UNITED STATES BANKRUPTCY COURT SOUTHERN DISTRICT OF NEW YORK

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In re:

Chapter 11

ENRON CORP., et al.,

Case No. 01-16034 (AJG)

Debtors.

Jointly Administered

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APPENDIXD

(Role of Citigroup and its Affiliates)

to

THIRD INTERIM REPORT OF NEAL BATSON, COURT-APPOINTED EXAMINER

Reference is made to the preceding Third Interim Report of Neal Batson, CourtAppointed Examiner (the "Report"). This Appendix constitutes an integral part of the Report. All capitalized terms not otherwise defined herein shall have the meanings set forth in the Report.

TABLE OF CONTENTS

I. INTRODUCTION 1

A. Introduction and Overview 1

B. Citigroup's Role in Enron's SPE Transactions 6

C. Background Information 8

II. HISTORY AND DEVELOPMENT OF CITIGROUP'S INVOLVEMENT

WITH ENRON 11

A. Relationship Between Citigroup and Enron 11

B. Citigroup's Knowledge of Enron's Financial Condition 32

III. CITIGROUP'S ROLE IN ENRON'S SPE TRANSACTIONS 45

A. Prepay Transactions 45

B. Minority Interest Transactions 88

C. Forest Products Transactions 115

IV. POTENTIAL LIABILITY OF CITIGROUP 135

A. Arguments Supporting the Imposition of Aiding and Abetting

Liability and Equitable Subordination 135

B. Arguments Against the Imposition of Aiding and Abetting

Liability and Equitable Subordination 142

C. Conclusions 148

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I. INTRODUCTION

A. Introduction and Overview

In Appendix C (Role of Enron's Officers), the Examiner concludes that there is

sufficient evidence for a fact-finder to determine that certain of the Debtors' officers

breached their fiduciary duties under applicable law by causing the Debtors to enter into

certain SPE transactions that were designed to manipulate the Debtors' financial

statements and that resulted in the dissemination of financial information known to be

materially misleading. These wrongful acts caused direct and foreseeable harm to Enron

itself, and they resulted in harm to innocent parties that dealt with Enron, including

certain creditors in the Bankruptcy Case.

This Appendix considers the role of Citigroup, Inc. ("Citigroup") in the Debtors'

SPE transactions. Through several of its subsidiaries, Citigroup helped Enron

implement-and in some cases Citigroup also designed-a number of such SPE

transactions. These include notably four Prepay Transactions referred to as Yosemite I

through IV in the Second Interim Report, I five additional Prepay Transactions that the

Examiner did not analyze earlier (these five Prepay Transactions, together with Yosemite

I through IV, are referred to collectively as the "Citigroup Prepays"), two Minority

Interest Transactions called Nighthawk and Nahanni/ and two Forest Products

J Second Interim Report, Appendix E (Prepay Transactions). Citigroup referred to Yosemite III and IV as Enron Credit Linked Notes I and II, respectively, or ECLN I and II, respectively.

2 Second Interim Report, Appendix I (Minority Interest Transactions). Citigroup also helped Enron complete the Rawhide Minority Interest Transaction, which is discussed in more detail later in this Appendix. Although the Examiner concluded in the Second Interim Report that Enron did not account for Rawhide in compliance with GAAP, the Examiner has not found sufficient evidence to date from which a fact-finder could conclude that Citigroup committed wrongful actions in connection with Rawhide.

Transactions called Bacchus (a FAS 140 Transaction) and Sundance Industrial.' In

Appendix C (Role of Enron's Officers), the Examiner concludes that there is sufficient

evidence for a fact-finder to detennine that certain of the Debtors' officers breached their

fiduciary duties by causing Enron to enter into these transactions.

In this Appendix, the Examiner discusses evidence indicating that: (i) Citigroup

had actual knowledge of the wrongful conduct giving rise to breaches of fiduciary duty

by the Debtors' officers; (ii) Citigroup gave substantial assistance to the Debtors' officers

by participating in the transactions; and (iii) injury to the Debtors was the direct or

reasonably foreseeable result of this conduct. The evidence reviewed by the Examiner,

and the reasonable inferences that may be drawn from that evidence, are sufficient for a

fact-finder to conclude" that Citigroup aided and abetted certain Enron officers in

breaching their fiduciary duties. In addition, there is sufficient evidence of inequitable

conduct by Citigroup in connection with the Enron SPE transactions described above for

a court to conclude that Citigroup's claims should be equitably subordinated to the claims

of other creditors.

Citigroup's conduct in the Citigroup Prepays, Nighthawk, Nahanni, Bacchus and

Sundance enabled Enron to complete approximately $5.9 billion of financings. As a

result of these financings, Enron improperly recorded more than $5 billion of cash flows

from operating activities, improperly recorded approximately $132 million of income,

3 Second Interim Report, Appendix K (Forest Products Transactions). Enron used the name "Sundance" for two limited partnerships, Sundance Industrial Partners L.P. ("Sundance Industrial" or "Sundance"), which is the entity involved in this forest products transaction, and Sundance Assets L.P., which was involved in the Rawhide transaction.

4 See Report, Standard Adopted by the Examiner.

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and understated the debt on its December 31, 2000 balance sheet by approximately $1.9

billion and on its June 30, 2001 balance sheet by approximately $2.7 billion.

The evidence would allow a fact-finder to conclude that:

• Citigroup assisted Enron in completing the Citigroup Prepays, with gross proceeds totaling over $4.6 billion' even though Citigroup knew that Enron's accounting for these transactions, with no other meaningful related disclosure, would result in misleading financial presentation;

• Citigroup assisted Enron in structuring and completing the credit linked notes fundings for the Yosemite I and II Citigroup Prepays, even though Citigroup had a substantial belief that Enron should have consolidated the borrowing entities in those transactions for accounting purposes and, therefore, should have reflected the approximately $1.1 billion of note proceeds as debt on its balance sheet;

• Citigroup designed and helped Enron implement the Nighthawk Minority Interest Transaction, allowing Enron to raise $500 million of year-end financing without reflecting that amount on its balance sheet as debt, even though Citigroup had a substantial belief that Enron should have consolidated the Nighthawk minority investor and, therefore, that the $500 million should have been reflected as debt on Enron's balance sheet;

• Citigroup proposed that Enron sell U.S. Treasury Securities in the Nahanni Minority Interest Transaction, in order to record $500 million of cash flow from operating activities, with knowledge that such securities likely did not qualify as merchant investments making such

5 The proceeds of certain of the Citigroup Prepays were used to repay outstanding Citigroup Prepays that were maturing. For example, the $675 million Jethro Prepay Transaction refinanced and extended the $500 million Truman Prepay Transaction. See Global Loans Approval Memorandum, regarding Truman, Sept. 19, 1999 (the "Truman Global Loans Approval Memo") [CITI-B 0035882-CITI-B 0035888]. The $4.6 billion total represents the gross amount of the nine Citigroup Prepays. This total includes the proceeds of three prepay transactions that were partially funded by other financial institutions, including: (i) Truman, a $500 million total transaction, in which Toronto Dominion Bank funded $250 million and Citigroup funded $250 million; (ii) Jethro, a $675 million total transaction, in which Toronto Dominion Bank funded $337.5 million and Citigroup funded $337.5 million; and (iii) Nixon, a $324 million total transaction, in which Barclays Bank PLC funded $110 million, Royal Bank of Scotland funded $110 million and Citigroup funded $104 million. The Examiner has included the total amounts of these transactions in the $4.6 billion total because, as discussed below in this Appendix, Citigroup played roles in each transaction that facilitated Enron's ability to obtain the full amount of each transaction, and Enron considered each transaction to be a single transaction. See Enron Corp. Chief Financial Officer Report, Aug. 13,2001 (the "August 2001 Fastow Report"), at 2-12 [AB0247 02299-AB0247 02310].

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cash flow reporting inappropriate, and with knowledge that the sale of the securities would bridge Enron's year end and be repaid only three to four weeks later;

• Citigroup invested $28.5 million in the Sundance Industrial transaction, agreeing to structure the investment as partnership equity in order for Enron to keep its forest products assets and related debt (in excess of $375 million) off its balance sheet, even though Citigroup considered the investment to be a loan and had a substantial belief that Enron should consolidate the partnership;

• Also in Sundance Industrial, Citigroup used $20 million of its investment to "purchase" a .01 % equity interest in an Enron SPE and then immediately contributed that equity to the partnership, despite having no business purpose for owning the equity, solely to assist Enron in recording "true sale" treatment on the purported purchase and, thereby, $20 million of income from gain on sale;

• In Bacchus, Citigroup relied upon Enron's verbal support of its 3% equity investment, knowing that the existence of such support would preclude Enron from receiving the accounting treatment that it desired for that transaction; and

• Citigroup agreed to fund the Bacchus transaction with $200 million at year-end 2000, despite a substantial belief that Enron's sole purpose for completing the transaction was to record a material amount of earnings from gain on the sale of an asset and that the transaction was structured so that no "true sale" occurred.

The Examiner has reviewed a substantial amount of evidence, including

documentary and testimonial evidence, and has noted reasonable inferences that could be

drawn from the evidence. A fact-finder may draw alternative or contrary inferences from

the same evidence. Moreover, there are certain defenses to aiding and abetting liability

and equitable subordination available to Citigroup. Whether Citigroup will succeed on

one or more of these defenses will depend upon the fact-finder' s resolution of the facts.

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The elements most likely to present issues of material fact for consideration by

the fact-finder are:

• The degree of Citigroup's knowledge of the acts giving rise to the breaches of fiduciary duty. In particular, whether Citigroup knew that Enron's reporting of the SPE transactions described above would result in materially misleading presentation of Enron's financial condition because: (i) the transactions were disclosed in a manner that disguised their economic substance so as to mislead Rating Agencies, creditors and investors; and/or (ii) the accounting for these transactions was incorrect. As part of this determination, the fact-finder may consider, among other things: (i) Citigroup's knowledge that the economic substance of these transactions was inconsistent with the disclosure; (ii) its knowledge that Enron's accounting for these transactions was likely incorrect; (iii) the impact of the verbal support in the Bacchus transaction; and (iv) whether there was any reliance on accounting representations from Enron or from Andersen through Enron, and if so, whether this reliance was reasonable.

• The degree of assistance provided by Citigroup to Enron's officers.

As part of this determination, the fact-finder may consider whether Citigroup designed the transaction, structured the transaction, assisted in the disclosure process, consummated the transaction or took any action that would invalidate the desired accounting.

• Whether it would have been reasonably foreseeable to Citigroup that these transactions would cause injury to Enron and/or its creditors. As part of this analysis, a fact-finder may consider whether the transaction had a material impact on Enron's financial statements.

Citigroup's claims in the Bankruptcy Case, which total approximately $2.4

billion," are susceptible of being equitably subordinated to the claims of other creditors.

This would be in addition to any affirmative recovery that may be available to the

6 The Examiner has reviewed the proofs of claim filed by Citigroup against the Debtors, Citigroup's responses to the Examiner's request for information about its relationship with Enron, and information provided by Enron itself. Based on that information, it appears that Citigroup's claims against the Debtors total approximately $2.4 billion. The Examiner has attempted to exclude claims that Citigroup filed but does not economically hold, such as claims on behalf of lenders in transactions in which Citigroup served as the syndicator, but in certain instances the Examiner's information may be incomplete.

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Debtors against Citigroup for aiding and abetting the officers' breach of fiduciary duty, assuming that the Debtors have standing to pursue such a claim.

B. Citigroup's Role in Enron's SPE Transactions

Citigroup had pivotal roles in three types of Enron's SPE transactions: the Prepay Transactions, the Minority Interest Transactions and two of the transactions related to Enron's forest products business.

In five of the nine Citigroup Prepays, Citigroup loaned its own funds to Enron.

These loans totaled over $1.4 billion in the aggregate, although some of the funds were immediately paid to Citigroup to repay existing Prepay Transactions and other outstanding obligations that Enron owed to Citigroup. In six of the Citigroup Prepays, Citigroup's SPE, Delta Energy Corporation ("Delta"), served as a swap counterparty or the conduit entity that Enron believed was necessary to accomplish its accounting objectives. In two other Citigroup Prepays, Enron used Toronto Dominion Bank ("TD Bank") as the conduit, and Citigroup reciprocated by serving as the conduit in mirror Prepay Transactions where TD Bank was the lender, in each case with the commodity risk being hedged back to Enron.

In the four Citigroup Prepays referred to as Yosemite I through IV, Citigroup played an even larger role. Each of these transactions included an Enron credit linked notes issuance, the proceeds of which funded an associated prepay. Citigroup designed the credit linked notes structure and served as an underwriter, raising approximately $2.4 billion from the institutional market.

The three Minority Interest Transactions all used a structure that Citigroup designed and considered to be its proprietary product. In addition, Citigroup loaned its

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own funds to Enron in each of these transactions, and it served as placement agent for obtaining the required equity investments. When Enron asked Citigroup at year-end 1999 to help find a way for Enron to increase its cash flows from operating activities, Citigroup suggested that Enron use U.S. Treasury Securities in the Nahanni transaction, which existed for only three weeks to bridge the year-end.

Finally, Citigroup participated in Bacchus and Sundance Industrial, which related to Enron's forest products business. Bacchus was a FAS 140 Transaction, in which Enron transferred its pulp and paper trading business to an SPE in December 2000 so that it could record $112 million of income from the gain on sale. Citigroup facilitated the transaction by loaning the purchaser SPE $194 million, which was guaranteed by an Enron Total Return Swap. Citigroup also purchased for $6 million the 3% equity necessary for Enron to take the position that the transaction qualified for "true sale" treatment, with the equity supported by Enron's verbal support.

In Sundance Industrial, Enron sought to move all of its forest products assets and their associated debt into a nonconsolidated partnership. Citigroup purchased "equity" in the partnership for a $28.5 million cash investment and a $160 million unfunded commitment. Citigroup's investment was intended to fulfill the requirement for nonconsolidation that an independent third party own at least 3% of the partnership's equity. Also, just prior to the June 1, 2001 closing date, Citigroup agreed to use $20 million of its investment to "purchase" a .01 % interest in one of the assets being contributed to the partnership, so that Enron could record $20 million of income from gain on the purported sale.

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c. Background Information

Citigroup is reported to be the world's second-largest financial services firm,"

with over $1 trillion in assets as of March 31, 2003.8 In October 1998, Citicorp merged

with a wholly owned subsidiary of Travelers Group, Inc., which had previously acquired

the investment bank Salomon Brothers. 9 The merged company adopted the name

Citigroup, Inc. 10 Through its subsidiaries, and with approximately 250,000 employees

worldwide, II Citigroup provides "a broad range of financial services to consumer and

corporate customers with some 200 million customer accounts in over 100 countries and

territories.t'"

Citigroup provides financial services and products to its corporate customers

through its Global Corporate and Investment Bank (the "GCIB,,).13 The GCIB

encompasses a number of business units, including notably Global Relationship

Banking.i" Global Investment Banking.f Global Capital Structuring.!" Fixed Income and

Derivatives Capital Markets.l" Energy and Mining," and Risk Management. 19

7 Citigroup Inc., Company Capsule, Hoovers Online, available at http://www.hoovers.com/co/capsule/ 510,2l63,58365,00.html (last visited June 25, 2003).

8 Citigroup Form 10-Q filed with the SEC for the Quarterly Period ended Mar. 31, 2003, Citigroup, Inc. and Subsidiaries Consolidated Statement of Financial Position.

9 Citigroup Form 10-K filed with the SEC for the Year ended Dec. 31, 1998 (the "Citigroup 10-K for 1998"), at 5; Citigroup Begins Trading Today as Big Merger Closes, Wall St. 1., Oct. 8, 1998, at C6.

10 Citigroup lO-K for 1998, at 5.

II Citigroup Form 10-K filed with the SEC for the Year ended 2002 (the "Citigroup 1 O-K for 2002"), at 2. 12 Citigroup 10-K for 2002, at 2.

13 Citigroup 10-K for 2002, at 2; Citigroup corporate and investment banking, Our Business, available at http://www.citigroupgcib.com/oUf_businesses/our_businesses.html (last visited June 25, 2003).

14 Citigroup corporate and investment banking, Global Relationship Banking, available at htrp.z/www.citigroupgcib.com/our _businesses/h_global_relationshi.html (last visited June 25, 2003).

15 Citigroup corporate and investment banking, Global Investment Banking, available

at http://www.citigroupgcib.com/oUf_businesses/g_global_investment.html (last visited June 25, 2003).

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Citigroup appears to structure its operations around business units rather than

legal entities. Units such as Global Capital Structuring and Derivatives design the

products, sell them, and use various legal entities within Citigroup to participate in and

book the transactions." Few of the Citigroup employees who gave testimony to the

Examiner were certain of the legal entity that employed them, and some had signing

authority for multiple legal entities."

In addition, the proofs of claim filed by Citigroup in the Bankruptcy Case do not

appear to distinguish among the various Citigroup legal entities. With the exception of a

claim made as a vendor under certain equipment leases, Citigroup has made each proof of

claim either in the name of Citibank, N.A. or Citicorp North America, Inc., or by

16 Citigroup corporate and investment banking, Global Capital Structuring, available at http://www.citigroupgcib.comlour_businesses/g_structured_corpora.html (last visited June 25, 2003).

17 Citigroup corporate and investment banking, Fixed Income and Derivatives Capital Markets, available at http://www.citigroupgcib.comlour_businesses/d_fixed_income_deriv.html (last visited June 25, 2003).

18 Citigroup corporate and investment banking, Energy and Mining, available

at http://www.citigroupgcib.com/our_businesses/h_industry_groups.html (last visited June 25, 2003).

19 Citigroup corporate and investment banking, Risk Management, available

at http://www.citigroupgcib.comlour_businesses/c_risk_manage.html (last visited June 25, 2003).

20 Sworn Statement of Paul Deards, Citigroup, to Steven M. Collins, A&B, June 9, 2003 (the "Deards Sworn Statement"), at 11 ("Legal vehicles out of which we traded depended upon customer preference, I think.").

21 See, e.g., Deards Sworn Statement, at 11 ("Q. During the period 1998 through 2001, do you know which legal entity within the Citigroup family you were employed by? A. I _ all I can say is that it changed from time to time."); Sworn Statement of Steven Wagman, Citigroup, to Steven M. Collins, A&B, May 29, 2003 (the "Wagman Sworn Statement"), at 44-45 ("We have many legal entities and, not only that, we have recently changed our name and changed the legal entity, and so which legal entity I actually was or is or am employed by is not 100-percent certain by me."); Sworn Statement of William T. Fox, III, Citigroup, to Steven M. Collins, A&B, May 14, 2003 (the "Fox Sworn Statement"), at 7 ("Q. If you think of it in terms of a legal entity, Citibank, Global Securities, Inc., Salomon Smith Barney, do you know which of those legal entities you are employed by? A. No."); Sworn Statement of Elliot Conway, Citigroup, to Steven M. Collins, A&B, Apr. 30, 2003 and May 23,2003 (the "Conway Sworn Statement"), at 6-7 (indicating signing authority for entity other than employer); Sworn Statement of James F. Reilly, Jr., Citigroup, to Steven M. Collins, A&B, Apr. 25, 2003 and May 6, 2003 (the "Reilly Sworn Statement"), at 8 ("Q. Are you employed by any Citigroup entity? A. I work for Citigroup Global Markets, I believe is what it's called."); Sworn Statement of Richard J. Caplan, Citigroup, to Steven M. Collins, A&B, Apr. 22, 2003 and May 9,2003 (the "Caplan Sworn Statement"), at 9-10 (indicating signing authority for entity other than employer).

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"Citigroup, Inc. on behalf of itself and its subsidiaries.'.22 Consequently, in this

Appendix, the Examiner uses the term "Citigroup" to refer to the institution as a whole

and does not identify the specific affiliate that was involved in a particular aspect of a

particular transaction. Similarly, the Examiner refers to "Enron" rather than identifying

the specific Enron affiliate involved, because such detail was addressed in the Second

Interim Report and is not relevant to the matters discussed in this Appendix.

22 See Citibank, N.A. Proof of Claim, No. 11264; Citibank, N.A. Proof of Claim, No. 12099; Citibank, N.A. Proof of Claim, No. 12100; Citibank, N.A. Proof of Claim, No. 12101; Citibank, N.A. Proof of Claim, No. 12102; Citibank, N.A. Proof of Claim, No. 12103; Citibank, N.A. Proof of Claim, No. 12104; Citibank, N.A. Proof of Claim, No. 12105; Citibank, N.A. Proof of Claim, No. 12106; Citibank, N.A. Proof of Claim, No. 12107; Citibank, N.A. Proof of Claim, No. 12108; Citibank, N.A. Proof of Claim, No. 12109; Citibank, N.A. Proof of Claim, No. 12110; Citibank, N.A. Proof of Claim No. 12111; Citibank, N.A. Proof of Claim, No. 14179; Citibank, N.A. Proof of Claim, No. 11264; Citibank, N.A. Proof of Claim, No. 14196; Citibank, N.A. Proof of Claim, No. 14208; Citibank, N.A. Proof of Claim, No. 14209; Citigroup, Inc. (on behalf of itself and subsidiaries) Proof of Claim, No. 12843; Citigroup, Inc. (on behalf of itself and subsidiaries) Proof of Claim, No. 14503; Citigroup, Inc. (on behalf of itself and subsidiaries) Proof of Claim, No. 14504; Citigroup, Inc. (on behalf of itself and subsidiaries) Proof of Claim, No. 14505; Citicorp North America, Inc. Proof of Claim, No. 12098; Citicorp North America, Inc. Proof of Claim, No. 14198. Citicorp Vendor Finance, Inc. also filed several small Proofs of Claim regarding various equipment leases it had entered into with the Debtors.

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II. HISTORY AND DEVELOPMENT OF CITIGROUP'S INVOLVEMENT WITHENRON

A. Relationship Between Citigroup and Enron

Citigroup's relationship with Enron began over 20 years ago.23 By 1997, Enron

considered Citigroup to be one of its most important banking relationships.i" From 1997

through 2001, Enron utilized the services of more than thirty banks in total and obtained

debt and privately placed equity investments from more than 200 institutional investors.f

Citigroup, however, never failed to be among Enron's group of nine or ten Tier 1 banks."

One Enron employee described Citigroup as "one of the solid performers" for his

business unit, "provid[ing] us with good ideas and valuable insight.,m Enron wrote that

Citigroup was the "[p]rimary banking relationship for Enron in 1999. They line up

perfectly with us - we should reward this structure.?"

Citigroup's involvement with Enron was extensive and frequent. During the

period 1997 through the Petition Date, Citigroup completed over 60 transactions with

23 Memorandum from GEM-Houston, to Onno Ruding, Fernando Ynigo, Tom Stott, John Byrne, Steven Victorin and Bill Fox, Citigroup, regarding Enron Rawhide/Corporate Revolving Credit Facilities, Apr. 14, 2000, at SEC00086274 ("Citibank has maintained a relationship with Enron for over 20 years. . . .") [SEC00086226-SEC00086297]; Standard Credit Memorandum: Enron Corporation, June 23, 1998, (the "1998 Credit Review"), at 7 [CITI-B 00978682-CITI-B 00978689] ("Citicorp has maintained a relationship with Enron for over 20 years, and is a co-lead bank for the company together with Chase."); Global Loans Approval Memorandum, regarding JED! II, May 11, 1998, at 10 [CITI-B 00446311-CITI-B 00446322).

24 In 1996, Citigroup wrote: "We are viewed by the company [Enron] as one of its most important banks if not the most important bank." Citicorp Loan Structuring Approval Memo, regarding Contractual Securitization Holding Trust 3, July 23, 1996 (the "CASH 3 Approval Memo"), at 10 (Ex. 37 to Reilly Sworn Statement) [SECOOI87444-SECOOI87461]; Reilly Sworn Statement, at 35.

25 See, e.g., Enron Mid-Year Debt Investor Relationship Review, July 2000 (the "July 2000 Relationship Review") [AB0252 01443-AB0252 01545].

26 See Enron Relationship Review Mid-Year 1999, July 1999 [AB0252 01557-AB0252 01601]; Enron Relationship Review, Jan. 2000 [0252 01602-AB0252 01659]; July 2000 Relationship Review; Enron Debt Investor Relationship Review, Jan. 2001 [AB0252 01349-AB0252 01442]; Enron Debt Investor Relationship Review, Aug. 2001 [AB0252 01291-AB0252 01348].

27 July 2000 Relationship Review, at AB 025201538.

28 [d. at AB 0252 01454.

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Enron, counting extensions of and modifications to existing financings and credit

facilities." This was an average of more than one per month. The following timeline

illustrates when each of the Prepay Transactions, Minority Interest Transactions and other

SPE transactions discussed in this Appendix was completed. It also indicates when

Citigroup completed other transactions with Enron during this time period.i"

January 1997 February 1997 March 1997 April 1997 May 1997 June 1997 July 1997

August 1997 September 1997 October 1997 November 1997

December 1997

January 1998 February 1998 March 1998 April 1998 May 1998 June 1998

1 lending transaction; 31 1 underwriting

1 lending transaction

1 lending transaction; 1 M&A transaction

1 lending transaction; 1 underwriting

2 underwritings

NIGHTHA WK/$500 million minority interest financing (closed (12/29/97)

Citigroup affiliates' purchase of Marlin Water Trust Certificates=

2 lending transactions

29 Response of Citigroup Inc., Citibank, N.A. and Salomon Smith Barney, Inc. to the Examiner's Request dated 2/4/03 for Rule 2004 Examination, Feb. 4, 2003 (the "Citigroup Responses"), at 9-43. This total considers each of Yosemite I through IV as including two transactions: the credit linked notes underwriting and the prepay transaction.

