2. "They're the largest pool of assets in the nation."
Holbein recommended the LJM2 partnership to his client, the Arkansas Teacher Retirement System, which pledged US$30 million. He didn't know at the time that Calpers had turned down the chance to invest, he said.
Merrill spokesman Joe Cohen, asked why Merrill emphasized the Jedi partnerships with Calpers in the marketing for LJM2, said: "That question would best be answered by the general partner.
Beyond that, we decline to comment."
LJM2 was one of dozens of partnerships set up to transfer as much as US$3 billion in Enron debt off its balance sheet. By recording asset sales to the partnerships as gains, the Houston energy trader further exaggerated profit. In November, it restated earnings for the three years to 2000, slicing earnings by at least US$586 million. Enron filed for bankruptcy in December.
LJM2 offered "a way they could manage the earnings" to bolster Enron's share price and credit ratings, said David Long, executive director of the Houston Municipal Employees Pension Fund. He met with Fastow but didn't invest in the partnership.
Merrill executives did invest in LJM2. Enron promised bond underwriting business to Merrill Lynch and First Union Corp, now Wachovia Corp, in return for investments, US Representative Billy Tauzin said yesterday during hearings on the energy company's bankruptcy.
Calpers and Enron teamed up in 1993 and again in 1998 to invest initially in natural gas companies and then in other assets, ventures named Joint Energy Development Investments I and II.
Jedi I returned 23 percent a year for Calpers and Jedi II returned 194 percent a year, according to the Merrill marketing materials for LJM2.
Fastow and colleague Michael Kopper managed both Jedi partnerships and LJM2, which was set up in 1999. Fastow declined comment through a spokesman, Gordon Andrew. Kopper could not be reached for comment.
"The principals have extensive experience in originating, structuring and executing complex transactions," the Merrill prospectus said. "The investments made by [Jedi I and Jedi II] are indicative of some of the types of investment opportunities that will be available to LJM2.''
One transaction cited was Jedi II's co-investment with Enron in East Coast Power LLC, which held stakes in three New Jersey natural gas plants. In July 1999, Jedi II sold about half its stake to El Paso Energy Corp for undisclosed proceeds that, when annualized, returned 5,048 percent before fees. Fastow and Kopper arranged that transaction.
The prospectus explained some differences between the Jedi funds and LJM2. Unlike Jedi, the new partnership could purchase existing investments from Enron. It would also aim for bigger returns -- more than 30 percent net annually, compared with 15 percent and 20 percent for Jedi I and II, respectively.
Fastow, who was ousted as chief financial officer in October, created LJM2 to hold or sell Enron assets in energy and communications.
In one transaction, LJM2 bought fiber-optic cable from Enron in June 2000 and resold it six months later to another partnership he controlled.
In a meeting in Fastow's Houston office in early 2000, Long said the CFO suggested LJM2 would make money by buying assets from Enron at a discount, enriching partnership investors at the expense of Enron shareholders. The prospectus said LJM2 would invest mainly in companies owned or controlled by Enron.
Long said that Fastow tried to encourage the Houston fund to invest by saying, "Look, Calpers has looked at us and they think we're sophisticated investors and can make money."
Danny Bowers, chief investment officer of the US$1.7 billion Houston Firefighters' Relief and Retirement Fund, said Fastow and Kopper brought up Jedi when they came to his office in January 2000 seeking money for LJM2. Fastow suggested LJM2 investors could expect to double their money, Bowers said.
Neither Houston pension fund invested in LJM2. Long and Bowers both cited the same reason as Calpers not to take part -- Fastow's conflict of interest as both the manager of LJM2 and Enron CFO Enron.
Calpers put US$250.5 million into Jedi I, which invested US$2.1 billion in more than 60 transactions. Encouraged by its success, Enron decided to form Jedi II to expand its trading business into areas such as fiber optic cable capacity. Calpers agreed on the condition that Enron buy its stake in Jedi I, which it did for US$383 million in 1997.
Calpers committed US$500 million to Jedi II, of which just US$156.6 million was tapped because investments were suspended last summer during California's energy crisis.
Jedi II invested US$810 million in more than 30 transactions. Calpers has gotten back US$171 million from Jedi II, which is being liquidated.
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