J.P. Morgan ( JPM), its stock up 65% since bottoming at $15 on Oct. 9, is about to see its headline-risk quotient head back into the stratosphere. The stock of the nation's second-largest bank has outpaced both the Dow industrials and the Philadelphia KBW Bank Index since then, in part because the cacophony of negative publicity it faced over the summer had finally quieted down. That run of good luck on the bad news front will very likely end Monday with the beginning of a civil trial in federal court in New York. The case is about J.P. Morgan's attempt to force a group of 11 insurers to honor a $1 billion insurance policy it took out on $3.7 billion in so-called prepay oil and gas contracts the bank arranged for Enron through an off-shore corporation called Mahonia. The insurers, which include Liberty Mutual, Travelers Property & Casualty ( TAPA) and Safeco Insurance ( SAFC), have refused to pay the bank's claim, contending the energy trades were nothing more than a series of "disguised'' bank loans to Enron and not actual contracts to transfer energy shipments. The insurers claim the policy is negated by the alleged fraud on J.P. Morgan's part. But this legal battle is much more than a dispute over the validity of a $1 billion insurance policy. Already in many investors' minds, the Mahonia transactions have tarnished J.P. Morgan's reputation and raised questions about the bank's risk-management strategies and corporate governance procedures. This summer, lawmakers on Capitol Hill, during a highly publicized Senate subcommittee hearing, denounced the Mahonia deals as "sham" transactions and accused J.P. Morgan of helping Enron improperly inflate its revenues. J.P. Morgan repeatedly has denied the lawmakers' allegations and steadfastly maintained that all of its business dealings with Enron were legitimate. But it hasn't helped J.P. Morgan's case that U.S. District Judge Jed Rakoff has consistently sided with the insurers in several pre-trial motions in the case. Just last month, Rakoff ruled the insurers had presented sufficient evidence of fraud by the bank to allow a jury to decide the matter.
The lawyers for the bank and the insurers declined to comment with the case about to start. But several bank investors and legal experts say a defeat for J.P. Morgan would not only result in the bank being forced to take a hefty charge against earnings, but it also could open the bank's vault to dozens of shareholder lawsuits. Indeed, within the past few days, a shareholder has filed a lawsuit claiming J.P. Morgan's management "irreparably damaged" the bank's reputation by approving the Mahonia transactions. J.P. Morgan also is one of the leading defendants in the massive class-action suit filed by Enron's shareholders. And the bank also faces other shareholder suits stemming from the sharp drop in its stock earlier this year after the Mahonia transactions first came to light. It's the threat of endless litigation over the Mahonia deals that some on Wall Street speculate will push J.P. Morgan to settle with the insurers before the jury gets a chance to weigh a flood of embarrassing internal emails and testimony. A settlement in the Mahonia case probably won't be cheap. The insurers, in light of their pretrial victories and all the negative publicity surrounding Enron, feel emboldened and are unlikely to agree to a deal that has them paying anything but a token sum to the bank, sources say. That kind of deal would allow the insurers to keep most of their money, but still permit J.P. Morgan to avoid an adverse ruling. But it also would likely mean a $1 billion charge for J.P. Morgan in the fourth quarter, a writedown that would erase half of the $2.01 billion in net income the bank has posted during the first nine months of this year.