CASE 12.1 Merrill Lynch and the Nigerian Barge Deal The investment bankers at Merrill Lynch were considering an unusual offer from the treasurer at Enron.' Daniel Bayly, the global head of the investment banking division at Merrill Lynch, had been approached by Jeffrey McMahon at Enron about the pur- chase of three electrical generating barges in the waters of Nigeria. Enron was com- ing to the end of 1999 and desperately needed to book more revenue to keep up the company's high-flying stock price, and this deal would earn Enron a much-needed $12 million profit. Merrill Lynch was not in the electrical generating business, but the deal did not require the investment banking giant to operate the barges, which, in any event, were not yet up and running. The plan, as conceived by Enron executives, was for Merrill Lynch to purchase the three barges for $28 million. Three-quarters of this amount, $21 million, would be loaned to Merrill Lynch by Enron, so that Merrill Lynch would need to put up only $7 million of the purchase price. In return, Enron would promise to find a buyer for the barges or else buy them back within six months with a guaranteed return of 15 percent on Merrill Lynch's $7 million outlay- Ordinarily, a return of this size would require the assumption of considerable risk, but Enron was offering the Merrill Lynch bankers an outsized, risk-free return- almost too good an offer to turn down. All that was needed was for Daniel Bayly to sign off on the deal. Mr. Bayly had some reasons for concern. If Enron was committed to buying back the barges with no risk for Merrill, then was this a true sale? Would Merrill Lynch be the real owner during this time? If not, then the "sale" would be more a dis- guised loan. Such a loan should be recorded in Enron's books as debt, but the pur- pose of the deal was clearly to enable Enron to report $12 million in revenue. Enron might thus be engaging in accounting fraud, but, if so, was this Merrill Lynch's responsibility? Enron did not promise to repurchase the barges itself but only toensure that a buyer would be found. If that buyer were a third party, then the trans- action would be a legitimate sale. In the meantime, Merrill Lynch would be provid- ing what is called "bridge equity," which is a short-term investment that is used until a long-term investor can be found. Enron had, in fact, been negotiating to sell the barges to a Japanese firm, the Marubeni Corporation. The negotiations were not pro- ceeding fast enough to complete a sale before the end of the year, but perhaps a sale could be concluded within six months' time. The repurchase could also be made by one of the many off-balance-sheet partnerships, or special purpose entities (SPEs), that Enron had set up. One partner- ship, called LJM2, which was controlled by Enron CFO Andrew Fastow, had engaged in a number of rapid sales and repurchases that created revenues for Enron and kept debt off its balance sheet. If the commitment to buy back the barges came from Mr. Fastow on behalf of the LJM2, then it would not be coming from Enron itself. Moreover, the Enron plan did not call for Merrill Lynch to directly buy the barges. Instead, an SPE would be created that would be funded with $21 million from Enron and $7 million from Merrill. Accounting standards permitted such a shell entity to be off Enron's balance sheet if it had 3 percent outside ownership, which would be provided by Merrill's investment. Since Enron would still have control of the SPE, the effect would be Enron buying from and selling to itself. After six months, Enron would not be buying the barges back from Merrill but merely closing down the partnership and returning to Merrill its investment plus the guaranteed return. The deal was submitted to Merrill's Debt Market Commitments Committee, where Robert Furst, a managing director of Merrill Lynch, and the Enron relationship manager at the time apparently supported it. The head of the Asset Lease and Finance Group, James A. Brown, was concerned, though, about Enron manipulating earnings. Others apparently thought that the amount was too small to be material given Enron's total revenues. Concern was also expressed about the firmness of Enron's commitment, and so Mr. Bayly talked directly with Andrew Fastow, who has testified that he said unequivocally that Merrill would not lose money on the deal and would receive a guaranteed return. Both Mr. Bayly and Mr. Brown insist that the Enron CFO promised only to make a "best effort" to find a buyer. According to other testimony, Mr. Bayly asked for Enron's commitment in writing but was told that Enron could not do that and get "the right accounting treatment." In the meantime, there was no due diligence in examining the three Nigerian barges and no bargain- ing over the price that Merrill would pay or the return, both of which would be expected in a real investment. In the end, the deal was accepted. Merrill Lynch invested $7 million; Enron recorded $12 million in revenues; and six months later Fastow's partnership LJM2 repurchased the barges for $7.525 million, which represents Merrill's $7 million investment plus a 15 percent annualized return. In 2003, the Securities and Exchange Commission (SEC) brought a suit alleging fraud. Messrs. Bayly, Brown, and Furst were convicted along with another Merrill Lynch employee and one low-level Enron employee. Before these individuals were tried, Merrill Lynch settled with the SEC, paying $80 million for the Nigerian barge deal and another transaction with Enron