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Merrill Lynch Sued Over Trading Unit

Sep 26, 2002 | Washington Post

Allegheny Energy Inc. filed a $1 billion damage suit against Merrill Lynch and Co. yesterday, contending that it overpaid for a Merrill Lynch energy-trading operation last year because of alleged sham deals between Merrill Lynch and Enron Corp.

In its suit, the Maryland energy company cited news reports that Enron and Merrill Lynch's trading unit had arranged round-trip energy transactions that swelled the trading unit's revenue and enabled Enron to add $60 million to its profit in 1999, although no energy was exchanged.

The transactions also boosted the Merrill unit's trading volume and growth rate and allowed Merrill Lynch to value the unit for far more than it was worth in selling it to Allegheny, the company contended.

Allegheny said it was told by Merrill Lynch that the trading unit's net operating revenue had increased from $2.19 million in April 2000 to $7.4 million in June 2000. "This information was consistent with the information provided by Merrill Lynch in the course of their negotiations -- namely, that [the unit's] revenue were increasing and the business was expanding," Allegheny said in its lawsuit.

Merrill Lynch denied yesterday that its trades with Enron, reported last month by the New York Times, were fraudulent.

"The trades we conducted with Enron were legitimate transactions involving real risk," Merrill said in a statement in August. "At no time did Merrill Lynch knowingly assist Enron in misstating revenues."

On Tuesday, Merrill Lynch sued Allegheny Energy to compel it to make a final $115 million payment that was part of the sale of the energy-trading unit.

Allegheny, based in the western Maryland town of Hagerstown, was primarily a regional utility company before moving aggressively into energy trading. Merrill Lynch contends Allegheny Energy's lawsuit is an attempt to offset losses in the collapse of the energy-trading market since Enron's bankruptcy filing last year.

"Allegheny Energy was eager to buy our energy trading business in 2001 when the energy trading markets were doing well," Merrill Lynch said in a statement Tuesday. Allegheny's core business provides electricity and natural gas to 3 million people in parts of Maryland, Ohio, Pennsylvania, Virginia and West Virginia. But along with many other utilities, it expanded into energy trading and unregulated power generation.

"Now that the energy trading market is extremely weak, Allegheny Energy does not want to live up to its agreement and wants Merrill Lynch to bear some of Allegheny Energy's losses," the New York financial services firm said. The contending lawsuits were filed in different courts -- Merrill Lynch's suit is in federal court; Allegheny filed its lawsuit in New York State Supreme Court.

Allegheny paid Merrill Lynch an initial $489 million plus a 2 percent stake in Allegheny's energy-supply subsidiary in March 2001. Allegheny agreed to buy out Merrill Lynch's 2 percent stake for the $115 million if Allegheny did not achieve an agreed-on expansion of its generating business. Merrill's suit seeks to force Allegheny to pay the $115 million because the energy-supply unit didn't expand as provided in the sale contract.

The Allegheny suit seeks to recover the $604 million cost of the acquisition plus other punitive and compensatory damages.

The dispute is the latest setback after Allegheny's leap into deregulated energy markets. The collapse of its energy-trading business has forced Allegheny to downsize and put a number of power plants, trading contracts and other assets up for sale.

Shortly after buying the trading business, Allegheny resold a long-term energy-supply contract -- originally acquired in the Merrill Lynch transaction to California. Allegheny said at the time that the 10-year deal would be worth $4.5 billion. But the contract is among those challenged by California authorities in a dispute pending before the Federal Energy Regulatory Commission.

On Sept. 5, the company fired Daniel L. Gordon, president of its energy-trading unit, Allegheny Energy Supply Co. LLC, for violating conflict-of-interest rules, the company said.

Gordon was head of Merrill Lynch's New York-based energy-trading operation when it was acquired by Allegheny. Gordon could not be reached for comment yesterday.

In July, it reported a loss of $32.3 million (26 cents per share) for the second quarter of 2002, compared with a second-quarter 2001 profit of $115.8 million (97 cents).

Its stock price has plummeted along with those of other energy-marketing companies, from $43.53 on April 23 to a low of $11.73 on Tuesday. Yesterday, its shares closed at $12.39, up 66 cents.

In July, Allegheny said it would eliminate 600 jobs, about 10 percent of its workforce, and cancel two power-plant projects because of the collapse of the energy-trading business after Enron's demise in December 2001.

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