Memorandum of Points and Authorities in Opposition to Motion to ...
Memorandum of Points and Authorities in Opposition to Motion to ...
Memorandum of Points and Authorities in Opposition to Motion to ...
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UNITED STATES DISTRICT COURTSOUTHERN DISTRICT OF TEXASHOUSTON DIVISIONIn re ENRON CORPORATION SECURITIESLITIGATIONThis Document Relates To:MARK NEWBY, et al., Individually <strong>and</strong> OnBehalf <strong>of</strong> All Others Similarly Situated,vs.ENRON CORP., et al.,Pla<strong>in</strong>tiffs,Defendants.THE REGENTS OF THE UNIVERSITY OFCALIFORNIA, et al., Individually <strong>and</strong> OnBehalf <strong>of</strong> All Others Similarly Situated,vs.KENNETH L. LAY, et al.,Pla<strong>in</strong>tiffs,Defendants.§§§§§§§§§§§§§§§§§§§§§§§§§§§§§Civil Action No. H-01-3624(Consolidated)CLASS ACTIONMEMORANDUM OF POINTS AND AUTHORITIES INOPPOSITION TO MOTION TO DISMISS BYCREDIT SUISSE FIRST BOSTON CORPORATION
TABLE OF CONTENTSPageI. INTRODUCTION AND FACTUAL OVERVIEW ................... 1A. Year-End 97 Crisis................................ 3B. The 97-00 Successes – Enron's S<strong>to</strong>ck Soars ................... 4C. The Partnerships <strong>and</strong> SPEs............................10D. Enron Energy Services ("EES") .........................16E. Enron Broadb<strong>and</strong> ("EBS") ............................17F. New Power....................................18G. Hidden/Disguised Loans.............................20H. Enron's Access <strong>to</strong> the Capital Markets......................20I. Late 00/Early 01 Prop-Up ............................22J. The Impend<strong>in</strong>g Collapse .............................23K. The End......................................24II. SUMMARY OF CS FIRST BOSTON'S INVOLVEMENT AND LIABILITY .....30III.IV.DETAILED ALLEGATIONS REGARDING THE INVOLVEMENT OF CSFIRST BOSTON.....................................43CS FIRST BOSTON CAN BE LIABLE UNDER 1934 ACT §10(b) AND RULE10b-5 FOR: (i) MAKING FALSE STATEMENTS, OR (ii) PARTICIPATING INA FRAUDULENT SCHEME OR COURSE OF BUSINESS THAT OPERATEDAS A FRAUD OR DECEIT ON PURCHASERS OF ENRON'S SECURITIES,OR (iii) EMPLOYING ACTS OR MANIPULATIVE DEVICES TO DECEIVE ....57V. CS FIRST BOSTON MADE FALSE AND MISLEADING STATEMENTS INREGISTRATION STATEMENTS AND ANALYST REPORTS ............78VI.VII.CS FIRST BOSTON ACTED WITH SCIENTER, I.E., WITH "THE REQUIREDSTATE OF MIND" AND HAD MOTIVES AND THE OPPORTUNITY TODEFRAUD ENRON INVESTORS, AS IT MADE FALSE STATEMENTS,EMPLOYED DECEPTIVE ACTS AND MANIPULATIVE DEVICES ANDCONTRIVANCES TO DECEIVE AND PARTICIPATED IN A FRAUDULENTSCHEME OR COURSE OF BUSINESS THAT OPERATED AS A FRAUD ORDECEIT ON PURCHASERS OF ENRON SECURITIES ...............97CONCLUSION.....................................118- i -
TABLE OF AUTHORITIESCASESPageAaron v. SEC,446 U.S. 680 (1980) ............................33, 58, 65, 69Adam v. Silicon Valley Bancshares,884 F. Supp. 1398 (N.D. Cal. 1995) ...................60, 69, 100, 101Affiliated Ute Citizens v. United States,406 U.S. 128 (1972) ............................... passimAmerican St<strong>and</strong>ard Credit, Inc. v. National Cement Co.,643 F.2d 248 (5th. Cir. 1981) ..........................112, 114A. T. Brod & Co. v. Perlow,375 F.2d 393 (2d Cir. 1967) ............................33. 63Azrielli v. Cohen Law Offices,21 F.3d 512 (2d Cir. 1994) ...............................71Basic Inc. v. Lev<strong>in</strong>son,485 U.S. 224 (1988) ..............................34, 60, 70Black Law Enforcement Officers Assoc. v. Akron,824 F.2d 475 (6th Cir. 1987) ..............................45Blackie v. Barrack,524 F.2d 891 (9th Cir. 1975) ........................... 67, 100Blumenthal v. United States,332 U.S. 539 (1947) ................................. 101Bryant v. Avado Br<strong>and</strong>s, Inc.,187 F.3d 1271 (11th Cir. 1999) .............................1Burzynski v. Aetna Life Ins. Co.,Civ. No. H-89-3976, 1992 U.S. Dist. LEXIS 21300(S.D. Tex. Mar. 31, 1992) .............................. 113Calliott v. HFS, Inc.,No. 3:97-CV-0924-I, 2000 U.S. Dist. LEXIS 4368(N.D. Tex. Mar. 31, 2000) ................................1Camacho v. Bowl<strong>in</strong>g,562 F. Supp. 1012 (N.D. Ill. 1983) .......................... 113Central Bank, N.A. v. First Interstate Bank, N.A.,511 U.S. 164 (1994) ............................... passim- ii -
- iii -PageChiarella v. United States,445 U.S. 222 (1980) ..................................64Competitive Assocs., Inc. v. Laventhol, Krekste<strong>in</strong>, Horwath & Horwath,516 F.2d 811 (2d Cir. 1975) ........................33, 34, 67, 70Conley v. Gibson,355 U.S. 41 (1957) ..................................1, 43Cooper v. Pickett,137 F.3d 616 (9th Cir. 1998) ............................passimDasho v. Susquehanna Corp.,380 F.2d 262 (7th Cir. 1967) ............................. 102Ernst & Ernst v. Hochfelder,425 U.S. 185 (1976) ............................33, 34, 58, 65F<strong>in</strong>e v. American Solar K<strong>in</strong>g Corp.,919 F.2d 290 (5th Cir. 1990) ..............................35F<strong>in</strong>kel v. Docutel/Olivetti Corp.,817 F.2d 356 (5th Cir. 1987) ............................34, 58Fitzgerald v. Henderson,251 F.3d 345 (2d Cir. 2001) ..............................44Flecker v. Hollywood Entm't Corp.,No. 95-1926-MA, 1997 U.S. Dist. LEXIS 5329(D. Or. Feb. 12 1997) ..............................40, 72, 73Harris v. United States,48 F.2d 771 (9th Cir. 1931) ..............................69Hellenic Inc. v. Bridgel<strong>in</strong>e Gas Distrib. LLC,252 F.3d 391 (5th Cir. 2001) ............................. 112Heller v. Am. Indus. Props. Reit,Civ. No. SA-97-CA-1315-EP, 1998 U.S. Dist. LEXIS 23286(W.D. Tex. Sept. 25, 1998) ...............................59Herman & MacLean v. Huddles<strong>to</strong>n,459 U.S. 375 (1983) ..................................31Hill v. Hanover Energy, Inc.,Civ. No. 91-1964(JHG) 1991 U.S. Dist. LEXIS 18566(D.D.C. Dec. 16, 1991) .................................68Hundahl v. United Ben. Life Ins. Co.,465 F. Supp. 1349 (N.D. Tex. 1979) ........................76, 77In re Boe<strong>in</strong>g Sec. Litig.,40 F. Supp. 2d 1160 (W.D. Wash. 1998) .........................1
PageIn re Cascade Int'l Sec. Litig.,840 F. Supp. 1558 (S.D. Fla. 1993) ........................40, 75In re Commonwealth Oil/Tesoro Petroleum Sec. Litig.,484 F. Supp. 253 (W.D. Tex. 1979) ........................76, 77In re Health Mgmt. Inc. Sec. Litig.,970 F. Supp. 192 (E.D.N.Y. 1997) ........................ 60, 100In re Honeywell Int'l Secs. Litig.,182 F. Supp. 2d 414 (D.N.J. 2002) ............................2In re L<strong>and</strong>ry's Seafood Restaurants, Inc. Sec. Litig.,No. H-99-1948 (S.D. Tex. Feb. 20, 2001) ....................passimIn re Livent, Inc.,174 F. Supp. 2d 144 (S.D.N.Y. 2001) ...................... passimIn re Nissan Mo<strong>to</strong>r Corp. Antitrust Litig.,430 F. Supp. 231 (S.D. Fla. 1977) .......................... 102In re Sec. Litig. BMC S<strong>of</strong>tware, Inc.,183 F. Supp. 2d 860 (S.D. Tex. 2001) ...................... passimIn re S<strong>of</strong>tware Toolworks Sec. Litig.,50 F.3d 615 (N.D. Cal. 1995) ............................ 101In re Union Carbide Corp. Consumer Products Bus<strong>in</strong>ess Sec. Litig.,676 F. Supp. 458 (S.D.N.Y. 1987) ...........................69In re Waste Mgmt, Inc. Sec. Litig.,Civ. No. H-99-2183 (S.D. Tex., Aug. 16, 2001) ..................36, 61In re ZZZZ Best Sec. Litig.,864 F. Supp. 960 (C.D. Cal. 1994) .........................passimInl<strong>and</strong> Freight L<strong>in</strong>es v. United States,191 F.2d 313 (10th Cir. 1951) ............................ 113Lawal v. British Airways, PLC,812 F. Supp. 713 (S.D. Tex. 1992) ..........................1, 43Lemmer v. Nu-Kote Hold<strong>in</strong>g, Inc.,Civ. No. 3:98-CV-0161-L, 2001 U.S. Dist. LEXIS 13978(N.D. Tex. Sept. 6, 2001) ..........................100, 103, 104Lip<strong>to</strong>n v. Documation, Inc.,734 F.2d 740 (11th Cir. 1984) .............................70Little v. United States,73 F.2d 861 (10th Cir. 1934) ..............................44- iv -
PageMcNamara v. Bre-X-M<strong>in</strong>erals Ltd.,No 5:97-CV-159, 2001 U.S. Dist. LEXIS 4571(E.D. Tex. Mar. 30, 2001) .............................40, 75Meason v. Bank <strong>of</strong> Miami,652 F.2d 542 (5th Cir. 1981) ............................37, 62Murphy v. Hollywood Entm't Corp.,No. 95-1926-MA, 1996 U.S. Dist. LEXIS 22207(D. Or. May 9, 1996) ..............................40, 72, 95Nathenson v. Zonagen Inc.,267 F.3d 400 (5th Cir. 2001) ........................... 43, 100Paul F. New<strong>to</strong>n & Co. v. Texas Commerce Bank,630 F.2d 1111 (5th Cir. 1980) ...........................37, 62Richardson v. MacArthur,451 F.2d 35 (10th Cir. 1971) ........................... 67, 100Riss & Company v. United States,262 F.2d 245 (8th Cir. 1958) ............................. 113Rub<strong>in</strong>ste<strong>in</strong> v. Coll<strong>in</strong>s,20 F.3d 160 (5th Cir. 1994) ...............................1SEC v. Capital Ga<strong>in</strong>s Research Bureau Inc.,375 U.S. 180 (1963) ............................... 63, 100SEC v. First Jersey Secs.,101 F.3d 1450 (2d Cir. 1996) ........................... passimSEC v. National Bankers Life Ins. Co.,324 F. Supp. 189 (N.D. Tex.),aff'd, 448 F.2d 652 (5th Cir. 1971) ........................101, 102SEC v. Seaboard Corp.,677 F.2d 1301 (9th Cir. 1982) .............................67SEC v. U.S. Envtl., Inc.,155 F.3d 107 (2d Cir. 1998) ............................40, 76STI Classic Fund v. Boll<strong>in</strong>ger Indus., Inc.,No. 3-96-CV-823-R, 1996 U.S. Dist. LEXIS 21553(N.D. Tex. Oct. 25, 1996) ...............................43Santa Fe Indus., Inc. v. Green,430 U.S. 462 (1977) ................................passimScheuer v. Rhodes,416 U.S. 232 (1974) .................................1, 43- v -
PageSchlick v. Penn-Dixie Cement Corp.,507 F.2d 374 (2d Cir. 1974) ............................. 102Scholnick v. Cont<strong>in</strong>ental Bank,752 F. Supp. 1317 (E.D. Mich. 1990) .......................41, 76Schreiber v. Burl<strong>in</strong>g<strong>to</strong>n Northern, Inc.,568 F. Supp. 197 (D. Del. 1983) ..........................76, 77Shores v. Sklar,647 F.2d 462 (5th Cir. 1981) ........................... passimSt<strong>and</strong>ard Oil Co. v. United States,307 F.2d 120 (5th Cir. 1962) ............................. 112Steere Tank L<strong>in</strong>es, Inc. v. United States,330 F.2d 719 (5th Cir. 1964) ...........................113, 114Summit Props. v. Hoechst Celanese Corp.,214 F.3d 556 (5th Cir. 2000),cert. denied, 531 U.S. 1132 (2001) ...........................34Super<strong>in</strong>tendent <strong>of</strong> Ins. v. Bankers Life & Cas. Co.,404 U.S. 6 (1971) ................................33, 36, 63Tuchman v. DSC Communications Corp.,818 F. Supp. 971 (N.D. Tex. 1993),aff'd, 14 F.3d 1061 (5th Cir. 1994) ............................1U.S. Quest, Ltd. v. Kimmons,228 F.3d 399 (5th Cir. 2000) ............................33, 58United States v. Alvarez,625 F.2d 1196 (5th Cir. 1980) ..........................100, 101United States v. Ashdown,509 F.2d 793 (5th Cir. 1975) ..............................44United States v. Bank <strong>of</strong> New Engl<strong>and</strong>, N.A.,821 F.2d 844 (1st Cir. 1987) ............................. 113United States v. Blosser,440 F.2d 697 (10th Cir. 1971) .............................44United States v. Craig,573 F.2d 455 (7th Cir. 1977) ...........................100, 101United States v. Elam,678 F.2d 1234 (5th Cir. 1982) ............................ 101United States v. Garv<strong>in</strong>,565 F.2d 519 (8th Cir. 1977) ..............................45- vi -
- vii -PageUnited States v. Hask<strong>in</strong>s,737 F.2d 844 (10th Cir. 1984) .............................44United States v. Humphrey,104 F.3d 65 (5th Cir. 1997) ............................. 101United States v. Lanier,838 F.2d 281 (8th Cir. 1988) ............................. 101United States v. Lothian,976 F.2d 1257 (9th Cir. 1992) ............................ 101United States v. Marconi,899 F. Supp. 458 (C.D. Cal. 1995) ...........................44United States v. Maxwell,920 F.2d 1028 (D.C. Cir. 1990) ........................... 101United States v. O'Hagan,521 U.S. 642 (1997) ..............................35, 61, 65United States v. Read,658 F.2d 1225 (7th Cir. 1981) ............................ 101United States v. Richmond,700 F.2d 1183 (11th Cir. 1983) ........................... 113United States v. Sawyer Transport, Inc.,337 F. Supp. 29 (D. M<strong>in</strong>n. 1971),aff'd, 463 F.2d 175 (8th Cir. 1972) .......................... 113United States v. T.I.M.E.-D.C., Inc.,381 F. Supp. 730 (W.D. W.Va. 1974) ........................ 113United States v. Whitt,718 F.2d 1494 (10th Cir. 1983) ............................44United States v. Wieh<strong>of</strong>f,748 F.2d 1158 (7th Cir. 1984) ............................ 101United States v. Wilshire Oil Co.,427 F.2d 969 (10th Cir. 1970) ............................ 114Young v. Nationwide Life Ins. Co.,2 F. Supp. 2d 914 (S.D. Tex. 1998) ...........................1Zuckerman v. Foxmeyer Health Corp.,4 F. Supp. 2d 618 (N.D. Tex. 1998) ...........................1STATUTES, RULES AND REGULATIONS15 U.S.C.§77k ........................................ 74, 106
Page§78a ............................................3§78j(b) .......................................passim§78m(a) .........................................95§78u-4 .........................................3718 U.S.C.§1341 ......................................... 101Federal Rules <strong>of</strong> Civil ProcedureRule 8...........................................2Rule 12(b)(6)....................................43, 9517 C.F.R.§240.10b-5 ....................................passimSECONDARY AUTHORITIESRestatement (Second) <strong>of</strong> Torts (1979)§875 .......................................... 102§876 .......................................... 102§876(a) ........................................ 102LEGISLATIVE HISTORY141 Cong. Rec. H. 13691 (daily ed. Nov. 28, 1995) ...................... 42- viii -
I. INTRODUCTION AND FACTUAL OVERVIEW 1In the face <strong>of</strong> a 500-page compla<strong>in</strong>t alleg<strong>in</strong>g the largest <strong>and</strong> worst securities fraud <strong>in</strong> thehis<strong>to</strong>ry <strong>of</strong> the United States 2 <strong>in</strong> excruciat<strong>in</strong>g detail, every s<strong>in</strong>gle defendant – Enron's <strong>in</strong>siders, Enron'soutside direc<strong>to</strong>rs, Enron's accountants, Enron's lawyers <strong>and</strong> Enron's bankers – has moved <strong>to</strong> dismiss.Some claim it is <strong>to</strong>o detailed. Some claim it is not detailed enough. Everyone denies responsibility<strong>and</strong> not one defendant has seen fit <strong>to</strong> answer. Every defendant seeks <strong>to</strong> avoid accountability byrais<strong>in</strong>g technical plead<strong>in</strong>g arguments based on the Private Securities Litigation Reform Act <strong>of</strong> 1995("95 Act") which was meant <strong>to</strong> deter the fil<strong>in</strong>g <strong>of</strong> frivolous suits – which everyone knows, exceptapparently the defendants, this case is not. While it does appear that the 95 Act was successful, atleast <strong>in</strong> this case, <strong>in</strong> deterr<strong>in</strong>g pla<strong>in</strong>tiffs' securities lawyers from fil<strong>in</strong>g cookie-cutter compla<strong>in</strong>ts, it1Because any changes <strong>to</strong> the plead<strong>in</strong>g requirements were not <strong>in</strong>tended <strong>to</strong> prevent aggrievedparties from obta<strong>in</strong><strong>in</strong>g redress for their valid claims, "courts still apply Rule 12(b)(6) pr<strong>in</strong>ciples <strong>to</strong>motions <strong>to</strong> dismiss securities class action cases." In re Boe<strong>in</strong>g Sec. Litig., 40 F. Supp. 2d 1160, 1166(W.D. Wash. 1998) (collect<strong>in</strong>g cases); see also Bryant v. Avado Br<strong>and</strong>s, Inc., 187 F.3d 1271, 1273n.1 (11th Cir. 1999). Consequently, the court must accept as true all well-pleaded allegations <strong>in</strong> thecompla<strong>in</strong>t <strong>and</strong> construe them <strong>in</strong> the light most favorable <strong>to</strong> pla<strong>in</strong>tiff. Scheuer v. Rhodes, 416 U.S.232 (1974); Calliott v. HFS, Inc., No. 3:97-CV-0924-I, 2000 U.S. Dist. LEXIS 4368, at *8 (N.D.Tex. Mar. 31, 2000); Zuckerman v. Foxmeyer Health Corp., 4 F. Supp. 2d 618, 621 (N.D. Tex.1998) (Maloney, J.) (stress<strong>in</strong>g that "the compla<strong>in</strong>t is <strong>to</strong> be liberally construed <strong>in</strong> favor <strong>of</strong> thepla<strong>in</strong>tiff"); Young v. Nationwide Life Ins. Co., 2 F. Supp. 2d 914, 919 (S.D. Tex. 1998); Lawal v.British Airways, PLC, 812 F. Supp. 713, 716 (S.D. Tex. 1992). "A motion <strong>to</strong> dismiss for failure <strong>to</strong>state a claim under Fed. R. Civ. P. 12(b)(6) 'is viewed with disfavor <strong>and</strong> is rarely granted.'" Calliott,2000 U.S. Dist. LEXIS 4368, at *7. (Unless otherwise noted, all emphasis is added <strong>and</strong> footnotes<strong>and</strong> citations are omitted.) Dismissal is appropriate only if it appears that no relief could be grantedunder any set <strong>of</strong> facts that could be proven consistent with the allegations. Rub<strong>in</strong>ste<strong>in</strong> v. Coll<strong>in</strong>s, 20F.3d 160, 166 (5th Cir. 1994) (cit<strong>in</strong>g Conley v. Gibson, 355 U.S. 41, 45-46 (1957)); Tuchman v. DSCCommunications Corp., 818 F. Supp. 971, 974 (N.D. Tex. 1993), aff'd, 14 F.3d 1061 (5th Cir. 1994);Calliott, 2000 U.S. Dist. LEXIS 4368, at *3.Pla<strong>in</strong>tiffs apologize for the length <strong>and</strong> repetition <strong>in</strong>volved <strong>in</strong> respond<strong>in</strong>g <strong>to</strong> motions <strong>to</strong> dismissfiled by each <strong>of</strong> the n<strong>in</strong>e banks sued as defendants. However, s<strong>in</strong>ce the banks <strong>in</strong>sisted, as was theirright, <strong>to</strong> move <strong>to</strong> dismiss separately <strong>and</strong> because they have chosen <strong>to</strong> either ignore or grosslymischaracterize the allegations aga<strong>in</strong>st them <strong>in</strong> the 500-page Consolidated Compla<strong>in</strong>t ("CC") –apparently <strong>in</strong> the hope that the Court will not be able <strong>to</strong> f<strong>in</strong>d <strong>and</strong> focus on those allegations –pla<strong>in</strong>tiffs had no choice but <strong>to</strong> respond separately as <strong>to</strong> each <strong>of</strong> the banks <strong>and</strong> set forth <strong>in</strong> detail theactual allegations made aga<strong>in</strong>st the banks <strong>in</strong> the CC. After all, pla<strong>in</strong>tiffs are entitled <strong>to</strong> have theadequacy <strong>of</strong> their CC aga<strong>in</strong>st the banks determ<strong>in</strong>ed based on the actual allegations <strong>of</strong> the CC, notdefendants' mischaracterization <strong>of</strong> them.2See John C. C<strong>of</strong>fee, Jr., "Guard<strong>in</strong>g the Gatekeepers," New York Times, 5/13/02, at A19(referr<strong>in</strong>g <strong>to</strong> Enron as a "[m]ajor debacle[] <strong>of</strong> his<strong>to</strong>ric dimensions").- 1 -
• Enron had very strong momentum. Its new trends were susta<strong>in</strong>able <strong>and</strong> wouldaccelerate.• Enron's bus<strong>in</strong>ess was boom<strong>in</strong>g. All its operations were ga<strong>in</strong><strong>in</strong>g momentum.• Inves<strong>to</strong>rs were about <strong>to</strong> see breakout performance for EES <strong>and</strong> rapid growth <strong>and</strong>development <strong>of</strong> EBS.• EES's new contracts <strong>and</strong> pr<strong>of</strong>itability were accelerat<strong>in</strong>g. EES had the potential <strong>to</strong>double Enron's size <strong>in</strong> a few years.• EBS trad<strong>in</strong>g was accelerat<strong>in</strong>g. The market was larger than expected, <strong>and</strong> wouldreach $100 billion <strong>in</strong> a few years with 3%-4% marg<strong>in</strong>s.• Enron/Blockbuster video-on-dem<strong>and</strong> ("VOD") deal a "killer app." Unparalleledquality <strong>of</strong> service. Contract worth over $1 billion. VOD <strong>to</strong> rollout nationally <strong>in</strong> 01.All components <strong>in</strong> place. VOD had solid technology <strong>and</strong> platform.• Enron's WEOS merchant <strong>in</strong>vestments were protected through hedg<strong>in</strong>g.• Enron had monumental earn<strong>in</strong>gs potential over the next five years. Enron was wellmanaged <strong>and</strong> a pioneer <strong>in</strong> global energy. Enron was never <strong>in</strong> better shape. Enronwas very optimistic about the cont<strong>in</strong>ued strong outlook for the Company.• Growth <strong>and</strong> strong earn<strong>in</strong>gs were why <strong>in</strong>ves<strong>to</strong>rs should buy Enron s<strong>to</strong>ck.As a result <strong>of</strong> Enron's strong earn<strong>in</strong>gs, the positive statements about its bus<strong>in</strong>ess <strong>and</strong> theforecasts <strong>of</strong> cont<strong>in</strong>u<strong>in</strong>g strong earn<strong>in</strong>gs growth, Enron's s<strong>to</strong>ck was a very strong performer <strong>and</strong> itsdebt securities also traded at high prices. 15. Enron's apparent success <strong>and</strong> forecasts <strong>of</strong> strongpr<strong>of</strong>it growth gave Enron <strong>and</strong> its bankers ready access <strong>to</strong> the capital markets by which they raisedbillions <strong>of</strong> dollars by sell<strong>in</strong>g newly issued Enron securities <strong>to</strong> public <strong>in</strong>ves<strong>to</strong>rs, us<strong>in</strong>g the proceeds<strong>to</strong> repay Enron's bank debt. 16. Enron's s<strong>to</strong>ck soared <strong>to</strong> its all-time high <strong>of</strong> $90-3/4 <strong>in</strong> 8/00 <strong>and</strong>then cont<strong>in</strong>ued <strong>to</strong> trade at or near this level for months, as shown below (15):- 6 -
Enron CorporationDaily Share Prices From 1/2/97 - 11/10/0040010090350Dollars Per Share [adjusted for 8/13/99 2 for 1 s<strong>to</strong>ck split]807060504030EnronPeerGroup30025020015010010/19/98=1002010/19/98Start <strong>of</strong> Class Period01/02/199707/21/199702/05/199808/24/199803/12/199909/28/199904/13/200011/10/200004/11/199710/27/199705/15/199812/01/199806/21/199901/05/200007/24/200050However, the apparent success <strong>of</strong> Enron was an illusion – a false picture created bycontrivances <strong>and</strong> deceptive acts – a fraudulent scheme <strong>and</strong> course <strong>of</strong> bus<strong>in</strong>ess that operated as a fraud<strong>and</strong> deceit on the purchasers <strong>of</strong> Enron's publicly traded securities. The fraudulent scheme wasaccomplished by Enron <strong>and</strong>, <strong>in</strong>ter alia, several banks, <strong>in</strong>clud<strong>in</strong>g CS First Bos<strong>to</strong>n, which pocketedhundreds <strong>of</strong> millions <strong>of</strong> dollars a year from Enron – which by 97-98 had become the golden goose<strong>of</strong> Wall Street. 17.Inside Enron there was a fixation on Enron's s<strong>to</strong>ck <strong>and</strong> do<strong>in</strong>g whatever was required <strong>to</strong>generate the f<strong>in</strong>ancial results necessary <strong>to</strong> push the s<strong>to</strong>ck ever higher. Throughout Enron's corporateheadquarters <strong>in</strong> Hous<strong>to</strong>n were TV moni<strong>to</strong>rs that displayed the price <strong>of</strong> Enron s<strong>to</strong>ck. Inside Enronthere was a say<strong>in</strong>g that managers were <strong>to</strong> be "ABC<strong>in</strong>g," mean<strong>in</strong>g <strong>to</strong> "always be clos<strong>in</strong>g" deals <strong>to</strong>generate revenues <strong>and</strong> pr<strong>of</strong>its, even if the economics <strong>of</strong> the deal were suspect – a practice facilitatedby a compensation system <strong>in</strong>side Enron for corporate managers <strong>and</strong> executives that directly rewardedthem f<strong>in</strong>ancially for clos<strong>in</strong>g transactions <strong>and</strong> plac<strong>in</strong>g a high (i.e., <strong>in</strong>flated) value on them, regardless<strong>of</strong> the true economic substance <strong>of</strong> the deal, so long as the deal generated an apparent pr<strong>of</strong>it when"marked <strong>to</strong> market." 50.- 7 -
Inside Enron, the pressures applied <strong>to</strong> corporate managers by the <strong>to</strong>p executives <strong>to</strong> doanyth<strong>in</strong>g necessary <strong>to</strong> enable Enron <strong>to</strong> make its numbers was widespread, as was the knowledge thatEnron's revenues <strong>and</strong> earn<strong>in</strong>gs were be<strong>in</strong>g falsified. Former <strong>in</strong>siders have been quoted as say<strong>in</strong>g"[y]ou don't object <strong>to</strong> anyth<strong>in</strong>g" <strong>and</strong> "[t]he whole culture at the vice-president level <strong>and</strong> above justbecame a yes-man culture."But that culture had a negative side beyond the <strong>in</strong>bred arrogance. Greed wasevident, even <strong>in</strong> the early days. "More than anywhere else, they talked about howmuch money we would make," says someone who worked for Skill<strong>in</strong>g.Compensation plans <strong>of</strong>ten seemed oriented <strong>to</strong>ward enrich<strong>in</strong>g executives ratherthan generat<strong>in</strong>g pr<strong>of</strong>its for shareholders. For <strong>in</strong>stance, <strong>in</strong> Enron's energy servicesdivision, which managed the energy needs <strong>of</strong> large companies like Eli Lilly,executives were compensated based on a market valuation formula that relied on<strong>in</strong>ternal estimates. As a result, says one former executive, there was pressure <strong>to</strong>,<strong>in</strong> effect, <strong>in</strong>flate the value <strong>of</strong> the contracts – even though it had no impact on theactual cash that was generated.Fortune, 12/24/01 (51)."If your boss was [fudg<strong>in</strong>g], <strong>and</strong> you have never worked anywhere else, you justassume that everybody fudges earn<strong>in</strong>gs," says one young Enron control person."Once you get there <strong>and</strong> you realized how it was, do you st<strong>and</strong> up <strong>and</strong> lose yourjob? It was scary. It was easy <strong>to</strong> get <strong>in</strong><strong>to</strong> 'Well, everybody else is do<strong>in</strong>g it, so maybeit isn't so bad.'"* * *The flaw only grew more pronounced as Enron struggled <strong>to</strong> meet the wildlyoptimistic expectations for growth it had set for itself. "You've got someone at the<strong>to</strong>p say<strong>in</strong>g the s<strong>to</strong>ck price is the most important th<strong>in</strong>g, which is driven byearn<strong>in</strong>gs," says one <strong>in</strong>sider. "Whoever could provide earn<strong>in</strong>gs quickly would bepromoted."The employee adds that anyone who questioned suspect deals quicklylearned <strong>to</strong> accept assurances <strong>of</strong> outside lawyers <strong>and</strong> accountants. She says therewas little scrut<strong>in</strong>y <strong>of</strong> whether the earn<strong>in</strong>gs were real or how they were booked. Themore people pushed the envelope with aggressive account<strong>in</strong>g, she says, the harderthey would have <strong>to</strong> push the next year. "It's like be<strong>in</strong>g a hero<strong>in</strong> junkie," she said."How do you go cold turkey?"Bus<strong>in</strong>ess Week, 2/25/02 (51). In fact, <strong>in</strong> mid-8/01, an Enron executive wrote Lay, tell<strong>in</strong>g him thatthe Company was "noth<strong>in</strong>g but an elaborate account<strong>in</strong>g hoax," <strong>and</strong>, <strong>in</strong> referr<strong>in</strong>g <strong>to</strong> special purposeentity ("SPE") transactions, which CS First Bos<strong>to</strong>n had designed <strong>and</strong> structured <strong>and</strong> CS FirstBos<strong>to</strong>n executives were fund<strong>in</strong>g, noted that noth<strong>in</strong>g "will protect Enron if these transactions areever disclosed <strong>in</strong> the bright light <strong>of</strong> day" – warn<strong>in</strong>g that many employees believed "[W]e're sucha crooked company." 51.- 8 -
By 97-98, Enron was a hall <strong>of</strong> mirrors <strong>in</strong>side a house <strong>of</strong> cards – report<strong>in</strong>g hundreds <strong>of</strong>millions <strong>of</strong> dollars <strong>of</strong> phony pr<strong>of</strong>its while conceal<strong>in</strong>g billions <strong>of</strong> dollars <strong>of</strong> debt that should have beenon its balance sheet, <strong>in</strong>flat<strong>in</strong>g its shareholder equity by billions <strong>of</strong> dollars. Enron had turned <strong>in</strong><strong>to</strong> thelargest Ponzi scheme <strong>in</strong> his<strong>to</strong>ry – constantly rais<strong>in</strong>g fresh money by sell<strong>in</strong>g its securities or those <strong>of</strong>related entities, while appear<strong>in</strong>g <strong>to</strong> achieve successful growth <strong>and</strong> pr<strong>of</strong>its. But, because Enron'sreported pr<strong>of</strong>its were be<strong>in</strong>g generated by phony, non-arm's-length transactions <strong>and</strong> improperaccount<strong>in</strong>g tricks – <strong>in</strong>clud<strong>in</strong>g the abuse <strong>of</strong> "mark-<strong>to</strong>-market" account<strong>in</strong>g 7 <strong>to</strong> accelerate the recognition<strong>of</strong> hundreds <strong>of</strong> millions <strong>of</strong> dollars <strong>of</strong> pr<strong>of</strong>its <strong>to</strong> current periods from transactions <strong>in</strong> which Enron wasonly entitled <strong>to</strong> receive cash over many future years – Enron was cash starved. Yet <strong>to</strong> cont<strong>in</strong>ue <strong>to</strong>report grow<strong>in</strong>g pr<strong>of</strong>its, Enron was forced not only <strong>to</strong> cont<strong>in</strong>ue <strong>to</strong> engage <strong>in</strong> such transactions <strong>and</strong>account<strong>in</strong>g abuses, but <strong>to</strong> accelerate the number <strong>and</strong> size <strong>of</strong> such transactions it engaged <strong>in</strong>. Thiscreated a vicious cycle further exacerbat<strong>in</strong>g Enron's need <strong>to</strong> obta<strong>in</strong> cash from these transactions. Tomake matters worse, with the help <strong>of</strong> CS First Bos<strong>to</strong>n <strong>and</strong> other <strong>of</strong> its banks, Enron had capitalizedentities it was do<strong>in</strong>g phony deals with (<strong>in</strong>clud<strong>in</strong>g deals designed by CS First Bos<strong>to</strong>n <strong>and</strong> funded byit <strong>and</strong> its executives via the LJM2 partnerships), with shares <strong>of</strong> Enron s<strong>to</strong>ck <strong>and</strong> had agreed <strong>to</strong> issuemillions <strong>and</strong> millions <strong>of</strong> additional shares <strong>of</strong> its s<strong>to</strong>ck <strong>to</strong> these entities if Enron's s<strong>to</strong>ck price fellbelow certa<strong>in</strong> "trigger prices," i.e., $83, $81, $79, $68, $60, $57, $52, $48, $34 <strong>and</strong> $19 per share,<strong>and</strong> <strong>to</strong> become liable for the debt <strong>of</strong> those entities if Enron lost its <strong>in</strong>vestment grade credit rat<strong>in</strong>g.7Enron engaged <strong>in</strong> several account<strong>in</strong>g tricks <strong>and</strong> manipulations <strong>to</strong> falsify its f<strong>in</strong>ancial resultsdur<strong>in</strong>g the Class Period. Chief among these was the abuse <strong>of</strong> "mark-<strong>to</strong>-market account<strong>in</strong>g,"whereby Enron computed the purported pr<strong>of</strong>it it would ultimately obta<strong>in</strong> on a multi-year contract,discount that <strong>to</strong> present value <strong>and</strong> recognize the entire "mark-<strong>to</strong>-market" pr<strong>of</strong>it <strong>in</strong> the current period.Enron misused <strong>and</strong> abused mark-<strong>to</strong>-market account<strong>in</strong>g throughout its entire bus<strong>in</strong>ess <strong>to</strong> grossly<strong>in</strong>flate its reported revenues <strong>and</strong> pr<strong>of</strong>its. In Enron's WEOS bus<strong>in</strong>ess this was done by assign<strong>in</strong>gunrealistic values <strong>to</strong> wholesale energy transactions which <strong>in</strong>flated current period <strong>in</strong>come. In Enron'sEES bus<strong>in</strong>ess, where Enron had no long-term track record <strong>to</strong> justify the use <strong>of</strong> mark-<strong>to</strong>-marketaccount<strong>in</strong>g, Enron nevertheless consistently utilized mark-<strong>to</strong>-market account<strong>in</strong>g <strong>to</strong> record hugecurrent period pr<strong>of</strong>its on long-term, highly speculative retail energy risk-management contractswhich, <strong>in</strong> fact, Enron had no basis <strong>to</strong> project a pr<strong>of</strong>it on <strong>and</strong> knew would likely result <strong>in</strong> losses.F<strong>in</strong>ally, <strong>in</strong> Enron's EBS bus<strong>in</strong>ess – also a new bus<strong>in</strong>ess where Enron had absolutely no track recordwhich would justify the use <strong>of</strong> mark-<strong>to</strong>-market account<strong>in</strong>g – Enron utilized mark-<strong>to</strong>-marketaccount<strong>in</strong>g <strong>to</strong> generate hundreds <strong>of</strong> millions <strong>of</strong> dollars <strong>of</strong> phony current period pr<strong>of</strong>its <strong>in</strong> severaltransactions. Also, when review<strong>in</strong>g those computations on a quarterly basis as it was required <strong>to</strong> do,Enron consistently <strong>in</strong>creased the estimated value <strong>of</strong> the transaction even though subsequent datarevealed a reduction <strong>of</strong> the estimated value <strong>of</strong> the transaction, a practice known with<strong>in</strong> Enron as"mov<strong>in</strong>g the curve." 36.- 9 -
Because <strong>of</strong> the "triggers" <strong>and</strong> the way Enron capitalized these entities, it was absolutely vital <strong>to</strong>Enron, CS First Bos<strong>to</strong>n <strong>and</strong> the other participants <strong>in</strong> the fraudulent scheme <strong>and</strong> course <strong>of</strong> bus<strong>in</strong>essthat Enron's s<strong>to</strong>ck cont<strong>in</strong>ue <strong>to</strong> trade at high levels <strong>and</strong> that Enron ma<strong>in</strong>ta<strong>in</strong> its "<strong>in</strong>vestment grade"credit rat<strong>in</strong>g, otherwise the scheme would unravel. 18, 20. 8Enron became completely dependent on ma<strong>in</strong>ta<strong>in</strong><strong>in</strong>g its <strong>in</strong>vestment grade credit rat<strong>in</strong>g <strong>and</strong>a high s<strong>to</strong>ck price so that Enron could cont<strong>in</strong>ue <strong>to</strong> have access <strong>to</strong> the capital markets <strong>to</strong> borrowbillions <strong>in</strong> commercial paper <strong>and</strong> <strong>to</strong> enable it <strong>to</strong> periodically raise hundreds <strong>of</strong> millions <strong>of</strong> dollars<strong>of</strong> new longer term capital it needed <strong>to</strong> repay its commercial paper debt <strong>and</strong> the short-term loansit was receiv<strong>in</strong>g from its banks – <strong>in</strong>clud<strong>in</strong>g CS First Bos<strong>to</strong>n – <strong>to</strong> susta<strong>in</strong> its bus<strong>in</strong>ess operations<strong>and</strong> so the s<strong>to</strong>ck issuance "triggers" would not be hit, which would force Enron <strong>in</strong><strong>to</strong> a deathspiral. 20.C. The Partnerships <strong>and</strong> SPEsTo falsify Enron's reported f<strong>in</strong>ancial results, Enron <strong>and</strong> its banks – <strong>in</strong>clud<strong>in</strong>g CS First Bos<strong>to</strong>n– engaged <strong>in</strong> a series <strong>of</strong> purported "partnership" <strong>and</strong> "related party" transactions with the entitiesknown as SPEs. A public company that conducts bus<strong>in</strong>ess with an SPE may treat that SPE as if itwere an <strong>in</strong>dependent entity only if it does not control the SPE. And, at a bare m<strong>in</strong>imum, two otherconditions must be met: (i) an <strong>in</strong>dependent party must make an equity <strong>in</strong>vestment <strong>of</strong> at least 3% <strong>of</strong>the SPE's assets, which must rema<strong>in</strong> at risk throughout the transaction; <strong>and</strong> (ii) the <strong>in</strong>dependentparty must exercise control <strong>of</strong> the SPE. 21.8Enron's <strong>in</strong>vestment grade credit rat<strong>in</strong>g was <strong>in</strong>dispensable. As Enron's CFO stated <strong>in</strong> a 10/01conference call: "We underst<strong>and</strong> that our credit rat<strong>in</strong>g is critical <strong>to</strong> both the capital markets as wellas our counterparties." Earlier, Fas<strong>to</strong>w stated <strong>to</strong> CFO Magaz<strong>in</strong>e: "My credit rat<strong>in</strong>g is strategicallycritical." This <strong>in</strong>vestment grade credit rat<strong>in</strong>g gave Enron access <strong>to</strong> the commercial paper market –a market reserved for America's largest <strong>and</strong> most creditworthy corporations – so that it could borrowbillions <strong>of</strong> dollars <strong>to</strong> ma<strong>in</strong>ta<strong>in</strong> its liquidity <strong>and</strong> f<strong>in</strong>ance its capital-<strong>in</strong>tensive bus<strong>in</strong>ess. Enron's access<strong>to</strong> the commercial paper market also meant that Enron's $3 billion commercial paper back-up creditl<strong>in</strong>e, arranged by the lead banks (J.P. Morgan <strong>and</strong> CitiGroup) with CS First Bos<strong>to</strong>n as a participat<strong>in</strong>gbank, would likely not be drawn down upon, thus limit<strong>in</strong>g those banks' f<strong>in</strong>ancial exposure <strong>to</strong> Enron.It also meant that Enron <strong>and</strong> its banks could easily sell debt securities <strong>to</strong> <strong>in</strong>ves<strong>to</strong>rs <strong>to</strong> raise long-termcapital, us<strong>in</strong>g the proceeds <strong>to</strong> reduce short-term commercial paper <strong>and</strong> other bank debt. Enron's<strong>in</strong>vestment grade credit rat<strong>in</strong>g was critical <strong>to</strong> the scheme, as only Enron's <strong>in</strong>siders <strong>and</strong> its banksknew, because under the terms <strong>of</strong> the partnership/SPE deals, if Enron's debt was downgraded <strong>to</strong>below <strong>in</strong>vestment grade, the debt <strong>of</strong> those entities would become recourse <strong>to</strong> Enron, which couldcause the house <strong>of</strong> cards <strong>to</strong> <strong>to</strong>pple. 19.- 10 -
In 99, Enron created <strong>and</strong> then entered <strong>in</strong><strong>to</strong> numerous transactions with two LJM partnerships(LJM <strong>and</strong> LJM2) that Enron secretly controlled. Enron then engaged <strong>in</strong> numerous non-arm'slengthtransactions – contrivances <strong>and</strong> devices <strong>to</strong> deceive – with the LJM partnerships <strong>and</strong>associated SPEs, which <strong>in</strong>flated Enron's reported pr<strong>of</strong>its by more than a billion dollars – at thesame time enrich<strong>in</strong>g Enron's CFO (Fas<strong>to</strong>w) <strong>and</strong> Enron's banks or bankers, <strong>in</strong>clud<strong>in</strong>g CS FirstBos<strong>to</strong>n executives who had been secretly allowed <strong>to</strong> <strong>in</strong>vest <strong>in</strong> the LJM2 partnership as a rewardfor their participation <strong>in</strong> the scheme, by hundreds <strong>of</strong> millions <strong>of</strong> dollars. The reason forestablish<strong>in</strong>g these partnerships was that they would permit Enron <strong>to</strong> accomplish transactions itcould not otherwise accomplish with an <strong>in</strong>dependent entity, by provid<strong>in</strong>g Enron with a buyer <strong>of</strong>assets that Enron wanted <strong>to</strong> sell. LJM <strong>and</strong> LJM2 were created, structured, <strong>and</strong> f<strong>in</strong>anced by Enron'sbankers. 23, 29, 646-647.One <strong>of</strong> the primary vehicles used <strong>to</strong> falsify Enron's f<strong>in</strong>ancial results was LJM2, which wassecretly controlled by Enron <strong>and</strong> used <strong>to</strong> help create numerous SPEs (<strong>in</strong>clud<strong>in</strong>g the <strong>in</strong>famous"Rap<strong>to</strong>rs"), which were then used <strong>to</strong> engage <strong>in</strong> transactions <strong>to</strong> artificially <strong>in</strong>flate Enron's pr<strong>of</strong>its whileconceal<strong>in</strong>g billions <strong>of</strong> dollars <strong>of</strong> its debt on terms so unfair <strong>to</strong> Enron that the deals would providehuge returns <strong>to</strong> the LJM2 <strong>in</strong>ves<strong>to</strong>rs. 24. Because the LJM2 partnership was go<strong>in</strong>g <strong>to</strong> be so lucrative<strong>to</strong> <strong>in</strong>ves<strong>to</strong>rs <strong>in</strong> that entity <strong>and</strong> provide exceptional returns as the Enron Ponzi scheme cont<strong>in</strong>ued,Enron decided that <strong>in</strong> fund<strong>in</strong>g LJM2, it would allow certa<strong>in</strong> favored high-level <strong>of</strong>ficers <strong>of</strong> Enron's<strong>in</strong>vestment banks, like CS First Bos<strong>to</strong>n, <strong>to</strong> get <strong>in</strong> on LJM2. The LJM2 partnership <strong>of</strong>fer<strong>in</strong>gmemor<strong>and</strong>um by which Enron <strong>and</strong> Merrill Lynch brought <strong>in</strong>ves<strong>to</strong>rs <strong>in</strong><strong>to</strong> the partnership – which wasnot a public document – conta<strong>in</strong>ed an <strong>in</strong>vitation <strong>to</strong> benefit from the self-deal<strong>in</strong>g transactions thatLJM2 would engage <strong>in</strong>. It stressed the "unusually attractive <strong>in</strong>vestment opportunity" result<strong>in</strong>g fromLJM2's connection <strong>to</strong> Enron. It emphasized Fas<strong>to</strong>w's position as Enron's CFO, <strong>and</strong> that LJM2's day<strong>to</strong>-dayactivities would be managed by Fas<strong>to</strong>w <strong>and</strong> other Enron <strong>in</strong>siders. 9 It expla<strong>in</strong>ed that "[t]hePartnership expects that Enron will be the Partnership's primary source <strong>of</strong> <strong>in</strong>vestment9In fact, Fas<strong>to</strong>w's dual role by which he could self-deal on behalf <strong>of</strong> the LJM2 partnership withEnron's assets was so important that <strong>in</strong>ves<strong>to</strong>rs <strong>in</strong> LJM2 were assured that they did not have <strong>to</strong>make any additional capital contributions if Fas<strong>to</strong>w's dual role ended. 24.- 11 -
opportunities" <strong>and</strong> that it "expects <strong>to</strong> benefit from hav<strong>in</strong>g the opportunity <strong>to</strong> <strong>in</strong>vest some $150million <strong>in</strong> Enron-generated <strong>in</strong>vestment opportunities that would not be available otherwise <strong>to</strong>outside <strong>in</strong>ves<strong>to</strong>rs." It specifically noted that Fas<strong>to</strong>w's "access <strong>to</strong> Enron's <strong>in</strong>formation perta<strong>in</strong><strong>in</strong>g<strong>to</strong> potential <strong>in</strong>vestments will contribute <strong>to</strong> superior returns." In addition, <strong>in</strong>ves<strong>to</strong>rs were <strong>to</strong>ld that<strong>in</strong>ves<strong>to</strong>rs <strong>in</strong> a similar Fas<strong>to</strong>w controlled partnership (JEDI) that had done deals with Enron likethe ones LJM2 would do had tripled their <strong>in</strong>vestment <strong>in</strong> just two years <strong>and</strong> that overall returns<strong>of</strong> 2,500% <strong>to</strong> LJM2 <strong>in</strong>ves<strong>to</strong>rs were actually anticipated. 25.Enron <strong>and</strong> CS First Bos<strong>to</strong>n knew that because LJM2 was go<strong>in</strong>g <strong>to</strong> engage <strong>in</strong> transactions withEnron where Enron <strong>in</strong>siders would be on both sides <strong>of</strong> the transactions, the LJM2 partnershipwould be extremely lucrative – a deal that was virtually guaranteed <strong>to</strong> provide huge returns <strong>to</strong>LJM2's <strong>in</strong>ves<strong>to</strong>rs as the Enron Ponzi scheme went forward. 24. In short, the non-public LJM2<strong>of</strong>fer<strong>in</strong>g memor<strong>and</strong>um was an <strong>in</strong>vitation <strong>to</strong> share <strong>in</strong> the benefits <strong>of</strong> non-arm's-length self-deal<strong>in</strong>gtransactions with Enron, i.e., the loot<strong>in</strong>g <strong>of</strong> Enron. Enron's bankers <strong>and</strong> the <strong>to</strong>p executives <strong>of</strong> thosebanks were permitted <strong>to</strong> <strong>in</strong>vest <strong>in</strong> LJM2 as a reward <strong>to</strong> them for their ongo<strong>in</strong>g participation <strong>in</strong> thescheme – a sure th<strong>in</strong>g for them. 25. 10It was <strong>in</strong>dispensable <strong>to</strong> the scheme that LJM2 be funded at year-end 99 <strong>to</strong> serve as a vehicle<strong>to</strong> consummate several deals with Enron before year-end 99 <strong>to</strong> create huge pr<strong>of</strong>its for Enron <strong>in</strong> the4thQ 99, so that Enron could meet <strong>and</strong> exceed its forecasted 99 earn<strong>in</strong>gs. However, as had been thecase with Chewco at year-end 97, there was tremendous time pressure <strong>and</strong> Enron <strong>and</strong> Merrill Lynch(which was rais<strong>in</strong>g the private equity capital for LJM2) could not complete the formation <strong>of</strong> LJM2<strong>and</strong> raise money from the equity <strong>in</strong>ves<strong>to</strong>rs <strong>in</strong> LJM2 by year-end 99 with sufficient capital <strong>to</strong> enableit <strong>to</strong> do the desperately needed transactions with Enron. So, <strong>in</strong> an extraord<strong>in</strong>ary step, on 12/22/99,CS First Bos<strong>to</strong>n <strong>to</strong>p executives (through DLJ Fund Investment Partners), even though LJM2 had not10While Enron's publicly filed reports disclosed the existence <strong>of</strong> the LJM partnerships, thesedisclosures did not reveal the essence <strong>of</strong> the transactions completely or clearly, <strong>and</strong> failed <strong>to</strong> conveythe substance <strong>of</strong> what was go<strong>in</strong>g on between Enron <strong>and</strong> the partnerships. The disclosures also didnot fully disclose the nature or extent <strong>of</strong> Fas<strong>to</strong>w's f<strong>in</strong>ancial <strong>in</strong>terest <strong>in</strong> the LJM partnerships. Thiswas the result <strong>of</strong> an effort <strong>to</strong> avoid disclos<strong>in</strong>g Fas<strong>to</strong>w's f<strong>in</strong>ancial <strong>in</strong>terest <strong>and</strong> <strong>to</strong> downplay thesignificance <strong>of</strong> the related-party transactions <strong>and</strong> <strong>to</strong> disguise their substance <strong>and</strong> import. Thedisclosures also represented that the related-party transactions were reasonable compared <strong>to</strong>transactions with third parties when, <strong>in</strong> fact, they were not. 67.- 12 -
yet been fully formed or funded – but know<strong>in</strong>g that LJM2 was go<strong>in</strong>g <strong>to</strong> be an extraord<strong>in</strong>arilylucrative <strong>in</strong>vestment anyway – advanced $750,000 <strong>to</strong> "pre-fund" LJM2, i.e., many times more thantheir allocated shares <strong>in</strong> LJM2's capital. 26, 27. The reason that CS First Bos<strong>to</strong>n <strong>and</strong> the otherbanks put up the money <strong>to</strong> pre-fund LJM2 <strong>in</strong> 12/99 was that they knew enabl<strong>in</strong>g Enron <strong>to</strong> do the 99year-end deals with LJM2 <strong>and</strong> its SPEs was <strong>in</strong>dispensable <strong>to</strong> Enron avoid<strong>in</strong>g report<strong>in</strong>g a very bad4thQ 99 – which would have caused its s<strong>to</strong>ck <strong>to</strong> plunge <strong>and</strong> endanger the fraudulent scheme. Thesevital year-end 99 deals <strong>in</strong>cluded:(a)Collateralized Loan Obligations ("CLOs"). On 12/22/99, Enron pooledpurchaser CLO rights <strong>and</strong> sold the lowest-rated tranche <strong>to</strong> Whitew<strong>in</strong>g LLP (an Enron affiliate) <strong>and</strong>LJM2. Whitew<strong>in</strong>g loaned LJM2 the money <strong>to</strong> purchase its <strong>in</strong>terest <strong>in</strong> the CLOs. Enron secretlyguaranteed Whitew<strong>in</strong>g's <strong>in</strong>vestment <strong>and</strong> loan <strong>to</strong> LJM2. This transaction allowed Enron <strong>to</strong> record thesale <strong>of</strong> millions <strong>of</strong> dollars <strong>in</strong> the 4thQ 99 <strong>to</strong> an entity that should have been consolidated.(b) Nowa Sarzyna (Pol<strong>and</strong> Power Plant). On 12/21/99, Enron sold LJM2 a 75%<strong>in</strong>terest <strong>in</strong> the Nowa Sarzyna power plant. Enron had tried <strong>to</strong> sell this <strong>in</strong>terest by year-end <strong>to</strong> an<strong>in</strong>dependent buyer but could not f<strong>in</strong>d an <strong>in</strong>dependent buyer <strong>in</strong> time, so it used LJM2, which paid $30million. This transaction moved millions <strong>of</strong> dollars <strong>of</strong> debt <strong>of</strong>f Enron's balance sheet. This was asham transaction. The debt f<strong>in</strong>anc<strong>in</strong>g required Enron <strong>to</strong> ma<strong>in</strong>ta<strong>in</strong> ownership <strong>of</strong> at least 47.5% <strong>of</strong> theequity until the project was completed. However, the lender granted a waiver <strong>of</strong> this until 3/31/00,at which time Enron <strong>and</strong> Whitew<strong>in</strong>g reacquired LJM2's equity <strong>in</strong>terest <strong>and</strong> repaid that loan.(c)MEGS, LLC. On 12/29/99, Enron sold LJM2 a 90% equity <strong>in</strong>terest <strong>in</strong>MEGS, a natural gas system <strong>in</strong> the Gulf <strong>of</strong> Mexico. This allowed Enron <strong>to</strong> avoid consolidat<strong>in</strong>g theasset at year-end 99, avoid<strong>in</strong>g millions <strong>of</strong> dollars <strong>of</strong> debt on Enron's balance sheet. Enronrepurchased LJM2's <strong>in</strong>terest <strong>in</strong> MEGS <strong>in</strong> early 00.(d)Yosemite. On 12/29/99, Enron purportedly sold certificates <strong>in</strong> Yosemite <strong>to</strong>LJM2, however, <strong>in</strong> fact, this transaction did not occur until 2/28/00. The transaction was made <strong>to</strong>appear <strong>to</strong> occur at year-end 99 <strong>to</strong> reduce Enron's <strong>in</strong>terest <strong>in</strong> Yosemite from 50% <strong>to</strong> 10% so Enronwould not have <strong>to</strong> disclose its ownership <strong>of</strong> these certificates <strong>in</strong> Enron's 99 f<strong>in</strong>ancial statements <strong>and</strong>that, <strong>in</strong> effect, Enron owned some <strong>of</strong> its own debt. On 12/29/99, Condor (an affiliate <strong>of</strong> Whitew<strong>in</strong>g),- 13 -
which was controlled by Enron, loaned the $35 million <strong>to</strong> LJM2 <strong>to</strong> buy the certificates. On 12/30/99,LJM2 transferred the certificates <strong>to</strong> Condor, satisfy<strong>in</strong>g the one-day loan. 28.From 6/99 through 6/01, Enron entered <strong>in</strong><strong>to</strong> numerous other non-arm's-length fraudulenttransactions with the LJM partnerships. Enron sold assets <strong>to</strong> LJM2 that it wanted <strong>to</strong> get <strong>of</strong>f its bookson terms that no <strong>in</strong>dependent third party would ever have agreed <strong>to</strong>. The transactions between theLJM partnerships <strong>and</strong> Enron or its affiliates occurred close <strong>to</strong> the end <strong>of</strong> f<strong>in</strong>ancial report<strong>in</strong>gperiods <strong>to</strong> artificially boost reported results <strong>to</strong> meet forecasts Enron <strong>and</strong> other participants <strong>in</strong> thescheme had been mak<strong>in</strong>g. For <strong>in</strong>stance, near the end <strong>of</strong> the 3rdQ <strong>and</strong> 4thQ 99, Enron sold <strong>in</strong>terests<strong>in</strong> seven assets <strong>to</strong> LJM <strong>and</strong> LJM2. The transactions permitted Enron <strong>to</strong> conceal its true debt levelsby remov<strong>in</strong>g the assets from Enron's balance sheet <strong>and</strong>, at the same time, record large ga<strong>in</strong>s.However, (i) as it had agreed <strong>in</strong> advance it would do, Enron bought back five <strong>of</strong> the seven assetsafter the close <strong>of</strong> the f<strong>in</strong>ancial report<strong>in</strong>g period; (ii) the LJM partnerships made large pr<strong>of</strong>its onevery transaction, even when the asset they had purchased actually decl<strong>in</strong>ed <strong>in</strong> market value; <strong>and</strong>(iii) those transactions generated "earn<strong>in</strong>gs" for Enron <strong>of</strong> $229 million <strong>in</strong> the second half <strong>of</strong> 99out <strong>of</strong> <strong>to</strong>tal earn<strong>in</strong>gs for that period <strong>of</strong> $549 million. In three <strong>of</strong> these transactions where Enronultimately bought back LJM's <strong>in</strong>terest, Enron had agreed <strong>in</strong> advance <strong>to</strong> protect the LJMpartnerships aga<strong>in</strong>st any loss. Thus, the LJM partnerships functioned only as vehicles <strong>to</strong>accommodate defendants <strong>in</strong> the falsification <strong>and</strong> artificial <strong>in</strong>flation <strong>of</strong> Enron's reported f<strong>in</strong>ancialresults, while enrich<strong>in</strong>g the LJM <strong>in</strong>ves<strong>to</strong>rs from the loot<strong>in</strong>g <strong>of</strong> Enron. 32. 11These favored <strong>in</strong>ves<strong>to</strong>rs <strong>in</strong> LJM2 – like the <strong>to</strong>p CS First Bos<strong>to</strong>n executives – actuallywitnessed a series <strong>of</strong> extraord<strong>in</strong>ary payouts from the Rap<strong>to</strong>r SPEs which LJM2 controlled over thenext two years, secur<strong>in</strong>g hundreds <strong>of</strong> millions <strong>of</strong> dollars <strong>in</strong> distributions from the Rap<strong>to</strong>rs <strong>to</strong> LJM2<strong>and</strong> then <strong>to</strong> themselves – cash generated by the illicit <strong>and</strong> improper transactions Enron was engag<strong>in</strong>g<strong>in</strong> with the Rap<strong>to</strong>rs, i.e., the manipulative or deceptive devices, <strong>to</strong> falsify Enron's f<strong>in</strong>ancial results.11The returns <strong>to</strong> the LJM2 <strong>in</strong>ves<strong>to</strong>rs were huge – up <strong>to</strong> 2,500% on one deal <strong>and</strong> 51% overall<strong>in</strong> the first year <strong>of</strong> the partnership. Skill<strong>in</strong>g recently <strong>to</strong>ld <strong>in</strong>vestiga<strong>to</strong>rs such gargantuan returnswere possible only because LJM2, with Fas<strong>to</strong>w at the wheel, was defraud<strong>in</strong>g Enron <strong>in</strong> the billions<strong>of</strong> dollars <strong>of</strong> deals it was do<strong>in</strong>g with Enron so Enron could create false pr<strong>of</strong>its <strong>and</strong> hide billions<strong>of</strong> dollars <strong>in</strong> debt. Kurt Eichenwald, "Enron Ex-Chief Said <strong>to</strong> Voice Suspicion <strong>of</strong> Fraud," New YorkTimes, 4/24/02.- 14 -
sufficient credit capacity <strong>to</strong> pay Enron on the "hedges." By 11/00, Enron had entered <strong>in</strong><strong>to</strong> derivativetransactions with the Rap<strong>to</strong>rs with a notional value <strong>of</strong> over $1.5 billion. In 12/00, Enron's ga<strong>in</strong> (<strong>and</strong>the Rap<strong>to</strong>rs' correspond<strong>in</strong>g net loss) on these transactions was over $500 million. Enron couldrecognize these ga<strong>in</strong>s – <strong>of</strong>fsett<strong>in</strong>g correspond<strong>in</strong>g losses on the <strong>in</strong>vestments <strong>in</strong> its merchant portfolio– only if the Rap<strong>to</strong>rs had the capacity <strong>to</strong> make good on their debt <strong>to</strong> Enron. If they did not, Enronwould be required <strong>to</strong> record a "credit reserve." Such a loss would defeat the very purpose <strong>of</strong> theRap<strong>to</strong>rs, which was <strong>to</strong> shield Enron's f<strong>in</strong>ancial statements from reflect<strong>in</strong>g the change <strong>in</strong> value <strong>of</strong> itsmerchant <strong>in</strong>vestments. 34.As year-end 00 approached, two <strong>of</strong> Enron's Rap<strong>to</strong>r SPEs were <strong>in</strong> danger <strong>of</strong> com<strong>in</strong>g unwoundas they lacked sufficient credit capacity <strong>to</strong> support their obligations. If someth<strong>in</strong>g was not done <strong>to</strong>prevent the unw<strong>in</strong>d<strong>in</strong>g <strong>of</strong> these SPEs, Enron would have <strong>to</strong> take a multi-million dollar charge aga<strong>in</strong>stearn<strong>in</strong>gs which would expose the prior falsification <strong>of</strong> Enron's f<strong>in</strong>ancial results <strong>and</strong> result <strong>in</strong> Enron'ss<strong>to</strong>ck plung<strong>in</strong>g lower <strong>and</strong> pierc<strong>in</strong>g more <strong>and</strong> more <strong>of</strong> the s<strong>to</strong>ck issuance "triggers" <strong>in</strong> the LJM2 SPEs<strong>and</strong> a vicious fatal down-cycle would kick <strong>in</strong>. Therefore, with the participation <strong>of</strong> certa<strong>in</strong> <strong>of</strong> itsbanks, Enron restructured <strong>and</strong> capitalized the Rap<strong>to</strong>r SPEs at year-end 00 by transferr<strong>in</strong>g <strong>to</strong> themrights <strong>to</strong> receive even more shares <strong>of</strong> Enron s<strong>to</strong>ck, creat<strong>in</strong>g ever-<strong>in</strong>creas<strong>in</strong>g pressure on Enron <strong>and</strong>the other participants <strong>in</strong> the scheme <strong>to</strong> support Enron's s<strong>to</strong>ck price. This artifice enabled Enron <strong>to</strong>avoid record<strong>in</strong>g a huge credit reserve for the year end<strong>in</strong>g 12/31/00. 35.D. Enron Energy Services ("EES")Enron <strong>and</strong> its banks (<strong>in</strong>clud<strong>in</strong>g CS First Bos<strong>to</strong>n) were also tell<strong>in</strong>g <strong>in</strong>ves<strong>to</strong>rs that an area <strong>of</strong>tremendous growth for Enron was its retail energy services bus<strong>in</strong>ess – EES – where Enronpurportedly under<strong>to</strong>ok <strong>to</strong> manage the energy needs <strong>of</strong> corporate consumers for multi-year periods<strong>in</strong> return for fees <strong>to</strong> be paid over a number <strong>of</strong> years. Enron <strong>and</strong> its banks – <strong>in</strong>clud<strong>in</strong>g CS First Bos<strong>to</strong>n– presented this bus<strong>in</strong>ess as achiev<strong>in</strong>g tremendous success by constantly sign<strong>in</strong>g new multi-millionor even billion dollar contracts which allowed EES <strong>to</strong> exceed <strong>in</strong>ternal forecasts <strong>and</strong> that this divisionhad turned pr<strong>of</strong>itable <strong>in</strong> the 4thQ 99 <strong>and</strong> was achiev<strong>in</strong>g substantial ga<strong>in</strong>s <strong>in</strong> its pr<strong>of</strong>itability thereafter.37.- 16 -