30 The classification of a transaction as lending, underwriting or M&A (mergers and acquisitions) was provided by Citigroup in its responses to the Examiner's requests for relationship information. Citigroup Responses, at 9-43.

31 This transaction was an increase of the principal amount of a term loan, originally $325 million and increased to $500 million, the proceeds of which were used by Enron for the construction of the Dabhol (India) power plant. See Citigroup Responses, at 16-17. The Citigroup Reponses indicated only that the transaction was completed in 1997, but did not indicate which month. Id.

32 The Citigroup Responses stated that certain entities affiliated with Travelers made an aggregate investment of $15 million in Marlin Water Trust Certificates sometime in 1998, but without specifying an exact closing date. Citigroup Responses, at 46.

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July 1998 August 1998 September 1998

October 1998 November 1998

December 1998

January 1999 February 1999 March 1999

April 1999 May 1999

June 1999

July 1999 August 1999

September 1999

October 1999

November 1999

1 underwriting

1 M&A transaction

RA WHIDE/$750 million minority interest financing (closed (12/18/98)

ROOSEVELT/$500 million prepay transaction (closed 12/30/98)

1 lending transaction; 1 underwriting

Citigroup affiliates' purchase of Osprey Notes33 1 underwriting

ROOSEVELT/amendments 1 lending transaction

TRUMAN/$250 million prepay transaction (closed 6/29/99)

1 lending transaction

1 lending transaction; 3 underwritings

JETHRO/$337.5 million prepay transaction (closed 9/29/99)34

1 underwriting

YOSEMITE I Prepay/$800 million prepay transaction funded via credit linked notes transaction (closed 11/18/99), and associated underwriting

33 The Citigroup Responses stated that five of Citigroup's insurance company affiliates purchased an aggregate of $129 million of notes from Osprey Trust, Osprey Trust I Inc. in 1999 and 2000. Citigroup Responses, at 46. However, Citigroup did not specify which month within each of those years the transactions closed.

34 Citigroup refers to Jethro as an extension of Truman. Citigroup Responses, at 38. However, Jethro (the nickname that Enron used) was completed one day after Truman expired by its terms, and the parties documented Jethro as a new Prepay Transaction rather than an amendment of Truman. See August 2001 Fastow Report, at 2-12. Enron used the proceeds of Jethro, in part, to repay Truman. Truman Global Loans Approval Memo, at 21.

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December 1999

January 2000

February 2000

March 2000

April 2000 May 2000

June 2000

July 2000

August 2000

September 2000 October 2000 November 2000

December 2000

January 2001 February 2001

YOSEMITE I Prepay/existing $800 million prepay transaction replaced with longer term prepay (closed 12/22/99)

NIXON/$104 million prepay transaction (closed 12/15/99)

NAHANNII$500 million minority interest financing (closed 12/29/99)

Citigroup affiliates' investment in LJM235

1 lending transaction

NAHANNIIsubstantially redeemed (1114/00)

RAWHIDE/amendments

YOSEMITE 111$331. 8 million prepay transaction funded via credit linked notes (closed 2/23/00), and associated underwriting

NIXON/amendments

RAWHIDE/amendments

1 lending transaction; I underwriting

2 lending transactions

RAWHIDE/amendments

YOSEMITE 1111$475 million prepay transaction funded via credit linked notes (closed 8/25/00), and associated underwriting

1 underwriting 1 underwriting

BACCHUS/$200 million FAS 140 structure (closed 12/20/00)

2 lending transactions; 1 M&A transaction

1 underwriting

35 The Citigroup Responses stated that certain of its affiliates made an aggregate $15 million investment in LJM2 sometime in 1999, but without specifying an exact closing date. Citigroup Responses, at 46. A letter agreement that Citigroup executed in connection with its subscription for the LJM2 interest is dated Dec. 20, 1999. Letter Agreement between Citigroup and LJM2 Capital Management, L.P., Dec. 20, 1999 [CITI-B 0017373-CITI-B 0017377].

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March 2001 April 2001

May 2001

June 2001

July 2001 August 2001 September 2001 October 2001

November 2001

December 2001

1 lending transaction; 1 M&A transaction36

YOSEMITE IV/$775.1 million prepay transactions (three transactions denominated in different currencies) funded via credit linked notes (closed 5/24/01), and associated underwriting

2 lending transactions; 1 underwriting

SUNDANCE INDUSTRIAL/Enron moved forest products assets into off-balance sheet partnership and redeemed Bacchus (closed 6/01101)

JUNE 2001 PREPAY/$250 million prepay transaction (closed 6/28/01)

1 lending transaction

1 underwriting

1 M&A transaction (failed merger with Dynegyr"

SUNDANCE INDUSTRIAL/redeemed with full payment of principal and interest (closed 11129/01)

1 lending transaction

PETITION DATE (12/02/01)

A bold line indicates the end of a quarterly or annual reporting period.

Types of Transactions

As the timeline illustrates, during the five years leading up to Enron's bankruptcy,

Citigroup was an important source of funding for Enron, both as a direct lender and as an

agent for locating other lenders and investors. During this period, Citigroup represented

36 This transaction is Enron's purchase of the stock of Compagnie de Papier Stadacona Ltee., which owned a paper mill in Canada that Citigroup referred to as Daishowa Paper Products. Citigroup Responses, at 32. Citigroup indicated that the transaction was completed in "late 2000," Citigroup Responses, at 32, however, the transaction documents indicate that Enron executed the purchase agreement in January 2001. See Share Purchase Agreement among Enron Industrial Markets, LLC, Enron Holdings (Canada) Co., ElM Holdings (U.S.) Inc. and Daishowa North America Corporation, Jan. 30, 2001 [AB000429016-AB000429354].

37 The Citigroup Responses did not include any other transactions in which Citigroup assisted Enron but that failed to close. Thus, this time line also does not include any such transactions.

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Enron in 21 initial or follow-on lending transactions.t" Citigroup arranged or assisted in

arranging over $8 billion in debt on behalf of Enron." These financings took a wide

variety of structures, including term loans, revolving credit facilities, a letter of credit

facility, a commercial paper liquidity backstop facility, and a monetization of contract

rights.l" Citigroup served at various times in practically every role available to a

financial institution, including lender, arranger (sole, lead and co-lead), adviser,

underwriter, documentation agent, administrative agent, paying agent and bookrunner."

In addition, Citigroup performed a wide range of investment banking services for

Enron, including designing and helping Enron implement complex and cutting edge

structured finance transactions. Some of the transactions used Citigroup's proprietary

products, and Citigroup played many roles for Enron, including arranger, syndicator,

underwriter, financial adviser and investor.f In one internal memorandum, Citigroup

described Enron as "a high profile customer of SSB [Salomon Smith Barney] and one of

the largest users of investment bank products and services.?"

During the period 1997 through 2001, Citigroup was an underwriter for 21 debt,

equity and partnership unit offerings made by Enron and its affiliates." These offerings

were often for Enron Corp., but they also related to many of Enron's subsidiaries,

38 Citigroup Responses, at 9-20. 39 Id.

40 Id.

41 Id.

42 [d. at 33-35.

43 Salomon Smith Barney Investment Banking Commitment Committee Memorandum, regarding Enron Credit Linked Note Trust Senior Notes offering [Yosemite IV], Apr. 16, 2001 ("Yosemite IV SSB Memo"), at 41 [CITI-B 0080904-CITI-B 0080945].

44 Citigroup Responses, at 21-31.

- 16 -

including Enron Oil & Gas Company, Northern Border Pipeline Company, Portland General Electric Company, The New Power Company, and Osprey Trust, which was affiliated with the Whitewing structure. 45 These underwritings, which included both

public and private placements, resulted in the sale of securities with an aggregate face

value of approximately $9.3 billion, and Citigroup served variously as lead, co-lead and

sole underwriter, as a member of the underwriting syndicate, as placement agent, and as

bookrunner."

During that same period, Citigroup acted as a financial adviser to Enron in four

completed merger and acquisition transactions, including notably the 1997 merger with

Portland General Electric, and the 2000 acquisition of Azurix Corp. 's publicly held stock." Citigroup also represented Enron in connection with its failed attempt to merge

with Dynegy, Inc. in the fall of 2001, for which Citigroup received a fee of $18.6 million."

In addition, Citigroup assisted Enron in completing the nine Citigroup Prepays between 1998 and 2001 totaling over $3.8 billion.l" and Citigroup participated in five

structured finance transactions with Enron=-including Nighthawk, Rawhide, Nahanni,

Bacchus and Sundance Industrial-which provided Enron almost $2 billion of financing. 50

45 Id. 46 Id.

47 Id. at 32-33. 48 ld.

49 Id. at 37-43. 50 ld. at 33-37.

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As a result of the many varied roles that Citigroup played for Enron, it had access

to substantial information about the company. As a lender, underwriter and investor,

Citigroup performed due diligence with respect to all aspects of Enron's operations, and

most particularly with respect to its financial condition." Many of the internal approval

documents at Citigroup relating to Enron transactions included lengthy reviews of

Enron.52 These reviews often included sections on market statistics, core businesses,

historical financial information, capital structure (including on and off balance sheet

debt), credit rating, recent developments, financial and stock market performance,

strategy, strengths and risk factors.53 Often, these memoranda also included detailed

descriptions about specific structured finance transactions that Enron had outstanding at

51 1998 Credit Review, at 8 ("Due Diligence: The primary credit files have been reviewed and are complete"); Salomon Smith Barney Interoffice Memo, to a number of Citigroup employees, regarding Investment Grade - New York Committee Meeting for Yosemite I, Oct. 25, 1999 (the "Yosemite I SSB Memo"), at 37 ("SSB will conduct an update financial and legal due diligence call with Enron during the week of October 24, 1999. Milbank Tweed will also conduct a thorough legal due diligence of Enron prior to closing of the transaction.") [CITI-B 0120905-CITI-B 0120944]; Investment Banking Commitment Committee Memorandum, regarding Enron Credit Linked Note Trust Senior Notes Offering [Yosemite III], Aug. 11,2000 (the "Yosemite III SSB Memo"), at 40 ("SSB will conduct an update financial and legal due diligence call with Enron prior to printing preliminary prospectus. Milbank Tweed will also conduct a thorough legal due diligence of Enron prior to closing of the transaction.") [CITI-B 0265865-CITI-B 0265907]; Yosemite IV SSB Memo, at 41 ("Salomon Smith Barney is in frequent dialogue with Enron's management team regarding the Company's, and each of its subsidiaries', operating and financial results and business outlook. Milbank Tweed will also conduct a thorough legal due diligence of Enron prior to closing of the transaction."); Investment Banking Commitment Committee Memorandum, regarding $1 Billion Enron Senior Notes Offering, Aug. 13, 2001 (the "August 2001 SSB Memo"), at 27 ("Salomon Smith Barney is in frequent dialogue with Enron's management team regarding the Company's, and each of its subsidiaries', operating and financial results and business outlook. Milbank Tweed will also conduct a thorough legal due diligence of Enron prior to closing of the transaction.") [CITI-B 00828332-CITI-B 00828359].

52 See, e.g., Yosemite I SSB Memo; Yosemite III SSB Memo; Citibank Global Loans Approval Memorandum, regarding Yosemite Corporation, Jan. 21, 2000 ("Yosemite II Global Loans Approval Memo") [CITI-B 0156189-CITI-B 0156198]; Global Loans Approval Memorandum, regarding Nahanni, Dec. 7,1999 (the "Nahanni Global Loans Approval Memo") [CITI-B 0046491-CITI-B 0046505].

53 See, e.g., Yosemite I SSB Memo; Yosemite III SSB Memo; Yosemite II Global Loans Approval Memo; Nahanni Global Loans Approval Memo.

- 18 -

the time, including some in which Citigroup was not involved.i" They also often

included detailed information about the company's directors and officera"

For this five-year period, Citigroup had an essentially continuous opportunity for

due diligence and had the need to stay abreast of Enron's operations and financial

condition. Citigroup appears to have had some type of transaction in progress with Enron

at all times during this period. Thus, Citigroup' s relationship with Enron presented it

with the opportunity to maintain substantial current, detailed and often nonpublic

information about the company.

Revenues

Citigroup received in the aggregate approximately $188 million in revenues"

from Enron during 1997 through 2001.57 The annual revenues steadily increased, as

reflected in the following chart:

54 See, e.g., Yosemite I SSB Memo, at 29-31 (describing Marlin (arranged by DLJ and Alex Brown) and Firefly (arranged by JPMorgan Chase, DLJ and Alex Brown».

55 See, e.g., id. at 32-34.

56 Fox testified that "when we typically talk about a client's revenue from Citibank, it's all revenue that Citigroup would have collected from all different types of transactions we may have been engaged in .... It somewhat varies a little bit by product area, but it is a measure we use when we determine how much revenue we have from a client." Fox Sworn Statement, at 154-55. Fox testified that "revenues" would include structuring fees and interest net of cost of funds, but that return on equity would not be included. Id. at 155.

57 Citigroup's internal documents contain discrepancies in the annual revenue amounts for 1998, 1999 and 2000. For 1998, documents report both $16.2 million and $18.1 million. See Standard Credit Memorandum: Enron Corp., Apr. 13, 1999 (the "4/13/99 Standard Credit Memo"), at 10 (reporting $16.2 million) [CITI-B 00534442-CITI-B 00534452]; Standard Relationship Credit Approval regarding Enron Corp., June 30, 2000 (the "6/30/00 Standard Relationship Credit Approval"), at 6 (reporting $18.1 million) [CITI-B 0046402-CITI-B 0046407]. For 1999, documents report $32.1 million, $44.0 million and $44.3 million. See 6/30/00 Credit Approval, at 6 (reporting $32.1 million); Interoffice Memo from Alberto Verme, Jim Reilly, Dean Keller and Damien Mitchell, Citigroup, to Robert Morse, Citigroup, regarding Enron Prepaid Transaction, Sept. 24, 2001 (the "9/24/01 Revenue Memo"), at 2-3 (reporting $44.0 million) [CITI-B 00397722-CITI-B 00397724]; Global Loans Short Form Approval Memorandum, regarding JED! II Renewal and $250 MM 180 Day Gas Prepaid, June 21, 2001 (the "June 2001 Prepay Global Loans Approval Memo"), at 8 (reporting $44.3 million) [CITI-B 0032222-CITI-B 0032232]. For 2000, documents report both $49.7 million and $50.2 million. See June 2001 Prepay Global Loans Approval Memo, at 8 (reporting $49.7 million); Standard Relationship Credit Approval regarding Enron Corp., Aug. 17,2001 (the "8/17/01 Standard Relationship Credit Approval"), at CITI-B 00883041 (reporting $50.2

- 19 -

Year Revenues
1997 $16.8 million"
1998 16.2 million"
1999 44.0 million'"
2000 49.7 million?'
2001 61.6 million" In September 2001, Citigroup acknowledged that "[o]ver the last three years,

Enron has grown to be one of the highest revenue clients within Citigroup.T" This

income likely gave Citigroup incentive to maintain Enron as a significant client. There is

evidence that Citigroup felt pressured to accommodate Enron's requests for transactions.

Often, Citigroup participated in deals with the understanding that Enron would reward

the bank with future business. Many internal documents and communications at

Citigroup contain references to such relationship pressure, including, for example:

• "Enron generates substantial GCm revenue ($50mm in 2000); any decision to limit/reduce credit availability will significantly reduce revenues going forward both at CIT and SSB and permanently impair the relationship.v'"

• "Based on the significant relationship pressure with which we are confronted, we recommend approval of a ninety day

million) [CITI-B 00883034-CITI-B 0000883042]. In deriving the $188 million revenue figure, the Examiner has used the lower of the two reported figures for each of 1998 and 2000, and the median reported figure for 1999.

58 4/13/99 Standard Credit Memo, at 10. 59 Jd.

60 9/24/01 Revenue Memo, at 2-3.

61 June 2001 Prepay Global Loans Approval Memo, at 8.

62 This amount is the sum of $31 million of revenue reported in the 8/17/01 Standard Relationship Credit Approval, plus $18.6 million that Citigroup received as a fee in Nov. 2001 for the failed merger with Dynegy Inc. and $12 million that Citigroup received as an arrangement fee for the Secured Line of Credit for two Enron pipeline subsidiaries in Nov. 2001. See 8/17/01 Standard Relationship Credit Approval, at CITI-B 00883041; Citigroup Responses, at 32-33, 20.

63 9/24/01 Revenue Memo, at 2.

64 Email from William Fox, Citigroup, to Thomas Stott, Citigroup, regarding Emon Credit Approval, Apr. 18,2001 [CITI-B 0236148].

- 20-

extension of our existing $36 million commitment to this revolver.,,65

• "We still have the existing $250mm prepaid to deal with for which they still 'owe' us one for having provided the $250mm originally. Joint call on GlisanlFastow appropriate.?"

• Regarding Enron's rejection of Citigroup as a participant in a project called Popeye:

[W]e were told that it was a result of our rejection of a 15mm participation in the brazos production-payment financing. . . . I believe it is too late to save popeye, but could we reconsider brazos in an attempt to get back into the ABS [asset-backed securities] hunt?,,67

• "As a part of Citi's broader relationship with Enron, we have been asked to support this transaction. Given the importance of this relationship to GEM [Global Energy and Mining], it is difficult ifnot impossible to deny this request.,,68

Exposure Limits

Throughout most of 1998 and 1999, Enron's outstanding obligations to Citigroup

and, therefore, Citigroup's credit exposure to Enron, exceeded the target amount, or

"Obligor Limit," that Citigroup had set for this client. Citigroup's general practice was to

assign each client an "Obligor Risk Rating" based in part on the client's credit rating.i"

65 Citibank Global Loans Short Form Approval Memorandum, May 3, 1999, at CITI-B 00317735 [CITI-B 00317734-CITI-B 00317737].

66 Email from William Fox, Citigroup, to James Reilly and Michael Nepveux and copy to Alberto Verme, Citigroup, et al., regarding Enron, Oct. 8,2001 [CITI-B 0236140].

67 Email from James Fi Reilly, Citigroup, to William Fox and Michael Nepveux and copy to Alberto 1. Verme, Citigroup, et al., regarding Enron, Oct. 8, 2001 (capitalization omitted in original) [CITI-B 00646226].

68 Global Loans Approval Memorandum, regarding Project Bacchus, Dec. 6, 2000 (the "Bacchus Global Loans Approval Memo"), at 4 [CITI-B 0290015-CITI-B 0290041].

69 Memorandum from Dave Bushnell and Ann Goodbody, Citigroup, to GCIB Credit Officers and Securities Officers, and GCIB Senior Business Managers, distributing an attached GCIB Credit Policies and Procedures, Dec. 21, 2000 (the "GCIB Credit Policy"), at CITI-B 00877013-CITI-B 00877014 [CITI-B 00876988-CITI-B 00877143]. It appears that, prior to the date of the GCIB Credit Policy, Citigroup had a formal credit policy, but the Examiner has been unable to obtain a copy. The GCIB Credit Policy from December 2000 identifies "Notable Changes" to the prior policy, and there do not appear to have been

- 21 -

For example, when Enron had a long-term credit rating of BBB+ from S&P and Baa2

from Moody's, Enron was considered to have an Obligor Risk Rating of "4+" on

Citigroup's ten-point scale." This Obligor Risk Rating was then used to help set the

Obligor Limit for that client for each of three categories of exposures: those with tenns

of up to two years, those with terms of two to five years, and those with terms of five to

ten years.i' Enron's Obligor Limit for exposures of two to five years was $375 million

until August 1999,72 when it increased to $450 million.i''

Citigroup did not always adhere to these Obligor Limits and would occasionally

permit clients to exceed the limits, with the excess being referred to as the client's

"Obligor Exception.?" According to Citigroup's guidelines for extending credit set out

in its 2000 "Credit Policies and Procedures" (the "GCIB Credit Policies"), however,

"[ e ]xceptions to the Obligor Limits will be rare, and will limited [sic] to specifically

defined, pre-approved, circumstances. All exceptions to Obligor Limits must be

approved by the Senior Risk Officer for Citigroup, or his designees.?" The GCIB Credit

Policies provided that "[r]equests for exception approvals must include an action plan and

material changes to the portions of the credit policy discussed in this Appendix. Id. at CITI-B 00876988. See also Sworn Statement of Thomas Stott, Citigroup, to Steven M. Collins, A&B, June 3, 2003 ("Stott Sworn Statement"), at 24-25; Reilly Sworn Statement, at 27.

70 See, e.g., Citicorp/Citibank Credit Approval, Dec. 21, 1999, regarding Nahanni, at 1 [CITI-B 0105079- CITI-B 0105084]. See also Stott Sworn Statement, at 25.

71 GCIB Credit Policy, at CITI-B 00877013; Stott Sworn Statement, at 26. 72 Truman Global Loans Approval Memo, at 3.

73 Id.

74 Id. See generally Stott Sworn Statement, at 29-32; Reilly Sworn Statement, at 28-29. To determine an Obligor Exception, Citigroup subtracted the client's Obligor Limit from its total amount of outstanding indebtedness and unused commitment (what Citigroup referred to as "OSUC"). GCIB Credit Policy, at CITI-B 00877013; Stott Sworn Statement, at 27. The unused commitments included within OSUC were committed facilities that Citigroup could not unilaterally withdraw. Stott Sworn Statement, at 28.

75 GCIB Credit Policy, at CITI-B 00877013.

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time frame for bringing the credit exposure back within Obligor Limits,,,76 but the

document otherwise does not explain factors that might influence Citigroup to allow an

Obligor Exception.

Thomas Stott ("Stott"), a senior officer in Citigroup's Risk Management Group,

testified that it was not unusual for clients to have Obligor Exceptions. He testified that

Citigroup "had a number of clients who exceeded the obligor limit by more than $500

[million] from time to time.,,77 He also testified that it was not a rare event for a client to

have an Obligor Exception of more than $1 billion, but he could not immediately think of

any examples, and he testified that he had experienced clients with exceptions of several

billion dollars."

Enron benefited from a substantial Obligor Exception during most of 1998 and

1999. As can be seen in the following chart, which reflects points in time at which

Citigroup reported Enron's Obligor Exception in its internal documents, Enron's Obligor

Exception increased steadily until the end of 1999, when Citigroup took action to reduce

the exposure:

76 Id.

77 Stott Sworn Statement, at 20. Stott testified that, in the industries for which he is responsible at Citigroup (energy, metals and mining, chemicals, pharmaceuticals and forest products, id. at 15), about 30 or more of the "250-ish clients" would have Obligor Exceptions at any given time. Id. at 30.

78 Stott Sworn Statement, at 31, 97.

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Enron Obligor Exception 79

12/97

12/98

4/99

7/99

9/99

IV99

1100

6/01

9/01

~ Obligor Exception

• Obligor Limit for Exposures of2-5 Years ($375 M increased to $450 M in 8/99)

The documents reflect there was concern over this exposure within Citigroup"

In January 1999, when warning colleagues that the bank likely would not approve a new

cash management facility for Enron, Citigroup's primary relationship manager for Enron

79 For 12/97 data, see Citibank Credit Approval regarding Nighthawk, Dec. 15, 1997, at 1 [CITI-B 00742230-CITI-B 00742233]. For 12/98 data, see Citibank Credit Approval regarding Roosevelt, on or about Dec. 22,1998, at 1 [CITI-B 0031965-CITI-B 0031970]. For 4/99 data, see 4113/99 Credit Memo at 11. For 7/99 data, see Citibank Credit Approval regarding Enron Corp. Annual Review, Jul. 7, 1999, at 1 [CITI-B 0052534-CITI-B 0052547]. For 9/99 data, see Truman Global Loans Approval Memo, at 3. For 11199 data, see Nahanni Global Loans Approval Memo, at 11. For 1100 data, see Yosemite II Global Loans Approval Memo, at 2, 4. For 6/01 data, see Draft Citibank Global Loans Short Form Approval Memorandum regarding JEDI II Renewal and $250 Million Prepay, June 21, 2001, at 2 [CITI-B 0032247- CITI-B 0032257]. For 9101 data, see Memorandum from Michael Nepveux, Citigroup, to Bill Fox, Citigroup, regarding Enron Corp. Sept. 30 Prepay, Sept. 19,2001, at CITI-B 00617118 [CITI-B 00617117- CITI-B 00617118].

80 As early as December 1997, Citigroup's primary relationship manager for Enron wrote in an email regarding Nighthawk: "Several rough patches: We are well over all exposure guidelines due to Nighthawk (which has, as we now account for it, structural features which do not easily allow for sell-down of the exposure) and are trying to manage it down to ensure that we can transact new business." Email from James F. Reilly, Citigroup, to Niels C. Kirk and Valerie Wilmot, Citigroup, regarding Enron, Mar. 27, 1998 [CITI-B 00315553].

- 24-

wrote that "our exposure predicament is legend.?" Toward the end of that year, in

November 1999, William T. Fox, III ("Fox"), then the head ofCitigroup's Global Energy

and Mining Group, noted that "we still have an exposure issue as it relates to obligor

limits [for Enron]; there is a developing view that limits are limits and not to be exceed

[sic]. This is something we will all have to deal with.,,82

That same month, just prior to the closing of the first Yosemite credit linked notes

funding, Onno Ruding ("Ruding"), a Vice Chairman of Citigroup, noted that the bank's

"overall exposure ... to Enron is huge .... ,,83 He refused to approve any additional

exposure until the Yosemite I proceeds had been received" He informed relationship

managers for Enron and Stott that "[u]ntil the moment that we have received the debt

repayment resulting from the Yosemite transaction, I am not willing to approve another

incremental exposure on Enron.,,85 Following the receipt of the Yosemite proceeds,

Citigroup was "under [its] Obligor Limit [with respect to Enron] for the first time in

years .... ,,86

Ruding's communication indicates that Citigroup was motivated to help Enron

complete new financings that would bring in cash to reduce Enron's Obligor Exception.

