A Love-Hate Relationship

Banks and their customers have grown closer to, and more wary of, each other.

True, Basel II banks will be able to offer good corporate risks cheaper credit, but that will also squeeze smaller, non-Basel banks. Treasurers can only hope Fed chairman Alan Greenspan means what he said in testimony last April, pledging Fed action if it appears that Basel II “will distort the balance of competition.”

Overall, however, Greenspan praised Basel II as the right response to the banking industry’s own improvements in risk management, including “the growth in secondary markets for weak or problem assets [that results] in greater liquidity for this segment of bank loan portfolios and the earlier removal of weakening credits from bank balance sheets.” Such developments, he continued, make existing regulatory capital requirements obsolete, “although [they] have sometimes helped banks circumvent existing rules.”

That last remark is a typically circumspect allusion to the fact that Basel II’s dependence on self-regulation may leave unwary borrowers vulnerable to questionable financing schemes. Many of the same basic structures that Greenspan praises for helping banks manage their risk were also abused in the Enron era — helping, and even encouraging, companies to move debt off their balance sheet and inflate cash flows.

JPMorgan Chase and Citigroup, of course, paid fines of $135 million and $82 million, respectively, for “aiding and abetting” Enron. They may have to pay far more to settle shareholder suits — total litigation reserves at just those two banks are $4.7 billion and $6.7 billion, respectively. “One situation can wipe out a tremendous amount of profit,” observes banking attorney Rodgin Cohen of New York’s Sullivan & Cromwell LLP. “Hundreds of transactions where banks made money are threatened just by Enron. If banks were to settle today, it would require very large amounts of money,” he says. But banks are unlikely to do that anytime soon. The Private Securities Litigation Reform Act of 1995 denies shareholders a private right of action against aiders and abettors of securities fraud.

That has focused attention on an otherwise unrelated case called Simpson v. Homestore.com. At issue is whether shareholders can sue Cendant, L90 Inc., and the America Online division of Time Warner for engaging in transactions that helped Homestore.com inflate its reported revenues. Shareholders argue that participation in the scheme by these companies was so deliberate that it makes them “primary actors” in Homestore’s fraud — and thus liable. Enron shareholders and groups representing the banking and financial-services industry have filed opposing amicus briefs. Cohen, whose firm wrote the brief for the banks and securities firms, says which-ever side loses is virtually guaranteed to appeal to the Supreme Court. “Enron is going to go on for a long time,” he says.

Regardless of the outcome, Lyons predicts that the resulting interest in bank relationships from shareholders’ attorneys makes corporate bank deals far more subject to the limelight going forward. “That is going to complicate relationships as banks try to provide all these great products, [yet] try to protect themselves from lawsuits, meritorious or not.”

Tim Reason is a senior writer at CFO.

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