Ex-Merrill Lynch energy trader pleads guilty to fraud

At 24, Daniel Gordon headed Merrill Lynch's energy trading business. He has now pleaded guilty to a $43 million fraud.

Daniel Gordon, former head of Merrill Lynch’s Global Energy Markets (GEM) Group, has pleaded guilty to defrauding the company of $43 million. And the US Securities and Exchange Commission (SEC) has also charged Gordon with securities violations in connection with his role in three separate illegal transactions.

Gordon now faces a prison term of 55 years and fines of $1.25 million for the three charges, which include conspiracy to falsify books and records. Gordon also agreed to forfeit the $43 million from illegal profits, during a hearing on 19 December, and is cooperating with prosecutors in their continuing investigation. He also agreed, without admitting or denying the allegations of the SEC complaints, to be barred from serving as an officer or director of a public company.

The SEC’s complaint alleges that in one transaction, Gordon, through an offshore entity he controlled, created and sold a bogus electricity call option to Merrill and pocketed the $43 million option premium, the SEC claims. In the other transaction, Gordon allegedly falsified the earnings figures for his Merrill energy business in an effort to secure a high sales price for the business, which was later sold to Maryland-based Allegheny Energy in December 2001 for $490 million. Allegheny launched a lawsuit against Merrill for fraudulent inducement and breach of contract relating to the sale in September 2002. Last month Allegheny reported a third quarter loss of $51 million, partially due to the poor performance of its energy trading business.

The SEC also alleges that Gordon aided and abetted Enron’s financial fraud by engaging in an energy trade that was designed to overstate Enron’s reported 1999 income by approximately $50 million.

The SEC alleges that, in 2000, Gordon became aware that Merrill sought certain insurance to hedge obligations the Wall Street firm had assumed under a long-term energy contract. Gordon then identified a company that was willing to provide that insurance for a payment by Merrill of $43 million, but the company was, in fact, an Anguilla-domiciled shell company, Falcon Energy Holdings, which Gordon controlled and had created for purposes of providing the insurance.

And the SEC alleges that Gordon and others falsified the earnings figures for Merrill’s GEM business for purposes of making the business more attractive to prospective purchasers. The SEC alleges that Gordon and others inflated GEM’s earnings by creating a false justification for releasing approximately $40 million in reserves and recognising it as income in 2000. The complaint also alleges that Gordon was aware that others at Merrill had also improved GEM’s financials by removing expenses and arbitrarily increasing the business’ 1999 revenue.

The SEC also alleges that in late December 1999 Gordon and others at Merrill entered into an energy transaction with Enron that involved two off-setting electricity call options – one physical and one financial. The SEC says Gordon knew that the two options were “back to back” and “delta-neutral”– essentially a wash trade. Nevertheless, Gordon and others demanded a multi-million dollar fee for entering into the transaction, the SEC alleges, because Enron wanted to complete the transaction by year-end 1999. Enron ultimately agreed to pay Merrill a $17 million fee to close the transaction.

In 2000, Enron approached Gordon and others seeking to unwind the transaction before trading under the off-setting energy options was scheduled to begin. As alleged in the complaint, Gordon learned that Enron had contemplated unwinding the transaction before the transaction had even closed. The deal was unwound in June 2000 after Merrill agreed to reduce its fee to $8.5 million to terminate the transaction. The SEC alleges that Gordon aided and abetted Enron’s violations of the antifraud, reporting, books and records, and internal controls provisions of the federal securities laws in connection with this transaction.

“The decision was made by my superiors to make the business look more profitable by altering certain data,” Gordon said in a statement. His sentencing was set for April 30, 2004 and he was released on $500,000 bail. The former trader said he would testify against others, if necessary, as part of the continuing probe.

A Merrill spokesman failed to return calls seeking comment about Gordon’s allegations that other GEM staff had colluded with him in the fraud.

Merrill is currently in the process of rebuilding an energy trading business. The firm hired Scott Kerson, formerly head of commodity marketing for the Americas at Deutsche Bank in New York, to head up energy marketing in August 2003. And Kuljinder Chase, previously head of energy trading at Allegheny, joined Merrill in May 2003 as head of its natural gas and oil trading business.

Energy Risk