For example, Citigroup designed the Yosemite credit linked notes structure to assist

81 Email from James Fi Reilly, Citigroup, to Nicola Stores, Citigroup, regarding Enron BACs Lines, Jan. 13, 1999, at CITI-B 00440585 [CITI-B 00440585-CITI-B 00440586].

82 Email from William Fox, Citigroup, to Niels C. Kirk and James F. Reilly, Citigroup, regarding Yosemite II (Europe), Nov. 10, 1999, at 2 [CITI-B 0223408-CITI-B 0223409].

83 Email fromH-OnnoRuding, Citigroup, to James F. Reilly, Steve Baillie and Thomas Stott and copy to William Rhodes, Citigroup, et al., regarding Enron Credit, Nov. 10, 1999 (the "Ruding 11110/99 Email") [CITI-B 0046533].

84 Ruding 11110/99 Email. 85 [d.

86 Email fromJamesF.Reilly. Citigroup, to Niels C. Kirk, Citigroup, regarding Yosemite II (Europe), Nov. 9,1999 [CITI-B 0143173].

- 25 -

Enron in accessing institutional investors when bank credit began to tighten. 87 That

structure also helped Citigroup by generating cash proceeds that Enron used to repay

some of its then existing exposure to Citigroup. Another example is Sundance Industrial,

in which Citigroup invested $28.5 million, but received a $200 million repayment of its

exposure in Bacchus. Using proceeds from new financings to reduce Enron's Obligor

Exception is noted in several of Citigroup's transaction and credit approval memos for

the SPE transactions.88

Appropriateness Test

Many of Citigroup's internal approval documents and communications about

Enron's SPE transactions mention "appropriateness" as one of the factors that the bank

considered'" Fox testified that Citigroup had and continues to have a policy of requiring

87 Transaction Memorandum, regarding Enron Project Yosemite, $500MM-$1,500MM Default Swap and Credit Linked Note, Apr. 6, 1999, at 1 [CITI-B 0119713-CITI-B 0119721].

88 See, e.g., Global Loans Approval Memorandum, regarding Yosemite I, Oct. 19, 1999 (the "Yosemite I Global Loans Approval Memo"), at 2 (Yosemite I proceeds used to repay Roosevelt and Truman) [CITI-B 0046548-CITI-B 0046556]; Yosemite II Global Loans Approval Memo, at 2 (Yosemite II proceeds used to repay Nixon; "Upon repayment of Nixon, Enron will have $617.3 million Total Facilities and $368.1 of outstanding and unused commitments, eliminating the Obligor Exception."); Citibank Global Loans Approval Memorandum, regarding Project Nixon Prepaid, Dec. 7, 1999 (the "Nixon Global Loans Approval Memo"), at 20 (Nixon bridge financing expected to be repaid with Yosemite II proceeds) [CITIB 0046517-CITI-B 0046521}.

89 See, e.g., Email from Saul Bernstein, Citigroup, to Frederick Battline and copy to Linda Bergen, Citigroup, et al., Nov. 3, 1999 (the "Bernstein 1113/99 Email"), at CITI-B 0129861 ("Please note that all transactions are approved from an appropriateness and suitability aspect.") [CITI-B 0129860-CITI-B 0129862}; Email fromJamesF. Reilly, Citigroup, to William Fox and copy to Thomas Stott, Citigroup, et al., regarding Enron!CMAC- Yosemite 2, Dec. 6, 1999 ("Among the issues for discussion: transaction 'appropriateness', tenor, booking for the equity (Enron exposure or otherwise)") [CITI-B 0145626}; Email from William Fox, Citigroup, to Steve Baillie and James Reilly and copy to Niels S. Kirk, Citigroup, Nov. 14, 1999, at 1 ("Two points: one can we technically strcuture [sic} a default swap from the trust that eliminates our exposure and two there is a question of appropriateness: presumably we will be representing to investors that we are putting up half the equity and then with or without disclsoure [sic} (?) we are doing a default swap with the trust; sound [sic} questionable.") [CITI-B 0223408-CITI-B 022341O}; Email from Steve Baillie, Citigroup, to William Fox, Lydia Junek, Niels Kirk, John Lyons and James F. Reilly, Citigroup, regarding Enron Update, Nov. 24, 2000, at 1 (identifying concerns with the Bacchus transaction, "I see three key concerns here: ... (2) appropriateness since there is now an earnings dimension to this deal, which was not there before") [CITI-B 0289702-CITI-B 0289703}; Email from William Fox, Citigroup, to Niels Kirk, Steve Baillie, William Fox, Lydia Junek, Chris Lyons and James F. Reilly and copy to Elliot S. Conway, Citigroup, regarding Enron Update, Nov. 27, 2000 (discussing possible Enron

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that all its structured transactions meet an appropriateness standard.r" Fox explained that

this policy "addresses whether or not the transaction is appropriate for the client to do,

meaning does the client understand the risks, does it under - does the client understand

the impact a transaction could have on its financials.?" He testified that Citigroup looks

at such appropriateness along with other factors when deciding whether the bank should

be involved in a transaction."

At the time that Enron's Minority Interest Transactions were completed.Y

Citigroup's Global Capital Structuring group considered the appropriateness of a

transaction by requiring that each approval request package include a written

questionnaire called an "Appropriateness Test Questionnaire.T" setting out ten areas of

review." These questions went beyond the objective types of financial criteria that had

year-end 2000 deals: "IfBaachauss [sic] and the Falcon bridge materialize, that's about a $1B incremental over year end; that's enough; maybe Nahanni since it will be small exposure but it will be major appropriateness issue as will the first two.") [CITI-B 0284049].

90 Fox Sworn Statement, at 46.

91 !d. at 47.

92 Id. at 47-48 ("Q. Is appropriateness an issue that you address routinely in deciding whether to approve transactions? A. It's an issue that I think we look at with all transactions, along with a host of other things."). When asked to give an example of circumstances in which it would be inappropriate for Citigroup to enter into a transaction, Fox testified: "This is a personal view now. If there was fraud involved, I think it would be inappropriate to be involved in a transaction. I'm sure there are others that may come up, but they are all going to be transaction-specific, and those all tend to be judgmental issues that are made in the context of the transaction and the circumstances at the time." Fox Sworn Statement, at 48. Caplan also testified that appropriateness encompassed concerns about illegality, but added that "reputational issues" fall "under the rubric of appropriateness" as well. Caplan Sworn Statement, at 91-93.

93 Nighthawk was completed in December 1997, Rawhide in December 1998, and Nahanni in December 1999. See Citigroup Responses, at 33-35.

94 Conway Sworn Statement, at 36; Sworn Statement of Otto Jager, Citigroup, to Steven M. Collins, A&B, Apr. 29, 2003 (the "Jager Sworn Statement"), at 46. Conway testified that the Global Capital Structuring group no longer uses the questionnaire form, but that it still requires "a discussion with the same questions being addressed." Conway Sworn Statement, at 36.

95 Project Nighthawk Transaction Approval Package, Dec., 1997 (the "Nighthawk Capital Structuring December Approval Package"), at CITI-B 00375913-CITI-B 00375914 (containing the Nighthawk Appropriateness Test Questionnaire) [CITI-B 00375890-CITI-B 00375914]; Rawhide Capital Structuring US Approval Request Package, Nov. 2, 1998 (the "Rawhide Capital Structuring Approval Package"), at CITI-B 00403920-CITI-B 00403921 (including the Rawhide Appropriateness Test Questionnaire) [CITI-B

- 27-

to be considered (such as the client's credit risk), and instead focused on the more

subjective features of the transaction. For example, the questionnaire focused on issues

such as whether the client had a legitimate business purpose for entering into the

transaction, and whether the documentation for the transaction was constructed to allow a

reader to understand if the deal was part of a larger overall transaction.r"

The ten areas that the Global Capital Structuring group required be addressed and

approved by the "Designated Responsible Senior" for each transaction were as follows:

1. Lack of transparency (Business Objective) - The true economic substance of the transaction cannot be determined from the structure without significant analysis.

2. Secrecy of identity of true party - The true identity of a party to the transaction cannot be determined because of the use of Spy s or charitable trusts in offshore tax havens or bank secrecy jurisdictions.

3. Circularity - The transaction is essentially circular with the customer being both the ultimate lender and borrower and/or ultimate buyer and seller.

4. Fragmentation - The transaction is constructed so that no one document describes the whole transaction, making it possible for a reader to review documents for a segment of the transaction and not understand that it is part of a larger transaction.

5. Unusual terms - The transaction is off-market or contains terms which are significantly different from what one would expect.

6. Absence of rules/guidance The applicable regulatory/

legal/accounting/tax systems lack developed rules or guidance for complex products.

7. Event risk in regulatory/legal/accounting systems - The rules governing the transaction are not predictable and could be subject to sudden application of tighter standards, or heightened prosecution because of political or social developments.

00403912-CITI-B 00403921]; Appropriateness Test Questionnaire, undated (the "Rawhide Amendment Appropriateness Test Questionnaire") (relating to amendments to Rawhide) [CITI-B 00402470-CITI-B 00402471]; Nahanni Global Capital Structuring US Approval Request Package, Oct. 25, 1999 (the "Nahanni Global Capital Structuring Approval Package"), at CITI-B 0105066-CITI-B 0105067 (including the Nahanni Appropriateness Test Questionnaire) [CITI-B 0105065-CITI-B 0105076).

96 Nighthawk Capital Structuring December Approval Package, at CITI-B 00375913-CITI-B 00375914 (the Nighthawk Appropriateness Test Questionnaire); Rawhide Capital Structuring Approval Package, at CITI-B 00403920-CITI-B 00403921 (the Rawhide Appropriateness Test Questionnaire); Rawhide Amendment Appropriateness Test Questionnaire; Nahanni Global Capital Structuring Approval Package, at CITI-B 0105066-CITI-B 0105067 (the Nahanni Appropriateness Test Questionnaire).

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8. Multiple jurisdictions - Multiple jurisdictions are involved with internal approvals sought individually in each making the process harder to manage and the risk of oversight of the entire transaction greater.

9. Lack of confirmation of customer assurances - The absence of third party confirmations (e.g. regulators, auditors, appraisers) of customer assurances on sensitive issues.

10. Disproportionate impact - The transaction will have a significant impact on the customer's financial condition or results, and will not be required to be disclosed."

It is not clear whether any unit within Citigroup other than Global Capital

Structuring, which was responsible for the Minority Interest Transactions, used this

formal appropriateness test questionnaire. However, Richard Caplan ("Caplan"), a

Managing Director formerly in the Derivatives group, which was involved in the

Citigroup Prepays, Bacchus and Sundance Industrial, testified that his group considered

these matters when considering whether to grant transaction approvals."

By its consideration of these matters, it appears that Citigroup felt responsibility

to ensure that it did not engage in a transaction that obscured the true economic

substance, that the transaction was disclosed clearly and adequately to investors and that

the transaction had a legitimate business purpose. As discussed in Part III of this

Appendix, there are numerous instances in which Citigroup's transactions with Enron did

not meet these standards."

97 Nighthawk Capital Structuring December Approval Package, at CITI-B 00375913-CITI-B 00375914 (the Nighthawk Appropriateness Test Questionnaire); Rawhide Capital Structuring Approval Package, at CITI-B 00403920-CITI-B 00403921 (the Rawhide Appropriateness Test Questionnaire); Rawhide Amendment Appropriateness Test Questionnaire; Nahanni Global Capital Structuring Approval Package, at CITI-B 0105066-CITI-B 0105067 (the Nahanni Appropriateness Test Questionnaire).

98 Caplan Sworn Statement, at 396-97 ("[I]n derivatives CMAC [Capital Markets Approval Committee] would deal with the questions that are in this questionnaire.") (referring to Exhibit 182, the Nighthawk Appropriateness Test Questionnaire).

99 Sanford Weill ("Weill"), Chairman of Citigroup, emphasized the commitment to consider such matters in a memorandum to all Citigroup employees on August 7, 2002. See Memorandum from Weill, to All Employees, regarding Progress Report, Aug. 7, 2002, available at http://www.citigroup.com/

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Analysts' Coverage

For much of the period 1997 through 2001, Citigroup employed an equity analyst

who covered Enron. Until late 1999, the analyst was Don Dufresne ("Dufresne,,).IOO On

at least one occasion, in March 1999, Fastow expressed displeasure with Dufresne's

rating of Enron.101 Robert Holloman ("Holloman"), a Citigroup employee who spoke

with Fastow about the matter, reported that Fastow said Dufresne "was not constructive

in his views on Enron" and that Enron "also did not believe Don had fully supported the

company in its recent equity offering and that this was reflected in the fact that

[Citigroup] sold less stock than any other manager."I02 Fastow also told Holloman that

Enron's displeasure with Dufresne was the "one reason" Enron did not allow Citigroup to

have more than a trivial role in the $750 million initial public offering of Azurix, Enron's

citigroup/pressI2002/020807a.htm (last visited June 23, 2003). Under the subheading "New Initiatives in our Structured Finance Business," Mr. Weill wrote:

At Citigroup, we are committed to greater transparency in the disclosure of structured finance transactions and we are answering the call from Washington and from investors by adopting strong initiatives ourselves.

Quite simply, if a company does not agree to record a material financing as debt on its balance sheet, Citigroup will only execute the transaction if the company agrees to publicly disclose its impact to investors.

Starting immediately, we will only do these transactions for clients that agree to make prompt disclosure of the details of the transaction including management's analysis of the net effect the transaction has on the financial condition of the company, the nature and amount of the obligations, and a description of events that may cause an obligation to arise, increase or become accelerated. In addition, we will only do these transactions for clients that agree to provide the complete set of transaction documents to their chief financial officer, chief legal officer and independent auditors. We believe our new policy will encourage companies to provide greater transparency than currently required by law and help restore investor confidence in our financial markets.

Id. at 2.

100 Memorandum from Michael Carpenter, Citigroup, to Dean Keller, Citigroup, regarding Enron, Dec. 15, 1999 (the "Carpenter 12/15/99 Memo"), at 4 [CITI-B 0131718-CITI-B 0131722].

101 Email from Robert Holloman, Citigroup, to James Reilly, Citigroup, et al., Mar. 16, 1999 (the "Holloman 3/16/99 Email") [CITI-B 00645887-CITI-B 00645888].

102 Id.

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water subsidiary.Y' Fastow sent Citigroup, through Holloman, a "strong message ...

that Enron would like to see some progress in our equity research view of Enron before

the relationship with SSB can really progress.,,104 Fastow offered to have senior

management at Enron spend time with Dufresne to help him better understand the

company's strategy and industry position. lOS

Dufresne remained with Citigroup until around the end of 1999, when Citigroup

terminated his employment.l'" He was replaced in March 2000 by Raymond Niles

("Niles"), an analyst who had been covering Enron for the investment banking firm

Schroders pic, which Citigroup acquired in 2000.107 Mark Koenig, Enron's head of

investor relations, specifically requested that Citigroup hire Niles.l08

Niles began his coverage of Enron for Citigroup with a rating of IH for Enron,

with the number 1 reflecting the highest possible buy recommendation and the letter H

representing the second highest rating for risk.109 Niles did not change his rating until

October 2001, when he reduced it to IS, which is still a buy recommendation but with the

103 Id. 104 Id. 105 Id.

106 Carpenter 12/15/99 Memo, at 4.

107 Sworn Statement of Raymond Niles, Citigroup, to Robb E. Hellwig, A&B, May 9, 2003 (the "Niles Sworn Statement"), at 11-13; Citigroup Form 10-K filed with the SEC for the Year ended Dec. 31,2000, at 37.

108 Memorandum from Maureen Hendricks, Citigroup, to Michael Carpenter, Citigroup, regarding Enron Meeting March 9 at 2pm, Mar. 8, 2000 (the "Hendricks 3/8/00 Memo"), at 1 [CITI-B 00324434-CITI-B 00324437].

109 Niles Sworn Statement, at 15-16. In contrast, in the Fall of 1999, Dufresne's rating had been 2H. Investment Banking Commitment Committee Memorandum, regarding Project Condor, prepared between June 30, 1999 and Sept. 13, 1999, at CITI-B 0098008 [CITI-B 0097976-CITI-B 0098021]. At this same time, Dufresne at Citigroup estimated Enron's earnings per share for 1999 to be $1.20 and classified the company as "outperform," id. at CITI-B 0098010, and Niles at Schroders estimated the 1999 earnings per share at $1.25 and classified the company as a "Top Pick." Id.

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highest risk rating ("speculative"). I 10 He then lowered it further to 3S, which was neutral

as to the buy recommendation with the same speculative risk rating. III

While Enron expressed its displeasure over Dufresne's ratings, it is not known if

that influenced Citigroup's decision to terminate his employment. Likewise, while Enron

recommended to Citigroup that it hire Niles, "a huge ENE fan," I 12 Niles may have been a

likely candidate for the position anyway because Citigroup acquired his then-current

employer. The Examiner has found no evidence to date that Citigroup breached any

"ethical wall"ll3 with respect to its Enron transactions and its analysts' coverage of the

company.l '"

B. Citigroup's Knowledge of Enron's Financial Condition

As a result of its extensive involvement with Enron between 1997 and 2001,

Citigroup had significant access to financial information about Enron. As a Tier 1 bank

to Enron, with transactions in progress virtually at all times, Citigroup had access to

confidential information and to senior management at the company. Citigroup

acknowledged this stating, for example, in October 1999, that "Salomon Smith Barney is

110 Niles Sworn Statement, at 16-17. III !d. at 17.

112 Hendricks 3/8/00 Memo, at 1.

113 For Citigroup's internal policies, see Citigroup Interoffice Correspondence from Legal and Compliance, to All Employees, regarding Information-Protection Guidelines, May 8, 2000 [CITI-B 00326132-CITI-B 00326135]. See also, e.g., SSB Interoffice Memorandum from Control Group to Global Investment Banking Managing Directors, Directors, Vice Presidents, Associates, and Analysts, regarding Notification Standards, May 8, 2000 [CITI-B 00326221-CITI-B 00326223]; SSB Interoffice Correspondence from David Fenimore to Global Control Groups and Legal/Compliance Directors, regarding Chinese Wall Breach Contingency Plan, Feb. 15,2000 [CITI-B 00326142-CITI-B 00326146].

114 Citigroup announced on May 24, 2003 that it had terminated the employment of eight analysts, including Niles. Landon Thomas, Jr., 8 Analysts Are Dismissed by Citigroup: Coverage of Companies Is Temporarily Cut Back, N.Y. Times, May 24,2003, at Bl.

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in frequent dialogue with Enron's management team regarding the company's, and each

of its subsidiaries', operating and financial results and business outlook.,,115

Citigroup was also knowledgeable about Enron's complex business operations, as

well as the complicated accounting that Enron employed. For example, Citigroup

understood generally how energy companies like Enron used complicated "value-at-risk"

and other methodologies to manage the risk in their investments.I'" Citigroup also

understood the effect that Enron's MTM accounting had when applied to the company's

merchant investments, resulting in gains and the potential for losses.117 Citigroup knew

that these gains and losses affected the amount of Enron's reported net income, even

though they did not generate cash. This knowledge is exhibited in a 1999 internal review

ofEnron, in which Citigroup seemed pleased to find that Enron's merchant activities may

have generated cash flows: "[a]fter factoring in the purchase of merchant assets, the

115 Yosemite I SSB Memo, at 37. See also Global Loans Approval Memorandum, regarding $1.75 Billion/364-Day facility and $1.25 Billion/5- Year facility, Apr. 17, 2000, at SEC00086292 ("We maintain regular contact at Management levels throughout the organization including CEO, COO, CFO, and SVP Finance. In addition, we have frequent contact with the business groups as a result of the broad range of deals under consideration.") [SEC00086287-SEC00086293).

116 See, e.g., Email from Shirley S. Elliott, Citigroup, to William Fox and copy to Steve Baillie, Citigroup, et al., Dec. 14, 2000, at 1 ("Enron, Dynegy, and El Paso utilize a one-day holding period and a 95% confidence level where Williams uses a 97.5% confidence interval. Enron evaluates, measures and manages the market risk in its investments on a daily basis utilizing value at risk and other methodologies. Value at risk represents an estimate of reasonably possible net losses in earnings that would be recognized on its investments assuming hypothetical movements in future market rates and no change in positions.") [CITI-B 0284053-CITI-B 0284055]; Email from Lynn Feintech, Citigroup, to Amanda Angelini, Citigroup, et al., regarding meeting with Forese, May 4,2001 ("We need a stop loss to insure that even ifVAR is not breeched [sic], unacceptable losses can be stopped.") [CITI-B 0302418]; Email from Timothy Leroux, Citigroup, to Doug Warren, Citigroup, et al., regarding Sundance Update from L. Feintech, May 4, 2001 ("Bill will investigate whether they will give us notification of losses in the trading book in excess of a certain amount (but still under VAR).") [CITI-B 00696696]; Email fromTimothyLeroux.Citigroup.to Lynn Feintech, Citigroup, et al., regarding Sundance Issues - Updated, May 10, 2001, at 1 ("Establish an INTERNAL stop loss for Fishtail ... Require notification of V AR changes within 2 business days") [CITIB 0297478-CITI-B 0297479]; Citibank, Capital Markets Approval Committee, regarding Project Sundance Transaction, undated, at 3 [CITI-B 0302137-CITI-B 0302140].

117 Enron Corp. Third Quarter Update, undated (but discussing revenues and EBITDA for twelve months ended Sept. 30, 1999, and citing market capitalization as of Oct. 21, 1999) (the "Third Quarter 1999 Update"), at SEC00086285 [SEC00086283-SEC00086286]; Nahanni Global Loans Approval Memo, at 13; Yosemite II Global Loans Approval Memo, at 7-8.

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business was still a positive cash generator in 1999, giving some comfort that these

activities produce 'real' cash flOW.,,118

Citigroup also came to understand that Enron was motivated, in large part by

Rating Agency pressures, to generate cash flow from operating activities in order to

match reported earnings.'!" A 1996 approval memorandum for the "CASH 3" contract

monetization stated that Enron was doing that transaction "for the purpose of accelerating

cashflow to better match earnings taken under [Enron's] mark-to-market accounting

methodology.v'f'' By 1999, Citigroup wrote in loan approval memoranda: "In recent

years, rating agencies have focused on 'managing to cash' the profits earned under MTM

accounting: that is ensuring earnings were a reflection of cash received.,,121

Many of the SPE transactions that Citigroup completed with Enron were intended

to generate such operating cash flows. In November 1999, a Citigroup credit profile of

Enron explained Citigroup's understanding of the transactions that it completed with

Enron:

Why do they do prep aids and the various other structured financings, what benefit do they think they get, and why therefore is it worth the premiums they pay?

Enron uses structured financings for varying reasons, depending on the type of transaction employed:

» Minority Interest Equity - Enron clearly believes its [sic] receives significant rating agency equity treatment from these transactions comparable to other quasi-equity instruments such as DECS. These structures also provide Enron with Minority Interest for GAAP reporting purposes, which is beneficial for certain constituencies.

118 Third Quarter 1999 Update, at SEC00086285.

119 See, e.g., Reilly Sworn Statement, at 156-57; Nahanni Global Loans Approval Memo, at 13; Yosemite II Global Loans Approval Memo, at 7-8.

120 CASH 3 Approval Memo, at 3.

121 Nahanni Global Loans Approval Memo, at 13. See also Yosemite II Global Loans Approval Memo, at 7.

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>- Deconsolidated Capital Structuring Transactions - (i.e Marlin, Condor, Firefly) which are settled in Enron stock. Again, Enron is confident that it receives significant equity credit from ratings agencies, and some GAAP reporting benefit.

>- Prep aids/Contract Monetizations - As explained in the attached memo titled "Enron Corporation Credit Profile" Enron has used contract monetizations and prep aids to address two issues which have been raised by the rating agencies. One of the agencies' issues was that earnings which Enron recognized when mark-to-marking [sic] its trading book produce a commensurate cash inflow on a timely basis. Another issue was the tenor mismatch between trading asset and trading liabilities. Enron used to deal with these issues through monetizations, that is effectively selling a given cash flow stream arising from a commodity contract. This produced upfront cash equal to the net present value of the profit in the transaction, and removed the asset and liability from the trading book. However due to certain accounting changes, contract monetizations became less attractive and are no longer used by Enron. Today, Enron enters into prepaids, which effectively monetize the earnings Enron recognizes in mark-tomarking [sic] its trading book, and "upfronts" the cash. Prep aids also have the benefit of lengthening the tenor of the trading book liabilities, and hence help to balance the tenor mismatch between trading assets and liabilities. The premium paid for entering into a prepaid transaction is relatively modest.

Overall, Enron believes that structured finance transactions provide benefits incremental to the alternative of straight debt - risk shifting, rating agency, commodity denomination, etc. - at costs not significantly higher than that available at the straight bank or capital markets. 122

Citigroup 's Knowledge of En ron 's Total Debt

Citigroup prepared detailed analyses of Enron's financial condition for purposes

of considering new underwritings for Enron and the extension of new credit to Enron,

and as part of its periodic reviews of its existing exposure to Enron.123 When Citigroup

122 Email from Sumit Mathai, Citigroup, to William Fox and Thomas Stott and copy to Steve Baillie and James F. Reilly, Citigroup, Nov. 5, 1999, at CITI-B 00449879-CITI-B 00449880 (attaching "Additional Information") (bold in original) [CITI-B 00449878-CITI-B 00449880].

