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PNC, Mellon tangled in separate paper jams

| Sunday, June 8, 2003

Pennsylvania's two giant banks -- PNC Financial Services Group and Mellon Financial Corp. -- are coping with a similar problem.

Paper jams.

Mellon's jam stems from paper it shredded -- income-tax forms. PNC's problem surfaced from the paper it shuffled -- accounting documents.

Both problems surfaced in 2001. And neither mess is cleaned up yet.

PNC agreed to pay $115 million last week to avoid a federal criminal trial for securities fraud. The case arose from PNC's illegal accounting maneuver to remove $762 million in sour corporate loans and investments from its books and disguise them as partnerships.

The scandal caused numerous key executives to leave PNC last summer. A class-action lawsuit by angry shareholders is pending. And the U.S. Justice Department could still prosecute PNC in the next 12 months, if it publicly disputes anything in the government's case.

"The analogy with Enron is that both structured partnerships to hold bad assets off the books, but the partnerships were still controlled by the companies that sold them, Enron and PNC," said Walker Todd, a veteran banking attorney formerly with the Federal Reserve Bank of Cleveland.

The difference is that PNC executives did not directly enrich themselves, as did Enron executives.

"I tend to think this is a little bit of overkill. They made a harsh example of PNC," said senior bank analyst Tom McCandless of Keefe Bruyette & Woods Inc. in New York. "Others in the industry had done similar things."

Boston's Fleet Financial Group, for example, sold about $1 billion in bad loans to partnerships in 2001. PNC's mistake was not checking with bank regulators before it moved the bad loans and investments, he said.

PNC spokesman Brian Goerke declined to comment.

A federal grand jury in Pittsburgh is investigating Mellon for shredding income tax returns in 2001. Another probe is underway by the U.S. Senate Finance Committee, which oversees the Internal Revenue Service, which had hired Mellon to process the returns.

"We anticipate bringing legal action in the next several months," said Special Agent Rodney Davis of the U.S. Treasury's Inspector General's office.

Mellon spokesman Ken Herz declined to comment.

In August 2001, Mellon discovered thousands of tax returns and payments mailed from New England had vanished from the IRS processing floor at Mellon's operating complex Downtown.

Federal investigators later determined 71,257 returns and taxpayer checks worth $1.2 billion were lost. Some of the 106 workers fired by Mellon said documents were ditched to keep up with the heavy work flow.

Last November, Mellon paid $18.1 million to the IRS to reimburse the government for interest lost before taxpayers could send replacement checks to the agency, as well as the cost of shifting the tax processing to a Bank One processing center near Philadelphia.

PNC's paper jam, however, may prove even tougher to unclog. Thorny questions still remain.

Why would PNC proceed with the questionable loan sales and partnerships when federal regulators by then, in fall 2001, were stiffening up because of the Enron caper?

What's the name of the unidentified Pittsburgh law firm that gave PNC the legal go-ahead to structure the questionable transactions after law firms in New York and Washington refused to do so, according to the government?

"When I started out in law 30 years ago, it was unseemly and unheard-of to shop for a legal opinion," said attorney Todd. "But some firms are willing to take a fair amount of payment to offer what the corporate client wants to hear."

PNC's accountant at the time, Ernst & Young, back-dated letters that blessed PNC's accounting maneuver, which pushed millions in bad loans off the books.

Back-dating those documents allowed PNC to claim profits in time for quarterly earnings reports to shareholders.

By year-end 2001, PNC racked up extra earnings of $155 million -- until the Federal Reserve stepped in. It ordered PNC to unwind the partnerships and put the bad loans back on the books. The related accounting charge left PNC with annual earnings of $412 million, instead of $567 million.

"Back-dating of accounting documents is a serious matter and will be dealt with seriously by regulators," Todd said.

PNC "did not act alone" in its fraudulent accounting, said the Justice Department. As part of its government settlement, PNC has reserved its right to sue any third party in connection with the accounting scandal.

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