The falsification <strong>of</strong> Enron's f<strong>in</strong>ancial statements was not limited <strong>to</strong> non-arm's-lengthfraudulent illicit partnership <strong>and</strong> SPE transactions. EES was also actually los<strong>in</strong>g hundreds <strong>of</strong>millions <strong>of</strong> dollars. This was because <strong>in</strong> order <strong>to</strong> <strong>in</strong>duce large enterprises <strong>to</strong> sign long-term energymanagement contracts <strong>and</strong> "jumpstart" this bus<strong>in</strong>ess so it could appear <strong>to</strong> obta<strong>in</strong> huge contractvolumes, Enron was enter<strong>in</strong>g <strong>in</strong><strong>to</strong> EES management contracts which it knew would likely result <strong>in</strong>huge losses. However, by the abuse <strong>of</strong> mark-<strong>to</strong>-market account<strong>in</strong>g, Enron grossly overvalued theultimate value <strong>of</strong> these contracts <strong>and</strong> created greatly <strong>in</strong>flated current period pr<strong>of</strong>its from transactionswhich generated little, if any, current period cash, <strong>and</strong> which would likely actually result <strong>in</strong> long-termcash-out plans <strong>and</strong> losses. As a letter written <strong>in</strong> 8/01 <strong>to</strong> Enron's Board by an EES manager stated justafter Skill<strong>in</strong>g "resigned" (38):One can only surmise that the removal <strong>of</strong> Jeff Skill<strong>in</strong>g was an action taken bythe board <strong>to</strong> correct the wrongdo<strong>in</strong>gs <strong>of</strong> the various management teams at Enron ...(i.e., EES's management's ... hid<strong>in</strong>g losses/SEC violations).* * *... [I]t became obvious that EES had been do<strong>in</strong>g deals for 2 years <strong>and</strong> waslos<strong>in</strong>g money on almost all the deals they had booked.* * *... [I]t will add up <strong>to</strong> over $500MM that EES is los<strong>in</strong>g <strong>and</strong> try<strong>in</strong>g <strong>to</strong> hide <strong>in</strong>Wholesale. Rumor on the 7th floor is that it is closer <strong>to</strong> $1 Billion.... [T]hey decided... <strong>to</strong> hide the $500MM <strong>in</strong> losses that EES was experienc<strong>in</strong>g.... EES has know<strong>in</strong>glymisrepresented EES['s] earn<strong>in</strong>gs. This is common knowledge among all the EESemployees, <strong>and</strong> is actually joked about. But it should be taken seriously.E. Enron Broadb<strong>and</strong> ("EBS")Another purported growth area <strong>of</strong> Enron's bus<strong>in</strong>ess was its broadb<strong>and</strong> services bus<strong>in</strong>ess –EBS – which consisted <strong>of</strong> construct<strong>in</strong>g an 18,000-mile fiber optic network which Enron wassupposedly successfully build<strong>in</strong>g out, while also engag<strong>in</strong>g <strong>in</strong> trad<strong>in</strong>g access <strong>to</strong> fiber optic cablecapability, i.e., "Broadb<strong>and</strong> Intermediation." Enron <strong>and</strong> its banks – <strong>in</strong>clud<strong>in</strong>g CS First Bos<strong>to</strong>n –presented both parts <strong>of</strong> Enron's broadb<strong>and</strong> bus<strong>in</strong>ess as poised <strong>to</strong> achieve <strong>and</strong> later as actuallyachiev<strong>in</strong>g huge success, report<strong>in</strong>g that its fiber optic network was be<strong>in</strong>g or had been successfullyconstructed, was state <strong>of</strong> the art <strong>and</strong> provided unparalleled quality <strong>of</strong> service, <strong>and</strong> that its broadb<strong>and</strong>- 17 -
trad<strong>in</strong>g bus<strong>in</strong>ess was succeed<strong>in</strong>g <strong>and</strong> achiev<strong>in</strong>g much higher trad<strong>in</strong>g volume <strong>and</strong> revenues thanexpected – i.e., "exponential growth." 39.A prime example <strong>of</strong> the purported success <strong>of</strong> Enron's broadb<strong>and</strong> content bus<strong>in</strong>ess was itsVOD jo<strong>in</strong>t venture with Blockbuster Enterta<strong>in</strong>ment, announced <strong>in</strong> 7/00. Enron presented this 20-year agreement as hav<strong>in</strong>g a billion dollar value, that it was a first-<strong>of</strong>-its-k<strong>in</strong>d product wherebyconsumers would obta<strong>in</strong> VOD content from Blockbuster <strong>in</strong> their home as if they were watch<strong>in</strong>g themovie on their own VCR (start, s<strong>to</strong>p, rew<strong>in</strong>d) <strong>and</strong> that this <strong>in</strong>credible advance <strong>in</strong> technology wasmade possible due <strong>to</strong> the high quality <strong>of</strong> Enron's fiber optic network. Abus<strong>in</strong>g mark-<strong>to</strong>-marketaccount<strong>in</strong>g <strong>and</strong> us<strong>in</strong>g an LJM2 SPE – funded by CS First Bos<strong>to</strong>n executives – Enron recognized anas<strong>to</strong>nish<strong>in</strong>g $110+ million bogus pr<strong>of</strong>it on this deal <strong>in</strong> the 4thQ 99 <strong>and</strong> 1stQ 00, even though theproject was fail<strong>in</strong>g <strong>in</strong> its test markets because Enron did not have the technology <strong>to</strong> deliver theproduct as represented – <strong>and</strong> which could never have gone forward because Blockbuster did not havethe legal right <strong>to</strong> deliver movies <strong>in</strong> digital format, the only format which could be utilized for VOD.40. 12 F. New PowerAnother example <strong>of</strong> how Enron <strong>and</strong> certa<strong>in</strong> <strong>of</strong> its banks falsified Enron's reported results isthe New Power IPO <strong>in</strong> 10/00, by which Enron improperly recognized a $370 million pr<strong>of</strong>it <strong>in</strong> the4thQ 00. Enron controlled New Power <strong>and</strong> owned millions <strong>of</strong> shares <strong>of</strong> New Power s<strong>to</strong>ck. If Enroncould take New Power public <strong>and</strong> create a trad<strong>in</strong>g market <strong>in</strong> its s<strong>to</strong>ck, then Enron could recognizea pr<strong>of</strong>it on the ga<strong>in</strong> <strong>in</strong> value on its shares by "hedg<strong>in</strong>g" that ga<strong>in</strong> through yet another non-arm's-lengthtransaction via LJM2. In the 4thQ 00, Enron desperately needed <strong>to</strong> create pr<strong>of</strong>its <strong>to</strong> perpetuate thePonzi scheme. Enron <strong>and</strong> CS First Bos<strong>to</strong>n did the New Power IPO – 27.6 million shares at $21 pershare <strong>in</strong> 10/00. After the IPO, Enron cont<strong>in</strong>ued <strong>to</strong> hold millions <strong>of</strong> shares <strong>of</strong> New Power s<strong>to</strong>ck <strong>and</strong>12Just eight months after announc<strong>in</strong>g this contract with great fanfare <strong>and</strong> just weeks afterrepresent<strong>in</strong>g that test<strong>in</strong>g <strong>of</strong> the system <strong>in</strong> four cities had succeeded <strong>and</strong> that the service was be<strong>in</strong>glaunched nationwide, Enron was forced <strong>to</strong> ab<strong>and</strong>on the venture. But Enron did not reverse the hugepr<strong>of</strong>its it had secretly recorded on this transaction, for <strong>to</strong> do so would have not only exposed itsongo<strong>in</strong>g abuse <strong>and</strong> misuse <strong>of</strong> mark-<strong>to</strong>-market account<strong>in</strong>g, but also would have crushed Enron's s<strong>to</strong>ckat a time when Enron <strong>and</strong> the other participants <strong>in</strong> the scheme were desperately attempt<strong>in</strong>g <strong>to</strong> haltEnron's then fall<strong>in</strong>g s<strong>to</strong>ck price so that it would not fall below certa<strong>in</strong> trigger prices. 41.- 18 -
warrants. Then, <strong>in</strong> a deal secretly structured before the IPO, Enron created a phony pr<strong>of</strong>it us<strong>in</strong>g anLJM2 SPE – which CS First Bos<strong>to</strong>n executives were fund<strong>in</strong>g – called Hawaii 125-0. CIBC (<strong>and</strong>several other <strong>of</strong> Enron's banks, <strong>in</strong>clud<strong>in</strong>g CS First Bos<strong>to</strong>n) made a "loan" <strong>of</strong> $125 million <strong>to</strong> Hawaii125-0, but secretly received a "<strong>to</strong>tal return swap" guarantee <strong>to</strong> protect them aga<strong>in</strong>st any loss fromEnron. Enron transferred millions <strong>of</strong> New Power warrants <strong>to</strong> Hawaii 125-0 <strong>to</strong> "secure" the banks'loan <strong>and</strong> thus created a huge $370 million "pr<strong>of</strong>it" on the purported ga<strong>in</strong> on the New Power warrants.Hawaii 125-0 supposedly "hedged" the warrants with another entity created <strong>and</strong> controlled by Enroncalled "Porcup<strong>in</strong>e." To supposedly capitalize Porcup<strong>in</strong>e, LJM2 – which CS First Bos<strong>to</strong>n executiveswere fund<strong>in</strong>g – put $30 million <strong>in</strong><strong>to</strong> Porcup<strong>in</strong>e <strong>to</strong> facilitate the so-called hedge <strong>of</strong> the New Powerwarrants, but, one week later, Porcup<strong>in</strong>e paid the $30 million back <strong>to</strong> LJM2 plus a $9.5 million pr<strong>of</strong>it– leav<strong>in</strong>g Porcup<strong>in</strong>e with no assets. New Power s<strong>to</strong>ck immediately fell sharply, as the chart belowshows:30New Power Hold<strong>in</strong>gs, Inc.25Dollars Per Share20151050Oct-00Nov-00Jan-01Feb-01Apr-01May-01Jul-01Aug-01Oct-01Nov-01Jan-02Feb-02This collapse converted Enron's huge ga<strong>in</strong> on its New Power equity hold<strong>in</strong>gs <strong>in</strong><strong>to</strong> a huge loss early<strong>in</strong> 01 – a loss <strong>of</strong> about $250 million – which was concealed. 42.- 19 -
G. Hidden/Disguised LoansAnother tactic utilized by Enron <strong>and</strong> its banks <strong>to</strong> falsify Enron's f<strong>in</strong>ancial condition <strong>and</strong> hidedebt <strong>in</strong>volved manipulative transactions with J.P. Morgan, CitiGroup <strong>and</strong> CS First Bos<strong>to</strong>n. J.P.Morgan used an entity it controlled known as "Mahonia," located <strong>in</strong> the Channel Isl<strong>and</strong>s <strong>of</strong>f Engl<strong>and</strong>.J.P. Morgan <strong>and</strong> Enron utilized a scheme by which large bank loans were disguised as commoditytrades. Offsett<strong>in</strong>g trades were arranged with the ultimate cost differential be<strong>in</strong>g <strong>in</strong> favor <strong>of</strong> J.P.Morgan, represent<strong>in</strong>g the <strong>in</strong>terest rate on the disguised loan. By utiliz<strong>in</strong>g this deception, J.P. Morgan<strong>and</strong> Enron falsified Enron's f<strong>in</strong>ancial condition, conceal<strong>in</strong>g some $4 billion <strong>in</strong> debt. 44.CitiGroup <strong>and</strong> CS First Bos<strong>to</strong>n engaged <strong>in</strong> similar subterfuges <strong>to</strong> disguise large loans <strong>to</strong>Enron. CitiGroup lent Enron $2.4 billion via "pre-paid" swaps – the so-called "Delta" transactions– conducted through CitiGroup's Cayman Isl<strong>and</strong>s subsidiary. These swap transactions perfectlyreplicated loans <strong>and</strong> were, <strong>in</strong> fact, loans – but Enron never reported them as such on its balance sheet.CS First Bos<strong>to</strong>n also engaged <strong>in</strong> mak<strong>in</strong>g disguised loans <strong>to</strong> Enron. CS First Bos<strong>to</strong>n gave Enron $150million <strong>to</strong> be repaid over two years, with Enron's payments <strong>to</strong> vary with the price <strong>of</strong> oil. Thetransaction was made <strong>to</strong> appear <strong>to</strong> be a "swap," but was, <strong>in</strong> fact, a loan – a reality admitted by thebank: "It was like a float<strong>in</strong>g-rate loan," said Pen Pendle<strong>to</strong>n, a CS First Bos<strong>to</strong>n spokesman. "Webooked the transaction as a loan." However, Enron did not show the loans on its balance sheet.45.H. Enron's Access <strong>to</strong> the Capital MarketsEnron needed constant access <strong>to</strong> huge amounts <strong>of</strong> capital. For Enron <strong>to</strong> cont<strong>in</strong>ue <strong>to</strong> appear<strong>to</strong> succeed it had <strong>to</strong> keep its <strong>in</strong>vestment grade credit rat<strong>in</strong>g <strong>and</strong> keep its s<strong>to</strong>ck price high. Enron's<strong>in</strong>vestment grade credit rat<strong>in</strong>g <strong>and</strong> high s<strong>to</strong>ck price could only be ma<strong>in</strong>ta<strong>in</strong>ed by (i) limit<strong>in</strong>g theamount <strong>of</strong> debt shown on Enron's balance sheet; (ii) report<strong>in</strong>g strong current period earn<strong>in</strong>gs; <strong>and</strong>(iii) forecast<strong>in</strong>g strong future revenue <strong>and</strong> earn<strong>in</strong>gs growth. Yet Enron was able <strong>to</strong> achieve theseends only by pursu<strong>in</strong>g an <strong>in</strong>creas<strong>in</strong>g number <strong>of</strong> phony transactions, many <strong>of</strong> which wereaccomplished by <strong>in</strong>creas<strong>in</strong>g the number <strong>and</strong> size <strong>of</strong> transaction entities which were supposedly<strong>in</strong>dependent <strong>of</strong> Enron but which, <strong>in</strong> fact, Enron controlled through a series <strong>of</strong> secret underst<strong>and</strong><strong>in</strong>gs<strong>and</strong> illicit f<strong>in</strong>anc<strong>in</strong>g arrangements, <strong>in</strong>clud<strong>in</strong>g the Chewco, LJM <strong>and</strong> LJM2 partnerships. As a result- 20 -
<strong>of</strong> report<strong>in</strong>g strong earn<strong>in</strong>gs, the apparent success <strong>of</strong> its bus<strong>in</strong>ess <strong>and</strong> its future earn<strong>in</strong>gs growthforecasts, Enron (or associated entities) had unlimited access <strong>to</strong> the capital markets, borrow<strong>in</strong>gbillions <strong>of</strong> dollars <strong>in</strong> the commercial paper markets <strong>and</strong> sell<strong>in</strong>g billions <strong>of</strong> dollars <strong>of</strong> Enron securities<strong>to</strong> the public. Enron <strong>and</strong> its bankers raised at least $10 billion <strong>in</strong> new capital from public <strong>in</strong>ves<strong>to</strong>rsthrough numerous <strong>of</strong>fer<strong>in</strong>gs <strong>of</strong> Enron <strong>and</strong> Enron-related securities, thus rais<strong>in</strong>g the capital necessary<strong>to</strong> allow Enron <strong>to</strong> repay or pay down its short-term debt <strong>and</strong> cont<strong>in</strong>ue <strong>to</strong> operate. The Enron<strong>of</strong>fer<strong>in</strong>gs <strong>in</strong>volv<strong>in</strong>g CS First Bos<strong>to</strong>n are shown below (48):Banks NamedAs DefendantsCS First Bos<strong>to</strong>nLehman BrothersMerrill LynchCIBCJ.P. MorganBank AmericaENRON SECURITIES UNDERWRITINGSDate <strong>of</strong>Offer<strong>in</strong>gSecurity Sold5/98 35 million shares <strong>of</strong> common s<strong>to</strong>ckat $25 per share rais<strong>in</strong>g $870 million forEnronCS First Bos<strong>to</strong>n 11/98 $250,000,0006.95% Notes due 7/15/2028CS First Bos<strong>to</strong>nLehman BrothersMerrill LynchCitiGroupbelow (49):02/99 27.6 million shares <strong>of</strong> common s<strong>to</strong>ckat $31.34 rais<strong>in</strong>g $870 million for EnronSome <strong>of</strong> the <strong>of</strong>fer<strong>in</strong>gs <strong>of</strong> Enron's associated entities <strong>in</strong>volv<strong>in</strong>g CS First Bos<strong>to</strong>n are shownENRON-RELATED SECURITIES UNDERWRITINGSBanks NamedAs DefendantsMerrill LynchCS First Bos<strong>to</strong>nDeutsche BankBank AmericaCS First Bos<strong>to</strong>nMerrill LynchDate <strong>of</strong>Offer<strong>in</strong>gSecurity Sold6/99 38.5 million shares Azurix s<strong>to</strong>ck at $19per share rais<strong>in</strong>g $370 million for Enron2/00 $600 million Azurix 10.375% <strong>and</strong>10.75% Senior Notes- 21 -
Banks NamedAs DefendantsCS First Bos<strong>to</strong>nDeutsche BankLehman BrothersCS First Bos<strong>to</strong>nCitiGroupCIBCCS First Bos<strong>to</strong>nDeutsche BankBank AmericaCIBCJ.P. MorganDate <strong>of</strong>Offer<strong>in</strong>gSecurity Sold9/00 $1+ billion 7.797% <strong>and</strong> 6.375% OspreyTrust <strong>and</strong> Osprey I Inc. Notes10/00 27.6 million shares New Power at $21per share enabl<strong>in</strong>g Enron <strong>to</strong> book a $370million phony pr<strong>of</strong>it7/01 $1 billion 6.31% <strong>and</strong> 6.19% Marl<strong>in</strong>Water Trust II <strong>and</strong> Marl<strong>in</strong> Water CapitalCorp. II NotesI. Late 00/Early 01 Prop-UpIn late 00/early 01, Enron's f<strong>in</strong>ancial results began <strong>to</strong> come under scrut<strong>in</strong>y from a fewaccount<strong>in</strong>g sleuths <strong>and</strong> short-sellers, who began <strong>to</strong> question the quality <strong>of</strong> Enron's reported f<strong>in</strong>ancialresults. While Enron, its <strong>to</strong>p <strong>in</strong>siders <strong>and</strong> its bankers assured <strong>in</strong>ves<strong>to</strong>rs <strong>of</strong> the correctness <strong>of</strong> Enron'saccount<strong>in</strong>g <strong>and</strong> the high quality <strong>of</strong> Enron's reported earn<strong>in</strong>gs, the success <strong>and</strong> strength <strong>of</strong> its bus<strong>in</strong>ess<strong>and</strong> its solid prospects for cont<strong>in</strong>ued strong pr<strong>of</strong>it growth, <strong>in</strong> part because <strong>of</strong> this <strong>in</strong>creas<strong>in</strong>gcontroversy, Enron's s<strong>to</strong>ck began <strong>to</strong> decl<strong>in</strong>e. As this price decl<strong>in</strong>e accelerated, it put pressure onEnron's <strong>to</strong>p executives <strong>to</strong> do someth<strong>in</strong>g – anyth<strong>in</strong>g – <strong>to</strong> halt the decl<strong>in</strong>e <strong>in</strong> the price <strong>of</strong> the s<strong>to</strong>ck asthey knew that if that price decl<strong>in</strong>e cont<strong>in</strong>ued <strong>and</strong> the s<strong>to</strong>ck fell <strong>to</strong> lower levels, more <strong>and</strong> more <strong>of</strong>the Enron s<strong>to</strong>ck "triggers" conta<strong>in</strong>ed <strong>in</strong> agreements for deals with entities controlled by Chewco,LJM <strong>and</strong> LJM2 would be triggered, which would require Enron <strong>to</strong> issue over 100 million shares<strong>of</strong> its common s<strong>to</strong>ck <strong>to</strong> those partnerships, caus<strong>in</strong>g a huge reduction <strong>in</strong> Enron's shareholders'equity. 52.In late 3/01, <strong>in</strong>side Enron it appeared that Enron would be required <strong>to</strong> take a pre-taxcharge aga<strong>in</strong>st earn<strong>in</strong>gs <strong>of</strong> more than $500 million <strong>to</strong> reflect a shortfall <strong>in</strong> credit capacity <strong>of</strong> theRap<strong>to</strong>r SPEs, which would have been catastrophic <strong>and</strong> exposed the scheme. Rather than take thatloss <strong>and</strong> face these consequences, Enron <strong>and</strong> CS First Bos<strong>to</strong>n "restructured" the Rap<strong>to</strong>r vehicles bytransferr<strong>in</strong>g more than $800 million <strong>of</strong> contracts <strong>to</strong> receive Enron's own s<strong>to</strong>ck <strong>to</strong> them just beforequarter-end, which permitted the participants <strong>in</strong> the scheme <strong>to</strong> conceal substantial losses <strong>in</strong>- 22 -
Enron's merchant <strong>in</strong>vestments, keep billions <strong>of</strong> dollars <strong>of</strong> debt <strong>of</strong>f Enron's balance sheet <strong>and</strong>allow the Enron Ponzi scheme <strong>to</strong> cont<strong>in</strong>ue. 53.Dur<strong>in</strong>g early 01, Enron cont<strong>in</strong>ued <strong>to</strong> report record results <strong>and</strong> it <strong>and</strong> its bankers – <strong>in</strong>clud<strong>in</strong>gCS First Bos<strong>to</strong>n – cont<strong>in</strong>ued <strong>to</strong> make very positive statements (54):• Enron's strong results reflected breakout performance <strong>in</strong> all bus<strong>in</strong>ess units. Enronwas a strong unified bus<strong>in</strong>ess.• WEOS had strong growth <strong>and</strong> a tremendous market franchise with significantsusta<strong>in</strong>able competitive advantages.• EBS <strong>in</strong>termediation was great. Broadb<strong>and</strong> glut <strong>and</strong> lowered prices would helpEnron.• VOD was successfully tested <strong>and</strong> launched. Proven technology created enormousopportunities.• All <strong>of</strong> Enron's bus<strong>in</strong>esses were generat<strong>in</strong>g high levels <strong>of</strong> earn<strong>in</strong>gs. Fundamentalswere improv<strong>in</strong>g. Enron was very optimistic. Enron was confident growth wassusta<strong>in</strong>able for years <strong>to</strong> come.J. The Impend<strong>in</strong>g CollapseBy the Summer <strong>of</strong> 01, Enron's <strong>to</strong>p <strong>in</strong>siders realized that Enron would not be able <strong>to</strong> cont<strong>in</strong>ue<strong>to</strong> susta<strong>in</strong> the illusion <strong>of</strong> strong pr<strong>of</strong>itable growth much longer <strong>and</strong> that it would have <strong>to</strong> take largewrite-<strong>of</strong>fs <strong>in</strong> the second half <strong>of</strong> 01 that, <strong>in</strong> turn, could result <strong>in</strong> a downgrade <strong>of</strong> Enron's critical<strong>in</strong>vestment grade credit rat<strong>in</strong>g – an event that they knew would mean that debt on the books <strong>of</strong> theSPEs Enron did bus<strong>in</strong>ess with (<strong>and</strong> partnerships controlled by them), which debt Enron had assured<strong>in</strong>ves<strong>to</strong>rs was "non-recourse" <strong>to</strong> Enron, would, <strong>in</strong> fact, become Enron's obligation. 55.In a 6/01 meet<strong>in</strong>g between an Enron manager <strong>and</strong> two CS First Bos<strong>to</strong>n manag<strong>in</strong>gdirec<strong>to</strong>rs, the CS First Bos<strong>to</strong>n people made statements show<strong>in</strong>g they had knowledge about thenature <strong>and</strong> extent <strong>of</strong> Enron's <strong>of</strong>f-balance sheet exposure. Dur<strong>in</strong>g discussions about structur<strong>in</strong>g an<strong>of</strong>f-balance-sheet partnership, the CS First Bos<strong>to</strong>n people commented <strong>to</strong> the Enron manager, "Howcan you guys keep do<strong>in</strong>g this?" – referr<strong>in</strong>g <strong>to</strong> Enron's repeated statements <strong>to</strong> the market that its s<strong>to</strong>ckwas undervalued. The CS First Bos<strong>to</strong>n people said that even at $40 per share, Enron's s<strong>to</strong>ck wasstill overvalued <strong>in</strong> their view <strong>and</strong> added, "Do employees actually believe it's worth whatmanagement is say<strong>in</strong>g?" At the time, Enron's s<strong>to</strong>ck was trad<strong>in</strong>g at around $48.50. The CS FirstBos<strong>to</strong>n people said "you guys are at a critical price po<strong>in</strong>t right now" <strong>and</strong> referenced the Rap<strong>to</strong>r- 23 -
deal <strong>and</strong> said that if Enron's s<strong>to</strong>ck cont<strong>in</strong>ued <strong>to</strong> fall, that would cause Rap<strong>to</strong>r <strong>to</strong> unw<strong>in</strong>d <strong>and</strong> thedebt balance <strong>to</strong> come due. The CS First Bos<strong>to</strong>n people asked the Enron manager, "Do you knowhow much <strong>of</strong>f-balance sheet debt you [Enron] have?" When the Enron executive said he thoughtit was around one <strong>to</strong> two billion dollars, the CS First Bos<strong>to</strong>n people said, "Try eight <strong>to</strong> 12 billion."They added that if Enron's s<strong>to</strong>ck hit $20 a share, th<strong>in</strong>gs were go<strong>in</strong>g <strong>to</strong> come fall<strong>in</strong>g down <strong>and</strong>"you guys are gonna be fucked." This knowledge did not s<strong>to</strong>p CS First Bos<strong>to</strong>n, however, fromissu<strong>in</strong>g a report on 8/14/01 rat<strong>in</strong>g Enron a "Strong Buy" with a price target <strong>of</strong> $84! 56.On 8/14/01, Enron announced that Skill<strong>in</strong>g – who had become Enron's CEO just monthsearlier – was resign<strong>in</strong>g, for "personal reasons." While this resignation fanned the controversy overthe true nature <strong>of</strong> Enron's f<strong>in</strong>ances <strong>and</strong> the condition <strong>of</strong> Enron's bus<strong>in</strong>ess, Enron <strong>and</strong> its banks –<strong>in</strong>clud<strong>in</strong>g CS First Bos<strong>to</strong>n – lied <strong>to</strong> <strong>in</strong>ves<strong>to</strong>rs, tell<strong>in</strong>g them that Skill<strong>in</strong>g's resignation was only forpersonal reasons <strong>and</strong> did not raise "any account<strong>in</strong>g or bus<strong>in</strong>ess issues <strong>of</strong> any k<strong>in</strong>d," <strong>and</strong> that Enron'sf<strong>in</strong>ancial condition "had never been stronger" <strong>and</strong> its "future had never been brighter." They saidthere was "noth<strong>in</strong>g <strong>to</strong> disclose," Enron's "numbers look good," there were "no problems" or"account<strong>in</strong>g issues." Accord<strong>in</strong>g <strong>to</strong> them, the Enron "mach<strong>in</strong>e was <strong>in</strong> <strong>to</strong>p shape <strong>and</strong> cont<strong>in</strong>ues <strong>to</strong>roll on – Enron's the best <strong>of</strong> the best." 57.K. The EndBy 8/01, Enron management employees were compla<strong>in</strong><strong>in</strong>g <strong>to</strong> Enron's Board that the fraudat Enron was so widespread it was out <strong>of</strong> control. In 8/01, two employees compla<strong>in</strong>ed <strong>to</strong> the Board(59):(a)One employee wrote:Skill<strong>in</strong>g's abrupt departure will raise suspicions <strong>of</strong> account<strong>in</strong>g improprieties <strong>and</strong>valuation issues. Enron has been very aggressive <strong>in</strong> its account<strong>in</strong>g – most notably theRap<strong>to</strong>r transactions <strong>and</strong> the Condor vehicle. We do have valuation issues with our<strong>in</strong>ternational assets <strong>and</strong> possibly some <strong>of</strong> our EES MTM positions.* * *We have recognized over $550 million <strong>of</strong> fair value ga<strong>in</strong>s on s<strong>to</strong>ck via our swapswith Rap<strong>to</strong>r, much <strong>of</strong> that s<strong>to</strong>ck has decl<strong>in</strong>ed significantly – Avici by 98%, from$178 mm <strong>to</strong> $5 mm. The New Power Co. by 70%, from $20/share <strong>to</strong> $6/share. Thevalue <strong>in</strong> the swaps won't be there for Rap<strong>to</strong>r, so once aga<strong>in</strong> Enron will issue s<strong>to</strong>ck <strong>to</strong><strong>of</strong>fset these losses. Rap<strong>to</strong>r is an LJM entity. It sure looks <strong>to</strong> the layman on the street- 24 -
that we are hid<strong>in</strong>g losses <strong>in</strong> a related company <strong>and</strong> will compensate that companywith Enron s<strong>to</strong>ck <strong>in</strong> the future.I am <strong>in</strong>credibly nervous that we will implode <strong>in</strong> a wave <strong>of</strong> account<strong>in</strong>g sc<strong>and</strong>als....[T]he bus<strong>in</strong>ess world will consider the past successes as noth<strong>in</strong>g but an elaborateaccount<strong>in</strong>g hoax....[W]e booked the Condor <strong>and</strong> Rap<strong>to</strong>r deals <strong>in</strong> 1999 <strong>and</strong> 2000, we enjoyed awonderfully high s<strong>to</strong>ck price, many executives sold s<strong>to</strong>ck, we then try <strong>and</strong> reverseor fix the deals <strong>in</strong> 2001 <strong>and</strong> it's a bit like robb<strong>in</strong>g the bank <strong>in</strong> one year <strong>and</strong> try<strong>in</strong>g<strong>to</strong> pay it back 2 years later. Nice try, but <strong>in</strong>ves<strong>to</strong>rs were hurt, they bought at $70<strong>and</strong> $80/share look<strong>in</strong>g for $120/share <strong>and</strong> now they're at $38 or worse. We areunder <strong>to</strong>o much scrut<strong>in</strong>y <strong>and</strong> there are probably one or two disgruntled "redeployed"employees who know enough about the "funny" account<strong>in</strong>g <strong>to</strong> get us <strong>in</strong> trouble.* * *I realize that we have had a lot <strong>of</strong> smart people look<strong>in</strong>g at this .... None <strong>of</strong> that willprotect Enron if these transactions are ever disclosed <strong>in</strong> the bright light <strong>of</strong> day.* * *I firmly believe that the probability <strong>of</strong> discovery significantly <strong>in</strong>creased withSkill<strong>in</strong>g's shock<strong>in</strong>g departure. Too many people are look<strong>in</strong>g for a smok<strong>in</strong>g gun.* * *3. There is a veil <strong>of</strong> secrecy around LJM <strong>and</strong> Rap<strong>to</strong>r. Employees questionour account<strong>in</strong>g propriety consistently <strong>and</strong> constantly....a. Jeff McMahon was highly vexed over the <strong>in</strong>herent conflicts <strong>of</strong> LJM.He compla<strong>in</strong>ed mightily <strong>to</strong> Jeff Skill<strong>in</strong>g .... 3 days later, Skill<strong>in</strong>g<strong>of</strong>fered him the CEO spot at Enron Industrial Markets ....b. Cliff Baxter compla<strong>in</strong>ed mightily <strong>to</strong> Skill<strong>in</strong>g <strong>and</strong> all who wouldlisten about the <strong>in</strong>appropriateness <strong>of</strong> our transactions with LJM.c. I have heard one manager level employee ... say "I know it would bedevastat<strong>in</strong>g <strong>to</strong> all <strong>of</strong> us, but I wish we would get caught. We're sucha crooked company."... Many similar comments are made whenyou ask about these deals.(b)A second employee wrote:One can only surmise that the removal <strong>of</strong> Jeff Skill<strong>in</strong>g was an action taken bythe board <strong>to</strong> correct the wrong do<strong>in</strong>gs <strong>of</strong> the various management teams at Enron.However ... I'm sure the board has only scratched the surface <strong>of</strong> the impend<strong>in</strong>gproblems that plague Enron at the moment. (i.e., EES's ... hid<strong>in</strong>g losses/SECviolations ... lack <strong>of</strong> product, etc.).* * *[I]t became obvious that EES had been do<strong>in</strong>g deals for 2 years <strong>and</strong> was los<strong>in</strong>g moneyon almost all the deals they had booked. (JC Penney be<strong>in</strong>g a $60MM loss alone, thenSafeway, Albertson's, GAP, etc.). Some cus<strong>to</strong>mers threatened <strong>to</strong> sue if EES didn't- 25 -
close the deal with a loss (Simon Properties – $8MM loss day one).... Overnight theproduct <strong>of</strong>fer<strong>in</strong>gs evaporated.... Starwood is also mad s<strong>in</strong>ce EES has not <strong>in</strong>vested the$45MM <strong>in</strong> equipment under the agreement.... Now you will loose [sic] at least$45MM on the deal.... You should also check on the Safeway contract, Albertson's,IBM <strong>and</strong> the California contracts that are be<strong>in</strong>g negotiated.... It will add up <strong>to</strong> over$500MM that EES is los<strong>in</strong>g <strong>and</strong> try<strong>in</strong>g <strong>to</strong> hide <strong>in</strong> Wholesale. Rumor on the 7th flooris that it is closer <strong>to</strong> $1 Billion....This is when they decided <strong>to</strong> merge the EES risk group with Wholesale <strong>to</strong>hide the $500MM <strong>in</strong> losses that EES was experienc<strong>in</strong>g. But somehow EES, <strong>to</strong>everyone's amazement, reported earn<strong>in</strong>gs for the 2nd quarter. Accord<strong>in</strong>g <strong>to</strong> FAS 131– Statement <strong>of</strong> F<strong>in</strong>ancial Account<strong>in</strong>g St<strong>and</strong>ards (SFAS) #131, "Disclosures aboutSegments <strong>of</strong> an Enterprise <strong>and</strong> related <strong>in</strong>formation," EES has know<strong>in</strong>glymisrepresented EES' earn<strong>in</strong>gs. This is common knowledge among all the EESemployees, <strong>and</strong> is actually joked about....There are numerous operational problems with all the accounts.* * *... Some would say the house <strong>of</strong> cards are fall<strong>in</strong>g....You are potentially fac<strong>in</strong>g Shareholder lawsuits, Employee lawsuits ... Heatfrom the Analysts <strong>and</strong> newspapers. The market has lost all confidence, <strong>and</strong> itsobvious why.You, the board have a big task at h<strong>and</strong>. You have <strong>to</strong> decide the moral, orethical th<strong>in</strong>gs <strong>to</strong> do, <strong>to</strong> right the wrongs <strong>of</strong> your various management teams.* * *... But all <strong>of</strong> the problems I have mentioned, they are very much commonknowledge <strong>to</strong> hundreds <strong>of</strong> EES employees, past <strong>and</strong> present.On 10/16/01, Enron shocked the markets with revelations <strong>of</strong> $1.0 billion <strong>in</strong> charges <strong>and</strong>a reduction <strong>of</strong> shareholders' equity by $1.2 billion. With<strong>in</strong> days, The Wall Street Journal beganan exposé <strong>of</strong> the JEDI, Chewco <strong>and</strong> the LJM SPEs, the SEC announced an <strong>in</strong>vestigation <strong>of</strong> Enron,<strong>and</strong> Fas<strong>to</strong>w "resigned." In 11/01, Enron was forced <strong>to</strong> admit that Chewco had never satisfied theSPE account<strong>in</strong>g rules <strong>and</strong> – because JEDI's non-consolidation depended on Chewco's status –neither did JEDI, <strong>and</strong> Enron consolidated Chewco <strong>and</strong> JEDI retroactive <strong>to</strong> 97. This retroactiveconsolidation resulted <strong>in</strong> a massive reduction <strong>in</strong> Enron's reported net <strong>in</strong>come <strong>and</strong> massive<strong>in</strong>crease <strong>in</strong> its reported debt. Enron then revealed that it was restat<strong>in</strong>g its 97, 98, 99 <strong>and</strong> 00 f<strong>in</strong>ancialresults <strong>to</strong> elim<strong>in</strong>ate $600 million <strong>in</strong> previously reported pr<strong>of</strong>its <strong>and</strong> approximately $1.2 billion <strong>in</strong>shareholders' equity as detailed below (61):- 26 -
ENRON ACCOUNTING RESTATEMENTSRecurr<strong>in</strong>g Net IncomeAmount <strong>of</strong>OverstatementDebtAmount <strong>of</strong>UnderstatementShareholders' EquityAmount <strong>of</strong>Overstatement1997 1998 1999 2000$ 96,000,000 $113,000,000 $250,000,000 $ 132,000,000$711,000,000 $561,000,000 $685,000,000 $ 628,000,000$313,000,000 $448,000,000 $833,000,000 $1,208,000,000These partnerships – Chewco, LJM <strong>and</strong> LJM2 – were used by Enron <strong>and</strong> its banks <strong>to</strong> enter<strong>in</strong><strong>to</strong> transactions that Enron could not, or would not, do with unrelated commercial entities. Thesignificant transactions were designed <strong>to</strong> create phony pr<strong>of</strong>its or <strong>to</strong> improperly <strong>of</strong>fset losses. Thesetransactions allowed Enron <strong>and</strong> its banks <strong>to</strong> conceal from the market very large losses result<strong>in</strong>g fromEnron's merchant <strong>in</strong>vestments by creat<strong>in</strong>g an appearance that those <strong>in</strong>vestments were hedged –that is, that a third party was obligated <strong>to</strong> pay Enron the amount <strong>of</strong> those losses, when <strong>in</strong> fact thatthird party was simply an entity <strong>in</strong> which only Enron had a substantial economic stake. TheRap<strong>to</strong>rs transactions alone resulted <strong>in</strong> Enron report<strong>in</strong>g earn<strong>in</strong>gs from the 3rdQ 00 through the3rdQ 01 that were almost $1 billion higher than should have been reported! 62. 13In 11/01, as the Enron scheme began <strong>to</strong> unravel, Enron tried desperately <strong>to</strong> arrange asalvation merger with Dynegy <strong>to</strong> avoid <strong>in</strong>solvency <strong>and</strong> the <strong>in</strong>evitable <strong>in</strong>vestigations <strong>and</strong> revelationsthat would follow. 64. However, Dynegy uncovered that the true f<strong>in</strong>ancial condition <strong>of</strong> Enron wasfar worse than had been disclosed publicly <strong>and</strong> that Enron had been engaged <strong>in</strong> a wide-rang<strong>in</strong>gfalsification <strong>of</strong> its f<strong>in</strong>ancial statements over the several prior years. Thus, Dynegy refused <strong>to</strong> acquireEnron. By 11/28/01, Enron's publicly traded debt had been downgraded <strong>to</strong> "junk" status <strong>and</strong> on12/2/01 Enron filed for bankruptcy – the largest bankruptcy <strong>in</strong> his<strong>to</strong>ry. Enron's s<strong>to</strong>ck <strong>and</strong> its13As huge as the 11/01 restatements <strong>of</strong> Enron's 97-00 f<strong>in</strong>ancial statements were, they justscratched the surface <strong>of</strong> the true extent <strong>of</strong> the prior falsification <strong>of</strong> Enron's f<strong>in</strong>ancial statements.63, 422-423.- 27 -
publicly traded debt securities have suffered massive price decl<strong>in</strong>es, <strong>in</strong>flict<strong>in</strong>g billions <strong>of</strong> dollars <strong>of</strong>losses on purchasers <strong>of</strong> those securities. 66.As Newsweek has written (69):In the late 1990s, by my count, Enron lost about $2 billion on telecom capacity, $2billion <strong>in</strong> water <strong>in</strong>vestments, $2 billion <strong>in</strong> a Brazilian utility <strong>and</strong> $1 billion on acontroversial electricity plant <strong>in</strong> India. Enron's debt was soar<strong>in</strong>g. If these harshtruths became obvious <strong>to</strong> outsiders, Enron's s<strong>to</strong>ck price would get clobbered – <strong>and</strong>a ris<strong>in</strong>g s<strong>to</strong>ck price was the company's be-all <strong>and</strong> end-all. Worse, what few peopleknew was that Enron had engaged <strong>in</strong> billions <strong>of</strong> dollars <strong>of</strong> <strong>of</strong>f-balance-sheet deals thatwould come back <strong>to</strong> haunt the company if its s<strong>to</strong>ck price fell.Newsweek, 1/21/02.The key <strong>to</strong> the Enron mess is that the company was allowed <strong>to</strong> givemislead<strong>in</strong>g f<strong>in</strong>ancial <strong>in</strong>formation <strong>to</strong> the world for years. Those fictional figures,show<strong>in</strong>g nicely ris<strong>in</strong>g pr<strong>of</strong>its, enabled Enron <strong>to</strong> become the nation's seventh largestcompany, with $100 billion <strong>of</strong> annual revenues. Once accurate numbers startedcom<strong>in</strong>g out <strong>in</strong> Oc<strong>to</strong>ber, thanks <strong>to</strong> pressure from s<strong>to</strong>ckholders, lenders <strong>and</strong> thepreviously quiescent SEC, Enron was bankrupt <strong>in</strong> six weeks. The bot<strong>to</strong>m l<strong>in</strong>e: wehave <strong>to</strong> change the rules <strong>to</strong> make companies deathly afraid <strong>of</strong> produc<strong>in</strong>g dishonestnumbers, <strong>and</strong> we have <strong>to</strong> make accountants mortally afraid <strong>of</strong> certify<strong>in</strong>g them.Anyth<strong>in</strong>g else is w<strong>in</strong>dow dress<strong>in</strong>g.Newsweek, 1/28/02. The rise <strong>and</strong> demise <strong>of</strong> Enron is graphically displayed below:- 28 -
1009080Total Shares Sold By Defendants: 20,788,957 sharesDefendants' Insider Trad<strong>in</strong>g Proceeds: $1,190,479,4723/00 World leader. EBS networkunbeatable scale <strong>and</strong> scope - <strong>of</strong>f <strong>to</strong>tremendous start. EES exceeded goals. Todouble contract volume <strong>in</strong> 00 <strong>to</strong> $16 billion.Pr<strong>of</strong>itability exp<strong>and</strong><strong>in</strong>g rapidly.6/00 Enron sells $325 million7.875% notes via Lehman.5/00 Enron sells $175 million8.375% notes via Bank America.5/00 Broadb<strong>and</strong> market larger thanestimated. Will reach $100 billion <strong>in</strong> 03-04with 3-4% marg<strong>in</strong>s. Monumental earn<strong>in</strong>gspotential.1/00-3/00Insiders sell2,940,125 sharesfor $208+ million.Enron Timel<strong>in</strong>e7/31/98 - 3/7/029/00 EES growth remarkable. Newcontracts over $2 billion. Potential <strong>to</strong> doublesize <strong>of</strong> Co. Turned corner on pr<strong>of</strong>itability.Great collection <strong>of</strong> large contracts. Wellmanaged. EIN buildout on schedule. FullVOD roll out <strong>in</strong> 01.4/00-5/00Insiders sell3,552,044shares for$266+ million.7/00-9/00Insiders sell1,239,388shares for10/00 New Power IPO - 27.6 million shares @$21via CS First Bos<strong>to</strong>n, JP Morgan Chase, CitiGroup.$108+ million. 10/00-12/00Insiders sell1,556,882 sharesfor $111+ million.10/00 Strong 3Q 00 <strong>in</strong>come. Merchant<strong>in</strong>vestments hedged. EES at breakoutpace. VOD deal value $1 billion - go<strong>in</strong>gf<strong>in</strong>e. All components <strong>in</strong> place. EBSdesigned <strong>to</strong> take advantage <strong>of</strong> broadb<strong>and</strong>glut.1/01-3/01Insiders sell1,136,548 sharesfor more than$82+ million.1/01 Strong 4Q 00 results. Breakout performance. $16 billion <strong>in</strong>EES contracts. Outst<strong>and</strong><strong>in</strong>g year. Increas<strong>in</strong>g pr<strong>of</strong>itability. WEOShas significant susta<strong>in</strong>able competitive advantage. Successfullylaunched VOD. Proven technology. Will <strong>in</strong>crease pr<strong>of</strong>itability.Increases forecasted EPS growth. S<strong>to</strong>ck worth $126.2/01 Enron sells $1.9 billion 0% convertible notes.Enron S<strong>to</strong>ck Issuance Price Trigger3/01 Bus<strong>in</strong>ess <strong>in</strong> good shape. WEOS, EBS <strong>in</strong>termediation great. Veryoptimistic for VOD. Everyth<strong>in</strong>g f<strong>in</strong>e. EBS bus<strong>in</strong>ess predicated on surplus<strong>of</strong> supply - decl<strong>in</strong><strong>in</strong>g prices good for Enron. Balance sheet great.F<strong>in</strong>anc<strong>in</strong>g vehicles have de m<strong>in</strong>imus share issuance requirements.3/01 Strong, unique bus<strong>in</strong>ess. Tremendous growth. Will cont<strong>in</strong>uestrong Erns performance. EES had breakout year - proven conceptwith pr<strong>of</strong>itable dealflow. $30 billion <strong>in</strong> contracts <strong>in</strong> 01. EBS modelwork<strong>in</strong>g. Intermediation grow<strong>in</strong>g exponentially. VOD sucessful.Enron <strong>in</strong> <strong>to</strong>p tier <strong>of</strong> world's corporations.400300Dollars Per Share7060504030201012/98 High return Int'lprojects - major Ernsga<strong>in</strong>s for years.Dabhol will contribute<strong>to</strong> Erns <strong>in</strong> 99.11/98 Enronsells $250 million6.95% notes viaCS First Bos<strong>to</strong>n.10/98 Strong 3Q<strong>in</strong>come. Excellentprogress on EES.Will move quickly <strong>to</strong>complete fiber opticnetwork.7/98 Strong 2Q<strong>in</strong>come. EEScont<strong>in</strong>ues <strong>to</strong>progress. Wessexwill be accretivenow <strong>and</strong> a $20billion bus<strong>in</strong>essw/i 5 years.3/99 Enron becom<strong>in</strong>g"BlueChip." Positioned forstrong growth. Extremelystrong franchise. Dabhol<strong>to</strong> be strong contribu<strong>to</strong>r <strong>to</strong>Erns. Azurix becom<strong>in</strong>gmajor global watercompany. Mgmt effectivelyus<strong>in</strong>g <strong>of</strong>f balance sheetnon-recourse f<strong>in</strong>anc<strong>in</strong>g.10/98-2/99Insiders sell2,253,958 sharesfor $67+ million.1/99 Strong 98 <strong>in</strong>come.Lead<strong>in</strong>g position <strong>in</strong> eachbus<strong>in</strong>ess. Strongbalance sheet. Wellmanaged. EESsuccessful - contractsworth $3.8 billion.WEOS strong. Veryoptimistic. 15% EPSgrowth.3/99-4/99Insiders sell2,021,640 sharesfor $71+ million.4/99 Strong 1Q 99<strong>in</strong>come - shows cont<strong>in</strong>uedstrength <strong>of</strong> bus<strong>in</strong>ess. EESadded $1.7billion <strong>in</strong>contracts. EES pr<strong>of</strong>itableby 4Q. Well managed.Erns power build<strong>in</strong>g.2/99 Enron sells 27.6 millionshares @ $31.34 via CS FirstBos<strong>to</strong>n, Lehman, Merrill Lynch,CitiGroup.6/99 Azurix IPO. 38.5 millionshares @$19 via Merrill Lynch,CS First Bos<strong>to</strong>n, DeutscheBank<strong>and</strong> Bank America.6/99 No other Co. <strong>of</strong>ferssuch impressive susta<strong>in</strong>ablegrowth. Management teamcapable - knows how <strong>to</strong>mitigate risk.5/99-7/99Insiders sell794,934 sharesfor $30+ million.10/99 Strong 3Q 99 <strong>in</strong>come. EESexceeds expectations. Optimisticabout Broadb<strong>and</strong> trad<strong>in</strong>g. EPSgrowth <strong>in</strong> excess <strong>of</strong> 15%.8/99 Enron sells $225 million7% notes, preferred s<strong>to</strong>ck viaBank America <strong>and</strong> CitiGroup.9/99 WEOS strong. 15-20%Erns growth. EES sign<strong>in</strong>g highquality contracts. Strong Ernsgrowth <strong>in</strong> com<strong>in</strong>g years.9/99-12/99Insiders sell 972,588shares for $39+ million.7/99 Strong 2Q 99 <strong>in</strong>come. Hitt<strong>in</strong>g on allcyl<strong>in</strong>ders. Master <strong>of</strong> risk management.EES well positioned for significant Erns <strong>in</strong>00 <strong>and</strong> beyond. $200 billion <strong>of</strong> potentialcontracts. Outlook excellent. Erns <strong>to</strong>grow 15+% per year.5/99 Well managed Co.Global powerhouse. Growth<strong>to</strong> exceed 17% per year.5/99 Enron sells $500 million7.375% notes via Lehman,Bank America <strong>and</strong> CIBC.Enron4/00 Strong 1Q 00.Positive momentum.Trends susta<strong>in</strong>able.Will accelerate.Strong response <strong>to</strong><strong>in</strong>termediation. EnronGE <strong>of</strong> New Economy.PeerIndex7/00 Enron/BlockbusterVOD deal: "Killer App."Unparalleled quality <strong>of</strong>service.10/00 Strong 3Q 00<strong>in</strong>come. Veryoptimistic about thestrong outlook.1/00 Strong 99 <strong>in</strong>come. Great year. Cont<strong>in</strong>ued strongWEOS growth, breakout performance from EES <strong>and</strong> rapiddevelopment <strong>of</strong> EBS. EBS will drive growth - expected <strong>to</strong>accelerate. EES pr<strong>of</strong>itable. Momentum build<strong>in</strong>g.Monumental earn<strong>in</strong>gs potential.11/99 Bus<strong>in</strong>ess excellent - strong growthprospects. S<strong>to</strong>ck hurt by rumors. Enron right -future bright. S<strong>to</strong>ck decl<strong>in</strong>e superb opportunity<strong>to</strong> buy <strong>to</strong>p growth name. Enron did firstb<strong>and</strong>width trade - "Day One" <strong>of</strong> a potentiallyhuge Enron market. EPS growth - 15-20%.7/00 Strong 2Q 00 <strong>in</strong>come.Bus<strong>in</strong>ess boom<strong>in</strong>g - ga<strong>in</strong><strong>in</strong>gmomentum. EBS pr<strong>of</strong>itsescalat<strong>in</strong>g. Ahead <strong>of</strong> expectations.VOD contract over $1 billion. NewEES contracts - $3.8 billion. Never<strong>in</strong> better shape. Very excitedabout future.11/00 Rumors <strong>of</strong>shortfall untrue.Bus<strong>in</strong>esses perform<strong>in</strong>gvery well. Comfortablewith $1.65 EPS for 01.12/00 Strong growth <strong>to</strong> cont<strong>in</strong>ue.Growth <strong>and</strong> strong Erns are reason<strong>to</strong> buy Enron. VOD launched.Unparalleled quality <strong>of</strong> service.Solid technical foundations.3/01-4/01Insiders sell465,329 sharesfor $30+ million.2/01 Fortune criticizes account<strong>in</strong>g.Enron says sour grapes by analystswho failed <strong>to</strong> get <strong>in</strong>vestment bank<strong>in</strong>gbus<strong>in</strong>ess. Enron no black box.6/01 Fundamentals improv<strong>in</strong>g.Long term Erns growth willreach 25%.4/01-7/01Insiders sell2,807,803 shares for$143+ million.7/01 Enron will hit or beatEPS estimates. Re: possiblelosses <strong>in</strong> Broadb<strong>and</strong> <strong>and</strong> India- "All <strong>of</strong> these [questions] arebunk!"7/01 Strong 2Q 01 <strong>in</strong>come - strong growth<strong>and</strong> strong pr<strong>of</strong>its. EES <strong>to</strong> double pr<strong>of</strong>its <strong>in</strong>01. Fundamentals excellent. No loss onDabhol. Will have 01/02 EPS <strong>of</strong> $1.80-$2.15.S<strong>to</strong>ck will recover.8/01 Skill<strong>in</strong>g resigns. Co. never <strong>in</strong> better shape.Strongest ever. No changes <strong>in</strong> outlook.Performance accelerat<strong>in</strong>g. Noth<strong>in</strong>g <strong>to</strong> disclose.Numbers look good. No problems. Noaccount<strong>in</strong>g issues. Enron mach<strong>in</strong>e <strong>in</strong> <strong>to</strong>p shape.The best <strong>of</strong> the best. Expect s<strong>to</strong>ck <strong>to</strong> recover.3/01 VOD deal term<strong>in</strong>ated - Blockbuster failed <strong>to</strong> providemovies. Technology sound. Rapid growth <strong>in</strong>tact. S<strong>to</strong>cksell<strong>of</strong>f overdone. All bus<strong>in</strong>esses do<strong>in</strong>g very well. Will hitErns targets.4/01 Great 1Q 01 results. WEOS outst<strong>and</strong><strong>in</strong>g,EES + EBS rapidly accelerat<strong>in</strong>g - eachgenerat<strong>in</strong>g high levels <strong>of</strong> Erns. Veryoptimistic. Increase 01 EPS <strong>to</strong> $1.75-$1.80.15% growth <strong>in</strong> 02. Growth susta<strong>in</strong>able foryears.8/01-9/01Insiders sell685,667 sharesfor $24+ million.5/01 Fundamentals improv<strong>in</strong>g.Enron's fortunes have notpeaked. Erns power cont<strong>in</strong>ues <strong>to</strong>grow.8/01 Performance neverstronger; bus<strong>in</strong>ess modelnever more robust; growthnever more certa<strong>in</strong>.9/01 Lay: "<strong>in</strong>crediblycheap s<strong>to</strong>ck."10/01Insiders sell 362,051 sharesfor $6+ million.10/01 $1 billion write<strong>of</strong>f;$1.2 billion shareholderequity reduction. Corefundamentals strong.Excellent prospects.Strong EPS outlook;liquidity f<strong>in</strong>e.12/01Enron bankrupt.20010010/19/98 = 1000Class Period 10/19/98 - 11/27/0107/31/1998 12/22/1998 05/18/1999 10/08/1999 03/02/2000 07/25/2000 12/14/2000 05/10/2001 10/08/2001 03/04/200210/12/1998 03/08/1999 07/29/1999 12/20/1999 05/12/2000 10/04/2000 02/28/2001 07/23/2001 12/18/20010
II.SUMMARY OF CS FIRST BOSTON'S INVOLVEMENT AND LIABILITYCS First Bos<strong>to</strong>n had an extensive <strong>and</strong> very close relationship with Enron. CS First Bos<strong>to</strong>nprovided both commercial bank<strong>in</strong>g <strong>and</strong> <strong>in</strong>vestment bank<strong>in</strong>g services <strong>to</strong> Enron, <strong>and</strong> helped structure<strong>and</strong> fund Enron's secretly controlled partnerships <strong>and</strong> illicit transactions with its SPEs, which enabledEnron <strong>to</strong> falsify its f<strong>in</strong>ancial statements <strong>and</strong> misrepresent its f<strong>in</strong>ancial condition by creat<strong>in</strong>g hundreds<strong>of</strong> millions <strong>of</strong> dollars <strong>in</strong> phony pr<strong>of</strong>its, while hid<strong>in</strong>g billions <strong>in</strong> debt that should have been on Enron'sbalance sheet. Also, <strong>to</strong>p executives <strong>of</strong> CS First Bos<strong>to</strong>n were permitted <strong>to</strong> personally <strong>in</strong>vest at least$22.5 million <strong>in</strong> Enron's lucrative LJM2 partnership as a reward <strong>to</strong> them for orchestrat<strong>in</strong>g CS FirstBos<strong>to</strong>n's participation <strong>in</strong> this fraud. 25-28, 693, 712. CS First Bos<strong>to</strong>n also sold over $5 billion<strong>in</strong> Enron <strong>and</strong> Enron-related securities <strong>to</strong> the public <strong>and</strong> extended over $5 billion <strong>in</strong> loans <strong>and</strong>/orlend<strong>in</strong>g commitments <strong>to</strong> Enron. At the same time, CS First Bos<strong>to</strong>n's securities analysts wereissu<strong>in</strong>g extremely positive – but false <strong>and</strong> mislead<strong>in</strong>g – reports on Enron, ex<strong>to</strong>ll<strong>in</strong>g Enron'sbus<strong>in</strong>ess success, the strength <strong>of</strong> its f<strong>in</strong>ancial condition <strong>and</strong> its prospects for strong earn<strong>in</strong>gs <strong>and</strong>revenue growth.CS First Bos<strong>to</strong>n made false <strong>and</strong> mislead<strong>in</strong>g statements <strong>in</strong> three SEC filed RegistrationStatements cover<strong>in</strong>g the sale <strong>of</strong> Enron or Enron-related securities <strong>and</strong> <strong>in</strong> 18 analyst reports on Enronit issued dur<strong>in</strong>g the Class Period, which helped <strong>to</strong> artificially <strong>in</strong>flate the trad<strong>in</strong>g prices <strong>of</strong> Enron'ssecurities. 154, 158, 167, 171, 180, 191, 198, 205, 213, 229, 268, 285, 290, 319, 345, 354, 374,378, 612-641 <strong>and</strong> 704. Such false statements are expressly made illegal by the text <strong>of</strong> Rule 10b-5,issued pursuant <strong>to</strong> §10(b) <strong>of</strong> the 1934 Act, which prohibits "any untrue statement <strong>of</strong> material fact"by "any person" <strong>in</strong> connection with securities transactions.CS First Bos<strong>to</strong>n's false statements <strong>in</strong> the three Registration Statements <strong>and</strong> its 18 analystreports were also part <strong>of</strong> a wider pattern <strong>of</strong> misconduct by CS First Bos<strong>to</strong>n <strong>in</strong> which CS First Bos<strong>to</strong>nemployed acts, manipulative or deceptive devices <strong>and</strong> contrivances <strong>and</strong> participated <strong>in</strong> a fraudulentscheme <strong>and</strong> course <strong>of</strong> bus<strong>in</strong>ess – disguis<strong>in</strong>g <strong>and</strong> thus conceal<strong>in</strong>g billions <strong>of</strong> dollars <strong>of</strong> loans <strong>to</strong> Enron,<strong>and</strong> provid<strong>in</strong>g millions <strong>to</strong> f<strong>in</strong>ance Enron's secretly controlled partnerships <strong>and</strong> Enron's illicittransactions with associated SPEs <strong>to</strong> falsify Enron's f<strong>in</strong>ancial condition <strong>and</strong> reported pr<strong>of</strong>its, all <strong>of</strong>which artificially <strong>in</strong>flated the prices <strong>of</strong> Enron's publicly traded securities. This conduct is also- 30 -
expressly prohibited by the language <strong>of</strong> §10(b) <strong>and</strong> Rule 10b-5. 14 CS First Bos<strong>to</strong>n's sale <strong>of</strong> Enron<strong>and</strong> Enron-related securities, its loans <strong>to</strong> Enron <strong>and</strong> its analyst reports on Enron are shown on thefollow<strong>in</strong>g graphic below:14False statements <strong>in</strong> a Registration Statement can create liability under both 1933 Act §11 <strong>and</strong>1934 §10(b) <strong>and</strong> Rule 10b-5. Herman & MacLean v. Huddles<strong>to</strong>n, 459 U.S. 375 (1983). Theremedies provided <strong>in</strong>ves<strong>to</strong>rs under the 1933 <strong>and</strong> 1934 Acts are cumulative. Id.- 31 -