123 See, e.g., Yosemite I SSB Memo; Salomon Smith Barney Interoffice Memo to a number of Citigroup employees, regarding Investment Grade - European Committee Meeting for Yosemite II, Nov. 19, 1999 (the "Yosemite II SSB Memo") [CITI-B 0146504-CITI-B 0146585]; Yosemite III SSB Memo; Yosemite IV SSB Memo; August 2001 SSB Memo; Truman Global Loans Approval Memo; Yosemite II Global Loans Approval Memo; Nahanni Global Loans Approval Memo; 8/17/01 Standard Relationship Credit

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prepared its analyses of Enron, it often included detailed descriptions of Enron's debt and

other obligations, recharacterizing as debt many types of obligations that Enron did not

report as debt, or taking into account obligations that Enron did not report at all in its

consolidated financial statements.'?" These obligations included such items as prepays,

structured financings, leases, receivables securitizations and guarantees of unconsolidated

subsidiaries. 125

In compiling its analyses of Enron, Citigroup used information from various

publicly available sources, including Enron's public filings, Rating Agency reports, press

releases and stock research.!" Importantly, however, Citigroup possessed knowledge of

Enron learned from the extensive and frequent contact it had with senior management of

the company. Because it was involved in so many of Enron's structured financings,

Approval; 6/30/00 Standard Relationship Credit Approval; Third Quarter 1999 Update; 4/13/99 Standard Credit Memo; 1998 Credit Review.

124 See, e.g., Yosemite I SSB Memo; Yosemite II SSB Memo; Yosemite III SSB Memo; Yosemite IV SSB Memo; August 2001 SSB Memo; Truman Global Loans Approval Memo; Nahanni Global Loans Approval Memo; 4/13/99 Standard Credit Memo.

125 See, e.g., Yosemite I SSB Memo, at 21-22; Yosemite II SSB Memo, at 8-10; Yosemite III SSB Memo, at 17-18; Yosemite IV SSB Memo, at 20-21; August 2001 SSB Memo, at 11-12; Truman Global Loans Approval Memo, at 5-6; Nahanni Global Loans Approval Memo, at 14-15; 4/13/99 Standard Credit Memo, at 9.

126 Sworn Statement of Maureen Hendricks, Citigroup, to Steven M. Collins, A&B, May 16, 2003 (the "Hendricks Sworn Statement"), at 19-20. Hendricks testified that, in gathering the information for such analyses: "we would have reviewed all of the public market data that was available .... We would have read all of the [Moody's and Standard & Poors'] reports. We would have read all of the financial information on Enron, all financial statements. We would have read any and all press releases. We would have reviewed any and all results of any meetings we had with the company. We would have read any available stock research that we could get our hands on." !d. When asked if she would "have canvassed or tapped into sources within, let's say, Citibank NA to find out what they knew about Enron," id. at 20, Hendricks replied "Yes. At this point we were working very closely, and I believe Jim Reilly [one of Citigroup's key relationship managers for Enron] was one of the participants at that meeting." Id. When asked "Did you attempt to get information about other structured financings that Citibank or its affiliates had outstanding with Enron at that time?", id. at 21, Hendricks replied "Yes. I believe that there would have been a discussion of previous structured financings that Citibank had done with Enron, and that would have been run by Jim, because I wouldn't have been party to those." Id. at 21.

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Citigroup understood many types of financings that Enron used and how they impacted

Enron's publicly disclosed financial statements. 127

As early as 1993, Citigroup was aware that Enron had significant amounts of off-

balance sheet obligations that were not included in Enron's publicly disclosed debt.128 In

later years, many of Citigroup's internal approval memoranda included an estimate of

this amount.129

The Salomon Smith Barney Investment Banking unit prepared detailed analyses

of Enron's total obligations. These reviews began in the Fall of 1999, in connection with

the internal approval process for the first Yosemite transaction. Jessica Palmer, co-head

of Citigroup's Investment Grade Commitment Committee, requested a special review of

Enron's financial condition.U'' That review, undertaken by the Global Energy and Power

group (which was headed by Maureen Hendricks ("Hendricks")),131 included a full-scale

analysis of Enron's capital structure.l'" Hendricks' group prepared similar, but

increasingly detailed, analyses for each of the three subsequent Yosemite transactions, as

well as for an August 2001 Enron notes offering.l "

127 Reilly testified that Citigroup was aware of Enron transactions other than those in which Citigroup itself participated. Reilly Sworn Statement, at 43 ("[W]e may have just known that the deal was in the market, or maybe we looked at a deal and didn't participate.").

128 CASH 3 Approval Memo, at 15 ("at year-end 1993, as Enron's total debt (not including off-balance sheet items of approximately $2.6 billion) was $2.805 billion ... ").

129 See, e.g., Yosemite I Global Loans Approval Memo, at 7; Nahanni Global Loans Approval Memo, at 14-15; Truman Global Loans Approval Memo, at 5.

130 See Email from Jessica Palmer, Citigroup, to Maureen Hendricks, Citigroup, et al., regarding Enron Corp Project Yosemite, Aug. 27, 1999, at 2 ("We will need to be briefed on the accounting that is being used by Enron in this transaction and how this transaction affects the company's accounts and disclosure. It will be important for us to know who has talked to the company's auditors. Would this affect the company's ratings?") [CITI-B 00782495-CITI-B 00782498]. See also Hendricks Sworn Statement, at 39.

131 Hendricks Sworn Statement, at 33.

132 Yosemite I 8SB Memo, at 21-22.

133 See Yosemite II 88B Memo; Yosemite III S8B Memo; Yosemite IV S8B Memo; August 2001 8SB Memo.

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In these reviews, Citigroup compared Enron's publicly reported debt amounts and

debt to capitalization ratio ("Debt/Cap Ratio") to amounts and ratios determined from the

other sources of Enron information available to Citigroup. These comparisons included

either three or, beginning in August 2000, four computations. The first was Enron's

publicly reported GAAP debt and Debt/Cap Ratio.134 The second computation was based

on a presentation Enron had given to the Moody's Rating Agency in 1999 in response to

Moody's concerns that Enron's financial statements did not accurately depict the full

extent of Enron's obligations. 135 Enron's presentation purported to take into account "the

kitchen sink" in its debt calculations, reclassifying as debt both unconsolidated subsidiary

debt and partner equity.':"

Citigroup called its third computation the "SSB Base Case Analysis," and it added

"certain significant 'off-balance-sheet' financing to the total debt number, excluding

contingent equity secured transactions.,,137 The fourth and final calculation was the "SSB

Alternative Analysis," and it "was the most conservative scenario, also including

contingent equity secured transactions as debt.,,138 The following chart shows the debt

amounts determined by Citigroup under its SSB Base Case Analysis and SSB Alternative

Analysis, which Citigroup compared to Enron's publicly reported debt amounts:

134 See, e.g., Yosemite IV SSB Memo, at 20; August 2001 SSB Memo, at 11. 135 Hendricks Sworn Statement, at 55; Yosemite II SSB Memo, at 8-10.

136 EnronPresentation to Moody's, Oct. 12-13, 1999 [CITI-B 0005494-CITI-B 0005498]. 137 Yosemite IV SSB Memo, at 20; August 2001 SSB Memo, at 11.

138 Yosemite IV SSB Memo, at 20; August 2001 SSB Memo, at 11.

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Enron's Total Obligattons!"

11'99

8/00

4/01

8/01

• Enron Debt - Publicly Disclosed

D Enron Debt - SSB Base Case Analysis

IS] Enron Debt - SSB Alternative Analysis

As part of the analyses, Citigroup recomputed Enron's Debt/Cap Ratios using the

different debt comparisons. For example, in August 2001, Citigroup estimated that

Enron had $18.8 billion of total debt obligations under the SSB Base Case Analysis, and

as much as $22.8 billion of total debt obligations under the SSB Alternative Analysis,

with only $11.9 billion of that amount reported as debt on its balance sheet.140 Citigroup

recomputed Enron's Debt/Cap Ratio to be 54.1 % under the SSB Base Case Analysis and

139 For 11199 data, see Yosemite II SSB Memo, at 8. For 8/00 data, see Yosemite III SSB Memo, at 17. For 4/01 data, see Yosemite IV SSB Memo, at 19. For 8/01, data see August 2001 SSB Memo, at 11. The Yosemite I SSB Memo, dated 10/99, is not included in the chart to avoid a misleading presentation of data because the methodology used in that first SSB analysis does not appear to be the same as in the other SSB Memos. See Yosemite I SSB Memo, at 21-22 (estimating $25.2 billion in off balance sheet debt, compared to Enron's reported debt of$12 billion).

140 August 2001 SSB Memo, at 11-12. In arriving at this determination, Citigroup characterized the following transactions as "Off Balance Sheet Financings": Yosemite I, Yosemite II, Yosemite III, Yosemite IV, Rawhide, Oil Prepays, Leases, Receivable Financing, Marlin, and Margaux. Id. Citigroup also included $1 billion in "miscellaneous" off-balance sheet financings that it could not specifically identify. Id.

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58.9% under the SSB Alternative Analysis, compared to Enron's reported Debt/Cap

Ratio of 42.8%.141

Citigroup's Concerns About Enron 's Financial Condition

Hendricks testified that Citigroup's analyses were "as conservative as possible"

and that the results showed that Enron was "well within the margin of an investment

grade credit, and that it was as good, if not better, than its peer group within the

industry.,,142 After preparing the SSB Memo analyses, Hendricks' group consistently

concluded that "Enron compares favorably with its integrated pipeline peer group

companies on most financial benchmarks.v'Y and recommended approval of the

proposed transactions. 144

Although Hendricks testified that she "derived great comfort" from comparing the

adjusted ratios for Enron with those of other energy companies,145 others within

Citigroup expressed concerns about Enron's financial condition. In an annual credit

review of Enron conducted in June 2000, Fernando Ynigo ("Ynigo"), a member of

Citigroup's Credit Policy Committee, added the following caveat to his approval: "Given

the direction this company is headed we need to keep track of their liquidity. Any

deterioration in their liquidity should be closely examined.,,146 Ynigo followed up in

August 2000 with a message to Fox and Stott, among others, saying: "It is my perception

141 Id.

142 Hendricks Sworn Statement, at 38.

143 Yosemite III SSB Memo, at 18; Yosemite IV SSB Memo, at 21; August 2001 SSB Memo, at 12. See also Yosemite III SSB Memo, at 16 ("Even after adjusting for off balance sheet obligations, Enron remains one of the most well capitalized companies in either peer group.").

144 Yosemite I SSB Memo, at 37; Yosemite III SSB Memo, at 40; Yosemite IV SSB Memo, at 41; August 2001 SSB Memo, at 27.

145 Hendricks Sworn Statement, at 38.

146 6/30/00 Standard Relationship Credit Approval, at 6.

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client is still highly leveraged and constantly evolving, so, I need to understand better to

get the obvious higher level of comfort that you all seem to have.,,147

In December 2000, Fox himself raised several questions about Enron, including

why Enron's third quarter 2000 financial report was not consistent with what he would

expect of a BBB+ rated company.i'" He asked Shirley Elliott ("Elliott"), a credit analyst

in Citigroup's Houston office, to compile some answers.l'" She responded that, although

Enron may "tidy up" its balance sheet for year end, it appeared to her that there was a

"substantial rather than cosmetic" change in Enron's EBITDA, revenue and debt between

year-end 1999 and September 30, 2000.150

Fox testified that, by the spring of 2001, Citigroup recognized that Enron's

business, as well as that of its major competitors, was becoming more dependent on

trading activities.i" He stated that he and others associated with the Enron team wanted

to understand better the risks and issues inherent in such a business.152 Consequently,

Citigroup conducted an internal analysis of Enronl53 and hired an outside consultant to

provide a one-day seminar to help it better understand "Risk Management Activities

reported by large energy marketing and trading companies, using specific examples from

147 Email fromFernandoYnigo, Citigroup, to James F. Reilly and Thomas Stott and copy to Tom Boland and William Fox, Citigroup, Aug. 16,2000 (the "Ynigo 8/16/00 Email") [CITI-B 00532095).

148 Email from Shirley S. Elliott, Citigroup, to William Fox and copy to Steve Baillie, Lydia Junek, Thomas Stott and Tero A. Tiilikainen, Citigroup, regarding Enron, Dec. 13, 2000 (the "Elliott 12/13/00 Email .. ).at3[CITI-B0284053-CITI-B0284055];FoxSwornStatement.at 96.

149 Elliott 12/13/00 Email.

150 Id. at 3.

151 Fox Sworn Statement, at 106-07. 152 Id. at 68-70, 106-08.

153 Email from Shirley Elliott, Citigroup, to Trebonias R. Jokhai and copy to JohnF. Mugno, Citigroup, et aI., July 20,2001 (the "Elliott 7/20/01 Email"), at CITI-B 00616905 [CITI-B 00616905-CITI-B00616924).

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Enron and Dynegy.,,154 Elliott again worked on the internal Enron analysis, and she

participated in the effort to review Enron's financial condition in detail, apparently with a

particular focus on Enron's cash flows, including prepay transactions. 155

Finally, by late summer and early fall 2001, as the public image of Enron's

financial condition was rapidly deteriorating, Citigroup redoubled its efforts to complete

the picture of Enron's true financial condition. Citigroup received a credit review

presentation from Enron dated August 7, 2001.156 An extensive and detailed list of

questions circulated within Citigroup on October 17.157 Also in October, Fox directed

others within Citigroup to "gather our collective knowledge" on Enron's finances,

including "Off Balance Sheet Structures: like Marlin, Osprey, Wessex, Electro, FASB

140 structures, Whitewing etc ie [sic] those deals that we are aware of but not involved

in," and Enron's liquidity requirements. 158

In late October 2001, as Enron was requesting a new $1 billion line of credit from

Citigroup and JPMorgan Chase, Hendricks expressed to Glisan, Enron's Treasurer, the

frustration at Citigroup that Enron and Citigroup were "not communicating as clearly as

154 Letter from William T. Fox, III, Citigroup, to Barry M. Frohlinger ("Frohlinger"), July 20, 2001, at CITI-B 01284035 (engaging Frohlinger's firm to provide training and educational services, including a discussion of "how to interpret and quantify the impact of off balance liabilities, such as pre-paids") [CITIB 01284035-CITI-B 01284036]. See also Fox Sworn Statement, at 68-70, 106-08. Stott testified that he could recall the following attendees: Thomas Stott, Dan Brill, Michael Nepveux, Lydia Junek and John Mugno. Stott Sworn Statement, at 130-31.

155 Elliott 7120/01 Email, at CITI-B 00616905 (noting that she was producing a cash flow analysis "using a t-account analysis 'backing into' cash received based upon Enron's disclosed risk Management Activity EBIT and balances.").

156 See Enron Credit Review, PowerPoint Presentation, prepared by Enron, Aug. 7, 2001 [CITI-B 0046235-CITI-B 0046277].

157 Email from Anne Clarke Wolff, Citigroup, to Maureen Hendricks, Citigroup, et al., Oct. 17,2001 (distributing a list of due diligence questions to be posed to Enron) [CITI-B 00827896-CITI-B 00827900].

158 Email from William Ti Fox.Tll, Citigroup, to Amy Pincu, Citigroup, et al., Oct. 23, 2001 [CITI-B 00616343].

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[they] needed to.,,159 She informed Glisan that if Enron "really wanted to advance this

process," Enron should tell Citigroup "everything and anything [they] wanted to

knoW.,,160 Citigroup funded $600 million of the requested loan in November 2001 for

which it received a $12 million fee; JPMorgan Chase funded the remaining $400

million. 161

Although Enron was a complex organization with complicated accounting and

was not always forthcoming with Citigroup about all aspects of its finances, it appears

that Citigroup had an in-depth understanding of Enron. James Reilly ("Reilly"), one of

Citigroup's key relationship managers for Enron,162 testified that, in November 2001

when Enron disclosed to its banks its true liquidity position, Citigroup was not surprised

by any of the disclosures except with respect to the magnitude of Enron's FAS 140

Transactions and Prepay Transactions.163 Despite Citigroup's special knowledge of

Enron's financial condition, and the importance of that information to Citigroup III

making its credit decisions, the Examiner has found no evidence that Citigroup disclosed

this information to investors to whom it sold Enron securities or to whom it syndicated

underwritings or debt. In fact, in November 2001, when Enron was representing

159 Email from Maureen A. Hendricks, Citigroup,toJamesF. Reilly, Dean Keller, Richard A. Stuckey and John Melesius and copy to Anne Clark-Wolff, Citigroup, et al. regarding Tonight's call with Glisan, Oct. 23,2001 (the "Hendricks 10/23/01 Email") [CITI-B 00931684].

160 Hendricks 10123/01 Email.

161 Citigroup Responses, at 20, Citigroup was a participant in Enron's presentation to several banks in New York on Nov. 19, 2001, in which Enron purported to disclose its financial condition. Reilly Sworn Statement, at 342.

162 See Reilly Sworn Statement, at 16-17 ("Q. At some point did you become the principal relationship manager for Enron at Citibank? A. Yes. Q, When was that? A. I was - probably from when I joined in '91 I would have been the senior relationship manager on the account.").

163 Reilly Sworn Statement, at 336-37 ("[T]here were substantially more FAS 125 or 140 transactions than we were aware of. We had been led to believe that we were aware of the bulk of the prep aids, and there were more meaningful prepaids than we knew about.").

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Citigroup in the failed merger with Dynegy, Citigroup's review of Enron helped it realize

that Enron had a $10 billion liquidity shortfall. 164 Fox wrote in an email that "we need to

down play the $10B number; if this get [sic] public circulation it could cause problems

with Dynegy and counterparties pending the merger.t''"

164 Fox Sworn Statement, at 157.

165 Email from William T. Fox, III, Citigroup, to Alberto J. Venne, Citigroup, regarding Enron, Nov. 12, 2001 [CITI-B 00646465].

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III. CITIGROUP'S ROLE IN ENRON'S SPE TRANSACTIONS

A. Prepay Transactions

The Prepay Transactions-completed mostly with the help of Citigroup and

JPMorgan Chase-were a powerful tool that Enron used to manage its reported financial

condition and satisfy Rating Agency expectations.i'" Enron's Prepay Transactions with

Citigroup and JPMorgan Chase constituted virtually all of the company's reported cash

flow from operating activities in 1999 and 32% of its reported net operating cash flows in

2000.167

Between 1998 and 2001, Citigroup assisted Enron in completing the nine

Citigroup Prepays, totaling over $4.6 billion, as identified in the following chart:

166 Second Interim Report, Appendix E (Prepay Transactions), includes a more detailed analysis of Enron's Prepay Transactions with Citigroup and IPMorgan Chase.

167 See August 2001 Fastow Report, at 2-12; Enron Form 10-K filed with the SEC for the Year ended Dec. 31, 2000 (the "Enron 10-K for 2000"), Enron Corp. and Subsidiaries Consolidated Statement of Cash Flows; Enron Form 10-K filed with the SEC for the Year ended Dec. 31, 1999 (the "Enron 10-K for 1999"), Enron Corp. and Subsidiaries Consolidated Statement of Cash Flows.

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Citigroup Prepays

Name Closing Date Amount Date Settled
Roosevelt Dec. 30, 1998 $500 million $375 million repaid in May 1999, l()~
remainder repaid in Nov. 1999 with
proceeds of Yosemite 1169
Truman June 29, 1999 $500 million Sept. 1999, repaid with proceeds of
Jethrol70
Jethro Sept. 29, 1999 $675 million Nov. 1999, repaid with proceeds of
Yosemite 1171
Yosemite I Nov. 18, 1999 $800 million Citigroup's exposure terminated per
(prepay extended credit default swap upon Enron's
Dec. 22, 1999)172 bankruptcy173
Nixon Dec. 14, 1999 $324 million April 2000, repaid with proceeds of
Yosemite II
Yosemite II Feb. 23,2000 $331.8 million IIq Same as Yosemite I
Yosemite III Aug. 25, 2000 $475 million Same as Yosemite I
Yosemite IV May 24,2001 $775.1 million I f) Same as Yosemite I
June 2001 June 28, 2001 $250 million Novated to loan agreements assumed
by Transwestem Pipeline Company
and Northern Natural Gas, Nov. 2001 168 Citibank Global Loans Short Form Approval Memorandum, regarding Project Roosevelt Prepaid, Apr. 29, 1999 (the "Roosevelt Amendment Global Loans Approval Memo"), at 2 [CITI-B 0032126-CITI-B 0032128].

169 Nixon Global Loans Approval Memo, at 21. 170 Truman Global Loans Approval Memo, at 2.

171 Nixon Global Loans Approval Memo. Citigroup referred to Jethro as an extension of Truman. Citigroup Responses, at 38.

172 See Cancellation Letter from ENA to Delta, Dec. 22, 1999 [AB000026334 - AB000026338}; see also, Second Interim Report, Annex 2 to Appendix E (Prepay Transactions).

173 For an explanation of the mechanics of Citigroup's ability to terminate its exposure upon Enron's bankruptcy, see Second Interim Report, Annex 2 to Appendix E (Prepay Transactions).

174 In Yosemite II, the amount was denoted in British pounds as approximately £206.75 million. The amount converts to approximately $331,771,725 using an exchange rate of $1.6047 per British pound on February 23, 2000. Federal Reserve Board, Federal Reserve Statistical Release, Foreign Exchange Rates, United Kingdom Historical Rates, H-10 (the "UK Rate Release"), available at http:// federalreserve.gov/releases/hl O/HistldatOO _ uk.htm (last visited May 27, 2003).

175 In Yosemite IV, there were three sets of prepay swaps, one denoted in U.S. dollars as $475 million, one denoted in British pounds as approximately £109.5 million, and one denoted in Euros as approximately € 170 million. The amount denoted in British pounds converts to approximately $154,427,850 using an exchange rate of $1.41 03 per British pound on May 24, 2001. See U.K. Rate Release. The amount denoted in Euros converts to approximately $145,690,000 using an exchange rate of $0.8570 per Euro on May 24, 2001. Federal Reserve Board, Federal Reserve Statistical Release, Foreign Exchange Rates, EMU Member Countries Historical Rates, H-IO, available at http://federalreserve.gov/releases/hlO/HistldatOO_eu.htm (last visited June 9, 2003).

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Each of the Citigroup Prepays was structured with the commodity price risk

moving through the other parties and back to Enron in a circle, so that it was eliminated.

An internal Citigroup email described the difference between prepay transactions,

distinguishing between transactions "where there was no underlying commodity risk, ...

and where the customer was managing a long or short position. the enron prepaid

transaction which we just closed [referring to the June 2001 Citigroup Prepay] clearly

falls in the former (ie no commodity risk being hedged) category."!" Thus, Enron's

Prepay Transactions were simply debt packaged as commodity swaps. Citigroup itself

considered the Citigroup Prepays to be debt for its own regulatory accounting purposes 177

and when analyzing Enron's debt to capital ratios.178

Nevertheless, Enron accounted for the Citigroup Prepays as pnce risk

management activity and characterized the proceeds of these financings as cash flows

from operating activities rather than from financing activities.!" This method of

176 Email from Paul Deards, Citigroup, to Christopher Fehon, Cititgroup, et al., (the "Deards 7/6/01 Email"), at CITI-B 00694155 (capitalization omitted in original) [CITI-B 00694153-CITI-B 00694155]. See also Email from Paul Deards, Citigroup, to Steve Wagman and James Forese, Citigroup, regarding Enron, June 25, 2001, at CITI-B 00706419 ("there is no underlying commodity exposure at all") [CITI-B 00706419-CITI-B 00706421]; Email from Steve Wagman, Citigroup, to Paul Deards, Citigroup, regarding Enron, July 6, 2001 [CITI-B 00639009]. This email contained a series of emails among Wagman, Deards and Sean Mulhearn, referring to the June 2001 Citigroup Prepay, as follows:

Mulhearn: "I presume deal was closed last Friday. Would be interested in the final prices & volumes you agreed given the sharp drop in ng [natural gas] prices last week."

Deards: "since this is all a circle, why does it matter? What was your response, or are you looking to me to reply?"

Wagman: "No just fyi."

177 Email from Saul Bernstein, Citigroup, to William J. Mackey, Citigroup, regarding Prepaid Swap, July 8, 1999, at 2 ("The business appropriately will be treating the prepaid amount as a loan for RBC purposes, but for GAAP reporting it is classified as a Revaluation Receivable.") [CITI-B 00649873-CITI-B 00649876]; Caplan Sworn Statement, at 238-48,406-08.

178 See, e.g., August 2001 SSB Memo, at 11-12 (including Prepay Transactions as "Off Balance Sheet Financings").

179 See ENA Memorandum from Financial Operations Accounting, to Distribution, regarding Prepaid Hydrocarbon Companies, Oct. 21, 1996 [AB0252 01068-AB0252 01073]. Enron reported the amount of

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accounting significantly understated Enron's true debt obligations and favorably affected

Enron's key financial ratios, considered by the Rating Agencies when establishing

Enron's credit rating. 180

The Citigroup Prepays alone, without consideration for Prepay Transactions that

Enron completed with JPMorgan Chase or other financial institutions, had a material

effect on Enron's cash flows from operating activities, as reflected in the following table:

the "magic notes" in the Yosemite transactions as debt. These were a small fraction of Enron's total prepay obligations, representing less than 3% of the total prepay obligations at June 30, 2001. See Second Interim Report, Appendix E (Prepay Transactions).

