A:

In 1992, J.P.Morgan went into the energy trading business by creating a venture company called Mahonia Limited. At least, that is how things appeared on paper. Mahonia was actually a type of tax shelter for energy-trading companies. Mahonia would buy large amounts of gas or oil at the end of the tax year with the request that they be delivered in increments over the following calendar year. The pre-paid sale would then be recorded as a debt on the seller's financials because the goods had not been delivered yet. By doing transactions like this at the end of every year, the companies dealing with Mahonia could defer their taxes and decrease their taxable income in good times.

Although devilishly clever, there is nothing outright illegal about these tax-deferral transactions as long as the goods are delivered. Unfortunately for Mahonia, more than half of its business was with Enron. Enron started doubling the value of its trades by recording the sales as cash flow in its financials and as debt on its taxes. As Enron's financial troubles increased, they asked Mahonia to buy more. Instead of being a tax haven, Mahonia became a lender to Enron when the goods weren't being delivered.

Mahonia (J.P.Morgan in all but name) wanted to cut ties with Enron but they were already on the hook for a significant chunk of change - a single sale in 1999 was for $650 million. Enron agreed to take out insurance on the delivery of the sales, perhaps knowing it was already so deep in fraud that a little more wouldn't hurt. The goods were, of course, never delivered. When Enron imploded, Mahonia was owed billions in bad sales.

The insurance firms refused to pay up when the financial wizardry was exposed and it turned out that, although Mahonia had lost heavily, J.P.Morgan had made millions on fees for brokering deals between Enron and Mahonia. The insurers alleged that the trades were actually high risk loans meant to prop up the floundering energy giant. J.P.Morgan took the insurers to court on the charge that the insurance policy Enron had drawn was unconditional despite suspicions of fraud. J.P.Morgan won a Pyrrhic victory, getting less than half of the $1.1 billion it sought and doing considerable damage to its reputation in the process.

For more information, read our related articles: The Kingpin Of Wall Street: J.P. Morgan and Enron's Collapse: The Fall Of A Wall Street Darling.

This question was answered by Andrew Beattie.

RELATED FAQS
  1. What stock factors should you consider when a company makes a CEO change?

    Learn about factors affecting the price of stock following a change in CEO. Explore why a change in CEO may be positive or ... Read Answer >>
  2. Are tax shelters legal in Canada?

    Understand whether tax shelters are legal in Canada and what types of scams have been committed. Learn what happens to illegal ... Read Answer >>
  3. What is the difference between principles-based accounting and rules-based accounting?

    Almost all companies are required to prepare their financial statements as set out by the Financial Accounting Standards ... Read Answer >>
  4. Who are the most famous people convicted of insider trading?

    Learn about some famous people who were convicted of illegal insider trading and find out about the reasons for their criminal ... Read Answer >>
  5. Do common stock owners have any protections against bankruptcy or fraud?

    Learn about common stock ownership including the standing of holders in the event of bankruptcy or fraud, and familiarize ... Read Answer >>
  6. What is the difference between the Sarbanes-Oxley Act and the Dodd-Frank Act?

    Learn about the differences between the Sarbanes-Oxley Act and the Dodd-Frank Act, and understand the reasons why each bill ... Read Answer >>
Related Articles
  1. Insights

    Enron Scandal: The Fall of a Wall Street Darling

    Today is the 15th anniversary of the former oil giant's bankruptcy filing.
  2. Small Business

    Why Enron Collapsed

    Enron’s collapse is a classic example of greed gone wrong.
  3. Insights

    4 Must Watch Films and Documentaries for Accountants

    Learn how these must-watch movies for accountants teach about the importance of ethics in a world driven by greed and financial power.
  4. Investing

    Are Your Stocks Doomed?

    When a company is headed for trouble, the warning signs are usually there. Learn how to spot disaster.
  5. Insights

    The Ghouls And Monsters On Wall Street

    Learn about some of the creepiest cases of fraud and the characters behind them.
  6. Investing

    JPMorgan Chase: Too Big (And Profitable) To Fail

    If there's any bank that's too big to fail, JPMorgan Chase & Co. may very well be the best example. Just look at its return on equity.
  7. Investing

    JPMorgan Q4 Earnings Friday: What to Expect

    The bank is the largest and arguably the most consistent performer among the "Big Four."
  8. Investing

    Top 5 Positions in J.P. Morgan's Portfolio (JPM, SPY)

    Learn about the top five holdings that JPMorgan Chase & Co. uses as a base for its $2.4 trillion investment portfolio.
  9. Investing

    Companies You Never Thought Would Go Bankrupt (RSHCQ, GM)

    Learn about some of the most shocking corporate bankruptcies in history, including General Motors, Chrysler, Lehman Brothers and Enron.
  10. Investing

    Why You Shouldn't Trust Ratings From Rating Agencies

    When the U.S. debt was downgraded, what does that really mean?
RELATED TERMS
  1. Enron

    A U.S. energy-trading and utilities company that perpetuated ...
  2. Nigerian Barge Deal

    A 1999 agreement between Enron and Merrill Lynch in which Enron ...
  3. Enronomics

    A fraudulent accounting technique that involves a parent company ...
  4. Special Purpose Vehicle/Entity - SPV/SPE

    1. Also referred to as a "bankruptcy-remote entity" whose operations ...
  5. Off-Balance-Sheet Financing

    A form of financing in which large capital expenditures are kept ...
  6. Accountant's Opinion

    A statement signed by an independent accountant outlining his ...
Hot Definitions
  1. Call Option

    An agreement that gives an investor the right (but not the obligation) to buy a stock, bond, commodity, or other instrument ...
  2. Pro-Rata

    Used to describe a proportionate allocation. A method of assigning an amount to a fraction, according to its share of the ...
  3. Private Placement

    The sale of securities to a relatively small number of select investors as a way of raising capital.
  4. AAA

    The highest possible rating assigned to the bonds of an issuer by credit rating agencies. An issuer that is rated AAA has ...
  5. Backward Integration

    A form of vertical integration that involves the purchase of suppliers. Companies will pursue backward integration when it ...
  6. Pari-passu

    A Latin phrase meaning "equal footing" that describes situations where two or more assets, securities, creditors or obligations ...
Trading Center