Total Shares Sold By Defendants: 20,788,957 sharesDefendants' Insider Trad<strong>in</strong>g Proceeds: $1,190,479,472Enron Timel<strong>in</strong>e - CS First Bos<strong>to</strong>n Underwrit<strong>in</strong>gs/Loans/Analyst Reports7/31/98 - 3/7/02CS First Bos<strong>to</strong>n Analyst ReportEnron S<strong>to</strong>ck Issuance Price TriggerDollars Per Share100908070605040302010Summary <strong>of</strong> CSFBInvolvementCS First Bos<strong>to</strong>n ExecutivesPrefunders ($750,000)/Inves<strong>to</strong>rs ($22.5 million) <strong>in</strong>LJM2 entity used <strong>to</strong> createhundreds <strong>of</strong> millions <strong>of</strong> boguspr<strong>of</strong>its <strong>and</strong> hide billions <strong>in</strong> debt<strong>and</strong> loot Enron$120 million loan <strong>to</strong> LJM2 <strong>in</strong>00-01 <strong>to</strong> help create hundreds<strong>of</strong> millions <strong>of</strong> bogus pr<strong>of</strong>its <strong>and</strong>hide billions <strong>in</strong> debt <strong>and</strong> lootEnronNew Power IPO <strong>to</strong> create$370 million bogus pr<strong>of</strong>it forEnron$150 million disguised loan <strong>to</strong>Enron <strong>to</strong> create bogus pr<strong>of</strong>it<strong>and</strong> hide debtIssued 18 false <strong>and</strong>mislead<strong>in</strong>g analyst reports8 securities <strong>of</strong>fer<strong>in</strong>gs rais<strong>in</strong>g$5 billion for Enron or relatedentities via false <strong>and</strong>mislead<strong>in</strong>g registrationstatements11/98 Enronsells $250 million6.95% notes viaCS First Bos<strong>to</strong>n.$5.5 billion <strong>in</strong> disclosed loans<strong>and</strong> commitments <strong>to</strong> EnronFormed, designed <strong>and</strong>structured SPE transactionswith s<strong>to</strong>ck triggers <strong>to</strong> createbogus pr<strong>of</strong>its <strong>and</strong> hide debt9/98 $1 billioncredit facility forEnron <strong>to</strong> back upcommercial paper.10/98-2/99Insiders sell 2,253,958shares for $67+ million.3/99-4/99Insiders sell2,021,640 sharesfor $71+ million.2/99 Enron sells 27.6 millionshares @ $31.34 via CS FirstBos<strong>to</strong>n. Raises $870 million.2/99 $567 million CS FirstBos<strong>to</strong>n loan <strong>to</strong> f<strong>in</strong>ance Dabhol.11/98 Enron sells $250 million6.95% notes via CS FirstBos<strong>to</strong>n.4/12/00Increas<strong>in</strong>g momentum across all bus<strong>in</strong>esses. EBS mak<strong>in</strong>g greatprogress <strong>in</strong> delivery <strong>and</strong> <strong>in</strong>termediation. EES bus<strong>in</strong>ess exceed<strong>in</strong>gexpectations. Major contracts signed. EBS validated by 20contracts <strong>in</strong> quarter. Trad<strong>in</strong>g a reality. EBS hits 85% <strong>of</strong> annualtargets <strong>in</strong> 1st Q alone. Forecasts 15% five-year EPS growth rate.11/30/99 Buy Rat<strong>in</strong>gConfident <strong>in</strong> cont<strong>in</strong>ued growth <strong>in</strong> WEOS bus<strong>in</strong>ess. Expectpositive retail earn<strong>in</strong>gs <strong>in</strong> 4th Q 99. Enron growthaccelerat<strong>in</strong>g, with susta<strong>in</strong>able expansion. Bus<strong>in</strong>ess across alll<strong>in</strong>es <strong>in</strong> excellent shape. EES momentum cont<strong>in</strong>ues <strong>to</strong>accelerate. Full confidence <strong>in</strong> ability <strong>to</strong> meet EPS estimates.Forecasts 15% five-year EPS growth rate.9/22/99 Buy Rat<strong>in</strong>gEES signs $1.1 billion Corn<strong>in</strong>g contract. Verypositive. Showcase contract for Enron. Clearendorsement <strong>of</strong> Enron's strong price riskmanagement skills. Forecasts 15% five-year EPSgrowth rate.9/2/99 Buy Rat<strong>in</strong>gMeet<strong>in</strong>g with management highlights astrong EES bus<strong>in</strong>ess. Reaffirmsearn<strong>in</strong>gs. Forecasts pr<strong>of</strong>it growth at highend <strong>of</strong> 15-20% range. Retail energy onpace for pr<strong>of</strong>itable quarter. EES provesthat "EDS<strong>in</strong>g absolutely works." EEScont<strong>in</strong>ues <strong>to</strong> sign high-quality contracts.Forecasts 15% five-year EPS growth rate.6/99 Azurix IPO. 38.5million shares @$19 viaCS First Bos<strong>to</strong>n. Enronsells 19.5 million sharesrais<strong>in</strong>g $370 million.1/21/00WEOS <strong>to</strong> cont<strong>in</strong>ue growth. Discounted presentvalue <strong>of</strong> EBS bus<strong>in</strong>ess is $30 billion. EES <strong>to</strong> add$16 billion <strong>in</strong> contracts <strong>in</strong> 00 generat<strong>in</strong>g $650million. Forecasts 15% five-year EPS growth rate.5/99-7/99Insiders sell794,934 sharesfor $30+ million.9/99-12/99Insiders sell972,588 sharesfor $39+ million.7/6/99 Buy Rat<strong>in</strong>gHigh acceptance <strong>of</strong> Enron's trad<strong>in</strong>g strategies.Network strategy a viable bus<strong>in</strong>ess on its own.B<strong>and</strong>width trad<strong>in</strong>g at much faster rate than expected.Enron a master <strong>of</strong> risk management. Forecasts 15%five-year EPS growth rate.7/13/99 Buy Rat<strong>in</strong>gWEOS rema<strong>in</strong>s strong. Expect cont<strong>in</strong>ued operat<strong>in</strong>gpr<strong>of</strong>it growth <strong>in</strong> the upper end <strong>of</strong> the 15-20% range.EES on pace for pr<strong>of</strong>itable 4th Q. Cont<strong>in</strong>ues <strong>to</strong> signcontracts. Substantial upside <strong>to</strong> EPS estimates.Forecasts 15% five-year EPS growth rate.Enron6/00 $500 million CS FirstBos<strong>to</strong>n l<strong>in</strong>e <strong>of</strong> credit for Enronsubsidiary.1/00-3/00Insiders sell2,940,125 sharesfor $208+ million.4/00-5/00Insiders sell3,552,044shares for$266+ million.1/18/00EES has $7 million pr<strong>of</strong>it for 4th Q 99.Expect 00 <strong>to</strong> be the year Enron's EDS<strong>in</strong>gexplodes. Substantial potential for upwardsearn<strong>in</strong>gs revisions. Growth 20%+ <strong>in</strong>wholesale. EES earn<strong>in</strong>gs <strong>to</strong> jump from $68million loss <strong>to</strong> $50-100 million pr<strong>of</strong>it <strong>in</strong> 00.Forecasts 15% five-year EPS growth rate.Peer Index10/12/99 Buy Rat<strong>in</strong>gStrong WEOS results, up 36%. Retail energy market<strong>in</strong>gdemonstrated further improvement. Cont<strong>in</strong>ue <strong>to</strong> expect apr<strong>of</strong>itable fourth quarter as EES cont<strong>in</strong>ues <strong>to</strong> sign contracts.Forecasts 15% five-year EPS growth rate.10/18/00 Strong Buy Rat<strong>in</strong>gTarget price $115. Increased 00 EPS forecast due <strong>to</strong> WEOS <strong>and</strong> EES. O1 EPS forecastconservative. $4.1 billion <strong>in</strong> new EES contracts on target. Expect $16 billion <strong>in</strong> ontracts <strong>in</strong>00. Pr<strong>of</strong>it rapidly ris<strong>in</strong>g. Expect rapid growth <strong>in</strong> 01 <strong>and</strong> beyond. Forecasts 00/01 EPS$1.40/$1.65 <strong>and</strong> 15% five-year EPS growth rate.7/00-9/00Insiders sell1,239,388shares for10/00 New Power IPO - 27.6 millionshares @$21 via CS First Bos<strong>to</strong>n.Enables Enron <strong>to</strong> create $370 millionbogus pr<strong>of</strong>it.$108+ million. 10/00-12/00Insiders sell1,556,882 sharesfor $111+ million.1/01-3/01Insiders sell1,136,548 sharesfor more than$82+ million.1/26/01 Strong Buy Rat<strong>in</strong>gTarget price $128. Compell<strong>in</strong>g growth <strong>and</strong> ris<strong>in</strong>g returnplatforms across all bus<strong>in</strong>ess units. Forecasts<strong>in</strong>creased due <strong>to</strong> EES <strong>and</strong> WEOS. EBS hit goal,network complete, over 300 trades. Blockbuster dealup <strong>and</strong> runn<strong>in</strong>g. Forecasts 01/02 $1.80/$2.20 <strong>and</strong> 15%five-year EPS growth rate.2/28/00Broadb<strong>and</strong> potential <strong>and</strong> value confirmed. Impressedby Enron's contracts with etablished long-haul telecoms<strong>and</strong> ability <strong>to</strong> create b<strong>and</strong>width market. Superiordelivery network. Market reception outst<strong>and</strong><strong>in</strong>g.Intermediation progress<strong>in</strong>g rapidly. EBS present value$30 billion. Forecasts 15% five-year EPS growth rate.2/20/01 Strong Buy Rat<strong>in</strong>gFortune article just negative sp<strong>in</strong> on Enron. Noth<strong>in</strong>g new. CSFB workhas dealt with each <strong>of</strong> these issues analytically, show<strong>in</strong>g repeatability<strong>and</strong> acceleration <strong>of</strong> growth <strong>and</strong> creation <strong>of</strong> new bus<strong>in</strong>ess with clearperformance metrics. Forecasts 01/02 EPS $1.80/$2.20. Forecasts15% five-year EPS growth rate.3/01-4/01Insiders sell465,329 sharesfor $30+ million.8/17/01 Strong Buy Rat<strong>in</strong>gNo truth <strong>to</strong> any <strong>of</strong> the speculations whichcaused the share price <strong>to</strong> decl<strong>in</strong>e.Bus<strong>in</strong>ess trends are good. Shouldexceed the 20% EPS model. Forecasts01/02 EPS $1.80/$2.25.4/17/01 Strong Buy Rat<strong>in</strong>gTarget price $110, <strong>in</strong>creases forecasts. 1st Q 01 results aboveestimates. EES $40 million <strong>in</strong> 1Q 01. $5.9 billion <strong>in</strong> contracts, EESon target. Increases forecasted 01/02 EPS <strong>to</strong> $1.80/$2.25.Forecasts 15% five-year EPS growth rate.4/01-7/01Insiders sell2,807,803 shares for$143+ million.10/19/01 Strong Buy Rat<strong>in</strong>gCSFB cont<strong>in</strong>ues <strong>to</strong> look at Enron as capable <strong>of</strong>exceed<strong>in</strong>g 20% EPS growth annually. Growth willoccur. EPS estimates are conservative. Forecasts01/02 EPS <strong>of</strong> $1.80/$2.15.7/01 $582 million CS First Bos<strong>to</strong>nrevolv<strong>in</strong>g l<strong>in</strong>e <strong>of</strong> credit for Enron.8/14/01 Strong Buy Rat<strong>in</strong>gTarget price $84. No other shoes <strong>to</strong> drop.Skill<strong>in</strong>g's resignation for personal reasons:CSFB analysis <strong>and</strong> <strong>in</strong>formation <strong>in</strong>dicatesthat there are no changes or disclosureitems <strong>in</strong>herent <strong>in</strong> the departure. Forecasts01/02 EPS $1.80/$2.25 <strong>and</strong> 15% five-yearEPS growth rate.8/01-9/01Insiders sell685,667 sharesfor $24+ million.10/23/01 Strong Buy Rat<strong>in</strong>gCommitted bank credit l<strong>in</strong>es <strong>of</strong> $3.35 billion un-drawn, $1.85billion <strong>of</strong> which already issued commercial paper. Enron has$1.5 billion available for new commercial paper. RegardEnron's credit rat<strong>in</strong>gs <strong>and</strong> balance sheet issues as unlikely <strong>to</strong>worsen materially. Forecasts 01/02 EPS $1.80/$2.15.8/01 $3 billion CS FirstBos<strong>to</strong>n committed l<strong>in</strong>e <strong>of</strong>credit <strong>to</strong> back up Enron'scommercial paper.10/01Insiders sell 362,051shares for $6+ million.12/01Enron bankrupt.40030020010010/19/98 = 1000Class Period 10/19/98 - 11/27/0107/31/1998 12/22/1998 05/18/1999 10/08/1999 03/02/2000 07/25/2000 12/14/2000 05/10/2001 10/08/2001 03/04/200210/12/1998 03/08/1999 07/29/1999 12/20/1999 05/12/2000 10/04/2000 02/28/2001 07/23/2001 12/18/20010
Accord<strong>in</strong>g <strong>to</strong> the Supreme Court, §10(b)'s prohibition <strong>of</strong> "any manipulative or deceptivedevice or contrivance" necessarily encompasses any "scheme <strong>to</strong> defraud." In Ernst & Ernst v.Hochfelder, 425 U.S. 185 (1976), the Court referred <strong>to</strong> the dictionary def<strong>in</strong>itions <strong>of</strong> §10(b)'s words,<strong>to</strong> f<strong>in</strong>d that a "device" is "'[t]hat which is devised, or formed by design; a contrivance; an <strong>in</strong>vention;project; scheme; <strong>of</strong>ten, a scheme <strong>to</strong> deceive; a stratagem; an artifice.'" Id. at 199 n.20 (quot<strong>in</strong>gWebster's International Dictionary (2d ed. 1934)). The Court found that a "contrivance" means "'ascheme, plan, or artifice.'" Id. (quot<strong>in</strong>g Webster's International Dictionary (2d ed. 1934)); see alsoAaron v. SEC, 446 U.S. 680, 696 n.13 (1980). Thus scheme liability is authorized by the text <strong>of</strong>§10(b). Rule 10b-5 – adopted by the SEC <strong>to</strong> implement §10(b) – accord<strong>in</strong>gly, <strong>in</strong> addition <strong>to</strong>prohibit<strong>in</strong>g false statements, makes it unlawful for any person "directly or <strong>in</strong>directly" <strong>to</strong> employ "anydevice, scheme, or artifice <strong>to</strong> defraud" or <strong>to</strong> "engage <strong>in</strong> any act, practice, or course <strong>of</strong> bus<strong>in</strong>esswhich operates ... as a fraud or deceit upon any person." 17 C.F.R. §240.10b-5. See also U.S.Quest, Ltd. v. Kimmons, 228 F.3d 399, 407 (5th Cir. 2000).In Affiliated Ute Citizens v. United States, 406 U.S. 128 (1972), the Court observed that "thesecond subparagraph <strong>of</strong> [Rule 10b-5] specifies the mak<strong>in</strong>g <strong>of</strong> an untrue statement <strong>of</strong> a material fact<strong>and</strong> the omission <strong>to</strong> state a material fact," id. at 152-53, but held that "[t]he first <strong>and</strong> thirdsubparagraphs are not so restricted." Id. at 153. It held that the defendants violated Rule 10b-5when they participated <strong>in</strong> "a 'course <strong>of</strong> bus<strong>in</strong>ess' or a 'device, scheme, or artifice' that operated asa fraud" – even though these defendants had never themselves said anyth<strong>in</strong>g that was false ormislead<strong>in</strong>g. Id. 15 "Not every violation <strong>of</strong> the anti-fraud provisions <strong>of</strong> the federal securities lawcan be, or should be, forced <strong>in</strong><strong>to</strong> a category headed 'misrepresentations' or 'nondisclosures.'"Competitive Assocs., Inc. v. Laventhol, Krekste<strong>in</strong>, Horwath & Horwath, 516 F.2d 811, 814 (2d Cir.15Super<strong>in</strong>tendent <strong>of</strong> Ins. v. Bankers Life & Cas. Co., 404 U.S. 6, 11 n.7 (1971) ("'[We do not]th<strong>in</strong>k it sound <strong>to</strong> dismiss a compla<strong>in</strong>t merely because the alleged scheme does not <strong>in</strong>volve the type<strong>of</strong> fraud that is "usually associated with the sale or purchase <strong>of</strong> securities." We believe that §10(b) <strong>and</strong> Rule 10b-5 prohibit all fraudulent schemes <strong>in</strong> connection with the purchase or sale <strong>of</strong>securities, whether the artifices employed <strong>in</strong>volve a garden type variety <strong>of</strong> fraud, or present aunique form <strong>of</strong> deception. Novel or atypical methods should not provide immunity from thesecurities laws.'") (quot<strong>in</strong>g A. T. Brod & Co. v. Perlow, 375 F.2d 393, 397 (2d Cir. 1967)).- 33 -
1975). "Fraudulent devices, practices, schemes, artifices <strong>and</strong> courses <strong>of</strong> bus<strong>in</strong>ess are also <strong>in</strong>terdictedby the securities laws." Id.Thus, the Fifth Circuit sitt<strong>in</strong>g en banc held that a defendant who did not himself make thestatements <strong>in</strong> a mislead<strong>in</strong>g <strong>of</strong>fer<strong>in</strong>g circular could be held primarily liable as a participant <strong>in</strong> alarger scheme <strong>to</strong> defraud <strong>of</strong> which that <strong>of</strong>fer<strong>in</strong>g circular was only a part: "Rather than conta<strong>in</strong><strong>in</strong>gthe entire fraud, the Offer<strong>in</strong>g Circular was assertedly only one step <strong>in</strong> the course <strong>of</strong> an elaboratescheme." Shores v. Sklar, 647 F.2d 462, 468 (5th Cir. 1981). See F<strong>in</strong>kel v. Docutel/Olivetti Corp.,817 F.2d 356, 363 (5th Cir. 1987) (compla<strong>in</strong>t which alleged two companies had manipulated thereported <strong>and</strong> f<strong>in</strong>ancial results <strong>of</strong> Docutel properly alleged a scheme <strong>to</strong> defraud or course <strong>of</strong> bus<strong>in</strong>essoperat<strong>in</strong>g as a fraud, the effect <strong>of</strong> which was <strong>to</strong> defraud certa<strong>in</strong> purchasers <strong>of</strong> Docutel securities <strong>in</strong>violation <strong>of</strong> 10b-5(1) <strong>and</strong> (3)).The fraudulent scheme <strong>and</strong> course <strong>of</strong> bus<strong>in</strong>ess <strong>in</strong>volv<strong>in</strong>g Enron was worldwide <strong>in</strong> scope,years <strong>in</strong> duration <strong>and</strong> unprecedented <strong>in</strong> scale. Wrongdo<strong>in</strong>g <strong>of</strong> this scope <strong>and</strong> on this scale couldnot have been accomplished solely by the efforts <strong>of</strong> Enron's executives, no matter how dishonest ordeterm<strong>in</strong>ed they may have been. Wrongdo<strong>in</strong>g <strong>of</strong> this scope <strong>and</strong> on this scale required the skills <strong>and</strong>active participation <strong>of</strong> lawyers, bankers <strong>and</strong> accountants. It could not have happened otherwise.The notion that Central Bank, N.A. v. First Interstate Bank, N.A., 511 U.S. 164 (1994), issueda broad edict that lawyers, banks <strong>and</strong> accountants are immune from liability for their participation<strong>in</strong> complex securities frauds is nonsense. Central Bank expressly recognized: "The absence <strong>of</strong>§10(b) aid<strong>in</strong>g abett<strong>in</strong>g liability does not mean that secondary ac<strong>to</strong>rs <strong>in</strong> the securities markets arealways free from liability under the securities Acts. Any person or entity, <strong>in</strong>clud<strong>in</strong>g a lawyer ...or bank, who employs a manipulative device 16 or makes a material misstatement (or omission) onwhich a purchaser ... relies 17 may be liable as a primary viola<strong>to</strong>r under 10b-5 .... In any complex16As po<strong>in</strong>ted out earlier, the Court has previously held that §10(b)'s language "'anymanipulative or deceptive device or contrivance'" <strong>in</strong>cludes a "scheme <strong>to</strong> deceive" or "scheme, plan,or artifice." Hochfelder, 425 U.S. at 197, 199 n.20.17Because this action's 1934 Act claims are "fraud-on-the-market" claims, reliance isestablished, i.e., presumed, based on the materiality <strong>of</strong> false representations <strong>to</strong> the market, subject<strong>to</strong> defendants' right <strong>to</strong> rebut that presumption. Basic Inc. v. Lev<strong>in</strong>son, 485 U.S. 224, 247 (1988);Summit Props. v. Hoechst Celanese Corp., 214 F.3d 556, 561 (5th Cir. 2000), cert. denied, 531 U.S.- 34 -
securities fraud, moreover, there are likely <strong>to</strong> be multiple viola<strong>to</strong>rs ...." Central Bank, 511 U.S. at191. A scheme <strong>to</strong> defraud <strong>of</strong>ten will <strong>in</strong>volve a variety <strong>of</strong> ac<strong>to</strong>rs, <strong>and</strong> <strong>in</strong>ves<strong>to</strong>rs are entitled <strong>to</strong> allege"that a group <strong>of</strong> defendants acted <strong>to</strong>gether <strong>to</strong> violate the securities laws, as long as each defendantcommitted a manipulative or deceptive act <strong>in</strong> furtherance <strong>of</strong> the scheme." Cooper v. Pickett, 137F.3d 616, 624 (9th Cir. 1998); accord SEC v. First Jersey Secs., 101 F.3d 1450, 1471 (2d Cir. 1996).Central Bank denied recovery <strong>to</strong> victims <strong>of</strong> an alleged securities fraud who pleaded only onetheory <strong>of</strong> recovery aga<strong>in</strong>st a bank defendant – "secondary" liability they dubbed "aid<strong>in</strong>g <strong>and</strong>abett<strong>in</strong>g." Central Bank, 511 U.S. at 188. However, neither the words aid<strong>in</strong>g <strong>and</strong> abett<strong>in</strong>g nor anyother language encompass<strong>in</strong>g aid<strong>in</strong>g <strong>and</strong> abett<strong>in</strong>g appear <strong>in</strong> §10(b) or Rule 10b-5. The Court said"[T]he text <strong>of</strong> the 1934 Act does not itself reach those who aid <strong>and</strong> abet a §10(b) violation ... [<strong>and</strong>]that conclusion resolves the case." Id. at 177. The Central Bank pla<strong>in</strong>tiffs did not, as the pla<strong>in</strong>tiffsdo here, plead or pursue recovery under the theory that the bank defendant (i) made false <strong>and</strong>mislead<strong>in</strong>g statements <strong>in</strong> Registration Statements where the bank acted as underwriter <strong>in</strong> sell<strong>in</strong>gsecurities or other documents the bank issued <strong>to</strong> the public, e.g., analyst reports, or (ii) employedacts, manipulative or deceptive devices <strong>and</strong> contrivances, or (iii) engaged <strong>in</strong> a fraudulent scheme orcourse <strong>of</strong> bus<strong>in</strong>ess that operated as a fraud or deceit on purchasers <strong>of</strong> the securities <strong>in</strong> issue. In thewords <strong>of</strong> the Court, the pla<strong>in</strong>tiffs "concede that Central Bank did not commit a manipulative ordeceptive act with<strong>in</strong> the mean<strong>in</strong>g <strong>of</strong> §10(b)." Id. at 191. Pla<strong>in</strong>tiffs here make no such concession.Thus, because the Central Bank pla<strong>in</strong>tiffs made fatal concessions <strong>and</strong> pursued a theory <strong>of</strong> recoverywhich found no support <strong>in</strong> the text <strong>of</strong> either the statute or the rule, they lost.Central Bank cannot mean that a defendant cannot be liable under §10(b) unless thedefendant itself made mislead<strong>in</strong>g statements because the Court later rejected that very argument <strong>in</strong>United States v. O'Hagan, 521 U.S. 642 (1997). The Eighth Circuit had held that, under CentralBank, "§10(b) covers only deceptive statements or omissions on which purchasers <strong>and</strong> sellers ...rely." Id. at 664. The Court reversed, hold<strong>in</strong>g that §10(b) does not require a defendant <strong>to</strong> speak.Id. Because §10(b) prohibits "any manipulative or deceptive device or contrivance" <strong>in</strong> contravention1132 (2001); F<strong>in</strong>e v. American Solar K<strong>in</strong>g Corp., 919 F.2d 290, 298 (5th Cir. 1990).- 35 -
<strong>of</strong> SEC rules, this reaches "any deceptive device," whether or not the defendant spoke. Id. at 650-51.Super<strong>in</strong>tendent <strong>of</strong> Ins., 404 U.S. 6, is consistent with O'Hagan. In Super<strong>in</strong>tendent <strong>of</strong> Ins., aunanimous Court upheld a §10b/Rule10b-5 compla<strong>in</strong>t <strong>in</strong>volv<strong>in</strong>g a "fraudulent scheme" <strong>in</strong>volv<strong>in</strong>gthe sale <strong>of</strong> securities where no false statement was alleged because:Id. at 9.There certa<strong>in</strong>ly was an "act" or "practice" with<strong>in</strong> the mean<strong>in</strong>g <strong>of</strong> Rule 10b-5which operated as "a fraud or deceit" on Manhattan, the seller <strong>of</strong> the Governmentbonds.In fact, this Court has repeatedly stated: "A defendant need not have made a false ormislead<strong>in</strong>g statement <strong>to</strong> be liable." L<strong>and</strong>ry's, slip op. at 9 n.12; In re Waste Mgmt, Inc. Sec. Litig.,Civ. No. H-99-2183, slip op. at 75 (S.D. Tex., Aug. 16, 2001); 18 In re Sec. Litig. BMC S<strong>of</strong>tware, Inc.,183 F. Supp. 2d 860, 869 (S.D. Tex. 2001). Thus, while actually mak<strong>in</strong>g false statements is not<strong>in</strong>dispensable <strong>to</strong> §10(b)/Rule 10b-5 liability, here CS First Bos<strong>to</strong>n made false statements <strong>in</strong>Registration Statements <strong>and</strong> analyst reports.That this read<strong>in</strong>g <strong>of</strong> §10(b)/Rule 10b-5 is clearly correct is shown by a new unanimousSupreme Court decision – SEC v. Z<strong>and</strong>ford, __ U.S. __, No. 01-147, 2002 U.S. LEXIS 4023 (June3, 2002). In Z<strong>and</strong>ford, the Court repeatedly cited with approval its sem<strong>in</strong>al "fraudulent scheme"case Super<strong>in</strong>tendent <strong>of</strong> Ins., <strong>and</strong> reversed dismissal <strong>of</strong> a §10(b)/Rule 10b-5 compla<strong>in</strong>t mak<strong>in</strong>g thefollow<strong>in</strong>g key po<strong>in</strong>ts:• "The scope <strong>of</strong> Rule 10b-5 is coextensive with the coverage <strong>of</strong> §10(b) ...." Id. at *7n.1.• "[N]either the SEC nor this Court has ever held that there must be a misrepresentationabout the value <strong>of</strong> a particular security" <strong>to</strong> violate §10(b). Id. at *13. 19• Allegations that defendant "'engaged <strong>in</strong> a fraudulent scheme'" or "'course <strong>of</strong>bus<strong>in</strong>ess that operated as a fraud or deceit'" stated a §10(b) claim. Id. at *13, *14-*17.Due <strong>to</strong> the length <strong>of</strong> the op<strong>in</strong>ions <strong>in</strong> L<strong>and</strong>ry's <strong>and</strong> Waste Mgmt., <strong>and</strong> the fact that this Courthas access <strong>to</strong> them, they have not been attached <strong>to</strong> this brief.1819To the extent Ziemba v. Cascade Int'l, Inc., 256 F.3d 1194, 1205 (11th Cir. 2001), seems <strong>to</strong>require a statement be made about a company which is "publicly attributable <strong>to</strong> the defendant at thetime the pla<strong>in</strong>tiff's <strong>in</strong>vestment decision was made," it is <strong>in</strong>consistent with Z<strong>and</strong>ford.- 36 -
Central Bank clearly – but merely – st<strong>and</strong>s for the proposition that no aid<strong>in</strong>g <strong>and</strong> abett<strong>in</strong>gliability exists under the 1934 Act because neither §10(b) nor Rule 10b-5 conta<strong>in</strong> languageencompass<strong>in</strong>g "aid<strong>in</strong>g <strong>and</strong> abett<strong>in</strong>g." The decision <strong>in</strong> Central Bank is actually quite narrow. Bycontrast, the language <strong>of</strong> §10(b) <strong>and</strong> Rule 10b-5 is very broad <strong>and</strong> the purposes <strong>of</strong> §10(b) <strong>and</strong> Rule10b-5 are remedial, <strong>in</strong>tended <strong>to</strong> provide access <strong>to</strong> federal court <strong>to</strong> persons victimized <strong>in</strong> fraudulentsecurities transactions:[T]he 1934 Act <strong>and</strong> its companion legislative enactments [<strong>in</strong>clud<strong>in</strong>g the 1933 Act]embrace a "fundamental purpose ... <strong>to</strong> substitute a philosophy <strong>of</strong> full disclosure forthe philosophy <strong>of</strong> caveat emp<strong>to</strong>r <strong>and</strong> thus <strong>to</strong> achieve a high st<strong>and</strong>ard <strong>of</strong> bus<strong>in</strong>essethics <strong>in</strong> the securities <strong>in</strong>dustry".... Congress <strong>in</strong>tended securities legislation enactedfor the purpose <strong>of</strong> avoid<strong>in</strong>g frauds <strong>to</strong> be construed "not technically <strong>and</strong> restrictively,but flexibly <strong>to</strong> effectuate its remedial purposes."Affiliated Ute Citizens, 406 U.S. at 151. As noted by the Fifth Circuit:[T]he Court has concluded that the Exchange Act <strong>and</strong> the Securities Act should beconstrued broadly <strong>to</strong> effectuate the statu<strong>to</strong>ry policy afford<strong>in</strong>g extensive protection<strong>to</strong> the <strong>in</strong>vest<strong>in</strong>g public. See Tcherepn<strong>in</strong>, 389 U.S. at 336, 88 S. Ct. at 553. See alsoS. Rep. No. 47, 73d Cong. 1st Sess. 1 (1933) (<strong>in</strong>dicat<strong>in</strong>g legislative <strong>in</strong>tent <strong>of</strong> theSecurities Act <strong>to</strong> protect the public from the sale <strong>of</strong> fraudulent <strong>and</strong> speculativeschemes).Meason v. Bank <strong>of</strong> Miami, 652 F.2d 542, 549 (5th Cir. 1981). "The federal securities statutes areremedial legislation <strong>and</strong> must be construed broadly, not technically <strong>and</strong> restrictively." Paul F.New<strong>to</strong>n & Co. v. Texas Commerce Bank, 630 F.2d 1111, 1118 (5th Cir. 1980).Here, CS First Bos<strong>to</strong>n did it all. CS First Bos<strong>to</strong>n made false statements <strong>in</strong> three RegistrationStatements where CS First Bos<strong>to</strong>n sold Enron <strong>and</strong> Enron-related securities <strong>and</strong> <strong>in</strong> CS First Bos<strong>to</strong>n's18 analyst reports on Enron. And CS First Bos<strong>to</strong>n employed specified acts, manipulative ordeceptive devices <strong>and</strong> contrivances <strong>to</strong> help falsify Enron's f<strong>in</strong>ances <strong>and</strong> which were essential <strong>to</strong> theongo<strong>in</strong>g fraudulent scheme <strong>and</strong> course <strong>of</strong> bus<strong>in</strong>ess. In short, <strong>in</strong> order <strong>to</strong> pocket billions <strong>of</strong> dollars<strong>of</strong> fees, commissions, <strong>in</strong>terest <strong>and</strong> other charges – pr<strong>of</strong>its from its <strong>in</strong>vestment <strong>in</strong> the fraudulentscheme <strong>and</strong> course <strong>of</strong> bus<strong>in</strong>ess – CS First Bos<strong>to</strong>n facilitated, furthered <strong>and</strong> participated <strong>in</strong> the fraud.All <strong>of</strong> these activities directly contravened prohibitions <strong>of</strong> the 1934 Act. CS First Bos<strong>to</strong>n was notan unwitt<strong>in</strong>g victim <strong>of</strong> the fraud <strong>in</strong>volv<strong>in</strong>g Enron – it was an active perpetra<strong>to</strong>r <strong>of</strong> <strong>and</strong> participant<strong>in</strong> that fraud. Thus, CS First Bos<strong>to</strong>n's alleged liability is "primary" <strong>and</strong> not "secondary."- 37 -
Not only does the CC assert viable legal theories <strong>of</strong> recovery aga<strong>in</strong>st CS First Bos<strong>to</strong>n underthe 1934 Act, it also pleads <strong>in</strong> detail why the statements made by CS First Bos<strong>to</strong>n were false whenmade <strong>and</strong> why CS First Bos<strong>to</strong>n knew or recklessly disregarded that those statements were false,thus satisfy<strong>in</strong>g the two-pronged plead<strong>in</strong>g st<strong>and</strong>ard, i.e., "falsity" <strong>and</strong> "scienter," <strong>of</strong> the 95 Act asapplicable <strong>to</strong> the 1934 Act. 15 U.S.C. §78u-4.The Registration Statement CS First Bos<strong>to</strong>n used <strong>to</strong> sell 27.6 million shares <strong>of</strong> Enroncommon s<strong>to</strong>ck <strong>in</strong> 2/99 conta<strong>in</strong>ed Enron's false 97 <strong>and</strong> 98 f<strong>in</strong>ancial results <strong>and</strong> false statementsconcern<strong>in</strong>g the structures <strong>of</strong> <strong>and</strong> Enron's relationship <strong>to</strong> SPEs <strong>and</strong> related parties, Enron's f<strong>in</strong>ancialrisk management statistics, as well as the condition <strong>of</strong> Enron's bus<strong>in</strong>ess operations <strong>and</strong> the value <strong>of</strong>its assets. The Registration Statement for the 10/00 New Power IPO conta<strong>in</strong>ed false statements. See<strong>in</strong>fra at 95-96. The 18 CS First Bos<strong>to</strong>n analyst reports on Enron issued between 7/99-10/01 alsoconta<strong>in</strong>ed false statements about Enron's f<strong>in</strong>ancial results <strong>and</strong> f<strong>in</strong>ancial condition <strong>and</strong> the success <strong>of</strong>Enron's EES <strong>and</strong> EBS bus<strong>in</strong>esses. See <strong>in</strong>fra at 78-93. Thus, the allegedly false statements made byCS First Bos<strong>to</strong>n are quoted, specified by the date made, <strong>and</strong> the reasons the statements were falsewhen made are pleaded, satisfy<strong>in</strong>g the 95 Act's "falsity" plead<strong>in</strong>g requirement.CS First Bos<strong>to</strong>n's scienter, i.e., its "required state <strong>of</strong> m<strong>in</strong>d," is also well pleaded. The CCexpla<strong>in</strong>s how, due <strong>to</strong> the close <strong>in</strong>volvement <strong>of</strong> CS First Bos<strong>to</strong>n <strong>to</strong>p executives <strong>and</strong> commercial <strong>and</strong><strong>in</strong>vestment bankers with Enron, <strong>in</strong> lend<strong>in</strong>g, deal-mak<strong>in</strong>g <strong>and</strong> other activities, CS First Bos<strong>to</strong>n knew<strong>of</strong> the falsity <strong>of</strong> the statements it was mak<strong>in</strong>g <strong>in</strong> Registration Statements <strong>and</strong> analyst reportsconcern<strong>in</strong>g Enron. See <strong>in</strong>fra §VI. The CC also details numerous specific fraudulent Enrontransactions <strong>in</strong>volv<strong>in</strong>g CS First Bos<strong>to</strong>n – which were <strong>in</strong>tentionally deceptive acts or contrivances <strong>to</strong>deceive – falsify<strong>in</strong>g Enron's publicly reported f<strong>in</strong>ancial results <strong>and</strong> f<strong>in</strong>ancial condition <strong>to</strong> makeEnron's bus<strong>in</strong>ess appear <strong>to</strong> be successful when it was not. These <strong>in</strong>clude:• Phony swap transactions by which CS First Bos<strong>to</strong>n enabled Enron <strong>to</strong> artificiallymanipulate <strong>and</strong> boost its revenues <strong>and</strong> disguise millions <strong>of</strong> dollars <strong>of</strong> loans <strong>to</strong>Enron. 44-45, 565-568, 706-711.• Help<strong>in</strong>g <strong>to</strong> "pre-fund" Enron's LJM2 partnership <strong>in</strong> the last days <strong>of</strong> 12/99 with$750,000 advanced by several CS First Bos<strong>to</strong>n executives through DLJ FundInvestment Partners III, L.P., which enabled LJM2 <strong>to</strong> fund four critical (<strong>and</strong> phony)year-end 99 deals with Enron <strong>to</strong> <strong>in</strong>flate Enron's 99 results – generat<strong>in</strong>g false pr<strong>of</strong>its<strong>and</strong> hid<strong>in</strong>g hundreds <strong>of</strong> millions <strong>of</strong> dollars <strong>of</strong> debt. 26-29, 647, 881-882.- 38 -
• Dur<strong>in</strong>g 99-01, CS First Bos<strong>to</strong>n executives ultimately put $22.5 million <strong>in</strong><strong>to</strong> LJM2,as CS First Bos<strong>to</strong>n made $120 million <strong>in</strong> loans <strong>to</strong> LJM2 <strong>to</strong> allow LJM2'sparticipation <strong>in</strong> billions <strong>of</strong> dollars worth <strong>of</strong> non-arm's-length transactions with Enron<strong>to</strong> boost its pr<strong>of</strong>its <strong>and</strong> hide billions <strong>of</strong> dollars <strong>of</strong> debt, while CS First Bos<strong>to</strong>nexecutives pocketed the fruits <strong>of</strong> the loot<strong>in</strong>g <strong>of</strong> Enron via these transactions. 26-27, 693, 712.• Design<strong>in</strong>g <strong>and</strong> structur<strong>in</strong>g the LJM2 SPEs <strong>and</strong> their non-arm's-length transactionswith Enron by which Enron artificially <strong>in</strong>flated its pr<strong>of</strong>its <strong>and</strong> hid debt while theLJM2 <strong>in</strong>ves<strong>to</strong>rs benefitted from the loot<strong>in</strong>g <strong>of</strong> Enron. 707, 712.F<strong>in</strong>ally, <strong>in</strong> addition <strong>to</strong> CS First Bos<strong>to</strong>n's alleged knowledge <strong>of</strong> the fraud <strong>and</strong> <strong>in</strong>tentional<strong>in</strong>volvement <strong>in</strong> many <strong>of</strong> Enron's deceptive <strong>and</strong> fraudulent transactions, the CC details CS FirstBos<strong>to</strong>n's motive <strong>and</strong> opportunity 20 <strong>to</strong> engage <strong>and</strong> participate <strong>in</strong> the fraudulent scheme <strong>and</strong> course <strong>of</strong>bus<strong>in</strong>ess. CS First Bos<strong>to</strong>n was reap<strong>in</strong>g huge amounts <strong>of</strong> money from the scheme via underwrit<strong>in</strong>gdiscounts, loan commitment fees, <strong>in</strong>terest charges, advisory fees <strong>and</strong> the like. Also, <strong>to</strong>p CS FirstBos<strong>to</strong>n <strong>of</strong>ficials were be<strong>in</strong>g rewarded by be<strong>in</strong>g allowed <strong>to</strong> get <strong>in</strong> on LJM2 <strong>and</strong> thus were reap<strong>in</strong>ghuge returns as secret <strong>in</strong>ves<strong>to</strong>rs <strong>in</strong> the LJM2 partnership, 21 unusually pr<strong>of</strong>itable returns generatedby that entity's illicit deals with Enron SPEs – transactions CS First Bos<strong>to</strong>n knew would collapseif Enron's s<strong>to</strong>ck fell through the equity issuance trigger prices embedded <strong>in</strong> those LJM2/SPEdeals.CS First Bos<strong>to</strong>n had made large loans <strong>to</strong> Enron <strong>and</strong> was also obligated <strong>to</strong> fund a $3 billioncommercial paper back-up l<strong>in</strong>e <strong>of</strong> credit <strong>to</strong> Enron if Enron could no longer borrow <strong>in</strong> the commercialpaper market – creat<strong>in</strong>g another powerful <strong>in</strong>centive for CS First Bos<strong>to</strong>n <strong>to</strong> take steps <strong>to</strong> not only keepEnron look<strong>in</strong>g highly pr<strong>of</strong>itable <strong>and</strong> solvent, but <strong>to</strong> ma<strong>in</strong>ta<strong>in</strong> its coveted <strong>in</strong>vestment grade creditrat<strong>in</strong>g, which provided Enron access <strong>to</strong> the commercial paper market.20By sell<strong>in</strong>g Enron <strong>and</strong> Enron-related securities <strong>and</strong> issu<strong>in</strong>g analyst reports on Enron <strong>and</strong>help<strong>in</strong>g structure <strong>and</strong> f<strong>in</strong>ance Enron's illicit partnerships <strong>and</strong> their related SPE transactions, CS FirstBos<strong>to</strong>n had plenty <strong>of</strong> opportunity <strong>to</strong> mislead <strong>in</strong>ves<strong>to</strong>rs <strong>and</strong> advance the fraud as well.21The returns <strong>to</strong> the LJM2 <strong>in</strong>ves<strong>to</strong>rs were huge – up <strong>to</strong> 2,500% on one deal <strong>and</strong> 51% overall<strong>in</strong> the first year <strong>of</strong> the partnership. Skill<strong>in</strong>g has recently <strong>to</strong>ld <strong>in</strong>vestiga<strong>to</strong>rs such gargantuanreturns were possible only because LJM2, with Fas<strong>to</strong>w at the wheel, was defraud<strong>in</strong>g Enron <strong>in</strong> thebillions <strong>of</strong> dollars <strong>of</strong> deals it was do<strong>in</strong>g with Enron so Enron could create false pr<strong>of</strong>its <strong>and</strong> hidebillions <strong>of</strong> dollars <strong>in</strong> debt. Kurt Eichenwald, "Enron Ex-Chief Said <strong>to</strong> Voice Suspicion <strong>of</strong> Fraud,"New York Times, 4/24/02.- 39 -
Thus, as <strong>to</strong> CS First Bos<strong>to</strong>n, the CC pleads 1934 Act "primary liability" based on legaltheories <strong>of</strong> recovery rooted <strong>in</strong> the express language <strong>of</strong> §10(b) <strong>and</strong> Rule 10b-5 <strong>and</strong> pleads the facts<strong>in</strong> sufficient detail <strong>to</strong> satisfy the "falsity" <strong>and</strong> "scienter" prongs <strong>of</strong> the 95 Act's plead<strong>in</strong>g st<strong>and</strong>ard.And, <strong>in</strong> fact, many courts have upheld compla<strong>in</strong>ts aga<strong>in</strong>st banks <strong>in</strong> §10(b)/Rule 10b-5 caseswhere, as here, false statements, manipulative or deceptive devices, contrivances <strong>and</strong> acts, <strong>and</strong>participation <strong>in</strong> a scheme <strong>to</strong> defraud have been alleged with sufficient particularity. Cooper, 137F.3d at 628 (Scheme liability survived Central Bank. Pla<strong>in</strong>tiffs' allegations that the <strong>in</strong>vestment bankdefendants had issued analyst reports that they knew were false because they had "access <strong>to</strong> <strong>in</strong>side<strong>in</strong>formation" stated a valid §10(b)/Rule 10b-5 claim.); In re Livent, Inc., 174 F. Supp. 2d 144, 150-52 (S.D.N.Y. 2001) (compla<strong>in</strong>t alleg<strong>in</strong>g <strong>in</strong>vestment bank made disguised loan <strong>to</strong> Livent enabl<strong>in</strong>gLivent <strong>to</strong> falsify f<strong>in</strong>ancial condition while sell<strong>in</strong>g securities <strong>to</strong> public states valid §10(b)/Rule 10b-5claims); Murphy v. Hollywood Entm't Corp., No. 95-1926-MA, 1996 U.S. Dist. LEXIS 22207 (D.Or. May 9, 1996); Flecker v. Hollywood Entm't Corp., No. 95-1926-MA, 1997 U.S. Dist. LEXIS5329, at *25 (D. Or. Feb. 12 1997) (refused <strong>to</strong> dismiss a compla<strong>in</strong>t aga<strong>in</strong>st <strong>in</strong>vestment bankers <strong>and</strong>then later refused <strong>to</strong> grant summary judgment <strong>to</strong> those banks, stat<strong>in</strong>g that their "roles as analysts,<strong>in</strong>vestment bankers <strong>and</strong> bus<strong>in</strong>ess advisors with extensive contacts with [issuer] defendants,superior access <strong>to</strong> non-public <strong>in</strong>formation <strong>and</strong> participation <strong>in</strong> both draft<strong>in</strong>g <strong>and</strong> decision-mak<strong>in</strong>gis sufficient <strong>to</strong> establish a triable primary liability claim under §10(b)"); In re Cascade Int'l Sec.Litig., 840 F. Supp. 1558, 1568 (S.D. Fla. 1993) (allegations that a securities broker issued falsereports on company which made exaggerated predictions while ignor<strong>in</strong>g "red flags" sufficient <strong>to</strong>show recklessness); McNamara v. Bre-X-M<strong>in</strong>erals Ltd., No 5:97-CV-159, 2001 U.S. Dist. LEXIS4571, at *166 (E.D. Tex. Mar. 30, 2001) (denied motion <strong>to</strong> dismiss by J.P. Morgan based onallegations it participated <strong>in</strong> a scheme <strong>to</strong> violate §10(b) <strong>and</strong> Rule 10b-5 by help<strong>in</strong>g <strong>to</strong> structurefraudulent bus<strong>in</strong>ess transactions, act<strong>in</strong>g as Bre-X's f<strong>in</strong>ancial advisor, <strong>and</strong> issu<strong>in</strong>g false analysts'reports, while ignor<strong>in</strong>g "red flags" that Bre-X's assets were falsified). See also SEC v. U.S. Envtl.,Inc., 155 F.3d 107, 112 (2d Cir. 1998) (while there is no aid<strong>in</strong>g <strong>and</strong> abett<strong>in</strong>g, compla<strong>in</strong>t properlyalleged defendant <strong>to</strong> be primary viola<strong>to</strong>r because he "'participated <strong>in</strong> the fraudulent scheme,'" not<strong>in</strong>g"lawyers, accountants, <strong>and</strong> banks who engage <strong>in</strong> fraudulent or deceptive practices at their client's- 40 -
direction [are] primary viola<strong>to</strong>r[s]"); Scholnick v. Cont<strong>in</strong>ental Bank, 752 F. Supp. 1317, 1323 & n.9(E.D. Mich. 1990) ("bank ... may still be held liable under Rule 10b-5(a) <strong>and</strong> 10b-5(c) as aparticipant <strong>in</strong> the allegedly fraudulent scheme" <strong>and</strong> "allegations that Cont<strong>in</strong>ental was directly<strong>in</strong>volved <strong>in</strong> perpetrat<strong>in</strong>g a fraudulent scheme dist<strong>in</strong>guish" case from situation where bank was onlyengag<strong>in</strong>g <strong>in</strong> a "'rout<strong>in</strong>e commercial f<strong>in</strong>anc<strong>in</strong>g transaction'"). Thus, the CC <strong>in</strong> this action pleads morewrongful conduct by CS First Bos<strong>to</strong>n vis-à-vis the fraudulent scheme <strong>in</strong>volv<strong>in</strong>g Enron <strong>and</strong> with morespecificity than was pleaded <strong>in</strong> any <strong>of</strong> the above cases where compla<strong>in</strong>ts nam<strong>in</strong>g banks as defendants<strong>in</strong> §10(b)/Rule 10b-5 actions were upheld.Of course, as with most fraudulent schemes, the scheme <strong>to</strong> falsify Enron's f<strong>in</strong>ances <strong>and</strong> <strong>in</strong>flatethe prices <strong>of</strong> its securities – <strong>and</strong> susta<strong>in</strong> its fraudulent course <strong>of</strong> bus<strong>in</strong>ess – ultimately collapsed fromthe accumulated weight <strong>of</strong> years <strong>of</strong> deceit <strong>and</strong> deception. But the fact that the scheme ultimatelycollapsed <strong>in</strong> late 01 is <strong>of</strong> little legal moment. It had succeeded for years, enrich<strong>in</strong>g the perpetra<strong>to</strong>rs<strong>to</strong> the tune <strong>of</strong> billions <strong>of</strong> dollars. Securities viola<strong>to</strong>rs frequently f<strong>in</strong>d themselves <strong>in</strong>volved <strong>in</strong>complicated schemes by which f<strong>in</strong>ancial reports are manipulated, securities prices are <strong>in</strong>flated, <strong>and</strong>new securities are sold <strong>to</strong> the public, <strong>and</strong> yet, despite all their efforts <strong>to</strong> perpetuate the wrongdo<strong>in</strong>g,the scheme ultimately collapses <strong>and</strong> their participation is disclosed. But participants <strong>in</strong> fraudulentschemes – especially securities Ponzi schemes like Enron – expect them <strong>to</strong> succeed <strong>and</strong> take action<strong>to</strong> help them cont<strong>in</strong>ue <strong>to</strong> succeed, as they ga<strong>in</strong> more pr<strong>of</strong>its from the scheme as long as itcont<strong>in</strong>ues. The fact that such complex schemes may ultimately fail – <strong>and</strong> the perpetra<strong>to</strong>rs may thensuffer some loss – <strong>in</strong> no way shields them from liability for the damage <strong>in</strong>flicted on the victims <strong>of</strong>their unlawful conduct while the scheme was succeed<strong>in</strong>g. In the end it is the public <strong>in</strong>ves<strong>to</strong>rs <strong>in</strong> asituation like Enron – the people <strong>and</strong> pension funds who <strong>in</strong>vested billions <strong>of</strong> dollars <strong>to</strong> purchasenewly issued Enron securities <strong>and</strong> the publicly traded securities <strong>of</strong> Enron at <strong>in</strong>flated prices – thatare left hold<strong>in</strong>g the bag. They are the ones who are truly damaged. And the federal securities lawsare supposed <strong>to</strong> protect them.The important remedial purposes <strong>of</strong> <strong>in</strong>ves<strong>to</strong>r suits under the anti-fraud provisions <strong>of</strong> the 1934Act were ratified by Congress when it enacted the 95 Act:- 41 -
The overrid<strong>in</strong>g purpose <strong>of</strong> our Nation's securities laws is <strong>to</strong> protect <strong>in</strong>ves<strong>to</strong>rs<strong>and</strong> <strong>to</strong> ma<strong>in</strong>ta<strong>in</strong> confidence <strong>in</strong> the securities markets, so that our national sav<strong>in</strong>gs,capital formation <strong>and</strong> <strong>in</strong>vestment may grow for the benefit <strong>of</strong> all Americans.Private securities litigation is an <strong>in</strong>dispensable <strong>to</strong>ol with which defrauded <strong>in</strong>ves<strong>to</strong>rscan recover their losses without hav<strong>in</strong>g <strong>to</strong> rely upon government action. Such privatelawsuits promote public <strong>and</strong> global confidence <strong>in</strong> our capital markets <strong>and</strong> help <strong>to</strong>deter wrongdo<strong>in</strong>g <strong>and</strong> <strong>to</strong> guarantee that corporate <strong>of</strong>ficers, audi<strong>to</strong>rs, direc<strong>to</strong>rs,lawyers <strong>and</strong> others properly perform their jobs.141 Cong. Rec. H. 13691, at *H13699 (daily ed. Nov. 28, 1995). The 95 Act's plead<strong>in</strong>grequirements must be applied <strong>and</strong> <strong>in</strong>terpreted with these important pr<strong>in</strong>ciples <strong>in</strong> m<strong>in</strong>d.It is an unfortunate reality that the worst securities frauds create the most difficult situationsfor the victims. 22 The issuer (here Enron) goes bankrupt – <strong>and</strong> is shielded from liability. Whateverdirec<strong>to</strong>rs' <strong>and</strong> <strong>of</strong>ficers' liability <strong>in</strong>surance policies exist (here some $350 million) are impaired – asthe carriers can claim that they were defrauded <strong>in</strong><strong>to</strong> issu<strong>in</strong>g the policies by the issuer's false f<strong>in</strong>ancialstatements. Here, the situation is further exacerbated by the fact that Andersen, which played asignificant role <strong>in</strong> the fraud, is f<strong>in</strong>ancially impecunious <strong>and</strong> able <strong>to</strong> pay only a fraction <strong>of</strong> the damagessuffered by the victims.If Enron <strong>in</strong>ves<strong>to</strong>rs are <strong>to</strong> achieve any significant recovery here, <strong>in</strong> what is acknowledged <strong>to</strong>be the largest <strong>and</strong> worst f<strong>in</strong>ancial fraud <strong>in</strong> U.S. his<strong>to</strong>ry, it will only be because our nation's securitieslaws permit these victims <strong>to</strong> hold accountable securities pr<strong>of</strong>essionals like banks <strong>and</strong> lawyers – whoare supposed <strong>to</strong> safeguard the public <strong>in</strong> securities transactions – for their misconduct <strong>in</strong>employ<strong>in</strong>g acts <strong>and</strong> contrivances <strong>to</strong> deceive, participat<strong>in</strong>g <strong>in</strong> a scheme <strong>to</strong> defraud <strong>and</strong> a course <strong>of</strong>bus<strong>in</strong>ess that operated as a fraud or deceit on those purchasers <strong>of</strong> Enron's securities. One man'sdeep pocket is another's legitimate defendant. If our Nation's securities laws do not provide anopportunity for the thous<strong>and</strong>s <strong>of</strong> <strong>in</strong>ves<strong>to</strong>rs <strong>in</strong> Enron – what appeared <strong>to</strong> be a hugely successful publiccompany earn<strong>in</strong>g a billion dollars <strong>of</strong> pr<strong>of</strong>it a year – <strong>to</strong> pursue Enron's bankers <strong>and</strong> lawyers, whoallegedly engaged <strong>and</strong> participated <strong>in</strong> the fraudulent scheme <strong>and</strong> course <strong>of</strong> bus<strong>in</strong>ess, that will makea mockery <strong>of</strong> the <strong>in</strong>ves<strong>to</strong>r protection purposes <strong>of</strong> our securities laws. To put it bluntly, if the 95 Act'senhanced plead<strong>in</strong>g st<strong>and</strong>ard comb<strong>in</strong>ed with the Court's decision <strong>in</strong> Central Bank operate <strong>to</strong> shieldFor <strong>in</strong>stance, Equity Fund<strong>in</strong>g, U.S. F<strong>in</strong>ancial, L<strong>in</strong>coln Sav<strong>in</strong>gs, Wash<strong>in</strong>g<strong>to</strong>n Public PowerSupply Systems <strong>and</strong> Global Cross<strong>in</strong>g.22- 42 -
the banks named as defendants here from even hav<strong>in</strong>g <strong>to</strong> answer the CC <strong>and</strong> defend the allegationson the merits, then Congress will have <strong>to</strong> act by ameliorat<strong>in</strong>g that harsh plead<strong>in</strong>g st<strong>and</strong>ard <strong>and</strong>res<strong>to</strong>r<strong>in</strong>g aid<strong>in</strong>g <strong>and</strong> abett<strong>in</strong>g liability.III.DETAILED ALLEGATIONS REGARDING THE INVOLVEMENT OF CSFIRST BOSTONIn review<strong>in</strong>g the sufficiency <strong>of</strong> a compla<strong>in</strong>t <strong>in</strong> response <strong>to</strong> a motion <strong>to</strong> dismissfor failure <strong>to</strong> state a claim under Fed. R. Civ. P. 12(b)(6), before any evidence hasbeen submitted, the district court's task is limited. Scheuer v. Rhodes, 416 U.S. 232,236 (1974). The issue is not whether a pla<strong>in</strong>tiff will ultimately prevail but whetherthe claimant is entitled <strong>to</strong> <strong>of</strong>fer evidence <strong>to</strong> support its claims. Id. The district courtshould consider all allegations <strong>in</strong> favor <strong>of</strong> the pla<strong>in</strong>tiff <strong>and</strong> accept as true all wellpleadedfacts <strong>in</strong> the compla<strong>in</strong>t. Lawal v. British Airways, PLC, 812 F. Supp. 713,716 (S.D. Tex. 1992). Dismissal is not appropriate "unless it appears beyond a doubtthat the pla<strong>in</strong>tiff can prove no set <strong>of</strong> facts <strong>in</strong> support <strong>of</strong> [his] claim which wouldentitle him <strong>to</strong> relief." Conley v. Gibson, 355 U.S. 41, 45-46 (1957).L<strong>and</strong>ry's, slip op. at 4 n.8. As the Fifth Circuit recently stated, "we will accept the facts alleged <strong>in</strong>the compla<strong>in</strong>t as true <strong>and</strong> construe the allegations <strong>in</strong> the light most favorable <strong>to</strong> the pla<strong>in</strong>tiffs."Nathenson v. Zonagen Inc., 267 F.3d 400, 406 (5th Cir. 2001). This Court must consider theallegations <strong>in</strong> their entirety. As Judge Buchmeyer stated <strong>in</strong> STI Classic Fund v. Boll<strong>in</strong>ger Indus.,Inc., No. 3-96-CV-823-R, 1996 U.S. Dist. LEXIS 21553, at *5 (N.D. Tex. Oct. 25, 1996), it isimproper <strong>to</strong> isolate "the circumstances alleged <strong>in</strong> Pla<strong>in</strong>tiffs' amended compla<strong>in</strong>t rather than <strong>to</strong>consider them <strong>in</strong> their <strong>to</strong>tality." Id. 23CS First Bos<strong>to</strong>n seems <strong>to</strong> argue that the three-year statute <strong>of</strong> repose for 1934 Act claims barspla<strong>in</strong>tiffs from pursu<strong>in</strong>g damages aga<strong>in</strong>st it for any time period prior <strong>to</strong> 4/8/99 <strong>and</strong> any consideration<strong>of</strong> its alleged misconduct prior <strong>to</strong> 4/8/99 for plead<strong>in</strong>g or other purposes. We agree as <strong>to</strong> the former23CS First Bos<strong>to</strong>n makes the po<strong>in</strong>t that the 500-page CC uses the words "help" or "helped" <strong>to</strong>describe its conduct vis-à-vis Enron on some occasions. Seiz<strong>in</strong>g on the words help/helped, CS FirstBos<strong>to</strong>n claims that their use conclusively shows that the true core allegation aga<strong>in</strong>st it here is one <strong>of</strong>aid<strong>in</strong>g <strong>and</strong> abett<strong>in</strong>g, which is barred by Central Bank. This argument is wrong. First <strong>of</strong> all, personswho participate <strong>in</strong> a scheme <strong>to</strong> defraud or a course <strong>of</strong> bus<strong>in</strong>ess that operates as a fraud or deceit onpurchasers <strong>of</strong> a public company's securities or employ acts or manipulative or deceptive devices areactually "help<strong>in</strong>g" <strong>to</strong> defraud <strong>in</strong>ves<strong>to</strong>rs. In any event, this is not medieval Engl<strong>and</strong> where meri<strong>to</strong>riousactions are dismissed because pleaders used an ambiguous word or mischaracterized a claim forrelief. Fortunately, <strong>in</strong> the United States <strong>to</strong>day, compla<strong>in</strong>ts are <strong>to</strong> be construed <strong>in</strong> favor <strong>of</strong> the pleaderwith all ambiguities resolved <strong>and</strong> <strong>in</strong>ferences drawn <strong>in</strong> the pleader's favor. And the CC clearly doesrepeatedly allege that CS First Bos<strong>to</strong>n participated <strong>in</strong> a fraudulent scheme or course <strong>of</strong> bus<strong>in</strong>ess whileemploy<strong>in</strong>g acts <strong>and</strong>/or contrivances <strong>to</strong> deceive. That conduct is actionable under the text <strong>of</strong> §10(b)<strong>and</strong> Rule 10b-5 as well as the wealth <strong>of</strong> decisions cited <strong>in</strong> this brief.- 43 -
po<strong>in</strong>t, but not as <strong>to</strong> the latter. In other words, while the three-year statute <strong>of</strong> repose bars damagerecovery from CS First Bos<strong>to</strong>n on behalf <strong>of</strong> purchasers who purchased before 4/8/99, it does notaffect pla<strong>in</strong>tiffs' ability <strong>to</strong> plead conduct or present evidence <strong>of</strong> its misconduct prior <strong>to</strong> that date.United States v. Ashdown, 509 F.2d 793 (5th Cir. 1975), affirmed defendants' mail fraud convictions,hold<strong>in</strong>g there was no merit <strong>in</strong> the argument that it was error <strong>to</strong> admit evidence <strong>of</strong> acts committedbeyond the statute <strong>of</strong> limitations period where the evidence helped <strong>to</strong> establish the scheme – "[t]hestatute <strong>of</strong> limitations is a defense <strong>to</strong> prosecution, not a rule <strong>of</strong> evidence. Therefore, once prosecutionis timely <strong>in</strong>stituted, the statute <strong>of</strong> limitations has no bear<strong>in</strong>g on the admissibility <strong>of</strong> evidence." Id.at 798. 24 Instead, the court found that the evidence defendants questioned "helps establish thescheme <strong>and</strong> the guilty <strong>in</strong>tent." Id. Accord United States v. Blosser, 440 F.2d 697, 699 (10th Cir.1971) (evidence <strong>of</strong> mail fraud occurr<strong>in</strong>g before the statute <strong>of</strong> limitations "bore on the existence <strong>of</strong>the scheme <strong>to</strong> defraud, the falsity <strong>of</strong> representations made, <strong>and</strong> <strong>in</strong>tent"). 25A similar result has been obta<strong>in</strong>ed <strong>in</strong> Title VII cases. Fitzgerald v. Henderson, 251 F.3d 345(2d Cir. 2001), held that evidence <strong>of</strong> defendant's sexual advances <strong>and</strong> the fact that the pla<strong>in</strong>tiffrebuffed those advances at an earlier time were relevant <strong>to</strong> show defendant's motivation for the24There is no dispute that as <strong>to</strong> CS First Bos<strong>to</strong>n, claims were timely filed for the three-yearperiod, beg<strong>in</strong>n<strong>in</strong>g 4/8/99.25An early case uphold<strong>in</strong>g this pr<strong>in</strong>ciple is Little v. United States, 73 F.2d 861 (10th Cir. 1934).There, the court held that "if the mails were used <strong>in</strong> execution <strong>of</strong> a fraudulent scheme, it is no defensethat the scheme was formed <strong>and</strong> partially carried out back <strong>of</strong> the statute <strong>of</strong> limitations. Pro<strong>of</strong> runn<strong>in</strong>gback <strong>of</strong> the statute is admissible provided it is connected up with the scheme exist<strong>in</strong>g when theletters were mailed." Id. at 867; accord United States v. Marconi, 899 F. Supp. 458, 463 (C.D. Cal.1995) (Defendant misunders<strong>to</strong>od the nature <strong>of</strong> the statute <strong>of</strong> limitations as "acts <strong>of</strong> fraud prior <strong>to</strong> thatdate are still evidence <strong>of</strong> this cont<strong>in</strong>u<strong>in</strong>g fraudulent scheme <strong>to</strong> defraud ...." The trier <strong>of</strong> fact canconsider defendant's pre-statute <strong>of</strong> limitations action <strong>to</strong> determ<strong>in</strong>e whether defendant had therequisite <strong>in</strong>tent <strong>to</strong> defraud.); United States v. Whitt, 718 F.2d 1494, 1501 (10th Cir. 1983) (Certa<strong>in</strong>testimony regard<strong>in</strong>g events that were not with<strong>in</strong> the statute <strong>of</strong> limitations was used "<strong>to</strong> establish ascheme or plan rather than as direct evidence ...."); United States v. Hask<strong>in</strong>s, 737 F.2d 844, 848 (10thCir. 1984) (The court affirmed mail fraud <strong>and</strong> ex<strong>to</strong>rtion convictions not<strong>in</strong>g that arguments relat<strong>in</strong>g<strong>to</strong> evidence <strong>of</strong> transactions not charged <strong>in</strong> the <strong>in</strong>dictment but used <strong>to</strong> help support scheme allegationscould be properly admitted. "The fact that a number <strong>of</strong> the overt acts performed <strong>in</strong> furtherance <strong>of</strong>the conspiracy were committed beyond the statute <strong>of</strong> limitations does not preclude the admission <strong>in</strong>evidence <strong>of</strong> such acts <strong>to</strong> show the nature <strong>of</strong> the scheme <strong>and</strong> [the commissioner's] <strong>in</strong>tent where thelater use <strong>of</strong> the mails occurred."). Although these cases relate <strong>to</strong> evidentiary issues, the samereason<strong>in</strong>g should apply <strong>in</strong> this case at the motion <strong>to</strong> dismiss stage. If evidence can be admissible attrial regard<strong>in</strong>g defendants' earlier acts <strong>in</strong> furtherance <strong>of</strong> their scheme, then so <strong>to</strong>o should allegationsregard<strong>in</strong>g actions taken beyond the statute <strong>of</strong> limitations be considered at the plead<strong>in</strong>g stage.- 44 -
harassment that occurred dur<strong>in</strong>g the time pla<strong>in</strong>tiff's claim was ripe. "A statute <strong>of</strong> limitations doesnot operate <strong>to</strong> bar the <strong>in</strong>troduction <strong>of</strong> evidence that predates the commencement <strong>of</strong> the limitationsperiod but that is relevant <strong>to</strong> events dur<strong>in</strong>g the period." Id. at 365. 26Contrary <strong>to</strong> CS First Bos<strong>to</strong>n's claim that the CC fails <strong>to</strong> dist<strong>in</strong>guish between the banks suedor make specific allegations as <strong>to</strong> CS First Bos<strong>to</strong>n, the CC is highly specific as <strong>to</strong> CS First Bos<strong>to</strong>n.CS First Bos<strong>to</strong>n had an extensive <strong>and</strong> very close relationship with Enron. CS First Bos<strong>to</strong>n providedboth commercial bank<strong>in</strong>g <strong>and</strong> <strong>in</strong>vestment bank<strong>in</strong>g services <strong>to</strong> Enron, helped structure <strong>and</strong> f<strong>in</strong>anceEnron's secretly controlled partnerships <strong>and</strong> illicit transactions with its SPEs <strong>and</strong> helped Enron falsifyits f<strong>in</strong>ancial statements <strong>and</strong> misrepresent its f<strong>in</strong>ancial condition by hid<strong>in</strong>g billions <strong>in</strong> debt that shouldhave been on Enron's balance sheet. Also, <strong>to</strong>p executives <strong>of</strong> CS First Bos<strong>to</strong>n were permitted <strong>to</strong>personally <strong>in</strong>vest at least $22.5 million <strong>in</strong> Enron's lucrative LJM2 partnership as a reward <strong>to</strong> themfor orchestrat<strong>in</strong>g CS First Bos<strong>to</strong>n's participation <strong>in</strong> this fraud. 26-27, 693, 712. CS First Bos<strong>to</strong>nalso sold over $5 billion <strong>in</strong> Enron <strong>and</strong> Enron-related securities <strong>to</strong> the public <strong>and</strong> extended over $5billion <strong>in</strong> loans <strong>and</strong>/or lend<strong>in</strong>g commitments <strong>to</strong> Enron. At the same time, CS First Bos<strong>to</strong>n'ssecurities analysts were issu<strong>in</strong>g extremely positive – but false <strong>and</strong> mislead<strong>in</strong>g – reports on Enron,ex<strong>to</strong>ll<strong>in</strong>g Enron's bus<strong>in</strong>ess success, the strength <strong>of</strong> its f<strong>in</strong>ancial condition <strong>and</strong> its prospects forstrong earn<strong>in</strong>gs <strong>and</strong> revenue growth. 27 In return for CS First Bos<strong>to</strong>n's participation <strong>in</strong> the scheme,26In Black Law Enforcement Officers Assoc. v. Akron, 824 F.2d 475 (6th Cir. 1987), the SixthCircuit found the lower court erred when it granted a motion by the City seek<strong>in</strong>g <strong>to</strong> limit evidencepresented <strong>in</strong> the case <strong>to</strong> events that occurred with<strong>in</strong> the one-year statute <strong>of</strong> limitations period. Id. at479. "It is clear that the district court erred <strong>in</strong> us<strong>in</strong>g the statute <strong>of</strong> limitations <strong>to</strong> bar the admission<strong>of</strong> evidence. The function <strong>of</strong> a statute <strong>of</strong> limitations is <strong>to</strong> bar stale claims." Id. at 482-83. "'Thestatute <strong>of</strong> limitations is a defense ..., not a rule <strong>of</strong> evidence. Therefore, ... [it] has no bear<strong>in</strong>g on theadmissibility <strong>of</strong> evidence.'" Id. at 483. The Sixth Circuit found that pla<strong>in</strong>tiffs were correct <strong>in</strong><strong>of</strong>fer<strong>in</strong>g evidence <strong>of</strong> events extend<strong>in</strong>g beyond the statute <strong>of</strong> limitations as "admissible <strong>to</strong> showmotive, <strong>in</strong>tent or cont<strong>in</strong>u<strong>in</strong>g scheme." Id. (cit<strong>in</strong>g United States v. Garv<strong>in</strong>, 565 F.2d 519, 523 (8thCir. 1977)).27As the CC expla<strong>in</strong>s, the banks named as defendants all evolved <strong>in</strong><strong>to</strong> their present form afterthe repeal <strong>of</strong> the Glass-Steagall Act <strong>in</strong> 99. That law prohibited banks from act<strong>in</strong>g <strong>in</strong> dual capacities,<strong>and</strong> was enacted <strong>to</strong> remedy abuses that occurred <strong>in</strong> the 20s when banks sold securities <strong>of</strong> <strong>and</strong> madeloans <strong>to</strong> their corporate cus<strong>to</strong>mers. With the repeal <strong>of</strong> Glass-Steagall, the banks sued here, <strong>in</strong>clud<strong>in</strong>gCS First Bos<strong>to</strong>n, quickly morphed back <strong>in</strong><strong>to</strong> f<strong>in</strong>ancial services <strong>in</strong>stitutions <strong>of</strong>fer<strong>in</strong>g commercial <strong>and</strong><strong>in</strong>vestment bank<strong>in</strong>g services <strong>to</strong> corporate cus<strong>to</strong>mers. The abuses <strong>of</strong> the 20s quickly returned as well.643-644. Accord<strong>in</strong>g <strong>to</strong> Bus<strong>in</strong>ess Week (id.):After the s<strong>to</strong>ck market crashed <strong>in</strong> 1929, Congress hauled <strong>in</strong> Wall Street- 45 -