180 See Testimony of John C. Diaz, Managing Director, Power & Energy Group, Moody's Investors Service, and Pamela M. Stumpp, Managing Director, Chief Credit Officer, Corporate Finance Group, Moody's Investors Service, before the PSI, July 23, 2002, ~ 4 ("If such transactions had been accounted for as a loan, Enron's operating cash flow would have been reduced and its debt would have been greater. The disclosure of these transactions as loans would have exerted downward pressure on Enron's credit rating.") [AB000359566-AB000359568]; Testimony of Ronald M. Barone, Managing Director, S&P's Ratings Services, before the PSI, July 23, 2002, at 13 [AB000359524-AB000359542]; Written Statement of Lynn Turner, Former Chief Accountant of the SEC, to the PSI, July 23, 2002, at ELIB00002247-00006- ELIB00002247-00007 ("When a company improperly reports cash flows generated by or used in financings as cash generated from typical business operations [then investors, analysts and credit rating agencies will be mislead [sic] as to the financial health of a company and its ability to meet future commitments on cash.") [ELI00002247-00001-ELIB00002247-00013]. See also id. at ELIB00002247- 00010 ("I have read the testimony of the subcommittee's chief investigator and various documents the staff of the subcommittee have provided to me. These documents lead to the conclusion that the Enron prepay transactions described therein should have been accounted for as bank or credit financings, rather than as liabilities from price risk management activities in the financial statements of Em on.").

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Enron's Operating Cash Flows

For Year Ended Reported Cash Net Cash Flows Cash Flows From Percentage
Flows From From Citigroup Operating Decrease
(dollar amounts in Operating Prepays Activities Without
millions) Activities Citigroup Prepays
1999 $1,228181 $935182 $293 76%
2000 $4,779183 $546184 $4,233 11% In addition, if Enron had reported its obligations arising out of the Citigroup

Prepays as debt, rather than as liabilities from price risk management activities, Enron's

reported debt levels would have looked markedly different, as shown in the following

table:

181 See Enron 10-K for 1999, Enron Corp. and Subsidiaries Consolidated Statement of Cash Flows.

182 This number was determined by subtracting the outstanding balance of the Citigroup Prepays as of December 31, 1998 from the outstanding balance of the Citigroup Prepays as of December 31, 1999. See August 2001 Fastow Report, at 2-12. The outstanding balance for 1998, however, does not include approximately $47 million for a transaction that the August 2001 Fastow Report referred to as "Crude:

Citibank - MahlI," which "Ended 12/99." August 2001 Fastow Report, at 2-12. The Examiner has been unable to determine the transaction to which this reference related and, thus, did not include it in the comparative analysis.

183 See Enron 10-K for 2000, Enron Corp. and Subsidiaries Consolidated Statement of Cash Flows.

184 This number was determined by subtracting the outstanding balance of the Citigroup Prepays as of December 31, 1999 from the outstanding balance of the Citigroup Prepays as of December 31, 2000. See August 2001 Fastow Report, at 2-12.

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Enron's Debt

As of Dec. 31, Reported Debt Amount Debt Including Percentage
(Does Not Include Outstanding on Amount Increase
(dollar amounts in Prepay Citigroup Prepays Outstanding on
millions) Transactions) Citigroup Prepays
1999 $8,152185 $1,125186 $9,277 14%
2000 $10,229187 $1,671188 $11,900 16% Enron provided no meaningful disclosure of the Prepay Transactions,

notwithstanding their magnitude and significance, and notwithstanding advice from

Andersen that Enron should provide more complete disclosure.l'" As discussed below,

Citigroup understood Enron's accounting for the Citigroup Prepays and the inadequacy

of the disclosures in Enron' s financial statements. Yet, Citigroup provided assistance to

Enron in connection with the Citigroup Prepays, including: (i) lending its own funds in

five of the transactions; (ii) assisting Enron in accessing other sources of funds by

developing the credit linked notes structure used in the four Yosemite transactions; (iii)

purchasing equity (synthetically through a "balance sheet provider") in the issuing entity

in Yosemite I and II and completing those credit linked notes transactions despite a

strong belief that Enron should have consolidated the issuing entity; (iv) providing its

185 See Enron 10-K for 1999, Enron Corp. and Subsidiaries Consolidated Balance Sheet.

186 This amount includes $797,744,000 for Yosemite I and $327,298,000 for Nixon. See August 2001 Fastow Report, at 2-12.

187 See Enron 10-K for 2000, Enron Corp. and Subsidiaries Consolidated Balance Sheet.

188 This amount includes $832,326,000 for Yosemite I, $332,814,000 for Yosemite II and $506,056,000 for Yosemite III. See August 2001 Fastow Report, at 2-12.

189 See Second Interim Report, Appendix D (Enron's Disclosure of its SPEs). See also Appendix B, PSI Prepay Report, at 5 (discussing an Andersen staff interview conducted by the PSI on July 19, 2002: "At one point, Arthur Andersen auditors recommended to Enron Chief Accounting Officer Rick Causey that Enron provide more complete disclosure on its prepay transactions, but Causey declined to do so."). As discussed in Appendix C (Role of Enron's Officers), and as discussed later in this Appendix, Andersen recommended that Enron model its disclosure after that of Aquila Energy Corporation.

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SPE, Delta, in six of the Citigroup Prepays to serve as a swap counterparty or the conduit entity that Enron believed was necessary; and (v) serving as the conduit entity itself in two Prepay Transactions where TD Bank was the lender, in return for TD Bank's serving as conduit in two mirror Citigroup Prepays, Truman and Jethro.

Summary Description

All of the Citigroup Prepays, other than Roosevelt, were financially settled and followed generally the same structure, which had the effect of eliminating all commodity price risk. Although Roosevelt was physically settled, it also had a circular structure that eliminated the price risk. Although each of the Citigroup Prepays has different details, with different parties playing the roles of lenders and conduit entities, the following description of a typical Citigroup Prepay shows the basic circular nature of the common transaction structure:

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Citigroup

Step 1

Step 2

Repayment of principal plus interest

Conduit Entity

Enron

Step 3

• Step One: CitigrouplEnron. Citigroup and Enron entered into a swap agreement pursuant to which Citigroup paid Enron a fixed sum on the closing date, i.e., a "prepayment." This is the amount loaned by Citigroup to Enron using the prepay structure. In exchange, Enron agreed to pay Citigroup the floating price of a specified quantity of a commodity on a specified settlement date.

• Step Two: Citigroup/Conduit. Citigroup and a conduit entity entered into a swap agreement, pursuant to which Citigroup agreed to pay the conduit entity the floating price of a specified quantity of a commodity, which matched the payment it would receive from Enron pursuant to the swap described in step one. In exchange, the conduit entity would pay Citigroup a fixed amount equal to the payment of principal plus interest on the prepayment made by Citigroup pursuant to the swap described in step one. This payment made by the conduit entity matched the payments it would receive from Enron pursuant to the swap described in step three.

• Step Three: ConduitlEnron. The conduit entity and Enron entered into a swap agreement, pursuant to which the conduit entity agreed to pay Enron on the settlement date an amount equal to the floating payment it would receive from Citigroup. In exchange, Enron agreed to pay to the conduit entity on the settlement date an amount equal to the principal and interest on the

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prepayment which, pursuant to the swap described in step two, the conduit entity would transfer to Citigroup.

The net effect of the three steps of each Citigroup Prepay was that, at the closing,

Enron received a prepayment that was effectively a loan. On the specified settlement

dates, the circular floating payment obligations of the parties based on the price of the

commodity would eliminate one another, ensuring that no party had any risk with respect

to such commodity price. In addition, on the specified settlement dates, Enron would

repay the principal it had borrowed plus interest, with such payment passing through the

conduit entity to Citigroup. In net economic substance, Citigroup made a loan to Enron

that Enron repaid with interest.

Each of the nine Citigroup Prepays was a variation of the structure described

above, but regardless of the details, each transaction was circular. All commodity price

risk was eliminated by having it circle back to Enron. The following is a brief summary

of each of the nine Citigroup Prepays. I 90

Roosevelt. The Roosevelt Prepay Transaction, which closed in December 1998,

was the only one of the nine Citigroup Prepays that was physically settled. 191 As a result,

the primary documents were a combination of a prepaid forward sales agreement and two

swap agreements, rather than strictly swaps. I 92

190 These summaries do not review all aspects of each transaction. Instead, the transaction descriptions are purposefully simplified to provide a general overview, including those facts that the Examiner believes are relevant to the scope of this Appendix. For example, in Roosevelt there were additional swap agreements such as an interest rate swap between Delta Energy Corp. and Barclays pIc, but that agreement was ancillary to, and had no effect on, the basic nature of the circular prepay structure. For a detailed review of Yosemite I through IV, see Second Interim Report, Annexes 2 through 5 to Appendix E (Prepay Transactions) .

191 Roosevelt Credit Approval Memorandum, Dec. 21, 1998, at 1-2 [CITI-B 0032040-CITI-B 0032046].

192 The Roosevelt Prepay Transaction consisted of a crude oil prepay and a natural gas prepay, both of which were separately documented. The primary documents for the crude oil prepay were: (i) Crude Oil Inventory Forward Sale Contract between Enron Natural Gas Marketing Corp. ("ENG") and Delta, Dec. 30, 1998 [CITI-B 0261387-CITI-B 0261444]; (ii) Confirmation Letter of Crude Oil Inventory Forward

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Marketing agreement, pursuant to which Enron sold oil and gas in market on behalf of Delta

In this transaction, an SPE called Delta, which had been formed by Citigroup.l'"

entered into step one with Enron. Delta paid Enron $500 million (which Delta had

Sale between Delta and ENG (the "Oil Forward Confirmation"), Dec. 30, 1998 [CITI-B 0261982-CITIB 0261983]; (iii) ISDA Master Agreement between Delta and Barclays Bank PLC ("Barclays"), Dec. 30, 1998 (the "Barclays/Delta Master Agreement") [BRC 000059073-BRC 000059117]; (iv) Commodity Confirmation between Delta and Barclays, Dec. 31, 1998 (the "Barclays/Delta Oil Swap Confirmation") [BRC 000010613-BRC 000010617]; (v) ISDA Master Agreement between ENA and Barclays, Jan. 13, 1994 (the "ENAIBarclays Master Agreement") [BRC 000023664-BRC 000023704]; (vi) Commodity Confirmation between ENA and Barclays, Dec. 31, 1998 (the "Barclays/ENA Oil Swap Confirmation") [BRC 000010575-BRC 000010579]. The primary documents for the natural gas prepay were: (i) Natural Gas Inventory Forward Sale Contract between ENG and Delta, Dec. 30, 1998 [CITI-B 0261445-CITIB 0261501]; (ii) Confirmation Letter of Natural Gas Inventory Forward Sale between ENG and Delta, Dec. 30, 1998 (the "Gas Forward Confirmation") [CITI-B 0261985-CITI-B 0261986]; (iii) the Barclays/Delta Master Agreement; (iv) Commodity Confirmation between Barclays and Delta, Dec. 31, 1998 (the "Barclays/Delta Gas Swap Confirmation") [BRC 000010618-BRC 000010622]; (v) the ENAlBarc1ays Master Agreement; and (vi) Commodity Confirmation between Barclays and ENA, Dec. 31, 1998 (the "Barclay siENA Gas Swap Confirmation") [BRC 000010589-BRC 000010593].

193 See Affidavit of Barbara Vastine, Chief Financial Officer, Corporate and Investment Bank, Citibank, July 29,2002 (the "Yastine Affidavit"), at 1 [AB000513031-AB000513034].

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borrowed from another Citigroup entity)194 as the prepayment under a forward

commodity sales contract.195 Enron agreed to deliver to Delta specified quantities of

natural gas and crude oil at specified points in time.196 Because Delta apparently had no

interest in taking delivery of the gas and oil, it signed a marketing agreement with Enron

pursuant to which Enron would act as Delta's agent and was required to resell the gas and

oil on behalf of Delta. 197

In order to eliminate its risk with respect to the price of the commodities and get

repaid a fixed amount of principal plus interest on its advance, Delta entered into a swap

agreement with Barclays Bank PLC ("Barclays,,).198 Pursuant to that agreement, Delta

agreed to pay Barc1ays the market price of the gas and oil, and Barclays agreed to pay

Delta a fixed amount (that it would receive from Enron).199 To close the circle, Barc1ays

entered into a swap agreement with Enron.2oo Pursuant to that swap agreement, Barc1ays

would pay Enron an amount equal to the market price of the gas and oil-i.e., the same

amount it received from Delta-and Enron would pay Barclays the $500 million

prepayment plus an amount that functioned as interest, which equaled the amount

Barclays was required to pay to Delta.201 The net effect was that all commodity price risk

194 See $500,000,000 Credit Agreement among Delta, as Borrower, Corporate Asset Funding Company, Inc. and Corporate Receivables Corp., as Lenders, and Citicorp North America, Inc., as Administrative Agent and Collateral Agent, Dec. 30, 1998 [CITI-B 0261689-CITI-B 0261793].

195 Oil Forward Confirmation; Gas Forward Confirmation.

196 Oil Forward Confirmation; Gas Forward Confirmation.

197 Marketing Agreement between ENA and Delta, Dec. 30, 1998 [CITI-B 0261844-CITI-B 0261868]. 198 BarclayslDelta Oil Swap Confirmation; BarclayslDelta Gas Swap Confirmation.

199 Barclays/Delta Oil Swap Confirmation; Barclays/Delta Gas Swap Confirmation.

200 Barclays/ENA Oil Swap Confirmation; Barclays/ENA Gas Swap Confirmation.

201 Barclays/ENA Oil Swap Confirmation; Barclays/ENA Gas Swap Confirmation.

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was eliminated, and Enron was required to repay to Delta the $500 million principal with

interest, with Barclays acting as the conduit entity.202

In May 1999, the parties amended Roosevelt.i'" Initially, Citigroup had agreed

not to syndicate its $500 million loan in the transaction until May 1999, at which time

Enron was scheduled to begin making amortization payments.i'" However, Enron

requested modifications to Roosevelt (i) to permit Enron to pay $375 million of the

outstanding principal in May 1999 and the remaining $125 million by September 30 of

that year, if (ii) Citigroup would agree not to syndicate the transaction until October and

to allow Enron to defer making amortization payments until October.i'"

In the spring of 1999, Enron's Obligor Exception at Citigroup was somewhere in

the range of$600 million to $900 million.i'" Thus, Citigroup had an incentive to approve

Enron's proposal and receive the $375 million immediate paydown of its exposure, with

the remaining $125 million paydown occurring five months later. Citigroup understood

from Enron, however, that Enron's commitment to repay the remaining $125 million by

202 Given Citigroup's experience with Enron's circular Prepay Transactions, and the fact that Delta hedged its cornrnodity and interest rate risk with Barc1ays, it is reasonable to infer that Citigroup was aware that Barc1ays passed the cornrnodity risk back to Enron. There is some documentary evidence of this knowledge, specifically a chart reflecting the structure of Roosevelt as it involved Citigroup and Delta, with a handwritten indication that an Enron affiliate entered into a swap with Barc1ays. Exhibit 144, PSI Prepay Report, at AB000153283 (Global Loans Approval Memorandum, regarding Roosevelt, Dec. 21, 1998) [ABOOOI53274-ABOOI53283].

203 Roosevelt Amendment Global Loans Approval Memo, at 2. 204 !d.

205 !d.

206 See Email from James Fi Reilly, Citigroup, to H-Onno Ruding, John J. Kennedy and Tom Boland and copy to William Fox, Citigroup, et al., regarding Enron/Consent to Amendment to Roosevelt, Apr. 27, 1999 (the "Reilly 4/27/99 Email"), at CITI-B 0046838 (stating that Obligor Exception was roughly $608 million) [CITI-B 0046838-CITI-B 0046839]; Citigroup Credit Approval, relating to amendments to Roosevelt, Apr. 5, 1999, at 1 (stating that Obligor Exception was $481 million) [CITI-B 0032129-CITI-B 0032133].

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September 30, 1999 could not be reduced to writing because the existence of such a

commitment would result in undesirable accounting treatment from Enron's perspective.

In testimony provided to the Examiner, Reilly explained the accounting concern,

which resulted because Roosevelt was structured to require physical settlement. He

testified that Roosevelt's three-year commodity settlement schedule could not be

converted into a one-day repayment because "there is simply no way for the physical

commodity to be delivered in that scale on that day.,,207 He stated that such a conversion

"would not have allowed the company to account for the transaction as a prepaid

commodity transaction, because I believe it would have been subject to some

reasonableness test, and ... that test couldn't have been passed if you had to deliver that

volume of commodity on that day.,,208 Reilly concluded that it was his "best guess" that

the alternate accounting treatment would have been to report the obligation as debt.209

Reilly explained Enron's proposed amendment and constraint to Ruding in an

April 27, 1999 email:

Enron has agreed to repay the remaining $125MM by 9/30. In return, they have asked for the following amendments:

amend the syndications agreement to read that syndication will commence on lOll if the deal is still outstanding (altho they have agreed to prepay by 9/30, the papers cannot stipulate that as it would require recategorizing the prepaid as simple debt); ... 210

207 Reilly Sworn Statement, at 118. 208 Jd. at 119.

209 Id. at 120. The Examiner does not have sufficient information at this time to reach a conclusion as to whether Enron's promise to repay the remaining balance of Roosevelt prior to the stated transaction expiration date actually invalidated Enron's accounting for the transaction.

210 Reilly 4/27/99 Email.

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In an earlier emailc Reilly had explained the accounting Issue to a number of other

Citigroup officers:

[T]hey have agreed to prepay that amount no later than 9/30;

- The paperwork cannot reflect their agreement to repay the $190MM as it would unfavorably alter the accounting; to compensate for that, we will amend the syndications letter to read that syndication will commence on 10/1; ... 211

An internal Citigroup approval memorandum for the changes to Roosevelt stated:

"The company has verbally agreed to repay the remaining $125 million by September 30,

1999.,,212 This approval memorandum also stated: "Based on the positive aspects of this

transaction including the repayment of$375 million and the promise to repay in 5 months

time, we recommend approval of the amended Roosevelt transaction.,,213 Citigroup

211 Email fromJamesF.Reilly. Citigroup, to Thomas Stott, Steve Baillie, Trevor Randolph, David B. Gorte, Chris Lyons, Joseph J. Mankiewicz, Jean M. Diaz and William Fox, Citigroup, regarding EnronIRoosevelt Update, Apr. 22, 1999 (Enron ultimately agreed to pay enough to reduce the balance of Roosevelt to $125 million, apparently to eliminate the need for Citigroup to obtain certain internal approvals, per a later paragraph in the email) [CITI-B 0219071).

212 Roosevelt Amendment Global Loans Approval Memo, at 2. See also Yosemite I Global Loans Approval Memo, at 4 ("By its terms, Roosevelt has an additional 4+ years until final maturity. However, the company has informally agreed to repay Roosevelt at 12/6/99."); Truman Global Loans Approval Memo, at 3 ("By its terms, Roosevelt has an additional 4+ years until final maturity. However, we had an agreement with Enron to prepay it on 9/30/99 (Enron prepaid $375 million on 5/1/99). As part of the Truman extension [i.e., Jethro], they have asked instead to repay Roosevelt at 12/5/99."); Email from James F. Reilly, Citigroup, to Thomas Stott, David S. Gorte, Steve Baillie, Joseph J. Mackiewicz, Jean M. Diaz and William Fox, Citigroup, regarding EnroniProject Roosevelt, Apr. 19, 1999 [CITI-B 0219067] ("I think we should approve the changes given the short time frame and the firm promise to fully repay before YE99 .... Enron characterizes this as a 'favor'.")

213 Roosevelt Amendment Global Loans Approval Memo, at 2. In this document, Citigroup acknowledged that it was relying on the oral commitment in reducing Enron's Obligor Exception, stating:

Citibank's insurance group is extending its approvals of the five surety bond providers from June 30, 1999 to September 30, 1999. Unlike the initial deal where the surety bond approvals expired prior to deal maturity, Enron's agreement to repay the entire obligation by September 30, 1999 for the amended deal coincides with Citibank's new surety bond approvals. In effect, Citibank's exposure in this transaction is now limited to five A-rated insurance companies, issuing surety bonds with a face value of $25 million each. The removal of Enron exposure from this transaction should enable Enron's obligor exception to be reduced by $125 million, or the size of the amended Roosevelt transaction.

ld.

- 58 -

granted such approval and later, in connection with the Jethro Prepay Transaction, agreed

to allow a further extension of the repayment obligation to early December 1999, so that

Roosevelt could be repaid with the proceeds of Yosemite 1.Z14

Truman. In mid to late June 1999, Enron requested that Citigroup underwrite

another $500 million Prepay Transaction, which would close by month end.215 Even

Citigroup felt the proposed timing was "daunting.Y'" but it proceeded to facilitate the

desired transaction. However, instead of funding the entire $500 million itself, Citigroup

funded $250 million, and TD Bank funded the remaining $250 million. The two

financial institutions entered into essentially mirror-image Prepay Transactions that

closed on the same day, and each served as the other's conduit entity. Both were

financially settled Prepays and this was apparently the first time that Citigroup had done a

Prepay that did not require any physical delivery of a commodity.i'"

214 Nixon Global Loans Approval Memo, at 21.

215 Email from James FrReilly, Citigroup, to William Fox, Tom Boland and Thomas Stott and copy to Steve Baillie, Citigroup, et al., regarding Enron/$500MM Prepaid, June 20, 1999 [CITI-B 0262788-CITI-B 0262789]; Reilly Sworn Statement, at 140.

216 Reilly Sworn Statement, at 142.

217 Id. at 153. Apparently Enron suggested using a financially settled structure, and Enron officers explained to Reilly that Enron believed the accounting treatment would be the same as for physically settled transactions. Reilly Sworn Statement, at 153-54 (recalling conversations with Bill Brown and Jeff McMahon).

- 59 -

$250 MM on closing date

$254 MM on settlement date

Enron

Enron

Citigroup

Floating payment based on market price of gas on settlement date

Floating payment based on market price of gas on settlement date

Specifically, in the Citigroup-funded Prepay Transaction, Citigroup entered into a

swap agreement with Enron, pursuant to which Citigroup paid Enron $250 million on the

closing date.218 Enron agreed to pay Citigroup the price of approximately 14 million

barrels of crude oil 90 days later.219 Citigroup then shifted the price risk of the oil to TD

Bank via a swap agreement, whereby Citigroup agreed to pay TD Bank the same oil price

on the same settlement date, and TD Bank agreed to pay Citigroup the fixed sum of

approximately $254 million, constituting the $250 million principal plus interest.22o

Finally, completing the circle, TD Bank entered into a swap with Enron, agreeing to pay

Enron the same price of the oil on the settlement date.221 Enron agreed to pay TD Bank

the same fixed sum of approximately $254 million.222

218 ISDA Master Agreement between ENA and Citigroup, Nov. 17, 1992 (the "Citigroup/ENA Master Agreement") [SS000037868-SS000037913]; Confirmation between ENA and Citigroup, June 29, 1999 (the "Citigroup/ENA Confirmation") [SS000036643-SS00003 6651].

219 Citigroup/ENA Master Agreement; Citigroup/ENA Confirmation.

220 Swap Transaction Confirmation between Citigroup and TD Bank, July 6, 1999 (the "Truman Confirmation between Citigroup and TD Bank") [CITI-B 00373899-CITI-B 00373901].

221 ISDA Interest Rate and Currency Exchange Agreement between ENA and TD Bank, Mar. 4, 1992 (the "ENA/TD Bank ISDA Interest Rate and Currency Exchange Agreement) [TDB-EX 002245-TDB-EX 002269]; Revised Swap Transaction Confirmation between TD Bank and ENA, Aug. 6, 1999 (the "TD

- 60-

The TD Bank-funded Prepay worked in the same fashion, except that TD Bank

made the initial $250 million payment to Enron, and Citigroup served as the conduit

entity to shift the price risk back to Enron so that it would be eliminated.Y' Enron paid

each of Citigroup and TD Bank a $1 million upfront fee for funding its $250 million

share, as well as a $100,000 fee for serving as the conduit entity for the other lender.224

Jethro. On September 29, 1999, the day that the 90-day Prepay Transactions in

Truman were to settle, Citigroup and TD Bank effectively refinanced and increased the

Truman obligations by executing two new Prepay Transactions. Although Citigroup

generally referred to this follow-on transaction as an extension of Truman,225 Enron

referred to it as Project Jethro.226 The parties executed a new set of documents as

opposed to amending the then-expiring Truman documents. According to Citigroup's

internal approval memorandum for Jethro, the parties' intent had been to retire Truman

Bank/ENA Revised Swap Transaction Confirmation") [SS000036594-SS000036596]. It is reasonable to infer that Citigroup was aware of this swap, since Citigroup entered into a similar swap with Enron in the mirror Prepay Transaction where it served as the conduit.

222 ENA/TD Bank ISDA Interest Rate and Currency Exchange Agreement; TD Bank/ENA Revised Swap Transaction Confirmation.

223 ISDA Master Agreement between ENA and Toronto Dominion (Texas), Inc. ("TD Texas"), Dec. 18, 1998 [TDB-EX 000604-TBD-EX 000631]; Swap Transaction Confirmation between TD Texas and ENA, Aug. 6, 1999 [SS000036591-SS000036593]; Citigroup/ENA Master Agreement; Revised Confirmation between ENA and Citigroup, July 30, 1999 [SS000036617-SS000036629]. The Examiner was unable to locate a copy of the Swap Transaction Confirmation between TD Texas and Citigroup; however, an Enron chart shows that this leg of the transaction existed. See Enron Crude Prepay Charts, undated (the "Enron Truman Charts") (showing the structure of the Truman transaction) [SS000037612-SS000037618].

