Many institutions and individual investors did not expect their investments in the once-stable energy company Enron to disappear. Others, however, looked to the energy giant for high-risk partnerships with promise of spectacular returns.
The Institute for Advanced Study invested $5 million in an Enron partnership founded in 1999. IAS trustee Leon Levy invested $4 million personally. IAS and Levy are among a few limited partners in the venture.
The House Committee on Energy and Commerce and the Securities and Exchange Commission are investigating the partnership.
The IAS investment in the limited partnership — known as LJM2 — represents about one percent of an endowment that exceeds $400 million.
IAS Treasurer Alan Rowe declined to comment.
IAS was among 51 named limited partners in LJM2. Other partners included Wall Street investors — high net worth individuals like Levy — pension funds like the Arkansas Teacher Retirement System and non-profit foundations like the MacArthur Foundation.
Demand for the partnership, which expected returns exceeding 30 percent per year, far outstripped the original $200 million target. The partnership, which was placed by Merrill Lynch, raised $349 million.
The original prospectus said that LJM2 "expects that Enron will be the Partnership's primary source of investment opportunities." The purpose of the LJM2 partnership was to allow a series of off-balance sheet transactions – guarantees or contracts – with Enron, according to a report prepared by McCullough Research, a research firm analyzing Enron based in Portland, Oregon.
"For this kind of investment, it was only offered to qualified institutions [and individuals,]" said Joe Cohen, spokesman for Merrill Lynch. "It was very high risk, potentially high reward with a significant element of loss."
Merrill Lynch did not create or manage the partnership but was involved in the placement of investors into LJM2, Cohen said.
Economics professor Burton Malkiel '64 said that it was not unusual for nonprofit organizations, like IAS, to buy risky investments as part of a diversified portfolio.
"Clearly Princeton University has done well in doing investments in venture capital," he said. "Putting money into risky investments is not per se a problem."
Initial returns on LJM2 far exceeded the anticipated 30-percent mark.
However, Malkiel said research would have shown some corporate governance problems in LJM2 to investors such as IAS.
"I guess in due diligence that should have been performed by any investor, I would have thought that the obvious conflicts that are involved in the structure should have been at least a red flag," Malkiel said.
At issue is whether Enron executives controlled LJM2. Enron's direct involvement is clouded by the presence of former Enron chief executive Jeffrey Skilling at the October 2000 LJM annual partner meeting. In that document, IAS and Levy are not mentioned.
The prospectus also identified the dual role of Enron Chief Financial Officer Andrew Fastow as a potential conflict of interest. To mitigate this problem, LJM2 provided an advisory committee to review decisions.
"What bothers me about that partnership and about Enron, and the directors of Enron who allowed that sort of thing to happen, is that where you have such an obvious conflict of interest that the chief financial officer of the firm is a principal that to me is prima facie the wrong thing to do," Malkiel said. "I simply cannot understand how directors of Enron and the audit committee of Enron allowed such a thing to happen."
In addition, the original prospectus cited that investors in LJM2 would "benefit from having the opportunity to invest in Enron-generated investment opportunities that would not be available otherwise to outside investors."
Only 11 percent of the partnership funds were invested in non-Enron related ventures, according to the McCullough Research report.
Robert McCullough, the principal in McCullough research, described at least two different categories of investors in LJM2. The first includes individuals and banks that are "deeply involved," he said. Other investors were involved in "stage-dressing."
This group includes investors that "we know are highly respected and not involved in schemes like the MacArthur Foundation," McCullough said.
"We expect IAS is not a group of accounting schemers."
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