it received huge underwrit<strong>in</strong>g <strong>and</strong> consult<strong>in</strong>g fees, <strong>in</strong>terest payments, commitment fees <strong>and</strong> otherpayments from Enron <strong>and</strong> related entities, while CS First Bos<strong>to</strong>n executives pocketed the lushreturns flow<strong>in</strong>g <strong>to</strong> them as LJM2 <strong>in</strong>ves<strong>to</strong>rs from the loot<strong>in</strong>g <strong>of</strong> Enron.CS First Bos<strong>to</strong>n engaged <strong>and</strong> participated <strong>in</strong> the fraudulent scheme <strong>and</strong> course <strong>of</strong> bus<strong>in</strong>ess<strong>in</strong> several ways. It participated <strong>in</strong> disclosed commercial loans <strong>and</strong> lend<strong>in</strong>g commitments <strong>of</strong> over $5bosses <strong>to</strong> expla<strong>in</strong> how bankers helped companies <strong>in</strong>flate earn<strong>in</strong>gs for a decadethrough complex structures. Congress scrut<strong>in</strong>ized bank practices for years, thenpassed the Glass-Steagall Act, splitt<strong>in</strong>g commercial banks from brokerages. Thatchecked the Street's temptation <strong>to</strong> monkey with clients' f<strong>in</strong>ances while flogg<strong>in</strong>g theirs<strong>to</strong>ck.Now Congress needs answers from Wall Street's chiefs aga<strong>in</strong>. Congressrepealed Glass-Steagall <strong>in</strong> 1999, under pressure from bankers who swore they wouldmanage such conflicts <strong>of</strong> <strong>in</strong>terests. They would erect so-called Ch<strong>in</strong>ese Walls thatforbade shar<strong>in</strong>g <strong>in</strong>formation between those sell<strong>in</strong>g a company's s<strong>to</strong>ck <strong>and</strong> thosearrang<strong>in</strong>g its f<strong>in</strong>anc<strong>in</strong>g.But the Ch<strong>in</strong>ese walls are porous. Bankers ignore them when it'sconvenient: They take analysts on road shows <strong>of</strong> <strong>in</strong>vestment-bank<strong>in</strong>g clients –their way <strong>of</strong> mak<strong>in</strong>g it clear they don't want downgrades <strong>of</strong> those companies. Thewalls also provide cover for bankers, who let analysts push a client's s<strong>to</strong>ck even whenthey know the company is <strong>in</strong> trouble. That's why analysts recommended Enron <strong>to</strong> theend, though the bankers beh<strong>in</strong>d its complex f<strong>in</strong>anc<strong>in</strong>g knew it was on the skids.Accord<strong>in</strong>g <strong>to</strong> the Miami Herald on 3/19/02:Banks Tangled <strong>in</strong> Fall <strong>of</strong> Enron* * *They are the titans <strong>of</strong> Wall Street, possess<strong>in</strong>g pedigrees that date <strong>to</strong> thefound<strong>in</strong>g <strong>of</strong> America <strong>and</strong> wealth greater than many nations.* * *Empowered by the massive deregulation <strong>of</strong> f<strong>in</strong>ancial services they zealouslysought, New York's <strong>in</strong>vestment banks created their masterpiece <strong>in</strong> Enron, provid<strong>in</strong>gevery conceivable product <strong>and</strong> service.They lent it money, <strong>of</strong>ten without collateral. They sold its securities <strong>to</strong> anunsuspect<strong>in</strong>g public. They wrote rosy, <strong>in</strong>accurate analyst reports.They were pivotal players <strong>in</strong> the mysterious <strong>of</strong>fshore partnerships thatultimately brought Enron down.Wear<strong>in</strong>g so many hats was unth<strong>in</strong>kable a generation ago, when laws kept thebank<strong>in</strong>g, brokerage <strong>and</strong> <strong>in</strong>surance <strong>in</strong>dustries separate. Deregulation changed all that,particularly <strong>in</strong> 1999 when the Depression-era Glass-Steagall Act was repealed....* * *Enron was such a lucrative cus<strong>to</strong>mer that virtually every Wall Street firm hada relationship with it.- 46 -
illion <strong>to</strong> Enron dur<strong>in</strong>g the Class Period. CS First Bos<strong>to</strong>n also helped raise billions from the<strong>in</strong>vest<strong>in</strong>g public for Enron via the sale <strong>of</strong> Enron <strong>and</strong> Enron-related securities, sales accomplished viafalse Registration Statements. CS First Bos<strong>to</strong>n also helped structure <strong>and</strong> f<strong>in</strong>ance the partnershipsEnron controlled <strong>and</strong> funded their illicit transactions with SPEs, know<strong>in</strong>g they were vehicles be<strong>in</strong>gutilized by Enron <strong>to</strong> falsify its reported f<strong>in</strong>ancial results. CS First Bos<strong>to</strong>n also engaged <strong>in</strong> numerousdeceptive transactions with Enron <strong>to</strong> disguise billions <strong>of</strong> dollars <strong>in</strong> loans <strong>to</strong> Enron, thus help<strong>in</strong>gEnron falsify its true f<strong>in</strong>ancial condition, liquidity <strong>and</strong> creditworth<strong>in</strong>ess. 694.CS First Bos<strong>to</strong>n acted as an underwriter <strong>of</strong> billions <strong>of</strong> dollars <strong>of</strong> Enron securities, <strong>in</strong>clud<strong>in</strong>g(696):DATESECURITY11/93 8 million shares 8% Enron capital preferred shares at $25 per share,rais<strong>in</strong>g $700 million7/94 3 million shares 9% Enron capital preferred shares at $25 per share,rais<strong>in</strong>g $75 million11/96 8 million shares 8.3% Enron capital preferred shares at $25 per share,rais<strong>in</strong>g $200 million1/97 6 million shares 8-1/8% Enron capital preferred shares at $25 per share,rais<strong>in</strong>g $150 million7/97 $200 million 6.75% Enron notes5/98 35 million Enron common shares at $25 per share,rais<strong>in</strong>g $870 million11/98 $250 million 6.95% Enron notes2/99 27.6 million shares Enron common s<strong>to</strong>ck at $31.34 per share,rais<strong>in</strong>g $870 millionIn addition, CS First Bos<strong>to</strong>n acted as underwriter <strong>of</strong> billions <strong>of</strong> dollars <strong>of</strong> other Enron-relatedsecurities, <strong>in</strong>clud<strong>in</strong>g (698, 699):DATESECURITY• Osprey Trust/Osprey I Inc. – $1 billion <strong>in</strong> notes• Marl<strong>in</strong> Water Trust/Marl<strong>in</strong> Water Capital Corp. II – $500million 6.19% <strong>and</strong> 6.31% notes• Azurix IPO – 38.5 million shares at $19, rais<strong>in</strong>g $370million for Enron- 47 -
• Azurix – $650 million 10.375% <strong>and</strong> 10.75% senior notesCS First Bos<strong>to</strong>n was also the lead underwriter <strong>in</strong> the New Power IPO <strong>in</strong> 10/00 which enabledEnron <strong>to</strong> improperly create a $370 million pr<strong>of</strong>it <strong>in</strong> the 4thQ 00. In 00, Enron owned millions <strong>of</strong>shares <strong>of</strong> New Power s<strong>to</strong>ck – then a private company – <strong>and</strong> controlled New Power. In the 4thQ 00,Enron desperately needed <strong>to</strong> create pr<strong>of</strong>its <strong>to</strong> perpetuate the scheme. If Enron could take New Powerpublic <strong>and</strong> create a trad<strong>in</strong>g market <strong>in</strong> its s<strong>to</strong>ck, then Enron could recognize a pr<strong>of</strong>it on the ga<strong>in</strong> <strong>in</strong>value on its shares by "hedg<strong>in</strong>g" that ga<strong>in</strong> via yet another non-arm's-length transaction with LJM2.CS First Bos<strong>to</strong>n did the huge New Power IPO – 27.6 million shares at $21 per share <strong>in</strong> 10/00. Afterthe IPO, Enron cont<strong>in</strong>ued <strong>to</strong> hold millions <strong>of</strong> shares <strong>of</strong> New Power. In a deal secretly structuredbefore the IPO, Enron quickly created a huge phony pr<strong>of</strong>it with an SPE called Hawaii 125-0.Several <strong>of</strong> Enron's banks (<strong>in</strong>clud<strong>in</strong>g CS First Bos<strong>to</strong>n) made a "loan" <strong>of</strong> $125 million <strong>to</strong> Hawaii 125-0, but secretly received a "<strong>to</strong>tal return swap" guarantee from Enron <strong>to</strong> protect them aga<strong>in</strong>st any loss.Enron transferred millions <strong>of</strong> New Power warrants <strong>to</strong> Hawaii 125-0 <strong>to</strong> "secure" the banks' loan <strong>and</strong>thus created a $370 million "pr<strong>of</strong>it" on the purported ga<strong>in</strong> on the New Power warrants. Hawaii 125-0simultaneously supposedly "hedged" the warrants with another entity created <strong>and</strong> controlled byEnron called "Porcup<strong>in</strong>e." To supposedly capitalize Porcup<strong>in</strong>e, LJM2 put $30 million <strong>in</strong><strong>to</strong>Porcup<strong>in</strong>e <strong>to</strong> facilitate the so-called hedge <strong>of</strong> the New Power warrants, but, one week later,Porcup<strong>in</strong>e paid the $30 million back <strong>to</strong> LJM2 plus a $9.5 million pr<strong>of</strong>it – leav<strong>in</strong>g Porcup<strong>in</strong>e with noassets. Dur<strong>in</strong>g 01, New Power s<strong>to</strong>ck fell sharply, convert<strong>in</strong>g Enron's huge ga<strong>in</strong> on its New Powerequity hold<strong>in</strong>gs <strong>in</strong><strong>to</strong> a huge loss early <strong>in</strong> 01 – a loss <strong>of</strong> about $250 million – which Enron concealed.42, 697.CS First Bos<strong>to</strong>n was also a major lender <strong>to</strong> Enron, loan<strong>in</strong>g or committ<strong>in</strong>g <strong>to</strong> loan over $5billion <strong>to</strong> Enron. 28 For <strong>in</strong>stance (701):28In analyz<strong>in</strong>g potential borrowers on commercial loans or credit facilities, CS First Bos<strong>to</strong>n wasrequired <strong>to</strong> perform extensive credit analysis <strong>of</strong> the borrower after obta<strong>in</strong><strong>in</strong>g detailed f<strong>in</strong>ancial<strong>in</strong>formation from it. Included <strong>in</strong> this credit analysis is a detailed review <strong>of</strong> the borrower's actual <strong>and</strong>cont<strong>in</strong>gent liabilities, its liquidity position, any equity issuance obligations it may have which couldadversely affect its shareholders' equity, any debt on which the borrower may be potentially liable,even if not on the borrower's books directly, the quality <strong>of</strong> the borrower's pr<strong>of</strong>its on earn<strong>in</strong>gs <strong>and</strong> theborrower's actual liquidity, <strong>in</strong>clud<strong>in</strong>g sources <strong>of</strong> fund<strong>in</strong>g <strong>to</strong> support repayment <strong>of</strong> any loans. Inaddition, when CS First Bos<strong>to</strong>n made large loans <strong>to</strong> or committed itself <strong>to</strong> credit facilities for a- 48 -
DATETRANSACTION9/98 $1 billion committed l<strong>in</strong>e <strong>of</strong> credit <strong>to</strong> back up Enron's commercialpaper2/99 $567 million loan <strong>to</strong> f<strong>in</strong>ance Dabhol power project6/00 $500 million l<strong>in</strong>e <strong>of</strong> credit for Enron Investments PLC, an Enronsubsidiary7/01 $582 million revolv<strong>in</strong>g l<strong>in</strong>e <strong>of</strong> credit for Enron8/01 $3 billion committed l<strong>in</strong>e <strong>of</strong> credit <strong>to</strong> back up Enron's commercialpaperCS First Bos<strong>to</strong>n's commercial paper back-up credit facilities for Enron were extremely significant.They enabled Enron <strong>to</strong> stay liquid by help<strong>in</strong>g Enron ma<strong>in</strong>ta<strong>in</strong> its access <strong>to</strong> the commercial papermarket where it could borrow billions <strong>to</strong> f<strong>in</strong>ance day-<strong>to</strong>-day operations, while CS First Bos<strong>to</strong>npocketed huge commitment fees on the back-up credit l<strong>in</strong>e. 702.CS First Bos<strong>to</strong>n was will<strong>in</strong>g <strong>to</strong> engage <strong>and</strong> participate <strong>in</strong> the fraudulent scheme <strong>and</strong> course<strong>of</strong> bus<strong>in</strong>ess because its participation created enormous pr<strong>of</strong>its for CS First Bos<strong>to</strong>n as long as thescheme cont<strong>in</strong>ued <strong>in</strong> operation – someth<strong>in</strong>g that CS First Bos<strong>to</strong>n was <strong>in</strong> a unique position <strong>to</strong> cause.While CS First Bos<strong>to</strong>n was lend<strong>in</strong>g hundreds <strong>of</strong> millions <strong>to</strong> Enron, it was limit<strong>in</strong>g its own risk <strong>in</strong> thisregard, as it knew that so long as Enron ma<strong>in</strong>ta<strong>in</strong>ed its <strong>in</strong>vestment grade credit rat<strong>in</strong>g <strong>and</strong> cont<strong>in</strong>ued<strong>to</strong> report strong current period f<strong>in</strong>ancial results <strong>and</strong> credibly forecast strong ongo<strong>in</strong>g revenue <strong>and</strong>pr<strong>of</strong>it growth, Enron's access <strong>to</strong> the capital markets would cont<strong>in</strong>ue <strong>to</strong> enable Enron <strong>to</strong> raisehundreds <strong>of</strong> millions, if not billions, <strong>of</strong> dollars <strong>of</strong> fresh capital from public <strong>in</strong>ves<strong>to</strong>rs which wouldbe used <strong>to</strong> repay or reduce Enron's commercial paper debt <strong>and</strong> the loans from CS First Bos<strong>to</strong>n<strong>to</strong> Enron so that the scheme could cont<strong>in</strong>ue. 702.corporation, it was required <strong>to</strong> closely moni<strong>to</strong>r the company by frequently review<strong>in</strong>g its f<strong>in</strong>ancialcondition <strong>and</strong> ongo<strong>in</strong>g operations for any material changes <strong>and</strong> <strong>in</strong>sist that <strong>to</strong>p f<strong>in</strong>ancial <strong>of</strong>ficers <strong>of</strong>the borrower keep it <strong>in</strong>formed <strong>of</strong> the current status <strong>of</strong> the borrower's bus<strong>in</strong>ess <strong>and</strong> f<strong>in</strong>ancial condition.As a result, CS First Bos<strong>to</strong>n obta<strong>in</strong>ed <strong>and</strong> reta<strong>in</strong>ed extremely detailed <strong>in</strong>formation concern<strong>in</strong>g theactual f<strong>in</strong>ancial condition <strong>of</strong> Enron throughout the Class Period <strong>and</strong> was aware that the actualcondition <strong>of</strong> Enron's bus<strong>in</strong>ess, its f<strong>in</strong>ances <strong>and</strong> its f<strong>in</strong>ancial condition was far worse than was be<strong>in</strong>gpublicly disclosed by Enron, or as described or disclosed <strong>in</strong> each <strong>of</strong> CS First Bos<strong>to</strong>n's analyst reportson Enron. 650.- 49 -
In fact, the proceeds <strong>of</strong> Enron's securities <strong>of</strong>fer<strong>in</strong>gs dur<strong>in</strong>g the Class Period underwritten byCS First Bos<strong>to</strong>n or other <strong>in</strong>vestment banks were utilized <strong>to</strong> repay Enron's exist<strong>in</strong>g commercial paper<strong>and</strong> bank <strong>in</strong>debtedness, <strong>in</strong>clud<strong>in</strong>g <strong>in</strong>debtedness <strong>to</strong> CS First Bos<strong>to</strong>n. 702. Thus, throughout theClass Period, CS First Bos<strong>to</strong>n was pocket<strong>in</strong>g millions <strong>of</strong> dollars a year <strong>in</strong> <strong>in</strong>terest payments,syndication fees <strong>and</strong> <strong>in</strong>vestment bank<strong>in</strong>g fees by participat<strong>in</strong>g <strong>in</strong> the Enron scheme <strong>to</strong> defraud <strong>and</strong>s<strong>to</strong>od <strong>to</strong> cont<strong>in</strong>ue <strong>to</strong> collect these huge amounts on an annual basis go<strong>in</strong>g forward so long as ithelped perpetuate the Enron Ponzi scheme, while CS First Bos<strong>to</strong>n's <strong>to</strong>p executives pocketed hugereturns on their secret <strong>in</strong>vestment <strong>in</strong> LJM2 – returns created by the very fraudulent acts <strong>and</strong>contrived transactions between Enron <strong>and</strong> LJM2 entities which CS First Bos<strong>to</strong>n was f<strong>in</strong>anc<strong>in</strong>g<strong>and</strong> which were hid<strong>in</strong>g billions <strong>of</strong> dollars <strong>of</strong> Enron's debt <strong>and</strong> artificially <strong>in</strong>flat<strong>in</strong>g its pr<strong>of</strong>its byhundreds <strong>of</strong> millions <strong>of</strong> dollars. 712.In addition, CS First Bos<strong>to</strong>n also participated <strong>in</strong> the scheme <strong>to</strong> defraud by mak<strong>in</strong>g falsestatements <strong>to</strong> the market regard<strong>in</strong>g Enron. First <strong>of</strong> all, the Registration Statements for the sale <strong>of</strong>$250 million <strong>of</strong> 6.95% Enron notes <strong>in</strong> 11/98 <strong>and</strong> the sale <strong>of</strong> 27.6 million shares <strong>of</strong> Enron commons<strong>to</strong>ck <strong>in</strong> 2/99 as well as the Registration Statements for the 10/00 New Power IPO conta<strong>in</strong>ed false<strong>and</strong> mislead<strong>in</strong>g statements – which are statements made by CS First Bos<strong>to</strong>n as an underwriter –<strong>in</strong>clud<strong>in</strong>g false <strong>in</strong>terim <strong>and</strong> annual f<strong>in</strong>ancial statements, <strong>and</strong> false statements concern<strong>in</strong>g thestructures <strong>of</strong> <strong>and</strong> Enron's relationship <strong>to</strong> SPEs <strong>and</strong> related parties, <strong>and</strong> Enron's f<strong>in</strong>ancial riskmanagement statistics, as well as the condition <strong>of</strong> Enron's bus<strong>in</strong>ess operations <strong>and</strong> the value <strong>of</strong> itsassets. 703. See <strong>in</strong>fra at 95-96.In addition, throughout the Class Period, CS First Bos<strong>to</strong>n issued 18 analyst reports on Enronwhich conta<strong>in</strong>ed false <strong>and</strong> mislead<strong>in</strong>g statements concern<strong>in</strong>g Enron's bus<strong>in</strong>ess, f<strong>in</strong>ances <strong>and</strong> f<strong>in</strong>ancialcondition <strong>and</strong> prospects, <strong>in</strong>clud<strong>in</strong>g those dated 7/6/99, 7/13/99, 9/2/99, 9/22/99, 10/12/99, 11/30/99,1/18/00, 1/21/00, 2/28/00, 4/13/00, 10/18/00, 1/26/01, 2/20/01, 4/17/01, 8/14/01, 8/17/01, 10/19/01<strong>and</strong> 10/23/01. 154, 158, 167, 171, 180, 191, 198, 205, 213, 229, 268, 285, 290, 319, 345, 354,374, 378 <strong>and</strong> 704. See <strong>in</strong>fra at 78-93.These were all statements by CS First Bos<strong>to</strong>n <strong>to</strong> the securities markets which helpedartificially <strong>in</strong>flate the trad<strong>in</strong>g prices <strong>of</strong> Enron's publicly traded securities. Keep<strong>in</strong>g Enron's s<strong>to</strong>ck- 50 -
price <strong>in</strong>flated was also important <strong>to</strong> CS First Bos<strong>to</strong>n as it knew that if the s<strong>to</strong>ck price fell belowvarious "trigger" prices <strong>in</strong> the LJM2 SPE deals it had designed <strong>and</strong> structured <strong>and</strong> its <strong>to</strong>pexecutives were fund<strong>in</strong>g, Enron would be required <strong>to</strong> issue millions <strong>of</strong> additional Enron shares,which would reduce Enron's shareholders' equity by hundreds <strong>of</strong> millions, if not billions, <strong>of</strong>dollars, endanger its <strong>in</strong>vestment grade credit rat<strong>in</strong>g, likely cut <strong>of</strong>f its access <strong>to</strong> the capital markets,<strong>and</strong> thus endanger the ongo<strong>in</strong>g scheme from which CS First Bos<strong>to</strong>n <strong>and</strong> its <strong>to</strong>p <strong>of</strong>ficials werepr<strong>of</strong>it<strong>in</strong>g. 704.In addition <strong>to</strong> mak<strong>in</strong>g false statements, CS First Bos<strong>to</strong>n also engaged <strong>and</strong> participated <strong>in</strong> <strong>and</strong>furthered the fraudulent scheme by participat<strong>in</strong>g <strong>in</strong> acts <strong>and</strong> contrivances <strong>to</strong> deceive, <strong>in</strong>clud<strong>in</strong>g illicittransactions with Enron which it knew would falsify Enron's f<strong>in</strong>ancial condition. 705.CS First Bos<strong>to</strong>n, like J.P. Morgan <strong>and</strong> CitiGroup, made disguised loans <strong>to</strong> Enron so thatEnron's true credit situation, liquidity <strong>and</strong> debt levels could be disguised. CS First Bos<strong>to</strong>n secretlylent Enron money us<strong>in</strong>g trades <strong>in</strong> derivatives. In 00, CS First Bos<strong>to</strong>n gave Enron $150 million <strong>to</strong>be repaid over two years. Enron's payments would vary with the price <strong>of</strong> oil. Technically, thetransaction was a swap. But because CS First Bos<strong>to</strong>n paid Enron up front, the transaction was <strong>in</strong> facta loan – a reality admitted by CS First Bos<strong>to</strong>n: "It was like a float<strong>in</strong>g-rate loan," said PenPendle<strong>to</strong>n, a CS First Bos<strong>to</strong>n spokesman. "We booked the transaction as a loan." Enron'sbalance sheet misrepresented this transaction. Enron posted the banks' loans as "assets from pricerisk management" <strong>and</strong> as "accounts receivable," admitted Charlie Leonard, a spokesman forAndersen: The repayments that Enron owed the banks were listed as "liabilities from price riskmanagement" <strong>and</strong> possibly a small amount as accounts payable, Leonard said. 706.CS First Bos<strong>to</strong>n also know<strong>in</strong>gly engaged <strong>and</strong> participated <strong>in</strong> <strong>and</strong>, <strong>in</strong> furtherance <strong>of</strong> thescheme, designed, structured <strong>and</strong> helped fund the SPEs which were the primary vehicles by whichEnron falsified its f<strong>in</strong>ancial condition <strong>and</strong> misrepresented pr<strong>of</strong>its. This was done by a group <strong>of</strong> 10bankers from CS First Bos<strong>to</strong>n who had jo<strong>in</strong>ed CS First Bos<strong>to</strong>n from Donaldson Lufk<strong>in</strong> &Jenrette <strong>in</strong> 98, led by Laurence Nath. Us<strong>in</strong>g the euphemism "structured products," Nath <strong>and</strong> histeam structured numerous illicit SPEs <strong>to</strong> engage <strong>in</strong> transactions with Enron <strong>to</strong> improperly boostEnron's reported pr<strong>of</strong>its while mov<strong>in</strong>g billions <strong>of</strong> dollars <strong>of</strong> debt <strong>of</strong>f Enron's balance sheet <strong>to</strong> the- 51 -
SPEs. These transactions <strong>in</strong>cluded Marl<strong>in</strong>, Firefly, Mar<strong>in</strong>er, Osprey, Whitew<strong>in</strong>g, <strong>and</strong> the<strong>in</strong>famous Rap<strong>to</strong>rs. With CS First Bos<strong>to</strong>n's help, Enron sold assets <strong>to</strong> these entities at <strong>in</strong>flatedprices – prices that Enron never could have obta<strong>in</strong>ed <strong>in</strong> arm's-length transactions with thirdparties – result<strong>in</strong>g <strong>in</strong> phony pr<strong>of</strong>its while hid<strong>in</strong>g billions <strong>of</strong> dollars <strong>of</strong> debt – transactions thatenriched CS First Bos<strong>to</strong>n's <strong>to</strong>p executives who, as <strong>in</strong>ves<strong>to</strong>rs <strong>in</strong> LJM2, were thus enjoy<strong>in</strong>g thebenefits <strong>of</strong> the loot<strong>in</strong>g <strong>of</strong> Enron. 707.Nath <strong>and</strong> CS First Bos<strong>to</strong>n worked very closely with Enron <strong>to</strong> create these entities <strong>and</strong> thesetransactions. Accord<strong>in</strong>g <strong>to</strong> a former Enron employee, "monetise" was the buzzword. Everyone wasalways say<strong>in</strong>g: "'We have <strong>to</strong> monetise this.'" The quick-fix solution was: "'We'll sell it <strong>to</strong> LJM, or<strong>to</strong> Rap<strong>to</strong>r, or <strong>to</strong> whatever the partnership <strong>of</strong> the month was .... They'd pick up the phone <strong>and</strong>Larry Nath would come down <strong>to</strong> Hous<strong>to</strong>n for a week or two <strong>and</strong> sit down with the ... accountants<strong>and</strong> come up with someth<strong>in</strong>g.'" Nath would gather with a group from Enron's treasury <strong>and</strong>global f<strong>in</strong>ance departments known <strong>in</strong>side the Company as "'Fas<strong>to</strong>w's field marshals.'" Thisgroup <strong>in</strong>cluded McMahon, Enron's former treasurer, <strong>and</strong> Glisan, who <strong>to</strong>ok over from McMahonas treasurer. 708.Most <strong>of</strong> the vehicles that emerged from these meet<strong>in</strong>gs conta<strong>in</strong>ed an unusual feature createdby Nath: They held Enron s<strong>to</strong>ck <strong>in</strong> order <strong>to</strong> comfort lenders <strong>and</strong> secure an <strong>in</strong>vestment grade rat<strong>in</strong>g,but required Enron <strong>to</strong> <strong>in</strong>ject more shares <strong>in</strong><strong>to</strong> the vehicles if the share price fell <strong>to</strong> certa<strong>in</strong> "triggerpo<strong>in</strong>ts" or prices, i.e., $83-$19 per share. They could also force their liquidation if Enron's creditrat<strong>in</strong>g was downgraded <strong>and</strong> the debt <strong>of</strong> the SPEs became recourse <strong>to</strong> Enron <strong>in</strong> such circumstances."'What I can't believe is that anyone ever got comfortable when you put all <strong>of</strong> this stuff <strong>to</strong>gether.Taken <strong>in</strong> comb<strong>in</strong>ation, these partnerships clearly posed a material risk for the company,'" aknowledgeable banker has said. The trigger po<strong>in</strong>ts <strong>in</strong>side the partnerships were a time bomb."'There's no question that senior people at CFSB knew what was go<strong>in</strong>g on <strong>and</strong> that it was a house<strong>of</strong> cards,'" one Enron <strong>in</strong>sider has said. The triggers were discussed by senior Enron executives<strong>and</strong> senior CS First Bos<strong>to</strong>n bankers at a meet<strong>in</strong>g <strong>in</strong> 7/01, when Enron's s<strong>to</strong>ck was <strong>in</strong> the $40s,accord<strong>in</strong>g <strong>to</strong> one person who was present. "'They (the CSFB bankers) said: "If this th<strong>in</strong>g hitsthe $20s, you better run for the hills." There was no question that they knew exactly what lay- 52 -
<strong>in</strong>side the structures, when the triggers went <strong>of</strong>f – everyth<strong>in</strong>g. You could almost say they knewmore about the company than people <strong>in</strong> Enron did.'" 709.In a 6/01 meet<strong>in</strong>g between an Enron manager <strong>and</strong> two CS First Bos<strong>to</strong>n manag<strong>in</strong>gdirec<strong>to</strong>rs, the CS First Bos<strong>to</strong>n people made statements show<strong>in</strong>g they had knowledge about thenature <strong>and</strong> extent <strong>of</strong> Enron's <strong>of</strong>f-balance-sheet exposure. Dur<strong>in</strong>g discussions about structur<strong>in</strong>gan <strong>of</strong>f-balance-sheet partnership, the CS First Bos<strong>to</strong>n people commented <strong>to</strong> the Enron manager,"How can you guys keep do<strong>in</strong>g this?" referr<strong>in</strong>g <strong>to</strong> Enron's repeated statements <strong>to</strong> the market that itss<strong>to</strong>ck was undervalued. The CS First Bos<strong>to</strong>n people said that even at $40 per share, Enron's s<strong>to</strong>ckwas still overvalued <strong>in</strong> their view <strong>and</strong> added, "Do employees actually believe it's worth whatmanagement is say<strong>in</strong>g?" 710.At the time, Enron's s<strong>to</strong>ck was trad<strong>in</strong>g at around $48.50. The CS First Bos<strong>to</strong>n people saidthat "you guys are at a critical price po<strong>in</strong>t right now" <strong>and</strong> referenced the Rap<strong>to</strong>r deal <strong>and</strong> saidthat if Enron's s<strong>to</strong>ck cont<strong>in</strong>ued <strong>to</strong> fall, that would cause Rap<strong>to</strong>r <strong>to</strong> unw<strong>in</strong>d <strong>and</strong> the debt balance<strong>to</strong> come due. The CS First Bos<strong>to</strong>n people asked the Enron manager, "Do you know how much<strong>of</strong>f-balance sheet debt you [Enron] have?" When the Enron executive said he thought it wasaround one <strong>to</strong> two billion dollars, the CS First Bos<strong>to</strong>n people said, "Try eight <strong>to</strong> 12 billion." Theyadded that if Enron's s<strong>to</strong>ck hits $20 a share, th<strong>in</strong>gs are go<strong>in</strong>g <strong>to</strong> come fall<strong>in</strong>g down <strong>and</strong> "you guysare gonna be fucked." 711.One <strong>of</strong> the primary vehicles utilized <strong>to</strong> falsify Enron's f<strong>in</strong>ancial condition <strong>and</strong> results dur<strong>in</strong>gthe Class Period was LJM2, which was secretly controlled by Enron <strong>and</strong> was used by Fas<strong>to</strong>w <strong>and</strong>other <strong>to</strong>p Enron executives <strong>to</strong> create numerous SPEs (<strong>in</strong>clud<strong>in</strong>g the <strong>in</strong>famous Rap<strong>to</strong>rs) with whichEnron engaged <strong>in</strong> contrived transactions <strong>to</strong> artificially <strong>in</strong>flate Enron's pr<strong>of</strong>its while conceal<strong>in</strong>gbillions <strong>of</strong> dollars <strong>in</strong> debt that should have been on Enron's balance sheet. 646.It was <strong>in</strong>dispensable that LJM2 be formed before year-end 99 because <strong>of</strong> the need <strong>to</strong> fundnew SPEs <strong>to</strong> deal with Enron <strong>to</strong> create huge 4thQ 99 pr<strong>of</strong>its for Enron so it could meet its forecasted99 earn<strong>in</strong>gs <strong>and</strong> move hundreds <strong>of</strong> millions <strong>of</strong> dollars <strong>of</strong> debt <strong>of</strong>f Enron's balance sheet. However,there was tremendous time pressure <strong>and</strong> the money from outside <strong>in</strong>ves<strong>to</strong>rs <strong>in</strong> LJM2 could not beraised <strong>in</strong> time <strong>to</strong> fund LJM2 by year-end 99 with sufficient capital <strong>to</strong> enable it <strong>to</strong> do four desperately- 53 -
needed transactions with Enron. CS First Bos<strong>to</strong>n knew, because LJM2 was go<strong>in</strong>g <strong>to</strong> be pr<strong>in</strong>cipallyutilized <strong>to</strong> engage <strong>in</strong> transactions with Enron where Enron <strong>in</strong>siders (Fas<strong>to</strong>w, Kopper <strong>and</strong> Glisan)would be on both sides <strong>of</strong> the transactions, that the LJM2 partnership would be extremely lucrative– virtually guaranteed <strong>to</strong> provide huge returns <strong>to</strong> LJM2's <strong>in</strong>ves<strong>to</strong>rs. So, <strong>in</strong> an extraord<strong>in</strong>ary step, <strong>to</strong>pexecutives <strong>of</strong> CS First Bos<strong>to</strong>n, through DLJ Fund Investment Partners III, L.P., put up $750,000early – many times more than its allocated share <strong>of</strong> LJM2's capital – on 12/22/99 – which, whencomb<strong>in</strong>ed with early funds put up by certa<strong>in</strong> other banks <strong>and</strong> bankers, provided the equity moneyneeded <strong>to</strong> allow LJM2 <strong>to</strong> complete four desperately needed deals before year end 99. 29 This early12/99 fund<strong>in</strong>g money from Enron's banks <strong>and</strong> bankers on 12/22/99 provided sufficient fund<strong>in</strong>g <strong>to</strong>29After LJM2 was fully funded <strong>in</strong> early 00 as other <strong>in</strong>ves<strong>to</strong>rs' money flowed <strong>in</strong><strong>to</strong> LJM2, thebanks' "over-fund<strong>in</strong>g" <strong>in</strong> 12/99 was adjusted for <strong>in</strong> the subsequent capital contributions <strong>to</strong> LJM2.The reason the banks put up virtually all the money <strong>to</strong> fund LJM2 <strong>in</strong> 12/99 was that they knew Enrondo<strong>in</strong>g the 99 year-end deals with the LJM2 SPEs was <strong>in</strong>dispensable <strong>to</strong> avoid<strong>in</strong>g Enron report<strong>in</strong>g4thQ 99 <strong>and</strong> year-end 99 results below expectation – which would have caused Enron's s<strong>to</strong>ck <strong>to</strong>plunge <strong>and</strong> impaired the cont<strong>in</strong>ued viability <strong>of</strong> the Enron Ponzi scheme from which they were allbenefitt<strong>in</strong>g. 647. This is shown below:LJM2 PARTNERSHIP FUNDINGPartnership Inves<strong>to</strong>rBankTotal LJM2Fund<strong>in</strong>gCommitment% <strong>of</strong> FundPre-Fund<strong>in</strong>g12/22/19992d/3d CloseDraw4th CloseDrawNetInvestment@ 6/30/00Chemical Investments, Inc.; J.P.Morgan Partnership InvestmentsCorp.; Sixty Wall Street Fund, LPJ.P. Morgan $ 25,000,000 6.3928% 3,750,000 $ (1,688,475) $ (894,485) $ 1,167,040CIBC Capital Corporation CIBC $ 15,000,000 3.83568% 2,250,000 $ (1,013,085) $ (536,679) $ 700,236Citicorp; Travelers; Primerica CitiGroup $ 15,000,000 3.83568% 1,500,000 $ (675,390) $ (106,470) $ 718,140BT Investment Partnership, Inc. Deutsche Bank $ 10,000,000 2.55712% 1,500,000 $ (675,390) $ (357,786) $ 466,824DLJ Fund Investment PartnersIII, L.P.*CS First Bos<strong>to</strong>n $ 5,000,000 1.27856% 750,000 $ (337,695) $ (178,893) $ 233,412LBJ Group Inc. Lehman $ 10,000,000 2.55712% 1,500,000 $ (675,390) $ (357,786) $ 466,824MLJDX Positions, Inc.; LouisChiovacci; ML/LJM2 Co-Investment, LPMerrill Lynch $ 22,645,000 5.79059% 750,000 $ (337,695) $ 707,820 $ 1,120,125Papyrus I Fund<strong>in</strong>g Trust Bank America $ 45,000,000 11.50703% $ 2,261,844 $ 2,261,844* The CC alleges CS First Bos<strong>to</strong>n executives <strong>in</strong>vested $22.5 million <strong>in</strong> LJM2 based on certa<strong>in</strong>publicly reported <strong>in</strong>formation. Other documents <strong>in</strong>dicate a $5 million <strong>in</strong>vestment. This differenceis one <strong>of</strong> degree only.- 54 -
enable Enron <strong>to</strong> engage <strong>in</strong> the Whitew<strong>in</strong>g, CLO, Nowa Sarzyna Power Plant, MEGS natural gas <strong>and</strong>Yosemite certificates deals between 12/22-29/99. These were SPE deals funded by LJM2 –transactions that generated millions <strong>in</strong> phony pr<strong>of</strong>its for Enron, just before year-end 99, <strong>and</strong> movedhundreds <strong>of</strong> millions <strong>of</strong> dollars <strong>of</strong> debt <strong>of</strong>f Enron's balance sheet. 646-647. These deals werenoth<strong>in</strong>g more than contrivances <strong>to</strong> deceive which were then "undone" <strong>in</strong> the 1stQ 00 with hugereturns <strong>to</strong> LJM2 <strong>and</strong> its <strong>in</strong>ves<strong>to</strong>rs, <strong>in</strong>clud<strong>in</strong>g the <strong>to</strong>p executives <strong>of</strong> CS First Bos<strong>to</strong>n. 466-475, 565-568.CS First Bos<strong>to</strong>n was also a ma<strong>in</strong> bank lender <strong>to</strong> the LJM2 partnership itself – provid<strong>in</strong>ga $120+ million credit l<strong>in</strong>e <strong>to</strong> that entity that provided the debt f<strong>in</strong>anc<strong>in</strong>g LJM2 needed <strong>to</strong> enableit <strong>to</strong> form <strong>and</strong> f<strong>in</strong>ance several SPEs – <strong>in</strong>clud<strong>in</strong>g the Rap<strong>to</strong>rs – with which Enron engaged <strong>in</strong>manipulative or deceptive devices <strong>and</strong> transactions <strong>to</strong> <strong>in</strong>flate its reported pr<strong>of</strong>its, while improperlymov<strong>in</strong>g billions <strong>in</strong> debt <strong>of</strong>f Enron's balance sheet <strong>and</strong> <strong>in</strong><strong>to</strong> the SPEs dur<strong>in</strong>g 00. 712.As a reward for its ongo<strong>in</strong>g participation <strong>in</strong> the scheme, CS First Bos<strong>to</strong>n executives wereultimately permitted <strong>to</strong> <strong>in</strong>vest $22.5 million <strong>in</strong> LJM2 <strong>to</strong> facilitate the f<strong>in</strong>anc<strong>in</strong>g <strong>of</strong> that criticalvehicle through DLJ Fund Investment Partners III, L.P. To the extent that Enron's bankers –<strong>in</strong>clud<strong>in</strong>g CS First Bos<strong>to</strong>n's <strong>to</strong>p executives – were permitted <strong>to</strong> <strong>in</strong>vest <strong>in</strong> LJM2, this was a reward<strong>to</strong> them for their ongo<strong>in</strong>g participation <strong>in</strong> the scheme. 646.Accord<strong>in</strong>g <strong>to</strong> The New York Times:Enron Ex-Chief Said <strong>to</strong> Voice Suspicion <strong>of</strong> FraudJeffrey K. Skill<strong>in</strong>g, the former chief executive <strong>of</strong> Enron, has <strong>to</strong>ld <strong>in</strong>vestiga<strong>to</strong>rsthat the <strong>to</strong>p-flight f<strong>in</strong>ancial returns that <strong>in</strong>ves<strong>to</strong>rs made from a partnership that didbus<strong>in</strong>ess with the company could have been achieved only if the corporation wasdefrauded, accord<strong>in</strong>g <strong>to</strong> documents <strong>and</strong> people <strong>in</strong>volved <strong>in</strong> the case.... He <strong>in</strong>dicated <strong>to</strong> the S.E.C. <strong>and</strong> <strong>to</strong> <strong>in</strong>vestiga<strong>to</strong>rs for a special committee <strong>of</strong>the Enron board that such returns – which were as high as 2,500 percent <strong>in</strong> onetransaction – could not have been achieved through arms-length transactions,accord<strong>in</strong>g <strong>to</strong> these people <strong>and</strong> <strong>in</strong>vestigative notes.When shown records that laid out the details <strong>of</strong> the f<strong>in</strong>ancial returns dur<strong>in</strong>ghis testimony several months ago before the S.E.C., Mr. Skill<strong>in</strong>g was said <strong>to</strong> havegrown agitated as he described his op<strong>in</strong>ion <strong>of</strong> the <strong>in</strong>formation.* * *- 55 -
Mr. Skill<strong>in</strong>g made his statements <strong>to</strong> <strong>in</strong>vestiga<strong>to</strong>rs after review<strong>in</strong>g LJM2records dur<strong>in</strong>g his testimony <strong>to</strong> the S.E.C., accord<strong>in</strong>g <strong>to</strong> documents <strong>and</strong> people<strong>in</strong>volved <strong>in</strong> the case.* * *In the LJM2 presentation, <strong>in</strong>ves<strong>to</strong>rs were <strong>to</strong>ld that the partnership had generated rates <strong>of</strong>return on its <strong>in</strong>vestments <strong>in</strong> the Rap<strong>to</strong>r rang<strong>in</strong>g from just more than 150 percent <strong>to</strong> 2,500percent.Kurt Eichenwald, "Enron Ex-Chief Said <strong>to</strong> Voice Suspicion <strong>of</strong> Fraud," New York Times, 4/24/02.These favored <strong>in</strong>ves<strong>to</strong>rs <strong>in</strong> LJM2, like the <strong>to</strong>p executives at CS First Bos<strong>to</strong>n, actuallywitnessed <strong>and</strong> benefitted from a series <strong>of</strong> extraord<strong>in</strong>ary payouts from the Rap<strong>to</strong>r SPEs which LJM2controlled over the next two years, secur<strong>in</strong>g hundreds <strong>of</strong> millions <strong>of</strong> dollars <strong>in</strong> distributions from theRap<strong>to</strong>rs <strong>to</strong> LJM2 <strong>and</strong> then <strong>to</strong> themselves – cash generated by the illicit <strong>and</strong> contrived transactionsEnron was engag<strong>in</strong>g <strong>in</strong> with the Rap<strong>to</strong>rs <strong>to</strong> falsify its f<strong>in</strong>ancial results. Thus, the banks <strong>and</strong> bankerswho were partners <strong>in</strong> LJM2 were not only know<strong>in</strong>g participants <strong>in</strong> the Enron scheme <strong>to</strong> defraud,they were direct economic beneficiaries <strong>of</strong> it <strong>and</strong> the loot<strong>in</strong>g <strong>of</strong> Enron. 31, 649. 3030After LJM2 was formed <strong>and</strong> CS First Bos<strong>to</strong>n <strong>and</strong>/or its <strong>to</strong>p executives had secretly beenpermitted <strong>to</strong> <strong>in</strong>vest <strong>in</strong> LJM2 (ultimately <strong>to</strong> the tune <strong>of</strong> over $22.5 million) <strong>and</strong> CS First Bos<strong>to</strong>n wasfund<strong>in</strong>g LJM2 so it could engage <strong>in</strong> transactions with Enron <strong>to</strong> conceal millions <strong>of</strong> dollars <strong>of</strong> loans<strong>to</strong> Enron, CS First Bos<strong>to</strong>n cont<strong>in</strong>ued <strong>to</strong> issue very positive analyst reports on Enron. Each <strong>of</strong> thesereports conta<strong>in</strong>ed "boilerplate" disclosures like:We may from time <strong>to</strong> time have long or short positions <strong>in</strong> any buy <strong>and</strong> sellsecurities referred <strong>to</strong> here<strong>in</strong>. The firm may from time <strong>to</strong> time perform <strong>in</strong>vestmentbank<strong>in</strong>g or other services for, or solicit <strong>in</strong>vestment bank<strong>in</strong>g or other bus<strong>in</strong>ess from,any company mentioned <strong>in</strong> this report.These boilerplate disclosures were the same as they were before 12/99 – i.e., they did not changeafter CS First Bos<strong>to</strong>n <strong>and</strong>/or its <strong>to</strong>p executives became huge <strong>in</strong>ves<strong>to</strong>rs <strong>in</strong> LJM2 <strong>and</strong> CS FirstBos<strong>to</strong>n was engag<strong>in</strong>g <strong>in</strong> transactions with Enron <strong>to</strong> conceal hundreds <strong>of</strong> millions <strong>of</strong> dollars <strong>of</strong> loans<strong>to</strong> Enron. The failure <strong>to</strong> disclose the LJM2 <strong>in</strong>vestments <strong>of</strong> CS First Bos<strong>to</strong>n's <strong>to</strong>p executives, CS FirstBos<strong>to</strong>n's fund<strong>in</strong>g <strong>of</strong> LJM2 dur<strong>in</strong>g 00-01, or its concealed loan transactions with Enron made its"boilerplate" disclosure false <strong>and</strong> mislead<strong>in</strong>g <strong>and</strong> concealed from the market the very significant <strong>and</strong>serious conflicts <strong>of</strong> <strong>in</strong>terest which Enron <strong>and</strong> CS First Bos<strong>to</strong>n knew would have cast serious doubtson the objectivity <strong>and</strong> honesty <strong>of</strong> CS First Bos<strong>to</strong>n's analyst reports on Enron <strong>and</strong> disclosed that CSFirst Bos<strong>to</strong>n or its executives had compromis<strong>in</strong>g ties <strong>to</strong> <strong>and</strong> serious conflicts <strong>of</strong> <strong>in</strong>terest regard<strong>in</strong>gEnron. 29.- 56 -
IV.CS FIRST BOSTON CAN BE LIABLE UNDER 1934 ACT §10(b) ANDRULE 10b-5 FOR: (i) MAKING FALSE STATEMENTS, OR (ii)PARTICIPATING IN A FRAUDULENT SCHEME OR COURSE OFBUSINESS THAT OPERATED AS A FRAUD OR DECEIT ONPURCHASERS OF ENRON'S SECURITIES, OR (iii) EMPLOYING ACTSOR MANIPULATIVE DEVICES TO DECEIVEPla<strong>in</strong>tiffs here have pleaded <strong>and</strong> are pursu<strong>in</strong>g theories <strong>of</strong> recovery that are well-grounded <strong>in</strong>the express language <strong>of</strong> §10(b) <strong>of</strong> the 1934 Act which states:provides:Manipulative <strong>and</strong> deceptive devicesIt shall be unlawful for any person, directly or <strong>in</strong>directly ....* * *(b) To use or employ, <strong>in</strong> connection with the purchase or sale <strong>of</strong> anysecurity registered on a national securities exchange ... any manipulative ordeceptive device or contrivance <strong>in</strong> contravention <strong>of</strong> such rules <strong>and</strong> regulations as theCommission may prescribe as necessary or appropriate <strong>in</strong> the public <strong>in</strong>terest or forthe protection <strong>of</strong> <strong>in</strong>ves<strong>to</strong>rs. 31Rule 10b-5 promulgated by the SEC flows directly from the language <strong>of</strong> §10(b) itself <strong>and</strong>§240.10b-5 Employment <strong>of</strong> manipulative <strong>and</strong> deceptive devices.It shall be unlawful for any person, directly or <strong>in</strong>directly, by the use <strong>of</strong> anymeans or <strong>in</strong>strumentality <strong>of</strong> <strong>in</strong>terstate commerce, or <strong>of</strong> the mails, or <strong>of</strong> any facility <strong>of</strong>any national securities exchange,(a)To employ any device, scheme, or artifice <strong>to</strong> defraud,(b) To make any untrue statement <strong>of</strong> a material fact or <strong>to</strong> omit <strong>to</strong>state a material fact necessary <strong>in</strong> order <strong>to</strong> make the statements made,<strong>in</strong> light <strong>of</strong> the circumstances under which they were made, notmislead<strong>in</strong>g, or(c) To engage <strong>in</strong> any act, practice, or course <strong>of</strong> bus<strong>in</strong>ess whichoperates or would operate as a fraud or deceit upon any person,<strong>in</strong> connection with the purchase or sale <strong>of</strong> any security.Not only does Rule 10b-5 forbid the mak<strong>in</strong>g <strong>of</strong> "any untrue statement <strong>of</strong> a material fact," italso provides for scheme liability. Scheme liability is authorized by the text <strong>of</strong> §10(b). Accord<strong>in</strong>g<strong>to</strong> the Supreme Court, §10(b)'s prohibition <strong>of</strong> "any manipulative or deceptive device or contrivance"31Note that §10(b) itself does not expressly prohibit untrue statements <strong>of</strong> material facts ormaterial omissions. This prohibition, like the prohibition aga<strong>in</strong>st fraudulent schemes <strong>and</strong> fraudulentcourses <strong>of</strong> bus<strong>in</strong>ess, are <strong>in</strong> Rule 10b-5.- 57 -
necessarily encompasses any "scheme <strong>to</strong> defraud." In Hochfelder, 425 U.S. 185, the Court referred<strong>to</strong> the dictionary def<strong>in</strong>itions <strong>of</strong> §10(b)'s words <strong>to</strong> f<strong>in</strong>d that a "device" is "'[t]hat which is devised, orformed by design; a contrivance; an <strong>in</strong>vention; project; scheme; <strong>of</strong>ten, a scheme <strong>to</strong> deceive; astratagem; an artifice.'" Id. at 199 n.20 (quot<strong>in</strong>g Webster's International Dictionary (2d ed. 1934)).The Court found that a "contrivance" means "'a scheme, plan, or artifice.'" Id. (quot<strong>in</strong>g Webster'sInternational Dictionary (2d ed. 1934)); see also Aaron, 446 U.S. at 696 n.13. Clearly, "scheme"is encompassed <strong>in</strong> the broad language <strong>of</strong> §10(b).Thus, Rule 10b-5 – adopted by the SEC <strong>to</strong> implement §10(b) – makes it unlawful for anyperson "directly or <strong>in</strong>directly" <strong>to</strong> employ "any device, scheme, or artifice <strong>to</strong> defraud," "[t]o makeany untrue statement[s]," or <strong>to</strong> "engage <strong>in</strong> any act, practice, or course <strong>of</strong> bus<strong>in</strong>ess which operates... as a fraud or deceit upon any person." 17 C.F.R. §240.10b-5. See also U.S. Quest, 228 F.3d at407.Prior <strong>to</strong> the Supreme Court's endorsement <strong>of</strong> the presumption <strong>of</strong> reliance based on the fraudon-the-markettheory for both misrepresentations <strong>and</strong> omissions <strong>in</strong> Basic, the Fifth Circuit had heldthat the theory applied only <strong>to</strong> omission cases <strong>and</strong> not misrepresentation cases. Thus, <strong>in</strong> some<strong>in</strong>stances, securities pla<strong>in</strong>tiffs sought recovery under subsection (1) <strong>and</strong> (3) <strong>of</strong> Rule 10b-5 alleg<strong>in</strong>gfraudulent scheme <strong>and</strong> course <strong>of</strong> bus<strong>in</strong>ess liability. The Fifth Circuit expressly recognized thevalidity <strong>of</strong> these theories <strong>of</strong> recovery.For <strong>in</strong>stance, <strong>in</strong> F<strong>in</strong>kel, 817 F.2d 356, pla<strong>in</strong>tiff sued under §10(b) <strong>and</strong> Rule 10b-5, claim<strong>in</strong>gthat the s<strong>to</strong>ck <strong>of</strong> Docutel was <strong>in</strong>flated due <strong>to</strong> false f<strong>in</strong>ancial reports. Accord<strong>in</strong>g <strong>to</strong> pla<strong>in</strong>tiff, Olivetti(which owned 46% <strong>of</strong> Docutel <strong>and</strong> controlled it) forced Docutel <strong>to</strong> buy Olivetti's excess <strong>in</strong>ven<strong>to</strong>riesat <strong>in</strong>flated prices so Olivetti could hide losses it was suffer<strong>in</strong>g. Docutel concealed this f<strong>in</strong>ancialmanipulation for some time but, when its audi<strong>to</strong>rs discovered the f<strong>in</strong>ancial manipulation <strong>and</strong> forceda large <strong>in</strong>ven<strong>to</strong>ry write-down, huge losses were disclosed <strong>and</strong> Docutel s<strong>to</strong>ck fell. The district courtdismissed the compla<strong>in</strong>t aga<strong>in</strong>st Olivetti <strong>and</strong> Docutel because pla<strong>in</strong>tiff failed <strong>to</strong> allege reliance onany <strong>of</strong> the false statements <strong>in</strong> Docutel's SEC fil<strong>in</strong>gs, etc. that were alleged <strong>in</strong> the compla<strong>in</strong>t.But the fact that the compla<strong>in</strong>t lists a number <strong>of</strong> documents filed with theSEC does not limit pla<strong>in</strong>tiff's claim <strong>to</strong> subsection (2) only. For, as <strong>in</strong> Shores,pla<strong>in</strong>tiff's lack <strong>of</strong> reliance on these documents does not resolve the claims made- 58 -
under 10b-5(1) <strong>and</strong> (3). We f<strong>in</strong>d that pla<strong>in</strong>tiff's compla<strong>in</strong>t properly alleges ascheme <strong>to</strong> defraud or course <strong>of</strong> bus<strong>in</strong>ess operat<strong>in</strong>g as a fraud for purposes <strong>of</strong> thefirst <strong>and</strong> third subsections; pla<strong>in</strong>tiff's compla<strong>in</strong>t, taken as a whole, alleges thatOlivetti forced Docutel <strong>to</strong> take its worthless <strong>in</strong>ven<strong>to</strong>ries, that this scheme or course<strong>of</strong> bus<strong>in</strong>ess was not disclosed, <strong>and</strong> that the effect was <strong>to</strong> defraud certa<strong>in</strong> purchasers<strong>of</strong> Docutel....The most significant event which allegedly led <strong>to</strong> the loss by pla<strong>in</strong>tiff is the claim thatOlivetti forced Docutel <strong>to</strong> take worthless <strong>in</strong>ven<strong>to</strong>ries without disclos<strong>in</strong>g that fact <strong>in</strong>the market place; if proved, that conduct could equate with a scheme <strong>to</strong> defraud orcourse <strong>of</strong> bus<strong>in</strong>ess operat<strong>in</strong>g as a fraud <strong>in</strong> violation <strong>of</strong> 10b-5(1) <strong>and</strong> (3). Thus, weconclude that the district court erred <strong>in</strong> its dismissal <strong>of</strong> the compla<strong>in</strong>t as <strong>to</strong> pla<strong>in</strong>tiff'sclaims under 10b-5(1) <strong>and</strong> (3).Id. at 363-64. Accord Heller v. Am. Indus. Props. Reit, Civ. No. SA-97-CA-1315-EP, 1998 U.S.Dist. LEXIS 23286, at *14 (W.D. Tex. Sept. 25, 1998) ("The first <strong>and</strong> third subsections, on the otherh<strong>and</strong>, create a duty not <strong>to</strong> engage <strong>in</strong> a fraudulent scheme or course <strong>of</strong> conduct ....").Thus, the Fifth Circuit sitt<strong>in</strong>g en banc held that a defendant who did not himself make thestatements <strong>in</strong> a mislead<strong>in</strong>g <strong>of</strong>fer<strong>in</strong>g circular could be held primarily liable as a participant <strong>in</strong> alarger scheme <strong>to</strong> defraud <strong>of</strong> which that <strong>of</strong>fer<strong>in</strong>g circular was only a part: "Rather than conta<strong>in</strong><strong>in</strong>gthe entire fraud, the Offer<strong>in</strong>g Circular was assertedly only one step <strong>in</strong> the course <strong>of</strong> an elaboratescheme." Shores, 647 F.2d at 468.The fraudulent scheme <strong>and</strong> course <strong>of</strong> bus<strong>in</strong>ess <strong>in</strong>volv<strong>in</strong>g Enron was worldwide <strong>in</strong> scope,years <strong>in</strong> duration <strong>and</strong> unprecedented <strong>in</strong> scale, <strong>and</strong> required the skills <strong>and</strong> active participation <strong>of</strong>lawyers, bankers <strong>and</strong> accountants <strong>to</strong> help design, implement, conceal <strong>and</strong> falsely account for thedeceptive acts <strong>and</strong> devices, manipulative or deceptive contrivances <strong>and</strong> artifices they <strong>and</strong> Enron wereus<strong>in</strong>g <strong>to</strong> falsify Enron's reported pr<strong>of</strong>its <strong>and</strong> f<strong>in</strong>ancial condition <strong>and</strong> <strong>to</strong> cont<strong>in</strong>ue its fraudulent course<strong>of</strong> bus<strong>in</strong>ess.The notion that Central Bank, 511 U.S. 164, issued a broad edict that lawyers, bankers <strong>and</strong>accountants are immune from liability for their participation <strong>in</strong> complex securities frauds isnonsense. Central Bank expressly recognized: "The absence <strong>of</strong> §10(b) aid<strong>in</strong>g <strong>and</strong> abett<strong>in</strong>g liabilitydoes not mean that secondary ac<strong>to</strong>rs <strong>in</strong> the securities markets are always free from liability underthe securities Acts. Any person or entity, <strong>in</strong>clud<strong>in</strong>g a lawyer ... or bank, who employs amanipulative device or makes a material misstatement (or omission) on which a purchaser ...relies may be liable as a primary viola<strong>to</strong>r under 10b-5 .... In any complex securities fraud,- 59 -
moreover, there are likely <strong>to</strong> be multiple viola<strong>to</strong>rs ...." Id. at 191. A scheme <strong>to</strong> defraud <strong>of</strong>ten will<strong>in</strong>volve a variety <strong>of</strong> ac<strong>to</strong>rs, <strong>and</strong> <strong>in</strong>ves<strong>to</strong>rs are entitled <strong>to</strong> allege "that a group <strong>of</strong> defendants acted<strong>to</strong>gether <strong>to</strong> violate the securities laws, as long as each defendant committed a manipulative ordeceptive act <strong>in</strong> furtherance <strong>of</strong> the scheme." Cooper, 137 F.3d at 624; accord First Jersey, 101F.3d at 1471; In re Health Mgmt. Inc. Sec. Litig., 970 F. Supp. 192, 209 (E.D.N.Y. 1997); Adam v.Silicon Valley Bancshares, 884 F. Supp. 1398, 1401 (N.D. Cal. 1995); In re ZZZZ Best Sec. Litig.,864 F. Supp. 960, 699-70 (C.D. Cal. 1994).In Central Bank, a public build<strong>in</strong>g authority issued bonds <strong>to</strong> f<strong>in</strong>ance public improvements.Central Bank served as <strong>in</strong>denture trustee. The bonds were secured by liens cover<strong>in</strong>g property. Thebond covenants required that the liened l<strong>and</strong> be worth at least 160% <strong>of</strong> the pr<strong>in</strong>cipal amount <strong>of</strong> thebonds. Central Bank got a letter express<strong>in</strong>g fear that property values were decl<strong>in</strong><strong>in</strong>g <strong>and</strong> that perhapsthe 160% value test was no longer met. The bank did noth<strong>in</strong>g. Soon afterwards, the public build<strong>in</strong>gauthority defaulted on the bonds. The bonds were not publicly traded. Central Bank, which had nocommercial lend<strong>in</strong>g relationship with the municipal entity <strong>in</strong>volved <strong>and</strong> which was not an <strong>in</strong>vestmentbank, issued no analyst reports about the issuer <strong>of</strong> the municipal bonds <strong>and</strong> thus made no statement<strong>and</strong> <strong>to</strong>ok no affirmative act that could have affected the trad<strong>in</strong>g price <strong>of</strong> the municipal bonds <strong>in</strong> issue.Clearly, this is a significantly different fact pattern from the Enron situation.The Central Bank majority noted that their reason<strong>in</strong>g was "confirmed" by the fact that if theyaccepted the pla<strong>in</strong>tiffs' aid<strong>in</strong>g <strong>and</strong> abett<strong>in</strong>g argument it would impose §10(b) liability "when at leas<strong>to</strong>ne element critical for recovery" was absent, i.e., reliance. 511 U.S. at 180 (cit<strong>in</strong>g Basic, 485 U.S.224 (the Supreme Court's "fraud-on-the-market" decision, for the proposition that a pla<strong>in</strong>tiff mustshow reliance <strong>to</strong> recover under Rule 10b-5). "Were we <strong>to</strong> allow the aid<strong>in</strong>g <strong>and</strong> abett<strong>in</strong>g actionproposed <strong>in</strong> this case, the defendant could be liable without any show<strong>in</strong>g that the pla<strong>in</strong>tiff relied uponthe aider <strong>and</strong> abet<strong>to</strong>r's statements or actions." Id. The Court found that allow<strong>in</strong>g pla<strong>in</strong>tiffs <strong>to</strong>"circumvent the reliance requirement would disregard the careful limits on 10b-5 recovery asm<strong>and</strong>ated by our earlier cases." Id. However, <strong>in</strong> this case, the alleged scheme <strong>and</strong> fraudulent course<strong>of</strong> bus<strong>in</strong>ess <strong>in</strong>flated the prices <strong>of</strong> Enron's publicly traded securities. 74, 418-424, 565-568, 693-- 60 -