224 Upfront Fee Letter from Citigroup, to Doug McDowell, Director, Enron, June 29, 1999 [SS000037494]; Swap Fee Letter from Citigroup, to Doug McDowell, Enron, June 29, 1999 [SS000037467]; Up front Fee Letter from Ann P. Scully, Vice President, TD Securities (USA) Inc., to Doug McDowell, Director, Enron, June 28, 1999 [SS000037465-SS000037466]; Swap Fee Letter from Ann P. Scully, Vice President, TD Securities (USA) Inc., to Doug McDowell, Director, Enron, June 28, 1999 [SS000037495-SS000037496}; Swap Fee Letter from Citigroup, to Doug McDowell, Enron, June 29, 1999 [SS000037467].

225 Truman Global Loans Approval Memo, at 2; Citigroup Responses, at 38.

226 Memorandum from Bill Brown, Enron, to Doug McDowell, Enron, regarding Annual Review - 1999, Nov. 30, 1999 (the "Bill Brown 1999 Annual Review Memo"), at 1 [SS000036560 - SS000036561].

- 61 -

with the proceeds of Yosemite I prior to the end of third quarter 1999.227 However, the

credit linked notes underwriting planned for Yosemite I was delayed, creating the need

for another short-term bridge financing.f"

Jethro mirrored the Truman transaction, with Citigroup and TD Bank agam

playing their same roles as lenders and conduit entities. Each lender funded $337.5

million to Enron, and the Jethro Prepays were set to expire in 90 days on December 28,

1999.229 Enron used the proceeds of Jethro, in part, to repay the maturing Truman

obligations.

Nixon. The Nixon Prepay Transaction closed in December 1999 and was

intended as a 180-day bridge financing that would be repaid with proceeds of the

Yosemite II transaction scheduled for closing in first quarter 2000_230 Nixon was actually

a set of three interrelated Prepay Transactions that provided Enron with a total of $324

million. It was financed by Citigroup, Barclays and Royal Bank of Scotland PLC

("RBS"), with TD Bank serving as the conduit entity for all three lenders.

227 Truman Global Loans Approval Memo, at 2. 228 Id.

229 The principal documents for the TD Bank prepay were: (i) Swap Transaction Confirmation between ENA and TD Texas, Sept. 29, 1999 [SS000036413-SS000036415]; (ii) Confirmation between Citigroup and ENA, Oct. 19, 1999 [SS000036416-SS 000036420]; and (iii) a confirmation between TD Texas and Citigroup. Although the Examiner was unable to locate a copy of this confirmation between TD Texas and Citigroup, it is presumed to exist based on the fact that Jethro is an extension of Truman, and Enron charts of the Truman structure show this step of the transaction. See Enron Truman Charts. The principal documents for the Citigroup prepay were: (i) Confirmation between ENA and Citigroup, Oct. 6, 1999 [SS000036423-SS000036427]; (ii) Confirmation between TD Bank and Citigroup, Oct. 18, 1999 (unsigned copy) [CITI-B 0032392-CITI-B 0032395]; and (iii) a confirmation between ENA and TD Bank. Although the Examiner was unable to locate a copy of this confirmation between ENA and TD Bank, it is presumed to exist since such confirmation exists between ENA and TD Bank for Truman, and Jethro is a refinancing of Truman. See Truman Confirmation between Citigroup and TD Bank.

230 Nixon Global Loans Approval Memo, at 20.

- 62-

Enron

Payment equal to market price

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$104 MM

on closing date

interest

RBS

Citigroup

Barclays

Citigroup paid Enron $104 million on the closing date pursuant to a swap

agreement.i" Enron agreed to pay Citigroup an amount based on the price of crude oil

on the settlement date.232 Citigroup then entered into a swap with TD Bank, pursuant to

which Citigroup agreed to pay the same price of crude oil to TD Bank in exchange for a

fixed payment equal to the $104 million prepayment amount plus an amount that

functioned as interest.233

231 Citigroup/ENA Master Agreement; Swap Transaction Confirmation between Citigroup and ENA, Dec. 14, 1999 (the "12/14/99 Citigroup/ENA Swap Transaction Confirmation") [CITI-B 0134703-CITI-B 0134706). The initial settlement date of Mar. 15,2001 was extended to Apr. 14,2000. Swap Transaction Confirmation between Citigroup and ENA, Mar. 15,2000 (the "3/15/00 Citigroup/ENA Swap Transaction Confirmation") [SS00003 7716-SS00003 7719].

232 Citigroup/ENA Master Agreement; 12114/99 Citigroup/ENA Swap Transaction Confirmation; 3/15/00 Citigroup/ENA Swap Transaction Confirmation.

233 Confirmation between TD Bank and Citigroup, Dec. 22, 1999 (unsigned copy) [CITI-B 0032437-CITIB 0032440]. The initial settlement date of Mar. 15, 2000 was extended to Apr. 14, 2000. Revised

- 63 -

RBS also entered into a swap with Enron, paying Enron $110 million on the

closing date.234 Enron agreed to pay RBS an amount based on the price of crude oil on

the settlement date.235 RBS then entered into a swap with TD Bank, pursuant to which

RBS agreed to pay the same price of crude oil to TD Bank, in exchange for a fixed

payment equal to the $110 million prepayment amount plus an amount that functioned as

interest. 236

The third lender, Barclays, also entered into a swap with Enron, paying Enron

$110 million on the closing date.237 Enron agreed to pay Barclays an amount based on

the price of crude oil on the settlement date.238 Barclays then entered into a swap with

TD Bank, pursuant to which Barclays agreed to pay the same price of crude oil to TD

Bank, in exchange for a fixed payment equal to the $110 million prepayment amount plus

an amount that functioned as interest. 239

Confirmation between TD Bank and Citigroup, Mar. 15, 2000 (unsigned copy) [CITI-B 0032562-CITI-B 0032565].

234 Swap Transaction Confirmation between RBS and ENA, Dec. 14, 1999 (the "12/14/99 RBS/ENA Swap Transaction Confirmation") [CITI-B 0032451-CITI-B 0032454]. The initial settlement date of Mar. 15, 2000 was extended to Apr. 14, 2000. Swap Transaction Confirmation between RBS and ENA, Mar. 15, 2000 (the "3/15/00 RBS/ENA Swap Transaction Confirmation") [SS000037780-SS000037783].

235 12/14/99 RBS/ENA Swap Transaction Confirmation; 3/15/00 RBS/ENA Swap Transaction Confirmation.

236 12/14/99 RBS/ENA Swap Transaction Confirmation. Presumably, the initial settlement date of this step was extended like all of the other steps, although the Examiner has not located a copy of the extending confirmation.

237 ENA/Barclays ISDA Master Agreement; Stand-Alone Swap Agreement between ENA and Barc1ays, Dec. 14, 1999 (the "12/14/99 ENAlBarc1ays Stand-Alone Swap Agreement") [CITI-B 0032445-CITIB0032450]. The initial settlement date of Mar. 15, 2000 was extended to Apr. 14, 2000. Stand-Alone Swap Agreement between ENA and Barclays, Mar. 14, 2000 (the "3/14/00 ENAIBarclays Stand-Alone Swap Agreement) [SS000037751-SS000037757].

238 ENAIBarclays ISDA Master Agreement; 12/14/99 ENA/Barclays Stand-Alone Swap Agreement; 3/14/00 ENAIBarclays Stand-Alone Swap Agreement.

239 Swap Transaction Confirmation between TD Bank and Barclays, dated Dec. 14, 1997 [CITI-B 0032441-CITI-B 0032444]. Presumably, the initial settlement date of this step was extended like all of the other steps, although the Examiner has not located a copy of the extending confirmation.

- 64-

To complete the circle for all three sets of swaps, TD Bank entered into a swap

with Enron_24o TD Bank served as a conduit for passing the floating price back to Enron,

and for receiving the principal repayments plus interest from Enron and passing those on

to the lenders.

Yosemite I through IV. The Yosemite structure consisted of two related

transactions, (i) a financially settled Prepay Transaction and (ii) the issuance of "credit

linked" promissory notes and certificates in the institutional market, the proceeds of

which funded the related Prepay Transactions. Citigroup takes credit for having designed

the credit linked notes structure.r" and it helped Enron complete four such structures

from 1999 to 2001. Enron raised a total of approximately $2.4 billion from institutional

investors through these transactions. The four Yosemite transactions are described in

more detail in Annexes 2 through 5 to Appendix E (Prepay Transactions) of the Second

Interim Report. The following is a chart showing salient features of the Yosemite

structure:

240 Swap Transaction Confirmation between ENA and TD Bank, Dec. 20, 1999 [CITI-B 0032459-CITI-B 0032462]. The initial settlement date of Mar. 15, 2000 was extended to Apr. 14, 2000. Revised Swap Transaction Confirmation among TD Bank, ENA and Citigroup, Mar. 14, 2000 [SS000037788- SS000037792]. Citigroup served as the Calculation Agent under the Revised Confirmation and, thus, Citigroup was aware that TD Bank had entered into a swap with Enron shifting the commodity price risk back to the company and completing the circularity of all three Prepay Transactions involving Citigroup, Barc1ays and RBS.

241 Testimony of Maureen Hendricks, Senior Advisory Director, Citigroup, before the PSI, July 23, 2002, at 173 ("Fitzgerald: Who came up with that idea [referring to Yosemite]? A. Mr. Caplan and colleagues of his in the credit derivatives group.") [AB00021 0232-AB00021 0500].

- 65 -

Certificate Holders

Note (Enron and

Holders Citigroup (via

Long Lane Master Trust))

$75MM

r---_"'_-'--f" _s~1E~!!~~!_p.!r1E~n!_s_b.!~eE_?!!!!l~~.:.~_!i~:..~f_?i! _

$800 MM on settlement date

$750MM

Yosemite Trust

$25 MM Ma ic Note

$706 MM on cJosin date

The Prepay Transaction within each Yosemite structure was essentially the same

circular design as all of the other financially settled Citigroup Prepays. The series of

swap agreements among Citigroup, Enron and Delta had the net effect of eliminating all

commodity price risk and resulting in Enron being obligated to repay a fixed amount of

financing with interest. The credit linked notes portion of each structure had the effect of

causing the institutional investors to provide the funding for each Prepay Transaction

instead of Citigroup.

Although each Yosemite transaction had variations, the basic structure included

forming a trust or similar entity (the "Trust") that sold promissory notes to institutional

investors. In Yosemite I and II, Enron initially owned 50% of the applicable Trust's

equity.242 Citigroup "synthetically" held the other 50%, by contracting with an

independent "balance sheet provider," Long Lane Master Trust IV ("Long Lane"), to

242 See Yosemite I Global Loans Approval Memo, at 2-3; Yosemite II Global Loans Approval Memo, at 3.

- 66-

purchase the equity and then providing Long Lane with a Total Return Swap that

transferred all economic risks and rewards back to Citigroup.243 In each of Yosemite III

and IV, an independent third party purchased all of the equity, but transferred the

economic risks and rewards to Citigroup through a Total Return Swap.244 Each Trust

invested the proceeds of the notes and the equity certificates in ways that effectively

funded the first step in the related Prepay Transaction.245

The Trust also entered into one or two swap agreements with Citigroup, which

were designed so that the notes sold to the institutional investors would be linked to the

credit of Enron.246 Under these swaps, Citigroup would make periodic payments to the

Trust in the amounts it needed to pay interest distributions on the notes and equity,

respectively.r" In return, the Trust paid to Citigroup any yield actually received by the

Trust on its investments.i'" Upon an "Enron Bankruptcy," Citigroup could deliver to the

Trust Enron obligations in exchange for the Trust's investments.r"

243 See Yosemite I Global Loans Approval Memo, at 2-3; Yosemite II Global Loans Approval Memo, at 3. 244 See Yosemite III SSB Memo, at 5; Yosemite IV SSB Memo, at 10.

245 In Yosemite I and II, the applicable Trust invested the proceeds in loans to Delta. In Yosemite III and IV, the applicable Trust invested the proceeds in Citigroup certificates of deposit. See Second Interim Report, Appendix E (Prepay Transactions).

246 In Yosemite I and II, there were two swaps: one that related to regular payments and one that was applicable upon the occurrence of an Event of Default. See, e.g., Sections 1, 2, 3 and Annex 1, Confirmation (Delta Energy Corporation Promissory Note) between Yosemite Securities Company Ltd. and Citigroup, Feb. 23, 2000 [CITI-B 0265015-CITI-B 0265031]; Sections 1, 2, 3 and Annex 1, Confirmation (Enron Debt Security) between Yosemite Securities Company, Ltd. and Citigroup, Feb. 23, 2000 (the foregoing, collectively, the ''YII CitibankIYosemite Swaps") [CITI-B 0006812-CITI-B 0006829]. In Yosemite III and Yosemite IV, there was only one swap. See e.g., Swap Confirmation between Enron Credit Linked Notes Trust and Citigroup, dated Aug. 25, 2000 [CITI-B 0007964-CITI-B 0007971].

247 See, e.g., Section 2, YII Citibank/Yosemite Swaps. 248 Id. Section 3.

249 Id.

- 67-

Thus, pursuant to each complete Yosemite transaction structure, Enron borrowed

money via a Prepay Transaction, which was funded by institutional investors.

Repayment to the note holders was supported only by the credit of Enron. As with other

Citigroup Prepays, no party had any commodity price risk. Enron recorded the Citigroup

Prepay financing as price risk management activity and cash flow from operating

activities.v'''

June 2001. In mid-June 2001, Enron requested that Citigroup complete another

Prepay Transaction before quarter end, looking for $250 million of "non-debt funding" that would mature in 2002.251

Citigroup

$250 MM on closing date (principal)

Delta

Floating payment based on market price of gas on settlement date

This June 2001 Citigroup Prepay, which apparently did not have a nickname,

followed the familiar circular structure, with Citigroup paying a fixed amount of $250

250 See Second Interim Report, Appendix E (Prepay Transactions).

251 Email fromMichaeINepveaux.Citigroup.toAmandaAngelini.JamesF.Reilly and Sean Mulhearn, Citigroup, regarding Urgent Enron Deal, June 18,2001 [CITI-B 00697794].

- 68-

million to Delta pursuant to a swap on the closing date.252 Delta agreed in return to pay

Citigroup a floating payment on the settlement date based on the price of natural gas.253

Delta then paid the $250 million to Enron on the closing date, in exchange for Enron's

agreement to pay Delta the floating payment on the settlement date based on the same gas

price.254 Finally, Enron and Citigroup executed a swap, pursuant to which Enron agreed

to pay approximately $256 million to Citigroup on the settlement date, thus repaying to

Citigroup the principal plus intcrest.f" Citigroup agreed to pay Enron a floating payment

based on the same price of gas, thus returning the commodity price risk to Enron and

thereby eliminating it.256

Enron 's Accounting and Other Disclosure

Enron used the Citigroup Prepays for several important financial statement

purposes: (i) to obtain cash when it needed financing, but in a manner that would not

increase its reported debt; (ii) to increase its cash flows from operating activities, in order

to more closely match its non-cash MTM income; and (iii) to thereby maintain favorable

credit ratings from the Rating Agencies.257 Enron did not use the Citigroup Prepays to

actually sell commodities or transfer any commodity price risk, as evidenced by the

apparent ability of Enron to use Prepay Transactions interchangeably with other

financing structures: "IF [sic] Bacchus [a $200 million FAS 140 Transaction] is

252 ISDA Master Agreement between ENA and Delta, Nov. 18, 1999 (the "ENAlDelta ISDA Master Agreement") [CITI-B 0034343-CITI-B 0034377]; Swap Transaction Confirmation between ENA and Delta, June 28, 2001 (the "ENAIDelta Swap Transaction Confirmation") [SS000037989-SS000037994].

253 ENAIDelta ISDA Master Agreement; ENAlDelta Swap Transaction Confirmation.

254 ENAlDelta ISDA Master Agreement; ENAIDeita Swap Transaction Confirmation.

255 Citigroup/ENA Master Agreement; Swap Transaction Confirmation between Citigroup and ENA, June 28,2001 (the "Citigroup/ENA Swap Transaction Confirmation") [SS000037848-SS000037853].

256 Citigroup/ENA Master Agreement; Citigroup/ENA Swap Transaction Confirmation.

257 See Second Interim Report, Appendix E (Prepay Transactions).

- 69-

withdrawn, Enron is likely to ask for Citi to provide a $200MM prepaid instead.,,258

Caplan described Enron's Prepay Transactions as Enron monetizing income.f" and Steve

Wagman ("Wagman"), a Director in Citigroup's Derivatives group, wrote that the Prepay

Transactions "give some oomph to revenues.,,260 In October 2001, when Citigroup

declined Enron's request for a new Prepay Transaction but was willing to consider

providing funds for a commercial paper facility, Fox explained the distinction by saying

"CP rollover was clear financial need in a difficult time while the prepaid was an

accounting need in a difficult time and we differentiated between the twO.,,261

Citigroup understood how Enron accounted for the Citigroup Prepays and the

effect that the Citigroup Prepays had on Enron's reported financial condition, including

income, assets, liabilities and cash flow:

• "The transaction provides favorable accounting treatment for the customer. Although the deal is effectively a loan, the form of the transaction would allow the customer to reflect it as 'liabilities from price risk management activity' on their on their [sic] balance sheet and also provide a favourable [sic] impact on reported cash flow from operations. ,,262

• "The prepaid forward structure will allow Enron to raise funds without classifying the proceeds from this transaction [Roosevelt] as debt (it is accounted for as 'deferred revenue,).,,263

258 Email from James Fv Reilly, Citigroup, to Steve Baillie, Chris Lyons, Lydia Junek, Rick Caplan, Amanda Angelini, Steven Becton and Steve Wagman, Citigroup, regarding ENElBacchus, Dec. 11, 2000 [CITI-B 0282857].

259 Caplan Sworn Statement, at 70-71, 402.

260 Email from Steve Wagman, Citigroup, to Asfar Hashmi, Citigroup, regarding my take on how to explain ECLN, Sept. 28, 2000 (the "Wagman 9/28/00 Email") [CITI-B 0235229].

261 Email from William Ti Fox. Hl, Citigroup, to Alberto Verme, Maureen Hendricks, Dean Keller, James F. Reilly, Michael Nepveux and Anne Clarke Wolff and copy to Thomas Stott and Lydia Junek, Citigroup, regarding Enron, Oct. 1,2001 [CITI-B 0236141].

262 Minutes of Citibank CMAC, June 22, 1999 (the "CMAC Truman Minutes"), at 2 [CITI-B 0260171- CITI-B 0260172].

263 Global Loans Approval Memorandum, regarding Project Roosevelt, Dec. 21, 1998 (the "Roosevelt Global Loans Approval Memo"), at CITI-B 0032096 [CITI-B 0032090-CITI-B 0032098].

-70 -

• "This form of financing is advantageous to Enron in that it allows the borrowing to be reported as 'price risk management' liability rather than debt. In addition, because of the way Enron classifies trading assets/liabilities on the balance sheet, the amount of the borrowing actually is recorded as cash from operations.t'f"

• "As we understand the accounting, the Pre-Paid creates price risk management liability, thereby receiving non-'D' debt treatment. Operating cash flow increases, helping to offset the current 'disconnect' between book and cash earnings.,,265

• "Citibank executed a six-month $250MM gas prepay with Enron on June 28th, 2001, thereby creating a price risk management liability for that period of time. (The prepay was earnings neutral, because the mark-to-market of the various legs of the transaction nets to zero.) ... [T]he fact is that the prepay creates cash from operating activities by monetizing value that was created during the period within the PRM portfolio. ,,266

• "Enron uses prepay transactions to raise quarter-end non-debt funding.

Also, the mark-to-market accounting method used in the trading business results in earnings recognition prior to receipt of the associated cash flow. A prepay transaction essentially monetizes this value creation, and helps to balance earnings with cash flow.,,267

Citigroup also recognized the importance of the Citigroup Prepays to Enron,

writing in one instance that "[t]he primary purpose of this transaction [Yosemite IV] is to

permit Enron to refinance certain borrowings, with proceeds from the Offering, while

allowing Enron to maintain the advantageous accounting and rating agency treatment of

these financings.,,268 Citigroup knew that Enron used the Citigroup Prepays to manage

financial statement presentation, with one senior officer writing in November 1999 that

264 Summary of Enron's Capital Market Exposure with Citibank, prepared by Elena Matrollo and Murray Barnes, Citigroup, Oct. 26, 2001 (the "Citigroup Exposure Memo") [SEC00091086-SEC00091087].

265 Citigroup Summary of Pre-Paid Accounting and Tax, June 25, 2001 [AB000153416].

266 Elliott 7/20101 Email, at CITI-B 00616908.

267 Memorandum from Michael Nepveux, Citigroup, to Bill Fox, Citigroup, regarding Enron Corp. - Sept. 30 Prepay Transaction, Sept. 19,2001, at 1 [CITI-B 00397725-CITI-B 00397726].

268 Yosemite IV SSB Memo, at 7.

- 71 -

Enron needed a Prepay "by year-end as the deal generates count [sic] as operational funds

flow which will evidently fill a gap left by certain European projects/contracts.r=" As

shown in the timeline above, six of the nine Citigroup Prepays closed near the end of a

quarterly or annual financial reporting period.

Reilly testified that he knew Rating Agency pressure was an important part of

Enron's motivation in doing Prepay Transacrions.i/" Bill Brown and McMahon of Enron

had explained to him in 1999 the Rating Agencies' concern about the widening gap

between Enron's cash flows from operating activities and its net income.i" This gap was

generated in large measure by the MTM accounting in Enron's trading book.272

According to Reilly, Enron knew that it needed to increase or "accelerate" cash flows

from operating activities in order to please the Rating Agencies.273

Citigroup recognized that the Citigroup Prepays had no commodity price risk and

were in substance debt. There is documentary evidence of Citigroup's knowledge,

including, for example:

• An internal approval memorandum for the Roosevelt Prepay Transaction said "this prepaid forward is effectively a commodity denominated corporate obligation .... ,,274

269 Email fromNielsKirk.Citigroup.toWilliamFoxandJamesF.Reilly. Citigroup, regarding Yosemite II (Europe), Nov. 5, 1999, at CITI-B 0131315 [CITI-B 0131314-CITI-B 0131315]. See also Email from William Fox, Citigroup, to Thomas Stott, Citigroup, Apr. 18, 2001 (recapping a number of Enron transactions, "There is no question that Enron cashflow has become more dependent on Price Management Activities.") [CITI-B 0236143].

270 Reilly Sworn Statement, at 162-65 ("[T]he driver behind the prep aids ... was not just the gap that was being created between net income and funds flow but the recognition of the focus of the rating agencies on that issue").

271 Id. at 156.

272 Id.

273 /d. at 156-57.

274 Roosevelt Global Loans Approval Memo, at CITI-B 0032092.

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• Minutes of a meeting of Citigroup's Capital Markets Approval Committee considering the Truman Prepay Transaction contained the following statement: "[a ]dditionally, the internal approval for the transaction will acknowledge the fact that we were basically making a loan to [Enron]."z75

• A credit approval memorandum relating to the Nixon Prepay Transaction described it as a "[fJinancially (cash) settled oil prepaid. At maturity Enron will deliver cash equal to the nominal number of barrels x the then-index price. Index will be converted to a fixed price via a swap with the Toronto Dominion Bank to provide the funds needed to retire the loan."z76

• A September 2000 Citigroup email summarizing Enron's accounting for Prepay Transactions contained the following succinct recognition of the economic reality of Prepay Transactions as loans: "oil goes in acircle [sic] so they all cancel ... net net economically like a 10an."z77

• An internal email discussing the Roosevelt Prepay Transaction noted, "The commodity delivery schedule is hedged to ensure that the price realized on the ultimate sale of the commodities is sufficient to retire the loan. ,,278

• A July 2001 analysis of Enron drafted by Citigroup officers stated:

"Enron's total volume of prepays ... represents essentially another layer of corporate debt in addition to debt accounted as such."z79

• "[G]iven that the flows on the prepaid oil swap, caps and floor all net down to the $475mm payment at maturity and a coupon of 7.474%, was there a reason not to simply structure it as a loan or a note?"Z80

Enron's disclosure of its Prepay Transactions, to the extent any was provided, was

merely a general description of Enron's accounting for price risk management and its

275 CMAC Truman Minutes, at 2.

276 Citicorp Credit Approval, Dec. 10, 1999, at 2 [CITI-B 0132240-CITI-B 0132246]. 277 Wagman 9128/00 Email.

278 Email fromJamesF.Reilly. Citigroup, to Thomas Stott, Citigroup, et al., regarding Enron/Consent to Amendment to Roosevelt Transaction, Apr. 27, 1999 [PSI00339097].

