Morgan, Insurers Settle on Enron Bonds

With jury verdict looming, insurers and bank agree on 60 percent payout for Enron surety bonds; who blinked? Plus: Ariba to restate, another big outsourcing deal, and more pension plan woes.


JP Morgan Chase & Co. finally settled its dispute with a group of 11 insurance companies that had issued surety bonds for obligations guaranteeing finance deals the bank set up for Enron Corp.

Under the agreement, JP Morgan Chase will receive about 60 percent of the principal amount of $965 million.

Bloomberg reported the figure could be as high as $654 million. But Reuters noted that this sum will be reduced to about $568 million as the bank agreed to buy the insurers’ rights to reclaim surety bond payments from Enron.

As a result, JP Morgan Chase said it will take a $1.3 billion charge in the fourth quarter.

About $400 million roughly represents the amount the bank will not receive from the insurance companies. It will also establish a $900 million reserve for costs of litigation and regulatory inquiries involving Enron, including $80 million for the research settlement with state and federal authorities.

The insurance dispute, which had been on trial for a month, was to go to the jury on Thursday,

The 11 insurers agreed to shell out the following: Travelers, $139 million after accounting for the sale of its bankruptcy claims; Chubb’s Federal Insurance, $95.8 million; Lumbermens Mutual Casualty, $93.7 million; Allianz’s Fireman’s Fund, $92.3 million; St. Paul’s St. Paul Fire & Marine Insurance, $70 million; CNA Financial’s Continental Casualty and National Fire Insurance of Hartford, $46.7 million; Safeco, $33.2 million; Hartford Financial Services Group, $21 million; and Liberty, less than $12 million.

So who blinked, JP Morgan Chase or the insurers? “The surety bond settlement represents us being on the right side of that deal but recognizes the risk of going all the way in a jury trial,” JP Morgan chief executive William Harrison said during a conference call on Thursday.

“It’s obviously a positive, because everyone I spoke to said there was no way in heaven or hell JP Morgan would win this case,” Richard Bove, an analyst at Hoefer & Arnett, told Reuters. first reported on the dispute in July. At the time, attorneys for the defendants claimed the insurers didn’t have to pay off on the surety bonds because JP Morgan Chase and Enron misrepresented the covered gas deals as real commodities trades—and not as financial transactions.

So why did the banks agree to write the bonds in the first place? An internal memo from Kemper Insurance dated April 26, 2001 (and later obtained by JP Morgan Chase) seems to show that Kemper employee James Crinnion considered the outstanding surety bonds to be quite risky.

Farther down in the note, however, Crinnion concedes that Enron’s stature makes it a risk worth taking. “From all accounts Enron is a large enough account with a strong balance sheet, cash flow and available credit facilities to warrant Kemper to issue such onerous bonds,” wrote Crinnion. “Based on Enron’s financial strength I would recommend these long-tail financial guarantees as an acceptable risk on a going forward basis.”

But, he added, “I would not recommend we write these types of obligations in the future.”

Trend? Another Big Outsourcing Deal Signed

Speaking of JP Morgan Chase: the bank announced it has signed a seven-year outsourcing agreement with IBM. The deal is valued at more than $5 billion.

The companies said in a press release the pact “will enable JP Morgan Chase to transform its technology infrastructure through absolute costs savings, increased cost variability, access to the best research and innovation, and improved service levels.”

Under the agreement, JP Morgan will outsource a substantial portion of its data-processing technology infrastructure, including data centers, help desks, distributed computing, data networks, and voice networks. The agreement includes the transfer of about 4,000 JP Morgan employees and contractors as well as selected resources and systems to IBM in the first half of 2003.

Application delivery and development, desktop support, and other core competencies will largely be retained inside JP Morgan Chase

More Pension Plan Blues

The three-year bear market continues to mar the pension plans of some of the oldest, largest companies.

For example, earlier this week IBM. said it contributed $3.95 billion to its U.S. pension plan, enabling it to return to fully funded status, as measured by its accumulated benefit obligation (ABO).

Big Blue contributed $2.09 billion in cash and the rest in IBM common stock.

The company concedes the contribution was greater than the $3 billion it estimated in early December due to the performance of the capital markets, which decreased the value of the pension plan’s assets in the intervening weeks.

“Our free cash flow and our balance sheet are strong enough for us to fully fund the U.S. pension plan,” said IBM chief financial officer John R. Joyce in a statement. “At the same time, we made a number of strategic investments throughout the year to better position our company to meet the changing requirements of our customers in this new ‘ebusiness on demand’ world.”

IBM’s pension fund is hardly the most underfunded of all U.S. companies. In early December management at Ford Motor said it expected the company’s pension fund to be underfunded by about $6.2 billion at the end of 2002.

Meanwhile, earlier this week, Honeywell reported it contributed $700 million in stock to its pension fund, bringing the total to $800 million for 2002. In September the company contributed $100 million in cash to the pension funds.

Honeywell estimates it could take a charge of up to $1.7 billion on shareholders’ equity because the fair value of the pension plan’s assets is less than the obligation.

Ariba to Restate

Management at Ariba Inc. said the company would restate its results for the fiscal year ended September 30, 2001. Mostly, the restatement stems from a $10 million payment provided personally by Keith Krach (the company’s chairman and co-founder) in March 2001 to Larry Mueller (the company’s president and chief operating officer at the time of the payment).

The company indicated it originally viewed the payment as a personal transaction because no company funds were used and there was no commitment to or from Ariba.

However, Ariba management said it later decided the company should treat the $10 million payment as a capital contribution from Krach to the company and the payment of compensation from the company to Mueller.

After the contribution, Mueller was promoted to chief executive. He left the company in July 2001 after just three months on that job. He received a severance package of more than $2 million and 2 million fully vested stock options, according to reports.

The company originally treated the payment as a personal transaction. After the review, it was decided that Krach, owner of 7.5 percent of the company’s stock at the time, is a “principal shareholder” under Securities and Exchange Commission guidelines and that accounting treatment of the payment should change, CFO James Frankola told wire services.

Liberate Fires COO

In other accounting news, Liberate Technologies fired chief operating officer Donald Fitzpatrick as a result of its investigation into various accounting transactions.

The maker of interactive-television software said it will file its restated fiscal 2002 annual report once the investigation is completed.

Liberate management said on October 15 that the “appropriateness and timing” of certain software license fees had been called into question and that the company would likely restate its fourth quarter and fiscal year 2002 financial results.

On November 21, Liberate revealed it discovered facts that call into question the appropriateness and timing of revenue recognition for various transactions that accounted for about $10 million in revenue during its 2002 fiscal year and the first quarter of its 2003 fiscal year.

The company also indicated it was investigating additional transactions and that it placed Fitzpatrick on leave pending the conclusion of the investigation.

Short Take

JP Morgan Chase was in the news a lot yesterday. Besides settling with its surety bond insurers—and outsourcing some of its IT functions—a report in Bloomberg said the bank will cut stock options for most employees by more than half. The Bloomberg story cited a memo from CEO Harrison.

Full-time employees will each receive 150 stock options when bonuses are handed out in February, compared with 375 options in 2002, according to the wire service.

“We all understand that 2002 has been a difficult year,” Harrison reportedly wrote in the memo. “We can only succeed if we work together with a positive, can-do attitude.”

JP Morgan said it will begin expensing stock options in January.

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