714. Thus, the reliance element is not "absent" <strong>and</strong> the Supreme Court's prior decision <strong>in</strong> Basic isnot circumvented – it is satisfied.Central Bank denied recovery <strong>to</strong> victims <strong>of</strong> an alleged securities fraud who pleaded only onetheory <strong>of</strong> recovery aga<strong>in</strong>st the defendant bank – secondary liability dubbed "aid<strong>in</strong>g <strong>and</strong> abett<strong>in</strong>g."511 U.S. at 191. However, the words aid<strong>in</strong>g <strong>and</strong> abett<strong>in</strong>g do not appear <strong>in</strong> §10(b) or Rule 10b-5.The Court said "[T]he text <strong>of</strong> the 1934 Act does not itself reach those who aid <strong>and</strong> abet a § 10(b)violation ... that conclusion resolves the case." Id. at 177. The Central Bank pla<strong>in</strong>tiffs did not, asthe pla<strong>in</strong>tiffs do here, plead or pursue recovery under the theory that the bank defendant made false<strong>and</strong> mislead<strong>in</strong>g statements <strong>in</strong> Registration Statements or other documents issued <strong>to</strong> the public, e.g.,analyst reports, or employed acts <strong>and</strong> manipulative or deceptive devices or engaged <strong>in</strong> a fraudulentscheme or course <strong>of</strong> bus<strong>in</strong>ess that operated as a fraud or deceit on purchasers <strong>of</strong> the securities <strong>in</strong>issue. In the words <strong>of</strong> the Court, the pla<strong>in</strong>tiffs "concede that Central Bank did not commit amanipulative or deceptive act with<strong>in</strong> the mean<strong>in</strong>g <strong>of</strong> §10(b)." Id. at 191. Thus, because the CentralBank pla<strong>in</strong>tiffs pursued a theory <strong>of</strong> recovery which found no support <strong>in</strong> the text <strong>of</strong> either the statuteor the rule, they lost.Central Bank cannot mean that a defendant cannot be liable under §10(b) unless it mademislead<strong>in</strong>g statements because the Court rejected that argument <strong>in</strong> O'Hagan, 521 U.S. 642. TheEighth Circuit had held that, under Central Bank, "§10(b) covers only deceptive statements oromissions on which purchasers <strong>and</strong> sellers, <strong>and</strong> perhaps other market participants, rely." Id. at 664.The Court reversed, hold<strong>in</strong>g that §10(b) does not require a defendant <strong>to</strong> speak. Id. Because §10(b)prohibits "'any manipulative or deceptive device or contrivance'" <strong>in</strong> contravention <strong>of</strong> SEC rules, thisreaches "any deceptive device," whether or not the defendant spoke. Id. at 650-51. This Court hasstated, cit<strong>in</strong>g O'Hagan, that: "A defendant need not have made a false or mislead<strong>in</strong>g statement <strong>to</strong>be liable." L<strong>and</strong>ry's, slip op. at 9 n.12; Waste Mgmt., slip op. at 75; BMC S<strong>of</strong>tware, 183 F. Supp.2d at 869. Here, however, CS First Bos<strong>to</strong>n made false statements <strong>in</strong> Registration Statements <strong>and</strong>analyst reports.That this read<strong>in</strong>g <strong>of</strong> §10(b)/Rule 10b-5 is clearly correct is shown by a new unanimousSupreme Court decision – Z<strong>and</strong>ford, 2002 U.S. LEXIS 4023. In Z<strong>and</strong>ford, the Court repeatedly- 61 -
cited with approval its sem<strong>in</strong>al "fraudulent scheme" case Super<strong>in</strong>tendent <strong>of</strong> Ins., <strong>and</strong> reverseddismissal <strong>of</strong> a §10(b)/Rule 10b-5 compla<strong>in</strong>t mak<strong>in</strong>g the follow<strong>in</strong>g key po<strong>in</strong>ts:• "The scope <strong>of</strong> Rule 10b-5 is coextensive with the coverage <strong>of</strong> §10(b) ...." Id. at *7n.1.• "[N]either the SEC nor this Court has ever held that there must be a misrepresentationabout the value <strong>of</strong> a particular security" <strong>to</strong> violate §10(b). Id. at *13. 32• Allegations that defendant "'engaged <strong>in</strong> a fraudulent scheme'" or "'course <strong>of</strong>bus<strong>in</strong>ess that operated as a fraud or deceit'" stated a §10(b) claim. Id. at *13, *14-*17.Central Bank clearly – but merely – st<strong>and</strong>s for the proposition that no aid<strong>in</strong>g <strong>and</strong> abett<strong>in</strong>gliability exists under the 1934 Act because neither §10(b) nor Rule 10b-5 conta<strong>in</strong> "aid<strong>in</strong>g <strong>and</strong>abett<strong>in</strong>g" language. The decision <strong>in</strong> Central Bank is quite narrow. By contrast, the language <strong>of</strong>§10(b) <strong>and</strong> Rule 10b-5 is very broad. Also, the purposes <strong>of</strong> §10(b) <strong>and</strong> Rule 10b-5 are remedial,<strong>in</strong>tended <strong>to</strong> provide access <strong>to</strong> federal court <strong>to</strong> persons victimized <strong>in</strong> securities transactions:[T]he 1934 Act <strong>and</strong> its companion legislative enactments [<strong>in</strong>clud<strong>in</strong>g the 1933 Act]embrace a "fundamental purpose ... <strong>to</strong> substitute a philosophy <strong>of</strong> full disclosure forthe philosophy <strong>of</strong> caveat emp<strong>to</strong>r <strong>and</strong> thus <strong>to</strong> achieve a high st<strong>and</strong>ard <strong>of</strong> bus<strong>in</strong>essethics <strong>in</strong> the securities <strong>in</strong>dustry...." Congress <strong>in</strong>tended securities legislation enactedfor the purpose <strong>of</strong> avoid<strong>in</strong>g frauds <strong>to</strong> be construed "not technically <strong>and</strong> restrictively,but flexibly <strong>to</strong> effectuate its remedial purposes."Affiliated Ute Citizens, 406 U.S. at 151. As noted by the Fifth Circuit:[T]he Court has concluded that the Exchange Act <strong>and</strong> the Securities Act should beconstrued broadly <strong>to</strong> effectuate the statu<strong>to</strong>ry policy afford<strong>in</strong>g extensive protection <strong>to</strong>the <strong>in</strong>vest<strong>in</strong>g public. See Tcherepn<strong>in</strong>, 389 U.S. at 336 .... See also S.Rep.No. 47, 73dCong. 1st Sess. 1 (1933) (<strong>in</strong>dicat<strong>in</strong>g legislative <strong>in</strong>tent <strong>of</strong> the Securities Act <strong>to</strong> protectthe public from the sale <strong>of</strong> fraudulent <strong>and</strong> speculative schemes).Meason, 652 F.2d at 549. "The federal securities statutes are remedial legislation <strong>and</strong> must beconstrued broadly, not technically <strong>and</strong> restrictively." Paul F. New<strong>to</strong>n, 630 F.2d at 1118. 3332To the extent Ziemba, 256 F.3d at 1205, seems <strong>to</strong> require a statement be made about acompany which is "publicly attributable <strong>to</strong> the defendant at the time the pla<strong>in</strong>tiff's <strong>in</strong>vestmentdecision was made," it is <strong>in</strong>consistent with Z<strong>and</strong>ford.33The broad purposes <strong>of</strong> §10(b)'s prohibition <strong>of</strong> securities fraud <strong>and</strong> the Supreme Court'slongst<strong>and</strong><strong>in</strong>g recognition <strong>of</strong> such broad purposes also support conspiracy <strong>and</strong> scheme liability. See,e.g., Santa Fe Indus., Inc. v. Green, 430 U.S. 462, 477 (1977) ("[n]o doubt Congress meant <strong>to</strong>prohibit the full range <strong>of</strong> <strong>in</strong>genious devices that might be used <strong>to</strong> manipulate securities prices");Affiliated Ute Citizens, 406 U.S. at 151 (Proscriptions <strong>of</strong> §10(b) <strong>and</strong> Rule 10b-5 "are broad <strong>and</strong>, byrepeated use <strong>of</strong> the word 'any,' are obviously meant <strong>to</strong> be <strong>in</strong>clusive. The Court has said that the 1934Act <strong>and</strong> its companion legislative enactments embrace a 'fundamental purpose ... <strong>to</strong> substitute a- 62 -
CS First Bos<strong>to</strong>n's claim that Central Bank elim<strong>in</strong>ated scheme liability is flawed.Notwithst<strong>and</strong><strong>in</strong>g Central Bank, primary liability may be based on participation <strong>in</strong> a scheme <strong>to</strong>defraud or a course <strong>of</strong> bus<strong>in</strong>ess that operated as a fraud or deceit on securities purchasers pursuant<strong>to</strong> subsections (a) or (c) <strong>of</strong> Rule 10b-5. Fraudulent scheme or course <strong>of</strong> bus<strong>in</strong>ess liability is viablebecause:• It is encompassed by the express language <strong>of</strong> the statute, which prohibits the"direct[] or <strong>in</strong>direct[] ... use or employ[ment]" <strong>of</strong> "any manipulative or deceptivedevice or contrivance";• It is encompassed by the express language <strong>of</strong> Rule 10b-5;• It comports with the broad antifraud purposes <strong>of</strong> the statute;• It has long been upheld by the courts; <strong>and</strong>• It imposes liability based on a primary violation <strong>of</strong> the federal securities lawscommitted directly by the defendant that goes beyond merely assist<strong>in</strong>g another <strong>in</strong>committ<strong>in</strong>g a violation.In Central Bank, the pla<strong>in</strong>tiffs did not allege primary liability aga<strong>in</strong>st the bank, did notallege a scheme <strong>to</strong> defraud, did not allege a fraudulent practice or course <strong>of</strong> bus<strong>in</strong>ess <strong>and</strong> did not<strong>in</strong>voke subsections (a) or (c) <strong>of</strong> Rule 10b-5. 34 The pla<strong>in</strong>tiffs alleged only that the bank was"'secondarily liable under § 10(b) for its conduct <strong>in</strong> aid<strong>in</strong>g <strong>and</strong> abett<strong>in</strong>g the fraud.'" 511 U.S. at168. The Court, therefore, did not address other liability theories. Yet defendants <strong>of</strong>fer up numerousrationales as <strong>to</strong> why Central Bank elim<strong>in</strong>ated Rule 10b-5(a) <strong>and</strong> (c) liability. They are:1. The "Textualist" Rationale. The Court <strong>to</strong>ok a strict textualist approach <strong>in</strong>conclud<strong>in</strong>g that there is no private aid<strong>in</strong>g <strong>and</strong> abett<strong>in</strong>g liability under §10(b). Just as the statute doesphilosophy <strong>of</strong> full disclosure for the philosophy <strong>of</strong> caveat emp<strong>to</strong>r <strong>and</strong> thus <strong>to</strong> achieve a high st<strong>and</strong>ard<strong>of</strong> bus<strong>in</strong>ess ethics <strong>in</strong> the securities <strong>in</strong>dustry.'") (quot<strong>in</strong>g SEC v. Capital Ga<strong>in</strong>s Research Bureau, Inc.,375 U.S. 180, 186 (1963)); Capital Ga<strong>in</strong>s Research, 375 U.S. at 186 (§10(b) should be construed"not technically <strong>and</strong> restrictively, but flexibly <strong>to</strong> effectuate its remedial purposes"); Super<strong>in</strong>tendent<strong>of</strong> Ins., 404 U.S. at 11 n.7 ("'[We do not] th<strong>in</strong>k it sound <strong>to</strong> dismiss a compla<strong>in</strong>t merely because thealleged scheme does not <strong>in</strong>volve the type <strong>of</strong> fraud that is "usually associated with the sale or purchase<strong>of</strong> securities." We believe that §10 (b) <strong>and</strong> Rule 10b-5 prohibit all fraudulent schemes <strong>in</strong> connectionwith the purchase or sale <strong>of</strong> securities, whether the artifices employed <strong>in</strong>volve a garden type variety<strong>of</strong> fraud, or present a unique form <strong>of</strong> deception. Novel or atypical methods should not provideimmunity from the securities laws.'") (quot<strong>in</strong>g A. T. Brod & Co., 375 F.2d at 397) (emphasis <strong>in</strong>orig<strong>in</strong>al).34The Central Bank decision did not dist<strong>in</strong>guish among the different subsections <strong>of</strong> Rule 10b-5.- 63 -
not explicitly mention "aid<strong>in</strong>g <strong>and</strong> abett<strong>in</strong>g," it also does not mention "scheme," "act," "practice,"or "course <strong>of</strong> bus<strong>in</strong>ess."2 The "Manipulation <strong>and</strong> Misrepresentation Is It" Rationale. The Court stated that"the statute prohibits only the mak<strong>in</strong>g <strong>of</strong> a material misstatement (or omission) or the commission<strong>of</strong> a manipulative act," id. at 177, which must be <strong>in</strong>terpreted <strong>to</strong> mean that liability can only bepremised upon conduct fall<strong>in</strong>g with<strong>in</strong> subsection (b) <strong>of</strong> Rule 10b-5.3. The "No More Secondary Liability" Rationale. The Court's op<strong>in</strong>ion holds that onlyprimary viola<strong>to</strong>rs may be held liable. Because scheme liability is a secondary liability theory similar<strong>to</strong> aid<strong>in</strong>g <strong>and</strong> abett<strong>in</strong>g, it is precluded.None <strong>of</strong> these rationales for preclud<strong>in</strong>g fraudulent scheme <strong>and</strong>/or course <strong>of</strong> bus<strong>in</strong>ess liabilityis supportable because scheme <strong>and</strong> course <strong>of</strong> bus<strong>in</strong>ess liability is a textually-based, primary liabilitytheory <strong>and</strong> there is no hard <strong>and</strong> fast rule that a defendant must make a false statement <strong>to</strong> face §10(b)liability – while <strong>in</strong> this case CS First Bos<strong>to</strong>n did, <strong>in</strong> fact, allegedly make several false <strong>and</strong> mislead<strong>in</strong>gstatements.None <strong>of</strong> the rationales as <strong>to</strong> how Central Bank elim<strong>in</strong>ated Rule 10b-5(a) <strong>and</strong> (c) liability holdwater.• The Flaws <strong>of</strong> the "Textualist" RationaleA major flaw <strong>of</strong> the textualist rationale is that scheme liability is firmly based on thelanguage <strong>of</strong> both the statute <strong>and</strong> the rule. The statute itself conta<strong>in</strong>s only the general "manipulativeor deceptive devices or contrivances" language, leav<strong>in</strong>g it <strong>to</strong> the SEC <strong>to</strong> more specifically proscribefraudulent conduct. The SEC's rule-mak<strong>in</strong>g authority would be superfluous if the rules it adoptedhad <strong>to</strong> use precisely the same words as the statute. To be sure, "the private pla<strong>in</strong>tiff may not br<strong>in</strong>ga 10b-5 suit aga<strong>in</strong>st a defendant for acts not prohibited by the text <strong>of</strong> § 10(b)," id. at 173, <strong>and</strong> "'the1934 Act cannot be read more broadly than its language <strong>and</strong> the statu<strong>to</strong>ry scheme reasonablypermit,'" id. at 174 (quot<strong>in</strong>g Chiarella v. United States, 445 U.S. 222, 234 (1980)). But it is patentlyreasonable for the SEC <strong>to</strong> have determ<strong>in</strong>ed that the "employment" <strong>of</strong> a "scheme <strong>to</strong> defraud" <strong>and</strong> the- 64 -
"engagement" <strong>in</strong> a fraudulent "act, practice, or course <strong>of</strong> bus<strong>in</strong>ess" constitute the "use oremploy[ment]" <strong>of</strong> a "manipulative or deceptive device or contrivance." 35In Hochfelder, 425 U.S. 185, the Court implicitly found that a "scheme <strong>to</strong> defraud" fallswith<strong>in</strong> the mean<strong>in</strong>g <strong>of</strong> the "manipulative or deceptive device or contrivance" language <strong>of</strong> §10(b).Id. at 199 n.20. The Court relied <strong>in</strong> part on the 1934 dictionary def<strong>in</strong>itions <strong>of</strong> "device" <strong>and</strong>"contrivance." See id.; see also Aaron, 446 U.S. at 696 n.13 (rely<strong>in</strong>g on same def<strong>in</strong>itions <strong>to</strong> f<strong>in</strong>dscienter requirement under §17(a)(1) <strong>of</strong> 1933 Act). Both <strong>of</strong> those def<strong>in</strong>itions <strong>in</strong>cluded a "scheme."See Hochfelder, 425 U.S. at 199 n.20. 36The Court itself showed that Central Bank should not be <strong>in</strong>terpreted as usher<strong>in</strong>g <strong>in</strong> a new era<strong>of</strong> strict textualist construction <strong>of</strong> the federal securities laws. In uphold<strong>in</strong>g the misappropriationtheory <strong>of</strong> <strong>in</strong>sider trad<strong>in</strong>g <strong>in</strong> O'Hagan, 521 U.S. 642, the Court upheld a non-textual form <strong>of</strong> securitiesfraud <strong>and</strong>, <strong>in</strong> do<strong>in</strong>g so, aga<strong>in</strong> exposed the long familiar broad expressions <strong>of</strong> the remedial purposes<strong>of</strong> the statute. 37• The Flaws <strong>of</strong> the "Manipulation <strong>and</strong> Misrepresentation Is It"RationaleThe Court <strong>in</strong> Central Bank said that §10(b) "prohibits only the mak<strong>in</strong>g <strong>of</strong> a materialmisstatement (or omission) or the commission <strong>of</strong> a manipulative act." 511 U.S. at 177. It also35No subsection <strong>of</strong> Rule 10b-5 has ever been successfully challenged <strong>in</strong> any court as be<strong>in</strong>goutside the scope <strong>of</strong> §10(b) <strong>in</strong> the 60-year existence <strong>of</strong> the rule.36The statu<strong>to</strong>ry prohibition aga<strong>in</strong>st "directly or <strong>in</strong>directly" violat<strong>in</strong>g §10(b) must cover ascheme <strong>to</strong> commit manipulative or deceptive acts. It is unlikely that Congress would have prohibitedthe direct commitment <strong>of</strong> a fraudulent act <strong>and</strong> yet approved the commission <strong>of</strong> the same fraudulentact through jo<strong>in</strong>t activity – i.e., a scheme. The "directly or <strong>in</strong>directly" language <strong>in</strong> §10(b) was notenough for the Supreme Court <strong>to</strong> save aid<strong>in</strong>g <strong>and</strong> abett<strong>in</strong>g liability <strong>in</strong> Central Bank. But that wasbecause aid<strong>in</strong>g <strong>and</strong> abett<strong>in</strong>g liability covered a broader range <strong>of</strong> conduct than the direct commission<strong>of</strong> a manipulative or deceptive act. Scheme conduct, however, <strong>in</strong>volves jo<strong>in</strong>t action <strong>to</strong> commit amanipulative or deceptive act that should itself be considered, directly or <strong>in</strong>directly, a manipulativeor deceptive act by each <strong>of</strong> the schemers.37The Court also noted that the misappropriation theory is designed <strong>to</strong> protect the <strong>in</strong>tegrity <strong>of</strong>the securities markets aga<strong>in</strong>st abuses <strong>and</strong> that the 1934 Act was enacted <strong>in</strong> part <strong>to</strong> <strong>in</strong>sure thema<strong>in</strong>tenance <strong>of</strong> fair <strong>and</strong> honest markets <strong>and</strong> thereby promote <strong>in</strong>ves<strong>to</strong>r confidence. Id. at 652, 657,658-59. For example, the Court stated that "[t]he theory is also well-tuned <strong>to</strong> an animat<strong>in</strong>g purpose<strong>of</strong> the Exchange Act: <strong>to</strong> <strong>in</strong>sure honest securities markets <strong>and</strong> thereby promote <strong>in</strong>ves<strong>to</strong>r confidence."Id. at 658. The Court detailed how <strong>in</strong>ves<strong>to</strong>rs would be hesitant <strong>to</strong> <strong>in</strong>vest <strong>in</strong> an unfair market. Seeid.- 65 -
<strong>in</strong>dicated §10(b) liability existed where there was reliance on a defendant's "statements or actions."Id. at 180; see also id. at 191 ("Any person or entity, <strong>in</strong>clud<strong>in</strong>g a lawyer, accountant, or bank, whoemploys a manipulative device or makes a material misstatement (or omission) on which a purchaseror seller <strong>of</strong> securities relies may be liable as a primary viola<strong>to</strong>r under 10b-5, assum<strong>in</strong>g all <strong>of</strong> therequirements for primary liability under Rule 10b-5 are met.") (emphasis <strong>in</strong> orig<strong>in</strong>al).There is absolutely noth<strong>in</strong>g <strong>in</strong> the language <strong>of</strong> the statute, the legislative his<strong>to</strong>ry, or the rulethat warrants restrict<strong>in</strong>g liability solely <strong>to</strong> misrepresentations or omissions or certa<strong>in</strong> technical forms<strong>of</strong> manipulation. The express language <strong>of</strong> §10(b) clearly allows for liability by a person who doesnot actually make a statement or omit <strong>to</strong> say someth<strong>in</strong>g he is under a duty <strong>to</strong> disclose. The statu<strong>to</strong>rylanguage "directly or <strong>in</strong>directly ... [t]o use or employ" <strong>in</strong> §10(b) is much broader than simply"directly <strong>to</strong> make." Similarly, the statu<strong>to</strong>ry language "any manipulative or deceptive device orcontrivance" is much broader than simply "a misrepresentation or omission." Therefore, if thestart<strong>in</strong>g po<strong>in</strong>t <strong>in</strong> <strong>in</strong>terpret<strong>in</strong>g a statute is the language itself, see Central Bank, 511 U.S. at 173, thereis no reason why liability under §10(b) must be limited <strong>to</strong> directly mak<strong>in</strong>g misstatements oromissions or manipulat<strong>in</strong>g securities prices through certa<strong>in</strong> specific technical or mechanical means. 38In addition, the SEC, <strong>in</strong> adopt<strong>in</strong>g subsections (a) <strong>and</strong> (c) <strong>of</strong> Rule 10b-5, implicitly recognizedthis. Unless this Court would strike down a rule that has been upheld for 60 years, the language"employ any device, scheme, or artifice <strong>to</strong> defraud" <strong>and</strong> "engage <strong>in</strong> any act, practice, or course<strong>of</strong> bus<strong>in</strong>ess which operates or would operate as a fraud or deceit" <strong>in</strong> subsections (a) <strong>and</strong> (c) <strong>of</strong>Rule 10b-5 is much broader than simply "make a misrepresentation or omission." 39If the Court <strong>in</strong> Central Bank meant <strong>to</strong> strike down subsections (a) <strong>and</strong> (c) <strong>of</strong> Rule 10b-5, theCourt certa<strong>in</strong>ly would have explicitly said so. To the contrary, the courts have long recognized thatthe scope <strong>of</strong> liability under subsections (a) <strong>and</strong> (c) <strong>of</strong> Rule 10b-5 is broader than that undersubsection (b) <strong>and</strong> that those who engage <strong>in</strong> a fraudulent scheme may be liable <strong>in</strong> the absence <strong>of</strong>38As the Supreme Court has stated: "No doubt Congress meant <strong>to</strong> prohibit the full range <strong>of</strong><strong>in</strong>genious devices that might be used <strong>to</strong> manipulate securities prices." Santa Fe, 430 U.S. at 477.39Even from a common sense st<strong>and</strong>po<strong>in</strong>t, schemes, acts, practices, <strong>and</strong> courses <strong>of</strong> conduct canreadily be manipulative or deceptive, irrespective <strong>of</strong> any statements or omissions.- 66 -
misrepresentations or omissions. See, e.g., Affiliated Ute Citizens, 406 U.S. at 152-53 (subsections(a) <strong>and</strong> (c) are broader than subsection (b) <strong>of</strong> Rule 10b-5); First Jersey, 101 F.3d at 1471-72; SECv. Seaboard Corp., 677 F.2d 1301, 1312 (9th Cir. 1982); Shores, 647 F.2d at 468; CompetitiveAssocs., 516 F.2d at 814-15 ("Not every violation <strong>of</strong> the anti-fraud provisions <strong>of</strong> the federal securitieslaw can be, or should be, forced <strong>in</strong><strong>to</strong> a category headed 'misrepresentations' or 'nondisclosures.'Fraudulent devices, practices, schemes, artifices <strong>and</strong> courses <strong>of</strong> bus<strong>in</strong>ess are also <strong>in</strong>terdicted bythe securities laws."); Blackie v. Barrack, 524 F.2d 891, 904 n.19 (9th Cir. 1975) ("Rule 10b-5liability is not restricted solely <strong>to</strong> isolated misrepresentations or omissions; it may also be predicatedon a 'practice, or course <strong>of</strong> bus<strong>in</strong>ess which operates ... as a fraud ....'"); Richardson v. MacArthur,451 F.2d 35, 40 (10th Cir. 1971) ("Rule 10b-5 is a remedial measure <strong>of</strong> far greater breadth thanmerely prohibit<strong>in</strong>g misrepresentations <strong>and</strong> nondisclosures concern<strong>in</strong>g s<strong>to</strong>ck prices. No attempt ismade <strong>in</strong> 10b-5 <strong>to</strong> specify what forms <strong>of</strong> deception are prohibited; rather, all fraudulent schemes <strong>in</strong>connection with the purchase <strong>and</strong> sale <strong>of</strong> securities are prohibited.") (emphasis <strong>in</strong> orig<strong>in</strong>al <strong>and</strong>added).• The Flaws <strong>of</strong> the "No More Secondary Liability" RationaleThe pr<strong>in</strong>cipal flaws <strong>of</strong> this rationale are that Central Bank did not strike down every form <strong>of</strong>"secondary" liability <strong>and</strong> that, <strong>in</strong> any event, violations through fraudulent schemes, acts, practices,or courses <strong>of</strong> bus<strong>in</strong>ess constitute primary violations <strong>of</strong> §10(b). In Central Bank, the Court did notmake f<strong>in</strong>e dist<strong>in</strong>ctions between conduct that constitutes a "primary" violation as opposed <strong>to</strong> thatwhich constitutes a "secondary" violation <strong>of</strong> the statute. Nor did it hold that only "primary"violations are cognizable. It held that aid<strong>in</strong>g <strong>and</strong> abett<strong>in</strong>g could not constitute a violation because,as <strong>in</strong>terpreted by the courts, aiders <strong>and</strong> abet<strong>to</strong>rs did not commit violations but only assisted them,<strong>and</strong> the statute holds liable only those who commit violations.Fraudulent acts, practices <strong>and</strong> scheme liability <strong>and</strong> course <strong>of</strong> bus<strong>in</strong>ess liability are primaryliability theories <strong>in</strong> the sense that the defendant is directly liable for committ<strong>in</strong>g a violation <strong>of</strong> thestatute. The fraudulent scheme, act, practice, or course <strong>of</strong> bus<strong>in</strong>ess is a direct violation <strong>of</strong> §10(b)<strong>and</strong> Rule 10b-5. With respect <strong>to</strong> fraudulent acts, practices <strong>and</strong> a participation <strong>in</strong> the scheme <strong>to</strong>defraud or fraudulent course <strong>of</strong> bus<strong>in</strong>ess is itself the manipulative or deceptive act, even without the- 67 -
mak<strong>in</strong>g <strong>of</strong> misrepresentations or omission. There is noth<strong>in</strong>g derivative, vicarious, or secondary aboutit. And CS First Bos<strong>to</strong>n here allegedly made false <strong>and</strong> mislead<strong>in</strong>g statements as well.All three subsections <strong>of</strong> Rule 10b-5 proscribe conduct for which a defendant may beprimarily liable. Therefore, liability for a scheme <strong>to</strong> defraud or fraudulent act, practice, or course<strong>of</strong> bus<strong>in</strong>ess does not run afoul <strong>of</strong> Central Bank's elim<strong>in</strong>ation <strong>of</strong> aid<strong>in</strong>g <strong>and</strong> abett<strong>in</strong>g liability. Casesboth before <strong>and</strong> after Central Bank have recognized that scheme liability is a form <strong>of</strong> primaryliability. Hill v. Hanover Energy, Inc., Civ. No. 91-1964(JHG) 1991 U.S. Dist. LEXIS 18566(D.D.C. Dec. 16, 1991), is an example <strong>of</strong> such a pre-Central Bank case. In Hill, the defendantargued that the §10(b) claim should be dismissed for failure <strong>of</strong> the pla<strong>in</strong>tiff <strong>to</strong> allege anymisrepresentations or omissions <strong>of</strong> material facts. Id. at *10-*11. The court rejected that argument,specifically f<strong>in</strong>d<strong>in</strong>g that Santa Fe does not restrict §10(b) liability <strong>to</strong> misrepresentations or omissions.See id. at *11-*12. Rather, the court found that the alleged conduct <strong>of</strong> the defendant HanoverEnergy, which <strong>in</strong>cluded fraudulently <strong>in</strong>duc<strong>in</strong>g the pla<strong>in</strong>tiff <strong>to</strong> give up his rights <strong>to</strong> acquire certa<strong>in</strong>s<strong>to</strong>ck <strong>and</strong> <strong>to</strong> post a letter <strong>of</strong> credit, could fairly be viewed as manipulative or deceptive with<strong>in</strong> themean<strong>in</strong>g <strong>of</strong> §10(b) <strong>and</strong> an unlawful scheme <strong>to</strong> defraud with<strong>in</strong> the mean<strong>in</strong>g <strong>of</strong> subsection (a) or (c)<strong>of</strong> Rule 10b-5. See id. 4040District court decisions after Central Bank have cont<strong>in</strong>ued <strong>to</strong> recognize scheme liability asa form <strong>of</strong> primary liability. For example, <strong>in</strong> BMC S<strong>of</strong>tware, 183 F. Supp. 2d at 885-86, this Courtseemed <strong>to</strong> recognize scheme liability, although it found that the pla<strong>in</strong>tiffs had failed <strong>to</strong> satisfy theplead<strong>in</strong>g requirements. In BMC, when discuss<strong>in</strong>g the plead<strong>in</strong>g requirements <strong>in</strong> securities fraud cases<strong>and</strong> what must be pled <strong>to</strong> support scheme allegations, this Court stated:As its first ground for dismissal, Defendants emphasize that the amendedcompla<strong>in</strong>t fails <strong>to</strong> allege with any particularity that n<strong>in</strong>e <strong>of</strong> the eleven <strong>in</strong>dividualDefendants made any representations or participated <strong>in</strong> any way <strong>in</strong> the allegedscheme <strong>to</strong> defraud.... Pla<strong>in</strong>tiffs must allege what actions each Defendant <strong>to</strong>ok <strong>in</strong>furtherance <strong>of</strong> the alleged scheme <strong>and</strong> specifically plead what he learned, when helearned it, <strong>and</strong> how Pla<strong>in</strong>tiffs know what he learned.* * *"Primary liability may be imposed 'not only on persons who made fraudulentmisrepresentations but also on those who had knowledge <strong>of</strong> the fraud <strong>and</strong> assisted<strong>in</strong> its perpetration.'"Id. at 885-86, 905-06.District court decisions prior <strong>to</strong> Central Bank recognized scheme liability. In ZZZZ Best, 864F. Supp. 960, the district court directly addressed Ernst & Young's liability under subsections (a) <strong>and</strong>- 68 -
A scheme is "'[a] plan or program <strong>of</strong> someth<strong>in</strong>g <strong>to</strong> be done.'" 41 A "scheme <strong>to</strong> defraud"encompasses any "plan designed or concocted for perpetrat<strong>in</strong>g a fraud." Ballent<strong>in</strong>e's Law Dictionary1142 (3d ed. 1969) ("scheme <strong>to</strong> defraud"). It has long <strong>in</strong>cluded any scheme <strong>to</strong> defraud <strong>in</strong>ves<strong>to</strong>rs bycaus<strong>in</strong>g securities <strong>to</strong> trade at fraudulently <strong>in</strong>flated prices. 42 When §10(b) was enacted such conductalready was an unlawful "scheme <strong>to</strong> defraud" under the mail fraud statute, <strong>and</strong> <strong>to</strong>day it is called a(c) <strong>of</strong> Rule 10b-5, explicitly recogniz<strong>in</strong>g that liability under §10(b) <strong>and</strong> Rule 10b-5 is not restricted<strong>to</strong> material misstatements <strong>and</strong> omissions. Id. at 971-72 ("It appears that the scope <strong>of</strong> deceptivedevices or schemes prohibited by subsections (a) <strong>and</strong> (c) [<strong>of</strong> Rule 10b-5] is quite extensive."). Thepla<strong>in</strong>tiffs alleged that Ernst & Young, hired <strong>to</strong> review the company's f<strong>in</strong>ancial statements, wasprimarily liable because it participated <strong>in</strong> the creation <strong>of</strong> publicly released statements, issued a reviewreport, <strong>and</strong> failed <strong>to</strong> disclose additional material facts related <strong>to</strong> the review report. Ernst & Youngmoved for dismissal on the ground that it was really be<strong>in</strong>g charged with aid<strong>in</strong>g <strong>and</strong> abett<strong>in</strong>g liabilityprecluded by Central Bank. The court denied the motion, conclud<strong>in</strong>g that the facts taken as a wholeas <strong>to</strong> Ernst & Young's participation <strong>and</strong> knowledge could render it liable under a scheme <strong>to</strong> defraud.Id. at 969-72.In Adam, 884 F. Supp. 1398, the pla<strong>in</strong>tiffs alleged that Deloitte & Touche was primarilyliable under §10(b) for misrepresentations <strong>and</strong> "participation <strong>in</strong> a scheme <strong>to</strong> defraud" through its<strong>in</strong>volvement with the issuer's press releases <strong>and</strong> f<strong>in</strong>ancial statements. Id. at 1401. The pla<strong>in</strong>tiffs alsoalleged that Deloitte knew <strong>of</strong> the <strong>in</strong>adequate controls <strong>and</strong> deviated from conduct<strong>in</strong>g its audits <strong>in</strong>accordance with generally accepted audit<strong>in</strong>g st<strong>and</strong>ards. Id. at 1399. The court denied the account<strong>in</strong>gfirm's motion <strong>to</strong> dismiss because it found that its participation <strong>in</strong> the preparation <strong>of</strong> the issuer'sstatements was part <strong>of</strong> a scheme <strong>to</strong> defraud, mak<strong>in</strong>g the firm primarily liable under Rule 10b-5. Id.at 1399-1401. In so hold<strong>in</strong>g, the court recognized that Rule 10b-5(b) "essentially outlaws the mak<strong>in</strong>g<strong>of</strong> a material misrepresentation or omission," but that subsections (a) <strong>and</strong> (c) <strong>of</strong> the Rule "also"outlaw fraudulent schemes <strong>and</strong> courses <strong>of</strong> conduct. Id. at 1400.In In re Union Carbide Corp. Consumer Products Bus<strong>in</strong>ess Sec. Litig., 676 F. Supp. 458,467-70 (S.D.N.Y. 1987), Morgan Stanley's liability did not depend on whether it "certified or madeother public representations about a corporation's allegedly mislead<strong>in</strong>g statements"; rather, its"alleged role <strong>in</strong> know<strong>in</strong>gly or recklessly prepar<strong>in</strong>g the projections could constitute the employment<strong>of</strong> a 'device, scheme, or artifice <strong>to</strong> defraud' <strong>in</strong> violation <strong>of</strong> 10b-5(1) or an 'act, practice, or course <strong>of</strong>bus<strong>in</strong>ess which operates or would operate as a fraud or deceit upon any person' <strong>in</strong> violation <strong>of</strong> 10b-5(3)."41Aaron, 446 U.S. at 696 n.13 ("Webster's International Dictionary (2d ed. 1934) def<strong>in</strong>es ...'scheme' as '[a] plan or program <strong>of</strong> someth<strong>in</strong>g <strong>to</strong> be done; an enterprise; a project; as, a bus<strong>in</strong>essscheme [,or a] crafty, unethical project ....'") (emphasis <strong>in</strong> orig<strong>in</strong>al). To "scheme" is "[t]o form plansor designs; <strong>to</strong> devise <strong>in</strong>trigue." Webster's International Dictionary 2234 (2d ed. 1934). The OxfordEnglish Dictionary 616 (2d ed. 1989) def<strong>in</strong>es "scheme": "A plan, design; a programme <strong>of</strong> action ....Hence, [a] plan <strong>of</strong> action devised <strong>in</strong> order <strong>to</strong> atta<strong>in</strong> some end; a purpose <strong>to</strong>gether with a system <strong>of</strong>measures contrived for its accomplishment; a project, enterprise." Black's Law Dictionary 1344 (6thed. 1990) def<strong>in</strong>es "scheme": "A design or plan formed <strong>to</strong> accomplish some purpose; a system."42In Harris v. United States, 48 F.2d 771, 774 (9th Cir. 1931), for example, "[t]he fraudulentscheme charged ... was one for the sale <strong>of</strong> [a m<strong>in</strong><strong>in</strong>g company's] corporate s<strong>to</strong>ck ... by themanipulation <strong>of</strong> the price <strong>of</strong> the s<strong>to</strong>ck on the [s<strong>to</strong>ck exchanges] <strong>and</strong> the circulation <strong>of</strong> false reportsconcern<strong>in</strong>g the m<strong>in</strong>e through the mails." "In fact, the whole scheme centered around theestablishment <strong>of</strong> an alleged s<strong>to</strong>ck exchange value which is <strong>in</strong> fact wholly fictitious." Id. at 775.- 69 -
"fraud-on-the-market" that is actionable under §10(b). See Basic, 485 U.S. at 241-47; Lip<strong>to</strong>n v.Documation, Inc., 734 F.2d 740, 744-47 (11th Cir. 1984). Every person who <strong>in</strong>tentionally engages<strong>in</strong> a "scheme" <strong>to</strong> defraud is thus a primary viola<strong>to</strong>r <strong>of</strong> Rule 10b-5 <strong>and</strong> §10(b).In Affiliated Ute Citizens, 406 U.S. 128, the Court observed that "the second subparagraph<strong>of</strong> the rule specifies the mak<strong>in</strong>g <strong>of</strong> an untrue statement <strong>of</strong> a material fact <strong>and</strong> the omission <strong>to</strong> statea material fact," id. at 152-53, but held that "[t]he first <strong>and</strong> third subparagraphs are not so restricted."Id. at 153. It held that the defendants violated Rule 10b-5 when they participated <strong>in</strong> "a 'course <strong>of</strong>bus<strong>in</strong>ess' or a 'device, scheme, or artifice' that operated as a fraud" – even though thesedefendants had never themselves said anyth<strong>in</strong>g that was false or mislead<strong>in</strong>g. Id. "Not everyviolation <strong>of</strong> the anti-fraud provisions <strong>of</strong> the federal securities law can be, or should be, forced <strong>in</strong><strong>to</strong>a category headed 'misrepresentations' or 'nondisclosures.'" Competitive Assocs., 516 F.2d at 814."Fraudulent devices, practices, schemes, artifices <strong>and</strong> courses <strong>of</strong> bus<strong>in</strong>ess are also <strong>in</strong>terdicted by thesecurities laws." Id.Subsections (a) <strong>and</strong> (c) <strong>of</strong> Rule 10b-5 thus are aimed at "broader schemes <strong>of</strong> securities fraud"than are necessarily embodied <strong>in</strong> a s<strong>in</strong>gle mislead<strong>in</strong>g statement or document, <strong>and</strong> the "'classic' fraudon the market case [which] arises out <strong>of</strong> transactions on an open <strong>and</strong> developed market" easily fitswith<strong>in</strong> the expansive language <strong>of</strong> Rule 10b-5(1) <strong>and</strong> (3). Lip<strong>to</strong>n, 734 F.2d at 744-45, 747. Thus,the Fifth Circuit sitt<strong>in</strong>g en banc held that a defendant who did not himself make the statements <strong>in</strong>a mislead<strong>in</strong>g <strong>of</strong>fer<strong>in</strong>g circular could be held primarily liable as a participant <strong>in</strong> a larger scheme <strong>to</strong>defraud <strong>of</strong> which that <strong>of</strong>fer<strong>in</strong>g circular was only a part: "Rather than conta<strong>in</strong><strong>in</strong>g the entire fraud,the Offer<strong>in</strong>g Circular was assertedly only one step <strong>in</strong> the course <strong>of</strong> an elaborate scheme." Shores,647 F.2d at 468.In Cooper, pla<strong>in</strong>tiffs sued Merisel, its <strong>of</strong>ficers <strong>and</strong> direc<strong>to</strong>rs, its accountants, Deloitte <strong>and</strong>Touche <strong>and</strong> Lehman Brothers <strong>and</strong> Rob<strong>in</strong>son-Humphrey, <strong>in</strong>vestment banks which served asunderwriters <strong>of</strong> Merisel's public <strong>of</strong>fer<strong>in</strong>gs <strong>and</strong> issued analyst reports on Merisel. The compla<strong>in</strong>talleged that "'defendants falsely presented the Company's current, <strong>and</strong> future bus<strong>in</strong>ess prospects <strong>and</strong>prolonged the illusion <strong>of</strong> revenue <strong>and</strong> earn<strong>in</strong>gs growth by mak<strong>in</strong>g it appear that the Company'srevenue <strong>and</strong> earn<strong>in</strong>gs growth was strong <strong>and</strong> would cont<strong>in</strong>ue.'" 137 F.3d at 620.- 70 -
Defendants argued that "pla<strong>in</strong>tiffs cannot allege a 'scheme' <strong>to</strong> defraud, because those areconspiracy allegations foreclosed by Central Bank." Id. at 624. However, the N<strong>in</strong>th Circuitrejected this argument, stat<strong>in</strong>g that the compla<strong>in</strong>t "alleges a 'scheme' <strong>in</strong> which Merisel <strong>and</strong> the otherdefendants directly participated, track<strong>in</strong>g the language <strong>of</strong> Rule 10b-5(a), which makes it unlawfulfor any person '<strong>to</strong> employ any device, scheme, or artifice <strong>to</strong> defraud.'" Id. Moreover, "CentralBank does not preclude liability based on allegations that a group <strong>of</strong> defendants acted <strong>to</strong>gether <strong>to</strong>violate the securities laws, as long as each defendant committed a manipulative or deceptive act <strong>in</strong>furtherance <strong>of</strong> the scheme." Id. Furthermore,Id. at 624-25."[t]he absence <strong>of</strong> §10(b) aid<strong>in</strong>g <strong>and</strong> abett<strong>in</strong>g liability does not mean that secondaryac<strong>to</strong>rs <strong>in</strong> the securities markets are always free from liability under the securitiesActs. Any person or entity, <strong>in</strong>clud<strong>in</strong>g a lawyer, accountant, or bank, who employsa manipulative device or makes a material misstatement (or omission) ... may beliable as a primary viola<strong>to</strong>r under 10b-5 .... In any complex securities fraud,moreover, there are likely <strong>to</strong> be multiple viola<strong>to</strong>rs ...."In First Jersey, 101 F.3d at 1471-72, a <strong>to</strong>p First Jersey corporate <strong>of</strong>ficial who had not madeany false statement claimed he should not be held liable under §10(b) <strong>of</strong> the 1934 Act for anextensive violation <strong>of</strong> §10(b) <strong>and</strong> Rule 10b-5 by First Jersey. The Second Circuit stated:Brennan contends that even if First Jersey committed fraud, he should not have beenheld personally liable for any violation ... as a primary viola<strong>to</strong>r <strong>of</strong> the securities law....1. Primary Liability"Any person or entity ... who employs a manipulative device or makes amaterial misstatement (or omission) on which a purchaser or seller <strong>of</strong> securities reliesmay be liable as a primary viola<strong>to</strong>r under [federal securities law], assum<strong>in</strong>g all <strong>of</strong> therequirements for primary liability ... are met." Central Bank v. First Interstate Bank,511 U.S. 164, 191, 128 L. Ed. 2d 119, 114 S. Ct. 1439 (1994) (emphasis omitted).Primary liability may be imposed "not only on persons who made fraudulentmisrepresentations but also on those who had knowledge <strong>of</strong> the fraud <strong>and</strong> assisted<strong>in</strong> its perpetration." Azrielli v. Cohen Law Offices, 21 F.3d 512, 517 (2d Cir. 1994).The evidence presented at trial sufficed <strong>to</strong> establish that Brennan hadknowledge <strong>of</strong> First Jersey's frauds <strong>and</strong> participated <strong>in</strong> the fraudulent scheme.* * *In light <strong>of</strong> the evidence presented at trial with regard <strong>to</strong> Brennan's h<strong>and</strong>s-on<strong>in</strong>volvement <strong>in</strong> the pert<strong>in</strong>ent decisions, we conclude that the trial court did not err <strong>in</strong>f<strong>in</strong>d<strong>in</strong>g that Brennan know<strong>in</strong>gly participated <strong>in</strong> First Jersey's illegal activity <strong>and</strong>that he should be held primarily liable for its violations <strong>of</strong> the securities laws.- 71 -
Id. And, <strong>in</strong> fact, many courts have upheld compla<strong>in</strong>ts aga<strong>in</strong>st banks <strong>in</strong> §10(b)/Rule 10b-5 caseswhere, as here, false statements, manipulative or deceptive devices, contrivances <strong>and</strong> acts, <strong>and</strong>participation <strong>in</strong> a scheme <strong>to</strong> defraud have been alleged with sufficient particularity.In Cooper, 137 F.3d at 616, the court held scheme liability had survived Central Bank, <strong>and</strong>specifically noted that allegations that the <strong>in</strong>vestment banks named as defendants there hadknow<strong>in</strong>gly issued false analyst reports <strong>and</strong> had "access <strong>to</strong> <strong>in</strong>side <strong>in</strong>formation" set them apart fromother analysts who had issued favorable reports on the issuer dur<strong>in</strong>g the class period <strong>and</strong> stated avalid §10(b)/Rule 10b-5 claim.Lehman Brothers also made specific forecasts.... Although the compla<strong>in</strong>tquotes other analysts who made similar positive statements about [the company's]current status <strong>and</strong> future prospects, this does not mean that the Lehman Brothers <strong>and</strong>Rob<strong>in</strong>son-Humphrey analysts' statements are somehow au<strong>to</strong>matically reasonable. Allthe analysts wrote optimistic reports based <strong>in</strong> part on <strong>in</strong>formation from [thecompany]; only Rob<strong>in</strong>son-Humphrey <strong>and</strong> Lehman Brothers are alleged <strong>to</strong> haveknown better through their access <strong>to</strong> <strong>in</strong>side <strong>in</strong>formation.Even the analysts' optimistic statements can be actionable if not genu<strong>in</strong>ely <strong>and</strong>reasonably believed, or if the speaker is aware <strong>of</strong> undisclosed facts that tend seriously<strong>to</strong> underm<strong>in</strong>e the statement's accuracy. The compla<strong>in</strong>t alleges that the analysts wereaware <strong>of</strong> undisclosed facts that showed there was no reasonable basis for theirforecasts, which they did not genu<strong>in</strong>ely believe.Id. at 629. These false analyst reports were mislead<strong>in</strong>g <strong>and</strong> deceptive acts <strong>and</strong> part <strong>of</strong> the fraudulentscheme. When the banks <strong>in</strong> Cooper claimed the so-called "Ch<strong>in</strong>ese Wall" shielded them fromliability, the N<strong>in</strong>th Circuit rejected this assertion:[Defendant <strong>in</strong>vestment banks] Rob<strong>in</strong>son-Humphrey <strong>and</strong> Lehman Brothersassert that they followed SEC rules which prevent the shar<strong>in</strong>g <strong>of</strong> <strong>in</strong>side <strong>in</strong>formationwith<strong>in</strong> their companies. 15 U.S.C. §78o(f) requires registered brokers or dealers <strong>to</strong>create <strong>and</strong> enforce "written policies <strong>and</strong> procedures reasonably designed ... <strong>to</strong> preventthe misuse ... <strong>of</strong> material, nonpublic <strong>in</strong>formation by such broker or dealer or anyperson associated with such broker or dealer," <strong>and</strong> authorizes the SEC <strong>to</strong> create rulesfor such policies. If Rob<strong>in</strong>son-Humphrey <strong>and</strong> Lehman Brothers have establishedsuch policies <strong>and</strong> followed them <strong>in</strong> this case, they may raise that as a defense. Theexistence <strong>of</strong> such policies does not, however, preclude pla<strong>in</strong>tiffs from assert<strong>in</strong>g <strong>in</strong>their compla<strong>in</strong>t that <strong>in</strong>side <strong>in</strong>formation was misused.Id. at 628-29. The court said that the Ch<strong>in</strong>ese Wall might later be used as a defense, but the courtsaid such an assertion (a factual issue) was not a defense at the motion <strong>to</strong> dismiss stage.In Murphy v. Hollywood Entm't Corp., 1996 U.S. Dist. LEXIS 22207, <strong>and</strong> Flecker v.Hollywood Entm't Corp., 1997 U.S. Dist. LEXIS 5329, the court refused <strong>to</strong> dismiss a compla<strong>in</strong>t- 72 -
aga<strong>in</strong>st <strong>in</strong>vestment bankers <strong>and</strong> then later refused <strong>to</strong> grant summary judgment <strong>to</strong> those banks, stat<strong>in</strong>gthat their "roles as analysts, <strong>in</strong>vestment bankers <strong>and</strong> bus<strong>in</strong>ess advisors with extensive contacts with[issuer] defendants, superior access <strong>to</strong> non-public <strong>in</strong>formation <strong>and</strong> participation <strong>in</strong> both draft<strong>in</strong>g<strong>and</strong> decision-mak<strong>in</strong>g is sufficient <strong>to</strong> establish a triable primary liability claim under § 10(b)."Flecker, 1997 U.S. Dist. LEXIS 5329, at *25. In <strong>in</strong>itially deny<strong>in</strong>g the bank's motion <strong>to</strong> dismiss, thecourt recognized that "any person or entity who directly participates <strong>in</strong> an alleged violation <strong>of</strong> §10(b), even if that person falls with<strong>in</strong> the category <strong>of</strong> pr<strong>of</strong>essionals usually deemed 'collateral'participants, may still be liable as a 'primary viola<strong>to</strong>r' under § 10(b)." Id. at *20-*21. The courtconcluded:As for the Underwriters' role <strong>in</strong> the alleged fraud, pla<strong>in</strong>tiffs do not allege theexistence <strong>of</strong> any contemporaneous "smok<strong>in</strong>g gun" type <strong>of</strong> documents which woulddemonstrate that the Underwriter defendants knew they were sell<strong>in</strong>g a l<strong>and</strong>fill whenthey sold Hollywood securities. However, pla<strong>in</strong>tiffs do allege that the underwriterdefendants had a "close association" with Hollywood which gave them "constantaccess" <strong>to</strong> the <strong>in</strong>dividual Hollywood defendants <strong>and</strong> all relevant, non-public<strong>in</strong>formation about the company. Pla<strong>in</strong>tiffs further allege that the underwriterdefendants were "direct participants" <strong>in</strong> the alleged wrongdo<strong>in</strong>g by their role <strong>in</strong>coord<strong>in</strong>at<strong>in</strong>g the <strong>of</strong>fer<strong>in</strong>g, draft<strong>in</strong>g disputed <strong>of</strong>fer<strong>in</strong>g documents <strong>and</strong> conduct<strong>in</strong>ga due diligence <strong>in</strong>vestigation. This is sufficient <strong>to</strong> br<strong>in</strong>g the compla<strong>in</strong>t with<strong>in</strong> thescope <strong>of</strong> allegations similar <strong>to</strong> those susta<strong>in</strong>ed by the N<strong>in</strong>th Circuit <strong>in</strong> S<strong>of</strong>twareToolworks.... Pla<strong>in</strong>tiffs' claims are not limited <strong>to</strong> account<strong>in</strong>g fraud <strong>and</strong> thus, theunderwriters' claimed reliance upon certified account<strong>in</strong>g statements does not bar thema<strong>in</strong>tenance <strong>of</strong> pla<strong>in</strong>tiffs' claims under 10(b). Further, whether the underwriters'reliance upon expertised portions <strong>of</strong> the f<strong>in</strong>ancial statements was reasonable as amatter <strong>of</strong> law is an issue best addressed on summary judgment.Id. at *21-*23.In later deny<strong>in</strong>g summary judgment, the court noted that the defendants' motives <strong>in</strong>cludeda "desire <strong>to</strong> keep the s<strong>to</strong>ck price above $25.50 <strong>to</strong> avoid hav<strong>in</strong>g <strong>to</strong> redeem" certa<strong>in</strong> shares previouslyissued <strong>in</strong> a corporate transaction, <strong>and</strong> that the <strong>in</strong>vestment banks "s<strong>to</strong>od <strong>to</strong> accrue significant fees."Flecker, 1997 U.S. Dist. LEXIS 5329, at *14. The court stated that "primary liability extends <strong>to</strong> allwho make assertions '<strong>in</strong> a manner reasonably calculated <strong>to</strong> <strong>in</strong>fluence the <strong>in</strong>vest<strong>in</strong>g public,'" id. at *23,<strong>and</strong> then denied summary judgment because:[T]he underwriters ... had long st<strong>and</strong><strong>in</strong>g close connections <strong>to</strong> Hollywood such thatthey either knew or should have known that his<strong>to</strong>rical revenues were misstated due<strong>to</strong> changes <strong>in</strong> the same s<strong>to</strong>re sales base, <strong>and</strong> that revenue projections were ill-foundedgiven the company's earn<strong>in</strong>gs track record as <strong>in</strong>fluenced by account<strong>in</strong>g changeswhich had the effect <strong>of</strong> add<strong>in</strong>g revenue <strong>to</strong> Hollywood's balance sheets <strong>and</strong> priorearn<strong>in</strong>gs per share dividends.- 73 -
* * *Based on the forego<strong>in</strong>g, I f<strong>in</strong>d that defendants' roles as analysts, <strong>in</strong>vestmentbankers <strong>and</strong> bus<strong>in</strong>ess advisors with extensive contacts with Hollywood defendants,superior access <strong>to</strong> non-public <strong>in</strong>formation <strong>and</strong> participation <strong>in</strong> both draft<strong>in</strong>g <strong>and</strong>decision-mak<strong>in</strong>g is sufficient <strong>to</strong> establish a triable primary liability claim under§10(b).Id. at *20, *25.Livent, 174 F. Supp. 2d 144, shows that a valid §10(b)/Rule 10b-5 claim has been allegedhere. In Livent, purchasers <strong>of</strong> Livent securities sued Livent's <strong>in</strong>vestment bank (CIBC) for violations<strong>of</strong> 1933 Act §11 <strong>and</strong> 1934 Act §10(b)/Rule 10b-5. The court held the §11 claims sufficient undera Rule 8 non-fraud plead<strong>in</strong>g st<strong>and</strong>ard. The court also susta<strong>in</strong>ed the adequacy <strong>of</strong> the §10(b)/Rule 10b-5 claims – f<strong>in</strong>d<strong>in</strong>g the bank's participation <strong>in</strong> "Livent's fraudulent scheme" was adequately pleaded.The key allegation aga<strong>in</strong>st CIBC was that CIBC allegedly made a $4.6 million payment <strong>to</strong> Livent<strong>in</strong> return for theatrical royalties, which <strong>in</strong> reality was a secret "bridge" loan, as CIBC had a sideagreement from Livent <strong>to</strong> repurchase the $4.6 million advance <strong>in</strong> six months for $4.6 million, plus<strong>in</strong>terest – the "CIBC Wood Gundy Agreement." This was a fraudulent contrivance because Liventrecorded <strong>in</strong>come on the transaction, but did not record the loan. The district court held scienter hadbeen adequately alleged, stat<strong>in</strong>g:It does not require an unreasonable <strong>in</strong>ferential leap <strong>to</strong> conclude, as the Noteholderssuggest, that <strong>in</strong> enter<strong>in</strong>g <strong>in</strong><strong>to</strong> the bridge loan transaction <strong>and</strong> secret side agreementswith Livent, CIBC, as Livent's <strong>in</strong>vestment bankers s<strong>in</strong>ce 1993, had acquiredsubstantial knowledge <strong>of</strong> Livent's real f<strong>in</strong>ancial condition <strong>and</strong> was aware <strong>of</strong> Livent'sreasons <strong>to</strong> account for the $4.6 million "non-refundable fee" as a revenue-generat<strong>in</strong>g<strong>in</strong>vestment rather than a repayable loan....... Significantly, accord<strong>in</strong>g <strong>to</strong> the compla<strong>in</strong>t, the proceeds from the allegedfraudulent arrangement were reported by Livent as current revenue <strong>in</strong> its accounts<strong>and</strong> public registration statements <strong>in</strong> order <strong>to</strong> create a false f<strong>in</strong>ancial basis <strong>to</strong> re<strong>in</strong>force<strong>and</strong> ensure the success <strong>of</strong> Livent securities issues <strong>in</strong>tended <strong>in</strong> part <strong>to</strong> repay Livent'ssubstantial debt <strong>to</strong> CIBC.From these allegations, it is fair <strong>to</strong> <strong>in</strong>fer that <strong>in</strong> enter<strong>in</strong>g <strong>in</strong><strong>to</strong> the CIBCWood Gundy Agreement, CIBC was aware not only that Livent contemplatedmarket<strong>in</strong>g securities on the basis <strong>of</strong> public representations <strong>of</strong> its f<strong>in</strong>ancialcondition that Livent knew <strong>to</strong> be false, but that CIBC itself subsequently under<strong>to</strong>ok<strong>to</strong> solicit <strong>and</strong> sell the very securities whose value <strong>in</strong>corporated <strong>and</strong> was affected bythe falsehood CIBC itself had conceived with Livent. In this manner, CIBC'sparticipation <strong>in</strong> Livent's fraudulent scheme went beyond a passive capacity asLivent's <strong>in</strong>vestment banker <strong>and</strong> f<strong>in</strong>ancial adviser.* * *- 74 -
Id. at 151-53.The Noteholders have pled facts suggest<strong>in</strong>g that CIBC became part <strong>and</strong> parcel <strong>of</strong>Livent's mislead<strong>in</strong>g statements by enter<strong>in</strong>g <strong>in</strong><strong>to</strong> a loan transaction whose truecharacter <strong>and</strong> f<strong>in</strong>ancial implications it agreed not <strong>to</strong> disclose. This f<strong>in</strong>ancial<strong>in</strong>terest <strong>and</strong> complicity not only assisted Livent <strong>in</strong> conceal<strong>in</strong>g critical <strong>in</strong>formation, italso committed CIBC <strong>to</strong> similarly withhold the truth from <strong>in</strong>ves<strong>to</strong>rs with whom itdealt <strong>in</strong> Livent securities, a commitment that effectively conflicted with anyapplicable duty CIBC had <strong>to</strong> disclose material facts <strong>in</strong> connection with subsequentpublic sales <strong>of</strong> such securities affected by the transaction.Rather than generally reflect<strong>in</strong>g the pr<strong>of</strong>it motive <strong>of</strong> any securities dealer,the concrete benefit derived by CIBC from Livent's fraud alleged here wasuniquely personal <strong>to</strong> CIBC <strong>in</strong> several ways. Only CIBC, as Livent's <strong>in</strong>vestmentbankers s<strong>in</strong>ce 1993, is alleged <strong>to</strong> have had a longst<strong>and</strong><strong>in</strong>g, <strong>in</strong>timate relationshipwith Livent executives that <strong>of</strong>fered it uncommon opportunity <strong>to</strong> know <strong>of</strong>, <strong>and</strong> playan active role <strong>in</strong> Livent's, f<strong>in</strong>ancial affairs. And only CIBC is accused, <strong>in</strong>furtherance <strong>of</strong> its own motives, <strong>of</strong> assist<strong>in</strong>g Livent <strong>in</strong> structur<strong>in</strong>g <strong>and</strong> keep<strong>in</strong>gsecret the misrepresented CIBC Wood Gundy Agreement. Later, <strong>in</strong> publiclymarket<strong>in</strong>g Livent securities whose value partly depended on the true nature <strong>of</strong> thatagreement, CIBC s<strong>to</strong>od <strong>to</strong> realize ga<strong>in</strong>s particular <strong>to</strong> it. Beyond the st<strong>and</strong>ard fees<strong>and</strong> commissions associated with any <strong>in</strong>vestment bank's sales <strong>of</strong> securities, CIBChad a higher stake <strong>in</strong> Livent's public f<strong>in</strong>anc<strong>in</strong>gs. It uniquely benefitted from theapplication <strong>of</strong> the proceeds <strong>of</strong> the Notes sales <strong>to</strong> Livent's considerable debt <strong>to</strong>CIBC.Similarly, <strong>in</strong> Cascade Int'l, 840 F. Supp. 1558, the court found that allegations that asecurities broker ignored red flags presented a sufficient show<strong>in</strong>g <strong>of</strong> recklessness <strong>to</strong> constitutescienter. Accord<strong>in</strong>g <strong>to</strong> the compla<strong>in</strong>t, the broker, Raymond James, cont<strong>in</strong>ued <strong>to</strong> recommendCascade's s<strong>to</strong>ck, ignor<strong>in</strong>g red flags that had been raised, while its"reports <strong>and</strong> statements with respect <strong>to</strong> [the company], while purport<strong>in</strong>g <strong>to</strong> bedis<strong>in</strong>terested <strong>and</strong> objective pr<strong>of</strong>essional <strong>in</strong>vestment analyses, based on <strong>in</strong>-depthcurrent research, were <strong>in</strong> reality substantially false <strong>and</strong> mislead<strong>in</strong>g sales brochureswhich made exaggerated predictions based on unverified <strong>and</strong> unsupported<strong>in</strong>formation for which Raymond James knew, or should have known, it had noreasonable basis."Id. at 1578. Based on the broker's alleged disregard <strong>of</strong> red flags, the court held the compla<strong>in</strong>tsufficiently pleaded scienter. "These allegations, if true, may ev<strong>in</strong>ce severe recklessness or pro<strong>of</strong> <strong>of</strong>know<strong>in</strong>g misconduct." Id.F<strong>in</strong>ally, <strong>in</strong> Bre-X-M<strong>in</strong>erals, 2001 U.S. Dist. LEXIS 4571, the court denied the motion <strong>to</strong>dismiss by J.P. Morgan based on allegations it participated <strong>in</strong> a scheme <strong>to</strong> violate §10(b) <strong>and</strong> Rule10b-5 <strong>in</strong> connection with the securities fraud <strong>in</strong>volv<strong>in</strong>g Bre-X. In Bre-X, pla<strong>in</strong>tiffs alleged the<strong>in</strong>volvement <strong>of</strong> J.P. Morgan <strong>in</strong> assist<strong>in</strong>g Bre-X <strong>in</strong> structur<strong>in</strong>g fraudulent bus<strong>in</strong>ess transactions, act<strong>in</strong>g- 75 -