279 Elliott 7/20/01 Email, at CITI-B 00616908.

280 Email from Andrew Lee, Citigroup, to Rick Caplan, Citigroup,Aug. 31,2000, at 1 [CITI-B 00499574- CITI-B 00499575].

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various price risk management activities. In footnotes 1 and 3 to Enron's consolidated

financial statements, Enron stated that its price risk management activities included

"forwards, swaps and other financial instruments with third parties [that] are reflected at

market value, net of future physical delivery related costs," but it never described any of

the Prepay Transactions specifically or disclosed the amount or nature of its obligations

thereunder.V' These footnotes did not provide an investor with adequate information on

the significant amount of cash flow that Enron received from any of its Prepay

Transactions or on the amount Enron had to repay on these transactions.282

Enron also failed to disclose the impact of its Prepay Transactions in its MD&A

disclosure. In the section of its MD&A captioned "Results of Operations" for the

wholesale services segment, Enron provided generic descriptions of its price risk

management activities that paralleled the descriptions found in the notes to the

281 Enron 10-K for 1998, Notes to the Consolidated Financial Statements, Notes 1 and 3. See also Second Interim Report, Appendix D (Enron's Disclosure ofIts SPEs), at 15-17.

282 In Note I to Enron's consolidated financial statements, captioned "Summary of Significant Accounting Policies," Enron stated:

Financial instruments utilized in connection with trading activities are accounted for using the mark-to-market method. Under the mark-to-market method of accounting, forwards, swaps, options and other financial instruments with third parties are reflected at market value, net of future physical delivery related costs, and are shown as "Assets and Liabilities From Price Risk Management Activities" in the Consolidated Balance Sheet ....

. . . . The cash flow impact of financial instruments is reflected as cash flows from operating activities in the Consolidated Statement of Cash Flows.

Enron 10-K for 1998, Notes to the Consolidated Financial Statements, Note 1. In Note 3, captioned "Price Risk Management and Financial Instruments," Enron disclosed that, through its wholesale services segment, it offered price risk management services through "a variety of financial and other instruments including forward contracts involving physical delivery of an energy commodity, swap agreements, which require payments to (or receipt of payments from) counterparties based on the differential between a fixed and variable price for the commodity, options and other contractual arrangements." Enron IO-K for 1998, Notes to the Consolidated Financial Statements, Note 3. See also Second Interim Report, Appendix D (Enron's Disclosure of Its SPEs), at 17-19.

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consolidated financial statements_283 Again, however, Enron provided no separate

disclosure on the Prepay Transactions themselves, failing to make clear to investors the

significant amount of reported cash flow from operating activities that was in fact

generated by these financings or Enron's related repayment obligations.i'"

283 In the MD&A section of its 2000 Form 10-K, Enron described the following factors that contributed to cash flows from operating activities in 2000, 1999 and 1998:

Net cash provided by operating activities increased $3,551 million in 2000, primarily reflecting decreases in working capital, positive operating results and a receipt of cash associated with the assumption of a contractual obligation. Net cash provided by operating activities decreased $412 million in 1999, primarily reflecting increases in working capital and net assets from price risk management activities, partially offset by increased earnings and higher proceeds from sales of merchant assets and investments. The 1998 amount reflects positive operating cash flow from Enron's major business segments, proceeds from sales of interests in energy-related merchant assets and cash from timing and other changes related to Enron's commodity portfolio, partially offset by new investments in merchant assets and investments.

Enron 10-K for 2000, Item 7 (MD&A) - Financial Condition - Cash flows. See also Second Interim Report, Appendix D (Enron's Disclosure ofIts SPEs), at 17-19.

284 In contrast to Enron's lack of disclosure, a number of companies that engaged in prepay transactions, some of which accounted for the transactions in a manner similar to Enron, provided some type of footnote and/or MD&A disclosure. For example, Occidental Petroleum Company ("Occidental"), which entered into a $500 million prepay transaction with JPMorgan Chase and its conduit entity, Mahonia Ltd., made a detailed disclosure in its 1998 financial statements on the advice of its auditors, Andersen. See Memorandum from Brian A. Levan, Occidental Petroleum Corporation, to J.R. Havert and S. Kumar, Occidental Petroleum Corporation, regarding Proposed Pre Sale of Gas, Nov. 16, 1998 [AB000512577- AB000512583]; Letter from Ahura Genack, Vice President and Assistant General Counsel, JPMorgan Chase, to Robert L. Roach, Counsel and Chief Investigator, PSI, July 18, 2002 [AB000153202]; Legal Department Memorandum from Philip Levy, In-house counsel, JPMorgan Chase, to Marjorie Gross, Inhouse counsel, JPMorgan Chase, regarding 1998 Accomplishments, Nov. 2, 1998, at 2 [JPMC 153925- JPMC 153926]. Occidental's disclosure described the salient terms of the prepay, including the "imputed interest rate," and the dollar amounts of Occidental's future obligations for each of the four years under the prepay. Occidental Petroleum Corporation Form 10-K filed with the SEC for the Year ended Dec. 31, 1998, at 52.

As discussed in Appendix C (Role of Enron's Officers), Andersen had recommended that Enron model its disclosure of the Prepay Transactions after a company called Acquila Energy Corporation ("Acquila"). Acquila discussed its prepay transactions in the MD&A of a registration statement filed with the SEC in 2000, as well as in the notes to the financial statements contained in that filing. Aquila wrote in its MD&A: "As part of our Wholesale Services segment, we periodically enter into long-term prepaid commodity contracts with our clients. Under these agreements, our clients pay us upfront for a specified commodity in exchange for a discounted, fixed-price for that commodity. To date, we have executed approximately $1 billion of these contracts, and we have used the proceeds to repay loans from UtiliCorp." Aquila Energy Corporation Form S-1 filed with the SEC on Dec. 13,2000 (the "Aquila Form S-1 "), at 42. Aquila also disclosed that it experienced "[a] $536 million increase in long-term price risk management liabilities due to additional commodity prepay transactions in 2000," id. at 42, and that its operating cash flow for the nine months ended September 30, 2000 was $270 million higher than in the comparable period of 1999 due in part to the impact of a gas prepay transaction. Id. at 43.

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Citigroup knew that Enron did not provide meaningful disclosure about the

Citigroup Prepays. When Citigroup attempted to determine the total amount of Enron's

Prepay Transactions with other lenders, it was unable to do so, despite its intimate

knowledge of how Prepay Transactions were structured and accounted for by Enron:

• As part of an internal effort to understand Enron's financial statements, a Citigroup employee reported to Stott that the amount of Enron's obligations from Prepay Transactions was not available. Stott responded, "Agree total prepaids is not available. Some one [sic] needs to ask the company as we've done in the past.,,285

• Enron apparently refused to give information about its Prepay Transactions to Citigroup, as noted by Elliott who had been charged with deciphering Enron's financial statements:

Enron's total volume of prepays (which it will not disclose to us) represents essentially another layer of corporate debt in addition to debt accounted as such. Although providing us only minimal comfort, it appears that the Company is using prepays only to monetize the ongoing net value creation within its marketing and trading activities, and is not creating PRM [Price Risk Management] liabilities in excess ofPRM assets_286

• In light of its inability to understand the full impact of Enron's Prepay Transactions using its internal resources, Citigroup hired an outside consultant in an effort to gain more understanding. Fox testified:

A. We felt that we had to go external for someone who had a better handle on this than we had.

Q. What was the transparency issue?

A. '" [A]s we talked about earlier, you know, prepaids got booked as liabilities in price risk management.

See also Columbia Energy Group Form 10-K filed with the SEC for Year ended Dec. 31,1999, at 31, 63; Crystal Oil Co. Form 10-K filed with the SEC for Year ended Dec. 31, 1997, at 27-28, 40-41; Equitable Resources, Inc. Form 10-K filed with the SEC for Year ended Dec. 31, 2000, at 50; Ocean Energy, Inc. Form 10-Q filed with the SEC for Quarter ended June 30, 1999, at 11; Santa Fe Snyder Corp. Form 10-K filed with the SEC for Year ended Dec. 31, 1999, at 24, 56.

285 Email from Thomas D. Stott, Citigroup, to Michael Nepveux and Lydia Junek and copy to William Fox, Citigroup, regarding Enron, June 28, 2001, at CITI-B 00740641 [CITI-B 00740641-CITI-B 00740642].

286 Elliott 07/20101 Email, at CITI-B 00616908.

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We were trying to understand how we could follow those transactions from the public financial statcmcnts.t'"

• The outside consultant hired by Citigroup listed as one of Citigroup's objectives, "Interpret and quantify the impact of off balance sheet liabilities, such as pre_paids.,,288

From its involvement in the Citigroup Prepays, Citigroup knew that Enron was

inflating its reported cash flows from operating activities by including the proceeds from

transactions that were effectively debt, that the magnitude of these transactions had a

material effect on Enron's financial statements, and that Enron failed to disclose

information publicly that would have allowed investors to understand the true nature and

impact of the Citigroup Prepays. Such knowledge is consistent with Citigroup's role in

structuring these deals. In discussing the June 2001 Citigroup Prepay, Paul Deards

("Deards"), then head of Citigroup's Derivatives group, acknowledged that his group

played an important role in structuring Prepay Transactions for Enron and other clients

generally:

[Ijt is critical that any transactions of this type, no matter how "plain vanilla", are viewed in the context of the overall funding strategy of the company (ie including interest rate profile, currency profile, liquidity preference, ratings agency considerations etc etc.). we are intricately involved in this process for key clients, indeed we are charged with providing the analytical rramework."?

Comparing his group's involvement with Prepay Transactions to that of

Citigroup's commodities trading group, Deards said:

if as you say, much of what you do does not involve management of commodity exposures at all, but is simply manipulating cash flows, there

287 Fox Sworn Statement, at 107-08.

288 Risk Management Activities Project Presentation by Dr. Neil S. Weiss, undated, at CITI-B 01284038 [CITI-B 01284037-CITI-B 01284076].

289 Deards 7/6/01 Email (capitalization omitted in original).

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may be a much greater overlap in our businesses than i had been led to believe.29o

Later in 2001, following the resignation of Skilling, Deards stated (in an email he

testified was a joke) that: "also want to get your [Caplan's] confirmation that (apart from

the fact we put deals together for Enron which we knew confused the ratings agencies)

there is no skellington in the c1oset.,,291

Citigroup also took actions to facilitate Enron's accounting treatment. For

example, Citigroup provided the Delta conduit entity, and it helped Enron develop cross-

default provisions among the swap agreements designed to avoid the appearance that the

swap agreements were linked.

Delta. Based upon Andersen's advice, Enron believed that its desired accounting

treatment of its Prepay Transactions depended, in part, on the participation of three

parties in the structure.i'" According to Andersen, Enron's purported sale and purchase

of the commodity needed to be with two different third parities, in order that those steps

of the transaction be "de-linked.,,293 Thus, the circular structure of the Prepay

Transactions was effected with three parties, with the price risk shifting away from Enron

and then back again after it passed through a third party, and with the repayment of the

financing moving through the conduit and back to the lender. All of the Citigroup

Prepays involved either another financial institution serving in the place of the conduit-

290 Id.

291 Email from Paul Deards, Citigroup, to Rick Caplan, Citigroup, regarding Ene, Oct. 25, 2001 (capitalization omitted in original) (Ex. 387 to Deards Sworn Statement) [CITI-B 00910235]. Deards testified that "skellington" may have been a pun on Skilling's name. Deards Sworn Statement, at 38-39.

292 Memorandum from Deb Cash and Kimberly Scardino, Andersen, to The Files, regarding Yosemite III - Transaction Summary, Aug. 2000 (the "Yosemite III Andersen Prepay Memo"), at 3 [AB000565301- AB000565305].

293 Id. at 3.

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namely Barclays or TD Bank-or Citigroup's SPE, Delta, serving as the conduit. The

parties used Delta in six of the Citigroup Prepays, including Roosevelt, Yosemite I

through IV and the June 2001 Prepay.

Andersen had advised Enron that there needed to be a "substantive business

purpose" for structuring the sale and purchase as separate steps,294 which meant that the

conduit entity needed to have a business purpose for entering into the commodity

transaction. Andersen apparently believed that the conduit could not satisfy this criteria

if it were an SPE.295 Andersen also apparently believed that the conduit entity needed to

be independent of the financial institution, and Citigroup was aware of this accounting

position. Handwritten notes on a diagram that Citigroup prepared about Yosemite I said

"Enron's Accountants don't want us to be seen to be controlling Delta.,,296 On a diagram

of the June 2001 Citigroup Prepay, handwritten notes said "[T]hey sell it to their

accountants by saying Citi gets paid by a combination of Enron & and [sic] independent

third party.,,297

However, Citigroup had formed Delta for the limited purpose of engaging in these

types of prepay transactions.t'" Delta only engaged in transactions involving Citigroup

294 Id.

295 Memorandum from Deb Cash and Patty Grutzmacher, Andersen, to The Files, regarding Yosemite Prepay, Dec. 1999 (the "Yosemite I Andersen Prepay Memo"), at 2 [AB0786 02820-AB0786 02822].

296 Yosemite funded prepaid, presentation by Citigroup, undated (the "Citigroup Yosemite Presentation"), at CITI-B 0035976 [CITI-B 0035973-CITI-B 0035976].

297 Enron PrePaid Cash Flows Diagram, undated (handwritten notes attribute statement to Steve Wagman ofCitigroup) [CITI-B 0035762].

298 Citigroup formed Delta at a time when Citigroup was prohibited under regulation from agreeing to take physical delivery of commodities. Yastine Affidavit, at 1. See also Email from Richard Caplan, Citigroup, to Andrew P. Lee, Citigroup, Aug. 31, 2000 (the "Caplan 8/31100 Email") [CITI-B 00499574-CITI-B 00499575].

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(all but one of which involved Enron),299 and Delta never received more than a "small

fee" for entering into the transactions.r'" The stock of Delta was owned by a charitable

trust in the Cayman Islands,'?' but on various occasions Citigroup paid the administrative

costs-including registration fees-relating to Delta, its attorneys' fees and its

transaction fees.302 Additionally, forms establishing a Citigroup bank account for Delta

listed Delta's address as "c/o Citicorp North America, Inc.," described the account as an

"internal account" to be "controlled" by Citigroup, and identified three Citigroup

employees as authorized signatories.Y' Citigroup employees referred to Delta as a "shell

corporation/Sl'Vi'P'" an affidavit that Citigroup provided to the PSI in July 2002

described Delta as a "special purpose entity,,,305 and even an internal Citigroup lawyer

referred to it as an SPV.306

299 See Summary in Lieu of Production of Document, Citigroup Response to July 2 Subpoena of PSI [ABOOOI53343-ABOOOI53344].

300 Email from Amanda Angelini, Citigroup, to Andrew P. Lee, Citigroup, et al., regarding Enron CLN Transaction-SFAS 133 Accounting For Prepaid Swaps, Nov. 20, 2000, at 1 [CITI-B 0035712-CITI-B 0035715]; see also Delta Energy Corporation, Written Resolutions of the Sole Director, June 26, 2001 (noting fee of $5,000 in connection with swap transactions with Citigroup and ENA) [CITI-B 0035873- CITI-B 0035874].

301 Yastine Affidavit, at 1-2 (stating that Delta was owned by Grand Commodities Corporation, which was owned by Givens Hall Bank and Trust, which had placed its entire interest in a charitable trust existing for the benefit of any qualifying charity, with the default being the National Council of Voluntary Organisations); Caplan Sworn Statement, at 103.

302 Yastine Affidavit, at 1.

303 Citibank Application for New Account for Delta, Sept. 27, 1994 [CITI-B 0036004-CITI-B 0036011].

304 Citigroup Exposure Memo, at 1. See also Email from Adam Kulick, Citigroup, to Rick Caplan, Doug Warren and William A. Sullivan, Citigroup, regarding Yosemite, Aug. 30, 1999 (the "Kulick 8/30/99 Email"), at CITI-B 00373610 (referring to the EnronlDelta forward contracts as the "Enron-SPV deals") [CITI-B 00373610-CITI-B 00373611].

305 Yastine Affidavit, at 3 ("Delta was established at Citibank's request in 1993 as a special purpose entity (SPE) with the express intention of making it independent of, and unaffiliated with, Citibank under relevant legal and regulatory standpoints.").

306 Email from William A. Sullivan, Citigroup, to Doug Warren, Rick Caplan and Adam Kulick and copy to Tom Francois, Citigroup, regarding Yosemite, Aug. 25, 1999 ("I spoke to Julian Reddyhough at Maples & Calder about using a Cayman SPC [sic] to be the 'purchaser' on the prepaid component of Yosemite ... if Delta not available, about USD 5M to set up a new SPV.") [CITI-B 00373615].

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On two occasions Citigroup caused Delta to make representations at the request of

Andersen that, although perhaps technically correct, were written in a manner that did not

disclose the reality of Delta's formation and use. In November 1999 in connection with

Yosemite 1,307 and again with respect to the June 2001 Prepay,308 Andersen requested that

Delta make representations that included, notably, (i) that Delta had undertaken business

with a number of entities, (ii) that Delta had assets other than those acquired through

transactions with Enron and (iii) that Delta had unencumbered assets available to the

Yosemite lenders upon a default.i'"

According to Wagman's testimony, Delta provided the requested representations

to Andersen.l'" However, according to Caplan's testimony and an email he wrote to

Wagman, (i) he was not aware of Delta having done business during 1999,2000 or 2001

with any entity other than Enron, Citigroup and the Yosemite Trusts.i!' and (ii) he knew

that Delta had only limited assets, consisting only of about $1,000 for the prefunding of

directors fees and its initial capital. 312

Cross Defaults. Andersen had advised Enron that one of the features necessary

for the swap agreements in the Prepay Transactions to be treated as trading contracts

(and, therefore, price risk management activity) was that the three swaps needed to be

307 Caplan Sworn Statement, at 257. 308 [d. at 258.

309 Email from Jung-Suk Suh, Enron, to William A. Sullivan and Rick Caplan and copy to Mark E. Lindsey, Citigroup, et al., regarding Andersen Language, Nov. 3, 1999 [CITI-B 0033746}; Email from Alan Quaintance Jr., Enron, to Steve Wagman, Citigroup, Timothy Swanson, Citigroup, et al., and Lisa Bills, Enron, regarding Delta Letter, June 22, 2001, (the "Quaintance 6/22/01 Email .. ).at1(attaching a letter with representations that Andersen wanted Delta to confirm) [CITI-B 00640610-CITI-B 00640611].

310 Wagman Sworn Statement, at 87,89.

311 Caplan Sworn Statement, at 411.

312 [d. at 261; Email from Rick Caplan, Citigroup, to Steve Wagman, Citigroup, regarding Delta Letter, June 22, 2001 (included in Ex. 138 to Caplan Sworn Statement) [CITI-B 00640610-CITI-B 00640611}.

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"de-linked.,,313 Andersen memoranda on this issue do not elaborate, but they imply that

"de-linking" means the swaps could not be cross-defaulted.l" Caplan testified that he

understood this to mean the three swaps in a Prepay Transaction could not be expressly

and directly connected to each other.31S

During Citigroup's development of the first Yosemite structure, William Sullivan

("Sullivan"), a lawyer at Citigroup, suggested that the swap agreement between Citigroup

and Delta should contain a provision causing it to terminate automatically if either the

swap agreement between Delta and Enron, or between Citigroup and Enron, were to

terminate.l'" He was especially concerned about a situation in which Enron had not filed

for bankruptcy but simply failed to perform on its obligations to either Delta or

Citigroup_317 Adam Kulick, one of the primary Citigroup contacts in the Derivatives

group for Yosemite I, knew that such a cross-default would "cause Enron accounting

problems.v'"

As an alternative, Citigroup agreed to include in the swap between Citigroup and

Delta a provision that caused the swap to terminate automatically if Delta experienced a

default under any other material (greater than $250 million) swap transaction to which it

313 See Memorandum from Deb Cash and Patty Gruzmacher, Andersen, to the Files, regarding Prepay Transactions, June 1999 (the "1999 Andersen Prepay Memo"), at 1-3 [ABOOOI53136-AB000153139]; see also Memorandum from Deb Cash, Patty Gruzmacher and Kate Agnew, Andersen, to The Files regarding Updated Prepay Transaction, June 2001 (the "2001 Andersen Prepay Memo") [AB0252 05240- AB0252 05243]; Yosemite I Andersen Prepay Memo, at 2.

314 See 1999 Andersen Prepay Memo; 2001 Andersen Prepay Memo; Yosemite I Andersen Prepay Memo. 315 Caplan Sworn Statement, at 112-13.

316 Email from Betty Ann Lofaso on behalf of William A. Sullivan, Citigroup, to Adam Kulick, Doug Warren and Rick Caplan and copy to Tom Francois, Citigroup, Aug. 30, 1999, at 2 [CITI-B 00373610- CITI-B 00373611].

317 Id. at 1.

318 Kulick 8/30/99 Email, at 1.

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was a party.319 This provision solved Sullivan's concerns, because Enron's failure to

perform under the swap between it and Delta would be such a default. In addition,

because Delta likely would have no transactions with anyone other than Enron, this

provision would not result in the swap between Citigroup and Delta being terminated for

any reason other than a default by Enron.

Accounting for the Yosemite Trusts

Citigroup had a substantial belief that Enron' s GAAP accounting for the Trust in

Yosemite I was wrong. Since the Yosemite II Trust had an identical equity structure, the

GAAP accounting problem would also extend to that transaction.V" Specifically,

Citigroup believed that Enron should have consolidated the Trusts, which would have

required that Enron reflect the proceeds of the note issuances on its balance sheet as debt.

Enron purchased 50% of the equity of the Trusts in Yosemite I and n.32J

Citigroup "synthetically" purchased the remaining 50%_322 Citigroup engaged Long

Lane to make the purchase directly, and then Citigroup assumed all equity exposure

through a Total Return Swap with Long Lane.323 Saul Bernstein ("Bernstein"), a senior

319 See, e.g., Delta/Citibank Swap Confirmation between Delta and Citigroup, Nov. 18, 1999 [AB000025706-AB000025715].

320 This issue was not present in Yosemite III and IV. In those transactions, 100% of the Trusts' equity was held by a balance sheet provider supported by a total return swap from Citigroup. As a result, Citigroup consolidated the Trusts for accounting purposes. This had no net adverse effect on Citigroup's balance sheet, however. The Trusts in Yosemite III and IV deposited the proceeds of the note issuances with Citigroup, causing the amount of those proceeds to be included as a liability on Citigroup's balance sheet regardless of the consolidation.

321 Certificate Purchase Agreement among Yosemite Securities Trust I, Enron and Fleet, as Trust Administrator for Long Lane, Nov. 18, 1999 [AB000080188-AB000080207]; Certificate Purchase Agreement among Yosemite Securities Company Ltd., Enron and Fleet, as Trust Administrator for Long Lane, Feb. 23, 2000 [AB000081621-AB000081640].

322 Email from Adam Kulick, Citigroup, to James Reilly, Citigroup, et al., regarding Approval Package, Oct. 18, 1999 (the "Kulick 10/18/99 Email"), at CITI-B 0215692 [CITI-B 0215687-CITI-B 0215696].

323 Swap Transaction Confirmation between Fleet and Salomon Brothers International Limited ("SBIL"), Aug. 11,2000 (for Yosemite I) [CC FL 001139-CC FL 001146]; ISDA Master Agreement between SBIL and Fleet, Jan. 28, 2000 [CC FL 001152-CC FL 001182]; Swap Transaction Confirmation between Fleet

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accountant in Citigroup's internal Accounting Advisory office, concluded in an October

1999 memorandum that Citigroup should not consolidate the Trust in Yosemite I because

its 50% of the equity was not at risk.324 Bernstein's accounting analysis concluded that,

because Long Lane's equity was not at risk, Long Lane was not considered a "real"

equity investor per applicable accounting guidelines.r" Bernstein also concluded that

Citigroup should not be viewed as a real equity investor on the basis of its Total Return

Swap, and that it would have been "unconventional in today's accounting literature and

practice" for Citigroup to consolidate the Trust based on Citigroup having risks and

rewards pursuant to a derivative instrument.V"

Bernstein's memorandum did not address whether Enron should consolidate the

Yosemite I Trust. However, several days after the date of Bernstein's memorandum,

another senior accountant at Citigroup, Frederick Battline ("Battline"), wrote an email to

Bernstein raising that question.327 Battline noted that, under applicable accounting

guidelines, one of the conditions for avoiding consolidation was that the majority owner

of the Trust must be an independent third party who made a substantive capital

investment. 328 Battline noted that neither Enron nor Citigroup was independent of the

and SBIL, Dec. 10, 2001 (for Yosemite II) [CC FL 002077-CC FL 002084]; ISDA Master Agreement between SBIL and Fleet, Oct. 26, 1992 [CC FL 001307-CC FL 001324]; Schedule to the ISDA Master Agreement between SBIL and Fleet, Oct. 26, 1992 [CC FL 001295-CC FL 001306].

324 Memorandum from Saul Bernstein, Citigroup, to Rick Caplan and Adam Kulick, Citigroup, regarding Project Yosemite - Yosemite Co. Structured Credit Derivative Transaction, Oct. 29, 1999 (the "Bernstein 10/29/99 Memo"), at 4 [CITI-B 0003517-CITI-B 0003522].

325 Bernstein 10/29/99 Memo, at 4.

326 Id.

327 Email from Frederick Battline, Citigroup, to Saul Bernstein, Citigroup, regarding Project Yosemite, Nov. 3, 1999 (the "Battline 11/03/99 Email"), at CITI-B 0129861 [CITI-BOI29860-CITI-B 0129862].

328 Id.

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rest of the transaction, and Long Lane was protected by the Total Return Swap.329

Battline wrote:

If it is our view that the client should be consolidating the trust, we need to be sure that the client accepts this view. We are not responsible for the client's accounting, but since we are advising on the transaction it could be rather embarrassing if Citigroup's accounting position relied on a view that is contrary to our client's interest. In this transaction the client may be indifferent to consolidating the trust, since the obligations are on its balance sheet in one form or another. But if this is the case, why not have the client provide (a) all of the equity in the trust or (b) the total return swap?330

Bernstein's memorandum did not address the prepay portion of the transaction,

and so it is unclear if he or Battline understood that the proceeds of the note issuances

would only be reflected on Enron's balance sheet as price risk management activity.