as Bre-X's f<strong>in</strong>ancial advisor, <strong>and</strong> issu<strong>in</strong>g false analysts' reports – ignor<strong>in</strong>g "red flags" that Bre-X'sclaimed assets were falsified. Thus, J.P. Morgan's motion <strong>to</strong> dismiss was denied. 43The CC <strong>in</strong> this action pleads more wrongful conduct by CS First Bos<strong>to</strong>n vis-à-vis thefraudulent scheme <strong>in</strong>volv<strong>in</strong>g Enron <strong>and</strong> with more specificity than was pleaded <strong>in</strong> any <strong>of</strong> the abovecases where compla<strong>in</strong>ts nam<strong>in</strong>g banks as defendants <strong>in</strong> §10(b)/Rule 10b-5 actions were upheld.CS First Bos<strong>to</strong>n cannot escape liability by claim<strong>in</strong>g that the illicit SPEs <strong>and</strong> contrivedtransactions detailed <strong>in</strong> the CC do not meet the technical def<strong>in</strong>ition <strong>of</strong> a "manipulative device." Itis <strong>of</strong> no moment that certa<strong>in</strong> cases, purportedly build<strong>in</strong>g on Santa Fe, 430 U.S. 462, appear <strong>to</strong> haveexpressly read <strong>in</strong><strong>to</strong> §10(b)'s manipulation language a limited <strong>and</strong> restrictive congressional <strong>in</strong>tent <strong>to</strong>simply prohibit such "practices <strong>in</strong> the marketplace which have the effect <strong>of</strong> either creat<strong>in</strong>g the falseimpression that certa<strong>in</strong> market activity is occurr<strong>in</strong>g when <strong>in</strong> fact such activity is unrelated <strong>to</strong> actualsupply <strong>and</strong> dem<strong>and</strong> or tamper<strong>in</strong>g with the price itself." Hundahl v. United Ben. Life Ins. Co., 465F. Supp. 1349, 1360 (N.D. Tex. 1979); see also Schreiber v. Burl<strong>in</strong>g<strong>to</strong>n Northern, Inc., 568 F. Supp.197 (D. Del. 1983); In re Commonwealth Oil/Tesoro Petroleum Sec. Litig., 484 F. Supp. 253 (W.D.Tex. 1979). First, whether or not the SPEs <strong>and</strong> transactions are technically "market manipulation"devices is academic even under these very cases. The SPE transactions have been pleaded as bothcontrivances <strong>and</strong> deceptive devices – <strong>and</strong> each was clearly deceptive, for they falsified Enronf<strong>in</strong>ancial condition – thereby allow<strong>in</strong>g for Rule 10b-5 scheme liability <strong>to</strong> attach. See, e.g., Hundahl,465 F. Supp. at 1362 ("Few efforts <strong>to</strong> play with the price <strong>of</strong> a traded s<strong>to</strong>ck can be successful withoutrunn<strong>in</strong>g afoul <strong>of</strong> section 10(b)'s other weapon deception."). 44 Second, Santa Fe is not so restrictive43U.S. Envtl., 155 F.3d at 112 (while there is no aid<strong>in</strong>g <strong>and</strong> abett<strong>in</strong>g, compla<strong>in</strong>t properly allegeddefendant <strong>to</strong> be primary viola<strong>to</strong>r because he "'participated <strong>in</strong> the fraudulent scheme,'" not<strong>in</strong>g"lawyers, accountants, <strong>and</strong> banks who engage <strong>in</strong> fraudulent or deceptive practices at their client'sdirection [are] primary viola<strong>to</strong>r[s]"); Scholnick, 752 F. Supp. at 1323 & n.9 ("bank ... may still beheld liable under Rule 10b-5(a) <strong>and</strong> 10b-5(c) as a participant <strong>in</strong> the allegedly fraudulent scheme" <strong>and</strong>"allegations that Cont<strong>in</strong>ental was directly <strong>in</strong>volved <strong>in</strong> perpetrat<strong>in</strong>g a fraudulent scheme dist<strong>in</strong>guish"this case from situation where bank was only engag<strong>in</strong>g <strong>in</strong> a "'rout<strong>in</strong>e commercial f<strong>in</strong>anc<strong>in</strong>gtransaction'").44Liability under §10(b) <strong>and</strong> Rule 10b-5 may be imposed for actions either manipulative ordeceptive. See, e.g. Cooper, 137 F.3d at 624 (Each defendant is a primary ac<strong>to</strong>r liable under §10(b)"as long as each defendant committed a manipulative or deceptive act <strong>in</strong> furtherance <strong>of</strong> thescheme.").- 76 -
as defendants <strong>and</strong> certa<strong>in</strong> courts would make it seem. Indeed, the Court clearly expressed itsapproval <strong>of</strong> read<strong>in</strong>g the manipulation language <strong>of</strong> §10(b) broadly by stat<strong>in</strong>g: "No doubt Congressmeant <strong>to</strong> prohibit the full range <strong>of</strong> <strong>in</strong>genious devices that might be used <strong>to</strong> manipulate securitiesprices." 430 U.S. at 477. 45 Third, Santa Fe, Hundahl, Schreiber <strong>and</strong> Commonwealth Oil/Tesoro areall clearly <strong>of</strong>f-po<strong>in</strong>t because each case really <strong>in</strong>volved what was merely a state law breach <strong>of</strong>fiduciary duty cause <strong>of</strong> action, stemm<strong>in</strong>g from a corporate merger or acquisition, dressed up <strong>in</strong> illfitt<strong>in</strong>gfederal securities law garb. 46 This case is not a mere mismanagement or breach <strong>of</strong> fiduciaryduty case. Without question, it is properly before the Court as a federal securities action alleg<strong>in</strong>gfraud <strong>and</strong> deception. No one could plausibly suggest otherwise.In f<strong>in</strong>d<strong>in</strong>g the compla<strong>in</strong>t <strong>in</strong> L<strong>and</strong>ry's did not adequately plead a §10(b) claim aga<strong>in</strong>st thedefendant <strong>in</strong>vestment banks there, this Court stated:Pla<strong>in</strong>tiffs have generally alleged without any particularity that the Underwriters alsoconducted a comprehensive due diligence <strong>in</strong>vestigation <strong>in</strong><strong>to</strong> L<strong>and</strong>ry's operations <strong>and</strong>future prospects <strong>in</strong> connection with the secondary <strong>of</strong>fer<strong>in</strong>g, for which they helpedprepare the Registration Statement <strong>and</strong> Prospectus. They purportedly had access <strong>to</strong>confidential corporate <strong>in</strong>formation <strong>and</strong> communicated frequently with Fertitta <strong>and</strong>West about the bus<strong>in</strong>ess, but Pla<strong>in</strong>tiffs fail <strong>to</strong> provide any details or identifyspecifically what k<strong>in</strong>d <strong>of</strong> <strong>in</strong>formation, when it was conveyed, by whom <strong>and</strong> <strong>to</strong>whom. Pla<strong>in</strong>tiffs have failed <strong>to</strong> identify any specific <strong>in</strong>formation communicated bydocument or conversations <strong>to</strong> the Underwriter Defendants or uncovered by them <strong>in</strong>their due diligence <strong>in</strong>vestigation. Instead they have made general statements thatmight give rise <strong>to</strong> speculation, but not particularized facts giv<strong>in</strong>g rise <strong>to</strong> a strong<strong>in</strong>ference that the Underwriters acted with severe recklessness or know<strong>in</strong>gly <strong>to</strong>support allegations <strong>of</strong> fraud under the Exchange Act.L<strong>and</strong>ry's, slip op. at 66.45See also Santa Fe, 430 U.S. at 475-76 ("Those cases forcefully reflect the pr<strong>in</strong>ciple that'[§]10(b) must be read flexibly, not technically <strong>and</strong> restrictively,' <strong>and</strong> that the statute provides acause <strong>of</strong> action for any pla<strong>in</strong>tiff who 'suffer[s] an <strong>in</strong>jury as a result <strong>of</strong> deceptive practices <strong>to</strong>uch<strong>in</strong>gits sale [or purchase] <strong>of</strong> securities.'"46See, e.g., Santa Fe, 430 U.S. at 479-80 ("There may well be a need for uniform federalfiduciary st<strong>and</strong>ards <strong>to</strong> govern mergers such as that challenged <strong>in</strong> this compla<strong>in</strong>t. But those st<strong>and</strong>ardsshould not be supplied by judicial extension <strong>of</strong> §10(b) <strong>and</strong> Rule 10b-5 ....") ; Schreiber, 568 F. Supp.at 205 ("This case is the perfect example <strong>of</strong> a pla<strong>in</strong>tiff, who may have nonfrivolous claims based onstate law for breach <strong>of</strong> contract, <strong>to</strong>rtious <strong>in</strong>terference with contract, breach <strong>of</strong> fiduciary duties <strong>and</strong>perhaps even conspiracy, attempt<strong>in</strong>g <strong>to</strong> characterize those state law claims as violations <strong>of</strong> the federalsecurities laws."); Commonwealth Oil/Tesoro, 484 F. Supp. at 259 (pla<strong>in</strong>tiffs br<strong>in</strong>g<strong>in</strong>g additionalclaims for "breach <strong>of</strong> fiduciary duty" stemm<strong>in</strong>g from merger activities); Hundahl, 465 F. Supp. at1362 ("[F]ederalism supports this court's def<strong>in</strong>ition <strong>of</strong> manipulation. The court <strong>in</strong> Santa Fe statedits reluctance <strong>to</strong> imply a federal cause <strong>of</strong> action for a claim 'traditionally relegated <strong>to</strong> state law....'[T]he acts <strong>of</strong> which pla<strong>in</strong>tiffs compla<strong>in</strong> ... are classic breaches <strong>of</strong> fiduciary duty.").- 77 -
Obviously, the allegations aga<strong>in</strong>st CS First Bos<strong>to</strong>n <strong>in</strong> this case are much more extensivelydetailed than those found want<strong>in</strong>g <strong>in</strong> L<strong>and</strong>ry's. The specifics regard<strong>in</strong>g (i) CS First Bos<strong>to</strong>n's <strong>to</strong>pexecutives secretly pre-fund<strong>in</strong>g LJM2 <strong>in</strong> late 12/99 <strong>to</strong> allow Enron <strong>to</strong> complete the bogus year-end99 deals; (ii) CS First Bos<strong>to</strong>n act<strong>in</strong>g as a $120 million funder <strong>of</strong> LJM2 <strong>in</strong> 00-01 <strong>to</strong> provide the moneyit needed <strong>to</strong> complete billions <strong>of</strong> dollars <strong>of</strong> illicit transactions with Enron <strong>to</strong> cont<strong>in</strong>ue <strong>to</strong> artificiallyboost Enron's pr<strong>of</strong>its <strong>and</strong> hide billions <strong>of</strong> dollars <strong>of</strong> Enron's debt; (iii) CS First Bos<strong>to</strong>n's executivespocket<strong>in</strong>g the fruits <strong>of</strong> the loot<strong>in</strong>g <strong>of</strong> Enron result<strong>in</strong>g from these bogus LJM2 deals dur<strong>in</strong>g 99-01; (iv)CS First Bos<strong>to</strong>n's hidden/disguised loans <strong>to</strong> Enron <strong>to</strong> falsify its f<strong>in</strong>ancial condition; <strong>and</strong> (v) CS FirstBos<strong>to</strong>n's role <strong>in</strong> design<strong>in</strong>g, structur<strong>in</strong>g <strong>and</strong> fund<strong>in</strong>g numerous LJM2 SPEs for Enron <strong>to</strong> facilitatethese phony transactions, plus the extensive <strong>in</strong>vestment bank<strong>in</strong>g <strong>and</strong> commercial lend<strong>in</strong>grelationships between CS First Bos<strong>to</strong>n <strong>and</strong> Enron, dist<strong>in</strong>guish the plead<strong>in</strong>g here from the one foundwant<strong>in</strong>g <strong>in</strong> L<strong>and</strong>ry's. Noth<strong>in</strong>g remotely resembl<strong>in</strong>g this was pleaded <strong>in</strong> L<strong>and</strong>ry's. Here, CS FirstBos<strong>to</strong>n <strong>to</strong>ok numerous specified affirmative steps <strong>to</strong> falsify Enron's f<strong>in</strong>ancial results <strong>and</strong> participate<strong>in</strong> the fraudulent scheme <strong>and</strong> course <strong>of</strong> bus<strong>in</strong>ess, while it <strong>and</strong> its <strong>to</strong>p executives achieved directf<strong>in</strong>ancial benefits from the fraud.V. CS FIRST BOSTON MADE FALSE AND MISLEADING STATEMENTSIN REGISTRATION STATEMENTS AND ANALYST REPORTSCS First Bos<strong>to</strong>n does not assert that its analyst reports were accurate, or not deceptive, butrather claims only that it did not have the requisite scienter (CS First Bos<strong>to</strong>n Mot. at 17-21) <strong>and</strong> thatthose statements are <strong>in</strong>actionable as forward-look<strong>in</strong>g statements <strong>and</strong> mere puffery (CS First Bos<strong>to</strong>nMot. at 21 n.10). Neither is true. Further, none <strong>of</strong> the cases cited by CS First Bos<strong>to</strong>n hold that<strong>in</strong>vestment banks cannot (or even should not) be liable for statements <strong>of</strong> their analysts. Nor do any<strong>of</strong> the cases CS First Bos<strong>to</strong>n cites support its <strong>in</strong>credible suggestion that it cannot be liable forconceal<strong>in</strong>g its $150 million <strong>in</strong> disguised loans <strong>to</strong> Enron. 706.Contrary <strong>to</strong> the claims <strong>of</strong> CS First Bos<strong>to</strong>n, the CC is actually very specific <strong>in</strong> detail<strong>in</strong>g thefalse <strong>and</strong> mislead<strong>in</strong>g statements made by CS First Bos<strong>to</strong>n.First, the CC quotes the false <strong>and</strong> mislead<strong>in</strong>g portions <strong>of</strong> the 18 analyst reports issued by CSFirst Bos<strong>to</strong>n dur<strong>in</strong>g the Class Period. Dur<strong>in</strong>g 5/99-10/99, Enron's s<strong>to</strong>ck, which had moved higher- 78 -
earlier <strong>in</strong> 99, stagnated. CS First Bos<strong>to</strong>n issued a series <strong>of</strong> positive reports on Enron. On 7/6/99, CSFirst Bos<strong>to</strong>n issued a report on Enron, rat<strong>in</strong>g Enron a "Buy," forecast<strong>in</strong>g a 15% five-year EPS growthrate for Enron, <strong>and</strong> stat<strong>in</strong>g:154.ENRON – A Real (<strong>and</strong> Valuable)Option <strong>in</strong> CommunicationsBus<strong>in</strong>ess Development Is Occurr<strong>in</strong>g Faster than Expected* * *• High acceptance <strong>of</strong> Enron's network <strong>and</strong> b<strong>and</strong>width trad<strong>in</strong>g strategies isevident as Communication makes major headway <strong>in</strong> network rollout, form<strong>in</strong>galliances, <strong>and</strong> privately negotiat<strong>in</strong>g a b<strong>and</strong>width trade.* * *Enron's physical network presence is necessary <strong>to</strong> create a b<strong>and</strong>width trad<strong>in</strong>g market– a market that we believe is <strong>in</strong>evitable given the vast capacity <strong>in</strong>efficiencies thatcurrently exist. The network provides access <strong>to</strong> key markets, a pool<strong>in</strong>g po<strong>in</strong>t fornetworks, asset flexibility, the ability <strong>to</strong> swap <strong>in</strong><strong>to</strong> a broader network reach, <strong>and</strong>telecommunications credibility. F<strong>in</strong>ally, Enron's network strategy is very much aviable bus<strong>in</strong>ess on its own.* * *Communications Is Runn<strong>in</strong>g Faster <strong>and</strong> Momentum Is Build<strong>in</strong>g• The network build is much accelerated from <strong>in</strong>itial conversations we had withmanagement just three months ago. We believe that Enron is on pace <strong>to</strong> build, swap<strong>in</strong><strong>to</strong>, or acquire at least 18,000 route miles by year-end 2000. More important, thenetwork should reach 15 cities by year-end 1999 <strong>and</strong> 45 cities by year-end 2000.* * *• Enron's b<strong>and</strong>width trad<strong>in</strong>g bus<strong>in</strong>ess, which focuses on pair<strong>in</strong>g parties thathave excess lit network capacity with parties that have a shortage (or temporaryshortage) <strong>of</strong> lit network capacity, is develop<strong>in</strong>g at a much faster pace thanexpected....There Are Several Implications from the Above Discussion• ... Enron's efforts <strong>in</strong> telecom should be considered by <strong>in</strong>ves<strong>to</strong>rs <strong>to</strong> have largepotential.... If Enron has proven anyth<strong>in</strong>g dur<strong>in</strong>g the past decade, it is that it is themaster <strong>of</strong> risk management, captur<strong>in</strong>g <strong>in</strong>efficiencies <strong>in</strong> volatile <strong>and</strong> develop<strong>in</strong>gmarkets by identify<strong>in</strong>g arbitrage opportunities, <strong>and</strong> be<strong>in</strong>g first-<strong>to</strong>-market at justabout everyth<strong>in</strong>g it does.On 7/13/99, CS First Bos<strong>to</strong>n issued a report on Enron, rat<strong>in</strong>g Enron a "Buy" <strong>and</strong> forecast<strong>in</strong>ga 15% five-year EPS growth rate for Enron. It also stated:ENRON – EARNINGS GROWTH CONTINUES- 79 -
2Q EPS <strong>of</strong> $[0.27] exceeds our EPS estimate <strong>of</strong> $[0.25] ....Wholesale energy market<strong>in</strong>g rema<strong>in</strong>s strong .... We expect cont<strong>in</strong>ued operat<strong>in</strong>gpr<strong>of</strong>it growth <strong>in</strong> the upper end <strong>of</strong> the 15-20% range.Retail energy market<strong>in</strong>g is on pace for a pr<strong>of</strong>itable fourth quarter ... as Enroncont<strong>in</strong>ues <strong>to</strong> sign ... outsourc<strong>in</strong>g contracts.* * *There exists substantial upside <strong>to</strong> our EPS estimates <strong>in</strong> the out-years (2001 <strong>and</strong>beyond).158.On 9/2/99, CS First Bos<strong>to</strong>n issued a report on Enron, rat<strong>in</strong>g Enron a "Buy" <strong>and</strong> stat<strong>in</strong>g:Meet<strong>in</strong>g with management highlights a strong EDS<strong>in</strong>g <strong>of</strong> Energy ... <strong>and</strong> reaffirmsearn<strong>in</strong>gs.Wholesale energy market<strong>in</strong>g rema<strong>in</strong>s strong .... We expect cont<strong>in</strong>ued operat<strong>in</strong>gpr<strong>of</strong>it growth <strong>in</strong> the upper end <strong>of</strong> the 15-20% range.Retail energy market<strong>in</strong>g is on pace for a pr<strong>of</strong>itable fourth quarter ....* * *In discuss<strong>in</strong>g the most recent decl<strong>in</strong>e <strong>in</strong> "b<strong>and</strong>width" values across the telecom<strong>in</strong>dustry with Mr. Skill<strong>in</strong>g, two po<strong>in</strong>ts we have made previously were re<strong>in</strong>forced.First, ENE Communications is not <strong>in</strong> the b<strong>and</strong>width bus<strong>in</strong>ess, it provides abundled service ... l<strong>in</strong>k<strong>in</strong>g application providers with end users. Second, ENEclearly views b<strong>and</strong>width as a commodity .... Skill<strong>in</strong>g's enthusiasm for the potential<strong>of</strong> ENE Communications as a whole <strong>and</strong> b<strong>and</strong>width trad<strong>in</strong>g specifically could notbe conta<strong>in</strong>ed ....... Enron Energy Services CEO, Lou Pai, noted that EES ... has proven throughcontracts signed <strong>to</strong> date that EDS<strong>in</strong>g absolutely works....... More importantly, EES ... cont<strong>in</strong>ues <strong>to</strong> sign high quality full EDS<strong>in</strong>g contracts.167.On 9/22/99, CS First Bos<strong>to</strong>n issued a report on Enron. It rated Enron a "Buy" <strong>and</strong> forecasta 15% five-year EPS growth rate for Enron. It also stated:Enron announced <strong>to</strong>day that its retail energy market<strong>in</strong>g subsidiary, Enron EnergyServices, has signed a $1.1 billion ten year <strong>to</strong>tal energy management outsourc<strong>in</strong>gcontract with Owens Corn<strong>in</strong>g ....This is a very positive, "Showcase" contract for Enron ....... Owens' will<strong>in</strong>gness <strong>to</strong> outsource these functions <strong>to</strong> Enron clearly endorsesEnron's strong price risk management skills.- 80 -
171.On 10/12/99, CS First Bos<strong>to</strong>n issued a report on Enron. It rated Enron a "Buy" <strong>and</strong> forecasta 15% five-year EPS growth rate for Enron. It also stated:180.Enron reported 3Q EPS from cont<strong>in</strong>u<strong>in</strong>g operations <strong>of</strong> $0.27 versus $0.24 a year ago.The quarter was lead by strong growth <strong>in</strong> Wholesale Energy Market<strong>in</strong>g, up 36% <strong>to</strong>$378 million versus $277 million <strong>in</strong> the year ago period....Retail energy market<strong>in</strong>g demonstrated further improvement, <strong>and</strong> we cont<strong>in</strong>ue <strong>to</strong>expect a pr<strong>of</strong>itable ... fourth quarter, as Enron cont<strong>in</strong>ues <strong>to</strong> sign <strong>to</strong>tal outsourc<strong>in</strong>gcontracts.In 11/99, Enron's s<strong>to</strong>ck fell sharply on rumors it would "miss" its year-end 99 numbers.While it worked beh<strong>in</strong>d the scenes <strong>to</strong> help Enron falsify its year-end 99 results, publicly, CS FirstBos<strong>to</strong>n assured <strong>in</strong>ves<strong>to</strong>rs all was well with Enron. On 11/30/99, CS First Bos<strong>to</strong>n issued a report onEnron. It forecast a 15% five-year EPS growth rate for Enron. It also stated:191.• After recently visit<strong>in</strong>g with EES President Lou Pai <strong>and</strong> speak<strong>in</strong>g with COOJeff Skill<strong>in</strong>g, we rema<strong>in</strong> very confident <strong>in</strong> the cont<strong>in</strong>ued growth <strong>in</strong> the wholesalebus<strong>in</strong>ess, <strong>and</strong> we cont<strong>in</strong>ue <strong>to</strong> expect the retail bus<strong>in</strong>ess <strong>to</strong> turn earn<strong>in</strong>gs positive <strong>in</strong>the fourth quarter <strong>of</strong> 1999 as Enron cont<strong>in</strong>ues <strong>to</strong> sign <strong>to</strong>tal outsourc<strong>in</strong>g contracts.• Enron cont<strong>in</strong>ues <strong>to</strong> transform itself ... [which] should lead <strong>to</strong> accelerat<strong>in</strong>gearn<strong>in</strong>gs growth <strong>and</strong> susta<strong>in</strong>able P/E multiple expansion over the next several years.* * *Once aga<strong>in</strong>, Enron common s<strong>to</strong>ck has come under severe price weakness ....We recently spoke with COO Jeff Skill<strong>in</strong>g regard<strong>in</strong>g the bus<strong>in</strong>ess condition.Mr. Skill<strong>in</strong>g articulated that bus<strong>in</strong>ess across all l<strong>in</strong>es is <strong>in</strong> excellent shape....Our conversation with Mr. Skill<strong>in</strong>g, as well as a very recent visit with Enron EnergyServices "Retail Energy Services/EDS<strong>in</strong>g <strong>of</strong> Energy" President Lou Pai suggestedthat momentum <strong>in</strong> the retail bus<strong>in</strong>ess cont<strong>in</strong>ues <strong>to</strong> accelerate. Backlogs ... cont<strong>in</strong>ue<strong>to</strong> grow, the impressive roster <strong>of</strong> Enron clients cont<strong>in</strong>ues <strong>to</strong> exp<strong>and</strong>, <strong>and</strong> Enronexpects a positive fourth quarter <strong>of</strong> 1999. We expect <strong>to</strong> see earn<strong>in</strong>gs for full year2000 exceed<strong>in</strong>g the $50 million target that Enron has set.Mr. Skill<strong>in</strong>g also added that he believes Enron's telecommunications bus<strong>in</strong>ess hassubstantial upside potential both on an earn<strong>in</strong>gs <strong>and</strong> valuation basis relative <strong>to</strong>market expectations <strong>and</strong>/or his view <strong>of</strong> what's <strong>in</strong> the s<strong>to</strong>ck.* * *... [W]e have full confidence <strong>in</strong> Enron's ability <strong>to</strong> meet our EPS estimates ....- 81 -
On 1/18/00, CS First Bos<strong>to</strong>n issued a report on Enron. It rated Enron a "Buy" <strong>and</strong> forecasta 15%five-year growth rate for Enron. It also stated:198.Retail (EES) turned earn<strong>in</strong>gs positive with a pr<strong>of</strong>it <strong>of</strong> $7 million for the quarter.We expect 2000 <strong>to</strong> be the year that "EDS<strong>in</strong>g" fully explodes ....... Substantial potential exists for upward earn<strong>in</strong>gs revisions as the knowledge- <strong>and</strong><strong>in</strong>formation-based Wholesale <strong>and</strong> Retail bus<strong>in</strong>esses have begun <strong>to</strong> fire on allcyl<strong>in</strong>ders. We expect earn<strong>in</strong>gs growth <strong>of</strong> 20% or better <strong>in</strong> Wholesale <strong>and</strong> growth <strong>in</strong>the Retail bus<strong>in</strong>ess with earn<strong>in</strong>gs <strong>in</strong>creas<strong>in</strong>g from a $68 million loss <strong>in</strong> FY99 <strong>to</strong> a$50-100 million pr<strong>of</strong>it <strong>in</strong> 2000.On 1/21/00, CS First Bos<strong>to</strong>n issued a report on Enron. It forecast a 15% five-year EPSgrowth rate for Enron. It also stated:205.The Enron analyst meet<strong>in</strong>g was positive....Enron confirmed that its wholesale energy market<strong>in</strong>g division should cont<strong>in</strong>ue its35% EBIT growth rate ....* * *ENE's long term revenue <strong>and</strong> operat<strong>in</strong>g <strong>in</strong>come projections detailed at the meet<strong>in</strong>gshowed a potential discounted present value for Enron's broadb<strong>and</strong>communications bus<strong>in</strong>ess approach<strong>in</strong>g $30 billion.We expect our EDS<strong>in</strong>g <strong>of</strong> energy theme <strong>to</strong> become more important this year. Enronpublicly raised its 2000 operat<strong>in</strong>g <strong>in</strong>come estimate <strong>to</strong> $75 million from $50 million.ENE expects <strong>to</strong> add $16 billion <strong>of</strong> EDS<strong>in</strong>g backlog <strong>in</strong> 2000, generat<strong>in</strong>g $650 million-$1 billion <strong>of</strong> future operat<strong>in</strong>g <strong>in</strong>come at an estimated 4-6% marg<strong>in</strong>.On 2/28/00, CS First Bos<strong>to</strong>n issued a report on Enron. It forecast a 15% five-year EPSgrowth rate for Enron. It also stated:Meet<strong>in</strong>g with Enron President <strong>and</strong> COO, Jeffrey Skill<strong>in</strong>g reaffirms Broadb<strong>and</strong>potential <strong>and</strong> valuesWe recently met with Enron President <strong>and</strong> COO Jeffrey Skill<strong>in</strong>g .... We cont<strong>in</strong>ue <strong>to</strong>be very impressed by [EBS's] ability <strong>to</strong> sign contracts with established long haultelecom carriers <strong>and</strong> their ability <strong>to</strong> facilitate the rapid evolution <strong>of</strong> a b<strong>and</strong>widthtrad<strong>in</strong>g market.... ENE's long term revenue <strong>and</strong> operat<strong>in</strong>g <strong>in</strong>come projections detailed at itsanalyst meet<strong>in</strong>g <strong>in</strong>dicate a potential discounted present value for Enron'sbroadb<strong>and</strong> communications bus<strong>in</strong>ess approach<strong>in</strong>g $30 billion.Enron Broadb<strong>and</strong> has already established a superior broadb<strong>and</strong> delivery network....- 82 -
* * *Mr. Skill<strong>in</strong>g <strong>in</strong>dicated the market reception <strong>to</strong> ENE's unique video stream<strong>in</strong>gservices cont<strong>in</strong>ues <strong>to</strong> be outst<strong>and</strong><strong>in</strong>g. Cus<strong>to</strong>mer reception is strong across the board,with many cus<strong>to</strong>mers ask<strong>in</strong>g, "When can we start?" The recent deal with US Westexemplifies the very strong reception from "baby bells" <strong>in</strong> their race with cablecompanies <strong>to</strong> <strong>in</strong>stall high-speed residential DSL services.Broadb<strong>and</strong> <strong>in</strong>termediation cont<strong>in</strong>ues <strong>to</strong> progress rapidly.213.By 1/00-2/00, Enron's s<strong>to</strong>ck had soared higher, reach<strong>in</strong>g over $70 per share due, <strong>in</strong> part, <strong>to</strong>the extremely positive reports CS First Bos<strong>to</strong>n had issued on Enron. However, the statements made<strong>in</strong> the n<strong>in</strong>e analysts' reports issued by CS First Bos<strong>to</strong>n between 7/6/99-2/28/00, were false ormislead<strong>in</strong>g when issued. The true but concealed facts were:(a)Enron's f<strong>in</strong>ancial statements <strong>and</strong> results issued dur<strong>in</strong>g this period were false<strong>and</strong> mislead<strong>in</strong>g as they <strong>in</strong>flated Enron's revenues, earn<strong>in</strong>gs, assets, <strong>and</strong> equity <strong>and</strong> concealed billions<strong>of</strong> dollars <strong>of</strong> debt that should have been shown on Enron's balance sheet, as described <strong>in</strong> 418-611.(b)Enron's f<strong>in</strong>ancial condition, <strong>in</strong>clud<strong>in</strong>g its liquidity <strong>and</strong> credit st<strong>and</strong><strong>in</strong>g, was notnearly as strong as represented, as Enron was conceal<strong>in</strong>g billions <strong>of</strong> dollars <strong>of</strong> debt that should havebeen reported on its balance sheet – <strong>and</strong> which would have very negatively affected its credit rat<strong>in</strong>g,f<strong>in</strong>ancial condition <strong>and</strong> liquidity – by improperly transferr<strong>in</strong>g that debt <strong>to</strong> the balance sheets <strong>of</strong>various non-qualify<strong>in</strong>g SPEs <strong>and</strong> partnerships it controlled, as detailed here<strong>in</strong>.(c)Enron generated hundreds <strong>of</strong> millions <strong>of</strong> dollars <strong>of</strong> pr<strong>of</strong>its <strong>and</strong> transferredbillions <strong>of</strong> dollars <strong>of</strong> debt <strong>of</strong>f its balance sheet by enter<strong>in</strong>g <strong>in</strong><strong>to</strong> non-arm's-length transactions withSPEs <strong>and</strong> partnerships Enron controlled.(d)The results <strong>of</strong> Enron's WEOS bus<strong>in</strong>ess – its largest bus<strong>in</strong>ess unit – weremanipulated <strong>and</strong> falsified <strong>to</strong> boost its reported pr<strong>of</strong>itability <strong>in</strong> various ways. First, by phony orillusory hedg<strong>in</strong>g transactions with entities that were not <strong>in</strong>dependent <strong>of</strong> Enron. Second, by the abuse<strong>of</strong> mark-<strong>to</strong>-market account<strong>in</strong>g by adopt<strong>in</strong>g unreasonable contract valuations <strong>and</strong> economicassumptions when contracts were <strong>in</strong>itially entered <strong>in</strong><strong>to</strong>. And third, by arbitrarily adjust<strong>in</strong>g thosevalues upward at quarter's end <strong>to</strong> boost the wholesale operation's pr<strong>of</strong>its for that period – a practice- 83 -
known <strong>in</strong>side Enron as "mov<strong>in</strong>g the curve." "Mov<strong>in</strong>g-the-curve" was "endemic" <strong>in</strong>side Enron –done <strong>in</strong> all <strong>of</strong> Enron's commodity-trad<strong>in</strong>g activities – everyth<strong>in</strong>g Enron traded.(e)The f<strong>in</strong>ancial performance <strong>and</strong> the value <strong>of</strong> contracts entered <strong>in</strong><strong>to</strong> by EES weregrossly overstated through various techniques, <strong>in</strong>clud<strong>in</strong>g the misuse <strong>and</strong> abuse <strong>of</strong> mark-<strong>to</strong>-marketaccount<strong>in</strong>g <strong>to</strong> create huge current-period values for Enron on what were, <strong>in</strong> fact, highly speculative<strong>and</strong> <strong>in</strong>determ<strong>in</strong>ate outcomes <strong>of</strong> long-term contracts. This resulted <strong>in</strong> EES improperly <strong>and</strong>prematurely recogniz<strong>in</strong>g hundreds <strong>of</strong> millions <strong>of</strong> dollars <strong>of</strong> revenue that not only boosted its f<strong>in</strong>ancialresults, but allowed <strong>to</strong>p EES managers <strong>and</strong> executives <strong>to</strong> collect huge bonuses based on theseimproperly <strong>in</strong>flated contract valuations.(f)EES was, <strong>in</strong> fact, los<strong>in</strong>g hundreds <strong>of</strong> millions <strong>of</strong> dollars on many <strong>of</strong> its retailenergy contracts. To <strong>in</strong>duce cus<strong>to</strong>mers <strong>to</strong> enter <strong>in</strong><strong>to</strong> these agreements – so that Enron could claimits EES bus<strong>in</strong>ess was grow<strong>in</strong>g <strong>and</strong> succeed<strong>in</strong>g – Enron had, <strong>in</strong> effect, "purchased" their participationby promis<strong>in</strong>g them unrealistic sav<strong>in</strong>gs, charg<strong>in</strong>g low prices Enron knew would likely result <strong>in</strong> a loss,<strong>and</strong> spend<strong>in</strong>g millions <strong>of</strong> dollars <strong>in</strong> the short term <strong>to</strong> purchase purportedly more energy-efficientequipment, a significant portion <strong>of</strong> which costs Enron was likely never <strong>to</strong> recover <strong>and</strong> certa<strong>in</strong>ly never<strong>to</strong> make a pr<strong>of</strong>it on. Enron would lose money on the EES deals, but had <strong>to</strong> make them more <strong>and</strong>more attractive <strong>to</strong> generate new clients, while the Company utilized unrealistic projections <strong>and</strong> mark<strong>to</strong>-marketaccount<strong>in</strong>g <strong>to</strong> mislead <strong>in</strong>ves<strong>to</strong>rs <strong>in</strong><strong>to</strong> believ<strong>in</strong>g that the EES contracts were mak<strong>in</strong>g money.(g)In the 4thQ 99 EES deal with Owens Ill<strong>in</strong>ois, EES recognized a multi-milliondollar pr<strong>of</strong>it when the deal closed, even though this deal would lose money for EES.(h)The purported prospects for, <strong>and</strong> actual success <strong>of</strong>, Enron's EBS division wasgrossly overstated. First, Enron's broadb<strong>and</strong> network – the so-called Enron Intelligent Network("EIN") – was plagued by serious <strong>and</strong> persistent technical difficulties, which prevented it fromprovid<strong>in</strong>g the type <strong>of</strong> high-speed <strong>and</strong> high-quality transmission that was <strong>in</strong>dispensable <strong>to</strong> any hope<strong>of</strong> commercial success. Second, Enron was encounter<strong>in</strong>g significant difficulties <strong>in</strong> complet<strong>in</strong>g thebuild-out <strong>of</strong> its broadb<strong>and</strong> network <strong>and</strong>, as a result, did not have currently, <strong>and</strong> would not have at anyreasonable time <strong>in</strong> the foreseeable future, a function<strong>in</strong>g broadb<strong>and</strong> network.- 84 -
(i)The prospects for future revenue <strong>and</strong> pr<strong>of</strong>its from Enron's EBS operation <strong>and</strong>the purported value <strong>of</strong> that operation <strong>to</strong> Enron <strong>and</strong> <strong>to</strong> its s<strong>to</strong>ck price were completely false based onarbitrary <strong>and</strong> unrealistic assertions without any basis <strong>in</strong> fact because Enron knew from currentproblems <strong>in</strong> that bus<strong>in</strong>ess, as well as the current state <strong>of</strong> EBS bus<strong>in</strong>ess, that such revenue <strong>and</strong> pr<strong>of</strong>itforecasts <strong>and</strong> valuations were unobta<strong>in</strong>able.(j)As a result <strong>of</strong> the forego<strong>in</strong>g, the forecasts for strong cont<strong>in</strong>ued revenue <strong>and</strong>earn<strong>in</strong>gs growth for Enron's wholesale <strong>and</strong> retail energy operations were completely false, <strong>in</strong> part,because the his<strong>to</strong>rical f<strong>in</strong>ancial performance <strong>and</strong> condition <strong>of</strong> those operations had been materiallyfalsified – thus there was no real basis upon which <strong>to</strong> forecast such further growth – <strong>and</strong> becauseneither <strong>of</strong> those bus<strong>in</strong>esses had the current strengths or success <strong>to</strong> justify the forecasts <strong>and</strong> claims <strong>of</strong>future growth that were be<strong>in</strong>g made.(k)As a result <strong>of</strong> the forego<strong>in</strong>g, the revenue <strong>and</strong> EPS forecasts be<strong>in</strong>g made by <strong>and</strong>for Enron go<strong>in</strong>g forward were also grossly false because his<strong>to</strong>rical earn<strong>in</strong>gs, upon which thoseforecasts were based, were falsified <strong>and</strong> the result <strong>of</strong> improper account<strong>in</strong>g manipulation. In truth,Enron's various bus<strong>in</strong>ess operations not only had huge concealed losses that would have <strong>to</strong> berecognized <strong>and</strong> would very adversely impact Enron's f<strong>in</strong>ancial results, but those core bus<strong>in</strong>essoperations simply did not have the strength or success necessary for them <strong>to</strong> generate anywhere nearthe k<strong>in</strong>d <strong>of</strong> revenue <strong>and</strong> pr<strong>of</strong>it growth be<strong>in</strong>g forecast for them. 214.229.On 04/12/00, CS First Bos<strong>to</strong>n issued a report on Enron. It stated:Strong Q1 Underscores Increas<strong>in</strong>g Momentum Across All Bus<strong>in</strong>esses(EBS) made great progress <strong>in</strong> both the content delivery <strong>and</strong> <strong>in</strong>termediationbus<strong>in</strong>esses ....... The Retail (EDS<strong>in</strong>g) bus<strong>in</strong>ess far exceeded our expectations, as major longterm, full outsourc<strong>in</strong>g contracts cont<strong>in</strong>ued <strong>to</strong> be signed <strong>in</strong> the US <strong>and</strong> <strong>in</strong>creas<strong>in</strong>gly<strong>in</strong> Europe, <strong>and</strong> ultimately Lat<strong>in</strong> America.We take particular note <strong>of</strong> EBS ability <strong>to</strong> sign 20 content delivery contracts throughthe quarter .... These contracts are quickly validat<strong>in</strong>g EBS's Enron IntelligentNetwork. B<strong>and</strong>width <strong>in</strong>termediation (trad<strong>in</strong>g) has become a reality. EBS realized85% <strong>of</strong> its full year transaction targets <strong>in</strong> the first quarter alone ....- 85 -
On 10/18/00, CS First Bos<strong>to</strong>n issued a report on Enron. It rated Enron a "Strong Buy," witha target price <strong>of</strong> $115, <strong>and</strong> forecast 00 <strong>and</strong> 01 EPS <strong>of</strong> $1.40 <strong>and</strong> $1.65 <strong>and</strong> a 15% five-year EPSgrowth rate for Enron. The report stated:268.ENE reported 3Q EPS <strong>of</strong> $0.34 .... Compares <strong>to</strong> our estimate <strong>of</strong> $0.30.* * *We are <strong>in</strong>creas<strong>in</strong>g our '00 eps estimate <strong>to</strong> $1.40 from $1.35 based on the trendsshown <strong>in</strong> Wholesale <strong>and</strong> EES. Ma<strong>in</strong>ta<strong>in</strong><strong>in</strong>g 2001 estimate <strong>of</strong> $1.65 per share,which appears conservative.* * *... Our target price for ENE is $115 <strong>and</strong> our rat<strong>in</strong>g is Strong Buy.* * *... At Enron Energy Services (EES), ENE showed EBIT <strong>of</strong> $30 million vs a loss <strong>of</strong>$18 million <strong>in</strong> 3Q'99 on revenues <strong>of</strong> $1.5 billion. EES reported new contracts <strong>of</strong>$4.1 billion ... <strong>in</strong> l<strong>in</strong>e with estimates ....* * *... [The Blockbuster] deal represents a major move for EBS <strong>in</strong> its content servicesbus<strong>in</strong>ess .... The speed <strong>of</strong> the rollout <strong>and</strong> move <strong>to</strong>ward revenues <strong>and</strong> pr<strong>of</strong>its fromthis deal suggest an acceleration <strong>of</strong> the valuations <strong>in</strong> our discounted cash flowmodel<strong>in</strong>g....... EES unit <strong>of</strong> ENE as on target for $16 billion <strong>of</strong> new contracts this year .... Withpr<strong>of</strong>it marg<strong>in</strong>s ris<strong>in</strong>g rapidly, EES is projected <strong>to</strong> be on target for $100 million <strong>in</strong>2000 ebit <strong>and</strong> rapid growth <strong>in</strong> '01 <strong>and</strong> beyond.On 1/26/01, CS First Bos<strong>to</strong>n issued a report on Enron. It rated Enron a "Strong Buy,"<strong>in</strong>creased the target price <strong>to</strong> $128, <strong>in</strong>creased Enron's forecasted 01 <strong>and</strong> 02 EPS <strong>to</strong> $1.80 <strong>and</strong> $2.20<strong>and</strong> ma<strong>in</strong>ta<strong>in</strong>ed a 15% five-year EPS growth rate for Enron. It also stated:Analyst Meet<strong>in</strong>g Shows Power <strong>of</strong> ENE Platforms For Growth. Rais<strong>in</strong>g '01 Estimate<strong>to</strong> $1.80. Introduc<strong>in</strong>g '02 Estimate <strong>of</strong> $2.20. Target Price $128 ....* * *Compell<strong>in</strong>g growth <strong>and</strong> ris<strong>in</strong>g return platforms across all bus<strong>in</strong>ess unitsshowcased at analyst meet<strong>in</strong>g.With this report we are <strong>in</strong>creas<strong>in</strong>g our 01 estimate from $1.65 <strong>to</strong> $1.80. We are<strong>in</strong>troduc<strong>in</strong>g a 2002 estimate <strong>of</strong> $2.20 per share.- 86 -
Estimate <strong>in</strong>crease due <strong>to</strong> strength at Energy Services <strong>and</strong> Wholesale units.Broadb<strong>and</strong> growth acceleration another plus.* * *... EBS has achieved its goal <strong>of</strong> worldwide connectivity <strong>and</strong> contract<strong>in</strong>g with metr<strong>of</strong>iberproviders <strong>in</strong> major cities.* * *With its Network complete, EBS has begun <strong>to</strong> move ahead <strong>in</strong><strong>to</strong> Intermediation <strong>and</strong>Content Services. EBS has done over 300 transactions <strong>in</strong> traded b<strong>and</strong>width witha <strong>to</strong>tal <strong>of</strong> over 5,000 DS3 months <strong>of</strong> service delivered.* * *... The Blockbuster deal is up <strong>and</strong> runn<strong>in</strong>g <strong>in</strong> four markets on a test basis with 12more markets scheduled for this year.285.On 2/20/01, CS First Bos<strong>to</strong>n issued a report on Enron. It rated Enron a "Strong Buy" <strong>and</strong>forecast 01 <strong>and</strong> 02 EPS <strong>of</strong> $1.80 <strong>and</strong> $2.20 for Enron <strong>and</strong> stated:290."Fortune" Article Very Negative; Focuses On Valuation <strong>and</strong> Complexity; Noth<strong>in</strong>gReally New, Just Negative "Sp<strong>in</strong>" on Co.Magaz<strong>in</strong>e calls ENE "black box" with "impenetrable f<strong>in</strong>ancial statements" .... Ourwork has dealt with each <strong>of</strong> these issues analytically, show<strong>in</strong>g repeatability <strong>and</strong>acceleration <strong>of</strong> growth <strong>and</strong> creation <strong>of</strong> new bus<strong>in</strong>esses with clear performancemetrics.On 4/17/01, CS First Bos<strong>to</strong>n issued a report on Enron. It rated Enron a "Strong Buy," witha $110 target price, <strong>and</strong> <strong>in</strong>creased Enron's forecasted 01 <strong>and</strong> 02 EPS <strong>to</strong> $1.80 <strong>and</strong> $2.25. It alsostated:319.ENE reported 1Q'01 EPS <strong>of</strong> $0.47 .... Our estimate was $0.45.* * *Enron Energy Services (EES) showed $40 million <strong>in</strong> 1Q'01 ebit vs. $6 <strong>in</strong> 1Q'00.New contract sign<strong>in</strong>gs <strong>of</strong> $5.9 billion keep EES on target for our ebit estimate <strong>of</strong>$225 million <strong>in</strong> '01 vs. $103 <strong>in</strong> '00.Our '01 estimate is $1.80 per share.... Based on the trends shown <strong>in</strong> the 1Q'01 data,we are <strong>in</strong>creas<strong>in</strong>g our '02 eps estimate from $2.20 <strong>to</strong> $2.25.- 87 -
The statements made <strong>in</strong> the five analysts' reports issued by CS First Bos<strong>to</strong>n between 4/00-4/01, were false or mislead<strong>in</strong>g when issued. The true but concealed facts were:(a)Enron's f<strong>in</strong>ancial statements <strong>and</strong> results issued dur<strong>in</strong>g this period were false<strong>and</strong> mislead<strong>in</strong>g as they <strong>in</strong>flated Enron's revenues, earn<strong>in</strong>gs, assets, <strong>and</strong> equity <strong>and</strong> concealed billions<strong>of</strong> dollars <strong>of</strong> debt that should have been shown on Enron's balance sheet, as described <strong>in</strong> 418-611.(b)Enron's f<strong>in</strong>ancial condition, <strong>in</strong>clud<strong>in</strong>g its liquidity <strong>and</strong> credit st<strong>and</strong><strong>in</strong>g, was notnearly as strong as represented, as Enron was conceal<strong>in</strong>g billions <strong>of</strong> dollars <strong>of</strong> debt that should havebeen reported on its balance sheet – <strong>and</strong> which would have very negatively affected its credit rat<strong>in</strong>g,f<strong>in</strong>ancial condition <strong>and</strong> liquidity – by improperly transferr<strong>in</strong>g that debt <strong>to</strong> the balance sheets <strong>of</strong>various non-qualify<strong>in</strong>g SPEs <strong>and</strong> partnerships it controlled, as detailed here<strong>in</strong>.(c)Enron generated hundreds <strong>of</strong> millions <strong>of</strong> dollars <strong>of</strong> pr<strong>of</strong>its <strong>and</strong> transferredbillions <strong>of</strong> dollars <strong>of</strong> debt <strong>of</strong>f its balance sheet by enter<strong>in</strong>g <strong>in</strong><strong>to</strong> non-arm's-length transactions withSPEs <strong>and</strong> partnerships Enron controlled.(d)The results <strong>of</strong> Enron's WEOS bus<strong>in</strong>ess – its largest bus<strong>in</strong>ess unit – weremanipulated <strong>and</strong> falsified <strong>to</strong> boost its reported pr<strong>of</strong>itability <strong>in</strong> various ways. First, by phony orillusory hedg<strong>in</strong>g transactions with entities that were not <strong>in</strong>dependent <strong>of</strong> Enron. Second, by the abuse<strong>of</strong> mark-<strong>to</strong>-market account<strong>in</strong>g by adopt<strong>in</strong>g unreasonable contract valuations <strong>and</strong> economicassumptions when contracts were <strong>in</strong>itially entered <strong>in</strong><strong>to</strong>. And third, by arbitrarily adjust<strong>in</strong>g thosevalues upward at quarter's end <strong>to</strong> boost the wholesale operation's pr<strong>of</strong>its for that period – a practiceknown <strong>in</strong>side Enron as "mov<strong>in</strong>g the curve." Curve manipulations occurred <strong>in</strong> every quarter <strong>in</strong> all<strong>of</strong> Enron's WEOS operation.(e)The f<strong>in</strong>ancial performance <strong>and</strong> the value <strong>of</strong> contracts entered <strong>in</strong><strong>to</strong> by EES weregrossly overstated through various techniques, <strong>in</strong>clud<strong>in</strong>g the misuse <strong>and</strong> abuse <strong>of</strong> mark-<strong>to</strong>-marketaccount<strong>in</strong>g <strong>to</strong> create huge current-period values for Enron on what were, <strong>in</strong> fact, highly speculative<strong>and</strong> <strong>in</strong>determ<strong>in</strong>ate outcomes <strong>of</strong> long-term contracts. This resulted <strong>in</strong> EES improperly <strong>and</strong>prematurely recogniz<strong>in</strong>g hundreds <strong>of</strong> millions <strong>of</strong> dollars <strong>of</strong> revenue that not only boosted its f<strong>in</strong>ancialresults, but allowed <strong>to</strong>p EES managers <strong>and</strong> executives <strong>to</strong> collect huge bonuses based on theseimproperly <strong>in</strong>flated contract valuations.- 88 -
(f)EES was, <strong>in</strong> fact, los<strong>in</strong>g hundreds <strong>of</strong> millions <strong>of</strong> dollars on many <strong>of</strong> its retailenergy contracts. To <strong>in</strong>duce cus<strong>to</strong>mers <strong>to</strong> enter <strong>in</strong><strong>to</strong> these agreements – so that Enron could claimits EES bus<strong>in</strong>ess was grow<strong>in</strong>g <strong>and</strong> succeed<strong>in</strong>g – Enron had, <strong>in</strong> effect, "purchased" their participationby promis<strong>in</strong>g them unrealistic sav<strong>in</strong>gs, charg<strong>in</strong>g low prices Enron knew would likely result <strong>in</strong> a loss,<strong>and</strong> spend<strong>in</strong>g millions <strong>of</strong> dollars <strong>in</strong> the short term <strong>to</strong> purchase purportedly more energy-efficientequipment, a significant portion <strong>of</strong> which costs Enron was likely never <strong>to</strong> recover <strong>and</strong> certa<strong>in</strong>ly never<strong>to</strong> make a pr<strong>of</strong>it on. Enron would lose money on the EES deals, but had <strong>to</strong> make them more <strong>and</strong>more attractive <strong>to</strong> generate new clients, while the Company utilized unrealistic projections <strong>and</strong> mark<strong>to</strong>-marketaccount<strong>in</strong>g <strong>to</strong> mislead <strong>in</strong>ves<strong>to</strong>rs <strong>in</strong><strong>to</strong> believ<strong>in</strong>g that the EES contracts were mak<strong>in</strong>g money.(g)EES entered <strong>in</strong><strong>to</strong> dem<strong>and</strong>-side-management ("DSM") contracts, whichbundled energy-related products <strong>and</strong> services for its cus<strong>to</strong>mers, <strong>in</strong>clud<strong>in</strong>g provid<strong>in</strong>g power <strong>and</strong>equipment as commodities <strong>to</strong> companies like J.C. Penney, Quaker Oats, IBM, Starwood Properties,Albertsons, Safeway, <strong>and</strong> others, along with long-term management <strong>and</strong> consult<strong>in</strong>g services on thecus<strong>to</strong>mers' usage <strong>of</strong> the power over the life <strong>of</strong> the contract. Enron booked 100% <strong>of</strong> the commodityportion <strong>of</strong> the contract up front, <strong>and</strong> 70% (on average) <strong>of</strong> the estimated long-term services revenue.Because the revenues from each contract were pulled <strong>in</strong><strong>to</strong> the s<strong>in</strong>gle quarter when the contract wassigned us<strong>in</strong>g mark-<strong>to</strong>-market account<strong>in</strong>g, EES had <strong>to</strong> close <strong>in</strong>creas<strong>in</strong>gly higher revenue-produc<strong>in</strong>gDSM transactions <strong>to</strong> show growth <strong>in</strong> EES's revenues <strong>and</strong> pr<strong>of</strong>its.(h)The Enron DSM contract with J.C. Penney had losses <strong>of</strong> $60 million, the IBMdeal was a significant loss for Enron from the outset, <strong>and</strong> the CitiGroup contract was known at its<strong>in</strong>ception <strong>to</strong> cost Enron millions <strong>in</strong> losses. In the 4thQ 99 EES deal with Owens Ill<strong>in</strong>ois, EESrecognized a multi-million dollar pr<strong>of</strong>it when the deal closed, even though it was known this dealwould likely lose money for EES.(i)The purported prospects for, <strong>and</strong> actual success <strong>of</strong>, Enron's EBS division wasgrossly overstated. First, Enron's broadb<strong>and</strong> network – the so-called Enron Intelligent Network orEIN – was plagued by serious <strong>and</strong> persistent technical difficulties, which prevented it from provid<strong>in</strong>gthe type <strong>of</strong> high-speed <strong>and</strong> high-quality transmission that was <strong>in</strong>dispensable <strong>to</strong> any hope <strong>of</strong>commercial success. Second, Enron was encounter<strong>in</strong>g significant difficulties <strong>in</strong> complet<strong>in</strong>g the- 89 -
uild-out <strong>of</strong> its broadb<strong>and</strong> network <strong>and</strong>, as a result, did not have currently, <strong>and</strong> would not have at anyreasonable time <strong>in</strong> the foreseeable future, a function<strong>in</strong>g broadb<strong>and</strong> network. The EIN – the core <strong>of</strong>the Enron Broadb<strong>and</strong> Operat<strong>in</strong>g System ("BOS") – was doomed <strong>to</strong> failure due <strong>to</strong> numerous<strong>in</strong>tractable problems.(j)The prospects for future revenue <strong>and</strong> pr<strong>of</strong>its from Enron's EBS operation <strong>and</strong>the purported value <strong>of</strong> that operation <strong>to</strong> Enron <strong>and</strong> <strong>to</strong> its s<strong>to</strong>ck price was completely arbitrary <strong>and</strong>without any basis <strong>in</strong> fact because <strong>of</strong> current problems <strong>in</strong> that bus<strong>in</strong>ess, such that revenue <strong>and</strong> pr<strong>of</strong>itforecasts <strong>and</strong> valuations were arbitrary, unreasonable <strong>and</strong> unobta<strong>in</strong>able.(k)Enron's purported growth <strong>in</strong> broadb<strong>and</strong> <strong>in</strong>termediation – trad<strong>in</strong>g b<strong>and</strong>widthaccess – was neither as successful as claimed nor was the market develop<strong>in</strong>g as quickly or <strong>in</strong> themanner Enron asserted. Enron grossly overstated the number <strong>of</strong> cus<strong>to</strong>mers or counterparties it wasdo<strong>in</strong>g b<strong>and</strong>width <strong>in</strong>termediation with by count<strong>in</strong>g as ongo<strong>in</strong>g cus<strong>to</strong>mers or trad<strong>in</strong>g partners entitiesthat had done only a test or an experimental trade <strong>and</strong> not engag<strong>in</strong>g <strong>in</strong> any ongo<strong>in</strong>g b<strong>and</strong>width<strong>in</strong>termediation. Even worse, the number <strong>of</strong> trades be<strong>in</strong>g conducted via Enron's broadb<strong>and</strong><strong>in</strong>termediation was grossly overstated <strong>to</strong> create the illusion <strong>of</strong> ever-<strong>in</strong>creas<strong>in</strong>g levels <strong>of</strong> activity,which it accomplished by splitt<strong>in</strong>g up what was, <strong>in</strong> fact, a s<strong>in</strong>gle unified trade <strong>in</strong><strong>to</strong> five or 10 or evenmore separate trades, thus creat<strong>in</strong>g the false image <strong>of</strong> <strong>in</strong>creas<strong>in</strong>g trad<strong>in</strong>g activity.(l)Enron was abus<strong>in</strong>g <strong>and</strong> misus<strong>in</strong>g mark-<strong>to</strong>-market account<strong>in</strong>g with respect <strong>to</strong>its broadb<strong>and</strong> <strong>in</strong>termediation activity, utiliz<strong>in</strong>g this account<strong>in</strong>g method – <strong>to</strong>gether with falseassumptions <strong>of</strong> ultimate value – <strong>to</strong> create much higher current-period revenue <strong>and</strong> bot<strong>to</strong>m-l<strong>in</strong>e resultsthan were reasonable <strong>and</strong> atta<strong>in</strong>able had proper account<strong>in</strong>g techniques been used.(m)The potential favorable impact <strong>of</strong> the Blockbuster VOD jo<strong>in</strong>t venture as wellas its success was grossly misrepresented <strong>and</strong> overstated. First, Blockbuster did not have the legalright <strong>to</strong> electronically distribute movie content – the <strong>in</strong>dispensable element <strong>of</strong> a successfulbroadb<strong>and</strong>-based VOD system – <strong>in</strong> cable-quality digital format. Second, due <strong>to</strong> technical problemswith its broadb<strong>and</strong> network, Enron could not transmit movies or other content with sufficient qualityor speed <strong>to</strong> permit the VOD system <strong>to</strong> ever succeed. Notwithst<strong>and</strong><strong>in</strong>g these substantial defects – plusgross abuse <strong>of</strong> mark-<strong>to</strong>-market account<strong>in</strong>g – Enron discounted <strong>and</strong> recognized a wholly unrealistic- 90 -
projection <strong>of</strong> revenue over the entire 20-year life <strong>of</strong> the Blockbuster VOD venture <strong>in</strong><strong>to</strong> currentperiods, <strong>of</strong>fset it by unrealistically low expense estimates, <strong>and</strong> failed <strong>to</strong> take any proper reserve foruncerta<strong>in</strong>ty <strong>of</strong> outcome or collectability. Consequently, Enron secretly recognized over $110 million<strong>of</strong> pr<strong>of</strong>its <strong>in</strong> the 4thQ 00 <strong>and</strong> the 1stQ 01 – two-thirds <strong>of</strong> the earn<strong>in</strong>gs claimed by EBS <strong>in</strong> those twoperiods – <strong>in</strong> one <strong>of</strong> the largest one-time <strong>and</strong> upward manipulations <strong>of</strong> Enron's f<strong>in</strong>ancial statements.(n)Enron was not successfully manag<strong>in</strong>g its balance sheet by effectively hedg<strong>in</strong>gits merchant <strong>in</strong>vestments <strong>and</strong> plac<strong>in</strong>g billions <strong>of</strong> dollars <strong>of</strong> non-recourse debt <strong>in</strong> related but<strong>in</strong>dependent parties. In fact, the hedges were illusory, not real, <strong>and</strong> were largely dependent on thevalue <strong>of</strong> Enron's own s<strong>to</strong>ck where Enron was still exposed <strong>to</strong> the risk <strong>of</strong> its merchant <strong>in</strong>vestments.In fact, that debt was not non-recourse because if Enron's credit rat<strong>in</strong>g was downgraded that debtwould become recourse as <strong>to</strong> Enron. This was an extraord<strong>in</strong>arily dangerous situation for Enronbecause, <strong>in</strong> fact, based upon its true f<strong>in</strong>ancial condition, which was known <strong>to</strong> its <strong>in</strong>siders, Enron didnot deserve the <strong>in</strong>vestment grade credit rat<strong>in</strong>g it was carry<strong>in</strong>g <strong>and</strong> it was <strong>in</strong> constant <strong>and</strong> precariousdanger <strong>of</strong> los<strong>in</strong>g that rat<strong>in</strong>g when the true structure <strong>of</strong> its <strong>of</strong>f-balance-sheet partnerships <strong>and</strong> SPEsbecame known <strong>and</strong> its true f<strong>in</strong>ancial condition was revealed.(o)In fact, Enron did not deserve an <strong>in</strong>vestment grade credit rat<strong>in</strong>g <strong>and</strong> did nothave a solid or substantial f<strong>in</strong>ancial structure because it was <strong>in</strong>flat<strong>in</strong>g the value <strong>of</strong> its assets bybillions <strong>of</strong> dollars while conceal<strong>in</strong>g billions <strong>of</strong> dollars <strong>of</strong> debt that should have been on its balancesheet. As a result, Enron's true f<strong>in</strong>ancial structure was extremely fragile.(p)As a result <strong>of</strong> the forego<strong>in</strong>g, the forecasts for strong cont<strong>in</strong>ued revenue <strong>and</strong>earn<strong>in</strong>gs growth for Enron's wholesale <strong>and</strong> retail energy operations were completely false, <strong>in</strong> part,because the his<strong>to</strong>rical f<strong>in</strong>ancial performance <strong>and</strong> condition <strong>of</strong> those operations had been materiallyfalsified – thus there was no real basis upon which <strong>to</strong> forecast such further growth – <strong>and</strong> becauseneither <strong>of</strong> those bus<strong>in</strong>esses had the current strengths or success <strong>to</strong> justify the forecasts <strong>and</strong> claims forfuture growth that were be<strong>in</strong>g made.(q)As a result <strong>of</strong> the forego<strong>in</strong>g, the revenue <strong>and</strong> EPS forecasts be<strong>in</strong>g made by <strong>and</strong>for Enron go<strong>in</strong>g forward were also grossly false because his<strong>to</strong>rical earn<strong>in</strong>gs, upon which thoseforecasts were based, were falsified <strong>and</strong> the result <strong>of</strong> improper account<strong>in</strong>g manipulation. In truth,- 91 -
Enron's various bus<strong>in</strong>ess operations not only had huge concealed losses, which would have <strong>to</strong> berecognized <strong>and</strong> would very adversely impact Enron's f<strong>in</strong>ancial results, but those core bus<strong>in</strong>essoperations simply did not have the strength or success necessary for them <strong>to</strong> generate anywhere nearthe k<strong>in</strong>d <strong>of</strong> revenue <strong>and</strong> pr<strong>of</strong>it growth be<strong>in</strong>g forecast for them. 300.On 8/14/01, CS First Bos<strong>to</strong>n issued a report on Enron. It reta<strong>in</strong>ed CS First Bos<strong>to</strong>n's "StrongBuy" rat<strong>in</strong>g on Enron with a price target <strong>of</strong> $84. It cont<strong>in</strong>ued <strong>to</strong> forecast 01 <strong>and</strong> 02 EPS <strong>of</strong> $1.80 <strong>and</strong>$2.25 for Enron. It also stated:345.CEO Skill<strong>in</strong>g Resigns; Chmn Lay Takes Back CEO & Pres Roles. No Other "Shoes<strong>to</strong> Drop." Reta<strong>in</strong> Strong Buy* * *Late yesterday, ENE announced that its CEO, Mr. Jeff Skill<strong>in</strong>g resigned for personalreasons....Our analysis <strong>and</strong> <strong>in</strong>formation <strong>in</strong>dicates that there are no changes or disclosureitems <strong>in</strong>herent <strong>in</strong> the departure....Our estimates for ENE are $1.80 <strong>in</strong> '01 <strong>and</strong> $2.25 <strong>in</strong> '02.On 8/17/01, CS First Bos<strong>to</strong>n issued a report on Enron. It cont<strong>in</strong>ued <strong>to</strong> rate Enron a "StrongBuy" <strong>and</strong> cont<strong>in</strong>ued <strong>to</strong> forecast 01 <strong>and</strong> 02 EPS <strong>of</strong> $1.80 <strong>and</strong> $2.25 EPS for Enron. It also stated:354.ENE fell a further 8% yesterday mostly related <strong>to</strong> speculation <strong>of</strong> negative issuessurround<strong>in</strong>g the departure <strong>of</strong> Mr. Jeff Skill<strong>in</strong>g as CEO....... [I]ntensive meet<strong>in</strong>gs with ENE management cont<strong>in</strong>ue <strong>to</strong> show no truth <strong>to</strong> any<strong>of</strong> the speculations, which caused the share price decl<strong>in</strong>e.Further comments <strong>and</strong> discussions show that bus<strong>in</strong>ess trends are good <strong>and</strong> ENEis <strong>in</strong> position <strong>to</strong> meet or exceed the 20% eps growth rate model we have estimated.The statements made made surround<strong>in</strong>g <strong>and</strong> after Skill<strong>in</strong>g's resignation by CS First Bos<strong>to</strong>n<strong>in</strong> its 8/01 analysts' reports were false <strong>and</strong> mislead<strong>in</strong>g. First <strong>of</strong> all, Skill<strong>in</strong>g did not resign for"personal reasons," but rather, because he knew that the scheme <strong>to</strong> defraud he had been activelyparticipat<strong>in</strong>g <strong>in</strong> was fall<strong>in</strong>g apart <strong>and</strong> about <strong>to</strong> be exposed, which would result <strong>in</strong> Enron's s<strong>to</strong>ck pricecompletely collaps<strong>in</strong>g <strong>and</strong> Enron los<strong>in</strong>g its <strong>in</strong>vestment grade credit rat<strong>in</strong>g <strong>and</strong> likely go<strong>in</strong>g bankrupt.The assurances made that Enron had never been <strong>in</strong> better shape, its numbers looked good, there were- 92 -
no changes <strong>in</strong> Enron's earn<strong>in</strong>gs outlook, that the Company was very strong <strong>and</strong> the resignation didnot signal any account<strong>in</strong>g problems or adverse disclosures were all lies as, <strong>in</strong> fact, Enron's bus<strong>in</strong>ess– which had been propped up through a series <strong>of</strong> manipulative or deceptive devices <strong>and</strong> contrivancesfor years – was now on the verge <strong>of</strong> complete collapse, due <strong>to</strong> the accumulated weight <strong>of</strong> thefalsification <strong>of</strong> its f<strong>in</strong>ancial results. 359.On 10/19/01, CS First Bos<strong>to</strong>n issued a report. The report cont<strong>in</strong>ued <strong>to</strong> rate Enron a "StrongBuy" <strong>and</strong> cont<strong>in</strong>ued <strong>to</strong> forecast 01 <strong>and</strong> 02 EPS <strong>of</strong> $1.80 <strong>and</strong> $2.15 for Enron. It also stated:374.ENE decl<strong>in</strong>ed by 10% yesterday <strong>in</strong> response <strong>to</strong> additional concerns about a $1.2billion reduction <strong>in</strong> shareholder's equity (<strong>of</strong>fset by a $1.2 b reduction <strong>in</strong> NotesReceivable).* * *Despite the obvious <strong>and</strong> serious concerns raised by the nature <strong>and</strong> background <strong>of</strong> the$1.2 billion equity reduction, we cont<strong>in</strong>ue <strong>to</strong> look at ENE as a Merchant, EnergyServices <strong>and</strong> Pipel<strong>in</strong>e bus<strong>in</strong>ess capable <strong>of</strong> exceed<strong>in</strong>g 20% eps growth on an annualbasis.Because we expect that this growth will occur <strong>and</strong> we regard our eps estimates forENE as conservative at $1.80 <strong>in</strong> '01 <strong>and</strong> $2.15 <strong>in</strong> '02, we cont<strong>in</strong>ue <strong>to</strong> rate it StrongBuy.On 10/23/01, CS First Bos<strong>to</strong>n issued a report on Enron. The report cont<strong>in</strong>ued <strong>to</strong> rate Enrona "Strong Buy" <strong>and</strong> cont<strong>in</strong>ued <strong>to</strong> forecast 01 <strong>and</strong> 02 EPS <strong>of</strong> $1.80 <strong>and</strong> $2.15 for Enron. It alsostated:378.ENE held a conference call this morn<strong>in</strong>g with <strong>in</strong>formation <strong>to</strong> address the recentdecl<strong>in</strong>e <strong>in</strong> its share price <strong>and</strong> the f<strong>in</strong>ancial <strong>and</strong> f<strong>in</strong>anc<strong>in</strong>g implications <strong>of</strong> the SECrequest for <strong>in</strong>formation regard<strong>in</strong>g "related party transactions."With committed bank credit l<strong>in</strong>es <strong>of</strong> $3.35 billion un-drawn, $1.85 billion <strong>of</strong> whichsupport already issued commercial paper, ENE has $1.5 billion available for newcommercial paper issuance.* * *ENEs debt rat<strong>in</strong>gs are generally three steps above "junk" status.... [W]e regard ENEscredit rat<strong>in</strong>gs <strong>and</strong> balance sheet issues as unlikely <strong>to</strong> worsen materially.The statements issued <strong>in</strong> CS First Bos<strong>to</strong>n's analyst reports <strong>in</strong> 10/01 were false <strong>and</strong> mislead<strong>in</strong>g.The true facts were that Enron's operat<strong>in</strong>g earn<strong>in</strong>gs for the 3rdQ 01 as reported were artificially- 93 -
<strong>in</strong>flated, as detailed here<strong>in</strong>, <strong>in</strong> part because <strong>of</strong> the huge dark-fiber swap transaction with Qwest; thewrite-<strong>of</strong>fs taken by Enron on 10/16/01 did not clean up its balance sheet – <strong>in</strong> fact, there were billions<strong>of</strong> dollars <strong>of</strong> additional overvalued assets still on Enron's balance sheet; <strong>and</strong> Enron's shareholderequity was still overstated by $1-$2 billion <strong>and</strong> Enron's previously reported earn<strong>in</strong>gs weregrotesquely false as detailed here<strong>in</strong>. The forecasts <strong>of</strong> strong 01 operat<strong>in</strong>g EPS <strong>of</strong> $1.80 per share <strong>and</strong>02 EPS <strong>of</strong> $2.15 for Enron were also completely false as there was no basis whatsoever for theseforecasts as, <strong>in</strong> fact, Enron's bus<strong>in</strong>ess <strong>in</strong>ternally was collaps<strong>in</strong>g <strong>and</strong> was riddled with huge operat<strong>in</strong>glosses which were actually <strong>in</strong>creas<strong>in</strong>g but cont<strong>in</strong>u<strong>in</strong>g <strong>to</strong> be concealed. In fact, Enron's liquidity wasextraord<strong>in</strong>arily endangered.The statements <strong>in</strong> the CS First Bos<strong>to</strong>n analyst reports issued after 12/99 were false for otherreasons. After LJM2 was formed <strong>and</strong> CS First Bos<strong>to</strong>n's <strong>to</strong>p executives had secretly pre-fundedLJM2 <strong>in</strong> 12/99 <strong>to</strong> permit the illicit 99 year-end deals <strong>and</strong> been permitted <strong>to</strong> cont<strong>in</strong>ue <strong>to</strong> <strong>in</strong>vest <strong>in</strong>LJM2 (ultimately <strong>to</strong> the tune <strong>of</strong> over $22.5 million) <strong>and</strong> as CS First Bos<strong>to</strong>n made $120 million <strong>in</strong>loans <strong>to</strong> LJM2, <strong>in</strong> 00-01 – so that Enron could create <strong>and</strong> report hundreds <strong>of</strong> millions <strong>of</strong> dollars <strong>of</strong>phony pr<strong>of</strong>its <strong>and</strong> hide billions <strong>in</strong> debt – CS First Bos<strong>to</strong>n cont<strong>in</strong>ued <strong>to</strong> issue very positive analystreports on Enron. Each <strong>of</strong> these reports conta<strong>in</strong>ed the follow<strong>in</strong>g "boilerplate" disclosure:The firm, or one or more <strong>of</strong> its partners or employees, from time <strong>to</strong> time may havelong or short positions <strong>in</strong>, or buy <strong>and</strong> sell <strong>and</strong> make markets <strong>in</strong>, any <strong>of</strong> thesecurities discussed here<strong>in</strong>. The firm may underwrite or provide <strong>in</strong>vestmentbank<strong>in</strong>g, credit <strong>and</strong> other f<strong>in</strong>ancial services <strong>to</strong> any company or issuer <strong>of</strong> securitiesor f<strong>in</strong>ancial <strong>in</strong>struments referred <strong>to</strong> here<strong>in</strong>. 47These boilerplate disclosures were the same as they were before 12/99 – i.e., they did not changeafter CS First Bos<strong>to</strong>n <strong>to</strong>p executives pre-funded <strong>and</strong> became <strong>in</strong>ves<strong>to</strong>rs <strong>in</strong> LJM2 <strong>and</strong> they <strong>and</strong> CSFirst Bos<strong>to</strong>n provided fund<strong>in</strong>g for repeated non-arm's-length fraudulent deals which created boguspr<strong>of</strong>its for Enron <strong>and</strong> hid its debt, which deals generated lush returns/pr<strong>of</strong>its for CS First Bos<strong>to</strong>nexecutives from the loot<strong>in</strong>g <strong>of</strong> Enron. The failure <strong>to</strong> disclose the LJM2 <strong>in</strong>volvement <strong>of</strong> CS FirstBos<strong>to</strong>n <strong>and</strong>/or its <strong>to</strong>p executives made its "boilerplate" disclosure false <strong>and</strong> mislead<strong>in</strong>g <strong>and</strong> concealedfrom the market the very significant <strong>and</strong> serious conflicts <strong>of</strong> <strong>in</strong>terest which Enron <strong>and</strong> CS First47Copies <strong>of</strong> relevant pages from pre- <strong>and</strong> post- 12/99 CS First Bos<strong>to</strong>n analyst reports areattached as Ex. 10 <strong>to</strong> pla<strong>in</strong>tiffs' Appendix.- 94 -
Bos<strong>to</strong>n knew would have cast serious doubts on the objectivity <strong>and</strong> honesty <strong>of</strong> CS First Bos<strong>to</strong>n'sanalyst reports on Enron <strong>and</strong> disclosed that CS First Bos<strong>to</strong>n or its executives had compromis<strong>in</strong>g ties<strong>to</strong> <strong>and</strong> serious conflicts <strong>of</strong> <strong>in</strong>terest regard<strong>in</strong>g Enron.CS First Bos<strong>to</strong>n also made false <strong>and</strong> mislead<strong>in</strong>g statements <strong>in</strong> the 2/99 Registration Statementused <strong>to</strong> sell 27.6 million shares <strong>of</strong> Enron s<strong>to</strong>ck. The 2/99 Registration Statement was false <strong>and</strong>mislead<strong>in</strong>g due <strong>to</strong> the <strong>in</strong>corporation <strong>of</strong> Enron's 97 10-K <strong>and</strong> 98 10-Qs that conta<strong>in</strong>ed Enron'sadmittedly false f<strong>in</strong>ancial statements for 97-98, which understated Enron's debt by billions <strong>of</strong>dollars <strong>and</strong> overstated its earn<strong>in</strong>gs by hundreds <strong>of</strong> millions <strong>of</strong> dollars, as detailed <strong>in</strong> 418-611 <strong>of</strong>the CC. The restatement <strong>of</strong> previously issued f<strong>in</strong>ancial statements is an admission that they werematerially false when issued <strong>and</strong> Enron has restated all these results <strong>in</strong> huge amounts. Id. While theRegistration Statement <strong>in</strong>cluded audited annual f<strong>in</strong>ancial statements, significantly, it also<strong>in</strong>corporated or <strong>in</strong>cluded all documents filed pursuant <strong>to</strong> §13(a) <strong>of</strong> the 1934 Act prior <strong>to</strong> therespective <strong>of</strong>fer<strong>in</strong>gs, <strong>in</strong>clud<strong>in</strong>g Enron's 98 10-Qs which conta<strong>in</strong>ed Enron's admittedly unauditedfalse <strong>and</strong> mislead<strong>in</strong>g 98 quarterly f<strong>in</strong>ancial results. 615. 48 Of course, s<strong>in</strong>ce the <strong>in</strong>terim 98f<strong>in</strong>ancial statements were unaudited they were not expertized <strong>and</strong> the underwriter banks areresponsible for them.CS First Bos<strong>to</strong>n also made false statements <strong>in</strong> the Registration Statement used by it <strong>to</strong> sellNew Power s<strong>to</strong>ck <strong>to</strong> <strong>in</strong>ves<strong>to</strong>rs <strong>in</strong> 10/00, a transaction that allowed Enron <strong>and</strong> CS First Bos<strong>to</strong>n <strong>to</strong>create a bogus $370 million pr<strong>of</strong>it. The successful completion <strong>of</strong> this IPO was a key part <strong>of</strong> thescheme. New Power was purportedly a nationwide provider <strong>of</strong> electrical power <strong>and</strong> natural gas <strong>to</strong>retail consumers. New Power was formed by Enron <strong>in</strong> 99, <strong>and</strong> controlled by it. The New Power10/00 Registration Statement represented that New Power could succeed <strong>in</strong> a volatile energy market(where other similar companies had failed) through sophisticated risk management strategiesconceived <strong>and</strong> managed by its affiliate, EES. In fact, neither EES nor New Power had any hedg<strong>in</strong>gstrategies which could enable New Power <strong>to</strong> operate pr<strong>of</strong>itably under market conditions prevail<strong>in</strong>g48While CS First Bos<strong>to</strong>n may be able at trial <strong>to</strong> establish a defense <strong>to</strong> liability for theseexpertized i.e., certified f<strong>in</strong>ancial statements, <strong>in</strong> light <strong>of</strong> the CC's allegations that CS First Bos<strong>to</strong>nknew those annual certified f<strong>in</strong>ancial statements were false, CS First Bos<strong>to</strong>n may not do so now atthe Rule 12(b)(6) stage. Murphy, 1996 U.S. Dist. LEXIS 22207, at *23.- 95 -
at the time <strong>of</strong> the IPO or, <strong>in</strong>deed, at any time thereafter. Indeed, <strong>in</strong> 8/01, n<strong>in</strong>e months after the IPO,Margaret Ceconi, an EES executive, <strong>in</strong>formed defendant Lay, a New Power direc<strong>to</strong>r, that EES hadfailed for two years (i.e., s<strong>in</strong>ce <strong>in</strong> or about 99) <strong>in</strong> "almost all" <strong>of</strong> its energy sales purportedly<strong>in</strong>volv<strong>in</strong>g hedg<strong>in</strong>g attempts, <strong>and</strong> had been report<strong>in</strong>g losses on hedg<strong>in</strong>g contracts as ga<strong>in</strong>s. See 38,59, 358, 853.The New Power Registration Statement emphasized the skill <strong>and</strong> expertise Enron wouldprovide <strong>in</strong> assist<strong>in</strong>g the company <strong>to</strong> economically obta<strong>in</strong> necessary power supplies, <strong>and</strong> <strong>to</strong> hedgeaga<strong>in</strong>st market volatility. The Registration Statement stated:We were formed by Enron Corp., the largest trader <strong>and</strong> marketer <strong>of</strong> electricity<strong>and</strong> natural gas <strong>in</strong> North America, <strong>to</strong> target the rapidly restructur<strong>in</strong>g residential <strong>and</strong>small commercial markets for these products. We believe we are uniquelypositioned <strong>to</strong> succeed because:– <strong>of</strong> our access <strong>to</strong> Enron's technical resources, regula<strong>to</strong>ry <strong>and</strong> riskmanagement expertise, <strong>and</strong> reliable wholesale commodity purchas<strong>in</strong>g power.The Registration Statement also made it appear that Enron <strong>and</strong> its affiliates were long-term<strong>in</strong>ves<strong>to</strong>rs <strong>in</strong> New Power, <strong>and</strong> believed <strong>in</strong> its prospects for success. The Registration Statement failed<strong>to</strong> disclose that Enron <strong>and</strong> the underwriters anticipated that New Power's shares would decl<strong>in</strong>e fromthe IPO price, <strong>and</strong> had <strong>in</strong>deed acted on this belief. Enron had set up a partnership known as "Rap<strong>to</strong>rIII," whose purpose was <strong>to</strong> hedge Enron's position aga<strong>in</strong>st the anticipated decl<strong>in</strong>e <strong>in</strong> New Power'ss<strong>to</strong>ck. Although the Registration Statement purported <strong>to</strong> describe fully the relationship betweenEnron, its affiliates, <strong>and</strong> New Power, <strong>and</strong> all <strong>of</strong> their related party transactions, it failed <strong>to</strong> fullydisclose these planned Rap<strong>to</strong>r transactions, known as Hawaii 125-0, 49 which CS First Bos<strong>to</strong>n <strong>and</strong>Enron had already secretly agreed on. The New Power IPO proceeds <strong>of</strong> $543 million were alsopurportedly sufficient for New Power <strong>to</strong> carry forward its bus<strong>in</strong>ess plan for at least 24 months.49Because Enron was a huge shareholder <strong>of</strong> New Power, the misrepresented or omitted factshad a positive impact on Enron's publicly traded securities <strong>and</strong> helped artificially <strong>in</strong>flate their trad<strong>in</strong>gprices. The motivation <strong>to</strong> conceal these facts from the <strong>in</strong>vest<strong>in</strong>g public was <strong>to</strong> enable New Power<strong>to</strong> raise money for a company operat<strong>in</strong>g <strong>in</strong> a market niche where economic conditions appeared <strong>to</strong>render successful operations close <strong>to</strong> impossible. Rais<strong>in</strong>g public money shifted the cost <strong>of</strong> NewPower's <strong>in</strong>evitable bus<strong>in</strong>ess failure away from Enron (<strong>to</strong> the extent possible), <strong>and</strong> on<strong>to</strong> the shoulders<strong>of</strong> public <strong>in</strong>ves<strong>to</strong>rs.- 96 -
Given the conditions <strong>in</strong> the energy markets, <strong>and</strong> the his<strong>to</strong>ry <strong>of</strong> EES, CS First Bos<strong>to</strong>n knew that suchproceeds could not carry New Power through one year <strong>of</strong> successful operations, let alone 24 months.As a result <strong>of</strong> these misrepresentations <strong>and</strong> omissions, Enron <strong>and</strong> CS First Bos<strong>to</strong>n were able<strong>to</strong> sell New Power shares at an IPO price <strong>of</strong> $21 per share, allow<strong>in</strong>g Enron <strong>to</strong> create <strong>and</strong> record abogus $370 million pr<strong>of</strong>it <strong>in</strong> the 4thQ 00. As the true nature <strong>of</strong> New Power's bus<strong>in</strong>ess operationswas revealed over the course <strong>of</strong> the next few months, its s<strong>to</strong>ck price collapsed. On 12/5/01, NewPower announced that its contracts with Enron had been term<strong>in</strong>ated. On 2/20/02, New Poweradmitted it was unable <strong>to</strong> operate as an <strong>in</strong>dependent company. By 2/26/02, New Power s<strong>to</strong>ck s<strong>to</strong>odat only $.90 per share!VI.CS FIRST BOSTON ACTED WITH SCIENTER, I.E., WITH "THEREQUIRED STATE OF MIND," AND HAD MOTIVES AND THEOPPORTUNITY TO DEFRAUD ENRON INVESTORS, AS IT MADEFALSE STATEMENTS, EMPLOYED DECEPTIVE ACTS ANDMANIPULATIVE DEVICES AND CONTRIVANCES TO DECEIVE ANDPARTICIPATED IN A FRAUDULENT SCHEME OR COURSE OFBUSINESS THAT OPERATED AS A FRAUD OR DECEIT ONPURCHASERS OF ENRON SECURITIESCS First Bos<strong>to</strong>n can claim neither ignorance nor <strong>in</strong>nocence with respect <strong>to</strong> the Enron debacle.CS First Bos<strong>to</strong>n had an extensive <strong>and</strong> extremely close relationship with Enron, dur<strong>in</strong>g which itga<strong>in</strong>ed knowledge <strong>of</strong> the fraudulent scheme <strong>and</strong> <strong>to</strong>ok affirmative steps <strong>to</strong> further it. It participated<strong>in</strong> disclosed commercial loans <strong>and</strong> lend<strong>in</strong>g commitments <strong>of</strong> over $5 billion <strong>to</strong> Enron. CS FirstBos<strong>to</strong>n also made disguised loans <strong>of</strong> at least $150 million <strong>to</strong> Enron, <strong>and</strong> directly participated <strong>in</strong> thefalsification <strong>of</strong> Enron's true f<strong>in</strong>ancial condition, liquidity <strong>and</strong> creditworth<strong>in</strong>ess. CS First Bos<strong>to</strong>n alsohelped raise over $5 billion for Enron via eight sales <strong>of</strong> Enron <strong>and</strong> Enron-related securities, sales<strong>of</strong>ten accomplished via false Registration Statements. CS First Bos<strong>to</strong>n's relationships with Enronwere so extensive that <strong>to</strong>p <strong>of</strong>ficials <strong>of</strong> the bank constantly <strong>in</strong>teracted with the very <strong>to</strong>p executives <strong>of</strong>Enron, i.e., Lay, Skill<strong>in</strong>g, Causey, McMahon or Fas<strong>to</strong>w, on an almost daily basis throughout theClass Period, discuss<strong>in</strong>g Enron's bus<strong>in</strong>ess, f<strong>in</strong>ancial condition, f<strong>in</strong>ancial needs <strong>and</strong> plans,partnerships, SPEs <strong>and</strong> future prospects. CS First Bos<strong>to</strong>n provided both commercial bank<strong>in</strong>g <strong>and</strong><strong>in</strong>vestment bank<strong>in</strong>g services <strong>to</strong> Enron, <strong>and</strong> helped structure <strong>and</strong> fund several <strong>of</strong> Enron's secretlycontrolled partnerships, <strong>in</strong>clud<strong>in</strong>g LJM2 <strong>and</strong> its SPEs – the illicit <strong>and</strong> contrived SPE transactions- 97 -
which falsified Enron's f<strong>in</strong>ancial statements <strong>and</strong> misrepresented its f<strong>in</strong>ancial condition. As a result<strong>of</strong> CS First Bos<strong>to</strong>n's participation <strong>in</strong> the fraudulent scheme, it received huge underwrit<strong>in</strong>g <strong>and</strong>consult<strong>in</strong>g fees, <strong>in</strong>terest payments, commitment fees <strong>and</strong> other payments from Enron <strong>and</strong> relatedentities. Top executives <strong>of</strong> CS First Bos<strong>to</strong>n were also permitted <strong>to</strong> personally <strong>in</strong>vest $22.5 million<strong>in</strong> Enron's lucrative LJM2 partnership as a reward for orchestrat<strong>in</strong>g CS First Bos<strong>to</strong>n's participation<strong>in</strong> this fraud, allow<strong>in</strong>g them <strong>to</strong> directly pr<strong>of</strong>it from the loot<strong>in</strong>g <strong>of</strong> Enron that <strong>to</strong>ok place via therepeated non-arm's-length fraudulent LJM2/SPE transactions with Enron, transactions which theyknew could cont<strong>in</strong>ue only if Enron's s<strong>to</strong>ck cont<strong>in</strong>ued <strong>to</strong> trade at high prices – above the so-calledequity issuance trigger prices <strong>in</strong> the LJM2/SPE deals. 18, 20, 618-622. At the same time, CS FirstBos<strong>to</strong>n's securities analysts were issu<strong>in</strong>g extremely positive – but false <strong>and</strong> mislead<strong>in</strong>g – reportson Enron, ex<strong>to</strong>ll<strong>in</strong>g Enron's bus<strong>in</strong>ess success, the strength <strong>of</strong> its f<strong>in</strong>ancial condition <strong>and</strong> itsprospects for strong revenue <strong>and</strong> earn<strong>in</strong>gs growth, help<strong>in</strong>g <strong>to</strong> push Enron's s<strong>to</strong>ck higher, butnever disclos<strong>in</strong>g CS First Bos<strong>to</strong>n's LJM2 <strong>in</strong>volvement with Enron. As alleged, this is <strong>in</strong>tentionalparticipation <strong>in</strong> the fraud.Thus, CS First Bos<strong>to</strong>n participated <strong>in</strong> the fraudulent scheme <strong>and</strong> course <strong>of</strong> bus<strong>in</strong>ess byengag<strong>in</strong>g <strong>in</strong> contrivances <strong>and</strong> devices <strong>to</strong> deceive <strong>and</strong> actually made repeated false <strong>and</strong> mislead<strong>in</strong>gstatements. At the same time, CS First Bos<strong>to</strong>n executives "pre-funded" LJM2 on 12/22/99 with$750,000, which funded four critical 99 year-end deals <strong>to</strong> create phony pr<strong>of</strong>its for, <strong>and</strong> hide debt <strong>of</strong>,Enron. CS First Bos<strong>to</strong>n executives cont<strong>in</strong>ued <strong>to</strong> fund LJM2 dur<strong>in</strong>g 00-01, while CS First Bos<strong>to</strong>nfurther funded LJM2 with a $120 million loan <strong>to</strong> enable LJM2 <strong>to</strong> engage <strong>in</strong> repeated non-arm'slengthdeals with Enron <strong>to</strong> artificially boost its pr<strong>of</strong>its by hundreds <strong>of</strong> millions <strong>of</strong> dollars, whilehid<strong>in</strong>g billions <strong>of</strong> debt – deceiv<strong>in</strong>g the securities markets. Dur<strong>in</strong>g 00-01, CS First Bos<strong>to</strong>n executivesenjoyed the lush pr<strong>of</strong>its flow<strong>in</strong>g from the loot<strong>in</strong>g <strong>of</strong> Enron <strong>to</strong> the LJM2 <strong>in</strong>ves<strong>to</strong>rs. CS First Bos<strong>to</strong>nalso did the New Power IPO <strong>in</strong> 10/00, which enabled Enron <strong>to</strong> create a phony $370 million pr<strong>of</strong>it,<strong>and</strong> structured <strong>and</strong> funded several other Enron-controlled SPEs know<strong>in</strong>g they were vehicles be<strong>in</strong>gutilized <strong>to</strong> falsify Enron's reported f<strong>in</strong>ancial results – via contrived <strong>and</strong> deceptive transactions –further artificially <strong>in</strong>flat<strong>in</strong>g Enron's reported pr<strong>of</strong>its <strong>and</strong> hid<strong>in</strong>g more debt. Aga<strong>in</strong>, as alleged <strong>in</strong> the- 98 -
CC, this is <strong>in</strong>tentional participation <strong>in</strong> the falsification <strong>of</strong> Enron's f<strong>in</strong>ancial statements <strong>and</strong> <strong>of</strong>course <strong>in</strong> the fraud.In evaluat<strong>in</strong>g the adequacy <strong>of</strong> the scienter allegations aga<strong>in</strong>st CS First Bos<strong>to</strong>n, it is important<strong>to</strong> keep <strong>in</strong> m<strong>in</strong>d the different liability theories be<strong>in</strong>g alleged under §10(b) <strong>and</strong> Rule 10b-5 aga<strong>in</strong>st CSFirst Bos<strong>to</strong>n. While the CC alleges that CS First Bos<strong>to</strong>n made false <strong>and</strong> mislead<strong>in</strong>g statements <strong>in</strong>Registration Statements <strong>and</strong> analyst reports, CS First Bos<strong>to</strong>n's liability is not limited <strong>to</strong> thoseallegedly false <strong>and</strong> mislead<strong>in</strong>g statements. The CC also alleges CS First Bos<strong>to</strong>n's liability for itsconduct <strong>in</strong> participat<strong>in</strong>g <strong>in</strong> the scheme <strong>to</strong> defraud or course <strong>of</strong> bus<strong>in</strong>ess that operated as a fraud <strong>and</strong>deceit on purchasers <strong>of</strong> Enron publicly traded securities. This dist<strong>in</strong>ction is important because if theCC fails <strong>to</strong> adequately allege the falsity <strong>of</strong> CS First Bos<strong>to</strong>n's own statements or CS First Bos<strong>to</strong>n'sknowledge or reckless disregard <strong>of</strong> the falsity <strong>of</strong> those statements, the CC may still adequately allegethat CS First Bos<strong>to</strong>n know<strong>in</strong>gly or recklessly employed deceptive acts or participated <strong>in</strong> thefraudulent scheme or course <strong>of</strong> bus<strong>in</strong>ess or vice versa. These are dist<strong>in</strong>ct liability theories – onebased on statements, the other based on conduct – which can result <strong>in</strong> liability, either <strong>in</strong> comb<strong>in</strong>ationor separately.It is clear that for §10(b) or Rule 10b-5 liability <strong>to</strong> attach under either theory, scienter mustbe present, i.e., there must be either <strong>in</strong>tentional or reckless conduct. Thus, with respect <strong>to</strong> CS FirstBos<strong>to</strong>n's alleged deceptive acts <strong>and</strong> participation <strong>in</strong> the fraudulent scheme or course <strong>of</strong> bus<strong>in</strong>ess,scienter would be adequately pleaded if the facts pleaded give rise <strong>to</strong> a "strong <strong>in</strong>ference" that <strong>in</strong>committ<strong>in</strong>g those acts, CS First Bos<strong>to</strong>n acted with the "required state <strong>of</strong> m<strong>in</strong>d," i.e., it acted<strong>in</strong>tentionally or recklessly. This would be so even if CS First Bos<strong>to</strong>n had no knowledge that its ownstatements <strong>in</strong> analyst reports <strong>and</strong> Registration Statements were false <strong>and</strong> mislead<strong>in</strong>g, for as this Courthas recognized, it is not necessary that a defendant made a false statement <strong>to</strong> be liable under§10(b) or Rule 10b-5. L<strong>and</strong>ry's, slip op. at 9 n.12.- 99 -
A defendant may be held liable for participat<strong>in</strong>g <strong>in</strong> a scheme <strong>to</strong> defraud if it has knowledge<strong>of</strong> the scheme <strong>and</strong> commits manipulative or deceptive acts <strong>in</strong> furtherance <strong>of</strong> it. 50 See BMC S<strong>of</strong>tware,183 F. Supp. 2d at 885-86, 905, 915; Cooper, 137 F.3d at 624 ("Central Bank does not precludeliability based on allegations that a group <strong>of</strong> defendants acted <strong>to</strong>gether <strong>to</strong> violate the securities laws,as long as each defendant committed a manipulative or deceptive act <strong>in</strong> furtherance <strong>of</strong> the scheme.");First Jersey, 101 F.3d at 1471; Lemmer v. Nu-Kote Hold<strong>in</strong>g, Inc., Civ. No. 3:98-CV-0161-L, 2001U.S. Dist. LEXIS 13978, at *26-*27 (N.D. Tex. Sept. 6, 2001); Health Mgmt., 970 F. Supp. at 209;Adam, 884 F. Supp. at 1401; ZZZZ Best, 864 F. Supp. at 967-72. Recklessness satisfies the scienterrequirement. See Nathenson, 267 F.3d 400.Whether a defendant has engaged <strong>in</strong> a scheme <strong>to</strong> defraud (or whether the compla<strong>in</strong>t hassufficiently alleged so) should be determ<strong>in</strong>ed by view<strong>in</strong>g the defendant's conduct (or the allegations<strong>of</strong> the compla<strong>in</strong>t) as a whole. See Blackie, 524 F.2d at 903 n.19 (for scheme liability, compla<strong>in</strong>tshould not be fragmented <strong>in</strong><strong>to</strong> <strong>in</strong>dividual, isolated acts but should be considered as a s<strong>in</strong>gle overallscheme <strong>to</strong> defraud); cf. Affiliated Ute Citizens, 406 U.S. at 151 ("Congress <strong>in</strong>tended securitieslegislation enacted for the purpose <strong>of</strong> avoid<strong>in</strong>g frauds <strong>to</strong> be construed 'not technically <strong>and</strong>restrictively, but flexibly <strong>to</strong> effectuate its remedial purposes.'") (quot<strong>in</strong>g Capital Ga<strong>in</strong>s Research, 375U.S. at 186).It is axiomatic that with respect <strong>to</strong> scheme liability, a defendant may be liable forparticipat<strong>in</strong>g <strong>in</strong> a scheme even if it did not <strong>in</strong>teract with all the other participants, was unaware <strong>of</strong>the identity <strong>of</strong> each <strong>of</strong> the other participants, did not know about the specific roles <strong>of</strong> the otherparticipants <strong>in</strong> the scheme, did not know about or participate <strong>in</strong> all <strong>of</strong> the details <strong>of</strong> each aspect <strong>of</strong>the scheme, or jo<strong>in</strong>ed the scheme at a different time than the other participants. See United Statesv. Craig, 573 F.2d 455, 483-84 (7th Cir. 1977) (scheme <strong>to</strong> defraud under mail fraud statute); United50We stress that the existence <strong>of</strong> the scheme <strong>and</strong> the banks' participation <strong>in</strong> it are highlyfactually dependent questions that either should not be resolved on a motion <strong>to</strong> dismiss or should beresolved <strong>in</strong> favor <strong>of</strong> the pla<strong>in</strong>tiffs. Richardson, 451 F.2d at 40 (Whether the defendant's conductamounts <strong>to</strong> a manipulative or deceptive act "depends upon the facts <strong>and</strong> circumstances developedat trial.").- 100 -
States v. Elam, 678 F.2d 1234, 1246 (5th Cir. 1982) (conspiracy); United States v. Alvarez, 625 F.2d1196, 1198 (5th Cir. 1980) (en banc) (conspiracy). 51Scheme <strong>to</strong> defraud <strong>and</strong> conspiracy liability theories, while they share some similarities, areseparate <strong>and</strong> dist<strong>in</strong>ct liability theories <strong>and</strong> the elements <strong>of</strong> the two theories are not identical. SeeUnited States v. Read, 658 F.2d 1225, 1239 (7th Cir. 1981). Most significantly, a conspiracyrequires an agreement <strong>and</strong> imposes liability based on the act <strong>of</strong> jo<strong>in</strong><strong>in</strong>g that agreement as well as onacts taken <strong>in</strong> furtherance <strong>of</strong> the conspiracy. See id. at 1240. A scheme <strong>to</strong> defraud, on the other h<strong>and</strong>,requires neither an agreement nor the jo<strong>in</strong><strong>in</strong>g <strong>of</strong> a scheme; liability is imposed based on us<strong>in</strong>g themails or securities exchanges <strong>to</strong> further the fraudulent scheme. See id. Therefore, if knowledge <strong>of</strong>all the other details, activities, <strong>and</strong> participants <strong>in</strong> a scheme is not essential for conspiracy liability,which requires an agreement among the participants, then such knowledge certa<strong>in</strong>ly is not necessaryfor scheme liability, which does not require an agreement.A defendant who participates <strong>in</strong> a scheme <strong>to</strong> defraud is liable for the damages caused by all<strong>of</strong> the acts taken by the participants <strong>in</strong> the scheme <strong>in</strong> furtherance <strong>of</strong> the fraud. See In re S<strong>of</strong>twareToolworks Sec. Litig., 50 F.3d 615, 627-29 & n.3 (N.D. Cal. 1995) (participants <strong>in</strong> scheme <strong>to</strong> defraudcan be liable for statements made by others <strong>in</strong> the scheme); Adam, 884 F. Supp. at 1401 (same);ZZZZ Best, 864 F. Supp. at 968-72 (same); SEC v. National Bankers Life Ins. Co., 324 F. Supp. 189,194-95 (N.D. Tex.), aff'd, 448 F.2d 652 (5th Cir. 1971) (same). 52 A scheme <strong>to</strong> defraud is a unitary51As the Supreme Court has stated with respect <strong>to</strong> conspiracy liability: "[T]he law rightly givesroom for allow<strong>in</strong>g the conviction <strong>of</strong> those discovered [<strong>to</strong> be participants <strong>in</strong> a conspiracy] uponshow<strong>in</strong>g sufficiently the essential nature <strong>of</strong> the plan <strong>and</strong> their connections with it, without requir<strong>in</strong>gevidence <strong>of</strong> knowledge <strong>of</strong> all its details or <strong>of</strong> the participation <strong>of</strong> others. Otherwise ... conspira<strong>to</strong>rswould go free by their very <strong>in</strong>genuity." Blumenthal v. United States, 332 U.S. 539, 557 (1947).Pla<strong>in</strong>tiffs cite these conspiracy cases not because they allege conspiracy liability here – theydo not. However, s<strong>in</strong>ce scheme liability is expressly provided for by the language <strong>of</strong> §10b/Rule 10b-5 <strong>and</strong> the extent <strong>of</strong> the scheme liability is at least as broad a conspiracy liability would be, theseconspiracy cases are useful <strong>in</strong> determ<strong>in</strong><strong>in</strong>g the parameters <strong>of</strong> scheme liability.52Similarly, under the federal mail fraud statute, 18 U.S.C. §1341, participants <strong>in</strong> a scheme <strong>to</strong>defraud are liable for the acts <strong>of</strong> the other participants <strong>in</strong> the scheme, even if the others committedthe key acts. See, e.g., United States v. Humphrey, 104 F.3d 65, 70 (5th Cir. 1997); United Statesv. Lothian, 976 F.2d 1257 (9th Cir. 1992); United States v. Maxwell, 920 F.2d 1028, 1035 (D.C. Cir.1990); United States v. Lanier, 838 F.2d 281, 284 (8th Cir. 1988); United States v. Wieh<strong>of</strong>f, 748 F.2d1158, 1161 (7th Cir. 1984); Craig, 573 F.2d at 483-84.- 101 -
violation, such that the pla<strong>in</strong>tiff need not prove transaction causation with respect <strong>to</strong> any particularmisrepresentations or omissions or other components <strong>of</strong> the scheme. See Shores, 647 F.2d at 469,472 ("The concept <strong>of</strong> [a] scheme <strong>to</strong> defraud satisfies the requirement <strong>of</strong> 'transaction causation.' Ithas as its core objective that the potential victim engage <strong>in</strong> the transaction for which the scheme wasconceived."); Schlick v. Penn-Dixie Cement Corp., 507 F.2d 374, 380-81 (2d Cir. 1974); ZZZZ Best,864 F. Supp. at 973 (<strong>to</strong> satisfy reliance requirement for scheme liability, it need only be shown thatmarket relied on overall fraudulent scheme rather than on <strong>in</strong>dividual statements or omissions).National Bankers Life Ins., 324 F. Supp. at 193-94 – a pre-Central Bank case – recognizedthat participants <strong>in</strong> a scheme <strong>to</strong> defraud under Rule 10b-5 may be held liable for all <strong>of</strong> the acts<strong>in</strong>volved <strong>in</strong> the scheme. In that case, the SEC brought an action aga<strong>in</strong>st 28 defendants forparticipat<strong>in</strong>g <strong>in</strong> a conspiracy <strong>to</strong> defraud <strong>and</strong> a scheme <strong>to</strong> defraud. See 324 F. Supp. at 193-94. S<strong>in</strong>cethis was a pre-Central Bank case, the SEC did not focus on the difference between conspiracy <strong>and</strong>scheme liability, treat<strong>in</strong>g them essentially as synonymous, <strong>and</strong> the court did not focus on thedifference between primary viola<strong>to</strong>rs <strong>and</strong> aiders <strong>and</strong> abet<strong>to</strong>rs, <strong>in</strong>stead assum<strong>in</strong>g that the SEC <strong>in</strong>tended<strong>to</strong> hold the co-schemers liable as aiders <strong>and</strong> abet<strong>to</strong>rs rather than as primary viola<strong>to</strong>rs. See id. at 195.But, although the court considered the scheme liability <strong>of</strong> the defendants under the rubric <strong>of</strong> aid<strong>in</strong>g<strong>and</strong> abett<strong>in</strong>g, it could just as well have considered it under the rubric <strong>of</strong> primary liability.Nevertheless, the important po<strong>in</strong>t is the court's recognition that co-schemers may be liable for allaspects <strong>of</strong> the scheme:This pr<strong>in</strong>ciple also applies <strong>to</strong> conspiracy liability. See Read, 658 F.2d at 1231-40(conspira<strong>to</strong>r liable for acts <strong>of</strong> co-conspira<strong>to</strong>rs even if statute <strong>of</strong> limitations has run on its own acts);Dasho v. Susquehanna Corp., 380 F.2d 262 (7th Cir. 1967) (conspiracy); id. at 267 n.2 (conspira<strong>to</strong>rliable even for acts <strong>of</strong> co-conspira<strong>to</strong>rs occurr<strong>in</strong>g after its own last act); In re Nissan Mo<strong>to</strong>r Corp.Antitrust Litig., 430 F. Supp. 231, 233 (S.D. Fla. 1977) (conspira<strong>to</strong>r liable even for acts <strong>of</strong> coconspira<strong>to</strong>rsoccurr<strong>in</strong>g prior <strong>to</strong> its jo<strong>in</strong><strong>in</strong>g conspiracy).The common law also recognized this, with respect <strong>to</strong> contribut<strong>in</strong>g <strong>to</strong>rtfeasors or personsact<strong>in</strong>g <strong>in</strong> concert, such as through a conspiracy or scheme. See Restatement (Second) <strong>of</strong> Torts §875(1979) ("Each <strong>of</strong> two or more persons whose <strong>to</strong>rtious conduct is a legal cause <strong>of</strong> a s<strong>in</strong>gle <strong>and</strong><strong>in</strong>divisible harm <strong>to</strong> the <strong>in</strong>jured party is subject <strong>to</strong> liability <strong>to</strong> the <strong>in</strong>jured party for the entire harm.");id. §876(a) ("For harm result<strong>in</strong>g <strong>to</strong> a third person from the <strong>to</strong>rtious conduct <strong>of</strong> another, one is subject<strong>to</strong> liability if he (a) does a <strong>to</strong>rtious act <strong>in</strong> concert with the other or pursuant <strong>to</strong> a common design withhim ...."); id. §876, Comment or Clause (a) ("Whenever two or more persons commit <strong>to</strong>rtious acts<strong>in</strong> concert, each becomes subject <strong>to</strong> liability for the acts <strong>of</strong> the others, as well as for his own acts.").- 102 -
Id. at 195.In the narrow sense, a defendant could have aided <strong>and</strong> abetted a particular fraudulentact under 10(b)(5)(2) or 10(b)(5)(3) or use <strong>of</strong> a particular device under 10(b)(5)(1)<strong>and</strong> thus be liable for only the results <strong>of</strong> that specific violation. In the moreexpansive sense, a defendant could have aided <strong>and</strong> abetted a general scheme under10(b)(5)(1) <strong>and</strong> thus be liable for the results <strong>of</strong> all aspects <strong>of</strong> the scheme (assum<strong>in</strong>gthe scheme was a broad one).As noted above, after Central Bank, a defendant may be held liable for participat<strong>in</strong>g <strong>in</strong> ascheme <strong>to</strong> defraud if it has knowledge <strong>and</strong> commits manipulative or deceptive acts <strong>in</strong> furtherance<strong>of</strong> it. Therefore, br<strong>in</strong>g<strong>in</strong>g the pr<strong>in</strong>ciple recognized <strong>in</strong> National Bankers <strong>in</strong> l<strong>in</strong>e with Central Bank,if a defendant with knowledge <strong>of</strong> a broad or general scheme <strong>to</strong> defraud commits manipulative ordeceptive acts <strong>in</strong> furtherance <strong>of</strong> broad aspects <strong>of</strong> the scheme, the defendant may be held liable forall <strong>of</strong> the results <strong>of</strong> the scheme. See generally Central Bank, 511 U.S. at 191 ("In any complexsecurities fraud, moreover, there are likely <strong>to</strong> be multiple viola<strong>to</strong>rs ...."). 5353In Lemmer, 2001 U.S. Dist. LEXIS 13978, the pla<strong>in</strong>tiffs alleged a scheme <strong>to</strong> defraud <strong>and</strong>sought <strong>to</strong> hold certa<strong>in</strong> <strong>of</strong> the alleged participants liable for the fraudulent acts <strong>of</strong> the other participants<strong>in</strong> the scheme. See id. at *25. The court held that, on the particular facts <strong>of</strong> the case before it, suchattribution could not be made because the pla<strong>in</strong>tiffs had failed <strong>to</strong> sufficiently allege either theexistence <strong>of</strong> the scheme or the defendants' manipulative or deceptive acts <strong>in</strong> furtherance <strong>of</strong> it. Seeid. at *26-*27. For example, the sole allegations as <strong>to</strong> the existence <strong>of</strong> the scheme were "vague,general, <strong>and</strong> unsupported by specific details that might support a strong <strong>in</strong>ference <strong>of</strong> such a scheme."Id. at *26. In addition, the compla<strong>in</strong>t made no allegations regard<strong>in</strong>g the manipulative or deceptiveacts <strong>of</strong> nearly all the defendants <strong>in</strong> furtherance <strong>of</strong> the scheme. See id. The scheme allegations <strong>of</strong> theLemmer compla<strong>in</strong>t consisted entirely <strong>of</strong> the follow<strong>in</strong>g provision:Each <strong>of</strong> the defendants actually knew the allegedly false statements about Nukote'sbus<strong>in</strong>ess <strong>and</strong> future prospects were false <strong>and</strong> mislead<strong>in</strong>g when made. Each <strong>of</strong>the defendants is liable as a participant <strong>in</strong> a fraudulent scheme <strong>and</strong> course <strong>of</strong> bus<strong>in</strong>essthat operated as a fraud or deceit on purchasers <strong>of</strong> Nu-kote s<strong>to</strong>ck, <strong>in</strong>clud<strong>in</strong>g false <strong>and</strong>mislead<strong>in</strong>g statements <strong>and</strong>/or concealed material, adverse facts. The fraudulentscheme <strong>and</strong> course <strong>of</strong> bus<strong>in</strong>ess: (a) deceived the <strong>in</strong>vest<strong>in</strong>g public regard<strong>in</strong>g Nu-kote'sproducts <strong>and</strong> bus<strong>in</strong>ess; (b) deceived the commercial markets regard<strong>in</strong>g Nu-kote'ssuccess <strong>in</strong> <strong>in</strong>tegrat<strong>in</strong>g the Pelikan acquisition <strong>and</strong> develop<strong>in</strong>g new products; (c)created false f<strong>in</strong>ancial results dur<strong>in</strong>g the 4thQ <strong>of</strong> FY96 <strong>and</strong> the first three quarters <strong>of</strong>FY97; <strong>and</strong> (d) caused pla<strong>in</strong>tiff <strong>and</strong> other members <strong>of</strong> the Class <strong>to</strong> purchase Nu-kotes<strong>to</strong>ck at <strong>in</strong>flated prices.Id. at *26-*27. On these facts, the Lemmer court concluded that "[a]llow<strong>in</strong>g such general,unsupported allegations <strong>of</strong> a fraudulent scheme, without any details that support a strong <strong>in</strong>ference<strong>of</strong> such a scheme such as acts <strong>of</strong> participation by each <strong>of</strong> the Defendants, would vitiate theparticularity requirements <strong>of</strong> the PSLRA." Id. at *27. In so f<strong>in</strong>d<strong>in</strong>g, the court dist<strong>in</strong>guished Cooper,137 F.3d 616, <strong>in</strong> which the compla<strong>in</strong>t was found <strong>to</strong> conta<strong>in</strong> sufficient allegations <strong>of</strong> the defendant'sparticipation <strong>in</strong> a scheme <strong>to</strong> defraud <strong>to</strong> support liability on that basis. See 2001 U.S. Dist. LEXIS13978, at *26.- 103 -
In evaluat<strong>in</strong>g the CC's allegations that CS First Bos<strong>to</strong>n employed acts <strong>and</strong> contrivances <strong>to</strong>deceive <strong>and</strong> participated <strong>in</strong> a fraudulent scheme <strong>and</strong> course <strong>of</strong> bus<strong>in</strong>ess, it is important <strong>to</strong> focus onthe type <strong>of</strong> actions CS First Bos<strong>to</strong>n is alleged <strong>to</strong> have committed <strong>in</strong> furtherance <strong>of</strong> the allegedfraudulent scheme or course <strong>of</strong> bus<strong>in</strong>ess. For <strong>in</strong>stance, the phony loan transactions between CS FirstBos<strong>to</strong>n <strong>and</strong> Enron <strong>in</strong>volve by their very nature <strong>in</strong>tentional conduct. These multi-million dollar, highlystructured transactions, which CS First Bos<strong>to</strong>n entered <strong>in</strong><strong>to</strong> with Enron <strong>to</strong> conceal loans <strong>to</strong> Enron <strong>and</strong>allow Enron <strong>to</strong> boost its reported results, could not have been the result <strong>of</strong> negligence or ignorance.Why make these loans but contrive these transactions <strong>and</strong> disguise them as "liabilities from price riskmanagement" unless the purpose was <strong>to</strong> conceal <strong>and</strong> deceive, as alleged?In this regard, CS First Bos<strong>to</strong>n's <strong>to</strong>p executives' participation <strong>in</strong> the pre-fund<strong>in</strong>g <strong>of</strong> LJM2 on12/22/99 – putt<strong>in</strong>g up $750,000 before LJM2 was fully formed or funded, much more money thantheir allocated share <strong>of</strong> LJM2's equity was or would have been – <strong>to</strong> f<strong>in</strong>ance four non-arm's-lengthyear-end 99 deals with Enron, which were then quickly unwound dur<strong>in</strong>g 00, with huge returns <strong>to</strong>these LJM2 pre-funders, is obviously <strong>in</strong>tentional conduct – it was not <strong>and</strong> could not have beenthe result <strong>of</strong> negligence or <strong>in</strong>advertence.With respect <strong>to</strong> CS First Bos<strong>to</strong>n's liability under §10(b) <strong>and</strong> Rule 10b-5 for its own false <strong>and</strong>mislead<strong>in</strong>g statements, it is necessary for the CC <strong>to</strong> plead specific facts rais<strong>in</strong>g a "strong <strong>in</strong>ference"that CS First Bos<strong>to</strong>n knew the statements were false or acted <strong>in</strong> reckless disregard <strong>of</strong> their truth orfalsity. However, <strong>in</strong> this regard, CS First Bos<strong>to</strong>n's alleged conduct its participat<strong>in</strong>g <strong>in</strong> the fraudulentscheme or course <strong>of</strong> bus<strong>in</strong>ess rema<strong>in</strong>s highly relevant, for those acts themselves can show CS FirstBos<strong>to</strong>n's knowledge <strong>of</strong> the falsity – or its reckless disregard for the truth or falsity – <strong>of</strong> the statementsit was mak<strong>in</strong>g.Aga<strong>in</strong>, CS First Bos<strong>to</strong>n's <strong>in</strong>volvement <strong>in</strong> LJM2 – where its <strong>to</strong>p executives helped pre-fundLJM2 <strong>in</strong> 12/99 <strong>to</strong> enable Enron <strong>to</strong> create bogus <strong>in</strong>come <strong>and</strong> hide debt – shows that CS First Bos<strong>to</strong>nknew (or at least recklessly disregarded) that Enron's f<strong>in</strong>ancial statements were false <strong>and</strong> that itsUnlike the compla<strong>in</strong>t <strong>in</strong> Lemmer, <strong>and</strong> like the compla<strong>in</strong>t <strong>in</strong> Cooper, the CC <strong>in</strong> this action<strong>in</strong>cludes specific, detailed, <strong>and</strong> substantial allegations concern<strong>in</strong>g both the existence <strong>of</strong> a scheme <strong>to</strong>defraud <strong>and</strong> the banks' participation <strong>in</strong> it through numerous manipulative <strong>and</strong> deceptive acts, as setforth above.- 104 -
purported bus<strong>in</strong>ess success was not due strong bus<strong>in</strong>ess conditions or the skill <strong>of</strong> its managers <strong>and</strong>the success <strong>of</strong> their risk management <strong>and</strong> hedg<strong>in</strong>g techniques, but rather <strong>to</strong> non-arm's-lengthfraudulent f<strong>in</strong>ancial transactions with controlled entities. CS First Bos<strong>to</strong>n knew, because its <strong>to</strong>pexecutives were <strong>in</strong>ves<strong>to</strong>rs <strong>in</strong> LJM2 <strong>and</strong> it was fund<strong>in</strong>g LJM2 dur<strong>in</strong>g 00-01 with some $120 million<strong>in</strong> loans, that LJM2 was constantly engag<strong>in</strong>g <strong>in</strong> transactions with Enron where Enron <strong>in</strong>siders(Fas<strong>to</strong>w, Kopper <strong>and</strong> Glisan) were on both sides <strong>of</strong> the transactions <strong>and</strong> that the LJM2 partnershipwas extraord<strong>in</strong>arily lucrative, provid<strong>in</strong>g huge <strong>and</strong> <strong>in</strong>deed excessive returns <strong>to</strong> LJM2's <strong>in</strong>ves<strong>to</strong>rs –returns Skill<strong>in</strong>g now says were only possible if the transactions with Enron were non-arm's-length<strong>and</strong> fraudulent, i.e., due <strong>to</strong> the loot<strong>in</strong>g <strong>of</strong> Enron. In this regard, Skill<strong>in</strong>g's recent testimony <strong>to</strong> the SECthat upon review<strong>in</strong>g LJM2 documents <strong>and</strong> the returns the LJM2 <strong>in</strong>ves<strong>to</strong>rs got – it was immediatelyapparent <strong>to</strong> him (a man who claims <strong>to</strong> lack f<strong>in</strong>ancial sophistication) – that the returns LJM2 wasgett<strong>in</strong>g via SPE deals with Enron were so huge – so lavish – that they had <strong>to</strong> be due <strong>to</strong> non-arm'slengthfraudulent transactions is key. Accord<strong>in</strong>g <strong>to</strong> The New York Times:Enron Ex-Chief Said <strong>to</strong> Voice Suspicion <strong>of</strong> FraudJeffrey K. Skill<strong>in</strong>g, the former chief executive <strong>of</strong> Enron, has <strong>to</strong>ld <strong>in</strong>vestiga<strong>to</strong>rsthat the <strong>to</strong>p-flight f<strong>in</strong>ancial returns that <strong>in</strong>ves<strong>to</strong>rs made from a partnership that didbus<strong>in</strong>ess with the company could have been achieved only if the corporation wasdefrauded, accord<strong>in</strong>g <strong>to</strong> documents <strong>and</strong> people <strong>in</strong>volved <strong>in</strong> the case.... He <strong>in</strong>dicated <strong>to</strong> the S.E.C. <strong>and</strong> <strong>to</strong> <strong>in</strong>vestiga<strong>to</strong>rs for a special committee <strong>of</strong>the Enron board that such returns – which were as high as 2,500 percent <strong>in</strong> onetransaction – could not have been achieved through arms-length transactions,accord<strong>in</strong>g <strong>to</strong> these people <strong>and</strong> <strong>in</strong>vestigative notes.When shown records that laid out the details <strong>of</strong> the f<strong>in</strong>ancial returns dur<strong>in</strong>ghis testimony several months ago before the S.E.C., Mr. Skill<strong>in</strong>g was said <strong>to</strong> havegrown agitated as he described his op<strong>in</strong>ion <strong>of</strong> the <strong>in</strong>formation.* * *Mr. Skill<strong>in</strong>g made his statements <strong>to</strong> <strong>in</strong>vestiga<strong>to</strong>rs after review<strong>in</strong>g LJM2records dur<strong>in</strong>g his testimony <strong>to</strong> the S.E.C., accord<strong>in</strong>g <strong>to</strong> documents <strong>and</strong> people<strong>in</strong>volved <strong>in</strong> the case.* * *In the LJM2 presentation, <strong>in</strong>ves<strong>to</strong>rs were <strong>to</strong>ld that the partnership had generated rates <strong>of</strong>return on its <strong>in</strong>vestments <strong>in</strong> the Rap<strong>to</strong>r rang<strong>in</strong>g from just more than 150 percent <strong>to</strong> 2,500percent.- 105 -