They may have assumed that the Trust would loan the proceeds of the note issuances

directly to Enron, in which event Enron would have been required to record the amount

as debt. However, because Delta provided the funds to Enron as part of the Prepay

Transaction, Enron would not have included that amount on its balance sheet as debt,

unless it were required to consolidate the Trust. The Yosemite I and II proceeds were

over $1.1 billion in total. 331 Thus, Enron was likely not indifferent to consolidating the

Trust, and at least Caplan, one of the primary Citigroup contacts for Yosemite I,

understood this.332

Bernstein, however, agreed with Battline that Enron should consolidate the Trust.

Bernstein responded to Battline's message:

329 [d. 330 [d.

331 Citigroup Responses, at 28-29. 332 Caplan Sworn Statement, at 156.

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It is our view that Enron should consolidate the Trust (implied by the accounting rational [sic] documented in my memorandum which supports non-consolidation by Citibank), but GClB Accounting Advisory nor the Business does not advise a customer regarding its accounting. We tell them to consult their internal accounting folks or external auditors. This is the customer's accounting risk to accept or reject. It has not been my experience that "we assure ourselves that the client accepts our view" regarding what we believe their accounting should be. This would be a new operating standard and business requirement, the competitive impact of which must be carefully considered. Please note that all transactions are approved from an appropriateness and suitability aspect.

Please also note, regarding our own accounting, this transaction was reviewed by Bill Bozarth, John Langer and Linda Bergen. We all got comfortable with not consolidating the Yosemite Trust, although we all share your concern. 333

Battline then expressed a concern that this difference in accounting conclusions could be

harmful to either Citigroup or its client:

You and others have spent more time on this than I have, but if we have structured a transaction to help a client avoid consolidation, how can we tum around and take the position that they should be consolidating?

I'm not suggesting that we are responsible for their accounting, but I am afraid that if we ever had to defend this we would either (a) embarrass the client or (b) lose the accounting argument. 334

According to Caplan, he and Kulick discussed Citigroup's concern with "some

combination of Bill Brown and Doug McDowe11.,,335 Caplan testified that the Enron

officers acknowledged they understood Citigroup's conclusion, but told him they would

make their own accounting interpretation.V"

333 Bernstein 11/3/99 Email, at CITI-B 0129861. Bozarth, Langer and Bergen were all involved in either accounting or finance functions at Citigroup. See Sworn Statement of Saul Bernstein, Citigroup, to Steven M. Collins, A&B, May, 212003 (the "Bernstein Sworn Statement), at 104, 111.

334 Email from Frederick Battline, Citigroup, to Saul Bernstein, Citigroup, regarding Project Yosemite, Nov. 3, 1999, at CITI B 0129860 [CITI-B 0129860-CITI-B 0129861].

335 Caplan Sworn Statement, at 154-55.

336 Id. at 155.

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Ultimately, Battline accepted Bernstein's position that "the client understands the

accounting risk and that it is their argument to lose,,,337 and the transaction was allowed

to close. Thus, Citigroup facilitated the transactions in Yosemite I and II, with a

substantial belief that Enron did not intend to account for them properly under GAAP.

Citigroup knew that the approximately $1.1 billion of proceeds would not be reflected as

debt on Enron's balance sheet, and its facilitation of Yosemite I and II included, among

other things, Citigroup's underwriting of the notes offered to the institutional investors.

Within Citigroup, concern about Citigroup's role in the Yosemite Trusts, and

particularly its disclosure of that role, continued to be expressed when Enron asked for a

second Yosemite transaction prior to the time that the first Yosemite transaction had

closed.338 Fox raised the question in an email, saying:

Also there is the issue on the equity. Two points: one can we technically strcuture [sic] a default swap from the trust that eliminates our exposure and two there is a question of appropriateness: presumably we will be representing to investors that we are putting up half the equity and then with or without disclsoure [sic] (?) we are doing a default swap with the trust; sound [sic] questionable.r'"

Citigroup did not, however, disclose its ownership of the equity in the offering

memorandum for the notes, and, therefore, it did not disclose its Total Return Swap

support of the equity purchased by Long Lane."" Enron was aware that Citigroup had

337 Email from Saul Bernstein, Citigroup, to Rick Caplan and Adam Kulick, Citigroup, regarding Project Yosemite, Nov. 3, 1999, at CITI-B 0129860 [CITI-B 0129860-CITI-B 0129861].

338 Email from William Fox, Citigroup, to Steve Baillie and James Reilly and copy to Niels C. Kirk, Citigroup, regarding Yosemite II (Europe), Nov. 14, 1999, at 1 [CITI-B 0223408-CITI-B 0223410].

339 !d.

340 Kulick responded to Fox's concerns in an email saying that "the equity is only in the structure to satisfy tax and accounting issues .... " Email from Adam Kulick, Citigroup, to James Reilly, Citigroup, regarding Yosemite II (Europe), Nov. 15, 1999 [CITI-B 0033749]. Kulick said, effectively, that the offering materials for the notes made it clear that the investors would not benefit from the equity in any way and that the default swap would cause them not to benefit from any non-Enron investment in the trust, and that

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synthetically purchased the equity.?" However, Andersen accountants have testified that

they were not aware of this swap arrangement, and they have concluded that such an

arrangement would have required Enron to consolidate the Trusts.342

B. Minority Interest Transactions

In December of 1997, 1998 and 1999, Citigroup assisted Enron in completing

year-end Minority Interest Transactions.343 These financings were referred to as

Nighthawk, Rawhide and Nahanni, respectively. Collectively, these transactions allowed

Enron to obtain $1.75 billion of year-end financing.I" which Enron did not reflect on its

financial statements as debt. Enron reported $500 million of this financing as cash flows

from operating activities.345

Citigroup developed the idea for the Minority Interest structure and considered it

to be a proprietary product.I" In addition, Citigroup funded the loans in each of the three

structures and served as placement agent for obtaining the required equity investments, as

well as serving in numerous other roles in each transaction.l'" In consideration, Enron

paid Citigroup a total of $24.45 million in upfront structure fees and $4.7 million in

he therefore believed there was no appropriateness issue related to the lack of disclosure in the offering materials. Id.

341 Email from Ann Marie Tiller, Enron, to Doug McDowell, Enron, regarding Salomon Bros. International, Jan. 11,2000 [AB0971 02183]; Email from Janine Juggins, Enron, to Treasa Kirby, Enron, and copy to Simon Crowe, Enron, et al., Jan. 14,2000, at AB0971 02187 ("Can you confirm whether a total return swap is planned between the Long Lane Master Trust and 55MB London? (this was the structure I believe on YI)") [AB0971 02186-AB0971 02187].

342 See Report, Appendix C (Role of Enron's Officers).

343 Citigroup Responses, at 33-35.

344 Id.

345 Enron 10-K for 1999, Note 4 - Merchant Activities.

346 The idea was jointly developed by Citigroup's Capital Structuring and Equity Derivatives groups. Nighthawk Capital Structuring December Approval Package, at CITI-B 00375892.

347 Citigroup Responses, at 33-35.

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underwriting fees.348 Citigroup also earned derivative gains ($5.3 million on Nighthawk alone) and other returns on its investments.r'"

As discussed in the Second Interim Report, the Examiner has concluded that Enron's accounting treatment for Nighthawk, Rawhide and Nahanni was not in compliance with GAAP.350 For accounting purposes, Enron should have consolidated the

entities that borrowed the funds because the independent equity was not at risk, and that debt should have been reflected as debt on Enron's balance sheet. The $500 million

obtained in Nahanni should have been reported as cash flow from financings, rather than

cash flow from operating activities. As a result of its accounting treatment of the

Minority Interest Transactions, Enron materially misstated its financial statements.

As discussed below, Citigroup was aware of Enron's accounting for these

transactions and was aware that the accounting for at least Nighthawk and Nahanni was

likely not in compliance with GAAP. In addition, it was Citigroup's idea for Enron to sell U.S. Treasury Securities ("T-Bills") in the Nahanni structure and record the

transaction as a sale of merchant investments, with knowledge that such securities did not

fit within Enron's, or any other commonly accepted, definition of merchant investments.

Moreover, Citigroup recommended the Nahanni transaction with knowledge that Enron would implement it in December 1999 and unwind it in January 2000.

Citigroup's role as architect of the Minority Interest Transaction structure and its crucial roles in helping Enron implement three such transactions helped Citigroup

understand that Enron was using Nighthawk, Rawhide and Nahanni to manage its year-

348 !d. 349 Id.

350 Second Interim Report, Appendix I (Minority Interest Transactions).

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end balance sheet. Citigroup itself described the Nahanni transaction as "year-end

window dressing.,,351 Citigroup also knew that such transactions were material to

Enron's financial condition. Nahanni alone accounted for 41 % of Enron's total reported

cash flow from operating activities in 1999.352

Summary Description of the Transaction Structure

The following chart shows the basic structure of a Minority Interest

Transaction.353

Enron

Third-Party Equity Investors

$ Loan (97%)

$ Loans

Lenders

Minority Investor

Note

$ Capital Contribution (amount equal to contributed capital plus bank loan amount) ~--~--~~--~

Notes

Majority-Owned Subsidiary

In such a transaction, Enron created a majority-owned, consolidated subsidiary

and arranged for a minority investor to invest cash or other assets in the subsidiary.

351 Citigroup Exposure Spreadsheet, undated, at 28 [CITI-B 0137997-CITI-B 0138003]. 352 Enron 10-K for 1999, at F-6.

353 For a detailed discussion of Enrou's Minority Interest Transactions, see Second Interim Report, Appendix I (Minority Interest Transactions).

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Typically, the majority-owned subsidiary would then loan the funds obtained from the

minority investor to Enron. On consolidation, this loan from the majority-owned

subsidiary to Enron was eliminated. The minority investor was typically an SPE funded

by one or more banks requiring a minimum of 3% of independent equity, and it was

established for the sole purpose of the minority interest financing. Payments by the

majority-owned subsidiary to the minority investor were in amounts and at times required

to allow the minority investor to make required payments to the banks and distributions

to its equity holders (who held 3% of the equity of the minority investor). In each of

these transactions, Enron provided significant credit support for the obligations of the

majority-owned subsidiary to the minority investor through various means. While the

economic characteristics of minority interest financings closely resembled loans, Enron

recorded no debt, but instead reflected these financing arrangements as "minority

interests" on its consolidated balance sheet.

Citigroup had used a minority interest financing structure with other clients and

referred to it generally as a venture financing structure, or "VFS" for short.354 In the

fourth quarter of 1996, Citigroup presented to Enron a new form of VFS it referred to as

Project Java.355 The Java structure was unique from any other VFS Citigroup had

devised previously, because it contemplated that Enron would contribute preferred

convertible securities to the majority-owed subsidiary instead of operating or other

assets.356

354 Capital Structuring US Approval Request Form, regarding Enron - Project Rawhide, Nov. 2, 1998, at 1, 6 [CITI-B 00403912-CITI-B 00403921].

355 Conway Sworn Statement, at 16, lines 17-24. See Nighthawk Capital Structuring December Approval Package; Nighthawk Capital Structuring, Aug. 13, 1997 (the "Nighthawk Capital Structuring August Approval Package"), at CITI-B 0052745 [CITI-B 0052741-CITI-B 0052751].

356 Conway Sworn Statement, at 16-17.

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In preparation for marketing the Java structure, Citigroup sought the advice of

Andersen's Professional Standards Group with respect to the accounting treatment+" It

also met with Moody's to ensure that the Rating Agencies would likely give the minority

interest substantial equity credit, rather than considering it to be debt, particularly for

sponsors with a credit rating above non-investment grade. 358 Thus, it is reasonable to

conclude that Citigroup was knowledgeable about all aspects of its proprietary structure

and was prepared to assist potential purchasers with all aspects of its benefits and

requirements.

Nighthawk

During 1997, Enron determined to pursue a $500 million, five-year minority

interest transaction with Citigroup based on the Java model, which the parties referred to

as Project Nighthawk.F" In this transaction, which closed on December 27, 1997, Enron

contributed shares of its convertible preferred stock to a majority-owned subsidiary

named Whitewing Associates L.L.C. ("Whitewing"), and borrowed from Whitewing

$500 million of cash.36o The transaction was designed (absent a dramatic decline in the

value of Enron's stock) for the loan to be repaid from the proceeds of future sales of

Enron stock.i'" Citigroup's Global Capital Structuring group had primary responsibility

357 Id. at 21.

358 Id. at 21-24.

359 Nighthawk Capital Structuring December Approval Package, at CITI-B 00375892.

360 See Second Interim Report, Annex 1 to Appendix I (Minority Interest Transactions). Project Nighthawk served as the starting point for the Whitewing Share Trust transaction. For further information about the Whitewing Share Trust transaction, see Second Interim Report, Appendix G (Whitewing Transaction) .

361 See Second Interim Report, Annex 1, Appendix I (Minority Interest Transactions).

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for the transaction, with a team led by Elliot Conway ("Conway"), a Managing Director

and co-head of the group.362

In a July 1997 marketing presentation, Citigroup explained to Enron that

Nighthawk's benefits would include: (i) the transaction would receive significant equity

credit from Rating Agencies; (ii) it would not dilute Enron's earnings per share because

the Enron common shares would not be deemed to have been issued unless and until the

preferred stock was converted; (iii) Enron would maintain control over all preferred

shares transferred to the majority-owned subsidiary; and (iv) the transaction would

remain "confidential" with "minimal public disclosure.,,363 Thus, Citigroup knew that

Nighthawk would accomplish a number of benefits for Enron, including obtaining

financing that would not increase its debt, would not cause it to relinquish control over its

assets, and would help it maintain a favorable credit rating. Citigroup also knew that

Enron had a desire to obtain these benefits before year-end 1997.364

As part of the July presentation, Citigroup gave Enron the proposed pro forma

balance sheets for each of the major entities involved, including Enron, the majority-

owned subsidiary and the minority investor.365 These pro formas showed that Enron's

assets would remain unchanged, its minority interest investment would increase by $500

million, and its debt would decrease by $500 million, assuming that Enron would use the

362 Nighthawk Capital Structuring December Approval Package, at CITI-B 00375890; Nighthawk Capital Structuring August Approval Package, at 0052741.

363 Project Nighthawk - Equity Monetization Structure, July 8, 1997 (the "Nighthawk Monetization Presentation"), at 2 [AB000512047-AB000512073].

364 Nighthawk Capital Structuring August Approval Package, at CITI-B 0052751; Nighthawk Capital Structuring December Approval Package, at CITI-B 00375907.

365 Nighthawk Monetization Presentation, at 17.

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Nighthawk proceeds to pay down other existing debt.366 Using Enron's actual financial

statement amounts as of year-end 1996, the pro formas showed that, if the $500 million

proceeds from Nighthawk had been included on Enron's balance sheet as debt, Enron's

on-balance sheet debt would have increased by 8.7%. Under the GAAP treatment used

by Citigroup in the pro formas, Nighthawk increased Enron's investments in minority

interests by 60%, from $755 million to $1.255 billion.f" Thus, Citigroup understood

how material Nighthawk would be to Enron's financial statements.i'"

Citigroup understood that the benefits to Enron of Project Nighthawk, or any

other Minority Interest Transaction, depended upon Enron's ability to treat the minority

investor as a nonconsolidated entity.369 If Enron were required to consolidate the

minority investor, then the minority investor's debt, the proceeds of which funded its

capital contribution to the majority-owned subsidiary, would have to be included on

Enron's financial statements. In such an event, Enron's reported debt would increase by

the amount of the financing, which was the opposite of the primary objective of Project

Nighthawk.

Citigroup understood that the relevant accounting literature under GAAP required

that there be 3% substantive, "independent" equity at risk in the minority investor, in

order for Enron to avoid consolidating the minority investor.V" To satisfy the 3% equity

requirement, the parties structured Nighthawk so that the total $500 million proceeds

366 Jd. at 10. 367 !d. at 17.

368 Memorandum from Elliot Conway, Citigroup, to Phil Sisneros, Enron, regarding Nighthawk, Nov. 10, 1997 [CITI-B 0256314].

369 See Nighthawk Monetization Presentation. 370 Jager Sworn Statement, at 15-18.

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were comprised of $485 million of debt and $15 million of equity.i" Citigroup made the

$485 million loan, using CXC, Inc., a commercial paper conduit managed by

Citigroup.372 The third party equity investor was Harch Capital Management, Inc.

("Harch"), a money management firm based in Boca Raton, Florida that had previously

participated in transactions with Citigroup's Global Capital Structuring Group.373 Harch

formed two new entities solely for the purposes of Nighthawk, Golden Eagle L.L.C.

("Golden Eagle") and its sole member, Kestrel Investor L.L.C. ("Kestrel,,).374 Kestrel's

sole member was HCM High Yield Opportunity Fund LP, which Harch controlled as its

adviser.375 Golden Eagle made the direct $15 million equity contribution to the minority

investor.Y" having obtained the funds through the following series of transactions: (i)

Harch contributed $7.9 million to Kestrel;377 (ii) Kestrel borrowed $7.1 million from

371 Section 2.01, Credit and Security Agreement among Nighthawk Investors LLC, CXC Incorporated ("CXC") and Citicorp North America, Inc. ("CNAI"), Dec. 29, 1997 (the "Nighthawk Credit Agreement") [AB000370573-AB000370669]; Preliminary Statements, Insurance Agreement among Ambac Assurance Corp. ("Ambac"), CXC Incorporated and Citicorp North America, Inc., Dec. 29, 1997 (the "Nighthawk Insurance Agreement"), at 1 [AB000371654-AB000371694]; Section 5.1, Nighthawk Investors LLC Amended and Restated Company Agreement, between Golden Eagle L.L.c. ("Golden Eagle") and Prairie Hawk, Inc. ("Prairie Hawk"), Dec. 29, 1997 (the "Nighthawk LLC Agreement") [AB000370949- AB000370992]; Nighthawk Investors LLC Class A Member's Certificate Regarding Capital Contributions to Nighthawk Investors LLC, Dec. 29, 1997 [AB000371996-AB000371997].

372 Nighthawk Credit Agreement; Nighthawk Insurance Agreement.

373 Project Nighthawk Closing Memorandum, Dec. 29, 1997 (the "Nighthawk Closing Memo"), at 5 [CITIB 00322418-CITI-B 00322425].

374 Nighthawk Closing Memo; Enron Funds Flow Memorandum, Apr. 19, 2000, at 1 [AB000494060- AB000494063]; Section 2.2, Kestrel Investor L.L.C. ("Kestrel") Company Agreement, Dec. 29, 1997 (the "Kestrel Company Agreement") [AB000373112-AB000373132]; Kestrel Investor L.L.C. Borrower's Certificate, Dec. 30, 1997 (the "Kestrel Borrower's Certificate") [AB000373282-AB000373283].

375 Kestrel Company Agreement; Kestrel Borrower's Certificate. HCM High Yield Opportunity Fund, LP ("HCM") also served as an equity investor in Rawhide Investors, L.L.c. in the Project Rawhide Structure. See Second Interim Report, Appendix I (Minority Interest Transactions).

376 Nighthawk LLC Agreement; Nighthawk Investors LLC Notice of Borrowing, Dec. 29, 1997 [AB000370921-AB000370922].

377 Kestrel Investor L.L.C. Member Certificate, Dec. 29, 1997 [CITI-B 0012469-CITI-B 0012471).

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CXC on a nonrecourse basis;378 and (iii) Kestrel contributed the full $15 million to

Golden Eagle.379

The parties put into place three types of protection that covered Golden Eagle's

$15 million equity investment. First, Citigroup obtained a surety bond from a third party,

Ambac Assurance Corporation, which covered the $7.1 million that Kestrel had

borrowed from CXC.380 Second, Citigroup issued to Kestrel a "costless collar" (the

"Kestrel Collar"), covering approximately $15 million of the Enron stock in the

Nighthawk structure.381 This collar consisted of an "at-the-market" put option (which

Citigroup hedged with an offsetting put option (the "Hedge Put") purchased from Swiss

Bank) and a 102.5% "out-of-the-money" call option_382 Third, Citigroup issued a

separate $15 million put option for the benefit of Kestrel and Ambac (the "Kestrel

Put,,).383 The effect of the Kestrel Collar and the Kestrel Put was to protect Kestrel from

any losses attributed to the minority investor as a result of a decline in the value of the

Enron stock that had been contributed to the Nighthawk structure. 384

378 Section 2.01, Credit and Security Agreement among Kestrel Investor L.L.C., CXC Incorporated and Citicorp North America, Inc., Dec. 29, 1997 (the "Kestrel Credit Agreement") [AB000372940- AB000373038); Kestrel Investor L.L.C. Notice of Borrowing, Dec. 29, 1997 [AB000373098- AB000373099).

379 Golden Eagle L.L.C. Company Agreement, Dec. 12, 1997 (the "Golden Eagle LLC Agreement") [AB000372502-AB000372522].

380 Surety Bond No. AB0154BE of Ambac, Dec. 30, 1997 [AB000373204-AB000373213]; Insurance Agreement among Ambac Assurance Corp., Citicorp North America and CXC Incorporated, Dec. 29, 1997 [AB000373215-AB000373251].

381 Confirmation from Citibank to Kestrel Investor L.L.C., Dec. 29, 1997 (the "Kestrel Collar") (also naming Ambac as an intended third-party beneficiary) [CITI-B 0012430-CITI-B 0012449]; Confirmation from Citibank, N.A., to Kestrel Investor L.L.C., Jan. 9, 1998 (the "Kestrel Confirmation") (setting the put strike price at $14.6 million and the call strike price at $15.0 million) [CITI-B 0012451-CITI-B 0012452]; ISDA Master Agreement between Citibank, N.A. and Kestrel Investor L.L.C., Dec. 29, 1997 (the "Kestrel ISDA Master Agreement") [CITI-B 0012399-CITI-B 0012428].

382 Kestrel Collar; Kestrel Confirmation; Kestrel ISDA Master Agreement. 383 Kestrel Confirmation; Kestrel ISDA Master Agreement.

384 See Second Interim Report, Annex 1 to Appendix I (Minority Interest Transactions).

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Based on this protection for the $15 million equity and the fact that a portion was

funded through nonrecourse debt, the Examiner concluded in the Second Interim Report

that the Nighthawk equity was not at risk and did not support Enron's decision not to

consolidate the minority investor. Around the time that the transaction closed in

December 1997, Bernstein, a senior member ofCitigroup's Accounting Advisory office,

reached a similar cooctuslon.l"

Sometime prior to December 15, 1997, Conway's team requested that Bernstein

review Nighthawk from an accounting perspective.P" Bernstein testified that his purpose

in making such a review was to determine whether Citigroup should consolidate the

minority investor.387 He concluded that it should not, and his pre-closing accounting

analysis, set out in a December 15, 1997 memorandum, included a review of the reasons

why Enron should consolidate the minority investor.i'"

Bernstein wrote:

Although the equity is substantive, at a 3% capitalization level the $15MM of equity is not at risk. A collar put option purchased by Citibank from an A-rated dealer protects the $15MM of equity (sharing in losses of the IV). The equity is back-levered on a non-recourse basis with a $7.1MM CXC loan with counterparty risk assumed by AMBAC.389

Bernstein then noted that the appropriate analysis was to consider which party in

the transaction had the "primary ownership risks or benefits," and he concluded that

385 Memo to File, regarding Project Nighthawk, Enron Monetization and Accounting Treatment, Dec. 15, 1997 (the "Bernstein 12/15/97 Nighthawk Memo") [CITI-B 00395280-CITI-B 00395283]. Bernstein testified that he prepared this memorandum. Bernstein Sworn Statement, at 33 (referring to Ex. 88 to Conway Sworn Statement).

386 Bernstein 12/15/97 Nighthawk Memo; Bernstein Sworn Statement, at 25. 387 Bernstein Sworn Statement, at 37.

388 Bernstein 12/15/97 Nighthawk Memo, at CITI-B 00395282. 389 Id. at CITI-B 00395281.

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Enron was the party predominately at risk of loss in the value of the underlying assets in Whitewing.390 Bernstein concluded that Enron had transferred its shares to Whitewing

without having relinquished the ownership risks and benefits of those shares, because (i)

Enron provided $500 million of first loss protection to Whitewing and, in tum, the

minority investor, and (ii) Enron was required to make Citigroup whole as derivative counterparty for reductions below $500 million in the value of the Enron shares.l'"

Therefore, according to Bernstein, "one can reasonably conclude that Enron has the equity risk related to ownership of the Investor (SPV) [the minority investor].,,392

Bernstein also concluded that Enron retained control over the assets (i.e., the

shares of Enron stock) in Whitewing, citing several supporting facts including, among

others, (i) Enron retained an unconditional right to convert and liquidate the shares at any time, and (ii) Enron could collapse the structure at its election.393 Bernstein noted that

"surrendering of control over assets is the lynchpin concept in determining whether to

consolidate or not per the recent F ASB Exposure Draft on Consolidation Policy and Procedures.Y" Concluding that it was "clear that the Spy activities are on behalf of

Enron," Bernstein wrote that "[i]t would therefore seem appropriate, pursuant to EITF 90-15, for Enron to consolidate the Investor (SPV) as well as the JV.,,395

390 Id. at CITI-B 00395281-CITI-B 00395282. 391 Id. at CITI-B 00395282.

392 Id.

393 [d.

394 Id.

395 [d.

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