Kurt Eichenwald, "Enron Ex-Chief Said <strong>to</strong> Voice Suspicion <strong>of</strong> Fraud," New York Times, 4/24/02. 54What does this testimony say about the knowledge <strong>of</strong> a f<strong>in</strong>ancially sophisticated bank like CSFirst Bos<strong>to</strong>n, whose <strong>to</strong>p executives were reap<strong>in</strong>g the very fruits <strong>of</strong> those fraudulent non-arm'slengthLJM2 transactions as they <strong>and</strong> Fas<strong>to</strong>w looted Enron for their own ga<strong>in</strong>!The favored <strong>in</strong>ves<strong>to</strong>rs <strong>in</strong> LJM2, like CS First Bos<strong>to</strong>n's <strong>to</strong>p executives, actually witnessed <strong>and</strong>benefitted from a series <strong>of</strong> extraord<strong>in</strong>ary payouts from the LJM2-controlled SPEs, secur<strong>in</strong>g hundreds<strong>of</strong> millions <strong>of</strong> dollars <strong>in</strong> distributions from the SPEs <strong>to</strong> LJM2 <strong>and</strong> then huge returns/pr<strong>of</strong>its <strong>to</strong>themselves from LJM2 – cash generated by the illicit <strong>and</strong> contrived transactions Enron wasengag<strong>in</strong>g <strong>in</strong> with the LJM2 SPEs <strong>to</strong> falsify its f<strong>in</strong>ancial results. Thus, CS First Bos<strong>to</strong>n's <strong>to</strong>pexecutives who were partners <strong>in</strong> LJM2 were not only know<strong>in</strong>g participants <strong>in</strong> the Enron scheme<strong>to</strong> defraud, they were direct economic beneficiaries <strong>of</strong> it <strong>and</strong> the loot<strong>in</strong>g <strong>of</strong> Enron. 31, 649.Assum<strong>in</strong>g these allegations are true, then how was it possible for CS First Bos<strong>to</strong>n <strong>to</strong> bemak<strong>in</strong>g the k<strong>in</strong>d <strong>of</strong> extremely positive statements <strong>in</strong> its analysts reports about Enron about the strongeconomic performance <strong>of</strong> Enron's various bus<strong>in</strong>esses, the skill <strong>and</strong> talent <strong>of</strong> its management team,the strength <strong>of</strong> its core bus<strong>in</strong>esses, as well as forecast<strong>in</strong>g strong cont<strong>in</strong>u<strong>in</strong>g earn<strong>in</strong>gs growth over thenext several years, <strong>and</strong> without any disclosure <strong>of</strong> its <strong>in</strong>volvement <strong>in</strong> LJM2, unless CS First Bos<strong>to</strong>nwas deliberately ly<strong>in</strong>g or had simply closed its eyes <strong>in</strong> the bl<strong>in</strong>d pursuit <strong>of</strong> mammon.Livent, 174 F. Supp. 2d 144, shows that scienter has been well alleged here. In Livent,purchasers <strong>of</strong> Livent securities sued Livent's commercial <strong>and</strong> <strong>in</strong>vestment bank (CIBC) for violations<strong>of</strong> 1933 Act §11 <strong>and</strong> 1934 Act §10(b)/Rule 10b-5. The court susta<strong>in</strong>ed the adequacy <strong>of</strong> the§10(b)/Rule 10b-5 claims – f<strong>in</strong>d<strong>in</strong>g the bank's participation <strong>in</strong> "Livent's fraudulent scheme" wasadequately pleaded. The key allegation was that CIBC made a $4.6 million payment <strong>to</strong> Liventsupposedly <strong>in</strong> return for theatrical royalties, but which <strong>in</strong> reality was a secret "bridge" loan <strong>to</strong> Livent,as CIBC had a secret side agreement from Livent <strong>to</strong> "repurchase" the advance <strong>in</strong> six months for $4.6million, plus <strong>in</strong>terest – the "CIBC Wood Gundy Agreement." This was a fraudulent contrivance54If poor Mr. Skill<strong>in</strong>g, who has publicly protested his lack <strong>of</strong> f<strong>in</strong>ancial sophistication, couldimmediately figure out LJM2 was a vehicle <strong>to</strong> defraud Enron, then it is a reasonable <strong>in</strong>ferencethat sophisticated bankers, like CS First Bos<strong>to</strong>n, who were actually reap<strong>in</strong>g these fantasticreturns, knew it all along.- 106 -
ecause Livent improperly recorded <strong>in</strong>come on the transaction, but did not record the loan. Thedistrict court held scienter was adequately alleged, stat<strong>in</strong>g:It does not require an unreasonable <strong>in</strong>ferential leap <strong>to</strong> conclude, as the Noteholderssuggest, that <strong>in</strong> enter<strong>in</strong>g <strong>in</strong><strong>to</strong> the bridge loan transaction <strong>and</strong> secret side agreementswith Livent, CIBC, as Livent's <strong>in</strong>vestment bankers s<strong>in</strong>ce 1993, had acquiredsubstantial knowledge <strong>of</strong> Livent's real f<strong>in</strong>ancial condition <strong>and</strong> was aware <strong>of</strong>Livent's reasons <strong>to</strong> account for the $4.6 million "non-refundable fee" as arevenue-generat<strong>in</strong>g <strong>in</strong>vestment rather than a repayable loan.... Significantly,accord<strong>in</strong>g <strong>to</strong> the compla<strong>in</strong>t, the proceeds from the alleged fraudulent arrangementwere reported by Livent as current revenue <strong>in</strong> its accounts <strong>and</strong> public registrationstatements <strong>in</strong> order <strong>to</strong> create a false f<strong>in</strong>ancial basis <strong>to</strong> re<strong>in</strong>force <strong>and</strong> ensure thesuccess <strong>of</strong> Livent securities issues <strong>in</strong>tended <strong>in</strong> part <strong>to</strong> repay Livent's substantialdebt <strong>to</strong> CIBC.From these allegations, it is fair <strong>to</strong> <strong>in</strong>fer that <strong>in</strong> enter<strong>in</strong>g <strong>in</strong><strong>to</strong> the CIBCWood Gundy Agreement, CIBC was aware not only that Livent contemplatedmarket<strong>in</strong>g securities on the basis <strong>of</strong> public representations <strong>of</strong> its f<strong>in</strong>ancialcondition that Livent knew <strong>to</strong> be false, but that CIBC itself subsequently under<strong>to</strong>ok<strong>to</strong> solicit <strong>and</strong> sell the very securities whose value <strong>in</strong>corporated <strong>and</strong> was affected bythe falsehood CIBC itself had conceived with Livent. In this manner, CIBC'sparticipation <strong>in</strong> Livent's fraudulent scheme went beyond a passive capacity asLivent's <strong>in</strong>vestment banker <strong>and</strong> f<strong>in</strong>ancial adviser.* * *The Noteholders have pled facts suggest<strong>in</strong>g that CIBC became part <strong>and</strong> parcel <strong>of</strong>Livent's mislead<strong>in</strong>g statements by enter<strong>in</strong>g <strong>in</strong><strong>to</strong> a loan transaction whose truecharacter <strong>and</strong> f<strong>in</strong>ancial implications it agreed not <strong>to</strong> disclose. This f<strong>in</strong>ancial<strong>in</strong>terest <strong>and</strong> complicity not only assisted Livent <strong>in</strong> conceal<strong>in</strong>g critical <strong>in</strong>formation, italso committed CIBC <strong>to</strong> similarly withhold the truth from <strong>in</strong>ves<strong>to</strong>rs with whom itdealt <strong>in</strong> Livent securities, a commitment that effectively conflicted with anyapplicable duty CIBC had <strong>to</strong> disclose material facts <strong>in</strong> connection with subsequentpublic sales <strong>of</strong> such securities affected by the transaction.Rather than generally reflect<strong>in</strong>g the pr<strong>of</strong>it motive <strong>of</strong> any securities dealer,the concrete benefit derived by CIBC from Livent's fraud alleged here wasuniquely personal <strong>to</strong> CIBC <strong>in</strong> several ways. Only CIBC, as Livent's <strong>in</strong>vestmentbankers s<strong>in</strong>ce 1993, is alleged <strong>to</strong> have had a longst<strong>and</strong><strong>in</strong>g, <strong>in</strong>timate relationshipwith Livent executives that <strong>of</strong>fered it uncommon opportunity <strong>to</strong> know <strong>of</strong>, <strong>and</strong> playan active role <strong>in</strong> Livent's, f<strong>in</strong>ancial affairs. And only CIBC is accused, <strong>in</strong>furtherance <strong>of</strong> its own motives, <strong>of</strong> assist<strong>in</strong>g Livent <strong>in</strong> structur<strong>in</strong>g <strong>and</strong> keep<strong>in</strong>gsecret the misrepresented CIBC Wood Gundy Agreement. Later, <strong>in</strong> publiclymarket<strong>in</strong>g Livent securities whose value partly depended on the true nature <strong>of</strong> thatagreement, CIBC s<strong>to</strong>od <strong>to</strong> realize ga<strong>in</strong>s particular <strong>to</strong> it. Beyond the st<strong>and</strong>ard fees<strong>and</strong> commissions associated with any <strong>in</strong>vestment bank's sales <strong>of</strong> securities, CIBChad a higher stake <strong>in</strong> Livent's public f<strong>in</strong>anc<strong>in</strong>gs. It uniquely benefitted from theapplication <strong>of</strong> the proceeds <strong>of</strong> the Notes sales <strong>to</strong> Livent's considerable debt <strong>to</strong>CIBC.Id. at 151-53. The facts <strong>in</strong> this case closely mirror the facts <strong>in</strong> Livent. Indeed, the only noteworthydifference between this case <strong>and</strong> Livent is that the defendants <strong>in</strong> Livent entered <strong>in</strong><strong>to</strong> only one secret- 107 -
loan transaction <strong>in</strong> furtherance <strong>of</strong> their fraudulent scheme. In this case, the defendants entered <strong>in</strong><strong>to</strong>numerous concealed transactions, <strong>in</strong>clud<strong>in</strong>g secret loans, that were hidden from <strong>in</strong>ves<strong>to</strong>rs. Thesimilarities between the <strong>in</strong>vestment bank defendants' scienter is clear. In Livent, CIBC knew <strong>of</strong> asecret side-letter agreement it signed with Livent that enabled Livent <strong>to</strong> avoid report<strong>in</strong>g a loan on itsbooks, thus (the court found), CIBC must have known that Livent's reported f<strong>in</strong>ancial condition wasnot its "real f<strong>in</strong>ancial condition." See Livent, 174 F. Supp. 2d at 151. Here, for example, CIBC knewthat it entered <strong>in</strong><strong>to</strong> two secret "no loss" agreements as part <strong>of</strong> Project Braveheart (one with Enron thatguaranteed CIBC's <strong>in</strong>vestment <strong>and</strong> elim<strong>in</strong>ated CIBC's risk <strong>and</strong> the other with nCUBE promis<strong>in</strong>g <strong>to</strong>return that third-party's <strong>in</strong>vestment <strong>and</strong> elim<strong>in</strong>at<strong>in</strong>g the outside equity necessary for properaccount<strong>in</strong>g treatment) (728), which enabled Enron <strong>to</strong> create $110 million <strong>in</strong> phony pr<strong>of</strong>its byabus<strong>in</strong>g mark-<strong>to</strong>-market account<strong>in</strong>g (727); thus, CIBC (one must <strong>in</strong>fer) knew that Enron's reportedf<strong>in</strong>ancial condition was not its "real f<strong>in</strong>ancial condition." Additionally, CIBC entered <strong>in</strong><strong>to</strong> a secret"<strong>to</strong>tal return swap" guarantee <strong>in</strong> connection with a loan it made <strong>to</strong> an Enron SPE (Hawaii 125-0), atransaction which enabled Enron <strong>to</strong> improperly recognize $370 million by "hedg<strong>in</strong>g" the value <strong>of</strong> itswarrants <strong>in</strong> New Power (731); aga<strong>in</strong>, CIBC was privy <strong>to</strong> <strong>in</strong>formation, one must <strong>in</strong>fer, that madeCIBC aware that Enron's reported f<strong>in</strong>ancial condition was not its "real f<strong>in</strong>ancial condition." Like thecourt <strong>in</strong> Livent, this Court should also f<strong>in</strong>d that the <strong>in</strong>vestment bank defendants here acted withscienter <strong>in</strong> enter<strong>in</strong>g <strong>in</strong><strong>to</strong> secret agreements <strong>and</strong> structur<strong>in</strong>g transactions <strong>to</strong> deceive <strong>in</strong>ves<strong>to</strong>rs, <strong>and</strong>therefore are liable for participation <strong>in</strong> a fraudulent scheme. 55In evaluat<strong>in</strong>g the CC's allegations <strong>of</strong> knowledge on the part <strong>of</strong> CS First Bos<strong>to</strong>n, it is important<strong>to</strong> appreciate that the banks named as defendants <strong>in</strong> this case, <strong>in</strong>clud<strong>in</strong>g CS First Bos<strong>to</strong>n, are verydifferent f<strong>in</strong>ancial <strong>in</strong>stitutions from the <strong>in</strong>vestment banks or commercial banks that may have beennamed as defendants <strong>in</strong> prior securities cases. Until recent years, <strong>in</strong>vestment banks were notpermitted <strong>to</strong> engage <strong>in</strong> commercial bank lend<strong>in</strong>g <strong>and</strong> commercial banks were not permitted <strong>to</strong> engage55Furthermore, as detailed above at great length, the CC pleads with great particularity thatbankers at CS First Bos<strong>to</strong>n, <strong>in</strong>clud<strong>in</strong>g Lawrence Nath, structured the Rap<strong>to</strong>rs <strong>and</strong> knew that theRap<strong>to</strong>rs hid a great deal <strong>of</strong> Enron's debt from <strong>in</strong>ves<strong>to</strong>rs <strong>and</strong> that the Rap<strong>to</strong>rs conta<strong>in</strong>ed secret pricetriggers (created by Nath), which were not revealed <strong>to</strong> the public. 707-711. Thus, CS First Bos<strong>to</strong>nknew that Enron's reported f<strong>in</strong>ancial condition was not its real f<strong>in</strong>ancial condition.- 108 -
<strong>in</strong> <strong>in</strong>vestment bank<strong>in</strong>g services. This was the essence <strong>of</strong> Glass-Steagall. However, when GlassSteagall was repealed the banks named as defendants <strong>in</strong> this case quickly morphed <strong>in</strong><strong>to</strong> "f<strong>in</strong>ancialservices <strong>in</strong>stitutions" <strong>and</strong> began <strong>to</strong> <strong>of</strong>fer both commercial <strong>and</strong> <strong>in</strong>vestment bank<strong>in</strong>g services.This change <strong>in</strong> the nature <strong>of</strong> the operations <strong>of</strong> the defendant banks has important implicationsfor the CC's allegations that they knew or were reckless <strong>in</strong> not know<strong>in</strong>g that the statements they weremak<strong>in</strong>g about Enron <strong>to</strong> <strong>in</strong>ves<strong>to</strong>rs were false <strong>and</strong> mislead<strong>in</strong>g. Because these banks were mak<strong>in</strong>g hugecommercial loans <strong>to</strong> Enron, as well as participat<strong>in</strong>g <strong>in</strong> securities <strong>of</strong>fer<strong>in</strong>gs by Enron <strong>and</strong> relatedentities, they had more extensive constant contact with Enron's <strong>to</strong>p executives <strong>and</strong> access <strong>to</strong> Enron'snon-public f<strong>in</strong>ancial records, performance <strong>and</strong> plans than would have been the case had they onlycome periodically <strong>in</strong><strong>to</strong> contact with Enron <strong>to</strong> act as an underwriter <strong>to</strong> sell its securities <strong>to</strong> the public.Dur<strong>in</strong>g the Class Period, CS First Bos<strong>to</strong>n was a major lender <strong>to</strong> Enron, be<strong>in</strong>g <strong>in</strong>volved <strong>in</strong> over$5.5 billion <strong>in</strong> loans or lend<strong>in</strong>g commitments, not <strong>in</strong>clud<strong>in</strong>g the disguised loans it made <strong>to</strong> Enron.In mak<strong>in</strong>g large commercial loans or commitments as CS First Bos<strong>to</strong>n did <strong>to</strong> Enron, CS First Bos<strong>to</strong>nwas required, not only by federal laws <strong>and</strong> regulations but by its own <strong>in</strong>ternal procedures, <strong>to</strong> engage<strong>in</strong> an extremely detailed review <strong>and</strong> analysis <strong>of</strong> the actual f<strong>in</strong>ancial condition <strong>and</strong>creditworth<strong>in</strong>ess <strong>of</strong> the borrower, not only at the outset when the loan was made but constantlythroughout the pendency <strong>of</strong> the loan or lend<strong>in</strong>g commitment. Obviously, the larger the size <strong>of</strong> theloan or loan commitment, the greater the amount <strong>of</strong> f<strong>in</strong>ancial analysis oversight <strong>and</strong> review required.Thus, CS First Bos<strong>to</strong>n was required <strong>to</strong> perform extensive credit analysis <strong>of</strong> Enron afterobta<strong>in</strong><strong>in</strong>g detailed f<strong>in</strong>ancial <strong>in</strong>formation from it. Included <strong>in</strong> this credit analysis was a detailedreview <strong>of</strong> Enron's actual <strong>and</strong> cont<strong>in</strong>gent liabilities, its liquidity position, any equity issuanceobligations it may have which could adversely affect its shareholders' equity, any debt on whichEnron may have been potentially liable, even if not on Enron's books directly, the quality <strong>of</strong> Enron'spr<strong>of</strong>its <strong>and</strong> earn<strong>in</strong>gs <strong>and</strong> Enron's actual liquidity, <strong>in</strong>clud<strong>in</strong>g sources <strong>of</strong> fund<strong>in</strong>g <strong>to</strong> support repayment<strong>of</strong> any loans. In addition, after CS First Bos<strong>to</strong>n made large loans <strong>to</strong> or committed itself <strong>to</strong> creditfacilities for a corporation, it was required <strong>to</strong> closely moni<strong>to</strong>r Enron by frequently review<strong>in</strong>g itsf<strong>in</strong>ancial condition <strong>and</strong> ongo<strong>in</strong>g operations for any material changes <strong>and</strong> <strong>in</strong>sist that <strong>to</strong>p f<strong>in</strong>ancial<strong>of</strong>ficers <strong>of</strong> the borrower keep it <strong>in</strong>formed <strong>of</strong> the current status <strong>of</strong> the borrower's bus<strong>in</strong>ess <strong>and</strong>- 109 -
f<strong>in</strong>ancial condition. As a result, CS First Bos<strong>to</strong>n obta<strong>in</strong>ed extremely detailed <strong>in</strong>formationconcern<strong>in</strong>g the actual f<strong>in</strong>ancial condition <strong>of</strong> Enron throughout the Class Period <strong>and</strong> knew that theactual condition <strong>of</strong> Enron's bus<strong>in</strong>ess, its f<strong>in</strong>ances <strong>and</strong> its f<strong>in</strong>ancial condition was far worse than wasbe<strong>in</strong>g publicly disclosed by Enron, or as described or disclosed <strong>in</strong> each <strong>of</strong> CS First Bos<strong>to</strong>n's analystreports on Enron. Thus, CS First Bos<strong>to</strong>n knew (or was reckless <strong>in</strong> not know<strong>in</strong>g):(a)Enron had set up LJM2 at year-end 99 so that Enron could use SPEs fundedby that vehicle <strong>to</strong> engage <strong>in</strong> non-arm's-length self-deal<strong>in</strong>g transactions which would enrich the<strong>in</strong>ves<strong>to</strong>rs <strong>in</strong> the LJM2 partnership – <strong>in</strong>clud<strong>in</strong>g CS First Bos<strong>to</strong>n's <strong>to</strong>p executives – <strong>and</strong>, at the sametime, permit Enron <strong>to</strong> generate artificial pr<strong>of</strong>its <strong>and</strong> conceal its true debt level by mov<strong>in</strong>g billions <strong>of</strong>dollars <strong>of</strong> debt <strong>of</strong>f its balance sheet <strong>and</strong> on<strong>to</strong> the balance sheet <strong>of</strong> LJM2's SPEs.(b)Enron was also engag<strong>in</strong>g <strong>in</strong> similar non-arm's-length transactions with anotherlimited partnership, JEDI, <strong>and</strong> an associated SPE known as Chewco, which was also permitt<strong>in</strong>gEnron <strong>to</strong> artificially <strong>in</strong>flate its reported earn<strong>in</strong>gs while mov<strong>in</strong>g large amounts <strong>of</strong> debt <strong>of</strong>f its balancesheet.(c)Enron's actual f<strong>in</strong>ancial condition <strong>and</strong> results from operations were far worsethan what was be<strong>in</strong>g publicly disclosed or presented: (i) because Enron was falsify<strong>in</strong>g its f<strong>in</strong>ancialresults <strong>and</strong> misus<strong>in</strong>g <strong>and</strong> abus<strong>in</strong>g mark-<strong>to</strong>-market account<strong>in</strong>g, result<strong>in</strong>g <strong>in</strong> Enron's pr<strong>of</strong>itability be<strong>in</strong>gfar less than publicly reported; (ii) because Enron was improperly mov<strong>in</strong>g debt <strong>of</strong>f its balance sheet<strong>and</strong> on<strong>to</strong> the balance sheets <strong>of</strong> entities it secretly controlled, thus Enron's true debt level <strong>and</strong> leveragewas much higher than what was be<strong>in</strong>g publicly presented; <strong>and</strong> (iii) because <strong>of</strong> the forego<strong>in</strong>g, Enron'sliquidity <strong>and</strong> creditworth<strong>in</strong>ess were far worse than publicly known <strong>and</strong> its f<strong>in</strong>ancial condition muchmore leveraged <strong>and</strong> precarious than was be<strong>in</strong>g disclosed <strong>to</strong> public <strong>in</strong>ves<strong>to</strong>rs.(d)Enron had entered <strong>in</strong><strong>to</strong> a number <strong>of</strong> transactions with secretly controlled SPEsbe<strong>in</strong>g funded by LJM2 – which CS First Bos<strong>to</strong>n's executives were secretly fund<strong>in</strong>g, whileadm<strong>in</strong>ister<strong>in</strong>g LJM2's affairs – <strong>to</strong> f<strong>in</strong>ance transactions which would require Enron <strong>to</strong> issue millions<strong>of</strong> shares <strong>of</strong> Enron common s<strong>to</strong>ck if Enron's common s<strong>to</strong>ck fell below trigger prices rang<strong>in</strong>g from$83-$19 per share. Not only could Enron be required <strong>to</strong> issue huge amounts <strong>of</strong> additional s<strong>to</strong>ck, also,the debt <strong>of</strong> the SPEs with which Enron was do<strong>in</strong>g bus<strong>in</strong>ess would not, <strong>in</strong> fact, be non-recourse <strong>to</strong>- 110 -
Enron as represented but, <strong>in</strong> fact, would become <strong>and</strong> be recourse <strong>to</strong> Enron if, as <strong>and</strong> when Enron'scredit rat<strong>in</strong>g was lowered – someth<strong>in</strong>g CS First Bos<strong>to</strong>n knew would occur if, as <strong>and</strong> when Enron'strue f<strong>in</strong>ancial condition became public or became known <strong>to</strong> the rat<strong>in</strong>g agencies.In addition <strong>to</strong> CS First Bos<strong>to</strong>n's extensive, ongo<strong>in</strong>g commercial bank<strong>in</strong>g relationship withEnron – <strong>and</strong> the knowledge it ga<strong>in</strong>ed therefrom – CS First Bos<strong>to</strong>n also acted as an underwriter <strong>in</strong>eight securities <strong>of</strong>fer<strong>in</strong>gs, rais<strong>in</strong>g $5 billion for Enron before <strong>and</strong> dur<strong>in</strong>g the Class Period.Thus, CS First Bos<strong>to</strong>n had constant access <strong>to</strong> Enron's <strong>to</strong>p executives <strong>and</strong> Enron's f<strong>in</strong>ancialrecords, f<strong>in</strong>ances, plans, etc. <strong>in</strong> connection with a series <strong>of</strong> large ongo<strong>in</strong>g major commercial loans<strong>and</strong>/or lend<strong>in</strong>g commitments, as well as several securities <strong>of</strong>fer<strong>in</strong>gs between 98 <strong>and</strong> 01! This isnot a situation <strong>of</strong> alleg<strong>in</strong>g scienter aga<strong>in</strong>st a bank that had only isolated contact with an issuer <strong>in</strong> thecontext <strong>of</strong> do<strong>in</strong>g limited due diligence only <strong>in</strong> connection with one or a few securities <strong>of</strong>fer<strong>in</strong>gs.Here, what is alleged is constant access by a sophisticated commercial lender <strong>to</strong> the <strong>in</strong>nermostdetails <strong>of</strong> the f<strong>in</strong>ancial structure <strong>and</strong> operations <strong>of</strong> a company that was a major borrower fromthe commercial operations <strong>of</strong> the bank, which, via the bank's <strong>in</strong>vestment bank<strong>in</strong>g operations, wasfrequently sell<strong>in</strong>g securities <strong>of</strong> the Company <strong>to</strong> the public, <strong>and</strong> was also constantly issu<strong>in</strong>g analystreports about that Company <strong>to</strong> the public, while the bank or its <strong>to</strong>p executives were secretly<strong>in</strong>ves<strong>to</strong>rs <strong>in</strong>, or funders <strong>of</strong>, a huge partnership (LJM2) which was do<strong>in</strong>g non-arm's-lengthfraudulent transactions with Enron that were generat<strong>in</strong>g hundreds <strong>of</strong> millions <strong>of</strong> dollars <strong>of</strong> phonypr<strong>of</strong>its, while hid<strong>in</strong>g billions <strong>of</strong> dollars <strong>of</strong> Enron's actual debt <strong>and</strong> generat<strong>in</strong>g massive returns <strong>to</strong>the bank's <strong>of</strong>ficers as their secret <strong>in</strong>vestment <strong>in</strong> the LJM2 partnership benefitted from the loot<strong>in</strong>g<strong>of</strong> Enron. With all due respect, this is a situation that has never before been presented s<strong>in</strong>ce thepassage <strong>of</strong> the federal securities laws <strong>in</strong> 1933-1934 because only <strong>in</strong> recent years have banks beenable <strong>to</strong> engage <strong>in</strong> the k<strong>in</strong>d <strong>of</strong> jo<strong>in</strong>t commercial <strong>and</strong> <strong>in</strong>vestment bank<strong>in</strong>g activity present <strong>in</strong> this case<strong>and</strong> which apparently was so abused by them <strong>to</strong> the great damage <strong>of</strong> purchasers <strong>of</strong> Enron's publiclytraded securities.In <strong>in</strong>teract<strong>in</strong>g with Enron, CS First Bos<strong>to</strong>n functioned as an unified entity. There was no socalled"Ch<strong>in</strong>ese Wall" <strong>to</strong> seal <strong>of</strong>f the CS First Bos<strong>to</strong>n securities analysts from the <strong>in</strong>formation whichCS First Bos<strong>to</strong>n obta<strong>in</strong>ed render<strong>in</strong>g commercial <strong>and</strong> <strong>in</strong>vestment bank<strong>in</strong>g services <strong>to</strong> Enron.- 111 -
Alternatively, even if some restrictions on the <strong>in</strong>formation made available <strong>to</strong> CS First Bos<strong>to</strong>n'ssecurities analysts existed, those unilateral <strong>and</strong> self-serv<strong>in</strong>g actions are <strong>in</strong>sufficient <strong>to</strong> preventimputation <strong>of</strong> all knowledge <strong>and</strong> scienter possessed by the CS First Bos<strong>to</strong>n legal entity, as itsknowledge <strong>and</strong> liability <strong>in</strong> this case is determ<strong>in</strong>ed by look<strong>in</strong>g at CS First Bos<strong>to</strong>n as an overall legalentity. 695. 56Knowledge is imputed <strong>to</strong> a corporation through its employees <strong>and</strong> agents via respondeatsuperior. To determ<strong>in</strong>e the mens rea <strong>of</strong> a corporation, courts not only consider the actual knowledge<strong>of</strong> each <strong>in</strong>dividual employee, but also aggregate each employee's knowledge under a theory referred<strong>to</strong> as the "Collective Knowledge Doctr<strong>in</strong>e."The Fifth Circuit has clearly found <strong>in</strong> favor <strong>of</strong> apply<strong>in</strong>g traditional notions <strong>of</strong> respondeatsuperior <strong>to</strong> impute knowledge <strong>to</strong> a corporate defendant <strong>in</strong> both civil <strong>and</strong> crim<strong>in</strong>al proceed<strong>in</strong>gs.St<strong>and</strong>ard Oil Co. v. United States, 307 F.2d 120, 127 (5th Cir. 1962). Furthermore, "'[w]hether thecorporate <strong>of</strong>ficer or agent was possessed <strong>of</strong> actual knowledge <strong>of</strong> facts is ord<strong>in</strong>arily (a question) <strong>of</strong>fact for the jury. Whether the knowledge <strong>of</strong>, or notice <strong>to</strong>, an <strong>of</strong>ficer <strong>of</strong> a corporation is <strong>to</strong> be imputed<strong>to</strong> the corporation is a question <strong>of</strong> law for the court.'" American St<strong>and</strong>ard Credit, Inc. v. NationalCement Co., 643 F.2d 248, 270 (5th. Cir. 1981).While St<strong>and</strong>ard Oil does not limit the imputation <strong>of</strong> knowledge <strong>to</strong> high-level employees, 57subsequent Fifth Circuit cases do appear <strong>to</strong> focus much more on the employee's position <strong>in</strong> thecompany. See Hellenic Inc. v. Bridgel<strong>in</strong>e Gas Distrib. LLC (In re Hellenic Inc.), 252 F.3d 391, 395(5th Cir. 2001) ("[W]e have observed that the question <strong>of</strong> 'privity or knowledge must turn on thefacts <strong>of</strong> the <strong>in</strong>dividual case,' stat<strong>in</strong>g that a corporation 'is charged with the privity or knowledge <strong>of</strong>its employees when they are sufficiently high on the corporate ladder.' We have further expla<strong>in</strong>ed56Any claimed "Ch<strong>in</strong>ese Wall" cannot provide a defense at the motion <strong>to</strong> dismiss stage.Cooper, 137 F.3d at 628-29.57"[N]o contention is made that 'knowledge' can be acquired only through supervisory orexecutive personnel. On the contrary, while status <strong>of</strong> the ac<strong>to</strong>r <strong>in</strong> the corporate hierarchy might wellhave decisive significance <strong>in</strong> determ<strong>in</strong><strong>in</strong>g the question we later discuss concern<strong>in</strong>g the <strong>in</strong>tention <strong>to</strong>benefit the corporation, the corporation may be crim<strong>in</strong>ally bound by the acts <strong>of</strong> subord<strong>in</strong>ate, evenmenial, employees. Likewise, no contention is, or can at this late date, be made that mereviolation <strong>of</strong> <strong>in</strong>structions would shield the corporation from crim<strong>in</strong>al responsibility for actionswhich its agents have taken for it." St<strong>and</strong>ard Oil, 307 F.2d at 127.- 112 -
that privity or knowledge 'is imputed <strong>to</strong> the corporation when the employee is "an executive <strong>of</strong>ficer,manager or super<strong>in</strong>tendent whose scope <strong>of</strong> authority <strong>in</strong>cludes supervision over the phase <strong>of</strong> thebus<strong>in</strong>ess out <strong>of</strong> which the loss or <strong>in</strong>jury occurred."'").such:The First Circuit has detailed the Collective Knowledge Doctr<strong>in</strong>e <strong>and</strong> its justifications as[Defendant] Bank contends that the trial court's <strong>in</strong>structions regard<strong>in</strong>gknowledge were defective because they elim<strong>in</strong>ated the requirement that it be proventhat the Bank violated a known legal duty. It avers that the knowledge <strong>in</strong>struction<strong>in</strong>vited the jury <strong>to</strong> convict the Bank for negligently ma<strong>in</strong>ta<strong>in</strong><strong>in</strong>g a poorcommunications network that prevented the consolidation <strong>of</strong> the <strong>in</strong>formation held byits various employees. The Bank argues that it is error <strong>to</strong> f<strong>in</strong>d that a corporationpossesses a particular item <strong>of</strong> knowledge if one part <strong>of</strong> the corporation has half the<strong>in</strong>formation mak<strong>in</strong>g up the item, <strong>and</strong> another part <strong>of</strong> the entity has the other half.A collective knowledge <strong>in</strong>struction is entirely appropriate <strong>in</strong> the context <strong>of</strong>corporate crim<strong>in</strong>al liability. Riss & Company v. United States, 262 F.2d 245, 250(8th Cir. 1958); Inl<strong>and</strong> Freight L<strong>in</strong>es v. United States, 191 F.2d 313, 315 (10th Cir.1951); Camacho v. Bowl<strong>in</strong>g, 562 F. Supp. 1012, 1025 (N.D. Ill. 1983); United Statesv. T.I.M.E.-D.C., Inc., 381 F. Supp. 730, 738-39 (W.D. W.Va. 1974); United Statesv. Sawyer Transport, Inc., 337 F. Supp. 29 (D. M<strong>in</strong>n. 1971), aff'd, 463 F.2d 175 (8thCir. 1972). The acts <strong>of</strong> a corporation are, after all, simply the acts <strong>of</strong> all <strong>of</strong> itsemployees operat<strong>in</strong>g with<strong>in</strong> the scope <strong>of</strong> their employment. The law on corporatecrim<strong>in</strong>al liability reflects this. See, e.g., United States v. C<strong>in</strong>cotta, 689 F.2d 238, 241,242 (1st Cir.), cert. denied, 459 U.S. 991, 103 S. Ct. 347, 74 L. Ed. 2d 387 (1982);United States v. Richmond, 700 F.2d 1183, 1195 n.7 (11th Cir. 1983). Similarly, theknowledge obta<strong>in</strong>ed by corporate employees act<strong>in</strong>g with<strong>in</strong> the scope <strong>of</strong> theiremployment is imputed <strong>to</strong> the corporation. Steere Tank L<strong>in</strong>es, Inc. v. United States,330 F.2d 719, 722 (5th Cir. 1964). Corporations compartmentalize knowledge,subdivid<strong>in</strong>g the elements <strong>of</strong> specific duties <strong>and</strong> operations <strong>in</strong><strong>to</strong> smaller components.The aggregate <strong>of</strong> those components constitutes the corporation's knowledge <strong>of</strong> aparticular operation. It is irrelevant whether employees adm<strong>in</strong>ister<strong>in</strong>g onecomponent <strong>of</strong> an operation know the specific activities <strong>of</strong> employees adm<strong>in</strong>ister<strong>in</strong>ganother aspect <strong>of</strong> the operation:"[A] corporation cannot plead <strong>in</strong>nocence by assert<strong>in</strong>g that the<strong>in</strong>formation obta<strong>in</strong>ed by several employees was not acquired by anyone <strong>in</strong>dividual who then would have comprehended its full import.Rather the corporation is considered <strong>to</strong> have acquired the collectiveknowledge <strong>of</strong> its employees <strong>and</strong> is held responsible for their failure<strong>to</strong> act accord<strong>in</strong>gly."United States v. T.I.M.E.-D.C., Inc., 381 F. Supp. at 738. S<strong>in</strong>ce the Bank had thecompartmentalized structure common <strong>to</strong> all large corporations, the court's collectiveknowledge <strong>in</strong>struction was not only proper but necessary.United States v. Bank <strong>of</strong> New Engl<strong>and</strong>, N.A., 821 F.2d 844, 855-56 (1st Cir. 1987).This district court has explicitly endorsed the Collective Knowledge Doctr<strong>in</strong>e. See Burzynskiv. Aetna Life Ins. Co., Civ. No. H-89-3976, 1992 U.S. Dist. LEXIS 21300, at *13 (S.D. Tex. Mar.- 113 -
31, 1992) ("[T]he knowledge <strong>of</strong> Aetna's agents <strong>and</strong> employees is imputed <strong>to</strong> the corporation underthe doctr<strong>in</strong>e <strong>of</strong> 'collective knowledge.'") (cit<strong>in</strong>g Steere Tank L<strong>in</strong>es, Inc. v. Unites States, 330 F.2d719,722 (5th Cir. 1963)). 58Also, knowledge held by one corporation prior <strong>to</strong> a merger with another corporation is carriedover <strong>to</strong>, i.e., imported <strong>to</strong> the successor succeed<strong>in</strong>g entity. In United States v. Wilshire Oil Co., 427F.2d 969 (10th Cir. 1970), defendant Wilshire purchased another asphalt distribu<strong>to</strong>r, Riffe PetroleumCo., which then became an un<strong>in</strong>corporated division <strong>of</strong> Wilshire Oil Co. Prior <strong>to</strong> the merger, Riffe,act<strong>in</strong>g through its agent, entered <strong>in</strong><strong>to</strong> a conspiracy <strong>to</strong> fix the price <strong>of</strong> asphalt sold <strong>to</strong> Kansas's highwaydepartments. This conspiracy was alleged <strong>to</strong> have cont<strong>in</strong>ued after Riffe was purchased by Wilshire<strong>and</strong> hence, Wilshire was <strong>in</strong>dicted (<strong>and</strong> ultimately convicted) for conspiracy <strong>to</strong> violate the ShermanAct. Wilshire claimed on appeal that "the only knowledge it could have had regard<strong>in</strong>g [its]participation <strong>in</strong> the conspiracy was knowledge acquired prior <strong>to</strong> the merger <strong>and</strong> [it was] therebyliable for neither the pre-merger crime nor [its] post-merger <strong>in</strong>volvement." Id. at 973. The court <strong>of</strong>appeals rejected Wilshire's "novel" argument, stat<strong>in</strong>g:Id. at 973-74.We pause <strong>to</strong> note that the argument does not deny that an agent's knowledge isimputed <strong>to</strong> the corporation if ga<strong>in</strong>ed while act<strong>in</strong>g <strong>in</strong> the scope <strong>of</strong> employment. Theproposition merely suggests that Wilshire is immune from prosecution here because<strong>of</strong> a fortui<strong>to</strong>us series <strong>of</strong> events which placed them at the scene after the acquisition<strong>of</strong> the agent's <strong>in</strong>formation.There is no question about the cont<strong>in</strong>u<strong>in</strong>g nature <strong>of</strong> the plot nor is therereasonable doubt that Wilshire was a part there<strong>of</strong>. And we believe the ticklishproblem <strong>of</strong> pre-merger knowledge must be decided aga<strong>in</strong>st Wilshire on the facts.Although appellant claims <strong>to</strong> have unwitt<strong>in</strong>gly bought <strong>in</strong><strong>to</strong> an on-go<strong>in</strong>g conspiracy<strong>and</strong> for that reason it ought <strong>to</strong> be excused, the <strong>to</strong>tality <strong>of</strong> the evidence supports theconclusion that Wilshire had ample opportunity <strong>to</strong> detect <strong>and</strong> reject the illegalpractices. This is not a case where a company was purchased without chance forscrut<strong>in</strong>iz<strong>in</strong>g observation prior <strong>to</strong> assumption <strong>of</strong> control.58Additionally, <strong>in</strong> American St<strong>and</strong>ard Credit, 643 F.2d at 271 n.16, the Fifth Circuit stated:"'[T]he general rule is well established that a corporation is charged with constructive knowledge,regardless <strong>of</strong> its actual knowledge, <strong>of</strong> all material facts <strong>of</strong> which its <strong>of</strong>ficer or agent receives noticeor acquires knowledge while act<strong>in</strong>g <strong>in</strong> the course <strong>of</strong> his employment with<strong>in</strong> the scope <strong>of</strong> hisauthority, even though the <strong>of</strong>ficer or agent does not <strong>in</strong> fact communicate his knowledge <strong>to</strong> thecorporation.'"- 114 -
Of course, motive <strong>and</strong> opportunity rema<strong>in</strong> relevant considerations <strong>in</strong> determ<strong>in</strong><strong>in</strong>g if scienterhas been adequately alleged. CS First Bos<strong>to</strong>n had very strong economic motives <strong>to</strong> employ acts <strong>and</strong>contrivances <strong>to</strong> deceive <strong>and</strong> participate <strong>in</strong> the fraudulent scheme or course <strong>of</strong> bus<strong>in</strong>ess. For <strong>in</strong>stance,the proceeds <strong>of</strong> Enron's securities <strong>of</strong>fer<strong>in</strong>gs underwritten by CS First Bos<strong>to</strong>n or other <strong>in</strong>vestmentbanks were utilized <strong>to</strong> repay Enron's exist<strong>in</strong>g commercial paper <strong>and</strong> bank <strong>in</strong>debtedness, <strong>in</strong>clud<strong>in</strong>g<strong>in</strong>debtedness <strong>to</strong> CS First Bos<strong>to</strong>n. And throughout the Class Period, CS First Bos<strong>to</strong>n was pocket<strong>in</strong>gmillions <strong>of</strong> dollars a year <strong>in</strong> <strong>in</strong>terest payments, syndication fees <strong>and</strong> <strong>in</strong>vestment bank<strong>in</strong>g fees byparticipat<strong>in</strong>g <strong>in</strong> the Enron scheme <strong>to</strong> defraud <strong>and</strong> s<strong>to</strong>od <strong>to</strong> cont<strong>in</strong>ue <strong>to</strong> collect these huge amountsgo<strong>in</strong>g forward so long as it helped perpetuate the Enron Ponzi scheme, while CS First Bos<strong>to</strong>n's <strong>to</strong>pexecutives pocketed huge returns on their secret <strong>in</strong>vestment <strong>in</strong> LJM2 – returns created by theloot<strong>in</strong>g <strong>of</strong> Enron via the very manipulative or deceptive acts <strong>and</strong> contrived transactions betweenEnron <strong>and</strong> LJM2 entities which CS First Bos<strong>to</strong>n was f<strong>in</strong>anc<strong>in</strong>g – transactions which were hid<strong>in</strong>gbillions <strong>of</strong> dollars <strong>of</strong> Enron's debt <strong>and</strong> artificially <strong>in</strong>flat<strong>in</strong>g its pr<strong>of</strong>its by hundreds <strong>of</strong> millions <strong>of</strong>dollars, provid<strong>in</strong>g it cont<strong>in</strong>ued access <strong>to</strong> the capital markets.CS First Bos<strong>to</strong>n was will<strong>in</strong>g participate <strong>in</strong> the fraudulent scheme <strong>and</strong> course <strong>of</strong> bus<strong>in</strong>essbecause its participation created enormous pr<strong>of</strong>its for CS First Bos<strong>to</strong>n <strong>and</strong> its <strong>to</strong>p executives as longas the Enron scheme cont<strong>in</strong>ued <strong>in</strong> operation – someth<strong>in</strong>g that CS First Bos<strong>to</strong>n was <strong>in</strong> a uniqueposition <strong>to</strong> cause. While CS First Bos<strong>to</strong>n was lend<strong>in</strong>g or committed <strong>to</strong> lend hundreds <strong>of</strong> millions <strong>to</strong>Enron, it was limit<strong>in</strong>g its own risk <strong>in</strong> this regard, as it knew that so long as Enron ma<strong>in</strong>ta<strong>in</strong>ed itscoveted <strong>in</strong>vestment grade credit rat<strong>in</strong>g <strong>and</strong> cont<strong>in</strong>ued <strong>to</strong> report strong earn<strong>in</strong>gs <strong>and</strong> credibly forecaststrong ongo<strong>in</strong>g revenue <strong>and</strong> pr<strong>of</strong>it growth, Enron's access <strong>to</strong> the capital markets would cont<strong>in</strong>ue<strong>to</strong> enable Enron <strong>to</strong> raise hundreds <strong>of</strong> millions, if not billions, <strong>of</strong> dollars <strong>of</strong> fresh capital frompublic <strong>in</strong>ves<strong>to</strong>rs which would be used <strong>to</strong> repay or reduce Enron's commercial paper debt <strong>and</strong> theloans from CS First Bos<strong>to</strong>n <strong>to</strong> Enron so that the scheme could cont<strong>in</strong>ue. 702.No one had a greater motive than those who were secretly loot<strong>in</strong>g Enron, i.e., Fas<strong>to</strong>w <strong>and</strong>Enron's banks <strong>and</strong> bankers, <strong>to</strong> deceive <strong>in</strong>ves<strong>to</strong>rs as <strong>to</strong> the true state <strong>of</strong> Enron's f<strong>in</strong>ancial condition <strong>and</strong>bus<strong>in</strong>ess prospects, because that deceit was central <strong>to</strong> preserv<strong>in</strong>g Enron's access <strong>to</strong> public capitalmarkets <strong>and</strong> keep<strong>in</strong>g Enron's s<strong>to</strong>ck price <strong>in</strong>flated, as that <strong>in</strong>flated s<strong>to</strong>ck price was the key support<strong>in</strong>g- 115 -
non-arm's-length fraudulent LJM transactions with SPEs that were enrich<strong>in</strong>g the banks <strong>and</strong> bankers.The <strong>in</strong>volvement <strong>of</strong> CS First Bos<strong>to</strong>n's executives <strong>in</strong> LJM2 was, bluntly put, a reward – a pay<strong>of</strong>f –for their participation <strong>in</strong> the fraudulent scheme <strong>and</strong> one that they would cont<strong>in</strong>ue <strong>to</strong> pr<strong>of</strong>it from aslong as the Enron Ponzi scheme could be cont<strong>in</strong>ued – generat<strong>in</strong>g huge returns for them as secretprivate equity <strong>in</strong>ves<strong>to</strong>rs <strong>in</strong> LJM2, which returns were only possible because the transactions thatwere be<strong>in</strong>g constantly entered <strong>in</strong><strong>to</strong> with Enron were non-arm's-length <strong>and</strong> fraudulent –generat<strong>in</strong>g bogus pr<strong>of</strong>its for Enron while hid<strong>in</strong>g debt <strong>and</strong> at the same time generat<strong>in</strong>g excessivereturns for LJM2 with Fas<strong>to</strong>w, Enron's CFO, operat<strong>in</strong>g the levers on both sides <strong>of</strong> all deals.Simply put, CS First Bos<strong>to</strong>n's executives who were <strong>in</strong>volved <strong>in</strong> LJM2 were engaged <strong>in</strong>loot<strong>in</strong>g Enron for their own personal pr<strong>of</strong>it. This gave them a tremendous motive <strong>to</strong> keep Enronafloat <strong>and</strong> its s<strong>to</strong>ck price <strong>in</strong>flated so that Enron could consistently go back, with their help, <strong>to</strong> thecapital markets <strong>to</strong> raise capital <strong>to</strong> keep the Enron Ponzi scheme go<strong>in</strong>g. While the banks may nowwh<strong>in</strong>e about the losses they claim <strong>to</strong> have suffered when the Enron Ponzi scheme collapsed, theywere secretly rubb<strong>in</strong>g their h<strong>and</strong>s <strong>in</strong> glee dur<strong>in</strong>g the years that the scheme succeeded <strong>and</strong> Enron wasbe<strong>in</strong>g looted while be<strong>in</strong>g propped up with public money which was flow<strong>in</strong>g back <strong>in</strong><strong>to</strong> their dirtyh<strong>and</strong>s <strong>and</strong> then their own deep pockets. And the longer Enron could be propped up <strong>and</strong> the Ponzischeme cont<strong>in</strong>ued, the longer CS First Bos<strong>to</strong>n could cont<strong>in</strong>ue <strong>to</strong> pocket these huge returns fromsuch transactions.Then add <strong>to</strong> this mix the huge <strong>in</strong>vestment bank<strong>in</strong>g fees, <strong>in</strong>terest charges, lend<strong>in</strong>g commitmentfees, etc., CS First Bos<strong>to</strong>n was extract<strong>in</strong>g from Enron by keep<strong>in</strong>g the Ponzi scheme go<strong>in</strong>g, eitherlend<strong>in</strong>g money <strong>to</strong> Enron <strong>to</strong> liquify Enron or by rais<strong>in</strong>g money from the public <strong>to</strong> liquify Enron, <strong>and</strong>then us<strong>in</strong>g money raised from public <strong>in</strong>ves<strong>to</strong>rs <strong>to</strong> repay itself or other banks. These were hugesecurities <strong>of</strong>fer<strong>in</strong>gs – $250 million raised via the sale <strong>of</strong> 6.95% notes <strong>in</strong> 11/98; $870 million raisedfrom the sale <strong>of</strong> Enron common s<strong>to</strong>ck <strong>in</strong> 2/99; $370 million raised for Enron via the sale <strong>of</strong> Azurixs<strong>to</strong>ck <strong>in</strong> 6/99 <strong>and</strong> $600 million more <strong>in</strong> the sale <strong>of</strong> Azurix notes later on; $1 billion raised via sale<strong>of</strong> Osprey Trust notes; $1 billion raised via sale <strong>of</strong> Marl<strong>in</strong> Water notes; <strong>and</strong> then the huge NewPower IPO <strong>in</strong> 10/00 which created a $370 million phony pr<strong>of</strong>it for Enron. While the <strong>in</strong>vestmentbank<strong>in</strong>g fee <strong>to</strong> be ga<strong>in</strong>ed <strong>in</strong> an isolated securities <strong>of</strong>fer<strong>in</strong>g by an <strong>in</strong>vestment bank which does not have- 116 -
an ongo<strong>in</strong>g relationship with the issuer may not, <strong>in</strong> <strong>and</strong> <strong>of</strong> itself, create sufficient weight <strong>to</strong> show amotive <strong>to</strong> defraud, surely the size <strong>and</strong> the cont<strong>in</strong>uity <strong>of</strong> the <strong>in</strong>vestment bank<strong>in</strong>g fees here, especiallywhen comb<strong>in</strong>ed with the fees be<strong>in</strong>g obta<strong>in</strong>ed from the banks' commercial activities <strong>in</strong> the context<strong>of</strong> the banks' secret <strong>in</strong>volvement <strong>in</strong> the LJM2 partnership, must be given great weight vis-à-vismotive. After all, a compla<strong>in</strong>t is <strong>to</strong> be construed <strong>in</strong> its entirety <strong>and</strong> the <strong>in</strong>ferences are <strong>to</strong> be drawn<strong>in</strong> favor <strong>of</strong> the pla<strong>in</strong>tiff.CS First Bos<strong>to</strong>n claims that it lost money at the end <strong>of</strong> the day when the Ponzi schemecollapsed. But this unsupported factual argument actually cuts aga<strong>in</strong>st them. Like a gambler at thecraps table who has a long run <strong>of</strong> good luck, but keeps doubl<strong>in</strong>g-up <strong>and</strong> ends up with a huge amount<strong>of</strong> chips at work on the table when he f<strong>in</strong>ally rolls a seven, CS First Bos<strong>to</strong>n did very, very well foritself <strong>and</strong> its <strong>to</strong>p executives as long as the run <strong>of</strong> good luck cont<strong>in</strong>ued, i.e., the Enron house <strong>of</strong> cardss<strong>to</strong>od. But they paid the price when seven came up. In fact, the <strong>in</strong>creas<strong>in</strong>g f<strong>in</strong>ancial exposure <strong>of</strong> thebanks <strong>to</strong> Enron as the scheme progressed only <strong>in</strong>creased the motive <strong>of</strong> the banks, like CS FirstBos<strong>to</strong>n, <strong>to</strong> keep Enron look<strong>in</strong>g good <strong>and</strong> keep its s<strong>to</strong>ck price up so that its <strong>in</strong>creas<strong>in</strong>gly fragilef<strong>in</strong>ancial structure would not collapse <strong>and</strong> so that Enron would cont<strong>in</strong>ue <strong>to</strong> have access, with thehelp <strong>of</strong> the banks, <strong>to</strong> the capital markets <strong>to</strong> raise monies <strong>to</strong> pay back Enron's debts <strong>to</strong> the banks.At the end <strong>of</strong> the day, the scienter allegations aga<strong>in</strong>st CS First Bos<strong>to</strong>n <strong>in</strong> the CC are uniquelystrong, <strong>in</strong> part because <strong>of</strong> the unique circumstances <strong>of</strong> this case. The banks named as defendantshere chose <strong>to</strong> vastly exp<strong>and</strong> the types <strong>of</strong> bus<strong>in</strong>ess they did with Enron <strong>and</strong> the types <strong>of</strong> commercialtransactions they engaged <strong>in</strong> with Enron. In so do<strong>in</strong>g, they entangled themselves <strong>in</strong> the affairs <strong>of</strong> theCompany that was committ<strong>in</strong>g the largest <strong>and</strong> worst securities fraud <strong>in</strong> the his<strong>to</strong>ry <strong>of</strong> the UnitedStates. The banks chose <strong>to</strong> facilitate <strong>and</strong> participate <strong>in</strong> that fraud – <strong>and</strong> <strong>to</strong> make false <strong>and</strong> mislead<strong>in</strong>gstatements because it gave them, the banks <strong>and</strong> their <strong>to</strong>p executives, the opportunity <strong>to</strong> reap hugepr<strong>of</strong>its.Hav<strong>in</strong>g <strong>to</strong>p bank executives <strong>and</strong> banks secretly <strong>in</strong>vest millions <strong>of</strong> dollars <strong>in</strong> partnerships thatengage <strong>in</strong> non-arm's-length fraudulent transactions with a public company <strong>to</strong> loot it, while creat<strong>in</strong>ghundreds <strong>of</strong> millions <strong>of</strong> dollars <strong>of</strong> phony pr<strong>of</strong>its <strong>and</strong> hid<strong>in</strong>g billions <strong>of</strong> dollars <strong>of</strong> debt, while thebanks are secretly engag<strong>in</strong>g <strong>in</strong> other bogus transactions with the public company, further artificially- 117 -
oost<strong>in</strong>g its reported earn<strong>in</strong>gs <strong>and</strong> hid<strong>in</strong>g additional billions <strong>of</strong> dollars <strong>of</strong> debt <strong>and</strong> all the whileissu<strong>in</strong>g glow<strong>in</strong>g analyst reports prais<strong>in</strong>g the skill <strong>and</strong> <strong>in</strong>tegrity <strong>of</strong> the company's management, thetremendous successes <strong>of</strong> its core bus<strong>in</strong>esses, the success <strong>of</strong> its risk management <strong>and</strong> hedg<strong>in</strong>gtechniques, <strong>and</strong> its wonderful future bus<strong>in</strong>ess <strong>and</strong> earn<strong>in</strong>gs prospects, is simply not bank<strong>in</strong>g bus<strong>in</strong>essas usual. Or if it is, this country <strong>and</strong> our f<strong>in</strong>ancial markets are <strong>in</strong> terrible trouble.VII.CONCLUSIONIn fact, as this Court knows, a key Andersen partner condemned the LJM2 partnership – <strong>in</strong>an e-mail once destroyed, but later resurrected. Accord<strong>in</strong>g <strong>to</strong> Kurt Eichenwald, "Andersen LawyerAccuses Prosecu<strong>to</strong>rs <strong>of</strong> Misconduct," New York Times, 5/10/02:[I]n one e-mail message written by Mr. Neuhausen [an Andersen partner] ... helambasted Enron's plan <strong>to</strong> allow its chief f<strong>in</strong>ancial <strong>of</strong>ficer <strong>to</strong> run a partnership that didbus<strong>in</strong>ess with the company, call<strong>in</strong>g it terrible <strong>and</strong> ask<strong>in</strong>g, "Why would any direc<strong>to</strong>rsign <strong>of</strong>f on such a scheme?"Indeed. And how could any sophisticated bank have gone <strong>in</strong> on such a "scheme"? The answer <strong>to</strong>Neuhausen's question is greed <strong>and</strong> arrogance – qualities that were present <strong>in</strong> abundance <strong>in</strong> Enron's<strong>in</strong>siders, its outside direc<strong>to</strong>rs, its lawyers, accountants <strong>and</strong> banks.On 2/26/02, Dow Jones News Service ran a s<strong>to</strong>ry headl<strong>in</strong>ed: "Next S<strong>to</strong>p On Enron Express:Wall Street." It noted the "long gravy tra<strong>in</strong> <strong>of</strong> s<strong>to</strong>ck <strong>and</strong> bond <strong>of</strong>fer<strong>in</strong>gs that Enron sent theStreets' way over the past decade." It also discussed (645):[T]he now-<strong>in</strong>famous LJM2 partnership set up by Enron's former chief f<strong>in</strong>ancial<strong>of</strong>ficer, Andrew Fas<strong>to</strong>w. It's been well-documented now ... that high-poweredf<strong>in</strong>ance firms such as CS First Bos<strong>to</strong>n, Merrill Lynch, J.P. Morgan <strong>and</strong> Citigroup,were lured <strong>in</strong><strong>to</strong> the LJM2 partnership by the promise <strong>of</strong> potentially rich returns <strong>and</strong>the chance <strong>to</strong> get an <strong>in</strong>side peek <strong>in</strong><strong>to</strong> Enron's mysterious deals.* * *... Wall Street – which got rich <strong>to</strong>ut<strong>in</strong>g Enron – is still act<strong>in</strong>g as if it has noth<strong>in</strong>g<strong>to</strong> answer for <strong>in</strong> the Enron mess.So far, most Wall Street <strong>in</strong>stitutions have said little about the Enron debacle, issu<strong>in</strong>geither blanket "no comments," or deny<strong>in</strong>g any responsibility for the company'scollapse. CS First Bos<strong>to</strong>n, which underwrote more than $4.5 billion <strong>in</strong> Enron s<strong>to</strong>ck<strong>and</strong> bond <strong>of</strong>fer<strong>in</strong>gs – roughly 20% <strong>of</strong> Enron's <strong>to</strong>tal underwrit<strong>in</strong>g work s<strong>in</strong>ce 1990 ...has refused <strong>to</strong> say anyth<strong>in</strong>g whatsoever. Merrill Lynch, which l<strong>in</strong>ed up <strong>in</strong>ves<strong>to</strong>rs forFas<strong>to</strong>w's LJM2 partnership <strong>and</strong> underwrote more than $4 billion <strong>in</strong> s<strong>to</strong>ck <strong>and</strong> bond<strong>of</strong>fer<strong>in</strong>gs for Enron, has been a bit more talkative – but only <strong>to</strong> say it's utterlyblameless.- 118 -
* * *Between them, Citigroup <strong>and</strong> J.P. Morgan served as lead manager on more than $20billion <strong>in</strong> syndicated bank loans <strong>to</strong> Enron over the past decade, with Citigroup alsounderwrit<strong>in</strong>g more than $4 billion <strong>in</strong> s<strong>to</strong>ck <strong>and</strong> bond <strong>of</strong>fer<strong>in</strong>gs for the company ....... Wall Street has plenty <strong>of</strong> expla<strong>in</strong><strong>in</strong>g <strong>to</strong> do. Jonathan Kord Lagemann, a securitieslawyer <strong>and</strong> former general counsel for a brokerage firm, says the Enron affair exposesthe "enormous conflict <strong>of</strong> <strong>in</strong>terest" <strong>in</strong>herent <strong>in</strong> these firms' efforts <strong>to</strong> be threeth<strong>in</strong>gs at one time: underwriter, corporate analyst <strong>and</strong> s<strong>to</strong>ck seller. To start, there'sthe obvious issue <strong>of</strong> whether pressure from their firms caused 10 <strong>of</strong> the 14 researchanalysts who followed Enron <strong>to</strong> keep recommend<strong>in</strong>g the s<strong>to</strong>ck <strong>to</strong> <strong>in</strong>ves<strong>to</strong>rs, even asthe company was rac<strong>in</strong>g <strong>to</strong>ward bankruptcy. A related issue is whether the analystsknew or should've known just how dire the situation was at Enron, s<strong>in</strong>ce many <strong>of</strong>them work for firms that were <strong>in</strong>vested <strong>in</strong> the partnerships that played a critical role<strong>in</strong> Enron's <strong>of</strong>f-balance-sheet transactions.The blatant self-deal<strong>in</strong>g by Enron's banks has not gone unnoticed:Many <strong>in</strong>stitutional <strong>in</strong>ves<strong>to</strong>rs decl<strong>in</strong>ed <strong>to</strong> buy <strong>in</strong><strong>to</strong> LJM2 because <strong>of</strong> Fas<strong>to</strong>w'sconflict <strong>of</strong> <strong>in</strong>terest. But some <strong>of</strong> the world's biggest <strong>in</strong>stitutions <strong>to</strong>ok a piece. Amongthem were Citigroup, Credit Suisse Group, Deutsche Bank, J.P. Morgan, <strong>and</strong>Lehman Brothers.What were they th<strong>in</strong>k<strong>in</strong>g? Much <strong>of</strong> the world's f<strong>in</strong>ancial communityturned out <strong>to</strong> be will<strong>in</strong>g enablers <strong>of</strong> Enron. No wonder "Wall Street credibility"is fast becom<strong>in</strong>g an oxymoron. Inves<strong>to</strong>rs are angry ....Bus<strong>in</strong>ess Week, 2/11/02 (648).- 119 -
The CC is not a blunderbuss long-w<strong>in</strong>ded journey <strong>to</strong> nowhere. It is a thoroughly <strong>in</strong>vestigateddetailed bluepr<strong>in</strong>t <strong>of</strong> CS First Bos<strong>to</strong>n's culpability, which states a claim upon which relief can begranted under accepted legal theories.DATED: June 10, 2002Respectfully submitted,MILBERG WEISS BERSHADHYNES & LERACH LLPWILLIAM S. LERACHDARREN J. ROBBINSHELEN J. HODGESBYRON S. GEORGIOUG. PAUL HOWESJAMES I. JACONETTEMICHELLE M. CICCARELLIJAMES R. HAILJOHN A. LOWTHERALEXANDRA S. BERNAY/S/WILLIAM S. LERACHWILLIAM S. LERACH401 B Street, Suite 1700San Diego, CA 92101Telephone: 619/231-1058MILBERG WEISS BERSHADHYNES & LERACH LLPSTEVEN G. SCHULMANSAMUEL H. RUDMANOne Pennsylvania PlazaNew York, NY 10119-1065Telephone: 212/594-5300Lead Counsel for Pla<strong>in</strong>tiffsSCHWARTZ, JUNELL, CAMPBELL& OATHOUT, LLPROGER B. GREENBERGFederal I.D. No. 3932State Bar No. 08390000/S/ROGER B. GREENBERGROGER B. GREENBERG- 120 -
Two Hous<strong>to</strong>n Center909 Fann<strong>in</strong>, Suite 2000Hous<strong>to</strong>n, TX 77010Telephone: 713/752-0017HOEFFNER & BILEK, LLPTHOMAS E. BILEKFederal Bar No. 9338State Bar No. 02313525440 Louisiana, Suite 720Hous<strong>to</strong>n, TX 77002Telephone: 713/227-7720At<strong>to</strong>rneys <strong>in</strong> ChargeBERGER & MONTAGUE, P.C.SHERRIE R. SAVETT1622 Locust StreetPhiladelphia, PA 19103Telephone: 215/875-3000At<strong>to</strong>rneys for Staro Asset ManagementWOLF POPPER LLPROBERT C. FINKEL845 Third AvenueNew York, NY 10022Telephone: 212/759-4600SHAPIRO HABER & URMY LLPTHOMAS G. SHAPIRO75 State StreetBos<strong>to</strong>n, MA 02109Telephone: 617/439-3939At<strong>to</strong>rneys for van deVeldeSCOTT & SCOTT, LLCDAVID R. SCOTTJAMES E. MILLER108 Norwich AvenueColchester, CT 06415Telephone: 860/537-3818860/537-4432 (fax)At<strong>to</strong>rneys for the Archdiocese <strong>of</strong> Milwaukee- 121 -
THE CUNEO LAW GROUP, P.C.JONATHAN W. CUNEOMICHAEL G. LENETT317 Massachusetts Avenue, N.E.Suite 300Wash<strong>in</strong>g<strong>to</strong>n, D.C. 20002Telephone: 202/789-3960Wash<strong>in</strong>g<strong>to</strong>n Counsel- 122 -